Regulation of Franchisor Opportunism and Production of the Institutional Framework: Federal Monopoly or Competition Between the States?

Abstract

The Sherman Act forbids contracts that restrain interstate commerce, and proof of significant market power is usually necessary to establish the existence of such a restraint. Recently, however, some have argued that courts should employ the Sherman Act to regulate opportunistic behavior by franchisors that do not possess the sort of market power ordinarily necessary to establish antitrust liability. Inspired by the Supreme Court's decision in Eastman Kodak v. Image Technical Services, these advocates find "market power" in the presence of relationship-specific investments and would impose antitrust liability on franchisors that abuse such power to the detriment of their franchisees. Informational asymmetries and bargaining costs, it is said, prevent franchisees from protecting themselves in the bargaining process from unduly onerous contractual terms. This essay argues that reliance upon the Sherman Act to combat franchisor opportunism would constitute an unjustified expansion of federal regulatory authority and upset the traditional division of labor between states and the national government. To be sure, scholars have provided a plausible story of opportunism in the franchising context, where bargaining and information costs can be significant. Still, these advocates have not explained why federal regulation of such behavior is warranted. As Professor Coase has recognized, bargaining and information costs do not exist in a vacuum, but are instead a function of the institutional framework, a framework constructed by background rules of (state) contract law that lower the costs of entering and maintaining relational contracts. Any argument for federal intervention to combat opportunism, then, must explain why the background rules of contract law are not adequate to minimize information and bargaining costs and thus deter opportunistic behavior. More precisely, those who advocate Sherman Act regulation of franchiser opportunism must demonstrate that competition between the states to produce the institutional framework governing the franchisor-franchisee relationship is characterized by a "race to the bottom" that warrants federal intervention. Preliminary analysis suggests that such a race to the bottom is unlikely. No state can become a "haven" for opportunistic franchisors without the cooperation of other states, who must enforce the franchisor's choice of law clauses. Moreover, states that adopt institutional frameworks that raise the cost of transacting and thus facilitate franchisor opportunism will raise the costs of intrastate transactions and make their own citizens vulnerable to opportunism. Federalizing this body of law, then, would unnecessarily deprive businesses and consumers of the benefits of interjurisdictional competition.