The sale of franchises is regulated by federal and state law. Federal law requires that franchisors disclose specific information about their franchise to prospective franchisees. The Federal Trade Commission (FTC) governs the disclosure procedure. The FTC's amended Franchise Disclosure Rule mandates that all franchisors make their disclosures according to the amended Rule beginning on July 1, 2008. Some states have their own franchise laws which require disclosure and registration with state agencies.
Federal Disclosure Requirements
Prior to the effective date of the amended Franchise Disclosure Rule, franchisors seeking to sell franchises had to make their disclosures according to the original Franchise Rule and its documents or according to the Uniform Franchise Offering Circular (UFOC) and its guidelines. Now, they must use the amended Rule, which can be found in the Code of Federal Regulations, Volume 16, Part 436, 16 CFR § 436. The Franchise Rule Compliance Guide for the amended Rule is available at the FTC Web site. The amended Rule requires franchisors to complete what is now called a Franchise Disclosure Document (FDD). The FDD mandates the disclosure of 23 kinds of financial and business information as well as a copy of the franchise agreement. These items of information include such things as:
- The franchisor and any parents, predecessors and affiliates
- Current and recent litigation against the franchisor
- Bankruptcy filings of the franchisor or its officers
- Initial fees
- Estimated initial investment
- Restrictions on sources of products and services
- Patents, copyrights, and proprietary information
- Restrictions on what the franchisee may sell
- Financial statements
Fifteen states have pre-sale disclosure laws for franchise sales. Sellers of franchises to be operated in the disclosure states must comply with the disclosure law of the appropriate state. These states include:
- New York
- North Dakota
- Rhode Island
- South Dakota
Sellers of franchises in other states must follow the FTC's amended Rule and use the FDD.
The FTC does not require franchisors to file the FDD with any agency. They only have to provide the completed documents to the franchisees. Some states, however, require the registration of franchise offerings. In those states, the franchisor must send to the appropriate state agency, which is usually a securities division of the state government, the following items:
- An application for registration
- Two or three copies of the proposed offering circular (which is the pre-sale disclosure), as provided for in the state's rules, including the proposed franchise agreement and financial statements
- A cross-reference sheet keying statements in the offering circular to appropriate paragraphs of the franchise agreement
- Two copies of any advertising to be used in connection with the offer or sale of the franchise
- The manually signed consent of the independent certified or public accountant
- The registration filing fee
Consult an Attorney
If you are thinking about buying a franchise, you should speak with an attorney who practices business and franchise law. The federal and state regulations are designed to protect purchasing franchisees from being taken advantage of by selling franchisors. The documents and the process of buying a franchise are complex. An attorney can help safeguard your interests and get you started in your new business.
Questions for Your Attorney
- Does a franchisor have to use a Franchise Disclosure Document to disclose information prior to selling a franchise?
- What kind of information is included in a Franchise Disclosure Document?
- Do all states require the registration of franchise offerings?