|Marriott International, Inc.
Marriott Law Department
Washington D.C. 20058
December 22, 1999
Re: 16 CFR Part 436 - Franchise Rule Comment
Dear Mr. Secretary:
In response to the Notice of Proposed Rulemaking ("ANPR") issued October 15, 1999, Marriott International, Inc. ("Marriott") respectfully offers the following comments on the proposed revisions to the Franchise Rule.
I. MARRIOTT'S BACKGROUND AND EXPERIENCE.
Marriott International, Inc. is a Delaware corporation with its principal place of business in Bethesda, Maryland, and is a publicly traded corporation listed on the New York Stock Exchange. Unless otherwise specifically noted, the term Marriott in this response is referring to Marriott International, Inc. and its affiliates and subsidiaries generally. Through its various predecessors, affiliates and subsidiaries, Marriott has operated, managed and franchised hotels since 1971. Marriott has also been both a franchisor and franchisee in the food service industry.
Today, Marriott and its affiliates offer franchises for seven hotel brands in the United States and five hotel brands internationally. The domestic franchise brands include: Marriott Hotels, Resorts and Suites; Courtyard by Marriott Hotels; Residence Inns by Marriott; Fairfield Inn Hotels; TownePlace Suites by Marriott Hotels; SpringHill Suites by Marriott Hotels; and Renaissance Hotels, Resorts and Suites. Marriott franchises offered internationally include Marriott Hotels, Resorts and Suites; Courtyard by Marriott Hotels; Renaissance Hotels, Resorts and Suites; and Ramada International Hotels and Resorts (all of which, including domestic and international, are collectively referred to as "Marriott-Branded Hotels"). Marriott uses different disclosure documents for each brand that it franchises, and each disclosure document ranges between one and one-half and two inches in thickness, double-sided copy.
Marriott-Branded Hotels are franchised and operated pursuant to three basic structures: (1) a franchise agreement with the owner and operator of the hotel; (2) a franchise agreement with the owner of the hotel who contracts with an independent management company to operate the hotel on its behalf; and (3) a franchise agreement with an independent management company that manages the hotel on behalf of the owner pursuant to a management agreement and a three party-owner agreement among the owner of the hotel, Marriott and the franchisee. Marriott also enters into management agreements with hotel owners to operate the hotel under a Marriott Brand. The estimated minimum initial investment in our Fairfield Inn Hotels, which is the least expensive Marriott-Branded Hotel to develop, generally exceeds $2.5 million exclusive of land. The estimated minimum initial investment in a 300 room standard Marriott Hotel, exclusive of real estate, generally exceeds $30 million. The cost to develop a first class Marriott or Renaissance Resort could often exceed $100 million in the aggregate.
II. SUMMARY OF MARRIOTT'S POSITION.
Our comments reflect the substantial franchising experiences of Marriott, described above, as well as the experiences of our franchise legal staff at Marriott and as counsel for other companies in the lodging industry and as a state franchise regulator.
Marriott strongly supports the efforts of the Commission in revising the Rule and the overall direction of the Proposal. Although the NPR proposes scores of changes to the current Rule, the vast majority of which Marriott supports, our comments focus on a few issues that are of greatest importance to Marriott and on those areas where we believe that our experience can provide additional insight to the Commission.
Marriott hopes that the overall goal of the revisions should be to make the current Rule both more effective and less burdensome on franchisors. Marriott recognizes that those objectives are not always complementary and that some efforts to make the Rule more effective may increase disclosure compliance burdens for franchisors. Marriott strongly urges that additional compliance burdens be imposed only to the extent that they materially aid in helping prospective franchisees overcome the perceived informational imbalance between franchisors and franchisees, which has been the stated objective of the Rule since its inception.
In this context, please consider that while there is no specific private right of action under the FTC Rule, plaintiff franchisees often look to the FTC Rule under state little FTC Acts alleging a violation of the Rule. The ability of a Franchisor to comply with new requirements may therefore have financial consequences that are not constrained by the good judgment of the FTC.
Marriott fully supports the FTC's decision to adopt a disclosure format similar to that contained within the UFOC Guidelines and urges the FTC to coordinate with NAASA so as to avoid any potential jurisdictional disputes that could result in franchisors being subject to conflicting disclosure standards in states having franchise disclosure requirements. Additionally, Marriott urges the FTC to clarify how pre-existing compliance guides, interpretative advisory opinions, federal court opinions, UFOC Guidelines, and NAASA commentaries would apply to the final Rule, and, to the extent possible, Marriott recommends that those interpretations be reflected in the language of the Rule itself.
A. Duty to Disclose Immediately Any Material Change.
FTC PROPOSAL: Franchisors will be required to notify a prospective franchisee about any material changes that have occurred between the time that the prospective franchisee receives the offering circular and the time that the franchisee receives the franchise agreement in executable form.
MARRIOTT'S POSITION: This provision would impose substantial unjustified burdens on franchisors. Marriott recommends that the provision be eliminated in its entirety or modified to (i) clarify that "materiality" is determined in the context of the entire offering and (ii) provide a "safe-harbor" time period for compliance.
