Rule: Trade Regulation Rules: Franchising and Business Opportunities Disclosure Requirements and Prohibitions

Friday,
March 30, 2007
Part V
Federal Trade
Commission
16 CFR Parts 436 and 437
Disclosure Requirements and Prohibitions
Concerning Franchising and Business
Opportunities; Final Rule
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15444 Federal Register / Vol. 72, No. 61 / Friday, March 30, 2007 / Rules and Regulations
FEDERAL TRADE COMMISSION SUPPLEMENTARY INFORMATION: The final (4) trademark-specific franchisee
amended Rule retains most of the associations.
16 CFR Parts 436 and 437 original Rule’s pre-sale disclosures.1 Finally, part 436 of the final amended
Part 436 pertains to franchising— Rule updates the original Rule and
Disclosure Requirements and business arrangements that offer
Prohibitions Concerning Franchising UFOC Guidelines by addressing new
purchasers the right to operate under a
marketing techniques and new
trademark or other commercial symbol
Disclosure Requirements and technologies. For example, part 436
and that typically offer a specific format
Prohibitions Concerning Business or method of doing business, such as permits franchisors to comply with pre-
Opportunities chain restaurants and hotels.2 Part 436 sale disclosure obligations
modifies the original Rule, however, by electronically. It also updates territorial
AGENCY: Federal Trade Commission. protection disclosures to address sales
reducing inconsistencies with state
ACTION: Final rule. franchise disclosure laws, by adopting, via the Internet, catalogs, and
in large measure, the disclosure telemarketing.
SUMMARY: The Federal Trade
Commission (the ‘‘Commission’’ or requirements and format of the Uniform Part 437 of the final amended Rule
‘‘FTC’’) amends its Trade Regulation Franchise Offering Circular (‘‘UFOC’’) pertains to business opportunity
Rule entitled ‘‘Disclosure Requirements Guidelines used by the 15 states with ventures. Business opportunities, such
and Prohibitions Concerning pre-sale franchise disclosure laws.3 Part as vending machine routes and rack
Franchising and Business Opportunity 436 of the final amended Rule, however, display ventures, typically do not
Ventures’’ (‘‘Franchise Rule’’ or ‘‘Rule’’) is not identical to the UFOC Guidelines. involve the right to use a trademark or
to streamline the Rule, minimize In several instances, part 436 is other commercial symbol and the seller
compliance costs, and to respond to narrower. For example, part 436 does must provide purchasers with locations
changes in new technologies and market not incorporate the UFOC Guidelines’ for machines or equipment or with
conditions in the offer and sale of mandatory cover page risk factors,
clients.4 Based upon the rulemaking
franchises. Part 436 sets forth those disclosures pertaining to brokers, or
record, the Commission has proposed
amendments to the Franchise Rule detailed disclosures pertaining to
franchisees’ computer equipment that business opportunities covered by
pertaining to the offer and sale of the original Rule should be addressed in
requirements. Part 436 also permits a
franchises. Part 437 sets forth a revised a separate, narrowly-tailored trade
phase-in of audited financial statements.
form of the original Franchise Rule Further, part 436 of the final amended regulation rule. On April 12, 2006, the
pertaining solely to the offer and sale of Rule corrects a problem with the UFOC Commission published a Notice of
business opportunities. This document Guidelines identified in the rulemaking Proposed Rulemaking (‘‘Business
provides background on the Franchise record. Specifically, the record Opportunity NPR’’) for a separate
Rule and this proceeding; discusses the establishes that the current Item 20 of Business Opportunity Rule.5 Pending
public comments the Commission the UFOC Guidelines—a provision completion of the proceeding initiated
received; and describes the amendments requiring the disclosure of franchisee with that notice, business opportunities
the Commission is making based on the statistics—results in inflated turnover presently covered by the requirements
record. This document also contains the rates. Part 436 of the final amended Rule of the original Rule will remain covered,
text of the final amended Rule and the corrects this problem, based upon as set forth as part 437 of the final
Rule’s Statement of Basis and Purpose suggestions contained in the record. amended Rule.
(‘‘SBP’’), including a Regulatory In a few instances, part 436 of the
Analysis. final amended Rule is broader than the Part 437 of the final amended Rule
UFOC Guidelines, addressing franchise differs from the original Rule in three
EFFECTIVE DATES: The effective date of
relationship issues that the rulemaking respects only. First, references to
the final amended Rule is July 1, 2007.
record establishes are a prevalent source ‘‘franchisor’’ and ‘‘franchisee’’ in the
Permission to use the original Franchise
of franchisee complaints. To that end, original Rule have been changed to
Rule, however, will continue until July
1, 2008. After that date, franchisors and part 436 of the final amended Rule ‘‘business opportunity seller’’ and
business opportunity sellers must provides additional information to ‘‘business opportunity purchaser,’’
comply with the final amended Rule prospective franchisees with which to respectively. Second, the original Rule’s
only. assess the quality of the franchise definition of ‘‘franchise’’ set out at
relationship before they buy, including: section 436.(2)(a) has been changed to
ADDRESSES: Requests for copies of the (1) franchisor-initiated litigation against ‘‘business opportunity’’ and the first
final amended Rule and the SBP should franchisees pertaining to the franchise part of the original definition—the
be sent to: Public Reference Branch, relationship; (2) protected territories; (3) ‘‘franchise’’ elements—have been
Room 130, Federal Trade Commission, the use of confidentiality clauses; and deleted; the definition now focuses on
600 Pennsylvania Avenue, NW, the second part of the original
Washington, D.C. 20580. The complete 1 See 16 CFR Part 436. Provisions of the original
definition—the business opportunity
record of this proceeding is also Rule are cited in this document as 16 CFR 436.[ ].
Citations to the final amended Rule are cited simply elements. Third, part 437 sets forth a
available at that address. Relevant
as 436.[ ] or 437.[ ], respectively. The text of the new exemption for franchises that
portions of the proceeding, including final amended Rule is set forth in Section VII. comply with, or are exempt from, part
the final amended Rule and SBP, are 2 The specific definition of the term ‘‘franchise’’
436. Except for these three changes, all
available at www.ftc.gov. is discussed below in connection with section
436.1(h). disclosures and prohibitions in part 437
FOR FURTHER INFORMATION CONTACT: 3 We were assisted in the effort to reduce are identical to those of the original
Steven Toporoff, (202) 326–3135, inconsistencies between the original Rule and Franchise Rule.
Division of Marketing Practices, Room UFOC Guidelines by NASAA’s submission of a

286, Bureau of Consumer Protection, document entitled ‘‘Comparison of UFOC and
4 The definition of ‘‘business opportunity’’ is
Proposed FTC Disclosure Requirements’’ (‘‘NASAA
Federal Trade Commission, 600 Comparison’’) (Jan. 8, 2002). A copy of this discussed below in connection with section
Pennsylvania Avenue, NW., document is on the public record in this 437.2(a).
Washington, D.C. 20580. proceeding. 5 71 FR 19054 (Apr. 12, 2006).
Federal Register / Vol. 72, No. 61 / Friday, March 30, 2007 / Rules and Regulations 15445
STATEMENT OF BASIS AND business opportunities and to correct state pre-sale disclosure law by
PURPOSE consumers’ misimpressions about incorporating in the Rule the UFOC
franchise and business opportunity Guidelines adopted by each of the 15
offerings, the Commission adopted the states with franchise disclosure laws.13
I. INTRODUCTION original Franchise Rule, which is Participants also discussed issues
A. Overview of the Original Franchise primarily a pre-sale disclosure rule. The arising from business opportunity sales.
Rule original Rule did not purport to regulate The second workshop—held on March
the substantive terms of the franchise or 11, 1996, in Washington, D.C.—focused
The Commission promulgated the business opportunity relationship. on the Franchise Rule’s application to
original Franchise Rule on December 21, Rather, it required franchisors and sales of franchises to be located outside
1978.6 Based upon the original business opportunity sellers to disclose the United States.
rulemaking record, the Commission material information to prospective
found widespread deception in the sale As a result of the Rule Review, the
purchasers on the theory that informed
of franchises and business opportunities investors can determine for themselves Commission determined that the
through both material whether a particular deal is in their best Franchise Rule continues to serve a
misrepresentations and nondisclosures interest.9 useful purpose and that it should be
of material facts.7 Specifically, the retained. The Commission also
Commission found that franchisors and B. The Rule Amendment Proceeding determined to modify the Rule in order
business opportunity sellers often made This Rule amendment proceeding to reduce inconsistencies with the
material misrepresentations about: the began with a regulatory review of the UFOC Guidelines, while updating the
nature of the seller and its business Franchise Rule in 1995.10 To initiate the Rule to address new technologies
operations, the costs to purchase a Rule Review, the Commission published developed since the original Rule was
franchise or business opportunity and a Federal Register notice seeking public promulgated. Accordingly, in February
other contractual terms and conditions comment on whether there was a 1997, the Commission published an
under which the business would continuing need for the Rule and, if so, Advance Notice of Proposed
operate, the success of the seller and its how to improve it in light of industry Rulemaking (‘‘ANPR’’).14 The ANPR
purchasers, and the seller’s financial changes since its promulgation in 1978. solicited comment on several proposed
viability. The Commission also found In response to this notice, the Rule modifications which would,
other unfair or deceptive practices Commission received 75 written among other things, create a separate
pervasive: franchisors’ and business comments.11 trade regulation for business
opportunity sellers’ use of false or In addition, the Commission staff held opportunity sales, revise the Rule’s
unsubstantiated earnings claims to lure two public workshops, in which a total disclosure requirements to mirror those
prospective purchasers into buying a of fifty individuals participated. The of the UFOC Guidelines, limit the Rule’s
franchise or business opportunity, and workshops were transcribed.12 The first application to sales of franchises located
franchisors’ and business opportunity workshop—held on September 11–13, in the United States, and permit
sellers’ failure to honor promised refund 1995, in Bloomington, Minnesota— electronic disclosure. In response to the
requests. The Commission concluded focused on the comments on the Rule, ANPR, the Commission received 166
that all of these practices led to serious in particular whether the Commission written comments.15 The staff also held
economic harm to consumers.8 should retain the Rule and, if so, six public workshops on the issues
To prevent deceptive and unfair whether the Commission should reduce raised in the comments, as set forth
practices in the sale of franchises and inconsistencies between federal and below.16
Topic(s) Location Dates
Trade Show Promoters Washington, D.C. July 28–29, 1997
Business Opportunities Chicago, IL August 21–22, 1997
UFOC, Internet, International, Co-branding, Alternatives to Traditional New York, NY September 18–19, 1997
Law Enforcement
Business Opportunities Dallas, TX October 20–21, 1997
6 43 FR 59614 (Dec. 21, 1978). Along with the amendment proceeding, and the abbreviations used the UFOC Guidelines address only required pre-sale
original Rule, the Commission published a to identify each, is set forth in Attachment A to this disclosures. Other provisions of state law applicable
Statement of Basis and Purpose (‘‘original SBP’’), 43 document. Many of the comments in this to franchise sales—such as the time for making
FR 59621 (Dec. 21, 1978) and later Final proceeding are available online at: www.ftc.gov. disclosures, disclosure document updating
Interpretive Guides to the Rule (‘‘Interpretive 12 Rule Review transcripts are cited as provisions, and exemptions—vary according to
Guides’’), 44 FR 49966 (Aug. 24, 1979). Since [Commenter] RR, [Sept.95] or [Mar.96] Tr. each state’s franchise statute or regulations.
promulgation of the original Rule in 1978, the 13 The UFOC Guidelines disclosure format is 14 62 FR at 9115 (Feb. 28, 1997).
Commission staff has also issued more than 100 similar in many respects to the original Rule’s 15 Written ANPR comments are cited as:
advisory opinions to help assist the public in [Commenter] ANPR [comment number].
disclosure requirements. To reduce compliance
interpreting various Rule provisions.
7 Original SBP, 43 FR at 59625.
costs and burdens, the Commission has permitted 16 In general, the first day of each public
franchisors to comply with the original Rule by workshop discussed specific issues announced in
8 Id., at 59627–39.
using the UFOC Guidelines format, provided that advance. Participants at these meetings were
9 The Commission used the same approach in
they did so completely and accurately. See 60 FR selected based upon their comments or interest in
other trade regulation rules. See, e.g., Funeral Rule, 51895 (Oct. 4, 1995) (authorizing states to use the subject matter. The second day of each
16 CFR Part 453; Used Car Rule, 16 CFR Part 455. revised UFOC Guidelines). A copy of the UFOC conference was an open forum in which the public
10 60 FR 17656 (Apr. 7, 1995).
Guidelines can be found at the corporate finance was invited to express their views on any franchise
11 Written Rule Review comments are cited as: section of the North American Securities or business opportunity issue. ANPR workshop
[Commenter] RR [comment number]. A list of all Administrators Association website: transcripts are cited as: [Commenter] ANPR [date]
commenters during the Rule Review and Rule www.nasaa.org. It should be noted, however, that Tr.
Topic(s) Location Dates
UFOC, Internet, International, Co-branding, Alternatives to Traditional Seattle, WA November 6–7, 1997
Law Enforcement
Business Opportunities Washington, D.C. November 20–21, 1997
A total of sixty-five individuals In response to the Franchise NPR, the commenters supported the proposed
participated in the various ANPR public Commission received 40 comments.20 Rule revisions pertaining to
workshops, including franchisees, Overwhelmingly, the comments franchising.25 Several, however, voiced
franchisors, business opportunity sellers supported the proposed revisions, albeit concern about the scope of one or more
and their representatives, state franchise with fine-tuning.21 No commenters Rule provisions, or offered various
and business opportunity regulators, requested a hearing, although, as noted, suggestions to fine-tune the Rule to
and computer consultants. the Franchise NPR allowed for them.22 avoid ambiguities.26 In other instances,
After the ANPR workshops, the The staff also determined that the record several commenters raised issues for
Commission published a Notice of was fully developed for franchise issues, further discussion in anticipated
Proposed Rulemaking (‘‘Franchise requiring no additional public
Compliance Guides, or offered
NPR’’) in October 1999.17 Focusing on workshops to explore further Rule
interpretations of Rule provisions for
franchise sales only, the Franchise NPR amendment issues.
Pursuant to the Rule amendment inclusion in the Compliance Guides.27
included the text of a proposed revised In several instances, franchisee
Franchise Rule and a detailed process announced in the Franchise
NPR, the Commission’s Bureau of representatives reiterated views
discussion of each proposed Rule previously expressed during the various
revision. Among other things, the Consumer Protection issued a Staff
Report on the Franchise Rule in August comment periods to the effect that the
Franchise NPR addressed: (1) the proposed revised Rule is deficient
2004.23 The Staff Report explained in
application of the Franchise Rule to because it does not mandate disclosure
detail the history of the Rule
franchise sales outside the United of financial performance data28 or does
amendment proceeding. It also
States; (2) the scope of certain existing
summarized the issues raised during the not adopt various substantive franchise
disclosure requirements, such as those
various notice and comment periods, in relationship provisions.29 As explained
regarding litigation and franchisee
particular those that arose in response to in greater detail below, the Commission
statistics; (3) new disclosure
the Franchise NPR. For each Franchise has considered each of these comments
requirements, such as those for
NPR issue, the Staff Report discussed: in determining the form and content of
franchisee associations; and (4) new
(1) similarities and differences between the final amended Rule.
instructions permitting disclosure via
the proposed revised Rule approach and
the Internet. It also proposed creating both the original Rule and the UFOC 25E.g., Bundy, at 1; Cendant, at 1 (representing
exemptions from the Franchise Rule for Guidelines approaches; (2) pertinent Ramada, Days Inn, Howard Johnson, Travelodge,
sophisticated prospective franchisees. comments; and (3) the staff Knights Inn, Super 8 Motel, Wingate Inn,
The Franchise NPR also specified the recommendations on franchise issues AmeriHost, Century 21, Coldwell Banker, ERA,
process the Commission would follow Sotherby’s Intl Realty, Avis, and Budget); IFA, at 1;
for inclusion in a final amended Rule. IL AG, at 1; J&G, at 1; Kaufmann, at 2 (representing
in amending the Franchise Rule, as it Forty-five commenters responded to Kaufmann, Feiner, Yamin, Gildin & Robbins; YUM!
pertains to franchise sales. Pursuant to the Staff Report.24 For the most part, the Brands [Pizza Hut, KFC, Taco Bell, Long John
the Commission’s Rules of Practice, 16 Silvers, and A&W]; 7-Eleven, Inc.; and Arby’s
CFR 1.20, the Commission determined 20 Franchise NPR comments are cited as: [Arby’s and T.J. Cinnamons Classic Bakery]);
[Commenter] NPR [comment number]. Marriott, at 2; NASAA, at 2; Piper Rudnick, at 1;
to use a modified version of the Spandorf, at 1; Starwood, at 1 (representing Four
21 Many commenters enthusiastically supported
rulemaking process set forth in section Points Hotels, Sheraton Hotels,Westin Hotels, and
the Commission’s overall approach to revising the
1.13 of those Rules.18 Specifically, the Rule. E.g., IL AG, NPR 3, at 10; PMR&W, NPR 4,
Luxury Collection Hotels); Wiggin and Dana, at 1.
26 Fourteen comments focused solely on a single
Commission announced that it would at 1; Holmes, NPR 8, at 1; H&H, NPR 9, at 2; Baer,
NPR 11, at 1; NFC, NPR 12, at 2; Lewis, NPR 15, issue. For example, eight comments addressed only
publish an NPR, with a 60-day comment the original Rule’s exclusion for cooperatives
at 1; IFA, NPR 22, at 3; AFC, NPR 30, at 3; J&G,
period, followed by a 40-day rebuttal NPR 32, at 1; Tricon, NPR 34, at 1; Marriott, NPR (Affiliated Foods; CHS; Graber; IDC; NCBA; NCFC;
period. In addition, pursuant to Section 35, at 2. NGA; Riezman Burger). Additional one-issue
18(c) of the FTC Act, the Commission 22 Accordingly, no Presiding Officer was comments were received on: the disclosure of
franchisee associations (AAFD); the single
announced that it would hold hearings established in this proceeding. See Rules of
trademark exclusion (Pillsbury Winthrop); the
with cross-examination and rebuttal Practice, 16 CFR 1.13(c).
23 See Bureau of Consumer Protection, Staff sophisticated investor exemptions (NADA); the
submissions only if an interested party Report to the Federal Trade Commission and
Petroleum Marketing Practices Act (Chevron); the
requested a hearing. The Commission disclosure of parent information (PREA); and
Proposed Revised Trade Regulation Rule (16 CFR
integration clauses (Lagarias). Two comments were
also stated that, if requested to do so, it Part 436) (Aug. 2004) (‘‘Staff Report’’). The Staff
beyond the scope of the Staff Report: Marks (urging
would contemplate holding one or more Report is available at: www.ftc.gov/os/2004/08/
0408franchiserulerpt.pdf. In September, 2004, the Commission to adopt franchise arbitration
informal public workshops in lieu of Commission published a notice in the Federal standards); Koutsoulis (opposing the proposed
hearings. Finally, pursuant to 16 CFR Register announcing the availability of, and seeking merger of two franchisors).
27 Compliance Guides, which the Commission
1.13(f), the Commission announced that comment on, the Staff Report. See 69 FR 53661
(Sept. 2, 2004). The announcement is also available anticipates staff will issue on part 436, would
staff would issue a Report on the update existing Interpretive Guides issued in 1979.
at: www.ftc.gov/os/2004/08/
Franchise Rule (‘‘Staff Report’’), which 040825franchiserulefrn.pdf. See generally Interpretive Guides, 44 FR 49966.
would be subject to additional public 24 Staff Report comments are cited as Compliance Guides on part 437 will be issued by
comment.19 ‘‘[Commenter], at lll .’’ These comments simply staff once any rulemaking on business opportunity
refer to the commenter and not to a specific ventures is concluded.
28E.g., Selden, at 2; Haff, at 1–3; Blumenthal, at
comment number. After the Franchise NPR, the
17 64 FR 57294 (Oct. 22, 1999). Commission’s Secretary’s Office discontinued the 1; Karp, at 2; Steinberg, at 1.
