Facing a company scandal — part 2

millernashgrahamdunnllp-logoPosted by McCarthy, Shannon
Miller, Nash, Graham & Dunn LLP
NW Law Firm

As my partner, Kathleen Petrich, mentioned in her recent post, Subway took quick action to distance itself from Jared Fogle upon learning of the investigation into his alleged involvement with child pornography. Subway’s actions included removing reference of Jared from its website and from the thousands of Subway restaurants. But how can Subway do that when it does not actually own thousands of those Subway locations?

Subway is a franchise system. The majority of stores are owned and operated by independent business owners. But if Subway does not own the restaurants, how could it act so quickly? It’s because Subway retained control over advertising in its franchise agreement. The franchise relationship is based on the franchise agreement signed by the franchisor (Subway*) and each of its independent franchisees (individual locations).

Through the franchise agreement, the franchisor grants its franchisees certain rights, which include limited, non-exclusive rights to use its trademarks (and other intellectual property), system manual, and proprietary goods or services. But a careful franchisor also expressly retains ultimate authority over all forms of advertising. It is this contractual control that allowed Subway to act so quickly to require its independent franchisees to remove all Jared-related advertising.

In exchange for the rights granted in the franchise agreement, most franchisees pay the franchisor a royalty and advertising fee. In the quick-service food industry, royalty and advertising fees are typically calculated based on the franchisees gross sales. Any drop in sales at Subway as a result of a consumer’s reaction to the news about Jared, and more recently the accusations that executives of the Subway Franchisee Advertising Fund Trust knew about Jared’s illegal activities as far back as 2008, will be felt proportionately by the franchisees and the Subway franchisor.

However, it is likely that any drop in sales will be short-lived. No wide-scale boycotts were declared as a result of public outrage, particularly because the criminal acts of a paid spokesperson are well outside the control of the brand owner. Contrast this with the recent revelations about Volkswagen’s intentional engine design to cheat emissions tests, where the brand owner has admitted wrongdoing. While the Subway franchisees likely do not have a basis on which to request a rebate for advertising costs related to replacing a few Jared ads within their stores, the Volkswagen auto dealers, who are considered franchisees in many states, may have significant claims against the franchisor for lost revenue related to the fraud.

While franchisors cannot predict every event that may negatively impact their brands, retaining control, and exercising that control, over their intellectual property rights is the best way to protect the long-term value of the brand.

*The franchisor for the Subway brand is Doctors Associates, Inc., but will be referred to in this article as “Subway” to avoid confusion.

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