Guide
to the FTC Franchise RuleTable
of Contents
A. Basic Requirement: Franchisors must furnish potential franchisees with written
disclosures providing important information about the franchisor, the franchised business
and the franchise relationship, and give them at least ten business days to review it
before investing.
B. Disclosure Option: Franchisors may make the required disclosures by following
either the Rule's disclosure format or the Uniform Franchise Offering Circular Guidelines
prepared by state franchise law officials.
C. Coverage: The Rule primarily covers business-format franchises, product
franchises, and vending machine or display rack business opportunity ventures.
D. No Filing: The Rule requires disclosure only. Unlike state disclosure laws, no
registration, filing, review or approval of any disclosures, advertising or agreements by
the FTC is required.
E. Remedies: The Rule is a trade regulation rule with the full force and effect
of federal law. The courts have held it may only be enforced by the FTC, not private
parties. The FTC may seek injunctions, civil penalties and consumer redress for
violations.
F. Purpose: The Rule is designed to enable potential franchisees to protect
themselves before investing by providing them with information essential to an assessment
of the potential risks and benefits, to meaningful comparisons with other investments, and
to further investigation of the franchise opportunity.
G. Effective Date: The Rule, formally
titled "Disclosure Requirements and
Prohibitions Concerning Franchising and Business Opportunity Ventures," took
effect on October 21, 1979, and appears at 16 C.F.R.
Part 436.
A. General: The Rule imposes
six different requirements in connection
with the "advertising, offering, licensing, contracting, sale or other promotion" of
a franchise in or affecting commerce:
1. Basic Disclosures: The Rule requires franchisors
to give potential investors a basic disclosure document
at the earlier of the first face-to-face meeting or
ten business days before any money is paid
or an agreement is signed in connection with the investment
(Part 436.1(a)).
2. Earnings Claims: If a franchisor makes earnings claims,
whether historical or forecasted, they must have a
reasonable basis, and prescribed substantiating disclosures
must be given to a potential
investor in writing at the same time as the basic disclosures
(Parts 436.1(b)-(d)).
3. Advertised Claims: The Rule affects only ads that
include an earnings claim. Such ads must disclose the
number and percentage
of existing franchisees who have achieved the
claimed results, along with cautionary
language. Their use triggers required compliance with
the Rule's earnings claim disclosure requirements (Part
436.1(e)).
4. Franchise Agreements: The franchisor must give investors
a copy of its standard-form franchise and related agreements
at the same time as the basic disclosures,
and final copies intended to
be executed at least 5 business days before signing
(Part 436.1(g)).
5. Refunds: The Rule requires franchisors to make refunds
of deposits and initial payments to potential investors,
subject to any conditions on refundability stated in
the disclosure document (Part 436.1(h)).
6. Contradictory Claims: While franchisors are free
to provide investors with any promotional or other materials
they wish, no written or oral claims may contradict
information provided in the required disclosure
document (Part 436.1(f)).
B. Liability: Failure to comply
with any of the six requirements is a violation
of the Franchise Rule. "Franchisors" and "franchise brokers" are
jointly and severally liable for Rule violations.
1. A "franchisor" is defined as any person
who sells a
"franchise" covered by the Rule (Part 436.2(c)).
2. A "franchise broker" is defined as any
person who "sells, offers
for sale, or arranges for the
sale" of
a covered franchise (Part
436.2(j)), and includes
not only independent sales
agents, but also subfranchisors that
grant
subfranchises (44 FR 49963)
A. Alternate Definitions: The
Rule employs parallel coverage definitions of the
term "franchise" to reach two types of
continuing commercial relationships: traditional
franchises and business opportunities.
B. "Traditional Franchises": There are three definitional prerequisites
to coverage of a business-format or product franchise (Parts 436.2(a)(1)(i) and (2)):
1. Trademark: The franchisor offers
the right to distribute goods or services that
bear
the franchisor's trademark, service mark, trade
name, advertising or other commercial
symbol.
2. Significant Control or Assistance: The
franchisor exercises significant control over,
or offers significant assistance in, the franchisee's
method of operation.
3. Required Payment: The franchisee
is required to make any payment to the franchisor
or an affiliate, or a commitment to make a
payment, as a condition of obtaining
the franchise or commencing operations.
(NOTE: There is an exemption from coverage
for required payments of less than $500 within
six months of the commencement of the franchise
(Part 436.2(a)(3)(iii)).
C. Business Opportunities: There are also three basic prerequisites to the Rule's
coverage of a business opportunity venture (Parts 436.2(a)(1)(ii) and (2)):
-
No Trademark: The seller simply offers the right to sell goods or services
supplied by the seller, its affiliate, or a supplier with which the seller requires the
franchisee to do business.
