How Franchise Sales Laws Affect The Franchise Sales Process Starting A Franchise Washington, DC Economic Partnership Presented By: Carl E. Zwisler Gray.

How Franchise Sales Laws Affect The Franchise Sales Process

Starting A Franchise

Washington, DC Economic Partnership

Presented By: Carl E. Zwisler

Gray Plant Mooty

Wednesday, January 12, 2011

(c) 2011 Gray Plant Mooty 2

How Franchise Laws Help New Franchisors And New Franchisees

• What is a franchise which is subject to franchise regulations?

• Which laws regulate franchise sales in metropolitan Washington, DC?

• What does the FTC Franchising Rule require franchisors to do?


• What additional requirements do the MD and VA franchise laws impose on franchisors?

• How do these laws help:– new franchisors?– prospective franchisees and franchisees?


What Is A “Franchise” For Purposes Of USA Laws?

• FRANCHISING DEFINED by FTC Rule*• Trademark (™) or service mark license• Promise of:

– Substantial assistance or– Substantial control regarding the operation

of a Business

• Payment of a Fee

* State definitions differ somewhat


How Is Franchising Regulated?

• Two general types of laws apply to franchisors– Franchise sales laws– Franchise relationship laws


What Are Franchise Sales Laws?

• Franchise sales laws regulate when and how a franchise may be offered and sold.

• The Federal Trade Commission Franchising Trade Regulation Rule (“FTC Rule”) is a federal law which applies to all franchises offered and sold in the USA


FTC Overview

• When must FDD’s be delivered to prospective franchisees?– 14 calendar days before:

• Paying a fee• Signing an agreement

– Earlier if reasonably requested


When Must Prospective Franchisees Be Given Complete Agreements?

• Franchisees must receive franchise contracts containing all material terms at least 7 calendar days before the franchisee signs the agreements, but only if standard disclosed agreements are unilaterally changed by Franchisor

• e.g. if description of an exclusive territory was not contained in disclosed franchise agreement


What Is The FDD?

• The FDD is a form of disclosure which is designed to satisfy disclosure requirements of the FTC Rule and state laws


What Is The FDD?• TABLE OF CONTENTS

• ITEM• 1. The Franchisor and any Parents,

Predecessors, and Affiliates• 2. Business Experience• 3. Litigation• 4. Bankruptcy• 5. Initial Fees• 6. Other Fees• 7. Estimated Initial Investment• 8. Restrictions on Sources of Products and

Services• 9. Franchisee’s Obligations• 10. Financing• 11. Franchisor’s Assistance, Advertising,

Computer Systems, and Training• 12. Territory


What Is The FDD?• TABLE OF CONTENTS

• ITEM• 13. Trademarks• 14. Patents, Copyrights, and Proprietary Information• 15. Obligation to Participate in the Actual Operation

ofthe Franchise Business

• 16. Restrictions on What the Franchisee May Sell• 17. Renewal, Termination, Transfer, and Dispute

Resolution• 18. Public Figures• 19. Financial Performance Representations• 20. Outlets and Franchisee Information• 21. Financial Statements• 22. Contracts• 23. Receipts• 24. Exhibits


Updating

• FDDs must be updated:– whenever information required to be

disclosed changes materially; – annually within 120 days of the

franchisor’s fiscal year end


Exemptions

• $ 1 Million initial investment

• $1 Million includes investment in multiple franchises under: Area Development and Master Franchise Agreements

• $1 Million does not include:– Amounts financed by the franchisor and its affiliates.– Investments in unimproved real property (“raw land”)


Exemptions

• $5 Million net worth and 5 years business experience of franchisee, its parent or affiliates.


Exemptions

• Franchise Officers, Managers and Owners

• If Franchisor or one or more of its officers, directors, general partners, owners, or managers…– Owns at least 50% of prospective

franchisee, the sale is exempt if:• as of 60 days before the franchise sale, officers

managers, or partners, etc. have been associated with the franchisor for at least 2 years, and

• owners have owned at least 25% interest in franchisor for at least 2 years


How Do States Regulate Franchise Sales?

