proposed small business franchise act: An attempt to level the playing field in the franchisor-franchisee relationship, The

Greco, Anthony J

While franchising, or the selective distribution system, can be traced to early 19th-century America, it experienced a great spurt of growth in the 1980s. In fact, franchising sales of goods and services reached approximately $640 billion near the end of that decade, a figure that exceeded the level of such sales at the start of the decade by over ninety percent (U. S. Department of Commerce, 1988). Presently, one of every three dollars spent by Americans on goods and services is done so in franchised businesses. Annual franchising sales are currently in excess of $800 billion (Maynard, 1997). This continuing expansion was set into motion because franchising offers advantages to franchisors (suppliers), franchisees (distributors), and consumers as well. These advantages have been adroitly discussed by other authors.1

With the growth of the franchising mode of distribution has come increased concern over the effects of such a system on the primary parties, i.e., franchisors and franchisees. Since franchise agreements are initiated by franchisors (suppliers), the tendency is to cast such agreements in ways that principally emphasize the well-being of the franchisors. This does not mean, of course, that the welfare of franchisees is totally ignored for one cannot hope to attract franchisees into a system that offers no benefits. However, franchisors certainly hold the advantage in this process due to their unilateral development of franchising agreements. Consequently, franchisees over time have become sensitive to certain provisions within franchising agreements that they consider to be unfair or unreasonable. These concerns have resulted in franchisee complaints relative to such things as fraudulent practices in the sale of franchised businesses, unfair practices on the part of franchisors in the operation of franchised businesses, and unpredictable and inconsistent settlements of disputes arising under franchising agreements.

These franchisee concerns have prompted considerable thought and discussion as to how to improve the fairness and consistency of treatment in the sale, operation, and interpretation of franchise agreements. One approach that has been advanced is the passage of legislation that addresses specific problem areas inherent in franchising agreements. Legislation relative to franchising has, in fact, been in effect for years at both the federal and state levels; however, to date, it has not comprehensively dealt with all the specific problem areas involved in franchising agreements. For example, there are provisions for the rendering of disclosure information on the part of franchisors at both the federal and state levels. Further, there are general state statutes dealing with the termination and non-renewal of franchises, as well as federal and state statutes dealing with the termination and non-renewal of franchises in specific industries. To fill this void of legislative coverage relative to various problem areas in the franchising relationship, the American Franchisee Association (AFA) introduced the Model Responsible Franchise Practices Act in December 1996.

The Model Responsible Franchise Practices Act grew out of the American Franchisee Association's participation in the 1995 White House Conference on Small Business. Over 2,000 small business owners attended the conference. The AFA sent 137 franchisees and franchisee lawyers as conference delegates and collaborated with the other small business groups to ensure that the protection of the legal and constitutional rights of franchisees would be included in the list of 60 issues that would ultimately be presented by the conference to the President and Congress. During the process, the AFA and its fellow groups were asked by various members of Congress what they were specifically aiming for in legislative initiatives. Thereafter, a group of franchisees representing 30 different chains, as well as three franchisee attorneys, formulated and drafted The Model Responsible Franchise Practices Act after six months of work.2 Subsequent to this, H.R. 4841, the Small Business Franchise Act of 1998, was introduced in the second session of the 105th Congress. No action was taken on this bill, but it was reintroduced as H.R. 3308 in the first session of the 106th Congress in November 1999. This author examines the purpose and main provisions of these bills and reviews positions taken both for and against them.

The Small Business Franchise Acts of 1998 and 1999

Purpose of the Acts

The original bill (H.R. 4841) was introduced in the U. S. House in 1998 and reintroduced as H.R. 3308 in 1999. Since the two bills are virtually identical, references to this Act, unless otherwise stated, will focus on the 1999 bill, H.R. 3308. The bill is based on the Model Responsible Franchise Practices Act, which has been discussed elsewhere by the author.3 Its purpose is to promote the vitality of franchising through fair and responsible franchise practices (American Franchisee Association, 1996). The purpose of the proposed Small Business Franchise Act is to promote fair franchise agreements and to establish uniform standards of conduct in franchise agreements while establishing uniform private federal remedies for violations of federal law (U. S. House of Representatives, 1999, Section 2). This purpose grew out of several "findings."

Most significant among these Congressional findings were that (a) despite the fact that they generally invest rather substantial amounts to obtain the franchise, most prospective franchisees lack bargaining power and are generally unfamiliar with operating any business, including the business being franchised and its peculiar industry practices; (b) many franchise agreements provide a profound imbalance of contractual power in favor of the franchisor and, consequently, provide insufficient regard to the legitimate business interests of the franchisee; (c) franchisees can suffer substantial financial losses when franchisors provide fraudulent or incomplete information relative to their franchises as well as when franchisors do not act in good faith in carrying out franchise agreements; (d) traditional common law doctrines have not evolved sufficiently to adequately protect franchisees from fraudulent or unfair practices in the sale and operation of franchises and, further, that franchisees have actually been denied adequate legal recourse to protect their interests by significant contractual and procedural restrictions; and (e) a franchisee's freedom to contract is greatly impeded by the factors described above in items (a) through (d) (U. S. House of Representatives, 1999, Section 2).

Franchise Sales Practices

The proposed Small Business Franchise Act of 1999 (hereafter known as "the Act") first enumerates unlawful practices regarding the advertising, offering, sale, or promotion of any franchise itself. Generally, the Act prohibits anything that defrauds or is intended to defraud prospective franchisees. The original bill (H.R. 4841) prohibited discrimination by franchisors among franchisees on virtually any basis, either in the solicitation of any franchise opportunity or in the selection of any location for a franchise business. However, this prohibition was curiously omitted from the current bill. In addition, the Act forbids misrepresentations in disclosures required of franchisors, such as making untrue statements or failing to furnish information required by law (U. S. House of Representatives, 1999, Section 3). Obviously, these prohibitions on disclosure are designed to protect prospective franchisees from being deliberately or accidentally misled about the nature and operation of specific franchise systems. This will protect such franchisees from becoming contractually obligated to undesirable franchising systems.

