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The Washington Court of Appeals has issued a decision, of apparently first impression, which potentially has widespread adverse consequences for franchisors that use area developers or sales representatives in their franchise marketing efforts.¹

In Pinchin v. Nick-N-Willy’s Franchise Pizza Co., Case No. 63417-8-I, the Washington Court of Appeals declined a franchisor’s request for discretionary review of partial summary judgment granted by a Seattle superior court, allowing the franchisee to rescind its franchise agreement, finding that an area developer who solicited the franchisee was a “subfranchisor” under the Washington Franchise Investment Protection Act (WFIPA) and its failure to register the franchise under the WFIPA was a violation of the Act even though the franchisor had registered and disclosed as required by law.

Under the marketing agreement between franchisor and the area developer, the developer was given the right to market Nick-N-Willy’s Pizza franchises in the Seattle area, and to submit qualified applicants to the franchisor for its approval. The area developer received a commission on franchise fees collected by the franchisor from the franchisees it solicited and for any services it was required by the franchisor to perform on its behalf. But the marketing agreement reserved to the franchisor the right to determine the terms and conditions of any franchise agreement and to approve any prospective franchisee. The area developer did not have authority to grant a franchise and was not a party to or third party beneficiary of the franchise agreement. The franchisor registered the offering circular with the Washington Department of Financial Institutions and gave a copy to the franchisee, as required by the WFIPA, but the area developer did not register as a subfranchisor and the offering circular did not include financial or other information about him.

Even though the area developer was not a party to the franchise agreement, did not have authority to modify the terms of the franchisor’s franchise offering and was not bound by or a beneficiary of the franchise agreement, the trial court found that it was a “subfranchisor” under the WFIPA. The trial court held that the area developer’s role in soliciting the franchisee satisfied the WFIPA’s definition of a subfranchisor as being one to whom the franchisor sells “the right to grant, sell or negotiate the sale of a franchise,” and that participation in the sales process constitutes negotiation of the sale of a franchise. The appellate court commissioner, in denying discretionary interlocutory review, stated that it was debatable whether a dual registration requirement applies when the franchisor has complied with registration requirements, yet noted that the Washington Department of Financial Institutions requires such dual registration by both franchisor and subfranchisor, and that deference is given to the interpretation by an agency charged with enforcement of a statutory scheme such as franchise registration and disclosure.

The commissioner’s opinion rejected the franchisor’s argument that the limited role of soliciting purchasers does not constitute “the right to grant, sell or negotiate the sale of a franchise,” as specified in the statute, because the argument depended on a “narrow reading of ‘negotiate.’” The commissioner found that the area developer’s presale communications with a franchise prospect “laying the groundwork [for franchisor’s interview of the prospect]” were part of the negotiation process.

There is no conceivable reason why an area developer, who lacks the legal right to modify the terms of the franchisor’s franchise offering, to enter into a franchise agreement or to approve a franchise prospect, should be treated as a subfranchisor with independent registration and disclosure obligations. In a previous decision of the Washington Court of Appeals, the court observed that while there was an administrative agency interpretation requiring a franchisor and a subfranchisor to register separately if both are offering similar franchises, it did not appear to be required by law. O.P.E.N. America, Inc. v. Phnouk, Bus. Fran. Guide, ¶ 10, 675 (Wash. App. Ct. April 24, 1995). Nevertheless, in Pinchin, the commissioner held that requiring a supplemental registration extending to information pertinent to the putative subfranchisor was not obvious or probable error permitting interlocutory review of the decision because it was arguable that financial and background information concerning the area developer might be material. The commissioner stated that such information could be material because the franchise agreement compelled the franchisee to accept the area developer’s sales, site and opening assistance and supervisor services as directed by the franchisor. This seems to conflate a requirement that a subfranchisor meet franchise registration requirements with a more general requirement that material information be disclosed. The fact remains that a very broad reading of “negotiate” is necessary for the purpose of imposing a separate registration obligation on area developers: one which universally has not been required either by the FTC or other state regulators. The FTC staff published answers to frequently asked questions concerning the Amended Franchise Rule; in answer to the question of whether “development agents” should be treated as subfranchisors because they provide post-sales services to franchisees and, thus, must include financial statements and other information in the disclosure document, the FTC said:

No. Even if a person performs post-sale on behalf of a franchisor, that person or entity is not a ‘subfranchisor’ under the Amended Rule unless that person is a party to the franchise agreement (or to another agreement involved in the franchise). This is true regardless of the name given to the person, be it ‘development agent,’ ‘area developer,’ or ‘regional developer.’

The appellate court’s denial of discretionary interlocutory review is not tantamount to affirmance of the trial court’s order permitting a franchisee to rescind the franchise agreement on the hypertechnical grounds that an area developer who was involved in the sales process had not registered the franchise – although the franchisor had. But it is a case that bears monitoring. Several states use language similar or identical to that of Washington in delineating those whose activities are governed by state registration and disclosure requirements – i.e., a party to an agreement “whereby the subfranchisor is granted the right to sell or negotiate the sale of franchises in the name of or on behalf of the franchisor.” Among those states including the word “negotiate” in the statutory definition are California, Hawaii, Illinois, Maryland, Michigan, Minnesota, New York, North Dakota, Rhode Island and Wisconsin. While there appears to be no basis for a conclusion that under any franchise or registration law a nonparty to the franchise agreement who simply participates in the sales process has a registration and disclosure obligation independent of that of the franchisor, if this decision is an accurate predictor of an ultimate determination on the merits by the Washington Court of Appeals, it is a potentially worrisome development.

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1 Although the Washington court used the term “area developer” to describe the marketing agreement, the relationship was more akin to a development agent arrangement, whereby the development agent refers potential franchisees in a specified territory to the franchisor and, in turn, typically receives a portion of the initial franchise fees for referrals as well as a portion of the royalties for providing services and support to the franchisees in its designated territory.