The utterly futile claim for freedom of contract has been the universal battle cry of all franchisors. Their championship of ""laissez faire"" has almost achieved biblical status…At best, the franchise agreement is completely one-sided. It is pre-drawn by highly experienced franchisors and their sophisticated counsel without any meaningful participation by the franchisee either in the drafting or negotiation of harsh terms. Under the aegis of contractual priority, almost every significant aspect of good faith and fair dealing has been restricted or disappeared in some jurisdictions.
U.S. Federal Trade Commission
Auugst 5, 1997
Public Comment
Harold Brown, attorney
Request for public comment on possible revisions to The Franchise Rule.
Comment #103
Application of FTC Pre-Sale Disclosure Rule to Sale of Foreign Franchises
By Harold Brown©
Introduction
The FTC announced that it is considering whether its Franchise (Pre-Sale Disclosure) Rule
should be revised to exclude an American franchisor's obligation to present a prospectus to a
prospective franchisee for a site that will be located outside the United States. The Commission
has scheduled informal hearings on this and other possible changes in the Rule. This
presentation recommends that the Rule remain applicable to such foreign franchise sales.
[a] Statutory Power Related to Foreign Activity
The application of the FTC Disclosure Rule to the sale of foreign franchises, starts with examination of the statute.(1) The language of section 5 of the FTCA applies to acts or practices "in commerce." By contrast, the Robinson-Patman Act expressly limits its prohibition of price discrimination to sales of products in the United States.(2) The FTC statute is thus plainly applicable to all commerce without any Congressional limitation to domestic business. When Congress intends to limit the coverage to domestic activities, it does so in clear language.
For antitrust restrictions, also covered by the FTCA, it has been affirmed that American jurisdiction covers pricing violations that occurred in a foreign jurisdiction such as Japan, because the conspiratorial conduct was intended and did have substantial anticompetitive effects within the United States.(3) In a case of first impression, it was ruled that any other result would encourage price fixers to do their nefarious conspiring in foreign territory in order to influence competition in U.S. markets. The defense of comity was rejected in this age of international commerce where there are immediate competitive reverberations around the globe. The assertion of American power is of historical importance because cartels have long flourished in foreign countries. Those entities often consist of groups of competing enterprises that horizontally control production and prices for products sold in the United States.
The authority of the FTC over foreign conduct has been confirmed in many other references.
The decision of the First Circuit on horizontal pricing conspiracies in Japan, also applies to
section 5 of the FTCA that primarily addresses the identical antitrust concerns. It is therefore
clear that the same considerations affect the remainder of section 5(a) of the FTC Act, the
section under whose authority the Franchise Rule was promulgated. As noted below, foreign
franchisee performance can vitally affect a domestic franchise system.
[b] Rise of Foreign Activities in Many Franchise Contexts
For franchising, the coverage of foreign activity can be a significant factor due to the surge of
domestic franchise systems into countries around the world. There has also been a rise in the
acquisition of American franchisor systems by foreign purchasers. Foreign parents of domestic
franchise systems have difficulty in shielding themselves from antitrust liability like tying or pricing
through the use of layers of corporate entities.(4) The same principles apply to other federal and
state laws in general and to franchise protection laws in particular.
Such foreign ownership was involved where an American franchisor had been acquired by a
foreign parent. That issue existed after ultimate recovery against the American franchisor for a
variety of common law violations, including breach of fiduciary duties and especially a state
"little" FTC Act.(5) In that case, the issue was avoided because the American franchisor posted
an appeal bond to cover the full judgment. Foreign parental liability could be established by
agency, piercing the corporate veil, fraudulent transfer of assets, alter ego,(6) or simply under a
little FTCA.(7)
[c] Applicability of FTC Franchise Rule to Foreign Transactions
Some have questioned whether the FTC Franchise (Pre-Sale Disclosure) Rule expressly
applies to the sale by a U.S. franchisor of a franchise that will be located in a foreign country.
There is no such restriction in the terms of the Rule or in its historical formulation. The question
is accentuated by the fact that there has been huge growth of domestic franchise systems into
foreign countries and that foreign countries generally provide little or any protection for local
franchisees either in pre-sale disclosure or conduct control.
