F.T.C. Public Comment 33

This author's law firm serves as franchise counsel to many of the world's oldest, largest and most prestigious franchisors, many of whom are by far the leaders in their respective business segments…This author respectfully requests to be assigned a speaking slot at any public workshop conference, panel or other forum…

FTC.jpg

U.S. Federal Trade Commission
May 11, 1997

Public Comment
David J. Kaufmann, attorney

Request for public comment on possible revisions to The Franchise Rule.

Comment #33

May 11, 1997

VIA FACSIMILE - (202) 326-3395
CONFIRMATION BY FEDERAL EXPRESS

Secretary
Federal Trade Commission
Sixth Street and Pennsylvania Avenue, N.W.
Room 159
Washington, D.C. 20580

Re: 16 CFR Part 436 — Response to Advance Notice of Proposed Rulemaking

Dear Sir:

We wish to respond to the recent Advance of Notice of Proposed Rulemaking (hereinafter "ANPR") regarding 16 CFR Part 436 (hereinafter the "FTC Franchise Rule" or the "Rule").

As a prefatory matter, we wish to note that the Commission's ANPR reflects a remarkably sophisticated, forward-thinking and creative approach to the regulation of franchising in the 21st century, and reflects as well a massive effort to harmonize and balance competing interests and create an ANPR of great intelligence. The Commission and its staff are to be commended for the devotion of resources, the outreach and the dedication to franchising which are so clearly reflected in the ANPR.

IDENTITY OF THE AUTHOR

This author's law firm serves as franchise counsel to many of the world's oldest, largest and most prestigious franchisors, many of whom are by far the leaders in their respective business segments.
Moreover, the undersigned authored the New York Franchise Act (General Business Law of New York, Article 33, §§680 et seq.), generally considered the toughest franchise registration and disclosure law extant in the United States. Further, the undersigned served as Special Deputy Attorney General of New York assigned to the Franchise Section of the New York Department of Law. Moreover, this author serves as an Advisor to the North American Securities Administrators Association ("NASAA") Franchise and Business Opportunities Committee and is Chair of the New York State Bar Association's Franchise Law Committee Section on Government Affairs.

Moreover, the undersigned serves as the New York Law Journal's franchise columnist; as Chairman of all Practising Law Institute ("PLI") programs on franchising nationwide; and, as the Executive Editor of Leader's Franchising Business & Law Alert, a prominent industry newsletter. In addition, the undersigned has authored a number of works on franchising, including Franchising: Business and Legal Issues, Franchising in New York and articles appearing in the ABA Franchise Law Journal and the IFA Franchise Legal Digest.

Finally, the undersigned authors the franchise and securities "Practice Commentaries" appearing in McKinney's New York Statutes, which are routinely relied upon by state and federal courts in rendering decisions, and is featured in the 1997-1998 edition of The Best Lawyers in America ("New York City — Franchising").

The following comments thus derive from experience serving franchisees (through public service and legislation), franchisors and governmental entities regulating franchising.

REQUEST FOR PARTICIPATION AT
FTC PUBLIC WORKSHOP CONFERENCES

This author respectfully requests to be assigned a speaking slot at any public workshop conference, panel or other forum convened by the Commission to consider the issues raised in the subject ANPR and responses thereto.

QUESTION "A": THE FRANCHISE RULE

This author strongly believes that there is a continuing need for the Commission's Franchise Rule.

Clearly, the Rule has beneficently served franchisors and franchisees alike. Too many forget that prior to the Commission's adoption of the Rule in 1979 — and prior to fourteen states enacting franchise registration and disclosure laws during the period 1971-1980 — the franchise arena had been invaded by a number of dishonest, unscrupulous, fraudulent and sometimes criminal operators who stripped individuals and entities of massive sums of money through franchise fraud. This circumstance not only deleteriously affected the franchisees so victimized, but deleteriously affected legitimate franchisors as well, which collectively confronted a skeptical public that had become inured to written and broadcast reports suggesting that franchising was less than savory. Both the Rule and the aforementioned state franchise laws have gone a long way toward eradicating massive franchise frauds and, by doing so, have restored franchising's reputation for integrity and thus cleared the marketplace for the offerings of legitimate franchisors.

