St. John's Law Review Volume 54 Number 2 Volume 54, Winter 1980, Number 2 Article 1 Regulating the Franchise Relationship Donald P. Horwitz Walter M. Volpi Follow this and additional works at: https://scholarship.law.stjohns.edu/lawreview This Article is brought to you for free and open access by the Journals at St. John's Law Scholarship Repository. It has been accepted for inclusion in St. John's Law Review by an authorized editor of St. John's Law Scholarship Repository. For more information, please contact [email protected]. ST. JOHN'S LAW REVIEW VOLUME 54 WINTER 1980 NUMBER 2 REGULATING THE FRANCHISE RELATIONSHIP DONALD P. HORWITZ* WALTER M. VOLPI** TABLE OF CONTENTS I. INTRODUCTION .......................................... 218 II. NATURE OF FRANCHISING ................................. 219 A. Definitional Problems ............................. 219 B. Types of Franchising .............................. 222 I. THE OVERPROMOTION OF FRANCHISING: EXAGGERATED PROMISES AND UNREALIZED EXPECTATIONS .................. 224 IV. THE BENEFITS OF FRANCHISING ........................... 228 A. The Benefits of Franchisingto Society .............. 228 1. The Creation of Small, Independently Owned Businesses .................................... 228 2. The Failure Rate of Franchised Businesses ....... 231 3. Franchising's Contribution to Increased Economic Opportunities for Minority Group M embers ............................... 233 B. The Benefits of Franchisingto the Franchisor ....... 234 1. Franchisor Capital Requirements ............... 235 2. Franchisee M otivation ......................... 236 C. The Benefits of Franchisingto the Franchisee ....... 237 1. Franchising's Low Entry Barriers ............... 237 2. The Franchisee as an Independent Businessman .. 238 3. Franchisor Assistance to the Franchisee ......... 240 4. Franchisee Satisfaction ........................ 243 D . Conclusions ...................................... 243 V. BARGAINING POWER IN FRANCHISING ....................... 244 A. BargainingPower Between Franchisorand Prospective Franchisee ............................ 245 * B.S. Northwestern University, 1957; J.D., Yale University, 1960. Member of the Illinois and District of Columbia Bars. Mr. Horwitz is Executive Vice President, Secretary, and General Counsel of McDonald's Corporation. ** B.A., 1968, J.D., 1974, St. John's University. Member of the New York Bar. Mr. Volpi is associated with Cleary, Gottlieb, Steen & Hamilton, which on occasion represents McDonald's Corporation. The views expressed in this article are solely the authors' and are not necessarily those of McDonald's Corporation. ST. JOHN'S LAW REVIEW [Vol. 54:217 B. Full Disclosure: The Effective Equalizer of BargainingPower ................................. 249 C. BargainingPower During the Course of the FranchiseRelationship ............................ 254 1. Franchisor Controls Over Franchisee Sources of Operating Supplies .......................... 255 2. Franchisor Control Over Termination and Non- renewal of the Franchise Agreement ............. 259 D . Conclusions ...................................... 264 VI. THE OVERREACTION TO THE OVERPROMOTION OF FRANCHISING .............................................. 264 VII. THE CONSEQUENCES OF OVERKILL .......................... 266 A. The Undermining of the FranchiseRelationship ..... 266 B. The Overburdening of the Legal System ............ 268 C. The Impairment of Freedom to Contract ............ 271 VIII. THE BALANCED APPROACH ................................. 276 I. INTRODUCTION To date, fifteen states have passed legislation regulating the franchise relationship;' similar legislation has frequently been pro- posed in Congress. 2 This deceptively simple and superficially ap- pealing legislation seeks to regulate the franchise relationship by prohibiting a franchisor from requiring "unreasonable" standards of franchisee performance3 and from terminating or declining to re- new a franchisee without "good cause."' Proponents of the legisla- tion claim it is necessary to protect franchisees who otherwise would continue to be victimized by franchisors. 5 Examination of the premises upon which existing and pro- posed legislation regulating the franchise relationship is based reveals serious misconceptions about the nature of the franchise re- I Legislation imposing restrictions on a franchisor's right to terniinate or decline to re- new a franchise according to the terms of the franchise agreement is referred to in this Arti- cle as "legislation regulating the franchise relationship." Such laws currently in effect are listed in note 202 infra, and are collected in the compilation of franchise laws published by Commerce Clearing House in STATE BusINEsS FRANCHISE DISCLOSURE AND RELATIONSHIP LAWS (CCH)(1978) [hereinafter cited as CCH], and in 1 G. GLICKMAN, FRANCHISING § 3.03, 4.02[7] n.45 (1978) [hereinafter cited as G. GLICKMAN]; 2 G. GLICKMAN at § 13.03111]. 