Franchise Fraud in U.S. Federal Law

Franchise fraud
From Wikipedia, the free encyclopedia
This article may require cleanup to meet Wikipedia's quality
standards. No cleanup reason has been specified. Please help improve thi
article if you can. (December 2010) (Learn how and when to remove this template
message)
Franchise fraud is defined by the United States Federal Bureau of Investigation as a pyramid
scheme.
Contents
[hide]
1Franchise fraud in U.S. federal law

o
1.1Means of committing franchise fraud

2Franchise fraud law in the U.S. state by state
2.1California
2.2Indiana
3See also
4References
o
4.1Bibliography
5Further reading
5.1Books and papers
5.2Newspapers
Franchise fraud in U.S. federal law[edit]

The FBI website states:
"pyramid schemes also referred to as franchise fraud or chain referral schemes
are marketing and investment frauds in which an individual is offered a distributorship
or franchise to market a particular product. The real profit is earned, not by the sale of
the product, but by the sale of new distributorships. Emphasis on selling franchises
rather than the product eventually leads to a point where the supply of potential
investors is exhausted and the pyramid collapses."
[1]
In the United States, franchising is regulated by a complex web of franchise rules and
franchising regulations consisting of the Federal Trade Commission Franchise Rule, state
laws, and industry guidelines.[2]
The most recent version of the FTC Franchise Rule was in 2007, is printed in FR 2007a,
pp. 1554415575.
The FTC franchise rule specifies what information a franchisor must disclose to a
prospective franchise business as a franchise opportunity in a document named
the Franchise Disclosure Document (FDD). [3][4]
Means of committing franchise fraud[edit]

Franchisors that practice franchise fraud will attempt to pressure a franchisee leaving the
franchise system to sign a non-disclosure agreement, confidentiality agreement or a gag
order. The gag order allows franchise misrepresentation by preventing prospective new
franchisees learning important details about the churning franchise. Unfortunately, the
Federal Trade Commission Rule and the State Franchise Disclosure Documents that
govern the sale of franchises appear to enable franchisors to withhold negative facts
concerning the performance of the franchised business plan from new buyers of franchises
and to disclaim that the franchisors have promised anything in the way of success and
profits in the written disclosure document and the binding, and generally non-negotiated,
franchise agreement. The sellers of franchised business plans, the franchisors,
themselves, appear to have no obligation under current rules and regulations to disclose
negative system UNIT performance statistics to new buyers of the franchised business
plans who then unknowingly purchase franchises that have demonstrated low or no
profitability and high failure rates of "founding" franchisees.
Uniquely, franchisors, themselves, under the FTC Rule and the State Franchise Disclosure
Documents appear not to have to disclose system UNIT Performance Statistics in their
possession to new buyers, and new buyers of franchises must do their due diligence with
current and ex-franchisees. It should be noted that current and ex-franchisees of systems
have no duty under the law to disclose information about their businesses to prospective
franchisees.
In the 2007 Franchise Rule, in the Federal Register from pages 15505 to 15506,
comments from former franchisees were listed concerning confidentiality agreements:
"commenters complained that the use of confidentiality clauses is widespread, and

several commenters urged the Commission to ban the use of confidentiality clauses as
a deceptive or unfair trade practice. Other opponents of confidentiality clauses
including state regulators and some franchisorsasserted that such provisions inhibit
prospective franchisees from learning the truth as they conduct their due diligence
investigation of a franchise offer."
"one franchisee representative, contended that the harm flowing from confidentiality
provisions goes beyond individual franchise sales, noting that such provisions
intimidate franchisees into not testifying before legislative committees and public
agencies, such as the Federal Trade Commission."
"[T]he gag order . . . prohibits me from being able to answer questions, you know, and
give cautionary remarks to other people who might be considering the franchise that I
was with."
"the use of gag orders is almost 100 percent in some franchise systems."
"Three franchisees Raymond Buckley, Roger C. Haines, and David E. Myklebust

