Last June we blogged about a lawsuit that ended favorably for a franchisor.  In Braatz, LLC v. Red Mango FC, LLC, the trial court determined that a franchisor did not violate Wisconsin’s “14-day Rule”, which requires franchisors to provide an “offering circular” (aka FDD) to prospects 14 days before selling a franchise.  3:14-CV-4516-G (N.D. Tex. Apr. 27, 2015).

Copyright: lauraluchi / 123RF Stock Photo
Copyright: lauraluchi / 123RF Stock Photo

The franchisees appealed to the 5th Circuit, and that court recently decided again in favor of the franchisors, but under a different rationale. See Braatz, LLC v. Red Mango FC, LLC, No. 15-10498 (5th Cir. Mar. 30, 2016).

In Braatz, potential franchisees inquired about purchasing a Red Mango franchise, and they received a business plan and financial projections.  The next day, they received Red Mango’s offering circular; however, it did not contain the business plan or financial projections.

The prospects decided to purchase the franchise, and in late December 2011 (over a month after receiving the offering circular) they returned a signed franchise agreement and check to Red Mango.  The franchise agreement included a questionnaire, in which the franchisees were asked whether Red Mango had given them financial information that was not in the offering circular.  The franchisees answered “yes” based on the business plan and financial projections.

Sometime between January 6 and 16, 2011, Red Mango mailed a blank copy of the same questionnaire to the franchisees.  Red Mango told the franchisees that they must change their answer or they could not open a franchise. They changed their answer and returned the questionnaire sometime before January 16.  Importantly, this portion of the transaction took place in less than 14 days.

In 2014, the franchisees’ franchise closed and they declared bankruptcy.  Shortly thereafter, the plaintiffs filed a suit against Red Mango, alleging that Red Mango’s failure to provide them with 14 days to consider the revised questionnaire was a violation of the Wisconsin Franchise Investment Law (“WFIL”).  The plaintiffs sought to rescind the franchise agreement.

Because the trial court determined that the violation was not material to the franchisee’s decision to purchase the franchise–as required by WFIL–it held in favor of Red Mango.  The appellate court also exonerated Red Mango, but under a different rationale.  It noted that the 14-Day Rule requires franchisors to provide the “offering circular” to prospects 14 days in advance of selling a franchise.  The court clarified what “offering circular” means under the WFIL:

The phrase ‘offering circular’ specifically refers to disclosure documents filed with the state when a franchisor registers. . . . The rule does not, for example, entitle a franchisee to 14 days to consider ‘any new information’ about the franchise agreement.

The court held that Red Mango complied with the 14-Day Rule when it provided the offering circular to the franchisees at least 14 days prior to selling the franchise.  The 14-Day Rule did not (as the franchisee’s argued) require Red Mango to give them another 14 days to consider the change to the questionnaire.

In Braatz, the claims against Red Mango were defeated twice in two courts and under two different legal rationales.  But a strong legal defense comes at a cost to a franchisor’s bottom line.  Of course, it’s not possible to avoid a lawsuit every time.  But strict compliance with federal and state disclosure laws and robust sales team training and communication provides the best defense against a lawsuit being filed in the first place.

 

 

 

 

The Federal Trade Commission (FTC) this week amended its rules under the Fair Packaging and Labeling Act (FPLA), which requires certain products to carry labels identifying the contents, source, item quantity, and other information to help consumers compare products.   The changes include:

Copyright: ragsac / 123RF Stock Photo
Copyright: ragsac / 123RF Stock Photo
  1. Modernizing the “place of business” requirement to account for new technologies. Labels are no longer required to contain the street address of the manufacturer, packer or distributor if it is “readily access well-known, widely published, and publicly available resource, including but not limited to a printed directory, electronic database, or website.”
  2. Incorporating a more comprehensive metric chart. It is certainly helpful for business compliance but this may be less interesting to consumers who still eschew the use of metric measurements.
  3. Eliminating sections addressing the use of “cents off,” “introductory offer, or “economy size” since they are now rarely seen although the FTC notes that it has other compliance measures at its disposal should businesses use these phrases deceptively.

