AN OVERVIEW OF FRANCHISE REGULATION IN THE UNITED STATES

Because of false starts in attempts to regulate franchising at the Federal level in the 1970's, California and a few other states jumped into the void and passed state statutes and regulations controlling the offering and sale of franchises and business opportunities within their boundaries. Eventually the plan for federal regulation gained momentum and the Federal Trade Commission Franchise rule (16 C.F.R. Part 436) was adopted as an overlay to the numerous state regulatory schemes that had been adopted in the interim. As a result, today the franchise industry is subject to a complex web of regulations that differ from the Federal level to the state level and differ widely from state to state.

The basic elements of this confusing regulatory scheme include:

1. The FTC rule;
2. A variety of state statutes addressing the sale of franchises and business opportunities;
3. Statutes in several states that restrict or control the ability of a franchisor to terminate or refuse renewal of a franchise or regulate other aspects of the relationship between franchisee and franchisor (the so called "state franchise relationship laws"); and
4. Industry specific statutes and regulations maintained by both Federal and state governments in particular businesses such as gasoline dealerships.

Of course, many other laws impact franchisors and franchisees. In fact, "franchise law", is not a discrete body of substantive of law but is instead the discipline of working with many substantive rules of law as they apply to franchise businesses. Franchise lawyers do much more than advise clients on compliance with the FTC Franchise Rule and state franchise laws. Trade regulation matters, licensing of intellectual property, commercial leasing, employment matters and complex commercial litigation are all part of the day-to-day work of a franchise lawyer. Franchisors and franchisees alike need to recognize that many areas of substantive law affect their businesses in ways that are different from non-franchised businesses. An example is the legal relationship that a franchisee forms with his commercial landlord. Basic terms and conditions for leases for franchise locations are often quite different from other leases simply by virtue of the fact that a franchise is occupying the premises. Another example is the apparently anti-competitive restriction on prices franchisees must pay for and suppliers from whom they must buy certain goods and services called for by their franchise agreements.

A threshold analysis of any client's new distribution arrangement is whether or not the franchise and business opportunities statutes and regulations apply to the particular business deal. The answer usually depends on the technical definitions in those statutes and regulations and whether the proposed business relationship meets and contains all of the necessary elements of those definitions. It is important to recognize that the name given to the contract or relationship by the contracting parties is by no means controlling. Clients often propose to rename the relationship a "dealership" or a "license" or to deny territorial exclusivity as a means of supposedly avoiding being classified as a franchise. The lore about these arrangements can be and often is misleading. Competent counsel with experience in franchise and distribution matters is a must for determining whether, and by whom, a certain distribution arrangement is regulated. The laws of the states in which a client proposes to do business as well as Federal law must be considered.

The Federal Trade Commission Franchise Rule
After several states had already begun regulating franchises and business opportunities, the Federal Trade Commission promulgated its "Disclosure Requirements and Prohibitions Concerning Franchising," 16 C.F.R. Part 436, and this has become known as the FTC Franchise Rule.

The FTC Franchise Rule requires detailed disclosure of a wide variety of information as a condition to selling a franchise, but the rule does not regulate the franchise relationship or require any filing or registration on the part of a seller of franchises. Because the rule is narrow and because this federal regulation does not preempt state law, the stricter laws of several states must always be attended to by franchisors intending to operate in those states. For example, numerous states require franchise disclosure documents to be registered with state authorities, and numerous states regulate the franchise relationship itself.

Under the FTC Franchise Rule a "franchise" is any ongoing relationship where the franchisee offers, sells, or distributes goods or services to third parties if:

1. The goods or services are identified by the franchisor's trademark or other commercial symbol;
2. The franchisor directly or indirectly exercises a significant amount of control over or provides significant assistance to the franchisee;
3. And, the franchise pays the franchior a fee of $500 or more during the first six months of operation.

This summary of the definition illustrates the complexity of determining whether a particular business deal is regulated by the rule.

The Disclosure Required by the FTC Franchise Rule
Once one determines that a particular business deal is regulated by the FTC Franchise Rule, detailed disclosures to prospective franchisees are required prior to selling a franchise. The rule requires that the franchisor provide a disclosure statement or prospectus to each prospective buyer at least fourteen calendar days prior to execution of a contract or payment of money relating to the franchise relationship.

The contents of the required disclosure are extremely detailed.

State Franchise Law and Regulation
The states of California, Florida, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Rhode Island, South Dakota, Texas, Utah, Virginia, Washington and Wisconsin all have franchise statutes and regulations which must be attended to by franchisors planning to do business in those states. Obviously the various business, commercial, trade regulation and other laws of all the states affect franchises doing business within their boundaries, but the states listed above have the most comprehensive regulation of franchises. These states typically require a franchisor to file or register its offering with the state government and to provide all prospective franchisees with the disclosure document.

Since the federal trade commission does not require disclosure statements to be filed or registered, it is only in these so called "registration states" that Franchise Disclosure Documents are reviewed under the critical eye of a regulatory authority. In these states the administrative agencies typically review the franchisor's registration application, its financial statements, the proposed franchise agreement and other agreements franchisees must sign. Of special interest to regulators are the financial condition of the franchisor, the background of the franchisor's executives and sales agents and provisions regarding the rights and remedies of the franchisor in the franchise agreement.

The state regulatory agencies can deny registration under circumstances where they believe that selling the franchise would be deceptive in some way. Because of this power to prevent a company from franchising in the state, these agencies wield considerable power over franchisors and their views are taken very seriously. Typically, a franchisor will receive at least one or two "comment letters" from the various registration states requesting changes in contract provisions or clarification or additional information on some of the topics covered in the disclosure and registration materials. Franchisors are well advised to respond to these letters promptly and thoroughly so that sales in the various registration states are not disrupted.

The states of Arkansas, California, Connecticut, Delaware, Hawaii, Illinois, Indiana, Iowa, Michigan, Minnesota, Mississippi, Missouri, Nebraska, New Jersey, North Dakota, South Dakota, Virginia, Washington and Wisconsin all have laws regulating various facets of the relationship between the franchisee and franchisor. These so called "relationship laws" typically regulate franchisors' ability to terminate or refuse renewal of a franchise. The relationship laws typically contain provisions requiring that a franchior have "good cause" before terminating or refusing to renew a franchise. They may address other issues such as the right of a deceased franchisee's next of kin to continue the franchise after the original investor's death. Some laws require a franchisor to buy back excess inventory from the franchisee in the event of termination. Other state laws may give franchisees a right to form an association with other franchisees of the same brand. Some laws make it illegal for a franchisor to demand a general release from a franchisee as a condition of renewing or entering into a new agreement. Sometimes these state laws protect broadly defined classes of dealerships as well as those who would qualify as "franchisees" under the FTC Franchise Rule. Counsel versed in franchise matters must check local law definitions to determine the applicability of the state provisions to a particular relationship.

Because of the wide variety of restrictions contained in these state statutes and regulations franchisors must have experienced counsel to offer advice at two stages. First, it is critical for a franchisor to have an accurate understanding of the requirements of state law when commencing to do business in a state. Second, before taking any action against an existing franchisee, such as terminating the franchise or exercising other rights and remedies, the franchisor must be fully aware of the restrictions on its rights created as a matter of law in the local jurisdiction.

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