Franchise Disclosure Issues

• Author: David W. Oppenheim and Rebekah Prince
• Pages: 91-139

91

Franchise Disclosure Issues

CHAPTER 3

David W. Oppenheim and Rebekah Prince

Contents

I. History of Franchise Disclosure Laws . . . . . . . . . . . . . . . . . . . . . . . . 93

A. State Franchise and Business Opportunity Disclosure Laws . . . . 93

B. FTC Franchise Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

C. NASAA 1993 UFOC Guidelines . . . . . . . . . . . . . . . . . . . . . . . . . 94

D. 2007 FTC Rule Amendments . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95

E. 2008 NASAA FDD Guidelines . . . . . . . . . . . . . . . . . . . . . . . . . . 95

II. Reasons for Disclosure and Disclosure Requirements . . . . . . . . . . . . 96

A. Business Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96

III. Exemptions from Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 6

IV. The Franchise Disclosure Document . . . . . . . . . . . . . . . . . . . . . . . . . 98

A. General Discussion of the FDD Subjects Covered . . . . . . . . . . . 98

B. Review of Each Item . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100

C. Multi-State Disclosure Documents . . . . . . . . . . . . . . . . . . . . . . . 120

V. The Disclosure Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120

A. Jurisdictional Scope of FTC Franchise Rule . . . . . . . . . . . . . . . 1 20

B. Timing of Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122

C. Who Must Receive Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . 122

D. Methods of Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 3

1. CD-Rom or Hard Copy of the FDD . . . . . . . . . . . . . . . . . . . 123

2. Electronic Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124

E. Identification of Franchise Sellers . . . . . . . . . . . . . . . . . . . . . . . 124

F. Multiple-State Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 5

G. Policing the Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 5

VI. Changes to the Franchise Disclosure Document . . . . . . . . . . . . . . . 127

A. FTC Rule Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127

1. FTC Rule Annual and Quarterly Updates . . . . . . . . . . . . . . . 127

2. Updates to Item 19 FPRs . . . . . . . . . . . . . . . . . . . . . . . . . . . 128

B. State Law Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128

1. FTC Rule Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129

2. State Law Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 30

92 Fundamentals of Franchising

C. Negotiated Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130

D. Procedures for Amending the Disclosure Document . . . . . . . . . 131

E. Effect of Amendment on Franchise Sales Activities . . . . . . . . . 131

VII. Unique Disclosure Issues for Multi-Unit Offerings . . . . . . . . . . . . . 132

VIII. Liability for Failure to Disclose . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 7

Chapter 3 Franchise Disclosure Issues 93

I. History of Franchise Disclosure Laws

Disclosure laws have been enacted to ensure that a prospective franchisee is

provided essential information about the franchised business and contract, the

relationship of the parties, and the prior business experience of the franchisor.

This information reduces the opportunities for fraud, helps to counterbalance

any greater bargaining power of the franchisor, and allows the franchisee to

make an informed investment decision based on more complete and reliable

information.1

A. State Franchise and Business Opportunity Disclosure Laws

California was the first state to regulate the offer and sale of franchises when, in

1971, it enacted the California Franchise Investment Law (CFIL), which sought

to protect prospective franchisees by requiring franchisors to register their fran-

chise offering in the state of California before the “offer” or “sale” of a franchise

in the state. The CFIL, modeled after federal and state securities laws, was de-

signed to ensure that all material information was provided to the prospective

franchisee (investor) by tendering a disclosure document to the prospective fran-

chisee well before it entered into a franchise relationship with the franchisor. A

franchisor (and possibly even its officers) that failed to comply with the CFIL

was subject to criminal and civil liability.

Over the next nine years, the following 14 additional states enacted their

own pre-sale registration and disclosure laws: Hawaii, Illinois, Indiana, Mary-

land, Michigan, Minnesota, New York, North Dakota, Oregon, Rhode Island,

South Dakota, Virginia, Washington, and Wisconsin. (These states, along with

California, are collectively referred to as the Franchise Registration States).

In addition to franchise registration and disclosure laws, many states (in-

cluding some of the Franchise Registration States) also have business opportu-

nity2 laws, which apply to the offer and sale of franchises. If applicable, and if

no exemption exists, these laws also require disclosure before any offer or sale

1. See, e.g., Section II of the Statement of Basis and Purpose Relating to Disclosure

Requirements and Prohibitions Concerning Franchising, 16 C.F.R. pt. 436 (2007), Bus.

Franchise Guide (CCH) ¶¶ 6050 et seq., at ¶ 6057 (hereinafter the FTC Statement); and CAL.

CORP. CODE § 31001, Bus. Franchise Guide (CCH) ¶ 3050.02 (the California legislature’s

statement of need in connection with the 1970 enactment of the first state franchise disclo-

sure law).

2. Laws governing the sale of business opportunities (also called seller-assisted mar-

keting plans) exist in 25 states: Alaska, California, Connecticut, Florida, Georgia, Illinois,

Indiana, Iowa, Kentucky, Louisiana, Maine, Maryland, Michigan, Minnesota, Nebraska,

New Hampshire, North Carolina, Ohio, Oklahoma, South Carolina, South Dakota, Texas,

Utah, Virginia, and Washington.