Franchise Fraud Models and Causes

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Franchising industry is very popular, as its rates of development are rather high. Though there numerous advantages of using franchising concept in the business, the potential franchisors should be aware of the existing risk of buying a franchise fraud and put much effort in investigating the ways to avoid dealing with franchise frauds.

Franchise systems developed between the 1860s and 1950s and today occupy a significant place in the mainstream of business in the USA and worldwide. In common sense, franchising is a “lease” of company’s brand and business strategy. Usage of a franchise is regulated by agreement between franchiser (the one who offers a franchise) and franchisee (the one who buys a franchise).

The United States occupy leading position in employing franchising concept in practice. This model appears to be a secure model of running a business. It has shown good results even in the tough economic market.

One of the most common claims made by a franchisee in the situation when a franchise has failed to achieve success and bring profit is a franchise fraud (Bundy & Satterlee, 2007, p. 191). The franchisee states that he is a victim of the fraud and that the franchisor was aimed at gaining personal profit. In the same time, the franchiser can claim that franchisee signed the agreement of free will. Such cases can lead to the need of appealing to the Court.

The problems can be avoided if the people involved in business are aware of difficulties related to signing an agreement with an unreliable franchiser. Such mistakes can easily be avoided if the franchisee is well informed about the appropriate procedure needed to exclude the risk of buying a franchise fraud before signing a contract.

Franchise frauds appear when unfair companies sell intellectual property that does not belong to them and make a fortune by using other brand’s popularity. It happens when the company creates its merchandise mark by copying the popular brand (branded colors, package, names of products, etc.). Another type of franchise fraud appears when the unfair companies even do not register its merchandise mark.

They simply create a franchise project that is based on the brand of the successful company and sell it to inexperienced franchisees. Franchise fraud has no commercial value, as it offers only copying of superficial specifics of the brand. Only valuable franchises offer the successful business models based on great experience and presenting commercial classified information.

Franchise frauds mostly appear in the industries using chain stores concept. They include fast food, fashion clothes, and automotive industries. Fast-food restaurant industry presents a special area of risk, as food restaurants represent the largest segment of the total franchised businesses (Gandhi, 2014, p. 3).

They are the most popular objects of creating and selling franchise frauds (e.g. Mash Donalds). Another risky area consists of fashion clothes brands (e.g. ZaraZara). Sometimes, franchise fraud can even gain more popularity and profit than the original company.

Merchandise mark, logotype, production technologies, and unique models of business conducting are regarded as an intellectual property of the company. Copying of intellectual property is punished by law. Therefore, the owner of the original is free to appeal to the Court and ask for material compensation in the case of fraud exposure. Both sellers and buyers of the fraud are punished in such case. The potential franchisees should be aware of the responsibility they accept when buying a franchise fraud.

The timeliness of the exposure of franchise fraud is of vital importance. The franchisee should ensure the reliability of franchisor before signing the documents. In the 1970s, the frequent cases of selling franchise frauds led to mass protests of businesspersons against sales of fraudulent franchises. The word “franchising” even was regarded as an abusive one. The situation became normal only after passing appropriate laws.

This experience shows that law regulation of franchising is one of the most important keys to avoiding the prevalence of fraud franchise frauds and ensure their early exposure. There are three federal laws, which are aimed at ensuring keeping of rights of franchisees (Abel & Burke, 2003, p. 361).

The Federal Trade Commissions Franchise Rule requires disclosure of information that is necessary to be known to make relevant decisions before signing a contract. However, there is a loophole in the law, which lets franchisors make undocumented oral claims, which are “typically inadmissible to establish fraud, even if inaccurate” (Abel & Burke, 2003, p. 362).

Several reforms of the rule have been proposed to make it more precise. As the law is not likely to expose the frauds and protect the franchisees, they should consider investigating the proposed franchisor and market, interviewing current franchisees, and consulting legal counselor prior to signing an agreement. Such precautions will help the franchisee to expose possible franchise frauds and prevent unpleasant consequences.

There are certain strategies that can help to prevent the risk of dealing with franchise frauds. The person eager to buy a franchise should directly contact the owner of the brand and avoid interacting with intermediaries. It is better to communicate with participants in the business market, whose contacts can be found on their official websites. It is also of vital importance to check the official registration documents of the selected merchandise mark.

The potential franchisee should require full information about the selected company, e.g. history, data about products and offers, the experience of other franchisees. The age of the company and the size of its current network are also essential aspects to be considered while investigating the chosen company. The consultation with a legal counselor can also reduce the risks of buying a franchise fraud.

There are some red flags for detecting franchise fraud. They include the franchisor’s reluctance to expose the relevant information about the company and other franchisees. Such behavior can be a sign of previous negative experience of other franchisees. Another alert is the company’s young age.

If the company has less than three years experience and already launches the franchising program, it can be a proof of the fact that the brand was created only for selling. Even if such network has certain success, it is appropriate to consider the insufficient experience of the franchiser. It can result in future mistakes made by the inexperienced franchiser.

There are many unfair companies, which are aimed at selling franchise frauds and receiving profit. Businesspersons willing to become a part of franchising industry should pay special attention to the exclusion of the possibility of buying a franchise fraud before signing the agreement with a franchisor. Exploring red flags for detecting the franchise fraud and the controls for preventing it can contribute to the franchisee’s successful decision on choosing an appropriate franchisor.

References

Abel, E. M. II, & Burke, D. (2003). Franchising fraud: The continuing need to reform. American Business Law Journal, 40(2), 355-384.

Bundy, K., & Satterlee, K. (2007). “You made me do it”: Reliance in franchise fraud cases. Franchise Law Journal, 26(4), 191-198.

Gandhi, H. V. (2014). Franchising in the United States. Law and Business Review of the Americas, 20(1), 3-24.

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Franchise Fraud Models and Causes

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