Thinking of buying a Franchise?  What you should know before you sign an Agreement.

• The Twelve Worst Franchise Agreement Provisions

• The Problems Franchisees Face

The AFA provides the following resources to assist you with your Franchise purchase...

The Twelve Worst Franchise Agreement Provisions

Do not sign a franchise agreement until you get these provisions changed! 

·       Gag Rules.  Some franchise agreements now prohibit franchisees from discussing any aspect of their franchise experience with anyone outside the system.  This defeats the FTC rule and other state disclosure laws which require lists of terminated franchisees to be provided to prospective franchisees. 

·    Franchisor Venue Provisions.  These provisions require franchise disputes to be litigated or arbitrated in the home state of the franchisor.  This not only increases costs for the franchisee, but also allows the franchisor to litigate, arbitrate or even mediate on their home turf. 

·     Lack of Reciprocal Cure Periods.   Many franchise agreements give the franchisor 30, 60, or 90 days to cure any alleged defaults; some even do not allow the franchisee any remedy if the franchisor defaults.  On the other hand, some franchise agreements provide for no cure periods for any alleged default by the franchisee.  What is good for the goose is certainly good for the gander. 

·  Nonreciprocal Noncompetition Covenants.  Many franchise agreements have oppressive post-term noncompetition covenants, both in terms of duration and geographical scope.  At the same time, many franchise agreements allow the franchisor to place competing units pretty much where they want.  If the franchisor wants protection from the franchisee after the agreement expires or terminates, why shouldn’t the franchisee be entitled to the same protection during the franchise agreement? 

·       Sole Sourcing Requirements.  Many product-oriented franchise systems require franchisees to purchase products solely from the franchisor or from suppliers designated by the franchisor.  No allowance is given to purchase from alternate sources even if quality standards are upheld.  This leaves the determination of the gross margin achieved by the franchisee solely in the hands of the franchisor. 

·       Mandatory Subleases with Rent Overrides.  Many franchise systems require the franchisee to sublease the franchised premises from the franchisor who has in turn leased the premises from the landlord.  This places the franchisor in the real estate business and able to net a profit essentially without risk.  In addition, the fact of these overrides and the amount of them are rarely disclosed in franchise offering circulars. 

·        Lack of Accountability of Advertising Fund. Over the years, franchise agreements have increasingly been drawn in a manner to give the franchisor maximum discretion over the use and application of advertising funds.  Agreements are often drafted in such a way as to allow franchisors to not spend advertising dollars in the market where franchisees have contributed to ad funds. 

·       Lack of Reciprocal Legal Fee Provisions.  Many franchise agreements require the franchisee to pay all of the franchisor’s legal expenses in the event of litigation between the parties.  However, if the franchisee wins the litigation, the franchise agreement does not provide for legal fees.  The only way a franchisee can obtain legal fees is if a state statute allows such recovery or in the unlikely event the franchisee prevails on a RICO claim. 

·        Kickbacks.  Some franchise agreements openly acknowledge that the franchisor has the right to make deals with vendors who sell goods and services to franchisees that are mandated by the franchise agreement.  Very often, these vendors provide kickbacks, promotional fees, and commissions to the franchisor in return for being allowed to sell their products and services to a captive market.  Instead of passing these kickbacks, promotional fees and commissions on to franchisees to reduce their cost of goods sold and increase their margins, these payments are pocketed by the franchisors. 

·        Mandatory Arbitration Provisions.  While arbitration is a faster and presumably cheaper, it has major disadvantages to franchisees.  Arbitration is private, with the resulting decisions not creating any precedents.  In addition, the ability of a franchisee to obtain documents from the franchisor and to take depositions is severely limited. 

·        Radically Different Franchise Agreements on Renewal.  Many franchisees find that when it is time to renew, they are not really renewing their existing franchise agreement, but entering into a wholly new franchise agreement, often with materially different financial and operational terms. 

·       Unilateral Amendments to the Franchise Agreements. Many franchise agreements provide that the franchisor can change its operations manual or other company policies from time to time without notice to or with the consent of the franchisee.  Thus, the franchisor has the right to unilaterally change the franchise agreement.  Moreover, the franchisee is rarely given an opportunity to inspect the franchisor’s operating manual in advance of the sale of the franchise. 

