ASK THE REGULATORS: CURRENT FRANCHISE DISCLOSURE AND REGISTRATION ISSUES. Moderator: Lacey Cordero Cheng Cohen LLC Chicago, Illinois.

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1 ASK THE REGULATORS: CURRENT FRANCHISE DISCLOSURE AND REGISTRATION ISSUES Moderator: Lacey Cordero Cheng Cohen LLC Chicago, Illinois Speakers: Dale Cantone Assistant Attorney General Maryland Attorney General s Office Baltimore, Maryland Cassandra Karimi Assistant Attorney General Office of the Illinois Attorney General Springfield, Illinois Theresa Leets Senior Corporations Counsel California Department of Corporations Los Angeles, California Craig Tregillus Franchise Rule Coordinator Federal Trade Commission Washington, DC

2 TABLE OF CONTENTS 1. Chart of State Filing Preferences and Requirements 2. Summary of State Laws and Regulations Addressing Franchise Advertising 3. FTC Amended Franchise Rule FAQs

3 STATE FILING PREFERENCES AND REQUIREMENTS 1, 2 STATE CA SUBMISSION OF HARD COPY OF FDD REQUIRED Yes Initial - 1 clean copy Renewal/Amendment - 1 redlined copy DOUBLE- SIDED Single- Sided Preferred CD-ROM REQUIRED 3 CONTENTS OF CD-ROM COMMENT LETTER RESPONSE VIA COMMENTS Yes FDD No Double-sided copy of FDD may be submitted but will significantly delay scanning into Cal-Easi and thus, review by counsel. CA not allowed to use CD-ROM to upload on to Cal-Easi website. Comment letter responses generally should be mailed, but minor comments may be ed at examiner s discretion. 1 The information contained herein and the opinions and observations expressed by Mses. Karimi and Leets and Messrs. Cantone and Tregillus during the oral presentation are their own and do not necessarily represent the views of the Federal Trade Commission or any individual commissioner, the California Department of Corporations, the Attorneys General of Illinois or Maryland, or the North American Securities Administrators Association ( NASAA ). 2 The information contained herein is based on communications with state examiners and is not derived from state laws or regulations. 3 Sections II.B and II.C of the NASAA 2008 Franchise Registration and Disclosure Guidelines require inclusion of a CD-ROM with an initial, renewal or amendment application. FDD State Filing Preferences and Requirements

4 STATE HI SUBMISSION OF HARD COPY OF FDD REQUIRED Yes Initial - 2 clean copies DOUBLE- SIDED No Preference CD-ROM REQUIRED 3 CONTENTS OF CD-ROM COMMENT LETTER RESPONSE VIA No N/A No COMMENTS IL Renewal/Amendment 1 clean/1 redlined copy Yes Initial 1 clean copy Renewal/Amendment 1 clean/1 redlined Single- Sided Preferred IN No Initial 1 clean copy (on CD-ROM) N/A Yes FDD Franchise Seller Forms (if > 2 sellers) Renewal 1 clean copy (on CD- ROM) KY No No Preference Yes FDD No Comment letter responses generally should be mailed, but minor comments may be ed at examiner s discretion. Make sure examiner receives clean FDD that has been registered on CD-ROM Yes Amendment filings are optional. CD-ROM may also include copy of application, but not required. Optional FDD N/A One-time filing FDD State Filing Preferences and Requirements 2

5 STATE MD MN SUBMISSION OF HARD COPY OF FDD REQUIRED Yes Initial 2 clean copies Renewal/Amendment 1 clean/1 redlined copy Yes Initial 1 clean copy DOUBLE- SIDED No Preference No Preference Renewal/Amendment 1 redlined copy NE No No Preference NY Yes No Preference Initial 2 clean copies (or 1 clean & 1 on CD) ND Renewal/Amendment 1 clean/1 redlined copy Either CD-ROM or Hard Copy Initial 1 clean copy (or CD) Renewal/Amendment 1 clean/1 redlined (or CD) Single- Sided Preferred CD-ROM REQUIRED 3 Yes Yes CONTENTS OF CD-ROM FDD Application Franchise Seller Forms Auditor s Consent FDD Application Franchise Seller Forms Auditor s Consent COMMENT LETTER RESPONSE VIA No Yes Optional FDD N/A COMMENTS Preferred FDD No FDD must be bound in some manner. Comment letter responses generally should be mailed, but minor comments may be ed at examiner s discretion. Preferred FDD Yes, if less than 10 changed pages in the FDD FDD State Filing Preferences and Requirements 3

6 STATE RI SD VA SUBMISSION OF HARD COPY OF FDD REQUIRED No Initial 1 clean copy (on CD-ROM) Renewal/Amendment 1 clean/1 redlined copy (on CD-ROM) No Initial 1 clean copy (on CD-ROM) Renewal 1 clean copy (on CD- ROM) Yes Initial 2 clean copies Renewal/Amendment 1 clean/1 redlined copy DOUBLE- SIDED CD-ROM REQUIRED 3 CONTENTS OF CD-ROM N/A Yes FDD Cover Ltr. Application Form Franchise Seller Forms Franchisor s Costs Form Auditor s Consent Form COMMENT COMMENTS LETTER RESPONSE VIA No All documents must be submitted via CD- ROM. Comment letter responses generally should be mailed, but minor comments may be ed at examiner s discretion. N/A Yes FDD No Amendments are not required to be filed. Comment letter responses generally should be mailed, but minor comments may be ed at examiner s discretion. No Preference CD-ROM may include copies of application materials. However, hard copies are preferred. Optional FDD No Comment letter responses generally should be mailed, but minor comments may be ed at examiner s discretion. FDD State Filing Preferences and Requirements 4

