United States: The Third Party To Your Franchise Agreement: Congress?

Last Updated: August 17 2015
Article by Alexander S. Radus

The Fair Franchise Act of 2015 (the "Act") makes a lot of promises: it will promote fair business relations, protect franchisees, and create a thriving franchise business climate, better wages and benefits, etc. But the Act can't fulfill any of them unless it makes (and keeps) one more promise – to become the squeaky third wheel in the contractual relationship between Zees and Zors. And that is the one promise the Act is certain to keep.

First, a little background. The Act was introduced in the House by Rep. Keith Ellison (D-MN) on July 23, 2015, and it was co-sponsored by Rep. John Conyers (D-MI) and Rep. Jared Huffman (D-CA). But it's not a new concept. Representative Conyers worked closely on similar legislation in the late 1990's as did Rep. Huffman four years ago when he was a California legislator.

Many prohibitions will sound familiar: Zors cannot make untrue statements; they cannot disclose FPR's that are inconsistent with their FDD's. What is different this time around is that the Act creates a private right of action, meaning Zee's can sue Zor's under federal law for such activities. And not only that – the Act creates a private right of action under the FTC Rule as well, which for nearly four decades has only been enforceable by the Federal Trade Commission.

Yes Zee can / No Zor can't

Among the Act's many prohibitions, Zor's cannot:

  • hinder the formation of or participation in Zee associations,
  • charge "excessive and unreasonable" renewal fees,
  • enforce certain arbitration provisions, or
  • require Zee's to maintain non-competes with the Zee employees.

Conversely, Zee's can do any or all of the following (and Zor's cannot terminate or fail to renew the franchise):

  • refuse to take part in a promotional campaign if it is not "reasonable, implemented in good faith, and expected to promote the profitability of the franchisee's business,"
  • refuse to sell product or services at the Zor's suggested (or even required) price, or
  • refuse to keep the business open during unprofitable hours.

We'll know it when we see it...

The Act also prohibits Zor's from engaging in conduct and behavior that is difficult to define with particularity. What does it all mean? No one will know until Zee's and Zor's litigate and courts decide. Zor's cannot impose a "standard of conduct or performance" on Zee's unless the Zor can "prove" that the standard is "reasonable" and "necessary." Zor's must deal "fairly" and "in good faith" and exercise "due care" with Zee's in all business matters. Zor's cannot sell (or even offer to sell) a product or service to a franchisee unless the price is "fair and reasonable" or unless the Zor has a "reasonable expectation" that the sale will be profitable for the franchisee's business.

Just when you thought you were out...

The Act singles out franchise transfers, renewals and terminations for specific treatment. Here perhaps more than anywhere else, the Act prohibits contractual provisions that parties routinely take for granted.

Transfers: Most contracts frequently contain prohibitions on one or both parties assigning their contractual rights. But under the Act, a Zor must accept a transfer if the transferee satisfies "reasonable qualifications," which must be based on "legitimate business reasons." A Zor may want to update a franchise agreement for the new transferee, but under the Act, the Zor cannot change any material terms or financial requirements. Finally, if existing Zee's want to sell assets or securities to one another or engage in other business consolidations, the Zor generally must accept such changes.

Renewals: Under the Act, Zor's must renew franchise agreements unless they have good cause. Of course, the failure to pay royalties is good cause, right? Not necessarily. The Act suggests that Zor's must renew a franchise even if a Zee does not pay royalties, advertising or marketing fees, unless the failure to pay is "repeated and intentional." Zor's must provide a cure period for nearly every kind of breach, cannot enforce certain non-competes, and Zor's cannot charge "unreasonable" renewal fees.

Terminations: The Act would require Zor's to show good cause to terminate a franchise or to "substantially change the competitive circumstances of the franchise." Alternatively, a Zee can terminate without any further liability over "substantial negative impacts" or "substantial financial hardship" caused by changes in the system or competitive circumstances.

The Act is still just a bill on capital hill, far from becoming law. But its provisions showcase how far from center some lawmakers stand on issues central to the franchise model – and how deeply into the contractual relationship between Zors and Zees some lawmakers are willing to reach.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Alexander S. Radus
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