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Overkill?

Protecting only those who need it would be the ideal


Published:

Philip Zeidman

Dateline: New Orleans

As in last month’s column, I want to address an issue raised, in one variant or another, during the “international” sessions at the annual International Franchise Association Convention here:

Aren’t some of these franchise laws overkill?  Do prospective franchisees need or even want these protections?  Isn’t there some way to target them to reach only those who most need the protection they’re designed to provide?

All good questions. It’s simply bad public policy, wasting private and public resources at a time when both are in short supply, to install the infrastructure and regulatory requirements of a franchise law unless those to be protected by it are truly in need of that protection.

All shapes and sizes

Let’s assume for the purpose of argument—and it is surely an arguable proposition—that the franchise disclosure laws are in fact necessary or desirable, and that there is a category of prospective franchisees who are in need of the protection they are designed to afford.

The problem, of course, is that franchisees come in all sizes, shapes and forms, and with a wide range of resources and sophistication. Unfortunately, the pattern of international regulation largely ignores these differences.

Several franchise statutes or regulations have sought to strike a sensible balance, targeting those in need of protection by excluding those who are not. Thus, the UNIDROIT Model Franchise Disclosure Law excludes from protection, among others, a franchisee of substance, who either commits to a total financial requirement in excess of an amount to be specified, or who, together with its affiliates, has a net worth or turnover in excess of an amount to be specified.  

The purpose is to relieve the franchisor of the cost, time and burden of compliance when there is a reason to conclude the franchisee is “a person of such level of sophistication and knowledge that he/she has access to the advice of legal counsel” or “who by virtue of his/her net worth or turnover is assumed to have such a level of sophistication and prior business experiences,” and thus “he/she does not require the protection of this law.”

This is similar to the theory of exempting “accredited investors” from certain aspects of the protection of the securities laws, using income and net worth as an admittedly arbitrary proxy for sophistication and experience.

But this approach has found little support, except in the United States. The U.S. Federal Trade Commission’s Franchise Rule (which preceded the UNIDROIT formulation) from the onset contained two exemptions for circumstances in which it could be concluded there was inadequate evidence that a prospective franchisee required the protection of disclosure:  a very minimal investment; and a “fractional franchise” (the franchisee or its principals have had at least a specified minimum period of prior experience in the same type of business; and the parties anticipate the sales from the proposed relationship will represent no more than a specified percentage of the dollar volume of the franchisee’s total projected gross sales for an initial period of time).  

More recently the FTC expanded this effort to narrow the protection of the rule to those deemed in most need of it, exempting very large investments and franchisees with large net worth. Most of the states with franchise registration and disclosure laws have enacted fractional franchise exemptions, but the exemptions vary from state to state and may require the payment of a filing fee and/or the submission of an exemption notice.  

Not welcome

Several of the states with franchise registration and disclosure laws have exemptions for large franchisees (meeting certain minimum net worth and/or experience requirements) and/or large investments (meeting a threshold level of investment in the franchise), but some of the exemptions provide the franchisor with freedom only from the obligation of registration, not of disclosure.

Jurisdictions outside the United States have, by and large, not welcomed such initiatives.  Australia and certain Canadian provinces have adopted a version of the “fractional franchise” exemption.  But other countries have typically not followed the approach, and with the exception of certain Canadian provinces none appear to have adopted the large investment or sophisticated/large net worth exemptions.

Exemptions and exclusions seem an eminently sensible way to narrow the target of these laws to those to whom they should be directed.  Unfortunately, far too few countries have taken this commonsense cause of action. In theory it is not too late for those countries to recognize the damage done by the blunderbuss approach, and to repeal provisions of this nature.  Realistically, that is almost certainly not going to happen:  the combination of pride of authorship, inertia and the lack of any organized and informed processes for change means we are probably going to have to live with what we have.

But that doesn’t mean that must be the case in the rest of the world—the countries without franchise laws, but forever potentially vulnerable to a legislative or regulatory proposal.  I’ll address those countries (still, most of the world) in a future column. 

Philip F. Zeidman is a senior partner in the Washington, D.C., office of DLA Piper. He can be reached at Philip.Zeidman@dlapiper.com

 
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