Emergence of State Initiatives Could Change Franchising

All of the recent activity at a state level creates a feeling among foreign franchisors looking to enter the U.S. market that there is a volatile and unpredictable legal environment in the U.S. for franchisors. An environment that at best leads to an extraordinarily high need for legal advice and, hence, legal fees in order to ensure compliance, or, at worst, presents significant barriers to effective market penetration.

I know of many foreign franchisors who have taken a look at the U.S. market over the past two years, but decided that it would easier and ultimately more profitable for them to enter markets with a more stable regulatory environment ' like China and the Middle East!

Charles S. Modell
Larkin Hoffman

Even the best franchise systems have failures. Sites go bad, people do not follow systems, and some people get into a business that is not suitable for them. And yes, some franchisors have poor systems and should not be franchising.

I believe the reason for the recent increase in legislative proposals to regulate franchising is twofold. First, people in the U.S. [including business owners] are short on teaching accountability and long on blaming others when something goes wrong. So long as we have that mindset, people will go to court and to their local legislator to seek redress for their losses. Second, with the significant setbacks suffered by the Republican Party in recent years, Democrat-controlled legislatures are more receptive to what they see as bills to protect “the little guy.”

No, this activity is not good for franchisors. It is also not good for the vast majority of franchisees who want their franchisors to protect the system in which they invested. Federal law is based on providing complete disclosure to prospective franchisees. To the extent that is not happening, that is what the focus of legislative reforms should be. The government should not be trying to protect people from their own failures, from investing in unproven systems, or from investing in one with a documented history of failures. And judges and juries should not be put in a position of second-guessing business decisions made by people responsible for developing, maintaining and/or expanding businesses.

Joel Buckberg
Baker, Donelson, Bearman, Caldwell & Berkowitz

State legislative activity falls into four buckets. Bucket 1 is conformity to the 2007 FTC franchise rule changes and exemption definitions, and this bucket is quite empty. Bucket 2 is the legislation seeking to stop or enact attempts by state unemployment and workers' compensation trust funds from defining franchises as employment, and forcing franchisors to pay unemployment taxes and workers' compensation premiums based on the net revenue distributed to franchisees after franchise fees are paid or deducted. These are revenue plays, pure and simple, for exhausted trust funds that have lost revenue as employees convert to entrepreneurs, and manufacturers leave the state. Bucket 3 is directed at the franchise relationship and the so-called “level the playing field” limitations on contractual rights and terms that affect the franchise agreement or its enforcement. These range from benign or procedural safeguards that give franchisees more time or better notice, to more extensive changes that shift risk and reward. Bucket 4 is the most extreme, seeking to reverse court decisions that would be enforceable outside the franchise context, and make huge changes in risk, certainty and reward to the point where franchising is too risky. Bucket 4 means that growth will be accomplished with company stores financed by securities and real estate offerings, not franchises.

Rupert Barkoff
Kilpatrick, Townsend & Stockton

It is time to replace our franchise regulatory system.

At a colloquium sponsored by the Franchise Law Institute in March 2012, as well as at the recent ABA Forum on Franchising in Orlando, strong sentiments were expressed about the deficiencies in the current U.S. regulatory scheme. Our Constitution was designed to give only specified powers to the federal government and to reserve for the states the remaining powers.

It is finally time for us to realize that when it comes to franchise regulation, the Commerce Clause, which allows the federal government to regulate commerce, should trump the reserved power principle. While I would not go so far as to say that the dual levels of regulation in franchising will kill the goose that lays the golden eggs, the regulatory scheme does inhibit franchising in the United States. My recent trip to Australia only confirmed my thoughts on this subject. The Aussies (and certainly business people in other countries), looking at our franchise regulatory scheme, think we are mad. The federal budget fight and debt default scare only further confirm this view generally.

Franchise regulation in the U.S. is broken and has been broken for over 40 years. The addition of any more state legislation will only exacerbate the problem. It is time for the franchise sector to call for full federal pre-emption and to develop, with the participation of all stakeholders, a system that is efficient and an enforcement process that has teeth when egregious violations occur. The baby steps in regulation we are now taking will just make the situation worse.

