Franchise Supply Programs: Maximizing Payments to Franchisors and Minimizing Risk
An obvious topic of interest to any franchisor is how much money can be made by operating its business. A smart franchisor will recognize its suppliers as an important source of revenue that can contribute directly to the franchisor’s bottom line. Recently, I discussed the law applicable to supplier payments with Kenneth A. Goss, Esq., Senior Counsel for a leading franchise system. The following is Mr. Goss' guest post on this important topic:
Franchisors can, and often do, enjoy the fruits of an effective supply program by receiving payments from suppliers based on the goods and services purchased by the franchise system. Payments from suppliers, which can be a significant source of revenue for a franchisor, are generally regarded by regulators and the courts as an established franchise industry practice based on the contractual rights each franchisor reserves in its franchise agreement. However, franchisors should be mindful that plaintiffs’ counsel in franchise litigation cases often look to exploit any weakness in a supplier payment program arguing that the franchisor has unfairly benefited from payments at the franchisees’ expense. The lesson to take away is that a well-structured supply program can ensure that a franchisor obtains maximum revenue from suppliers while minimizing the potential risk from franchisee claims.
Franchisors realize revenue from suppliers in many ways. Federal regulations recognize that payments from suppliers include all revenue and other material consideration, whether direct or indirect, that franchisors receive from suppliers based on purchases by franchisees. Direct payments may take the form of an ongoing rebate, an ongoing marketing allowance or an up-front contract signing bonus. Additionally, franchisors may receive indirect payments, for example, when a supplier sells a certain good or service to units owned by the franchisor at a lower price than the supplier sells the same good or service to units owned by franchisees. In the case of an indirect payment, the franchisor is deemed to have received the cash value of the discount or other benefit to the franchisor. Simply put, a payment from a supplier is the value the franchisor receives for allowing a supplier to participate in the franchise system’s restrictive sourcing program.
Federal trade commission regulations governing the offer and sale of franchises are concerned primarily with imposing upon franchisors the obligation to disclose payments from suppliers in the franchisor’s disclosure document. Specifically, federal regulations state that each franchise disclosure document should disclose whether the franchisor or any of its affiliates have the right to receive payments from suppliers and, if so, require franchisors to further disclose: (a) the precise basis by which the franchisor or its affiliate derives such revenue; and (b) the total revenue, either as a flat dollar amount or percentage of the franchisor’s total revenue, that the franchisor and its affiliates receive from the purchase and lease of required products and services by franchisees. Franchisors must also disclose the identity of suppliers that contribute to the franchisor’s advertising fund in each case where the franchisor collects payments from a supplier for that purpose. As long as a franchisor complies with its disclosure obligations under federal regulations, the franchisor is largely free to enter into whatever payment relationships with a supplier it wants.
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