Franchise Registration

• Author: Barkoff, Rupert M., Selden, Andrew C.
• Pages: 119-170

119

Franchise Registration

CHAPTER 4

Rochelle B. Spandorf and Mark B. Forseth

Contents

I. The Origins of Franchise Sales Regulation . . . . . . . . . . . . . . . . . . 120

II. The Regulatory Scheme . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122

A. State Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122

B. Federal Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125

III. The Jurisdictional Scope of State Franchise Registration Laws . . 127

A. Exemptions From Coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131

IV. The Registration Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133

A. The Application Filing Process . . . . . . . . . . . . . . . . . . . . . . . . . 133

B. The Review Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135

C. The Registration Period; Renewal Obligations and

Annual Reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139

D. Amendment Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141

V. Capitalization Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148

A. Capital Infusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149

B. Guarantee of Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150

C. Surety Bond . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150

D. Deferral of Initial Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151

VI. Other Registration Duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151

A. Registration of Salespersons . . . . . . . . . . . . . . . . . . . . . . . . . . . 151

B. Advertising and Promotional Materials . . . . . . . . . . . . . . . . . . . 153

C. Subfranchisor Registration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155

D. Agent for Service of Process . . . . . . . . . . . . . . . . . . . . . . . . . . . 158

VII. Enforcement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158

A. Administrative Enforcement . . . . . . . . . . . . . . . . . . . . . . . . . . . 159

B. Criminal Penalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159

C. Civil Actions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160

120 Fundamentals of Franchising

VIII. Franchise Relationship Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 163

IX. Business Opportunity and Sales Representative Laws . . . . . . . . . 164

A. Business Opportunity Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164

B. Sales Representative Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167

X. The Future of Franchise Regulation . . . . . . . . . . . . . . . . . . . . . . . 168

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

prospective investors. About a dozen U.S. states require registration with a state

agency of the seller’s offering circular 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 speaking. Fran-

chising 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 start-

ing 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 January 1, 1971.

2. FTC Statement of Basis and Purpose, Bus. Franchise Guide (CCH) ¶ 6302. Singer Sew-

ing Machine’s use of a network of independent sales agents in 1851 to distribute its sewing ma-

chines is often cited as the first modern-day example of a franchise system. STAN LUXENBERG,

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 AND JOHN HAYS , FRANCHISING: THE INSIDE STORY (1986).

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

islative activity during this period. Sales of goods and services through franchising reached $757.8

billion in 1991, over one-third of all U.S. retail sales. Robert W. Emerson, Franchise Termina-

tions: Legal Rights and Practical Effects When Franchisees Claim the Franchisor Discriminates,

35 AM. BUS. L.J. 559, 561 (1998) (citing late 1990s statistics on franchising’s role in the economy

in terms of retail sales and the number of jobs franchise outlets provide). Since 1988, when the

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

the U.S. economy, reliable statistics have been hard to come by. Francine LaFontaine, Franchis-

ing: Myth, Reality and What It May Mean for You, FINANCIAL TIMES (LONDON), Nov. 22, 1999, at 10.

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

ing, 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 A1 (34-2d BNA Corporate Practice Series 1983).

Chapter 4 Franchise Registration 121

With the dramatic growth of franchising came a corresponding growth in com-

plaints over the franchise selling practices being employed.5 The magic of “rags to

riches” stories, often sensationalized by the press, induced an easily influenced and

relatively unsophisticated audience to make investments in franchise 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 franchi-

see, usually accompanied by economic disparity between the parties.7 The FTC le-

gal response has been aimed strictly at franchise selling practices, 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 franchise sales prac-

tices, but also by targeting certain substantive aspects of the franchise relationship.9

Franchise sales regulation has reacted to the informational imbalance by tak-

ing on the basic attributes of the federal securities laws.10 The regulations require a

franchisor to make detailed disclosure of all material terms and conditions of the

5. FTC Statement of Basis and Purpose, Bus. Franchise Guide (CCH) § 6304.

6.Id.

7.Id. The FTC’s reaction is set forth in a trade regulation rule discussed infra in Section 2

of this chapter, 16 C.F.R. pt. 436 (1979) (hereinafter the “FTC Rule”), reprinted at Bus. Fran-

chise Guide (CCH) ¶¶ 6090-6193.

8. The record that impelled franchise legislation related predominantly to franchise sell-

ing activities and attendant abuses during the 1960s and early 1970s. There is no comprehensive

evidence existing today of the state of franchise sales practices. The regulatory reaction appears

to have curbed the pattern of widespread abuse, which raises to some observers the political

issue of the continuing need for expansive franchise legislation, such as the duty to register with

a state agency in order to sell franchises in a state. See Section XI of this chapter for additional

thoughts on the direction of franchise registration legislation. Notably, as this book goes to

press, the FTC is in the final stages of completing its first overhaul of the FTC Rule (hereinafter

the Proposed FTC Rule), a process it began in 1989 by issuing an advance notice of proposed

rule making (ANPR). Nothing in the extensive public record currently available on the scope

and content of the proposed amendments shows that regulators or commentators believe that

federal regulation could be made more effective by adding a federal registration component.

9. These laws, commonly referred to as “franchise relationship laws,” are discussed in

Section IX of this chapter. As discussed in Sections II and IX, 15 states currently have some

form of franchise sales law, and of these states, nine also address certain franchise relationship

issues either in the same statute or in another statute. Another 11 states and territories have

enacted laws that just regulate franchise relationship issues but not sales practices.

10. See Southland Corp. v. Keating, 465 U.S. 1 (1984).