Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising...

48
American Bar Association 37 th Annual Form on Franchising ____________________________________________________________ FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES Alan R. Greenfield Greenberg Traurig, LLP Chicago, IL Theresa Leets 1 Department of Business Oversight Los Angeles, CA Karen B. Satterlee Hilton Worldwide, Inc. McLean, VA October 15-17, 2014 Seattle, WA ©2014 American Bar Association 1 The opinions expressed by Theresa Leets in this paper and during the oral presentation are her own and do not necessarily represent the views of the California Department of Business Oversight, its Commissioner or NASAA. This paper is a combined work of the three authors. It does not, however, necessarily represent the personal views or opinions of any particular author or his or her employer.

Transcript of Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising...

Page 1: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

American Bar Association 37th Annual Form on Franchising

____________________________________________________________

FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND

FRANCHISE COMPANIES

Alan R. Greenfield Greenberg Traurig, LLP

Chicago, IL

Theresa Leets1 Department of Business Oversight

Los Angeles, CA

Karen B. Satterlee Hilton Worldwide, Inc.

McLean, VA

October 15-17, 2014 Seattle, WA

©2014 American Bar Association

                                                            1 The opinions expressed by Theresa Leets in this paper and during the oral presentation are her own and do not necessarily represent the views of the California Department of Business Oversight, its Commissioner or NASAA.  This paper is a combined work of the three authors.  It does not, however, necessarily represent the personal views or opinions of any particular author or his or her employer. 

Page 2: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

 

 

Table of Contents

I. INTRODUCTION ....................................................................................................................... 1

II. THE PURPOSE OF DISCLOSURE .......................................................................................... 1

III. EXEMPTIONS TYPICALLY APPLICABLE TO LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES ....................................................................... 2

A. Federal Exemptions ...................................................................................................... 2

1. Fractional Franchises ........................................................................................... 2

2. Large Investment Exemption ................................................................................ 3

3. Large Franchisee Exemption ................................................................................ 4

B. Registration State Exemptions ...................................................................................... 5

1. Large Franchisor Exemptions ............................................................................... 5

2. Transactional Exemptions .................................................................................... 6

a. Fractional Franchise Exemption .................................................................. 6

b. Large Investment Exemption ....................................................................... 6

c. Large Franchisee Exemption ....................................................................... 7

d. Renewal of Existing Franchise Agreement .................................................. 7

e. Sales of Existing Franchisee ....................................................................... 8

f. Franchisor Insider Exemption ...................................................................... 9

g. Sales by Existing Franchisee ....................................................................... 9

3. Discretionary Exemption .................................................................................... 10

IV. EXEMPTION CHALLENGES FOR LARGE, SOPHISTICATED AND MULTI-BRAND FRANCHISE COMPANIES ................................................................................................... 10

A. Exemption Challenges for Large and Sophisticated Franchise Companies ............. 10

1. Corporate Structure ........................................................................................... 11

2. Financial Statements ......................................................................................... 11

3. Sophisticated Corporate Actions and Financing Transactions .......................... 12

a. Stock Repurchase Program ...................................................................... 13

Page 3: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

 

 

b. Securitization Financing............................................................................ 13

4. Acquisitions ....................................................................................................... 13

B. Exemption Challenges for Multi-Brand Franchise Companies ................................... 14

V. DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED AND MULTI-BRAND FRANCHISE COMPANIES .................................................................................................... 16

A. Disclosure Challenges for Large and Sophisticated Franchise Companies .............. 16

1. Related Entity Disclosures: Parents, Predecessors, and Affiliates .................. 16

2. Financial Statements ........................................................................................ 18

3. Potential Acquisitions and Other Sophisticated Financing Arrangements ................................................................................................... 19

4. Franchise Owner-Initiated Disclosure Challenges ............................................ 20

5. Routine Material Events ................................................................................... 21

B. Disclosure Challenges for Multi-Brand Franchise Companies .................................. 23

1. Multiple Brands offered in a Single FDD .......................................................... 23

2. Disclosure of Competitive Businesses ............................................................. 24

VI. CONCLUSION ....................................................................................................................... 25

APPENDIX I .................................................................................................................................... 26

APPENDIX II .................................................................................................................................... 42

 

Page 4: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

1

I. INTRODUCTION

This paper explores the challenges that large, sophisticated and/or multi-brand franchise companies experience in complying with federal and state pre-sale disclosure requirements. These challenges take primarily four forms: 1) the requirement that a franchise disclosure document (“FDD”) be created at all, given the nature of the transaction; 2) content restrictions on the FDD that do not permit and exchange of information that would otherwise be an FPR; 3) timing issues relating to the 14-day waiting period; and 4) disclosure requirements that do not appear to consider the business realities of complex business transactions, such as sophisticated franchisors and franchisees engaging in transactions that are unconventional in format or setting.

The first part of this paper will explore whether the franchisor has a disclosure obligation

at all or whether the transaction may be exempt from federal and state franchise disclosure requirements due to the availability of exemptions. This paper is not intended to be a comprehensive discussion on federal and state exemptions, but only a review of federal and state exemptions that enable the franchisor to completely dispense with pre-sale disclosure.1

The second part of this paper will review disclosure issues that large, sophisticated or

multi-brand franchisors often encounter, including: (i) the corporate history of the franchisor and its extended corporate family; (ii) having to include multiple sets of financial statements; (iii) disclosure procedures and timing constraints to be assessed in connection with potential acquisitions and other sophisticated financing arrangements; (iv) franchisee initiated disclosure challenges; (v) the occurrence of material events; and (vi) whether a franchisor may use a single FDD to offer multiple brands.

Finally, we will offer practical tips to manage these issues.

II. THE PURPOSE OF DISCLOSURE The original FTC Rule was issued on December 21, 1978.2 This rule was adopted in

response to the “widespread deception in the sales of franchises and business opportunities through both material misrepresentations and non-disclosures of material facts.”3 The purpose of the FTC Rule was not to regulate the substantive terms of the franchise relationship, but rather, to ensure that franchisees were given specific information that the FTC Rule deemed necessary to enable a prospective franchisee to make an informed investment decision prior to purchasing a franchise.4

1 For a comprehensive discussion see Earsa R. Jackson & Karen B. Satterlee, Navigating the

Exemption/Exclusion Maze Under the Amended FTC Rule and State Laws, ABA 31ST ANNUAL FORUM ON FRANCHISING (2008); Robin Day Glenn & Mary Beth Trice, A Scenic Tour of Exemptions and Exclusions to Franchise Registration Laws, ABA 24TH ANNUAL FORUM ON FRANCHISING (2001).

2 43 Fed. Reg. 59,614 (December 21, 1978). 3 Disclosure Requirements and Prohibitions Concerning Franchising, 72 Fed. Reg. 15,445 (March 30, 2007). 4 Id.

Page 5: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

2

As a general rule, experienced franchisors understand and support the underlying purpose of pre-sale disclosure laws and agree that it is important that the investing public have a complete understanding of the franchise offering prior to making an investment. However, not all franchise concepts, and not all franchise candidates, are similarly situated. The prospective franchisee that is purchasing a home cleaning franchise or other low capital investment franchise is not the same type of institutional investor that is investing in building hotels and restaurants. In these circumstances, one must consider whether a “one size fits all” disclosure requirement is appropriate for all franchisors and all franchisee candidates, whether sophisticated investors are the type of investor that the franchise laws are (or should be) designed to protect, and whether a franchise disclosure document is needed at all to help a sophisticated franchisee make an informed investment decision, in accordance with the purpose of the FTC Rule.

Partially to address these concerns, the FTC amended the FTC Rule in 2007, the

“Amended FTC Rule.”5 The Amended FTC Rule exempts certain classes of franchisees that, because of their size and sophistication, or the fractional nature of the franchised concept, do not need additional regulatory protection. The federal exemptions we will consider for the purposes of this paper are: the Large Franchisee Exemption, the Large Investment Exemption and the Fractional Franchise Exemption. Even though a transaction may be exempt under the FTC Rule, state franchise disclosure requirements must also be considered to determine if a transaction is exempt. State disclosure requirements, and their interplay with the federal exemptions, are discussed in section IV of this paper.

III. EXEMPTIONS TYPICALLY APPLICABLE TO LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

A. Federal Exemptions As we have stated, the focus of this paper is discussing and finding potential solutions to

disclosure challenges for franchisors. However, as precursor to solving disclosure problems, the franchisor should first ensure that it actually has a disclosure obligation.

1. Fractional Franchises

Fractional franchises are extensions of, or add-ons to, a product or service the franchisee is already offering to the public.6 Fractional franchises are commonly found in hotels, grocery stores, universities, airports or in facilities where the product or service offered is within the confines of another business.7 A franchise is “fractional” under the FTC Rule if: (1) the franchisee, any of the franchisee’s current directors or officers, or any current directors or officers of a parent or affiliate, has more than two years of experience in the same type of business; and (2) the parties have a reasonable basis to anticipate that the sales arising from the relationship will not exceed 20% percent of the franchisee’s total dollar volume in sales

5 16 CFR § 436 6 Karen B. Satterlee & Leslie D. Curran, Exemption-Based Franchising: Are You Playing in a Minefield?, 28

FRANCHISE L.J. 191, 192 (2009). 7 Id.

Page 6: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

3

during the first year of operation.8 Starbucks uses this model for its exemption based franchise program.

It should be relatively easy for a franchisor to determine if a prospect meets the

experience element of the standard and for the franchisee candidate to project a dollar volume of sales in the first year of operation. The greater challenge is determining if the franchised concept is “in the same line of business” in which the franchisee is engaged. The FTC Interpretive Guides state: “[t]he required experience may be in the same business selling competitive goods, or in a business that would ordinarily be expected to sell the type of goods to be distributed under the franchise.”9 For example, one would have to contemplate whether a big box retailer adding a restaurant concept to the big box store or an airport operator adding a newsstand would be engaging in the same line of business? This determination is clearly a judgment call.

In addition, it remains an open question as to whether a franchisor is required to

calculate gross sales on a store-by-store basis or whether it may aggregate sales at the corporate level. Aggregating sales at the corporate level arguably permits the franchisor licensing stand-alone units to qualify for the fractional franchise exemption on the theory that the gross sales of the individual unit is less than 20% percent of the franchisee enterprise. An FTC informal staff opinion suggested that a fractional franchise located outside of the franchisee’s primary place of business was not, in itself, disqualified, stating: “It is the nature of the franchisees' business experience, not the location of its business per se, which may bring the business relationship within the fractional franchise exemption. Nonetheless, location is one factor we will consider in determining the similarities and differences between the established business and the new franchised business.”10 Note that this opinion does not state that stand-alone units do qualify for use of the exemption, only that they are not inherently outside its scope.11 Franchisors should consider the risk they are exposing themselves to if the fractional franchise exemption was deemed by a court or state regulator not to apply in this circumstance relative to the alternative of simply complying with the FTC Rule.

2. Large Investment Exemption

The rationale underpinning the large investment exemption is that sophisticated investors are capable of obtaining material information relating to the franchise investment without the assistance of government mandated disclosures. In order to qualify for this exemption, the franchise’s initial investment, excluding any financing received from the franchisor or its affiliates, the cost of unimproved land, must exceed $1,084,900.12 The initial investment is limited to those costs set forth in Item 7, not the investment required over the life of the franchise agreement.13 If the sale is for the transfer of an existing unit, the investment of

8 16 C.F.R. § 436.8(a) (2) (2007). 9 44 Fed. Reg. 49,968 (Aug. 5, 1980). 10 Informal Staff Adv. Op. 99-5 (July 2, 1999). 11 Id. 12 16 C.F.R. § 436.8(a)(5)(i). 13 72 Fed. Reg. 15,526 (Mar. 30, 2007).

Page 7: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

4

the selling franchisee may be considered in meeting the threshold.14 In addition, this investment must come from a single investor, rather than a pool of investors, the idea being that a group of small investors aggregating funds, do not evidence the sophistication of the large single investor.15 Franchisor financing provided to the investor is excluded from the initial investments because the FTC felt that it added “a measure of protection to the prospective franchisee because traditional lenders are very likely to require a due diligence investigation of the offering, whereas the franchisor or its affiliate likely would not.”16

In order to claim this exemption, a franchisor must obtain a written acknowledgment from

the franchisee verifying the grounds for the exemption. The FTC Rule requires the following acknowledgement be used verbatim: “The franchise sale is for more than $1,084,900—excluding the cost of unimproved land and any financing received from the franchisor or an affiliate—and thus is exempted from the Federal Trade Commission’s FTC Rule disclosure requirements, pursuant to 16 CFR § 436.8(a)(5)(i).”17 The challenge with this exemption is finding a person, not an entity, which has made the requisite investment. The more complex the entity is, such as in the case of REITS or investments funds, the more common this issue is. Therefore, a franchisor may find that it is in a transaction with a public company that is unable to satisfy this requirement. While the reader may suggest that the public company would likely qualify for the large franchisee exemption (which is probably the case) the large franchisee exemption does not exist in all registration states. Without an applicable state level exemption, an exemption at the federal is meaningless.

