The FTC filed suit against California fast food franchisor Burgerim in early February. The case is the FTC’s first major enforcement action against a franchisor in about a decade.
The Federal Trade Commission (FTC) took the unusual step of filing a civil action against a franchisor earlier this month. The complaint was filed in a federal court in Los Angeles against California-based fast food concept Burgerim. The complaint alleges that Burgerim sold franchises to more than 1,500 purchasers using false promises in violation of the Federal Trade Commission Act (FTC Act) and the Franchise Rule.
The FTC has not taken major action against a franchisor since 2013. According to the complaint, Burgerim targeted purchasers with limited franchise experience. Burgerim also allegedly offered discounts to buyers of multiple franchises and promised refunds if purchasers could not secure financing. However, Burgerim downplayed the financial risks and complexity involved with purchasing franchises and touted the investment opportunity as a “business in a box.” Despite these assurances, most buyers were never able to open Burgerim restaurants even after paying up to $70,000 in franchise fees. Burgerim founder and CEO Oren Loni then reportedly fled the country in 2019. The FTC now seeks an injunction, monetary damages, and penalties of up to $46,517 for each violation of the Franchise Rule.
Although the facts and circumstances of this case were especially egregious, the FTC has signaled a more aggressive approach towards heightened federal regulation against franchisors more broadly. The Biden administration has appointed several new FTC officials, and United States Senator Catherine Cortez Masto (D-Nevada) recently proposed legislation in 2021 requiring additional financial disclosures for franchisors who qualify for Small Business Administration loans.
The FTC’s Allegations Against Burgerim
The FTC alleges Burgerim violated two key federal franchise laws—Section 5(a) of the FTC Act (15 U.S.C. § 45(a)) and the Franchise Rule (i.e., FTC Trade Regulation Rule, “Disclosure Requirements and Prohibitions Concerning Franchising” codified at 16 C.F.R. Part 436).
Section 5(a) of the FTC Act prohibits business practices in or affecting commerce that are unfair or deceptive to consumers. Deceptive practices under Section 5(a) include misrepresentations and other conduct likely to mislead potential franchisees. In its complaint, the FTC alleges Burgerim violated Section 5(a) by reneging on its promise to provide franchise fee refunds. Burgerim allegedly promised buyers a refund on franchise fees where a franchisee could not secure a restaurant location or financing. According to the complaint, qualifying franchisees could not obtain refunds from Burgerim despite franchisees making repeated requests over many months.
The Franchise Rule requires franchisors to provide consumers with material information in order to weigh the risks and benefits of purchasing a franchise. Under the Franchise Rule, franchisors must disclose required information in a Franchise Disclosure Document or “FDD.” An FDD must include information about the franchisor, the franchised business, and the franchise agreement. The FTC alleges Burgerim failed to disclose required information in its FDD, such as: (i) the identities of Burgerim management personnel; (ii) the contact information of all former Burgerim franchisees that ceased operations during the previous fiscal year; and (iii) the revenue Burgerim received from franchisees. The FTC also alleges that Burgerim misrepresented the financial performance expectations of existing Burgerim franchises.
The Burgerim Case Signals a Shift in Franchisor Regulation
The FTC’s suit against Burgerim comes after extensive state-level actions against the company. In 2020, the company was barred from selling franchises in Indiana, Washington, and Maryland based on violations of local franchise laws. In 2021, the California Financial Protection and Innovation Commissioner also issued a cease and desist order against Burgerim.
The FTC’s case also signals a more deliberate approach by federal officials to regulate franchisors. The Burgerim complaint is the first major action against a franchisor in years, following several new appointments to the FTC in 2021. These appointments include Lisa Khan as FTC Chair. The FTC also recently introduced a new franchise-specific whistleblower option for consumers to report deceptive business practices.
The Bottom Line
The FTC’s civil action against Burgerim shows federal officials are more focused on stringently regulating the franchise industry in general. This shift is clear in light of the FTC’s new appointments, and the introduction of new proposed franchise legislation in Congress. As franchisors navigate this evolving regulatory space, Foley & Lardner will continue to monitor market trends, including developments in the Burgerim case and additional changes to franchisor disclosure requirements.