Unfair Franchise Practices

Section 4 of the Act prohibits certain unfair practices in connection with the performance, enforcement, renewal, or termination of any franchise agreement. These practices are lumped under three categories: (a) Deceptive and Discriminating Practices, (b) Termination Without Good Cause, and (c) Post-Term Restrictions on Competition. The Deceptive and Discriminating Practices category reiterates the prohibitions on defrauding and discrimination found in the previous section of the Act. Further, this category prohibits any franchisor attempts to interfere with lawful associations of franchisees, inclusive of forming and participating in trade associations. Also, this category forbids franchisors from discriminating against a franchisee by imposing additional requirements not imposed on other franchisees or by retaliating against any franchisee for belonging to or participating in a franchise association (U. S. House of Representatives, 1999, Section 4(a)). No franchisor or any other entity has the right to interfere with anyone's constitutional right to free association. The protection of this right may enable franchisees to operate more efficiently and deal more effectively with their franchisors. However, discrimination among franchisees on the basis of such things as race, religion, age, etc., was again removed from this section of the current bill. This is an unfortunate development that may represent a compromise agreement reached among sponsors of the latest bill.

Termination Without Good Cause prior to the expiration of the franchise agreement is prohibited under Section 4(b) of the Act. Good cause is said, under the Act, to exist under three sets of circumstances. First, good cause for termination may occur when (a) the franchise fails to comply with a provision of the agreement after having received specific notification from the franchisor of the area of noncompliance and being granted 30 days to cure the default; and (b) the nature of the default defies curing through reasonable efforts, or the franchisee fails to initiate and pursue corrective conduct within the 30-day period provided (U. S. House of Representatives, 1999, Section 4(b)). Such provisions provide fair opportunities for franchisees to correct existing franchise problems.

Second, good cause for termination may arise under the Act when the franchisee, without the requirement of notice and opportunity to cure, either (a) voluntarily abandons the franchised business (this does not apply to premature lease losses due to cases of eminent domain, foreclosure sales, and natural disasters); (b) is convicted of a felony that substantially harms the goodwill of the franchisor; (c) is repeatedly in default of a given nondiscriminatory provision of the franchise agreement; or (d) operates the franchised business in a way that is dangerous to public health or safety.

The third circumstance under which good cause for termination can be declared under the Act occurs when the franchisor withdraws from the marketing area of the licensed franchise business after providing reasonable compensation to the franchisee as well as agreeing not to use the contract to interfere with the continued operation of the franchisee (U. S. House of Representatives, 1999, Section 4(b)). All of these proposed termination provisions protect franchisees from arbitrary and capricious terminations while allowing franchisors to reasonably protect the goodwill and overall profitability of their franchise systems.

Under Section 4(c) of the Act, franchisors cannot prohibit franchisees from continuing to do business at any location subsequent to the expiration of franchise agreements. However, the Act does not prohibit the enforcement of certain contractual obligations on franchisees after the expiration or termination of a franchise. For example, noncontinuing franchisees may be required to (a) stop using trademarks or trade secrets of a franchisor; and (b) change the appearance of the business premises so that it is not substantially similar to that of continuing franchisees (U. S. House of Representatives, 1999, Section 4(c)). This even-handed treatment protects the right of noncontinuing franchisees to remain in business while preventing them from exploiting former franchisors.

Standards of Conduct

Section 5 of the Act requires both parties to a franchise contract to act in good faith in the performance and enforcement of said contract. It also imposes a duty of due care on franchisors. Both "good faith dealing" and "due care" are defined within this section. Further, this section imposes a limited fiduciary duty on franchisors wherein they are to exercise the highest standard of care for franchisee interests in conjunction with their performance of general payroll or accounting services for franchisees or their administration of any promotional fund or program to which franchisees must routinely contribute. Specific requirements are proscribed in this section of the Act for franchisors administering these types of promotional funds (U. S. House of Representatives, 1999, Section 5). While exhorting both franchising parties to adhere to the provisions of their contract, this section emphasizes the special obligation of franchisors to protect the financial interests of their franchisees. Hence, its enforcement would help eradicate past abuses by franchisors that have harmed franchisees and have damaged trust in franchisors.

Procedural Fairness and Actions by State Attorneys General

To ensure procedural fairness to franchisees, franchisors are prohibited from imposing certain requirements on franchisees, either directly or indirectly, through franchise agreements in Section 6 of the Act (1999, Section 6). State attorneys general are empowered under Section 7 (1999) of the Act to bring civil actions on behalf of their residents whenever they believe that the interests of these residents are being threatened or adversely affected by violations of the Act. In such actions, the attorneys general may seek to prohibit such violations or seek damages or other relief deemed appropriate by the courts.

Franchise Transfers by Franchisees

The Act permits a franchisee to assign an interest in a franchise to a transferee as long as that transferee satisfies the reasonable renewal qualifications used by the franchisor for existing franchisees. If the franchisor does not renew a significant number of franchises, a transferee may have to satisfy the reasonable conditions generally applicable to new franchisees. The franchisor may refuse to approve the transfer if it is determined that the proposed transferee fails to satisfy current qualifications, provided that the franchisor does so fairly and provides written grounds for refusal (U. S. House of Representatives, 1999, Section 8(a)).

A franchisee must provide the franchisor no less than a 30-day written notice of a proposed transfer of a franchise interest. Once notified, the franchisor has 30 days to refuse to approve the transfer. A failure to do so results in the automatic approval of the transfer. The Act permits the franchisor to establish various conditions of transfer, dealing with such things as (a) a reasonable training program for transferees; (b) a reasonable transfer fee paid to the franchisor; and (c) franchisee payment of any amount due to the franchisor. The Act also limits the conditions that the franchisor may impose upon franchisees before consenting to a transfer. In general, franchisors cannot impose conditions on transferees that exceed those applied to existing franchisees (U. S. House of Representatives, 1999, Section 8(b-d)).