18 16 CFR 1.13. practice of assigning a specific comment number to 29E.g., Blumenthal, at 1; Karp, at 3; Steinberg, at
19 Franchise NPR, 64 FR at 57324. each comment. 1–2.
C. Continuing Need for the Rule disclosure rule enables prospective leaves open the related questions of
Based upon the original rulemaking franchisees to comparison shop for the whether such franchisor acts or
record and the Commission’s law best franchise offering.36 practices are prevalent and whether the
enforcement experience extending On the other hand, many franchisees injury resulting from acts or practices is
nearly 30 years,30 the Commission and their advocates criticized the Rule substantial, when viewed from the
concludes that a pre-sale disclosure rule for not going far enough. They urged the standpoint of the franchising industry as
continues to serve a useful purpose. Commission to address in this a whole, not from just a particular
Overwhelmingly, the comments rulemaking a variety of post-sale franchise system.
submitted during the Rule amendment franchise contract or ‘‘relationship’’ With regard to avoidability of injury,
proceeding supported the continued issues, including prohibiting or limiting the unfairness analysis falls short. A
need for the Franchise Rule.31 For the use of post-contract covenants not to franchise purchase is entirely voluntary.
example, some commenters emphasized compete,37 encroachment of The Franchise Rule ensures that each
that pre-sale disclosure is still necessary franchisees’ market territory,38 and prospective franchisee receives
to prevent fraud.32 Others observed that restrictions on the sources of products disclosures—expanded in key respects
pre-sale disclosure is a cost-effective or services.39 Indeed, some franchisees by the current amendments—that
way to provide material information to asserted that if the Rule cannot address explain the terms and conditions under
prospective purchasers about the costs, post-sale relationship issues, then the which the franchise will operate.
benefits, and potential legal and Commission should abolish the Rule.40 Prospective franchisees can avoid harm
To address post-sale relationship by comparison shopping for a franchise
financial risks associated with entering
issues by adopting rule provisions that system that offers more favorable terms
into a franchise relationship. These
prohibit or limit the use of certain and conditions, or by considering
commenters also stressed that the Rule
contract terms would require record alternatives to franchising as a means of
assists prospective franchisees in
evidence demonstrating specific unfair operating a business. Prospective
conducting a due diligence investigation
acts or practices. The FTC Act defines franchisees are also free to discuss the
of the franchise offering by providing
an unfair act or practice as one that is nature of the franchise system with
information that is not readily available,
‘‘likely to cause substantial injury to existing and former franchisees, as well
such as the franchisor’s litigation
consumers which is not reasonably as trademark-specific franchisee
history and franchisee termination avoidable by consumers themselves and associations, and the amended Rule
rates.33 Other commenters noted that not outweighed by countervailing facilitates such discussion by providing
pre-sale disclosure helps franchisees benefits to consumers or to prospects with contact information.
understand the franchise relationship competition.’’41 The Act also requires Under these circumstances, the
they are entering better than they could that, to justify an industry-wide rule, Commission cannot categorically
absent such disclosure, thereby such practice be prevalent.42 This conclude that prospective franchisees
reducing potential conflicts in franchise proceeding did not yield adequate who voluntarily enter into franchise
systems and post-sale litigation costs.34 evidence to support a finding of agreements, after receiving full
Indeed, some commenters expressed the prevalent acts or practices that meet disclosure, nonetheless cannot
view that repeal of the Franchise Rule each of the three prerequisites for reasonably avoid harm resulting from a
might actually increase franchisors’ unfairness as articulated in Section franchisor enforcing the terms of its
costs and compliance burdens by 45(n) of the FTC Act. franchise agreement.44
opening the door for individual states to With regard to the first prerequisite, The third element requires an analysis
enact franchise disclosure laws that may substantial injury, the record shows that of whether injury to franchisees
be inconsistent, making it difficult for some franchisees in several franchise deriving from specific franchisor acts or
franchisors to conduct business on a systems have suffered post-sale harm in practices outweighs countervailing
national basis.35 One commenter noted the course of operating their franchises, benefits to the public at large or to
that retaining a uniform pre-sale and in some instances this injury may competition. In our law enforcement
be ascribable to acts or practices of a experience investigating relationship
30 As of the date of this Notice, the Commission
franchisor.43 The record, however, issues in individual franchise systems,
has filed more than 210 suits against more than 650
defendants (both franchises and business it has been the case that the franchisor
opportunities) for Franchise Rule violations since
36 Kaufmann, ANPR 33, at 3. actions allegedly causing harm to
37E.g., Brown, ANPR 4, at 3; AFA, ANPR 62, at
the Rule was promulgated in 1978. See also individual franchisees also frequently
Business Opportunity NPR, 71 FR 19054 (Apr. 12, 3; Slimak, ANPR 130; Leap, ANPR 147; Vidulich,
2006) (discussing the Commission law enforcement ANPR, 22 Aug. 97 Tr., at 21. generate countervailing benefits to the
history in combating business opportunity covered 38 E.g., Brown, ANPR 4, at 2; Donafin, ANPR 14; system as a whole or to consumer
by the Franchise Rule). AFA, ANPR 62, at 1; Buckley, ANPR 97; Zarco & welfare overall that may or may not be
31E.g., H&H, ANPR 28, at 2; Kaufmann, ANPR 33, Pardo, ANPR 134, at 2.
at 2; NCL, ANPR 35, at 2; SBA Advocacy, ANPR 39 E.g., Brown, ANPR 4, at 2; Weaver, ANPR 17;
franchising overall, as to whether franchisor acts or
36, at 2–3; IL AG, ANPR 77, at 1. See also Staff Colenda, ANPR 71; Haines, ANPR 100; Chiodo, practices are a direct and primary cause of poor
Report, at notes 15–16. But see, generally, Winslow ANPR, 21 Nov. 97 Tr., at 293–94. performance or failure by franchisees. In this
(opposing the Rule). 40See AFA, ANPR 62, at 1 (‘‘Our members feel so
regard, it is noteworthy that in its 2001 audit of the
32E.g., Kaufmann, ANPR 33, at 3 (‘‘Both the Rule strongly about the Commission’s inability to deal Commission’s Franchise Rule Program, the General
and . . . state franchise laws have gone a long way with substantive issues of concern to them, they Accounting Office (‘‘GAO’’) concluded that there
toward eradicating massive franchise frauds and, by would rather work to abolish the FTC rule than are ‘‘no readily available, statistically reliable data
doing so, have restored franchising’s reputation for suffer the abuses of both a government agency and on the overall extent and nature of [franchise
integrity and thus cleared the marketplace for the their franchisors.’’). relationship] problems.’’ United States General
offerings of legitimate franchisors.’’). 41 15 U.S.C. 45(n).
Accounting Office, GAO Report to Congressional
33 E.g., Marks, ANPR, 19 Sept. 97 Tr., at 8–9, 29; 42 15 U.S.C. 57a. Requesters, Federal Trade Commission
Wieczorek, RR, Sept.95 Tr., at 62–63. But see 43 There are many factors that influence the Enforcement of the Franchise Rule, GAO–01–776, at
Winslow, at 21. success or failure of a franchisee, including 29 (July 31, 2001). See also Staff Report, at 10–11.
34E.g., H&H, ANPR 28, at 2; SBA Advocacy,
downturns in the economy, shifting consumer 44See FTC v. J.K. Publ’ns, Inc., 99 F. Supp. 2d
ANPR 36, at 2; Zarco & Pardo, ANPR 134, at 1; ABA preferences, or even franchisees’ own conduct. 1176, 1201 (C.D. Cal. 2000) (‘‘With regard to
Antitrust, RR 22, at 7. Accordingly, franchisor conduct post-sale may be [avoidability], the focus is on ‘whether consumers
35 E.g., WA Securities, ANPR 117; Shay, RR, only one factor that leads to injury to franchisees. had a free and informed choice that would have
Sept.95 Tr., at 104. The record is inconclusive, with respect to the enabled them to avoid the unfair practice.’’’).
outweighed by the alleged harm to D. Overview of the Final Amended Rule franchisees, and franchise
franchisees. Commenters advocating The final amended Rule maintains the administrators, and were subject to
that the Rule include unfairness benefits of the original Rule, preventing public hearings and notice and
remedies have asserted injury, but have deceptive and unfair practices identified comment.49 Therefore, the UFOC
failed to bring forth evidence that such in the original rulemaking through pre- Guidelines, like the Franchise Rule,
injury outweighs potential sale disclosure of material information reflect a balance of interests among all
countervailing benefits that arise from necessary to make an informed affected parties.
the alleged acts or practices. Therefore, purchasing decision and prohibition of Overwhelmingly, franchisors,
the Commission declines to impose specified misrepresentations. At the franchisees, and franchise regulators
industry-wide provisions mandating same time, part 436 of the final urged the Commission throughout the
substantive terms of private franchise amended Rule reduces unnecessary Rule amendment proceeding to adopt
contracts that would impact on the compliance costs. First, part 436 covers the UFOC Guidelines disclosure format.
entire franchise industry, not just those only the sale of franchises to be located These commenters include a broad
franchise systems that are the subject of in the United States and its territories. range of interests, such as NASAA, the
commenters’ complaints.45 Second, based upon the record, the International Franchise Association
Notwithstanding this determination, the Commission also has created several (‘‘IFA’’), the American Bar Association’s
Commission, in pursuit of its law new exemptions for sophisticated Antitrust Section, the American
enforcement mission can consider franchise purchasers, including Franchisee Association, the State Bar of
exemptions for large investments and California Business Law Section, and
whether individual franchisors’ conduct
large franchisees with sufficient net major franchisors, such as Cendant,
constitutes an unfair act or practice on
worth and prior experience. Marriott, YUM! Brands, 7-Eleven,
a case-by-case basis.
Part 436 of the final amended Rule Arby’s, and Starwood Hotels and
Nonetheless, the Commission also reduces inconsistencies between Resorts.50
concludes that the record is sufficient to federal and state pre-sale disclosure Accordingly, part 436 of the final
show that misunderstandings about the requirements. Since the original Rule amended Rule closely tracks the UFOC
state of the franchise relationship are was promulgated, NASAA, which Guidelines. Nevertheless, part 436 is not
prevalent, and some more disclosure is represents the 15 states with pre-sale identical to the UFOC Guidelines. In a
warranted to ensure that prospective franchise disclosure laws, has few instances, part 436 omits or
franchisees are not deceived about the developed a standard disclosure streamlines a UFOC Guidelines
quality of the franchise relationship document, the UFOC. The Commission, disclosure requirement that the
before they commit to buying a as a matter of policy, has in the past Commission believes is unnecessary or
franchise. Franchisee concerns about permitted franchisors to comply with is overly burdensome—for example,
relationship issues persuade us that the Franchise Rule by furnishing mandatory cover page risk factors,
better disclosure is necessary to ensure prospective franchisees with a UFOC, broker disclosures, and detailed
that prospective franchisees are fully even in the 35 states without franchise computer equipment disclosures. As
informed about the relationships that disclosure laws.46 The Commission explained in greater detail below, part
they will be entering. To that end, part found that the UFOC Guidelines, taken 436 of the final amended Rule also
436 of the final amended Rule expands as a whole, offer consumers the same or avoids problems with Item 20 of the
the Rule’s pre-sale disclosures in a few greater consumer protection as that UFOC Guidelines (the disclosure of
instances to address franchise provided by the original Rule. As a statistical information on franchisees in
relationship issues, as detailed result, the UFOC Guidelines already are the system) that were revealed during
throughout this document. used by the vast majority of franchisors the proceeding and that were examined
to comply with the Rule,47 and, in fact, in detail by a number of commenters,
45 The Commission notes that it has voiced the UFOC Guidelines have become the including NASAA.
concern that government-mandated contractual national franchise industry standard.48 Part 436 of the final amended Rule
terms may result in affirmative harm to consumer Further, as NASAA noted, the UFOC also retains a few provisions from the
welfare. Contractual terms that are driven by market Guidelines were developed with original Rule that are not in the UFOC
forces and forged by private parties acting in their
own self-interest are the ones most likely to result
significant input from franchisors, Guidelines, because the Commission
in products being brought to market quickly and believes they are necessary to prevent
efficiently. The Commission therefore has 46 Authorization to use the UFOC Guidelines to deception. For example, part 436 of the
authorized its staff to file a number of advocacy comply with the original Rule’s disclosure final amended Rule retains the original
comments recommending against proposed state requirements was first granted by the Commission
bills that would have unduly limited manufacturers in the Interpretive Guides, 44 FR at 49970–71, on Rule’s requirement that, in some
in managing their distribution systems, such as by the grounds that the UFOC Guidelines, taken in instances, franchisors disclose
requiring exclusive territories, prohibiting or their entirety, provide equal or greater consumer information about a parent. Similarly,
seriously burdening wholesaler terminations, or protection as the original Rule. The Commission part 436 retains the original Rule’s
limiting the ability to reorganize a distribution ratified this position following subsequent
system in response to changing competitive amendments to the UFOC requirements by the phase-in of audited financial statements,
conditions. See, e.g., Letter from Maureen NASAA, most recently in 1993, 58 FR 69224 (Dec.
Ohlhausen, Dir., Office of Policy Planning, et al., to 30, 1993). 49 NASAA, ANPR 120, at 2. See also WA
the Hon. Wesley Chesbro, Cal. State Senate (Aug. Beginning on July 1, 2008, however, franchisors Securities, ANPR 117, at 1.
24, 2005) (comment on proposed beer franchise may use part 436 of the final amended Rule only. 50 E.g., PMR&W, NPR 4, at 1; H&H, NPR 9, at 2;
act); Letter from C. Steven Baker, Dir., Chicago Permission to use the UFOC Guidelines will be 7-Eleven, NPR 10, at 2; Lewis, NPR 15, at 5;
Regional Office, to the Hon. Dan Cronin, Ill. State withdrawn on that date because those Guidelines NASAA, NPR 17, at 2–4; Bundy, NPR 18, at 6;
Senate (Mar. 31, 1999) (comment on proposed will no longer afford prospective franchisees equal Gurnick, NPR 21, at 2; IFA, NPR 22, at 4–5;
legislation on wine and spirits distribution); cf. or greater protection as part 436. This would not Stadfeld, NPR 23, at 2; J&G, NPR 32, at 2; Marriott,
Testimony of Jerry Ellig, Deputy Dir., Office of preclude consideration of any new or revised UFOC NPR 35, at 2; Brown, ANPR 4, at 1; Duvall, ANPR
Policy Planning, before joint committee hearings of Guidelines promulgated by the states in the future. 19, at 1; Baer, ANPR 25, at 2; Kaufmann, ANPR 33,
47E.g., H&H, ANPR 28, at 5–6; Kaufmann, ANPR
the Haw. state legislature (recommending against at 3; SBA Advocacy, ANPR 36, at 3; Kestenbaum,
gasoline price control legislation, in part on 33, at 3; Kestenbaum, ANPR 40, at 1; WA Securities, ANPR 40, at 1; AFA, ANPR 62, at 2; IL AG, ANPR
grounds that repeal of anti-encroachment statute ANPR 117, at 1. 77, at 1; WA Securities, ANPR 117, at 1; Selden,
would be a more effective means of reducing prices 48 E.g., IFA, NPR 22, at 4–5; Stadfeld, NPR 23, ANPR 133, at 1; Zarco & Pardo, ANPR 134; at 1;
(Jan. 28, 2003)). at 2; Karp, ANPR, 19 Sept. 97 Tr., at 90. Cendant, ANPR 140, at 2.
thereby preserving flexibility not from unilaterally altering the material final amended Rule, with NASAA’s
present in the UFOC Guidelines. terms and conditions of its franchise Franchise and Business Opportunity
At the same time, part 436 of the final agreements, unless the franchise seller Project Group in order to minimize
amended Rule adds to the UFOC informs the prospective franchisee differences between FTC and state Rule
Guidelines a few narrowly tailored about the changes within a reasonable interpretations.
disclosures based upon the time before execution. Part 436 of the
Commission’s law enforcement II. THE LEGAL STANDARD FOR
final amended Rule also prohibits the AMENDING THE RULE
experience and the rulemaking record, use of shills, who are persons paid or
mostly to prevent deception involving otherwise given consideration to A. Section 18 Rulemaking
the nature of the franchise provide a false favorable report about Section 18(d)(2)(B) of the FTC Act
relationship.51 For example, as the franchisor’s performance history. states that ‘‘[a] substantive amendment
explained in greater detail below, part to, or repeal of, a rule promulgated
436 of the final amended Rule expands E. Continued Application of
Commission and NASAA Precedent under subsection (a)(1)(B) shall be
the UFOC Guidelines’ Item 3 litigation prescribed, and subject to judicial
disclosure requirements to include the As noted throughout, most of the review, in the same manner as a rule
disclosure of franchisor-initiated provisions of the original Rule have prescribed under such subsection.’’55
litigation. In addition, part 436 of the been retained in the final amended Thus, the standard for amendment or
final amended Rule goes beyond the Rule. Accordingly, the original SBP repeal of a Section 18 rule is identical
UFOC Guidelines’ Item 20 franchisee remains valid, except to the extent of to that for promulgating a trade
statistics disclosures to require any conflict with the final amended regulation rule pursuant to Section 18.
disclosure of information about the Rule. In the event of any conflict, this Additionally, an SBP must address
franchisor’s use of confidentiality document supersedes the original SBP. four factors: (1) the prevalence of the
clauses and the existence of trademark- In the same vein, all former informal acts or practices addressed by the rule;
specific franchisee associations. In staff advisories remain a source of Rule (2) the manner and context in which the
addition, in a few instances, part 436 of interpretation, except where this SBP acts or practices are unfair or deceptive;
the final amended Rule requires contradicts a staff advisory. To the (3) the economic effect of the rule,
franchisors to make prescribed extent that any member of the public is taking into account the effect on small
statements to clarify issues that the concerned that a previous advisory may businesses and consumers; and (4) the
record established are often no longer be applicable in light of the effect of the rule on state and local
misinterpreted by prospective final amended Rule, we invite that laws.56 These four factors are discussed
franchisees, particularly in the area of person or entity to seek further in detail throughout this document. In
protected territories and financial clarification from the Commission or the the next section, we summarize our
performance representations. staff.52 findings regarding each of these
Further, part 436 of the final amended Further, the Commission anticipates factors.57
Rule updates the original Rule and issuance of new Compliance Guides on
UFOC Guidelines by addressing changes part 436 that will replace the original 1. The effect of the rule on state and
in the marketplace and new Interpretive Guides.53 Because much of local laws
technologies. For example, as explained part 436 of the final amended Rule is The Commission begins with the
below, part 436 of the final amended based upon the UFOC Guidelines, the effect of the final amended Rule on state
Rule permits franchisors to furnish Commission anticipates that and local laws, because that factor is
disclosures electronically and enables Compliance Guides will likely unusually prominent in this proceeding.
franchisees to use electronic signatures. incorporate, in large measure, the UFOC As noted above, 15 states have pre-sale
Part 436 of the final amended Rule also franchise disclosure laws in the form of
Guidelines’ existing sample answers
updates the original Rule and UFOC the UFOC Guidelines. The rulemaking
and NASAA’s previously issued
Guidelines to address the impact of the record shows that, as a practical matter,
commentaries on the UFOC Guidelines,
Internet on a franchisor’s business the UFOC Guidelines are, in fact, the
to the extent such sample answers and
operations. Specifically, part 436 national disclosure standard for the
commentaries do not deviate from the
requires more disclosure about the affect
final amended Rule.54 The Commission franchise industry. Therefore, by design,
of the Internet on sales restrictions
intends that the staff coordinate the the overwhelming effect of the final
imposed on franchisees and any right of
issuance of Compliance Guides, and amended Rule on state franchise law
franchisors to compete online. It also
future interpretations of part 436 of the will be to mesh more closely with it and
addresses financial performance
representations made on the Internet. 52 The Commission’s Rules of Practice prescribe 55 15 U.S.C. 57a(d)(2)(B). The Commission’s
Finally, part 436 of the final amended procedures to follow in seeking such advice. 16 rulemaking standards applicable to the
Rule contains a few provisions and CFR 1.3. promulgation and amendment of a Section 18 rule
prohibitions that are necessary to make 53 Throughout the Rule amendment proceeding, require a preponderance of reliable evidence. See
the Rule effective, to facilitate commenters have requested that the Commission Statement of Basis and Purpose, Funeral Rule, 59
explain or interpret various provisions in FR 1592 (Jan. 11, 1994); Credit Practices Rule, 49
compliance, and to prevent deception. FR 7740 (Mar. 1, 1984).
Compliance Guides. The Commission anticipates
For example, part 436 of the final that staff will respond affirmatively to those 56 Rules of Practice, 16 CFR 1.14(a)(1)(i)–(iv). In
amended Rule prohibits a franchisor requests. Compliance Guides on part 437 (the addition, the SBP must specify how the public may
business opportunity section) will be issued after obtain a copy of the Rule’s final regulatory analysis.
51 A decision to retain any portion of the original the conclusion of the business opportunity 16 CFR 1.14(a)(v). The current notice does not set
Rule may be based upon evidence gathered during rulemaking proceeding. forth a separate regulatory analysis. Instead, it
the original rulemaking and the Commission’s 54 The Commission also recognizes that over the incorporates the Commission’s regulatory analysis
subsequent enforcement experience, as well as course of the years, franchisors have developed throughout the SBP portion of the notice. This
evidence adduced during the current rulemaking. specific language approved by the states for notice, including the SBP, is being published in the
Indeed, to the extent that nothing supplements compliance with the UFOC Guidelines. The Federal Register and posted on the FTC’s website
evidence from the initial rulemaking, there is a Commission anticipates that part 436 of the final at: www.ftc.gov.
presumption that the existing rule should be amended Rule will be interpreted, where consistent 57 Support in the record for each factor is set forth
retained. See Motor Vehicle Mfrs. Ass’n v. State with the public interest, in a manner that conforms in the substantive discussion of each provision of
Farm Mut. Auto. Ins. Co., 463 U.S. 29, 42 (1983). with historic industry practices. the final amended Rule.
enhance its effectiveness by promoting information alone trigger the Rule’s aspects of this type of misrepresentation
consistency and extending its reach to financial performance disclosure and that have been revealed by our
nationwide scope.58 Moreover, the substantiation requirements. enforcement experience or the record
overwhelming majority of commenters developed here. Specifically, part 436 of
2. Deceptive practices
throughout the Rule amendment the final amended Rule requires
proceeding, including NASAA and The original Rule remedied through franchisors to disclose information
other state law advocates, urged the pre-sale disclosure five types of harmful about the franchisor’s predecessors.
Commission to update the original Rule material misrepresentations or Similarly, based upon the Commission’s
by adopting the UFOC Guidelines to omissions that were found to be law enforcement experience in over 50
bring greater uniformity to the field of widespread —specifically, franchise cases, part 436 also remedies
franchise pre-sale disclosure.59 misrepresentations about: (1) the misrepresentations about those
Accordingly, in considering the factors opportunity being offered for sale (2) controlling the franchise system by
outlined above, the Commission has costs; (3) contractual terms; (4) success requiring not only disclosures about
given great weight to state franchise of the seller and prior purchasers; and directors and officers, but also about
laws and their impact on the market, as (5) the seller’s financial viability. Each other individuals who have
well as the desire of all parties in the part 436 disclosure amendment to the management responsibility relating to
field to reduce inconsistencies between original Rule addresses one of these five the sale or operation of the franchises
federal and state franchise disclosure types of misrepresentations or being offered for sale.
laws. omissions of material information.60
b. Misrepresentations about costs
The Commission has also carefully a. Misrepresentations about the
weighed the benefits of any suggestion In promulgating the original Rule, the
franchisor and the franchise system
to revise the Rule that would compound Commission recognized the harm to
In the original rulemaking, the franchisees and business opportunity
inconsistencies between the Rule and Commission found that franchisors and
the UFOC Guidelines. Only in very few purchasers resulting from misleading
business opportunity sellers routinely cost representations. Representing that
instances, an existing weakness in the misrepresented the nature of the
UFOC Guidelines compels deviation costs of buying and operating a
business. For example, franchisors franchise, for example, are less than
from those Guidelines. The chief misrepresented how long they had been
example is the revision to the Item 20 they actually are is likely to mislead
in business or the extent of their prospective franchisees, acting
franchise statistics disclosures. Part 436 directors’ and officers’ prior business reasonably under the circumstances,
of the final amended Rule adopts a experience. Such misrepresentations into believing that the franchise is more
proposal submitted by NASAA to mislead consumers acting reasonably financially attractive than is actually the
eliminate revealed problems with UFOC under the circumstances into believing case. Obviously, cost representations are
Item 20 in a streamlined fashion that that the franchise offered for sale is a highly material. Thus, the original Rule
provides prospective franchisees with safe or low risk investment. required franchisors and business
material information about the franchise To prevent such deception, the opportunity sellers to disclose fully not
system, while reducing unnecessary original Rule required franchisors and only the initial fee, but continuing costs
compliance burdens. business opportunity sellers to disclose throughout the relationship. For
The Commission also has adopted background information on the example, franchisors must disclose
several suggestions offered by state franchisor or business opportunity seller required purchases or leases for, among
regulators, mostly through NASAA, for and the business, including: the name other things, inventory, signs, supplies,
streamlining the Rule. For example, in and address of the franchisor or and equipment. In addition, the
part 436 the Commission has revised the business opportunity seller and any Commission was concerned about
financial performance claim disclosures parent company; the name under which undisclosed indirect payments to the
to eliminate the original Rule’s the franchise or business opportunity franchisor or business opportunity
requirements that: (1) existing franchise seller does or intends to conduct seller, and therefore required
performance data be prepared according business; its trademarks; the prior franchisors and business opportunity
to generally accepted accounting business experience of the franchisor or sellers to disclose the basis for
principles; (2) financial performance business opportunity seller and its calculating payments to the franchisor
data be presented to a prospective directors and officers; and the business or business opportunity seller from
franchisee in a separate financial experience of the franchisor or business suppliers that franchisees or business
performance document; and (3) cost opportunity seller —e.g., experience opportunity purchasers are required to
58 As noted above, part 437 (the business
selling franchises under the same or use. Similarly, franchisors and business
opportunity section) of the final amended Rule is
different trademarks, as well as the opportunity sellers must disclose any
identical in all respects to the original Rule, except franchisor or business opportunity interest or payments made to celebrity
for its scope of coverage. Accordingly, the seller’s other lines of business. endorsers.
