All the Franchisor’s Charges – All of Your Disappearing Money — by Cary Ichter

Franchisors often make quite a bit of their money from taking kickbacks from suppliers, real estate brokers, general contractors, or anyone else they say franchisee must use—despite what the franchise agreement says.  The franchisor may call these payments referral fees, commissions, rebates, or some similar nonsense.  They are kickbacks, plain and simple.

The disclosure rule promulgated under the terms of the FTC Act provide that a franchisor is required to identify all areas of known expense the franchisee will incur as a consequence of operating their business.  The rules further require the franchisor to disclose all “franchisee[] obligations to purchase or lease good, services, supplies, fixtures, equipment, inventory, computer hardware and software, real estate. Or comparable items related to establishing or operating the franchised business either from the franchisor, its designee, or suppliers approved by the franchisor….” 16 CFR 436.5(h).

Additionally, the franchisor is also required to disclose to the franchise “[w]hether the franchisor or its affiliates will or may derive revenue or material consideration from required purchases or leases by franchisees.” If they will, the franchisor is required to describe the precise basis by which it or its affiliates may derive that revenue, stating the amount of revenue to be made from all required purchases, the percentage of franchisor or affiliate’s revenues derived from such sources.  16 CFR 436.5(h)(6).

The problem with this rule is that it is roundly ignored by franchisors. Franchisors will often push franchisees in the direction of certain vendors who will pay the franchisor for the referral.  If the franchisee is not inclined to use the services of the vendor, the franchisor will apply pressure—lean on you a bit.  If the franchisee resists, the franchisor will often tell you that you are required to use the vendor.  Of course, they will not refer you to the provision of the agreement containing that requirement, and you—shame, shame—will not ask for a reference or look at the agreement.  You trust that they know the agreement better than you and that they know how the business should be run.  You don’t know that they have no idea how the business should be run until it is too late and they have stripped you bear with royalties, fees, and kickbacks.

As many of you already know, there is no private right of action for franchisees under the FTC Rule or the regulations promulgated thereunder.  In other words, if the franchisor violates—blatantly or otherwise—the disclosure rules of the Act, you cannot sue them for that violation.  This is the typical type of efficiency we have come to expect from government—a big bite with no teeth.  The FTC will not even gnaw on the worst of franchisors.

So, what can you do?  Well, if you are in Georgia, you are in luck because under Georgia law—courtesy of a case handled by yours truly—you can enforce the FTC disclosure rules using Georgia tort law. Under OCGA § 51–1–6, “[w]hen the law requires a person to perform an act for the benefit of another or to refrain from doing an act which may injure another, although no cause of action is given in express terms, the injured party may recover for the breach of such legal duty if he suffers damage thereby.”

In Mamilove, LLC v. Legacy Academy, the Georgia Court of Appeals held that a franchisee can pursue a claim under OCGA § 51–1–6 to assert damage claims for violations of the FTC Rules. While the Georgia Supreme Court reversed certain parts of the Court of Appeals decision, it left that portion of the ruling intact.

What does this mean for you?  It means that if your franchisor is requiring you to use the services of, or if they are getting kickbacks from, vendors or service providers that have not been disclosed to you in the Franchise Disclosure Document (“FDD”) or in your Franchise Agreement, there is a good chance you have a claim against them.  If you want specific advice regarding your situation, call Cary Ichter or Dan Davis at Ichter Davis, LLC (404) 869-7600 or write at cichter@ichterdavis.com or ddavis@ichterdavis.com.