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Understanding And Complying With Federal And State Franchise Laws

With extensive experience handling franchise law matters, the Franchise Law Practice Group of Huck Bouma is able to provide franchise clients with the personalized and cost-effective legal solutions they need to achieve their business goals while being in compliance with the applicable franchise laws. Below are some of the questions our clients frequently ask when they are seeking to establish a franchise.

Address Your Compliance Concerns

What is a franchise?

Determining whether or not a business is a franchise can be a complicated process. Some companies may think they can avoid the legal regulation of franchising by calling their arrangement a license agreement, business opportunity or dealership. In reality, it does not matter how an arrangement is labeled, nor does it matter whether or not the parties intended to create a franchise relationship.

When three specific characteristics are present in a business relationship, it is a franchise, regardless of what it is called and regardless of the parties’ intent. Under federal law, these factors include:

  • Use of trademark: The franchisee sells goods or services that are identified by the franchisor’s trademark or service mark.
  • Control or assistance: The franchisor exercises or has the authority to exercise significant control over the franchisee’s method of operation, or gives the franchisee significant assistance.
  • Fee: The franchisee is required to make a payment to the franchisor or a person affiliated with the franchisor as a condition of obtaining or commencing the business.

Variations of the “control or assistance” prong of the franchise definition exist in specific state franchise laws. For example, in some states the “control or assistance” characteristic is replaced by the presence of a marketing plan or system prescribed or suggested by a franchisor. In other states, the “control or assistance” characteristic is replaced by the presence of a community of interest in the marketing of goods or services.

If your business arrangement falls within the definition of a franchise, you must comply with federal franchise law. If you have a franchise and are offering it in certain states that have franchise laws, you must also comply with the applicable state franchise laws.

There are some exclusions and exemptions under state and federal franchise laws that allow the arrangement to be offered without complying with the registration and/or disclosure requirements of the federal and/or state franchise laws.

What state laws apply to a franchise?

The Amended FTC Franchise Rule applies to the offer and sale of franchises in all 50 states. The federal law allows states to impose greater requirements on franchisors, including franchise registration and additional disclosure requirements.

The following states have their own franchise laws and regulations that apply to the offer and sale of franchises in their state, if prospective franchisees reside in their state, and/or if the franchise business will be located in their state:

  • California
  • Hawaii
  • Illinois
  • Indiana
  • Maryland
  • Michigan
  • Minnesota
  • New York
  • North Dakota
  • Rhode Island
  • South Dakota
  • Virginia
  • Washington
  • Wisconsin

These states are known as franchise registration states. They require franchisors to obtain a franchise registration or meet certain conditions for exemption before selling a franchise. If a franchisor does not register or meet the criteria for exemption, they cannot legally sell a franchise in those states.

These laws give protection to franchisees that reside in the state or establish a franchise business in the state and also impose additional obligations to franchisors and subfranchisors desiring to offer and sell franchises in their state. If you are a franchisor or subfranchisor/master franchisee, you need to be aware of the state law requirements of franchise registration states.

In addition to franchise registration laws, some states have business opportunity laws.   If franchisors are offering franchises in states that have business opportunity laws that would apply to the offer and sale of a franchise, they may be able to obtain a franchise exemption by meeting certain conditions, including having a registered trademark and filing a request for exemption to the state.  States with business opportunity laws that offer franchisor exemptions include:

  • Connecticut
  • Florida
  • Kentucky
  • Maine
  • Nebraska
  • North Carolina
  • South Carolina
  • Texas
  • Utah

That leaves the remaining states, which are known as non-registration states. A non-registration state is one that does not have a state law governing franchisors and the offer and sale of franchises. In these states, a franchisor needs only to follow the federal franchise law.

What should I know about a Franchise Disclosure Document (FDD)?

