Only YOU can prevent franchise fraud | Fox Rothschild LLP

Smokey the Bear’s slogan is that “Only you can prevent forest fires”. This can also be true for franchise professionals when it comes to outright fraud. The good news is that our profession is getting stronger and these pernicious frauds are becoming rarer.

For the first time in at least a decade, the Department of Justice, on behalf of the Federal Trade Commission, has filed a civil lawsuit against Burgerim Group USA, Inc., Burgerim Group, Inc. and founder Oren Loni for violation of the FTC’s Trade Regulation Rule. entitled “Disclosure Obligations and Prohibitions Regarding Franchising”. The case was filed in the Central District of California at No. 2: 22-C-825, seeking a permanent injunction, money judgments, consumer relief, and other relief. This lawsuit follows the states of California and Maryland banning the offering for sale of these franchises due to numerous disclosure violations and complaints from franchisees. Burgerim is accused of targeting veterans with discounts and distorted material information regarding their franchises’ predictions of success. Additionally, Burgerim omitted information that the FTC rule requires to have been provided to potential franchisees. This rare action by the FTC demonstrates the tools available to this powerful government agency to address franchise fraud, but also serves as a lesson in how franchise lawyers and consultants could have helped prevent or contain the fraud earlier.

I. The Department of Justice’s allegations.

The defendants allegedly lured veterans through rebates and other would-be entrepreneurs to buy a burger franchise. The buyers obtained loans from all sources, including those guaranteed by the US Small Business Administration to purchase and open the franchises. But defendants “seriously failed” to comply with the FTC’s disclosure rule, which omitted information necessary to allow potential franchisees to “analyze revenue representations” or obtain an “unvarnished experience.” previous buyers”. In an effort to close the sales, the defendants made verbal statements inconsistent with the written disclosures, or falsely filled in gaps of information omitted from the written disclosures. More than 1,500 franchises were sold, but “the overwhelming majority never saw the light of day.” Hundreds have canceled their franchises promising to recoup their original franchise fees. In many cases, these promises have not been kept. In an effort to hide their scheme, the defendants indicated that they were filing for bankruptcy. While the disappointed franchisees waited, Burgerim never filed a case, which perhaps ensured the transparency of the operation and the failure. The FTC commissioners voted 4-0 to take the extraordinary step of referring the case to the Department of Justice.

II. Franchise industry efforts to shut down Burgerim.

The franchise industry is designed to effectively enable others to live the American Dream. Hardworking restaurateurs and educators can start a franchise system by complying with the FTC rule. People from all walks of life who want to be in business for themselves, but not by themselves, can purchase a franchise. The US Small Business Administration allows lenders to take the risk and support small businesses by guaranteeing loans, and the SBA has a system for franchisors to qualify loans to their franchisees. Franchise attorneys, accountants and other consultants are available to review franchisor offers and provide support to franchise buyers. The franchise industry has a voice through the International Franchise Association to help veterans and underserved people buy franchises, and to support quality franchisors who meet IFA criteria. Finally, state regulators have the ability to stop illegal franchise sales. All of these industry checkpoints eventually helped contain the fraud, but not fast enough to cause significant damage.

Many Burgerim buyers have been targeted because of their vulnerability. Many did not speak English as their first language and were looking to establish a business in the United States. The veterans and underserved in our community weren’t sophisticated enough to look past the 100-plus-page Official Franchise Disclosure Document (the “FDD”), to notice its obvious inadequacies under the rule. of the FTC. They didn’t have access to, or chose not to engage, competent consultants before buying, who probably could have sniffed out fraud just by looking at the inadequacies of the FDD. Fraud could have been avoided in the first place for those who sought competent legal advice early on, and perhaps many disasters have been avoided for those who did so by asking the right questions. But other institutional protections could not help the victims until the evidence began to accumulate.

The SBA and lenders vetted Burgerim before approving the loans, but they couldn’t have sounded a siren before an alarming default occurred. State regulators, with all they have to do, nabbed Burgerim based on reports from injured parties, and those reports came quickly and furiously from most of the franchise attorneys and victimized franchisees. The IFA supports the elimination of bad franchisors from the market and endorses the regulatory response. Institutions acted when the carnage became apparent, but the storm clouds weren’t seen soon enough.

III. The best we can do.

Vocational and non-vocational training in our law schools and colleges would have helped prevent some of the damage. Not every city has a franchise attorney qualified to spot a problem by simply reading the FDD. Some states, such as California, have a specialization in franchise law and certification by the California State Bar. We can do better by providing resources on franchise law to lawyers and their clients so that the early warning radar can be activated. The FTC has a website, ReportFraud.ftc.gov, where fraudulent scams can be reported. Many states also have similar sites for reporting fraud. Basically, the private sector has the tools to nip this in the bud and should be more proactive so that fraudulent scams like this don’t escalate. Not all franchise failures by a franchisee are due to fraud. But when we see something, we have to say something, and even do something.

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