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Impact of the FTC’s Policy Statement on Franchisors’ Use of Contract Provisions
The Federal Trade Commission (FTC) recently issued a policy statement addressing the use and enforcement of contractual provisions in franchise agreements that effectively discourage or prohibit franchisees from reporting potential legal violations by franchisors. This policy, issued as a result of the FTC’s 2023 Request for Information on franchisors’ control over franchisees (and the public comments submitted in response), aims to enhance the fairness and transparency within the franchising industry and encourage franchisees to report potential legal violations to governmental agencies.
In the policy statement, the FTC made clear that while such clauses are not banned in their entirety, it considers such provisions to be unfair and unenforceable by the franchisor. Further, any attempts by a franchisor to use such provisions to prevent or retaliate against a franchisee for reporting potential violations also will be viewed by the FTC as an unfair practice. This position will significantly impact how franchisors manage brand reputation and franchisee issues and may necessitate revisions to their franchise agreements and other form documents going forward.
What types of clauses are affected?
The policy statement specifically focuses on the following types of clauses:
Non-disparagement: These clauses generally prevent franchisees from making negative public statements about the franchisor or the franchise system. While not considered a standard or typical provision, franchisors sometimes include it to maintain brand reputation and prevent the spread of false or derogatory information, which can greatly impact the value and protection of its intellectual property.
However, the FTC’s view is these clauses can be misused to silence legitimate complaints about franchisor misconduct and may stifle franchisees from sharing their negative experiences with prospective franchisees and customers. The FTC went a step further in indicating that it also would take a negative view of such clauses included in any settlement agreement or termination document between a franchisor and a franchisee (where such clauses are much more common).
Goodwill: These clauses prohibit franchisees from doing anything that may tarnish the reputation and value of the franchise brand. While recognizing that preserving brand integrity is important, the FTC asserted these clauses can sometimes be interpreted too broadly and possibly be used to penalize franchisees for actions that actually do not have a negative impact on the brand’s reputation, such as sharing complaints with other franchisees or a trade association.
Confidentiality: These clauses are standard in many business contracts (not just franchise agreements) to protect sensitive information from being disclosed to third parties. However, the FTC sees these provisions as a possible mechanism for preventing franchisees from discussing the terms of their contracts or potential violations with other franchisees, legal counsel or regulatory bodies. This, in the FTC’s eyes, is seen as a way to discourage franchisees from seeking advice or support and conceal unfair practices by the franchisor.
What should franchisors do in response?
Rather than remove such provisions entirely, franchisors should assess their form agreements carefully to ensure they are not overly broad and do not expressly prohibit franchisees from making legitimate complaints about the franchisor to governmental authorities. Tailoring these provisions to clearly permit franchisee transparency with government agencies, while still maintaining restrictions on other harmful actions by a franchisee, may be key to avoiding or minimizing future FTC action against the franchisor.
What are the broader implications of the policy?
The FTC made clear that its policy statement does not confer rights on any individual or create any new regulations, nor does it supersede any related federal, state or local laws. However, its position does provide crucial insight into how the FTC will assess complaints of franchisor violations, especially where the franchisor sought to enforce one of these provisions against a franchisee.
This policy statement is part of a broader effort by the FTC to address issues within the franchising sector, particularly those raised in the 2023 Request for Information. It also signals the possible direction of changes to the Franchise Rule, which is currently in its decennial review by the FTC. No timeline has been published by the FTC for when it will release the results of these efforts.
For more detailed information, please refer to the full policy statement on the FTC's official website.
If you have any questions regarding the FTC policy statement or related provisions in your franchise agreement documents, please contact Ashley B. Veltman in the Business Law Practice Group.
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Disclaimer: This alert has been prepared by Eastman & Smith Ltd. for informational purposes only and should not be considered legal advice. This information is not intended to create, and receipt of it does not constitute, an attorney/client relationship.