amendments to the original Rule set forth in part Part 436 of the final amended Rule Part 436 of the final amended Rule
437 will have no effect on state or local business retains these required cost disclosures.
opportunity laws.
continues to address misrepresentations
59 The Commission intends to continue working about the nature of the franchisor and It also adopts a few additional cost
with NASAA and individual states after the final the franchise system by requiring the disclosures that the states found
amended Rule goes into effect in order to same disclosures as did the original necessary to address related
harmonize federal and state franchise disclosure Rule. In a few instances, part 436 misrepresentations or omissions, or
laws. The Commission recognizes that the states
have a wealth of experience in interpreting the expands on these disclosures to remedy misrepresentations revealed by our law
UFOC Guidelines that form the basis of the final enforcement experience or the record
amended Rule. Accordingly, the Commission 60 As noted above, part 437 (the business developed here. These include, for
anticipates that the staff will coordinate with opportunity section) of the final amended Rule is example, a description of laws or
NASAA and the states in issuing future Compliance identical in all respects to the original Rule, except
Guides and informal staff advisory opinions, in for its scope of coverage. Accordingly, there are no
regulations specific to the industry in
keeping with our goal of federal and state amendments in part 437 that must be addressed which the franchise operates.
harmonization. here. Obviously, a franchisee’s operating costs
may increase if he or she must incur misrepresentations identified in the to 100 franchised outlets, as well as
hidden costs in the form of compliance original rulemaking record. These contact information for former
with various industry-specific included misrepresentations about: the franchisees. Part 436 of the final
regulations governing the particular number of franchisees or business amended Rule also provides additional
field. Part 436 of the final amended Rule opportunity purchasers, the expected sources of information about the
also adopts the UFOC Guidelines’ growth of the system, and, most franchise system, including the
required disclosure of fees that the important, the financial performance of disclosure of trademark-specific
franchisee is expected to pay within the existing purchasers. franchisee associations. These
first three months of operation (or other To remedy misleading success claims, provisions prevent misrepresentations
reasonable time for the industry), as the original Rule required franchisors by giving prospective franchisees
well as more details about payments, and business opportunity sellers to additional sources of information with
such as to whom a payment is to be disclose statistics about the system, which to assess franchisor claims. With
made and whether a payment is including the number of purchasers in respect to financial performance
refundable. At the same time, part 436 the system, the number of purchasers representations, it follows the more
of the final amended Rule updates cost who left the system in the previous year, streamlined approach of the UFOC
disclosures by requiring, for example, and why they left (i.e., termination, Guidelines. Specifically, part 436 of the
additional information about any cancellation, non-renewal, final amended Rule eliminates the need
required computer systems, based upon reacquisition). The original Rule also for a separate earnings claims
the UFOC Guidelines. Each of these required franchisors and business document. Instead, the required
UFOC provisions is designed to prevent opportunity sellers to furnish the names information is incorporated into the text
misrepresentation of the costs required and contact information for at least 10 of the disclosure document itself (Item
to commence operation of a franchised current purchasers. This information 19).
outlet. enabled prospective purchasers to verify Finally, as discussed throughout this
the seller’s claims of success, and it gave document, franchisees have brought to
c. Misrepresentations about contractual prospective purchasers additional the Commission’s attention what they
terms sources from which to obtain financial believe to be abusive practices in
Another area of deception identified performance data. franchising. These practices include
in the original rulemaking record The original Rule also remedied encroachment of territories, imposition
concerns the underlying franchise or misleading success claims by requiring of source of supply restrictions,
business opportunity contract. For franchisors and business opportunity modification of original franchise
example, the Commission found that sellers to disclose lawsuits filed by agreements as a precondition for
franchisors may misrepresent the extent purchasers against them pertaining to renewal, and the use of disclaimers to
of promised assistance, or fail to their relationship and counterclaims limit liability for misrepresentations,
disclose restrictions and other filed by a franchisor or business among others. As detailed in Section
obligations imposed on the franchisee. opportunity seller in response to a suit I.C. above, the Commission declines to
Accordingly, the original Rule specified filed by a purchaser. The existence of attempt to promulgate a franchise
a number of disclosures pertaining to such lawsuits is material because this relationship law and, further, concludes
the legal obligations of both parties information would likely influence a that the record does not support the
under their agreement. Specifically, the prospective purchaser’s decision about promulgation of such a law.
original Rule required franchisors, for what can be a sizeable investment in a Nonetheless, the record is sufficient to
example, to disclose information about franchise or business opportunity. The support requiring additional disclosures
contractual requirements to use nature of the relations between the that will help inform prospective
designated suppliers, financing seller and the purchaser, as reflected in franchisees about the quality of the
arrangements, product sales restrictions litigation, is of central importance. franchise relationship. These include:
and protected territories, site selection, In the original rulemaking, the expanded litigation disclosures to
and training programs. In addition, Commission also sought to ensure the include franchisor-initiated litigation
franchisors had to disclose basic terms accuracy and reliability of any financial against franchisees; a warning of the
of the contract, such as the duration, performance claims made by a consequences to a franchisee when a
renewal and termination rights, franchisor or business opportunity franchisor offers no exclusive territory;
assignment rights, and covenants not to seller. Accordingly, the Commission a statement of what the term ‘‘renewal’’
compete. prohibited the making of earnings means in the franchise system; and a
Part 436 of the final amended Rule claims unless the franchisor or business disclosure of the use, if any, of
retains these disclosure requirements. opportunity seller possessed a confidentiality clauses. Taken together,
Adopting the UFOC Guidelines reasonable basis for the claim, along each of these amended disclosures in
approach, however, the contract with written substantiation, at the time part 436 will enable prospective
disclosures are required to be presented the claim was made. In addition, the franchisees to better assess the quality of
in easy-to-read tables, with references to seller had to set forth the claim in a the franchise relationship, and their
the franchise agreement, rather than in separate earnings claims statement likely success as franchisees.
the form of more detailed descriptions. containing the bases and assumptions
underlying the claim. Franchisors and e. Misrepresentations about financial
In addition, part 436 updates the
business opportunity sellers were also viability
disclosures by, for example, requiring
franchisors to explain how they use the required to warn prospective purchasers In the original rulemaking record, the
term ‘‘renewal’’ in their system. that there is no assurance that they will Commission found that franchisors and
achieve the same level of earnings. business opportunity sellers often
d. Misrepresentations about success
Part 436 of the final amended Rule misrepresented or failed to disclose

False or misleading representations retains each of these disclosures, and it material information about their
about the success of franchise systems expands on them by requiring financial viability. As a result,
and business opportunities were franchisors to provide, consistent with prospective purchasers invested
perhaps the most prevalent the UFOC Guidelines, the names of up thousands of dollars in systems having
a poor financial history, or even facing to adopt two UFOC Guidelines Item 5 permits franchisors to disclose
bankruptcy. Obviously, a franchisee’s provisions on the grounds that such either fixed fees or ranges of fees.
investment, for example, is at risk if the provisions are unnecessarily Similarly, Item 11 permits franchisors to
franchisor is not able to perform its burdensome, without corresponding summarize computer system
contractual obligations as promised. To benefits to prospective franchisees. requirements, in lieu of more extensive
remedy these practices, the original These provisions are mandatory risk disclosures.
Rule required franchisors and business factors (choice of law and venue) on the In amending the Rule, the
opportunity sellers to disclose disclosure document cover page and the Commission has been guided by a
bankruptcy information, as well as to disclosure of franchise broker preference for an approach that
provide audited financial information. information in Items 2, 3, and 4 of the prohibits identified harmful practices
The final amended Rule continues to UFOC Guidelines. and eschews burdensome affirmative
require these disclosures. Further, for each disclosure item, the compliance obligations that may only be
Commission considered less costly warranted for some few unscrupulous
3. The economic effect of the rule disclosure alternatives. For example, actors. Thus, part 436 of the final
At every stage of the Rule amendment part 436 of the final amended Rule amended Rule drops the original Rule’s
proceeding, the Commission solicited requires the disclosure of franchisor- across-the-board obligation to furnish
comment on the economic impact of the initiated litigation. In response to disclosures early in the sales process—
Rule, as well as the costs and benefits concerns raised by franchisor at the first personal meeting between the
of each proposed Rule amendment. In representatives, Item 3 of part 436 prospective purchaser and the franchise
finalizing the final amended Rule, the makes clear that this disclosure is seller. Instead, part 436 of the final
Commission has carefully weighed limited to a one-year snap-shot in time amended Rule allows greater flexibility,
these costs and benefits, reducing and franchisors need only update the requiring that franchisors furnish
compliance costs wherever possible. disclosure on an annual basis. disclosures early in the sales process
Thus, for example, part 436 reduces Franchisors also can reduce costs by only if the prospective franchisee
compliance costs by limiting the Rule’s grouping similar franchisor-initiated requests them at that point. Similarly,
scope of coverage to the sale of suits under a single descriptive heading, part 436 of the final amended Rule
franchises to be located in the United in lieu of detailed summaries for each eliminates burdensome waiting periods
States and its territories.61 suit. in some instances. Thus, in lieu of the
In the same vein, part 436 of the final Similarly, the Commission has original Rule’s mandate that all
amended Rule reduces compliance adopted in part 436 a narrow franchisors furnish copies of their
burdens where the record establishes requirement to disclose independent completed franchise agreements at least
that the abuses the Rule is intended to trademark-specific franchisee five business days before execution, part
address are not likely to be present. associations. Franchisors must make 436 targets potential fraud directly by
Thus, part 436 of the final amended this disclosure only if the franchisee prohibiting a franchisor from failing to
Rule retains the exemptions in the association asks to be included in the disclose unilateral changes to a
original Rule as the ones for fractional franchisor’s disclosure document, and franchise agreement seven days prior to
franchises and leased departments. Part the association’s request must be its execution. As a final example, part
436 of the final amended Rule also updated on an annual basis. 436 of the final amended Rule prohibits
incorporates the Commission’s long- Part 436 of the final amended Rule a franchisor from failing to furnish a
standing policies exempting from Rule also reduces the franchisors’ burdens copy of its most recent disclosure
coverage franchises covered by the associated with making financial document and any quarterly updates to
Petroleum Marketing Practices Act, as performance claims. Among other a prospective franchisee, upon
well as instances where the only things, the original Rule specified that: reasonable request, before the prospect
required payments made by the (1) all financial performance claims signs the franchise agreement. This
franchisee are for inventory at bona fide must be geographically relevant to the prohibition is in lieu of suggestions that
wholesale prices. Further, part 436 of franchise being offered for sale; and (2) the Commission impose onerous
the final amended Rule adds new all historical earnings data from existing disclosure updating obligations on an
exemptions for large investments of at franchisees must be presented using ongoing basis.
least $1 million (excluding unimproved generally accepted accounting Finally, in numerous instances the
land and any amounts financed by the principles. Moreover, the original Rule Commission has rejected suggestions to
franchisor), investments by large required franchisors to disseminate impose certain additional requirements
franchisees with five years of business financial performance information in a upon franchisors, and has opted instead
experience and $5 million net worth, separate document. Part 436 of the final to address the underlying issues that
and for franchise sales to company amended Rule eliminates these prompted those suggestions through
insiders who are already familiar with requirements. redoubled consumer education efforts.
the company’s operations. Part 436 of the final amended Rule For example, several commenters in the
The Commission also has limited the also promotes efficiency and reduces rulemaking record urged the
required disclosures of part 436 in order compliance costs by enabling Commission to expand the disclosure
to minimize compliance burdens. For franchisors to use their own judgment in document to provide prospective
example, the Commission has declined deciding how to disseminate disclosure franchisees with more general
documents. For example, part 436 information about the nature of
61 In so doing, the Commission specifically
permits franchisors to furnish franchising. Others suggested more
rejected the suggestion that franchisors should
prepare individual disclosure documents tailored to
disclosures electronically through a disclosure on post-termination
each specific foreign market. Not only would such variety of media, including CD–ROM, obligations to third-party vendors,
a requirement put American franchisors at a Internet website, and email. Individual obligations to purchase from specific
competitive disadvantage with franchisors from sections of the disclosure document also suppliers, and sources of financing,
countries lacking comparable disclosure
regulations, the minimal benefits of such a
allow more flexibility than the original among others. While there is merit in
requirement would not likely outweigh the Rule, again to promote efficiency and their suggestions, the Commission has
extraordinary costs and burdens involved. reduced compliance costs. For example, concluded that the appropriate vehicle
to disseminate such information is help obviate deception of prospective contained in either the original Rule or
through consumer education materials, franchisees. UFOC Guidelines. These include the
not through the Rule itself. To that end, To that end, part 436 of the final terms: ‘‘affiliate,’’ ‘‘fiscal year,’’
the cover page of the disclosure amended Rule adopts a few new ‘‘fractional franchise,’’ ‘‘franchise,’’
document set forth in part 436 of the disclosures that provide prospective ‘‘franchisee,’’ ‘‘franchisor,’’ ‘‘leased
final amended Rule references the franchisees with material information department,’’ ‘‘person,’’ ‘‘prospective
Commissions’ Consumer Guide to about the quality of the franchise franchisee,’’ and ‘‘sale of a franchise.’’
Buying a Franchise, where such relationship or with sources of Part 436 of the final amended Rule,
background information is furnished. information about such relationships. however, adds several new definitions
This approach enables prospective For example: to the original Rule, including the terms:
franchisees to obtain desirable • In section 436.5(c), the Item 3 ‘‘action,’’ ‘‘confidentiality clause,’’
information without imposing new requirements to disclose information ‘‘disclose, state, describe, and list,’’
compliance burdens on franchisors. about franchisor litigation have been ‘‘financial performance representation,’’
amended to encompass franchisor- ‘‘franchise seller,’’ ‘‘parent,’’ ‘‘plain
4. Statement of prevalence initiated litigation, such as suits to English,’’ ‘‘predecessor,’’ ‘‘principal
collect royalty payments, in order to business address,’’ ‘‘required payment,’’
The Commission promulgated the ensure prospective franchisees have
original Rule based upon its finding of ‘‘signature,’’ ‘‘trademark,’’ and
material information about the nature of ‘‘written.’’ At the same time, part 436 of
prevalent deception in the offer and sale the franchisor’s relationship with its
of franchises and business opportunity the final amended Rule eliminates four
franchisees;63 of the original Rule’s terms, and their
ventures, leading to significant • In section 436.5(l), the Item 12
consumer injury. That finding retains its definitions, that are no longer necessary:
requirements to disclose information ‘‘business day,’’64 ‘‘time for making of
validity and the final amended Rule about territories contain a new warning
retains almost all of the original Rule’s disclosures,’’65 ‘‘personal meeting,’’66
to prospective franchisees about the and ‘‘cooperative association.’’67
disclosure requirements for both consequences of not having an exclusive
franchises and business opportunity Section 436.1 of the final amended
territory— that, as a result of having no Rule is very similar to the
sellers. In the franchise context, exclusive territory, the franchisee ‘‘may
modifications of those requirements corresponding section of the proposed
face competition from other franchisees, Rule published in the Franchise NPR,
have been driven by four from outlets that we own, or from other
considerations: the goal of harmonizing but makes the following revisions: (1)
channels of distribution or competitive substitutes a definition of
the Rule with the UFOC Guidelines; the brands that we control;’’
need to update the original Rule to ‘‘confidentiality clause’’ for the
• In section 436.5(q), the Item 17 definition of ‘‘gag clause;’’ (2) omits
address new technologies; to reduce requirements to disclose information
unnecessary compliance burdens; and, proposed definitions of ‘‘Internet,’’
about renewal of the franchise mandate ‘‘officer,’’ and ‘‘material;’’ and (3) makes
based on the record developed here, to that a franchisor describe what the term
remedy prevalent nondisclosure on non-substantive revisions to improve
‘‘renewal’’ means for its system, and readability, organization, and precision
issues relating to the franchise state what has been absent from
relationship.62 throughout, as well as some substantive
disclosure to date—that franchisees will revisions in response to the comments.
This last category of modifications be required to sign a different agreement The following sections discuss each
constitutes the most significant when renewing, as opposed to definition of part 436 of the final
additions to the original Rule. extending the term of their original amended Rule.
Throughout the Rule amendment agreement.
proceeding, franchisees have 1. Section 436.1(a): Action
These new disclosure requirements are
complained repeatedly about various tailored to address the prevalent Consistent with the original Rule,68
practices in franchising that they believe franchisor nondisclosure of material section 436.5(c) of the final amended
are abusive. These practices include information that prospective franchisees
encroachment of territories, source of need to avoid forming the kind of 64See 16 CFR 436.2(f).
supply restrictions, modification of misconceptions about these three key 65 See 16 CFR 436.2(g).
franchise agreements upon renewal, and aspects of the franchise relationship that 66See 16 CFR 436.2(o). The original Rule required
the use of confidentiality clauses to have prompted the franchisee franchisors to provide disclosure documents at the
prevent franchisees from speaking with earlier of the first ‘‘personal meeting’’ or ‘‘the time
complaints noted in this record. for making disclosures,’’ which generally meant 10
prospects. To address these issues, business days before the prospective franchisee
franchisees urged the Commission to III. SECTION–BY–SECTION ANALYSIS paid any fee or signed any contract in connection
promulgate a substantive franchise OF PART 436 with the franchise sale. The final amended Rule
relationship law. As detailed above in streamlines this requirement by eliminating those
A. Section 436.1: Definitions timing provisions in favor of a clear, bright-line 14
Section I.C., the applicable legal calendar-day provision. Accordingly, the terms
In many instances, the part 436
standard that could theoretically ‘‘time for making disclosures,’’ ‘‘personal meeting,’’
definitions of the final amended Rule
support promulgation of such a law has and ‘‘business day’’ are obsolete.
are substantively similar to those 67 See 16 CFR 436.2(l). Cooperative associations
not been met. Nonetheless, the
are one of four non-franchise relationships that the
Commission is persuaded by evidence 63 Multiple franchisor-initiated suits could Commission has excluded from the final amended
in the record that nondisclosure of indicate franchisees’ inability to comply with Rule. Unlike Rule exemptions (which are
material information about franchise royalty payment obligations, or possibly a royalty substantive limitations on the Rule’s scope), the
relationships is prevalent and the record boycott by franchisees. Suits to enforce system original Rule exclusions are explanatory, helping
standards, on the other hand, could show active the public better distinguish between franchise and
supports additional disclosures that will
involvement by the franchisor in maintaining non-franchise relationships. Accordingly, the

standards for the benefit of all franchisees within Commission anticipates that staff will address non-
62 The Commission is also considering its system. In either case, this is information franchise relationships—including the four
amendments to the original Rule as they pertain to material to prospective franchisees attempting to exclusions—in the Compliance Guides instead of in
business opportunity sales. See Business determine the nature of the franchisor’s relationship the text of the amended Rule.
Opportunity NPR, 71 FR 19054 (Apr. 12, 2006). with its franchisees. 68See 16 CFR 436.1(a)(4).
Rule requires a franchisor to disclose to adopt these additional revisions to 3. Section 436.1(c): Confidentiality
certain legal actions involving the the definition of ‘‘action.’’ clause
franchisor and its directors and officers. Part 436 of the final amended Rule
2. Section 436.1(b): Affiliate
The original Rule did not define the requires franchisors for the first time to
term ‘‘action.’’ Section 436.1(a) in the Many of the part 436 disclosures
pertain to both the franchisor and its disclose the use of confidentiality
final amended Rule is nearly identical clauses that prohibit or restrict existing
to the definition proposed in the affiliates.75 The original Rule defined
the term ‘‘affiliated person’’ to mean a or former franchisees from discussing
Franchise NPR, and closely tracks the
person: their experience with prospective
UFOC Guidelines’ definition of the term
franchisees.79 Accordingly, section
‘‘action.’’69 That definition is: ‘‘Action (1) Which directly or indirectly 436.1(c) of the final amended Rule adds
includes complaints, cross claims, controls, is controlled by, or is to the original Rule definitions the term
counterclaims, and third-party under common control with, a ‘‘confidentiality clause,’’80 defined as
complaints in a judicial action or franchisor; or follows:
proceeding, and their equivalents in an
(2) Which directly or indirectly any contract, order, or settlement
administrative action or arbitration.’’70
owns, controls, or holds with power provision that directly or indirectly
The definition differs from the UFOC
to vote, 10 percent or more of the
Guidelines definition only in that it restricts a current or former
outstanding voting securities of a
refers to a ‘‘judicial action or franchisee from discussing his or
franchisor; or
proceeding,’’ in lieu of just a ‘‘judicial her personal experience as a
proceeding.’’ This modification (3) Which has, in common with a franchisee in the franchisor’s
addresses one commenter’s observation franchisor, one or more partners, system with any prospective
that some states may retain the officers, directors, trustees, branch franchisee. It does not include
distinction between an ‘‘action’’ at law managers, or other persons clauses that protect a franchisor’s
and a ‘‘proceeding’’ in equity.71 Clearly, occupying similar status or trademarks or other proprietary
both types of legal matters must be performing similar functions.76 information.
disclosed. Section 436.1(b), like the
The Commission has declined to corresponding definition in the As explained below, the
adopt an additional suggestion that proposed Rule, harmonizes federal and confidentiality clause disclosure
‘‘complaints’’ referred to in the state law, closely following the UFOC requirement is intended to prevent
definition of ‘‘action’’ be limited to Guidelines by defining ‘‘affiliate’’ to deception in the offer and sale of
‘‘served complaints.’’72 Such a mean: ‘‘an entity controlled by, franchises by assisting prospective
narrowing of the definition of ‘‘action’’ controlling, or under common control franchisees in verifying a franchisor’s
would be inconsistent with the UFOC with, another entity.’’77 This is slightly claims. Specifically, this disclosure
Guidelines. Moreover, it would broader than the UFOC Guidelines’ requirement is tied to the requirement to
effectively enable a franchisor to avoid definition, however. The UFOC disclose contact information for existing
disclosing potentially material Guidelines’ definition uses the narrower franchised outlets.81 Knowing that a
litigation, even though it had notice of term ‘‘franchisor’’ in place of ‘‘another franchisor uses a confidentiality clause
an action, merely because it was not entity.’’ This slight departure from the enables prospective franchisees to
served with the papers yet or had UFOC Guidelines is necessary for the understand that a former or current
successfully avoided service of process. ‘‘large franchisee’’ exemption, section franchisee may be prohibited from
In the Commission’s law enforcement 436.8(a)(5)(ii), as discussed below in the speaking about his or her experience
experience, it is not uncommon for section covering that exemption.78 and will make efforts to contact other
defendants to know that a Commission former or current franchisees not subject
action was filed prior to service either 75E.g., Sections 436.5(a) (Item 1); 436.5(c) (Item to such a clause. This being the
by learning of the suit from co- 3); 436.5(d) (Item 4); 436.5(h) (Item 8). disclosure’s purpose, the operant
76 16 CFR 436.2(i).
defendants or as a result of an asset 77See NASAA Commentary on the Uniform
definition is limited to confidentiality
freeze.73 Franchise Offering Circular Guidelines (1999), Bus.
clauses impinging on communications
In the same vein, IL AG suggested that Franchise Guide (CCH), ¶ 5790, at 8466 (‘‘NASAA between current or former franchisees
the term ‘‘action’’ should refer to both Commentary’’ or ‘‘Commentary’’). The Commentary and prospective franchisees only.82 It
‘‘ filed’’ and ‘‘served’’ complaints.74 A notes that this general definition of affiliate should would not cover clauses that prohibit
be used throughout a UFOC, unless a particular
reference to ‘‘filed complaints’’ is disclosure Item defines it differently or limits its communications between current or
unnecessary, however, and would be use. The record contains no indication that the
inconsistent with the UFOC Guidelines: UFOC Guidelines’ narrower definition is deficient 79 Section 436.5(t)(7).
the definition of action already refers to or would impede the Commission’s ability to target 80 Originally, the Commission proposed using the
affiliates in law enforcement actions, where
‘‘complaints . . . in a judicial action or term ‘‘gag clause’’ to refer to such provisions.
warranted.