7 STATE WA SUBMISSION OF HARD COPY OF FDD REQUIRED Yes Initial 2 clean copies DOUBLE- SIDED No Preference CD-ROM REQUIRED 3 CONTENTS OF CD-ROM COMMENT LETTER RESPONSE VIA Optional FDD Yes COMMENTS WI Renewal/Amendment 1 clean/1 redlined copy No Initial 1 clean copy (on CD-ROM) Renewal/Amendment 1 clean copy (on CD-ROM) N/A Yes FDD Cover Ltr. Application Form N/A Hard copy of cover letter preferred. Franchise e-filing application preferred (all e-filed FDDs are made publicly available online); currently, 16.5% of applications are e-filed. FDD State Filing Preferences and Requirements 5

8 Definition of Advertising SUMMARY OF STATE LAWS AND REGULATIONS ADDRESSING FRANCHISE ADVERTISING 1 The term advertisement is broadly defined under most state franchise laws to include any prospectus, circular, notice, advertisement or letter of communication, in writing, audio or video, that offers a franchise for sale or confirms the sale of a franchise. Advertising includes newspaper, television, or radio advertisements, as well as brochures, form letters, recorded telephone messages and other similar means of communication that might be used to solicit prospective franchisees. 2 Exceptions National Advertisements: A published advertisement shall not be treated as an offer made in a state (and is therefore exempt from any filing requirement described below) if it has more than 2 / 3 of its circulation outside the state during the past 12 months. 3 A few states have specified that with respect to publications having separate editions containing advertisements that don t appear in all editions, each edition is considered a separate publication for purposes of meeting this exemption. 4 Some states also exclude from the definition of advertisement any radio or television advertisement contained in programming originating outside the state. 5 California Post-Registration Notice: In California, any notice, circular or other communication which is published or transmitted after a registration of the franchise is not considered advertising if it includes only the specific information permitted under the California rules. 6 Approval Requirements Depending on the state and the type of advertising conducted, franchise advertisements may be subject to state administrator review and approval. Seven states require review and approval of franchise advertising materials before they are published, circulated or disseminated to prospective franchisees within the state. Unless exempted, all advertising within a state must meet the following review requirements: State California Maryland Review Requirement A true copy of the advertisement must be filed in the office of the commissioner at least three business days prior to the first publication, 7 but the review period may be shortened if the filer shows a need 8 The franchisor must submit two copies of the advertisement to the Division of Securities for review at least five days before the date of its anticipated initial use; 9 any advertising submitted in the form of videotapes or audiotapes must be accompanied by a written transcript 1

9 Minnesota New York North Dakota Rhode Island Washington and description of the contents 10 A true copy of the advertisement must be filed in the office of the commissioner at least five business days prior to the first publication; 11 if not disallowed in writing by the third business day after filing, the advertisement may be published 12 Two copies of the sales literature must be submitted to the New York State Department of Law not less than seven days prior to its intended use; 13 the franchisor must submit a signed statement that the sales literature is not inconsistent with the franchise disclosure document 14 A true copy of the advertisement must be filed with the office of the commissioner at least five business days prior to the first publication 15 The advertisement and a $10 filing fee must be filed with the director at least five business days prior to its first publication 16 A copy of the advertisement must be filed in the office of the director at least seven days prior to the publication. 17 The state administrators are not required to issue a formal approval, but will notify the franchisor in the event of a disapproval during the respective review period. In addition to these review requirements, a franchisor that uses advertising in a state with business opportunity laws may also be subject to advertising regulations under the business opportunity laws if the franchisor has not obtained an exemption. Required Disclosures in the Advertising Materials Disclaimers: In New York, one of two legends must be included within the advertisement depending on the size: a. A classified advertisment not more than 5 inches long and no more than one column (or less than 30 seconds long) must include the following legend: This offering is made by prospectus only. b. All other forms of advertisement must contain the following language: This advertisement is not an offering. An offering can only be made by a prospectus filed first with the Department of Law of the State of New York. Such filing does not constitute approval by the Department of Law. 18 In California, an advertisement that specifically refers to the registration of the franchise offering under the California Franchise Investment Law must contain the following in at least 10-point font, all capital letters: THESE FRANCHISES HAVE BEEN REGISTERED UNDER THE FRANCHISE INVESTMENT LAW OF THE STATE OF CALIFORNIA. SUCH REGISTRATION DOES NOT CONSTITUTE APPROVAL, RECOMMENDATION OR ENDORSEMENT BY THE COMMISSIONER OF CORPORATIONS NOR A FINDING BY THE COMMISSIONER THAT THE 2

