United States

• Author: John R. F. Baer - Susan Grueneberg
• Pages: 503-542

502 International Franchise Sales Laws

United States

Introduction

The United States of America (U.S.) was the first country to adopt a franchise law

when California in 1970 adopted the California Franchise Investment Law, effec-

tive January 1, 1971. Subsequently, between 1971 and 1980, a number of other

states and the Federal Trade Commission (FTC) adopted various forms of franchise

sales laws or regulations. All of those laws and regulations required pre-sale disclo-

sure, and initially all but the federal regulation and one state law required registra-

tion. Although many of those laws and regulations have since been amended or

revised, no new franchise sales law or regulation has been enacted in the U.S. since

New York’s law was enacted in 1980, and many have since simplified their registra-

tion process.

Because the original federal disclosure regulation did not fully preempt the state

laws, the states were essentially free to enforce their own sales laws. A state organi-

zation called the Midwest Securities Commissioners Association (now known as the

North American Securities Administrators Association, or NASAA) adopted a dis-

closure format in 1974 known as the Uniform Franchise Offering Circular (UFOC)

Guidelines, which the FTC allowed the states to use instead of the FTC’s own dis-

closure requirements. The UFOC Guidelines were amended several times. Most

franchisors in the United States used the UFOC Guidelines’ disclosure format for a

variety of reasons.

The most significant revision in U.S. franchise sales law occurred July 1, 2007,

when the FTC adopted an amended version of its federal disclosure regulation (FTC

Franchise Rule). The FTC Franchise Rule disclosure format was essentially a modi-

fied version of the UFOC Guidelines and required all franchisors to convert to a

modified format called a Franchise Disclosure Document (FDD) by July 1, 2008.

Subsequently, a number of the states with franchise sales laws have modified their

laws to conform more closely to the revised FTC requirements, and NASAA adopted

its 2008 Franchise Registration and Disclosure Guidelines to provide a procedure

for states to enforce their own franchise sales laws in conjunction with the federal

requirements.

While the history of franchise sales regulation in the United States would make

for interesting reading (to some of us, at least), this chapter instead focuses on the

current U.S. franchise sales requirements in the U.S. as reflected in the FTC Fran-

chise Rule, the 15 state franchise sales laws, the NASAA 2008 Franchise Registra-

tion and Disclosure Guidelines, and other explanatory materials or guidance issued

by the FTC, NASAA, and the states, and is current through January 2015.

John R. F. Baer

Susan Grueneberg

United States 503

I. What Is a Franchise?

A. Scope of Law

The United States of America (U.S.) legal system is a federal system, and both the

federal government and a number of the states have enacted franchise sales laws or

promulgated franchise sales regulations. Since 1970, when California enacted the

first law, 15 states and the Federal Trade Commission (FTC) have adopted franchise

disclosure, registration, or notice laws or regulations that apply to the sale of a

franchise. All of those regulations and laws define “franchise.” Unfortunately, the

U.S. does not have a uniform definition, and the definition in each applicable law or

regulation must be reviewed by a franchise seller to determine its applicability to a

particular system.

Franchisors should also understand that a variety of other federal and state laws

can affect the franchise relationship: business opportunity laws, relationship laws,

and special industry laws. This chapter focuses on franchise sales laws and regula-

tions, but Section VIII discusses the relationship laws. The special industry laws that

relate to sellers in specific industries (e.g., automobile dealers, petroleum market-

ing, farm and industrial equipment, etc.) are not covered.

The FTC promulgated its original Trade Regulation Rule on Franchising and

Business Opportunity Ventures in 1978 (Original FTC Franchise Rule). The Origi-

nal FTC Franchise Rule required disclosure but no registration or filing with the

FTC. Although the Original FTC Franchise Rule applied in all 50 states and U.S.

territories and possessions, it preempted state franchise sales law only in a limited

respect. That left the 15 states that adopted their own disclosure, registration, or

notice laws free to enforce them in most respects.

On July 1, 2007, an amended version of the FTC Franchise Rule, called Disclo-

sure Requirements and Prohibitions Concerning Franchising (FTC Franchise Rule),

became effective. The FTC Franchise Rule defines “franchise” as follows:

Franchise means any continuing commercial relationship or arrangement,

whatever it may be called, in which the terms of the offer or contract specify,

or the franchise seller promises or represents, orally or in writing, that:

(1) The franchisee will obtain the right to operate a business that is identi-

fied or associated with the franchisor’s trademark, or to offer, sell, or

distribute goods, services, or commodities that are identified or associ-

ated with the franchisor’s trademark;

(2) The franchisor will exert or has authority to exert a significant degree of

control over the franchisee’s method of operation, or provide significant

assistance in the franchisee’s method of operation; and

(3) As a condition of obtaining or commencing operation of the franchise,

the franchisee makes a required payment or commits to make a required

payment to the franchisor or its affiliate.

504 International Franchise Sales Laws

The FTC Franchise Rule will not apply if the total required payments, or com-

mitments to make a required payment, to the Franchisor or an affiliate that are made

at any time from before to within six months after commencing operation of the

Franchisee’s business are less than $500. A “required payment” is defined in the

FTC Franchise Rule as “all consideration that the Franchisee must pay to the

Franchisor or an affiliate, either by contract or by practical necessity, as a condition

of obtaining or commencing operation of the franchise. A required payment does

not include payments for the purchase of reasonable amounts of inventory at bona

fide wholesale prices for resale or lease.” Because of the bona fide wholesale price

exception, the typical distribution system that requires no payments other than the

purchase price of goods is not a franchise.

All three elements of the franchise definition must be present in order for a

franchise to exist. If any one element is missing, there is no franchise for purposes

of the FTC Franchise Rule.

Under the FTC Franchise Rule, in connection with the offer or sale of a fran-

chise to be located in the U.S. or its territories, a Franchisor must provide a prospec-

tive Franchisee with a copy of its current disclosure document at least 14 calendar

days before the prospective Franchisee signs a binding agreement with or makes

any payment to the Franchisor or an affiliate in connection with the proposed fran-

chise sale. The disclosure document, called a Franchise Disclosure Document (FDD),

must contain information in 23 different categories. No filing or registration with

the FTC is required.

All Franchisors in the U.S. had to convert to the FDD format by July 1, 2008.

However, the FTC expressly provided that it did not intend to preempt the franchise

laws of any state or local government except to the extent of any inconsistency with

the FTC Franchise Rule. A law is not inconsistent with FTC Franchise Rule if it

provides prospective Franchisees with equal or greater protection, such as registra-

tion of disclosure documents or more extensive disclosures.

Fifteen states have non-preempted registration, disclosure, or notice filing fran-

chise sales laws (with the approximate original effective date year): California (1971),

Hawaii (1975), Illinois (1974), Indiana (1975), Maryland (1978), Michigan (1974),

Minnesota (1973), New York (1980), North Dakota (1975), Oregon (1973), Rhode

Island (1973), South Dakota (1974), Virginia (1972), Washington (1972), and Wis-

consin (1972). All of these states require that a Disclosure Document (now only in

the FDD format) be provided to a prospective Franchisee prior to the franchise sale,

and all except Oregon require some registration or filing with the state prior to

selling or offering to sell a franchise.

The state law definitions of “franchise” vary somewhat. The California Fran-

chise Investment Law definition was the model for the definitions used in most of

the other states with franchise sales laws. Under the California definition:

“Franchise” means a contract or agreement, either express or implied,

whether oral or written, between two or more persons by which: