Application of FTC Pre-Sale Disclosure Rule to Sale of Foreign Franchises
By Harold Brown©
The FTC announced that it is considering whether its Franchise (Pre-Sale Disclosure) Rule should be revised to exclude an American franchisor's obligation to present a prospectus to a prospective franchisee for a site that will be located outside the United States. The Commission has scheduled informal hearings on this and other possible changes in the Rule. This presentation recommends that the Rule remain applicable to such foreign franchise sales.
[a] Statutory Power Related to Foreign Activity
The application of the FTC Disclosure Rule to the sale of foreign franchises, starts with examination of the statute.(1) The language of section 5 of the FTCA applies to acts or practices "in commerce." By contrast, the Robinson-Patman Act expressly limits its prohibition of price discrimination to sales of products in the United States.(2) The FTC statute is thus plainly applicable to all commerce without any Congressional limitation to domestic business. When Congress intends to limit the coverage to domestic activities, it does so in clear language.
For antitrust restrictions, also covered by the FTCA, it has been affirmed that American jurisdiction covers pricing violations that occurred in a foreign jurisdiction such as Japan, because the conspiratorial conduct was intended and did have substantial anticompetitive effects within the United States.(3) In a case of first impression, it was ruled that any other result would encourage price fixers to do their nefarious conspiring in foreign territory in order to influence competition in U.S. markets. The defense of comity was rejected in this age of international commerce where there are immediate competitive reverberations around the globe. The assertion of American power is of historical importance because cartels have long flourished in foreign countries. Those entities often consist of groups of competing enterprises that horizontally control production and prices for products sold in the United States.
The authority of the FTC over foreign conduct has been confirmed in many other references. The decision of the First Circuit on horizontal pricing conspiracies in Japan, also applies to section 5 of the FTCA that primarily addresses the identical antitrust concerns. It is therefore clear that the same considerations affect the remainder of section 5(a) of the FTC Act, the section under whose authority the Franchise Rule was promulgated. As noted below, foreign franchisee performance can vitally affect a domestic franchise system.
[b] Rise of Foreign Activities in Many Franchise Contexts
For franchising, the coverage of foreign activity can be a significant factor due to the surge of domestic franchise systems into countries around the world. There has also been a rise in the acquisition of American franchisor systems by foreign purchasers. Foreign parents of domestic franchise systems have difficulty in shielding themselves from antitrust liability like tying or pricing through the use of layers of corporate entities.(4) The same principles apply to other federal and state laws in general and to franchise protection laws in particular.
Such foreign ownership was involved where an American franchisor had been acquired by a foreign parent. That issue existed after ultimate recovery against the American franchisor for a variety of common law violations, including breach of fiduciary duties and especially a state "little" FTC Act.(5) In that case, the issue was avoided because the American franchisor posted an appeal bond to cover the full judgment. Foreign parental liability could be established by agency, piercing the corporate veil, fraudulent transfer of assets, alter ego,(6) or simply under a little FTCA.(7)
[c] Applicability of FTC Franchise Rule to Foreign Transactions
Some have questioned whether the FTC Franchise (Pre-Sale Disclosure) Rule expressly applies to the sale by a U.S. franchisor of a franchise that will be located in a foreign country. There is no such restriction in the terms of the Rule or in its historical formulation. The question is accentuated by the fact that there has been huge growth of domestic franchise systems into foreign countries and that foreign countries generally provide little or any protection for local franchisees either in pre-sale disclosure or conduct control.
Three categories of sale may be involved, namely, (1) sale in the U.S. of a franchise to be located abroad; (2) sale of franchise executed in a foreign country for operation abroad; and (3) sale of a franchise in a foreign country that may be or eventually is located in the U.S. It is also possible to make a distinction based on whether or not the buyer is an American citizen or resident.