Franchise NPR, 64 FR at 57332. Several
proceeding’’ and ‘‘complaints . . . in 78See Triarc, NPR 6, at 2. The Staff Report
commenters, however, opposed the term ‘‘gag
. . . an arbitration,’’ meaning that a recommended that the term ‘‘affiliate’’ mean clause’’ because, in their view, it is pejorative. They
complaint has already been filed. ‘‘controlled by, controlling, or under common prefer a neutral term, such as ‘‘confidentiality
control with, the franchisor or a franchisee.’’ See
Accordingly, the Commission declines agreement,’’ ‘‘confidentiality clause,’’
Staff Report, at 21 (emphasis added). While this
‘‘nondisclosure clause,’’ or ‘‘privacy clause.’’ E.g.,
version was intended to capture franchisee
NFC, NPR 12, at 26; BI, NPR 28, at 10. Accordingly,
69 This definition is also consistent with the affiliates, for purposes of the ‘‘large franchisee’’
the Commission has adopted the term
Commission’s interpretation of the term ‘‘action,’’ exemption, it also had the unintended consequence
of broadening affiliate disclosures generally. For ‘‘confidentiality clause.’’
as discussed in the Interpretive Guides to the 81See section 436.5(t)(5). See also UFOC
Franchise Rule. Interpretive Guides, 44 FR at 49973. example, section 436.5(d) (Item 4) requires a
70See UFOC Guidelines, Item 3 Definitions, ii. franchisor to disclose a prior bankruptcy of an Guidelines Item 20 B.
82 At the same time, the confidentiality clause

71 NFC, NPR 12, at 25.
affiliate. Defining ‘‘affiliate’’ expressly to include
‘‘franchisee’’ would arguably require a franchisor to disclosure requirement is not designed to cover
72 Lewis, NPR 15, at 7.
list in its Item 4 bankruptcy disclosures the specific settlement terms if the franchisee is
73 E.g., FTC v. Joseph Hayes, No.
bankruptcy history of its franchisees’ affiliates. The otherwise free to discuss his or her experience
4:96CV02162SNL (E.D. Mo. 1996). final amended Rule does not follow this within the franchise system, including the existence
74 IL AG, at 2. problematic recommendation. of a litigated action with the franchisor.
former franchisees and, for example, the original Rule. The proposed definition Therefore, the Commission adopts the
media. published in the Franchise NPR was definition as quoted above.
After carefully considering the taken from the UFOC Guidelines, stating Another commenter urged that the
comments, the Commission has rejected that these terms mean ‘‘to present all definition specify that the meaning of
suggestions to limit the definition of material facts accurately, clearly, ‘‘disclose,’’ ‘‘state,’’ ‘‘describe,’’ and
confidentiality clause to cover only concisely, and legibly in plain ‘‘list’’ incorporates the concept that the
broad clauses that prohibit all English.’’87 language must be ‘‘understandable by a
communications by current or former person unfamiliar with the franchise
The Commission is persuaded that
franchisees83 or only circumstances business.’’91 The Commission believes
franchisors should have flexibility in
where all or at least 20% of franchisees that the final amended Rule’s definition
presenting their disclosures, provided
are under speech restrictions.84 These of ‘‘plain English’’ in section 436.1(o)
that the disclosures are clear and
suggestions are narrower than necessary gives more direction to franchisors in
and would defeat the very purpose of legible. The Staff Report recommended preparing their disclosures than the
the confidentiality clause disclosure. that franchisors should be required to more general phrase ‘‘understandable by
Moreover, as stated throughout this make disclosures in at least 12 point a person unfamiliar with the franchise
document, the Commission favors upper and lower case type.88 This business.’’ Therefore, we decline to
bright-line standards that enable recommendation generated two adopt this suggestion.
franchisors, prospective franchisees, comments, however, asserting that the Finally, we note that three
and law enforcers to know when a Rule Commission should not mandate 12 commenters urged the Commission to
provision applies without resort to fact- point type. The commenters noted that define separately the term ‘‘material.’’92
finding. In this instance, the parties 12 point type may result in some of the In particular, they asserted that it is
should know whether the Rule’s charts being split into two unclear whether materiality should be
confidentiality clause is applicable sections. They suggested that smaller determined from the franchisor’s or the
without having to first determine the fonts, especially in charts, can be very prospective franchisee’s viewpoint. For
exact number of franchisees under readable and result in reduced example, isolated instances of
speech restrictions at any given period. compliance costs.89 The Commission franchisee-initiated lawsuits might not
Finally, the definition expressly agrees. Accordingly, part 436 of the final be material to a franchisor (i.e., not
excludes confidentiality agreements amended Rule does not mandate any affecting the franchisor’s financial
designed to protect proprietary specific font size: franchisors may status), but could be highly material to
information. Many commenters—both choose any font size, provided that their a prospective franchisee seeking
franchisor and franchisee disclosures are clear and likely to be information on the quality of the
representatives alike—agreed that noticed, read, and understood by a franchise relationship.93
proprietary information should be reasonable prospective franchisee. The original Rule defined ‘‘material,
exempted from the definition because a Two additional Staff Report material fact, and material change.’’94
franchisor has a reasonable and commenters sought refinements to The Commission, however, believes that
legitimate concern about protecting its section 436.1(d), as proposed therein. such definitions are not necessary. An
trademark and business secrets.85 One One commenter opined that the understanding of materiality under the
commenter suggested that the final amended Rule can best be gained
definition could be interpreted to mean
Commission make clear that the by looking to long-established
that a franchisor must disclose ‘‘every
existence of a confidentiality agreement Commission jurisprudence.
material fact regarding the offered
cannot be considered ‘‘proprietary ‘‘Materiality’’ is a cornerstone concept
franchise, rather than disclosing all
information.’’86 Otherwise, according to of that jurisprudence. To be clear on this
material facts pertaining specifically to
this commenter, a franchisor could important point, the Commission, when
the disclosures required pursuant to the interpreting Section 5, regards a
attempt to circumvent the
Rule.’’90 The Commission believes that representation, omission, or practice to
confidentiality agreement disclosure by
having a prospective franchisee sign an this reading of the definition is strained be deceptive if: (1) it is likely to mislead
agreement stating that the existence of a and expressly notes that it does not consumers acting reasonably under the
confidentiality agreement is itself intend such a reading. Throughout the circumstances; and (2) it is material;
‘‘proprietary.’’ The Commission, final amended Rule, the topic on which that is, likely to affect consumers’
however, intends that the term the franchisor is required to ‘‘present all conduct or decisions with respect to the
‘‘proprietary information’’ be limited to material facts accurately, clearly, product at issue.95 Accordingly, it is
trade secrets and intellectual property, concisely, and legibly in plain English’’ amply clear that ‘‘materiality’’ is
the type of information that, if is clear. Moreover, nothing in the record determined by the reasonable consumer
disclosed, would put a franchisor at a suggests that a virtually identical standard, or in franchise matters, by the
competitive disadvantage. definition in the UFOC Guidelines has reasonable prospective franchisee
generated the problems anticipated by standard. Moreover, since violations of
4. Section 436.1(d): Disclose, state, this commenter. This being the case, the the Franchise Rule constitute violations
describe, and list Commission is disinclined to deviate of Section 5, we believe that the Section
Section 436.1(d) sets forth the from the UFOC Guidelines on this issue.
definition of the terms ‘‘disclose,’’ 91 IL AG, at 2.
‘‘state,’’ ‘‘describe,’’ and ‘‘list,’’ which 87See UFOC Guidelines, General Instruction 150. 92 Bundy, at 3; Cendant, at 3; IL AG, at 3. The
are used throughout part 436. This is The phrase ‘‘plain English’’ is defined separately in Staff Report recommended deletion of this
section 436.1(o), consistent with the UFOC definition based on use of the term in the Rule text
another definition not contained in the Guidelines. in at least two distinguishable ways, creating
88 This presentation requirement would be unnecessary confusion. Staff Report, at 68–9.

83 PMR&W, NPR 4, at 15. consistent with the Commission’s approach in the 93 See Cendant, at 3.
84 NFC, NPR 12, at 33. original Rule. See 16 CFR 436.1(b)(4). 94 16 CFR 436.2(n).
85E.g., Baer, ANPR 25, at 3; AFA, ANPR 62, at 3; 89 Gust Rosenfeld, at 2–3; Wiggin & Dana, at 6– 95See generally Federal Trade Commission Policy
Zarco & Pardo, ANPR 134, at 4. 7. Statement on Deception, appended to Cliffdale
86 Bundy, NPR 18, at 3. 90 J&G, at 2. Assocs., 103 FTC 110 (1984).
5 deception jurisprudence provides retains the original Rule’s reference to section 436.1(e) definition of ‘‘financial
adequate guidance on what the term financial performance representations performance representation’’ is not
‘‘material’’ means in the Franchise Rule made in the general media.100 At the intended to reach disclosures of expense
context. same time, section 436.1(e) adopts information, and specifically sought
several aspects of the UFOC Guidelines comment on this issue.105 Most
5. Section 436.1(e): Financial
definition, including references to commenters who responded on this
performance representation
‘‘actual’’ and ‘‘potential’’ performance issue felt that disclosures of expense
This section of part 436 defines the (to capture both historical financial information should not fall within the
term ‘‘financial performance performance and projections),101 as well definition.106 Some, however, sought
representation’’ to mean: as the use of charts, tables, and additional clarification. For example,
any representation, including any mathematical calculations.102 the IL AG urged the Commission to
oral, written, or visual Two aspects of the definition of the modify the definition of ‘‘financial
representation, to a prospective term ‘‘financial performance performance representation’’ to
franchisee, including a representation’’ generated significant expressly exclude expense disclosures
representation in the general media, comment: whether the Commission mandated in Items 5–7 of the final
that states, expressly or by should treat information about costs and amended Rule (initial fees, ongoing
implication, a specific level or expenses as financial performance costs, and initial investment), offering
range of actual or potential sales, representations;103 and whether the the following additional sentence:
income, gross profits, or net profits. Commission should interpret the ‘‘Expenses required in Items 5, 6, and 7
The term includes a chart, table, or definition’s express inclusion of any of the disclosure document are not to be
mathematical calculation that ‘‘representation in the general media’’ to considered performance claims and do
shows possible results based on a include all financial information not contradict Item 19 requirements.’’107
combination of variables.96 available on a franchisor’s website or Others went further, arguing that the
through a franchisor’s speeches and dissemination of any expense
This definition comes into play in one press releases.104 Each of these
of the most important sections of the information should not trigger the Item
interpretive issues is discussed in the 19 disclosure requirements.108
final amended Rule, section 436.5(s), sections immediately below.
corresponding to Item 19 of the UFOC 105 Neither the original Rule nor the final
Guidelines. Like Item 19, it governs the a. Treatment of cost and expense
amended Rule includes mention of expenses in the
making of financial performance information definition of ‘‘financial performance
representations.97 The definition In the Franchise NPR, the representation,’’ but the Commission indicated its
incorporates the original Rule’s intended interpretation in the Franchise NPR’s
Commission made it clear that the discussion of the definition of the term.
approach, in that it specifies that a Specifically, it stated that ‘‘[w]hile the Commission
financial performance representation published in the Franchise NPR similarly used that does not consider the disclosure of such expense
may be in an ‘‘oral, written, or visual’’ term. One franchisee representative observed that information alone to constitute the making of a
the word ‘‘suggests’’ in this context is flawed: it financial performance claim, others arguably may
format.98 To ensure that part 436 covers would not reach the furnishing of fragments of interpret some expense information as implying a
implied financial performance financial data from which a prospect may readily financial performance representation, such as a
representations, the definition also estimate or calculate earnings. Bundy, NPR 18, at break-even point. To avoid any confusion, the
refers to financial performance 1. The Commission agrees that a franchisor can proposed definition of ‘financial performance
imply a performance claim by giving a prospect a representation’ . . . specifically omits expense
representations that are made both few pieces of financial information from which the information.’’ Franchise NPR, 64 FR at 57329. This
‘‘expressly or by implication.’’99 It also prospect can fill in the blanks and draw his or her interpretation is a departure from the Commission’s
own conclusion about a specific level of potential former policy, as articulated in the Interpretive
96 The part 436 definition is nearly identical to earnings. In addition, a franchisor can imply that Guides. The Guides expressed the view that cost
the definition as proposed in the Franchise NPR, a prospect can earn a specific level of income, such information alone could be a financial performance
with slightly modified language in some places to as by using a proxy for earnings (for example, ‘‘You claim because a prospective franchisee could use
improve clarity and precision. No commenter raised will do so well that you can buy that Porsche.’’). such information to calculate likely profits by
any concerns about the basic ‘‘financial See Interpretive Guides, 44 FR at 49982. Both types simply selecting arbitrary sales figures. Interpretive
performance representation’’ definition. of implied claims constitute financial performance Guides, 44 FR at 49982. It also departs from UFOC
Nevertheless, IL AG posed a number of questions representations that are, and should be, covered by Guidelines Item 19, which expressly lists costs
about how the definition would be applied in the final amended Rule. To clarify this policy, the among the items of information that constitute an
various situations, such as representations based final amended Rule uses the phrase ‘‘states, earnings claims. See also UFOC Guidelines, Item
upon earnings of a franchisor’s affiliates or expressly or by implication.’’ This phrase is widely 19, Instructions i. Nevertheless, in light of the
representations based upon industry data. IL AG, at used, for example, in connection with comments and the Commission’s long law
2. Questions such as these are best addressed in the representations challenged under Section 5. E.g., enforcement history, the Commission, reiterating its
Compliance Guides or in staff advisory opinions, FTC v. Prophet 3H, Inc., 06 CV 1692 (N.D. Ga. Franchise NPR statement quoted immediately
where they can be analyzed in the context of 2006); FTC v. Morrone’s Water Ice, Inc., No. 02– above, states its intent that expense information not
specific facts. 3720 (E.D. Pa. 2002). be included in the part 436 definition of ‘‘financial
100See 16 CFR 436.1(e).
97 The final amended Rule uses the broad term performance representation.’’ As discussed above,
101 This streamlines the original Rule, which the states agree. See NASAA, NPR 17, at 2.
‘‘financial performance representation,’’ rather than
the original Rule’s more limited term ‘‘earnings addressed historical performance representations 106E.g., IL AG, NPR 3, at 3; Baer, NPR 11, at 7;
claim.’’ This modification recognizes that some and projections in two distinct Rule provisions, 16 NFC, NPR 12, at 13; NASAA, NPR 17, at 2; BI, NPR
industries, such as hotels, use variables other than CFR 436.1(b) (projections) and 436.1(c) (historical 28, at 10. But see Bundy, NPR 18, at 2 (arguing that
earnings to measure performance, such as room information). expense disclosures inevitably will lead prospective
occupancy rates. See Franchise NPR, 64 FR at 102 The staff of the Commission has adopted the franchisees to extrapolate earnings without the
57297. same position in several informal advisory protection of an Item 19 disclosure).
98 The original Rule described performance opinions. E.g., Handy Hardware Centers, Bus. 107 IL AG, NPR 3, at 8–9. See also Baer, NPR 11,
information as ‘‘any oral, written, or visual Franchise Guide (CCH) ¶ 6426 (1980) (The Rule’s at 7.
representation to a prospective franchisee which ‘‘earnings claim requirements are applicable to ‘any 108 NFC, NPR 12, at 13. The NFC also suggested
states a specific level of potential sales, income, oral, written, or visual representation.’’’); Diet that the Commission modify the Rule to exclude
gross, or net profit for the prospective franchisee, Center, Inc., Bus. Franchise Guide (CCH) ¶ 6437 from the definition of ‘‘financial performance
or which states other figures which suggest such a (1983) (table with arithmetic calculations uniformly representation’’ financial data furnished to existing
specific level.’’ 16 CFR 436.1(b) and (c). demonstrating net profits constitutes a financial franchisees. Id. The Commission concludes,
99 To address implied claims, the original Rule performance representation). however, that part 436 need not be revised to
103 See Interpretive Guides, 44 FR 49982.
used the term ‘‘suggests.’’ The proposed definition address this issue. A franchisor is always free to
of ‘‘financial performance representation’’ 104 See Interpretive Guides, 44 FR at 49984–85. furnish truthful information about its system to
Notwithstanding language to the In the Franchise NPR, the franchisors’ speeches and news releases.
contrary in the original Interpretive Commission proposed that the term In the Interpretive Guides, the
Guides,109 the Commission is persuaded ‘‘financial performance representation’’ Commission described ‘‘general media’’
that expense information alone is should broadly include the broadly to include: ‘‘advertising (radio,
insufficient to enable prospective dissemination of financial performance television, magazines, newspapers,
franchisees to gauge their potential information via the Internet.113 The billboards, etc) as well as those
earnings with any degree of specificity majority of commenters who addressed contained in speeches or press
that could rise to the level of a financial this issue, however, questioned whether releases.’’119 David Kaufmann, for
performance claim.110 The Commission financial performance information example, asserted that the inclusion of
explained in the Franchise NPR and posted online should constitute speeches and news releases harms
now reiterates here that mere disclosure ‘‘financial performance franchisors by making it difficult for
of cost information does not, in its view, representations,’’ thus triggering the them to disseminate financial
constitute a financial performance Rule’s disclosure and substantiation performance information in ‘‘speeches,
representation triggering Item 19 requirements.114 These commenters press interviews, and other forums not
disclosure obligations. The Commission asserted that the Commission should specifically geared to the franchise sales
intends that the explanation that mere not deem financial performance process.’’120 He urged the Commission
expense disclosures alone do not information posted on a franchisor’s to permit franchisors and their
constitute a financial performance website to be financial performance executives to disseminate financial
representation, coupled with the representations under the Rule, unless performance information to the public
deliberate omission of any mention of the information is located in a section freely, unless copies are subsequently
expense information from section of a website that solicits franchise used in the franchisor’s franchise
436.1(e) of the final amended Rule, will purchasers or otherwise specifically marketing effort.
be enough to address this issue. targets prospective franchisees.115 In Based upon the comments, the
their view, financial performance Commission is persuaded that it is
b. General media claims unwarranted to sweep broadly into the
information on a franchisor’s website—
Section 436.1(e) of the final amended including links to press releases, part 436 definition of ‘‘financial
Rule retains the original Rule’s interviews, or articles—is intended to performance representation’’ all
provision governing the making of educate the general public about the financial performance information
financial performance representations in company, rather than to attract posted online or appearing in press
the general media. Under the original prospective franchisees.116 Indeed, releases or speeches. The dissemination
Rule, a general media financial some posted information may consist of of financial information online and in
performance representation, like all copies of publicly filed reports, such as press stories and releases is for the
other financial performance 10–Qs and 10–Ks, that are submitted to benefit of more than prospective
representations, must have a reasonable the SEC.117 At least one commenter franchisees, including investors,
basis and state the number and feared that equating online financial potential suppliers, and members of the
percentage of outlets earning the performance information with financial general public.121 Further, the
claimed amount, among other performance representations under the Commission believes that the
substantiation and disclosure Rule would have a chilling effect, commenters’ concerns are well-founded
requirements.111 There is no comparable unreasonably restricting the kinds of with respect to publicly filed reports
provision in the UFOC Guidelines.112 materials a franchisor could have on its required by the SEC. The Commission
website: ‘‘Does this mean that a agrees that such filings are already
existing franchisees, especially if no additional franchise company, unlike any other publicly available and, more important,
franchise sales are contemplated. If the franchisor
contemplates an additional franchise sale under
business, must choose between taking have indicia of reliability. Indeed, the
materially different terms and conditions than the advantage of articles or press releases dissemination of false financial data by
franchisee’s original purchase, then the existing about itself on its own web site page or publicly traded franchisors is already
franchisee, like any prospective franchisee, could risk the claim that a prospective illegal. Thus, to impose the Rule’s
be misled and therefore should receive financial
performance disclosures in the form of an Item 19
franchisee has been given unauthorized substantiation and disclosure
disclosure. For example, an Item 19 disclosure will non-Item 19 financial data?’’118 requirements with respect to SEC filing
assist an existing franchisee operating in a shopping Two Staff Report commenters
mall or urban area in the northeast to understand broadened this argument beyond the 119 Interpretive Guides, 44 FR at 49984–85. The
an earnings projection for an additional stand-alone Commission excluded, however, ‘‘communications
outlet or outlet to be located in a rural section of
online context to encompass
to financial journals or the trade press in
the southwest. connection with bona-fide news stories, or directly
109 Interpretive Guides, 44 FR at 49982. 113 In the proposed Rule, the term ‘‘financial
to lenders in connection with arranging financing
110 At any rate, according to NASAA, franchisors performance representation’’ expressly included ‘‘a for the franchisee.’’ Id. at 49985.
do not routinely disseminate individualized representation disseminated in the general media 120 Kaufmann, at 6. See also Cendant, at 2.
expense information geared to a specific offering and Internet.’’ Franchise NPR, 64 FR at 57297, 121 Indeed, the staff previously has advised that
that might be used to insinuate an earnings level. 57332. (emphasis supplied.) In accordance with the
discussion in this section of the SBP, the the dissemination of financial performance
NASAA, 17 NPR, at 2. information through bona fide news stories may
111 See 16 CFR 436.1(b)(5)(i); 436.1(c)(6)(i); Commission has deleted this phrase to dispel
potential readings that financial information posted generate benefits to the public that outweigh
436.1(e)(5)(ii). Unlike other financial performance potential harm to prospective franchisees. ‘‘For
on the Internet is per se a financial performance
claims, a claim made in the general media need not example, such information may be useful to
representation.
be geographically relevant to the market in which 114E.g., PMR&W NPR 4, at 16; H&H, NPR 9, at 14; potential suppliers seeking growing businesses as
franchises are being offered for sale. customers; shopping center or mall developers
112 Although the UFOC Guidelines do not address NFC, NPR 12, at 23–24.
115E.g., Gust Rosenfeld, at 7; Quizno’s, NPR 1, at
seeking promising franchised systems as tenants;
general media claims, many of the states with and financial analysts who follow market or
disclosure laws require franchisors to register their 3; PRM&W, NPR 4, at 16; NFC, NPR 12, at 24; BI, industry trends. Accordingly, the exemption from
advertisements in advance of their use. E.g., Cal. NPR 28, at 9. the general media earnings claims disclosure
116E.g., Quizno’s, NPR 1, at 3. See also BI, NPR
Corp. Code § 31156 (1997) (franchisor must register requirements ensures that the Rule does not chill
advertising at least three business days before first 28, at 9. the free flow of newsworthy information about
117E.g., Quizno’s, NPR 1, at 3; PMR&W, NPR 4,
publication); Md. Code Ann., Bus. Reg. § 14–225 franchising or particular franchise systems.’’
