Franchising - LegalFranchising - LegalTrainingTraining

Matthew J. Kreutzer, Esq.Matthew J. Kreutzer, Esq.Partner, Howard & Howard PLLCPartner, Howard & Howard PLLC

What We’ll Talk AboutWhat We’ll Talk About 1 – What is a franchise?1 – What is a franchise?

2 – Types of Franchise Laws and Regulation2 – Types of Franchise Laws and Regulation

Federal LawsFederal Laws

State LawsState Laws

3 – Franchise Disclosure Document (“FDD”)3 – Franchise Disclosure Document (“FDD”)

What is a Franchise? What is a Franchise?

TraditionallyTraditionally::

The right or license granted to an The right or license granted to an individual or entity to market and sell individual or entity to market and sell a company’s goods or services in a a company’s goods or services in a particular industry using that particular industry using that company’s intellectual property (company’s intellectual property (i.e.,i.e., trademark)trademark)

What is a Franchise?What is a Franchise?

FTC:FTC: A franchise is a business A franchise is a business opportunity involving three (3) elements:opportunity involving three (3) elements:

1.1. TrademarkTrademark.. Business involves distribution of goods or Business involves distribution of goods or services associated with the franchisor’s trademark or services associated with the franchisor’s trademark or trade name;trade name;

2.2. FeeFee.. Payment of at least $500 within six months of Payment of at least $500 within six months of signing of an agreement; andsigning of an agreement; and

3.3. Significant Control or AssistanceSignificant Control or Assistance.. Franchisor Franchisor exercises significant control over, or provides significant exercises significant control over, or provides significant assistance in, franchisee’s method of operation. assistance in, franchisee’s method of operation.

What is a franchise?What is a franchise? (McDonald’s Italy)(McDonald’s Italy)

What is a franchise? What is a franchise? (McDonald’s Spain)(McDonald’s Spain)

What is a franchise? What is a franchise? (McDonald’s France)(McDonald’s France)

Federal Franchise LawFederal Franchise Law Federal Law (called the “FTC Rule”)Federal Law (called the “FTC Rule”):: require require

franchisors to prepare a Franchise Disclosure Document franchisors to prepare a Franchise Disclosure Document (“FDD”) which is similar to a securities disclosure, and (“FDD”) which is similar to a securities disclosure, and provide that document to prospective franchisees provide that document to prospective franchisees

Governs all franchisors operating in the USGoverns all franchisors operating in the US

Must furnish FDD to all prospective franchiseesMust furnish FDD to all prospective franchisees f/k/a the “Uniform Franchise Offering Circular” or f/k/a the “Uniform Franchise Offering Circular” or

“UFOC”“UFOC”

Disclosure law onlyDisclosure law only

What is a franchise?What is a franchise?

All three of the definitional elements must All three of the definitional elements must be met before a business opportunity will be met before a business opportunity will be considered a “franchise”be considered a “franchise”

The name which the parties give to their The name which the parties give to their relationship is not relevant in determining relationship is not relevant in determining whether the relationship is or is not a whether the relationship is or is not a franchisefranchise

State Franchise LawsState Franchise Laws State LawsState Laws::

Disclosure and Registration Laws Disclosure and Registration Laws - Before a franchisor - Before a franchisor can sell in a jurisdiction or to residents of that can sell in a jurisdiction or to residents of that jurisdiction, it must file its FDD with the applicable jurisdiction, it must file its FDD with the applicable regulatory authority. The regulator will review and, in regulatory authority. The regulator will review and, in some instances, comment on the FDD and require the some instances, comment on the FDD and require the franchisor to make changes.franchisor to make changes.

- Registration must be renewed annually, - Registration must be renewed annually, and and any time there any time there is a is a material change in the franchisor or the franchise material change in the franchisor or the franchise system.system.

Relationship LawsRelationship Laws – Govern elements of the relationship – Govern elements of the relationship between franchisor-franchisee; primarily restrict when a between franchisor-franchisee; primarily restrict when a franchisor can terminate or refuse to renew a franchise .franchisor can terminate or refuse to renew a franchise .