A Franchise Disclosure Document discloses information needed by a prospective franchisee for making a decision about whether to purchase a franchise. It includes information on the franchisor and its history, fees and costs that will be incurred by the franchisee, the obligations of the franchisee, and the obligations of the franchisor during the term of the franchise relationship. It also includes a copy of the franchise agreement and any other contracts the franchisee must sign. Under the federal franchise law, franchisors are obligated to prepare and provide to prospective franchisees a FDD that is accurate and complete.  The prospective franchisee must receive and have the FDD for at least 14 days before signing a franchise agreement or paying the franchisor any fees.

What questions should prospective franchisees ask franchisors?

Franchisees are provided a wealth of information in the FDD that they are given by the franchisor. There may be other questions that a prospective franchisee may ask if considering whether to become part of the franchise system, including:

  • Does the franchisor have the experience, personnel, and facilities to help me establish and continue operating my franchised business throughout the franchise term?
  • Is the franchisor serious about compliance with federal and state franchise laws?
  • What is the franchisor’s growth plan for the franchise system?
  • What does the franchisor do to continue to improve the franchise system and its product and service offerings for franchise owners and customers?
  • How does the franchisor communicate with franchisees and do they solicit franchisee input?

With these answers, a prospective franchisee may be in a better position to make an investment decision. Contacting existing franchisees and asking them about the franchisor and the franchise business also provides valuable information.

What legal needs do franchisees and franchisors have?

There are many regulations surrounding franchising. Both parties need their own counsel to advise them of their rights and ensure compliance. Some of the legal issues you may face include:

  • Information disclosed in the FDD
  • The legal obligations under the franchise agreement
  • Financing
  • Noncompete agreements
  • Territorial protection
  • Purchasing restrictions
  • Labor and employment issues
  • Arbitration or other forms of dispute resolution
  • Franchise litigation

With a reliable franchise lawyer to represent you, you can navigate through these legal concerns with confidence.

What agreements exist in a franchise and how flexible are they?

A franchise agreement is the most important document when it comes to franchising. It is the binding contract between the franchisor and the franchisee. It states the terms and conditions of the franchise relationship and includes provisions covering:

  • Fees
  • Trademark use
  • Length of the franchise relationship
  • Site selection and territorial protections
  • Training and opening and ongoing assistance
  • Compliance with system standards
  • Suppliers and purchasing restrictions
  • Transfer and renewal rights
  • Dispute resolution

Some of the terms grant rights to the franchisees and some of the terms impose mandatory obligations on the franchisees. Whether a franchisor is willing to negotiate with the franchisee on any terms depends on a number of factors, including the impact the negotiated changes would have on the entire franchise system.

Whether you are a franchisor, subfranchisor or a franchisee, having a franchise attorney in your corner goes a long way toward making sure that the agreements benefit you and what you want to accomplish with your business.

Address Your Compliance Concerns

When starting a business, whether or not you intend to establish a franchise program, failing to comply with applicable federal and state franchise laws can have significant financial and legal consequences. The government may investigate your company and determine that your agreement with the licensee or dealer is actually a franchise and that franchise laws have been violated.  A licensee or dealer may later claim that you failed to comply with franchise laws in selling them a license or dealership resulting in your inability to enforce your agreement with them, or may claim protections under franchise termination and nonrenewal laws that should have been provided to them.

If you intend to establish a franchise program and offer and sell franchises, compliance with all applicable state and franchise laws is critical to the success of your business.  Failure to comply with the franchise laws may subject you to investigation by state or federal franchise regulators or expose you to liability for claims to franchisees.

The franchise attorneys at Huck Bouma are committed to helping you take the right steps to become or remain in compliance with the law. The franchise law attorneys at the firm can review your proposed or existing business arrangement to ensure that you are in compliance with applicable federal and state franchise laws. Alternatively, if your business model permits, the structure and the arrangement of your business can be reviewed to avoid the creation of a franchise.

If you intend to operate as a franchise company, the franchise attorneys at Huck Bouma, who have extensive experience in representing franchisers nationwide, will guide you through the legal requirements and prepare the necessary documents to ensure your compliance with all applicable federal and state franchise laws. Consultations with our nationwide franchise attorneys help you structure your business correctly and minimize compliance concerns. Call today at 630-395-7809 or send an email through the online contact form.