-
Location Assistance: The seller offers to secure retail outlets or accounts for
the goods or services to be sold, to secure locations or sites for vending machines or
rack displays, or to provide the services of someone who can do so.
-
Required Payment: The same as for franchises.
D. Coverage Exemptions/Exclusions: The Rule also exempts or excludes some
relationships that would otherwise meet the coverage prerequisites (Parts 436.2(a)(3) and
(4)):
1. Minimum investment: This exemption
applies if all payments to the franchisor or
an affiliate until six months after the franchise
commences operation are $500 or less
(Part 436.2(a)(iii)).
2. Fractional Franchises: Relationships
adding a new product or service to an established
distributor's existing products or services,
are exempt if: (i) the franchisee
or any of its current directors or executive
officers has been in the same type of business
for at least two years, and (ii) both parties
anticipated, or should have, that
sales from the franchise would represent no
more than 20% of the franchisees sales in dollar
volume (Parts 436.2(a)(3)(i) and 436.2(h)).
3. Single Trademark Licenses: The
Rule language excludes a "single license
to license a [mark]" where it "is
the only one of its general nature and type
to
be granted by the licensor with respect to
that [mark]" (Part 436.2(a)(4)(iv)). The
Rule's Statement of Basis and Purpose indicates
it also applies to "collateral" licenses
[e.g., logo on sweatshirt, mug] and
licenses granted to settle trademark
infringement litigation
(43 FR 59707-08).
4. Employment and Partnership Relationships: The
Rule excludes pure employer-employee and general
partnership arrangements. Limited partnerships
do not
qualify for the exemption (Part 436.2(a)(4)(i)).
5. Oral Agreements: This exemption,
which is narrowly construed, applies only if
no material term of the relationship is in
writing (Part 436.2(a)(3)(iv)).
6. Cooperative Associations: Only
agricultural co-ops and retailer-owned
cooperatives "operated
'by and for' retailers on a cooperative basis," and
in which control and ownership is substantially
equal are excluded from coverage (Part
436.2(a)(4)(ii)).
7. Certification/Testing Services: Organizations
that authorize use of a certification mark
to any business selling products or services
meeting their standards
are excluded from coverage (e.g., Underwriters
Laboratories) (Part 436.2(a)(4)(iii)).
8. Leased Departments: Relationships
in which the franchisee simply leases space
in the premises of another retailer and is
not required or advised to buy the goods or
services it sells from the retailer or an affiliate
of the retailer are exempt (Part
436.2(a)(3)(ii)).
E. Statutory Exemptions: Section
18(g) of the FTC Act authorizes "any
person" to petition the Commission for an exemption from a rule where coverage is
"not necessary to prevent the acts or practices" that the rule prohibits (15
U.S.C. § 57a(g)). Franchise Rule exemptions have
been granted for service station franchises (45
FR 51765), many automobile dealership franchises
(45
FR 51763; 49 FR 13677;
52 FR 6612; 54 FR 1446), and wholesaler-sponsored
voluntary chains in the grocery industry (48 FR 10040).
A. Alternatives: Franchisors
have a choice of formats for making the disclosures
required by the Rule. They may use either
the format provided by the Rule or the Uniform Franchise
Offering Circular ("UFOC") format prescribed by the North American
Securities Administrators' Association ("NASAA").
B. FTC Format: Franchisors may comply by following the Rule's requirements for
preparing a basic disclosure document (Parts 436.1(a)(1)-(24)), and if they make earnings
claims, for a separate earnings claim disclosure document (Parts 436.1(b)(3), (c)(3), and
(d)). The Rule's Final Interpretive Guides provide detailed instructions and sample
disclosures (44 FR 49966).
C. UFOC Format: The Uniform Franchise Offering Circular format may also be used
for compliance in any state:
1. Guidelines: Effective January 1, 1996, franchisors using
the UFOC disclosure format must comply with the UFOC
Guidelines, as amended by NASAA on April 25, 1993. (44
FR 49970; 60 FR 51895).
2. Cover Page: The FTC cover page must be furnished to each
potential franchisee, either in lieu of the UFOC cover
page in non-registration states or along with the UFOC
(Part 436.1(a)(21); 44 FR 49970-71).
3. Adaptation: If the UFOC is registered or used in one state,
but will be used in another without a franchise registration
law, answers to state-specific questions must be
changed to refer to the law of the state
in which the UFOC is used.
4. Updating: If the UFOC is registered in a state, it must
be updated as required by the state's franchise law.
If the same UFOC is also adapted for use in a non-registration
state, updating must occur
as required by the law of the state where the UFOC is
registered. If the UFOC is not registered in a state
with a franchise registration
law, it
must be revised annually and updated
quarterly as required by the Rule.
5. Presumption: The Commission will presume the sufficiency,
adequacy and accuracy of a UFOC that is registered by
a state, when it is used in that state.
