Closing the Sale of a Franchise

Once a franchisee is found and the sale of the franchise is ready to close, there are additional compliance requirements. Preparation and execution of the documents is a complicated process and it is easy to make mistakes resulting in liability for the franchisor.

As part of the Franchise Disclosure Document (FDD), the franchisor also must prepare and provide to the franchisee various other contracts prior to selling the franchise. In addition to the Franchise Agreement, these often include a Territory Attachment, Non-Disclosure and Non-Competition Agreement, Lease Rider, Release, state-required Addenda, and an individual guaranty to be signed by all owners of a corporate franchisee. Other agreements may be required as well, such as Electronic Funds Authorization, Assignment of Telephone and Internet Listings, Franchise Compliance Certification and where applicable a Development Agreement and associated attachments.

Franchisors should gather in advance of closing, certain information and documents from the franchisee. These often include the franchisee’s articles of incorporation/organization, by-laws or operating agreement, certificate of insurance, certificate of authority to do business in the state, list of owners/members and their interests, and other pertinent material in order to complete the various contracts for the closing.

Notably, within each of the documents needed for closing, there are numerous places where information must be entered by the franchisor, and one or both parties must sign. This includes names, contact information, type of entity, dates, location, territories, and other details. As a result, prior to finalizing a sale, best practice is for the franchisor’s “franchise compliance officer” or attorney to review all documents to confirm that all required information is included and accurate. In addition, “execution ready” versions of the franchise agreement and related agreements must be given to the prospective franchisee in compliance with FTC and state laws regarding timing and disclosures.

In the event there are mistakes in the documents or in execution, there may be significant liability for the franchisor. Federal and many state laws have requirements regarding what must be provided to franchisees and when. Failure to comply with these laws, may result in injunctions, civil penalties, and even criminal penalties.

In addition, any franchisee purchasing a franchise without timely receipt of the FDD and franchise agreement, may be able to bring a lawsuit against the franchisor for rescission and restitution. If the franchisee is successful, the franchisor may be required to reimburse it for its entire investment costs. Litigation may also arise related to any of the contracts attached to the FDD if errors were made. This could result in liability or the loss of contractual benefits for the franchisor.

Franchise law compliance does not end with preparing the FDD. Throughout the process, there are specific rules that must be followed. We can educate you and your representatives on how to comply with the various laws until you are comfortable with moving forward on your own. If you are considering franchising your business, contact Lusthaus Law for a consultation.