Additional Issues Brought into Play in Franchise Rule Comments

Part Two of a Two-Part Series

Last month, we wrote about the FTC Staff Report on Franchise Rule and the many comments it attracted. This month, we continue with broader comments about franchising regulation that were received.

Regulation of the Franchise Industry

In addition to specific proposals about how to amend the UFOC, the Federal Trade Commission's (FTC) Staff Report included an extensive discussion of the Commission's current philosophy about regulation of the franchise industry. The comments from individuals and organizations propose more general issues for the FTC to address, rather than offering specific modifications to the proposed changes to the Franchise Rule and UFOC.

Exclusions for Cooperatives

Until now, cooperatives have been exempted from the Franchise Rule, on the grounds that they do not represent a franchisor-franchisee relationship (the exemption can be found at 16 CFR Section 436.2 (a)(4)(ii)). The Staff Report proposes changing this policy, and the idea brought criticism from six trade associations and law firms representing cooperatives.

“Our owner retailers view us as a division of their business, not as a separate entity that they are invested in,” wrote Tammy Young of cooperative Affiliated Foods Midwest, in a typical comment.

The arguments by Robert D. Jacob of Reizman Berger, P.C. (St. Louis) are the most extensive on the subject.

Private Right of Action

The American Franchisee Association (AFA) was critical of the FTC for continuing to resist allowing franchisees to bring private rights of action for violations of the Franchise Rule in the 38 states without franchise registration and disclosure laws. Giving franchisees private rights of action has been a legislative priority for AFA for more than a decade (see interview with AFA President Susan Kezios in the January 2004 issue of FBLA).

Post-Sale FTC Oversight

Franchisee advocates have long been concerned about the post-sale relationship between franchisors and franchisees. The proposed rule does not change government policies in that area.

Jeffrey Haff, principal, Jeffrey S. Haff & Associates (Minnesota), criticized the FTC Staff Report for stating that the Commission would not regulate post-sale arrangements because the Commission receives few complaints. He noted that the reason the Commission receives few complaints is its “oft-stated position that it will not address such complaints.”

Arbitration

Gerald Marks, an attorney who represents franchisees, used the example of his clients' current dispute with Snap-On Tools to illustrate what he views as inequities in the current arbitration system. Marks claimed that the arbitration system to which franchisees are bound is inherently biased against them because, in many cases: rights such as the number of depositions or the statute of limitations are severely restricted; franchisors can require that the complaints must be heard in the franchisor's home state; and franchisees choice of arbitrators is limited by the franchisor.

Business Opportunities

Several commenters agreed with the FTC's plan to regulate “Business Opportunities” separately from franchising.

A Few More Comments on the UFOC

Here are a few more specific comments about the draft revisions to the UFOC that were received by the FTC.

Information Technology

Many franchisors stay in contact with franchisees through sophisticated information technology. The Bundy & Morrill law firm suggested that franchisees be notified in the UFOC about how much they will be tied to a franchisor's proprietary software, what the franchisor's obligations are for updating it and assuring its compliance with state tax information, and the cost that a franchisee will incur to pay for updates.

Trademark

Piper Rudnick noted that the proposed trademark warning might be interpreted by a franchisee as if a federal trademark is a permanent possession of a franchisor. However, Piper Rudnick pointed out that a federal trademark “may be, and frequently is, challenged for a variety of reasons.” The law firm suggested other language that better illustrates the relative risk of unregistered and registered trademarks.

History of Specific Unit/Site

The Illinois Attorney General's Office and others agreed that Item 20 in the UFOC would be improved by the proposals in the Staff Report, but they suggest that the FTC should go further. In particular, they propose at least a 5-year history of performance of the specific franchise operation or site that is being purchased, rather than the 3 years that the FTC is proposing.

Transfers

Seid & Associates and Kaufmann, Feiner, Yamin, Gildin & Robbins LLP each questioned the value of giving a prospective franchisee a UFOC for a transfer of an existing franchise. In these cases, they argued that the UFOC is misleading, because the costs and performance of an existing franchise are likely to be very different than a startup, and the discrepancies will increase the chance of litigation. Another law firm noted that transfers when a franchisor has stopped selling new franchises also should be specifically exempted from the requirement to provide a UFOC, as the UFOC might be outdated.

Witmer, Karp & Warner suggested that records of attempted and successful sales of existing franchises should be included in Item 20, to give franchisees a sense of whether franchisees have been able to “harvest his or her equity.”

Commissioned Agent Exemption

Gary Duvall, Dorsey & Whitney LLP, wrote that eliminating the exemption for “commissioned agents” would open the door to litigation about whether a commissioned agent is indeed a franchisee who is paying a franchisee fee in the form of a commission.

Updating Requirements

The Rule would expand the time for updating UFOCs from 90 days after the close of the franchisor's fiscal year to 120 days. Several commenters supported this idea. Yet, Wiggin & Dana noted that it might be in a franchisor's interest to produce its update in 90 days, and the franchisor should be allowed to do so.