Three categories of sale may be involved, namely, (1) sale in the U.S. of a franchise to be
located abroad; (2) sale of franchise executed in a foreign country for operation abroad; and
(3) sale of a franchise in a foreign country that may be or eventually is located in the U.S. It is
also possible to make a distinction based on whether or not the buyer is an American citizen or
resident.
There is little doubt that U.S. law can constitutionally apply to all of those cases because of the
weighty amount of U.S. contacts that each of the foreign franchisees will have with their United
States franchisor from their first pre-sale contact and throughout the life-time of the franchise.(8)
Those relationships far exceed the constitutional requirement of "minimum contacts" and
traditional motions of fair play and substantial justice.(9) More significantly, they demonstrate
that the heart of the franchisor-franchisee relationship involves joint activities of the franchisor
and all of its franchisees in the U.S. and everywhere else. Every aspect of the franchise is
created, marketed, monitored, instructed, modified, and operated by the franchisor within the
U.S. or by its agents acting abroad with constant interaction between all of its foreign and
domestic franchises. All of the franchisees, both domestic and foreign, operate as a single family
with intra-performing synergistic accomplishments.(10)
In many franchise systems, the surge of international franchising has challenged or exceeded
U.S. operations. The operations of foreign franchisees will directly impact domestic dealers,
both in marketing and in physical participation. For example, a major domestic franchisor
appropriately complained that the poor operations of its multi-unit foreign franchisee seriously
damaged its U.S. goodwill.(11)
Prospective foreign franchise locations are equally in need of pre-sale disclosure. They are
entitled to all of the reasonably available data needed for them to make a rational purchase
decision that may endure for a life-time. The success of the foreign locations can constitute an
important factor not only in the welfare of the domestic franchisor, but also in behalf of its family
of United States franchisees. Some major franchisors have publicly disclosed that their earnings
from foreign franchisees equal or exceed their domestic profits. As with the Franchise Rule's
possible state law conflict, the regulations can be made effective unless there are equal or
superior foreign local requirements.
[d] IFA Objections to Foreign Application of the FTC Disclosure Rule
[1] Overview
The International Franchise Association (IFA) has filed with the FTC its objections to the
foreign application of the Franchise Rule requiring disclosure to franchise purchasers where the
business will be located abroad. While the IFA purports to speak both for franchisors and the
tens of thousands of franchisees now included in its membership, its objections continue to
reflect severe bias in favor of its franchisor constituency. Its stand is consistent, however, with
its universal complaint that franchisors should not be subject to any presale disclosure or
applicable conduct control; that the marketplace will provide adequate protection through
competitive forces; and that franchisees will better prosper for their deprivation of all franchisor
regulation. It is, of course, well established that after the franchisee purchases a franchise, he is
virtually helpless to resist any franchisor demand.(12)
[2] Foreign Purchasers Lack of Need for Franchisor Pre-Sale Disclosure
In overly simplistic terms, the IFA has asserted that domestic franchisors do not have adequate
knowledge of the multi-faceted foreign markets. They say that such foreign expansion is usually
done by the use of master franchises in which the foreign sub- franchisor sells to
sub-franchisees. Such substantial entities allegedly have far greater knowledge of local
conditions and they do not need the data provided by the American franchisor.
All of those premises are at fault. Even if the subfranchisors are substantial, some purchases of
single franchises will be made directly from the American franchisor. Further, such
subfranchisors are seldom knowledgeable about the particular franchise system nor even about
franchising in general. Their subfranchisees will be even more needful of disclosures by the
franchisor that created, marketed, and administered the franchise system for an extended time
period. That principle has already been acknowledged by the FTC in its requirement that the
franchisor must make full disclosure to subfranchisors and that both entities are directly liable to
the sub-franchisees no matter whether the documentation runs directly to the franchisor or to
the subfranchisor.
It is improper to claim that neither foreign subfranchisors nor their subfranchisees are entitled to
the pre-sale disclosures mandated by the Franchise Rule either in its present form or however it
may be modified to comport with the current Revised UFOC that has been basically approved
by the FTC as an alternative. Such distant purchasers are probably in the greatest need of the
data in the Rules various categories. They need to know the franchisor, its executives, and their
criminal and civil histories. They require reasonable descriptions of the franchise business, the
approximate costs, and the money payments that are required in royalties, advertising
contributions and otherwise. They need the franchisor's documented earnings and capital assets.
