Fair Franchising

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This article will separate the optimists from the pessimists on the important subject of “fairness” in hotel ownership. Hopefully, we will make an optimist out of even the most cynical readers amongst us.

We begin with a simple question: Which of the following is the most likely to occur first?

a) America’s leading hotel franchisors will voluntarily embrace AAHOA’s 12 Points of Fair Franchising.

b) The U.S. Congress will pass comprehensive “fair franchising” legislation (or the Federal Trade Commission will enact a new regulation) that effectively implements the 12 Points and makes further efforts by AAHOA members unnecessary.

c) The U.S. Supreme Court will decide a “fair franchising” case that establishes, once and for all, that liquidated damage clauses (and other contract provisions to which franchisees usually object) are “unconscionable” because they “shock the conscience” of the Court.

d) None of the above.

Obviously, if you answered (a), (b), or (c), you have an optimistic nature, while those that say (d) are probably doomed to spend their lives as pessimists. We respectfully submit that too many observers of franchising are far too pessimistic about the prospects for “fairness in franchising”; in the balance of this article we hope to persuade you to join the optimistic camp as well!

Furthermore, for the optimists, we are going out on a limb to say that the correct answer is (a), that the franchisor community will voluntarily embrace the 12 Points of Fair Franchising long before fair franchising is imposed upon them by law.

That said, the pessimists unfortunately have a lot of history on their side that cannot be ignored. Like a voice in the wilderness, the first known calls for “fair franchising” came nearly 40 years ago when a dedicated Boston lawyer, the late Harold Brown, decried the commonality of franchise agreement provisions that left most franchisees vulnerable to a total loss of equity in their investment. Two obvious examples were provisions that allowed arbitrary terminations, and liquidated dam- ages clauses that make it hard, or impossible, to extricate oneself from a failing brand or a bad deal.

Over the last 40 years, there have been many attempts to “level the playing field”. Among the high- lights, or lowlights, in 40 years of “Fair Franchising” efforts:

1) The FTC in the late 1970’s en- acted franchise regulation, but the FTC Franchise Rule has always been limited to the regulation of what the franchisor must disclose to prospective franchisees, without regulating the contents of franchise agreements or imposing limitations on franchisor conduct.

2) A handful of states enacted their own disclosure laws and some states have legislated against arbitrary terminations, but no state has en- acted comprehensive protection that would come anywhere near the protection for franchisees that AAHOA seeks in the 12 Points of Fair Fran-chising. No new state franchising legislation has been enacted in the last 20 years!

3) Efforts to enact a comprehensive federal fair franchising law peaked in the 1990’s, as the proposed legislation never made it to the floor of the U.S. Congress.

4) Judicial efforts to restrain franchisor conduct have historically centered on both efforts to impose fiduciary duties upon franchisors and efforts to hold certain clauses unconscionable. By and large, franchisors have beaten back efforts to establish fiduciary duties, as most courts see franchising as a two-way business relationship, and not as a fiduciary relationship akin to the relationship between a trustee and beneficiary. Likewise, there have been a handful of cases, mainly from the West Coast, in which courts have found some arbitration clauses in franchise agreements to be unconscionable, but at this time there is not a good precedent in any jurisdiction to argue that a franchise agreement that does not meet the 12 Points is unconscionable.

By and large, the courts have imposed a “good faith and fair dealing” standard on franchisor behavior in performing their contract duties; and of course, the courts remain willing to protect a franchisee from fraud in cases where it can be proved. Thus, it remains possible for individual franchisees to win specific cases, but because most individual, single unit franchisees lack the resources to fight back, the prospects of being defeated in individual cases has not persuaded franchisors to change the terms of their standard franchise agreements fundamentally. Being a good franchisor today remains more a matter of enlightened self-interest among those franchisors that desire “win-win” relationships with their franchisees, more so than any legal mandate.

