Franchising is the fastest growing business growth system in America and is increasing its popularity throughout the world as well. This explosion of franchising opportunities in business has created a new area of legal practice: franchise law.

Franchise law is a complex and specialized area of law requiring particular training and experience. The American Bar Association recognizes this need and has established specific training regarding the franchise relationship.

Due to the many franchise opportunities available, people all over the world are considering franchising as a means to realize their dream as an entrepreneur. Likewise, many small business owners are considering franchising as an avenue to expand and grow their business. As a result, there are companies who have begun taking advantage of those seeking to open their own business. It is for this reason that we recommend, prior to opening your own business, investigate the franchisor thoroughly and understand your commitment. We have provided for you a listing of Franchise Attorneys who can assist you with this investigation, as well as further advise you on what the Franchisors are required to give you in return for your investment.

We have also attached a list of U.S. and State government links that will provide additional information and allow you to fully investigate a franchise before you invest.

GUIDE TO THE FTC and the FTC FRANCHISE RULE

• The Function of the Federal Trade Commission
• Rule Overview
• Rule Requirements
• Business Relationships Covered
• Disclosure Options
• Potential Liability for Violations
• Legal Resources
• Frequently Asked Questions about the FTC
• How the FTC Brings an Action

The Function of the Federal Trade Commission (FTC):
The Federal Trade Commission enforces a variety of federal antitrust and consumer protection laws. It seeks to ensure that the nation's markets function aggressively, and are strong, efficient and free of undue limitations. The FTC also works to improve the steady operation of the marketplace by eradicating practices that are unfair or misleading. Generally, the Commission's efforts are directed toward stopping actions that threaten consumers' opportunities to exercise informed choice.

Finally, the Commission undertakes economic analysis to support its law enforcement efforts and to contribute to the policy deliberations of the Congress, the Executive Branch, other independent agencies and state and local governments when requested.

In addition to carrying out its constitutional enforcement responsibilities, the Commission advances the policies underlying Congressional orders through cost-effective and non-enforcement activities, such as consumer education.

Below you will also find a complete description of the Franchise Rule and it's intricacies.

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The Franchise Rule Overview
A. Basic Requirement: Franchisors must furnish potential franchisees with written disclosures providing important information about the franchisor, the franchised business and the franchise relationship, and give them at least ten business days to review it before investing.

B. Disclosure Option: Franchisors may make the required disclosures by following either the Rule's disclosure format or the Uniform Franchise Offering Circular Guidelines prepared by state franchise law officials.

C. Coverage: The Rule primarily covers business-format franchises, product franchises, and vending machine or display rack business opportunity ventures.

D. No Filing: The Rule requires disclosure only. Unlike state disclosure laws, no registration, filing, review or approval of any disclosures, advertising or agreements by the FTC is required.

E. Remedies: The Rule is a trade regulation rule with the full force and effect of federal law. The courts have held it may only be enforced by the FTC, not private parties. The FTC may seek injunctions, civil penalties and consumer redress for violations.

F. Purpose: The Rule is designed to enable potential franchisees to protect themselves before investing by providing them with information essential to an assessment of the potential risks and benefits, to meaningful comparisons with other investments, and to further investigation of the franchise opportunity.

G. Effective Date: The Rule, formally titled "Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures," took effect on October 21, 1979, and appears at 16 C.F.R. Part 436.

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Rule Requirements
A. General: The Rule imposes six different requirements in connection with the "advertising, offering, licensing, contracting, sale or other promotion" of a franchise in or affecting commerce:

1. Basic Disclosures: The Rule requires franchisors to give potential investors a basic disclosure document at the earlier of the first face-to-face meeting or ten business days before any money is paid or an agreement is signed in connection with the investment (Part 436.1(a)).

2. Earnings Claims: If a franchisor makes earnings claims, whether historical or forecasted, they must have a reasonable basis, and prescribed substantiating disclosures must be given to a potential investor in writing at the same time as the basic disclosures (Parts 436.1(b)-(d)).

3. Advertised Claims: The Rule affects only ads that include an earnings claim. Such ads must disclose the number and percentage of existing franchisees who have achieved the claimed results, along with cautionary language. Their use triggers required compliance with the Rule's earnings claim disclosure requirements (Part 436.1(e)).

4. Franchise Agreements: The franchisor must give investors a copy of its standard-form franchise and related agreements at the same time as the basic disclosures, and final copies intended to be executed at least 5 business days before signing (Part 436.1(g)).

5. Refunds: The Rule requires franchisors to make refunds of deposits and initial payments to potential investors, subject to any conditions on refundability stated in the disclosure document (Part 436.1(h)).

