LAWS

Franchise law is complex and involves both federal and state laws. These laws are not uniform and vary from state to state. To further complicate matters, there are state and federal laws that govern "business opportunities" and "seller-assisted marketing plans" which can also apply to franchising. The following overview explains only the basics.

For a detailed understanding, an interested franchisor should always consult with an experienced franchise lawyer.

The FTC Franchise Rule

The U.S. Federal Trade Commission (FTC) and various state agencies regulate franchising. The FTC Franchise Rule applies everywhere in the United States. A state's franchise law usually applies only if the offer or sale of a franchise is made in the state, if the franchised business will be located in the state, or if the franchisee is a resident of the state.

Under federal law, the FTC Franchise Rule states that there are three elements of a franchise:

1. Trademark. The franchisee is given the right to distribute goods and services that bear the franchisor's trademark, service mark, trade name, logo, or other commercial symbol.

2. Significant Control or Assistance. The franchisor has significant control of, or provides significant assistance to, the franchisee’s method of operation. Examples of significant control or assistance include:

• approval of the site.
• requirements for site design or appearance.
• designated hours of operation.
• specified production techniques.
• required accounting practices.
• required participation in promotional campaigns.
• training programs.
• providing an operations manual.

3. Required Payment. The franchisee is required to pay the franchisor (or an affiliate of the franchisor) at least $500 either before or within six months after opening for business. Required payments include any payments the franchisee makes to the franchisor for the right to be a franchisee. These include franchise fees, royalties, training fees, payments for services, and payments from the sale of products unless reasonable amounts are sold at bona fide wholesale prices. If all three elements are present, then the relationship will be a "franchise" for purposes of the FTC Franchise Rule.

State Law

State law definitions of franchises vary, but there are several common themes. In twelve states, the three elements of the legal definition of a "franchise" are:

• Marketing Plan. The franchisee is granted the right to engage in the business of offering, selling or distributing goods or services under a marketing plan or system substantially prescribed by the franchisor.
• Association with Trademark. The operation of the franchisee’s business is substantially associated with the franchisor’s trademark, trade name, service mark, etc.
• Required Fee. The franchisee is required to pay a fee, directly or indirectly.

In five other states, the three elements of the legal definition of a franchise are:

• Trademark License. The franchisee is granted the right to engage in the business of offering, selling or distributing goods or services using the franchisor’s trademark, trade name, service mark, etc.
• Community of Interest. The franchisor and franchisee have a community of interest in the marketing of goods or services.
• Required Fee. The franchisee is required to pay a fee, directly or indirectly.

These requirements are unique to the states which have passed them, and not to others. You should always do research on the laws governing franchise relationships in your jurisdiction before beginning a franchise project.

Categories of Franchise Law

There are three general categories of laws regulating franchises: disclosure laws, registration laws and relationship laws. Disclosure laws regulate things like required pre-sale disclosures, prohibited franchise sales practices, and a mandatory cooling-off period before franchise sales. Registration laws require things like registration of the franchise, franchise salespersons and franchise advertising. Relationship laws govern certain aspects of the relationship between franchisor and franchisee, such as grounds for terminating a franchise, notice and cure periods before termination, grounds for not renewing a franchise, and equal treatment of franchisees.

Disclosure Laws

The FTC Franchise Rule requires that franchisors provide each prospective franchisee with a disclosure document, which is sometimes called an offering circular, at a certain point early in the process of offering and selling a franchise.

Laws in more than a dozen states also require franchisors to provide a similar disclosure document. Because the FTC format for disclosure does not satisfy the law requirements in these states, most franchisors choose to use the UFOC (Uniform Franchise Offering Circular) format which is acceptable in all of the registration states. The UFOC Guidelines are lengthy and there are detailed requirements for the preparation of a UFOC. See UFOC Outline for a discussion of these requirements.

The franchisor must give the UFOC to the prospect:

• during the first face-to-face meeting with the prospect involving a discussion about the sale of a franchise
• at least ten business days before the prospect signs any agreement with the franchisor
• at least ten business days before the prospect pays any money to the franchisor

The franchisor also must provide the prospect with a complete version of the franchise agreement (with all blanks filled in) at least five business days before the prospect signs any agreement or pays any money.

State Registration Laws

-Franchise Registration

The FTC Franchise Rule does not provide for any registration of a franchise with the Federal Trade Commission, so there is no federal registration of franchises. However, various states require that franchises, business opportunities and seller-assisted marketing plans must be registered with the state and filing fees provided before they can be sold in the state.

In most of these states, registration involves a review of the UFOC by a franchise regulator who checks to make sure the UFOC meets the state requirements. But in a few states, the UFOC is simply filed.

State registrations are generally valid for one year. In some states, the effective period of registration is a full calendar year from the first registration date, but in other states the registration expires a certain number of days (typically 90 to 120 days) after the end of the franchisor’s fiscal year. To renew registration, a franchisor must file a renewal application or annual report each year, which includes certain forms, an updated UFOC, and a filing fee. Maryland also requires franchisors to file quarterly reports.

The UFOC also needs to be updated every time there is a change to any of the material information regarding the franchisor or the franchise opportunity. "Material information" means information that a potential franchisee could consider important in making a decision whether to invest in a franchise. If there are any of these changes, then the franchisor must update its UFOC and file an amendment in the relevant registration states.

-Business Opportunity Registration or Exemption

A number of states require registration of business opportunities and seller-assisted market plans. The statutory definitions of these types of business relationships are often broad enough to include franchises, but most of these states provide some type of exemption for franchises that comply with the FTC Franchise Rule. The exemption is automatic in some states. Others require a one-time or an annual filing. The franchise exemption in some states is available only for franchisors that have obtained registration of the trademarks or service marks involved in the franchise. Franchisors that do not have these mark registrations will need to register their franchise under the business opportunity laws if they will offer franchises in these states.

