Susan Kezios Expert Public Hearing Testimony

…Mr and Mrs Smith don't have a chance,…The fact that you cannot buy locally and that you cannot buy the same quality of product or service at a competitive price leaves your gross margins totally in the hands of the franchisors, and that is a big problem following closely behind encroachment in the States…it's easier to evict a franchisee than to terminate their contract…

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Legislative Assembly of Ontario
March 6, 2000

Public Hearing Testimony
Toronto, Ontario, Canada
Ms. Susan Kezios, Expert Witness, AFA

Standing Committee on Regulations and Private Bills
1st session, 37th Parliament

FRANCHISE DISCLOSURE ACT, 1999
Consideration of Bill 33, An Act to require fair dealing between parties to franchise agreements, to ensure that franchisees have the right to associate and to impose disclosure obligations on franchisors

AMERICAN FRANCHISEE ASSOCIATION, AFA

The Acting Chair (Mr George Smitherman): I'd like to call upon the first expert witness, Susan Kezios from the American Franchisee Association. Welcome to Toronto, Chicago's sister city.

Ms Susan Kezios: Thank you, Mr Chairman and members of the committee. My name is Susan Kezios. I am president of the American Franchisee Association. We're based in Chicago, Illinois. We are the largest trade association in the United States, representing the interests of small business franchisees. We have 16,000 members, by the way, who own over 30,000 outlets in about 65 different industries all over the United States.

I should tell you that I am a former franchisee. I was an employee in a franchise. I worked under two franchisees. I thought that the reason the franchise was having problems was because the franchisees didn't know what they were doing. I eventually bought the franchise from the second set of operators. I became the third franchisee in about four years and realized it was because the franchisor didn't know what they were doing at the time, which is why we were having such problems.

I worked with our fellow franchisees around the country. We formed our own franchisee association. We started training ourselves. In conjunction with the franchisor, we developed advanced programs that the franchisor hadn't been developing. The franchisor hired me as vice-president of marketing, so I went and worked for the franchisor.

I have had an interesting career track in franchising: employee in a franchise, franchisee, vice-president of marketing for the franchisor, and in that capacity I was the franchisor's liaison to the franchisors' trade association in the United States, which is now our opposition on legislation of this type in the United States. I served on several of their women and minorities in franchising committees.

That is a little bit about my background. I also have my own business, called Women in Franchising. We encourage women and minorities in the States to get involved as entrepreneurs through franchising. You have to understand that early on I was concerned that women would sign bad contracts with franchisors. I realized as years went on that it was all white men in the United States who were also signing bad contracts with the franchisors. I should tell you that I am not a lawyer. I will probably offend somebody here today—I will probably offend a lot of people here today—but I'm known in the United States for speaking rather bluntly and candidly about the problems that franchisees face, having gone through many of those problems myself.

I thank you for the opportunity to be here and to present some testimony. The two things that I can possibly share are the American experience and how you might restore a level of honesty and reduce further opportunities for deception in franchising here in Canada. To summarize where I'm going in my remarks, Bill 33 doesn't go far enough; it doesn't go to the heart of the problems that current franchisees face. We have 30 years of disclosure legislative history in the United States, and disclosure alone doesn't work. The third point is that the duty of good faith that is offered in Bill 33 is not enforceable; it's not strong enough.

I can portray for you where the United States is and what we consider to be the state of the art. The United States Congress is right now looking at and discussing very strongly current franchisee problems, because they realize the current scheme has not worked for 30 years. Actually, the American Franchisee Association has maintained in the United States that the potential franchisee investor would be better off without disclosure, just to know that there is no protection, because in the States there is an appearance of government oversight with no actual teeth. Unfortunately, when I read Bill 33, that is what I am reading as well: the appearance of government oversight but with no real teeth for enforcement.

Part of the problem is that once you sign a franchise contract you're not in pre-sale any longer.
Disclosure has to do with pre-sale, what happens before you become a franchisee. The significant problems for current franchisees are involved post-sale. In the States, we call that "relationship legislation." You have elements of relationship legislation in Bill 33, the freedom to associate and the duty of good faith, but, as I said, the duty of good faith seems to be very weak.