(1998) (franchisor must register advertising at least at 16; H&H, NPR 9, at 14; BI, NPR 28, at 9. Advisory 97–5, Bus. Franchise Guide (CCH) ¶ 6485
seven business days before publication). 118 Quizno’s, NPR 1, at 3. at 9687 (July 31, 1997).
would be pointless, unworkable, and releases to the list of communications the Commission’s long-standing policy
unduly burdensome. not constituting financial performance that the parties must ‘‘anticipate that
With respect to the dissemination of representations under the final amended sales arising from the relationship will
other financial performance Rule. There is one important caveat, not exceed 20% of the franchisee’s total
information, the Commission believes however. Where the franchisor directs volume in sales during the first year of
that a distinction should be made the speeches or news releases to operation.’’129 Second, it makes explicit
between information disseminated in prospective franchisees or uses copies of what previously has been only implied:
advertisements directed at franchisees— speeches or news releases in marketing that the parties must have ‘‘a reasonable
be it in print, radio, television, or materials aimed at prospective basis’’ to assert the exemption.130
Internet—and information disseminated franchisees, then such materials will During the Rule amendment
to the general public. We are convinced constitute general media financial proceeding, a few commenters
that deeming financial performance performance representations under the suggested that the Commission broaden
information disseminated publicly to be Rule. the fractional franchise exemption. Two
‘‘financial performance representations’’ commenters urged the Commission to
under the Rule would have a chilling 6. Section 436.1(f): Fiscal year
broaden the first prong of the fractional
effect, discouraging franchisors from Several Rule disclosures are based franchise exemption —‘‘experience in
furnishing truthful information to the upon the franchisor’s fiscal year.124 the same type of business’’—to exempt
public. However, where a franchisor Section 436.1(f) retains the original Rule franchisees with experience in the same
utilizes financial performance definition of the term ‘‘fiscal year,’’ industry or selling similar or
information disseminated, or intended making clear that it ‘‘refers to the complementary goods or services.131
to be disseminated, to the general public franchisor’s fiscal year.’’125 This issue The suggestion that the exemption be
in its franchise promotional materials generated no comment. broadened to ‘‘experience in the same
(e.g., in a brochure or franchisee section industry’’ goes far beyond the
of a website), includes in its franchise 7. Section 436.1(g): Fractional franchise
underlying rationale that supports the
promotional materials a reference to Section 436.1(g) of the final amended fractional franchise exemption—
general financial information on its Rule adopts the definition of the term namely, the notion that prior experience
website, or otherwise repeats the general ‘‘fractional franchise’’ that was proposed in the same line of business reduces the
financial information to prospective in the Franchise NPR with only minor likelihood of fraud or deception because
franchisees (such as in a face-to-face language changes to improve clarity. the fractional franchisee likely will be
meeting with an audience of prospective This definition comes into play in familiar with the products to be offered
franchisees), such information will be section 436.8(a)(2) of the final amended for sale through the franchise
deemed ‘‘financial performance Rule, which retains the original Rule’s relationship.
representations,’’ triggering part 436’s exemption for fractional franchises.126 The Commission does not believe that
disclosure and substantiation In most instances, the fractional a franchisee in any particular economic
requirements.122 franchise exemption arises where an sector necessarily has sufficient
The Commission anticipates that staff existing business seeks to expand its experience to operate a different
will address the narrowed scope of product line through a franchise franchise within the same sector. For
general media financial performance meeting two criteria: (1) the franchisee example, we would not necessarily
representations in the Compliance or its principals have more than two expect a muffler shop franchisee to
Guides. This is consistent with the years of experience in the same line of automatically understand the financial
approach historically adopted, whereby business; and (2) the parties reasonably risks of operating a quick-lube service
the Commission explained the scope of expect that the franchisee’s sales from station, although both operations are in
general media claims in the Interpretive the new line of business will not exceed the automotive repair industry. Nor
Guides, providing illustrative examples 20% of its total sales.127 would we expect a franchisee operating
and more detailed discussion than is Section 436.1(g) clarifies the scope of
a small fast-food kiosk in a mall to
possible in the text of the Rule itself. As the original ‘‘fractional franchise’’
necessarily appreciate the risks of
an initial matter, the Commission exemption by adding greater precision
operating a large, sit-down full-service
anticipates that staff will retain in the and specificity.128 First, it incorporates
restaurant, although both are in the food
Compliance Guides the original service industry.
124E.g., section 436.5(a) (Item 1); section 436.5(c)
Interpretive Guides’ determination that Nevertheless, the Commission has
(Item 3); section 436.5(e) (Item 5); section 436.5(t)
communications about financial (Item 20); section 436.5(u) (Item 21). never required experience in the
performance made to the trade press 125 16 CFR 436.2(m).
identical type of business. Rather, the
and directly to lenders do not constitute 126 The fractional franchise is one of several
sale of similar goods may qualify for the
general media financial performance exemptions contained in the original Rule that are
exemption. As explained in the current
representations.123 At the same time, the retained in the final amended Rule. In contrast, the
UFOC Guidelines contain no exemptions. State
Commission anticipates that staff will exemptions, which vary from state to state, are set scope of the fractional franchise exemption since
add SEC filings, speeches, and news out in state statutes or regulations. In general, state the original Rule was promulgated. See, e.g.,
franchise laws do not exempt franchisors from the Advisory 93–5, Bus. Franchise Guide (CCH),¶ 6449
122See Advisory 97–5, Bus. Franchise Guide basic obligation to furnish prospects with UFOCs. (1993); Advisory 94–4, id., at ¶ 6460 (1994);
(CCH) at 9687 (‘‘By disseminating copies of [news At most, states may exempt franchisors from state Advisory 95–2, id., at ¶ 6467 (1995); Advisory 96–
articles containing earnings claims], the franchisor registration requirements. 1, id., at ¶ 6476 (1996); Advisory 97–1, id., at ¶
effectively ratifies the journalist’s words as its own 127 In the original SBP, the Commission reasoned, 6481 (1997).
129See Interpretive Guides, 44 FR at 49968.
and, in so doing, converts the article into an with respect to fractional franchisees, that pre-sale
advertising piece designed to solicit prospective disclosure is unwarranted where the prospective 130 The proposed definition in the Franchise NPR
franchisees.’’). franchisee already is familiar with the products and formulated this as ‘‘The parties reasonably
123 Interpretive Guides, 44 FR at 49984–85 services to be sold through the franchise and where anticipate . . .’’ The final language is more
(‘‘‘General media claim’ does not include the prospective franchisee faces a minimal precisely in line with basic concepts of FTC
communications to financial journals or the trade investment risk. Original SBP, 43 FR at 59707. jurisprudence.
press in connection with bona-fide news stories, or 128 The Commission believes that greater 131 Piper Rudnick, at 4 (suggesting experience in
directly to lenders in connection with arranging precision in the Rule text is warranted in light of the same basic industry should suffice); H&H, NPR
financing for franchisees.’’). numerous requests for advisory opinions on the 9, at 4 (complementary experience should suffice).
Interpretive Guides, ‘‘the required business with prior experience. It makes protections. Accordingly, we believe
experience may be in the same business little difference whether the business retaining the prior experience
selling competitive goods or in a can call upon its own directors or prerequisite for the fractional franchise
business that would ordinarily be officers for guidance or whether the exemption is a sound approach.
expected to sell the type of goods to be business can call upon those of a
8. Section 436.1(h): Franchise
distributed under the franchise.’’132 subsidiary, as long as those individuals
This approach is reasonable because a have prior experience in the same line The original Rule defined ‘‘franchise’’
prospective franchisee who is already of business. As in the large franchisee broadly to encompass both franchises
familiar with the goods or services of exemption, we recognize that and business opportunity ventures. A
the franchise can better assess the franchisors may establish subsidiaries franchisor was covered by the original
financial risk involved in entering into for limited liability or tax purposes. In Rule if it represented that the business
a relationship with the franchisor. such instances, the operations of the arrangement it offered entailed the
Our reluctance to expand the franchisor and its subsidiaries are likely following three elements: (1) permission
fractional franchise exemption also to be close, such that the prior to use the franchisor’s trademark; (2)
holds true with respect to the sale of experience of one is available to help significant franchisor control over the
‘‘complementary goods.’’ What may be direct the business decisions of the franchise operation or significant
viewed as ‘‘complementary goods’’ in other. We believe the same is no less franchisor assistance to the franchisee;
any particular line of business may be true in the fractional franchise context. and (3) a required payment from the
quite subjective. For example, Finally, one commenter, focusing on franchisee to the franchisor.137
reasonable minds may differ whether the second prong of the fractional Similarly, a business opportunity seller
the introduction of ice cream sales at a franchise exemption, recommended that was covered by the original Rule if the
donut/coffee shop is ‘‘complementary.’’ any franchise arrangement that accounts seller represented that the business
While certain products may make for less than 25% of the franchisee’s arrangement it offered entailed: (1)
complementary sales combinations— business in the next year should be supplying the buyer with goods or
such as ice cream and donuts—it does exempt from the Rule, even if the services to market to the public; (2)
not necessarily follow that a donut shop fractional franchisee has had no prior providing location assistance or
franchisee is experienced with the risks experience with the products or services accounts for vending machines or other
involved with marketing and selling ice being added to his or her product equipment; and (3) charging a required
cream. line.135 In short, this commenter would payment from the opportunity
While the Commission declines to delete the prior experience prong from purchaser.138
revise the Rule to broaden the types of the fractional franchise definition. We Like the proposed section 436.1(h)
experience needed to qualify for the reject this suggestion. published in the Franchise NPR, this
fractional franchise exemption, we agree The Commission believes that prior section of the final amended Rule
that the exemption should be expanded experience is a necessary component of focuses exclusively on franchise sales,
with respect to the types of individuals the fractional franchise exemption. A eliminating the business opportunity
whose experience can qualify for the business owner seeking a new section of the definition. The amended
exemption. opportunity is no different from a definition is also more precise than the
The original definition specified that, novice when it comes to entering into a original definition. Specifically, the
in determining whether a relationship type of business with which he or she amended definition clarifies two issues
qualified as a the fractional franchise is unfamiliar.136 It is precisely in such that the Commission’s Rule enforcement
exemption, a franchisor could consider circumstances that the prospective experience suggests are not well
the prior experience of the franchisee franchisee needs the material understood: (1) that a business
‘‘or any of the current directors or disclosures the Rule affords in order to relationship will be deemed a franchise
executive officers thereof.’’133 Marriott make an informed decision whether to if it satisfies the three elements of a
recommended that the prior experience invest in the opportunity. What franchise, regardless of the
of an officer or director of an affiliate or distinguishes a fractional franchisee nomenclature used to label or describe
parent of the franchisee should also be from novices and business owners it;139 and (2) that a business relationship
deemed a sound basis for the generally is that the fractional will be deemed a franchise if the
‘‘experience’’ prong of the definition. franchisee has prior experience with the franchisor represents that the
Marriott noted that the Staff Report goods and services being offered for relationship being offered has the
recommended the same approach in sale, and thus is less in need of the characteristics of a franchise, regardless
connection with the prior experience Rule’s protections. Indeed, the record is of any failure on the franchisor’s part to
prerequisite of the ‘‘large franchisee’’ devoid of any data from which we could perform as promised.140
exemption.134 conclude that ongoing businesses 137 See 16 CFR 436.2(a)(1)(i) and 436.2(a)(2). The
We are persuaded by Marriott’s seeking to expand into unfamiliar areas UFOC Guidelines do not define what constitutes a
arguments that a broad reading of the do not continue to need the Rule’s franchise. Rather, definitions of the term
fractional franchise exemption is ‘‘franchise’’ are set forth in individual state statutes.
warranted when determining which 135J&G, NPR 32. For a discussion of state definitions of the term
individuals may qualify as having the 136The Commission recognizes, however, that in ‘‘franchise,’’ see Staff Report, at 37–41, available
online at: www.ftc.gov/os/2004/08/
requisite prior experience. The principal some instances, prior experience or the ability to
0408franchiserulerpt.pdf.
factor in applying the fractional consult those with prior experience, can be
138 See 16 CFR 436.2(a)(1)(ii) and 436.2(a)(2).
assumed. That is the basis of the new large
franchise exemption of part 436 is investment exemption from the final amended Rule, 139 See Interpretive Guides, 44 FR at 49966. See
whether the business seeking to expand discussed below. See section 436.8(a)(5)(i). Where also FTC v. Morrone’s Water Ice, Inc., No. 02–3720
can obtain practical guidance and an investment is sufficiently large—$1 million (E.D. Pa. 2002). The staff has provided the same
excluding the cost of unimproved land and any advice in several informal advisory opinions. E.g.,
direction from someone within the Con-Wall Corp. Bus. Franchise Guide (CCH) ¶ 6427
franchisor financing—we believe that the
prospective franchisee is sophisticated and can (1981).
132 Interpretive Guides, 44 FR at 49968. obtain the information necessary to assess the 140 This is not a change of policy. The original
133 16 CFR 436.2(h). franchise offering without our mandating that it be definition of ‘‘franchise’’ added that ‘‘[a]ny
134 Marriott, at 4. provided. Continued
Early in the Rule amendment ‘‘franchise’’ to describe their business interest in a franchise is sold.’’147 The
proceeding, a few commenters offered relationship. A business relationship definition proposed in the Franchise
suggestions for modifying the definition constitutes a franchise only if, as NPR was ‘‘any person who is granted an
of ‘‘franchise.’’ For example, one promised or represented, it satisfies the interest in a franchise.’’ Section 436.1(i)
commenter urged the Commission to three elements of the term ‘‘franchise,’’ of the final amended Rule adopts an
adopt the states’ definition of the term and nothing in the ‘‘franchise’’ even more precise version: ‘‘Franchisee
‘‘franchise.’’141 However, there is no definition is to the contrary. means any person who is granted a
single state definition of the term The clarification in the amended franchise.’’148 This narrowing of the
‘‘franchise.’’142 Nevertheless, the Rule’s definition addresses the second issue— definition is in response to commenters
definition is entirely consistent with the whether representing a business who voiced concern that the phrase ‘‘an
principles underlying the various state relationship as satisfying the three interest in a franchise’’ is too broad,
definitions, and the Commission definitional elements of the ‘‘franchise’’ arguably sweeping in shareholders of
concludes that there is no persuasive definition (as opposed to merely calling publicly traded companies and other
argument to modify the definition a relationship a franchise) is sufficient investors.149 The amended definition’s
further. to bring a business relationship under focus on the granting of a franchise (as
Another commenter voiced concern opposed to an interest in a franchise) is
the Rule. The original Rule took the
over the Commission’s policy that a also consistent with the states’
position that it was sufficient, and the
business relationship will be deemed a approach, thereby reducing unnecessary
Commission believes that position
franchise ‘‘if it is offered or represented inconsistencies.150
remains sound.145 A prospect seeking to
as having the characteristics of a
purchase an opportunity that is 10. Section 436.1(j): Franchise seller
franchise, irrespective of whether or not
represented as being a franchise should
the relationship independently meets Section 436.1(j) of the final amended
receive a disclosure document in order
the actual . . . definition of a Rule defines the term ‘‘franchise seller.’’
to make an informed investment
franchise.’’143 He stated that such an This term and its definition are needed
approach would be a mistake, ‘‘raising decision. The prospect should not have
in order to delineate easily all parties
the form of a description of a business to investigate whether or not the seller,
subject to one or more provisions of the
relationship to a level which would post-sale, actually delivers a franchise
final amended Rule.151 Consistent with
control over the actual substance of the or some other type of opportunity. For
relationship.’’144 example, a start-up company may seek 147 16 CFR 436.2(d).
There are two distinct issues here: (1) to sell its first franchised outlet, 148 The phrase ‘‘granted a franchise’’ is intended
whether the Rule should apply to a advertising that, for a $500 fee, it will to be interpreted consistent with ordinary contract
license its mark and provide significant law principles. Accordingly, a prospective
business relationship that the parties franchisee becomes a ‘‘franchisee’’ at the point
call a ‘‘franchise,’’ even if the assistance to buyers. Under these when he or she enters into a valid and enforceable
relationship does not satisfy the three circumstances, a prospect should contractual relationship. This clarification is
definitional elements of a franchise; and receive a disclosure document before necessary to avoid circumvention of the Rule,
the sale because, as represented, the especially the Rule’s financial performance
(2) whether the Rule should apply to a requirements. In our experience, we are aware of
business relationship that is represented business offered satisfies each of the instances where a franchisor obtains full payment
as satisfying the three definitional three elements of a franchise. This is from a prospective franchisee before the prospective
elements of the term ‘‘franchise,’’ even true, even if the franchisor, in fact, lied franchisee actually enters into a franchise
and has no ability to perform as agreement. Once payment is made, the franchisor
if the relationship, in fact, does not then proceeds to furnish the individual with
satisfy those elements—e.g., because of promised, such as having no right to the earnings information without the accompanying
the seller’s non-performance. The trademark offered or having no staff to disclosures on the mistaken belief that the
commenter correctly asserted that the provide promised assistance, facts that individual has become a franchisee, to whom
Rule should not cover situations where may only be discovered by the earnings information can be provided without the
benefit of an Item 19 disclosure. An individual
the parties mistakenly use the term purchaser post-sale. In short, the seller becomes a ‘‘franchisee,’’ however, only after the
should not be able to raise as a defense franchise is ‘‘granted,’’ meaning both payment of
relationship which is represented . . . to be a to a post-sale Rule violation that it, in consideration and the signing or acceptance of the
franchise (as defined in the original Rule) is subject fact, offered a non-franchise business franchise agreement. Otherwise, any franchisor
to the requirements of this part.’’ 16 CFR could avoid the Rule’s financial performance
arrangement if, at the time of sale, its requirements by simply delaying the furnishing of
436.2(a)(5). However, this provision was set out in
the original ‘‘franchise’’ definition after exemptions representations about the business financial performance data until after the
and exclusions, and, therefore, was largely satisfied the definition of a franchise.146 prospective franchisee either makes a ‘‘payment to
overlooked or ignored. The final amended Rule the franchisor’’ or simply agrees to the terms of the
makes the definition of ‘‘franchise’’ more precise by 9. Section 436.1(i): Franchisee franchise arrangement.
including this policy in the introductory part of the 149E.g., H&H, NPR 9, at 25; BI, NPR 28, at 2. The
amended definition. See also United States v. The original Rule defined phrase ‘‘an interest in a franchise’’ has been deleted
Protocol, Inc., Bus. Franchise Guide (CCH) [1996– ‘‘franchisee’’ as: ‘‘any person (1) who elsewhere in the final amended Rule text for the
97 Transfer Binder], ¶ 11184 at 29550, 29555 (D. participates in a franchise relationship same reason.
Minn. 1997); FTC v. Wolf, Bus. Franchise Guide 150E.g., Mich. Comp. Laws. 445.1502(4); Wis. Stat.
(CCH), ¶ 10401 (S.D. Fla. 1994); FTC v. Int’l as a franchisee . . . or (2) to whom an
Ann. 553.03(5). In response to the Staff Report, one
Computer Concepts, No. 1:94cv1678 (N.D. Ohio commenter, IL AG, suggested that the definition of
1994); FTC v. Sage Seminars, Inc., No. C–95–2854– 145 16 CFR 436.1 (‘‘any relationship which is ‘‘franchisee’’ make clear that a franchisee who sells
SBA (N.D. Cal. 1995). The staff of the Commission represented . . . to be a franchise’’); 436.2(a)(5) franchises is also a subfranchisor. IL AG, at 3. This
has provided the same advice in several informal (‘‘Any relationship which is represented either is unnecessary. The definition of ‘‘franchisor’’
advisory opinions. E.g., Real America Real Estate orally or in writing to be a franchise [as defined in includes a subfranchisor, which is defined as any
Corp., Bus. Franchise Guide (CCH) ¶ 6428 (1982) the Rule] is subject to the requirements of this person who functions as a franchisor by engaging
(‘‘the applicability of the rule will not be defeated part.’’). in both pre-sale activities and post-sale
by a franchisor’s subsequent failure to live up to 146 With respect to required payments, the performance. Section 436.1(k). By its terms, this
any such commitment’’).
Commission will also consider any obligation to would include a franchisee that also engages in
141 Baer, NPR 11, at 7.
make a payment imposed by the franchisor post- franchise sales activities, if he or she also has post-
142See Staff Report, at 37–41.
sale, as long as the payment must be made within sale performance obligations.
