[Federal Register: March 30, 2007 (Volume 72, Number 61)]
[Rules and Regulations]
[Page 15443-15575]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr30mr07-12]
[[Page 15443]]
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Part V
Federal Trade Commission
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16 CFR Parts 436 and 437
Disclosure Requirements and Prohibitions Concerning Franchising and
Business Opportunities; Final Rule
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FEDERAL TRADE COMMISSION
16 CFR Parts 436 and 437
Disclosure Requirements and Prohibitions Concerning Franchising
Disclosure Requirements and Prohibitions Concerning Business
Opportunities
AGENCY: Federal Trade Commission.
ACTION: Final rule.
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SUMMARY: The Federal Trade Commission (the ``Commission'' or ``FTC'')
amends its Trade Regulation Rule entitled ``Disclosure Requirements and
Prohibitions Concerning Franchising and Business Opportunity Ventures''
(``Franchise Rule'' or ``Rule'') to streamline the Rule, minimize
compliance costs, and to respond to changes in new technologies and
market conditions in the offer and sale of franchises. Part 436 sets
forth those amendments to the Franchise Rule pertaining to the offer
and sale of franchises. Part 437 sets forth a revised form of the
original Franchise Rule pertaining solely to the offer and sale of
business opportunities. This document provides background on the
Franchise Rule and this proceeding; discusses the public comments the
Commission received; and describes the amendments the Commission is
making based on the record. This document also contains the text of the
final amended Rule and the Rule's Statement of Basis and Purpose
(``SBP''), including a Regulatory Analysis.
EFFECTIVE DATES: The effective date of the final amended Rule is July
1, 2007. Permission to use the original Franchise Rule, however, will
continue until July 1, 2008. After that date, franchisors and business
opportunity sellers must comply with the final amended Rule only.
ADDRESSES: Requests for copies of the final amended Rule and the SBP
should be sent to: Public Reference Branch, Room 130, Federal Trade
Commission, 600 Pennsylvania Avenue, NW, Washington, D.C. 20580. The
complete record of this proceeding is also available at that address.
Relevant portions of the proceeding, including the final amended Rule
and SBP, are available at http://www.ftc.gov.
FOR FURTHER INFORMATION CONTACT: Steven Toporoff, (202) 326-3135,
Division of Marketing Practices, Room 286, Bureau of Consumer
Protection, Federal Trade Commission, 600 Pennsylvania Avenue, NW.,
Washington, D.C. 20580.
SUPPLEMENTARY INFORMATION: The final amended Rule retains most of the
original Rule's pre-sale disclosures.\1\ Part 436 pertains to
franchising--business arrangements that offer purchasers the right to
operate under a trademark or other commercial symbol and that typically
offer a specific format or method of doing business, such as chain
restaurants and hotels.\2\ Part 436 modifies the original Rule,
however, by reducing inconsistencies with state franchise disclosure
laws, by adopting, in large measure, the disclosure requirements and
format of the Uniform Franchise Offering Circular (``UFOC'') Guidelines
used by the 15 states with pre-sale franchise disclosure laws.\3\ Part
436 of the final amended Rule, however, is not identical to the UFOC
Guidelines. In several instances, part 436 is narrower. For example,
part 436 does not incorporate the UFOC Guidelines' mandatory cover page
risk factors, disclosures pertaining to brokers, or detailed
disclosures pertaining to franchisees' computer equipment requirements.
Part 436 also permits a phase-in of audited financial statements.
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\1\ See 16 CFR Part 436. Provisions of the original Rule are
cited in this document as 16 CFR 436.[ ]. Citations to the final
amended Rule are cited simply as 436.[ ] or 437.[ ], respectively.
The text of the final amended Rule is set forth in Section VII.
\2\ The specific definition of the term ``franchise'' is
discussed below in connection with section 436.1(h).
\3\ We were assisted in the effort to reduce inconsistencies
between the original Rule and UFOC Guidelines by NASAA's submission
of a document entitled ``Comparison of UFOC and Proposed FTC
Disclosure Requirements'' (``NASAA Comparison'') (Jan. 8, 2002). A
copy of this document is on the public record in this proceeding.
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Further, part 436 of the final amended Rule corrects a problem with
the UFOC Guidelines identified in the rulemaking record. Specifically,
the record establishes that the current Item 20 of the UFOC
Guidelines--a provision requiring the disclosure of franchisee
statistics--results in inflated turnover rates. Part 436 of the final
amended Rule corrects this problem, based upon suggestions contained in
the record.
In a few instances, part 436 of the final amended Rule is broader
than the UFOC Guidelines, addressing franchise relationship issues that
the rulemaking record establishes are a prevalent source of franchisee
complaints. To that end, part 436 of the final amended Rule provides
additional information to prospective franchisees with which to assess
the quality of the franchise relationship before they buy, including:
(1) franchisor-initiated litigation against franchisees pertaining to
the franchise relationship; (2) protected territories; (3) the use of
confidentiality clauses; and (4) trademark-specific franchisee
associations.
Finally, part 436 of the final amended Rule updates the original
Rule and UFOC Guidelines by addressing new marketing techniques and new
technologies. For example, part 436 permits franchisors to comply with
pre-sale disclosure obligations electronically. It also updates
territorial protection disclosures to address sales via the Internet,
catalogs, and telemarketing.
Part 437 of the final amended Rule pertains to business opportunity
ventures. Business opportunities, such as vending machine routes and
rack display ventures, typically do not involve the right to use a
trademark or other commercial symbol and the seller must provide
purchasers with locations for machines or equipment or with clients.\4\
Based upon the rulemaking record, the Commission has proposed that
business opportunities covered by the original Rule should be addressed
in a separate, narrowly-tailored trade regulation rule. On April 12,
2006, the Commission published a Notice of Proposed Rulemaking
(``Business Opportunity NPR'') for a separate Business Opportunity
Rule.\5\ Pending completion of the proceeding initiated with that
notice, business opportunities presently covered by the requirements of
the original Rule will remain covered, as set forth as part 437 of the
final amended Rule.
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\4\ The definition of ``business opportunity'' is discussed
below in connection with section 437.2(a).
\5\ 71 FR 19054 (Apr. 12, 2006).
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Part 437 of the final amended Rule differs from the original Rule
in three respects only. First, references to ``franchisor'' and
``franchisee'' in the original Rule have been changed to ``business
opportunity seller'' and ``business opportunity purchaser,''
respectively. Second, the original Rule's definition of ``franchise''
set out at section 436.(2)(a) has been changed to ``business
opportunity'' and the first part of the original definition--the
``franchise'' elements--have been deleted; the definition now focuses
on the second part of the original definition--the business opportunity
elements. Third, part 437 sets forth a new exemption for franchises
that comply with, or are exempt from, part 436. Except for these three
changes, all disclosures and prohibitions in part 437 are identical to
those of the original Franchise Rule.
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STATEMENT OF BASIS AND PURPOSE
I. INTRODUCTION
A. Overview of the Original Franchise Rule
The Commission promulgated the original Franchise Rule on December
21, 1978.\6\ Based upon the original rulemaking record, the Commission
found widespread deception in the sale of franchises and business
opportunities through both material misrepresentations and
nondisclosures of material facts.\7\ Specifically, the Commission found
that franchisors and business opportunity sellers often made material
misrepresentations about: the nature of the seller and its business
operations, the costs to purchase a franchise or business opportunity
and other contractual terms and conditions under which the business
would operate, the success of the seller and its purchasers, and the
seller's financial viability. The Commission also found other unfair or
deceptive practices pervasive: franchisors' and business opportunity
sellers' use of false or unsubstantiated earnings claims to lure
prospective purchasers into buying a franchise or business opportunity,
and franchisors' and business opportunity sellers' failure to honor
promised refund requests. The Commission concluded that all of these
practices led to serious economic harm to consumers.\8\
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\6\ 43 FR 59614 (Dec. 21, 1978). Along with the original Rule,
the Commission published a Statement of Basis and Purpose
(``original SBP''), 43 FR 59621 (Dec. 21, 1978) and later Final
Interpretive Guides to the Rule (``Interpretive Guides''), 44 FR
49966 (Aug. 24, 1979). Since promulgation of the original Rule in
1978, the Commission staff has also issued more than 100 advisory
opinions to help assist the public in interpreting various Rule
provisions.
\7\ Original SBP, 43 FR at 59625.
\8\ Id., at 59627-39.
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To prevent deceptive and unfair practices in the sale of franchises
and business opportunities and to correct consumers' misimpressions
about franchise and business opportunity offerings, the Commission
adopted the original Franchise Rule, which is primarily a pre-sale
disclosure rule. The original Rule did not purport to regulate the
substantive terms of the franchise or business opportunity
relationship. Rather, it required franchisors and business opportunity
sellers to disclose material information to prospective purchasers on
the theory that informed investors can determine for themselves whether
a particular deal is in their best interest.\9\
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\9\ The Commission used the same approach in other trade
regulation rules. See, e.g., Funeral Rule, 16 CFR Part 453; Used Car
Rule, 16 CFR Part 455.
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B. The Rule Amendment Proceeding
This Rule amendment proceeding began with a regulatory review of
the Franchise Rule in 1995.\10\ To initiate the Rule Review, the
Commission published a Federal Register notice seeking public comment
on whether there was a continuing need for the Rule and, if so, how to
improve it in light of industry changes since its promulgation in 1978.
In response to this notice, the Commission received 75 written
comments.\11\
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\10\ 60 FR 17656 (Apr. 7, 1995).
\11\ Written Rule Review comments are cited as: [Commenter] RR
[comment number]. A list of all commenters during the Rule Review
and Rule amendment proceeding, and the abbreviations used to
identify each, is set forth in Attachment A to this document. Many
of the comments in this proceeding are available online at:
http://www.ftc.gov.
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In addition, the Commission staff held two public workshops, in
which a total of fifty individuals participated. The workshops were
transcribed.\12\ The first workshop--held on September 11-13, 1995, in
Bloomington, Minnesota--focused on the comments on the Rule, in
particular whether the Commission should retain the Rule and, if so,
whether the Commission should reduce inconsistencies between federal
and state pre-sale disclosure law by incorporating in the Rule the UFOC
Guidelines adopted by each of the 15 states with franchise disclosure
laws.\13\ Participants also discussed issues arising from business
opportunity sales. The second workshop--held on March 11, 1996, in
Washington, D.C.--focused on the Franchise Rule's application to sales
of franchises to be located outside the United States.
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\12\ Rule Review transcripts are cited as [Commenter] RR,
[Sept.95] or [Mar.96] Tr.
\13\ The UFOC Guidelines disclosure format is similar in many
respects to the original Rule's disclosure requirements. To reduce
compliance costs and burdens, the Commission has permitted
franchisors to comply with the original Rule by using the UFOC
Guidelines format, provided that they did so completely and
accurately. See 60 FR 51895 (Oct. 4, 1995) (authorizing states to
use revised UFOC Guidelines). A copy of the UFOC Guidelines can be
found at the corporate finance section of the North American
Securities Administrators Association website: http://www.nasaa.org. It
should be noted, however, that the UFOC Guidelines address only
required pre-sale disclosures. Other provisions of state law
applicable to franchise sales--such as the time for making
disclosures, disclosure document updating provisions, and
exemptions--vary according to each state's franchise statute or
regulations.
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As a result of the Rule Review, the Commission determined that the
Franchise Rule continues to serve a useful purpose and that it should
be retained. The Commission also determined to modify the Rule in order
to reduce inconsistencies with the UFOC Guidelines, while updating the
Rule to address new technologies developed since the original Rule was
promulgated. Accordingly, in February 1997, the Commission published an
Advance Notice of Proposed Rulemaking (``ANPR'').\14\ The ANPR
solicited comment on several proposed Rule modifications which would,
among other things, create a separate trade regulation for business
opportunity sales, revise the Rule's disclosure requirements to mirror
those of the UFOC Guidelines, limit the Rule's application to sales of
franchises located in the United States, and permit electronic
disclosure. In response to the ANPR, the Commission received 166
written comments.\15\ The staff also held six public workshops on the
issues raised in the comments, as set forth below.\16\
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\14\ 62 FR at 9115 (Feb. 28, 1997).
\15\ Written ANPR comments are cited as: [Commenter] ANPR
[comment number].
\16\ In general, the first day of each public workshop discussed
specific issues announced in advance. Participants at these meetings
were selected based upon their comments or interest in the subject
matter. The second day of each conference was an open forum in which
the public was invited to express their views on any franchise or
business opportunity issue. ANPR workshop transcripts are cited as:
[Commenter] ANPR [date] Tr.
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Topic(s) Location Dates
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Trade Show Promoters Washington, D.C. July 28-29, 1997
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Business Opportunities Chicago, IL August 21-22,
1997
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UFOC, Internet, International, Co- New York, NY September 18-19,
branding, Alternatives to 1997
Traditional Law Enforcement
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Business Opportunities Dallas, TX October 20-21,
1997
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UFOC, Internet, International, Co- Seattle, WA November 6-7,
branding, Alternatives to 1997
Traditional Law Enforcement
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Business Opportunities Washington, D.C. November 20-21,
1997
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A total of sixty-five individuals participated in the various ANPR
public workshops, including franchisees, franchisors, business
opportunity sellers and their representatives, state franchise and
business opportunity regulators, and computer consultants.
After the ANPR workshops, the Commission published a Notice of
Proposed Rulemaking (``Franchise NPR'') in October 1999.\17\ Focusing
on franchise sales only, the Franchise NPR included the text of a
proposed revised Franchise Rule and a detailed discussion of each
proposed Rule revision. Among other things, the Franchise NPR
addressed: (1) the application of the Franchise Rule to franchise sales
outside the United States; (2) the scope of certain existing disclosure
requirements, such as those regarding litigation and franchisee
statistics; (3) new disclosure requirements, such as those for
franchisee associations; and (4) new instructions permitting disclosure
via the Internet. It also proposed creating exemptions from the
Franchise Rule for sophisticated prospective franchisees.
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\17\ 64 FR 57294 (Oct. 22, 1999).
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The Franchise NPR also specified the process the Commission would
follow in amending the Franchise Rule, as it pertains to franchise
sales. Pursuant to the Commission's Rules of Practice, 16 CFR 1.20, the
Commission determined to use a modified version of the rulemaking
process set forth in section 1.13 of those Rules.\18\ Specifically, the
Commission announced that it would publish an NPR, with a 60-day
comment period, followed by a 40-day rebuttal period. In addition,
pursuant to Section 18(c) of the FTC Act, the Commission announced that
it would hold hearings with cross-examination and rebuttal submissions
only if an interested party requested a hearing. The Commission also
stated that, if requested to do so, it would contemplate holding one or
more informal public workshops in lieu of hearings. Finally, pursuant
to 16 CFR 1.13(f), the Commission announced that staff would issue a
Report on the Franchise Rule (``Staff Report''), which would be subject
to additional public comment.\19\
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\18\ 16 CFR 1.13.
\19\ Franchise NPR, 64 FR at 57324.
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In response to the Franchise NPR, the Commission received 40
comments.\20\ Overwhelmingly, the comments supported the proposed
revisions, albeit with fine-tuning.\21\ No commenters requested a
hearing, although, as noted, the Franchise NPR allowed for them.\22\
The staff also determined that the record was fully developed for
franchise issues, requiring no additional public workshops to explore
further Rule amendment issues.
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\20\ Franchise NPR comments are cited as: [Commenter] NPR
[comment number].
\21\ Many commenters enthusiastically supported the Commission's
overall approach to revising the Rule. E.g., IL AG, NPR 3, at 10;
PMR&W, NPR 4, at 1; Holmes, NPR 8, at 1; H&H, NPR 9, at 2; Baer, NPR
11, at 1; NFC, NPR 12, at 2; Lewis, NPR 15, at 1; IFA, NPR 22, at 3;
AFC, NPR 30, at 3; J&G, NPR 32, at 1; Tricon, NPR 34, at 1;
Marriott, NPR 35, at 2.
\22\ Accordingly, no Presiding Officer was established in this
proceeding. See Rules of Practice, 16 CFR 1.13(c).
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Pursuant to the Rule amendment process announced in the Franchise
NPR, the Commission's Bureau of Consumer Protection issued a Staff
Report on the Franchise Rule in August 2004.\23\ The Staff Report
explained in detail the history of the Rule amendment proceeding. It
also summarized the issues raised during the various notice and comment
periods, in particular those that arose in response to the Franchise
NPR. For each Franchise NPR issue, the Staff Report discussed: (1)
similarities and differences between the proposed revised Rule approach
and both the original Rule and the UFOC Guidelines approaches; (2)
pertinent comments; and (3) the staff recommendations on franchise
issues for inclusion in a final amended Rule.
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\23\ See Bureau of Consumer Protection, Staff Report to the
Federal Trade Commission and Proposed Revised Trade Regulation Rule
(16 CFR Part 436) (Aug. 2004) (``Staff Report''). The Staff Report
is available at: http://www.ftc.gov/os/2004/08/0408franchiserulerpt.pdf. In
September, 2004, the Commission published a notice in the Federal
Register announcing the availability of, and seeking comment on, the
Staff Report. See 69 FR 53661 (Sept. 2, 2004). The announcement is
also available at: http://www.ftc.gov/os/2004/08/040825franchiserulefrn.pdf
.
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Forty-five commenters responded to the Staff Report.\24\ For the
most part, the commenters supported the proposed Rule revisions
pertaining to franchising.\25\ Several, however, voiced concern about
the scope of one or more Rule provisions, or offered various
suggestions to fine-tune the Rule to avoid ambiguities.\26\ In other
instances, several commenters raised issues for further discussion in
anticipated Compliance Guides, or offered interpretations of Rule
provisions for inclusion in the Compliance Guides.\27\ In several
instances, franchisee representatives reiterated views previously
expressed during the various comment periods to the effect that the
proposed revised Rule is deficient because it does not mandate
disclosure of financial performance data\28\ or does not adopt various
substantive franchise relationship provisions.\29\ As explained in
greater detail below, the Commission has considered each of these
comments in determining the form and content of the final amended Rule.
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\24\ Staff Report comments are cited as ``[Commenter], at ------
.'' These comments simply refer to the commenter and not to a
specific comment number. After the Franchise NPR, the Commission's
Secretary's Office discontinued the practice of assigning a specific
comment number to each comment.
\25\E.g., Bundy, at 1; Cendant, at 1 (representing Ramada, Days
Inn, Howard Johnson, Travelodge, Knights Inn, Super 8 Motel, Wingate
Inn, AmeriHost, Century 21, Coldwell Banker, ERA, Sotherby's Intl
Realty, Avis, and Budget); IFA, at 1; IL AG, at 1; J&G, at 1;
Kaufmann, at 2 (representing Kaufmann, Feiner, Yamin, Gildin &
Robbins; YUM! Brands [Pizza Hut, KFC, Taco Bell, Long John Silvers,
and A&W]; 7-Eleven, Inc.; and Arby's [Arby's and T.J. Cinnamons
Classic Bakery]); Marriott, at 2; NASAA, at 2; Piper Rudnick, at 1;
Spandorf, at 1; Starwood, at 1 (representing Four Points Hotels,
Sheraton Hotels,Westin Hotels, and Luxury Collection Hotels); Wiggin
and Dana, at 1.
\26\ Fourteen comments focused solely on a single issue. For
example, eight comments addressed only the original Rule's exclusion
for cooperatives (Affiliated Foods; CHS; Graber; IDC; NCBA; NCFC;
NGA; Riezman Burger). Additional one-issue comments were received
on: the disclosure of franchisee associations (AAFD); the single
trademark exclusion (Pillsbury Winthrop); the sophisticated investor
exemptions (NADA); the Petroleum Marketing Practices Act (Chevron);
the disclosure of parent information (PREA); and integration clauses
(Lagarias). Two comments were beyond the scope of the Staff Report:
Marks (urging Commission to adopt franchise arbitration standards);
Koutsoulis (opposing the proposed merger of two franchisors).
\27\ Compliance Guides, which the Commission anticipates staff
will issue on part 436, would update existing Interpretive Guides
issued in 1979. See generally Interpretive Guides, 44 FR 49966.
Compliance Guides on part 437 will be issued by staff once any
rulemaking on business opportunity ventures is concluded.
\28\E.g., Selden, at 2; Haff, at 1-3; Blumenthal, at 1; Karp, at
2; Steinberg, at 1.
\29\E.g., Blumenthal, at 1; Karp, at 3; Steinberg, at 1-2.
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C. Continuing Need for the Rule
Based upon the original rulemaking record and the Commission's law
enforcement experience extending nearly 30 years,\30\ the Commission
concludes that a pre-sale disclosure rule continues to serve a useful
purpose. Overwhelmingly, the comments submitted during the Rule
amendment proceeding supported the continued need for the Franchise
Rule.\31\ For example, some commenters emphasized that pre-sale
disclosure is still necessary to prevent fraud.\32\ Others observed
that pre-sale disclosure is a cost-effective way to provide material
information to prospective purchasers about the costs, benefits, and
potential legal and financial risks associated with entering into a
franchise relationship. These commenters also stressed that the Rule
assists prospective franchisees in conducting a due diligence
investigation of the franchise offering by providing information that
is not readily available, such as the franchisor's litigation history
and franchisee termination rates.\33\ Other commenters noted that pre-
sale disclosure helps franchisees understand the franchise relationship
they are entering better than they could absent such disclosure,
thereby reducing potential conflicts in franchise systems and post-sale
litigation costs.\34\ Indeed, some commenters expressed the view that
repeal of the Franchise Rule might actually increase franchisors' costs
and compliance burdens by opening the door for individual states to
enact franchise disclosure laws that may be inconsistent, making it
difficult for franchisors to conduct business on a national basis.\35\
One commenter noted that retaining a uniform pre-sale disclosure rule
enables prospective franchisees to comparison shop for the best
franchise offering.\36\
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\30\ As of the date of this Notice, the Commission has filed
more than 210 suits against more than 650 defendants (both
franchises and business opportunities) for Franchise Rule violations
since the Rule was promulgated in 1978. See also Business
Opportunity NPR, 71 FR 19054 (Apr. 12, 2006) (discussing the
Commission law enforcement history in combating business opportunity
covered by the Franchise Rule).
\31\E.g., H&H, ANPR 28, at 2; Kaufmann, ANPR 33, at 2; NCL, ANPR
35, at 2; SBA Advocacy, ANPR 36, at 2-3; IL AG, ANPR 77, at 1. See
also Staff Report, at notes 15-16. But see, generally, Winslow
(opposing the Rule).
\32\E.g., Kaufmann, ANPR 33, at 3 (``Both the Rule and . . .
state franchise laws have gone a long way toward eradicating massive
franchise frauds and, by doing so, have restored franchising's
reputation for integrity and thus cleared the marketplace for the
offerings of legitimate franchisors.'').
\33\ E.g., Marks, ANPR, 19 Sept. 97 Tr., at 8-9, 29; Wieczorek,
RR, Sept.95 Tr., at 62-63. But see Winslow, at 21.
\34\E.g., H&H, ANPR 28, at 2; SBA Advocacy, ANPR 36, at 2; Zarco
& Pardo, ANPR 134, at 1; ABA Antitrust, RR 22, at 7.
\35\ E.g., WA Securities, ANPR 117; Shay, RR, Sept.95 Tr., at
104.
\36\ Kaufmann, ANPR 33, at 3.
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On the other hand, many franchisees and their advocates criticized
the Rule for not going far enough. They urged the Commission to address
in this rulemaking a variety of post-sale franchise contract or
``relationship'' issues, including prohibiting or limiting the use of
post-contract covenants not to compete,\37\ encroachment of
franchisees' market territory,\38\ and restrictions on the sources of
products or services.\39\ Indeed, some franchisees asserted that if the
Rule cannot address post-sale relationship issues, then the Commission
should abolish the Rule.\40\
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\37\E.g., Brown, ANPR 4, at 3; AFA, ANPR 62, at 3; Slimak, ANPR
130; Leap, ANPR 147; Vidulich, ANPR, 22 Aug. 97 Tr., at 21.
\38\ E.g., Brown, ANPR 4, at 2; Donafin, ANPR 14; AFA, ANPR 62,
at 1; Buckley, ANPR 97; Zarco & Pardo, ANPR 134, at 2.
\39\ E.g., Brown, ANPR 4, at 2; Weaver, ANPR 17; Colenda, ANPR
71; Haines, ANPR 100; Chiodo, ANPR, 21 Nov. 97 Tr., at 293-94.
\40\See AFA, ANPR 62, at 1 (``Our members feel so strongly about
the Commission's inability to deal with substantive issues of
concern to them, they would rather work to abolish the FTC rule than
suffer the abuses of both a government agency and their
franchisors.'').
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To address post-sale relationship issues by adopting rule
provisions that prohibit or limit the use of certain contract terms
would require record evidence demonstrating specific unfair acts or
practices. The FTC Act defines an unfair act or practice as one that is
``likely to cause substantial injury to consumers which is not
reasonably avoidable by consumers themselves and not outweighed by
countervailing benefits to consumers or to competition.''\41\ The Act
also requires that, to justify an industry-wide rule, such practice be
prevalent.\42\ This proceeding did not yield adequate evidence to
support a finding of prevalent acts or practices that meet each of the
three prerequisites for unfairness as articulated in Section 45(n) of
the FTC Act.
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\41\ 15 U.S.C. 45(n).
\42\ 15 U.S.C. 57a.
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With regard to the first prerequisite, substantial injury, the
record shows that some franchisees in several franchise systems have
suffered post-sale harm in the course of operating their franchises,
and in some instances this injury may be ascribable to acts or
practices of a franchisor.\43\ The record, however, leaves open the
related questions of whether such franchisor acts or practices are
prevalent and whether the injury resulting from acts or practices is
substantial, when viewed from the standpoint of the franchising
industry as a whole, not from just a particular franchise system.
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\43\ There are many factors that influence the success or
failure of a franchisee, including downturns in the economy,
shifting consumer preferences, or even franchisees' own conduct.
Accordingly, franchisor conduct post-sale may be only one factor
that leads to injury to franchisees. The record is inconclusive,
with respect to the franchising overall, as to whether franchisor
acts or practices are a direct and primary cause of poor performance
or failure by franchisees. In this regard, it is noteworthy that in
its 2001 audit of the Commission's Franchise Rule Program, the
General Accounting Office (``GAO'') concluded that there are ``no
readily available, statistically reliable data on the overall extent
and nature of [franchise relationship] problems.'' United States
General Accounting Office, GAO Report to Congressional Requesters,
Federal Trade Commission Enforcement of the Franchise Rule, GAO-01-
776, at 29 (July 31, 2001). See also Staff Report, at 10-11.
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With regard to avoidability of injury, the unfairness analysis
falls short. A franchise purchase is entirely voluntary. The Franchise
Rule ensures that each prospective franchisee receives disclosures--
expanded in key respects by the current amendments--that explain the
terms and conditions under which the franchise will operate.
Prospective franchisees can avoid harm by comparison shopping for a
franchise system that offers more favorable terms and conditions, or by
considering alternatives to franchising as a means of operating a
business. Prospective franchisees are also free to discuss the nature
of the franchise system with existing and former franchisees, as well
as trademark-specific franchisee associations, and the amended Rule
facilitates such discussion by providing prospects with contact
information. Under these circumstances, the Commission cannot
categorically conclude that prospective franchisees who voluntarily
enter into franchise agreements, after receiving full disclosure,
nonetheless cannot reasonably avoid harm resulting from a franchisor
enforcing the terms of its franchise agreement.\44\
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\44\See FTC v. J.K. Publ'ns, Inc., 99 F. Supp. 2d 1176, 1201
(C.D. Cal. 2000) (``With regard to [avoidability], the focus is on
`whether consumers had a free and informed choice that would have
enabled them to avoid the unfair practice.''').
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The third element requires an analysis of whether injury to
franchisees deriving from specific franchisor acts or practices
outweighs countervailing benefits to the public at large or to
competition. In our law enforcement experience investigating
relationship issues in individual franchise systems, it has been the
case that the franchisor actions allegedly causing harm to individual
franchisees also frequently generate countervailing benefits to the
system as a whole or to consumer welfare overall that may or may not be
[[Page 15448]]
outweighed by the alleged harm to franchisees. Commenters advocating
that the Rule include unfairness remedies have asserted injury, but
have failed to bring forth evidence that such injury outweighs
potential countervailing benefits that arise from the alleged acts or
practices. Therefore, the Commission declines to impose industry-wide
provisions mandating substantive terms of private franchise contracts
that would impact on the entire franchise industry, not just those
franchise systems that are the subject of commenters' complaints.\45\
Notwithstanding this determination, the Commission, in pursuit of its
law enforcement mission can consider whether individual franchisors'
conduct constitutes an unfair act or practice on a case-by-case basis.
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\45\ The Commission notes that it has voiced concern that
government-mandated contractual terms may result in affirmative harm
to consumer welfare. Contractual terms that are driven by market
forces and forged by private parties acting in their own self-
interest are the ones most likely to result in products being
brought to market quickly and efficiently. The Commission therefore
has authorized its staff to file a number of advocacy comments
recommending against proposed state bills that would have unduly
limited manufacturers in managing their distribution systems, such
as by requiring exclusive territories, prohibiting or seriously
burdening wholesaler terminations, or limiting the ability to
reorganize a distribution system in response to changing competitive
conditions. See, e.g., Letter from Maureen Ohlhausen, Dir., Office
of Policy Planning, et al., to the Hon. Wesley Chesbro, Cal. State
Senate (Aug. 24, 2005) (comment on proposed beer franchise act);
Letter from C. Steven Baker, Dir., Chicago Regional Office, to the
Hon. Dan Cronin, Ill. State Senate (Mar. 31, 1999) (comment on
proposed legislation on wine and spirits distribution); cf.
Testimony of Jerry Ellig, Deputy Dir., Office of Policy Planning,
before joint committee hearings of the Haw. state legislature
(recommending against gasoline price control legislation, in part on
grounds that repeal of anti-encroachment statute would be a more
effective means of reducing prices (Jan. 28, 2003)).
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Nonetheless, the Commission concludes that the record is sufficient
to show that misunderstandings about the state of the franchise
relationship are prevalent, and some more disclosure is warranted to
ensure that prospective franchisees are not deceived about the quality
of the franchise relationship before they commit to buying a franchise.
Franchisee concerns about relationship issues persuade us that better
disclosure is necessary to ensure that prospective franchisees are
fully informed about the relationships that they will be entering. To
that end, part 436 of the final amended Rule expands the Rule's pre-
sale disclosures in a few instances to address franchise relationship
issues, as detailed throughout this document.
D. Overview of the Final Amended Rule
The final amended Rule maintains the benefits of the original Rule,
preventing deceptive and unfair practices identified in the original
rulemaking through pre-sale disclosure of material information
necessary to make an informed purchasing decision and prohibition of
specified misrepresentations. At the same time, part 436 of the final
amended Rule reduces unnecessary compliance costs. First, part 436
covers only the sale of franchises to be located in the United States
and its territories. Second, based upon the record, the Commission also
has created several new exemptions for sophisticated franchise
purchasers, including exemptions for large investments and large
franchisees with sufficient net worth and prior experience.
Part 436 of the final amended Rule also reduces inconsistencies
between federal and state pre-sale disclosure requirements. Since the
original Rule was promulgated, NASAA, which represents the 15 states
with pre-sale franchise disclosure laws, has developed a standard
disclosure document, the UFOC. The Commission, as a matter of policy,
has in the past permitted franchisors to comply with the Franchise Rule
by furnishing prospective franchisees with a UFOC, even in the 35
states without franchise disclosure laws.\46\ The Commission found that
the UFOC Guidelines, taken as a whole, offer consumers the same or
greater consumer protection as that provided by the original Rule. As a
result, the UFOC Guidelines already are used by the vast majority of
franchisors to comply with the Rule,\47\ and, in fact, the UFOC
Guidelines have become the national franchise industry standard.\48\
Further, as NASAA noted, the UFOC Guidelines were developed with
significant input from franchisors, franchisees, and franchise
administrators, and were subject to public hearings and notice and
comment.\49\ Therefore, the UFOC Guidelines, like the Franchise Rule,
reflect a balance of interests among all affected parties.
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\46\ Authorization to use the UFOC Guidelines to comply with the
original Rule's disclosure requirements was first granted by the
Commission in the Interpretive Guides, 44 FR at 49970-71, on the
grounds that the UFOC Guidelines, taken in their entirety, provide
equal or greater consumer protection as the original Rule. The
Commission ratified this position following subsequent amendments to
the UFOC requirements by the NASAA, most recently in 1993, 58 FR
69224 (Dec. 30, 1993).
Beginning on July 1, 2008, however, franchisors may use part 436
of the final amended Rule only. Permission to use the UFOC
Guidelines will be withdrawn on that date because those Guidelines
will no longer afford prospective franchisees equal or greater
protection as part 436. This would not preclude consideration of any
new or revised UFOC Guidelines promulgated by the states in the
future.
\47\E.g., H&H, ANPR 28, at 5-6; Kaufmann, ANPR 33, at 3;
Kestenbaum, ANPR 40, at 1; WA Securities, ANPR 117, at 1.
\48\ E.g., IFA, NPR 22, at 4-5; Stadfeld, NPR 23, at 2; Karp,
ANPR, 19 Sept. 97 Tr., at 90.
\49\ NASAA, ANPR 120, at 2. See also WA Securities, ANPR 117, at
1.
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Overwhelmingly, franchisors, franchisees, and franchise regulators
urged the Commission throughout the Rule amendment proceeding to adopt
the UFOC Guidelines disclosure format. These commenters include a broad
range of interests, such as NASAA, the International Franchise
Association (``IFA''), the American Bar Association's Antitrust
Section, the American Franchisee Association, the State Bar of
California Business Law Section, and major franchisors, such as
Cendant, Marriott, YUM! Brands, 7-Eleven, Arby's, and Starwood Hotels
and Resorts.\50\
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\50\ E.g., PMR&W, NPR 4, at 1; H&H, NPR 9, at 2; 7-Eleven, NPR
10, at 2; Lewis, NPR 15, at 5; NASAA, NPR 17, at 2-4; Bundy, NPR 18,
at 6; Gurnick, NPR 21, at 2; IFA, NPR 22, at 4-5; Stadfeld, NPR 23,
at 2; J&G, NPR 32, at 2; Marriott, NPR 35, at 2; Brown, ANPR 4, at
1; Duvall, ANPR 19, at 1; Baer, ANPR 25, at 2; Kaufmann, ANPR 33, at
3; SBA Advocacy, ANPR 36, at 3; Kestenbaum, ANPR 40, at 1; AFA, ANPR
62, at 2; IL AG, ANPR 77, at 1; WA Securities, ANPR 117, at 1;
Selden, ANPR 133, at 1; Zarco & Pardo, ANPR 134; at 1; Cendant, ANPR
140, at 2.
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Accordingly, part 436 of the final amended Rule closely tracks the
UFOC Guidelines. Nevertheless, part 436 is not identical to the UFOC
Guidelines. In a few instances, part 436 omits or streamlines a UFOC
Guidelines disclosure requirement that the Commission believes is
unnecessary or is overly burdensome--for example, mandatory cover page
risk factors, broker disclosures, and detailed computer equipment
disclosures. As explained in greater detail below, part 436 of the
final amended Rule also avoids problems with Item 20 of the UFOC
Guidelines (the disclosure of statistical information on franchisees in
the system) that were revealed during the proceeding and that were
examined in detail by a number of commenters, including NASAA.
Part 436 of the final amended Rule also retains a few provisions
from the original Rule that are not in the UFOC Guidelines, because the
Commission believes they are necessary to prevent deception. For
example, part 436 of the final amended Rule retains the original Rule's
requirement that, in some instances, franchisors disclose information
about a parent. Similarly, part 436 retains the original Rule's phase-
in of audited financial statements,
[[Page 15449]]
thereby preserving flexibility not present in the UFOC Guidelines.
At the same time, part 436 of the final amended Rule adds to the
UFOC Guidelines a few narrowly tailored disclosures based upon the
Commission's law enforcement experience and the rulemaking record,
mostly to prevent deception involving the nature of the franchise
relationship.\51\ For example, as explained in greater detail below,
part 436 of the final amended Rule expands the UFOC Guidelines' Item 3
litigation disclosure requirements to include the disclosure of
franchisor-initiated litigation. In addition, part 436 of the final
amended Rule goes beyond the UFOC Guidelines' Item 20 franchisee
statistics disclosures to require disclosure of information about the
franchisor's use of confidentiality clauses and the existence of
trademark-specific franchisee associations. In addition, in a few
instances, part 436 of the final amended Rule requires franchisors to
make prescribed statements to clarify issues that the record
established are often misinterpreted by prospective franchisees,
particularly in the area of protected territories and financial
performance representations.
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\51\ A decision to retain any portion of the original Rule may
be based upon evidence gathered during the original rulemaking and
the Commission's subsequent enforcement experience, as well as
evidence adduced during the current rulemaking. Indeed, to the
extent that nothing supplements evidence from the initial
rulemaking, there is a presumption that the existing rule should be
retained. See Motor Vehicle Mfrs. Ass'n v. State Farm Mut. Auto.
Ins. Co., 463 U.S. 29, 42 (1983).
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Further, part 436 of the final amended Rule updates the original
Rule and UFOC Guidelines by addressing changes in the marketplace and
new technologies. For example, as explained below, part 436 of the
final amended Rule permits franchisors to furnish disclosures
electronically and enables franchisees to use electronic signatures.
Part 436 of the final amended Rule also updates the original Rule and
UFOC Guidelines to address the impact of the Internet on a franchisor's
business operations. Specifically, part 436 requires more disclosure
about the affect of the Internet on sales restrictions imposed on
franchisees and any right of franchisors to compete online. It also
addresses financial performance representations made on the Internet.
Finally, part 436 of the final amended Rule contains a few
provisions and prohibitions that are necessary to make the Rule
effective, to facilitate compliance, and to prevent deception. For
example, part 436 of the final amended Rule prohibits a franchisor from
unilaterally altering the material terms and conditions of its
franchise agreements, unless the franchise seller informs the
prospective franchisee about the changes within a reasonable time
before execution. Part 436 of the final amended Rule also prohibits the
use of shills, who are persons paid or otherwise given consideration to
provide a false favorable report about the franchisor's performance
history.
E. Continued Application of Commission and NASAA Precedent
As noted throughout, most of the provisions of the original Rule
have been retained in the final amended Rule. Accordingly, the original
SBP remains valid, except to the extent of any conflict with the final
amended Rule. In the event of any conflict, this document supersedes
the original SBP. In the same vein, all former informal staff
advisories remain a source of Rule interpretation, except where this
SBP contradicts a staff advisory. To the extent that any member of the
public is concerned that a previous advisory may no longer be
applicable in light of the final amended Rule, we invite that person or
entity to seek further clarification from the Commission or the
staff.\52\
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\52\ The Commission's Rules of Practice prescribe procedures to
follow in seeking such advice. 16 CFR 1.3.
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Further, the Commission anticipates issuance of new Compliance
Guides on part 436 that will replace the original Interpretive
Guides.\53\ Because much of part 436 of the final amended Rule is based
upon the UFOC Guidelines, the Commission anticipates that Compliance
Guides will likely incorporate, in large measure, the UFOC Guidelines'
existing sample answers and NASAA's previously issued commentaries on
the UFOC Guidelines, to the extent such sample answers and commentaries
do not deviate from the final amended Rule.\54\ The Commission intends
that the staff coordinate the issuance of Compliance Guides, and future
interpretations of part 436 of the final amended Rule, with NASAA's
Franchise and Business Opportunity Project Group in order to minimize
differences between FTC and state Rule interpretations.
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\53\ Throughout the Rule amendment proceeding, commenters have
requested that the Commission explain or interpret various
provisions in Compliance Guides. The Commission anticipates that
staff will respond affirmatively to those requests. Compliance
Guides on part 437 (the business opportunity section) will be issued
after the conclusion of the business opportunity rulemaking
proceeding.
\54\ The Commission also recognizes that over the course of the
years, franchisors have developed specific language approved by the
states for compliance with the UFOC Guidelines. The Commission
anticipates that part 436 of the final amended Rule will be
interpreted, where consistent with the public interest, in a manner
that conforms with historic industry practices.
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II. THE LEGAL STANDARD FOR AMENDING THE RULE
A. Section 18 Rulemaking
Section 18(d)(2)(B) of the FTC Act states that ``[a] substantive
amendment to, or repeal of, a rule promulgated under subsection
(a)(1)(B) shall be prescribed, and subject to judicial review, in the
same manner as a rule prescribed under such subsection.''\55\ Thus, the
standard for amendment or repeal of a Section 18 rule is identical to
that for promulgating a trade regulation rule pursuant to Section 18.
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\55\ 15 U.S.C. 57a(d)(2)(B). The Commission's rulemaking
standards applicable to the promulgation and amendment of a Section
18 rule require a preponderance of reliable evidence. See Statement
of Basis and Purpose, Funeral Rule, 59 FR 1592 (Jan. 11, 1994);
Credit Practices Rule, 49 FR 7740 (Mar. 1, 1984).
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Additionally, an SBP must address four factors: (1) the prevalence
of the acts or practices addressed by the rule; (2) the manner and
context in which the acts or practices are unfair or deceptive; (3) the
economic effect of the rule, taking into account the effect on small
businesses and consumers; and (4) the effect of the rule on state and
local laws.\56\ These four factors are discussed in detail throughout
this document. In the next section, we summarize our findings regarding
each of these factors.\57\
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\56\ Rules of Practice, 16 CFR 1.14(a)(1)(i)-(iv). In addition,
the SBP must specify how the public may obtain a copy of the Rule's
final regulatory analysis. 16 CFR 1.14(a)(v). The current notice
does not set forth a separate regulatory analysis. Instead, it
incorporates the Commission's regulatory analysis throughout the SBP
portion of the notice. This notice, including the SBP, is being
published in the Federal Register and posted on the FTC's website
at: http://www.ftc.gov.
\57\ Support in the record for each factor is set forth in the
substantive discussion of each provision of the final amended Rule.
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1. The effect of the rule on state and local laws
The Commission begins with the effect of the final amended Rule on
state and local laws, because that factor is unusually prominent in
this proceeding. As noted above, 15 states have pre-sale franchise
disclosure laws in the form of the UFOC Guidelines. The rulemaking
record shows that, as a practical matter, the UFOC Guidelines are, in
fact, the national disclosure standard for the franchise industry.
Therefore, by design, the overwhelming effect of the final amended Rule
on state franchise law will be to mesh more closely with it and
[[Page 15450]]
enhance its effectiveness by promoting consistency and extending its
reach to nationwide scope.\58\ Moreover, the overwhelming majority of
commenters throughout the Rule amendment proceeding, including NASAA
and other state law advocates, urged the Commission to update the
original Rule by adopting the UFOC Guidelines to bring greater
uniformity to the field of franchise pre-sale disclosure.\59\
Accordingly, in considering the factors outlined above, the Commission
has given great weight to state franchise laws and their impact on the
market, as well as the desire of all parties in the field to reduce
inconsistencies between federal and state franchise disclosure laws.
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\58\ As noted above, part 437 (the business opportunity section)
of the final amended Rule is identical in all respects to the
original Rule, except for its scope of coverage. Accordingly, the
amendments to the original Rule set forth in part 437 will have no
effect on state or local business opportunity laws.
\59\ The Commission intends to continue working with NASAA and
individual states after the final amended Rule goes into effect in
order to harmonize federal and state franchise disclosure laws. The
Commission recognizes that the states have a wealth of experience in
interpreting the UFOC Guidelines that form the basis of the final
amended Rule. Accordingly, the Commission anticipates that the staff
will coordinate with NASAA and the states in issuing future
Compliance Guides and informal staff advisory opinions, in keeping
with our goal of federal and state harmonization.
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The Commission has also carefully weighed the benefits of any
suggestion to revise the Rule that would compound inconsistencies
between the Rule and the UFOC Guidelines. Only in very few instances,
an existing weakness in the UFOC Guidelines compels deviation from
those Guidelines. The chief example is the revision to the Item 20
franchise statistics disclosures. Part 436 of the final amended Rule
adopts a proposal submitted by NASAA to eliminate revealed problems
with UFOC Item 20 in a streamlined fashion that provides prospective
franchisees with material information about the franchise system, while
reducing unnecessary compliance burdens.
The Commission also has adopted several suggestions offered by
state regulators, mostly through NASAA, for streamlining the Rule. For
example, in part 436 the Commission has revised the financial
performance claim disclosures to eliminate the original Rule's
requirements that: (1) existing franchise performance data be prepared
according to generally accepted accounting principles; (2) financial
performance data be presented to a prospective franchisee in a separate
financial performance document; and (3) cost information alone trigger
the Rule's financial performance disclosure and substantiation
requirements.
2. Deceptive practices
The original Rule remedied through pre-sale disclosure five types
of harmful material misrepresentations or omissions that were found to
be widespread --specifically, misrepresentations about: (1) the
opportunity being offered for sale (2) costs; (3) contractual terms;
(4) success of the seller and prior purchasers; and (5) the seller's
financial viability. Each part 436 disclosure amendment to the original
Rule addresses one of these five types of misrepresentations or
omissions of material information.\60\
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\60\ As noted above, part 437 (the business opportunity section)
of the final amended Rule is identical in all respects to the
original Rule, except for its scope of coverage. Accordingly, there
are no amendments in part 437 that must be addressed here.
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a. Misrepresentations about the franchisor and the franchise system
In the original rulemaking, the Commission found that franchisors
and business opportunity sellers routinely misrepresented the nature of
the business. For example, franchisors misrepresented how long they had
been in business or the extent of their directors' and officers' prior
business experience. Such misrepresentations mislead consumers acting
reasonably under the circumstances into believing that the franchise
offered for sale is a safe or low risk investment.
To prevent such deception, the original Rule required franchisors
and business opportunity sellers to disclose background information on
the franchisor or business opportunity seller and the business,
including: the name and address of the franchisor or business
opportunity seller and any parent company; the name under which the
franchise or business opportunity seller does or intends to conduct
business; its trademarks; the prior business experience of the
franchisor or business opportunity seller and its directors and
officers; and the business experience of the franchisor or business
opportunity seller --e.g., experience selling franchises under the same
or different trademarks, as well as the franchisor or business
opportunity seller's other lines of business.
Part 436 of the final amended Rule continues to address
misrepresentations about the nature of the franchisor and the franchise
system by requiring the same disclosures as did the original Rule. In a
few instances, part 436 expands on these disclosures to remedy aspects
of this type of misrepresentation that have been revealed by our
enforcement experience or the record developed here. Specifically, part
436 of the final amended Rule requires franchisors to disclose
information about the franchisor's predecessors. Similarly, based upon
the Commission's law enforcement experience in over 50 franchise cases,
part 436 also remedies misrepresentations about those controlling the
franchise system by requiring not only disclosures about directors and
officers, but also about other individuals who have management
responsibility relating to the sale or operation of the franchises
being offered for sale.
b. Misrepresentations about costs
In promulgating the original Rule, the Commission recognized the
harm to franchisees and business opportunity purchasers resulting from
misleading cost representations. Representing that costs of buying and
operating a franchise, for example, are less than they actually are is
likely to mislead prospective franchisees, acting reasonably under the
circumstances, into believing that the franchise is more financially
attractive than is actually the case. Obviously, cost representations
are highly material. Thus, the original Rule required franchisors and
business opportunity sellers to disclose fully not only the initial
fee, but continuing costs throughout the relationship. For example,
franchisors must disclose required purchases or leases for, among other
things, inventory, signs, supplies, and equipment. In addition, the
Commission was concerned about undisclosed indirect payments to the
franchisor or business opportunity seller, and therefore required
franchisors and business opportunity sellers to disclose the basis for
calculating payments to the franchisor or business opportunity seller
from suppliers that franchisees or business opportunity purchasers are
required to use. Similarly, franchisors and business opportunity
sellers must disclose any interest or payments made to celebrity
endorsers.
Part 436 of the final amended Rule retains these required cost
disclosures. It also adopts a few additional cost disclosures that the
states found necessary to address related misrepresentations or
omissions, or misrepresentations revealed by our law enforcement
experience or the record developed here. These include, for example, a
description of laws or regulations specific to the industry in which
the franchise operates. Obviously, a franchisee's operating costs
[[Page 15451]]
may increase if he or she must incur hidden costs in the form of
compliance with various industry-specific regulations governing the
particular field. Part 436 of the final amended Rule also adopts the
UFOC Guidelines' required disclosure of fees that the franchisee is
expected to pay within the first three months of operation (or other
reasonable time for the industry), as well as more details about
payments, such as to whom a payment is to be made and whether a payment
is refundable. At the same time, part 436 of the final amended Rule
updates cost disclosures by requiring, for example, additional
information about any required computer systems, based upon the UFOC
Guidelines. Each of these UFOC provisions is designed to prevent
misrepresentation of the costs required to commence operation of a
franchised outlet.
c. Misrepresentations about contractual terms
Another area of deception identified in the original rulemaking
record concerns the underlying franchise or business opportunity
contract. For example, the Commission found that franchisors may
misrepresent the extent of promised assistance, or fail to disclose
restrictions and other obligations imposed on the franchisee.
Accordingly, the original Rule specified a number of disclosures
pertaining to the legal obligations of both parties under their
agreement. Specifically, the original Rule required franchisors, for
example, to disclose information about contractual requirements to use
designated suppliers, financing arrangements, product sales
restrictions and protected territories, site selection, and training
programs. In addition, franchisors had to disclose basic terms of the
contract, such as the duration, renewal and termination rights,
assignment rights, and covenants not to compete.
Part 436 of the final amended Rule retains these disclosure
requirements. Adopting the UFOC Guidelines approach, however, the
contract disclosures are required to be presented in easy-to-read
tables, with references to the franchise agreement, rather than in the
form of more detailed descriptions. In addition, part 436 updates the
disclosures by, for example, requiring franchisors to explain how they
use the term ``renewal'' in their system.
d. Misrepresentations about success
False or misleading representations about the success of franchise
systems and business opportunities were perhaps the most prevalent
misrepresentations identified in the original rulemaking record. These
included misrepresentations about: the number of franchisees or
business opportunity purchasers, the expected growth of the system,
and, most important, the financial performance of existing purchasers.
To remedy misleading success claims, the original Rule required
franchisors and business opportunity sellers to disclose statistics
about the system, including the number of purchasers in the system, the
number of purchasers who left the system in the previous year, and why
they left (i.e., termination, cancellation, non-renewal,
reacquisition). The original Rule also required franchisors and
business opportunity sellers to furnish the names and contact
information for at least 10 current purchasers. This information
enabled prospective purchasers to verify the seller's claims of
success, and it gave prospective purchasers additional sources from
which to obtain financial performance data.
The original Rule also remedied misleading success claims by
requiring franchisors and business opportunity sellers to disclose
lawsuits filed by purchasers against them pertaining to their
relationship and counterclaims filed by a franchisor or business
opportunity seller in response to a suit filed by a purchaser. The
existence of such lawsuits is material because this information would
likely influence a prospective purchaser's decision about what can be a
sizeable investment in a franchise or business opportunity. The nature
of the relations between the seller and the purchaser, as reflected in
litigation, is of central importance.
In the original rulemaking, the Commission also sought to ensure
the accuracy and reliability of any financial performance claims made
by a franchisor or business opportunity seller. Accordingly, the
Commission prohibited the making of earnings claims unless the
franchisor or business opportunity seller possessed a reasonable basis
for the claim, along with written substantiation, at the time the claim
was made. In addition, the seller had to set forth the claim in a
separate earnings claims statement containing the bases and assumptions
underlying the claim. Franchisors and business opportunity sellers were
also required to warn prospective purchasers that there is no assurance
that they will achieve the same level of earnings.
Part 436 of the final amended Rule retains each of these
disclosures, and it expands on them by requiring franchisors to
provide, consistent with the UFOC Guidelines, the names of up to 100
franchised outlets, as well as contact information for former
franchisees. Part 436 of the final amended Rule also provides
additional sources of information about the franchise system, including
the disclosure of trademark-specific franchisee associations. These
provisions prevent misrepresentations by giving prospective franchisees
additional sources of information with which to assess franchisor
claims. With respect to financial performance representations, it
follows the more streamlined approach of the UFOC Guidelines.
Specifically, part 436 of the final amended Rule eliminates the need
for a separate earnings claims document. Instead, the required
information is incorporated into the text of the disclosure document
itself (Item 19).
Finally, as discussed throughout this document, franchisees have
brought to the Commission's attention what they believe to be abusive
practices in franchising. These practices include encroachment of
territories, imposition of source of supply restrictions, modification
of original franchise agreements as a precondition for renewal, and the
use of disclaimers to limit liability for misrepresentations, among
others. As detailed in Section I.C. above, the Commission declines to
attempt to promulgate a franchise relationship law and, further,
concludes that the record does not support the promulgation of such a
law. Nonetheless, the record is sufficient to support requiring
additional disclosures that will help inform prospective franchisees
about the quality of the franchise relationship. These include:
expanded litigation disclosures to include franchisor-initiated
litigation against franchisees; a warning of the consequences to a
franchisee when a franchisor offers no exclusive territory; a statement
of what the term ``renewal'' means in the franchise system; and a
disclosure of the use, if any, of confidentiality clauses. Taken
together, each of these amended disclosures in part 436 will enable
prospective franchisees to better assess the quality of the franchise
relationship, and their likely success as franchisees.
e. Misrepresentations about financial viability
In the original rulemaking record, the Commission found that
franchisors and business opportunity sellers often misrepresented or
failed to disclose material information about their financial
viability. As a result, prospective purchasers invested thousands of
dollars in systems having
[[Page 15452]]
a poor financial history, or even facing bankruptcy. Obviously, a
franchisee's investment, for example, is at risk if the franchisor is
not able to perform its contractual obligations as promised. To remedy
these practices, the original Rule required franchisors and business
opportunity sellers to disclose bankruptcy information, as well as to
provide audited financial information. The final amended Rule continues
to require these disclosures.
3. The economic effect of the rule
At every stage of the Rule amendment proceeding, the Commission
solicited comment on the economic impact of the Rule, as well as the
costs and benefits of each proposed Rule amendment. In finalizing the
final amended Rule, the Commission has carefully weighed these costs
and benefits, reducing compliance costs wherever possible. Thus, for
example, part 436 reduces compliance costs by limiting the Rule's scope
of coverage to the sale of franchises to be located in the United
States and its territories.\61\
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\61\ In so doing, the Commission specifically rejected the
suggestion that franchisors should prepare individual disclosure
documents tailored to each specific foreign market. Not only would
such a requirement put American franchisors at a competitive
disadvantage with franchisors from countries lacking comparable
disclosure regulations, the minimal benefits of such a requirement
would not likely outweigh the extraordinary costs and burdens
involved.
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In the same vein, part 436 of the final amended Rule reduces
compliance burdens where the record establishes that the abuses the
Rule is intended to address are not likely to be present. Thus, part
436 of the final amended Rule retains the exemptions in the original
Rule as the ones for fractional franchises and leased departments. Part
436 of the final amended Rule also incorporates the Commission's long-
standing policies exempting from Rule coverage franchises covered by
the Petroleum Marketing Practices Act, as well as instances where the
only required payments made by the franchisee are for inventory at bona
fide wholesale prices. Further, part 436 of the final amended Rule adds
new exemptions for large investments of at least $1 million (excluding
unimproved land and any amounts financed by the franchisor),
investments by large franchisees with five years of business experience
and $5 million net worth, and for franchise sales to company insiders
who are already familiar with the company's operations.
The Commission also has limited the required disclosures of part
436 in order to minimize compliance burdens. For example, the
Commission has declined to adopt two UFOC Guidelines provisions on the
grounds that such provisions are unnecessarily burdensome, without
corresponding benefits to prospective franchisees. These provisions are
mandatory risk factors (choice of law and venue) on the disclosure
document cover page and the disclosure of franchise broker information
in Items 2, 3, and 4 of the UFOC Guidelines.
Further, for each disclosure item, the Commission considered less
costly disclosure alternatives. For example, part 436 of the final
amended Rule requires the disclosure of franchisor-initiated
litigation. In response to concerns raised by franchisor
representatives, Item 3 of part 436 makes clear that this disclosure is
limited to a one-year snap-shot in time and franchisors need only
update the disclosure on an annual basis. Franchisors also can reduce
costs by grouping similar franchisor-initiated suits under a single
descriptive heading, in lieu of detailed summaries for each suit.
Similarly, the Commission has adopted in part 436 a narrow
requirement to disclose independent trademark-specific franchisee
associations. Franchisors must make this disclosure only if the
franchisee association asks to be included in the franchisor's
disclosure document, and the association's request must be updated on
an annual basis.
Part 436 of the final amended Rule also reduces the franchisors'
burdens associated with making financial performance claims. Among
other things, the original Rule specified that: (1) all financial
performance claims must be geographically relevant to the franchise
being offered for sale; and (2) all historical earnings data from
existing franchisees must be presented using generally accepted
accounting principles. Moreover, the original Rule required franchisors
to disseminate financial performance information in a separate
document. Part 436 of the final amended Rule eliminates these
requirements.
Part 436 of the final amended Rule also promotes efficiency and
reduces compliance costs by enabling franchisors to use their own
judgment in deciding how to disseminate disclosure documents. For
example, part 436 permits franchisors to furnish disclosures
electronically through a variety of media, including CD-ROM, Internet
website, and email. Individual sections of the disclosure document also
allow more flexibility than the original Rule, again to promote
efficiency and reduced compliance costs. For example, Item 5 permits
franchisors to disclose either fixed fees or ranges of fees. Similarly,
Item 11 permits franchisors to summarize computer system requirements,
in lieu of more extensive disclosures.
In amending the Rule, the Commission has been guided by a
preference for an approach that prohibits identified harmful practices
and eschews burdensome affirmative compliance obligations that may only
be warranted for some few unscrupulous actors. Thus, part 436 of the
final amended Rule drops the original Rule's across-the-board
obligation to furnish disclosures early in the sales process--at the
first personal meeting between the prospective purchaser and the
franchise seller. Instead, part 436 of the final amended Rule allows
greater flexibility, requiring that franchisors furnish disclosures
early in the sales process only if the prospective franchisee requests
them at that point. Similarly, part 436 of the final amended Rule
eliminates burdensome waiting periods in some instances. Thus, in lieu
of the original Rule's mandate that all franchisors furnish copies of
their completed franchise agreements at least five business days before
execution, part 436 targets potential fraud directly by prohibiting a
franchisor from failing to disclose unilateral changes to a franchise
agreement seven days prior to its execution. As a final example, part
436 of the final amended Rule prohibits a franchisor from failing to
furnish a copy of its most recent disclosure document and any quarterly
updates to a prospective franchisee, upon reasonable request, before
the prospect signs the franchise agreement. This prohibition is in lieu
of suggestions that the Commission impose onerous disclosure updating
obligations on an ongoing basis.
Finally, in numerous instances the Commission has rejected
suggestions to impose certain additional requirements upon franchisors,
and has opted instead to address the underlying issues that prompted
those suggestions through redoubled consumer education efforts. For
example, several commenters in the rulemaking record urged the
Commission to expand the disclosure document to provide prospective
franchisees with more general information about the nature of
franchising. Others suggested more disclosure on post-termination
obligations to third-party vendors, obligations to purchase from
specific suppliers, and sources of financing, among others. While there
is merit in their suggestions, the Commission has concluded that the
appropriate vehicle
[[Page 15453]]
to disseminate such information is through consumer education
materials, not through the Rule itself. To that end, the cover page of
the disclosure document set forth in part 436 of the final amended Rule
references the Commissions' Consumer Guide to Buying a Franchise, where
such background information is furnished. This approach enables
prospective franchisees to obtain desirable information without
imposing new compliance burdens on franchisors.
4. Statement of prevalence
The Commission promulgated the original Rule based upon its finding
of prevalent deception in the offer and sale of franchises and business
opportunity ventures, leading to significant consumer injury. That
finding retains its validity and the final amended Rule retains almost
all of the original Rule's disclosure requirements for both franchises
and business opportunity sellers. In the franchise context,
modifications of those requirements have been driven by four
considerations: the goal of harmonizing the Rule with the UFOC
Guidelines; the need to update the original Rule to address new
technologies; to reduce unnecessary compliance burdens; and, based on
the record developed here, to remedy prevalent nondisclosure on issues
relating to the franchise relationship.\62\
---------------------------------------------------------------------------
\62\ The Commission is also considering amendments to the
original Rule as they pertain to business opportunity sales. See
Business Opportunity NPR, 71 FR 19054 (Apr. 12, 2006).
---------------------------------------------------------------------------
This last category of modifications constitutes the most
significant additions to the original Rule. Throughout the Rule
amendment proceeding, franchisees have complained repeatedly about
various practices in franchising that they believe are abusive. These
practices include encroachment of territories, source of supply
restrictions, modification of franchise agreements upon renewal, and
the use of confidentiality clauses to prevent franchisees from speaking
with prospects. To address these issues, franchisees urged the
Commission to promulgate a substantive franchise relationship law. As
detailed above in Section I.C., the applicable legal standard that
could theoretically support promulgation of such a law has not been
met. Nonetheless, the Commission is persuaded by evidence in the record
that nondisclosure of material information about franchise
relationships is prevalent and the record supports additional
disclosures that will help obviate deception of prospective
franchisees.
To that end, part 436 of the final amended Rule adopts a few new
disclosures that provide prospective franchisees with material
information about the quality of the franchise relationship or with
sources of information about such relationships. For example:
In section 436.5(c), the Item 3 requirements to disclose
information about franchisor litigation have been amended to encompass
franchisor-initiated litigation, such as suits to collect royalty
payments, in order to ensure prospective franchisees have material
information about the nature of the franchisor's relationship with its
franchisees;\63\
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\63\ Multiple franchisor-initiated suits could indicate
franchisees' inability to comply with royalty payment obligations,
or possibly a royalty boycott by franchisees. Suits to enforce
system standards, on the other hand, could show active involvement
by the franchisor in maintaining standards for the benefit of all
franchisees within its system. In either case, this is information
material to prospective franchisees attempting to determine the
nature of the franchisor's relationship with its franchisees.
---------------------------------------------------------------------------
In section 436.5(l), the Item 12 requirements to disclose
information about territories contain a new warning to prospective
franchisees about the consequences of not having an exclusive
territory-- that, as a result of having no exclusive territory, the
franchisee ``may face competition from other franchisees, from outlets
that we own, or from other channels of distribution or competitive
brands that we control;''
In section 436.5(q), the Item 17 requirements to disclose
information about renewal of the franchise mandate that a franchisor
describe what the term ``renewal'' means for its system, and state what
has been absent from disclosure to date--that franchisees will be
required to sign a different agreement when renewing, as opposed to
extending the term of their original agreement.
These new disclosure requirements are tailored to address the prevalent
franchisor nondisclosure of material information that prospective
franchisees need to avoid forming the kind of misconceptions about
these three key aspects of the franchise relationship that have
prompted the franchisee complaints noted in this record.
III. SECTION-BY-SECTION ANALYSIS OF PART 436
A. Section 436.1: Definitions
In many instances, the part 436 definitions of the final amended
Rule are substantively similar to those contained in either the
original Rule or UFOC Guidelines. These include the terms:
``affiliate,'' ``fiscal year,'' ``fractional franchise,''
``franchise,'' ``franchisee,'' ``franchisor,'' ``leased department,''
``person,'' ``prospective franchisee,'' and ``sale of a franchise.''
Part 436 of the final amended Rule, however, adds several new
definitions to the original Rule, including the terms: ``action,''
``confidentiality clause,'' ``disclose, state, describe, and list,''
``financial performance representation,'' ``franchise seller,''
``parent,'' ``plain English,'' ``predecessor,'' ``principal business
address,'' ``required payment,'' ``signature,'' ``trademark,'' and
``written.'' At the same time, part 436 of the final amended Rule
eliminates four of the original Rule's terms, and their definitions,
that are no longer necessary: ``business day,''\64\ ``time for making
of disclosures,''\65\ ``personal meeting,''\66\ and ``cooperative
association.''\67\
---------------------------------------------------------------------------
\64\See 16 CFR 436.2(f).
\65\ See 16 CFR 436.2(g).
\66\See 16 CFR 436.2(o). The original Rule required franchisors
to provide disclosure documents at the earlier of the first
``personal meeting'' or ``the time for making disclosures,'' which
generally meant 10 business days before the prospective franchisee
paid any fee or signed any contract in connection with the franchise
sale. The final amended Rule streamlines this requirement by
eliminating those timing provisions in favor of a clear, bright-line
14 calendar-day provision. Accordingly, the terms ``time for making
disclosures,'' ``personal meeting,'' and ``business day'' are
obsolete.
\67\ See 16 CFR 436.2(l). Cooperative associations are one of
four non-franchise relationships that the Commission has excluded
from the final amended Rule. Unlike Rule exemptions (which are
substantive limitations on the Rule's scope), the original Rule
exclusions are explanatory, helping the public better distinguish
between franchise and non-franchise relationships. Accordingly, the
Commission anticipates that staff will address non-franchise
relationships--including the four exclusions--in the Compliance
Guides instead of in the text of the amended Rule.
---------------------------------------------------------------------------
Section 436.1 of the final amended Rule is very similar to the
corresponding section of the proposed Rule published in the Franchise
NPR, but makes the following revisions: (1) substitutes a definition of
``confidentiality clause''; for the definition of ``gag clause;'' (2)
omits proposed definitions of ``Internet,'' ``officer,'' and
``material;'' and (3) makes non-substantive revisions to improve
readability, organization, and precision throughout, as well as some
substantive revisions in response to the comments. The following
sections discuss each definition of part 436 of the final amended Rule.
1. Section 436.1(a): Action
Consistent with the original Rule,\68\ section 436.5(c) of the
final amended
[[Page 15454]]
Rule requires a franchisor to disclose certain legal actions involving
the franchisor and its directors and officers. The original Rule did
not define the term ``action.'' Section 436.1(a) in the final amended
Rule is nearly identical to the definition proposed in the Franchise
NPR, and closely tracks the UFOC Guidelines' definition of the term
``action.''\69\ That definition is: ``Action includes complaints, cross
claims, counterclaims, and third-party complaints in a judicial action
or proceeding, and their equivalents in an administrative action or
arbitration.''\70\ The definition differs from the UFOC Guidelines
definition only in that it refers to a ``judicial action or
proceeding,'' in lieu of just a ``judicial proceeding.'' This
modification addresses one commenter's observation that some states may
retain the distinction between an ``action'' at law and a
``proceeding'' in equity.\71\ Clearly, both types of legal matters must
be disclosed.
---------------------------------------------------------------------------
\68\See 16 CFR 436.1(a)(4).
\69\ This definition is also consistent with the Commission's
interpretation of the term ``action,'' as discussed in the
Interpretive Guides to the Franchise Rule. Interpretive Guides, 44
FR at 49973.
\70\See UFOC Guidelines, Item 3 Definitions, ii.
\71\ NFC, NPR 12, at 25.
---------------------------------------------------------------------------
The Commission has declined to adopt an additional suggestion that
``complaints'' referred to in the definition of ``action'' be limited
to ``served complaints.''\72\ Such a narrowing of the definition of
``action'' would be inconsistent with the UFOC Guidelines. Moreover, it
would effectively enable a franchisor to avoid disclosing potentially
material litigation, even though it had notice of an action, merely
because it was not served with the papers yet or had successfully
avoided service of process. In the Commission's law enforcement
experience, it is not uncommon for defendants to know that a Commission
action was filed prior to service either by learning of the suit from
co-defendants or as a result of an asset freeze.\73\
---------------------------------------------------------------------------
\72\ Lewis, NPR 15, at 7.
\73\ E.g., FTC v. Joseph Hayes, No. 4:96CV02162SNL (E.D. Mo.
1996).
---------------------------------------------------------------------------
In the same vein, IL AG suggested that the term ``action'' should
refer to both `` filed'' and ``served'' complaints.\74\ A reference to
``filed complaints'' is unnecessary, however, and would be inconsistent
with the UFOC Guidelines: the definition of action already refers to
``complaints . . . in a judicial action or proceeding'' and
``complaints . . . in . . . an arbitration,'' meaning that a complaint
has already been filed. Accordingly, the Commission declines to adopt
these additional revisions to the definition of ``action.''
---------------------------------------------------------------------------
\74\ IL AG, at 2.
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2. Section 436.1(b): Affiliate
Many of the part 436 disclosures pertain to both the franchisor and
its affiliates.\75\ The original Rule defined the term ``affiliated
person'' to mean a person:
---------------------------------------------------------------------------
\75\E.g., Sections 436.5(a) (Item 1); 436.5(c) (Item 3);
436.5(d) (Item 4); 436.5(h) (Item 8).
(1) Which directly or indirectly controls, is controlled by, or is
---------------------------------------------------------------------------
under common control with, a franchisor; or
(2) Which directly or indirectly owns, controls, or holds with
power to vote, 10 percent or more of the outstanding voting securities
of a franchisor; or
(3) Which has, in common with a franchisor, one or more partners,
officers, directors, trustees, branch managers, or other persons
occupying similar status or performing similar functions.\76\
---------------------------------------------------------------------------
\76\ 16 CFR 436.2(i).
Section 436.1(b), like the corresponding definition in the proposed
Rule, harmonizes federal and state law, closely following the UFOC
Guidelines by defining ``affiliate'' to mean: ``an entity controlled
by, controlling, or under common control with, another entity.''\77\
This is slightly broader than the UFOC Guidelines' definition, however.
The UFOC Guidelines' definition uses the narrower term ``franchisor''
in place of ``another entity.'' This slight departure from the UFOC
Guidelines is necessary for the ``large franchisee'' exemption, section
436.8(a)(5)(ii), as discussed below in the section covering that
exemption.\78\
---------------------------------------------------------------------------
\77\See NASAA Commentary on the Uniform Franchise Offering
Circular Guidelines (1999), Bus. Franchise Guide (CCH), ] 5790, at
8466 (``NASAA Commentary'' or ``Commentary''). The Commentary notes
that this general definition of affiliate should be used throughout
a UFOC, unless a particular disclosure Item defines it differently
or limits its use. The record contains no indication that the UFOC
Guidelines' narrower definition is deficient or would impede the
Commission's ability to target affiliates in law enforcement
actions, where warranted.
\78\See Triarc, NPR 6, at 2. The Staff Report recommended that
the term ``affiliate'' mean ``controlled by, controlling, or under
common control with, the franchisor or a franchisee.'' See Staff
Report, at 21 (emphasis added). While this version was intended to
capture franchisee affiliates, for purposes of the ``large
franchisee'' exemption, it also had the unintended consequence of
broadening affiliate disclosures generally. For example, section
436.5(d) (Item 4) requires a franchisor to disclose a prior
bankruptcy of an affiliate. Defining ``affiliate'' expressly to
include ``franchisee'' would arguably require a franchisor to list
in its Item 4 bankruptcy disclosures the bankruptcy history of its
franchisees' affiliates. The final amended Rule does not follow this
problematic recommendation.
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3. Section 436.1(c): Confidentiality clause
Part 436 of the final amended Rule requires franchisors for the
first time to disclose the use of confidentiality clauses that prohibit
or restrict existing or former franchisees from discussing their
experience with prospective franchisees.\79\ Accordingly, section
436.1(c) of the final amended Rule adds to the original Rule
definitions the term ``confidentiality clause,''\80\ defined as
follows:
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\79\ Section 436.5(t)(7).
\80\ Originally, the Commission proposed using the term ``gag
clause'' to refer to such provisions. Franchise NPR, 64 FR at 57332.
Several commenters, however, opposed the term ``gag clause''
because, in their view, it is pejorative. They prefer a neutral
term, such as ``confidentiality agreement,'' ``confidentiality
clause,'' ``nondisclosure clause,'' or ``privacy clause.'' E.g.,
NFC, NPR 12, at 26; BI, NPR 28, at 10. Accordingly, the Commission
has adopted the term ``confidentiality clause.''
any contract, order, or settlement provision that directly or
indirectly restricts a current or former franchisee from discussing his
or her personal experience as a franchisee in the franchisor's system
with any prospective franchisee. It does not include clauses that
---------------------------------------------------------------------------
protect a franchisor's trademarks or other proprietary information.
As explained below, the confidentiality clause disclosure
requirement is intended to prevent deception in the offer and sale of
franchises by assisting prospective franchisees in verifying a
franchisor's claims. Specifically, this disclosure requirement is tied
to the requirement to disclose contact information for existing
franchised outlets.\81\ Knowing that a franchisor uses a
confidentiality clause enables prospective franchisees to understand
that a former or current franchisee may be prohibited from speaking
about his or her experience and will make efforts to contact other
former or current franchisees not subject to such a clause. This being
the disclosure's purpose, the operant definition is limited to
confidentiality clauses impinging on communications between current or
former franchisees and prospective franchisees only.\82\ It would not
cover clauses that prohibit communications between current or
[[Page 15455]]
former franchisees and, for example, the media.
---------------------------------------------------------------------------
\81\See section 436.5(t)(5). See also UFOC Guidelines Item 20 B.
\82\ At the same time, the confidentiality clause disclosure
requirement is not designed to cover specific settlement terms if
the franchisee is otherwise free to discuss his or her experience
within the franchise system, including the existence of a litigated
action with the franchisor.
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After carefully considering the comments, the Commission has
rejected suggestions to limit the definition of confidentiality clause
to cover only broad clauses that prohibit all communications by current
or former franchisees\83\ or only circumstances where all or at least
20% of franchisees are under speech restrictions.\84\ These suggestions
are narrower than necessary and would defeat the very purpose of the
confidentiality clause disclosure. Moreover, as stated throughout this
document, the Commission favors bright-line standards that enable
franchisors, prospective franchisees, and law enforcers to know when a
Rule provision applies without resort to fact-finding. In this
instance, the parties should know whether the confidentiality clause is
applicable without having to first determine the exact number of
franchisees under speech restrictions at any given period.
---------------------------------------------------------------------------
\83\ PMR&W, NPR 4, at 15.
\84\ NFC, NPR 12, at 33.
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Finally, the definition expressly excludes confidentiality
agreements designed to protect proprietary information. Many
commenters--both franchisor and franchisee representatives alike--
agreed that proprietary information should be exempted from the
definition because a franchisor has a reasonable and legitimate concern
about protecting its trademark and business secrets.\85\ One commenter
suggested that the Commission make clear that the existence of a
confidentiality agreement cannot be considered ``proprietary
information.''\86\ Otherwise, according to this commenter, a franchisor
could attempt to circumvent the confidentiality agreement disclosure by
having a prospective franchisee sign an agreement stating that the
existence of a confidentiality agreement is itself ``proprietary.'' The
Commission, however, intends that the term ``proprietary information''
be limited to trade secrets and intellectual property, the type of
information that, if disclosed, would put a franchisor at a competitive
disadvantage.
---------------------------------------------------------------------------
\85\E.g., Baer, ANPR 25, at 3; AFA, ANPR 62, at 3; Zarco &
Pardo, ANPR 134, at 4.
\86\ Bundy, NPR 18, at 3.
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4. Section 436.1(d): Disclose, state, describe, and list
Section 436.1(d) sets forth the definition of the terms
``disclose,'' ``state,'' ``describe,'' and ``list,'' which are used
throughout part 436. This is another definition not contained in the
original Rule. The proposed definition published in the Franchise NPR
was taken from the UFOC Guidelines, stating that these terms mean ``to
present all material facts accurately, clearly, concisely, and legibly
in plain English.''\87\
---------------------------------------------------------------------------
\87\See UFOC Guidelines, General Instruction 150. The phrase
``plain English'' is defined separately in section 436.1(o),
consistent with the UFOC Guidelines.
---------------------------------------------------------------------------
The Commission is persuaded that franchisors should have
flexibility in presenting their disclosures, provided that the
disclosures are clear and legible. The Staff Report recommended that
franchisors should be required to make disclosures in at least 12 point
upper and lower case type.\88\ This recommendation generated two
comments, however, asserting that the Commission should not mandate 12
point type. The commenters noted that 12 point type may result in some
of the Rule's charts being split into two sections. They suggested that
smaller fonts, especially in charts, can be very readable and result in
reduced compliance costs.\89\ The Commission agrees. Accordingly, part
436 of the final amended Rule does not mandate any specific font size:
franchisors may choose any font size, provided that their disclosures
are clear and likely to be noticed, read, and understood by a
reasonable prospective franchisee.
---------------------------------------------------------------------------
\88\ This presentation requirement would be consistent with the
Commission's approach in the original Rule. See 16 CFR 436.1(b)(4).
\89\ Gust Rosenfeld, at 2-3; Wiggin & Dana, at 6-7.
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Two additional Staff Report commenters sought refinements to
section 436.1(d), as proposed therein. One commenter opined that the
definition could be interpreted to mean that a franchisor must disclose
``every material fact regarding the offered franchise, rather than
disclosing all material facts pertaining specifically to the
disclosures required pursuant to the Rule.''\90\ The Commission
believes that this reading of the definition is strained and expressly
notes that it does not intend such a reading. Throughout the final
amended Rule, the topic on which the franchisor is required to
``present all material facts accurately, clearly, concisely, and
legibly in plain English'' is clear. Moreover, nothing in the record
suggests that a virtually identical definition in the UFOC Guidelines
has generated the problems anticipated by this commenter. This being
the case, the Commission is disinclined to deviate from the UFOC
Guidelines on this issue. Therefore, the Commission adopts the
definition as quoted above.
---------------------------------------------------------------------------
\90\ J&G, at 2.
---------------------------------------------------------------------------
Another commenter urged that the definition specify that the
meaning of ``disclose,'' ``state,'' ``describe,'' and ``list''
incorporates the concept that the language must be ldquo;understandable
by a person unfamiliar with the franchise business.''\91\ The
Commission believes that the final amended Rule's definition of ``plain
English'' in section 436.1(o) gives more direction to franchisors in
preparing their disclosures than the more general phrase
``understandable by a person unfamiliar with the franchise business.''
Therefore, we decline to adopt this suggestion.
---------------------------------------------------------------------------
\91\ IL AG, at 2.
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Finally, we note that three commenters urged the Commission to
define separately the term ``material.''\92\ In particular, they
asserted that it is unclear whether materiality should be determined
from the franchisor's or the prospective franchisee's viewpoint. For
example, isolated instances of franchisee-initiated lawsuits might not
be material to a franchisor (i.e., not affecting the franchisor's
financial status), but could be highly material to a prospective
franchisee seeking information on the quality of the franchise
relationship.\93\
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\92\ Bundy, at 3; Cendant, at 3; IL AG, at 3. The Staff Report
recommended deletion of this definition based on use of the term in
the Rule text in at least two distinguishable ways, creating
unnecessary confusion. Staff Report, at 68-9.
\93\ See Cendant, at 3.
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The original Rule defined ``material, material fact, and material
change.''\94\ The Commission, however, believes that such definitions
are not necessary. An understanding of materiality under the final
amended Rule can best be gained by looking to long-established
Commission jurisprudence. ``Materiality'' is a cornerstone concept of
that jurisprudence. To be clear on this important point, the
Commission, when interpreting Section 5, regards a representation,
omission, or practice to be deceptive if: (1) it is likely to mislead
consumers acting reasonably under the circumstances; and (2) it is
material; that is, likely to affect consumers' conduct or decisions
with respect to the product at issue.\95\ Accordingly, it is amply
clear that ``materiality'' is determined by the reasonable consumer
standard, or in franchise matters, by the reasonable prospective
franchisee standard. Moreover, since violations of the Franchise Rule
constitute violations of Section 5, we believe that the Section
[[Page 15456]]
5 deception jurisprudence provides adequate guidance on what the term
``material'' means in the Franchise Rule context.
---------------------------------------------------------------------------
\94\ 16 CFR 436.2(n).
\95\See generally Federal Trade Commission Policy Statement on
Deception, appended to Cliffdale Assocs., 103 FTC 110 (1984).
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5. Section 436.1(e): Financial performance representation
This section of part 436 defines the term ``financial performance
representation'' to mean:
any representation, including any oral, written, or visual
representation, to a prospective franchisee, including a representation
in the general media, that states, expressly or by implication, a
specific level or range of actual or potential sales, income, gross
profits, or net profits. The term includes a chart, table, or
mathematical calculation that shows possible results based on a
combination of variables.\96\
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\96\ The part 436 definition is nearly identical to the
definition as proposed in the Franchise NPR, with slightly modified
language in some places to improve clarity and precision. No
commenter raised any concerns about the basic ``financial
performance representation'' definition. Nevertheless, IL AG posed a
number of questions about how the definition would be applied in
various situations, such as representations based upon earnings of a
franchisor's affiliates or representations based upon industry data.
IL AG, at 2. Questions such as these are best addressed in the
Compliance Guides or in staff advisory opinions, where they can be
analyzed in the context of specific facts.
This definition comes into play in one of the most important
sections of the final amended Rule, section 436.5(s), corresponding to
Item 19 of the UFOC Guidelines. Like Item 19, it governs the making of
financial performance representations.\97\ The definition incorporates
the original Rule's approach, in that it specifies that a financial
performance representation may be in an ``oral, written, or visual''
format.\98\ To ensure that part 436 covers implied financial
performance representations, the definition also refers to financial
performance representations that are made both ``expressly or by
implication.''\99\ It also retains the original Rule's reference to
financial performance representations made in the general media.\100\
At the same time, section 436.1(e) adopts several aspects of the UFOC
Guidelines definition, including references to ``actual'' and
``potential'' performance (to capture both historical financial
performance and projections),\101\ as well as the use of charts,
tables, and mathematical calculations.\102\
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\97\ The final amended Rule uses the broad term ``financial
performance representation,'' rather than the original Rule's more
limited term ``earnings claim.'' This modification recognizes that
some industries, such as hotels, use variables other than earnings
to measure performance, such as room occupancy rates. See Franchise
NPR, 64 FR at 57297.
\98\ The original Rule described performance information as
``any oral, written, or visual representation to a prospective
franchisee which states a specific level of potential sales, income,
gross, or net profit for the prospective franchisee, or which states
other figures which suggest such a specific level.'' 16 CFR 436.1(b)
and (c).
\99\ To address implied claims, the original Rule used the term
``suggests.'' The proposed definition of ``financial performance
representation'' published in the Franchise NPR similarly used that
term. One franchisee representative observed that the word
``suggests'' in this context is flawed: it would not reach the
furnishing of fragments of financial data from which a prospect may
readily estimate or calculate earnings. Bundy, NPR 18, at 1. The
Commission agrees that a franchisor can imply a performance claim by
giving a prospect a few pieces of financial information from which
the prospect can fill in the blanks and draw his or her own
conclusion about a specific level of potential earnings. In
addition, a franchisor can imply that a prospect can earn a specific
level of income, such as by using a proxy for earnings (for example,
``You will do so well that you can buy that Porsche.''). See
Interpretive Guides, 44 FR at 49982. Both types of implied claims
constitute financial performance representations that are, and
should be, covered by the final amended Rule. To clarify this
policy, the final amended Rule uses the phrase ``states, expressly
or by implication.'' This phrase is widely used, for example, in
connection with representations challenged under Section 5. E.g.,
FTC v. Prophet 3H, Inc., 06 CV 1692 (N.D. Ga. 2006); FTC v.
Morrone's Water Ice, Inc., No. 02-3720 (E.D. Pa. 2002).
\100\See 16 CFR 436.1(e).
\101\ This streamlines the original Rule, which addressed
historical performance representations and projections in two
distinct Rule provisions, 16 CFR 436.1(b) (projections) and 436.1(c)
(historical information).
\102\ The staff of the Commission has adopted the same position
in several informal advisory opinions. E.g., Handy Hardware Centers,
Bus. Franchise Guide (CCH) ] 6426 (1980) (The Rule's ``earnings
claim requirements are applicable to `any oral, written, or visual
representation.'''); Diet Center, Inc., Bus. Franchise Guide (CCH) ]
6437 (1983) (table with arithmetic calculations uniformly
demonstrating net profits constitutes a financial performance
representation).
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Two aspects of the definition of the term ``financial performance
representation'' generated significant comment: whether the Commission
should treat information about costs and expenses as financial
performance representations;\103\ and whether the Commission should
interpret the definition's express inclusion of any ``representation in
the general media'' to include all financial information available on a
franchisor's website or through a franchisor's speeches and press
releases.\104\ Each of these interpretive issues is discussed in the
sections immediately below.
---------------------------------------------------------------------------
\103\ See Interpretive Guides, 44 FR 49982.
\104\ See Interpretive Guides, 44 FR at 49984-85.
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a. Treatment of cost and expense information
In the Franchise NPR, the Commission made it clear that the section
436.1(e) definition of ``financial performance representation'' is not
intended to reach disclosures of expense information, and specifically
sought comment on this issue.\105\ Most commenters who responded on
this issue felt that disclosures of expense information should not fall
within the definition.\106\ Some, however, sought additional
clarification. For example, the IL AG urged the Commission to modify
the definition of ``financial performance representation'' to expressly
exclude expense disclosures mandated in Items 5-7 of the final amended
Rule (initial fees, ongoing costs, and initial investment), offering
the following additional sentence: ``Expenses required in Items 5, 6,
and 7 of the disclosure document are not to be considered performance
claims and do not contradict Item 19 requirements.''\107\ Others went
further, arguing that the dissemination of any expense information
should not trigger the Item 19 disclosure requirements.\108\
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\105\ Neither the original Rule nor the final amended Rule
includes mention of expenses in the definition of ``financial
performance representation,'' but the Commission indicated its
intended interpretation in the Franchise NPR's discussion of the
definition of the term. Specifically, it stated that ``[w]hile the
Commission does not consider the disclosure of such expense
information alone to constitute the making of a financial
performance claim, others arguably may interpret some expense
information as implying a financial performance representation, such
as a break-even point. To avoid any confusion, the proposed
definition of `financial performance representation' . . .
specifically omits expense information.'' Franchise NPR, 64 FR at
57329. This interpretation is a departure from the Commission's
former policy, as articulated in the Interpretive Guides. The Guides
expressed the view that cost information alone could be a financial
performance claim because a prospective franchisee could use such
information to calculate likely profits by simply selecting
arbitrary sales figures. Interpretive Guides, 44 FR at 49982. It
also departs from UFOC Guidelines Item 19, which expressly lists
costs among the items of information that constitute an earnings
claims. See also UFOC Guidelines, Item 19, Instructions i.
Nevertheless, in light of the comments and the Commission's long law
enforcement history, the Commission, reiterating its Franchise NPR
statement quoted immediately above, states its intent that expense
information not be included in the part 436 definition of
``financial performance representation.'' As discussed above, the
states agree. See NASAA, NPR 17, at 2.
\106\E.g., IL AG, NPR 3, at 3; Baer, NPR 11, at 7; NFC, NPR 12,
at 13; NASAA, NPR 17, at 2; BI, NPR 28, at 10. But see Bundy, NPR
18, at 2 (arguing that expense disclosures inevitably will lead
prospective franchisees to extrapolate earnings without the
protection of an Item 19 disclosure).
\107\ IL AG, NPR 3, at 8-9. See also Baer, NPR 11, at 7.
\108\ NFC, NPR 12, at 13. The NFC also suggested that the
Commission modify the Rule to exclude from the definition of
``financial performance representation'' financial data furnished to
existing franchisees. Id. The Commission concludes, however, that
part 436 need not be revised to address this issue. A franchisor is
always free to furnish truthful information about its system to
existing franchisees, especially if no additional franchise sales
are contemplated. If the franchisor contemplates an additional
franchise sale under materially different terms and conditions than
the franchisee's original purchase, then the existing franchisee,
like any prospective franchisee, could be misled and therefore
should receive financial performance disclosures in the form of an
Item 19 disclosure. For example, an Item 19 disclosure will assist
an existing franchisee operating in a shopping mall or urban area in
the northeast to understand an earnings projection for an additional
stand-alone outlet or outlet to be located in a rural section of the
southwest.
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[[Page 15457]]
Notwithstanding language to the contrary in the original
Interpretive Guides,\109\ the Commission is persuaded that expense
information alone is insufficient to enable prospective franchisees to
gauge their potential earnings with any degree of specificity that
could rise to the level of a financial performance claim.\110\ The
Commission explained in the Franchise NPR and now reiterates here that
mere disclosure of cost information does not, in its view, constitute a
financial performance representation triggering Item 19 disclosure
obligations. The Commission intends that the explanation that mere
expense disclosures alone do not constitute a financial performance
representation, coupled with the deliberate omission of any mention of
expense information from section 436.1(e) of the final amended Rule,
will be enough to address this issue.
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\109\ Interpretive Guides, 44 FR at 49982.
\110\ At any rate, according to NASAA, franchisors do not
routinely disseminate individualized expense information geared to a
specific offering that might be used to insinuate an earnings level.
NASAA, 17 NPR, at 2.
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b. General media claims
Section 436.1(e) of the final amended Rule retains the original
Rule's provision governing the making of financial performance
representations in the general media. Under the original Rule, a
general media financial performance representation, like all other
financial performance representations, must have a reasonable basis and
state the number and percentage of outlets earning the claimed amount,
among other substantiation and disclosure requirements.\111\ There is
no comparable provision in the UFOC Guidelines.\112\
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\111\ See 16 CFR 436.1(b)(5)(i); 436.1(c)(6)(i);
436.1(e)(5)(ii). Unlike other financial performance claims, a claim
made in the general media need not be geographically relevant to the
market in which franchises are being offered for sale.
\112\ Although the UFOC Guidelines do not address general media
claims, many of the states with disclosure laws require franchisors
to register their advertisements in advance of their use. E.g., Cal.
Corp. Code Sec. 31156 (1997) (franchisor must register advertising
at least three business days before first publication); Md. Code
Ann., Bus. Reg. Sec. 14-225 (1998) (franchisor must register
advertising at least seven business days before publication).
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In the Franchise NPR, the Commission proposed that the term
``financial performance representation'' should broadly include the
dissemination of financial performance information via the
Internet.\113\ The majority of commenters who addressed this issue,
however, questioned whether financial performance information posted
online should constitute ``financial performance representations,''
thus triggering the Rule's disclosure and substantiation
requirements.\114\ These commenters asserted that the Commission should
not deem financial performance information posted on a franchisor's
website to be financial performance representations under the Rule,
unless the information is located in a section of a website that
solicits franchise purchasers or otherwise specifically targets
prospective franchisees.\115\ In their view, financial performance
information on a franchisor's website--including links to press
releases, interviews, or articles--is intended to educate the general
public about the company, rather than to attract prospective
franchisees.\116\ Indeed, some posted information may consist of copies
of publicly filed reports, such as 10-Qs and 10-Ks, that are submitted
to the SEC.\117\ At least one commenter feared that equating online
financial performance information with financial performance
representations under the Rule would have a chilling effect,
unreasonably restricting the kinds of materials a franchisor could have
on its website: ``Does this mean that a franchise company, unlike any
other business, must choose between taking advantage of articles or
press releases about itself on its own web site page or risk the claim
that a prospective franchisee has been given unauthorized non-Item 19
financial data?''\118\
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\113\ In the proposed Rule, the term ``financial performance
representation'' expressly included ``a representation disseminated
in the general media and Internet.'' Franchise NPR, 64 FR at 57297,
57332. (emphasis supplied.) In accordance with the discussion in
this section of the SBP, the Commission has deleted this phrase to
dispel potential readings that financial information posted on the
Internet is per se a financial performance representation.
\114\E.g., PMR&W NPR 4, at 16; H&H, NPR 9, at 14; NFC, NPR 12,
at 23-24.
\115\E.g., Gust Rosenfeld, at 7; Quizno's, NPR 1, at 3; PRM&W,
NPR 4, at 16; NFC, NPR 12, at 24; BI, NPR 28, at 9.
\116\E.g., Quizno's, NPR 1, at 3. See also BI, NPR 28, at 9.
\117\E.g., Quizno's, NPR 1, at 3; PMR&W, NPR 4, at 16; H&H, NPR
9, at 14; BI, NPR 28, at 9.
\118\ Quizno's, NPR 1, at 3.
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Two Staff Report commenters broadened this argument beyond the
online context to encompass franchisors' speeches and news releases. In
the Interpretive Guides, the Commission described ``general media''
broadly to include: ``advertising (radio, television, magazines,
newspapers, billboards, etc) as well as those contained in speeches or
press releases.''\119\ David Kaufmann, for example, asserted that the
inclusion of speeches and news releases harms franchisors by making it
difficult for them to disseminate financial performance information in
``speeches, press interviews, and other forums not specifically geared
to the franchise sales process.''\120\ He urged the Commission to
permit franchisors and their executives to disseminate financial
performance information to the public freely, unless copies are
subsequently used in the franchisor's franchise marketing effort.
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\119\ Interpretive Guides, 44 FR at 49984-85. The Commission
excluded, however, ``communications to financial journals or the
trade press in connection with bona-fide news stories, or directly
to lenders in connection with arranging financing for the
franchisee.'' Id. at 49985.
\120\ Kaufmann, at 6. See also Cendant, at 2.
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Based upon the comments, the Commission is persuaded that it is
unwarranted to sweep broadly into the part 436 definition of
``financial performance representation'' all financial performance
information posted online or appearing in press releases or speeches.
The dissemination of financial information online and in press stories
and releases is for the benefit of more than prospective franchisees,
including investors, potential suppliers, and members of the general
public.\121\ Further, the Commission believes that the commenters'
concerns are well-founded with respect to publicly filed reports
required by the SEC. The Commission agrees that such filings are
already publicly available and, more important, have indicia of
reliability. Indeed, the dissemination of false financial data by
publicly traded franchisors is already illegal. Thus, to impose the
Rule's substantiation and disclosure requirements with respect to SEC
filing
[[Page 15458]]
would be pointless, unworkable, and unduly burdensome.
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\121\ Indeed, the staff previously has advised that the
dissemination of financial performance information through bona fide
news stories may generate benefits to the public that outweigh
potential harm to prospective franchisees. ``For example, such
information may be useful to potential suppliers seeking growing
businesses as customers; shopping center or mall developers seeking
promising franchised systems as tenants; and financial analysts who
follow market or industry trends. Accordingly, the exemption from
the general media earnings claims disclosure requirements ensures
that the Rule does not chill the free flow of newsworthy information
about franchising or particular franchise systems.'' Advisory 97-5,
Bus. Franchise Guide (CCH) ] 6485 at 9687 (July 31, 1997).
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With respect to the dissemination of other financial performance
information, the Commission believes that a distinction should be made
between information disseminated in advertisements directed at
franchisees--be it in print, radio, television, or Internet--and
information disseminated to the general public. We are convinced that
deeming financial performance information disseminated publicly to be
``financial performance representations'' under the Rule would have a
chilling effect, discouraging franchisors from furnishing truthful
information to the public. However, where a franchisor utilizes
financial performance information disseminated, or intended to be
disseminated, to the general public in its franchise promotional
materials (e.g., in a brochure or franchisee section of a website),
includes in its franchise promotional materials a reference to general
financial information on its website, or otherwise repeats the general
financial information to prospective franchisees (such as in a face-to-
face meeting with an audience of prospective franchisees), such
information will be deemed ``financial performance representations,''
triggering part 436's disclosure and substantiation requirements.\122\
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\122\See Advisory 97-5, Bus. Franchise Guide (CCH) at 9687 (``By
disseminating copies of [news articles containing earnings claims],
the franchisor effectively ratifies the journalist's words as its
own and, in so doing, converts the article into an advertising piece
designed to solicit prospective franchisees.'').
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The Commission anticipates that staff will address the narrowed
scope of general media financial performance representations in the
Compliance Guides. This is consistent with the approach historically
adopted, whereby the Commission explained the scope of general media
claims in the Interpretive Guides, providing illustrative examples and
more detailed discussion than is possible in the text of the Rule
itself. As an initial matter, the Commission anticipates that staff
will retain in the Compliance Guides the original Interpretive Guides'
determination that communications about financial performance made to
the trade press and directly to lenders do not constitute general media
financial performance representations.\123\ At the same time, the
Commission anticipates that staff will add SEC filings, speeches, and
news releases to the list of communications not constituting financial
performance representations under the final amended Rule. There is one
important caveat, however. Where the franchisor directs the speeches or
news releases to prospective franchisees or uses copies of speeches or
news releases in marketing materials aimed at prospective franchisees,
then such materials will constitute general media financial performance
representations under the Rule.
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\123\ Interpretive Guides, 44 FR at 49984-85 (```General media
claim' does not include communications to financial journals or the
trade press in connection with bona-fide news stories, or directly
to lenders in connection with arranging financing for
franchisees.'').
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6. Section 436.1(f): Fiscal year
Several Rule disclosures are based upon the franchisor's fiscal
year.\124\ Section 436.1(f) retains the original Rule definition of the
term ``fiscal year,'' making clear that it ``refers to the franchisor's
fiscal year.''\125\ This issue generated no comment.
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\124\E.g., section 436.5(a) (Item 1); section 436.5(c) (Item 3);
section 436.5(e) (Item 5); section 436.5(t) (Item 20); section
436.5(u) (Item 21).
\125\ 16 CFR 436.2(m).
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7. Section 436.1(g): Fractional franchise
Section 436.1(g) of the final amended Rule adopts the definition of
the term ``fractional franchise'' that was proposed in the Franchise
NPR with only minor language changes to improve clarity. This
definition comes into play in section 436.8(a)(2) of the final amended
Rule, which retains the original Rule's exemption for fractional
franchises.\126\ In most instances, the fractional franchise exemption
arises where an existing business seeks to expand its product line
through a franchise meeting two criteria: (1) the franchisee or its
principals have more than two years of experience in the same line of
business; and (2) the parties reasonably expect that the franchisee's
sales from the new line of business will not exceed 20% of its total
sales.\127\
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\126\ The fractional franchise is one of several exemptions
contained in the original Rule that are retained in the final
amended Rule. In contrast, the UFOC Guidelines contain no
exemptions. State exemptions, which vary from state to state, are
set out in state statutes or regulations. In general, state
franchise laws do not exempt franchisors from the basic obligation
to furnish prospects with UFOCs. At most, states may exempt
franchisors from state registration requirements.
\127\ In the original SBP, the Commission reasoned, with respect
to fractional franchisees, that pre-sale disclosure is unwarranted
where the prospective franchisee already is familiar with the
products and services to be sold through the franchise and where the
prospective franchisee faces a minimal investment risk. Original
SBP, 43 FR at 59707.
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Section 436.1(g) clarifies the scope of the original ``fractional
franchise'' exemption by adding greater precision and specificity.\128\
First, it incorporates the Commission's long-standing policy that the
parties must ``anticipate that sales arising from the relationship will
not exceed 20% of the franchisee's total volume in sales during the
first year of operation.''\129\ Second, it makes explicit what
previously has been only implied: that the parties must have ``a
reasonable basis'' to assert the exemption.\130\
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\128\ The Commission believes that greater precision in the Rule
text is warranted in light of numerous requests for advisory
opinions on the scope of the fractional franchise exemption since
the original Rule was promulgated. See, e.g., Advisory 93-5, Bus.
Franchise Guide (CCH),] 6449 (1993); Advisory 94-4, id., at ] 6460
(1994); Advisory 95-2, id., at ] 6467 (1995); Advisory 96-1, id., at
] 6476 (1996); Advisory 97-1, id., at ] 6481 (1997).
\129\See Interpretive Guides, 44 FR at 49968.
\130\ The proposed definition in the Franchise NPR formulated
this as ``The parties reasonably anticipate . . .'' The final
language is more precisely in line with basic concepts of FTC
jurisprudence.
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During the Rule amendment proceeding, a few commenters suggested
that the Commission broaden the fractional franchise exemption. Two
commenters urged the Commission to broaden the first prong of the
fractional franchise exemption --``experience in the same type of
business''--to exempt franchisees with experience in the same industry
or selling similar or complementary goods or services.\131\ The
suggestion that the exemption be broadened to ``experience in the same
industry'' goes far beyond the underlying rationale that supports the
fractional franchise exemption--namely, the notion that prior
experience in the same line of business reduces the likelihood of fraud
or deception because the fractional franchisee likely will be familiar
with the products to be offered for sale through the franchise
relationship.
---------------------------------------------------------------------------
\131\ Piper Rudnick, at 4 (suggesting experience in the same
basic industry should suffice); H&H, NPR 9, at 4 (complementary
experience should suffice).
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The Commission does not believe that a franchisee in any particular
economic sector necessarily has sufficient experience to operate a
different franchise within the same sector. For example, we would not
necessarily expect a muffler shop franchisee to automatically
understand the financial risks of operating a quick-lube service
station, although both operations are in the automotive repair
industry. Nor would we expect a franchisee operating a small fast-food
kiosk in a mall to necessarily appreciate the risks of operating a
large, sit-down full-service restaurant, although both are in the food
service industry.
Nevertheless, the Commission has never required experience in the
identical type of business. Rather, the sale of similar goods may
qualify for the exemption. As explained in the current
[[Page 15459]]
Interpretive Guides, ``the required experience may be in the same
business selling competitive goods or in a business that would
ordinarily be expected to sell the type of goods to be distributed
under the franchise.''\132\ This approach is reasonable because a
prospective franchisee who is already familiar with the goods or
services of the franchise can better assess the financial risk involved
in entering into a relationship with the franchisor.
---------------------------------------------------------------------------
\132\ Interpretive Guides, 44 FR at 49968.
---------------------------------------------------------------------------
Our reluctance to expand the fractional franchise exemption also
holds true with respect to the sale of ``complementary goods.'' What
may be viewed as ``complementary goods'' in any particular line of
business may be quite subjective. For example, reasonable minds may
differ whether the introduction of ice cream sales at a donut/coffee
shop is ``complementary.'' While certain products may make
complementary sales combinations--such as ice cream and donuts--it does
not necessarily follow that a donut shop franchisee is experienced with
the risks involved with marketing and selling ice cream.
While the Commission declines to revise the Rule to broaden the
types of experience needed to qualify for the fractional franchise
exemption, we agree that the exemption should be expanded with respect
to the types of individuals whose experience can qualify for the
exemption.
The original definition specified that, in determining whether a
relationship qualified as a the fractional franchise exemption, a
franchisor could consider the prior experience of the franchisee ``or
any of the current directors or executive officers thereof.''\133\
Marriott recommended that the prior experience of an officer or
director of an affiliate or parent of the franchisee should also be
deemed a sound basis for the ``experience'' prong of the definition.
Marriott noted that the Staff Report recommended the same approach in
connection with the prior experience prerequisite of the ``large
franchisee'' exemption.\134\
---------------------------------------------------------------------------
\133\ 16 CFR 436.2(h).
\134\ Marriott, at 4.
---------------------------------------------------------------------------
We are persuaded by Marriott's arguments that a broad reading of
the fractional franchise exemption is warranted when determining which
individuals may qualify as having the requisite prior experience. The
principal factor in applying the fractional franchise exemption of part
436 is whether the business seeking to expand can obtain practical
guidance and direction from someone within the business with prior
experience. It makes little difference whether the business can call
upon its own directors or officers for guidance or whether the business
can call upon those of a subsidiary, as long as those individuals have
prior experience in the same line of business. As in the large
franchisee exemption, we recognize that franchisors may establish
subsidiaries for limited liability or tax purposes. In such instances,
the operations of the franchisor and its subsidiaries are likely to be
close, such that the prior experience of one is available to help
direct the business decisions of the other. We believe the same is no
less true in the fractional franchise context.
Finally, one commenter, focusing on the second prong of the
fractional franchise exemption, recommended that any franchise
arrangement that accounts for less than 25% of the franchisee's
business in the next year should be exempt from the Rule, even if the
fractional franchisee has had no prior experience with the products or
services being added to his or her product line.\135\ In short, this
commenter would delete the prior experience prong from the fractional
franchise definition. We reject this suggestion.
---------------------------------------------------------------------------
\135\ J&G, NPR 32.
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The Commission believes that prior experience is a necessary
component of the fractional franchise exemption. A business owner
seeking a new opportunity is no different from a novice when it comes
to entering into a type of business with which he or she is
unfamiliar.\136\ It is precisely in such circumstances that the
prospective franchisee needs the material disclosures the Rule affords
in order to make an informed decision whether to invest in the
opportunity. What distinguishes a fractional franchisee from novices
and business owners generally is that the fractional franchisee has
prior experience with the goods and services being offered for sale,
and thus is less in need of the Rule's protections. Indeed, the record
is devoid of any data from which we could conclude that ongoing
businesses seeking to expand into unfamiliar areas do not continue to
need the Rule's protections. Accordingly, we believe retaining the
prior experience prerequisite for the fractional franchise exemption is
a sound approach.
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\136\ The Commission recognizes, however, that in some
instances, prior experience or the ability to consult those with
prior experience, can be assumed. That is the basis of the new large
investment exemption from the final amended Rule, discussed below.
See section 436.8(a)(5)(i). Where an investment is sufficiently
large--$1 million excluding the cost of unimproved land and any
franchisor financing--we believe that the prospective franchisee is
sophisticated and can obtain the information necessary to assess the
franchise offering without our mandating that it be provided.
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8. Section 436.1(h): Franchise
The original Rule defined ``franchise'' broadly to encompass both
franchises and business opportunity ventures. A franchisor was covered
by the original Rule if it represented that the business arrangement it
offered entailed the following three elements: (1) permission to use
the franchisor's trademark; (2) significant franchisor control over the
franchise operation or significant franchisor assistance to the
franchisee; and (3) a required payment from the franchisee to the
franchisor.\137\ Similarly, a business opportunity seller was covered
by the original Rule if the seller represented that the business
arrangement it offered entailed: (1) supplying the buyer with goods or
services to market to the public; (2) providing location assistance or
accounts for vending machines or other equipment; and (3) charging a
required payment from the opportunity purchaser.\138\
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\137\ See 16 CFR 436.2(a)(1)(i) and 436.2(a)(2). The UFOC
Guidelines do not define what constitutes a franchise. Rather,
definitions of the term ``franchise'' are set forth in individual
state statutes. For a discussion of state definitions of the term
``franchise,'' see Staff Report, at 37-41, available online at:
http://www.ftc.gov/os/2004/08/0408franchiserulerpt.pdf.
\138\ See 16 CFR 436.2(a)(1)(ii) and 436.2(a)(2).
---------------------------------------------------------------------------
Like the proposed section 436.1(h) published in the Franchise NPR,
this section of the final amended Rule focuses exclusively on franchise
sales, eliminating the business opportunity section of the definition.
The amended definition is also more precise than the original
definition. Specifically, the amended definition clarifies two issues
that the Commission's Rule enforcement experience suggests are not well
understood: (1) that a business relationship will be deemed a franchise
if it satisfies the three elements of a franchise, regardless of the
nomenclature used to label or describe it;\139\ and (2) that a business
relationship will be deemed a franchise if the franchisor represents
that the relationship being offered has the characteristics of a
franchise, regardless of any failure on the franchisor's part to
perform as promised.\140\
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\139\ See Interpretive Guides, 44 FR at 49966. See also FTC v.
Morrone's Water Ice, Inc., No. 02-3720 (E.D. Pa. 2002). The staff
has provided the same advice in several informal advisory opinions.
E.g., Con-Wall Corp. Bus. Franchise Guide (CCH) ] 6427 (1981).
\140\ This is not a change of policy. The original definition of
``franchise'' added that ``[a]ny relationship which is represented .
. . to be a franchise (as defined in the original Rule) is subject
to the requirements of this part.'' 16 CFR 436.2(a)(5). However,
this provision was set out in the original ``franchise'' definition
after exemptions and exclusions, and, therefore, was largely
overlooked or ignored. The final amended Rule makes the definition
of ``franchise'' more precise by including this policy in the
introductory part of the amended definition. See also United States
v. Protocol, Inc., Bus. Franchise Guide (CCH) [1996-97 Transfer
Binder], ] 11184 at 29550, 29555 (D. Minn. 1997); FTC v. Wolf, Bus.
Franchise Guide (CCH), ] 10401 (S.D. Fla. 1994); FTC v. Int'l
Computer Concepts, No. 1:94cv1678 (N.D. Ohio 1994); FTC v. Sage
Seminars, Inc., No. C-95-2854-SBA (N.D. Cal. 1995). The staff of the
Commission has provided the same advice in several informal advisory
opinions. E.g., Real America Real Estate Corp., Bus. Franchise Guide
(CCH) ] 6428 (1982) (``the applicability of the rule will not be
defeated by a franchisor's subsequent failure to live up to any such
commitment'').
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[[Page 15460]]
Early in the Rule amendment proceeding, a few commenters offered
suggestions for modifying the definition of ``franchise.'' For example,
one commenter urged the Commission to adopt the states' definition of
the term ``franchise.''\141\ However, there is no single state
definition of the term ``franchise.''\142\ Nevertheless, the Rule's
definition is entirely consistent with the principles underlying the
various state definitions, and the Commission concludes that there is
no persuasive argument to modify the definition further.
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\141\ Baer, NPR 11, at 7.
\142\See Staff Report, at 37-41.
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Another commenter voiced concern over the Commission's policy that
a business relationship will be deemed a franchise ``if it is offered
or represented as having the characteristics of a franchise,
irrespective of whether or not the relationship independently meets the
actual . . . definition of a franchise.''\143\ He stated that such an
approach would be a mistake, ``raising the form of a description of a
business relationship to a level which would control over the actual
substance of the relationship.''\144\
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\143\ Holmes, NPR 8, at 1. See also Gurnick, NPR 21A; IL AG, NPR
3.
\144\Id., at 2.
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There are two distinct issues here: (1) whether the Rule should
apply to a business relationship that the parties call a ``franchise,''
even if the relationship does not satisfy the three definitional
elements of a franchise; and (2) whether the Rule should apply to a
business relationship that is represented as satisfying the three
definitional elements of the term ``franchise,'' even if the
relationship, in fact, does not satisfy those elements--e.g., because
of the seller's non-performance. The commenter correctly asserted that
the Rule should not cover situations where the parties mistakenly use
the term ``franchise'' to describe their business relationship. A
business relationship constitutes a franchise only if, as promised or
represented, it satisfies the three elements of the term ``franchise,''
and nothing in the ``franchise'' definition is to the contrary.