10 INFORMATION PROVIDED HEREIN IS TRUE, COMPLETE AND NOT MISLEADING. 19 Franchisor Identity: Maryland and Minnesota require disclosure of the name and address of the party making the offer. 20 In California and Washington, advertisements should normally contain the franchisor s name and address. 21 In Minnesota, the franchisor s name or primary commercial symbol must be included. 22 File Number: The Minnesota regulations require disclosure of the registration number assigned to the franchise offering by the Minnesota commissioner on the advertisement. 23 Public Figure Endorsement: In California or Washington, if an advertisement contains any endorsement or recommendation of the franchise by any public figure, the franchisor must disclose the compensation or other benefit given or promised to the public figure. This disclosure must be provided within the advertisement, even if it is on radio or television. 24 Opinion of Counsel: In Illinois, Maryland and Minnesota, no advertisment shall contain or refer to the opinion of counsel unless the advertisement includes the name and address of such counsel in the advertisement. 25 If a California or Washington advertisement refers to an exemption from or reduction in taxation under any law, the assertion must be based on an opinion of counsel and the name of such counsel must be stated in the advertisement. 26 Restrictions On the Content of Advertisements In addition to the state statutes addressing fraud or deceptive trade practices that apply to advertising generally, state franchise laws may also regulate the content of franchise advertising. Misleading Statements: Several state laws specifically prohibit the inclusion of misleading information in the advertisement. 27 Financial Performance Representations: No franchise advertisement in Maryland and Minnesota may include financial performance representations. 28 In California and Illinois, any financial performance representation must conform with Item 19 of the franchise disclosure document and contain consistent information. 29 In Washington, an advertisement may not contain a projection of future franchisee earnings unless it is based on historic information over a reasonable period and is substantiated by supporting data. 30 Assurance of Investment: A number of state regulations provide that an advertisement must not contain any statement that (i) a purchase of a franchise is a safe investment, 3

11 (ii) failure, loss or default is impossible or unlikely, or (iii) assures of earnings or profits. 31 In Illinois, the advertisement may include words such as success, profits, or profit potential so long as these terms are reasonably qualified. 32 Inconsistencies with Disclosure Document: In Illinois, Minnesota and New York, the franchisor is prohibited from making any statement in an advertisement that is inconsistent with any disclosure made in the franchise disclosure document registered in that state. 33 Representations Regarding the Franchise: Maryland and Minnesota regulations also place restrictions on certain oral or written representations in relation to a number of specific subjects, such as under what timeframe the prospective franchisee s business will be operational, the experience required for a prospective franchisee, and the support provided by the franchisor. 34 These restrictions would also apply to statements made in advertising materials. Internet Advertising On May 3, 1998, the North American Securities Administrators Association ( NASAA ), which promulgates the rules for preparing franchise disclosure documents, issued the Statement of Policy Regarding Offers of Franchises on the Internet. The statement makes it clear that communicating the availability of franchises on the Internet may be deemed to constitute an offer of a franchise that triggers state registration and disclosure requirements. Nonetheless, NASAA proposes a form of exemption for unregistered Internet offers. To be exempt: (1) The website must indicate that the franchise is not being offered to residents of the state; (2) The offer must not otherwise be directed into the state by or on behalf of the franchisor; and (3) No franchise sales may take place until the franchisor has complied with the state s registration and disclosure requirements. 35 The NASAA policy does not have the force of law, but California, Illinois, Indiana, Maryland, Minnesota, New York, North Dakota, Rhode Island, South Dakota and Washington have adopted laws or administrative orders which exempt offers on the Internet that comply with these elements. 36 In general, states have interpreted this exemption to also exempt Internet advertising meeting the criteria from the state filing and approval requirements described above. However, California, Minnesota and New York have established additional criteria to meet the filing exemption. Under California regulations, (1) franchisors must complete and sign an annual notice concerning franchise solicitation information on their 4

12 websites 37 and (2) a preface, exhibit or appendix of the franchisor s franchise disclosure document must include the URL address of the franchisor s website and the following statement, in at least 12-point font: OUR WEBSITE HAS NOT BEEN REVIEWED OR APPROVED BY THE CALIFORNIA DEPARTMENT OF CORPORATIONS, ANY COMPLAINTS CONCERNING THE CONTENT OF THIS WEBSITE MAY BE DIRECTED TO THE CALIFORNIA DEPARTMENT OF CORPORATIONS AT 38 Minnesota requires that the URL address identifying the location of the advertisement be included on the cover page of the franchise disclosure document. 39 Similarly, in New York and Washington, the franchisor must provide the URL address identifying the location of the advertisement on the cover page of the franchise disclosure document or in a written notice to the administrator. 40 Although franchisors are already required to include a primary Internet home page address on the cover page of the franchise disclosure document under federal law, 41 disclosure of additional URL addresses may be necessary to reveal franchise-specific advertising. Maintaining Records of Advertisements In Maryland, Rhode Island and South Dakota, a franchisor is required by law to maintain complete and accurate records of all advertising materials The information contained herein and the opinions and observations expressed by Mses. Karimi and Leets and Messrs. Cantone and Tregillus in this document and during the oral presentation are their own and do not necessarily represent the views of the Federal Trade Commission or any individual commissioner, the California Department of Corporations, the Attorneys General of Illinois or Maryland, or the North American Securities Administrators Association (NASAA). Franchise Investment Law, Cal. Corp. Code 31003; Indiana Franchise Act, Ind. Code ; Maryland Franchise Registration and Disclosure Law, Md. Code Ann., Bus. Reg ; Minnesota Franchise Act, Minn. Stat. 80C.01; New York Franchise Sales Act, N.Y. Gen. Bus. Law 681; North Dakota Franchise Investment Law, N.D. Cent. Code ; Rhode Island Franchise Investment Act, R.I. Gen. Laws ; South Dakota Franchise Investment Act, S.D. Codified Laws 37-5A- 5; and Washington Franchise Investment Protection Act, Wash. Rev. Code ; Wash. Admin. Code (including communications on the Internet and at trade shows). California Franchise Investment Law, Cal. Corp. Code 31013; Cal. Code Regs. tit. 10, ; Illinois Franchise Disclosure Act of 1987, 815 Ill. Comp. Stat. 705/3; Indiana Franchise Act, Ind. Code ; Maryland Franchise Registration and Disclosure Law, Md. Code Ann., Bus. Reg ; Michigan Franchise Investment Law, Mich. Comp. Laws ; New York Franchise Sales Act, N.Y. Gen. Bus. Law 681; Rhode Island Franchise Investment Act, R.I. Gen. Laws ; Washington Franchise Investment Protection Act, Wash. Rev. Code ; and Wisconsin Franchise Investment Law, Wis. Stat Cal. Code Regs. tit. 10, and Md. Code Regs California Franchise Investment Law, Cal. Corp. Code 31013; Illinois Franchise Disclosure Act of 1987, 815 Ill. Comp. Stat. 705/3; Indiana Franchise Act, Ind. Code ; Maryland Franchise Registration and Disclosure Law, Md. Code Ann., Bus. Reg ; Michigan Franchise Investment Law, Mich. Comp. Laws ; New York Franchise Sales Act, N.Y. Gen. Bus. Law 681; Rhode Island Franchise Investment Act, R.I. Gen. Laws ; Washington Franchise 5

