Why Franchise Regulation Reform Fails

Franchisors have an opportunity to limit franchise turnover by being completely transparent in initial registration and disclosure documents, but many fail to do so and not always unintentionally. …

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Franchisors have an opportunity to limit franchise turnover by being completely transparent in initial registration and disclosure documents, but many fail to do so and not always unintentionally. Some are of the mindset that the initial franchisee fees and store opening is all that matters because the franchisor will ultimately get paid, particularly when litigation after the fact favors the franchisor. Law professor Elizabeth Spencer has made a study of the real-world roadblocks to franchise reform in each state and reviews the many hindrances in the system, from a lack of state budget funds for registration review to reform inaction from the Federal Trade Commission. For more on this continue reading the following article from Blue MauMau.

There is no doubt in my mind that if none of the states required close scrutiny of initial registration disclosure documents, and some review of annual filings was not done [It’s not.], the quality of disclosure to franchisees would deteriorate from pretty good to very bad.

System puts burden on franchisee to litigate

The initial legislative theory for franchise regulation was to force franchisors to make reasonable, useful disclosure before a contract was signed and thereby avoid many problems up front.  A lot of franchisors want to eliminate or greatly diminish state oversight and leave it up to each franchisee to complain after they are under contract and they find out the salesperson misrepresented the fabulous future the prospective franchisee might expect.  This approach places the burden on the franchisee to litigate their disputes at a time when they may have exhausted their resources and they must face the reality that very few court or arbitration awards actually make the franchisee whole – if the franchisee wins.  The companion issue is the fact that both the FTC [Federal Trade Commission] and the states have limited resources to pursue multiple litigation cases.

There are two types of franchisors:

  1. One carefully selects franchisees and treats them like gold to hold down turnover and thereby keep experienced, devoted good will ambassadors selling their goods and services. 

  2. Type two franchisors treasure the initial franchise fee and do not care how often a franchise location turns over because there is always someone to take their place and their corporate mind says the franchisor is the reason a business thrives and franchisees are really just a different class of employee that is easily replaced without the customers caring. 

Prior to the 1970’s the lack of regulation, state or federal, encouraged the type two franchisor.

Real world roadblocks to regulation change

[In a recent interview series on regulating franchising] Professor Spencer seems to have made a thorough study of franchising, although some real world limitations make meaningful changes in the U.S. doubtful.  A few factors:

  1. Illinois has been in the top four states that have taken disclosure (initial registration and annual reviews) and our few relationship laws seriously, but even we found it very difficult to keep up with a total staff of seven.  I am not being critical of other states, particularly because most do not have a staff and state budgets are not going to allow hiring more franchise regulators.  What is now happening in regulatory states is leaving vacant positions unfilled and in turn reducing the level of review.  My solution would require additional registration fees and such fees would be designated for franchise law enforcement (not deposited in the state’s General Fund) to make the respective agencies self sustaining.  It would also be a wonderful accomplishment if there was an FTC regulation making it mandatory that a franchisor disclosure document must be prepared under the supervision of an experienced franchise attorney.  The franchisee would get a better document and the regulators could avoid endless conversations and correspondence trying to get franchisors to comply with FTC and state laws.

  2. California’s on-line information is very helpful, but from prior detailed discussions with the California A.G. I know that if they were currently trying to create and implement the system today that it would never be completed.  I doubt that any other state will be in a financial position to mirror California’s accomplishments.

  3. The FTC, franchisees, franchisors, attorneys, accountants and several state regulators invested thousands of hours over a decade of meetings and correspondence to produce the revised FTC Franchise Rule.  Initially the FTC was very disinterested in any subsequent amendment recommendations.  Some improvements have been made, but the changes envisioned by Prof. Spencer are not likely to be championed by the FTC.

  4. If a nationwide system of registration, disclosure and monitoring is the goal, there should be federal funding for each state to have the resources to supplement the FTC presence in the regulatory world.

  5. Many franchisors and franchisees do not realize that franchise regulations have evened the playing field and made the franchise "product" more valuable and respectable, but such improvements during the prior thirty-five years will have little meaning if only a few states, and a few FTC fines actually enforce the franchise laws.  Franchisor/Franchisee relationship laws continue to be an anathema to most franchisors.  They thought that with pre-sale disclosure there would be a wall preventing relationship regulation.  Even the FTC has resisted relationship rules.

  6. With the exception of some sales and distribution laws, franchising represents a unique system that tries to protect the less sophisticated investor who is giving up many areas of control for decades.  However, it is true that too many prospective franchisees do not seek professional advice before committing to buy and those franchisees are the same ones that glance at a few paragraphs in the disclosure and probably don’t read the entire contract before signing.  I thought of creating a "Letter of Acknowledgment" that would be required of any prospect that doesn’t obtain experienced, professional advice.  It would be in large, bold, red type and the franchisee would acknowledge that despite being warned about the importance of having an expert review the proposed purchase, they will just wing it.  I know this will never happen and that despite such a letter some franchisees would continue to think they are the smartest person in the room.  For these people there is no solution.

  7. If we have been asking for too much information to be disclosed, what should be eliminated?  I always approached proposed legislation and speaking to prospective franchisee groups from the theory that the disclosure we were requiring represented the bare minimum  an experienced investor would require, and that in virtually every proposed deal the buyer should get answers to many additional questions that we cannot foresee when writing the laws.

 

Editor’s note: Mr. Tingler is a retired state franchise regulator. He is the former Franchise Bureau Chief with the Illinois Attorney General’s office. His comments are a response to Blue MauMau’s interview of Professor Elizabeth Crawford Spencer on Regulating Franchising. Highlights, subtitles, links and explanations in brackets have been inserted by the editor.

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