Disclosure of Parties with a Financial Interest

These disclosures, found in Items 1 and 2 of the Franchise Rule, were the subject of requests by commenters for clarifying when a party has sufficient interest that it must be disclosed. Several commenters said that the primary shareholder in a privately held company should be identified.

Owner's Share in the Competition

Several commenters noted that the proposed Rule would require disclosure that an officer of the franchisor owns a few shares of a competing firm ' shares most likely purchased for access to information, not with the intent of giving the shareholder any influence at the company. This disclosure should be eliminated, the commenters argued.

Coordination of State, Federal Rules

The North American Securities Administrators Association provided ideas about how to coordinate the timing of registration requirements for franchisors covered by state and federal laws so as to reduce the burden on franchisors and their legal representatives.

Petroleum Marketer Exemption

Bruce McDiarimid of Pillsbury Winthrop LLP (San Francisco) noted that the language in the Staff Report might call into question the exemption for the non-fuel part of a contract that a service station franchisee has with a franchisor. He wrote that the Staff Report should clarify that all aspects of a service station franchise – fuel and non-fuel – are covered under the Petroleum Marketers Protection Act if they are a single contract.

A Little Extra

In a series of comment letters that totaled more than 150 pages, Lance Winslow, founder of The Car Wash Guys, a franchisor based in Palm Desert, CA, offered an interesting and, at times, entertaining perspective. In general, Winslow proposed a less-restrictive Franchise Rule, arguing that new regulations stifle free enterprise. In one of his more colorful similes, Winslow likened regulations to highway safety checkpoints. “The Federal Trade Commission is [proposing] a systematic blocking off of lanes during rush hour, when there has not been franchising roadwork in on the highway in 10 years … no major accidents or pileups have been caused by franchisors. Yet we as franchisors are being treated like Islamic HazMat drivers under the influence with bogus ID,” Winslow wrote.

Elsewhere, Winslow described how the FTC can help in the fight against terrorism. “Why not make Al Queda meet the definition of a franchise, since they have similar training methods, collect fees, and use similar handbooks and methods?” he wrote. “Then you can get a list of all their franchisees, and the FTC can sue them to prevent attacks.”

And in a letter dated Nov. 9, Winslow floated a suggestion that is perhaps a dream of many franchisors. He suggested that the Franchise Rule include a clause to enable him to “terminate the franchise contract with all franchisees in that region immediately” if those franchisees create an association to bargain with him.

Part Two of a Two-Part Series

Last month, we wrote about the FTC Staff Report on Franchise Rule and the many comments it attracted. This month, we continue with broader comments about franchising regulation that were received.

Regulation of the Franchise Industry

In addition to specific proposals about how to amend the UFOC, the Federal Trade Commission's (FTC) Staff Report included an extensive discussion of the Commission's current philosophy about regulation of the franchise industry. The comments from individuals and organizations propose more general issues for the FTC to address, rather than offering specific modifications to the proposed changes to the Franchise Rule and UFOC.

Exclusions for Cooperatives

Until now, cooperatives have been exempted from the Franchise Rule, on the grounds that they do not represent a franchisor-franchisee relationship (the exemption can be found at 16 CFR Section 436.2 (a)(4)(ii)). The Staff Report proposes changing this policy, and the idea brought criticism from six trade associations and law firms representing cooperatives.

“Our owner retailers view us as a division of their business, not as a separate entity that they are invested in,” wrote Tammy Young of cooperative Affiliated Foods Midwest, in a typical comment.

The arguments by Robert D. Jacob of Reizman Berger, P.C. (St. Louis) are the most extensive on the subject.

Private Right of Action

The American Franchisee Association (AFA) was critical of the FTC for continuing to resist allowing franchisees to bring private rights of action for violations of the Franchise Rule in the 38 states without franchise registration and disclosure laws. Giving franchisees private rights of action has been a legislative priority for AFA for more than a decade (see interview with AFA President Susan Kezios in the January 2004 issue of FBLA).

Post-Sale FTC Oversight

Franchisee advocates have long been concerned about the post-sale relationship between franchisors and franchisees. The proposed rule does not change government policies in that area.

Jeffrey Haff, principal, Jeffrey S. Haff & Associates (Minnesota), criticized the FTC Staff Report for stating that the Commission would not regulate post-sale arrangements because the Commission receives few complaints. He noted that the reason the Commission receives few complaints is its “oft-stated position that it will not address such complaints.”

Arbitration

Gerald Marks, an attorney who represents franchisees, used the example of his clients' current dispute with Snap-On Tools to illustrate what he views as inequities in the current arbitration system. Marks claimed that the arbitration system to which franchisees are bound is inherently biased against them because, in many cases: rights such as the number of depositions or the statute of limitations are severely restricted; franchisors can require that the complaints must be heard in the franchisor's home state; and franchisees choice of arbitrators is limited by the franchisor.

