Attorneys Weigh In as Action at FTC Turns to Franchising | Legal-eagles
The Federal Trade Commission in early 2022 sued failed burger franchise Burgerim, signaling a renewed regulatory focus on franchising as it also reviews and proposes a number of moves that could affect the industry.
Among them are the Franchise Rule, non-compete employment clauses and establishing a private right of action. Some steps could have far-reaching impacts, franchise attorneys say, while others feel essentially obsolete.
The FTC is reviewing the Franchise Rule, which establishes what franchisors are required to disclose to franchisees, and is considering a number of changes. FTC Chair Lina Kahn has made clear she wants to eliminate deceptive practices that negatively impact franchisees, employees and consumers. The commission has been seeking public comments on the matter since 2019.
Shipe Dosik Law attorney Kitt Shipe said the FTC is reviewing rules related to franchising because of franchisors who have violated disclosure laws. She referenced Burgerim and its owner, Oren Loni, who sold more than 1,000 franchises in five years, collected franchise fees and opened few stores. The stores that did open weren’t turning the profits promised, she said.
Neither the FTC nor the Franchise Rule guarantee a franchisee’s private right of action, but there’s nothing that prohibits it outright. An effort is being made in Congress, though, with the American Data Privacy and Protection Act. Introduced in June 2022, the legislation would guarantee U.S. citizens a private right of action, enforceable by the FTC, meaning individuals could sue regardless of the state they live in
“I do think it has sprung from a lot of abuses in franchising, accumulated abuses,” Shipe said. “But, the really big one is Burgerim. Members of the different regulatory authorities are being called to answer for what the heck happened. What went wrong? How did that get through and create hardship for so many franchisees?”
Changes to disclosure rules could put an end to franchisors who—knowingly or unknowingly—misrepresent the brand in their FDDs. “No longer will franchisors be able to just print shoddy FDDs and there not be recourse,” Shipe said, speaking on if the bill is passed.
David Koch of Plave Koch
The FTC is also considering proposing an earnings claim rule, which would address misrepresenting potential earnings. Plave Koch attorney David Koch said that rule would likely have a heavier impact on franchising than a non-compete ban. “I think that the mindset of the commissioners right now is to move toward broader, multi-industry rules, as opposed to industry-specific rules,” Koch said.
Koch doesn’t see Franchise Rule changes going forward until these other rulemaking proceedings are completed. “Even if they were to adopt changes in the Franchise Rule, that’s not satisfying because they really want the concepts to apply across the board,” he said.
Non-compete ban wouldn’t impact ‘zors—yet
In early 2023, the FTC announced a proposed ban on new and existing non-compete clauses, agreements that prohibit employees from moving to a competing brand within a specified time period. As proposed, the ban wouldn’t impact the non-competes franchisees sign that restrict them from owning a competing brand or starting their own. The FTC, however, has asked for comment on whether to include franchising in the ban.
Tom Spadea of Spadea Lignana
Spadea Lignana attorney Tom Spadea, whose firm represents franchisors in regulatory and transactional matters, said he wouldn’t see the point of extending the non-compete clauses to franchisees. In recent years, his clients are focused more on protecting the brand’s intellectual property, rather than enforcing non-competes.
When franchise lawyers are writing and reviewing a franchise agreement—a document that typically is good for 10 years—they have to plan for potential amendments to current laws, rather than what’s in the law at the time, Spadea said. “We’re trying to lean a lot heavier on the intellectual property and the trademarks and operations manual and the non-solicitation actions, as opposed to leaning everything on the non-compete,” he said.
“It’s a recognition that even if nothing happens at the federal level, a lot of states are moving in that direction,” Spadea continued. “You want a document that you can enforce across the country, because it’s a real potential harm to franchisors” if a franchisee signs a deal, spends a few years learning the ins and outs of the business, and then that franchisee abandons the brand and starts a competing business.
A ban on non-competes for franchisors “seems like an overreach, and could really hurt franchising,” he said.
Andrew Bleiman, an attorney at Marks & Klein, has worked in all realms of franchise law since he started in the space 20 years ago. In the employment arena, he’s seen a “softening of enforceability” in regards to non-compete clauses. In franchising, however, he thinks the ban could be problematic.
“It could potentially lead to franchisees … operating a competitive business without continuing to be a part of the brand, paying royalties and all that,” Bleiman said. If franchisees can own and operate a competing business, franchising as a whole would be negatively impacted. “It can really deteriorate the brand that they were a part of, if it’s a lot of people doing that.”
Bleiman doesn’t think there’s a problem regarding non-competes in franchising. For franchisees, “The notion that ‘I want to do this alone and not be a part of the brand anymore’ usually doesn’t come up,” he said.
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