The business world runs on agreements. As long as everyone fulfills his or her end of the bargain, things tend to run smoothly. But the question of the most effective way to enforce or regulate these agreements remains. Adam B. Badawi, JD, PhD, associate professor of law at Washington University in St. Louis, looks at this question in the context of franchises.
After examining a large number of franchise agreements, Badawi found that despite sometimes allowing contract damage awards against franchisees, the more effective method of enforcing these agreements is often through informal, non-legal rewards system.
He discusses the study in a forthcoming article for the Journal of Empirical Legal Studies.
“Franchisors must ensure that their franchisees do not cut corners on the brand’s quality and uniformity standards,” Badawi says.
“One solution to this problem is for a franchisor to threaten a breach of contract action for violation of the franchise standards. Alternatively, a franchisor can rely on more informal means such as awarding an extra franchise outlet to those franchisees that behave well.”
He notes that there is a tradeoff between theses two mechanisms: the informal rewards are costly to provide, but easy to enforce, while contractual threats are cheap, but their enforcement is expensive.
“Contract damages are something of a last resort for franchisors,” Badawi says. “They appear to be reluctant to even include the right to pursue damages in the franchise agreement when they have more informal ways to encourage and punish franchisees. You might analogize to bargaining over the amount of a divorce payout in a premarital agreement. Specifying that right can change the nature of the relationship.”
Badawi’s article, “Relational Governance and Contract Damages: Evidence from Franchising,” is available at papers.ssrn.com/sol3/papers.cfm?abstract_id=1443515.