D. UFOC vs. Rule: Many franchisors have adopted the UFOC disclosure format
because roughly half of the 13 states with franchise registration requirements will not
accept the Rule document for filing. When a format is chosen, all disclosure must conform
to its requirements. Franchisors may not pick and choose provisions from each format when
making disclosures (44 FR 49970).
E. Rule Primacy: If the UFOC is used, several
key Rule provisions will still apply:
1. Scope: Disclosure will be required in all cases required
by the Rule, regardless of whether it would be required
by state law.
2. Coverage: The Rule will determine who is obligated to
comply, regardless of whether they would be required to make
disclosures under state law.
3. Disclosure Timing: When disclosures must be made will
be governed by the Rule, unless state law requires even
earlier disclosure.
4. Other Material: No information may appear in a disclosure
document not required by the Rule or by non-preempted
state law, regardless of the format used, and no
representations may be made that contradict
a disclosure.
5. Contracts: Failure to provide potential
franchisees with final agreements at least 5 days before signing
will
be a Rule
violation regardless of the disclosure format
used.
6. Refunds: Failure to make promised refunds also will be
a Rule violation regardless of which document is used.
A. FTC Action: Rule violations may subject franchisors,
franchise brokers, their officers and agents to significant liabilities
in FTC enforcement actions.
1. Remedies: The FTC Act provides the Commission
with a broad range of remedies for Rule violations:
a. Injunctions: Section
13(b) of the Act authorizes preliminary and permanent injunctions
against
Rule violations (15
U.S.C. § 53(b)).
Rule cases routinely have sought and obtained
injunctions
against
Rule violations and misrepresentations in
the offer
or sale of any business
venture, whether or not covered by the Rule.
b. Asset Freezes: Acting under their inherent equity powers, the courts have
routinely granted preliminary asset freezes in appropriate Rule cases. The assets frozen
have included both corporate assets and the personal assets, including real and personal
property, of key officers and directors.
c. Civil Penalties: Section
5(m)(1)(A)
of the Act authorizes civil penalties of up to $11,000
for each
violation of the Rule (15 U.S.C. § 5(m)(1)(A)). The
courts
have granted civil penalties of as much as $870,000 in a Rule
case to date.
d. Monetary Redress: Section
19(b) of the Act authorizes the Commission to seek monetary redress
on behalf
of investors injured economically by a Rule violation
(15 U.S.C. § 57b).
The courts have
granted consumer
redress of as
much as $4.9
million in a
Rule case
to date.
e. Other Redress: Section 19(b) of the Act also authorizes such other forms of
redress as the court finds necessary to redress injury to consumers from a Rule violation,
including rescission or reformation of contracts, the return of property and public notice
of the Rule violation. Courts may also grant similar relief under their inherent equity
powers.
2. Personal Liability: Individuals who formulate, direct and control the
franchisor's activities can expect to be named individually for violations committed in
the franchisor's name, together with the franchisor entity, and held personally liable for
civil penalties and consumer redress.
3. Liability For Others: Franchisors and their key officers and executives are
responsible for violations by persons acting in their behalf, including independent
franchise brokers, sub-franchisors, and the franchisor's own sales personnel.
B. Private Actions: The courts have held that
the FTC Act generally may not be enforced by private lawsuits.
1. Rule Claims: The Commission expressed its view when the Rule was issued that
private actions should be permitted by the courts for Rule violations (43 FR 59723; 44 FR
49971). To date, no federal court has permitted a private action for Rule violations.
2. State Disclosure Law Claims: Each of the franchise laws in the 15 states with
franchise registration and/or disclosure requirements authorizes private actions for state
franchise law violations.
3. State FTC Act Claims: The
courts in some states have
interpreted state deceptive practices laws ("little FTC Acts")
as permitting private actions
for Rule violations
A. Text of Rule: 16 C.F.R. Part 436.
B. Statement of Basis and Purpose: 43 FR 59614-59733 (Dec. 21, 1978) (Discusses
the evidentiary basis for promulgation of the Rule, and shows Commission intent and
interpretation of its provisions - particularly helpful in resolving coverage questions).
C. Final Interpretive Guides: 44 FR 49966-49992 (Aug. 24, 1979) (Final statement
of policy and interpretation of each of the Rule's requirements - important discussions of
coverage issues, use of the UFOC and requirements for basic and earnings claims
disclosures in the Rule's disclosure format).
E. Staff Advisory Opinions: Business
Franchise Guide (CCH) ¶6380 et seq.
(Interpretive opinions issued in response to requests for interpretation of coverage
questions and disclosure requirements pursuant to 16 C.F.R. §§ 1.2-1.4).
Last Updated:
Friday, February 13, 2004
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