Franchisees, too, have clearly benefitted from the Rule's disclosure requirements. Nationwide, they now receive a wealth of information designed to enable them to make informed investment decisions which are based on realistic expectations.

QUESTION "B": THE UFOC GUIDELINES

The Rule Disclosure Format Should Yield To The UFOC Disclosure Format

It is this author's belief that the Rule-mandated format of disclosure be eliminated in its entirety in favor of the Uniform Franchise Offering Circular ("UFOC") Guidelines as promulgated by NASAA.

First, as you know, no franchise regulating state accepts the FTC Franchise Rule's disclosure format, so that virtually every franchisor is compelled to follow the UFOC format of disclosure in any event. Further, a single format of disclosure would enable prospective franchisees more intelligently to compare and contrast franchise offerings. In addition, the disclosure required by the UFOC Guidelines are frequently more expansive and, at times, superior to those mandated by the Rule, and are certainly more "user friendly". And, finally, if the Commission in fact adopts the UFOC Guidelines in lieu of its own disclosure requirements, we will have finally achieved a single format of disclosure nationwide, the goal of uniformity being an important one.

Modification of UFOC Guidelines — Item 20

If the Commission so revises the Rule and adopts the UFOC Guidelines in lieu of the current Rule-mandated format of disclosure, it ought to consider modifying certain UFOC disclosure requirements. Particular attention should be paid to "Item 20" of the UFOC Guidelines, which requires franchisors inter alia to set forth a table indicating the number of franchise transfers; franchise cancellations or terminations; franchise non-renewals; franchise reacquisitions; and, the number of franchisees who otherwise "left the system" during the prior three years. Under the current UFOC Guidelines for Item 20, franchisors are prejudiced because franchise transfers, terminations, non-renewals and reacquisitions must in certain instances be "double counted", suggesting to prospective franchisees that there is more turmoil within a given franchise network than actually is the case. Fine tuning must be engaged in to eliminate this prejudice.

No Modification Required Of UFOC Item 3

We do not believe, however, that the UFOC Guidelines governing Item 3 should be revamped so as to require franchisors to disclose litigation they commenced against their franchisees. Such a requirement would serve no useful purpose. The goal of UFOC Item 3 is to inform prospective franchisees regarding the extent of franchisee "upset" with any given franchisor, to the extent that same is reflected in litigation or arbitration proceedings commenced by franchisees. To the extent that a franchisor must commence actions against its franchisees for non-payment, wrongful holdover or other violations of the subject franchise agreement, no useful information would be imparted to prospective franchisees from the compulsory disclosure of such adversarial proceedings. However, franchisors making such disclosures would be significantly prejudiced, with their disclosure document litigation sections now "bulked up" with inapposite information which nonetheless would be accorded a negative connotation.

To the extent that franchisees sued by their franchisors feel that they have somehow been aggrieved, they will assert counterclaims which will be subject to UFOC Item 3 disclosure in any event. To the extent such franchisees do not feel aggrieved and thus do not interpose counterclaims, we respectfully submit that disclosing franchisor-initiated litigation would furnish no useful information to prospective franchisees but would prejudice franchisors in the manner indicated above.

Confidentiality Provisions

Regarding the issue of so-called "gag orders", we assume that the Commission's ANPR is referring to the confidentiality provisions contained in many franchisor-franchisee litigation (or pre-litigation) settlement agreements. Such confidentiality provisions serve a most useful function and should not be barred. It is all too frequently the case that certain consistently unhappy franchisees are not satisfied with pressing their legitimate or illegitimate claims against their franchisor. (Such franchisee "unhappiness" frequently has nothing to do with franchisor non-performance, but instead is a subjective phenomenon embracing such displeasures as not making as much money as the franchisee wants to make; unhappiness over having to comply with the franchisor's standards and systems; unwillingness to adopt new programs, products and services to respond to a changing marketplace; and, other such "displeasures" which have no legal standing but nevertheless engender confrontation by some franchisees.)