Assignments of their interests in franchises may be made by franchisees, under the Act, for the unexpired term of the agreement. Franchisors are not allowed to alter the terms or financial requirements as a condition of such transfers (U. S. House of Representatives, 1999, Section 8(e)). Further, franchisors cannot refuse to give consent to public offerings of franchisees' securities without good cause if such franchisees retain control over more than 25 percent of the voting power as franchisees (U. S. House of Representatives, 1999, Section 8(f)). Nor can franchisors withhold consent to any consolidations among its franchisees, as long as these franchisees are complying with their respective obligations to the franchisors involved (U. S. House of Representatives, 1999, Section 8(g)). The Act specifically identifies a number of occurrences that are not to be considered transfers requiring the consent of the franchisor under the franchise agreement (U. S. House of Representatives, 1999, Section 8(h)). Further, the Act does not allow franchisors to prevent the transferring party from engaging in any lawful business pursuit after the transfer is completed. However, franchisors are allowed to enforce contractual arrangements that prevent exploitation of their trade secrets or intellectual property rights (U. S. House of Representatives, 1999, Section 8(i)). Hence, the Act does not allow franchisors to arbitrarily or capriciously deny franchisees to transfer their interests in a franchise or to hold transferring franchisors or their transferees to unreasonable conditions of transfer. Moreover, the Act requires franchisees to give franchisors ample notice of their intentions to transfer and protects the intellectual property rights of franchisors during such transfers.

Franchise Transfers by Franchisors

The Act limits the ability of a franchisor to transfer interest in a franchise to situations wherein (a) the franchisor provides at least 30 days notice to every franchisee of the effective date of the transfer; (b) the franchisor provides within this notice a complete description of the business and financial terms of the proposed transfer; and (c) the entity to whom the franchisor's obligations are transferred has the business experience and financial wherewithal to complete these obligations (U. S. House of Representatives, 1999, Section 9). This brief, yet powerful, section of the Act provides timely and comprehensive notice of transfers to affected franchisees and seeks to ensure the continued viability of the franchising contracts.

Independent Sourcing

Under the Act, franchisors are generally not allowed to interfere with franchisee efforts to obtain independent supply sources. This addresses the problem of franchisors obligating franchisees to obtain equipment, fixtures, supplies, goods, or services used in the establishment or operation of the franchised business exclusively from franchisors or their approved vendors. However, the restriction does not apply to franchisors in situations in which these kinds of purchases are required to meet reasonably established, uniform, system-wide quality standards of the franchisor. Further, if the franchisor approves sellers of such equipment and the like, the franchisor must, under the Act, provide a continually-updated list of approved sellers as well as respond objectively and quickly to reasonable franchise requests for approval of competitive sources of supply (U. S. House of Representatives, 1999, Sections 10(a) and 10(b)).

In addition, under the Act, franchisors are required to fully disclose whether they receive any benefits, such as rebates, commissions, and payments from vendors, connected with purchases by franchisees. Any such benefits must be distributed directly to the purchasing franchisees. Further, franchisors are required to report at least yearly the amounts of revenue and profit they earn from the sale of equipment, supplies, goods, or services to their franchisees. The prohibition against franchisors interfering with independent sourcing by their franchisees does not apply to reasonable quantities of equipment and other items that the franchisor requires its franchisees to obtain from the franchisor, as long as such purchases are central to the franchised business and incorporate a trade secret, patent, or copyright arranged by the franchisor (U. S. House of Representatives, 1999, Sections 10(c), 10(d), and 10(e)). Given these provisions, franchisees would be given great latitude in searching for competitive sources of supplies that could substantially lower their costs of operation. In many cases, they presently have no capability to do so.

Encroachment

As a further protection to franchisees, the Act prohibits franchisors from placing or licensing another to place any new franchised outlets unreasonably close to their existing outlets if the following conditions apply: (a) the intent or probable effect of the new outlet is to diminish gross sales by the established outlet of more than five percent in the twelve months following the establishment of the new outlet; and (b) the established outlet either sells merchandise or services bearing the same trademarks as those sold by the new outlet or has premises that are identified by the same trademark as the new outlet. The above provisions do not apply to new outlets if, prior to the opening of such an outlet, a franchisor provides a written offer to compensate his franchisees in specific amounts for loss of their sales under very specific conditions. Therefore, this section of the Act is designed to permit reasonable encroachment efforts of franchisors, compensating existing franchisees for their concurrent loss of sales (U. S. House of Representatives, 1999, Sections 11(a) and 11(b)).

A right of private action is granted under Section 12 of the Act to any party to a franchise who is injured by a violation or threatened violation of the Act. This right of action halts the violation and makes restitution for it by providing that all damages and injunctive relief, and related legal costs are the responsibility of violators of the Act (U. S. House of Representatives, 1999, Section 12(a)). Further, the Act allows for the use of alternative dispute resolution techniques such as arbitration, mediation, or other nonjudicial methods, consistent with the standards and protections established by the Act (U. S. House of Representatives, 1999, Section 12(c)). Finally, the Act establishes a five-year statute of limitations within which action must be brought against violations of the Act. This is reduced to three years after the date on which the violation is discovered or should have been discovered through the exercise of reasonable diligence (U. S. House of Representatives, 1999, Section 12(d)). Notice, of course, that the right of private action is not restricted to aggrieved franchisees and that cost-saving alternative methods of dispute resolution are encouraged for franchising parties.

Opposition to H.R. 3308

As mentioned above, H.R. 3308 was reintroduced in Congress in November 1999. Almost immediately, the Section of Antitrust Law of the American Bar Association (ABA) issued a report in opposition to the bill contending that, on balance, the bill was inconsistent with current antitrust policies, could possibly restrict competition unduly, and might raise consumer prices as well as limit the array of competitive goods and services. The Section views this proposed legislation as a substantial expansion of federal regulation of franchise and other distribution arrangements (American Bar Association, 1999).

