Small Business Franchise Act will stop franchisees' bleeding

Feb. 19, 2002

Following 18 months of debate and the expenditure of more than $2.25 million in legal fees, the Independent Organization of Little Caesar's Franchisees (IOLCF) finally settled its class-action lawsuit (see related story, "A Fair Deal for All") against Little Caesar's Enterprises (LCE).

What a wonderful way to start a new year -- knowing your group has one of the best franchise contracts in the pizza business and, as part of the settlement, the parent company paid the legal fees.

Susan Kezios, President of the AFA

Too bad that the Little Caesars settlement takes care of issues that, over the past 25 years, have been litigated time and time again by franchisees in chains as diverse as Dunkin' Donuts to Spee Dee Oil to Dairy Queen. Unfortunately, without national standards of conduct such as those proposed in the Small Business Franchise Act (SBFA), introduced to Congress in 1998, protracted, multimillion dollar legal battles between franchisors and franchisees are destined to continue.

How would the SBFA affect your business? Simply put, the proposed legislation would ensure that franchisors' opportunity to profit won't come at the expense of their franchisees.

In the franchising industry as a whole, right now there is no cop on the beat. Recently, the Federal Trade Commission (FTC) came under the scrutiny of the U.S. General Accounting Office (GAO) for its poor record keeping procedures regarding problems reported by franchisees. Despite the FTC's claims to have no jurisdiction in this area, the GAO found a tenfold increase in the number of franchise complaints reported to the agency. Ninety-two percent of those complaints were similar to those the Little Caesar's franchisees recently settled with their franchisor.

One of the key provisions of the SBFA relates to the independent sourcing of goods and services. In this area, the SBFA is pro-competitive. It prohibits current exclusionary and anti-competitive practices of certain franchisors by stating the following: A franchisor shall not prohibit a franchisee from obtaining equipment, goods or services used in the franchise from sources of the franchisee's choosing, except that such goods or services may be required to meet reasonable established uniform systemwide quality standards enforced by the franchisor. The SBFA provides for an exception and does not apply to reasonable quantities of goods or services that are essential to the franchised business and which incorporate a trade secret or other intellectual property owned by the franchisor.

Attention Pizzeria Franchisees!

Generally speaking, pizza franchisees are severely restricted in their ability to shop for and negotiate the best price on supplies. A study completed by the American Franchisee Association (AFA) comparing the franchise agreement provisions of the top eight pizza franchisors revealed that the percentage of total franchisee purchases subject to restricted suppliers is no less than 80 percent. And when the franchisor begins to impose policies that result in foiling competition for the sale of supplies and services to franchisees -- which ultimately results in supra-competitive prices -- the franchisee cannot abandon his/her sunk costs and investments. This is especially true if the franchisee is also saddled with long-term lease commitments and a restrictive covenant-not-to-compete.

There already are laws on the books guaranteeing competition across non-proprietary products. Both Indiana (since 1985) and Iowa (since 1992) have laws stating it is unlawful for any franchise agreement to contain a provision that requires goods or services to be purchased exclusively from the franchisor or sources designated by the franchisor when comparable-quality products are available from other sources. Like the SBFA, both the Indiana and Iowa laws state that this does not apply to goods or services manufactured or trademarked by the franchisor. And because there has been no mass exodus of franchisors from either Indiana or Iowa since these two statutes became law, it seems reasonable to expect that franchisors will be able to thrive with similar provisions as proposed nationally in the SBFA.

Passage of the Small Business Franchise Act will help keep franchisees viable. For the first time in more than 10 years, sales in the restaurant industry as a whole are projected to be flat this year. While franchisees' labor, insurance, food and operating costs are rising, franchisors are marketing --if not mandating-- lower prices for customers. The consumer is getting the benefits of competitive pricing between chains, the franchisor is getting increased royalty revenue from inflated pricing, and the franchisee is just getting "it" from both ends.

Finally, with passage of the Small Business Franchise Act, franchisees won't have to litigate their franchisors into a corner like Little Caesars' operators were forced to in order to receive a fair and equitable deal. If you aren't like the IOLCF, which had 18 months time and $2.25 million dollars set aside for legal fees, you could end up bleeding to death slowly like so many other small business franchisees have in the past.

The opinions expressed in this commentary are not necessarily those of

* Editor's note: The International Franchise Association (IFA) declined's invitation to submit its opinion on the Small Business Franchise Act.

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