All too frequently, such "unhappy" franchisees are not satisfied by communicating their displeasure to their franchisors or, going a step further, with commencing litigation or arbitration proceedings against their franchisors. Instead, such franchisees also feel the need to inflame other franchisees within the network, as part of a "power play", out of spite or otherwise. Such activity gives rise to needless conflicts; drains both franchisor and franchisee resources; and, can prove destructive of a franchise network. To rid themselves of such destructive franchisees (and their more radical proponents), franchisors unfortunately must frequently enter into settlements, not in response to any legitimate claims, but merely to preserve (or resurrect) tranquil relationships with their franchisee populations. Clearly, in such circumstances, confidentiality provisions barring such soon-to-be-former franchisees from communicating with any current or prospective franchisees make eminent sense.

So, too, do such settlement agreement confidentiality provisions make sense even with regard to franchisees having legitimate claims against their franchisors. For the Commission should be
advised that far fewer settlements would be entered into by franchisors if such settlement agreement confidentiality provisions were made illegal. Simply stated, a franchisor seeking to settle a legitimate claim advanced by an aggrieved franchisee will not want a "piling on" effect to follow its entry into a settlement with such a franchisee. If this "piling on" danger cannot be eradicated — and it is a most destructive phenomenon frequently seen in franchising — then many settlements with franchisees will never be consummated, to the detriment of the very franchisees whose claims should be settled.

Accordingly, it is respectfully submitted that, if the Commission determines to adopt the UFOC Guidelines as the sole method for complying with the Rule's disclosure mandates, UFOC Item 3
should not be altered to preclude "confidentiality provisions" freely entered into between a franchisor and a franchisee settling a dispute (or otherwise).

Three Year Phase-In Of Audited Financial Statements

This author believes that the Commission should retain the three year phase-in of audited financial statements for new franchisors.

QUESTION "C": DISTINGUISHING BETWEEN DISCLOSURE REQUIREMENTS FOR BUSINESS OPPORTUNITIES AND FRANCHISES

This author strongly believes that the Commission should amend the Rule to distinguish between business opportunities and franchises.

Should the Commission determine to proceed along these lines, we strongly suggest that any definition of the term "business opportunity" specifically exclude a franchisor complying with the Rule's franchise disclosure requirements. We note that the proposed definition of the term "business opportunity" set forth in the Commission's ANPR, without such a definitional exclusion, would embrace virtually all franchisors and subject them to "business opportunity" regulation, which is clearly not the Commission's intent.

QUESTION "D": TRADE SHOWS

This author believes that the Commission should modify the Rule to exempt trade show promoters from Rule coverage as "franchise brokers", for all of the reasons set forth in the Commission's ANPR.

However, this author strongly believes that the Commission should not modify the Rule so as to require franchisors exhibiting at trade shows to have readily available thereat for public inspection either a specimen copy of their disclosure documents or letters explaining why they fall within one of the Rule's exclusions or exemptions. Nor should the Commission modify the Rule's definition of "personal meeting" to achieve this goal. Instead, we believe that the Rule's current definition of the term "personal meeting" suffices to insure that the Commission's goal of proper pre-sale disclosure in accordance with the Rule's mandates is achieved even in the trade show environment.

Were the Commission to require all franchisors to have specimen copies of their UFOC's available at trade shows, no significant additional benefits will be afforded to prospective franchisees (who, after all, will receive their disclosure documents should a "personal meeting" transpire at such shows), but franchisors will be deleteriously affected. The franchise exhibition setting is highly competitive. Prospective franchisees wander from one exhibit to another, and the time spent with such prospects may prove minimal and thus critical. Slowing down the exhibition process by having to announce (in one fashion or another) the availability of the franchisor's UFOC; responding to inquiries regarding said UFOC (even those posed by the vast majority of visitors who have no intention of buying any franchise, let alone the subject franchisor's franchise); and, otherwise going into far greater detail regarding the franchise offering than franchise exhibitions are meant to accomplish would negatively impact the franchise exhibition environment for no good reason. Accordingly, it is respectfully suggested that franchisors not be subject to a Rule-imposed requirement that they have available for public inspection at such franchise trade shows copies of their disclosure documents.

