A federal district court recently granted the United States’ Motion for Default Judgment against the quick-service burger restaurant franchise concept, Burgerim Group USA, Inc. and its owner (“Burgerim”). The Federal Trade Commission (“FTC”) filed a complaint against the defendants alleging they used misleading sales practices to sell more than 1,500 franchises in violation of the FTC Franchise Rule.  The complaint arose after several states, particularly California, Indiana, Maryland and Washington, filed cease and desist orders and barred Burgerim from offering and selling franchisees in their respective jurisdictions.

This was the first major civil enforcement action against a franchise system by the FTC in over ten years.  The court held that the FTC has proved its damages as defendants were paid $57,707,244 in franchise fees from 2015 through July 2019 and of that amount, the defendants only issued $9,230,555 in refunds.  The court also found the United States’ request for a $5,000 penalty per violation was reasonable as it was far below the amount authorized by the FTC’s Rule of Practice.  The court granting the United States request for consumer redress in the amount of $48,747,689 and a civil penalty of $7,750,000.  The court also found that a permanent injunction prohibiting the defendants from selling additional franchises was warranted and an appropriate sanction for their conduct.

Unfortunately, this may do little to assuage the purchasers as the franchisor ceased operations and its founder is purported to have fled abroad. This is why prospective franchisees are urged to conduct thorough due diligence before signing any franchise agreements or paying any initial fees, especially with unproven and emerging brands.  Anyone seeking to purchase a franchise should, at a minimum:

1. Hire a franchise attorney to review the FDD and identify any concerns, follow-up questions for the franchisor, or red flags particularly with respect to: (A) previous litigation or bankruptcy matters; (B) indications of inadequate administrative, training, and operational support evidenced by too few Item 2 staff biographies, limited pages in the operations manuals, and non-specific and insufficient training disclosures; (C) uneven growth patterns (including large spikes in sales without corresponding successful openings) and unexplained terminations and non-renewals; (D) additional financial assurance requirements imposed by state regulators evidencing weak financial statements; and (E) financial performance representations (earnings claims) in Item 19.
2. Call and email both former and current franchisees listed as an exhibit to the FDD and interview these franchisees about their experiences with the system.  Ask probing questions such as whether (A) they opened within the time frame specified in Item 11; (B) they received adequate training and pre-opening and post-opening support; (C) the technology, brand fund and other fees paid provide sufficient return of value; and (D) most importantly, they are making money!
3. Engage an accountant, trusted business or tax or financial advisor who can prepare pro-formas and work with you to determine break-even and whether purchasing a franchise makes financial sense.  

There are no guarantees in business, but with the right trusted advisors and sufficient due diligence, prospective franchisees can decrease the risk of investing in an untrustworthy franchise brand.

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