FTC issues significant guidance for franchisors
In March 2023, the Federal Trade Commission (FTC) released a Request for Information (RFI), soliciting public comments regarding the franchise relationship, franchise agreement provisions, franchisor business practices, third-party payments to franchisors, indirect effect on franchisee labor costs, and language barriers. In the wake of the reported thousands of comments that it received in response to the RFI, on July 12, 2024, the FTC (1) reopened the RFI, extending the close of the comment period from June 8, 2023 to October 10, 2024, (2) released a Staff Guidance on franchisors’ imposition of new, undisclosed fees on franchisees through unilateral modifications to the franchise operating manual (the Guidance), (3) issued a Policy Statement on provisions in franchise or other agreements restricting or inhibiting franchisees from communicating, and/or filing complaints and reports, with government officials regarding potential franchisor violations of law (the Policy Statement), and (4) released an Issue Spotlight, which, among other things, described the top concerns raised by franchisees in response to the RFI. The Commission also adjusted for inflation (as is its mandate every four years) the monetary thresholds for the minimum payment, large franchise investment, and sophisticated franchisee exemptions under the Franchise Rule.
Imposition of new, undisclosed fees through unilateral modification of the operating manual
One of the top concerns that franchisees identified in response to the RFI is a franchisor’s unilateral right to modify its operating manual, including to impose on franchisees various fees that were not disclosed in the Franchise Disclosure Document (FDD) delivered to franchisees pre-sale during their due diligence process. In response to these comments, the FTC stated in the Guidance that a franchisor’s failure to disclose certain fees in the FDD is a violation of the Franchise Rule and Section 5 of the FTC Act and observed that a franchisor’s imposition or collection of a new fee that was not disclosed in the FDD and the franchise agreement – through a unilateral change to the manual or otherwise – likewise may be an unfair act or practice in violation of Section 5 of the FTC Act.
In primary support of its position, the FTC cited a 1988 11th Circuit case, Orkin Exterminating Co. v. FTC, in which the court upheld the FTC’s determination that Orkin had engaged in an unfair act or practice by unilaterally amending its customer contracts to increase the fixed annual fee payable to Orkin. The FTC’s reliance on Orkin appears to be inapposite as the court in that case concluded that Orkin had no contractual right to increase the fees at issue, which is in contrast to what has become a franchisor’s fairly standard right (and often practical need) to amend its operating manual unilaterally.
While franchisors should, in theory, disclose in the FDD and franchise agreement all required fees of which it is aware at the time of the FDD’s issuance, given the term length of franchise agreements and the potential changes in circumstances that are likely to occur over the course of the relationship (eg, changes in the market, technology, innovations, improvements, or developments), it is unclear whether the FTC meant to prohibit (and whether the courts would find unfair) a franchisor’s imposition of new, undisclosed fees on franchisees through the franchisor’s unilateral modification of the operating manual.
Contractual provisions restricting franchisees from reporting potential franchisor violations of law to government agencies
In the Policy Statement, the FTC expressed its concern that franchisees might be hesitant to discuss or file reports regarding their experiences with franchisors, even when a franchisee believes that the franchisor’s conduct has violated the law. The FTC sought to clarify that contractual provisions in the franchise agreement or other contracts between a franchisor and a franchisee may not restrict the franchisee’s communications with the FTC or any other governmental agency or regulator regarding the franchisor’s potential violations of law. Highlighting the potential chilling effect that non-disparagement, goodwill, confidentiality (including those in settlement agreements), and similar clauses can have on franchisees’ willingness to speak with governmental agencies regarding their experiences with franchisors, the FTC stated that such clauses, and any communications referencing or invoking such clauses, are unfair and unenforceable. The FTC reiterated that threats to sue or otherwise retaliate against a franchisee that reports a franchisor’s potentially unlawful conduct to a governmental agency likewise constitute an unfair practice.
The retaliation aspect of the Policy Statement should not be groundbreaking for most franchisors. Retaliating against a franchisee that reports the franchisor’s potentially unlawful conduct to a government agency or regulator, or relying in that situation on the types of contractual provisions referenced above as the sole basis for claiming a breach by the franchisee of its obligations to the franchisor, clearly is not a sound practice. While the franchise agreement provisions that the FTC identified might in some situations be interpreted to restrict, or have the effect of restricting, franchisees from reporting potential violations of law to government authorities, this is certainly not their intended purpose. Their primary objective is to protect the franchisor’s accumulated goodwill in its trademarks and system, reputation, and proprietary confidential information.
To address the potential chilling effect of these types of provisions – and unless and until the FTC elaborates further on the Policy Statement – franchisors going forward (for example, as opportunities to renew or amend existing franchise agreements arise) are encouraged to consider including in their franchise agreements clear language that none of these types of provisions is intended to restrict the franchisee’s good faith communications with government agencies or regulators regarding franchisor conduct, provided that the franchisee reasonably believes that the content of its communications is true and accurate. Otherwise, a franchisor may be met with a claim sometime in the future that what traditionally has been considered a benign provision intended to protect the brand has been interpreted by a franchisee’s counsel to be an unfair business practice.
Issue Spotlight: Top franchisee concerns raised in response to the RFI
In addition to franchisors’ unilateral changes to the operating manual and actual and feared franchisor retaliation, the FTC identified in the July 12 Issue Spotlight other franchisee concerns emerging from the RFI: franchisor misrepresentations and deception, fees and royalties, franchise supply restrictions and vendor kickbacks, non-competes and no-poach clauses, private equity takeovers, renewal issues, franchisor refusal to negotiate terms, FDD issues, marketing fund transparency, and liquidated damages and early termination fees. It would not be surprising to see in the near future FTC input on some or all of these additional franchisee concerns.
Inflation-adjusted monetary thresholds for franchise rule exemptions
Lastly, in accordance with 16 C.F.R. § 436.8(b), which requires the FTC to adjust the monetary thresholds under the (i) minimum payment, (ii) large franchise investment, and (iii) sophisticated franchisee exemptions under the Franchise Rule every four years based upon the Consumer Price Index, the FTC increased such thresholds to, respectively, (i) $735, (ii) $1,469,600, and (iii) $7,348,000, effective July 12, 2024.
If you have any questions or want to discuss any issues relating to these FTC announcements, please contact one of the authors or your usual DLA Piper attorney.
