Franchise Law

The problem is that “franchise fraud” is not legally defined under the law. Is it fraud to sell a franchise when over 10%, 20%, or 40% of the first owners of the franchise fail to thrive within the first year or two? At what point is it not successful for the franchisor?– who doesn’t share the failure with the failed franchisees but does share in the success of those who survive, and who even gets the benefit of the assets of those who fail when these assets are sold-transferred in a fire sale to a second-generation franchisee who may make it to break-even because of reduced overhead and debt, and who will continue to pay royalties to the franchisor on the gross sales of the business.

Is franchise fraud committed when the franchisor sells new franchises and indicates in the hard sell that there will be profits in the investment (outside of the actual contract) knowing that a high percentage of the startup franchisees won’t succeed based on historical performance statistics in their possession?

Unfortunately, as a franchisee, you are not a partner, you are not an employee, you are merely a contracted resource for the franchisor who by way of the adhesory contract really owns you and your gross sales both in success and in failure. Franchisors NEVER promise success or profits within the standard and boilerplare contracts that are signed by the new buyers and are protected by the contract terms in the courts from failed first-owner franchisees who finance and build the physical units that wear the brand name when these first-owners fail to thrive.

It is impossible to track the actual failure rate of first owners of franchises because many first -owner failures don’t show up on public records because when they give their businesses away to get out from under the debt of the long-term lease that is personally guaranteed, they continue to pay on their start-up debt that is personally guaranteed to avoid default and bankruptcy and to avoid surrender of the collateral posted for the loan. They don’t show up on default lists that the banks and lenders use.

Yes! the law should be changed to mandate that the franchisors themselves, and not past and present franchisee references, disclose or make available the UNIT financial performance statistics in their possession to new buyers of their franchises. Franchisors should be required under law to give some PROOF of the success of their franchise UNITS to new buyers. But such disclosure would reveal churning and pumping and dumping of units as well as low unit profitability or no unit profitability in systems.

Yes, the law should be changed to make franchisors share some of the risk with the franchisees and to provide a fair exit strategy for those franchisees who do not thrive when they have exhausted the estimated start-up costs of the franchisor.

The franchisors and the other special interests, the lenders and the banks, the developers and the landlords and the elected government officials would fight such laws because this could inhibit the sale of franchises somewhat and could adversely affect the economy. Governments depend on franchising to bring economies out of recession. When jobs are in short supply, the franchise opportunity appears to be a good solution to both a job and profits, as well, and those with the resources to buy a franchise are willing to invest in themselves. The trouble is that they are not informed of the actual risk involved in any real sense and the SELLER of the franchise takes unfair advantage of the need of the buyer for a job and income.

Remember that the concept of “franchising” wherein the franchisor is able to avoid the expense and risk of building and operating the physical business units that produce and grow SYSTEM gross sales upon which he profits is also a means of the franchisor beating the brutal statistics of failure of ALL “start-up” small businesses, independent or franchised, in all world economies. ( Do a Google Search of Start-up Failure Rates -The Real Numbers, written by Scott Shane, Western Reserve University, Cleveland, Ohio)

The capture of the cheap labor and the cheap “venture” capital of prospective franchisees has no doubt increased franchising activity in all world economies and this capture to this extent would not be possible if the true “failure rate” of first owners of franchises were disclosed to new buyers of franchises. It is not surprising, therefore, that the failure rate of franchise investments for first owners has not been a matter for research and that this risk factor is not disclosed to new buyers of franchises.

Would or could franchising survive if the unit performance statistics of systems were mandated to be disclosed to new buyers under the law?

I find that franchising is conducted pretty much the same way all over the world.

From my point of view, once you sign a franchise contract, you probably have no recourse for any of the misrepresentations made outside of the contract. Franchise law tends to protect franchisors under the sanctity of “contract law” —-that is, if it isn’t in the contract and you acknowledged that you were not expecting anything that wasn’t promised in the contract, this is the end of things.

Franchises are marketed, with the approval of governments and the special interests who gain from franchising, as having very little actual risk and this is where so many franchisees find out the hard way that franchising is very risky —-especially when they have signed personal guarantees that can destroy them in failure.

Remember that you are not alone. This is going on all over the world.

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