The laws of franchising can certainly seem a bit overwhelming and intimidating at first for even the most seasoned entrepreneurs. It can especially be a lot to process for those new to entrepreneurship and just beginning their search for the franchise that suits them. At times, you may feel like you need to hire a lawyer just to explain the basics of franchise law!
Fortunately, franchise law is much easier to understand than you think. How so? It can typically be broken down into three categories: registration law, disclosure law, and relationship law. Each plays a key role in the broader laws of franchising in its own distinct way.
Interested in learning more about the laws of franchising? Here’s an in-depth look at the three main categories of franchise law below!
Franchise Registration Law
One of the major laws of franchising is franchise registration law, which deals with registration of the franchise itself as well as salespeople and advertising pertaining to the franchise.
It’s important to note that there’s actually no Federal registration laws regarding franchising, not even within the FTC Franchise Rule. That being said, a number of states do indeed require in-state registration. These states include:
- New York
- North Dakota
- Rhode Island
- South Dakota
In most of these states, the registration process involves a thorough review of a franchisor’s most recent franchise disclosure document (FDD) to ensure compliance with state regulators. In other states, registration may simply be just filing the FDD with state authorities. State registrations typically last a year, after which the license to operate in the state must be renewed and an updated FDD submitted for approval.
Some states, such as Ohio, require the registration of business opportunities, though these regulations typically exclude franchises.
Most states that require the registration of franchises themselves also require the registration of franchise sales and advertising. Some states may restrict the advertising of franchise opportunities, or at least the language and content of such advertisements. People involved in sales on behalf of the franchisor are also typically required to register in these states.
Franchise Disclosure Law
Another key aspect of the laws of franchising is franchise disclosure law, which concerns how franchisors disclose critical information to prospective franchisees through FDDs.
Regulated by the Federal Trade Commission (FTC), franchise disclosure law aims to help prospective franchisees understand all of a franchise’s important and relevant information and facts before signing a franchise agreement. Ultimately, its goal is to make the franchise offering process as transparent as possible so that the prospective franchisee can choose if the opportunity is right for them before taking the next step to formally sign a franchise agreement with the franchisor.
In accordance with the 2007 update of the FTC Franchise Rule, the governing body of the laws of franchising in the United States, franchisors must provide a prospective franchisee with an FDD at least 14 days prior to the signing of a legally-binding franchise agreement, giving them two weeks to review the documents in detail and get answers to any outstanding questions. These documents can be given to the prospective franchisee through any method available, including electronically.
The FDD, one of the cornerstones of the laws of franchising in the United States, is divided into 23 specific points, each of which deals with an aspect of franchise ownership in detail: They include:
Item 1. The Franchisor and any Parents, Predecessors, and Affiliates
Details the history and background of the franchisor in-depth, giving the prospective franchisee a look at its origins.
Item 2. Business Experience
Provides information on the franchisor’s current leadership team, such as directors, business partners, and other important people.
Item 3. Litigation
This important section details any completed or pending litigation involving the franchisor.
Item 4. Bankruptcy
Discloses any bankruptcies by the franchisor within the past 10 years.
Item 5. Initial Fees
Another key section of the FDD, this item offers information on the initial fees, such as the initial franchise fee, that the franchisee is expected to pay upfront upon signing a franchise agreement with the franchisor.
Item 6. Other Fees
Divulges any additional fees required by the franchisor, such as monthly royalty fees or advertising fees.
Item 7. Estimated Initial Investment
Outlines the major expenses a franchisee is expected to pay, like insurance premiums, license fees, inventory costs, training expenses and the like.
Item 8. Restrictions on Sources of Products and Services
Details the franchisor’s relationships with its vendors and suppliers.
Item 9. Franchisee’s Obligations
This important section takes a close look at the day-to-day job details and responsibilities of a franchisee.
Item 10. Financing
Discusses any financing options offered by the franchisor, if available.
Item 11. Franchisor’s Assistance, Advertising, Computer Systems, and Training
This section details the training and support offered by the franchisor to assist its franchisees.
Item 12. Territory
Explains what protected territory a franchisee has access to.
Item 13. Trademarks
Discusses the company’s trademarks and their appropriate uses.
Item 14. Patents, Copyrights, and Proprietary Information
Details any patents, copyrights, and proprietary material and information owned by the franchisor.
Item 15. Obligation to Participate in the Actual Operation of the Franchise Business
Offers a closer, more detailed look at the franchisee’s responsibilities.
Item 16. Restrictions on What the Franchisee May Sell
Explained what franchisees may or may not sell and any restrictions put in place by the business.
Item 17. Renewal, Termination, Transfer, and Dispute Resolution
Important section that details dispute resolution methods used by the franchisor as well as how franchise agreement renewals and terminations are handled.
Item 18. Public Figures
Discloses any public figures associated with the franchise.
Item 19. Financial Performance Representations
This section looks at the historical financial performance of franchisees and lays out the revenue range of what they possibly could make. It’s important to note that this information isn’t a guarantee or projection of what prospective franchisees can expect to make, only historical data.
Item 20. Outlets and Franchisee Information
Outlines the company’s franchised locations over the past 3 years on a state-by-state basis.
Item 21. Financial Statements
Details audited financial statements from the franchisor.
Item 22. Contracts
Franchise agreement, non-disclosure documents, and other applicable agreements and forms are provided here.
Item 23. Receipts
Verifies that the prospective franchisee has received the FDD.
Franchise Relationship Law
The third and final category of the laws of franchising is franchise relationship law. Regulated at the state level, franchise relationship laws regulate the franchisee-franchisor relationship.
Per guidelines in most states, a franchise relationship can be established if it meets the following criteria:
- The use of a trademark is involved
- The franchisor levies a fee on its franchisees
- The franchisor provides franchisees with a marketing plan or a “community of interest” is involved in the business opportunity.
As no Federal law governs the franchisee-franchisor relationship, these laws can differ on a state-by-state basis. Specifically, these laws usually govern aspects of franchise law such as the fair and equal treatment of franchisees, the termination of franchise agreements, and other details of the franchisee-franchisor relationship.
Understand the Laws of Franchising to Succeed In It!
Understanding the laws of franchising may seem complex at first, but by breaking them down into three distinct categories, they become much easier to process. By understanding the details of registration, disclosure, and relationship laws, entrepreneurs can feel more confident doing things like signing franchise agreements, reading FDDs, and the like. Ultimately, they can become a better franchisee in the long-term!