In a recent Insights installment, we addressed business opportunity laws against the backdrop of franchise sales and relationship rules. Lusthaus Law’s readers and clients asked to know more about the Federal Trade Commission’s (FTC) Business Opportunity Rule and how it differs from the Franchise Rule.
So let’s dive right in.
The Franchise Rule
The FTC’s Code of Federal Regulations contains the Franchise Rule (16 CFR Part 436), which obligates franchisors to provide to prospective buyers with a Franchise Disclosure Document (FDD). The FDD is intended to provide prospective purchasers of franchises material information to help them weigh the risks and benefits of such an investment.
A key detail of the FDD is Item 20, which requires franchisors to show the number of franchised units and company-owned units for the prior three years. Franchisors are also required to include contact information for current and former franchisees. As previously discussed, it is customary for prospective franchisees (buyers) to leverage the information in Item 20 to connect with others currently and previously in the franchise system. By speaking with these owners, franchisees will (ideally) receive pragmatic and honest information about the franchisor and its industry.
The concept of Item 20 is one of several that similarly appears in the Business Opportunity Rule.
The FTC Business Opportunity Rule
The federal Business Opportunity Rule (16 CFR Part 437) went into effect in 2012 and is intended to ease the process for prospective buyers to obtain information they may find useful when considering investing in a new business opportunity.
Many fraudulent business models have emerged through the years, the best examples being web-based companies and work-from-home concepts. The Business Opportunity Rule is calculated to help ensure that prospective purchasers have the information they need in order to assess the risks of investing in certain business endeavors.
The rule defines a “business opportunity” as a commercial arrangement in which:
(1) A seller solicits a prospective purchaser to enter into a new business; and
(2) The prospective purchaser makes a required payment; and
(3) The seller, expressly or by implication, orally or in writing, represents that the seller or one or more designated persons will:
(i) Provide locations for the use or operation of equipment, displays, vending machines, or similar devices, owned, leased, controlled, or paid for by the purchaser; or
(ii) Provide outlets, accounts, or customers, including, but not limited to, Internet outlets, accounts, or customers, for the purchaser’s goods or services; or
(iii) Buy back any or all of the goods or services that the purchaser makes, produces, fabricates, grows, breeds, modifies, or provides, including but not limited to providing payment for such services as, for example, stuffing envelopes from the purchaser’s home.
Like the FTC Rule, the Business Opportunity Rule prohibits sellers from making deceptive statements and requires them to make a number of key disclosures to potential buyers, including:
- Identifying information about the seller.
- Whether the seller is making claims about possible earnings or profits, and if so, information that supports those claims.
- Whether the seller, its affiliates, or key personnel have been involved in certain legal actions, and if so, information about those actions.
- Whether the seller has a cancellation or refund policy, and if so, the terms of that policy.
- A list of people who have purchased the business opportunity in the last three years.
Which Rule Applies To You?
A franchisor who complies with the FTC Franchise Rule and uses a federally registered trademark, is often exempt from the federal business opportunity rule and most state business opportunity laws, however some state laws require franchisors to file for the exemption. Franchisors operating without a federally registered trademark may be required to comply with various state business opportunity laws.
Franchisors and business opportunity sellers who fail to comply with FTC rules and regulations may find the agency taking action against them. Such action may include the imposition of penalties such as fines and other significant monetary damages.
Consult with your NY franchise lawyer to ensure you follow the correct rule and maintain a positive reputation.
Contact Lusthaus Law
Lusthaus Law has deep experience helping franchisors and franchisees navigate complex federal and state rules. Contact us for a consultation today.