Part 1 of this blog series addressed business issues to consider in deciding whether to franchise your business and preparations to be made before launching a franchise program. Part 2 of this blog series addressed preparation of the legal documents required under federal and state franchise law – the Franchise Agreement and the Franchise Disclosure Document (“FDD”). Part 3 of this blog series addressed state registration of franchises. This blog addresses compliance with franchise laws as a new franchisor begins offering and selling franchises. In addition to franchise disclosure and registration requirements, the federal and state franchise laws cover actions that must be taken when offering and selling franchises and actions that are prohibited in the offer and sale of franchises.
The first step Carter & Tani recommends to our new franchisor clients is to have key management and sales personnel attend one of our franchise sales compliance training classes (we also hold refresher classes for more established franchise companies). It is critical that officers, managers, employees and agents of a franchise company have a general understanding of the laws that regulate franchise sales so that they can avoid violating any of the franchise laws.
Violations of franchise laws can lead to investigations by federal or state franchise regulators. Violations of franchise law can lead to a lawsuit being brought in the future by a disgruntled or unsuccessful franchisee. A regulatory action being taken against the franchisor and/or its personnel or a lawsuit filed against a franchisor and/or its personnel for franchise violations must then be disclosed in the franchisor’s Franchise Disclosure Document for 10 years. Also, it is likely that a franchisor will not be able to take enforcement action against a defaulting franchisee if it is discovered that franchise law violations occurred when the franchise was sold to this franchisee.
Here is a short list of some of the rules that govern franchise sales. (This is not intended to be an exhaustive list.)
1. You cannot discuss the offer of a franchise in a registration state unless you have first obtained a franchise registration (or exemption) in that state. Part 3 of the blog identified the franchise registration states. As a new franchisor, you often begin with registering in only a few of the franchise registration states. If prospective franchisees from other registration states contact you, you cannot discuss the offer of a franchise with them.
2. All information and materials provided to prospective franchisee must be consistent with the contents of the Franchise Disclosure Document. For that reason, you must be careful that the content of all franchise advertising and promotional materials, including your website, is consistent with the disclosures in the FDD. Also, franchise advertising must comply with the regulations of the franchise registration states, and in some cases, must be filed with the registration state before use.
3. All of the discussions that your sales personnel have with prospective franchisees must be consistent with and not contradict the contents of the Franchise Disclosure Document. For that reason, all sales personnel must thoroughly read and become familiar with the FDD contents.
4. You are limited in making any comments or providing any information on financial performance of company-owned, affiliate-owned or franchised outlets (or projecting how a new franchise might perform) to the information that you included in Item 19 of the FDD (Financial Performance Representations). If you do not include any financial data in Item 19 of your Franchise Disclosure Document, you cannot discuss any financial performance information with prospective franchisees. If you do include financial performance data in Item 19, you are limited to discussing what is contained in Item 19 of the FDD.
5. At some point in the sales process, you will provide the Franchise Disclosure Document to your prospective franchisee. The prospective franchisee must have the FDD for at least 14 calendar days before you can permit them to sign a franchise agreement or pay you any money. The first thing to be done when you deliver the FDD is to have the prospective franchisee date and sign the receipt at the back of the FDD and return it to you. Federal law requires that you keep this receipt in your records. You also want to keep it for proof that you did meet this 14 day disclosure rule.
6. If the prospective franchisee decides that they want to purchase the franchise after having the FDD, you must prepare a completed, execution copy of the franchise agreement and deliver it to the prospect. The prospective franchisee must have this completed franchise agreement for at least 7 days before signing or paying any money. (There is an exception to this rule if no material terms need to be filled in on the standard franchise agreement found in the FDD.)
7. The franchise laws require that the Franchise Disclosure Document be updated at least once each year. In addition, there is an ongoing obligation to update the FDD when material changes occur in the information disclosed in the FDD (the timing of when this must be done varies under federal law and the various state laws). If any changes occur during the year, the FDD must be amended and the amended FDD delivered to prospective franchisees before any additional sales are made.
8. Of course, the franchise laws also prohibit fraud and misrepresentation in the offer and sale of franchises.
While all of these rules may seem daunting, a good franchise sales compliance training program, the establishment of internal franchise sales compliance policies and procedures, and counsel from an experienced franchise attorney can go a long way to ensuring that you sell franchises in compliance with the franchise laws.