The main thrust of franchise disclosure laws in the United States are all pre-sale to deter fraud and misrepresentation in the pre-sale process. The current disclosure scheme in the US, and it seems to me what Bill 33 is modelled after, was enacted in the 1970s based on a 1960s marketplace. Times have changed. You need to jumpstart yourself maybe a little bit by looking at the US experience and get yourself to a newer position. You are wise, and I was very pleased to see freedom of association and an attempt at duty of good faith in Bill 33, because you need to incorporate elements of relationship legislation right out front.

I'll talk a little bit more about US disclosure laws. California was the first state to enact a disclosure law, in 1971. Now there are a total of 14 states that have disclosure laws where a prospectus, an offering circular, has to be provided to the potential franchisee at least 10 business days before they sign the contract or give any money to buy the franchise. In 1979 the US Federal Trade Commission promulgated the regulation. It's called "Disclosure requirements and prohibitions concerning franchising and business opportunity ventures." We call the FTC franchise rule "the rule." I might refer to it in any number of those manners.

The FTC requires pre-disclosure of 23 items of information. There is no central repository for the documents; no one reviews the documents. Supposedly franchisors are providing complete, accurate and truthful information. Only in those 14 states that require some kind of review and registration of the documents is somebody actually reading the documents. In the other 30-odd states there's nobody looking over the shoulder of the franchisors, reading to see if these documents are in fact true, accurate and correct.

By the way, the franchisors' trade association in the US lobbied for 10 years prior to the promulgation of the FTC franchise rule in 1979, saying: "You don't need disclosure. The industry is fine." However, presale problems were so acute that the federal government in the US said, "Hey, we're going to enact disclosure legislation." Today, the same people, the franchisors' trade association, who lobbied against presale disclosure are saying: "That's all we need. Disclosure is fine." In fact, they continue to lobby against any promulgation of any new kind of standards of conduct.

To most members of our association, probably 90% of them, the FTC rule borders on irrelevancy because, again, it's a pre-sale. The majority of our members, and we've surveyed our members, have been in business for longer than 9-point-something years, so these are people who've gotten to break-even and profitability. They've been around for a while. They are what we'd consider successful franchisees, mature franchisees. They feel the FTC rule does not help them because they signed the contract and now their problems are post-sale. In fact, the Federal Trade Commission has told me four times in public hearings: "Ms Kezios, we will never get to all the issues your members consider substantive. We just don't have the time; we don't have the resources. We can't possibly deal with them."

As a matter of fact, the United States Senate asked, in 1993, for an accounting of the FTC's enforcement of the franchise rule, and the General Accounting Office found that the Federal Trade Commission acted on fewer than 6% of all franchise complaints brought to it and took to federal court only 2% of those. I have attached to my written statement a copy of that report so that you can in fact see what was reported to the United States Senate.

The important thing that you have under your Bill 33 that we don't have under the FTC rule is a private right of action. In the states that do not regulate and register franchise documents, those franchisees have a private right of action if they find out that their franchisor may have violated the FTC rule. In the other 30-odd states, the franchisees are supposed to go to the FTC and ask the government to get redress on their behalf. Now you're seeing why our members feel the FTC rule is irrelevant. We have actually called for it to be abolished, because it would be better that the investor knows that there is no government oversight. Don't give the appearance of government oversight without any real enforcement, any teeth.

There is also under the FTC rule no obligation for franchisors to disclosure historical financial performance information. That's what I heard this morning that was also not required in Bill 33. That is inherently misleading to an investor by omission. Why else do you buy a franchise? It's like buying a car without having an engine in it. You buy a franchise because supposedly you can make a living, a good living. All franchisors are selling a proven business system. They supposedly have a proven operating prototype that they are selling to someone. They have historical financial data, they have royalty reports from the franchisees, they certainly know how much those units are doing, and they certainly should be mandated to disclose that information.

In the States, it's a voluntary disclosure, and since 1979, 85% of franchisors have volunteered not to disclosure that information. They don't say that to you when you're buying a franchise. This, in fact, may be what will happen in Canada. They don't say, "We can give this information on how well some of our units have done." They say: "Ah, the government; we're prohibited by law from giving you this information." They are actually twisting the truth to a couple, perhaps, who have a severance package, retirement money, who are not wise in the artful terminology of what is going on in franchising that the franchise lawyers have written. So they believe that the federal government prohibits giving you any financial information. So that is actually a very serious omission in both the FTC rule and in Bill 33.

