SUMMARY

Small Business Franchise Act
(SBFA)

The Small Business Franchise Act of 1999 will establish uniform standards of conduct in franchise relationships between franchisors and small business entrepreneurs. The bill will re-affirm existing prohibitions against the offering of a franchise that would in any way perpetrate a fraud upon any prospective franchisee investor. It will restore freedom to contract for franchisees.

Freedom to form trade associations by franchisees. The bill makes it unlawful for corporations that sell franchises to hinder or intimidate the free association of franchisees for any lawful purpose. Why would anybody oppose that?

Termination without Good Cause. SBFA protects the franchisee from the unfounded loss of his/her business--often without any compensation. It is by no means a free ride for the small businessperson. A compulsory 30-day opportunity to cure period is allowed franchisors in order to eject truly deficient franchisees. Why would anybody oppose that?

Post-Term Restrictions Non-Compete Clauses. The bill promotes free trade by allowing the former franchisee entrepreneur to make a living in their chosen field or business at any location after expiration of the franchise agreement. The former franchisee could not, of course, use the franchisor s intellectual property, trademark, trade secrets, etc. after expiration of the franchise. Why shouldn t an accountant be able to prepare taxes after he/she leaves the H&R Block franchise system? Why would anybody oppose that?

Good Faith & Fair Dealing.  Certain well-known franchisors boast that they do not have to abide by the Uniform Commercial Code (UCC).  SBFA will help small business franchisees by imposing on each party to a franchise contract a duty to act honestly, reasonably and in good faith with each other and to observe reasonable standards of fair dealing.  Neither party can deny the other party the intended benefits of the contract. What makes franchisors exempt from dealing in good faith?  Why would anybody oppose that?

 Duty of Due Care.  Franchisors routinely brag of their great skill; that they will train the new franchisee to invest his/her time, money and personal effort.  When the franchisor s promises do not materialize, they currently try to hide behind various defenses.  Who opposes due care in this sense?

  Limited Fiduciary Duty when handling the small businessperson s money.  When the franchisor requires franchisees to pool their money for a general advertising fund, or handles all of the franchisees bookkeeping functions, SBFA states the franchisor owes the franchisees the highest standard of care and accountability when handling those monies.  SBFA requires that franchisees be given annually a full disclosure of disbursements and requires a full accounting of discounts or kickbacks in every form.  Why would anybody oppose that?

 Procedural Fairness.  A franchisor cannot require any term or condition in a franchise agreement, which violates SBFA.  Also, franchisors cannot require that the franchisee entrepreneur waive or restrict his/her rights under the bill.  Why would anybody oppose that?

 Venue.  This section states that a franchisee shall not be deprived of the application of and benefits of SBFA, of any other Federal law or of the law of the state in which the franchisee s principal place of business is located.  It also voids the compulsory use of distant venue for court or arbitration a major hardship on small businesspeople.  Why would anybody oppose that?  

Actions by State Attorneys General.  If a state s Attorney General (AG) believes the interests of the residents of that state have been or are being threatened or adversely affected because any person has engaged or is engaging in a pattern which violates SBFA, the AG can bring a civil action on behalf of its residents in an appropriate U.S. District Court.  Under SBFA there will finally be a formidable alliance in federal / state cooperation in enforcement proceedings against errant franchisors.  Why would anybody oppose that?

 Transfer of a Franchise.  The basic principle here assures a small business franchisee s right to realize his/her equity at the time of sale, subject to the new franchisee satisfying the franchisor s reasonable qualifications.  The franchisor may still turn down the transfer, provided the rationale is not arbitrary or capricious.   Why would anybody oppose that?

 Transfer of Franchise by Franchisor.  Due to the growing trends in mergers, acquisitions, and leveraged buy-outs, SBFA requires that franchisees be given 30 days notice of the franchisor s transfer of ownership to another entity.  The entity assuming the franchisor s obligations must have the business experience and financial means necessary to perform the franchisor s obligations.  This is only reasonable as franchisee entrepreneurs often invest their entire life savings based upon their respect for the franchisor s knowledge and experience.  Why would anybody oppose that?

 Procurement Flexibility Independent Sourcing of Goods & Services.  Why should a local pizza franchisee be required to purchase his/her cardboard boxes or drivers uniform shirts from corporate headquarters, at an inflated price, if a local vendor in the community can provide a similar commodity that will meet corporate specs? An exception is made for reasonable quantities of proprietary items that must be bought from the franchisor or its affiliates, but only if they are central to the franchised business.  SBFA also requires the franchisor to fully disclose whether it receives rebates, commissions, payments 

or other benefits as a result of the franchisees purchases.  The bill requires that any such receipts shall be distributed directly to the franchisees who actually paid for the goods.  Why would anybody want to restrain trade?

