[Congressional Record Volume 144, Number 146 (Wednesday, October 14, 1998)]
[Extensions of Remarks]
[Pages E2172-E2174]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]




          INTRODUCTION OF SMALL BUSINESS FRANCHISE ACT OF 1998

                                 ______
                                 

                         HON. JOHN CONYERS, JR.

                              of michigan

                    in the house of representatives

                      Wednesday, October 14, 1998

  Mr. CONYERS. Mr. Speaker, I am pleased to be introducing the ``Small 
Business Franchise Act of 1998'' along with my good friend from North 
Carolina Mr. Coble. This legislation represents the culmination of many 
months of work in crafting legislation which creates an appropriate 
balance between the rights of franchisors and franchisees.
  There is currently no federal law establishing standards of conduct 
for parties to a franchise contract. The Federal Trade Commission rule 
promulgated in 1979 (16 C.F.R. 436), was designed to deter fraud and 
misrepresentation in the pre-sales process and provides disclosure 
requirements and prohibitions concerning franchising and business 
opportunity ventures. However, the FTC has consistently maintained that 
it has no jurisdiction over problems franchisees face after the 
franchise agreement is entered into.
  In the absence of any federal controls or regulation, a number of 
problems and complaints have been lodged in recent years, principally 
stemming from the fact that franchisees do not have equal bargaining 
power with large franchisors. The concerns include the following:
  Taking of Property without Compensation. The franchise relationship 
almost always includes a post-termination covenant not-to-compete which 
prohibits the franchisee from becoming an independent business owner in 
a similar business upon expiration of the contract. This can have the 
effect of appropriating to the franchisor all of the equity built up by 
the franchisee without compensation.
  Devaluation of Assets. Franchisors often induce a franchisee to 
invest in creating a business and then establish a competing outlet in 
such proximity to the existing franchisee that it causes significant 
damage or destruction to the existing franchised business.
  Restraint of Trade. Most franchise relationships mandate that 
franchisees purchase supplies, equipment, furniture, or other items 
from the franchisor or sources affiliated with or approved by the 
franchisor. While it may be appropriate for franchisors to exercise 
some control concerning the characteristics of the products or services 
offered to franchisees, tying franchisees to certain vendors can cost 
franchisees millions of dollars, prevents competition among vendors, 
and can have an adverse impact upon consumers.
  Inflated Pricing. Many franchise agreements specify that the 
franchisor has the right to enter into contractual arrangements with 
vendors who sell goods and services to franchisees that are mandated by 
the franchise agreement. It has been alleged that these vendors often 
provide kickbacks, promotional fees, and commissions to the franchisor 
in return for being allowed to sell their products and services to a 
captive market. Instead of passing these kickbacks, promotional fees, 
and commissions on to the franchisee to reduce their cost of goods sold 
and increase their margin, these payments, it is asserted, benefit the 
franchisor.
  While our nation has enjoyed an unprecedented economic boom, it is 
essential that we in Congress insure that prosperity reaches down to 
the small businesses that make up the heart and soul of our economy. 
There is of course little time left in the 105th Congress to allow for 
consideration and inaction of this legislation. However, I am hopeful 
that this legislation will be at the top of the Judiciary's committee 
agenda when we return next year, and I will be seeking hearings on this 
matter at the earliest occasion.
  The following is a section-by-section description of the legislation.

               Section 1. Short Title; Table of Contents

       Sets forth the short title of the Act and the table of 
     contents.


                    Section 2. Findings and Purpose

       Subsection (a) specifies a series of Congressional 
     findings. Subsection (b) states that the purpose of the Act 
     is to promote fair and equitable franchise agreements, to 
     establish uniform standards of conduct in franchise 
     relationships, and to create uniform private Federal remedies 
     for violations of Federal law.


