MORSE, BARNES-BROWN & PENDLETON, P.C. The Business Law Firm on Route 128 ® Franchises and Business...

MORSE,BARNES-BROWN &PENDLETON, P.C.

The Business Law Firm on Route 128®

Franchisesand

Business Opportunity Ventures

Disclosure, Registration, Going Global …

and a Trap for the Unwary

By Thomas F. Dunn, Esq. ([email protected]) © 2004 Morse, Barnes-Brown & Pendleton, P.C.

Before we begin …

Q: Why do we care ?

A: Because franchises are BIG business

Franchised businesses experience lower default rates than independent businesses

Securing financing often easier because the franchisor typically has an established trademark and goodwill, as well as marketplace experience

Can achieve levels of brand awareness, market penetration and purchasing power not readily achieved by individual business owners


Franchise Overview: Main Considerations

Disclosure Federal Government and Some States

Require Disclosure

Registration Some States (but not the Federal

Government) Require Registration

Going Global UNIDROIT (Model Franchise Disclosure Law)

Trap for the unwary


Franchise Law: Where to Begin?

Federal 416 C.F.R. 436.1-3 (the “Rule”) Mandates Disclosure Alternatively may disclose under UFOC

(Uniform Franchise Offering Circular) State

15 states regulate franchises 23 states regulate business opportunities

International National Laws UNIDROIT

(Model Franchise Disclosure Law)



THE RULE: 16 C.F.R. 436 (the “Rule”) compels and provides the minimum requirements for disclosure regardless of which state(s) the franchise operates in

UFOC: Alternatively, one may disclose under UFOC (Uniform Franchise Offering Circular)

Promulgated by NASAA (North American Securities Administrators Association)



Roughly half of the 15 states that regulate franchises will not accept the Rule document but will accept the UFOC document

For this reason, many franchisors offer disclosure by means of the UFOC; but several UFOC requirements are awkward so consider disclosure under the Rule if limited geographic scope and/or in certain states

The FTC will presume adequacy of a UFOC when registered by a state, but several key provisions of the Rule will govern

Therefore, understanding the Rule is the best place to begin


The Rule: Franchise Defined

Q: What is a Franchise?

A: The Rule under 16 C.F.R. 436.2 captures two types of continuing commercial relationships:

Traditional FranchisesBusiness Opportunities


The Rule: Traditional Franchises

Three definitional prerequisites:1. Trademark

The franchisor offers to the franchisee the right to offer to sell, sell or distribute the franchisors goods or services under the franchisors commercial symbol

2. Significant Control or AssistanceFranchisor exerts significant control or assistance over the franchisee’s method of operation (significant assistance over promotion, without more, does not meet the test)

3. Required PaymentFranchisee required to make payment, or commitment to make payment, to franchisor or affiliate


The Rule: Business Opportunities

Three Definitional Prerequisites:1. No Trademark

The seller simply offers the right to offer to sell, sell or distribute goods or services supplied by the seller, its affiliate, or a supplier with which the seller requires the franchisee to do business

2. Location AssistanceSeller offers to secure retail outlets or accounts for the goods or services to be sold, to secure locations or sites for vending machines or rack displays, or to refer franchisee

3. Required PaymentSame as for traditional franchise.


The Rule: Exemptions Minimum Investment (Under $500)

Fractional Franchises (Existing business adds a franchised product or service to its other lines of business )

Simple TM License (Licensee lacks the right to use the mark in connection with a business system; licensor lacks control over the licensee’s business and typically does not provide significant assistance to the licensee)

Employer-Employee & General Partnership Relationships (not Limited Partnerships)

Verbal Agreements (Only if no material term is in writing)


The Rule: Exemptions

Coops (agricultural coops; retailer-owned coops

Leased Departments (lease space in the premises of a franchisor but not required or advised to buy the goods or services it sells from the retailer or affiliate)

Statutory Exemptions (petition the Commissioner)


