12 May 2023
Commissioner Lina M. Khan
Federal Trade Commission
600 Pennsylvania Avenue, NW
Washington, DC 20580
Dear Commissioner Khan:
On 10 March 2023 the Federal Trade Commission issued a Request for Information on franchise agreements and franchise business practices. The following is my response to your Request for Information.
I am the founder and Managing Director of MSA Worldwide, an advisory firm in franchising. During my career, I have been both a franchisor and a franchisee. I have served on the International Franchise Associations Board of Directors and on its Executive Committee and in September 2022, I was reelected to the IFA’s board. I am also an Adjunct Professor at the Fisher School of Business at The Ohio State University where I teach a graduate course on Commercial and Social Franchising.
In addition to my books, articles and lectures on the subject of franchising, I have authored a prospective franchisee due diligence workbook titled Making the Franchise Decision,1 which is published on dfpi.ca.gov (State of California website), and I chaired a task force and am the principal author of the IFA’s Statement of Guiding Principles,2 acknowledged as the general accepted standards and practices in franchising.
The Regulatory Landscape
With its adoption of 16 CFR Part 436 (the Federal Trade Commission’s Franchise Rule), the Commission has played an integral and beneficial part in franchising by mandating that franchisors prepare and present to prospective franchisees a prescribed disclosure document (the Franchise Disclosure Document). In addition to the FTC Rule, several states have adopted alternatives to the FTC’s definition of franchising and have enacted state franchise regulations. The North American Securities Administrators Association (NASAA) is an organization of state franchise examiners that oversee the franchise regulatory environment in their states.
In addition to the FTC Rule and State franchise regulations, franchisors, as with all licensors, are also governed by 15 U.S.C. § 1051 (1946) (the Federal Lanham (Trademark) Act). For consumers, trademarks and service marks serve to identify the source or maker of a product or service. The Lanham Act, as a federal law, regulates the use of trademarks and service marks throughout the United States necessary to protect the consuming public.
Because of the Lanham Act, franchisors are able to license their brands to franchisees without losing control of their marks. Under the Lanham Act, all licensors, including franchisors, are required to exercise controls over their Intellectual Property (IP). If they have insufficient controls, the result can be the loss of their intellectual property, including but not limited to, the abandonment of their marks. In deciding what controls are necessary to protect their Intellectual Property and the consuming public, franchisors, as do all licensors, independently determine the types and breadth of brand standards and controls they include in their license to franchisees.
Because the FTC’s Franchise Rule is limited to its mandate of requiring franchisors to disclose the terms of their offering and other information to prospective franchisees in a timely manner, the Commission has not materially impeded on a franchisor’s obligations under the Lanham Act. In adopting the Franchise Rule, the Commission recognized that mandating or limiting common terms of agreement, governing over one hundred and fifty (150) separate and distinct industries and multiples of contractual relationships, was not commercially reasonable or possible. The Commission also recognized that it lacked the authority to do so as those are the purview of the U.S. Congress and State Legislators.
The FTC’s Inaccurate Assumptions
The FTC’s Announcement3 of its RFI refers to franchising as an “industry.” Franchising is not an industry and is simply a defined method to distribute products and services through licensees. There is certainly commonality among franchisors in how they approach their agreements with franchisees but, referring to it as industry makes it appear that the Commission believes the franchise relationship is fungible in structure regardless of the industry or the company. This misstates the reality of how franchising functions and is why the FTC Rule is a disclosure regulation and why Congressional hearings have not resulted in federal franchise relationship laws.
As an experienced person in franchising, I question the FTC’s assertion that there is a “growing concern around unfair and deceptive practices in franchising,”4 as the evidence does not support this assertion. Simply because a relatively small group of individuals represent that they speak for the vast majority of franchisees, or anonymously provide anecdotal examples in reply to the RFI, does not equate to a growing or significant problem in franchising nor, does it make it a fact. The facts do not support any assumption that there is a large and growing concern by the vast majority of franchisees or that there are significant issues in the licensing practices of franchise opportunities or the management practices of franchisors.
According to a survey conducted by Franchise Business Review5, eighty-two (82) percent of franchisees are supportive of their brand. In addition they report that:
- 85% of franchisees surveyed enjoy being part of their franchise organizations
- 78% of franchisees would recommend their franchise to others, and,
- 82% of franchisees respect their franchisor.
There will of course always be some poorly performing franchise systems and some poorly performing franchisees. Franchising is also not immune to bad acts by franchisors or franchisees – nor is any other form of business relationship. When that occurs, the parties in franchising have agreed in advance on how to settle those conflicts.