There is little doubt that U.S. law can constitutionally apply to all of those cases because of the weighty amount of U.S. contacts that each of the foreign franchisees will have with their United States franchisor from their first pre-sale contact and throughout the life-time of the franchise.(8) Those relationships far exceed the constitutional requirement of "minimum contacts" and traditional motions of fair play and substantial justice.(9) More significantly, they demonstrate that the heart of the franchisor-franchisee relationship involves joint activities of the franchisor and all of its franchisees in the U.S. and everywhere else. Every aspect of the franchise is created, marketed, monitored, instructed, modified, and operated by the franchisor within the U.S. or by its agents acting abroad with constant interaction between all of its foreign and domestic franchises. All of the franchisees, both domestic and foreign, operate as a single family with intra-performing synergistic accomplishments.(10)
In many franchise systems, the surge of international franchising has challenged or exceeded U.S. operations. The operations of foreign franchisees will directly impact domestic dealers, both in marketing and in physical participation. For example, a major domestic franchisor appropriately complained that the poor operations of its multi-unit foreign franchisee seriously damaged its U.S. goodwill.(11)
Prospective foreign franchise locations are equally in need of pre-sale disclosure. They are entitled to all of the reasonably available data needed for them to make a rational purchase decision that may endure for a life-time. The success of the foreign locations can constitute an important factor not only in the welfare of the domestic franchisor, but also in behalf of its family of United States franchisees. Some major franchisors have publicly disclosed that their earnings from foreign franchisees equal or exceed their domestic profits. As with the Franchise Rule's possible state law conflict, the regulations can be made effective unless there are equal or superior foreign local requirements.
[d] IFA Objections to Foreign Application of the FTC Disclosure Rule
The International Franchise Association (IFA) has filed with the FTC its objections to the foreign application of the Franchise Rule requiring disclosure to franchise purchasers where the business will be located abroad. While the IFA purports to speak both for franchisors and the tens of thousands of franchisees now included in its membership, its objections continue to reflect severe bias in favor of its franchisor constituency. Its stand is consistent, however, with its universal complaint that franchisors should not be subject to any presale disclosure or applicable conduct control; that the marketplace will provide adequate protection through competitive forces; and that franchisees will better prosper for their deprivation of all franchisor regulation. It is, of course, well established that after the franchisee purchases a franchise, he is virtually helpless to resist any franchisor demand.(12)
 Foreign Purchasers Lack of Need for Franchisor Pre-Sale Disclosure
In overly simplistic terms, the IFA has asserted that domestic franchisors do not have adequate knowledge of the multi-faceted foreign markets. They say that such foreign expansion is usually done by the use of master franchises in which the foreign sub- franchisor sells to sub-franchisees. Such substantial entities allegedly have far greater knowledge of local conditions and they do not need the data provided by the American franchisor.
All of those premises are at fault. Even if the subfranchisors are substantial, some purchases of single franchises will be made directly from the American franchisor. Further, such subfranchisors are seldom knowledgeable about the particular franchise system nor even about franchising in general. Their subfranchisees will be even more needful of disclosures by the franchisor that created, marketed, and administered the franchise system for an extended time period. That principle has already been acknowledged by the FTC in its requirement that the franchisor must make full disclosure to subfranchisors and that both entities are directly liable to the sub-franchisees no matter whether the documentation runs directly to the franchisor or to the subfranchisor.
It is improper to claim that neither foreign subfranchisors nor their subfranchisees are entitled to the pre-sale disclosures mandated by the Franchise Rule either in its present form or however it may be modified to comport with the current Revised UFOC that has been basically approved by the FTC as an alternative. Such distant purchasers are probably in the greatest need of the data in the Rules various categories. They need to know the franchisor, its executives, and their criminal and civil histories. They require reasonable descriptions of the franchise business, the approximate costs, and the money payments that are required in royalties, advertising contributions and otherwise. They need the franchisor's documented earnings and capital assets. And they also want identification of existing and prior franchisees, both domestic and foreign, in order to research the franchisor's track record. There may be variations that are necessitated by the differences in the foreign and domestic circumstance.