The Proposal is intended to "enhance" the current Rule's updating provisions to require franchisors to notify a prospective franchisee about any material changes that have occurred between the time the prospective franchisee has received the offering circular and the time the franchisee receives the franchise agreement in an executable form. This requirement, however, places an impossible burden on large franchisors, especially if they actually operate the business that they franchise, because of the uncertainty as to what constitutes "any material change" and the requirement of "real time" ongoing disclosure. The requirement may therefore expose franchisors to unwarranted liability because compliance by franchisors may be impossible regardless of absolute best efforts and intentions.
If the Commission is unwilling to drop this requirement, it should be revised in two ways so that franchisors have the ability to comply:
1. The update requirement should apply only to those changes that are material to the entire offering, not just an isolated aspect of the offering; and
2. The franchisor must be given some "safe harbor" time period in which to comply because information cannot be disseminated and analyzed immediately within a large corporate organization. Most franchisors are not individuals but organizations that perform a variety of business functions, not all of which are related. Many franchisors are part of larger corporate organizations that may have hundreds to thousands of employees (approximately 180,000 in the case of Marriott) all working in different departments, including: development, corporate and field operations, information resources, training, legal, advertising and marketing, corporate secretary's office, purchasing and supply, and architecture and construction. Each department may have a different person responsible for a portion of the information contained in the offering circular for each brand of franchise being offered.
To impose the continuous ongoing duty to update disclosure contemplated by the Proposal would place an unfair burden on franchisors like Marriott. For example, it will be virtually impossible for the Training Department (every time they change a subject or the hours allotted to a particular subject in the training program) or for the Information Resources Department (every time there is an update to a software program) to contact Legal and for legal to determine if the change is material and to then contact development to make sure before the closing of every franchise deal that there is not a particular piece of information that must be notified to a franchisee. This requirement will cause complete havoc on the franchise sales process. Franchisors will not be able to close sales without notifying every department out of fear that some minute change in fact may later be deemed to be material.
Of all the proposed changes, this Proposal has the greatest likelihood of creating unwarranted liability. If this requirement is going to be considered for the Final Rule, Marriott strongly requests that a hearing be held to present testimony or that interested parties be given opportunity to provide further comments on this subject.
B. Exemptions and Exclusions.
1. International Transactions.
FTC PROPOSAL: The Rule should apply only to franchise locations to be established in the United States.
MARRIOTT'S POSITION: Marriott strongly supports this provision of the Proposal but believes that the provision should be further clarified to limit the Rule's application to franchise locations to be established in the fifty States of the United States and the District of Columbia only. Franchisees offered outside of the fifty states of the United States and the District of Columbia (i) are treated like any other international transaction, (ii) are offered often times through foreign affiliates, and (iii) on different agreement terms than those offered in the United States, including modifications to those agreements necessary for local country laws.
Marriott strongly supports the FTC's decision that the Rule only should apply to franchise locations to be established in the United States. In Marriott's experience, the most beneficial form of exemption would be to create a clear, "bright-line" exemption covering all franchise transactions involving businesses to be operated outside of the states of the United States, any other exemption would fall short of the mark and leave the disclosure obligations in international transactions ambiguous. The approach the Commission has proposed is the most appropriate approach for addressing international franchise transactions (except with respect to Territories and Possessions as described below).
For historical, tax, and logistical reasons, among others, a number of Marriott subsidiaries, which own or are licensed to use particular marks, offer franchises for hotels to be located outside of the United States. The entities used vary by brand and location of the franchised hotel. The subsidiaries include an indirect subsidiary formed in Maryland, an indirect subsidiary formed in Delaware, an in indirect subsidiary formed in Luxembourg, and an indirect subsidiary formed in Holland. It is not unusual for investors in these franchised hotels to include one or more American citizens domiciled in the United States or corporations, partnerships or LLCs that have been formed or have officers in the United States, as well as individual investors or other entities formed or located in the host country. In turn, they may form a separate entity under the laws of the United States, or, more often, the laws of the host country in which the hotel will operate. The host country may also have laws applicable to the offer or sale of franchises.
Marriott, however, encourages the FTC to further clarify that the Rule only applies to the offer and sale of franchises in the fifty states of the United States and the District of Columbia, and that it does not apply to transactions where the franchised business will be located merely in United States possessions, commonwealths, territories or U.S. military bases located abroad. Information in a franchisor's standard U.S. UFOC may be totally irrelevant and may be misleading despite our best efforts to provide accurate information concerning the franchise offered for a location to be operated in Guam, American Samoa or Puerto Rico because most companies handle these jurisdictions as part of their international businesses. This means that different operational requirements, management, and costs may be involved. The entities offering those franchises generally will be different from those entities offering franchises in the United States. The agreement will be substantially different than the agreements used in the United States and will be modified for local country law. Obtaining the information necessary to comply with the Rule's requirements to establish a franchise in those locales would be difficult and would create compliance costs which are disproportionate to those required for compliance in the United States (e.g., cost to prepare an offering circular solely for use in offers for hotels to be located in Guam). Having the Final Rule apply to transactions in the United States territories and possessions would create potential liability and additional costs for franchisors with marginal benefits for franchisees.
2. Sophisticated Franchisee.
FTC PROPOSAL: The Rule will exempt from its disclosure requirements certain franchises involving significant initial investments or those involving sophisticated investors.
MARRIOTT'S POSITION: Marriott strongly supports these provisions of the Proposal but believes that the provisions should be revised to better reflect the manner in which such transactions usually are structured. Marriott recommends expanding the definition of Ainvestment@ to include any credit extended by any lenders, including but not limited to franchisors, and expanding the Anet worth@ and Abusiness history@ requirements to include not only the prospective franchisee but also any entities that own or control the prospective franchisee.