-Advertising Filing

Some states require that all advertising for the sale of franchises must be filed with the state before they are published. These states also generally have laws that restrict what franchisors can say in advertisements. These restrictions usually prohibit characterizing the franchise as a safe investment, or implying that state registration of the franchise means that the state has approved of the franchise. A few other states have similar content restrictions but do not require the ads to be filed.

-Salesperson Registration

Most of the franchise registration states require the franchisor to file certain information about each person who will sell franchises in the state. This information includes the salesperson’s home address and phone number, business addresses and phone number, social security number, date of birth, employment history, and information about certain civil and criminal proceedings involving the person. If the salesperson is not an employee of the franchisor, some states require that additional detailed information be filed.

State Relationship Laws

There is no federal law governing franchise relationships, despite many attempts by Congress. There are nineteen states that regulate some aspect of the franchise relationship.

-Restrictions on Termination

In some states, it is illegal for a franchisor to terminate a franchise agreement without good cause. "Good cause" usually includes things like:

• the franchisee becomes insolvent or bankrupt
• the franchisee voluntarily abandons its operations
• the franchisee is convicted of a crime relating to the franchise operations
• the franchisee fails to substantially comply with its material obligations under the franchise agreement

These laws typically require the franchisor to give the franchisee written notice of the proposed termination a certain number of days before the termination. This advance notice period ranges from 30 to 120 days. These laws also usually provide the franchisee with an opportunity to cure the default, although there are often exceptions for defaults that cannot be cured such as voluntary abandonment, bankruptcy, and criminal conviction.

-Non-Renewal Restrictions

State laws do not require franchise agreements to include a provision for renewal of the franchise after the end of the initial term. But if a franchise agreement does have a renewal provision, then the franchise relationship laws in twelve states restrict the franchisor's ability to not renew the franchise.

Most of these states treat non-renewal just like termination. This means that a franchisor must renew the franchise unless there is good cause not to, and the franchisee has been given the required advance written notice and opportunity to cure.

The relevant laws in several states require the franchisor to give the franchisee advance written notice of non-renewal (typically at least six months), and they impose certain restrictions or requirements on the franchisor in some circumstances, such as repurchase of the franchisee's assets or waiver of any non-competition restrictions.

-Repurchase Obligations

In ten states, the franchisor must repurchase some or all of the franchisee's furnishings, equipment, inventory, supplies and other assets following the end of the franchise relationship. Most of these states allow the franchisor to offset any money the franchisee owes to the franchisor. In Arkansas and California, the repurchase obligation is only imposed in certain situation where the termination or non-renewal by the franchisor violates state law. In Connecticut, the law requires the franchisor to repurchase certain franchisee’s assets following any termination of the franchise. In Hawaii and Washington, the repurchase obligation applies to terminations and non-renewals. The repurchase requirement is more limited in other states.

-Transfer Restrictions

In ten states, it is illegal for a franchisor to refuse to allow a transfer of the franchise without good cause. Many of these states permit a franchisor to have a right of first refusal to purchase the franchise prior to a transfer. The California and Indiana statutes limit the circumstances in which transfer must be allowed. In California, the spouse, heirs and estate of a deceased franchisee/dealer can operate the business if they qualify, or they can transfer the business to a qualified third party. Indiana simply grants the spouse, heirs and estate of a deceased franchisee/dealer the right to operate the business for a reasonable period of time.

-Other Restrictions

There are various other restrictions or requirements imposed on franchise relationships by state law. Some of these include:

• Encroachment. The franchisor’s ability to open a new unit in the vicinity of a franchise’s existing unit is regulated in some states.
• Free Association. It is illegal for a franchisor to prohibit free association among franchisees or to prohibit them from participating in a trade association in some states.
• Good Faith/Reasonableness. A franchisor must deal with its franchisees in a commercially reasonable manner and/or in good faith in some states.
• Management. It is illegal for a franchisor to require or prohibit any change in the management of the franchisee without good cause in some states.
• Marketing Fees. It is illegal to collect marketing fees from franchisees and not spend them on marketing in Arkansas.
• Non-Compete Agreements. The scope of a franchisee’s non-competition agreement is limited in Indiana and Louisiana.
• Non-Discrimination. It illegal for a franchisor to discriminate among similarly situated franchisees in some states..
• Non-Waiver. A franchisee’s waiver of any of the protections provided to it under state law is illegal or unenforceable in every state.
• Required Purchases. There are limits on a franchisor’s ability to require franchisees to purchase supplies, inventory, goods and services from the franchisor or designated sources in some states.

-Common Violations

The most common types of franchise law violations are:

• Offering or selling an unregistered franchise.
• Failing to provide a UFOC on time.
• Failing to provide all required disclosures in the UFOC.
• Making misrepresentations to franchisee prospects.
• Improperly terminating or not renewing a franchise.

Governmental penalties for violating franchise laws can include fines, permanent bans on engaging in franchising, freezing of assets, money damages for victims, and even jail sentences. These penalties can be applied to the franchisor and to its officers, directors, and managers who formulate, direct or control the franchisor's activities. The violation of state franchise laws is typically treated under the statutes as either a fraudulent and deceptive trade practice, misdemeanor or felony. In some states, a franchisee who has been harmed by the franchisor’s conduct can be awarded money damages, including punitive damages and attorneys fees, or cancellation of the franchise agreement and reimbursement of all fees paid to the franchisor.

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