Are franchisees well-informed? Revisiting the debate over franchise relationship laws.

• Author: Emerson, Robert W.

Abstract

The most vital debate in the field of franchise contract law over the last few decades has focused on the following issue: Whether the law should protect franchisees against franchisor opportunism. Franchisor advocates suggest that franchisee protection laws, commonly known as "franchise relationship laws," are undesirable. Their opposition to such laws is based primarily on an assumption that franchisees consider all relevant information before signing a franchise contract and make a well-informed choice among the range of franchise alternatives available. In particular, prior to signing the contract, franchisees are assumed to have read the franchise disclosure documents made available to them, compare the various contracts and disclosure documents offered by different franchisors, and consult with a specialized franchise attorney regarding the terms of the franchise contract. Since franchisees consider all of the relevant information and make a well-informed decision, they do not deserve, according to franchisor advocates, any special legislative protection that would interfere with the franchisor-franchisee free-market relationship.

Based on a significant body of existing empirical research, which has thus far been overlooked in the debate over franchise relationship laws, this article will argue that the assumption that franchisees consider all relevant information before signing a franchise contract and make a well-informed choice is questionable. Briefly summarized, the argument presented in this article is as follows: New franchisees that join a franchise network normally lack prior business ownership experience. This lack of experience presents significant cognitive obstacles for novice franchisees when attempting to consider all of the relevant information before acquiring ownership of a franchise unit. Such cognitive obstacles-contrary to the franchisor advocates' view--often lead franchisees to ignore franchise disclosure documents, avoid conducting a comparison between various franchise contracts and disclosure documents, and neglect to consult with a specialized franchise attorney prior to signing the franchise contract. Given this reality, theoreticians and legislators interested in creating franchise laws that protect novice franchisees from possible opportunism by franchisors must cast doubt on the assumption that franchisees are well-informed business people and incorporate into their analyses a more representative conception of franchisee characteristics.

1. INTRODUCTION II. FRANCHISE RELATIONSHIP LAWS--OVERVIEW III. THE FRANCHISOR ADVOCATES' VIEW IV. THE CRITIQUE A. New Franchisees Lack Prior Business Ownership Experience 1. Explanation 2. Empirical Evidence B. Inexperienced Franchisees Ignore Relevant Information 1. Explanation 2. Empirical Evidence V. CONCLUSION I. INTRODUCTION

   The most vital debate in the field of franchise contract law over the last few decades has focused on the issue of whether the law should protect franchisees against franchisor opportunism. (1) Franchisor advocates claim that franchisee protection laws, commonly known as "franchise relationship laws," are undesirable. (2) Their opposition to such laws is based mainly on an assumption that franchisees consider all relevant information before signing a franchise contract and make a well-informed choice among the range of franchise alternatives available. (3) In particular, according to this analysis, prior to signing the franchise contract, franchisees read the franchise disclosure documents made available to them before signing the franchise contract, compare the various contracts and disclosure documents offered by different franchisors, and consult with a specialized franchise attorney regarding the terms of the franchise contract. (4) According to franchisor advocates, since franchisees consider all of the relevant information and make well-informed decisions, they do not require any special legislative protection that would interfere with the franchisor-franchisee free market relationship. (5) Franchisor advocates' opposition to franchise relationship laws has been significantly influential in the development of franchise law in general, as is evident in state and federal policy making. (6) To date, most states have refused to adopt general franchise relationship laws. (7) At the federal level, such laws have been rejected entirely. (8)