The clarification in the amended definition addresses the second
issue--whether representing a business relationship as satisfying the
three definitional elements of the ``franchise'' definition (as opposed
to merely calling a relationship a franchise) is sufficient to bring a
business relationship under the Rule. The original Rule took the
position that it was sufficient, and the Commission believes that
position remains sound.\145\ A prospect seeking to purchase an
opportunity that is represented as being a franchise should receive a
disclosure document in order to make an informed investment decision.
The prospect should not have to investigate whether or not the seller,
post-sale, actually delivers a franchise or some other type of
opportunity. For example, a start-up company may seek to sell its first
franchised outlet, advertising that, for a $500 fee, it will license
its mark and provide significant assistance to buyers. Under these
circumstances, a prospect should receive a disclosure document before
the sale because, as represented, the business offered satisfies each
of the three elements of a franchise. This is true, even if the
franchisor, in fact, lied and has no ability to perform as promised,
such as having no right to the trademark offered or having no staff to
provide promised assistance, facts that may only be discovered by the
purchaser post-sale. In short, the seller should not be able to raise
as a defense to a post-sale Rule violation that it, in fact, offered a
non-franchise business arrangement if, at the time of sale, its
representations about the business satisfied the definition of a
franchise.\146\
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\145\ 16 CFR 436.1 (``any relationship which is represented . .
. to be a franchise''); 436.2(a)(5) (``Any relationship which is
represented either orally or in writing to be a franchise [as
defined in the Rule] is subject to the requirements of this
part.'').
\146\ With respect to required payments, the Commission will
also consider any obligation to make a payment imposed by the
franchisor post-sale, as long as the payment must be made within six
months after the franchisee commences operation of the business. See
section 436.8(a)(1) (minimum payment exemption).
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9. Section 436.1(i): Franchisee
The original Rule defined ``franchisee[r]dquo; as: ``any person (1)
who participates in a franchise relationship as a franchisee . . . or
(2) to whom an interest in a franchise is sold.''\147\ The definition
proposed in the Franchise NPR was ``any person who is granted an
interest in a franchise.'' Section 436.1(i) of the final amended Rule
adopts an even more precise version: ``Franchisee means any person who
is granted a franchise.''\148\ This narrowing of the definition is in
response to commenters who voiced concern that the phrase ``an interest
in a franchise'' is too broad, arguably sweeping in shareholders of
publicly traded companies and other investors.\149\ The amended
definition's focus on the granting of a franchise (as opposed to an
interest in a franchise) is also consistent with the states' approach,
thereby reducing unnecessary inconsistencies.\150\
---------------------------------------------------------------------------
\147\ 16 CFR 436.2(d).
\148\ The phrase ``granted a franchise'' is intended to be
interpreted consistent with ordinary contract law principles.
Accordingly, a prospective franchisee becomes a ``franchisee'' at
the point when he or she enters into a valid and enforceable
contractual relationship. This clarification is necessary to avoid
circumvention of the Rule, especially the Rule's financial
performance requirements. In our experience, we are aware of
instances where a franchisor obtains full payment from a prospective
franchisee before the prospective franchisee actually enters into a
franchise agreement. Once payment is made, the franchisor then
proceeds to furnish the individual with earnings information without
the accompanying disclosures on the mistaken belief that the
individual has become a franchisee, to whom earnings information can
be provided without the benefit of an Item 19 disclosure. An
individual becomes a ``franchisee,'' however, only after the
franchise is ``granted,'' meaning both payment of consideration and
the signing or acceptance of the franchise agreement. Otherwise, any
franchisor could avoid the Rule's financial performance requirements
by simply delaying the furnishing of financial performance data
until after the prospective franchisee either makes a ``payment to
the franchisor'' or simply agrees to the terms of the franchise
arrangement.
\149\E.g., H&H, NPR 9, at 25; BI, NPR 28, at 2. The phrase ``an
interest in a franchise'' has been deleted elsewhere in the final
amended Rule text for the same reason.
\150\E.g., Mich. Comp. Laws. 445.1502(4); Wis. Stat. Ann.
553.03(5). In response to the Staff Report, one commenter, IL AG,
suggested that the definition of ``franchisee'' make clear that a
franchisee who sells franchises is also a subfranchisor. IL AG, at
3. This is unnecessary. The definition of ``franchisor'' includes a
subfranchisor, which is defined as any person who functions as a
franchisor by engaging in both pre-sale activities and post-sale
performance. Section 436.1(k). By its terms, this would include a
franchisee that also engages in franchise sales activities, if he or
she also has post-sale performance obligations.
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10. Section 436.1(j): Franchise seller
Section 436.1(j) of the final amended Rule defines the term
``franchise seller.'' This term and its definition are needed in order
to delineate easily all parties subject to one or more provisions of
the final amended Rule.\151\ Consistent with
[[Page 15461]]
long-standing Commission policy, the definition also makes explicit
that an individual franchisee seeking to sell his or her own outlet is
excluded from Rule coverage:\152\
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\151\ The original Rule uses the terms ``franchisor'' and
``franchise broker'' throughout the Rule, and, in some instances,
references employees and agents. The term ``franchise seller''
streamlines the Rule by referencing all such individuals, where
appropriate, through the use of a single term. But see Winslow, at
85 (suggesting that the term ``seller'' in the context of
franchising is inappropriate).
\152\ See Interpretative Guides, 44 FR at 49969.
Franchise seller means a person that offers for sale, sells, or
arranges for the sale of a franchise. It includes the franchisor and
the franchisor's employees, representatives, agents, subfranchisors,
and third-party brokers who are involved in franchise sales activities.
It does not include existing franchisees who sell only their own outlet
and who are otherwise not engaged in franchise sales on behalf of the
---------------------------------------------------------------------------
franchisor.
The definition incorporates several suggestions submitted during
the Rule amendment proceeding. First, the definition expressly includes
``subfranchisors,'' a category of franchise sellers not mentioned in
the Franchise NPR's proposed definition of ``franchise seller.''\153\
The inclusion of subfranchisors in the definition is entirely
consistent with current Commission policy\154\ and the UFOC
Guidelines.\155\
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\153\ See Franchise NPR, 64 FR at 57298.
\154\ Interpretive Guides, 44 FR at 49969.
\155\ The UFOC Guidelines provide that ``[i]n offerings by a
subfranchisor, `franchisor' means both the franchisor and
subfranchisor.'' UFOC Guidelines, General Instructions 240.
---------------------------------------------------------------------------
Second, the definition narrows the express exclusion of sales of a
franchise by an existing franchisee. One commenter noted that this
exclusion should apply only in those situations where an existing
franchisee transfers ownership in his or her franchise to a purchaser
without any continuing obligation to the purchaser. He suggested that
the Rule make clear that the exclusion does not apply where an existing
franchisee is engaged in repeated franchise sales.\156\ The Commission
agrees. If an existing franchisee engages in repeated franchise sales,
he or she will be covered by the final amended Rule as either the
franchisor's agent, broker, or subfranchisor. To clarify this point,
the definition narrows the existing franchisee exemption to those
existing franchisees ``who are otherwise not engaged in franchise sales
on behalf of the franchisor.''\157\
---------------------------------------------------------------------------
\156\ Bundy, NPR 18, at 3.
\157\See IL AG, at 3.
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Finally, the definition addresses one commenter's concern that the
term ``franchise seller'' should exclude a franchisor's employees who
are not actively involved in franchise sales.\158\ We agree. To that
end, the definition makes clear that the franchisor's employees,
representatives, agents, subfranchisors, and third-party brokers are
covered only if they ``are involved in franchise sales activities.''
---------------------------------------------------------------------------
\158\ Tricon, NPR 34, at 3.
---------------------------------------------------------------------------
The Commission has considered, but declines to adopt, two
additional suggestions with respect to the ``franchise seller''
definition. J&G suggested that the Commission define the term
``broker'' in the Rule itself and proposed the following, narrow
definition: individuals who: (1) are not employed by franchisors or
subfranchisors; (2) are compensated pursuant to a written agreement for
qualifying prospects; and (3) are active participants in the sales
process.\159\ The commenter also proposed that the definition
specifically exclude certain individuals who arguably might be involved
in a franchise sale, including franchisees,\160\ trade show promoters,
website owners, the mass media, or others who may be paid for
referrals, but ``who do not spend more than an hour with a prospective
franchisee, or engage in substantive discussions with a prospective
franchisee about the terms of a franchise agreement.''\161\
---------------------------------------------------------------------------
\159\ J&G, NPR 32. See also IL AG, at 2; Michael Seid.
\160\See also Lewis, NPR 15, at 8 (``broker'' definition should
not ``include a franchisee merely because the franchisee receives a
payment from the franchisor or subfranchisor in consideration of the
referral or a prospective franchisee to the franchisor or
subfranchisor, if the franchisee does not otherwise participate in
the sale of the franchise to the prospective franchisee. A
franchisee does not participate in the sale of a franchise merely by
participating in initial conversations or communications with a
prospective franchisee about a franchise.'').
\161\ J&G, NPR 32, at 10. But see Baer, NPR 11, at 9 (``If any
party offers to sell a franchise on behalf of a franchisor, that
person should be considered a franchise seller.'').
---------------------------------------------------------------------------
The Commission believes that a separate definition of the term
``broker'' is unnecessary in part 436. In the original Rule, franchise
brokers were jointly and severally liable with franchisors to prepare
and to furnish prospective franchisees with disclosure documents.\162\
In contrast, under part 436 of the final amended Rule, brokers are no
longer obligated to prepare or to furnish disclosure documents, as
explained later in this document. The preparation and distribution of
the disclosure document is the sole responsibility of the franchisor.
Rather, coverage of brokers under the final amended Rule is limited to
prohibitions.\163\ For example, any franchise seller, including
brokers, cannot make statements that are inconsistent with those found
in the franchisor's disclosure document.\164\ Because brokers are no
longer liable for the preparation and distribution of disclosure
documents and the term ``broker'' does not appear in the final amended
Rule outside the definition of ``franchise seller,'' no separate
definition of the term ldquo;broker'' is warranted.
---------------------------------------------------------------------------
\162\ Interpretive Guides, 44 FR at 49969.
\163\ Moreover, the final amended Rule includes a separate
definition of ``franchisor,'' to whom the affirmative disclosure
requirements apply.
\164\ Section 436.9(a).
---------------------------------------------------------------------------
In a similar vein, Frannet, a franchise referral company, urged the
Commission to distinguish between franchise brokers and middlemen. The
company agreed that anyone who sells franchises should be included in
the definition of a franchise seller.\165\ According to Frannet,
middlemen or finders who just arrange for prospects to meet
franchisors--but do not negotiate price or terms for the franchisor, or
sign franchise agreements on behalf of a franchisor--should not be
deemed brokers.
---------------------------------------------------------------------------
\165\ Frannet, NPR 2, at 1.
---------------------------------------------------------------------------
With respect to ``brokers,'' we reject the suggestion that brokers
are distinguishable from middlemen or finders. When promulgating the
original Rule, the Commission defined the term ``broker'' broadly to
mean ``any person other than a franchisor or a franchisee who sells,
offers for sale, or arranges for the sale of a franchise.''\166\
Similarly, in the original SBP, the Commission clarified that a broker
acts on behalf of a franchisor and receives compensation for arranging
a franchise sale.\167\ The term ``broker,'' therefore, has not been
limited to those persons who negotiate contract terms or sign franchise
agreements and accept payments on behalf of a franchisor.\168\
---------------------------------------------------------------------------
\166\ 16 CFR 436.2(j).
\167\ Original SBP, 43 FR at 59717 and nn. 176 and 178. Staff
advisory opinions have interpreted the term ``arranges'' to include,
for example, discussions with prospective franchisees about their
specific business interests, pre-screening prospects through
interest questionnaires, recommending specific franchise options,
and assisting prospects in completing a franchisor's application
form. These opinions are based upon the original SBP, in which the
Commission stated that group discussions about franchising and pre-
screening of prospects may constitute a first personal meeting that
would require a franchisor or broker to furnish disclosure
documents. See Informal Staff Advisories 99-6 and 99-7, Bus.
Franchise Guide (CCH), ]] 6503-04 (1999).
\168\See generally FTC v. Entrepreneur Media, Inc., Bus.
Franchise Guide (CCH), ] 10583 (C.D. Cal. 1994); FTC v. Shulman
Promotions, Inc., Bus. Franchise Guide (CCH), ] 10584 (S.D. Ohio
1994) (trade show promoters held jointly and severally liable as
brokers under the original Rule for financial performance claims
made by franchisor-exhibitors on the trade show floor).
---------------------------------------------------------------------------
[[Page 15462]]
The Commission declines to follow a different approach in adopting
the final amended Rule. As noted above, the final amended Rule
prohibits franchise sellers from engaging in certain conduct that may
deceive prospective franchisees during the sales process. In order to
prevent deceptive sales practices, the prohibitions section of the
final amended Rule is broad, covering all persons engaged in sales
activity. Accordingly, the Commission intends that the term broker in
the ``franchise seller'' definition to mean a person who: (1) is under
contract with the franchisor relating to the sale of franchises; (2)
receives compensation from the franchisor related to the sale of
franchises; and (3) arranges franchise sales by assisting prospective
franchisees in the sales process.\169\
---------------------------------------------------------------------------
\169\ See Gust Rosenfeld, at 2 (supporting the above-noted
interpretation of the term ``broker''). This interpretation is
sufficiently narrow to exclude existing franchisees who may refer
potential franchisees to the franchisor because they are not under
contract with the franchisor to sell franchises. In most instances,
it also would exclude trade show promoters and the media who,
typically, are not under contract with the franchisor, do not
receive compensation from the franchisor for franchise selling, and
who do not pre-screen or otherwise assist prospects in identifying
specific franchise systems, or otherwise advance the franchise sale.
---------------------------------------------------------------------------
11. Section 436.1(k): Franchisor
The original Rule defined ``franchisor'' as: ``any person who
participates in a franchise relationship as a franchisor, as denoted in
paragraph (a) of this subsection.''\170\ The final amended Rule
streamlines the original definition: ``any person who grants a
franchise and participates in the franchise relationship.''\171\
Consistent with the UFOC Guidelines, the definition also makes clear
that, ``[u]nless otherwise stated, it includes subfranchisors.''\172\
---------------------------------------------------------------------------
\170\ 16 CFR 436.2(c).
\171\ The Franchise NPR proposed that a franchisor include a
person who grants an ``interest in a franchise.'' The reference to
granting ``an interest'' is deleted. As BI observed, granting an
interest is too broad, arguably including a franchisee who sells an
ownership interest in her own business. BI, NPR 28, at 2. The
amended definition is also consistent with the language used in
several state franchise statutes, namely ``grants a franchise,'' or
``grants or offers to grant a franchise.'' E.g., Mich. Comp. Laws.
445.1502(5); Wash. Rev. Code 19.100.010(8).
\172\See Lewis, NPR 15, at 11 (suggesting that the definition
address ``subfranchisors,'' noting comparable language in the
Illinois and California Franchise Acts).
---------------------------------------------------------------------------
In considering revisions to the ``franchisor'' definition, the
Commission has rejected three additional suggestions. First, one
commenter opined that it is unclear whether the phrase ``and
participates in the franchisor relationship'' is intended to modify
``any person who grants a franchise,'' or is intended to include
persons other than those who grant a franchise. She urged the
Commission to revise the definition narrowly to mean the person who
signs the agreement granting a franchise.\173\
---------------------------------------------------------------------------
\173\ Spandorf, at 2.
---------------------------------------------------------------------------
The commenter's suggested change is unwarranted. The two
definitional phrases are read conjunctively. To be considered a
``franchisor,'' a person must satisfy two definition elements: (1)
granting a franchise; and (2) participating in the franchise
relationship. Further, the second definitional element--participating
in the franchise relationship--is necessary to distinguish a franchisor
(who has post-sale performance obligations), from others involved
solely in the initial franchise sales process (such as a broker).
Indeed, this commenter's proposed substitute definition could
inappropriately sweep within the definition of ``franchisor'' third-
party brokers or other agents who are authorized by the franchisor to
sign the franchise agreement, but who have no post-sale performance
obligations. We therefore decline to adopt this suggestion.
Second, NASAA urged the Commission to expand the definition to
include shareholders of privately-held corporations.\174\ Although
NASAA did not elaborate, its suggestion is apparently designed to make
it easier to hold owners of closely-held corporations liable for
violations of the final amended Rule. We do not believe, however, that
a mere showing that an individual is a shareholder in a privately held
corporation can suffice, without more, as a legal basis for subjecting
that individual to liability to pay potentially significant civil
penalties or consumer redress\175\ for Rule violations committed by the
corporation or those actively in control of it. At any rate, where
warranted, the Commission's enforcement experience indicates no
difficulty in proving up the necessary level of participation in the
violative conduct to justify civil penalties, or the requisite control
over the corporation and knowledge of its violative activity to justify
recovery of consumer redress. We therefore decline to adopt NASAA's
suggestion on this issue.
---------------------------------------------------------------------------
\174\ NASAA, at 4; NASAA, NPR 17, at 3.
\175\E.g., FTC v. Morrone's Water Ice, Inc., No. 02-3720 (E.D.
Pa. 2002) (naming Stephen D. Aleardi and John J. Morrone, III,
individually and as officers of corporate defendants); FTC v. Car
Wash Guys Int'l, Inc., No. 00-8197 ABC (RNBx) (C.D. Cal. 2000)
(naming Lance Winslow, III, individually and as an officer of the
corporate defendants).
---------------------------------------------------------------------------
12. Section 436.1(l): Leased department
The final amended Rule retains the original Rule's exemption for
leased department arrangements.\176\ A leased department is created
when a retailer rents space from a larger retailer in order to conduct
business. For example, a jeweler may rent space from a department store
to sell jewelry and watches. Technically, this relationship may be a
franchise because the jeweler becomes associated with the department
store's trademark, and the department store may impose what arguably
could be considered control over the operation, such as operating
hours. As noted in the original SBP, these types of relationships need
not be protected by the Rule because the likelihood of deception is not
great, the retailer-lessee typically being experienced and able to
assess the value of the location. Moreover, the risk is small because
the retailer-lessee's financial liability to the retailer-grantor is
limited to rent.\177\
---------------------------------------------------------------------------
\176\ See 16 CFR 436.2(a)(3)(ii).
\177\ Original SBP, 43 FR at 59708. See also Interpretive
Guides, 44 FR at 49968.
---------------------------------------------------------------------------
Section 436.1(l) of the final amended Rule defines the term
``leased department'' as:
an arrangement whereby a retailer licenses or otherwise permits a
seller to conduct business from the retailer's location where the
seller purchases no goods, services, or commodities directly or
indirectly from: (1) the retailer; (2) a person the retailer requires
the seller to do business with; or (3) a retailer-affiliate if the
retailer advises the seller to do business with the affiliate.\178\
---------------------------------------------------------------------------
\178\ Originally, the Commission proposed in the Franchise NPR a
much more streamlined version of the definition, as follows: Leased
department means ``an arrangement whereby a retailer licenses or
otherwise permits an independent seller to conduct business from the
retailer's premises.'' Franchise NPR, 64 FR 57332. However, one
commenter voiced concern that this proposed definition could be
misinterpreted as broadening the exemption to include even
arrangements where the retailer-grantor requires the retailer-lessee
to purchase goods from, for example, a specific third-party
supplier. J&G, NPR 32, Attachment 6, at 13. This was not the
Commission's intent, and the revised definition corrects that
possible misinterpretation.
No commenter raised any substantive concerns about the leased
department exemption. One commenter, however, suggested that the
Commission expand the definition of leased department to
[[Page 15463]]
include ``co-branding'' arrangements.\179\ Co-branding, a relatively
new marketing development in franchising, enables a franchisee to use
the trademarks and sell the goods or services of more than one
franchise system. For example, an outlet that sells Taco Bell foods
might also sell Pizza Hut pizza, or a gasoline franchise, such as
Shell, may operate an on-site Subway Shop or 7-Eleven store.
---------------------------------------------------------------------------
\179\ J&G, NPR 32, Attachment at 6, 13. Two other commenters
suggested that the Commission provide more guidance about co-
branding generally, but not in the leased department context.
Selden, at 3; Quizno's, ANPR 16, at 2. None of these commenters
identified specific problems posed by co-branding arrangements--
other than noting that co-branded arrangements can be complex--nor
did they offer any solutions for the Commission's consideration.
---------------------------------------------------------------------------
The Commission declines to adopt this suggestion. The issue of Rule
compliance in co-branded arrangements was raised in the ANPR\180\ and
discussed in detail at the staff's New York public workshop conference
on September 18, 1997. The ANPR commenters generally agreed that the
current Rule and UFOC Guidelines are sufficient to address any
deception issues that may arise in co-branded franchise arrangements.
The same view was expressed by the participants at the New York
workshop.\181\ Indeed, no franchisee or state regulator voiced any
concerns to the contrary.\182\ Therefore, taken as a whole, the record
does not support the need to adopt new rule provisions specifically
addressing co-branding.\183\
---------------------------------------------------------------------------
\180\ In the ANPR, the Commission noted its uncertainty as to
whether the purchaser of a co-branded franchise acquires two
individually-trademarked franchises (and thus should receive
separate disclosures from each franchisor) or acquires a hybrid
franchise arrangement that has its own risks and, thus, should
receive a single unified document that discloses information
specific to the co-branding arrangement. The ANPR asked whether
franchisors have sufficient guidance under the Rule to determine
their disclosure obligations with respect to the sale of co-branded
franchises and whether new or different disclosures should apply to
the sale of co-branded franchises. ANPR, 62 FR at 9122. Ten ANPR
commenters addressed co-branding. Quizno's, ANPR 16, at 2; Baer,
ANPR 25, at 7; H&H, ANPR 28, at 9; Kaufmann, ANPR 33, at 16;
Kestenbaum, ANPR 40, at 2-3; IL AG, ANPR 77, at 4-5; IFA, ANPR 82,
at 4; Kirsch, ANPR 98; Jeffers, ANPR 116, at 9; WA Securities, ANPR
117, at 4. With the exception of Quizno's, the ANPR commenters
maintained that the Commission's current pre-sale disclosure
approach is sufficient to address co-branded franchise arrangements.
\181\E.g., Kirsch, ANPR, 18 Sept. 97 Tr., at 176; Wieczorek,
id., at 177-78; Kestenbaum, id., at 178-79; Simon, id., at 179.
\182\ For example, Dale Cantone, of Maryland Securities, stated:
``We haven't had too many problems on the issue of co-branding.
We've had franchisors file disclosures and we really haven't had too
many issues with it.'' Cantone, ANPR, 18 Sept. 97 Tr., at 182.
\183\ To the extent that franchisors may be uncertain how to
apply the final amended Rule in a specific co-branded arrangement,
they can always seek further guidance from Commission staff through
an informal advisory opinion. To date, no such requests have been
submitted, suggesting limited, if any, confusion over this issue.
---------------------------------------------------------------------------
13. Section 436.1(m): Parent
Section 436.1(m) of the final amended Rule defines the term
``parent'' as ``an entity that controls another entity directly, or
indirectly though one or more subsidiaries.'' Several commenters
suggested that because several Rule provisions address parent
disclosures,\184\ the Commission should expressly define that
term.\185\ Although the Rule proposed in the Franchise NPR did not
define this term, the Commission believes this point is well-taken.
Accordingly, part 436 of the final amended Rule expressly defines the
term ``parent.''\186\
---------------------------------------------------------------------------
\184\See section 436.5(a) (Item 1); section 436.5(c) (Item 3);
section 436.5(d) (Item 4).
\185\E.g., PMR&W, NPR 4, at 9; H&H, NPR 9, at 12.
\186\ The final amended Rule's definition of ``parent'' is
consistent with the definition of the term ``parent'' in the
Interpretive Guides: ``an entity that controls the franchisor
directly, or indirectly through one or more subsidiaries.''
Interpretive Guides, 44 FR at 49972. However, because the term
parent is also used in the final amended Rule to refer to a
franchisee's parent--e.g., section 436.8 (Exemptions)--the
definition of ``parent'' deletes the reference to ``franchisor'' and
replaces it with the broader term ``another entity.'' This is the
identical approach taken in defining the term ``affiliate.'' See
section 436.1(b) above.
---------------------------------------------------------------------------
One commenter suggested an alternative definition: ``Parent means
an entity that directly or indirectly has an 80% or greater ownership
interest in the franchisor.''\187\ The commenter, however, did not
state the basis for his recommendation. Indeed, in promulgating the
original Rule, the Commission did not adopt an ownership test, but
focused on control.\188\ We believe that is the proper approach.\189\
It is the control and resulting influence over the direction of the
franchisor--not mere ownership--that is material to a prospective
franchisee.
---------------------------------------------------------------------------
\187\ Lewis, NPR 15, at 9. This suggested definition appears to
derive from the following language in UFOC Item 21: ``a company
controlling 80% or more of a franchisor may be required to include
its financial statements.'' Item 21, however, does not specifically
purport to define the term ``parent.'' Rather, it merely suggests
that a large controlling interest may give rise to financial
disclosure obligations.
\188\ Interpretive Guides, 44 FR at 49972.
\189\ The Staff Report's discussion of the ``parent'' definition
generated one comment. Gust Rosenfeld suggested that a second
sentence should be added to the definition to the effect that a
parent entity is an affiliate, but is separately defined because
certain requirements apply to a parent, but not to other types of
affiliates. Gust Rosenfeld, at 2. We agree, but believe issues such
as this are more appropriately addressed in Compliance Guides.
---------------------------------------------------------------------------
14. Section 436.1(n): Person
Section 436.1(n) of the final amended Rule retains the original
Rule's definition of the term ``person''--``any individual, group,
association, limited or general partnership, corporation, or any other
entity.''\190\ This is identical to the proposed version of this
definition in the Franchise NPR. During the Rule amendment proceeding,
a few commenters offered suggestions to modify the definition. Warren
Lewis, for example, suggested that the Commission add the following to
the definition: ``An individual is not an entity.''\191\ Mr. Lewis
maintained that this change would make it clear throughout the Rule
that ``person'' means an individual or business entity; while entity
means only a business entity. As another example, IL AG and J&G
suggested that the definition of ``person'' reference limited liability
companies.\192\
---------------------------------------------------------------------------
\190\See 16 CFR 436.2(b).
\191\ Lewis, NPR 15, at 10.
\192\ IL AG, at 3; J&G, NPR 32, Attachment, at 14.
---------------------------------------------------------------------------
The term ``person'' is defined in many Commission rules, as
referring to a party, regardless of whether the party is an individual,
organization, or business entity.\193\ Where necessary, the rule text
distinguishes between parties by using the more specific terms--
individual, organization, or entity. We believe that these more
specific terms are clear, and, therefore, we need not distinguish
between individuals and entities in the definition of ``person,'' as
suggested. The Commission also finds that the term ``entity'' is
sufficient to cover limited liability companies, as well as other forms
of business arrangements.
---------------------------------------------------------------------------
\193\E.g., Telemarketing Sales Rule, 16 CFR 310.2(v).
---------------------------------------------------------------------------
15. Section 436.1(o): Plain English
Part 436 of the final amended Rule adopts the UFOC Guidelines
requirement that disclosure documents be prepared in plain
English.\194\ Section 436.1(o) defines ``plain English'' as:
---------------------------------------------------------------------------
\194\ Section 436.6(a).
the organization of information and language usage understandable
by a person unfamiliar with the franchise business. It incorporates
short sentences; definite, concrete, everyday language; active voice;
and tabular presentation of information, where possible. It avoids
legal jargon, highly technical business terms, and multiple
negatives.\195\
---------------------------------------------------------------------------
\195\ This definition is based upon the definition of ``plain
English'' used in the securities context. See Registration Form Used
by Open-Ended Management Investment Companies, SEC Release No. 33-
7512, 63 FR 13916, at 13939 (Mar. 23, 1998). See also UFOC General
Instruction 150.
This definition is one of several features of the final amended Rule
that are designed to preserve the integrity of
[[Page 15464]]
disclosure documents. Application of these writing standards will
enhance the legibility and understandability of disclosure documents,
thereby reducing the likelihood of franchisee deception, confusion, or
misunderstandings.
16. Section 436.1(p): Predecessor
Section 436.1(p) adopts the UFOC Guidelines' definition of
``predecessor'' as: ``a person from whom the franchisor acquired,
directly or indirectly, the major portion of the franchisor's
assets.''\196\ This definition comes into play in several substantive
provisions of the final amended Rule, where the Commission is adopting
the UFOC Guidelines requirement that franchisors disclose material
information about their predecessors.\197\ The original Rule did not
require the disclosure of predecessor information. However, as
discussed later in this document--in particular in connection with Item
3 litigation disclosures and Item 4 bankruptcy disclosures--predecessor
disclosures are necessary to prevent fraudulent franchise sales.\198\
Our law enforcement experience demonstrates that, in some instances,
franchisors reincorporate under a new name as a simple way to avoid
disclosing damaging information.\199\ The disclosure of predecessor
information will prevent such efforts to circumvent the final amended
Rule.
---------------------------------------------------------------------------
\196\ UFOC Guidelines, Item 1 Instructions, iii. See also NASAA
Commentary, Bus. Franchise Guide (CCH), ] 5790, at 8465 (``The
definition of predecessor in instruction iii to Item 1 should be
applied throughout the UFOC.'').
\197\E.g., section 436.5(a)(2) (Item 1); section 436.5(c) (Item
3); section 436.5(d) (Item 4).
\198\ Initially, the Commission proposed in the Franchise NPR a
broader definition that would include as a predecessor a person
``from whom the franchisor obtained a license to use the trademark
or trade secrets in the franchise operation.'' Franchise NPR, 64 FR
at 57332. This proposal was widely criticized as overbroad, H&H, NPR
9, at 15; BI, NPR 28, at 2, and would result in burdensome
disclosures that are immaterial to prospective franchisees, PMR&W,
NPR 4, at 8; Baer, NPR 11, at 11; NFC, NPR 12, at 3-4; Snap-On, NPR
16, at 2; Marriott, NPR 35, at 13-14. See also Gust Rosenfeld, at 2.
Commenters also observed that information about the franchisor's
trademark is already disclosed in Items 12-13. E.g., Baer, NPR 11,
at 10; Lewis, NPR 15, at 10. The staff of the Commission agreed.
Accordingly, the proposal was deleted in the revised proposed Rule
set forth in the Staff Report.
\199\E.g., FTC v. Wolf, Bus. Franchise Guide (CCH) ] 10401 (S.D.
Fla. 1994); FTC v. Inv. Dev., Inc., Bus. Franchise Guide (CCH) ]
9326 (E.D. La. 1989). See also United States v. Lasseter, No. 3:03-
01177 (M.D. Tenn. 2003).
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17. Section 436.1(q): Principal business address
The final amended Rule requires the disclosure of the principal
business address of the franchisor, as well as any parent,
predecessors, and affiliates.\200\ Section 436.1(q) defines the term
``principal business address'' to mean: ``the street address of a
person's home office in the United States. A principal business address
cannot be a post office box or private mail drop.''\201\ This
definition was not included in the original Rule. Nevertheless, the
Commission finds that this definition is necessary to enable a
prospective franchisee to contact the franchisor easily, as well as to
facilitate effective law enforcement.
---------------------------------------------------------------------------
\200\ See section 436.5(a).
\201\ See UFOC Guidelines, Item 1C, Instructions, i.
---------------------------------------------------------------------------
The proposed version of section 436.1(q) has been slightly revised
to improve its precision, as suggested in one Staff Report comment.
Initially, the definition of principal business address referred to the
franchisor's home office. J&G correctly observed, however, that the
disclosure of a principal business address applies not only to a
franchisor, but to others, such as a predecessor, as well.\202\
Accordingly, the definition has been revised to refer to the more
general ``person's home office''--be it the franchisor, parent,
predecessor, or affiliate.
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\202\ J&G, at 2.
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18. Section 436.1(r): Prospective franchisee
The final amended Rule retains a streamlined version of the
definition of the term ``prospective franchisee'' set forth in the
original Rule at 16 CFR 436.2(e). Specifically, section 436.1(r)
defines the term to mean ``any person (including any agent,
representative, or employee) who approaches or is approached by a
franchise seller to discuss the possible establishment of a franchise
relationship.''\203\ This is identical to the version of this
definition proposed in the Franchise NPR.
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\203\ The final amended Rule definition uses the term
``franchise seller'' in lieu of ``franchisor, or franchise broker,
or any representative, agent, or employee thereof.'' See section
436.1(i).
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The amended definition addresses several comments raised during the
Rule amendment proceeding. First, one commenter voiced concern about
who may receive a disclosure document, suggesting that the Commission
permit any representative of the franchisee to receive the
disclosures.\204\ The Commission agrees that representatives of a
prospective franchisee should be permitted to accept delivery of the
disclosure document on the prospective franchisee's behalf. Indeed, in
some instances a prospective franchisee may be a corporation or other
entity, not an individual. Thus, delivery in such circumstances can
only be made upon a representative. Even individuals may wish to have
their attorney or other agent receive the disclosures on their behalf,
and the Rule should accommodate that possibility. We believe that the
reference to agent, representative, or employee in section 436.1(r) is
sufficient for this purpose. Further detail about who may accept
disclosures for a prospective franchisee is best addressed in the
Compliance Guides.\205\
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\204\ BI, NPR 28, at 3.
\205\See also Piper Rudnick, at 5 (seeking clarification in the
Compliance Guides on whether the phrase ``agent, representative, or
employee'' also includes an individual on behalf of a family member
(spouse, children, siblings), other general and limited partners,
shareholders, and/or the individual's corporate employer).
---------------------------------------------------------------------------
One commenter also questioned the use of the word ``approaches'' in
the definition. Specifically, the commenter feared that the definition
would include someone surfing the Internet who ``approaches'' a
franchisor's website.\206\ We believe this concern is unwarranted. The
``prospective franchisee'' definition states that the parties must
``discuss the possible establishment of a franchise relationship.''
This limiting language makes clear that for an individual to become a
``prospective franchisee'' he or she must communicate with the
franchisor about a franchise offering. Merely perusing a franchisor's
website alone does not turn an ordinary Internet surfer into a
prospective franchisee. Accordingly, no further revision to the
``prospective franchisee'' definition is warranted.
---------------------------------------------------------------------------
\206\ J&G, NPR 32, at 7.
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19. Section 436.1(s): Required payment
The making of a ``required payment'' (or a commitment to make a
``required payment'') is one of the definitional elements of the term
``franchise.''\207\ Section 436.1(s) defines the term ``required
payment'' to mean:
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\207\See section 436.1(h)(3).
all consideration that the franchisee must pay to the franchisor
or an affiliate, either by contract or by practical necessity,\208\ as
a condition of obtaining or commencing operation of the franchise. A
required payment does not include payments for the purchase of
reasonable amounts of inventory at bona fide wholesale prices for
resale or lease.
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\208\ The ``required payment'' definition incorporates the
Commission's long-standing policy that a payment can be required by
contract or by practical necessity. See Interpretive Guides, 44 FR
at 49967.
The only substantive difference between the provision as proposed in
the
[[Page 15465]]
Franchise NPR and the final amended Rule provision is the addition of
the second sentence. There is no corresponding definition in the
original Rule.
During the Rule amendment proceeding, several commenters raised
concerns about the scope of the ``required payment'' definition.
Specifically, commenters voiced concern whether the definition: (1)
covers royalty payments; (2) covers payments to obtain or commence the
franchise relationship; (3) excludes payments for inventory; and (4)
includes payments to third parties. Each of these issues is discussed
in greater detail below.
a. Royalty payments
As noted above, the definition of ``required payment'' uses the
phrase ``consideration that the franchisee must pay.'' IL AG
interpreted the word ``consideration'' as excluding royalty payments.
It urged the Commission to clarify that royalties can constitute a
required fee. Otherwise, ``it will be too simple, even for traditional
franchisors, to evade franchise laws.''\209\
---------------------------------------------------------------------------
\209\ IL AG, NPR 3, at 5. See also J&G, NPR 32, Attachment, at
15 (questioning whether ``consideration'' excludes royalty
payments).
---------------------------------------------------------------------------
The Commission has always considered royalty payments to be a form
of required payment under the Rule and nothing in the definition of
``required payment'' is to the contrary.\210\ Royalty payments
constitute a direct form of consideration flowing to the franchisor in
exchange for the ability to conduct business. Indeed, if royalties were
excluded from the required payment definition, then any franchisor
could avoid Rule coverage by charging a large post-sale royalty fee in
lieu of an initial franchise or related fee. The Rule uses the term
``consideration'' not to imply that only an upfront franchise fee
constitutes a required payment under the Rule, but to avoid the
circular use of the word ``payment'' in the definition of ``required
payment.'' Also, alternatives such as ``funds, or moneys'' are too
limited because they would preclude payments in-kind.
---------------------------------------------------------------------------
\210\See Interpretive Guides, 44 FR at 49967 (``Among the forms
of required payments are . . . continuing royalties on sales.'').
---------------------------------------------------------------------------
b. Payments to obtain or commence a franchise
One commenter voiced concern that because the definition of
``required payment'' covers payments made ``as a condition of obtaining
or commencing operation of the franchise,'' it would encompass ordinary
business expenses paid to the franchisor. He urged the Commission to
narrow the definition by specifying that a required payment must be
made ``for the right to enter into the franchise relationship.''\211\
---------------------------------------------------------------------------
\211\ Baer, NPR 11, at 8.
---------------------------------------------------------------------------
The Commission declines to adopt this suggestion. The phrase
``right to enter into a franchise relationship'' is too narrow,
suggesting that the required payment definitional element should be
limited to payments made solely for the right to enter into the
business, such as an up-front franchise fee. However, the Commission
has made clear that the required payment element is not limited to up-
front fees alone: ``Often, required payments are not limited to a
simple franchise fee, but entail other payments which the franchisee is
required to pay to the franchisor or an affiliate.''\212\ The
Interpretive Guides further provide as examples of required payments
equipment rentals and real estate leases.\213\ Thus, expenses incurred
in the ordinary course of business and paid to a franchisor or its
affiliate may constitute a required payment. Otherwise, unscrupulous
franchisors could easily circumvent the Rule by refraining from
imposing any up-front fee in favor of charging for ordinary business
expenses, such as training or other services, or purchases of equipment
or unreasonable amounts of inventory.\214\
---------------------------------------------------------------------------
\212\ Interpretive Guides, 44 FR at 49967.
\213\Id.
\214\See Original SBP, 43 FR at 59703 and note 51 (discussing
problem of ``indirect or disguised'' franchise fees).
---------------------------------------------------------------------------
c. Payments for inventory
As a matter of Commission policy, reasonable amounts of inventory
purchased at bona fide wholesale prices have not been interpreted to
constitute a ``required payment'' under the original Rule.\215\ This is
commonly referred to as ``the inventory exemption.'' David Gurnick
urged the Commission to update the Rule by incorporating the inventory
exemption into the definition of ``required payment.''\216\ (As noted
above, the definition proposed in the Franchise NPR did not exclude
payments for inventory.) Another commenter agreed with Mr. Gurnick and
urged further expansion of the exemption to include not only inventory
for resale, but inventory for lease. Otherwise, the situation could
arise where inventory obtained from a company is intended for resale--
thus taking it outside of the Rule--but later on leased to a customer--
thus arguably creating a franchise relationship retroactively.\217\
---------------------------------------------------------------------------
\215\See Interpretive Guides, 44 FR at 49967. In the Franchise
NPR, the Commission proposed incorporating the inventory exemption
into the current minimum payment exemption. See Franchise NPR, 64 FR
at 57345. The minimum payment exemption applies where the total
required payment made by the franchisee ``from any time before to
within six months after commencing operation of the franchisee's
business, is less than $500.'' 16 CFR 436.2(a)(3)(iii). Accordingly,
the amount of any ``required payment'' must be known before
determining the applicability of the minimum payment exemption.
Because the inventory exemption helps to define what constitutes a
``required payment,'' we conclude that it should be included
directly in the definition of ``required payment.'' See Staff
Report, at 61-62.
\216\ Gurnick, NPR 21A, at 10.
\217\ Baer, NPR 11, at 8.
---------------------------------------------------------------------------
The Commission has concluded that the definition of ``required
payment'' should incorporate the inventory exemption as these
commenters suggested. Since the Rule's inception, the Commission's
policy has been that reasonable purchases of inventory for resale at
bona fide wholesale prices are not construed to be a ``required
payment.'' The Interpretive Guides state that it is ``virtually
impossible to draw a clear line between start-up inventory that is
purchased at the franchisee's option, and that which is purchased as a
matter of practical or contractual necessity.''\218\ Therefore, the
final amended Rule provision incorporates this policy, and extends it
to encompass inventory purchased for lease as well as resale, there
being no distinction, as a practical matter, between the two
categories.
---------------------------------------------------------------------------
\218\ Interpretive Guides, 44 FR at 49967.
---------------------------------------------------------------------------
d. Payments to third parties
Howard Bundy urged expansion of the concept of ``required payment''
to include payments made to third parties. According to Mr. Bundy,
franchisors can effectively ``hook'' a prospective franchisee if they
can get the prospect to expend funds early in the sales process, such
as paying travel expenses:
In franchising, it has become common to use the ``takeaway close''
to entice prospects to travel to the franchisor's headquarters as a
condition precedent to receiving a disclosure document. Likewise, we
see instances of franchisors requiring a franchisee to contract with or
pay for demographic or real estate services with technically
``unaffiliated'' entities as a condition precedent to being
``approved'' as a franchisee.\219\
---------------------------------------------------------------------------
\219\ Bundy, NPR 18, at 4.
To address this concern, Mr. Bundy suggested that the Commission modify
the definition of ``required payment'' to include, after the word
affiliate: ``or to a vendor, financing provider or other third party
that the prospective
[[Page 15466]]
franchisee is required to deal with either by contract or practical
necessity or to any third party as a condition precedent to obtaining
the Franchise Disclosure Document.''\220\
---------------------------------------------------------------------------
\220\Id.
---------------------------------------------------------------------------
Mr. Bundy's suggestion generated one rebuttal comment. David
Gurnick observed that defining ``required payment'' to include third-
party payments would be: ``a radical departure from the Commission's
long-standing policy regarding the definition of a franchise, would
create a major inconsistency between the Franchise Rule and the state
franchise laws, and would extend coverage to arrangements which the
Rule was never intended to regulate.''\221\ Observing that all
businesses make payments to vendors and service providers, he also
asserted that the Bundy proposal would be overbroad: ``For example,
`practical necessity' may dictate that a business use a Microsoft
software product or that an employee of the business fly to an airport
that is served by only one airline.''\222\ Mr. Gurnick added that if a
franchisor establishes a company to receive some monetary benefit from
prospects, those funds would already fall within the ``required
payment'' definition as a payment to an affiliate.\223\
---------------------------------------------------------------------------
\221\ Gurnick, NPR Rebuttal 36, at 2.
\222\Id., at 3.
\223\Id., at 3-4. Mr. Gurnick also disputed the view that
franchisors entice prospects to incur costs, such as airline
tickets. ``No data is [sic] provided to support this claim, and
frankly I question whether companies really have an interest in
enticing prospects to buy, for example, airline tickets.'' Id., at
4.
---------------------------------------------------------------------------
It is true that the Commission has never considered ordinary
business payments to third parties as a ``required payment'' under the
Rule. Indeed, doing so could sweep very broadly. Ordinary business
expenses paid to third parties, such as the cost of installing
telephone lines, insurance, and occupancy fees--expenses typically
incurred by all businesses--can hardly be deemed a precondition imposed
by the franchisor for obtaining or commencing operation of a franchise.
Rather, a third-party payment constitutes a required payment only if
the third party collects and remits the payment on behalf of the
franchisor.\224\
---------------------------------------------------------------------------
\224\See Interpretive Guides, 44 FR at 49967.
---------------------------------------------------------------------------
Nonetheless, a franchisor may direct or encourage a prospective
franchisee to incur some costs in order to advance the franchise sale.
The prospective franchisee may incur these costs and make these kinds
of payments without the benefit of pre-sale disclosures. Encouraging a
prospect to incur expenses to advance the franchise sale could
conceivably increase the likelihood that he or she will go through with
the deal without a thorough due-diligence investigation. Therefore, the
Commission has incorporated into the final amended Rule an express
prohibition barring a franchisor from failing to furnish a copy of its
disclosure document to a prospective franchisee early in the sales
process, upon reasonable request.\225\ This prohibition enables a
prospective franchisee to ask to see a copy of the franchisor's
disclosure document before agreeing to travel to company headquarters
or purchase demographic data, for example. The Commission believes this
approach will better address concerns about pre-disclosure third-party
payments than would an unworkable alteration of the definition of the
term ``required payment.''
---------------------------------------------------------------------------
\225\See section 436.9(e).
---------------------------------------------------------------------------
20. Section 436.1(t): Sale of a franchise
The part 436 disclosure obligations are triggered only when there
is an offer for the sale of a franchise.\226\ Section 436.1(t) defines
the term ``sale of a franchise'' as follows:
---------------------------------------------------------------------------
\226\See section 436.2.
an agreement whereby a person obtains a franchise from a franchise
seller for value by purchase, license, or otherwise. It does not
include extending or renewing an existing franchise agreement where
there has been no interruption in the franchisee's operation of the
business, unless the new agreement contains terms and conditions that
differ materially from the original agreement. It also does not include
the transfer of a franchise by an existing franchisee where the
franchisor has had no significant involvement with the prospective
transferee. A franchisor's approval or disapproval of a transfer alone
---------------------------------------------------------------------------
is not deemed to be significant involvement.
Like the original Rule provision, the final amended provision embodies
the concept that franchisees extending or renewing an existing
franchise agreement, where there is no interruption in business
operations, will not be deemed to be entering into a sale, unless their
new agreement contains terms and conditions materially different from
their original agreement.\227\
---------------------------------------------------------------------------
\227\ 16 CFR 436.2(k). See also Interpretive Guides, 44 FR at
49969.
---------------------------------------------------------------------------
The final amended Rule provision differs substantively from the
provision as proposed in the Franchise NPR\228\ because it incorporates
the Commission policy, as stated in the Interpretive Guides, that the
term ``sale of a franchise'' does not encompass the transfer of a
franchise by an existing franchisee where the prospective purchaser has
no significant contact with the franchisor.\229\ Under long-standing
Commission policy, a franchisor or subfranchisor must provide
disclosures to prospective franchisees, but ``a person who purchases a
franchise directly from an existing franchisee, without significant
contact with the franchisor, is not a prospective franchisee.''\230\
Where a franchisor is not involved in the private sale of an existing
franchise, the franchisor makes no representations to the prospective
new purchaser. If there is any fraud in the private sale, it could be
only by the current franchisee owner, and pre-sale disclosure by the
franchisor would not likely prevent it. Accordingly, section 436.1(t)
of part 436 makes clear that a transfer without significant involvement
of the franchisor is not the sale of a franchise within the ambit of
the Rule. Further, the franchisor's mere approval or disapproval of the
purchaser alone is not considered to be significant involvement.\231\
---------------------------------------------------------------------------
\228\ Franchise NPR, 64 FR at 57333.
\229\See H&H, NPR 9, at 11.
\230\ Interpretive Guides, 44 FR at 49969.
\231\See Interpretive Guides, 44 FR at 49969-70. In contrast, a
franchisor who actively participates in a franchise transfer must
make disclosures to a potential transferee, no less than to a
prospective franchisee. In such an event, the prospective transferee
may rely on the franchisor's representations in deciding to purchase
the franchise, and therefore, should receive the benefit of pre-sale
disclosure.
---------------------------------------------------------------------------
At the same time, the Commission declines to adopt several
suggested narrowing modifications to the definition of ``sale of a
franchise.'' H&H urged the Commission to exclude from the definition of
``sale of a franchise'' the modification of an existing franchise
agreement where there is no interruption in the franchisee's business
operation.\232\ The firm observed that material modifications to
existing franchise agreements typically arise in two situations: (1) a
settlement of litigation or other disputes with franchisees, in which
the franchisor makes concessions; and (2) management initiative with
the involvement of independent franchisee associations or franchisee
advisory councils.\233\ According to H&H, these modifications typically
entail no new investment and both sides are familiar with the
[[Page 15467]]
franchise terms: ``An offer to exchange different forms of agreement or
add an addendum to existing franchise agreements does not establish a
new franchise relationship--that relationship already exists and will
continue regardless of the decision the franchisee makes.''\234\
---------------------------------------------------------------------------
\232\ H&H, NPR 9, at 9-10.
\233\ H&H, NPR 9, at 10.
\234\Id.
---------------------------------------------------------------------------
The Commission agrees that disclosure is unwarranted where an
existing franchisee and the franchisor merely seek to amend their
ongoing contractual relationship. In such circumstances, the material
information the franchisee needs is the actual revised franchise
agreement itself that spells out the terms and conditions that will
govern the parties' ongoing relationship. Requiring franchisors to
furnish a new disclosure document whenever there may exist agreed upon
material changes in a contract is likely to be an unwarranted
formality, the cost of which is probably not outweighed by any tangible
benefit to the existing franchisee. In any event, franchise agreement
modifications, most obviously those without any new payment, would not
constitute a ``sale.'' The definition of ``sale of a franchise,''
therefore, need not be revised to address this concern.
H&H further contended that disclosure is never warranted for
renewals, asserting that a renewing franchisee makes no investment
decision: ``His decision relates to whether to continue a relationship,
with which he should be intimately familiar at that point, under the
terms of a new form of franchise agreement. The UFOC does little to
help him understand the terms of that agreement.''\235\ After
considering this suggestion, we are unconvinced that renewals should
always be excluded from the definition of ``sale of a franchise.''
---------------------------------------------------------------------------
\235\Id., at 11.
---------------------------------------------------------------------------
As discussed in greater detail below in connection with section
436.5(q)--Item 17's renewal disclosure--franchisees and their
representatives have voiced concern about renewals, arguing that
franchisors control the governing terms and conditions and offer
renewals on a take-it-or-leave-it basis.\236\ Franchisees, they have
asserted, not only lack bargaining power over the renewal agreement,
but also often must accept new onerous terms because they are
frequently subject to covenants not to compete that effectively prevent
them from continuing in the same business independently. Especially in
an age of new technologies and changes in franchise marketing, renewal
contracts may be significantly different from original contracts that
franchisees signed 10 to 20 years ago. A renewing franchisee, for
example, may reasonably wish to see Item 20 closure rates for
franchises operating under the new franchise agreement. Accordingly,
the Commission concludes that where the franchise agreement contains
terms and conditions materially different from the original agreement,
the renewing franchisee needs advance disclosures in order to make an
informed renewal decision.\237\
---------------------------------------------------------------------------
\236\ See discussion of section 436.5(q) below. See also Staff
Report, at 153-156; Franchise NPR, 64 FR at 57308-09.
\237\ This assumes, of course, that there is a ``sale,'' meaning
the existing franchisee makes a required payment for the right to
enter into a new franchise agreement. Entering into a new franchise
agreement without any required payment or extending an existing
franchise agreement for a fee would not be deemed a ``sale of a
franchise'' for Rule purposes.
---------------------------------------------------------------------------
21. Section 436.1(u): Signature
The original Rule contained no definition of ``signature.'' To
facilitate the use of electronic signatures, however, section 436.1(u)
of the final amended Rule updates the UFOC Guidelines by adding such a
definition: ``a person's affirmative step to authenticate his or her
identity. It includes a person's handwritten signature, as well as a
person's use of security codes, passwords, electronic signatures, and
similar devices to authenticate his or her identity.'' No comments were
submitted on this definition, but the Commission has refined the
language of the proposed definition to achieve greater precision and
clarity, expressly including the descriptor ``handwritten,''
substituting ``electronic'' for ``digital,`` and adding the phrase ``to
authenticate his or her identity.''
22. Section 436.1(v): Trademark
Section 436.1(v) of the final amended Rule defines the term
``trademark.'' The original Rule did not define this term. Consistent
with long-standing Commission interpretation of the term and the UFOC
Guidelines, the final amended Rule definition is broad, including
``trademarks, service marks, names, logos, and other commercial
symbols.''\238\ No comments were submitted on this definition, and it
is identical to the version of the definition published in the
Franchise NPR.
---------------------------------------------------------------------------
\238\See Interpretive Guides, 44 FR at 49966-967. See also UFOC
Guidelines, Item 13 Instructions, i.
---------------------------------------------------------------------------
23. Section 436.1(w): Written or in writing
The final amended Rule updates the original Rule and UFOC
Guidelines to permit the use of electronic disclosures.\239\ To that
end, section 436.1(w) of the final amended Rule defines the term
``written or in writing'' to include not only printed documents, but:
---------------------------------------------------------------------------
\239\See section 436.6 of the final amended Rule.
any document or information . . . in any form capable of being
preserved in tangible form and read. It includes: type-set, word
processed, or handwritten document; information on computer disk or CD-
ROM; information sent via email; or information posted on the Internet.
It does not include mere oral statements.\240\
---------------------------------------------------------------------------
\240\See also section 436.8(a)(7), which retains the original
Rule's exemption for oral statements at 16 CFR 436.2(a)(3)(iv).
No comments were submitted on the Franchise NPR's proposed definition,
and only minor non-substantive changes in language were made to improve
clarity.
B. Section 436.2: Obligation To Furnish Documents
Section 436.2 of the final amended Rule retains the original Rule's
requirement that franchisors provide prospective franchisees with
advance written disclosures.\241\ It also retains, in streamlined form,
elements of the original Rule's requirement that a franchisor ``furnish
the prospective franchisee with a copy of the franchisor's franchise
agreement . . . prior to the date the agreements are to be
executed.''\242\ The final amended Rule provision follows the basic
concepts of the corresponding provision of the proposed Rule published
in the Franchise NPR, but, as explained below, it reflects important
refinements suggested by the comments, and its language has been
reorganized to improve clarity.
---------------------------------------------------------------------------
\241\ 16 CFR 436.1(a).
\242\ 16 CFR 436.1(g).
---------------------------------------------------------------------------
Section 436.2 of part 436 covers four issues relating to the basic
obligation to provide a disclosure document. First, it describes the
geographical scope within which the disclosure obligation applies.
Second, it establishes the time frame for fulfilling that obligation.
Third, it limits the obligation of the franchisor to furnish to the
prospective franchisee an advance copy of the completed franchise
agreement--apart from the disclosure document--to only those
circumstances when the franchisor makes material unilateral changes to
the agreement while the offer is still under consideration. Fourth, and
finally, the provision sets forth the specific actions
[[Page 15468]]
that constitute the furnishing of disclosures. Each of these aspects of
section 436.2 generated comments. The following sections discuss those
issues and the various views of the commenters.
1. Geographical scope of the Rule's application
Section 436.2 of the final amended Rule makes clear that the part
436 disclosure requirements and prohibitions are limited to ``the offer
or sale of a franchise to be located in the United States of America or
its territories.''\243\ This provision of part 436 is substantively
identical to the corresponding provision in the proposed Rule. The
original Rule did not address whether pre-sale disclosure is required
for sales of franchises to be located outside the United States and its
territories, and this issue has remained an unsettled area of franchise
law. This issue was raised early in the proceeding and, based upon the
record developed, the Commission concludes that application of part 436
to franchises to be located outside the United States and its
territories is unwarranted at this time.\244\
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\243\ Limitation of the geographic scope of part 436 of the
final amended Rule is not intended to limit the FTC's jurisdiction,
as set forth in section 5(a) of the FTC Act, 15 U.S.C. 45(a), and
section 3 of the U.S. SAFE WEB Act of 2006, Pub. L. No. 109-455, 120
Stat. 3372.
\244\ The Staff Report recommended limitation of the Rule's
scope to sales of franchises to be located in the United States.
Staff Report, at 72-5.
---------------------------------------------------------------------------
The record reveals overwhelming support among various franchise
interests for limiting the reach of the part 436 to sales of domestic
franchises.\245\ Among other things, the commenters noted that foreign
franchise purchasers are large sophisticated investors represented by
counsel and do not need the Rule's protections. Some commenters made
the point that the Commission developed the Franchise Rule in response
to problems occurring in the domestic market.\246\ Indeed, a disclosure
document addressing the American market may be irrelevant and
potentially misleading when applied to a purchase of a franchise to be
located outside the United States, due to the vast differences between
American and foreign markets, cultures, and legal systems.\247\
Further, many risks to the prospective franchisee arise from economic
conditions and cultural values in those countries, not in the United
States. To be relevant, a franchisor arguably would have to prepare
individual disclosure documents tailored to each specific foreign
market. Not only would such a requirement put American franchisors at a
competitive disadvantage with franchisors from countries lacking
comparable disclosure regulations, but it is likely that any possible
benefits of such a requirement would not outweigh the extraordinary
costs and burdens involved.\248\
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\245\E.g., MSA, at 3-4; PMR&W, NPR 4, at 1; 7-Eleven, NPR 10, at
1; IFA, NPR 22, at 5; AFC, NPR 30, at 1-2; Duvall, ANPR 19, at 2-3;
SBA Advocacy, ANPR 36, at 9; Tifford, ANPR 78, at 7; NASAA, ANPR
120, at 8-9. Five commenters, however, urged the Commission to
enforce the Rule with respect to foreign franchises, raising
essentially three points. First, many American foreign franchise
sales contracts require disputes to be resolved in the United
States. It would be inconsistent for a franchisor to subject a
foreigner to American law and American courts without simultaneously
extending the benefits of American law, namely pre-sale disclosure.
Brown, ANPR 6; Argentine Embassy, ANPR 132; Selden, ANPR 133, at 2-
3. Second, limiting the Rule's applicability to sales of domestic
franchises would mean that American citizens who purchase a
franchise to be located abroad from an American franchisor would not
be protected by American law. Stadfeld, ANPR 23, at 3; Selden, ANPR
133, at 2-3. See also Stubbings, ANPR 21. Third, the Commission has
jurisdiction over sales of foreign franchises and should not
willingly restrict its own jurisdiction. Brown, ANPR 4. None of the
commenters, however, have shown that limiting the reach of part 436
to franchises to be located in the United States or its territories,
as a matter of policy, compromises the Commission's jurisdiction
over foreign sales under the FTC Act. The Commission retains its
jurisdiction over such sales, and may exercise its discretion to
bring an action in appropriate cases.
\246\ As H&H observed, a close reading of the text of both the
original Rule and UFOC Guidelines indicates an intent to require
disclosures involving only domestic franchises. For example, UFOC
Item 20 refers to the number of franchise sales ``in this state.''
The firm added: ``Other disclosures about the franchise offering,
including litigation and bankruptcy history, franchisor's and
franchisee's obligations, royalty rates, initial investment, fees,
and trademarks, are U.S.-specific.'' H&H, ANPR 28, at 3-4.
\247\E.g., Miolla, 11 Mar.96 Tr., at 74-79; Shay, id., at 84-85;
Forseth, id., at 103; Papadakis, id., at 139; Zwisler, id., at 163-
64. See also Konigsberg, id., at 97 (franchisees in foreign
countries look to their own laws, not to anything contained in an
American disclosure document).
\248\See Cendant, ANPR 140, at 4-5 (``Creating a disclosure
document for . . . international master license transactions . . .
would be nightmarish. . . . The cost of compliance would be high and
American franchisors placed at an extreme disadvantage when
competing with foreign franchisors.''). See also Winslow, at 140.
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At the same time, the Commission has rejected suggestions to limit
the scope of the Rule further to exclude sales of franchises to be
located in American territories.\249\ The FTC Act gives the Commission
authority to promulgate trade regulation rules involving unfair or
deceptive acts or practices\250\ ``in or affecting commerce.''\251\ The
FTC Act includes multiple references to territories in its definition
of commerce,\252\ including commerce ``in any territory of the United
States.''\253\ The record does not suggest any convincing rationale for
contraction of the exercise of that authority as expressed through part
436 of the final amended Rule. Residents of American territories rely
on American law for protection, and the Franchise Rule is part of that
protection.
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\249\ For example, Marriott asserted that the same policy
concerns about applying the Rule to franchises located abroad are
also relevant to Puerto Rico. Marriott apparently treats Puerto Rico
as a foreign country. It contended that furnishing prospective
franchisees in this context with a copy of the franchisor's
disclosure document may be irrelevant or misleading. Marriott, NPR
35, at 4-5. See also J&G, NPR 32, at 3.
\250\See section 18(a)(1) of the FTC Act (``The Commission may
prescribe . . . rules which define with specificity acts or
practices which are unfair or deceptive acts or practices in or
affecting commerce (within the meaning of section 45(a)(1) of this
title).''
\251\ 15 U.S.C. 45(a).
\252\ 15 U.S.C. 44 (```Commerce''' means commerce . . . in any
Territory of the United States . . ., or between any such Territory
and another, or between any such Territory and any State or foreign
nation, or between the District of Columbia and any State or
Territory or foreign nation.'').
\253\ 15 U.S.C. 44.
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2. Section 436.2(a): Time frame for making disclosures
Part 436 of the final amended Rule substantially revises the
original Rule's timing for making franchise disclosures. Under the
original Rule, franchisors and brokers had to furnish prospective
franchisees with disclosure documents at the earlier of two time
periods: (1) the first personal (face-to-face) meeting; or (2) ``the
time for making disclosures,'' which was defined as 10 business days
before the execution of the franchise agreement or payment of any fees
in connection with the franchise sale.\254\ The final amended Rule
streamlines the timing provision in two respects. First, part 436
eliminates the first personal meeting disclosure trigger. Second, part
436 replaces the original 10-business day trigger with a 14 calendar-
day disclosure trigger. Both of these revisions were included in the
Rule proposed in the Franchise NPR, but have been slightly revised for
clarification and better organization. Each is discussed in greater
detail below.
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\254\See 16 CFR 436.1(a), 436.2(g), and 436.2(o).
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a. Elimination of the first personal meeting trigger
The Franchise NPR's proposal to eliminate the first personal
meeting disclosure trigger prompted overwhelming support from
franchisors and their representatives, as well as NASAA.\255\ These
commenters asserted
[[Page 15469]]
that the first personal meeting trigger has become obsolete in the
electronic age, where even large investments are made by telephone or
via the Internet.\256\
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\255\See, e.g., PMR&W, NPR 4, at 1; Holmes, NPR 8, at 3; NFC,
NPR 12, at 13; NASAA, NPR 17, at 3; Marriott, NPR 35, at 9. The
Commission also raised this issue in the ANPR, prompting favorable
franchisor comment. See Duvall, ANPR 19, at 3; Baer, ANPR 25, at 6;
Tifford, ANPR, 18 Sept. 97 Tr., at 158-59; Staff Report, at 76-8.
\256\E.g., IFA, NPR 22, at 9; Stadfeld, NPR 23, at 4. Kennedy
Brooks, for example, observed that franchise sales can occur
entirely electronically ``where the contact is made over the Web,
where E-mail is exchanged, where telephone [calls] are exchanged,
where documents are sent out by Federal Express, and where, in fact,
there never is a face-to-face meeting.'' Brooks, ANPR, 18 Sept. 97
Tr., at 160. See also NCL, ANPR 35, at 4-5; SBA Advocacy, ANPR 36,
at 9; IL AG, ANPR 77, at 3-4.
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Some franchisees and their advocates, however, maintained that the
first personal meeting trigger continues to serve a useful purpose. For
example, one franchisee representative asserted that there is no basis
to believe that personal meetings will completely become a thing of the
past, and warned that eliminating the current first personal meeting
disclosure trigger would enable franchisors to induce a high level of
commitment on the part of prospects through protracted discussions
without providing the disclosure document, with the result that ``the
14 day cooling off period will then start when the franchisee has
already decided to make the investment.''\257\
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\257\ Karp, NPR 24, at 5-6. See also Bundy, NPR 18, at 5-6;
Turner, NPR 13, at 1.
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The Commission believes that a first personal meeting trigger alone
does little to ensure that a prospective franchisee will receive
disclosures early in the sales process.\258\ While at the time the Rule
was promulgated it may have been routine, or perhaps necessary, to have
a face-to-face meeting early on, that is no longer true. Nowadays, a
franchisor and a prospect may have numerous telephone conversations or
send documents to each other via fax or email long before any personal
meeting occurs. Therefore, after carefully considering the comments,
the Commission is persuaded that the first personal meeting trigger has
become largely obsolete and should be deleted.
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\258\ In the Interpretive Guides, the Commission acknowledged
that the term ``first personal meeting'' is imprecise:
``Even where a face to face meeting occurs, it is not
necessarily a ``first'' personal meeting. In interpreting this term,
the Commission will consider such factors as whether the franchisor
clearly indicated at the outset of the discussion that it was not
prepared to discuss the possible sale of a franchise at that time,
whether the meeting was initiated by the prospective franchisee
rather than the franchisor, whether the meeting was limited to a
brief and generalized discussion and whether earnings claims were
made. The Commission believes that by using common sense
precautions, franchisors can defer the first personal meeting until
such time as they are prepared to provide the required
disclosures.``
Interpretive Guides, 44 FR at 49970.
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Nonetheless, the Commission shares commenters' concern about a
franchisor influencing a prospective franchisee's decision before the
prospect receives the franchisor's disclosures.\259\ To address this
concern, the Staff Report recommended adoption of a new provision to
prohibit franchise sellers from refusing to honor a prospective
franchisee's reasonable request for a copy of the franchisor's
disclosure document during the sales process.\260\ The Commission has
determined to follow this recommendation. Accordingly, 436.9(e) of the
final amended Rule specifies that it is an unfair or deceptive practice
to ``[f]ail to furnish a copy of the franchisor's disclosure document
to a prospective franchisee earlier in the sales process than required
under Sec. 436.2 of this part, upon reasonable request.'' This
prohibition does not mean that a franchisor must tender a disclosure
document to any person who may desire a copy. Rather, it applies where
the parties have already conducted specific discussions or negotiations
or otherwise taken steps to begin the sales process. This promotes the
goal of early disclosure in the sales process without reliance on the
obsolete personal meeting trigger. It also is likely to impose only a
de minimis burden, if any, on franchisors, who presumably have a
disclosure document already prepared when discussing a sale with a
prospective franchisee.
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\259\ Karp, at 6. See also Original SBP, 43 FR at 59639
(``[O]nce a prospect has been `hooked,' it is difficult, if not
impossible, to `extricate himself.''').
\260\ Staff Report, at 77-8.
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b. Fourteen calendar-days
Section 436.2(a) of the final amended Rule requires franchisors to
furnish disclosures ``at least 14 calendar-days before the prospective
franchisee signs a binding agreement with, or makes any payment to, the
franchisor or an affiliate in connection with the proposed franchise
sale.'' The Franchise NPR proposed this modification of the original
Rule's ``10 business day'' disclosure trigger. Commenters who addressed
this issue unanimously agreed that a 14 calendar-day disclosure trigger
is clearer than the original Rule's ``10 business day'' trigger.\261\
One commenter, however, urged the Commission to clarify further how to
count the 14 days to ``resolve any question as to whether or not the
day on which the documents are delivered, or the day on which they are
signed, may be counted for purposes of compliance with the Rule.''\262\
The Commission intends that the 14 days commence the day after delivery
of the disclosure document and that the signing of any agreement or
receipt of payment can take place on the 15\th\ day after delivery.
This ensures that prospective franchisees have at least a full 14 days
in which to review the disclosures.\263\
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\261\E.g., Gust Rosenfeld, at 3; Baer, NPR 11, at 10; NFC, NPR
12, at 13; AFC, NPR 30, at 2; Marriott, NPR 35, at 9. See also
Winslow, at 76.
\262\ Holmes, NPR 8, at 3. See also Baer, NPR 11, at 10.
\263\ This approach is consistent with current industry
practice. See, e.g., http://www.msaworldwide.com/index.cfm/franchise/calendar
(2006). But see J&G, at 2 (noting that this approach is
inconsistent with the approach used in the Federal Rules of Civil
Procedure).
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Section 436.2(a) of the final amended Rule also tightens the
language used in the proposed version of this provision to describe the
events that trigger the 14-day disclosure requirement.\264\ The
original Rule required a franchisor to provide its disclosure document:
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\264\ The Commission also has decided to clarify the provision
further by specifying that the described time period is measured in
``calendar-days'' rather than the possibly ambiguous ``days.''
ten (10) business days prior to the earlier of (1) the execution
by a prospective franchisee of any franchise agreement or any other
agreement imposing a binding legal obligation on such prospective
franchisee, about which the franchisor, franchise broker, or any agent,
representative, or employee thereof, knows or should know, in
connection with the sale or proposed sale of a franchise, or (2) the
payment by a prospective franchisee, about which the franchisor,
franchise broker, or any agent, representative, or employee thereof,
knows or should know, of any consideration in connection with the sale
or proposed sale of a franchise.\265\
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\265\ 16 CFR 436.2(g). See also Interpretive Guides, 44 FR at
49970.
In the proposed Rule, section 436.2(a) would have altered this
formulation by eliminating the franchisor's knowledge as a triggering
factor, and rephrasing the remaining factors. Specifically, the
proposed provision would have conditioned the disclosure obligation on
either ``the prospective franchisee sign[ing] a binding agreement or
pay[ing] any fee in connection with the proposed franchise sale.''
Several commenters, focusing on the use of the terms ``binding
agreement'' and ``pays any fee,'' criticized the perceived overbreadth
of this proposed provision. For example, H&H and
[[Page 15470]]
Tricon urged inclusion of the phrase ``with the franchisor or an
affiliate of the franchisor,'' arguing that these limiting words are
needed because ``the franchisor cannot control whether a prospective
franchisee proceeds to commit with independent third parties (e.g.,
lessor of real estate) before expiration of the cooling off
period.''\266\
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\266\ H&H, NPR 9, at 21. See also Tricon, NPR 34, at 3-4. In a
related but distinct vein, Piper Rudnick urged the Commission to
clarify in the Compliance Guides that the 14-day deadline for
disclosure is not triggered by a confidentiality agreement. The firm
maintained that prospective franchisees often sign confidentiality
agreements in the course of negotiations with franchisors. Piper
Rudnick, at 5. While the signing of a confidentiality agreement is
``in connection with the proposed franchise sale,'' it does not bind
the prospective franchisee to purchase the franchise or to undertake
other obligations, such as the signing of a lease. The firm urged
clarification that the term ``binding agreement'' in the 14-day rule
is limited to franchise agreements or other agreements that commit
the prospective franchisee to purchase a franchise. Id. The
Commission agrees. A confidentiality agreement--often signed by
prospective franchisees before being granted access to the
franchisor's operations manual and other proprietary information--
may be a necessary initial step in the sales process, but is not the
type of agreement that triggers disclosure obligations. This
assumes, however, that the confidentiality agreement contains no
other agreements that, in the absence of the confidentiality
agreement, would trigger disclosure, such as a lease agreement.
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On the other hand, Howard Bundy urged broadening the Rule so that a
franchisor would be required to provide the disclosure document at
least 14 days before the prospective franchisee signs a binding
agreement, pays any fee in connection with the proposed franchise sale,
or is required to travel or make other financial commitments as a
precondition to receiving additional information.\267\ Mr. Bundy's
concern was that prospective franchisees may risk losing significant
sums of money to pursue a franchise before they receive any disclosures
about the franchise offer.
---------------------------------------------------------------------------
\267\ Bundy, NPR 18, at 5.
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The Commission believes that the concern that prompts Mr. Bundy's
suggestion is adequately addressed by section 436.9(e) --the new
prohibition barring franchisors from failing to furnish disclosures
earlier in the sales process upon reasonable request. A prospect can
always ask the franchisor for a disclosure document before undertaking
such obligations as signing a binding agreement, paying any fee in
connection with the proposed franchise sale, or incurring travel or
other costs. Thus, a broad disclosure trigger such as Mr. Bundy
advocates is not necessary.
Furthermore, the Commission agrees with the commenters who
suggested that this provision should be more carefully tailored so as
not to be overly inclusive or imprecise. Accordingly, the final
provision specifies that disclosure must be made at least 14 calendar-
days ``before the prospective franchisee signs a binding agreement
with, or makes any payment to, the franchisor or an affiliate in
connection with the proposed franchise sale.'' Addition of the
underscored language adds clarity and precision, and puts appropriate
limits on the provision's reach.
3. Section 436.2(b): Modified contract review period
Part 436 of the final amended Rule significantly narrows the
circumstances under which a franchisor must furnish a prospective
franchisee with a copy of the completed franchise agreement in advance
of the date of execution. The original Rule required that franchisors
and brokers furnish prospective franchisees with a copy of the
completed franchise and related agreements at least five business days
before the date of execution.\268\ The proposed Rule published in the
Franchise NPR retained this requirement.\269\ During the Rule amendment
proceeding, several franchisors and their supporters, as well as NASAA,
urged the Commission to eliminate the contract review period.\270\
PMR&W, for example, asserted that the delay resulting from the
mandatory disclosure period often harms prospective franchisees:
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\268\See 16 CFR 436.1(g).
\269\ The proposed rule provision used the term ``days'' instead
of the original Rule's ``business days.''
\270\ The UFOC Guidelines contain no comparable provision
requiring advanced disclosure of the completed franchise agreement.
In practice, the 5-day rule typically hurts rather than aids
franchisees, since the ``price'' of an additional concession by the
franchisor is an additional 5-day delay. Franchisees often are more
time sensitive than franchisors, either because of a financing
commitment or a lease option that might be expiring or the need to
attend a training program. As a result, the 5-day rule can discourage a
franchisee from requesting last-minute changes. Thus, the current
provision, especially now that business opportunities are not covered,
has little potential benefit to either franchisor or franchisee and
may, in fact, discourage, rather than promote, last minute
negotiations.\271\
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\271\ PMR&W, NPR 4, at 4. See also IFA, NPR 22, at 9; J&G, NPR
32, at 6; Marriott, NPR 35, at 9; GPM, NPR Rebuttal 40, at 2.
Similarly, Marriott noted that the timing of closing the deal is often
---------------------------------------------------------------------------
critical to the franchisee:
as loan commitments may expire, options to acquire sites may
expire or financial commitments may be required to prevent the site
from being sold or leased to a different entity. Securities offerings
may be held up until franchise agreements are executed. Interest rates
may change so as to make a project unavailable unless commitments are
promptly made.\272\
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\272\ Marriott, NPR 35, at 9-10. See also Marriott, at 4.
The Staff Report recommended that the contract review period be
restricted to instances where the franchisor unilaterally modifies its
standard franchise agreement. It also recommended substituting ``seven
calendar-days'' for the Franchise NPR provision's ``five days,'' to be
consistent with the revision of the former 10-day disclosure trigger to
14 calendar-days.\273\ After careful consideration of the record, the
staff recommendation, and the rationale for that recommendation, the
Commission has decided to modify the text of this Rule requirement in
the manner recommended in the Staff Report. Section 436.2(b) of the
final amended Rule specifies that it is a Rule violation for any
franchisor:
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\273\ Staff Report, at 80-2. As a practical matter, five
business days typically amounts to seven calendar-days.
to alter unilaterally and materially the terms and conditions of
the basic franchise agreement or any related agreements attached to the
disclosure document without furnishing the prospective franchisee with
a copy of each revised agreement at least seven 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.
The Commission intended the original Rule's five business day
review requirement to advance two goals: (1) to ensure that prospective
franchisees would have time to review and understand the franchise and
any related agreement before undertaking significant financial and
legal obligations; and (2) to prevent fraud by discouraging a
franchisor from unilaterally substituting pages or
[[Page 15471]]
otherwise altering agreements presented to the prospective franchisee
for signing.
The first concern--providing time to study the franchise and
related agreements--is already served by the Rule's basic disclosure
requirement.\274\ Attached to each disclosure document is a copy of the
franchisor's basic agreement and any related agreements. At the very
least, these documents enable prospects to review the basic terms and
conditions governing the franchise system. Based upon the Commission's
experience in enforcing and administering the Rule, it also appears
that franchisors routinely use standardized franchise agreements. Last-
minute changes to a franchise agreement, therefore, most likely arise
at the franchisee's initiation. When a prospective franchisee is the
party introducing contract modifications, redisclosure by the
franchisor is hardly warranted. Thus, section 436.2(b) expressly states
that ``[c]hanges to an agreement that arise out of negotiations
initiated by the prospective franchisee do not trigger this seven
calendar-day period.''
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\274\See Gust Rosenfeld, at 3. Gust Rosenfeld noted, however,
that while the original Rule referred to franchise and related
agreements, the Staff Report's proposed Rule focused narrowly on
franchise agreements. Id. See also J&G, at 3. The final amended Rule
appropriately broadens the contract review provision to refer to
franchise and related agreements.
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Further, the Commission does not believe that the Rule should
impede a prospective franchisee's ability to negotiate agreement
changes. The delay inherent in a mandatory contract review period may
discourage negotiations if a prospective franchisee believes that he or
she will suffer as a result of the delay. As Marriott noted, the timely
signing of a franchise agreement may be a prerequisite for other parts
of the overall deal, such as obtaining leases and loans. Indeed, in
most instances a prospective franchisee is in the best position to
judge how much review time is warranted and, as a practical matter, can
seek additional review time, if desired.
Nonetheless, the possibility of fraud remains a concern. To prevent
a franchisor from substituting at the last minute provisions that
differ materially from those in the agreements previously attached to
the disclosure document, the final amended Rule includes two
safeguards. First, section 436.2(b) retains a mandatory contract review
period of seven full days\275\ in situations where the franchisor has
materially altered the terms and conditions of the standard agreements
attached to the disclosure document.\276\ The Commission intends that
this not include situations where the only differences between the
standard agreements and the completed agreements are ``fill-in-the-
blank'' provisions, such as the date, name, and address of the
franchisee.\277\ Nor does it include instances where deviations from
the standard agreement are initiated at the prospective franchisee's
request.
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\275\ As previously noted, part 436 of the final amended Rule
provision substitutes ``seven calendar-days'' for the Franchise NPR
provision's ``five days'' to be consistent with the revision of the
former 10 business-day disclosure trigger to 14 calendar-days.
\276\See Gust Rosenfeld, at 3; IL AG, NPR 3, at 5; Stadfeld, NPR
23, at 4.
\277\ J&G questioned whether ``fill-in-the-blank'' provisions
include ``things such as the specific radius or geographic area
comprising a protected territory, or the actual number of stores to
be opened pursuant to an area development agreement, . . . or the
specific interest rate payable by the franchisee.'' J&G at 3. The
Commission will interpret ``fill-in-the-blank'' provisions narrowly
to include non-contractual items, such as the parties' names,
addresses, and dates. To the extent that substantive contractual
details--such as geographic area of a protected territory and
interest rates--are not disclosed in the basic disclosure document
or its attachments, then the completed document must be disclosed
seven calendar days before signing.
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Second, the final amended Rule targets potential fraud directly by
adopting a new prohibition, section 436.9(g), which prohibits a
franchisor from unilaterally substituting provisions or pages in a
franchise agreement resulting in a material change unless the
franchisor first alerts the prospective franchisee about the change
seven days before execution of the franchise agreement. This approach
remedies deceptive unilateral modification of franchise agreements in a
material way without imposing additional disclosure burdens.
In response to the Staff Report, a few commenters asked for
additional clarification of the meaning of the term ``negotiations
initiated by the prospective franchisee.'' For example, Gust Rosenfeld
urged the Commission to make clear in the Compliance Guides that
negotiated changes will be considered initiated by the prospective
franchisee even where some of the changes favor the franchisor.\278\ In
the same vein, Marriott urged the Commission to change the Staff
Report's proposed language ``Changes to a franchise agreement that
result solely from negotiations initiated by the prospective franchisee
. . . .'' to ``Changes to a franchise agreement that arise out of
negotiations initiated by the prospective franchisee. . .''\279\
Marriott contended that the original language--``result solely from
negotiations initiated by the prospective franchisee''--could be read
narrowly to exclude instances where both parties receive benefits
during the negotiation.
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\278\ Gust Rosenfeld, at 3.
\279\ Marriott, at 4-5. See also Spandorf, at 2.
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The Commission recognizes that a negotiated franchise or related
agreement may result in some changes favoring the franchisor. Whether
or not a particular change benefits a particular party, however, is
irrelevant. What is determinative is whether the prospective franchisee
has knowledge of the change before signing the agreement. As long as
the prospective franchisee opens the door to changing documents that
previously have been presented for signing, any discussions about
changes and any agreed upon changes are clearly made with the
prospective franchisee's knowledge. Under these circumstances,
redisclosure would be unwarranted. To make this point clear, the final
amended Rule adopts an edited form of Marriott's suggested language
noted above: ``Changes to an agreement that arise out of negotiations
initiated by the prospective franchisee do not trigger this seven
calendar-day period.''
4. Section 436.2(c): Actions that constitute the furnishing of
disclosures
Section 436.2(c) of the final amended Rule specifies what actions
constitute furnishing required documents. Although the original Rule
did not include such a provision, such specificity is needed now, given
the wide array of disclosure formats and delivery mechanisms available
in today's marketplace. Accordingly, a franchisor will be considered to
have furnished a disclosure document 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.\280\
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\280\ One commenter urged the Commission to require franchisors
to prove that an electronic disclosure document was actually
delivered. Bundy, at 4. He fears that a franchisor could furnish a
disclosure document using slow bandwidth or other procedures, making
it difficult for a franchisee to actually read the disclosure
document. In the same vein, another commenter also urged the
Commission to spell out what specific documents or types of evidence
would qualify as valid evidence of the mailing date. BI, NPR 28, at
4-5. As an initial matter, franchisors always have the burden of
proof to show that they have complied with the Rule's obligation to
furnish disclosures. We also believe that the Rule should be as
flexible as possible, allowing franchisors to keep records and to
offer proof, in the format that is most convenient to them.
Nonetheless, to prevent any potential abuse in this area, the final
amended Rule sets forth several safeguards. Among other things, a
franchisor must notify the prospective franchisee in advance of any
prerequisites for obtaining a disclosure document. Section 436.6(g).
That would include any unusual bandwidth requirements. In addition,
the franchisor must ensure that its disclosures not only can be
downloaded, but preserved for future use. Section 436.6(b). Finally,
the final amended Rule retains a receipt requirement, which will
effectively prove delivery. Section 436.5(w).
[[Page 15472]]
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The basic concepts of the final amended Rule provision track those
in the corresponding provision proposed in the Franchise NPR, but the
language has been revised, reorganized, and in some cases, expanded, to
achieve greater clarity and specificity.\281\
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\281\ For example, where the Franchise NPR version said ``has
been delivered,'' the final Rule provision says ``was hand-
delivered, faxed, emailed, or otherwise delivered,'' to remove any
doubt that the alternative modes of delivery are acceptable.
Similarly, where the Franchise NPR version said ``if a copy has been
sent . . . by first class mail,'' the final amended provision states
``a paper or tangible electronic copy (for example, computer disk or
CD-ROM) was sent . . . by first-class United States mail'' to make
it clear that a disclosure document in an electronic format is
considered equivalent to paper.
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C. Sections 436.3-436.5: The Disclosure Document
Sections 436.3-436.5 of part 436 set forth the substantive
disclosures and attachments that franchisors must include in their
disclosure documents, beginning with the cover page.
1. Section 436.3: Cover page
The cover page informs prospective franchisees that the disclosure
document they are receiving contains important information about the
franchise offer. The proposed Rule published in the Franchise NPR
incorporated each item of information required in the original Rule's
counterpart,\282\ with a few exceptions discussed below.\283\ The final
amended Rule provision follows the cover page proposed in the Franchise
NPR, with minor editing for clarity.
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\282\ 16 CFR 436.1(a)(21).
\283\ Franchise NPR, 64 FR at 57302.
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The proposed cover page set forth in the Franchise NPR generated
little comment. The few comments received generally suggested various
improvements to the text of the cover page, many of which have been
incorporated into the final amended Rule.\284\ The substantive
revisions to the cover page requirement fall into four broad
categories. First, final amended Rule section 436.3(e)(4) requires that
the cover page reference sources of additional background information
that prospective franchisees can use in conducting their due diligence
investigations, such as the FTC's website and its Consumer Guide to
Buying a Franchise.\285\ This will enable prospective franchisees to
find additional background information on franchising, including
information on how to use a disclosure document.
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\284\ In addition, some non-substantive refinements have been
made to improve the clarity, consistency, and organization of the
Rule's text. For example, the text now specifies that the various
required elements of the cover page are to be presented ``in the
order and form as follows.'' Similarly, section 436.3(a) now
specifically instructs franchisors that the title is to appear ``in
capital letters and bold type,'' not merely giving franchisors a
model that depicts the words ``FRANCHISE DISCLOSURE DOCUMENT'' in
capitals in the Rule's text, as proposed in the Franchise NPR. In
addition, the cover page disclosure informing the prospective
franchisee that he or she must be given 14 days to review the
document has been conformed to the convention, adopted elsewhere in
the Rule text, to state time frames in calendar days. See section
436.2(a) (setting forth the 14 calendar-day time frame within which
a franchisor must provide disclosure documents). Thus, the required
cover page disclosure now states that a franchisor must furnish its
disclosures at least 14 calendar-days before the prospective
franchisee signs a binding agreement with, or makes any payment to,
the franchisor or an affiliate in connection with the proposed
franchise sale. See J&G, at 4 (noting a wording inconsistency in the
Staff Report's recommended Rule text between the cover page
disclosure and the substantive timing requirement). Similarly, the
Commission has adopted the staff recommendation to adapt the UFOC
Guidelines cover page disclosure requirement on the total investment
necessary to begin operations (as explained more fully in the text),
but has modified the staff's recommended version by changing the
phrase ``including [the total amount in Item 5] that must be paid to
the franchisor'' to ``This includes [the total amount in Item 5
(Sec. 436.5(e))] that must be paid to the franchisor or
affiliate.'' See NASAA; WA Securities (noting a wording
inconsistency in the Staff Report's recommended Rule text between
the cover page disclosure of total investment necessary to begin
operation and Item 5 initial fee disclosure requirements in proposed
section 436.5(e)).
\285\See Heron, ANPR 80. A copy of the Consumer Guide to Buying
a Franchise is currently available at the Commission website:
http://www.ftc.gov.
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Second, final amended Rule section 436.3(b) updates the cover page
to embrace electronic disclosure. It requires franchisors to include on
the cover page their email and primary home page addresses, so that
prospective franchisees can communicate with the franchisor
electronically. In the same vein, section 436.3(f) permits franchisors
to state on the cover page how prospective franchisees may receive a
copy of the disclosure document in an alternative medium.\286\
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\286\ In drafting this provision, we have recognized the NFC's
concern that franchisors have flexibility in directing prospects to
particular individuals who can assist the prospects in receiving an
alternatively formatted disclosure document. NFC, NPR 12, at 27. To
provide as much flexibility as possible, the provision permits
franchisors to designate either a specific individual or office as a
contact.
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Third, final amended Rule section 436.3, like the proposed version
published in the Franchise NPR, eliminates information from the
original Rule's cover page that might be misinterpreted as implying
greater Commission oversight of franchising than is the case. Several
franchisees contended that phrases in the original cover page--such as
``information . . . required by the Federal Trade Commission'' and ``to
protect you''--are misleading because they imply greater federal
oversight of franchise offerings than actually exists.\287\
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\287\ Kezios, ANPR, 18 Sept. 97 Tr., at 10. See also Karp, ANPR,
19 Sept. 97 Tr., at 89-90.
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Fourth, to promote greater uniformity with state disclosure laws,
final amended Rule section 436.3 has been revised to track more closely
the UFOC Guidelines' cover page elements.\288\ For example, section
436.3 includes the franchisor's name, logo, brief description of the
franchised business, total purchase price as reflected in Item 5
(initial fees) and in Item 7 (estimated initial investment), and a
notice that states may be able to provide sources of information about
franchising.
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\288\See generally UFOC Guidelines, Cover Page, Instructions. As
explained below, however, the Commission has not adopted the UFOC
Guidelines' cover page risk factors.
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With respect to cover page disclosure of the total purchase price,
final amended section 436.3(e)(1) revises slightly the comparable UFOC
Guidelines requirement,\289\ based on the record developed here.
Specifically, BI asserted that the total purchase price disclosure on
the UFOC Guidelines cover page can be misleading. According to the
firm, the cover page should put prospects on notice of the initial
franchise fee that must be paid for the right to commence business
under the mark. BI argued that the inclusion of the broader Item 5
initial fees would cloud the issue, making comparisons of initial
franchise fees among competitors difficult: ``For example, in cases
where a franchisor sells or leases the premises of the franchised
business to the franchisee, this payment would need to be included in
Item 5, but would severely distort the amount of the initial franchise
fee disclosed on the cover page.''\290\
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\289\ UFOC Guidelines, Cover Page, 5 (requiring franchisors to
state the total amounts in Item 5 (initial fees and payments to the
franchisor) and Item 7 (initial investment).
\290\ BI, NPR 28, at 5.
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The Commission's view, however, is that the purpose of the cover
page's
[[Page 15473]]
price disclosure is not simply to indicate the fee paid to the
franchisor for using the franchisor's mark, but to disclose the total
costs paid to the franchisor associated with commencing business
operations. In fact, limiting the disclosure to the initial franchise
fee alone could be misleading because that could understate the
totality of fees that must be paid to the franchisor in order to start
the business. The cover page price disclosures will better enable
prospective franchisees to assess their full potential business costs,
and ultimately their financial risk, than a disclosure limited to the
initial franchise fee alone.\291\ Nevertheless, the Commission
recognizes that it is possible to achieve the goal of informing
prospective franchisees about the investment by referring to Item 7
alone--Initial Investment. Indeed, Item 5 is basically a subset of Item
7. Therefore, to maximize consistency between federal and state law,
section 436.3 incorporates a modified version of the UFOC cover page
references to Item 5 and Item 7, as follows: ``The total investment
necessary to begin operation of a [franchise system name] franchise is
[the total amount of Item 7 (Sec. 436.5(g))]. This includes [the total
amount in Item 5 (Sec. 436.5(e))] that must be paid to the franchisor
or affiliate.''
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\291\ BI's concern would be valid if the cover page required the
disclosure of only Item 5 (initial fees), but not Item 7 (estimated
initial investment). For example, in such a scenario, a franchisor
who leased premises to a franchisee would include the lease payment
in the Item 5 initial fees, whereas a franchisor who required a
franchisee to lease premises from a third party would not include
such payment in Item 5. Arguably, this would distort the first
franchisor's Item 5 initial fees. However, lease payments to third
parties would nonetheless appear in Item 7. Accordingly, Item 5 and
Item 7, considered together, enable prospective franchisees to
compare initial expenses across franchise systems.
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In addition, section 436.3 diverges from the UFOC Guidelines in
that it does not call for the two cover page risk factor disclosures
required by the UFOC Guidelines regarding choice of venue and choice of
law.\292\ These two risk factors essentially repeat what franchisors
already must disclose in Item 17 of the disclosure document.\293\
Moreover, mandating the disclosure of these two risk factors on the
cover page might incorrectly signal prospective franchisees that these
are the most important risk factors to consider.\294\ Nonetheless,
section 436.3(g) of the final amended Rule expressly permits
franchisors to ``include additional disclosures on the cover page . . .
to comply with state pre-sale disclosure laws.'' This provision
effectively permits franchisors to include state mandated risk factors
on the cover page, without adopting risk factor requirements into the
final amended Rule.\295\
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\292\ See UFOC Guidelines, Cover Page, Instructions, iv.
\293\ See Cendant, ANPR 140, at 3 (suggesting that risk factors
belong in the Item 17 disclosures on franchise relationship issues).
\294\ Other commenters suggested additional risk factors. For
example, Greg Gaither, a GNC franchisee, suggested that the cover
page include a warning that encroachment--marketing in a
franchisee's territory--is a risk that might severely affect a
franchised outlet's performance. Michael Garner would require
franchisors to disclose how their contracts may be imbalanced:
``[I]sn't it better to have an unbalanced franchisor/franchisee
relationship disclosed as such early on rather than buried in the
legalese of a franchise agreement?'' Dady & Garner, ANPR 127, at 3.
Mr. Garner recommended that franchisors disclose up-front on the
cover page: (1) if franchisees have no protected territory; (2) if
franchisees can be terminated upon failing to comply with the
franchise agreement; (3) if franchisees cannot transfer without
prior approval; and (4) if the franchisor reserves the right to
receive royalty payments even if it breaches obligations to provide
support services. Dady & Garner, ANPR 127, at 3. We conclude that
each of these issues, for the most part, already is addressed in the
substantive rule disclosure items, or is better handled in
Commission consumer education materials.
\295\See NASAA, at 3-4; WA Securities, at 2 (Commission should
permit state risk factors). See also Tifford, ANPR, 18 Sept. 97 Tr.,
at 15-16 (suggesting that the Commission accommodate risks factors
developed by the individual states). One commenter, GPM, opposed
permitting states to add additional risk factors on the cover page.
The firm suggested that a state should be permitted to require
additional information only in a state-specific addendum. GPM, NPR
Rebuttal 40, at 4. We reject this suggestion. As discussed below,
the final amended Rule does not preempt state laws that afford
greater or equal protection to prospective franchisees. Indeed,
states enjoy great latitude in fashioning franchise disclosure laws,
including how and when state-specific information is to be included
in disclosure documents. Therefore, franchisors must be permitted to
add to an FTC disclosure document in order to comply with non-
preempted state law.
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The Commission has decided not to make further revisions in the
cover page requirements that would call for additional education
messages, notwithstanding several comments urging us to do so. For
example, the AFA suggested that the Commission warn prospective
franchisees that they are not purchasing their own business. To that
end, the AFA would include the following warning on the cover page:
``You will not own your own business. You will lease the rights to sell
[company's name] goods [services] to the public under the [company's
name] tradename and trademarks. This agreement will expire and you will
have no rights to continue in operation upon expiration.''\296\
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\296\ AFA, NPR 14, at 4.
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The Commission agrees in principle with the AFA's broad point that
prospective franchisees should be fully informed about the nature of
franchising. However, the appropriate vehicle for educating prospects
is through educational materials, not the final amended Rule itself.
Indeed, the cover page advances this goal because it will reference the
Commission's Consumer Guide to Buying a Franchise, which contains the
advice the AFA wants communicated.
2. Section 436.4: Table of contents
The final amended Rule section 436.4 retains the original Rule's
requirement for a table of contents, but, like the version of this
provision proposed in the Franchise NPR, conforms to the UFOC
Guidelines in the wording and the ordering of required disclosure items
listed.\297\ This provision generated minimal comment.
---------------------------------------------------------------------------
\297\ In the original Rule, the table of contents was set forth
in a footnote at the back of the Rule. See 16 CFR Part 436, note 3.
---------------------------------------------------------------------------
The final amended provision revises the proposed Rule provision's
use of the UFOC Guidelines headings in only a few instances to reflect
more accurately the Rule requirements, as follows: (1) Item 1 is
changed from ``The Franchisor, its Predecessors, and Affiliates'' to
``The Franchisor and any Parents, Predecessors, and Affiliates;''\298\
(2) Item 5 is changed from ``Initial Franchise Fees'' to ``Initial
Fees;''\299\ (3) Item 7 is changed from ``Initial Investment'' to
``Estimated Initial Investment;'' (3) Item 11 is changed from
``Franchisor's Obligations'' to ``Franchisor's Assistance, Advertising,
Computer Systems, and Training;'' (4) Item 19 is changed from
``Earnings Claims'' to ``Financial Performance Representations;'' (5)
Item 20 is changed from ``List of Outlets'' to ``Outlets and Franchisee
Information;'' and (6) Item 23 is changed from ``Receipt'' to
``Receipts.''
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\298\ This recognizes the final amended Rule's retention of
parent disclosures from the original Rule. See discussion of section
436.5(a)(1) below.
\299\ Responding to a comment urging that the title of Item 5 be
changed from ``Initial Franchise Fee'' (as proposed in the Franchise
NPR) to ``Initial Fees'' so that it would more accurately describe
the actual subject matter of the Item, the Staff Report recommended
that the title of Item 5 be ``Initial Fees Paid to the Franchisor.''
Staff Report, at 121. However, Howard Bundy's Staff Report comment
correctly noted that the recommended reference to ``franchisor'' is
inaccurate because the disclosure applies to fees paid to affiliates
as well. Accordingly, the final amended Rule deletes the phrase
``paid to the franchisor'' in favor of simply ``initial fees.''
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3. Section 436.5(a) (Item 1): The franchisor and any parents,
predecessors, and affiliates
Section 436.5(a) of part 436 sets forth the first of the final
amended Rule's substantive disclosure requirements. As
[[Page 15474]]
proposed in the Franchise NPR,\300\ it retains the original Rule's
requirement that franchisors disclose background information on the
franchisor and any parents and affiliates.\301\ It also expands the
original Rule in three respects to maximize consistency with the UFOC
Guidelines.\302\ First, franchisors must now disclose information about
their predecessors for the 10-year period immediately before the close
of the franchisor's most recent fiscal year.\303\ This will prevent
unscrupulous franchisors from hiding prior misconduct and avoiding
disclosure obligations simply by assuming a new corporate
identity.\304\ Second, franchisors must disclose any regulations
specific to the industry in which the franchise business operates, such
as any necessary licenses or permits,\305\ that may affect the
franchisee's operating costs and ability to conduct business.\306\
Third, franchisors must describe the general competition prospective
franchisees are likely to face.\307\ This disclosure better ensures
that the prospective franchisee can understand the likely economic
risks in purchasing a franchise.\308\
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\300\ Franchise NPR, 64 FR at 57302-03.
\301\ See 16 CFR 436.1(a)(1), (3), and (6). The Commission
historically has emphasized the materiality of franchisor background
information. In the original SBP, the Commission concluded that:
``the failure to disclose such material information . . . may
mislead the franchisee as to the business experience of the parties
with whom he or she is dealing and . . . could readily result in
economic injury to the franchisee because of the franchisee's
dependence upon the business experience and expertise of the
franchisor.''
Original SBP, 43 FR at 59642.
\302\ The final amended Rule also corrects an apparent oversight
in the UFOC Guidelines. Item 1 requires franchisors to disclose the
address of the franchisor's agent, but does not specifically require
the franchisor to identify the agent. IL AG, at 4. Section
436.5(a)(4) of the final amended Rule now requires franchisors to
both identify the agent and state the agent's principal business
address.
\303\See UFOC Guidelines, Item 1.
\304\See FTC v. Morrone's Water Ice, Inc., No. 02-3720 (E.D. Pa.
2002) (company allegedly reincorporated as a ``licensor'' following
an adverse arbitration decision); FTC v. Inv. Dev., Inc., Bus.
Franchise Guide (CCH), ] 9326 (E.D. La. 1989) (company allegedly
reincorporated after filing of Commission law enforcement action).
Cf. FTC. v. Jani-King, Int'l, No. 3-95-CV-1492-G (N.D. Tex. 1995)
(company allegedly conducted business through multiple regional
corporations thereby avoiding certain disclosures).
\305\See UFOC Guidelines, Item 1E Instructions, vi.
\306\E.g., FTC v. Car Checkers of Am., Inc., No. 93-623 (mlp)
(D.N.J. 1993) (failure to disclose state restrictions on the sale of
service contracts); United States v. Lifecall Sys., Inc., No. 90-
3666 (D.N.J. 1990) (failure to disclose state registration
requirements). Cf. Funeral Rule, 16 CFR 453.3 (it is a
misrepresentation to mischaracterize state or local funeral industry
laws).
\307\ UFOC Guidelines, Item 1E Instructions, v. Cf. SEC
Regulations-K (Standard Instructions for Filing Forms Under
Securities Act of 1933, Securities Act of 1934, and Energy Policy
and Conservation Act of 1975), 17 CFR 229.101(c)(1)(x) (requiring
registrants to list, where material, ``the identity of the
particular market in which the registrant competes, an estimate of
the number of competitors, and the registrant's competitive
position, if known or reasonably available to the registrant.'').
This disclosure is intended to aid prospective franchisees in their
decision whether to enter a proposed relationship. It is neither
intended nor interpreted to be a complete antitrust analysis.
Indeed, such a goal would be impractical in light of the number and
variety of relevant local antitrust markets that might be involved.
\308\ Franchisors need only state the types of businesses that
sell competing goods or services. They need not identify specific
businesses. See UFOC Guidelines, Item 1, Sample Answer 1 (``Your
competitors include department store service departments, service
stations, and other national chains of muffler shops.''). This
provision is designed to prevent deception by ensuring that
prospective franchisees understand whether the business they are
entering is unique. While the potential benefit of this provision is
limited, the compliance burden is small. Throughout the original
SBP, the Commission emphasized that potential economic risks to
prospective franchisees are material. E.g., Original SBP, 43 FR at
59650-651 (bankruptcy); at 59662 (sales restrictions); at 59668
(post-term covenants not to compete). A competition disclosure is
also warranted in light of several franchisee comments about
competition issues. E.g., Packer, ANPR 10 (franchisor has opened
franchisor-owned stores to compete with its own franchisees);
Manuszak, ANPR 13 (competition from encroachment); Gray, ANPR 22
(franchisor sold to competing system); Lopez, ANPR 123 (competition
from franchisor's co-branded outlets).
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The final amended rule provision tracks the proposed Rule published
in the Franchise NPR, but is more narrowly tailored in its treatment of
required disclosures about affiliates. Slight non-substantive
modifications in the provision's language and organization have also
been made to improve clarity and precision. Two aspects of section
436.5(a) that prompted comment are discussed in the following sections:
the required parent disclosures, and the required predecessor
disclosures. Finally, various suggestions advanced by commenters but
not adopted in the final amended Rule are discussed in the final part
of this section.\309\
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\309\ The Commission declines to adopt one additional
recommendation in the Staff Report. Specifically, staff recommended
that, in addition to the disclosure of the general competition a
franchisor may face, the Rule should also require franchisors to
disclose ``any competition from any entity in which an officer of
the franchisor owns an interest.'' Staff Report, at 98. The purpose
of this recommendation was to require franchisors to disclose any
potential conflicts of interest by their officers. See Bundy, NPR
18, at 6. But see Piper Rudnick, at 5 (contending that such a
provision would be overbroad, sweeping in even minority ownership of
mutual funds); J&G, at 4 (suggesting that such a provision would be
overbroad, and should be limited to only ``material interests'' in a
competitor). However, the Commission believes that ordinary
corporate fiduciary and conflicts of interest law principles are
sufficient to resolve any potential harm when officers of a
franchisor own interests in competitors. See generally American Law
Institute, Principles of Corporate Governance: Analysis and
Recommendations (2005).
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a. Parent disclosures
The retention of the original Rule's parent disclosure requirement
was not controversial for the vast majority of commenters, including
NASAA.\310\ A few comments, however, raised two concerns about it.
First, a few franchisor representatives asserted that a separate parent
disclosure is unnecessary because a parent, in most instances, would
already be covered by the Rule's broad definition of
``affiliate''\311\-- ``an entity controlled by, controlling, or under
common control with another entity.''\312\ Other commenters questioned
the relevance of a parent's information, asserting that a parent is a
legally distinct entity and that disclosing a parent may mislead
prospective franchisees into believing that the parent exercises
greater oversight or gives financial backing to the franchisor than
actually exists. These commenters add that a parent disclosure simply
clutters an already lengthy disclosure document.\313\
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\310\See 16 CFR 436.1(a)(1)(i). The Commission stated in the
original SBP that parent information is material and that it would
require the disclosure of information about a parent, even though it
recognized that the UFOC Guidelines contained no comparable
disclosure requirement. Original SBP, 43 FR at 59639.
\311\ Gust Rosenfeld, at 2; PMR&W, NPR 4, at 9; H&H, NPR 9, at
15-16; J&G, NPR 32, at 9.
\312\ Section 436.1(b).
\313\E.g., IFA, at 3; Prudential Financial, at 1; Spandorf, at
3.
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On the other hand, the materiality of parent information was
demonstrated by Dr. Spencer Vidulich, a Pearle Vision franchisee. He
related that his franchisor was bought by Cole National Corporation,
which operates company-owned optical departments in Sears stores. In
this instance, the disclosure of parent information would have alerted
prospective Pearle Vision franchisees that their franchisor is owned by
a company that operates competing outlets.\314\
---------------------------------------------------------------------------
\314\ Vidulich, ANPR, 22 Aug. 97 Tr., at 16-17. Similarly, a
franchise system with a poor financial record or significant
litigation could, for example, seek to shield itself from disclosure
by establishing a new subsidiary that will offer identical
franchises, but under a different trademark.
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Also, contrary to some commenters' assertions, part 436 will not
reach all parents when, for example, section 436.5(a) reaches only
those affiliates that ``offer franchises in any line of business or
provide products or services to the franchisees of the franchisor.'' As
Dr. Vidulich suggested, it is possible that a parent does not sell
franchises at all--falling outside the scope of the section's coverage
of ``affiliates''--but nonetheless could operate competing company-
owned outlets. A requirement
[[Page 15475]]
that a franchisor identify any parent, therefore, is necessary to
ensure that any parent not falling within Item 1's limited use of
affiliate will be disclosed.
Moreover, the Item 1 parent disclosure is significantly limited:
franchisors must simply identify a parent.\315\ In contrast with the
Item 1 disclosures for affiliates and predecessors,\316\ a franchisor
need not disclose, for example, the parent's business background,
length of time selling franchises or engaging in other lines of
business.\317\ The Commission concludes that this limited disclosure
will, at most, impose a minor burden for most franchise systems that is
outweighed by the potential benefit to prospective franchisees.
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\315\ Section 436.5(a)(1).
\316\ Section 436.5(a)(7).
\317\ Despite the narrow Item 1 parent disclosure in section
436.5(a)(1), one commenter asserted that the parent disclosure could
be a significant burden on some franchisors with elaborate corporate
structures. Spandorf, at 3. She contended that the final amended
Rule would require a franchisor to disclose ``all non-affiliate
parents, including all intermediate parents, not just the ultimate
parent.'' Id. Accordingly, she urged the Commission to limit the
parent disclosure to those parents with ultimate control ``and any
intermediate parent that guarantees the franchisor's obligations to
franchisees.'' Id. The Commission rejects these suggestions. Item 1
requires franchisors to disclose the identity of parents to ensure
that a prospective franchisee understands who may control or
influence the franchisor's operations. As noted above in the example
of Pearle Vision, it is highly material to a prospective Pearle
Vision franchisee that Pearle Vision is owned and controlled by a
competing system--Cole Vision. That information would escape
disclosure, however, if Cole Vision did not guarantee Pearle
Vision's performance or if Cole Vision were, in turn, a subsidiary
of a larger corporate parent.
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b. Predecessor disclosures
Part 436 of the final amended Rule adopts the UFOC Guidelines'
requirement that franchisors disclose background information about any
predecessors for 10 years.\318\ During the rulemaking process, no
commenters objected to the basic principle that predecessor information
should be disclosed.\319\ A few commenters, however, questioned the
scope of the disclosure. One commenter asserted that the 10-year
reporting period is too long, noting that Item 2 establishes only a
five-year disclosure period for business experience of company officers
and managers.\320\ Another commenter urged the Commission to narrow the
focus of Item 1 to require the disclosure of information about only any
immediate predecessor.\321\ The Commission is not convinced, however,
that the burden of supplying 10 years of predecessor information--as
the majority of franchisors already do to comply with the UFOC
Guidelines--is so great as to justify deviating from the UFOC
Guidelines on this issue.
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\318\ One commenter suggested that the Commission address in the
Compliance Guides an inconsistency between the Item 1 disclosure set
forth in the Staff Report and the UFOC Guidelines' Item 1
disclosure. Whereas the UFOC Guidelines clearly limit the
predecessor disclosures--the predecessor's name and address and
prior experience--to a 10-year reporting period, the Staff Report's
proposed revised Rule could have been read as limiting the
application of the time period to only the predecessor's name and
address. Piper Rudnick, at 5. The Commission agrees that the 10-year
reporting should also limit the reporting of a predecessor's
experience, and the final amended Rule is revised accordingly by
adding a cross-reference that limits the applicability of the
experience disclosures in section 436.5(a)(7) to only those
predecessors covered by section 436.5(a)(2). The commenter also
suggested that the prior experience of affiliates should similarly
be limited to 10 years. Id. This suggestion goes too far and would
introduce an unnecessary inconsistency between the final amended
Rule and the UFOC Guidelines, which does not so limit affiliate
disclosures.
\319\ As noted above, this provision prevents franchisors from
hiding prior misconduct and avoiding disclosure obligations simply
by assuming a new corporate identity. See FTC v. Morrone's Water
Ice, Inc., No. 02-3720 (E.D. Pa. 2002) (company allegedly
reincorporated as a ``licensor'' following an adverse arbitration
decision); FTC v. Inv. Dev., Inc., Bus. Franchise Guide (CCH), ]
9326 (E.D. La. 1989) (company allegedly reincorporated after filing
of Commission law enforcement action).
\320\ H&H, NPR 9, at 16.
\321\ GPM, NPR Rebuttal 40, at 4.
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c. Suggestions for additional disclosure requirements that the
Commission has not adopted
IL AG urged the Commission to expand the scope of Item 1 in several
respects. First, IL AG would expand the types of business organizations
that must be disclosed under section 436.5(a)(5) to include ``members
with a controlling interest in the franchisor.'' In its view, this is
necessary to cover limited liability companies.\322\ The Commission
declines to adopt this suggestion because the examples of different
types of entities included there is intended to be illustrative, not
exhaustive, and additional examples of business organizations are
unnecessary.
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\322\ IL AG, at 4.
---------------------------------------------------------------------------
In addition, IL AG suggested that Item 1 be expanded to include the
date when the franchisor was organized.\323\ The Commission also
declines to adopt this suggestion. The franchisor already must disclose
how long it has been in business and has offered franchises. We believe
that time period, not the date of organization, is most relevant to a
prospective franchisee. Moreover, neither the original Rule nor the
UFOC Guidelines requires this information, and the Commission is
reluctant to introduce an inconsistency with the Guidelines on this
point.