The Antitrust Section specifically raises six objections to H.R. 3308. First, the Section asserts that no convincing hard evidence exists of widespread, systematic, and regular abuses perpetrated by franchisors against their franchisees that would justify the passage of what the Section describes as "this sweeping legislation." Second, the Section believes that many of the potential abuses that H.R. 3308 attempts to address are already covered by existing, welldeveloped statutory provisions and doctrines such as the antitrust laws, as well as by trademark laws and common-law contract doctrines inclusive of the duty of good faith (American Bar Association, 1999).

Third, although the ABA Section of Antitrust Law concedes that there may be some situations in which neither current legal remedies nor market forces actually succeed in punishing or deterring franchisors from employing tactics that deprive franchisees of reasonable expectations they may have had upon entering into franchise relationships, it maintains that many key provisions of H.R. 3308 are not reasonably designed to deal exclusively with such conduct on the part of franchisors. The ABA Section goes on to take the framers of H.R. 3308 to task for taking an exclusive approach involving extensive legislative redrafting of franchise agreements in order to deal with potential abuses by franchisors. This approach, the Section insists, not only conflicts with the competitive principles underlying federal antitrust legislation but also unnecessarily limits the efficiency of existing franchise relationships (American Bar Association, 1999). That is to say, the ABA Section believes that H.R. 3308 is a legislative cure that is worse than the laws it seeks to redress.

Further, the ABA Section cautions that H.R. 3308 is likely to have various unintended adverse consequences. Among these would be (a) incorporating under its jurisdiction ordinary distribution arrangements that are virtually free of abuses; (b) curtailing the ability of businesses to respond to changing market conditions; (c) hampering businesses' efforts to innovate and alter their plans of operation; (d) limiting the expansion plans of businesses; (e) increasing the difficulty of franchisors and manufacturers to sever relationships with unsatisfactory franchisees and distributors; and (f) lowering the value of a business to both franchising parties by undermining the value of a brand, trademark, or even a method of doing business (American Bar Association, 1999).

Finally, the Antitrust Section suggests that most of the objectives of H.R. 3308 can be better realized through the use of more encompassing, clearly-- stated disclosures by franchisors made prior to the signing of a franchise agreement. Specifically, the Section recommends that such disclosures would address (a) post-agreement restrictions on business operations of former franchisees; (b) grounds for terminations of agreements by franchisors; (c) sourcing requirements that franchisors may impose on their franchisees; and (d) any limitations imposed on franchisors relative to encroaching upon the sales areas of their franchisees. Such information, the ABA Antitrust Section contends, will enable prospective franchisees to consider alternative franchising opportunities prior to entering into any agreements, thereby stimulating competition in the terms proposed in franchise relationships. This, the Section finds, is preferable to imposing the terms of all franchise relationships through legislation such as H.R. 3308 (American Bar Association, 1999).

Opposition to H.R. 3308 has also been voiced by the International Franchise Association (IFA) and the U. S. Chamber of Commerce. In arguments similar to those raised by the ABA's Antitrust Section, the IFA maintains that H.R. 3308 will increase the potential for lawsuits in franchising arrangements, will discourage future franchising opportunities, and will decrease the value of existing franchise businesses. The IFA is urging its members to contact their Congressional representatives with criticisms of H.R. 3308. Specifically, the IFA advises its members to tell Congressional representatives that H.R. 3308 is controversial and not well supported, that the legislation would immerse the federal government through the federal courts into the business relations of franchisors and franchisees, that the bill imposes new obligations and unnecessary duties thereby opening up prospects for litigation, and that the bill especially threatens the entrepreneurial activities of women and minorities (International Franchise Association, 2000a). For its part, the U. S. Chamber of Commerce has sent letters opposing H.R. 3308 to all members of the U. S. House as well as a letter to House Judiciary Committee members. The latter of these was sent by the Chamber's Institute for Legal Reform and is specifically critical of H.R. 3308's proposed changes to legal remedies and rights under contract law. Further, the National Association of Manufacturers as well as the Small Business Survival Committee has publicly opposed H.R. 3308 (International Franchise Association, 2000b).

Support for H.R. 3308

Not surprisingly, the chief proponent of H.R. 3308 is the American Franchisee Association (AFA) that, as noted previously, had proposed the original Model Responsible Franchise Practices Act from which H.R. 3308 was ultimately derived. The AFA, which represents over 16,000 franchisees who own 30,000 franchised businesses, argues that, in effect, "an unlevel playing field" situation exists in the franchisor-franchisee relationship. That is, to date, this relationship has been established through contracts initiated by franchisors who then seek to implement the same with individual franchisees, individuals who are dwarfed by franchisors in terms of both economic strength and in bargaining power. This situation, the AFA maintains, has allowed franchisors to freely engage in unscrupulous business practices, which they have incorporated within their contractual arrangements with franchisees.

As a consequence, the AFA continues, entry into markets has been impeded and free competition has been stifled. For, as the AFA believes, individuals wishing to enter or expand within a specific industry have no viable options. They must, instead, decide to make it on their own or join a franchise system. If they go it alone, they face the reputation and power of the franchise system; and, if they seek to join a franchise system, they find franchise opportunities characterized by agreements that are not only substantively alike but also sharply slanted in favor of the prospective franchisors. This permits said franchisors to deny prospective franchisees many of the safeguards normally expected in a business relationship (Kezios, 2000). Little, if any, legal recourse for franchisees who feel they have been treated unfairly by other franchisors has been built into typical franchise agreements. In fact, non-competition covenants are usually incorporated in these agreements, thereby preventing franchisees from leaving the franchise system to either compete on their own or join another franchise system of their choice. Litigation has proven to be a costly and ineffective option for franchisees in dealing with the flaws of the franchising system. Even when franchisees are financially able to legally challenge the conduct of franchisors, the AFA maintains that these franchisees have been dealt with in a highly subjective and inconsistent manner by the courts. Due to the lack of any federal legislation establishing consistent national standards, franchisors are afforded the opportunity to "forum shop" relative to the substantive law applicable in disputes as well as to the place of venue in which the matter is litigated (Kezios, 2000).

