Franchising your business is an exciting process and an effective way to expand your
commercial footprint. However, there are numerous federal and state laws that must be
complied with before you can offer and sell franchises to potential franchisees.
The Federal Trade Commission (“FTC”) is the federal agency governing the sale of
franchises and its regulations are commonly referred to as the “franchise rule.” See 16 C.F.R.
Part 436. This rule was created to protect consumers who are considering investing significant
funds into a franchise business. The franchise rule requires franchisors to provide prospective
franchisees with certain information related to the business and the expected investment in the
business. This disclosure is known as the Franchise Disclosure Document or Uniform Franchise
Disclosure Document (“FDD”), and must be provided to the franchisee at least fourteen (14)
days before any agreement is signed or before any initial money is exchanged. The FDD was
previously known as the Uniform Franchise Offering Circular (“UFOC”) before it was revised
by the FTC in July 2007.
by the FTC in July 2007.
What Must be Included in the FDD
The FDD must contain information deemed essential to potential franchisees. This
information must be structured in a particular format and be written in “plain English” rather
than legalese.
than legalese.
The FDD must include:
1. A description of the franchisor’s company, its history and any relationships it has
with affiliated companies;
2. Professional biographies of the franchisor’s officers, directors and executives;
3. A description of current and past criminal and civil litigation involving the
franchisor and its management;
4. A description of any bankruptcy petitions filed by the franchisor and its
management;
5. Identification of any initial fees required to be paid to the franchisor or any
affiliated company, such as the initial franchise fee;
6. Identification of all other recurring fees and payments that must be paid to the
franchisor, such as royalties and advertising fees;
7. An estimation of all costs necessary to open and initially operate the franchise
business;
8. Disclosure of any requirements or restrictions regarding the sources of products or
services;
9. A list of the franchisee’s principal obligations under the franchise agreement or
other related contract;
10. A disclosure of any financing terms, if financing is offered by the franchisor;
11. A list of the franchisor’s principal obligations under the franchise agreement,
including location selection and training;
12. A description of any territory assigned to the franchisee;
13. A description of any trademarks held or used by the franchisor;
14. A description of any patents, copyrights and proprietary information held or used
by the franchisor;
15. A description of the franchisee’s obligation to participate in the operation of the
business;
16. Disclosure of any restrictions on what the franchisee may sell;
17. A summation of contract provisions regarding renewal, termination, transfer and
dispute resolution;
18. Disclosure of any public figures endorsing the franchise;
19. An optional estimation of the anticipated financial performance of the franchise
business;
20. A list of all current and former franchise outlets;
21. The franchisor’s financial statements for the preceding three years;
22. A list of any related contracts the franchisee must execute;
23. An acknowledgment of the franchisee’s receipt of the FDD.
23. An acknowledgment of the franchisee’s receipt of the FDD.
The franchise rule sets forth the minimum standards regarding the franchisor’s
obligations, but does not include any type of registration or filing requirement. The franchise
rule, however, allows individual states to supplement the federal law with their own state specific
franchise laws and requirements. Fifteen (15) states have enacted state-specific franchise laws
and added additional regulations to be followed by franchisors. Thirteen (13) of these states
require franchisors to file and have their FDD approved before franchises can be offered in their
state. These states are commonly referred to as “registration states.” These state-specific laws
apply to franchises that are intended to be opened in these states and/or to potential franchisees
who are residents of these states.
Duty to Update an FDD
At a minimum, franchisors must update their FDD on an annual basis at the close of each
fiscal year. However, the franchise rule also requires franchisors to update their FDD upon the
occurrence of any “material change” or “material event.” While the franchise rule does not
expressly define what constitutes a “material change” or “material event,” six of the registration
states identify detailed examples of what they consider “material changes” or “material events” –
Hawaii, Illinois, Maryland, Minnesota, New York and Wisconsin.
Under the franchise rule, franchisors must revise their FDD within a “reasonable time”
after the close of each fiscal quarter in which a “material change” or “material event” happens.
However, if the change relates to Item 19, Financial Performance Representations, the franchise
rule requires franchisors to immediately notify any prospective franchisee of such change. In
registration states, there are varying requirements about when a franchisor must update and file
their amended FDD.
Under the franchise rule, the updated FDD is immediately effective upon its issuance. In
registration states, the updated FDD will become effective at the time it is either filed with the
state or approved by the state, depending upon the state’s specific laws.
state or approved by the state, depending upon the state’s specific laws.
Penalties for Disclosure Violations
Federal and state franchise laws impose significant penalties for violating any applicable
disclosure requirements. Under the franchise rule, the FTC can pursue federal civil and criminal
penalties. The FTC can obtain injunctive relief precluding the franchisor from selling any more
franchises, along with relief for the effected franchisees that includes rescission of any franchise
agreement, a refund of any franchise fees previously paid and the payment of any damages
incurred by the franchisee. The FTC can also levy fines of up to $11,000 per violation. The
franchise rule, however, does not provide for a private right of action for franchisees that have
been damaged.
Registration states provide for similar remedies that their applicable state agencies can
pursue. Additionally, almost all of the registration states provide for a private right of action for
an aggrieved franchisee whereby a franchisee can file a civil lawsuit directly against the
franchisor seeking rescission of the franchise agreement and the recovery of any financial
damages.
damages.
Recommendations
Federal and state franchise laws are designed to protect potential franchisees so they are
aware risks any of their money in the investment. From the franchisor’s point of view, you want
to protect your business from the threat of any litigation. It should be expected that a franchisee
will look for any way they can recover their investment should their franchise location fail,
including suing the franchisor for any disclosure violation. That is why it is important to seek
the guidance of an experienced attorney to properly draft and register your business’ FDD.
LegalStandard.com offers several packages to assist franchisors with drafting their FDD,
registering the FDD with any states requiring registration and assisting with the closing of any
transaction with a potential franchisee – all for a fixed fee.
From the franchisee’s point of view, FDDs are usually very lengthy, complex and
potentially intimidating. LegalStandard.comsm can review any FDD and explain the document to the
potential franchisee so that he or she understands the documents and the risks associated with
the investment. The cost of an FDD review starts at $895.00.
