Selling a franchise? Be prepared because when it comes to selling a franchise, there are many laws regulating every sale. First to consider are the disclosure laws.
What is full disclosure?
Before selling even a single franchise in the United States, every franchisor must provide prospective franchisees with a copy of their franchise disclosure document (FDD). These documents, which must be updated annually, are required under the Federal Trade Commission Rule on Franchising (FTC Rule) enacted in 1978.
To assist prospective franchisees in evaluating your franchise offering, you, as a franchise seller, will detail 23 items of information in your FDD. Included among these 23 items will be mandated information about you as the franchisor, the business to be operated, the franchisee’s initial investment costs as well as copies of all agreements that the franchisee may be required to sign.
As a seller, you also must include your financial statements which will allow franchisees to evaluate the franchisor’s financial condition before paying a franchise fee and investing in the offering.
Are there state specific franchise regulations?
Along with the FTC Rule, a number of states, including New York, require state FDD registration before franchisors can offer franchises for sale. California was the first state to regulate the offer and sale of franchises when in 1971, it enacted the California Franchise Investment Law, known as CFIL. The CFIL requires franchisors to register their FDD (or franchise offering) with the state before the franchisor can offer for sale or sell a franchise to, inter alia, a California resident.
Similar to California, New York’s Franchise Sales Act (“FSA”) requires franchisors to register their FDD with the New York Department of Law before selling franchises in New York. However, unlike California or the 13 other “registration” states, New York also requires New York-based franchisors to register their FDD with the New York Department of Law before selling franchises to be operated outside of New York. If you are a franchisor operating in New York state in any capacity, it is important to note that New York’s FSA has broader implications than many other state franchise laws.
In addition to California and New York, the 13 other states that have enacted pre-sale franchise registration and disclosure laws are: Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, North Dakota, Oregon, Rhode Island, South Dakota, Virginia, Washington and Wisconsin. If you are planning to sell a franchise in any of these states, you must first register your FDD with the applicable state regulators
Why all the legal franchise fuss?
Protection from fraud.
The FTC Rule and state disclosure laws were enacted to ensure prospective franchisees received what the regulators deemed important information to enable them to make an informed decision as to whether or not buy the franchise. For example, the New York legislators, when codifying the FSA, determined that the statute was necessary to prohibit the sale of franchises where such sale would lead to fraud or a likelihood that the franchisor’s promises would not be fulfilled.
By requiring that franchisors provide prospective investors with an FDD, the regulators intended to minimize an opportunity for fraud, help counterbalance franchisors’ greater bargaining power and allow franchisees to make a more informed decision about their investment
What does requiring registration of franchise disclosure documents mean for franchisors?
Before you sell a franchise or offer to sell a franchise to someone else, be sure that you check with counsel to determine whether your FDD must first be registered
What do the FTC Rule and state disclosure laws mean for franchisees?
As a prospective franchisee, you hopefully will have sufficient information to make that informed investment decision. Caveat emptor: Before you buy a franchise, make sure your franchisor is properly registered with the applicable state authorities and in compliance with all applicable franchise laws.
In addition to franchise disclosure laws, some states have enacted “relationship laws” which are intended to address abuses by franchisors relating to the improper termination of a franchise agreement, failure to renew a franchise agreement and failure to permit the assignment of franchises. (More on this issue in the next blog covering Franchise Relationship Laws.)
Bottom Line: Pay attention to details whether you are a franchisor or a franchisee. Confused about which laws and regulations apply to your franchise? Feel free to call or email me, Julie Lusthaus, at firstname.lastname@example.org or (914)265-4100 and let’s talk.