In addition, while the AFA acknowledges that the Federal Trade Commission (FTC) promotes sufficient pre-sale disclosures,4 the AFA charges that the FTC virtually refuses to take part in and has been woefully ineffective in promoting fairness and free competition in the franchising relationship. That is, the AFA claims that the FTC requires, but does not review, the circulars offered by franchisors. To substantiate this claim, the AFA has quoted a 1993 U. S. General Accounting Office Report that the FTC acted on less than six percent of the franchise complaints it had received (U. S. Senate Sub-committee on Oversight, 1993). Further, the AFA finds little relief in the various existing state disclosure rule laws. In fact, the AFA finds the current regulatory system composed of the FTC disclosure rule and these state disclosure laws "totally inadequate in dealing with current franchising issues" (American Franchisee Association, 1999). While acknowledging that there are many unresolved problems relating to pre-sale disclosure, the AFA asserts that it is the abuses in the ongoing franchise relationship (the aftermath of the disclosure process) that need to be addressed via new legislation. It apparently does not share the ABA's Antitrust Section's belief that adjustments in the disclosure process would rectify existing problems in the franchising relationship (American Franchisee Association, 1999).

As a consequence of the foregoing arguments, the AFA asserts that universal baseline standards of conduct for franchising arrangements are plainly and sorely needed. The AFA feels that H.R. 3308 will essentially provide such standards, which will alleviate the inconsistent treatment to which franchises have long been subjected. Further, this proposed legislation would also, the AFA claims, result in less costly and unproductive litigation as well as promote the viable and competitive expansion of franchising in the economy (Kezios, 2000). In addition, the AFA would label the ABA's Antitrust Section's characterization of H.R. 3308 as a substantial expansion of federal regulation of franchising arrangements alluded to previously as a misrepresentation of the proposed legislation. Rather, the AFA would contend that H.R. 3308 simply endeavors to establish legal standards of review, not outcome, when conflict situations arise concerning the expectations of franchisors and franchisees. Such standards, the AFA maintains, would avoid the imposition of arbitrary and unilateral changes to franchise arrangements by franchisors upon unsuspecting franchisees (American Franchisee Association, 1999).

To reinforce its position that H.R. 3308 is non-regulatory in nature, the AFA asserts that the bill's main thrust is to promote private remedies rather than government regulation. The AFA notes that H.R. 3308 does provide for a private right of actions under the FTC Disclosure Rule, a situation that the AFA has endorsed since the inception of H.R. 3308's concept. The AFA argues that individuals who sign franchise agreements should not have to waive the right to private remedies that all other businesses enjoy. That is, rather than seeking the government's assistance, franchisees should be given the private right of redress if they can substantiate violations of the FTC Rule. Further, the AFA maintains that a federal private right of action should also supplement the state disclosure laws alluded to previously. That is, the AFA's position is that such a private right of action must be recognized somehow (in this case, legislatively) to allow franchisees, acting individually or collectively, to seek judicial redress for violations of statutorily-established disclosure procedure. If franchisors have benefitted as greatly from the existence of the disclosure requirements imposed under federal and state statutes as the AFA claims, then these franchisors should be taken to task when they violate these disclosure requirements (American Franchisee Association, 1999).

The AFA strongly endorses several other provisions of H.R. 3308. As noted previously, Section 4(b) of H.R. 3308 establishes a federal good cause standard for termination of franchise agreements. The AFA has supported such a standard because it wants to limit the use of arbitrary standards for termination unilaterally imposed by franchisors. Further, Section 4(c) of H.R. 3308 would render postterm restrictions on competition unenforceable. Such restrictions have been commonly placed in franchise agreements in order to prevent franchisees from operating a business similar to their former franchisors. However, as noted previously, the section attempts to also protect franchisors by preventing former franchisees from using the franchisor's proprietary system or from somehow creating the impression that it is still a part of a franchise system (U. S. House of Representatives, 1999, Section 4(c)(2)(A)). While endorsing this check on the conduct of franchisees, the AFA remains emphatic that post-term restrictions on franchisees are contrary to the strong procompetition policy of the United States. It notes that the basis of our free enterprise economic system is to promote innovation and free movement within the marketplace by businesses. If a franchisor is permitted to license a replacement franchisee once a franchise is terminated, the AFA insists that the same franchisee should be free to compete against the former franchisor (Kezios, 2000).

In an apparent response to a concern raised by the ABA's Antitrust Section that Section 5 (a) of H.R. 3308 represented a novel codification of the duty of good faith, the AFA stresses that this section merely confirms the common law doctrine that every contract imposes such an implied duty. To reinforce this notion, the AFA cites the Restatement of the Law of Contracts that not only asserts that such a covenant is part of every contract but also provides examples of good and bad faith performance.6 Further, the Antitrust Section of the ABA is concerned that the duty of due care of Section 5(b) of H.R. 3308 might deter market entry and innovation. This duty requires a franchisor to possess a minimum level of skill or knowledge in its field. To counter the ABA Section's concern, the AFA labels the duty of due care a logical requirement because most franchisors, indeed, sell this skill or knowledge to prospective franchisees. The AFA points out that H.R. 3308 provides several opportunities for franchisors lacking such skill or knowledge to avoid violation of the due care requirement.7 Essentially, franchisors can avoid liability under the due care section of H.R. 3308 by providing a clear disclosure of their actual level of skill and knowledge. Rather than fulfill the ABA's Antitrust Section concern, the due care provisions the AFA maintains, will, at worst, caution the unscrupulous not to misrepresent skill or knowledge. The due care provision should be feared, the AFA stresses, only by those desirous of defrauding franchisees (Kezios, 2000).

