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IFA Warns States Not to Interfere with Contracts

Statue of a man bridling a horse in front of the Federal Trade Commission
Statue of man bridling wild horse for commerce in front of FTC building, D.C.

BOSTON – Fair franchising legislation is being debated and discussed at the Massachusetts state capitol, with franchise industry insiders offering their input. Franchisors aren't keen on the Bay State enacting a law that aims to make franchise relations fairer, but some franchisee advocates say that legal protection is necessary to prevent gross inequities.

One Association Warns States Considering Fair Franchise Laws

Franchisors typically argue that states should not regulate what two consenting adults have signed in contract. If one adult can convince the other to sign on the dotted line, why does the state presume it knows better? The International Franchise Association stresses that very point. "The IFA would oppose any state action taken to interfere with negotiated business agreements between two private parties," says vice president of communications and marketing for the IFA, Alisa Harrison, to Blue MauMau.

Boston-based attorney Shannon Liss-Riordan stresses that the two consenting adults do not have equal bargaining power. She cites a client in which his franchisor exploited those differences to its advantage. In Awuah v Coverall, "an immigrant from Africa whose first language was not English, put thousands of dollars on his credit card, putting himself into severe debt, in exchange for an empty promise that he was going to get work cleaning office buildings," says Liss-Riordan. "Coverall buried in a dense fine print document (which it knows its "franchisees" will not read or understand) entirely self-serving terms that no sophisticated businessperson would agree to. Coverall and other companies like it are predators who knowingly take advantage of vulnerable workers desperate for work."

Harrison adds a warning to legislators who would enact such franchise relationship laws. "At a time with 9 percent unemployment and uncertain economic times, it makes little sense for states to create more regulations that will ultimately stifle small franchised business growth," says the spokesperson.

chart: bmm; source for unemployment rates, bureau of labor statistics

The implication is that franchise relations laws would add to higher unemployment in a state. And yet there is little evidence of that. The sizable number of states that already have enacted franchise relations laws largely have lower unemployment rates than the national average (see chart).

John Gordon, principal of San Diego-based Pacific Management Consulting Group, thinks that franchisors actually are in a better position than most other business models to handle regulations. The national restaurant chain analyst argues that a franchisor would simply pass on the costs of complying with a specific state's regulation to franchisees of all states. "The economics of franchising is that franchisors use others' money, not the franchisor's, to power the system. Should a franchisor actually realize incremental costs of any kind relating to regulations, they would likely eventually be passed on to its franchisee community via incremental royalties, other fees or other revenue — or cost recovery methods that spread the cost to the entire franchisee community."

The IFA also warns that states may later come to regret passing franchise laws. "When states have passed such regulations in the past," says Harrison, "we have seen declines in franchising in those states, leading some state legislatures to repeal them."

Gordon, who analyzes the economics of restaurant chains, thinks that such warnings from the IFA do not make sense for franchising firms. For example, should Canton-based Dunkin' Brands leave Massachusetts, Tim Hortons or Plainville-based franchisor Honey Dew Donuts, headquartered further south of Boston, would thank their lucky stars for the franchising opportunities it would provide them. "No franchisor would cede a state or major market to lie fallow to their competitors," declares the analyst. "Someone else would be right behind them to take their place, and erode their existing franchise system," Gordon stresses. "A wholesale abandonment of growth or operations is not rewarded by their investors or the financial community as a whole."

Franchise Disclosure Not Enough

Rather than regulating the franchise relationship, the International Franchise Association thinks the better solution is that franchisors continue to fill out information about a franchise chain in a form that the FTC requires. Harrison declares, "The FTC rule provides comprehensive franchise disclosure to ensure that prospects have the appropriate information needed in order to make an informed decision whether to invest in a franchise or not."

One Washington D.C.-based franchise attorney involved in establishing federal franchisor disclosure regulation and who also pushed unsuccessfully on Capitol Hill for a federal franchise relationship bill back in the '90s thinks such a stance by the association is providing cover for franchisors. Attorney Mario Herman observes, "The effect of additional franchisor disclosures serves as a legal shield for the franchisor against potential lawsuits by franchisees." He has seen that more disclosure does not mean more protection for franchisees.

