The FTC recently announced that it has made three monetary exemption threshold adjustments for inflation in its Franchise Rule. The thresholds are used to determine whether the sale of a franchise qualifies for an exemption from the Franchise Rule. The Franchise Rule requires franchisors to disclose key information to potential buyers, which allows the potential buyer to evaluate the risks and benefits of investing in a franchise.
FTC Begins Regulating Franchises in 1978
The FTC began examining the business practices of the of franchisors in 1970. In 1971, the FTC engaged in formal rulemaking regarding the business practices franchisors. By 1978, the FTC promulgated the FTC Franchise Rule as part of its authority to prescribe rules that define with specificity acts or practices that are unfair or deceptive under the FTC Act. In January 2007, the FTC approved amendments to the Franchise Rule, which were made mandatory on all franchisors as of July 1, 2008.
Required Disclosures Under the Franchise Rule
The Franchise Rule provides potential franchise purchasers (“franchisees”) the material information they need in order to weigh the risks and benefits associated with investing in a franchise. The Franchise Rule requires franchisors to provide all potential franchisees with a disclosure document containing 23 specific items of information regarding the offered franchise, its officers, and other franchisees. Some of the required items of information include: the franchise’s litigation history, past and current franchisees and their contact information, any exclusive territory that comes with the franchise, assistance the franchisor provides franchisees, and the cost of purchasing and starting up a franchise. Additionally, if a franchisor makes representations about the financial performance of the franchise, this topic also must be covered, as well as the material basis backing up those representations.
2007 Amendments to the Franchise Rule
As part of the 2007 amendments, the FTC sought to harmonize the federal Franchise Rule with state franchise disclosure laws. The FTC has said that their amendments:
[A]lso serve the purposes of updating the original rule to adapt to changes in the marketing of franchises and new technologies, reducing compliance costs where possible, and addressing complaints voiced by many franchisees during the amendment proceeding about the franchisees’ experience with franchisors after they have signed an agreement and entered into a franchise relationship.
The 2007 amendments to the Franchise Rule brought the rule much closer in alignment with state franchise disclosure laws, which state laws are based upon the Uniform Franchise Offering Circular (“UFOC”) guidelines, developed and administered by the North American Securities Administrators Association (“NASAA”). The FTC has noted that while the amended Franchise Rule “closely tracks the UFOC Guidelines, in some instances it requires more extensive disclosures – mostly with respect to certain aspects of the franchisee-franchisor relationship.” For instance, under the amended Franchise Rule, a franchisor is required to make more extensive disclosures as it relates to: lawsuits the franchisor has filed against franchisees; the franchisor’s use of so-called “confidentiality clauses” in lawsuit settlements; a warning when there is no exclusive territory; an explanation of what the term “renewal” means for each franchise system; and trademark-specific franchisee associations. However, in other instances, the amended Franchise Rule requires less than the UFOC guidelines, including that it does not require disclosure of so-called “risk factors,” franchise broker information, or extensive information about every component of any computer system that a franchisee must purchase.
Amended Franchise Rule Separates Franchises and Business Opportunity Ventures
The original Franchise Rule, in a single part of the Code of Federal Regulations (“CFR”), covered only two distinct types of offerings franchises and business opportunity ventures. Business opportunity ventures, unlike franchises, usually do not involve the right to use a trademark or other commercial symbol. Even still, they do call for the opportunity seller to provide purchasers with locations for machines or equipment or with clients. The amended Franchise Rule separates the requirements applicable to franchises from those applicable to business opportunity ventures. Part 436 of the amended rule covers only franchises, while a newly-numbered Part 437 (“the Business Opportunity Rule”) preserves the text of the original rule in so far as it covers business opportunity ventures.
2016 Adjustments to Franchise Rule Exemption Thresholds
Under the Franchise Rule, the FTC is required to make threshold adjustments for inflation every four years based on the Consumer Price Index (“CPI”). The FTC’s latest adjustments the applicable thresholds under the Franchise Rule, which take place as of July 1, 2016, are as follows:
- Sales where the buyer pays less that $570 (currently $540) for the franchise;
- Sales requiring a large investment where the franchisee pays at least $1,143,100 (currently $1,084,900), excluding the cost of unimproved land and any franchisor (or affiliate) financing; and
- Sales to large entities, such as multi-unit franchisees, airports, hospitals, and universities that have been in business for at least five years and have a net worth of at least $5,715,500 (currently $5,424,500).
Or, in other words, if a buyer pays less than $570 for a franchise, then the sale is eligible for exemption from the Franchise Rule. Likewise, on the higher endo of the financial spectrum, if the sale requires a franchisee to pay at least $1,143,100, then the sale will be eligible for exemption. And finally, when a sale is made to a large entity or entities, such as multi-unit franchisees, airports, hospital and universities, these entities must have been in business for at least five years and have a net worth of at least $5,715,500 in order to qualify for an exemption under the Franchise Rule.
Other Laws and Regulations Governing Franchises
In addition to the Franchise Rule discussed above, franchises must also comply with federal and state registration law requirements, involving things like: registration of the franchise; registration of franchise salespersons; and registration of franchise advertising. Franchises must also follow federal and state relationship laws, which govern certain aspects of the relationship between the franchisor and franchisee, such as: grounds for terminating a franchise; notice and cure periods before termination; grounds for not renewing a franchise; and equal treatment of franchisees. Some of the more common potential violations a franchise may face include:
- Offering or selling an unregistered franchise
- Failing to provide a UFOC on time
- Failing to provide all required disclosures in the UFOC
- Making misrepresentations to franchisee prospects
- Improperly terminating or not renewing a franchise
Contact our FTC Team Today
If you or someone you know is considering investing into a franchise or are already a franchisee or franchisor, please contact our FTC team and other franchise law attorneys for a consultation. We can be reached via email at email@example.com, by phone at (801) 323-5000, or through our contact form.