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
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.
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
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.
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.
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
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
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.
| Solutions for Existing
Franchisors| Solutions for
the New Franchisor | Contact
Solutions for the Prospective
Franchisee | About the Firm |
Resources | Attorney