3. Large Franchisee Exemption

To qualify for this exemption, the franchisee, which may be an entity, its parent and affiliates as well as an individual, must have been in business for at least five years and have a net worth of at least $5,424,500.18 Business experience may be “tacked” on from individuals, parents and affiliates to meet the five year business experience and net worth requirements.19 The franchisee’s business experience does not have to be in the area of the franchised business.20 This is arguably the most useful of the exemptions discussed herein, given the ability to tack on business experience of corporate affiliates and consolidate their collective net worth.

Franchisors should take care to consider the definition of “affiliate” for this purpose,

especially since sophisticated and multi-brand franchisors may attract sophisticated franchisees. Many of these franchisees will use joint ventures to enter into the franchise relationship. Are joint venture partners “affiliates” for the purpose of the FTC Rule? A franchisor wanting to rely on this exemption should consider how they want their own joint ventures to be construed for tax and other legal reasons. The franchisor who exempts the franchisee candidate for this

14 Id. at 15,527. 15 Id. at 15,526. 16 Id. at 15,525. 17 16 C.F.R. § 436.8(a)(5)(i). 18 16 C.F.R. § 436.8(a)(6). 19 72 Fed. Reg. 15,528 (Mar. 30, 2007). 20 Id.

Page 8: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

5

purpose may be hard pressed to distinguish why they are not affiliated with their joint venture partners in other circumstances.

B. Registration State Exemptions Keep in mind that the burden of proving the exemption is on the person claiming it.21

Exemptions and/or exceptions from the state laws governing the offer and sale of franchises are diverse. In Appendix 1, we provide is a state-by-state table that shows the available exemptions and/or exceptions and whether the exemption and/or exception is from registration, disclosure, or both, and whether the exemption or exception is self-executing or requires a filing. NASAA Model Exemptions are not included in this discussion but it is noted they provide a compelling uniform alternative to the existing patch work that a franchisor must navigate depending on which state(s) have jurisdiction.

1. Large Franchisor Exemptions

This state exemption is based upon the experience and net worth of the franchisor. The rationale for this exemption is that the franchisor is well-capitalized with a proven track record. The track record demonstrates the viability of the business and the franchisor’s ability to run it. And the capitalization is important because it affords franchisees’ recourse should they pursue a legal claim against the franchisor.

The states that recognize this exemption are California, Illinois, Indiana, Maryland, New York, North Dakota, Rhode Island, Virginia, and Washington.22 Generally a franchisor is required to have a minimum net worth of $5 million to $15 million, depending on the jurisdiction, and a number of years of related experience (generally 5 years) administering a franchise system with at least 25 franchisees continuously operating during that period or continuous operations of the business itself.

If a franchisor is eligible for this exemption, it will still have pre-sale disclosure requirements in California, Illinois, Indiana, Maryland, New York, North Dakota, Rhode Island, Virginia and Washington. Also, the franchisor must make Notice filings in California, Illinois (if up to $15 million), Maryland, New York (net worth less than $15 million), North Dakota, Rhode Island, Virginia, and Washington.23 New York does not review a “large jumbo” (net worth of 15 million or more) exemption and only requires that the agent for service of process be provided. While some states use the notice filings to verify that the franchisor is eligible for the claimed exemption, the state does not undertake a full review, thus allowing the franchisor to avoid the risk of unwanted deal delays that may occur if the registration state issues comments.

21 Dollar Systems, Inc. v. Avcar Leasing Systems, Inc., 890 F. 2d 165, 172 (9th Cir. 1989). 22 CAL. CORP. CODE § 31101(c); ILL. ADMIN. CODE tit. 14, § 200.202(e)(3); IND. CODE § 23-2-2.5-3(c); MD.

CODE REGS. § 02.02.08.10(D); N.Y. GEN. BUS. LAW § 684(2)(c); N.D. CENT. CODE § 51-19-04(1)(c); R.I. GEN. LAWS § 19-28.1-6(1)(iii); 21 VA. ADMIN. CODE § 5-110-75(4); WASH. REV. CODE § 19.100.030(4)(a); NASAA MODEL FRANCHISE EXEMPTIONS § 2(b)(vi) (2012).

23CAL. CORP. CODE § 31101(d), ILL. ADMIN. CODE tit. 14, § 200.202(e)(5); MD. CODE REGS. §

02.02.08.10(D)(2)(a), (d); N.Y. GEN. BUS. LAW § 684(2)(b), N.D. CENT. CODE § 51-19-04(1)(e), R.I. GEN. LAWS § 19-28.1-6(1)(iv); 21 VA. ADMIN. CODE § 5-110-75(4)(b)(1); WASH. REV. CODE § 19.100.030(4)(b)(i)(D); NASAA MODEL FRANCHISE EXEMPTIONS § 2(b)(i) (2012).

Page 9: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

6

2. Transactional Exemptions

a. Fractional Franchise Exemption

As mentioned above, a fractional franchise is an extension of, or add-on to, a product or service the franchisee is already offering the public. The exemption is predicated on the concept that the franchisee has enough experience in its going concern to assess the risks and benefits of entering into the fractional franchise, thus, diminishing the need for the protections provided in the state franchise laws. Where available, this exemption offers the franchisor an exemption from both registration and disclosure requirements at the state level. When available, the exemption allows the franchisor to sell a franchise without creating a disclosure document. Note that California and New York require notice filings.24 And New York is deal-by-deal and subject to approval while California is a blanket annual filing.

The states that have adopted this exemption are California, Illinois, Indiana, Michigan,

Minnesota, New York, South Dakota, and Wisconsin.25 Illinois, Indiana, Minnesota, South Dakota, and Wisconsin adopted the same standards as found under the FTC Amended Rule. California, Michigan, and New York are more restrictive, as they require the fractional franchise to be operated from the same location as the franchisee’s existing business.26 In addition, California is unique in that it requires that the experienced officer must have been employed by the franchisee for 24 month period before the sale and that the franchisee not be “controlled” by the franchisor.27

b. Large Investment Exemption

If the initial investment is substantial, some states have determined that the franchisee

does not need the protection of the state franchise laws. If the franchisee has the ability to make a substantial investment, it is assumed the franchisee has the business experience to assess the risk and benefits of the investment. While a single-unit franchise transaction may not meet the investment threshold some parties are of the view that a multiple unit transaction (e.g., four $300,000 investments) may be counted together when evaluating whether these thresholds are met.

The states that provide this exemption are: Illinois (over $1,000,000); Maryland (over

$750,000); South Dakota ($1,000,000 or more); and Wisconsin (at least $100,000 and does not exceed 20% of the franchisee’s net worth).28

24CAL. CORP. CODE § 31108(f); N.Y. GEN. BUS. LAW § 200.10(2)(f); NASAA MODEL FRANCHISE EXEMPTIONS §

1 (2012). 25CAL. CORP. CODE § 31108; 815 ILL. COMP. STAT. 705/3; IND. CODE § 23-3-2.5-1(a); MICH. COMP. LAWS §

445.1506(1)(h); MINN. STAT. §80C.03(f); N.Y. COMP. CODES R. & REGS. tit. 13, § 200.10(2); S.D. CODIFIED LAWS § 37-5B-12(3); WIS. STAT. § 553.22.

26CAL. CORP. CODE § 31108(c); MICH. ADMIN. CODE § 445.1506(1)(h); N.Y. COMP. CODES R. & REGS. tit. 13, §

200.10(2)(c). 27CAL. CORP. CODE § 31108(a), (e). 28ILL. ADMIN. CODE tit.14, § 200.201(c); MD. CODE REGS. 02.02.08.10(E)(1); S.D. Franchise Investment Act §

13(1); WIS. STAT. § 553.235(1)(a); NASAA MODEL FRANCHISE EXEMPTIONS § 3(d) (2012).

Page 10: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

7

c. Large Franchisee Exemption The large franchisee exemption is akin to the exemption under securities laws for an

accredited investor. The concept underlying this exemption is that the franchisee (or one of its principals as an investor) is financially sophisticated and less likely to need the protection provided by the state franchise laws. The basis for the exemption also assumes the franchisee already has significant information about the business or can assess the risks of the investment through due diligence or because of access to expert advisors.

This exemption is available in California, Illinois, Rhode Island, South Dakota,

Washington and Wisconsin.29 In California, this exemption requires that a notice be filed before the offer is made; however, franchisors may file the notice once a year and rely on that same notice for future deals (facts permitting) throughout the year. Unfortunately, if a franchisor waits to file the exemption notice in California until after a deal negotiation is underway, the exemption would be unavailable for that particular deal.30 Disclosure under this exemption is required by Illinois and Rhode Island. Notice filings must be made in California and Rhode Island.

Illinois and South Dakota. The exemptions mirror the large franchisee exemption

under the FTC Rule, as described under III.A.3. California. If the franchise owner is (i) an entity, then the entity must have a total assets

exceeding $5,000,000 and not be specifically formed for the purpose of acquiring the franchise, or have all of its equity owners qualify under (ii) below, (ii) an individual, then the individual must have either a net worth (single or joint) exceeding $1,000,000, a gross income exceeding $300,000 per year in each of the two prior years, or an annual joint gross income with that person’s spouse exceeding $500,000 in each of those years.

Rhode Island. The franchise owner must have a net worth of at least $1,000,000 or

income (single or joint) in excess of $200,000 per year in each of the two prior years. Washington. The franchise owner must be an “accredited investor,” defined as (i) an

entity or trust with total assets in excess of $5,000,000 and not be specifically formed for the purpose of acquiring the franchise, (ii) an individual whose net worth (single or joint) exceeds $1,000,000, (iii) an individual whose annual gross income exceeds $200,000 per year in each of the two prior years, or whose annual joint gross income with that person’s spouse exceeds $300,000 in each of those years, or (iv) an entity in which all of the equity owners are accredited investors.

d. Renewal of Existing Franchise Agreement

In some form or another, all of the “registration states” have some form of an exception from their state laws for the renewal of an existing franchise agreement subject to different standards among the states, so that the renewal need not comply with the franchise registration and/or disclosure requirements if certain conditions are met. All of the states that offer this exception require that there be no interruption in the operation of the franchise business;

29CAL. CORP. CODE § 31109; 815 ILL. COMP. STAT. 705/8(a)(2); R.I. GEN. LAWS § 19-28.1-6(4); S.D. CODIFIED

LAWS § 37-5B-13(2); WASH. REV. CODE § 19.100.030(5); WIS. STAT. § 553.235; NASAA MODEL FRANCHISE EXEMPTIONS § 3(a) (2012).

30CAL. CORP. CODE § 31109(e).

Page 11: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

8

however, the states vary as to whether or not material modifications to the existing franchise agreement are permitted.

California, Hawaii, Illinois, Michigan, Rhode Island, Virginia and Wisconsin follow the

more restrictive language under the FTC Rule and allow the exclusion only where there are no material modifications to the existing franchise agreement.31 Meanwhile, New York has case law that permits material modifications to be made to an existing franchise agreement,32 and Indiana and Maryland statutes are silent as to material modifications. However, since the FTC Rule only allows this exception when there are no material modifications, a prudent franchisor would not rely on the state exception in New York, Indiana, or Maryland unless the franchisor can also claim a different exemption or exception under the FTC Rule. The renewal of an existing franchise agreement exception, allows the franchisor to avoid franchise registration (except North Dakota33) and disclosure obligations under the state franchise laws, (except in Indiana and Michigan, where disclosure is still required34). In addition, in order to qualify for this exception, Rhode Island requires a notice filing.35

e. Sales to Existing Franchisee

Existing franchisees may be deemed to already have the material information that they

need to make an informed investment decision. Consequently, California, Hawaii, Maryland, Michigan, New York, Rhode Island, South Dakota, Virginia, Washington and Wisconsin recognize this exemption.36 It is interesting to note that if an existing franchisee later claims fraud as to its initial purchase but has bought a second franchise, after discovery of the alleged fraud, this second purchase may act as a waiver to claim damages for fraudulent inducement.37

The FTC rule also offers this exemption and, as with the renewal of an existing

franchise, it applies only if there are no material changes to the terms and conditions of the existing franchise agreement. Rhode Island, Virginia and Washington allow the exception if the franchise is substantially the same and the franchisee has 2 years of experience. California, Hawaii and Wisconsin allow the exception if the sale is to an existing franchisee. Michigan and New York require the sale be to a franchisee that actively operated the franchise for the immediately preceding 18 months (and the purchase is for investment and not for resale).

