An Introduction to Franchising in the United

States

Andrew Loewingeraloewinger@nixonpeabody.com

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Franchising in the U.S.

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Non-U.S. Franchisors in the United States

Cartridge World

Ikea

The Body Shop

Senor Frog’s /Carlos’n Charlie’s

FamilyMart Co. Ltd

Pollo Campero

Tim Hortons

Benetton

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Franchise Regulation: Working Towards a More Perfect Union

Federal Regulation:

– Federal Trade Commission (FTC) Amended Franchise Rule (2007)

State Regulation:

– Franchise Sales Laws

– Franchise Relationship Laws

– Business Opportunity Laws

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Federal Regulation• In 2007, the FTC amended its

Franchise Rule• The original Franchise Rule (1979):

-- Disclosure requirements designed to enable prospective franchisees to make informed decisions about whether to enter into a franchise agreement

– Was not consistent with requirements imposed by various states

– Imposed additional burdens on franchisors – The Amended Rule does not govern the

Franchisor – Franchisee relationship.

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The Franchise Relationship Defined

FTC Franchise Rule:

The Franchisor:

• Promises to provide a trademark or other commercial symbol;

• Promises to exercise significant control or provide significant assistance in the operation of the business; and

• Requires a minimum payment of at least $500 during the first 6 months of operation.

* Definitions under state law vary

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Disclosure Under the Amended Rule

OLD RULE:• First personal meeting

OR• 10 business days prior to

– payment of any monies

– execution of the Agreement

NEW RULE:• 14 calendar days prior to:

– payment of any monies– execution of the

AgreementOR

• Earlier in the process upon a reasonable request from a prospective franchisee

Franchisors must provide a “prospective franchisee” with a Franchise Disclosure Document (formerly known as a UFOC), which contains information about the Franchisor and the franchised business.

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Presentation to a Prospective Franchisee

• Disclosure no longer mandatory at first-personal meeting • Franchisors can conduct initial information gathering

and sales meetings without having to provide an FDD • “Prospective franchisee”

– Completed initial application– Qualified & approved by franchisor– Attendance at “discovery day”

• Reduces compliance costs • Allows Non-U.S. Franchisors to test the market

* Some states have different disclosure “timing” rules

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What Must Be Disclosed in the FDD?

25 REQUIRED ITEMS• Background on the Franchisor,

Management Personnel, and the Franchised Business (Items 1-4)

• Fees: Initial Investment, Fees Paid to the Franchisor (Items 5-7)

• Assistance by Franchisor, Sources of Products & Services, Training, Advertising Requirements, Territorial Restrictions (Items 9-12)

• Intellectual Property: Trademarks and Patents (Items 13-14)

• Franchisee’s Obligations, Summary of the Franchise Agreement, Public Figures, Franchisee Tables (Items 15-18, 20)

• Financial Performance Representations (Item 19)

• Financial Statements (Item 21)

• Contracts (Item 22)

• Receipt Page (Item 23)

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Item 19: Financial Performance Representations

• Previously known as “Earnings Claims” • Strictly optional – not mandatory

– If a Franchisor does not make Financial Performance Representations in Item 19, it is strictly prohibited from making any such representation anywhere else

• Franchisor must have “reasonable basis” and written substantiation for the representations

• Potential source of liability

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Item 21: Financial Statements

• Mandatory requirement: 3 years of audited financial statements prepared according to GAAP

• Phase-in of audited financials for start-up franchise systems *

• Disclosure of parent financial information required in limited circumstances

* Certain states may not allow phase-in of audited financials

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Updating the FDD

• Under the Amended Rule, the FDD must be updated – Annually (within 120 days after the close of

Franchisor’s fiscal year); and – Quarterly, to reflect material changes

• State laws differ, but most require updates on an annual basis and “promptly” after any material changes

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State Regulation:Franchise Sales Laws

• Many state laws govern disclosure requirements and the franchisor-franchisee relationship

• Franchise relationship laws typically prohibit:– Termination without “good cause” – Requiring that arbitration or litigation be

conducted outside the state – Discriminating between franchisees or restricting

free association among franchisees– Encroaching on a franchisee’s territory – Unfair restrictions on a franchisee’s right to

transfer its franchise

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Registration States

California New YorkHawaii North DakotaIllinois Rhode IslandIndiana South DakotaMaryland VirginiaMichigan WashingtonMinnesota Wisconsin

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A State’s Franchise Law May Apply If:

• The offer to sell originates in the state• The offer to sell is directed to the state• The offer to buy is accepted in the state• The prospective franchisee is a resident of

the state; or • The franchised business will be located in the

state

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Exemptions Under State Law

Exemptions include: • Net Worth and Experience• Franchisee Sale• Existing Franchisee• Isolated Transaction• Fractional Franchise• By Order of the Administrator

Even if a Franchisor qualifies for an exemption, it must still provide disclosure to prospective franchisees.

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CONCLUSION

• Fewer barriers to entry in the U.S. Market • Franchisors may conduct exploratory meetings

without triggering the FTC disclosure requirements

• FTC Rule applies to the offer or sale of a franchise to be located in the U.S.