Independent sourcing of franchisee supplies, the subject of Section 10 of H.R. 3308, is also keenly advocated by the AFA. By effectively ending the ability of franchisors to stipulate a single supplier with whom franchisees are required to deal, this section, as the AFA points out, greatly enhances the freedom of franchisees to contract with honest suppliers at fair prices. It presents franchisees with an environment in which they can shop for the most competitive prices for non-proprietary products. Franchisors would no longer be able to stipulate supplies in return for a rebate or discount from said suppliers, which benefits the franchisors alone. For when suppliers grant such discounts to franchisors, the AFA contends that they pass along the cost of these to the now-captive franchisees in the form of higher prices charged. Under Section 10 of H.R. 3308, however, franchisors would have to both disclose and distribute to their franchisees any benefits received from suppliers (Kezios, 2000).

Statutory bases for such independent sourcing quoted by the AFA include the Indiana Deceptive Practices Act of 1985 and the Iowa Franchise Act of 1992. The Indiana statute makes it unlawful for franchisors to require the exclusive purchase of goods, supplies, inventions, or services when these items are available from alternative sources.8 Further, the Indiana law specifically prevents franchisors from receiving money or any other benefits from anyone with whom the franchisee does business unless said benefits are accounted for and given to the franchisee.9 The Iowa statute permits franchisees free choice in obtaining equipment, fixtures, supplies, and services appropriate to the establishment and operation of their franchise as long as their acquisitions meet the standards of quality established by their franchisors.10 As mentioned previously, this provision excludes reasonable quantities of inventory, goods, or services that are central to the business and that are either produced by the franchisor or involve a trade secret of the same.11

Section 11 of H.R. 3308, as reviewed previously, limits the ability of franchisors to encroach upon the territories of these existing franchisees. As the AFA points out, this section does not prevent all expansion and encroachment by franchisors. Rather, Section 11 of H.R. 3308 requires franchisors to pay a consideration to an existing franchisee if the impact (in terms of sale reduction) of encroachment by the franchisor is five percent or greater on the existing franchisee. The AFA views this as a reasonable attempt to make franchisees whole who have suffered economic losses as a direct cause of the expansion activities of their franchisors. As the AFA suggests, such injured franchisees would not have agreed to pay a franchisor to operate a franchised outlet if they knew that the franchisor could freely establish other franchises in the immediate vicinity of their original outlet (Kezios, 2000).

Section 11 does not compensate such franchisees for substantial losses suffered from encroachment and smacks of deceitful and inequitable treatment by their franchisors. In countering the ABA Antitrust Sections contention that the independent sourcing and encroachment provisions of H.R. 3308 might lead to a curtailment of franchised outlets, the AFA maintains that similar provisions of the Indiana and Iowa statutes noted previously have not resulted in an exodus of franchisors from either state. In fact, the AFA has stated that it is unaware of any brand-name franchisor that has refused to do business in these two states due to their franchise statutes. Further, the AFA cites a study" that concluded that both good faith franchisors and franchisees had the same opportunity for profit in Iowa after the passage of the Iowa Franchise Act in 1992 as they did before the enactment of said legislation (American Franchise Association, 1999).

As evidence of the need for such legislation as H.R. 3308, the AFA cites a survey of franchisee satisfaction that it sponsored. Returns were eventually received from 470 respondents over the nine-month period, April 1, 1993-january 31, 1994. Generally, the results suggested that many franchisees were dissatisfied with their franchising relationships. For example, nearly half of the respondents (46.3 percent) felt that their franchisors had forced discounting and promotional activities on them that resulted in an average decline in profits of ten percent. More than half of the respondents (57.4 percent) believed that the goods and services, which they purchased from franchisors, were inflated in price. Further, in excess of twothirds of responding franchisees (68 percent) maintained that they were not getting full value from advertising fees paid to franchisors and nearly that many franchisees (61.3 percent) believed that support services provided by their franchisors were inadequate. Over half of the respondents (55 percent) would advise others against joining their franchise systems. Finally, roughly 40 percent of responding franchisees maintained that they were encroached upon by their franchisors in some way, had been threatened by a franchisor representative, and either were or had been in dispute with their franchisor. Nearly all of the 40 percent feeling that they were encroached upon (i.e., 90.5 percent of the 40 percent holding this view) maintained that their profits were diminished by such encroachment, and they perceived that the decline amounted to almost 19 percent (Wadsworth a Jones, 1996).

Grass roots support for legislation such as H.R. 3308 is evidenced by the fact that bills similar to H.R. 3308 have recently been introduced in two states. In late January 2000, a franchise relationship bill was introduced in the Missouri House of Representatives. This bill, which is virtually identical to H.R. 3308, has been referred to a committee of the Missouri House. There is currently no indication of a similar bill being introduced in the Missouri Senate. In addition, a bill was also introduced in late January 2000 into the Arizona House of Representatives. The bill is also patterned after H.R. 3308 (International Franchise Association, 2000a).

Summary

Franchising, or the selective distribution system, has experienced dramatic growth over the last twenty years. Since franchising agreements struck between franchisors and franchisees are initiated by the franchisors, historically the tendency has been to cast such agreements in ways that primarily promote the best interests of such franchisors. Over time, franchisees have generally become sensitive to various provisions of their franchising agreements, which they consider to be unfair or unreasonable, whether unintentionally or by design of the franchisors. Consequently, they have been raising complaints increasingly relative to a number of practices employed by franchisors under existing franchise agreements. These complaints have focused on actions of franchisors relative to the sale, operation, and interpretation of franchise agreements.