31CAL. CORP. CODE § 31018(c); HAW. REV. STAT. § 482E-4(a)(5); 815 ILL. COMP. STAT. 705/7; MICH. COMP.

LAWS § 445.1506(1)(e); R.I. GEN. LAWS § 19-28.1-6(6); 21 VA. ADMIN. CODE 5-110-75(2); WIS. ADMIN. CODE § 32.05(1)(g).

32Rich Food Services, Inc. v. Rich Plan Corp., 5:02-CV-1447, at 6 (N.D.N.Y. Sept. 17, 2004). 33N.D. CENT.CODE § 51-19-03. 34IND. CODE § 23-2-2.5-9; MICH. COMP. LAWS § 445.1506(1)(g). 35R.I. GEN. LAWS § 19-28.1-6(1)(iv). 36CAL. CORP. CODE § 31106; HAW. REV. STAT. § 482E-4(a)(6); MD. CODE ANN., BUS. REG. § 14-214(b)(2);

MICH. COMP. LAWS § 445.1505(1)(g); N.Y. GEN. BUS. LAW § 684(3)(d); R.I. GEN. LAWS § 19-28.1-6(5); S.D. CODIFIED LAWS § 37-5B-14; 21 VA. ADMIN. CODE 5-110-75(3); WASH. REV. CODE § 19.100.030(6); WIS. ADMIN. CODE § 32.05(1)(e); NASAA MODEL FRANCHISE EXEMPTIONS § 3(a) (2012).

37 See, e.g., Burne v. Lee, 156 Cal. 221; 104 P. 438 (Cal 1909); and Oakland Raiders v. Oakland-Alameda

County Coliseum, Inc., 144 Cal. App. 4th 1175 (2006).

Page 12: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

9

California, New York and Rhode Island require a notice filing38 and disclosure may be required in Michigan if the franchisor has a disclosure statement in compliance with the laws of any state or the Amended FTC Rule,39 but disclosure is required in Rhode Island and Virginia.40

f. Franchisor Insider Exemption

Generally insiders are individuals who either own at least a 25% interest in the franchisor

for the last 2 years or have been an officer, director or own an interest in the franchisor and have management responsibility within the franchise system. The insider exemption acknowledges the franchisor is fully informed about the business and has actual experience managing the franchise being offered so the protections offered by the state franchise laws are not necessary or appropriate.

This exemption can be utilized in California, Illinois, Rhode Island, South Dakota and

Washington.41 Disclosure is only required in Illinois. Notice is required by California and Rhode Island.

g. Sales by Existing Franchisee

All states recognize the need of business owners to be able to sell their business.

Consequently, they all have an exemption that permits the franchisees to sell an existing franchise business to a third party. It is important to note that while the franchisor may approve the new franchisee under this exemption the sale cannot be “affected by or through” the franchisor.

Case law provides guidance on when a sale has been “affected by or through” the

franchisor.42 Specifically, if the franchisor matched buyers and sellers, advised the parties on the financial terms, facilitated or identified financing, or required the buyer to sign a new franchise agreement, the franchisor may be deemed to have “effected” the sale and the franchisor will no longer eligible for this exemption.

38CAL. CORP. CODE § 31106(b); N.Y. GEN. BUS. LAW § 684(3)(d)(iii); R.I. GEN. LAWS § 19-28.1-6(1)(iv);

NASAA MODEL FRANCHISE EXEMPTIONS § 3(a)(ii)(1) (2012). 39MICH. COMP. LAWS § 445.1506(2). 40R.I. GEN. LAWS § 19-28.1-6(5); 21 VA. ADMIN. CODE 5-110-75(3); NASAA MODEL FRANCHISE EXEMPTIONS §

3(a)(ii)(5) (2012). 41CAL. CORP. CODE § 31106; 815 ILL. COMP. STAT. 705/8(a)(3); R.I. GEN. LAWS § 19-28.1-6(3); S.D. CODIFIED

LAWS § 37-5B-13(4); WASH. REV. CODE § 19.100.030(5); Wash. Admin. Code § 460-44A-501(1)(d); NASAA MODEL FRANCHISE EXEMPTIONS § 3(b) (2012).

42See Little Caesar Enters., Inc. v. OPPCO, LLC, 219 F.3d 547 (6th Cir. 2000); Johnson v. Mail Boxes Etc.

USA, Inc., No. 44438–7–I, 2000 WL 264026, at *1 (Wash. Ct. App. Mar. 6, 2000).

Page 13: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

10

3. Discretionary Exemption

Upon a showing of appropriate cause, some state administrators (commissioners) have the authority to grant exemptions from registration and/or disclosure on a case-by-case basis, for example, where they determine that the franchise laws are not necessary or appropriate in the public interest, or needed to protect prospective investors.

This option is available in Illinois, Indiana, Maryland, Minnesota, New York, North

Dakota, Rhode Island, South Dakota and Wisconsin.43 In California and Hawaii44, it appears that the statute provides the commissioner authority to grant discretionary exemptions but as a matter of policy these states only offer exemptions through their respective rule making processes. So for the practical purposes of this paper California and Hawaii do not offer discretionary exemptions from pre-sale disclosure. In addition, North Dakota has only granted this exemption 3 times in the last decade.

As a practical matter, some large, sophisticated and multi-brand franchise companies have a general policy of delivering an FDD to prospective franchise owners in connection with all offers and sales – even those that are expected to qualify for an exemption – for informational purposes and to maintain consistency and uniformity in its business development process across all prospects, jurisdictions, and transactions. This policy would mean that even where a proposed franchise transaction may qualify for an exemption to both registration and disclosure requirements under the FTC Franchise Rule and state franchise laws, the franchisor would disclose the prospective franchise owner with an FDD (assuming the franchisor has a current FDD) as a belt and suspenders approach.45 IV. EXEMPTION CHALLENGES FOR LARGE, SOPHISTICATED AND MULTI-BRAND

FRANCHISE COMPANIES

A. Exemption Challenges for Large and Sophisticated Franchise Companies

Large and sophisticated franchise companies often rely on exemptions under the FTC Rule and state law to exempt the franchisor or a particular transaction from franchise disclosure and/or franchise registration requirements. The more common of such exemptions are the fractional franchise and large franchisee exemptions under the FTC Rule and the fractional franchise and large/seasoned franchisor exemptions under state law. As illustrated below, the exemption qualifications under state law often do not translate well when applied to large and sophisticated franchise companies. The following Section explores common challenges for large and sophisticated franchisors attempting to rely on these exemptions.

43815 ILL. COMP. STAT. 705/9; IND. CODE §§ 23-2-2.5-5, 23-2-2.5-8; MD.CODEREGS.02.02.08.10(G), MINN.

STAT. §80C.03(g); N.Y. GEN. BUS. LAW § 684(1), (4); N.D. Cent. Code §§ 51-19-04(3), 51-19-05; R.I. GEN. LAWS § 19-28.1-6(10); S.D. CODIFIED LAWS § 37-5B-15; WIS. STAT. § 553.25; NASAA MODEL FRANCHISE EXEMPTIONS § 4 (2012).

44See CAL. CORP. CODE § 31100; HAW. REV. STAT. § 482E-4(b). 45Remember this approach will create a requirement to disclose in Michigan under MICH. COMP. LAWS §

445.1506(2).

Page 14: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

11

1. Corporate Structure

Sophisticated franchisors and franchise owners, alike, often have elaborate corporate structures to account for operational complexities, in view of multiple operating entities (each with their own history), and help take advantage of tax benefits and insulate liability. These elaborate structures create challenges when trying to satisfy the “experience” or “net worth” elements under the exemptions to federal and state franchise disclosure and registration requirements frequently relied on by large and sophisticated companies, as discussed under section III above.

While the federal exemptions appear to accommodate today’s complex corporate

structures by accounting for the possibility of a parent "or affiliate" satisfying one of the elements of the exemptions in lieu of the franchise owner,46 most state franchise statutes still do not. Federal and state exemptions still vary greatly and are yet to be reconciled. For example, the large/seasoned franchisor exemption is available in certain states to franchisors that meet minimum net worth and franchise experience requirements. Qualifying franchisors are generally still subject to state disclosure requirements or annual filings and fees, but are permitted to forego agency review of franchise registration and renewal applications (with the exception of the “super large franchisor” exemption in Illinois and New York, under which there are no filing requirements or fees payable).47

Although the net worth and experience requirements vary by state, none of the

large/seasoned franchisor exemptions permit a franchisor to rely on an affiliate’s net worth or experience. All of the states with a large/seasoned franchisor exemption require that the franchisor, or a parent or company that owns 80% or more of the franchisor, satisfy the net worth element under the exemption.48 Likewise, while the experience element under the large/seasoned franchisor exemption varies among the states (and in Illinois and New York the exemption does not include an experience element), all of the exemptions with an experience element require the franchisor, or a parent or company that owns at least 80% or more of the franchisor, to satisfy the minimum experience requirements. The challenge in both instances is that large or sophisticated companies may, for one reason or another, establish a sister company (affiliate) or indirect subsidiary as the franchisor entity rather than a direct subsidiary; in that case, a transaction that would otherwise qualify for the large/seasoned franchisor exemption had the franchisor entity been a wholly-owned subsidiary of the parent entity will not qualify for the exemption simply due to the franchise company’s corporate structure. As a practical matter, in these instances, a franchise company may be able to request a discretionary exemption on the grounds that complying with the registration requirements under state law has little value to the interest of the public and that granting a discretionary exemption is consistent with the purpose of the large/seasoned franchisor exemption.

2. Financial Statements

When dealing with large and sophisticated franchise companies, often times a franchise company’s financial statements (or lack of audited financial statements) present challenges when trying to qualify for the large/seasoned franchisor exemption under state law. As noted

46 See 16 C.F.R. § 436.8. 47 815 ILL. COMP. STAT. 705/8(a)(1); N.Y. GEN. BUS. LAW § 684(3)(a). 48 Large Franchisor Exemptions, supra note 22.

Page 15: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

12

under section III.B.1. above, in order to satisfy the minimum net worth element under the large/seasoned franchisor exemption, the franchisor or a parent or company that owns 80% or more of the franchisor must have a certain minimum net worth,49 and in most states, both the parent and franchisor must have a certain minimum net worth according to audited financial statements. One of the challenges resulting from the language of the statutes and regulations is that many large and sophisticated franchise systems do not issue audited financial statements at the franchisor entity level. Rather, the franchisor entity’s financials are typically consolidated with a direct or indirect parent company with little or no specific mention of the franchisor entity’s financials. A franchisor without its own audited financial statements may not be able to meet the exemption requirements, even if the consolidated financial statements at the parent level show a net worth for the franchisor entity considerably in excess of the minimum net worth required for the parent to qualify for the exemption.

Another common challenge with respect to financial statements for large and

sophisticated franchise companies arises where the franchisor – on its own – may have a sufficient net worth to satisfy the minimum net worth element under the large/seasoned franchisor exemption, but when the franchisor’s financials are consolidated with its parent company, the parent company may have a substantially lower net worth because of underperformance by a separate business entity or a dividend issued to stockholders at the parent company level. In that case, the franchisor’s net worth cannot be viewed in isolation from the rest of the consolidated financial statements, and therefore the franchise company would not qualify for the exemption.

Again, as a practical matter, in both of these instances, a franchise company may be

able to request a discretionary exemption on the grounds that complying with the registration requirements under state law has little value to the interest of the public and that granting a discretionary exemption is consistent with the purpose of the large/seasoned franchisor exemption.

3. Sophisticated Corporate Actions and Financing Transactions

It is not uncommon for large and sophisticated franchise companies to take certain company actions or utilize non-traditional forms of financing that are not a consideration for small or medium franchise companies. For example, a publicly-traded franchise company, such as Marriott International, Inc., may decide to institute a stock repurchase program,50 or a large franchise company, such as Sonic Corp., may decide to refinance existing debt or raise new capital through securitization financing.51 Both of these company actions could affect the franchise company’s net worth and the company’s ability to qualify for the large/seasoned franchisor exemption under state law.

