See also the amended FTC rule
Franchising is subject to many regulations, including:
- required “disclosure” of information it is believed that a franchisee should know before purchasing
- control of the relationship itself in some states
- restrictions on or requirements for termination in some states
Federal Trade Commission (“FTC”) “Rule”
The Federal Trade Commission (“FTC”) “Rule” defines a “franchise” and requires “disclosure” of information deemed important to prospective franchisees in making a decision to purchase a franchise.
The FTC rule often defines operations not anticipated to be a “franchise” as such, and provides that a franchise exists where:
- the franchisee sells goods or services meeting the franchisor’s quality standards or which are identified by the franchisor’s mark
- the franchisor exercises significant control or gives significant assistance in the method of operations
- the franchisee is required to pay $500 or more to the franchisor or an affiliate within 6 months of opening
or
- the franchisee sells goods or services supplied by the franchisor or an affiliate
- the franchisor assists in securing accounts, or locations or sites for vending machines or rack displays, or provides the services of person able to do either
- the franchisee is required to pay $500 or more to the franchisor or an affiliate within 6 months of opening
The FTC Rule requires a specific format in making the required disclosure and applies in all states, but the Rule is also satisfied by the alternate “Uniform Franchise Offering Circular” (“UFOC”) format, which is specified by a national group of regulatory agency representatives. All registration states require the UFOC format, so most franchisors use the UFOC format. The disclosure document must be updated at least annually within 90 days of the end of franchisor’s fiscal year, and also must be amended to disclose any material changes between annual registrations.
Required disclosure items
Some of the required disclosure items include information on:
- franchisor, its predecessors, affiliates and persons operating or managing franchisor
- bankruptcy involving the above persons
- certain litigation and administrative proceeding involving franchisor and the above persons
- services franchisor is required to provide
- restrictions on goods and services offered by franchisee
- purchases franchisee is required to make from specified sources and any fees franchisor receives based on those purchases
- restrictions on transfer of the franchise by franchisee
- fees and minimum and maximum investment
- training provided by franchisor, including identification of teachers and their experience
- financing offered by franchisor or affiliates
- basis required to make “earnings claims”
- trademarks, patents, copyrights and trade secrets
- endorsements by “public figures”
- franchisor’s financial information
- a list of current franchisees
- a list of franchisees who have left the system
- copies of all contracts and agreements franchisee will sign
- franchisor financial statements for the last 3 years
Business Opportunity Laws
Some states have “Business Opportunity Laws” (see also the proposed new FTC business opportunity rule), which typically apply where the seller:
- represents the opportunity will generate income
- offers to help purchaser find locations for the “opportunity”, e.g., locations for placing vending machines the purchaser will service
- offers to buy products the purchaser creates using the opportunity, or
- offers to buy the opportunity back if it does not produce income
These laws can apply to franchises, but exemptions which vary by state may apply, e.g., where franchisor licenses franchisee to sells goods or services under franchisor’s federally registered trademark.
State registration and disclosure
A number of individual state laws require disclosures, and some require state registration. The registration process can range from a thorough review of the disclosure document to a mere “notice” filing with no review.
Franchise relationship regulation
Some states regulate the franchise relationship itself, e.g. requiring:
- adjacent territories must be offered to the existing franchise first
- payment to the existing franchisee where a new nearby franchise location decreases sales at a prior existing location, or
- payment to franchisee for the business on non-renewal of the franchise
Not all states regulate the franchise relationship, or even if a state does, the regulation may be minimal, e.g., Missouri merely requires 90 days prior notice of termination, but does not require that termination be “for cause”, etc.