Franchise Fraud FAQ

What is a franchise?

Many franchises are the businesses you know and love: Subway, 7-11, Little Caesars, Kumon, Meinke, Dunkin’ Donuts and more.

There are also many smaller franchises. These days, many small business owners choose to become franchises when they want to expand without using their own capital.

Franchised businesses have corporate franchiSORS and individual franchiSEES. The franchiSORS and the franchiSEES have a contract that allows franchiSEES to use franchiSORS’ brand names and business models. In exchange, franchiSEES invest their own money in the franchiSORS’ businesses.

What is a franchiSOR?

A franchiSOR is the corporate owner of the franchised brand names, products and services Americans use every day.

What is a franchiSEE?

A franchiSEE is an individual: a United States citizen, a veteran, or a legal hard-working immigrant who wants to use corporate franchiSOR brand recognition and support to own and run a business.

Why is there a conflict between franchiSORS and franchiSEES?

The franchiSORS are unjustly using the franchiSEES’ money to illegitimately expand the franchiSORS’ businesses.

Many franchiSEES report being deceived about the franchised businesses before they signed their contracts. Many find that despite their hefty upfront investments in the franchiSORS’ businesses, they can’t make ends meat in their own franchised outlet. In many many cases, the franchiSORS take the franchiSEES’ investment and the franchiSEES go bankrupt and lose their homes.

Who is involved in the conflict?

The franchiSORS are lobbying congress through the International Franchise Association (IFA). The franchiSORS don’t want any change to the status quo.

The franchiSEES are unhappy. They’re angry that the franchiSORS have been the only voices influencing congress for the last many years. Their owners’ associations have joined together in a larger franchiSEE coalition. They’re working to make change.

How are franchiSORS taking franchiSEES’ life savings and homes?

FranchiSEES are required to sign contracts that revoke many of the franchiSEES’ basic rights, giving franchiSORS a major advantage in court. The franchiSEES are also required to sign personal guarantees. A personal guarantee gives the franchiSORS the right to take whatever a franchiSEE owns to satisfy the terms of the contract if something goes wrong.

And a lot of things seem to go wrong….

Many franchiSORS unscrupulously and very aggressively use the court system. The contracts are written by the franchiSORS in the franchiSORS’ favor and the franchiSORS have more to spend on attorney fees. The franchiSORS go into every conflict pretty dang sure they’ll win if they’re aggressive enough.

At the same time, many of the things that go wrong with the franchised businesses are the franchiSORS’ fault, but the litigious franchiSORS use their attorneys to blame the problems on the franchiSEES so they can take their money.

How does franchise fraud affect the taxpayer?

Small Business Administration (SBA) loans are backed by taxpayers. When bad SBA franchise loans are made, the taxpayers share the burden of the loan default.

As part of their fraud, franchiSORS use aggressive civil process to enforce unjust franchise contracts and take the homes and life savings of their victims. This malicious use of process clogs up our civil courtrooms. That costs taxpayers money because taxpayer dollars fund our judicial system.

When franchiSEES lose everything, including their homes, government programs funded by the taxpayer must jump in to support the families in their new indigence. Their life savings go to the franchiSORS and the franchiSORS’ suppliers. The franchiSEES declare bankruptcy and the taxpayer then supports the franchiSEES until the franchiSEES find a way to return to self-sufficiency.

How does franchise fraud affect the economy?

Franchise fraud allows franchiSORS to expand their businesses using investment money from franchiSEES. According to numbers provided by Franchise Grade, approximately 78% of the money invested by franchiSEES between 2010 and 2018, or $357.1 billion, was put into franchised outlets that are no longer operating.

FranchiSORS have a sweet deal. They get to expand their own businesses at no risk to themselves. They take the benefits and the franchiSEES take the losses.

This arrangement incentivizes franchiSORS to expand illegitimately, meaning that demand for their products and services may be low while the supply is high. But since franchiSORS make money when a franchiSEE invests and opens a new location, the franchiSORS keep right on selling new franchises and opening new outlets.

This illegitimate expansion creates a false impression of economic strength.

Many of the franchised outlet locations that do not close transfer ownership from one franchiSEE to another. Over a period of ten years, for example, three franchiSEE families may own the outlet. This gives the public the impression that the outlet has been successful when in reality it has actually cost multiple franchiSEE owner families their homes, life savings and livelihoods.

This means that the price of the goods and services Americans enjoy when they frequent franchise outlets are often subsidized by franchiSEE families who are on the path to bankruptcy.

How does franchise fraud affect local small businesses?

Illegitimate franchiSOR expansion is paid for by franchiSEES rather than from selling goods and services. This floods the market with services for which there is little demand, driving prices down and making it more difficult for non-franchised small businessesthat are not subsidized by franchiSEES to compete.

How do franchiSORS accomplish this fraud?

FranchiSORS require franchiSEES to sign dangerous contracts and pay hefty upfront franchisee fees. When a fanchiSEE’S outlet location fails, franchiSORS keep the large franchise fees and many use the contracts and the court system to take the franchiSEES life savings and homes.

Why do franchiSEES ever fall for this?

FranchiSORS target people in transition, retirees, veterans and hard-working, legal immigrants for franchise sales. These people tend to be in more vulnarable positions than others. FranchiSORS use very extensive advertising campaigns and bank on franchisees believing in the legitimacy of the United States and the legitimacy of the franchiSORS’ brand names.