And they also want identification of existing and prior franchisees, both domestic and foreign, in
order to research the franchisor's track record. There may be variations that are necessitated by
the differences in the foreign and domestic circumstance.
The above review establishes that most of the Rule's disclosure consists of identical data for
domestic as well as foreign sales. As for strictly local conditions, it is quite reasonable to require
the franchisor-adventurer to make the pre-sale investigations abroad that are required of every
seller, probably founded on its own local experimentation and probably in association with its
prospective subfranchisors. But only the franchisor can provide the fundamental data, including
its own history of success or failure in foreign sales. In a recent matter, all four foreign
subfranchisors had completely failed, but that was not disclosed to a new prospective
subfranchisor for a nearby country.(13)
[3] Alleged Conflict with Foreign Laws
The IFA complains that the Franchise Rule may conflict with foreign laws. That pretext can be
quickly overcome by the fact that a franchisor would presumptively have to make a thorough
search of the laws in a projected territory. It is absurd to suggest that any foreign nation would
object to required pre-sale disclosures to its local constituencies. It might possibly have higher
requirements.
The FTC has not sought to employ preemptive jurisdiction over the laws of states or of foreign
countries. In fact, where it could have elected such control over state regulation, it wisely
decided to permit conformity with local laws as a substitute for compliance with the Rule,
provided that local protection for franchisees was equal or superior to that of the Rule. Such a
precedent would be equally appropriate where a foreign entity so provides. The IFA objection
completely omits any consideration for the need to provide minimal disclosure to persons who
need such data in order to make a meaningful lifetime investment.
[4] Inapplicability of American Data for Use in a Foreign Country
The IFA has strongly objected to the inapplicability of its UFOC data for use in a foreign country. It objects to the high cost of obtaining the basic data in numerous parts of the world. The objection has already been partly addressed in the prior discussion. There is, however, a major misleading factor in this contention.
The American franchisor is the sole entity that knows what information has to be developed. That applies not only to local marketing, pricing, and advertising, but more especially to the comparative factors that relate to each aspect of the franchisor's capital, operational, and procedural facets of the allegedly unique franchise system that it has developed. Local legal research may be needed, but it cannot be done by anyone without total involvement of the domestic franchisor.
[5] Limitations on Governmental Enforcement
The IFA argues that the personnel and financial enforcement assets of the FTC are already
strained in its domestic support of the existing Rule. It claims that application to foreign
franchising would therefore be a nullity due to lack of enforcement.
This contention flies in the face of reality. The FTC was not enacted to litigate claims between
private persons. Instead, it was designed as a vehicle to fashion needed regulation of future
market activities. A wealth of sanction mechanisms has been designed and have been widely
enforced by the Commission. Admittedly, the FTC does not have adequate staff or means to
protect all of those in need.
Recognizing that dilemma, the FTC expressly called upon the courts to enable private
enforcement of the Franchise Rule. That policy was given some initial support, but it has now
succumbed to a substantial array of judicial rejection, at least by lower courts. Fortunately,
however, every state has now enacted some form of "little" FTCA, many of which have enabled
private enforcement together with devices to implement enforcement by exemplary damage
awards and allowances for attorney fees.
It is unwise for the violator to object to foreign application of the Rule because the FTC does
not have the means of enforcement. Such an argument would eliminate the entire Rule. The
answer is that the FTC can act, both through education, consent decrees, and even civil fines.
Presumably, law abiding franchisors will comply. For others, the opportunity for private
enforcement remains available, facilitated by the frequent franchise covenant selecting local
American venue and the application of the law in the franchisor's home jurisdiction.