6. Contradictory Claims: While franchisors are free to provide investors with any promotional or other materials they wish, no written or oral claims may contradict information provided in the required disclosure document (Part 436.1(f)).

B. Liability: Failure to comply with any of the six requirements is a violation of the Franchise Rule. "Franchisors" and "franchise brokers" are jointly and severally liable for Rule violations.

1. A "franchisor" is defined as any person who sells a "franchise" covered by the Rule (Part 436.2(c)).

2. A "franchise broker" is defined as any person who "sells, offers for sale, or arranges for the sale" of a covered franchise (Part 436.2(j)), and includes not only independent sales agents, but also subfranchisors that grant subfranchises (44 FR 49963)

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Business Relationships Covered
A. Alternate Definitions: The Rule employs parallel coverage definitions of the term "franchise" to reach two types of continuing commercial relationships: traditional franchises and business opportunities.

B. "Traditional Franchises": There are three definitional prerequisites to coverage of a business-format or product franchise (Parts 436.2(a)(1)(i) and (2)):

1. Trademark: The franchisor offers the right to distribute goods or services that bear the franchisor's trademark, service mark, trade name, advertising or other commercial symbol.

2. Significant Control or Assistance: The franchisor exercises significant control over, or offers significant assistance in, the franchisee's method of operation.

3. Required Payment: The franchisee is required to make any payment to the franchisor or an affiliate, or a commitment to make a payment, as a condition of obtaining the franchise or commencing operations. (NOTE: There is an exemption from coverage for required payments of less than $500 within six months of the commencement of the franchise (Part 436.2(a)(3)(iii)).

C. Business Opportunities: There are also three basic prerequisites to the Rule's coverage of a business opportunity venture (Parts 436.2(a)(1)(ii) and (2)):

1. No Trademark: The seller simply offers the right to sell goods or services supplied by the seller, its affiliate, or a supplier with which the seller requires the franchisee to do business.

2. Location Assistance: The seller offers to secure retail outlets or accounts for the goods or services to be sold, to secure locations or sites for vending machines or rack displays, or to provide the services of someone who can do so.

3. Required Payment: The same as for franchises.

D. Coverage Exemptions/Exclusions: The Rule also exempts or excludes some relationships that would otherwise meet the coverage prerequisites (Parts 436.2(a)(3) and (4)):

1. Minimum investment: This exemption applies if all payments to the franchisor or an affiliate until six months after the franchise commences operation are $500 or less (Part 436.2(a)(iii)).

2. Fractional Franchises: Relationships adding a new product or service to an established distributor's existing products or services, are exempt if: (i) the franchisee or any of its current directors or executive officers has been in the same type of business for at least two years, and (ii) both parties anticipated, or should have, that sales from the franchise would represent no more than 20% of the franchisees sales in dollar volume (Parts 436.2(a)(3)(i) and 436.2(h)).

3. Single Trademark Licenses: The Rule language excludes a "single license to license a [mark]" where it "is the only one of its general nature and type to be granted by the licensor with respect to that [mark]" (Part 436.2(a)(4)(iv)). The Rule's Statement of Basis and Purpose indicates it also applies to "collateral" licenses [e.g., logo on sweatshirt, mug] and licenses granted to settle trademark infringement litigation (43 FR 59707-08).

4. Employment and Partnership Relationships: The Rule excludes pure employer-employee and general partnership arrangements. Limited partnerships do not qualify for the exemption (Part 436.2(a)(4)(i)).

5. Oral Agreements: This exemption, which is narrowly construed, applies only if no material term of the relationship is in writing (Part 436.2(a)(3)(iv)).

6. Cooperative Associations: Only agricultural co-ops and retailer-owned cooperatives "operated 'by and for' retailers on a cooperative basis," and in which control and ownership is substantially equal are excluded from coverage (Part 436.2(a)(4)(ii)).

7. Certification/Testing Services: Organizations that authorize use of a certification mark to any business selling products or services meeting their standards are excluded from coverage (e.g., Underwriters Laboratories) (Part 436.2(a)(4)(iii)).

8. Leased Departments: Relationships in which the franchisee simply leases space in the premises of another retailer and is not required or advised to buy the goods or services it sells from the retailer or an affiliate of the retailer are exempt (Part 436.2(a)(3)(ii)).