QUESTION "E": EARNINGS DISCLOSURES

This author strongly agrees with the Commission's ANPR suggestion that a franchisor's failure to provide earnings information is not necessarily deceptive or unfair; that the marketplace may compel an increasing number of franchisors to voluntarily disclose earnings information; that prospective franchisees can obtain earnings information from other sources; that no mandatory earnings disclosure could be promulgated that would prove both useful and not misleading to prospective franchisees; and, that mandating earnings disclosure will impose significant liabilities upon franchisors with no concomitant benefits to prospective franchisees.

Required Earnings Disclosures Would Disseminate Useless — Even Misleading — Information to Prospective Franchisees But Will Trigger Significant Liabilities for Franchisors

Mandatory earnings claims are a certain prescription for the dissemination of information which will prove useless, even misleading, to prospective franchisees — but which will trigger significant liabilities for franchisors compelled to make such claims.

First, prospective franchisees already receive "earnings claim" information from quite reliable sources — experienced operating franchisees of the very chain the prospective franchisee is investigating. Isn't this why franchisors are already required to disclose in Item 20 of their UFOC's the names, addresses and telephone numbers of no fewer than one hundred (100) franchisees? And isn't this also why UFOC Item 20 requires franchisors to set forth the names, last known home addresses and telephone numbers of every franchisee who has had an outlet terminated, cancelled, not renewed or who otherwise voluntarily or involuntarily ceased to do business within the franchisor's most recently completed fiscal year? Finally, won't existing franchisees give more accurate data to prospective franchisees than if such information had to be filtered through their franchisor?

Moreover, a variety of sources indicate that roughly 25% of franchisors already make UFOC Item 19 "earnings claim" disclosures. Do they yield any useful information to prospective franchisees? Do the operating histories of franchisees who received such disclosure bear any resemblance to the pre-sale "earnings claim" information they were given? These would seem to be critical questions to be addressed before franchisors are saddled with earnings claim-related responsibilities and liabilities.

What is so problematical about mandatory "earnings claims"?

Let us first examine what some would term the "easiest" and least controversial species of earnings claim under consideration: the required dissemination of "average gross sales" figures. Concededly, gathering information of this type will in most instances not prove difficult for many franchisors (although a significant minority of franchisors will not readily be able to obtain such information). But as easily as this data can be obtained, so too can it be easily dismissed as irrelevant and of little value to prospective franchisees. What prospective franchisees most want to know, according to franchisee advocates and regulatory authorities, is how much they are going to make — not how much they are going to gross. Learning about "average unit gross sales" tells you nothing about average unit profitability or, conversely, average unit near-bankruptcy.

Moreover, "average unit gross sales" is the product of so many variables as to render the figure meaningless — even misleading — to prospective franchisees. Geographic variations among units
is one factor rendering "average unit gross sales" virtually irrelevant. Seasonality is another. And the ages of units whose gross sales are being disclosed may further skew the earnings claim picture.

Similarly, what if the prospective franchisee is purchasing one of many different types of franchised units? For example, in the quick serve restaurant ("QSR") segment, one can expect to find in any given chain one or more of the following: traditional "sit down" restaurants; drive-thru units; delivery facilities; "express" units; and, "take-out" stores (or a combination of same under one roof). If a prospective franchisee is considering acquiring the rights to establish an "express" unit in midtown Manhattan — one which is almost exclusively geared to capture lunchtime traffic — then of what utility is the disclosure of "average unit gross sales"?