Interaction of the Various Interaction of the Various Franchise LawsFranchise Laws

Fourteen states have Fourteen states have disclosuredisclosure and and registrationregistration laws laws

Some states have Some states have relationshiprelationship laws laws but no registration lawsbut no registration laws

Franchise Registration StatesFranchise Registration States

State Franchise LawsState Franchise Laws

State Franchise RegistrationState Franchise Registration

In some states, franchisor must disclose In some states, franchisor must disclose “franchise sellers” who will be selling “franchise sellers” who will be selling franchises in-statefranchises in-state

““Franchise seller”: a person that offers for Franchise seller”: a person that offers for sale, sells, or arranges for the sale of a sale, sells, or arranges for the sale of a franchise. Includes franchisor’s employees, franchise. Includes franchisor’s employees, representatives, agents, subfranchisors, and representatives, agents, subfranchisors, and third-party brokers.third-party brokers.

State Franchise LawsState Franchise Laws

Franchise Seller disclosure:Franchise Seller disclosure:• Current positionCurrent position• 5 year employment history5 year employment history• Pending /completed actions (5 Pending /completed actions (5

years) involving fraud, years) involving fraud, embezzlement, violation of embezzlement, violation of franchise law, unfair / franchise law, unfair / deceptive practices, or similar deceptive practices, or similar allegationsallegations

• Felony /no contest pleas Felony /no contest pleas within 10 yearswithin 10 years

• Injunctive /restrictive order Injunctive /restrictive order relating to franchises, relating to franchises, securities, antitrust lawssecurities, antitrust laws

State Franchise LawsState Franchise Laws Franchise seller disclosure must be updated annually, Franchise seller disclosure must be updated annually,

or when the information on the form changes (or when the information on the form changes (e.g.e.g., , address, position, civil / criminal actions)address, position, civil / criminal actions)

Generally the responsibility of the Franchisor to Generally the responsibility of the Franchisor to provide franchise seller disclosure as part of its annual provide franchise seller disclosure as part of its annual registrationregistration

State Licensing of Franchise BrokersState Licensing of Franchise Brokers 48 states: no license needed for “finders” who 48 states: no license needed for “finders” who

simply refer candidates to franchise companiessimply refer candidates to franchise companies Exceptions: NY and WA – it is Exceptions: NY and WA – it is your your responsibility responsibility

to become licensed thereto become licensed there

Disclosure RequirementDisclosure Requirement

Contents of FDD per regulation – 23 separate Contents of FDD per regulation – 23 separate ItemsItems FTC and the Disclosure/Registration States have created FTC and the Disclosure/Registration States have created

a set of guidelines that generally make FDD’s uniform a set of guidelines that generally make FDD’s uniform across statesacross states

As a result, FDDs will look substantially the same As a result, FDDs will look substantially the same regardless of prospect’s state of residenceregardless of prospect’s state of residence

““Plain English Rule”: No legalese or technical Plain English Rule”: No legalese or technical jargonjargon

Timing of DisclosuresTiming of Disclosures

FDD must be given 14 calendar days before FDD must be given 14 calendar days before signing binding agreement or accepting signing binding agreement or accepting payment (certain states: first personal payment (certain states: first personal meeting or 10 business days)meeting or 10 business days) Critically, no money or signed agreements can Critically, no money or signed agreements can

be accepted before 14 day review period has be accepted before 14 day review period has passedpassed

Signed, dated receipt is critical Signed, dated receipt is critical Signatures can be handwritten or use security Signatures can be handwritten or use security

codes, passwords, electronic signatures, and codes, passwords, electronic signatures, and similar devices through which a person’s identity similar devices through which a person’s identity can be authenticated. can be authenticated.