Marriott strongly endorses the Proposal to exempt from the Rule=s disclosure requirements, franchises involving significant initial investments or sophisticated investors. Because the franchises granted by Marriott typically involve sophisticated investors and a substantial investment, Marriott believes its experiences are very relevant to fashioning the details of these exemptions so that they can provide the deserved benefits. Marriott suggests several modifications to the language so that the exemptions better reflect the manner in which such transactions involving sophisticated franchisees are usually structured.
The exemption is justified because the type of transaction that takes place with persons investing more than $1.5 million in a franchised business is no different than an myriad of other commercial transactions between sophisticated parties. It is worth noting, that many of Marriott's franchisees are also owners of other hotels that are either franchised under other brands or are managed by Marriott or its competitors. If those Owners enter into a franchise agreement, they receive a disclosure document and are subject to the Rule. If those Owners enter into a management agreement with Marriott, or one of its competitors, where the manager will have control of the operations and cash flow of the hotel, no disclosure is required. In transactions with sophisticated investors, the disclosures required by the Rule do not provide a material benefit in equalizing an imbalance in bargaining power between the franchisor and prospective franchisee where no imbalance exists.
Sophisticated investors typically finance the investments through contributions of equity made by individual investors, corporate or institutional investors, and/or they obtain debt financing either through major banks or financial institutions or issue some form of public debt financing. Further, many of the franchisees investing more than $1.5 million in franchised businesses are publicly traded entities themselves. These prospective franchisees are represented by their own in-house or retained lawyers, many of whom are from well respected nationally recognized law firms. Also, in the lodging industry, it is commonplace for high net worth investors (including individuals or entities, including some publicly traded, such as pension funds) to hire professional hotel management companies to manage their hotels. Financing of this magnitude usually is not available unless the investors and financial institutions providing the financing for the project have reached a conclusion as to the potential success of the project and the franchise. Often negotiations concerning a hotel franchise place a franchisor in the position of negotiating with financial institutions, which typically employ Wall Street counsel, as well as the franchisee and the owner of the hotel (if the franchisee is the manager). In short, a sophisticated franchisee not only can protect its own interests, those interests would be protected in part by the self-interest of others involved in the project.
Some clarifications, however, are necessary to make the exemption reflect normal and legitimate commercial practices. The following comments are ordered to track the Proposal.
AInvestment@ for purposes of the exemption should be defined as the initial investment as set forth in Item 7, plus credit extended by any lender and commitments for real property (not just mortgage or lease payments for the first few months). Further, for purposes of calculating whether the $1.5 million threshold has been met, a prospective franchisee's sunk costs in the property should be included. For example, if a prospective franchisee currently owns a hotel facility and wishes to convert the hotel to a different (or from an independent to a) franchised brand, the franchisee's existing investment in the hotel should be included in the initial investment analysis for purposes of determining whether the terms of the exemption has been met. Conversion franchising plays a significant role in hotel franchising.
In addition, Marriott does not believe that there exists any inherent risks that would justify excluding credit extended by franchisors for purposes of determining whether a transaction is exempt from the Rule. Rather, excluding such franchisor financing would have the unintended effect of harming franchisees by discouraging the franchisor from providing such financing. In the hotel industry, it is not unusual for a franchisor to agree to provide credit enhancements or a guarantee to a lender to either help the franchisee obtain financing for large projects or to buy down or reduce the interest rate available to the franchisee. Sometimes the franchisor may negotiate a credit facility with a major lending institution that in turn makes financing available to franchisees (which for purposes of Item 10 constitutes Afranchisor financing@). The fact that a franchisor provides a credit enhancement or other back-up guarantee on a construction on permanent loan to assist in getting a hotel built should have no bearing on whether the transaction is exempt.
Moreover, when franchisors do finance a part of a franchisee's $1.5 million investment B whether it is land, buildings, computer systems or signs B the franchisor is at risk and has an even greater incentive to help the franchisee to succeed. The same analysis set forth in the "Interpretive Guides" to the Rule which supported the Commission=s conclusion that a franchise fee which is financed by the franchisor for the first six months of the franchise relationship is not a "payment" for the purpose of determining the existence of a franchise, should apply to the large investment exemption. Therefore, for the reasons noted above, Marriott does not believe financing provided by the franchisor should be excluded from the computation of the franchisee's initial investment.
Because sophisticated investors utilize a variety of corporate forms, the exemption must apply to the legal entity, regardless of form of organization, and it should be based upon a consolidated net worth and experience standard so that the net worth and experience of those owning or controlling the franchisee entity may be taken into consideration. For example, if a multinational corporation establishes corporation or a limited partnership or liability company to acquire and operate a franchised business, the exemption should apply regardless of the fact that the new entity itself has neither $5 million in net worth nor a five-year operating experience.
Sophisticated franchisees/investors generally form special purpose entities ("SPEs") for each hotel or restaurant that they own (or operate on behalf of third parties) to insulate either a parent company or the individual investors from liability. To take advantage of certain tax laws, wealthy sophisticated individuals also set up SPEs for each franchised business in which they own an interest so they can buy and sell the hotels and restaurants, to take advantage of like kind exchange rules to avoid capital gains, and as a result, those investor groups will not establish a holding company. Those same individuals may also establish trusts to own each individual asset or a group of assets for estate planning purposes. One must be able to look to the experience of the individuals, parents, affiliates and predecessors of the prospective franchisee.
