Business Resources / Franchise Issues

CHECKLIST OF FRANCHISE REGULATORY ISSUES

I. Applicable Law.

A. Identify Which Law Applies. The Federal Trade Commission's Trade Regulation Rule, "Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures,"  commonly known as the "FTC Rule," applies in all 50 states but can be preempted by state laws that require more stringent disclosure and enforcement.

B. Definition of "Franchise" Under Applicable Law. There are no single definitions of the business concepts known as "franchises," "business opportunity plans," and "distributorships." The definitions of these concepts are a function of statutory law and, in some instances, case law. Further, some definitions of these terms may include all three concepts. Thus, an analysis of whether a particular business opportunity is specifically defined and, in turn, a regulated transaction, must begin with a review of the relevant definitions under federal and state laws.

C. Determine If Franchise Laws Apply. While a business offering may walk, talk, and look like a franchise, the FTC Rule and various states have exempted or excluded certain business transactions from the scope of their franchise laws. An examination of the definition must always occur in conjunction with a review of the exemptions and exceptions which exist under the appropriate regulation.

D. Determine if any Specialized Industry Laws Apply. On the state and federal level certain industries such as petroleum retailing and automobile retail sales are governed by specialized termination/nonrenewal laws regulating the circumstances under which dealers in these industries can be terminated or their contracts not renewed.

E. Determine the Relationship between Applicable State Law and FTC Rule. Some states' disclosure and registration laws make reference to the FTC Rule and indicate for instance, that use of the disclosure format provided in the FTC Rule is adequate for purposes of disclosure under the relevant state law. In addition, the state laws may draw upon the timing of disclosure required under the FTC Rule to specify when prospective franchise buyers are entitled to disclosure information under a state's law.

F. Determine What Types of Law Apply to Franchising. Some states require disclosure, some states require registration and disclosure, and some states have relationship laws which govern the nature of the contract itself as well as terminations or nonrenewals of the franchise agreement.

II. Registration and Disclosure.

A. Determine Whether Registration Is Required. No registration is required with the Federal Trade Commission but approximately 14 states require registration of franchise offerings and 18 states require registration of business opportunity plans. In the remaining states, disclosure under the FTC Rule or the Uniform Franchise Offering Circular Guidelines is generally acceptable. Check each state's law to determine if registration is required.

B. Registration of Sales Brokers. If a franchisor chooses to use a franchise broker or sales person to sell franchises in a particular state, that state's law should be consulted to determine if a separate registration of that individual is necessary prior to commencement of the sales program.

C. Choose or Determine which Disclosure Format Will Be Utilized. In the franchise industry, three formats exist from which a franchisor may choose to produce its disclosure documents. The FTC Rule specifies a certain format, many states permit the use of the Uniform Franchise Offering Circular adopted by the North American Securities Administrators Association, and, finally, most states set forth their own acceptable disclosure format. While many of the categories of disclosure under the FTC Rule, Uniform Franchise Offering Circular Guidelines and the various state laws are very similar, they are not identical. The choice of a specific format brings with it a certain set of rules governing the creation of the disclosure document itself, the disclosure of ancillary information, and the provision of necessary financial information to prospective buyers.

D. What Information Applicable Law Requires to Be Disclosed. After determining which law is germane, seek out the information which the law requires to be disclosed. Generally speaking, the information required is:

1. The name of the franchisor, its predecessors, and any affiliates.

2. The identity and business experience of persons affiliated with the franchisor and franchisor brokers.

3. Litigation.

4. Bankruptcy.

5. The franchisee's initial franchise fee or other initial payment.

6. Other fees.

7. The franchisee's initial investment.

8. Restrictions on sources of products and services.

9. Obligations of the franchisee.

10. Financing arrangements offered by the franchisor.

11. Obligations of the franchisor.

12. Territory.

13. Trademarks.

14. Patents, copyrights, and proprietary information.

15. Obligation of the franchisee to participate in the actual operation of the franchise business.

16. Restrictions on what the franchisee may sell.

17. Renewal, termination, transfer, and dispute resolution.

18. Arrangements with public figures.

19. Earnings claims.

20. List of outlets.

21. Financial statements.

22. Contracts.

23. Receipt.

E. Special Offering Circular or Franchise Agreement Provisions. Either through the general state law or through specific regulations adopted by a specific state's administrator, some states mandate the insertion of specialized language or provisions in disclosure statements or franchise contracts themselves.

