Many business owners became successful by purchasing and operating a franchise. But other franchisees have not been so fortunate and broke even, lost money, or went bankrupt, which is why it’s important for a potential franchisee to learn about franchise law and the Franchise Rule. The Federal Trade Commission’s Franchise Rule regulates franchising and the relationship between franchisors and franchisees. The Rule promotes business and growth by supporting the franchising of trademarks and brands, but it also requires extensive disclosure about the franchise opportunity to help potential franchisees understand the franchise and its operations as well as the upside potential and the downside risk.
What Is Franchise Law?
Franchise law is a business-related area of law that regulates the relationship between franchisors and franchisees. It involves trademark licensing, detailed contracts between the franchisor and franchisee, and a range of business-law matters that can arise when running a business.
Franchisors are basically offering a business opportunity to potential franchisees that allows the franchisee to use the franchisor’s trademark while operating their own independent business. To reduce the chances of exploitation by franchisors, the Federal Trade Commission adopted the Franchise Rule in 1979. The key requirement of this rule is the Franchise Disclosure Document (“FDD”), which calls for mandatory disclosure of extensive information to potential franchisees about the franchise purchase, the potential for success, and the risk of loss, among other things. The Franchise Rule helps protect franchisees against misleading practices and/or incomplete information prior to signing a franchise agreement.
What’s Included in a Franchise Disclosure Document?
The FDD is the most-important requirement of the Franchise Rule, and it must be provided to any potential franchisee at least 14 days before a franchise agreement is signed. In the FDD, the franchisor must disclose extensive, detailed information about the franchisor’s business, purchasers of a franchise, fees that will be due to the franchisor, copies of the franchise agreement and any other agreement, and other matters. The FDD requires these disclosures in 23 different categories:
- The Franchisor, and any Parent Entities, Predecessors, and Affiliates
- The Franchisor’s Business Experience
- Current and Past Litigation
- Bankruptcy (within the past ten years)
- Initial Fees for the Franchise Purchase
- Other Fees Related to Purchasing or Owning the Franchise
- Estimated Initial Investment
- Restrictions on Sources of Products and Services
- Franchisee’s Obligations
- Financing (if offered)
- Franchisor’s Assistance, Advertising, Computer Systems, and Training
- Territory Covered by the Franchise Purchase
- Trademark Identification, Licensing, and Use
- Patents, Copyrights, and Proprietary Information
- Obligation to Participate in Actual Operation of the Franchise Business
- Restrictions on What the Franchisee May Sell
- Renewal, Termination, Transfer, and Dispute Resolution
- Compensation to Any Public Figure Associated with the Trademark or Franchise
- Financial Performance Representations
- Number of Outlets and Franchisee Information
- Financial Statements
- Copies of Franchise Agreements
- Acknowledgment of Receipt of FDD
FDDs can be quite lengthy—often around 400 pages—and the potential franchisee should scrutinize the information provided carefully. Although some experienced franchisees may not need to consult an attorney, the best approach for first-time and less experienced franchisees is to consult with an attorney about the legal perspective. Potential franchisees may also want to consult an accountant or other business advisor.
Conclusion
Owning a franchise provides franchisees with the opportunity to own a business and succeed in that business. But running a franchise operation also requires knowledge and experience as well as business and legal savvy. The length and detail of the FDD is intended to provide business people interested in purchasing a franchise with full disclosure of downside risks and the upside potential of owning a franchise. For those who are new to owning a franchise or running a business, the best approach is to discuss the FDD with an attorney before signing a franchise agreement.
Attorney James D. Griffith at Endurance Business Law, PLLC, is an experienced business attorney who can review FDDs and provide advice and guidance on the legal risk. To set up a consultation regarding a contract matter, please call our office at (480) 997-2951 or use the Contact form on this website.