Matt Haller
International Franchise Association

Is there a need for more franchise legislation? Absolutely not. Franchising is already highly regulated by the Federal Trade Commission (FTC), and most states have laws governing franchise relations and disclosure laws regulating the sale of franchises. State legislatures have recognized franchising is highly regulated, and when coupled with built-in dispute resolution procedures in franchise contracts, believe expanded government regulation would be unnecessary, duplicative and potentially impact franchise development.

IFA believes that when there are the occasional disputes between franchisees and franchisors, the solution should be found between these two parties, and not through legislation. Once government gets involved in a business, it is very hard to extract it.

As an alternative to governmental intervention, the IFA has a long-established ombudsman program to help franchisees and franchisors resolve their differences. Additionally, the IFA commissioned a task force that produced a document reflecting guiding principles between franchisees and franchisors that will be released soon. Further, the IFA has had a long-standing Franchise Relations Committee consisting of franchisees and franchisors to address issues facing our industry.

Stanley M. Dub
Law Offices of Stanley M. Dub

I'm a franchise attorney in private practice, and I've represented both franchisors and franchisees. I don't think this latest wave of regulatory activity at the state level amounts to much. Just because a new law is proposed, doesn't mean it will pass ' most don't. And even if some pass, most of these proposed laws are very limited.

Broadly speaking, state franchise laws are divided into disclosure laws, which regulate the way franchisors sell their franchises, and relationship laws, which control some of the restrictions that franchisors might otherwise put in their agreements. Franchise sellers are required to comply with FTC disclosure rules when they sell franchises, but the FTC leaves the enforcement to the states, and many states don't regulate franchises at all. I think every state should at least require that franchisees receive a disclosure document that complies with FTC rules. However, franchisees as a group lack power and a voice within state legislatures, and the franchisor-oriented business community typically opposes any new franchise laws.

Franchise agreements are loaded with terms and requirements that are slanted in favor of the franchisor. Often, some of these terms cannot be justified. A potential franchise buyer offered such an agreement can choose only to take it or leave it. Buyers of successful franchises like McDonald's may thrive despite these one-sided agreements, but other franchisors write similar agreements even though they don't deliver similar results. State laws may eventually address some of these imbalances, but no forces are in place to suggest these changes will occur soon.

Peter Lagarias
Lagarias Law Offices

Opponents of legislation do not want to address the overreaching of franchisors in franchising. To them, all legislation is excessive regulation and a drag on the economy. Yet how can they ignore franchise systems, including nationally touted franchisors, with large numbers of franchisee failures?

Bad behavior by franchisors is compounded by the ever-prevalent, one-sided franchise agreements prepared by and for franchisors. Franchisees need legislation to protect their investments and equity in their franchise businesses. A franchisee with multiple-six-figure investment of her life savings should not be terminated or not renewed for minor violations. Nor should she have her franchise business cannibalized by franchisor encroachment or be forced to buy overpriced product from vendors paying kickbacks to her franchisor. But franchise agreements almost never provide real rights for franchisees over these and many other fundamental issues.

Franchise agreements and disclosure documents should not allow franchisors to disclaim responsibility for marketing franchises with phony earnings claims and promises. Such fine-print sales documents should not absolve franchisors, especially when they market their franchises as successful and proven business models. Statutory protections with private rights of action are essential to confirm to courts that Franchise Disclosure Documents and representations may be relied upon by franchisees. The days of “Franchise Disclaimer Documents” should end.

Adequate franchise legislation, like securities and antitrust laws, is warranted to curb marketplace abuses.

Matthew J. Kreutzer
Armstrong Teasdale LLP

The uptick in proposed franchise legislation is part of a vicious cycle: the proposed laws are a symptom of a continuing frustration on the part of franchisees with what they view as increasingly unfair franchise agreements. Those agreements, in turn, are a reflection of the need by franchisors to account for and address risks presented by adverse court decisions industry-wide. But, by trying to bring balance to the franchise relationship, some of the proposed laws may cause harm.

As an example, if passed, California Assembly Bill 1141 (2013) (as amended, http://bit.ly/1c2WR70) would make certain individuals associated with the franchisor jointly and severally liable to franchisees for any violation of California's Franchise Investment Law. It would also seek to prohibit a franchisor to refuse to renew a franchise, possibly creating a perpetual relationship. These and other aspects of that law could have an anti-business effect.