13 Investment Protection Act, Wash. Rev. Code ; and Wisconsin Franchise Investment Law, Wis. Stat Cal. Code Regs. tit. 10, California Franchise Investment Law, Cal. Corp. Code Cal. Code Regs. tit. 10, Maryland Franchise Registration and Disclosure Law, Md. Code Ann., Bus. Reg ; Md. Code Regs Md. Code Regs Minnesota Franchise Act, Minn. Stat. 80C.09. Minn. R N.Y. Comp. Codes R. & Regs. tit. 13, New York Franchise Sales Act, N.Y. Gen. Bus. Law 683; N.Y. Comp. Codes R. & Regs. tit North Dakota Franchise Investment Law, N.D. Cent. Code Rhode Island Franchise Investment Act, R.I. Gen. Laws , 29. Washington Franchise Investment Protection Act, Wash. Rev. Code N.Y. Comp. Codes R. & Regs. tit. 13, Cal. Code Regs. tit. 10, Md. Code Regs and Minn. R Cal. Code Regs. tit. 10, and Wash. Admin. Code Minn. R Id. Cal. Code Regs. tit. 10, and Wash. Admin. Code Ill. Admin. Code, tit. 14, ; Md. Code Regs ; and Minn. R Cal. Code Regs. tit. 10, and Wash. Admin. Code California Franchise Investment Law, Cal. Corp. Code 31157; Indiana Franchise Act, Ind. Code ; Md. Code Regs ; Michigan Franchise Investment Law, Mich. Comp. Laws ; Minnesota Franchise Act, Minn. Stat. 80C.09; North Dakota Franchise Investment Law, N.D. Cent. Code ; South Dakota Franchise Investment Act, S.D. Codified Laws 37-5B-23; Washington Franchise Investment Protection Act, Wash. Rev. Code ; and Wisconsin Franchise Investment Law, Wis. Stat Md. Code Regs ; Md. Code Regs ; Minn. R ; and Minn. R Cal. Code Regs. tit. 10, and Ill. Admin. Code, tit. 14, Wash. Admin. Code Cal. Code Regs. tit. 10, ; Ill. Admin. Code, tit. 14, ; Md. Code Regs ; Minn. R ; and Wash. Admin. Code Ill. Admin. Code, tit. 14, Ill. Admin. Code, tit. 14, ; Minn. R ; and N.Y. Comp. Codes R. & Regs. tit. 13, Md. Code Regs and Minn. R North American Securities Administrators Association, Statement of Policy Regarding Offers of Franchises on the Internet, adopted May 3, Cal. Code Regs. tit. 10, ; Ill. Admin. Code, tit. 14, ; Order re Exemption for Internet Sales, Ind. Sec. Comm r, Admin. Order No , Dec. 24, 1997; Order re Offers of Franchises Made on the Internet, Minn. Dep t of Commerce, Dec. 4, 2002; Md. Code Regs ; N.Y. Comp. Codes R. & Regs. tit. 13, ; Order re Exemption of Certain Offers of Franchises Made on the Internet, N.D. Sec. Comm r, Nov. 29, 2000; R.I. Code R ; Order re Internet Offers and Sales, S.D. Div. of Sec., Oct. 16, 2000; and Wash. Admin. Code Cal. Code Regs. tit. 10, Id. Order re Franchise Advertising Made on the Internet, Minn. Dep t of Commerce, Dec. 4, N.Y. Comp. Codes R. & Regs. tit. 13, and Wash. Admin. Code

14 41 42 Disclosure Requirements and Prohibitions Concerning Franchising, 16 C.F.R (b) (2007). Md. Code Regs ; Rhode Island Franchise Investment Act, R.I. Gen. Laws ; and South Dakota Franchise Investment Act, S.D. Codified Laws 37-5B-19. 7

15 Amended Franchise Rule FAQs With Prefatory Index by Disclosure Item and Subject 1 Item 1: The Franchisor, and any Parents, Predecessors and Affiliates FAQ 16 - What is the scope of the parent disclosures, as set forth in Items 1, 3, 4, and 21 of the amended Rule? Item 3: Litigation FAQ 5 -Is the disclosure of whether the franchisor was a party to any material civil action involving the franchise relationship in the last fiscal year. cumulative that is, does the franchisor have to disclose any suit to which it is a party that was ongoing in the last fiscal year? FAQ 16 -What is the scope of the parent disclosures, as set forth in Items 1, 3, 4, and 21 of the amended Rule? Item 4: Bankruptcy FAQ 16 -What is the scope of the parent disclosures, as set forth in Items 1, 3, 4, and 21 of the amended Rule? Item 5: Initial Fees FAQ 10 - Can a franchisor avoid the seven-day waiting period by disclosing a range of initial fees, with a blank in the agreement that the parties will sign to be filled in later for the exact fee? Item 6: Other Fees FAQ 13 - May a franchisor use separate charts for different types of franchise agreements? Item 7: Estimated Initial Investment FAQ 13 - May a franchisor use separate charts for different types of franchise agreements? 1 Prepared by the Division of Marketing Practices in the Bureau of Consumer Protection of the Federal Trade Commission. The views expressed in the FAQs are those of Commission staff responsible for enforcing the Franchise Rule, and do not necessarily reflect the views of the Commission or of any individual Commissioner.

