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BOSTON — One of the franchise industry's most renowned attorneys for franchisees, Robert Zarco, flew up from his office in Miami to Boston. Franchisee members of the Dunkin' Donuts Independent Franchise Owners Association and the Coalition of Franchisee Associations, a group that represents franchisees of some of the country's largest franchise brands, had asked him to testify and support the fair franchising bill, S 1843, sponsored by Massachusetts state senator Brian A. Joyce.
For over twenty-five years Zarco has seen a lot of bad franchising practices. The extraordinary litigator has won cases for franchisees from franchisors Blimpie's all the way to giant 7-Eleven, the largest franchise chain on the planet. A few of his cases have been landmark decisions, such as Scheck v Burger King Corp of 1992, where a court ruled that franchisors cannot use their discretionary powers to flippantly set up competing stores next to franchises. Litigators cite Scheck to this day.
After having just participated in a three and a half hour legislative hearing on Boston's Beacon Hill alongside a number of franchisees, advocates and franchisor representatives, Robert Zarco sat down at a close-by café to share his insights on the hearing.
BMM: I understand that you flew up by unconventional means.
Zarco: I have the good fortune to have been able to purchase my own jet. I flew up at my own expense and without billing any time to any of these associations to testify in favor of this franchise bill. I want to help establish fairer franchising in Massachusetts.
BMM: In the hearing, you gave testimony about the problems in franchising, mentioning Dunkin' Donuts and other franchisors that have had a lot of litigation. Please recap what you think Massachusetts legislators need to consider with this bill.
Zarco: The most significant aspect of this bill is to create awareness that the perception of franchising in this country is very different than the reality. There are many, many franchisees that you would believe that because they bear the brand of Burger King, McDonald's, Dunkin' Donuts, or a Choice Hotels and other service brands that they are automatically wealthy individuals. The reality is that many have gone from riches to rags. But many give up the American Dream, their life's savings and their retirement fund into a false promise. And that frankly is a tragedy.
The issues that actually arise in the franchisor/franchisee relationship that cause this imbalance and victimization of franchisees is that there is not a level playing field in which the franchisors and franchisees are operating. Franchisees are nowhere near as sophisticated as franchisors. Professional franchisor sales people are very clever, very astute, and well trained to seduce and induce franchisees into buying franchises. There are all sorts of representations made by these professional sales people.
When the franchisees get into trouble, and later the franchisees wish to rely on those representations made by the franchisor representatives, the franchisors say that it is unjustifiable for you to rely on such statements when you look at the fine print in the franchise agreement. In the disclaimer clause, it specifically says the opposite. These mergers and integration clauses will specify that the franchisee cannot rely on any representations, warrantees or statements made by the franchisor representative. In so doing, the franchisor relies on the fact that the franchisee is buying based on the franchisee's own independent investigation and due-diligence. We all know that this is not a factually accurate statement.
Franchisor representatives can be motivated to be very loose-lipped. Many of these individuals are commissioned-based or receive bonuses based on the number of franchises sold. They know that franchisees will be lured into these franchises because they perceive it is an easy path to financial independence and the American Dream.
We are in the middle of a credit crunch and an economic crisis. More and more middle management and executives who have been laid off or terminated from these large corporations who have a nest-egg saved, and in the middle of their life, 45, 55 or 60 years old, they invest their life savings into a franchise believing that their chance of success will be much greater than if they open up their own independent business. After all, the franchisee pays the fee and the franchisor gives up the brand. Because the franchisor has supposedly invented the mousetrap, the franchisee can benefit.
That is the lure of franchising.
There are times in which that relationship is abused. Because these agreements are very long term contracts, as opposed to a single-event transaction, which is where you pay money and immediately get the product. Long-term franchise contracts are often 15 - 20 years in duration. These cannot be drafted in a way to anticipate at the time of signing every little nuance that is going to arise in that long relationship. As a result, these contracts are full of provisions that allow the franchisor to exercise their discretion in the ongoing relationship. If that discretion is not exercised in good faith then any arbitrary or capricious decision made by the franchisor that is not commercially reasonable can lead to the accelerated demise of the franchisee.
That is what this legislation that is sponsored by Senator Brian Joyce is designed to do.
BMM: Is there more that you would like to see this fair franchising bill address?
Zarco: One of the elements of the bill is that at the end of a term, the franchisee has a right to renew. Well, that is wonderful because in many franchise systems the right to renew does not exist. But the reality is that having a right to renew by itself is insufficient. You have to have the right to renew on material terms that are substantially similar to the existing agreement. Otherwise you have what is called a "constructive nonrenewal." You can say, here, you want a silver dollar? Here, you can have it. But it's going to come out of the furnace. You won't take it because it will burn a hole through your hand. The same thing happens with franchise agreements.
Some of the provisions in this bill, which address this through fair franchise legislation, need more fine tuning to better reflect the true conditions in the marketplace. There are terms and conditions that deal with encroachment. The fact that the franchisor has the opportunity to pay the franchisee the fair market value of the impact that placing a unit in close proximity to an existing location would have. That's also a good provision but it needs to be fine-tuned. You almost have to tailor these conditions on a case-by-case basis. But to the extent that a franchisor does not want to expressly describe a protected territory, a bill like this would let the franchisee know that they will be able to benefit from statutory protection.
Another element is that a franchisor must be required to pay a franchisee for the equity that a franchisee has developed in their business. This whole thing about the franchisor owning the goodwill of the brand may be okay and appropriate to the extent that what you mean is that the franchisee cannot claim a one one-hundredth per cent interest or one one-thousandth interest in a $4 billion dollar sale of the franchising company.
I agree with that principle.
What I don't agree with is that franchisors can hide behind that principle and say that a franchisee has a $1 million business. The franchise has already built up $700,000 in equity. You owe $300,000, but as a result of being a victim of the economy, you lose your franchise. You stop paying royalties. The franchisor terminates you. And then the franchisor takes the entire business for itself and resells it for $700,000. It pays itself the $300,000 that it is owed. And then on top of that, it gets the windfall of the $400,000 in equity.
That equity really belongs to the franchisee.
BMM: You've seen fair franchising laws that are aimed to protect franchisees come and go in your time. What's your impression of this bill? Does it have legs?
Zarco: I believe that the franchise bill in Massachusetts has legs. We went through a three-and-a-half hour hearing today of a joint committee of the senate and house. Based on the presentations made by the professionals, including myself, as well as by franchisees, I believe that the bill gained substantial, and I mean substantial, traction today.
There was a tremendous amount of interest. The questions asked by the panel were very pointed. They were focused and reflected a keen understanding that the lawmakers are aware that the perception of franchising is very different than the reality in Massachusetts.