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2012 Franchise Development Seminar Series
April 19, 2012Tampa, Florida
Legal Issues Facing Franchise Development
Professionals
David A. Beyer, AttorneyCheryl S. Lucente, AttorneyQuarles & Brady LLP101 E. Kennedy Blvd., Suite 3400Tampa, FL 33602-5195
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I. Disclosure Requirements: Federal and State
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Franchise Sales Compliance
Because It’s the Law Protect Company Assets Avoiding lawsuits, liability and
administrative costs Maintaining brand reputation Fewer distractions from core business Clean record to facilitate company
objectives (e.g., financing, IPO, or sale)
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Laws Governing Franchises
The FTC Rule– Disclosure only
– No Filings
– Applies in all 50 states and territories
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Laws Governing Franchises
State laws– Registration and disclosure laws
– Relationship laws
– Business opportunity laws
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The FTC Rule
The FTC Rule requires that a prospective franchisee receive a disclosure document within a prescribed time period.
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Prospective franchisee:– Any person (including agents, employees and
representatives) who approaches or is approached by a franchise seller to discuss the possible establishment of a franchise relationship
Applies only to prospective U.S. franchisees– FTC Rule does not apply to sales outside of the U.S.
www.quarles.comWho Must Make Disclosure?
Franchise Seller– Anyone that offers for sale, sells, or arranges for the
sale of a franchise
– This includes the franchisor, its employees, representatives, agents, sub-franchisors, and third party brokers who are involved in franchise sales activities
– This does not include existing franchisees selling their own units
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When to Provide a Disclosure Document
FTC Rule14 calendar days
before signing or $
Some StatesEarlier of first personal
meeting or 10 businessdays before signing or $
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When to Provide a Disclosure Document
State laws– Registration before offer– Same as New FTC:
California, Hawaii, Illinois, Indiana, Maryland, Minnesota, New York, North Dakota, South Dakota and Virginia
– 10 Business Days: Michigan and Washington
– First Personal Meeting / 10 Business Days New York and Rhode Island
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Delivery of Franchise Agreements
7-Calendar Day Waiting Period– If Franchisor makes unilateral and material changes to
the Franchise Agreement, it must furnish “execution copies” to the prospect at least 7 calendar days prior to execution. Fees, interest rates, protected territory
– Delivery requirement is not triggered by: Changes to the standard franchise agreement made at
the prospect’s request and for its benefit Completing “fill in the blank” provisions (e.g., name and
address of franchisee)
– 7-calendar day and 14-calendar day periods can run concurrent
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Disclosure Document Procedures
The day on which the FDD is delivered is not
included for purposes of calculating the
disclosure time period
Don’t count the date when the agreements
are signed
Don’t count holidays or weekends for
“business days”
Use a calendar
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FTC Considers Documents Furnished by the Required Date:
If it’s:
– Hand-delivered, faxed, e-mailed or otherwise delivered by the date;
– Directions for accessing the document on the Internet are provided by that date; or
– A paper or tangible electronic copy (CD Rom) was sent by first-class U.S. Mail at least 3 calendar days before the required date.
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Disclosure Compliance: Electronic Disclosure
FDD may be sent via e-mail or on CD-ROM
Internet access allowed as well Must be in a form that permits
prospect to store, download, print, or otherwise maintain the document for future reference
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Disclosure Compliance: Electronic Disclosure
Must advise prospect of– Formats in which FDD is available– Prerequisites for obtaining FDD in particular format– Conditions necessary for reviewing FDD in particular
format (Adobe Acrobat, browsers, etc.) Can communicate this form information
however you wish– In person or telephone– E-mail– Franchise applications– Marketing materials
Must be able to prove you made “format disclosure”
E-Receipts
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Disclosure Compliance:Electronic Disclosure
Sample Communication for E-Disclosure:We will be sending you the FDD as an attachment to a separate e-mail. Please note that your e-mail account must be able to accept attachments larger than __ MB. If you do not have a high-speed internet connection, it may take a while to download the FDD. You must have Adobe Reader to open the FDD. If you do not already have Adobe Reader installed on your computer, you can download it for free at www.adobe.com.
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Receipts
2 copies of the Receipt for each FDD Must identify franchise seller Must be signed and dated by prospective
franchisee May include instructions for returning Maintain for 3 years minimum (best practice is to
keep for duration of franchise relationship)
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E-Disclosure: Receipts
Must obtain “signed” Receipt after the FDD is e-mailed to prospect.
Franchisor can include a link from Item 23 to a receipt-only web page, which must be identical to the printed Receipt.
It should provide “fill-in boxes” for prospect to complete. No other links or materials can be accessible from the
web page. Alternatively, the prospect can open the electronic FDD,
print the last two pages, sign and date the Receipts, and return one copy to the Franchisor.
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Franchise Registration
In a registration state, a franchisor cannot offer or sell a franchise before it is registered with the state
Must amend if there is “material change”
Annual renewals and amendments
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Disclosure Compliance
Does Everyone Get the Same FDD?– Multi-State Disclosure Document
One main FDD used to comply with FTC Rule and state franchise laws
Exhibit of State-Specific Disclosures and Agreement Riders
State-Specific Effective Dates
– State law changes (State Addenda)– State-Specific FDDs
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Franchise Registration States
CaliforniaHawaiiIllinoisIndianaMarylandMichiganMinnesota
New York North DakotaRhode IslandSouth DakotaVirginiaWashingtonWisconsin
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Business Opportunity States
Alabama
Indiana Michigan S. Dakota
California Iowa Nebraska Texas
Conn. Kentucky New Hamp. Utah
Florida Louisiana N. Carolina Virginia
Georgia
Maine Ohio Washington
Illinois
Maryland S. Carolina
Alaska
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Jurisdictional Scope
What document(s) to provide to prospects?– Where does the prospect live?– What territory will be covered?– Where are discussions/
negotiations held?– Where will the franchisee’s
principal place of business be located?