C. Integration and Merger Clauses.
FTC PROPOSAL: The use of a merger and integration clause in a franchise agreement, where such clause does not expressly exclude any statements or representations contained in the offering circular or its exhibits, would be a violation of the Rule. The Rule also would permit changes to the standard documents only if each change is initialed.
MARRIOTT'S POSITION: Marriott believes that the proposed provisions are inconsistent with the fundamental purposes of the Rule and should be eliminated.
Marriott understands the Commission=s desire to protect individuals who have made substantial financial investments in franchises based upon representations contained in the offering circular or upon other written or oral representations that later prove to be untrue or incomplete. While Marriott agrees that franchisors should not be able to escape their obligations under the Rule by requiring franchisees to sign waivers or releases of claims in connection with the offer and sale, the remedy contained in the Proposal and basis for the change described in the NPR goes well beyond the problem.
The FTC is the only entity authorized to bring a claim for violation of the Franchise Rule. The FTC is not a party to franchise agreements and is not bound by merger and integration clauses. If a franchisor misrepresents or omits material information in a disclosure document, the FTC may commence an enforcement action, regardless of the existence of a merger or integration clause in a franchise agreement, and is therefore not deprived of a remedy because of such clause.
Merger and integration clauses are a time honored tenant of common law adopted to clarify the boundaries of the agreement between and among the parties and is designed to support the parol evidence rule. Without such a Rule, parties are unable to rely upon the final executed documents as a manifestation of the parties= intent. Further, there is no evidence that courts routinely ignore disclosures when interpreting ambiguous terms of franchise agreements or other agreements. See, Blum, Fisher and Seidler, "Integration and 'No Reliance' Clauses vs. Fraud and Other Claims," IFA 1999 Legal Symposium Course Materials, Tab 7. Finally, it is unclear how a franchisor could draft an integration clause so as to confine contractual rights and duties within the four corners of the document without also potentially limiting claims regarding pre-sale representations in disclosure packages. Requiring all franchisors to modify their standard integration and merger clauses in all their franchise and related agreements to carve out representations in the offering circular seems a bit draconian.
As drafted, the proposed prohibition (Section 436.10(e))only would permit changes to the standard documents if each change is initialed. Although this may help franchisees better identify the changes, the requirements tends to elevate form over substance, is unworkable when substantial changes are negotiated by the parties, and will not aid the Commission materially in its enforcement efforts. Further, while initialing changes and sometimes every page of an agreement, is a practice utilized by some lawyers and franchisors, making it an unfair an deceptive trade practice for failing to do so can create an absurd results (e.g., a franchisee brings a cause of action under a state little FTC act because terms negotiated by the parties have not been initialed). The five day waiting requirement also contained in (Section 436.10(e))presents other problems described below.
D. Timing Requirements.
1. The 14-Day Rule.
FTC PROPOSAL: The Proposal will delete the obligation to deliver an offering circular to the prospective franchisee at the first personal meeting between franchisor and franchisee and will instead adopt a 14-calendar day pre-sale disclosure requirement.
MARRIOTT'S POSITION: Marriott supports this proposed revision.
The adoption of a 14-calendar day pre-sale disclosure requirement in lieu of the existing standard is a positive step. Deleting the obligation to deliver an offering circular at the first personal meeting eliminates significant ambiguity (and potential unnecessary liability) with regard to determining what constitutes a first personal meeting and creates a bright-line test as to when the duty to provide the offering circular arises and when full compliance has been met. The 14-day rule generally assures that prospective franchisees have a sufficient amount of time to read and evaluate the disclosures and form agreements, to contact prospective franchisees, to consult with advisors and to begin the negotiation process.
2. The 5-Day Rule.
FTC PROPOSAL: The Proposal will carry on the existing obligation that franchisees hold franchise agreements for five business days before executing them.
MARRIOTT'S POSITION: Marriott believes that this requirement imposes an undue hardship on franchisees, provides little if any benefit to franchisees, frequently disrupts the timing of transactions, and should be eliminated.
The 5-day waiting requirement for execution of final agreements is one of the "technical" requirements of the current Rule and Proposal that Marriott believes provides little additional benefit to franchisees and causes compliance problems for parties to the franchise transaction. In hotel franchise transactions, many interests are involved in addition to the franchisor's and the franchisee's (e.g., lenders (often more than one), real estate sellers or syndications, lessors, management companies, brokers, etc, all of whom are generally represented by counsel). Franchise sales are usually concluded and documents are executed at a closing at which all interested parties and their lawyers are present (often times, excluding the franchisor), and which involve the simultaneous execution of all related documents. Although drafts of documents may have circulated among the interested parties for weeks or months, final terms often are agreed upon the eve of or at the closing. A change in one document may require changes in many others. Even before closing, lenders, investors or others may have negotiated conditions of their participation in a hotel project which may require Marriott=s consent to franchise agreement modifications. These modifications can include a change in the identity of the franchisee entity for tax reasons, substitution of guarantors, changes in lender or owner cure of default rights, changes in transfer rights, owner termination rights, and changes to the renovation scope of the hotel, among others, all of which must be documented.