E. Statutory Exemptions: Section 18(g) of the FTC Act authorizes "any person" to petition the Commission for an exemption from a rule where coverage is "not necessary to prevent the acts or practices" that the rule prohibits (15 U.S.C. § 57a(g)). Franchise Rule exemptions have been granted for service station franchises (45 FR 51765), many automobile dealership franchises (45 FR 51763; 49 FR 13677; 52 FR 6612; 54 FR 1446), and wholesaler-sponsored voluntary chains in the grocery industry (48 FR 10040).

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Disclosure Options
A. Alternatives: Franchisors have a choice of formats for making the disclosures required by the Rule. They may use either the format provided by the Rule or the Uniform Franchise Offering Circular ("UFOC") format prescribed by the North American Securities Administrators' Association ("NASAA").

B. FTC Format: Franchisors may comply by following the Rule's requirements for preparing a basic disclosure document (Parts 436.1(a)(1)-(24)), and if they make earnings claims, for a separate earnings claim disclosure document (Parts 436.1(b)(3), (c)(3), and (d)). The Rule's Final Interpretive Guides provide detailed instructions and sample disclosures (44 FR 49966).

C. UFOC Format: The Uniform Franchise Offering Circular format may also be used for compliance in any state:

1. Guidelines: Effective January 1, 1996, franchisors using the UFOC disclosure format must comply with the UFOC Guidelines, as amended by NASAA on April 25, 1993. (44 FR 49970; 60 FR 51895).

2. Cover Page: The FTC cover page must be furnished to each potential franchisee, either in lieu of the UFOC cover page in non-registration states or along with the UFOC (Part 436.1(a)(21); 44 FR 49970-71).

3. Adaptation: If the UFOC is registered or used in one state, but will be used in another without a franchise registration law, answers to state-specific questions must be changed to refer to the law of the state in which the UFOC is used.

4. Updating: If the UFOC is registered in a state, it must be updated as required by the state's franchise law. If the same UFOC is also adapted for use in a non-registration state, updating must occur as required by the law of the state where the UFOC is registered. If the UFOC is not registered in a state with a franchise registration law, it must be revised annually and updated quarterly as required by the Rule.

5. Presumption: The Commission will presume the sufficiency, adequacy and accuracy of a UFOC that is registered by a state, when it is used in that state.

D. UFOC vs. Rule: Many franchisors have adopted the UFOC disclosure format because roughly half of the 13 states with franchise registration requirements will not accept the Rule document for filing. When a format is chosen, all disclosure must conform to its requirements. Franchisors may not pick and choose provisions from each format when making disclosures (44 FR 49970).

E. Rule Primacy: If the UFOC is used, several key Rule provisions will still apply:

1. Scope: Disclosure will be required in all cases required by the Rule, regardless of whether it would be required by state law.

2. Coverage: The Rule will determine who is obligated to comply, regardless of whether they would be required to make disclosures under state law.

3. Disclosure Timing: When disclosures must be made will be governed by the Rule, unless state law requires even earlier disclosure.

4. Other Material: No information may appear in a disclosure document not required by the Rule or by non-preempted state law, regardless of the format used, and no representations may be made that contradict a disclosure.

5. Contracts: Failure to provide potential franchisees with final agreements at least 5 days before signing will be a Rule violation regardless of the disclosure format used.

6. Refunds: Failure to make promised refunds also will be a Rule violation regardless of which document is used.

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Potential Liability for Violations
A. FTC Action: Rule violations may subject franchisors, franchise brokers, their officers and agents to significant liabilities in FTC enforcement actions.

1. Remedies: The FTC Act provides the Commission with a broad range of remedies for Rule violations:

a. Injunctions: Section 13(b) of the Act authorizes preliminary and permanent injunctions against Rule violations (15 U.S.C. § 53(b)). Rule cases routinely have sought and obtained injunctions against Rule violations and misrepresentations in the offer or sale of any business venture, whether or not covered by the Rule.

b. Asset Freezes: Acting under their inherent equity powers, the courts have routinely granted preliminary asset freezes in appropriate Rule cases. The assets frozen have included both corporate assets and the personal assets, including real and personal property, of key officers and directors.

c. Civil Penalties: Section 5(m)(1)(A) of the Act authorizes civil penalties of up to $11,000 for each violation of the Rule (15 U.S.C. § 5(m)(1)(A)). The courts have granted civil penalties of as much as $870,000 in a Rule case to date.

d. Monetary Redress: Section 19(b) of the Act authorizes the Commission to seek monetary redress on behalf of investors injured economically by a Rule violation (15 U.S.C. § 57b). The courts have granted consumer redress of as much as $4.9 million in a Rule case to date.

e. Other Redress: Section 19(b) of the Act also authorizes such other forms of redress as the court finds necessary to redress injury to consumers from a Rule violation, including rescission or reformation of contracts, the return of property and public notice of the Rule violation. Courts may also grant similar relief under their inherent equity powers.