Most franchiSEES thought there were better protections in place before they signed their contracts. The Federal Trade Commission Franchise Rule has supposedly been regulating the industry for decades. The FTC requires franchisors to prepare extensive disclosure documents (or FDDS). The length and complexity of the FDD makes it appear to prospective franchiSEES that the FTC is involved when it really isn’t.

FranchiSEES believe in United States regulations. The problem is that the United States is allowing franchiSORS to self-regulate and franchiSORS are using dangerous contracts and the civil justice system.

The FTC doesn’t require the franchiSORS to file the FDDS and does nothing to validate the information disclosed within them.

Ultimately, the long FDD makes it very much appear to potential franchiSEES that the FTC is involved. But franchiSORS can easily intentionally make omissions or state inaccuracies without anyone knowing. Plus, franchiSORS aren’t even required to disclose outlet earnings or the number of outlets that closed or were transferred in the first years of operation. This is the information that is most important to the investors.

After the dangerous contract is signed, the franchiSEES realize the franchiSORS have little incentive to honestly follow regulations that aren’t enforced. when franchiSORS can use aggressive civil process and the dangerous contracts to win just about every case.

This sounds very dangerous for franchiSEES, taxpayers and the economy. Why aren’t there already better protections in place?

1) FranchiSORS lobby against reform in congress.

2) FranchiSORS say the market should self-regulate (despite the fact that they’re illegitimately expanding using franchiSEE money when supply and demand and revenue from goods and services provided do not support expansion).

3) FranchiSORS have power over franchiSEES because the contracts are written in favor of the franchiSORS. FranchiSORS keep franchiSEES silent through threatening them with expensive litigation.

4) Only recently have franchiSEES begun to create associations of owners’ associations to help them protect their rights.

On July 25th, 2019, Mr. Keith Miller, a Subway franchiSEE, testified before congress. This was the first time a franchiSEE had testified to congress — ever. Prior to Mr. Miller’s appearance, congress had only ever heard from franchiSORS through the International Franchise Association or IFA.

What about the good franchiSORS?

All franchiSORS use franchSEES’ money to expand their businesses. To my knowledge, all franchiSORS use contracts that are dangerous to franchiSEES and give the franchiSORS extreme advantage in court.

I would define a good franchiSOR as a franchiSOR that does not require franchiSEES to sign personal guarantees or initial ALL CAPS statements that revoke the franchiSEES rights. A “good” franchiSOR should be able to count on branding, marketing, service and supply and demand to make money and would have no need for contracts that give them the right to take franchiSEES’ homes and life savings.

As far as I know, there are no franchiSORS that do not use the unjust contracts standard to the franchise industry. Therefore, my opinion is that there are no good franchiSORS. If I am wrong, will the good franchiSORS please stand up and introduce yourselves?

Why shouldn’t we just hold franchiSEES accountable for their own bad investments?

It appears to franchiSEES as if the FTC is regulating the industry when in actuality, the regulations that have been put in place are not functioning and are not being enforced. FranchiSEES have trusted in the United States but the United States has been supporting the franchiSORS over the franchiSEES. The United States is responsible to resolve this trade problem.

What role are attorneys playing?

Attorneys are helping the franchiSORS enforce the unjust contracts in the civil courtroom. Many of the attorneys understand how the fraud is being perpetuated, but since “everybody else is doing it,” they join in. They argue like attorneys. It is not their fault, as individuals, that the laws and the system support franchiSORS in taking franchiSEE investment. They are just representing their franchiSOR clients and “doing their jobs.”

Why haven’t I ever heard anything about this before?

In general, franchiSEES are afraid to say anything because they know they might face extreme legal consequences for speaking. They are very disempowered due to the dangerous contracts they signed. In many cases, franciSORS threaten them with litigation that will bankrupt them and take their homes. Sometimes franchiSORS use litigation against franchiSEES to set an example of the harm that will come to other franchiSEES if they speak about what is going on.

What can we do to solve this problem?

The Fair Franchise Act of 2017 was introduced to congress, but it never got past the House. The franchiSORS lobbied against the bill. An act like the Fair Franchise Act would help.

FranchiSEES could engage in some class action lawsuits against franchiSORS and the other companies that assist them in perpetuating this fraud.

Personal guarantees and some of the particularly unjust clauses could be barred from inclusion in franchise agreements. This would incentivize franchiSORS to sell franchises only when they sincerely believe supply and demand in a particular territory would support the franchise location. At present, the unjust contracts and high franchise fees incentivize franciSORS to sell new franchise locations regardless of supply and demand because the contracts allow the franchiSORS access to the franchiSEES’ money.

The Federal Trade Commission requires franchiSORS to write long disclosure documents called Franchise Disclosure Documents or FDDs, but does not require the disclosures to be verified or filed. The FTC could require public federal filing and could require franchiSORS to have third-party private companies verify the disclosure information. The third-party companies could share liability for any inaccuracies. This would help prevent franchiSORS from omitting material information or lying about material facts.

What’s the new bill that’s been introduced to the Senate?

The SBA Franchise Loan Transparency Act of 2019 was introduced by Senator Cortez Masto of Nevada on July 31st, 2019.

The bill requires franchiSORS that want their businesses to qualify for SBA loans to provide franchiSEES the average and median first-year revenues before the franchiSEES sign the dangerous contracts. (This is a no-brainer, but the franchiSORS are lobbying against it.)

It also requires franchiSORS to disclose how many of the franchiSORS’ new franchised outlets were closed or transferred to new owners in the first year of operation. That way franchiSEES will know how many of the franchiSORS other outlets didn’t make the cut before they risk everything they own.

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