The U.S. Federal Trade Commission (FTC) on July 12 told franchisors to stop charging their franchisees “junk fees” not disclosed in their franchise agreements and also deemed illegal certain uses of non-disparagement clauses.
The agency released new guidance Friday that was critical of franchisors’ growing use of extra fees they charge to franchisees for a variety of uses, including technology, training, marketing or property improvement.
The FTC’s guidance makes it illegal for franchisors to impose fees that are not previously disclosed in the franchise disclosure document (FDD).
The agency also released a policy statement that limits franchisors’ use of non-disparagement or other clauses that are seen as limiting franchisees’ ability to file complaints about their franchisor with government officials.
“The FTC takes seriously its statutory obligation to enforce the FTC Act,” the agency said in its policy statement. “Whether the contract includes a non-disparagement, non-disclosure, goodwill or similar clause, the case law is clear that such clauses cannot operate to inhibit a franchisee from reporting potential law violations to the government.”
“Clauses prohibiting franchisees from reporting potential law violations to the government are considered unfair and unenforceable.”
The agency’s announcement followed its request for comments on franchising last year, a request that generated more than 2,200 comments from a wide section of franchisors, franchisees and others involved in the industry.
The FTC also released an issue spotlight highlighting the top dozen concerns franchisees raised about the industry in those comments. Those concerns specifically highlighted a handful of franchises—including restaurant chains Dickey’s Barbecue Pit and Subway.
The FTC highlighted Dickey’s over franchisee concerns regarding franchisor misrepresentation of the cost it takes to operate the business, fees and royalties, supply restrictions and vendor kickbacks, disclosure issues and marketing fund transparently.
Specifically, the FTC said it received several comments from franchisees describing misrepresentations made during the sales process on startup costs, sales, revenues and profit. The agency highlighted a comment from a Dickey’s operator noting that the franchisor would tell prospective operators it would cost $400,000 to open a location.
“It will cost sometimes double that, but you don’t know until you are already heavily invested,” the franchisee said.
Vendor kickbacks, meanwhile, can drive up the cost of food and paper. Franchisors will make deals with vendors, who will sometimes pay the franchisor to get that contract—then charge the franchisee based on how much it paid the franchisor. The result can sometimes make the cost of food and paper more expensive, hurting profits for the operator.
Subway, meanwhile, was referenced in franchisee concerns about retaliation, problems renewing franchises and marketing fund transparency.
Fear of retaliation is a frequent issue in franchising, as many franchisors have non-disparagement clauses that are designed to ensure operators don’t publicly trash the brand. But many franchisees argue that this is often used to stifle dissent and prevent them from making legitimate comments to either government regulators or even prospective franchisees looking for honest feedback before investing in a business.
A quarter of the franchisee comments to the FTC were anonymous, and a quarter of those cited the fear of retaliation for their anonymity. The International Franchise Association (IFA), a trade group representing the franchise business, had been critical of the anonymous comments.
The FTC’s comments on Friday made it illegal for franchisors to take any retaliatory action against franchisees that complain to the federal government over their franchisors’ actions.
Among the other concerns the FTC cited on Friday: Franchisors’ unilateral changes to franchise operating manuals; non-compete clauses in franchise agreements; franchisors’ refusal to negotiate contract terms and clauses that charge franchisees liquidated damages if they close their stores before the end of their franchise agreements.
“Several franchisees singled out liquidated damages clauses as trapping them in unprofitable franchise systems,” the agency wrote.
The FTC’s comments on Friday continue the agency’s more deliberative approach to regulating the franchise industry. The agency had largely taken a hands-off approach to the business model, requiring disclosure but rarely enforcing any violations and leaving franchise enforcement largely up to the states.
But the agency under Chair Lina Khan appears more willing to take a harder line on some franchising practices that franchisees consider problematic.
The agency has now reopened its comment period on franchise regulations through Oct. 10, “to facilitate continued engagement with all market participants on these topics.”
Franchisee advocates cheered the announcement. “Franchising is a great business model with many great brands, but unfortunately, due to the historical lack of oversight and enforcement, it is a business model that can be abused by bad actors,” Keith Miller, a Subway franchisee and franchise advocate, said in a statement.
The IFA earlier this year made a series of recommendations designed to improve the agency’s “franchise rule.”
“IFA encourages the FTC to focus on improving the franchise rule by adopting IFA’s 2024 policy recommendations, which seek to empower prospective franchisees with the best information possible to make an informed decision before buying a franchise, and clarify both parties’ obligations as part of a franchise agreement,” Matt Haller, IFA’s CEO, said in a statement.
“The bottom line is that franchising works for the overwhelming number of existing owners and brands. As evidenced by its consistent growth and franchisees continuing to add more locations within existing systems, franchising is opening doors in every community around the nation, and IFA will continue to work to improve the model for all parties involved and the customers they serve,” he said.
Dickey’s and Subway did not respond to Restaurant Business requests for comment.
This story first appeared inRestaurant Business.
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