Franchising Attacked Again

Earlier this year, we questioned whether franchising was in the crosshairs of federal regulators and legislators. It appears that the answer may be a resounding yes.

Hit #1 appeared in September 2020, when Rohit Chopra, one of five commissioners on the Federal Trade Commission (FTC), declared on Twitter that “[franchise] regulators must stop unfair, deceptive, and discriminatory practices that target franchisees and their employees” and three House of Representative members wrote a letter to the Chairman of the FTC urging the agency to step up investigations of franchisor practices as a result of recent abuses by a relatively small number of franchisors in the sale of their franchises.

Hit #2 occurred when the FTC held a virtual workshop on its Franchise Rule (16 C.F.R. § 436) on November 10, 2020 to respond to the FTC’s 2019 request for comments about the current Franchise Rule and to provide guidance on the possible updating of the Franchise Rule, including the possible mandatory inclusion of Financial Performance Representations (FPRs) in Franchise Disclosure Documents (FDDs).

Here’s Hit #3. In April 2021, U.S. Senator Catherine Cortez Masto of Nevada issued an 87-page report, “Strategies to Improve the Franchise Model: Preventing Unfair and Deceptive Franchise Practices” which, according to the report, “highlights four areas where franchise complaints are most problematic, including (1) unfair and deceptive contracts that give nearly all control to the franchise corporation; (2) a lack of honesty and transparency in the financial disclosure documents; (3) costly kickbacks and overpriced goods; and (4) fees charged for limited or no actual benefit” and concludes that these characteristics “are the hallmarks of a franchise model that operates to strip small business owners of their wealth.”

The report recommends that Congress, state governments and franchisors, as the case may be, take the following actions:

• Provide for a private right of action against franchisors under the Franchise Rule;

• Increase funding for the FTC so it can enforce fair contracts and require the Small Business Administration (SBA) to mandate timely disclosure of financial performance information by franchise brands for all SBA-guaranteed loans;

• Revise the Franchise Rule to provide more franchise candidate protection, including mandatory Item 19 FPRs on revenues, costs and other data for both first-year stores and mature stores;

• Prohibit franchise contracts from requiring mandatory arbitration, non-disparagement and non-disclosure clauses and prohibitions against associations in their agreements;

• Enable the FTC to take enforcement action against duplicitous or unfair franchisors and seek penalties;

• Enable the SBA to require franchisors to provide actual historic revenue data and store closing information to franchise candidates before providing a government guaranteed loan to a franchisee;

• Require the SBA to publish loan performance information for franchisors by brand and refuse to guarantee any loan to a franchise candidate if the franchisor has high levels of defaults on government guaranteed loans, or has a franchise agreement with terms such as mandatory arbitration, non-disparagement and non-disclosure clauses, or prohibitions against associations;

• Enact legal protections for franchise investors and owners and provide resources for enforcement of fair practices;

• Require franchisors and their trade associations to set standards for their brands that mandate fair treatment for franchisees and establish best practices and guidelines for fair trade and marketing; and

• Require franchise sales agents and consultants to register, receive annual education and have a fiduciary duty to their franchisee clients and establish and provide assistance when a franchisor mistreats its franchise owners.

The report generously acknowledges that “there are good franchise corporations out there that provide profits to investors, living wage jobs, and support for the community” and that “franchises contribute millions of dollars to state and local economies.” The compliments are short-lived however and pale in comparison to the details provided in the report about the very real harm caused by some admittedly less than scrupulous franchisors.

Only time will tell if any of the changes demanded in the report are adopted by Congress, state governments or franchisors.

Barry Kurtz is a State Bar of California Certified Specialist in Franchise & Distribution Law.