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FTC's Proposed Changes In Franchise Rules Elicit Chain Reactions

By Cindy Skrzycki
Tuesday, April 19, 2005; Page E01

In 1978, when the Federal Trade Commission issued its first disclosure rule governing franchise operations, the Internet was not a factor in business, there were half the number of franchise brands that we all now recognize, and the Small Business Administration had 2,000 applicants for franchise loan guarantees, compared with 6,000 last year.

Franchising has proliferated rapidly since then. There are more than 750,000 franchises -- double the number a decade go -- employing 10 million workers in fast-food restaurants, lodging and other retail outlets, according to a study done for the International Franchise Association, an industry trade group.

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"Over the past 10 years, there has been steady progress in the growth of franchising," said Darrell Johnson, president of Frandata, a research firm in Rosslyn.

This growth is what prompted the FTC to update its rules, an effort that began in 1995. The agency recently completed a 423-page report on proposed changes in those rules, which is expected to be put before the commission for a vote this fall. Many of the recommendations track what states and franchisers already are doing.

"The substance is broad and detailed, but it's pretty simple," said Eileen Harrington, associate director of marketing practices for the FTC. "The marketplace is served by as much truthful disclosure as possible."

In the franchise business model, the relationship is co-dependent. The franchiser makes money from royalties, and the franchisee hopes for success by operating under an established brand. Thus any regulatory changes have the potential for tipping the balance of power.

Some franchisees hoped to use the FTC rulemaking process to gain more equity in the relationship. Because agreements can last 10 to 20 years and the average investment is around $250,000, these business owners wanted more protection from the federal government after the contract is signed.

They allege that abuses often arise after the parties sign on the dotted line: encroachment on sales territories, restrictions on which suppliers they can use, restricted access to the courts, gag orders on talking about their experiences after a relationship is terminated, and do-not-compete covenants.

"It's buyer beware," said Susan P. Kezios, president of the American Franchisee Association, which represents 20,000 franchise owners. "There is no enforcement. It's like the wild, wild West and the FTC only deals with pre-sale [issues]."

The FTC's Harrington said prospective investors need to read the contract underlying the transaction carefully, since the agency does not have the statutory authority to address post-sale issues. "They need to talk to lawyers and other franchisees to understand what they are really buying into," she said.

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