As we have seen with California's law regarding negotiated sales (which has chilled negotiations between franchisees and franchisors), sometimes laws that are intended to bring balance and fairness to the relationship can have the opposite effect. A broad-sweeping, pro-franchisee law may protect existing franchisees. But, at the same time, it may also harm people who want to buy franchises: If the law discourages franchisors from doing business in the state, it may prevent new franchise relationships from forming.

Maisa Jean
Frank Gray Plant Mooty

There does appear to be somewhat of a recent uptick in attempted state legislation governing the franchise relationship, but as has been noted, legislators have not been successful in passing proposed legislation. Many of these bills seem to have been proposed by franchisees and/or their attorneys, and this may simply represent an increasing level of sophistication and organization among franchisees and their attorneys.

Both franchisors and franchisees should take an interest in proposed changes or additions to laws that govern their relationship because such laws could have an impact on the quality of the system. For example, both franchisors and franchisees ultimately opposed the [California A.B. 1141] because they recognized the importance of preserving franchisors' ability to enforce the provisions in the franchise agreement. The bill would have limited a franchisor's ability to terminate or refuse to renew a franchise agreement and would have imposed a good faith standard of dealing between the parties. A franchisor needs to be able to protect the quality and reputation of its system by taking necessary actions, including termination, with underperforming franchisees. Franchisees have an interest in protecting the quality of the system and their investment in it, and so they, too, should want franchisors to have the ability to deal with underperforming franchisees. Thus, both franchisors and franchisees had an interest in preventing the passage of [California A.B. 1141]. In addition, franchisors and franchisees both likely recognized that the imposition of the good faith standard may have potentially increased the cost of resolving disputes between the parties.

Ultimately, it does not appear likely that many (or any) of the bills related to the franchise relationship will pass.

Erik Wulff
DLA Piper

Are these shots across the bow? We are experiencing an unusually high level of state legislative efforts to tilt the playing field more towards franchisees. If enacted, these laws would be detrimental to the franchising business model. Franchisors ' and those who believe in franchising ' as a strong engine for economic growth need to pay heed. All is not well.

The economic downturn and slow recovery has not spared many small businesses, including franchised businesses. Is enough being done to help franchisee networks (which are imperative for the success of a franchisor) survive and flourish during these challenging times?

Franchisee lawyers tell us that franchise agreements are becoming more onerous on franchisees. Do these agreements reflect the franchisees' legitimate interests? Is a proper balance being struck?

Anecdotal evidence indicates that franchisee organizational activity is on the rise. Are there effective channels of communications, and are franchisee concerns being heard and respectfully dealt with?

Although the current state legislative efforts appear less coordinated than the federal efforts in the 1990s (and, therefore, perhaps less likely to succeed), one can never discount the possibility that some of these efforts will pass. Franchisors need to continue to improve their franchise models in order to ward off legislation that will adversely affect franchising. One need only consider the state of the automobile industry and its dealership regulatory regime to envision how legislation has the potential to straight-jacket business format franchising. Positive steps can ' and need ' to be taken to ward this off.

David Koch
Plave Koch

I don't see the current level of state legislative activity as unusual. If anything, the period of relative quiet that preceded this latest round was unusual.

Some of the individual proposals have merit ' in particular, bills to clarify that franchisees are not employees. But as a whole, the state proposals are not particularly good for franchising, for the same reasons as in other industries. First, they introduce a businessperson's worst enemy: uncertainty. Second, in the worst cases (especially [California A.B. 1141] and Maine's [proposed LD 1458, The Small Business Investment Protection Act]), the proposals have the potential to fundamentally alter the allocation of risks and rewards in franchise contracts. Their effect, if not the purpose, is to shift risk from the franchisee to the franchisor. What the proposals fail to recognize is that the initial franchise fee, ongoing royalty and other commercial terms have been structured based on a whole set of assumptions ' such as whether the franchisor will be able to protect the brand by enforcing non-compete obligations. If legislation shifts risks and compliance costs to franchisors, it likely means increased fees for franchisees to offset the new obligations. And at an extreme, the new risks and costs reduce the incentive to franchise at all. We already counsel franchisor clients that they might want to consider omitting certain states from their franchising plans.

I don't deny that franchisees are sometimes injured by irresponsible franchisors, and it is natural for legislators to respond to complaints from constituent franchisees by introducing a bill. But a legislative solution hits everyone, good and bad, and legislators lose sight of the potential ramifications for future franchisees.

