Franchise Rule

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The Franchise Rule defines acts or practices that are unfair or deceptive in the franchise industry in the United States. The Franchise Rule is published by the Federal Trade Commission. The Franchise Rule seeks to facilitate informed decisions and to prevent deception in the sale of franchises by requiring franchisors to provide prospective franchisees with essential information prior to the sale. It does not, however, regulate the substance of the terms that control the relationship between franchisors and franchisees. Also, while The Franchise Rule removed the regulation of the sale of franchises from the purview of the states under the authority of the FTC to regulate interstate commerce, The FTC Franchise Rule does not require franchisors to disclose the unit performance statistics of the franchised system to new buyers of franchises as would be necessary and material under state and federal Securities and Exchange law.

Franchise Law[edit]

In the United States, the Federal Trade Commission has oversight of franchising, rather than the US Securities and Exchange Commission. The FTC administrates oversight via the FTC Franchise Rule.[1] The FTC announced an update to the franchise Rule on January 23, 2007, becoming effective July 1, 2007.[2]

The most recent version of the FTC Franchise Rule was in 2007, is printed in FR 2007a, pp. 15544–15575.

After July 2008, all franchisors in the United States are to use the Franchise Disclosure Document with potential franchisees.

Franchise Law background[edit]

The Federal Trade Commission began examining practices in franchising in 1970. In 1971 the FTC began a formal rule making proceeding, to possibly develop a regulation requiring disclosure and prohibiting unfair practices in offering and selling franchises. These developments resulted in promulgation of the FTC Franchise Rule in 1979. The FTC enforces the Federal Trade Commission Act ("FTC Act"), which prohibits unfair methods of competition and unfair or deceptive acts or practices in or affecting commerce.

The FTC Act also empowers the Commission to prescribe rules that define with specificity acts or practices that are unfair or deceptive. One such rule is the Commission's Franchise Rule.[3]

The Commission focuses much of its Franchise Rule enforcement and consumer educational resources on combating business opportunity fraud.

The Franchise Rule requires franchisors to make material disclosures in five categories:

  • (1) the nature of the franchisor and the franchise system;
  • (2) the franchisor's financial viability;
  • (3) the costs involved in purchasing and operating a franchised outlet;
  • (4) the terms and conditions that govern the franchise relationship; and
  • (5) the names and addresses of current franchisees who can share their experiences within the franchise system, thus helping the prospective franchisee to verify independently the franchisor's claims.

In addition, franchisors must have a reasonable basis and substantiation for any earnings claims made to prospective franchisees, as well as disclose the basis and assumptions underlying any such earnings claims. Earnings Claims are not required to be provided to prospective franchisees under the FTC Rule and the majority of franchisors do not make earnings claims and do not disclose the unit performance statics of their franchisees to prospective franchisees.

The Franchise Rule generally covers two different types of business arrangements: franchises and business opportunity ventures.

Franchise Agreements[edit]

Franchise agreements typically involve retail outlets that bear the franchisor's trademark and follow the franchisor's business operations model, such as fast-food restaurants, hotels, and automotive repair shops. These are commonly known as "business-format" franchises.

Franchise business opportunities rip offs[edit]

Franchise business opportunities rip offs often do not entail a trademark or detailed business plan. The franchise business opportunity typically promises to provide the buyer with equipment that is used to sell products or services to the public, such as vending machines, rack displays, pay phones, or medical billing software, and frequently promises to find the buyer a market for the products or services. Many business opportunities are outright scams that disappear shortly after taking consumers' money. Compliance with The Franchise Rule by business opportunity sellers is low.[3]

UFOC Franchise Disclosure Laws[edit]

In addition to the FTC, fifteen states require pre-sale disclosure in franchise sales in the form of a Uniform Franchise Offering Circular ("UFOC"). Because a UFOC is accepted by both the states and the FTC, the UFOC Guidelines have effectively become the national franchise disclosure standard.

Franchise Rule Enforcement[edit]

The Franchise Rule has the force and effect of law, and it may be enforced through civil penalty actions in federal courts.(10) The FTC Act authorizes courts to impose civil penalties of not more than $11,000 per compliance violation.

Franchise Disclosure Document[edit]

The Franchise Rule requires franchisors to provide all potential franchisees with a disclosure document containing 23 specific items of information about the offered franchise, its officers, and other franchisees.

Required Franchise Disclosure Document topics include: the franchise’s litigation history, past and current franchisees and their contact information, any exclusive territory that comes with the franchise, assistance the franchisor provides franchisees, and the cost of purchasing and starting up a franchise. If a franchisor makes representations about the financial performance of the franchise, this topic also must be covered, as well as the material basis backing up those representations." [2][4]

Franchise termination[edit]

Franchise termination is covered in the franchise agreement between the franchiser and franchisee. In the 2007 Franchise Rule, comments from former franchisees were listed concerning confidentiality agreements and Franchise fraud.

See also[edit]

References[edit]

Further reading[edit]