The timing of closing is often critical to the franchisee as loan commitments may expire, options to acquire sites may expire or financial commitments may be required to prevent the site from being sold or leased to a different entity. Securities offerings may be held up until franchise agreements are executed. Interest rates may change so as to make a project unavailable unless commitments are promptly made.
While in theory the requirement that franchisees receive completed contracts at least five days before they sign them sounds well and good (i.e., franchisee and its counsel will have time to review changes and have an additional cooling-off period), this requirement is unnecessary and penalizes the franchisee under most circumstances. If the franchisee has negotiated changes, or if the completed documents merely reflect insertion of the franchisee=s name, location, address, other standard disclosed terms in the offering circular, or a territory agreed to by the parties, there is no justification for further slowing the closing process. This requirement creates a "Hobson=s Choice" for the franchisor and the franchisee. When these last minute changes occur, the franchisor can require the franchisee to postpone its closing at a significant cost to the franchisee or permit the franchisee to close in escrow with the franchise agreements held until the period expires (the franchise agreement is signed by and binding on the franchisor, but is not signed or binding on the franchisee, until the period has expired and conditions of closing have been met). The franchisee on the other hand, if the franchisor or the other parties are unwilling to permit the franchisee to close in escrow on the franchise agreement, must choose between delaying its closing at significant cost or having to negotiate with its lenders and other parties interested in the project to agree and execute the franchise agreement without the last minute proposed changes (which are generally to the franchisee=s benefit). This Proposal should be deleted or substantially revised.
3. The 5-Day Receipt Rule.
FTC PROPOSAL: The Proposal would require that franchisors receive an executed offering circular receipt from franchisees at least five business days before any money is accepted from a franchisee or any contracts are signed.
MARRIOTT'S POSITION: Marriott believes that this requirement would impose an inappropriate impediment to franchise sales with no meaningful corresponding benefit to franchisees. Marriott=s recommendation is to eliminate this requirement.
The five-day receipt requirement is really a technical requirement that is more likely to result in inadvertent non-compliance with the Rule than assurance that disclosures are timely made. For the reasons described above concerning the 5-Day Rule, the FTC should not create a new requirement that franchisors receive the offering circular receipt at least five days before money is accepted from a franchisee or contracts are signed. Franchisees receive the offering circular, and because signing the receipt is not a priority to the franchisee, they do not always return the receipt on a timely basis. This new requirement would, in practice, put franchisors in the awkward position of again delaying a franchisee=s closing because the franchisee failed to timely send to the franchisor the receipt, or allowing the franchisee to close the deal in escrow.
E. Financial Performance Representations.
FTC PROPOSAL: The Proposal makes a number of changes to the existing earnings claims standard.
MARRIOTT'S POSITION: Marriott generally supports a number of the proposed changes but believes that further refinement is necessary to (i) eliminate actual or potential conflicts with normal business disclosure and other financial disclosure obligations imposed by law on franchisors and (ii) to reflect that not all meaningful financial performance information that franchisees desire can be prepared in accordance with GAAP. The revision of the earnings claims standard is generally favorable. In particular, Marriott supports the FTC=s Proposal not to mandate Financial Performance Representations (AFPRs@). Marriott also agrees that elimination of cost statements from the definition of FPRs is a positive step. The Proposal to adopt standards allowing sub-groups of units to be used as the basis for FPRs is laudable, especially when franchisors are frequently adopting new business strategies which may result in different FPRs, depending upon whether the old or new system format is followed by the franchisees.
The Proposal, however, creates several problems, which Marriott urges be addressed in the Final Rule, and we suggest that the following points be considered:
1. Disclosure does not occur in a vacuum separate and apart from the day-to-day business of operating hotels, managing the on-going relationships with existing franchisees, buying and selling of real estate and hotel properties, offer and sale of securities, and other general conduct of business.
2. By imposing limitations on the dissemination of financial performance information, The Rule creates conflict with other duties under securities laws, lender disclosure requirements, duties with regard to disclsoure in the sale of businesses, and what should be good business practice in sharing market information with existing franchisees (who also may be prospective franchisees, as defined in the Rule).
While many of these concerns have existed under the current Rule and state disclosure laws, this may be an opportune time for the Commission to address some of these issues. Marriott includes an FPR containing certain hotel industry relevant operating information in its offering circulars. Item 19(i) states that "financial performance information that differs from that included in Item 19 may be given only where: (1) a franchisor provides the actual records of an existing outlet you are considering buying; or (2) a franchisor provides financial performance information in Item 19 and supplements that information by providing, for example, information about possible performance at that location." Marriott is a publicly traded company and has a duty to provide to its shareholders and prospective investors copies of its 10K and 10Q, its annual report and its proxy statement, all of which contain financial operating information that differs from that contained in the offering circular. That information, along with analyst reports, are readily available to the public from any number of sources, including the company's web site and its investor relations department. The company has no way of knowing that the person either downloading the information from the web site or requesting information from investor relations is a prospective franchisee.
