Considerations in Establishing a Franchise System
| Publication year | 1979 |
| Pages | 562 |
| Citation | Vol. 8 No. 4 Pg. 562 |
1979, April, Pg. 562. Considerations in Establishing a Franchise System
Greg L. Perczak is in private practice in Denver and represents several franchisors.
© The Colorado Lawyer 1979
Franchised retailers of goods and services accounted for over $250 billion in retail sales in 1978, approximately one-third of total retail sales in the entire nation. Sales through franchised outlets have grown at a rate in excess of 12 percent per year since 1970 and show every sign of continuing such growth.(fn1) Perceived advantages in franchised retailing include greater opportunities for persons of modest means to go into business for themselves, a decrease in the risk of failure of individual businesses, increased effectiveness in distribution of goods and services to a mobile public, and increased spread of capital investment possibilities in small businesses. Yet the history of franchise growth has likewise been marked by arbitrary franchise terminations, coercive sales tactics and fraudulent promotional schemes, all of which have been the object of legislative concern.(fn2)
On December 21, 1978, the Federal Trade Commission (FTC) issued a long-anticipated rule regarding franchise investment disclosure, entitled "Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures."(fn3) The Rule, effective July 21, 1979, will require extensive personal and financial disclosures regarding potential franchising investments.
Although many states regulate various aspects of a franchise relationship, including disclosure, registration and termination provisions, Colorado currently has no statute of general applicability. The FTC Rule, which has the effect of federal law, will set minimum informational standards applicable to such offerings in the state. This article discusses provisions of the Rule of interest to the general practitioner, as well as fundamental considerations in establishing a franchise system.
It is noteworthy that the FTC first gave notice of its concern with franchise offerings and published a proposed rule on November 11, 1971.(fn4) Much of the lengthy delay in promulgating the final Rule can be attributed to the difficulty of formulating a precise definition of "franchising" in a modern commercial context.(fn5) Out of two prior definitional attempts by the FTC and thirteen existing definitions adopted by states regulating franchise offerings, the only consensus seems to be that franchising is a method of doing business involving certain marketing
The current Rule defines two types of continuing commercial relationships as a "franchise":
... the term "franchise" means any continuing commercial relationship created by any arrangement or arrangements whereby:
(1)(i)(a) ... a person (hereinafter "franchisee") offers, sells, or distributes to any person other than a "franchisor". . . goods, commodities or services which are:
(1) identified by a trademark, servicemark [or] advertising. . . designating [the franchisor], or
(2) indirectly or directly required or advised to meet the quality standards prescribed by [the franchisor]. . . and
(b) (1) the franchisor exerts or has authority to exert a significant degree of control over the franchisee's method of operation, ... or
(2) the franchisor gives significant assistance to the franchisee in the latter's method of operation. . . or
(ii)(a) ... a [franchisee] offers, sells, or distributes to any person other than a "franchisor". . . goods, commodities or services which are:
(1) supplied by [the franchisor], or
(2) supplied by a third person (e.g., a supplier) with whom the franchisee is directly or indirectly required to do business by [the franchisor]. . . and
(b) the franchisor
(1) secures for the franchisee retail outlets or accounts for said goods, commodities or services, or
(2) secures for the franchisee locations or sites for vending machines. . . or other product sales display. . ., or
(3) provides to the franchisee the services of a person able to secure the retail outlets, accounts, sites or locations [listed above]; and
(2) [in either event] the franchisee is required as a condition of obtaining or commencing the franchise operation to make a payment or a commitment to pay [the franchisor] [more than $500 in consideration].(fn6)
The broad sweep of the definition obviously includes much more than the typical fast food operation usually deemed a franchise. For example, automobile dealerships, soft drink bottlers, dry cleaners, gasoline stations, convenience stores, automotive parts distributors and furniture outlets may all qualify as "franchises" under the Rule in certain circumstances. Moreover, certain key terms in the definition are likely to produce problems (e.g., "quality standards," "significant assistance," "indirectly required to do business").
The definition exempts "fractional franchises," leased department arrangements (e.g., in a department store), and purely verbal agreements.(fn7) The Rule excludes relationships between employer and employee, relationships among general business partners, memberships in retail-owned cooperatives, certification services, and single-license trademark arrangements.(fn8)
The Rule makes it an unfair or deceptive act or practice under Section 5 of the Federal Trade Commission Act to fail to furnish a prospective franchisee with a
Section 436.1 requires specific information...
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