Restaurant Chain Franchises Face Scrutiny From the FTC

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Kenneth Laskin felt like a family member rather than just a potential franchisee when he flew to California to meet with executives of Burgerim, a start-up chain of restaurants.

He mentioned that the company’s executives stressed their shared Jewish faith by engaging in a Hebrew prayer session with him one evening.

Back in 2017, Mr. Laskin thought he struck a great deal. For $50,000, he obtained the rights to launch any number of Burgerim franchise restaurants he desired in Oregon. As Mr. Laskin put it, “I got an entire state.”

Currently, Burgerim is facing challenges, leaving a path of financial difficulties, a Federal Trade Commission lawsuit and raising questions regarding the adequacy of franchisee protection, exemplified by Mr. Laskin’s case.

The issues underscored by Burgerim occur as more people are opting to start small businesses via franchising.

Concerns over the need for stronger franchisee protection in contracts with franchisors have been growing. These concerns have gained traction in the Biden administration and numerous state legislatures, leading to several proposed restrictions on franchisors’ authority.

In the end, Mr. Laskin was only able to open a single Burgerim outpost, situated in Eugene, Oregon, which shut its doors in 2020 amid the pandemic. Since then, Mr. Laskin has been using his savings to cover his bills.

Burgerim, praised for its creative and high-quality burgers, is under fire from ex-franchisees for making lofty promises and lacking transparency about business risks. The commission, in a lawsuit filed last year against the company and its founder in U.S. District Court in California, stated that most of the 1,500+ franchises Burgerim sold never opened their doors.

Peter Bronstein, the attorney representing Oren Loni, the former principal executive of Burgerim in the United States, argued that while Burgerim made some business blunders, it generally aimed to aid its franchisees in succeeding. The court record reveals the two parties are currently in mediation.

Even amidst the pandemic, the count of franchised businesses grew 2.8% in 2021 and 2% in 2022 in the U.S., with projections of a further 2% increase this year, taking the total to 805,436 franchises. This data comes from the latest release by the International Franchise Association, a trade body.

As the franchise network expands, so does its impact on the overall economy. In 2022, franchises employed 8.4 million individuals, marking a 3% increase from 2021.

Based on historical records from the International Franchise Association, the initial U.S. franchise traces its origins back to Ben Franklin, who established a network of printing collaborations.

Presently, the core symbiotic relationship propelling the business model involves franchisees paying an upfront fee to a franchisor like Applebee’s or Dunkin’ Donuts, granting them access to the brand’s technology, advertising, and suppliers. Rather than starting from zero, the franchisee can leverage these established structures to quickly launch their business. In return, the franchisor receives the franchise fee, often amounting to tens of thousands of dollars, and a consistent royalty payment from the franchisee.

Charlie Chase, the CEO of FirstService Brands, a franchisor of house painting and renovation services, commented, “Franchising has always been an on-ramp for the middle class to open their own business.”

Over the years, according to Mr. Chase, who served on the International Franchise Association’s board of directors, he has assisted numerous successful franchisees in their start-up journey. “We have created a lot of millionaires,” he said.

Nevertheless, Chase expressed concern about some franchisees who are pressured into businesses without a full understanding of the associated risks.

Chase attributes part of this issue to aggressive web marketing (Mr. Laskin discovered Burgerim through a Facebook ad, for instance) and a network of third-party agents who often encourage prospective franchisees to purchase multiple franchises simultaneously.

The Federal Trade Commission, under Lina Khan’s leadership, is casting a wide net to examine industry practices, including disclosure and issues such as altering the terms of a franchisor franchisee agreement without mutual consent.

“Franchising can be a good business model, but it can also lead to a lot of harm,” said Elizabeth Wilkins, Director of the Commission’s Office of Policy and Planning. “We are concerned about instances where the promise does not match with reality. We believe there is a significant gap that is worth our investigation.”

In the case against Burgerim, federal officials argued that the company executives assured franchisees that franchise fees would be refunded if their businesses didn’t open. However, a significant number of people never got their money back. According to Mr. Bronstein, Mr. Loni’s lawyer, offering refunds “was not the best way to run a business.”

From the 2008 financial crisis onward, regulators have strengthened protections for consumers by compelling greater disclosure by banks and prohibiting certain charges they can levy. However, small businesses, including franchisees, haven’t seen the same level of regulatory scrutiny.

“There’s a belief in the consumer protection space that small businesses don’t receive the same level of protection as other consumers,” notes Samuel Levine, the director of the F.T.C.’s Bureau of Consumer Protection. “However, consumers and small businesses, including franchisees, face many of the same challenges. This is what we’re hoping to address.”

As part of this endeavor, the Federal Trade Commission is exploring applying laws like the Robinson-Patman Act, an antitrust statute that prevents major corporations from leveraging discriminatory pricing tactics against small businesses. Furthermore, the agency has proposed a regulation that would ban non-compete clauses in work contracts and may also contemplate limiting the use of non-compete clauses in franchise agreements.

When Mr. Laskin bought a franchise, he wasn’t aspiring to become a millionaire. Instead, he wanted to secure a stable middle-class existence.

In 2019, he launched his single Burgerim store in Oregon.

Nonetheless, difficulties arose promptly following his grand opening, Mr. Laskin shares. Burgerim hadn’t set up a dependable food distribution system in Oregon, forcing Mr. Laskin to independently source his restaurant’s supplies. While attempting to assist new branches in taking off, the company never gathered royalties from franchisees, limiting its capacity to offer long-term support to its restaurant network, according to Mr. Bronstein. He added that numerous Burgerim locations managed to be successful despite these challenges.

Mr. Laskin kept his business afloat during the pandemic by providing takeaway services. However, he struggled to hire staff throughout the lockdowns, forcing him and his wife to manage the entire operation.

Suffering severe backache due to years of work in the restaurant industry, he had hoped owning a franchise would allow him to delegate tasks to employees, thus easing his back pressure.

On certain occasions, post-working at his burger joint, Mr. Laskin would return home at night unable to walk the last few meters up his driveway due to the pain from standing all day.

Mr. Laskin said he received no support from Burgerim’s leadership during the pandemic.

In May 2020, he closed his restaurant and relocated to Florida. Mr. Laskin, aged 57, says his back problems restrict his capacity to work and he’s found it tough finding a job after his burger venture closed down.

In 2020, the struggles faced by ex-Burgerim franchisees were brought to light by Restaurant Business, a publication concentrating on the food service sector, via a series of articles.

Some franchisees believe that better disclosure or augmented regulation of fee structures will not necessarily eradicate the industry’s problematic actors.

“Transparency is a great thing, but I’m not sure that more disclosure is going change any outcomes,” says Greg Flynn, the founder and CEO of Flynn Restaurant Group, the nation’s largest franchisee with 2,400 locations and 73,000 workers, operating brands such as Taco Bell, Panera, and Pizza Hut.

“There are plenty of stories of franchisees buying into a system and then things go poorly for them,” Flynn adds. “I would just suggest that they might’ve had a similar experience outside of a franchise system.”

Mr. Laskin believes it’s not just bad luck or circumstances at fault. “The system is fundamentally crippled,’’ he said. “There is too much secrecy. It shouldn’t be this difficult.”

The FTC Puts Restaurant Chain Franchises Under Examination