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As you probably know, there are no federal laws requiring franchisors to abide by the common law duty of good faith in their dealings with franchisees; no fiduciary duty when the franchisor handles its franchisees' money in pooled advertising funds; and no duty of due care that the franchisor must show to its franchisees. It is the absence of national minimum standards of fair dealing that is responsible for most franchise litigation.
In other words, the only rules that apply in franchising are those that the franchisor's attorneys include in the one-sided license agreements, which are presented to franchisees on a take-it-or-leave-it basis.
It is also astounding to consider that the only regulatory body overseeing the franchise industry, the Federal Trade Commission (FTC), says that it "does not have the resources to follow up on all meritorious complaints". Remember that franchise industries employ more than eight million workers in over half a million small businesses. Combined annual sales in these franchised businesses total more than $1 trillion in retail sales in the United States.
In 1994, Attorney Robert L. Purvin, Jr. wrote about the Federal Trade Commission:
In 1971, following a public outcry over a rash of franchising horror stories in California, the California state legislature responded to widespread claims of franchise fraud by enacting the California Franchise Investment Act. About the same time, the Federal Trade Commission announced its intent to adopt regulations pursuant to the Commission's rule-making authority under the Federal Trade Act. Although the Federal Trade Act was not established with franchising in mind, the Federal Trade Commission's authority under the act is broad enough to cover most kinds of fraudulent business practices. Therefore the act gave the FTC the ability to create franchising regulations even in the absence of specific law.
After eight years of public hearings and comment, which generated more than 30,000 pages of testimony and documented more than 5,000 consumer complaints about the franchising industry, the Federal Trade Commission finally promulgated the FTC Rule on Franchising in October 1979.
The FTC Rule on Franchising required all franchisors to provide a disclosure document (the Uniform Franchise Offering Circular) to prospective franchisees and further required that franchisors disclose all material information that a prospective franchisee would reasonably rely on in making a franchise purchase decision....
The FTC's franchise rule was instituted in 1979 to address the scams and rip-offs instituted by franchise companies in the 1960s when franchising was in its infancy. That franchise rule was intended to provide better information to the potential franchise before the franchise contract was signed.
After 23 years of inadequate FTC enforcement, the major problem facing franchisees today is the post-sale franchise relationship, which comprise 92% of the current franchise complaints before the FTC.
Corporate lawyers have managed to draft contracts to eliminate the implied covenant of good faith and fair dealing in franchise agreements. Furthermore, they have lobbied successfully in every state legislature to eliminate the fiduciary duty that franchisors should owe to their franchisees.
Back in 1992, the state legislature of Iowa passed ground-shaking, benchmark legislation (the Iowa Franchise Investment Act) which:
The law was so abhorrent to franchisors that many of them stopped all franchising in Iowa until the law was repealed. Both McDonalds and Holiday Inns sued the governor of the State of Iowa challenging the constitutionality of the law. Holiday Inn objected to several provisions of the law: 1) if a franchisor opens a franchise within an "unreasonable proximity" of an existing franchise, the existing licensee has the right to first refusal of the new business or a right to compensation for any lost market share 2) allowing a hotel owner to transfer his franchise agreement at any time, as long as the new franchisee meets the franchisor's qualifications 3) franchisors are precluded from not renewing a franchise agreement except for "good cause" 4) a retroactive clause which applied these provisions to the 16 franchised hotels that Holiday Inns already had in Iowa.
Both McDonalds and Holiday Inns "quarantined" the state and cancelled all new projects in order to prevent the spread of the law to other states. At least 70 other franchisors withdrew completely from Iowa and stated "We cannot risk a law like this being duplicated and have other states follow suit."
Gradually, during the next five years, under the intense and relentless lobbying efforts of the Iowa Coalition for Responsible Franchising (consisting of the largest franchise companies), the Iowa Franchise Investment Act was revised and weakened.
The political battlefields for fair franchising probably reside in the state capitals of the United States. Hotel franchisees (perhaps in concert with other industry independent franchise associations) should investigate the possibility of creating and financing political action committees that can lobby for fair franchising laws in every state. Ultimately, the goal should be to establish in law a fiduciary relationship between the franchise company (agent) and the franchisee (principal). When two entities have fiduciary relationship, they owe one another the highest degree of trust and loyalty and the duty to look out for each other's interest before their own. The laws often impose a fiduciary relationship in circumstances where there is opportunity for natural conflicts. Thus a hotel management company (agent) is legally bound as the fiduciary of the hotel owner (principal) and is obligated to put the owner's needs over the management company's financial interests. The absence of uniform franchisee-protection laws in most states prevents franchisees from persuading court to apply even minimum standards of good faith and fair dealing.
This editorial was first published on January 15, 2003 by Hotel Interactive