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Franchise Legal Considerations

One of the most important events in franchising is the introduction of the Franchise Rule on October 21, 1979 by the Federal Trade Commission (FTC). The FTC Franchise Rule requires all franchisors operating anywhere in the U.S. to make full disclosure of the information that a prospective franchisee needs in order to make a rational decision about whether or not to invest.

In effect, the rule obliges franchisors to meet certain FTC standards, such as ensuring that a reasonable basis for any claims exists, that the disclosure has been prepared in accordance with accepted accounting principles, and that there is evidence to support the financial claims, and that the franchisee, among others, can see this evidence.

In particular, the disclosure rule requires that the franchisor provide information about:

(a) The franchisor and its affiliates, describing the business experience of each of its officers, directors, and management personnel responsible for franchise services, training, and other aspects of its program.

(b) Any lawsuits or previous bankruptcies in which the franchisor, its officers, directors, and management personnel have been involved.

(c) Initial franchise fees and other payments required to obtain a franchise, and a description of continuing payments to be made after the franchise opens.

(d) Any restrictions on the quality of goods and services used by the franchisee and where they may be purchased, including restrictions requiring purchases to be made from the franchisor or its affiliates.

(e) Any assistance available from the franchisor or its affiliates in financing the purchase of the franchise.

(f) Restrictions on the goods or services franchisees are allowed to sell and any restrictions on the customers with whom they may deal.

(g) Any territorial protection to be granted the franchisee.

(h) The conditions under which the franchise may be repurchased or refusal renewal by the franchisor, transferred to a third party by the franchisee, and terminated or modified by either party.

(i) Any training programs provided to the franchisees.

(j) Any involvement of any celebrity or public figures in the franchise.

(k) Any assistance provided by the franchisor in selecting the site for the franchisee.

(l) The number of present franchises, franchises projected for the future, franchises terminated or not to be renewed, and the number repurchased in the past.

(m) The financial statements of the franchisors.

(n) The extent to which franchisees must personally participate in the operation of the franchise.

(o) The basis for any earnings claims made to the franchisee, including the percentage of existing franchises that have achieved the results claimed.

(p) The names and addresses of other franchisees.

This disclosure must occur at the first contact with the franchisor, franchise broker, or anyone who represents the franchise for sale, where the subject of buying a franchise is discussed. The disclosure must be at least ten business days before the signing of any franchise or related contract or payment to the franchisor.

Although the FTC does not require registration from franchisor, several states do have registration rules requiring franchise sellers to register. Most states have adopted the Uniform Franchise Circular Offering (UFOC) guidelines for their disclosure requirements, but as a potential franchisee, do not assume that if a franchise is registered with the state or provides some type of full disclosure document, you are protected from the possibility of a failure or rip-off. You must use common sense and do your research!

For more information about the Franchise Rule, please click here.

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