The most rational approach to the topic would be for the Rule to impose the restrictions on the information which is contained in the franchisor's offering circular and which franchisors provide to prospective franchisees in connection with the offer and sale of the franchise. Information that may be provided to securities investors, to the trade press or by others as it relates to the operating results of the businesses that are coincidentally being franchised should be specifically excluded from the FPR standards. Further, as noted in the comments of the National Franchise Council, at page 14, a franchisor should be free to disseminate FPRs to its existing franchisees regardless of whether that franchisee may be a prospective franchisee on another project with the franchisor. Information made available to lenders also should be excluded from the definition of FPRs. An additional admonition to the franchisee also should be included in the offering circular to state that Astatements provided outside of the offering circular should not be relied upon by franchisee in deciding whether to purchase a franchise.@
Currently, the UFOC Guidelines only require that a franchisor state whether the FPR was prepared in accordance with United States Generally Accepted Accounting Principles (AGAAP@) . The Commission also should abandon the requirement that historical data must be prepared according to GAAP because this requirement would prevent franchisors from providing relevant and accurate information to the franchisees . Information about franchisees= performance almost always is based upon information provided by franchisees, which may or may not be in a form which satisfies GAAP. Moreover, it is unclear that relevant information used in particular industries would meet this standard. For example, the lodging industry disseminates information concerning revenue per available room, average occupancy, average daily room rate, reservation system contribution, and frequent traveler programs. While this is the relevant industry information desired by most hotel franchisees, this information is not collected or prepared according to GAAP standards.
F. Disclosure Issues.
1. Definition of "De Facto Officers".
FTC PROPOSAL: The Proposal would expand the definition of the persons about whom disclosures must be made to include de facto officers of franchisor or its parent.
MARRIOTT'S POSITION: Marriott believes that the expansion of the group of individuals about whom disclosures must be made to include Ade facto officers@ creates confusion and the possibility of additional liability for franchisors with little if any corresponding benefit to franchisees. Marriott's recommendation is to eliminate this provision and conform the Rule to the existing UFOC Guidelines, or at a minimum, to eliminate the label "de facto officers". Alternatively, if the Commission chooses to retain this requirement, Marriott recommends the Commission adopt the disclaimer proposed by the National Franchise Council.
The addition of the Ade facto officer@ definition creates more problems than it solves. Its intent is to expand the group of individuals about whom disclosures must be made in Items 2, 3 and 4. AOfficer@ is defined to include Aany individual with significant management responsibility for marketing and/or servicing of franchises (sic) ....@ Item 2 requires disclosures about officers Aof the franchisor or any parent who will have management responsibility relating to the offered franchises.@ Logically, an individual only should be subject to Item 2 disclosure if such individual both had Asignificant management responsibility for marketing and/or servicing franchises and management responsibility relating to offered franchises. Creating a category of de facto officers may create confusion and additional liability for the franchisor, as well as for those individuals, by requiring the franchisor to identify persons as de facto officers of the company when they do not have that responsibility or corporate authority. The UFOC Guidelines simply require disclosure in Item 2 of "... principal officers and other executives ... who will have management responsibility for the franchises offered by this offering circular." Marriott believes that this approach is fundamentally sound and should be retained. If the Commission is not persuaded by our arguments to eliminate the changes proposed in the NPR, we strongly recommend that the Commission adopt the use of the disclaimers proposed by the National Franchise Council to at least partially address the confusion that may result from the proposed disclosure requirement.
2. Parent Company Disclosure.
FTC PROPOSAL: The Proposal would expand the disclosure requirements of Items 1 through 4 to include information concerning the franchisor=s Aparent.@
MARRIOTT'S POSITION: Marriott believes that this requirement would cause significant confusion and should be eliminated. Alternatively, if the Commission chooses to retain this requirement, Marriott recommends that the Commission adopt the disclaimer proposed by the National Franchise Council.
Expanding the disclosure in Items 1-4 to include information concerning a franchisor's "parent" and the officers, directors, trustees, general partners and subfranchisors of its parent (which term is undefined and could be interpreted to include direct or indirect subsidiary relationships) will cause significant confusion in structures where there are multiple corporate layers and franchising of more than one brand is involved, and will result in additional burdensome disclosure and could create a misimpression that the parent has obligations to the Franchisee.
Marriott, as well as many other franchisors, have many related companies in their corporate structure, some of which are holding companies for others. While Marriott currently offers franchises in the United States through its ultimate corporate parent, Marriott International, Inc. (as described above), and this change currently would have little material impact on its current disclosures, if Marriott's corporate structure should change or Marriott continues to have to disclose for the international transactions done through its subsidiaries, determining the information to be disclosed will be difficult to say the least. In addition, it will be confusing to prospective franchisees as to who ultimately is responsible for performance under the franchise agreement. Adding to the entities that already must be disclosed would be burdensome and would provide little benefit to prospective franchisees. If the Commission is not persuaded by our arguments to eliminate the changes proposed in the NPR, we strongly recommend that the Commission adopt the use of the disclaimers proposed by the National Franchise Council to at least partially address the confusion that may result from the proposed disclosure requirement.
FTC PROPOSAL: The Proposal would extend the definition of "predecessor" to include any entities that license any trademarks or trade secrets that are used in the franchisor's Afranchise operation.@
MARRIOTT'S POSITION: Marriott believes that this provision is unjustified and should be eliminated.
The "predecessor" definition should not be extended beyond the current definition (which has its own inherent problems). The Proposal would require disclosures in Item 1, 3 and 4 about entities which license any trademarks or trade secrets used in the "franchise operation" (sic). The term is not limited to principal trademarks, but even if it were so limited, it is not clear why, for example, disclosure of such information about the late Roy Rogers or King Features Syndicate, the licensor of "Popeye's" trademark, is relevant or desirable to the prospective purchasers of a Roy Rogers or Popeye's franchises.
