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Federal Trade Commission Issues Revised Franchise Rule

Written by: Anthony Delyani

(Article originally published in the New Hampshire Business Review, June 6, 2008. http://www.nhbr.com/apps/pbcs.dll/article?AID=/20080606/INDUSTRY18/16875010/-1/Industry18)

One would be hard pressed to drive more than a few blocks in a retail zone these days without running into a franchised business. Is there a town in New Hampshire without its fair share of classic franchises, such as Dunkin Donuts or McDonalds, or less obvious franchises, such as Hannoush Jewelers or Edible Arrangements? And what about all of the domestic service providers who have bought into service franchise brands, such as MaidPro or LawnDoctor? It might surprise franchisees or those contemplating a franchising opportunity that the rule governing disclosures to a prospective franchisee has not been modified since they it was first created back in 1978. Until now

In 1978, the Federal Trade Commission established detailed disclosure requirements for franchisors in the sale and marketing of franchises. Under an FTC rule ponderously entitled "Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures", but known within the franchise industry simply as "the Rule", franchisors were for the first time required to provide to prospective franchisees extensive historical and financial information about themselves and the franchises they were marketing. Consistent with the FTC's mandate, the focus of the Rule was to safeguard consumers from unfair and deceptive practices.

In light of the proliferation since 1978 of franchises across the country offering a vast array of goods and services, and recognizing technological changes that simplify the transmission of information but that can also enable an unscrupulous franchisor to exploit inexperienced prospective franchisees, the FTC recently revised the Rule for the first time since 1978. While franchisors are permitted to follow the 1978 version of the Rule until June 30, 2008, they may also begin to follow the revised Rule immediately, and many have chosen to do so.

One problem that developed for franchisors after 1978 was that numerous states created their own regulations for franchisors offering franchises with their borders. State regulations often required disclosures different from, and usually more extensive than, those required under the Rule. Therefore, franchisors wishing to market franchises in those states were required to develop disclosure packages specially tailored to those states' requirements (or, commonly, to create a standard disclosure package with a separate addendum for each regulating state). The FTC has to a large degree, but not completely, eliminated this problem by basing the revised Rule on the guidelines on which most state disclosure requirements are based. While the new Rule reduces the number of adjustments a typical franchisor will likely be required to make to satisfy state regulators, adjustments will still be necessary in many cases. Therefore, cautious franchisors will continue to review the franchise regulations of each state in which they intend to market franchises.

The full range of changes to the rule is extensive and, in some instances, highly technical. Franchisors should be aware generally that the revised Rule changes their disclosure requirements in the following areas:

  • The number of days prior to the signing of a franchise agreement by which all disclosures may be made to a prospective franchisee.
  • Licensing and permitting requirements that might affect a franchisee's operating costs and ability to conduct business.
  • Competition that a franchisee is likely to face.
  • Advertising and purchasing cooperatives from which a franchisee might be required to buy goods or services.
  • Non-refundable franchise fees.
  • Whether the franchisor rewards franchisees who use specified suppliers.
  • Conditions for business relocation, the establishment of additional locations, and territorial exclusivity.
  • Whether the franchisor plans to operate a competing franchise system.
  • Rights and claims associated with trademarks.
  • Policies for the renewal of franchises.

As the deadline for compliance with the revised Rule approaches, franchisors should be aware of the requirements of the Rule and be ready to comply when the deadline arrives. Franchisees, both existing and prospective, should be aware of the information they should expect to receive from a franchisor. Time will tell whether the revised Rule will streamline the disclosure process for franchisors without sacrificing safeguards created to protect franchisees, but with so much that has changed, revisiting a rule drafted 30 years ago seems like a prudent move for all parties considered.

Tony Delyani is a director in the Corporate Department at the law firm of McLane, Graf, Raulerson & Middleton, Professional Association. He focuses on all aspects of business law, including mergers and acquisitions, entity selection and formation, liquidations, financing, taxation, and intellectual property. He can be reached at McLane's Portsmouth offices at 603-436-2818 or [email protected]. The McLane Law Firm is the largest full-service law firm in the state of New Hampshire, with offices in Concord, Manchester and Portsmouth.

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