143 Holmes, NPR 8, at 1. See also Gurnick, NPR
six months after the franchisee commences 151 The original Rule uses the terms ‘‘franchisor’’
21A; IL AG, NPR 3. operation of the business. See section 436.8(a)(1) and ‘‘franchise broker’’ throughout the Rule, and, in
144Id., at 2. (minimum payment exemption). some instances, references employees and agents.
long-standing Commission policy, the Finally, the definition addresses one coverage of brokers under the final
definition also makes explicit that an commenter’s concern that the term amended Rule is limited to
individual franchisee seeking to sell his ‘‘franchise seller’’ should exclude a prohibitions.163 For example, any
or her own outlet is excluded from Rule franchisor’s employees who are not franchise seller, including brokers,
coverage:152 actively involved in franchise sales.158 cannot make statements that are
Franchise seller means a person We agree. To that end, the definition inconsistent with those found in the
that offers for sale, sells, or arranges makes clear that the franchisor’s franchisor’s disclosure document.164
for the sale of a franchise. It employees, representatives, agents, Because brokers are no longer liable for
includes the franchisor and the subfranchisors, and third-party brokers the preparation and distribution of
franchisor’s employees, are covered only if they ‘‘are involved disclosure documents and the term
representatives, agents, in franchise sales activities.’’ ‘‘broker’’ does not appear in the final
subfranchisors, and third-party The Commission has considered, but amended Rule outside the definition of
brokers who are involved in declines to adopt, two additional ‘‘franchise seller,’’ no separate
franchise sales activities. It does not suggestions with respect to the definition of the term ‘‘broker’’ is
include existing franchisees who ‘‘franchise seller’’ definition. J&G warranted.
sell only their own outlet and who suggested that the Commission define In a similar vein, Frannet, a franchise
are otherwise not engaged in the term ‘‘broker’’ in the Rule itself and referral company, urged the
franchise sales on behalf of the proposed the following, narrow Commission to distinguish between
franchisor. definition: individuals who: (1) are not franchise brokers and middlemen. The
employed by franchisors or company agreed that anyone who sells
The definition incorporates several subfranchisors; (2) are compensated franchises should be included in the
suggestions submitted during the Rule pursuant to a written agreement for definition of a franchise seller.165
amendment proceeding. First, the qualifying prospects; and (3) are active According to Frannet, middlemen or
definition expressly includes participants in the sales process.159 The finders who just arrange for prospects to
‘‘subfranchisors,’’ a category of franchise commenter also proposed that the meet franchisors—but do not negotiate
sellers not mentioned in the Franchise definition specifically exclude certain price or terms for the franchisor, or sign
NPR’s proposed definition of ‘‘franchise individuals who arguably might be franchise agreements on behalf of a
seller.’’153 The inclusion of involved in a franchise sale, including franchisor—should not be deemed
subfranchisors in the definition is franchisees,160 trade show promoters, brokers.
entirely consistent with current website owners, the mass media, or With respect to ‘‘brokers,’’ we reject
Commission policy154 and the UFOC others who may be paid for referrals, but the suggestion that brokers are
Guidelines.155 ‘‘who do not spend more than an hour distinguishable from middlemen or
Second, the definition narrows the with a prospective franchisee, or engage finders. When promulgating the original
express exclusion of sales of a franchise in substantive discussions with a Rule, the Commission defined the term
by an existing franchisee. One prospective franchisee about the terms ‘‘broker’’ broadly to mean ‘‘any person
commenter noted that this exclusion of a franchise agreement.’’161 other than a franchisor or a franchisee
should apply only in those situations The Commission believes that a who sells, offers for sale, or arranges for
where an existing franchisee transfers separate definition of the term ‘‘broker’’ the sale of a franchise.’’166 Similarly, in
ownership in his or her franchise to a is unnecessary in part 436. In the the original SBP, the Commission
purchaser without any continuing original Rule, franchise brokers were clarified that a broker acts on behalf of
obligation to the purchaser. He jointly and severally liable with a franchisor and receives compensation
suggested that the Rule make clear that franchisors to prepare and to furnish for arranging a franchise sale.167 The
the exclusion does not apply where an prospective franchisees with disclosure term ‘‘broker,’’ therefore, has not been
existing franchisee is engaged in documents.162 In contrast, under part limited to those persons who negotiate
repeated franchise sales.156 The 436 of the final amended Rule, brokers contract terms or sign franchise
Commission agrees. If an existing are no longer obligated to prepare or to agreements and accept payments on
franchisee engages in repeated franchise furnish disclosure documents, as behalf of a franchisor.168
sales, he or she will be covered by the explained later in this document. The
final amended Rule as either the preparation and distribution of the 163 Moreover, the final amended Rule includes a
franchisor’s agent, broker, or separate definition of ‘‘franchisor,’’ to whom the

disclosure document is the sole affirmative disclosure requirements apply.
subfranchisor. To clarify this point, the responsibility of the franchisor. Rather, 164 Section 436.9(a).
definition narrows the existing 165 Frannet, NPR 2, at 1.
franchisee exemption to those existing 158 Tricon, NPR 34, at 3. 166 16 CFR 436.2(j).
franchisees ‘‘who are otherwise not 159 J&G, NPR 32. See also IL AG, at 2; Michael 167 Original SBP, 43 FR at 59717 and nn. 176 and
engaged in franchise sales on behalf of Seid. 178. Staff advisory opinions have interpreted the
160See also Lewis, NPR 15, at 8 (‘‘broker’’
the franchisor.’’157 term ‘‘arranges’’ to include, for example,
definition should not ‘‘include a franchisee merely discussions with prospective franchisees about
because the franchisee receives a payment from the their specific business interests, pre-screening
The term ‘‘franchise seller’’ streamlines the Rule by franchisor or subfranchisor in consideration of the prospects through interest questionnaires,
referencing all such individuals, where appropriate, referral or a prospective franchisee to the franchisor recommending specific franchise options, and
through the use of a single term. But see Winslow, or subfranchisor, if the franchisee does not assisting prospects in completing a franchisor’s
at 85 (suggesting that the term ‘‘seller’’ in the otherwise participate in the sale of the franchise to application form. These opinions are based upon
context of franchising is inappropriate). the prospective franchisee. A franchisee does not
152 See Interpretative Guides, 44 FR at 49969.
the original SBP, in which the Commission stated
participate in the sale of a franchise merely by that group discussions about franchising and pre-
153 See Franchise NPR, 64 FR at 57298.
participating in initial conversations or screening of prospects may constitute a first
154 Interpretive Guides, 44 FR at 49969. communications with a prospective franchisee personal meeting that would require a franchisor or
155 The UFOC Guidelines provide that ‘‘[i]n about a franchise.’’). broker to furnish disclosure documents. See
offerings by a subfranchisor, ‘franchisor’ means 161 J&G, NPR 32, at 10. But see Baer, NPR 11, at Informal Staff Advisories 99–6 and 99–7, Bus.
both the franchisor and subfranchisor.’’ UFOC 9 (‘‘If any party offers to sell a franchise on behalf Franchise Guide (CCH), ¶¶ 6503–04 (1999).
Guidelines, General Instructions 240. of a franchisor, that person should be considered a 168See generally FTC v. Entrepreneur Media, Inc.,
156 Bundy, NPR 18, at 3. franchise seller.’’). Bus. Franchise Guide (CCH), ¶ 10583 (C.D. Cal.
157See IL AG, at 3. 162 Interpretive Guides, 44 FR at 49969. Continued
The Commission declines to follow a has rejected three additional the corporation and knowledge of its
different approach in adopting the final suggestions. First, one commenter violative activity to justify recovery of
amended Rule. As noted above, the final opined that it is unclear whether the consumer redress. We therefore decline
amended Rule prohibits franchise phrase ‘‘and participates in the to adopt NASAA’s suggestion on this
sellers from engaging in certain conduct franchisor relationship’’ is intended to issue.
that may deceive prospective modify ‘‘any person who grants a
franchise,’’ or is intended to include 12. Section 436.1(l): Leased department
franchisees during the sales process. In
order to prevent deceptive sales persons other than those who grant a The final amended Rule retains the
practices, the prohibitions section of the franchise. She urged the Commission to original Rule’s exemption for leased
final amended Rule is broad, covering revise the definition narrowly to mean department arrangements.176 A leased
all persons engaged in sales activity. the person who signs the agreement department is created when a retailer
Accordingly, the Commission intends granting a franchise.173 rents space from a larger retailer in
that the term broker in the ‘‘franchise The commenter’s suggested change is order to conduct business. For example,
seller’’ definition to mean a person who: unwarranted. The two definitional a jeweler may rent space from a
(1) is under contract with the franchisor phrases are read conjunctively. To be department store to sell jewelry and
relating to the sale of franchises; (2) considered a ‘‘franchisor,’’ a person watches. Technically, this relationship
receives compensation from the must satisfy two definition elements: (1) may be a franchise because the jeweler
franchisor related to the sale of granting a franchise; and (2) becomes associated with the department
franchises; and (3) arranges franchise participating in the franchise store’s trademark, and the department
sales by assisting prospective relationship. Further, the second store may impose what arguably could
franchisees in the sales process.169 definitional element—participating in be considered control over the
the franchise relationship—is necessary operation, such as operating hours. As
11. Section 436.1(k): Franchisor to distinguish a franchisor (who has noted in the original SBP, these types of
The original Rule defined post-sale performance obligations), from relationships need not be protected by
‘‘franchisor’’ as: ‘‘any person who others involved solely in the initial the Rule because the likelihood of
participates in a franchise relationship franchise sales process (such as a deception is not great, the retailer-lessee
as a franchisor, as denoted in paragraph broker). Indeed, this commenter’s typically being experienced and able to
(a) of this subsection.’’170 The final proposed substitute definition could assess the value of the location.
amended Rule streamlines the original inappropriately sweep within the Moreover, the risk is small because the
definition: ‘‘any person who grants a definition of ‘‘franchisor’’ third-party retailer-lessee’s financial liability to the
franchise and participates in the brokers or other agents who are retailer-grantor is limited to rent.177
franchise relationship.’’171 Consistent authorized by the franchisor to sign the
Section 436.1(l) of the final amended
with the UFOC Guidelines, the franchise agreement, but who have no
Rule defines the term ‘‘leased
definition also makes clear that, post-sale performance obligations. We
department’’ as:
‘‘[u]nless otherwise stated, it includes therefore decline to adopt this
subfranchisors.’’172 suggestion. an arrangement whereby a retailer
In considering revisions to the Second, NASAA urged the licenses or otherwise permits a
‘‘franchisor’’ definition, the Commission Commission to expand the definition to seller to conduct business from the
include shareholders of privately-held retailer’s location where the seller
1994); FTC v. Shulman Promotions, Inc., Bus. corporations.174 Although NASAA did purchases no goods, services, or
Franchise Guide (CCH), ¶ 10584 (S.D. Ohio 1994) not elaborate, its suggestion is commodities directly or indirectly
(trade show promoters held jointly and severally apparently designed to make it easier to
liable as brokers under the original Rule for
from: (1) the retailer; (2) a person
financial performance claims made by franchisor- hold owners of closely-held the retailer requires the seller to do
exhibitors on the trade show floor). corporations liable for violations of the business with; or (3) a retailer-
169 See Gust Rosenfeld, at 2 (supporting the final amended Rule. We do not believe, affiliate if the retailer advises the
above-noted interpretation of the term ‘‘broker’’). however, that a mere showing that an seller to do business with the
This interpretation is sufficiently narrow to exclude
existing franchisees who may refer potential
individual is a shareholder in a affiliate.178
franchisees to the franchisor because they are not privately held corporation can suffice,
under contract with the franchisor to sell without more, as a legal basis for No commenter raised any substantive
franchises. In most instances, it also would exclude subjecting that individual to liability to concerns about the leased department
trade show promoters and the media who, typically,
pay potentially significant civil exemption. One commenter, however,
are not under contract with the franchisor, do not suggested that the Commission expand
receive compensation from the franchisor for penalties or consumer redress175 for
franchise selling, and who do not pre-screen or Rule violations committed by the the definition of leased department to
otherwise assist prospects in identifying specific corporation or those actively in control
franchise systems, or otherwise advance the 176 See 16 CFR 436.2(a)(3)(ii).
franchise sale.
of it. At any rate, where warranted, the
177 Original SBP, 43 FR at 59708. See also
170 16 CFR 436.2(c). Commission’s enforcement experience Interpretive Guides, 44 FR at 49968.
171 The Franchise NPR proposed that a franchisor indicates no difficulty in proving up the 178 Originally, the Commission proposed in the
include a person who grants an ‘‘interest in a necessary level of participation in the Franchise NPR a much more streamlined version of
franchise.’’ The reference to granting ‘‘an interest’’ violative conduct to justify civil the definition, as follows: Leased department means
is deleted. As BI observed, granting an interest is ‘‘an arrangement whereby a retailer licenses or
too broad, arguably including a franchisee who sells
penalties, or the requisite control over
otherwise permits an independent seller to conduct
an ownership interest in her own business. BI, NPR business from the retailer’s premises.’’ Franchise
28, at 2. The amended definition is also consistent 173 Spandorf, at 2. NPR, 64 FR 57332. However, one commenter voiced
with the language used in several state franchise 174 NASAA, at 4; NASAA, NPR 17, at 3. concern that this proposed definition could be
statutes, namely ‘‘grants a franchise,’’ or ‘‘grants or 175E.g., FTC v. Morrone’s Water Ice, Inc., No. 02– misinterpreted as broadening the exemption to
offers to grant a franchise.’’ E.g., Mich. Comp. Laws. 3720 (E.D. Pa. 2002) (naming Stephen D. Aleardi include even arrangements where the retailer-
445.1502(5); Wash. Rev. Code 19.100.010(8). and John J. Morrone, III, individually and as officers grantor requires the retailer-lessee to purchase
172See Lewis, NPR 15, at 11 (suggesting that the of corporate defendants); FTC v. Car Wash Guys goods from, for example, a specific third-party
definition address ‘‘subfranchisors,’’ noting Int’l, Inc., No. 00–8197 ABC (RNBx) (C.D. Cal. 2000) supplier. J&G, NPR 32, Attachment 6, at 13. This
comparable language in the Illinois and California (naming Lance Winslow, III, individually and as an was not the Commission’s intent, and the revised
Franchise Acts). officer of the corporate defendants). definition corrects that possible misinterpretation.
include ‘‘co-branding’’ arrangements.179 13. Section 436.1(m): Parent definition of the term ‘‘person’’—‘‘any
Co-branding, a relatively new marketing Section 436.1(m) of the final amended individual, group, association, limited
development in franchising, enables a Rule defines the term ‘‘parent’’ as ‘‘an or general partnership, corporation, or
franchisee to use the trademarks and entity that controls another entity any other entity.’’190 This is identical to
sell the goods or services of more than directly, or indirectly though one or the proposed version of this definition
one franchise system. For example, an more subsidiaries.’’ Several commenters in the Franchise NPR. During the Rule
outlet that sells Taco Bell foods might suggested that because several Rule amendment proceeding, a few
also sell Pizza Hut pizza, or a gasoline provisions address parent commenters offered suggestions to
franchise, such as Shell, may operate an disclosures,184 the Commission should modify the definition. Warren Lewis, for
on-site Subway Shop or 7-Eleven store. expressly define that term.185 Although example, suggested that the Commission
The Commission declines to adopt the Rule proposed in the Franchise NPR add the following to the definition: ‘‘An
this suggestion. The issue of Rule did not define this term, the individual is not an entity.’’191 Mr.
compliance in co-branded arrangements Commission believes this point is well- Lewis maintained that this change
was raised in the ANPR180 and taken. Accordingly, part 436 of the final would make it clear throughout the Rule
discussed in detail at the staff’s New that ‘‘person’’ means an individual or
amended Rule expressly defines the
York public workshop conference on business entity; while entity means only
term ‘‘parent.’’186
September 18, 1997. The ANPR One commenter suggested an a business entity. As another example,
commenters generally agreed that the alternative definition: ‘‘Parent means an IL AG and J&G suggested that the
current Rule and UFOC Guidelines are entity that directly or indirectly has an definition of ‘‘person’’ reference limited
sufficient to address any deception 80% or greater ownership interest in the liability companies.192
issues that may arise in co-branded The term ‘‘person’’ is defined in many
franchisor.’’187 The commenter,
franchise arrangements. The same view Commission rules, as referring to a
however, did not state the basis for his
was expressed by the participants at the party, regardless of whether the party is
recommendation. Indeed, in
New York workshop.181 Indeed, no an individual, organization, or business
promulgating the original Rule, the
franchisee or state regulator voiced any entity.193 Where necessary, the rule text
Commission did not adopt an distinguishes between parties by using
concerns to the contrary.182 Therefore, ownership test, but focused on
taken as a whole, the record does not the more specific terms—individual,
control.188 We believe that is the proper organization, or entity. We believe that
support the need to adopt new rule approach.189 It is the control and
provisions specifically addressing co- these more specific terms are clear, and,
resulting influence over the direction of therefore, we need not distinguish
branding.183 the franchisor—not mere ownership— between individuals and entities in the
179 J&G, NPR 32, Attachment at 6, 13. Two other
that is material to a prospective definition of ‘‘person,’’ as suggested.
commenters suggested that the Commission provide
franchisee. The Commission also finds that the term
more guidance about co-branding generally, but not 14. Section 436.1(n): Person ‘‘entity’’ is sufficient to cover limited
in the leased department context. Selden, at 3;
liability companies, as well as other
Quizno’s, ANPR 16, at 2. None of these commenters Section 436.1(n) of the final amended
identified specific problems posed by co-branding forms of business arrangements.
Rule retains the original Rule’s
arrangements—other than noting that co-branded
arrangements can be complex—nor did they offer 15. Section 436.1(o): Plain English
any solutions for the Commission’s consideration. through an informal advisory opinion. To date, no
such requests have been submitted, suggesting
Part 436 of the final amended Rule
180 In the ANPR, the Commission noted its
limited, if any, confusion over this issue. adopts the UFOC Guidelines
uncertainty as to whether the purchaser of a co-
branded franchise acquires two individually-
184See section 436.5(a) (Item 1); section 436.5(c) requirement that disclosure documents
trademarked franchises (and thus should receive (Item 3); section 436.5(d) (Item 4). be prepared in plain English.194 Section
185E.g., PMR&W, NPR 4, at 9; H&H, NPR 9, at 12.
separate disclosures from each franchisor) or 436.1(o) defines ‘‘plain English’’ as:
acquires a hybrid franchise arrangement that has its 186 The final amended Rule’s definition of
own risks and, thus, should receive a single unified ‘‘parent’’ is consistent with the definition of the the organization of information and
document that discloses information specific to the term ‘‘parent’’ in the Interpretive Guides: ‘‘an entity language usage understandable by a
co-branding arrangement. The ANPR asked whether that controls the franchisor directly, or indirectly person unfamiliar with the
franchisors have sufficient guidance under the Rule through one or more subsidiaries.’’ Interpretive franchise business. It incorporates
to determine their disclosure obligations with Guides, 44 FR at 49972. However, because the term
respect to the sale of co-branded franchises and parent is also used in the final amended Rule to short sentences; definite, concrete,
whether new or different disclosures should apply refer to a franchisee’s parent—e.g., section 436.8 everyday language; active voice;
to the sale of co-branded franchises. ANPR, 62 FR (Exemptions)—the definition of ‘‘parent’’ deletes and tabular presentation of
at 9122. Ten ANPR commenters addressed co- the reference to ‘‘franchisor’’ and replaces it with information, where possible. It
branding. Quizno’s, ANPR 16, at 2; Baer, ANPR 25, the broader term ‘‘another entity.’’ This is the
at 7; H&H, ANPR 28, at 9; Kaufmann, ANPR 33, at identical approach taken in defining the term avoids legal jargon, highly technical
16; Kestenbaum, ANPR 40, at 2–3; IL AG, ANPR 77, ‘‘affiliate.’’ See section 436.1(b) above. business terms, and multiple
at 4–5; IFA, ANPR 82, at 4; Kirsch, ANPR 98; 187 Lewis, NPR 15, at 9. This suggested definition negatives.195
Jeffers, ANPR 116, at 9; WA Securities, ANPR 117, appears to derive from the following language in
at 4. With the exception of Quizno’s, the ANPR UFOC Item 21: ‘‘a company controlling 80% or This definition is one of several features
commenters maintained that the Commission’s more of a franchisor may be required to include its of the final amended Rule that are
current pre-sale disclosure approach is sufficient to financial statements.’’ Item 21, however, does not designed to preserve the integrity of
address co-branded franchise arrangements. specifically purport to define the term ‘‘parent.’’
181E.g., Kirsch, ANPR, 18 Sept. 97 Tr., at 176; Rather, it merely suggests that a large controlling 190See 16 CFR 436.2(b).
Wieczorek, id., at 177–78; Kestenbaum, id., at 178– interest may give rise to financial disclosure
79; Simon, id., at 179. obligations.
182 For example, Dale Cantone, of Maryland 188 Interpretive Guides, 44 FR at 49972. 192 IL AG, at 3; J&G, NPR 32, Attachment, at 14.
193E.g., Telemarketing Sales Rule, 16 CFR
Securities, stated: ‘‘We haven’t had too many 189 The Staff Report’s discussion of the ‘‘parent’’
problems on the issue of co-branding. We’ve had definition generated one comment. Gust Rosenfeld 310.2(v).
franchisors file disclosures and we really haven’t suggested that a second sentence should be added 194 Section 436.6(a).
had too many issues with it.’’ Cantone, ANPR, 18 to the definition to the effect that a parent entity 195 This definition is based upon the definition
Sept. 97 Tr., at 182. is an affiliate, but is separately defined because of ‘‘plain English’’ used in the securities context.
183 To the extent that franchisors may be certain requirements apply to a parent, but not to See Registration Form Used by Open-Ended
uncertain how to apply the final amended Rule in other types of affiliates. Gust Rosenfeld, at 2. We Management Investment Companies, SEC Release
a specific co-branded arrangement, they can always agree, but believe issues such as this are more No. 33–7512, 63 FR 13916, at 13939 (Mar. 23, 1998).
seek further guidance from Commission staff appropriately addressed in Compliance Guides. See also UFOC General Instruction 150.
disclosure documents. Application of parent, predecessors, and affiliates.200 individual. Thus, delivery in such
these writing standards will enhance the Section 436.1(q) defines the term circumstances can only be made upon a
legibility and understandability of ‘‘principal business address’’ to mean: representative. Even individuals may
disclosure documents, thereby reducing ‘‘the street address of a person’s home wish to have their attorney or other
the likelihood of franchisee deception, office in the United States. A principal agent receive the disclosures on their
confusion, or misunderstandings. business address cannot be a post office behalf, and the Rule should
box or private mail drop.’’201 This accommodate that possibility. We
16. Section 436.1(p): Predecessor definition was not included in the believe that the reference to agent,
Section 436.1(p) adopts the UFOC original Rule. Nevertheless, the representative, or employee in section
Guidelines’ definition of ‘‘predecessor’’ Commission finds that this definition is 436.1(r) is sufficient for this purpose.
as: ‘‘a person from whom the franchisor necessary to enable a prospective Further detail about who may accept
acquired, directly or indirectly, the franchisee to contact the franchisor disclosures for a prospective franchisee
major portion of the franchisor’s easily, as well as to facilitate effective is best addressed in the Compliance
assets.’’196 This definition comes into law enforcement. Guides.205
play in several substantive provisions of The proposed version of section One commenter also questioned the
the final amended Rule, where the 436.1(q) has been slightly revised to use of the word ‘‘approaches’’ in the
Commission is adopting the UFOC improve its precision, as suggested in definition. Specifically, the commenter
Guidelines requirement that franchisors one Staff Report comment. Initially, the feared that the definition would include
disclose material information about definition of principal business address someone surfing the Internet who
their predecessors.197 The original Rule referred to the franchisor’s home office. ‘‘approaches’’ a franchisor’s website.206
did not require the disclosure of J&G correctly observed, however, that We believe this concern is unwarranted.
predecessor information. However, as the disclosure of a principal business The ‘‘prospective franchisee’’ definition
discussed later in this document—in address applies not only to a franchisor, states that the parties must ‘‘discuss the
particular in connection with Item 3 but to others, such as a predecessor, as possible establishment of a franchise
litigation disclosures and Item 4 well.202 Accordingly, the definition has relationship.’’ This limiting language
bankruptcy disclosures—predecessor been revised to refer to the more general makes clear that for an individual to
disclosures are necessary to prevent ‘‘person’s home office’’—be it the become a ‘‘prospective franchisee’’ he or
fraudulent franchise sales.198 Our law franchisor, parent, predecessor, or she must communicate with the
enforcement experience demonstrates affiliate. franchisor about a franchise offering.
that, in some instances, franchisors Merely perusing a franchisor’s website
18. Section 436.1(r): Prospective alone does not turn an ordinary Internet
reincorporate under a new name as a franchisee
simple way to avoid disclosing surfer into a prospective franchisee.
damaging information.199 The The final amended Rule retains a Accordingly, no further revision to the
disclosure of predecessor information streamlined version of the definition of ‘‘prospective franchisee’’ definition is
will prevent such efforts to circumvent the term ‘‘prospective franchisee’’ set warranted.
the final amended Rule. forth in the original Rule at 16 CFR
19. Section 436.1(s): Required payment
436.2(e). Specifically, section 436.1(r)
17. Section 436.1(q): Principal business defines the term to mean ‘‘any person The making of a ‘‘required payment’’
address (including any agent, representative, or (or a commitment to make a ‘‘required
The final amended Rule requires the employee) who approaches or is payment’’) is one of the definitional
disclosure of the principal business approached by a franchise seller to elements of the term ‘‘franchise.’’207
discuss the possible establishment of a Section 436.1(s) defines the term
address of the franchisor, as well as any
franchise relationship.’’203 This is ‘‘required payment’’ to mean:
196 UFOC Guidelines, Item 1 Instructions, iii. See identical to the version of this definition all consideration that the franchisee
also NASAA Commentary, Bus. Franchise Guide proposed in the Franchise NPR. must pay to the franchisor or an
(CCH), ¶ 5790, at 8465 (‘‘The definition of The amended definition addresses affiliate, either by contract or by
predecessor in instruction iii to Item 1 should be several comments raised during the practical necessity,208 as a
applied throughout the UFOC.’’).