2. Personal Liability: Individuals who formulate, direct and control the franchisor's activities can expect to be named individually for violations committed in the franchisor's name, together with the franchisor entity, and held personally liable for civil penalties and consumer redress.

3. Liability For Others: Franchisors and their key officers and executives are responsible for violations by persons acting in their behalf, including independent franchise brokers, sub-franchisors, and the franchisor's own sales personnel.

B. Private Actions: The courts have held that the FTC Act generally may not be enforced by private lawsuits.

1. Rule Claims: The Commission expressed its view when the Rule was issued that private actions should be permitted by the courts for Rule violations (43 FR 59723; 44 FR 49971). To date, no federal court has permitted a private action for Rule violations.

2. State Disclosure Law Claims: Each of the franchise laws in the 15 states with franchise registration and/or disclosure requirements authorizes private actions for state franchise law violations.

3. State FTC Act Claims: The courts in some states have interpreted state deceptive practices laws ("little FTC Acts") as permitting private actions for Rule violations.

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Legal Resources
A. Text of Rule: 16 C.F.R. Part 436.

B. Statement of Basis and Purpose: 43 FR 59614-59733 (Dec. 21, 1978) (Discusses the evidentiary basis for promulgation of the Rule, and shows Commission intent and interpretation of its provisions - particularly helpful in resolving coverage questions).

C. Final Interpretive Guides: 44 FR 49966-49992 (Aug. 24, 1979) (Final statement of policy and interpretation of each of the Rule's requirements - important discussions of coverage issues, use of the UFOC and requirements for basic and earnings claims disclosures in the Rule's disclosure format).

E. Staff Advisory Opinions: Business Franchise Guide (CCH) ¶6380 et seq. (Interpretive opinions issued in response to requests for interpretation of coverage questions and disclosure requirements pursuant to 16 C.F.R. §§ 1.2-1.4).

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Frequently Asked Questions About the FTC
1. Where can I get a company's pre-sale disclosures?
2. How can I find out about complaints against a company?
3. How can I file a complaint against a company?
4. Where can I get the forms for drafting an offering circular?

1. Where can I get a company's pre-sale disclosures?
We are unable to provide copies of pre-sale disclosures, as the FTC does not require filings of such disclosure statements or offering circulars. However, there are 13 states that do keep franchise offering circulars on file, and 23 states that require business opportunity disclosure filings. Most states aren't permitted to provide copies of these disclosures, but typically, office visits are allowed and they will permit a review of the documents by appointment.

Frandata
1155 Connecticut Avenue, NW,
Suite 275
Washington, DC 20036
(202) 659-8640

2. How can I find out about complaints against a company?
No federal or state agency or private organization can tell you whether or not a company is legitimate or operates in good faith. Only reports on whether complaints have been filed against a company can be disclosed. Beware, as scam operators are aware of this fact, and may change the name and location of their company every six to twelve months so they never have a record of consumer complaints.

It is recognized however, that there is no parallel alternative for checking the track record of a franchisor or business opportunity seller by talking to at least ten prior purchasers in person. That is why the Franchise Rule requires companies to include in their disclosures a list of the names, addresses and telephone numbers of at least ten recent purchasers who are geographically closest to you, for you to obtain legitimate references.

If you want information about consumer complaints, your request be in writing. We need to check whether complaints have been received not only in Washington, but also in our 10 regional offices. You can address your request to:

Freedom of Information Act Request
Federal Trade Commission
Washington, D.C. 20580

Please identify your letter as a "FOIA Request" and include (1) your name, address and daytime phone number, and (2) the name and address of the company you are checking on.

In most cases, there are no fees for searching, document review, or copying for members of the general public. This being said, it is a a good idea to state the maximum you are willing to pay, so we can contact you in the unusual event that any applicable fees for these services will cost more than the limit you set.

3. How can I file a complaint against a company?
While we regret that you're having a problem with a franchisor or business opportunity seller, we do like to offer assistance. We cannot offer a guarantee of the success of our help, as the Commission lacks the resources to explore every individual complaint received. For this reason, we urge that you also consider talking with a private attorney about the possibility of bringing a private lawsuit, or taking other action that may help resolve the dilemma at hand.

Despite the Commission's lack of resources, we encourage you to send us your complaint because consumer complaints give us important information. They help us identify companies and practices that affect a broad segment of the public, and are useful for law enforcement purposes.

