In April 2021, the Office of Nevada Senator Catherine Cortez Masto released a report titled, Strategies to Improve the Franchise Model: Preventing Unfair and Deceptive Franchise Practices. The report provides a detailed look at the current state of franchise regulation in the United States and offers suggestions for what state and federal authorities can do to improve protections for franchisees.
In identifying the regulatory shortcomings that need to be addressed, the report highlights four factors that lead to franchise failures. As discussed in greater detail by franchisee lawyer Jeffrey M. Goldstein below, these factors are:
- Unfair Franchise Agreements
- Missing or Misleading Financial Disclosures
- Overpriced Fees and Missing Services
- Requirements to Buy from Preferred Vendors
Unfair Franchise Agreements
It is no secret that franchise agreements are almost universally heavily one-sided in favor of the franchisor. This has been an issue in franchising for decades, and it is an issue that has only gotten worse as franchisors have found new ways to leverage their control over their franchisees. The report highlights eight unfair franchise agreement terms in particular that present risks for franchise owners:
- Clauses that prevent franchisees from forming associations
- Non-disparagement and non-disclosure clauses
- Mandatory arbitration clauses
- Clauses that allow franchisors to modify the system
- Clauses that impose unnecessary and unreasonable controls
- Mandatory pricing provisions
- Termination rights and renewal restrictions
- Transfer restrictions
Missing or Misleading Financial Disclosures
Under the FTC Franchise Rule (which establishes the requirement for franchisors to prepare and provide Franchise Disclosure Documents (FDDs)), franchisors are not required to make financial disclosures. However, if they make these disclosures, then they must be true, substantiated, and non-misleading in all respects. Unfortunately, with limited oversight and enforcement, franchisors will often make unauthorized and misleading financial performance representations (FPRs) to their franchise candidates.
Overpriced Fees and Missing Services
Excessive initial franchise fees, royalties that prevent franchisees from earning a reasonable profit, and other overpriced fees are common factors in franchisee failures. As the report notes, in many cases, franchisees pay these fees based on franchisors’ promises of support and other services—only to find that these services are never provided.
Unfortunately, though perhaps unsurprisingly, many of these types of promises do not make their way into franchisors’ franchise agreements. Instead, franchise agreements include general clauses that give franchisors the discretion to provide (or not provide) support and other services as they see fit.
Requirements to Buy from Preferred Vendors
Many franchisors require their franchisees to buy from preferred vendors. As the report notes, while these requirements, “may make sense in order to achieve a consistent aesthetic or meet safety standards, [preferred vendors’] costs can be inflated.” In many cases, they are inflated because they include kickbacks or rebates paid to the franchisor. With already-slim profit margins, franchisees who are forced to overpay for necessary services and supplies will often face failure as a result.
Speak with Franchisee Lawyer Jeffrey M. Goldstein
Is your franchise struggling due to unfair franchise practices? If so, we encourage you to get in touch. You may have options available. To discuss your situation with franchisee lawyer Jeffrey M. Goldstein in confidence, call 202-293-3947 or request a free consultation online today.