Instead of concern about enforcement debilities, the FTC should focus on the needs of
prospective franchisees, their entitlement to the pre-sale disclosure regulations, and the minimal
cost of its achievement by international franchisors with considerable assets and the prospect of
their increase in sales abroad. Foreign purchasers are entitled to assume that an American
franchisor has a trademark properly registered in the United States, that the company has
complied with American regulations, and that it will be answerable in an appropriate American
forum. The latter would be reinforced where there was contractual choice of American
venue.(14)
[6] All Regulation Should be Eliminated in Favor of Franchise Agreements Achieved by the
Direct Parties
The utterly futile claim for freedom of contract has been the universal battle cry of all
franchisors. Their championship of "laissez faire" has almost achieved biblical status.
At best, the franchise agreement is completely one-sided. It is pre-drawn by highly experienced
franchisors and their sophisticated counsel without any meaningful participation by the
franchisee either in the drafting or negotiation of harsh terms. Under the aegis of contractual
priority, almost every significant aspect of good faith and fair dealing has been restricted or
disappeared in some jurisdictions. Some states, like Texas and New York, recognize that the
good faith obligation has its origin in the severe imbalance of the relationship and that
performance under the covenants is subordinated to "good faith."(15) State conduct legislation
has rapidly stepped in to fill the need for statutory protection, but IFA opposition never ceases.
Perhaps the worst illustration has been publicly disclosed in Amway's successful lobbying of the
FTC's Congressional reauthorization with a hobbling amendment that severely restricts the
FTC's regulation-making authority.
The Franchise Rule is here to stay because the FTC has repeatedly confirmed its necessity both
in principle and in a long string of administrative and judicial proceedings.(16) The current
posture of the FTC does not import efforts to destroy the Rule, but how best to improve its
effectiveness at worthwhile cost.
The same IFA arguments have been used to combat federal as well as state regulation in this
field. In every State that has managed to enact disclosure or other controls, franchisors have
fought its adoption at every opportunity, including both in the pre-adoption period and after
enactment. This has taken the form of litigation and, more notoriously, efforts to repeal
regulation or to gut it by amendments to such an extent that it remains of questionable value.
[e] Overall Comment
There are strong domestic reasons why the Franchise Rule should continue to apply to all direct
or indirect franchise sales abroad by American franchisors. There are valid systemic reasons
why foreign franchisees should have the same disclosure protection as their American
counterparts in the same franchise. The entire array of franchisor obligations is centered in its
domestic home office and should be equally involved and available to all franchisees, wherever
located. Illustratively, it would be strange to find a different Manual of Operations for each
country.
As declared by the First Circuit, in this age of international commerce, there are immediate
competitive reverberations around the globe.(17) That trend is evidenced in the European Union
(EU) as well as the North American Free Trade Association (NAFTA) and will undoubtedly
continue to expand. The largest American auto factory has initiated a multi-billion dollar
program to establish four mammoth-sized factories around the globe, capping a swarm of
comparable activities in every field of corporate endeavour.
It would be counterproductive for the FTC to recoil from the forum by retracting its regulation
of how domestic franchisors should act in selling their franchises for foreign operation. Such
retraction and compartmentalization is unjustified. For decades, franchisors have claimed that
contracts should govern all obligations. They say that conduct control is not essential because
pre-sale disclosure will provide the basic information. There is strong belief that disclosure is not
enough and that conduct control is essential but, in any case, disclosure should be retained for
its "sunshine" catharsis. Notably, future foreign purchasers are helpless to know about this arena
and to promote and lobby for such minimal protection that will cost franchisors very little.
1. © Harold Brown, 1997. Senior Partner in Law Offices of Harold Brown & Associates,
Boston, MA. Author of numerous books and articles, including H. Brown, "Franchising
Realities and Remedies," (Law Journ. Seminars-Press Rev. Ed. 1997).
1 15 U.S.C. 41-58, particularly sec. 45(a)(1) prohibiting "unfair methods of competition"
(oriented to antitrust violations) and "unfair and deceptive acts or practices in commerce".
2. See 15 U.S.C. §13; Texaco, Inc. v. Hasbrouk, 496 U.S. 543, 110 S.Ct. 2535, 110
L.Ed.2d 192 (1990).
3. See, e.g. U.S. v. Nippon Paper Industries Co. Ltd., _ F.3d _ (1st Cir. 1997); Dee-K
Enterprises, Inc. v. Heveafil, SDN. BHD. (BNA) 73 ATRR 449 (E.D. Va. Dkt. No.
