Franchising

When the Federal Trade Commission (FTC) regulated franchising back in late 1979, the FTC indicated in the preamble to the Rule that the purpose of the Rule was to protect prospective buyer of franchises with mandated franchisor disclosure of "essential" information which would enable the buyers of franchises to assess the risks and rewards of the investment and compare the investment with other investments.

Obviously, the FTC Rule that preempted state law and that prohibits a private right of action for any violation of the FTC Rule does not protect new buyers of retail franchises, and doesn't give them "essential" information on which to assess the risks and rewards of the investment and compare the investment with other investments. '

The FTC Rule does, however, together with the franchise contract, almost always protect the franchisors from common law fraud claims and tort law in the state courts, as was the intent and is the effect of the FTC Rule in 1979 and, today, in 2009,

Authorities on franchising have indicated to the FTC in invited public comments that the real purpose of the FTC Rule promulgated in late 1979 was to protect franchisors, and their franchisees who thrived, from those franchisees who would fail, and who would cry "fraudulent inducement" to the courts. Robert Purvin, Chairman of the AAFD, in a public comment to the FTC in 1997 asked the FTC to remember that the Rule was promulgated primarily to protect the franchisors from fraud. Others, like Susan Kezios of the American Franchisee Association, have also commented to the FTC and have appeared before the Congress of the United States to testify about the flaw in the FTC Franchise Rule that misleads prospective franchisees.

The flaw is the failure of the FTC Rule to require that franchisors, themselves, disclose, or make available, the historical UNIT performance statistics of their systems. This omission in disclosure is misleading and prospective franchisees unknowingly invest in franchise systems with low profitability or no profitability, and a high rate of failure of the founding franchisees of the system.

By 1979, franchising had already grown rapidly in our economy and had a strong presence in our communities. The government and the special interests believed that franchising had been instrumental in bringing the economy out of the recession earlier in the 1970's and were anxious to support the great potential of franchising. Franchising appeared to grow even during recessions because those with financial resources who lost their jobs or were early retired or downsized, etc.. would look to self-employment in a franchised business of their own and would provide the cheap labor and cheap venture capital on which the franchisors could rapidly grow their branded chains that stimulated the economy.

Did The Congress and the Department of Commerce and the FTC remember the episode in the 1960's where the Minnie Pearl Chicken Franchisor got into trouble with the Securities and Exchange Commission (SEC)who put them out of business? Republican and Democrat politics were also involved. John Jay said at the time that the government (the SEC) made a virgin franchise look like a whore and this was unfortunate for all involved and unnecessary.

Did the Congress and the Executive and the special interests who profit from franchising then ask: If franchising were to grow in the economy, could it grow under the jurisdiction of the state regulators and the SEC? If franchisors were routinely found guilty of fraudulent inducement to contract or fraudulent concealment, wouldn't this destroy entire franchise systems if, under the law of contracts, the franchisees were made "whole?" There would always be some failures, even in the best of systems but should the failures be allowed to take down the whole system when there was fraudulent inducement to contract? Couldn't this be avoided if only the government, state or federal, had the standing to sue the franchisor and negotiate recissions that wouldn't destroy the franchise systems?

Could the FTC, under their authority to regulate interstate commerce, be the regulator of franchisors who sold their franchise investments on an interstate basis, even though the franchises generally operated within the states and were subject to state and local laws?

Could the FTC license the franchisors to sell their franchise investments to the public, and eliminate a SEC-type prospectus that would require the seller of the investment to disclose all material information to the buyer of the franchise?

The answer was "yes." We have lived with the FTC Rule for 30 years and we understand the use of the word "essential" instead of the word "material" in the explanation of the "purpose" of the FTC Rule suggests the premeditation of the FTC to produce a Rule that would render the facts of unit performance statistics not to be material information that has to be disclosed by the seller of the franchise to the buyer of the franchise.

Obviously, the alternative, which would be to mandate frnchisors to disclose or make available all material information in their possession to new buyers would be cumbersome and could inhibit the sale of franchises. Especially, if the unit performance statistics disclosed low or no profitability to new buyers, and a high rate of failure of "founding" franchisees. Apparently, "churning was around in 1979 and had already been recognized as a practice that contributed to the durability of franchisors in the economy. Mandated disclosure of unit performance statistics would necessasrily disclose compounded churning within franchise systems and would make them less durable.

Apparently, franchising was considered to be so vital to the health of our economy and to the wealth of the special interests, thirty years ago, in 1979, that the doctrine of "deceptive puffery" and "fraudulent inducement/concealment" in the sale of franchises had to be redefined by the FTC, as condoned by The Congress of the United States, the Executive, and the Judiciary.

The FTC Rule that protects franchisors from fraud in arbitration and the state courts became public policy that was rationalized as serving the greater good of the American economy, and the greatest good of the greatest number of citizens. It is really only the founding franchisees who lose in the scheme of things when they fail and their assets can be churned to second generation franchisees who can, often, because of lowered investment costs, bring the franchise to a breakeven status.

Prospective franchisees, therefore, are often a calculated sacrifice to the "public good" and to "public policy" that serves the greater good. The Congress and the FTC defend this ineffective and deceptive regulation of franchising as necessary and their patriotic duty. While they are aware of the flaw in the rule and the fact that franchisors are abusing their free insurance against fraud, the Congress fails to act. The special interests who profit from franchising own the committees in the Congress and the law surrounding franchising has accommodated the public policy and the FTC Rule.

Is the deception necessary? Is it justified? Can't franchising survive full disclosure of the risk? Is it patriotism, or ugly opportunism that debases the principles of our democracy?