Attorney Dan Davis: Is Franchising Highly Regulated?

UnhappyFranchisee.Com asked leading franchisee attorneys – those who deal with franchise regulation (and the lack thereof) on a daily basis – whether the characterization of franchising as “highly regulated” is accurate.

(See IS FRANCHISING HIGHLY REGULATED? Top Franchisee Attorneys Weigh In).

Attorney Dan Davis is a Litigation Associate with Ichter Thomas LLC.

Ichter Thomas is the Atlanta-based firm that has notably and successfully represented numerous Legacy Academy franchisees in their disputes with their controversial franchisor.

While Dan Davis believes that franchising can rightfully be considered “highly regulated,” he points out that “the nature of that regulation is limited in ways that prospective franchisees may not understand.”

For example, Davis points out that the FTC’s Franchise Rule simply requires franchisors to disclose certain information during the sales process “so prospective franchisees can make more informed (and therefore presumably better) decisions.”

Davis writes “the Franchise Rule does not regulate the substance of franchise agreements.”

“…As a practical matter,” writes Davis, “…Franchisors can draft their franchise agreements in a way that limit the scope and nature of their duty to act in good faith.”

Dan Davis’ response to our inquiry (below) also references the proposed PA franchise bill known as HB 1620.

Read more about HB 1620 here:  PA’s Responsible Franchise Practices Bill: Overview and Discussion

Attorney Dan Davis: Is Franchising Highly Regulated?

Franchising is a highly-regulated industry, but the nature of that regulation is limited in ways that prospective franchisees may not understand.

The Federal Trade Commission’s (“FTC”) Franchise and Business Opportunities Rule imposes extensive disclosure requirements on franchisors. The FTC’s Compliance Guide, for example, is 154 pages long. It is important to understand, however, that the Franchise Rule does not regulate the substance of franchise agreements. All the Franchise Rule does is to require franchisors to disclose certain information so prospective franchisees can make more informed (and therefore presumably better) decisions. See Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunities, 72 Fed. Reg. 15,477 (Mar. 30, 2007) (“[T]he Commissions cannot categorically conclude that prospective franchisees who voluntarily enter into franchise agreements, after receiving full disclosure, nonetheless cannot reasonably avoid harm resulting from a franchisor enforcing the terms of its franchise agreement”).

Pennsylvania HB 1620 is premised on a fundamentally different assumption; to wit, “[t]raditional common law doctrines have not evolved sufficiently to protect franchisees from fraudulent or unfair practices in the sale and operation of franchised businesses, and significant contractual and procedural restrictions have denied franchisees viable legal recourse to protect their interests in the businesses.” See § 902(3). To this end, HB 1620 contemplates widespread regulation of franchise agreements themselves. Perhaps most importantly, HB 1620 would impose a duty of “good faith” and “fair dealing” on franchisors (and franchisees). See § 905.

This duty is already implied under Pennsylvania common law. See, e.g., Kamco Indus. Sales, Inc. v. Lovejoy, Inc., 779 F. Supp. 2d 416, 424-26 (E.D. Pa. 2011) (collecting and reconciling case law); Atl. Richfield v. Razumic, 390 A.2d 736, 742 (Pa. 1978). District courts sitting in Pennsylvania disagree, however, as to whether the implied duty of good faith and fair dealing in the franchise relationship applies to conduct other than termination of the franchise. Compare Martrano v. Quizno’s Franchise Co., LLC, No. 08-0932, 2009 WL 1704469, at *17-19 (W.D. Pa. June 15, 2009) (yes), with AAMCO Transmissions, Inc. v. Wirth, No. 11-4250, 2011 WL 6088671, at *11 (E.D. Pa. Dec. 7, 2011) (no).

Furthermore, an important limitation on the common law doctrine is that the express terms of a franchise agreement control to the extent of any conflict with the implied duty. See, e.g., Northview Motors, Inc. v. Chrysler Motors Corp., 227 F.3d 78, 91 (3d Cir. 2000) (“Courts have utilized the good faith duty as an interpretive tool to determine the parties justifiable expectations in the context of a breach of contract action, but that duty is not divorced from the specific clauses of the contract and cannot be used to override an express contractual term”); Witmer v. Exxon Corp., 434 A.2d 1222, 1127 (Pa. 1981) (affirming dismissal of franchisee’s bad faith claim where franchisor’s conduct was “explicitly contemplated by the plain terms” of the franchise contract). What this means, as a practical matter, is the franchisors can draft their franchise agreements in a way that limit the scope and nature of their duty to act in good faith.

In this respect, a critical aspect of HB 1620 is its provision that “[a] franchisor that simply acts in compliance with the terms of its franchise contract with a franchisee is not necessarily dealing with its franchisees fairly and in good faith.” See § 902(5); see also § 905(a)(1)(ii) (“An action with prevents enjoyment [of the full expected benefits of the franchise contract], even if it is not prohibited by the express terms of the contract, is prohibited”).

Frankly, this is a bit of a Pandora’s box. There should be little doubt that HB 1620 will make it more difficult for parties to franchise contracts, including franchisees, to understand the outer limits of their duties and responsibilities and act accordingly. See Kaplan v. Cablevision of PA, Inc., 671 A.2d 716, 722 (Pa. Super Ct. 1996) (“The breach of the obligation to act in good faith cannot be precisely defined …”). At the same time, a very real benefit would be to provide some check on franchisor opportunism, e.g., pretextual termination to capture franchisee-specific goodwill or threats of termination to extract higher royalty fees.

In my opinion, legislation like HB 1620, such as that currently working its way through the California legislature (SB 610 and AB 1141), reflects the perception that there are problems in the marketplace that are not being properly remedied by courts applying contract law. Unless that perception is remedied (preferably by addressing any actual underlying abuses), expect more proposals for similar regulations, with their attendant problems, to be forthcoming.

Dan Davis Franchise AttorneyDan Davis is a Litigation Associate at Atlanta-based Ichter Thomas LLC.  Dan focuses his practice on franchise and distribution litigation, and represents individuals and businesses as plaintiffs and defendants in state and federal courts as well as various arbitration forums.  Dan’s represented clients in a variety of industries, including food and beverage, preschool and daycare and tax consulting services, from the pre-complaint stage through discovery into trial.




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