97-556-A, decided Oct. 23, 1997).
4. See, e.g., Caribe BMW, Inc. v. Bayerische Motoren Werke Aktiengesellschaft, et al., 821
F.Supp. 802 (D. P.R. 1993) vacated and remanded 19 F.3d 745 (1st Cir. 1994)
5. See, e.g., Broussard v. Meineke Discount Muffler Shops, Inc., _ F.Supp. _, 1997 WL
112235 (W.D.N. Mar. 6, 1997) (on appeal) (recovery of over $650 million against American
franchisor owned by foreign corporation. The finding was reduced to $406 million because of
releases and other considerations. A surety bond has been filed for the appeal to the Fourth
Circuit).
6. Temmallo et al. v. Academy of Learning et al., No. 95-10596-EFH, decided June 2, 1995
(D. Mass. 1995).
7. See, e.g. Nader v. Citron, 372 Mass. 96, 99-100, 360 N.E.2d 870, 873 (1977) (recovery
as unfair practice under little FTCA); In re Larkin, Hoffman, Daly and Lindgren, Ltd. _ FTC
, CCH Trade Reg. Rep. 23,293 (1992); FTC v. Security Rare Coin & Bullion Corp.,
1992-2 CCH Trade Case 69,423 (D. Minn. 1992).
8. See, e.g. Burger King Corp. v. Rudzewicz, 471 U.S. 462, 85 L.Ed.2d 528, 105 S.Ct.
2174, 2187 (1985), citing, generally, H. Brown, "Franchising: Realities & Remedies" (Law
Journal Seminars-Press, rev. ed. 1997).
9. Id.; see Fish v. Tandy Corp., (CCH) Bus. Franch. Guide 11,187 (Tex. Ct. App. July,
1997) (long-arm Texas jurisdiction appropriate for purposeful minimum contacts by a
developer of distributorships in Russia, where it dealt with the Texas-based manufacturer of
consumer electronics through personal visits to Texas in negotiating the letter agreement; in
communications with Texas through telephone, mail and facsimile; and for the conflicting claims
for declaratory judgment, fraud and breach of contract related to or arising from the individual's
contacts with Texas).
10. See, e.g., Dayan v. McDonalds Corp., 466 N.E.2d 958 (Ill. App. Ct. 1984); 45 N.E.2d
1188 (Ill. App. Ct. 1985) (breach of domestic franchisor's contract by its French multiple
franchisee, establishing serious impact on McDonald's goodwill caused by foreign franchise operators'
conduct abroad).
11. Id.; see also, e.g. U.S. v. Nippon Paper Industries Co., Ltd., _ F.3d _ (1st Cir.
1997).
12. See, e.g., Wright-Moore Corp. v. RICOH Corp., 908 F.2d 128, (CCH) Bus. Franch.
Guide 9665 (7th Cir. 1990), after remand, 794 F.Supp. 844 (N.D. Ind. 1991), aff'd, 980
F.2d 432 (7th Cir. 1992).
13. The last subfranchisor was legally represented by the author.
14. See, e.g. Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth Inc., 473 U.S. 614, 626, 87
L.Ed.2d 444, 105 S.Ct. 3346, 3353 (1985) (Puerto Rico auto dealer required to comply with
contractual choice of venue in Japan, including application of American antitrust laws).
15. See, e.g. Carvel Corp. v. Diversified Management Group, Inc., 930 F.2d 228 (2nd Cir.
1991) (CCH) Bus. Franch. Guide 9794.
16. Bailey Employment Systems, Inc. v. Hahn, 655 F.2d 473 (2nd Cir. 1981), on remand, 545
F.Supp. 62 (D. Conn. 1982), aff'd per curiam in an unpublished opinion (2d Cir. 1982).
17. See Nippon Paper Industries, n. 3, supra.
For Review, see FTC “Table of Commenters”
http://www.ftc.gov/bcp/franchise/comments/tabcomm.htm
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Risks: F.T.C. Public Comments, United States, 1997, Harold Brown, Masterpieces of deceptive wording and artful omission, Controlling, trapping or defeating the franchisee, Trap for the trusting, International Franchise Association, IFA, United States, 19970805 Comment 103
