Guide To The FTC Franchise and Business Opportunity Rule

Rule Overview

Rule Requirements

Business Relationships Covered

Disclosure Options

Potential Liability for Violations

Legal Resources

I. Rule Overview

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

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

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

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

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

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

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

II. Rule Requirements

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

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

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

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

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

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

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

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

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

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

III. Business Relationships Covered

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

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

1. Trademark: The franchisor offers the right to distribute goods or services that bear the franchisor's trademark, service mark, trade name, advertising or other commercial symbol.
2. Significant Control or Assistance: The franchisor exercises significant control over, or offers significant assistance in, the franchisee's method of operation.
3. Required Payment: The franchisee is required to make any payment to the franchisor or an affiliate, or a commitment to make a payment, as a condition of obtaining the franchise or commencing operations. (NOTE: There is an exemption from coverage for required payments of less than $500 within six months of the commencement of the franchise (Part 436.2(a)(3)(iii)).

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

1. No Trademark: The seller simply offers the right to sell goods or services supplied by the seller, its affiliate, or a supplier with which the seller requires the franchisee to do business.
2. Location Assistance: The seller offers to secure retail outlets or accounts for the goods or services to be sold, to secure locations or sites for vending machines or rack displays, or to provide the services of someone who can do so.
3. Required Payment: The same as for franchises.

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

1. Minimum investment: This exemption applies if all payments to the franchisor or an affiliate until six months after the franchise commences operation are $500 or less (Part 436.2(a)(iii)).
2. Fractional Franchises: Relationships adding a new product or service to an established distributor's existing products or services, are exempt if: (i) the franchisee or any of its current directors or executive officers has been in the same type of business for at least two years, and (ii) both parties anticipated, or should have, that sales from the franchise would represent no more than 20% of the franchisees sales in dollar volume (Parts 436.2(a)(3)(i) and 436.2(h)).

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

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

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

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

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

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

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

IV. Disclosure Options

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

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

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

1. Guidelines: Effective January 1, 1996, franchisors using the UFOC disclosure format must comply with the UFOC Guidelines, as amended by NASAA on April 25, 1993. (44 FR 49970; 60 FR 51895).
2. Cover Page: The FTC cover page must be furnished to each potential franchisee, either in lieu of the UFOC cover page in non-registration states or along with the UFOC (Part 436.1(a)(21); 44 FR 49970-71).
3. Adaptation: If the UFOC is registered or used in one state, but will be used in another without a franchise registration law, answers to state-specific questions must be changed to refer to the law of the state in which the UFOC is used.
4. Updating: If the UFOC is registered in a state, it must be updated as required by the state's franchise law. If the same UFOC is also adapted for use in a non-registration state, updating must occur as required by the law of the state where the UFOC is registered. If the UFOC is not registered in a state with a franchise registration law, it must be revised annually and updated quarterly as required by the Rule.
5. Presumption: The Commission will presume the sufficiency, adequacy and accuracy of a UFOC that is registered by a state, when it is used in that state.

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

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

1. Scope: Disclosure will be required in all cases required by the Rule, regardless of whether it would be required by state law.
2. Coverage: The Rule will determine who is obligated to comply, regardless of whether they would be required to make disclosures under state law.
3. Disclosure Timing: When disclosures must be made will be governed by the Rule, unless state law requires even earlier disclosure.
4. Other Material: No information may appear in a disclosure document not required by the Rule or by non-preempted state law, regardless of the format used, and no representations may be made that contradict a disclosure.
5. Contracts: Failure to provide potential franchisees with final agreements at least 5 days before signing will be a Rule violation regardless of the disclosure format used.
6. Refunds: Failure to make promised refunds also will be a Rule violation regardless of which document is used.

V. Potential Liability for Violations

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

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

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

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

c. Civil Penalties: Section 5(m)(1)(A) of the Act authorizes civil penalties of up to $10,000 for each violation of the Rule (15 U.S.C. § 45(m)(1)(A)). The courts have granted civil penalties of as much as $870,000 in a Rule case to date.

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

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

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

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

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

1. Rule Claims: The Commission expressed its view when the Rule was issued that private actions should be permitted by the courts for Rule violations (43 FR 59723; 44 FR 49971). To date, no federal court has permitted a private action for Rule violations.
2. State Disclosure Law Claims: Each of the franchise laws in the 15 states with franchise registration and/or disclosure requirements authorizes private actions for state franchise law violations.
3. State FTC Act Claims: The courts in some states have interpreted state deceptive practices laws ("little FTC Acts") as permitting private actions for Rule violations.

VI. Legal Resources

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

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

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

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