Franchisor/Franchisee Relations in Pennsylvania – – Redressing the Balance of Power

Except for specific regulations that apply to certain businesses such as car dealerships or beer distributors, the Commonwealth of Pennsylvania engages in very little regulation of the franchisor/franchisee relationship. Although it is commonly assumed that the franchisor holds disproportionate power in this relationship and it is commonly recognized that franchisees take on a significant financial risk when it enters a franchise arrangement, Pennsylvania has ceded most efforts to protect its resident franchisees to the federal government, and particularly to the Federal Trade Commission. Most of the cases in which Pennsylvania courts have determined the rights of franchisees have depended on the application of standard contract law, which does not recognize the widely perceived imbalance of power between the two parties.

There is legislation pending in the Pennsylvania legislature that aims to change that, however. House Bill 1620 of 2013 (the “Bill”) states among its purposes that “(t)raditional common law doctrines have not evolved sufficiently to protect franchisees adequately from fraudulent or unfair practices in the sale and operation of franchised business, and significant contractual and procedural restrictions have denied franchisees viable legal recourse . . .” The Bill goes on to state that “(a) franchisor that simply acts in compliance with the terms of a franchise with a franchisee is not necessarily dealing with its franchisee fairly and in good faith.”

What exactly does this legislation intend to require or prohibit, then? Here are the more significant features of the law:

  • The Bill imposes on both franchisor and franchisee a duty to act in good faith and a duty to deal fairly. Among other things this is meant to prevent a franchisor from performing an action “even if not prohibited by the express terms of the contract” if that action interferes with franchisee’s “enjoyment” under the franchise agreement. Whether this vague and far-reaching clause makes it into a final Act is somewhat questionable.
  • The Bill provides that the franchisor owes the franchisee a fiduciary duty in such activities as bookkeeping, collections, payroll and accounting services and administering advertising and payroll funds. A fiduciary duty is a higher than the normal contractual duty; for example a trustee’s duty to a beneficiary is a fiduciary duty. Implicit in this proposed fiduciary relationship is that if any decision-making needs to be done in connection with these functions, those decisions have to be made carefully and for the benefit of the franchisee, and if any monies are missing or not properly accounted for the franchisor would be responsible.
  • The Bill requires an on-going obligation to train and provide technical assistance to the franchisee.
  • Generally, provided that goods and service meet with “established uniform system-wide quality standards,” a franchisor may not prohibit or restrict a franchisee from obtaining equipment, supplies, goods or services from a source of the franchisee’s choosing. If the franchisor were to receive any rebate, commission, or other benefit from the transferee’s purchase of a good or service from a particular vendor, then the franchisor is required to pay over that benefit to the franchisee.
  • A franchisor would have to provide 120 days’ written notice to all franchisees if the franchisor placed a new franchise in proximity to an existing franchise or in its chain of distribution.
  • Significantly, this Bill would to a large extent gut covenants not to compete in new franchise agreements. Under the Bill a franchisee would be able to continue to operate a business (even a competing business) in the franchise location after the termination or expiration of the franchise, provided that the former franchisee ceased using the trademarks and intellectual property of the franchisor and altered the appearance of the business to prevent any likelihood of confusion.
  • Regarding system changes and the renewal of agreements, a franchisor may not, under the proposed law, change the franchisee fee, royalty rates or other material franchise term, although a franchisor may impose a reasonable renewal fee.
  • A franchisor cannot prohibit a franchisee from or discriminate against a franchisee in the event that the franchisee joins a trade organization.
  • Finally, termination of a franchise by the franchisor prior to the franchises natural expiration date must be for “good cause”.

It is important to note that (to paraphrase School House Rock) this is only a Bill. It is not a law. Various franchisor groups are, not surprisingly, vigorously lobbying against its passage. It is also important to note that if the Bill becomes law, it would affect only franchise agreements that are entered into or become law after the effective date of (what would then be) the Act. In the meantime (or if the passage of the Bill never comes) please contact us if you have any questions about the start-up, operation or termination of your franchise. Our firm has significant experience representing franchisees in several industries.

— Rod Fluck

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