Domonic Mochrie
Osler, Hoskin & Harcourt

Changes to state-level franchise legislation can have interesting trickle-down effects in other countries. Speaking from the Canadian perspective, when faced with new or proposed legislation that would impact the operation of the franchise program in the U.S., franchisors with operations in Canada often enquire with local Canadian counsel whether similar legislation is under consideration in any provinces or at the federal level. As our provincial franchise legislation focuses on disclosure, and, other than imposing a duty of fair dealing on the parties, does not regulate the relationship between the franchisor and the franchisee, the answer is usually no.

Even still, given the general similarities between the two countries, franchisors may still be sensitive to developing issues in the U.S. and may consider mirroring any changes to its U.S. program in Canada to maintain system uniformity. In other instances, the introduction (or even the threat of) legislation which would have a fundamental impact on the structure of a franchise program in the U.S. can result in the franchisor diverting greater resources to jurisdictions, like Canada, where the original business model can operate without requiring any modification.

Beata Krakus
Greensfelder, Hemker & Gale, P.C.

The pending Maine [LD 1458], Massachusetts [S. 1843] and Pennsylvania [H.B. 1620; ] bills are, in some regards, similar to the franchise relationship statutes that many other states already have. However, they go significantly further in providing franchisee protection. This is done in a rather heavy-handed manner, and one that is not appropriate for a diverse business model such as franchising. While it is unlikely such one-sided bills will pass, if they did, they are likely to have a chilling effect on franchising in those states and, consequently, wouldn't benefit franchisors or franchisees. Franchisors are likely to avoid those states because of the significant loss of freedom of contract that the bills entail.

The proposed bills apply as if franchising was a uniform industry and not a business model. Franchise programs vary exceedingly because the industries in which they operate do, too. However, the bills contain detailed provisions that treat all franchisors as if they were operating in an identical fashion. For example, franchisors could not require franchisees to operate evening hours. Presumably, this provision would protect franchisees from operation during hours of low profitability. But how will hotel, night-time nursing franchises or other businesses that, by default, are open at night operate?

In the last two years, many state legislatures have considered new franchise laws. Few of these bills have been passed or enacted, but some of the bills represent the potential for significant changes in treatment of franchising as a unique business model and of the franchisor-franchisee relationship. At the very least, franchisors need to be more aware of state legislators' interest in franchising than in the past.

Franchising Business & Law Alert surveyed leaders in franchising about whether the trend toward greater involvement in franchising at the state level would be beneficial or harmful for the industry.

Dr. Mark Abell
Bird & Bird

All of the recent activity at a state level creates a feeling among foreign franchisors looking to enter the U.S. market that there is a volatile and unpredictable legal environment in the U.S. for franchisors. An environment that at best leads to an extraordinarily high need for legal advice and, hence, legal fees in order to ensure compliance, or, at worst, presents significant barriers to effective market penetration.

I know of many foreign franchisors who have taken a look at the U.S. market over the past two years, but decided that it would easier and ultimately more profitable for them to enter markets with a more stable regulatory environment ' like China and the Middle East!

Charles S. Modell
Larkin Hoffman

Even the best franchise systems have failures. Sites go bad, people do not follow systems, and some people get into a business that is not suitable for them. And yes, some franchisors have poor systems and should not be franchising.

I believe the reason for the recent increase in legislative proposals to regulate franchising is twofold. First, people in the U.S. [including business owners] are short on teaching accountability and long on blaming others when something goes wrong. So long as we have that mindset, people will go to court and to their local legislator to seek redress for their losses. Second, with the significant setbacks suffered by the Republican Party in recent years, Democrat-controlled legislatures are more receptive to what they see as bills to protect “the little guy.”

No, this activity is not good for franchisors. It is also not good for the vast majority of franchisees who want their franchisors to protect the system in which they invested. Federal law is based on providing complete disclosure to prospective franchisees. To the extent that is not happening, that is what the focus of legislative reforms should be. The government should not be trying to protect people from their own failures, from investing in unproven systems, or from investing in one with a documented history of failures. And judges and juries should not be put in a position of second-guessing business decisions made by people responsible for developing, maintaining and/or expanding businesses.

