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The Regulation of Franchising
A series of laws have been enacted to
regulate various aspects of franchising. These laws
were the result of a public policy debate that began
in the early 1970's to combat alleged abuses in franchising.
These laws regulate franchisor conduct before the sale
of the fast food franchise, during the term of the relationship
and upon termination of the fast food franchise. If
a commercial relationship falls within the definition
of a "fast food franchise" as set forth in
these laws, it will be subject to a variety of legal
requirements and restrictions. Failure to comply can
result in lawsuits by private parties and/or penalties,
civil fines, injunctions and even criminal prosecution
by a government authority.
Federal Regulation of the Sale
of Fast food franchises
At the federal level, the Federal Trade Commission issued
a Trade Regulation Rule (the "FTC Rule") on
October 21, 1979, requiring disclosure of specified
categories of information to a prospective fast food
franchisee. The FTC Rule defines a prospective fast
food franchisee as any person who approaches or who
is approached by the franchisor or fast food franchise
broker or any of their representatives, agents or employees
for the purpose of discussing the establishment, or
possible establishment of a fast food franchise relationship.
These disclosures must be made to a
prospective fast food franchisee at the earlier of:
the first personal meeting for the purpose of discussing
the sale of a fast food franchise; or 10 business days
(excluding weekends and national holidays) prior to
the execution of any fast food franchise document or
the payment of any consideration for the fast food franchise.
By requiring the franchisor to provide
this information, the FTC Rule is intended to reduce
the prospective fast food franchisee's investigative
costs by providing comprehensive materials about the
fast food franchise and the franchisor, enabling the
prospective fast food franchise buyer to make comparisons
with other fast food franchise offerings. A second goal
of the FTC Rule is to discourage high-pressure sales
tactics and to provide the prospective purchaser with
a "cooling-off" period before returning any
signed documents or making any payments to the seller.
A first personal meeting is defined in the FTC Rule
as a "face to face" meeting between the franchisor
or fast food franchise broker, or any agents, representatives
or employees, and a prospective fast food franchisee,
which is held for the purpose of discussing the sale
or possible sale of a fast food franchise. A telephone
conversation or written communications concerning a
fast food franchise program with a prospective fast
food franchisee will not constitute a "first personal
meeting" under the FTC Rule. If the meeting involves
only generalized discussion, the prospective fast food
franchisee's interest in purchasing a fast food franchise
or the fact that the meeting was initiated by the franchisor's
representatives will not convert the meeting into a
"first personal meeting."
The FTC Rule also requires the franchisor to deliver
the completed fast food franchise and other agreements
that actually are intended to be signed by a prospective
fast food franchisee at least five business days prior
to the date such agreements are signed. Only agreements
that have been completed and are ready for the prospective
fast food franchisee's signature will satisfy the five
business day rule.
Application of the FTC Rule
Only if a relationship meets all of the jurisdictional
elements of a fast food franchise will the requirements
of the FTC Rule apply.
These elements are as follows:
" the offer, sale or distribution of goods, commodities
or services by a business (the "fast food franchisee");
" the identification or association of the fast
food franchisee's business with a trademark, service
mark, trade name, advertising or other commercial symbol
of another person (the "franchisor");or requirements
that the fast food franchisee meet quality standards
in connection with the use of the mark or symbol;
" significant control by the franchisor over the
business operation of the fast food franchisee, or significant
assistance by the franchisor to the fast food franchisee
(the FTC Rule enumerates certain controls and assistance,
any one of which will satisfy this standard, including
site approval, hours of operation, production techniques);
and
" direct or indirect initial payment or commitment
to make an initial payment by the fast food franchisee
to the franchisor, as a condition of obtaining or commencing
the fast food franchise operation, of $500 or more at
any time before or within the first six months of the
relationship.
This definition of a fast food franchise, in application,
is quite broad. Anytime payment of $500 or more is made
to enter into a commercial relationship associated with
a trademark or service mark where the seller asserts
some form of control over or assistance to the business
operation, a fast food franchise within the meaning
of the FTC Rule probably exists. However, the FTC Rule
does not cover pure product distribution arrangements
where the purchaser only buys good at bona fide wholesale
prices for resale.
Exemptions from the FTC Rule
Even if a commercial relationship meets the FTC Rule's
definition of a fast food franchise, the seller of the
relationship may not be subject to the FTC Rule's disclosure
obligations if the commercial relationship falls within
one of the following specific exemptions to the FTC
Rule:
" Fractional Fast food franchises. A fractional
fast food franchise relationship exists when an established
distributor adds a fast food franchised product line
to its existing line of goods. To be exempt from the
FTC Rule, the fast food franchisee must have more than
two years' prior management experience in the same business
as the fast food franchise, and the proposed relationship
must be anticipated to represent no more than 20 percent
of the dollar value of the fast food franchisee's projected
gross sales in the reasonably foreseeable future.
