Federal Franchise Sales Law Updated for First Time Since 1978

By L. Seth Stadfeld (Published 2007)

In response to changes in technology and market conditions, after 12 years of rulemaking proceedings on January 22, 2007 the Federal Trade Commission approved (by a 5-0 vote) a substantially revised FTC Franchise Rule (16 C.F.R. Part 436), our only federal franchise sales regulation. This regulation (the "New Rule") has been significantly modernized for the first time since October 1978 (the "Old Rule"). In support of the New Rule, the FTC published a Statement of Basis and Purpose. It sets forth the agency's rationale for many rule changes and provides detailed explanations of the New Rule's requirements. The New Rule becomes effective on July 1, 2007, when franchisors may (but need not) provide prospects with franchise disclosures in accordance with its terms. Compliance is mandatory on July 1, 2008.

Brief History. Led by California, in the 1970's some 15 states enacted franchise registration/disclosure laws to deal with franchise fraud. The FTC followed in October 1978 with the first federal disclosure law. Significantly, the states refused to follow the FTC's disclosure format largely because they sought more comprehensive regulation. Through the North American Securities Administrators Association, in the 1970's these states promulgated a more rigorous disclosure format called the "Uniform Franchise Offering Circular" ("UFOC"), together with instructions for their use ("UFOC Guidelines"). To simplify compliance by franchisors facing two disclosure formats, in 1979 in its Interpretive Guides, the FTC allowed franchisors to satisfy its rule by use of the UFOC format. FTC Interpretive Guides, 44 Fed. Reg. 49970-71, 8/24/79, ┬žI(D)(1). Since then franchisors have followed the UFOC format when complying with the franchise sales laws. By minimizing differences between federal and state regulations, the FTC expects that the New Rule will reduce compliance costs and modernize disclosure methods.

Set forth below are the most significant changes under the New Rule.

  1. Franchise and Business Opportunity Regulation Addressed Separately. The Old Rule applied both to traditional franchise offerings and lower cost business opportunities such as rack distributorships and vending machine routes. The New Rule applies only to franchise offerings. The FTC will deal with business opportunity disclosures through a separate rulemaking effort. 16 C.F.R. Part 437.
  2. No Regulation of Ongoing Franchise Relationships. Despite its power to regulate unfair trade practices and franchisee claims of abuses by franchisors, the FTC determined that such regulation is not yet needed. It found insufficient record evidence that such practices are widespread. Accordingly, like the Old Rule, the New Rule applies only to franchise offer and sale activity.
  3. International Transactions Excluded. Because the Old Rule was unclear, the New Rule makes plain that its jurisdictional scope is limited to offers and sales of franchises to be located in the United States, its territories and possessions.
  4. Pure Electronic Disclosure Embraced. Under the New Rule franchisors may provide disclosure documents in any manner they wish including by regular mail, e-mail, hand delivery, fax or access over the Internet (subject to certain conditions). They can furnish the disclosure document by mail with a paper copy or in tangible electronic form (CD Rom or computer disk). They may not use electronic enhancements (e.g., pop-up screens, ads or links), as any electronic version must resemble the paper version. Franchisors may use navigational devices (e.g., scroll bars), however, to help prospects deal with these electronic documents. Finally, franchisors may disclose electronically before July 2008 even if their documents don't satisfy New Rule requirements until then.
  5. Simpler Disclosure Timing Rules. Under the Old Rule, franchisors had to provide disclosure to prospects at the earlier of the "first personal meeting" or ten business days before the prospect pays or signs a binding contract. Under the New Rule, they must simply provide disclosure 14 business days before the prospect pays or signs a binding contract. Also, the FTC eliminated the requirement that franchisors give prospects five business days from when they provide the contract in final form and the time the prospect signs or pays.
  6. Plain English. Echoing 1993 UFOC Guideline changes, the New Rule mandates that franchise disclosure documents be prepared in "plain English". This requirement does not apply to franchise agreements.
  7. Disclosure Document Changes. Among many changes to the disclosure document itself, the following are most significant.

This article highlights some of the many changes under the New Rule. It remains to be seen, however, whether and to what extent states with franchise disclosure statutes will embrace such changes. For decades franchisors have sought uniformity in U.S. franchise regulation. The New Rule represents a welcome development toward achieving that goal. For a detailed account on the New Rule, see FTC Disclosure Rules for Franchising and Business Opportunity Ventures, Commerce Clearing House (Chicago 2007).

Weston Patrick, P.A.
L. Seth Stadfeld, Member

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