Also, consider the competitive prejudice which will result if franchisors are required to disseminate "average unit gross sales" earnings claims in their UFOC's. If one QSR chicken chain boasts average annual gross sales of $1.2 million dollars while a direct competitor's average gross is only $700,000 — but the first chain suffered average unit losses in each of the past two fiscal years, while the second chain enjoyed average unit net profits of approximately $150,000 — then a prospective franchisee examining "gross sales" data only would walk away with the notion that the first chain is almost twice as successful as the second. Clearly, this prospective franchisee would have been misled by the "average unit gross sales" figures. Just as clearly, the second chain will be suffering gross competitive prejudice in the marketplace.

Perhaps the greatest shortfall of "average unit gross sales" as a meaningful earnings claim is its complete exclusion of the single most important business factor to a prospective franchisee: the
competition. One who is about to open the first QSR restaurant in a college town will in all likelihood enjoy gross sales significantly higher than those of a franchisee opening his/her unit in close proximity to existing quick serve restaurants of long standing (all other variables being equal). Yet each of these franchisees would receive the same "average unit gross sales" number.

Just as is the case with "average unit gross sales", the other two categories of mandatory "earnings claims" currently being discussed — average net operating profits and/or average annual sales required to "break even" — will prove useless or even misleading to a prospective franchisee. For the unit-to-unit variations which so impact, and render useless, "average unit gross sales" as a reliable determinant are only magnified in the "net" scenarios, which must take into account what the "average" unit's costs have been. These costs are subject to as wide a variation as "average unit gross sales". Franchisors would have to subtract these widely varying cost factors from the above-referenced widely varying gross sales figures to arrive at any average unit net profit or "breakeven" figure, thus magnifying the impact of such variables and rendering any mathematical result virtually useless.

Moreover, most franchisors do not have access to any cost, net profit or "breakeven" figures other than for their company-owned units. Even if franchisees could be compelled to furnish such information, franchisors would thereupon become responsible for the accuracy of such data, since they would be imparting same in Item 19 of their UFOC's — a position no franchisor should want to assume.

In addition, as a result of what we shall charitably term "tax-based accounting", it is frequently the case that franchisees overstate costs and/or are creative when denominating "business expenses". Such franchised businesses never show a profit. The anticompetitive impact of such activity upon franchisors required to disclose average unit "net profits" or "breakeven gross sales" is self-evident.

Thus, as meaningless and unreliable as "average unit gross sales" would be to a prospective franchisee, any "bottom line" figure (even assuming franchisors could extract from their
franchisees the necessary economic data) would prove even more useless and misleading.
While they will prove of very little use to prospective franchisees (and could, indeed, mislead them), mandatory earnings claims are certain to give rise to massive liabilities for those franchisors compelled to make them.

Every time a franchisee's actual gross sales/net profits/"breakeven" points (as applicable) fail to match those set forth in its franchisor's UFOC, that franchisee will possess a new cause of action against its franchisor. Perhaps that cause of action will be asserted merely when the franchisee is dissatisfied with his or her income. Perhaps in the course of a franchise termination proceeding. Or, perhaps in connection with an extortive class action proceeding commenced solely to wrest financial or other concessions from the franchisor.

This cause of action related to earnings claims may sound in fraud; or, violation of state franchise registration and disclosure statutes; or, violation of "little FTC" statutes; or, negligence. But regardless of how denominated, this cause of action will have a particular appeal to franchisees and their counsel, who will stand before judge, jury or arbitrator and exclaim: "The book told me that the average unit in my chain grossed $X. That led me to believe that my unit would gross $X. In fact, my franchised business only grossed $Y. The franchisor owes me the difference."

The simplicity of this argument, and its ability to sway judges, juries and arbitrators, is what could result in franchisors accruing mandatory earnings claim-related liabilities of unknown and but possibility devastating dimension. And while certain of my colleagues assure me that this will not take place because franchisors will be able to "disclaim" their mandated earnings claim information, or because any mandatory earnings claim requirement will be coupled with a "safe harbor" limitation on judicial actions, or because — as in the securities arena — the "bespeaks caution" doctrine will shield franchisors from liability, still this author is not at all comforted.

