Franchise Registration

• Author: Rupert M. Barkoff, Andrew C. Selden
• Pages: 125-181

125

Franchise Registration

CHAPTER 4

Rochelle B. Spandorf and Mark B. Forseth

Contents

I. The Origins of Franchise Sales Regulation . . . . . . . . . . . . . . . . . . 126

II. The Regulatory Scheme . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129

A. State Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129

B. Federal Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131

III. The Jurisdictional Scope of State Franchise Registration Laws . . 13 3

A. Exemptions from Coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136

IV. The Registration Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139

A. The Application Filing Process . . . . . . . . . . . . . . . . . . . . . . . . . 1 40

B. The Review Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142

C. The Registration Period: Renewal Obligations and

Annual Reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 7

D. Amendment Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149

V. Capitalization Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 7

A. Capital Infusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159

B. Guarantee of Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 9

C. Surety Bond . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 0

D. Deferral of Initial Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160

E. Informal Undertaking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160

VI. Other Registration Duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 1

A. Registration of Salespersons . . . . . . . . . . . . . . . . . . . . . . . . . . . 161

B. Advertising and Promotional Materials . . . . . . . . . . . . . . . . . . . 164

C. Subfranchisor Registration . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 66

D. Agent for Service of Process . . . . . . . . . . . . . . . . . . . . . . . . . . . 169

VII. Enforcement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 69

A. Administrative Enforcement . . . . . . . . . . . . . . . . . . . . . . . . . . . 170

B. Criminal Penalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171

C. Civil Actions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171

VIII. Franchise Relationship Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174

126 Fundamentals of Franchising

The heart of franchise law in the United States is the duty of presale disclosure to

prospective investors. Fourteen states require registration with a state agency of

the seller’s disclosure document used to satisfy the disclosure requirement. This

chapter explains how the registration process works.

I. The Origins of Franchise Sales Regulation

Until 1970, when California enacted its Franchise Investment Law,1 franchise sell-

ing practices were virtually unchecked, both practically and legally. Franchising

had been a sleeping industry until the 1950s, despite historical beginnings traceable

to the previous century,2 but expanded rapidly through the 1950s and 1960s in a

laissez-faire legal environment.3 The explosive growth of franchising forced a change

in legal climate, triggering a chain reaction of state regulatory activity starting in

1970 and a judicial awakening to franchising as a distinct legal relationship.4

1. CAL. CORP. CODE §§ 31000-31516, Bus. Franchise Guide (CCH) ¶¶ 3050.01-3050.90,

became effective on Jan. 1, 1971.

2. Singer Sewing Machine’s use of a network of independent sales agents in 1851 to

distribute its sewing machines is often cited as the first modern-day example of a franchise

system. STAN L UXENBERG, ROADSIDE EMPIRES: HOW THE CHAINS FRANCHISED AMERICA (1985). Some

claim that the concept of franchising is traceable as far back as the Middle Ages to the network

of tax collectors established by the Catholic Church. JOHN B. KINCH & JOHN HAY S, FRANCHISING:

THE INSIDE S TORY (1986).

3. Franchising’s expansion has steadily continued since the 1970s despite the burst of

legislative activity during this period. Unfortunately, reliable statistics about franchising’s

role in the U.S. and global economies have been hard to come by since 1988, when the U.S.

Commerce Department stopped publishing data on the extent and growth of franchising in the

U.S. economy. ROGER D. BLAIR & FRANCINE LAFONTAINE, THE ECONOMICS OF FRANCHISING (Cambridge

Univ. Press, 2005) (excerpt at http://www.cambridge.org/catalogue/catalogue.asp?isbn=

9780521772525&ss=exc (April 30, 2007). The International Franchise Association’s Web

site (www.ifa.org) has some published data on franchising’s role in the U.S. economy, but there

are no government-issued statistics of recent vintage.

