The FTC filed a lawsuit against California fast-food franchiser 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 suit against a franchisor earlier this month. The lawsuit was filed in federal court in Los Angeles against California fast food concept Burgerim. The complaint alleges that Burgerim sold franchises to more than 1,500 buyers 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 buyers with limited franchising experience. Burgerim also reportedly offered discounts to buyers from several franchises and promised refunds if buyers could not obtain financing. However, Burgerim downplayed the financial risks and complexity of buying franchises and presented 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 is now seeking injunctive relief, damages and penalties of up to $46,517 for each violation of the franchise rule.
While the facts and circumstances of this case were particularly stark, the FTC signaled a more aggressive approach toward increased federal regulation against franchisors more broadly. The Biden administration named several new FTC officials, and U.S. Senator Catherine Cortez Masto (D-Nevada) recently proposed legislation in 2021 requiring additional financial information for franchisors eligible for Small Business Administration loans.
The FTC Allegations Against Burgerim
The FTC alleges that Burgerim violated two key federal franchise laws – Section 5(a) of the FTC Act (15 USC § 45(a)) and the Franchise Rule (c. at 16 CFR Part 436).
Section 5(a) of the FTC Act prohibits dealing practices in commerce or affecting commerce that are unfair or deceptive to consumers. Deceptive practices under Section 5(a) include misrepresentations and other conduct that may mislead potential franchisees. In its complaint, the FTC alleges that Burgerim violated Section 5(a) by reneging on its promise to reimburse franchise fees. Burgerim reportedly promised buyers reimbursement of franchise fees when a franchisee could not secure a restaurant location or financing. According to the complaint, eligible franchisees have been unable to obtain reimbursement from Burgerim despite repeated requests from franchisees for many months.
The Franchise Rule requires franchisors to provide consumers with important information to weigh the risks and benefits of buying 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 that Burgerim failed to disclose required information in its FDD, such as: (i) the identity of Burgerim’s management personnel; (ii) the contact details of all former Burgerim franchisees who ceased operations during the previous financial year; and (iii) revenue that Burgerim received from franchisees. The FTC also alleges that Burgerim misrepresented the financial performance expectations of existing Burgerim franchises.
The Burgerim case signals a change in the regulation of franchisors
The FTC’s lawsuit against Burgerim comes after extensive state-level actions against the company. In 2020, the company was banned from selling franchises in Indiana, Washington, and Maryland due to violations of local franchise laws. In 2021, California’s Financial Protection and Innovation Commissioner also issued a cease and desist order against Burgerim.
The FTC case also signals a more deliberate approach by federal authorities to regulating franchisors. Burgerim’s complaint is the first major action against a franchisor in years, following several new FTC appointments in 2021. Those appointments include Lisa Khan as FTC chairwoman. The FTC also recently introduced a new franchise-specific whistleblower option for consumers to report deceptive marketing practices.
The FTC’s civil action against Burgerim shows that federal officials are more focused on tight regulation of the franchise industry in general. This shift is clear in light of new FTC appointments and the introduction of a new franchise bill in Congress.