Laws Governing Franchising

Franchising is only regulated on the Federal level by the Federal Trade Commission through disclosure requirements,¹ referred to as the Franchise Rule,² and the current version’s effective date was July, first, 2007.³ However, specific industries may have other federal laws regulating them: for instance, the Petroleum Marketing Practices Act.⁴

In short, to be recognized as a franchise, three requirements need to be present: the franchisee must receive IP rights, be supervised by the franchisor, and pay a fee. A fee is considered anything above five hundred and seventy USD ($570).⁵ The FTC has stated that the Franchise Rule governs the relationship if the business relationship fulfills all the three requirements of a franchise.⁶

The Franchise Rule has twenty-three (23) items that need to be included in the Federal Disclosure Document, which must be updated yearly.⁷ However, unlike some states, the FTC does not require the Federal Disclosure Document to be registered or filed with the agency. The Federal Disclosure Document must be provided to the franchisee fourteen (14) days before the investor signs any binding franchise agreement or pays any fee to the franchisor.⁸ The FTC has a civil penalty of eleven thousand USD ($11,000) for each violation of the Franchise Rule.⁹ The Franchise Rule does not allow franchisees a private right of action against the franchisor.¹⁰

A public comment period by the FTC for the Franchise Rule closed on May 13, 2019.¹¹ Altogether forty-six comments were filed, including comments from the International Franchise Association and eighteen members of Congress.¹² The commentators generally argued that the Franchise Rule should not be deleted or altered because of the valuable information it provides for franchisees.¹³

The same cannot be said for groups that represent the franchisees, which include: The Coalition of Franchisee Associations, the North American Securities Administrators Association, and the Franchisee Advocacy Consulting. All of these groups wanted more comprehensive disclosure, and changes to the FTC rule which would include a whistle blower provision to protect the identities of franchisees in case of retaliation;¹⁴ a private cause of action for Franchise Rule violations for the franchisee;¹⁵ make the Federal Disclosure Document more user friendly;¹⁶ and improve item three litigation disclosure;¹⁷ item nineteen earnings claims disclosure;¹⁸ and item twenty disclosure.¹⁹

While a disclosure document is an excellent way to reduce information asymmetry between the franchisor and franchisee, additional disclosure will not assist the investor if they do not hire proper counsel to review the franchise contract. The franchise contract includes the franchise agreement and Federal Disclosure Document which can often be a lengthy and complicated document.

The subsequent blogs will analyze each item of the Federal Disclosure Document in detail.