Working with the Federal Trade Commission

The basic focus of the Federal Trade Commission’s franchise rule is to provide prospective franchisees with pre-sale disclosure about the contract they would be entering into, and about the company that’s franchising the concept.

Proposed changes to the FTC rule, which have been in the works for more than a decade now, aim to benefit franchisees and franchisors alike. Franchisees will receive more information during the disclosure process, while franchisors will face less of a burden in navigating through a tangle of complicated laws.

“Over the years, we’ve gone from a situation where it was very difficult for a franchisor to comply with the federal law and with the laws of the various states,” says Susan Grueneberg, a partner in Alschuler Grossman Stein & Kahan LLP’s Transactional Department. “The FTC and the states have really made strong efforts to increase the ability to comply with these laws in a meaningful and uniform manner for franchise companies.”

Smart Business spoke with Grueneberg about proposed amendments to the rule, how both franchisees and franchisors can take advantage of the changes, and what some of the common legal disputes between the two parties are.

When will the new FTC franchise rule become effective?
That’s a question we’ve all been asking for quite some time now. The rule-making process began in 1995 — the original rule was actually first effective in 1979 — and for the past 10 years, there have been a series of comment periods, drafts of changes to the rule and hearings. It culminated with the Staff Report to the FTC in August, 2004. Since then, we’ve been waiting for the final rule to be issued.

What are some of the rule’s proposed amendments?
The one that jumps out at people is a change to the disclosure format. The current FTC rule has its own format for disclosure to franchisees, but the states — through a group called NASAA (North American Securities Administrators Association) — had adopted a format called Uniform Franchise Offering Circular (UFOC) Guidelines. The FTC had previously decided that this format would be acceptable as well, so the new rule adopts many of the elements of the UFOC format.

The new rule also would provide some additional exemptions from the disclosure requirements, and it takes the element of business opportunities out of the franchise rule. The FTC will be promulgating a separate rule to cover business opportunities.

In regard to disclosure requirements, what are some of the additional proposed changes?
One of the exciting things that the new rule would provide for is electronic disclosure. Since the early 1980s, there have been extremely dramatic developments in the way that people communicate information, and the new rule would provide for that. It also would eliminate the requirement that disclosure be provided at the first personal meeting. Then there are some specific disclosure additions, including franchisor-initiated litigation and, under certain circumstances, disclosure about franchisee associations.

What were some of the old rules that caused a point of contention between franchisors and franchisees?
There is some tension in the area of earnings claims and whether or not information about how much a franchisee will be able to earn from a franchise opportunity should be mandated. The FTC does not require that this information be disclosed. Another point of contention is whether the FTC should regulate the relationship itself. In other words, when and under what circumstances a franchisor can terminate or refuse to renew a franchisee’s contract.

What are some of the legal disputes that can arise between franchisors and franchisees?
Termination and nonrenewal often cause disputes between the two. The concepts of the market area in which the franchisee is operating and territorial protection are other areas where franchisor and franchisee disputes tend to arise.

How can both a franchisor and franchisee take advantage of the looming revisions?
From a prospective franchisee’s perspective, the changes are positive, because prospective franchisees like to have electronic access to documents, and this would make that possible. There is also more information in the disclosure that they will be receiving, which is a positive development for them.

Franchisors, meanwhile, will have the advantage of additional exemptions available when dealing with sophisticated or experienced franchisees. Also, the changes tend to promote uniformity, although the states will have to make some changes along the way, too, in order to increase the uniformity once the changes to the FTC rule are adopted.

SUSAN GRUENEBERG is a partner in Alschuler Grossman Stein & Kahan LLP’s Transactional Department. Reach her at [email protected].