Franchise Disclosure Issues

• Author: Barkoff, Rupert M., Selden, Andrew C.
• Pages: 93-118

93

Franchise Disclosure Issues

CHAPTER 3

Judith M. Bailey and Dennis E. Wieczorek

Contents

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

provided essential information about the franchise business and contract, the rela-

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

I. Reasons for Disclosure and Disclosure Requirements . . . . . . . . . . 94

A. Business Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

B. Legal Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

C. Exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95

D. Liability for Failure to Disclose . . . . . . . . . . . . . . . . . . . . . . . . . . 96

II. The Disclosure Document . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

A. Document Contents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

B. Electing the FTC Rule or UFOC Format . . . . . . . . . . . . . . . . . . . 99

C. UFOC Guidelines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101

D. Multistate Document . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112

III. The Disclosure Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113

A. Timing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113

B. Multiple-State Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113

C. Policing the Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114

IV. Changes to the Disclosure Document . . . . . . . . . . . . . . . . . . . . . . . 115

A. Annual Updates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115

B. Interim Amendments for Material Changes . . . . . . . . . . . . . . . . 116

C. Negotiated Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117

D. Procedures for Amending the Disclosure Document . . . . . . . . . 118

94 Fundamentals of Franchising

I. Reasons for Disclosure and Disclosure

Requirements

A. Business Benefits

From the franchisor’s perspective, the required disclosure document can also be a

sales tool that includes positive information about the franchisor and its franchise

program. Furthermore, full disclosure helps prevent misunderstandings and false as-

sumptions by a franchisee. It is to the advantage of both the franchisor and the franchi-

see that each makes a fully informed decision that the franchisee is qualified 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 so-called FTC Rule,2 which was adopted by the Federal Trade Commission

(FTC) in 1978 and became effective in 1979, requires disclosure by franchisors and

sellers of certain business opportunities before any offer or sale is made unless an

exemption applies. No federal filing or registration is required.3 The FTC Rule only

preempts state disclosure laws that are inconsistent with the FTC Rule or provide

less protection to prospective franchisees.4

More than half of the states have either general franchise5 or business oppor-

1. See, e.g. , Chapter III of the Statement of Basis and Purpose Relating to Disclosure

Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures, 43

Fed. Reg. 59,614 (1978), Bus. Franchise Guide (CCH) ¶¶ 6300 et. seq., at ¶ 6305; and CAL.

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

ment of need in connection with the 1970 enactment of the first state franchise disclosure law).

2. Disclosure Requirements and Prohibitions Concerning Franchising and Business Op-

portunity Ventures, 16 C.F.R. pt. 436 (1979), Bus. Franchise Guide (CCH) ¶¶ 6080 et. seq.

(hereinafter the FTC Rule).

3. FTC Rule Interpretive Guides to Franchising and Business Opportunity Ventures Trade

Regulation Rule, 44 Fed. Reg. 49,966 (Aug. 24, 1979), Introduction, Bus. Franchise Guide

(CCH) ¶¶ 6201 et. seq. (hereinafter FTC Rule Interpretive Guides).

4. FTC Rule Interpretive Guides § I.D.2, Bus. Franchise Guide (CCH) ¶ 6228.

5. Fifteen states have laws governing the offer and sale of franchises: California, Hawaii,

Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Oregon, Rhode

Island, South Dakota, Virginia, Washington, and Wisconsin.

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