The above review establishes that most of the Rule's disclosure consists of identical data for domestic as well as foreign sales. As for strictly local conditions, it is quite reasonable to require the franchisor-adventurer to make the pre-sale investigations abroad that are required of every seller, probably founded on its own local experimentation and probably in association with its prospective subfranchisors. But only the franchisor can provide the fundamental data, including its own history of success or failure in foreign sales. In a recent matter, all four foreign subfranchisors had completely failed, but that was not disclosed to a new prospective subfranchisor for a nearby country.(13)
 Alleged Conflict with Foreign Laws
The IFA complains that the Franchise Rule may conflict with foreign laws. That pretext can be quickly overcome by the fact that a franchisor would presumptively have to make a thorough search of the laws in a projected territory. It is absurd to suggest that any foreign nation would object to required pre-sale disclosures to its local constituencies. It might possibly have higher requirements.
The FTC has not sought to employ preemptive jurisdiction over the laws of states or of foreign countries. In fact, where it could have elected such control over state regulation, it wisely decided to permit conformity with local laws as a substitute for compliance with the Rule, provided that local protection for franchisees was equal or superior to that of the Rule. Such a precedent would be equally appropriate where a foreign entity so provides. The IFA objection completely omits any consideration for the need to provide minimal disclosure to persons who need such data in order to make a meaningful lifetime investment.
 Inapplicability of American Data for Use in a Foreign Country
The IFA has strongly objected to the inapplicability of its UFOC data for use in a foreign country. It objects to the high cost of obtaining the basic data in numerous parts of the world. The objection has already been partly addressed in the prior discussion. There is, however, a major misleading factor in this contention.
The American franchisor is the sole entity that knows what information has to be developed. That applies not only to local marketing, pricing, and advertising, but more especially to the comparative factors that relate to each aspect of the franchisor's capital, operational, and procedural facets of the allegedly unique franchise system that it has developed. Local legal research may be needed, but it cannot be done by anyone without total involvement of the domestic franchisor.
 Limitations on Governmental Enforcement
The IFA argues that the personnel and financial enforcement assets of the FTC are already strained in its domestic support of the existing Rule. It claims that application to foreign franchising would therefore be a nullity due to lack of enforcement.
This contention flies in the face of reality. The FTC was not enacted to litigate claims between private persons. Instead, it was designed as a vehicle to fashion needed regulation of future market activities. A wealth of sanction mechanisms has been designed and have been widely enforced by the Commission. Admittedly, the FTC does not have adequate staff or means to protect all of those in need.
Recognizing that dilemma, the FTC expressly called upon the courts to enable private enforcement of the Franchise Rule. That policy was given some initial support, but it has now succumbed to a substantial array of judicial rejection, at least by lower courts. Fortunately, however, every state has now enacted some form of "little" FTCA, many of which have enabled private enforcement together with devices to implement enforcement by exemplary damage awards and allowances for attorney fees.
It is unwise for the violator to object to foreign application of the Rule because the FTC does not have the means of enforcement. Such an argument would eliminate the entire Rule. The answer is that the FTC can act, both through education, consent decrees, and even civil fines. Presumably, law abiding franchisors will comply. For others, the opportunity for private enforcement remains available, facilitated by the frequent franchise covenant selecting local American venue and the application of the law in the franchisor's home jurisdiction.
Instead of concern about enforcement debilities, the FTC should focus on the needs of prospective franchisees, their entitlement to the pre-sale disclosure regulations, and the minimal cost of its achievement by international franchisors with considerable assets and the prospect of their increase in sales abroad. Foreign purchasers are entitled to assume that an American franchisor has a trademark properly registered in the United States, that the company has complied with American regulations, and that it will be answerable in an appropriate American forum. The latter would be reinforced where there was contractual choice of American venue.(14)
 All Regulation Should be Eliminated in Favor of Franchise Agreements Achieved by the Direct Parties
The utterly futile claim for freedom of contract has been the universal battle cry of all franchisors. Their championship of "laissez faire" has almost achieved biblical status.