---------------------------------------------------------------------------
\323\ IL AG, at 4.
---------------------------------------------------------------------------
Finally, IL AG suggested that a description of the competition
should include competitors of the franchisor's affiliates.\324\ We note
that the UFOC Guidelines require only a ``general description of the
competition.'' Depending upon the franchise system, competition of
affiliates could be sizeable, especially with respect to large,
publicly traded franchisors. We are not inclined to diverge from the
UFOC Guidelines in the absence of evidence showing a problem on this
point.
---------------------------------------------------------------------------
\324\ IL AG, at 4.
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4. Section 436.5(b) (Item 2): Business experience
Consistent with the original Rule and UFOC Guidelines, section
436.5(b) of the final amended Rule requires the disclosure of the
business experience of the franchisor's directors, trustees, general
partnerships, and certain executives.\325\ It differs from the UFOC
Guidelines's Item 2, however, in two respects. First, it does not
require a franchisor to disclose brokers.\326\ Second, it expands the
original Rule and UFOC Guidelines to prevent fraud by requiring the
disclosure of prior experience of not only directors and executives,
but other individuals who do not necessarily possess a title, but
nonetheless will exercise management responsibility relating to the
sale or operation of franchises being offered for sale. Additionally,
this final amended Rule provision is narrower than its counterpart as
proposed in the Franchise NPR, in that it deletes the proposed
requirement to disclose prior experience of the officers or executives
[[Page 15476]]
of any parent of the franchisor. Each of these issues is discussed in
detail below.
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\325\See 16 CFR 436.1(a)(2). In the original SBP, the Commission
explained that a franchisor's failure to disclose its business
experience violates Section 5 because ``it (1) misleads the
prospective franchisees as to the business experience of the parties
with whom they are dealing, and (2) could readily result in economic
injury to franchisees due to their heavy dependence upon the
experience of those persons associated with the franchisor.''
Original SBP, 43 FR at 59642. See Buckley, ANPR 97, at 1
(``franchisor represented his company as highly trained in all
phases of the business and capable of supporting a franchise
system''); FTC v. Nat'l Consulting Group, Inc., Bus. Franchise Guide
(CCH) ] 11335 (N.D. Ill. 1998) (claims regarding medical billing
expertise and contacts with medical community are material); FTC v.
Richard L. Levinger, No. 94-0925-PHX RCB (D. Ariz. 1994) (earnings
claims tied to purported expertise in the restaurant industry are
material); FTC v. Car Checkers of Am., Inc., No. 93-623 (mlp)
(D.N.J. 1993) (claims regarding car inspection business expertise
are material). Cf. FTC v. Goddard Rarities, Inc., No. CV93-4602-JMI
(C.D. Cal. 1993) (representations of expertise in coin investments
are material).
\326\See UFOC Guidelines, Item 2 and Instructions, v.
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a. Brokers
The original Rule did not require disclosure of brokers. The
proposed Rule, however, tracking the UFOC Guidelines, required that
franchisors ``list all brokers.''\327\ As noted above, based upon the
comments, the final amended Rule does not include the UFOC Guidelines'
provision that franchisors identify its brokers in Item 2.\328\ During
the Rule amendment proceeding, a few commenters asserted that such
disclosure is unnecessary.\329\ For example, Frannet, a franchise
broker, voiced concern that the proposed inclusion of brokers in Item 2
would require franchisors to disclose immaterial information about
``literally hundreds of business brokers each of whom will receive a
commission in the event that a prospect referred by any such person
ultimately purchases a franchise,'' resulting in a ``voluminous'' UFOC,
with ``no value to the prospective franchisee.''\330\
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\327\ Franchise NPR, 64 FR at 57334.
\328\ Franchisors, of course, would still be required to include
broker information, if mandated by state law.
\329\ E.g., Gust Rosenfeld, at 4; J&G, NPR 32, at 10.
\330\ Frannet, NPR 2, at 2. In this regard, it is noteworthy
that, had the broker disclosure requirement been retained in the
final amended Rule, broker information also would have been required
in Items 3 and 4 disclosures. See Staff Report, at note 320.
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On the other hand, Michael Seid, a franchise industry consultant,
strongly objected to the deletion of broker information from Item 2
because prospective franchisees often rely on statements made by
brokers in deciding whether to purchase a franchise. In his view,
prospective franchisees perceive brokers as being independent, third-
party experts. He opined that listing them in a disclosure document
would dispel that notion, making it clear that brokers are authorized
agents of the franchisor.\331\
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\331\ Seid, at 5-7. See also IL AG, at 4.
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Some prospective franchisees may rely on a broker's statements in
the course of purchasing a franchise, and some brokers may make false
claims--such as false financial performance representations.
Nonetheless, the Commission is not convinced that broker disclosures
are warranted in a franchise disclosure document.
Item 2 appropriately requires franchisors to disclose the
background of those individuals who control the franchisor and those
who actually manage franchisees. That information is material because
prospective franchisees need to know the identity and business
experience of the individuals in command of the franchisor in order to
assess whether these individuals are likely to be able to perform as
promised under the franchise agreement. Unlike franchisors, brokers do
not create or implement franchisor policy, nor do they oversee
performance of post-sale obligations to the franchisee. Accordingly,
prospective franchisees are less likely to give decisive weight to an
individual broker's expertise or background in assessing the merits of
purchasing a franchise.
Moreover, even if a broker were to make false claims, the
prospective franchisee has the benefit of the franchisor's disclosure
document to assess those claims before purchasing a franchise. For
example, a franchisor statement in Item 19 that it does not authorize
the making of financial performance claims should raise doubts about a
broker's veracity if the broker were to make his or her own performance
claims. Similarly, a franchisor's statement in Item 3 that it has been
sued by franchisees would dispel any claim by a broker that the
franchisor has not been previously sued. The counteractive effect of
the disclosure document gives the Commission reason to doubt that the
inclusion of broker information among the required Item 2 disclosures
would yield more than a scant benefit to prospective franchisees.
Further, the disclosure of brokers would also be cumbersome, especially
for large franchise systems that may employ hundreds of brokers
nationally. Thus, the Commission concludes that this benefit would not
likely outweigh the corresponding compliance costs and burdens.
Finally, the deletion of brokers from Item 2 as had been proposed
in the Franchise NPR obviously does not curtail brokers' liability for
false claims. Franchise brokers, like virtually all other individuals
conducing interstate commerce, remain liable under Section 5 of the FTC
Act for their own misrepresentations. In short, while the Commission
favors adopting UFOC Guidelines approach to the fullest extent
possible, we believe this is one area where an exception is warranted.
b. Individuals with management responsibility
Section 436.5(b) of part 436 requires a franchisor to disclose not
only the background of the franchisor's directors and executives, but
also ``individuals who will have management responsibility relating to
the sale or operation of franchises offered by this document.''\332\
Individuals listed in Item 2 must also disclosure their litigation
(Item 3) and bankruptcy (Item 4) histories as well. This provision
ensures that franchisors cannot conceal a manager's lack of experience,
prior litigation, or bankruptcy history by simply avoiding giving the
manager a formal title.\333\ Although the language has been revised to
achieve greater clarity and specificity, this aspect of this provision
is conceptually very similar to the rule as proposed in the Franchise
NPR.\334\ The breadth of this provision is intended to leave no doubt
that franchisors must disclose all individuals who in fact exercise
management responsibility over the sale or operation of franchises
being offered for sale, regardless of any formal title.\335\
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\332\ One commenter voiced concern that Item 2 could be
misinterpreted to include owners with a controlling interest and
asked the Commission to clarify this point in the Compliance Guides.
Gust Rosenfeld, at 3-4. We note that neither the original Rule nor
the final amended Rule focuses on ownership. Rather, the determining
factor is control over the franchise operations. Accordingly, an
owner/investor in a franchise system would not ordinarily have to be
disclosed in Item 2, unless that owner/investor also manages or
otherwise exercises control over the franchise operation.
\333\See FTC v. P.M.C.S., Inc., No. 96-5426 (E.D.N.Y. 1996)
(franchisor failed to disclose control figure with prior
bankruptcy); FTC v. The Building Inspector of Am., Inc., No. 93-
10838Y (D. Mass. 1993) (alleging that the franchisor failed to
disclose the franchisor's current executive officers and their
business experience, litigation history concerning fraud or
misrepresentation, and bankruptcy history); FTC v. Why USA, Inc.,
No. 92-1227-PHX-SMM (D. Ariz. 1992) (alleging that franchisor failed
to disclose officers and their prior litigation). During the Chicago
public workshop, a former franchisee related that his franchisor did
not disclose that the franchisor's director of franchising (who was
not a titled corporate officer) had been discharged in bankruptcy.
The franchisee stated that, because the franchisor was small,
operated by only five or six people, such a disclosure was
``critical, even though this person was not formally an officer.''
Lay, ANPR, 22 Aug. 97 Tr., at 6. See also NASAA, NPR 17, at 3 (``The
law enforcement experience of some members of the [NASAA] Franchise
Project Group reflects that franchisors and sellers of business
opportunities have attempted to avoid litigation disclosures
. . . by purposefully not giving the title `officer' to
individuals who, in fact, exercise significant management
responsibility over a business.''). Cf. FTC v. Netfran Dev. Corp.,
No. 05-CV-22223 (S.D. Fla. 2005) (failure to disclose that executive
was subject to a Commission order involving fraud or deceptive
practices); FTC v. Int'l Bartending Inst., No. 94-1104-A (E.D. Va.
1994) (franchisor failed to disclose that chairman was subject to a
Commission order involving fraud or deceptive practices).
\334\ The Franchise NPR's version of Item 2 also referenced
subfranchisors. As one commenter noted, however, a reference to
subfranchisors is unnecessary because the term ``franchisor,'' as
set forth in the Rule's definitions (and the UFOC Guidelines'
definition), already includes the term ``subfranchisor.'' Gust
Rosenfeld, at 4. Therefore, that reference has been deleted.
\335\See Staff Report, at 101-02. In the Franchise NPR, the
Commission proposed achieving this goal by including within the
definition of ``officer,'' any ``de facto officer,'' ``namely any
individual with significant management responsibility for the
marketing and/or servicing of franchisees whose title does not
reflect the nature of the position.'' Franchise NPR, 64 FR at 57332.
Some commenters agreed with the Commission that it is necessary to
capture individuals who, without an appropriate title, in fact
function as officers or directors. E.g., NASAA, NPR 17, at 3. Others
asserted that the term ``de facto officer'' is ``nebulous,''
creating more problems than it would solve. E.g., Snap-on, NPR 16,
at 2; Gurnick, NPR 21, at 3-4; J&G, NPR 32, at 8; Marriott, NPR 35,
at 12. Another voiced concern about application to large
corporations, where there may be many directors or managers, each of
whom would now have to be disclosed. Tricon, NPR 34, at 3. Based
upon the Franchise NPR comments, the Commission has determined to
delete the term and description of ``de facto officer'' from the
final amended Rule. At the same time, Item 2 requires a franchisor
to identify all individuals who have management responsibility over
the franchises, regardless of any formal title. This is true even if
the individual happens to be an officer of a parent or an affiliate.
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[[Page 15477]]
c. Parents
Part 436 as proposed in the Franchise NPR required franchisors to
disclose the prior experience of a parent's officers or
executives.\336\ This proposal, however, was criticized on the grounds
that such a broad disclosure about directors and officers of a parent
would clutter Item 2 with information ``of marginal relevance and
importance to prospective franchisees.''\337\ In response to
commenters' persuasive arguments, the Commission has determined to omit
the requirement from section 436.5(b).
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\336\ Franchise NPR, 64 FR at 57334.
\337\ Lewis, NPR 15, at 12. See also Gust Rosenfeld, at 4. BI,
NPR 28, at 5. But see Bundy, NPR 18, at 6-7 (Item 2 should cover not
only officers and executives of parents, but affiliates as well).
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The Commission has come to the view that the disclosure of prior
experience of individuals associated with a parent of a franchisor is
generally unnecessary. While in many instances a parent's officers may
exercise general management responsibilities that may affect the
franchisor, they are not necessarily involved in managing the
franchisor or its franchises. Because of their lack of direct control
over the franchisor, background information on them is unlikely to be
material to a prospective franchisee. Accordingly, the minimal benefit
that might accrue to prospective franchisees from a disclosure of the
prior experience of individuals associated with the franchisor's parent
would not likely outweigh the compliance costs and burdens.
5. Section 436.5(c) (Item 3): Litigation
Section 436.5(c) of the final amended Rule retains the original
Rule's requirements to disclose certain pending and prior litigation,
as well as current injunctive or restrictive orders. Like the original
Rule, the final amended Rule requires disclosure, in some instances, of
litigation involving the franchisor's parent.\338\ Consistent with the
UFOC Guidelines, however, part 436 expands on the original Rule by
requiring franchisors to disclose actions involving not only the
franchisor, its directors and officers, and affiliates, but
predecessors as well.\339\ In addition, section 436.5(c)(1)(i)(B), in
accord with the UFOC Guidelines, now requires the disclosure of routine
litigation that may impact the franchisor's financial condition or
ability to operate the business.\340\ At the same time, as also
proposed in the Franchise NPR, the Commission has determined that
section 436.5(c)(1)(B)(ii) of the final amended Rule should expand on
both the original Rule and UFOC Guidelines by requiring franchisors to
disclose material franchisor-initiated litigation against franchisees
involving the franchise relationship.
---------------------------------------------------------------------------
\338\See 16 CFR 436.1(a)(4). In the original SBP, the Commission
stated that a franchisor's litigation history is material because it
bears directly on the ``integrity and financial standing of the
franchisor.'' Original SBP, 43 FR at 59649. See, e.g., United States
v. We The People Forms and Serv. Centers USA, Inc., No. CV 04 10075
GHK FMOx (C.D. Cal. 2004) (full disclosure would have revealed
lawsuits and injunctions involving the franchisor's bankruptcy
petition preparation services); FTC v. WhiteHead, Ltd., Bus.
Franchise Guide (CCH) ] 10062 (D. Conn. 1992) (full disclosure would
have revealed a $10 million judgment in a fraud action brought by
former franchisees); FTC v. Joseph Hayes, No. 4:96CV02162SNL (E.D.
Mo. 1996) (full disclosure would have revealed prior state fines and
injunctions); FTC v. Inv. Dev., Inc., Bus. Franchise Guide (CCH) ]
9326 (full disclosure would have revealed insurance fraud
convictions). See also Marks, ANPR, 19 Sept. 97 Tr., at 8 (``I
always counsel clients . . . to look at the litigation section among
one of the first sections.'').
\339\ See UFOC Guidelines, Item 3. See AFA, at 2.
\340\ See UFOC Guidelines, Item 3 A. See also AFA, at 2. Under
this provision, a fast-food restaurant franchisor, for example,
would have to disclose a product liability class action suit that,
if successful, might materially affect its financial condition or
ability to maintain its business operations. This disclosure is
consistent with long-standing Commission policy that a franchisor's
continued financial viability and ability to perform as promised is
material to a potential investor. See, e.g., Original SBP, 43 FR at
59649.
---------------------------------------------------------------------------
The comments on Item 3 focused on five broad topics: (1) whether
and to what extent disclosures about a franchisor's parent should be
required; (2) to what extent disclosures about a franchisor's
affiliates should be required; (3) whether disclosure about out-of-
court settlements favorable to the franchisor or settlements that by
their terms are confidential should be required; (4) whether the Rule
as proposed in the Franchise NPR needed clarification to avoid implying
that dismissed actions should be disclosed in cases when no liability
is imposed upon or accepted by the franchisor; and (5) whether and to
what extent disclosure of franchisor-initiated litigation would be
required. Each of these topics is discussed in the sections that
follow.
a. Parent disclosures
The original Rule required the disclosure of litigation relating to
a franchisor's parent.\341\ Part 436 as proposed in the Franchise NPR
retained this broad approach. The Commission, however, has decided that
the final amended Rule should narrow considerably the scope of the
franchisor's obligation to disclose litigation relating to a parent. As
recommended in the Staff Report, the final amended Rule requires the
disclosure of litigation relating to a franchisor's parent only in the
case of a ``parent . . . who guarantees the franchisor's
performance.''\342\
---------------------------------------------------------------------------
\341\ As noted previously, this is one area where the original
Rule was broader than the UFOC Guidelines, which require no
disclosure of parent information, unless the parent is an affiliate.
\342\ Staff Report, at 104.
---------------------------------------------------------------------------
The narrowed scope of the parent litigation disclosure responds to
persuasive comments challenging the value of broad parent litigation
disclosures to prospective purchasers and complaining of the burden to
franchisors. Typical of these comments are those submitted by PMR&W,
arguing that the parent litigation disclosure is confusing at best and
offers little if any benefit to prospective franchisees, and noting
that a publicly-traded parent may face countless securities fraud
claims, for example, that would have to be disclosed, ``overflowing
[the disclosure document] with largely irrelevant parent litigation
summaries, obscuring and diverting readers from the more important
disclosures of franchisor litigation, and greatly increasing compliance
burdens and costs.''\343\
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\343\ PMR&W, NPR 4, at 9. See also IFA, at 3; PREA, at 1-2;
Spandorf, at 4; Triarc, NPR 6, at 2; NFC, NPR 12, at 28; PREA, NPR
20, at 1.
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Based upon review of the record, including the Staff Report, the
Commission is persuaded that litigation involving a parent (which may
be voluminous in the case of a publicly-traded parent) may have little
bearing on the operation of the franchise system itself. Yet, the
Commission does not believe that complete elimination of the parent
litigation disclosure is justified. Rather, the Commission has
determined to narrowly tailor the parent litigation disclosure to those
circumstances where the parent guarantees the franchisor's performance,
as recommended in the
[[Page 15478]]
Staff Report.\344\ Where a parent, for whatever reason, induces
franchise sales by promising to back the franchisor financially or
otherwise guarantees the franchisor's performance, the parent's prior
litigation history becomes material to the prospective franchisee and
must be disclosed.\345\ As noted throughout this document, background
information on all parties having post-sale performance obligations is
material to a prospective franchisee. There is no meaningful
distinction between parents who make performance guarantees and
franchisors with various contractual performance obligations.
---------------------------------------------------------------------------
\344\ See Staff Report, at 104. The Staff Report recommendation
that the parent litigation disclosure be narrowed to instances where
the parent guarantees the franchisor's performance prompted few
comments. PREA and Spandorf opined that parent disclosures have
merit where the franchisor has few assets or a prior history such
that the prospect is looking to the parent for assurance of
continued financial viability, and advocated an exemption from the
Item 3 parent litigation disclosure if the franchisor has sufficient
net worth and experience. They proposed a net worth of not less than
$5 million and a requirement that the franchisor has had at least 25
franchisees for each of the preceding five years. PREA, at 1-2;
Spandorf, at 4-7. See also PREA, NPR 20, at 1. The Commission finds
this suggestion unworkable. As noted throughout this document, the
Commission favors bright-line provisions that enable franchisors to
determine easily where the Rule applies to a franchise sale.
Moreover, the Commission is disinclined to adopt exemptions from
specific required disclosures--as opposed to exemptions from the
Rule itself. On balance, the Commission believes that the narrowly-
tailored parent litigation disclosure included in the final amended
Rule strikes the appropriate balance, reducing compliance costs and
burdens without depriving prospective franchisees of material
information necessary to make an informed investment decision.
\345\ But see PREA, at 1-2; Spandorf, 4-7 (asserting that prior
litigation of a parent who guarantees performance may be irrelevant,
and urging the Commission to adopt a net worth standard). As an
alternative, PREA and Spandorf suggested that the Commission adopt
an approach similar to that of the SEC for the disclosure of legal
proceedings to securities investors: a guarantor need only disclose
material legal proceedings other than ordinary routine litigation.
PREA, at 2. We noted, however, that Item 3 is already limited to
material suits, or individual suits which, in the aggregate, are
material. This is sufficient to limit Item 3's reach with respect to
guarantors.
---------------------------------------------------------------------------
b. Affiliates
As noted, the original Rule did not require the disclosure of
litigation involving a franchisor's affiliate. The proposed rule
published in the Franchise NPR incorporated the UFOC Guidelines'
requirement that franchisors disclose litigation involving an
``affiliate who offers franchises under the franchisor's principal
trademark.'' Section 436.5(c) of the final amended Rule retains this
concept, but modestly broadens the requirement, consistent with the
Staff Report and Staff Report comments, to encompass: (1) litigation
involving not only affiliates who offer franchises under the
franchisor's principal trademark, but also any affiliate who
``guarantees the franchisor's performance;'' and (2) with respect to
the requirement to disclose government injunctions or restrictive
orders, actions involving an affiliate ``who has offered or sold
franchises in any line of business within the last 10 years.''\346\
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\346\ Item 3 of the proposed Rule published in the Franchise NPR
required disclosure of government enforcement actions only for an
affiliate ``who offers franchises under the franchisor's principal
trademark.'' The final amended Rule requires such disclosure for
``an affiliate who has offered or sold franchises in any line of
business within the last 10 years.'' Section 436.5(c)(2) (emphasis
added).
---------------------------------------------------------------------------
The affiliate litigation disclosure provision generated limited
comment.\347\ One commenter urged the Commission to broaden Item 3's
scope to include litigation involving all affiliates, not just those
under the franchisor's principal trademark. The UFOC Guidelines' narrow
reach extends only to instances where affiliates offer franchises under
the franchisor's principal trademark. Arguably, this restrictive
approach could allow a franchise system to hide derogatory facts about
its litigation history by acquiring and operating a competing franchise
system that uses a different mark. In such an instance, the newly-
acquired franchisor would have no obligation to disclose its past
litigation, falling outside the definition of both ``predecessor'' and
``affiliate.'' On the other hand, the record contains no suggestion
that such instances are common. Thus, the Commission does not believe
it warranted to require franchisors to disclose all affiliate
litigation to address that hypothetical concern. Such a measure would
be broader than necessary to address concerns documented in the record,
would be burdensome, especially for large companies with multiple
brands, and would not likely yield commensurate benefits to prospective
franchisees.
---------------------------------------------------------------------------
\347\ Piper Rudnick urged the Commission to clarify in the
Compliance Guides that disclosures involving affiliates and
predecessors--in Items 1, 3 and 4 --should be limited to the time
period when the affiliates or predecessors were ``associated'' or
``affiliated with the franchisor.'' Piper Rudnick, at 5-6. The
Commission disagrees. As an initial matter, depending upon the
facts, a predecessor entity and successor franchisor may not exist
contemporaneously and thus may never be ``associated'' or
``affiliated'' with each other. As for affiliates, Piper Rudnick's
suggestion could seriously undermine the very purpose for the
disclosure itself. The affiliate disclosures in Items 1, 3, and 4
ensure that a prospective franchisee understands fully the
background of the franchisor's affiliates. Significant litigation or
a prior bankruptcy, for example, may signal that the affiliate lacks
business acumen and, therefore, poses a potential risk, especially
if franchisees of the system are contractually required to conduct
business with the affiliate. For that reason, the history of the
affiliate as a business entity, not its history of association with
the franchisor, is material to a prospective franchisee and should
be disclosed.
---------------------------------------------------------------------------
Nevertheless, as noted above, the Commission has determined to
expand the requirement to disclose affiliate litigation in two respects
in order to provide prospects with material information. First, for
currently effective government injunctive or restrictive orders
delineated in section 436.5(c)(2), the final amended Rule adopts the
Staff Report recommendation to broaden Item 3 affiliate coverage to
include any affiliate who has offered or sold franchises in any line of
business within the last 10 years.\348\ In the Commission's view, a
government injunction or comparable order\349\ (with or without a civil
penalty or other redress), may be an indicator of fraud or other
unlawful conduct.\350\ Accordingly, a franchisor with a history of
fraud or Rule violations should not be able to avoid disclosure of
government actions against it merely by establishing a new corporation
or switching trademarks. We believe this approach will result in the
disclosure of material litigation history, without unduly burdening
large, multi-brand franchise networks.
---------------------------------------------------------------------------
\348\ Staff Report, at 104-5.
\349\ The Item 3 disclosure of currently effective injunctive or
restrictive orders and decrees is also broader than the other Item 3
disclosures in that it covers Canadian orders and decrees. This is
consistent with the UFOC Guidelines. See UFOC Guidelines, Item 3, C.
\350\ We note that there is no private right of action to
enforce the Franchise Rule. See, e.g., Holloway v. Bristol-Meyers
Corp., 485 F.2d 986 (D.C. Cir. 1973) (no implied private right of
action under the FTC Act); Days Inn of Am. Franchising, Inc., v.
Windham, 699 F. Supp. 1581 (N.D. Ga. 1988) (no private right of
action exists to enforce the Franchise Rule).
---------------------------------------------------------------------------
Second, section 436.5(c)(1) of the final amended Rule requires
franchisors to disclose litigation involving not only affiliates that
offer franchises under the franchisor's principal trademark, but also
any affiliate that guarantees performance. This responds to NASAA's
comment, urging the Commission to make clear that the term
``affiliate'' in Item 3 includes those guaranteeing performance,
similar to the parent disclosure noted above.\351\ As NASAA noted,
there is no practical distinction between a parent and an affiliate who
guarantees performance. In both instances, the prospective franchisee
may rely on the guarantee in considering whether to purchase the
franchise. Therefore, the litigation history of both parents and
affiliates
[[Page 15479]]
who guarantee performance is material and should be disclosed.
---------------------------------------------------------------------------
\351\ NASAA, at 5.
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c. Settlements
With respect to settled actions, the original Rule required
disclosure of any civil action a person subject to the provision ``has
settled out of court'' in the previous seven fiscal years. It did not
distinguish between confidential and nonconfidential settlements.\352\
Consistent with the UFOC Guidelines, the Franchise NPR proposed that
franchisors disclose the terms of any settled actions, expressly
including confidential settlements.\353\ Several commenters voiced
concern about the requirement to disclose settlements--including
confidential settlements.
---------------------------------------------------------------------------
\352\ 16 CFR at 436.1(a)(4)(ii).
\353\ Footnote 4 in the proposed Rule stated, in relevant part:
``If a settlement agreement must be disclosed in this Item, all
material settlement terms must be disclosed, whether or not the
agreement is confidential.'' Franchise NPR, 64 FR at 57334. See also
NASAA Commentary, Item 3.
---------------------------------------------------------------------------
Settlements Favorable to the Franchisor. PMR&W and Warren Lewis
observed that Item 3 in the Rule as proposed in the Franchise NPR did
not allow franchisors to omit settled litigation where the settlement
is favorable to the franchisor or neutral.\354\ Both commenters cited
to the UFOC Guidelines,\355\ which state that ``settlement of an action
does not diminish its materiality if the franchisor agrees to pay
material consideration or agrees to be bound by obligations which are
materially adverse to its interests.''\356\ The point these commenters
were making is that the UFOC Guidelines, by implication, would deem
favorable or neutral settlements to a franchisor not material and would
not call for their disclosure. The Commission believes this
interpretation is correct, and intends that result in adopting the
final version of this provision. Item 3, therefore, permits franchisors
to omit settled litigation where a settlement is favorable to the
franchisor or otherwise neutral.\357\
---------------------------------------------------------------------------
\354\ Footnote 2 in the proposed rule stated: ``Franchisors are
not required to disclose actions that were dismissed by final
judgment without liability or entry of an adverse order. However,
franchisors must disclose dismissal of a material action in
connection with a settlement.'' Franchise NPR, 64 FR at 57334. As
explained in the text above, this footnote has been deleted from the
final amended Rule.
\355\ UFOC Guidelines, Item 3 Definitions, iv.
\356\ PMR&W, NPR 4, at 10; Lewis, NPR 15, at 13. According to
Mr. Lewis, without such a limitation, the Rule would penalize
franchisors and subfranchisors who achieve favorable settlements,
thereby discouraging settlement of litigation. See also Snap On, NPR
16, at 3.
\357\ Section 436.5(c)(1)(iii)(B) of the final amended Rule
specifies that ``held liable'' as used in Item 3 means that ``as a
result of claims or counterclaims, the person must pay money or
other consideration, must reduce an indebtedness by the amount of an
award, cannot enforce its rights, or must take action adverse to its
interests.'' In other words, a franchisor need not disclose a
settlement if the franchisor neither pays any material
consideration, nor is bound by obligations that are materially
adverse to its interests.
---------------------------------------------------------------------------
Confidential Settlements. With respect to the disclosure of
confidential settlements, David Gurnick commented that the disclosure
of any settlement terms that the parties agreed to keep confidential is
bad policy because confidential settlements benefit both parties and
the ``opportunity for confidentiality is often an important dynamic to
resolve a dispute.''\358\ He urged that the Rule permit the disclosure
of material facts about confidential settlements in the aggregate, so
that the franchisor could make the disclosure about a group of cases,
without violating the confidentiality of any one or more cases. For
example, a franchisor could state: ``we have settled 10 cases with
confidentiality agreements. In each of these cases, we made payments to
the franchisee in the mid five figure range.''\359\
---------------------------------------------------------------------------
\358\ Gurnick, NPR 21, at 4. See also J&G, NPR 32, at 10-11;
Marriott, NPR 35, at 15.
\359\ Gurnick, NPR 21, at 5. But see Stadfeld, NPR 23, at 12
(urging the Commission to keep the UFOC requirement of disclosing
specific payments in settlements regardless of confidentiality
agreements).
---------------------------------------------------------------------------
Similarly, John Baer questioned the disclosure of exact dollar
amounts or other confidential settlement terms. ``This often can expose
the franchisor to the choice of not being able to register its
franchise in a particular state or making a disclosure and possibly
breaching the terms of the confidential settlement agreement.''\360\ He
suggested that the Commission allow franchisors to disclose approximate
dollar amounts, such as ``the low four figures,'' or, in the
alternative, a range of figures.\361\
---------------------------------------------------------------------------
\360\ Baer, NPR 11, at 11.
\361\ Mr. Baer also suggested that where a case has been settled
by purchase or re-purchase of a franchised business and the amount
does not exceed the fair market value of the business, a franchisor
should be permitted to state: ``The settlement included a purchase
of the franchise . . . for an amount which, in our judgment, does
not exceed its fair market value.'' Baer, NPR, 11, at 11.
---------------------------------------------------------------------------
In keeping with the goal of reducing inconsistencies with the UFOC
Guidelines, the Commission is disinclined, based on this record, to
deviate from the UFOC Guidelines with respect to the scope of the
confidential settlements disclosure. This issue was debated when NASAA
revised the UFOC Guidelines in 1993, with input from many interested
parties. Moreover, franchisors using the UFOC Guidelines format have
been living under this policy on the state level for more than 10
years, apparently without much hardship.
Further, NASAA has recognized that the disclosure requirements
concerning confidential settlements might raise breach of contract
issues. Accordingly, the NASAA Commentary on the UFOC Guidelines
specifically limited the disclosure to those settlements that were
entered into after the adoption of the UFOC Guideline revisions on
April 25, 1993. Item 3 of the final amended Rule incorporates a similar
concept. The Commission recognizes that some small or regional
franchisors who use the Franchise Rule format exclusively have not had
the opportunity to phase-in confidential settlement disclosures. Based
on this consideration, the Commission has added a footnote 2 to section
436.5(c)(3)(ii) of the final amended rule that specifies that ``any
franchisor who has historically used only the Franchise Rule format, or
who is new to franchising, need not disclose confidential settlements
entered prior to the effective date of this Rule.'' Thus, franchisors
historically using only the Franchise Rule format need not disclose
confidential settlements entered into prior to the effective date of
the final amended Rule, and only franchisors who have used the UFOC
Guidelines format in the past must continue to disclose confidential
settlements, as is the current practice.
John Baer raised a related point that the Commission finds
persuasive. He asserted that it would be unfair to require the
disclosure of confidential settlement agreements ``if they were entered
into by a company at a time when it was not yet engaged in franchise
activities.''\362\ It would be unreasonable to expect a non-franchisor
to negotiate settlements with an eye toward the possibility that it may
engage in franchise sales in the future. Accordingly, footnote 2 to
section 436.5(c) of the final amended Rule provides that ``franchisors
need not disclose the terms of confidential settlements entered into
before commencing franchise sales.''
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\362\ Baer, NPR 11, at 11.
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d. Dismissed actions
As noted above, Item 3 requires a franchisor to disclose certain
prior actions in which it has been ``held liable.'' Under this
standard, a dismissal without any imposition or acceptance of liability
on the franchisor's part, would not have to be disclosed.\363\
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\363\ See Franchise NPR, 64 FR at 57334, note 2.
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In response to the Staff Report, two commenters observed that this
[[Page 15480]]
limitation on prior actions is undercut by the inclusion in the
proposed Franchise NPR version of Item 3 of a broad provision requiring
franchisors and others to disclose if they have ``been a defendant in a
material action.'' They observed that while dismissals without
liability need not be disclosed under the ``held liable'' requirement
of Item 3, they would have to be disclosed under the second more
general ``defendant in a material action'' requirement. They urged the
Commission to delete the ``defendant in a material action'' element of
Item 3, to limit prior litigation disclosures to only those actions in
which the defendant incurred liability.\364\ In response to these
comments, the Staff Report concluded that the drafting of the Franchise
NPR's version of Item 3 resulted in overbreadth, and therefore
recommended that Item 3 be narrowed accordingly.\365\
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\364\ Piper Rudnick, at 1; Duvall, at 1.
\365\ Additionally, H&H opined that Item 3 of the proposed Rule
published in the Franchise NPR seemed to suggest that a franchisor
must disclose all material civil litigation in which the defendant
was held liable in the 10-year time period, but only the enumerated
list of actions if named in civil litigation. H&H suggested that the
disclosure of civil litigation should be limited to the enumerated
list regardless of whether the franchisor was named or was held
liable in a prior suit. H&H, NPR 9, at 17-18. See also NFC, NPR 12,
at 28. H&H also suggested that the word ``material'' be substituted
for ``significant.'' H&H, NPR 9, at 18. The final amended Rule
incorporates these suggestions.
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The Commission has carefully considered this point. As noted above,
the UFOC Guidelines clearly permit franchisors to limit the disclosure
of prior actions to matters in which they were ``held liable.'' This
approach is also consistent with the original Rule, which limited prior
litigation to matters in which the franchisor ``has been held liable .
. . resulting in a final judgment or has settled out of court.''\366\
Moreover, the language ``been a defendant in a material action'' is
arguably redundant: if a defendant was not held liable in a prior
action, then the underlying suit was not material. For these reasons,
the phrase ``been a defendant in a material action'' included in the
proposed Rule published in the Franchise NPR has been deleted from the
final amended Rule.\367\
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\366\ 16 CFR 436.1(a)(4)(ii).
\367\ IL AG asserted that franchisors should be permitted to
disclose settled litigation in its favor or which is neutral. It
explains that a state franchise examiner would question why a case
previously listed as pending in one version of a disclosure document
would then disappear upon settlement or dismissal from later
versions without explanation. IL AG, at 5. We do not find this
rationale sufficient to justify retaining a redundancy in the final
amended Rule. As noted throughout this document, however, states
have the power to include additional disclosures, if they so choose,
provided it is possible simultaneously to comply with both the state
rule and a corresponding final amended Rule provision.
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e. Franchisor-initiated litigation
One of the most important ways part 436 of the final amended Rule
differs from both the original Rule and the UFOC Guidelines is that
part 436 includes a requirement that franchisors disclose franchisor-
initiated litigation.\368\ Specifically, section 436.5(c)(1)(ii)
requires a franchisor to disclose litigation in which it:
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\368\ Section 436.5(c)(1)(ii) requires disclosure of litigation
to which a covered person ``was a party,'' and therefore reaches
more than just actions where the franchisor or other covered person
was a plaintiff. As a practical matter, however, because other
elements of Item 3 cover various actions where the franchisor or
other covered person was or is the defendant, the significance of
this new part 436 section is that it reaches actions initiated by
the franchisor or other covered person.
was a party to any material civil action involving the franchise
relationship in the last fiscal year. For purposes of this section,
``franchise relationship''; means contractual obligations between the
franchisor and franchisee directly relating to the operation of the
franchised business (such as royalty payment and training obligations).
It does not include suits involving suppliers or other third parties,
or indemnification for tort liability.\369\
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\369\ See Cendant, ANPR 140, at 3 (noting that in vicarious
liability cases--where a customer sues the franchisor for alleged
wrongdoing by the individual franchisee--the franchisor often must
sue the franchisee to protect its interests and to obtain
indemnification. Such suits, therefore, are essentially between the
customer and the franchisee and are not indicative of franchise
system performance.).
This final amended Rule provision is substantially the same as its
counterpart proposed in the Franchise NPR.\370\ Throughout the Rule
amendment proceeding, franchisees and their representatives,\371\ as
well as the Small Business Administration,\372\ urged the Commission to
adopt such a requirement, asserting that franchisor-initiated
litigation is material because it is a clear indicator of: (1) the
quality of the franchisor-franchisee relationship; and (2) the extent
to which the franchisor may be litigious. Others added that the
original Rule and the UFOC Guidelines compelled franchisors to disclose
franchisor-initiated litigation only if a franchisee subsequently filed
a counterclaim. Yet, as these commenters noted, franchisees often do
not have the financial resources to initiate a suit or to pursue a
counterclaim.\373\ Therefore, according to their argument, disclosure
of franchise relationship litigation should not depend upon which party
happens to have the resources to file a suit. Typical of these comments
is the one submitted by NFA, an association of Burger King franchisees,
stating that the disclosure of such information:
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\370\ The only difference is that the time frame of the
requirement has been tightened, now covering only actions ``within
the past fiscal year,'' instead of ``pending actions.'' This topic
is addressed in greater detail near the end of the Item 3
discussion.
\371\See AFA, at 2; Gee, at 2; Bundy, at 5; Karp, at 2; AFA,
ANPR 62, at 2; Lagarias, ANPR 125, at 3; Selden, ANPR 133,
Attachment at 2; Karp, ANPR, 19 Sept. 97 Tr., at 98.
\372\ SBA, ANPR 36, at 5-6. See also IL AG, ANPR 77, at 2.
\373\ Peter Lagarias observed that ``[f]ranchisors are often
able to wield the threat of litigation, especially by threatening to
seek attorneys' fees, to deter franchisees from suing or maintaining
lawsuits against them. Thus while loss of a single lawsuit is seldom
significant to franchisors, loss of a lawsuit against their
franchisor is often fatal for franchisees.'' Lagarias, ANPR 125, at
3. See also Merret, ANPR 126; Brandt, ANPR 137; Doe, ANPR, 7 Nov. 97
Tr., at 267.
would be beneficial to potential franchisees, as it would allow
such franchisees to be aware of any difficulties current or prior
franchisees have encountered with the franchisor. In addition, the
required disclosure of franchisor-initiated litigation would further
aid potential franchisees by serving as an indicator of how franchisors
resolve their disputes, and whether or not such franchisors are quick
to resort to litigation in order to resolve disputes. The possibility
of extensive litigation is important to a potential franchisee, as it
may affect the calculation of costs involved in acquiring such a
franchise. In addition, the continued threat of litigation from the
franchisor may well affect later dealings between the parties, and as
such is critical information of which the franchisee should be
aware.\374\
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\374\ NFA, NPR 27, at 2. See also AFA, NPR 14, at 4; NASAA, NPR
17, at 4; Bundy, NPR 18, at 7; Stadfeld, NPR 23, at 11; Karp, NPR
24, at 19.
A few commenters also maintained that compliance costs arising from
such a disclosure are not great. For example, Seth Stadfeld observed
that ``once the initial changes are made [to the disclosure document],
all that must be done is to update the disclosed litigation annually or
sooner if material changes take place.''\375\ The AFA was more blunt in
its assessment:
---------------------------------------------------------------------------
\375\ Stadfeld, NPR 23, at 11. See also Karp, NPR 24, at 20
(disclosure costs pale in comparison with litigation costs).
The Commission has a choice. It can save franchisors a few pennies
on a slightly larger offering circular
[[Page 15481]]
or save a franchisee from investing hundreds of thousands of dollars in
a franchise that he/she might not have invested in if he/she would have
known all of the franchisor-initiated lawsuits against its own
franchisees.\376\
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\376\ AFA, NPR 14, at 4.
In contrast, franchisors generally opposed the disclosure of
franchisor-initiated litigation. Among other things, they asserted that
franchisor-initiated litigation is immaterial\377\ and would
unnecessarily ``bulk up'' disclosure documents, thereby increasing
compliance costs.\378\ Others opined that the disclosure was
unnecessary because, in their view, a franchisee aggrieved by a
franchisor-initiated suit will surely file a counterclaim, which
clearly must be disclosed under the original Rule.\379\ Other
franchisors asserted that the disclosure document already informs
prospective franchisees about the state of the relationship.\380\ Still
others asserted that Item 3 litigation should be limited to suits that
imply wrongdoing on the franchisor's part: franchisor-initiated suits
simply demonstrate that the franchisor is enforcing its rights under
the franchise agreement.\381\ Indeed, some franchisors argued that the
disclosure could be misleading, wrongly implying that the franchisor
has engaged in illegal or other misconduct.\382\ In the same vein, some
franchisors feared that a mandatory franchisor-initiated litigation
disclosure might actually discourage franchisors from bringing suits,
even meritorious suits, that are needed to maintain the integrity of
the franchise system.\383\
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\377\ H&H, NPR 9, at 17 (little value in requiring franchisors
to disclose garden variety litigation involving franchisees, such as
debt collection actions). See also Cendant, at 3; Quizno's, NPR 1,
at 1; Gurnick, NPR 21, at 5; Kaufmann, ANPR 33, at 4.
\378\ E.g., Baer, ANPR 25, at 3; Kaufmann, ANPR 33, at 4;
Jeffers, ANPR 116, at 1-2; Forseth, ANPR, 18 Sept. 97 Tr., at 20. In
addition, several franchisors voiced concern about the interplay
between the franchisor-initiated litigation disclosure and state
registration laws. Specifically, they opposed the disclosure because
it might trigger burdensome state updating requirements. For
example, Quizno's asserted that if the disclosure of franchisor-
initiated litigation is deemed material by the Commission, it also
would be deemed material by the states and, therefore, franchisors
would have to stop selling in a state every time they filed a suit
until they could amend their registrations. Quizno's, NPR 1, at 1.
See also Lewis, NPR 15, at 13 (franchisor would have to amend their
disclosure documents); J&G, NPR 32, at 10 (would prevent sales in
states that require sales to stop until amendments are filed and
approved).
\379\ E.g., Quizno's NPR 1, at 1; PMR&W, NPR 4, at 9; Holmes,
NPR 8, at 4; Quizno's, ANPR 16, at 1; Kaufmann, ANPR 33, at 4; IFA,
ANPR 82, at 1-2; Cendant, ANPR 140, at 3. But see Lagarias, ANPR
125, at 3.
\380\ J&G, for example, contended that any material information
about the franchise relationship can be determined from the Item 20
termination rates, as well as through the franchisor's financial
statements. J&G, NPR 32, at 10. See also GPM, NPR Rebuttal 40, at 4-
5.
\381\ E.g., Kestenbaum, ANPR 40, at 1; Tifford, ANPR 78, at 3.
PMR&W asserted that Item 3 has a limited intent, namely, to:
``inform the franchisee about proven or alleged franchisor
actions which may reflect poorly on the franchisor; disclosure also
is required for franchisor-initiated litigation where a defendant
files a counterclaim containing specified claims. A franchisor's
lawsuit against the franchisee, in the absence of a relevant
counterclaim, does not reflect any adverse conduct by the
franchisor.''
PMR&W, NPR 4, at 10. See also Winslow, at 77; H&H, NPR 9, at 17;
J&G, NPR 32, at 10; Marriott, NPR 35, at 14. But see Jeffers, ANPR
116, at 1-2 (franchisor-initiated suits could be viewed as a
``positive attribute,'' showing that the franchisor is willing to
enforce its standards and trademark, and is willing to aggressively
eliminate continuing violations of its franchise agreement).
\382\ Snap-On, NPR 16, at 2. See also, e.g., Gurnick, NPR 21, at
5; NaturaLawn, NPR 26, at 1; J&G, NPR 32, at 10; GPM, NPR Rebuttal
40, at 4-5; Kaufmann, ANPR 33, at 4; Tifford, ANPR 78, at 3;
Cendant, ANPR 140, at 3.
\383\ PMR&W, NPR 4, at 9. See also Snap-On, NPR 16, at 2; J&G,
NPR 32, at 10; Marriott, NPR 35, at 14.
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Based upon the record developed in this proceeding, the Commission
is convinced that franchisor-initiated litigation is material
information that prospective franchisees need in order to assess a
critical aspect of the franchise relationship--the nature of disputes
and the level of litigation within a franchise system.\384\ We
recognize that the UFOC Guidelines' Item 3, in limiting required
disclosures to instances where a franchisee has filed a counterclaim,
may have focused more narrowly on suits where arguably there was a
greater probability of wrongdoing on a franchisor's part. We now
believe that this should be broadened to include additional information
about the state of the franchise relationship. For example, we agree
with the commenters who made the point that franchisor suits to enforce
system standards could be viewed as a positive attribute, showing that
the franchisor is willing to maintain uniformity for the benefit of the
entire system. A franchisor's willingness to protect its system is a
material fact about the franchise relationship that should be disclosed
to prospective franchisees.
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\384\ For example, a pattern of franchisor-initiated lawsuits,
such as royalty collection suits, may indicate franchisees'
unwillingness or inability to pay. Such information would be
material to a prospective franchisee because it may be an indicator
of risk in purchasing a franchise and in the quality of the
relationship with the franchisor.
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Nevertheless, the Commission declines to broaden further the
franchisor-initiated litigation disclosure of part 436, as some have
suggested, to include litigation involving another franchise system
owned by the franchisor, as well as litigation involving affiliates and
third-party suppliers.\385\ The core concern underlying the franchisor-
initiated litigation requirement is the status of the relationship
between the franchisor and its franchisees in the offered system.\386\
Accordingly, the Commission has weighed the modest potential benefit of
a broader litigation disclosure against the compliance costs and
burdens, and decided not to require disclosures about litigation
initiated by the franchisor's affiliates, third-party suppliers, or
other systems.
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\385\ See Bundy, NPR 18, at 7; Stadfeld, NPR 23, at 13. Eric
Karp urged the Commission to broaden the disclosure further to
include franchisor-initiated litigation against third-party
suppliers: ``If a franchisor were to sue a supplier of goods or
services it sells to franchisees, over issues relating to quality or
efficiency of supply or to block sales not authorized by the
franchisor, the prospective franchisee would have good reason to
want to know about the claim.'' Karp, NPR 24, at 20. The Commission
has rejected this suggestion because it goes beyond the goal of
providing material information to prospective franchisees about the
quality of the franchisor-franchisee relationship.
\386\ Piper Rudnick also urged the Commission to clarify in the
Compliance Guides the definition of the term ``franchisor
relationship.'' In particular, the firm would limit ``franchise
relationship'' to a matter arising from the franchise contract.
Piper Rudnick, at 6. We believe a definition is unnecessary. Since
the promulgation of the original Rule, franchisors have had to
disclose franchisee-initiated litigation and counterclaims involving
the franchise relationship. Accordingly, such disclosures are not
new. Moreover, we disagree that the franchise relationship is as
narrow as Piper Rudnick suggests. Surely, a dispute that arises from
a lease agreement or promissory note, for example, falls within the
purview of a relationship issue that should be disclosed.
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At the same time, the Commission also has considered various
alternatives that franchisors assert would reduce franchisors'
compliance burdens. The alternative that garnered the most support was
to tie the disclosure to a threshold level of suits.\387\ For example,
John Baer suggested a 5% threshold, under which a franchisor would not
[[Page 15482]]
have to disclose litigation it initiated unless it has filed suit
against at least 5% of the franchisees in its system.\388\ Others
suggested a higher percentage, such as 10%,\389\ 15%,\390\ or 20%,\391\
while the IL AG suggested a lower percentage, such as 2%.\392\
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\387\ Other suggested alternatives failed to garner significant
support, including the following. PMR&W suggested requiring a
franchisor to disclose, on an annual basis, the number of litigation
and arbitration proceedings it has pending against franchisees,
along with a general summary of the types of claims involved. PMR&W,
NPR 4, at 10. Wendy's suggested that the disclosure should be
limited to ``specifically enumerated types of claims which are
significant to the entire franchised system,'' as well as a
significant dollar amount. Wendy's, NPR 5, at 2. Wendy's, however,
failed to identify a list of appropriate types of suits or an
appropriate dollar figure. David Holmes would limit the disclosure
by eliminating counterclaims filed by a franchisor merely in
response to a franchisee-initiated suit. In his view, this is
appropriate if the Commission's concern is ``with franchisors having
a practice of suing their franchisees, not merely defending
themselves.'' Holmes, NPR 8, at 4-5. We disagree because a
counterclaim may shed light on issues in the franchise relationship
to the same extent as the franchisee's complaint.
\388\ Baer, NPR 11, at 11. See also Lewis, NPR 15, at 12; BI,
NPR 28, at 11; Tricon, NPR 34, at 6. NASAA stated that if the
Commission were to limit the disclosure by imposing a threshold, it
would support a 5% threshold. NASAA, NPR 17, at 4. Not everyone
agreed, however, on the proposal to establish a threshold. Eric
Karp, for example, stated: ``the prospective franchisee should make
his or her own determination as to whether the number of lawsuits is
at a level that indicates a problematic franchise system.'' Karp,
NPR 24, at 19-20. According to Howard Bundy, the imposition of a
threshold number of cases before an obligation to disclose arises
``invites abuse.'' Bundy, NPR 18, at 7. Seth Stadfeld also argued
that a threshold prerequisite would ``discriminate[] arbitrarily in
favor of large mature franchise systems to the detriment of small
franchise systems.'' Stadfeld, NPR 23, at 13.
\389\ NFC, NPR 12, at 28.
\390\ Holmes, NPR 8, at 4.
\391\ AFC, NPR 30, at 3.
\392\ IL AG, NPR 3, at 6 (also recommending no threshold for
smaller systems, such as those with fewer than 25 franchisees).
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The Commission is reluctant to tie the franchisor-initiated
litigation disclosure of part 436 to a threshold. We believe it is
impossible, given the limited record on this issue, to fashion a ``one
size fits all'' approach for every franchise system in all industries.
Moreover, any threshold would focus on the quantity of suits,
suggesting that the sole purpose of the provision is to reveal
litigiousness. When it comes to the state of the relationship, however,
even a small number of suits initiated by a franchisor could be
material to a prospective franchisee because they may reveal the nature
of problems in the franchise system or show the franchisor's
willingness to enforce system standards.\393\ With full disclosure,
prospects can review the number and types of franchisors' suits for
themselves and draw their own conclusions about whether those suits are
significant.
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\393\ One commenter asserted that the Commission should require
litigation disclosures only when there have been three consecutive
fiscal years of lawsuits, regardless of the number of such suits.
NaturaLawn, NPR 26, at 1. The purpose of the disclosure, however, is
not limited to litigiousness. As discussed above, any number of
suits initiated by the franchisor against its franchisees is
material because it sheds light on the quality of the franchise
relationship.
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Turning more generally to Item 3 of the final amended Rule, it
includes several refinements to the proposed rule that were offered
during the proceeding, and that were recommended in the Staff Report.
These refinements preserve the utility of the disclosure, while
reducing compliance costs.\394\ First, in order to minimize compliance
burdens, the franchisor-initiated litigation disclosure requirement is
limited to suits filed in the previous one-year period.\395\ We believe
this ``snap-shot'' in time is sufficient to reveal the franchisor's
practice of initiating litigation, as well as to reveal the types of
franchise relationship problems that typically arise in the franchise
system.\396\
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\394\ In addition to the refinements noted below, the Commission
considered, but rejected, several others that find no additional
support in the rulemaking record and which would be unnecessarily
inconsistent with the UFOC Guidelines. For example, Duvall urged
limiting the disclosure of pending actions to franchise disputes
only, eliminating the reference to actions for fraud, unfair and
deceptive trade practices, and the like. Duvall, at 1. IL AG urged
expansion of the scope of the affiliate disclosure to cover all
affiliates in any line of business. IL AG, at 5. Pu advocated a
requirement to disclose the name, address, and telephone number of
the lawyer for the franchisee in any litigation. Pu, at 1.
\395\ Initially, the Commission proposed that the disclosure of
franchisor-initiated litigation be limited to pending litigation.
Franchise NPR, 64 FR at 57303-04. Several commenters opposed that
approach. For example, Howard Bundy would require the disclosure of
all franchise relationship suits by the franchisor or an affiliate
commenced during at least the last three years. ``Just giving the
`pending' cases is like giving only one month of financial
statements. It does not permit the prospect to see and evaluate
trends and developments.'' Bundy, NPR 18, at 7. See also Stadfeld,
NPR 23, at 13. We agree that focusing on pending litigation is
insufficient to achieve the goal of shedding light on the quality of
the franchise relationship. However, we believe that a one-year time
period is sufficient for that purpose, giving a prospective
franchisee a snap-shot in time of the franchise system. But see
Karp, at 2 (contending that suits filed in one year are not
necessarily representative of the problems that arise in the system
or the propensity of the franchisor to sue its franchisees).
\396\ One commenter suggested that the Commission permit a
franchisor to explain in Item 3 that this disclosure is limited to
only certain types of actions and only updated annually. Gust
Rosenfeld, at 4. To the extent that a franchisor finds that its
compliance with any particular disclosure item may result in
inaccurate or misleading information being furnished to a
prospective franchisee, the franchisor may add footnotes to ensure
accuracy or to avoid misleading statements. This applies to any
misleading Item 3 litigation disclosure as well.
---------------------------------------------------------------------------
Second, Item 3 permits franchisors to report franchisor-initiated
litigation annually, not quarterly. That is, a franchisor would
disclose all material litigation to which it was a party in the last
fiscal year. This is intended to make it clear that quarterly updating
requirements do not demand disclosure of franchisor-initiated actions
filed in the 12 months prior to the date of the updated document. This
approach improves on the proposed Rule's ``pending litigation''
approach.\397\ It also would have the additional benefit of reducing
more frequent quarterly updating, which may be burdensome and perhaps
impracticable in franchise registration states with more frequent
updating requirements.\398\
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\397\ This disclosure approach also would be more representative
of franchisor-initiated litigation than ``pending litigation,''
which would omit suits that may have been settled during the year,
or which took less than a year to resolve.
\398\ States typically require immediate updating upon a
material change.
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Third, Item 3 incorporates a ``materiality'' standard.\399\ This is
consistent with both the original Rule and UFOC Guidelines.\400\
Indeed, immaterial information, by definition, is unlikely to influence
a prospective franchisee's investment decision, while imposing
unwarranted costs and unnecessarily lengthening disclosure documents.
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\399\ The Commission declines to adopt suggested expansion of
section 436.5(c)(1)(ii) to encompass all suits, regardless of their
materiality. Stadfeld, NPR 23, at 13.
\400\ See 16 CFR 436.1(a)(4) (only material actions need be
disclosed); UFOC Guidelines, Item 3 Definitions at iii (``Included
in the definition of material is an action or an aggregate of
actions if a reasonable prospective franchisee would consider it
important in making a decision about the franchised business.'').
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As noted above in the discussion of section 436.1(d), materiality
is determined from the viewpoint of the reasonable prospective
franchisee. Accordingly, any franchisor-initiated litigation that goes
to the quality of the franchise relationship being offered for sale is
likely to be material. Indeed, the Commission intends the disclosure of
franchisor-initiated litigation to be interpreted broadly to cover most
suits. Nonetheless, we believe a requirement that franchisors disclose
literally all franchisor-initiated suits goes too far. There may be
instances where a franchisor-initiated suit might have no bearing on
the specific franchise relationship being offered for sale. For
example, franchisors may offer for sale ``non-traditional'' outlets
operating a unique franchise agreement--such as the operation of an
outlet on a military base. Franchisor-initiated litigation involving
unique franchise agreements may be immaterial to the sale of
``traditional'' outlets operating under the franchisor's standard
franchise agreement. A blanket provision requiring disclosure of suits
involving unique agreements might be overbroad and might unnecessarily
increase the size of the Item 3 disclosure to the disadvantage of both
prospective franchisees who must read it, as well as the franchisors
who must prepare the disclosure. A ``materiality'' standard, therefore,
will ensure that only suits shedding light on the type of relationship
being offered for sale must be disclosed.
[[Page 15483]]
Fourth, as recommended in the Staff Report, Item 3 permits a
franchisor to provide basic, summary information on its initiated
litigation, without the need for long discussions on each and every
case.\401\ In addition, franchisors may list individual suits under one
common heading, which will serve as the summary (for example, royalty
collection suits). The franchisor would then merely list each
applicable suit (case name, court, file number), without the need to
provide any additional explanation.
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\401\ See Staff Report, at 117-18. The Staff Report proposal
permitting franchisors to limit the description of each disclosed
suit generated no comment.
---------------------------------------------------------------------------
Fifth, and finally, the final amended Rule clarifies the
relationship between the disclosure of franchisor-initiated litigation
and the disclosure of counterclaims. Staff Report comments by Wiggin &
Dana noted that the rule proposed in the Franchise NPR did not
explicitly address the filing of a franchisee counterclaim after a
franchisor initiates a suit.\402\ The firm questioned whether a
franchisor-initiated case followed by a counterclaim would be treated
as a franchisor-initiated case only--receiving the more narrow
disclosure treatment--or whether the counterclaim would be considered
like all other counterclaims--receiving the more extensive disclosure
treatment.\403\
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\402\ Under the original Rule, a counterclaim must be disclosed
for 10 years and the franchisor must provide more detailed
information about the nature and status of the action. 16 CFR
436.1(a)(4)(ii) (actions ``brought by a present or former franchisee
or franchisees and which involves or involved the franchise
relationship'').
\403\ Wiggin & Dana, at 1-2.
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The Commission intends the franchisor-initiated litigation
provision of the final amended Rule to expand upon the approach taken
by the original Rule, not constrict it. Accordingly, franchisors must
disclose any counterclaims in the same manner as they would have done
under the original Rule, providing complete case summaries. Only in
those instances where a franchisor initiates a suit--absent the filing
of any subsequent counterclaim filed by the franchisee--does the
franchisor-initiated litigation disclosure requirement apply.
The final amended Rule makes this point clear as follows. First,
section 436.5(c)(3) provides instructions for all litigation that must
be disclosed in Item 3. It requires, for each suit, the disclosure of
the case title, number or citation, initial filing date, names of the
parties, the forum, and the relationship of the opposing party to the
franchisor. Following these basic disclosures are more specific
disclosures (e.g., summaries of legal and factual claims, relief
sought, conclusions of law) that pertain to all suits, except for
franchisor-initiated litigation, which is covered in a separate section
(section 436.5(c)(4)). Any counterclaim filed by a franchisee in a suit
would be covered by the section 436.5(c)(3) disclosure requirements.
The next section--section 436.5(c)(4)--sets forth the instructions
for ``any other franchisor-initiated suit identified'' in Item 3.\404\
The use of the phrase ``any other franchisor-initiated suit'' is
intended to limit the provision to suits in which no franchisee
counterclaim has been filed. This section makes clear that, in lieu of
the more comprehensive disclosure instructions of section 436.5(c)(3),
a franchisor may disclose franchisor-initiated litigation ``by listing
individual suits under one common heading.'' Accordingly, Item 3
affords the franchisor flexibility, permitting the disclosure of
franchisor-initiated litigation either through the comprehensive
disclosures of section 436.5(c)(3) or the more abbreviated disclosures
of section 436.5(c)(4).
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\404\ See Wiggin & Dana, at 2.
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6. Section 436.5(d) (Item 4): Bankruptcy
Section 436.5(d) of the final amended Rule retains the original
Rule's disclosure of prior bankruptcies, including any parent's
bankruptcy.\405\ Consistent with the UFOC Guidelines, it extends the
original Rule by requiring franchisors to disclose bankruptcy
information about predecessors and affiliates, to disclose foreign
proceedings comparable to bankruptcy, and to make bankruptcy
disclosures for 10 years, instead of the original Rule's seven years
limitation.\406\
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\405\ See 16 CFR 436.1(a)(5). In the original SBP, the
Commission found that bankruptcy information is material because it
bears directly on the ``integrity and managerial ability of the
parties with whom [the franchisee] is dealing and . . . could
readily result in drastic economic injury to the franchisee because
it could lead him or her to invest substantial amounts of money in a
bankrupt business.'' Original SBP, 43 FR at 59650-51.
\406\ See UFOC Guidelines, Item 4.
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Item 4 of the final amended Rule also incorporates several
refinements based upon the record developed in this proceeding. The
Rule as proposed in the Franchise NPR, at Item 4, would have required
the disclosure of an affiliate's prior bankruptcy only if the affiliate
currently offers franchises under the franchisor's trademark.\407\ One
commenter suggested that the bankruptcy disclosure should apply to all
affiliates, consistent with the UFOC Guidelines.\408\ We agree. It is
clear that the UFOC Guidelines require franchisors to disclose the
bankruptcy of any affiliate of the franchisor, not just those
affiliates who offer franchises under the franchisor's principal
mark.\409\ In order to reduce inconsistencies between part 436 and the
UFOC Guidelines, we have revised the disclosure of an affiliate's
bankruptcy accordingly.\410\
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\407\ Franchise NPR, 64 FR at 57304.
\408\ Bundy, NPR 18, at 7. See NASAA Comparison, at 6.
\409\ As previously noted, the definition of ``affiliate'' in
the UFOC Guidelines varies for purposes of specific disclosure
items. For example, ``affiliate'' for Item 3 (litigation) purposes
is limited to ``an affiliate offering franchises under the
franchisor's principal trademark.'' UFOC Guidelines, Item 3. The
more limited Item 3 definition of affiliate reduces franchisors'
compliance burdens significantly. A franchisor may have numerous
affiliates, any of which may have been involved in, or is currently
involved in, litigation. The disclosure of such affiliate
information arguably might impose significant compliance costs that
may not outweigh any benefits to prospective franchisees. Therefore,
the Item 3 litigation disclosure--limited to affiliates offering
franchises under the franchisor's principal trademark--strikes the
right balance between pre-sale disclosure and costs. On the other
hand, where any affiliate has a current or prior bankruptcy, that
fact is highly material because the affiliate's parent may wish to
divert funds away from the franchisor to the affiliate, thereby
depriving the franchisor of advertisements, training, or other
services. Under the circumstances, a broader definition of affiliate
in the Item 4 bankruptcy disclosure is warranted.
\410\ Consistent with Item 2, the final amended Rule at Item 4
also extends the UFOC Guidelines by requiring the bankruptcy
disclosures not only for officers or general partners, but for any
``other individual who will have management responsibility relating
to the sale or operation of franchises offered by this document.''
This is necessary to prevent franchisors from hiding prior
bankruptcies of individuals who in fact will manage the franchises,
but who do not have a formal title.
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In its response to the Staff Report, J&G also contended that the
introductory paragraph of both the proposed Rule in the Franchise NPR
and the Staff Report are unclear.\411\ As recommended in the Staff
Report, for example, this paragraph would require a franchisor to
disclose ``whether the franchisor, any parent, predecessor, affiliate,
officer, general partner . . . filed for bankruptcy.''\412\ J&G
contended that it is unclear whether this language requires a
franchisor to disclose the bankruptcy history of officers or affiliates
of a predecessor, as well as officers of a parent or affiliate. To
eliminate confusion on this point, the final amended Rule reads as
follows:
[[Page 15484]]
``Disclose whether the franchisor; any parent; predecessor; affiliate;
officer, or general partner of the franchisor, or any other individual
who will have management responsibility relating to the sale or
operation of franchises offered by this document . . .''
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\411\ J&G, at 4. IL AG advocated that the Commission deviate
from the UFOC Guidelines by including in the list of persons needing
to disclose bankruptcy information ``members,'' to make it clear
that limited liability companies are included. IL AG, at 5. This is
also unnecessary because nothing in part 436 would prevent a limited
liability company from qualifying as a parent, predecessor, or
affiliate, as those terms are used in part 436.
\412\See Staff Report, proposed section 436.5(d)(1).
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The Commission has rejected, however, other suggestions to modify
Item 4. Several commenters questioned the need to require predecessor
and parent bankruptcy disclosures. They asserted that the additional
disclosure burden is not outweighed by any benefit to prospective
franchisees.\413\ Consistent with our discussions in connection with
Items 1-3, we believe that information about predecessors and parents
is material and should be disclosed. Where a parent is in bankruptcy,
for example, its assets include any franchisor-subsidiary. Under such
circumstances, a prospective franchisee should be made aware that the
franchisor in which it is considering investing might be sold, possibly
to a competitor or to a company lacking prior franchise experience.
---------------------------------------------------------------------------
\413\ J&G, NPR 32, at 11; Marriott, NPR 35, at 15; GPM, NPR
Rebuttal 40, at 5.
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Further, David Gurnick suggested that the time period for reporting
a bankruptcy should be reduced from 10 to five years.\414\ J&G also
observed that a 10-year obligation would compel the disclosure of a
bankruptcy that was actually filed significantly earlier:
---------------------------------------------------------------------------
\414\ Gurnick, NPR 21, at 6.
[I]t would seem that ten years from the date of the filing of a
petition would be the appropriate beginning date. We are aware of one
case in which an officer was involved with a company when a petition
was filed in 1986, and the bankruptcy proceeding is still pending. Were
it settled this month (December 1999), disclosure of that event would
be required for a total of 23 years!\415\
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\415\ J&G, NPR 32, at 11.
Although the 10-year reporting period may, in rare instances,
result in the disclosure of a bankruptcy filed more than 10 years
earlier, the Commission has determined that the 10-year reporting
period is reasonable in order to give prospective franchisees a
complete picture of the franchisor's bankruptcy history. We are not
inclined to deviate from the UFOC Guidelines on this point.
Finally, NaturaLawn urged the Commission to exclude from Item 4 the
disclosure of personal bankruptcies. The company noted that personal
bankruptcies can be filed for a variety of reasons, such as divorces,
medical issues, or insurance claims.\416\ The Commission believes that
the disclosure of personal bankruptcy information is necessary to
prevent deception or fraud. In many instances, prospective franchisees
entrust considerable initial fees and ongoing funds to franchise
managers for training and advertising, among other forms of post-sales
assistance. Accordingly, prospective franchisees may rely to their
detriment on claims made by such managers. The disclosure of a
franchisor manager's bankruptcy, therefore, would shed light on that
manager's ability to safeguard and use those funds properly. Under the
circumstances, we see no compelling reason to omit a personal
bankruptcy, especially since such an approach would also deviate from
the UFOC Guidelines.
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\416\ NaturaLawn, NPR 26, at 1.
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7. Section 436.5(e) (Item 5): Initial fees
Section 436.5(e) of the final amended Rule requires the disclosure
of initial fees.\417\ This disclosure is substantively similar to the
comparable disclosure provision found in the original Rule at 16 CFR
436.1(a)(7). The final amended Rule, like the proposed Rule published
in the Franchise NPR, follows the UFOC Guidelines in explicitly
permitting franchisors to provide a range of fees, whereas the original
Rule implicitly contemplated a fixed fee.
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\417\ In the original SBP, the Commission recognized that the
disclosure of complete and accurate information about initial
franchise fees is material. The failure to disclose such information
pre-sale is deceptive because ``it (1) misleads, or at least
confuses prospective franchisees as to the amount of the required
initial franchise investment and (2) could readily result in
economic injury to a franchisee unable to fully obtain all such
funds or unable to recoup the full amount of such funds in the
course of the franchise business.'' Original SBP, 43 FR at 59653.
---------------------------------------------------------------------------
Item 5 of the final amended Rule is substantially similar to Item 5
in the proposed Rule published in the Franchise NPR, but it
incorporates several technical revisions that the commenters suggested.
One commenter recommended that the title of Item 5 should refer to
``Initial Fees'' instead of the proposed title, ``Initial Franchise
Fee,'' recognizing that a prospective franchise may pay more than just
one fee in order to acquire a franchise.\418\ Consistent with that
revision, references to ``fee'' in Item 5 have been revised as follows:
(1) ``these fees are refundable,'' in place of ``this fee is
refundable;'' and (2) ``Initial fees mean,'' in place of ``initial fee
means.''\419\
---------------------------------------------------------------------------
\418\ Lewis, NPR 15, at 14. CA Bar, however, asserted that the
term ``initial fee,'' as opposed to ``initial franchise fee'' may
have negative consequences for franchisors selling company-owned
stores. CA Bar explained that ``initial fees'' or ranges of
``initial fees'' paid to a franchisor for a company-owned store may
be proprietary information, especially if fees charged are not
uniform. CA Bar, at 9. We disagree. Under the current UFOC Item 5,
all franchisors must disclose the ``initial franchise fee,'' which
is defined to include ``all fees and payments for services or goods
received from the franchisor before the franchisee's business
opens.'' UFOC, Item 5. Accordingly, the Item 5 disclosure is not
limited to payments marked ``franchise fee.'' We decline to
introduce a distinction between ``initial fees'' and ``initial
franchise fees,'' as CA Bar suggested, which would be inconsistent
with the UFOC Guidelines.
\419\ Lewis, NPR 15, at 14. But see Gust Rosenfeld, at 8
(suggesting the broader ``initial payments'' than ``fees,'' which
may be misconstrued narrowly to refer only to any upfront franchise
fee).
---------------------------------------------------------------------------
Second, another commenter correctly noted that the Franchise NPR
version of Item 5 did not expressly define ``initial fees'' to include
commitments to make payments to the franchisor. Rather, Item 5 as
proposed in the Franchise NPR would have defined an initial fee only in
terms of cash actually paid at the time of the sale.\420\ The
commenter's point is well-taken. The ``initial fees'' disclosure
requirements of Item 5 relate to the required payment element in the
definition of the term ``franchise.''\421\ Under that definition, a
``required payment'' is not limited to cash, but expressly includes
commitments to make payments to the franchisor at a later date.
Otherwise, a franchisor could seriously undercut the Item 5 cost
disclosure by requiring prospects to sign notes or other obligations in
lieu of immediate payment. Accordingly, Item 5 of the final amended
Rule expressly includes not just fees that are actually paid, but
commitments to pay as well.\422\
---------------------------------------------------------------------------
\420\ Bundy, NPR 18, at 7. (``It should include any amounts that
the franchisee becomes obligated to pay before entering into the
franchise. For example, if the entire initial franchise fee is
deferred into a promissory note, that does not change the fact that
it is an `initial fee.''').
\421\ Section 436.1(h).
\422\ The Commission has also clarified the language of Item 5
in two respects. First, the final amended Rule makes clear that the
term ``initial fees'' includes payments or commitments to pay an
affiliate of the franchisor. See NASAA, at 3. This is consistent
with the NASAA Commentary on the UFOC Guidelines. See also NASAA
Comparison, at 7. Second, the final amended Rule adds, at the end of
Item 5, the following sentence: ``Disclose installment payment terms
in this subsection or in paragraph 436.5(j) of this section.''
---------------------------------------------------------------------------
Commenters also offered various proposals for modifying Item 5 that
we believe are unwarranted. While Item 5 requires disclosure of ``the
range or formula used to calculate the initial fees paid in the fiscal
year before the issuance date,'' Howard Bundy urged that it require the
disclosure of any contractual formulas for determining the current
initial fee. Mr. Bundy opined that it is ``important to have disclosure
of any contractual formulas that will
[[Page 15485]]
result in this prospect paying a different initial fee than the
historic information would suggest.''\423\
---------------------------------------------------------------------------
\423\ Bundy, NPR 18, at 7.
---------------------------------------------------------------------------
The Commission's view, however, is that as long as the prospect is
aware of the amount to be paid before the sale, the method the
franchisor used to derive that amount is not necessarily material. The
Commission notes that Item 5 ensures that a prospective franchisee
knows whether fees are uniform and, where they are not, enables the
prospect to bargain for a lower rate. Item 5 supplies the prospect with
some historical information that can aid in gauging the parameters of
the franchisor's willingness to negotiate fees. We believe that this is
more useful by far than including in the disclosure document current
contractual formulas. Thus, there is no reason to diverge from the UFOC
Guidelines on this issue.
Three other commenters voiced concern about Item 5 as it relates to
the negotiation of fees. The NFC asserted that Item 5 implies that a
franchisee can seek to negotiate initial fees only if the franchisor
already disclosed in its Item 5 a range of previously accepted fees.
Such a result, in its view, restricts prospective franchisees' ability
to initiate fee negotiations.\424\ The Commission's intention is to
promote the parties' ability to negotiate terms and conditions,
including fees and other costs. Full and accurate prior disclosure
furthers that goal. Accordingly, nothing in Item 5 or any other
provision of part 436 of the final amended Rule prevents the parties
from negotiating fees.
---------------------------------------------------------------------------
\424\ NFC, NPR 12, at 10-11.
---------------------------------------------------------------------------
David Gurnick suggested that the Rule permit a franchisor to
disclose whether or not it will negotiate fees, and if it does so,
permit disclosure of the conditions that may affect the
negotiation.\425\ Similarly, BI urged that franchisors be permitted to
disclose that they may lower the initial fees.\426\
---------------------------------------------------------------------------
\425\ Gurnick, NPR 21, at 6.
\426\ BI, NPR 28, at 6.
---------------------------------------------------------------------------
As noted above, however, Item 5 ensures that prospects know when
fees may vary. This is sufficient to prompt them, if they wish, to
negotiate for a fee level that suits them. A more extensive or detailed
disclosure on this issue would only introduce needless nonconformity
with the UFOC Guidelines without producing any appreciably increased
benefit to prospective franchisees.
BI also urged that when the initial fee is negotiated rather than
established by applying a formula or fixed calculation, the range of
such negotiated initial fees in the prior fiscal year need not be
disclosed.\427\ The Commission's view, however, is that providing a
range of fees, regardless of how or why these ranges came about, is
useful to prospective franchisees in the negotiation process. Such
disclosure compels neither party to reach agreement on unacceptable
terms: franchisors and prospective franchisees remain free to negotiate
in and outside of any disclosed range. Accordingly, we see no reason to
deviate from the UFOC Item 5 approach in this regard.\428\
---------------------------------------------------------------------------
\427\Id.
\428\ The Commission has decided not to adopt various suggested
revisions to Item 5 offered by the IL AG. For example, IL AG
suggested that the Rule require franchisors to disclose specific
information about the amount of fees that are refundable. IL AG, at
5. The Commission believes that Item 5 adequately covers this by
requiring a franchisor to state ``any conditions under which these
fees are refundable.'' Clearly, this language is flexible enough to
permit a franchisor to state in its Item 5 disclosure whether it
offers a full or partial refund.
---------------------------------------------------------------------------
8. Section 436.5(f) (Item 6): Other fees
Section 436.5(f) of the final amended Rule requires franchisors to
disclose recurring or occasional fees associated with operating a
franchise (e.g., royalties, advertising fees, and transfer fees). This
requirement recognizes that a prospective franchisee's investment is
not limited to the initial franchise fee alone. Rather, a franchisee
may incur considerable costs in the operation of the business, which
will significantly impact upon his or her ability to continue in
business and ultimately be successful. This provision covers payments
made directly to the franchisor or an affiliate, or collected by the
franchisor or affiliate for the benefit of a third party. This
disclosure is substantially similar to the comparable original Rule
disclosure found at 16 CFR 436.1(a)(8).\429\ Following the UFOC
Guidelines, the Rule, as proposed in the Franchise NPR, expanded the
scope of this original Rule provision by requiring a disclosure about
the existence of advertising and purchasing cooperatives from which
franchisees may be required to purchase goods or services. The proposed
Rule also required disclosure about the voting power of any franchisor-
owned outlets in the cooperative and, if company store voting power is
controlling, the range of required fees charged by the cooperative.
This is material information about restrictions on prospective
franchisees' independence in operating the offered franchise, as well
as the total costs of doing so.
---------------------------------------------------------------------------
\429\ In the original SBP, the Commission noted that the failure
to disclose continuing costs violates Section 5 because it ``(1)
misleads or at least confuses the franchisee as to the required
amount of his or her total investment; and (2) could readily result
in economic injury to the franchisee unable to meet such continuing
obligations.'' Original SBP, 43 FR at 59654-55.
---------------------------------------------------------------------------
The Commission has determined to adopt proposed Item 6 from the
Franchise NPR, with some fine tuning. Accordingly, Item 6 of the final
amended Rule incorporates a suggestion from both Warren Lewis and NASAA
that the proposed title of Item 6 taken from the UFOC Guidelines
(``Recurring or Occasional Fees'') be replaced with ``Other Fees,'' the
term actually used throughout the disclosure.\430\ The Commission
believes this change improves the clarity of the Rule's text and Item
6.
---------------------------------------------------------------------------
\430\ Lewis, NPR 15, at 14; NASAA, NPR 17, at 4.
---------------------------------------------------------------------------
In addition, to conform more closely to the UFOC Guidelines, Item 6
of the final amended Rule requires that franchisors state explicitly
what fees are non-refundable (rather than just stating the conditions
when a fee is refundable).\431\ Again, to conform more closely with the
UFOC Guidelines, Item 6 requires franchisors to disclose whether
continuing fees currently being charged are uniformly imposed on all
franchisees.\432\
---------------------------------------------------------------------------
\431\ As previously noted, NASAA has urged the Commission
throughout the Rule amendment proceeding to reduce inconsistencies
with the UFOC Guidelines to the fullest extent possible. To that
end, it has submitted into the record a comparison between the
original Rule and UFOC Guidelines. See NASAA Comparison, at 8; UFOC
Guidelines, Item 6, Instructions vi. As noted throughout this
Statement, a primary objective in revising this Rule is to align it
more closely with the UFOC Guidelines.
\432\ See NASAA Comparison, at 8.
---------------------------------------------------------------------------
The Staff Report recommended expansion of Item 6 to require
franchisors to disclose required payments made to third parties.\433\
The Commission has decided not to adopt that recommendation. Early in
the Rule amendment proceeding, NASAA urged this expansion of Item
6.\434\ Another commenter supported this suggestion, noting that in the
``vast majority of the franchise cases we see, the franchisee's ongoing
legal obligations to third parties far exceed the franchisee's ongoing
legal obligations to the franchisor. However, the franchisee cannot
obtain the franchise without incurring the third-party
obligations.''\435\
---------------------------------------------------------------------------
\433\ Staff Report, at 126.
\434\ NASAA, NPR 17, at 4.
\435\ Bundy, NPR 8, at 8. Mr. Bundy also suggested that
franchisees need to understand that third-party obligations continue
even if the franchise is terminated. Id. We agree, but believe that
this raises a consumer education issue, not a pre-sale disclosure
one, that is best handled by Commission and industry educational
efforts.
---------------------------------------------------------------------------
Eight Staff Report comments, however, opposed the proposed
expansion of Item 6 to require the
[[Page 15486]]
disclosure of payments made to third parties. Gust Rosenfeld's comment
is typical, noting that a franchisor may require franchisees to lease
premises, obtain necessary licenses, and operate in compliance with
applicable laws. ``All of the payments to do these things are
technically `required,' but they are generally applicable to all
businesses, and the franchisor does not control when they are made, to
whom they are made, or what the amount is.''\436\ Similarly, Piper
Rudnick and IFA asserted that a required listing of all possible third-
party suppliers of goods or services would expose a franchisor to
liability if it forgot to include one or more.\437\
---------------------------------------------------------------------------
\436\ Gust Rosenfeld, at 4-5. See also Wiggin & Dana, at 2
(questioning whether the proposed disclosure of payments to third
parties in Item 6 would cover employee wages, uniform dry cleaning,
or accountant fees to prepare taxes). Several commenters recommended
that Item 6 be limited to ongoing payment made to the franchisor or
its affiliates. Piper Rudnick, at 2; Spandorf, at 7.
\437\ Piper Rudnick, at 2; IFA, at 3. See also J&G, at 5
(asserting that the provision would cover not only garden variety
fees, but an ``infinite plethora of potential and unpredictable (or
unknowable as a practical matter) payments and fees that may vary by
locality, such as license and permit fees, or may arise due to
unpredictable events.''); Duvall, at 1-2 (a franchisor cannot know
all the required payments made to hundreds of vendors and accounts).
---------------------------------------------------------------------------
The Commission agrees that the disclosure of third-party fees in
Item 6 would be overbroad, resulting in the mandatory disclosure of
information that might not be readily obtainable by the franchisor and
unnecessarily increasing franchisor's compliance burden without any
commensurate benefit to prospective franchisees. Moreover, estimates of
initial payments to third parties are already covered by Items 7 and 8,
as discussed below. Specifically, Item 7 requires franchisors to
disclose estimates of pre-sale expenses paid during the initial
period--typically the first three months--and also requires franchisors
to ``[l]ist separately and by name any other specific required payments
(for example, additional training, travel, or advertising expenses)
that the franchisee must make to begin operations.\438\ Franchisors
must also include an ``additional funds'' category to capture ``any
other required expenses the franchisee will incur before operations
begin and during the initial phase of operations.''\439\ Item 8 already
requires franchisors to disclose franchisee obligations to make
purchases from required or approved suppliers. These include
obligations to purchase items such as supplies, equipment, inventory,
computer hardware and software, and real estate. The Commission is
persuaded that the Item 7 and Item 8 part 436 disclosures are more than
sufficient to advise prospective franchisees of the likely purchase
obligations incurred in operating a franchise.
---------------------------------------------------------------------------
\438\ Section 436.5(g)(1)(ii).
\439\ Section 436.5(g)(1)(iii).
---------------------------------------------------------------------------
9. Section 436.5(g) (Item 7): Estimated initial investment
Section 436.5(g) of the final amended Rule requires franchisors to
set out in an easy-to-read table all the expenses necessary to commence
business (e.g., rent, equipment, and inventory)--not just the initial
fees covered by Item 5 and other fees covered by Item 6. It also
requires franchisors to disclose any refund conditions. Comparable cost
disclosures are found in the original Rule at 16 CFR 436.1(a)(7).\440\
Consistent with the UFOC Guidelines,\441\ Item 7 also extends the
original Rule by requiring a franchisor to disclose not only payments
that the franchisee must make to the franchisor or its affiliates, but
also estimated payments the franchisee must make to third parties in
some instances. For example, franchisors must estimate payments for
utility deposits and business licenses. It also requires franchisors to
include an ``additional funds'' category\442\ that captures other
expenses franchisees will incur during the ``initial period'' of
operations.\443\
---------------------------------------------------------------------------
\440\ ``Since . . . fees frequently involve substantial sums of
money, it must be assumed that if they were fully disclosed, they
would play a significant role in a prospective franchisee's decision
of whether to enter into a franchise relationship.'' Original SBP,
43 FR at 59652. The ``[f]ailure to disclose material information as
to the true cost of the franchise'' is an unfair and deceptive trade
practice in violation of Section 5. Id., at 59653.
\441\ UFOC Guidelines, Item 7.
\442\ PMR&W asserted that the additional funds category is too
broad. Citing the NASAA Commentary, the firm noted that owners'
salary, for example, should be excluded. PMR&W, NPR 4, at 10-11. We
agree, but believe this issue is best addressed by staff in the
Compliance Guides, which will explain the term ``additional funds''
in greater detail.
\443\ The term ``initial period'' means at least three months or
some other reasonable period for the industry. A franchisor seeking
to apply an initial phase other than three months has the burden of
showing the reasonableness of the phase selected.
---------------------------------------------------------------------------
Item 7 generated little comment. In response to the Staff Report,
Howard Bundy asserted that Item 7 is insufficient, failing to reveal a
franchisee's total initial investment because it does not include
various payments to third parties beyond the first 90 days.
Specifically, it misses real estate costs and equipment financing and
leasing. Mr. Bundy urged the Commission to adopt the following:
Disclose the total amount (in a range, if appropriate) of all
obligations to third parties during the entire initial term of the
franchise that will be necessary to operate the franchised business
(including real estate leases and equipment leases) that the franchisee
may be required to personally guaranty.\444\
---------------------------------------------------------------------------
\444\ Bundy, at 5.
The Commission declines to adopt this proposal. By its terms, Item
7 of the UFOC Guidelines is designed to furnish prospective franchisees
with material information about the likely expenses faced in the start-
up phase of the franchise. Armed with such information, a prospective
franchisee will know whether or not he or she has the financial ability
to get the franchised outlet operational. Item 7 is not intended to
capture all expenses made over the life of the franchise, which may
vary depending upon such factors as the franchisee's choice of
suppliers and the terms he or she negotiates with them. For example,
Item 7 recognizes that a franchisor may not know the exact amount of
real property expenses. Rather than requiring an exact figure, Item 7
permits franchisors to give an estimate or a low-high range. If neither
can be determined, Item 7 permits franchisors to simply describe
property requirements, such as property size and type, and location.
Moreover, prospective franchisees may be able to get more detailed
estimates of long-term expenses by speaking directly with existing
franchisees in their location, or with trademark-specific franchisee
associations. For these reasons, the Commission is not inclined to
deviate from the UFOC Guidelines Item 7 on this issue.
Item 7 of the final amended Rule is substantially similar to its
counterpart in the Franchise NPR, but has been modified in a number of
ways to adhere more closely to the UFOC Guidelines. For example, the
Franchise NPR proposed that the Item 7 table be titled: ``YOUR
ESTIMATED INITIAL INVESTMENT FOR THE FIRST [REASONABLE INITIAL PHASE]
MONTHS.''\445\ As one commenter noted, however, the language proposed
in the Franchise NPR is unnecessarily inconsistent with title of Item 7
table of the UFOC Guidelines, which is titled ``YOUR ESTIMATED INITIAL
INVESTMENT.''\446\ Moreover, the ``initial phase'' referenced in UFOC
Guidelines Item 7 pertains only to the
[[Page 15487]]
``additional funds'' category, not to the entire table.\447\
---------------------------------------------------------------------------
\445\ Franchise NPR, 64 FR at 57335.
\446\See PMR&W, NPR 4, at 10-11.
\447\Id.
---------------------------------------------------------------------------
In addition, Item 7 as proposed in the Franchise NPR would have
required franchisors to disclose ``additional funds'' required before
operations begin and during the initial phase of the franchise.''\448\
The Commission noted in the Franchise NPR that this language was
intended to require a working capital disclosure that could assist
prospective franchisees in understanding their break-even point.
Several commenters opposed the Franchise NPR's intention to capture
working capital and a break-even point; they pointed out that such an
approach goes beyond what the UFOC Guidelines require and asserted that
this could be misleading without more detailed earnings information,
such as in an earnings claim statement.\449\ Indeed, one commenter
argued persuasively that the Franchise NPR's proposal could create a
``back-door'' mandatory earnings claim, a position contrary to the
Commission's view that earnings claims should be voluntary.\450\ The
Commission finds these arguments persuasive. Accordingly, the final
amended Rule tracks the language of UFOC Guidelines Item 7 more
closely, eliminating any implication that the Commission intends for
franchisors to disclose either a working capital or breakeven point.
---------------------------------------------------------------------------
\448\ Franchise NPR, 64 FR at 57305.
\449\ Lewis, NPR 15; Snap-On, NPR 16, at 3; Holmes, NPR 8, at 6.
\450\ Homes, NPR 8, at 6. See Staff Report, at 159-62.
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10. Section 436.5(h) (Item 8): Restrictions on sources of products and
services
The original Rule required franchisors to disclose obligatory
purchases, restrictions on sources of products and services, and the
amount of any revenue the franchisor may receive from required
suppliers.\451\ The final amended Rule requires more detailed and
extensive disclosures on these topics, consistent with the UFOC
Guidelines. Specifically, section 436.5(h) of the final amended Rule
requires franchisors to disclose whether it makes the criteria for
approving suppliers available to franchisees.\452\ In addition,
franchisors must state whether, by contract or practice, the franchisor
provides material benefits to franchisees who use designated or
approved suppliers (e.g., permitting renewals or additional outlets).
Finally, it requires franchisors to disclose the existence of
purchasing or distribution cooperatives, and whether the franchisor
negotiates purchase agreements with suppliers on behalf of franchisees.
These highly material disclosures inform prospective franchisees about
critical restrictions on how they will have to operate the franchise,
which comprise a vitally important aspect of the franchise
relationship.
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\451\See 16 CFR 436.1(a)(9)-(11). In the original SBP, the
Commission noted that buying restrictions are common in franchise
agreements and are material because they will ``have a significant
impact on the sources of supplies and prices which a franchisee will
pay for his or her supplies and thus also on the profitability of
the franchise.'' Original SBP, 43 FR at 59655. Similarly, required
purchases ``limit the independence of the franchisee, affect the
profitability of the franchisee, and constitute a potential source
of hidden profit for the franchisor.'' Id., at 59656-57.
\452\ In the Franchise NPR, the Commission proposed that
franchisors disclose the actual criteria for evaluating, approving,
or disapproving of alternative suppliers. Franchise NPR, 64 FR at
57336. Two Franchise NPR commenters voiced concern that this
proposal goes well beyond what the UFOC Guidelines require, forcing
franchisors to disclose proprietary information. PMR&W, NPR 4, at 1;
NFC, NPR 12, at 29. See also Staff Report, at 130-31. The Commission
agrees. Consistent with the UFOC Guidelines Item 8, the final
amended Rule requires franchisors to disclose only a general
description of its selection criteria.
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During the course of the Rule amendment proceeding, franchisee
advocates raised various concerns about Item 8. For example, several
franchisees voiced concern about source restrictions that prevent them
from obtaining supplies at lower market rates.\453\ Commenters
generally did not allege that franchisors fail to disclose source
restrictions, but complained about the ``abusive nature'' of such
restrictions.\454\ Nevertheless, franchisee advocates questioned the
sufficiency of the Item 8 disclosures. Specifically, Andrew Selden
urged the Commission to expand the disclosure of supplier restrictions
to require franchisors to disclose more information about their
practices and intentions with respect to the provision of competitive
alternative sources of supply.\455\ Mr. Selden, however, offered no
specific language for the Commission's consideration. Robert Zarco
urged the Commission to require franchisors to warn prospective
franchisees that:
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\453\E.g., Manuszak, ANPR 13; Weaver, ANPR 17; Mueller, ANPR 29;
Colenda, ANPR 71; Gagliati, ANPR 72; Buckley, ANPR 97; Haines, ANPR
100; Myklebust, ANPR 101; Rafizadeh, ANPR, 7 Nov. 97, at 288-89;
Slimak, ANPR, 22 Aug. 97 Tr., at 26. See also Kezios, ANPR 64.
\454\E.g., Brickner, ANPR 128; Buckley, ANPR 97, at 3;
Myklebust, ANPR 101. A few franchisees reported that their
franchisor failed to approve alternative suppliers or made it
difficult for franchisees to find alternative sources of supplies.
E.g., Chiodo, ANPR, 21 Nov. 97 Tr., at 308; Hockert-Lotz, id., at
325-27.
\455\ Selden, ANPR 133, Appendix B, at 1.
The company retains the right to approve all outside vendors
supplying products to the franchisees. Our criteria generally focus on
quality and concept-uniformity, but we reserve the right to modify the
criteria for approving suppliers at any time. Additionally, there are
no time limitations as to how long the review/approval of franchisee-
endorsed vendors may take.\456\
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\456\ Zarco & Pardo, ANPR 134, at 2. In the same vein, the AFA
asserted that it is insufficient to require a franchisor to disclose
whether a franchisee can purchase products from unaffiliated
suppliers. It urged the Commission to require franchisors to
disclose how long it actually takes for the franchisor to approve
alternative suppliers, by stating the following:
``We have been known to take up to one year or more to approve a
non-franchisor-affiliated vendor; or We have been known to change
the specifications for [specific product] during the approval
process. This has caused delays of between [number of days/weeks/
months/years] to [number of days/weeks/months/years].''
AFA, NPR 14, at 4. While the Commission understands that some
franchisees have experienced difficulties in obtaining franchisor
approval to use alternative supply sources, the record is
insufficient to justify a sweeping consumer warning that assumes
delay in the approval process as a matter of course. Rather, advice
concerning the approval of alternative suppliers can be addressed in
consumer education materials.
The Commission agrees that full disclosure of source restrictions
and purchasing obligations is warranted. To that end, the final amended
Rule adopts the broader UFOC Guidelines' Item 8 disclosures. Item 8
strikes the right balance between pre-sale disclosure and compliance
costs and burdens. It is sufficient to warn prospective franchisees
about source restrictions, purchase obligations, and approval of
alternative suppliers, without requiring franchisors to disclose their
past practices regarding approving alternative suppliers (which may be
irrelevant to their current practices) or their future intentions
(which may be proprietary information or misleading if the franchisor
abandons the intended direction). Moreover, prospective franchisees can
always ask existing franchisees or trademark-specific franchisee
associations about a franchisor's history of approving alternative
suppliers, if this issue is important in their decision-making process.
With respect to the disclosure of revenues received from suppliers,
Howard Bundy suggested that franchisors should disclose the dollar
amount of any revenues received during some stated period, such as
during the
[[Page 15488]]
last year.\457\ The disclosure of revenues from suppliers serves an
``anti-conflict of interest'' purpose, putting prospective franchisees
on notice that the franchisor, by benefitting materially from a
relationship with a supplier, may be motivated to require franchisees
obtain goods or services from that supplier. Accordingly, the highly
material fact is that the franchisor receives revenues from suppliers
it requires franchisees to use, not the exact dollar amount received.
By requiring franchisors to disclose the percentage of revenue derived
from suppliers, Item 8 achieves that purpose, consistent with the UFOC
Guidelines.
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\457\ Bundy, NPR 18, at 8. See also Brown, ANPR 4, at 3 (urging
the Commission to prohibit direct and indirect ``kick-backs'' from
third-party vendors to the franchisor).
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Finally, in response to the Staff Report, a few commenters offered
various technical refinements to Item 8.\458\ First, Piper Rudnick
noted that Item 8 of the Staff Report would require disclosures about
purchases from ``suppliers . . . under the franchisor's
specifications[, including] obligations to purchase imposed by written
agreement or by the franchisor's practice.'' The firm interpreted the
phrase ``imposed by written agreement'' as modifying the word
``supplier.'' If so, it maintained that a franchisor would have no
reason to know if a supplier has a written agreement.\459\ We believe
this is a strained reading of the provision: ``written agreement'' is
intended to refer to ``franchisor,'' not to a ``supplier.''
Nevertheless, in order to avoid any confusion, we have modified Item 8
in the final amended Rule now to read as follows: ``Include obligations
to purchase imposed by the franchisor's written agreement or by the
franchisor's practice.''\460\
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\458\ The IL AG also urged the Commission to add ``affiliates''
to the list of suppliers. IL AG, at 5. This is unnecessary.
Franchisors already must disclose purchasers from ``the franchisor,
its designee, or suppliers approved by the franchisor, or under the
franchisor's specifications.'' Accordingly, ``designee, or suppliers
approved by the franchisor'' would cover any required purchases from
affiliates.
\459\ Piper Rudnick, at 6.
\460\ Piper Rudnick also recommended that the Compliance Guides
clarify the phrase ``obligations to purchase imposed by . . . the
franchisor's practice.'' Piper Rudnick, at 6. As far as we are
aware, this phrase, taken from the UFOC Guidelines, has not
previously raised any interpretive issues. At the very least,
``franchisor's practice'' may include purchases that are recommended
by the franchisor, or purchases that are prevalent among
franchisees, even if not required by contract.
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Second, NASAA addressed the placement of footnote 5. Item 8, as
proposed in the Staff Report, would require franchisors to disclose
``whether the franchisor or its affiliates will or may derive revenue
or other material consideration from required purchases or leases by
franchisees,'' and ``if so describe the precise basis by which the
franchisor or its affiliates will or may derive that consideration by
stating . . .'' Footnote 5 added: ``Take figures from the franchisor's
recent annual audited financial statement . . . If audited statements
are not yet required, or if the entity deriving the income is an
affiliate, disclose the sources of information used in computing
revenues.'' NASAA observed that the footnote incorrectly seems to
modify ``precise basis,'' when it should modify ``franchisor's total
revenue.'' It suggested moving the footnote to the end of section
436.5(h)(6)(i) so that it will modify ``the franchisor's total
revenue.''\461\ The final amended Rule adopts that suggestion.
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\461\ NASAA, at 5. See also WA Securities, at 3.
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11. Section 436.5(i) (Item 9): Franchisee's Obligations
Section 436.5(i) of the final amended Rule adopts UFOC Item 9, as
proposed in the Franchise NPR.\462\ This disclosure gives prospective
franchisees an easy-to-understand guide to 25 enumerated contractual
obligations that are common in franchise relationships, with cross
references to the specific sections of the franchise agreement and
disclosure document that discuss each obligation in greater detail.
There is no counterpart in the original Rule.
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\462\ Franchise NPR, 64 FR at 57305.
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Item 9 generated only a few comments during the Rule amendment
proceeding. One franchisor representative maintained that the
disclosure is unnecessary. He urged that a franchisor be permitted to
opt out of Item 9 if the franchisor provides prospective franchisees
with a detailed table of contents or index to its franchise
agreement.\463\ Similarly, another franchisor representative suggested
that the Item 9 disclosures should apply only to franchise agreements,
but not to any accompanying ``licenses, leases, subleases, guarantees,
security agreement, load documents, software agreements, etc.''\464\
According to this commenter, references to these ancillary agreements
are burdensome and of little value to prospective franchisees. On the
other hand, a franchisee representative asserted that Item 9 does not
go far enough: ``As currently structured, this disclosure is not worth
the time and effort largely because it provides no benefit to the
prospect.''\465\ He suggested that franchisors use a remarks column to
describe briefly the nature of each obligation.
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\463\ Duvall, ANPR 19, at 2.
\464\ J&G, NPR 32, at 11.
\465\ Stadfeld, NPR 23, at 14.
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The Commission believes that Item 9 serves a useful purpose. As
stated throughout this document, franchisee complaints submitted during
the Rule amendment proceeding supported better pre-sale disclosure
about the nature of the franchise relationship.\466\ Item 9 addresses
that concern by providing a detailed table of contents to the franchise
agreement, with the additional benefit of cross references to the
relevant sections of the disclosure document. It facilitates review of
a franchise offering by enabling a prospective franchisee to find and
review the contractual provisions detailing their legal obligations,
better ensuring that prospective franchisees are not mislead about the
nature of the franchise relationship. Moreover, many franchisors
already use the UFOC Guidelines and prepare an Item 9 table. Further,
Item 9 should impose few costs or compliance burdens because
franchisors need only reference existing materials, most likely the
franchise agreement and disclosure document. To the extent that legal
obligations are spelled out in any ancillary agreements, franchisors
must direct prospects to those provisions as well.\467\
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\466\ Item 9 is consistent with other trade regulation rules
where the Commission has recognized that information about legal
risks to consumers is material. E.g., Negative Option Rule, 16 CFR
425.1(a)(ii) (minimum purchase obligations); Door-to-Door Sales
Rule, 16 CFR 429.1 (obligations regarding cancellations).
\467\ The UFOC Guidelines clearly contemplate that franchisors
should reference other ancillary agreements, where appropriate. For
example, the beginning of UFOC Item 9 reads: ``Disclose the
principal obligations of the franchisee under the franchise and
other agreements after the signing of these agreements.'' The
express reference to ``other agreements'' and the use of the words
``these agreements,'' clearly indicate that the drafters directed
franchisors to reference all applicable agreements. We see no
compelling reason to deviate from the UFOC Guidelines on this point.
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12. Section 436.5(j) (Item 10): Financing
Consistent with the UFOC Guidelines Item 10, section 436.5(j) of
the final amended Rule requires a franchisor to disclose all the
material terms and conditions of any financing agreements, which
encompass: the rate of interest, plus finance charges, expressed on an
annual basis; the number of payments; penalties upon default; and any
consideration received by the franchisor for referring a prospective
franchisee to a lender. This disclosure is comparable to the original
Rule provision found at 16 CFR 436.1(a)(12).\468\ The final
[[Page 15489]]
amended Rule's Item 10 closely tracks the version of this provision as
proposed in the Franchise NPR, revised to improve the clarity and
overall consistency of the Rule.\469\
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\468\ In the original SBP, the Commission found that a
prospective franchisee's ability to obtain sufficient funding on
reasonable terms is a critical element in determining whether to
enter into a franchise relationship. Accordingly, it concluded that
it is both unfair and deceptive for a franchisor to fail to disclose
or misrepresent financing terms and conditions, and to fail to
disclose rebates received in connection with franchise financing.
Original SBP, 43 FR at 59659-60.
\469\ The disclosures required by Item 10 are modeled on the
disclosures lenders make under the Federal Reserve's Regulation M
(Consumer Leasing),12 CFR Part 213, and Regulation Z (Truth in
Lending), 12 CFR Part 226. Because these regulations cover personal
property leases and credit transactions that are ``primarily for
personal, family, or household purposes,'' however, they generally
do not apply directly with respect to lease and financing
transactions undertaken in connection with the purchase of a
franchise. Sales of franchises generally are not undertaken to
advance personal, family, or household purposes. The version of Item
10 proposed in the NPR, following Item 10 in the UFOC Guidelines,
expressly referenced the Consumer Credit Protection Act's Truth in
Lending (``TILA'') provisions, 15 U.S.C. 1605-1606. While not
intending to depart unnecessarily from the UFOC Guidelines, the
Commission believes that this reference is potentially confusing,
because the TILA likely does not apply to transactions within the
scope of the amended Rule. Nevertheless, franchisors can look to
TILA and to the Consumer Leasing Act for guidance in crafting their
disclosures under Item 10. The Commission anticipates that staff
Compliance Guides will illuminate this topic further.
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Section 436.5(j), like UFOC Guidelines Item 10, extends the
original Rule disclosures by requiring franchisors to disclose any
interest on the financing in terms of the rate of interest, plus
finance charges, expressed on an annual basis, consistent with such
disclosures required in consumer credit transactions.\470\ It also
requires more disclosure than the original Rule about what the
financing covers, waiver of defenses, and the franchisor's practice or
intent to sell or assign the obligation to a third party.\471\
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\470\ It is worth noting that interest rates or finance charges
may fluctuate between the time when the prospective purchaser
receives the disclosure document and the time when he or she
actually executes the financing agreement. Section 436.5(j)(1)(iv)
requires disclosure of what the rate of interest, plus finance
charges, expressed on an annual basis, was on a specified recent
date. In situations where the rate may change during the life of the
loan, disclosure of this fact would be required under the catch-all
requirement of section 436.5(j)(x), which calls for disclosure of
``other material financing terms.'' Of course, Item 22--section
436.5(v)--requires that any financing agreement be attached to the
disclosure document, and the Item 10 disclosures merely summarize
key terms.
\471\ The introduction to UFOC Item 10 makes clear that
franchisors are permitted to provide this information in summary
table format, and Appendix A to the final amended Rule offers a
sample table.
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Three commenters voiced concerns about Item 10. First, H&H
suggested that leases referred to in Item 10 should be called
```finance leases,' a well-established term in commercial law.''\472\
The Commission declines to adopt this suggestion. While ``finance
leases'' may be a term of art used in commercial law, we do not believe
that the UFOC Guidelines Item 10--upon which section 436.5(j) is
based--is ambiguous or otherwise unclear. Deviating from the UFOC
Guidelines on this point, therefore, is unwarranted.
---------------------------------------------------------------------------
\472\ H&H, NPR 9, at 18.
---------------------------------------------------------------------------
Second, David Gurnick suggested that the Rule expressly permit
negotiation of financial terms, and require disclosure indicating
``that there are other sources of financing, such as banks, which the
franchisee should consider.''\473\ The Commission, of course, intends
that franchisees be free to negotiate financing terms. The Commission
does not believe that the text of the final amended Rule at Item 10 can
be read to imply that negotiation of financial terms is not permitted,
or that Item 10 contemplates any restriction of a franchisee's choice
of lender. Therefore, we believe it unnecessary to deviate from the
UFOC Guidelines on this point.\474\
---------------------------------------------------------------------------
\473\ Gurnick, NPR 21, at 6-7.
\474\ The Commission will ensure that the Compliance Guides
reiterate the point made here: nothing in Item 10 restricts the
parties' ability to negotiate over financing terms.
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Finally, in response to the Staff Report, IL AG raised a technical
issue about the sample Item 10 Financing Table, noting that ``Equip.
Lease'' and ``Equip. Purchase'' have separate lines, while ``Land/
Constr.'' has a single line. The form of the Item 10 Financing Table in
the final amended Rule, however, is taken directly from the UFOC
Guidelines, and the record does not reflect that this format has caused
difficulty for franchisors or confusion on the part of prospective
franchisees. We therefore decline to deviate from the UFOC Guidelines
on this point.
13. Section 436.5(k) (Item 11): Franchisor's assistance, advertising,
computer systems, and training
Section 436.5(k) retains the original Rule's disclosure of
franchisor's assistance obligations, including pre-opening assistance
(e.g., site selection), as well as ongoing assistance (e.g.,
training).\475\ Item 11 of the final amended Rule expands the original
Rule, however, based upon the UFOC Guidelines' more detailed assistance
disclosure requirements, including disclosures relating to advertising
assistance and computer system requirements.\476\
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\475\See 16 CFR 436.1(a)(17) and (18). The offer of business
assistance is one of the hallmarks of a franchise system. In the
original SBP, the Commission stated that promises of assistance made
to induce prospective franchisees to purchase a franchise are
material, especially to those prospects with ``little or no
experience at running a business.'' Original SBP, 43 FR at 59676-77.
\476\See UFOC Guidelines, Item 11.
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Section 436.5(k) requires franchisors to begin their Item 11
disclosure with the statement, in bold type, that ``[e]xcept as listed
below, [the franchisor] is not required to provide you with any
assistance.'' This alert counters any express misrepresentations to the
contrary and corrects any misconception on the prospective franchisee's
part that a minimum degree of assistance is inherent in any franchise
offer.\477\ Item 11 also requires franchisors to explain in detail the
franchisor's site selection criteria and the franchisor's training
program. As noted above, this provision also requires franchisors to
disclose the extent of any advertising assistance and the operation of
local, regional, and national advertising councils or co-ops. These
disclosures address a common franchisee complaint, namely, that
franchisees do not get the quality or quantity of advertising they pay
for.\478\
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\477\ Our law enforcement experience demonstrates that
misrepresentation about the level of support and assistance is one
of the most common problems in franchise cases. See Staff Program
Review, at 24-26 (next to earnings claims, support problems are the
second most frequent issue raised by franchisee complainants). E.g.,
FTC v. Car Wash Guys Int'l, Inc., No. 00-8197 ABC (RNBx) (C.D. Cal.
2000); FTC v. Indep. Travel Agencies of Am., Inc., No. 95-6137-CIV
Gonzalez (S.D. Fla. 1995); FTC v. Sage Seminars, Inc., No. C-95-
2854-SBA (N.D. Cal. 1995); FTC v. Skaife, Bus. Franchise Guide (CCH)
] 9555 (C.D. Cal. 1990).
Indeed, misrepresentations about support and assistance continue
to be a source of numerous franchisee complaints. For example, one
franchisee-commenter reported that her outlet failed, in part,
because the franchisor did not adhere to its own criteria in
selecting a store. Based upon her experience, she asserted that it
is very important to have full disclosure on site selection
criteria. Lundquist, ANPR, 22Aug. 97 Tr., at 45. See also Dady &
Garner, ANPR 127, at 4; Mousey, ANPR, 29 July 97 Tr., at 4-7.
\478\See, e.g., FTC v. Car Checkers of Am., Inc., No. 93-623
(mlp) (D.N.J. 1993) (misrepresenting that advertising expenses would
be minimal or low); United States v. Fed. Energy Sys., Inc., Bus.
Franchise Guide (CCH) ] 8180 (C.D. Cal. 1984) (misrepresenting
extent of company advertising assistance); United States v. Ferrara
Foods, Inc., Bus. Franchise Guide (CCH) ] 7926 (W.D. Mo. 1983)
(misrepresenting availability of national media advertising). The
issue of advertising funds continues to generate concerns on the
part of franchisees and their advocates. E.g., Brown, ANPR 4, at 3
(favoring restrictions on franchisor's unreasonable use of
advertising funds); Manuszak, ANPR 13 (franchisor refuses to account
for use of franchisees' advertising funds); Weaver, ANPR 17 (no
discretion on use of advertising funds); Rachide, ANPR 32
(mismanagement of advertising funds); Colenda, ANPR 71 (alleging
inappropriate use of advertising payments); Zarco & Pardo, ANPR 134,
at 5 (``A franchisor should be required to disclose the extent of
its veto power over the allocation of any franchisee-generated
funds, such as advertising cooperatives.'').
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[[Page 15490]]
Section 436.5(k) also addresses major technological changes in
franchising since the original Rule was promulgated in 1978. Based upon
UFOC Item 11, this provision requires material disclosure about the
required use of computers and electronic cash registers.\479\ For
example, it requires franchisors to disclose whether they will have
independent access to information and data stored on electronic cash
register systems or software programs that the franchisee is required
to use or buy.\480\
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\479\ In response to the ANPR, a few commenters voiced concerns
about obligations to purchase computers or related equipment. E.g.,
Fetzer, ANPR, 19 Sept. 97 Tr., at 42 (needed to purchase a computer
converter, an additional $7,000 expense); Rafizadeh, ANPR, 7 Nov. 97
Tr., at 292 (GNC unilaterally forcing franchisees to pay a new $80
monthly maintenance fee on computer equipment purchased from GNC).
\480\See NCA 7-Eleven Franchisees, ANPR 113, at 2 (noting 7-
Eleven's use of ``point-of-sale'' cash registers, which enable
headquarters to monitor sales).
