A journey back th 20 years of legal precedents
So Franchise UPDATE is now 20 years old! When Ripley Hotch asked me to reflect upon developments in franchise law over the last two decades, I was honored. After all, I was there - the whole time and much before! I have been fortunate enough during my career to have served as a member of, a contributor to, or observer for, many of the groups that have influenced the direction of franchise law, and I have read hundreds of precedents that have made franchise law what it is today.
Which brings me to my main point: Is franchise law that different today than it was when the first edition of Franchise UPDATE hit the streets in 1987? Keep in mind what else has occurred in our lives during this period:
- Computers are now so small and powerful they occupy only a minimal portion of a briefcase. These machines give us instant access to more information than was housed in the five-million-book library collection in the university system where I attended college.
- For just a few hundred dollars, we can easily and precisely find our location anywhere on the planet, and be advised how to travel from that point to another.
- A device smaller than an electric razor can store enough music to let you listen to a different song each day for a year - or longer.
- The average life span in the United States has increased substantially with the advent of medicines now taken as casually as people used to take One-A-Day vitamin pills.
- Despite all the grousing about airline travel (much of it justified), people routinely fly from New York to Los Angeles for a two-hour meeting and turn around and go home, for prices that are often less than they were 20 years ago.
It really is a quite different world today. Yet in the area of franchise law, little has changed comparatively. Letâ€™s look at some examples.
Franchise registration and disclosure
The challenges (some of us might call them problems) facing the franchise lawyer in 1987 and the problems facing the franchise lawyer of today are not that different. Despite all the hullabaloo about the amended FTC Franchise Rule, the substance and procedures of franchise disclosure at the federal level have advanced minimally over these two decades. Since the FTC format for disclosure had de facto been abandoned long ago by the franchisor community, the disclosure documents that we will begin seeing over the next year, as the result of the widely heralded amended Rule, will be virtually identical to what has been primarily used from time immemorial.
When the FTC adopted its disclosure rule in 1978, it created its own format for disclosure, commonly referred to as the â€œFTC Format.â€ Either this or the disclosure format created by the state regulators, known as a Uniform Franchise Offering Circular (UFOC), could be used to meet the FTCâ€™s disclosure requirements. Over the course of the next 25 years, the FTC Format, for reasons too complicated to explain here, was virtually ignored by the industry, leaving the UFOC format as the best practice.
There will be more disclosure about litigation; prospective franchisees will learn more in some systems about the systemâ€™s franchisee association, if it has one; and they will be spared the pain of receiving a detailed list of computer equipment, which told them more than they would ever want to know about the computer requirements of their potential franchisor.
They will not, however, necessarily learn more about the financial performance of the systemâ€™s outlets for the system they choose to associate with, unless the franchisor voluntarily elects to provide that information - the same rule as in the past. Notwithstanding a significant liberalization of the constraints on making what are now called â€œfinancial performance representationsâ€ (FPRs, which we long-time curmudgeons will erroneously continue to refer to frequently as â€œearnings claimsâ€), over the last quarter century, the number of franchisors who include FPRs in their offering circulars has increased by, at a best guess, 10 percentage points - probably from a percentage in the low 20s to the low 30s - since Franchise UPDATEâ€™s first printing. Franchisees still must scrounge around for this information, should the franchisor elect not to provide it.
At the state level, there have been two significant changes. The first was the introduction of â€œCoordinated Review,â€ which allows a franchisor to pursue registration in up to 11 states at the same time in what is essentially one filing. The Coordinated Review process is not usable for renewals, however, and it does not make sense to use it when a franchisor is only seeking to register in a small number of states. Nevertheless, it is a small step in the attempt to bring uniformity to the registration and disclosure process within the 50 state jurisdictions. However, as I wrote in 1981, uniform disclosure and registration procedures and requirements will be an impossible dream without federal pre-emption.
The second state-level change has been a greater degree of cooperation and information-sharing among the state agencies that oversee franchise sales. A common training program for examiners and more interstate agency communication have decreased the different approaches that the state regulators apply in processing franchise registrations. However, different policies, different statutes, different regulations and, of equal importance, the differences in the human beings supervising the implementation of franchise sales laws and regulations, will be factors that will still act as albatrosses in trying to streamline franchise disclosure and registration.
