The slogan of Smokey the Bear is that “Only you can prevent forest fires.” This may also be true of franchise professionals when it comes to egregious franchise fraud. The good news is that our profession is stepping up and that such pernicious fraud is becoming increasingly rare.
For the first time in at least a decade, the Department of Justice on behalf of the Federal Trade Commission filed a civil action against Burgerim Group USA, Inc., Burgerim Group, Inc. and founder Oren Loni for violation of the FTC’s Trade Regulation Rule entitled “Disclosure Requirements and Prohibitions Concerning Franchising.” The case was filed in the Central District of California, at No. 2:22-C-825 seeking a permanent injunction, monetary judgments, consumer redress and other relief. This lawsuit follows the states of California and Maryland enjoining the offer of sales of these franchises due to numerous disclosure violations and franchisee complaints. Burgerim is alleged to have targeted veterans with discounts and misrepresented material information regarding the forecast of success of their franchises. Additionally, Burgerim omitted information which the FTC Rule requires to have been given to prospective franchisees. This rare action by the FTC demonstrates the tools available to this powerful government agency to redress franchise fraud, but is also a lesson on how franchise lawyers and consultants could have helped prevent or contain the fraud earlier.
I. The allegations of the Department of Justice.
Defendants are alleged to have lured veterans through discounts and other would-be entrepreneurs to buy a burger franchise. The purchasers obtained loans from all sources, including those guaranteed by the US Small Business Administration to buy and open the franchises. But the Defendants “fell woefully short” of complying with the FTC Rule on disclosure, which left out information necessary to enable prospective franchisees to “analyze earnings representations” or to obtain an “unvarnished experiences from prior purchasers.” In an effort to close the sales, Defendants made verbal representations inconsistent with the written disclosures, or falsely filled in the gaps of the omitted information from the written disclosures. Over 1,500 franchises were sold, but “the overwhelming majority never got off the ground.” Hundreds cancelled their franchises with promises to have their initial franchise fees returned. In many cases, those promises were not fulfilled. In an effort to mask their scheme, Defendants advised that they were filing bankruptcy. While disappointed franchisees waited, Burgerim never filed, which may have provided transparency into the operation and failure. The FTC commissioners voted 4-0 to take the extraordinary step to refer the case to the Justice Department.
II. Efforts by the franchise industry to stop Burgerim.
The franchise industry is designed to efficiently allow others to experience the American Dream. Hardworking restaurant operators and educators can start a franchise system by complying with the FTC Rule. People of all walks of life who want to be in business for themselves, but not by themselves, can buy a franchise. The US Small Business Administration enables lenders to take the risk and support small business by backstopping the loans, and the SBA has a system for qualifying franchisors for the loans to their franchisees. Franchise lawyers, accountants and other consultants are available to review the franchisor offerings and provide support to franchise purchasers. The franchising industry has a voice through the International Franchise Association to help enable veterans and the underserved to buy franchises, and to support quality franchisors who meet IFA criteria. Finally, state regulators have the ability to stop illegal franchise sales. All of these industry checkpoints ultimately did help contain the fraud, but not quick enough to cause widespread damage.
Many of the Burgerim purchasers were targeted because of their vulnerability. Many did not speak English as a first language and sought to establish a business in the United States. Veterans and the underserved in our community were not sophisticated enough to look beyond the official looking, over 100 page Franchise Disclosure Document (the “FDD”), to notice its obvious inadequacies under the FTC Rule. They did not have access to, or chose not to, engage knowledgeable consultants before they purchased, who likely could have smelled the fraud just looking at the FDD’s inadequacies. The fraud first could have been avoided for those who sought competent legal advice early on, and perhaps many a disaster was averted for those who did by asking the proper questions. But the other institutional protections could not help the victims until the evidence started mounting.
The SBA and lenders screened Burgerim before approving loans, but they could not have sounded a siren before an alarming default had occurred. The state regulators, with everything they have to do, did catch Burgerim based on reports by those harmed, and those reports came fast a furiously from mostly franchise specialist lawyers, and victimized franchisees. The IFA supports taking bad franchisors out of the market and endorses the regulatory response. The institutions acted when the carnage became apparent, but the storm clouds were not seen early enough.
III. What we can do better.
Professional and lay franchise education in our law schools and our colleges would have helped prevent some of the harm. Not every city has qualified franchise counsel to have detected a problem by just reading the FDD. Some states, like California has a franchise law specialization and certification by the California State Bar. We can do better by making franchise law resources to lawyers and their clients so that the early warning radar could be activated. The FTC has a website, ReportFraud.ftc.gov, where fraud scams can be reported. Many states also have similar sites to report the fraud as well. At bottom, the private sector has the tools to nip this at the bud, and should be more proactive so that fraud scams like this do not gain momentum. Not every franchise failure by a franchisee is caused by fraud. But when we see something, we have to say something, and even do something.