F. Financial Statements. The FTC Rule, Uniform Franchise Offering Circular Guidelines, and various state laws contain provisions relating to the preparation of financial statements that must be attached to the disclosure documents provided to prospective buyers. The treatment of the preparation of financial statements is slightly different under each of the rules and regulations and must be consulted in advance of the disclosure of information to franchisees as well as the preparation of the documentation to be attached to the franchise offering circular.

G. Earnings Claim Restrictions. The FTC Rule and most state laws regulate a franchisor's ability to state or predict the amount of profit, sales, or earnings a franchisee may realize from the operation of its franchise business. In fact, earnings claims are generally prohibited unless accompanied by substantiating data and conspicuous warnings provided to a franchise candidate. The FTC Rule and various state laws should be consulted before a franchisor makes any such claims and before a franchisee relies upon any such statements.

H. Determine the Proper Time for Disclosure. Franchise regulations are very specific about the timing of disclosure to a franchisee. In registration states, the offering circular or disclosure document of the franchisor must be registered with the state agency prior to offering a franchise opportunity to any prospective candidate. Disclosure documents must generally be presented to prospective candidates, under the FTC Rule, at the time of the first personal meeting or 10 business days prior to the execution of any franchise agreement or acceptance of funds by the franchisor, whichever is sooner. Some states simply require the disclosure documents to be provided 10 business days in advance of the execution of a franchise agreement or acceptance of the initial franchise fee.

I. Determine Whether Franchise Advertisements Are Regulated. Some states, generally the registration states, require a franchisor to submit any intended advertisement for solicitation of franchise sales in the relevant state for approval to the franchise regulator before publication.

III. Franchise Law Regulation and Enforcement.

A. Determine Appropriate State Regulator. In addition to the Federal Trade Commission, various states have special agencies regulating franchising within their borders. In some states, this is handled by the state attorney general but in others special administrators are specifically assigned to franchising.

B. Enforcement of Franchise Violations. The Federal Trade Commission entertains complaints for violations of the FTC Rule and various state attorneys general or state administrators pursue violations of their state franchise laws. In some instances, investigations and prosecutions by governmental agencies result in redress to injured franchise purchasers.

C. Private Enforcement of Franchise Regulations. While the FTC intended that there be a private cause of action for a violation of the FTC Rule, federal courts have denied private litigants this right. Most state franchise laws provide franchise purchasers with a private cause of action for violations of that state's franchise laws and provide enhanced remedies in the event of a violation. Should litigation be necessary, a review of the possible state laws which may be involved is appropriate.

D. Choice of Law. Although the practitioner may determine which state law is germane to registration and disclosure, it is possible that the laws that guide the practitioner in these areas may not be pertinent when it comes to the enforcement of the franchise agreement. Many franchise agreements provide for a specific state's laws application in the event of the interpretation of the contract. Generally, the specified state law will govern the interpretation of the contract. However, there are circumstances under which the law specified in the contract may not be accepted by the courts interpreting the franchise agreement. An examination of various statutory laws and case law must be undertaken. Furthermore, some states require the insertion of that state's law as the controlling law in the franchise agreement at the time of registration or disclosure.

E. Exclusive Territories and Proximity of Franchisees. Recently, a few courts and some states have tackled the issue of a franchisor's placement of a new franchisee in near proximity to an existing franchisee and the effect that the placement may have upon the existing franchisee's business. State law should be consulted in regard to how close franchisees may be placed to each other or the consequences of the same.

F. Trademark and Service Mark Registrations. If the franchisor associates itself with specific trademarks, service marks, and related logos, registration of these marks with the United States Patent & Trademark Office and the appropriate Secretary of State in the states in which franchises are being offered should be undertaken prior to offering franchises for sale.

G. State and Federal Antitrust Issues. Because franchising generally involves the distribution of products and services from a manufacturer or franchisor to a dealer or franchisee, issues involving price discrimination, tying arrangements, price advantages, and monopolization are matters which may impact the franchise relationship.  Federal and state antitrust laws should be consulted on such issues.