Another strong indicator that the vast majority of franchisees are satisfied with their choice of franchise opportunities and, the management of their franchise systems, is the relatively few legal disputes there actually are in franchising. Given the extremely large number of franchisees in the United States today, there most certainly should be a high number of arbitrations and litigations if there were any substance to the claims of material and growing problems in franchising. The reality is that arbitrations and litigations are remarkably few. Where disputes occur, as they will in any complex form of business relationship such as franchising, there are mechanisms in place for communications and discussions, including but not limited to franchise advisory councils, franchisee associations, ombudsmen, mediation, and direct discussion between the franchisor and each franchisee. There are routine methods for solving issues in franchising as there are in other business relationships.
When disclosure in franchising began in the states in the 1960s and when the FTC Rule was adopted in the 1970s the vast majority of franchises were owned and operated by single unit, mom and pop franchisees. This is no longer the case. Franchising has grown and matured in size and the sophistication and the capabilities of both franchisor management and franchisees has also grown. According to FRANdata, a well-regarded research firm in franchising, in 2019, fifty-four (54) percent of franchises were independently owned and operated by multi-unit franchisees.6 This number has grown, and many single and multi-unit franchisees own and independently operate businesses in multiple franchise systems. The reason that there are a de minimus number of legal disputes in franchising today is because of the sophistication of modern-day franchisees, who are well capitalized and can afford representation by legal and business advisors.
For less experienced franchisees, there is a considerable library of literature available today to educate franchisees in their acquisition of a franchise license. The FTC publishes information on its website to aid prospective franchisees, as do many of the states. The due diligence workbook I authored (with can be downloaded for free), my books, and many of my articles are just a few of the examples of the vast library of literature available to potential franchisees today.
Different from when the Franchise Rule was first adopted, there is also a growing number of lawyers and qualified business advisors available to assist prospective franchisees in conducting a proper and supported due diligence. My firm annually updates and publishes a list, by state, of franchisee lawyers7 on our website.
While the FTC and most professionals in franchising advise a potential franchisee to seek qualified professional advisors prior to making their franchise decision, when they choose not to do so, that is their choice. However, simply because a franchisee has made that choice does not grant them additional rights under their franchise agreements or obligate the franchisor to modify the terms of their franchise offering after the agreement has been executed.
Response to the Request for Information
I earlier referenced the International Franchise Association’s Statement of Guiding Principles8 that was adopted by the IFA Board in 2013. It is important to understand that sixty (60) percent of the task force that participated in drafting the Guiding Principles were franchisees. While I recommend you review these generally accepted principles, there are three that I would like to call to your attention at this time.
Article 4: “Prospective franchisees have the prerogative, at the start of the franchise relationship, whether or not to enter into any particular franchise relationship. Prospective franchisees may also choose to not become franchisees of any franchise system.”
Article 11: “Improved pre-investment disclosure will benefit both prospective franchisees and franchisors by enhancing the competition among franchisors for qualified franchisee candidates. By clearly communicating the terms contained in a franchise offering, prospective franchisees will be better able to evaluate and make investment choices among the wide range of franchise opportunities available to them and to choose from those that meet their goals, ambitions, financial and other requirements.”
Article 12: “Market Forces, and not government mandates and relationship laws, should create the climate for changes to Franchise Agreements and should drive improvements in franchising practices.”
Contrary to the assertion that franchisees are limited in their ability to negotiate the terms of their franchise agreements, as discussed in Article 4, the power to decide whether or not to enter into any franchise relationship is solely held by the franchisee prior to joining any franchise system. Not becoming a franchisee of any system is a choice every potential franchisee can and should make when the terms of the franchise offering do not meet their requirements. This is why we included that proclamation as one of the first Articles. Should a franchisor’s offering not meet the needs of a prospective franchisee, like any other service or product, the consumer will select an alternative, or choose not to buy. Becoming a franchisee is not the only method of becoming a business owner.
Franchisors, as required by the Lanham Act and for a host of other important reasons, independently set the terms of how they wish to license their Intellectual Property. This is their right and obligation under federal law as the owners of their Intellectual Property.
Franchisors most certainly limit the scope of areas of the franchise agreement they will negotiate for valid business reasons. Franchisees in a franchise system share a common brand and it is the uniformly in meeting a system’s consumer brand promise, and other requirements, that are essential in protecting the public under the Lanham Act. Also, uniformity is essential in protecting the equity of all of the franchisees in the franchisor’s network as well as the franchisor’s Intellectual Property rights. However, it is important to recognize that negotiations of certain terms in franchise agreements are relatively common today in many franchise systems, because of the experience, sophistication and size of multi-unit franchisees.
If there are significant issues in franchising, it is not in the terms of the license offered by individual franchisors but rather in the FTC’s specified disclosure document itself.