   Empirical evidence, however, casts significant doubt on the theoretical assumption that, before signing a franchise contract, franchisees consider all relevant information which leads to a well-informed choice. (9) Briefly summarized, the argument presented in this article is as follows: New franchisees that join a franchise network normally lack prior business ownership experience. (10) This lack of experience presents significant cognitive obstacles for novice franchisees when attempting to consider all of the relevant information before acquiring ownership of a franchise unit. (11) Specifically, inexperienced franchisees often do not know in which subjects they are ignorant or what information they should consider before acquiring ownership of a franchise unit (the "unawareness problem"). (12) In addition, unseasoned franchisees must invest significant cognitive efforts in distinguishing between relevant and irrelevant business and legal information on franchise ownership ("screening difficulty"). (13) Finally, novice franchisees have great difficulty in fully understanding the business and legal data to which they are exposed in the pre-contractual process, or how to place it in context, evaluate it, and act accordingly ("comprehension limitations"). (14) Such cognitive obstacles often lead franchisees-contrary to the franchisor advocates' view--to ignore franchise disclosure documents, avoid conducting a comparison between various franchise contracts and disclosure documents, and neglect to consult with a specialized franchise attorney prior to signing the franchise contract. (15)

   This article proceeds as follows: Part II will provide legal context by briefly reviewing the statutory framework underlying the debate over the desirability of franchise relationship laws. Part III will provide theoretical context through outlining the assumption on which franchisor advocates base their opposition to franchise relationship laws--namely, that franchisees consider all relevant information before signing a franchise contract and make a well-informed decision. Part IV will present our critique of the franchisor advocates' assumption.

2. FRANCHISE RELATIONSHIP LAWS--OVERVIEW

   Franchise relationship laws are statutes that mainly govern the ongoing relationship between franchisors and franchisees. (16) These laws have two central alleged purposes: first, to correct a perceived inequality in bargaining power between franchisors and franchisees; (17) and second, to protect franchisees against perceived abusive behavior by franchisors, (18) The major franchisor abuses (19) at which franchise relationship laws are aimed include: unjust termination of the franchise contract without adequate notice or reasonable cause, (20) restrictions on free association among franchisees, (21) requirements of arbitration outside the franchisee's state, (22) and encroachment on the franchisee's territory--namely, establishment of a new franchise unit in unreasonable proximity to an existing franchisee. (23) Notably, such abuses often are prohibited by mandatory franchise relationship laws, regardless of the express franchise contract provisions. (24)

   To date, only a minority of states have enacted general franchise relationship laws that are not restricted to particular industries. (25)

   In addition, several states have industry-specific franchise relationship laws. (26) These industry-specific statutes relate to automobile dealerships, (27) alcoholic beverages, (28) farm equipment, (29) petroleum, (30) and office products, (31) among other industries (32)

   At the federal level, several general franchise relationship bills have been introduced, but all were rejected. (33) For example, a federal franchise relationship law of general application was proposed in 1971; however, no such law has ever been adopted. (34) In 1992, former Democratic Congressman James H. Scheuer introduced a franchise relationship bill which ultimately was not adopted. (35) Similarly, former Democratic Congressman John J. LaFalce in 1993 and 1995, and Republican Congressman Howard Coble in 1998 and 1999, each proposed franchise relationship bills that did not pass. (36) In addition, in 2007, the Federal Trade Commission (FTC) considered but eventually rejected federal regulation of the franchise relationship. (37) To date, there is no franchise relationship law of general application in existence. (38)

   While broad legislative efforts have failed at the federal level, franchisees in certain industries have been successful in obtaining two central federal industry-specific relationship laws. (39) The first federal law specifically regulating franchise relationships was the Automobile Dealers' Franchise Act, commonly known as the Dealers' Day in Court Act (ADDCA). (40) Broadly speaking, the ADDCA provides that the franchisor must act in "good faith," not only in performing the franchise contract, but also in terminating the contract. (41) In 1978, Congress adopted another federal law, the Petroleum Marketing Practices Act (the PMPA), which sets forth procedures that a gas station franchisor must follow before it may terminate or refuse to renew a franchisee. (42)

3. THE FRANCHISOR ADVOCATES' VIEW

   Franchisor advocates suggest that franchisees do not need any special legal protection against franchisor abuses under franchise relationship laws or other legal regimes. (43) To begin with, franchisor advocates assume that franchisees are sophisticated business people. (44) As Larry Ribstein explains, in franchise contracts...