Let me talk a little bit about relationship legislation in the United States. Again, this is different from pre-sale. Relationship laws actually started springing up in the States in 1972. In 1971, California enacts the first disclosure law and right away there are relationship laws starting to be enacted. Why? To adjust the imbalance in the ongoing relationship between franchisor and franchisee. This is all post-sale.

As franchising has grown in the United States, another 20 states have enacted some kind of franchise relationship. So you've got the 20 states with franchise relationship laws; you've got the 14 states with disclosure laws. Many of them overlap, but 24 of the 50 states have some kind of franchise laws. In the States, it is often not a consequence of the franchise chain you are buying as to how fair or how protected you are; it depends on what state you're in and the law changes. Usually the franchisor contract, the venue, will be the home state of the franchisor because they know how important home court advantage is in a legal sense.

You could be a California franchisee who bought a franchise from a franchisor based in Connecticut, which is on the east coast. In order to take up any kind of dispute, mediation, arbitration or litigation, you have to go to the home court of the franchisor. How many franchisees in California do you think are actually going to do that? They'll say: "Forget it. I've lost my $150,000. I'll go get a job. I'll close the place down and I'll go on with my life." That in fact is often what happens.

The state legislatures have recognized over the years that franchisees are only governed often by lengthy and totally one-sided contracts drafted by franchisor attorneys that are basically non-negotiable. A franchisee relies on the trust they place in the franchise salesperson rather than on what to a first-time investor is impenetrable legal documentation. The most recent example of a relationship statute to all business format franchisees in the States is the Iowa Franchise Act, which is the most recent one. The Iowa Franchise Act, enacted in 1992, has a duty of good faith in it. Actually, the state of Washington has had duty of good faith since 1972. So there are thousands of franchisors doing business in both of those states with an enforceable duty of good faith. There is not one reported appellate case in either of those states — there's no litigation is what I'm saying — under an enforceable duty-of-good-faith provision. What I would propose to you is that an enforceable duty of good faith would cause franchisors to be more reasonable and factual and fair before they take some actions post-sale because they would know in fact that there is a statute that they can be brought into court with. That seems to be the only market force that franchisors in the States truly fear, the fact that there is a statute and they can be brought into court.

I don't think it will increase litigation. I think something like that will actually deter litigation, because the rules of the game will be better defined. It's like speed limit signs. You have a speed limit sign up and surveys in the States are that 90% of people stay within the speed limit, but the 10% of those who don't, when they get caught, there is a problem. In fact, I think that's what you may be trying to do here; that is, to set up a speed limit sign—rules of the game.

In the US, we visualize it as kind of a patchwork quilt of a federal rule requiring disclosure but no registration or review of the documents. Then you've got all these different states with different requirements, either disclosure pre-sale or relationship post-sale requirements, yet the problems between franchisors and franchisees continue to escalate in the States.

What are some of the issues that franchisees face in the States and they're facing here? I've seen enough of the press coverage. I've heard enough here in Canada. I could walk into any meeting with franchisees blindfolded and probably talk about eight out of 10 of the problems they are facing. I don't care what brand names they're from, where they're based; they all have essentially similar problems.

One is encroachment, which Mr Colle talked a little bit about. We call that encroachment in the States. You talked about the doughnut franchise. We call it cannibalization with some chains because there is such a proliferation of the same—there are eight doughnut shops. There's a proliferation of the shops. It is patently unfair and it is no deal that you get the first right of refusal to say, "I'll take that second or third one." Why would you want to do that? What franchisees will say to me, "Susan, either I do that, I take the second or third location, and cannibalize my own gross revenue and net revenue or they're going to put somebody else in there and they'll cannibalize my sales"?

Why would that be a benefit to the franchisor? It's quite simple. In franchising, the franchisor makes their money off the top. They are getting a percentage of the royalties, of the gross sales. Franchisees are worried about the bottom line. There's a distinct conflict of interest here. Now we're way beyond the pre-sale courtship of: "We're going to be a family. We're going to be a partnership." No, now we're into: "I want more money off the top and you're looking for more money off the bottom. I don't care. The contract says you're going to pay me my royalty fee whether I provide services to you and whether you make money or not."

