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The Federal Trade Commission (FTC) recently issued a Compliance Guide to assist franchisors in complying with the recently revised franchise disclosure rule (the Amended Rule). The Franchise Disclosure Document (FDD) format contained in the Amended Rule has become the new standard for franchise disclosure, and all franchisors must follow the FDD format beginning on July 1, 2008.
The FTC promulgated the Amended Rule on January 22, 2007 after more than a decade of rulemaking activity. The FDD disclosure format brings the FTC’s franchise disclosure requirements into greater harmony with, but effectively replaces, the North American Securities Administrators Association’s Uniform Franchise Offering Circular Guidelines (the UFOC Guidelines).
The Compliance Guide is intended to explain and provide additional background information regarding the Amended Rule, rather than to fundamentally alter or expand the Amended Rule. As such, the Compliance Guide reveals no substantial changes in FTC policy or practice and will be of most interest to those involved in the nuts and bolts of franchise disclosure document drafting and compliance.
While the Compliance Guide does not contain any major surprises, it does provide insight into the FTC staff’s thinking on several topics, including the following:
Initial Investment Estimates for Company-Owned Outlets – Like the UFOC Guidelines, the Amended Rule requires in Item 7 that the franchisor disclose the franchisee’s estimated initial investment, which is typically based on the estimated costs incurred in establishing a new franchised outlet. However, franchisors sometimes sell existing outlets to franchisees. The Compliance Guide clarifies that sales of company-owned outlets need to be reflected in Item 7 only if the sale price of a company-owned outlet in the prior fiscal year exceeds the highest investment estimate in Item 7, and in such case a footnote must be included stating by how much the company-owned unit sales price exceeded the highest initial investment estimate contained in the Item 7 chart. The now outdated UFOC Guidelines were not as clear regarding disclosure of company outlet sale prices.
Supplier Payments to Advertising Cooperatives – Item 8 of the Amended Rule continues to require disclosure of certain payments by system suppliers to parties affiliated with the franchisor. The Compliance Guide notes that payments to an advertising fund or a trademark-specific franchisee association, or any third party controlled directly or indirectly by the franchisor or its affiliate, must be disclosed. On the other hand, the Compliance Guide clarifies that no disclosure is required for payments to independent advertising cooperatives.
Pre-Sale Confidentiality Agreements for the Operating Manual – As with the former UFOC Guidelines, the Amended Rule requires that franchisors either include the table of contents of the Operating Manual in the FDD or else allow the franchisee to view the Operating Manual before purchasing the franchise. Given the proprietary nature of the Operating Manual, franchisors often require a prospective franchisee to sign a confidentiality agreement before viewing the manual. Does the signing of such a confidentiality agreement trigger disclosure requirements (including a requirement to wait 14 days after disclosure before signing the confidentiality agreement)? The Compliance Guide makes clear that, because signing a confidentiality agreement does not require the franchisee to commit to purchase the franchise or to undertake financial obligations, the signing of a confidentiality agreement does not by itself trigger the Amended Rule’s disclosure obligations. Note, however, that state regulators could reach a different conclusion regarding whether the signing of such a confidentiality agreement triggers franchise disclosure obligations.
Contact Information for Former Franchisees – Seasoned franchisors are quite familiar with the requirement to provide contact information for former franchisees. Based upon privacy concerns, the Amended Rule provides for disclosure of home contact information for a former franchisee only where the franchisor is unable to obtain business contact information for the former franchisee. Further, a franchisor may honor a franchisee’s request to use alternative contact information, such as an e-mail address or post office box address.
Electronic Disclosure – The Amended Rule expands and provides further clarification regarding use of electronic disclosure. To enable electronic disclosure, the Amended Rule allows a prospective franchisee to sign the FDD receipt electronically. The Compliance Guide clarifies that a prospective franchisee may “sign” the FDD receipt by entering a unique password provided by the franchisor.
Integration Clauses – The Amended Rule states that franchise sellers may not require prospective franchisees to waive reliance on the franchise disclosure document and exhibits. The Compliance Guide clarifies that this prohibition covers franchise agreement integration clauses that purport to disclaim liability for statements made in the franchisor’s franchise disclosure document. In light of the Amended Rule and the Compliance Guide, franchisors will need to review their franchise agreement integration clauses to ensure compliance with the Amended Rule.
The points above highlight only a few of the many amplifications and clarifications the FTC has made in the Compliance Guide. The full text of the Compliance Guide can be found here.
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For more information on the Compliance Guide, please contact your DLA Piper Franchise attorney, or:
Richard J. Morey
John P. Siemsen
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