believed that they were kept in the dark about the failure of their franchisors system
due to confidentiality clauses imposed on current and former franchisees."
"confidentiality clauses "typically release the franchisor from legal liability and bar the
franchisee (under threat of legal action) from making any oral or written statements
about the franchise system or their experience with the franchised business. The
purpose of such clauses is to shut down any negative public comment about the
franchise system."
"franchisee, related: "I had spoken to some of the franchisees that had left the system.
I now feel certain that they painted a picture that was not close to being the truth based
on the gag order that [the franchisor] imposed. Had I gotten the truth from these
people, my decision certainly would have been different. Every franchisee leaving the
system has had a gag order placed on them, making it impossible for current and
future franchisees to get the facts."
By having former franchisees under a gag order, franchisors that practice business
franchise fraud or franchise churning "inhibit prospective franchisees from learning the
truth about the franchising opportunity as they conduct their due diligence investigation of
a franchise offer." (page 15505 of the Federal Register Franchise Rule)
Franchise fraud law in the U.S. state by state[edit]

This section requires expansion.
(December 2010)
California[edit]
California Franchise Investment Law,[5] begins at section 31000 of the California
Corporations Code.[6] Part 1 lists the definitions of the California Franchise code. Part 2 is
the Regulation Of The Sale Of Franchises. There are three chapters, 1) Exemptions, 2)
Disclosures, and 3) General Provisions.
Under chapter 2, section 31125 the following exists
(A) The proposed modification is in connection with the resolution of a bona fide
dispute between the franchisor and the franchisee or the resolution of a claimed or
actual franchisee or franchisor default, and the modification is not applied on a
franchise systemwide basis at or about the time the modification is executed. A
modification shall not be deemed to be made on a franchise systemwide basis if it is
offered on a voluntary basis to fewer than 25 percent of the franchisor's California
franchises within any12-month period.
(B) The proposed modification is offered on a voluntary basis to fewer than 25
percent of the franchisor's California franchises within any 12-month period, provided
each franchisee is given a right to rescind the modification agreement if the
modification is not made in compliance with paragraph (1) of subdivision (c).
(d) Any modification of a franchise agreement with an existing franchise of a
franchisee shall be exempted from this chapter if the modification is offered on a
voluntary basis and does not substantially and adversely impact the franchisee's rights,
benefits, privileges, duties, obligations, or responsibilities under the franchise
agreement.
(f) A franchisor shall not make modifications in consecutive years for the purpose of
evading the 25 percent requirements set forth above.
If a franchisor in California keeps less than 25% of former California
franchisees (not nationwide franchisees), per year, under a Gag order,
there is no violation. The modification agreement can have a clause in the
document stating that it was "signed voluntarily".
Part 3 of this code describes Fraudulent and Prohibited Practices. Chapter
1 describes Fraudulent practices.[7] Chapter 2 describes Prohibited
practices.[8] Chapter 3 describes Unfair practices.[9]
Indiana[edit]
In Indiana fraud, deceit, and misrepresentation during the process of
franchise contract formation or performance is actionable at civil law under
the Indiana Franchise Act. There is no general right of action, only a
specific right of private action by a party on the aforementioned grounds.
The scope of franchise fraud is also narrower than the scope of ordinary
common law fraud action. The Indiana Supreme Court holds that "the
circumstances of fraud would be the time, the place, the substance of the
false representations, the facts mispresented, and the identification of
what was procured by the fraud. [ However,] the plaintiff in a franchise
fraud action must nevertheless plead the facts and circumstances alleged
to constitute fraud, deceit, or misrepresentation with at least the same
degree of particularity and detail as would be necessary to maintain an
action for common law fraud".[10]
Also held by the Supreme Court is that scienter is not an element of
franchise fraud. Nor does failure to disclose on the part of a franchisor a
pending civil lawsuit at the time of making a franchise agreement
constitute franchise fraud, so long as any such representations as to legal
action are not relied upon by either party as part of their decision-making
process. Statements by the franchisor as to potential earnings by the
franchisee do not constitute franchise fraud, since they do not constitute a
material (mis-)representation of past or existing facts.[11]
Civil action under the Franchise Disclosure Act must be brought within
three years of discovery of the violation. Action brought under the
Deceptive Franchise Practices Act must be brought within two. [11]
See also[edit]
American Association of Franchisees and Dealers
Franchise termination
Censorship
Chilling effect (law)
Fear mongering
Franchise Disclosure Document
Franchising
Rollovers as Business Start-Ups
The Franchise Rule
Frivolous litigation
Legal threat
SLAPP
U.S. Securities and Exchange Commission
References[edit]
1.
Jump up^ FBI Common Fraud Schemes. Fbi.gov. Retrieved on 201012-06.
2.
Jump up^ "AN OVERVIEW OF FRANCHISE REGULATION IN THE