4. Franchising operated in a “regulatory vacuum” until the 1970s mainly because fran-

chising, as a business concept and legal relationship, failed to fit neatly into any recognized

traditional legal mold. PHILIP F. Z EIDMAN, PERRY C. AUSBROOK & H. BRET LOWELL, FRANCHISING:

REGULATION OF BUYING AND SELLING A FRANCHISE, at Al (34-2d BNA Corporate Practice Series 1983).

IX. Business Opportunity and Sales Representative Laws . . . . . . . . . 1 76

A. Business Opportunity Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 76

B. Sales Representative Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . 179

X. The Future of Franchise Regulation . . . . . . . . . . . . . . . . . . . . . . . . 180

Chapter 4 Franchise Registration 127

With the dramatic growth of franchising came a corresponding growth in

complaints over the franchise selling practices being employed.5 The magic of

“rags to riches” stories, often sensationalized by the press, induced an easily in-

fluenced and relatively unsophisticated audience to make investments in fran-

chise opportunities based upon a paucity of information.6

Following California’s legislative response in 1970, the FTC devoted the

next nine years to investigating the franchising industry. It finally concluded in

October 1979 that the abuses in franchise selling practices were both attributable

to and compounded by a serious informational imbalance between franchisor and

franchisee, usually accompanied by economic disparity between the parties.7 Since

then, the FTC legal response has been aimed strictly at franchise selling prac-

tices—that is, on the formation of franchise relationships.8 Many of the states that

joined the regulatory bandwagon reacted to the imbalance not only by regulating

5. See the FTC Statement of Basis and Purpose (1979 SBP), Bus. Franchise Guide (CCH)

§ 6304, to the original FTC Rule adopted by the Federal Trade Commission in 1978 and

effective on Oct. 21, 1979, entitled “Disclosure Requirements and Prohibitions Concerning

Franchising and Business Opportunity Ventures,” 16 C.F.R. pt. 436 (1979), reprinted at Bus.

Franchise Guide (CCH) ¶¶ 6090-6193 (hereinafter the Old FTC Rule).

6. Id.

7. Id. On January 22, 2007, the Federal Trade Commission approved significant amend-

ments to the Old FTC Rule, reprinted at Bus. Franchise Guide (CCH) ¶¶ 6011-6027. The 2007

revisions, referred to in this chapter as the “Amended Franchise Rule,” contemporize and

mainstream federal disclosure standards, as discussed supra in Chapter 3 of this book. Based

on nearly 30 years of law enforcement experience since the FTC began regulating franchise

sales in 1979, the FTC’s Statement of Basis and Purpose, published with the 2007 Amended

Franchise Rule, found at Bus. Franchise Guide (CCH) ¶¶ 6051-6082 (2007 SBP), finds an

overwhelming, continuing need for pre-sale disclosure as unfair and deceptive practices per-

sist in franchise sales. 2007 SBP, Bus. Franchise Guide (CCH) ¶ 6054.

To aid franchisors that must migrate from old disclosure standards to the new disclo-

sure requirements under the Amended Franchise Rule, the FTC has issued (and will continue to

issue) detailed Compliance Guides. See Bus. Franchise Guide (CCH) ¶ 6086. The FTC has also

issued a series of frequently asked questions (FAQs) in response to questions from practitioners

and franchisors to assist the franchise community in understanding the Amended Franchise

Rule requirements, which the FTC publishes on its website. The FAQs are rich with informa-

tion on the nuances of the Amended Franchise Rule and its deviation from the UFOC. See Bus.

Franchise Guide (CCH) ¶ 6090.

8. In the 2007 SBP at Bus. Franchise Guide (CCH) ¶ 6054, the FTC explains its reasons

for refusing to expand federal regulation to address various post-sale relationship issues that

franchisee advocates alleged were abusive, like sourcing restrictions, territorial encroach-

ment, and post-term covenants not to compete. The FTC instead chose to address franchisee

concerns by requiring franchisors to provide additional pre-sale disclosures concerning these

subjects. Id.