16 Item 8: Restrictions on Sources of Products and Services FAQ 18 - Does Item 8 of the amended Rule require the disclosure of a de minimis ownership interest in a supplier by an officer of the franchisor, and is there a threshold level of ownership that triggers disclosure? Item 9: Franchisee s Obligations FAQ 13 - May a franchisor use separate charts for different types of franchise agreements? Item 10: Financing FAQ 35 - Is a franchisor required to include in its Franchise Disclosure Document ( FDD ) a statement that the financing it offers includes a waiver of a jury trial that will also constitute a waiver of that right in litigation concerning its franchise agreement or other related agreements, if that is the case? Item 11: Franchisor s Assistance, Advertising, Computer Systems, and Training FAQ 13 - May a franchisor use separate charts for different types of franchise agreements? Item 12: Territory FAQ 10 - With respect to a protected territory can a franchisor avoid the sevenday waiting period by disclosing a general formula for determining a protected territory in the copy of the standard agreement attached to the disclosure document with a blank to be filled in later for the specific term in the actual franchise agreement that the parties will sign? FAQ 25 - Item 12 requires that a franchisor that does not provide an exclusive territory include a disclaimer underscoring that fact. What constitutes an exclusive territory that would permit a franchisor to omit this disclaimer? Item 17: Renewal, Termination, Transfer and Dispute Resolution FAQ 13 - May a franchisor use separate charts for different types of franchise agreements? 2

17 Item 19: Financial Performance Representations FAQ 8 - Does the amended Rule now prohibit the use of performance claims based upon affiliates? FAQ 27 - May a franchisor that makes a financial performance representation in Item 19 include a statement that the franchisor does not make any other financial performance representation and has not authorized its employees or representatives to do so? FAQ 33 - May a franchisor comply with Section 436.5(s) of the Rule by placing a financial performance representation ( FPR ) in an attachment to its Franchise Disclosure Document ( FDD ), rather than in Item 19? Item 20: Outlets and Franchsiee Information FAQ 13 - May a franchisor use separate charts for different types of franchise agreements? FAQ 19 - Does Item 20 of the amended Rule require franchisors to disclose the names of franchisees that have binding franchise agreements, but have not opened an outlet, and of former franchisees who never opened an outlet? FAQ 28 - Section 436.5(t)(5) of the Rule requires disclosure in Item 20 of contact information for former franchisees. It also requires, in immediate conjunction with that information, a cautionary notice advising potential purchasers that their contact information may be disclosed if they buy a franchise and later leave the franchise system. May a franchisor disclose this information, including the required notice, in an exhibit or an attachment to its Franchise Disclosure Document? FAQ 36 - Where Item 20 requires disclosures about company-owned outlets, is that term intended to include not only outlets owned by the franchisor, but also affiliate-owned outlets that are substantially similar to the outlets offered by the Franchise Disclosure Document ( FDD )? Item 21: Financial Statements FAQ 4 - Must a franchisor include in its disclosure document the financials of its parent when the parent only sells goods or services to franchisees? FAQ 9 - Should development agents be treated as subfranchisors because they provide post-sale services to franchisees and, thus, must include financial statements and other information in the disclosure document? 3

18 FAQ 11 - Item 21 of the amended Rule permits a new franchisor to issue an unaudited initial balance sheet, so long as that balance sheet is prepared in accordance with generally accepted accounting principles. What is the CPA s responsibility to verify the data, and what is the franchisor s responsibility in terms of the data used to prepare the statement? FAQ 16 - What is the scope of the parent disclosures, as set forth in Items 1, 3, 4, and 21 of the amended Rule? FAQ 17 - Can financial statements be audited by a Canadian chartered accountant who is unable to state that he or she is an independent certified public accountant? What about other foreign accountants? FAQ 30 - Notwithstanding FAQ 4, if a franchisor s parent is the sole supplier of a good or service without which a franchise cannot be operated, must the financials of the parent be disclosed in Item 21? FAQ 32 - Section 436.5(u) of the Rule mandates that the financial statements required in Item 21 be prepared according to United States generally accepted accounting principles ( GAAP ). May franchisors use financial statements to comply with Item 21 if an auditor issues a qualified opinion because the statements do not comply with FIN 46R issued by the Financial Accounting Standards Board ( FASB )? Item 23: Receipts FAQ 12 - The amended Rule requires franchisors to disclose on the Item 23 receipt page the name, principal business address, and telephone number of each franchise seller offering the franchise. Who is a franchise seller for purposes of this disclosure? If at the time of furnishing the disclosure document a franchisor does not know the particular seller, such as a broker, what should Item 23 of the disclosure document say? FAQ 15 - How may a franchisor taking advantage of the amended Rule s disclosure provisions effectively comply with the Item 23 receipt requirement? FAQ 23 - Must a franchisor identify more than a single individual as a franchise seller on its Item 23 receipt, or must a franchisor supplement the receipt page if that is necessary to list every individual with whom a prospective franchisee has significant contacts before the sale is concluded? If any supplementation is required, would it trigger a new 14 calendar day waiting period before a sale may be completed, or may the supplementation be accomplished at the closing of a sale by requiring a purchaser to list all the individual franchise sellers with whom she has had significant contacts? 4