The current form of federal disclosure was modeled after the State of California’s disclosure developed in the 1960s. Besides changing the name of the disclosure from a Uniform Franchise Offering Circular to a Franchise Disclosure Document, modifying the waiting period to calendar days from business days and some other relatively minor tweaks, franchise disclosure has not been significantly modernized by the Commission in the over forty (40) years since the FTC Rule was first adopted. Despite the evolution in the business of franchising and the advances in technology and communication, the FDD has remained relatively unchanged. It still provides for the same twenty-two (22) items and a receipt it did when it was created.
While much of the information a prospective franchisee requires, when first assessing a franchise opportunity, is contained in the current FDD, the FTC’s required disclosure incorporates confusing charts and lacks features commonly available in modern business disclosures. Its mandated flow of information is also counter-intuitive to what a prospective franchisee wishes to understand in comparing franchise opportunities. The disclosure of information to prospective franchisees is further limited by the FTC’s prohibition in allowing franchisors to provide material additional information they may believe is important for prospective franchisees to consider (the FTC’s “bulk up” rule).
Because of these issues, the International Franchise Association has created a task force of franchisees, franchisors and professional advisors to develop an alternative and more robust approach to the current Franchise Disclosure Document. I am a member of the task force but I do not speak for the task force. However, I can attest that the work of that task force is ongoing and I expect that prior to the end of this year the IFA will provide its recommendations for a revised disclosure document to the Commission.
A major feature of its work is to create a disclosure document where the material terms of the offering and information about the franchisor are readily available and understandable to the prospective franchisee. This will enable potential franchisees to compare franchise offerings and determine which franchise system, if any, meets their needs and requirements more easily. Some of the elements under consideration are:
- An Executive Summary of material terms and information
- A Management Discussion and Analysis letter to give management’s analysis of company performance with potential future looking statements
- Evaluation of the information that should be disclosed
- Evaluation of the flow of the information provided
- Elimination of unclear charts
- Inclusion of links to robust and more current information
- The potential for industry-specific disclosures
The purpose for the IFA’s future recommendations of potentially sweeping changes to the FDD is to better communicate and clarify the franchise offering to prospective franchisees. By doing so, the information provided will better serve prospective franchisees and will enable market forces to govern what is included in a franchisor’s license and also how franchisors manage and operate their systems. This was the reason the IFA included Articles Eleven (11) and Twelve (12) in its Guiding Principles as a modernized FDD will support the mandated purpose of the Commission. It will also eliminate the possible imposition of unwarranted restrictions on a licensor’s terms of license to franchisees, which is commercially unworkable given the large number of industries included in franchising. Further it will avoid the anticipated judicial and legislative challenges should such restrictions be attempted.
Many in franchising believe that the Commission made a serious mistake in its last review of the FTC Rule and the IFA’s task force is also examining how to fix that error. In its update in 2007, the Commission decided to eliminate the requirement that franchise sales organizations and brokers provide material disclosure to the potential franchisees they are working with. While removing that information from a franchisor’s disclosure document was a sensible decision, eliminating broker information entirely left prospective franchisees in significant jeopardy. Many also believe that the trend by brokers to identify themselves as consultants or advisors to prospective franchisees has caused harm, as their material source of revenue is from their franchisor clients in the form of franchise brokerage commissions and not from prospective franchisees.
There has been an increase in the use of brokers by franchisors and it is acknowledged that some of the practices of some of the brokerages have not been beneficial to prospective franchisees or franchising in general. For this reason the task force is working through recommendations on a separate broker disclosure document that would be presented to prospective franchisees by the brokerage, on their first substantive contact in the franchisee recruiting process.
Patterned after the elements of disclosure found in the FDD, the task force is considering the inclusion of the following in a brokerage disclosure.
- Description of the brokerage’s relationship with the prospective franchisee and their relationship with their franchisor client
- Information on the brokerage, its predecessors and affiliates
- Business experience of its key executives
- Litigation, bankruptcy, and regulatory history of the brokerage
- A list of their franchisor clients along with their sales commission and other compensation
- A list of franchisees placed by a brokerage (three years) with contact information
- Audited financial statements
- Copy of any agreements required between the brokerage and the prospective franchisee
The task force is also considering a separate form of disclosure by each individual broker that would be presented to the prospective franchisee on their first substantive discussion.
As the Franchise Rule is meant to protect prospective franchisees, the failure to include brokerages in the disclosure process should be corrected as they play a material part in the franchise recruitment process and in the selection of a franchise opportunity by many prospective franchisees.
The Franchise Rule was established as a disclosure rule because it provides to prospective franchisees the necessary information to make informed decisions while preserving the rights of franchisors to protect their Intellectual Property under federal law. I believe that modernizing franchise disclosure is the critical element that the Commission needs to focus on during this current review period.
Michael H. Seid