Method of TransmissionMethod of Transmission

Electronic disclosure is encouraged (but Electronic disclosure is encouraged (but not required)not required) Before disclosure, Franchisor must Before disclosure, Franchisor must

advise franchisee of different formats in advise franchisee of different formats in which disclosure document is availablewhich disclosure document is available

Paper copies always okayPaper copies always okay

FDD Cover PageFDD Cover PageFDD Cover PageFDD Cover Page

Caution – Caution – investment and investment and initial fee initial fee amountsamounts

Contact person Contact person to discuss to discuss available e-available e-disclosure disclosure formatsformats

FTC contact infoFTC contact info

State Cover PageState Cover Page Risk Factors: including a warning Risk Factors: including a warning

regarding choice of law and choice of regarding choice of law and choice of forum clausesforum clauses

Warning about Franchise Broker Warning about Franchise Broker involvement:involvement: We use the services of one or more FRANCHISE We use the services of one or more FRANCHISE

BROKERS or referral sources to assist us in BROKERS or referral sources to assist us in selling our franchise. A franchise broker or selling our franchise. A franchise broker or referral source represents us, not you. We pay referral source represents us, not you. We pay this person a fee for selling our franchise or this person a fee for selling our franchise or referring you to us. You should be sure to do referring you to us. You should be sure to do your own investigation of the franchise. your own investigation of the franchise.

Contents of FDD – In BriefContents of FDD – In Brief

Items 1, 2Items 1, 2 Franchisor’s parent, predecessor, affiliatesFranchisor’s parent, predecessor, affiliates History and background of franchisorHistory and background of franchisor 5 year employment history of key officers 5 year employment history of key officers

and employeesand employees

Items 3, 4Items 3, 4 Litigation history (system and officers)Litigation history (system and officers) Bankruptcy history (system and officers)Bankruptcy history (system and officers)

Contents of FDD – In BriefContents of FDD – In Brief Items 5, 6Items 5, 6

Discloses costs – $$$ paid to franchisorDiscloses costs – $$$ paid to franchisor

Item 7Item 7 Discloses total estimated initial investment (range) Discloses total estimated initial investment (range)

including monies to be paid to third partiesincluding monies to be paid to third parties

Item 8Item 8 Sourcing restrictionsSourcing restrictions

Item 11Item 11 Franchisor’s assistance and training Franchisor’s assistance and training Franchisee must either have reasonable opportunity to Franchisee must either have reasonable opportunity to

review Operating Manual review Operating Manual oror the TOC must be an exhibit the TOC must be an exhibit

Contents of FDD – In BriefContents of FDD – In Brief Item 10Item 10

Whether or not the franchisor provides financing to Whether or not the franchisor provides financing to its franchisees, must be disclosed hereits franchisees, must be disclosed here

If yes, financing documents must be included as If yes, financing documents must be included as exhibits in the FDDexhibits in the FDD

Item 12Item 12

Must warn franchisee if no territorial exclusivity is Must warn franchisee if no territorial exclusivity is offeredoffered

Must disclose “alternate channels of distribution”Must disclose “alternate channels of distribution” Internet, catalog sales, telemarketing, or other Internet, catalog sales, telemarketing, or other

direct marketing salesdirect marketing sales

Contents of FDD – In Brief Contents of FDD – In Brief Items 13, 14Items 13, 14

Trademarks (registered vs. non-registered; Trademarks (registered vs. non-registered; indemnification obligations, use restrictions)indemnification obligations, use restrictions)

Patents and copyrights (same)Patents and copyrights (same)

Item 15Item 15 Discloses the requirement that the franchise owner Discloses the requirement that the franchise owner

MUST participate in the actual operation of the MUST participate in the actual operation of the franchised businessfranchised business

Item 17Item 17 Explains and discloses various provisions of Explains and discloses various provisions of

franchise agreement, including non-competes, franchise agreement, including non-competes, renewal, termination, transfer, and other key pointsrenewal, termination, transfer, and other key points