Joel Buckberg
Baker, Donelson, Bearman, Caldwell & Berkowitz

State legislative activity falls into four buckets. Bucket 1 is conformity to the 2007 FTC franchise rule changes and exemption definitions, and this bucket is quite empty. Bucket 2 is the legislation seeking to stop or enact attempts by state unemployment and workers' compensation trust funds from defining franchises as employment, and forcing franchisors to pay unemployment taxes and workers' compensation premiums based on the net revenue distributed to franchisees after franchise fees are paid or deducted. These are revenue plays, pure and simple, for exhausted trust funds that have lost revenue as employees convert to entrepreneurs, and manufacturers leave the state. Bucket 3 is directed at the franchise relationship and the so-called “level the playing field” limitations on contractual rights and terms that affect the franchise agreement or its enforcement. These range from benign or procedural safeguards that give franchisees more time or better notice, to more extensive changes that shift risk and reward. Bucket 4 is the most extreme, seeking to reverse court decisions that would be enforceable outside the franchise context, and make huge changes in risk, certainty and reward to the point where franchising is too risky. Bucket 4 means that growth will be accomplished with company stores financed by securities and real estate offerings, not franchises.

Rupert Barkoff
Kilpatrick, Townsend & Stockton

It is time to replace our franchise regulatory system.

At a colloquium sponsored by the Franchise Law Institute in March 2012, as well as at the recent ABA Forum on Franchising in Orlando, strong sentiments were expressed about the deficiencies in the current U.S. regulatory scheme. Our Constitution was designed to give only specified powers to the federal government and to reserve for the states the remaining powers.

It is finally time for us to realize that when it comes to franchise regulation, the Commerce Clause, which allows the federal government to regulate commerce, should trump the reserved power principle. While I would not go so far as to say that the dual levels of regulation in franchising will kill the goose that lays the golden eggs, the regulatory scheme does inhibit franchising in the United States. My recent trip to Australia only confirmed my thoughts on this subject. The Aussies (and certainly business people in other countries), looking at our franchise regulatory scheme, think we are mad. The federal budget fight and debt default scare only further confirm this view generally.

Franchise regulation in the U.S. is broken and has been broken for over 40 years. The addition of any more state legislation will only exacerbate the problem. It is time for the franchise sector to call for full federal pre-emption and to develop, with the participation of all stakeholders, a system that is efficient and an enforcement process that has teeth when egregious violations occur. The baby steps in regulation we are now taking will just make the situation worse.

Matt Haller
International Franchise Association

Is there a need for more franchise legislation? Absolutely not. Franchising is already highly regulated by the Federal Trade Commission (FTC), and most states have laws governing franchise relations and disclosure laws regulating the sale of franchises. State legislatures have recognized franchising is highly regulated, and when coupled with built-in dispute resolution procedures in franchise contracts, believe expanded government regulation would be unnecessary, duplicative and potentially impact franchise development.

IFA believes that when there are the occasional disputes between franchisees and franchisors, the solution should be found between these two parties, and not through legislation. Once government gets involved in a business, it is very hard to extract it.

As an alternative to governmental intervention, the IFA has a long-established ombudsman program to help franchisees and franchisors resolve their differences. Additionally, the IFA commissioned a task force that produced a document reflecting guiding principles between franchisees and franchisors that will be released soon. Further, the IFA has had a long-standing Franchise Relations Committee consisting of franchisees and franchisors to address issues facing our industry.

Stanley M. Dub
Law Offices of Stanley M. Dub

I'm a franchise attorney in private practice, and I've represented both franchisors and franchisees. I don't think this latest wave of regulatory activity at the state level amounts to much. Just because a new law is proposed, doesn't mean it will pass ' most don't. And even if some pass, most of these proposed laws are very limited.

Broadly speaking, state franchise laws are divided into disclosure laws, which regulate the way franchisors sell their franchises, and relationship laws, which control some of the restrictions that franchisors might otherwise put in their agreements. Franchise sellers are required to comply with FTC disclosure rules when they sell franchises, but the FTC leaves the enforcement to the states, and many states don't regulate franchises at all. I think every state should at least require that franchisees receive a disclosure document that complies with FTC rules. However, franchisees as a group lack power and a voice within state legislatures, and the franchisor-oriented business community typically opposes any new franchise laws.

Franchise agreements are loaded with terms and requirements that are slanted in favor of the franchisor. Often, some of these terms cannot be justified. A potential franchise buyer offered such an agreement can choose only to take it or leave it. Buyers of successful franchises like McDonald's may thrive despite these one-sided agreements, but other franchisors write similar agreements even though they don't deliver similar results. State laws may eventually address some of these imbalances, but no forces are in place to suggest these changes will occur soon.

