Susan Kezios Oversight Hearing

Despite the highly visible role that franchising plays within our economy, there are fundamental flaws in its basic structure. Some franchisors take advantage of those flaws…Most Americans don't rob banks, yet we still have laws against bank robbery. Most issuers and underwriters of corporate securities don't lie and cheat, yet we still have laws against securities fraud.

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

Oversight Hearing on the Franchising Relationship
Susan P. Kezios, AFA

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

SUSAN KEZIOS, American Franchisee Association

Chairman Gekas and Members of the Subcomittee, my name is Susan P. Kezios. I am President of the American Franchisee Association (AFA). The American Franchisee Association is the largest trade association in the U.S. solely representing the interests of small business franchisees. We have over 9,000 individual members who own approximately 22,000 franchised businesses in 60 different industries.

I thank you for the opportunity to present our position to the committee regarding the status of franchised business relationships in the U.S. today.

Despite the highly visible role that franchising plays within our economy, there are fundamental flaws in its basic structure. Some franchisors take advantage of those flaws.

Let me show you what someone confronts when they investigate purchasing a franchise. As you can see by these advertisements, the American dream of owning your own business is the lure that pulls many individuals to investigate franchising as a means of small business ownership. Companies offering franchises for sale entice the buyer with promises of owning their "own cruise business, printing business, consulting business, training business." The analogy is made first through these advertisements and then in conversations with franchise salespeople that owning a franchise is like purchasing a home in that the investor will be building equity in him or herself by buying the franchise. The reality in most cases is you're not owning your own business, its more like renting an apartment.

That reality hits home once the franchisees try to realize the long-term equity they thought they were building once they try to transfer or sell the franchise.

Franchisees are possibly the only small business owners in the world who cannot sell what they own. At some point a franchisee may choose to sell her franchise to a new owner. Most franchise systems require in the event of transfer that the buyer must sign the "then-current" franchise agreement, meaning that the current franchisee cannot sell the remaining years on his agreement at the financial and operational terms originally agreed to with the franchisor. Because the "then-current" franchise agreement is likely to have different financial obligations for the transferee (a windfall gain to the franchisor) this requirement automatically drives down the value of the current franchisee's business, lowering the purchase price and devaluing the assets. Neither of these agreements is negotiated; they are drafted unilaterally by the franchisor's lawyers.

I recently talked with a fast food franchisee about the transfer of one of his locations. He told me that when he bought the franchise he signed a contract that stated that his franchisor must approve the new buyer-to which he didn't object. He recognized there were three potential buyers for his outlet; the franchisor, another franchisee or an outside party. So he signed the contract, learned how to run his business and became known as a good operator within the system.

His contract also stated that to be in compliance and not in default, he may have to adhere to the franchisor's operations manual(s) and other company policies as the franchisor might change them from time to time. During the term of his contract, the franchisor changed their internal policy regarding to whom he could sell his franchises. He no longer could sell his franchise to an outside party, effectively cutting the value of his franchise by 1/3rd. This man bought the franchise, learned how to run the business, became a good operator within the system, was building equity in his business and assets and through no action of his own lost 1/3rd of his equity in his business by an arbitrary and unilateral decision of his franchisor.

Another example to illustrate the "renting an apartment" analogy: Many franchise systems require franchisees to purchase products solely from the franchisor or from suppliers designated by the franchisor. Even though identical goods are often available from competitive sources no allowance is given to purchase from competitive sources even if quality standards are upheld. That means the small business franchisees in your district are buying products and services to sell to the consuming public from outside of your district and most probably outside of your state from high cost vendors.

Many franchise corporations routinely and unnecessarily restrain trade between competing vendors. Their franchisees are severely restricted in their ability to shop for and negotiate the best prices on conforming products and supplies. This drives up costs for franchisees and prices for consumers. And federal courts just as routinely hold that these restrictive trade practices do not violate the anti-trust laws.

How has franchising evolved to this point? Two reasons: One, as franchising has grown from its humble beginnings in the 1950's, so too have franchise agreements evolved between franchisor and franchisee. From a simple hand-shake with the Colonel in the 1950's the franchise agreements of today have developed to the point where other than the provisions relating to the use of the trademark, use of the proprietary information and the payment of fees, almost every other provision of the agreement seems to have some aspect of controlling, trapping or defeating the franchisee.

Franchisees are governed solely by lengthy and totally one-sided contracts drafted by the franchisors' attorneys. The vast disparity in economic power and bargaining strength enables the franchisor to determine arbitrarily the rules by which the two parties conduct their business affairs post-sale. These rules are incorporated into the franchise agreement which the franchisor prepares unilaterally for the franchisee's signature. What is even worse is that franchisors then justify their own abuses by claiming that pre-sale disclosure-in lengthy, unintelligible, legal prospectuses-makes any abusive trade practice lawful and proper.

