Juan came to me in a near panic, practically begging me to help him with his failing business. He was working over 90 hours per week; he was receiving excellent performance feedback from his customers; the company providing his sales leads kept sending more business his way; yet the business was broke. He had to borrow against his home just to cover basic living expenses. I sat down with Juan and began what turned out to be a year-long ordeal that didn’t have a happy ending.
Like hundreds of other victims, Juan had fallen prey to a franchising scam operating in Northern New Jersey. The franchisor targeted immigrants promising an easier and more profitable life through ownership of a commercial janitorial franchise. For tens of thousands of dollars in fees, the company promised to train franchisees, provide them with supplies and professional services and, most importantly, secure a continuous stream of clients. The franchisor also promised to handle billing and collections so the budding entrepreneurs would only need to focus on doing the work and keeping the profits. For an immigrant like Juan, who had managed to buy a home and amass a decent level of savings through hard work and frugal living, it sounded like a dream.
A Multimillion-Dollar Fraud?
I estimate that the franchisor took in over $5 million in fees from franchisees who received far less than they expected. To a trained eye, the pattern of fraud was evident, but to someone simply looking to start a business and not knowing what to look for, the signs were easy to miss. Based on the documents I reviewed and the people I spoke with, the franchisor:
- Pressured potential franchisees to sign contracts without allowing them to read them first
- Provided a franchising agreement that was intentionally confusing, bloated and in some parts completely nonsensical
- Forged signatures of franchisees
- Diverted revenues that rightfully belonged to the franchisees
- Ran a Ponzi-like scheme with client assignments
Juan wasn’t making any money for several reasons:
- The franchisor, as part of the agreement, provided liability insurance to franchisees and charged them 10 to 20 times the market premiums for the policies.
- The franchisor, as part of the agreement, provided the franchisees with commercial cleaning contracts. The franchisor would prepare two versions of the contract—one for the commercial cleaning clients that included the true price per square foot for cleaning and a second version for the franchisee. The franchisee's version would have the fee altered, showing a price that was as low as 10 percent of the true price. The franchisor kept the difference and still billed the franchisee for the sales service. In a few cases they were so lazy, they just whited-out the price and changed it instead of preparing two versions.
- The franchisor would tell franchisees that certain services had to be performed for free to win business when in reality they were being billed and the franchisor just pocketed the money.
- The franchisor, which also handled billing services on behalf of the franchisees, would tell them that a particular client was very unhappy with the quality of service, had fired the franchisee and was refusing to pay the outstanding invoices. In reality the clients were happy and had paid. The franchisor just pocketed the money and would give the contract to a new franchisee to keep the fraud going.
Despite the fraudulent activity taking place, Juan and other franchisees were afraid to take action due to threats and the belief that at least some revenues coming in were better than none. The franchisor also promised them more sales contracts to make up for any “misunderstandings,” quieting them for the time being.
Among those who thought twice about pursuing any actions against the franchisor was Juan. The franchisor could easily take away his remaining contracts and force him into bankruptcy. In the end, he didn't want to run that risk. How can something like this go on for years?
Who Protects Franchisees?
The Federal Trade Commission has, as part of its mission, the duty to oversee franchises and pursue cases of franchise fraud aggressively. There are also regulations and state attorneys general who oversee franchisors at the state level.
The Franchise Rule, which is overseen by the FTC and regulates franchisors, hasn’t been updated since 2007, and that update took over a decade to finally pass. Lobbying efforts by franchising industry associations have slowed the process down considerably. The FTC’s newly redesigned consumer website gives far less prominence to franchising. According to a search I conducted on the Bureau of Consumer Protection’s legal case listing, the FTC has yet to bring any cases against franchisors this year.
Some larger franchisors that have also failed to deliver as promised have very aggressive legal counsel and mandatory arbitration clauses in their contracts. They pursue complaining franchisees aggressively and make examples out of them to scare other potential complainants.
How to Protect Yourself
It’s difficult to avoid being the target of a fraud if you don’t know the warning signs. Every franchisor must file a Uniform Franchise Offering Circular, which is a document required by the FTC disclosing important information about the franchise opportunity. Make sure that the copy you receive from the franchisor is identical to the copy submitted to the FTC. Speak with existing franchisees that have been in business at least 3 to 5 years. Make sure that these are franchisees you locate independently. Stay away from franchises where you do not control sales and billing. Bottom line: If you suspect anything is amiss, stay away; there are plenty of worthwhile and honest franchising opportunities to choose from.
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