197E.g., section 436.5(a)(2) (Item 1); section
Rule amendment proceeding. First, one condition of obtaining or
436.5(c) (Item 3); section 436.5(d) (Item 4). commenter voiced concern about who commencing operation of the
198 Initially, the Commission proposed in the may receive a disclosure document, franchise. A required payment does
Franchise NPR a broader definition that would suggesting that the Commission permit not include payments for the
include as a predecessor a person ‘‘from whom the any representative of the franchisee to purchase of reasonable amounts of
franchisor obtained a license to use the trademark
or trade secrets in the franchise operation.’’
receive the disclosures.204 The inventory at bona fide wholesale
Franchise NPR, 64 FR at 57332. This proposal was Commission agrees that representatives prices for resale or lease.
widely criticized as overbroad, H&H, NPR 9, at 15; of a prospective franchisee should be The only substantive difference between
BI, NPR 28, at 2, and would result in burdensome permitted to accept delivery of the
disclosures that are immaterial to prospective the provision as proposed in the
franchisees, PMR&W, NPR 4, at 8; Baer, NPR 11, at
disclosure document on the prospective
11; NFC, NPR 12, at 3–4; Snap-On, NPR 16, at 2; franchisee’s behalf. Indeed, in some 205See also Piper Rudnick, at 5 (seeking
Marriott, NPR 35, at 13–14. See also Gust Rosenfeld, instances a prospective franchisee may clarification in the Compliance Guides on whether
at 2. Commenters also observed that information be a corporation or other entity, not an the phrase ‘‘agent, representative, or employee’’ also
about the franchisor’s trademark is already includes an individual on behalf of a family
disclosed in Items 12–13. E.g., Baer, NPR 11, at 10; member (spouse, children, siblings), other general
Lewis, NPR 15, at 10. The staff of the Commission
200 See section 436.5(a). and limited partners, shareholders, and/or the
agreed. Accordingly, the proposal was deleted in
201 See UFOC Guidelines, Item 1C, Instructions, individual’s corporate employer).
the revised proposed Rule set forth in the Staff i. 206 J&G, NPR 32, at 7.
Report. J&G, at 2.
202 207See section 436.1(h)(3).
199E.g., FTC v. Wolf, Bus. Franchise Guide (CCH) The final amended Rule definition uses the
203 208 The ‘‘required payment’’ definition
¶ 10401 (S.D. Fla. 1994); FTC v. Inv. Dev., Inc., Bus. term ‘‘franchise seller’’ in lieu of ‘‘franchisor, or incorporates the Commission’s long-standing policy
Franchise Guide (CCH) ¶ 9326 (E.D. La. 1989). See franchise broker, or any representative, agent, or that a payment can be required by contract or by
also United States v. Lasseter, No. 3:03–01177 (M.D. employee thereof.’’ See section 436.1(i). practical necessity. See Interpretive Guides, 44 FR
Tenn. 2003). 204 BI, NPR 28, at 3. at 49967.
Franchise NPR and the final amended Commission to narrow the definition by Franchise NPR did not exclude
Rule provision is the addition of the specifying that a required payment must payments for inventory.) Another
second sentence. There is no be made ‘‘for the right to enter into the commenter agreed with Mr. Gurnick
corresponding definition in the original franchise relationship.’’211 and urged further expansion of the
Rule. The Commission declines to adopt exemption to include not only inventory
During the Rule amendment this suggestion. The phrase ‘‘right to for resale, but inventory for lease.
proceeding, several commenters raised enter into a franchise relationship’’ is Otherwise, the situation could arise
concerns about the scope of the too narrow, suggesting that the required where inventory obtained from a
‘‘required payment’’ definition. payment definitional element should be company is intended for resale—thus
Specifically, commenters voiced limited to payments made solely for the taking it outside of the Rule—but later
concern whether the definition: (1) right to enter into the business, such as on leased to a customer—thus arguably
covers royalty payments; (2) covers an up-front franchise fee. However, the creating a franchise relationship
payments to obtain or commence the Commission has made clear that the retroactively.217
franchise relationship; (3) excludes required payment element is not limited The Commission has concluded that
payments for inventory; and (4) to up-front fees alone: ‘‘Often, required the definition of ‘‘required payment’’
includes payments to third parties. Each payments are not limited to a simple should incorporate the inventory
of these issues is discussed in greater franchise fee, but entail other payments exemption as these commenters
detail below. which the franchisee is required to pay suggested. Since the Rule’s inception,
to the franchisor or an affiliate.’’212 The the Commission’s policy has been that
a. Royalty payments
Interpretive Guides further provide as reasonable purchases of inventory for
As noted above, the definition of examples of required payments resale at bona fide wholesale prices are
‘‘required payment’’ uses the phrase equipment rentals and real estate not construed to be a ‘‘required
‘‘consideration that the franchisee must leases.213 Thus, expenses incurred in payment.’’ The Interpretive Guides state
pay.’’ IL AG interpreted the word the ordinary course of business and paid that it is ‘‘virtually impossible to draw
‘‘consideration’’ as excluding royalty to a franchisor or its affiliate may a clear line between start-up inventory
payments. It urged the Commission to constitute a required payment. that is purchased at the franchisee’s
clarify that royalties can constitute a Otherwise, unscrupulous franchisors option, and that which is purchased as
required fee. Otherwise, ‘‘it will be too could easily circumvent the Rule by a matter of practical or contractual
simple, even for traditional franchisors, refraining from imposing any up-front necessity.’’218 Therefore, the final
to evade franchise laws.’’209 fee in favor of charging for ordinary amended Rule provision incorporates
The Commission has always business expenses, such as training or this policy, and extends it to encompass
considered royalty payments to be a other services, or purchases of
form of required payment under the inventory purchased for lease as well as
equipment or unreasonable amounts of resale, there being no distinction, as a
Rule and nothing in the definition of inventory.214
‘‘required payment’’ is to the practical matter, between the two
contrary.210 Royalty payments c. Payments for inventory categories.
constitute a direct form of consideration As a matter of Commission policy, d. Payments to third parties
flowing to the franchisor in exchange for reasonable amounts of inventory Howard Bundy urged expansion of
the ability to conduct business. Indeed, purchased at bona fide wholesale prices the concept of ‘‘required payment’’ to
if royalties were excluded from the have not been interpreted to constitute include payments made to third parties.
required payment definition, then any a ‘‘required payment’’ under the original According to Mr. Bundy, franchisors
franchisor could avoid Rule coverage by Rule.215 This is commonly referred to as can effectively ‘‘hook’’ a prospective
charging a large post-sale royalty fee in ‘‘the inventory exemption.’’ David franchisee if they can get the prospect
lieu of an initial franchise or related fee. Gurnick urged the Commission to to expend funds early in the sales
The Rule uses the term ‘‘consideration’’ update the Rule by incorporating the process, such as paying travel expenses:
not to imply that only an upfront inventory exemption into the definition
franchise fee constitutes a required of ‘‘required payment.’’216 (As noted In franchising, it has become
payment under the Rule, but to avoid above, the definition proposed in the common to use the ‘‘takeaway
the circular use of the word ‘‘payment’’ close’’ to entice prospects to travel
in the definition of ‘‘required payment.’’ 211 Baer, NPR 11, at 8. to the franchisor’s headquarters as a
Also, alternatives such as ‘‘funds, or 212 Interpretive Guides, 44 FR at 49967. condition precedent to receiving a
moneys’’ are too limited because they 213Id. disclosure document. Likewise, we
would preclude payments in-kind.
214See Original SBP, 43 FR at 59703 and note 51
see instances of franchisors
(discussing problem of ‘‘indirect or disguised’’ requiring a franchisee to contract
b. Payments to obtain or commence a franchise fees).
215See Interpretive Guides, 44 FR at 49967. In the with or pay for demographic or real
franchise estate services with technically
Franchise NPR, the Commission proposed
One commenter voiced concern that incorporating the inventory exemption into the ‘‘unaffiliated’’ entities as a
because the definition of ‘‘required current minimum payment exemption. See condition precedent to being
Franchise NPR, 64 FR at 57345. The minimum
payment’’ covers payments made ‘‘as a payment exemption applies where the total
‘‘approved’’ as a franchisee.219
condition of obtaining or commencing required payment made by the franchisee ‘‘from any To address this concern, Mr. Bundy
operation of the franchise,’’ it would time before to within six months after commencing
suggested that the Commission modify
encompass ordinary business expenses operation of the franchisee’s business, is less than
$500.’’ 16 CFR 436.2(a)(3)(iii). Accordingly, the the definition of ‘‘required payment’’ to
paid to the franchisor. He urged the amount of any ‘‘required payment’’ must be known include, after the word affiliate: ‘‘or to
before determining the applicability of the a vendor, financing provider or other
209 IL AG, NPR 3, at 5. See also J&G, NPR 32, minimum payment exemption. Because the
Attachment, at 15 (questioning whether inventory exemption helps to define what
third party that the prospective
‘‘consideration’’ excludes royalty payments). constitutes a ‘‘required payment,’’ we conclude that
210See Interpretive Guides, 44 FR at 49967 it should be included directly in the definition of 217 Baer, NPR 11, at 8.
(‘‘Among the forms of required payments are . . . ‘‘required payment.’’ See Staff Report, at 61–62. 218 Interpretive Guides, 44 FR at 49967.
continuing royalties on sales.’’). 216 Gurnick, NPR 21A, at 10. 219 Bundy, NPR 18, at 4.
franchisee is required to deal with either expenses to advance the franchise sale as proposed in the Franchise NPR228
by contract or practical necessity or to could conceivably increase the because it incorporates the Commission
any third party as a condition precedent likelihood that he or she will go through policy, as stated in the Interpretive
to obtaining the Franchise Disclosure with the deal without a thorough due- Guides, that the term ‘‘sale of a
Document.’’220 diligence investigation. Therefore, the franchise’’ does not encompass the
Mr. Bundy’s suggestion generated one Commission has incorporated into the transfer of a franchise by an existing
rebuttal comment. David Gurnick final amended Rule an express franchisee where the prospective
observed that defining ‘‘required prohibition barring a franchisor from purchaser has no significant contact
payment’’ to include third-party failing to furnish a copy of its disclosure with the franchisor.229 Under long-
payments would be: ‘‘a radical document to a prospective franchisee standing Commission policy, a
departure from the Commission’s long- early in the sales process, upon franchisor or subfranchisor must
standing policy regarding the definition reasonable request.225 This prohibition provide disclosures to prospective
of a franchise, would create a major enables a prospective franchisee to ask franchisees, but ‘‘a person who
inconsistency between the Franchise to see a copy of the franchisor’s purchases a franchise directly from an
Rule and the state franchise laws, and disclosure document before agreeing to existing franchisee, without significant
would extend coverage to arrangements travel to company headquarters or contact with the franchisor, is not a
which the Rule was never intended to purchase demographic data, for prospective franchisee.’’230 Where a
regulate.’’221 Observing that all example. The Commission believes this franchisor is not involved in the private
businesses make payments to vendors approach will better address concerns sale of an existing franchise, the
and service providers, he also asserted about pre-disclosure third-party franchisor makes no representations to
that the Bundy proposal would be payments than would an unworkable the prospective new purchaser. If there
overbroad: ‘‘For example, ‘practical alteration of the definition of the term is any fraud in the private sale, it could
necessity’ may dictate that a business ‘‘required payment.’’ be only by the current franchisee owner,
use a Microsoft software product or that and pre-sale disclosure by the franchisor
20. Section 436.1(t): Sale of a franchise would not likely prevent it.
an employee of the business fly to an
airport that is served by only one The part 436 disclosure obligations Accordingly, section 436.1(t) of part 436
airline.’’222 Mr. Gurnick added that if a are triggered only when there is an offer makes clear that a transfer without
franchisor establishes a company to for the sale of a franchise.226 Section significant involvement of the
receive some monetary benefit from 436.1(t) defines the term ‘‘sale of a franchisor is not the sale of a franchise
prospects, those funds would already franchise’’ as follows: within the ambit of the Rule. Further,
fall within the ‘‘required payment’’ the franchisor’s mere approval or
an agreement whereby a person disapproval of the purchaser alone is
definition as a payment to an obtains a franchise from a franchise
affiliate.223 not considered to be significant
seller for value by purchase, involvement.231
It is true that the Commission has license, or otherwise. It does not
never considered ordinary business At the same time, the Commission
include extending or renewing an declines to adopt several suggested
payments to third parties as a ‘‘required existing franchise agreement where
payment’’ under the Rule. Indeed, doing narrowing modifications to the
there has been no interruption in definition of ‘‘sale of a franchise.’’ H&H
so could sweep very broadly. Ordinary the franchisee’s operation of the
business expenses paid to third parties, urged the Commission to exclude from
business, unless the new agreement the definition of ‘‘sale of a franchise’’
such as the cost of installing telephone contains terms and conditions that
lines, insurance, and occupancy fees— the modification of an existing franchise
differ materially from the original agreement where there is no
expenses typically incurred by all agreement. It also does not include
businesses—can hardly be deemed a interruption in the franchisee’s business
the transfer of a franchise by an operation.232 The firm observed that
precondition imposed by the franchisor existing franchisee where the
for obtaining or commencing operation material modifications to existing
franchisor has had no significant franchise agreements typically arise in
of a franchise. Rather, a third-party involvement with the prospective
payment constitutes a required payment two situations: (1) a settlement of
transferee. A franchisor’s approval litigation or other disputes with
only if the third party collects and or disapproval of a transfer alone is
remits the payment on behalf of the franchisees, in which the franchisor
not deemed to be significant makes concessions; and (2) management
franchisor.224 involvement.
Nonetheless, a franchisor may direct initiative with the involvement of
or encourage a prospective franchisee to Like the original Rule provision, the independent franchisee associations or
incur some costs in order to advance the final amended provision embodies the franchisee advisory councils.233
franchise sale. The prospective concept that franchisees extending or According to H&H, these modifications
renewing an existing franchise typically entail no new investment and
franchisee may incur these costs and
agreement, where there is no both sides are familiar with the
make these kinds of payments without
the benefit of pre-sale disclosures. interruption in business operations, will 228 Franchise NPR, 64 FR at 57333.
Encouraging a prospect to incur not be deemed to be entering into a sale, 229See H&H, NPR 9, at 11.
unless their new agreement contains 230 Interpretive Guides, 44 FR at 49969.
220Id. terms and conditions materially 231See Interpretive Guides, 44 FR at 49969–70. In
221 Gurnick, NPR Rebuttal 36, at 2. different from their original contrast, a franchisor who actively participates in
222Id., at 3. agreement.227 a franchise transfer must make disclosures to a
223Id., at 3–4. Mr. Gurnick also disputed the view
The final amended Rule provision potential transferee, no less than to a prospective
that franchisors entice prospects to incur costs, franchisee. In such an event, the prospective
differs substantively from the provision
such as airline tickets. ‘‘No data is [sic] provided transferee may rely on the franchisor’s
to support this claim, and frankly I question representations in deciding to purchase the
225See section 436.9(e). franchise, and therefore, should receive the benefit
whether companies really have an interest in
enticing prospects to buy, for example, airline 226See section 436.2. of pre-sale disclosure.
tickets.’’ Id., at 4. 227 16 CFR 436.2(k). See also Interpretive Guides, 232 H&H, NPR 9, at 9–10.
224See Interpretive Guides, 44 FR at 49967. 44 FR at 49969. 233 H&H, NPR 9, at 10.
franchise terms: ‘‘An offer to exchange independently. Especially in an age of permit the use of electronic
different forms of agreement or add an new technologies and changes in disclosures.239 To that end, section
addendum to existing franchise franchise marketing, renewal contracts 436.1(w) of the final amended Rule
agreements does not establish a new may be significantly different from defines the term ‘‘written or in writing’’
franchise relationship—that relationship original contracts that franchisees to include not only printed documents,
already exists and will continue signed 10 to 20 years ago. A renewing but:
regardless of the decision the franchisee franchisee, for example, may reasonably any document or information . . .
makes.’’234 wish to see Item 20 closure rates for in any form capable of being
The Commission agrees that franchises operating under the new preserved in tangible form and read.
disclosure is unwarranted where an franchise agreement. Accordingly, the It includes: type-set, word
existing franchisee and the franchisor Commission concludes that where the processed, or handwritten
merely seek to amend their ongoing franchise agreement contains terms and document; information on
contractual relationship. In such conditions materially different from the computer disk or CD–ROM;
circumstances, the material information original agreement, the renewing information sent via email; or
the franchisee needs is the actual franchisee needs advance disclosures in information posted on the Internet.
revised franchise agreement itself that order to make an informed renewal It does not include mere oral
spells out the terms and conditions that decision.237 statements.240
will govern the parties’ ongoing 21. Section 436.1(u): Signature No comments were submitted on the
relationship. Requiring franchisors to
The original Rule contained no Franchise NPR’s proposed definition,
furnish a new disclosure document
definition of ‘‘signature.’’ To facilitate and only minor non-substantive changes
whenever there may exist agreed upon
the use of electronic signatures, in language were made to improve
material changes in a contract is likely
however, section 436.1(u) of the final clarity.
to be an unwarranted formality, the cost
of which is probably not outweighed by amended Rule updates the UFOC B. Section 436.2: Obligation To Furnish
any tangible benefit to the existing Guidelines by adding such a definition: Documents
franchisee. In any event, franchise ‘‘a person’s affirmative step to
authenticate his or her identity. It Section 436.2 of the final amended
agreement modifications, most Rule retains the original Rule’s
obviously those without any new includes a person’s handwritten
signature, as well as a person’s use of requirement that franchisors provide
payment, would not constitute a ‘‘sale.’’ prospective franchisees with advance
The definition of ‘‘sale of a franchise,’’ security codes, passwords, electronic
signatures, and similar devices to written disclosures.241 It also retains, in
therefore, need not be revised to address streamlined form, elements of the
this concern. authenticate his or her identity.’’ No
comments were submitted on this original Rule’s requirement that a
H&H further contended that franchisor ‘‘furnish the prospective
disclosure is never warranted for definition, but the Commission has
refined the language of the proposed franchisee with a copy of the
renewals, asserting that a renewing franchisor’s franchise agreement . . .
franchisee makes no investment definition to achieve greater precision
and clarity, expressly including the prior to the date the agreements are to
decision: ‘‘His decision relates to be executed.’’242 The final amended
whether to continue a relationship, with descriptor ‘‘handwritten,’’ substituting
‘‘electronic’’ for ‘‘digital,‘‘ and adding Rule provision follows the basic
which he should be intimately familiar concepts of the corresponding provision
the phrase ‘‘to authenticate his or her
at that point, under the terms of a new of the proposed Rule published in the
identity.’’
form of franchise agreement. The UFOC Franchise NPR, but, as explained below,
does little to help him understand the 22. Section 436.1(v): Trademark it reflects important refinements
terms of that agreement.’’235 After Section 436.1(v) of the final amended suggested by the comments, and its
considering this suggestion, we are Rule defines the term ‘‘trademark.’’ The language has been reorganized to
unconvinced that renewals should original Rule did not define this term. improve clarity.
always be excluded from the definition Consistent with long-standing Section 436.2 of part 436 covers four
of ‘‘sale of a franchise.’’ Commission interpretation of the term issues relating to the basic obligation to
As discussed in greater detail below and the UFOC Guidelines, the final provide a disclosure document. First, it
in connection with section 436.5(q)— amended Rule definition is broad, describes the geographical scope within
Item 17’s renewal disclosure— including ‘‘trademarks, service marks, which the disclosure obligation applies.
franchisees and their representatives names, logos, and other commercial Second, it establishes the time frame for
have voiced concern about renewals, symbols.’’238 No comments were fulfilling that obligation. Third, it limits
arguing that franchisors control the submitted on this definition, and it is the obligation of the franchisor to
governing terms and conditions and identical to the version of the definition furnish to the prospective franchisee an
offer renewals on a take-it-or-leave-it published in the Franchise NPR. advance copy of the completed
basis.236 Franchisees, they have franchise agreement—apart from the
asserted, not only lack bargaining power 23. Section 436.1(w): Written or in disclosure document—to only those
over the renewal agreement, but also writing circumstances when the franchisor
often must accept new onerous terms The final amended Rule updates the makes material unilateral changes to the
because they are frequently subject to original Rule and UFOC Guidelines to agreement while the offer is still under
covenants not to compete that consideration. Fourth, and finally, the
effectively prevent them from 237 This assumes, of course, that there is a ‘‘sale,’’
provision sets forth the specific actions
continuing in the same business meaning the existing franchisee makes a required
payment for the right to enter into a new franchise
239See section 436.6 of the final amended Rule.

agreement. Entering into a new franchise agreement
234Id. 240See also section 436.8(a)(7), which retains the
without any required payment or extending an
235Id.,at 11. existing franchise agreement for a fee would not be original Rule’s exemption for oral statements at 16
236 See discussion of section 436.5(q) below. See deemed a ‘‘sale of a franchise’’ for Rule purposes. CFR 436.2(a)(3)(iv).
241 16 CFR 436.1(a).
also Staff Report, at 153–156; Franchise NPR, 64 FR 238See Interpretive Guides, 44 FR at 49966–967.
at 57308–09. See also UFOC Guidelines, Item 13 Instructions, i. 242 16 CFR 436.1(g).
that constitute the furnishing of commenters noted that foreign franchise or deceptive acts or practices250 ‘‘in or
disclosures. Each of these aspects of purchasers are large sophisticated affecting commerce.’’251 The FTC Act
section 436.2 generated comments. The investors represented by counsel and do includes multiple references to
following sections discuss those issues not need the Rule’s protections. Some territories in its definition of
and the various views of the commenters made the point that the commerce,252 including commerce ‘‘in
commenters. Commission developed the Franchise any territory of the United States.’’253
Rule in response to problems occurring The record does not suggest any
1. Geographical scope of the Rule’s
in the domestic market.246 Indeed, a convincing rationale for contraction of
application
disclosure document addressing the the exercise of that authority as
Section 436.2 of the final amended American market may be irrelevant and expressed through part 436 of the final
Rule makes clear that the part 436 potentially misleading when applied to amended Rule. Residents of American
disclosure requirements and a purchase of a franchise to be located territories rely on American law for
prohibitions are limited to ‘‘the offer or outside the United States, due to the protection, and the Franchise Rule is
sale of a franchise to be located in the vast differences between American and part of that protection.