Product categories exempt from FTC regulations under the FPLA include meat products, poultry, tobacco products, items under the Food and Drug Administration’s jurisdiction and alcoholic beverages.  Businesses should carefully review the Amendment which will go into effect 30 days after publication in the Federal Register which the FTC says will occur shortly. The full text can be found here.

“It is the purpose of this Act to . . . govern franchise agreements . . . to the full extent consistent with the Constitution of the United States . . . .” 

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The Fair Franchise Act of 2015 (the “Act”) makes a lot of promises:  it will promote fair business relations, protect franchisees, and create a thriving franchise business climate, better wages and benefits, etc.  But the Act can’t fulfill any of them unless it makes (and keeps) one more promise – to become the squeaky third wheel in the contractual relationship between Zee’s and Zor’s.  And that is the one promise the Act is certain to keep.

First, a little background. The Act was introduced in the House by Rep. Keith Ellison (D-MN) on July 23, 2015, and it was co-sponsored by Rep. John Conyers (D-MI) and Rep. Jared Huffman (D-CA). But it’s not a new concept. Representative Conyers worked closely on similar legislation in the late 1990’s as did Rep. Huffman four years ago when he was a California legislator.

Many prohibitions will sound familiar:  Zors cannot make untrue statements; they cannot disclose FPR’s that are inconsistent with their FDD’s. What is different this time around is that the Act creates a private right of action, meaning Zee’s can sue Zor’s under federal law for such activities. And not only that – the Act creates a private right of action under the FTC Rule as well, which for nearly four decades has only been enforceable by the Federal Trade Commission.

Yes Zee can / No Zor can’t

Among the Act’s many prohibitions, Zor’s cannot:

  • hinder the formation of or participation in Zee associations,
  • charge “excessive and unreasonable” renewal fees,
  • enforce certain arbitration provisions, or
  • require Zee’s to maintain non-competes with the Zee employees.

Conversely, Zee’s can do any or all of the following (and Zor’s cannot terminate or fail to renew the franchise):

  • refuse to take part in a promotional campaign if it is not “reasonable, implemented in good faith, and expected to promote the profitability of the franchisee’s business,”
  • refuse to sell product or services at the Zor’s suggested (or even required) price, or
  • refuse to keep the business open during unprofitable hours.

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We’ll know it when we see it…

The Act also prohibits Zor’s from engaging in conduct and behavior that is difficult to define with particularity. What does it all mean?  No one will know until Zee’s and Zor’s litigate and courts decide.  Zor’s cannot impose a “standard of conduct or performance” on Zee’s unless the Zor can “prove” that the standard is “reasonable” and “necessary.”  Zor’s must deal “fairly” and “in good faith” and exercise “due care” with Zee’s in all business matters.  Zor’s cannot sell (or even offer to sell) a product or service to a franchisee unless the price is “fair and reasonable” or unless the Zor has a “reasonable expectation” that the sale will be profitable for the franchisee’s business.

Just when you thought you were out…

The Act singles out franchise transfers, renewals and terminations for specific treatment. Here perhaps more than anywhere else, the Act prohibits contractual provisions that parties routinely take for granted.

Transfers:  Most contracts frequently contain prohibitions on one or both parties assigning their contractual rights. But under the Act, a Zor must accept a transfer if the transferee satisfies “reasonable qualifications,” which must be based on “legitimate business reasons.” A Zor may want to update a franchise agreement for the new transferee, but under the Act, the Zor cannot change any material terms or financial requirements.  Finally, if existing Zee’s want to sell assets or securities to one another or engage in other business consolidations, the Zor generally must accept such changes.

Renewals:  Under the Act, Zor’s must renew franchise agreements unless they have good cause.  Of course, the failure to pay royalties is good cause, right? Not necessarily. The Act suggests that Zor’s must renew a franchise even if a Zee does not pay royalties, advertising or marketing fees, unless the failure to pay is “repeated and intentional.”  Zor’s must provide a cure period for nearly every kind of breach, cannot enforce certain non-competes, and Zor’s cannot charge “unreasonable” renewal fees.

Terminations:  The Act would require Zor’s to show good cause to terminate a franchise or to “substantially change the competitive circumstances of the franchise.” Alternatively, a Zee can terminate without any further liability over “substantial negative impacts” or “substantial financial hardship” caused by changes in the system or competitive circumstances.

