Forza Coffee Franchise Owner Sues; Alleges FTC Violations & "Churning" Scheme
May 23, 2008 by Sean Kelly
Filed under FORZA COFFEE
(FranchisePick.Com)
RE: Forza Coffee Franchise: Franchisee Alleges She Was Set Up To Fail
The term “churning” in franchising refers to the practice of a franchisor taking back unsuccessful franchise locations, then reselling them to new franchisees over and over… collecting new franchise fees and transfer fees each time. What makes this practice so potentially insidious - and successful - is that these transactions are included in required disclosure documents as “Transfers,” not failures. The result? A franchise chain could, hypothetically, accurately state they’ve never had a “failure” or closed a store, despite the fact that dozens - or hundreds - of franchisees have lost their investments.
That’s one of the claims in a lawsuit against Forza Coffee by Forza Coffee franchise owner, reported at UnhappyFranchisee.com.
(UnhappyFranchisee.com) Forza Coffee franchise owner Sheri Lynn Tanson recently filed a lawsuit against Forza Coffee Company and franchisor Brad Carpenter. Tanson, whose Forza Coffee franchise was open less than a year before closing down, alleges in her suit not only that Forza Coffee sold the franchise using misleading and incomplete disclosure documents, but did so as part of a scheme known to industry insiders as “churning.” [Read on: Forza Coffee Franchise: Franchisee Alleges She Was Set Up To Fail]
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Sean Kelly of Franchise Pick is an honest man and expert who points out that franchisors can “churn” efficiently under the cover of the UFOC by indicating 100% failures of startup franchisees as merely transfers in the Item 20 columns of the UFOC/FDD.
Forza Coffee and others too numerous to mention realize that they can “churn” with impunity under the law because the FTC Rule doesn’t require any explanations for the transfers that appear in the UFOC/FDD. Additionally, it appears that regulators never look at the FDD until there is a complaint from a franchisee, etc.. and then ONLY the State and the Federal Government have standing to punish the franchisor for the violation of the Rule/FDD.
Originally! When the FTC Rule was promulgated, in the late 70’s, the FTC Rule required a reason for terminations and offered the example “lack of sales or insufficient sales.” However, the State UFOC didn’t and doesn’t today require a reason for either terminations or transfers and this, of course, enables churning and pumping and dumping of startup units in franchise systems. While “lack of sufficient sales” is ALWAYS the reason for the failure of a franchise, the failures of startup franchisees within Franchisor systems is a material fact and risk factor that should be disclosed to new buyers of the franchise for obvious reasons.
Perhaps this lawsuit will bring some pressure on the “powers that be” to do something about the imprecision of Item 20 in the FDD and the incomplete and inaccurate and misleading picture it paints for new buyers of franchises.
Apparently, the omission of a reason for the termination or the transfer of a franchised unit was a subsidy negotiated with the FTC by the IFA and other special interests in the late 1970’s when the Rule was first prolmugated.
Additionally, a further subsidy was given to franchisors in that while the FTC considers “earnings” to be MATERIAL information, they have deemed “earnings” to be OPTIONAL under federal regulatory policy. Therefore, franchisors appear to be able to withhold MATERIAL information concerning risk and rewards of the investment from new buyers of their franchises with immunity under regulatory policy and the law.
The “safe harbor” that protects franchisors from lawsuits for “fraudulent inducement to contract” emboldens franchisors who develop churning as a management tool to grow the gross sales of the system.
Thanks to men like Sean Kelly, more franchisees will understand what happened to them and more prospective franchisees will become aware of the dangers of ineffective federal regulatory policy.
Thanks for the kind words.
I’m just a guy with a big mouth. It’s comments like yours and everyone else sharing their opinions and insights that drives these posts high in the search engines and attracts greater readership and awareness.
I don’t hold out much hope for government regulation to solve these problems… but I do believe that the Internet and these blog sites are making a huge impact. The availability of information being shared here and on the other franchise sites in the last year is unprecedented a revolutionary. As long as we can keep the dialogue open here, there’s hope yet.
Yes! I believe the Internet and sites like Franchise Pick and Franchise Pundit and Blue Mau Mau will provide a “reputational” vehicle that will help prospective franchisees to find “profitable” franchises in which to invest their time and money, and to avoid the bad ones.
Those prospective franchisees who deal with large successful looking franchise networks will, however, still not get the information they need before they buy the franchise unless past and present UNIT perfomance statistics are disclosed to them before the sale. After prospective franchisees put their signature to the contract, it is TOO late, of course, and many franchisees are stuck for years at breakeven trying to service their debt and never realize any actual profits. If they can’t sell at a “wash” there is nowhere to go. The chains of the contracts that build the paper empires of the big chain franchisors cannot be broken.
This FATAL FLAW of the FTC Rule is a subsidy for the franchise industry that protects the franchisors from “fraudulent inducement to contract” that, of course, at the same time encourages the sale of flawed and unviable franchises to the public. Are franchises flawed and unviable when 20% or more of the startup franchisees fail out of business and are churned over a five year period? Is “churning” out of view of the prospective buyers and the regulators essential to the durability of franchising in the economy?
Perhaps the stockholders of public franchise companies will demand these unit performance statistics in the future, as well as the private investors in franchisor systems, and prospective franchisees will benefit from this greater transparency. Churning and encroachment that can be obscured from view under current regulatory policy does impact on the bottom line of some franchise systems, as you have indicated.
There is no doubt that the banks and lenders will take a better look at the unit performance statistics before they approve “home equity” loans for the business purpose of buying a franchise. At least, this is what is being indicated in the June-July issue of the Franchise Times. There is no doubt that the sub-prime mortgage scandal will have some fallout in the franchise industry where the securitization of franchises and leases has become routine.
Do you, Sean Kelly, believe that the franchise industry could stand if franchisors were mandated to provide unit performance statistics to new buyers, and if franchisors had to compete for the labor and capital of prospective franchisees?