Some critics consider the disclosure documents little more than marketing pieces for franchisors because the information that franchisors fill in the disclosure documents are not looked at by the Federal Trade Commission or States. It is not checked for accuracy.

Still, franchisors advocate that one of the best ways to raise fair franchising practices is not through new laws but through education. "IFA provides numerous programs and forums for franchisors and franchisees to share best practices," emphasizes the IFA's spokesperson.

Franchisee advocate Herman thinks that argument is also a canard.

"Best practices do not substitute for the protections afforded by franchise relationship statutes that prohibit unlawful terminations or bad faith nonrenewal of franchises," observes Herman. "Many unscrupulous franchisors still look for clever ways to steal the equity of unsuspecting franchisees, or unlawfully tap the advertising funds of those same franchisees. Relationship statutes prohibit such devious practices." The international attorney adds, "Gateway protections are important to protect naive purchasers, but protectionist statutes are equally important to level the playing field that is inevitably skewed in favor of franchisors, that insist prospective franchisees sign one-sided contracts affording the franchisees with little to no contractual rights to remedy franchisor abuses. A "business agreement between two private parties" presupposes an arm's length negotiation where the parties have equal bargaining strength. Present day franchising (both domestic and international) certainly is not such an animal."

But the IFA's spokesperson emphasizes the needed supremacy of the franchise contract. Harrison declares, "Once a decision is made to buy a franchise, the franchise contract is, and should remain, a business agreement between two private parties."

Boston-based franchise attorney Eric Karp disagrees. He thinks prospective franchisees can be under the false impression that they can't negotiate. "Incredibly, we still hear from time to time of franchisor salespersons telling a prospect that it is illegal for them to negotiate." Having testified in D.C. and in the Massachusetts legislature over the years, the attorney to franchisees and their associations has been a fierce advocate of franchise relations laws. "Even if franchisors did negotiate, there is an overwhelming and increasing imbalance in the legal and financial resources of the parties," he says. "This is especially true in the context of renewal, when the franchisee must choose between signing the then current agreement (almost always heavily more favorable to the franchisor than the expiring agreement) or abandoning the business he or she has built to that point."

Shannon Liss-Riordan thinks that it isn't just a matter of franchisees mistakenly thinking that they can't negotiate, but that there are actually predatory franchisors out there who knowingly take advantage of vulnerable individuals. "The concept of franchising has been used to justify some egregious abuses in Massachusetts and around the country," she declares. She thinks the current regulation of simply asking franchisors to fill out a form that discloses information about its system, unmonitored for accuracy by any government body, has not been anything close to sufficient protection. "The state should take responsibility to regulate franchisors in a meaningful way, since federal regulations provide no real protections, only disclosure requirements," she declares.

Regulatory Costs to Franchisors?

Gordon thinks that any real incremental costs from new regulations would be a mere rounding error for franchisors. "Most of those costs are now provided for in the franchisor's general and administrative cost structure, and are essentially fixed," he says. "One that might be more variable is outside legal counsel costs if franchisors assume a heavy litigation approach. But that is within the franchisor's ability to control."

The restaurant analyst adds that the bigger the franchise system, the less the cost would be for compliance. "In the restaurant sector, smaller franchisors might attain a 60 percent franchising margin. McDonald's is the worldwide leader at an 82 percent franchising margin." Gordon describes the franchising margin as the operating profits from franchising. "Those big numbers outweigh the potential occurrence of any speculative additional costs," declares Gordon.

All of these arguments will come to a head next Wednesday in Boston. Massachusetts lawmakers are asking for franchise owner-operators with ties to the state to attend a hearing of the Joint Committee on Community Development and Small Businesses, scheduled at room B-1 of the Massachusetts State House for 10:30 a.m., June 29. It is expected that local franchisees and their associations, like the Dunkin' Donuts Independent Franchise Owners group, will be in attendance to share their franchise experiences with Massachusetts lawmakers.

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Don Sniegowski is editor of Blue MauMau, the daily news journal for franchise & small business owners. Call him at +1 (270) 321-1268, tweet @bluemaumau or email don@bluemaumau.org.