At best, the franchise agreement is completely one-sided. It is pre-drawn by highly experienced franchisors and their sophisticated counsel without any meaningful participation by the franchisee either in the drafting or negotiation of harsh terms. Under the aegis of contractual priority, almost every significant aspect of good faith and fair dealing has been restricted or disappeared in some jurisdictions. Some states, like Texas and New York, recognize that the good faith obligation has its origin in the severe imbalance of the relationship and that performance under the covenants is subordinated to "good faith."(15) State conduct legislation has rapidly stepped in to fill the need for statutory protection, but IFA opposition never ceases. Perhaps the worst illustration has been publicly disclosed in Amway's successful lobbying of the FTC's Congressional reauthorization with a hobbling amendment that severely restricts the FTC's regulation-making authority.
The Franchise Rule is here to stay because the FTC has repeatedly confirmed its necessity both in principle and in a long string of administrative and judicial proceedings.(16) The current posture of the FTC does not import efforts to destroy the Rule, but how best to improve its effectiveness at worthwhile cost.
The same IFA arguments have been used to combat federal as well as state regulation in this field. In every State that has managed to enact disclosure or other controls, franchisors have fought its adoption at every opportunity, including both in the pre-adoption period and after enactment. This has taken the form of litigation and, more notoriously, efforts to repeal regulation or to gut it by amendments to such an extent that it remains of questionable value.
[e] Overall Comment
There are strong domestic reasons why the Franchise Rule should continue to apply to all direct or indirect franchise sales abroad by American franchisors. There are valid systemic reasons why foreign franchisees should have the same disclosure protection as their American counterparts in the same franchise. The entire array of franchisor obligations is centered in its domestic home office and should be equally involved and available to all franchisees, wherever located. Illustratively, it would be strange to find a different Manual of Operations for each country.
As declared by the First Circuit, in this age of international commerce, there are immediate competitive reverberations around the globe.(17) That trend is evidenced in the European Union (EU) as well as the North American Free Trade Association (NAFTA) and will undoubtedly continue to expand. The largest American auto factory has initiated a multi-billion dollar program to establish four mammoth-sized factories around the globe, capping a swarm of comparable activities in every field of corporate endeavor.
It would be counterproductive for the FTC to recoil from the forum by retracting its regulation of how domestic franchisors should act in selling their franchises for foreign operation. Such retraction and compartmentalization is unjustified. For decades, franchisors have claimed that contracts should govern all obligations. They say that conduct control is not essential because pre-sale disclosure will provide the basic information. There is strong belief that disclosure is not enough and that conduct control is essential but, in any case, disclosure should be retained for its "sunshine" catharsis. Notably, future foreign purchasers are helpless to know about this arena and to promote and lobby for such minimal protection that will cost franchisors very little.
1. © Harold Brown, 1997. Senior Partner in Law Offices of Harold Brown & Associates, Boston, MA. Author of numerous books and articles, including H. Brown, "Franchising Realities and Remedies," (Law Journ. Seminars-Press Rev. Ed. 1997).
1 15 U.S.C. 41-58, particularly sec. 45(a)(1) prohibiting "unfair methods of competition" (oriented to antitrust violations) and "unfair and deceptive acts or practices in commerce".
2. See 15 U.S.C. §13; Texaco, Inc. v. Hasbrouk, 496 U.S. 543, 110 S.Ct. 2535, 110 L.Ed.2d 192 (1990).
3. See, e.g. U.S. v. Nippon Paper Industries Co. Ltd., ___ F.3d ___ (1st Cir. 1997); Dee-K Enterprises, Inc. v. Heveafil, SDN. BHD. (BNA) 73 ATRR 449 (E.D. Va. Dkt. No. 97-556-A, decided Oct. 23, 1997).
