Franchise Sales and Managing Growth

• Author: Steven M. Goldman, H. Bret Lowell.
• Pages: 55-139

CHAPTER 2

Franchise Sales and Managing Growth

Mark B. Forseth and Grover C. Outland, III

Contents

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56

Overview of Franchise Registration and Disclosure Laws . . . . . . . . . . . . . . . . 57

The FTC Rule. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

First Personal Meeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

Time for Making of Disclosures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

Franchise Broker . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

Prospective Franchisee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

Business Day . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

State Franchise Registration and Disclosure Laws . . . . . . . . . . . . . . . . . . . 61

The Offer of a Franchise. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

Exemption from State Franchise Registration Requirements . . . . . . . . . . . 64

State Business Opportunity Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

Preparation of the Offering Circular. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67

Multistate Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73

Registration of Salespersons and Franchise Brokers . . . . . . . . . . . . . . . . . 74

Advertising. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

Amendments and Renewals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

Material Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

Commencement of Amendment and Renewal Process . . . . . . . . . . . . . . . 76

Effect on Sales Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76

Document Use, Filing, and Control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

Permissible Representations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79

Negotiation with Prospective Franchisees . . . . . . . . . . . . . . . . . . . . . . . . . 80

Private Rights of Action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80

Administrative Liability Under State and Federal Franchise Laws . . . . . . . . . 81

Common Characteristics of State Franchise Laws . . . . . . . . . . . . . . . . . . . 81

FTC Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82

Implementing Sales Compliance Policies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82

Role of In-House Counsel. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

Internal Compliance Manual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84

Sales Compliance Training. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84

Internal Auditing and Monitoring Compliance . . . . . . . . . . . . . . . . . . . . . 86

Curing Franchise Sales Law Compliance Violations . . . . . . . . . . . . . . . . . 87

Granting the Franchise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90

55

Legal Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90

Business Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

Coordinating Growth Strategies and Compliance for Litigation Avoidance . . . 92

Traditional and Nontraditional System Expansion . . . . . . . . . . . . . . . . . . 92

Communication of Expansion Policies with Franchisees. . . . . . . . . . . . . . 97

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99

Exhibit 2-A: Chart of State Franchise Law Jurisdictional Requirements . . . . 104

Exhibit 2-B: Salesperson’s Franchise Law Jurisdictional Checklist . . . . . . . . 106

Exhibit 2-C: Registration Summary Checklist . . . . . . . . . . . . . . . . . . . . . . . . 107

Exhibit 2-D-1: Questionnaire for Directors, Trustees, General Partners,

Officers, and Executives. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108

Exhibit 2-D-2: Information for Item 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113

Exhibit 2-D-3: Information for Training. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117

Exhibit 2-E: Uniform Franchise Salesman Disclosure Form . . . . . . . . . . . . . 119

Exhibit 2-F: State Advertising Filing Requirements . . . . . . . . . . . . . . . . . . . 121

Exhibit 2-G: Franchise Sales Advertising Tracking Chart . . . . . . . . . . . . . . . 122

Exhibit 2-H: Summary of Acknowledgments Form . . . . . . . . . . . . . . . . . . . . 123

Exhibit 2-I: Franchise Sales Compliance Tracking Form. . . . . . . . . . . . . . . . 126

Exhibit 2-J: Memorandum on Offering Circular Changes . . . . . . . . . . . . . . . 128

Appendix 2-A: McDonald’s Franchise Agreement. . . . . . . . . . . . . . . . . . . . . 131

Appendix 2-B: Burger King Franchise Agreement. . . . . . . . . . . . . . . . . . . . . 132

Appendix 2-C: Burger King Target Reservation Agreement. . . . . . . . . . . . . . 133

Appendix 2-D: Dunkin’ Donuts Franchise Agreement . . . . . . . . . . . . . . . . . 135

Appendix 2-E: Dunkin’ Donuts Store Development Agreement . . . . . . . . . . 136

Appendix 2-F: Cottman Transmission Franchise Agreement . . . . . . . . . . . . 138

