Product Fundamentals: Professional Indemnity & other insurance requirements for Franchisors
Bellrock assists Franchisors identify, manage and transfer the range of risks they may be exposed to in the course of running their business. In doing so, Bellrock has designed a range of risk management initiatives complemented by insurance solutions exclusively available to our clients. Further, we have bespoke IT solutions that allow Franchisees to transact (apply for, renew and notify claims under their policies). The system allows the Franchisor to monitor compliance of each Franchisee as regards the insurance and indemnity obligations under their various agreements (including with the Franchisor, suppliers or lessors).
The overall aim is to ensure Franchisors have appropriate governance and protection so that they and their Franchisees are protected in the event of a claim. Further, by bulk-purchasing insurance there are significant benefits the Franchisor and Franchisees can attain, including centralised risk management strategy, broader insurance coverage and reduced premiums.
Below, we run through coverages Franchisors should consider.
1. Professional Indemnity for Franchisors
Professional indemnity is purchased by Franchisors to cover them for legal costs and damages arising from allegations made against them by Franchisees in connection with representations by the Franchisor made under the Franchise Disclosure Agreement (FDA), and otherwise acts, errors and omissions in the day-to-day activities of the Franchisor providing ‘support’ to the Franchisee.
More specifically, the cover intends to cover claims arising for breach of contract, allegations of services not rendered, misstatements and misrepresentations in the FDA, statements during Franchisee procurement and issues arising out of non-competition covenant claims.
Commonly, claims have their genesis in the failure of a Franchisee. Otherwise Bellrock has observed trends where the Franchisor seeks to recover fees against the Franchisee. The Franchisee then ‘counter-sues’ alleging various failures or misrepresentations by the Franchisor. Both large and small Franchisors face litigation from numerous sources, including prospective, current, and past Franchisees, regulatory agencies, competitors, and consumers.
- Competing licensing of jurisdiction and branding rights between sub-franchisors.
- Failure to select or adequately screen key suppliers of business-critical services and products.
- Losses sustained by Franchisees resultant of failure to train, or failure to have adequate systems, processes, policies and procedures.
- Losses sustained to Franchisee profit as a result of understated budgets in connection with representations of values made by master Franchisor in connection with products sold by Franchisees.
- Legal liability of Franchisor in connection with employee entitlements (although the employment practices liability section of the management liability policy has greater relevance here).
- Losses sustained by Franchisees as a result of geographic proximity of competing Franchisees and/or business.
- As regards timing and costs of matters, quantum will typically depend on purchase price of a franchise, amounts paid in royalties and industry type.
A franchise license agreement was terminated by the Franchisor after several breaches. The Franchisor brought a claim against the Franchisee for breaches of the agreement, in particular outstanding fees owed to it. The Franchisee counter-claimed alleging misleading and deceptive conduct in contravention of the Australian Consumer Law by the Franchisor through various representations made to the Franchisee before it entered into the Franchise Agreement. The counter claimant sought damages in excess of $1m.
- Legal costs and expenses of the Franchisor are covered under the professional indemnity policy.
- The policy is enlivened as regards damages, save for the following qualifications:
- The Franchisee pleads that the Franchisor made express representations as to estimates of profit. The policy will not cover any damages (if found) that flow from an express warranty or guarantee.The policy we propose carries the same exclusion (all policies do).
- The Franchisee seeks to establish these are not commonly covered.
Otherwise, for the scope of cover provided by a Professional Indemnity policy please see our product fundamentals article here.
In August 2021, 7-Eleven Stores Pty Ltd (7-Eleven) settled two class-actions reportedly in the amount of $98m brought by Franchisees. They alleged the franchisor engaged in misleading or deceptive and unconscionable conduct, and, were in breach of various contractual, equitable and industry codes.
The allegations included that the franchisor induced franchisees into entering franchise agreements by various misrepresentations including: profitability of the stores; labour costs in documents and records supplied to prospective franchisees; wages the franchisee would have to pay to operate their store in compliance with employment awards; the choice available to franchisees of suppliers and merchandise from which they could choose product lines to offer at their stores.
It was otherwise alleged that disclosure obligations under the Franchising Code were not met – including that there were no particulars provided as to whether rebates were being received from the supply of goods and the extent to which that would be shared with the Franchisees.
Claims brought by Franchisees are a significant risk to Franchisors. The legal costs in defending such action, damages that may be awarded if there is liability, internal resourcing in preparing to defend a claim and reputational expenses can be extensive.
2. Management Liability
Where Professional Indemnity covers loss in connection with providing professional advice or the making of representations in a professional capacity (As a Franchisor and under the Franchise disclosure agreement), a Management Liability policy covers wrongful acts or conduct during the course of “managing a company”. Particulars of what is covered under a Management Liability policy may be found here.
The insured beneficiaries under the Management Liability policy vary by policy coverage sections: they can include natural persons or any entity. Under a Professional Indemnity policy, the company is insured, and by extension, so too are its principals, partners directors and employees.
In the ordinary course claims brought for wrongful management of a company or breach of statute in connection with the management of a company (brought by regulators) are brought against the directors in their personal capacity (for breaching their obligations to the company) and the company itself.
