The Federal Trade Commission (FTC) is the federal governing body of franchise law in the US. The FTC is a federal agency, established in 1914, that regulates consumer protection legislation, ensuring a free and fair competition in the marketplace. The Original Franchise Rule was established in 1978 after the Commission “found widespread deception in the sale of franchises and business opportunities through both material misrepresentations and nondisclosures of material facts.” With the Rule, the FTC hoped to prevent deceptive or unfair practices in the sale of franchises by requiring disclosure within the franchisor/franchisee relationship.
The FTC is a federal agency, established in 1914, that regulates consumer protection legislation, ensuring a free and fair competition in the marketplace.
While the Original Rule did regulate disclosure, it failed to express specifically which pieces of information a franchisor must disclose to a prospective franchisee. The Original Rule also conflicted with the Uniform Franchise Offering Circular, which regulates disclosure at the state level. So, the Rule was revised , ultimately resulting in the 2007 Rule used today.
The 2007 Rule applies to all franchisors in the US and lists 23 categories that each franchisor must disclose to any prospective franchisee. These categories are disclosed within a Franchise Disclosure Document (FDD), which the FTC legally mandates. An exhaustive list of the categories required in an FDD can be found here.
Whereas states regulate franchise registration and relations between franchisors and franchisees, the FTC federally regulates disclosure. Below are some key elements of the FTC Franchise Rule:
- 436.2 Obligation to furnish documents
Any franchisor must furnish a prospective franchisee with a copy of the most current disclosure document at least 14 days before the Franchise Agreement is signed. Furthermore, it is unlawful for the franchisor to change or alter any terms and conditions of the Franchise Agreement, or any other agreements attached to the disclosure document, at least seven days before signing.
- 436.6 Instructions for Preparing Disclosure Documents
It is legally required that any franchisor include all the required information (mentioned in link above). The FTC, however, also promulgates specific instructions regarding the preparation of the FDD.
First and foremost, all required information must be clearly and concisely expressed in a single, printable or tangible document. The prospective franchisee must be able to tangibly hold the document in some form or another.
Furthermore, the franchisor is required to provide full information for each item in the FDD. If an item does not apply to the business, the franchisor is required to state that the category is inapplicable. In order to ensure a comprehensive FDD, the franchisor is also prohibited from including extra information or materials.
Before the FDD is furnished, the franchisor must inform the potential franchisee of the document’s format so that they may plan accordingly. The franchisor is also expected to keep sample copies available for three years after the FDD is last used.
- 436.8 Exemptions
There are certain scenarios wherein a franchisor can be exempt from the above mentioned requirements. For instance, if the franchise relationship is a fractional franchise or is a leased department, the franchisor may be exempt from the provisions of part 436. Furthermore, if the franchisee is an entity in business for at least five years with a net worth of at least $5,715,500, then, too, the franchisor can be exempted.
Any prospective franchisor or franchisee should thoroughly review the FTC Franchising Rule. Another option is to hire an attorney that specializes in franchise law.
While the Federal Trade Commission (FTC) regulates disclosure in franchising, the states regulate franchise registration and the franchisor/franchisee relationship. Generally, registration laws regulate the registration of the franchise, the registration of franchise advertising, and the registration of franchise salespeople. Relationship laws, on the other hand, govern aspects of the franchisee/franchisor relationship. This includes grounds for franchise termination, notice periods before the termination, and grounds for nonrenewal of a franchise. However, specific criteria varies state-by-state. Nevertheless, there are certain aspects of state franchise statute that are generally applicable and worth reviewing.
In order to register a franchise within a desired state, the business must meet the state’s criteria for qualification. However, these criteria are not consistent across the entire US. For instance, in California, Illinois, Indiana, Iowa, Maryland, Michigan, North Dakota, Oregon, Rhode Island, Virginia, Washington, and Wisconsin, the criteria are as follows:
Marketing Plan: The franchisee is given the right to offer or sell their goods or services within a preset marketing plan, which is outlined by the franchisor.
Association with Trademark: Any business operations conducted by the franchisee must be associated with the franchisor’s trademark, which has been properly registered.
Required Fee: All franchisees are expected to pay the fees promulgated by the franchisor.
On the other hand, in other states, the three elements of a franchise do not totally match up. In Hawaii, Minnesota, Mississippi, Nebraska, and South Dakota, the criteria are as follows:
Trademark License: The franchisee is expected to be granted the right to distribute or sell goods and service using the company’s properly registered trademark.
Community of Interest: The franchise must have a desired demographic or community of interest to which intends to market its goods or services.
Required Fee: The franchisee is required to pay the appropriate fees as expressed by the franchisor.
As far as registration pricing is concerned, the numbers vary according to state. Typically the process for registering a franchise requires review of the UPOC by a franchise regulator. However, there are states where the UPOC is filed without review. On average, state registrations last for about a year but can be renewed with a renewal application or annual report (and an additional filing fee). An outlier, Maryland additionally requires that franchisors file quarterly reports.
Much like an FDD, the UFOC must be updated whenever there is a change to the substantive information regarding the franchisor or franchise opportunity. This means information that a potential franchisee would consider significant in making a decision to purchase a franchise.
Some states are even pickier than the others, requiring that all advertising for the sale of franchises be filed within the state. Typically, this means that the states also have the ability to censor what the franchisors express in their advertisements. Through this regulation, the states make an effort to limit false advertising or misleading information, ensuring a transparent exchange between potential franchisees and franchisors. States that regulate advertising are: California, Indiana, Maryland, Minnesota, New York, North Dakota, Rhode Island, South Dakota and Washington.
Most of the franchise registration states also require the franchisor file information regarding franchise salespeople. Often the desired information includes the salesperson’s home address, phone number, business address, social security number, date of birth, five-year employment history, among other criteria. States that require information regarding franchise salespeople include: California, Hawaii, Illinois, Indiana, Maryland, Minnesota, North Dakota, Rhode Island, South Dakota, and Washington.
State Relationship Laws
Relationship laws are in place to ensure lawful interaction between the franchisor and franchisee. These laws often restrict termination. In all 19 states, except North Dakota, it is illegal for a franchisor to terminate a franchise agreement without good cause. In this case, good cause usually includes the franchise becoming bankrupt, the franchisee abandoning operations, the franchisee convicted of a crime related to the franchise, or the franchisee failing to comply with obligations. The states’ restrictions on termination usually require an advance notice period ranging between 30 to 120 days.
The states also restrict non-renewal. While state laws do not require franchise agreements include renewal provisions, if the agreement does have a renewal provision then the franchisor’s ability to not renew is restricted. In other words, if an agreement promises renewal, the franchisor can’t refuse to renew without good cause. Lawful nonrenewal also requires advance written notice. States that restrict non-renewal include: Arkansas, Connecticut, Delaware, Hawaii, Iowa, Indiana, Minnesota, Mississippi, Missouri, Nebraska, New Jersey, and Wisconsin.
In several states it is also unlawful for a franchisor to refuse a franchise transfer without good cause.