Appendix 2-G: Ramada Hotels Franchise Agreement . . . . . . . . . . . . . . . . . . 139

Introduction

In order to manage the franchise sales activity and the growth of a franchise sys-

tem, a franchisor must establish internal policies and programs that facilitate com-

pliance with federal and state laws and regulations applicable to the offer and sale

of a franchise. Further, a franchisor must promote the franchise relationship and

manage system expansion to control, or at least minimize, conflicts with fran-

chisees. Effective implementation of such policies and programs dictates that all

personnel of the franchisor who have contact with prospective and existing fran-

chisees understand how the applicable legal and regulatory frameworks affect the

franchisor’s dealings with prospective and existing franchisees. While this chap-

ter provides an overview of the applicable franchise relationship laws in connec-

tion with state registration requirements and issues related to system expansion,

full discussion of such relationship laws is beyond the scope of this chapter.

Implementing the policies and procedures memorialized in an internal com-

pliance program should lessen the franchisor’s exposure for violations of state and

federal laws. Further, the franchisor’s adherence to an effective compliance pro-

gram can provide the basis for a highly credible defense should any transaction be

56 The Franchise Law Compliance Manual

challenged, to the extent that the franchisor conducts its sales activity and busi-

ness dealings in a manner consistent with its policies. The franchisor’s failure to

comply with announced policies and procedures, however, can be introduced as

evidence in order to prove that the franchisor failed to meet its own minimum

standards of conduct. Consequently, system policies (in particular, notification

and/or impact policies) should establish standards that are achievable by the fran-

chisor and consistent with its short-term and long-term expansion plans.1

Overview of Franchise Registration

and Disclosure Laws

The offer and sale of franchises are regulated under both federal and state law.

Such laws specify the form and content of the disclosure that must be made to

prospective franchisees, the timing of delivery of such disclosure, and who must

receive disclosure. On October 21, 1979, the Federal Trade Commission adopted

the “FTC Rule” (formally titled “Disclosure Requirements and Prohibitions Con-

cerning Franchising and Business Opportunity Ventures” ).2The FTC Rule requires

delivery of the prescribed disclosure by a franchisor (and any franchise broker, if

applicable) to prospective franchisees, in accordance with its timing require-

ments, prior to concluding the sale of a franchise, but does not require any filing

or registration of the disclosure document with any federal agency. The FTC Rule

applies in all fifty states and the U.S. territories.

In addition to the federal law, fifteen states specifically regulate the offer and

sale of franchises.3On January 1, 1971, California became the first state to adopt

a law specifically requiring registration and disclosure in connection with the

offer and sale of a franchise.4The other 14 states enacted their laws prior to the

enactment of the FTC Rule, with the exception of New York.5These states gen-

erally require the following: the registration (or filing) of the disclosure document

with the state prior to offering and selling a franchise in that state (as defined by

statute), the standards for and pre-use filing of all franchise sales advertising, and

the registration of salespersons representing a franchisor in each state.6Further,

24 states have business opportunity laws or seller-assisted marketing plan prac-

tice acts that may impact a franchisor’s ability to offer and sell franchises in a par-

ticular state.7

Most franchisors structure their franchise programs in order to qualify, where

possible, for exemptions or to be excluded from such statutes. Several of these

states, however, require franchisors to file a notice for, or otherwise to claim, the

exemption under the law prior to offering and selling in that state (again as

defined by statute). If a franchisor does not qualify for an exemption (or is other-

wise excluded from coverage of the act), the franchisor may be required to regis-

ter in accordance with the terms of such laws prior to any offer or sale of a

franchise in that state. If the manner in which the franchisor offers its franchises

falls within state statutory definitions of a business opportunity or a seller-assisted

marketing plan, then the franchisor may face registration and disclosure obliga-

tions under these statutes that are similar to, or in addition to, those required

Chapter 2 Franchise Sales and Managing Growth 57