5) Franchisees in a minority of systems formed independent franchisee associations in an attempt to engage in collective bargaining with their franchisors. There have been some notable successes on this front, but so far, the independent franchisee association movement has not gained serious traction toward the goal of negotiating agreements that are more palatable to the franchisee. Moreover, efforts by associations to bring system-wide litigation or arbitration to redress franchisee grievances have had mixed results, as it remains difficult to establish association “standing to sue” (or to obtain class action certification) in any case that depends on proof of franchisor conduct with respect to specific individual franchised locations.

6) Efforts to establish national umbrella franchisee associations (such as the American Franchisee Association and the American Association of Franchisees & Dealers) have achieved limited success as these organizations are perennially out- funded by the International Franchise Association, which speaks for franchisors.

7) The Federal Trade Commission in 2007-08 adopted the first serious amendments to its franchise rule since the late 1970’s. However, to the disappointment of most franchisee advocates, the FTC declined again to go beyond the regulation of the franchise sales process. Efforts to extend regulation to the contents of franchise agreement — or to franchisor conduct during the relationship or upon termination — were considered but rejected.

8) One bright spot, however, is that in the amended FTC Franchise Rule, franchisors must now disclose whether the franchisees in its system have created an independent franchisee association and whether the franchisor recognizes the association as legitimate. Other highlights/low- lights of the amended FTC Rule are that:

[T]he amended Rule requires more extensive disclosures on: lawsuits the franchisor has filed against franchisees; the franchisor’s use of so- called “confidentiality clauses” in lawsuit settlements; a warning when there is no exclusive territory; an explanation of what the term “renew- al” means for each franchise system . . . In a few instances, the amended Rule requires less than the UFOC guidelines — for example, it does not require disclosure of so-called “risk factors,” franchise broker in- formation, or extensive information about every component of any computer system that a franchisee must purchase.

9) Last but not least, AAHOA has adopted the 12 Points of Fair Franchising, but so far, the major hotel franchisors have been slow to embrace them.

Against this history, I remain very optimistic that franchisees — whom AAHOA correctly refers to as “hotel owners” — have a future that is much brighter than the past. How- ever, the question that we posed at the beginning of this article was a trick question. No great change in the direction of “fair franchising” will simply occur but instead this important goal must be achieved. Furthermore, franchised business owners in general and AAHOA members in particular have much greater odds of success in striving to achieve voluntary compliance with fair franchising standards for the simple reason that “self-help” is al- ways better than waiting for charity from others. To wait for the courts, the legislatures, or the regulators to rescue hotel owners from “unfair” contracts is to place your fate in the hands of others, who have much more funding, and to abdicate personal responsibility for your own future. That would be a tragic mistake, especially since all the ingredients for hotel owner success are readily at hand. Specifically, hotel owners will win the struggle for fairness when three things happen:

1) Enlightened hotel owners will decline to sign contracts that do not meet the standards established by the 12 Points of Fair Franchising. You would not buy a car that was unsafe and place your family in physical danger. Why would you buy a hotel on terms that are legally unsafe and thereby place your family in economic danger?

2) Taking advantage of the amended FTC Franchise Rule, hotel owners will create single-brand independent franchisee associations and demand recognition, and will demand the opportunity to collectively bargain the franchise agreement. Future hotel purchasers will scrutinize the Franchise Disclosure Documents that must now comply with the amended FTC Rule (replacing the old Uniform Franchise Offering Circulars or “UFOCs”) to see whether the particular brand has recognized its association.

3) Savvy hotel owners will explore alternatives to being franchisees. Two alternatives come readily to mind: Establishing cooperative associations, and becoming franchisors instead of franchisees. Both of these alternatives are very viable from a legal standpoint. The question is not whether these developments will occur, but when, and whether AAHOA members will be at the forefront.

Each of these three actions are steps to independence, and hence to fairness. As more and more hotel owners take these steps, there will very quickly come a tipping point at which the established hotel brands either will have to get on board with the 12 Points of Fair Franchising or lose franchise sales. By taking the steps outlined herein, hotel owners will change the game in their favor. Am I optimistic? You bet! 

Published in AAHO Lodging Business Magazine March 2009, by Carmen Caruso.

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