Guiding You Through the Legal Maze^sm

The FTC has amended the Franchise Rule after 12 years of study and comments.  The new FTC Franchise Rule becomes mandatory on July 1, 2008.  The new disclosure document will be called a Franchise Disclosure Document (FDD) rather than a Franchise Offering Circular (FOC).  The following is a summary of the major changes made to the FTC Franchise Rule:

          FTC and State Cover Page – These have been combined into one new page.  A franchisor must include its e-mail address and home web page address.  Risk factors will not have to be disclosed.

          ITEM 1 – THE FRANCHISOR AND ANY PARENTS, PREDECESSORS AND AFFILIATES – If there is a parent corporation that is not a franchisor of another concept and does not furnish products or services to the franchisees of the network, then only the name and business address of the parent needs to be disclosed.  Otherwise, detailed information regarding its prior business experience must be disclosed.

          ITEM 2 – BUSINESS EXPERIENCE – Franchise brokers will not have to be disclosed.  Any individual having management responsibility relating to the sale or operation of the franchises.

          ITEM 3 – LITIGATION – Under the current Rule you only have to disclose litigation where a franchisee sues you or where you sued a franchisee and they filed a counterclaim against you.  Under the new Rule, you will have to disclose litigation where you sue the franchisee even if there is no counterclaim.  Franchisor-initiated litigation must only be updated annually and grouped under general types of suits (e.g., Royalty Collection Suits” or Suits to Enforce System Standards”) with disclosure of only the case name, court and file number.

          ITEM 4 – BANKRUPTCY – You must also disclose the bankruptcy history of any other individual having management responsibility relating to the sale or operation of the franchises.

        ITEM 8 – RESTRICTIONS ON SOURCES OF PRODUCTS AND SERVICES – A franchisor will have to disclose the identity of any supplier in which an officer of the franchisor has an interest.

          ITEM 11 – FRANCHISOR’S ASSISTANCE, ADVERTISING, COMPUTER SYSTEMS AND TRAINING – The new Rule requires less disclosure regarding computer systems.  Only a general description of the computer system is required, their purchase and maintenance costs, and whether the franchisor will have access to the computer information.

          ITEM 12 – TERRITORIES – Under the new Rule there is be additional disclosure of: (1) the conditions under which a franchisor will approve the relocation of a franchisee’s business; (2) the franchisee’s rights to establish additional outlets; (3) the present plans of the franchisor to operate a competing system; and (4) a prescribed warning if the franchisor does not offer an exclusive territory.  Disclosure must also be given for sales via the Internet, catalogs and telemarketing.

          ITEM 14 – PATENTS, COPYRIGHTS AND PROPRIETARY INFORMATION – Patents pending will so have to be disclosed.

          ITEM 17 – RENEWAL TERMINATION, TRANSFER AND DISPUTE RESOLUTION - As to “renewal,” the franchisor must state that franchisee may be asked to sign a new franchise agreement with materially different terms and conditions than their original franchise agreement.

          ITEM 19 – FINANCIAL PERFORMANCE REPRESENTATIONS – Franchisors are permitted to disclose to prospective franchisees expense or cost information without it being considered an earnings claim.  Also, a franchisor can disclosure financial performance information limited to a subset of company-owned or franchised outlets.

          ITEM 20 – OUTLETS AND FRANCHISEE INFORMATION – The charts regarding franchisees have been modified.  As to former franchisees, only their name, city, state and current business telephone number (rather than their home address and home telephone number) needs to be disclosed.  If a franchisor is reselling an existing franchise outlet, a history of the outlet including the names, addresses and telephone numbers of each previous owner and the reason for the change in owners must be disclosed for the past 5 fiscal years.  In addition, if any franchisee has signed a settlement agreement with the franchisor in the past 3 fiscal years, new prescribed language has to be included.  Also, the names of any franchisee advisory boards or independent franchisee associations relating solely to your system have to be included.

          ITEM 21 – FINANCIAL STATEMENTS – If a franchisor’s parent corporation commits to perform post-sale obligations for the franchisor or guarantees the franchisor’s obligations to its franchisees, the parent’s audited financial statements must be included.  Start-up franchisors are allowed a 3-year phase-in of audited financial statements. 

          ITEM 23 – RECEIPTS – A franchisor must keep the Acknowledgment of Receipt at least 3 years.  I recommend you keep it as long as possible.

Delivery Requirements – The requirement to deliver the FOC on or before the “first personal meeting” and “Business Days” have been eliminated.  A franchisor must have delivered the FDD at least 14 days before the prospective franchisee signs any document with the franchisor or gives the franchisor any money.  In additional the prospective franchisee must have the completed franchise agreement with all the blanks filled in at least 7 calendar days before he or she signs it or gives the franchisor any money.  The FDD can be delivered electronically.  A agent of the prospective franchisee (e.g., attorney) can accept the FDD on behalf of the prospective franchisee.

          Updating the FDD – The franchisor is now allowed 120 days (rather than 90 days) from the end if its fiscal year to prepare the annual update to the FDD.  Any material changes to the information contained in the FDD must be updated immediately.

          Impact on State Franchise Laws.  Unfortunately the new Rule, while closer to state franchise laws does not preempt state law.  Therefore, you will still have to comply with the state franchise registration and disclosure laws existing in 19 states and state business opportunity laws existing in 25 states.  There is a movement to change state laws to be consistent with the new Rule but we are not there yet.

          If you have any questions about the new FTC Franchise Rule and its impact upon your operations, please do not hesitate to contact me.                                     Keith J. Kanouse, Esq.

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