This page explains thebasics about U.S. franchise law. Franchise law is complex. There are federal laws governing franchising, and there are state laws governing franchising. These laws are not uniform, and they vary from state to state. To further complicate matters, there are state and federal laws that govern "business opportunities" and "seller-assisted marketing plans" that can also apply to franchising. This page explains only the basics. For a detailed understanding, you should consult with an experienced franchise lawyer.
Overview of Franchise Regulations
In the United States, franchising is a regulated industry.
At the federal level, franchising is governed by the regulations in the U.S. Federal Trade Commission's Franchise Rule. These regulations require the pre-sale disclosure to each prospective franchisee of certain material information regarding the franchisor and the franchise oipportunity.
At the state level, there are about 20 states that have some type of state laws and regulations that directly affect franchising. Some of these state laws deal with pre-sale disclosure requirements. Some of these state laws deal with pre-sale registration requirements. Some of these state laws deal with the franchise relationship between franchisor and franchisee on such issues as discrimination, default, termination and non-renewal. Unfortunately, the state laws are not uniform from state-to-state, and some states have different required disclosures than the FTC.
The FTC Franchise Rule applies everywhere in the United States. A state's franchise laws usually apply only if:
the offer or sale of a franchise is made in the state; or
the franchised business will be located in the state; or
the franchisee is a resident of the state.
What is a Franchise?
1. Federal Law
Under the FTC Franchise Rule, there are 3 elements of a franchise:
2. Significant Control or Assistance
3. Required Payment
If all 3 elements are present, then the relationship will be a "franchise" for purposes of the FTC Franchise Rule.
a. Trademark. The franchisee is given the right to distribute goods and services that bear the franchisor's trademark, service mark, trade name, logo, or other commercial symbol.
b. Significant Control or Assistance. The franchisor has significant control of, or provides significance to the franchisee’s method of operation. Examples of significant control or assistance include:
approval of the site
requirements for site design or appearance
designated hours of operation
specified production techniques
required accounting practices
required participation in promotional campaigns
providing an operations manual
c. Required Payment. The franchisee is required to pay the franchisor (or an affiliate of the franchisor) at least US$500 either before (or within 6 months after) opening for business. Required payments include any payments the franchisee makes to the franchisor for the right to be a franchisee. These include franchise fees, royalties, training fees, payments for services, and payments from the sale of products (unless reasonable amounts are sold at bona fide wholesale prices).
2. State Law
State law definitions of franchises vary, but there are several common themes:
a. In California, Illinois, Indiana, Iowa, Maryland, Michigan, North Dakota, Oregon, Rhode Island, Virginia, Washington, and Wisconsin, the 3 elements of the legal definition of a "franchise" are:
Marketing Plan. The franchisee is granted the right to engage in the business of offering, selling or distributing goods or services under a marketing plan or system substantially prescribed by the franchisor.
Association with Trademark. The operation of the franchisee’s business is substantially associated with the franchisor’s trademark, trade name, service mark, etc.
Required Fee. The franchisee is required to pay a fee, directly or indirectly.
b. In Hawaii, Minnesota, Mississippi, Nebraska, and South Dakota, the 3 elements of the legal definition of a "franchise" are:
Trademark License. The franchisee is granted the right to engage in the business of offering, selling or distributing goods or services using the franchisor’s trademark, trade name, service mark, etc.
Community of Interest. The franchisor and franchisee have a community of interest in the marketing of goods or services.
Required Fee. The franchisee is required to pay a fee, directly or indirectly.
c. In Connecticut, Missouri, New York and New Jersey, the definition of a "franchise" involves some (but not all) of the elements in the first 2 sets of states.
d. In Arkansas, Delaware and Florida, the state definitions are unique, and not like any other state (or each other).
Types of Franchise Regulations
1. Disclosure Laws
These types of laws regulate things like:
required pre-sale disclosures;
prohibited franchise sales practices; and
mandatory cooling-off period before franchise sales.
2. Registration Laws
These types of laws require things like:
registration of the franchise;
registration of franchise salespersons; and
registration of franchise advertising.
3. Relationship Laws
These laws govern certain aspects of the relationship between franchisor and franchisee, such as:
grounds for terminating a franchise;
notice and cure periods before termination;
grounds for not renewing a franchise; and
non-discrimination among franchisees.
Franchise Disclosure Laws
The FTC Franchise Rule requires franchisors to provide each prospective franchisee with a franchise disclosure document, which is sometimes called an offering circular, at a certain point early in the process of offering and selling a franchise. See FDD Outline for a discussion of these requirements.
Laws in more than a dozen states also require franchisors to provide a similar disclosure document.
Under the FTC Rule and state franchise laws in most states, the franchisor must give the FDD to the prospect at the earlier of:
at least 14 calendar days before the prospect signs any agreement with the franchisor; or
at least 14 calendar days before the prospect pays any money to the franchisor.