We ask that all complaints be in writing, but no special form is required. Merely indicate what you believe to be misleading or deceptive in the company's promotional materials, disclosure statement or offering circular. If you want your letter to remain confidential, please print the words, "Privileged and Confidential," on the top of each page.

Be sure your letter includes your name, address and a daytime telephone number where we can reach you. It also helps if you can provide the names and telephone numbers of other purchasers who have experienced the same problems, and if you can send us copies of any written claims in promotional materials or elsewhere that you believe are false. Be sure to send copies, not originals, of any documents you think we should have.

Please address your complaint to:
Franchise & Business Opportunity Complaint
Federal Trade Commission - Rm. 238
Washington, D.C. 20580

4. Where can I get the forms for drafting an offering circular?
The Franchise Rule provides its own disclosure format, published in the Code of Federal Regulations, Volume 16, Part 436 (16 CFR § 436). The Commission also permits the use of an alternative disclosure format called the Uniform Franchise Offering Circular, or "UFOC," issued by the North American Securities Administrators' Association, for Franchise Rule compliance. A copy of the Guidelines for preparing UFOC disclosures, which franchisors wishing to use the UFOC must follow to comply with the Franchise Rule, can be obtained from:

North American Securities Administrators' Association
One Massachusetts Avenue, N.W.
Suite 310
Washington, D.C. 20001
(202) 737-0900

The current Guidelines are also reprinted in the Business Franchise Guide published by Commerce Clearing House, Inc., which is available in many law libraries.

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HOW THE FTC BRINGS AN ACTION. . .
The FTC may begin an investigation in a variety of ways. Letters from consumers or businesses, Congressional inquiries, or articles on consumer or economic subjects can all be an impetus for FTC action.
Investigations are either public or nonpublic. Generally, FTC investigations are nonpublic in order to protect both the investigation and the company.

If the FTC believes there was a violation of the law, it might attempt to obtain voluntary compliance by entering into a consent order with the company. A company that signs a consent order need not admit that it violated the law, but it must agree to stop the disputed practices outlined in an accompanying complaint.

If a consent agreement cannot be reached, the FTC may issue an administrative complaint. If an administrative complaint is issued, a formal proceeding that is much like a court trial begins before an administrative law judge: evidence is submitted, testimony is heard, and witnesses are examined and cross-examined. If a law violation is found, a cease and desist order or other appropriate relief may be issued. Initial decisions by administrative law judges may be appealed to the full Commission.

Final decisions issued by the Commission may be appealed to the U.S. Court of Appeals and, ultimately, to the U.S. Supreme Court. If the Commission's position is upheld, the FTC, in certain circumstances, may then seek consumer redress in court. If the company ever violates the order, the Commission also may seek civil penalties or an injunction.
In some circumstances, the FTC can go directly to court to obtain an injunction, civil penalties, or consumer redress. This usually happens in cases of ongoing consumer fraud. By going directly to court, the FTC can stop the fraud before too many consumers are injured.

The Commission can also issue Trade Regulation Rules. If the FTC staff finds evidence of unfair or deceptive practices in an entire industry, it can recommend that the Commission begin a rulemaking proceeding. Throughout the rulemaking proceeding, the public will have opportunities to attend hearings and file written comments. The Commission will consider these comments along with the entire rulemaking record--the hearing testimony, the staff reports, and the Presiding Officer's report -- before making a final decision on the proposed rule. An FTC rule may be challenged in any of the U.S. Courts of Appeal. When issued, these rules have the force of law.

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FTC Regional Offices
Offering Circulars by State
Fifteen states have franchise investment laws that require franchisors to provide pre-sale disclosures, known as "offering circulars," to potential purchasers. Thirteen of these state laws treat the sale of a franchise like the sale of a security. Typically, the offer or sale of a franchise within said state is prohibited until a franchise offering circular has been filed on the public record with, and registered by, a designated state agency. Please note that two of the fifteen states listed below do not require a filing of offering circulars.

These state laws are in place to give franchise purchasers their mandatory legal rights, including the right to bring private lawsuits for violation of the state disclosure requirements. We promote potential franchisees residing in these states to contact their state franchise law administrators for additional information about the protection provided by these laws.

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FOR MORE INFORMATION:
Letters from consumers are very important to the work of the FTC. They are often the first indication of a problem in the marketplace and may provide the initial evidence to begin an investigation. If you have a consumer problem or complaint, write to the Federal Trade Commission. Although the agency cannot act to resolve individual problems, it can act when it sees a pattern of possible law violations develop.

Contact your nearest FTC regional office for additional information or check the FTC Web site at http://www.ftc.gov/