The Rule:When Is Disclosure

Required? If business is

(i) a “traditional franchise” or (ii) a “business opportunity” and (iii) no exemption applies then

… then you must meet federal disclosure requirements under the Rule

This applies in all 50 states


The Rule: Disclosure Requirements

1. Identifying info (Name, address, mark, etc.)

2. Prior 5 years business experience of franchisor's directors and executive officers.

3. Business experience of franchisor in connection with the type of franchise offered (not just any type of franchise).

4. Litigation history: Criminal, emphasizing felony convictions; or Civil, emphasizing fraud convictions.



5. Bankruptcy history: Prior 7 years.

6. Description of franchise.

7. Initial funds: Fees, deposits, inventory, etc.

8. Recurring funds: Royalty, lease, etc.



9. Affiliated persons with whom the franchisee is required or advised by the franchisor to do business.

10. Obligations to purchase: Signs,

supplies, fixtures, etc.

11. Consideration received by the franchisor or affiliate from suppliers for franchisee purchases.



12. Statement of material terms of financing

offered by franchisor or affiliate to franchisee

13. Restriction of sales (goods, customers, geography) & territorial protection

14. Personal participation required of the franchisee in the operation of the

franchise. 15. Term, termination, cancellation, renewal,

assignment, etc., of the franchise.



16. Statistical information concerning the number of franchises (number of renewals, number of renewals refused, number cancelled, etc.)

17. Site selection: Time from execution to site selection.

18. Training programs: Type, amount, cost

19. Public figure involvement in the franchise:

Endorsement; involvement.



20. Financial information concerning the franchisor:

Balance sheet for most recent fiscal year

Income statement

Statement of changes

All for the most recent three years



The foregoing 20 disclosures shall be contained in a single disclosure statement or prospectus which shall not contain any materials or information other than that required by this part or by State law not preempted by this part. (16 C.F.R. 436.1)

In addition, this disclosure statement shall carry a cover sheet with the magic language ….



The Magic Language ... in bold 12 point font …

Information for Prospective Franchisees Required by Federal Trade Commission

****************To protect you, we've required your franchisor to give

you this information. We haven't checked it, and don't know if it's correct. It should help you make up your mind. Study it carefully. While it includes some information about your contract, don't rely on it alone to understand your contract. Read all of your contract carefully. Buying a franchise is a complicated investment. Take your time to decide. If possible, show your contract and this information to an advisor, like a lawyer or an accountant. If you find anything you think may be wrong or anything important that's been left out, you should let us know about it. It may be against the law.

There may also be laws on franchising in your state. Ask your state agencies about them.

Federal Trade Commission,

Washington, D.C.


UFOC:Disclosure Requirements

As with disclosure under the Rule, disclosure under UFOC consists of:

The foregoing 20 disclosures; and

A cover sheet with the magic language ….



Q: So what makes UFOC so much more desirable to most states that regulate franchises?



A: (i) Less legalese;

and

(ii) Expanded disclosure requirements in

the following areas:



The franchisee's potential market. (Marks, territory, relocation, option to acquire others)

Items that enhance the franchisor/franchisee relationship (termination, option to purchase)

Expanded treatment of potential earnings claims (range of actual or potential sales, costs or profit)



Lists of outlets (should total at least 100)

Financial statements balance sheet for the last two fiscal years plus the statement of operations, equity and cash flow for the last three fiscal years)

Patents, Copyrights and Proprietary Information


State Franchise Law

15 states require franchisors to provide pre-sale disclosures, known as "offering circulars," to potential purchasers.

13 of these 15 states treat the sale of a franchise like the sale of a security. Typically prohibit the offer or sale of a franchise

within their state until a franchise offering circular has been filed on the public record with, and registered by, a designated state agency.

2 of these 15 states require use of a disclosure document but do not require that such a document be filed with the state.


