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Why Ontario Should Get Active in NASAA -- Franchise Lawyer Canada

Written by: Peter Macrae Dillon

Article Overview: This article examines the reasons why Ontario should become active in the North American Securities Administrators Association, a body composed primarily of US regulators that has done much to promote the harmonization of franchise laws in the United States. peter macrae dillon franchise franchisor lawyer attorney Toronto Ontario Canada www.franchiselaw.ca

Why Ontario Should Get Active in NASAA -- Franchise Lawyer Canada

ONTARIO’S FRANCHISE REGULATORY REGIME: THROUGH A GLASS DIMLY

Why Ontario Should Get Active in NASAA

Executive Summary

In 2000, Ontario introduced legislation to regulate a segment of the economy responsible for approximately 40 percent of all retail sales. With very little formal study, Ontario introduced flawed legislation into a marketplace that was ill-prepared. We stand on the brink of a painful period of learning in the school of hard knocks. There is an easier, softer way.

Early Franchise Regulation In The U.S.

Franchising -- at least as we currently conceive of it -- is generally considered to have evolved from the early 20th-century American economy, as a means of rapidly expanding soft drink bottling and gasoline distribution. “Business format” franchising, its most visible current guise, took off in the 1960s. While some of these brands prospered, many did not. Even brand-name franchise systems utilized questionable earnings information and other sales practices; the so-called “fly by night” franchise systems were simply a method to fleece helpless would-be investors.

In situations where a defendant could be identified, aggrieved parties turned to the courts for redress using laws of general application (contracts, fraud, misrepresentation, etc.). Usually, there was none.

Early efforts to apply securities law to franchising proved unsuccessful. The active involvement of the franchisee/investor in the management of the franchised business took a typical franchise out of the category of investment security that the state Blue Skies laws were meant to regulate.

In 1971, California adopted franchise-specific legislation, closely modeled on its securities statute, that required comprehensive presale disclosure to prospective investors. Fifteen other states quickly followed California, representing about 50 percent of the U.S. population at the time.

In the U.S., jurisdiction over franchising is shared between state and federal government. The unsavory practices that were complained of in the franchise industry had also drawn the attention of the United States Federal Trade Commission. The FTC investigation into franchising practices reported as follows:

The franchise industry…has been plagued by numerous cases of abuses and misrepresentations aimed at unsophisticated prospective franchisees. Widespread instances have been documented involving such malpractices as high pressure franchise sales tactics, unscrupulous and inexperienced franchisors, financially unstable franchisors, hidden fee requirements and kick-backs, failure to provide information on services and training to be furnished to the franchisee, and use of coercive methods to get quick large deposits. ... franchisees’ complaints frequently involve both material misrepresentations and nondisclosure of material facts on the part of franchisors. In addition, a large number of comments on the record describe franchisor conduct wherein the franchise offering itself was fraudulent, resulting in serious economic harm to franchisees. [see CCH BFG ¶ 6304]

In 1979, the FTC responded with its Franchise Rule, applicable in all 50 states (and superseding any existing state law that provided a lower standard in any respect). The FTC Rule requires mandatory presale disclosure. The FTC Rule does not provide any private right of action, does not provide for any regulatory review or registration of the disclosure document, and is manifestly of a “consumer protection” nature.

Almost without exception, state laws have continued to be administered by securities regulators who have vigorously enforced their provisions -- including penalties. The review process leading up to the registration of a disclosure document with a state regulator can be an arduous affair.

NASAA

Franchising, by its nature, is multijurisdictional. It is the means par excellence of expanding product and service distribution nationally and internationally.

It is trite to say that the regulation of anything presents a hindrance to that activity (although an argument can be made that, on a macroeconomic scale, the regulation of franchising is good for the industry as a whole). While the cost of compliance with the laws of the single jurisdiction might be supportable, the exponential increase in cost--coupled with the almost insurmountable task of administrative compliance--brought on by the requirement to comply with a hodgepodge of state franchise legislation was not supportable.

It's worth mentioning at this point that the direct regulation of franchising occurs in one of three different ways. The first is to mandate and stipulate the format for presale disclosure to prospective franchisees. The second is to require and maintain a system for the vetting and registration of the disclosure document with a regulatory body. The third is to regulate the ongoing relationship between franchisor and franchisee, in such areas as fair dealing, the right to associate, good cause for termination, post-term restrictive covenants, etc.

In 1975, the Midwestern Securities Commissioners Association, an organization of state securities regulators, attempted to harmonize their disclosure requirements to enable franchisors to produce a single disclosure documents for use in each of their states. The one format which they agreed upon as embodying the minimum disclosure requirement of each of their respective state statutes was dubbed the “uniform franchise offering circular” or UFOC -- a moniker that stuck. The MSCA's Model Franchise Legislation met with little acceptance.

The UFOC format was quickly adopted by all of the U.S. registration states. With the promulgation of the FTC Rule 1979, even the FTC accepted the UFOC format as an alternative acceptable form of disclosure to the FTC's own idiosyncratic format. Practically speaking, the UFOC format is almost universally employed in the U.S., and the FTC is poised to discard its own franchise disclosure rules in favour of the UFOC format.

In 1981, the North American Securities Administrators Association assumed the mantle of franchise regulator to the regulators. NASAA, which traces its origins back to 1919, is concerned primarily with the harmonization of securities laws in North America. Its members include all 50 states, all 10 Canadian provinces and Mexico. NASAA's involvement in franchising is overseen by its Franchise and Business Opportunities Committee, currently chaired by Dale Cantone of Maryland, and consisting of regulatory members from five other states. In 1993 , NASAA updated the form of UFOC originally developed by the MSCA (originally dubbed the "NUFOC" but since happily re-baptised as simply UFOC).

NASAA also promulgated its own Model Franchise Investment Act. That Model Act contained extensive franchise relationship content , including obligations of good faith, nondiscrimination, good cause termination requirements , etc. Like its MSCA predecessor, this Model Act has not seen the light of day. Two factors have combined to radically curtail the regulation of franchising since the heyday of this activity in the early seventies. First, the initial array of presale disclosure legislation appears to have had desired salutary effect. Second, budget-conscious governments have eschewed forms a regulation that actually require the involvement of regulators, in favour of legislation that promotes marketplace regulation. The second trend is probably responsible for two states -- Indiana and Michigan, who were originally full-blown registration states, becoming notice filing states only.

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