Why Franchise Laws and Regulations Were Needed
The booming popularity and growth of franchising in the 1950s and 1960s brought during the late 1960s increasingly frequent franchisee complaints of abuses by franchisors. By the latter half of the 1960s, franchisors started popping up who were more focused on selling franchises than on operating sound franchise businesses.
Salesmen began to make misrepresentations and promises to attract franchisees; some based their sales efforts on the use of celebrity names and endorsements; and some became “franchise sale focused’, rather than “franchise operations focused.” Some even sold franchises for concepts that didn’t exist. In some situations, representations of expected gross or net income had been vastly exaggerated.
The roaring profits to franchisors, and oft-repeated stories of franchisees who “struck it rich” through franchising were accompanied by the abuse of that system by a few fly-by-night, unethical and, often, criminal operators.
Futuristic Foods, Holiday Magic, and other such scams were horror stories resulting in the loss of peoples’ life savings invested in what they thought were businesses which would provide them the entrepreneurial success they dreamed of, but which instead turned out to be schemes to defraud.
Adding to the discontent was the emergence of the celebrity backed franchises in the late 1960s, franchises for which the celebrities had done little more than lend their names or appearances. Johnny Carson, Edie Adams, and Mickey Mantle testified in January 1970 before a highly publicized Senate hearing on franchising. Other celebrities were hired to publicize franchises: some include Tony Bennett, Eva Gabor, Ed McMahon, Jerry Lewis, Fats Domino, Rocky Graziano, Roy Rogers, James Brown, and Willie Mays.
To prevent such abuse and misuse of the franchise system at the hands of franchisors or scamsters selling fake ‘business opportunities’, several franchise laws and regulations have been placed to protect franchisees. So if you’re a franchisee or budding entrepreneur who is looking to purchase a business franchise to realize your business dreams, it’s time to get acquainted with the franchise laws and regulations that protect your interests.
- Read More: What Constitutes a Franchise?
Franchise Laws and Regulations You Should Know About
Franchise laws and regulations exist at both the federal and state levels. However before proceeding to the categories of federal and state franchise laws, it would be worthwhile to note that not all states have franchise laws, so some or all of these state laws may not pertain to your jurisdiction. Secondly federal franchise law does not cover some of the topics covered by state laws. Let’s examine them for a better understanding.
Here are the broad categories of franchise laws and regulations:
Federal Pre-sale Franchise Disclosure Regulations
Both federal and state laws (applicable to some jurisdictions) regulate the offer and sale of a franchise business. This is especially relevant considering the previous instances of misrepresentation and abuse by franchisors to entice franchisees to invest in their businesses, by using false promises.
At the federal level, the FTC franchise rule implemented by the US Federal Trade Commission (FTC) requires that a franchisor provide a franchise disclosure document (FDD) to prospective franchisees no less than 14 days prior to the sale (signing of the franchise agreement or any payment transactions).
The FDD must include 23 specific disclosure items that provide information about the franchise arrangement and the franchisor. It must also include financial statements of the franchisor, copies of the contracts and any other forms of the agreement that the franchisee will need to sign along with contact information of all existing franchisees.
State-level Pre-sale Franchise Disclosure Laws
Fourteen states have both pre-sale franchise disclosure and pre-sale registration laws. These states are California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Rhode Island, South Dakota, Virginia, Washington and Wisconsin. The pre-sale registration law requires that both the offer and the FDD must be registered in the state before the franchisor makes any offers for franchise sale.
State-level Franchise ‘Relationship’ Laws
23 U.S. jurisdictions have state franchise laws and regulations that govern various aspects of the franchisor-franchisee relationship. While these vary from state to state, broadly speaking they include the conditions in which a franchisor may terminate, refuse to renew, or buy back or agree to the transfer of a franchise.
To protect the rights of franchisees and to prevent abuse by franchisors, these franchise laws and regulations governing the franchise relationship ensure that the franchisor does not unlawfully or without just cause terminate the agreement. To that effect, they require that the franchisor provide specific time periods for rectifying any faults before termination.
In jurisdictions where the pre-sales registration law applies, most states even require that certain provisions be excluded from the agreement. For instance, mandating that the franchisee appear in court outside the home state in case of a dispute is prohibited in some states. To that effect, the state requires that if such a provision is included in the agreement, it be stricken off and alternative clause/language may be included in its place.
Additionally, some states restrict the franchisor from interfering with the right of free association among franchise owners, disapproving the transfer of a franchise without just cause, discriminating among similarly located franchisees regarding royalty and fees, or placing new facilities too close to existing franchises.
Regulations Governing the Sale of a ‘Business Opportunity’
If a commercial arrangement is deliberately structured in order to make it appear as a ‘non-franchise’ under federal or state laws, there are other laws to keep that in check. These laws regulate the seller-assisted marketing plans or ‘business opportunities’ and are present at the federal level and in some states.
As the name suggests, industry-specific laws regulate franchises belonging to specific sectors. This is because some franchise laws and regulations are relevant to certain industries like automobile dealerships, retail, service stations, or food and beverage, to name just a few. It’s essential for prospective entrepreneurs to understand the franchise laws governing their sector.
Know Your State’s Franchise Laws for Tax Considerations
Franchises typically begin operations in one state and then expand to other regions within the state or outside the state, as business grows. In case of a single state presence, the taxation structure is quite straightforward.
However when a business franchise acquires multi-state presence, it may have tax liabilities in more than one jurisdiction. For instance, if a franchisee is opening or operating a store in a state, they have nexus – a taxable presence in that state. However a franchisee that has units in multiple other states might unknowingly be responsible for tax liabilities in those states.
Contrary to popular perception, opening a physical store or unit in a state is not the only determining factor when it comes to ascertaining tax liabilities in that state. If a sales team travels to another state to solicit customers, the franchise may still be liable for tax payments in that state. In such cases, the tax liabilities may increase significantly.
Whether you’re trying to make sense of state franchise laws and regulations concerning purchase of a franchise, unlawful termination, renewal, or taxes, be sure to check what laws are applicable to your state or industry to avoid any unpleasant surprises later. State and local franchise laws and taxes can vary considerably from state to state. Therefore it’s best for franchisors and franchisees with a multi-state presence or activity to seek professional counsel.
For a better understanding of federal franchise laws and regulations, refer to the article ‘Federal Franchise Law, Explained’. It explains the difference between federal and state franchise laws, federal franchise laws including the 436.6 – Instructions for Preparing Disclosure Documents, 436.2 – Obligation to furnish documents, and 436.8 – Exemptions.
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