Are Franchisor Profits from Franchisee Purchases a Kickback?

Businessman Stomping Out The Competition
Let’s say a deal is negotiated where a manufacturer provides logo napkins to franchisees for $5 [I am in to simple math]. The manufacture deal for the napkins is negotiated by a third party business that is owned by founders of the franchise system. The third party business entity makes $.50 from each napkin purchase. Is that a kickback?
 
In this hypothetical, we use napkins. But, it could be cleaning products, raw ingredients to make food products, beverages. It could be anything. Are franchisors or franchisors’ officers making a profit off of franchisee purchases, is it a kickback?
 
That is the heart of 17 allegations of Moe’s Southwest Grill against the franchisor and founders that lasted 8 years. The case is finally over. But, the question remains. The case was decided in favor of the franchisor. However, the case did not rest on the determination of whether a kickback was present or not.
 
There is no resolution to the 8 year old question. Are franchisor and founder profits on a franchisee purchase a kickback? The court did not answer the question. The court’s said- “Hey, franchisees you should have looked into it. You knew it existed. You can’t claim you were defrauded if you knew.”
 
The Moe’s Southwest Grill franchise disclosure document [FDD], back when the dispute arose was called the Uniform Offering Circular [UFOC], disclosed that the founders of the franchisor were owners of a brokerage company named SOC, which negotiated food supply agreements for Moe’s Southwest Grill franchisees. The court said, disclosure of SOS was sufficient notice to franchisees there may be a kickback scheme and they should look into it. The disclosure document [then called the offering circular] also said and disclosed that “we will not derive a profit from franchisees’ purchases.“
 
Okay, that sounds bad. If franchisor officers, directors, founders own an entity that negotiates deals for the franchisee, check it out because there may be a kickback. How about if an entity provides services to franchisee? How about if an entity sells a product to franchisees? Should that be checked-out, too?
 
As part of the Item 8 in the Franchise Disclosure Document [FDD], franchisors must disclose if they receive a profit from franchisees’ required purchases from affiliates or vendors. And, franchisors must disclose, in item 8, any franchise supplier, in which an officer of the franchisor owns an interest.
 
Note, there is no requirement to disclose franchisor or affiliate profits from non-required purchases. Nor is there a requirement to disclose profits derived by officer owned business entities. Sometimes what is not said is as important as what is said.
 
But, wait. Is it not deductive reasoning to assume that if an affiliate offers services to franchisees, or an officer owned business entity negotiates deals for franchisee purchases, there is a kickback? Yes. It is deductive. And, maybe there is plausible benefit or justification. Yes. There are reasons and benefits for negotiated deals and closely held transactions.
 

Required purchases from franchisors or its affiliates or designated supply may foster franchise brand uniformity.

Designating suppliers ensures quality standards and reduces time expenditure for locating and securing suppliers.

Requiring franchisees to buy from one supplier [whether affiliate suppliers or designated third party suppliers] leverages the buying power of the whole franchisee system.

There are caveats. If the franchisees are paying higher prices than their competitors, the franchisees are less competitive or franchisee profits may suffer.
 
Whether officer ownership of suppliers is a benefit or negative, is question to investigate. If requiring purchase from a designated supplier is good thing, is question to answer for each system and each transaction. And, just because someone earns a profit is not proof positive of a problem.
 
If benefit is given or cost and expense are incurred by the franchisor, affiliate of officer owned entities, profit franchisee purchases may be justified. Franchisees should ask the questions and franchisors should be prepared to give answers. Required purchases and franchisor profits are an area of scrutiny.
 

Get franchise and business tips and tools.  Get our free newsletter.

click here