To begin with, disclaimers are routinely set aside by the courts as not sufficiently specific, or as violative of the anti-waiver provisions of state franchise registration and disclosure statutes.(1) Similarly, integration clauses — one of the principal groundings of American contractual law — are, in the franchise law setting, too often rendered nugatory. (2)

Nor is this author comforted by promises of a litigation "safe harbor" to be incorporated in any mandated earnings claim requirement (see below for a separate discussion of this topic). "Safe
harbors" are subject to judicial interpretation. Recall how judicial creativity impacted the statutory "safe harbors" afforded by the Securities Act of 1933 and the Securities Exchange Act of 1934 (among other securities laws), creativity so disingenuous and giving rise to so many crippling "strike suit" judicial actions and verdicts as to recently prompt Congress to rectify what clearly was an abusive situation.

Further, recall that each state franchise registration and disclosure law contains an express "anti-waiver" provision.(3) The courts having already utilized such statutory "anti-waiver" provisions to render nugatory franchise agreement disclaimers and integration clauses, can franchisors truly be comforted that any earnings claim-related "safe harbor" will not similarly be judicially made to yield to the "anti-waiver" and all important "anti-fraud" provisions of state franchise registration and disclosure laws?

Finally, franchisors must be aware that under the law of fraud in most jurisdictions, one has no duty to speak of any given subject absent the existence of a "special relationship" (such as a fiduciary relationship) or in extremely narrow settings (principally involving the sale of residential real estate). But if one does speak, then one is required to tell all about the subject in question; anything less is deemed to constitute fraud. Also recall that virtually every state franchise registration and disclosure law mirrors this principle by making it illegal for a franchisor to "omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading".(4) Given this identical common law fraud and statutory standard, will it surprise anyone when a franchisor — which has been mandated to disclose, shall we say, "average unit gross sales" in Item 19 of its UFOC — is later found guilty of engaging in common law fraud or violating state franchise registration and disclosure statutes because the franchisor did not also furnish to the prospective franchisee yet additional information regarding such "earnings claims", the absence of which a court will deem an "omission of material facts necessary in order to make the earnings claim made not misleading"?

Indeed, the Alabama Supreme Court — in the case of Sperau et al. v. Ford Motor Company et al., [1995 WL 341765] [Ala.] — issued just such a ruling. In Sperau, an African-American Ford dealer which prior to investing had received Ford's standard sales/profit forecast and capitalization requirements data— incorporating information culled from Ford dealers nationwide — sued for fraud, deceit and fraudulent suppression, claiming that Ford knew that its minority dealers typically fared worse than the national average and that, based on a "confidential relationship and/or special circumstances", Ford was under a duty to disclose all material facts concerning the profitability, performance and failure rates of Ford's minority dealers. Following a jury trial, plaintiffs were awarded in excess of $7,500,000 [including $6,000,000 in punitive damages]. The Alabama Supreme Court affirmed, holding that there existed a special "confidential relationship" between the parties which required Ford to disseminate such particularized "minority only" data to the plaintiff. (To reach this result, the Alabama Supreme Court struck down as "unjustifiable" integration clauses contained in two separate writings executed by the parties.)

Contrary to popular opinion, Sperau has not been reversed. To the contrary, following the U.S. Supreme Court's decision in BMW of North America, Inc. v. Gore, 517 U.S —, 116 S.Ct. 1589, —
L.Ed.2d — (1996) — a seminal decision addressing for the first time in many years the factors to be considered in awarding or limiting punitive damages — the U.S. Supreme Court granted a writ of certiorari vacating the Sperau decision and remanding same to the Supreme Court of Alabama for further consideration in light of BMW. As of this date, the Supreme Court of Alabama has yet to readdress the issue. But let us recall that only the punitive damages portion of the Sperau award was the subject of the writ of certiorari to the U.S. Supreme Court; the balance of the Sperau decision — including the "duty to speak" doctrine which gave rise to the damage award to begin with — will per force remain intact.