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The Problems Franchisees Face

WAIVER OF LEGAL RIGHTS

When purchasing a franchise, the franchise agreement will often require the prospective franchisee to waive his/her rights under applicable federal or state franchise laws.  Franchisors must be prohibited from requiring franchisees to agree to specific provisions in franchise agreements which are intended to relieve the franchisor of liability or duties imposed by other areas of law. 

FREEDOM OF ASSOCIATION

A surprising number of franchisors engage in aggressive intimidation tactics designed to prevent their franchisees from forming or organizing independent associations.  Franchisees who are considered “leaders” are often bullied by their own franchisors.  Freedom of association is a basic constitutional right that franchisors routinely deny – either contractually or procedurally – to their franchisees. 

NO FIDUCIARY DUTY

Fiduciary duties are common in many business transactions.  The franchise relationship is particularly well suited for such duties.  The parties are of vastly unequal bargaining power; the franchisor has enormously more information than does the franchisee; and a franchisee’s business is completely at the mercy of the franchisor.  Franchisees feel the franchisor owes a limited fiduciary duty and is obligated to perform the highest standard of care when performing bookkeeping, collections, payroll or accounting services on behalf of the franchisee – or when administering an advertising or promotional fund to which the franchisee is required to make contributions. 

ENCROACHMENT

It is fundamentally unfair for a franchisor to induce a franchisee to invest to create a business and then establish a competing outlet in sufficient proximity to the existing franchise to cause significant damage or even destruction to the existing franchised outlet.  Franchisors must be prevented from encroaching on their own business partners, their franchisees. 

BAD FAITH

The duty of good faith is broadly recognized in contract and commercial law.  It should be applicable to contractually defined franchise relationships.  Good faith does not mean that the express terms of the written document will be modified.  It does mean that the franchisor will probably be more reasonable, factual and fair in the exercise of discretionary authority under the contract.  A franchisor should not be immunized against consequences of its own bad faith just because the courts are reluctant to apply the duty of good faith. 

SOURCING OF SUPPLIES

Most franchise relationships mandate that franchisees purchase supplies, equipment, furniture or other items from the franchisor or sources affiliated or approved by the franchisor.  Franchisees should be allowed to purchase goods that meet the franchisor’s standards from independent, competitive sources.  Tying franchisees to certain vendor(s) costs them in the millions of dollars, prevents competition among local vendors and has an adverse impact upon consumers.  Franchisors should be controlling the characteristics of items supplied by a vendor and not be allowed to restrain competition in the sourcing of conforming goods. 

INFLATED PRICING

Some franchise agreements openly acknowledge that the franchisor has the right to make deals with vendors who sell goods and services to franchisees that are mandated by the franchise agreement.  Almost always these vendors provide kickbacks, promotional fees and commissions to the franchisor in return for being allowed to sell their products and services to a captive market.  Instead of passing these kickbacks, promotional fees and commissions on to the franchisee to reduce their cost of goods sold and increase their margin, these payments are pocketed by the franchisors. 

SIGN A RELEASE TO SELL

When a small business person wants to sell his or her business, they just put a price on the business, find a willing buyer and sell the business.  When a franchisee wants to sell his or her business, however, the franchisor often requires, as a condition of completing the sale, that  the selling franchisee sign a termination and release form which says the outgoing franchisee gives the franchisor a general release of claims. 

TERMINATION WITHOUT CAUSE

Simply stated, franchise agreements should not be arbitrarily terminated.  Good cause should exist for the termination. 

NON-COMPETE CLAUSES

The franchise relationship almost always includes a post-termination covenant not to compete which does not allow the franchisee to become an independent business owner in a similar business upon expiration of the contract.  This has the effect of appropriating to the franchisor all of the equity built up by the franchisee, with no compensation.  Franchisees should be allowed to preserve their “sweat equity” and engage in a similar business provided that the franchisee ceases using the franchisor’s trade marks and trade secrets and returns all confidential operating materials to the franchisor. 

NO PRIVATE RIGHT OF ACTION

Under the current Federal Trade Commission (FTC) Rule on franchising and business opportunity ventures, in 38 states, franchisees have no private right of action.  In today’s world, franchisees actually have to go to the government for redress if their franchisor violates the FTC Rule.  A July 1993 GAO report on the FTC’s enforcement activities in franchising found that the FTC acts on less than 6% of all franchise complaints brought to it, going to federal court in just 2% of those instances.  If the prohibition against certain activities is a federal issue, then relief should be in federal court.  Therefore, franchisees are asking to de-regulate and seek privatization of the enforcement mechanism.