State Franchise Law:

The Following 13 states treat the sale of a franchise like the sale of a security requiring registration:

California North DakotaHawaii Rhode Island Illinois South DakotaIndiana VirginiaMaryland WashingtonMinnesota WisconsinNew York

The Following 2 states require disclosure but not registration:

Oregon (no filing) Michigan (file notice only)


State: Business Opportunities

The Following 23 states regulate business opportunities: California Connecticut Florida Georgia Illinois Indiana Iowa Kentucky Louisiana Maine Maryland Michigan Minnesota Nebraska New Hampshire North Carolina Ohio, Oklahoma South Carolina South Dakota Texas Utah Virginia Washington


Massachusetts

Massachusetts is not one of the 15 states with special rules or laws governing franchises or one of the 23 governing business opportunities


Massachusetts

“The Federal Trade Commission requires that many types of business opportunities, such as franchise offers, provide a disclosure statement with pertinent information about the business and its owners. Ask for one if you are considering a particular offer.”

Source: Massachusetts Attorney General’s Office http://www.ago.state.ma.us/sp.cfm?pageid=1202 (August 7, 2004)


Massachusetts

For a Massachusetts franchisor (or franchisee or franchise broker), we care about: The Rule or UFOC (whichever disclosure

mechanism is at issue); and Remedies under 93A


Remedies for Failure to Disclose and/or Register

The Rule The Rule is a trade regulation rule with

the full force and effect of federal law.

The courts have held it may be enforced by the FTC only, not by private parties



FTC Action: Injunctions Asset Freezes (corporate and personal) Civil Penalties ($11,000 per violation) Monetary redress on behalf of investors Other redress, e.g., rescission or

reformation of contracts



What’s a private party to do? Each of the franchise laws in the 15

states with franchise registration and/or disclosure requirements authorizes actions for state franchise law violations

The courts in some states have interpreted state deceptive practices laws (“little FTC Acts”) as permitting private actions for Rule violations: 93A


Going Global

National laws

National Model Law Model Franchise Disclosure Law UNIDROIT

International Model Law Model International Franchising Agreement International Chamber of Commerce (ICC)


Going Global: National laws

Only a relative handful of countries have laws specific to franchises


Going Global: Model Law (National)

Model Franchise Disclosure Law UNIDROIT

International Institute For the Unification of Private Law

Drafted by Committee of Governmental Experts

Endorsed by the Governing Council Limited to Disclosure (like the Rule in

U.S.)

Source: Peters, Lena, Franchising: Recent Legislation and the UNIDROIT Model Franchise Disclosure Law, Bus. Law J. Jan. 2004.



Based primarily on review of franchise laws in: Italy Korea Japan Canada (Ontario) Canada (Alberta)

Source: Peters, Lena, Franchising: Recent Legislation and the UNIDROIT Model Franchise Disclosure Law, Bus. Law J. Jan. 2004.



The disclosure requirements under the Model Franchise Disclosure Law are remarkably similar to those required by the Rule and UFOC

http://www.unidroit.org/english/modellaws/2002franchise/main.htm


Going Global: Model Law (International)

ICC Model International Franchising Agreement


Trap for the Unwary

Is your license, distribution, partnership or other “agreement” actually a franchise?

Does the “licensor” assist significantly with its client’s “method of operation” ?

Does the “licensor” charge its client a fee for its services?

Can the “licensor” permit it’s client to use the licensor’s mark?

If the answer to these three questions is ‘yes’ then a franchise agreement exists and the “licensor” must comply with franchise laws


Franchise Law: Contact Information

Thomas F. DunnMorse, Barnes-Brown & Pendleton, P.C.

1601 Trapelo RoadWaltham, MA 02451Tel: 781.622.5930Email: [email protected]: www.mbbp.comBio: www.mbbp.com/thomasd.html

Directions: www.mbbp.com/directions.html

MORSE, BARNES-BROWN & PENDLETON, P.C. The Business Law Firm on Route 128 ® Franchises and Business...

Documents

Transcript of MORSE, BARNES-BROWN & PENDLETON, P.C. The Business Law Firm on Route 128 ® Franchises and Business...