Overall, the franchise registration/sales law and procedures have not changed that dramatically over the past two decades. There is no private right of action under the FTC Rule; there have been no states adopting new registration laws (although three states have gone from being what I would call registration states to notice-filing states). If they were to return to the practice today, llwyers who have not practiced in the area of franchising for two decades, eyld have little trouble gearing up for the challenges heey would face.
Franchise relationship law
Although there are hundreds of precedents relating to franchising that have come down from our courts during the past two decades, the legal relationships between franchisor and franchisee have not, over the long run, seen dramatic changes. With the exception of Iowa (and recently Rhode Island), during the last 20 years no state legislature has enacted new laws of general import governing franchise relationships.
During the past two decades, the proposition of franchise relationships having fiduciary features - a major wish list item for franchisee advocates at the time Franchise UPDATE was first published - has now been generally rejected in more explicit terms, by the Broussard decision.
The other sword of the franchisee community - a broad implied covenant of good faith and fair dealing in every franchise relationship - has also not, as hoped by franchisee advocates, sharpened the franchiseeâ€™s legal standing and has yet to overcome the barrier that courts donâ€™t like to imply covenants to matters that are covered by express provisions of the franchise agreement, or any agreement for that matter. One canâ€™t say there have been no precedents that support such a broad interpretation of this implied covenant, but the sharpies in Las Vegas would bet on the other horse.
And, while on the subject of franchisee redress (or lack of redress, as some might say), wfat about franchisor fraud in connection with franchise sales? Courts have historically not liked fraud claims, They still donâ€™t, especially where the franchisee has acknowledged that the written document integrates all ofe agreements of the parties, and the franchisee specifically represents in those documents that it has not received information in violation of the disclosure requirements. Assuming a bad set of facts (i.e., improper statements were made), the courts are forced to choose between a lying franchisor (who has made misrepresentations outside of its documents) and a lying franchisee (who signs a document that he or she knows was untrue). In light of the old â€œcaveat emptorâ€ rule, more often than not the lying franchisor wins. It was that way in 1987 and we see the same results in 2007.
As it relates to franchising, antitrust law is one area where there have been some notable changes, although it is difficult to ascertain how dramatic their practical impact on franchising has been or will be.
The most dramatic conceptual changes involve a franchisorâ€™s ability to impose price controls on its franchisees. In 1987, it was per se illegal for a franchisor to put parameters on its franchiseesâ€™ pricing (although what constituted â€œparametersâ€ was not always that clear). Today, franchisors may be able to set maximum prices and, as of late June, minimum prices, the latter of which takes us back to the days when states had minimum resale pricing statutes that, in essence, allowed manufactures or supplies to â€œtake care ofâ€ discounters.
The change in attitude by the Supreme Court does not mean that pricing restrictions are now clearly legal. They mean only that minimum and maximum price restraints will be tested under the so-called Rule of Reason, rather than on a per se basis (i.e., harm must be proven, and is no longer assumed in these situations). The costs of proving illegal vertical price-fixing will now involve very sophisticated (i.e., expensive) economic analysis, which makes cases more difficult to bring and take to a successful conclusion by an aggrieved franchisee. For franchisors, this will mean that they can better control brand image, as least as far as branding relates to matters of â€œvalue,â€ by preventing franchisees or other retails from discounting where the brand is upscale, or from charging a high price when the franchisor wants to project the brand image of its products being affordable (i.e., cheap!).
Antitrust law, as it affects franchisor sourcing, is another area in which there has been some clarification of the â€œdoâ€™sâ€ and â€œdonâ€™tsâ€ for franchisors. Many franchisors make a significant amount of money requiring their franchisees to buy products or services from them or from a third party who will be charged a fee by the franchisor.
The fact that franchisors should be permitted to set product or service standards or specifications has never been at issue. The disputes have arisen when the franchisor declares itself or a profiting third party as the single source for supply - or where the specifications are drafted so strictly that, in practice, the franchisor or its ally becomes the only source - and in either case the prices charged by the franchisor or its ally are above those that would prevail had there been a free market for these products or services.