The Act is still just a bill on Capitol Hill, far from becoming law. But its provisions showcase how far from center some lawmakers stand on issues central to the franchise model – and how deeply into the contractual relationship between Zors and Zees some lawmakers are willing to reach.

Copyright:  / 123RF Stock Photo
Copyright: / 123RF Stock Photo

Opening a new front in the War Against Franchising, the Wall Street Journal is reporting today that the Service Employees International Union or SEIU has targeted disgruntled franchisees and former franchisees in an attempt to form an alliance against some of the biggest franchisors, including McDonald’s Corp. and 7-Eleven Inc. According to today’s article, the effort centers on allegations of failures to disclose financial information to prospective franchisees and wrongful termination of franchisees. The centerpiece of the effort is a petition filed with the Federal Trade Commission to investigate what the SEIU claims are “abusive and predatory practices” of franchisors.

As the Wall Street Journal notes, it doesn’t appear that the SEIU has been able to build a large or strong coalition of franchisees for its effort. And that shouldn’t come as a surprise. For the past several years now, the SEIU and has been front-and-center in an effort to attack the entire franchise industry–franchisors and franchisees alike–pushing for dramatically higher minimum wages and the so-called “joint employer doctrine“. Now, perhaps sensing that its expensive public relations effort aimed at destroying the franchise industry is failing, the SEIU wants franchisees to join its crusade? It does not surprise me that franchisees are saying “no”.

I’m not going to say that the franchise industry is perfect. Every industry has a few bad apples. But we know that the vast majority of franchisees are satisfied, successful small business owners. We also know that the FTC Franchise Rule and the disclosure requirements of the Franchise Disclosure Document–not to mention the many state disclosure laws and regulations–when properly followed, provide prospective franchisees with a wealth of information about the realities of running a franchised business. And we know that there are many state regulators and franchisee-side attorneys who are ready to hold franchisors accountable if the franchise contract, or the law and its regulations, are not properly followed.

As Steve Caldeira of the IFA noted recently, independent studies show that 80 percent of franchisees would recommend their brand to others and nearly 75 percent would do it “all over again” even knowing what they now know about their brand. That doesn’t suggest to me the existence of systemic abuses of franchisees by franchisors, as claimed by the SEIU. Instead, it suggests to me that the SEIU has a “solution” in search of a nonexistent problem.

 

Many franchisors’ fiscal year ended on December 31st.   The FTC gives a franchisor 120 days to update its franchise disclosure document (FDD) but  you should be gathering the information needed to update your FDD and file your statespiral photos renewals (if applicable) NOW!    Below are some quick tips franchisors should follow to ensure they meet the deadlines:

  1. Keep in contact with your accountants or finance division and remind them that the audited financials must be completed before April 30th. Many delays in updating an FDD will be the result of auditors not having adequate time to prepare the financials. For franchisors filing state registration renewals the deadline for the audit may be sooner. Some states require that renewal registration applications be filed days or weeks in advance of the 120 day deadline.  If you are filing state renewal registrations make sure you get your Consents of Accountant forms returned with the financials.
  2. Begin compiling the additional information needed to update your FDD in an organized and complete manner. This includes changes to executive personnel, disclosure of new litigation, updated financial performance representations under Item 19, and current franchise sales data for the 2013 year.  If your outside or in-house counsel does not provide you with a renewal questionnaire or list of needed information to easily compile this data then request they do so.
  3. Make sure that the outside or in-house counsel responsible for overseeing the final updates or filing state renewals are provided with accurate draft documents and other information with ample time to review, revise, comment, and finalize. Seasoned franchise counsel should have a streamlined system in place for handling updates and renewals. The starting place to this process, however, is getting accurate information from the franchisor.

Failing to update or file renewal registrations on time can impede a franchisor’s ability to offer and sell. Therefore, it is important to get a head start on the process to give all parties involved adequate lead time.

Aaron’s, a national Rent-to-Own retail store with approximately 1,300 corporate locations and 700 franchised locations, recently reached a consent agreement (pdf) with the Federal Trade Commission (“FTC”) respecting its privacy practices.  Specifically, the FTC had filed a complaint against Aaron’s for violation of section 5 of the FTC Act, 15 U.S.C. section 45(a).