The second reason these situations occur is because there is no existing baseline standard of conduct for franchisors and franchisees to abide by after the franchise sale has been made. There is no federal requirement for franchisors and franchisees to abide by the familiar common law duty of good faith in their dealings with each other; no duty of due care that the franchisor must show to its franchisees; no limited fiduciary duty when the franchisor handles its franchisees' money in bookkeeping or accounting functions or pooled advertising funds. The current scheme of the Federal Trade Commission's (FTC) Trade Regulation Rule on Franchising and Business Opportunity Ventures and the hodgepodge of state disclosure laws are totally inadequate in dealing with current franchisee issues.

The real problem with the FTC's franchise rule is that it gives the appearance of government oversight without any enforcement. The FTC, despite its staff's good intentions, is truly a paper tiger. The FTC requires each franchisor to attach to its disclosure document a front cover page as you see here, which states in part, "To protect you, we've required your franchisor to give you this information. We haven't checked it and don't know if its correct." The cover page then deputizes the prospective franchisee, someone who is not a business owner yet with: "If you find anything you think may be wrong or anything important that's been left out, you should let us know about it. It may be against the law." This despite consistent rulings in all federal court circuits that franchisees cannot sue to enforce the FTC's franchise rule.

The absence of any minimum standards of conduct in a multi-billion dollar industry should be a serious concern for us all. Franchising is the least scrutinized investment market in the United States today. Securities, lending, banking, leasing, the professions, the purchase of commodities-each of these multi-billion dollar markets has minimum standards of conduct set by federal law. Securities issuers cannot gain access to the public to sell securities without meeting minimum financial standards under both federal and state laws. By federal law securities issuers can only sell stock to suitable investors-those who have the experience and financial resources to afford the risks associated with the investment. The securities industry recognizes the fiduciary relationship between brokers and buyers of securities. No such minimum standards exist for franchise companies. Many franchise chains would be unable to sell stock on the U.S. markets, yet they are able to solicit investors for franchises at $150,000 and more. And these same franchise chains are unwilling to accept any enforceable standards of conduct.

Most Americans don't rob banks, yet we still have laws against bank robbery. Most issuers and underwriters of corporate securities don't lie and cheat, yet we still have laws against securities fraud. And even if many or even most franchisors do not abuse their position and power, and even if some franchisees are large and sophisticated investors, we still need effective federal standards to discourage franchise abuses.

Our opponents will say that the stories you have heard regarding the problems in franchising are "merely anecdotal. They are not widespread. They are just a few disgruntled, unsuccessful franchisees asking the government to intervene on their behalf." Attached to my testimony is a copy of the American Franchisee Association's (AFA) Franchisee Satisfaction Survey. Forty percent of the franchisees surveyed feel they have an unsuccessful relationship with their franchisor, have been encroached upon by their franchisor, have been threatened by a representative of the franchisor and are/have been in a dispute with their franchisor. Fifty-five percent of responding franchisees would not advise others to join their franchise systems. This sounds like more than mere "anecdote" to me.

Most of the problems experienced by current franchisees derive from a misuse of power. That is why we are here seeking changes that will level the playing field.

There is no freedom to contract when one party to a business transaction can arbitrarily and unilaterally increase its opportunity for profit at the expense of the other party.

There is no freedom to contract when one party can arbitrarily and unilaterally change the terms of the contract.

There is no freedom to contract when one party can disavow ordinary common law duties of good faith, fair dealing and due care.

The American Franchisee Association asks that you establish minimum standards of conduct for the franchise industry and restore freedom of contract for small business people who choose franchising as a way of doing business in the United States.

Thank you.

Susan P. Kezios is the Founder and President of the American Franchisee Association (AFA), the national trade association for small business franchisees. AFA's 9,000 members own over 20,000 outlets in 60 different industries including fast food, lodging, automotive, business and personal services.

Ms. Kezios is a former franchisee, having purchased a VR Business Brokers franchise in suburban Chicago, in which she worked. After helping form the VR Franchisee Association and creating training programs for the franchise network, she was hired as Vice President of Marketing for the franchisor.

Ms. Kezios also owns her own business, Women in Franchising, Inc. (WIF), which she started in 1987 to assist women with their franchise business development needs. In 1992 as contractor to the U.S. Department of Commerce's Minority Business Development Agency (MBDA) WIF designed the Agency's National Franchise Initiative which was implemented in conjunction with the Agency's 80+ Minority Business Development Centers (MBDCs) nationwide. In 1993 and 1994, WIF was a subcontractor to the Agency's Chicago and Los Angeles Minority Enterprise Growth Assistance (MEGA) Centers. Finally, in 1994, as contractor to the U.S. Small Business Administration's (SBA) Office of Advocacy (SBA 8143-0A-94), WIF conducted a research study regarding "Women and Minorities in Franchising and Financing Practices." The study was completed in 1999.

Ms. Kezios was an elected delegate to the 1995 White House Conference on Small Business (WHCSB), where she encouraged and organized franchisee participation. As a result "franchisee legal and constitutional rights" was among the final list of small business issues presented to the President and Congress for action.

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