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Item 11, as proposed in the Franchise NPR, would have adopted the
UFOC Guidelines requirement that franchisors identify each piece of
hardware and software by brand, type, and principal function, or to
identify compatible equivalents and whether they have been approved by
the franchisor.\481\ The computer system disclosure was the only Item
11 issue that generated significant comment during the Rule amendment
proceeding. Several comments asserted that the UFOC Guidelines Item 11
computer system disclosures are burdensome, not helpful to prospective
franchisees, and are unnecessary because the costs associated with
purchasing computers and related equipment are already disclosed in
Items 5, 7, and 8.\482\ Marriott, for example, explained that its Item
11 computer usage disclosure ``results in four to five pages of
disclosure in each of Marriott's offering circulars yet provides little
or no benefit to franchisees.''\483\ In addition, one franchisor
representative noted that many start-up franchisors are ``not certain
which computer system or software they expect to have the franchisees
use. Provision should be made for these new franchisors.''\484\
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\481\ Franchise NPR, 64 FR at 57338.
\482\ Baer, NPR 11, at 13; J&G, NPR 32, at 11.
\483\ Marriott, NPR 35, at 15-16.
\484\ Kestenbaum, ANPR 40, at 2. In response to the Franchise
NPR--which proposed adopting the UFOC Item 11's detailed computer
systems disclosures--H&H suggested that a franchisor should be
required to disclose the specifications of any mandatory computer
system to the extent known or available, observing that start-up
franchisors may not have identified software systems before they
start franchising. The firm suggested that a franchisor should be
permitted to satisfy the Item 11 requirements by disclosing that
specifications are not known or available. H&H, NPR 9, at 23. Cf.
Bundy, NPR 18, at 9 (suggesting that a start-up franchisor disclose
some guidelines it will follow in selecting a computer system). We
agree. Accordingly, the Commission intends that, for start-up
franchisors, the computer system disclosures of Item 11 should be
read to allow flexibility: a start-up franchisor may indicate that
computer requirements are yet unknown, or otherwise state its policy
concerning computer usage, as is warranted. As Mr. Bundy noted, the
lack of selected computer systems by the franchisor itself reveals
material information: that the franchisor is not yet computerized,
which may ``plac[e] the franchisee at a disadvantage in many, if not
most industries.'' Bundy, NPR 18, at 9.
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The Commission believes that Item 11's computer systems
disclosures, which track the UFOC Guidelines' disclosures, serve a
useful purpose. There is no question that the costs a franchisee must
incur to purchase or lease computer and related equipment or software,
as well as any continuing maintenance or upgrade obligations and their
associated costs, comprise information that is material to the
prospective franchisee's purchasing decision. Information about whether
the franchisor will have access to information stored on the
franchisee's computers or electronic cash registers also is material,
because such access very likely would be a key component of the
relationship between the franchisor and franchisee. As noted throughout
this document, the Commission is convinced that additional disclosures
are warranted where they will likely prevent deception about the nature
of the franchise relationship a prospective franchisee is deciding to
enter.
Nonetheless, the computer usage disclosures as set forth in the
UFOC Guidelines appear to go beyond what is material in some instances
and likely would impose unwarranted compliance burdens. Specifically,
we are disinclined to require a franchisor to identify each and every
piece of hardware and software by brand, type, and principal function,
or to identify compatible equivalents and whether they have been
approved by the franchisor. We agree with the Franchise NPR commenters
who observed that some franchisors (start-up franchisors in particular)
may not have decided upon specific systems at the time of sale or, even
if they did, that the technology very likely will change over the
course of the franchise agreement. Thus, the compliance burden to
prepare component-specific disclosures would not likely outweigh any
tangible benefits to prospective franchisees.\485\ We are persuaded
that it is sufficient for franchisors to describe generally the
computer systems to be used, if any; any required purchase and
maintenance costs and obligations; and whether the franchisor will have
access to information contained in those systems. This information not
only will enable prospects to weigh the costs and benefits of
purchasing a specific franchise, but will better enable prospects to
learn if they will be at a technological disadvantage compared to other
franchise systems in the industry.
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\485\See Staff Report, at 137-38. It is noteworthy that NASAA
has not opposed this substantive revision to Item 11 of the UFOC
Guidelines.
---------------------------------------------------------------------------
On the other hand, one franchisee advocate, Howard Bundy, firmly
defended the materiality and usefulness of detailed itemized
disclosures about required computer systems. Specifically, Mr. Bundy
voiced concern about franchisors that require franchisees to use
proprietary technology that the franchisor has developed or plans to
develop. Mr. Bundy asserted that this may negatively impact upon
franchisees' ability to fix flaws in software, for example. He
contended that prospective franchisees should have the right to know
whether they can use ``off-the-shelf'' products, and whether software
can interface with common systems such as Microsoft Office or Outlook.
Similarly, they should know whether accounting software complies with
IRS standards or if they will get periodic updates.\486\
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\486\ Bundy, at 6-7.
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Mr. Bundy's concern about the potential limitations of franchisor-
developed software has merit. However, we believe the final amended
Rule already addresses this issue. As noted above, section 436.5(k)
requires franchisors to ``describe the systems (which includes hardware
and software components) generally in non-technical language, including
the types of data to be generated or stored in these systems.'' Thus,
the ``general description'' requirement is broad enough to cover
proprietary systems that can be obtained only from the franchisor.
Moreover, section 436.5(k) will require the franchisor to disclose any
obligation to provide ongoing maintenance, repair, upgrades, or
updates. Taken together, these provisions are sufficient to capture
instances where franchisors require the use of their own software.
Finally, we note that in response to the Staff Report, Gust
Rosenfeld raised a technical point about the Item 11 disclosure of the
franchisor's operating manual. The firm noted that, under the UFOC
Guidelines, franchisors must include the Table of Contents of the
operating manual in the disclosure
[[Page 15491]]
document, unless ``the prospective franchisee views the manual before
purchase of the franchise.''\487\ The firm asserted that the Staff
Report erred in recommending that the alternative to providing the
Table of Contents be revised to permit a franchisor to ``offer a
prospective franchisee the opportunity to review the manual before
buying the franchise.''
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\487\ Gust Rosenfeld, at 5 (citing UFOC Guidelines, Item 11, at
B. vii.).
---------------------------------------------------------------------------
The Commission believes the Staff Report is correct. As a practical
matter, we question how it could be proven that a prospective
franchisee actually reviewed a manual. Even if a franchisor had a
prospective franchisee initial each page of a manual, there is no
assurance that the prospect actually ``reviewed'' the manual. For that
reason, at most we can require a franchisor to afford a prospective
franchisee the opportunity to review the manual. At the same time, we
stress that the ``opportunity to review'' a manual must be a reasonable
one. A franchisor would not satisfy its disclosure obligation if, for
example, it offered to show the manual to a prospect only if the
prospect agreed to fly across country to the franchisor's corporate
headquarters. In that regard, the opportunity to review a manual means
that the franchisor must show the manual to the prospect (for example
in person or online) and permit the prospect sufficient time to review
it.
14. Section 436.5(l) (Item 12): Territory
Section 436.5(l) of the final amended Rule retains the original
Rule's disclosures concerning exclusive territories and sales
restrictions.\488\ Like the proposed Rule published in the Franchise
NPR, the final amended Rule is closely modeled on the UFOC Guidelines.
It therefore expands the original Rule's disclosure requirements
regarding territories in several respects. These new disclosure
requirements cover: (1) the conditions, if any, under which a
franchisor will approve the relocation of the franchisee's business and
the franchisee's establishment of additional outlets; (2) any present
plans on the part of the franchisor to operate a competing franchise
system offering similar goods or services; and (3) in instances when a
franchisor does not offer an exclusive territory, a prescribed warning
about the consequences of purchasing a non-exclusive territory. In
response to some comments, the Commission also has decided to make
additional modifications to the text of Item 12 in order to update both
the original Rule and the UFOC Guidelines to address new technologies
and market developments, such as the Internet and alternative channels
for distributing a franchisor's goods.\489\
---------------------------------------------------------------------------
\488\See 16 CFR 436.1(a)(13). In the original SBP, the
Commission recognized that sales restrictions and limited
territories affect a franchisee's ability to conduct business and
are, therefore, material. Original SBP, 43 FR at 59662. See, e.g.,
FTC v. Am. Legal Distrib., Inc., Bus. Franchise Guide (CCH) [1987-
1989 Transfer Binder] ] 9090 (N.D. Ga. 1988); United States v. C.D.
Control Tech. Inc., Bus. Franchise Guide (CCH), ] 9851 (E.D.N.Y.
1985); United States v. Fed. Energy Sys, Inc., Bus. Franchise Guide
(CCH) [1983-85 Transfer Binder] ] 8180 (C.D. Cal. 1984); FTC v.
Nat'l Bus. Consultants, Inc., Bus. Franchise Guide (CCH) ] 9365
(E.D. La. 1989). Cf. FTC v. Vendors Fin. Serv., Inc., No. 98-N-1832
(D. Colo. 1998); FTC v. Int'l Computer Concepts, Inc., No.
1:94cv1678 (N.D. Ohio 1994); FTC v. O'Rourke, Bus. Franchise Guide
(CCH) ] 10243; FTC v. Am. Safe Mktg., Inc., Bus. Franchise Guide
(CCH) ] 9350 (N.D. Ga. 1989).
\489\ Specifically, Item 12 of the final amended Rule extends
the original Rule by providing a prospective franchisee with
material information about competition not only through outlets
within the prospective franchisee's intended location, but through
alternative channels of distribution, such as the Internet, catalog
sales, telemarketing, and direct marketing. In the same vein, it
addresses any restrictions on a franchisee's ability to conduct
business outside of his or her territory through traditional sales
and alternative channels of distribution. The Staff Report
recommended this modification to the proposed Rule. Staff Report, at
144-45. See PRM&W, NPR 4, at 11 (supporting need to update the
original Rule to address new technologies and marketing practices).
---------------------------------------------------------------------------
The Item 12 territory disclosures generated several comments.
First, franchisees and their advocates urged the Commission to address
``encroachment,'' the practice by which a franchisor essentially
competes with its franchisees by establishing franchisor-owned or new
franchised-outlets in the same market territory, by purchasing and
operating a competing franchise system, or by selling the same goods or
services through alternative channels of distribution. Second, other
commenters questioned the scope of Item 12, urging the Commission to
require franchisors to disclose more information about their past
expansion practices, as well as future expansion plans. Third, some
commenters questioned the terminology used to describe territories,
urging the Commission to avoid implying that a protected territory is
inherent in the concept of franchising. Finally, several commenters
offered different views on the form of warning that might be
appropriate where a franchisor sells franchises without an exclusive
territory. Each of these issues is discussed below.
a. Encroachment
Throughout the Rule amendment proceeding, franchisees and their
advocates urged the Commission to address ``encroachment.''\490\ The
commenters contended that encroachment may have a devastating effect
upon an individual franchisee who does not have a contractually
protected exclusive territory,\491\ and some urged the Commission to
ban encroachment as ``an abusive and unfair'' trade practice under
Section 5 of the FTC Act.\492\
---------------------------------------------------------------------------
\490\E.g., Brown, ANPR 4, at 2; Packer, ANPR 10; Manuszak, ANPR
13; Donafin, ANPR 14; Weaver, ANPR 17; Rachide, ANPR 32, at 3; AFA,
ANPR 62, at 1; Orzano, ANPR 73; Buckley, ANPR 97, at 3; Marks, ANPR
107, at 2; Zarco & Pardo, ANPR 134, at 2.
\491\ For example, Laurie Gaither, an owner of a GNC franchise,
reported that the company opened a franchisor-owned outlet in a mall
within two miles from her store. She claimed that this development
has reduced her profits by 50%. L. Gaither, ANPR 68.
\492\E.g., AFA, ANPR 62, at 1 (putting up a new outlet to
compete with an existing franchisee is an unfair trade practice);
Bell, ANPR 30 (FTC needs to prohibit franchisors from devaluing
assets through encroachment); Rachide, ANPR 32 (encroachment among
practices that FTC should prohibit); Marks, ANPR 107 (FTC should
consider prohibiting franchisor encroachment, unless franchisee
compensated).
---------------------------------------------------------------------------
The Commission's view is that the granting of a protected territory
is fundamentally a private contractual matter for the parties to
determine for themselves.\493\ While the record establishes
franchisees' concerns about encroachment, it falls far short of
supporting a conclusion that not granting a protected territory in a
franchise agreement constitutes an unfair practice within the meaning
of the FTC Act. Nor does the record support a conclusion that a
franchisor's expansion where there are existing franchisees is an
unfair practice.
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\493\ Absent an express grant of a protected territory, a
franchisor is generally free to establish as many outlets
(franchisor-owned or franchised) in any particular market as it
wishes. A few state courts (or federal courts applying state law),
however, have held that encroachment violates state implied
covenants of good faith and fair dealing. See, e.g., In re Vylene
Enterprises, Inc., 90 F.3d 1472 (9th Cir. 1996).
---------------------------------------------------------------------------
Section 5(n) of the FTC Act provides that an ``unfair'' practice is
one that ``causes or is likely to cause substantial injury to consumers
which is not reasonably avoidable by consumers themselves and not
outweighed by countervailing benefits to consumers or to competition.''
While the record suggests that some franchisees in several franchise
systems may have been harmed by franchisor encroachment, the record
leaves open the question whether encroachment is prevalent and whether
the injury resulting from encroachment is substantial, when viewed from
the standpoint of the franchising industry as
[[Page 15492]]
a whole,\494\ not just from a few franchise systems.\495\ Second,
assuming a regulatory regime of full and truthful pre-sale disclosure
on the issue of territories, prospective franchisees can avoid
potential harm from encroachment by shopping for a franchise
opportunity that offers an exclusive territory. Finally, the record
does not support a finding that harm to franchisees resulting from
encroachment necessarily outweighs potential benefits (expansion of
markets and increased consumer choice) to consumers or to competition.
For these reasons, the Commission has determined that the criteria for
an industry-wide prohibition on encroachment has not been met. Thus,
the Commission declines to mandate specific contractual terms regarding
territories.
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\494\ As discussed above in the overview of the final rule above
(section I.D. of this document), the Commission has voiced concern
that government-mandated contractual terms may result in affirmative
harm to consumer welfare. Accordingly, the Commission has authorized
staff to file a number of advocacy comments recommending against
proposed state bills that would have unduly limited manufacturers in
managing their distribution systems, such as by requiring exclusive
territories.
\495\See Staff Program Review, at 59.
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b. Scope of the Item 12 disclosures
A few commenters urged the Commission to require franchisors to
disclose more information about their past practices with regard to
expansion into franchisees' areas or their future plans to do so.\496\
For example, Andrew Selden, a franchisee representative, suggested that
``Item 12 should be elaborated to require full disclosure of past
practice, current intention or future possibility of franchisor-
sponsored competitive activities that have the prospect of impacting
the franchisee's business.''\497\
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\496\ One commenter in the Rule amendment proceeding advocated
broadening the scope of the Rule to require more expanded
disclosures covering competition by affiliates, the franchisor's
officers, and franchise sellers. Bundy, NPR 18, at 9. In the absence
of persuasive record evidence that competition by franchisor
officers or sellers is a prevalent problem, however, the Commission
has determined not to deviate from the UFOC Guidelines on this
issue.
\497\ Selden, ANPR 133, Appendix B. See also Dady & Garner, ANPR
127, at 4 (``Explicit statements about the nature and extent of
protection against same-brand competition that will or will not be
provided is essential to an informed buying decision.'').
---------------------------------------------------------------------------
Franchisors addressing current development plans uniformly opposed
any disclosure. H&H's comment is typical. Most franchisors consider
current development plans to be proprietary information ``that would
place them at a competitive disadvantage if they were to be made
publicly available.''\498\ The firm also stressed that franchisors need
flexibility to adapt development plans to market realities.
``Disclosure of development plans could lead to possible claims by
franchisees who anticipated greater or lesser franchise development in
a particular area.''\499\
---------------------------------------------------------------------------
\498\ H&H, NPR 9, at 23.
\499\Id. See also Wendy's, NPR 5, at 2; Baer, NPR 11, at 13 ;
Lewis, NPR 15, at 15; BI, NPR 28, at 11; J&G, NPR 32, at 12; GPM,
NPR Rebuttal 40, at 6.
---------------------------------------------------------------------------
Based on review of the record as a whole, the Commission has
determined that requiring disclosure of past and planned future
expansion is unwarranted. With respect to past expansion, prospective
franchisees arguably can discover such information on their own by
directly observing the number and location of outlets in their
community and by speaking with current and former franchisees.
Moreover, past practices are not necessarily a predictor of future
intent. It is also unreasonable to require franchisors to disclose
hypothetical possibilities about their future expansion. Indeed, by not
granting an exclusive territory, the franchisor has effectively
reserved to itself the unrestricted right to expand into new or
existing locations or to sell its products or services via alternative
channels of distribution.
The UFOC Guidelines require a franchisor to disclose only if the
franchisor ``may establish'' other outlets in the area; it does not
require the franchisor to disclose its specific plans for the
franchisee's territory. Franchisors need to elaborate on their
expansion plans only if they have ``present plans to operate or
franchise a business under a different trademark and that business
sells goods or services similar to those to be offered by the
franchisee.''\500\ Moreover, the Commission is inclined to the view
that a franchisor's development plan is proprietary information that a
franchisor should not be required to make public.\501\ It could also
subject franchisors to future liability for fraud or misrepresentation
should the franchisor alter, abandon, or delay its stated expansion
plans. Further, requiring a franchisor to disclose plans to develop a
territory may be costly and burdensome because the franchisor
conceivably would have to prepare multiple Item 12 disclosures to focus
on each franchise location. The disclosures already contained in Item
12 are sufficient to warn prospects about likely competition because
any prospective franchisee who buys a franchise without any protected
territory is essentially taking the risk that the franchisor will
further develop the market area. For these reasons, we have determined
not to deviate from the UFOC Guidelines on this point.
---------------------------------------------------------------------------
\500\ UFOC Item 12C (emphasis added).
\501\E.g., Wendy's, NPR 5, at 2.
---------------------------------------------------------------------------
c. Terminology
The final amended Rule fine-tunes the terminology and organization
of Item 12. As proposed in the Franchise NPR, Item 12 would have
required that franchisors disclose information ``concerning the
franchisee's market area with or without an exclusive territory.'' It
also referred to the franchisee's ``defined area.''\502\ Several
commenters raised concerns about the use of these terms.
---------------------------------------------------------------------------
\502\ Franchise NPR, 64 FR at 57339.
---------------------------------------------------------------------------
First, BI opposed the use of the term ``exclusive territory'' in
the Franchise NPR, urging the Commission to use the term ``protected
territory'' instead. It asserted that the term ``protected territory''
is more descriptive of a franchisee's typical contractual rights
regarding its territory, if any.\503\ Similarly, the firm opposed the
use of the term franchisee's ``market area.'' It maintained that the
term ``market area'' is undefined and imprecise. BI advocated use of
the term ``location.''\504\
---------------------------------------------------------------------------
\503\ BI, NPR 28, at 6 (``[E]xclusive . . . is ambiguous and
often misleading.'').
\504\Id.
---------------------------------------------------------------------------
The NFC agreed, asserting that the term ``market area'' is a
``charged word.''\505\ According to the NFC, under franchisee
agreements, franchisees have, at most, a right only to a specified
location or narrowly defined geographic area. Use of the term ``market
area'' may advance the false notion that the grant of a franchise
inherently ``confers upon a franchisee exclusive rights within the
franchisee's economic `market area,' despite the terms of the subject
franchise agreement.''\506\ Similarly, the NFC opposed the use of the
term ``defined area.'' In its view, the appropriate term should be
``limited protected territory,'' noting that an area is almost never
granted unconditionally by a franchisor. The NFC advised that by using
the phrase ``limited protected territory'' in lieu of ``defined area,''
the Commission could ``actually reduce the misconception which
otherwise may be engendered in the minds of prospective franchisees
over what territorial protections, if any, they can expect to
receive.''\507\
---------------------------------------------------------------------------
\505\ NFC, NPR 12, at 19.
\506\ NFC, NPR 12, at 19. See also J&G, NPR 32, at 12.
\507\Id. See also J&G, NPR 32, at 12.
---------------------------------------------------------------------------
[[Continued on page 15493]]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
]
[[pp. 15493-15542]] Disclosure Requirements and Prohibitions Concerning Franchising
[[Continued from page 15492]]
[[Page 15493]]
The Commission agrees that terms such as ``market area'' and
``defined area'' are potentially misleading. Such terms inaccurately
imply an inherent right to a territory, where, in fact, the right to a
territory, protected or otherwise, is purely a matter of contract.
Accordingly, we believe the term ``exclusive territory''--as used in
the UFOC Guidelines\508\--is more precise. While the term ``exclusive
territory'' is, perhaps, not as ``descriptive'' as the terms
``protected area,'' or ``limited protected territory,'' its use is
clarified for prospective franchisees through the disclosures set forth
in paragraphs (5) and (6) of section 436.5(l). Accordingly, in the
absence of a stronger showing that alternatives to ``exclusive
territory'' are more accurate, the Commission has determined to revise
Item 12 to adhere more closely to the UFOC Guidelines on this point, as
recommended in the Staff Report.\509\ Thus, the final amended Rule
substitutes the words ``location'' or ``exclusive territory'' for
``market area,'' ``area,'' and ``defined'' area, as appropriate.
---------------------------------------------------------------------------
\508\ See, e.g., UFOC Item 12 (``Describe any exclusive
territory granted the franchisee. Concerning the franchisee's
location (with or without exclusive territory, disclose . . .'').
See also NASAA Comparison at Item 12.
\509\ In response to the Staff Report, no commenters raised any
concerns about the recommended choice of terminology used in Item
12.
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d. Warning
Item 12 of the final amended Rule fine-tunes and expands slightly
the standard warning proposed in the Franchise NPR that is required in
those instances when franchisors do not offer exclusive territories:
``You will not receive an exclusive territory. You may face competition
from other franchisees, from outlets that we own, or from other
channels of distribution or competitive brands that we control.''\510\
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\510\ This language, with minor editing, was suggested by PMR&W,
which observed that the proposed version of the warning focused only
on sales from outlets. PMR&W argued convincingly that such a warning
could be misleading because it fails to take into consideration
competition from other sources, such as the Internet, direct mail,
and mail order. PMR&W, NPR 4, at 11. See also J&G, NPR 32, at 12; IL
AG, NPR Rebuttal 38, at 3.
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Given the potential financial risks associated with a non-exclusive
territory, the Commission believes that franchisors who do not offer an
exclusive territory should warn prospective franchisees about such
possible risks.\511\ The Commission generally disfavors the use of
warnings that merely repeat what is already expressly stated in the
franchise agreement, but believes that a specific warning regarding
exclusive territories is warranted in light of the volume and
persuasiveness of franchisee complaints regarding territory
issues.\512\ As noted previously, the Commission is convinced that
additional disclosures are warranted where they will likely prevent
deception about the nature of the franchise relationship.
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\511\ Indeed, several franchisee advocates urged the Commission
to strengthen the existing UFOC Guidelines' encroachment risk
factor. For example, Robert Zarco suggested that franchisors be
required to state:
``The company reserves the right to increase the number of
franchised or company-owned units in an area. In the past, we have
been known to put another outlet in close proximity to an existing
unit. This action generally has a negative impact on the gross and/
or net sales of the pre-existing unit.''
Zarco & Pardo, ANPR 134, at 2. See also Dady & Garner, ANPR 127,
at 3 (suggesting: ``You have no protected area. Your franchisor,
without any compensation to you, may place another store in a
location that may completely erode your profitability.'').
\512\ E.g., Brown, ANPR 4, at 2; Parker, ANPR 10; Manusak, ANPR
13, at 1; Donaphin, ANPR 14; Weaver, ANPR 17; Rachide, ANPR 32, at
3; AFA, ANPR 62, at 1; L. Gaither, ANPR 68; Orzano, ANPR 73, at 1;
Buckely, ANPR 97, at 3; Marks, ANPR 107, at 2; Zarco & Pardo, ANPR
134, at 2; Vidulich, 22 Aug. 97 Tr., at 17; Christiano, 19 Sept. 97
Tr., at 50; Bundy, 6 Nov. 97 Tr., at 135; Cordell, 6 Nov. 97 Tr., at
136; Kezios, 6 Nov. 97 Tr., at 142. See also FTC v. Fax Corp. of
Am., Inc., No. 90-983 (D. N.J. 1990); FTC v. Nat'l Bus. Consultants,
Inc., No. 89-1740 (E.D. La.1989); FTC v. Am. Legal Distrib., Inc.,
No. 1:89-CV-462-RLV (N.D. Ga. 1989).
---------------------------------------------------------------------------
15. Section 436.5(m) (Item 13): Trademarks
The original Rule required a franchisor to list the trademark
identifying the goods or service to be sold by the prospective
franchisee.\513\ Consistent with the UFOC Guidelines, section 436.5(m)
of the final amended Rule requires franchisors to disclose whether the
trademark is registered with the United States Patent & Trademark
Office; the existence of any pending litigation, settlements,
agreements, or superior rights that may limit the franchisee's use of
the trademark; and any contractual obligations to protect the
franchisee's right to use the mark against claims of infringement or
unfair competition.
---------------------------------------------------------------------------
\513\See 16 CFR 436.1(a)(1)(iii).
---------------------------------------------------------------------------
These expanded disclosures are consistent with the Commission's
long-standing policy of requiring franchisors to disclose the material
costs and benefits of the franchise sale. One of the principal reasons
that one may wish to purchase a franchise--as opposed to starting one's
own business--is the right to use the franchisor's mark, which
presumably creates an instant market for the franchisees' goods or
services.\514\ For that reason, trademark usage is one of three
definitional elements of the term franchise. Any pending litigation,
settlement restrictions, or other potential limitations on the use of
the trademark are material because they will necessarily affect the
value of the trademark to a prospective franchisee and ultimately may
impact the franchisee's ability to continue operating the business.
---------------------------------------------------------------------------
\514\ In the original SBP, for example, the Commission noted
that a key feature of franchising is the right to use the
franchisor's trademark. Original SBP, 43 FR at 59623.
---------------------------------------------------------------------------
Item 13 generated little comment. Howard Bundy suggested that
franchisors should disclose not only pending trademark litigation, but
all such litigation in the last 10 years.\515\ The Commission declines
to adopt this suggestion. The fact that the franchisor may have been
involved in a trademark dispute a decade ago is not inherently
material.\516\ What influences a decision to purchase a franchise is
whether there are any current restrictions or disputes over the
trademark license. Obviously, any existing trademark restrictions or
challenges not only may decrease the value of the mark and the goodwill
associated with it, but may increase franchisees' costs if they must
switch to a different mark. Accordingly, we decline to deviate from the
UFOC Guidelines by requiring more extensive disclosures on this point.
---------------------------------------------------------------------------
\515\ Bundy, NPR 18, at 9.
\516\ On this issue, the UFOC Guidelines specifically note that
a franchisor need not disclose historical challenges to
registrations of trademarks that were resolved in the franchisor's
favor. UFOC Guidelines, Item 13B Instructions, iv.
---------------------------------------------------------------------------
The Commission has determined to adopt staff's recommendation to
adhere more closely to the UFOC Guidelines on Item 13 than did the
proposed Rule on two points. First, the Franchise NPR proposed that
franchisors disclose how any infringement, opposition, or cancellation
proceeding ``affects the franchised business.''\517\ This is
unnecessarily inconsistent with the wording of the UFOC Guidelines,
which state: ``affects the ownership, use, or licensing'' of the
trademark.\518\
---------------------------------------------------------------------------
\517\ Franchise NPR, 64 FR at 57339.
\518\See NASAA Comparison, at 17.
---------------------------------------------------------------------------
Second, the Franchise NPR included a footnote addressing the use of
summary opinions of counsel: ``Franchisors may include a summary
opinion of counsel concerning any action if a consent to use the
summary opinion is included as part of the disclosure document.''\519\
The footnote, however, did not address the discretionary use of a full
opinion letter, nor the need to attach the full opinion letter if a
summary is used. On this point, the UFOC Guidelines state:
---------------------------------------------------------------------------
\519\ Franchise NPR, 64 FR at 57339.
the franchisor may include an
[[Page 15494]]
attorney's opinion relative to the merits of litigation or of an action
if the attorney issuing the opinion consents to its use. The text of
the disclosure may include a summary of the opinion if the full opinion
is attached and the attorney issuing the opinion consents to the use of
the summary.\520\
---------------------------------------------------------------------------
\520\ UFOC Guidelines, Item 13B Instructions, v.
---------------------------------------------------------------------------
The Commission adopts the UFOC Guidelines language in both instances.
In addition, the final amended Rule improves on the clarity and
precision of the proposed Rule's standard disclosure required when the
franchisor's trademark is not registered on the Principal Register of
the United States Patent and Trademark Office. The proposed disclosure
reads as follows: ``If the trademark is not registered on the Principal
Register of the U.S. Patent and Trademark Office, state: `By not having
a Principal Register federal registration for [name or description of
symbol], [name of franchisor] does not have certain presumptive legal
rights granted by a registration.'''\521\
---------------------------------------------------------------------------
\521\ Franchise NPR, 64 FR at 57339.
---------------------------------------------------------------------------
The final amended Rule's disclosure is:
We do not have a federal registration for our principal trademark.
Therefore, our trademark does not have as many legal benefits and
rights as a federally registered trademark. If our right to use the
trademark is challenged, you may have to change to an alternative
trademark, which may increase your expenses.\522\
---------------------------------------------------------------------------
\522\ Arguing that many prospective franchisees would not
understand the standard disclosure prescribed in the Franchise NPR's
proposed Rule--particularly the phrase ``presumptive legal
rights''--the Staff Report recommended that the Commission simplify
it. The simplified version recommended by staff, however, was
criticized by two commenters on the ground that it was not entirely
accurate from a legal standpoint. Gust Rosenfeld, at 6; Piper
Rudnick, at 2. The version adopted here corrects the problems
pointed out by these commenters.
---------------------------------------------------------------------------
16. Section 436.5(n) (Item 14): Patents, copyrights, and proprietary
information
Section 436.5(n) of the final amended Rule adopts the UFOC
Guidelines' requirement for disclosure of information about the
franchisor's intellectual property. There is no comparable provision in
the original Rule. Item 14 elicited no comment during the amendment
proceeding.
Item 14 requires franchisors to describe in general terms the types
of intellectual property involved in the franchise and any legal
proceedings, settlements, and restrictions that may impact the
franchisee's ability to use such property.\523\ If counsel permits,
Item 14 allows a franchisor to include a counsel's opinion or a summary
of the opinion about legal actions, if the full opinion is
attached.\524\
---------------------------------------------------------------------------
\523\ Restrictions on the use of the franchisor's intellectual
property are material because they not only may seriously diminish
the value of the franchise, but could undermine the franchisee's
ability to operate the business. Item 14 also may improve the
relationship between franchisors and franchisees by preventing any
misunderstanding about the value or use of the franchisors'
intellectual property.
\524\See NASAA Comparison, at 20.
---------------------------------------------------------------------------
The final amended Rule differs from the Franchise NPR proposal,
however, in several non-substantive respects to add precision and
improve organization of the provision. Specifically, Item 14 of the
final amended Rule separates those disclosures pertaining to patents
from those pertaining to patent applications. At the same time, it also
groups closely related disclosures--those for patents, patent
applications, and copyrights--under a single common direction. For
example, section 436.5(n)(1) of the Franchise NPR stated: ``For each
patent or copyright: (i) Describe the patent or copyright and its
relationship to the franchisee; (ii) State the duration of the patent
of copyright.'' Section 436.5(n)(1) of the final amended Rule
simplifies this language by eliminating the use of multiple directions.
Instead, it says: ``(1) Disclose whether the franchisor owns rights in,
or licenses to, patents or copyrights that are material to the
franchise. Also, disclose whether the franchisor has any pending patent
applications that are material to the franchise. If so, state . . .''
followed by the specific disclosure requirement for patents, patent
applications, and copyrights.
Similarly, section 436.5(n)(1), as proposed in the Franchise NPR,
referred to the ``issue date.'' The final amended Rule instead uses the
correct language: ``issuance date.'' In the same vein, Item 14 of the
final amended Rule corrects imprecise language that would have required
the disclose of material determinations pending in ``the U.S. Patent
and Trademark Office or the U.S. Court of Appeals for the Federal
Circuit.'' In fact, patent and copyright determinations can be made in
courts other than the U.S. Court of Appeals for the Federal Circuit, as
noted in other sections of Item 14 (``Describe any current material
determination of the United States Patent and Trademark Office, the
United States Copyright office, or a court regarding the patent or
copyright.''). The language now reads more broadly ``pending in the
United States Patent and Trademark Office or any court.''
Finally, Item 14, as proposed in the Franchise NPR, would have
required franchisors to disclose the ``length of time of any
infringement.'' However, it is possible that a franchisor may not know
how long a third party has been infringing its rights. Accordingly,
Item 14 of the final amended Rule adds the qualifying phrase ``to the
extent known.''
17. Section 436.5(o) (Item 15): Obligation to participate in the actual
operation of the franchise business
Section 436.5(o) of the final amended Rule retains the original
Rule requirement that franchisors disclose whether franchisees are
required to participate personally in the direct operation of the
franchise.\525\ Like the corresponding provision in the Franchise NPR's
proposed rule, this section of the final amended Rule closely tracks
the UFOC Guidelines' Item 15. It therefore expands the original Rule on
this point by requiring franchisors to disclose: (1) participation
obligations arising not only from the parties' franchise agreement, but
from other agreements or as a matter of practice; (2) whether direct
participation is recommended; and (3) any limitations on whom the
franchisee can hire as a supervisor and any restrictions that the
franchisee must place on his or her manager. If the franchisee operates
as a business entity, the franchisor must also disclose the amount of
equity interest, if any, that the supervisor must have in the
franchise.
---------------------------------------------------------------------------
\525\ See 16 CFR 436.1(a)(14). In the original SBP, the
Commission noted that the degree of personal participation required
of a franchisee is a material fact in the franchise relationship.
Accordingly, the omission of such information is an unfair or
deceptive practice in violation of Section 5. Original SBP, 43 FR at
59663.
---------------------------------------------------------------------------
Item 15 generated little comment. In response to the Staff Report,
NASAA and Washington Securities noted an inconsistency between the
proposed final amended Rule and the UFOC Guidelines on the disclosure
of whom a franchisee may hire as an on-premises supervisor and that
person's training. Whereas the UFOC Guidelines provide that these
disclosures pertain to all franchisees, the Franchise NPR suggested
that these disclosures should be limited to franchisees who are
individuals, but not to business entities.\526\ We agree with the
commenters that the Franchise NPR's proposed limitation was based upon
an erroneous reading of the UFOC
[[Page 15495]]
Guidelines, and the final amended Rule makes the appropriate
correction.
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\526\ NASAA, at 5; WA Securities, at 3-4.
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NASAA also urged the Commission to consider expanding Item 15 to
include the disclosure of ``operating hours and the method used by
franchisors to notify franchisees of changes in required operating
hours.''\527\ The Commission, however, declines to adopt this
suggestion. While this information might be useful for prospective
franchisees, it does not rise to the level of materiality such that
non-disclosure of it may put prospective franchisees in jeopardy of
being deceived. Moreover, no other commenter raised this point, and in
the absence of a record dictating that we deviate from the UFOC
Guidelines, the Commission is reluctant to do so.
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\527\ NASAA, NPR 17, at 4.
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Finally, NASAA and Washington Securities recommended that the
Commission require franchisors to disclose in Item 15 all agreements
regarding the franchise that apply to the owners of the franchise.\528\
While this suggestion is rooted in the NASAA Commentary on the UFOC
Guidelines, nothing in Item 15 of the UFOC Guidelines says that
franchisors must present copies of the actual agreements to prospective
franchisees. The Commission believes such a requirement would be
duplicative and burdensome. Franchisors already must include in Item 22
copies of ``all agreements proposed for use or in use . . . regarding
the offering of a franchise, including the franchise agreement, leases,
options, and purchase agreements.'' Presumably, contracts with
franchise owners would already be disclosed in Item 22. Thus, this
suggested modification is unnecessary.
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\528\ NASAA, at 5; WA Securities, at 3-4.
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18. Section 436.5(p) (Item 16): Sales restrictions
Section 436.5(p) of part 436 retains the original Rule's
disclosures on sales restrictions. Like other disclosure requirements
addressing how a franchisee may conduct business, this provision
requires franchisors to disclose any restrictions limiting the goods or
services that the franchisee may offer for sale or the customers to
whom a franchisee may sell goods or services.\529\ Consistent with UFOC
Guidelines, Item 16 also extends the original Rule disclosures by
requiring a franchisor to disclose whether the franchisor has the right
to change the types of goods or services authorized for sale, as well
as any limits on the franchisor's right to make such changes. These
disclosures better enable a prospective franchisee to understand the
extent to which the franchisor has the contractual right to control
sales, which may directly affect the prospect's ability to conduct
business, its independence from the franchisor, and ultimately, its
profitability. No comments were submitted on the Item 16 sales
restrictions disclosures, and the adopted version is almost identical
to the version proposed in the Franchise NPR.\530\
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\529\See 16 CFR 436.1(a)(13). In the original SBP, the
Commission recognized that sales restrictions are material because
they can limit the scope of the franchisee's market and ultimately
the franchisee's profitability. Original SBP, 43 FR at 59661. The
sales restriction disclosures are comparable to other Commission
trade regulation disclosures concerning restrictions on the use of
goods and services. E.g., Telemarketing Sales Rule, 16 CFR
310.3(a)(1) (requiring disclosure of all material restrictions,
limitations, or conditions to purchase, receive, or use the goods or
services); Negative Option Rule, 16 CFR 425.1(a)(1)(ii) (requiring
disclosure of post-sale minimum purchase requirements); Disclosure
of Warranty Terms and Conditions, 16 CFR 701.3(a)(8) (requiring
material disclosures of limitations and exclusions on warranty
coverage).
\530\ The final amended Item 16 is reorganized for greater
precision and uses more precise language. For example, the final
amended Item 16 eliminates a redundancy in the Franchise NPR
regarding the disclosure of any restrictions on customers, which
appeared in both the introduction to the Item (disclose . . . any
franchisor-imposed restrictions . . . that limit the franchisee's
customers) and in the main text (disclose . . . any restrictions on
the franchisee's customers). The final amended Item 16 also uses
more precise language, substituting ``disclose [any restrictions] .
. . that limit access to customers,'' rather than the Franchise
NPR's inaccurate language ``any restrictions on the franchisee's
customers.''
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19. Section 436.5(q) (Item 17): Renewal, termination, transfer, and
dispute resolution
Section 436.5(q) adopts UFOC Item 17, which requires franchisors to
summarize in tabular form 23 enumerated terms and conditions of a
typical franchise relationship, such as the duration of the franchise
agreement, rights and obligations upon expiration of the franchise
agreement, post-term covenants not to compete, and assignment and
transfer rights. The final amended Rule provision is almost identical
to the proposed rule in the Franchise NPR, with only a slight
modification, described below, with respect to the treatment of the
term ``renewal.''
The approach taken in the final amended Rule greatly streamlines
the original Rule, which required franchisors to detail the rights and
obligations already spelled out in the franchise agreement.\531\ Item
17, therefore, reduces compliance burdens, while providing prospective
franchisees with a detailed road map to the franchise contract, where
they can read the various provisions in greater detail. At the same
time, Item 17 expands on the original Rule by requiring disclosures
pertaining to dispute resolution, including any arbitration or
mediation requirements, as well as forum-selection and choice of law
provision disclosures. For each enumerated contract term, the
franchisor must cross reference the applicable franchise agreement
provisions and briefly summarize the governing terms.\532\
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\531\See 16 CFR 436.1(a)(15) (requiring franchisors to describe
14 categories of terms and conditions).
\532\ In the original SBP, the Commission stated that the terms
and conditions of the franchise relationship--such as those
governing transfers, renewals, and terminations--are material
because they ``may limit what the franchisee may do with his or her
capital asset.'' Original SBP, 43 FR at 59664. Given the length and
complexity of the typical franchise agreement, prospective
franchisees may overlook, or do not fully appreciate, such terms and
conditions. Id.
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Most of the comments submitted on Item 17 concerned the use of the
term ``renewal.'' Franchisee advocates asserted that the term
``renewal'' is misleading.\533\ In their view, the term implies that a
franchisee, upon expiration of the franchise term, can continue
operating the franchise under substantially similar terms and
conditions. They observed, that in practice, franchisees who wish to
continue operating their franchises at the end of the franchise term
must often sign new contracts that impose materially different terms
and conditions, such as higher royalty payments or the elimination of
an exclusive territory. They asserted that renewing franchisees, in
many instances, have no choice but to sign even the most abusive, one-
sided renewal contracts because they have a substantial economic
investment in their franchises and simply cannot walk away without
incurring significant economic loss.\534\ Worse, when a
[[Page 15496]]
franchisee does walk away, he or she is often bound by a covenant not
to compete, which restricts his or her ability to operate a similar
business for a number of years.
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\533\ For example, the AFA stated:
```Renewal' is a misnomer. `Re-license,' `rewrite' or even `re-
franchise' is a more accurate description of what actually happens
at the end of the initial contract term. Most franchisees find that
when it is time to `renew,' they are not `renewing' their existing
franchise agreement, but are entering into a wholly new franchise
agreement, often with materially different financial and operational
terms. They are presented these `renewal' contracts on a `take it or
leave it' basis and are under enormous coercion pressures to sign--
especially if the old agreement contains a post-termination covenant
not to compete. This is truly `holding a gun to the head' of the
`renewing' franchisee.''
AFA, ANPR 62, at 2.
\534\E.g., AFA, NPR 14, at 5; Bundy, NPR 18, at 4; Karp, NPR 24,
at 20-21; Morrell, NPR 31, at 2; Bores, ANPR 9, at 1; Rachide, ANPR
32; Chabot, ANPR 37; Rich, ANPR 65; Orzano, ANPR 73; Geiderman, ANPR
131; Karp, ANPR, 19 Sept. 97 Tr., at 83; Chiodo, ANPR, 21 Nov. 97
Tr., at 303-04.
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Several franchisor representatives supported the view that the term
``renewal'' may be inappropriate. The NFC, for example, stated that the
term ``renewal'' is somewhat ambiguous: it could mean either ``a simple
extension of the existing agreement under the same terms or--as is far
more common--the grant of a `successor franchisor' under the terms
being offered at the time that the existing agreement expires.''\535\
However, the NFC did not believe that the term ``renewal'' is
misleading, and it was uncertain whether the ambiguity compels a
revision of the Rule. J&G asserted that the term is potentially
misleading,\536\ and Tricon urged the Commission to avoid its use
entirely.\537\
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\535\ NFC, NPR 12, at 30.
\536\ J&G, NPR 32, at 13.
\537\ Tricon, NPR 34, at 6-7.
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On the other hand, several commenters maintained that the term
``renewal'' is clear and requires no modification. For example, John
Baer stated that ``renewal'' is a term of art in franchising and should
not be changed. He also observed that the various state relationship
laws use that term and ``to revise it for disclosure purposes is likely
to cause more confusion than clarity.''\538\ Seth Stadfeld, a
franchisee advocate, agreed, explaining that the term ``renewal''
refers to the relationship between the franchisor and franchisee, not
to the underlying contract. He also shared Mr. Baer's concern that the
term is used in state relationship statutes and should not readily be
changed.\539\
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\538\ Baer, NPR 11, at 13. See also IL AG, NPR 3, at 7.
\539\ Stadfeld, NPR 23, at 15-16. See also NaturaLawn, NPR 26,
at 2.
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Several commenters suggested that the Commission adopt various
disclosures or warnings for prospective franchisees that would explain
the concept of renewal in greater detail. The IL AG, for example,
suggested that franchisors make the following statement: ``You should
learn what changes in your agreement might occur and what rights you
have when your contract expires. Renewal may change important contract
terms.''\540\
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\540\ IL AG, NPR 3, at 7. Similarly, the AFA urged the
Commission to adopt the following warning:
``You do not own your own business. You are leasing the rights
to sell our goods/services to the public under our trade name. At
the end of your initial [number of years] term, your current
contract will expire [terminate]. You will have the choice of
signing a new contract written by us at the time of expiration
[termination]. The new contract will be written by us with no input
from you and will contain materially different financial and
operational terms.''
AFA, NPR 14, at 5. See also Bundy, at 7; Bundy, NPR 18, at 5
(urging the Commission to require franchisors to disclose the
consequences of renewal).
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While the record reveals that there may be confusion over the use
of the term ``renewal,'' it does not show that use of the term is
inherently deceptive. The Commission concludes that the term
``renewal'' is a franchising term of art, meaning that upon the
expiration of a contract, the franchisees may have the right to enter
into a new contract, where materially different terms and conditions
may apply. Moreover, as several commenters noted, the term ``renewal''
is used in various state relationship laws, in addition to the UFOC
Guidelines. In light of that background, the Commission is disinclined
to mandate use of a different term or prohibit use of ``renewal.'' At
any rate, a prospective franchisee may be just as prone to misinterpret
the substitute language (e.g., ``re-license'') as the term ``renewal.''
It short, any term may be misleading if prospective franchisees fail to
understand the underlying concept that a franchisor may require a
change in contract terms and conditions upon expiration of the original
agreement as a condition of renewal. Therefore, the Commission has
determined not to introduce nonconformity between federal and state
approaches on the use of this term.
Nonetheless, the record is persuasive that many prospective
franchisees may not appreciate the legal import of the term
``renewal.'' Indeed, franchisees often are surprised to discover that
``renewal'' means the continuation of their franchise relationship
under potentially vastly different terms. To prevent potential
deception with respect to use of the term ``renewal,'' Item 17 of the
final amended Rule requires franchisors to explain their renewal policy
in the summary field for provision Item 17(c) (requirements for
franchisee to renew or extend).\541\ We do not suggest any particular
form of explanation, however, because that will depend upon the
individual policies of each franchisor.\542\ If applicable, the
franchisor must also state that franchisees ``may be asked to sign a
contract with materially different terms and conditions than their
original contract.''\543\ While we are reluctant to add consumer
education notices to the disclosure document, especially where the UFOC
Guidelines require no parallel notice, we believe it is warranted in
this instance, given the continued concern raised by franchisee
advocates and others about renewals.\544\
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\541\ In response to the Staff Report, Spandorf opined that Item
17 as recommended by staff was still confusing, asserting that it
could mean that a franchisor would have to make the statement about
renewal even if the franchisor does not offer renewals. Spandorf, at
7. We do not believe this is a serious concern. Item 17 clearly
states that franchisors need only address those issues listed in
Item 17 if applicable. ``If a particular item is not applicable,
state `Not Applicable.'''
\542\ One example of a renewal explanation may be: ``If you seek
to renew your franchise agreement upon expiration, know that royalty
payments and the size of your exclusive territory may change'' or
``Upon expiration, you will renegotiate the terms and conditions of
your contract. Be aware that these terms and conditions may be
different from those in your original agreement.''
\543\ Section 436.5(q)(3).
\544\ In response to the Staff Report, Howard Bundy urged the
Commission to adopt a negative disclosure whenever a franchisor does
not offer renewal on the same exact terms as the original agreement:
``We do not give you the right to renew or extend your franchise on
the same terms as your current franchise agreement. You should
consult your franchise attorney about the consequences of this.''
Bundy, at 7. We believe the Item 17 requirement that franchisors
explain what they mean by ``renewal'' is sufficient to address this
concern.
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20. Section 436.5(r) (Item 18): Public figures
Consistent with the UFOC Guidelines, Item 18 requires franchisors
to disclose the involvement of a public figure in the franchise system,
including his or her management responsibilities, total investment made
in the franchise system, and compensation, if any. This section is
substantively similar to the comparable disclosure provision of the
original Rule found at 16 CFR 436.1(a)(19).\545\ The final amended Rule
adopts Item 18 as proposed, with only minor language changes for the
sake of clarity and improved organization.\546\
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\545\ In the original SBP, the Commission stated that this
information is material because it helps prospective franchisees
understand the extent of any financial and managerial commitments
from the public figure, as well as any obligations to the public
figure. Prospective franchisees can then decide for themselves
whether an association with a public figure is valuable to them.
Original SBP, 43 FR at 59677-78.
\546\ For example, Item 18 of the Franchise NPR used the
language: ``Disclose . . . any compensation paid or promised to the
public figure.'' The final amended Rule substitutes the word
``given'' for ``paid,'' recognizing that a public figure may be
``given'' tangible benefits, such as a car, not just a cash payment.
Accordingly, the term ``given'' is more precise and broader. The
final amended Rule also improves the organization of Item 18. As
proposed in the Franchise NPR, Item 18 included the definition of
``public figure'' upfront, where it interrupted the flow of the
basic disclosure requirements. Accordingly, Item 18 of the final
amended Rule is easier to read.
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Item 18 generated few comments during the Rule amendment
proceeding.
[[Page 15497]]
Two commenters questioned the utility of the disclosure. H&H noted that
this Item is seldom, if ever, applicable and urged the Commission to
delete it.\547\
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\547\ H&H, NPR 9, at 18. Howard Bundy agreed, proposing instead
that the space be used for more important issues: ``It would make
more sense to elevate the renewal issue, the gag order issue, and
the integration clause issue, and perhaps even the arbitration
clause issue to full Item status and move the public figure
information elsewhere.'' Bundy, NPR 18, at 10. Of the franchisees
who participated in the Rule amendment proceedings, only one voiced
concerns about a public figure. Dianne Mousley purchased a Mike
Schmidt's Philadelphia Hoagies franchise, in part based upon the
representation that Mike Schmidt, a former baseball player, would be
actively involved in the franchise system. However, Ms. Mousley's
primary concerns did not involve Mr. Schmidt. Rather, she complained
about delays in constructing the store and lack of promised training
and support. See generally Mousley, 29 July 97 Tr., at 1-32.
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The Commission has determined that the information required under
Item 18 remains material in those instances, relatively uncommon though
they may be, when a public figure creates his or her own franchise
system or when a franchisor uses a public figure pitchman. A public
figure's ownership or management of a franchise system could create the
impression of greater oversight or influence in the operation of the
system, making the franchise offering appear to be a less risky
investment. Similarly, a public figure pitchman's endorsement of a
franchise system may create the impression that the franchise system is
sound or a low risk. How much weight a prospect may give a public
figure endorser's pitch may vary with the level of compensation
received from the franchisor. If, for example, a pitchman is paid a
nominal sum, then a prospective franchisee may be inclined to give the
pitch more weight because the pitchman has little to gain financially
and thus little motive to fabricate his or her pitch. Accordingly, the
public figure disclosures concerning level of involvement and
compensation are material and their potential benefits to prospective
franchisees would outweigh their costs. To that limited degree, these
disclosures still serve a useful purpose. In those more typical
instances when no public figure is involved, Item 18 entails no
additional compliance burden. On balance, therefore, the Commission is
disinclined to deviate from the UFOC Guidelines on this point.
21. Section 436.5(s) (Item 19): Financial performance representations
Section 436.5(s) of part 436, a key anti-fraud provision, addresses
the making of financial performance representations.\548\ Consistent
with the original Rule and the UFOC Guidelines, the final amended Rule
permits, but does not require, franchisors to make such representations
under limited circumstances. When a franchisor elects to make a
financial performance claim, the franchisor must, among other things,
have a reasonable basis for the representation\549\ and disclose the
basis and assumptions underlying the representation.\550\ Franchisors
also must include an admonition that a prospective franchisee's actual
earnings may differ.\551\
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\548\ In the original SBP, the Commission found that one of the
most frequent abuses occurring in the marketing of franchises is the
use of deceptive past and potential franchise sales, income, and
profits claims. Indeed, the Commission stated that the ``use of
deceptive and inaccurate profit and loss statements by franchisors
has resulted in a legion of `horror stories.''' Original SBP, 43 FR
at 59684.
\549\See 16 CFR 436.(1)(b)(2); 436.(1)(c)(2); 436.1(e)(2); UFOC
Guidelines, Item 19A.
\550\See 16 CFR 436.1(b)(3); 436.1(c)(3); 436.1(e)(5)(i); UFOC
Guidelines, Item 19B.
\551\See 16 CFR 436.1(b)(4); 436.1(c)(5); 436.1(e)(5)(iii); UFOC
Guidelines, Item 19B Instructions, (c).
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Bringing the original Rule's provisions on financial performance
representations into closer alignment with the UFOC Guidelines entailed
several deletions or departures from the original Rule. Specifically,
the final amended Rule differs from the original Rule in that:
It eliminates the requirement that franchisors who decide
to make financial performance claims provide prospective franchisees
with a separate financial performance claim document.\552\ Instead,
consistent with the UFOC Guidelines, it requires any performance claim
to appear in Item 19 of the disclosure document itself;
---------------------------------------------------------------------------
\552\See 16 CFR 436.1(d).
---------------------------------------------------------------------------
It eliminates the requirement that all financial
performance claims be geographically relevant to the franchise offered
for sale;\553\
---------------------------------------------------------------------------
\553\See 16 CFR 436.1(b)(1); 436.1(c)(1).
---------------------------------------------------------------------------
It eliminates the requirement that any historical
financial performance claims must be based upon generally accepted
accounting principles (``GAAP'');\554\
---------------------------------------------------------------------------
\554\See 16 CFR 436.1(c)(4); 436.1(e)(2).
---------------------------------------------------------------------------
It permits franchisors, under specific circumstances, to
disclose, apart from the disclosure document, the actual operating
results of a specific unit being offered for sale;\555\ and
---------------------------------------------------------------------------
\555\See UFOC Guidelines, Item 19 Instructions i.
---------------------------------------------------------------------------
It permits franchisors to furnish supplemental performance
information directed at a particular location or circumstance.\556\
---------------------------------------------------------------------------
\556\See UFOC Guidelines, Item 19 Instructions ii.
For the reasons explained below, the final amended Rule provision,
however, diverges from Item 19 of the UFOC Guidelines by permitting
greater disclosure of financial information about subsets of
franchisor-owned or franchised outlets, provided the franchisor
discloses specified information about the subset at issue. With certain
additional refinements described in the following paragraphs of this
section, including the preamble requirements, Item 19 of the final
amended Rule closely tracks Item 19 as proposed in the Franchise
NPR.\557\
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\557\ The greatest difference between Item 19 as proposed in the
Franchise NPR and Item 19 in the final amended Rule is the
elimination of the GAAP requirement, discussed in greater detail,
infra.
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Nearly all comments on the Item 19 disclosure requirements focused
on four issues: (1) whether financial performance disclosures should be
mandatory or voluntary; (2) whether the Rule should permit disclosure
of financial performance information about geographical or other
subsets of franchisor-owned or franchised outlets; (3) whether the Rule
should retain the requirement that historical financial performance
data be prepared according to GAAP; and (4) whether the Rule should
require prescribed preambles. Each of these issues is discussed in the
sections immediately below.\558\
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\558\ Piper Rudnick's comment on the Staff Report raised an
issue on a separate topic that the Commission has decided to
address. The firm noted that there is a problem with section
436.5(s)(3)(ii)(A) as proposed in the Franchise NPR (and as
recommended in the Staff Report). Specifically, that provision
required that the material bases for a financial performance
representation include a statement of ``the degree of competition in
the market area.'' Piper Rudnick observed that there may be no
single ``market.'' If national performance claims are made, it would
be extremely difficult to describe the ``market.'' As a result,
franchisors are likely to adopt ``some meaningless boilerplate'' to
comply. Accordingly, the firm recommended dropping the entire quoted
phrase. Piper Rudnick, at 3. The Commission has carefully considered
this point, and has determined that competition is a factor that may
impact upon a prospective franchisee's ability to achieve
represented financial performance. A reference to competition
generally, therefore, is warranted. Nevertheless, the phrase
``market area'' may be so problematic as to render the particular
disclosure element meaningless, as the firm predicts. Therefore
section 436.5(s)(3)(ii)(A) of Item 19 as adopted refers simply to
``degree of competition,'' without reference to a ``market area.''
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a. Voluntary disclosure of financial performance information
The Franchise NPR proposed that the making of financial performance
representations remain voluntary, as was the case under the original
Rule\559\ and UFOC Guidelines.\560\ Many
[[Page 15498]]
franchisees and their representatives, however, urged the Commission to
mandate the disclosure of financial performance information.\561\ In
support of this recommendation, these commenters advanced a number of
arguments: (1) that financial performance information is the most
material information prospective franchisees need to make an informed
investment decision;\562\ (2) that franchisors already have performance
information and it is a deceptive omission for them to fail to disclose
this information; (3) that franchisors are in the best position to
collect and disseminate performance information; (4) that a mandated
financial performance disclosure would reduce the level of false and
unsubstantiated oral and written financial performance claims; and (5)
that more disclosure regarding performance would benefit the
marketplace and competition.\563\
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\559\ Franchise NPR, 64 FR 57309-10.
\560\ UFOC Guidelines, Item 19.
\561\E.g., AFA, at 2; Bundy, at 7-8; Karp, at 3; Selden, at 2;
Haff, at 2; Blumenthal, at 1.
\562\ Karp, ANPR, 19 Sept. 97 Tr., at 100-03. Quoting several
business texts, Mr. Karp asserted that historical financial
performance information is critical to any evaluation of a business.
Internal Revenue Service Ruling 59-60, Item D, for example, provides
that: ``detailed profit and loss statements should be obtained and
considered for a representative period immediately prior to the
required date of appraisal, preferably five or more years.''
According to Mr. Karp, the failure of franchisors to disclose
historical performance information deprives prospects of material
information that is essential in evaluating the franchise offering.
\563\See Staff Report, at 159-60; ANPR, 62 FR at 9118. See also
Brown, ANPR 4, at 4; SBA Advocacy, ANPR 36, at 8; Purvin, ANPR 79;
Lagarias, ANPR 125, at 1-2; Dady & Garner, ANPR 127, at 1-2; and
Selden, ANPR 133, at 1-2 and Appendix C; Lundquist, ANPR, 22 Aug. 97
Tr., at 46-47.
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In contrast, franchisors and their advocates uniformly opposed
mandatory financial performance disclosures, based on the following
arguments: (1) it is impossible for the Commission to create a single
performance disclosure format that will be relevant for all industries;
(2) not all franchisors have the contractual right to collect extensive
financial information with which to prepare a reasonable performance
disclosure; (3) financial performance data collected from existing
franchisees is not necessarily complete and accurate; (4) a mandatory
performance disclosure would be misinterpreted as a guarantee of future
performance, thus increasing litigation; and (5) mandating financial
performance disclosures would have a negative impact upon the
franchisor-franchisee relationship, subjecting franchisees to more
extensive accounting oversight and audits.\564\
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\564\See Staff Report, at 161-62. E.g., Gust Rosenfeld, at 6;
Duvall, ANPR 19, at 2; Kaufmann, ANPR 33, at 7; Tifford, ANPR 78, at
5; Jeffers, ANPR 116, at 5. See also 7-Eleven, NPR 10, at 3
(suggesting that a typical franchisor would be hard-pressed to
generate financial performance information without ``very extensive
and significant effort.''). In addition, a few commenters urged the
Commission to coordinate its financial performance disclosure policy
with NASAA to promote uniformity. For example, John Tifford stated:
``Federal and state regulators must develop a coherent and
compatible earnings claim policy in order to ensure that franchisors
will not be exposed to risks caused by inconsistent and
uncoordinated federal and state policies.'' Tifford, ANPR 78, at 6.
See also AFA, ANPR 62, at 4; IL AG, ANPR 77, at 2; IFA, ANPR 82, at
3. On the other hand, Cendant, representing several major franchise
systems, suggested that the FTC prohibit states from mandating
financial performance disclosures by preempting the field. Cendant,
ANPR 140, at 2.
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Based upon its assessment of the record as a whole, the Commission
concludes that financial performance representations should remain
voluntary. In reaching this conclusion, we recognize that false or
misleading financial performance claims are the most common allegation
in Commission franchise law enforcement actions.\565\ However, there is
no assurance that mandating performance claims will in fact reduce the
level of false claims. Given that many different industries are
affected by part 436, what makes a financial performance disclosure
reasonable, complete, and accurate is quite varied. Thus, the
Commission will not mandate a particular set of financial performance
disclosures. However, if a franchisor chooses to make such disclosures,
they, of course, must be reasonable, non-misleading, and accurate.
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\565\See, e.g., FTC v. Minuteman Press, Int'l, 93-CV-2494 (DRH)
(E.D.N.Y.) (1998 Order) (finding that the making of false gross
sales and profit representations to prospective franchisees was
pervasive in the Minuteman and Speedy Sign-A-Rama franchise
systems). See also, e.g., FTC v. Car Wash Guys, Int'l, No. 00-8197
ABD (RNBx) (C.D. Cal. 2000); FTC v. Tower Cleaning Sys., Inc., No.
96 58 44 (E.D. Pa. 1996); FTC v. Majors Med. Supply, No. 96-8753-
Zloch (S.D. Fla. 1996); FTC v. Indep. Travel Agencies of Am., Inc.,
No. 95-6137-CIV-Gonzalez (S.D. Fla. 1995); FTC v. Mortgage Serv.
Assoc., Inc., No. 395-CV-1362 (AVC) (D. Conn. 1995); FTC v. Robbins
Research Int'l, Inc., No. 95-CV-627-H(AJB) (S.D. Cal. 1995); FTC v.
Sage Seminars, Inc., No. C-95-2854-SBA (N.D. Cal. 1995). See
generally Vidulich, 22 Aug. 97 Tr., at 18-19; Marks, 19 Sept. 97
Tr., at 2-3; Fetzer, 19 Sept. 97 Tr., at 40-41.
---------------------------------------------------------------------------
Mandating financial performance disclosures would also impose
substantial new accounting, data collection, and review costs on all
franchise systems. At the same time, it potentially could expose
existing franchisees, upon whose data the franchisor would rely, to
more extensive audits. In addition, existing franchisees might be
subject to potential liability for indemnification should a franchisor,
relying on the franchisees' performance data, be found to have violated
the Rule by failing to furnish accurate financial performance data.
Further, the record reveals that approximately 20% or more of
franchisors choose to make financial performance disclosures.\566\
Accordingly, prospective franchisees can find franchise systems that
voluntarily disclose such information. If prospective franchisees were
to seek out such franchise systems, or demand the disclosure of such
information from franchisors, ordinary market forces might compel an
increasing number of franchisors to disclose earnings information
voluntarily, without a federal government mandate. More important, a
disclosure document is not the only potential source of financial
performance information. Prospective franchisees can obtain financial
performance information from a variety of third-party sources. For
example, typical expenses, such as labor and rent, may be available
from industry trade associations and industry trade press. Prospective
franchisees may be able to discuss earnings and other financial
performance issues directly with current and former franchisees, as
well as with trademark-specific franchisee associations. For these
reasons, we conclude that financial performance representations should
remain voluntary, consistent with the original Rule and UFOC
Guidelines.
---------------------------------------------------------------------------
\566\See, e.g., Bortner, ANPR 37, at 3; NASAA, ANPR 43, at 3.
---------------------------------------------------------------------------
b. Geographic relevance and subgroups
As noted above, Item 19 of the final amended Rule eliminates the
original Rule's geographic relevance requirement for financial
performance representations.\567\ This brings the Rule's financial
performance disclosure requirements into closer alignment with Item 19
of the UFOC Guidelines,\568\ as proposed in the Franchise NPR.\569\
---------------------------------------------------------------------------
\567\See 16 CFR 436.1(b)(1); 436.1(c)(1). The original Rule's
geographic relevance prerequisite was designed to ensure that a
financial performance representation was reasonable in light of the
opportunity being offered for sale. In short, geographic relevance
``helps to ensure that the representation reflects what the
franchisee is likely to achieve.'' Original SBP, 43 FR at 59691.
\568\ The UFOC Guidelines, for example, permit a franchisor
selling a franchise in Florida to disclose that franchised outlets
in urban areas of Oregon and Washington have averaged a specific
profit level. In contrast, the original Rule barred such a
performance claim because such claim is not geographically relevant
to the prospective franchisee's territory--Florida.
\569\ Franchise NPR, 64 FR at 57310.
---------------------------------------------------------------------------
At the same time, the final amended Rule deviates from the
Franchise NPR by omitting the UFOC Guidelines' requirement that
franchisors disclose the number and percentage of all
[[Page 15499]]
existing outlets known to have attained a represented performance
level.\570\ Rather, for the reasons explained below, Item 19 of the
amended Rule is consistent with the original Rule in requiring
franchisors to disclose the number and percentage of existing outlets
known to have attained the represented performance level in the area
that formed the basis for the representation.\571\
---------------------------------------------------------------------------
\570\ Item 19B ii of the UFOC Guidelines instructions requires
``a concise summary of the basis for the claim including a statement
of whether the claim is based upon actual experience of franchised
units and, if so, the percentage of franchised outlets in operation
for the period covered by the earnings claims that have actually
attained or surpassed the stated results.'' The original Rule did
not include any counterpart requirement. The original Rule contained
the same broad number and percentage requirements only for financial
performance claims made in the general media. 16 CFR
436.1(e)(5)(ii).
\571\ 16 CFR 436.1(b)(5)(i); 16 CFR 436.1(c)(6)(i).
---------------------------------------------------------------------------
The UFOC Guidelines require a franchisor to compare the number of
franchisees who have performed at a claimed level against all
franchisees in its system, not just against franchisees it has measured
or against franchisees in a subgroup. For example, a franchisor may
have statistics showing that nine out of 10 franchised stores in a
particular location (such as Seattle) average $100,000 net profit a
year. Yet, the UFOC Guidelines prevent the franchisor from disclosing
truthful information about the universe the franchisor had measured--
the 10 franchised outlets in Seattle. Rather, the franchisor would be
forced instead to state 9 out of the entire number of all franchises
nationwide (e.g., 9 out of 1,000) have earned the $100,000 claimed.
This approach can mislead a prospective franchisee because it suggests
that the franchisor has in fact measured the financial performance of
all franchisees, when that may not be true. It also may deflate
franchisees' actual performance records. More important, a franchisor
may decline to disclose performance information if, in order to do so,
it must first incur the expense of conducting a system-wide franchisee
performance analysis.
To correct this problem, Item 19 of the revised Rule permits
franchisors to disclose truthful financial performance information
about a subgroup of existing franchisees under limited conditions.\572\
Specifically, the financial information furnished to prospective
franchisees must have a reasonable basis and the franchisor must
disclose: (1) the nature of the universe of outlets measured; (2) the
total number of outlets in the universe measured; (3) the number of
outlets from the universe that were actually measured; and (4) any
characteristics of the measured outlets that may differ materially from
the outlet offered to the prospective franchisee (e.g., location, years
in operation, franchisor-owned or franchisee-owned, and likely
competition).\573\
---------------------------------------------------------------------------
\572\ This approach to financial performance substantiation, as
proposed in the Franchise NPR and recommended in the Staff Report,
prompted few comments from any of the participants in this
proceeding.
\573\See Gust Rosenfeld, at 6 (supporting option of marking
financial performance representations based upon sub-group data).
---------------------------------------------------------------------------
Few commenters addressed the revision of Item 19. Among those that
commented on Item 19, a few specifically supported the elimination of
the separate geographic relevance prerequisite.\574\ On the other hand,
IL AG voiced concern that eliminating the geographic relevance
requirement would not prevent franchisors from ldquo;cherry picking''
their best performing franchise locations and then allowing prospects
to assume that their performance results will be similar.\575\
---------------------------------------------------------------------------
\574\ ``[T]he omission of the geographic relevancy requirement
represents the removal of a substantial impediment to franchisors
who might wish to provide financial performance data to prospective
franchisees, because it will lower the obstacles to, and cost of,
compiling the data necessary to produce a meaningful representation.
We believe it is unlikely to have any material effect on the quality
of such representation, as geographic relevancy is often quite
attenuated.'' BI, NPR 28, at 11. See also Baer, NPR 11, at 13.
\575\ IL AG, NPR 3, at 7.
---------------------------------------------------------------------------
At the same time, other commenters supported allowing financial
performance claims based on franchisee subgroups with the specified
substantiation requirements. John Baer, for example, maintained that
the disclosures for subgroups ``provide franchisors with sufficient
guidance about what characteristics of the outlets must be disclosed
and how they may differ materially from outlets offered to a
prospective franchisee.''\576\ Similarly, Marriott observed that
allowing disclosure of subgroup performance is laudable ``especially
when franchisors are frequently adopting new business strategies which
may result in different [financial performance representations],
depending upon whether the old or new system format is followed by the
franchisees.''\577\
---------------------------------------------------------------------------
\576\ Baer, NPR 11, at 14.
\577\ Marriott, NPR 35, at 11. But see PMR&W, NPR 4 (suggesting
that these provisions may deter the dissemination of financial
performance information).
---------------------------------------------------------------------------
Based upon the record, the Commission has concluded that
eliminating the geographic relevance requirement, coupled with
permitting broader disclosure of financial performance of subgroups,
will remove obstacles that discourage franchisors from making financial
performance data available to prospective franchisees. At the same
time, Item 19 prevents franchisors from ``cherry picking'' their best
locations as a basis for financial performance representations.
Specifically, Item 19's substantiation requirements ensure that
franchisors disclose how they derived the performance results of
subgroups, so that prospective franchisees can assess for themselves
the sample size, the number of franchisees responding, and the weight
of the results. In addition, these provisions require franchisors to
disclose the material differences between the subgroup-units tested and
the units being offered for sale, so that prospects can avoid drawing
unreasonable inferences from the representations.
c. GAAP
As noted, Item 19 of the final amended Rule eliminates the original
Rule requirement that historical financial performance data must be
prepared according to GAAP.\578\ The Franchise NPR proposed retention
of this requirement.\579\ Without exception, the commenters who
addressed this issue opposed the GAAP requirement. For example, NASAA
advised that GAAP goes beyond what the UFOC Guidelines require and the
accounting rules would discourage the making of financial performance
representations:
---------------------------------------------------------------------------
\578\ See 16 CFR 436.1(c)(4) and 436.1(e)(2). The Commission
adopted the original GAAP requirement to address concerns about the
validity of franchisee financial statements used by franchisors to
make historical financial performance representations. Not only may
some franchisees understate profits, but each could have his or her
own accounting system. ``Differences between franchisees also occur
due to such factors as variations in the drawing accounts of
principals, fringe benefits of principals, salaries charged to
income, and preparation of statements on a cash rather than an
accrual basis.'' Original SBP, 43 FR at 59691. To minimize the
potential dangers inherent in using franchisee performance data, the
Commission determined that historical performance claims and the
data underlying them must have been prepared according to GAAP.
\579\ Franchise NPR, 64 FR at 57341, note 13: ``If a financial
performance representation is a representation concerning historical
financial performance or if historical financial performance data
are used as the basis for a forecast of future earnings, the
historical data must be prepared according to U.S. generally
accepted accounting principles.''
Based upon the experience of states that register franchise
offerings, many franchisors that currently include historical financial
performance data in UFOC Item 19 may not prepare them according to
GAAP. In some instances, a
[[Page 15500]]
franchisor's historical financial performance data presented may be
accurate and material, yet may not be presented according to GAAP. In
many other instances, the franchisor may not be aware whether the data
presented is according to GAAP. This requirement would discourage
franchisors that have a factual basis for making financial performance
disclosures from doing so. In addition, this requirement likely would
increase costs to franchisors who do choose to make historical
financial performance disclosures by requiring them to obtain an
accountant's opinion as to whether their data is presented according to
GAAP.\580\
---------------------------------------------------------------------------
\580\ NASAA, NPR 17, at 5. See also Bundy, at 7; Gust Rosenfeld,
at 6; PMR&W, NPR 4, at 12; H&H, NPR 9, at 13; NFC, NPR 12, at 31;
Lewis, NPR 15, at 15; Snap-On, NPR 16, at 3; J&G, NPR 32, at 7;
Marriott, NPR 35, at 12; IL AG, Rebuttal NPR 38, at 5. Based on the
comments, particularly those submitted by NASAA, the Staff Report
recommended elimination of the GAAP requirement. Staff Report, at
166-67.
---------------------------------------------------------------------------
Based upon an assessment of the record, the Commission has
determined that the GAAP requirement is unnecessary and may impede
franchisors' ability to disclose performance information, to the
detriment of both franchisors and prospective franchisees. GAAP is not
the only approach to ensure the accuracy of historic performance data.
Franchisors making historical performance representations should have
the flexibility to formulate such representations, provided that such
representations are truthful and reasonable. Indeed, franchisors always
have the burden to establish that any financial performance
representations are reasonable. Moreover, it is apparent that some
franchisors using the UFOC format have disseminated non-GAAP compliant
historic performance representations, without any pattern of deception
identified by the states. Finally, eliminating the GAAP requirement is
likely to reduce compliance burdens, while bringing greater uniformity
to federal and state disclosure law.
d. Preambles
As noted above, Item 19 of the final amended Rule differs from the
original Rule and the UFOC Guidelines by requiring franchisors to
include prescribed preambles in their Item 19 disclosures. The preamble
requirements are incorporated in Item 19 as proposed in the Franchise
NPR.\581\ The preamble requirements address two concerns. First, there
is evidence in the record that some franchisors falsely state that the
Commission or the Franchise Rule prohibits franchisors from making
financial information available.\582\ Second, our law enforcement
experience tells us that prospective franchisees may rely on
unsubstantiated financial performance representations.\583\
---------------------------------------------------------------------------
\581\ Franchise NPR, 64 FR 57311 and 57341. Slight wording
changes have been made to improve overall clarity and consistency,
and the sentence ``If you are purchasing an existing outlet,
however, we may provide you with the actual records of that
outlet,'' to conform with the Rule's substantive liberalization on
this point.
\582\E.g., Bundy, at 7; CA BLS, ANPR 124, at 1; Lagarias, ANPR
125, at 4. See also H&H, ANPR 28, at 8; SBA Advocacy, ANPR 36, at 8;
AFA, ANPR 62, at 5; Purlin, ANPR 79, at 2; Jeffers, ANPR 116, at 5.
\583\E.g., FTC v. Minuteman Press, Int'l, No. 93-CV-2494 (DRH)
(E.D.N.Y. 1998). See also Franchise NPR, 64 FR at 57311; ANPR, 62 FR
at 9118.
---------------------------------------------------------------------------
To prevent deception arising from these two practices, Item 19
requires franchisors to include in their Item 19 disclosures a
prescribed preamble stating that the Rule permits the making of
financial performance representations, if the representations are set
forth in the franchisor's disclosure document.\584\ This statement
counters any suggestion that the Franchise Rule prohibits franchisors
from disclosing financial performance information. Armed with such
material information, prospective franchisees could question why a
franchisor does not provide financial performance data, if they wish,
or shop for a system that discloses financial performance information.
In addition, this preamble will discourage prospects from relying on
unauthorized financial performance claims made outside of the
disclosure document.
---------------------------------------------------------------------------
\584\ The first preamble reads:
``The FTC's Franchise Rule permits a franchisor to provide
information about the actual or potential financial performance of
its franchised and/or franchisor-owned outlets, if there is a
reasonable basis for the information, and if the information is
included in the disclosure document. Financial performance
information that differs from that included in Item 19 may be given
only if: (1) a franchisor provides the actual records of an existing
outlet you are considering buying; or (2) a franchisor supplements
the information provided in this Item 19, for example, by providing
information about possible performance at a particular location or
under particular circumstances.''
---------------------------------------------------------------------------
For those franchisors who elect not to disclose financial
performance information, Item 19 requires a second preamble, warning
prospective franchisees not to rely on unauthorized performance
representations and to report the making of such unauthorized
representations to the franchisor, the Commission, and appropriate
state agencies.\585\
---------------------------------------------------------------------------
\585\ The second preamble reads:
``We do not make any representations about a franchisee's future
financial performance or the past financial performance of company-
owned or franchised outlets. We also do not authorize our employees
or representatives to make any such representations either orally or
in writing. If you are purchasing an existing outlet, however, we
may provide you with the actual records of that outlet. If you
receive any other financial performance information or projections
of your future income, you should report it to the franchisor's
management by contacting [name and address], the Federal Trade
Commission, and the appropriate state regulatory agencies.''
---------------------------------------------------------------------------
Several commenters supported the inclusion of preambles in Item 19
in order to clarify the state of the law regarding the making of
financial performance representations. In particular, the first
preamble would correct the common misstatement that the Rule actually
prohibits the making of such representations. According to the AFA, for
example, a clarification of the law is crucial: ``[T]he great untruth
that franchise salespeople have been allowed to perpetrate over the
years is the following statement in one form or another--the federal
government prohibits us from giving you information regarding the
financial performance of [name of our] franchises.''\586\
---------------------------------------------------------------------------
\586\ AFA, NPR 14, at 3. Several commenters confirmed that such
misrepresentations are prevalent and urged the Commission to clarify
the Rule to combat them. For example, the CA BLS stated:
``Franchisees have reported to certain members of the California
Franchise Legislative Committee that franchisor salespersons
informed them during the pre-sale discussions in the offer and sale
of a franchise that the FTC Rule prohibited them from making
earnings claims. Based on these reports, we agree that there is a
need to clarify the Rule to make clear that neither the Commission
nor the Rule prohibits franchisors from making earnings
representations.''
CA BLS, ANPR 124, at 1. Peter Lagarias, a franchisee
representative, similarly told us: ``I am personally aware of
franchisors (and sometimes even their lawyers) stating that earnings
claims are forbidden by the Commission's Rule. The Commission should
clarify in the Rule that the franchisor could elect to make earnings
claims but has elected not to make earnings claims.'' Lagarias, ANPR
125, at 4.
---------------------------------------------------------------------------
Other commenters asserted that the preambles, coupled with market
forces, will encourage the disclosure of financial data. For example,
7-Eleven stated: ``We believe this approach--affirmatively informing
would-be investors about the requirements under the Rule and the manner
in which such information should be disclosed--when combined with the
competitive force of the marketplace, ensures that earnings information
can be identified and properly appraised by franchise investors.''\587\
---------------------------------------------------------------------------
\587\ 7-Eleven, NPR 10, at 3. See also IFA, NPR 22, at 11;
Stadfeld, NPR 23, at 17; H&H, ANPR 28, at 8; Duvall, ANPR 19, at 2;
Jeffers, ANPR 116; CA BLS, ANPR 124, at 2; Zarco & Pardo, ANPR 134,
at 6. But see J&G, NPR 32, at 7 (admonition to prospective
franchisees to notify the FTC and an appropriate state agency of an
unauthorized earnings claim seems a bit excessive).
---------------------------------------------------------------------------
[[Page 15501]]
At the same time, the Commission has rejected various suggestions
to require more strongly worded preambles. For example, Eric Karp would
amplify the second preamble to warn prospects that, although the
franchisor collects financial information, it does not disclose any,
and he suggested including the phrase, ``Consider why we are unwilling
to do so.''\588\ In effect, these commenters would turn the absence of
a financial performance claim into a risk factor. The Commission
rejects this approach. It does not necessarily follow that the absence
of a financial performance disclosure necessarily signals a riskier
investment. It could well be that a company bent on defrauding
prospective franchisees would manipulate its numbers to create a
stronger success image, while a successful but punctilious system might
choose not to disclose numbers because it may not believe that it can
make a reasonable disclosure that would be applicable to all potential
buyers. In addition, any concern that prospective franchisees need to
see actual earnings figures in order to judge success is mitigated by
Item 20, which compels the disclosure of franchise turnover rates, as
well as the names and addresses of current and former franchisees, who
can be contacted for information.
---------------------------------------------------------------------------
\588\ Karp, at 3. In the same vein, Howard Bundy would
strengthen the second preamble to read:
``Financial Performance Information is material to any decision
to invest. [Franchisor] does not provide you with Financial
Performance Information. The absence of such information makes it
very difficult for you to estimate your prospects of success in the
business. You should proceed with caution and consult your franchise
attorney and other business advisors.''
Bundy, NPR 18, at 10.
---------------------------------------------------------------------------
22. Section 436.5(t) (Item 20): Outlets and franchisee information
Section 436.5(t) of the final amended Rule retains the original
Rule's requirement that franchisors disclose the number of franchised
and franchisor-owned outlets; the names, business addresses, and
business telephone numbers of current franchised outlets, and
statistical information on franchise turn-over rates, in particular the
number of franchises voluntarily and involuntarily terminated, not
renewed, and reacquired by the franchisor.\589\ To align the final
amended Rule more closely to the UFOC guidelines, it also extends the
original Rule by requiring franchisors to disclose the names, business
addresses, and business telephone numbers of at least 100 current
franchised outlets (as opposed to the original Rule requirement of at
least 10 franchised outlets).\590\ It also requires the disclosure of
some contact information for former franchisees\591\ who have left the
franchise system in the last fiscal year. Finally, it also makes the
disclosure more user-friendly than it was in the original Rule by
requiring the statistical information to be presented in a tabular
format.
---------------------------------------------------------------------------
\589\See 16 CFR 436.1(a)(16). In the original SBP, the
Commission explained that the required statistical information gives
prospective franchisees material information about the size of the
franchise system they are contemplating joining and goes to the
prospect's likelihood of success. ``Providing a prospective
franchisee with an accurate statement of the number of units
operated by his or her franchisor will convey information relating
to the financial success of the particular franchise business since
the franchisee's ultimate success depends in large measure on public
recognition of the franchisor's name.'' Original SBP, 43 FR at
59670. See also ANPR,
62 FR at 9118. In addition, the disclosure of contact
information for current franchisees prevents fraud by arming
prospects with a valuable alternative source of information with
which to verify franchisor's representations. Id.
\590\ UFOC Guidelines, Item 20B.
\591\ Current and former franchisees often have widely different
experiences. For that reason, in Blenheim Expositions, Inc., 120 FTC
1078 (1995), the Commission challenged as a violation of Section 5,
franchisee success claims based upon a Gallup Poll study of current
franchisees only.
---------------------------------------------------------------------------
Item 20 of the final amended Rule differs from the UFOC Guidelines
model in several respects. First, it corrects a double-counting problem
brought to the Commission's attention during the Rule Review. Second,
it requires more limited disclosure of personal contact information of
former franchisees.\592\ Third, when a franchisor resells a specific
outlet it has reacquired, it mandates that the franchisor disclose the
outlet's prior franchisee-owners during the franchisor's last five
fiscal years. Fourth, it addresses franchisors' use of
``confidentiality clauses,'' which effectively restrict franchisees
from discussing their experiences with prospective franchisees.
Finally, it requires the disclosure of trademark-specific franchisee
associations.\593\ We address each of these issues below.
---------------------------------------------------------------------------
\592\ The UFOC Guidelines require the disclosure of names, last
known home address, and telephone number of each franchisee who left
the system within the last fiscal year. UFOC Guidelines, Item 20E.
The purpose of the disclosure is to reduce fraud by enabling
prospective franchisees to learn about the nature of the franchise
system and, most important, the nature of the franchise relationship
from those who recently exited the system, voluntarily or
involuntarily. To reduce inconsistencies between with the UFOC
Guidelines, the Franchise NPR followed the same approach. Franchise
NPR, 64 FR at 57343. As explained below, however, Item 20, as
proposed in the Franchise NPR, would require the disclosure of
personal information, raising privacy concerns. For that reason, the
Commission has adopted a more limited approach in the final amended
Rule.
\593\ The provision does not require franchisors to disclose the
existence of broad-based organizations that represent franchisee
interests generally, such as the American Franchisee Association,
the American Association of Franchisees & Dealers, or the
International Franchise Association.
---------------------------------------------------------------------------
a. Double-counting
As proposed in the Franchise NPR, the final amended rule avoids a
problem with the UFOC Guidelines' version of Item 20.\594\ Like the
UFOC Guidelines, the final amended Rule Item 20 requires disclosure of
information about franchisees who have recently left the franchise
system, as well as changes in ownership of franchised outlets. During
the Rule amendment proceeding, no commenters opposed this requirement
in principle, but commenters almost unanimously voiced concern that
UFOC Item 20 is seriously flawed and needs to be fixed.\595\
Specifically, UFOC Item 20 often results in franchisors ``double-
counting'' changes in franchised outlet ownership, resulting in
inflated turnover rates.
---------------------------------------------------------------------------
\594\ The problems with the UFOC Guidelines' Item 20 first
surfaced during the Rule review that preceded initiation of the rule
amendment proceeding. Simon, RR Tr., at 223-24; Maxey, RR Tr., at
224-25. To develop a record on this issue, the ANPR solicited
comment on whether UFOC Guidelines Item 20 accurately reflects
franchisees' performance history and, if it does not, how the
Commission could modify the Item 20 disclosures to reflect
performance history more accurately. ANPR, 62 FR at 9116. In
response to the ANPR, several commenters confirmed that Item 20
results in ``double-counting'' of franchise turnover rates. E.g.,
H&H, ANPR 28, at 6; AFA, ANPR 62, at 3; IL AG, ANPR 77, at 2;
Tifford, ANPR 78, at 4; IFA, ANPR 82, at 2; Cendant, ANPR 140, at 3;
Karp, 19 Sept. 97 Tr., at 91. Accordingly, in the Franchise NPR, the
Commission attempted to address the identified problems with the
UFOC version. Franchise NPR, 64 FR at 57342-44. However, commenters
criticized proposed Item 20 of the Franchise NPR as inadequate to
solve the problem. E.g., IL AG, NPR 3, at 7; PMR&W, NPR 4, at 13-14;
H&H, NPR 9, at 19; Snap-On, NPR 16, at 4; NASAA, NPR 17, at 5; Karp,
NPR 24, at 11; Frandata, NPR 29, at 10. At that time, NASAA, in
consultation with an Industry Advisory Committee, developed a
comprehensive revamping of Item 20, which it submitted in its
Franchise NPR comments. NASAA, NPR 17, at 5-10. Several additional
commenters either submitted the same proposal or endorsed the NASAA
proposal. PMR&W, NPR 4, at 14-66 and Exhibit A; NPC, NPR 12, at 31-
32; Frandata, NPR 29, at 11. The Staff Report recommended adoption
of NASAA's suggested revamping of Item 20. Staff Report, at 180. No
Staff Report comments offered further criticism of the staff's
recommendation for revising Item 20.
\595\E.g., H&H, ANPR 28, at 6; AFA, ANPR 62, at 3; IL AG, ANPR
77, at 2; Tifford, ANPR 78, at 4; IFA, ANPR 82, at 2; Cendant, ANPR
140, at 3; Karp, ANPR, 19 Sept. 97 Tr., at 91; Simon, RR, Sept.95
Tr., at 223-24.
---------------------------------------------------------------------------
The Commission believes that the UFOC Guidelines' ``double-
counting'' problem is attributable to at least two factors. First, UFOC
Item 20 requires franchisors to report changes in
[[Page 15502]]
franchised outlet ownership according to five enumerated categories:
(1) transferred; (2) canceled or terminated; (3) not renewed; (4)
reacquired by the franchisor; or (5) reasonably known to have ``ceased
to do business.'' The terms describing these categories, however, are
undefined. The absence of precise definitions blurs the line between
categories, resulting in a double-counting of outlet closures.\596\ For
example, a single transaction can quite correctly be characterized as
either a transfer or a reacquisition. They are often two sides of the
same coin: a franchisor's assumption of control of a franchised outlet
that has gone out of business reasonably could be captured either as a
transfer by the franchisee, or as a reacquisition by the franchisor.
---------------------------------------------------------------------------
\596\See UFOC Item 20D. See also Wieczorek, ANPR, 18 Sept. 97
Tr., at 31.
---------------------------------------------------------------------------
Second, even if the definitions were clear, UFOC Item 20 can be
interpreted to require the disclosure of each of a series of events
associated with a single outlet ownership change.\597\ For example,
after terminating a franchise agreement, the franchisor may reacquire
the outlet. The franchisor could then either operate the outlet as a
franchisor-owned store, or sell it to a new franchisee. In such a case,
UFOC Item 20 arguably calls for the franchisor to report a termination
followed by a reacquisition as two separate events. Similarly, a
franchisee may abandon an outlet, and, in response, the franchisor may
send the franchisee a termination letter, reacquire the outlet, and
then transfer it to a new franchisee. Although the outlet has changed
franchisee-ownership only once, the franchisor conceivably would report
this event four times as a ceased to do business, termination,
reacquisition, and transfer.\598\
---------------------------------------------------------------------------
\597\ For a detailed discussion of this issue, see Franchise
NPR, 64 FR at 57312; Staff Report, at 173-77.
\598\ While the UFOC Item 20 instructions provide that the
franchisor can add footnotes to clarify the numbers, the use of
multiple explanatory footnotes removes the benefit of presenting
information in a readily accessible tabular format. In addition,
prospective franchisees may not read or fully appreciate the import
of the footnotes. See Zarco & Pardo, ANPR 134, at 6-7 (``If the
[Item 20] information becomes too complicated, the potential
franchisee will not know how to interpret the data and thus, derive
no benefit from the increased efforts at meaningful disclosure.'').
---------------------------------------------------------------------------
The final amended Rule remedies the imprecision that characterized
the delineated reporting categories. Item 20 of the final amended Rule
sets forth precise definitions to avoid overlapping categories.
Specifically, ``termination'' means ``the franchisor's termination of a
franchise agreement prior to the end of its term and without paying
consideration to the franchisee (whether by payment or forgiveness or
assumption of debt).'' ``Non-renewal'' occurs ``when the franchise
agreement for a franchised outlet is not renewed at the end of its
term.'' ``Reacquisition'' means ``the franchisor's acquisition of an
outlet for consideration (whether by payment or forgiveness or
assumption of debt) of a franchised outlet during its term.''
``Transfer'' means ``the acquisition of a controlling interest in a
franchised outlet during its term by a person other than the franchisor
or an affiliate.''\599\
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\599\ Staff Report, at 48-53. The definitions of the terms
``transfer'' and ``reacquisition'' are the same as those proposed in
the Franchise NPR, with minor reorganization for clarity. The
definitions of the terms ``termination'' and ``non-renewal,''
however, have been revised for greater precision. Specifically, the
Franchise NPR defined the terms ``termination'' and ``non-renewal''
as occurring when the franchisor sends out an ``unconditional notice
of intent'' to exercise its rights to terminate or not to renew,
respectively. Franchise NPR, 64 FR at 57343. One commenter noted,
however, that these proposed definitions are inaccurate, noting that
``intent to exercise'' rights does not ``necessarily result in the
completion of the event.'' PMR&W, NPR 4, at 13. The Commission
agrees. In addition, the final amended Rule deletes the proposed
definition for ``cancellation''--which would have been similar to
the definition for ``termination''--because the ``cancellation''
reporting category has been deleted from Item 20 because it is
duplicative of other reporting categories (termination, non-renewal,
or ceased operations). No commenters raised any concerns in response
to the Staff Report's revised definitions of the terms
``termination'' and ``non-renewal.''
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Beyond better defined reporting categories, commenters offered
various suggestions to improve Item 20.\600\ The approach suggested by
NASAA garnered the most support. NASAA asserted that UFOC Item 20 needs
to be revised in its entirety and, as noted above, submitted for the
Commission's consideration an alternative that was produced with the
assistance of an Industry Advisory Committee.\601\ Several other
commenters submitted the same proposal or endorsed the NASAA
proposal.\602\ The Staff Report recommended that the NASAA suggestion
be incorporated into the final amended Rule. After careful
consideration, the Commission has determined to adopt NASAA's proposal.
It is the best way to solve the Item 20 double-counting problem. It
will be easily understood by those in the industry, and it will provide
prospective franchisees with the information they need without imposing
undue compliance burdens on franchisors.
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\600\ Three commenters suggested that the Commission address
double-counting by adding additional reporting categories to the
Item 20 disclosure. For example, Robert Zarco recommended that the
Commission create multiple categories to capture various
combinations of ownership changes. Transfers, for instance, would be
divided into four distinct categories: (1) transfers by the
franchisee to the franchisor; (2) transfers by franchisees to the
franchisor, but ultimately re-franchised; (3) transfers by
franchisee directly to new franchisee; and (4) transfers by
franchisee directly to new franchisee more than once. Zarco & Pardo,
ANPR 134, at 6-7. See also Karp, ANPR 136 (suggesting that the
Commission add columns for newly developed outlets and outlets
converted from franchisor-owned, as well as distinguish between
units not renewed by franchisor and units not renewed by
franchisee). Similarly, the AFA recommended that franchisors create
as many categories as needed to capture all combinations of
ownership changes that might occur at each outlet during the course
of the year. For example, a termination followed by a transfer to a
new owner would be reported as a ``termination and transfer,'' while
a termination followed by a reacquisition to the franchisor and then
a transfer to a new franchisee would be reported as a ``termination,
reacquisition, transfer.'' AFA, ANPR 62, at 3. Another franchisor
representative opined that most double-counting problems are
attributable to the inclusion of transfers and reacquisitions in the
table summarizing the status of franchised outlets. He advised that
transfers and reacquisitions usually follow an initial closing, such
as a termination or non-renewal. He suggested that transfers and
reacquisitions--which are the consequence of an outlet closure--be
offset from the outlet closing statistics. To that end, he proposed
that transfers be removed from the main body of the franchisee
statistics table and placed in a separate column located on the side
of the franchisee statistics table. Further, he suggested that
reacquisitions should be moved to the second Item 20 table
concerning franchisor-owned outlets. Wieczorek, ANPR 122, at 3-4.
Mr. Wieczorek attached sample tables for the Commission's
consideration. Id.
\601\ NASAA, NPR 17, at 5-10.
\602\See, e.g., Gust Rosenfeld, at 6; PMR&W, NPR 4, at 14-66 and
Exhibit A; NFC, NPR 12, at 31-32; Frandata, NPR 29, at 11.
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Accordingly, Item 20 of the final amended Rule contains five
tables. Table No. 1 indicates the status of a franchisor's system. It
shows the number of franchised and company-owned outlets at the
beginning and end of each of the last three fiscal years, and the total
net change.\603\
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\603\ The instructions to Table No. 1--section 436.5(t)(1)--
defines ``outlet'' to include ``outlets of a type substantially
similar to that offered to the prospective franchisee.'' Piper
Rudnick urged the Commission to clarify the phrase ``substantially
similar'' further in the Compliance Guides. Specifically, the firm
recommended that ``substantially similar'' should be limited to
where the outlet does ``business under the same trademark and
system.'' Piper Rudnick, at 6. We disagree. Section 436.5(t)(1)'s
``substantially similar'' outlet disclosure serves an important
anti-fraud purpose, ensuring that a franchise system does not simply
sell outlets under a new name in order to hide a poor growth record
or high turnover history. For that reason, the focus of the
disclosure is properly on the similarities between the goods or
services sold at the outlets, not the name under which the outlets
conduct business.
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Table No. 2 shows transfers, treating them separately from
terminations and non-renewals. This is appropriate because, as NASAA
observed, transfers do not affect the total number of outlets in a
franchise system, and the mere fact that an outlet has been transferred
tells nothing about the reason for the transfer: ``While some transfers
are
[[Page 15503]]
problematic for franchisees or prompted from disputes, many other
transfers simply reflect a desire on the part of the franchisee to
cease operating a franchise or to pursue other opportunities.''\604\
Nonetheless, the total number of transfers within a system is material
because it goes to the stability within the franchise system over time.
Table No. 2 indicates the number of franchise transfers in each state
over the last three fiscal years.
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\604\ NASAA, NPR 17, at 8.
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Table No. 3 tracks the turnover rate of franchised outlets.\605\
Franchisors must report, by state and for each of the last three fiscal
years, the outlets at the start of the year, new outlets opened,
terminations, non-renewals, reacquisitions by the franchisor, outlets
that ceased to do business,\606\ and outlets at the end of the year.
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\605\ To reduce double-counting, Item 20 specifies that multiple
events are to be reported using a ``last-in-time'' approach. See
PMR&W, NPR 4, at 13-14. See also NASAA, NPR 17, at 5-10; Frandata,
NPR 29, at 11. During the Rule amendment proceeding, other
commenters offered other options, such as a ``first-in-time''
approach, or establishing an order of priority among events. We are
persuaded that a last-in-time approach is appropriate, for the
reasons noted in the PMR&W comment: ``A last-in-time prioritization
is appropriate for at least three reasons: (1) it allows for an
easily ascertainable confirmation of the event; (2) it represents a
fact, rather than an intention (e.g., a termination notice) or a
proposal (e.g., a transfer rather than request); (3) in dispute
situations, it labels the event in a manner consistent with the
parties' settlement of their dispute.'' PMR&W, NPR 4, at 13-14.
\606\ The instructions accompanying Table No. 3 include the
statement that the franchisor must, in column 8 of the table,
``state the total number of outlets in each state not operating as
one of the franchisor's outlets at the end of each fiscal year for
reasons other than termination, non-renewal, or reacquisition by the
franchisor.''
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Table No. 4 tracks the turnover at company-owned outlets.
Franchisors must disclose, for each of the last three fiscal years, the
number of their outlets at the start of the year, new outlets,
reacquired outlets, closed outlets, outlets sold to franchisees, and
outlets at the end of the year.
Finally, Table No. 5 retains the current UFOC projected openings
table. This table gives prospective franchisees insight into
anticipated growth within the system by requiring the disclosure of
both projected franchised and company-owned openings in the next fiscal
year. It also reveals the number of franchise agreements signed in the
previous year where a store has not yet been opened. This information
is material because it enables a prospective franchisee to gauge how
long it may take before his or her store actually becomes operational.
During the Rule amendment proceeding, Eric Karp submitted a
variation of the NASAA proposal for the Commission's consideration that
would greatly expand the NASAA proposal. For example, according to the
Karp proposal, Table No. 2 would require franchisors to disclose not
only the number of transfers in each of the last three fiscal years,
but also the number of completed transfers, requests for transfer that
were denied, and those transfers in progress at the end of the fiscal
year. His Table No. 3 would divide new outlets into two categories: new
outlets that are newly developed and new outlets that were purchased
from a franchisor. Mr. Karp also proposed a new table that would
calculate a specific turnover rate, expressed as a percentage, by
comparing the number of outlets at the beginning of a fiscal year with
the number of outlets during the year that were terminated by the
franchisor, non-renewed, repurchased by the franchisor, transferred to
another franchisee, or ceased operations for other reasons. Finally,
Mr. Karp would revise the new growth projection chart, requiring
franchisors to disclose for each of the last three fiscal years:
previously projected franchised new outlets; actual number of
franchised new outlets; franchise agreements signed but outlets not in
operation; and projected franchised new outlets for next fiscal
year.\607\
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\607\ Karp, at 4; Karp, NPR 24, at 14-19.
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The Commission is not persuaded to expand Item 20 as Mr. Karp
suggested. The additional proposed disclosures would greatly increase
the size of the already extensive Item 20 disclosure, potentially
overwhelming prospective franchisees while increasing franchisor
compliance costs. Further, to streamline the Rule and reduce
inconsistencies with the UFOC Guidelines, we are disinclined to add new
Item 20 charts that merely restate information that can already be
gleaned from the existing charts. For example, the amended Item 20
disclosures enables prospective franchisees to calculate turnover rates
for themselves from the data contained in Tables 1 and 3 by comparing
outlets at the beginning of a fiscal year with the number of outlets
closed during the year.
b. Identification of former franchisees
Section 436.5(t)(5) of the final amended Rule adopts the Franchise
NPR proposal that franchisors disclose contact information for
franchisees who have exited the franchise system in the most recently
completed fiscal year, consistent with the UFOC Guidelines.\608\ This
disclosure, like the parallel disclosure of contact information for
current franchisees, prevents fraud by giving prospective franchisees
additional sources of material information about the franchisor, the
nature of the franchise system and the franchisor-franchisee
relationship. As explained below, the final amended Rule provision
differs from the UFOC Guidelines and the Franchise NPR proposal,
however, to address privacy concerns regarding the disclosure of
personal contact information.\609\
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\608\ UFOC Guidelines Item 20 E. In contrast, the comparable
provision of the original Rule required the disclosure of only the
number of franchisees who left the system within the last fiscal
year. 16 CFR 436.1(a)(16).
\609\ No commenter--including current and former franchisees--
raised any privacy concerns during the course of the Rule amendment
proceeding. Accordingly, this was not addressed in the Staff Report.
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The Franchise NPR, incorporating UFOC Guidelines Item 20, would
have required franchisors to disclose the name and last known home
address and telephone number of every franchisee that exited the system
within the last fiscal year.\610\ While the Commission believes that
such information serves a valuable anti-fraud purpose--enabling
prospective franchisees to obtain material information from those with
hands-on experience with the franchise system--it can be achieved in a
more limited fashion that also protects former franchisees' privacy--
notwithstanding that this type of information may be available in the
public domain from such sources as telephone directories. To that end,
the final amended Rule provision requires franchisors to disclose only
the name, city and state, and current business telephone number, or, if
unknown, the last known home telephone number of former franchisees.
Further, to give prospective franchisees notice that their contact
information may be disclosed even after they leave the franchise
system, franchisors must state the following language in immediate
conjunction with the list of former franchisees: ``If you buy this
franchise, your contact information may be disclosed in the future to
other buyers when you leave the franchise system.''\611\ To allow for
greater flexibility, footnote 10 to the final amended Rule provides
that franchisors may substitute alternative contact
[[Page 15504]]
information at the request of the former franchisee, such as a home
address, post office address, or a personal or business email address.
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\610\ In contrast, the disclosure of current franchisees'
contact information is limited to their business address and
business telephone number.
\611\ This approach is similar to the proposed disclosure of
current business opportunity buyers' contact information in recently
published Business Opportunity Rule Notice of Proposed Rulemaking,
71 FR 19054, 19071 (Apr. 12, 2006).
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c. Identification of former franchisee-owners of a specific outlet
being resold
Section 436.5(t)(6) of the final amended Rule extends the original
Rule and UFOC Guidelines Item 20 by addressing turnover at a specific
outlet. When a franchisor resells an outlet under its control that was
previously owned by a franchisee,\612\ Item 20 requires the franchisor
to disclose contact information for each previous owner of that outlet,
the time period when the previous owner controlled the outlet; the
reason for each previous ownership change; and the time period(s) when
the franchisor retained control of the outlet. As explained below, this
provision is designed to prevent fraud in the resale of a specific
franchised outlet, by giving prospective purchasers of that outlet
sources of information with hands-on experience operating the
outlet.\613\
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\612\ This modifies slightly the version of Item 20 set forth in
the Staff Report, which stated: ``If a franchisor is selling an
existing franchised outlet, disclose the following additional
information . . .'' Staff Report, at 181 and proposed revised Rule,
64 FR at 57342-44. Two commenters correctly noted that this language
is ambiguous because ordinarily a franchisor does not sell an
existing franchised outlet. Rather, a franchisor may sell an outlet
in its control that was previously owned by a franchisee. Wiggin &
Dana, at 3; J&G, at 6. We agree. This provision applies only where
the franchisor has reacquired or otherwise gained control of an
outlet. It would not apply where an existing franchisee merely asks
for the franchisor's assistance in transferring an outlet to a new
owner.
\613\ As discussed in the previous section in connection with
the disclosure of contact information for former franchisees, the
disclosure of contact information for former franchisees of a
specific outlet differs from the Franchise NPR proposal to address
privacy issues. To protect the privacy of former franchisee-owners
of a specific outlet, the amended Item 20 requires the disclosure of
only the name, city and state, business telephone number, or, if
unknown, last known home telephone number of the former franchisee-
owners.
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During the Rule amendment proceeding, the IL AG asserted that a
number of successive sales of a franchised outlet could indicate
``churning,'' the practice whereby a franchisor turns a blind eye to
franchisee failures--or worse, encourages them--in order to sell the
same outlet repeatedly. The IL AG urged the Commission to require
franchisors to provide a prospect with a detailed site history when a
buyer is being directed to a particular location. ``This could be a
three year history that would chart prior franchisees, their dates of
operation, dates of store management by the franchisor for the site,
and the reasons previous franchisees departed from that site.''\614\
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\614\ IL AG, NPR 3, at 7. See also Singler, at 1. This provision
also complements Item 19 provision that permits a franchisor to
provide supplemental financial performance information about a
specific unit being offered for sale. In order to prevent
misrepresentation, a prospective franchisee should be able to speak
with former owners of a specific unit being offered for sale when a
franchisor provides financial performance information about that
specific unit.
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The Commission agrees, but is convinced that a five-year reporting
period is warranted in order to allow sufficient time to identify a
trend.\615\ As noted throughout this document, the Commission believes
that more disclosure is warranted to give prospective franchisees
information about the quality of the relationship between the
franchisor and franchisee. Information about franchise operations at a
specific unit advances that goal. Surely, significant turnover at a
particular location might indicate a lack of promised support for the
location, or worse, as the IL AG explained, a possible franchisor
strategy to have the franchisee fail in order to resell the unit. We
believe any compliance costs to the franchisor, therefore, are
outweighed by the countervailing benefits to prospective franchisees.
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\615\ We note that the Staff Report urged the Commission to
adopt a three-year reporting period, while the text of the proposed
revised Rule attached to the Staff Report stated a five-year
reporting period. Compare Staff Report, at 181 with proposed revised
Rule, at 56. Some commenters urged the Commission to adopt a three
year reporting period, Wiggin & Dana, at 3, while others said that
even a five-year period is insufficient to ``discern the most
egregious trends''). Singler, at 2. We are convinced that a three-
year reporting period is too short to expose a trend of specific
unit sales. For example, a single unit could be resold three times:
once immediately before a three-year reporting period, a second time
during a three-year period, and a third time immediately after the
three-year period. In such a scenario, a three-year reporting period
would capture only one resale. We believe a five-year reporting
period strikes the right balance between ensuring material
disclosure and reducing compliance burdens.
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In response to the Staff Report, two commenters raised questions
about the application of this provision. Specifically, they observed
that a franchisor might not have a particular unit in mind when it
begins negotiations with a prospective franchisee. They speculated as
to whether this provision would be triggered if a franchisor were to
direct a prospect to a particular unit after the franchisor has
furnished the prospect with a disclosure document. In particular, they
noted that it would be an open question under state law as to whether a
franchisor would have to redisclose including unit-specific
disclosures, and whether redisclosure would trigger an additional 14
days before signing the agreement.\616\
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\616\ Wiggin & Dana, at 4; J&G, at 6.
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The commenters urged that a franchisor be permitted to furnish the
unit-specific disclosures outside the disclosure document, just as a
franchisor may make supplemental financial performance claims outside
of the disclosure document without triggering a redisclosure
obligation.\617\ The Commission believes these comments are well-taken.
The purpose of this provision is to provide prospective franchisees
with material information about a specific unit being considered for
purchase. The need for furnishing this information must be balanced
against the legitimate concerns of franchisors about compliance costs.
On balance, the Commission is persuaded that a franchisor who
recommends a specific unit after having made proper disclosure should
have the option of providing the unit-specific information in a
supplement to the disclosure document, if it so chooses. Accordingly,
Item 20 provides: ``This information may be attached as an addendum to
a disclosure document, or, if disclosure has already been made, then in
a supplement to the previously furnished disclosure document.''\618\
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\617\ Wiggin & Dana, at 4.
\618\ Indeed, this approach is consistent with UFOC Guidelines
Item 19, which permits franchisors who have made an Item 19
financial performance disclosure to provide prospective franchisees
with supplemental data ``directed to a particular location or
circumstance, apart from the [disclosure document.]'' UFOC
Guidelines, Item 19A, Instructions (ii).
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d. Confidentiality clauses
Section 436.5(t)(7) addresses franchisors' uses of confidentiality
clauses, as proposed in the Franchise NPR.\619\ This is a new provision
that is not in the original Rule or UFOC Guidelines. If, during the
last three fiscal years, franchisees signed a confidentiality clause in
a franchise agreement, settlement, or in any other contract with the
franchisor, the franchisor must insert in their Item 20 disclosure the
following prescribed statement: ``In some instances, current and former
franchisees sign provisions restricting their ability to speak openly
about their experience with [name of franchise system]. You may wish to
[[Page 15505]]
speak with current and former franchisees, but be aware that not all
such franchisees will be able to communicate with you.'' In addition, a
franchisor may, at its option, also disclose the number and percentage
of current and former franchisees who signed confidentiality
agreements, as well as the circumstances under which such clauses were
signed.
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\619\ Franchise NPR, 64 FR at 57312-14. As set forth in the
definitions section, the term ``confidentiality clause'' means ``any
contract, order, or settlement provision that directly or indirectly
restricts a current or former franchisee from discussing his or her
personal experience as a franchisee in the franchisor's system with
any prospective franchisee. It does not include clauses that protect
franchisor's trademarks or other proprietary information.'' Section
436.1(c).
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This provision was prompted by numerous comments from franchisees
and their advocates urging the Commission to address the use of
confidentiality clauses in franchising. Indeed, one quarter of the ANPR
commenters (42 out of 166 commenters) and several speakers at public
workshop conferences addressed the confidentiality clause issue, the
majority opposing their use.\620\ The most poignant example was a
franchisee of an undisclosed franchise system who related that she had
to speak quickly because she was on her way to sign a final agreement
terminating her relationship with her franchisor. The agreement she was
about to sign included a confidentiality clause.\621\ These commenters
complained that the use of confidentiality clauses is widespread,\622\
and several commenters urged the Commission to ban the use of
confidentiality clauses as a deceptive or unfair trade practice.\623\
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\620\E.g., Manuszak, ANPR 13; Paquet, ANPR 18; Rachide, ANPR 32;
Sibent, ANPR 41 (and 19 identical ANPR commenters); AFA, ANPR 62, at
3; Buckley, ANPR 97; Marks, ANPR 107, at 2; NASAA, ANPR 120, at 4;
Dady & Garner, ANPR 127, at 2; Karp, ANPR, 19 Sept. 97 Tr., at 95.
Opponents included several franchisor representatives. E.g.,
Kestenbaum, ANPR 40, at 2. Cendant opposed the use of
confidentiality clauses, except to protect trade secrets or other
proprietary information. Cendant, ANPR 140, at 3.
