Wed. Jul 24th, 2024

Restaurant Chain Franchises Face Scrutiny From the FTC

By admin Nov25,2023

“Making It Work” is a series about small-business owners striving to endure hard times.


When Kenneth Laskin flew to California to meet with executives at Burgerim, a start-up chain of restaurants, he was made to feel not just like another prospective franchisee, but like part of a family.

The company’s executives, he said, made a point one evening of highlighting their common Jewish faith by praying with him in Hebrew.

At the time, in 2017, Mr. Laskin believed he was being offered a plum deal. He paid $50,000 for the right to open up as many Burgerim franchised restaurants as he wanted in Oregon. “I got an entire state,” Mr. Laskin recalled.

Today, Burgerim has run into trouble, leaving a trail of financial problems, a lawsuit by the Federal Trade Commission and broader regulatory scrutiny of whether protections for franchisees like Mr. Laskin are adequate.

The challenges highlighted by Burgerim come as franchising continues to grow as a way that people are choosing to start small businesses.

There has been rising concern about whether franchisees need more protection in their contracts with franchisers. That concern has found a sympathetic ear in the Biden administration and in several state legislatures, and has resulted in multiple proposed limits on franchisers’ powers.

In the end, Mr. Laskin opened only one Burgerim restaurant, in Eugene, Ore., which closed in 2020 during the pandemic. Since then, Mr. Laskin has been depleting his savings to pay the bills.

Burgerim, which boasted of having inventive high-quality burgers, has been criticized by former franchisees for making grand promises and poor disclosure about business risks. Of the more than 1,500 franchises Burgerim sold, most never opened, the commission said in a lawsuit that the agency filed last year against the company and its founder in U.S. District Court in California.

Peter Bronstein, a lawyer for Oren Loni, who was the company’s principal executive in the United States, said that Burgerim made some business mistakes but that it was often trying to help its franchisees succeed. The two sides have been in mediation, according to the court file.

Even as the pandemic was still bearing down, the number of franchised establishments in the country grew 2.8 percent in 2021 and 2 percent in 2022. That number is expected to increase an additional 2 percent this year, bringing the total to 805,436 franchises, according to the latest data released by the International Franchise Association, an industry group.

As the franchising network expands, so does its contribution to the broader economy. Franchises employed 8.4 million people last year, a 3 percent increase from 2021.

There is historical evidence, according to the International Franchise Association, that the first U.S. franchise dates back to Ben Franklin, who created a network of printing partnerships.

Today a fundamental symbiosis drives the business model: Franchisees pay an upfront fee to an franchiser like Dunkin’ Donuts or Applebee’s, which gets them access to all of that brand’s suppliers, advertising and technology. The franchisee can lean on these established systems to get their business up and running quickly rather than having to start from scratch. And the franchiser, in turn, receives the franchising fee, typically tens of thousands of dollars, in addition to a regular royalty payment from the franchisee.

“Franchising has always been an on-ramp for the middle class to open their own business,” said Charlie Chase, the chief executive of FirstService Brands, a franchiser of home renovation and painting services.

Over the years, Mr. Chase, who has served on the board of directors of the International Franchise Association, said he had helped hundreds of successful franchisees get their start. “We have created a lot of millionaires,” he said.

Still, Mr. Chase said he was concerned about how some franchisees were being pushed into businesses without understanding all of the risks.

He blames aggressive internet advertising for some of this (Mr. Laskin learned about Burgerim from a Facebook advertisement, for example), and also a network of third-party brokers that often push prospective franchisees to buy multiple franchises at a time.

The Federal Trade Commission, under the leadership of Lina Khan, is looking broadly at industry practices including disclosure and issues such as franchisers’ unilaterally changing the terms of an agreement with a franchisee.

“Franchising can be a good business model, but it can also lead to a lot of harm,” Elizabeth Wilkins, the director of the commission’s Office of Policy and Planning, said. “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 said that the company executives told franchisees they would refund their franchise fees if their business did not open, but that many people never got their money back. Mr. Bronstein, the lawyer for Mr. Loni, said offering refunds “was not the best way to run a business.”

In the years since the 2008 financial crisis and mortgage meltdown, regulators have bolstered protections for consumers by improving disclosure by banks and banning certain fees they can charge. But small businesses, including franchisees, have not benefited from the same extensive regulatory scrutiny.

“There is a view in the consumer protection world that small businesses do not get the same level of protections as other consumers,” Samuel Levine, the director of the F.T.C.’s Bureau of Consumer Protection, said. “Yet, consumers and small businesses, including franchisees, face many of the same challenges. That is something we are trying to address.”

As part of that effort, the Federal Trade Commission is looking at how to apply laws like the Robinson-Patman Act, an antitrust law that prevents large corporations from using discriminatory pricing to take advantage of small businesses. The agency also has proposed a rule banning noncompete clauses in employment contracts and may consider limiting the use of noncompete clauses in franchise agreements.

When Mr. Laskin bought a franchise, he was not looking to become a millionaire, but rather to build a stable middle-class life.

He opened his sole Burgerim store in Oregon in September 2019.

But the problems started soon after his grand opening, Mr. Laskin said. Burgerim had not established a reliable food distribution system in Oregon, he said, forcing Mr. Laskin to fend for himself to supply his restaurant. In trying to help new locations get off the ground, the company never collected royalties from the franchisees, which limited its ability to support its restaurant network over the long term, Mr. Bronstein said. Still, he added, there are many Burgerim restaurants that operated successfully.

Mr. Laskin kept the business going during the pandemic by offering take out. But he couldn’t find people to work during the lockdowns, which meant he and his wife ran the entire operation themselves.

Mr. Laskin, who has severe back pain from years of restaurant work, hoped a franchise would offer him the chance to delegate work to employees and spare his back.

But some days, Mr. Laskin would return from the burger restaurant at night unable to walk the final few yards up his driveway because of the pain from standing on his feet all day.

The Burgerim leadership, Mr. Laskin said, provided no support during the pandemic.

He closed his restaurant in May 2020 and moved to Florida. Mr. Laskin, 57, said that his back problems limited the type of work he can do and that it had been difficult finding work after his burger business closed.

The struggles of the former Burgerim franchisees were brought to light in 2020 by the publication Restaurant Business, which focuses on the food service industry, in a series of articles.

Some franchisees say improving disclosure or increasing regulations on fee structures will not be a panacea in rooting out the industry’s troubled actors.

“Transparency is a great thing, but I am not sure more disclosure is going to change any outcomes,” said Greg Flynn, the founder and chief executive of Flynn Restaurant Group, the largest franchisee in the country with 2,400 locations and 73,000 employees, operating brands like Taco Bell, Pizza Hut and Panera.

“There are a lot of stories of franchisees buying into a system and then it goes badly for them,” he added. “I would just suggest that they might have had a similar experience outside of a franchise system.”

Mr. Laskin says it is not just bad timing or circumstances that were to blame. “The system is fundamentally crippled,’’ he said. “There is too much secrecy. It shouldn’t be this difficult.”

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