Franchise Disclosure Issues

• Author: Rupert M. Barkoff, Andrew C. Selden
• Pages: 95-123

95

Franchise Disclosure Issues

CHAPTER 3

Judith M. Bailey and Dennis E. Wieczorek

Contents

I. Reasons for Disclosure and Disclosure Requirements . . . . . . . . . . 96

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

B. Legal Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96

C. Exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97

D. Liability for Failure to Disclose . . . . . . . . . . . . . . . . . . . . . . . . . . 98

II. The Franchise Disclosure Document . . . . . . . . . . . . . . . . . . . . . . . 1 00

A. Disclosure Subjects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100

B. Franchise Disclosure Document Contents . . . . . . . . . . . . . . . . 101

C. Multistate Disclosure Documents . . . . . . . . . . . . . . . . . . . . . . . 116

III. The Disclosure Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117

A. Timing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117

B. Electronic Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 17

C. Multiple-State Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 18

D. Policing the Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 8

IV. Changes to the Franchise Disclosure Document . . . . . . . . . . . . . . 120

A. Annual Updates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 0

B. Interim Amendments for Material Changes . . . . . . . . . . . . . . . 121

C. Negotiated Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121

D. Procedures for Amending the Disclosure Document . . . . . . . . 122

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

vided essential information about the franchised business and contract, the rela-

tionship of the parties, and the prior business experience of the franchisor. This

96 Fundamentals of Franchising

I. Reasons for Disclosure and Disclosure

Requirements

A. Business Benefits

Presale disclosure is designed to provide prospective franchisees with prescribed

information to allow better-informed decisions concerning investment in particu-

lar franchises. But it also provides benefits to franchisors. From the franchisor’s

perspective, the required disclosure document can be a sales tool that includes

positive information about the franchisor and its franchise program. Furthermore,

full disclosure helps align expectations and prevent misunderstandings and false

assumptions by a franchisee. It is to the advantage of both the franchisor and the

franchisee that each makes a fully informed decision that the franchisee is quali-

fied and capable to operate within the franchise system. Sales to uninformed or

unprepared franchisees (who are “qualified” only by virtue of being able to pay

the initial fee) carry tremendous risks of failure for all concerned, especially for

the start-up franchisor, since the failure of a system’s first franchisees may doom

the franchisor as well.

B. Legal Requirements

The original FTC Rule,2 which was adopted by the Federal Trade Commission

(FTC) in 1978, became effective in 1979, and was updated in 2007, required

disclosure by franchisors and sellers of certain business opportunities before mak-

ing any offer or sale. The original FTC Rule was amended in 2007, among other

reasons, to revise the prescribed disclosure document format and to remove the

business opportunity portion of the rule.3 No federal filing or registration is re-

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. Fran-

chise 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 disclosure law).

2. Disclosure Requirements and Prohibitions Concerning Franchising and Business

Opportunity Ventures, 16 C.F.R. pt. 436 (1979), Bus. Franchise Guide (CCH) ¶¶ 6190 et seq.

3. Disclosure Requirements and Prohibitions Concerning Franchising, 16 C.F.R. pt. 436

(2007), Bus. Franchise Guide (CCH) ¶¶ 6010 et seq. (hereinafter the FTC Rule).

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