An Introduction to Franchising in the United States Andrew Loewinger

2 Franchising in the U.S.

3 Non-U.S. Franchisors in the United States  Cartridge World  Ikea  The Body Shop  Senor Frog’s /Carlos’n Charlie’s  FamilyMart Co. Ltd  Pollo Campero  Tim Hortons  Benetton

4 Franchise Regulation: Working Towards a More Perfect Union Federal Regulation: –Federal Trade Commission (FTC) Amended Franchise Rule (2007) State Regulation: –Franchise Sales Laws –Franchise Relationship Laws –Business Opportunity Laws

5 Federal Regulation In 2007, the FTC amended its Franchise Rule The original Franchise Rule (1979): -- Disclosure requirements designed to enable prospective franchisees to make informed decisions about whether to enter into a franchise agreement –Was not consistent with requirements imposed by various states –Imposed additional burdens on franchisors –The Amended Rule does not govern the Franchisor – Franchisee relationship.

6 The Franchise Relationship Defined FTC Franchise Rule: The Franchisor: Promises to provide a trademark or other commercial symbol; Promises to exercise significant control or provide significant assistance in the operation of the business; and Requires a minimum payment of at least $500 during the first 6 months of operation. * Definitions under state law vary

7 Disclosure Under the Amended Rule OLD RULE: First personal meeting OR 10 business days prior to –payment of any monies –execution of the Agreement NEW RULE: 14 calendar days prior to: –payment of any monies –execution of the Agreement OR Earlier in the process upon a reasonable request from a prospective franchisee Franchisors must provide a “prospective franchisee” with a Franchise Disclosure Document (formerly known as a UFOC), which contains information about the Franchisor and the franchised business.

8 Presentation to a Prospective Franchisee Disclosure no longer mandatory at first-personal meeting Franchisors can conduct initial information gathering and sales meetings without having to provide an FDD “Prospective franchisee”  –Completed initial application –Qualified & approved by franchisor –Attendance at “discovery day” Reduces compliance costs Allows Non-U.S. Franchisors to test the market * Some states have different disclosure “timing” rules

9 What Must Be Disclosed in the FDD? 25 REQUIRED ITEMS Background on the Franchisor, Management Personnel, and the Franchised Business (Items 1-4) Fees: Initial Investment, Fees Paid to the Franchisor (Items 5-7) Assistance by Franchisor, Sources of Products & Services, Training, Advertising Requirements, Territorial Restrictions (Items 9- 12) Intellectual Property: Trademarks and Patents (Items 13-14) Franchisee’s Obligations, Summary of the Franchise Agreement, Public Figures, Franchisee Tables (Items 15-18, 20) Financial Performance Representations (Item 19) Financial Statements (Item 21) Contracts (Item 22) Receipt Page (Item 23)

10 Item 19: Financial Performance Representations Previously known as “Earnings Claims” Strictly optional – not mandatory –If a Franchisor does not make Financial Performance Representations in Item 19, it is strictly prohibited from making any such representation anywhere else Franchisor must have “reasonable basis” and written substantiation for the representations Potential source of liability

11 Item 21: Financial Statements Mandatory requirement: 3 years of audited financial statements prepared according to GAAP Phase-in of audited financials for start-up franchise systems * Disclosure of parent financial information required in limited circumstances * Certain states may not allow phase-in of audited financials

12 Updating the FDD Under the Amended Rule, the FDD must be updated –Annually (within 120 days after the close of Franchisor’s fiscal year); and –Quarterly, to reflect material changes State laws differ, but most require updates on an annual basis and “promptly” after any material changes

13 State Regulation: Franchise Sales Laws Many state laws govern disclosure requirements and the franchisor-franchisee relationship Franchise relationship laws typically prohibit: –Termination without “good cause” –Requiring that arbitration or litigation be conducted outside the state –Discriminating between franchisees or restricting free association among franchisees –Encroaching on a franchisee’s territory –Unfair restrictions on a franchisee’s right to transfer its franchise

14 Registration States CaliforniaNew York HawaiiNorth Dakota IllinoisRhode Island IndianaSouth Dakota MarylandVirginia MichiganWashington MinnesotaWisconsin

15 A State’s Franchise Law May Apply If: The offer to sell originates in the state The offer to sell is directed to the state The offer to buy is accepted in the state The prospective franchisee is a resident of the state; or The franchised business will be located in the state

16 Exemptions Under State Law Exemptions include: Net Worth and Experience Franchisee Sale Existing Franchisee Isolated Transaction Fractional Franchise By Order of the Administrator Even if a Franchisor qualifies for an exemption, it must still provide disclosure to prospective franchisees.

17 CONCLUSION Fewer barriers to entry in the U.S. Market Franchisors may conduct exploratory meetings without triggering the FTC disclosure requirements FTC Rule applies to the offer or sale of a franchise to be located in the U.S.