The FTC’s complaint (pdf) challenged Aaron’s use of privacy-invasive software installed on computers rented to customers.  Aaron’s installed the software on computers rented at company stores and, according to the FTC, “knowingly assisted” and encouraged its franchisees to utilize the software.  The software has two modes.  In the first mode, the software surreptitiously captured private, confidential and personal information about customers.  Aaron’s and its franchisees used this information to assist in collecting past-due accounts and recovering computers after default.

computer keyboardIn the second mode, called “Detective Mode”, the software could log keystrokes, capture screen shots and activate a computer’s webcam.  According to the FTC, Detective Mode even collected sensitive information through the use of fake software registration notices.  Another feature of Detective Mode allowed stores to track the physical location of rented computers using Wi-Fi hotspot information.  Interestingly, the FTC’s complaint states that at least one franchisee was “uncomfortable with the ability to see the customer through the webcam”.  The webcams were allegedly used to capture images of not just customers but their families, children and guests.

Important to the FTC’s complaint and the consent agreement, all of the information collected by the software was routed to stores—including stores owned and operated by franchisees—through Aaron’s corporate computers.  Aaron’s was aware of the large volume of sensitive information being collected because its own IT professionals found the information reported to be “very intrusive” and because it was sued, along with a franchisee, in May 2011 by a customer for state and federal privacy violations.  Nonetheless, the program did not formally end until December 2011, and Aaron’s received the last batch of information collected by the program in 2012.

The FTC believes that Aaron’s actions caused “actual consumer harm”.  The consent order prohibits Aaron’s from using monitoring technology on computers and from receiving, storing or communicating information collected from customers.  It further prevents the use of geophysical location tracking software without notifying and obtaining prior consent from consumers for its use.  Even then, Aaron’s must notify a user before activating tracking software unless it has a reasonable basis to believe a computer has been stolen and a police report filed.  Similarly, Aaron’s may use monitoring or geotracking software for purposes of providing customer support, but only where the customer has affirmatively consented to its use.  Finally, all information already collected must be destroyed.  A compliance report must be filed within 60 days, and the order will remain in place for 20 years.

Importantly, the provisions of the consent order make it explicitly applicable to franchisees, and require Aaron’s to oversee and monitor its franchisees’ compliance with the “core constraints” imposed by the consent order.  Aaron’s must monitor its franchisees’ compliance with those constraints on at least an annual basis.  If it discovers any violation, it must take immediate action to correct the franchisee’s practices.  Additionally, if the franchisee does not change practices, Aaron’s must terminate that franchisee.

This FTC action and the consent decree are going to be costly for Aaron’s and its franchisees.  Moreover, as we have written before, it demonstrates that the FTC is going to remain hyper-vigilant regarding computer and data privacy even in the absence of new mandates from a divided Congress.

The case offers important lessons for all of us respecting online privacy and data collection.  First, when it comes to data collection, use common sense.  The franchisee who felt uncomfortable viewing his customers on the webcam was clearly onto something.  If it doesn’t seem right:  don’t do it.  Second, disclose the existence of the software to customers.  The FTC seemed to be particularly bothered by the fact that even the existence of the software was “surreptitiously” concealed from the customer.  Finally, be explicit about what you are collecting, and make sure it fits legitimate business goals.  The FTC recognized that stolen computers and computer operational assistance were legitimate and appropriate uses of the software if disclosed.  Moreover, while not an issue in this case, I would expect little difficulty with explicit advance notice to a consumer that a rented computer could be geotracked and/or shut down remotely if payments were not timely made.

Bottom line:  think about the appropriate use of monitoring and tracking software before deploying it, and tailor the software to legitimate, disclosed needs.

