Franchise Agreements: Understanding the Franchisor’s Bargaining Position

Recently, a franchisor’s legal representative told me that she was legally prohibited from changing her system’s franchise agreement. As stated, this is an unabashed – or maybe uninformed …

Recently, a franchisor’s legal representative told me that she was legally prohibited from changing her system’s franchise agreement. As stated, this is an unabashed – or maybe uninformed – deceit, not at all uncommon among new or unsophisticated franchisors, according to some state franchise authorities. A more accurate statement would be that negotiating the franchise agreement may be fraught with challenging issues and can be fairly burdensome. And, ironically, that burden may be almost untenable for franchisors selling franchises in or to residents of California, a state usually associated with protecting franchisees.

There are a lot of reasons that a franchisor does not want to alter its basic franchise agreement, but the most fundamental motive is based on the franchisor’s desire to maintain the uniformity and integrity of its documentation. Franchisors are all about systems and processes and are always loath to do anything to change or gum up the works. In addition, franchisors do not want to foment unrest among their franchisees who may be more than a little put off if they discover that the franchisors agreed to concessions that were not uniformly offered. There’s also the not insignificant matter of bargaining power, almost all of which resides with the franchisor. So, a prospective franchisee generally should not expect the normal give and take incident to most commercial negotiations.

But the prospective franchisee also should expect candor. If the franchisor says, “Look, we just don’t want to change our agreement,” it may smart a little, but a prospective franchisee at least knows he or she is dealing with a straight shooter.

On the other hand, when a franchisor tells a prospective franchisee that it is legally constrained from changing the franchise agreement, that statement should be parsed carefully as it may not be entirely forthcoming. Specifically, franchisors who bargain on the terms of their franchise agreements face both disclosure issues as well as some state law impediments to negotiation. But they are not prohibited from negotiating their franchise agreements.

Changes to certain franchise agreement provisions – royalties, ad fees and other ongoing fees – may trigger a statement in the franchisor’s next annual franchise disclosure document (FDD) that such terms are not uniformly imposed. Moreover, if the initial franchise fees are not uniform, the franchisor must disclose the range or formula used to calculate the fees as well as the factors used to determine the amount of the fees. Franchisors generally want to avoid such disclosures. And for good reason: if a prospective franchisee sees that a franchisor has made any economic concessions, he or she would want the benefit of such compromises too.

Franchisors generally build their business model on the basic economic terms of their franchise relationship and may not stay in business very long if they compromise a proven business model through negotiated concessions.

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Nevertheless, there is no legal compulsion behind a franchisor’s refusal to negotiate its franchise agreement. There are simply no requirements under any federal or state franchise laws that compel intransigence. In fact, both federal and state laws generally contemplate or even encourage negotiation. But certain state law requirements may make franchise agreement negotiation more challenging and, in the case of California, may even discourage negotiation.

Under the Franchise Rule, the Federal Trade Commission (FTC) regulation that governs the offer and sale of franchises in the United States, changes to a franchise agreement that arise out of negotiations initiated by a prospective franchisee do not trigger an otherwise mandatory seven calendar day “cooling off period” before the prospective franchisee may sign the revised agreement. In other words, the FTC does not want to step in the way of franchisors bargaining with prospective franchisees.

Moreover, state franchise law is generally aimed at protecting franchisees and, for the most part, any implication that state law considerations may impede bargaining ignores the franchise investor protection role that state franchise authorities play. Specifically, certain “registration states,” by regulation or practice, provide that franchise agreement negotiation should not create any additional burden for the franchisor. For example, Maryland franchise regulations specify that an amendment to the franchise registration “is not required if a particular franchise agreement is changed as a result of negotiations between the franchisee and the franchisor and the franchisor agrees to the change or a similar change only on an individual or isolated basis.” Virginia has no similar provision but unofficially takes a like position: a franchise registration statement need not be updated every time a franchisor negotiates a change to its franchise agreement.

Still, some registration states, including Maryland and Virginia, provide that a negotiated change may be considered a “material change” to the FDD if the same change is made for a number of different franchisees such that it alters the basic form of franchise agreement being offered. In these circumstances, a post-effective amendment to the franchise registration statement may be triggered.

In addition, in the handful of states that have franchise relationship laws, the franchisor and its counsel may be wary of negotiating the franchise agreement because of concerns about unfair discrimination between franchisees. For example, Section 2(5) of Indiana’s franchise relationship law prohibits any franchisor from “discriminating unfairly among its franchisees.”

Finally, there’s California’s regulation of negotiated sales under its Franchise Investment Law and its associated regulations, a topic that truly warrants an entirely separate discussion. For a very thoughtful and well informed take on negotiated franchise sales in California, take a look at a couple of articles by one of the best franchise attorneys in the country and a Franchise Times “Legal Eagle,” Matthew Kreutzer: Negotiated Sales in California and Negotiating Franchise Sales in California. Kreutzer notes that “While the law was originally intended to permit or even facilitate negotiation, it presents businesses and economic issues that have resulted in this unintended consequence: Many franchisors refuse to negotiate any terms with California franchisees.” That’s largely “Because franchisors may be required to disclose all such negotiated terms” making them “less likely to provide a particular franchisee a special deal because they fear others will demand the same terms,” according to Kreutzer.

A threshold test for the health of your future relationship with a franchisor may be its willingness to consider and negotiate proposed changes to franchise agreement provisions. But a franchisor’s unwillingness to negotiate its franchise agreement should not be a litmus test. Whether you should expect the franchisor’s pre-commitment inflexibility to morph into a more accommodating approach once the franchisor has you locked into the franchise agreement really depends upon what’s beneath the franchisor’s intransigence: don’t confuse “can’t,” which is at best deceptive, with “won’t,” may simply may be grounded in unyielding but defensible precedent.

Mike Sheehan is a franchise consultant and franchise attorney. He is the president of Focus Ventures Franchise Services and formerly served as a securities attorney and as general counsel for a Fortune 100 financial services company.

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Office: 703.372.6241 (703.FRANCH1)

This article should not be construed as legal advice or a legal opinion on any specific facts or circumstances. The contents are intended for general information purposes only and you are urged to consult your own franchise attorney concerning your own situation and any specific legal questions you may have.

© 2013 Mike Sheehan. All rights reserved.

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