During periods of growth and expansion, entrepreneurs and business owners will often recognize that their business needs to consult an attorney. This is especially true in the area of franchising that has strict rules and procedures for offering the sale of business opportunities. While most businesses hire attorneys in connection with acquiring businesses, assets, or expanding to new states or territories; franchises will require significant legal work that comes from the Federal Trade Commission’s (the “FTC”) franchise rules and varying franchise laws from state to state.
The FTC’s franchise rule requires that all franchisors create and maintain a franchise disclosure document (“FDD”). The FDD contains 23 specific items that consolidate all material information about the franchisor in one document for potential franchisees to review before investing in the franchisor.
These 23 specific items include categories that help highlight who owns the franchise and their experience, the financial and legal status of the franchise, the estimated fees and expenses associated with buying and operating a franchise, and rules and procedures of operating a franchise. Additionally, the FDD will include the franchise agreement, which defines the relationship between the franchisor and franchisee. Although the FDD has set categories, it is far from generic and takes significant time drafting, reviewing, and revising to accurately provide all material information specific to each franchise.
From here, states have varying requirements regarding the maintenance and care of the FDD and the franchise as a whole. In all states, the FDD must be updated within 120 days after the franchisor’s year end, and some states require an update following any material change to an item contained in the FDD.
Generally, states are broken down into (1) registration states; (2) filing states; and (3) non-registration states that determine how a franchise must maintain its FDD in addition to other compliance requirements to legally offer franchise opportunities in a particular state.
1. Registration States
Franchise registration states have the strictest compliance rules by requiring that the FDD be registered with the state who then has its examiners review the FDD to ensure that the FDD meets the state’s compliance and regulatory requirements. Once this FDD is registered with a particular state, the franchisor must amend its registration at the time of any material change to the FDD. The timeframe of this required amendment varies, but best practice is to amend the FDD as soon as reasonably practical.
2. Filing States
In comparison to franchise registration states, the franchise filing states have a much simpler, and also much cheaper process. These states typically have laws called “business opportunity laws”, which require a filing of an application of the intent to offer a franchise in the state, an application fee, and usually financial documents. These states do not require the FDD to be filed, but the franchise still must maintain an FDD to remain in compliance with the FTC.
Filing states often allow for exemptions to the business opportunity filing that are usually available when the franchise is licensing a registered trademark in connection with the franchise opportunity. In these cases, you may simply write a no action letter to the state’s relevant department providing notice of your intent to offer the sale of franchises and proof of a registered mark. From here, the state will determine whether or not you will be required to file or if the no action letter is sufficient to meet the requirements of business opportunity exemption.
3. Non-Registration States
True non-registration states have no requirement other than following the rules set forth by the FTC. This means that as long as you maintain the FDD and follow relevant state laws in licenses to do business, then you have no further requirements. However, some states, like Georgia, are non-registration so long as the business has a registered trademark. If you do not have a registered trademark, then the state becomes a filing state, and your franchise would have to file with the state’s business opportunity department.
These compliance requirements set forth at both federal and state levels help highlight the level of protection that federal and state governments feel potential franchisees need. For this reason, states allow severe punishments for failure to comply with franchise laws.
First, laws provide that you can be found guilty of criminal activity as a misdemeanor for offering franchises without fully complying with relevant franchise rules. Additionally, respective agencies have the power to shut down your business, freeze your bank accounts, order restitution, prevent an operator from opening new locations, impose huge penalties, award attorneys’ fees to all injured parties, and rescind every one of your agreements under claim of fraud. These penalties for franchise compliance infractions are severe and can be detrimental to your business, so it is essential to understand what you need to do to comply with the law in every state that you operate and how to maintain compliance as your business grows and changes over time.
If your business has overlooked franchise requirements as its expanded, or has fallen behind on updates to the FDD, it is incredibly important to contact an attorney to amend your documents and contact relevant authorities to bring your business to compliance and avoid the legal penalties described above. This process may be overwhelming, but clear communication with an attorney and remaining available for follow up will help resolve your compliance issues in a timely manner.
George Fowler is an associate at Henderson & Henderson. Contact him with any of your franchise needs.