49 Large Franchisor Exemptions, supra note 22. 50 See Press Release, Marriott Int’l Inc., Marriott International Declares Cash Dividend; Announces Increase

in Stock Buyback Authorization (Feb. 14, 2014), http://news.marriott.com/2014/02/marriott-international-declares-cash-dividend-announces-increase-in-stock-buyback-authorization.html.

51 See Press Release, Sonic Corp., Sonic Completes Issuance of Securitized Notes (July 18, 2013),

http://ir.sonicdrivein.com/releasedetail.cfm?ReleaseID=778638.

Page 16: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

13

a. Stock Repurchase Program

A stock repurchase program is when a company purchases its own outstanding shares (repurchase) in order to reduce the number of outstanding shares. Companies will buy back shares either to increase the value of shares still available (reducing supply), or to eliminate any threats by shareholders who may be looking to acquire a controlling stake. Stock repurchase is often seen as an indication that the company's management thinks the shares are undervalued. The challenge for franchise companies in connection with a stock repurchase program is that the program can result in the company taking on a significant liability on its books (and thereby effecting the company’s net worth), which, alone, should have little bearing on whether the company is financially sound. However, in such instances, the franchise company may not only have difficulty satisfying the minimum net worth requirement under the large/sophisticated franchisor exemption or sophisticated franchisee exemption, whichever is applicable, but the franchise company may experience a difficult time obtaining registration in the states absent a financial assurance condition (such as a fee deferral, escrow requirement or posting of a surety bond). Accordingly, a franchise company that has a practice of relying on either of these exemptions should be mindful of the amount of the company’s cash reserves allocated to a stock repurchase program.

b. Securitization Financing

Additional challenges exist for franchise companies considering securitization financing, which is generally a financing option available to only large franchise companies with a significant network size. The essence of a securitization is that a franchisor’s revenue stream (e.g., royalty payments) is “securitized” by structurally isolating the revenue stream in a newly created, bankruptcy-remote, special-purpose entity that issues debt instruments, preferred stock, or certificates of beneficial interest secured by that revenue stream. The subject assets (typically existing franchise agreements that serve as the basis for the royalty payments), once properly isolated, become distinct from the company’s balance sheet. Under the securitization model, the new special-purpose entity will serve as the “franchisor” after the completion of the securitization, not only in administering the existing franchise network, but in selling new franchises as well.

Accordingly, although the franchisor may have been able to rely on the large/seasoned franchisor exemption prior to the securitization transaction, the new special-purpose “franchisor” entity may not be able to meet the experience element under the exemption. Depending on whether the new franchisor entity executed an inter-company guarantee as part of the securitization (which typically occurs), the franchisor entity may not have a net worth sufficient to satisfy the minimum net worth requirements under the state exemptions. It has become a common practice for franchise companies undertaking securitization financing to work with state examiners to obtain discretionary exemptions in order for the franchisor to be able to continue to seek on the large/seasoned franchisor exemption post-securitization.

4. Acquisitions

There continue to be a high number of acquisitions involving franchise companies, as franchise companies are attractive investment targets for both strategic and private equity purchasers. However, being the target of an acquisition can result in a number of challenges for the franchise company post-acquisition when trying to satisfy the “experience” and “net worth” elements under the large/seasoned franchisor exemption.

Page 17: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

14

If an acquisition of a franchise company is structured as an asset purchase -- the purchase of the franchise company’s assets -- it is important to consider whether the assets are being purchased by a special purpose entity formed specifically for the acquisition or whether the assets are being purchased by an existing franchise company. The former is common where a purchaser is trying to limit its liability post-acquisition for claims that may have occurred pre-acquisition, and the latter is common where an existing franchise company is looking to make a strategic acquisition. If a franchise company’s assets are purchased by a special purpose entity, the new franchisor entity (post-acquisition) will have difficulty satisfying the experience requirement under the large/seasoned franchisor exemption because the new franchisor entity will not have been in existence for five years, as required under all of the states with a large/seasoned franchisor exemption (except for New York, which has no experience requirement). Two states,52 Illinois and Virginia, do permit a franchisor to rely on the prior experience of the franchisor’s predecessor, which could be helpful to a franchisor post-acquisition in its attempt to satisfy the experience element under the large/seasoned franchisor exemption.53

It is not uncommon for franchise companies purchased by private equity firms to be saddled with a significant amount of debt post-acquisition and be forced to pay significant dividends to the private equity firm periodically during that firm’s ownership of the franchise company. In these instances, it is often difficult for a franchisor to satisfy the net worth element under the large/seasoned franchisor exemption post-acquisition. It is also not uncommon for a purchaser to assign a significant percentage of the purchase price to the goodwill of the franchise company. Franchisors should be mindful that an attempt to rely solely on intangible assets to satisfy the net worth element under the large/seasoned franchisor exemption will likely be met with resistance from some state examiners, unless the franchisor can also demonstrate tangible assets in excess of the minimum net worth requirements.

B. Exemption Challenges for Multi-Brand Franchise Companies

Multi-brand franchising is where several different franchise brands are held by one conglomerate. Diversification is a driving factor in the growth of multiple-brand franchising. As multi-unit franchise owners seek new avenues for growth, increasing numbers of them are adding multiple brands to their franchise brand portfolios. The increase in multi-brand franchising has been accompanied by a growth in the number of franchisors offering multiple brands from under the same corporate roof. Usually, the family of brands is limited to a single industry segment (hotel or retail fast food, for example), but not always. Since not all of the brands held by one conglomerate may be in the same industry segment, and brands within the same industry segment typically vary from one another, franchisors often face challenges in trying to satisfy the “experience” element under exemptions from federal and state franchise disclosure and registration requirements frequently relied on by multi-brand franchise companies.

As noted under section III.A.1., in order for a franchisor to rely on the fractional franchise exemption under the FTC Rule54 for a particular transaction, the franchise owner must satisfy

52 ILL. ADMIN. CODE tit. 14, § 200.201(e)(2); 21 VA. ADMIN. CODE § 5-110-75(4)(a)(3). 53 See also, Cal. Comm'r of Corp., Comm. File No. OP 6420F, Bus. Franchise Guide (CCH) ¶ 10,476 (June

22, 1994). 54 16 C.F.R. § 436.1(g)(1).

Page 18: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

15

the “experience” element of the exemption. One would think that it is relatively easy for a franchisor to determine whether the franchise owner satisfies the "experience" element under the exemption; however, such is not necessarily the case when dealing with multi-brand franchise owners.

Under the FTC Rule, the franchise owner must have more than two years of experience in the “same type of business” as the franchise being offered by the franchisor. The challenge when attempting to rely on the fractional franchise exemption for a particular transaction is determining whether the existing brand owned by the franchise owner is “the same type of business.” For example, is a Hilton Garden Inn hotel the same type of business as a Conrad hotel? Is a Popeye’s franchise the same type of business as a Checkers franchise? According to the FTC Rule Statement of Basis and Purpose ("SBP"), the “Commission has never required experience in the identical type of business. Rather, the sale of similar goods may qualify for the exemption … [and] a broad reading of the fractional franchise exemption is warranted when determining which individuals may qualify as having the requisite prior experience.”55 However, according to the FTC Compliance Guide, the “same line of business” means “selling competitive goods, or being in a business that would ordinarily be expected to sell the type of goods to be distributed under the franchise.”56 Using this reasoning, a franchisor could take the position that the Hilton Garden Inn is in the same line of business as a Conrad hotel; however, it may be more difficult to argue that Popeye’s and Checkers franchises are in the same line of business. As noted earlier in this paper, this determination is clearly a judgment call.

The fractional franchise exemption is also available in certain states57 for transactions that meet its requirements, which are similar to those under the federal exemption. The primary benefit of qualifying for the fractional franchise exemption is that the transaction is exempt from both state franchise disclosure and registration requirements.

The “experience” element under the fractional franchise exemption varies among the states. Certain states, such as California and New York, require the multi-brand franchise owner to have more than two years of experience in a “substantially similar” business as the franchise being offered by the franchisor, while other states require the two years of experience to be in the “same type” of business as the franchise being offered by the franchisor. As with the fractional franchise exemption under the FTC Rule, the challenge for a franchisor is determining whether the existing brand owned by the franchise owner is “substantially similar” or the “same type” of business. Like with the federal exemption, this determination is a judgment call.

When dealing with multi-brand franchise companies, the launch of a new brand by a franchisor often times presents challenges when trying to qualify for the large/seasoned franchisor exemption under state law. The challenge for a multi-brand franchisor is determining whether an existing brand can be used by a franchisor to satisfy (or help satisfy) the experience element under the large/seasoned franchisor exemption.

55 72 Fed. Reg. 15,458-59 (Mar. 30, 2007). 56 FEDERAL TRADE COMMISSION, FRANCHISE RULE COMPLIANCE GUIDE 8 (2008). 57 CAL. CORP. CODE § 31108; 815 ILL. COMP. STAT. 705/3; IND. CODE § 23-3-2.5-1(a); MICH. COMP. LAWS §

445.1506(1)(h); MINN. STAT. §80C.03(f); N.Y. COMP. CODES R. & REGS. tit. 13, § 200.10(2); S.D. CODIFIED LAWS § 37-5B-12(3); WIS. STAT. § 553.22.

Page 19: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

16

As noted earlier in this paper, the experience element under the large/seasoned franchisor exemption (for the states that include an experience requirement) varies among the states. In order to satisfy the experience element under the large/seasoned franchisor exemption (for the states that include an experience requirement), the franchisor or a parent or company that owns 80% or more of the franchisor must have had at least twenty-five franchisees “conducting business” at all times during the five year period immediately preceding the offer or sale. California and Illinois require that the business conducted by the twenty-five franchisees be “the subject of the franchise,” 58 while Maryland and Virginia require that the business conducted by the twenty-five franchisees be “the same franchised business”59 as the franchised business being offered by the franchisor. Rhode Island, on the other hand, requires that the business conducted by the twenty-five franchisees be “substantially the same franchised business”60 as the franchised business being offered by the franchisor. While the determination depends, in part, on how similar the existing brand is to the franchisor’s new brand, the franchisor likely will not be able to rely on an existing brand to satisfy the experience element under the large/seasoned franchisor exemption in most states.

V. DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED AND MULTI-

BRAND FRANCHISE COMPANIES A. Disclosure Challenges for Large and Sophisticated Franchise Companies As explained above, even the most ubiquitous and well-established franchise companies

may be unable to satisfy applicable criteria for an exemption from the disclosure obligations of the FTC Rule and/or state franchise laws. Moreover, even if a franchise company satisfies the criteria for an exemption under the FTC Rule and state franchise laws, qualifying franchisors are generally still subject to state disclosure requirements or annual filings and fees, but are permitted to forego agency review of franchise registration and renewal applications. This section explores significant disclosure issues facing large and sophisticated franchise companies, including: (i) information relating to the franchisor’s history and extended corporate family that must be shared with prospective franchise owners; (ii) the possibility of having to include multiple sets of financial statements in the franchisor's FDD; (iii) disclosure procedures and timing constraints to be assessed in connection with potential acquisitions and other sophisticated financing arrangements; (iv) franchisee initiated disclosure challenges; and (v) the occurrence of routine material events.

1. Related Entity Disclosures: Parents, Predecessors, and Affiliates

Experienced franchisors and counsel likely are familiar with required FDD disclosures concerning parent, predecessor, and affiliate-related information as minimally required under FDD Item 1 (describing the company’s 10-year chain of ownership and certain currently-related entities and brands), and as otherwise possibly implicated by Item 3 (certain actions involving certain related entities and persons), Item 4 (10-year bankruptcy history involving related entities and persons), Item 10 (affiliate-sponsored financing available to franchise owners), Item 12 (territorial concerns with respect to related brands), and Item 21 (financial statements of

58 CAL. CORP. CODE § 31101(b)(1); ILL. ADMIN. CODE tit. 14, § 200.202(e)(2). 59 MD. CODE REGS. § 02.02.08.10(D)(1)(b); 21 VA. ADMIN. CODE § 5-110-75(4)(a)(3). 60 R.I. GEN. LAWS § 19-28.1-6(1)(ii).

