The original federal Franchise Rule was issued by the United States Federal Trade Commission (FTC) in 1979 and since that time has been amended and updated only once in a revised rule that became effective in 2008.
The Franchise Rule requires that any prospective franchisee, including the purchaser of an existing franchise unit or an existing franchisee that opens a new location, receives a comprehensive disclosure document at least 14 calendar days before signing any agreement or paying any money to the franchisor.
The disclosure document contains an example of the franchise agreement to be signed and a variety of other disclosures regarding the franchisor. Those include its executives and management personnel, litigation history, fees and charges to be paid by the franchisee, estimated initial investment, history of changes in store counts over three years, financial statements of the franchisor and many other items. Most importantly, the FTC Franchise Rule does not regulate the substance of the relationship between franchisee and franchisor. So-called relationship laws exist in a limited number of states, but not at the federal level. In the past, we have been privileged to work with DDIFO on proposed franchisee protection legislation in Massachusetts, which is significant because the Dunkin’ franchise agreement specifies that Massachusetts law applies.
In March 2019, the FTC kicked off a new review of the Franchise Rule by making a request for public comments, posing a number of questions including whether there is a continuing need for the Franchise Rule; whether, and to what extent, the Rule should be modified or changed; and how any such changes would add or subtract to the burden of compliance with the Rule. This request for comment highlighted a divide among the legal community. Those who primarily represent franchisors argued that the present rule should be retained and, given the current regulatory climate, any proposals for substantial changes might provoke an actual revocation of the entire Rule. Generally speaking, franchisors favor the Franchise Rule because it acts to protect them from liability, by consolidating any and all representations regarding the franchise relationship into a massive document. Franchisee representatives, including this author, reject this analysis and point out that there are many deficiencies in the disclosure regime which acts to the detriment of prospective and existing franchisees.
Franchisee representatives also argue that the FTC has the power to enact regulations which promote fairness and balance in the franchise relationship, but thus far it has abdicated that responsibility. It is quite significant that on March 14, 2019, the Australian Joint Parliamentary Committee issued a massive report regarding the state of franchising in that country. Their investigation involved nine public hearings and 406 written submissions. One of the findings of the Committee are that disclosure and transparency alone cannot overcome the imbalance in the typical franchisor/franchisee relationship. Among the Committee’s many recommendations was to enact whistleblower protections, outlaw unfair contract terms and provide efficient and cost-effective resolution of system wide disputes.
While space available for this article does not permit a comprehensive review and analysis of the 41 comments that were received by the FTC, it would be appropriate to highlight one proposal which could revolutionize franchise disclosure: the creation of a summary franchise disclosure document similar to one that has been used in the mutual fund industry since at least 2012. The mutual fund rule was based on extensive focus group analysis indicating that investors would benefit from a summary document.
This proposal is grounded in the fact that the typical franchise disclosure document is seemingly impenetrable to even the most sophisticated reader. In fact, the most recent Dunkin’ franchise disclosure document (issued on April 2, 2019) is 703 pages.
The proposed summary disclosure document would be (1) provided electronically to the prospective franchisee along with and at the same time as the main disclosure document, (2) written in plain English, (3) limited to five pages in length, and no more than 1,500 words using 12 point type, (4) contain simple and straightforward charts to present data in a clear and understandable format, and (5) feature hyperlinks allowing readers toggle back and forth between parallel sections with ease.
With this last feature, if the reader was reviewing a section of the summary disclosure document discussing royalty rates, the reader could link directly to
the portions of the main disclosure document – as well as the underlying franchise agreement – to read more about that topic. Such changes outlined here would bring franchise disclosure into the 21st century, creating a digestible document allowing the reader to make an informed choice about how best to use their capital.
More information regarding this proposal and other comments by franchisor and franchisee advocates can be found on the FTC’s website.
Eric H. Karp is a partner in the Boston law firm of Witmer Karp Warner and Ryan LLP. He is the Immediate Past Chair of the American Bar Association Forum on Franchising. Since 1996, he has been a member of the Franchise Project Group of the North American Securities Administrators Association.