UNITED STATES". Franchise Law Source. Kern & Hillman LLC.
3.
Jump up^ Franchise and Business Opportunities | BCP Business

Center. Business.ftc.gov. Retrieved on 2010-12-06.
4.
Jump up^ FTC Issues Updated Franchise Rule. Ftc.gov. Retrieved on

2010-12-06.
5.
Jump up^ http://www.corp.ca.gov/srd/ccfil.asp
6.
Jump up^ "CALIFORNIA CORPORATIONS CODE". Retrieved 22

March 2015.
7.
Jump up^ "WAIS Document Retrieval". Retrieved 22 March 2015.
8.
Jump up^ "CA Codes (corp:31210-31211)". Retrieved 22 March 2015.
9.
Jump up^ "CA Codes (corp:31220)". Retrieved 22 March 2015.
10. Jump up^ Garner 2001, pp. 278279.

11. ^ Jump up to:a b Garner 2001, p. 279.
Bibliography[edit]
Garner, W. Michael (2001). "Indiana". Franchise desk book: selected

state laws, commentary and annotations (2nd ed.). American Bar
Association. ISBN 978-1-57073-972-9.
Further reading[edit]

Franchise Fraud in U.S. Federal Law

Uploaded by

Copyright:

Available Formats

Franchise Fraud in U.S. Federal Law

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Franchise Fraud in U.S. Federal Law

Uploaded by

Copyright:

Available Formats

Franchise fraud

From Wikipedia, the free encyclopedia

This article may require cleanup to meet Wikipedia's quality

1Franchise fraud in U.S. federal law

1.1Means of committing franchise fraud

5.1Books and papers

Franchise fraud in U.S. federal law[edit]

Means of committing franchise fraud[edit]

"commenters complained that the use of confidentiality clauses is widespread, and

"Three franchisees Raymond Buckley, Roger C. Haines, and David E. Myklebust

Franchise fraud law in the U.S. state by state[edit]

American Association of Franchisees and Dealers

Chilling effect (law)

Franchise Disclosure Document

Rollovers as Business Start-Ups

The Franchise Rule

U.S. Securities and Exchange Commission

Jump up^ FBI Common Fraud Schemes. Fbi.gov. Retrieved on 201012-06.

Jump up^ "AN OVERVIEW OF FRANCHISE REGULATION IN THE

Jump up^ Franchise and Business Opportunities | BCP Business

Jump up^ FTC Issues Updated Franchise Rule. Ftc.gov. Retrieved on

Jump up^ http://www.corp.ca.gov/srd/ccfil.asp

Jump up^ "CALIFORNIA CORPORATIONS CODE". Retrieved 22

Jump up^ "WAIS Document Retrieval". Retrieved 22 March 2015.

Jump up^ "CA Codes (corp:31210-31211)". Retrieved 22 March 2015.

Jump up^ "CA Codes (corp:31220)". Retrieved 22 March 2015.

10. Jump up^ Garner 2001, pp. 278279.

Garner, W. Michael (2001). "Indiana". Franchise desk book: selected

You might also like