A Corporate Governance Perspective on the Franchisor- Franchisee Relationship

Abstract

The franchisor-franchisee relationship is unique in that it has characteristics of both an arm’s length business transaction as well as an ongoing business relationship. As time goes by, however, the interests of the parties may diverge. It is in the franchisees’ interest to make their individual units as profitable as possible while, conversely, franchisors also profit from the licensing of the trademark and the collection of royalties from all their franchisees. For example, an increase in the number of stores in a given market will likely benefit the franchisor, whereas the same expansion may dilute the profitability of a particular franchisee through encroachment. The parties’ interests, thus, become misaligned.

We argue that that, in addition to increased disclosure under Federal Trade Commission (FTC) rules, the misalignments in the franchisor-franchisee relationship can be addressed by taking a more self-regulatory approach that recasts the duties owed among the parties. The FTC regulations focus on greater disclosure and as government regulations the rules are aimed at external incentives and protecting of the party that is perceived as having less leverage and (i.e., the franchisee). We argue for a more fiduciary duty-like relationship for franchisor-franchisee relationship and look at two somewhat related ways that the relationship is “self-regulated” by the market and, thus, the parties. We first examine the time-tested mechanism of fiduciary duties imposed by the courts as an additional balancing mechanism to supplement the mere disclosure under the FTC. Second, we examine the equitable standards applied to restrictive covenants, such as non-compete agreements and non-disclosure (confidentiality) agreements as a further reference point for how the common law can provide guidance on the boundaries of the franchisor-franchisee relationship. We conclude that this mix of court intervention to impose fiduciary duties and the existing FTC regulation is sensible because the parties are in a relatively long-term, well-defined relationship in which the initial disclosure under the FTC rules is insufficient.