• Franchise registration and disclosure laws

• Business opportunity laws• “Little FTC acts” or consumer protection

laws• Common law prohibiting fraud and

misrepresentation


Franchise Registration And Disclosure Laws

• Franchise sales laws regulate franchise offers and sales in 15 states, including MD and VA


State Franchise RegistrationAnd Disclosure Laws

Washington

Montana

Oregon

Idaho

Nevada

California

Wyoming

Utah

Arizona

Colorado

New Mexico

Oklahoma

Texas

Kansas

Nebraska

South Dakota

North DakotaMinnesota

Iowa

Missouri

Wisconsin Michigan

Illinois IndianaOhio

Kentucky

Tennessee

Arkansas

Louisiana

Mis

siss

ippi

Alabama Georgia

Florida

South Carolina

North Carolina

Virginia

Wes

t

Virgin

ia

Pennsylvania

New York

Maine

New Hampshire

Vermont

Mass.

RhodeIsland

Connecticut

New Jersey

Delaware

Maryland

Puerto RicoAlaska

Hawaii

REG/DIS


What Must Franchisors Do To Comply With State Franchise Registration And Disclosure Laws?

• File an application which includes an FDD with a state agency for approval

• A filing fee of $250 - $600


What Do State Agencies Review?

• FDD and franchise agreements to determine compliance with disclosure format requirements and state relationship laws

• Financial statements to determine franchisor’s ability to fulfill duties to franchisees

• Litigation history of franchisor and executives to determine whether their involvement creates unreasonable risk to franchisees


When Must Franchise FilingsBe Made?

• Before making an “offer” of a franchise– In or from a state with a registration law– To a resident of a state with a

registration law– To one purchasing a franchise to be

located in the state (sometimes)


Advertising

• All forms of advertising for franchisees are regulated as offers, including internet advertising, and usually must be approved before use

• N.B., state review, not federal


How Long Is A Registration Effective?

• Usually for one calendar year, or until 90 - 120 days after franchisor’s fiscal year end

• Amendments to registration are required if a material change occurs to required disclosures


Sources Of Franchise Disclosure Documents

• www.corp.ca.gov/CalEASI/caleasi.asp Caleasi is an official site of the California Department of Corporations, which retains files of franchises which are registered under the California Franchise Investment Law

• Two other sites which offer free access to FDDs are:– www.OpenFran.org– www.FreeFranchiseDocs.com


How The Franchise Disclosure Requirements Help New Franchisors• Preparing an FDD forces new

franchisors to consider issues relating to their franchising programs which would often be overlooked– Territorial rights and

restrictions– Purchase restrictions– Franchise renewal– Restrictions on transfer of ownership of the

franchisee


How FDDs Help Prospective Franchisees

• Contact information for current and former franchisees

• Financial statementsof the franchisor

• Initial investment estimates• Litigation, bankruptcy and

franchise turnoverinformation


How Franchise Sales Laws Help Franchisees• FTC and state enforcement actions• State laws provide right to recover

damages or to obtain rescission when a franchisor violates them


What Franchise Sales Laws Do Not Do • Assure that a business

will be successful• Prohibit a franchisor from

making bad businessdecisions

• Provide information about earnings of franchisee- and franchisor-owned units (in most cases)

• Prohibit franchisors from using contract provisions which franchisees may consider to be unfair (in most cases)


How Can New Franchisors and Franchisees Best Protect Themselves? • Use experienced franchise professionals• Read and seek to understand all legal

documents. If they are not intelligible,the franchise program is destined for problems

• Obtain referencesfor– Franchise

professionals– franchisors


• Trust your instincts. If it does not feel right, don’t do it

• Obtain FDDs fromindustry competitors andunderstand their competitive advantages and disadvantages


Sources Of Information On Franchising

• “Franchising Basics: The Official IFA Course,” available online at www.franchise.org

• Informative Articles:– How United States Laws Regulate

Franchising: An Overview of Franchise Law for Franchisor Executives

– How To Evaluate A Franchise• e-mail Kimberly Bradshaw at

[email protected]


Carl Zwisler• Principal• 35 years representing franchisors and master

franchisees in domestic and international franchise transactions

• Former IFA General Counsel• Author:

– Master Franchising: Selecting, Negotiating, and Operating a Master Franchise, Commerce Clearing House, 1999

– International Franchising: A Practitioner’s Guide, chapter “Selecting a Format for International Franchising”

• Author/presenter of more than 100 articles and presentations on all facets of international and domestic franchising


Thank you.

Carl E. Zwisler

Gray Plant Mooty

2600 Virginia Avenue, NW

Suite 1111 – The Watergate

Washington, DC 20037

Phone: 202-295-2225

Facsimile: 202-295-2275

[email protected]

How Franchise Sales Laws Affect The Franchise Sales Process Starting A Franchise Washington, DC Economic Partnership Presented By: Carl E. Zwisler Gray.

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