19 Disclaimers and Waivers FAQ 21 - May a franchisor require a prospective franchisee to list the statements in the franchisor s disclosure document that he or she regards as material to his or her decision to sign the franchise agreement? FAQ 23 - May a franchisor require a purchaser to supplement an Item 23 receipt at the closing of a sale with a list of all the individual franchise sellers with whom she has had significant contacts? FAQ 34 - Does a general release in a franchise agreement violate the prohibition in Section 436.9(h) of the Franchise Rule against requiring a prospective franchisee to disclaim or waive reliance on representations made in the Franchise Disclosure Document ( FDD )? Updating Disclosures FAQ 14 - The amended Rule prohibits a franchisor from failing, upon reasonable request, to furnish a copy of its disclosure document to a prospective franchisee early in the sales process. What happens if a prospective franchisee asks for a copy of the disclosure document at a time when the franchisor is in the process of preparing its annual update or is awaiting registration in one or more of the registration states? Should the franchisor furnish a document that it knows will soon be updated with more current information? FAQ 24 - Does a franchisor risk violating section 436.9(e) of the Rule if a prospective franchisee makes a reasonable request for the franchisor s Franchise Disclosure Document ( FDD ) earlier in the sales process than required by section 436.2, but at a time when an applicable state franchise investment law prohibits the franchisor from providing its FDD to that prospect until an amendment reflecting a material change has been filed with or made effective by the state? FAQ 29 - If a new FAQ is issued that would necessitate revision of a franchisor s Franchise Disclosure Document ( FDD ), when must the franchisor revise its FDD? FAQ 31 - Section 436.7(a) of the Franchise Rule requires a franchisor to revise its Franchise Disclosure Document ( FDD ) within 120 days of the close of its fiscal year, after which [it] may distribute only the revised document and no other disclosure document. If a franchisor s registration does not expire until after this annual update deadline, may the franchisor continue to use a validly registered FDD in that state after the update deadline, until either: (a) the state completes registration of its updated FDD; or (b) the franchisor s prior registration expires? 5

20 If so, and if the franchisor uses the same FDD in non-registration states, may it continue to use the FDD in those states as well? Seven-Day Waiting Period FAQ 10 - With respect to a protected territory can a franchisor avoid the sevenday waiting period by disclosing a general formula for determining a protected territory in the copy of the standard agreement attached to the disclosure document with a blank to be filled in later for the specific term in the actual franchise agreement that the parties will sign? Franchise Sellers Exemptions FAQ 7 - At times, a franchisor may pay existing franchisees a fee for referring leads to the franchisor. In such circumstances, are the existing franchisees acting as franchise sellers under the amended Rule? If so, are such existing franchisees subject to the amended Rule s prohibitions section? FAQ 20 - When a franchise broker seeks to induce franchise purchases by independently offering a rebate or similar payment from its own funds, must a franchisor disclose that fact? May such a rebate offer be limited in its duration? FAQ 3 - Does the new large investment exemption apply to entities? FAQ 26 - Does the insiders exemption in Section 436.8(a)(6) allow a company that has not yet publicly offered or sold franchises to sell a franchise to a manager with two years of experience with the company without providing that manager with a Franchise Disclosure Document? Phase-In Issues FAQ 1 - On July 1, 2007, franchisors may start to use the amended Franchise Rule. Does this mean that franchisors can use the amended Rule disclosure format only as of July 1, 2007, or does it mean that franchisors may also apply the non-disclosure provisions (such as timing provisions and prohibitions) of the amended Rule as well? For example, may a franchisor ignore the first personal meeting requirement after July 1, 2007, if the franchisor continues to use the UFOC Guidelines format? FAQ 2 - On July 1, 2007, may franchisors furnish disclosures electronically even if they elect to use the original Rule or UFOC format? 6

21 FAQ 6 - If a franchisor wishes to use the amended Rule on or after July 1, 2007, must it first amend its current UFOC or FTC disclosure document? FAQ 22 - If a prospective franchisee has received a UFOC disclosure document prior to July 1, 2008, but has not purchased a franchise by that date, must the franchisor provide the prospective franchisee with its Franchise Disclosure Document ( FDD ) 14 calendar days before he or she pays any money or signs a binding agreement in connection with the proposed franchise sale? 7

22 Amended Franchise Rule FAQs 1. On July 1, 2007, franchisors may start to use the amended Franchise Rule. Does this mean that franchisors can use the amended Rule disclosure format only as of July 1, 2007, or does it mean that franchisors may also apply the non-disclosure provisions (such as timing provisions and prohibitions) of the amended Rule as well? For example, may a franchisor ignore the first personal meeting requirement after July 1, 2007, if the franchisor continues to use the UFOC Guidelines format? Answer: Since original promulgation of the Franchise Rule, the Commission has always permitted franchisors to comply either by following the provisions of the Franchise Rule itself, or by following the UFOC Guidelines. However, mix-andmatch disclosures are not permitted: franchisors must use all of one set of requirements or all of the other set. They may not combine elements of the two different formats in a single disclosure document. This same policy will continue in effect on and after July 1, Franchisors will still have to select one set of disclosure requirements to follow, but they will have three options instead of just two. They can choose to follow ether the original Rule, the UFOC Guidelines, or the amended Rule. Once they make a choice, they must be consistent, following the chosen set of requirements and none other until July 1, 2008, at which time the only format permitted will be the one prescribed in the amended Rule. This means that a franchisor that chooses to comply with the original Rule on July 1, 2007, must continue complying with the first personal meeting provision, as well as other provisions unique to the original Rule such as the five business-day contract review provision and separate earnings claims statement until July 1, Similarly, a franchisor that chooses to use the UFOC format on July 1, 2007, would not have to comply with any of the amended Rule s provisions for example, the amended Rule s integration clause prohibition until July 1, On July 1, 2007, may franchisors furnish disclosures electronically even if they elect to use the original Rule or UFOC format? Answer: From July 1, 2007, until June 30, 2008, franchisors must select one and only one set of disclosure requirements: original Franchise Rule, amended Franchise Rule, or UFOC Guidelines. Technically, that would preclude a franchisor from furnishing disclosures electronically unless the franchisor opted to use the amended Rule the only one of the three available sets of disclosure requirements that expressly permits electronic disclosure. Nevertheless, there are strong policy reasons for permitting franchisors to take advantage of technologies that offer the promise of reduced compliance costs, and the FTC 8

