FTC Takes Action Impacting the Franchise Relationship
On Friday, July 12, 2024, the Federal Trade Commission (“FTC”) published an analysis of the information it received in response to its Request for Information related to franchisors’ business practices, launched in March 2023 (the “RFI”). As a result of that analysis, the FTC also issued guidance that prohibits “junk fees” and restricts contract clauses that impose restrictions on franchisees ability to speak freely with government agencies
Junk Fee Guidance
The FTC released guidance that addressed the issue of undisclosed fees being charged to franchisees’, and stated that it is illegal for franchisors to impose and enforce such undisclosed “junk fees.” The FTC’s position is that such junk fees are in conflict with the Franchise Rule’s requirements for franchisors to disclose certain fees and inform prospective franchisees of their likely economic obligations. Franchisees reported the potential junk fees in response to the RFI. Examples of junk fees include ever-increasing payment processing and technology fees, as well as undisclosed fees related to marketing, training, property improvement and other franchisor-mandated products or services.
The FTC warned against both the practices of (i) imposing a new and undisclosed fee upon its franchisees, and (ii) enacting unilateral changes (i.e., increases) to its franchisees’ existing fixed fees. The policy statement explicitly addressed the issue of some franchisors increasing fees by making changes to their operations manuals.
Regardless of which method a franchisor utilizes, the FTC’s guidance stated a franchisor’s failure to disclose its fees (and attempts to collect junk fees) is a violation of the Franchise Rule and Section 5 of the FTC Act, and may constitute an unfair act or practice.
We recommend franchisors disclose all known and anticipated fees in your FDDs. Avoid introducing new fees that have not been disclosed to your franchisees. If any fees are described as set or fixed, do not attempt to increase them unilaterally. Rebates and markups in the FDD also require this topic’s attention. Although the application of the FTC’s policy statement to the franchisor’s supply chain remains a gray area, franchisors should provide specific language in Item 8 regarding any anticipated purchase requirements and/or price increases, especially when the franchisor acts as the supplier of particular goods or services. For more information regarding the FTC’s staff guidance, click here.
Issue Spotlight
In addition, the FTC released an issue spotlight, regarding comments it received in response to the RFI. The RFI focused on the franchise relationship, franchise agreements, franchisor business practices, and language barriers, among other areas of concern. It sought information regarding “how franchising is working well, and how it is not”—and how to improve the franchise model. In summary, one third of those franchisees, franchisors, and other stakeholders who commented called for additional substantive regulation of the franchisor-franchisee relationship beyond the Franchise Rule. Key concerns included unilateral changes to operating manuals, franchisor misrepresentations and deception, fees and royalties, non-competes, transparency issues, and liquidated damages clauses. The FTC also detailed a finding that franchise borrowers of SBA loans had higher default rates (3.9%) than their non-franchise counterparts (3.5%). Additionally, the FTC called out certain franchisors with the highest default rates—with highs of 8-20%. For more information regarding the Commission’s issue spotlight, click here.
FTC Policy Statement
The FTC also issued a policy statement that views contractual provisions restricting franchisees’ communications with the FTC, and other state, federal, and regulatory agencies, unfair and unenforceable. In particular, the FTC took concern with non-disparagement clauses, confidentiality, non-disclosure clauses, goodwill clauses, and other similar terms, which may be included in franchise agreements or other documents between franchisors and franchisees. Coupled with fears of retaliation from franchisors (i.e., threats of suit), the FTC and certain public commentators, who provided responses to the RFI, are concerned that these provisions may chill truthful communications from franchisees to government agencies.
The FTC will evaluate the legality of chilling contractual provisions on a case-by-case basis. This policy statement is applicable to all binding agreements or any other documents between franchisors and franchisees, regardless of when they were executed. In response to the FTC’s policy statement, franchisors may: (i) although burdensome, amend pre-existing agreements to remove terms that restrict franchisees’ communications with government bodies, (ii) ensure that all future agreements are similarly aligned, (iii) refrain from enforcing any such restrictions against franchisees, and (iv) refrain from taking any retaliatory actions (express or implied). For more information regarding the FTC’s policy statement, click here.
The FTC recently launched a new franchise website. For more information regarding the FTC’s latest franchising materials, click here. The FTC also reopened the public comment period for the RFI to allow for additional comments until October 10, 2024.