\621\ The franchisee stated:
``I am at this point not going to state the franchise because I
am on my way at 1:00 to sign the final divorce papers, as such, the
papers that separate us legally. There's a gag order there. So, if
you are planning on putting this on the Internet, that could be a
problem. . . [T]he gag order . . . prohibits me from being able to
answer questions, you know, and give cautionary remarks to other
people who might be considering the franchise that I was with.''
Lundquist, ANPR, 22 Aug. 97 Tr., at 42-43. See also Maloney,
ANPR 38, at 2 (``When it became apparent to both me and Southland
Corporation that it was time to terminate our business relationship,
we began negotiating my exit from the system. We came to a mutually
acceptable agreement, however, the agreement contained a
confidentiality clause. Even if my name appears in a UFOC as a
former Franchisee, how much help can I give to anyone asking a
question?'').
\622\ For example, Susan Kezios of the AFA stated that ``the use
of gag orders is almost 100 percent in some franchise systems.''
Kezios, ANPR, 6 Nov. 97 Tr., at 241. See also NASAA, at 6 (noting
``continued prevalence of confidentiality clauses in franchising'');
Lagarias, ANPR 125, at 3 (``I have found that in most of the actions
I have settled, the defendant franchisors and their counsel insist
on confidentiality.''); Selden, ANPR 133, at Appendix B
(``[Confidentiality clauses] are becoming increasingly problematic
to franchisees.''). See also Karp, ANPR, 19 Sept. 97 Tr., at 92-93.
Several franchisor representatives, on the other hand, insisted that
confidentiality clauses are rare. E.g., Tifford, ANPR 78, at 3;
Duvall, ANPR, 6 Nov. 97 Tr., at 240.
It is apparent that franchisee and franchisor commenters
addressed two different types confidentiality clauses: pre-sale and
post-sale confidentiality clauses. The record indicates that
franchisors do not routinely require franchisees to sign
confidentiality agreements at the time of sale. See Wieczorek, ANPR,
18 Sept. 97 Tr., at 50. Indeed, no franchisees who commented on
confidentiality clauses reported that they were required to sign a
confidentiality provision in their initial franchise agreement.
Nonetheless, it is clear that franchisors often require franchisees
to sign post-sale confidentiality provisions in dispute settlements
or as a condition to termination. See, e.g., Slimak, NPR 130;
Maloney, ANPR 38, at 2; D'Alessandro, ANPR, 22 Aug. 97 Tr., at 40;
AFA, ANPR 62, at 3; Doe, ANPR, 7 Nov. 97 Tr., at 276; Rafizadeh,
id., at 299-300; Lundquist, ANPR, 22 Aug. 97 Tr., at 42-43;
Lagarias, ANPR 125, at 3. Franchisors' forceful defense of
confidentiality clauses on the grounds that they promote informal
settlement of disputes also tends to support the view that such
clauses are common in settlements. See Forseth, ANPR, 18 Sept. 97
Tr., at 40. See also Marks, ANPR, 19 Sept. 97 Tr., at 8-9.
\623\See IL AG, NPR 3, at 3 (``The ability of a prospective
franchisee to freely discuss a present or former franchisee's
experience with the franchisor may be the single most important step
in a buyer's due diligence investment evaluation.''). See also IL
AG, NPR Rebuttal 38, at 3; Manuszak, ANPR 13, at 1; Rachide, ANPR
32, at 3; Sibent, ANPR 41, at 1 (and 19 identical ANPR comments).
Three franchisees-- Raymond Buckley, Roger C. Haines, and David E.
Myklebust--believed that they were kept in the dark about the
failure of their franchisor's system due to confidentiality clauses
imposed on current and former franchisees. Buckley, ANPR 97, at 1;
Haines, ANPR 100, at 2; Myklebust, ANPR 101, at 1.
---------------------------------------------------------------------------
Other opponents of confidentiality clauses--including state
regulators and some franchisors--asserted that such provisions inhibit
prospective franchisees from learning the truth as they conduct their
due diligence investigation of a franchise offer. As noted above,
current and former franchisees are often a valuable source of
information about the franchise investment and can often verify or
discredit the franchisor's claims, especially financial performance
representations.\624\ Attempts to restrict franchisee speech through
confidentiality provisions may deceive prospects by effectively
eliminating one crucial source of information, namely those current and
former franchisees who may have a dispute with the franchisor or are
otherwise disgruntled.\625\ Indeed, a franchisor, if it wished to do
so, could attempt to use confidentiality provisions to ensure that
prospects speak with only those franchisees who are successful or
otherwise inclined to give a positive report.\626\ In addition, one
franchisee representative, contended that the harm flowing from
confidentiality provisions goes beyond individual franchise sales,
noting that such provisions intimidate franchisees into not testifying
before legislative committees and public agencies, such as the Federal
Trade Commission.\627\
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\624\ For example, the AFA stressed that confidentiality clauses
``typically release the franchisor from legal liability and bar the
franchisee (under threat of legal action) from making any oral or
written statements about the franchise system or their experience
with the franchised business. The purpose of such clauses is to shut
down any negative public comment about the franchise system.'' AFA,
NPR 14, at 3. See also, NCL, ANPR 35, at 3; Baer, ANPR 25, at 3;
Karp, ANPR, 19 Sept. 97 Tr., at 95-96.
\625\ For example, Roger Haines, a Scorecard Plus franchisee,
related:
``I had spoken to some of the franchisees that had left the
system. I now feel certain that they painted a picture that was not
close to being the truth based on the gag order that [the
franchisor] imposed. Had I gotten the truth from these people, my
decision certainly would have been different. Every franchisee
leaving the system has had a gag order placed on them, making it
impossible for current and future franchisees to get the facts.''
Haines, ANPR 100, at 2. See also Cantone, ANPR, 18 Sept. 97 Tr.,
at 50 (``[T]he whole concept of a gag order is really destructive
and . . . needs to be addressed.'').
\626\See NASAA, ANPR 120, at 4.
\627\ Selden, ANPR 133, Appendix B.
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On the other hand, several franchisors and their representatives
opposed banning the use of confidentiality clauses. For example, David
Kaufmann asserted that confidentiality provisions prevent disgruntled
franchisees from inflaming others and enable franchisors to end bad
relationships with problem franchisees without spending considerable
resources. He contended that banning confidentiality provisions would
discourage informal settlements with franchisees.\628\ Others added
that franchisors must have the ability to protect their trade secrets
from disclosure.\629\
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\628\ E.g., Kaufmann, ANPR 33, at 5-6. See also, e.g., Quizno's,
NPR 1, at 2; H&H, NPR 9, at 20; Baer, NPR 11, at 14; NaturaLawn, NPR
26, at 2; Marriott, NPR 35, at 16; Snap-On, NPR 16, at 4 (urging the
Commission either not to adopt the proposed disclosure or to revise
it in a manner to accommodate franchisors' interests in fostering
early and amicable settlements). J&G added that a confidentiality
clause disclosure is unnecessary because the Rule already sheds
light on the franchise relationship. ``If efforts at obtaining
additional information are unsuccessful because of confidentiality
agreements, a reasonable prospective franchisee should be able to
take that fact into its evaluation of whether to buy the franchise.
And additional disclosure about `gag clauses' is not helpful.'' J&G,
NPR 32, at 14.
\629\E.g., Baer, ANPR 25, at 3. Franchisee advocates also
recognized franchisor's legitimate need for trademark protection.
E.g., Singler, at 2; AFA, ANPR 62, at 3; Dady & Garner, ANPR 127, at
2; Zarco & Pardo, ANPR 134, at 4. For that reason, the definition of
``confidentiality clause'' specifically excludes confidentiality
agreements to protect trademarks and other proprietary information.
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The Commission believes that the record does not support an
outright ban
[[Page 15506]]
on confidentiality clauses. Clearly there are instances where both
franchisors and franchisees enter into such clauses voluntarily. As
Marriott noted, franchisees in contract modification negotiations may
seek or at least agree to confidentiality in order to gain certain
advantages.\630\ Under the circumstances, we cannot conclude that harm
to franchisees from confidentiality clauses necessarily outweighs the
potential benefits to franchisees, as well as franchisors.
Nevertheless, based upon the record, the Commission is persuaded to
adopt a balanced provision requiring franchisors to disclose their use
of confidentiality clauses over the last three years. The Commission is
convinced that franchisees often sign post-sale agreements containing
confidentiality clauses in connection with dispute settlements and
terminations. This practice may impede prospective franchisees' ability
to conduct due diligence investigations of franchise offerings,
undercutting the primary goal of pre-sale disclosure.\631\
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\630\ Marriott, NPR 35, at 16. But see Karp, at 8 (``It
incorrectly implies that the franchisee that signed the
confidentiality provision had a choice whether to do so or not.'').
\631\See AFA, at 3; Karp, at 8. See also FTC v. Orion Prods.,
Bus. Franchise Guide (CCH) ] 10970 (N.D. Cal. 1997) and United
States v. Tutor Time Child Care Sys., Inc., No. 96-2603 (N.D. Cal.
1996). While in these two cases the Commission did not challenge the
defendants' use of confidentiality clauses as either a Rule or
Section 5 violation in its complaints, it did obtain fencing-in
provisions in settlements that prohibited the defendants from
enforcing or entering into confidentiality provisions for a limited
time.
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The Commission believes that the final amended Rule's
confidentiality clause disclosure requirement strikes the appropriate
balance between informing prospective franchisees that franchisees in
the system may not be able to share information with them, and
minimizing compliance burdens. Of the various proposals offered by the
commenters, a general disclosure notifying prospects about the
franchisor's use of a confidentiality provision garnered the most
support. For example, Howard Bundy told us that ``[i]n a perfect world
I would have a list of those that are subject to [confidentiality
provisions], so I didn't have to make all those extra 75 calls. But I
could live with or without that. It's more important to disclose the
fact that they do exist.''\632\
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\632\ Bundy, ANPR, 6 Nov. 97 Tr., at 249. See also AFA, at 3;
Gee, at 2; Pu, at 1-2; Selden, ANPR 133, Appendix B; Zarco & Pardo,
ANPR 134, at 4; Jeffers, ANPR, 6 Nov. 97 Tr., at 251-52; Wieczorek,
ANPR, 6 Nov. 97 Tr., at 260. But see Singler, at 2 (permitting
disclosure, but accepting that individuals may be contractually
forbidden to discuss the franchisor makes little sense).
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Other than the required statement explaining the nature of
confidentiality clauses to prospects who may be unfamiliar with their
use, any other disclosures--such as number and percentage or the
reasons for the clauses--are entirely voluntary.\633\ Moreover, we are
unpersuaded that this approach would discourage settlements.
Franchisors opting to pursue litigation in lieu of settlement in order
to avoid the confidentiality disclosure would most likely have to
disclose even more revealing information about the suit in their Item 3
disclosure.
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\633\ Several commenters generally supported this provision. See
NFA, NPR 27, at 1. See also AFA, NPR 14, at 3; Bundy, NPR 18, at 3;
Stadfeld, NPR 23, at 5; Karp, NPR 24, at 21-22. But see NASAA, at 6;
WA Securities, at 4-5; Singler, at 2 (asserting that franchisor
should be required to disclose number and percentage information
concerning their use of confidentiality agreements).
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Further, the confidentiality disclosure does not reach
confidentiality clauses addressing specific contract negotiation terms
and conditions.\634\ We recognize that there may be instances where
both franchisors and franchisees may not wish to discuss specific terms
of an arrangement, such as the price paid for a franchise, or other
concessions made to a franchisee. The confidentiality clause disclosure
would be unwarranted, therefore, where the parties agree to a limited
restriction that still enables franchisees to discuss their overall
experience in the franchise system.\635\
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\634\See Tricon, NPR 34, at 3 (urging the Commission to exclude
settlement details--such as the price paid to reacquire a franchised
outlet--from the disclosure if the franchisee is otherwise free to
discuss his or her personal experience as a franchisee). See also
Quizno's, NPR 1, at 2; Marriott, NPR 35, at 16. Marriott asserted
that the disclosure will create a disincentive for franchisors to
accommodate franchisees' needs in non-standard deals. It noted that
franchisors ``make a variety of concessions to franchisees in
connection with workouts or in connection with sales, or purchasing
or conversion of multiple units, among others, in exchange for which
the franchisor will request the terms of such arrangements to be
kept confidential.'' Id.
\635\ The extent to which franchisors must disclose confidential
settlement terms and conditions is spelled out in Item 3.
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In reaching our conclusion to adopt the confidentiality clause
disclosure, we have carefully weighed suggestions to expand or to
narrow the disclosure requirement. For example, we reject the
suggestion that franchisors identify specific individual franchisees
listed in Item 20 who are subject to a confidentiality clause.\636\ We
are persuaded that this suggestion goes beyond what is reasonably
necessary to address the use of confidentiality clauses. No doubt a
prospective franchisee's due diligence investigation of the franchise
offering would be more efficient if the prospect could eliminate from
its contact list those franchisees under a confidentiality agreement.
However, we believe this approach would impose an unnecessary burden on
those franchise systems that list all of their franchisees in Item 20
on a national basis. Presumably, franchisors would have to update
records continually on each individual franchisee. Moreover, a
requirement that franchisors note which specific franchisees are
subject to a confidentiality clause may have the unintended consequence
of actually encouraging large franchisors to eliminate from their list
of 100 franchisees those who are subject to confidentiality clauses,
thereby leaving a biased list of only those franchisees who are most
successful or satisfied with the system.
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\636\ Commenters maintained that such a requirement would
accomplish two goals simultaneously. It would alert prospective
franchisees that the franchisor may require franchisees to sign a
confidentiality provision and would save prospects the time and
trouble of trying to contact franchisees who are not free to speak.
See AFA, NPR 14, at 3; Stadfeld, NPR 23, at 6; Cordell, ANPR, 6 Nov.
97 Tr., at 247-48; Kezios, id., at 256. But see GPM, NPR Rebuttal
40, at 7 (opposing release of names); Wieczorek, ANPR, 6 Nov. 97
Tr., at 258-59 (this approach would be unnecessarily burdensome:
franchisors would have to update their disclosures more frequently,
especially in franchise registration states).
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We also reject suggestions to limit the disclosure to only those
circumstances where franchisees have signed broad provisions
restricting all speech\637\ or where a threshold level of franchisees
have signed confidentiality clauses.\638\ If the purpose of the
confidentiality clause disclosure were primarily to shed light on the
extent of problems in the franchise relationship, then we might agree.
As noted above, however, the disclosure aims to make prospective
franchisees aware of the use of confidentiality clauses. Armed with
such knowledge, prospective franchisees would understand that: (1) a
refusal by one or more existing franchisees to speak is not necessarily
benign; and (2) that the sample of
[[Page 15507]]
franchisees listed in the disclosure document might actually be skewed.
More important, adopting a threshold would not address the use of
confidentiality clauses to restrict speech by a minority of franchisees
(such as franchisees located in a particular city), which might be the
most relevant universe of existing franchisees to an individual
prospective franchisee.
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\637\ PMR&W, for example, ``acknowledge[s] the FTC's concern
about prospects being unable to raise questions with current or
former franchisees who are subject to confidentiality requirements.
The FTC's position is particularly understandable if a gag clause
prevents all franchisee communication about the franchise system.''
PMR&W, NPR 4, at 15. Rather, the firm urged the Commission to limit
the disclosure's application to only broad ``non-communication on
any subject'' prohibitions. Id.
\638\ The NFC advised that the disclosure should apply ``where
either all franchisees, or at least twenty percent of the franchisee
population, is barred from communicating with third parties.'' NFC,
NPR 12, at 33. See Bundy, ANPR, 6 Nov. 97 Tr., at 249 and Jeffers,
id., at 251-52 (arguing in favor of a threshold).
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e. Franchisee associations
One important difference between the original Rule and UFOC
Guidelines, on the one hand, and the final amended Rule, on the other,
is the new requirement that franchisors disclose trademark-specific
franchisee associations.\639\ The obligation to disclose such
associations differs depending upon whether the association is
sponsored or endorsed by the franchisor or is an independent
association. Section 436.5(t)(8) provides that identifying
information--name, address, telephone number, email address and Web
address, to the extent known--must be included for each association
``created, sponsored, or endorsed by the franchisor.'' For independent
associations, the same identifying information must disclosed only if
the independent association:
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\639\ The growth of trademark-specific system franchisee
associations is a recent development in franchising. These
associations are comprised of franchisees who operate a franchisor's
particular brand. In some instances, these associations are
franchisor sponsored or endorsed councils, where franchisee-
participants are either selected by the franchisor or are elected by
franchisees themselves. In other instances, the associations are
independent of the franchisor. The emergence of independent
franchisee associations is not always well-received by the
franchisor. See Winslow, at 141 (``I believe franchisors ought to be
allowed to put in the contract that if any franchisees get together
and form a franchise association to use as a collective bargaining
power against the franchisor, other than an association approved by
the franchisor, then the franchisor should have the right to
terminate the franchise contract with all franchisees in that region
immediately and shut down further operations under the brand name in
that area indefinitely.''). Some commenters reported that, in some
instances, franchisors have filed suit to stop the formation of an
independent group or have retaliated against individuals who have
participated in such groups. E.g., Donafin, ANPR 14 (noting pending
federal lawsuit alleging franchisor interference with franchisees'
right to form organizations). Cf. Mueller, ANPR 29 (``The FTC should
take actions against franchisors who intimidate or retaliate against
franchisees for getting together for any legitimate business
purpose.''); Rachide, ANPR 32 (``[The FTC should prohibit [t]he use
of retaliation against franchisees involved in franchisee
organizations that work to educate or rally the franchise group.'').
See also Karp, at 4; Karp, NPR 24, Appendix A (listing cases
addressing franchisee organizations). A few states, including
California, Illinois, and Washington, have addressed this issue by
specifically prohibiting franchisors from restricting franchisees
from freely associating or joining franchisee organizations. See
Cal. Corp. Code 31220; 815 Ill. Comp. Stat. 705/17; Wash. Rev. Code
19.100.180(2)(a).
is incorporated or otherwise organized under state law and asks
the franchisor to be included in the franchisor's disclosure document
during the next fiscal year. Such organizations must renew their
request on an annual basis by submitting a request no later than 60
days after the close the franchisor's fiscal year.\640\
---------------------------------------------------------------------------
\640\ As discussed below, section 436.5(t)(8) also makes clear
that the franchisor has no obligation to verify the association's
continued existence at the end of each fiscal year. Franchisors may
also include the following statement in conjunction with the
disclosure of independent franchisee associations: ``The following
independent franchisee associations have asked to be included in
this disclosure document.''
During the Rule amendment proceeding, several franchisees and their
representatives urged the Commission to adopt a trademark-specific
franchisee association disclosure requirement. For example, one
---------------------------------------------------------------------------
franchisee representative stated:
The UFOC Guidelines currently require disclosure of the existence
of purchasing cooperatives known to the franchisor, but this is not
adequate disclosure of a fact of growing importance to franchisees,
which is the existence, or non-existence, of an autonomous franchisee
association representing franchisees in that particular franchise
organization. When an organization represents a substantial plurality
of franchisees in the system, perhaps over 30%, and its existence is
known to the franchisor, that fact should be disclosed, possibly by an
additional category in the list of existing franchisees required in
Item 20, as an additional and critical source of information about the
franchise opportunity.\641\
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\641\ Selden, ANPR 133, Appendix B. Similarly, Martin Cordell, a
franchise examiner for the State of Washington, observed that
disclosing trade associations could ``be a much more ready source of
information as opposed to individual franchisees who have to take
time out of their businesses to share information with the
prospective franchisee.'' Cordell, ANPR, 6 Nov. 97 Tr., at 168-69.
Susan Kezios of the AFA added that these associations ``have a
collective memory of what has been going on historically in the
franchise system that one or another individual franchisees may or
may not have.'' Id., at 176. See also, NFA, NPR 27, at 2; Stadfeld,
NPR 23, at 14; Karp, NPR 24, at 9; Bundy, ANPR, 6 Nov. 97 Tr., at
173; Manuszak, ANPR 13; Zarco & Pardo, ANPR 134, at 3.
Some franchisors did not oppose a disclosure of franchisee
associations, especially franchisor-sponsored franchisee advisory
councils. However, they voiced concern about any mandate to disclose
all independent franchisee associations. In their view, independent
associations are often small, informal groups of individual franchisees
that may come and go at any time, and are often formed on the local or
regional level without the knowledge or involvement of the
franchisor.\642\ In short, they fear liability for failing to disclose
a franchisee association that they did not know exists.
---------------------------------------------------------------------------
\642\See Baer, NPR 11, at 14; Shay, ANPR, 18 Sept. 97 Tr., at
71; Wieczorek, ANPR, 6 Nov. 97 Tr., at 169-70; Duvall, id., at 171.
J&G asserted that independent franchisee associations should qualify
for inclusion only if they are representative of system franchisees
and meet or communicate with the franchisor at least twice annually
for the purpose of addressing franchise relationship issues.
Further, the firm would require the association to:
``provide written notice to the franchisor no later than 30 days
after the close of the franchisor's fiscal year end identifying the
organization, its mission, its form of organization and the number
of franchisees and franchised units which are dues-paying members or
otherwise accredited members of the organization. If some
franchisees are not dues-paying members, standards used for
accreditation should be enclosed in the notice.''
J&G, NPR 32, at 13. See also PMR&W, NPR 4, at 15; Marriott, NPR
35, at 16.
---------------------------------------------------------------------------
Based upon the record developed in this proceeding, the Commission
is convinced that a trademark-specific association disclosure is
warranted under certain circumstances. The disclosure of trademark-
specific franchisee associations--both those sponsored or endorsed by
the franchisor and independent franchisee associations--will greatly
assist prospective franchisees in their due diligence investigation of
the franchise offering, thereby preventing misrepresentations in the
offer and sale of franchises. We recognize that Item 20 already
requires franchisors to disclose the names of, and some contact
information for, franchisees in their systems. This disclosure
requirement, however, is limited to not more than 100 franchisees. This
is true even for medium and large franchise systems with several
hundred, if not several thousand, franchisees. Therefore, it is
possible for some franchisors to hand-select franchisees listed in
their disclosure documents, revealing only successful franchisees who
maintain a good relationship with their franchisor.\643\ Moreover, a
franchisor
[[Page 15508]]
could use confidentiality clauses to achieve the same goal. Therefore,
the Item 20 list of franchisees may not be a random sample or otherwise
representative of franchisees within a particular system. One approach
to counter any franchisor-bias in Item 20 is to require that
franchisors disclose the existence of certain franchisee associations,
providing prospective franchisees with an alternative view of the
franchise system.
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\643\ While 100 franchisees may know about franchisor-sponsored
associations, they would not necessarily know about independent
associations, such as those in particular locations, or about
associations for specific-use franchisee groups (e.g., those
operating kiosks in malls). Further, there is also evidence in the
record that franchisors do not readily inform prospects about the
existence of independent associations. For example, Michael W.
Chiodo, the executive director of the Domino's Franchisee
Organization, explained that Domino's does not inform franchisees
about the existence of the Organization, nor does Domino's inform
the Organization about new franchisees. Chiodo, ANPR, 21 Nov. 97
Tr., at 294-95.
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The record also suggests that individual franchisees often are
reluctant to share information with prospective franchisees. For
example, Howard Bundy told us that he often instructs his franchisee-
clients to state only their ``name, rank, and serial number and refer
[the prospect] back to the franchisor for everything else.''\644\ In
his view, franchisees who speak in connection with a franchise sale
might be deemed franchise brokers under state law and could be liable
for any claims or damages resulting from the sale. Franchisees who
volunteer information also might be subject to a defamation suit by the
franchisor.\645\ The trademark-specific franchisee association
disclosure, therefore, is an important alternative source of
information about the franchise system.\646\
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\644\ Bundy, ANPR, 6 Nov. 97 Tr., at 236-37. See also, e.g.,
Hayden, RR 42; Spencer, RR, Sept.95 Tr., at 74.
\645\ Bundy, ANPR, 6 Nov. 97 Tr., at 237.
\646\ Chiodo, ANPR, 21 Nov. 97 Tr., at 294-95. See also
Galloway, id., at 317-18; Manuszak, ANPR 13.
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Finally, a franchisee association disclosure is particularly
important given that the final amended Rule does not mandate financial
performance disclosures. One rationale for not mandating performance
information is that prospects can contact franchisees directly to
obtain such information. Indeed, franchisees are the best source of
information about their own earnings. If true, then prospective
franchisees, at the very least, should be able to contact as many
existing and former franchisees as possible to learn about franchisee
performance. A franchisee association disclosure may greatly assist
prospective franchisees in their effort to obtain and review
franchisees' financial performance by providing an independent source
of information.
At the same time, the disclosure of franchisee associations is very
narrowly tailored to address franchisors' concerns about the disclosure
of independent franchisee associations. Specifically, Item 20 of the
final amended Rule provides that a franchisor must list in its
disclosure document independent trademark-specific associations only to
the extent such associations make their existence known to the
franchisor on an annual basis. This will reduce franchisors' burdens by
requiring franchisors to disclose only those independent associations
actually known to them. It requires no special research or
recordkeeping or updating requirements on a franchisor's part.
Accordingly, the compliance burden imposed by disclosing independent
franchisee associations is minimal.
The final Rule amendment differs from the Franchise NPR, however,
to add more precision. Specifically, Item 20 of the final amended Rule:
(1) broadens the types of associations that qualify for inclusion as a
trademark-specific franchisee association; (2) requires franchisee
associations to request inclusion in the franchisor's disclosure
document within 60 days of the end of the franchisor's fiscal year end;
and (3) permits franchisors to add qualifying language alerting
prospective franchisees that the associations listed in its disclosure
document are independent associations. Each of these modifications is
discussed in the section immediately below.
Item 20 of the final amended Rule requires franchisors to disclose
only those independent franchisee associations that are incorporated or
otherwise organized under state law. This differs slightly from the
Franchise NPR and Staff Report, which recommended that only
incorporated franchisee associations qualify for inclusion in a
disclosure document.\647\ The Commission is persuaded that informal,
unorganized groups of franchisees are more akin to individual
franchisees, than an association. In such instances, additional
disclosure is unwarranted because a prospective franchisee can already
speak with individual franchisees, whose contact information is also
provided in Item 20. At the same time, the Commission agrees with Staff
Report commenters that Item 20 should be read broadly to enable any
organized independent franchisee association to seek inclusion in the
franchisor's disclosure document.\648\ Accordingly, any organized
independent association--whether it is incorporated, a partnership,
limited liability company, or trust, among other forms of association--
qualifies for inclusion under Item 20.
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\647\ Franchise NPR, 64 FR at 57344; Staff Report, at 58. The
original approach was taken in response to commenters' concerns that
requiring the disclosure of independent associations would be too
broad, requiring the disclosure of even informal groups of
franchisees, as noted above. However, several comments contended
that the incorporation requirement was too restrictive, asserting
that the Commission should permit the inclusion of all franchisee
association that make their existence known to the franchisor.
Bundy, at 9; Gust Rosenfeld, at 6-7; Singler, at 2-3; Stadfield, NPR
23.
\648\ In response to the Staff Report, AAFD, in particular,
noted that it is organized as a trust and its member franchisee
associations form as chapters of that trust. It asserted that such
association members, although not incorporated, are organized and
should qualify for inclusion in a disclosure document. AAFD. See
also IL AG, at 8.
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Item 20 of the final amended Rule makes explicit that an
independent franchisee association's request for inclusion in a
disclosure document must be renewed annually by submitting a request
for inclusion no later than 60 days after the close of the franchisor's
fiscal year. This is more precise than the Franchise NPR, which
contains no specific time frame during which independent associations
should submit their request to the franchisor.\649\
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\649\ The Staff Report recommended that the Commission add
precision to the Rule by requiring franchisee associations to submit
their requests 90 days after the close of the franchisor's fiscal
year. Staff Report, at 197. The staff's thinking was that a 90-day
period would afford franchisors sufficient time to include any
franchisee association information well before the expiration of the
120-day annual update period. Id. This view, however, was based on
the assumption that a significant number of franchisors need 120
days to complete their annual updates. One commenter, however,
argued that 60 days would be sufficient, noting that many
franchisors complete their annual updates earlier than 120 days.
Wiggin & Dana, at 4. In determining the appropriate time period for
inclusion requests, it is appropriate not to interfere with
franchisor's ordinary business practices. In particular, requiring
franchisors ready to disseminate their updated disclosure documents
to wait 90 days on the mere chance that a franchisee association may
ask for inclusion in their document is unwarranted. Independent
franchisee associations seeking inclusion should make their requests
known to the franchisor as soon as possible. Surely, a franchisee
association can submit its request before the close of the
franchisor's fiscal year or soon thereafter. We are convinced that a
60-day period is a more balanced approach, enabling franchisee
associations to request inclusion, while minimizing franchisor's
compliance burden.
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Third, Item 20 of the final amended Rule permits franchisors to
include a limited disclaimer, if they wish. Specifically, Item 20
provides that a franchisor can add to the independent franchisee
association disclosure the following statement: ``The following
independent franchisee associations have asked to be included in this
disclosure document.''\650\ We believe
[[Page 15509]]
this statement makes clear that the franchisor is not necessarily
endorsing or supporting the associations listed. This statement,
coupled with the requirement that only an organized independent
association must be disclosed and only upon the association's request,
strikes the right balance between pre-sale disclosure and compliance
burdens.
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\650\ This revises the disclaimer recommended in the Staff
Report, which added the following additional sentence: ``We do not
endorse these associations and their members may not represent all
franchisees in the [name of franchisor] franchise system.'' Several
commenters criticized this additional statement on the grounds that
no association is going to represent 100% of all franchisees in a
system. AFA, at 3-4. The commenters also noted that the proposed
additional sentence is unnecessarily negative in tone. It should
suffice that a franchisor simply notes that the independent
associations have asked to be included, without implying that the
independent association is a renegade group. AFA, at 3-4;
Blumenthal, at 1-2; Bundy, at 9; Karp, at 5. While we are persuaded
that an introductory statement may be warranted before listing
independent associations--to distinguish them from franchisor
endorsed or sponsored associations--the statement should be neutral
and not imply any opinion on the merits of the independent
associations. This is the same approach taken with respect to
franchisor-endorsed or sponsored associations, where no such
disclaimer is required. Accordingly, Item 20 of the final amended
Rule deletes the last sentence from the Staff Report's version of
the trademark-specific franchisee association voluntary disclaimer.
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At the same time, the Commission has rejected the suggestion
offered by some commenters that independent franchisee associations
seeking inclusion in the franchisor's disclosure document should be
representative of a significant number of franchisees in the franchise
system.\651\ These commenters urged the Commission to apply a threshold
qualification test whereby a franchisor would not have to disclose an
independent franchisee association unless the association represented a
portion of system franchisees, such as 25% of system franchisees.\652\
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\651\See PMR&W, NPR 4, at 15; BI, NPR 28, at 13.
\652\ Stadfeld, NPR 23, at 14-15. See also H&H, NPR 9, at 20-21
(if the organization represents 30% of franchisees); NFC, NPR 12, at
33 (if the organization represents 20% of the franchisees); BI, NPR
28 (unspecified threshold). But see IL AG, NPR Rebuttal 38, at 4
(``Setting a minimum percentage of franchisees to be a qualified
association is virtually unworkable.'').
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The Commission recognizes that Item 20 may result in the disclosure
of independent franchisee associations that are not necessarily
representative of franchisees as a whole. However, we believe there is
value in enabling prospective franchisees to speak with an association
representing similar interests, even if not representative of the
entire system. For example, a small independent association of
franchisees in Anchorage, Alaska, might provide prospective franchisees
with valuable information about local labor costs, financial
performance data, as well as information about third-party suppliers.
For this reason, we reject the notion that an independent association
should be forced to establish that they represent a specific percentage
of franchisees in a system. Rather, prospective franchisees can
determine for themselves whether to contact independent franchisee
associations and what weight to give any information such associations
provide.
23. Section 436.5(u) (Item 21): Financial statements
Section 436.5(u) of the final amended Rule retains the original
Rule's basic requirement that franchisors disclose three years of
audited financial statements prepared according to generally accepted
accounting principals (``GAAP'').\653\ To maximize consistency with the
UFOC Guidelines, it expands the original Rule by incorporating the UFOC
Guidelines' requirement that financial disclosures be in a tabular
format that compares at least two fiscal years. This provides
prospective franchisees with information with which to assess financial
trends, rather than just an isolated snap-shot of the franchisor's
finances.
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\653\ 16 CFR 436.1(a)(20). In the original SBP, the Commission
noted that a franchisee is purchasing, ``along with the franchise
itself, some assurance of the financial stability of the franchisor,
of the franchisor's ultimate ability to meet its obligations to its
franchisees.'' Original SBP, 43 FR at 59679. For that reason, the
Commission concluded that the disclosure of basic financial
information by all franchisors ``is essential.''
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The final amended Rule provision differs from UFOC Guidelines Item
2, however, in three respects. First, while it requires the use of
GAAP, it also recognizes that what currently is ``GAAP'' may change by
federal government oversight of the accounting profession. Accordingly,
it provides that franchisors must use GAAP, as revised by any future
government mandated accounting principles. It also allows flexibility
by permitting accounting standards recognized by the Securities and
Exchange Commission. Second, consistent with other provisions of the
final amended Rule, it requires the disclosure of a parent's financial
information in limited circumstances. Specifically, a franchisor must
include a parent's financial statements if the parent has post-sale
performance obligations or guarantees the franchisor's performance.
Third, Item 23 retains the Commission's long-standing policy of
permitting franchisors to phase-in audited financial statements over
three years.\654\
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\654\ ``Without the auditing requirement, the financial
statements remain nothing more than the franchisor's own
representation of its financial condition.'' Original SBP, 43 FR at
59679-680. Nonetheless, the costs associated with preparing audited
financial statements might create a barrier to entry by start-up
franchisors. In the original SBP, the Commission made it clear that,
as a matter of policy, franchisors can use unaudited financials
during a phase-in period. Id., at 59681.
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Four aspects of section 436.5(u) that prompted comment are
discussed in the following section: (1) the required use of GAAP in
preparing financial statements; (2) the scope of a parent's obligation
to disclose financial information; (3) the obligation of subfranchisors
to disclose financial information; and (4) the phase-in of audited
financial statements. We discuss each of these issues below.
a. The requirement to prepare financial statements according to GAAP
Section 436.5(u)(1) of the final amended Rule requires franchisors
to prepare financial statements according to ``United States generally
accepted accounting principles, as revised by any future government
mandated accounting principles, or as permitted by the Securities and
Exchange Commission.'' This differs from the Franchise NPR, which
proposed that franchisors use United States GAAP only in preparing
their financial statements, consistent with the original Rule and UFOC
Guidelines.\655\
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\655\ Franchise NPR, 64 FR at 57344. See 16 CFR 436.1(a)(20);
UFOC Item 21. See also Advisory 02-4, Bus. Franchise Guide (CCH), ]
6515 (Nov. 18, 2002).
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During the Rule amendment proceeding, a few commenters opposed the
Franchise NPR's proposed requirement that foreign franchisors prepare
financial statements according to United States GAAP only. These
commenters asserted that this requirement would impose expenses and
burdens on foreign corporations entering the American market. H&H's
comment was typical: ``For companies located in many foreign countries,
. . . a requirement to convert to US accounting standards would be
enormously expensive.''\656\ H&H urged the Commission to permit foreign
franchisors to prepare financial statements that ``conform to U.S. GAAP
or otherwise to generally accepted accounting principles established in
the country of the company's domicile.''\657\ IL AG, however, argued
that foreign companies should follow United States GAAP or be permitted
to reconcile their financial statements to United States
[[Page 15510]]
GAAP through footnotes and explanations.\658\
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\656\ H&H, NPR 9, at 13. See also NFC, NPR 12, at 33.
\657\ H&H, NPR 9, at 13. Warren Lewis suggested that the
Commission permit foreign franchisors to ``use financial statements
prepared according to their countries' GAAPs, provided that those
GAAPs are comparable to US GAAP.'' Lewis, NPR 15, at 17. Mr. Lewis,
however, provided no criteria or examples that would help us
determine what GAAP are or are not ``comparable.''
\658\ IL AG, NPR Rebuttal 38, at 5.
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As noted in our discussion of section 436.2 concerning the scope of
the Rule, the sale of franchises outside the United States was not an
important issue when the Commission promulgated the Franchise Rule in
1978. The Commission recognizes, however, that application of only
United States GAAP in today's global economy may impede competition
from foreign franchisors. Accordingly, a more flexible approach is
warranted, especially in the absence of any evidence in the record that
financial statements prepared by foreign franchisors to date have been
deceptive or misleading.
In determining whether to maintain the original Rule's stance on
the use of GAAP in Item 21 financial statements, the Commission focuses
strongly on the primary purpose of a disclosure document, which is to
provide prospective franchisees with material information in a clear
and conspicuous manner. Consistent with that principle, the Commission
believes that franchisors must present financial data in a format that
is meaningful to American prospective franchisees, as well as to their
advisors. To that end, the suggestion offered by IL AG--that foreign
franchisors use United States GAAP or reconcile their financial
statements to United States GAAP--adds needed flexibility, while
reducing costs and burdens on foreign franchisors. As noted in the
Staff Report, this is the very position adopted by the SEC for the
registration of securities by foreign companies.\659\
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\659\ Staff Report, at 201.
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The SEC permits foreign companies registering securities to prepare
financial statements using accounting procedures other than United
States GAAP under limited circumstances. The first prerequisite is that
such statements be prepared ``according to a comprehensive body of
accounting principles.''\660\ The company must also disclose the
specific comprehensive body of accounting principles used to prepare
the statements and explain material differences between the principles
and United States GAAP. The company must also reconcile its statements
with United States GAAP. For example, through additional notes,
franchisors must reconcile figures for net income and total
shareholders' equity for the period presented. Finally, the statements
must provide all additional disclosures required by United States GAAP
and applicable SEC regulations.\661\
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\660\ We noted that NASAA, in response to the Staff Report,
suggested that the Rule simply mandate United States GAAP, or a
reconciliation to United States GAAP, without referencing the SEC.
NASAA, at 7. See also WA Securities, at 5. The Commission concludes
that referencing the SEC is appropriate. Given the absence of any
indication in the record that foreign accounting principles are
inherently deceptive, flexibility in preparing financial statements
is warranted. As long as the SEC would permit foreign accounting
standards or foreign financial statements, we see no policy reason
to differ. This is particularly true of financial statements
prepared according to Canadian GAAP, which receives more lenient
treatment under SEC law. See Spandorf, at 8 (recommending an
accommodation to permit the use of Canadian GAAP).
\661\ See SEC Form 20-F, Part III, Items 17 and 18. The SEC has
also made clear that even if a foreign company reconciles its
financial statements to United States GAAP, it must audit the
financials according to United States generally accepted auditing
standards (United States GAAS) and the auditor must comply with the
United States standards for auditor independence. See Id., General
Instruction E(c).
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The Staff Report recommended that the final amended Rule permit
foreign financial statements that satisfy the SEC criteria. The
Commission has determined that that recommendation is sound. As a
starting point, application of the SEC accounting standards ensures
against deception by requiring foreign franchisors to establish that
their financials are prepared ``according to a comprehensive body of
accounting principles.'' Further, it adds flexibility and minimizes
costs and burdens on foreign franchisors, while ensuring that
prospective franchisees receive the same material financial information
as they would receive from a domestic franchisor. The Commission has
determined to adopt this flexible approach, given the absence of any
showing or suggestion in the record that reconciled foreign financial
statements are inherently deceptive or misleading.\662\ At the same
time, we recognize the possibility exists that American accounting
principles may evolve over time. Under the circumstances, Item 21
updates the original Rule by adding language designed to ensure that
financial statements are prepared according to United States GAAP, ``as
revised by any future government mandated accounting principles, or as
permitted by the Securities and Exchange Commission.''\663\
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\662\ Of course, the Commission retains its Section 5 authority
to challenge any deceptive foreign statements.
\663\ This modifies the version of Item 21 in the Staff Report,
which would permit financial statements prepared according to
``United States generally accepted accounting principles, or as
permitted by the Securities and Exchange Commission, or as revised
by any future government mandated accounting principles.'' One
comment questioned whether the third part--revised by any future
government mandated accounting principles--was a third option
distinct from the other two. Piper Rudnick, at 3-4. The language
``or as revised by any future government mandated accounting
principles'' recognizes that what is currently considered United
States GAAP may be modified in the future by government mandate,
especially by regulations or rulings of the Federal Accounting
Standards Board. Accordingly, it is not intended to comprise a
separate option, but should be read to modify ``United States
generally accepted accounting principles.'' The final amended Rule
adopts this revised language.
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b. Parent financial information
Section 436.5(u)(iv) of the final amended Rule requires a
franchisor to disclose a parent's financial statements in two
circumstances: (1) when the parent commits to perform post-sale
obligations for the franchisor; or (2) when the parent guarantees
obligations of the franchisor. This narrows the Franchise NPR proposal,
which would have required disclosure of parent financial information in
all instances.\664\ As with other Rule provisions, several commenters
questioned the routine inclusion of parent information in a disclosure
document. For example, PMR&W observed that the UFOC Guidelines specify
only that state examiners may ask for audited financials of a parent,
but the Guidelines do not mandate it. In its view, parent financial
statements are not relevant and are rarely requested.\665\ Warren Lewis
suggested that the Commission require the disclosure of parent
financial statements ``only if (i) the company with the control chooses
to guarantee the obligations of the franchisor or subfranchisor to the
franchisee in writing, and (ii) a copy of the written guarantee is
included in Item 21 or an exhibit.''\666\
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\664\ Franchise NPR, 64 FR at 57315. We also note that the Staff
Report recommended that franchisors disclose financial statements of
any parent ``or other entity'' with post-sale performance
obligations or which guarantees the franchisor's performance. The
inclusion of the phrase ``other entity'' prompted three comments
voicing concern that it would sweep in suppliers that provide goods
or services to franchisees. Piper Rudnick, at 3; Spandorf, at 8-9;
Starwood, at 3. The Commission agrees that a reference to ``other
entity'' would be an unwarranted expansion of Item 21. According,
the reference to ``other entity'' has been deleted from the final
amended Rule.
\665\ PMR&W, NPR 4, at 16. See also Lewis, NPR 15, at 18; Snap-
On, NPR 16, at 4; PREA, NPR 20, at 2; Marriott, NPR 35, at 17.
Similarly, J&G opposed consolidated financial statements of
affiliates where the franchisor has included its own financial
statements. ``The increased cost and potential liability of other
affiliates is unwarranted.'' J&G, NPR 32, at 13.
\666\ Lewis, NPR 15, at 18. See also Baer, NPR 11, at 5; IL AG,
NPR Rebuttal 38, at 4. In the same vein, Howard Bundy suggested that
a franchisor should be permitted to use an affiliate's financial
statements only ``if the affiliate guarantees all of the duties and
obligations of the franchisor in writing and for the entire term of
the franchise, including any renewals and extensions'' and a copy of
the written guarantee is included in the disclosure document. Bundy,
NPR 18, at 11 (emphasis in original).
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[[Page 15511]]
The Commission believes these points are well-taken and are
consistent with our view expressed in other sections of this document
that a franchisor need not disclose parent information in all
instances. Therefore, proposed Item 21 has been modified to limit a
parent's financial information to those circumstances when the parent
either: (1) commits to perform post-sale obligations for the
franchisor; or (2) guarantees obligations of the franchisor. To the
extent that a prospective franchisee is asked to rely on a parent to
perform post-sale contractual obligations,\667\ or relies on a parent's
guarantee, the financial stability of the parent becomes a material
fact that should be disclosed.\668\
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\667\ Two commenters voiced concern about the ``post-sale
performance obligation'' language set forth in the Staff Report.
Specifically, they contended that sections 436.5(u)(1)(ii) and
436.5(u)(1)(iv) of the Staff Report are inconsistent. In their view,
section 436.5(u)(1)(iv) requires a franchisor to furnish financial
statements if the franchisor has post-sale performance obligations.
They then noted that is it highly unlike that a franchisor would
ever enter into a franchise relationship without some post-sale
obligations to the franchisee. The commenters concluded therefore
that section 436.5(u)(1)(iv) requires franchisor financials in all
instances. This interpretation is in direct conflict with section
436.5(u)(1)(ii), however, that expressly permits a franchisor to use
the financials of an affiliate-guarantor. Piper Rudnick, at 3-4;
Spandorf, at 8-9. The commenters misread section 436.5(u)(1)(iv) of
the Staff Report. Under that section of the Staff Report, a
franchisor must provide financial statements ``for the franchisor,
subfranchisor, and any parent . . . that commits to perform post-
sale obligations for the franchisor or guarantees the franchisor's
obligations.'' The reference to ``post-sale obligations'' refers to
``parent,'' not to the ``franchisor.'' If the commenter's reading of
section 436.5(u)(1)(iv) were correct, then the section would have
the following absurd meaning: ``a franchisor must provide financial
statements for the franchisor . . . that commits to perform post-
sale obligations for the franchisor.'' To avoid any confusion on
this point, section 436.5(u)(1)(iv) of the final amended Rule has
been revised to read: ``Include separate financial statements for
the franchisor and subfranchisor, as well as for any parent that
commits to perform post-sale obligations for the franchisor or
guarantees the franchisor's obligations.''
\668\ Where a parent guarantees performance, Item 21 also
requires a franchisor to attach a copy of the guarantee to the
disclosure document. Although the UFOC Guidelines are not clear on
this point, we believe that Item 21, Instruction v. contemplates
this requirement. Moreover, it is sound policy. Before a prospective
franchisee is asked to invest in a franchise, he or she should be
able to assess the extent of any performance or financial
guarantees.
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c. Subfranchisor financial information
Section 436.5(u)(iv) of the final amended Rule also requires the
disclosure of financial information of any subfranchisor. During the
Rule amendment proceeding, a few commenters opined that it is
unnecessary to require routine financial statements of subfranchisors:
financial statements should be provided only by the entity with whom
the franchisee will have a contractual relationship.\669\ The
commenters, however, interpreted the term ``subfranchisor'' more
broadly than it is used in the final amended Rule. As noted in our
discussion of the term ``franchisor'' above, the term ``subfranchisor''
is limited in the Rule to circumstances where the subfranchisor steps
into the shoes of the franchisor by selling and performing post-sale
obligations. It does not reach those individuals who may be called
``subfranchisors,'' but who act like brokers, having no post-sale
commitments to franchisees.\670\ Where a person--be it subfranchisor or
parent --commits to perform under the franchise agreement, its
financial information becomes material in order to provide prospective
franchisees with the opportunity to assess the person's financial
stability before risking their own investment.
---------------------------------------------------------------------------
\669\ Bundy, at 9; H&H, NPR 9, at 21; Lewis, NPR 15, at 17.
\670\ This approach parallels the UFOC Guidelines, which require
subfranchisor financial statements only when the subfranchisor is
the applicant for franchise registration.
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d. Phase-in of audited financial statements
Section 436.5(u)(2) of the final amended Rule retains the original
Rule provision permitting start-up franchise systems to phase-in
audited financial statements within three years.\671\ However, the
final amended Rule streamlines the phase-in. Under the original Rule's
phase-in, a franchisor could furnish a balance sheet for ``the first
full fiscal year following the date on which the franchisor must first
comply with [the Rule.]''\672\ This can be problematic because it is
often unclear when the franchisor's first fiscal year ends. For
example, a franchisor may have started selling franchises three months
into its first fiscal year (e.g., in March 1, 2006, using a calendar
fiscal year). At the conclusion of that fiscal year (December 31,
2006), the franchisor would have sold franchises for ten months. Yet,
under the original Rule's phase-in, the franchisor's first fiscal year
would not end until December 31, 2007, because the phase-in uses the
language ``first full fiscal year'' after starting to sell
franchises.\673\
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\671\ There is no comparable provision in the UFOC Guidelines.
The extent to which any state may permit a phase-in of audited
financial statements is a matter of individual state law. For
example, California and Illinois permit a phase-in of audited
financial statements under limited conditions set forth in their
franchise regulations. On the other hand, Virginia and Minnesota,
for example, always require audited financial statements.
\672\ 16 CFR 436.1(a)(20)(ii).
\673\Id.
---------------------------------------------------------------------------
To clarify the timing of the phase-in, section 436.5(u)(2) of the
final amended Rule replaces the word ``full'' with ``first partial or
full fiscal year'' so that a franchisor's first fiscal year will end
consistent with its general accounting practices, regardless of when
the franchisor may have started offering franchises within that
year.\674\ Under this revised approach, the Commission will look to the
close of the franchisor's first fiscal year after selling franchises,
regardless of whether that time period was a partial or full year.\675\
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\674\See Franchise NPR, 64 FR at 57315.
\675\ No comments were submitted on this modification of the
original Rule's phase-in of audited financial statements.
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The phase-in of audited financial statements generated little
comment during the Rule amendment proceeding. Franchisors, the AFA, and
IL AG supported the phase-in.\676\ One franchisee advocate, however,
noted, among other things, that the states do not have a comparable
provision. He also cited Small Business Administration statistics
showing that only 25% of franchisors survive five years. ``If we excuse
audited financial statements for the first two years, for all practical
purposes, even more investors will risk losing everything.''\677\ On
the other hand, John Baer not only supported the phase-in, as drafted
in the Franchise NPR, but urged the Commission to make it
preemptive.\678\
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\676\E.g., Duvall, ANPR 19, at 1; Baer, ANPR 25, at 4; Kaufmann,
ANPR 33, at 6; Kestenbaum, ANPR 40, at 2; AFA, ANPR 62, at 3; IL AG,
ANPR 77, at 3; Tifford, ANPR 78, at 4; IFA, ANPR 82, at 1; Jeffers,
ANPR 116, at 2.
\677\ Bundy, NPR 18, at 11. Mr. Bundy also noted that an audit
gives a franchisee a potential remedy that otherwise would be
unavailable. ``[T]here is no doubt that the auditor has liability to
the franchisee if the auditor did not follow proper procedures and
provide the appropriate warnings--including notes to the effect that
the company may not be solvent or may be reliant upon selling more
franchises for its economic survival.'' Bundy, NPR 18, at 11.
\678\ ``The Commission should be aware that several of the
states require the use of audited opening balance sheets in order to
register a start-up franchisor. We believe that this is another
example of why the Franchise Rule should preempt inconsistent state
law requirements. One set of financials should be acceptable
throughout the country.'' Baer, NPR 11, at 15.
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NASAA supported the phase-in generally, but raised two concerns.
First, NASAA observed that the phase-in section of the Rule does not
specifically reference GAAP, possibly leading franchisors to conclude
that unaudited financial statements need not be prepared according to
GAAP. It urged
[[Page 15512]]
the Commission to apply GAAP to all financial statements, audited or
unaudited.\679\ We agree. There are two prerequisites for financial
statements: (1) the data underlying the statement must be prepared
according to GAAP (or according to SEC standards), and (2) the
financials must be audited according to United States generally
accepted audited standards (``GAAS'').\680\ The phase-in of audited
financials addresses only the second prerequisite--audits. Where a
franchisor takes advantage of the phase-in, it nonetheless must satisfy
the first prerequisite, preparing its financial data according to GAAP
(or SEC standards).
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\679\ NASAA, at 7. See also WA Securities, at 6; CA Dept of
Corps., at 2.
\680\ 16 CFR 436.1(a)(20)(i) (``such statements are required to
have been examined in accordance with generally accepted auditing
standards by an independent certified or licensed public
accountant). See also IL AG, at 9.
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Nevertheless, we believe that the final amended Rule already is
clear on this point. As noted above, the introduction to Item 21 starts
with the first prerequisite--that financial statements must be prepared
according to ``United States generally accepted accounting principles,
as revised by any future government mandated accounting principles, or
as permitted by the Securities and Exchange Commission.'' Item 21 then
discusses the second prerequisite--audits: with the exception of the
phase-in of audited financials, ``financial statements must be audited
. . . using generally accepted United States auditing standards.''
Thus, the Rule makes clear that the phase-in modifies the GAAS
prerequisite only; the accounting prerequisite still continues to apply
to all financial statements prepared under Item 21.\681\
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\681\ NASAA also noted that the Staff Report referred
incorrectly to ``United States auditing principles,'' when the
proper accounting term is ``United States auditing standards'' or
``GAAS.'' NASAA, at 7-8. See also WA Securities, at 6. Item 21 of
the amended Rule makes that correction.
---------------------------------------------------------------------------
NASAA also questioned the reference to ``start-ups'' in the phase-
in provision. It voiced concern that: ``[i]f a major corporation that
has been in business for many years and then begins to franchise, that
corporation should not enjoy the same exemption from disclosing audited
financial statements as a new company that just organized as a true
`start up' franchise system.''\682\ The NASAA Project Group suggested
that franchisors that have been in any type of business for three years
or more, not just the business of selling franchises, should be
required to provide audited financial statements.\683\
---------------------------------------------------------------------------
\682\ NASAA, NPR 17, at 11.
\683\Id.
---------------------------------------------------------------------------
The Commission believes NASAA's point is well-taken, and, therefore
we wish to clarify that for Item 21 purposes, the term ``start-up'' is
to be read narrowly, meaning entities that are new to franchising and
that ordinarily have not prepared audited financials statements to
date. Any non-franchise company that has prepared audited financials in
the ordinary course of business must include such audited financials in
its disclosure documents if it decides to begin offering
franchises.\684\ The phase-in is also not intended for spin-offs,
affiliates, or subsidiaries of a franchisor, where the franchisor has
been engaged in franchising or has prepared audited financial
statements for any other purpose.
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\684\See Interpretive Guides, 44 FR at 49981 (``Franchisors may
use unaudited financial statements . . . if they lack audited
statements for the fiscal years to be reported when they are first
required to furnish a basic Disclosure Document.'').
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24. Section 436.5(v) (Item 22): Contracts
Consistent with the UFOC Guidelines, section 436.5(v) requires
franchisors to attach to the disclosure document a copy of all relevant
agreements, such as the franchise agreement, leases, options, or
purchase agreements.\685\ This is substantively similar to the original
Rule requirement that franchisors provide prospective franchisees with
copies of relevant documents at least five business days prior to the
date of execution.\686\ The final amended Rule's Item 22 is identical
to the Item 22 proposed in the Franchise NPR.
---------------------------------------------------------------------------
\685\ UFOC Guidelines, Item 22.
\686\ See 16 CFR 436.1(g). The attached documents would enable
prospective franchisees to compare a franchisor's disclosure about
the parties' legal obligations with the actual agreements that will
govern the franchise relationship. In the original SBP, the
Commission recognized that this requirement ``will therefore have a
remedial effect in that it will encourage accurate discussion of the
required information in the disclosure statement.'' Original SBP, 43
FR at 59696.
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Only one comment was submitted on Item 22. In response to the
Franchise NPR, David Gurnick expressed concern that the term
``contract'' could be misinterpreted to suggest that Item 22 requires
the disclosure of post-sale settlement agreements. He suggested that
Item 22 should expressly state that ``the contracts to be attached do
not include forms of negotiated settlement agreements,'' especially
since the terms of any such agreements are unknown at the time of
sale.\687\ While it is possible that a franchisor may misread Item 22
to include future settlement negotiations, we do not believe this is
likely. Item 22 refers to those contracts that involve the franchise
offering at the time of the sale. Clearly, franchisors cannot disclose
something that may only exist at some future date. Therefore, we
decline to revise Item 22, as this commenter suggested.
---------------------------------------------------------------------------
\687\ Gurnick, NPR 21, at 7.
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25. Section 436.5(w) (Item 23): Receipts
Section 436.5(w) of the final amended Rule reduces inconsistencies
with the UFOC Guidelines by adopting the UFOC Guidelines Item 23
requirement that franchisors include an acknowledgment of receipt in
the disclosure document.\688\ The original Rule has no counterpart.
Like the cover page, the receipt serves an important educational
purpose,\689\ informing prospects that they have 14 calendar-days to
review the disclosures, that they should receive certain attachments,
and that they can report possible law violations.\690\
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\688\ Item 23 of the final amended Rule differs from the
Franchise NPR in one respect. It deletes the Franchise NPR proposal
that franchisors obtain a signed copy of the Item 23 receipt five
days in advance of a prospective franchisee's signing the franchise
agreement or payment of a fee in connection with the franchise sale.
Franchise NPR, 64 FR at 57344. The Commission proposed this
requirement in the Franchise NPR to ensure that the prospective
franchisee in fact received the disclosures before the franchisor
finalized the franchise sale. This proposal prompted comments both
for and against the proposal. Compare PMR&W, NPR 4, at 5 with Baer,
NPR 11, at 15. The Staff Report recommended that this provision be
deleted. Staff Report, at 207-08. For the reasons stated in the
Staff Report, we agree. Franchisors always have the burden of proof
to establish compliance with the Rule's disclosure and timing
provisions. In addition, the amended Rule's general recordkeeping
requirements at section 436.6--requiring franchisors to retain a
copy of each signed receipt for at least three years--are sufficient
to prove compliance. Finally, given the elimination of the automatic
contract review waiting period from the final amended Rule, the
addition of another waiting period would add an unnecessary
compliance burden.
\689\ Other Commission trade regulation rules contain similar
messages. E.g., Energy Guides, 16 CFR Part 305, App. L. (``Compare
the energy use . . . with others before you buy.''); Cooling-Off
Rule, 16 CFR 429.1 (Notice of right to cancel); Used Car Rule, 16
CFR 455.2 ( ``Below is a list of some major defects that may occur
in used motor vehicles.'').
\690\See IL AG, NPR 3, at 9 (``If no disclosure document is
provided we would hope it would make the franchisee refuse to sign
the receipt. . . . [T]he receipt is an extremely important document
when a franchisee later alleges that disclosure was never
effected.''). See also Baer, NPR 11, at 15.
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At the same time, Item 23 is flexible, affording franchisors and
franchisees greater latitude in demonstrating receipt than the
comparable UFOC Guidelines provision. Whereas UFOC Item 23 requires
franchisors to acknowledge receipt with a handwritten signature, Item
23 updates the Rule by allowing the parties to use electronic
acknowledgments of receipt. As discussed in the definitions section
above, the term ``signature'' includes not only written signatures, but
electronic
[[Page 15513]]
signatures, passwords, security codes, and other devices that enable a
prospective franchisee to easily acknowledge receipt, confirm his or
her identity, and submit the information to the franchisor.\691\
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\691\ Item 23 also provides that franchisors may include
specific instructions on how prospects should submit the receipt,
such as via facsimile or email. This enables the parties to
determine for themselves the most efficient and cost-effective way
for the prospective franchisee to transmit the acknowledgment.
---------------------------------------------------------------------------
Item 23 of the final amended Rule also incorporates several
suggestions offered by commenters. For example, Warren Lewis advised
that the title of Item 23 should be ``receipts,'' observing that the
current industry practices is to have two receipts at the end of the
disclosure document, one the franchisee retains as part of the
disclosure document and the other returned to the franchisor.\692\ He
also urged the Commission to replace ``franchisee's signature'' used in
the Franchise NPR version of Item 23 with ``prospective franchisee's
signature,'' noting that some prospective franchisees object to signing
receipts as ``franchisees,'' since this designation is inaccurate until
they have actually signed the franchise agreement.\693\ NASAA also
suggested that the Commission clarify that the acknowledgment page must
be placed as the last two pages of the disclosure document. It observed
that ``[t]he States that review franchise offerings have noted many
instances where this page was buried in the middle of the disclosure
document.''\694\ We believe these suggestions are sound, and Item 23 of
the final amended Rule reflects these changes.
---------------------------------------------------------------------------
\692\ Lewis, NPR 15, at 18.
\693\ Lewis, NPR 15, at 18.
\694\ NASAA, NPR 17, at 11.
---------------------------------------------------------------------------
Another commenter addressed the second paragraph of the Item 23
receipt. As proposed in the Franchise NPR, this paragraph stated, in
relevant part: ``If [name of the franchisor] offers you a franchise, it
must provide this disclosure document to you 14 days before the earlier
of: (1) the signing of a binding agreement; or (2) any payment to [name
of franchisor or affiliate].'' H&H urged the Commission to substitute
``binding agreement'' with ``binding agreement with the franchisor or
any of its affiliates.'' The firm asserted that the franchisor cannot
control whether a prospective franchisee proceeds to commit with
independent, third parties before expiration of the 14 day period.\695\
As noted in our discussion of the disclosure trigger above, we agree
with this approach and have revised Item 23 of the final amended Rule
accordingly.\696\
---------------------------------------------------------------------------
\695\ H&H, NPR 9, at 21.
\696\ At the same time, the final amended Rule prohibits a
franchisor from failing to furnish disclosures earlier in the sale
process, upon reasonable request. See section 436.9(e).
---------------------------------------------------------------------------
At the same time, we reject several suggestions offered in response
to the Staff Report to modify Item 23. Four commenters noted that Item
23, as recommended in the Staff Report, requires franchisors to state
the name, principal business address, and telephone number of each
``franchise seller'' in the receipt.\697\ These commenters maintained
that this disclosure requirement is a carry-over from the UFOC Item 2
requirement, now eliminated in the final amended Rule, that franchisors
disclose brokers. They urged the Commission to delete the reference to
``sellers'' in Item 23 as well, asserting that this requirement would
result in franchisors having to disclose potentially hundreds of
names.\698\
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\697\ The version of Item 23 proposed in the Franchise NPR
referenced ``any subfranchisor or broker.'' Staff recommended
instead ``franchise seller,'' and the Commission has adopted this
approach.
\698\ Wiggin & Dana, at 4; Piper Rudnick, at 4; J&G, at 7;
Duvall, at 2.
---------------------------------------------------------------------------
As a preliminary matter, we note that UFOC Item 2 requires not only
the naming of brokers, but a statement about their prior experience.
Also, once an individual is named in Item 2, the franchisor must also
disclose their litigation history in UFOC Item 3 and their bankruptcy
history in UFOC Item 4. As discussed previously, we believe such
extensive disclosures are unnecessary with respect to brokers.
Nonetheless, we believe that a prospective franchisee should have
contact information for any seller with whom he or she is dealing.\699\
Accordingly, the disclosure of ``sellers'' in the Item 23 receipt is to
be read narrowly, referring to the specific individual(s) dealing with
the prospective franchisee. This approach is also helpful for law
enforcement purposes, identifying who may be responsible for furnishing
the disclosures. Accordingly, we believe there are sufficient grounds
for retaining the seller disclosure in Item 23.
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\699\ This does not mean that a franchisor must create
individualized disclosure documents for each franchise sale.
Clearly, a franchisor could create a receipt with a fill-in-the-
blank for the seller's information. The company or its agent could
fill in the blank with the appropriate information prior to
furnishing the disclosure document.
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D. Section 436.6: General Instructions
Section 436.6 of part 436 sets forth the basic instructions for
preparing a disclosure document. In the Franchise NPR, the Commission
proposed two new sections that would set forth the basic instructions
for preparing a disclosure document. The first section--Franchise NPR
section 436.6--set forth general instructions applicable to all
disclosure documents.\700\ Specifically, the Franchise NPR proposed
retaining the original Rule's three basic instructions: (1) that
disclosures be prepared clearly, legibly, and concisely in a single
document; (2) that franchisors respond positively or negatively to each
disclosure item; and (3) that franchisors do not add any materials to a
disclosure document, except for information required or permitted by
non-preempted state law. The proposed instructions also contained the
Commission's current policy that subfranchisors should provide
disclosures about the franchisor, and, to the extent applicable, about
themselves. Consistent with the UFOC Guidelines, disclosure documents
would also have to be written in plain English.\701\ None of these
basic instructions generated any significant comment in response to the
Franchise NPR or Staff Report.
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\700\ Franchise NPR, 64 FR at 57345.
\701\ The Staff Report proposed the same general instructions.
Staff Report, at 208-09.
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In a second section--Franchise NPR section 436.7--the Franchise NPR
proposed specific instructions pertaining to electronic
disclosures.\702\ In order to prevent fraud and circumvention of the
Rule's pre-sale disclosure requirements, the Franchise NPR proposed,
among other things, that: (1) prospective franchisees consent to
receiving electronic disclosures; and (2) franchisors using electronic
media provide prospective franchisees with a paper summary document
containing an expanded cover page, table of contents, and
acknowledgment of receipt. In addition, it called for all disclosures
to be in a form that would permit each prospective franchisee to
download, print, or otherwise maintain the document for future
reference. Multimedia features--such as audio, video, ``pop-up''
screens, and external links--would be prohibited in all disclosure
documents. In order to facilitate the reading of an electronic
disclosure document, however, the Franchise NPR proposed permitting
franchisors to include navigational tools, such as internal links,
scroll bars, and search features. Finally, the Franchise NPR proposed
that franchisors furnishing disclosure documents electronically retain
a
[[Page 15514]]
specimen copy of their disclosures for a period of three years.
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\702\ Franchise NPR, 64 FR at 57345.
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On June 30, 2000, Congress enacted the Electronic Signatures in
Global and National Commerce Act (``E-SIGN'').\703\ E-SIGN eliminates
barriers to ecommerce by, among other things, giving legal effect to
electronic transactions, including pre-sale disclosure, and permitting
electronic signatures. Further, E-SIGN preserves certain consumer
rights. Specifically, it provides that consumers must give their
informed consent before engaging in electronic transactions and
requires companies to disclose any rights consumers may have to receive
paper records and to withdraw previously-given consent to receive
electronic records. E-SIGN, however, limits such rights to ``consumer''
transactions, defining ``consumer'' to mean an ``individual who
obtains, through a transaction, products or services which are used
primarily for personal, family, or household purposes.''\704\ Thus, by
its terms, E-SIGN may have prohibited restrictions such as those
proposed in the Franchise NPR for electronic franchise disclosure.
---------------------------------------------------------------------------
\703\ 15 U.S.C. 7001.
\704\ 15 U.S.C. 7006(1).
---------------------------------------------------------------------------
In light of E-SIGN, the Commission has reconsidered the Franchise
NPR proposals. As explained below, the final amended Rule eliminates
the Franchise NPR's proposed electronic disclosure instructions--
Franchise NPR section 436.7. In lieu of specific electronic disclosure
instructions, the final amended Rule contains a broad general
instructions section that covers the furnishing of all disclosure
documents, paper and electronic alike. We discuss each general
instruction immediately below.
1. Section 436.6(a): Requirement to follow the Rule's disclosure and
updating provisions
Section 436.6(a) of the final amended Rule provides that it is an
``unfair or deceptive act or practice in violation of Section 5 of the
FTC Act for any franchisor to fail to include the information and
follow the instructions for preparing disclosure documents set out in
Subpart C (basic disclosure requirements) and Subpart D (updating
requirements) of the Rule. The Commission will enforce this provision
according to the standards of liability applicable in actions under
Sections 5, 13(b), and 19 of the FTC Act.''\705\
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\705\ 15 U.S.C 45(a); 53(b); 57b.
---------------------------------------------------------------------------
The original Rule specified that franchisors and franchise brokers
are jointly and severally liable for furnishing disclosure documents.
However, it did not specifically address who would be liable for a
disclosure document's content. During the Rule amendment proceeding,
the Commission sought to clarify liability for preparing disclosures,
proposing in the Franchise NPR that franchise sellers would be liable
for the contents of a disclosure document if they knew or should have
known of the violation.\706\
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\706\ Franchise NPR, 64 FR at 57301, 57333. A showing of
knowledge is necessary when seeking to hold an individual liable for
redress for a corporation's law violations in Section 5 matters, as
discussed further below.
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A few commenters voiced concern about the proposed standard. John
Baer, for example, stated that the Franchise NPR proposal imposed an
``impossible'' standard of liability:
As anyone who has drafted an Offering Circular can testify, there
is no certainty as to the nature of the information that has to be
included in the various disclosure sections of the Offering Circular
and reasonable persons often differ in good faith as to what has to be
disclosed.\707\
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\707\ Baer, NPR 11, at 10.
He suggested that the Commission revise the standard to ``make it a
violation for a franchisor to fail to use `commercially reasonable good
faith efforts' to disclose the required information.''\708\ Similarly,
Tricon stated that the proposal would result in all employees being
potentially liable for Rule violations, even those employees who are
not involved in any franchise sales. According to Tricon, an employee
should not be liable, even if that person had actual knowledge, unless
that person:
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\708\Id.
(a) knew (or should have known) the legal significance of those
facts, and (b) was in a position to influence the outcome of the
matter. For example, a secretary could ``know'' that financial
performance data was routinely provided to buyers, but neither knew the
significance of doing so nor be in a position to stop the
practice.\709\
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\709\ Tricon, NPR 34, at 6. See also Baer, NPR 11, at 10.
In contrast, NASAA supported the view that franchisors and individual
owners of franchisors should be held liable for Rule violations
``regardless of whether they knew or should have known of the
violation.''\710\
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\710\ NASAA, NPR 17, at 3.
---------------------------------------------------------------------------
Based upon the comments, the staff recommended a revised liability
standard in the Staff Report. The staff noted that all Commission trade
regulation rules implement Section 5 of the FTC Act and, therefore, the
final amended Rule should incorporate the standard of liability
developed in Section 5 cases. Under Section 5 law, individuals can be
enjoined in connection with a corporation's law violations if they
participated directly in them or had the authority to control
them.\711\ Applying this standard to the Franchise Rule, the Staff
recommended that franchise sellers (for example, third-party brokers
and franchisor employees) be liable for the content of a disclosure
document if they either directly participated in the document's
creation or had authority to control it.
---------------------------------------------------------------------------
\711\E.g., FTC v. Amy Travel Servs., Inc., 875 F.2d 564, 573
(7\th\ Cir.), cert denied, 439 U.S. 954 (1989); FTC v. Atlantex
Assocs., 1987-2 Trade Cas. (CCH), ] 67788 at 59255 (S.D. Fla. 1978),
aff'd, 872 F.2d 966 (11\th\ Cir. 1989); FTC v. Kitco of Nevada, 612
F. Supp. 1282, 1292 (D. Minn. 1985). Under Section 5 case law, it is
also clear that individual franchise salespersons are also directly
liable for their own misrepresentations in connection with franchise
sales. See, e.g., FTC v. J.K. Publ'ns, Inc., 99 F. Supp. 2d 1176,
1203 and note 67 (C.D. Cal. 2000).
---------------------------------------------------------------------------
Several commenters voiced concern about the Staff Report's proposed
``direct participation or control'' liability standard. In particular,
the commenters asserted that the ``authority to control'' language is
too broad. For example, David Kaufmann noted that all senior officers
of a corporate franchisor technically could be deemed to have the
authority to control the contents of a disclosure document and,
therefore, could be deemed liable, even if they were unaware of the
particular violation, or had no responsibility for it.\712\ Mr.
Kaufmann opined, however, that it is appropriate to hold an individual
liable for directly participating in a content violation.\713\
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\712\ Mr. Kaufmann observed that the New York Franchise Act
imposes liability upon any officer, director, or management employee
who materially aids in the act or transaction constituting the
violation of the Act. Lack of knowledge after due diligence is a
defense. Kaufmann, at 7-8.
\713\See also Cendant, at 2-3 (suggesting that the following
liability standard: ``Any other franchise seller will be liable for
the violations . . . if he or she directly participated in
preparation of the disclosure document.'').
---------------------------------------------------------------------------
J&G criticized the Staff Report's proposed liability standard as
imposing strict liability for all sellers even where their ``control''
is limited, attenuated, or indirect. According to J&G, under the
standard recommended in the Staff Report, liability could be found for
employees, advisors, consultants, attorneys, and accountants of a
franchisor who ``participate'' in the preparation of a disclosure
document or in the sales process in some manner. Outside consultants,
advisors, and attorneys could be held liable even if
[[Page 15515]]
they had no knowledge of the facts underlying the violation.\714\
---------------------------------------------------------------------------
\714\ J&G, at 3-4.
---------------------------------------------------------------------------
On the other hand, Howard Bundy argued that those in a corporate
structure who have ``authority to control'' content should be liable
for conduct of the corporation. ``This is consistent with what Congress
and the SEC have mandated in the post-Enron world with regard to
officers of a public corporation.''\715\ Mr. Bundy stated that a broad
standard is important to force responsibility for accuracy and
completeness to the highest levels in the franchisor's organization.
---------------------------------------------------------------------------
\715\ Bundy, at 2.
---------------------------------------------------------------------------
Because violations of part 436 constitute violations of Section 5,
the Commission is persuaded that liability for the content of a
disclosure document must be based upon liability standards applicable
in FTC enforcement actions under Sections 5, 13(b), and 19. In that
regard, there is a distinction between the standard of liability for
injunctive relief and that for redress. In general, case law
establishes that an individual may be enjoined for corporate misconduct
if he or she participated directly in the wrongful practice or had the
authority to control the corporate defendant.\716\ In the franchise
context, an officer or director of a franchisor may be enjoined against
violating the Rule if the officer or director, for example, has
authority to control or directly prepared, or directed others to
prepare, false or otherwise inaccurate disclosure documents.\717\
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\716\FTC v. Publ'g Clearing House, Inc., 104 F.3d 1168, 1170
(9\th\ Cir. 1997). See also FTC v. J.K. Publ'ns, Inc., 99 F. Supp.
2d at 1203; FTC v. Am. Standard Credit Sys., Inc., 874 F. Supp.
1080, 1087 (C.D. Cal. 1994). Authority to control the company can be
evidenced by active involvement in business affairs and the making
of corporate policy, including assuming the duties of a corporate
officer. FTC v. Amy Travel Serv., Inc., 875 F.2d at 573. Similarly,
an individual's status as a corporate officer and authority to sign
documents on behalf of the corporate defendant can be sufficient to
demonstrate the requisite control. FTC v. Publ'g Clearing House,
Inc., 104 F.3d at 1170.
\717\See FTC v. Five-Star Auto Club, Inc., 97 F. Supp. 2d 501
(S.D.N.Y. 2000) (individual defendant participated directly in the
deceptive acts or practices by, among other things, drafting and/or
approving marketing materials); FTC v. Atlantex Assocs.,1987-2 Trade
Cas. (CCH), ] 67788 (individual defendant liable because he had the
authority to control the company's actions, including the authority
to control representations made by salespeople).
---------------------------------------------------------------------------
In order to hold an individual liable to pay consumer redress,
however, the Commission must show more than just authority to control
the corporation. It must show the individual possessed some level of
knowledge or awareness of the misrepresentations.\718\ The Commission
may establish the requisite knowledge by showing that the individual
had ``actual knowledge of material misrepresentations, or an awareness
of a high probability of fraud along with an intentional avoidance of
the truth.''\719\ For example, an officer or director of a franchisor
would be liable for redress if he or she directed the franchisor's
employees to prepare false or misrepresented disclosures, or failed to
stop the company from using a faulty disclosure document that one or
more states had previously rejected as insufficient.\720\ Similarly, a
franchisor's sales manager could be held individually liable for
redress where the sales manager has authority to control those
preparing disclosure documents, and has knowledge that the disclosures
are false, or otherwise inaccurate.\721\
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\718\FTC v. Amy Travel Serv., Inc., 875 F.2d at 574. See also
FTC v. J.K. Publ'ns, Inc., 99 F. Supp. 2d 1176 at 1204; FTC v.
Atlantex Assocs., 1987-2 Trade Cas. ] 67788; FTC v. Kitco of Nevada,
Inc., 612 F. Supp. at 1282. For the Commission to obtain civil
penalties against a defendant, the standard of knowledge is even
higher: ``actual knowledge or knowledge fairly implied on the basis
of objective circumstances that [the] act or practice is unfair or
deceptive and is prohibited by such rule.'' 15 U.S.C. 45(m)(1)(A).
\719\FTC v. Publ'g Clearing House,104 F.3d at 1171; FTC v. Am.
Standard Credit Sys., Inc., 874 F. Supp. at 1089; FTC v. Minuteman
Press, Int'l, 53 F. Supp. 2d 248, 259-260 (E.D.N.Y. 1998); FTC v.
Int'l Diamond Corp., 1983-2 Trade Cas., ] 65725 at 69707 (N.D. Cal.
1983). It is axiomatic that the Commission need not show intent to
defraud, or bad faith. See, e.g., FTC v. World Travel Vacation
Brokers, Inc., 861 F.2d 1020, 1029 (7\th\ Cir. 1988) (citing
Beneficial Corp. v. FTC, 542 F.2d 611, 617 (3\rd\ Cir. 1976), cert
denied, 430 U.S. 983 (1977)); Removatron Int'l Corp. v. FTC, 884
F.2d 1489, 1495 (1\st\ Cir. 1989) (citing Chrysler Corp. v. FTC, 561
F.2d 357, 363 (D.C. Cir. 1977)); Regina Corp. v. FTC, 322 F.2d 765,
768 (3\rd\ Cir. 1963); FTC v. Patriot Alcohol Testers, Inc., 798 F.
Supp. 851, 855 (D. Mass. 1992).
\720\See, e.g., FTC v. Five-Star Auto Club, 97 F. Supp. 2d at
501 (failure to reform program in light of extensive state law
enforcement cease and desist orders shows reckless indifference to
the truth, or an awareness of high probability of fraud coupled with
an intentional avoidance of the truth); FTC v. Safety Plus, Inc.,
No. 91-352 (E.D. Ky. 1992) (taking affirmative steps to remedy
deceptive practices shows knowledge of the deceptive practices).
\721\See FTC. v. H.N. Singer, Inc., 668 F.2d 1107 (9\th\ Cir.
1982) (sales manager liable for restitution because of his authority
to control and knowledge of the deceptive acts and practices of his
salespeople).
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2. Section 436.6(b): Formatting requirements
As proposed in the Franchise NPR, section 436.6(b) of the final
amended Rule specifies that all disclosures must be prepared ``clearly,
legibly, and concisely in a single document.''\722\ At the same time,
it includes the UFOC Guidelines requirement that disclosures must be
prepared using plain English. It also updates the UFOC Guidelines to
address electronic disclosure: section 436.6(b) provides that
disclosures must be in a form that ``permits each prospective
franchisee to store, download, print, or otherwise maintain the
document for future reference.'' This prevents deception, ensuring that
prospective franchisees can review the disclosure document at will, as
well as show a copy of the disclosure document to their advisors, if
they wish to do so.\723\ Thus, for example, a franchisor would violate
section 436.6(b) if it sought to provide disclosures merely by
permitting a prospect to glance at a paper copy of its disclosure
document, providing a continuous loop video of its disclosure document
at a trade show, or transmitting its disclosures via email or the
Internet in a format that was incapable of being downloaded or printed.
No comments addressed this issue. Accordingly, the final amended Rule
adopts this provision as proposed in the Franchise NPR.
---------------------------------------------------------------------------
\722\ Franchise NPR, 64 FR at 57345. See 16 CFR 436.1(a) and
436.1(a)(21). The ``single document'' requirement prevents
``piecemeal and confusing disclosures by the franchisor.'' Original
SBP, 43 FR at 59682.
\723\See Bundy, ANPR, 6 Nov. 97 Tr., at 129 (disclosures need to
be either downloaded onto disk or provided in paper form).
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3. Section 436.6(c): Affirmative responses
Consistent with the original Rule and Franchise NPR, section
436.6(c) of the final amended Rule specifies that franchisors must
respond affirmatively or negatively to each disclosure item.\724\ If a
disclosure item is not applicable, then the franchisor must respond
negatively, including a reference to the type of information required
to be disclosed by the Item. For example, a franchisor without any
litigation would state something to the effect: ``The franchisor has no
litigation required to be disclosed by Item 3.'' In addition, each
disclosure item must contain the appropriate heading.\725\ No comments
addressed this issue. Accordingly, the final amended Rule adopts this
provision as proposed in the Franchise NPR.
---------------------------------------------------------------------------
\724\ Franchise NPR, 64 FR at 57345. See 16 CFR 436.1(a)(24).
This instruction is intended to ``aid the franchisee in using the
disclosure document and [is] intended as a remedial measure to
prevent franchisors' violations of the rule and the [FTC] Act.''
Original SBP, 43 FR at 59684.
\725\See 16 CFR 436.1(a)(24).
---------------------------------------------------------------------------
4. Section 436.6(d): Additional materials
The final amended Rule retains the original Rule's policy
prohibiting franchisors from including additional materials in their
disclosures, except for information ``required or permitted by this
Rule or by state law not pre-empted
[[Page 15516]]
by this Rule.''\726\ This prohibition is necessary to ensure that
franchisors do not include information that is non-material, confusing,
or distracting from the core disclosures.\727\ As proposed in the
Franchise NPR, the final amended Rule also updates the original Rule by
prohibiting the use of new technological developments, such as audio,
video, and ``pop-up'' screens, and external links,\728\ which could be
used to call attention to favorable portions of a disclosure document
or to distract prospective franchisees from damaging disclosures.\729\
The Commission recognizes, however, that navigational features may
benefit prospective franchisees by making it easier to read an
electronic disclosure document.\730\ To that end, the final amended
Rule, consistent with the Franchise NPR, specifically permits the use
of ``scroll bars, internal links, and search features.''
---------------------------------------------------------------------------
\726\ Franchise NPR, 64 FR at 57345. See 16 CFR 436.1(a)(21).
The Franchise NPR referred to ``any materials or information other
than that required by this Rule or by state law not preempted by
this Rule.'' One commenter noted that because some of the proposed
Rule's disclosures are optional (such as the Item 19 financial
performance disclosures), the prohibition on additional information
should read ``any materials or information other than that required
or permitted by this Rule . . .'' Lewis, NPR 15, at 19. We agree,
and the final amended Rule reflects this change.
\727\See Original SBP, 43 FR at 59682. Accordingly, franchisors
may include information expressly required or expressly permitted by
state law or information requested by a state franchise examiner.
This provision is not intended to permit franchisors to include any
information (such as testimonials or general promotional materials)
in a disclosure document on the ground that it is not specifically
prohibited by state law.
\728\ The prohibition on external links, like the requirement
that a disclosure be a single document, effectively prevents
franchisors from furnishing disclosures through a series of linked,
but separate, documents. This ensures that electronic disclosures,
in particular, can be downloaded and printed in their entirety. See
Bundy, NPR 18, at 13 (suggesting that the Rule should expressly
require that all exhibits and attachments must be part of the single
disclosure document and it should prohibit external links). If not,
a prospective franchisee downloading or printing an electronic
disclosure document may only capture isolated sections. This would
violate the very concept of full disclosure underlying the Rule.
\729\ BI commented that a prohibition on the use of multimedia
features ``appears to be overly broad.'' BI, NPR 28, at 8. It
proposed that the Commission consider that some features may assist
a prospective franchisee in reading a disclosure document. BI,
however, did not specify which features it had in mind or how those
features might assist prospective franchisees.
\730\ Frandata, for example, observed that internal links will
enable a prospective franchisee to shift between the disclosure
document and corresponding agreement provisions, ``thus affording a
franchisee a more intelligent and efficient review of a disclosure
document.'' Frandata, NPR 29, at 4. Indeed, Frandata suggested that
the Commission formulate a specific set of cross-links and features
in order to ensure that all electronic disclosure documents are
uniform. In its view, uniformity would foster comparison shopping
among franchise offers. In addition, it would avoid stigmatizing
those franchise systems that fail to incorporate features in their
electronic disclosure documents. ``For example, viewing a document
with extensive search features keyed to words in the disclosure
document might predispose a prospect to envision that all electronic
versions contained such a feature, and would therefore create a
negative impression (or customer service issues) for other systems
which have not incorporated such a feature, while simultaneously
confusing the prospect.'' Id. We would not go so far. Rather than
dictate the features that a franchisor should use in preparing
disclosure documents, we believe the Rule should allow for maximum
flexibility, enabling franchisors to incorporate those navigational
features it believes are warranted.
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The prohibition against adding to a disclosure document generated a
number of comments during the Rule amendment proceeding. Several
commenters voiced concern that the prohibition against adding to a
disclosure document ``is an unfair trap for franchisors and
subfranchisors.'' For example, Warren Lewis asserted:
[W]e note that a franchisor or subfranchisor sometimes needs to
include information in a disclosure document that it believes is
material or possibly material (even though the information is not
required or permitted under federal or state law) or that it believes
will help a prospect to better understand required information or its
significance. Providing supplementary or explanatory information of
this type should not be a rule violation, unless the information is
excessive, misleading, or intentionally diversionary.\731\
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\731\ Lewis, NPR 15, at 19. See also Holmes, NPR 8, at 9;
Stadfeld, NPR 23, at 15; BI, NPR 28, at 8.
The Commission believes that its long-standing policy limiting
disclosures to only authorized or permitted materials is sound. As
discussed above, this limitation is necessary to ensure that a
franchisor does not bulk-up a disclosure document with unnecessary
information or features that will discourage a prospective franchisee
from reading the document or distract a prospective franchisee's
attention from negative disclosures. For example, it is entirely proper
to prohibit a franchisor from including general advertising,
testimonials, or-- in the case of electronic media-- multimedia tools,
in its disclosure documents. On the other hand, the Commission
recognizes that unique features of electronic media, such as scroll
bars, internal links, and search features that may aid prospective
franchisees in reviewing their disclosures. Such features serve a
useful purpose in an electronic environment, and the final amended Rule
specifically permits their use.\732\
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\732\ Section 436.6(d), however, makes clear that navigational
tools must be for the prospective franchisee's benefit. Accordingly,
a franchisor's selective use of navigational tools for its own
benefit (i.e., to draw the prospect's attention to, or away from,
certain disclosure items) is prohibited.
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In reaching this conclusion, we agree with the commenters' concern
that it may be desirable to include additional material information in
a disclosure document to ensure that required disclosures are accurate.
The prohibition on adding to a disclosure document should be read
narrowly to prohibit the inclusion of materials that are not
specifically required or permitted by the Rule.\733\ Where the Rule
requires a franchisor to make a disclosure, however, the franchisor
always may add brief footnotes or other clarifications to ensure that
the disclosure is complete and not misleading.
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\733\ We note that nothing in the Rule prohibits a franchisor
from furnishing prospective franchisees with non-deceptive and non-
contradictory information outside of its disclosure document. See 16
CFR 436.1(a)(21) (``This does not preclude franchisors . . . from
giving other nondeceptive information orally, visually, or in
separate literature so long as such information is not contradictory
to the information in the disclosure statement.'').
---------------------------------------------------------------------------
Finally, in response to the Staff Report, David Kaufmann asserted
that the prohibition against adding to a disclosure document set forth
at section 436.6(d) creates an inconsistency with state anti-fraud laws
that require a disclosure document to contain all material
information.\734\
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\734\ Kaufmann, Attachment 1, at 10-11. In the same vein, Howard
Bundy recommended that the Commission create a separate,
miscellaneous section of a disclosure document, where a franchisor
can add other material disclosures necessary to make the disclosure
document non-deceptive. Bundy, at 2-3.
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Section 436.6(d) is not intended to preempt state law. As
previously discussed, a franchisor can always include information in a
disclosure document that is required by state law. Typically, such
state disclosures will arise in two circumstances. First, state law may
require specific disclosures that go beyond those required by the
Franchise Rule, or may contain a broad anti-fraud provision requiring
franchisors to include in their disclosure document all material
information. Second, a state franchise examiner may require, as a
matter of discretion, on a case-by-case basis, a particular disclosure
in order to prevent deception by a franchisor. In either instance, the
final amended Rule accommodates state interests by permitting the
franchisor to add state
[[Page 15517]]
information to its basic disclosure document.
5. Section 436.6(e): Multi-state documents
As proposed in the Franchise NPR, section 436.6(e) of the final
amended Rule permits franchisors to ``prepare multi-state disclosure
documents by including non-preempted, state-specific information in the
text of the document or in Exhibits attached to the disclosure
document.''\735\ This instruction will decrease compliance costs
significantly, by enabling franchisors to use one, united disclosure
document for both federal and state purposes. No comments were
submitted on this issue. Accordingly, the final amended Rule adopts
this provision, as proposed in the Franchise NPR.
---------------------------------------------------------------------------
\735\ Franchise NPR, 64 FR at 57345.
---------------------------------------------------------------------------
6. Section 436.6(f): Subfranchisor disclosures
Consistent with the original Rule, section 436.6(f) makes clear
that subfranchisors must disclose the required information about the
franchisor, and, to the extent applicable, the same information
concerning the subfranchisor.\736\
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\736\See Interpretive Guides, 44 FR at 49969. While the
Commission has allowed some flexibility in how franchisors and
subfranchisors should prepare disclosure documents, it also made
clear that both ``the franchisor and the subfranchisor are
responsible for each other's compliance with the rule, and are
jointly and severally liable for each other's violations.'' Id. The
Commission also stated that it expects franchisors and
subfranchisors to provide the required background information,
litigation, and bankruptcy disclosures of both parties, and that
subfranchisors should provide franchisee statistical information in
all instances. Id.
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The Franchise NPR proposed that subfranchisors ``should'' disclose
the required information. Howard Bundy suggested that the subfranchisor
instructions be revised to replace ``should disclose'' with ``shall
disclose.''\737\ He noted that the word ``should'' implies an advisory
only, that is, that a subfranchisor has the discretion to include its
own information in the disclosure document. We agree, and section
436.6(f) of the final amended Rule is revised accordingly.
---------------------------------------------------------------------------
\737\ Bundy, NPR 18, at 11.
---------------------------------------------------------------------------
At the same time, H&H voiced concern about subfranchisors'
disclosure obligations, correctly observing that ``subfranchising''
takes many different forms. For example, a subfranchisor may in fact
function as a franchisor by signing a franchise agreement with a
subfranchisee, or the franchisor may sign the franchise agreement, but
delegate many support functions to the subfranchisor. In the first
``example, the proposed [disclosure] requirement may lead to disclosure
about the franchisor in a subfranchise offering that is irrelevant and,
in some circumstances, could be misleading to prospective
franchisees.''\738\ As discussed above in connection with the
definition of ``franchisor,'' subfranchisors are treated the same as
franchisors under the Rule in narrow circumstances only: where the
subfranchisor steps into the shoes of the franchisor by both granting
franchises, as well as by performing post-sale disclosure
obligations.\739\ Accordingly, we believe that the subfranchisor
instructions set forth at section 436.6(f) are clear and no additional
revision is necessary.
---------------------------------------------------------------------------
\738\ H&H, NPR 9, at 6.
\739\ In our view, a new definition to address subfranchising is
unnecessary because the term ``franchisor'' adequately addresses the
issue. The Commission anticipates that staff will also explain
subfranchising more fully in the Compliance Guides, with
hypothetical examples.
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7. Section 436.6(g): Disclosure of any prerequisites to receiving or
reviewing disclosure documents
Section 436.6(g) requires that, before a franchisor furnishes a
disclosure document, it must ``advise the prospective franchisee of the
formats in which the disclosure document is made available, any
prerequisites for obtaining the disclosure document in a particular
format, and any conditions necessary for reviewing the disclosure
document in a particular format.''\740\
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\740\ This instruction is an alternative to the originally
proposed prior-consent mandate for electronic disclosures. Several
commenters opposed a prior consent requirement. See NFC, NPR 12, at
15; Frandata, NPR 29, at 5; AFC, NPR 30, at 2. The NFC, for example,
feared that an advance consent precondition would stifle new
technological advances that would enable franchisors and prospective
franchisees to conduct business online ``seamlessly,'' without any
additional contacts or discussions. NFC, NPR 12, at 15. See also
McDonalds, NPR 7, at 2. We agree. Section 436.6 permits a wide
variety of disclosure formats, provided that the prospective
franchisee is made aware of any prerequisites to using them.
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This provision was not previously noted in the Franchise NPR.\741\
It is intended to prevent deception, by ensuring that prospective
franchisees, prior to disclosure, know whether or not they will receive
a disclosure document in a form they can easily review.\742\ For
example, a franchisor would disclose if it furnishes disclosures via
CD-ROM only. In addition, the franchisor must disclose if there are any
special conditions to reviewing a disclosure document. The franchisor
would disclose, for example, whether the prospective franchisee's
computer must be capable of reading pdf files or whether any specific
applications are necessary to view the disclosures (such as Windows
2000 or DOS, or a particular Internet browser). No comments were
submitted on this proposed Rule amendment. Accordingly, the Commission
adopts this provision in the final amended Rule.\743\
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\741\ As noted above, the Franchise NPR proposed a new section--
section 436.7--that set forth comprehensive electronic disclosure
instructions. Among other things, that proposed section would have
permitted prospective franchisees to furnish disclosures
electronically only with the prospective franchisee's ``express
consent.'' Proposed section 436.7(a). While an ``express consent''
requirement is now prohibited by E-SIGN, the underlying concepts--
that a prospective franchisee should know the formats in which
disclosure documents will be provided, and any prerequisites to
obtaining one--nonetheless continue to apply, regardless of the
media (i.e., paper document or electronic document) selected by the
franchisor to comply with the final amended Rule.
\742\ This is consistent with section 436.3(f) of the final
amended Rule, allowing franchisors to state in the cover page
whether alternative disclosure formats are available and how
prospective franchisees may obtain one.
\743\ One commenter, however, observed that this section does
not specify how or when the franchisor should communicate this
information to the prospect. Kaufmann, at 3. He suggested that the
Commission advise in the Compliance Guides that franchisors may
communicate this information in any fashion and at any time prior to
furnishing the disclosure document it chooses-- in person,
telephonically, in writing, in email, in its marketing materials, or
applications. Id. But see Bundy, at 10 (asserting that the provision
does not provide sufficient guidance, recommending that the
Commission specify which formats are preferred). We agree that the
final amended Rule should be as flexible as possible. Section
436.6(g) is not intended to be a new trigger or timing for
disclosures provision. As long as the franchisor has communicated
this information before the 14 calendar-days for disclosure starts
running, the franchisor has complied with this provision.
Flexibility is also called for, provided that the franchisor can
demonstrate that it has communicated the required information. For
many systems, the easiest way to impart this information will be in
the franchisor's initial application form, or in the first written
contact after acceptance of the application when the issue of
furnishing the disclosure document first arises.
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8. Section 436.6(h): Disclosure document recordkeeping
Section 436.6(h) of the final amended Rule requires franchisors to
``retain, and make available to the Commission upon request, a sample
copy of each materially different version of their disclosure documents
for three years after the close of the fiscal year when it was last
used.'' This provision modifies slightly the language used in the
Franchise NPR--which limited the recordkeeping instruction to
electronic disclosure documents.\744\ Section 436.6(h) now applies to
all disclosure documents, regardless of the medium
[[Page 15518]]
used.\745\ This is consistent with E-SIGN, which generally prohibits
discriminating between paper and electronic commerce. It is also
consistent with standard business practices and state law requirements,
and, therefore, should impose only a de minimis burden on franchisors.
At the same time, a three-year recordkeeping provision will greatly
assist the Commission in its law enforcement work, by ensuring the
availability of evidence in rule enforcement actions.\746\
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\744\ Franchise NPR, 64 FR at 57345.
\745\ Many states require franchisors to keep records on
franchise sales transactions. E.g., Cal. Corp. Code at 31150; Haw.
Rev. Stat. at 482E-5; 815 Ill. Comp. Stat. at 705/36; Md. Code Ann,
Bus. Reg. at 14-224; Minn. Stat. at 80C.10; N.D. Cent. Code at 51-
19-16; Or. Rev. Stat. at 650.010; R.I. Gen. Laws at 19-28.1-13;
Wash. Rev. Code at 19.100.150.
\746\ Rule enforcement actions brought under Section 19 of the
FTC Act have a three-year statute of limitations. 15 U.S.C. 57b.
Reliance on franchisees for copies of disclosure documents in law
enforcement work is impracticable. Franchisees may not retain copies
or may not have complete copies. Moreover, large franchise systems
may use multiple versions of their disclosures over time and in
different states. Obtaining all relevant copies from franchisees may
be unworkable. Therefore, for law enforcement purposes, it is
essential that franchisors retain copies of their disclosures for
some length of time, consistent with state practices.
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During the Rule amendment proceeding, a few commenters urged the
Commission to adopt a longer recordkeeping requirement.\747\ A longer
recordkeeping provision, no doubt, might also assist franchisees who
wish to bring common law actions with longer limitations periods.
However, we believe such a step is unnecessary in light of the other
Rule instructions ensuring that prospective franchisees can retain
copies of their disclosures for future reference. In short, franchisees
should safeguard their disclosure documents post-sale, and the Rule
instructions, as noted above, accommodate that interest.
---------------------------------------------------------------------------
\747\ Bundy, NPR 18, at 13; Stadfeld, NPR 23, at 5.
---------------------------------------------------------------------------
9. Section 436.6(i): Receipt recordkeeping
Finally, section 436.6(i) of the final amended Rule requires
franchisors to ``retain a copy of the signed receipt for at least three
years.''\748\ This section was proposed in the Franchise NPR in
connection with the Item 23 receipt requirement. However, because this
recordkeeping requirement is not a disclosure, but is more akin to an
instruction, it has been moved to the final amended Rule's general
instructions section.
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\748\See BI, NPR 28, at 7-8 (This ``provides useful
clarification regarding the minimum time period the Commission
expects franchisors to maintain such records.'').
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Section 436.6(i)'s three-year record retention period is consistent
with the statute of limitations for trade regulation rule enforcement
actions brought under Section 19 of the FTC Act.\749\ Further, many
franchise registration states already require franchisors to maintain
complete records involving each franchise sales transaction.\750\
Therefore, franchisors routinely ask for and retain some kind of
receipt in the ordinary course of business to protect themselves from
any future allegations that they sold franchises without disclosure.
Thus, a recordkeeping requirement is likely to foster compliance with
the Rule's disclosure obligation without imposing significant
compliance costs.\751\
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\749\ Several Commission trade regulation rules also require a
three-year recordkeeping requirement. See, e.g., Wool Labeling Rule,
16 CFR 300.31(c); Fur Labeling Rule, 16 CFR 301.41(b); Textile
Labeling Rule, 16 CFR 303.39(c); Alternative Fuel Labeling Rule, 16
CFR 309.23; R-Value Rule, 16 CFR 460.9.
\750\E.g., Cal. Corp. Code at 31150; Haw. Rev. Stat. at 482E-5;
815 Ill. Comp. Stat. at 705/36; Md. Code Ann, Bus. Reg. at 14-224;
Minn. Stat. at 80C.10; N.D. Cent. Code at 51-19-16; Or. Rev. Stat.
at 650.010; R.I. Gen. Laws at 19-28.1-13; Wash. Rev. Code at
19.100.150.
\751\ No comments were submitted on this proposed Rule section.
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E. Section 436.7: Updating Requirements
Section 436.7 of the final amended Rule specifies three updating
requirements to ensure that franchisors' disclosures are timely. In
most respects, the updating requirements are identical to those set
forth in the original Rule and Franchise NPR, and have generated few
comments.
First, section 436.7(a) of the final amended Rule retains the
current requirement that franchisors prepare annual updates after the
close of their fiscal year,\752\ but it has expanded the number of days
in which franchisors are permitted to prepare updates from 90 to 120
days.
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\752\See 16 CFR 436.1(a)(22).
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Second, sections 436.7(b) and (c) retain the requirement that
franchisors update their disclosures within a reasonable time after the
close of each quarter to reflect any material changes.\753\
---------------------------------------------------------------------------
\753\See 16 CFR 436.1(a)(22).
---------------------------------------------------------------------------
Third, section 436.7(d) continues the original Rule's policy that
franchise sellers, when furnishing their disclosures, must notify
prospective franchisees of any material changes that the seller knows
or should have known in any Item 19 financial performance
representations.\754\ We discuss each of these provisions immediately
below.
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\754\See 16 CFR Sec. Sec. 436.1(d)(2) and (e)(6). Section
436.7(e) also retains the Commission's current policy that audited
information in a disclosure document need not be re-audited on a
quarterly basis. Rather, a franchisor can update its audited
disclosures by including unaudited information, provided the
franchisor discloses that the information is unaudited. See 16 CFR
436.1(22).
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1. Section 436.7(a): Annual updates
As noted above, section 436.7(a) expands the time period proposed
in the Franchise NPR for making annual updates from 90 to 120 days
after the close of the franchisor's fiscal year.\755\ In response to
the Franchise NPR, several commenters urged the Commission to adopt a
120-day requirement. For example, PMR&W stated that many franchisors
have difficultly obtaining annual audited financial statements from
their auditors within the current 90-day period. Because most
franchisors use the calendar fiscal year, company auditors are usually
overwhelmed at the beginning of the fiscal year, given the busy tax
season. Recognizing this problem, many state franchise regulators allow
franchisors 120 days to prepare updated disclosures.\756\ For these
reasons, the Commission is persuaded that the updating requirement
should be expanded from the original Rule's 90 days to 120 days. This
revision has the potential of reducing franchisors' compliance burdens,
while potentially reducing inconsistencies with state updating
policies.\757\
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\755\ Franchise NPR, 64 FR at 57345 (retaining the original
Rule's 90-day annual update requirement).
\756\ PMR&W, NPR 4, at 5. See also Baer, NPR 11, at 4; Lewis,
NPR 15, at 19-20; IFA, NPR 22, at 11; J&G, NPR 32, Attachment, at 3.
\757\ In response to the Staff Report, however, Gust Rosenfeld
suggested that ``120 days'' should be expressed as ``four months.''
The firm noted that during leap years, 120 days would fall on April
29, or if the franchisor's fiscal year end is June 30\th\, 120 days
would fall on October 28. Gust Rosenfeld, at 7. While we recognize
there may be rare instances where 120 days does not fall at the end
of a month, we are reluctant to change the language of section
436.7(a) to be inconsistent with state law.
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2. Sections 436.7(b)-(c): Quarterly updates
Sections 436.7(b) and (c) of the final amended Rule retain the
original Rule and Franchise NPR requirement that franchisors update
their disclosures at least quarterly to reflect any material
changes.\758\ This requirement generated no significant comment during
the Rule amendment proceeding.\759\ We believe it
[[Page 15519]]
strikes the right balance between ensuring the timeliness of
disclosures and reducing compliance burdens. Franchisors need to
prepare quarterly updates only if there is a material change, and they
may include the quarterly update in an addendum. In short, franchisors
need not prepare new disclosure documents each quarter as a matter of
course. We believe the current quarterly update requirement establishes
a clear, bright line tied to each franchisor's fiscal year. It has
worked well and has generated few, if any, complaints during the 20
years that the Rule has been in existence.
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\758\ Franchise NPR, 64 FR at 57345. See also 16 CFR
436.1(a)(22).
\759\ PMR&W, for example, noted that the original Rule's
quarterly update requirement is a bright-line rule that ``is clear
and intelligible to franchisors and their counsel.'' PMR&W, NPR 4,
at 6. Similarly, the NFC states that a quarterly update requirement
is consistent with long-standing Commission policy. NFC, NPR 12, at
16. One commenter, responding to the comparable provision in the
Staff Report, noted that the Franchise NPR would have required a
franchisor to update information quarterly ``relating to the
franchise business of the franchisor.'' J&G, at 7. The firm asserted
that this language could require the disclosure of more information
than is required by the actual disclosure Items. It suggested that
the Commission adopt the alternative language: any material change
to ``the disclosures included, or required to be included, in the
disclosure document.'' We agree, and section 436.7(b) of the final
amended Rule reflects that change.
---------------------------------------------------------------------------
Section 436.7(c) modifies the quarterly update provision proposed
in the Franchise NPR, however, to accommodate the extension of the
annual update from 90 to 120 days, as previously discussed. The
obligation to update disclosures quarterly necessarily precedes the
conclusion of the 120-day annual update period. Accordingly, additional
clarification of the interrelationship between the annual and quarterly
update requirements is warranted. To that end, section 436.7(c)
provides that a franchisor's annual update (120 days after the close of
the fiscal year) ``shall include the franchisor's first quarterly
update, either by incorporating the quarterly update information into
the disclosure document itself, or through an addendum.'' The following
tables illustrate the point, by comparing procedures under the original
Rule with those under section 436.7(c).
Hypothetical Using Procedures Under the Original Rule
December 31, 2005........................... Fiscal year ends.
January-March, 2006......................... First quarter of new fiscal year.
April 1, 2006............................... Franchisor must use annual updated disclosure document.
Reasonable time after April 1, 2006......... Franchisor amends annual update with a quarterly update, if
warranted.
Reasonable time after July 1, 2006.......... Franchisor amends annual update (and any previous quarterly
update) with a quarterly update, if warranted.
Reasonable time after October 1, 2006....... Franchisor amends annual update (and any previous quarterly
update(s)) with a quarterly update, if warranted.
Reasonable time after January 1, 2007....... Franchisor amends 2006 annual update (and any previous quarterly
updates(s)) with a quarterly update, if warranted.
----------------------------------------------------------------------------------------------------------------
Hypothetical Using Final amended Rule Procedures
December 31, 2005........................... Fiscal year ends.
January-March, 2006......................... First quarter of new fiscal year.
May 1, 2006................................. Franchisor must use annual updated disclosure document containing
any first quarter update either integrated in the body of the
disclosure document itself or in an addendum.
Reasonable time after July 1, 2006.......... Franchisor amends annual update with a quarterly update, if
warranted.
Reasonable time after October 1, 2006....... Franchisor amends annual update (and any previous quarterly
update(s)) with a quarterly update, if warranted.
Reasonable time after January 1, 2007....... Franchisor amends annual update (and any previous quarterly
updates(s)) with a quarterly update, if warranted.
----------------------------------------------------------------------------------------------------------------
3. Section 436.7(d): Material changes to financial performance
information
Section 436.7(d) retains the original Rule requirement that a
franchisor notify prospective franchisees of any material changes to
previously furnished financial performance information.\760\ The
Franchise NPR proposed a broader updating requirement that would have
compelled franchisors to notify prospects of any material changes
before delivery of the disclosure document.\761\ This proposal
generated several comments, both supporting and opposing the expanded
updating proposal.
---------------------------------------------------------------------------
\760\ 16 CFR 436.1(d)(2) and 436.1(e)(6).
\761\ NPR, 64 at 57319.
---------------------------------------------------------------------------
IL AG and Howard Bundy favored the broader updating requirement,
but they would require all such updates to be in writing. The IL AG,
for example, stated that ``[o]ral notification is the ammunition for
rescission litigation.''\762\
---------------------------------------------------------------------------
\762\ IL AG, NPR 3, at 4. See also Bundy, NPR 18, at 13; BI, NPR
28, at 8-9. On the other hand, the NFC praised the Commission's
flexibility in permitting notification by any means. NFC, NPR 12, at
16.
---------------------------------------------------------------------------
On the other hand, several franchisors opposed the updating
requirement for various reasons. Marriott, for example, asserted the
proposal would be extremely burdensome, imposing ``an impossible burden
on large franchisors, especially if they actually operate the business
that they franchise because of the uncertainty of what constitutes `any
material change' and the requirement of `real time' ongoing
disclosure.''\763\ Marriott would eliminate the proposed expanded
update provision in its entirety.\764\
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\763\ Marriott, NPR 35, at 3-4. Marriott noted that it, and
other large corporations, may have several thousand employees in
different departments. Each department (e.g., training, legal,
advertising, marketing) may have a different person responsible for
a portion of the information that is in a disclosure document for
each different brand offered. A continuous updating requirement:
``would place an unfair burden on franchisors like Marriott. For
example, it will be virtually impossible for the Training Department
(every time they change a subject or the hours allotted to a
particular subject in the training program) . . . to contact Legal
and for Legal to determine if the change is material and to then
contact development to make sure before the closing of every
franchise deal that there is not a particular piece of information
that must be notified to a franchisee. This requirement will cause
complete havoc in the franchise sales process. Franchisors will not
be able to close sales without notifying every department out of
fear that some minute change in fact may later be deemed to be
material.''
Marriott, NPR 35, at 4.
\764\ Marriott, NPR 35, at 4. See also PMR&W, NPR 4, at 6.
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PMR&W and the NFC advised that the proposal is confusing. In
particular, PMR&W found the relationship between the basic quarterly
update provision and the proposed continuing update provision less than
clear:
It is unclear whether these ``material changes'' must be more
``material'' than any changes disclosable in the quarterly updates.
[[Page 15520]]
Depending on the answer to this question, is there any need to require
quarterly updates when immediate updates are mandated; i.e., does the
immediate update rule preclude the need for the quarterly update?\765\
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\765\ PMR&W, NPR 4, at 6.
In a similar vein, the NFC questioned whether a franchisor must provide
a prospective franchisee with each and every quarterly update, as long
as the prospect is in the sales cycle. If so, it asked how franchisors
should determine whether prospects are no longer in the sales
cycle.\766\
---------------------------------------------------------------------------
\766\ NFC, NPR 12, at 16.
It is clear from the comments that there are two competing
concerns. On the one hand, prospective franchisees should have all
material information they need to make an informed purchase decision,
regardless of when they entered the sales process. On the other hand,
there are practical considerations, including the costs and burdens on
franchisors to update each franchisee on a continuing basis, as
Marriott observed. Indeed, at some point, the burden and cost to
franchisors (which inevitably will be passed along to prospective
franchisees or other consumers) outweighs the potential benefit of more
frequent updating.
Based upon the record, the Commission is persuaded that, on
balance, a continuing update requirement is unwarranted. We are
convinced that franchisors should have a bright-line directive when
they can be assured that they have complied with the Rule's disclosure
requirements. We believe that the original Rule's quarterly update
requirement is sufficient to ensure timely disclosures, while
minimizing compliance costs.
Further, any prospective franchisee who has been in the sales cycle
can always request a copy of the franchisor's most recent disclosure
document before he or she agrees to execute the franchise agreement. To
facilitate that goal, the Commission has adopted a new prohibition that
would bar franchisors from failing to honor a prospective franchisee's
reasonable request for a copy of the franchisor's most recent
disclosure document and/or quarterly update before he or she signs a
franchise agreement.\767\ We believe this prohibition is unlikely to
increase franchisor's compliance costs and burdens. Franchisors most
likely will have updated disclosures documents prepared in the ordinary
course of their business. With the advent of electronic communications,
emailing a copy of the updated disclosure document to a prospective
franchisee, or otherwise permitting a prospective franchisee to see a
copy of the updated disclosure document on the franchisor's website,
would impose only a small cost.
