John J. LaFalce Oversight Hearing

In short, Mr. Chairman, a growing number of American business people must routinely sign away their basic rights and legal remedies as citizens and as business owners in order to purchase a franchise. This is unfair and it is unacceptable.

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U.S.A. House of Representatives
June 24, 1999

Oversight Hearing on the Franchising Relationship
John J. LaFalce

United States of America
House of Representatives
Subcommittee on Commercial and Administrative Law

JOHN J. LaFALCE

Chairman Gekas, Ranking Member Nadler, Members of the Subcommittee, I appreciate the opportunity to appear before the Subcommittee this morning and commend the Chairman for organizing today's hearing to examine the important issues of franchise business relationships and franchise regulation.

In 1990, while serving as Chairman of the Committee on Small Business, I released the House of Representatives' first comprehensive study of franchising. This study formed the background for hearings that I conducted on franchising issues over the succeeding five years. These hearings, in turn, provided the basis for franchising bills which I introduced in 1991 and 1992, and reintroduced as the Federal Fair
Franchise Practices Act in the three succeeding Congresses. I was pleased to see that the legislation introduced last Fall by Mr. Coble, Mr. Conyers, Mr. Nadler and other Members of this Committee included all the key proposals of my earlier legislation.

The Small Business Committee's hearings on franchising were initially intended to document the growing trend and importance of franchising in our nation's economy and in new small business formation. That trend and importance has increased significantly in the ensuing decade. My subsequent hearings focused more on the legal and operational aspects of franchise business relationships. Those hearings sought to answer the questions of whether franchises provide investors with a greater chance for long-term business ownership and success? Whether franchisees possess ownership rights that are commensurate with independent businesses? And whether current law and regulation are adequate to protect the investment and ownership rights of franchise business owners?

The answer to these questions was generally "no". The Committee's inquiry encouraged a number of independent studies showing, for the first time, that a franchisee's chances for success is statistically similar to that of independent business start-ups. We also found, most disturbingly, that franchisees enjoy few of the legal rights and protections available in Federal and state law for other private business owners.
And we found that franchisees have limited legal recourse to protect their livelihood and their investment in courts of law.

While many factors contribute to these problems, four strike me as particularly important. First, with very few exceptions, such as auto and gasoline dealers, there are no Federal laws governing either the sale or operation of franchise systems-which clearly operate on an inter-state and, often, a multi-national basis. The only regulatory procedure at the Federal level, the Federal Trade Commission's franchise disclosure rule, is outdated and inadequately enforced. Only a handful of states have laws or regulations governing franchise sales and practices, and most of these have largely deferred to the Federal government for enforcement.

Second, forty years of successful litigation by franchisors has left the role of the franchisee largely undefined for purposes of federal and state law. They are not employees for purposes of employee benefits or protections, nor are they independent agents for purposes of the uniform commercial code and contract law. They are neither consumers, customers nor investors for purposes of consumer, investor and fiduciary protections. As a result, basic legal standards applicable in all other business relationships-concepts such as good faith, good cause, duty of competence and due care, and fiduciary responsibility-typically are not applicable to franchisees.

Third, franchisees confront a tremendous imbalance in franchise contracts that bind them to accept virtually all actions and decisions of their franchisor no matter how arbitrary or abusive. These contracts have become 50- to 70-page documents that outline in great detail the duties, obligations and restrictions on franchisees, while remaining almost silent on the obligations and promised services of franchisors. And
franchisors have vigorously enforced these contracts with the help of courts that have most often refused to consider anything beyond the strict terms of the contract.

Fourth, the problems of franchise contracts are compounded by the fact that they are written by franchisors to preempt every possible legal challenge. Procedural devices are routinely employed to bar legal actions, to deny protections in state laws and to make litigation inconvenient, costly and, thus, prohibitive for most franchisees. Indemnification clauses are written so broadly as to preclude almost any possible legal claim. As a former chairman of the American Bar Association's Franchise Forum once told the Small Business Committee, indemnification provisions in franchise contracts are drafted so broadly as to protect franchisors even "for the franchisor's gross negligence, wanton recklessness and intentional misconduct."

In short, Mr. Chairman, a growing number of American business people must routinely sign away their basic rights and legal remedies as citizens and as business owners in order to purchase a franchise. This is unfair and it is unacceptable.

I will shortly introduce a new version of my Federal Fair Franchise Practices Act legislation that will be targeted, more specifically than my previous proposals, to the problems I outline in my testimony. Its purpose is to minimize the legal disadvantages of franchise ownership-First, by clarifying existing law to provide basic standards of fair conduct for franchise relationships; Second, by enhancing available private remedies to permit franchisees to protect their legitimate financial interests in a court of law.

Briefly, my legislation clarifies that five standards of conduct that are widely recognized in common law for most business and professional relationships would also apply in contractually defined franchise relationships. These include-

(1) Duty of Good Faith: It requires that all parties to a franchise agreement act in good faith in the performance and enforcement of the contract. There is absolutely no reason why this basic principle of the Uniform Commercial Code, which applies to all other business relationships, should not apply to franchises.

(2) Duty of Due Care: It would impose on franchisors a duty to exercise due care and reasonable standards of competence in establishing and operating its franchise system. This basic precept of the Restatement (second) of Torts applies to all other business professionals and requires that they have both the qualifications and the capacity to perform the services they advertise or promise. Again, there is absolutely no good reason this should not be adopted.

(3) Good Cause Standard: The legislation would apply the common law principle of good cause to franchise terminations. No legitimate purpose is served when a franchisor can arbitrarily terminate a franchisee's contract, and thus his livelihood, without any proven breach of contract or any opportunity to cure any alleged breach or default.

(4) Fiduciary Obligation: It would subject franchisors to a fiduciary standard in the limited circumstances where the franchisor requires that it handle basic financial or accounting services for its franchisees or administers pooled advertising funds to which it requires franchisees to contribute. This is a basic common law protection.

(5) Right of Association: The bill requires franchisors to recognize the right of franchisees to form independent associations and requires a good faith standard in all undertakings between the franchisor and the association. Independent associations need not be adversarial, and can provide information sharing, training, joint purchasing and other functions that are vital to successful franchise systems.

In addition, the bill provides a private right of action for franchisees to initiate actions in federal court for alleged violations of these standards of conduct and for violations of the disclosure requirements in the
FTC's Franchise Rule (something the FTC has sought for nearly 20 years). It would also nullify provisions in future franchise contracts that are intended to limit or exempt franchisors from liability under these standards or that seek to bar or limit a franchisee's rights to bring legal actions.

Contrary to what some franchisors will tell you, this legislation does not constitute government regulation of franchising. On the contrary, it simply identifies standards of fair conduct and legal redress in current law and clarifies their application to franchise relationships. These are minimal standards of conduct for an industry of this size and importance. But they will have a tremendous impact in helping to restore basic fairness to franchising.

Mr. Chairman, on numerous occasions since 1990 I have said that enacting proposals that define the legal relationship between franchisors and franchisees would constitute landmark legislation. In much the same way as the Wagner Act helped structure labor-management relations for the industrial economy of the 1930s, I believe this legislation can bring balance and fairness to the huge franchising sector of our services-based economy.

Thank you again for the opportunity to address the Subcommittee.

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