 Encroachment devaluation of the small business franchisee s assets by his/her franchisor.  Why would a fair-minded franchisor pursue a placement strategy that would undercut its own franchisee?  Because royalty payments received from the small business franchisee are based on gross sales, not on profits.  The more stores the more royalties to the franchisor.  In SBFA, a franchisor cannot place or license another to place one or more new outlets in unreasonable proximity to an established outlet if the intent or probable effect is to cause a reduction of gross sales by the established outlet of more than five percent in the twelve months immediately following establishment of the new outlet(s).  SBFA will level the playing field dramatically for the small business franchisee in this regard.  Why would anybody oppose that?

 Individual Rights/Private Right of Action in Federal Court.  The only federal regulation which carries the weight of law to safeguard would-be franchise investors is the franchise rule promulgated by the FTC which was designed to deter fraud and misrepresentation in the pre-sales process.  Currently, under the FTC s franchise rule, there is no private right of action.  SBFA will grant the franchisee a private right of action in federal court when the corporate franchise seller has breached the FTC s franchise rule or any provision of SBFA.  While the FTC originally recommended a private remedy in its enactment of the FTC Franchise Rule, that did not occur.  However, nothing in the bill limits the rights of the franchisor or franchisee to engage in arbitration or mediation.  Why would anybody oppose the right to due process?   

Opponents Claim:  This bill establishes a private right of action in federal court for any dispute arising under the bill.  The bill does not even require a monetary threshold for access to federal court.  

 Opponents Claim:  The bill not only allows for attorney s fees and costs, but also allows for expert witness fees.  

Opponents Claim:  The bill goes well beyond piercing the corporate veil.  It places a very high degree of joint and several personal liability on every executive and director in the franchise company.

The Facts Are: This a grossly misleading statement. The Bill does not make every executive of the franchisor liable, only those who materially aid in the transaction that involves a violation. This portion of the bill contains identical language from Section 3102 of the California Franchise Investment Act, where this language has been law for almost 30 years and where more than 2,500 franchisors have registered for the purpose of selling franchises.

Unlike the laws of California, Hawaii, Maryland, Mississippi, North Dakota, Illinois and Washington, SBFA does not provide for criminal penalties for willful violations of the act.

Opponents Claim:  The bill prohibits franchisors from discriminating against similarly situated franchisees.  Under the bill, a franchisor would not be able to give a franchisee a few extra days to make royalty payments.  A franchisor would not be able to exercise individual discretion under this bill without setting off a slippery slope of reduced standards in the franchise system.  

The Facts Are: This is a grossly misleading statement of what SBFA says. The Bill only states that the franchisor cannot impose requirements not imposed on other similarly situated franchisees. It does not require the franchisor to refrain from granting waivers or extensions of time. Several states, including Hawaii, Indiana, Minnesota, Washington and Wisconsin have statutes that prohibit discrimination among franchisees in varying circumstances.  There is nothing novel about such a provision. It would allow a franchisor to exercise discretion as long as it had a reasonable basis to do so. 

 Opponents Claim: While the bill states that a franchisee has 30 days to cure any defects, it arguably would have an indefinite period of time to go in and out of compliance.  The bill says as long as the franchisee diligently pursue[s] substantial continuing action to cure.

Opponents Claim: The bill greatly expands the common law doctrine of Duty of Good Faith.  A statutory duty of good faith would give any disgruntled franchisee a cause of action in court with an amorphous definition that only a jury could decide.  This would invite courts to independently assess and retroactively judge whether the contract terms are valid or void.

The Facts Are: Congress has apparently determined that the words good faith are not so amorphous as to be excluded from the US Code where they appear 918 times including in the Internal Revenue Code. In addition, it is not the franchise agreement terms that would be examined for validity under the good faith standards of SBFA; rather, it would be the conduct of either party to the franchise agreement.

Opponents Claim: Under this bill, anytime that a franchisor would terminate a contract with good cause, based on the terms agreed to under the contract, the franchisee could sue for being denied the expected fruits of the contract.

The Facts Are: This is another grossly misleading statement.  SBFA grants to franchisors the right to terminate if there is good cause.  The obligation of good faith and fair dealing is a two way street in the Bill.  If  the franchisee violates a material provision of the franchise agreement and then does not cure the default within the grace period allowed, he or she would not be acting in good faith and would not be protected by SBFA.

