FRANCHISE LEGISLATION

TUESDAY, OCTOBER 17, 1967

U.S. SENATE,

SUBCOMMITTEE ON ANTITRUST AND MONOPOLY OF THE COMMITTEE ON THE JUDICIARY, Washington, D.C. The subcommittee met, pursuant to recess, at 10:05 a.m. in room 1318, New Senate Office Building, Senator Philip A. Hart (chairman) presiding.

Present: Senators Hart, Fong, Dirksen, and Hruska.

Also present: S. Jerry Cohen, staff director and chief counsel; Charles E. Bangert, assistant counsel; Peter N. Chumbris, chief counsel for minority; James S. Schultz, minority counsel; Gladys Montier, clerk; and Patricia Bario, editorial director.

Senator HART. The committee will be in order.

Our first witness today is Jerrold G. Van Cise. Mr. Van Cise is a distinguished member of the New York bar, a graduate of Princeton and Yale Law School, and was formerly chairman of the antitrust law section of the American Bar Association, and the section of antitrust law of the New York State Bar Association. He is a member of the firm of Cahill, Gordon, Sonnett, Reindel & Ohl, New York City.

Mr. Van Cise is appearing this morning at the request of the subcommittee. We asked Mr. Van Cise because of his experience in this field, only briefly summarized, and we are very grateful that he responded.

STATEMENT OF JERROLD G. VAN CISE, ESQ., OF CAHILL, GORDON, SONNETT, REINDEL & OHL, NEW YORK CITY

Mr. VAN CISE. Thank you, Mr. Chairman.

Senator FONG. Mr. Van Cise, as an alumnus of the Harvard Law School, I welcome you, too.

Mr. VAN CISE. Thank you very much, sir. I have a lot to learn from many law schools.

My name is Jerrold G. Van Cise. Mr. Chairman, your courtesy in inviting me to appear and comment upon S. 2321 has been appreciated. Originally, I had planned to reciprocate this courtesy by sparing you the reading of a formal statement. Upon receipt of your letter of September 28, 1967, however, I have reduced to writing, as requested, the three thoughts concerning this legislation that have troubled me. 1. My first thought is that S. 2321 will carve out an exemption to the right of customer selection recognized by the antitrust laws.

Heretofore, the antitrust laws have assured both buyers and sellers (except where exempted by special legislation), that they are free to

deal or refuse to deal with whom they please, so long as they do not engage in unfair competition, participate in an unreasonable restraint, or attempt to monopolize. I give the cases on this.

This general right under the antitrust laws to deal or not to deal was originally spelled out in United States v. Colgate and Company, 250 U.S. 300 (1919), but in subsequent years it has repeatedly been reaffirmed. Thus, in Federal Trade Commission v. Brown Shoe Company, 384 U. S. 316 (1966), the Supreme Court upheld this freedom on the part of buyers. Similarly, in United States v. Arnold, Schwinn, and Company, 388 U.S. 365 (1967), the Court emphasized that sellers enjoy a comparable right.

Only where unique problems in a particular industry have required an exception to this general rule, for example, the automobile industry, has this freedom of choice been qualified.

If enacted, however, S. 2321 will virtually destroy the freedom of a franchisor in all industries to deal or not to deal, regardless of the necessity for any such drastic action in many, if not most, of these industries. For under this proposed legislation, once a franchisor has entered into a relationship with a franchisee for a period of more than 1 year, relating to goods and services in excess of 25 percent of the latter's gross income, the former cannot refuse to deal with the latter except upon the payment of what may be an exorbitant ransom to regain his freedom of choice. This ransom may include the purchase price of buildings and equipment (possibly useless to the franchisor), the cost of inventory (however obsolete), and an unpredictable sum for the value of goodwill (in large part created by the franchisor) all subject to being determined, in the event of dispute, by some third party arbitrators. Many franchisors are relatively small companies that could not afford to pay any such substantial sums.

The net effect of the foregoing-in penalizing the exercise by a franchisor of his freedom to refuse to deal with franchisee-is effectively to exempt such a franchise (a) from competition by other applicants for his franchise appointment, who may offer to perform more effectively than he in his franchised territory, (b) from competition by other appointees seeking nonexclusive rights in his franchise territory (which cannot be granted in the event that he enjoys exclusive rights), and (c) even from competition by the franchisor.

2. My second thought is that S. 2321, in carving out this new exemption to the right of customer selection under the antitrust laws, will adversely affect competition.

The franchisee obviously need not compete effectively under its provisions. He may be complacent-and may I interject that each one of these situations is one with which I have had personal experience in my practice-inefficient, negligent, indifferent to customer complaints, unreceptive to changed market needs, a playboy son of a deceased hardworking father, have overextended credit, be operating with wastefully high costs, be paying out excessive salaries and bonuses, and even be headed for eventual bankruptcy. Indeed, his conduct may constitute an outright breach of his franchise contract, so long as his actions do not represent "conscious malfeasance" or "willful failure." Objective tests may prove him to be far less effective than other franchisees or other outlets of competing franchisors. Yet, according to

S. 2321, the franchisor may not refuse to deal with him except upon payment of an excessive ransom.

The franchisor, on his part, cannot compete effectively under these provisions. He may know that the customers of his franchisee are dissatisfied, that his share of the market is declining, that the shares of the market of his competitors are increasing, but he is virtually helpless. He cannot even deal directly with dissatisfied purchasers who are so incensed with the franchisee that they plan to change to other sources of supply. Under the bill he must either continue to deal with the ineffective franchisee or redeem his right to compete upon payment of an oppressive penalty.

