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Is a franchisee a consumer or not?


Philip Zeidman

Let’s cut to the chase:  The answers are, respectively:  generally not (thus far) and yes.

Now, let’s take them in reverse order:  First, what are the consequences of consumer protection laws and thinking being applied to franchising?

Hardly a day passes without another example of the advance of such legislation and regulation, and in ways that take dead aim at franchise agreements. For example:

1. Requirements of “honest” or “fair” or “responsible” conduct by the seller.

2. An insistence on “choice” by the buyer.

3. An intense focus on the quality of the information provided to the buyer.

4. A focus on equal treatment of buyers.  

5. Striking down of techniques designed to make it more difficult for buyers to dispute their treatment by sellers.

It takes little imagination to reckon the impact on franchising if “consumers” were to include buyers of franchises as well as buyers of goods and services. So the answer is, quite clearly, yes:  It does, or can, make quite a difference. But the answer is never in a vacuum: Where might a franchisee be deemed a consumer?

A survey of the laws of franchising turns up relatively few danger spots, so far. In most countries, it is still clear that consumer protection laws are designed to protect individuals (or possibly companies) that are the end users of products or services, purchasing them for personal consumption.

In some countries, while as a general rule a franchisee is not covered by consumer protection laws, atypical circumstances may invoke the protection of those laws. Thus, in small transactions where the franchisee is deemed a “founder,” those laws might apply in Germany.  A “very small” or “micro” characterization of a buyer or transaction might trigger Mexico’s laws.  In France, that can only arise if the franchisee is viewed as a “non-professional.”

But the issue can arise in Italy where, for instance, the franchisee sells the products door to door and is obligated to buy them from the franchisor. In Japan and in New Zealand and in Guatemala, the expansive protection of consumers requires careful study of the scope of applicable laws.  

In two countries, the law clearly now goes further. Both are important markets, and the consequences for franchisors are correspondingly significant.

First, consider South Africa: For some years, that country has had a sweeping consumer protection law, explicitly applicable to franchise agreements. Among the ramifications: requirements of “fair value and good quality,” “honest dealing,” “choice,” the prohibition of “unconscionable conduct” and other desiderata that can be interpreted subjectively. 

But some of the consequences are objective in nature, and go far beyond most other franchise laws. Consider only two examples:

Violations of the act can lead to a fine, which can be as high as 10 percent of the franchisor’s turnover the previous year. While there is some dispute as to whether that was intended to reach turnover only in South Africa or globally, under either circumstance it could be far more punitive than under other regimes.

The act requires a “cooling off period,” like some other countries, but potentially much more disruptive to the franchisor than the U.S. Federal Trade Commission rule’s equivalent of a required period of time after disclosure before payment or execution.

Second, consider Australia: In November of this year, a new law will come into effect to “protect small business from unfair terms in standard form contracts.” That’s a lot of language requiring flesh on the bone. But picking one’s way through the minefield of interpretation, the effect on franchising looms large:

A franchise is almost always a “standard form agreement,” although how much “negotiation” afforded to the franchisee will be required to remove it from that characterization will certainly be debated and perhaps litigated.

The law addresses size in terms of the number of employees of the franchisee and the upfront price payable under the agreement. But many franchise agreements will certainly be caught.

“Unfair terms,” as might be expected, provides ample room for differences of opinion, but the statutory guidance leaves precious little reason for franchisors to be complacent.

Does it cause a “significant imbalance?” Is it reasonably necessary to protect the franchisor’s position? Will it cause “detriment” if enforced?  

Terms permitted or required by Australia’s franchise regulations are exempt. While the law is not yet in force, it will apply not only to new agreements after that date but also to renewals or amendments of agreements in effect before the law’s effective date.

In short, a substantial number of franchisors will be affected. They should be examining their agreements and their practices now.

And what of the United States? Every state and the District of Columbia has its own version of an unfair and deceptive acts or practices (UDAP) statute.  These statutes, nicknamed Little FTC Acts, are primarily intended to benefit consumers, but can have broader reach.

While the statutes vary by state, they all provide a private cause of action (unlike the FTC franchise rule) and the basis for a state enforcement action.  Plaintiffs’ counsel like UDAP statutes because, at least in some states, they provide attractive remedies such as treble damages, punitive damages, and attorney’s fees, and because, depending on the state, they can broadly prohibit unfair, deceptive and unconscionable practices.

The die has been cast. Two major jurisdictions have swept many franchise agreements under the umbrella of “consumer contracts.” Several other countries may reach the same result in particular circumstances.   Franchisors and their counsel who proceed on the assumption of business as usual do so at their peril.

Philip Zeidman is a senior partner in the Washington, D.C., office of DLA Piper and an expert in international franchise law. Reach him at philip.zeidman@dlapiper.com. He wishes to acknowledge Melinda Upton from the firm’s Sydney, Australia, office for her assistance with this article.

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