Page 20: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

17

certain related entities).61 Still, as a franchisor’s extended corporate family grows larger and more intricate through changed ownership and management of the franchisor itself, as well as the development and acquisitions of new brands by its affiliates and parent companies, a sophisticated franchisor must assess the full organizational chart and related portfolio of its entire corporate family to properly address the nuanced disclosure obligations concerning predecessors and affiliates.

The FTC Rule defines an “affiliate” as “an entity controlled by, controlling, or under

common control with, another entity.”62 This broad definition includes, but is not limited to, any of the franchisor’s “parents,” which means “any entity that controls another entity directly or indirectly through one or more subsidiaries.”63 But not all of a franchisor’s parents, or all of its non-parent affiliates, are reached by the FTC Rule disclosure instructions employing these terms. Rather, the scope of a franchisor’s discloseable parents and affiliates, and their related information, is restricted to information that must be disclosed only in certain Items, and may vary in breadth from Item to Item. A “predecessor” for disclosure purposes is any “person from whom the franchisor acquired, directly or indirectly, the major portion of the franchisor’s assets,” where such former owner of the assets “itself operated or franchised the same or a similar business.”64 Like parent and affiliate-related disclosures, predecessor information is only selectively required under certain disclosure Items, as applicable.65

A franchisor must disclose under Item 1, among other things, the names and addresses

of any parent in the chain of ownership that exercises control over the policies and direction of the franchise system (rather than merely own the franchisor),66 any of franchisor’s predecessors during the ten-year period immediately before the close of the franchisor’s most recent fiscal year, and any of franchisor’s affiliates that offer franchises in any line of business or that otherwise provide products or services to the franchise owners of the franchisor.67 In addition, for any predecessors during the past ten years, and any affiliates offering other franchises or that service the franchisor’s franchisees, the franchisor must disclose each entity’s relevant operating experience in the type of business being offered and that entity’s franchising experience and franchise sales history across any line of business.68 Large and sophisticated franchise companies may find these disclosures particularly tedious, if not challenging to capture accurately, when faced with a complex organizational chart of affiliates as well as direct and indirect parent entities. For instance, typical hotel companies must track and disclose numerous affiliated companies and brands across various hotel chains, as do restaurant holding

61 16 C.F.R. § 436.5. 62 72 Fed. Reg. 15,454 (Mar. 30, 2007) (regarding Section 436.1(b): Affiliate). 63 Id. at 15,463 (regarding Section 436.1(m): Parent). 64 FEDERAL TRADE COMMISSION, FRANCHISE RULE COMPLIANCE GUIDE 30 (2008). 65 72 Fed. Reg. 15,463 (Mar. 30, 2007) (regarding Section 436.1(m): Parent). 66 FEDERAL TRADE COMMISSION, AMENDED FRANCHISE RULE FAQ’S 16 (2007) (The definition of a “parent” for

FTC Rule purposes focuses on control such that a parent that merely owns, but does not control, a franchise system is not a “parent” for purposes of any disclosure Item).

67 16 C.F.R. § 436.5(a). 68 Id.

Page 21: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

18

companies that offer many dining concepts.69 Hilton Worldwide, for example, has an Item 1 disclosure in its FDD relating to its affiliates and their corporate history that is four pages long and details information relating to every separate franchise company Hilton Worldwide has in the United States (there are currently 9) and in international markets (more than 9). In addition, to the extent a franchisor has changed hands many times over (which are not uncommon for private equity-owned franchise companies), the franchisor must document all predecessors in the chain of ownership during the prior ten years to properly comply with Item 1 disclosure requirements under the FTC Rule. Finally, the more diverse and sizable the organization, the more likely that ongoing transactions are being consummated involving discloseable entities, which may trigger materiality analyses and possible franchise sales interruptions, FDD supplemental disclosure or amendment, and re-disclosure (discussed further below in this paper).

2. Financial Statements

Often the biggest issue a sophisticated franchise company faces with respect to disclosure concerns which financial statements to produce and include in the FDD. Sophisticated franchise companies should remain mindful that certain commitments a parent undertakes for, or on behalf of, its subsidiary franchisor can have far-reaching implications. Any parent that performs post-sale, direct-to-franchisee obligations on the franchisor’s behalf must include its own financial statements (audited in accordance with US GAAP) under Item 21 of the franchisor's FDD in addition to the franchisor's financial statements. Such disclosure could be challenging for a parent company should the parent not already have its own audited financial statements. In addition, a parent or affiliate that agrees to guarantee the franchisor’s financial performance must disclose its own audited financial statements under Item 21 of the franchisor’s FDD (and include the executed guarantee in the FDD).70 In such cases, the parent or affiliate has possibly made its own financial stability material to the franchise owner’s investment decision by affirmatively committing to satisfy obligations for the prospective franchise owner’s benefit.71

While some sophisticated franchisors are willing to disclose a parent's or affiliates

financial statements and/or to have a parent entity guarantee the franchisor’s performance, others understandably would rather avoid doing so. This potential obstacle can arise for complex franchise companies that want to centralize and perform post-sale obligations of the franchisor through a parent operating company that undertakes the franchisor’s obligations. This issue often arises in the hotel industry where a parent entity provides centralized hotel services (marketing, F&B services, etc.) directly to all hotels operating under each of the brands owned by the parent company. What if the organization is unwilling to release its financial statements in the franchisor’s FDD, guarantee the subsidiary franchisor’s performance or to otherwise disclose? One possible solution to address this challenge is to reposition the franchisor entity within the larger corporate structure as a same-line affiliate – rather than a subsidiary – of the former parent entity that was performing post-sale obligations. While Item 21

69 See W. Michael Garner, Richard Greenstein, and Mary McMonagle, When Competitive Franchise

Systems Merge: Opportunities & Pitfalls, IFA 43RD ANNUAL LEGAL SYMPOSIUM 1 (2014). A recent count reflected Starwood operating at least 9 brands, Marriott at least 17 brands, Hilton Worldwide at least 9 brands, Wyndham at least 14 brands, Choice Hotels at least 11 brands, and restaurant companies such as Darden (Olive Garden, Red Lobster, etc.) and Bloomin’ Brands (Outback, Fleming’s, Roy’s, etc.) that offer a wide array of dining concepts.

70 FEDERAL TRADE COMMISSION, FRANCHISE RULE COMPLIANCE GUIDE 114 (2008). 71 Id.

Page 22: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

19

requires that parents providing a guarantee or commitment to perform post-sale obligations must disclose its financial statements, the same is not true of non-parent affiliates that may similarly commit to perform post-sale obligations for the franchisor.

Publicly-traded franchise companies face another set of challenges if attempting to

register or renew their franchise offer in certain registration states more than 120 days after the close of the franchise company’s fiscal year. States such as Hawaii, Maryland, Minnesota, and Virginia require unaudited financial statements (i.e., balance sheet and statement of cash flows) current within 90 to 120 days from the filing date (depending on the state) to be included in the franchisor's FDD. While providing unaudited financial statements is generally a non-issue for most small or medium franchise companies, publicly-traded franchise companies are unable to issue unaudited statements. Publicly-traded companies must wait until the next quarterly SEC filing (e.g., 10-Q) if the most recent 10-Q filing is not current with the ninety to one hundred twenty day period. Such delay can result in the franchise company going "dark," which can be extremely problematic for the company because no offer or sales activities can be conducted in the state until the franchise offer is registered. Accordingly, publicly-traded franchise companies need to make sure to plan ahead in order ensure that their franchise system avoids any prolonged dark periods as a result of having to wait for financial statements to be issued.

3. Potential Acquisitions and Other Sophisticated Financing

Arrangements

As discussed earlier in this section, a franchisor’s required disclosures concerning its affiliates, parent entities and brands can be particularly broad and nuanced throughout the disclosures required to be included in its FDD. New or changed circumstances independent of a franchisor’s day-to-day franchising operations and policies can nevertheless impact the information that may need to be disclosed in a franchisor’s FDD. This is particularly true of potential acquisitions, divestments, and sophisticated financing activities that are common occurrences with large and sophisticated franchise companies, the facts of any or all of which may be "material" to prospective franchise owners and/or to current franchise owners, depending on the circumstances.

The timing for disclosing a potential transaction in the FDD is often a challenging

assessment for franchise companies. Should a potential acquisition or sale be disclosed at the time the franchisor, parent or affiliate signs a preliminary agreement, such as an NDA, term sheet or LOI, or should the franchisor postpone disclosing the potential transaction until after a definitive agreement is signed? Perhaps both of those timings are premature and the franchisor should wait to disclose the potential transaction until after the closing of the transaction occurs? Franchise companies often face such questions without much guidance from the FTC Rule or state franchise laws.

Though “materiality” is not defined in the FTC Rule,72 the SBP alludes to the FTC’s long-

standing interpretation of Section 5 of the FTC Act (on deceptive practices) to suggest that a representation or omission is “material” if such information would be likely to affect a reasonable prospective franchise owner’s decision to purchase the franchise.73 This commentary echoes the predecessor federal law’s definition of “materiality”, and some state franchise laws include

72 For the definition of “materiality” in the predecessor franchise rule see 16 C.F.R. § 436.2(n) (2006). 73 72 Fed. Reg. 15,455 (Mar. 30, 2007).

Page 23: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

20

similar definitions or references. However, the definition of “materiality” is anything but uniform. The circumstantial nature and timing of events relating to a franchisor and the franchise system force all franchisors to readily assess what information is “material” for purposes of disclosure. By way of example, an affiliate’s potential acquisition of a small regional franchisor that offers franchises in a wholly different line of business may not be viewed as “material” by the franchisor when soliciting prospective franchise owners in a different region of the country, but the potential acquisition of a large and directly competitive brand very likely would be.

Many franchise companies have adopted a practice of not disclosing a potential

acquisition, sale or sophisticated financing transaction, such as a securitization, until a definitive agreement is signed. The rationale is that before the signing of a definitive agreement, negotiations between the parties are not indicative that the parties will consummate an agreement. Moreover, the transaction may be confidential, which is a particularly sensitive issue for publicly-traded franchise companies. Upon signing a definitive agreement, however, the level of expected certainty that the transaction will actually be consummated is such that a franchisor must consider whether the information could be “material” to prospective franchise owners.

While the FTC Rule does not mention anticipated transactions as a required disclosure,

the omission of such information could nevertheless be deemed a fraudulent or deceptive act if such information is deemed to be “material” to a reasonable prospective franchise owner.74 At the point a franchisor believes a proposed transaction is material (and in any case no later than the transaction’s closing), then the franchisor should consider stopping sales activities under its existing FDD, and begin steps to amend or issue a supplemental disclosure to its FDD for prospective franchise owners in non-registration states and to amend its franchise registration in the registration states where it has a then-effective registration. Further, some franchisors have adopted a practice of distributing information (such as press releases, or an informal “supplement”) disclosing the signing of a definitive agreement and the anticipated consummation of the transaction to prospective and existing franchise owners as a risk-management mechanism to avoid potential state law claims for fraud or misrepresentation; the rationale for doing so being that even if the franchisor is not certain that the transaction at its current stage is "material," the benefit of disclosing the potential transaction to prospective and existing franchise owners outweighs the burden of having to fend off fraud and/or misrepresentation claims by franchise owners for not disclosing the transaction. Although the practice of distributing a "supplement" to the FDD is not contemplated by existing state franchise laws, the FTC Rule does contemplate supplemental disclosure by permitting franchisors to disclose any material changes within a reasonable period of time after the close of each quarter of the fiscal year in the form of an addendum or supplement to the FDD.75

4. Franchise Owner-Initiated Disclosure Challenges

When it comes to large and sophisticated franchisors, large and multi-unit franchises are becoming more the rule than the exception. This reality is beneficial in many ways to sophisticated franchise companies, by allowing them to engage a growing pool of highly qualified, experienced, and well-capitalized prospective franchise owners, and in turn more readily take advantage of transaction-based exemptions from state franchise laws (as discussed

74 See Century Pac., Inc. v. Hilton Hotels Corp., 528 F. Supp. 2d 206, 236 (S.D.N.Y. 2007) (granting

summary judgment for defendants on fraud claim involving sale of Red Lion brand after hotel franchisor told franchisee pre-sale that it was not planning to sell the chain), aff’d, 354 F. App’x 496, 499 (2d. Cir. 2009).

75 72 Fed. Reg. 15,566 (Mar. 30, 2007).

Page 24: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

21

above). Nonetheless, having a large multi-unit franchise owner base is not without challenges for a franchisor.

