New Franchise Regulations on the Horizon?
On September 16, 2020, Rohit Chopra, one of the five commissioners on the Federal Trade Commission (FTC), declared on Twitter that “[franchise] regulators must stop unfair, deceptive, and discriminatory practices that target franchisees and their employees.” Later in September, three House of Representative members wrote a letter to the Chairman of the FTC urging the agency to step up investigations of franchisor practices as a result of recent abuses by a relatively small number of franchisors in the sale of their franchises.
It appears that the tweet and the letter are both precursors for the FTC’s online public workshop on the review of its Franchise Rule (slated for November 10, 2020) which is designed to provide franchisee candidates with extensive information about their potential franchisor and the franchise opportunity being offered.
The FTC Franchise Rule was adopted in 1978 and revised in 2008 after a nine-year review process and requires the pre-sale delivery of a Franchise Disclosure Document (FDD) to franchise candidates at least 14 calendar days before the signing of a binding agreement or the payment of any money to the franchisor. The Rule does not require registration of an FDD with the FTC.
The current Rule requires franchisors to respond to 23 questions and dozens of sub-questions about the franchisor and the franchised business in a narrative “plain English” FDD. The purposes of the disclosure requirements are to provide each prospective franchisee with the information necessary to make an intelligent decision regarding the franchise being offered, document the franchisor’s promises and to prohibit the sale of franchises where the sale would lead to fraud.
All parties that sign a franchise agreement (and, under many interpretations, all of the franchisee’s investors and guarantors) must receive an FDD before purchasing a franchise. Required disclosures include:
- Background, business experience, litigation history and bankruptcy history of the franchisor and its executive personnel.
- Fees that will be payable to the franchisor and its affiliates.
- Costs involved in opening and operating the franchised business.
- Pre-opening and post-opening obligations of the franchisor and the franchisee.
- Criteria for the selection of the location of the franchised business, territorial exclusivity, sales quotas and additional development rights.
- Listing of all trademarks, patents and other intellectual property used in the operation of the franchised business.
- Disclosure and explanation of any financing assistance provided by the franchisor or its affiliates.
- Terms for renewal and termination of the agreement by the franchisor and the franchisee of the franchised business.
- Name, address and telephone number of each current franchisee and each franchisee whose Franchise Agreement was terminated or not renewed or who otherwise left the franchise system during the preceding year.
- Audited financial statements for the franchisor in a comparative format for the last three fiscal years.
- All documents that the franchisor anticipates entering into with a franchisee.
The November 10th workshop will be webcast live on the FTC’s website and will explore issues regarding the FTC Franchise Rule and responses to the FTC’s 2019 request for comments about the current Rule. This review and any subsequent changes to the FTC Rule will likely take a considerable amount of time and result in additional burdens and disclosure obligations for franchisors. In addition, it remains to be seen if any new or expanded regulations will deal with future pandemic-related issues that have surfaced since March 2020.
Barry Kurtz is a Certified Franchise & Distribution Law Specialist (State Bar of California Board of Legal Specializations) and Chair of our firm’s Franchise & Distribution Practice Group.