The Management Liability policy operates to distinguish between claims against natural persons and the company.
3. Material Damage and Public/Products Liability
Material Damage cover is often provided under a business package, or Industrial Special Risks (ISR) policy. The ISR policy comprises two sections: replacement of tangible assets caused by an insured peril (fire, storm, flood, etc) and consequential loss of the damage (additional increased costs of working and business interruption).
As regards Public and Products Liability, this offers coverage for personal injury and property damage arising from the sale or supply of your goods or services and the operation of a premises. Cover for same may be offered under a broadform general liability policy or as an additional section to a business package.
Bellrock offers a review of policies held by Franchisees in order to benchmark the cover and otherwise set minimum standards of insurance to protect the Franchisor. In doing so we assess various agreements (including leases), and understand the key priorities in the event of a claim (including but not limited to fit-out, replacement of stock and loss of profits).
Thereafter we work on key risk transfer strategies for the stores to assist in minimising exposure to property damage and public liability frequency claims. This includes attending to franchise agreements focussing on indemnity and insurance obligations. On conclusion of same we set out to obtain appropriate insurance coverage that achieves the indemnities sought in the relevant agreements and otherwise in line with the strategy of the Franchisor. The approach to insurers is done on a bulk purchasing basis. This, coupled with the approach to risk management leverage that comes with the spreading of risk, ensures the Franchisor and Franchisees attain the broadest level of cover priced very competitively.
From a risk and governance perspective, this process is invaluable as it ensures the Franchisor sets its Franchisees coverage and that said coverage is adequate, appropriate and is in place. Our bespoke IT system allows the Franchisor to track coverage and claims in real-time.
4. Transit risk
Marine policies give coverage for all transits, land, air and sea and can provide valuable insurance for businesses involved in transporting goods. Marine insurance policies can be tailored to cover a range of different risks but its primary purpose in the case of a Franchisor would be to cover goods transported by road, rail, air or sea from collection point to delivery point. This covers costs incurred with incidents involving lost goods, third party injury and property damage. Bellrock reviews logistics agreements to understand and quantify risk associated with damage to goods whilst in transit for our Franchisor clients.
5. Product Contamination and Recall
Products Contamination and Recall insurance responds to indemnify for recall costs and expenses, as well as other benefits such as legal and public relations costs and expenses. It also extends to cover extortion and ransom costs. Products Recall insurance is particularly relevant in the food and beverage space where product recalls number around 63 per year in Australia. Strong consideration should be had to this cover in circumstances Franchisors are sole suppliers and distributors of products in Australia.
6. Cyber risk
Cyber Liability insurance provides cover for a business’ financial losses as a result of a number of cyber-related incidents such as ransomware, cryptoware, denial of service (Dos) attack, malware, viruses, worms, and social engineering fraud. It also covers the costs of notifying persons whose data has been misappropriated as a result of the breach and the costs to pay damages and legal costs to defend claims for privacy breaches. Further particulars regarding covered offered under a Cyber Liability insurance policy can be found here.
The average cost of a cyber incident to a business in Australia is $276,000. The frequency of these breaches is also on the rise with 164 cybercrime reports made by Australians every day. That’s one every 9 minutes. Cyber Liability insurance can help businesses manage the risk of these threats by covering losses arising from cyber related incidents and related claims.
7. Intellectual Property Defence
This policy covers legal fees, damages and expenses incurred in defending any judicial proceedings brought against your business relating to the infringement of any patent, mark, copyright, design, domain name, or miscellaneous Intellectual Property (IP) rights.
Intellectual Property Defence covers defence costs incurred by the policyholder which are brought against it alleging infringement of a third party’s IP. Otherwise, cover is provided for judicial proceedings brought by a third party against the policyholder as a result of any indemnity or hold-harmless provisions granted by it to a third party in respect of an infringement by the policyholder.
There is no cover for pursuit of third-party infringers; deliberate or electronic distribution, disclosure of, use or inability to use, any application, trade secret, intellectual property due to any computer virus; payment of licence fees; any fine, penalty, punitive, exemplary, treble or multiple damages and any non-compensatory damages; taxes, lost profit, anticipated profit, revenues or any anticipated savings.
This insurance ought to be considered by Franchisors, particularly those governed under a Master Franchise Agreement. Do note that most professional indemnity and directors’ and officers’ liability insurers are applying onerous exclusions for loss arising from or in connection with any breach (actual or alleged) of intellectual property.
8. Legal Expense Insurance
This policy is designed to provide cover for unexpected legal expenses and is held in addition to the commercial insurance policies outlined above.
The policy can be used to cover your legal expenses required to defend or pursue possible disputes associated with your business activities. It may assist alleviate the financial strain associated with legal disputes and reduce the need for litigation.
Examples include disputes with employees, disputes arising out of commercial contracts, breaches of statutes and regulations, tax audit disputes etc.
Policies are generally structured with a $100,000 limit of liability and the total cost will start at around $500.
Bellrock’s team of specialised insurance advisors are here to assist you. To engage Bellrock to undertake a risk assessment, and prepare a strategy and insuring plan for your franchise operation, please contact us via the form below.