4. See, e.g., Caribe BMW, Inc. v. Bayerische Motoren Werke Aktiengesellschaft, et al., 821 F.Supp. 802 (D. P.R. 1993) vacated and remanded 19 F.3d 745 (1st Cir. 1994)
5. See, e.g., Broussard v. Meineke Discount Muffler Shops, Inc., ___ F.Supp. ___, 1997 WL 112235 (W.D.N. Mar. 6, 1997) (on appeal) (recovery of over $650 million against American franchisor owned by foreign corporation. The finding was reduced to $406 million because of releases and other considerations. A surety bond has been filed for the appeal to the Fourth Circuit).
6. Temmallo et al. v. Academy of Learning et al., No. 95-10596-EFH, decided June 2, 1995 (D. Mass. 1995).
7. See, e.g. Nader v. Citron, 372 Mass. 96, 99-100, 360 N.E.2d 870, 873 (1977) (recovery as unfair practice under little FTCA); In re Larkin, Hoffman, Daly and Lindgren, Ltd. ___ FTC __, CCH Trade Reg. Rep. ¶23,293 (1992); FTC v. Security Rare Coin & Bullion Corp., 1992-2 CCH Trade Case ¶69,423 (D. Minn. 1992).
8. See, e.g. Burger King Corp. v. Rudzewicz, 471 U.S. 462, 85 L.Ed.2d 528, 105 S.Ct. 2174, 2187 (1985), citing, generally, H. Brown, "Franchising: Realities & Remedies" (Law Journal Seminars-Press, rev. ed. 1997).
9. Id.; see Fish v. Tandy Corp., (CCH) Bus. Franch. Guide ¶11,187 (Tex. Ct. App. July, 1997) (long-arm Texas jurisdiction appropriate for purposeful minimum contacts by a developer of distributorships in Russia, where it dealt with the Texas-based manufacturer of consumer electronics through personal visits to Texas in negotiating the letter agreement; in communications with Texas through telephone, mail and facsimile; and for the conflicting claims for declaratory judgment, fraud and breach of contract related to or arising from the individual's contacts with Texas).
10. See, e.g., Dayan v. McDonalds Corp., 466 N.E.2d 958 (Ill. App. Ct. 1984); 45 N.E.2d 1188 (Ill. App. Ct. 1985) (breach of domestic franchisor's contract by its French multiple franchisee,
establishing serious impact on McDonald's goodwill caused by foreign franchise operators' conduct abroad).
11. Id.; see also, e.g. U.S. v. Nippon Paper Industries Co., Ltd., ___ F.3d ___ (1st Cir. 1997).
12. See, e.g., Wright-Moore Corp. v. RICOH Corp., 908 F.2d 128, (CCH) Bus. Franch. Guide ¶9665 (7th Cir. 1990), after remand, 794 F.Supp. 844 (N.D. Ind. 1991), aff'd, 980 F.2d 432 (7th Cir. 1992).
13. The last subfranchisor was legally represented by the author.
14. See, e.g. Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth Inc., 473 U.S. 614, 626, 87 L.Ed.2d 444, 105 S.Ct. 3346, 3353 (1985) (Puerto Rico auto dealer required to comply with contractual choice of venue in Japan, including application of American antitrust laws).
15. See, e.g. Carvel Corp. v. Diversified Management Group, Inc., 930 F.2d 228 (2nd Cir. 1991) (CCH) Bus. Franch. Guide ¶9794.
16. Bailey Employment Systems, Inc. v. Hahn, 655 F.2d 473 (2nd Cir. 1981), on remand, 545 F.Supp. 62 (D. Conn. 1982), aff'd per curiam in an unpublished opinion (2d Cir. 1982).
17. See Nippon Paper Industries, n. 3, supra.