The industry itself, in due course, may become noncompetitive under these provisions. Potential franchisors will tend to enter into old and new markets solely through captive outlets. Existing franchisors will tend to expand into new markets only through company stores. And presently integrated manufacturers may drive out of the market any independent manufacturer who is forced to put up with ineffective franchisees. Under the bill, the trend to concentration in our economy-I might add which I strongly deplore-will be further accelerated.

3. My third thought is that the availability of alternatives to S. 2321 should be explored, before enacting any such controversial new legislation.

Those appearing at these hearings will presumably do more than view with alarm the enactment of this bill. Alternative courses of action have and will be suggested. My alternative proposal is mediation. Personal experience in the field of franchising leads me to the belief that the head office of a successful franchisor-in the absence of some antitrust violation-rarely approves the cutting off of an effective and loyal franchisee if it knows all of the relevant facts. This experience further causes me to conclude that the head office of such a franchisor usually, although not always, makes a generous settlement when it acts to drop an ineffective, but nevertheless loyal, franchisee. But the top management does not always know all of the facts. On occasion a franchisee will be cut off without having been accorded the opportunity to tell his story impartially and effectively to the controlling executives of the franchise organization involved.

My modest proposal, therefore, is that Congress might consider, in lieu of enacting S. 2321, the authorization of some existing Government agency to act as a Federal mediator to which a distributor, who is threatened with the loss of his franchise, might turn. This Federal mediator might then consult all parties to the dispute, possibly obtain the advice and assistance of impartial industry panels, and eventually seek to obtain a solution that is just and equitable both to franchisee and to franchisor. The credentials of the Federal mediatorthis is so important-would insure its ready access even to the chief executives of our largest corporations.

The experience in the field thus gained by the mediation agency might further be reported to Congress after a reasonable period of time with a recommendation, based upon its actual rather than any theoretical knowledge of the relevant facts, as to whether or not any further legislation is required to assure fair treatment to franchisees. The merit of this modest proposal, in part, is that it would do some

thing now for franchisees, while it would permit Congress to decide later, on the basis of actual experience, whether or not to do more for them. A further merit is that it would also postpone any further breach in the antitrust dam, which today shelters our free economy alike from capitalistic cartels and communistic combinations.

I believe that I am second to none in my desire to help sustain and support small business. But I also believe that any such assistance should be consistent with the competitive principles of our antitrust laws. Just as I oppose relaxing the antitrust laws to give any privileged position to franchisors may I interject I am very strongly against proposed bills to allow them to divide territories, and so onI am equally against making an exception under these laws for franchisees. Surely one does not love small business any less because he loves a free economy more.

Thank you.

Senator HART. Thank you very much, Mr. Van Cise. It is a very reasoned, balanced discussion of an admittedly rather difficult thing fairly to balance.

Mr. VAN CISE. Thank you, sir.

Senator HART. You are suggesting, oversimplifying it some, that rather than doing as the two bills that we have before us would doturning the controversy over to a court with certain specific rights provided the franchisee-you would have us direct a Federal agency to act as mediator. I take it you would not have us, as we do in these bills, spell out certain fixed rights that would be available to the franchisee, is that right?

Mr. VAN CISE. No, sir. What I would like, however, is to have the agency authorized to preserve the status quo for a reasonable time while it explores the facts. This is essential. My feeling is that franchisees do not know how effective their remedies are. First of all, unless there is a highly concentrated industry like the automobile industry where one company is 50 percent, there usually is another source of supply. If you have an effective franchisee and I hold no brief for a franchisor bailing out an ineffective franchisee-if you have an effective franchisee who has exploited his territory, built up sales, has a prosperous business, if he can do it for one supplier, he can do it for another, because he has clientele, people satisfied with him, a reputation. There is a great demand for effective franchisees if there are alternative sources of supply. So first, he has the right of self-help; and I do not believe any contract that provides that the franchisor can refuse to extend a franchise when the franchisee has been effective, can prevent that franchisee from staying right there and going into business for himself or someone else.

In addition to the right of self-help, the antitrust laws today, thanks to the Supreme Court, and some of my friends in the antitrust bar will not like my saying thanks to the Supreme Court, have carved a way out from this right of refusal to deal. The Colgate case did not say that you can fire a franchisee for any reason. That right cannot be exercised if it is in violation of the Sherman or Clayton or FTC Acts, and if there is any attempt to try to force the franchisee to take goods that he does not want, and he is cut off, he can sue. Mr. Bangert has a copy of an article that I have written recently outlining how strict the antitrust laws are upon the franchisor. And they should be strict.