Franchisors should not be comforted by the fact that there exist relatively few judicial decisions in which franchisors making "earnings claims" were judicially challenged by franchisees. To begin with, while such decisions are few, most of them imposed liability on the franchisor making the earnings claim.(5) But more significantly, these are the types of cases that usually go to the jury and are unreported.

Few can quarrel with the desire to assist franchisees in making informed investment decisions. However, this laudatory goal will not be advanced by the mandatory dissemination of "earnings claim" information related to "average" unit gross sales, net profits or annual breakeven points. Such data will prove relatively meaningless to prospective franchisees, while giving rise to undeserved and unnecessary franchisor liabilities.

No "Safe Harbor" Can Be Afforded To Franchisors Compelled To Disclose Earnings Information

Further aggravating the mandatory earnings claims scenario is the fact that no federal or state regulation can afford any "safe harbor" to franchisors compelled to disclose earnings data.

For a "safe harbor" afforded by means of a mere federal or state regulation cannot supercede either the "10b-5" materiality disclosure standard of state franchise registration/disclosure statutes or the common law fraud "duty to speak" doctrine. As a result, franchisors making limited earnings claim disclosures in complete compliance with any governmental edict will receive no "safe harbor" protection at all but, instead, will accrue liabilities for failing to "say more" under these statutory and common law fraud standards.

In the legal hierarchy, statutes always supercede regulations. Statutes are the "will of the people"; regulations merely implement a statute's edicts. A regulation conflicting with or contravening the express terms of its implementing statute will be given no force or effect; to the contrary, it will be
judicially discarded. Accordingly, the expansive "10b-5" materiality disclosure standard contained in every state franchise registration/disclosure law will supercede any earnings claim "safe harbor" afforded by means of a mere federal or state regulation. The result? Franchisors making mandated limited earnings claim disclosures will find themselves accruing actions and liabilities complaining of their not "saying more" despite the earnings claim "safe harbor" purportedly afforded to such franchisors by means of mere state regulations. Critically, NASAA has already acknowledged this central truism in its "new" UFOC Guidelines, which have been adopted with the force of law by every franchise regulating state.

Further, only statutes can supercede common law doctrines, duties and liabilities. Regulations not contemplated by their authorizing statutes — or conflicting with them — may not. Regulatory "safe
harbors" are not contemplated by any state franchise registration/disclosure law and, in fact, would clash with the "10b-5" materiality disclosure standard contained in each such law. Accordingly, franchisors making mandated limited earnings claims will find themselves accruing actions and liabilities relating to their alleged need to "say more" under the common law fraud "duty to speak" doctrine, which doctrine will supercede any earnings claim "safe harbor" afforded by a mere state regulation.

For all of the reasons set forth herein, it is respectfully submitted that the Commission should in no fashion mandate that franchisors disclose "earnings information" to prospective franchisees.

New Earnings Claim Prescribed Statement

We believe that the first (lengthier) ANPR-proposed disclosure for franchisors which do not make earnings claims in their disclosure documents will prove prejudicial to franchisors. For the language suggests that the franchisor in question is entitled to disseminate earnings information outside of that franchisor's disclosure document, so long as a reasonable basis exists and the franchisor offers written substantiation. However, we strongly endorse the second ANPR-suggested prescribed statement for franchisors electing not to set forth earnings information in their disclosure documents ("This franchisor does not make any representations…").

QUESTION "F": NEW MARKETING PRACTICES AND TECHNICOLOGICAL DEVELOPMENTS

International Transactions
For all of the reasons set forth in the ANPR itself, we strongly believe that the Commission should codify the Rule to clarify that the Rule does not reach the sale of franchises to be located or operated outside of the United States, its territories and possessions. We defer to other comments the
commission is receiving regarding the precise language to be utilized to effect such a clarification.

Stream Of Revenue Package Franchises
We strongly believe that the sale of "stream of revenue" franchises should not be construed as the taking of an "earnings claim". To the contrary, we believe that were the Commission to equate these two phenomena, great confusion would result.

