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FRANCHISE SALES AND DISCLOSURE LAW COMPLIANCE ISSUES By: Delia Burke

1. The Federal Trade Commission Rule 2. State Franchise Registration Laws 3. The Franchise Registration Process 4. Relationship Laws 5. Earnings Claims

I. Disclosure Oriented Regulation-regulation of the offer and sale process 1. The FTC Rule 2. State Franchise Registration Laws 3. Business Opportunity Laws

II. Substantive Regulation Relationship Laws

Pre-Sale Disclosure Providing all material information necessary for the prospective purchaser to make an informed investment decision.

Substantive Regulation Regulating the conduct of the Franchisor, or the substance of the Franchisor s activities TERMINATION NONRENEWAL

DISCLOSURE REGULATION The Federal Trade Commission Rule 16 CFR 436 All States Requires use of a disclosure document Prohibits unfair and deceptive practices in violation of Section 5 of the Federal Trade Commission Act

Delivery of a Disclosure Document At the earlier of: First personal meeting, or Time for making disclosure

FIRST PERSONAL BUSINESS MEETING Face to face meeting with the prospective franchisee TIME FOR MAKING DISCLOSURES Ten business days prior to the earlier of: Execution of a binding agreement, or Payment of money

Acts or Practices That Violate the Rule Fail to furnish disclosure document Make representations on earnings claims not in accordance with the Rule Make representations that are inconsistent with information in disclosure document Fail to furnish agreements within time frames Fail to return funds to prospective franchisees that are identified as refundable

State Registration Laws 14 States Offer and Sale Requires Registration Registration-includes includes a disclosure document Anti-Fraud Provisions

14 Franchise Registration States California Hawaii Illinois Maryland Minnesota New York North Dakota Rhode Island South Dakota Virginia Washington Indiana Wisconsin Michigan

Offer of a Franchise Generally, an offer of a franchise includes Every attempt to offer or dispose of, or any solicitation of an offer to buy, a franchise or interest in a franchise for value

Sale of a Franchise Execution of an agreement Franchise License Or other binding agreement Payment of money or other consideration

State Franchise Registration Laws apply: Offer is made from regulating state Acceptance of offer is made from or in the regulating state Franchised business is or will be operated in regulating state Offeree or franchisee is a resident of regulating state

Acts or Practices that Violate State Registration Law Failure to register prior to offering and selling franchises Violations of the anti-fraud provisions Failure to provide disclosure document Earnings claims not in compliance with law Misrepresentations in disclosure document

Penalties for Failure to Comply with Federal and State Franchise laws Civil Penalties Private civil litigation Governmental actions Criminal penalties

Business Opportunity Laws Some states require the pre-sale registration and disclosure of business opportunities Generally, definition includes an arrangement in which- the seller, for a fee, provides products or services that enable the purchaser to start a business, and the seller provides a marketing plan

The Registration Process Uniform Franchise Registration Application Consent to Service Of Process UFOC Forms and Fees Auditors Consent Supplemental Information Page Certification Page Sales Agent Disclosure Form Sales Broker Registration (ILL and WA)

UFOC Uniform Franchise Offering Circular prepared in accordance with the Uniform Franchise Offering Guidelines which were prepared and adopted by the North American Securities Administration Association Items 1-231 Exhibits to Offering Circular

Application Filed Review period Effective unless deficiency notice Must receive effective notice

Renewal and Amendment Issues FTC- update UFOC for material changes State Registration Laws Amend-promptly for a material change Renew- Registration expires after 1 year Renewal required 90-120 after franchisor s s fiscal year end

II. Substantive Regulation State Relationship Laws- prohibit certain practices by the Franchisor

Relationship Laws-18 states Arkansas California Connecticut Delaware Florida Hawaii Illinois Indiana Iowa Michigan Minnesota Mississippi Missouri Nebraska New Jersey Virginia Washington Wisconsin

Relationship Laws- regulate the conditions under which the franchisor may terminate or refuse to renew the franchise relationship Regulate the transfer of a franchise

Good Cause Requirement Franchisor may terminate or refuse to renew only for: Good cause Reasonable cause Just cause

Generally What is good cause? Failure to comply with a lawful and material provision of the franchise agreement Failure to comply with an essential and reasonable requirement of the franchise agreement Legitimate business reason

Notice Requirement Minimum advance notice requirement to cure the default and avoid termination Cure period 10-90 days

No Cure Required Certain circumstances where no cure period is required: Franchisee is bankrupt Business is abandoned Franchisee is convicted of a crime Franchisee makes a material misrepresentation to the franchisor Franchisee loses the right to occupy the business premises

State Laws that Regulate Transfers Arkansas Nebraska New Jersey Iowa Hawaii Certain procedural steps must be taken for the transfer to be valid Transferee must meet current reasonable qualifications of franchisor Good cause standard for franchisor to disapprove transfer

Earnings Claims/Financial Performance Information General Rule- No Earnings Claims may be made to a prospective franchisee unless the earnings claim appears in Item 19 of the UFOC

Definition of an Earnings Claim FTC Rule definition- any oral, written or visual representation to a prospective franchisee or for general dissemination in the media which states or suggests a specific level or range of potential or actual sales, income, gross or net profits.

Definition of an Earnings Claim Includes-any presentation of facts which suggests or infers a specific level or range of income, sales or profits, including a presentation of data such as costs only- from which income or profits can be determined simply by arbitrarily selecting a sales figure.

Definition used by the States under Item 19 of the UFOC Definition of Earnings Claim- Information given to a prospective franchisee by a franchisor from which a specific level or range of actual or potential sales, cost, income or profit from franchised or non- franchised units may be easily ascertained.

Earnings Claims will include representations of a specific level or range of earnings: In your first year you will be able to buy a Jaguar Earn a $10,000 profit Sales volume of $250,000 100% Return on your investment

Earning claims will not include Sales Puffery Such as : Make Big Money The Opportunity of a Lifetime

Examples Of Earnings Claims Average Annual Breakeven Average Unit Revenues Average Cost of Sales/Cost of Goods, Labor or Occupancy Pro Forma franchisee financial statements

Two Prerequisites for an Earnings Claim: An Earnings Claim must be included in full in Item 19 of the UFOC The Earnings Claim must have a reasonable basis at the time it is made Law does not define reasonable basis Burden of proving reasonable basis lies with the Franchisor