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Commerce in the United States and in most of the so-called developed world is Laissez-Faire -- unfettered, free and open. One does business much as one would like to do business. It is intended that there be a minimum of affirmative regulation, and that what regulation there is be limited to the prohibition of abusive practices and prohibition of monopolies from which abusive practices naturally flow.
When the United States was first formed, it was an amalgamation of independent states that held beliefs that they alone should be 'in charge' of what happens within them. Accordingly, commercial law developed into a hodge podge of different rules and approaches to doing business. It was deemed more important to focus upon what might happen in any given state than it was to consider the importance of commerce among the several states. And yet, interstate commerce was to be the engine that would drive the economy of the nation, and the realization of that brought efforts to make it easier for a company in New York to do business across all state borders with reasonable security that the rules were much the same as doing business at home. What ensued were the Uniform Sales Act and, eventually, the Uniform Commercial Code.
The purpose of the UCC is not to mandate rules that must be followed, in the sense that a failure to follow them would constitute a violation of law. It was rather to provide uniform standard practices, rights and obligations in a civil law context so that commercial enterprises could use similar documentation of transaction protocols no matter where they might be located or where their customers might be located. This uniformity of commercial practice standards provided reliability and the ability to assume that one could count on contracts being of similar enforceability regardless of the locations of the parties. The joke is, of course, that there are still differences in commercial practices from state to state, although practically everything that one needs to be able to rely upon is functionally uniform.
This leaves parties free to make almost any deal they like and set it down in writing that will be recognized anywhere as legally binding and enforceable. The trick word in that sentence is 'almost'. Local public policy issues still exist. Illustratively, covenants not to compete are of varying enforceability depending upon the public policy of the state where the person against whom it is to be enforced lives. Such covenants that are appurtenant to the sale of a business are enforced just about everywhere if their temporal scope is reasonable. Non competition agreements in employment settings vary more greatly in their enforceability from state to state. Post termination/expiration covenants not to compete in franchise agreements are enforceable in most states with varying degrees of strength and varying qualities of defenses being able to be raised against enforceability, and in at least one state are not enforceable at all. How to defeat/enforce them is dealt with in other tutorials on this web site.
One of the differences in categories of commerce that is recognized as the basis for different treatment is the question of whether a transaction is one directed at mass markets, a consumer transaction, as opposed to transactions that are more business-to-business. In the latter instance, the parties are deemed to have more savvy, and the arena of commerce is more a free for all in many important respects. Mass market, consumer transactions tend more to require sellers to provide 'perfect tender', to deliver what is offered with little wiggle room for such tricks as 'substantial' though imperfect performance. In B-to-B transactions, the rules of the game are rougher. In my view, that is how is should be. The government is not my babysitter. If I am in business, I ought to know how it operates. My capital is at risk. I am required to be smarter than someone who is only buying a candy bar. If I am not smarter, the free and competitive market will simply award success to my smarter competitors, and I will be chopped up into a terrine and fed to my creditors on a cracker. You don't have to be that bright to buy a candy bar. In the B-to-B world, however, free and open fierce competition is seen as the best and most efficient allocator of economic resources, so success goes to the most effective competitor with no one holding an umbrella over your head to protect you from the risks of unfettered competition.
Which brings us to franchising. Franchising is apparently a B-to-B transaction. You are going into business and purchasing the right to participate in an ongoing business relationship. It would normally be considered a 'Devil take the hindmost' affair. However, there have been so many Devils and they have taken so many hindmosts that an obvious and abusive imbalance in the bargaining equation has been recognized. The sale of franchises is now regulated a little more as a consumer affair, as that is seen as the only way to impede fraud and other abuses. It is the same approach that was adopted with respect to the sale of investment securities seventy years ago. And the reason is also the same -- flagrant abuse and fraud.
While there are some state statutes that purport to regulate the ongoing franchise relationship, most state laws in the states that do regulate franchise sales are disclosure laws. Tell 'em the truth and you're home free so long as you warn them that they still face normal business risks and there is no guaranty of success.
The Federal Trade Commission has promulgated a Franchise Rule that is also a disclosure only approach, but the rule is promulgated pursuant to Section 5 of the FTC Act that prohibits unfair and deceptive acts and practices in commerce, and there is no right for a private citizen to bring a lawsuit under that act. If the FTC doesn't institute an enforcement action, the abuser cannot otherwise be reached under that act. In a few states the abuser can be reached under the state Deceptive Trade Practices or Little FTC Act for practices that violate the FTC Franchise Rule.
