|Secretary, Federal Trade Commission
600 Pennsylvania Ave. N.W.
Washington, D.C. 20580
Re: Proposed Changes to the FTC Franchise Rule
The following are comments to the Notice of Proposed Rulemaking issued in October 1999 with respect to the FTC Franchise Rule (hereinafter referred to as the "Proposed Rules"). In that the Commission will undoubtedly receive many comments on a broad array of issues implicated by the Proposed Rules, I have limited the following thoughts to a few select areas that I think would have significant practical implications for the day-to-day operations of a franchisor.
Comment 1: Item 3 Disclosure of Franchisor Initiated Litigation. The Proposed Rules would require disclosure of material pending franchisor initiated lawsuits against franchisees involving the franchise relationship. Such disclosure would presumably include lawsuits filed to collect advertising or royalty fees or to enforce system standards. The proposed disclosure is based on the Commission's feeling that prospective franchisees need broader litigation disclosure to alert them to potential problems in the franchise relationship.
As a threshold matter, there is some question about the importance of the information conveyed to a prospective franchisee by such disclosure. In large part, the disclosure simply states the obvious - that the franchisor is willing to enforce its rights under the franchise agreement. To the extent that the failure to pay royalties or comply with standards is based on a systemic problem with the franchise system, it seems highly probable that such a problem would be disclosed by the significant counterclaims (or claims) filed by the franchisees against the franchisor, which are in turn currently required disclosures in Item 3.
The more vexing problem for a franchisor is the issue of post-effective amendments required by the new disclosure. Although the Commission indicates an ability to disclose via an addendum (or letter) or through the quarterly update process, as a practical matter it's the state disclosure rules the present the more significant problem. Surely a state regulatory body will consider an FTC mandated disclosure as "material," thereby requiring a post-effective amendment to the circular potentially each time the franchisor files a breach of contract action against a franchisee. In a system of significant size, this could create an ongoing re-registration cycle. In states such as California or Washington, in which the regulators must declare the circular effective, franchisors could find themselves perpetually out of registration, and, therefore, sales. Given that the states would probably be resistant to the idea of a letter disclosure as opposed to compliance with the amendment process, this change could create a significant hardship for franchisors of any size while providing arguably little in the way of useful information to the prospective franchisee.
Perhaps an alternative would be a new Item 3 or Item 20 disclosure, updated annually, on the number of actions brought by the franchisor against franchisees in the prior year. This would give the prospective franchisee the same basic information - how frequently the franchisor is filing suits against its franchisees - without the amendment issues implicated by the Proposed Rule. Obviously, any material counterclaims would still be disclosed in Item 3 through the amendment requirements that currently exist.
Comment 2: Amendment Timing. A related issue is the timing of a required amendment. Although the current Rule refers to quarterly updates, in practice, franchisors amend only when there is a material event or change that requires the amendment. The Proposed Rules would require a disclosure of material changes to a prospective franchisee, although would not require a post-effective amendment other than once per quarter. This appears to be somewhat like a Form 8-K current event report required by the Securities Exchange Act of 1934. States, however, do not have a similar non-amendment procedure for identifying material changes, and have various rules regarding how quickly an amendment must be filed after the date of the material event.
It would be helpful for franchisors to have a single time frame to deal with, and perhaps now is the opportunity for the Commission to preempt state requirements and adopt a standard requirement that the franchisor file a post-effective amendment within 90 days following the occurrence of a material event, and disclose intervening material changes via a supplement to the circular such as an addendum or letter (or perhaps a standard form stating the date and description of the event).
Comment 3: Supplemental Earnings Claims (or Financial Performance Disclosure). The Proposed Rules with respect to supplemental financial performance are unclear in the following respect: If a franchisor discloses a certain type of financial performance for its entire system, can it disclose different types of information for a subset of the system as a supplement. For example, if the franchisor discloses average unit volume for its entire system, could it create a supplement that discloses AUVs and costs of goods sold for units located in a particular area?
Comment 4: Gag Clauses. It would also be helpful to have some clarification as to what constitutes a "gag clause." For example, is a confidentiality provision in an addendum to the franchise agreement or in a settlement agreement a gag clause if it simply prohibits the franchisee from discussing the terms of the amendment or settlement? If so, the Proposed Rules with respect to gag clauses seem overreaching, since the franchisee (or former franchisee) is not prohibited from talking with prospects, but only from talking about certain issues. With respect to settlements, the confidentiality provision would theoretically apply only to non-material aspects of the settlement, since any material consideration paid to the franchisee would be disclosed in Item 3.
Comment 5: Internet. Although the Proposed Rules discuss at some length the procedures for electronic disclosure of UFOCs, those procedures and how to deal with electronic disclosure of any documents involve more mechanical questions than policy issues. A part of the Proposed Rules not substantially addressed deal with financial performance information and the Internet.
The Proposed Rules forbid dissemination of any financial performance representation to prospective franchisees, including representations made to the general media and Internet. At first blush, this appears to be substantially similar to the current practice, which allows a franchisor to make earnings claim-type representations to the general media but forbids the franchisor from then directing the resulting articles to the prospective franchisee as a "back-door" earnings claim not included in Item 19. But expanding the rules to the Internet could unreasonably restrict what kind of materials a franchisor can have on its Internet web page altogether. The issue involves at least two types of information - republication of articles or press releases, and publicly filed reports required by the securities laws.
Visit virtually any company's web site, and there is a link to "press releases" or "articles" related to the company. A company's web site should be used to educate the public about that company, and press releases or, perhaps more so, third party articles about the company are among the more useful tools in that education process. Many of those articles or releases include earnings or "financial performance" data. On the one hand, the Proposed Rules require disclosure of the franchisor's web site (thereby inviting the prospect to visit the site and learn more about the company), but then specifically prohibit "dissemination" of financial performance information on the Internet. Does this mean that a franchise company, unlike any other business, must chose between taking advantage of articles or press releases about itself on its own web site or risk the claim that a prospective franchisee has been given unauthorized non-Item 19 financial data?
What about public companies and their '34 Act filings? Again, most public companies have a link to their recent 10-Qs, 10-Ks, 8-Ks, and other publicly filed documents. Many of these documents will have financial performance information not included in Item 19. For example, a franchisor may file a report that includes earnings information for its company-owned units, which clearly, if handed to a prospect, would constitute an earnings claim or financial performance information. This issue is made more complicated by the fact that the information may well be in the company's statement of operations already presented to the prospective franchisee in the circular.
In short, there are now a multitude of ways in which a prospective franchisee can gain information about a company that, to some extent, arguably makes Item 19-type limitations obsolete with respect to certain information. At the least, the Commission should consider exempting information on a franchisors' web site (but which is not specifically targeted to prospective franchisees by direct mail, advertising, oral presentations, etc.) from the prohibitions of proposed Section 436.10.
I appreciate the Federal Trade Commission's consideration of my comments.
Patrick E. Meyers