New York and Rhode Island require the franchisor to deliver the FDD at the earlier of the first personal meeting or 10 business days before the execution of the franchise or other agreement or the payment of any consideration that relates to the franchise relationship. Michigan, Oregon, Washington and Wisconsin require the franchisor to provide the FDD at least 10 business days before the execution of any binding franchise or other agreement or the payment of any consideration, whichever occurs first.
The franchisor also must provide the prospect with a complete version of the franchise agreement (with all blanks filled in) at least 7 calendar days before the prospect signs any agreement or pays any money.
State Registration Laws
1. Franchise Registration Laws
The FTC Franchise Rule does not provide for any registration of a franchise with the Federal Trade Commission, so there is no federal registration of franchises in the United States.
However, 14 states require the registration of franchises. The franchise registration states are:
In most of these states, registration involves a review of the FDD by a franchise regulator, who checks to make sure the FDD meets the state franchise law requirements. But, in a few of these states, the FDD is simply filed but not reviewed. In Michigan, the registration process does not even involve the filing of the FDD.
State registrations are generally valid for 1 year. In some states, the effective period of registration is a full calendar year from the first registration date; but, in other states, the registration expires a certain number of days (typically 90 to 120 days) after the end of the franchisor’s fiscal year.
To renew registration, a franchisor must file a renewal application or annual report each year, which includes certain forms, an updated FDD, and a filing fee. Maryland also requires franchisors to file quarterly reports.
The FDD also needs to be updated every time there is a change to any of the material information regarding the franchisor or the franchise opportunity. "Material information" means information that a potential franchisee could consider important in making a decision whether or not to invest in a franchise. If there are any of these changes, then the franchisor must update its FDD and file an amendment in the relevant registration states.
2. Business Opportunity Registration or Exemption
There are a number of states that require registration of business opportunities and seller-assisted market plans. The statutory definitions of these types of business relationships are often broad enough to include franchises, but most of these states provide some type of exemption for franchises that comply with the FTC Franchise Rule.
In some states, the exemption is automatic.
In Kentucky, Nebraska and Texas, there is a one-time filing required in order to claim the exemption.
In Florida and Utah, it is necessary to file an exemption application each year.
In Connecticut, Maine, North Carolina and South Carolina, the exemption is available only for franchisors that have obtained registration of the trademarks or service marks involved in the franchise. Franchisors who do not have these mark registrations will need to register their franchise under the business opportunity laws if they will offer franchises in these states.
Franchise Advertising Regulations
Some states require that all advertising for the sale of franchises must be filed with the state before they are published. These states include: California, Indiana, Maryland, Minnesota, New York, North Dakota, Rhode Island, South Dakota and Washington.
These states also generally have laws that restrict what franchisors can say in advertisements. These restrictions usually prohibit characterizing the franchise as a safe investment, or implying that state registration of the franchise means that the state has approved of the franchise. A few other states have similar content restrictions, but do not require the ads to be filed.
Franchise Salesperson Registration
Most of the franchise registration states require the franchisor to file certain information about each person who will sell franchises in the state. This information includes the salesperson’s current employer information, business address and phone number, five-year employment history, and information about certain civil and criminal proceedings involving the person. These states include California, Hawaii, Illinois, Indiana, Maryland, Minnesota, North Dakota, Rhode Island, South Dakota and Washington. If the salesperson is not an employee of the franchisor, Illinois, New York and Washington require that additional detailed information be filed.
Franchise Relationship Regulations
There is no federal law governing franchise relationships, although in the 1990s new legislation on this topic was proposed in the U.S. Congress several times.
There are 19 states that regulate some aspect of the franchise relationship. These states include Arkansas, California, Connecticut, Delaware, Hawaii, Illinois, Indiana, Iowa, New Jersey, Michigan, Minnesota, Mississippi, Missouri, Nebraska, North Dakota, South Dakota, Virginia, Washington and Wisconsin.
1. Restrictions on Termination
In all 19 states except for North Dakota, it is illegal for a franchisor to terminate a franchise agreement without good cause. "Good cause" usually includes things like:
the franchisee become insolvent or bankrupt;
the franchisee voluntarily abandons its operations;
the franchisee is convicted of a crime relating to the franchise operations; or
the franchisee fails to substantially comply with its material obligations under the franchise agreement.
These laws typically require the franchisor to give the franchisee written notice of the proposed termination a certain number of days before the termination. This advance notice period ranges from 30 to 120 days. These laws also usually provide the franchisee with an opportunity to cure the default, although there are often exceptions for defaults that cannot be cured such as voluntary abandonment, bankruptcy, and criminal conviction.
2. Restrictions on Non-Renewal
State laws do not require franchise agreements to include a provision for renewal of the franchise after the end of the initial term. But, if a franchise agreement does have a renewal provision, then the franchise relationship laws in 12 states restrict the franchisor's ability to not renew the franchise. Most of these state treat non-renewal just like termination. This means that a franchisor must renew the franchise unless there is good cause no to, and the franchisee has been given the required advance written notice and opportunity to cure. These states include: Arkansas, Connecticut, Delaware, Hawaii, Iowa, Indiana, Minnesota, Mississippi, Missouri, Nebraska, New Jersey and Wisconsin.