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Jurisdictional Scope
Scenario:
Franchisor is approached by an Indiana corporation interested in operating a franchise in Virginia. The prospect’s representatives met with the franchise seller at a convention in Maryland. The closing will occur in New York.
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Jurisdictional Scope How to Avoid Problems
Register everywhere Closely track
– Domicile/residence
– Location/territory
– Mail and calls
Black-out map of the U.S. Check with counsel; review
monthly reports
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Annual Franchise Filings
Disclosure Document updates and revisions
Renewal requirements Amendments for Material
Changes
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• Annual updates within 120 days from FYE • States:
• 1 Year from Effective Date:
Indiana North Dakota Washington
Maryland South Dakota Wisconsin
Michigan Virginia
• 120 Days from FYE (110 in California and 90 in Hawaii)
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UFOC
Updating the Disclosure Document
Amendments as needed for any “material change” in the information
Substantial likelihood of influencing a reasonable franchisee or a reasonable prospective franchisee in the making of a significant decision
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• Quarterly updates for material changes – FTC
• Pre-sale “notices” of any material changes in financial performance information (but not an amended document)
• States VaryFDD
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Material Change - Samples
Change in the franchise fee or a significant increase in the initial investment
A significant adverse change in financial condition
The filing of any litigation required to be disclosed in item 3
Changes in Financial Performance Representations
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Classic Blunders: Franchise Registration
Offering without Registration Providing the Disclosure Document for the
wrong state Offer or sale in lapse period Failure to amend Failure to re-disclose prospects in “pipeline”
following an amendment or renewal
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II. Financial, Performance Representations
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Financial Performance Representations
What Can I Make?– Item 19 – Financial Performance
Representations
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Financial Performance Representations
Definition: written or verbal statements that state or suggest a specific level or range of past or projected sales, income or profit
In Disclosure Document － no verbal claims even if 100% true
Reasonable basis; substantiation Bases & assumptions
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Financial Performance Representations
Expense and Cost Information not restricted
Franchise sellers must notify prospective franchisees of any material changes in the Item 19 Financial Performance Representation at the time of furnishing a disclosure document
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Financial Performance Representations
Which if any of these statements are “FPR’s”?– Your franchise will do $2,000 per
week
– An average franchisee does $2,000 per week
– We have franchisees that do $2,000 per week
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Financial Performance Representations (cont.)
– Business Week did a profile on our industry and found that the average unit does $2,000 a week
– I was speaking with a franchisee in Omaha last week who told me that he does $2,000 a week
– Their franchisees do only $1,000 a week
– Buy a new Mercedes with your profits
– This business is a money machine
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Financial Performance Representations (cont.)
– You’ll be able to retire in five years
– Figure a 10% return on your investment
– Tell me what you think you can make and I’ll let you know if it’s realistic
– 1/3 of your sales will be gross profit
– The financial projections which you prepared and asked me to comment on look realistic
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Financial Performance Representation Claims
Oral FPR in absence of Item 19 disclosureRandall v. Lady of Am. Franchise Corp., 532 F. Supp. 2d (D. Minn. 2007)
Inaccurate Item 19 disclosure Rocky Mountain Chocolate Factory, Inc. v. SDMS, Inc., C.A. No. 06-cv-01212, 2007 U.S. Dist. LEXIS 88268 (D. Colo. Nov. 30, 2007)
Use of disclaimers to defeat FPR claimsWesterfield v. The Quizno’s Franchise Co., 527 F. Supp. 2d 840 (E.D. Wis. 2007), modified, 2008 U.S. Dist. LEXIS 74398 (Apr. 16, 2008)
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Financial Performance Representation Claims
What must be included in FPR?
7-Eleven, Inc. v. Spear, Case No. 10-cv-6697, 2011 WL 2516579 (N.D. Ill. June 23, 2011)
Colorado Coffee Bean, LLC v. Peaberry Coffee, Inc., 251 P. 3d 9 (Colo. App. 2010)
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Financial Information--Alternatives
Disclose in the FDD Refer to existing franchisees Sale of company-owned or
franchisee-owned territories Refer to industry statistics or
relevant articles; make suggestions on where to find information
Give info to the franchisee’s lenders Cost Info (Not % of Sales)
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III. Papering the Deal
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Meetings withProspective Franchisees
Sales pitch and presentation Deliver the FDD to the prospect
before signing agreement– Obtain the signed acknowledgment
of receipt
Maintain records of disclosure Follow-up correspondence
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Who Gets Disclosed?
Pre-formation – All individuals involved as principals
Corporation – Any officer Partnerships – All general partners LLC – Any member if member managed,
person designated as managing member, or officer if officer or director managed
FTC Rule allows representative (agent) to be recipient– Applies only in non-registration states
– Relationship should be confirmed in writing by principal before closing
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Franchise and Related Agreements
Who Can Sign All Blanks Completed Ancillary Agreements Franchise Compliance
Questionnaire
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Record Keeping
Goals: Practice compliance in ordinary
course of business Prove compliance to auditors,
litigators and regulators Avoid rescission claims
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Record Keeping
Key Dates and Actions: What was done and when? Who was involved? What was delivered/received? Were violations found and corrected
before the sale closed?
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IV. Questions?
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©2014 Quarles & Brady LLP. This document provides information of a general nature. None of the information contained herein is intended as legal advice or opinion relative to specific matters, facts, situations or issues. Additional facts and information or future developments may affect the subjects addressed in this document. You should consult with a lawyer about your particular circumstances before acting on any of this information because it may not be applicable to you or your situation.
