All businesses are subject to a variety of laws. Franchised businesses are subject to their own particular laws, such as state and federal laws that govern the disclosures that must be given to franchisees, the registration of the franchise offering, and the ongoing relationship with franchisees.
Franchise laws can be divided into two categories: (1) registration and disclosure requirements; and (2) relationship restrictions. Franchising is regulated at both the state and federal level in some states, and only at the federal level in others (where the state does not have a state franchise law).
Registration & Disclosure Requirements
The federal law regulating the disclosure of franchises is the Amended Federal Trade Commission Rule (“Amended FTC Rule”). This federal law requires that certain disclosures be made to any prospective franchisee about the franchisor and the franchise system before the franchisee can purchase a franchise. Specifically, a franchisor must have a detailed Franchise Disclosure Document, Franchise Agreement, and ancillary contracts that comply with the Amended FTC Rule, regardless of which state the franchise offering may be offered in. The Franchise Disclosure Document describes in detail the history of the franchisor and the franchise system, current information on the franchisor and the franchise system (including financial statements and the current number of outlets in the franchised system), and the franchise system itself (e.g., products and services offered, trademarks and other intellectual property that can be used, fees, and supplier relationships). The Franchise Disclosure Document is not a contract between the franchisor and franchisee, but merely a disclaimer document required by law. The Franchise Agreement and any ancillary contracts (such as licenses, leases, equipment purchase agreements, guaranties, etc.) are the binding contracts between the franchisor and each franchisee governing the franchise relationship. The Amended FTC Rule does not, however, require that the franchise offering be registered; it is only a disclosure law.
14 states have adopted their own registration and disclosure laws: California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Rhode Island, South Dakota, Virginia, Washington, and Wisconsin. In these states, a franchisor must register its Franchise Disclosure Document (together with the Franchise Agreement and ancillary contracts) with a state regulatory agency before it can make any offers or sales of franchises in the state or to residents of the state. Sometimes, the franchisor (or a particular franchise sale between the franchisor and a particular franchisee) is exempt from registering the franchise offering in a state, but this is not typically the case for small franchisors. These states also require specific disclaimers and limitations in addition to the Amended FTC Rule; we incorporate these specific disclaimers and limitations in state-specific addenda to the Franchise Disclosure Document, Franchise Agreement, and ancillary contracts.
Registering your franchise means completing a relatively simple filing in some states, but in most, the state will do a comprehensive review of your documents to ensure they comply with applicable law and do not include provisions that the state deems unfair. The state will also review your financial statements and, if it determines that you do not have sufficient assets to perform all the duties you are promising to franchisees, it will require some form of financial assurance from you. This is especially common for new franchisors. Some options for providing financial assurance to the state include a cash infusion into the company, deferring collection of initial fees from franchisees, escrowing initial fees from your franchisees with a bank until you perform all your pre-opening obligations to the franchisee, or posting a surety bond. Unfortunately, each state uses different criteria to determine whether these “financial assurances” are necessary.
California, Maryland, Minnesota, New York, North Dakota, South Dakota, and Washington also require you to file or register any advertisements you want to use to offer or sell your franchise before your advertisements can be used. Sometimes, the state must approve the advertisement itself before you can use it. And a few states have specific disclaimers or other information that you must include in any advertisements. The Larkin Hoffman Franchise Team will review and, if needed, revise any advertisements, and file or register them with states that require it.
Offering or Selling Franchises
Once you have a Franchise Disclosure Document (registered and filed, if required), Franchise Agreement, and ancillary contracts, you can give those documents to a prospective franchisee. The franchisee has a certain amount of time to review the documents, and after that, you can sell them the franchise (e.g., sign the Franchise Agreement and ancillary contracts and receive any initial franchise fees).
Annual Renewals & Amendments
To continue franchising after the first year, you must file renewal applications in the 14 registration states, usually within 120 days of your company’s fiscal year end. These renewal applications require you to update and file your Franchise Disclosure Document. The timeframe between filing a renewal application and the state granting the renewal ranges anywhere from a few days to a few months, depending on the state and the specific circumstances. Sometimes, a state may reject a renewal application for one or more reasons. If that happens, the Larkin Hoffman Franchise Team will respond to the states to ensure that the renewal application is accepted. In all other states, you still have to update your Franchise Disclosure Document to continue offering or selling franchises. All information in the Franchise Disclosure Document must be updated at least annually, and certain new information must be provided each year (including audited financial statements and the number of units existing as of the end of each fiscal year).
If a material change or event occurs in the franchise system or with the franchisor, state and federal law also requires you to update your Franchise Disclosure Document and file it with certain states within a certain time period after this material change or event—even if your franchise offering is not yet due for renewal.
But wait, there’s more! The above laws just govern the registration and disclosure requirements before you can offer or sell a franchise. Some states also have “relationship laws” which govern the relationship between the franchisor and existing franchisees. These relationship laws vary state by state, but usually regulate (a) whether the franchisor can make changes to the franchise system during the term of a Franchise Agreement, (b) whether the franchisor can terminate a franchisee early for breaches of the Franchise Agreement (and whether the franchisor must give the franchisee a “cure period” to try and correct the breach), (c) whether a franchise must be renewed when it expires, and (d) what types of practices the state deems “unfair” (e.g., clauses in your Franchise Agreement that discriminate among franchisees).
The Larkin Hoffman Franchise Team help you navigate these state and federal laws so you can focus on growing and operating your franchise system, and not be distracted by the legal technicalities.
There are several other laws that apply to franchising that are worth noting. Many states have business opportunity laws. Every franchise is a business opportunity, but not every business opportunity is a franchise—so business opportunity laws generally cover “dealership” or “distributorship” relationships that may not fall within the franchise laws. Most of these laws require pre-sale disclosure and registration. Traditional franchises are generally exempted from registering as a business opportunity in many states, often by virtue of having a federally-registered trademark or by complying with the Amended FTC Rule. However, there are filing requirements for franchisors in some states.
Franchisors must also be mindful of intellectual property, antitrust, and tax laws. Additionally, each franchise outlet must comply with all laws applicable to businesses in the place where it is located. For example, a franchisee in Minneapolis, Minnesota has to comply with the federal Americans With Disabilities Act, Minnesota minimum wage requirements, licensing and permit requirements, and county, state, and city building ordinances, among many other laws.