There has recently been much discussion regarding service of legal process–things like complaints, writs and subpoenas–via Facebook and other social media. You may recall some hyperbolic media reporting earlier this year around the case of the FTC v. PCCare247, Inc., No. 12 Civ. 7189 (PAE), (S.D.N.Y. March 7, 2013), where a federal district court did in fact authorize service via Facebook and email. What seems to have been lost in the chatter is that the PCCare247 decision provided for service via Facebook in addition to service by regular mail. Facebook and email service were approved in PCCare247, moreover, only after the court had been satisfied that it was “highly likely” the defendants would actually receive service at their email addresses and/or Facebook pages, largely because of evidence that the defendants regularly used the email addresses and Facebook pages for business.

spiral stairsThe importance of this “highly likely to receive service” test was recently driven home in an opinion issued by the same court in a companion case. While not widely reported, the decision in the FTC v. Pecon Software, Ltd., prevented the FTC from utilizing Facebook and email service for certain defendants. Specifically, while the court again approved email service where the FTC made a showing that it was “highly likely” those defendants would receive email at the propsoed email service address, the FTC did not demonstrate that other email addresses it proposed to use for service actually belonged to the defendants in question because they were “among many” the defendant used. Similarly, the court refused Facebook service because the FTC did not provide it with actual screenshots of the defendants’ Facebook pages. Because the service names were “common”, the court found it necessary to review the actual screenshots and invited the FTC to resubmit the Facebook service request with additional documentation.

In another recent case from the District of Kansas, Joe Hand Promotions, Inc., v. Mario Carrette et al., No. 12-2633, the plaintiff sought permission to serve a complaint via Facebook alone. The plaintiff, an Ultimate Fighting Championship (UFC) promoter, alleges that Mario Carrette and partners in a restaurant/bar enterprise illegally pirated pay-per-view broadcasts of UFC events. The problem for plaintiff is that the restaurant/bar is now shuttered, and they cannot seem to physically locate Mr. Carrette for service. He still has an extant Facebook page, however, and the plaintiff sought to serve him there. The court rejected the request. It did not reach the question of whether Facebook service alone could satisfy constitutional due process because, unlike the facts in PCCare247, the plaintiff could not show that the Facebook page it proposed to serve was “current, active, or authentic”.

The takeaway appears to be that courts are willing to consider verifiably authentic Facebook pages as an alternative means of service where such service compliments other alternative means of service and is highly likely to result in actual service upon the individual or entity in question. Nonetheless, it looks like it will be a long time before any court authorizes Facebook or other social media as a sole means of service–let alone the rules will be amended to allow for such service as a matter of course.

Today the Federal Trade Commission issued updated guidance regarding endorsements.  As you may recall, the FTC last issued endorsement guidance in June 2010. That guidance focused on three major principles:

  1. Endorsements must be truthful and not misleading;
  2. Endorsements cannot contain claims requiring proof you don’t have; and
  3. Endorsements must clearly disclose any material connection between the endorser and the advertiser.

That last point has been the subject of some discussion and concern for consumers using social media. The FTC’s Testimonial Guides, in fact, specifically address social media concerns. Nevertheless, it seems that, in practice, compliance with the FTC’s guidance has not been too great a burden, as common sense has prevailed.

Nonetheless, because the social media activities of endorsers cannot be pre-screened at all times, or even directly monitored in many instances, it is a good idea to remind those associated with your franchise system, especially current franchisees, of the FTC endorsement guides.  While current franchisees are probably some of your most ardent fans, neither you nor they want to run afoul of the guidance.

Which brings us full circle  to today’s updated guidance.  For the most part, today’s message from the FTC reinforces the current endorsement guidance.  What is new,  and I believe quite helpful, is a short video that describes the guidance and answers some frequently asked questions. It will likely become a useful education tool for anyone subject to the guidance.

 

A few months ago we wrote about the FTC’s decision to launch a Consumer Privacy Bill of Rights. One of the more interesting things about the Bill of Rights was that the FTC seemed to be setting up a regime where a company’s voluntary decision to "opt-in" to the regime could become the basis for FTC enforcement, if the voluntary policy was breached. In fact, Commissioner J. Thomas Rosch dissented from that portion of the FTC’s privacy report and recommendations.

So it was interesting to me to note that Commissioner Rosch voted with a unanimous majority of FTC Commissioners to authorize a complaint against a large, international hotel group where the violation is based upon the group’s own privacy policy. Specifically, the FTC complaint alleges that the hotel group’s "privacy policy misrepresented the security measures that the company and its subsidiaries took to protect consumers’ personal information." The agency charges that the security practices were unfair and deceptive and violated the FTC Act.

