Showdown in Harrisburg

by Nexsen Pruet, PLLC
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Franchise Post - November 5, 2013

Like a strong marriage, a strong franchise relationship must be built on shared success. In the end, no relationship is likely to work out when one side holds all the cards.

The Pennsylvania legislature may confront this lesson when it considers a proposed new franchise relationship law, House Bill 1620, the Responsible Franchise Practices Act.

As its preamble makes clear, this bill is intended to address what proponents see as an imbalance of power, with franchisors holding all the cards and the courts offering no effective means to check that imbalance. Drafters of the bill assert that it is necessary to combat the “failure of traditional common law doctrines to evolve sufficiently to protect franchisees adequately from fraudulent or unfair practices in the sale and operation of franchised businesses.” They blame “significant contractual and procedural restrictions” for denying franchisees “viable legal recourse to protect their interests in their businesses.” The legislation emphasizes that “a franchisor that simply acts in compliance with the terms of its franchise contract with a franchisee is not necessarily dealing with its franchisee fairly and in good faith.”

House Bill 1620 may be the result of a public perception that franchisees are powerless and need protecting. But the bill, if enacted, would tip the balance of power too far in the opposite direction. Rather than recognize the franchisor-franchisee relationship as an arm’s length commercial contractual relationship, House Bill 1620 would impose fiduciary and other duties on franchisors. 

A section of the bill on good faith and fair dealing would prohibit a party from taking action that would destroy or injure the other party’s right “to receive the full expected benefits of the contract” – even if the action is not prohibited by the express terms of the contract.

The legislation also would impose limited fiduciary duties on franchisors, requiring them to “exercise the highest standard of care” in performing bookkeeping, collection, payroll, and accounting services on behalf of franchisees, as well as in administering, or supervising the administration of, advertising funds to which franchisees are required to contribute. (Franchisors would even be required, at their own expense, to give franchisees an independent certified audit of the advertising fund within 60 days of the close of the franchisor’s fiscal year.) 

In a separate section on due care, the bill would impose on franchisors a duty “to exercise the skill and knowledge normally possessed by franchisors in good standing in the same or similar types of business.” Franchisors and franchisees would be required to conform to “clearly established systemwide standards of operation which are not arbitrarily promulgated or enforced.”

The bill would expand franchisors’ obligations to renew and would limit their rights to change the franchise fees, royalty rates, or other material financial terms of the franchise relationship, or to materially change, abrogate, or deprive franchisees of the intended benefits of the franchise agreement. This provision would appear to nullify the requirement in many franchise agreements that a franchisee that wishes to renew must sign the franchisor’s then-current form franchise agreement, even though it may include materially different terms, including increased royalty rates and advertising contributions. Franchisors’ rights to enforce noncompetes also would be limited.

A franchisor that violates the provisions of House Bill 1620 would be required to pay consequential damages, as well as civil penalties of at least $2,500 for each violation. Criminal sanctions could be imposed for intentional violations. Costs and attorney fees may be awarded to prevailing franchisees. And any requirement for a franchisee to mediate, arbitrate, or litigate a claim under the franchise agreement outside the state where the franchised business is located would be void.

The legislation would apply to franchise agreements initiated or renewed on or after the effective date.

For franchisors that have long fought to remove the concept of fiduciary duty from commercial contractual relationships, this legislation would appear to undo much of the common law that has developed over the last 20 years. Already, the International Franchise Association (“IFA”) is marshaling its forces to turn back this legislative initiative before it advances out of Pennsylvania General Assembly’s Consumer Protection Committee. For this legislative showdown, the IFA will attempt to recruit legions of franchisors and franchisees to explain why this bill would have a chilling effect on franchising in the State of Pennsylvania and would spawn litigation that will challenge the very essence of the franchise model. [1]

Proponents of the legislation, on the other hand, will invite franchisee advocates to tell stories of franchisors abusing their power.  They will make pleas for bringing much-needed balance to the franchise relationship, which they believe is weighted strongly in favor of franchisors.

In the past, the IFA has had good success in tabling or stalling franchise relationship bills in California and Maine. Success in Pennsylvania will depend on many factors, including the passion shown by the franchisor community. If this bill becomes law, it is a sure bet that other states will seek to copy Pennsylvania’s example.

The more fundamental question is why over the past few years the franchising community is seeing so many state franchise relationship initiatives. What changes in the franchise model have triggered these legislative initiatives? Have franchise agreements really become a barrier to success for the franchisee?

Long the cornerstone of the franchise relationship, franchise agreements have evolved into a document intended to protect the franchisor from any possible contingency, whether or not applicable to the specific franchise concept. Almost all franchise agreements today are prepared by franchisor counsel, with little input from franchisees. As a result, many of these agreements contain similar if not identical franchisor friendly provisions. 

During the late 1990’s and early 2000’s, when the American Franchise Association proposed national franchise relationship legislation, another franchisee-sponsored organization sought to rebalance the franchise relationship though market forces anchored by the concept of a fair and balanced franchise agreement. The American Association of Franchisees and Dealers (“AAFD”), formed in 1992, pioneered the idea of “Total Quality Franchising,” and encouraged franchise systems to engage in collaborative negotiations to develop a fair contract under AAFD Fair Standards guidelines. The prize for this collaborative conduct was the fair franchising seal, which could be affixed to a franchisor’s disclosure document. Today, however, the AAFD’s initiatives have waned. A new crop of franchise system owners has emerged, focused on growth and the integration of multiple franchise systems. Their goals are reflected in the terms of today’s franchise agreements.  

Franchisees tend to shop hot franchise concepts, not franchise agreements. Unfortunately, the terms of the franchise agreement may not engage the franchisees’ attention until difficulties in the franchise relationship surface. As Pennsylvania’s legislative initiative shows, when the perception arises that franchise agreements prevent franchisees from receiving the all of the benefits of franchising that they should expect, franchise relationship legislation to right the seemingly unbalanced relationship is likely to arise. And even though franchise relationship laws may be off federal legislative radar screens, what is not reserved for the federal government becomes the province of the fifty states.

If the ground is indeed fertile for House Bill 1620, as its sponsors believe, then the franchise community must be ready for this legislative showdown and must exercise its voice to support, reject, or amend the proposed legislation. Make your voice count.


[1]  In September, the IFA, which boasts the nation’s 25th largest PAC, marshaled more than 350 franchisors, franchisees, and suppliers to call on their legislators on Capitol Hill to discuss hot-button legislative issues affecting franchising. For the first time at this annual gathering, the North Carolina contingent boasted the largest number of delegates.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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