In the wake of these complaints, considerable thought and discussion have been devoted to the task of improving fairness and consistency of treatment in the sale, operation, and interpretation of franchise agreements. One approach that has emerged is the passage of legislation that addresses specific problem areas that have surfaced under existing franchise agreements. Although both state and federal franchising legislation have existed for years, this legislation has not focused on the specific problem areas inherent in franchise agreements. This, in fact, induced the American Franchisee Association to propose the Model Responsible Franchise Practices Act in late 1996. This proposed Act formed the basis of the Small Business Franchise Act, introduced in the U. S. House of Representatives in October of 1998 and reintroduced in November 1999 as H.R. 3308. This Act addresses the ongoing concerns of franchisees relative to the treatment they have received from franchisors in conjunction with the sale, operation, and interpretation of franchise agreements. It attempts to interject fairness and reasonableness in these various stages of the franchising process by leveling the playing field for both groups of franchise participants. As such, it places more limits and obligations upon franchisors than have heretofore existed in franchise agreements. However, it does require franchisees, as well as franchisors, to act in good faith relative to the provisions of franchise agreements. The Act is designed to correct past franchise abuses and establish standards to prevent future abuses perpetrated by either party to franchise agreements.

Critics of H.R. 3308 argue that there is little or no evidence of widespread abuses practiced by franchisors on franchisees and that existing antitrust laws are the proper vehicles to handle present and potential problems. They insist that H.R. 3308 is an inappropriate mechanism to address the franchisor-franchisee relationship and, further, that H.R. 3308 constitutes substantial and unwarranted extension of federal regulation of this relationship. Concerns are raised by critics of H.R. 3308 that it will restrict competition resulting in increased prices and limitations on the array of competitive goods and services. These critics contend that the passage of H.R. 3308 will lead to a deluge of unnecessary litigation. In short, the critics of H.R. 3308 believe it is unnecessary legislation that will do more harm than good.

Proponents of H.R. 3308 make a strong case for this legislation. They point out that franchisees have historically had few options in dealing with franchisors who create agreements that are primarily favorable to themselves. These proponents argue that such practices by franchisors have themselves impeded entry into various markets and have, consequently, stifled free competition. Franchisees who have been aggrieved by the action of their franchisors, H.R. 3308's proponents contend, have had virtually no legal resources to address such mistreatment. Although pre-sale disclosures are required by the FTC, the proponents of H.R. 3308 maintain that the FTC actually does little to promote competitive fairness in the franchising relationship.

Supporters of H.R. 3308 dispel the argument that the bill represents a substantial extension of federal regulation of the franchising relationship. Rather, these supporters argue that the bill actually promotes private remedies dealing with problems in the franchising arena. The proponents of H.R. 3308 specifically and emphatically endorse various provisions of the bill such as those limiting (a) arbitrary termination of franchisees, (b) post-term restrictions on franchisees, (c) encroachment by franchisors upon their system of existing franchisees, and (d) independent sourcing by franchisees of their needed supplies.

On balance, it would seem that proponents of H.R. 3308 make a stronger case than detractors of the bill, for the bill's detractors have offered mainly speculative arguments. Proponents of H.R. 3308, such as AFA, have pointed to a list of long-standing concrete problems that franchisees have had with their franchisors. The current "regulatory" mix of the FTC disclosure rule and the various disclosure laws of the states have apparently not proven to be adequate to the task of resolving or substantially alleviating these problems. As noted previously, the evidence suggests that the FTC has responded to only six percent of franchise complaints. Given the lack of universal baseline standards for franchising arrangements, aggrieved franchisees have had to rely, they claim, mainly on expensive litigation to address their complaints. The outcome of such litigation has, as they further claim, resulted in inconsistent treatment by the courts.

In addition, the statutes of such states as Indiana and Iowa, as noted previously, provide legal precedents for the establishment of such legislations as H.R. 3308. Nor have such statues apparently resulted in an exodus of franchisors from either state, evidence to the contrary of one of the concerns raised by H.R. 3308's opponents. Further, previous reference was made to the AFA survey of franchisees, which suggested a high level of dissatisfaction among franchisees with existing relationships with their franchisors. However, it would be unfair to infer, at this point, that proponents of H.R. 3308 argue a more compelling case than the bill's opponents. Both franchising parties should, in fact, carefully consider the arguments for and against the bill. Perhaps the bill's opponents are correct in asserting that the full body of existing law, inclusive of antitrust laws, trademark laws, etc., is adequate to handle current franchising problems. Indeed, perhaps franchisees have not taken full advantage of the existing body of law in seeking resolution of their franchising problems. Therefore, caution should be taken in this regard.

There are, of course, two overriding problems involved in this matter of franchising disputes. The first deals with the resolution of past and existing problems and areas of dispute between franchisors and franchisees. The second problem concerns the prevention of future problems and disputes. Unquestionably, there have been, and are still, a number of ongoing problems and disputes between the franchising parties. To deny this is sheer folly, for the problems will surely only persist and worsen. Hence, the parties need to discern the best courses) of action to resolve existing problems and disputes.

This would seem to involve a choice between using the existing body of law, new legislation, or some other means of resolution. If opponents of H.R. 3308 are truly convinced that the existing body of law is the best approach to problem resolution in franchising relations, they must go beyond the mere declaration of this and demonstrate conclusively to the bill's proponents how the existing law can be expeditiously and efficiently applied to such problems. Arguing for this position in the abstract will not be very fruitful. If, however, the Act's opponents cannot demonstrate the efficiency and desirability of the application of existing law to franchising-- problem resolution, then other means of resolution must be sought.

An alternative means of resolution of franchising problems, which has been proffered by opponents of H.R. 3308, is fuller disclosure on the part of franchisors to prospective franchisees. However, this solely addresses the problem of preventing future disputes and does nothing to correct existing problems. Here again, the Act's opponents must present a specific disclosure plan for consideration. Proponents of the Act should be willing to consider such a plan and should be allowed to have input into its components. Obviously, this proposed disclosure plan should incorporate the concerns of franchisees implicitly and explicitly expressed in H.R. 3308. Hence, the use of H.R. 3308 as a jumping off point may lead to a compromise disclosure plan, which may be appealing to franchisees and other proponents of H.R. 3308.