In the case of multiple units, I have a successful unit here. It took me two or three years to get to break-even. The franchisor knows when I'm getting to break-even. He knows when I'm really profitable, because the franchisor has my financial statements, and if he doesn't have my financial statements, he has my royalty reports. He knows what I'm paying off the top. The franchisor determines that that unit or that marketplace could certainly sustain another unit. If this unit is doing $1 million and the second until comes in and this unit does $750,000, but this unit's doing $750,000, the franchisor is still making out because the franchisor's money is coming off the $1.5 million gross, not the single $1 million. Are you following me, there? All right. So that's the benefit to cannibalization, or encroachment, as we call it in the United States.

Sole-sourcing requirements is another problem. Many franchise systems require that franchisees purchase products solely from the franchisor or from the franchisor's designated suppliers. No allowance is given to purchase from alternative sources of supply, even if the franchisee can get a better deal. Initially, when you're a first-time investor, you're thinking: "This is kind of good. I won't have to worry about where I'm going to buy my products from. I've got enough to worry about. I'm opening the store. I've got the carpenters coming in. I have leasehold improvements. I've got to hire employees. So that's good, I'll buy from their suppliers." What you don't realize and you don't learn until way after the statutes of limitations are up and gone is that, guess what, you could buy the same products locally, the exact same quality locally, cheaper, but you've tied yourself into a 10-, 15- or 20-year contract saying you would always buy from the franchisor or from their designated suppliers. That's where a lot of problems start.

In the States, there are certain states—Indiana has had a prohibition against requiring franchisees to purchase from designated suppliers since 1985, and Iowa has had that prohibition since 1992. There is no mass exodus of franchisors running out of Indiana into Illinois, because we don't have that prohibition. There's no mass exodus of franchisors running out of Iowa into Nebraska or Minnesota. There's no evidence whatsoever that franchisors will not come to the province of Ontario if you dare put that kind of legislation in place. They just have no evidence. It will not happen. They want to sell franchises and they want their brand names out there.

Franchisors, when they talk about the sourcing of supply issue, say, "We must ensure the same level of product and service from all our outlets, so we have to have control over the products and services that the franchisees buy and then deliver to the consuming public." That's total baloney. They want to have control because that's where they get their kickbacks, their rebates, their commissions from, because they are extorting money often from the suppliers. They can set the characteristics and standards of the products or services that are delivered to the consuming public, but they should not have the right to restrain trade and to tell a local business owner they cannot buy from another local business owner, that they must buy from certain suppliers only. This protects consumers and the franchisees. The only thing the franchisors are trying to protect is the status quo. They're not interested in being pro-competitive. They're interested in protecting their exclusionary practices, which they have already written into the franchise documents, which Mr and Mrs Smith, who just got a severance amount of money, are not going to be thinking about when they're signing a 15-year contract to buy a franchise. They're thinking that the franchisor is going to make their life easier as a first-time new business owner.

Other issues that are problems with current franchisees and how you have to attack them in disclosure - you'll get some ideas now of why I'm saying that Bill 33 doesn't go far enough - relative to encroachment: We've proposed this in the States to the Federal Trade Commission. They haven't bought it. We didn't think they would, which is why we are seeking legislative solutions in the States. But relative to encroachment, because most franchisors know when they are going to encroach, we have suggested that on the front cover page they list as a risk factor and make a statement something like the following: "It has been our practice in the past that after your unit has been opened two to three years" - you fill in the blank - "we will come in and put another unit so close to you that it may in fact diminish your growth and therefore your net revenue." That is true and complete disclosure, and you can imagine what the franchisor lawyers in the States are saying about that kind of disclosure.

Regarding the restrictions on sourcing of supplies and products, in the States many franchisors will say: "We have our approved vendor list but we have an approval process. If you find another local product, bring it to us and, as long as it has the same characteristics, we'll put it through the approval process and it will probably be approved." That's disclosed; that is put in the disclosure document. But they don't tell you that they've been known to take more than one or two years to approve a vendor. "We've been known to change the specifications so your vendor can't possibly create the proper specifications." We have suggested to the Federal Trade Commission: This is true disclosure. Put that in the disclosure documents.

Assistance from the franchisor: What they promise and what they deliver is often two different things. We have suggested that language in the disclosure documents ought to be required that says, "Your franchisor, regardless of what it has told you, reserves the right to receive whatever the percentage of royalty payment while providing you with absolutely no franchise services," because that is what often happens in the United States, and I would assume it happens here in Canada.

