FTC fires warning shot over franchisor disclosures
For the past few years now, franchise lawyers and lobbyists have been telling fast-food chains that the Federal Trade Commission has all but given up enforcing those cumbersome franchise disclosure rules adopted to protect prospective franchisees during the late 1970’s.
But late last month FTC’s Consumer Protection Bureau fired a warning shot that should serve notice to the nation’s restaurant franchisors that those preoffering disclosure requirements are still very much alive.
The commission’s target: New Jersey-based Philly Mignon–a financially troubled fast-food chain charged with a string of Franchise Rule violations ranging from failure to distribute the required disclosure document to prospective investors to making unsubstantiated earnings claims.
Although top officials at the chain did not admit to committing any of these alleged violations, they did agree to pay FTC at least 5% of the sales price of all franchises sold during the next four years (a minimum of $87 each) in settlement of the charges.
Philly Mignon’s minimum liability under the agreement will be $80,000 (plus interest), but according to FTC officials the total could run far higher if the chain’s “future sales increase dramatically over the next four years.”
But that’s just for openers. To guarantee payment of the penalty–all of which will go directly to the Federal Treasury–the agreement requires Philly Mignon to set aside a proportion of its franchise fees in escrow and to provide FTC with a $70,000 second mortgage on the chain’s Chester, N.J., corporate headquarters.
On top of that, the chain’s two principals–John R. Fiddes Jr. and Frederick B. Collins–will each be required to provide the commission with a $35,000 security interest mortgage on their personal homes.
According to the FTC complaint that prompted that order, Philly Mignon did not provide “complete and accurate information” in the disclosure documents which it distributed to prospective franchisees, failed to supply some investors with any of the required documents and did not make the necessary earnings claims disclosures required of any franchisor who makes representations about potential franchisee sales, earnings or profits.
In addition, FTC charged the chain with a series of other “unfair or deceptive acts” which would be illegal even if there were no Federal franchise disclosure law.
Among other things, the chain told prospects “that most existing [Philly Mignon] franchisees are highly successful, with typical franchises earning thousands of dollars in profits in their first year of operation,” FTC said. “In fact, the great majority of [the chain’s] franchisees are … unprofitable, and few, if any, have achieved the revenues and profit claimed by” Fiddes and Collins.
Further, FTC charged that the franchisor “substantially” understated the average investment needed to launch a Philly Mignon restaurant, and failed to follow through on presale promises to secure “suitable sites” for franchises or to provide franchisees with “substantial ongoing management assistance and support after the opening of their restaurants.”
As for the company’s claim that most of its franchised outlets open for business within six months, commission investigators charged that in reality “many [Philly Mignon] franchisees have never opened, and those franchises that have opened have done so more than six months after contract execution.”
As a result of these alleged misrepresentations and franchise rule violations, FTC charged that individuals purchasing Philly Mignon franchises suffered “substantial” losses ranging from “$8,000 to $100,000.”
Don’t be misled by the relatively modest $80,000 penalty imposed on the New Jersey food-service franchisor by FTC. Although such a fine would barely merit a footnote in the financial statements of most major fast feeders, commission officials told Nation’s Restaurant News that they softened the penalty to avoid forcing Philly Mignon out of business altogether.
In announcing the settlement, FTC officials noted that they “would have sought a much larger civil penalty, of several hundred thousand dollars, but the company is in serious financial difficulties.”
For the same reason, attorneys at FTC’s New York Regional Office told NRN that they dropped a separate plan to seek “redress” for individual Philly Mignon franchisees injured by the chain’s practices.
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