August 26, 2014
Addressing Legal Risk Requires Team-building
For the entrepreneur or business considering franchising their successful business, one of the biggest hurdles to overcome is meeting the franchising legal requirements. Doing the things the government requires as well as the things that are necessary in order to maintain industry standards are a part of meeting franchising legal requirements. Beyond that, however, the wise business decision-maker will think long-term, and consider whether the contracts they use might be challenged in Court.
An average small business earning $1 million per year spends $20,000 on lawsuits each year.1 By using well-drafted contracts and other preventive legal services, a business can significantly reduce the risk of having to defend a lawsuit. You will need a business attorney. When it comes to legal issues cutting corners and DIY solutions are ineffective and inefficient, and, in the long run, often lead to greater costs than benefits.
Understanding the Minimum Franchising Legal Requirements
Where to Find the Rules
The Federal Trade Commission (FTC) promulgates rules, codified in the Code of Federal Regulations (C.F.R.), governing the federal disclosure requirements and prohibitions concerning franchising. These requirements and prohibitions are published in Title 16 of the C.F.R., Part 436 (16 C.F.R. 436). Section 436.2 (§436.2) covers the obligation a franchisor has to furnish disclosure documents to potential franchisees. Failing to meet the requirements of 16 C.F.R. 436.2, according to its own terms, is “an unfair or deceptive act or practice in violation of Section 5 of the Federal Trade Commission Act” (Title 15 of the United States Code Annotated, Section 45; 15 U.S.C.A. § 45). The FTC’s Bureau of Consumer Protection also has a somewhat helpful FAQ for helping interested parties understand the Amended Franchise Rule.
Penalties for Violating the Rules
Title 15 of the United States Code Annotated, Section 45, Subsection “(m)” provides:
“(1)(a) The Commission may commence a civil action to recover a civil penalty in a district court of the United States against any person, partnership, or corporation which violates any rule under this subchapter respecting unfair or deceptive acts or practices (other than an interpretive rule or a rule violation of which the Commission has provided is not an unfair or deceptive act or practice in violation of subsection (a)(1) of this section) with actual knowledge or knowledge fairly implied on the basis of objective circumstances that such act is unfair or deceptive and is prohibited by such rule. In such action, such person, partnership, or corporation shall be liable for a civil penalty of not more than $10,000 for each violation.” (emphasis added)
Clearly, these are very serious federal rules with stiff penalties. Also, if you haven’t noticed by now, they’re not the easiest rules to read, much less to follow. Having a business attorney to help you navigate through these regulations is strongly advised. Also, keep in mind that the registration states’ regulations are actually more stringent than the federal regulations on franchises.
The Big Three
There are three major requirements imposed by 16 C.F.R. §436. These are:
(a) The franchisor must provide to a prospective franchisee a copy of the franchisor’s current disclosure document at least 14 calendar days before the prospective franchisee signs any contract or makes any payments to the franchisor (or any affiliate of the franchisor) in connection with the proposed sale of a franchise;
(b) The franchisor may not “unilaterally and materially” alter the terms and conditions of the basic franchise agreement or any related agreements attached to the disclosure document without furnishing to the prospective franchisee a copy of each revised agreement at least 7 calendar days before the prospective franchisee signs the revised agreement. “Changes to an agreement that arise out of negotiations initiated by the prospective franchisee do not trigger this seven calendar-day period.” 16 C.F.R. 436.2(b).; and
(c) The required documents are considered furnished by the required date if “(1) a copy of the document was hand-delivered, faxed, emailed, or otherwise delivered to the prospective franchisee by the required date; (2) directions for accessing the document on the Internet were provided to the prospective franchisee by the required date; or (3) a paper or tangible electronic copy (for example, computer disk or CD-ROM) was sent to the address specified by the prospective franchisee by first-class United States mail at least three calendar days before the required date.” 16 C.F.R. 436.2(c).
The Franchise Disclosure Document
There are many, many things that must go into an acceptable Franchise Disclosure Document (FDD). In fact, “