Moreover, franchisors are regularly employing technology developed by and licensed to them by third parties for use in the franchise system which may be trade secrets, or which may incorporate trade secrets. Placing information about their licensors and the litigation and bankruptcy history of those licensors in a franchisor=s disclosure document would be intrusive and unwarranted. This expansion of the definition would create tremendous additional work and potential liability for franchisors without providing any material corresponding benefit to prospective franchisees.
Further, a franchisor may acquire a brand, including a trademark, from an independent third party and may simply not have access to any information regarding the litigation history of the prior owner of the franchisor. In this age of frequent mergers and acquisitions, information about predecessors and parents may be unavailable or unreliable. The Rule should clarify that franchisors only need make such disclosures to the extent that they possess information that they believe is reasonably reliable.
4. Disclosure of Franchisor Initiated Litigation.
FTC PROPOSAL: The Proposal would require franchisors to disclose in Item 3 litigation initiated by franchisor, not simply litigation initiated against franchisor, and would continue the existing UFOC requirement to disclose the settlement terms of any disclosed litigation.
MARRIOTT'S POSITION: Marriott believes that expanding the disclosure requirements of Item 3 to include litigation initiated by the franchisor and continuing to require disclosure of litigation settlement terms is unjustified, overly intrusive, and would impose undue burdens on franchisors. Marriott recommends that these provisions be eliminated.
Although we agree that the required disclosure for franchisee litigation against franchisors should continue to be disclosed, requiring disclosure of franchisor initiated litigation would create a large burden on franchisors that lacks any corresponding benefit. The objective of Item 3 was to disclose claims of wrongdoing by the franchisor, not wrongdoing by franchisees. That objective is adequately covered in the existing requirements.
Disclosure of franchisor initiated lawsuits against franchisees which are not followed by counterclaims should not be required in Item 3. Such a requirement would create a disincentive for franchisors to enforce their agreements, would clutter the document with useless information, cause sales to stop in states that require sales to stop until amendments are filed and approved, and provide little, if any, benefit to prospective franchisees. Although Marriott has very little litigation with franchisees, Marriott still would be adversely affected by the proposed change if it were forced to stop sales (thus requiring prospective franchisees to reschedule closings) and to amend its UFOCs for all seven brands each time that it filed or settled a claim until all disclosures are made and filed (see Duty to Immediately Amend).
As the Commission reevaluates current UFOC requirements in Item 3, Marriott proposes another change. Marriott finds the requirement to disclose all material settlement terms to be intrusive and often counter-productive to the process of settling claims. The objective of the disclosure is to provide information to the prospective franchise buyer that will help him make an intelligent decision about whether to buy the franchise. It is not to provide him with a basis for litigation or for negotiating settlements of claims or litigation. If franchisors purchase franchised businesses from franchisees in connection with the settlement of litigation, disclosure of the fact or the nature of the resolution should be adequate. The dollar amounts or financial terms involved are private and seem immaterial to a decision about whether to buy the franchise.
Settlement terms are not offered to franchisees at the time they acquire their franchises. It would be a mistake for a prospective franchisee reading about a claim that was resolved eight years earlier, or even one year earlier, to believe that if he should ever have a claim against the franchisor that the settlement terms would be at all relevant to terms of a settlement in his case. The only real beneficiaries of these disclosures are persons who already are franchisees or their lawyers who are looking for help in formulating current claims. They do not satisfy the express objective of the Rule.
5. Expanded Bankruptcy Disclosure.
FTC PROPOSAL: The Proposal would expand the required bankruptcy disclosures to include several additional entities.
MARRIOTT'S POSITION: Marriott recommends retaining the requirements of the existing Rule.
Item 4, Bankruptcy disclosures, should not be required of the (undefined) parent, predecessors which include trademark and trade secret licensors, or outside directors of franchisors. This is a significant expansion of the current requirements under the UFOC. The additional burden created by this requirement would far outweigh any benefit that it would provide to prospective franchisees.
6. Computer Hardware and Software Disclosure.
FTC PROPOSAL: The Proposal would continue the existing requirements for disclosure of computer hardware and software in Item 11.
MARRIOTT'S POSITION: Marriott believes that the existing provisions regarding disclosure of computer hardware and software impose substantial undue burdens on franchisors with little corresponding benefit to franchisees and are duplicative of other required disclosures. Marriott recommends modifying these provisions.
Marriott suggests that the Commission reevaluate the benefits of extensive disclosures about computer hardware and software in Item 11. The information required is extensive, not easy to compile, and is subject to frequent change. The instructions also are inconsistent with the general requirement. The requirement states that the franchisor should describe the systems Agenerally in non-technical language,@ and then goes on to require the franchisor to identify each hardware component and software program by brand, type and principal function. Responding to this detailed disclosure requirement results in four to five pages of disclosure in each of Marriott's offering circulars, yet provides little or no benefit to the franchisee. This information must be monitored, as it changes constantly, to determine if an offering circular amendment is required to comply with these requirements. It is not clear why most of the disclosures required in Item 11 about computer hardware and software and point of sale systems are material to a prospective franchisee=s decision to buy a franchise, especially considering that disclosures about computer requirements and costs associated therewith may be found in Items 5, 7 and 8.