What anyone thinking of buying a franchise needs to know, however, is that it is almost impossible ever to convince a prosecutor or enforcement agency to take action to protect you against an abusive franchisor. There is simply no enforcement budget for it. What enforcement budget there is does not provide resources for any public agency to become the protector of an individual. Maybe if the abuse is pervasive and seen to affect many victims, there might be government enforcement, but even then it is very rare. IF THE DEAL IS A BUMMER, YOU ARE ON YOUR OWN. YOU HAVE TO BE ABLE TO AFFORD YOUR OWN LAWYER AND DO ALL THE WORK YOURSELF. The Government is not your babysitter.
In most instances a cheated franchisee lacks adequate resources to deal with franchise abuse. Bad franchisors count on your not being able to do anything about it if they cheat you out of your investment and leave you financially ruined. Few competent lawyers will consider contingent fee deals for franchise lawsuits anymore unless there are many franchisees affected, the proofs are not that difficult, and the franchisor has a deep pocket able to pay big damages plus attorney fees. If there is no large group franchisee cohesive action, you are on your own and unable to do anything about it. And with tort reform, the big group verdicts against franchisors are harder to get and more often than not reversed on appeal.
If you get cheated, you are probably going to be on your own. Except for the very rare franchisee, you can't afford it.
How do you protect yourself from being cheated? There are two answers, and both require that you do what is needed before -- NOT AFTER -- you buy the franchise.
The first and best way to prevent yourself from being scammed is for you to keep your investment money in your pocket and get a job with a franchisee of the franchise system you like for a year and learn it from the inside. Even if you spend a year with a small salary, you do not lose your life savings and you are not bound to very one sided contracts. After that year, you will know every problem in that franchise system. In almost every instance, you will be really happy you did that, and in almost every instance you will decide that you do not want to be a franchisee of that franchisor. The reason for that is that franchises are simply not as good as the franchise sales brochures and sales pitches represent them to be. The secondary reason for that is that you will, at the end of that year, know enough about the business that you can do it as an independent and save yourself hundreds of thousands of dollars over the life of what would have been the length of a franchise contract you might have signed. The universal representation that franchised start-up businesses have a better chance to succeed than independent start-ups is and always was false. The odds on success or failure are exactly the same whether one is franchised or not.
The second best way to protect yourself from being scammed is to recognize that having a lawyer 'read contracts' is not competent due diligence. Investment due diligence involves a great deal more than contract reading. The lawyer who handled your divorce or real estate closing or who drafted your will -- any lawyer without a great deal of experience dealing with the franchise industry -- will not be able to do the due diligence you need to reduce critical risk. You need a lawyer who can vet the deal in its entirety, who knows where most of the dangers are hidden and how to root them out. Even with such a lawyer, there is no guaranty of success, no guaranty that you won't get robbed. But the likelihood of your getting ripped off can be greatly reduced because you see more of the risks. What kills you in most instances are the risks that you didn't recognize before you wrote the big check and signed the franchise agreement. You have to budget for this. If you can't afford about $ 5,000 for that due diligence, then you don't have enough money to buy a franchise. It is as important as any item in your total initial investment package, and, if you look at the expenses you are told about in the total investment list of costs, that due diligence is among the least expensive -- less than initial lease payments, initial inventory, initial franchise fees, start up advertising expenses and less that most other items of expense in the total initial investment. For that retainer you should expect to be able to have several franchise offerings vetted. It most instances the first franchise offering that you bring in for evaluation won't pass muster, and you will be looking at other opportunities. You don't pay a separate fee for each franchise that is evaluated. The practical history of it is that most people looking to invest in a franchise either find something that passes the smell test by the third choice or they change their minds about buying a franchise. Experience also shows that when a franchise opportunity is brought in for evaluation, the client is already pre-sold and has decided to buy it unless there is an overwhelming and glaring problem. You should expect your enthusiasm to be dampened by the very critical and searching examination and the adverse information that is discovered in that process. This is reality, not salesmanship. If you think that 'they wouldn't put it in writing if it weren't true, and the government regulates it', and on that basis you don't get competent help, you are probably on your way to the poor house, and that franchise you just can't resist is the express train to tap city.
How are franchises regulated? They are regulated by careful examination done before the purchase is made of the areas of risk that can only be identified by someone with a great deal of experience working with the franchise industry. All other regulatory resources are of little use because they are all after the fact and too expensive for practically any franchisee. Government assistance is simply an illusion. And that is how it should be. We all need to be responsible for taking care of our own interests, and that is the major assumption in franchise regulation.
Copyright 1997 - 2008 || Richard A. Solomon
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