What is franchise law?
Imagine reading a 100 plus page contract filled with unfamiliar legal jargon. Then, imagine researching all of the federal law that regulates franchising. But wait, there’s more! After that, you have to dive into the franchise law that applies specifically to your state. Don’t forget international law! All of these different levels and aspects of franchise law can seem overwhelming for just about anyone.
Franchise law isn’t the most straightforward area of legal study. While there exists federal regulation of franchising, laws also vary from state to state. Understanding the basics behind franchise law can give both the franchisor and franchisee a better grasp of the rules and regulations they need to follow. Anyone interested in pursuing franchising (or simply, anyone interested in learning more) can benefit from a quick refresher on the law.
What Constitutes a Franchise?
A franchisor must satisfy three elements, according to the Federal Trade Commission (FTC):
A trademark or other symbol must be provided to the franchisee. However, before the franchisor can give out a trademark license, their mark must be registered. This process can be lengthy and complicated but must be completed before the trademark is used. Once a franchisee purchases a franchise, they gain the right to use and sell products bearing the trademark name.
The franchisor has primary, overarching control over the operation of the business. This can include site approval, hours of operation, personnel policies, among other categories. The franchisor also sets the business practices, methods, and services. In other words, they establish the business, which the franchisee later carries out.
Depending on the terms of The Franchise Agreement, the franchisee is expected to pay an initial investment fee. There are also fees and royalties associated with the franchise purchase. All fees that the franchisee must pay are detailed in the Franchise Disclosure Document (FDD).
Trademark, authority and payment
Given that a business satisfies these three categories, it is considered a franchise under the FTC Franchise Rule. State definitions of a franchise vary, however. Nevertheless, there are characteristics that many states use to define a franchise. In California, Illinois, Indiana, Iowa, Maryland, Michigan, North Dakota, Oregon, Rhode Island, Virginia, Washington and Wisconsin, a business must have a marketing plan, association with a trademark, and a required fee to qualify as a franchise.
A key part of any franchise is the sale of a good or service, which is promoted and advertised through the help of a developed marketing plan. Each franchisee is also given the right to sell or distribute the company’s goods within the preexisting marketing plan.
Association with Trademark
As with the FTC, the above states require that a franchise be associated with a trademark.The franchisee’s business, too, must be directly associated with the trademark in order to qualify as a franchise.
Any franchisee is required to pay fees to the franchisor in order to purchase their own branch of the franchise.
In Hawaii, Minnesota, Mississippi, Nebraska, and South Dakota, the franchise must have an association with a community of interest rather than a marketing plan. In other words, these states require that a business have a specific desired demographic, association with trademark and the required fee.
3 Categories of Franchise Law
According to Vinson Franchise Law Firm, the FTC upholds three categories of franchise law, which dictate the regulations behind franchising in the US
Disclosure law is regulated at the federal level by the Federal Trade Commission (FTC). This agency works to ensure fair business practices throughout the country. Disclosure law in franchising seeks to ensure that all relative and important information regarding the franchise is disclosed at the time of the franchise offering. This area of franchise law creates a transparent interaction between the franchisor and franchisee.
This area of franchise law creates a transparent interaction between the franchisor and franchisee.
According to the FTC’s 2007 Franchising Rule, franchisors must provide franchise disclosure documents (FDD) at the offering or sale of a new franchise. These documents can be furnished by any method, including electronically. FTC rule holds that franchisors must provide franchisees with the disclosure document at least 14 days before the signing of a binding contract. This clause gives the franchisee two weeks to review disclosures before any agreements are made.
The FDD consists of 23 different items, which specify the different aspects of franchise ownership. The franchise agreement is also included in the FDD, which draws out the terms and conditions of the purchase and ownership of the franchise. These items include:
Item 1. The Franchisor and any Parents, Predecessors, and Affiliates
Item 2. Business Experience
Item 3. Litigation
Item 4. Bankruptcy
Item 5. Initial Fees
Item 6. Other Fees
Item 7. Estimated Initial Investment
Item 8. Restrictions on Sources of Products and Services
Item 9. Franchisee’s Obligations
Item 10. Financing
Item 11. Franchisor’s Assistance, Advertising, Computer Systems, and Training
Item 12. Territory
Item 13. Trademarks
Item 14. Patents, Copyrights, and Proprietary Information
Item 15. Obligation to Participate in the Actual Operation of the Franchise Business
Item 16. Restrictions on What the Franchisee May Sell
Item 17. Renewal, Termination, Transfer, and Dispute Resolution
Item 18. Public Figures
Item 19. Financial Performance Representations
Item 20. Outlets and Franchisee Information
Item 21. Financial Statements
Item 22. Contracts
Item 23. Receipts
All of these items are approached in depth within the FDD. This document also contains the franchise agreement. This is another crucial document, which is, essentially, the contract that binds the franchise relationship.
These documents are all provided prior to the actual franchise purchase in order to ensure transparency throughout the entire transaction. Each year, franchises are required to submit an updated FDD in order to fulfill the federal disclosure requirements.
As there is no federal registration of franchises, various states require in-state registration. In most states, the registration process involves review of the most recent FDD. Most state registrations expire after about a year after the registration, after which the franchisor must reapply for registration and provide updated disclosure documents. The states that require registration include:
- New York
- North Dakota
- Rhode Island
- South Dakota
Most states require that the FDD be updated any time there is a significant alteration to the document, especially if it affects the franchisee. Others even require that all advertisements geared towards selling the franchise be reviewed before they are released.
State relationship laws govern the franchisor/franchisee relationship. There is no federal law that governs these relationships, thus regulations vary from state to state. These laws typically regulate matters such as grounds for franchise termination or equal franchisee treatment. Relationship laws also ensure equal treatment of franchisees.
According to the guidelines of most states, a franchise relationship is established if:
- It involves the use of a trademark
- There is a “community of interest” and the franchisor provides the franchisee with a marketing plan
- The franchisor charges the franchisee a fee
There are more than 20 countries that have instituted some form of disclosure law regarding franchising. While the specific content of these laws varies from country to country, most foreign disclosure laws are generally more lenient than US regulation.
It is necessary that franchisors also register their trademark in a foreign country. This process, too, depends on the foreign country of interest. Most often, countries possess some sort of federal register that contains all of the currently active trademarks. Franchisors may research these databases to deduce whether their trademark is available in the country. It is also necessary that franchisors consider whether their trademark has the potential to translate smoothly in the new country.
Now, keep reading…
Now that you have a general understanding of franchise law in the US, don’t stop there. Both federal and state law goes much further than the surface and affects nearly all industries in the country. Not to mention, US franchising has even spread to different countries!
I. How the law is organized: Federal
II. How the law is organized: State
III. Some Relevant International Statute