Is Franchising In the Crosshairs of Federal Regulators and Legislators?
The Feds may be targeting franchising.
In September 2020, Rohit Chopra, one of the 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.
Coincidently, but unrelated, 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 Rule and to provide guidance on the possible updating of the Rule. A principal topic of the workshop was the possible mandatory inclusion of Financial Performance Representations (FPRs) in Franchise Disclosure Documents (FDDs).
The FTC adopted the original Franchise Rule in December 1978 to prevent deceptive and unfair practices in the sale of franchises. The FTC amended the Franchise Rule in 2007 to reduce inconsistencies between federal and state pre-sale disclosure requirements and to otherwise regulate franchise sales.
The current Rule requires the pre-sale delivery of an FDD to franchise candidates at least 14 calendar days before the signing of a binding agreement or the payment of any money to the franchisor. An FDD must respond to 23 questions and dozens of sub-questions about the franchisor and the franchised business in a narrative “plain English” FDD to adequately inform franchise consumers about the risks inherent in their purchase of a franchise opportunity.
For purposes of an FDD, “Financial Performance Representations” are any indication of “a specific level or range of actual or potential sales, income, gross profits, or net profits.” A franchisor need not include an Item 19 disclosure in its FDD, but the franchise marketplace encourages franchisors to make FPRs in Item 19.
Franchisors choose what Item 19 disclosures to make. Choices include historical gross revenue of company-owned and franchised units, gross revenue with expense information or gross revenue, expense information and gross and/or net profit. Each choice requires franchisors to gather the information from its operating affiliates and franchisees, which in the case of franchisee data, may often be difficult or impossible to collect.
Workshop members who supported mandatory disclosure of FPRs believed that an FPR is a key disclosure and that the necessary information is readily available to franchisors. Those who opposed mandatory disclosure argued, among other comments, that the necessary information is not uniformly available to or collected by franchisors.
The review of the FTC Rule will likely take a considerable amount of time; however, franchisors should assume that the mandatory disclosure of FPRs will be inevitable and begin to gather the data required to provide compliant FPRs in the future. To think otherwise would be unrealistic.
As American crime fiction author, child protection consultant and attorney Andrew Vachss once said, “if a train is coming at you, closing your eyes won’t save you … but if you look right at it, you at least have a chance to jump.”
Barry Kurtz is the Chair of our Franchise Practice Group, and a State Bar of California Certified Specialist in Franchise & Distribution Law.