Therefore, the ideal solution for the resolution of problems in franchisor-franchisee relations for opponents of H.R. 3308 would be to rely on existing legislation to cure current problems and a carefully molded disclosure plan to prevent future problem situations. If these same H.R. 3308 opponents cannot convince franchisees that the existing legislation is sufficient to solve the present franchising problems, these opponents must be willing to move forward with franchisees to adopt new legislation that will, indeed, be adequate to the task. Under these circumstances, the disclosure plan becomes an integral part of the new legislation.

Since H.R. 3308 formally presents the current concerns and problems of franchisees, it is the logical place to start in fashioning new legislation. Though it may be imperfect, H.R. 3308 at least attempts to present a well-- balanced approach to the resolution of existing franchising problems. It offers relief to franchisees who feel aggrieved in some ways) because of the franchising agreement under which they operate, while attempting to protect the goodwill and reputation of and, indeed, the very structure of existing franchisors. Hence, it would behoove franchisors and franchisees to work together in good faith to establish the best means to solve existing franchising problems and to prevent future problems from occurring. Franchisors must be willing to admit to the existence of such problems and franchisees must be certain to pinpoint specific problem areas without exaggerating the scope of franchising problems.

This would mean, as indicated previously, that the franchising parties must consider the use of both existing legislation as well as new legislation to solve existing problems and prevent future problems. It is likely that a combination of both existing and new legislation will be found to be the best approach to providing such relief. Certainly, H.R. 3308, as proposed, can provide excellent guidance to the formulation of new legislation. The very process of establishing the machinery to deal with these franchising problems should induce a more cooperative spirit among franchisors and franchisees in the formulation of future franchising agreements. No longer should these be exclusively prepared by franchisors on a "one-size-fits-all" basis. That is, such agreements should be arrived at on a bilateral, rather than a unilateral, basis to allow for flexibility and adaptability to changing conditions.

Endnotes

1. See, for example, Petersen, Business and Government, 1985 and U. S. Department of Commerce, Bureau of Industrial Economics, 1983.

2. Information provided by Susan P. Kezios, president of the American Franchisee Association, in an email message to the author on February 4, 2000.

3. See "Franchise Legislation: Existing and Proposed," by Anthony J. Greco, Southwest Business and Economics Journal, 1999.

4. Such pre-sale disclosures are regulated by the Federal Trade Commission's, "Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures," 16 C.ER. 436, effective 10-2179.

5. See Section 12 of H.R. 3308. 6. See Restatement, Second, Contracts, 205.

7. See H.R. 3308; Section 5(b)(1) and 5(b)(2)(B).

8. See Indiana Code, Title 23, Art.2, Ch.2, Section 1(1).

9. See Indiana Code, Title 23, Art.2, Ch.2, Section 1(4).

10. See Iowa Acts 1992 (74 G.A.) Ch.1134, Section 1(4).

11. See Iowa Acts 1992 (74 G.A.) Ch.1134, Section 12(2).

12. See "Economic Impact of the Iowa Franchise Act," by Mark Edelman, Iowa State University Economic Staff Paper, Ames, IA, 1994.

References

American Bar Association, Section of Antitrust Law. (1999, December). Report of the American Bar Association Section of Antitrust Law on Proposed Small Business Franchise Act, Washington, DC.

American Franchisee Association. (1996). Model Responsible Franchise Practices Act.

American Franchisee Association. (1999, October). The response of the AFA to twelve questions about regulating franchising. 1999 ABA Forum on Franchising, Palm Springs, CA.

American Law Institute (1981, 1982). Restatement of Contracts, Second, Vol. 2, and Appendices, Vol. 4, Philadelphia, PA.

Edelman, M. (1994). Economic impact of the Iowa Franchise Act. Iowa State University Economic Staff Paper, Ames, IA.

Greco, A. J. (1999). Franchise legislation: Existing and proposed. Southwest Business and Economic Journal.

Indiana Deceptive Practices Act (1985). Indiana Code, Title 23, Art.2, Ch.2, 74).

International Franchise Association. (2000a). Franchise relationship legislative update: H.R.3308 The Small Business Franchise Act of 1999. IFA website Government Relations section [Online].

International Franchise Association. (2000b). Grassroots 101. IFA website Government Relations section [Online].

Iowa Franchise Act, Acts 1992 (74 G.A.) Ch.1134, 1-17.

Kezios, S. P. (2000, January 31). Letter to Donald S. Clark, secretary, FTC.

Maynard, R. (1997, January). The changing landscape. Nation's Business.

Petersen, H. C. (1985). Business and government (2nd ed.). New York: Harper and Row.

United States Department of Commerce, Bureau of Industrial Economics. (1983). Franchising in the economy, 1981-1983. Washington, DC: U. S. Government Printing Office.

United States Department of Commerce, International Trade Administration. (1988). Franchising in the economy, 1986-1988. Washington, DC: U. S. Government Printing Office.

United States House of Representatives. (1998). Small Business Franchise Act of 1998. H.R. 4148, 105Congress, 2' Session.

United States House of Representatives. (1999). Small Business Franchise Act of 1999. H.R. 3308, 106-- Congress, 1st Session.

U. S. Senate Subcommittee on Oversight of Government Management, Committee on Governmental Affairs. (1993, July). Federal Trade Commission enforcement of the trade regulation rule on franchising.

Wadsworth, F. H., & Jones, W. (1996). American Franchisee Association franchisee satisfaction survey report. Chicago: American Franchisee Association.

Anthony J. Greco, Ph.D., is professor of economics and department head, Department of Economics and Finance, College of Business Administration, University of Louisiana Lafayette, Lafayette, LA 70504-4570.

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