Pre-Internet Contracts Lead to Franchise Fight

The FTC says Mr. Winslow engaged in an overall ""web of deceit,"" including a shell corporation, phantom offices and bounced checks. An FTC employee, posing as a potential franchisee, tape-recorded Mr. Winslow making hyped claims, according to regulators.

The Wall Street Journal
June 1, 2000

Pre-Internet Contracts Lead to Franchise Fight
Dan Morse

If you own a bricks-and-mortar franchise, it is a worry that could have you staring at ceilings at 3 a.m.: My parent company is selling the same products on the Web, so just how many customers is that nabbing from me?

If you are the parent, the early-morning questions become: Why should a bunch of franchisees force me to ignore customers who have quit leaving their homes to shop?

During the past two years, the gulf has widened because of a complete lack of legal precedent in this whole area of "Internet encroachment."

Enter a tiny group of drugstore franchisees in the Drug Emporium Inc. chain, based in Powell, Ohio. In a 2-to-1 vote last month, arbitrators ruled the parent franchiser can't use the Web to sell to customers who live in franchisees' immediate areas.

Arbitration decisions, of course, carry less weight than regular court rulings. Moreover, it is a temporary order, subject to a final hearing set for next month. But the order is likely to stand, and it takes on importance as the first of its kind. "It's something everybody was waiting for," says Barry Heller, an attorney with Piper Marbury Rudnick & Wolfe, who represents parent franchise companies.

The order is likely to cause these parents to move more quickly to tighten aging, pre-Internet contracts with their franchisees. The contracts speak to "exclusive territories," but that generally just covered the opening of nearby stores.

The parents also may tone down how they market their Internet sites. This is part of the way Drug Emporium got into its bind. Drug Emporium called the pharmacy portion of the Web site, "your neighborhood pharmacy for 20 years." This allowed franchisees to argue the Web site was essentially a store across the street.

Nonsense, says Andrew Tomback, an attorney who represents the parent franchise company. His client needed to go on the Web to compete, he says, and the franchisees should have embraced all the "cross-marketing" advantages of doing so. Mr. Tomback says the case is too fact-specific to have much of an impact and adds, "To the extent a victory has been won, it's very much a victory for a dated way of doing business and thinking about the world."

(Last month, Drug Emporium completed the sale of its DrugEmporium.com to HealthCentral.com, of Emeryville, Calif., in a transaction that parties say is unrelated to the franchise spat. HealthCentral.com president Albert Greene says he isn't concerned about the spat, since it represents only a tiny fraction of his business.)

Meanwhile, looming larger is a lawsuit at H&R Block Inc. A group of franchisees say their parent's online tax software "constitutes impermissible competition" near their offices. But H&R Block executives say the offerings target a totally different kind of customer – someone who might download Intuit Inc.'s TurboTax, for instance.

“They don't overlap," says Neil Getzlow, a company spokesman. "Those customers were do-it-yourselfers from the beginning."

* * *

F-MAC SACKED: A leading franchise lender goes down.

Citing "prevailing capital market conditions," Bay View Capital Corp. is shutting down its franchise-lending unit, the Franchise Mortgage Acceptance Co., or "F-Mac." In the past few years, highflying F-Mac aggressively lent money to franchisees in the form of securitized loans, whereby lenders bundle groups of loans. The bundles were then sold to investors in the bond market.

F-Mac started on its own, writing loans to fast-food franchisees in the early 1990s. It branched into casual-dining concepts such as Applebee's, and it more recently expanded into convenience stores and oil-lubrication operations. F-Mac, whose business includes $1 billion in franchise loans and servicing rights to $2.1 billion of F-Mac securitized loans, was purchased by Bay View in November 1999.

But at least two of F-Mac's big franchisee clients ran into financial trouble recently, and investors have cooled to the whole concept. Bay View, based in San Mateo, Calif., considered selling the unit but decided last month to shut it down. It has laid off about 140 staffers. Bay View will continue to own and service F-Mac loans.

Some competing lenders acknowledge they felt pressure to loosen credit standards to keep up with F-Mac.

Bob LaRue, manager of franchise lending at Merrill Lynch & Co., says tighter standards will make it tougher for some franchisees to expand. "There's still a way to go in this tightening," he says.

* * *

NETTED ON THE NET: FTC cracks down on the Car Wash Guys.

The Federal Trade Commission has filed what is believed to be its first-ever case against alleged Internet franchise-sales hype. Regulators say Lance Winslow III used the Web to help lure those considering signing up as franchisees. The overall pitch from the mobile car-wash franchiser: For somewhere around $59,000, you get a washing truck, marketing help, lots of training and a chance to make it big.

Mr. Winslow's Web site featured "Frequently Asked Questions," including this one: "What is the Average Earnings Potential for One Man/Woman Operation Starting Out?"

According to FTC, the answer sparkled: "A typical single-unit franchise should do somewhere near $130,000 gross for the first year. … We have two franchisees which will probably hit the million dollar mark soon and both are fewer than two years old."

The claims were inflated and unsubstantiated, the FTC says. Overall, franchise regulators at the agency have mixed feelings about the Web. In one sense, it is a natural home for hype. Yet it also leaves a trail of words, as opposed to the whispered franchise promises of yesteryear.

The FTC says Mr. Winslow engaged in an overall "web of deceit," including a shell corporation, phantom offices and bounced checks. An FTC employee, posing as a potential franchisee, tape-recorded Mr. Winslow making hyped claims, according to regulators.

Reached by telephone, Mr. Winslow unleashed a tirade against the FTC.

"Everything in their complaint is totally, utterly bull," he says, blaming the allegations on four disgruntled franchisees who fell behind on royalty payments or didn't make them at all. "We're the greatest franchise company ever created."

Mr. Winslow says his earnings projections were accurate and substantiated. Most franchisees are doing great, he adds.

"This isn't over when the FTC fat lady sings," Mr. Winslow says. "No. This ends when I say it ends."


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Risks: Encroachment (too many outlets in area), Blame the franchisee, Internet franchise-sales hype, Internet sales cannibalization, False earnings claims, Model of de-regulated free-marketeers, Misrepresentations, United States, 20000601 Pre-Internet

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