---------------------------------------------------------------------------
\767\See section 436.9(f). This provision also address the
commenters' concerns about permitting franchisors to furnish updates
orally.
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At the same time, we are persuaded that the final amended Rule
should retain the original Rule's continuing update requirement for
financial performance information.\768\ The original Rule required
franchisors to notify prospective franchisees of any material changes
in a financial performance representation before the prospective
franchisee pays a fee or signs the franchise agreement.\769\ We believe
this provision is sound, recognizing the particular materiality of
financial data to prospective franchisees. Any false impression created
by stale data at the time of sale is likely to cause significant injury
to prospective franchisees who rely on financial data in making their
investment decision.\770\
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\768\ But see IL AG, at 10 (suggesting that the Rule state that
franchisors may have other disclosure obligations under Section 5 of
the FTC Act); Bundy, at 3 (suggesting a continuous updating
requirement for ``materially adverse events.''). The quarterly
update provision specifies when a franchisor must prepare revised
disclosures to ensure that they are timely. It does not address
whether a franchisor may have other obligations to notify
prospective franchisees of material changes under state common law
fraud or misrepresentation principles.
\769\See 16 CFR 436.1(d)(2) and 436.1(e)(6). Like the original
Rule, the final amended Rule requires the franchisor to ``notify''
the prospective franchisee of any material change in financial
performance information. It does not require a franchisor to update
its disclosures more often than quarterly, nor does it require a
franchisor to re-disclose to a prospective franchisee. Rather,
``notification'' means that the franchisor must inform the
prospective franchisee, which can be accomplished outside of the
disclosure document. How a franchisor ``notifies'' a prospective
franchisee is within the sound discretion of the franchisor.
Notification can be made in writing, or by telephone call, email, or
other electronic transmission, provided that the franchisor can
prove that it has informed the prospective franchisee about the
material change to the performance data.
\770\But see J&G, at 11 (asserting that financial performance
information should be updated only quarterly).
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F. Section 436.8: Exemptions
Section 436.8 of part 436 sets forth exemptions from the final
amended Rule. In the original Rule, the exemptions were set out in the
middle of the Rule's definitions, where they modified the term
``franchise.''\771\ To make the exemptions easier to find, the
Commission has decided to move them to a separate ``exemptions''
section in the final amended Rule.\772\
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\771\ 16 CFR 436.2(a)(3).
\772\ This approach is consistent with other Commission rules,
including the Telemarketing Sales Rule, 16 CFR 310.6; the Care
Labeling Rule, 16 CFR 423.8, and the Cooling-Off Period Rule, 16 CFR
429.3. The UFOC Guidelines do not contain any exemptions. Rather, at
most, some of the 15 franchise disclosure states may exempt
franchisors from registration requirements as a matter of statute or
regulation. See generally Duvall & Mandel, ANPR 114. Thus,
franchisors exempted from disclosure under the final amended Rule
may nonetheless have to prepare and disseminate UFOCs for state law
purposes.
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Section 436.8 retains the original Rule exemptions for: (1)
franchise sales under $500;\773\ (2) fractional franchises;\774\ (3)
leased departments;\775\ and (4) oral contracts.\776\ Section 436.8
also adds two new exemptions, one for franchise sales involving
petroleum marketers, and one for three categories of ``sophisticated
investors.'' Finally, the final amended Rule deletes the original
Rule's four exclusions found at 16 CFR 436.2(a)(4)(i)-(iv) for non-
franchise relationships involving: (1) employer-employees and general
partnerships; (2) cooperative organizations; (3) testing or
certification services; and (4) single trademark licenses.\777\
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\773\See 16 CFR 436.2(a)(3)(iii).
\774\See 16 CFR 436.2(a)(3)(i).
\775\See 16 CFR 436.2(a)(3)(ii).
\776\See 16 CFR 436.2(a)(3)(iv).
\777\ As discussed below, although the Commission is deleting
the exclusions from the final amended Rule text, it is retaining the
exclusions as a matter of policy and incorporating them by reference
in this Document.
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The final amended Rule section 436.8 is substantially similar in
both form and content to its counterpart proposed in the Franchise
NPR.\778\ The principal difference is a lowering of the dollar
threshold for the sophisticated investor ``large investment'' exemption
from $1.5 million to $1 million. This and the other substantive
differences between the proposed and final amended Rules are explained
below.
---------------------------------------------------------------------------
\778\ Franchise NPR, 64 FR at 57345. The final amended Rule
provision, however, has been renumbered as section 436.8. In the
Franchise NPR, it was numbered section 436.9.
---------------------------------------------------------------------------
1. Section 436.8(a)(1): Minimum payment exemption
Section 436.8(a)(1) retains the original Rule's $500 required
minimum payment exemption found at 16 CFR 436.2(a)(3)(iii). This
exemption ensures that the Rule ``focus[es] upon those franchisees who
have made a personally significant monetary investment and who cannot
extricate themselves from the unsatisfactory relationship without
suffering a financial setback.''\779\ As explained below, the
Commission believes the exemption and its $500
[[Page 15521]]
threshold continue to serve a useful purpose.
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\779\ Original SBP, 43 FR at 59704.
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During this Rule amendment proceeding, no commenter recommended
eliminating or reducing the $500 minimum payment threshold. Several
commenters, however, urged the Commission to raise the $500 minimum
threshold, with some commenters suggesting a $1,000 threshold,\780\
while others suggested a $2,500,\781\ or a $5,000 threshold.\782\ These
commenters maintained that an upward adjustment is warranted to reflect
the increase in costs since the Rule was promulgated in 1978. In
addition, two commenters also urged the Commission to increase the
thresholds periodically, perhaps every four years, to reflect the rate
of inflation.\783\
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\780\ Typical of these comments was H&H, which urged the
Commission to raise the threshold to $1,000 in order to recognize
the fact that costs in general have increased substantially since
the Rule was initially promulgated. H&H, NPR 9, at 4. See also
Gurnick, NPR 21A, at 8; GPM, NPR Rebuttal 40, at 9.
\781\ Baer, NPR 11, at 15-16. In the alternative, Mr. Baer
suggested that the threshold should be set at 1% of the amount of
average retail sales achieved by outlets using the franchise system
in the United States in the most recent year for which data is
available. Mr. Baer asserted that if ``a system has average retail
sales of $1 million, $10,000 is not a number which should trigger
concerns. There is no need for the Commission to regulate de minimis
investments with this type of burdensome and costly disclosure
obligation.'' Id.
\782\ J&G, NPR 32, at 14.
\783\See H&H, NPR 9, at 4; Baer, NPR 11, at 15-16.
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In contrast, the IL AG urged the Commission to retain the $500
threshold in order to protect small investors.\784\ In a similar vein,
a franchisee representative urged the Commission to modify the minimum
payment exemption to provide that the $500 threshold includes ``both
amounts the franchisee actually pays, but also any amounts that the
franchisee, during the first six months, agrees to pay in the future--
either by contract or by practical necessity.''\785\
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\784\ IL AG, NPR Rebuttal 38, at 2 (``To exempt franchises that
do not have an initial fee, or ones that have what appears to be a
modest fee of $1,000 or $2,500, would put too many ``small''
investors at risk.'').
\785\ Bundy, NPR 18, at 14.
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The Commission has determined to retain the original Rule's $500
minimum payment exemption. The original Rule included a threshold
dollar amount to exclude transactions where the prospective franchisee
was at risk to lose an amount of money too small to justify imposition
of the expense and burden of preparing a disclosure document upon
sellers. This is particularly true with less complex business
opportunities, which, even today, may cost under $500. However, with
the extraction of business opportunity regulation to a new rule
separate from the Franchise Rule, it can be argued that any investment
in a franchise, as a practical matter, will be a significant investment
risk. This may suggest that the exemption may no longer serve a useful
purpose.
We note that the Staff Report described research exploring the
relevance of the $500 threshold to the amounts actually charged for
initial franchise fees in the current market. The staff examined over
1,000 franchise profiles listed in Bond's Franchise Guide (13\th\ ed.
2001).\786\ All but 41 of the franchise systems responding to Bond's
survey reported initial franchise fees of $5,000 or more (approximately
96% of reporting systems). Indeed, only 22 systems reported that an
initial fee was ``not applicable,'' or that they charged an initial
franchisee fee of $1,000 or less.\787\ Thus, even a $5,000 threshold
would not reduce significantly the number of franchisors that must
comply with the Rule's disclosure obligations.
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\786\ Bond's keeps files on 2,500 American and Canadian
franchise systems. Of these, Bond's surveyed 2294 systems that it
identified as current and active. Detailed profiles of the 1050
systems responding to the survey appear in Bond's 2001 edition.
\787\ The Staff Report noted that Bond's does not report
``required payments,'' but initial franchisees fees and total
investments. Therefore, it is likely that at least some franchise
systems charging a minimum fee or even no initial fee (14 systems)
actually collect other required payments (e.g., royalties,
equipment), making the overall financial risk in purchasing a
franchise significant.
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Given the significant investment required to purchase nearly any
franchise, a plausible argument could be made for eliminating the
threshold altogether. However, the minimum payment exemption continues
to serve a very narrow, but important, purpose: To the extent that a
less complex business opportunity might come close to satisfying the
elements of a franchise, the $500 threshold would help to make it clear
that such opportunities are exempt from the Franchise Rule. Thus, the
final amended Rule retains the minimum payment exemption.\788\
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\788\ Howard Bundy opined that the $500 minimum payment
exemption should reference payments by contract or by practical
necessity. Bundy, NPR 18, at 4. The $500 minimum payment exemption,
however, already references the term ``required payment,'' which in
turn is defined to include both payments by contract and by
practical necessity. Accordingly, no further refinement of the Rule
is necessary on this point.
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2. 436.8(a)(4): Petroleum marketers and resellers exemption
Section 436.8(a)(4) of the final amended Rule expressly exempts
petroleum marketers and resellers covered by the Petroleum Marketing
Practices Act (``PMPA'').\789\ Although this exemption was not part of
the original Rule, in 1980 the Commission granted a petition for an
exemption from the Rule filed by several oil companies and oil jobbers,
pursuant to Section 18(g) of the FTC Act.\790\
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\789\ 15 U.S.C. 2801.
\790\ 45 FR 51765 (Aug. 5, 1980).
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In considering the petition, the Commission noted that the most
frequently cited complaint about the petroleum franchise industry
concerned termination and renewal practices. The Commission also noted
that, after the close of the original franchise rulemaking record,
Congress had passed the PMPA, which specifically addressed those
complaints, requiring, among other things, pre-sale disclosure of
franchisees' termination and renewal rights. In light of that
legislation, the Commission concluded that the Franchise Rule was
largely duplicative of the PMPA and related federal regulations.
In granting the petition, the Commission stated that the Rule
``shall not apply to the advertising, sale or other promotion of a
[petroleum] `franchise,' as the term `franchise' is defined by the
[PMPA].''\791\ The final amended Rule incorporates the 1980 exemption
as an express Rule exemption.
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\791\ 45 FR at 51766. In reaching its conclusion, the Commission
nonetheless recognized that circumstances may change in the industry
that would warrant a fresh review:
``[I]f circumstances change in the future and evidence of
renewed misrepresentations in the sale of petroleum franchises
reappears on a significant scale, a new rulemaking proceeding may be
undertaken that is tailored to the specific needs of the industry.
In the interim, if isolated abuses occur, they will be subject to
the adjudicative procedures and remedies provided by Section 5 of
the FTC Act.''
45 FR at 51766. Since 1980, the Commission has received only
isolated complaints regarding abuses in the relationship between
petroleum company franchisors and their franchisees, and has no
reason to believe that a pattern of abuse is likely to develop in
the near future.
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Two commenters voiced concern about this exemption. J&G maintained
that the exemption leaves unanswered whether disclosure is warranted
when other businesses--such as convenience stores, fast food, and ice
cream shops--operate in these exempt gasoline franchise
establishments.\792\ In the same vein, Chevron noted that the PMPA
covers agreements not only for gasoline sales, but for other refiner-
branded services or products at a gasoline station. For example, a
Chevron gasoline station may also have a Chevron branded (or no brand)
car wash, repair
[[Page 15522]]
center, or mart. According to Chevron, all of these services or
products are sold as part of a unified deal when the prospective
franchisee purchases the franchised gasoline outlet. Therefore, the
Commission should also exempt the sale of such tangential services or
goods sold along with a gasoline station under a unified
agreement.\793\
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\792\ J&G, NPR 32, Attachment at 6.
\793\See Pillsbury Winthrop (on behalf of Chevron U.S.A. Inc.).
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In response to these comments, the Commission intends that it be
clear that the PMPA exemption should be read broadly to cover other
branded services and products (such as a car wash or mart) sold to the
prospective franchisee under the same franchise agreement as the
gasoline station. The Commission believes that, as a practical matter,
it may be impossible to divide a single franchise agreement for
gasoline and other services into its component parts for disclosure
purposes, and such an approach is inconsistent with the PMPA.
Nevertheless, separate or subsequent sales of a franchise to a gasoline
station owner, such as a 7-Eleven or Subway outlet, fall outside of the
exemption. An individual who operates a gasoline station is just as
much in need of pre-sale disclosure for the purchase of a non-related
franchise, such as an ice cream store, as any other prospective
franchisee.
3. Sections 436.8(a)(5) and (a)(6): Sophisticated investor exemptions
Sections 436.8(a)(5) and (a)(6) add three new exemptions to the
final amended Rule, collectively referred to as the ``sophisticated
investor exemptions.'' As noted, the sophisticated investor exemptions
as adopted are substantially similar to their counterparts as proposed
in the Franchise NPR.\794\
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\794\ Franchise NPR, 64 FR at 57345.
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Franchisors enthusiastically supported the creation of
sophisticated investor exemptions.\795\ They maintained that
franchising today often involves heavily-negotiated, multi-million
dollar deals between franchisors and highly sophisticated individuals
and corporate franchisees with highly competent counsel. In the course
of such deals, prospective franchisees often demand and receive
material information from the franchisor that equals or exceeds the
disclosures required by the Rule. These commenters asserted that such
business arrangements are not the kinds of franchise sales that the
Commission originally intended to cover.
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\795\E.g., Gust Rosenfeld, at 7; J&G, at 7; Marriott, at 2-4;
Starwood, at 2-3; 7-Eleven, NPR 10, at 2; NFC, NPR 12, at 17; IFA,
NPR 22, at 7; AFC, NPR 30, at 2-3; Marriott, NPR 35, at 6. See also
Kaufmann, ANPR, 18 Sept. 97 Tr., at 165; Wieczorek, id., at 187-88;
Tifford, id., at 194 (noting that the Rule imposes unnecessary costs
on sophisticated franchisees and adds unwarranted delay in the high-
paced negotiation process, where parties often are anxious to cement
their deals quickly to beat out the competition).
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On the other hand, several franchisees and their advocates opposed
the exemptions, or expressed reservations about them.\796\ Some feared
that while prospective franchisees may appear to be sophisticated--
either because of their net worth or general prior business
experience--they actually may have limited knowledge of the risks
inherent in operating the specific franchise being offered. In short,
these commenters advised the Commission to protect the wealthy, but
inexperienced.\797\
---------------------------------------------------------------------------
\796\See, e.g., Bundy, NPR 18, at 14; Stadfeld, NPR 23, at 7-8;
Karp, NPR 24, at 6-8. But see Caruso, ANPR 118 (``[F]ranchisees in
the larger successful systems are themselves fairly sophisticated
and in less need of protection by the FTC or any other government
agency.'').
\797\See Selden, at 1; Gee, at 2; Karp, at 6-7; Pu, at 2; Zarco
& Pardo, ANPR 134, at 4-5; Kezios, ANPR, 6 Nov. 97 Tr., at 47-48;
Bundy, id., at 48-49; Stadfeld, NPR 23, at 8; Karp, NPR 24, at 6-8;
NFA, NPR 27, at 3. See also NADA (urging the Commission to consider
exemptions on a case-by-case basis only).
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Section 436.8(a)(5)(i)--the ``large franchise investment''
exemption--exempts franchise sales where the initial investment is at
least $1 million, exclusive of unimproved land and franchisor
financing. Section 436.8(a)(5)(ii)--the ``large franchisee''
exemption--exempts franchise sale to ongoing entities--such as
airports, hospitals, and universities--with at least $5 million net
worth and five years of prior business experience. Section
436.8(a)(6)--the ``insiders'' exemption--exempts franchise sales to the
owners, directors, and managers of an entity before it becomes a
franchisor.\798\ Each of these exemptions is discussed in the section
below.
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\798\ Two commenters noted that the inclusion of the three
sophisticated investor exemptions in the final amended Rule could be
misleading because a franchisor may still have obligations to make
disclosures under state law. Bundy, at 3; IL AG, at 10. Howard
Bundy, for example, urged the Commission to include a warning in the
final amended Rule itself that exemption from the Franchise Rule
does not necessarily mean exemption from state disclosure law. While
this observation is true, the Commission believes the appropriate
place to delineate the relationship between the final amended Rule
and state law is in anticipated Compliance Guides and other business
and consumer education materials.
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a. Section 436.8(a)(5)(i): Large investment exemption
Section 436.8(a)(5)(i) exempts from the Rule franchise sales where
the prospective franchisee makes an initial investment totaling at
least $1 million, excluding the cost of unimproved land.\799\ To ensure
that the large investment exemption is not overly broad and does not
create a loophole, section 436.8(a)(5)(i) sets forth additional
safeguards beyond the $1 million threshold to preserve protection for
the average investor.\800\ First, section 436.8(a)(5)(i) makes clear
that funds obtained from the franchisor (or an affiliate) cannot be
counted toward the $1 million initial investment threshold. Second,
section 436.8(a)(5)(i) requires the prospective franchisee to sign an
acknowledgment that the franchise sale is exempt from the Franchise
Rule because the prospective franchisee will be making an initial
investment of at least $1 million.
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\799\ At least two states provide some form of exemption for
transactions involving large initial investments. Illinois permits a
franchisor to apply for an exemption from both registration and
disclosure where the investment for a single franchise unit exceeds
$1 million. Maryland exempts franchises that require an initial
investment of $750,000 or more from registration, but not from
disclosure.
\800\ These safeguards were included in the proposed version of
this provision. Franchise NPR, 64 FR at 57321 and 57345.
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i. Need for the large initial investment exemption
As noted above, franchisors urged the Commission to adopt a large
initial investment exemption,\801\ while franchisees either opposed it
or offered suggestions to limit it.\802\ Specifically, several
franchisee commenters asserted that wealth or ability to make a large
franchise investment does not necessarily equate with business
sophistication. They urged the Commission to focus instead on the
investor and his or her business background, rather than ability to pay
alone.\803\
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\801\E.g., PMRW, NPR 4, at 3; Wendy's, NPR 5, at 2; McDonalds,
NPR 7, at 2; H&H, NPR 9, at 4; Baer, NPR 11, at 16; NFC, NPR 12, at
20. Marriott, for example, stated that not only are sophisticated
franchisees able to protect their own interests, but the self-
interest of others involved in the project, such as bankers, is
sufficient to protect those interests as well. Marriott, NPR 35, at
6. See, e.g., Baer, NPR 11, at 16; Gurnick, NPR 21, at 3; J&G, NPR
32, at 3.
\802\ Stadfeld, NPR 23, at 8; Karp, NPR 24, at 6.
\803\ Karp, at 7; Karp, NPR 24, at 6-7. See also Stadfeld, NPR
23, at 7-8 (``Being wealthy should not be a basis for being
screwed.'').
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For example, Eric Karp criticized the notion of a large investment
exemption because it does not consider the source of the prospective
franchisee's funds:
Did she re-mortgage her residence? Did he borrow from a friend or
relative? Did they cash in their retirement fund? The investment
standard also does not consider what other assets, liabilities, and
[[Page 15523]]
income the prospective franchisee has from which one can estimate his
or her financial sophistication and tolerance of risk.\804\
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\804\ Karp, NPR 24, at 7. See also Selden, at 2 (``The idea that
disclosure becomes unnecessary when the investment exceeds an
arbitrary threshold, because scale is a proxy for sophistication or
bargaining power, is an oxymoron.''); Gee, at 3 (``The FTC should
focus on the capabilities of the investor as opposed to the size of
the investment.''). Mr. Selden also asserted that franchisors are
not always forthcoming with information, suggesting that had the
Commission solicited the views of franchisees of large hotel
systems, for example, we would have a different impression. Id. We
note, however, that not a single hotel franchisee or large
restaurant franchisee submitted any comment in response to the large
investment exemption discussed in the ANPR, NPR, and Staff Report.
Accordingly, we are unconvinced that Mr. Selden's concerns raise a
serious issue.
In lieu of the ``investment'' model offered by the Commission, Mr. Karp
urged the Commission to consider SEC Regulation D,\805\ which
``properly focuses on the qualifications of the investor, not the size
of the investment.'' In his view, the large franchise exemption does
the opposite. ``The fact that a franchisee may be ready to invest a
highly leveraged $1.5 million franchise investment does not prove that
such a person is so sophisticated that a disclosure document would be
of no benefit.''\806\
---------------------------------------------------------------------------
\805\See 17 CFR 230.501(5), (6), and (8). See also Wendy's, NPR
5, at 2.
\806\ Karp, NPR 24, at 8.
---------------------------------------------------------------------------
Mr. Karp also discounted the potential benefit of the large
investment exemption to franchisors. According to Mr. Karp, the
exemption would be of little benefit to the franchisor unless 100% of
its franchise sales involved transactions over the threshold level. If
so, he insisted, there is no additional compliance burden imposed by
requiring disclosures be given to all prospective franchisees because
the franchisor has to prepare the disclosures in any event.\807\
---------------------------------------------------------------------------
\807\ Karp, NPR 24, at 6. See also Bundy, ANPR, 6 Nov. 97 Tr.,
at 21-22; Jeffers, id., at 23-24; Stadfeld, NPR 23, at 8.
---------------------------------------------------------------------------
After reviewing the comments, we are persuaded that a large
investment exemption is warranted. Since the Rule's inception, the
Commission has considered a prospective franchisee's level of
investment as one measure of sophistication. For example, in granting
the Automobile Importers of America's petition for exemption from the
Rule under Section 18(g), the Commission observed:
Prospective motor vehicle dealers make extraordinarily large
investments. As a practical matter, investments of this size and scope
involve relatively knowledgeable investors or the use of independent
business advisors, and an extended period of negotiation. The record is
consistent with the conclusion that the transactions negotiated by such
knowledgeable investors over time and with the aid of business advisors
produce the pre-sale information disclosure necessary to ensure that
investment decisions are the product of an informed assessment of the
potential risks and benefits of the proposed investment.\808\
---------------------------------------------------------------------------
\808\ 45 FR 51763-64 (Aug. 5, 1980).
Accordingly, it is clear that investment level is one indicium of
sophistication.
More important, we are convinced that franchisors should have a
bright-line standard that will clearly indicate when and under what
circumstances the sophisticated investor exemption will apply. An
exemption based upon the specific business experience of each
individual prospective franchisee would be burdensome to administer.
For example, in some instances franchisors would not be able to take
advantage of the exemption unless they first verified each prospective
franchisee's business background. Similarly, absent such verification,
law enforcers would not be able to discern whether any specific
franchise relationship was covered by the Rule. This approach could
create a regulatory nightmare for both franchisors and franchise law
enforcers.
We are also convinced that the large investment exemption offers
tangible benefits to franchisors. Clearly, there are franchise systems,
such as lodging, where the typical franchise investment is likely to
exceed the large investment exemption's monetary threshold.
Accordingly, the large investment exemption will provide regulatory
relief at least in those instances. We recognize that the large
franchise investment exemption, however, will provide only limited
relief for franchisors that sell franchises both above and below the
threshold. In such instances, the franchisor must prepare disclosure
documents in order to sell at levels below the threshold. Accordingly,
the costs of providing disclosures to all franchisees, including those
above the threshold, may not be large, but neither is the potential
benefit to the purchaser. Indeed, the argument that sophisticated
investors could benefit from disclosure misses the mark. The basis for
the large investment exemption is not that ``sophisticated'' investors
do not need pre-sale disclosure, but that they will demand and obtain
material information with which to make an investment decision
regardless of the application of the Rule. Where prospective
franchisees are likely to demand and obtain pre-sale material
information regardless of external prompting or compulsion, then the
case for federal intervention is not compelling.
Further, the Rule's costs and burdens are unwarranted in situations
where the likelihood of abuse is low. This concept is incorporated into
the statutory provision of the FTC Act that gives franchisors the right
to petition the Commission for a trade regulation rule exemption,
including an exemption limited to a specific set of facts.\809\ Thus, a
franchisor, if it wished, could petition the Commission for an
exemption only for sales above a certain dollar figure (although to
date none has done so). The large investment exemption need not be
``all or nothing'' to benefit franchisors. The very fact that
franchisors uniformly supported the large investment exemption tends to
confirm that it will provide them with some desired regulatory relief.
On balance, we believe that a narrowly crafted large investment
exemption offers the potential for reducing franchisors' regulatory
burdens and preserving Commission resources by reducing the number of
exemption petitions, without sacrificing protections for the average
investors the Franchise Rule was originally promulgated to protect.
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\809\ Section 18(g) of the FTC Act. 15 U.S.C. 57a(g). One
commenter observed that while franchisors can file individual
petitions for exemptions from the Rule under Section18(g) of the FTC
Act, the process is costly and the delay involved often renders this
approach an unviable option. Duvall & Mandel, ANPR 114, at 16.
Section 18(g) of the FTC Act provides a mechanism for parties to
petition for relief from Commission trade regulation rules where
potential abuse is unlikely. Section 18(g) exemption petitions are
placed on the public record for comment. The entire process of
reviewing and granting such a petition may take several months to
more than one year, depending on any comments received.
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ii. The $1 million investment threshold
Section 436.8(a)(5)(i) provides that franchise sales involving an
investment of $1 million --excluding the cost of unimproved land and
franchisor financing--qualify for the large investment exemption. We
are convinced that a $1 million threshold strikes the right balance
between providing relief for sophisticated investors and protecting
consumers.
The large investment exemption proposed in the Franchise NPR
incorporated a higher $1.5 million threshold, based upon the Commission
staff's analysis of the costs to purchase more than 1,350 franchises
listed in various trade publications, including Enterprise Magazine's
The Franchise
[[Page 15524]]
Handbook; (``Franchise Handbook''); Entrepreneur Magazine's Franchise
500, and the International Franchise Organization's Franchise
Opportunities Guide.\810\
---------------------------------------------------------------------------
\810\ For a detailed discussion of staff's analysis, see Staff
Report, at 238.
---------------------------------------------------------------------------
Very few single-unit franchises cost more than $1.5 million: the
maximum estimated cost of establishing a franchise exceeded $1.5
million in only about 3% of the listed systems. Thus, an investment of
$1.5 million most likely would involve the purchase of several units.
For example, more than 90% of the franchise systems listed in the cited
sources involve a maximum investment totaling less than $500,000. Thus,
in order to qualify for the $1.5 million exemption, an investment in
the vast majority of systems would involve the purchase of either a
single large franchise--such as a hotel or the most expensive
restaurant location--or multiple units.\811\ Of the 12 restaurant
systems listed in the Franchise Handbook with maximum investments of
$1.5 million or above, all listed a minimum investment below $1.5
million to establish a location. Three listed less than $1 million as
the minimum investment, and seven estimated the minimum investment to
be between $1 million and $1.2 million, or the purchase of three or
more units.\812\
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\811\ In light of the management demands on operating multiple
units, it is reasonable to believe that purchasers of multiple units
may be persons with significant prior business experience.
\812\ We also assume that in many instances this universe of
sophisticated investors will include existing franchisees with
significant ``hands-on'' experience with the franchisor. In its
Franchise NPR comment, NFC describes at length the changing nature
of franchising in the United States. Specifically, NFC notes that:
``While franchising's roots may be traced to the grant of an
individual franchise to one entrepreneur (or a small group of
entrepreneurs) possessing no prior knowledge of or experience in the
subject industry . . . it is nevertheless the case that over the
decade many of America's oldest and largest franchisors do not
follow that paradigm. Instead, they find it far more efficient and
profitable for all concerned to largely restrict the grant of United
States franchises to: (i) sophisticated corporations with the
resources and background necessary to optimally operate subject
franchises and (ii) existing franchisees whose experience,
profitability, and mastery of the franchisor's system strongly
suggest future success.''
NFC, NPR 12, at 17. Accordingly, at least some franchisees
purchasing multiple units are existing franchisees with prior
``hands-on'' experience with the franchisor.
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During this proceeding no consensus emerged on the appropriate
investment threshold for the large investment exemption. Several
commenters supported the Franchise NPR's proposed $1.5 million
threshold.\813\ Other commenters urged the Commission to increase the
threshold. For example, NASAA recommended a $3 million threshold. In
its view, a $1.5 million threshold may place too many transactions
outside the Rule's protections, because, according to NASAA, even
unsophisticated investors may have access to $1.5 million to invest in
a franchise.\814\ On the other hand, several commenters suggested that
the threshold should be lower. For example, McDonald's suggested that
the threshold should be set at $1 million.\815\ The IFA proposed a
variation on this theme. It supported a $1 million threshold, excluding
land.''\816\ It observed that a 1997 update to the Profile of
Franchising identified 52 franchise companies offering franchises with
an initial investment exceeding $1 million, excluding land. This
equates to 4.4% or less of all franchise systems.\817\ Thus, at a $1
million threshold for the exemption, more than 95% of all franchise
systems would remain within the ambit of the Rule.\818\ Some commenters
recommended an even lower threshold. PMR&W, for example, recommended
$500,000.\819\
---------------------------------------------------------------------------
\813\E.g., Baer, NPR 11, at 16; Gurnick, NPR 21, at 3; Marriott,
NPR 35, at 6.
\814\ NASAA, NPR 17, at 12. Seth Stadfeld added that it is not
difficult to invest $1.5 million when there is a down payment plus
financing of a substantial portion of the investment. ``Indeed,
because they are taking on larger obligations, there is all the more
reason and urgency why they should get the material, factual and
contractual information that is otherwise available under the
Rule.'' Stadfeld, NPR 23, at 8. See also NFA, NPR 27, at 3.
\815\ ``In our considerable experience, individuals purchasing
franchises involving a $1 million investment have a clear
understanding of the terms and conditions of the business
arrangements and have obtained professional financial and/or legal
advice before entering into the franchise agreement.'' McDonald's,
NPR 7, at 2. See also 7-Eleven, NPR 10, at 3; NFC, NPR 12, at 20;
BI, NPR 28, at 13. Wendy's suggested that the threshold be lowered,
but did not offer any specific amount. Wendy's, NPR 5, at 2.
\816\ As discussed below, IFA initially stated that ``real
estate'' should be excluded in calculating the large investment
threshold. IFA, NPR 22, at 7. In its Staff Report comment, however,
the IFA clarified that by ``real estate,'' it mean raw, unimproved
land. See IFA, at 3.
\817\ IFA, NPR 22, at 7.
\818\ The Staff Report recommended a $1 million threshold for
the exemption, excluding land and franchisor financing, as discussed
below. Staff Report, at 240.
\819\ PMR&W opined that the $1.5 million threshold would benefit
only:
``a very few franchised businesses, typically lodging facilities
and perhaps the most expensive restaurant franchises. We suggest a
$500,000 threshold as a more reasonable alternative based on the
franchisee's likely resort to sophisticated advisory services from
accountants and/or attorneys and the probable need for financing,
and resulting due diligence oversight, from a financial
institution.''
PMR&W, NPR 4, at 3. See also Cendant, ANPR 140, at 4 (suggesting
a $750,000 threshold); H&H, NPR 9, at 4 (advocating a lowered
threshold, but not specifying an amount); Duvall & Mandel, ANPR 114,
at 21 (suggesting a $250,000 threshold provided there is a showing
that the purchaser, alone or with counsel, can understand the merits
and risks of the investment). The Commission rejects this approach
as unworkable, because it would require franchisors to make
subjective judgments about each purchaser's business acumen.
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The Commission gives particular weight to the statements offered by
franchisors such as McDonald's and Marriott that, in their experience,
a $1 million investment is likely to involve sophisticated
investors.\820\ The Commission believes that a $3 million dollar
threshold would be too high, effectively restricting the exemption to
only the rarest of instances, mostly large hotel franchises. On the
other hand, the suggested $500,000 threshold, in our view, is too low.
There is insufficient record support for the proposition that investors
at the $500,000 level are sophisticated. Thus, the Commission has
adopted a $1 million threshold for the exemption.
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\820\ The Commission has a history of considering and granting
petitions for exemption to the Franchise Rule under section 18(g) of
the FTC Act. In numerous exemption petition proceedings, the
Commission has considered the size of investment as an indicium of
sophistication. E.g., Paccar, Inc., 68 FR 67442 (Dec. 2, 2003);
Rolls-Royce Corp., 68 FR 67443 (Dec. 2, 2003); Austin Rover Cars of
North America, 52 FR 6612 (Mar. 4, 1987); Volkswagen of America,
Inc., 49 FR 13677 (Apr. 6, 1984); Automobile Importers of America,
Inc., 45 FR 51783 (Aug. 5, 1980). Based upon this experience in
analyzing various franchise systems, the Commission believes that a
large investment typically entails a sophisticated purchaser: ``As a
practical matter, investments of this size and scope typically
involve knowledgeable investors, the use of independent business and
legal advisors, and an extended period of negotiation that generates
the exchange of information necessary to ensure that investment
decisions are the product of an informed assessment of the potential
risks and benefits.'' Mercedes-Benz of North America, Inc., 57 FR
1745 (Jan. 15, 1992) (granting petition for exemption).
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Exclusion of unimproved land. The $1 million threshold for the
large investment exemption excludes payments for unimproved land. The
Commission believes that the inclusion of unimproved land in the
exemption would have two negative consequences. First, inclusion of
unimproved land would tend to inflate the initial cost of a franchise
investment and place too many transactions outside the ambit of the
Rule's protections. As the IFA noted, approximately 52 franchise
systems, or less than 5% of the universe of franchise systems, would
qualify for an exemption with a threshold investment of $1 million,
excluding unimproved land.
Second, the Commission has a strong preference for a bright-line
standard that can be readily applied across franchise systems. It seems
unworkable to require a franchisor to calculate on an offer-by-
[[Page 15525]]
offer basis the cost of land, which could vary widely depending on
local market conditions. A single, clear threshold is vastly superior,
in our view. Accordingly, for these reasons, we believe that $1
million, excluding unimproved land, strikes the appropriate balance.
Finally, we note that the Staff Report, adopting language offered
by the IFA in response to the Franchise NPR, proposed to exclude ``real
estate.'' In response to the Staff Report, three commenters urged the
Commission to clarify the meaning of the term ``real estate'' either in
the Rule or in Compliance Guides. The IFA, for example, noted that the
term ``real estate'' may encompass ``raw land, buildings, leasehold
improvements, fixtures, and the like.''\821\ The IFA asserted that the
value of the exemption would be diminished if all such items were
excluded from consideration in determining whether an initial
investment totals $1 million. It suggested that the term ``real
estate'' be defined to exclude only the franchisee's investment in
unimproved land.\822\ Similarly, Starwood urged that only ``land''
should be excluded, but ``all real estate improvements and fixtures
should be counted in the sum invested.''\823\ Piper Rudnick offered yet
a different version: ``any real property acquired to establish and
operate the franchised business.''\824\
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\821\ IFA, at 3.
\822\ IFA, NPR 22, at 7.
\823\ Starwood, at 2. See also Marriott, at 2 (an ``investment''
should include buildings).
\824\ Piper Rudnick, at 6-7.
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After considering the comments, the Commission has concluded that
the phrase ``unimproved land'' is more appropriate than ``real
estate.'' As IFA noted, the exclusion of fixtures, equipment, and other
improvements to property from the $1 million threshold would leave the
exemption so narrow, that it would be useless in all but the most
expensive franchise offerings, defeating the very purpose of the
exemption. Excluding ``real estate''--which is significantly broader
than the more limited term ``unimproved land''--would also impact
disproportionately real estate-intensive companies--such as hotels and
restaurants. The justification for a large investment exemption is that
individuals investing $1 million or more are sufficiently sophisticated
that they do not need the Rule's protections. This rationale applies
equally whether the prospective franchisee invests $1 million to
purchase a building or the prospective franchisee buys equipment or
other assets. Accordingly, excluding unimproved land from the large
investment exemption's $1 million threshold strikes the appropriate
balance between providing franchisors with a clear threshold, while
ensuring regulatory relief for large investments.
Exclusion of franchisor financing. Section 436.8(5)(i) does not
count monies that are obtained through franchisor (or affiliate)
financing toward the large initial investment exemption's $1 million
threshold. The exclusion of franchisor financing adds a measure of
protection to the prospective franchisee because traditional lenders
are very likely to require a due diligence investigation of the
offering, whereas the franchisor or its affiliate likely would not.
A few commenters opposed the exclusion of franchisor-financing when
calculating a prospective franchisee's initial investment. For example,
Marriott asserted that it does not believe that there are inherent
risks that would justify excluding financing from the franchisor.
Indeed, it feared that this exclusion might have the unintended effect
of harming franchisees by discouraging franchisors from offering
financing to prospects in order to qualify for the exemption.\825\
---------------------------------------------------------------------------
\825\ Marriott, NPR 35, at 6. See also J&G, NPR 32, at 4. At the
same time, Eric Karp disputed the view expressed in the Franchise
NPR that lenders may act as an effective check, requiring a prospect
to have sufficient equity capital before granting a loan. He
contended that there is ``no support in the record as to what amount
of equity a bank might require on a franchise investment of $1.5
Million.'' Karp, NPR 24, at 7.
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After careful assessment of the comments, the Commission has
concluded that financing obtained from the franchisor or an affiliate
should not be counted toward the large investment exemption threshold.
Otherwise, a franchisor could be tempted to increase the cost of the
initial investment to qualify for the large investment exemption, while
simultaneously offering to finance the deal itself, all without proper
pre-sale disclosures. In that regard, the Commission agrees with Eric
Karp, who observed that the assumption that a prospective franchisee
will have a sufficient level of equity tends to disappear ``where a
franchisee obtains financing from the franchisor or its affiliates or
from a selling franchisee; in such instances, far less equity may be
required.''\826\
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\826\ Karp, NPR 24, at 7.
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Further, it is reasonable to assume that a lender, in order to
minimize its own financial risk, will ensure that a prospective
franchisee will conduct a due diligence investigation of the franchise
offering. Indeed, by involving a lender, the prospective franchisee
effectively ensures that there is an independent, sophisticated entity
inserted into the sales process. This additional safeguard would be
lost if sources of financing for purposes of the exemption included the
franchisor and its affiliates.
iii. Acknowledgment
To take advantage of the large investment exemption, section
436.8(5)(i) requires the franchisor to obtain the prospective
franchisee's signed acknowledgment that the investment satisfies the $1
million threshold. This will reduce the opportunity for fraud by
enabling the prospect to verify that the investment meets or exceeds
the exemption threshold. Therefore, it will reduce the probability that
the franchisor will misrepresent the initial cost of the franchise to
qualify for the exemption, as well as provide a paper trail in the
event an enforcement action becomes necessary.
Several commenters failed to understand the purpose of the
acknowledgment or believed that it would serve no useful purpose. For
example, BI stated: ``We do not understand the purpose or the
importance of the acknowledgment by the prospective franchisee of the
application of the exemption. The acknowledgment does not protect the
prospective franchisee, except, perhaps to put the prospect on notice
that it may be entitled to receive a disclosure document.''\827\
---------------------------------------------------------------------------
\827\ BI, NPR 28, at 13.
---------------------------------------------------------------------------
Seth Stadfeld asserted that the acknowledgment requirement could be
abused. ``[F]ranchisors could further a fraud by playing up to and
flattering the prospective franchisee into thinking that he is so
sophisticated that he doesn't need the disclosures that the little
people need.''\828\ On the other hand, Howard Bundy advised that the
acknowledgment should be expanded. He would revise the Rule to read:
``The franchisee's estimated investment, excluding any affiliate
financing, totals at least $1.5 million and the prospective franchisee
signs an acknowledgment stating the basis for the exemption from the
Rule and providing the CFR citation to the Rule and verifying the
grounds for the exemption . . .''\829\
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\828\ Stadfeld, NPR 23, at 8.
\829\ Bundy, NPR 18, at 14.
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The Commission is convinced that the acknowledgment requirement
serves a useful purpose. As previously noted, the acknowledgment will
ensure that a
[[Page 15526]]
prospective franchisee receives notice that the transaction is exempt
from the Rule. This would tend to prevent fraud by enabling the
prospective franchisee to verify the applicability of the exemption.
Further, we believe that abuse of the acknowledgment requirement is
unlikely. A prospective franchisee's signing of the acknowledgment does
not give rise to the exemption. A franchisor must furnish disclosures
unless the specific criteria for the exemption is satisfied. Thus,
whether a prospective franchisee is flattered into signing an
acknowledgment is irrelevant. At the same time, we agree with Mr. Bundy
that the acknowledgment should reference the Franchise Rule itself.
This would enable a prospective franchisee to review the Rule,
understand the exemption, and, ultimately, verify the exemption's
application. Accordingly, the acknowledgment requirement of the final
amended Rule has been revised to incorporate these revisions.
iv. Meaning of ``initial investment''
During the Rule amendment proceeding, several commenters voiced
concerns about how to define ``investment'' for purposes of the large
investment exemption. For example, J&G questioned: ``Is it the initial
investment described in Item 7? Is it the amount of the investment over
the term of the franchise? Or is it some other calculation?''\830\ The
NFC voiced similar concerns and urged the Commission to clarify that
the term ``investment'' means the franchisee's estimated investment, as
set out in Item 7 of the disclosure document.\831\
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\830\ J&G, NPR 32, Attachment, at 6.
\831\ NFC, NPR 12, at 20. See also CA Bar, at 7; Marriott, at 2;
Marriott, NPR 35, at 6 (```Investment' for purposes of the exemption
should be defined as the initial investment as set forth in Item 7,
plus credit extended by any lender and commitments for real property
(not just mortgage or lease payments for the first few months.'')).
Others raised alternative calculation approaches. For example,
Wendy's observed that the focus on the franchisee's investment
should ``exclude those expenses to be incurred during the first
three months of operation which are not offset by sales. . . .
[This] artificially raises the threshold.'' Wendy's, NPR 5, at 2.
Similarly, J&G urged the Commission to include all commitments for
real property over the life of the contract, not just mortgage or
lease payments for the first few months. J&G, NPR 32, at 4.
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The Commission's intent is that, for purposes of the large
investment exemption, the level of a prospective franchisee's
investment should be limited to the ``initial investment,'' as set
forth in Item 7. For that reason, the phrase ``estimated investment''
has been replaced in the Rule's text with the phrase ``initial
investment.'' Focusing on Item 7 when applying the exemption brings
needed certainty to all parties, while ensuring that the exemption is
narrowly focused to protect prospective franchisees making smaller
investments. It is not farfetched to assume that a large universe of
franchisees investing $100,000 or less today might actually pay more
than $1 million (excluding unimproved land) to the franchisor during
the course of a lengthy franchise agreement, especially when royalty
and advertising fees, as well as ongoing product purchases, are
considered. For that reason, a broad large investment exemption would
effectively eviscerate the Rule's protection.\832\
---------------------------------------------------------------------------
\832\ CA Bar, at 7 (including expenses over the life of the
franchise term ``would likely render the $1 million threshold
meaningless . . . because the accumulated expenditures over a 10 or
20 year period could easily exceed $1 million dollars.'').
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The term ``initial investment,'' however, need not be limited to a
single unit. The Commission notes with approval the comments of H&H and
the NFC, urging revision of the Rule to clarify that the threshold
includes the total projected investment, whether in single- or
multiple-unit transactions. As the NFC noted: ``A multi-unit franchisee
investing the threshold amount (or more) in a number of units is just
as sophisticated as another franchisee investing a like amount in a
single unit.''\833\
---------------------------------------------------------------------------
\833\ NFC, NPR 12, at 21. See also H&H, NPR 9, at 4.
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The Commission has carefully considered the Staff Report
recommendation to place limits on the large investment exemption to
protect investors who pool their resources to purchase a franchise at
or above the threshold level.\834\ The Commission shares the staff's
concern. Clearly there is a significant difference between a single
individual purchasing a franchise for $1 million, versus a group of 10,
for instance, each contributing $100,000. Obviously, the larger the
group of investors, the smaller each individual investor's risk. In
such a circumstance, the level of each individual investment provides
no indicium of sophistication. Accordingly, the Commission has added
footnote 11 to the Rule to provide that the large franchise exemption
applies only if at least one individual in an investor-group qualifies
as ``sophisticated'' by investing at the threshold level.
---------------------------------------------------------------------------
\834\ Staff Report, at 243.
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Several commenters assessed this issue differently. IL AG suggested
that each member of an investment group should be required to satisfy
the $1 million investment threshold in order to be deemed
``sophisticated.\835\ In contrast, Marriott asserted that franchisees
in large transactions typically form joint ventures or obtain financing
from outside equity investors. Marriott maintained that there is little
benefit in requiring a franchisee to break down the relative financial
responsibilities of each equity investor in order to determine the
application of the large investment exemption.\836\ Marriott also noted
that the list of investors may change over the course of contract
negotiations, making it difficult to determine at the time of sale
whether any single investor qualifies for the exemption.
---------------------------------------------------------------------------
\835\ IL AG, at 11.
\836\ Marriott, at 3. See also Starwood, at 2.
---------------------------------------------------------------------------
The Commission has concluded, however, that the limitation in
footnote 11 is necessary to ensure that the large investment exemption
strikes the right balance between providing relief for franchisors
where the likelihood of abuse is reduced, and ensuring continued
protection for those prospective franchisees who, although wealthy, may
lack business experience. As explained above, the large investment
exemption is premised on the Commission's assumption that ability to
pay indicates sophistication. That assumption fails when no one
investor standing alone is investing at the requisite threshold level.
In short, sophistication does not arise merely by aggregating otherwise
unsophisticated investors.
v. Conversion franchises and transfers
During this proceeding, several commenters questioned whether the
large investment exemption would cover business arrangements such as
conversion franchises and transfers. In a conversion franchise, a
business owner has already invested in his or her existing business and
now seeks to associate with a particular franchisor's brand by entering
into a franchise agreement with that franchisor. H&H stated that the
term ```investment' should include the fair market value of an existing
facility as part of the investment, so as to include an existing
facility that is being converted to the franchise system.''\837\
---------------------------------------------------------------------------
\837\ H&H, NPR 9, at 4. The NFC noted that conversion franchise
activity is the ``dominant form of franchise activity extant in the
guest lodging and real estate brokerage arenas, and is common in
other sectors as well. While new construction of franchised hotels
does transpire, much franchising activity in the guest lodging
sector involves the conversion of existing hotels . . . to the name,
mark, and system of a guest lodging franchisor.'' NFC, NPR 12, at
20. See also Starwood, at 2; PREA, NPR 20, at 3; Marriott, NPR 35,
at 6.
---------------------------------------------------------------------------
In a similar vein, the NFC questioned whether a transfer of a
franchise directly from a franchisee to a new purchaser
[[Page 15527]]
can qualify for the exemption. It urged the Commission to include
transfers in the definition of ``investment,'' where the purchasing
franchisee pays an existing franchisee the threshold amount and then
enters into a new franchise agreement with the franchisor. ``[W]e . . .
submit that franchisees making such an investment prior to the
execution of the subject franchise agreement are as `sophisticated' as
their brethren who make the investment after executing that
agreement.''\838\
---------------------------------------------------------------------------
\838\ NFC, NPR 12, at 21.
---------------------------------------------------------------------------
The Commission's view is that the definition of ``initial
investment'' is broad enough to include conversion franchises and
transfers without sacrificing necessary protection for franchise
purchasers. Specifically, when considering a conversion franchisee's
``initial investment'' in a franchise, it is reasonable to consider the
conversion franchisee's previous investment in the unit. Indeed, a
strong argument can be made that a conversion franchisee is even more
sophisticated than a new franchisee, having worked in the business for
a period of time. Similarly, the sale of an existing franchise would
qualify for the large investment exemption in a transfer. The fact that
a transferee will assume an existing contract or may renegotiate an
existing contract with the franchisor should have no bearing on his or
her level of sophistication as an investor, as long as he or she
satisfies the monetary threshold.
b. Section 436.8(a)(5)(ii): Large franchisee exemption
Section 436.8(a)(5)(ii) exempts from the final amended Rule
franchise sales to large entities; namely, those who have been in any
business for at least five years and have a net worth of at least $5
million.\839\ The Commission is persuaded that large entities
negotiating franchise deals--such as airports, hospitals, and
universities--can obtain the benefits of the amended Rule without
federal government intervention.
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\839\ No state has a comparable disclosure exemption. Several
states--including California, Indiana, Maryland, New York, North
Dakota, Rhode Island, South Dakota, and Washington--have an
exemption from registration for ``experienced franchisors.'' To
qualify for the exemption, a franchisor must typically have a net
worth of at least $5 million and have had 25 franchise locations in
operation during the previous five years.
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i. Need for the large franchisee exemption
In the Franchise NPR, the Commission proposed exempting franchise
sales to large ``corporate'' franchisees.\840\ For example, a fast food
franchisor may sell a number of franchised outlets to a hotel chain.
Such transactions often are heavily negotiated by sophisticated counsel
who have significant experience in the franchise industry. Even if a
large entity does not have prior experience in franchising, or in the
franchised business in particular, it is reasonable to assume that it
can nevertheless protect its own interests when negotiating a franchise
deal.
---------------------------------------------------------------------------
\840\ Franchise NPR, 64 FR at 57321. See Kaufmann, ANPR, 18
Sept. 97 Tr., at 190. But see Kezios, 18 Sept. 97 Tr., at 191-92
(opposing exemption for large institutions, suggesting that they
need franchise advice and counsel as well).
---------------------------------------------------------------------------
Indeed, the Commission stated in the Franchise NPR that a large
franchisee exemption is a logical extension of the original Rule's
fractional franchise exemption. To qualify as a fractional franchisee,
among other things, a prospect must have two years of experience in the
same line of business. Thus, the fractional franchise exemption is very
narrowly tailored, focusing only on persons who wish to expand their
existing product lines. While the fractional franchise exemption is
appropriate for individuals and small businesses seeking to expand, it
may be unnecessarily narrow for larger, more sophisticated corporations
seeking to become franchisees.\841\
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\841\ For example, in 1997, FTC staff was asked for an advisory
opinion on whether a travel services company would be covered by the
Rule if it sold outlets to hospitals. The staff advised that the
hospital could not qualify as a fractional franchisee because it did
not have the requisite two years of experience in providing travel-
related services. Advisory 97-7, Bus. Franchise Guide (CCH) ] 6487
(1997). Hospitals and other large institutions such as airports and
universities, however, are hardly unsophisticated prospective
franchisees.
---------------------------------------------------------------------------
The Staff Report proposed a large franchisee exemption identical to
that in the Franchise NPR. Five franchisor representatives continued to
support the proposed exemption,\842\ while three franchisees opposed it
for the same reasons previously voiced in response to the Franchise
NPR.\843\
---------------------------------------------------------------------------
\842\ Gust Rosenfeld, at 7; J&G, at 7; Marriott, at 2; Piper
Rudnick, at 6-7; Starwood, at 3.
\843\ Selden, at 1 (large franchisee exemption thresholds are
too low); Gee, at 2; Pu, at 2 (Commission should focus on
capabilities of franchisee, not size of investment). Two franchisee
associations--the AAFD and the AFA--did not comment on this issue.
---------------------------------------------------------------------------
ii. Covered entities
The large franchisee exemption is intended to cover franchisees
that are ``entities.'' In the Franchise NPR, the Commission proposed
that the large franchisee exemption be limited to corporations. Many
commenters supported the proposed exemption, but criticized its narrow
application.\844\ Specifically, several commenters urged the Commission
to consider exempting other large entities, such as partnerships,
finding no rationale for restricting the exemption only to
corporations. The Commission agrees, and has expanded the provision in
the final amended Rule to encompass corporations, partnerships, and
similar arrangements.\845\
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\844\E.g., IL AG, NPR 3, at 2; PMR&W, NPR 4, at 3; Wendy's, NPR
5, at 3; Triarc, NPR 6, at 1; H&H, NPR 9, at 5; Baer, NPR 11, at 16;
NFC, NPR 12, at 22; BI, NPR 28, at 14; Tricon, NPR 34, at 7;
Marriott, NPR 35, at 7.
\845\ Nothing prevents an ``entity'' under this provision from
being an individual, but most individuals who have been in business
for at least five years and have generated an individual net worth
of at least $5 million are likely to have created a corporation or
other formal organization through which to conduct business.
---------------------------------------------------------------------------
iii. Net worth
To qualify for the large franchisee exemption, section
436.8(a)(5)(ii) specifies that the prospective franchisee-entity must
have a net worth of $5 million.\846\ During the Rule amendment
proceeding, several commenters opined that the exemption's net worth
prerequisite is overly restrictive.\847\ H&H, for example, contended
that a $5 million net worth threshold is too high, limiting the
exemption to a small number of publicly-traded companies. ``Many
successful private companies do not seek to accumulate equity, but
instead to maximize cash flow to their owners. Thus, such a high net
worth requirement would prevent the exemption of many sophisticated
investors.''\848\ The firm urged a net worth requirement of $1
million.\849\ On the other hand, Howard Bundy asserted that the $5
million net worth requirement is too low, sweeping in many very small
companies. ``That is a
[[Page 15528]]
small enough net worth to not be indicative of the level of
sophistication that would indicate no need for mandatory
disclosures.''\850\ The Commission believes that the $5 million net
worth requirement strikes the right balance, granting relief to
sophisticated entities, while protecting those entities for whom the
purchase of a franchise would be a significant financial risk.
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\846\ Net worth of an entity can readily be determined from the
entity's balance sheet or other financial information, typically
submitted as part the application process.
\847\ At the same time, several franchisee representatives
criticized the large franchisee exemption as inappropriate. For
example, Andrew Selden asserted that the large franchisee exemption
will ``sweep in thousands of small business entrepreneurs who own
three or four units or independent businesses, or perhaps unrelated
family wealth. Personal net worth has no correlation whatsoever with
the need for information to make an informed business investment
decision in respect to an unfamiliar franchise.'' Selden, at 1. As
noted above, however, the sophisticated investor exemptions are
premised not on the notion that sophisticated investors do not need
pre-sale disclosure, but that they are able to obtain such
information, or greater information, without federal government
intervention. This is particularly true of large franchisees, such
as hospitals, airports, and universities, among others.
\848\ H&H, NPR 9, at 5.
\849\Id.
\850\ Bundy, NPR 18, at 14.
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iv. Prior experience
In addition to requiring $5 million net worth, section
436.8(a)(5)(ii) requires large franchisees to have five years of prior
business experience in any line of business, as proposed in the
Franchise NPR. A few commenters opined that the prior experience
prerequisite is unnecessary, and urged the Commission to focus only on
the large franchisee's net worth. The NFC, for example, asserted that:
``Even if a large corporation does not have prior experience in
franchising specifically, it is reasonable to assume that it can
protect its own interests when negotiating for the purchase of a
franchise.''\851\
---------------------------------------------------------------------------
\851\ NFC, NPR 12, at 21-22. Similarly, J&G maintained that any
``entity or group of entities with a $5 million or more net worth
should, by definition, be deemed to have the requisite
sophistication to satisfy the exclusion or exemption.'' J&G, NPR 32,
at 4.
---------------------------------------------------------------------------
On the other hand, Triarc urged the Commission to focus on prior
experience in lieu of net worth. It noted that it is possible that a
franchisee with 10 years of experience and 50 units may wish to finance
its operation with debt rather than equity. Under the circumstances,
this presumably sophisticated franchisee would fail the net worth test:
What if a large corporate franchisee with $20.0 million of net
worth declares a $16.0 million dividend to its shareholders or
otherwise does a recapitalization which takes its net worth below the
threshold? Over the years, some gigantic companies that are financially
healthy have had huge negative net worths and negative earnings. . . .
We would suggest that net worth is often an indicator of how a company
chooses to finance itself rather than of sophistication.\852\
---------------------------------------------------------------------------
\852\ Triarc, NPR 6, at 2.
After considering these arguments, the Commission concludes that
both the $5 million net worth and five years experience prerequisites
are necessary to ensure that the Rule continues to protect businesses
with limited experience, limited assets, and, by inference, limited
prior success. For example, a small sandwich shop franchisee is not
necessarily sophisticated enough to purchase a hotel merely because the
franchisee has operated one or more sandwich shops for five years.
Similarly, several wealthy individuals who form a partnership without
any prior business experience are not necessarily sophisticated merely
because of their net worth. Both prerequisites are necessary to ensure
that the large franchisee exemption does not create a loophole, putting
small and unsophisticated entities at an unacceptable financial risk.
v. Affiliates and parents
Finally, section 436.8(a)(5)(ii) refines the proposed exemption
published in the Franchise NPR, which used the term ``corporation'' and
made no mention of parents or affiliates. As revised, a franchisor may
consider the prior experience and net worth of the franchisee's
affiliates and parents when determining whether the franchisee
qualifies as a ``large franchisee.''
A few commenters noted that the prior experience and net worth
prerequisites would essentially disqualify new corporations. They
asserted that there are legitimate tax and liability reasons why an
experienced franchisee may wish to establish a separate corporation for
a particular franchise transaction. For example, according to Marriott,
it is not unusual in the lodging and restaurant industries to form
``special purpose entities (SPEs) . . . to insulate either a parent
company or the individual investors from liability.''\853\ If so, then
such a new corporation would not meet the exemption's net worth and
prior experience prerequisites.\854\ These commenters urged the
Commission to permit the franchisor to consider the consolidated net
worth and experience of franchisee affiliates and parents.\855\ The
Commission is persuaded that the net worth and prior experience
prerequisites may not make sense when applied to franchisee spin-off
subsidiaries or affiliates that are formed primarily for tax or
limited-liability purposes. Accordingly, section 436.8(5)(ii) makes
clear that a franchisor may aggregate commonly-owned franchisee assets
in determining the availability of the large entity exemption:\856\
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\853\ Marriott, NPR 35, at 7.
\854\See also, e.g., NFC, NPR 12, at 22; J&G, NPR 32, at 4; H&H,
NPR 9, at 5. Triarc, for example, noted that one Arby's franchisee
owns 700 units and is one of the largest privately owned restaurant
operators in the world. It asked ``why should we have to give
disclosure to that franchisee merely because he sets up a new
corporate entity to own his next Arby's store?'' Triarc, NPR 6, at
1-2.
\855\ Starwood, at 3; NFC, NPR 12, at 22; J&G, NPR 32, at 4;
H&H, NPR 9, at 5.
\856\ In the same vein, the definition of ``affiliate'' covers
both franchisee and franchisor affiliates, as noted in our
discussion of the definitions, above.
The franchisee (or its parent and any affiliates) is an entity
that has been in business for at least five years and has a net worth
of at least $5 million.\857\
---------------------------------------------------------------------------
\857\ This modifies slightly an earlier version of the large
franchisee exemption which would have required the purchaser and its
parent or affiliates to satisfy the net worth and prior experience
prerequisites. See Marriott, at 3-4; J&G, at 7.
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c. Section 436.8(a)(6): Officers, owners, and managers exemption
Section 436.8(a)(6) of the final amended Rule adds a new exemption
for officers, owners,\858\ and managers of a business before it becomes
a franchisor.\859\ In such circumstances, it reasonably can be assumed
that the prospective franchisee already is familiar with every aspect
of the business system and the associated risks. Thus, disclosure would
serve little purpose. Indeed, in some instances, a company may wish to
offer units only to its owners, officers, and managers. If not exempt
from the Rule, these companies would have to go through the burden and
expense of creating a disclosure document for isolated sales to company
insiders. To ensure that individuals qualifying for the exemption have
recent and sufficient experience with the business, however, section
436.8(a)(6) is limited to individuals who have been associated with the
company within 60 days of the sale and who have been involved for at
least two years with the company.
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\858\ CA Bar would limit this exemption to those with an equity
ownership in the company. In its view, those with a non-equity
interest, such as a lender, typically do not participate in the
business, in contrast to an equity owner, and therefore should be
excluded from the exemption. CA Bar, at 8. While CA Bar's
observation is correct, the Rule need not be revised to address this
issue. A lender or other non-equity interest owner will be excluded
from the exemption because he or she will not satisfy the
exemption's prior experience prerequisite.
\859\ The ``insider'' exemption is modeled after nearly
identical language in California's statute. Washington and Rhode
Island have similar exemptions. See Duvall & Mandel, ANPR 114, at 21
(suggesting a narrower approach).
---------------------------------------------------------------------------
Section 436.(8)(a)(6) refines the proposed Rule's ``insiders''
exemption which would have limited the exemption to owners and
officers. During the Rule amendment proceeding, several commenters
urged the Commission to broaden the exemption to include ``trustees,
general partners and any individual who has or had management
responsibility for the offer
[[Page 15529]]
and sale of the franchisor's franchises or the administration of the
franchised network.''\860\ In short, these comments urged that the
exemption parallel the list of company insiders disclosed in Item 2.
Seth Stadfeld, however, questioned the need for the exemption if the
company is already providing disclosures to others.\861\ Howard Bundy
urged the Commission to limit the exemption to bona fide officers,
fearing that a franchisor could attempt to skirt disclosure obligations
by putting a prospective franchisee on the board of directors, for
example, for a few days or weeks before the sale and removing him or
her shortly thereafter.\862\
---------------------------------------------------------------------------
\860\ NFC, NPR 12, at 23. See also AFC, NPR 30, at 3.
\861\ Stadfeld, NPR 23, at 9.
\862\ Bundy, NPR 18, at 14.
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Based upon the record, the Commission has adopted the NFC's
suggestion that the exemption should cover not just owners and officers
of a franchise system, but others with direct management
experience.\863\ It is reasonable to assume that managers and others
with at least two years of direct experience in the business should be
well-informed about its operations.\864\ Where a non-franchised company
wishes to sell a limited number of outlets to experienced company
personnel only, it would be overly burdensome to force the company to
create a disclosure document when the only beneficiaries of the
disclosures are already knowledgeable individuals. The Commission notes
that the exemption is company-specific: we do not mean to suggest that
a manager of one company is deemed sophisticated for all franchise
sales. Rather, the exemption would apply only to a manager or other
officer seeking to purchase a franchise of that very company.
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\863\ For that reason, we decline to include ``trustees.''
Nothing in the designation ``trustee'' ensures that the individual
will have an adequate level of experience within the system to
justify an exemption from receiving pre-sale disclosures. On the
other hand, if a trustee functions as an officer or manages the
franchise systems, he or she will qualify for the exemption as
either an officer or manager.
\864\ CA Bar observed that section 436.8(a)(6) refers to
``purchasers'' It questioned whether the insider exemption is
limited to individual insiders only, or to entities formed by
individual-insiders. It correctly observed that insiders who are
likely to purchase a franchise are likely to do so by forming a
partnership, corporation, or other entity through which to conduct
business. We believe the term ``purchaser'' is broad enough to
include an individual who intends to operate as an entity.
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Howard Bundy's concern that franchisors may abuse the exemption in
an effort to skirt the Rule is adequately addressed. Specifically, in
order to qualify for the exemption, the prospective franchisee must
have served in one of the enumerated positions for at least two years.
Moreover, their relationship with the company must be current: within
60 days of the sale. These prerequisites are likely to ensure that the
prospect is in fact a bona fide officer or owner.
d. Section 436.8(b): Inflation adjustment
Section 436.8(b) of the final amended Rule provides that the
Commission shall adjust the size of the monetary thresholds for the
exemptions listed in section 436.8 every fourth year based upon the
Consumer Price Index.\865\ This would affect the minimum payment
exemption,\866\ as well as the three sophisticated investor exemptions.
As explained below, this approach differs from the proposed inflation
adjustment published in the Franchise NPR in two respects: (1) it sets
a specific time period when the adjustments must occur (every fourth
year); and (2) adds specificity by tying the adjustment to the Consumer
Price Index.
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\865\ This approach is also consistent with the Commission's
procedures for adjusting thresholds or other information in
Commission enforced statutes. Under the Debt Collection Improvement
Act of 1996, the Commission adjusted civil penalty amounts from
$10,000 to $11,000 per violation to account for inflation. Those
amounts must be adjusted at least once every four years. See 61 FR
54549 (Oct. 21, 1996). Similarly, the Appliance Labeling Rule, 16
CFR Part 305, sets forth ranges of estimated annual energy costs and
consumption for various appliances. Because energy cost and
appliance efficiencies fluctuate, the Commission adjusts the label
requirements periodically by publishing in the Federal Register new
costs and ranges, which then become part of that rule's labeling
requirements. The Commission also publishes in the Federal Register
adjustments for determining illegal interlocking directorates in
connection with Section 19(a)(5) of the Clayton Act.
\866\See, e.g., H&H, NPR 9, at 4; Baer, NPR 11, at 15-16.
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In the Franchise NPR, the Commission proposed revising the amended
Rule's monetary thresholds once every four years to adjust for
inflation.\867\ The Commission believed that a four-year adjustment is
necessary to ensure that the thresholds reasonably keep up with
inflation.
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\867\ Franchise NPR, 64 FR at 57321-22.
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The Franchise NPR proposal garnered three comments. PMR&W and John
Bear agreed with the need for a threshold adjustment and supported the
Franchise NPR proposal. The NFC supported the inflation adjustment, but
offered a slightly different approach. It suggested that the Commission
tie the threshold amounts automatically to reflect increases in the
Consumer Price Index, while placing the burden on the franchisor to
prove that it qualified for the exemption at the time in question.\868\
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\868\ NFC, NPR 12, at 22.
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The Commission is persuaded that the final amended Rule should
contain bright-line thresholds that are clear to both franchisor and
franchisee alike. Thus, any adjustment to the Rule thresholds should be
imposed only after an announcement to the public, where the effective
date of the adjustment and the adjustment amount is clear. The most
effective way to provide such notice is through Federal Register
announcements and that the adjustments should be based upon a clear
standard--the Consumer Price Index.\869\ Accordingly, the Commission
intends to publish every fourth year adjustments to the amended final
Rule's monetary thresholds based upon the Consumer Price Index.
Finally, to add greater specificity, the final amended Rule makes clear
that the term ``Consumer Price Index'' means ``the Consumer Price Index
for all urban consumers published by the Department of Labor.''\870\
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\869\ The Staff Report made the same recommendation. Staff
Report, at 250-51. No comments were submitted on this
recommendation.
\870\ See Federal Maritime Commission, Civil Monetary Penalty
Inflation Adjustment, 46 CFR 506.2(c) (```Consumer Price Index'
means the Consumer Price Index for all urban consumers published by
the Department of Labor.'').
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4. Exclusions
Finally, the final amended Rule removes the four exclusions for
non-franchise relationships found in the original Rule: (1) employer-
employee and general partners; (2) cooperative associations; (3)
certification and testing services; and (4) single trademark
licenses.\871\ In the original SBP, the Commission stressed that these
four relationships are not franchises, but might be perceived as
falling within the definition of a franchise.\872\ To avoid any
confusion, the Commission expressly excluded these four relationships
from Rule coverage.
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\871\ See 16 CFR 436.2(a)(4).
\872\ 43 FR at 59708.
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During the Rule amendment proceeding, several commenters opposed
the removal of the exclusion for cooperatives for various reasons.\873\
According to these commenters, the exclusion helps to distinguish
between franchises and cooperatives, a distinction that may not be
apparent to new cooperative members.\874\ Second, removing the
cooperative exclusion from the Rule could lead to costly
[[Page 15530]]
litigation over Rule coverage issues.\875\ Third, retaining an express
exclusion in the Rule itself is needed to ensure that the Commission
does not change its view and seek to enforce the Rule against
cooperatives in the future.\876\ Fourth, the value of retaining the
exclusion outweighs any benefit from streamlining the Rule.\877\
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\873\E.g, Spandorf, at 12.; Duvall, at 2-3; AMF; CHS; IDS.
\874\E.g., CHS, at 1-2; IDS, at 2; NCBA, at 2. See also J&G, NPR
32, Attachment, at 9; TruServ, NPR 33, at 2; Baer, NPR 11, at 5; IL
AG, NPR 3, at 3; PMR&W, NPR 4, at 3; H&H, NPR 9, at 3; Gurnick, NPR
21, at 7.
\875\E.g., NCBA, at 4; NCFC, at 2.
\876\E.g., AMF; CHS; NCBA, at 5.
\877\E.g., Spandorf, at 12; CHS; Reizman Burger, at 3-4.
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The Commission appreciates the concern raised by these commenters.
Nonetheless, we see no compelling reason to keep the exclusions in the
Rule itself. As a preliminary matter, removing the exclusions from the
Rule should not be equated with expanding the scope of part 436 to
cover entities currently dealt with in these exclusions: the Commission
continues to hold that these business relationships do not meet the
criteria for such coverage. They simply do not satisfy the definitional
elements of the term ``franchise.'' Removal of the exclusions from the
Rule is part of the Commission's effort to streamline the Rule.
Nevertheless, the Commission included the exclusions in the
original Rule to clarify the limits of the term ``franchise,'' and for
that reason the concepts embodied in the exclusions continue to serve a
valuable consumer education function.\878\ However, as with other
sections of this document, we are disinclined to include general
consumer education materials in the text of the final amended Rule
itself, absent compelling evidence that such messages are warranted to
address specific problems identified in the record. While the
commenters asserted that confusion exists over the definition of the
term ``franchise,'' not a single individual cooperative member voiced
any confusion over the scope of the ``franchise'' definition, nor any
concern about the distinction between franchises and cooperatives,
during the entire Rule amendment proceeding. Under the circumstances,
the proper forum to discuss limits to the definition of the term
``franchise'' is in this document and in future Compliance Guides. To
that end, the Commission reaffirms the four exclusions and specifically
adopts the discussion of the exclusions set forth in the original SBP
at 43 FR 59708-10.
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\878\ We also note that there are many other business
relationships that share some similarities with franchises, such as
distributorships, multilevel marketing programs, and some work-at-
home schemes. Yet, these arrangements were not expressly excluded
from the Rule. Rather, the definition of the term ``franchise'' is
sufficient to set out the parameters of the Rule's scope. To the
extent that these relationships may be confused with franchises, the
Commission has provided needed clarification in the Final
Interpretative Guides. The same approach is warranted for
cooperatives. Nonetheless, based upon the comments, the Commission
specifically reaffirms the four exemptions in this Statement and
anticipates that future Compliance Guides will do the same. As in
other areas of Rule interpretation, the staff of the Commission can
also address future questions concerning the definition of the term
``franchise'' on a case-by-case basis through informal advisory
opinions.
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G. Section 436.9: Additional Prohibitions
The final amended Rule prohibits nine acts or practices that
violate Section 5 of the FTC Act. The original Rule contained four of
them, namely, prohibitions against: (1) making statements that
contradict the franchisor's disclosures;\879\ (2) making financial
performance representations without a reasonable basis and without
written substantiation for the representation at the time the
representation is made;\880\ (3) failing to make available written
substantiation for any financial performance representations;\881\ and
(4) failing to make promised refunds.\882\
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\879\See 16 CFR 436.1(f). ``Without this provision, the
Commission believes that the disclosures required by the rule could
be contradicted in oral sales presentations and rendered of little
value without violating the rule.'' Original SBP, 43 FR at 59695.
\880\See 16 CFR 436.1(b)(2) and (c)(2); UFOC Item 19. Original
SBP, 43 FR at 59684-690 (The earnings representation standards are
``intended to prevent or minimize potential misrepresentations or
distortions in the representations made by franchisors, while at the
same time permitting franchisors to use informative representations
as part of their marketing scheme.'').
\881\See 16 CFR 436.1(b)(2) and (c)(2); UFOC Item 19. In the
original SBP, the Commission rejected the idea that franchisors
should always provide a copy of their substantiation of financial
performance claims to the prospective franchisee. At the same time,
it found that ``the benefit to be derived from permitting those
prospective franchisees who so wish to review the franchisor's
substantiation far outweighs speculative harms that could arise from
such disclosure.'' Original SBP, 43 FR at 59691.
\882\See 16 CFR 436.1(h). In the original SBP, the Commission
observed that numerous consumers complained about the difficulty
they experienced when they attempted to obtain refunds from their
franchisors. ``It is clear from the record that all franchisors do
not adequately adhere to the refund policies they themselves agree
to in their contracts.'' Original SBP, 43 FR at 59696-97. See also
Staff Review, at 29 (some franchisees continue to experience
problems with obtaining refunds).
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Second, the final amended Rule adds two new prohibitions concerning
the furnishing of disclosures. Specifically, section 436.9(e) prohibits
franchise sellers from failing to furnish a copy of the basic
disclosure documents to prospective franchisees early in the sales
process, upon reasonable request. Section 436.9(f) prohibits franchise
sellers from failing to furnish a prospect in the sales process who has
already received the basic disclosure document with a copy of any
updated disclosure document or quarterly update to an existing
disclosure document, upon reasonable request, before the prospective
franchisee signs a franchise agreement.\883\
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\883\ We decline to adopt a third prohibition recommended in the
Staff Report that would have prohibited franchisors from failing to
furnish a prospective transferee of an existing franchised outlet
with a copy of an existing disclosure document of the franchisor,
upon request. As recommended in the Staff Report, this prohibition
would not have required a franchisor to prepare a current disclosure
document solely for the benefit of a transferee. Rather, a
franchisor would have been permitted to give a prospective
franchisee a copy of its most recent disclosure document. For
example, a franchisor who stopped selling franchises and no longer
possessed a current disclosure document could have complied with
this prohibition by giving a prospective transferee a copy of its
most recent disclosure document, even if that document were at the
time out-of-date. See Staff Report, at 264. In response to the Staff
Report, five commenters opined that this proposed prohibition would
have resulted in franchisors being forced to disclose information
that could have been misleading to the prospective transferee,
subjecting the franchisor to potential liability. CA Bar, at 10;
Kaufmann, at 6; Seid, at 7; Spandorf, at 10-11; Wiggin and Dana, at
5. We agree. An ``existing'' disclosure document would have no
relevance to a transfer unless the document were current. Moreover,
a current disclosure document may not accurately portray the
business arrangement entailed in the transfer, because it would
explain the terms and conditions of the franchisor's current
franchise agreement, while a transferee assumes the terms and
conditions of an ongoing franchise agreement. Moreover, to the
extent that a potential transferee wishes to see a copy of the
franchisor's disclosure document, he or she can obtain a copy from a
commercial service, from a franchise registration state, and more
frequently online (such as through California's Cal-Easi website).
But see Bundy, at 10.
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Third, the final amended Rule adds two anti-fraud prohibitions
designed to preserve the integrity of the disclosure document and
franchise agreement. Section 436.9(g) prohibits franchise sellers from
materially altering the terms and conditions of any franchise agreement
presented to a prospective franchisee for signing, unless the seller
informs the prospective franchisee of the changes seven days before
execution of the agreement. Section 436.9(h) prohibits franchise
sellers from disclaiming or requiring a franchisee to waive reliance on
any representation made in a disclosure document or its exhibits or
attachments.
Finally, section 436.9, based upon our law enforcement history and
the obviously deceptive nature of the practice, adds a new anti-shill
prohibition designed to prevent the use of paid testimonials or shill
references. Specifically, section 436.9(b) prohibits franchise sellers
from misrepresenting that any person has purchased a similar franchise
or operated a similar franchise
[[Page 15531]]
from the franchisor, or that any person can provide an independent and
reliable report about the franchise or the experiences of any current
or former franchisees. Each of these prohibitions is discussed in the
following sections.
1. Section 436.9(a): Inconsistent statements
Section 436.9(a) of the final amended Rule retains the original
Rule prohibition against making statements that contradict the
information required to be disclosed in the disclosure document. Such
prohibited contradictory statements include those made orally,
visually, or in writing. Because the information in the disclosure
document must be complete and accurate, any statements contradicting
that information would be false or likely to mislead prospective
franchisees. Moreover, such statements would likely influence the
purchasing decision of a prospect giving reasonable interpretation to
such statements.
This is particularly true of financial performance representations.
Our law enforcement experience\884\ and the record\885\ show that
franchisors often state in their disclosure document that they do not
furnish financial performance claims, yet give prospective franchisees
false or misleading financial performance data outside of the
disclosure document. Thus, the purpose of this prohibition is to
prevent deception and to preserve the integrity of the information
disseminated to prospective franchisees by ensuring that all required
information will be disclosed in the form of the disclosure
document.\886\
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\884\E.g., FTC v. Netfran Dev. Corp., No. 05-CV-22223 (S.D. Fla.
2005); FTC v. Morrone's Water Ice, Inc., No. 02-3720 (E.D. Pa.
2002).
\885\ For example, Peter Lagarias stated: ``In my experience,
the providing of earnings claims in contravention of . . . [Item 19]
often occurs both orally and in writing. The most common written
method of earnings claims is by newspaper or magazine articles about
the franchise system which contain the earnings claims. These news
articles are reproduced and provided to prospective franchisees in
contravention of the Rule.'' Lagarias, RR 13, at 2. See also Brown,
ANPR 4, at 4 (``There have therefore been endless variations of
supposedly `indirect' franchisor representations of profitability,
[ranging] from the proverbial notation on a napkin or envelope, to
prearranged referrals to `typical'' franchisees, to use of `company
store' figures with plain implications of comparability, and to the
required preparation of a `business plan' by the prospective
franchisee and its `review' and `oral adjustment' by franchisor or
personnel.''); Bundy, ANPR 119, at 1 (``I have never met a
franchisee who had been in operation more than a few weeks who did
not receive earnings claims before investing in a franchise. It
simply does not happen. They either have received them from the
franchisor or its agent directly (often in writing or on floppy
disk) or from third parties to whom they have been directed.''); IL
AG, RR 25, at 2 (``The most common situation and opportunity for
abuse is the franchisor sales representative who makes oral
representations as to earnings potential when talking with
prospects.''); WA Securities, RR 37, at 3 (``Our fraud
investigations reveal that a substantial number of franchisors or
their sales representatives are making written or oral earnings
claims to prospective franchisees even when the disclosure document
states that no earnings claims are made.''); AAFD, RR 39, at 6
(``Probably less than 2% of franchisors make formal earnings
disclosures, [while] the vast majority of franchisees claim they
have received oral (and often informal written) earnings claims and
projections.'').
\886\ Of course, franchisors are always free to disseminate
additional truthful information to a prospective franchisee. See 16
CFR 436.1(a)(21) (franchisors are not precluded from giving other
nondeceptive information orally, visually, or in separate literature
so long as such information is not contradictory to the information
in the disclosure document).
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2. Section 436.9(b): Shills
Section 436.9(b) of the final amended Rule prohibits the use of
fictitious references or ``shills.''\887\ Specifically, it prohibits
franchise sellers from misrepresenting that any person has actually
purchased or operated one of the franchisor's franchises or that any
person can give an independent and reliable report about the experience
of any current or former franchisee. Because information provided by
shills is inherently false, it is likely to mislead prospective
purchasers. Yet, a reasonable prospective purchaser would have no
reason to doubt the shill's statements. Also, because shills are
represented as having experience with the franchisor or otherwise able
to give an independent and reliable report about the franchisor, their
statements are likely to influence the prospect's purchasing decision.
Indeed, the Commission's law enforcement experience\888\ shows that
shills are often the glue that holds a scam together by allaying
consumers' concerns about the investment risks.\889\
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\887\ The anti-shill prohibition is also broad enough to cover
the use of ``institutional shills,'' companies that purport to act
like a Better Business Bureau that provide consumers with
``independent'' reports on its members. See FTC v. United States
Bus. Bureau, Bus. Franchise Guide (CCH) ] 10865 (S.D. Fla. 1995).
\888\ Scam franchisors frequently use shill references in order
to bolster their financial performance and success claims. E.g., FTC
v. Car Checkers of Am., Inc., No. 93-623 (mlp) (D.N.J. 1993); FTC v.
Am. Legal Distrib., Inc., No. 1:88-CV-519-MHS (N.D. Ga. 1988). Harm
resulting from the use of shills is also demonstrated by numerous
Commission business opportunity law enforcement actions. E.g., FTC
v. Am. Entertainment Distrib., Inc., No. 04-22431 CIV-Huck (S.D.
Fla. 2004); FTC v. Hart Mktg. Enter., No. 98-222-CIV-T-23 E (M.D.
Fla. 1998); FTC v. Unitel Sys., Inc., No. 3-97CV18780-D (N.D. Tex.
1997).
\889\ The NCL reported that complaints about fake references are
among the most common franchisee and business opportunity complaints
it receives. NCL, ANPR 35, at 2. See also Staff Program Review at 39
(showing that false or deceptive representations pertaining to
testimonials and references is the second most common Section 5
allegation (28 counts) in Commission business opportunity and
franchise cases).
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The anti-shill provision generated only one comment. J&G expressed
concern that actors or public figures used in a franchisor's
advertising campaigns ``will need to exercise caution when making
endorsements of franchises so as not to run afoul of prohibitions
against misrepresenting that they are able to provide `an independent
and reliable report about the franchise or the experiences of any
current or former franchisees.'''\890\
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\890\ J&G, NPR 32, Appendix, at 9.
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The Commission finds the rulemaking record lacks any evidence that
would shed light on the extent to which franchisors use actors or
public figures to sell franchises, as opposed to selling products and
services to the end-user. Based upon our law enforcement experience, we
believe such practices are rare. More important, our primary concern is
with preventing deception: we see little difference between a
franchisor paying (or otherwise inducing) unknown individuals to
deceive prospective franchisees, on the one hand, and paying (or
otherwise inducing) actors or celebrities to deceive prospective
franchisees, on the other. In each case, a franchisor should not be
able to pay (or otherwise induce) individuals to lie about their
purported experience in order to lure unsuspecting consumers to buy a
franchise.\891\ We are persuaded, therefore, that the anti-shill
prohibition is entirely proper.
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\891\ This view is consistent with the Commission's Guides
Concerning The Use of Endorsements and Testimonials In Advertising,
16 CFR 255. These guides require that any representation in an ad
that purports to represent the view of a consumer must, in fact,
reflect the consumer's actual views or experience:
``Endorsements must always reflect the honest opinions,
findings, beliefs, or experience of the endorser. Furthermore, they
may not contain any representations which would deceive, or could
not be substantiated if made directly by the advertiser.'' 16 CFR at
255.2(a). Therefore, any actor or public figure who might run afoul
of this provision in the Franchise Rule already risks violating the
FTC Act.
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3. Section 436.9(c): Financial performance representations
Section 436.9(c) of the final amended Rule retains the original
Rule's prohibition on the making of financial performance
representations, unless the franchisor has a reasonable basis and
written substantiation for the representation at the time the
representation is made. As discussed above in connection with Item 19,
false and unsubstantiated financial performance claims have been
prevalent in fraudulent sales, are highly material, and are inherently
likely to mislead
[[Page 15532]]
prospective franchisees acting reasonably under the circumstances.\892\
Indeed, our law enforcement experience demonstrates that prospects rely
on financial performance claims in making their investment
decision.\893\ Thus, this prohibition is necessary to prevent
deception.
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\892\E.g., original SBP, 43 FR at 59684-85 (``The use of
deceptive and inaccurate profit and loss statements by franchisors
has resulted in a legion of `horror stories.''). See also Staff
Review, at 25 (earnings claims most frequently reported franchise
problem).
\893\E.g., FTC v. Netfran Dev. Corp., No. 05-CV-22223 (S.D. Fla.
2005); United States v. Robert Lasseter, No. 3:03-1177 (M.D. Tenn.
2003); FTC v. Morrone's Water Ice, Inc., No. 02-3720 (E.D. Pa.
2002); FTC v. Car Wash Guys Int'l., Inc., No. 00-8197 ABC (RNBx)
(C.D. Cal.); FTC v. Tower Cleaning Sys., Inc., No. 96 58 44 (E.D.
Pa. 1996); United States v. Tutor Time Child Care Sys., Inc., No.
96-2603 (N.D. Cal. 1996); FTC v. Mortgage Serv. Assocs., Inc., No.
395-CV-1362 (AVC) (D. Conn. 1995); FTC v. Sage Seminars, Inc., C-95-
2854-SBA (N.D. Cal. 1995).
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Section 436.9(c) of the amended Final Rule revises the original
Rule, however, by permitting the franchisor to make financial
representations in Item 19 of the disclosure document. This achieves
greater uniformity with the UFOC Guidelines, by eliminating the
original Rule's requirement that a franchisor making financial
performance claims furnish prospects with a separate earnings
disclosure document.
4. Section 436.9(d): Availability of financial performance
substantiation
Section 436.9(d) of the final amended Rule also retains the
original Rule's prohibition against failing to make available to
prospective franchisees and to the Commission, upon reasonable request,
written substantiation for any financial performance representation
made in Item 19.\894\ This prohibition is tied to the previous
prohibition against the making of unreasonable and unsubstantiated
financial performance representations. The prohibition against failing
to make available written substantiation ensures that prospective
franchisees and the Commission can review and verify the data
underlying any performance representation, while relieving franchisors
of the burden of having to present what could be voluminous data in the
disclosure document itself. Knowing that their financial performance
claims are subject to Commission review--coupled with the Commission's
authority to bring Rule enforcement actions for false or
unsubstantiated claims--helps discourage the making of unsubstantiated
claims, thus ultimately preventing fraud.
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\894\ 16 CFR 436.1(b)(2); 436.1(c)(2).
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5. Section 436.9(e): Earlier disclosure upon request
Section 436.9(e) of the final amended Rule prohibits a franchise
seller from failing to furnish a copy of the franchisor's disclosure
document to a prospective franchisee earlier than required, upon
request.\895\ Accordingly, any prospective franchisee in the sales
process can obtain a copy of the franchisor's disclosure document
before the standard 14-day time for making disclosures set out in
section 436.2 (14 calendar-days before the signing of a franchise
agreement or payment of any fee in connection with the franchise sale).
Because prospects may incur a variety of costs in determining whether
to consider a particular franchise offering, a franchisor's withholding
of its disclosure document can result in economic injury. For example,
as discussed above in connection with the timing of making disclosures,
early disclosure may prevent injury by enabling prospects to review the
franchisor's disclosure document before agreeing to pay money to
advance the sale, such as incurring travel expenses to visit company
headquarters.
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\895\ The prohibition on failing to give out disclosures earlier
in the sales process pertains to ``prospective franchisees'' only. A
franchisor has no obligation to furnish disclosures to competitors,
the media, academicians, or researchers. It applies to prospective
franchisees already in the sales process. Accordingly, a franchisor
need not furnish a copy of its disclosures to individuals seeking
general information on the franchisor or who do not qualify to
purchase a franchise. We would expect a franchisor to furnish
disclosures, upon request, to any prospective franchisees who have
submitted a franchise application and who have been notified that
they qualify to purchase a franchise. See IFA, at 3. See also
Winslow, at 91.
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Further, the Commission is convinced that this prohibition is also
necessary in light of our decision to eliminate the original Rule's
mandatory face-to-face disclosure trigger. As discussed in connection
with section 436.2 above, the Commission is persuaded that the face-to-
face meeting trigger is unnecessary given the explosion of alternative
media since the original Rule was promulgated in the 1970s.
Nonetheless, the Commission recognizes that several commenters voiced
concern that, absent early disclosure, a franchise seller could
influence a prospective franchisee's investment decision well before
the prospect could verify the franchisor's claims through the
disclosure document, or before the prospect expends funds reviewing the
offering.\896\ To address these concerns, we are persuaded that it is
proper to require franchise sellers to furnish disclosures earlier than
the standard 14 calendar-days disclosure trigger, upon the franchisee's
reasonable request.\897\ The Commission believes this prohibition
strikes the right balance between relieving franchisors of the burden
to furnish disclosures at the first face-to-face meeting in all
instances, and the prospective franchisee's desire to review
disclosures early in the sales process before investing significant
time, effort, and money in considering the franchise offering.\898\
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\896\ Turner, NPR 13, at 1; Karp, NPR 24, at 5-6; Bundy, NPR 18,
at 5-6. See also original SBP, 43 FR at 59639 (``[O]nce a prospect
has been `hooked,' it is difficult, if not impossible, to `extricate
himself.''').
\897\ IFA urged the Commission to define the term ``reasonable
request.'' IFA, at 3. We note that the similar term ``reasonable
demand'' has long been part of the original Rule in connection with
the provision of written substantiation for financial performance
representations. 16 CFR 436.1(b)(2) and 1(c)(2) (``such material is
made available to any prospective franchisee and to the Commission
or its staff upon reasonable demand.''). Similarly, the UFOC
Guidelines provide that a franchisor making financial performance
claims must include a statement in its Item 19 disclosure that
``substantiation of the data used in preparing the earnings claim
will be made available to the prospective franchisee on reasonable
request.'' UFOC, Item 19d. There is no indication in the record that
the use of the terms ``reasonable request'' or ``reasonable demand''
has been confusing or otherwise unclear. We believe determinations
about ``reasonableness'' can be made only on a case-by-case basis.
At a minimum, we will consider whether a request is ``reasonable''
based upon the timing and manner in which the request has been made.
For example, it may be unreasonable for a prospective franchisee to
request a copy of the disclosure document on the morning of the day
a franchisor's representative flies to the prospect's city for a
meeting. Similarly, it may not be reasonable for a prospective
franchisee to make the request by leaving a message with the doorman
at the franchisor's headquarters, or at the hotel where a
franchisor's representative is staying.
\898\ It is noteworthy that state franchise laws, at the very
least, require franchisors to file current disclosure documents
before franchisors may offer franchises for sale. Franchisors
typically have disclosure documents available at the time they make
franchise offerings. Accordingly, this new prohibition imposes no
requirement that did not already exist under the original Rule's
first face-to-face meeting disclosure requirement and under state
franchise filing laws. But see Duvall, at 2 (this prohibition
negates any benefit gained from eliminating the ``first personal
meeting requirement'').
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6. Section 436.9(f): Furnishing updated disclosures
Section 436.9(f) prohibits a franchisor from failing to furnish a
prospective franchisee who has received a basic disclosure document
with updated disclosures, upon the prospect's reasonable request.
Specifically, it prohibits the franchisor from failing to furnish ``the
franchisor's most recent disclosure document and any quarterly updates
to a prospective franchisee, upon reasonable request, before the
prospective franchisee signs a franchise agreement.''
[[Page 15533]]
Section 436.9(f) recognizes that the information contained in a
disclosure document may become out-of-date by the time a prospect who
relies on such information is ready to sign a franchise agreement.\899\
It prevents deception by enabling such prospective franchisees, if they
wish, to get any updated disclosures prepared by the franchisor. At the
same time, section 436.9(f) imposes no continuous updating requirement
on franchisors.\900\ Rather, it strikes the appropriate balance,
preventing deception by enabling a prospective franchisee to gain
access to the most current updated disclosures prepared by the
franchisor, while imposing no new affirmative disclosure obligations on
the franchisor.\901\
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\899\ For example, a franchisor may have filed for bankruptcy
after having furnished disclosures to a prospective franchisee. A
bankruptcy filing, as discussed above, is clearly material because
it calls into question the franchisor's continued financial
viability and, thus, ability to perform its obligations under the
franchise agreement.
\900\ This is consistent with the original Rule, which required
franchisors to update their disclosures to ensure accuracy of its
current disclosure document used with new prospects, but did not
require re-disclosure to prospective franchisees who have already
received a basic disclosure document. 16 CFR 436.1(a)(22) (setting
forth two update requirements: (1) the annual update after the close
of the franchisor's fiscal year; and (2) quarterly updates if there
is a material change).
\901\ Franchise sellers other than the franchisor can satisfy
their obligation to provide updated disclosures by promptly
forwarding a prospective franchisee's request to the franchisor,
provided that the franchisor has promised to fulfill any such
requests promptly.
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7. Section 436.9(g): Unilateral modifications
As previously discussed, the final amended Rule eliminates the
original Rule's requirement that franchisors in every case afford a
prospective franchisee five business days to review the completed
franchise agreement. The Commission concluded that the review period is
unnecessary, provided that the franchise seller does not make any
unilateral modifications to the basic form of the franchise agreement
previously furnished to the prospective franchisee at the time of
furnishing its disclosure document. Unilateral modifications of
material contract terms by the franchise seller without notice to the
prospective franchisee are likely to mislead a prospect who has been
relying on a previous draft as setting forth the parties' agreement.
Indeed, a franchise seller could commit fraud at the time of
executing a franchise agreement by substituting material contract
provisions, without notice to the prospective franchisee, that differ
materially from those in the original standard contract attached to the
disclosure document. To prevent such deception, we adopt a new
prohibition barring franchise sellers from substituting provisions or
pages in the agreement without first bringing such changes to the
prospective franchisee's attention at least seven days before execution
of the agreement.
8. Section 436.9(h): Disclaimers and waivers
Section 436.9(h) prohibits franchise sellers from disclaiming or
requiring ``a prospective franchisee to waive reliance on any
representation made in the disclosure document or in its exhibits or
amendments.'' This prohibition is intended to prevent fraud by
preserving the completeness and accuracy of information contained in
disclosure documents.
The Franchise NPR proposal to prohibit the use of disclaimers and
waivers prompted comment on three issues: (1) the need for the
prohibition; (2) the scope of the prohibition; and (3) the effect of
the prohibition on parties' ability to negotiate contract terms. The
following section discusses each of these issues in detail.
a. Section 436.9(h) is necessary to prevent fraud by preserving the
truthfulness of information contained in a disclosure document
During the Rule amendment proceeding, several franchisees and their
representatives observed that franchisors routinely seek to disclaim
liability for statements made in their disclosure documents through the
use of contract integration clauses in their franchise agreements. By
signing a franchise agreement containing such a clause, franchisees
effectively waive any rights they may have to rely on information
contained in the disclosure document.\902\ The use of such clauses,
therefore, may lead to deception by enabling franchisors to make
incomplete, inaccurate, or even false statements in their disclosure
documents, while prospects effectively waive reliance on any such
statements by signing the franchise agreement.
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\902\ For example, Peter Lagarias, a franchisee advocate,
asserted:
``In virtually every lawsuit I have filed for franchisees
alleging fraud, franchise disclosure, or unfair or deceptive
practices (under California law since the FTC rule does not provide
a private right of action), counsel for the franchisor defendants
have defended the action on lack of justified reliance. Franchisors
and their counsel have systemically written the agreements to strip
franchisees of all fraud claims and rights the minute the agreement
is signed by sophisticated integration, no representation, and no
reliance clauses. . . . The Commission should provide that reliance
on the disclosure document and other representations made in the
sale of a franchise is per se justified.''
Lagarias, ANPR 125, at 4. See also, e.g., Manuszak, ANPR 13;
Bell, ANPR 30; Sibent, ANPR 41 (and 19 identical ANPR comments);
AFA, ANPR 62, at 3; Bundy, ANPR 119, at 2; Selden, ANPR 133,
Appendix B, at 2; Zarco & Pardo, ANPR 134, at 3.
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To remedy this problem, several franchisee advocates and state
regulators urged the Commission to prohibit the use of contract
integration clauses as a means of disclaiming statements made in a
disclosure document.\903\ The IL AG, for example, asserted that such a
prohibition would be a valuable addition to the Rule, noting that
franchisees signing a franchise agreement may have no idea that they
are waiving reliance on the disclosure document.\904\ Similarly, the
AFA stated:
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\903\E.g., AFA, at 4; Bundy, 11-12; Haff, at 3; Karp, at 7;
Lagarias, at 1-3.
\904\ IL AG, NPR 3, at 6; IL AG, NPR Rebuttal 38, at 3.
The integrity of a franchisor's disclosure document is critical to
prospective franchisees. The prevalent use of integration clauses to
disclaim liability for required disclosures undermines the very purpose
of the Rule, which is to prevent fraud and misrepresentation in the
pre-sale process by ensuring prospective franchisees have complete and
truthful information from which to make sound investment
decisions.\905\
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\905\ AFA, NPR 14, at 6.
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A few commenters urged the Commission to expand on the prohibition
that was proposed in the Franchise NPR. Howard Bundy, for example,
urged prohibiting franchisors from disclaiming liability for any
authorized statements, including those made in their written marketing
material.\906\ Seth Stadfeld advocated a ban on integration clauses in
franchise agreements altogether. He asserted that such clauses are
``the single greatest tool used by franchisors to evade responsibility
for misrepresentations and omissions of material facts that take place
in a franchise marketing program.''\907\
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\906\ Bundy, NPR 18, at 14. See also Haff, at 3; Singler, at 3;
IL AG, NPR 3, at 6.
\907\ Stadfeld, NPR 23, at 9-10. In the alternative, Mr.
Stadfeld suggested that the cover sheet contain an explicit warning
that anything stated by the franchisor that is not in the contract
should not be relied upon in any way. Id., at 10.
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Franchisors, on the other hand, either opposed the prohibition on
disclaimers or urged limitation on the prohibition's scope. Several
franchisors strongly asserted that integration clauses are necessary
for two purposes. First, as J&G
[[Page 15534]]
explained, franchisors have to be able to rely on the final franchise
agreement as the manifestation of the intent of the parties. Second,
franchisors must be able to disclaim liability for unauthorized
statements made by a rogue salesman, such as unauthorized earnings
claims.\908\
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\908\ J&G, NPR 32, at 4-5. See also Marriott, NPR 35, at 8; GPM,
NPR Rebuttal 40, at 10-11.
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PMR&W asserted that the prohibition would effectively ban the use
of integration clauses. The firm, however, suggested that the
Commission could limit the prohibition by applying it only ``if an
integration clause or other contract provision specifically disclaims
representations made in the disclosure document. Alternatively, or
perhaps additionally, require a representation by the franchisor at the
end of Item 17 that the information contained in the disclosure
document is unaffected by any integration clause.''\909\
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\909\ PMR&W, NPR 4, at 17.
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CA Bar observed that the disclaimer prohibition is likely to
increase the use of legalese in disclosure documents. It opined that,
if the prohibition is adopted, franchisors are likely to import
legalese from their franchise agreements to the disclosure document in
order to avoid any conflicting language. On the other hand, ``[i]f the
franchisor is able to include (and rely upon) an integration clause, it
decreases that potential for problems arising from unintentional
inconsistency.''\910\
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\910\ CA Bar, at 10.
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Finally, a few franchisors suggested that the disclaimer
prohibition is unnecessary. According to John Baer, for example, the
Commission could always take action if a franchisor's disclosure
document contains false information.\911\ In the same vein, J&G
asserted that the basis for the prohibition is that integration clauses
may deny a franchisee a remedy when franchisees litigate against
franchisors. The firm noted, however, that only the FTC is authorized
to bring a claim for violation of the Franchise Rule; the Commission's
ability to address false representations in a disclosure document will
survive any integration clause between the franchisor and
franchisee.\912\
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\911\ Baer, NPR 11, at 16-17.
\912\ J&G, NPR 32, at 4-5. See also Marriott, NPR 35, at 7-8.
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After carefully reviewing the record, the Commission is persuaded
that a limited disclaimer prohibition, rather than a total ban, is
warranted. As an initial matter, the Commission is convinced that
integration clauses and waivers serve valid purposes, including
ensuring that a prospective franchisee relies solely on information
authorized by the franchisor or within the franchisor's control in
making an investment decision. For example, a franchisor reasonably may
seek to disclaim responsibility for unauthorized claims made by former
or existing franchisees, or unattributed statements found in the trade
press. Therefore, at the very least, integration clauses and waivers
protect a franchisor from unauthorized statements or representations
made by non-agent, third parties.\913\
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\913\ The Staff Report stated that integration clauses may be
warranted to enable franchisors to disclaim liability for statements
made by a ``rogue salesman.'' Staff Report, at 258. This statement
generated significant comment by franchisee representatives
asserting that franchisors should always be liable for statements
made by their sales force. E.g., AFA, at 4 (``The franchisor must
accept responsibility for the person who it authorized and directed
to sell franchises to prospective franchisees.''); Bundy, at 12
(``No one can reasonably argue that the franchisor should be able to
disclaim statements made by its employees or agents within the scope
of their agency.''); Gee, at 2 (``Sales staff puff, exaggerate, and
outright misrepresent the terms of the agreement. . . . Appropriate
protection . . . for such abuses is essential.''); Haff, at 3
(``That salesperson is often the franchisee's only connection to the
franchisor.''); Lagaria, at 2 (``A franchisor should remain liable
for misconduct in the sales process, particularly by its own
employees and agents.''); Pu, at 2 (``The FTC should not permit
franchisors to disclaim responsibility for the statements of rogue
salespeople.''). While we agree that franchisors in most instances
are responsible for statements made by their sales force, there may
be exceptions that can be only be determined based upon the
particular facts on a case-by-case basis, in light of agency law and
Section 5 of the FTC Act.
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At the same time, we are persuaded that franchise sellers should
not be able to use integration clauses or waivers to insulate
themselves from false or deceptive statements made in a franchisor's
disclosure document. This is particularly true of those sections of the
disclosure document pertaining to matters other than the terms of the
franchise agreement that cannot be negotiated, such as the franchisor's
prior business experience, litigation history, financial performance
representations, and financial statements. The Commission has long
recognized that the integrity of a franchisor's disclosures is critical
to prospective franchisees who rely on such information in making their
investment decision. For that reason, disclosure documents must be
complete, accurate, legible, and current. Further, as discussed above,
the original\914\ and final amended Rules also prohibit franchisors
from making statements that contradict those in their disclosure
documents. The use of integration clauses or waivers\915\ to disclaim
statements in the disclosure document that the franchisor authorizes
would undermine the Rule's very purpose by signaling to prospective
franchisees that they cannot trust or rely upon the disclosure
document.\916\
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\914\See 16 CFR 436.1(f).
\915\ Waivers of rights afforded by Commission trade regulation
rules are disfavored. For example, section 455.3(b) of the Used Car
Rule, 16 CFR 455.3(b), requires used car sellers to incorporate the
Buyers Guide into their sales contracts. This ensures that used car
sellers cannot technically comply with the Rule by affixing the
Buyers Guide to a car window, and then turn around and require
consumers to waive the very rights granted them under the Rule.
Similar anti-waiver provisions can be found in the Credit Practices
Rule, 16 CFR 444.2 (barring certain waivers in credit transactions),
Cooling-Off Period Rule, 16 CFR 429.1(d) (barring inclusion in any
door-to-door contract of any confession of judgment or ``any waiver
of any rights to which the buyer is entitled under this section''),
and Ophthalmic Practices Rule, 16 CFR 456.2(d) (barring efforts to
have a patient waive or disclaim the liability or responsibility of
the ophthalmologist or optometrist for the accuracy of the eye
examination).
\916\ Prospective franchisees often rely on the disclosures in
making their investment decision, especially when such disclosures
appear to have the backing of the Federal Trade Commission. Cf. FTC
v. Minuteman Press, Int'l, No. 93-CV-2494 (DRH) (E.D.N.Y. 1998)
(holding that a reasonable consumer could ``legitimately conclude
that he or she was being furnished important specific earnings
information . . . notwithstanding . . . general disclaimers in the
UFOC'').
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It is true that the Commission can bring law enforcement actions
against false or deceptive disclosures, regardless of any contract
integration clause or waiver. This encourages complete and accurate
disclosure. Nevertheless, we believe that franchisees should not have
to rely on Commission action post-sale to resolve conflict between a
disclosure document and franchise agreement. Rather, we believe that
section 436.9(h) will prevent pre-sale deception by encouraging
franchisors to review their disclosures for accuracy prior to use,
thereby avoiding post-sale conflicts and litigation.
Further, courts have limited the circumstances where integration
clauses have the most potential for harm. Where there is fraud in the
inducement, courts are likely to void the contract, regardless of any
integration clause or waiver.\917\
[[Page 15535]]
Finally, integration clauses or waivers are not likely to protect
franchisors from private suits based upon fraudulent statements made in
a disclosure document, even without Commission intervention.\918\
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\917\E.g., Cummings v. HPG Int'l, Inc., 244 F.3d 16, 21 (1\st\
Cir. 2001) (a party cannot induce a contract by fraudulent
misrepresentations and then use contractual devices to escape
liability); Betz Labs. v. Hines, 647 F.2d 402 (3d Cir. 1989)
(integration clause is part of the contract and if fraud taints the
relationship between the parties, the integration clause itself is
struck down); Tibo Software, Inc. v. Gordon Food Serv., Inc., 51
U.C.C. Rep. Serv. 2d, 2003 U.S. Dist. LEXIS 12020 (W.D. Mich. 2003)
(An explicit integration clause bars parol evidence with the
exception of fraud or other grounds sufficient to set aside a
contract); Jones Distrib. Co. v. White Consol. Indus., 943 F. Supp.
1445, 1470-71 (N.D. Iowa 1996) (fine-print, boiler-plate integration
provision is not legally enforceable when there has been fraud that
has induced the making of the contract); Ron Greenspan Volkswagen v.
Ford Motor Land Dev. Corp., 38 Cal. Rptr. 2d 783, 790 (Ct. App.
1995) (merger clause will not insulate a seller from liability for
misrepresentations, even if the clause specifically disclaims such
misrepresentations); Nobles v. Citizens Mortgage Corp., 479 So.2d
822 (Fla. Dist. Ct. App. 1985) (under Florida law, a merger or
integration clause will not bar evidence of fraud in the
inducement).
\918\ For example, in Alphagraphics Franchising, Inc., v. Whaler
Graphics, Inc., 840 F. Supp. 708 (D. Ariz. 1993), the court held
that there was fraud in the inducement regarding an arbitration
forum selection clause, despite the presence of an integration
clause in the franchise contract. ``It is well-settled that a party
cannot free himself from fraud by incorporating [an integration
clause] in a contract.'' Id., at 711 (citations omitted).
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The Commission recognizes that an integration clause or waiver may
be one way for a franchisor to narrow its disclosures efficiently in
unique circumstances. For example, an ice cream store franchisor may
make an Item 19 financial performance representation pertaining to
units based in Florida. If the franchisor sells units in southern
states, the Florida-based representation would be reasonable. However,
if the franchisor were to sell a unit in Alaska, the franchisor might
wish to use a contract integration clause to ensure that the financial
performance representation is inapplicable to the particular sale in
Alaska.\919\
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\919\See J&G, NPR 32, at 5.
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Nevertheless, franchisors could protect themselves from liability
without resort to integration clauses or waivers. For example, the ice
cream store franchisor noted above, at the very least, could provide
the prospective Alaskan franchisee with a disclosure document that
deletes the Item 19 representation. In the alternative, the statement
of bases and assumptions attached to the disclosure document could make
clear that the financial performance representation pertains to Florida
or other southern states only. Nothing in section 436.9(h) would
prevent a franchisor from having a prospective franchisee sign a clear
and conspicuous acknowledgment that the Florida-based performance
representation does not apply to states such as Alaska.
Finally, we recognize the possibility that some franchisors may be
tempted to import into their disclosure documents legalese from their
franchise agreements, in an effort to avoid having conflicting
provisions. Such a possibility, however, is addressed by the Rule's
requirement that disclosure documents be prepared in plain
English.\920\ On balance, however, we are persuaded that the benefit of
promoting the reliability and integrity of substantive disclosures
outweighs any possible loss of clarity in how the disclosures are
presented.
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\920\ Section 436.6(b).
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b. Scope of section 436.9(h)
As noted above, section 436.9(h) is designed to address a specific
problem brought to our attention during the Rule amendment proceeding:
franchisors' use of integration clauses to disclaim authorized
statements made in disclosure documents or in their exhibits or
attachments. By prohibiting this practice, the disclaimer prohibition
preserves the integrity of the material information disclosed in a
franchisor's disclosure document, thus preventing deception. By its
terms, section 436.9(h) does not reach statements made in a
franchisor's advertising materials.
A few commenters urged the Commission to adopt a broader
prohibition that would prevent franchisors from disclaiming any
authorized statement--whether in a disclosure document or promotional
materials.\921\ However, the Commission is persuaded that a broader
prohibition would go beyond what is necessary to address the underlying
issue identified in the record--the need to prevent deceptive
disclosure documents. Further, franchise advertisements, like other
industry advertisements, are already subject to Commission
substantiation and anti-deception requirements under Section 5 of the
FTC Act. Moreover, any franchisor who makes statements in promotional
literature that are inconsistent with the disclosure document and
franchise agreement would violate the section 436.9(a) ban on the
making of contradictory statements.\922\ Accordingly, a broader
disclaimer prohibition is unwarranted to achieve the goal of preserving
the integrity of franchisors' disclosures.
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\921\ Haff, at 3; Singler, at 3. Mr. Haff, for example, asserted
that it is unconscionable for the FTC to permit a franchisor to
disclaim its own materials through a franchise agreement integration
clause. Haff, at 3.
\922\ For example, a franchisor would be liable for a Rule
violation if its promotional literature made financial performance
claims, while its Item 19 said that no such claims are authorized,
or its promotional literature stated that exclusive territories are
available, while its disclosure document offered no such benefit.
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c. Effect of section 436.9(h) on parties' ability to negotiate
contracts
Section 436.9(h) states that the disclaimer prohibition ``is not
intended to prevent a prospective franchisee from voluntarily waiving
specific contract terms and conditions set forth in his or her
disclosure document during the course of franchise sales
negotiations.'' This proviso is necessary because, in its absence, a
franchisor might conclude that it is prohibited from agreeing to any
terms or conditions not spelled out in the standard agreement attached
as an exhibit to its disclosure document.\923\ Clearly, franchise
sellers and prospective franchisees should be free to negotiate the
terms of the franchise agreement, as in all other commercial
transactions. The Commission has no interest in preventing the parties
from seeking the best deal possible, as long as the prospective
franchisee understands in advance of the sale how the terms and
conditions differ from the standard ones set forth in the disclosure
document and has the opportunity to review the actual franchise
agreement prior to the sale.