Business Opportunities

Several commenters agreed with the FTC's plan to regulate “Business Opportunities” separately from franchising.

A Few More Comments on the UFOC

Here are a few more specific comments about the draft revisions to the UFOC that were received by the FTC.

Information Technology

Many franchisors stay in contact with franchisees through sophisticated information technology. The Bundy & Morrill law firm suggested that franchisees be notified in the UFOC about how much they will be tied to a franchisor's proprietary software, what the franchisor's obligations are for updating it and assuring its compliance with state tax information, and the cost that a franchisee will incur to pay for updates.

Trademark

Piper Rudnick noted that the proposed trademark warning might be interpreted by a franchisee as if a federal trademark is a permanent possession of a franchisor. However, Piper Rudnick pointed out that a federal trademark “may be, and frequently is, challenged for a variety of reasons.” The law firm suggested other language that better illustrates the relative risk of unregistered and registered trademarks.

History of Specific Unit/Site

The Illinois Attorney General's Office and others agreed that Item 20 in the UFOC would be improved by the proposals in the Staff Report, but they suggest that the FTC should go further. In particular, they propose at least a 5-year history of performance of the specific franchise operation or site that is being purchased, rather than the 3 years that the FTC is proposing.

Transfers

Seid & Associates and Kaufmann, Feiner, Yamin, Gildin & Robbins LLP each questioned the value of giving a prospective franchisee a UFOC for a transfer of an existing franchise. In these cases, they argued that the UFOC is misleading, because the costs and performance of an existing franchise are likely to be very different than a startup, and the discrepancies will increase the chance of litigation. Another law firm noted that transfers when a franchisor has stopped selling new franchises also should be specifically exempted from the requirement to provide a UFOC, as the UFOC might be outdated.

Witmer, Karp & Warner suggested that records of attempted and successful sales of existing franchises should be included in Item 20, to give franchisees a sense of whether franchisees have been able to “harvest his or her equity.”

Commissioned Agent Exemption

Gary Duvall, Dorsey & Whitney LLP, wrote that eliminating the exemption for “commissioned agents” would open the door to litigation about whether a commissioned agent is indeed a franchisee who is paying a franchisee fee in the form of a commission.

Updating Requirements

The Rule would expand the time for updating UFOCs from 90 days after the close of the franchisor's fiscal year to 120 days. Several commenters supported this idea. Yet, Wiggin & Dana noted that it might be in a franchisor's interest to produce its update in 90 days, and the franchisor should be allowed to do so.

Disclosure of Parties with a Financial Interest

These disclosures, found in Items 1 and 2 of the Franchise Rule, were the subject of requests by commenters for clarifying when a party has sufficient interest that it must be disclosed. Several commenters said that the primary shareholder in a privately held company should be identified.

Owner's Share in the Competition

Several commenters noted that the proposed Rule would require disclosure that an officer of the franchisor owns a few shares of a competing firm ' shares most likely purchased for access to information, not with the intent of giving the shareholder any influence at the company. This disclosure should be eliminated, the commenters argued.

Coordination of State, Federal Rules

The North American Securities Administrators Association provided ideas about how to coordinate the timing of registration requirements for franchisors covered by state and federal laws so as to reduce the burden on franchisors and their legal representatives.

Petroleum Marketer Exemption

Bruce McDiarimid of Pillsbury Winthrop LLP (San Francisco) noted that the language in the Staff Report might call into question the exemption for the non-fuel part of a contract that a service station franchisee has with a franchisor. He wrote that the Staff Report should clarify that all aspects of a service station franchise – fuel and non-fuel – are covered under the Petroleum Marketers Protection Act if they are a single contract.

A Little Extra

In a series of comment letters that totaled more than 150 pages, Lance Winslow, founder of The Car Wash Guys, a franchisor based in Palm Desert, CA, offered an interesting and, at times, entertaining perspective. In general, Winslow proposed a less-restrictive Franchise Rule, arguing that new regulations stifle free enterprise. In one of his more colorful similes, Winslow likened regulations to highway safety checkpoints. “The Federal Trade Commission is [proposing] a systematic blocking off of lanes during rush hour, when there has not been franchising roadwork in on the highway in 10 years … no major accidents or pileups have been caused by franchisors. Yet we as franchisors are being treated like Islamic HazMat drivers under the influence with bogus ID,” Winslow wrote.

Elsewhere, Winslow described how the FTC can help in the fight against terrorism. “Why not make Al Queda meet the definition of a franchise, since they have similar training methods, collect fees, and use similar handbooks and methods?” he wrote. “Then you can get a list of all their franchisees, and the FTC can sue them to prevent attacks.”

And in a letter dated Nov. 9, Winslow floated a suggestion that is perhaps a dream of many franchisors. He suggested that the Franchise Rule include a clause to enable him to “terminate the franchise contract with all franchisees in that region immediately” if those franchisees create an association to bargain with him.