                  Section 3. Franchise Sales Practices

       Subsection (a) prohibits any person, in connection with the 
     advertising, offering, or sale of any franchise, from (1) 
     employing a device, scheme, or artifice to defraud; (2) 
     engaging in an act, practice, course of business, or pattern 
     of conduct which operates or is intended to operate as a 
     fraud upon

[[Page E2173]]

     any prospective franchisee; (3) obtaining property, or 
     assisting others in doing so, by making an untrue statement 
     of a material fact or failing to state a material fact; and 
     (4) discriminating among prospective franchisees on the basis 
     of race, color, sexual orientation, sex, religion, 
     disability, national origin, or age in (a) the solicitation, 
     offering or sale of any franchise opportunity, or (b) the 
     selection of any site or location for a franchise business.
       Subsection (b) prohibits franchisors, sub franchisors, and 
     franchise brokers, in connection with any disclosure 
     document, notice, or report required by any law, from (i) 
     making an untrue statement of material fact, (ii) failing to 
     state a material fact, or (iii) failing to state any fact 
     which would render any required statement or disclosure 
     either untrue or misleading. The subsection also prohibits 
     franchisors, sub franchisors, and franchise brokers from 
     failing to furnish any prospective franchisee with all 
     information required to be disclosed by law and at the time 
     and in the manner required and from making any claim or 
     representation to a prospective franchisee, whether orally or 
     in writing, which is inconsistent with or contradicts such 
     disclosure document.
       ``Disclosure document'' is defined as the disclosure 
     statement required by the Federal Trade Commission in Trade 
     Regulation Rule 436 (16 CFR 436) or an offering circular 
     prepared in accordance with Uniform Franchise Offering 
     Circular guidelines as adopted and amended by the North 
     American Securities Administrators Association, Inc. or 
     its successor.


                 Section 4. Unfair Franchise Practices

       Subsection (a) prohibits any franchisor or subfranchisor, 
     in connection with the performance, enforcement, renewal and 
     termination of any franchise agreement, from (1) engaging in 
     an act, practice, course of business, or pattern of conduct 
     which operates as a fraud upon any person; (2) discriminating 
     among franchisees on the basis of race, color, sexual 
     orientation, sex, religion, disability, national origin, or 
     age; (3) hindering, prohibiting, or penalizing, either 
     directly or indirectly, the free association of franchisees 
     for any lawful purpose, including the formation of or 
     participation in any trade association made up of franchisees 
     or of associations of franchises; and (4) discriminating 
     against a franchisee by imposing requirements not imposed on 
     other similarly situated franchisees or otherwise 
     retaliating, directly, or indirectly, against any franchisee 
     for membership or participation in a franchisee association.
       Subsection (b) prohibits a franchisor from terminating a 
     franchise agreement prior to its expiration without good 
     cause.
       Subsection (c) prohibits a franchisor from prohibiting, or 
     enforcing a prohibition against, any franchisee from engaging 
     in any business at any location after expiration of a 
     franchise agreement. This subsection does not prohibit 
     enforcement of a franchise contract obligating a franchisee 
     after expiration or termination of a franchise to (i) cease 
     or refrain from using a trademark, trade secret or other 
     intellectual property owned by the franchisor or its 
     affiliate, except that language in the franchise agreement 
     purporting to determine ownership of a trademark, trade 
     secret, or other intellectual property shall not be binding 
     upon any court or forum for purposes of this paragraph, but 
     may be considered as evidence of such ownership, (ii) alter 
     the appearance of the business premises so that it is 
     substantially similar to the standard design, decor criteria, 
     or motif in use by other franchisees using the same name or 
     trademarks within the proximate trade or market area of the 
     business, or (iii) modify the manner or mode of business 
     operation so as to avoid any substantial confusion with the 
     manner or mode of operations which are unique to the 
     franchisor and commonly in practice by other franchisees 
     using the same name or trademarks within the proximate trade 
     or market area of the business.


                    Section 5. Standards of Conduct

       Subsection (a) imposes a duty to act in good faith in the 
     performance and enforcement of a franchise contract on each 
     party to the contract.
       Subsection (b) imposes a nonwaivable duty of due care on 
     the franchisor. Unless the franchisor represents that it has 
     greater skill or knowledge in its undertaking with its 
     franchisees, or conspicuously disclaims that it has skill or 
     knowledge, the franchisor is required to exercise the skill 
     and knowledge normally possessed by franchisors in good 
     standing in the same or similar types of business.
       Subsection (c) imposes a fiduciary duty on the franchisor 
     when the franchisor undertakes to perform bookkeeping, 
     collection, payroll, or accounting services on behalf of the 
     franchisee, or when the franchisor requires franchisees to 
     make contributions to any pooled advertising, marketing, or 
     promotional fund which is administered, controlled, or 
     supervised by the franchisor. A franchisor that administers 
     or supervises the administration of a pooled advertising or 
     promotional fund must (i) keep all pooled funds in a 
     segregated account that is not subject to the claims of 
     creditors of the franchisor, (ii) provide an independent 
     certified audit of such pooled funds within sixty days 
     following the close of the franchisor's fiscal year, and 
     (iii) disclose the source and amount of, and deliver to the 
     fund or program, any discount, rebate, compensation, or 
     payment of any kind from any person or entity with whom such 
     fund or program transacts.