2 See, e.g., H.R. 2305, 96th Cong., 1st Sess. (1979) [hereinafter cited as the Mikva Bill]; H.R. 9144, 95th Cong., 1st Sess. (1977); H.R. 5016, 95th Cong., 1st Sess. (1977); H.R. 8349, 94th Cong., 1st Sess. (1975); S. 2335, 94th Cong., 1st Sess. (1975); S. 2507, 90th Cong., 1st Sess. (1967). 3 See, e.g., N.J. STAT. ANN. § 56:10-7(e) (West Supp. 1979-1980); Mikva Bill, supra note 2, § 3(3)(A). See, e.g., CONN. GEN. STAT. § 42-133f(a) (1979); Mikva Bill § 5(2). See, e.g., Hearings on H.R. 5016 Before the Subcomm. on Consumer Protectionand Finance of the House Comm. on Interstate and Foreign Commerce, 95th Cong., 1st Sess. 33- 37 (1977) (statement of Rep. Mikva) [hereinafter cited as Mikva Bill Hearings]; id. at 64, 79 (statement of Harold Brown). 1980] REGULATING FRANCHISES lationship and the practices sought to be prohibited or controlled. The thesis of this paper is that this legislation is the product of an overreaction to a specific practice-overpromotion-once prevalent in franchising but today largely eliminated. The subject legislation not only poses a crippling threat to franchising as an effective method of doing business but, more important, is being advanced without due regard to its potentially adverse effects on our econ- omy and legal system. The first substantive part of this paper (Part II) is devoted to an analysis of the nature of the franchise relationship and the two principal forms franchising has taken: product and trade name franchising and business format franchising. In Part III, the past overpromotion of franchising is discussed, with particular focus on the once prevalent abuse of misrepresentation by some franchisors, and the resultant obscuring of the benefits of franchising. Part IV of this paper consists of a compilation and analysis of the available facts regarding the benefits of franchising, which fre- quently run counter to many of the assumptions held by the propo- nents of legislation regulating the franchise relationship. Part IV demonstrates that, despite its problems, franchising significantly benefits society, the franchisor, and the franchisee. Part V of this paper discusses a critical issue in franchis- ing-bargaining power between franchisor and franchisee. It is con- cluded that proven franchisor abuses which may stem from a dis- parity of bargaining power-misrepresentation, nondisclosure and other forms of overpromotion-may be cured by requiring full and fair disclosure by the franchisor, and that other franchisor abuses which may occur are not widespread and are susceptible of correc- tion by the enforcement of existing remedies. Part VI examines the overreaction to the overpromotion of franchising-existing and proposed legislation regulating the franchise relationship. The unfortunate consequences of this legis- lative overkill are set forth in Part VII. Finally, Part VIII presents a balanced approach to the problems existing in franchising-full and fair disclosure, the en- forcement of existing remedies, remedial legislation where neces- sary to correct specific, proven abuses, and the development and maintenance of a healthy franchise relationship. H. THE NATURE OF FRANCHISING A. Definitional Problems Sales of franchised goods and services are expected to reach ST. JOHN'S LAW REVIEW [Vol. 54:217 $338 billion in 1980, an eighteen percent increase over 1978.6 De- spite its clear importance to the economy, franchising is a fre- quently misunderstood concept. There appears to be a common be- lief that franchising is itself a business or industry, rather than a way of doing business in many different industries. 7 Franchising is not a business or industry;' it is only one of several different tech- niques for achieving certain business goals by contractual agree- ment rather than by vertical integration? Essentially, franchising is a method of allocating costs and decisionmaking in a marketing channel."° It is difficult to formulate a definition of franchising suffi- ciently broad to encompass all its various forms yet restrictive enough to avoid including other ways of doing business.1 Typically a U.S. DEP'T OF COMMERCE, FRANCHISING IN THE ECONOMY 1978-1980, at 1 (1980) [herein- after cited as FRANCHISING-1980]. The Commerce Department publishes a comprehensive annual analysis of statistics regarding franchising; the series is called "Franchising in the Economy." The data reported by the Commerce Department is collected from nearly all franchisors. Some data are not strictly comparable with earlier reported data due to revisions in types of franchised business categories. Id. at vi. 7 See Burck,