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\923\ Two franchisor representatives specifically urged the
Commission to clarify the Rule to ensure that the parties are free
to negotiate contract terms. See Baer, ANPR 25, at 4-5; Duvall &
Mandel, ANPR 114, at 22. They feared that if the franchisor
negotiates with a prospective franchisee for different terms than
what appears in the disclosure document, (e.g., a different initial
franchise fee or royalty payment), the franchisor will effectively
violate the Rule because the franchisor will not have furnished the
prospective franchisee with a disclosure document spelling out the
specific agreed-upon terms and conditions in advance of the sale.
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In response to the Staff Report, Howard Bundy voiced concern that
the section 436.9(h) contract negotiation proviso is too broad and
could subsume the Rule.\924\ He feared that a franchisor could initiate
negotiations and permit a person to become a franchisee only if he or
she agrees to waive essential terms. Mr. Bundy urged the Commission to
limit the proviso ``to negotiations initiated by the prospective
franchisee and that result in changes that are no less favorable to the
franchisee than the standard terms.''\925\
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\924\ Bundy, at 11.
\925\Id., at 12.
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The Commission recognizes that an integration clause may facilitate
negotiations by releasing the parties from restraints imposed by the
contractual terms previously disclosed in the disclosure document. The
use of an integration or waiver clause, however, is unnecessary to
permit contract negotiations. As previously discussed, the final
amended Rule addresses how franchisors and prospective franchisees may
negotiate contracts without violating the Rule. Specifically, section
436.2(b) provides that no mandatory contract review period is necessary
where changes are made at the request of the prospective franchisee.
This recognizes that where the prospective franchisee is fully informed
about the contractual terms
[[Page 15536]]
that will govern the relationship before signing the contract, no harm
can result. Where changes to the contract are initiated by the
franchisor, however, section 436.9(g) prohibits the franchisor from
failing to point out the changes, and section 436.2(b) provides for a
limited contract review period. These Rule provisions are sufficient to
prevent fraud in the negotiation process, while preserving the
integrity of the franchisor's disclosures.
9. Section 436.9 (i): Refunds
Section 436.9(i) prohibits franchisors from failing to make refunds
as promised in their disclosure document or in a franchise or other
agreement. The failure to honor refund promises is an unfair practice
in violation of Section 5.\926\ It often results in substantial injury
to franchisees that they cannot reasonably avoid.\927\ Moreover, the
record is devoid of any evidence suggesting that this harm is
outweighed by any countervailing benefits.
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\926\See FTC v. Hillary's Servs., Inc., No. 94-CV-2312 (E.D. Pa.
1994); FTC v. Richard L. Levinger, No. 94-0925-PHXRCB (D. Ariz.
1994); FTC v. McKleans, Inc., Bus. Franchise Guide (CCH) ] 9853 (D.
Conn. 1989) (franchisors violated the Franchise Rule by, among other
things, failing to provide promised refunds). See also FTC v.
William A. Skaife, Bus. Franchise Guide (CCH) [1989-1990 Transfer
Binder] ] 9555 (C.D. Cal. 1990); FTC v. Nat'l Bus. Consultants,
Inc., Bus. Franchise Guide (CCH) ] 9385 (E.D. La. 1989); FTC v. Am.
Legal Distrib., Inc., No. 1:88-CV-519-MHS (N.D. Ga. 1988); United
States v. Tuff-Tire Am., Inc., Bus. Franchise Guide (CCH) [1985-1986
Transfer Binder] ] 8353 (M.D. Fla. 1985); United States v. Fed.
Energy Sys., Inc., Bus. Franchise Guide (CCH) [1983-85 Transfer
Binder] ] 8180 (C.D. Cal. 1984) (franchisors misrepresented refund
policy in violation of Section 5); FTC v. Nat'l Audit Defense
Network, Inc., No. CV-S-02-0131 LRH-PAL (D. Nev. 2002); FTC v.
Travel Bahamas Tours, Inc., No. 97-6181-CIV-Ferguson (S.D. Fla.
1997) (companies misrepresented refund policy in violation of
Section 5 of the FTC Act). Cf. Philips Elecs. N. Am. Corp., FTC No.
022-3095 (2002); Tim R. Wofford, FTC No. 012 3191 (2002) (the
failure to honor rebate offers as promised violates Section 5 of the
FTC Act).
\927\See original SBP, 43 FR at 59696 (``Numerous consumers
complained about the difficulty they experienced when they attempted
to obtain refunds from their franchisors.'').
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Section 436.9(i) retains, but slightly revises, the original Rule's
prohibition against failing to make promised refunds. As set forth at
16 CFR 436.1(h), the original Rule prohibited franchisors and brokers
from failing ``to return any funds or deposits in accordance with any
conditions disclosed pursuant to paragraph (a)(7) of this section.''
This provision was limited to instances where the franchisor or broker
makes an express refund promise in the disclosure document itself. It
is possible, however, that a franchise seller may not make any specific
promise in the disclosure document itself, but may do so either in the
franchise agreement, or in a separate contract or letter of
understanding. The harm resulting from the failure to honor a promised
refund is the same, regardless of where that promise is written.
Accordingly, section 436.9(i) makes clear that the failure to honor any
written refund promise will constitute a Rule violation.\928\
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\928\ One commenter, Dady & Garner, suggested that franchisees
should always receive a refund (excluding actual costs) if they
never actually open or operate an outlet. Dady & Garner, ANPR 127,
at 4. We believe the substantive terms and conditions of refunds are
a matter of contract between the parties, provided the terms and
conditions of any refund policy are spelled out in the disclosure
document or franchise agreement. No other comments were submitted in
connection with the Franchise NPR's proposed retention of the refund
prohibition.
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H. Sections 436.10 and 436.11: Other Laws and Rules, and Severability
The last sections of the final amended Rule address three
additional issues: (1) the final amended Rule's effect on other
Commission laws and rules; (2) preemption of state franchise laws that
may be inconsistent with the Rule; and (3) ``severability.'' Each of
these issues is addressed below.
1. Section 436.10(a): Relationship to other laws and rules
The first part of section 436.10(a) provides that the Commission
does not approve or express any opinion on the legality of any matter a
franchisor may be required to disclose by the Rule. At the same time,
it makes clear that the Commission intends to enforce all applicable
statutes and rules.\929\ This is slightly broader than the same
provision in the proposed Rule, which was limited to ``trade regulation
rules.''\930\
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\929\ This is slightly broader than the same provision in the
original Rule set forth at 16 CFR 436.3, which is limited to
enforcement of statutes: ``A provision for disclosure should not be
construed as . . . an indication of the Commission's intention not
to enforce any applicable statute.'' The revised language of final
amended Rule is also clearer, eliminating the use of double
negatives.
\930\ Franchise NPR, 64 FR at 57346.
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This provision clarifies the relationship between Franchise Rule
disclosure and other statutes and rules enforced by the Commission. As
stated in the original SBP, some of the Rule's provisions may require
franchisors to disclose practices that may raise legal issues, such as
antitrust issues.\931\ By requiring disclosure, the Commission does not
approve of practices that might violate other Commission laws. In
short, pre-sale disclosure does not create a safe harbor for
franchisors engaging in otherwise unlawful conduct.\932\
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\931\ Original SBP, 43 FR at 59719.
\932\ Howard Bundy urged the Commission to add a separate
prohibition against a franchisor representing to any person that the
Commission has reviewed or approved the form or content of any
disclosure document. Bundy, NPR 18, at 15. While we agree with Mr.
Bundy, in principle, we are not persuaded that a new prohibition is
warranted. The final amended Rule already mandates that franchisors
state expressly on their disclosure document cover page that the
Commission has not reviewed or approved of the disclosures. This
should be sufficient to correct any misrepresentation to the
contrary. Moreover, any misrepresentation about Commission approval
of a disclosure document is already actionable as a violation of
Section 5 of the FTC Act.
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During the Rule amendment proceeding, the NFC focused on the
sentence that the ``Commission also intends to enforce all applicable
statutes and trade regulation rules.'' The NFC contended that, under
more recent case law, disclosure in some instances may shield a
practice that otherwise might be a law violation. According to the NFC,
a franchisor's disclosure of certain product or sourcing restrictions,
for example, may relieve the franchisor from antitrust ``tying''
liabilities.\933\
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\933\ NFC, NPR 12, at 24.
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The NFC's concerns are misplaced. Section 436.10 restates the
general policy that disclosure alone does not shield a franchisor from
otherwise illegal conduct. Section 436.10(a) does nothing more than
state that the Commission will continue to enforce the laws it
administers in accordance with its legal authority. If a disclosure
makes conduct legal, as the NFC asserted, then the Commission obviously
would have no reason to believe the franchisor has committed a law
violation.
The second part of section 436.10(a) provides that ``franchisors
may have additional obligations to impart material information to
prospective franchisees outside of the disclosure document under
Section 5 of the Federal Trade Commission Act.''\934\ During the Rule
[[Page 15537]]
amendment proceeding, a few franchisors voiced concern that this
provision does not give any guidance to franchisors about what specific
information needs to be disclosed. For example, Piper Rudnick stated
that ``no matter how thorough or detailed the franchise offering
circular may be, this sentence places all franchisors at risk of
violating the Revised Rule by not also making whatever disclosure may
be required by this open-ended and ambiguous disclosure
obligation.''\935\
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\934\ For example, under the original Rule, no disclosure of
state or local licensing provisions was required. Nonetheless, in
United States v. Lifecall Sys., Inc., No. 90-3666 (D.N.J. 1990), the
Commission alleged that the defendants violated Section 5 by
misrepresenting that purchasers of their emergency alert system
franchises would not have to register with state or local
authorities. See also FTC v. Car Checkers of Am., Inc., No. 93-623
(mlp) (D.N.J. 1993) (alleging that defendants violated Section 5 by
failing to disclose state insurance licensing requirements); FTC v.
Claude Blanc, Bus. Franchise Guide (CCH) ] 10032 (alleging that
defendants violated Section 5 by misrepresenting availability of
medical insurance). Cf. FTC v. Carribean Clear, Inc., Bus. Franchise
Guide (CCH) ] 10029 (D.S.C. 1992) (permanent injunction included
prohibition against future misrepresentations of the effectiveness
and safety of defendants' swimming pool water purifier). Similarly,
a practice may violate the Rule and Section 5 simultaneously. For
example, in numerous Franchise Rule cases the Commission has alleged
that the defendants violated Section 5 by using shills (fictitious
references), even though that conduct also violated the Rule's
mandate to disclose completely and accurately information about
existing franchisees. See 16 CFR 436.1(a)(16).
\935\ Piper Rudnick, at 4. See also Kaufmann, Attachment 1, at
9-10; H&H, NPR 9, at 8.
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No franchisor need worry that it may violate the Rule for failing
to include material information not specifically required or permitted
by the Rule or state law. As for every other person over which the
Commission has jurisdiction, franchisors must not engage in unfair or
deceptive acts or practices. For example, Section 5 would prohibit a
used car seller from misrepresenting a rebate program or from
misrepresenting whether a used car had previous damage, even though the
seller may otherwise comply with the Used Car Rule's warranty
disclosures.
2. Section 436.10(b): Preemption
Section 436.10(b) retains the original Rule's preemption statement
found at footnote 2:\936\
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\936\ Elevating the preemption discussion from a footnote to a
Rule section is consistent with other Commission trade regulations
rules. See, e.g., Appliance Labeling Rule, 16 CFR Part 305.17;
Cooling-Off Rule, 16 CFR 429.2; Mail Order Rule, 16 CFR 435.3(b)(2);
R-Value Rule, 16 CFR 460.23.
The FTC does not intend to preempt the franchise practice laws of
any state or local government, except to the extent of any
inconsistency with this Rule. A law is not inconsistent with this Rule
if it affords prospective franchisees equal or greater protection, such
---------------------------------------------------------------------------
as registration of disclosure documents or more extensive disclosures.
16 CFR Part 436, note 2.\937\
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\937\ As noted previously, starting on July 1, 2007, franchisors
have the option of complying with either part 436 of the final
amended Rule, the UFOC Guidelines, or the original Franchise Rule.
Beginning on July 1, 2008, however, franchisors may use part 436 of
the final amended Rule only. Permission to use the UFOC Guidelines
will be withdrawn on that date because those Guidelines will no
longer afford prospective franchisees equal or greater protection as
part 436. This would not preclude consideration of any new or
revised UFOC Guidelines promulgated by the states in the future.
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During the Rule amendment proceeding, several franchisors urged the
Commission to preempt the field of pre-sale disclosure to ensure a
single, national, disclosure standard.\938\ The preemptive effect of
the final amended Rule, however, is not a subject of Commission
discretion. Rather, the preemptive effect of any federal law is
fundamentally a question of Congressional intent.\939\
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\938\E.g., IFA, at 4; Kaufmann, at 9-10; Spandorf, at 10; PMR&W,
NPR 4, at 7-8; Baer, NPR 11, at 2; Snap-On, NPR 16, at 2; GPM, NPR
Rebuttal 40, at 8. But see IL AG, NPR Rebuttal 38, at 1-2
(``federalism has served the public well'').
\939\English v. Gen. Elec. Co., 496 U.S. 72, 78 (1990);
Schneidewind v. ANR Pipeline Co., 485 U.S. 293, 299 (1988).
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First, Congress can define explicitly the extent to which federal
law preempts state law.\940\ If Congress has explicitly addressed the
issue of preemption in a statute, then the statutory language governs
and no further analysis is required.\941\ Even in the absence of
explicit statutory language, state law is preempted where it regulates
conduct in a field that Congress intended the federal government to
occupy exclusively. Congressional intent to occupy a field may be
inferred from a ``scheme of federal regulation . . . so pervasive as to
make reasonable the inference that Congress left no room for the States
to supplement it,'' or where an act of Congress ``touch[es] a field in
which the federal interest is so dominant that the federal system will
be assumed to preclude enforcement of state laws on the same
subject.''\942\ In addition, Congress may choose to grant sufficiently
broad regulatory authority to a federal agency as to permit the agency
itself, by regulation, to provide expressly for the preemption of state
law.\943\
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\940\Shaw v. Delta Air Lines, Inc., 463 U.S. 85, 95-98 (1983).
\941\Cipollone v. Liggett Group, 505 U.S. 504, 517 (1992).
\942\English, 496 U.S. at 79; Rice v. Santa Fe Elevator Corp.,
331 U.S. 218, 230 (1947). Where the field in question has been
traditionally occupied by the states, congressional intent to
supersede state laws much be ``clear and manifest.'' Jones v. Rath
Packing Co., 430 U.S. 519, 525 (1977) (quoting Rice, 331 U.S. at
230).
\943\City of New York v. FCC, 486 U.S. 57, 62-68 (1988)
(upholding FCC regulations preemping state and local standards for
the quality of cable television signals).
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Finally, state law is preempted to the extent that it actually
conflicts with federal law. Thus, federal law will preempt state law
where it is impossible for a private party to comply with both state
and federal requirements.\944\ In addition, preemption occurs where
state law ``stands as an obstacle to the accomplishment and execution
of the full purposes and objectives of Congress.''\945\
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\944\English, 496 U.S. at 79; Fla. Lime & Avocado Growers, Inc.,
v. Paul, 373 U.S. 132, 141 (1963).
\945\English, 496 U.S. at 79; Gade v. Nat'l Solid Wastes Mgmt.
Ass'n, 505 U.S. 88, 98-99 (1992); Hines v. Davidowitz, 312 U.S. 52,
67 (1941). These standards apply to federal regulations as well as
federal statutes. E.g., Fid. Fed. Sav. & Loan Ass'n v. de la Cuesta,
458 U.S. 141, 153 (1982).
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The Federal Trade Commission Act does not include any clause
directly preempting state law or authorizing the Commission to do so.
Furthermore, the legislative history of the Act and of the 1975
amendments to the Act establishing the Commission's rulemaking
authority indicate that Congress did not intend the Act to occupy the
field of consumer protection regulation.\946\ Any preemptive effect of
the Franchise Rule, therefore, is limited to instances where it is
impossible for a private party to comply with both state and the
Commission regulations, or where application of state regulations would
frustrate the purposes of the Franchise Rule.\947\ In this regard, the
Commission generally has declared the preemptive effect of Commission
rules to be limited to the extent of an inconsistency only.\948\
Accordingly, the amended Franchise Rule would not affect state laws
providing greater consumer protection.\949\
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\946\E.g., Am. Fin. Servs. Ass'n v. FTC, 767 F.2d 957, 989
(1985). See also Paul R. Verkuil, Preemption of State Law by the
Federal Trade Commission, 1976 Duke L.J. 225.
\947\ Preemption would occur where there is an ``actual conflict
between the two schemes of regulation [such] that both cannot stand
in the same area.'' Fla. Lime & Avocado Growers, 373 U.S. at 141.
See also, Am. Fin. Servs., 767 F.2d 957 (Credit Practices Rule);
Harry and Bryant Co. v. FTC, 726 F.2d 993 (4\th\ Cir. 1984) (Funeral
Rule); Am. Optometric Assoc. v. FTC, 626 F.2d 896 (D.C. Cir. 1980)
(Opthalmic Practices Rule).
\948\E.g., Mail or Telephone Order Merchandise Rule, 16 CFR
435.3; R-Value Rule, 16 CFR 460.23.
\949\ When promulgating the original Rule, the Commission
authorized franchisors to use the UFOC Guidelines to comply with the
original Rule's disclosure requirements on the grounds that the UFOC
Guidelines, taken in their entirety, provide equal or greater
consumer protection as the original Rule. See Interpretive Guides,
44 FR at 49970-71. The Commission ratified this position following
subsequent amendments to the UFOC requirements by the NASAA, most
recently in 1993, 58 FR 69224 (Dec. 30, 1993). Examples of state and
local laws not preempted by the original or amended Rule include
registration of franchisors and franchise salespersons, escrow or
bonding requirements, substantive regulation of the franchisor-
franchisee relationship (e.g., termination practices, contract
provisions, and financing arrangements), and disclosure laws
requiring more extensive disclosures than those provided by the
amended Rule.
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We further note that preemption of state franchise disclosure laws
would be inconsistent with the current policy on federalism, as
announced in Executive Order 13132 on August 4, 1999.\950\
[[Page 15538]]
Among other things, the Executive Order provides that federal agencies
should carefully assess the necessity of limiting the policymaking
discretion of the states and such actions should be taken ``only where
there is constitutional and statutory authority for the action and the
national activity is appropriate in light of the presence of a problem
of national significance.'' It also encourages agencies, in appropriate
circumstances, to defer to the states to establish standards. As noted
above, there is no statutory basis for preempting the states in the
franchise pre-sale disclosure arena, nor do we find any compelling
reason to limit the states' discretion in this field. Rather, by
adopting the UFOC Guidelines in large measure, which the commenters
agreed is superior to the current Franchise Rule, the states have taken
a leadership role in this field. Under the circumstances, we must
reject any suggestion that the Commission expand the Franchise Rule's
preemptive effect. There simply is no legal or policy basis for such an
expansion.
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\950\ Although the Executive Order is not binding on independent
agencies, such as the Federal Trade Commission, it nonetheless sets
forth principles that the Commission might consider in determining
the preemptive effect of its regulations.
---------------------------------------------------------------------------
3. Section 436.11: Severability
Finally, as proposed in the Franchise NPR,\951\ section 436.11
contains a standard severability provision, stating that if any
provision of this regulation is stayed or held invalid, the remainder
will stay in force.\952\ This provision is comparable to the
severability provisions in other Commission trade regulation
rules.\953\ This provision generated no comments in response to both
the Franchise NPR and Staff Report. Accordingly, the amended Rule
adopts the severability provision proposed in the Franchise NPR.
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\951\ Franchise NPR, 64 FR at 57324.
\952\See 16 CFR 436.3.
\953\E.g., Pay-Per-Call Rule, 16 CFR 308.8; Used Car Rule, 16
CFR 455.7
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IV. SECTION-BY-SECTION ANALYSIS OF PART 437
As noted above, part 437 of the final amended Rule continues to
cover the offer and sale of business opportunities, such as vending
machine and rack display promotions.\954\ Except for the three changes
discussed immediately below, part 437 is identical to the original
Rule, imposing no new substantive disclosure requirements or
prohibitions.
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\954\See Interpretive Guides, at 49968. See generally Business
Opportunity NPR, 71 FR at 19054-57.
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A. New definition for ``business opportunity''
Section 437.2(a) of the final amended Rule defines the term
``business opportunity'' consistent with the original Rule's business
opportunity definitional elements. In so doing, it eliminates
references to franchising, which are now addressed in part 437 of the
final amended Rule. First, the term ``franchise'' in the original Rule
definitions has been eliminated and substituted with the term
``business opportunity.'' Second, the franchise definitional elements
of the original Rule's ``franchise'' definition have been eliminated.
Accordingly, the definitional elements of the term ``business
opportunity'' are now identical to those set forth in the original
Rule:
(a) The term business opportunity means any continuing commercial
relationship created by any arrangement or arrangements whereby:
(1) A person (hereinafter ``business opportunity purchaser'')
offers, sells, or distributes to any person other than a ``business
opportunity seller'' (as hereinafter defined), goods, commodities, or
services which are:
(i)(A) Supplied by another person (hereinafter ``business
opportunity seller''); or
(B) Supplied by a third person (e.g., a supplier) with whom the
business opportunity purchaser is directly or indirectly required to do
business by another person (hereinafter ``business opportunity
seller''); or
(C) Supplied by a third person (e.g., a supplier) with whom the
business opportunity purchaser is directly or indirectly advised to do
business by another person (hereinafter ``business opportunity
seller'') where such third person is affiliated with the business
opportunity seller; and
(ii) The business opportunity seller:
(A) Secures for the business opportunity purchaser retail outlets
or accounts for said goods, commodities, or services; or
(B) Secures for the business opportunity purchaser locations or
sites for vending machines, rack displays, or any other product sales
displays used by the business opportunity purchaser in the offering,
sale, or distribution of said goods, commodities, or services; or
(C) Provides to the business opportunity purchaser the services of
a person able to secure the retail outlets, accounts, sites, or
locations referred to in paragraphs (a)(ii)(A) and (B) of this section;
and
(2) The business opportunity purchaser is required as a condition
of obtaining or commencing the business opportunity operation to make a
payment or a commitment to pay to the business opportunity seller, or
to a person affiliated with the business opportunity seller.
B. Eliminating other references to franchising
Part 437 of the final amended Rule further eliminates all other
references to franchising, by substituting for the terms
``franchisor,'' ``franchisee,'' and ``franchise'' used throughout part
437 the terms ``business opportunity seller,'' ``business opportunity
purchaser,'' and ``business opportunity.'' This ensures that part 437
will cover only the offer and sale of business opportunities. For
example, section 437.2(a)(3) retains, but modifies, the original Rule's
exemption for fractional relationships to cover business opportunities
only: the term ``fractional franchise'' is replaced by the term
``fractional business opportunity.''
C. Franchise exemption
Section 437.2(a)(3)(v) adds a new exemption to part 437 of the
final amended Rule for those business arrangements that comply with the
Franchise Rule, or are exempt from compliance with the Franchise Rule,
as set forth in part 436. Accordingly, it is designed to eliminate
potential overlap and duplicative compliance burdens between the
franchise rule and the business opportunity rule, parts 436 and 437,
respectively. Specifically, section 437.2(a)(3)(v) exempts from
coverage of part 437 all business arrangements that comply with part
436, or that satisfy one or more exemptions to part 436. For example,
businesses exempt from part 436 coverage pursuant to the fractional
franchise exemption would not be subjected to coverage under part 437.
This is an appropriate result because the same rationale underlying
exemption of these types of businesses from part 436 would also dictate
that they not be covered by part 437-- i.e., in the case of a
fractional franchise, the franchisor is not likely to deceive the
prospective franchisee or to subject the prospective franchisee to
significant investment risk. Therefore, imposing the requirements of
either part 436 or part 437 would not be justified.
V. REGULATORY ANALYSIS AND REGULATORY FLEXIBILITY ACT REQUIREMENTS
Under section 22 of the FTC Act,\955\ the Commission must issue a
regulatory analysis for a proceeding to amend a rule only when it: (1)
estimates that the
[[Page 15539]]
amendment will have an annual effect on the national economy of
$100,000,000 or more; (2) estimates that the amendment will cause a
substantial change in the cost or price of certain categories of goods
or services; or (3) otherwise determines that the amendment will have a
significant effect upon covered entities or upon consumers.
---------------------------------------------------------------------------
\955\ 15 U.S.C. 57b.
---------------------------------------------------------------------------
In general, the commenters supported the proposed franchise
amendments because they reduce inconsistencies with state franchise
disclosure laws, reduce compliance burdens on franchisors that are not
likely to engage in abusive practices that the Rule was intended to
prevent, and update the original Rule to address new technologies. Only
one commenter addressed the economic impact of part 436, voicing
concern generally that the original and amended Franchise Rule impose
unnecessary costs.\956\ No commenter, however, indicated that the
amendments would have an annual impact of more than $100,000,000, cause
substantial change in the cost of goods or services, or otherwise have
a significant effect upon covered entities or consumers.\957\
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\956\See generally Winslow. However, this commenter did not
quantify the additional cost burdens arising as a result of the Rule
amendments--as opposed to those imposed by the original Rule or by
state law--nor provide any data or statistics supporting his view,
that would permit us to assess the economic impact of the Rule
amendments.
\957\ As previously noted, part 437 of the final amended rule
(the business opportunity section) is substantively identical to the
business opportunity coverage of the original Rule. Part 437 imposes
no additional disclosures, recordkeeping requirements, or
prohibitions on business opportunity sellers. Accordingly, the part
437 amendments impose no economic costs or compliance burdens on
business opportunities covered by the original Franchise Rule.
---------------------------------------------------------------------------
At the same time, some commenters questioned whether particular
rule amendments pertaining to franchising might be unnecessary, or
offered alternatives. Section III of this document analyzes these
comments in detail. After careful consideration of the comments, and
the record as a whole, the Commission has determined that there are no
facts in the record, or other reasons to believe, that the part 436
amendments will have significant effects on the national economy, on
the cost of goods or services, or on covered parties or consumers. In
any event, to the extent, if any, these final rule amendments will have
such effects, the Commission has previously explained above the need
for, and the objectives of, the final amendments; the regulatory
alternatives that the Commission has considered; the projected benefits
and adverse economic or other effects, if any, of the amendments; the
reasons that the final amendments will attain their intended objectives
in a manner consistent with applicable law; the reasons for the
particular amendments that the agency has adopted; and the significant
issues raised by public comments, including the Commission's assessment
of and response to those comments on those issues.
The Regulatory Flexibility Act (``RFA''),\958\ requires that the
agency conduct an analysis of the anticipated economic impact of
proposed rule amendments on small businesses. The purpose of a
regulatory flexibility analysis is to ensure that the agency considers
the impact on small entities and examines regulatory alternatives that
could achieve the regulatory purpose while minimizing burdens on small
entities. Section 605 of the RFA provides that such an analysis is not
required if the agency head certifies that the regulatory action will
not have a significant economic impact on a substantial number of small
entities.\959\
---------------------------------------------------------------------------
\958\ 5 U.S.C. 601- 612.
\959\ 5 U.S.C. 605.
---------------------------------------------------------------------------
The Commission believes that none of the amendments to the original
Franchise Rule is likely to have a significant impact on small
businesses. Most small businesses covered by the original Franchise
Rule are likely to be business opportunity sellers, such as vending
machine and rack display route sellers. These small businesses will
continue to be covered by the same substantive provisions of the
original Rule, through part 437. On the other hand, the numerous
amendments to the original Franchise Rule that pertain to franchising--
set out in part 436--will not apply to the offer or sale of business
opportunities. In short, none of the amendments to the original
Franchise Rule are likely to affect a substantial number of small
businesses. Accordingly, the Commission has no reason to believe that
the amendments will have a significant impact upon such entities.
Moreover, the Commission is adopting amendments that in large
measure reduce inconsistencies with state law. In many instances, small
businesses that sell franchises, especially those conducting business
on a national basis, already comply with state disclosure laws in the
form of the UFOC Guidelines. Accordingly, many of the amendments will
impose no new compliance costs on either small or large businesses.
Further, in some instances, the Commission has specifically narrowed a
UFOC provision to reduce compliance costs, which will benefit small
business franchisors in particular. For example, in considering the
disclosure of computer systems, the Commission declined to adopt the
states' sweeping disclosure of computer system requirements, in favor
of a more limited disclosure. In addition, the Commission will permit
electronic compliance with the Franchise Rule, which holds the promise
of reducing costs for all franchisors, including small business
franchisors.
In a few instances, the part 436 amendments will impose new
disclosure requirements on all franchisors. These amendments are
designed to provide prospective franchisees with more information about
the quality of the franchise relationship. In these instances, the
Commission has taken great care to keep compliance costs to a minimum.
For example, with respect to the new franchisor-initiated litigation
disclosure, franchisors need only report such litigation for a period
of one year. This contrasts with the original Rule's seven-year
reporting period (and the UFOC Guidelines 10-year reporting period) for
prior litigation against the franchisor. Similarly, a franchisor may
disclose franchisor-initiated litigation by grouping any suits under a
single heading, as opposed to the original Rule and UFOC Guidelines
approach for other litigation, which requires full case summaries.
Similarly, the Commission has narrowed the new disclosure of
independent trademark-specific franchisee associations. Franchisors
need not make this disclosure unless the association specifically asks
to be included in the franchisor's disclosure document. Further, such
requests must be renewed by the association on an annual basis. In
addition, franchisors need not update this disclosure on a quarterly
basis. The Commission believes that these, and other efforts to narrow
amendments to the Rule discussed throughout this document, will result
in the easing of compliance burdens for all franchisors, especially
small business franchisors.
Accordingly, the Commission concludes that the amendments to the
original Franchise Rule will not have a significant or disproportionate
impact on the costs of small business, whether they sell franchises or
business opportunities. Based on available information, therefore, the
Commission certifies that the Franchise Rule amendments published in
this document will not have significant economic impact on a
substantial number of small businesses.
[[Page 15540]]
Nonetheless, to ensure that no such impact, if any, has been
overlooked, the Commission has conducted the following final regulatory
flexibility analysis, as summarized below.
A. Need For And Objective Of The Rule
As previously discussed, the Commission is issuing these rule
amendments to achieve four goals: (1) to reduce inconsistencies with
state franchise disclosure laws; (2) to respond to changes in the
marketing of franchises and new technological developments, in
particular electronic communications; (3) to reduce compliance costs
where the record and the Commission's law enforcement experience shows
that the abuses the Rule was intended to address are not likely to
occur; and (4) to address the need for franchisors to disclose material
information about the quality of the franchise relationship, the
absence of which the record shows is a prevalent problem.
B. Significant Issues Raised By Public Comment, Summary Of The Agency's
Comment, Summary Of The Agency's Assessment Of These Issues, And
Changes, If Any, Made In Response To Such Comments
The Commission has reviewed the comments received during the Rule
amendment proceeding and has made changes to the original Rule, as
appropriate. Section III of this document contains a detailed
discussion of the comments and the Commission's responses. Among other
things, the Commission, based upon the record, has narrowed the scope
of part 436--the franchise section--by eliminating coverage of business
opportunities, many of which are small businesses. In addition, part
436 will apply only to the sale of franchises to be located in the
United States.
Further, part 436 of the final amended Rule reduces many
inconsistencies with state franchise laws that use the UFOC Guidelines
format. Accordingly, many of the rule amendments will impose no new
compliance costs on small businesses, especially those that conduct, or
plan to conduct, business on a national basis. Further, in some
instances, the Commission has specifically narrowed a UFOC provision to
reduce compliance costs, which will benefit small businesses in
particular. For example, based upon the comments, the Commission
declined to adopt the states' sweeping disclosure of computer system
requirements, in favor of a more limited disclosure. Most important,
part 436 of the final amended Rule permits franchisors to furnish
disclosure documents electronically, which holds the promise of
reducing costs for all franchisors, including small business
franchisors.
Where part 436 of the final amended Rule imposes new disclosure
requirements, the Commission has carefully considered approaches that
will reduce compliance burdens, especially on small businesses. For
example, with respect to the new franchisor-initiated litigation
disclosure, franchisors need only report such litigation for a period
of one year. This contrasts with the original Rule's seven-year
reporting period (and the UFOC Guidelines 10-year reporting period) for
prior litigation against the franchisor. Similarly, a franchisor may
disclose franchisor-initiated litigation by grouping any suits under a
single heading, as opposed to the original Rule and UFOC Guidelines
approach for other litigation, which requires full case summaries.
Similarly, the Commission has narrowed the new disclosure of
independent trademark-specific franchisee associations. Franchisors
need not make this disclosure unless the association specifically asks
to be included in the franchisor's disclosure document. Further, such
requests must be renewed by the association on an annual basis. In
addition, franchisors need not update this disclosure on a quarterly
basis. The Commission believes that these, and other efforts to narrow
amendments to the original Franchise Rule discussed throughout this
document, will result in the easing of compliance burdens for all
franchisors, especially small business franchisors.
C. Description And Estimate Of Number Of Small Entities Subject To The
Final Rule Or Explanation Why No Estimate Is Available
The Commission cannot readily estimate the number of small entities
subject to the final amended Rule. Franchising is a method of
distribution, not an industry, nor an economic sector. Accordingly,
businesses in a wide array of industries engage in the distribution of
products or services through franchising, and the number of franchisors
in any one economic sector is constantly changing.
Moreover, the SBA's standards for determining size--based on either
number of employees or annual receipts--are inapplicable to
franchising.\960\ For example, the most relevant SBA standards
pertaining to franchising are arguably those for the retail sales
industry. The most common ``small business'' threshold (measured in
receipts) for the retail trade industry is $6 million.\961\ However,
these standards apply to franchisees engaging in retail sales
activities, not to the franchisors that sell the underlying franchised
units.\962\
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\960\ The SBA size thresholds set forth what constitutes a small
entity in a particular line of business, regardless of whether the
entity is a franchisor, licensee, contractor, parent corporation,
affiliate, agent, or other entity. For the same reason, it is
difficult to estimate the number of small entities that will be
subject to the business opportunity requirements set forth at part
437.
\961\ See generally 13 CFR Part 121. According to the SBA
standards, the $6 million receipts threshold applies to retailers as
diverse as automotive parts and tire stores; floor coverings and
window treatment stores; camera and photography stores; hardware and
garden suppliers; many food stores; health care product stores; many
clothing stores; sporting good stores; florists; and pet supply
stores. The $6 million threshold also is applicable to hotels;
restaurants; automotive repair centers; car washes; and laundry
services. While the $6 million threshold is typical of a wide cross-
section of small businesses, some of which may be franchises, it
sheds no light on the number of franchisors that are small
businesses.
\962\ Industry data are also difficult to come by. In the
1990's, the International Franchise Association produced a series of
reports called The Profile of Franchising that sought to quantify
and describe franchise systems in the United States. While these
reports shed light on numerous aspects of franchising--such as the
number of franchise systems in various economic sectors, how long
companies were in business before beginning to franchise, and how
many franchisees are in the system--the reports did not purport to
examine the number of staff employed by the franchisors nor
franchisors' annual receipts, factors used in a regulatory
flexibility analysis. More recently, in 2004, the International
Franchise Association produced a study called Economic Impact of
Franchised Businesses. This study examined the economic impact that
franchised units have in the marketplace, for example, the number of
individuals employed by franchised units. This study, like the
Profiles of Franchising, is not useful in determining the number of
franchisors that are small businesses and subject to the final
amended Rule.
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Nonetheless, in the Franchise NPR the Commission estimated that
there are 2,500 business format and product franchisors and 2,500
business opportunities covered by the original Rule.\963\ The
Commission estimated that as many as 70% of those 5,000 franchisors are
small entities, including some start-up franchise systems and most
business opportunities.\964\ The Franchise NPR specifically asked for
comment on these estimates. No comments were submitted. Accordingly,
our best estimate is that 3,500 franchisors covered by the original
Rule were small businesses, 2,500 of which were business opportunities.
---------------------------------------------------------------------------
\963\ Franchise NPR, 64 FR at 57325. See also 70 FR 51817,
51818-20 (Aug. 31, 2005).
\964\ Franchise NPR, 64 FR at 57325.
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Once business opportunity ventures are no longer covered by part
436 of the final amended Rule, the number of
[[Page 15541]]
``small businesses'' subject to the Rule amendments will be greatly
reduced. Of the remaining 2,500 franchisors covered by part 436 of the
final amended Rule, many are mature, well-established franchise
systems, including many publicly traded companies. In the absence of
additional information on the size of franchisors, we will estimate for
purposes of this analysis that 1,000 franchisors (3,500 covered by the
original Rule minus the exclusion of 2,500 business opportunities) will
qualify as small businesses subject to the part 436 amendments. At the
same time, each of the 2,500 business opportunities covered by the
original Rule--most likely small entities--will remain covered by the
identical disclosure requirements, as set forth in part 437.
D. Description Of The Projected Reporting, Recordkeeping, And Other
Compliance Requirements Of The Rule, Including An Estimate Of The
Classes Of Small Entities That Will Be Subject To The Rule And The Type
Of Professional Skills That Will Be Necessary To Comply
As discussed in the Paperwork Reduction Act analysis of this notice
(Section VI), the amendments will impose compliance requirements (e.g.,
disclosure) and minor recordkeeping requirements on franchisors. This
may affect some small business franchisors. No additional recordkeeping
or disclosure requirements are imposed on business opportunities that
remain covered under part 437. The incremental cost of the part 436
amendments on franchisors is difficult to estimate. As suggested by the
lack of comment on the subject, the Commission expects that the added
costs of the amendments will be small. Finally, compliance with the
amended Rule will require, in many instances, the professional
assistance of an attorney to prepare disclosure documents.\965\
However, franchisors (and business opportunity sellers) typically need
such professional assistance in order to comply with state franchise
and business opportunity disclosure laws, in particular the preparation
of required financial statements. Accordingly, no new or additional
professional skills are required as a result of amendments to the
original Rule.
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\965\ In preparing disclosure documents for franchisor clients,
attorneys may also arrange for the assistance of accountants,
especially to prepare audited financial statements.
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E. Steps The Agency Has Taken To Minimize Any Significant Economic
Impact On Small Entities, Consistent With The Stated Objectives Of The
Applicable Statutes, Including The Factual, Policy, And Legal Reasons
For Selecting The Alternative(s) Finally Adopted, And Why Each Of The
Significant Alternatives, If Any, Was Rejected
As discussed throughout this document, the Commission has
considered all alternatives that would reduce compliance costs on all
franchisors, including small business franchisors, while achieving the
intended objectives of the Rule. For example, part 436 of the final
amended Rule narrows the scope of the original Rule by eliminating
coverage of business opportunities, many of which are small businesses.
Part 436 of the final amended Rule, while reducing compliance with
state pre-sale disclosure laws, minimizes compliance costs where
possible. For example, part 436 of the final amended Rule narrows the
disclosure of computer system requirements. Where a part 436 rule
amendment expands the original Rule, it does so in a fashion designed
to minimize compliance burdens. This is most evident regarding the new
disclosures pertaining to franchisor-initiated litigation and
independent, trademark-specific franchisee associations, as discussed
above. Further, in many instances part 436 of the final amended Rule
permits franchisors the flexibility to comply with Rule provisions in a
manner that makes the most sense for their particular business. For
example, franchisors can determine the best medium in which to furnish
their disclosures, as well as to receive receipts from prospective
franchisees.
Moreover, part 436 of the final amended Rule permits disclosure and
recordkeeping electronically. This offers the promise of greatly
reducing compliance costs, especially for small businesses. All
franchisors, including small businesses, may furnish disclosures using
the approach that is most economical for their business, whether that
means furnishing a paper document, an electronic disclosure document
made available to prospective franchisees through a password-protected
website, or through email or CD-ROM.
At the same time, the Commission has rejected numerous suggestions
to revise the original Rule that would result in significantly
increased costs for all franchisors, in particular small business
franchisors. For example, several commenters urged the Commission to
mandate the disclosure of financial performance data. Other commenters
urged the Commission to expand greatly the reporting of franchise
turnover rates. Further, commenters suggested that the Commission
incorporate into the disclosure document various risk factors or
consumer education notices to prospective franchisees. As discussed
above in Section III, the Commission finds that the benefits of these
suggested amendments would not outweigh the compliance costs.
Finally, the Commission has determined to give franchisors ample
time to come into compliance with the final amended Rule. To that end,
franchisors can start using the final amended Rule on July 1, 2007, if
they so choose. At the very latest, all franchisors must come into
compliance with the final amended Rule by July 1, 2008. This approach
will benefit large and more seasoned franchisors that wish to take
advantage of the improvements incorporated in part 436 of the final
amended Rule. At the same time, it permits small business franchisors,
in particular, ample opportunity to consider the best and most cost-
effective means to comply with part 436 of the final amended Rule.
VI. PAPERWORK REDUCTION ACT
In accordance with the Paperwork Reduction Act, as amended, 44
U.S.C. 3501-3520, the Office of Management and Budget (``OMB'') has
approved the information collection requirements contained in the
amended Rule through October 31, 2008, and has assigned OMB control
number 3084-0107.
No comments were received in response to the Franchise NPR
addressing the Commission's paperwork burden estimates. Nonetheless,
the Commission staff revised its approach to calculating the burden
when seeking to extend the clearance for the Rule in 2002.\966\
Specifically, taking into account that new entries are more likely to
require additional time to prepare disclosures than their more seasoned
counterparts, the Commission staff distinguished between existing
entities covered by the Rule and the likely number of new entries when
calculating compliance burdens.\967\ This burden analysis approach was
retained when Commission staff sought an extension of the clearance for
the Rule in 2005.\968\ As with the Franchise NPR, no paperwork
[[Page 15542]]
related comments were received in response to the Commission's 2002 and
2005 Notices.\969\
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\966\See 67 FR 21243 (Apr. 30, 2002); 67 FR 45734 (July 10,
2002) (``2002 Notices'').
\967\ 67 FR at 21245; 67 FR at 45736.
\968\See 70 FR 28937, 28940 (May 19, 2005); 70 FR 51817, 51819
(Aug. 31, 2005) (``2005 Notices'').
\969\ One Staff Report commenter voiced concern that the
Franchise Rule imposed unnecessary burdens. See generally Winslow.
Mr. Winslow's concerns are addressed below.
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As set forth in the 2005 Notices, based on a review of trade
publications and information from state regulatory authorities, staff
believes that, on average, from year to year, there are approximately
5,000 American franchise systems, consisting of about 2,500 business
format franchises and 2,500 business opportunity sellers, with perhaps
about 10% of that total (500) reflecting an equal amount of new and
departing business entrants.\970\
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\970\ Unless otherwise noted, ``franchisors'' as used in this
document solely pertains to business format franchisors.
---------------------------------------------------------------------------
A. Part 436
Staff has calculated burdens based on the above estimates. Some
franchisors, however, for various reasons, are not covered by the Rule
in certain situations (e.g., when a franchisee buys bona fide inventory
but pays no franchisor fees). Moreover, 15 states have franchise
disclosure laws similar to the Rule. These states use a disclosure
document format known as the Uniform Franchise Offering Circular
(``UFOC''). In order to ease compliance burdens on the franchisor, the
Commission has authorized use of the UFOC in lieu of its own disclosure
format to satisfy the Rule's disclosure requirements. Staff estimates
that about 95 percent of all franchisors use the UFOC format. As noted
throughout this document, revised part 436 tracks the UFOC Guidelines
in large measure. Accordingly, the burden hours stated below reflects
staff's estimate of the incremental burden that part 436 may impose
beyond information requirements imposed by states and/or followed by
franchisors who use the UFOC.
Estimated annual hours burden for part 436: 19,500 hours.
As set forth in the 2005 Notices, staff estimates that, during the
first year of clearance, the 250 or so new franchisors will require 32
hours to prepare their disclosure document (two more hours than under
the original Rule) and the remaining 2,250 established franchisors will
require six hours to update their existing disclosure document (three
more hours than under the original Rule). After the first year,
however, the time required for established franchisors should be the
same as under the original Rule, as the new disclosure format becomes
familiar. Accordingly, during the remaining two years of the clearance,
staff estimates it will take three hours for established franchisors to
update their existing disclosure document (same as the original Rule).
Thus, the average annual hours burden for established franchisors
during the three-year clearance period will be approximately 4 hours
((6 hours during first year of clearance + 3 hours during second year
of clearance + 3 hours during third year of clearance) / 3 years).
As set forth in the 2005 Notices, under the original Rule, covered
franchisors may need to maintain additional documentation for the sale
of franchises in non-registration states, which could take up to an
additional hour of recordkeeping per year. This yields a cumulative
total of 2,500 hours per year for covered franchisors (1 hour x 2,500
franchisors).
Part 436 of the amended Rule would also increase franchisors'
recordkeeping obligations. Specifically, a franchisor would be required
to retain copies of receipts for disclosure documents, as well as
materially different versions of its disclosure documents. Such
recordkeeping requirements, however, are consistent with, or less
burdensome, than those imposed by the states.
Thus, staff estimates the average hours burden for new and
established franchisors during the three-year clearance period will be
19,500 ((32 hours of annual disclosure burden x 250 new franchisors) +
(4 hours of average annual disclosure burden x 2,250 established
franchisors) + (1 hour of annual recordkeeping burden x 2,500
franchisors)).
Estimated annual labor cost burden for part 436: $4,282,500.
One commenter, Lance Winslow, stated in response to the Staff
Report that the average total cost to prepare a franchise disclosure
document is $25,000-35,000.\971\ The Commission agrees that many
franchisors typically spend $25,000-35,000 on disclosure documents.
Much of these costs, however, are not imposed by part 436, but by state
law. For example, a large portion of the costs that franchisors
typically pay for disclosures is the result of audited financial
requirements and state registration requirements, costs that would
continue to exist whether or not the Commission adopted the amended
Rule. As stated above, staff's burden estimates reflect the incremental
burden that part 436 may impose beyond the information requirements
imposed by states.
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\971\ Winslow, at 23-35.
---------------------------------------------------------------------------
As set forth in the 2005 Notices, staff estimates that an attorney
will prepare the disclosure document at $250 per hour. Accordingly,
staff estimates that 250 new franchisors will annually each incur
$8,000 in labor costs (32 hours x $250 per hour) and, during the first
year of the clearance, established franchisors will each incur $1,500
in labor costs (6 hours x $250). During the remaining two years of
clearance, staff estimates established franchisors will annually each
incur $750 in labor costs (3 hours x $250 per hour). Thus, the average
annual labor cost estimate for established franchisors during the
three-year clearance period will be approximately $1,000 (($1,500 in
labor costs during first year of clearance + $750 in labor costs during
second year of clearance + $750 in labor costs during third year of
clearance) / 3 years).
Further, staff anticipates that recordkeeping under part 436 will
be performed by clerical staff at approximately $13 per hour. Thus, at
2,500 hours of recordkeeping burden per year for all covered
franchisors will amount to a total annual cost of $32,500 (2,500 hours
x $13 per hour).
Thus, the total estimated labor costs under part 436 is $4,282,500
(($8,000 attorney costs x 250 new franchisors) + ($1,000 attorney costs
x 2,250 established franchisors) + ($13 clerical costs x 2,500
franchisors)).
Estimated non-labor costs for part 436: $8,000,000.
In response to the Staff Report, Mr. Winslow stated that the costs
of printing documents for his franchise system exceed $24,000 without
postage.\972\ Mr. Winslow further indicated that the number of
disclosure documents sent out each year will increase under the amended
Rule.\973\ Finally, Mr. Winslow stated that franchisors will incur
significant costs if they send disclosure documents electronically,
including bandwidth fees and fees associated with hiring a contractor
to create a searchable website.\974\
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\972\ Winslow at 28.
\973\ Winslow at 31, 93.
\974\ Winslow at 28.
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As an initial matter, in developing cost estimates, Commission
staff consulted with practitioners who prepare disclosure documents for
a cross-section of franchise systems. Accordingly, the Commission
believes that its cost estimates are representative of the costs
incurred by franchise systems generally. In addition, Mr. Winslow fails
to provide a basis for his
[[Continued on page 15543]]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
]
[[pp. 15543-15575]] Disclosure Requirements and Prohibitions Concerning Franchising
[[Continued from page 15542]]
[[Page 15543]]
assertion that the demand for disclosure documents will increase as a
result of the amended Rule. Finally, many franchisors establish and
maintain websites for ordinary business purposes, including advertising
their goods or services and to facilitate communication with the
public. Accordingly, any costs franchisors would incur specifically as
a result of electronic disclosure under part 436 appear to be low.
As set forth in the 2005 Notices, staff estimates that the non-
labor burden incurred by franchisors under part 436 will differ based
on the length of the disclosure document and the number of disclosure
documents produced. Staff estimates that 2,000 franchisors (80% of
total franchisors covered by the Rule) will print 100 disclosure
documents at $35 each. Thus, staff estimates that 80% of covered
franchisors will each incur $3,500 in printing and mailing costs ($35
for printing and mailing x 100 disclosure documents). Staff estimates
that the remaining 20% of franchisors (500) will send 50% of the 100
documents electronically, with a cost of $5 per electronic disclosure.
Thus, staff estimates that 20% of covered franchisors will each incur
$2,000 in distribution costs (($250 for electronic disclosure [$5 for
electronic disclosure x 50 disclosure documents] + $1,750 for printing
and mailing [$35 for printing and mailing x 50 disclosure documents])).
Thus, the cumulative annual hours burden for part 436 of the
amended Rule is approximately 19,500 hours ((32 hours of annual
disclosure burden x 250 new franchisors) + (4 hours of average annual
disclosure burden x 2,250 established franchisors) + (1 hour of annual
recordkeeping burden x 2,500 total business format franchisors)). The
cumulative annual labor costs for part 436 of the amended Rule is
approximately $4,282,500 (($8,000 attorney costs x 250 new franchisors)
+ ($1,000 attorney costs x 2,250 established franchisors) + ($13
clerical costs x 2,500 total business format franchisors)). Finally,
the cumulative annual non-labor costs for part 436 of the amended Rule
is approximately $8,000,000 (($3,500 printing and mailing costs x 2,000
franchisors) + (($250 electronic distribution costs + $1,750 printing
and mailing costs) x 500 franchisors)).
B. Part 437
As noted throughout this document, business opportunities covered
by the original Franchise Rule will remain covered, without any
substantive change, under part 437 of the amended Rule. Part 437 of the
amended Rule imposes no additional disclosures, recordkeeping, or
prohibitions.\975\
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\975\ In April 2006, the Commission published the Business
Opportunity NPR, 71 FR 19054 (Apr. 12, 2006). Among other things,
the proposed Business Opportunity Rule would amend part 437
substantially, reducing the number of disclosures pertaining to
business opportunities. At the same time, the proposed Business
Opportunity Rule would expand part 437 to include a broader array of
business opportunities than covered by the original Franchise Rule.
In response to the business opportunity NPR, the Commission received
over 17,000 comments, many opposing the inclusion of multilevel
marketing companies under the proposed rule. Several comments
specifically questioned the paperwork burdens that might be imposed
by the part 437 amendments. E.g., DSA, Business Opportunity NPR.
Commission staff is currently analyzing the comments. For now,
however, only those businesses opportunities covered by the original
Franchise Rule--such as vending machine and rack display
opportunities--remain covered under part 437.
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Estimated annual hours burden for part 437: 16,750 hours.
The burden estimates for compliance with part 437 will vary
depending on the business opportunity sellers' prior experience with
the Franchise Rule. As set forth in the 2005 Notices, staff estimates
that 250 or so new business opportunity sellers will enter the market
each year, requiring approximately 30 hours each to develop a Rule-
compliant disclosure document. Thus, staff estimates that the
cumulative annual disclosure burden for new business opportunity
sellers will be approximately 7,500 hours (250 new business opportunity
sellers x 30 hours). Staff further estimates that the remaining 2250
established business opportunity sellers will require no more than
approximately 3 hours each to update the disclosure document.
Accordingly, staff estimates that the cumulative annual disclosure
burden for established business opportunity sellers will be
approximately 6,750 hours (2250 established business opportunity
sellers x 3 hours).
Business opportunity sellers may need to maintain additional
documentation for the sale of business opportunities in some states,
which could take up to an additional hour of recordkeeping per year.
Accordingly, staff estimates that business opportunity sellers will
cumulatively incur approximately 2,500 hours of record keeping burden
each year (2,500 business opportunity sellers x 1 hour).
Thus, the total burden for business opportunity sellers is
approximately 16,750 hours ((7,500 hours of disclosure burden for new
business opportunity sellers + 6,750 hours of disclosure burden for
established business opportunity sellers + 2,500 of recordkeeping
burden for all business opportunity sellers)).
Estimated annual labor cost burden for part 437: $3,595,000.
Labor costs are determined by applying applicable wage rates to
associated burden hours. Staff presumes an attorney will prepare or
update the disclosure document at $250 per hour. Accordingly, staff
estimates that business opportunity sellers incur approximately
$3,562,500 in labor costs due to compliance with the Rule's disclosure
requirements ((250 new business opportunity sellers x $250 per hour x
30 hours per business opportunity) + (2,250 established business
opportunity sellers x $250 per hour x 3 hours per business
opportunity)).
Staff anticipates that recordkeeping would be performed by clerical
staff at approximately $13 per hour. At 2,500 hours per year for all
affected business opportunities, this would amount to a total cost of
$32,500 (2,500 hours for recordkeeping x $13 per hour). Thus, the
combined labor costs for recordkeeping and disclosure for business
opportunity sellers is approximately $3,595,000 ($3,562,500 for
disclosures + $32,500 for recordkeeping).
Estimated non-labor cost for part 437: $3,887,500.
Business opportunity sellers must also incur costs to print and
distribute the disclosure document. These costs vary based upon the
length of the disclosures and the number of copies produced to meet the
expected demand. Staff estimates that 2,500 business opportunity
sellers print and mail 100 documents per year at a cost of $15 per
document, for a total cost of $3,750,000 (2,500 business opportunity
sellers x 100 documents per year x $15 per document).
Business opportunity sellers must also complete and disseminate an
FTC-required cover sheet that identifies the business opportunity
seller, the date the document is issued, a table of contents, and a
notice that tracks the language specifically provided in part 437 of
the Rule. Although some of the language in the cover sheet is supplied
by the government for the purpose of disclosure to the public, and is
thus excluded from the definition of ``collection of information''
under the PRA, see 5 CFR 1320.3(c)(2), there are residual costs to
print and mail these cover sheets, including within them the
presentation of related information beyond the supplied text. Staff
estimates that 2,500 business opportunity sellers
[[Page 15544]]
complete and disseminate 100 cover sheets per year at a cost of
approximately $0.55 per cover sheet, or a total cost of approximately
$137,500 (2,500 business opportunity sellers x 100 cover sheets per
year x $0.55 per cover sheet).
Accordingly, the cumulative non-labor cost incurred by business
opportunity sellers each year due to compliance with part 437 will be
approximately $3,887,500 ($3,750,000 for printing and mailing documents
+ $137,500 for completing and mailing cover sheets).
Thus, the cumulative annual hours burden for part 437 of the
amended Rule is approximately 16,750 hours ((30 hours of average annual
disclosure burden x 250 new business opportunity sellers) + (3 hours of
annual disclosure burden x 2,250 established business opportunity
sellers) + (1 hour of annual recordkeeping burden x 2,500 total
business opportunity sellers)). The cumulative annual labor costs for
part 437 of the amended Rule is approximately $3,595,000 (($7,500
attorney costs x 250 new business opportunity sellers) + ($750 attorney
costs x 2,250 established business opportunity sellers) + ($13 clerical
costs x 2,500 total business opportunity sellers)). Finally, the
cumulative annual non-labor costs for part 437 of the amended Rule is
approximately $3,887,500 (($1,500 printing and mailing costs x 2,500
business opportunity sellers) + ($55 cover sheet costs x 2500 business
opportunity sellers)).
List of Subjects in 16 CFR Part 436 and 437
Advertising, Business and industry, Franchising, Trade practices.
VII. FINAL RULE LANGUAGE
0
For the reasons set out in this document, the Commission revises 16 CFR
Part 436 as follows:
PART 436--DISCLOSURE REQUIREMENTS AND PROHIBITIONS CONCERNING
FRANCHISING
Subpart A--Definitions
Sec.
436.1 Definitions.
Subpart B--Franchisor's Obligations
436.2 Obligation to furnish documents.
Subpart C--Contents of a Disclosure Document
436.3 Cover page.
436.4 Table of contents.
436.5 Disclosure items.
Subpart D--Instructions
436.6 Instructions for preparing disclosure documents.
436.7 Instructions for updating disclosures.
Subpart E--Exemptions
436.8 Exemptions.
Subpart F--Prohibitions
436.9 Additional prohibitions.
Subpart G--Other Provisions
436.10 Other laws and rules.
436.11 Severability.
Appendix A to Part 436--Sample Item 10 Table--Summary of Financing
Offered
Appendix B to Part 436--Sample Item 20(1) Table--Systemwide Outlet
Summary
Appendix C to Part 436--Sample Item 20(2) Table --Transfers of
Franchised Outlets
Appendix D to Part 436--Sample Item 20(3) Table--Status of Franchise
Outlets
Appendix E to Part 436--Sample Item 20(4) Table--Status of Company-
Owned Outlets
Appendix F to Part 436--Sample Item 20(5) Table--Projected New
Franchised Outlets
Authority: 15 U.S.C. 41-58.
Subpart A--Definitions
Sec. 436.1 Definitions.
Unless stated otherwise, the following definitions apply throughout
part 436:
(a) Action includes complaints, cross claims, counterclaims, and
third-party complaints in a judicial action or proceeding, and their
equivalents in an administrative action or arbitration.
(b) Affiliate means an entity controlled by, controlling, or under
common control with, another entity.
(c) Confidentiality clause means any contract, order, or settlement
provision that directly or indirectly restricts a current or former
franchisee from discussing his or her personal experience as a
franchisee in the franchisor's system with any prospective franchisee.
It does not include clauses that protect franchisor's trademarks or
other proprietary information.
(d) Disclose, state, describe, and list each mean to present all
material facts accurately, clearly, concisely, and legibly in plain
English.
(e) Financial performance representation means any representation,
including any oral, written, or visual representation, to a prospective
franchisee, including a representation in the general media, that
states, expressly or by implication, a specific level or range of
actual or potential sales, income, gross profits, or net profits. The
term includes a chart, table, or mathematical calculation that shows
possible results based on a combination of variables.
(f) Fiscal year refers to the franchisor's fiscal year.
(g) Fractional franchise means a franchise relationship that
satisfies the following criteria when the relationship is created:
(1) The franchisee, any of the franchisee's current directors or
officers, or any current directors or officers of a parent or
affiliate, has more than two years of experience in the same type of
business; and
(2) The parties have a reasonable basis to anticipate that the
sales arising from the relationship will not exceed 20% of the
franchisee's total dollar volume in sales during the first year of
operation.
(h) Franchise means any continuing commercial relationship or
arrangement, whatever it may be called, in which the terms of the offer
or contract specify, or the franchise seller promises or represents,
orally or in writing, that:
(1) The franchisee will obtain the right to operate a business that
is identified or associated with the franchisor's trademark, or to
offer, sell, or distribute goods, services, or commodities that are
identified or associated with the franchisor's trademark;
(2) The franchisor will exert or has authority to exert a
significant degree of control over the franchisee's method of
operation, or provide significant assistance in the franchisee's method
of operation; and
(3) As a condition of obtaining or commencing operation of the
franchise, the franchisee makes a required payment or commits to make a
required payment to the franchisor or its affiliate.
(i) Franchisee means any person who is granted a franchise.
(j) Franchise seller means a person that offers for sale, sells, or
arranges for the sale of a franchise. It includes the franchisor and
the franchisor's employees, representatives, agents, subfranchisors,
and third-party brokers who are involved in franchise sales activities.
It does not include existing franchisees who sell only their own outlet
and who are otherwise not engaged in franchise sales on behalf of the
franchisor.
(k) Franchisor means any person who grants a franchise and
participates in the franchise relationship. Unless otherwise stated, it
includes subfranchisors. For purposes of this definition, a
``subfranchisor'' means a person who functions as a franchisor by
engaging in both pre-sale activities and post-sale performance.
(l) Leased department means an arrangement whereby a retailer
licenses or otherwise permits a seller to conduct
[[Page 15545]]
business from the retailer's location where the seller purchases no
goods, services, or commodities directly or indirectly from the
retailer, a person the retailer requires the seller to do business
with, or a retailer-affiliate if the retailer advises the seller to do
business with the affiliate.
(m) Parent means an entity that controls another entity directly,
or indirectly through one or more subsidiaries.
(n) Person means any individual, group, association, limited or
general partnership, corporation, or any other entity.
(o) Plain English means the organization of information and
language usage understandable by a person unfamiliar with the franchise
business. It incorporates short sentences; definite, concrete, everyday
language; active voice; and tabular presentation of information, where
possible. It avoids legal jargon, highly technical business terms, and
multiple negatives.
(p) Predecessor means a person from whom the franchisor acquired,
directly or indirectly, the major portion of the franchisor's assets.
(q) Principal business address means the street address of a
person's home office in the United States. A principal business address
cannot be a post office box or private mail drop.
(r) Prospective franchisee means any person (including any agent,
representative, or employee) who approaches or is approached by a
franchise seller to discuss the possible establishment of a franchise
relationship.
(s) Required payment means all consideration that the franchisee
must pay to the franchisor or an affiliate, either by contract or by
practical necessity, as a condition of obtaining or commencing
operation of the franchise. A required payment does not include
payments for the purchase of reasonable amounts of inventory at bona
fide wholesale prices for resale or lease.
(t) Sale of a franchise includes an agreement whereby a person
obtains a franchise from a franchise seller for value by purchase,
license, or otherwise. It does not include extending or renewing an
existing franchise agreement where there has been no interruption in
the franchisee's operation of the business, unless the new agreement
contains terms and conditions that differ materially from the original
agreement. It also does not include the transfer of a franchise by an
existing franchisee where the franchisor has had no significant
involvement with the prospective transferee. A franchisor's approval or
disapproval of a transfer alone is not deemed to be significant
involvement.
(u) Signature means a person's affirmative step to authenticate his
or her identity. It includes a person's handwritten signature, as well
as a person's use of security codes, passwords, electronic signatures,
and similar devices to authenticate his or her identity.
(v) Trademark includes trademarks, service marks, names, logos, and
other commercial symbols.
(w) Written or in writing means any document or information in
printed form or in any form capable of being preserved in tangible form
and read. It includes: type-set, word processed, or handwritten
document; information on computer disk or CD-ROM; information sent via
email; or information posted on the Internet. It does not include mere
oral statements.
Subpart B--Franchisors' Obligations
Sec. 436.2 Obligation to furnish documents.
In connection with the offer or sale of a franchise to be located
in the United States of America or its territories, unless the
transaction is exempted under Subpart E of this part, it is an unfair
or deceptive act or practice in violation of Section 5 of the Federal
Trade Commission Act:
(a) For any franchisor to fail to furnish a prospective franchisee
with a copy of the franchisor's current disclosure document, as
described in Subparts C and D of this part, at least 14 calendar-days
before the prospective franchisee signs a binding agreement with, or
makes any payment to, the franchisor or an affiliate in connection with
the proposed franchise sale.
(b) For any franchisor to alter unilaterally and materially the
terms and conditions of the basic franchise agreement or any related
agreements attached to the disclosure document without furnishing the
prospective franchisee with a copy of each revised agreement at least
seven 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.
(c) For purposes of paragraphs (a) and (b) of this section, the
franchisor has furnished the documents 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.
Subpart C--Contents of a Disclosure Document
Sec. 436.3 Cover page.
Begin the disclosure document with a cover page, in the order and
form as follows:
(a) The title ``FRANCHISE DISCLOSURE DOCUMENT'' in capital letters
and bold type.
(b) The franchisor's name, type of business organization, principal
business address, telephone number, and, if applicable, email address
and primary home page address.
(c) A sample of the primary business trademark that the franchisee
will use in its business.
(d) A brief description of the franchised business.
(e) The following statements:
(1) The total investment necessary to begin operation of a
[franchise system name] franchise is [the total amount of Item 7 (Sec.
436.5(g))]. This includes [the total amount in Item 5 (Sec. 436.5(e))]
that must be paid to the franchisor or affiliate.
(2) This disclosure document summarizes certain provisions of your
franchise agreement and other information in plain English. Read this
disclosure document and all accompanying agreements carefully. You must
receive this disclosure document at least 14 calendar-days before you
sign a binding agreement with, or make any payment to, the franchisor
or an affiliate in connection with the proposed franchise sale. [The
following sentence in bold type] Note, however, that no governmental
agency has verified the information contained in this document.
(3) The terms of your contract will govern your franchise
relationship. Don't rely on the disclosure document alone to understand
your contract. Read all of your contract carefully. Show your contract
and this disclosure document to an advisor, like a lawyer or an
accountant.
(4) Buying a franchise is a complex investment. The information in
this disclosure document can help you make up your mind. More
information on franchising, such as ``A Consumer's Guide to Buying a
Franchise,'' which
[[Page 15546]]
can help you understand how to use this disclosure document, is
available from the Federal Trade Commission. You can contact the FTC at
1-877-FTC-HELP or by writing to the FTC at 600 Pennsylvania Avenue,
NW., Washington, D.C. 20580. You can also visit the FTC's home page at
http://www.ftc.gov for additional information. Call your state agency or visit
your public library for other sources of information on franchising.
(5) There may also be laws on franchising in your state. Ask your
state agencies about them.
(6) [The issuance date].
(f) A franchisor may include the following statement between the
statements set out at paragraphs (e)(2) and (3) of this section: ``You
may wish to receive your disclosure document in another format that is
more convenient for you. To discuss the availability of disclosures in
different formats, contact [name or office] at [address] and [telephone
number].''
(g) Franchisors may include additional disclosures on the cover
page, on a separate cover page, or addendum to comply with state pre-
sale disclosure laws.
Sec. 436.4 Table of contents.
Include the following table of contents. State the page where each
disclosure Item begins. List all exhibits by letter, as shown in the
following example.
Table of Contents
1. The Franchisor and any Parents, Predecessors, and Affiliates
2. Business Experience
3. Litigation
4. Bankruptcy
5. Initial Fees
6. Other Fees
7. Estimated Initial Investment
8. Restrictions on Sources of Products and Services
9. Franchisee's Obligations
10. Financing
11. Franchisor's Assistance, Advertising, Computer Systems, and
Training
12. Territory
13. Trademarks
14. Patents, Copyrights, and Proprietary Information
15. Obligation to Participate in the Actual Operation of the
Franchise Business
16. Restrictions on What the Franchisee May Sell
17. Renewal, Termination, Transfer, and Dispute Resolution
18. Public Figures
19. Financial Performance Representations
20. Outlets and Franchisee Information
21. Financial Statements
22. Contracts
23. Receipts
Exhibits
A. Franchise Agreement
Sec. 436.5 Disclosure items.
(a) Item 1: The Franchisor, and any Parents, Predecessors, and
Affiliates.
Disclose:
(1) The name and principal business address of the franchisor; any
parents; and any affiliates that offer franchises in any line of
business or provide products or services to the franchisees of the
franchisor.
(2) The name and principal business address of any predecessors
during the 10-year period immediately before the close of the
franchisor's most recent fiscal year.
(3) The name that the franchisor uses and any names it intends to
use to conduct business.
(4) The identity and principal business address of the franchisor's
agent for service of process.
(5) The type of business organization used by the franchisor (for
example, corporation, partnership) and the state in which it was
organized.
(6) The following information about the franchisor's business and
the franchises offered:
(i) Whether the franchisor operates businesses of the type being
franchised.
(ii) The franchisor's other business activities.
(iii) The business the franchisee will conduct.
(iv) The general market for the product or service the franchisee
will offer. In describing the general market, consider factors such as
whether the market is developed or developing, whether the goods will
be sold primarily to a certain group, and whether sales are seasonal.
(v) In general terms, any laws or regulations specific to the
industry in which the franchise business operates.
(vi) A general description of the competition.
(7) The prior business experience of the franchisor; any
predecessors listed in Sec. 436.5(a)(2) of this part; and any
affiliates that offer franchises in any line of business or provide
products or services to the franchisees of the franchisor, including:
(i) The length of time each has conducted the type of business the
franchisee will operate.
(ii) The length of time each has offered franchises providing the
type of business the franchisee will operate.
(iii) Whether each has offered franchises in other lines of
business. If so, include:
(A) A description of each other line of business.
(B) The number of franchises sold in each other line of business.
(C) The length of time each has offered franchises in each other
line of business.
(b) Item 2: Business Experience. Disclose by name and position the
franchisor's directors, trustees, general partners, principal officers,
and any other individuals who will have management responsibility
relating to the sale or operation of franchises offered by this
document. For each person listed in this section, state his or her
principal positions and employers during the past five years, including
each position's starting date, ending date, and location.
(c) Item 3: Litigation. (1) Disclose whether the franchisor; a
predecessor; a parent or affiliate who induces franchise sales by
promising to back the franchisor financially or otherwise guarantees
the franchisor's performance; an affiliate who offers franchises under
the franchisor's principal trademark; and any person identified in
Sec. 436.5(b) of this part:
(i) Has pending against that person:
(A) An administrative, criminal, or material civil action alleging
a violation of a franchise, antitrust, or securities law, or alleging
fraud, unfair or deceptive practices, or comparable allegations.
(B) Civil actions, other than ordinary routine litigation
incidental to the business, which are material in the context of the
number of franchisees and the size, nature, or financial condition of
the franchise system or its business operations.
(ii) Was a party to any material civil action involving the
franchise relationship in the last fiscal year. For purposes of this
section, ``franchise relationship'' means contractual obligations
between the franchisor and franchisee directly relating to the
operation of the franchised business (such as royalty payment and
training obligations). It does not include actions involving suppliers
or other third parties, or indemnification for tort liability.
(iii) Has in the 10-year period immediately before the disclosure
document's issuance date:
(A) Been convicted of or pleaded nolo contendere to a felony
charge.
(B) Been held liable in a civil action involving an alleged
violation of a franchise, antitrust, or securities law, or involving
allegations of fraud, unfair or deceptive practices, or comparable
allegations. ``Held liable'' means that, as a result of claims or
counterclaims, the person must pay money or other consideration, must
reduce an indebtedness by the amount of an
[[Page 15547]]
award, cannot enforce its rights, or must take action adverse to its
interests.
(2) Disclose whether the franchisor; a predecessor; a parent or
affiliate who guarantees the franchisor's performance; an affiliate who
has offered or sold franchises in any line of business within the last
10 years; or any other person identified in Sec. 436.5(b) of this part
is subject to a currently effective injunctive or restrictive order or
decree resulting from a pending or concluded action brought by a public
agency and relating to the franchise or to a Federal, State, or
Canadian franchise, securities, antitrust, trade regulation, or trade
practice law.
(3) For each action identified in paragraphs (c)(1) and (2) of this
section, state the title, case number or citation, the initial filing
date, the names of the parties, the forum, and the relationship of the
opposing party to the franchisor (for example, competitor, supplier,
lessor, franchisee, former franchisee, or class of franchisees). Except
as provided in paragraph (c)(4) of this section, summarize the legal
and factual nature of each claim in the action, the relief sought or
obtained, and any conclusions of law or fact.\1\ In addition, state:
---------------------------------------------------------------------------
\1\ Franchisors may include a summary opinion of counsel
concerning any action if counsel consent to use the summary opinion
and the full opinion is attached to the disclosure document.
---------------------------------------------------------------------------
(i) For pending actions, the status of the action.
(ii) For prior actions, the date when the judgment was entered and
any damages or settlement terms.\2\
---------------------------------------------------------------------------
\2\ If a settlement agreement must be disclosed in this Item,
all material settlement terms must be disclosed, whether or not the
agreement is confidential. However, franchisors need not disclose
the terms of confidential settlements entered into before commencing
franchise sales. Further, any franchisor who has historically used
only the Franchise Rule format, or who is new to franchising, need
not disclose confidential settlements entered prior to the effective
date of this Rule.
---------------------------------------------------------------------------
(iii) For injunctive or restrictive orders, the nature, terms, and
conditions of the order or decree.
(iv) For convictions or pleas, the crime or violation, the date of
conviction, and the sentence or penalty imposed.
(4) For any other franchisor-initiated suit identified in paragraph
(c)(1)(ii) of this section, the franchisor may comply with the
requirements of paragraphs (c)(3)(i) through (iv) of this section by
listing individual suits under one common heading that will serve as
the case summary (for example, ``royalty collection suits'').
(d) Item 4: Bankruptcy. (1) Disclose whether the franchisor; any
parent; predecessor; affiliate; officer, or general partner of the
franchisor, or any other individual who will have management
responsibility relating to the sale or operation of franchises offered
by this document, has, during the 10-year period immediately before the
date of this disclosure document:
(i) Filed as debtor (or had filed against it) a petition under the
United States Bankruptcy Code (``Bankruptcy Code'').
(ii) Obtained a discharge of its debts under the Bankruptcy Code.
(iii) Been a principal officer of a company or a general partner in
a partnership that either filed as a debtor (or had filed against it) a
petition under the Bankruptcy Code, or that obtained a discharge of its
debts under the Bankruptcy Code while, or within one year after, the
officer or general partner held the position in the company.
(2) For each bankruptcy, state:
(i) The current name, address, and principal place of business of
the debtor.
(ii) Whether the debtor is the franchisor. If not, state the
relationship of the debtor to the franchisor (for example, affiliate,
officer).
(iii) The date of the original filing and the material facts,
including the bankruptcy court, and the case name and number. If
applicable, state the debtor's discharge date, including discharges
under Chapter 7 and confirmation of any plans of reorganization under
Chapters 11 and 13 of the Bankruptcy Code.
(3) Disclose cases, actions, and other proceedings under the laws
of foreign nations relating to bankruptcy.
(e) Item 5: Initial Fees. Disclose the initial fees and any
conditions under which these fees are refundable. If the initial fees
are not uniform, disclose the range or formula used to calculate the
initial fees paid in the fiscal year before the issuance date and the
factors that determined the amount. For this section, ``initial fees''
means all fees and payments, or commitments to pay, for services or
goods received from the franchisor or any affiliate before the
franchisee's business opens, whether payable in lump sum or
installments. Disclose installment payment terms in this section or in
Sec. 436.5(j) of this part.
(f) Item 6: Other Fees. Disclose, in the following tabular form,
all other fees that the franchisee must pay to the franchisor or its
affiliates, or that the franchisor or its affiliates impose or collect
in whole or in part for a third party. State the title ``OTHER FEES''
in capital letters using bold type. Include any formula used to compute
the fees.\3\
---------------------------------------------------------------------------
\3\ If fees may increase, disclose the formula that determines
the increase or the maximum amount of the increase. For example, a
percentage of gross sales is acceptable if the franchisor defines
the term ``gross sales.''
Item 6 Table
OTHER FEES
------------------------------------------------------------------------
Column 1 Type of Column 3 Due Column 4
fee Column 2 Amount Date Remarks
------------------------------------------------------------------------
................. ................ ................
------------------------------------------------------------------------
(1) In column 1, list the type of fee (for example, royalties, and
fees for lease negotiations, construction, remodeling, additional
training or assistance, advertising, advertising cooperatives,
purchasing cooperatives, audits, accounting, inventory, transfers, and
renewals).
(2) In column 2, state the amount of the fee.
(3) In column 3, state the due date for each fee.
(4) In column 4, include remarks, definitions, or caveats that
elaborate on the information in the table. If remarks are long,
franchisors may use footnotes instead of the remarks column. If
applicable, include the following information in the remarks column or
in a footnote:
(i) Whether the fees are payable only to the franchisor.
(ii) Whether the fees are imposed and collected by the franchisor.
(iii) Whether the fees are non-refundable or describe the
circumstances when the fees are refundable.
(iv) Whether the fees are uniformly imposed.
(v) The voting power of franchisor-owned outlets on any fees
imposed by
[[Page 15548]]
cooperatives. If franchisor-owned outlets have controlling voting
power, disclose the maximum and minimum fees that may be imposed.
(g) Item 7: Estimated Initial Investment. Disclose, in the
following tabular form, the franchisee's estimated initial investment.
State the title ``YOUR ESTIMATED INITIAL INVESTMENT'' in capital
letters using bold type. Franchisors may include additional expenditure
tables to show expenditure variations caused by differences such as in
site location and premises size.
Item 7 Table:
YOUR ESTIMATED INITIAL INVESTMENT
----------------------------------------------------------------------------------------------------------------
Column 4 To whom
Column 1 Type of Column 2 Amount Column 3 Method of Column 4 When due payment is to be
expenditure payment made
----------------------------------------------------------------------------------------------------------------
..................... ..................... ..................... ....................
----------------------------------------------------------------------------------------------------------------
Total. ..................... ..................... ..................... ....................
----------------------------------------------------------------------------------------------------------------
(1) In column 1:
(i) List each type of expense, beginning with pre-opening expenses.
Include the following expenses, if applicable. Use footnotes to include
remarks, definitions, or caveats that elaborate on the information in
the Table.
(A) The initial franchise fee.
(B) Training expenses.
(C) Real property, whether purchased or leased.
(D) Equipment, fixtures, other fixed assets, construction,
remodeling, leasehold improvements, and decorating costs, whether
purchased or leased.
(E) Inventory to begin operating.
(F) Security deposits, utility deposits, business licenses, and
other prepaid expenses.
(ii) List separately and by name any other specific required
payments (for example, additional training, travel, or advertising
expenses) that the franchisee must make to begin operations.
(iii) Include a category titled ``Additional funds-- [initial
period]'' for any other required expenses the franchisee will incur
before operations begin and during the initial period of operations.
State the initial period. A reasonable initial period is at least three
months or a reasonable period for the industry. Describe in general
terms the factors, basis, and experience that the franchisor considered
or relied upon in formulating the amount required for additional funds.
(2) In column 2, state the amount of the payment. If the amount is
unknown, use a low-high range based on the franchisor's current
experience. If real property costs cannot be estimated in a low-high
range, describe the approximate size of the property and building and
the probable location of the building (for example, strip shopping
center, mall, downtown, rural, or highway).
(3) In column 3, state the method of payment.
(4) In column 4, state the due date.
(5) In column 5, state to whom payment will be made.
(6) Total the initial investment, incorporating ranges of fees, if
used.
(7) In a footnote, state:
(i) Whether each payment is non-refundable, or describe the
circumstances when each payment is refundable.
(ii) If the franchisor or an affiliate finances part of the initial
investment, the amount that it will finance, the required down payment,
the annual interest rate, rate factors, and the estimated loan
repayments. Franchisors may refer to Sec. 436.5(j) of this part for
additional details.
(h) Item 8: Restrictions on Sources of Products and Services.
Disclose the franchisee's obligations to purchase or lease goods,
services, supplies, fixtures, equipment, inventory, computer hardware
and software, real estate, or comparable items related to establishing
or operating the franchised business either from the franchisor, its
designee, or suppliers approved by the franchisor, or under the
franchisor's specifications. Include obligations to purchase imposed by
the franchisor's written agreement or by the franchisor's practice.\4\
For each applicable obligation, state:
---------------------------------------------------------------------------
\4\ Franchisors may include the reason for the requirement.
Franchisors need not disclose in this Item the purchase or lease of
goods or services provided as part of the franchise without a
separate charge (such as initial training, if the cost is included
in the franchise fee). Describe such fees in Item 5 of this section.
Do not disclose fees already described in Sec. 436.5(f) of this
part.
---------------------------------------------------------------------------
(1) The good or service required to be purchased or leased.
(2) Whether the franchisor or its affiliates are approved suppliers
or the only approved suppliers of that good or service.
(3) Any supplier in which an officer of the franchisor owns an
interest.
(4) How the franchisor grants and revokes approval of alternative
suppliers, including:
(i) Whether the franchisor's criteria for approving suppliers are
available to franchisees.
(ii) Whether the franchisor permits franchisees to contract with
alternative suppliers who meet the franchisor's criteria.
(iii) Any fees and procedures to secure approval to purchase from
alternative suppliers.
(iv) The time period in which the franchisee will be notified of
approval or disapproval.
(v) How approvals are revoked.
(5) Whether the franchisor issues specifications and standards to
franchisees, subfranchisees, or approved suppliers. If so, describe how
the franchisor issues and modifies specifications.
(6) Whether the franchisor or its affiliates will or may derive
revenue or other material consideration from required purchases or
leases by franchisees. If so, describe the precise basis by which the
franchisor or its affiliates will or may derive that consideration by
stating:
(i) The franchisor's total revenue.\5\
---------------------------------------------------------------------------
\5\ Take figures from the franchisor's most recent annual
audited financial statement required in Sec. 436.5(u) of this part.
If audited statements are not yet required, or if the entity
deriving the income is an affiliate, disclose the sources of
information used in computing revenues.
---------------------------------------------------------------------------
(ii) The franchisor's revenues from all required purchases and
leases of products and services.
(iii) The percentage of the franchisor's total revenues that are
from required purchases or leases.
(iv) If the franchisor's affiliates also sell or lease products or
services to franchisees, the affiliates' revenues from those sales or
leases.
(7) The estimated proportion of these required purchases and leases
by the franchisee to all purchases and leases by the franchisee of
goods and services in establishing and operating the franchised
businesses.
[[Page 15549]]
(8) If a designated supplier will make payments to the franchisor
from franchisee purchases, disclose the basis for the payment (for
example, specify a percentage or a flat amount). For purposes of this
disclosure, a ``payment'' includes the sale of similar goods or
services to the franchisor at a lower price than to franchisees.
(9) The existence of purchasing or distribution cooperatives.
(10) Whether the franchisor negotiates purchase arrangements with
suppliers, including price terms, for the benefit of franchisees.
(11) Whether the franchisor provides material benefits (for
example, renewal or granting additional franchises) to a franchisee
based on a franchisee's purchase of particular products or services or
use of particular suppliers.
(i) Item 9: Franchisee's Obligations. Disclose, in the following
tabular form, a list of the franchisee's principal obligations. State
the title ``FRANCHISEE'S OBLIGATIONS'' in capital letters using bold
type. Cross-reference each listed obligation with any applicable
section of the franchise or other agreement and with the relevant
disclosure document provision. If a particular obligation is not
applicable, state ``Not Applicable.'' Include additional obligations,
as warranted.
Item 9 Table:
FRANCHISEE'S OBLIGATIONS
[In bold] This table lists your principal obligations under the
franchise and other agreements. It will help you find more detailed
information about your obligations in these agreements and in other
items of this disclosure document.
------------------------------------------------------------------------
Section in Disclosure
Obligation agreement document item
------------------------------------------------------------------------
a. Site selection and acquisition/ ................. .................
lease
------------------------------------------------------------------------
b. Pre-opening purchase/leases ................. .................
------------------------------------------------------------------------
c. Site development and other pre- ................. .................
opening requirements
------------------------------------------------------------------------
d. Initial and ongoing training ................. .................
------------------------------------------------------------------------
e. Opening ................. .................
------------------------------------------------------------------------
f. Fees ................. .................
------------------------------------------------------------------------
g. Compliance with standards and ................. .................
policies/operating manual
------------------------------------------------------------------------
h. Trademarks and proprietary ................. .................
information
------------------------------------------------------------------------
i. Restrictions on products/ ................. .................
services offered
------------------------------------------------------------------------
j. Warranty and customer service ................. .................
requirements
------------------------------------------------------------------------
k. Territorial development and ................. .................
sales quotas
------------------------------------------------------------------------
l. Ongoing product/service ................. .................
purchases
------------------------------------------------------------------------
m. Maintenance, appearance, and ................. .................
remodeling requirements
------------------------------------------------------------------------
n. Insurance ................. .................
------------------------------------------------------------------------
o. Advertising ................. .................
------------------------------------------------------------------------
p. Indemnification ................. .................
------------------------------------------------------------------------
q. Owner's participation/ ................. .................
management/staffing
------------------------------------------------------------------------
r. Records and reports ................. .................
------------------------------------------------------------------------
s. Inspections and audits ................. .................
------------------------------------------------------------------------
t. Transfer ................. .................
------------------------------------------------------------------------
u. Renewal ................. .................
------------------------------------------------------------------------
v. Post-termination obligations ................. .................
------------------------------------------------------------------------
w. Non-competition covenants ................. .................
------------------------------------------------------------------------
x. Dispute resolution ................. .................
------------------------------------------------------------------------
y. Other (describe) ................. .................
------------------------------------------------------------------------
------------------------------------------------------------------------
[[Page 15550]]
(j) Item 10: Financing. (1) Disclose the terms of each financing
arrangement, including leases and installment contracts, that the
franchisor, its agent, or affiliates offer directly or indirectly to
the franchisee.\6\ The franchisor may summarize the terms of each
financing arrangement in tabular form, using footnotes to provide
additional information. For a sample Item 10 table, see Appendix A of
this part. For each financing arrangement, state:
---------------------------------------------------------------------------
\6\ Indirect offers of financing include a written arrangement
between a franchisor or its affiliate and a lender, for the lender
to offer financing to a franchisee; an arrangement in which a
franchisor or its affiliate receives a benefit from a lender in
exchange for financing a franchise purchase; and a franchisor's
guarantee of a note, lease, or other obligation of the franchisee.
---------------------------------------------------------------------------
(i) What the financing covers (for example, the initial franchise
fee, site acquisition, construction or remodeling, initial or
replacement equipment or fixtures, opening or ongoing inventory or
supplies, or other continuing expenses).\7\
---------------------------------------------------------------------------
\7\ Include sample copies of the financing documents as an
exhibit to Sec. 436.5(v) of this part. Cite the section and name of
the document containing the financing terms and conditions.
---------------------------------------------------------------------------
(ii) The identity of each lender providing financing and their
relationship to the franchisor (for example, affiliate).
(iii) The amount of financing offered or, if the amount depends on
an actual cost that may vary, the percentage of the cost that will be
financed.
(iv) The rate of interest, plus finance charges, expressed on an
annual basis. If the rate of interest, plus finance charges, expressed
on an annual basis, may differ depending on when the financing is
issued, state what that rate was on a specified recent date.
(v) The number of payments or the period of repayment.
(vi) The nature of any security interest required by the lender.
(vii) Whether a person other than the franchisee must personally
guarantee the debt.
(viii) Whether the debt can be prepaid and the nature of any
prepayment penalty.
(ix) The franchisee's potential liabilities upon default, including
any:
(A) Accelerated obligation to pay the entire amount due;
(B) Obligations to pay court costs and attorney's fees incurred in
collecting the debt;
(C) Termination of the franchise; and
(D) Liabilities from cross defaults such as those resulting
directly from non-payment, or indirectly from the loss of business
property.
(x) Other material financing terms.
(2) Disclose whether the loan agreement requires franchisees to
waive defenses or other legal rights (for example, confession of
judgment), or bars franchisees from asserting a defense against the
lender, the lender's assignee or the franchisor. If so, describe the
relevant provisions.
(3) Disclose whether the franchisor's practice or intent is to
sell, assign, or discount to a third party all or part of the financing
arrangement. If so, state:
(i) The assignment terms, including whether the franchisor will
remain primarily obligated to provide the financed goods or services;
and
(ii) That the franchisee may lose all its defenses against the
lender as a result of the sale or assignment.
(4) Disclose whether the franchisor or an affiliate receives any
consideration for placing financing with the lender. If such payments
exist:
(i) Disclose the amount or the method of determining the payment;
and
(ii) Identify the source of the payment and the relationship of the
source to the franchisor or its affiliates.
(k) Item 11: Franchisor's Assistance, Advertising, Computer
Systems, and Training. Disclose the franchisor's principal assistance
and related obligations of both the franchisor and franchisee as
follows. For each obligation, cite the section number of the franchise
agreement imposing the obligation. Begin by stating the following
sentence in bold type: ``Except as listed below, [the franchisor] is
not required to provide you with any assistance.''
(1) Disclose the franchisor's pre-opening obligations to the
franchisee, including any assistance in:
(i) Locating a site and negotiating the purchase or lease of the
site. If such assistance is provided, state:
(A) Whether the franchisor generally owns the premises and leases
it to the franchisee.
(B) Whether the franchisor selects the site or approves an area in
which the franchisee selects a site. If so, state further whether and
how the franchisor must approve a franchisee-selected site.
(C) The factors that the franchisor considers in selecting or
approving sites (for example, general location and neighborhood,
traffic patterns, parking, size, physical characteristics of existing
buildings, and lease terms).
(D) The time limit for the franchisor to locate or approve or
disapprove the site and the consequences if the franchisor and
franchisee cannot agree on a site.
(ii) Conforming the premises to local ordinances and building codes
and obtaining any required permits.
(iii) Constructing, remodeling, or decorating the premises.
(iv) Hiring and training employees.
(v) Providing for necessary equipment, signs, fixtures, opening
inventory, and supplies. If any such assistance is provided, state:
(A) Whether the franchisor provides these items directly or only
provides the names of approved suppliers.
(B) Whether the franchisor provides written specifications for
these items.
(C) Whether the franchisor delivers or installs these items.
(2) Disclose the typical length of time between the earlier of the
signing of the franchise agreement or the first payment of
consideration for the franchise and the opening of the franchisee's
business. Describe the factors that may affect the time period, such as
ability to obtain a lease, financing or building permits, zoning and
local ordinances, weather conditions, shortages, or delayed
installation of equipment, fixtures, and signs.
(3) Disclose the franchisor's obligations to the franchisee during
the operation of the franchise, including any assistance in:
(i) Developing products or services the franchisee will offer to
its customers.
(ii) Hiring and training employees.
(iii) Improving and developing the franchised business.
(iv) Establishing prices.
(v) Establishing and using administrative, bookkeeping, accounting,
and inventory control procedures.
(vi) Resolving operating problems encountered by the franchisee.
(4) Describe the advertising program for the franchise system,
including the following:
(i)The franchisor's obligation to conduct advertising, including:
(A) The media the franchisor may use.
(B) Whether media coverage is local, regional, or national.
(C) The source of the advertising (for example, an in-house
advertising department or a national or regional advertising agency).
(D) Whether the franchisor must spend any amount on advertising in
the area or territory where the franchisee is located.
(ii) The circumstances when the franchisor will permit franchisees
to use their own advertising material.
(iii) Whether there is an advertising council composed of
franchisees that advises the franchisor on advertising policies. If so,
disclose:
(A) How members of the council are selected.
(B) Whether the council serves in an advisory capacity only or has
operational or decision-making power.
[[Page 15551]]
(C) Whether the franchisor has the power to form, change, or
dissolve the advertising council.
(iv) Whether the franchisee must participate in a local or regional
advertising cooperative. If so, state:
(A) How the area or membership of the cooperative is defined.
(B) How much the franchisee must contribute to the fund and whether
other franchisees must contribute a different amount or at a different
rate.
(C) Whether the franchisor-owned outlets must contribute to the
fund and, if so, whether those contributions are on the same basis as
those for franchisees.
(D) Who is responsible for administering the cooperative (for
example, franchisor, franchisees, or advertising agency).
(E) Whether cooperatives must operate from written governing
documents and whether the documents are available for the franchisee to
review.
(F) Whether cooperatives must prepare annual or periodic financial
statements and whether the statements are available for review by the
franchisee.
(G) Whether the franchisor has the power to require cooperatives to
be formed, changed, dissolved, or merged.
(v) Whether the franchisee must participate in any other
advertising fund. If so, state:
(A) Who contributes to the fund.
(B) How much the franchisee must contribute to the fund and whether
other franchisees must contribute a different amount or at a different
rate.
(C) Whether the franchisor-owned outlets must contribute to the
fund and, if so, whether it is on the same basis as franchisees.
(D) Who administers the fund.
(E) Whether the fund is audited and when it is audited.
(F) Whether financial statements of the fund are available for
review by the franchisee.
(G) How the funds were used in the most recently concluded fiscal
year, including the percentages spent on production, media placement,
administrative expenses, and a description of any other use.
(vi) If not all advertising funds are spent in the fiscal year in
which they accrue, how the franchisor uses the remaining amount,
including whether franchisees receive a periodic accounting of how
advertising fees are spent.
(vii) The percentage of advertising funds, if any, that the
franchisor uses principally to solicit new franchise sales.
(5) Disclose whether the franchisor requires the franchisee to buy
or use electronic cash registers or computer systems. If so, describe
the systems generally in non-technical language, including the types of
data to be generated or stored in these systems, and state the
following:
(i) The cost of purchasing or leasing the systems.
(ii) Any obligation of the franchisor, any affiliate, or third
party to provide ongoing maintenance, repairs, upgrades, or updates.
(iii) Any obligations of the franchisee to upgrade or update any
system during the term of the franchise, and, if so, any contractual
limitations on the frequency and cost of the obligation.
(iv) The annual cost of any optional or required maintenance,
updating, upgrading, or support contracts.
(v) Whether the franchisor will have independent access to the
information that will be generated or stored in any electronic cash
register or computer system. If so, describe the information that the
franchisor may access and whether there are any contractual limitations
on the franchisor's right to access the information.
(6) Disclose the table of contents of the franchisor's operating
manual provided to franchisees as of the franchisor's last fiscal year-
end or a more recent date. State the number of pages devoted to each
subject and the total number of pages in the manual as of this date.
This disclosure may be omitted if the franchisor offers the prospective
franchisee the opportunity to view the manual before buying the
franchise.
(7) Disclose the franchisor's training program as of the
franchisor's last fiscal year-end or a more recent date.
(i) Describe the training program in the following tabular form.
Title the table ``TRAINING PROGRAM'' in capital letters and bold type.
Item 11 Table
TRAINING PROGRAM
------------------------------------------------------------------------
Column 2 Hours Column 3 Hours
Column 1 Subject of Classroom of On-The-Job Column 4
Training Training Location
------------------------------------------------------------------------
................. ................ ................
------------------------------------------------------------------------
(A) In column 1, state the subjects taught.
(B) In column 2, state the hours of classroom training for each
subject.
(C) In column 3, state the hours of on-the-job training for each
subject.
(D) In column 4, state the location of the training for each
subject.
(ii) State further:
(A) How often training classes are held and the nature of the
location or facility where training is held (for example, company,
home, office, franchisor-owned store).
(B) The nature of instructional materials and the instructor's
experience, including the instructor's length of experience in the
field and with the franchisor. State only experience relevant to the
subject taught and the franchisor's operations.
(C) Any charges franchisees must pay for training and who must pay
travel and living expenses of the training program enrollees.
(D) Who may and who must attend training. State whether the
franchisee or other persons must complete the program to the
franchisor's satisfaction. If successful completion is required, state
how long after signing the agreement or before opening the business the
training must be completed. If training is not mandatory, state the
percentage of new franchisees that enrolled in the training program
during the preceding 12 months.
(E) Whether additional training programs or refresher courses are
required.
(l) Item 12: Territory.
Disclose:
(1) Whether the franchise is for a specific location or a location
to be approved by the franchisor.
(2) Any minimum territory granted to the franchisee (for example, a
specific radius, a distance sufficient to encompass a specified
population, or another specific designation).
(3) The conditions under which the franchisor will approve the
relocation of the franchised business or the franchisee's establishment
of additional franchised outlets.
[[Page 15552]]
(4) Franchisee options, rights of first refusal, or similar rights
to acquire additional franchises.
(5) Whether the franchisor grants an exclusive territory.
(i) If the franchisor does not grant an exclusive territory, state:
``You will not receive an exclusive territory. You may face competition
from other franchisees, from outlets that we own, or from other
channels of distribution or competitive brands that we control.''
(ii) If the franchisor grants an exclusive territory, disclose:
(A) Whether continuation of territorial exclusivity depends on
achieving a certain sales volume, market penetration, or other
contingency, and the circumstances when the franchisee's territory may
be altered. Describe any sales or other conditions. State the
franchisor's rights if the franchisee fails to meet the requirements.
(B) Any other circumstances that permit the franchisor to modify
the franchisee's territorial rights (for example, a population increase
in the territory giving the franchisor the right to grant an additional
franchise in the area) and the effect of such modifications on the
franchisee's rights.
(6) For all territories (exclusive and non-exclusive):
(i) Any restrictions on the franchisor from soliciting or accepting
orders from consumers inside the franchisee's territory, including:
(A) Whether the franchisor or an affiliate has used or reserves the
right to use other channels of distribution, such as the Internet,
catalog sales, telemarketing, or other direct marketing sales, to make
sales within the franchisee's territory using the franchisor's
principal trademarks.
(B) Whether the franchisor or an affiliate has used or reserves the
right to use other channels of distribution, such as the Internet,
catalog sales, telemarketing, or other direct marketing, to make sales
within the franchisee's territory of products or services under
trademarks different from the ones the franchisee will use under the
franchise agreement.
(C) Any compensation that the franchisor must pay for soliciting or
accepting orders from inside the franchisee's territory.
(ii) Any restrictions on the franchisee from soliciting or
accepting orders from consumers outside of his or her territory,
including whether the franchisee has the right to use other channels of
distribution, such as the Internet, catalog sales, telemarketing, or
other direct marketing, to make sales outside of his or her territory.
(iii) If the franchisor or an affiliate operates, franchises, or
has plans to operate or franchise a business under a different
trademark and that business sells or will sell goods or services
similar to those the franchisee will offer, describe:
(A) The similar goods and services.
(B) The different trademark.
(C) Whether outlets will be franchisor owned or operated.
(D) Whether the franchisor or its franchisees who use the different
trademark will solicit or accept orders within the franchisee's
territory.
(E) The timetable for the plan.
(F) How the franchisor will resolve conflicts between the
franchisor and franchisees and between the franchisees of each system
regarding territory, customers, and franchisor support.
(G) The principal business address of the franchisor's similar
operating business. If it is the same as the franchisor's principal
business address stated in Sec. 436.5(a) of this part, disclose
whether the franchisor maintains (or plans to maintain) physically
separate offices and training facilities for the similar competing
business.
(m) Item 13: Trademarks. (1) Disclose each principal trademark to
be licensed to the franchisee. For this Item, ``principal trademark''
means the primary trademarks, service marks, names, logos, and
commercial symbols the franchisee will use to identify the franchised
business. It may not include every trademark the franchisor owns.
(2) Disclose whether each principal trademark is registered with
the United States Patent and Trademark Office. If so, state:
(i) The date and identification number of each trademark
registration.
(ii) Whether the franchisor has filed all required affidavits.
(iii) Whether any registration has been renewed.
(iv) Whether the principal trademarks are registered on the
Principal or Supplemental Register of the United States Patent and
Trademark Office.
(3) If the principal trademark is not registered with the United
States Patent and Trademark Office, state whether the franchisor has
filed any trademark application, including any ``intent to use''
application or an application based on actual use. If so, state the
date and identification number of the application.
(4) If the trademark is not registered on the Principal Register of
the United States Patent and Trademark Office, state: ``We do not have
a federal registration for our principal trademark. Therefore, our
trademark does not have many legal benefits and rights as a federally
registered trademark. If our right to use the trademark is challenged,
you may have to change to an alternative trademark, which may increase
your expenses.''
(5) Disclose any currently effective material determinations of the
United States Patent and Trademark Office, the Trademark Trial and
Appeal Board, or any state trademark administrator or court; and any
pending infringement, opposition, or cancellation proceeding. Include
infringement, opposition, or cancellation proceedings in which the
franchisor unsuccessfully sought to prevent registration of a trademark
in order to protect a trademark licensed by the franchisor. Describe
how the determination affects the ownership, use, or licensing of the
trademark.
(6) Disclose any pending material federal or state court litigation
regarding the franchisor's use or ownership rights in a trademark. For
each pending action, disclose:\8\
---------------------------------------------------------------------------
\8\ The franchisor may include an attorney's opinion relative to
the merits of litigation or of an action if the attorney issuing the
opinion consents to its use. The text of the disclosure may include
a summary of the opinion if the full opinion is attached and the
attorney issuing the opinion consents to the use of the summary.
---------------------------------------------------------------------------
(i) The forum and case number.
(ii) The nature of claims made opposing the franchisor's use of the
trademark or by the franchisor opposing another person's use of the
trademark.
(iii) Any effective court or administrative agency ruling in the
matter.
(7) Disclose any currently effective agreements that significantly
limit the franchisor's rights to use or license the use of trademarks
listed in this section in a manner material to the franchise. For each
agreement, disclose:
(i) The manner and extent of the limitation or grant.
(ii) The extent to which the agreement may affect the franchisee.
(iii) The agreement's duration.
(iv) The parties to the agreement.
(v) The circumstances when the agreement may be canceled or
modified.
(vi) All other material terms.
(8) Disclose:
(i) Whether the franchisor must protect the franchisee's right to
use the principal trademarks listed in this section, and must protect
the franchisee against claims of infringement or unfair competition
arising out of the franchisee's use of the trademarks.
(ii) The franchisee's obligation to notify the franchisor of the
use of, or claims of rights to, a trademark identical to or confusingly
similar to a trademark licensed to the franchisee.
(iii) Whether the franchise agreement requires the franchisor to
take
[[Page 15553]]
affirmative action when notified of these uses or claims.
(iv) Whether the franchisor or franchisee has the right to control
any administrative proceedings or litigation involving a trademark
licensed by the franchisor to the franchisee.
(v) Whether the franchise agreement requires the franchisor to
participate in the franchisee's defense and/or indemnify the franchisee
for expenses or damages if the franchisee is a party to an
administrative or judicial proceeding involving a trademark licensed by
the franchisor to the franchisee, or if the proceeding is resolved
unfavorably to the franchisee.
(vi) The franchisee's rights under the franchise agreement if the
franchisor requires the franchisee to modify or discontinue using a
trademark.
(9) Disclose whether the franchisor knows of either superior prior
rights or infringing uses that could materially affect the franchisee's
use of the principal trademarks in the state where the franchised
business will be located. For each use of a principal trademark that
the franchisor believes is an infringement that could materially affect
the franchisee's use of a trademark, disclose:
(i) The nature of the infringement.
(ii) The locations where the infringement is occurring.
(iii) The length of time of the infringement (to the extent known).
(iv) Any action taken or anticipated by the franchisor.
(n) Item 14: Patents, Copyrights, and Proprietary Information. (1)
Disclose whether the franchisor owns rights in, or licenses to, patents
or copyrights that are material to the franchise. Also, disclose
whether the franchisor has any pending patent applications that are
material to the franchise. If so, state:
(i) The nature of the patent, patent application, or copyright and
its relationship to the franchise.
(ii) For each patent:
(A) The duration of the patent.
(B) The type of patent (for example, mechanical, process, or
design).
(C) The patent number, issuance date, and title.
(iii) For each patent application:
(A) The type of patent application (for example, mechanical,
process, or design).
(B) The serial number, filing date, and title.
(iv) For each copyright:
(A) The duration of the copyright.
(B) The registration number and date.
(C) Whether the franchisor can and intends to renew the copyright.
(2) Describe any current material determination of the United
States Patent and Trademark Office, the United States Copyright Office,
or a court regarding the patent or copyright. Include the forum and
matter number. Describe how the determination affects the franchised
business.
(3) State the forum, case number, claims asserted, issues involved,
and effective determinations for any material proceeding pending in the
United States Patent and Trademark Office or any court.\9\
---------------------------------------------------------------------------
\9\ If counsel consents, the franchisor may include a counsel's
opinion or a summary of the opinion if the full opinion is attached.
---------------------------------------------------------------------------
(4) If an agreement limits the use of the patent, patent
application, or copyright, state the parties to and duration of the
agreement, the extent to which the agreement may affect the franchisee,
and other material terms of the agreement.
(5) Disclose the franchisor's obligation to protect the patent,
patent application, or copyright; and to defend the franchisee against
claims arising from the franchisee's use of patented or copyrighted
items, including:
(i) Whether the franchisor's obligation is contingent upon the
franchisee notifying the franchisor of any infringement claims or
whether the franchisee's notification is discretionary.
(ii) Whether the franchise agreement requires the franchisor to
take affirmative action when notified of infringement.
(iii) Who has the right to control any litigation.
(iv) Whether the franchisor must participate in the defense of a
franchisee or indemnify the franchisee for expenses or damages in a
proceeding involving a patent, patent application, or copyright
licensed to the franchisee.
(v) Whether the franchisor's obligation is contingent upon the
franchisee modifying or discontinuing the use of the subject matter
covered by the patent or copyright.
(vi) The franchisee's rights under the franchise agreement if the
franchisor requires the franchisee to modify or discontinue using the
subject matter covered by the patent or copyright.
(6) If the franchisor knows of any patent or copyright infringement
that could materially affect the franchisee, disclose:
(i) The nature of the infringement.
(ii) The locations where the infringement is occurring.
(iii) The length of time of the infringement (to the extent known).
(iv) Any action taken or anticipated by the franchisor.
(7) If the franchisor claims proprietary rights in other
confidential information or trade secrets, describe in general terms
the proprietary information communicated to the franchisee and the
terms for use by the franchisee. The franchisor need only describe the
general nature of the proprietary information, such as whether a
formula or recipe is considered to be a trade secret.
(o) Item 15: Obligation to Participate in the Actual Operation of
the Franchise Business. (1) Disclose the franchisee's obligation to
participate personally in the direct operation of the franchisee's
business and whether the franchisor recommends participation. Include
obligations arising from any written agreement or from the franchisor's
practice.
(2) If personal ``on-premises'' supervision is not required,
disclose the following:
(i) If the franchisee is an individual, whether the franchisor
recommends on-premises supervision by the franchisee.
(ii) Limits on whom the franchisee can hire as an on-premises
supervisor.
(iii) Whether an on-premises supervisor must successfully complete
the franchisor's training program.
(iv) If the franchisee is a business entity, the amount of equity
interest, if any, that the on-premises supervisor must have in the
franchisee's business.
(3) Disclose any restrictions that the franchisee must place on its
manager (for example, maintain trade secrets, covenants not to
compete).
(p) Item 16: Restrictions on What the Franchisee May Sell. Disclose
any franchisor-imposed restrictions or conditions on the goods or
services that the franchisee may sell or that limit access to
customers, including:
(1) Any obligation on the franchisee to sell only goods or services
approved by
the franchisor.
(2) Any obligation on the franchisee to sell all goods or services
authorized by
the franchisor.
(3) Whether the franchisor has the right to change the types of
authorized goods or services and whether there are limits on the
franchisor's right to make changes.
(q) Item 17: Renewal, Termination, Transfer, and Dispute
Resolution. Disclose, in the following tabular form, a table that
cross-references each enumerated franchise relationship item with the
applicable provision in the franchise or related agreement. Title the
table ``THE FRANCHISE RELATIONSHIP'' in capital letters and bold type.
(1) Describe briefly each contractual provision. If a particular
item is not applicable, state ``Not Applicable.''
(2) If the agreement is silent about one of the listed provisions,
but the
[[Page 15554]]
franchisor unilaterally offers to provide certain benefits or
protections to franchisees as a matter of policy, use a footnote to
describe the policy and state whether the policy is subject to change.
(3) In the summary column for Item 17(c), state what the term
``renewal'' means for your franchise system, including, if applicable,
a statement that franchisees may be asked to sign a contract with
materially different terms and conditions than their original contract.
Item 17 Table:
THE FRANCHISE RELATIONSHIP
[In bold] This table lists certain important provisions of the franchise and related agreements. You should read
these provisions in the agreements attached to this disclosure document.
----------------------------------------------------------------------------------------------------------------
Section in franchise or
Provision other agreement Summary
----------------------------------------------------------------------------------------------------------------
a. Length of the franchise term ............................ ............................
----------------------------------------------------------------------------------------------------------------
b. Renewal or extension of the term ............................ ............................
----------------------------------------------------------------------------------------------------------------
c. Requirements for franchisee to renew or extend ............................ ............................
----------------------------------------------------------------------------------------------------------------
d. Termination by franchisee ............................ ............................
----------------------------------------------------------------------------------------------------------------
e. Termination by franchisor without cause ............................ ............................
----------------------------------------------------------------------------------------------------------------
f. Termination by franchisor with cause ............................ ............................
----------------------------------------------------------------------------------------------------------------
g. ``Cause'' defined--curable defaults ............................ ............................
----------------------------------------------------------------------------------------------------------------
h. ``Cause'' defined--non-curable defaults ............................ ............................
----------------------------------------------------------------------------------------------------------------
i. Franchisee's obligations on termination/non- ............................ ............................
renewal
----------------------------------------------------------------------------------------------------------------
j. Assignment of contract by franchisor ............................ ............................
----------------------------------------------------------------------------------------------------------------
k. ``Transfer'' by franchisee--defined ............................ ............................
----------------------------------------------------------------------------------------------------------------
l. Franchisor approval of transfer by franchisee ............................ ............................
----------------------------------------------------------------------------------------------------------------
m. Conditions for franchisor approval of transfer ............................ ............................
----------------------------------------------------------------------------------------------------------------
n. Franchisor's right of first refusal to acquire ............................ ............................
franchisee's business
----------------------------------------------------------------------------------------------------------------
o. Franchisor's option to purchase franchisee's ............................ ............................
business
----------------------------------------------------------------------------------------------------------------
p. Death or disability of franchisee ............................ ............................
----------------------------------------------------------------------------------------------------------------
q. Non-competition covenants during the term of the ............................ ............................
franchise
----------------------------------------------------------------------------------------------------------------
r. Non-competition covenants after the franchise is ............................ ............................
terminated or expires
----------------------------------------------------------------------------------------------------------------
s. Modification of the agreement ............................ ............................
----------------------------------------------------------------------------------------------------------------
t. Integration/merger clause ............................ ............................
----------------------------------------------------------------------------------------------------------------
u. Dispute resolution by arbitration or mediation ............................ ............................
----------------------------------------------------------------------------------------------------------------
v. Choice of forum ............................ ............................