7. "Gag Clause" Disclosures.
FTC PROPOSAL: The Proposal requires disclosure of franchisor=s practices of entering into confidentiality agreements and further requires disclosure of trademark- specific franchisee associations.
MARRIOTT'S POSITION: Marriott believes that these provisions should be clarified or eliminated.
The Proposal to require disclosures about practices of entering into confidentiality agreements is burdensome and will cause a variety of unintended consequences. It creates a disincentive for franchisors to accommodate needs of franchisees in non-standard deals. Franchisors make a variety of concessions to franchisees in connection with workouts or in connection with sales, or purchasing or conversion of multiple units, among others, in exchange for which the franchisor will request the terms of such arrangements to be kept confidential. Rather than make the pejorative proposed statement (which resembles a Arisk factor@ in many respects), franchisors may refuse to make concessions or accommodations to franchisees. Marriott believes that if prospective franchisees call existing or former franchisees and learn that certain issues can=t be discussed because of a confidentiality agreement, the prospect is aware of the issue and can evaluate the risks of whether to proceed knowing that he will not know about terms of some agreements.
The Proposal to require disclosures about Atrademark-specific@ franchisee associations that are associated with the franchisor if they have been Acreated, supported or recognized@ by the franchisor, or incorporated, is ambiguous. It should either be clarified or eliminated. The Commission would be better served to define the type of entity that should be disclosed. Its characteristics should be that it is comprised of a substantial number of franchisees of a particular franchisor which at least twice annually communicate or meet with the franchisor for the purpose of addressing issues arising from the franchise relationship. To qualify for inclusion in the disclosure, the leader of the association should provide a written notice to the franchisor no later than 30 days after the close of the franchisor=s fiscal year end identifying the association, its mission, its form of organization and the number of franchisees and franchise units which are dues paying members or are otherwise accredited members of the organization. If franchisees are not dues paying members, standards for accreditation should be enclosed in the notice.
Inclusion in the disclosure should not be dependent upon the form of the organization. Nor should amendments to this item be required more than once annually. The contact person for the association to be disclosed should be a current franchise owner, not an association executive or lawyer for the association.
8. Controlling Company Financial Statements.
FTC PROPOSAL: The Proposal would require that the separate financial statements of any company controlling 80% or more of the franchisor be included in the offering circular.
MARRIOTT'S POSITION: Marriott believes that this requirement is confusing, misleading, and creates uncertainty both for franchisors and franchisees. Marriott recommends that this requirement be eliminated.
Under the current UFOC Guidelines, the inclusion of separate financial statements for a company controlling 80% or more of the franchisor is at the option of a state administrator. The proposed revisions to the Rule would now require that the statements of such a controlling company be included in the offering circular. Making this requirement mandatory will have unintended consequences of misleading potential franchisees, as well as creating uncertainty, liability and possibly significant costs to many franchisors. First, the controlling company could be significantly more stable and have a greater net worth than the franchisor. Thus, the inclusion of its financial statements could mislead a potential franchisee to believe that the franchisor was more successful and solvent than it is. Second, of greater importance to Marriott, however, is the fact that franchisors often are owned by larger public or privately held companies that choose to grant franchises through subsidiaries for a variety of reasons. The franchisor is required to prepare audited financial statements in order to comply with disclosure requirements.
There is no definition of what constitutes a company controlling 80% or more of the franchisor in the proposed Rule for purposes of this Item 21 disclosure requirement. Is it limited to the entity that owns the franchisor or does it include the ultimate parent in a sophisticated chain of structured affiliated entities? Many of the companies, either directly or indirectly, controlling a franchisor will have no reason to prepare audited financial statements. The cost to have audited financial statements prepared is significant, and imposing such a cost merely to include such statements in an offering circular without a specific reason for doing so (i.e., there is a material relationship between the controlling company=s statements and those of the franchisor) will be unnecessarily burdensome. For example, currently, in the 50 United States and the District of Columbia, Marriott offers franchises through the ultimate publicly-held parent; in the past it had done so through third and fourth level subsidiaries. Audited financial statements were not prepared for the intermediate level subsidiaries. If this were the requirement, Marriott, and other similarly situated franchisors, would have to base their corporate structuring decisions around the disclosure requirements, rather than the efficient delivery of services, tax planning, and other business concerns.
If the Commission does not clarify that the Rule does not apply to the offer and sale of franchises in the U.S. territories and possessions, this requirement will create significant problems for Marriott and similarly situated franchisors in the future. As noted above, Marriott offers franchises outside of the 50 United States and the District of Columbia through different indirect subsidiaries (some of which are U.S. companies, others of which are based outside of the United States) depending on the location of the franchised hotel. For the reasons stated above, this requirement could cause Marriott and other similarly situated franchisors significant liability and cost, if not revised, and the Rule's requirements are applicable to those transactions.
The NPR reflects considerable thought and effort to fashion a form of franchise regulation for the next decade. Marriott has commented on a few of the hundreds of issues addressed in the Proposal, and we join in the comments of the National Franchise Council and the International Franchise Association. We are more than willing to respond further to any questions the FTC or its staff may have for us in this respect. We do again wish to congratulate the FTC staff for their efforts and thank you for soliciting and considering our opinions.
Very truly yours,
MARRIOTT INTERNATIONAL, INC.