What particularly seems to have upset the FTC in this case is the fact that one breach allegedly facilitated other breaches. The hotel group learned in 2008 of a data breach to its system through one property. The FTC claims the security flaws exploited in that breach were not corrected, allowing two other breaches to occur. In those two subsequent breaches, the FTC says that approximately 120,000 consumer payment card records were stolen. Those records were supposedly used by crime syndicates–including some in Russia–to make fraudulent purchases.

This enforcement action by the FTC again highlights the importance of developing best practices for the protection private consumer data and maintenance of privacy policies. Perhaps more importantly, it also demonstrates that, despite some public misgivings from at least one Commissioner, the FTC seems intent upon using its enforcement powers to require companies to fully comply with their stated privacy policies. This development will bear watching, and, at the same time, it suggests a careful review of privacy policy and practice is in order so as to ensure both are in alignment.

By now, you have almost certainly seen the reports that the White House and the Federal Trade Commission want a Consumer Privacy Bill of Rights with seven principles:

  • Individual Control: Consumers have a right to exercise control over what personal data companies collect from them and how they use it.
  • Transparency: Consumers have a right to easily understandable and accessible information about privacy and security practices.
  • Respect for Context: Consumers have a right to expect that companies will collect, use, and disclose personal data in ways that are consistent with the context in which consumers provide the data.
  • Security: Consumers have a right to secure handling of personal data.
  • Access and Accuracy: Consumers have a right to access and correct personal data in usable formats, in a manner that is appropriate to the sensitivity of the data and the risk of adverse consequence to consumers if the data is inaccurate.
  • Focused Collection: Consumers have a right to reasonable limits on the personal data that companies collect and retain.
  • Accountability: Consumers have a right to have personal data handled by companies with appropriate measures in place to assure they adhere to the Consumer Privacy Bill of Rights.

 Today, the FTC took a significant step toward establishing a framework that would implement that last principle, Accountability. In outlining the new framework, the FTC report (PDF) suggested several significant changes for businesses who interact with consumers online:

 

First, the FTC expects consumers will have an “easy to use and effective ‘Do Not Track’ option by the end of the year.” According to the Washington Post, the FTC, the Commerce Department and the Digital Media Alliance are working together to create a one-click icon that will permit consumers an easy way to “opt-out” of online tracking. The Digital Advertising Alliance represents 90 percent of all web sites with advertising.

 

Second, the FTC urged companies offering mobile services to voluntarily improve privacy protections, including in particular, the retrieval and storage of location information. As the Wall Street Journal (subscription required) noted under the headline "Your Apps are Watching You", over one-half of tested mobile apps sent unique ID or location information without informing the app user first.

 

Third, FTC called on big data brokers to develop a centralized website that would allow people to view all the entities that hold their data and how that data is used. The FTC also called for the passage of legislation that will allow people to view their data and correct inaccuracies, similar to what is currently permitted for credit reports. As previously announced, the FTC will continue to bring enforcement actions against companies that engage in deceptive or unfair practices.

 

Finally, and of particular interest to the franchise community, while the framework applies to all commercial entities that collect or use consumer data that can be linked to a specific consumer, computer, or other device, the FTC report explicitly recognizes “the potential burden on small businesses” and accordingly “concludes that the framework should not apply to companies that collect and do not transfer only non-sensitive data from fewer than 5,000 consumers a year.” The details of this “small business” option will need to be fleshed out and seem narrow upon initial review.  For example, the Commission defines “non-sensitive data” as data that is not a Social Security number or financial, health, children’s, or geolocation information.

 

There was a dissent from the report by Commissioner Thomas Rosch. The dissent seems principally concerned that the framework is too focused on what consumers may believe is unfair, as opposed to what is actually deceptive. It also noted that the recommendations probably aren’t voluntary in practice, because most firms will feel obliged to comply the proposed best practices or face the wrath of the FTC.

 

As expected for several years now, the FTC has staked out a strong position in favor of “opt-in” online privacy controls for consumers combined with substantial transparency regarding how personal information gathered online will be used. The good news is that the framework is voluntary and permits significant industry involvement in crafting best practices. The bad news, as Commissioner Rosch correctly notes, is that the FTC report and rhetoric strongly implies that adoption of the best practices will be nearly mandatory and that it will enforce those practices against those who opt-in.