Franchise Disclosure and Sales Compliance

• Author: Leslie D. Curran, Mark B. Forseth, and Karen Spencer
• Pages: 63-229

63

CHAPTER 2

Franchise Disclosure and

Sales Compliance

Leslie D. Curran, Mark B. Forseth, and Karen Spencer

Contents

2-1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

2-2. Overview of Franchise Registration and Disclosure Laws . . . . . . . . . . . . . 65

2-3. What Is a Franchise? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

(a) The FTC Definition—The Federal Law . . . . . . . . . . . . . . . . . . . . . . . . 67

(b) State Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67

(i) Marketing Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

(ii) Community of Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

(c) Understanding the Definitional Elements . . . . . . . . . . . . . . . . . . . . . . 68

(i) Payment of a Fee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

(ii) Trademark . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69

(iii) The “Control” Element . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69

(iv) Marketing Plan Definition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70

(v) Community of Interest Definition . . . . . . . . . . . . . . . . . . . . . . . . . 71

2-4. Preparing the FDD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71

(a) Information Required to Be Disclosed . . . . . . . . . . . . . . . . . . . . . . . . . 72

(b) Compiling the Information for the FDD . . . . . . . . . . . . . . . . . . . . . . . . 86

(c) Using and Registering the Completed FDD . . . . . . . . . . . . . . . . . . . . . 86

(d) Capitalization Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89

(e) Use of a Multistate FDD or Roll-Up FDD . . . . . . . . . . . . . . . . . . . . . . . 90

(f) Filing of Franchise Sales Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . 91

(g) Effective Dates, Annual Renewal, and Interim Updating . . . . . . . . . . 91

(i) Annual Renewal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

(ii) Interim Updating Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . 93

2-5. State Law Applicability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

(a) Jurisdictional Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

(b) Multistate Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96

(c) Delivery of FDD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97

(d) Delivery Methods—Electronic Disclosure . . . . . . . . . . . . . . . . . . . . . .98

(e) Who Must Receive Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99

(f) Delivery of Franchise Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99

2-6. Exemptions and Exclusions from Franchise Laws . . . . . . . . . . . . . . . . . . 100

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64 Franchise Law Compliance Manual

2-7. State Business Opportunity Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102

2-8. Document Use, Filing, and Control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103

2-9. Permissible Representations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104

2-10. Negotiation with Prospective Franchisees . . . . . . . . . . . . . . . . . . . . . . . . 104

2-11. Franchise Disclosure Violations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

(a) Private Rights of Action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

(b) Administrative Liability under State Franchise Laws . . . . . . . . . . . . 106

2-12. Implementing Sales Compliance Policies . . . . . . . . . . . . . . . . . . . . . . . . . 106

(a) Role of Counsel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .107

(b) Internal Compliance Manual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107

(c) Sales Compliance Training . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108

(d) Internal Auditing and Monitoring Compliance . . . . . . . . . . . . . . . . . 110

(e) Curing Franchise Sales Law Compliance Violations . . . . . . . . . . . . . 111

2-13. Granting the Franchise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114

(a) Legal Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114

(b) Business Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115

2-14. Coordinating Growth Strategies and Compliance

for Litigation Avoidance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 116

(a) Traditional and Nontraditional System Expansion . . . . . . . . . . . . . .116

(b) Communication of Expansion Policies with Franchisees . . . . . . . . . 120

2-15. Dispute Resolution Mechanism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121

2-16. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123

Notes 123

Exhibit 2-1: Sample Charts and Excerpts from FDD . . . . . . . . . . . . . . . . . . . . . 131

Exhibit 2-2: Excerpts from FDD Questionnaire to Gather Information . . . . . . . 144

Exhibit 2-3: Initial FDD Filing Requirements for Registration States . . . . . . . . 171

Form 2-1: State Franchise Registration Forms . . . . . . . . . . . . . . . . . . . . . . . . . . 174

