The Federal Trade Commission took action Friday to address concerns raised by the franchise community last year.
In 2023, the FTC made a request for information on franchise agreements and franchisor business practices, including how franchisors exert control over franchisees and their workers. The comment period for the request closed June 8, 2023, with 5,291 comments submitted.
In those comments, some franchisees reported increasing payment processing and technology fees that make it difficult to make a living, while others identified undisclosed fees for training, marketing, property improvement or any other product or service required by the franchisor. In total, the FTC released 12 primary concerns from the RFI.
- Unilateral changes to franchise operating manuals.
- Franchisor misrepresentations and deception.
- Fees and royalties.
- Franchise supply restrictions and vendor kickbacks.
- Actual and feared retaliation.
- Non-competes and no-poach clauses.
- Franchise renewal problems.
- Franchisor refusal to negotiate contract terms.
- Franchise disclosure document issues.
- Private equity takeovers.
- Marketing fund transparency.
- Liquidated damages clauses and early termination fees.
At their worst, the FTC stated these concerns represent “unfair” and “deceptive” practices by franchisors, and that its goal now is to “ensure that the franchise business model remains a ladder of opportunity to owning a business for honest small business owners.”
FTC Chair Lina Khan
As part of its response, the FTC issued a policy statement warning that franchisors’ use of contract provisions, including non-disparagement clauses that prohibit franchisees’ communications with the government, violate the law. The statement also emphasizes that franchisee reports and voluntary interviews are a critical part of FTC investigations.
“Whether the contract includes a non-disparagement, non-disclosure, goodwill, or similar clause, the caselaw is clear that such clauses cannot operate to inhibit a franchisee from reporting potential law violations to the government,” the conclusion in the statement reads. “Clauses prohibiting franchisees from reporting potential law violations to the government are considered unfair and unenforceable. Further the use of implicit or explicit threats to sue or otherwise retaliate against a franchisee who reports potential law violations to the government is also an unfair practice.”
Additionally, it cites how a franchisee’s reluctance or inability to file reports and discuss their experience may hamper the agency’s work to protect the franchisees. Along with the policy statement the Commission provided a guidance document making clear that it is illegal for franchisors to impose undisclosed junk fees.
“Franchising is a chance for Americans to build a business, but the FTC heard concerns about how unfair franchisor practices, like a failure to fully disclose fees upfront, go unreported thanks to a fear of retaliation,” said FTC Chair Lina Khan in a release. “Today the Commission is making clear that contractual terms prohibiting franchisees from reporting potential law violations to the government are unfair, unenforceable and illegal.”
The FTC’s decision to adopt the policy statement was made in a 3-2 vote. Joining Khan in favor were Commissioners Rebecca Kelly Slaughter and Alvaro Bedoya, while Commissioners Melissa Holyoak and Andrew Ferguson were against.
In her dissenting opinion, Holyoak called the action an overstatement of law and wrote “the policy statement – whose ostensible purpose is to provide guidance that reflects existing law – does not explain what franchisors looking to stay on the right side of the law should do.
FTC Commissioner Melissa Holyoak
Today’s policy statement neither provides useful guidance, nor does it increase certainty about the state of the law,” wrote Holyoak. “Rather, it casts a pall over the use of non-disclosure, non-disparagement, confidentiality and goodwill clauses in franchisor-franchisee contracts, in a manner that is unlikely to help franchisors comply with the law while potentially impeding franchisors’ ability to protect their brands and intellectual property.”
In his dissent, Ferguson wrote, “policy statements are a form of sub-regulatory guidance – like circulars, dear colleague letters, and memoranda – that are supposed to supply nonbinding guidance on an agency’s understanding of the law or regulations. They can be useful to alert regulated entities of an agency’s enforcement priorities, or to provide practical suggestions for complying with the law.
“But agencies… now use these [guidance documents] not just to advise the public, but to bind them,” Ferguson’s opinion continued. “Indeed, using the policy statement as the ground for enforcement actions – a threat this policy statement makes plain in its closing paragraphs – turns this nonbinding policy statement into a type of informal law.”
With the decision now made, the FTC is now looking to continue the engagement with the franchise community, and it has reopened the comment period for the RFI. Comments can be made on the subject until Oct. 10 at regulations.gov.
In a release, International Franchise Association President and CEO Matthew Haller was critical of the Commission’s decision.
“The FTC’s actions today are contrary to the reality that the vast majority of franchise relationships are working and that franchising continues to grow each year,” Haller said. “We have long supported greater transparency and visibility in the franchise sales process.
IFA President and CEO Matt Haller
“The IFA encourages the FTC to focus on improving the Franchise Rule by adopting the IFA’s 2024 Responsible Franchising policy recommendations, which seek to empower prospective franchisees with the best information possible and clarify both parties’ obligations as part of the franchise agreement,” said Haller.
Haller added that the IFA has urged the FTC to avoid broad changes that don’t consider the nature of the business model.
“The FTC’s guidance today regarding fee disclosure in franchise agreements stands to unnecessarily restrict franchisors’ ability to innovate and evolve their system, damaging the equity of franchisees for whom the FTC actions are purposely taken,” Haller said. “The IFA will continue to work with the FTC to improve the model for all parties involved and the customers they serve.”
The new actions by the come just over two months after the FTC announced a new ban on non-compete agreements at the national level, which excluded those between franchisors and franchisees. In its May decision, the FTC found the relationship between a franchisee and a franchisor more similar to those between two businesses than between an employer and employee.
The FTC’s ban has since been partially blocked in federal court before it could take effect in September.