Franchise Regulations Change, but No ‘Existential Threat’

Talk to franchise lawyers about the legal landscape and the many hot-button issues, and you’ll get a wide range of predictions and opinions.

At the same time, attorneys close to the action agree that while franchisors and franchisees need to keep an eye on governmental moves, they believe the model is safe and will continue to grow and prosper, despite increased rules and regulations.

Joint employer in flux

The National Labor Relations Board announced in October an updated rule that broadened the joint employer standard, increasing the likelihood of franchisors being held liable with their franchisees for labor law violations.

Attorney Amy Cheng of Cheng Cohen said regardless of whether a congressional action ultimately rescinds the rule or a lawsuit brought by the U.S. Chamber of Commerce and other business groups to block it succeeds, franchisors should review all their agreement documents and manuals to see where they possess authority of direct or indirect control of their employees.

“A lot of this simply is understanding what joint employer liability means and how franchisors and franchisees accomplish the same goals in regards to the new rules without stepping over the line.” Cheng said. “I don’t see any reason why that can’t be accomplished.”

Workplace safety and health standards are also among the terms under the new rule, which as of press time was on hold after a federal judge in Texas blocked its implementation March 8. The rule was set to take effect March 11. The NLRB said it is reviewing the court’s decision and will determine next steps in the case.

“I think many of our clients understand joint employer with respect to their executive team,” Cheng said. “But my question to them is, ‘are your field reps being trained on joint employer liability as well?’ Because they’re the ones who are dealing with the franchisees day in and day out, and are likely conducting the field inspections and providing the actual employee training.”

Cheng said franchisors should carefully review their agreements to make sure they’re not retaining authority to control terms of employment of franchisees, and have all employees, not just the executive team, review their manuals. Training is also imperative for franchisors.

“Two hours of training goes such a long way, in my experience, in educating all employees within the entire community to make them sensitive to this issue,” Cheng said. “If the franchisor does that, I don’t think the world is coming to an end. I have no doubt that franchisors can control brand standards in regards to health and safety and that franchising will survive and come out of this OK.”

FTC’s review still ongoing

Amid the Federal Trade Commission’s review of franchise disclosures in agreements and considerations of new rules aimed at enhancing fairness within the franchisor-franchisee relationship, attorney Michael Sturm of Lathrop GPM said advising clients on next steps at this time is difficult when the scope of future requirements is so unclear.

“It’s really impossible to know what the FTC is going to do at this point,” he said. “We can only speculate.”

The FTC, which enforces the Franchise Rule, wrapped up a public comment period last June in response to its request for information on the franchising industry and its business practices. The FTC received more than 5,500 comments on the inquiry, and said there was “broad interest in ensuring fairness in franchising,” adding “all options are on the table.”

Labor advocates said changes could benefit service workers, while industry groups like the International Franchise Association warn against “one-size-fits-all” regulatory changes and is advocating lawmakers to block any new legislation that they believe will hinder the model.

Sturm said his firm, which participated in FTC’s public comment period, is particularly interested in what, if any, changes are made to Section 5 of the FTC Act that permits the FTC to regulate “unfair methods of competition” and “unfair or deceptive acts” or trade practices.

“Commission leadership has taken an unprecedented and extraordinarily expansive view of its Section 5 authority, explicitly rejected prior statements of interpretive policy, and asserted that Section 5 confers authority,” Sturm said. “For example, to displace longstanding state common law principles with respect to the covenants against competition on a nationwide basis.

“Former Commissioner Wilson characterized this position as, and I quote, ‘a radical departure from hundreds of years of legal precedent,’” said Sturm of Christine Wilson, the Republican FTC commissioner who resigned last March in protest over chair Lina Khan’s antitrust agenda.

He noted any regulatory actions recommended by the FTC, such as changes to the Franchise Rule or a new rule regarding non-competes, will face a litany of litigation challenges and could make their way up to the U.S. Supreme Court, where it’s unlikely they would survive review.

Sturm did not mince words when asked where his firm stands on the FTC’s actions. “As demonstrated by its continued expansion, the franchise industry as a whole represents a great success story, for both franchisors and franchisees,” he said. “The public interest would be better served by the FTC’s enforcement of existing rules, rather than re-writing those rules in an attempt to solve perceived problems that, in our experience, are primarily anecdotal and not pervasive in the industry.”

More state regulations

New franchise bills introduced In Arizona and Georgia in February addressed the relationship between the franchisor and franchisee, and the lawful termination of franchisees. Attorney Susan Grueneberg of Cozen O’Connor said she expects other states to take up similar motions to further regulate franchising.

“One of the things I see in California, and a number of other states that regulate franchising, is the focus on regulation of franchise brokers,” Gruenberg said. “I’ve talked to franchise brokers I know and alerted them that there’s going to be something coming down the pike regarding this.”

Grueneberg, who sits on the industry advisory committee for the North American Securities Administrators Association’s Franchise and Business Opportunities Project Group, pointed out only New York and Washington require separate registration of franchise brokers. She anticipates California and other states to begin requiring the same.

She also said more states adopted the new NASAA policy on the use of questionnaires and acknowledgments in the franchise disclosure document. (For more on this topic, turn to page 41). She said those changes will make it more difficult for franchisors to get out of litigation with franchisees.

“Another thing we can see with this adoption of questionnaires and acknowledgements is more systems going to arbitration,” Grueneberg said.

Her advice to franchisors who are unnerved by new state regulations is not to panic. Compliance often requires some slight adjustments to the wording in the FDD and franchise agreements.

“Yes, we need to monitor what the FTC is doing and how it applies to individual states,” Grueneberg said. “But like I keep reminding my franchise clients, none of this, at least in my mind, is threatening the franchising model. Franchisors will continue to franchise in California and grow their business here and in other states that regulate franchising. Maybe it’s just the Pollyanna in me, but I don’t see any of these new state regulations being an existential threat to franchising.

“Franchising is very strong business model that’s only growing in attractiveness by every study I’ve ever seen, and there will always be bad actors in it,” she said. “We should all want the bad actors to suffer consequences, right?”