Member Article

The Federal Trade Commission yesterday published its long awaited revisions to the FTC’s Franchising Rule.

The new disclosures may be used effective July 1, 2007 and must be used for all franchises offered or sold after July 1, 2008. The Amended Rule prescribes a disclosure format which largely mirrors the Uniform Franchise Offering Circular ("UFOC") format, and modifies it in certain places by adding new disclosures. The Commission plans to publish Compliance Guidelines, which will use the current UFOC Guidelines as their point of departure.

Franchisors will find many things to like about the Amended Rule. Requirements related to the delivery of disclosures will be welcomed by all, while exemptions for high investment franchises and for sales to certain high net worth franchisees will eliminate compliance obligations altogether for some franchisors. All franchisors will be allowed to use electronic means to deliver disclosure documents. Financial Performance Representations (i.e., earnings claims) remain optional, not mandatory. New franchisors may continue to phase into the financial audit requirement if they have not previously had audits

The Amended Rule has addressed many of the concerns raised by the franchising community since the August, 2004 FTC Staff Report was issued. For example, thresholds for large investment franchises have been lowered, and the number of franchisor employees who are entitled to qualify for a new exemption have been expanded.

New Exemptions

Several new exemptions are created, including:

1. The sale of franchises to be located outside the United States;

2. Franchises involving investments of at least $1 million (excluding unimproved land and amounts financed by the franchisor). This initial investment would be calculated to include multi-unit development commitments, and the value of a business which is converted to a franchise through an affiliation franchise agreement;

3. Investments by high net worth, experienced franchisees –those with 5 years of business experience and a net worth of at least $5 million; and

4. Sales to certain officers, owners and managers of franchisors.

No More Broker Disclosures or Venue/Law Choice Risk Factors

Franchisors which use franchise brokers will find that their burdens are relaxed considerably, as disclosures about franchise brokers no longer are required. The UFOC’s required use of "risk factors" based upon a franchisor’s choice of law or venue for disputes no longer will be required either.

Timing of Disclosures Simplified

The rules for when disclosures must be given to prospective franchisees also provide a welcome change. The duty to provide a disclosure at the "first personal meeting" has been deleted, and the cumbersome 10 business day counting problem has been eliminated. Now, disclosures must be provided 14 calendar days before the franchisor receives money from the franchisee or the franchisee signs a franchise related agreement. However, if a prospective franchisee "reasonably requests" a disclosure document earlier than 14 days before the agreement is signed or money is paid, he is entitled to receive it earlier. Completed agreements must be provided to prospects 7 days before signing, only if the franchisor has unilaterally made a change to the standard form agreement provided with the disclosure document.

New Disclosure Highlights

Some of the additional disclosure information which will be required includes:

1. Information about the franchisor’s parent in items 1, 3 and 4. Financial statements of the parent must be included if the parent will provide services to franchisees or if it guarantees obligations of the franchisor;

1. 2. Information about franchisor-initiated litigation against franchisees;

    

1. 3. Information about the franchisor’s use of confidentiality clauses;

    

1. 4. Information about the existence of "trademark-specific franchisee associations;"

    

1. 5. Earnings claims, renamed as "Financial Performance Representations," may be provided in a document which is separate from the basic disclosure document. The term includes certain cost information provided by franchisors;

    

1. 6. Franchisee turnover information will be presented in a way which will substantially reduce the likelihood of "double counting" transfers and terminations; and

    

1. 7. Information about the use of confidentiality agreements.

    

New Prohibitions

The Amended Rule contains several new prohibitions. They include requiring a prospective franchisee to waive reliance on any representation made in a disclosure document or its exhibits or amendments, and using "shills" to promote franchises.

The highlights of changes to the Rule are just that. The Amended Rule is part of a 398 page document, which contains the details with which franchisors and their lawyers will need to become familiar to meet the new requirements. Still unknown is exactly how quickly states with franchise registration laws will be able to adapt to the changes, and the extent to which they will require additional information. To that end, the Haynes and Boone Franchise and Distribution Practice Group is preparing a series of presentations in cities around the country to explain details of the changes. We also are preparing revised disclosure questionnaires which will be used to update the current UFOC format disclosures. We will distribute these at the forthcoming presentations, as well as other practical information about complying with the new requirements, exemptions and record keeping requirements.

Finally, Joyce Mazero will be moderating a panel discussion of federal and state regulators at the upcoming IFA Legal Symposium, held in May 2007. The discussion will focus on addressing the many unanswered questions concerning the Amended Rule, including its use in compliance with state registration and disclosure laws.

By: Carl E. Zwisler and Jan S. Gilbert

If you have questions about the Amended Rule, please contact the Haynes and Boone Franchise and Distribution Law Practice Group.