Peter Lagarias
Lagarias Law Offices

Opponents of legislation do not want to address the overreaching of franchisors in franchising. To them, all legislation is excessive regulation and a drag on the economy. Yet how can they ignore franchise systems, including nationally touted franchisors, with large numbers of franchisee failures?

Bad behavior by franchisors is compounded by the ever-prevalent, one-sided franchise agreements prepared by and for franchisors. Franchisees need legislation to protect their investments and equity in their franchise businesses. A franchisee with multiple-six-figure investment of her life savings should not be terminated or not renewed for minor violations. Nor should she have her franchise business cannibalized by franchisor encroachment or be forced to buy overpriced product from vendors paying kickbacks to her franchisor. But franchise agreements almost never provide real rights for franchisees over these and many other fundamental issues.

Franchise agreements and disclosure documents should not allow franchisors to disclaim responsibility for marketing franchises with phony earnings claims and promises. Such fine-print sales documents should not absolve franchisors, especially when they market their franchises as successful and proven business models. Statutory protections with private rights of action are essential to confirm to courts that Franchise Disclosure Documents and representations may be relied upon by franchisees. The days of “Franchise Disclaimer Documents” should end.

Adequate franchise legislation, like securities and antitrust laws, is warranted to curb marketplace abuses.

Matthew J. Kreutzer
Armstrong Teasdale LLP

The uptick in proposed franchise legislation is part of a vicious cycle: the proposed laws are a symptom of a continuing frustration on the part of franchisees with what they view as increasingly unfair franchise agreements. Those agreements, in turn, are a reflection of the need by franchisors to account for and address risks presented by adverse court decisions industry-wide. But, by trying to bring balance to the franchise relationship, some of the proposed laws may cause harm.

As an example, if passed, California Assembly Bill 1141 (2013) (as amended, http://bit.ly/1c2WR70) would make certain individuals associated with the franchisor jointly and severally liable to franchisees for any violation of California's Franchise Investment Law. It would also seek to prohibit a franchisor to refuse to renew a franchise, possibly creating a perpetual relationship. These and other aspects of that law could have an anti-business effect.

As we have seen with California's law regarding negotiated sales (which has chilled negotiations between franchisees and franchisors), sometimes laws that are intended to bring balance and fairness to the relationship can have the opposite effect. A broad-sweeping, pro-franchisee law may protect existing franchisees. But, at the same time, it may also harm people who want to buy franchises: If the law discourages franchisors from doing business in the state, it may prevent new franchise relationships from forming.

Maisa Jean
Frank Gray Plant Mooty

There does appear to be somewhat of a recent uptick in attempted state legislation governing the franchise relationship, but as has been noted, legislators have not been successful in passing proposed legislation. Many of these bills seem to have been proposed by franchisees and/or their attorneys, and this may simply represent an increasing level of sophistication and organization among franchisees and their attorneys.

Both franchisors and franchisees should take an interest in proposed changes or additions to laws that govern their relationship because such laws could have an impact on the quality of the system. For example, both franchisors and franchisees ultimately opposed the [California A.B. 1141] because they recognized the importance of preserving franchisors' ability to enforce the provisions in the franchise agreement. The bill would have limited a franchisor's ability to terminate or refuse to renew a franchise agreement and would have imposed a good faith standard of dealing between the parties. A franchisor needs to be able to protect the quality and reputation of its system by taking necessary actions, including termination, with underperforming franchisees. Franchisees have an interest in protecting the quality of the system and their investment in it, and so they, too, should want franchisors to have the ability to deal with underperforming franchisees. Thus, both franchisors and franchisees had an interest in preventing the passage of [California A.B. 1141]. In addition, franchisors and franchisees both likely recognized that the imposition of the good faith standard may have potentially increased the cost of resolving disputes between the parties.

Ultimately, it does not appear likely that many (or any) of the bills related to the franchise relationship will pass.

Erik Wulff
DLA Piper

Are these shots across the bow? We are experiencing an unusually high level of state legislative efforts to tilt the playing field more towards franchisees. If enacted, these laws would be detrimental to the franchising business model. Franchisors ' and those who believe in franchising ' as a strong engine for economic growth need to pay heed. All is not well.