                     Section 6. Procedural Fairness

       Subsection (a) prohibits a franchisor from requiring any 
     term or condition in a franchise agreement, or in any 
     agreement ancillary or collateral to a franchise, which 
     violates the Act. It also prohibits a franchisor from 
     requiring that a franchisee relieve any person from a duty 
     imposed by the Act, except as part of a settlement of a bona 
     fide dispute, or assent to any provision which would protect 
     any person against any liability to which he would otherwise 
     be subject under the Act by reason of willful misfeasance, 
     bad faith, or gross negligence in the performance of duties, 
     or by reason of reckless disregard of obligations and duties 
     under the franchise agreement. Nor may a franchisor require 
     that a franchisee agree to not make any oral or written 
     statement relating to the franchise business, the operation 
     of the franchise system, or the franchisee's experience with 
     the franchise business.
       Subsection (b) makes void and unenforceable any provision 
     of a franchise agreement, or of any agreement ancillary or 
     collateral to a franchise, which would purport to waive or 
     restrict any right granted under the Act.
       Subsection (c) forbids any stipulation or provision of a 
     franchise agreement or of an agreement ancillary or 
     collateral to a franchise from (i) depriving a franchisee of 
     the application and benefits of the act or any Federal law of 
     the State in which the franchisee's principal place of 
     business is located, (ii) depriving a franchisee of the right 
     to commence an action or arbitration against the franchisor 
     for violation of the Act, or for breach of the franchise 
     agreement or of any agreement or stipulation ancillary or 
     collateral to the franchise, in a court of arbitration forum 
     in the State of the franchisee's principal place of business, 
     or (iii) excluding collective action by franchisees to settle 
     like disputes arising from violation of the Act by civil 
     action or arbitration.
       Subsection (d) states that compliance with the Act or with 
     an applicable State franchise law is not waived, excused or 
     avoided, and evidence of violation of the Act or State law 
     shall not be excluded, by virtue of an integration clause, 
     any provision of a franchise agreement or an agreement 
     ancillary or collateral to a franchise, the parol evidence 
     rule, or any other rule of evidence purporting to exclude 
     consideration of matters outside the franchise agreement.


             Section 7. Actions by State Attorneys General

       Subsection (a) permits a State attorney general to bring an 
     action under the Act in an appropriate United States district 
     court using the powers conferred on the attorney general by 
     the laws of his State.
       Subsection (b) states that this section does not prohibit a 
     State attorney general from exercising the powers conferred 
     on him by the laws of his State to conduct investigations or 
     to administer oaths or affirmations or to compel the 
     attendance of witnesses or the production of documentary and 
     other evidence.
       Subsection (c) states that any civil action brought under 
     subsection (a) in a United States district court may be 
     brought in the district in which the defendant is found, is 
     an inhabitant, or transacts business, or wherever venue is 
     proper under 28 U.S.C. 1391 which establishes general venue 
     rules. Process may be served in any district in which the 
     defendant is an inhabitant or in which he may be found.
       Subsection (d) states that nothing in this section shall 
     prohibit an authorized State official from proceeding in 
     State court on the basis of an alleged violation of any civil 
     or criminal statute of such State.


                   Section 8. Transfer of a Franchise

       Subsection (a) permits a franchisee to assign an interest 
     in a franchised business and franchise to a transferee if the 
     transferee satisfies the reasonable qualifications generally 
     applied in determining whether or not a current franchisee is 
     eligible for renewal. If the franchisor does not renew a 
     significant number of its franchisees, then the transferee 
     may be required to satisfy the reasonable conditions 
     generally applied to new franchisees. The qualifications must 
     be based upon legitimate business reasons. If the 
     qualifications are not met, the franchisor may refuse to 
     permit the transfer, provided that the refusal is not 
     arbitrary or capricious and the franchisor states the grounds 
     for its refusal in writing to the franchisee.
       Subsection (b) requires that a franchisee give the 
     franchisor at least thirty days' written notice of a proposed 
     transfer, and that a franchisee, upon request, will provide 
     in writing to the franchisor a list of the ownership 
     interests of all persons holding or claiming an equitable or 
     beneficial interest in the franchise subsequent to the 
     transfer.
       Subsection (c) states that a franchisor is deemed to have 
     consented to a transfer thirty days after the request for 
     consent is submitted, unless the franchisor withholds consent 
     in writing during that time period specifying the reasons for 
     doing so. Any such notice is privileged against a claim of 
     defamation.
       Subsection (d) establishes that a franchisor may require 
     the following four conditions before consenting to a 
     transfer: (1) the transferee successfully complete a 
     reasonable training program, (2) payment of a reasonable 
     transfer fee, (3) the franchisee pay or

