Federal agencies take action to protect franchisees from illegal fees and retaliation by franchisors

The Federal Trade Commission announced several measures on Friday to stop “unfair and deceptive” practices by franchise companies.

The FTC has issued new guidelines requiring franchisors not to charge fees that were not previously disclosed. Federal officials have heard from franchisees about rising fees for payment processing and technology, as well as surprise fees for training, marketing and property improvements that were not clearly disclosed by the franchisor. The FTC referred to these as “undisclosed junk fees,” or expenses that can drive up costs and impact profitability and losses.

Another step is a policy statement emphasizing the illegality of contract clauses that prevent franchisees from speaking to the government. The FTC said it has been concerned for several years that current and former operators have been reluctant to file reports or speak to officials about their experiences with certain franchisees. The commission has heard that franchisees fear retaliation for speaking out, even if they do so anonymously.

“Franchising is an opportunity for Americans to build a business, but the FTC has heard concerns that unfair franchisor practices, such as not fully disclosing fees up front, are not reported for fear of retaliation,” FTC Chair Lina M. Khan said in a statement. “Today, the Commission is making clear that contract terms that prevent franchisees from reporting potential violations of government law are unfair, unenforceable and illegal.”

In addition, the FTC has released a “Franchise Issue Spotlight,” which provides an in-depth analysis of concerns surrounding the franchise business model, focusing on questions raised in the academic literature, responses to a March 2023 FTC request for information, and ongoing efforts.

These are the main concerns of franchisees:

Unilateral changes to franchise operating manuals: Franchisees expressed frustration with franchisors making unilateral changes to operating manuals, effectively changing the terms of the franchise agreement and adding new costs or requirements.

False statements and deception by the franchisor: Cases where franchisors provide misleading information or make deceptive claims.

Fees and royalties: High fees and royalties, including undisclosed or “surprise” fees, were a significant problem and often impacted franchisees’ profitability.

Franchise supply restrictions and supplier rebates: Franchisees reported problems because they were forced to purchase supplies from certain suppliers at inflated prices, often in the form of bribes to the franchisors.

Actual and feared retaliation: There was great concern about retaliation by franchisors for participating in independent franchisee associations or for reporting misconduct.

Non-competition and non-solicitation clauses: There were concerns about restrictions on franchisees’ ability to work in or operate similar businesses.

Problems with franchise renewal: Difficulties and unfair practices have been identified in relation to the renewal of franchise agreements.

Refusal of the franchisor to negotiate the terms of the contract: Franchisees reported that franchise agreements are often presented as non-negotiable, leading to a power imbalance.

FDD problems: Inadequacies and misleading information in FDDs.

Private equity acquisitions: The impact of private equity ownership on franchise operations, which often leads to cost-cutting measures that harm franchisees.

Transparency in marketing funds: Lack of transparency regarding the use of marketing funds collected by franchisees.

Penalty clauses and fees for early termination: Franchisees felt trapped by high contractual penalties and early termination fees, making it difficult to exit unprofitable franchises.

Keith Miller, principal at Franchisee Advocacy Consulting, called the measures “a huge step toward better franchising practices.” He noted that while franchising is a low-cost business model with many big-name brands, it lacks oversight, which has allowed some to take advantage. Miller also explained that franchisors who charge undisclosed fees in the FDD undermine the purpose of the document. The unexpected costs hurt franchisees’ margins, especially during times of inflation. While they seem small, these fees can amount to millions, according to Miller, and hurt operators and customers.

“I applaud the FTC’s hard work. Today’s announcement is an important step in protecting franchisees, the primary investors in franchising,” Miller said in a statement.

However, Matthew Haller, president and CEO of the International Franchise Association, was critical of the announcement. He said franchising supports the American dream of owning a business and most franchise relationships are successful and growing. However, he expressed concern that the FTC’s actions could hamper innovation and harm franchisees.

Haller called on the FTC to adopt the IFA’s 2024 Responsible Franchising Policy Recommendations, which aim to increase transparency and clarify obligations in franchise agreements. The IFA has been advocating for these recommendations since the FTC’s March 2023 request for information, emphasizing the need for sensible updates rather than sweeping changes. In May, the IFA released a set of policy recommendations developed by a working group of franchisors, franchisees and suppliers to provide greater transparency in the pre-sale process.

“The FTC’s actions today run counter to the fact that the vast majority of franchise relationships work and franchising continues to grow every year,” Haller said in a statement. “We have long supported greater transparency and visibility in the franchise sales process. … Today’s FTC guidelines on disclosure of fees in franchise agreements unnecessarily limit franchisors’ ability to innovate and evolve their system and harm the equity of the franchisees for whom these FTC actions are allegedly being taken. The IFA will continue to work with the FTC to improve the model for all parties involved and the customers they serve.”