"Stream of revenue" franchises, as noted in the ANPR, confer upon franchisees customer contracts yielding a specified level of gross revenues. No advantage would inure to such prospective franchisees if such contracts were construed as implicit "earnings claims", but additional liabilities would needlessly be thrust upon "stream of revenue" franchisors. For, today, "stream of revenue" franchisees have a readily available remedy should contractually promised contracts yielding specified revenues not be accorded — a lawsuit or arbitration proceeding alleging breach of contract, fraud and violation of applicable state franchise laws. There is no need to further prejudice such a proceeding by equating "stream of revenue" franchise agreements with "earnings claims".

Co-Branding
We believe that it is premature for the Commission to impose "co-branding"-specific disclosure requirements.

Co-branding is a relatively recent phenomenon in franchising. While the practice has been engaged in on a very small scale over the past two decades, it has only recently emerged in a broader fashion within the franchise arena. Co-branding arrangements can range from the simple (two franchisors/one franchisee/two separate franchise agreements/two separate disclosure documents) to the extraordinarily complex (a joint venture between franchisors or the creation of a franchisor/subfranchisor relationship to accomplish the co-branding goal).

Thus far, it is respectfully submitted that franchisors have sufficient guidance under the Rule to determine their disclosure obligations with respect to the sale of co-branded franchises and have,
indeed, fulfilled the disclosure mandates of both the Rule and state franchise laws in offering co-branded franchises. This author is unaware of any widespread (or even limited) franchisee claims that co-branded franchises were insufficiently disclosed thus requiring Rule modification to address this area. And, again, the variations on co-branding are such that any attempt to promulgate a "co-branding"-specific disclosure paradigm will necessarily prejudice co-branding offerings.

For all of the reasons set forth herein, it is respectfully submitted that the Commission should not modify its Rule at this time to address co-branded franchise offerings.

Pursuant to the ANPR, we are submitting contemporaneously herewith a computer diskette containing the contents of the within transmittal.

Again, the Commission and its staff are to be commended for rendering an ANPR of great intelligence, farsightedness and inclusiveness. We also commend the Commission and its staff for conferring multiple opportunities for input into the Commission's consideration of possible Rule revisions.

We thank the Commission and its staff in advance for considering the within comments and look forward to further consideration of the issues identified in the ANPR.

Very truly yours,

KAUFMANN, FEINER, YAMIN,
GILDIN & ROBBINS LLP

By: DAVID J. KAUFMANN

DJK:tm

Enclosure

- Computer Diskette

1. See, for example, A.J. Temple Marble & Tile, Inc. v. Union Carbide Marble Care, Inc. et al., 162 Misc. 2d 941, 618 NYS2d 155 (1994) aff'd. 625 NYS2d 904 (App. Div. 1995).

2. Id.

3. See, for example, Section 687(5) of the New York Franchise Act, General Business Law of New York, Article 33, Sections 680 et seq.

4. See, for example, Section 687(2)(b) of the New York Franchise Act, supra.

5. See, for example, TCBY Systems, Inc. v. RSP Co., Inc., Business Franchise Guide (CCH) 10,206 (E.D.Ark. 1993); Wright v. The Spaghetti Place, Inc., Business Franchise Guide (CCH) 8652 (Ohio Ct. App. 1984); Morgan v. Airbrook Limousine, Inc., Business Franchise Guide (CCH) 8560 (N.J. Superior Court, 1986).

For Review, see FTC “Table of Commenters”
http://www.ftc.gov/bcp/franchise/comments/tabcomm.htm


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Risks: F.T.C. Public Comments, United States, 1997, Hubris, Disgruntled, Sincerity, Gag order (confidentiality agreement), Serve franchisors or franchisees, never both, Subservient intellectual class, 95 per cent of legal fees are paid by franchisors, Controlling, trapping or defeating the franchisee, Masterpieces of deceptive wording and artful omission, Protect gross negligence, wanton recklessness and intentional misconduct, Terminate or buy off leaders, Ignore, gag, belittle and post head on pole, Fraud, United States, 19970511 Comment 33

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