Opponents Claim: The bill creates a Duty of Due Care by requiring business persons/franchisors to possess a special skill or knowledge to operate a business.  This duty does not exist in any other business code.  New businesses clearly do not have as many skills and resources of older, larger companies.  It would be left to juries to decide if younger companies have enough skill or knowledge to franchise.  

The Facts Are: This is yet another a grossly inaccurate statement of what SBFA says. It actually says that the franchisor must choose between claiming or specifically disclaiming such special skill or knowledge.  Franchisors sell franchises with the claim that they have a proven business format which gives the franchisee a greater chance of success than if they started an independent business.  Why would any fair-minded franchisor wish to make that claim and then be insulated from responsibility if it is not true?  Why would any fair-minded franchisor not want the record clear as to whether they are or are not claiming any such special expertise?

Opponents Claim:  The bill places an ambiguous limited fiduciary duty on franchisors for managing advertising funds and performing accounting functions.  

The Facts Are: There is nothing ambiguous or unusual about the notion of a fiduciary duty.  The word limited signals that the fiduciary duty is created only where the franchisor administers a pooled advertising fund or acts as the custodian of the franchisee s revenue.  In these situations, the franchisor is handling funds that do not belong to it; they belong to someone else.  Like any other person who holds the funds of another, they must act in the best interests of the owner of the funds.  Examples in everyday life abound: a custodian of minor s funds, the trustee of a trust, an executor of an estate, shareholders of a closely held corporation and real estate broker holding a deposit on a sale.  

While the weight of common law authority is that franchise agreements do not generally create a fiduciary duty, SBFA carefully carves out the two specific aspects of the franchise relationship which in any other context would be seen as creating such a duty.

Opponents Claim:  Generally when the parties settle a dispute out of court, they enter into a confidentiality agreement where the parties agree not to discuss the contents of the settlement.  This bill would prohibit such an agreement in the franchise context.  

The Facts Are: The FTC Rule and the UFOC Guidelines require the disclosure of the details of all material litigation and a list of franchisees who have left the system. It is very important for a prospective franchisee to know about disputes in the system that have ended up in litigation and how they were resolved. A confidentially agreement between a franchisor and a franchisee in this context is designed to defeat the letter and spirit of these disclosure requirements.

Opponents Claim:  The bill destroys centuries of contract common law by prohibiting integration clauses, thereby seriously bringing into question the sanctity of any contract making.  Integration clauses say that nothing outside the contract, i.e., outside verbal conversations, are binding on the parties when the terms of the contract are clear.  

The Facts Are: The bill destroys nothing except the right of a franchisor to make warranties and representations designed to induce the franchisee to invest and then hide behind the integration clause even when reliance is clear. This is the rationale used by the federal district court in New York in holding Minuteman Press liable for making false earnings claims when the franchise agreement and the UFOC said that no such claims had been made. See FTC v. Minuteman Press, Bus. Franchise Guide (CCH) 11,516 (E.D.N.Y. October 2, 1998).    

Opponents Claim: The bill would prohibit venue clauses that are common in many contracts.  Such clauses usually specify where litigation should occur if it arises.  

The Facts Are: Venue clauses are deemed so highly prejudicial to the franchisee that the UFOC Guidelines require that they be listed as a separate Risk Factor at the front of the UFOC.    

Opponents Claim: The bill expands the ability of franchisees to engage in class action lawsuits against the franchisor.  Since most franchise disputes are contractual in nature and rely on very specific facts, they generally do not lend themselves to class action lawsuits.  

The Facts Are: The text of SBFA does no such thing. The courts will continue to make a case by case determination on the question of class certification under Rule 23. The Bill only prevents a franchisor from barring the franchisee s participation in a class if and when certified by the court.  

Opponents Claim: The bill will require franchisors to allow a transfer of the franchise to almost anyone as long as the transferee meets the reasonable current qualifications of the franchisor.  What is reasonable would be left to a jury to decide.  

The Facts Are:  The word reasonable (with its derivations of reasonably unreasonable and unreasonably ) appear in the U.S. Code more than 7,000 times.   The transfer provisions of SBFA are drawn heavily from the New Jersey Franchise Practices Act. That statute makes is unlawful for a franchisor:  To impose unreasonable standards of performance upon a franchisee.   Franchising is very much alive and well in New Jersey.