Federal Law: The offer and sale of franchises requires compliance with both federal and state laws. The threshold regulation is a Federal Trade Commission (FTC) rule entitled “Disclosure Requirements and Prohibitions Concerning Franchising” (the “Franchise Rule”). The Franchise Rule requires a franchisor to provide each prospective franchisee with a detailed franchise disclosure document, or “FDD” (until 2007 referred to as a Uniform Franchise Offering Circular, or “UFOC”), at least 14 calendar days before the prospect signs a contract or pays a franchise fee. The Franchise Rule applies in every state, the District of Columbia, Puerto Rico and other U.S. territories, and establishes a minimum disclosure requirement.
State Laws: In addition federal laws, just over a dozen states have laws that require a franchisor to file its FDD with the state securities administrator for approval before offering or selling franchises in the state. These states may also require more detailed disclosures than those required by the Franchise Rule.
Another 17 states have “business opportunity” laws that may require additional compliance, although these laws typically do not apply to franchises that comply with the Franchise Rule (by providing an FDD to prospects) or include, as part of the franchise, a federally registered trademark. All of these laws require pre-sale disclosure and, in some cases, pre-sale registration, but there are also a number of states that regulate the relationship between a franchisor and franchisee. For example, some states prohibit the termination of or refusal to renew a franchise without “cause.”
PRE-SALE DISCLOSURE REQUIREMENTS
Delivery of FDD. The Company must give a “prospective franchisee” a copy of its FDD at least 14 calendar days before he signs a binding agreement with, or makes any payment to, the Company or any affiliate in connection with the proposed sale. Under no circumstances may you accept any money or other consideration or sign any agreements without following this procedure. The penalties for failing to observe these requirements can be severe and include both criminal and civil liability.
Prospective Franchisees: The Franchise Rule defines “prospective franchisee” as “any person (including any agent, representative, or employee of that person) who approaches or is approached by a ‘franchise seller’ (defined below) to discuss the possible establishment of a franchise relationship.” Note that under this definition, a person is not a prospective franchisee if he is simply interested in a franchise or in obtaining information about a franchise. The definition requires an affirmative act on the part of the franchisor or on the part of the interested person, and action that intends some type of discussion or communication regarding the establishment of a franchise. Therefore, mere inquiries for information about your franchises do not make the person requesting the information a “prospective franchisee,” since that does not involve a discussion about the establishment of a franchise.
Franchise Sellers: The term “franchise seller” means a person or organization that offers for sale, sells, or arranges for the sale of a franchise. It includes the franchisor and the franchisor’s employees, representatives, agents, sub-franchisors, and third-party brokers who are involved in franchise sales activities. It does not include existing franchisees who sell only their own outlet and who are otherwise not engaged in franchise sales on behalf of the franchisor. So the Company is a franchise seller, as are the Company’s franchise salespersons and any other employee of the Company who is involved in the franchise sales process.
Timing of Disclosure. You may meet with MOST prospects without providing them with an FDD, so long as they do not sign a binding agreement or make any payment for at least 14 days after they receive the FDD. However, 5 states, Iowa, Maryland, New York, Oklahoma, and Rhode Island, have a “first personal meeting” requirement (a carry-over from the FTC’s old Franchise Rule, before it was updated in 2007). In those states, you must provide the prospect with a copy of the FDD at the first “personal meeting.” The term “personal meeting” means a face-to-face meeting between a franchisor seller and a prospective franchisee held for the purpose of discussing the sale or possible sale of a franchise. And in 6 states, Maryland, Michigan, Oklahoma, Oregon, Rhode Island, and Washington, the prospective franchisee may not make any payments or sign a binding agreement for at least 10 business days (instead of 14 calendar days) after they receive the FDD.
In all states, it is unlawful to “fail to furnish a copy of the franchisor’s FDD to a prospective franchisee upon reasonable request.” In other words, you cannot require a prospect to come to a “discovery day” at your corporate office in order to receive an FDD; you must provide it to him before the discovery day if he asks for it. This does not mean that you have to provide an FDD to anyone who asks for it; for example, someone who has not yet completed an application/profile, or someone whom you have eliminated as unqualified. And if the Company has updated or amended its FDD since a prospect received it, you must provide him with a copy of the updated FDD upon request at any time before he signs the franchise agreement.
Disclosure of Existing Franchisees. In some situations, disclosure must be made to existing franchisees. In all cases, if there is an interruption of the operation of a franchisee’s business, a subsequent renewal or extension of an existing franchise agreement is a sale of a new franchise, and the franchisee must be treated as a prospective franchisee (i.e., he must be furnished with an FDD describing the renewed or extended franchise agreement). Even when there is no interruption in the operation of the franchisee’s business, if the renewed or extended franchise agreement contains material changes from the existing agreement, the renewal or extension is considered a sale of a new franchise and again, the existing franchisee must be treated as a prospective franchisee and must be furnished with an FDD describing the renewal franchise agreement.
Disclosures upon Modification. A material modification of an existing franchise agreement also may constitute an offer of a new franchise. If at any time you want to make any changes to an existing franchise agreement, or if a franchisee has requested changes, please call me so we can determine whether the changes are material and if so what steps are required.
Disclosure of Assignees. The Franchise Rule imposes, in some cases, an obligation to make disclosure to assignees of existing franchises. This obligation to furnish an FDD only arises when the Company has “significant contact” with the assignee. If the assignee is required to sign a new franchise agreement containing terms that are different from the assignor’s agreement, an FDD must be delivered. If the franchisee sells a franchise and you have no knowledge of the transaction and had no reason to know of the transaction, you would have no obligation to furnish an FDD. However, your franchise agreement requires your prior written consent to an assignment, so in most cases you will have notice of the assignment before it closes. Your right to approve the assignment will not by itself be deemed “significant contact” with the franchisee. To be safe however, it is suggested that you furnish an FDD at least 14 days before the assignee executes the new franchise agreement or makes any payment to either the former franchisee or to the you.
For more information about franchising and disclosures laws, contact Gettins’ Law, LLC at 513-831-6660 or by email at firstname.lastname@example.org.