23 staff would not recommend enforcement action against a franchisor that disclosed electronically and was otherwise in total compliance with either the UFOC Guidelines or the original Franchise Rule. This approach ensures that franchise purchasers receive adequate protection and at the same time conforms to the spirit of the Electronic Signatures in Global and National Commerce Act ( E-SIGN ), 15 U.S.C Moreover, electronic disclosure is a method of delivery; it does not affect substantive disclosure requirements. Accordingly, for FTC purposes, all franchisors can begin using electronic disclosure on July 1, Of course, any franchisor electing to furnish disclosures electronically must follow the provisions for doing so set forth in the amended Rule. 3. Does the new large investment exemption apply to entities? Answer: The large investment exemption focuses on individuals and level of their investment, based on the rationale that a prospective investor able to invest at least $1 million (minus franchisor financing and the cost of unimproved land) is likely to be sophisticated and able to make an investment decision without federal government intervention. As noted in the Statement of Basis and Purpose, that rationale does not pertain when individuals, each investing only a small amount, combine in a group. Merely aggregating the small investments of a group of individuals does not transform the individuals into sophisticated investors. For that reason, the amended Rule requires that at least one individual in an investor group contribute at the $1 million threshold. The same analysis applies in the case of individual owners of an entity. In order to ensure that such owners are sophisticated, at least one individual owner must contribute at the $1 million threshold. The large investment exception, however, does not address how a qualifying individual may organize its business. Nothing in the amended Rule would preclude a qualifying individual contributing $1 million and thus exempt from the amended Rule from forming a partnership, corporation, or joining with a corporation or other entity, to operate the franchised outlet after signing the franchise agreement. 4. Must a franchisor include in its disclosure document the financials of its parent when the parent only sells goods or services to franchisees? Answer: The amended Rule requires separate financials for any parent that commits to perform post-sale obligations for the franchisor or guarantees the franchisor s obligations. Thus, this requirement would apply when the franchisor has an obligation to provide goods or services to franchisees, and that obligation is guaranteed or assumed by the franchisor s parent. If a parent happens to supply goods or services to franchisees where there is no underlying obligation 9

24 on the part of the franchisor to supply them, then the parent is no different from any other third-party supplier and its financials need not be disclosed. On the other hand, if a franchisor is obligated to provide goods and services and the parent assumes that responsibility, or the franchisor arranges for the parent to provide goods and services directly to franchisees on its behalf, then the parent s financials must be disclosed. 5. Item 3 of the amended Rule states that a franchisor must state whether it was a party to any material civil action involving the franchise relationship in the last fiscal year. At the same time, the Statement of Basis and Purpose for the amended Rule says that this disclosure of franchisorinitiated litigation covers only suits filed in the last fiscal year and needs to be updated only annually. Is the disclosure cumulative that is, does the franchisor have to disclose any suit to which it is a party that was ongoing in the last fiscal year? Answer: The franchisor-initiated litigation disclosure is intended to capture suits that were filed by the franchisor in the last fiscal year. In that regard, party to a material civil action in the last fiscal year means party to any new material civil action filed in the last fiscal year. This disclosure, therefore, is not cumulative: pending suits filed by the franchisor against a franchisee more than a fiscal year ago need not be included. Accordingly, when preparing an annual update, the franchisor must disclose the suits it has filed against franchisees in the last fiscal year only (e.g., 2006 suits). Those suits must remain in the disclosure document used for the new fiscal year (e.g disclosure document). No quarterly updating is required. Franchisors that initiate suits in the middle of a fiscal year or companies new to franchising can wait until their next annual update (e.g., 2008) to reference these new suits. At the beginning of each new fiscal year (e.g., 2008), the franchisor should delete the list of previously disclosed suits (e.g., 2006 suits) and substitute it with any new franchisor-initiated litigation filed in the most recently concluded fiscal year (e.g., 2007 suits). 6. If a franchisor wishes to use the amended Rule on or after July 1, 2007, must it first amend its current UFOC or FTC disclosure document? Answer: On or after July 1, 2007, franchisors may start using the amended Franchise Rule. By July 1, 2008, all franchisors must use the amended Rule format only. It is entirely at the discretion of each individual franchise system to decide when during the course of the phase-in period to make the conversion to the amended Rule format. 10