----------------------------------------------------------------------------------------------------------------
w. Choice of law ............................ ............................
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
(r) Item 18: Public Figures.
Disclose:
(1) Any compensation or other benefit given or promised to a public
figure arising from either the use of the public figure in the
franchise name or symbol, or the public figure's endorsement or
recommendation of the franchise to prospective franchisees.
(2) The extent to which the public figure is involved in the
management or control of the franchisor. Describe the public figure's
position and duties in the franchisor's business structure.
(3) The public figure's total investment in the franchisor,
including the amount the public figure contributed in services
performed or to be performed. State the type of investment (for
example, common stock, promissory note).
(4) For purposes of this section, a public figure means a person
whose name or physical appearance is generally known to the public in
the geographic area where the franchise will be located.
(s) Item 19: Financial Performance Representations.
(1) Begin by stating the following:
The FTC's Franchise Rule permits a franchisor to provide
information about the actual or potential financial performance of
its franchised and/or franchisor-owned outlets, if there is a
reasonable basis for the information, and if the information is
included in the
[[Page 15555]]
disclosure document. Financial performance information that differs
from that included in Item 19 may be given only if: (1) a franchisor
provides the actual records of an existing outlet you are
considering buying; or (2) a franchisor supplements the information
provided in this Item 19, for example, by providing information
about possible performance at a particular location or under
particular circumstances.
(2) If a franchisor does not provide any financial performance
representation in Item 19, also state:
We do not make any representations about a franchisee's future
financial performance or the past financial performance of company-
owned or franchised outlets. We also do not authorize our employees
or representatives to make any such representations either orally or
in writing. If you are purchasing an existing outlet, however, we
may provide you with the actual records of that outlet. If you
receive any other financial performance information or projections
of your future income, you should report it to the franchisor's
management by contacting [name, address, and telephone number], the
Federal Trade Commission, and the appropriate state regulatory
agencies.
(3) If the franchisor makes any financial performance
representation to prospective franchisees, the franchisor must have a
reasonable basis and written substantiation for the representation at
the time the representation is made and must state the representation
in the Item 19 disclosure. The franchisor must also disclose the
following:
(i) Whether the representation is an historic financial performance
representation about the franchise system's existing outlets, or a
subset of those outlets, or is a forecast of the prospective
franchisee's future financial performance.
(ii) If the representation relates to past performance of the
franchise system's existing outlets, the material bases for the
representation, including:
(A) Whether the representation relates to the performance of all of
the franchise system's existing outlets or only to a subset of outlets
that share a particular set of characteristics (for example, geographic
location, type of location (such as free standing vs. shopping center),
degree of competition, length of time the outlets have operated,
services or goods sold, services supplied by the franchisor, and
whether the outlets are franchised or franchisor-owned or operated).
(B) The dates when the reported level of financial performance was
achieved.
(C) The total number of outlets that existed in the relevant period
and, if different, the number of outlets that had the described
characteristics.
(D) The number of outlets with the described characteristics whose
actual financial performance data were used in arriving at the
representation.
(E) Of those outlets whose data were used in arriving at the
representation, the number and percent that actually attained or
surpassed the stated results.
(F) Characteristics of the included outlets, such as those
characteristics noted in paragraph (3)(ii)(A) of this section, that may
differ materially from those of the outlet that may be offered to a
prospective franchisee.
(iii) If the representation is a forecast of future financial
performance, state the material bases and assumptions on which the
projection is based. The material assumptions underlying a forecast
include significant factors upon which a franchisee's future results
are expected to depend. These factors include, for example, economic or
market conditions that are basic to a franchisee's operation, and
encompass matters affecting, among other things, a franchisee's sales,
the cost of goods or services sold, and operating expenses.
(iv) A clear and conspicuous admonition that a new franchisee's
individual financial results may differ from the result stated in the
financial performance representation.
(v) A statement that written substantiation for the financial
performance representation will be made available to the prospective
franchisee upon reasonable request.
(4) If a franchisor wishes to disclose only the actual operating
results for a specific outlet being offered for sale, it need not
comply with this section, provided the information is given only to
potential purchasers of that outlet.
(5) If a franchisor furnishes financial performance information
according to this section, the franchisor may deliver to a prospective
franchisee a supplemental financial performance representation about a
particular location or variation, apart from the disclosure document.
The supplemental representation must:
(i) Be in writing.
(ii) Explain the departure from the financial performance
representation in the disclosure document.
(iii) Be prepared in accordance with the requirements of paragraph
(s)(3)(i)-(iv) of this section.
(iv) Be furnished to the prospective franchisee.
(t) Item 20: Outlets and Franchisee Information. (1) Disclose, in
the following tabular form, the total number of franchised and company-
owned outlets for each of the franchisor's last three fiscal years. For
purposes of this section, ``outlet'' includes outlets of a type
substantially similar to that offered to the prospective franchisee. A
sample Item 20(1) Table is attached as Appendix B to this part.
Item 20 Table No. 1
Systemwide Outlet Summary
For years [ ] to [ ]
----------------------------------------------------------------------------------------------------------------
Column 3 Outlets at Column 4 Outlets at
Column 1 Outlet Type Column 2 Year the Start of the Year the End of the Year Column 5 Net Change
----------------------------------------------------------------------------------------------------------------
Franchised 2004 ..................... ..................... ....................
------------------------------------------------------------------------------------------
2005 ..................... ..................... ....................
------------------------------------------------------------------------------------------
2006 ..................... ..................... ....................
----------------------------------------------------------------------------------------------------------------
Company-Owned 2004 ..................... ..................... ....................
------------------------------------------------------------------------------------------
2005 ..................... ..................... ....................
------------------------------------------------------------------------------------------
2006 ..................... ..................... ....................
----------------------------------------------------------------------------------------------------------------
[[Page 15556]]
Total Outlets 2004 ..................... ..................... ....................
------------------------------------------------------------------------------------------
2005 ..................... ..................... ....................
------------------------------------------------------------------------------------------
2006 ..................... ..................... ....................
----------------------------------------------------------------------------------------------------------------
(i) In column 1, include three outlet categories titled
``franchised,'' ``company-owned, and ``total outlets.''
(ii) In column 2, state the last three fiscal years.
(iii) In column 3, state the total number of each type of outlet
operating at the beginning of each fiscal year.
(iv) In column 4, state the total number of each type of outlet
operating at the end of each fiscal year.
(v) In column 5, state the net change, and indicate whether the
change is positive or negative, for each type of outlet during each
fiscal year.
(2) Disclose, in the following tabular form, the number of
franchised and company-owned outlets and changes in the number and
ownership of outlets located in each state during each of the last
three fiscal years. Except as noted, each change in ownership shall be
reported only once in the following tables. If multiple events occurred
in the process of transferring ownership of an outlet, report the event
that occurred last in time. If a single outlet changed ownership two or
more times during the same fiscal year, use footnotes to describe the
types of changes involved and the order in which the changes occurred.
(i) Disclose, in the following tabular form, the total number of
franchised outlets transferred in each state during each of the
franchisor's last three fiscal years. For purposes of this section,
``transfer'' means the acquisition of a controlling interest in a
franchised outlet, during its term, by a person other than the
franchisor or an affiliate. A sample Item 20(2) Table is attached as
Appendix C to this part.
Item 20 Table No. 2
Transfers of Outlets from Franchisees to New Owners (other than the
Franchisor)
For years [ ] to [ ]
------------------------------------------------------------------------
Column 3 Number of
Column 1 State Column 2 Year Transfers
------------------------------------------------------------------------
2004 ......................
------------------------------------------------
2005 ......................
------------------------------------------------
2006 ......................
------------------------------------------------------------------------
2004 ......................
------------------------------------------------
2005 ......................
------------------------------------------------
2006 ......................
------------------------------------------------------------------------
Total 2004 ......................
------------------------------------------------
2005 ......................
------------------------------------------------
2006 ......................
------------------------------------------------------------------------
(A) In column 1, list each state with one or more franchised
outlets.
(B) In column 2, state the last three fiscal years.
(C) In column 3, state the total number of completed transfers in
each state during each fiscal year.
(ii) Disclose, in the following tabular form, the status of
franchisee-owned outlets located in each state for each of the
franchisor's last three fiscal years. A sample Item 20(3) Table is
attached as Appendix D to this part.
[[Page 15557]]
Item 20 Table No. 3
Status of Franchised Outlets
For years [ ] to [ ]
----------------------------------------------------------------------------------------------------------------
Column 3 Column 7 Column 8 Column 9
Column 1 Column 2 Outlets at Column 4 Column 5 Column 6 Reacquired Ceased Outlets
State Year Start of Outlets Terminations Non- by Operations- at End of
Year Opened Renewals Franchisor Other Reasons the Year
----------------------------------------------------------------------------------------------------------------
2004 .......... .......... .............. .......... ............ ............. .........
------------
2005 .......... .......... .............. .......... ............ ............. .........
------------
2006 .......... .......... .............. .......... ............ ............. .........
----------------------------------------------------------------------------------------------------------------
2004 .......... .......... .............. .......... ............ ............. .........
------------
2005 .......... .......... .............. .......... ............ ............. .........
------------
2006 .......... .......... .............. .......... ............ ............. .........
----------------------------------------------------------------------------------------------------------------
Totals 2004 .......... .......... .............. .......... ............ ............. .........
------------------------------------------------------------------------------------------------------
2005 .......... .......... .............. .......... ............ ............. .........
------------------------------------------------------------------------------------------------------
2006 .......... .......... .............. .......... ............ ............. .........
----------------------------------------------------------------------------------------------------------------
(A) In column 1, list each state with one or more franchised
outlets.
(B) In column 2, state the last three fiscal years.
(C) In column 3, state the total number of franchised outlets in
each state at the start of each fiscal year.
(D) In column 4, state the total number of franchised outlets
opened in each state during each fiscal year. Include both new outlets
and existing company-owned outlets that a franchisee purchased from the
franchisor. (Also report the number of existing company-owned outlets
that are sold to a franchisee in Column 7 of Table 4).
(E) In column 5, state the total number of franchised outlets that
were terminated in each state during each fiscal year. For purposes of
this section, ``termination'' means the franchisor's termination of a
franchise agreement prior to the end of its term and without providing
any consideration to the franchisee (whether by payment or forgiveness
or assumption of debt).
(F) In column 6, state the total number of non-renewals in each
state during each fiscal year. For purposes of this section, ``non-
renewal'' occurs when the franchise agreement for a franchised outlet
is not renewed at the end of its term.
(G) In column 7, state the total number of franchised outlets
reacquired by the franchisor in each state during each fiscal year. For
purposes of this section, a ``reacquisition'' means the franchisor's
acquisition for consideration (whether by payment or forgiveness or
assumption of debt) of a franchised outlet during its term. (Also
report franchised outlets reacquired by the franchisor in column 5 of
Table 4).
(H) In column 8, state the total number of outlets in each state
not operating as one of the franchisor's outlets at the end of each
fiscal year for reasons other than termination, non-renewal, or
reacquisition by the franchisor.
(I) In column 9, state the total number of franchised outlets in
each state at the end of the fiscal year.
(iii) Disclose, in the following tabular form, the status of
company-owned outlets located in each state for each of the
franchisor's last three fiscal years. A sample Item 20(4) Table is
attached as Appendix E to this part.
Item 20 Table No. 4
Status of Company-Owned Outlets
For years [ ] to [ ]
----------------------------------------------------------------------------------------------------------------
Column 3 Column 5 Column 8
Column 1 Column 2 Outlets at Column 4 Outlets Column 6 Column 7 Outlets at
State Year Start of Outlets Reacquired From Outlets Outlets Sold End of the
Year Opened Franchisee Closed to Franchisee Year
----------------------------------------------------------------------------------------------------------------
2004 ............ ............ ............... ............ .............. ...........
----------------------------------------------------------------------------------------------------
2005 ............ ............ ............... ............ .............. ...........
----------------------------------------------------------------------------------------------------
2006 ............ ............ ............... ............ .............. ...........
----------------------------------------------------------------------------------------------------------------
2004 ............ ............ ............... ............ .............. ...........
----------------------------------------------------------------------------------------------------
2005 ............ ............ ............... ............ .............. ...........
----------------------------------------------------------------------------------------------------
2006 ............ ............ ............... ............ .............. ...........
----------------------------------------------------------------------------------------------------------------
Totals 2004 ............ ............ ............... ............ .............. ...........
----------------------------------------------------------------------------------------------------
[[Page 15558]]
2005 ............ ............ ............... ............ .............. ...........
----------------------------------------------------------------------------------------------------
2006 ............ ............ ............... ............ .............. ...........
----------------------------------------------------------------------------------------------------------------
(A) In column 1, list each state with one or more company-owned
outlets.
(B) In column 2, state the last three fiscal years.
(C) In column 3, state the total number of company-owned outlets in
each state at the start of the fiscal year.
(D) In column 4, state the total number of company-owned outlets
opened in each state during each fiscal year.
(E) In column 5, state the total number of franchised outlets
reacquired from franchisees in each state during each fiscal year.
(F) In column 6, state the total number of company-owned outlets
closed in each state during each fiscal year. Include both actual
closures and instances when an outlet ceases to operate under the
franchisor's trademark.
(G) In column 7, state the total number of company-owned outlets
sold to franchisees in each state during each fiscal year.
(H) In column 8, state the total number of company-owned outlets
operating in each state at the end of each fiscal year.
(3) Disclose, in the following tabular form, projected new
franchised and company-owned outlets. A sample Item 20(5) Table is
attached as Appendix F to this part.
Item 20 Table No. 5
Projected Openings As Of [Last Day of Last Fiscal Year]
------------------------------------------------------------------------
Column 2 Column 3 Column 4
Franchise Projected New Projected New
Column 1 State Agreements Signed Franchised Company-Owned
But Outlet Not Outlet In The Outlet In the
Opened Next Fiscal Year Next Fiscal Year
------------------------------------------------------------------------
................. ................ ................
------------------------------------------------------------------------
................. ................ ................
------------------------------------------------------------------------
Total ................. ................ ................
------------------------------------------------------------------------
(i) In column 1, list each state where one or more franchised or
company-owned outlets are located or are projected to be located.
(ii) In column 2, state the total number of franchise agreements
that had been signed for new outlets to be located in each state as of
the end of the previous fiscal year where the outlet had not yet
opened.
(iii) In column 3, state the total number of new franchised outlets
in each state projected to be opened during the next fiscal year.
(iv) In column 4, state the total number of new company-owned
outlets in each state that are projected to be opened during the next
fiscal year.
(4) Disclose the names of all current franchisees and the address
and telephone number of each of their outlets. Alternatively, disclose
this information for all franchised outlets in the state, but if these
franchised outlets total fewer than 100, disclose this information for
franchised outlets from contiguous states and then the next closest
states until at least 100 franchised outlets are listed.
(5) Disclose the name, city and state, and current business
telephone number, or if unknown, the last known home telephone number
of every franchisee who had an outlet terminated, canceled, not
renewed, or otherwise voluntarily or involuntarily ceased to do
business under the franchise agreement during the most recently
completed fiscal year or who has not communicated with the franchisor
within 10 weeks of the disclosure document issuance date.\10\ State in
immediate conjunction with this information: ``If you buy this
franchise, your contact information may be disclosed to other buyers
when you leave the franchise system.''
---------------------------------------------------------------------------
\10\ Franchisors may substitute alternative contact information
at the request of the former franchisee, such as a home address,
post office address, or a personal or business email address.
---------------------------------------------------------------------------
(6) If a franchisor is selling a previously-owned franchised outlet
now under its control, disclose the following additional information
for that outlet for the last five fiscal years. This information may be
attached as an addendum to a disclosure document, or, if disclosure has
already been made, then in a supplement to the previously furnished
disclosure document.
(i) The name, city and state, current business telephone number, or
if unknown, last known home telephone number of each previous owner of
the outlet;
(ii) The time period when each previous owner controlled the
outlet;
(iii) The reason for each previous change in ownership (for
example, termination, non-renewal, voluntary transfer, ceased
operations); and
(iv) The time period(s) when the franchisor retained control of the
outlet (for example, after termination, non-renewal, or reacquisition).
(7) Disclose whether franchisees signed confidentiality clauses
during the last three fiscal years. If so, state the following: ``In
some instances, current and former franchisees sign provisions
restricting their ability to speak openly about their experience with
[name of franchise system]. You may wish to
[[Page 15559]]
speak with current and former franchisees, but be aware that not all
such franchisees will be able to communicate with you.'' Franchisors
may also disclose the number and percentage of current and former
franchisees who during each of the last three fiscal years signed
agreements that include confidentiality clauses and may disclose the
circumstances under which such clauses were signed.
(8) Disclose, to the extent known, the name, address, telephone
number, email address, and Web address (to the extent known) of each
trademark-specific franchisee organization associated with the
franchise system being offered, if such organization:
(i) Has been created, sponsored, or endorsed by the franchisor. If
so, state the relationship between the organization and the franchisor
(for example, the organization was created by the franchisor, sponsored
by the franchisor, or endorsed by the franchisor).
(ii) Is incorporated or otherwise organized under state law and
asks the franchisor to be included in the franchisor's disclosure
document during the next fiscal year. Such organizations must renew
their request on an annual basis by submitting a request no later than
60 days after the close of the franchisor's fiscal year. The franchisor
has no obligation to verify the organization's continued existence at
the end of each fiscal year. Franchisors may also include the following
statement: ``The following independent franchisee organizations have
asked to be included in this disclosure document.''
(u) Item 21: Financial Statements. (1) Include the following
financial statements prepared according to United States generally
accepted accounting principles, as revised by any future United States
government mandated accounting principles, or as permitted by the
Securities and Exchange Commission. Except as provided in paragraph
(u)(2) of this section, these financial statements must be audited by
an independent certified public accountant using generally accepted
United States auditing standards. Present the required financial
statements in a tabular form that compares at least two fiscal years.
(i) The franchisor's balance sheet for the previous two fiscal
year-ends before the disclosure document issuance date.
(ii) Statements of operations, stockholders equity, and cash flows
for each of the franchisor's previous three fiscal years.
(iii) Instead of the financial disclosures required by paragraphs
(u)(1)(i) and (ii) of this section, the franchisor may include
financial statements of any of its affiliates if the affiliate's
financial statements satisfy paragraphs (u)(1)(i) and (ii) of this
section and the affiliate absolutely and unconditionally guarantees to
assume the duties and obligations of the franchisor under the franchise
agreement. The affiliate's guarantee must cover all of the franchisor's
obligations to the franchisee, but need not extend to third parties. If
this alternative is used, attach a copy of the guarantee to the
disclosure document.
(iv) When a franchisor owns a direct or beneficial controlling
financial interest in a subsidiary, its financial statements should
reflect the financial condition of the franchisor and its subsidiary.
(v) Include separate financial statements for the franchisor and
any subfranchisor, as well as for any parent that commits to perform
post-sale obligations for the franchisor or guarantees the franchisor's
obligations. Attach a copy of any guarantee to the disclosure document.
(2) A start-up franchise system that does not yet have audited
financial statements may phase-in the use of audited financial
statements by providing, at a minimum, the following statements at the
indicated times:
(i) The franchisor' first partial An unaudited opening balance sheet.
or full fiscal year selling
franchises.
------------------------------------------------------------------------
(ii) The franchisor' second fiscal Audited balance sheet opinion as of
year selling franchises. the end of the first partial or
full fiscal year selling
franchises.
------------------------------------------------------------------------
(iii) The franchisor' third and All required financial statements
subsequent fiscal years selling for the previous fiscal year, plus
franchises. any previously disclosed audited
statements that still must be
disclosed according to paragraphs
(u)(1)(i) and (ii) of this
section.
------------------------------------------------------------------------
(iv) Start-up franchisors may phase-in the disclosure of audited
financial statements, provided the franchisor:
(A) Prepares audited financial statements as soon as practicable.
(B) Prepares unaudited statements in a format that conforms as
closely as possible to audited statements.
(C) Includes one or more years of unaudited financial statements or
clearly and conspicuously discloses in this section that the franchisor
has not been in business for three years or more, and cannot include
all financial statements required in paragraphs (u)(1)(i) and (ii) of
this section.
(v) Item 22: Contracts. Attach a copy of all proposed agreements
regarding the franchise offering, including the franchise agreement and
any lease, options, and purchase agreements.
(w) Item 23: Receipts. Include two copies of the following
detachable acknowledgment of receipt in the following form as the last
pages of the disclosure document:
(1) State the following:
Receipt
This disclosure document summarizes certain provisions of the
franchise agreement and other information in plain language. Read
this disclosure document and all agreements carefully.
If [name of franchisor] offers you a franchise, it must provide
this disclosure document to you 14 calendar-days before you sign a
binding agreement with, or make a payment to, the franchisor or an
affiliate in connection with the proposed franchise sale.
If [name of franchisor] does not deliver this disclosure
document on time or if it contains a false or misleading statement,
or a material omission, a violation of federal law and state law may
have occurred and should be reported to the Federal Trade
Commission, Washington, D.C. 20580 and [state agency].
(2) Disclose the name, principal business address, and telephone
number of each franchise seller offering the franchise.
(3) State the issuance date.
(4) If not disclosed in paragraph (a) of this section, state the
name and address of the franchisor's registered agent authorized to
receive service of process.
(5) State the following:
I received a disclosure document dated ---------- that included
the following Exhibits:
(6) List the title(s) of all attached Exhibits.
(7) Provide space for the prospective franchisee's signature and
date.
(8) Franchisors may include any specific instructions for returning
the receipt (for example, street address, email address, facsimile
telephone number).
[[Page 15560]]
Subpart D--Instructions
Sec. 436.6 Instructions for preparing disclosure documents.
(a) It is an unfair or deceptive act or practice in violation of
Section 5 of the FTC Act for any franchisor to fail to include the
information and follow the instructions for preparing disclosure
documents set forth in Subpart C (basic disclosure requirements) and
Subpart D (updating requirements) of part 436. The Commission will
enforce this provision according to the standards of liability under
Sections 5, 13(b), and 19 of the FTC Act.
(b) Disclose all required information clearly, legibly, and
concisely in a single document using plain English. The disclosures
must be in a form that permits each prospective franchisee to store,
download, print, or otherwise maintain the document for future
reference.
(c) Respond fully to each disclosure Item. If a disclosure Item is
not applicable, respond negatively, including a reference to the type
of information required to be disclosed by the Item. Precede each
disclosure Item with the appropriate heading.
(d) Do not include any materials or information other than those
required or permitted by part 436 or by state law not preempted by part
436. For the sole purpose of enhancing the prospective franchisee's
ability to maneuver through an electronic version of a disclosure
document, the franchisor may include scroll bars, internal links, and
search features. All other features (e.g., multimedia tools such as
audio, video, animation, pop-up screens, or links to external
information) are prohibited.
(e) Franchisors may prepare multi-state disclosure documents by
including non-preempted, state-specific information in the text of the
disclosure document or in Exhibits attached to the disclosure document.
(f) Subfranchisors shall disclose the required information about
the franchisor, and, to the extent applicable, the same information
concerning the subfranchisor.
(g) Before furnishing a disclosure document, the franchisor shall
advise the prospective franchisee of the formats in which the
disclosure document is made available, any prerequisites for obtaining
the disclosure document in a particular format, and any conditions
necessary for reviewing the disclosure document in a particular format.
(h) Franchisors shall retain, and make available to the Commission
upon request, a sample copy of each materially different version of
their disclosure documents for three years after the close of the
fiscal year when it was last used.
(i) For each completed franchise sale, franchisors shall retain a
copy of the signed receipt for at least three years.
Sec. 436.7 Instructions for updating disclosures.
(a) All information in the disclosure document shall be current as
of the close of the franchisor's most recent fiscal year. After the
close of the fiscal year, the franchisor shall, within 120 days,
prepare a revised disclosure document, after which a franchise seller
may distribute only the revised document and no other disclosure
document.
(b) The franchisor shall, within a reasonable time after the close
of each quarter of the fiscal year, prepare revisions to be attached to
the disclosure document to reflect any material change to the
disclosures included, or required to be included, in the disclosure
document. Each prospective franchisee shall receive the disclosure
document and the quarterly revisions for the most recent period
available at the time of disclosure.
(c) If applicable, the annual update shall include the franchisor's
first quarterly update, either by incorporating the quarterly update
information into the disclosure document itself, or through an
addendum.
(d) When furnishing a disclosure document, the franchise seller
shall notify the prospective franchisee of any material changes that
the seller knows or should have known occurred in the information
contained in any financial performance representation made in Item 19
(section 436.5(s)).
(e) Information that must be audited pursuant to Sec. 436.5(u) of
this part need not be audited for quarterly revisions; provided,
however, that the franchisor states in immediate conjunction with the
information that such information was not audited.
Subpart E--Exemptions
Sec. 436.8 Exemptions.
(a) The provisions of part 436 shall not apply if the franchisor
can establish any of the following:
(1) The total of the required payments, or commitments to make a
required payment, to the franchisor or an affiliate that are made any
time from before to within six months after commencing operation of the
franchisee's business is less than $500.
(2) The franchise relationship is a fractional franchise.
(3) The franchise relationship is a leased department.
(4) The franchise relationship is covered by the Petroleum
Marketing Practices Act, 15 U.S.C. 2801.
(5)(i) The franchisee's initial investment, excluding any financing
received from the franchisor or an affiliate and excluding the cost of
unimproved land, totals at least $1 million and the prospective
franchisee signs an acknowledgment verifying the grounds for the
exemption. The acknowledgment shall state: ``The franchise sale is for
more than $1 million--excluding the cost of unimproved land and any
financing received from the franchisor or an affiliate-- and thus is
exempted from the Federal Trade Commission's Franchise Rule disclosure
requirements, pursuant to 16 CFR 436.8(a)(5)(i)'';\11\ or
---------------------------------------------------------------------------
\11\ The large franchise exemption applies only if at least one
individual prospective franchisee in an investor-group qualifies for
the exemption by investing at the threshold level stated in this
section.
---------------------------------------------------------------------------
(ii) The franchisee (or its parent or any affiliates) is an entity
that has been in business for at least five years and has a net worth
of at least $5 million.
(6) One or more purchasers of at least a 50% ownership interest in
the franchise: within 60 days of the sale, has been, for at least two
years, an officer, director, general partner, individual with
management responsibility for the offer and sale of the franchisor's
franchises or the administrator of the franchised network; or within 60
days of the sale, has been, for at least two years, an owner of at
least a 25% interest in the franchisor.
(7) There is no written document that describes any material term
or aspect of the relationship or arrangement.
(b) For purposes of the exemptions set forth in this section, the
Commission shall adjust the size of the monetary thresholds every
fourth year based upon the Consumer Price Index. For purposes of this
section, ``Consumer Price Index'' means the Consumer Price Index for
all urban consumers published by the Department of Labor.
Subpart F--Prohibitions
Sec. 436.9 Additional prohibitions.
It is an unfair or deceptive act or practice in violation of
Section 5 of the Federal Trade Commission Act for any franchise seller
covered by part 436 to:
(a) Make any claim or representation, orally, visually, or in
writing, that contradicts the information required to be disclosed by
this part.
(b) Misrepresent that any person:
(1) Purchased a franchise from the franchisor or operated a
franchise of the type offered by the franchisor.
[[Page 15561]]
(2) Can provide an independent and reliable report about the
franchise or the experiences of any current or former franchisees.
(c) Disseminate any financial performance representations to
prospective franchisees unless the franchisor has a reasonable basis
and written substantiation for the representation at the time the
representation is made, and the representation is included in Item 19
(Sec. 436.5(s)) of the franchisor's disclosure document. In
conjunction with any such financial performance representation, the
franchise seller shall also:
(1) Disclose the information required by Sec. Sec.
436.5(s)(3)(ii)(B) and (E) of this part if the representation relates
to the past performance of the franchisor's outlets.
(2) Include a clear and conspicuous admonition that a new
franchisee's individual financial results may differ from the result
stated in the financial performance representation.
(d) Fail to make available to prospective franchisees, and to the
Commission upon reasonable request, written substantiation for any
financial performance representations made in Item 19 (Sec. 436.5(s)).
(e) Fail to furnish a copy of the franchisor's disclosure document
to a prospective franchisee earlier in the sales process than required
under Sec. 436.2 of this part, upon reasonable request.
(f) Fail to furnish a copy of the franchisor's most recent
disclosure document and any quarterly updates to a prospective
franchisee, upon reasonable request, before the prospective franchisee
signs a franchise agreement.
(g) Present for signing a franchise agreement in which the terms
and conditions differ materially from those presented as an attachment
to the disclosure document, unless the franchise seller informed the
prospective franchisee of the differences at least seven days before
execution of the franchise agreement.
(h) Disclaim or require a prospective franchisee to waive reliance
on any representation made in the disclosure document or in its
exhibits or amendments. Provided, however, that this provision is not
intended to prevent a prospective franchisee from voluntarily waiving
specific contract terms and conditions set forth in his or her
disclosure document during the course of franchise sale negotiations.
(i) Fail to return any funds or deposits in accordance with any
conditions disclosed in the franchisor's disclosure document, franchise
agreement, or any related document.
Subpart G--Other Provisions
Sec. 436.10 Other laws and rules.
(a) The Commission does not approve or express any opinion on the
legality of any matter a franchisor may be required to disclose by part
436. Further, franchisors may have additional obligations to impart
material information to prospective franchisees outside of the
disclosure document under Section 5 of the Federal Trade Commission
Act. The Commission intends to enforce all applicable statutes and
rules.
(b) The FTC does not intend to preempt the franchise practices laws
of any state or local government, except to the extent of any
inconsistency with part 436. A law is not inconsistent with part 436 if
it affords prospective franchisees equal or greater protection, such as
registration of disclosure documents or more extensive disclosures.
Sec. 436.11 Severability.
If any provision of this part is stayed or held invalid, the
remainder will stay in force.
Appendix A to Part 436--Sample Item 10 Table
SUMMARY OF FINANCING OFFERED
----------------------------------------------------------------------------------------------------------------
Loss of
Liability Legal
Item Source of Down Amount Term Interest Monthly Prepay Security Upon Right
Financed Financing Payment Financed (Yrs) Rate Payment Penalty Required Default on
Default
----------------------------------------------------------------------------------------------------------------
Initial .......... ........ ......... ....... ......... ........ ........ ........ ......... .......
Fee
----------------------------------------------------------------------------------------------------------------
Land/ .......... ........ ......... ....... ......... ........ ........ ........ ......... .......
Constr
----------------------------------------------------------------------------------------------------------------
Leased .......... ........ ......... ....... ......... ........ ........ ........ ......... .......
Space
----------------------------------------------------------------------------------------------------------------
Equip. .......... ........ ......... ....... ......... ........ ........ ........ ......... .......
Lease
----------------------------------------------------------------------------------------------------------------
Equip. .......... ........ ......... ....... ......... ........ ........ ........ ......... .......
Purchase
----------------------------------------------------------------------------------------------------------------
Opening .......... ........ ......... ....... ......... ........ ........ ........ ......... .......
Inventor
y
----------------------------------------------------------------------------------------------------------------
Other .......... ........ ......... ....... ......... ........ ........ ........ ......... .......
Financin
g
----------------------------------------------------------------------------------------------------------------
Appendix B to Part 436--Sample Item 20(1) Table
Systemwide Outlet Summary
For years 2004 to 2006
----------------------------------------------------------------------------------------------------------------
Column 3 Outlets at Column 4 Outlets at
Column 1 Outlet Type Column 2 Year the Start of the Year the End of the Year Column 5 Net Change
----------------------------------------------------------------------------------------------------------------
Franchised 2004 859 1,062 +203
------------------------------------------------------------------------------------------
[[Page 15562]]
2005 1,062 1,296 +234
------------------------------------------------------------------------------------------
2006 1,296 2,720 +1,424
----------------------------------------------------------------------------------------------------------------
Company Owned 2004 125 145 +20
------------------------------------------------------------------------------------------
2005 145 76 -69
------------------------------------------------------------------------------------------
2006 76 141 +65
----------------------------------------------------------------------------------------------------------------
Total Outlets 2004 984 1,207 +223
------------------------------------------------------------------------------------------
2005 1,207 1,372 +165
------------------------------------------------------------------------------------------
2006 1,372 2,861 +1,489
----------------------------------------------------------------------------------------------------------------
Appendix C to Part 436--Sample Item 20(2) Table
Transfers of Franchised Outlets from Franchisees to New Owners (other
than the Franchisor)
For years 2004 to 2006
------------------------------------------------------------------------
Column 3 Number of
Column 1 State Column 2 Year Transfers
------------------------------------------------------------------------
NC 2004 1
------------------------------------------------
2005 0
------------------------------------------------
2006 2
------------------------------------------------------------------------
SC 2004 0
------------------------------------------------
2005 0
------------------------------------------------
2006 2
------------------------------------------------------------------------
Total 2004 1
------------------------------------------------
2005 0
------------------------------------------------
2006 4
------------------------------------------------------------------------
Appendix D to Part 436--Sample Item 20(3) Table
Status of Franchise Outlets
For years 2004 to 2006
----------------------------------------------------------------------------------------------------------------
Column 3 Column 7 Column 8 Column 9
Column 1 Column 2 Outlets at Column 4 Column 5 Column 6 Reacquired Ceased Outlets
State Year Start of Outlets Terminations Non- by Operations- at End of
Year Opened Renewals Franchisor Other Reasons the Year
----------------------------------------------------------------------------------------------------------------
AL 2004 10 2 1 0 0 1 10
------------------------------------------------------------------------------------------------------
2005 11 5 0 1 0 0 15
------------------------------------------------------------------------------------------------------
2006 15 4 1 0 1 2 15
----------------------------------------------------------------------------------------------------------------
AZ 2004 20 5 0 0 0 0 25
------------------------------------------------------------------------------------------------------
2005 25 4 1 0 0 2 26
------------------------------------------------------------------------------------------------------
2006 26 4 0 0 0 0 30
----------------------------------------------------------------------------------------------------------------
Totals 2004 30 7 1 0 0 1 35
------------------------------------------------------------------------------------------------------
2005 36 9 1 1 0 2 41
------------------------------------------------------------------------------------------------------
[[Page 15563]]
2006 41 8 1 0 1 2 45
----------------------------------------------------------------------------------------------------------------
Appendix E to Part 436--Sample Item 20(4) Table
Status of Company-Owned Outlets
For years 2004 to 2006
----------------------------------------------------------------------------------------------------------------
Column 3 Column 5 Column 8
Column 1 Column 2 Outlets at Column 4 Outlets Column 6 Column 7 Outlets at
State Year Start of Outlets Reacquired From Outlets Outlets Sold to End of the
Year Opened Franchisees Closed Franchisees Year
----------------------------------------------------------------------------------------------------------------
NY 2004 1 0 1 0 0 2
----------------------------------------------------------------------------------------------------
2005 2 2 0 1 0 3
----------------------------------------------------------------------------------------------------
2006 3 0 0 3 0 0
----------------------------------------------------------------------------------------------------------------
OR 2004 4 0 1 0 0 5
----------------------------------------------------------------------------------------------------
2005 5 0 0 2 0 3
----------------------------------------------------------------------------------------------------
2006 3 0 0 0 1 2
----------------------------------------------------------------------------------------------------------------
Totals 2004 5 0 2 0 0 7
----------------------------------------------------------------------------------------------------
2005 7 2 0 3 0 6
----------------------------------------------------------------------------------------------------
2006 6 0 0 3 1 2
----------------------------------------------------------------------------------------------------------------
Appendix F to Part 436--Sample Item 20(5) Table
Projected New Franchised Outlets
As of December 31, 2006
------------------------------------------------------------------------
Column 4
Column 2 Column 3 Projected New
Franchise Projected New Company-Owned
Column 1 State Agreements Signed Franchised Outlets in the
But Outlet Not Outlets in the Current Fiscal
Opened Next Fiscal Year Year
------------------------------------------------------------------------
CO 2 3 1
------------------------------------------------------------------------
NM 0 4 2
------------------------------------------------------------------------
Total 2 7 3
------------------------------------------------------------------------
------------------------------------------------------------------------
0
Add a new part 437 as follows:
PART 437--DISCLOSURE REQUIREMENTS AND PROHIBITIONS CONCERNING
BUSINESS OPPORTUNITIES
Sec.
437.1 The Rule.
437.2 Definitions.
437.3 Severability.
Authority: 15 U.S.C. 41-58.
Sec. 437.1 The Rule.
In connection with the advertising, offering, licensing,
contracting, sale, or other promotion in or affecting commerce, as
``commerce'' is defined in the Federal Trade Commission Act, of any
business opportunity, or any relationship which is represented either
orally or in writing to be a business opportunity, it is an unfair or
deceptive act or practice within the meaning of Section 5 of that Act
for any business opportunity seller or business opportunity broker:
(a) To fail to furnish any prospective business opportunity
purchaser with the following information accurately, clearly, and
concisely stated, in a legible, written document at the earlier of the
``time for making of disclosures'' or the first ``personal meeting'':
(1)(i) The official name and address and principal place of
business of the business opportunity seller, and of the parent firm or
holding company of the business opportunity seller, if any;
(ii) The name under which the business opportunity seller is doing
or intends to do business; and
(iii) The trademarks, trade names, service marks, advertising or
other commercial symbols (hereinafter collectively referred to as
``marks'') which identify the goods, commodities, or services to be
offered, sold, or distributed by the prospective business opportunity
purchaser, or under which
[[Page 15564]]
the prospective business opportunity purchaser will be operating.
(2) The business experience during the past 5 years, stated
individually, of each of the business opportunity seller's current
directors and executive officers (including, and hereinafter to
include, the chief executive and chief operating officer, financial,
business opportunity marketing, training and service officers). With
regard to each person listed, those persons' principal occupations and
employers must be included.
(3) The business experience of the business opportunity seller and
the business opportunity seller's parent firm (if any), including the
length of time each: (i) Has conducted a business of the type to be
operated by the business opportunity purchaser; (ii) has offered or
sold a business opportunity for such business; (iii) has conducted a
business or offered or sold a business opportunity for a business (A)
operating under a name using any mark set forth under paragraph
(a)(1)(iii) of this section, or (B) involving the sale, offering, or
distribution of goods, commodities, or services which are identified by
any mark set forth under paragraph (a)(1)(iii) of this section; and
(iv) has offered for sale or sold business opportunities in other lines
of business, together with a description of such other lines of
business.
(4) A statement disclosing who, if any, of the persons listed in
paragraphs (a) (2) and (3) of this section:
(i) Has, at any time during the previous seven fiscal years, been
convicted of a felony or pleaded nolo contendere to a felony charge if
the felony involved fraud (including violation of any business
opportunity law, or unfair or deceptive practices law), embezzlement,
fraudulent conversion, misappropriation of property, or restraint of
trade;
(ii) Has, at any time during the previous seven fiscal years, been
held liable in a civil action resulting in a final judgment or has
settled out of court any civil action or is a party to any civil action
(A) involving allegations of fraud (including violation of any business
opportunity law, or unfair or deceptive practices law), embezzlement,
fraudulent conversion, misappropriation of property, or restraint of
trade, or (B) which was brought by a present or former business
opportunity purchaser or business opportunity purchasers and which
involves or involved the business opportunity relationship; Provided,
however, That only material individual civil actions need be so listed
pursuant to this paragraph (4)(ii) of this section, including any group
of civil actions which, irrespective of the materiality of any single
such action, in the aggregate is material;
(iii) Is subject to any currently effective State or Federal agency
or court injunctive or restrictive order, or is a party to a proceeding
currently pending in which such order is sought, relating to or
affecting business opportunity activities or the business opportunity
seller-purchaser relationship, or involving fraud (including violation
of any business opportunity law, or unfair or deceptive practices law),
embezzlement, fraudulent conversion, misappropriation of property, or
restraint of trade.
Such statement shall set forth the identity and location of the
court or agency; the date of conviction, judgment, or decision; the
penalty imposed; the damages assessed; the terms of settlement or the
terms of the order; and the date, nature, and issuer of each such order
or ruling. A business opportunity seller may include a summary opinion
of counsel as to any pending litigation, but only if counsel's consent
to the use of such opinion is included in the disclosure statement.
(5) A statement disclosing who, if any, of the persons listed in
paragraphs (a) (2) and (3) of this section at any time during the
previous 7 fiscal years has:
(i) Filed in bankruptcy;
(ii) Been adjudged bankrupt;
(iii) Been reorganized due to insolvency; or
(iv) Been a principal, director, executive officer, or partner of
any other person that has so filed or was so adjudged or reorganized,
during or within 1 year after the period that such person held such
position in such other person. If so, the name and location of the
person having so filed, or having been so adjudged or reorganized, the
date thereof, and any other material facts relating thereto, shall be
set forth.
(6) A factual description of the business opportunity offered to be
sold by the business opportunity seller.
(7) A statement of the total funds which must be paid by the
business opportunity purchaser to the business opportunity seller or to
a person affiliated with the business opportunity seller, or which the
business opportunity seller or such affiliated person imposes or
collects in whole or in part on behalf of a third party, in order to
obtain or commence the business opportunity operation, such as initial
business opportunity fees, deposits, down payments, prepaid rent, and
equipment and inventory purchases. If all or part of these fees or
deposits are returnable under certain conditions, these conditions
shall be set forth; and if not returnable, such fact shall be
disclosed.
(8) A statement describing any recurring funds required to be paid,
in connection with carrying on the business opportunity business, by
the business opportunity purchaser to the business opportunity seller
or to a person affiliated with the business opportunity seller, or
which the business opportunity seller or such affiliated person imposes
or collects in whole or in part on behalf of a third party, including,
but not limited to, royalty, lease, advertising, training, and sign
rental fees, and equipment or inventory purchases.
(9) A statement setting forth the name of each person (including
the business opportunity seller) the business opportunity purchaser is
directly or indirectly required or advised to do business with by the
business opportunity seller, where such persons are affiliated with the
business opportunity seller.
(10) A statement describing any real estate, services, supplies,
products, inventories, signs, fixtures, or equipment relating to the
establishment or the operation of the business opportunity business
which the business opportunity purchaser is directly or indirectly
required by the business opportunity seller to purchase, lease or rent;
and if such purchases, leases or rentals must be made from specific
persons (including the business opportunity seller), a list of the
names and addresses of each such person. Such list may be made in a
separate document delivered to the prospective business opportunity
purchaser with the prospectus if the existence of such separate
document is disclosed in the prospectus.
(11) A description of the basis for calculating, and, if such
information is readily available, the actual amount of, any revenue or
other consideration to be received by the business opportunity seller
or persons affiliated with the business opportunity seller from
suppliers to the prospective business opportunity purchaser in
consideration for goods or services which the business opportunity
seller requires or advises the business opportunity purchaser to obtain
from such suppliers.
(12)(i) A statement of all the material terms and conditions of any
financing arrangement offered directly or indirectly by the business
opportunity seller, or any person affiliated with the business
opportunity seller, to the prospective business opportunity purchaser;
and
[[Page 15565]]
(ii) A description of the terms by which any payment is to be
received by the business opportunity seller from (A) any person
offering financing to a prospective business opportunity purchaser; and
(B) any person arranging for financing for a prospective business
opportunity purchaser.
(13) A statement describing the material facts of whether, by the
terms of the business opportunity agreement or other device or
practice, the business opportunity purchaser is:
(i) Limited in the goods or services he or she may offer for sale;
(ii) Limited in the customers to whom he or she may sell such goods
or services;
(iii) Limited in the geographic area in which he or she may offer
for sale or sell goods or services; or
(iv) Granted territorial protection by the business opportunity
seller, by which, with respect to a territory or area, (A) the business
opportunity seller will not establish another, or more than any fixed
number of, business opportunities or company-owned outlets, either
operating under, or selling, offering, or distributing goods,
commodities or services, identified by any mark set forth under
paragraph (a)(1)(iii) of this section; or (B) the business opportunity
seller or its parent will not establish other business opportunities or
company-owned outlets selling or leasing the same or similar products
or services under a different trade name, trademark, service mark,
advertising or other commercial symbol.
(14) A statement of the extent to which the business opportunity
seller requires the business opportunity purchaser (or, if the business
opportunity purchaser is a corporation, any person affiliated with the
business opportunity purchaser) to participate personally in the direct
operation of the business opportunity.
(15) A statement disclosing, with respect to the business
opportunity agreement and any related agreements:
(i) The term (i.e., duration of arrangement), if any, of such
agreement, and whether such term is or may be affected by any agreement
(including leases or subleases) other than the one from which such term
arises;
(ii) The conditions under which the business opportunity purchaser
may renew or extend;
(iii) The conditions under which the business opportunity seller
may refuse to renew or extend;
(iv) The conditions under which the business opportunity purchaser
may terminate;
(v) The conditions under which the business opportunity seller may
terminate;
(vi) the obligations (including lease or sublease obligations) of
the business opportunity purchaser after termination of the business
opportunity by the business opportunity seller, and the obligations of
the business opportunity purchaser (including lease or sublease
obligations) after termination of the business opportunity by the
business opportunity purchaser and after the expiration of the business
opportunity;
(vii) The business opportunity purchaser's interest upon
termination of the business opportunity, or upon refusal to renew or
extend the business opportunity, whether by the business opportunity
seller or by the business opportunity purchaser;
(viii) The conditions under which the business opportunity seller
may repurchase, whether by right of first refusal or at the option of
the business opportunity seller (and if the business opportunity seller
has the option to repurchase the business opportunity, whether there
will be an independent appraisal of the business opportunity, whether
the repurchase price will be determined by a predetermined formula and
whether there will be a recognition of goodwill or other intangibles
associated therewith in the repurchase price to be given the business
opportunity purchaser);
(ix) The conditions under which the business opportunity purchaser
may sell or assign all or any interest in the ownership of the business
opportunity, or of the assets of the business opportunity business;
(x) The conditions under which the business opportunity seller may
sell or assign, in whole or in part, its interest under such
agreements;
(xi) The conditions under which the business opportunity purchaser
may modify;
(xii) The conditions under which the business opportunity seller
may modify;
(xiii) The rights of the business opportunity purchaser's heirs or
personal representative upon the death or incapacity of the business
opportunity purchaser; and
(xiv) The provisions of any covenant not to compete.
(16) A statement disclosing, with respect to the business
opportunity seller and as to the particular named business being
offered:
(i) The total number of business opportunity purchasers operating
at the end of the preceding fiscal year;
(ii) The total number of company-owned outlets operating at the end
of the preceding fiscal year;
(iii) The names, addresses, and telephone numbers of (A) The 10
business opportunity outlets of the named business opportunity business
nearest the prospective business opportunity purchaser's intended
location; or (B) all business opportunity purchasers of the business
opportunity seller; or (C) all business opportunity purchasers of the
business opportunity seller in the State in which the prospective
business opportunity purchaser lives or where the proposed business
opportunity is to be located, Provided, however, That there are more
than 10 such business opportunity purchasers. If the number of business
opportunity purchasers to be disclosed pursuant to paragraph
(a)(16)(iii)(B) or (C) of this section exceeds 50, such listing may be
made in a separate document delivered to the prospective business
opportunity purchaser with the prospectus if the existence of such
separate document is disclosed in the prospectus;
(iv) The number of business opportunities voluntarily terminated or
not renewed by business opportunity purchasers within, or at the
conclusion of, the term of the business opportunity agreement, during
the preceding fiscal year;
(v) The number of business opportunities reacquired by purchase by
the business opportunity seller during the term of the business
opportunity agreement, and upon the conclusion of the term of the
business opportunity agreement, during the preceding fiscal year;
(vi) The number of business opportunities otherwise reacquired by
the business opportunity seller during the term of the business
opportunity agreement, and upon the conclusion of the term of the
business opportunity agreement, during the preceding fiscal year;
(vii) The number of business opportunities for which the business
opportunity seller refused renewal of the business opportunity
agreement or other agreements relating to the business opportunity
during the preceding fiscal year; and
(viii) The number of business opportunities that were canceled or
terminated by the business opportunity seller during the term of the
business opportunity agreement, and upon conclusion of the term of the
business opportunity agreement, during the preceding fiscal year.
With respect to the disclosures required by paragraphs (a)(16) (v),
(vi), (vii), and (viii) of this section, the disclosure statement shall
also include a general categorization of the reasons
[[Page 15566]]
for such reacquisitions, refusals to renew or terminations, and the
number falling within each such category, including but not limited to
the following: failure to comply with quality control standards,
failure to make sufficient sales, and other breaches of contract.
(17)(i) If site selection or approval thereof by the business
opportunity seller is involved in the business opportunity
relationship, a statement disclosing the range of time that has elapsed
between signing of business opportunity agreements or other agreements
relating to the business opportunity and site selection, for agreements
entered into during the preceding fiscal year; and
(ii) If operating business opportunity outlets are to be provided
by the business opportunity seller, a statement disclosing the range of
time that has elapsed between the signing of business opportunity
agreements or other agreements relating to the business opportunity and
the commencement of the business opportunity purchaser's business, for
agreements entered into during the preceding fiscal year.
With respect to the disclosures required by paragraphs (a)(17) (i)
and (ii) of this section, a business opportunity seller may at its
option also provide a distribution chart using meaningful
classifications with respect to such ranges of time.
(18) If the business opportunity seller offers an initial training
program or informs the prospective business opportunity purchaser that
it intends to provide such person with initial training, a statement
disclosing:
(i) The type and nature of such training;
(ii) The minimum amount, if any, of training that will be provided
to a business opportunity purchaser; and
(iii) The cost, if any, to be borne by the business opportunity
purchaser for the training to be provided, or for obtaining such
training.
(19) If the name of a public figure is used in connection with a
recommendation to purchase a business opportunity, or as a part of the
name of the business opportunity operation, or if the public figure is
stated to be involved with the management of the business opportunity
seller, a statement disclosing:
(i) The nature and extent of the public figure's involvement and
obligations to the business opportunity seller, including but not
limited to the promotional assistance the public figure will provide to
the business opportunity seller and to the business opportunity
purchaser;
(ii) The total investment of the public figure in the business
opportunity operation; and
(iii) The amount of any fee or fees the business opportunity
purchaser will be obligated to pay for such involvement or assistance
provided by the public figure.
(20)(i) A balance sheet (statement of financial position) for the
business opportunity seller for the most recent fiscal year, and an
income statement (statement of results of operations) and statement of
changes in financial position for the franchisor for the most recent
three fiscal years. Such statements are required to have been examined
in accordance with generally accepted auditing standards by an
independent certified or licensed public accountant.
Provided, however, That where a business opportunity seller is a
subsidiary of another corporation which is permitted under generally
accepted accounting principles to prepare financial statements on a
consolidated or combined statement basis, the above information may be
submitted for the parent if (A) the corresponding unaudited financial
statements of the business opportunity seller are also provided, and
(B) the parent absolutely and irrevocably has agreed to guarantee all
obligations of the subsidiary;
(ii) Unaudited statements shall be used only to the extent that
audited statements have not been made, and provided that such
statements are accompanied by a clear and conspicuous disclosure that
they are unaudited. Statements shall be prepared on an audited basis as
soon as practicable, but, at a minimum, financial statements for the
first full fiscal year following the date on which the business
opportunity seller must first comply with this part shall contain a
balance sheet opinion prepared by an independent certified or licensed
public accountant, and financial statements for the following fiscal
year shall be fully audited.
(21) All of the foregoing information in paragraphs (a) (1) through
(20) of this section shall be contained in a single disclosure
statement or prospectus, which shall not contain any materials or
information other than that required by this part or by State law not
preempted by this part. This does not preclude business opportunity
sellers or brokers from giving other nondeceptive information orally,
visually, or in separate literature so long as such information is not
contradictory to the information in the disclosure statement required
by paragraph (a) of this section. This disclosure statement shall carry
a cover sheet distinctively and conspicuously showing the name of the
business opportunity seller, the date of issuance of the disclosure
statement, and the following notice imprinted thereon in upper and
lower case bold-face type of not less than 12 point size:
Information for Prospective Business Opportunity Purchasers Required by
Federal Trade Commission
* * * * *
To protect you, we've required your business opportunity seller
to give you this information. We haven't checked it, and don't know
if it's correct. It should help you make up your mind. Study it
carefully. While it includes some information about your contract,
don't rely on it alone to understand your contract. Read all of your
contract carefully. Buying a business opportunity is a complicated
investment. Take your time to decide. If possible, show your
contract and this information to an advisor, like a lawyer or an
accountant. If you find anything you think may be wrong or anything
important that's been left out, you should let us know about it. It
may be against the law.
There may also be laws on business opportunities in your state.
Ask your state agencies about them.
Federal Trade Commission,
Washington, D.C.
Provided, That the obligations to furnish such disclosure statement
shall be deemed to have been met for both the business opportunity
seller and the business opportunity broker if either such party
furnishes the prospective business opportunity purchaser with such
disclosure statement.
(22) All information contained in the disclosure statement shall be
current as of the close of the business opportunity seller's most
recent fiscal year. After the close of each fiscal year, the business
opportunity seller shall be given a period not exceeding 90 days to
prepare a revised disclosure statement and, following such 90 days, may
distribute only the revised prospectus and no other. The business
opportunity seller shall, within a reasonable time after the close of
each quarter of the fiscal year, prepare revisions to be attached to
the disclosure statement to reflect any material change in the business
opportunity seller or relating to the business opportunity business of
the business opportunity seller, about which the business opportunity
seller or broker, or any agent, representative, or employee thereof,
knows or should know. Each prospective business opportunity purchaser
shall have in his or her possession at the ``time for making of
disclosures,'' the disclosure statement and quarterly revision for the
period most recent to the ``time for making of disclosures'' and
available at
[[Page 15567]]
that time. Information which is required to be audited pursuant to
paragraph (a)(20) of this section is not required to be audited for
quarterly revisions. Provided, however, That the unaudited information
is accompanied by a statement in immediate conjunction therewith that
clearly and conspicuously discloses that such information has not been
audited.
(23) A table of contents shall be included within the disclosure
statement.
(24) The disclosure statement shall include a comment which either
positively or negatively responds to each disclosure item required to
be in the disclosure statement, by use of a statement which fully
incorporates the information required by the item. Each disclosure item
therein must be preceded by the appropriate heading, as set forth in
Note 3 of this part.
(b) To make any oral, written, or visual representation to a
prospective business opportunity purchaser which states a specific
level of potential sales, income, gross or net profit for that
prospective business opportunity purchaser, or which states other facts
which suggest such a specific level, unless:
(1) At the time such representation is made, such representation is
relevant to the geographic market in which the business opportunity is
to be located;
(2) At the time such representation is made, a reasonable basis
exists for such representation and the business opportunity seller has
in its possession material which constitutes a reasonable basis for
such representation, and such material is made available to any
prospective business opportunity purchaser and to the Commission or its
staff upon reasonable demand.
Provided, further, That in immediate conjunction with such
representation, the business opportunity seller shall disclose in a
clear and conspicuous manner that such material is available to the
prospective business opportunity purchaser; and Provided, however, That
no provision within paragraph (b) of this section shall be construed as
requiring the disclosure to any prospective business opportunity
purchaser of the identity of any specific business opportunity
purchaser or of information reasonably likely to lead to the disclosure
of such person's identity; and Provided, further, That no additional
representation as to a prospective business opportunity purchaser's
potential sales, income, or profits may be made later than the ``time
for making of disclosures'';
(3) Such representation is set forth in detail along with the
material bases and assumptions therefor in a single legible written
document whose text accurately, clearly and concisely discloses such
information, and none other than that provided for by this part or by
State law not preempted by this part. Each prospective business
opportunity purchaser to whom the representation is made shall be
furnished with such document no later than the ``time for making of
disclosure''; Provided, however, That if the representation is made at
or prior to a ``personal meeting'' and such meeting occurs before the
``time for making of disclosures'', the document shall be furnished to
the prospective business opportunity purchaser to whom the
representation is made at that ``personal meeting'';
(4) The following statement is clearly and conspicuously disclosed
in the document described by paragraph (b)(3) of this section in
immediate conjunction with such representation and in not less than
twelve point upper and lower-case boldface type:
CAUTION
These figures are only estimates of what we think you may earn.
There is no assurance you'll do as well. If you rely upon our
figures, you must accept the risk of not doing as well.
(5) The following information is clearly and conspicuously
disclosed in the document described by paragraph (b)(3) of this section
in immediate conjunction with such representation:
(i) The number and percentage of outlets of the named business
opportunity business which are located in the geographic markets that
form the basis for any such representation and which are known to the
business opportunity seller or broker to have earned or made at least
the same sales, income, or profits during a period of corresponding
length in the immediate past as those potential sales, income, or
profits represented; and
(ii) The beginning and ending dates for the corresponding time
period referred to by paragraph (b)(5)(i) of this section, Provided,
however, That any business opportunity seller without prior business
opportunity experience as to the named business opportunity business so
indicate such lack of experience in the document described in paragraph
(b)(3) of this section.
Except, That representations of the sales, income or profits of
existing business opportunity outlets need not comply with paragraph
(b) of this section.
(c) To make any oral, written, or visual representation to a
prospective business opportunity purchaser which states a specific
level of sales, income, gross or net profits of existing outlets
(whether business opportunity purchaser-owned or company-owned) of the
named business opportunity business, or which states other facts which
suggest such a specific level, unless:
(1) At the time such representation is made, such representation is
relevant to the geographic market in which the business opportunity is
to be located;
(2) At the time such representation is made, a reasonable basis
exists for such representation and the business opportunity seller has
in its possession material which constitutes a reasonable basis for
such representation, and such material is made available to any
prospective business opportunity purchaser and to the Commission or its
staff upon reasonable demand, Provided, however, That in immediate
conjunction with such representation, the business opportunity
purchaser discloses in a clear and conspicuous manner that such
material is available to the prospective franchisee; and Provided,
further, That no provision within paragraph (c) of this section shall
be construed as requiring the disclosure to any prospective business
opportunity purchaser of the identity of any specific business
opportunity purchaser or of information reasonably likely to lead to
the disclosure of such person's identity; and Provided, further, That
no additional representation as to the sales, income, or gross or net
profits of existing outlets (whether business opportunity purchaser-
owned or company-owned) of the named business opportunity business may
be made later than the ``time for making of disclosures'';
(3) Such representation is set forth in detail along with the
material bases and assumptions therefor in a single legible written
document which accurately, clearly and concisely discloses such
information, and none other than that provided for by this part or by
State law not preempted by this part. Each prospective business
opportunity purchaser to whom the representation is made shall be
furnished with such document no later than the ``time for making of
disclosures,'' Provided, however, That if the representation is made at
or prior to a ``personal meeting'' and such meeting occurs before the
``time for making of disclosures,'' the document shall be furnished to
the prospective business opportunity purchaser to whom the
representation is made at that ``personal meeting'';
(4) The underlying data on which the representation is based have
been
[[Page 15568]]
prepared in accordance with generally accepted accounting principles;
(5) The following statement is clearly and conspicuously disclosed
in the document described by paragraph (c)(3) of this section in
immediate conjunction with such representation, and in not less than
twelve point upper and lower case boldface type:
CAUTION
Some outlets have [sold] [earned] this amount. There is no
assurance you'll do as well. If you rely upon our figures, you must
accept the risk of not doing as well.
(6) The following information is clearly and conspicuously
disclosed in the document described by paragraph (c)(3) of this section
in immediate conjunction with such representation:
(i) the number and percentage of outlets of the named business
opportunity business which are located in the geographic markets that
form the basis for any such representation and which are known to the
business opportunity seller or broker to have earned or made at least
the same sales, income, or profits during a period of corresponding
length in the immediate past as those potential sales, income, or
profits represented; and
(ii) The beginning and ending dates for the corresponding time
period referred to by paragraph (c)(6)(i) of this section, Provided,
however, That any business opportunity seller without prior business
opportunity experience as to the named business opportunity business so
indicate such lack of experience in the document described in paragraph
(c)(3) of this section.
(d) To fail to provide the following information within the
document(s) required by paragraphs (b)(3) and (c)(3) of this section
whenever any representation is made to a prospective business
opportunity purchaser regarding its potential sales, income, or
profits, or the sales, income, gross or net profits of existing outlets
(whether business opportunity purchaser-owned or company-owned) of the
named business opportunity business:
(1) A cover sheet distinctively and conspicuously showing the name
of the business opportunity seller, the date of issuance of the
document and the following notice imprinted thereon in upper and lower
case boldface type of not less than twelve point size:
Information for Prospective Business Opportunity Purchasers About
Business Opportunity [Sales] [Income] [Profit] Required by the Federal
Trade Commission.
To protect you, we're required the business opportunity seller
to give you this information. We haven't checked it and don't know
if it's correct. Study these facts and figures carefully. If
possible, show them to someone who can advise you, like a lawyer or
an accountant. Then take your time and think it over.
If you find anything you think may be wrong or anything
important that's been left out, let us know about it. It may be
against the law.
There may also be laws on business opportunities in your State.
Ask your State agencies about them.
Federal Trade Commission,
Washington, D.C.
(2) A table of contents.
Provided, however, That each prospective business opportunity
purchaser to whom the representation is made shall be notified at the
``time for making of disclosures'' of any material change (about which
the business opportunity seller, broker, or any of the agents,
representations, or employees thereof, knows or should know) in the
information contained in the document(s) described by paragraphs (b)(3)
and (c)(3) of this section.
(e) To make any oral, written, or visual representation for general
dissemination (not otherwise covered by paragraph (b) or (c) of this
section) which states a specific level of sales, income, gross or net
profits, either actual or potential, of existing or prospective outlets
(whether business opportunity purchaser-owned or company-owned) of the
named business opportunity business or which states other facts which
suggest such a specific level, unless:
(1) At the time such representation is made, a reasonable basis
exists for such representation and the business opportunity seller has
in its possession material which constitutes a reasonable basis for
such representation and which is made available to the Commission or
its staff upon reasonable demand;
(2) The underlying data on which each representation of sales,
income or profit for existing outlets is based have been prepared in
accordance with generally accepted accounting principles;
(3) In immediate conjunction with such representation, there shall
be clearly and conspicuously disclosed the number and percentage of
outlets of the named business opportunity business which the business
opportunity seller or broker knows to have earned or made at least the
same sales, income, or profits during a period of corresponding length
in the immediate past as those sales, income, or profits represented,
and the beginning and ending dates for said time period;
(4) In immediate conjunction with each such representation of
potential sales, income or profits, the following statement shall be
clearly and conspicuously disclosed:
CAUTION
These figures are only estimates; there is no assurance you'll
do as well. If you rely upon our figures, you must accept the risk
of not doing as well.
Provided, however, That if such representation is not based on
actual experience of existing outlets of the named business opportunity
business, that fact also should be disclosed;
(5) No later than the earlier of the first ``personal meeting'' or
the ``time for making of disclosures,'' each prospective business
opportunity purchaser shall be given a single, legible written document
which accurately, clearly and concisely sets forth the following
information and materials (and none other than that provided for by
this part or by State law not preempted by this part):
(i) The representation, set forth in detail along with the material
bases and assumptions therefor;
(ii) the number and percentage of outlets of the named business
opportunity business which the business opportunity seller or broker
knows to have earned or made at least the same sales, income or profits
during a period of corresponding length in the immediate past as those
sales, income, or profits represented, and the beginning and ending
dates for said time period;
(iii) With respect to each such representation of sales, income, or
profits of existing outlets, the following statement shall be clearly
and conspicuously disclosed in immediate conjunction therewith, printed
in not less than 12 point upper and lower case boldface type:
CAUTION
Some outlets have [sold] [earned] this amount. There is no
assurance you'll do as well. If you rely upon our figures, you must
accept the risk of not doing as well.
(iv) With respect to each such representation of potential sales,
income, or profits, the following statement shall be clearly and
conspicuously disclosed in immediate conjunction therewith, printed in
not less than 12 point upper and lower case boldface type:
CAUTION
These figures are only estimates. There is no assurance you'll
do as well. If you rely upon our figures, you must accept the risk
of not doing as well.
(v) If applicable, a statement clearly and conspicuously disclosing
that the business opportunity seller lacks prior
[[Page 15569]]
business opportunity experience as to the named business opportunity
business;
(vi) If applicable, a statement clearly and conspicuously
disclosing that the business opportunity seller has not been in
business long enough to have actual business data;
(vii) A cover sheet, distinctively and conspicuously showing the
name of the business opportunity seller, the date of issuance of the
document, and the following notice printed thereon in not less than 12
point upper and lower case boldface type:
Information for Prospective Business Opportunity Purchasers About
Business Opportunity [Sales] [Income] [Profit] Required by the Federal
Trade Commission
To protect you, we've required the business opportunity seller
to give you this information. We haven't checked it and don't know
if it's correct. Study these facts and figures carefully. If
possible, show them to someone who can advise you, like a lawyer or
an accountant. If you find anything you think may be wrong or
anything important that's been left out, let us know about it. It
may be against the law. There may also be laws about business
opportunities in your State. Ask your State agencies about them.
Federal Trade Commission,
Washington, D.C.
(viii) A table of contents;
(6) Each prospective business opportunity purchaser shall be
notified at the ``time for making of disclosures'' of any material
changes that have occurred in the information contained in this
document.
(f) To make any claim or representation which is contradictory to
the information required to be disclosed by this part.
(g) To fail to furnish the prospective business opportunity
purchaser with a copy of the business opportunity seller's business
opportunity agreement and related agreements with the document, and a
copy of the completed business opportunity and related agreements
intended to be executed by the parties at least 5 business days prior
to the date the agreements are to be executed.
Provided, however, That the obligations defined in paragraphs (b)
through (g) of this section shall be deemed to have been met for both
the business opportunity seller and the broker if either such person
furnishes the prospective business opportunity purchaser with the
written disclosures required thereby.
(h) To fail to return any funds or deposits in accordance with any
conditions disclosed pursuant to paragraph (a)(7) of this section.
Sec. 437.2 Definitions.
As used in this part, the following definitions shall apply:
(a) The term business opportunity means any continuing commercial
relationship created by any arrangement or arrangements whereby:
(1) A person (hereinafter ``business opportunity purchaser'')
offers, sells, or distributes to any person other than a ``business
opportunity seller'' (as hereinafter defined), goods, commodities, or
services which are:
(i)(A) Supplied by another person (hereinafter ``business
opportunity seller''); or
(B) Supplied by a third person (e.g., a supplier) with whom the
business opportunity purchaser is directly or indirectly required to do
business by another person (hereinafter ``business opportunity
seller''); or
(C) Supplied by a third person (e.g., a supplier) with whom the
business opportunity purchaser is directly or indirectly advised to do
business by another person (hereinafter ``business opportunity
seller'') where such third person is affiliated with the business
opportunity seller; and
(ii) The business opportunity seller:
(A) Secures for the business opportunity purchaser retail outlets
or accounts for said goods, commodities, or services; or
(B) Secures for the business opportunity purchaser locations or
sites for vending machines, rack displays, or any other product sales
displays used by the business opportunity purchaser in the offering,
sale, or distribution of said goods, commodities, or services; or
(C) Provides to the business opportunity purchaser the services of
a person able to secure the retail outlets, accounts, sites or
locations referred to in paragraphs (a)(ii)(A) and (B) of this section;
and
(2) The business opportunity purchaser is required as a condition
of obtaining or commencing the business opportunity operation to make a
payment or a commitment to pay to the business opportunity seller, or
to a person affiliated with the business opportunity seller.
(3) Exemptions. The provisions of this part shall not apply to a
business opportunity:
(i) Which is a ``fractional business opportunity''; or
(ii) Where pursuant to a lease, license, or similar agreement, a
person offers, sells, or distributes goods, commodities, or services on
or about premises occupied by a retailer-grantor primarily for the
retailer-grantor's own merchandising activities, which goods,
commodities, or services are not purchased from the retailer-grantor or
persons whom the lessee is directly or indirectly (A) required to do
business with by the retailer-grantor or (B) advised to do business
with by the retailer-grantor where such person is affiliated with the
retailer-grantor; or
(iii) Where the total of the payments referred to in paragraph
(a)(2) of this section made during a period from any time before to
within 6 months after commencing operation of the business opportunity
purchaser's business, is less than $500; or
(iv) Where there is no writing which evidences any material term or
aspect of the relationship or arrangement; or
(v) Which complies with the franchise disclosure requirements set
forth at part 436 or falls under one or more of the exemptions set
forth at Sec. 436.8 of part 436.
(4) Exclusions. The term ``business opportunity'' shall not be
deemed to include any continuing commercial relationship created solely
by:
(i) The relationship between an employer and an employee, or among
general business partners; or
(ii) Membership in a bona fide ``cooperative association''; or
(iii) An agreement for the use of a trademark, service mark, trade
name, seal, advertising, or other commercial symbol designating a
person who offers on a general basis, for a fee or otherwise, a bona
fide service for the evaluation, testing, or certification of goods,
commodities, or services; or
(iv) An agreement between a licensor and a single licensee to
license a trademark, trade name, service mark, advertising or other
commercial symbol where such license is the only one of its general
nature and type to be granted by the licensor with respect to that
trademark, trade name, service mark, advertising, or other commercial
symbol.
(4) Any relationship which is represented either orally or in
writing to be a business opportunity (as defined in paragraph (a) of
this section) is subject to the requirements of this part.
(b) The term person means any individual, group, association,
limited or general partnership, corporation, or any other business
entity.
(c) The term business opportunity seller means any person who
participates in a business opportunity relationship as a business
opportunity seller, as denoted in paragraph (a) of this section.
(d) The term business opportunity purchaser means any person (1)
who participates in a business opportunity relationship as a business
opportunity purchaser, as denoted in paragraph (a)
[[Page 15570]]
of this section, or (2) to whom an interest in a business opportunity
is sold.
(e) The term prospective business opportunity purchaser includes
any person, including any representative, agent, or employee of that
person, who approaches or is approached by a business opportunity
seller or broker, or any representative, agent, or employee thereof,
for the purpose of discussing the establishment, or possible
establishment, of a business opportunity relationship involving such a
person.
(f) The term business day means any day other than Saturday,
Sunday, or the following national holidays: New Year's Day,
Washington's Birthday, Memorial Day, Independence Day, Labor Day,
Columbus Day, Veterans' Day, Thanksgiving, and Christmas.
(g) The term time for making of disclosures means ten (10) business
days prior to the earlier of (1) the execution by a prospective
business opportunity purchaser of any business opportunity agreement or
any other agreement imposing a binding legal obligation on such
prospective business opportunity purchaser, about which the business
opportunity seller, broker, or any agent, representative, or employee
thereof, knows or should know, in connection with the sale or proposed
sale of a business opportunity, or (2) the payment by a prospective
business opportunity purchaser, about which the business opportunity
seller, broker, or any agent, representative, or employee thereof,
knows or should know, of any consideration in connection with the sale
or proposed sale of a business opportunity.
(h) The term fractional business opportunity means any
relationship, as denoted by paragraph (a) of this section, in which the
person described therein as a business opportunity purchaser, or any of
the current directors or executive officers thereof, has been in the
type of business represented by the business opportunity relationship
for more than 2 years and the parties anticipated, or should have
anticipated, at the time the agreement establishing the business
opportunity relationship was reached, that the sales arising from the
relationship would represent no more than 20 percent of the sales in
dollar volume of the business opportunity purchaser.
(i) The term affiliated person means a person (as defined in
paragraph (b) of this section):
(1) Which directly or indirectly controls, is controlled by, or is
under common control with, a business opportunity seller; or
(2) Which directly or indirectly owns, controls, or holds with
power to vote, 10 percent or more of the outstanding voting securities
of a business opportunity seller; or
(3) Which has, in common with a business opportunity seller, one or
more partners, officers, directors, trustees, branch managers, or other
persons occupying similar status or performing similar functions.
(j) The term business opportunity broker means any person other
than a business opportunity seller or a business opportunity purchaser
who sells, offers for sale, or arranges for the sale of a business
opportunity.
(k) The term sale of a business opportunity includes a contract or
agreement whereby a person obtains a business opportunity or an
interest in a business opportunity for value by purchase, license, or
otherwise. This term shall not be deemed to include the renewal or
extension of an existing business opportunity where there is no
interruption in the operation of the business opportunity business by
the business opportunity purchaser, unless the new contracts or
agreements contain material changes from those in effect between the
business opportunity seller and business opportunity purchaser prior
thereto.
(l) A cooperative association is either (1) an association of
producers of agricultural products authorized by section 1 of the
Capper-Volstead Act, 7 U.S.C. 291; or (2) an organization operated on a
cooperative basis by and for independent retailers which wholesales
goods or furnishes services primarily to its member-retailers.
(m) The term fiscal year means the business opportunity seller's
fiscal year.
(n) The term material, material fact, and material change shall
include any fact, circumstance, or set of conditions that has a
substantial likelihood of influencing a reasonable business opportunity
purchaser in the making of a significant decision relating to a named
business opportunity business or that has any significant financial
impact on a business opportunity purchaser or prospective business
opportunity purchaser.
(o) The term personal meeting means a face-to-face meeting between
a business opportunity seller or broker (or any agent, representative,
or employee thereof) and a prospective business opportunity purchaser
which is held for the purposes of discussing the sale or possible sale
of a business opportunity.
Sec. 437.3 Severability.
If any provision of this part or its application to any person,
act, or practice is held invalid, the remainder of the part or the
application of its provisions to any person, act, or practice shall not
be affected thereby.
Note 1: The Commission expresses no opinion as to the legality
of any practice mentioned in this part. A provision for disclosure
should not be construed as condonation or approval with respect to
the matter required to be disclosed, nor as an indication of the
Commission's intention not to enforce any applicable statute.
Note 2: By taking action in this area, the Federal Trade
Commission does not intend to annul, alter, affect, or exempt any
person subject to the provisions of this part from complying with
the laws or regulations of any State, municipality, or other local
government with respect to business opportunity practices, except to
the extent that those laws or regulations are inconsistent with any
provision of this part, and then only to the extent of the
inconsistency. For the purposes of this part, a law or regulation of
any State, municipality, or other local government is not
inconsistent with this part if the protection such law or regulation
affords any prospective business opportunity purchaser is equal to
or greater than that provided by this part. Examples of provisions
that provide protection equal to or greater than that provided by
this part include laws or regulations which require more complete
record keeping by the business opportunity seller or the disclosure
of more complete information to the business opportunity purchaser.
Note 3: [As per Sec. 437.1(a)(24) of this part]:
DISCLOSURE STATEMENT
Pursuant to 16 CFR 437.1 et seq., a Trade Regulation Rule of the
Federal Trade Commission regarding Disclosure Requirements and
Prohibitions Concerning Business Opportunities, the following
information is set forth on [name of business opportunity seller]
for your examination:
1. Identifying information as to the business opportunity
seller;
2. Business experience of the business opportunity seller's
directors and executive officers.
3. Business experience of the business opportunity seller.
4. Litigation history.
5. Bankruptcy history.
6. Description of business opportunity.
7. Initial funds required to be paid by a business opportunity
purchaser.
8. Recurring funds required to be paid by a business opportunity
purchaser.
9. Affiliated persons the business opportunity purchaser is
required or advised to do business with by the business opportunity
seller.
10. Obligations to purchase.
11. Revenues received by the business opportunity seller in
consideration of purchases by a business opportunity purchaser.
12. Financing arrangements.
13. Restriction on sales.
[[Page 15571]]
14. Person participation required of the business opportunity
purchaser in the operation of the business opportunity.
15. Termination, cancellation, and renewal of the business
opportunity.
16. Statistical information concerning the number of business
opportunity purchasers (and company-owned outlets).
17. Site selection.
18. Training programs.
19. Public figure involvement in the business opportunity.
20. Financial information concerning the business opportunity
seller.
By direction of the Commission.
Donald S. Clark,
Secretary.
Note: Attachment A is published for information purposes only
and will not be codified in Title 16 of the Code of Federal
Regulations.
ATTACHMENT A.
TABLE OF COMMENTERS
Rule Review Commenters
RR 1. Robert E. Mulloy, Jr. (``Mulloy'')
RR 2. Stanley M. Dub, Dworken & Bernstein (``Dub'')
RR 3. Marvin J. Migdol, Nationwide Franchise Marketing Services
(``Migdol'')
RR 4. SCPromotions, Inc. (``SCPromotions'')
RR 5. R. Dana Pennell (``Pennell'')
RR 6. Robin Day Glenn (``Glenn'')
RR 7. Jack McBirney, McGrow Consulting (``McBirney'')
RR 8. SRA International (``SRA International'')
RR 9. Harold Brown, Brown & Stadfeld (``Brown'')
RR 10. Ronald N. Rosenwasser (``Rosenwasser'')
RR 11. Louis F. Sokol (``Sokol'')
RR 12. J. Howard Beales III, Professor, George Washington
University (``Beales'')
RR 13. Peter Lagarias (``Lagarias'')
RR 14. Harold L. Kestenbaum (``Kestenbaum'')
RR 15. Walter D. Wilson, Better Business Bureau of Central Georgia,
Inc. (``Wilson'')
RR 16. Connie B. D'Imperio, Color Your Carpet, Inc. (``D'Imperio'')
RR 17. Q.M. Marketing, Inc (``Q.M. Marketing'')
RR 18. David Gurnick, Kindel & Anderson (``Gurnick'')
RR 19. U-Save Auto Rental (``U-Save Auto Rental'')
RR 20. The Longaberger Co. (``Longaberger'')
RR 21. Direct Selling Association (``DSA'')
RR 22. American Bar Association, Section on Antitrust Law (``ABA
AT'')
RR 23. Dennis E. Wieczorek, Rudnick & Wolfe (``Wieczorek'')
RR 24. Real Estate National Nework (``RENN'')
RR 25. Attorney General Jim Ryan (``General Ryan''), State of
Illinois
RR 26. Alan S. Nopar (``Nopar'')
RR 27. Snap-On, Inc. (``Snap-On'')
RR 28. Steven Rabenberg, Explore St. Louis (``Rabenberg'')
RR 29. Douglas M. Brooks, Martland & Brooks (``Brooks'')
RR 30. Robert N. McDonald (``Commissioner McDonald''), Securities
Commissioner, State of Maryland
RR 31. Little Ceasars (``Little Ceasars'')
RR 32. International Franchise Association (``IFA'')
RR 33. Brownstein, Zeidman & Lore (``Brownstein Zeidman'')
RR 34. Jere W. Glover (``Glover''), Counsel for Advocacy, U.S.
Small Business Administration (``SBA Advocacy'')
RR 35. Jan Meyers, Chair, House Committee on Small Business
(``Representative Myers'')
RR 36. Neil A. Simon, Hogan and Hartson (``Simon'')
RR 37. Deborah Bortner (``Bortner''), Washington State Department
of Financial Institutions, Securities Division
RR 38. American Franchisee Association (``AFA'')
RR 39. American Association of Franchisees & Dealers (``AAFD'')
RR 40. Warrren Lewis, Lewis & Trattner (``Lewis'')
RR 41. Century 21 Real Estate Corp. (``Century 21'')
RR 42. John Hayden (``Hayden'')
RR 43. North American Securities Administrators Association
(``NASAA'')
RR 44. Robert L. Perrry (``Perry'')
RR 45. The State Bar of California, Business Law Section (``CA
BLS'')
RR 46. Mike Gaston, Barkely & Evergreen (``Gaston'')
RR 47. The Southland Corp. (``Southland'')
RR 48. Medicap Pharmacies, Inc. (``Medicap'')
RR 49. Rochelle B. Spandorf (``Spandorf''), ABA Forum on
Franchising, Andrew C. Selden (``Selden''), David J. Kaufman
(``Kaufmann'')
RR 50. Joyce G. Mazero, Locke Pernell Rain Harrell (``Mazero'')
RR 51. Mark B. Forseth, Locke Pernell Rain Harrell (``Forseth'')
RR 52. Forte Hotels (``Forte Hotels'')
RR 53. R.A. Politte (``Politte'')
RR 54. Politte (see supra, RR 53).
RR 55. Brown (see supra, RR 9).
RR 56. Wieczorek (see supra, RR 23).
RR 57. Scott Shane, Georgia Institute of Technology (``Shane'')
RR 58. Friday's (``Friday's'')
RR 59. Carl E. Zwisler, Keck, Mahin & Cate (``Zwisler'')
RR 60. Wieczorek (see supra, RR 23)
RR 61. Enrique A. Gonzalez, Gonzalez Cavillo Y Forastierei
(``Gonzalez'')
RR 62. Pepsico Restaurants (``Pepsico'')
RR 63. IFA (see supra, RR 32)
RR 64. Atlantic Richfield Co (``ARCO'')
RR 65. David Clanton (``Clanton'')
RR 66. Leonard Swartz, Arthur Andersen & Co. (``Swartz'')
RR 67. John R.F. Baer, Keck, Mahin & Cate (``Baer'')
RR 68. Lynn Scott (``Scott'')
RR 69. Eversheds ([ldqu]o;Eversheds'')
RR 70. Brownstein Zeidman (see supra, RR 33)
RR 71. Penny Ward, Baker & McKenzie (``Ward'')
RR 72. Matthias Stein (``Stein'')
RR 73. Byron Fox, Hunton & Williams (``Fox'')
RR 74. Papa John's Pizza (``Papa Johns'')
RR 75. Harold L. Kestenbaum (see supra, RR 14)
Rule Review September 1995 Public Workshop Conference
Panelists
Harold Brown, Brown & Stadfeld (``Brown'')
Sam Damico, Q.M. Marketing, Inc. (``Damico'')
Connie B. D'Imperio, Color Your Carpet, Inc. (``D'Imperio'')
Eric Ellman (``Ellman''), Direct Selling Assocation (``DSA'')
Mark B. Forseth, Locke Purnell Rain Harrell (``Forseth'')
Mike Gason, Barkely & Evergreen (``Gaston'')
Susan Kezios, American Franchisee Association (``AFA'')
(``Kezios'')
William Kimball, Iowa Coalition for Responsible Franchising
(``Kimball'')
Warren Lewis, Lewis & Trattner (``Lewis'')
Steven Maxey (``Maxey''), North American Securities Administrators
Association (``NASAA'')
Joyce G. Mazero, Locke Purnell Rain Harrell (``Mazero'')
Barry Pineles (``Pineles''), U.S. Small Business Administration
(``SBA Advocacy'')
Robert Purvin, American Association of Franchisees & Dealers
(``AAFD'') (``Purvin'')
Steven Rabenberg, Explore St. Louis (``Rabenberg'')
Matthew R. Shay (``Shay''), International Franchise Association
(``IFA'')
Neil A. Simon, Hogan & Hartson (``Simon'')
Robin Spencer (``Spencer''), representing American Franchisee
Association
[[Page 15572]]
Leonard Swartz, Arthur Anderson & Co. (``Swartz'')
John Tifford, Brownstein Zeidman & Lore
Ronnie Volkening (``Volkening''), The Southland Corp.
(``Southland'')
Dennis E. Wieczorek, Rudnick & Wolfe (``Wieczorek'')
William J. Wimmer (Wimmer''), Iowa Coalition for Responsible
Franchising
Public Participants
Peter Denzen (``Denzen'')
Bob Hessler, Wendy's (``Hessler'')
Chris Huke, SC Promotions (``Huke'')
Michael Jorgensen (``Jorgensen'')
Robert L. Perry (``Perry'')
Brian Schnell, Gray, Plant Mooty (``Schnell'')
March 1996 Public Workshop Conference
Panelists
Kay M. Ainsley, Ziebart Intl, Corp. (``Ainsley'')
John R.F. Baer, Keck, Mahin & Cate (``Baer'')
Michael Brennan, Rudnick & Wolfe (``Brennan'')
Joel R. Buckberg, HFA, Inc. (``Buckberg'')
David A. Clanton, Baker & McKenzie (``Clanton'')
Kenneth R. Costello, Loeb & Loeb (``Costello'')
Edward J. Fay, Kwik Kopy Corp. (``Fay'')
Mark B. Forseth, Locke Purnell Rain Harrell (``Forseth'')
Byron E. Fox, Hunton & Willaims (``Fox'')
Bruce Harsh, International Trade Specialist, U.S. Department of
Commerce (``Harsh'')
Arnold Janofsky, Precision Tune (``Janofsky'')
Susan P. Kezios (``Kezios''), American Franchisee Association
(``AFA'')
Alex S. Konigsberg, QC (``Konigsberg''), Lapoint Rosenstein
Andrew P. Loewinger, Abraham Pressman & Bauer (``Loewinger'')
H. Bret Lowell, Brownstein Zeidman (``Lowell'')
John Melle, Office of U.S. Trade Representative (``Melle'')
Raymond L. Miolla, Burger King Corp. (``Miolla'')
Alex Papadakis, Hurt Sinisi Papadakis (``Papadakis'')
Matthew R. Shay (``Shay''), International Franchise Association
(``IFA'')
Neil A. Simon, Hogan & Hartson (``Simon'')
Leonard Swartz, Arthur Anderson & Co. (``Swartz'')
Greg L. Walther, Outback Steakhouse Intl (``Walther'')
Dennis E. Wieczorek, Rudnick & Wolfe (``Wieczorek'')
Erik B. Wulff, Hogan & Hartson (``Wulff'')
Philip F. Zeidman (``Zeidman'')
Carl Zwisler, Keck, Mahin & Cate (``Zwisler'')
Public Participants
Jeff Brams, Sign-A-Rama and Shipping Connections (``Brams'')
Pamela Mills, Baker & McKenzie (``Mills'')
Advance Notice of Proposed Rulemaking Commenters
ANPR 1. Kevin Brendan Murphy, Mr. Franchise (``Murphy'')
ANPR 2. Murphy (see supra, ANPR 1).
ANPR 3. Mike Bruce, The Michael Bruce Fund (``Bruce'')
ANPR 4. Harold Brown, Brown & Stadfeld (``Brown'')
ANPR 5. Frances L. Diaz (``Diaz'')
ANPR 6. Brown (see supra, ANPR 4).
ANPR 7. Diaz (see supra, ANPR 5).
ANPR 8. Marian Kunihisa (``Kunihisa'')
ANPR 9. Kevin Bores, Domino's Pizza Franchisee (``Bores'')
ANPR 10. Terrence L. Packer, Supercuts Franchisee (``Packer'')
ANPR 11. John Delasandro (``Delasandro'')
ANPR 12. William Cory (``Cory'')
ANPR 13. Joseph Manuszak, Domino's Franchisee (``Manuszak'')
ANPR 14. Daryl Donafin, Taco Bell Franchisee (``Donafin'')
ANPR 15. David Muncie, National Claims Service, Inc. (``Muncie'')
ANPR 16. Patrick E. Meyers, The Quizno's Corp. (``Quizno's'')
ANPR 17. David Weaver, Domino's Pizza Franchisee (``Weaver'')
ANPR 18. Karen M. Paquet, Domino's Pizza Franchisee (``Paquet'')
ANPR 19. Gary R. Duvall Graham & Dunn (``Duvall'')
ANPR 20. Andrew J. Sherman, Greenberg & Tauris (``Sherman'')
ANPR 21. S. Beavis Stubbings (``Stubbings'')
ANPR 22. Jim & Evalena Gray, Pearle Vision Franchisee (``J&E
Gray'')
ANPR 23. Ernest Higginbotham (``Higginbotham'')
ANPR 24. Henry C. Su & Bryon Fox (``Su'')
ANPR 25. John R. F. Baer, Keck, Mahin & Cate (``Baer'')
ANPR 26. Clay Small & Lowell Dixon, Nat'l Franchise Mediation
Program Steering Committee (``NFMP'')
ANPR 27. Richard T. Catalano (``Catalano'')
ANPR 28. Neil Simon & Erik Wulff, Hogan & Hartson (``H&H'')
ANPR 29. Glenn A. Mueller, Domino's Pizza Franchisee (``Mueller'')
ANPR 30. Doug Bell et al. Supercuts Franchisees (``Supercut
Franchisees'')
ANPR 31. Michael L. Bennett, Longaberger Co. (``Longaberger'')
ANPR 32. John Rachide, Domino's Pizza Franchisee (``Rachide'')
ANPR 33. David J. Kaufmann, Kaufmann, Feiner, Yamin, Gildin &
Robbins (``Kaufmann'')
ANPR 34. Joseph N. Mariano, Direct Selling Association (``DSA'')
ANPR 35. Linda F. Golodner & Susan Grant, National Consumers League
(``NCL'')
ANPR 36. Jere W. Glover & Jennifer A. Smith, U.S. Small Business
Administration Office of Chief Counsel for Advocacy (``SBA Advocacy'')
ANPR 37. Robert Chabot, Domino's Pizza Franchisee (``Chabot'')
ANPR 38. Teresa Maloney, National Coalition of 7-Eleven Franchisees
(``Maloney'')
ANPR 39. BLANK
ANPR 40. Harold L. Kestenbaum (``Kestenbaum'')
ANPR 41. Samuel L. Sibent, KFC Franchisee (``Sibent'')
ANPR 42. Oren C. Crothers, KFC Franchisee (``Crothers'')
ANPR 43. Matthew Jankowski, KFC Franchisee (``Jankowski'')
ANPR 44. Rodney A. DeBoer, KFC Franchisee (``DeBoer'')
ANPR 45. Liesje Bertoldi, KFC Franchisee (``L. Bertoldi)''
ANPR 46. Steve Bertoldi, KFC Franchisee (``S. Bertoldi'')
ANPR 47. Charles Buckner, KFC Franchisee (``Buckner'')
ANPR 48. Walter J. Knezevich, KFC Franchisee (``Knezevich'')
ANPR 49. Jeffrey W. Gray, KFC Franchisee (``J. Gray'')
ANPR 50. Fred Jackson, KFC Franchisee (``Jackson'')
ANPR 51. Ronald L. Rufener, KFC Franchisee (``Rufener'')
ANPR 52. Tim Morris, KFC Franchisee (``Morris)''
ANPR 53. Scarlett Norris Adams, KFC Franchisee (``Adams'')
ANPR 54. Calvin G. White, KFC Franchisee (``White'')
ANPR 55. Nick Iuliano, KFC Franchisee (``N. Iuliano'')
ANPR 56. Dolores Iuliano, KFC Franchisee (``D. Iuliano'')
ANPR 57. Ralph A Harman, KFC Franchisee (``R. Harman'')
ANPR 58. Saundra S. Harman, KFC Franchisee (``S. Harman'')
ANPR 59. Richard Braden, KFC Franchisee (``Barden'')
ANPR 60. K.F. C. of Pollys, KFC Franchisee (``Pollys'')
[[Page 15573]]
ANPR 61. Joan Fiore, McDonalds Franchisee (``Fiore'')
ANPR 62. Susan P. Kezios, American Franchisee Association (``AFA'')
ANPR 63. Kenneth R. Costello, Loeb & Loeb (``Costello'')
ANPR 64. AFA (see supra, ANPR 62)
ANPR 65. Susan Rich, KFC Franchisee (``Rich'')
ANPR 66. Fiore (see supra, ANPR 61)
ANPR 67. Mike Johnson, Subway Franchisee (``Johnson'')
ANPR 68. Laurie Gaither, GNC Franchisee (``L. Gaither'')
ANPR 69. Greg Gaither, GNC Franchisee (``G. Gaither'')
ANPR 70. Greg Suslovic, Subway Franchisee (``Suslovic'')
ANPR 71. Richard Colenda, GNC Franchisee (``Colenda'')
ANPR 72. Bob Gagliati, GNC Franchisee (``Gagliati'')
ANPR 73. Pat Orzano, 7-Eleven Franchisee (``Orzano'')
ANPR 74. Linda Gaither, GNC Franchisee (``Li Gaither'')
ANPR 75. Kevin 100 (``Kevin 100'')
ANPR 76. Robert James, Florida Department of Agriculture & Consumer
Services (``James'')
ANPR 77. Robert A. Tingler, Office of the Attorney General, State
of Illinois (``IL AG'')
ANPR 78. John M. Tifford, Rudnick, Wolfe, Epstien & Zeidman
(``Tifford'')
ANPR 79. Robert L. Purvin, Jr. (``Purvin'')
ANPR 80. Teresa Heron, My Favorite Muffin Franchisee (``Heron'')
ANPR 81. Purvin (see supra, ANPR 79)
ANPR 82. Matthew R. Shay, International Franchise Association
(``IFA'')
ANPR 83. Duvall (see supra, ANPR 19)
ANPR 84. Lance Winslow, Car Wash Guys (``Winslow'')
ANPR 85. Winslow (see supra, ANPR 84)
ANPR 86. Rick Gue, The Pampered Chef, (``Pampered Chef'')
ANPR 87. John M. Tifford, Coverall North America (``Coverall'')
ANPR 88. John M. Tifford, Merchandise Mart Properties (``Merchanise
Mart'')
ANPR 89. Dirk C. Bloemendaal, Amway Corproation (``Amway'')
ANPR 90. Winslow (see supra, ANPR 84)
ANPR 91. Winslow (see supra, ANPR 84)
ANPR 92. Winslow (see supra, ANPR 84)
ANPR 93. Winslow (see supra, ANPR 84)
ANPR 94. Andrew A. Caffey (``Caffey'')
ANPR 95. Entrepreneur Media, Inc. (``Entrepreneur'')
ANPR 96. Brown (see supra, ANPR 4)
ANPR 97. Raymond & Robert Buckley, Scorecard Plus Franchisees
(``Buckley'')
ANPR 98. Mark A. Kirsch, Rudnick, Wolfe, Epstien & Zeidman
(``Kirsch'')
ANPR 99. Dale E. Cantone, Maryland Division of Securities, Office
of the Attorney General (``Md Securities'')
ANPR 100. Roger C. Haines, Scorecard Plus Franchisee (``Haines'')
ANPR 101. David E. Myklebust, Scorecard Plus Franchisee
(``Myklebust'')
ANPR 102. Robert Larson (``Larson'')
ANPR 103. Brown (see supra, ANPR 4)
ANPR 104. Mark B. Forseth, CII Enterprises (``CII'')
ANPR 105. Bertrand T. Unger, PR One (``Pr One'')
ANPR 106. Dennis E. Wieczorek, Rudnick & Wolfe (``Wieczorek'')
ANPR 107. Gerald A. Marks, Marks & Krantz (``Marks'')
ANPR 108. Brown (see supra, ANPR 4)
ANPR 109. Everett W. Knell (``Knell'')
ANPR 110. Anne Crews, Mary Kay, Inc. (``Mary Kay'')
ANPR 111. Carl Letts, Domino's Pizza Franchisee (``Letts'')
ANPR 112. Kat Tidd (``Tidd'')
ANPR 113. Ted Poggi, National Coalition of Associations of 7-Eleven
Franchisees (``NCA 7-Eleven Franchisees)
ANPR 114. Gary R. Duvall & Nadine C. Mandel (``Duvall & Mandel'')
ANPR 115. Sherry Christopher, Christopher Consulting, Inc.
(``Christopher'')
ANPR 116. Carl C. Jeffers, Intel Marketing Systems, Inc.
(``Jeffers'')
ANPR 117. Deborah Bortner, State of Washington, Department of
Financial Institutions, Securities Divisions (``WA Securities'')
ANPR 118. Carmen D. Caruso, Noonan & Caruso (``Caruso'')
ANPR 119. Howard Bundy, Bundy & Morrill, Inc.(``Bundy'')
ANPR 120. Franchise & Business Opportunity Committee, North
American Securities Administrations Association (``NASAA'')
ANPR 121. Tifford (see supra, ANPR 78)
ANPR 122. Wieczorek (see supra, ANPR 106)
ANPR 123. John & Debbie Lopez, Baskin & Robbins Franchisee
(``Lopez'')
ANPR 124. Susan R. Essex & Ted Storey, California Bar, Business Law
Section (``CA BLS'')
ANPR 125. Peter C. Lagarias, The Legal Solutions Group
(``Lagarias'')
ANPR 126. James G. Merret, Jr. (``Merret'')
ANPR 127. W. Michael Garner, Dady & Garner (``Garner'')
ANPR 128. Jeff Brickner (``Brickner'')
ANPR 129. Bernard A. Brynda, Baskin & Robbins Franchisee
(``Brynda'')
ANPR 130. Caron B. Slimak, Jacadi USA Franchisee (``Slimak'')
ANPR 131. Dr. Ralph Geiderman, Pearl Vision Franchisee
(``Geiderman'')
ANPR 132. Felipe Frydmann, Minister of Economic & Trade Affairs,
Embassy of the Argentine Republic (``Argentine Embassy'')
ANPR 133. Andrew C. Selden, Briggs & Morgan (``Selden'')
ANPR 134. Robert Zarco, Zarco & Pardo (``Zarco & Pardo'')
ANPR 135. Jason H. Griffing, Baskin & Robbins Franchisee
(``Griffing'')
ANPR 136. Erik H. Karp, Witmer, Karp, Warner & Thuotte (``Karp'')
ANPR 137. William D. Brandt, Ferder, Brandt, Casebeer, Copper, Hoyt
& French (``Brandt'')
ANPR 138. Robert S. Keating, Baskin & Robbins Franchisee
(``Keating'')
ANPR 139. A. Patel, Baskin & Robbins Franchisee (``A. Patel'')
ANPR 140. Joel R. Buckberg, Cendant Corporation (``Cendant'')
ANPR 141. Duvall (see supra, ANPR 19)
ANPR 142. NCL (see supra, ANPR 35)
ANPR 143. AFA (see supra, ANPR 62)
ANPR 144. Catalano (see supra, ANPR 27)
ANPR 145. DSA (see supra, ANPR 34)
ANPR 146. Keating (see supra, ANPR 139)
ANPR 147. Kathie & David Leap, Baskin & Robbins Franchisee
(``Leap'')
ANPR 148. Ted D. Kuhn, Baskin & Robbins Franchisee (``Kuhn'')
ANPR 149. Mike S. Lee, Baskin & Robbins Franchisee (``Lee'')
ANPR 150. R. Deilal, Baskin & Robbins Franchisee (``Deilal'')
ANPR 151. Frank J. Demotto, Baskin & Robbins Franchisee
(``Demotto'')
ANPR 152. Thomas Hung, Baskin & Robbins Franchisee (``Hung'')
ANPR 153. Jean Jones, Baskin & Robbins Franchisee (``Jones'')
ANPR 154. Hang, Baskin & Robbins Franchisee (``Hang'')
ANPR 155. Dilip Patel, Baskin & Robbins Franchisee (``D. Patel'')
ANPR 156. Terry L. Glase, Baskin & Robbins Franchisee (``Glase'')
ANPR 157. R.E. Williamson, Baskin & Robbins Franchisee
(``Williamson'')
ANPR 158. R. M Valum, Baskin & Robbins Franchisee (``Valum'')
ANPR 159. Rajendra Patel, Baskin & Robbins Franchisee (``R.
Patel'')
ANPR 160. Jerry & Debbie Robinett, Baskin & Robbins Franchisee
(``Robinett'')
ANPR 161. Ronald J. Rudolf, Baskin & Robbins Franchisee
(``Rudolf'')
[[Page 15574]]
ANPR 162. Kamlesh Patel, Baskin & Robbins Franchisee (``K. Patel'')
ANPR 163. Nicholas & Marilyn Apostal, Baskin & Robbins Franchisee
(``Apostal'')
ANPR 164. Patrick Sitin, Baskin & Robbins Franchisee (``Sitin'')
ANPR 165. Paul & Lisa SeLander, Baskin & Robbins Franchisee
(``SeLander'')
ANPR 166. S. Bhilnym, Baskin & Robbins Franchisee (``Bhilnym'')
ANPR 167. Mike & Kathy Denino, Baskin & Robbins Franchisee
(``Denino'')
ANPR Workshop Participants
Michael Bennett, Longaberger Company (``Bennett'')
Kennedy Brooks (``Brooks'')
John Brown, Amway Corporation (``J. Brown'')
Howard Bundy, Bundy & Morrill (``Bundy'')
Delia Burke, Jenkins & Gilchrist (``Burke'')
Andrew Caffey, Esq. (``Caffey'')
Dale Catone, Office of the Maryland Attorney General (``Cantone'')
Emilio Casillas, Washington State Securities Division
(``Casillas'')
Richard Catalano, Esq. (``Catalano'')
Sherry Christopher, Esq. (``Christopher'')
Michael W. Chiodo, Domino's Franchisee (``Chiodo'')
Martin Cordell, Washington State Securities Division (``Cordell'')
Joseph Cristiano, Carvel Franchisee (``Cristiano'')
John D'Alessandro, Quaker State Lube Distributor (``D'Alessandro'')
Mark Deutsch, former franchisee (``Deutsch'')
Steve Doe, Franchisee (``Doe'')
Gary Duvall, Graham & Dunn (``Duvall'')
Eric Ellman, Direct Selling Association (``Ellman'')
Debbie Fetzer, Snap-On Franchisee (``Fetzer'')
David Finigan, Illinois Securities Department (``Finigan'')
Mark B. Forseth, Jenkens & Gilchrist (``Forseth'')
Richard W. Galloway, Domino's Pizza Franchisee (``Galloway'')
Elizabeth Garceau, Pro Design (``E. Garceau'')
Michael Garceau, Pro Design (``M. Garceau'')
Roger Gerdes, Microsoft Corp. (``Gerdes'')
Rick Geu, The Pampered Chef (``Geu'')
Judy Gitterman, Jenkens & Gilchrist (``Gitterman'')
Susan Grant, National Consumers League (``Grant'')
Bruce Hoar, Hanes Franchisee (``B. Hoar'')
Thomas Hoar, Hanes Franchisee (``T. Hoar'')
Nelson Hockert-Lotz, Domino's Pizza Franchisee (``Hockert-Lotz'')
Tee Houston-Aldridge, World Inspection Network (``Houston-
Aldridge'')
Robert James, Florida Dept. of Agriculture & Consumer Services
(``James'')
Carl Jeffers, Intel Marketing Systems (``Jeffers'')
Erik Karp, Witmer, Karp, Warner & Thuotte (``Karp'')
David Kaufmann, Kaufmann, Feiner, Yamin, Gildin & Robbins
(``Kaufmann'')
Harold Kestenbaum, Hollenbrug, Bleven, Solomon, Ross
(``Kestenbaum'')
Susan Kezios, American Franchisee Association (``Kezios'')
Mark Kirsch, Rudnick Wolfe, Epstien & Zeidman (``Kirsch'')
Charles Lay, Brite Site Franchisee (``Lay'')
Mike Ludlum, Entreprenuer Media (``Ludlum'')
Marge Lundquist, Franchisee (``Lundquist'')
Gerald Marks, Marks & Krantz (``Marks'')
Philip McKee, National Consumers League (``McKee'')
Dianne Mousley, Mike Schmidt's Phil. Hoagies Franchisee
(``Mousley'')
Joseph Punturo, Office of the New York Attorney General
(``Punturo'')
Mehran Rafizadeh, GNC Franchisee (``Rafizadeh'')
David R. Raymond, Esq. (``Raymond'')
Iris Sandow, Blimpie Franchisee (``Sandow'')
Philip Sanson, Illinois Securities Department (``Sanson'')
Matthew Shay, International Franchise Association (``IFA'')
David Silverman, Sportworld Int'l (``Silverman'')
Neil Simon, Hogan & Hartson (``Simon'')
Caron Slimak (``Slimak''), Jacadi USA Franchisee
J. H. Snow, Jenkens & Gilcrist (``Snow'')
Adam Sokol, Illinois Attorney General's Office (``Sokol'')
Kat Tidd, Esq. (``Tidd'')
John Tifford, Rudnick Wolfe, Epstien & Zeidman, (``Tifford'')
Robert Tingler, Franchise Bureau Chief. Illinois Attorney General's
Office (``Tingler'')
Bertrand Unger, PR One (``Unger'')
Dr. Spencer Vidulich, Pearle Vision Franchisee (``Vidulich'')
Dick Way, PR One (``Way'')
Dennis Wieczorek, Rudnick & Wolfe (``Wieczorek'')
Erik Wulff, Hogan & Hartson (``Wulff'')
Barry Zaslav, Coverall North America (``Zaslav'')
Franchise Rule Notice of Proposed Rulemaking Commenters
NPR 1. Patrick E. Meyers, The Quizno's Corporation (``Quizno's'')
NPR 2. Steven A. Rosen, Frannet (``Frannet'')
NPR 3. Robert Tingler, Franchise Bureau Chief, Illinois Attorney
General (``IL AG'')
NPR 4. Dennis E. Wieczorek, Piper Marbury Rudnick & Wolfe
(``PMR&W'')
NPR 5. Jack Schuessler, Wendy's Intl, Inc. (``Wendy's'')
NPR 6. Curtis S. Gimson, Triarc Restaurant Group (``Triarc'')
NPR 7. Eugene Stachowiak, McDonald's (``McDonalds'')
NPR 8. David E. Holmes (``Holmes'')
NPR 9. Erik B. Wulff, John F. Dienelt, Hogan & Hartson (``H&H'')
NPR 10. Ronnie R. Volkening, 7-Eleven, Inc. (``7-Eleven'')
NPR 11. John R.F. Baer, Robert T. Joseph, Alan H. Silberman,
Sonnenschein Nath & Rosenthal (``Baer'')
NPR 12. Morton A. Aronson, Neil A. Simon, David J. Kaufmann,
National Franchise Council (``NFC'')
NPR 13. Alaska Turner (``Turner'')
NPR 14. Susan P. Kezios, American Franchisee Association (``AFA'')
NPR 15. Warren L. Lewis, Lewis & Kolton (``Lewis'')
NPR 16. John W. Regnery, Snap-On Inc. (``Snap-On'')
NPR 17. Dale E. Cantone, Stephen W. Maxey, Joseph J. Punturo, NASAA
Franchise and Business Opportunity Project Group (``NASAA'')
NPR 18. Howard E. Bundy, Bundy & Morrill, Inc. (``Bundy'')
NPR 19. Laurie Taylor (``Taylor'')
NPR 20. Jonathan Hubbell, Prudential Real Estate Affiliates
(``PREA'')
NPR 21. David Gurnick, Arter & Hadden (``Gurnick'')
NPR 22. Don J. DeBolt, Matthew R. Shay, International Franchise
Association (``IFA'')
NPR 23. L. Seth Stadfeld, Weston, Patrick, Willard & Redding
(``Stadfeld'')
NPR 24. Eric H. Karp, Witmer, Karp, Warner & Thuotte (``Karp'')
NPR 25. Janet L. McDavid, American Bar Association, Section of
Antitrust Law (``ABA AT'')
NPR 26. Randall Loeb, NaturaLawn of America (``NaturaLawn'')
NPR 27. Tony Rolland, National Franchisee Association (``NFA'')
NPR 28. Andrew P. Loewinger, Buchannan Ingersoll (``BI'')
NPR 29. Jeffrey E. Kolton, Frandata (``Frandata'')
NPR 30. AFC Enterprises (``AFC'')
[[Page 15575]]
NPR 31. Howard Morrill, Bundy & Morrill, Inc. (``Morrill'')
NPR 32. Carl E. Zwisler, Jenkens & Gilchrist (``J&G'')
NPR 33. Diane T. Nauer, TruServ Corporation (``TruServ'')
NPR 34. Brian H. Cole, Tricon (``Tricon'')
NPR 35. Steven Goldman, Mark Forseth, Marriott Corp. (``Marriott'')
NPR Rebuttal 36. Gurnick (see supra, FR-NPR 21)
NPR Rebuttal 37. Kezios (see supra, FR-NPR 14)
NPR Rebuttal 38. IL AG (see supra, FR-NPR 3)
NPR Rebuttal 39. Bundy (see supra, FR-NPR 18)
NPR Rebuttal 40. John W. Fitzgerald, Gray, Plant, Mooty, Mooty &
Bennett (``GPM'')
Staff Report
Affiliated Foods Midwest (``Affiliated Foods'')
American Association of Franchisees and Dealers (``AAFD'')
American Franchisee Association (``AFA'')
Briggs & Morgan (``Selden'')
Bundy & Morrill, Inc. (``Bundy'')
Car Wash Guys (``Winslow'')
Cendant Corp. (``Cendant'')
CHS, Inc. (``CHS'')
Gary Duvall (``Duvall'')
Frost Brown Todd (``Graber'')
David Gurnick (``Gurnick'')
Gust Rosenfeld (``Gust Rosenfeld'')
Illinois Attorney General (``IL AG'')
Independent Distributors Cooperative (``IDC'')
International Franchise Association (``IFA'')
Jeffrey S. Haff (``Haff'')
Jenkens & Gilchrist (``J&G'')
Johnson, Hearn, Vinegar, Gee & Mercer (``Gee'')
Kaufmann, Feiner, Yamin, Gildin & Robbins (``Kaufmann'')
A. Koutsoulis (``Koutsoulis'')
Law Office of Marc N. Blumenthal (``Blumenthal'')
Law Office of Peter A. Singler (``Singler'')
Legal Solutions Group (``Lagarias'')
Marks & Associates (``Marks'')
Michael H. Seid & Assoc. (``Seid'')
National Automobile Dealers Assoc. (``NADA'')
National Cooperative Business Assoc. (``NCBA'')
National Council of Farmer Cooperatives (``NCFC'')
National Grocers Assoc. (``NGA'')
North American Securities Administrators Association (``NASAA'')
Pillsbury Winthrop (``Chevron'')
Pillsbury Winthrop (``Pillsbury Winthrop'')
Piper Rudnick (``Piper Rudnick'')
Prudential Real Estate Affiliates (``PREA'')
Richard Pu (``Pu'')
Riezman Berger (``Riezman Berger'')
Spandorf, Silberman, Joseph, and Baer (``Spandorf'')
Starwood (``Starwood'')
State Bar of California--Franchise Law Committee (``CA Bar'')
State of California Department of Corporations (``CA Dep't of
Corps'')
Paul Steinberg (``Steinberg'')
Washington State Department of Financial Institutions (``WA
Securities'')
Wiggin & Dana (``Wiggin & Dana'')
Witmer, Karp & Warner (``Karp'')
[FR Doc. E7-5829 Filed 3-29-07; 8:45 am]
BILLING CODE 6750-01-S