A big problem comes up - I don't know how mature the franchisees are in Canada and if they're coming up to the end of their contractual terms, because a franchise contract is for a specified period of time, 10, 15 or sometimes 20 years. When you are buying the franchise and you sign the contract, you say, "What happens at the end of my initial term?" and the franchisor sales representative says, "Don't worry, we'll renew you." What they don't tell you is that you're not going to be renewed on exactly the same contract. They say, "You will sign" - this is important: Today, when I'm buying the franchise, I am signing that when my initial term ends, I will sign the then current contract. As long as I'm not in default, I will be able to sign the then current contract. You don't know what that contract is going to be. The franchisor doesn't even know what that contract is going to be. The franchisor may have been acquired by somebody else by that time and someone totally new will be writing the contract. So you are agreeing today to sign something 10 or 15 years hence that is a moving target.

This is when franchisees start to realize: "You know what? I don't get the feeling I'm not owning my own business. This is more like renting an apartment, because at the end of my 10 or 15 years the landlord is going to put a new lease down in front of me and he is going to say, 'Press hard, there are three copies, if you want to continue as a — fill in the blank — franchisee.'"

We have suggested that the terms be called "rewrite, relicense." I'm going to get "rewritten" in the contract, and "relicensed." Someone who is a first-time investor doesn't understand what that means; again, it's an artful term: "Renew." We have suggested that in the disclosure documents it be written: "You do not own your own business. You are leasing the rights to sell our goods or services to the public under our trade name. At the end of your initial 10-year term, your current contract will expire or terminate. You will have the choice of signing a new contract with us at the time of expiration or termination. The new contract will be written by us, with no input from you, and will contain materially different financial and operational terms." That needs to be put in Bill 33 to warn people about what will happen at the end of the current term.

Part of the problem is, as was mentioned, the unilateral and arbitrary decisions that can be made by franchisors without the input of franchisees. There are a lot of things in the franchise contracts that franchisors have total discretion over. Initially, when you're buying a franchise, you're thinking: "That's great. I'm glad because I can't possibly know everything about business and that's why I'm buying a franchise. I'm investing a lot of money for someone to teach me to be an entrepreneur." Once you become an entrepreneur, you start realizing that the deal you signed was not so good.

You have to understand that none of the franchisees in the States is trying to get out of their current contracts. They understand what they signed. The franchisees who are part of our organization are successful operators. The United States Congress is realizing that it is the most successful operators, from chain to chain and from coast to coast, who understand that rules of the game need to be put in place. Whatever legislation is enacted in the States will not apply to current contracts. It will apply to any contracts entered into, amended or extended/renewed after the effective date of the legislation. I wanted to make that important point.

We hear in the States, and you may hear it here, that the stories regarding problems with franchising are "merely anecdotal; they are not widespread; it's a few disgruntled people who couldn't run a business anyway; they're just whiny-butts; they don't know what they're talking about." Well, we surveyed our members, and I have a copy of the survey for each of you. Forty per cent of our members felt they had unsuccessful relationships with their franchisors. Close to half of them, over 46%, felt that discounting and promotional activities forced on them by their franchisors had caused an average 10% decline in profits. A majority of them, almost 60%, felt they purchased goods and services from the franchisors that were inflated in price—going back to having to buy from approved suppliers. Two thirds, 68% of the franchisees, felt they were not getting full value from the advertising fees they paid to the franchisors. Sixty-one per cent felt that the support services were inadequate. Fifty-five per cent of the franchisees who responded to our survey said they would not advise others to join their franchise system currently. Forty per cent of them felt they had been encroached upon in some way and, of those, 90.5% felt their profits had suffered as a result. So the problems with franchising that we relate to you here and to the United States Congress are not anecdotal. They are widely documented.

Let me conclude. Why has franchising evolved to where legislation is necessary? Two reasons: When it started in the United States in the 1950s, it was often a handshake. It was a two- or three-page agreement, a pretty easy contractual relationship. But franchise agreements have evolved today to the point where, except for the provisions relating to the use of the trademark, the use of the proprietary information and payment of fees, almost every other provision has some element of controlling, trapping or defeating the franchisee.

