Since the FTC Franchise Rule was last amended in 2007, franchisors have disclosed certain fees in the Franchise Agreement as well as the FDD. These fees are generally stated as a fixed dollar amount or percentage of gross revenue, and include the royalty fee, marketing fund contribution, as well as renewal fees and transfer fees. In situations where a franchisor reserves the right to increase any of these fees during the term of the Franchise Agreement, the FDD provides a maximum fee amount. This structure makes sense because these types of fees are not generally dependent on external factors, and because no sensible franchisee would sign a contract that allowed a franchisor to unilaterally increase, for example, the royalty fee, at any time and by any amount.

On the other hand, several other fees have been historically disclosed in Item 6 as the franchisor’s “then-current” fee. While franchisors disclosed the current amount, they often reserved the right to increase these fees at any time through updates to the Operations Manual. This reservation of rights was not for nefarious purposes, as these types of fees often reflected costs that were driven by external factors or the evolution of the franchise system. The most common example is a technology fee, which naturally will change as new technologies become available, or as the system changes its technology strategy. Another example is an ongoing training fee, which is dependent on the amount of training necessitated by new products or processes, as well as the investment needed to develop new training tools



In recent years, we have seen several registration states push back on the “then-current” fee disclosures in the FDD by requiring franchisors to disclose a maximum fee or the maximum amount that the fee can be increased each year. This line of thinking is embodied the Interpretive Statement released by the Washington earlier this month answering the question “May a franchisor impose fees through its operations manual or otherwise that were not disclosed in the Franchise Disclosure Document?”—Disclosure of Franchise Fees: Interpretive Statement (wa.gov).

In this document, the Washington Department of Financial Institutions unequivocally states that franchisors are not permitted to impose fees in their Operations Manual that were not disclosed in the FDD, citing Washington’s statute and case law to support the premise that doing so would be considered the omission of a material fact in the FDD. But what if a franchisor clearly discloses in its FDD that a fee payable to the franchisor or an affiliate may be subject to increase without restriction at any time during the term? Does this not satisfy the disclosure requirement? Are contracting parties not free to agree to such terms? While this Interpretive Statement does not explicitly say that this practice is prohibited, this is a clear step in that direction, with the next logical step being a statement that a fee with an open-ended right to be modified is not disclosed properly in the FDD. Our firm has already seen several state examiners issue this exact comment and refuse to register FDDs with this type of fee disclosure.

Presumably, the intention of this position is to protect franchisees from significant fee increases during the term of their Franchise Agreement that they were unaware of and are unable to oppose. This intention, however, ignores the franchisor’s practical business needs for this flexibility to remain competitive in the industry, such as allowing for increases to cover costs associated with new developments and advancements in technology, as well as higher rates charged by third-party service providers that are born by the franchisor and simply passed through to the franchisees. Prohibiting these types of fee structures forces franchisors to look into a crystal ball and predict the future in order to satisfy the regulators and register their FDD. This prohibition may also force franchisors to forego structuring arrangements with third-party suppliers, instead requiring such suppliers to deal directly with system franchisees, which may result in increased costs to the franchisees.



To further muddy the waters, the requirement that franchisors disclose maximum fee amounts or maximum fee increases in their FDD will not automatically solve the problem that regulators are hoping to solve, even if this is extended to third-party fees. If these disclosures are a condition to registration in certain states, franchisors are likely to give themselves a lot of wiggle room by setting very high fee caps that don’t reflect their actual intent but rather an outlier scenario. The use of AI is a perfect example of this, as the overarching benefits are apparent, but it is still unclear how much this technology will impact franchising and what type of fee structure would be necessary to incorporate and deploy AI within a franchise system.

From here, it’s easy to see how the current trajectory just leads to a back-and-forth that doesn’t solve the underlying issue. If franchisors set artificially high fee caps, will states impose their own cap on what is a “reasonable” fee increase, despite the inherent clumsiness of an across-the-board approach? And to counter this, will franchisors shorten the terms of their Franchise Agreements so that they can more easily impose new fees or increase existing fees, which would negatively impact a franchisee’s ability to secure a loan?

This is not to say that franchisors should have an unfettered right to make unilateral increases to their fees during the term of the Franchise Agreement. This is admittedly a very challenging issue with good arguments on both sides. However, as we seem to be heading toward the next iteration of the FTC Franchise Rule, this presents a great opportunity to solicit suggestions from the industry that balance the flexibility needed by franchisors and the predictability needed by franchisees.

Part of the purpose of the FTC Franchise Rule’s current form is to mandate disclosure to protect franchisees from unseen, unilateral system changes after they have made a substantial investment in their business. However, the purpose was not and cannot be to prevent franchise systems from evolving, even if some of the franchisees disagree with the specific changes being implemented.

As a perfect solution seems unlikely, the franchise industry needs to work together on the best possible solution for this moment in time. Should some fees be treated differently than others? Should there be an allowance for fees that are impacted by third-party costs, and if so how will that be monitored? These are just a couple of the questions that we may need to answer, but we also invite you to pose other questions (and hopefully propose some answers) to this complicated issue.