The economic downturn and slow recovery has not spared many small businesses, including franchised businesses. Is enough being done to help franchisee networks (which are imperative for the success of a franchisor) survive and flourish during these challenging times?

Franchisee lawyers tell us that franchise agreements are becoming more onerous on franchisees. Do these agreements reflect the franchisees' legitimate interests? Is a proper balance being struck?

Anecdotal evidence indicates that franchisee organizational activity is on the rise. Are there effective channels of communications, and are franchisee concerns being heard and respectfully dealt with?

Although the current state legislative efforts appear less coordinated than the federal efforts in the 1990s (and, therefore, perhaps less likely to succeed), one can never discount the possibility that some of these efforts will pass. Franchisors need to continue to improve their franchise models in order to ward off legislation that will adversely affect franchising. One need only consider the state of the automobile industry and its dealership regulatory regime to envision how legislation has the potential to straight-jacket business format franchising. Positive steps can ' and need ' to be taken to ward this off.

David Koch
Plave Koch

I don't see the current level of state legislative activity as unusual. If anything, the period of relative quiet that preceded this latest round was unusual.

Some of the individual proposals have merit ' in particular, bills to clarify that franchisees are not employees. But as a whole, the state proposals are not particularly good for franchising, for the same reasons as in other industries. First, they introduce a businessperson's worst enemy: uncertainty. Second, in the worst cases (especially [California A.B. 1141] and Maine's [proposed LD 1458, The Small Business Investment Protection Act]), the proposals have the potential to fundamentally alter the allocation of risks and rewards in franchise contracts. Their effect, if not the purpose, is to shift risk from the franchisee to the franchisor. What the proposals fail to recognize is that the initial franchise fee, ongoing royalty and other commercial terms have been structured based on a whole set of assumptions ' such as whether the franchisor will be able to protect the brand by enforcing non-compete obligations. If legislation shifts risks and compliance costs to franchisors, it likely means increased fees for franchisees to offset the new obligations. And at an extreme, the new risks and costs reduce the incentive to franchise at all. We already counsel franchisor clients that they might want to consider omitting certain states from their franchising plans.

I don't deny that franchisees are sometimes injured by irresponsible franchisors, and it is natural for legislators to respond to complaints from constituent franchisees by introducing a bill. But a legislative solution hits everyone, good and bad, and legislators lose sight of the potential ramifications for future franchisees.

Domonic Mochrie
Osler, Hoskin & Harcourt

Changes to state-level franchise legislation can have interesting trickle-down effects in other countries. Speaking from the Canadian perspective, when faced with new or proposed legislation that would impact the operation of the franchise program in the U.S., franchisors with operations in Canada often enquire with local Canadian counsel whether similar legislation is under consideration in any provinces or at the federal level. As our provincial franchise legislation focuses on disclosure, and, other than imposing a duty of fair dealing on the parties, does not regulate the relationship between the franchisor and the franchisee, the answer is usually no.

Even still, given the general similarities between the two countries, franchisors may still be sensitive to developing issues in the U.S. and may consider mirroring any changes to its U.S. program in Canada to maintain system uniformity. In other instances, the introduction (or even the threat of) legislation which would have a fundamental impact on the structure of a franchise program in the U.S. can result in the franchisor diverting greater resources to jurisdictions, like Canada, where the original business model can operate without requiring any modification.

Beata Krakus
Greensfelder, Hemker & Gale, P.C.

The pending Maine [LD 1458], Massachusetts [S. 1843] and Pennsylvania [H.B. 1620; ] bills are, in some regards, similar to the franchise relationship statutes that many other states already have. However, they go significantly further in providing franchisee protection. This is done in a rather heavy-handed manner, and one that is not appropriate for a diverse business model such as franchising. While it is unlikely such one-sided bills will pass, if they did, they are likely to have a chilling effect on franchising in those states and, consequently, wouldn't benefit franchisors or franchisees. Franchisors are likely to avoid those states because of the significant loss of freedom of contract that the bills entail.

The proposed bills apply as if franchising was a uniform industry and not a business model. Franchise programs vary exceedingly because the industries in which they operate do, too. However, the bills contain detailed provisions that treat all franchisors as if they were operating in an identical fashion. For example, franchisors could not require franchisees to operate evening hours. Presumably, this provision would protect franchisees from operation during hours of low profitability. But how will hotel, night-time nursing franchises or other businesses that, by default, are open at night operate?