Franchisees, you have to understand, are governed by these totally one-sided contracts that are drafted by the franchisors' attorneys. There is unequal bargaining power from the beginning. If somebody is inexperienced in business to begin with, and you have somebody who knows everything there is to know about the pizza, doughnut or hotel business, there is unequal bargaining power right from the beginning, and the franchisor has arbitrarily decided on the rules by which the two parties are going to conduct their business after they sign the contract. Those rules are incorporated into the franchise agreement, which the franchisor prepares unilaterally for the franchisee to sign. What is even worse is that franchisors justify their own abuses, post-sale, by claiming that pre-sale disclosure in these lengthy, unintelligible legal prospectuses makes any abusive trade practice they do after sale totally legal.

The second reason these abuses continue to occur is that there are no existing baseline standards of conduct for franchisors and franchisees to abide by after the sale. In addition to the duty of good faith, in the United States our franchisees are looking for a duty of due care, meaning that the franchisor must have the level of knowledge and skill they purport to have when they sell the franchise. They can buy that level of knowledge of skill or care from an outsider, a consultant, but they must disclose that they have purchased it from someone else, or they could disclaim that they have such level of skill or ability. But again, this goes to the point that when you buy a franchise you are told, "We have a proven business system." The implication is that you will be able to make a living, not that you are going to be an indentured servant for a period of time.

Another duty we are looking for in the States is a limited fiduciary duty when the franchisor handles bookkeeping or accounting and payroll functions for the franchisees. In a legal sense, a fiduciary duty is the highest standard of care. Your banker has a fiduciary duty with you, your lawyer has a fiduciary duty with you and, indeed, in the States, business partners have a fiduciary duty: If either party is going to take an action, they must do it with the highest standard of care for the other party. The current scheme in the US — the federal rule, which has been there since 1979, the state disclosure laws and the various state relationship laws — is just a hodgepodge which only goes to fuel, as someone has said here this morning, the lawyers' pension funds. They are the only ones who benefit from this entire mishmash. That's why members of both parties in the United States Congress are considering what's called House Bill 3308, which I thought was kind of interesting because you were considering Bill 33. It's called the Small Business Franchise Act in the States, and the absence of any kind of standards of conduct for a multi-billion-dollar industry, almost trillion-dollar industry, is becoming a big concern to the United States Congress.

Again, my summary remarks: Bill 33 by itself doesn't go far enough. Based on our experience, 30 years of disclosure alone is not good enough. You need an enforceable duty of good faith, and I think I've given you some ideas about what the state of the art might be right now. You certainly shouldn't enact something that the States did 30 years ago because you'll probably be where we are 30 years hence.

Thank you very much. I'm able to answer questions at this time.

The Acting Chair: Are there questions?

Questions

Mr Martin: I don't want to be one to hog the time here. Divvy it up and make sure everybody gets a chance.

The Acting Chair: We've got about 12 minutes for questions so I'm interested to know what interest there is.

Mr Martin: I really appreciate your taking the time out of what I know is a busy schedule to come and be with us today. Your presentation was very enlightening and challenging and thoughtful. You raised a number of issues that I think are important and that I didn't actually get time to raise in my own opening comments, that I just want to touch on very quickly.

First is the issue that many franchisees are first-time investors - maybe that will be a question for you - people who get a severance package. In Ontario today we have a lot of workplaces restructuring, so a lot of people are given severance packages and they are looking for someplace to invest it that will guarantee them some income and, hopefully, a pension. They're not experienced business folk, and so they probably stand to be victimized more than, say, somebody who has experience. Do you want to comment on that?

Ms Kezios: I agree with you. Unfortunately, those people when they have been victimized, as you put it, go out of business, and they want nothing more than to leave their shameful franchise experience behind. Those are not often the kinds of people who will show up in these kinds of hearings to talk about it. They've gone on with their lives. What we're finding is that the successful operators are the ones who realize, when their contracts are coming up for renewal, that they don't want to not have a choice at that point. I agree with you that there are unsophisticated investors. If they read the disclosure document in the States, they don't understand what they've read. They take it to a lawyer - 99% of the lawyers who are involved in franchising in the States are franchisor lawyers.

