As a franchisee, you should understand the areas of franchise law that protects your interests.
Franchise law is a blend of federal and state laws that regulate the sale of franchises, franchise registrations, and the contractual franchisor and franchisee relationship.
A franchise is a commercial relationship in which:
- A franchisor gives a franchisee the right to distribute goods and services under its trademark or business symbol.
- A franchisor maintains substantial control of or provides considerable assistance to a franchisee’s business.
- The franchisee pays a fee to the franchisor for utilizing its trademark and services.
If you currently own or thinking about purchasing a franchise, understanding the intricacies of federal and state franchise law is critical.
What A Franchisee Should Know About Federal Franchise Law
Franchises are regulated by the U.S. Federal Trade Commission (FTC). The FTC rule requires franchisors to disclose information to a potential franchisee about their business, its officers, and other franchisees.
A prospective franchisee should understand the disclosure items and the risks of purchasing a franchise based on these disclosures.
The Franchise Disclosure Document (FDD) and Franchising Risks
A franchisor must give prospective franchisees a franchise disclosure document (FDD) at least 14 calendar days before a franchisee signs an agreement or makes a payment to the franchisor for their proposed franchise. 16 CFR § 436.2.
Franchisors are required to disclose 23 items to franchisees within the FDD. Franchisees should ensure that the franchisor provides them with the FDD and that they wholly understand the terms of these disclosures.
Franchisees should be especially vigilant about:
- Litigation Disclosures (Item 3): This disclosure notifies franchisees about whether the franchisor has pending civil, administrative, or criminal actions against them. It should also outline whether a franchisor was previously convicted of a crime or held liable for a civil violation.
Franchisees should be mindful of how pending litigation could negatively impact a franchisor’s ability to maintain their business.
- Bankruptcy Disclosures (Item 4): This disclosure notifies franchisees about whether the franchisor filed for bankruptcy.
A bankruptcy filing is an indicator of a franchisor’s past financial issues, heightening the possibility of a future bankruptcy filing. Franchisees should be aware that a future filing would be detrimental to their business investment.
Franchisees should ensure that they review all the FDD items with an expert franchise attorney who understands these disclosures’ implications.
What A Franchisee Should Know About State Franchise Laws
Franchise laws vary by state; therefore, a franchisee should understand the laws of their franchise state.
State franchise law generally covers registration, filing, and relationship requirements.
- If a franchisee is in a registration state, they should ensure that the franchisor’s FDD is registered with the state before making any payments to the franchisor, because a franchisor must receive government approval of their FDD before accepting these payments.
- If a franchisee is in a filing state, they should ensure that the franchisor has filed their FDD with the state before making any franchisor payments. They should also ensure that the franchisor renews their filing if required.
- If a franchisee is in a relationship state, they should understand the termination and default benefits that the state may have for franchisees.
We Can Help You
Franchise law is complex. If you plan to purchase or if you are currently operating a franchise, there are many factors that you should be aware of to operate your business successfully.
We want to help you navigate this complicated area of law.
Contact us today to discuss your franchisee concerns!