[[Page E2174]]

     make reasonable provisions to pay any amount due the 
     franchisor or the franchisor's affiliate, (4) the financial 
     terms of the transfer at the time of the transfer comply with 
     the franchisor's current financial requirements for 
     franchisees. A franchisor may not condition its consent to a 
     transfer on (1) a franchisee forgoing existing rights other 
     than those contained in the franchise agreement, (2) entering 
     into a release of claims broader in scope than a counterpart 
     release of claims offered by the franchisor to the 
     franchisee, or (3) requiring the franchisee or transferee to 
     make, or agree to make, capital improvements, reinvestments, 
     or purchases in an amount greater than the franchisor could 
     have reasonably required under the terms of the franchisee's 
     existing franchise agreement.
       Subsection (e) permits a franchisee to assign his interest 
     for the unexpired term of the franchise agreement and 
     prohibits the franchisor from requiring the franchisee or 
     transferee to enter an agreement which has different material 
     terms or financial requirements as a condition of the 
     transfer.
       Subsection (f) prohibits a franchisor from withholding its 
     consent without good cause to a franchisee making a public 
     offering of its securities if the franchisee or owner of the 
     franchisee's interest retains control over more than 25 
     percent of the voting power as the franchisee.
       Subsection (g) prohibits a franchisor from withholding its 
     consent to a pooling of interests, to a sale or exchange of 
     assets or securities, or to any other business consolidation 
     among its existing franchisees, provided the constituents are 
     each in material compliance with their respective obligations 
     to the franchisor.
       Subsection (h) establishes six occurrences which shall not 
     be considered transfers requiring the consent of the 
     franchisor under a franchise agreement and for which the 
     franchisor shall not impose any fees or payments or changes 
     in excess of the franchisor's cost to review the matter.
       Subsection (i) prohibits a franchisor from enforcing 
     against the transferor any covenant of the franchise 
     purporting to prohibit the transferor from engaging in any 
     lawful occupation or enterprise after the transfer of a 
     transferor's complete interest in a franchise. This 
     subsection does not limit the franchisor from enforcing a 
     contractual covenant against the transferor not to exploit 
     the franchisor's trade secrets or intellectual property 
     rights except by agreement with the franchisor.


             Section 9. Transfer of Franchise by Franchisor

       Subsection (1) prohibits a franchisor from transferring 
     interest in a franchise by sale or in any other manner unless 
     he give notice thirty days prior to the effective date of the 
     transfer to every franchisee of his intent to transfer the 
     interest.
       Subsection (2) requires that the notice given contains a 
     complete description of the business and financial terms of 
     the proposed transfer or transfers.
       Subsection (3) requires that the entity assuming the 
     franchisor's obligations have the business experience and 
     financial means necessary to perform the fanchisor's 
     obligations.


         Section 10. Independent Sourcing of Goods and Services

       Subsection (a) prohibits a franchisor from prohibiting or 
     restricting a franchisee from obtaining equipment, fixtures, 
     supplies, goods or services used in the establishment or 
     operation of the franchised business from sources of the 
     franchisee's choosing, except that such goods or services may 
     be required to meet established uniform system-wide quality 
     standards promulgated or enforced by the franchisor.
       Subsection (b) requires that if the franchisor approves 
     vendors of equipment, fixtures, supplies, goods, or services 
     used in the establishment or operation of the franchised 
     business, the franchisor will provide and continuously update 
     an inclusive list of approved vendors and will promptly 
     evaluate and respond to reasonable requests by franchisees 
     for approval of competitive sources of supply. The franchisor 
     shall approve not fewer than two vendors for each piece of 
     equipment, each fixture, each supply, good, or service.
       Subsection (c) requires a franchisor and its affiliates 
     officers and/or its managing agents, must fully disclose 
     whether or not it receives any rebates, commissions, 
     payments, or other benefits from vendors as a result of the 
     purchase of goods or services by franchisees and requires a 
     franchisor to pass all such rebates, commissions, payments, 
     and other benefits directly to the franchisee.
       Subsection (d) requires a franchisor to report not less 
     frequently than annually, using generally accepted accounting 
     principles, the amount of revenue and profit it earns from 
     the sale of equipment, fixtures, supplies, goods, or services 
     to the franchisee.
       Subsection (e) excepts reasonable quantities of goods and 
     services that the franchisor requires the franchisee to 
     obtain from the franchisor or its affiliate from the 
     requirements of subsection (a), but only if the goods and 
     services are central to the franchised business and either 
     are actually manufactured or produced by the franchisor or 
     its affiliate, or incorporate a trade secret owned by the 
     franchisor or its affiliate.