Multi-jurisdictional transfers are a challenge large and sophisticated franchisors often

face as a result of having multi-unit franchise owners. These transfers can be challenging for franchisors who may not be registered in all of the registration states or who have a practice of relying on transaction-based state exemptions. If the franchisor is not currently registered in a state in which one of the franchised outlets is located or if the franchisor is unable to rely on a federal and state exemption in connection with the transfer, the franchisor may need to navigate the complexities of transferring the franchised outlets in piecemeal or delay its consent to the transaction pending registration approval.

Another challenge franchisors often face as a result of attracting a greater number of

prospective multi-unit franchise owners is an expectation for negotiating the development and franchise agreements. While a franchisor may be willing to accommodate certain requested changes, franchisors should keep in mind the possible implications a negotiated change may have on disclosure in the franchisor's FDD. Further, if the negotiated changes occur in connection with a sale of a franchise in California (and the franchisor is not exempt from the franchise registration laws in California), the franchisor may be required to disclose the negotiated changes to future prospective franchise owners.76 While not necessarily within the focus of this paper, Appendix II includes a brief summary on how to comply with the negotiated changes and material modifications requirements under the California Franchise Investment Law.

Even after the parties enter into the franchise agreement, franchisors often continue to

face greater transaction costs when dealing with a multi-unit franchise owner base in connection with activities that are normally straightforward and routine when dealing with single-unit franchise owners. Franchisors with a large number of multi-unit franchise owners regularly field requests to consent to complex refinancings and ownership interest transfers, which can become time consuming. These requests typically involve having to negotiate subordination agreements, amendments to franchise agreements, in addition to the consent agreement, itself. In addition, franchisors that own and lease, or rent and sublease, real property or significant equipment and other assets to franchise owners may have to prepare, review or revise numerous other documents (and consult with landlords, vendors and legal counsel) each time one of these activities occurs. Franchisors should be cognizant of the likelihood for higher transaction costs that usually accompany large multi-unit franchise deals, and include reimbursement rights and sufficient transfer amounts in the franchise agreements with multi-unit franchise owners to help offset the increase in expenses.

5. Routine Material Events

As discussed above, franchisors must constantly assess new or changed information in their ongoing business activities to determine whether such information would be reasonably likely to affect a prospective franchise owner’s investment decision. If the franchisor decides that the answer is “yes,” then the information should be considered material and will have to be disclosed in accordance with applicable franchise laws. However, even information that the franchisor might not think would be reasonably likely to affect a prospective franchise owner’s investment decision, may still qualify as “material” if its subject matter is covered by the FTC Rule’s disclosure instructions. In fact, a prospective franchise owner is entitled to regard as

76 See CAL. CORP. CODE §§ 31109.1(a)(4), 31123; CAL. CODE REGS. tit. 10, §§ 310.100.2, 310.100.4 (2010).

Page 25: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

22

material each and every statement in a FDD. According to the FTC Rule FAQ’s issued by the FTC staff to assist franchisors in their review of the FTC Rule requirements, the text of the FTC Rule, as well as the Compliance Guide, “make it clear that Section 436.9(h) reflects a Commission finding that each disclosure required by the [FTC] Rule is material to a prospective franchise owner’s investment decision.”77 As such, any change to existing disclosure in the franchisor’s existing FDD would be considered material, and the franchisor must determine the appropriate time and method by which to disclose the new material information.

With respect to the timing of any amendment to the franchisor’s existing FDD, the FTC

Rule requires a franchisor to issue quarterly updates to its FDD within a “reasonable time after the close of each quarter in its fiscal year,” 78 while state franchise laws vary on specified timing for amending a registration. For example, California and Maryland require that the FDD be amended “promptly” in the event any material change occurs while Virginia requires that the FDD be amended “within 30 days after a material change.”79 Thus, there is no clear rule across all jurisdictions as to when to amend an FDD to account for a material change. Further, although all information falling within the purview of the FTC Rule’s disclosure Items is considered material, under the FTC Rule, not all material changes require in a quarterly update. “Material changes include such events as the recent filing of a bankruptcy petition or the filing against the franchisor of a legal action that may have a negative effect on its financial condition,” but “several of the disclosure requirements. . . require only annual updating,” such as Item 3 franchisor-initiated litigation, and Item 20 outlet statistics and trademark-specific association information.80

Without a unified timing metric for amending an FDD under the FTC Rule and state

franchise laws, a common practice is for the franchisor to implement material changes to its existing FDD no later than 30 days following the end of the franchisor’s fiscal quarter. However, if the information underlying the material change is of such significance – for example, a sale of the franchisor entity – that the franchisor’s failure to convey such information to a prospective franchise owner would represent a damaging omission or fraudulent misrepresentation by the franchisor, then the franchisor should not wait until the end of its fiscal quarter to amend the FDD. Rather, in such instances the franchisor should immediately amend the FDD upon the occurrence of the material event and cease franchise sales activities until the FDD is amended and registered in any applicable franchise registration states, if required.

The challenge for large and sophisticated franchise companies is that companies of

significant size are often confronted with new events or information that have an impact on its existing FDD disclosures, but may not be material as a practical matter in the context of prospective franchise owners considering the franchise investment. For example, while a change in the chief executive officer or VP of Franchise Development of the franchisor could be material to a prospective franchisee, changes to a director seat on the franchisor’s board or an officer of the franchisor’s publicly-traded parent company likely carry no bearing on a prospective franchise owner’s investment decision. Similarly, the filing of a new lawsuit against the franchisor or its parent company that is discloseable under Item 3 of the FTC Rule may not

77 FEDERAL TRADE COMMISSION, AMENDED FRANCHISE RULE FAQ’S 21 (answering that a franchisor may not

require a prospective franchisee to identify what statements within the FDD it deems material). 78 72 Fed. Reg. 15,566 (Mar. 30, 2007). 79 CAL. CORP. CODE § 31123; ) MD. CODE REGS. § 02.02.08.06(A)(1); 21 VA. ADMIN. CODE § 5-110-40(A). 80 FEDERAL TRADE COMMISSION, FRANCHISE RULE COMPLIANCE GUIDE 126 (2008).

Page 26: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

23

impact a franchise owner’s decision to purchase a franchise if the FDD already discloses fifteen similar lawsuits. Also, although the signing of a purchase agreement by the franchisor’s private equity parent company to acquire another franchise company may be discloseable under the Item 1 of the FTC Rule, the franchise company’s operation in an unrelated line of business may not be relevant to the franchisor’s pending prospective franchise owners who are on the verge of signing franchise agreements. In all of these cases, a franchisor might choose for business reasons to absorb the calculated risk of waiting to disclose the information until the franchisor’s next planned quarterly amendment to its existing FDD. Alternatively, as mentioned in section 3 above, the franchisor might elect to distribute the relevant information (such as press releases, or an informal supplement) to prospective franchise owners as a risk-management mechanism to preclude potential state law claims for fraud or misrepresentation.

B. Disclosure Challenges for Multi-Brand Franchise Companies

1. Multiple Brands Offered in a Single FDD

The aggregation of different commercially-related franchise brands under a single FDD has become a common practice for franchise conglomerates.81 Preparing one FDD across multiple brands might appeal to a multi-brand franchise company for many reasons, including uniformity of common disclosure information and corresponding agreements (e.g., one document containing all agreements) and to assist with soliciting prospective franchise owners. Combining multiple brands into a single FDD may also help facilitate franchise registration and tracking state registration, as well as result in lower registration fees and legal and accounting expenses. Nonetheless, the practice is not devoid of potential pitfalls that large and sophisticated franchise companies with multiple brands should weigh when considering adopting a single FDD for multiple brands.

The most fundamental challenge to producing a multi-branded FDD arguably lies in the

level of potential disparity between each brand’s business terms. While much of Item 1 organizational information or Item 17 boilerplate provisions (such as dispute resolution procedures, etc.) may align between brands, the substantive business terms and infrastructures of the brands may be vastly different. The brands might have different personnel, fees, start-up costs, required purchases, training programs, territory restrictions, financial performance representations and operational policies, which may be problematic when trying to organize disclosure under Item 2 (officers, directors and management), Item 5 (initial fees), Item 6 (other costs), Item 7 (estimated initial investment), Item 8 (supply chain), Item 9 (contract info), Item 10 (financing), Item 11 (training programs), Item 12 (territory), and Item 19 (financial performance representations). The less standardized the programs, the more work required to combine the franchise offers into one FDD, and the more potentially confusing and problematic the FDD may become for state examiners and prospective franchisees. If the changes in the FDD are confusing for state examiner to assess, combining the multiple brands into a single FDD could result in delays in registration or even a requirement by the state examiner to file separate FDDs for each brand as a condition to registration.

Besides the complexity - and possible misunderstanding of the document - a multi-brand

FDD may also be an impediment to a franchise company's franchise sales efforts. While examiners may have reservations as to whether such an FDD is too cumbersome and confusing, potential franchise owners may also find the documents overwhelming. In a multi-

81 By way of example, Midas and SpeeDee, and Tasti D-Lite and Planet Smoothie are franchise companies

with common ownership that offer multiple brands in a single FDD.

Page 27: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

24

brand FDD, the volume of information and the appearance of different information for each of the brands must be carefully handled. Further, if Brand A’s policies on certain issues are more favorable to a franchisee than those of Brand B, such as lower fees or a larger territory protection, then a Brand B prospect may more readily notice these differences and request negotiated concessions than he might not have otherwise.

The most practical guidance for franchise companies considering combining multiple

brands into one FDD is to analyze the similarities and differences between programs to determine whether one offering be advisable. As discussed above, a franchise company whose program details differ significantly may create more obstacles for itself, particularly in the near term, if it proceeds with combining multiple brands into a single FDD. In addition, if the programs differ significantly, the state examiners may require the filing of separate FDDs for each brand. Further, it may help facilitate registration if a franchise company that desires to combine brands into one FDD first obtain renewal registrations on the existing, separate FDDs, and later follow up with amendment filings to state agencies with the combined FDD when state administrators have emerged from the backlog of renewal registrations from the months of March and April.

2. Disclosure of Competitive Businesses

Regardless of whether a multi-brand franchise company offers various franchises through a combined FDD or in separate documents, each of the affiliated franchise companies will have to include certain territorial disclosures in Item 12 of the FDD regarding the other affiliated brands. The FTC Rule requires disclosure under Item 12 regarding other trademarked businesses operated, franchised, or planned to be operated or franchised, by the franchisor or any affiliate and that sells or will sell similar goods as the franchise owner will offer.82 The franchisor also has to disclose how it will resolve conflicts between franchise owners of each system regarding territory, customers, and franchise support, plus whether the other-trademarked outlets will be franchisor-owned or operated, and whether the other system will occupy its own physical offices and training facility rather than sharing the franchisor’s resources. In addition, the franchisor must also describe any of franchisor’s affiliates that have the ability, within the franchise owner’s territory, to use other channels of distribution to make sales under the franchisor’s principal trademark or to sell products or services under trademarks other than the franchise owner will use under the franchise agreement. 83 This last disclosure is not restricted to similar goods as those offered by the franchisor, but instead reaches to any types of goods or services. Thus, a multi-brand franchise company must address these questions of inter-brand competition among all of its affiliates with respect to all products and services offered by the franchisor and each of its affiliates. Such disclosure can be extremely cumbersome for multi-brand franchise companies with a number of brands under common control.

Unfortunately these potential cumbersome Item 12 disclosures cannot be avoided where

the franchisor is unable to qualify for a disclosure exemption. That said, one commonly-used approach for addressing such disclosure in Item 12 the FDD is for a highly diversified, multi-brand franchise company to think about these disclosures in the context of the particular category or subcategory of the franchise owner’s business line. For example, a multi-brand franchisor that operates and franchises many different restaurant chains may distinguish its

82 16 C.F.R. § 436.5(l)(6). 83 Id.

Page 28: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

25

offerings between quick-service restaurants, fast casual restaurants, and fine dining restaurants as a way of indicating the franchisor’s reasonable belief that the brands’ target consumers are different and the locations will not cannibalize one another’s market share, regardless of the proximity.

A multi-brand franchise company might want to consider creating and adopting

confidential impact policies for use internally by each brand. The impact policy can serve as a method to set forth a process for franchise owners to raise, and the franchisor to evaluate by applying pre-established evaluation criteria, concerns about possible encroachment of other proposed outlets on the territories of existing franchise owners or a franchise owner’s customer base. Such a policy would allow a franchisor to proactively set forth a relatively uniform approach for its various brand personnel to field and respond to franchise owner concerns.