The relevant laws in California, Illinois, Michigan and Washington require the franchisor to give the franchisee advance written notice of non-renewal (typically at least 6 months), and they impose certain restrictions or requirements on the franchisor in some circumstances, such as repurchase of the franchisee's assets, or waiver of any non-competition restrictions.
3. Repurchase Obligations
In 10 states, the franchisor must repurchase some or all of the franchisee's furnishings, equipment, inventory, supplies and other assets following the end of the franchise relationship. These states include: Arkansas, California, Connecticut, Hawaii, Illinois, Iowa, Michigan, North Dakota, Washington and Wisconsin. Most of these states allow the franchisor to offset any money the franchisee owes to the franchisor. In Arkansas and California, the repurchase obligation is only imposed in certain situation where the termination or non-renewal by the franchisor violates state law. In Connecticut, the law requires the franchisor to repurchase certain of the franchisee’s assets following any termination of the franchise, and in Hawaii and Washington, the repurchase obligation applies to terminations and non-renewals. The repurchase requirement is more limited in Illinois, Iowa, Michigan, North Dakota and Wisconsin.
4. Transfer Restrictions
In 10 states, it is illegal for a franchisor to refuse to allow a transfer of the franchise without good cause. These states include: Arkansas, California, Hawaii, Indiana, Iowa, Michigan, Minnesota, Nebraska, New Jersey and Washington. Many of these states permit a franchisor to have a right of first refusal to purchase the franchise prior to a transfer. The California and Indiana statutes limit the circumstances in which transfer must be allowed. In California, the spouse, heirs and estate of a deceased franchisee/dealer can operate the business, if they qualify, or they can transfer the business to a qualified third party. Indiana simply grants the spouse, heirs and estate of a deceased franchisee/dealer the right to operate the business for a reasonable period of time.
5. Other Restrictions
There are various other restrictions or requirements imposed on franchise relationships by state law. Some of these include:
Encroachment. The franchisor’s ability to open a new unit in the vicinity of a franchise’s existing unit is regulated in Hawaii, Indiana, Iowa, Minnesota and Washington.
Free Association. It is illegal for a franchisor to prohibit free association among franchisees or to prohibit them from participating in a trade association in Arkansas, California, Hawaii, Illinois, Iowa, Michigan, Minnesota, Nebraska, New Jersey, Rhode Island and Washington.
Good Faith / Reasonableness. A franchisor must deal with its franchisees in a commercially reasonable manner and/or in good faith in Arkansas, Hawaii, Iowa, Minnesota, Nebraska, New Jersey and Washington.
Management. It is illegal for a franchisor to require or prohibit any change in the management of the franchisee without good cause in Arkansas, Minnesota, Nebraska and New Jersey.
Marketing Fees. It is illegal to collect marketing fees from franchisees and not spend them on marketing in Arkansas.
Non-Compete Agreements. The scope of a franchisee’s non-competition agreement is limited in Indiana, and Louisiana.
Non-Discrimination. It illegal for a franchisor to discriminate among similarly situated franchisees in Hawaii, Illinois, Indiana, Minnesota and Washington.
Non-Waiver. A franchisee’s waiver of any of the protections provided to it under state law is illegal or unenforceable in every state.
Required Purchases. There are limits on a franchisor’s ability to require franchisees to purchase supplies, inventory, goods and services from the franchisor or designated sources in Hawaii, Indiana, Iowa and Washington.
Typical Violations and Penalties
1. Common Types of Violations of Franchise Laws
Offering or selling an unregistered franchise
Failing to provide an FDD on time
Failing to provide all required disclosures in the FDD
Making misrepresentations to franchisee prospects
Improperly terminating or not renewing a franchise
2. Common Types of Penalties for Violating Franchise Laws
Governmental penalties for violating franchise laws can include fines, permanent bans on engaging in franchising, freezing of assets, money damages for victims, and even jail sentences. These penalties can be applied to the franchisor, and to its officers, directors, and managers who formulate, direct or control the franchisor's activities.
The violation of state franchise laws is typically treated under the statutes as either a fraudulent and deceptive trade practice, or a misdemeanor, or a felony. In some states, a franchisee who has been harmed by the franchisor’s conduct can be awarded money damages (including punitive damages and attorneys fees), or cancellation of the franchise agreement and reimbursement of all fees paid to the franchisor.
Additionally, violations of franchise laws must be disclosed in the franchisor's FDD for the next 10 years.
Other Resources on U.S Franchise Law Basics
Click FTC Franchise Rule for the full text version of the amended FTC Franchise Rule (and the Statement of Basis and Purpose)
Click FTC Compliance Guide for the Complaince Guide published by the FTC in May 2008 for the amended FTC Franchise Rule
Click FTC FAQs for the Amended Franchise Rule FAQs issued by the FTC
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