25 Most likely, many franchisors will start using the amended Rule when they prepare their annual update. For example, we expect that many franchisors with a calendar-year fiscal year will start using the amended Rule in March or April of 2008, when preparing their annual update for Under the amended Rule, a franchisor need not amend its disclosure document immediately in order to start using the amended Rule. For example, a franchisor with a calendar-year fiscal year may decide on July 1, 2007, that it will start using the amended Rule format on September 1, 2007, which falls within the third quarter of the franchisor s fiscal year. The amended Rule requires franchisors to revise their disclosure document only quarterly. Accordingly, the franchisor need not revise its current disclosure document until the time for preparing a quarterly update, which, in the example, would fall in October, Nonetheless, if the franchisor continues to sell franchises, it must furnish a quarterly update for the third quarter that contains all of the required disclosures set forth in the amended Rule. For example, the quarterly update must include the amended Rule s more detailed Item 20 information. For that reason, franchisors, as a practical matter, may wish to amend their disclosure documents when they start using the amended Rule even if they do so during a fiscal quarter rather than preparing detailed quarterly updates until their next annual update. Regardless of when it starts to update its disclosures, the franchisor in the example above must begin to comply with the amended Rule s timing provisions and prohibitions on September 1, For example, even if the franchisor decides to update its disclosures through a quarterly update, it must immediately start on September 1, 2007, complying with the amended Rule s non-disclosure provisions, such as timing provisions (e.g., disclosure earlier in the sales process upon reasonable request) and prohibitions (e.g., prohibition against inclusion of disclaimers or waivers). 7. At times, a franchisor may pay existing franchisees a fee for referring leads to the franchisor. In such circumstances, are the existing franchisees acting as franchise sellers under the amended Rule? If so, are such existing franchisees subject to the amended Rule s prohibitions section? Answer: Merely accepting compensation for referring leads to a franchisor, without more, is not enough to bring an existing franchisee within the amended Rule s definition of franchise seller and, therefore, does not subject the franchisee to the amended Rule s prohibitions. 11

26 This issue arises under the amended Rule s definition of franchise seller, which includes brokers. The Statement of Basis and Purpose to the amended Rule states that a broker is a person who: (1) is under contract with the franchisor relating to the sale of franchises; (2) receives compensation from the franchisor related to the sale of franchises; and (3) arranges franchise sales by assisting prospective franchisees in the sales process. At the same time, the Statement of Basis and Purpose states that the term broker is sufficiently narrow to exclude existing franchisees who may refer potential franchisees to the franchisor because such individuals are not under contract with the franchisor to sell franchises. 72 Fed. Reg. 15,462 n. 169 (Mar. 30, 2007). 8. Item 19 of the amended Rule deletes the UFOC s express permission to use performance results of substantially similar businesses of affiliates. Was this intentional? Does the amended Rule now prohibit the use of performance claims based upon affiliates? Answer: All financial performance representations must have a reasonable basis. When a franchisor has adequate performance data of its own upon which to base a performance representation, basing a financial performance representation on affiliate information likely would not be reasonable. Nevertheless, in limited circumstances, a franchisor may base a financial performance claim upon the results of operations of the substantially similar business of an affiliate. The question posed above refers to the following statement in the UFOC Guidelines instructions for Item 19: In the absence of an adequate operating experience of its own, a franchisor may base an earnings claim upon the results of operations of a substantially similar business of a person affiliated with the franchisor or franchisees of that person; provided that disclosure is made of any material differences in the economic or market conditions known to, or reasonably ascertainable by, the franchisor. The amended Rule does not incorporate this specific language; nevertheless, consistent with the UFOC Guidelines, the amended Rule does allow franchisors to use affiliate information as a basis for a performance claim in certain narrow circumstances specifically, when the franchisor lacks an adequate operating experience of its own. However, as in the case of using any financial performance representation based on a subset of outlets that share a particular set of characteristics, the franchisor must also disclose any characteristics of such outlets that may differ materially from the outlets being offered for sale. 12

27 9. Should development agents be treated as subfranchisors because they provide post-sale services to franchisees and, thus, must include financial statements and other information in the disclosure document? Answer: No. Even if a person performs post-sale on behalf of a franchisor, that person or entity is not a subfranchisor under the amended Rule unless that person is a party to the franchise agreement (or to another agreement involved in the franchise). This is true regardless of the name given to the person, be it development agent, area developer, or regional developer. Staff s determination as to whether a development agent should be considered a subfranchisor begins with consideration of how the amended Rule treats the term subfranchisor. The amended Rule delineates the term subfranchisor within the definition of the term franchisor, as follows: Franchisor means any person who grants a franchise and participates in the franchise relationship. Unless otherwise stated, it includes subfranchisors. For purposes of this definition, a subfranchisor means a person who functions as a franchisor by engaging in both pre-sale activities and post-sale performance. Thus, a subfranchisor is a person who functions as a franchisor; by use of the qualifying phrases grants a franchise and participates in the franchise relationship, the amended Rule clarifies that in order to be considered a subfranchisor, a party must have as a franchisor has (1) the authority to enter into a franchise agreement (or another agreement relating to the franchise), and (2) as a result of entering into such an agreement, that party is obligated to perform after the purchase of the franchise is consummated. The role of a subfranchisor is materially different from that of a broker, for example, because a broker typically is not a party to the franchise agreement and does not have post-sale contractual obligations to franchisees. In this regard, the amended Rule s Statement of Basis and Purpose, in the discussion of Item 21 regarding subfranchisor financial information, states that the term subfranchisor is limited in the Rule to circumstances where the subfranchisor steps into the shoes of the franchisor by selling [franchises] and performing post-sale obligations. It does not reach those individuals who may be called subfranchisors, but who act like brokers, having no post-sale commitments to franchisees. 72 Fed. Reg. 15,511 (Mar. 30, 2007). 13