Exhibit 2-4: Summary of Provisions That May Not Be Enforceable under

State Franchise Sales Laws (and Other Special Requirements) . . . . . . . . 186

Exhibit 2-5: State Advertising Filing Requirements . . . . . . . . . . . . . . . . . . . . . . 189

Form 2-2: Advertising Tracking Form . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191

Exhibit 2-6: Summary of Expiration Dates and Renewal Filing Dates . . . . . . .192

Exhibit 2-7: Renewal Filing Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195

Exhibit 2-8: Filing Requirements for Amendments . . . . . . . . . . . . . . . . . . . . . . 198

Exhibit 2-9: Chart of State Franchise Law Jurisdictional Requirements . . . . . .200

Checklist 2-1: Sample Registration Summary Checklist . . . . . . . . . . . . . . . . . . 202

Exhibit 2-10: Compliance Questionnaire . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203

Checklist 2-2: Franchise Compliance Checklists . . . . . . . . . . . . . . . . . . . . . . . . 207

Exhibit 2-11: Information and Checklists Prepared by Consultant . . . . . . . . . . 210

Exhibit 2-12: Excerpts from McDonald’s and Burger King Franchise

Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 223

Exhibit 2-13: Excerpts from Dunkin’ Donuts Store Development Agreement . 226

Exhibit 2-14: Excerpts from Cottman Transmission License Agreement . . . . . 227

Exhibit 2-15: Excerpts from Motel 6 Franchise Agreement . . . . . . . . . . . . . . . .228

Exhibit 2-16: List of State Franchise Examiner Websites. . . . . . . . . . . . . . . . . . 229

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Chapter 2 Franchise Disclosure and Sales Compliance 65

2-1. Introduction

To manage the franchise sales activity and the growth of a franchise system, a

franchisor should establish internal policies and programs that facilitate compli-

ance with federal and state laws and regulations applicable to the offer and sale

of a franchise. Further, a franchisor must promote the franchise relationship and

manage system expansion to control, or at least minimize, conflicts with franchi-

sees. Effective implementation of such policies and programs dictates that all of

the franchisor’s personnel who may have contact with prospective and existing

franchisees understand how the applicable legal and regulatory frameworks affect

the franchisor’s dealings with prospective and existing franchisees. While this

chapter provides an overview of the applicable franchise relationship laws in

connection with state registration requirements and issues related to system

expansion, a discussion of such relationship laws in other contexts is addressed

in chapter 5.

Implementing the policies and procedures memorialized in an internal com-

pliance program should minimize the franchisor’s exposure for violations of state

and federal franchise sales laws. The franchisor’s adherence to an effective com-

pliance program can provide the basis for a highly credible defense should any

transaction be challenged, to the extent that the franchisor and its personnel con-

duct franchise sales activity and business dealings in a manner consistent with

the established policies. The failure of the franchisor’s personnel to comply with

announced policies and procedures, however, can be introduced as evidence to

prove that the franchisor failed to meet its own minimum standards of conduct.

Consequently, system policies (in particular, notification and/or impact policies

or guidelines) should establish standards that are achievable by the franchisor’s

personnel and consistent with the franchisor’s short-term and long-term expan-

sion plans, yet provide sufficient flexibility to address a variety of circumstances

the franchisor may face. In addition, these policies should be reviewed regularly

and should be communicated to all personnel of the franchisor who may have

relevant contact with prospective and existing franchisees.

2-2. Overview of Franchise Registration

and Disclosure Laws

The offer and sale of franchises are regulated under both federal and state law.

Such laws specify, among other things, the form and content of the disclosures

that must be made to prospective franchisees, the timing for delivery of the

required disclosures, and who must receive the disclosures.

The Federal Trade Commission (FTC) promulgated the trade regulation rule

entitled Disclosure Requirements and Prohibitions Concerning Franchising and

Business Opportunity Ventures (FTC Rule) on December 21, 1978. The FTC Rule

became effective on October 21, 1979. The FTC amended the original rule on

March 30, 2007, and the amended rule now applies only to franchises, with an

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