The Federal Trade Commission (FTC) on July 12, 2024 released a policy statement warning that the use of contract provisions that prohibit franchisees from communicating with the government about legal violations are unlawful. The FTC also published staff guidance on prohibitions against the imposition of undisclosed fees by franchisors. These actions signal the FTC’s increased focus on the regulation of franchisor-franchisee relationships and portend the possibility of further enforcement activity in the franchise space.
Franchising generally refers to a method of distributing products and services in which the franchisor grants a license to a franchisee to use the franchisor’s intellectual property and business model in exchange for payment—typically in the form of an upfront payment and royalties. The commercial relationship between the franchisor and the franchisee is typically governed by a franchise agreement. The use of the franchise model is ubiquitous in the United States across a wide range of industries, including restaurants, gas stations, and retail.
In March 2023, amidst what it described as “growing concern around unfair and deceptive practices in the franchise industry,” the FTC issued a request for public comment on franchise agreements and franchisor business practices, particularly with respect to the disclosure of terms to prospective franchisees. The FTC received more than 2,000 comments in response, which it summarized in an Issue Spotlight publication. The Issue Spotlight highlighted the following 12 “issues of concern” identified by franchisees:
- Unilateral changes to franchise operating manuals
- Franchisor misrepresentations and deception
- Unilateral changes to fees and royalties
- Franchise supply restrictions and vendor kickbacks
- Actual and feared retaliation
- Noncompetes and no-poach clauses
- Franchise renewal problems
- Franchisor refusal to negotiate contract terms
- Franchise disclosure document issues
- Private equity takeovers
- Marketing fund transparency
- Liquidated damages clauses
- Early termination fees
FTC’S ISSUANCE OF THE POLICY STATEMENT AND STAFF GUIDANCE
Policy Statement on Franchisors’ Use of Contract Provisions
Following its receipt of public commentary, on July 12, by a 3-2 vote among the FTC commissioners, the FTC issued the document titled Policy Statement of the Federal Trade Commission on Franchisors’ Use of Contract Provisions, Including Non-Disparagement, Goodwill, and Confidentiality Clauses (Policy Statement). The Policy Statement begins by explaining that the FTC is generally concerned about instances in which franchisors may be actively discouraging franchisees from reporting potential legal violations to the FTC and other regulators, including through the use of express contractual provisions in franchise agreements or through more subtle forms of coercion (including threats of retaliation). The Policy Statement cites public commentary reflecting the presence of non-disparagement, goodwill,[1] and confidentiality clauses in franchise agreements and notes that franchisees may construe those provisions to prohibit them from reporting illegal conduct by franchisors to law enforcement.
The Policy Statement does not state outright that the inclusion of such provisions is unlawful. However, it does suggest that the FTC may seek to challenge such provisions under either Section 5 of the FTC Act or as a violation of the FTC’s Franchise Rule. FTC Act Section 5 prohibits “unfair or deceptive acts or practices in or affecting commerce,” and the Franchise Rule, enacted in 1979 and most recently revised in 2007, sets forth specific requirements for the disclosures that franchisors must make to franchisees prior to entering a franchise agreement.
The Policy Statement specifically states that “[c]lauses that prohibit a franchisee from reporting potential law violations to the government” and “implicit or explicit threats of retaliation . . . against a franchisee for reporting potential law violations to the government are unfair.” It also notes that the suppression of such information by franchisors “undermines the government’s ability to learn about practices that violate the Franchise Rule, the FTC Act, and other laws.” The Policy Statement concludes by noting the FTC’s view that it is immaterial whether provisions of this sort are included in a signed franchise agreement, but rather the Policy Statement’s guidance applies to all communications between franchisors and franchisees that are intended to inhibit the ability of franchisees to report legal violations to law enforcement.
The FTC’s issuance of the Policy Statement was not without internal disagreement. Two of the five FTC commissioners, Andrew N. Ferguson and Melissa Holyoak, issued dissenting opinions. Commissioner Ferguson expressed his view that although Policy Statements are intended to provide nonbinding guidance, this Policy Statement goes too far by implying that the FTC may bring an enforcement action in response to the inclusion of non-disparagement, goodwill, or confidentiality clauses in franchise agreements, thus threatening to make “this nonbinding policy statement into a type of informal law.” Commissioner Holyoak’s dissent similarly concludes that the Policy Statement improperly “attempts to effect a change in the law” and also observes that the Policy Statement is likely to sow confusion because it does not offer guidance on what actions franchisors should take to ensure compliance.
Staff Guidance on the Unlawfulness of Undisclosed Fees Imposed on Franchisees
On the same day that the FTC released the Policy Statement, it also released separate guidance titled Staff Guidance on the Unlawfulness of Undisclosed Fees Imposed on Franchisees (Staff Guidance).[2] The Staff Guidance notes that the imposition of undisclosed fees by franchisors on franchisees may violate FTC Act Section 5 and the Franchise Rule. It also expresses specific concern about what FTC staff perceives as a recent trend toward the imposition of new fees on franchisees—not through modification of the franchise agreement, but instead through modification of the franchisor’s operating manual, or through other means.
WHAT COMES NEXT: POTENTIAL EXPANSION OF ENFORCEMENT ACTIVITY
The FTC’s focus on franchise-related issues is a signal that the FTC may be considering increased enforcement activity in the franchise space. To that end, the FTC posted its Policy Statement and the Staff Guidance on the FTC’s newly launched “Franchise Guidance” website, a point that the FTC touted in its press release announcing the Policy Statement and Staff Guidance.
In light of these developments, franchisors would be well advised to review their franchise agreements and other franchisee-facing materials to ensure they do not contain terms that could explicitly or implicitly discourage franchisees from reporting unlawful conduct to law enforcement. Franchisors should also consider training franchisee-facing staff on legal risks stemming from conduct that could be interpreted as seeking to chill the reporting of unlawful activity.
In the area of franchisee fee payments to franchisors, in the interest of mitigating the risk of FTC or franchisee challenges to fees and costs, franchisors would be well served to review the variety of fees that they charge to franchisees and the documentation and/or agreements that are relied upon as the basis for such fees.
[1] In the franchise context, goodwill provisions refer to contractual terms that prohibit franchisees from taking any action detrimental to the public reputation of the franchisor.
[2] Unlike Policy Statements, the FTC may issue staff guidance without a vote of the Commissioners. Staff guidance documents represent the views of FTC staff but are not binding on the FTC.
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