Most of the lawyers in the States do real estate law, they write the wills, and they do other kinds of business transactions. They'd look at the contract and say to this couple with the severance package: "Well, you know, I wouldn't sign it. This is a contract of adhesion." Other lawyers call franchise contracts in the States contracts of adhesion. You're tied to these terms. I think Mr Colle brought it up that, what do you do? Ensure that these men and women have a lawyer read the document? Oftentimes the lawyer doesn't know enough about franchise law. The lawyer is nowhere I see the franchise lawyers teaching each other to write these documents. In the States, it's the American Bar Association that's the forum on franchising. The first time I went, I was appalled. I said to myself, Mr and Mrs Smith don't have a chance, because the lawyers were teaching each other how to avoid making certain disclosures and how to get around whatever the current disclosure or relationship laws happen to be, so that this unsophisticated buyer -

Mr Martin: It seems to me then, in a jurisdiction such as ours where there is a lot of shifting and restructuring, we as government have a responsibility to make sure that it's fair at least, if nothing else.

You also talked about an issue that I hope we'll all look at, which is the issue of sole-sourcing of product and how that's a huge bone of contention and concern. In my own community we have a number of local, small producers who can't get their product onto the shelves of some of the bigger grocery chains because the shelf space is sold someplace else. Many of them are basically being put out of business. They get into business because they love doing what they do. They're good at it, as I said before. They invest the money and they do the work. At the end of the day, through no fault of their own but simply because they can't access the shelf space, they can't sell their product. I know that plays out negatively for the franchisee who might see that as an opportunity for them to make some money and also participate in the local economy that they need to keep healthy if they're going to succeed.

I have a number of pieces of research that I have done on the whole sole-sourcing issue because it affects my local area so much. How big an issue is that in the US and what do you suggest re our legislation here?

Ms Kezios: It is a big problem in the US. Encroachment is probably the number one problem, but sole-sourcing seems to be another. I will tell you something: Franchisees in the US have sued for the right to buy supplies from their own suppliers since the mid-1970s. The Dunkin' Donuts franchisees in 1971 sued for the right to buy from their own suppliers. They won that right in 1971, but every year since then there is some other chain in the States that is suing for the very same right, which is the problem if you have no ability to buy locally.

The fact that you cannot buy locally and that you cannot buy the same quality of product or service at a competitive price leaves your gross margins totally in the hands of the franchisors, and that is a big problem following closely behind encroachment in the States. Many of the franchisees are mature chains. They've been around 25 or 30 years in the States, and these franchisees are putting together their own purchasing co-operatives and they're doing their own buying of products. I don't know the situation enough in your particular area to understand or even comment appropriately on how those franchisees might deal with that situation.

Mr Ted Chudleigh (Halton): Thank you very much for joining us today. I think you mentioned that there are 14 states with legislation. Does the legislation in any of those states deal with the lease, as to whether it's appropriate for the franchisee to be the holder of the lease or anything that prevents the franchisor from holding the lease?

Ms Kezios: I don't believe so - that prevents the franchisor from holding the lease? No. McDonald's is in the real estate business all over the world. Subway holds the leases. Subway does that for a variety of reasons; one is that it's easier to evict a franchisee than to terminate their contract. There's nothing prohibiting that in the States. Is that a concern here?

Mr Chudleigh: It is for me. A lot of the problems that I've run into with franchisors are based on the fact that they are the leaseholder, and it makes the franchisee very much more of a pawn in the process.

Ms Kezios: Absolutely.

Mr Chudleigh: They lack total control when that happens. To your knowledge, that hasn't been talked about in legislation?

Ms Kezios: No, not to legislate in the States. It's not being considered in Bill 3308 pending now.

Mr Steve Gilchrist (Scarborough East): Thank you very much for your presentation. It's very informative. As somebody who spent 25 years in a franchise that did in fact start with that one-page contract and a handshake and is one of Canada's more successful franchises, I certainly have seen the evolution that you talked about, where now it's far more legalese and less trust that seems to be embodied in many of these agreements.

We have tended to follow a path these last four years of less overt regulation and greater support for the private sector, and that really is at the heart of the full disclosure. Would you agree with me that if in fact, as outrageous as you may have been in trying to craft those phrases for possible inclusion in a contract — the upfront notice, for example, that at the end of your first term you have absolutely no say and no control on any renewal terms — if that were done, if that were part of the full disclosure that we're talking about, because we've said "all material facts," would you agree with us that there's no need to go further in legislation?

Ms Kezios: No. But if you're going to do disclosure, you have to -

Mr Gilchrist: No, you don't agree, or no, there's no further need for legislation?

Ms Kezios: You need to go further.

Mr Gilchrist: Why is that?

Ms Kezios: First of all on disclosure, I wish we could throw the entire prospectus out in the States for the reasons that you and I have already cited. If you're going to have disclosure, you have to use some of those outrageous statements that I am making because that's the only way a layperson will understand what is happening. These are not lawyers who are buying these franchises.