Contents of FDD – In BriefContents of FDD – In Brief Item 19Item 19

““Financial Performance Representations” (a/k/a Financial Performance Representations” (a/k/a “earnings claims”) “earnings claims”)

Many franchisors do not make claims (not Many franchisors do not make claims (not required to by law)required to by law)

Franchisors must state that they are Franchisors must state that they are permittedpermitted to disclose financial performance information, to disclose financial performance information, but choose not tobut choose not to

Addresses common complaint under prior Addresses common complaint under prior rule: sales people claiming “not allowed” to rule: sales people claiming “not allowed” to disclose earningsdisclose earnings

Financial Performance Financial Performance Representations Representations

Defined:Defined:

““Any oral, written, or visual Any oral, written, or visual representation for general dissemination. representation for general dissemination. . . which states a specific level of sales, . . which states a specific level of sales, income, gross or net profits, either actual income, gross or net profits, either actual or potential, of existing or prospective or potential, of existing or prospective outlets of the named franchise business outlets of the named franchise business or which states other facts which or which states other facts which suggests a specific level.”suggests a specific level.”

As you can see, an FPR can take many, many As you can see, an FPR can take many, many different forms.different forms.

Financial Performance Financial Performance RepresentationsRepresentations

RULE OF THUMB:RULE OF THUMB:

To avoid liability as the franchisor’s agent, To avoid liability as the franchisor’s agent, do NOT make do NOT make anyany statements about a statements about a prospect’s earnings potential. Refer prospect’s earnings potential. Refer prospect to Item 19 of the FDD.prospect to Item 19 of the FDD.

If the Franchisor does not make an Item 19 If the Franchisor does not make an Item 19 disclosure, then refer prospect to Item 20 disclosure, then refer prospect to Item 20 – list of existing and former franchises.– list of existing and former franchises.

Contents of FDD – In BriefContents of FDD – In Brief Item 20 – Outlet InformationItem 20 – Outlet Information

Number of outlets per stateNumber of outlets per state Information regarding system change (terminations, Information regarding system change (terminations,

transfers, new outlets)transfers, new outlets) Includes information regarding corporate-owned and Includes information regarding corporate-owned and

franchised outletsfranchised outlets Also, franchisor’s projections for new outlets in coming Also, franchisor’s projections for new outlets in coming

yearyear

List of existing and former franchiseesList of existing and former franchisees

Confidentiality clauses disclosedConfidentiality clauses disclosed Prohibit or restrict existing or former franchisees from Prohibit or restrict existing or former franchisees from

discussing their experience with prospective franchiseesdiscussing their experience with prospective franchisees

Contents of FDD – In BriefContents of FDD – In Brief

Item 21 - Audited Financial Item 21 - Audited Financial StatementsStatements Phase-in of audits permitted but not Phase-in of audits permitted but not

if prior audits were conducted or the if prior audits were conducted or the entity was previously involved in entity was previously involved in franchisingfranchising

Parent statement must be included if Parent statement must be included if it guarantees franchisor’s obligationsit guarantees franchisor’s obligations

Contents of FDD – In BriefContents of FDD – In Brief

Item 22 – A Description of Exhibits Item 22 – A Description of Exhibits to Items 1 through 23 of the FDD to Items 1 through 23 of the FDD All contracts the franchisee will or All contracts the franchisee will or

may sign during the franchise may sign during the franchise relationship relationship

Item 23 – Receipt PageItem 23 – Receipt Page

Resource LinksResource Links

FTC’s Franchise Rule:FTC’s Franchise Rule: www.ftc.gov/bcp/franchise/netfran.shtm

International Franchise Association:International Franchise Association: www.franchise.org

Matt’s Franchising Blog – “Forward Matt’s Franchising Blog – “Forward Franchising”Franchising” www.forwardfranchising.com

The EndThe End

Thank you!Matt Kreutzer

Howard & Howard PLLCEmail: mkreutzer@howardandhoward.com

Telephone: (702) 667-4827Websites: www.forwardfranchising.com

www.howardandhoward.com