V. CONCLUSION

Federal and state franchise disclosure regulations, in large part, target start-up and

middle market franchisors. While it may be common for large, sophisticated and multi-brand franchise companies to have elaborate corporate structures to account for operational complexities, to take certain company actions, such as stock repurchases, or to utilize non-traditional forms of financing that are not a consideration for small or medium franchise companies, federal and state franchise disclosure regulations often do not translate well when applied to larger and more sophisticated companies. Fortunately, there are certain federal and state-level exemptions available to large, sophisticated and multi-brand franchise companies to help relieve the franchisor of the additional obligations associated with franchise registration and disclosure requirements. However, as illustrated above, navigating these exemptions can be tricky and the exemption qualifications often do not translate well when applied to large and sophisticated franchise companies. Large, sophisticated and multi-brand franchise companies must remain aware of the disclosure obligations associated with particular transactions unique to franchisors of their size and sophistication, as well as possible available exemptions from the disclosure obligations of the FTC Rule and/or state franchise laws.

Page 29: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

26

Appendix I

Federal, State & NASAA Model Exemptions1

The following tables were created as a quick reference guide only. Please remember the burden of proving eligibility for any exemption or exception is on the entity claiming it. So it is strongly recommended that you read and then re-read the specific language of each statute before relying on an exemption or exception.

FTC

Type of Exemption Cite Disclosure Required

Exempt from

Disclosure Notice Filing

Self-Executing

Discretionary            

Fractional Franchise 16 C.F.R. § 436.8(a)(2)      

Insiders 16 C.F.R. § 436.8(a)(6)      

Institutional Franchisee            

Large Franchisee 16 C.F.R. § 436.8(a)(5)(ii)      

Large Franchisor            

Large Investment 16 C.F.R. § 436.8(a)(5)(i)      

Nominal Fee2 16 C.F.R. § 436.8(a)(1)      

Out of State Sales            Renewal of Existing Agreement3

16 C.F.R. § 436.1(t)      

Sale of Single Franchise            Sales by Existing Franchisees3

16 C.F.R. § 436.1 (j),(t)      

Sales to Existing Franchisees4

Compliance Guide, p. 19      

1 A special thanks to those who assisted in reviewing the tables for accuracy: Craig Tregillus (FTC); Theresa Leets (CA); Henry Tanji (HI); Cassandra Karimi (IL); Patrick Sanders (IN); Dale Cantone (MD); Suzanne Hassan (MI); Dan Sexton (MN); Alicia Brown (NY); Diane Lillis (ND); William Hawkins (RI); Jay Addison (SD); Timothy O’Brien (VA); Martin Cordell (WA); Lindsay Fedler (WI); Susan Grueneberg, Advisory Committee Chair for the NASAA Franchise Project Group (NASAA Model Exemptions). 2 Nominal fee is less than $540 3 No material changes to terms and conditions of franchise agreement 4 Franchisor must not play significant role in the sale (permissible for franchisor to approve transfer)

Page 30: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

27

CALIFORNIA 

Type of Exemption Cite

(CA Corp Code) Disclosure Required

Exempt from

Disclosure Notice Filing

Self-Executing

Discretionary1   

Fractional Franchise § 31108

Insiders § 31106

Institutional Franchisee

Large Franchisee2 §31109

Large Franchisor § 31101

Large Investment

Nominal Fee3 Rule 310.011

Out of State Sales4 § 31105 Renewal of Existing Agreement5 § 31018

Sale of Single Franchise Sales by Existing Franchisees6 § 31102 Sales to Existing Franchisees § 31106

1: See Commissioner's Release 61-C: How to request an Interpretive Opinion

2: § 31109(e) The notice must be filed before the offer is made.

3: Nominal fee cannot exceed $500 annually

4: No CA residents purchasing and all business located outside of CA

5: Exempt only if there is no interruption in the operation of the business and no material modification of the existing franchise.

6: Sale cannot be effected by or through franchisor but franchisor may approve new franchisee

CAVEAT: §31153 places burden of proving an exemption the person claiming it

Page 31: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

28

HAWAII

Type of Exemption Cite Disclosure Required

Exempt from

DisclosureNotice Filing

Self-Executing

Discretionary1 § 482E-4(b)

Fractional Franchise

Insiders

Institutional Franchisee § 482E-4(a)(2)

Large Franchisee

Large Franchisor

Large Investment

Nominal Fee

Out of State Sales § 482E-4(a)(4)

Renewal of Existing Agreement2

§ 482E-4(a)(5)

Sale of Single Franchise Sales by Existing Franchisees3 § 482E-4(7) Sales to Existing Franchisees

§ 482E-4(a)(6)

1: Policy is to refuse to grant exemptions despite authority to do so.

2: No interruption in operation of the franchise and no material change in franchise relationship

3: Must be an isolated sale by Franchisee for its own benefit

Page 32: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

29

Illinois

Type of Exemption Cite (Admin. Code tit. 14)

Registration Required

Disclosure Required

Exempt from

Disclosure Notice Filing

Self-Executing

Discretionary § 705/9 *   

Fractional Franchise § 705/3

Insiders § 705/8(a)(3) Institutional Franchisee § 705/8(b)

Large Franchisee § 705/8(a)(2) Large Franchisor ($5 - $15 mil) §200.202(e) Large Franchisor (over $15 mil) § 705/8(a)(1)

Large Investment §200.201(c)

Nominal Fee6 705/3(1)(c)

Out of State Sales Renewal of Existing Agreement7 § 705/7 Sale of Single Franchise §200.201(b)(1) Sales by Existing Franchisees8 § 705/7 Sales to Existing Franchisees

5 Depends on the offering. Disclosure is required, unless the Commissioner orders otherwise. 6 Fee cannot exceed $500. 7 Exempt only if there is no interruption in the operation of the business and no material modification of the existing franchise agreement 8 Sale cannot be effected by or through franchisor but franchisor may approve new franchisee/

Page 33: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

30

Indiana

Type of Exemption Cite Disclosure Required

Exempt from

Disclosure Notice Filing

Self-Executing

Discretionary9 IC 23-2-2.5-5 & IC 23-2-2.5-8

Fractional Franchise IC 23-3-2.5-1(a)

Insiders Institutional Franchisee

Large Franchisee

Large Franchisor IC 23-2-2.5-3(a)

Large Investment

Nominal Fee

Out of State Sales Renewal of Existing Agreement IC 23-2-2.5-1(g) Sale of Single Franchise10 IC 23-2-2.5-3 Sales by Existing Franchisees11 IC 23-2-2.5-4 Sales to Existing Franchisees   

9 It is self-executing but there is an option that any interested party may ask the Commissioner make a determination that the exemption is valid by filing a verified statement as to the facts regarding the proposed offer/sale. The filing fee is $50. 10 Only 1 sale within a 24-month period. 11 Offer or sale must not be affected by or through a franchisor.

Page 34: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

31

Maryland

Type of Exemption Cite Disclosure Required

Exempt from Disclosure

Notice Filing

Self-Executing

Discretionary § 02.02.08.10(G) *  * 

Fractional Franchise See Discretionary *  * 

Insiders Institutional Franchisee § 02.02.08.10(F)

Large Franchisee

Large Franchisor § 02.02.08.10(D)

Large Investment § 02.02.08.10(E)

Nominal Fee12 § 02.02.08.10(C)

Out of State Sales § 02.02.08.10(B) Renewal of Existing Agreement § 14-203(c) Sale of Single Franchise Sales by Existing Franchisees § 14-214(c) Sales to Existing Franchisees § 14-214(b)(2)

 *Depends on the offering. Disclosure is required, unless the Commissioner orders otherwise.

12 Fee cannot exceed $100.

Page 35: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

32

Michigan

Type of Exemption Cite Disclosure Required1

Exempt from Disclosure131

Notice Filing

Self-Executing

Discretionary   

Fractional Franchise § 445.1506 (1)(h)

Insiders14 Institutional Franchisee § 445.1506 (1)(b)

Large Franchisee

Large Franchisor

Large Investment

Nominal Fee15 § 445.1506 (1)(c)

Out of State Sales § 445.1506 (1)(d) Renewal of Existing Agreement16 § 445.1506 (1)(e) Sale of Single Franchise Sales by Existing Franchisees § 445.1506 (1)(f) Sales to Existing Franchisees17 § 445.1505 (1)(g)

13 §445.1506 (2) - If the franchisor has a disclosure statement in compliance with the laws of any state or rule of the federal trade commission then disclosure is required/ 14 See reference to Sales to Existing Franchisees. 15 Nominal Fee cannot exceed $500. 16 No interruption in the operation of the franchise business and no material change in the franchise relationship. 17 Must be an isolated sale by Franchisee for its own benefit

Page 36: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

33

Minnesota

Type of Exemption Cite Registration

Required Disclosure Required

Exempt from

Disclosure Notice Filing

Self-Executing

Discretionary §80C.03(g) Fractional Franchise §80C.03(f)

Insiders Institutional Franchisee §80C.03(c)

Large Franchisee

Large Franchisor Large Investment18

§§ 2860.8100-8300

Nominal Fee19 Not subject to franchise statute

Out of State Sales §80C.03(h) Renewal of Existing Agreement Sale of Single Franchise20 §80C.03(e) Sales by Existing Franchisees21 §80C.03(a) Sales to Existing Franchisees

18 Investment exceeds $200,00, Must file financial statements 19 Annual payment is less than $100. 20 One sale per 12 months, no general solicitation and franchise fee must be deposited into an escrow. 21 Sale cannot be effected by or through franchisor but franchisor may approve new franchisee.

Page 37: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

34

New York

Type of Exemption Cite Disclosure Required

Exempt from

Disclosure Notice Filing

Self-Executing

Discretionary22 § 684(1), (4)

Fractional Franchise

Title 13, § 200.10(2) or Admin R. § 441-325-0030 (1)

Insiders Institutional Franchisee § 684(3)(b)

Large Franchisee

Large Franchisor § 684(2) &(3)(a)

Large Investment

Nominal Fee

Out of State Sales

Renewal of Existing Agreement23

Rich Food Services, Inc. v. Rich Plan Corp.

Sale of Single Franchise24 § 684(3)(c) Sales by Existing Franchisees25 § 684(5) Sales to Existing Franchisees § 684(3)(d)

Trade Show26 § 684(1)

22 Generally NY grants discretionary exemptions to NY franchisor selling a unit outside USA. Requests take approximately 2 weeks to process. 23 Franchisor has no obligation to engage in disclosure at renewal. 24 May not offer to more than 2 people; no commission paid and franchisor is domiciled in NY or filed consent to service of process with the Department. 25 Sale cannot be effected by or through franchisor but franchisor may approve new franchisee. Must be an isolated sale. 26 Exemption allows franchisor to show at the trade show for 3-days. No offers or sales.

Page 38: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

35

North Dakota

Type of Exemption Cite

Registration Required

Disclosure Required

Exempt from

Disclosure Notice Filing

Self-Executing

Discretionary27 § 51-19-04(3) & § 51-19-05

Fractional Franchise

Insiders Institutional Franchisee

Large Franchisee

Large Franchisor § 51-19-04(1)

Large Investment

Nominal Fee

Out of State Sales

Renewal of Existing Agreement

§ 51-19-02(14)(a)(2)

Sale of Single Franchise Sales by Existing Franchisees28 § 51-19-04.2 Sales to Existing Franchisees

27 For more information about this exemption, contact Diane Lillis (701) 328-4712. The Commissioner has allowed 3 discretionary exemptions in the last 10 years. 28 Sale cannot be effected by or through franchisor but franchisor may approve new franchisee.

Page 39: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

36

Rhode Island

Type of Exemption Cite Disclosure Required

Exempt from

Disclosure Notice Filing29

Self-Executing

Discretionary § 19-28.1-6 (10) Fractional Franchise

Insiders § 19-28.1 -6(3) Institutional Franchisee

Large Franchisee § 19-28.1 -6(4)

Large Franchisor § 19-28.1 -6(1)

Large Investment

Nominal Fee

Out of State Sales § 19-28.1 -7 Renewal of Existing Agreement30 § 19-28.1 -6(6) Sale of Single Franchise Sales by Existing Franchisees31 § 19-28.1 -6(2) Sales to Existing Franchisees § 19-28.1-6(5)

29 The filing fee for exemption Notice is $360. See § 19-28.1 -29(c) 30 No interruption in the operation of the business and no material change in the franchise relationship. 31 Sale cannot be effected by or through franchisor but franchisor may approve new franchisee.

