What Every Attorney Should Know About Franchise Law
by Earsa R. Jackson
The concept of franchising dates back many centuries; however, what we know today as franchising did not develop until the early 1900s. Some of the earlier models were licensing arrangements created by manufacturers. Later, hotels were franchised. Franchising has developed exponentially since that time. Today, there are franchises in scores of industries.
Franchising is highly regulated both at the state and federal level.Franchises face both specific regulations and business opportunity regulations. Moreover, there are two types of regulatory schemes: (1) registration and disclosure laws that govern the offer and sale of franchises or business opportunities; and (2) franchise relationship laws that govern the ongoing relationship between the parties. Some states have both regulatory schemes.
The federal definition of a franchise includes the following elements: a continuing commercial relationship in which (1) the franchisor grants franchisee the right to operate using franchisor’s trademarks; (2) the franchisor has the authority to exert a significant degree of control over franchisee’s method of operation; and (3) the franchisee pays $500 or more for the right to operate the franchise. 16 CFR Part 436.1(h). Numerous states also have franchise laws that define a “franchise” a bit differently.
Federal Franchise Law. The Federal Trade Commission (FTC) is the federal regulatory agency with jurisdiction over franchises and business opportunities. The FTC’s regulations require that certain disclosures be made to prospective franchisees and business opportunity purchasers before a franchise is sold. There are 23 required “Items” for disclosure. The disclosure document is referred to as the Franchise Disclosure Document or FDD. The FTC’s regulations apply to all franchises in the U.S. (subject to certain limited exceptions), but do not provide for any federal registration of the franchise or filing of the disclosure document, only disclosure. The FTC also regulates business opportunities, but franchisors are excluded from this regulatory scheme.
State Franchise Law. Fifteen states, excluding Texas, have some type of franchise registration and/or disclosure laws. These states do not have uniform regulations in this regard. The states have adopted the FDD format, but they typically require additional state specific disclosures be added to the FDD. About 20 states, excluding Texas, also have some type of franchise relationship law that regulates matters such as permissible grounds for termination or nonrenewal of the franchise, as well as required notice and cure periods for defaults. These laws will trump language in the standard franchise agreement.
State Business Opportunity Law. About 25 states, including Texas, have laws requiring registration and/or disclosure of business opportunity sales. The laws of most states with business opportunity regulations provide an exemption for franchises; however, the exemption is generally subject to certain conditions. Some states require the filing of additional documentation in order to obtain the exemption.
Determining the Governing State Law. A franchise transaction may be governed by the laws of more than one state. The possible applicable state lawsinclude: (1) the state of the franchisor’s domicile or where its sales office is located; (2) the state where the prospective franchisee resides or is domiciled; (3) the state where the prospective franchisee’s business is or will be located; (4) the state(s) to be included in the prospective franchisee’s territory; (5) the state where the offer of a franchise is made; and (6) the state(s) where any partner or joint venturer of the prospective franchisee resides or is domiciled.
Penalties for Noncompliance.Many companies have attempted to structure models to avoid franchise implications. Others have merely called the relationship something else. Regardless of what the relationship is called by the parties, courts will look at the actual relationship and transaction to determine whether a franchise exists.
Noncompliance with franchise laws carries serious consequences such as civil penalties, criminal fines, and jail sentences. In some states, the violation of the state franchise law is a misdemeanor. In other states, it is considered to be a fraudulent and deceptive practice. Under the laws of some states, franchisees affected by the illegal conduct of a franchisor have special rights, including the right to terminate the franchise agreement and receive reimbursement of the fees paid to the franchisor, and/or the recovery of actual damages suffered by the franchisee as a result of the illegal conduct, plus a penalty of up to three times the amount of actual damages. As with most areas of law, ignorance of franchise laws does not excuse illegal conduct.
Earsa R. Jackson is a Partner at Strasburger & Price, LLP. She can be reached at Earsa.firstname.lastname@example.org.