The Amended Federal Trade Commission (FTC) Franchise Disclosure Rule (the Amended FTC Rule) took effect on July 1, 2007 and represents a significant change in franchise sales regulation in the United States. This new federal standard modernizes a rule that was nearly 30 years old and ushers in extensive changes to earlier disclosure requirements.
All franchisors that sell franchises in any state in the U.S. will need to rewrite their disclosure documents and ensure that their franchise sales practices conform to this federal standard. The Amended FTC Rule applies not only to U.S. franchisors but also to any foreign franchisors who sell franchises that will be operated in the U.S. Although it is anticipated that they will adopt the Amended FTC Rule, individual states may choose to impose additional disclosure requirements, provided that such state requirements are not inconsistent with the requirements in the Amended FTC Rule.
The FTC used the basic Uniform Franchise Offering Circular (UFOC) as a guide for the new federal disclosure standard. However, the changes will both introduce expanded obligations on franchisors and offer franchisors some interesting options in the way they disclose information and present disclosure documents to prospective franchisees.
The key changes introduced by the Amended FTC Rule are set out below:
Electronic Disclosure: This is perhaps the most innovative of the changes, and it should help franchisors significantly reduce the expense of disclosure. Franchisors may now deliver their disclosure document through e-mail or by making it accessible on a password-protected website. The document may be enhanced electronically only to assist prospective franchisees with navigation. Franchisors must ensure that they keep records of disclosure documents that have been released electronically and of e-signatures on receipts. Prospective franchisees must be informed of their right to receive disclosure in another format. Even where franchisors have not converted to the new disclosure format, they may disclose electronically.
New Delivery Rules: Franchisors no longer have to deliver their disclosure documents at the first personal meeting. This should reduce some hassles franchisors currently face, such as having to bring copies of disclosure documents to trade shows and conferences. Further, time periods (such as the minimum waiting time between delivery and signing of the disclosure document) have been re-stated to refer to “calendar” days instead of “business” days. Finally, where a franchisee initiates negotiations regarding the disclosure document, the 5-day waiting period has been eliminated.
Financial Performance Representations: Franchisors may now provide cost-only data to franchisees without triggering the disclosure rules related to earnings claims. This allows franchisors to be creative in terms of how expense information is presented to prospective franchisees. The data may be tailored to suit a prospective franchisee’s geographic area or size of outlet.
Expanded Parent Disclosure Obligations: This is perhaps the most onerous of the new disclosure rules, particularly for small or foreign franchisors. Franchisors must now disclose the name and address of parent entities, along with bankruptcies and certain pending or concluded litigation with respect to any parent entity. Where a parent entity provides post-sale goods and services on behalf of the franchisor, its financials must be disclosed. A “parent” is defined as an entity that controls another entity directly (or indirectly through one or more subsidiaries). Franchisors wishing to avoid disclosure of parent financials may need to consider restructuring so that post-sale goods and services are provided by a non-parent entity.
Additional Litigation Disclosures: Franchisors must now disclose all material franchisor-initiated litigation actions brought during the past fiscal year against franchisees. However, these actions may be categorized into subgroups (i.e. “failure to pay royalties”) and franchisors do not have to fully describe each action.
Exemptions: There are exemptions from the new disclosure rules for transactions involving “sophisticated investors.” The first such exemption is for franchise sales in which an individual franchisee makes an initial investment of at least $1 million within the first three months of operation, excluding franchisor financing and unimproved land costs. The second is for large entities which have been in business for a minimum of five years and possess a minimum of $5 million net worth. Third, transactions involving “franchisor insiders,” such as officers and owners, are exempt from the new disclosure requirements.
In addition to the above changes, the tables and disclosure obligations under Item 20 of the UFOC have been expanded and will require more extensive summaries of franchisor information. The most significant of these changes is the need for franchisors to disclose to a prospective franchisee the name of each previous owner of the particular unit for the past five years. These Item 20 changes will likely account for the most time-consuming part of the conversion to the new disclosure format.
Although the Amended FTC Rule does not require mandatory compliance until July 1, 2008 franchisors who sell franchises in the United States should begin converting their disclosure documents as soon as possible. Not only will early compliance allow franchisors to avoid the last-minute scramble next spring, it will also allow franchisors to take advantage of the many franchisor-friendly changes. Franchisors may begin to enjoy the conveniences of electronic disclosure immediately.