But post-sale, what is the problem with having a duty of good faith imposed on both parties? In the States our duty of good faith is going to be reciprocal. Neither party to the franchise can do anything that would deprive the other party of the expected benefits of the contract. What is wrong with that? Why wouldn't franchisors and why wouldn't the government be willing to put that in there and maybe run the unethical performers out of business? What's wrong with it? Who is against a duty of good faith?

Mr Gilchrist: I guess, without going down that road, you raised the issue of full disclosure and how that was somewhat suspect in many of the prospectuses. If it were in plain English, if there really were an opportunity, before you'd written a cheque, to know absolutely everything that possibly could happen to you down the road, every business practice of the franchisor, where's the role of the due diligence that the purchaser is supposed to be putting in, if it were crafted in plain language and all material facts were disclosed? Would you not agree with me that that's the very fundamental of contract law, that each party has a responsibility to at least be aware of what they're getting into?

Ms Kezios: Yes, but no lawyer can write in plain English, so let's just start with that.

Mr Gilchrist: I wouldn't disagree, and maybe that's where government has a role, then.

Ms Kezios: Plain English to a lawyer is something totally different than plain English to Susan. All right?

Mr Gilchrist: Fair enough.

Ms Kezios: So that's how I would answer you.

Mr Gilchrist: Thank you.

The Acting Chair: To Mike Colle for four minutes, please.

Mr Colle: If they wrote in plain English, they wouldn't have as much work, so I think that's why they don't write in plain English. Obviously it's employment opportunities.

The question I have is that if you need these protections post-sale - and I think that's basically what you're saying, that whatever you put in up front is almost meaningless, it seems; in other words, that full disclosure doesn't really amount to much - what do we need in the post-sale provisions that would offer some protections?

Ms Kezios: You need an enforceable duty of good faith and perhaps one that's reciprocal. You need duty of due care, that I've mentioned, perhaps even as limited fiduciary duty. A number of the issues - and I've looked at Bill 35, which seems to be going towards the way of our HR3308 in the States - those are all relationship issues: what happens after the sale, the sourcing of supply issue, the encroachment. If they're going to encroach, if they're going to take away some of your gross and therefore net revenue, they should make reparations to you. That's what a business partner would do if you harmed the other partner. That's common sense to a layperson. So you can put something relative to encroachment, proximity, after. There's a whole laundry list of issues.

The Acting Chair: This will be the final question.

Mr Colle: Essentially you see this bill that you've looked at as not the solution. It's going to be basically further litigation, no protection really in place, so you don't see this bill in any way, shape or form as solving anything?

Ms Kezios: No. You will still have the majority of the problems that current franchisees are experiencing.

The Acting Chair: Thank you for your presentation. Safe trip home.

Ms Kezios: Thank you, especially with all the franchisors out there, right?

This document is a verbatim copy of this witness’ oral testimony. To review the original transcript: http://www.ontla.on.ca/web/committee-proceedings/committee_transcripts_details.do?locale=en&Date=2000-03-06&ParlCommID=1&BillID=740&Business=&DocumentID=19737#P164_73962

Copyright (c) 2000
Office of the Legislative Assembly of Ontario
Toronto, Ontario, Canada


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Risks: Shame and stigma, Eviction cheaper and faster than termination, Abolish the FTC Rule, Ontario Public Hearings, Canada, 2000, Secret kickbacks and rebates, No franchisor support, Indentured servants, Lease controlled by franchisor, Tied contracting, International Franchise Association, IFA, American Franchisee Association, AFA, Susan Kezios, US Federal Trade Commission, Encroachment (too many outlets in area), Cannibalization, Tony Martin, Must buy only through franchisor (tied buying), Disclosure laws: 10 per cent solution, Franchise agreements: Masterpieces of deceptive wording and artful omission, Franchising practiced the same, worldwide, American Bar Association, Forum on Franchising, Disputes heard on franchisor’s home turf, Franchise agreements virtually non-negotiable, Monopoly, Renewing contract much tougher, Disgruntled, Controlling, trapping or defeating the franchisee, Fiduciary duty, 95 per cent of legal fees are paid by franchisors, Lease controlled by franchisor, Canada, United States, 20000306 Susan Kezios

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