In many states, it is illegal for a franchisor to offer or sell a franchise without an effective franchise registration or exemption. In some states, the typical time period involved to obtain an effective registration or exemption could be several months. A franchisor may be tempted to provide its FDD to a prospective franchisee “for informational purposes only” while the registration or exemption application is pending. But, is this legal?
The problem with this practice is that it is not specifically authorized by any state franchise laws, and the laws regarding the illegal offers of unregistered franchises are broad enough to prohibit this practice. For example, California Franchise Investment Law Section 31110, states “it shall be unlawful for any person to offer or sell any franchise in this state unless the offer of the franchise has been registered . . . or exempted . . . .” Under that law, “offer” means to make an offer to sell a franchise or to solicit an offer to buy a franchise. It is quite possible that a franchise regulator could consider that a franchisor providing an FDD for informational purposes only is still making an offer to sell or soliciting an offer to buy a franchise. So, there is some risk that providing an FDD for informational purposes would be considered to be a violation of state franchise law.
For those franchisors willing to take this risk, the following procedure would likely help minimize the risk. First, before providing the FDD for informational purposes only, obtain from the recipient a signed written document that the recipient understands and acknowledges that:
1. The FDD is being provided for informational purposes only. The delivery of the FDD does constitute an offer to sell a franchise or a solicitation of an offer to buy a franchise.
2. The delivery of the FDD before the state registration is effective has no legal effect in the franchise sales process and will not be considered as the starting point for the legal disclosure periods required under federal or state franchise laws.
3. The applicable state franchise registration is not yet effective. The information in the FDD has not been reviewed by the state franchise regulator. There could be changes to the information in the FDD after it has been reviewed by the state franchise regulator.
4. After the state franchise registration or exemption has become effective, if the franchisor desires to offer to sell a franchise to the recipient, the franchisor will provide a copy of the final FDD registered in the state AND a red-lined version of the FDD showing all material changes from the FDD provided before registration became effective.
Second, do not have the recipient sign the FDD receipt page for the FDD for informational purposes. Third, actually follow through on the process outlined in the written acknowledgement and obtain signed receipt for the final registered FDD and the red-lined version. Fourth, retain proof of all of these communications and disclosures.
In California (but not in any other state), there is a special provision under the Franchise Investment Law that allows a franchisor to provide an FDD to prospective franchisees for information purposes during the time period while an application for renewal or amendment (but not for initial registration or exemption) is pending before the franchise regulators. The procedure outlined above is based on the steps required under that law.
Again, even with the procedure outlined above, there is some risk that providing an FDD for “informational purposes” while a registration or exemption application is pending could be interpreted by a franchise regulator as actually being the solicitation of an offer to purchase a franchise. Franchisors who use this procedure do so at their own risk.