As you begin to investigate the possibility of franchising your business, or perhaps buying into the franchise system of a franchise brand of interest, you may start to wonder what kind of laws are at-issue.
Maybe you’ve done a little bit of research already or maybe you just aren’t sure. What you should know is that there are federal and state laws that regulate the activity of all franchisors, which laws are also designed to provide some protection to franchisees.
What do these laws do? In general, they set forth the types of disclosures franchise companies must make to prospective franchisees, as well as certain rules pertaining to the contract between the franchisor and its franchisees – i.e. the franchise agreement.
We’ll look more specifically at state laws that may apply in the moment, but first let’s look at laws at the federal level.
Under federal law (and some state laws), a franchisor is required to prepare what is known as a “Franchise Disclosure Document”. While there are 23 actual disclosure requirements in this document, they generally fall into five categories:
- Historical information: Franchisors are required to reveal things like business experience of the company, including that of principle players in the company, litigation against the company, and bankruptcy information, if any.
- Financial Data: Franchisors must disclose the upfront actual and/or projected fees and costs for starting the business, as well as types of fees that franchisees can anticipate when engaged in the business. A franchisor that chooses to make “Financial Performance Representations” – the kind of information a franchisee may rely upon to predict how well it may do if it buys a franchise unit –falls into the category of financial data that may be included as well.
- Obligations and Restrictions: Franchisees learn through the Franchise Disclosure Document any obligations and restrictions there may be on them when they are operating the business. what rights they will have in such things as territory and trademarks and on renewal or transfer of their interest in their franchise.
- Rights: Franchisees also learn through the Franchise Disclosure Document what rights they will have in such things as territory and trademarks and on renewal or transfer of their interest in their franchise.
- Exhibits: A fifth category in the Franchise Disclosure Document constitute the attachments to the document itself, which include not just the form franchise agreement a franchisee will need to sign but also financial information about the franchisor (which generally must be audited financials), data about franchisees, and contact information to connect with other franchisees in the due diligence process.
State Specific Laws
Some states offer protection above and beyond what is offered at a federal level. There are 14 states that have their own disclosure registration requirements and overall, there are nuances within each state. Some states’ laws that impact franchisors are not franchise specific, but apply to all “business opportunities” in the state, meaning franchisors and franchisees must be aware of what these laws require as they contemplate a transaction between them.
FDD registration is required in the following states, and that registration will mean that the state will scrutinize the Franchise Disclosure Document to make sure it presents the business fairly and reasonably. Each of the below states’ franchise laws should be examined in detail before a franchisor even attempts registration there, as these are the 14 “registration” states:
- New York
- North Dakota
- Rhode Island
- South Dakota
FDA Notice Filing States
While there are many states that don’t require “registration”, certain states require a minimal notice to the state government that a company intends to sell franchises within the state. In contrast to “registration” states, there will be no scrutiny of the FDD in these states:
- North Carolina
- South Carolina
- South Dakota
As an aside, a state like Oregon may not require FDD notice filing, but franchisors and prospective buyers of franchises in Oregon should know that Oregon has its own laws dictating how franchises are offered for sale.
Failure to properly follow federal and/or state laws that regulate franchise sales can have significant implications. Contracts can be rescinded; money may need to be returned; and/or intellectual property may be lost.
When and where possible, it’s always best to enlist the help of a qualified attorney to help you understand franchise obligations and requirements, and ensure your business is protected at a federal and state level. Don’t leave this to chance.