" Leased Departments. The FTC Rule exempts arrangements
by which an independent retailer sells goods or services
from the premises of another, larger retailer, but only
if the larger retailer does not restrict the "lessee's"
sources of supply.
" Minimal Investments. The FTC Rule exempts from
its disclosure requirements sales of fast food franchises
where the "initial" required payment within
six months after commencing operation of the fast food
franchised business is less than $500.
In addition to these exemptions, the FTC Rule also excludes
(a) bona fide employee-employer relationships;
(b) general business partnerships;
(c) relationships created by, membership in a retailer-owned
cooperative association (for example, farmer cooperatives
for the sale of farm products);
(d) relationships with testing or certification services
(for example, electronic products approved by Underwriter's
Laboratories and bearing its logo);
(e) "single" trademark licensing relationships;
and
(f) purely "oral" agreements. However, since
some writings are usually involved even where there
is only a verbal agreement, this last exemption is available
only in rare circumstances.
In addition to the offering circular, the franchisor
also must furnish a copy of the proposed fast food franchise
agreement and any other agreements to be signed by the
prospective fast food franchisee. The FTC Rule deals
only with full disclosure and does not regulate any
terms of the fast food franchise relationship. No filing
or registration of the Offering Circular need be made
with the Federal Trade Commission.
The FTC Rule applies in all 50 states and is intended
as a minimum level of protection for prospective purchasers.
If the protection afforded under state law is greater
in states that have adopted similar specific fast food
franchise regulations, the FTC Rule defers to state
law. However, where any portion of the state law provides
less protection to a purchaser, the corresponding portion
of the FTC Rule will apply. For instance, the FTC Rule
supersedes less stringent state requirements with respect
to the "cooling-off" periods following delivery
of an offering circular (before a purchaser may sign
any documents or pay any money to the franchisor). Many
states that have adopted fast food franchise regulations
require the Uniform Fast food franchise Offering Circular
disclosure format, which will be discussed later. In
such states, the FTC Rule disclosure format may not
be accepted for registration.
The information contained in the Offering Circular must
be updated annually, or quarterly in the event of any
material change in such areas of information as the
franchisor's business, terms of sale and obligations
of the fast food franchisee. Failure to comply with
the FTC Rule may result in an FTC action for injunction,
a cease and desist order, monetary damages and civil
penalties of up to $10,000 per day. There is no federal
private right of action available to an individual for
a violation of the FTC Rule. However, the FTC may require
a franchisor to repay money to the purchaser of a fast
food franchise that was sold in violation of the FTC
Rule. Further, at least one state court has taken the
view that violations of the FTC Rule constitute violations
of the states' consumer protection laws (also known
as "little FTC Acts").
Federal Regulation of Business Opportunities
The FTC Rule also regulates the offer and sale of "business
opportunities." The FTC Rule was intended to correct
abusive practices in business arrangements in which
the purchaser sells goods supplied by the seller through
outlets obtained by the seller. The requirements of
the FTC Rule with respect to offers and sales of business
opportunities are substantially the same as those for
fast food franchises.
State Regulation of Fast food franchise Offers and Sales
Since 1971, 15 states (California, Hawaii, Illinois,
Indiana, Maryland, Michigan, Minnesota, New York, North
Dakota, Oregon, Rhode Island, South Dakota, Virginia,
Washington and Wisconsin) have enacted laws regulating
the offer and sale of fast food franchises. With the
exception of Michigan and Oregon, these states require
the franchisor to register the fast food franchise offering
with a designated state agency prior to the offer and
sale of fast food franchises. Oregon requires only a
full disclosure of all of relevant information relating
to the fast food franchise to the prospective fast food
franchisee in advance of purchase. The State of Michigan
requires disclosure complying with its statute, as well
as the filing of a notice of the franchisor's intent
to offer and sell fast food franchises in the state.
In most instances, the registration process involves
administrative review of the required disclosure materials.
If the examiner is satisfied that (1) the required disclosure
format has been used (i.e., that all required categories
of information have been covered and all questions answered;
the examiner makes no determination regarding the inclusion
of all relevant information or the accuracy of the information
contained in the disclosure materials) and (2) that
the franchisor has sufficient financial capacity to
offer fast food franchises in the state (or is willing
to escrow or defer collection of initial fees and other
payments due from the fast food franchisee until the
fast food franchisee's business is in operation), the
franchisor will usually secure registration in that
state to offer and sell fast food franchises. Occasionally,
a state administrative agency will deny registration
due to the precarious financial condition of the franchisor
or the background of its principal managers.
Part
I: Introduction to Franchising
Part
II: In What Ways Is Franchising A Superior Expansion
Method?
Part
III: When Is A Company Ready To Franchise?
Part
IV: Buying A Fast Food Franchise
Part
V: Elements Of Successful Franchising
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