Page 40: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

37

South Dakota

Type of Exemption Cite Disclosure Required

Exempt from

Disclosure Notice Filing

Self-Executing

Discretionary § 37-5B-15

Fractional Franchise § 37-5B-12(3)

Insiders § 37-5B-13(4) Institutional Franchisee § 37-5B-14(2)

Large Franchisee § 37-5B-13(2)

Large Franchisor

Large Investment § 37-5B-13(1)

Nominal Fee32 § 37-5B-12(5)

Out of State Sales § 37-5B-3

Renewal of Existing Agreement33

§ 37-5B-1(16), (28)

Sale of Single Franchise Sales by Existing Franchisees34 § 37-5B-1(16) Sales to Existing Franchisees § 37-5B-14(1)

32 Fee is less than $500. 33 No interruption in the franchisee's operation of the business and no terms and conditions that differ materially from the original agreement. 34 Sale cannot be effected by or through franchisor but franchisor may approve new franchisee.

Page 41: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

38

Virginia

Type of Exemption Cite Disclosure Required

Exempt from

DisclosureNotice Filing

Self-Executing

Discretionary            

Fractional Franchise Title 13.1, ch. 8, § 13.1-559B Not subject to franchise statute

Insiders            

Institutional Franchisee 21 VAC 5-110-75(5)      

Large Franchisee            

Large Franchisor 21 VAC 5-110-75(5)      

Large Investment            

Nominal Fee            

Out of State Sales            Renewal of Existing Agreement35

21 VAC 5-110-75(2)      

Sale of Single Franchise            

Sales by Existing Franchisees36

21 VAC 5-110-75(1)   

Sales to Existing Franchisees

21 VAC 5-110-75(3)      

  

  

35 No interruption in the operation of the franchised business, and there is no material change in the franchise relationship. 36 Sale cannot be effected by or through franchisor but franchisor may approve new franchisee.

Page 42: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

39

Washington

Type of Exemption Cite

Registration Required

Disclosure Required

Exempt from

Disclosure Notice Filing

Self-Executing

Discretionary Fractional Franchise

Accredited Investors

RCW 19.100.030(5) WAC 480-80-108

Insiders RCW 19.100.030(5) WAC 480-80-108(4)

Institutional Franchisee37

RCW 19.100.030(3) RCW 19.100.030(5) WAC 480-80-108

Large Franchisee

RCW 19.100.030(5) WAC 480-80-108(2) & (3)

Large Franchisor

RCW 19.100.030(4)(b)

Large Investment

Nominal Fee38 RCW 19.100.030(4)(b)(iii)

Out of State Sales Renewal of Existing Agreement Sale of Single Franchise or Isolated Sales39

RCW 19.100.030(4)(ii)

Sales by Existing Franchisees40

RCW 19.100.030(1)

Sales to Existing Franchisees41

RCW 19.100.030(6)

37 See WAC 480-80-108(1)-(3) and (7). 38 Fee cannot exceed $500. 39 Available only to WA based franchises and franchisor grants 3 or fewer franchises. 40 Franchisee may not be a franchisor affiliate, must sell their entire franchise and the sale cannot be made by or through the franchisor. 41 Franchisee must have operated similar franchise for 2 years and the prior sale of the franchise must have been registered in the state of Washington.

Page 43: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

40

Wisconsin

Type of Exemption Cite Registration

Required Disclosure Required

Exempt from

Disclosure Notice Filing42

Self-Executing43

Discretionary § 553.25 * 

Fractional Franchise § 553.22

Insiders

Institutional Franchisee

§ 32.05 (1)(c)(2) * 

Large Franchisee

Large Franchisor

Large Investment § 553.235 (1)(a)

Nominal Fee44 §32.05 (1)(b) * 

Out of State Sales45 §32.05(1)(d) * 

Renewal of Existing Agreement46

§ 553.03 (8r) & (11)

Sale of Single Franchise

Sales by Existing Franchisees47 § 553.23

Sales to Existing Franchisees

§ 32.05 (1)(e) * 

42 See §32.03: Franchisors whose franchises are exempted under s. 553.25, Stats., shall be required, as a condition of maintenance of the exemption, to notify the division in writing within 30 days after the happening of any material event or material change within the meaning of s. DFI-Sec 31.01 (2), affecting the exempted franchises or the franchisor 43 See §553.24 (6) the division may require that additional information be filed if the division determines that the information is reasonably necessary to establish an exemption 44 Annual payment less than $1,000 for bona fide wholesale price for products or services. 45 Must comply with state's franchise laws where the sale takes place. 46 No interruption in the operation of the franchise business. 47 Sale cannot be effected by or through franchisor but franchisor may approve new franchisee/

Page 44: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

41

NASAA Model Exemptions48

Type of Exemption Disclosure Required

Exempt from Disclosure Notice Filing

Self-Executing

Discretionary

Fractional Franchise

Insiders

Institutional Franchisee

Large Franchisee   

Large Franchisor   

Large Investment   

Nominal Fee

Out of State Sales Renewal of Existing Agreement

Sale of Single Franchise Sales by Existing Franchisees   

Sales to Existing Franchisees

48 North American Securities Administrators Association (NASAA) adopted a proposed set of model

exemption on September 9, 2012

Page 45: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

42

Appendix II

California Negotiated Sales and Material Modifications

Under the California Franchise Investment Law a franchisor is prohibited from offering to prospective franchise owners any franchise terms different from the terms of the offer registered under Sections 31111 (initial registration), 31121 (renewal) or 31123 (post-effective Amendment). There are 3 options for addressing negotiates sales in California.

Note that Negotiated Sales are different than Material Modifications made to existing

franchise agreements. If the franchisor proposes to change any terms of an existing franchise agreement for a California franchise then an application must be sent into the Department under Section 31125 before the change is made (unless an exception applies).

Negotiated Sales:

I. Section 31109.1 and Rule 310.100.4132 of the California law require the franchisor to take the following actions: 1. The initial offer must be registered under Section 31111, 31121, or 31123;

2. In an appendix to the FDD, the franchisor must provide a prospective franchise

owner with a summary description of all of the material negotiated terms during the prior 12 month period in the form prescribed under California Rule 310.100.4, along with a statement that copies of the negotiated terms are available upon written request and the contact information of the franchisor's representative from whom negotiated terms can be obtained;

3. The franchisor must certify or declare in an appendix to its application for renewal

that it has complied with all of the requirements under Section 31109.1 (in the event this exemption is claimed);

4. The negotiated terms, on the whole, must confer additional benefits on the prospective franchise owner;

5. The franchisor must provide a copy of all negotiated terms to the prospective franchise owner within five business days following the request of the prospective franchise owner; and

6. The franchisor must keep copies of all material negotiated terms for a period of five years from the date of the first agreement containing the relevant negotiated term. Upon the request of the commissioner, the franchisor must make the copies available to the commissioner for review.

II. Rule 310.100.2 of the California law exempts the offer or sale of a franchise on terms different from the terms of the offer registered if all of the following conditions are met:

1. The initial offer must be registered under Section 31111, 31121, or 31123;

132 The rules referred to herein are in Title 10, California Code of Regulations (CCR).

Page 46: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

43

2. When the prospective franchise owner receives the FDD, he or she must also receive copies of all Notices of Negotiated Sale of Franchise filed with the state within the last 12 months, if any;

3. Before selling another franchise, the franchisor must amend its registered offer with prescribed language indicating that Items have been negotiated with other franchise owners and copies of filed notices of negotiated sales are attached to document (which can also be done by amendment that is auto-effective upon filing);

4. A Notice of Negotiated Sale of Franchise in prescribed form must be filed with the state within fifteen business days after the negotiated sale is consummated; and

5. The franchisor certifies or declares in an appendix to its application for renewal that all notices have been filed with the state as required under Regulation 310.100.2.

III. Section 31123 requires a franchisor shall promptly notify the commissioner in writing, by an application to amend the registration, of any material change in the information contained in the application as originally submitted, amended or renewed. The negotiated changes under this option must be sent to the Department as a post-effective amendment. The prospective franchisee is re-disclosed after the Department issues an order and the sale is not consummated until after the 14-day waiting period.

Material Modification:

I. Section 31125(c) and (d) of the California law excepts modifications of an existing franchise or of existing franchises if all of the following conditions are met:

1. The franchise owner must receive the complete written modification at least five

business days prior to the execution of a binding agreement, or provide that the franchise owner may, by written notice mailed or delivered to the franchisor or a specified agent of the franchisor within not less than five business days following the execution of the agreement, rescind the agreement to the material modification;

2. The modification agreement must not be signed within twelve months after the

date of the franchise agreement;

3. The modification must not waive any right of the franchise owner under the California Franchise Relations Act, but the modification may include a general release of all known and unknown claims by a party to the modification; and

4. (i) The proposed modification must be in connection with the resolution of a bona fide dispute between the franchisor and the franchise owner, and the modification must not be applied on a franchise system wide basis (meaning offered on a voluntary basis to fewer than twenty-five percent of the franchisor's California franchises within any twelve month period); or (ii) The proposed modification must be offered on a voluntary basis to fewer than twenty-five percent of the franchisor's California franchises within any twelve month period, provided each

Page 47: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

44

franchise owner must be given a right to rescind the modification agreement if the modification is not made in compliance with paragraph (i); or

5. The modification must be offered on a voluntary basis and must not substantially or adversely impact the franchise owner's rights, benefits, privileges, duties, obligations, or responsibilities under the franchise agreement.

Page 48: Franchise Disclosure Challenges For Large, … Bar Association 37th Annual Form on Franchising FRANCHISE DISCLOSURE CHALLENGES FOR LARGE, SOPHISTICATED OR MULTI-BRAND FRANCHISE COMPANIES

THERESA LEETS Theresa Leets is a Senior Corporations Counsel for the California Department of Business Oversight’s Securities Regulation Division. She is 1 of 6 lawyers that regulate the offer and sale of franchises and securities in California. She is a member of the NASAA Corporation Finance Franchise and Business Opportunities Project Group and an IFA Certified Franchise Executive (CFE). In addition, she is licensed as a Real Estate Broker with an inactive MLO (mortgage loan originator) endorsement in California. Ms. Leets received her BA at the University of California at Santa Barbara and her JD at the University of California at Davis.

ALAN R. GREENFIELD

Alan Greenfield is a Shareholder in the Chicago and Miami offices of Greenberg Traurig, LLP. Mr. Greenfield concentrates his practice on international and domestic franchising, licensing and distribution matters. Mr. Greenfield works with both experienced and start-up franchise companies in structuring franchise programs and drafting franchise-related documents. He counsels franchisors and manufacturers on everyday compliance and other franchise or distributor-related issues, such as registration and disclosure matters, negotiating agreements, relationship termination laws, maintaining good franchisee/distributor relations and resolving disputes with franchisees/distributors. Mr. Greenfield also works extensively on international franchising, licensing and distribution transactions. He counsels a broad range of clients in expanding their brands around the globe through various means, such as master franchising, multi-unit licensing and area development. Mr. Greenfield also handles mergers and acquisitions and sophisticated financing transactions involving franchise, license or distribution networks. Mr. Greenfield earned his J.D., cum laude, from the University of Miami School Law and his B.A., cum laude, from the University of Central Florida.

KAREN BORING SATTERLEE Karen Satterlee is Vice President and Senior Counsel for Hilton Worldwide, Inc. Ms. Satterlee is responsible for the legal affairs of Hilton’s Americas development team function, which includes legal supports for the negotiation, drafting, interpretation and enforcement of hotel management and franchise agreements, real estate acquisitions, dispositions and asset management. She also manages the global franchise regulatory process. Prior to Hilton Worldwide, Ms. Satterlee was Director and Senior Counsel for Franchise Licensing for Starbucks Corporation in Seattle, Washington, where she served as a member of the Starbucks Licensed Store leadership team. Prior to working at Starbucks, Ms. Satterlee worked in a variety of capacities for Cendant Corporation in Parsippany, New Jersey and Exxon Corporation in Houston, Texas. Ms. Satterlee is the Publications Officer for the American Bar Association Forum on Franchising’s Governing Committee and was the co-chair of the 34th Forum on Franchising in October of 2011. She is also a member of the Board of Trustees for the International Franchise Association’s Educational Foundation and a former member of the Board of Governors for the Institute of Certified Franchise Executives. Ms. Satterlee has authored a number of articles for the Franchise Law Journal and is a frequent speaker at legal and industry conferences. Ms. Satterlee received her JD and BA at the University of Tennessee in Knoxville and lives in Ashburn, Virginia.