by Noel Bagwell
for Executive Legal Professionals, PLLC

September 14, 2015

Government Thugs: Understanding the Essence of Regulation

In order to understand franchising regulations, you need to really take a step back and consider who regulators and what regulations are. Simply put, regulators are thugs. They operate at the state and national levels, and their job, essentially, is this: to take money or property from you without your consent (fine, tax) for freely operating your business, unless you jump through their loopholes (comply with regulations). You would think, in “the land of the free and the home of the brave,” we wouldn’t put up with the government acting like thugs. Originally, we didn’t. The federal government, at least, was not originally understood to have the broad power to control commerce under the guise of “regulation.”

The most persuasive evidence of original meaning–statements made during the drafting and ratification of the Constitution as well as dictionary definitions and The Federalist Papers–strongly supports Justice Thomas’s and the Progressive Era Supreme Court’s narrow interpretation of Congress’s power “To regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes.” “Commerce” means the trade or exchange of goods (including the means of transporting them); “among the several States” means between persons of one state and another; and the term “To regulate” means “to make regular”–that is, to specify how an activity may be transacted–when applied to domestic commerce, but also includes the power to make “prohibitory regulations” when applied to foreign trade. In sum, Congress has power to specify rules to govern the manner by which people may exchange or trade goods from one state to another, to remove obstructions to domestic trade erected by states, and to both regulate and restrict the flow of goods to and from other nations (and the Indian tribes) for the purpose of promoting the domestic economy and foreign trade. Randy J. Barnett, The Original Meaning of the Commerce Clause, 68 U. Chi. L. Rev. 101 (2001).

In the last hundred years or so, the federal government has seized power from the states and from the People with startlingly little resistance. The problem–and the government–has grown so large that the federal government now more-or-less claims authority to make any rule, define any term, or institute and demand conformity with any regulation on any aspect of human life. Try to imagine a rule the federal government admits it cannot make. When we are ruled by thugs in a largely unelected Administrative State, understanding the rules–both laws and regulations–by which a company must play in order to profitably transact business is nearly impossible, and it is practically impossible without good legal counsel.

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Street Smarts: Franchise Regulations Demystified

Federal Disclosure Regulations

Franchising regulations exist at both the national (federal) and state level. The Federal Trade Commission (“FTC”) enforces a the trade regulation rule called “Disclosure Requirements and Prohibitions Concerning Franchising,” codified at 16 C.F.R. 436. In the franchising industry, this is more often simply called the “FTC Rule” or the “Franchise Rule.” The FTC Rule requires franchisors in the U.S. to deliver to prospective franchisees a “Franchise Disclosure Document (“FDD”) with any offer of a franchise. The FTC determines what must be included in the FDD; but the Franchise Rule does not require franchisors to file a copy of the FDD with the FTC before use, nor does the Franchise Rule require franchisors to have the FTC review the FDD before a franchisor can use it.

If, at any time in the sales process, a prospective franchisee requests a copy of the FDD, the franchisor must provide them with one. Franchisors must deliver their FDD to prospective franchisees to whom a franchise offer has been made more than two weeks before the prospective franchisee can sign any legally binding agreement or make any payment to the franchisor related to the franchise offer. Also, at any time after the FDD has been delivered to a prospective franchisee, if the franchisor makes a material change to the franchise agreement or any related agreements, the franchisor must deliver a copy of the revised FDD to the prospective franchisee more than one week before the prospective franchisee can sign any legally binding agreement or make any payment to the franchisor related to the franchise offer.

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State Registration and Disclosure Laws

Not every state in the U.S. requires franchisors to register their franchise with the state, though about 14 states do. To complicate matters, registration requirements vary from state to state. Some states merely require franchisors to file a notice with the state, while others may require full state-level review of the FDD. Also, a few states have small differences in the timing requirements for delivery of the FDD, which add more time for prospective franchisees to review the FDD before signing any legally binding agreements with the franchisor or paying any money to the franchisor in connection with the franchise offer.

Some states also have what they call “business opportunity” laws, which usually deal with regulating how businesses can offer to sell or lease products, equipment, or services for the purpose of enabling an investor to start a business. Business Opportunity laws can also regulate what representations promoters can make to induce prospective investors to invest in a business. For example, states tend to frown on promises or guarantees that an investor will make a profit, and they typically also dislike promoters’ promises to buy goods or services produced by the investor or to set-up client or customer relationships for the investor.

Because “business opportunity” laws really have a different focus than laws specifically written to regulate franchises, per se, franchisors, in some cases, can obtain an exemption from compliance with these laws. Exemptions obtained by filing notices are most common in Florida, Kentucky, Nebraska, Texas, and Utah. Other states have different requirements for obtaining an exemption, and a few will require full registration of the franchise in the state. At the federal level, the FTC Rule no longer governs “business opportunities,” which are now regulated under 16 C.F.R. Part 437, and if a franchisor complies with the requirements of 16 C.F.R. 436, it can safely ignore the requirements of 16 C.F.R. Part 437.

EVEN MORE Franchising Regulations

but-wait-theres-more“But wait, there’s more!” In nearly two dozen states and U.S. territories, franchisors and franchisees must comply with additional regulations. With so many individual jurisdictions, there is considerable variety in the content of each state’s or territory’s regulations over the relationships between franchisors and franchisees. The additional regulations in these states often require some kind of notice or good cause, and, in some cases, an opportunity to cure a material breach of contract before a franchisor may cancel a franchise agreement with a franchisee in the relevant state or territory.

Navigating the labyrinth of laws and regulations with which a franchisor must comply to simply offer a franchise to a franchisee can be a crushing burden, but it does not have to be. Affordable General Counsel is available. Executive Legal Professionals can provide your business with the guidance it needs to avoid the pitfalls in the path to operating a successful franchise company. If you are considering starting a franchise, we’d love to hear from you. Contact Executive Legal Professionals online, or give us a call at (615) 669-6566, and don’t forget to download a copy of our free White Paper on Franchising, today!


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