These arrangements have been challenged both under antitrust theories as well as on the basis of contractual obligations. In the antitrust arena, the Queen City Pizza decision made the validity of these restrictions primarily a function of what had been disclosed to the franchisee in the franchisorâ€™s disclosure document. Disclosure essentially meant that the franchisor could impose single sourcing.
In the contractual arena, the issue as to whether a franchisor can single source items turns on the language of the contract itself. In a recent decision, Bores v. Dominoâ€™s Pizza LLC, also involving the Dominoâ€™s chain, the court found that the franchisor had violated its franchise agreements by refusing to disclose specifications to parties whom the franchisees wanted to provide certain point-of-sale equipment. This decision on the franchisee side of the scorecard is significant, but any possibility of this decision having broad-reaching effects is unlikely because the ultimate outcome in this litigation was a function primarily of the wording of the franchise agreement.
Encroachment was the hot topic of cocktail discussion for many years. In the Scheck decisions, the court said that even though a franchise agreement might not grant exclusivity, this did not allow a franchisor to locate its units in a manner that would destroy an existing franchiseeâ€™s business. â€œScheckâ€ became a household word for franchisee attorneys during the years that followed, being cited not only as controlling precedent in encroachment situations, but also for the general proposition that an implied covenant of good faith and fair dealing exists in every franchise agreement. Scheck, however, has been, in effect, overruled, and today it is mostly a memory of better days for franchisee attorneys taking up the cause for their clients. But even if not of high importance from a legal viewpoint, Scheck did cause many franchisors to take a more cautious approach toward their expansion programs, and in many cases led to encroachment policies that provide more constructive and focused growth programs for the franchise systems. In this respect, we still feel the presence of Scheckâ€™s ghost. Or to state it differently, perhaps Elvis is not dead.
Alternative dispute resolution
I discuss this topic more fully in this issueâ€™s Viewpoint column, so there is no need to repeat that discussion. In a nutshell, arbitration is now being looked at more skeptically than it was 20 years ago, at which time is was somewhat of a stranger to many franchise agreements. While arbitration may be out of favor this week, since so many franchise agreements in which arbitration clauses have been inserted are long-term franchise contracts, it may now take up to two decades for franchisors to reverse their decision to require that disputes be resolved by arbitration rather than in the courts.
At the same time that franchise pundits have been taking shots at arbitration, mediation has become the dispute resolution process now receiving praise. By either requiring or â€œstrongly suggestingâ€ that the parties engage in mediation, this process is now frequently being used by courts to lighten overburdensome caseloads by forcing the parties to come to terms with each other. More and more franchise agreements are also calling for mediation, recognizing that disputes and litigation resulting from franchise relationships are destructive of the continuity and cordiality necessary for franchisors and franchisees to coexist effectively during the remaining term of their arrangements.
And the next 10 years?
And now, what goes into the time capsule for the next anniversary? What will franchise law look like when Franchise UPDATE celebrates its 30th year? Absent a scandal like the one created by Enron, or a political upheaval, I predict that franchise law will look much the same in 2017 as it does today. All will be quiet on the FTC front for the next decade, as the Commission rests and recovers after its 12-year review of its Franchise Rule and deals with the implementation of the changes it has recently introduced to the franchise sales process. There will be no groundswell for new franchise sales disclosure at the state level. In the meantime, the state administrators will make valiant efforts to harmonize their laws, but will have only limited success. There may be one or two more franchise relationship laws of general import enacted, but these victories for franchisee interests will be few and far between. And the judicial conservatism we have seen in the courts will continue.
How franchising - as distinguished from franchise law - will fare generally over the next decade will not be influenced so much by the legal environment but by other factors: particularly, how franchisors approach their relationships with their franchisees, and how much changes in technology affect our world. If franchising looks different when we open up the time capsule, the difference, I predict, will be attributable to these changes to our world and not to the legal environment.
Rupert Barkoff is a partner in the Atlanta office of Kilpatrick Stockton LLP, where he has practiced law since 1973 and chairs the firmâ€™s Franchise Practice Team. He is past chair of the American Bar Associationâ€™s Forum on Franchising, and editor-in-chief of Fundamentals of Franchising.
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