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The Bureau of Consumer Protection, a division of the Federal Trade Commission, recently issued a report analyzing the effect that an FTC regulation pertaining to the offer and sale of franchises and business opportunity ventures has had on the franchise sales process. The report used data the FTC had accumulated concerning complaints by parties injured economically because of violations of the regulation — called Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures (the FTC Rule) — and covered the FTC’s franchise and business opportunity program from 1993 through 2000. At first blush, the bureau’s report would indicate that the FTC Rule has curtailed many of the ills associated with franchising during the 1960s while having a lesser impact in regards to business opportunity offerings. For example, the bureau found that only about 6 percent of the complaints lodged with the FTC involved franchises and that the economic value of the alleged economic injury in all cases was less than $10,000. BACKGROUND The FTC Rule was devised in the late 1970s because of fraud and false and misleading sales tactics used amid explosive growth in the franchising industry. Congress initially focused on reported abuses in franchise and related industries beginning in 1969 as the Small Business committees of the Senate and House conducted hearings on unethical franchise sales. Ultimately, Congress chose not to pass legislation governing the franchise sales process. However, the FTC promulgated the FTC Rule, a comprehensive regulatory scheme mandating, among other things, that pre-sale disclosures be made by franchisors to prospective franchisees. The FTC has the authority under the Federal Trade Commission Act to prevent unfair methods of competition and unfair or deceptive acts or practices. Using that authority, the FTC first conducted hearings concerning the state of the franchise industry in the 1960s and published its first proposed rule-making on franchise regulation in 1971. The FTC Rule became effective October 21, 1979. By its terms, the FTC Rule applies to the offer and sale of franchises throughout the United States. The thrust of the FTC Rule is disclosure. The rule was designed to address the problems of nondisclosure and misrepresentation that arise when prospective franchisees purchase franchises without the benefit of full and fair disclosure. For example, the FTC noted that “since many individuals seeking opportunities as franchisees are not familiar with franchising operations, it has become common practice for franchisors to use a complete range of promotional and selling techniques to reach such persons. Newspapers, magazines and direct mailings are used to attract the attention of prospective franchisees. In both advertising and promotional literature, franchisors often stress that a prospective franchisee needs no prior business experience.” The FTC Rule expressly covers two types of continuing commercial relationships: “package and product franchises” and “business opportunity ventures.” Package and product franchises include fast-food restaurants, motels and automotive after-market services. The less well-known business opportunity venture is one in which: (a) the offeree sells goods or services supplied by the offeror (or suppliers which are designated by the offeror); (b) the offeror secures retail outlets or accounts for the goods or services or secures locations for vending devices or racks; and (c) the offeree is required to pay the offeror to obtain or commence the business. The Interpretive Guides to the FTC Rule succinctly describe business opportunity ventures as distributorships, rack-jobbing and vending machine routes, where the franchisee is put in the business of “distributing certain goods or services, usually those of a third party (such as film, juice or pantyhose, etc.), by providing or suggesting a supplier for the goods and representing that the franchisor will establish retail accounts or place vending machines or rack displays in suitable locations.” The FTC Rule mandates disclosure of certain information to prospective franchisees. Franchisors must deliver a disclosure document to prospective franchisees at the earlier of the first personal meeting between franchisor and prospective franchisee, or 10 business days prior to the execution of a franchise agreement or other binding agreement or the payment of any consideration by the franchisee. It is against this backdrop that the Bureau of Consumer Protection undertook its review of the FTC’s program on franchising and business opportunities. The bureau’s findings are particularly enlightening regardless of whether the reader is pro-franchisor or pro-franchisee. THE BUREAU’S REPORT The bureau divided its report into three parts: � A statistical analysis of franchise and business opportunity complaints. � A statistical analysis of FTC enforcement activities. � A review of the FTC’s consumer education activities in connection with franchises and business opportunities. The FTC created the Consumer Response Center in 1997 for the purpose of standardizing the handling of complaints of violations of the FTC Rule. During the relevant period, the FTC received about 4,500 complaints, the overwhelming majority of which pertained to transgressions in connection with business opportunities. Specifically, more than 75 percent of these complaints involved business opportunities, while less than 10 percent involved franchises. Another notable statistic is that of the 4,500 complaints lodged, 950 were against business opportunity sellers, while only 200 were brought against franchisors. These statistics would seem to portend that the FTC Rule, at least as applied to franchising, is having its intended effect that franchisors are taking care to prepare and deliver disclosure documents to prospective franchisees as and when required. This is especially true when it is considered in light of the number of franchisors doing business in the United States during the period in question. DETERMINATIONS There are about 2,300 franchisors operating in the United States. Thus, only a discrete minority of these franchisors — less than 10 percent — were the subject of a complaint. At least two potential conclusions can be drawn from this statistic: The promulgation of the FTC Rule had the effect of deterring fraudulent franchise schemes, and consumers are better educated about franchise offerings in general and are obtaining the requisite offering circulars. Further statistics lend credence to the success of the FTC Rule. For example, the bureau found that almost 75 percent of the complaints made with respect to franchises represented a single complaint against a single company. This would indicate that the franchising industry is not rife with fraud as it was perceived to have been during the 1960s. The logical assumption is that the promulgation of the FTC Rule and similar laws in certain states have heightened awareness of the need and requirement for disclosure in franchise offerings. “Only a few companies appeared to exhibit any pattern of problematic behavior,” the bureau said. The statistics regarding alleged injuries are notable as well. In particular, the bureau reported that the majority of all injuries reported came to less than $50,000, and that more than 90 percent of all injuries were less than $20,000. According to the bureau, injury over $100,000 was “extremely rare.” These findings would lend further support for the proposition that the franchise industry is not plagued by the same ills which engendered passage of state franchise registration and disclosure laws and the FTC Rule. The bureau tracked complaints using a variety of different identifiers. For example, the bureau tracked complaints by both company location and consumer location. The greatest number of complaints against franchise companies was made in states having the greatest populations — Florida, California, Texas and New York. The greatest number of complaints was made by parties in the most heavily populated states — California, Texas, Florida, New York, Pennsylvania, Ohio, Illinois and New Jersey. The complaints comprised three primary violations of the FTC Rule: � earnings claims made in violation of the FTC Rule, � failure to furnish a disclosure document; and � allegations of inaccuracy or incompleteness of disclosure documents. The bureau also noted that as regards franchising and business opportunities, the use of the Internet is still in its infancy. Most franchisors and business opportunity sellers continue to rely on mail, telephone and print advertising and solicitation. Less than 10 percent of the complaints lodged with the FTC during the period related to Internet offerings. It would seem that as use of the Internet becomes more prevalent, the incidence of noncompliance with the FTC Rule will increase. The report does validate much of the work done by franchisors and trade association groups such as the International Franchise Association. It is important to note, however, when reviewing the bureau’s findings, that the FTC Rule only applies to pre-sale disclosure and not to post-contract matters. Thus, while it is clear that the rule and associated state law cured many of the ills once associated with franchising, the bureau’s report does not address the need for a federal franchise relationship law. Edward J. DeMarco Jr. is a partner in the business and finance department of Ballard Spahr Andrews & Ingersoll, practicing in the franchise and distribution law group.

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