                        Section 11. Encroachment

       Subsection (a) prohibits a franchisor from placing, or 
     licensing another to place, one or more, new outlet(s) in 
     unreasonable proximity to an established outlet, if (i) the 
     intent or probable effect of establishing the new outlet(s) 
     is to cause a diminution of gross sales by the established 
     outlet of more than five percent of the twelve months 
     immediately following establishment of the new outlet(s), and 
     (ii) the established franchisee offers goods or services 
     identified by the same trademark as those offered by the new 
     outlet(s), or has premises that are identified by the same 
     trademark as the new outlet(s).
       Subsection (b) creates an exception to this section if, 
     before a new outlet(s) opens for business, a franchisor 
     offers in writing to each franchisee of an established outlet 
     concerned to pay to the franchisee an amount equal to fifty 
     percent of the gross sales of the new outlet(s), for the 
     first twenty-four months of operation of the new outlet(s), 
     if the sales of the established outlet decline by more than 
     five percent in the twelve months immediately following 
     establishment of the new outlet(s), as a consequence of the 
     opening of such outlet(s).
       Subsection (c) places upon the franchisor the burden of 
     proof to show that, or the extent to which, a decline in 
     sales of a established franchised outlet occurred for reasons 
     other than the opening of the new outlet(s), if the 
     franchisor makes a written offer under subsection (b) or in 
     an action or proceeding brought under section 12.


                  Section 12. Private Right of Action

       Subsection (a) gives a party to a franchise who is injured 
     by a violation or impending violation of this Act a right of 
     action for all damages caused by the violation, including 
     costs of litigation and reasonable attorney's fees, against 
     any person found to be liable for such violation.
       Subsection (b) makes jointly and severally liable every 
     person who directly or indirectly controls a person liable 
     under subsection (a), every partner in a firm so liable, 
     every principal executive officer or director of a 
     corporation so liable, every person occupying a similar 
     status or performing similar functions and every employee of 
     a person so liable who materially aids in the act or 
     transaction constituting the violation, unless that person 
     who would otherwise be liable hereunder had no knowledge of 
     or reasonable grounds to know of the existence of the facts 
     by reason of which the liability is alleged to exist.
       Subsection (c) states that nothing in the Act shall be 
     construed to limit the right of a franchisor and a franchisee 
     to engage in arbitration, medication, or other nonjudicial 
     dispute resolution, either in advance or after a dispute 
     arises, provided that the standards and protections applied 
     in any binding nonjudicial procedure agreed to the parties 
     are not less than the requirements set forth in the Act.
       Subsection (d) prohibits an action from being commenced 
     more than five years after the date on which the violation 
     occurs, or three years after the date on which the violation 
     is discovered or should have been discovered through exercise 
     of reasonable diligence.
       Subsection (e) provides for venue in the jurisdiction where 
     the franchise business is located.
       Subsection (f) states that the private rights created by 
     the Act are in addition to, and not in lieu of, other rights 
     or remedies created by Federal or State law.


                  Section 13. Scope and Applicability

       Subsection (a) applies the requirements of the Act to 
     franchise agreements entered into, amended, exchanged, or 
     renewed after the date of enactment of the Act, except as 
     provided in subsection (b).
       Subsection (b) delays implementation of Section 3 of the 
     act until ninety days after the date or enactment of the Act 
     and applies Section 3's requirements only to actions, 
     practices, disclosures, and statements occurring on or after 
     such date.


                        Section 14. Definitions

       Defines terms used in the Act.

       

                          ____________________