Recall the difference between State and Federal Law
There are many different types of laws in the US, including federal law, state law, and even local or municipal law. As far as franchising is concerned, the relevant law and regulation are divided between federal and state.
Federal law is the law of the United States and applies evenly to all citizens. So, if you are a franchisor or franchisee in the US, all federal franchise laws apply to you and must be followed. On the other hand, state law applies only to specific states. State franchising laws may say one thing in one state but something else in another. In other words, you are not only subject to federal law but also to the law of your state.
YOU ARE NOT ONLY SUBJECT TO FEDERAL LAW BUT ALSO THE LAWS WITHIN YOUR STATE.
In order to ensure lawful business operations, it’s vital to understand both the federal and state statutes that apply to you.
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 vary state-by-state. Nevertheless, there are certain aspects of state franchise statute that are generally applicable and worth reviewing.
REGISTRATION LAWS REGULATE THE REGISTRATION OF THE FRANCHISE BUT VARY FROM STATE TO STATE
Certain states in the US, known as franchise registration states, require that a franchisor not only submit pre-sale disclosures (the franchise disclosure document [FDD]) but also register the franchise within the state before any sales can be made. The registration states include:
- New York
- North Dakota
- Rhode Island
- South Dakota
Most of these states require that the FDD be filed along with the registration application in order to meet all disclosure criteria before they may sell or offer their franchise.
In order to register a franchise within the desired state, the business must meet the state’s criteria for qualification. However, these criteria are not consistent across the entire US.
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 services 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 FDD by a franchise regulator. However, there are states where the FDD 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.
The FDD must be updated whenever there is a change to the substantive information regarding the franchisor or franchise opportunity. This means any information that a potential franchisee may 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.
STATES REGULATE FRANCHISE ADVERTISING IN ORDER TO PREVENT FALSE ADVERTISING OR MISLEADING INFORMATION.
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.
Registering a Franchise Offering
Before any offers or sales of a franchise can be made in a certain state, the franchisor must register its franchise offering. In other words, this is the first step to selling your franchise. This registration must be renewed each year with an updated and current FDD. Other necessary paperwork includes audited financial statements. Franchise registration renewal is time sensitive and must be completed before the initial registration expires. Expiration typically occurs around 90-120 days after the franchisor’s fiscal year end. Should a franchisor fail to renew their registration within the necessary time frame, they subject themselves to higher fees and heightened scrutiny when their FDD is reviewed.
The Filing Process
The required documents for franchise filing vary by state. The North America Securities Administrators Association (NASAA)’s 2008 Franchise Registration and Disclosure Guidelines provide a list of documents necessary to successfully complete the filing process. These documents include:
- Uniform Franchise Registration Application
- Franchisor’s Costs and Sources of Funds
- Uniform Franchise Consent to Service of Process
- Franchise Seller Disclosure Forms
- Application Fee
- Guaranty of Performance
- Consent of Accountant
- Advertising/Promotional Materials
All of these documents must be presented at the filing and also the renewal. In the context of renewal, the franchisor must provide an updated and revised FDD wherein any revisions are made apparent with a blackline of the original version to show the specific changes. Several states (Indiana, South Dakota, and Wisconsin) only require the updated FDD—no blacklines necessary. Additionally, New York and Hawaii require that the franchisor disclose the number of franchises sold in the year.
Multi-Unit Franchise Offerings
For a long time, states did not provide any specific registration guidelines regarding multi-unit franchises. Not only was this a difficult structure to regulate but franchise lawyers and state franchise examiners alike had difficulty issuing disclosure guidelines and criteria for multi-unit franchises.
In 2014, the NASAA issued the Multi-Unit Commentary, which promoted a more succinct guideline for registration and disclosure of multi-unit franchise offerings. In this document, the NASAA establishes that a franchisor may grant a franchisee the right to develop multiple units within the same FDD that is used to offer single-unit franchises.
State Relationship Laws
Relationship laws are in place to ensure lawful interaction between the franchisor and franchisee. Franchise relationships are not regulated at the federal level and are therefore mandated by states. Relationship laws regulate issues such as unjust termination, no renewal rights, no right to assign, among other abuses.
The 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
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 fails to comply with obligations. The states’ restrictions on termination usually require an advance notice period ranging from 30 to 120 days.
RELATIONSHIP LAWS REGULATE THE RELATIONSHIP BETWEEN THE FRANCHISOR AND FRANCHISEE.
The states also restrict non-renewal. While state laws do not require that a franchise agreement 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.