United States of America or its foreign markets, cultures, and legal
territories.’’243 This provision of part 2. Section 436.2(a): Time frame for
systems.247 Further, many risks to the
436 is substantively identical to the making disclosures
prospective franchisee arise from
corresponding provision in the economic conditions and cultural Part 436 of the final amended Rule
proposed Rule. The original Rule did values in those countries, not in the substantially revises the original Rule’s
not address whether pre-sale disclosure United States. To be relevant, a timing for making franchise disclosures.
is required for sales of franchises to be franchisor arguably would have to Under the original Rule, franchisors and
located outside the United States and its prepare individual disclosure brokers had to furnish prospective
territories, and this issue has remained documents tailored to each specific franchisees with disclosure documents
an unsettled area of franchise law. This foreign market. Not only would such a at the earlier of two time periods: (1) the
issue was raised early in the proceeding requirement put American franchisors first personal (face-to-face) meeting; or
and, based upon the record developed, at a competitive disadvantage with (2) ‘‘the time for making disclosures,’’
the Commission concludes that franchisors from countries lacking which was defined as 10 business days
application of part 436 to franchises to comparable disclosure regulations, but before the execution of the franchise
be located outside the United States and it is likely that any possible benefits of agreement or payment of any fees in
its territories is unwarranted at this such a requirement would not outweigh connection with the franchise sale.254
time.244 the extraordinary costs and burdens The final amended Rule streamlines the
The record reveals overwhelming involved.248 timing provision in two respects. First,
support among various franchise At the same time, the Commission has part 436 eliminates the first personal
interests for limiting the reach of the rejected suggestions to limit the scope of meeting disclosure trigger. Second, part
part 436 to sales of domestic the Rule further to exclude sales of 436 replaces the original 10-business
franchises.245 Among other things, the franchises to be located in American day trigger with a 14 calendar-day
territories.249 The FTC Act gives the disclosure trigger. Both of these
243 Limitation of the geographic scope of part 436
Commission authority to promulgate revisions were included in the Rule
of the final amended Rule is not intended to limit trade regulation rules involving unfair proposed in the Franchise NPR, but
the FTC’s jurisdiction, as set forth in section 5(a)
of the FTC Act, 15 U.S.C. 45(a), and section 3 of
have been slightly revised for
the U.S. SAFE WEB Act of 2006, Pub. L. No. 109– jurisdiction over such sales, and may exercise its clarification and better organization.
455, 120 Stat. 3372. discretion to bring an action in appropriate cases. Each is discussed in greater detail
246 As H&H observed, a close reading of the text
244 The Staff Report recommended limitation of
below.
the Rule’s scope to sales of franchises to be located of both the original Rule and UFOC Guidelines
in the United States. Staff Report, at 72–5. indicates an intent to require disclosures involving a. Elimination of the first personal
only domestic franchises. For example, UFOC Item
245E.g., MSA, at 3–4; PMR&W, NPR 4, at 1; 7-
20 refers to the number of franchise sales ‘‘in this
meeting trigger
Eleven, NPR 10, at 1; IFA, NPR 22, at 5; AFC, NPR
30, at 1–2; Duvall, ANPR 19, at 2–3; SBA Advocacy, state.’’ The firm added: ‘‘Other disclosures about The Franchise NPR’s proposal to
ANPR 36, at 9; Tifford, ANPR 78, at 7; NASAA, the franchise offering, including litigation and eliminate the first personal meeting
ANPR 120, at 8–9. Five commenters, however, bankruptcy history, franchisor’s and franchisee’s
obligations, royalty rates, initial investment, fees, disclosure trigger prompted
urged the Commission to enforce the Rule with
respect to foreign franchises, raising essentially and trademarks, are U.S.-specific.’’ H&H, ANPR 28, overwhelming support from franchisors
three points. First, many American foreign at 3–4. and their representatives, as well as
247E.g., Miolla, 11 Mar.96 Tr., at 74–79; Shay, id.,
franchise sales contracts require disputes to be NASAA.255 These commenters asserted
resolved in the United States. It would be at 84–85; Forseth, id., at 103; Papadakis, id., at 139;
inconsistent for a franchisor to subject a foreigner Zwisler, id., at 163–64. See also Konigsberg, id., at 250See section 18(a)(1) of the FTC Act (‘‘The
to American law and American courts without 97 (franchisees in foreign countries look to their
own laws, not to anything contained in an Commission may prescribe . . . rules which define
simultaneously extending the benefits of American with specificity acts or practices which are unfair
law, namely pre-sale disclosure. Brown, ANPR 6; American disclosure document).
248See Cendant, ANPR 140, at 4–5 (‘‘Creating a or deceptive acts or practices in or affecting
Argentine Embassy, ANPR 132; Selden, ANPR 133, commerce (within the meaning of section 45(a)(1)
at 2–3. Second, limiting the Rule’s applicability to disclosure document for . . . international master
of this title).’’
sales of domestic franchises would mean that license transactions . . . would be nightmarish. 251 15 U.S.C. 45(a).
American citizens who purchase a franchise to be . . . The cost of compliance would be high and
252 15 U.S.C. 44 (‘‘‘Commerce’’’ means commerce
located abroad from an American franchisor would American franchisors placed at an extreme
not be protected by American law. Stadfeld, ANPR disadvantage when competing with foreign . . . in any Territory of the United States . . ., or
23, at 3; Selden, ANPR 133, at 2–3. See also franchisors.’’). See also Winslow, at 140. between any such Territory and another, or between
Stubbings, ANPR 21. Third, the Commission has 249 For example, Marriott asserted that the same any such Territory and any State or foreign nation,
jurisdiction over sales of foreign franchises and policy concerns about applying the Rule to or between the District of Columbia and any State
should not willingly restrict its own jurisdiction. franchises located abroad are also relevant to Puerto or Territory or foreign nation.’’).
253 15 U.S.C. 44.

Brown, ANPR 4. None of the commenters, however, Rico. Marriott apparently treats Puerto Rico as a
254See 16 CFR 436.1(a), 436.2(g), and 436.2(o).
have shown that limiting the reach of part 436 to foreign country. It contended that furnishing
franchises to be located in the United States or its prospective franchisees in this context with a copy 255See, e.g., PMR&W, NPR 4, at 1; Holmes, NPR
territories, as a matter of policy, compromises the of the franchisor’s disclosure document may be 8, at 3; NFC, NPR 12, at 13; NASAA, NPR 17, at
Commission’s jurisdiction over foreign sales under irrelevant or misleading. Marriott, NPR 35, at 4–5. 3; Marriott, NPR 35, at 9. The Commission also
the FTC Act. The Commission retains its See also J&G, NPR 32, at 3. raised this issue in the ANPR, prompting favorable
that the first personal meeting trigger Commission is persuaded that the first which the documents are delivered, or
has become obsolete in the electronic personal meeting trigger has become the day on which they are signed, may
age, where even large investments are largely obsolete and should be deleted. be counted for purposes of compliance
made by telephone or via the Nonetheless, the Commission shares with the Rule.’’262 The Commission
Internet.256 commenters’ concern about a franchisor intends that the 14 days commence the
Some franchisees and their advocates, influencing a prospective franchisee’s day after delivery of the disclosure
however, maintained that the first decision before the prospect receives the document and that the signing of any
personal meeting trigger continues to franchisor’s disclosures.259 To address agreement or receipt of payment can
serve a useful purpose. For example, this concern, the Staff Report take place on the 15th day after delivery.
one franchisee representative asserted recommended adoption of a new This ensures that prospective
that there is no basis to believe that provision to prohibit franchise sellers franchisees have at least a full 14 days
personal meetings will completely from refusing to honor a prospective in which to review the disclosures.263
become a thing of the past, and warned franchisee’s reasonable request for a Section 436.2(a) of the final amended
that eliminating the current first copy of the franchisor’s disclosure Rule also tightens the language used in
personal meeting disclosure trigger document during the sales process.260 the proposed version of this provision to
would enable franchisors to induce a The Commission has determined to describe the events that trigger the 14-
high level of commitment on the part of follow this recommendation. day disclosure requirement.264 The
prospects through protracted Accordingly, 436.9(e) of the final original Rule required a franchisor to
discussions without providing the amended Rule specifies that it is an provide its disclosure document:
disclosure document, with the result unfair or deceptive practice to ‘‘[f]ail to
ten (10) business days prior to the
that ‘‘the 14 day cooling off period will furnish a copy of the franchisor’s
earlier of (1) the execution by a
then start when the franchisee has disclosure document to a prospective
already decided to make the franchisee earlier in the sales process prospective franchisee of any
investment.’’257 than required under § 436.2 of this part, franchise agreement or any other
The Commission believes that a first upon reasonable request.’’ This agreement imposing a binding legal
personal meeting trigger alone does prohibition does not mean that a obligation on such prospective
little to ensure that a prospective franchisor must tender a disclosure franchisee, about which the
franchisee will receive disclosures early document to any person who may desire franchisor, franchise broker, or any
in the sales process.258 While at the time a copy. Rather, it applies where the agent, representative, or employee
the Rule was promulgated it may have parties have already conducted specific thereof, knows or should know, in
been routine, or perhaps necessary, to discussions or negotiations or otherwise connection with the sale or
have a face-to-face meeting early on, taken steps to begin the sales process. proposed sale of a franchise, or (2)
that is no longer true. Nowadays, a This promotes the goal of early the payment by a prospective
franchisor and a prospect may have disclosure in the sales process without franchisee, about which the
numerous telephone conversations or reliance on the obsolete personal franchisor, franchise broker, or any
send documents to each other via fax or meeting trigger. It also is likely to agent, representative, or employee
email long before any personal meeting impose only a de minimis burden, if thereof, knows or should know, of
occurs. Therefore, after carefully any, on franchisors, who presumably any consideration in connection
considering the comments, the have a disclosure document already with the sale or proposed sale of a
prepared when discussing a sale with a franchise.265
franchisor comment. See Duvall, ANPR 19, at 3; prospective franchisee. In the proposed Rule, section 436.2(a)
Baer, ANPR 25, at 6; Tifford, ANPR, 18 Sept. 97 Tr., would have altered this formulation by
at 158–59; Staff Report, at 76–8. b. Fourteen calendar-days
256E.g., IFA, NPR 22, at 9; Stadfeld, NPR 23, at eliminating the franchisor’s knowledge
Section 436.2(a) of the final amended as a triggering factor, and rephrasing the
4. Kennedy Brooks, for example, observed that
franchise sales can occur entirely electronically Rule requires franchisors to furnish remaining factors. Specifically, the
‘‘where the contact is made over the Web, where E- disclosures ‘‘at least 14 calendar-days proposed provision would have
mail is exchanged, where telephone [calls] are before the prospective franchisee signs a conditioned the disclosure obligation on
exchanged, where documents are sent out by binding agreement with, or makes any
Federal Express, and where, in fact, there never is either ‘‘the prospective franchisee
a face-to-face meeting.’’ Brooks, ANPR, 18 Sept. 97 payment to, the franchisor or an affiliate sign[ing] a binding agreement or
Tr., at 160. See also NCL, ANPR 35, at 4–5; SBA in connection with the proposed pay[ing] any fee in connection with the
Advocacy, ANPR 36, at 9; IL AG, ANPR 77, at 3– franchise sale.’’ The Franchise NPR proposed franchise sale.’’
4. proposed this modification of the
257 Karp, NPR 24, at 5–6. See also Bundy, NPR Several commenters, focusing on the
18, at 5–6; Turner, NPR 13, at 1.
original Rule’s ‘‘10 business day’’ use of the terms ‘‘binding agreement’’
258 In the Interpretive Guides, the Commission disclosure trigger. Commenters who and ‘‘pays any fee,’’ criticized the
acknowledged that the term ‘‘first personal addressed this issue unanimously perceived overbreadth of this proposed
meeting’’ is imprecise: agreed that a 14 calendar-day disclosure provision. For example, H&H and
‘‘Even where a face to face meeting occurs, it is trigger is clearer than the original Rule’s
not necessarily a ‘‘first’’ personal meeting. In
interpreting this term, the Commission will
‘‘10 business day’’ trigger.261 One 262 Holmes, NPR 8, at 3. See also Baer, NPR 11,
consider such factors as whether the franchisor commenter, however, urged the at 10.
clearly indicated at the outset of the discussion that Commission to clarify further how to 263 This approach is consistent with current
it was not prepared to discuss the possible sale of count the 14 days to ‘‘resolve any industry practice. See, e.g.,
a franchise at that time, whether the meeting was www.msaworldwide.com/index.cfm/franchise/
initiated by the prospective franchisee rather than
question as to whether or not the day on calendar (2006). But see J&G, at 2 (noting that this
the franchisor, whether the meeting was limited to approach is inconsistent with the approach used in
259 Karp, at 6. See also Original SBP, 43 FR at the Federal Rules of Civil Procedure).
a brief and generalized discussion and whether
earnings claims were made. The Commission 59639 (‘‘[O]nce a prospect has been ‘hooked,’ it is 264 The Commission also has decided to clarify
believes that by using common sense precautions, difficult, if not impossible, to ‘extricate himself.’’’). the provision further by specifying that the
franchisors can defer the first personal meeting 260 Staff Report, at 77–8. described time period is measured in ‘‘calendar-
until such time as they are prepared to provide the 261E.g., Gust Rosenfeld, at 3; Baer, NPR 11, at 10; days’’ rather than the possibly ambiguous ‘‘days.’’
required disclosures.‘‘ NFC, NPR 12, at 13; AFC, NPR 30, at 2; Marriott, 265 16 CFR 436.2(g). See also Interpretive Guides,
Interpretive Guides, 44 FR at 49970. NPR 35, at 9. See also Winslow, at 76. 44 FR at 49970.
Tricon urged inclusion of the phrase inclusive or imprecise. Accordingly, the Similarly, Marriott noted that the timing
‘‘with the franchisor or an affiliate of the final provision specifies that disclosure of closing the deal is often critical to the
franchisor,’’ arguing that these limiting must be made at least 14 calendar-days franchisee:
words are needed because ‘‘the ‘‘before the prospective franchisee signs as loan commitments may expire,
franchisor cannot control whether a a binding agreement with, or makes any options to acquire sites may expire
prospective franchisee proceeds to payment to, the franchisor or an affiliate or financial commitments may be
commit with independent third parties in connection with the proposed required to prevent the site from
(e.g., lessor of real estate) before franchise sale.’’ Addition of the being sold or leased to a different
expiration of the cooling off period.’’266 underscored language adds clarity and entity. Securities offerings may be
On the other hand, Howard Bundy precision, and puts appropriate limits held up until franchise agreements
urged broadening the Rule so that a on the provision’s reach. are executed. Interest rates may
franchisor would be required to provide
3. Section 436.2(b): Modified contract change so as to make a project
the disclosure document at least 14 days
review period unavailable unless commitments
before the prospective franchisee signs a
are promptly made.272
binding agreement, pays any fee in Part 436 of the final amended Rule
connection with the proposed franchise significantly narrows the circumstances The Staff Report recommended that
sale, or is required to travel or make under which a franchisor must furnish the contract review period be restricted
other financial commitments as a a prospective franchisee with a copy of to instances where the franchisor
precondition to receiving additional the completed franchise agreement in unilaterally modifies its standard
information.267 Mr. Bundy’s concern advance of the date of execution. The franchise agreement. It also
was that prospective franchisees may original Rule required that franchisors recommended substituting ‘‘seven
risk losing significant sums of money to and brokers furnish prospective calendar-days’’ for the Franchise NPR
pursue a franchise before they receive franchisees with a copy of the provision’s ‘‘five days,’’ to be consistent
any disclosures about the franchise completed franchise and related with the revision of the former 10-day
offer. agreements at least five business days disclosure trigger to 14 calendar-
The Commission believes that the before the date of execution.268 The days.273 After careful consideration of
concern that prompts Mr. Bundy’s proposed Rule published in the the record, the staff recommendation,
suggestion is adequately addressed by Franchise NPR retained this and the rationale for that
section 436.9(e) —the new prohibition requirement.269 During the Rule recommendation, the Commission has
barring franchisors from failing to amendment proceeding, several decided to modify the text of this Rule
furnish disclosures earlier in the sales franchisors and their supporters, as well requirement in the manner
process upon reasonable request. A as NASAA, urged the Commission to recommended in the Staff Report.
prospect can always ask the franchisor eliminate the contract review period.270 Section 436.2(b) of the final amended
for a disclosure document before PMR&W, for example, asserted that the Rule specifies that it is a Rule violation
undertaking such obligations as signing delay resulting from the mandatory for any franchisor:
a binding agreement, paying any fee in disclosure period often harms to alter unilaterally and materially
connection with the proposed franchise prospective franchisees: the terms and conditions of the
sale, or incurring travel or other costs. basic franchise agreement or any
Thus, a broad disclosure trigger such as In practice, the 5-day rule typically
hurts rather than aids franchisees, related agreements attached to the
Mr. Bundy advocates is not necessary. disclosure document without
Furthermore, the Commission agrees since the ‘‘price’’ of an additional
concession by the franchisor is an furnishing the prospective
with the commenters who suggested
additional 5-day delay. Franchisees franchisee with a copy of each
that this provision should be more
often are more time sensitive than revised agreement at least seven
carefully tailored so as not to be overly
franchisors, either because of a calendar-days before the
266 H&H, NPR 9, at 21. See also Tricon, NPR 34, financing commitment or a lease prospective franchisee signs the
at 3–4. In a related but distinct vein, Piper Rudnick option that might be expiring or the revised agreement. Changes to an
urged the Commission to clarify in the Compliance need to attend a training program. agreement that arise out of
Guides that the 14-day deadline for disclosure is
As a result, the 5-day rule can negotiations initiated by the
not triggered by a confidentiality agreement. The prospective franchisee do not
firm maintained that prospective franchisees often discourage a franchisee from
sign confidentiality agreements in the course of requesting last-minute changes. trigger this seven calendar-day
negotiations with franchisors. Piper Rudnick, at 5. Thus, the current provision, period.
While the signing of a confidentiality agreement is
‘‘in connection with the proposed franchise sale,’’ especially now that business The Commission intended the
it does not bind the prospective franchisee to opportunities are not covered, has original Rule’s five business day review
purchase the franchise or to undertake other little potential benefit to either requirement to advance two goals: (1) to
obligations, such as the signing of a lease. The firm franchisor or franchisee and may, in
urged clarification that the term ‘‘binding ensure that prospective franchisees
agreement’’ in the 14-day rule is limited to fact, discourage, rather than would have time to review and
franchise agreements or other agreements that promote, last minute understand the franchise and any
commit the prospective franchisee to purchase a negotiations.271 related agreement before undertaking
franchise. Id. The Commission agrees. A
confidentiality agreement—often signed by significant financial and legal
268See 16 CFR 436.1(g).
prospective franchisees before being granted access obligations; and (2) to prevent fraud by
to the franchisor’s operations manual and other 269 The proposed rule provision used the term
‘‘days’’ instead of the original Rule’s ‘‘business
discouraging a franchisor from
proprietary information—may be a necessary initial
step in the sales process, but is not the type of days.’’ unilaterally substituting pages or
agreement that triggers disclosure obligations. This 270 The UFOC Guidelines contain no comparable
assumes, however, that the confidentiality provision requiring advanced disclosure of the 272 Marriott, NPR 35, at 9–10. See also Marriott,
agreement contains no other agreements that, in the completed franchise agreement. at 4.
absence of the confidentiality agreement, would 271 PMR&W, NPR 4, at 4. See also IFA, NPR 22, 273 Staff Report, at 80–2. As a practical matter,
trigger disclosure, such as a lease agreement. at 9; J&G, NPR 32, at 6; Marriott, NPR 35, at 9; GPM, five business days typically amounts to seven
267 Bundy, NPR 18, at 5. NPR Rebuttal 40, at 2. calendar-days.
otherwise altering agreements presented where the franchisor has materially be read narrowly to exclude instances
to the prospective franchisee for signing. altered the terms and conditions of the where both parties receive benefits
The first concern—providing time to standard agreements attached to the during the negotiation.
study the franchise and related disclosure document.276 The The Commission recognizes that a
agreements—is already served by the Commission intends that this not negotiated franchise or related
Rule’s basic disclosure requirement.274 include situations where the only agreement may result in some changes
Attached to each disclosure document is differences between the standard favoring the franchisor. Whether or not
a copy of the franchisor’s basic agreements and the completed a particular change benefits a particular
agreement and any related agreements. agreements are ‘‘fill-in-the-blank’’ party, however, is irrelevant. What is
At the very least, these documents provisions, such as the date, name, and determinative is whether the
enable prospects to review the basic address of the franchisee.277 Nor does it prospective franchisee has knowledge of
terms and conditions governing the include instances where deviations from the change before signing the agreement.
franchise system. Based upon the the standard agreement are initiated at As long as the prospective franchisee
Commission’s experience in enforcing the prospective franchisee’s request. opens the door to changing documents
and administering the Rule, it also Second, the final amended Rule that previously have been presented for
appears that franchisors routinely use targets potential fraud directly by signing, any discussions about changes
standardized franchise agreements. Last- adopting a new prohibition, section and any agreed upon changes are clearly
minute changes to a franchise 436.9(g), which prohibits a franchisor made with the prospective franchisee’s
agreement, therefore, most likely arise at from unilaterally substituting provisions knowledge. Under these circumstances,
the franchisee’s initiation. When a or pages in a franchise agreement redisclosure would be unwarranted. To
prospective franchisee is the party resulting in a material change unless the make this point clear, the final amended
introducing contract modifications, franchisor first alerts the prospective Rule adopts an edited form of Marriott’s
redisclosure by the franchisor is hardly franchisee about the change seven days suggested language noted above:
warranted. Thus, section 436.2(b) before execution of the franchise ‘‘Changes to an agreement that arise out
expressly states that ‘‘[c]hanges to an agreement. This approach remedies of negotiations initiated by the
agreement that arise out of negotiations deceptive unilateral modification of prospective franchisee do not trigger
initiated by the prospective franchisee franchise agreements in a material way this seven calendar-day period.’’
do not trigger this seven calendar-day without imposing additional disclosure
burdens. 4. Section 436.2(c): Actions that
period.’’ constitute the furnishing of disclosures
Further, the Commission does not In response to the Staff Report, a few
believe that the Rule should impede a commenters asked for additional Section 436.2(c) of the final amended
prospective franchisee’s ability to clarification of the meaning of the term Rule specifies what actions constitute
negotiate agreement changes. The delay ‘‘negotiations initiated by the furnishing required documents.
inherent in a mandatory contract review prospective franchisee.’’ For example, Although the original Rule did not
period may discourage negotiations if a Gust Rosenfeld urged the Commission include such a provision, such
prospective franchisee believes that he to make clear in the Compliance Guides specificity is needed now, given the
or she will suffer as a result of the delay. that negotiated changes will be wide array of disclosure formats and
As Marriott noted, the timely signing of considered initiated by the prospective delivery mechanisms available in
a franchise agreement may be a franchisee even where some of the today’s marketplace. Accordingly, a
prerequisite for other parts of the overall changes favor the franchisor.278 In the franchisor will be considered to have
deal, such as obtaining leases and loans. same vein, Marriott urged the furnished a disclosure document if:
Indeed, in most instances a prospective Commission to change the Staff Report’s (1) A copy of the document was
franchisee is in the best position to proposed language ‘‘Changes to a hand-delivered, faxed, emailed, or
judge how much review time is franchise agreement that result solely otherwise delivered to the
warranted and, as a practical matter, can from negotiations initiated by the prospective franchisee by the
seek additional review time, if desired. prospective franchisee . . . .’’ to required date;
Nonetheless, the possibility of fraud ‘‘Changes to a franchise agreement that
arise out of negotiations initiated by the (2) Directions for accessing the
remains a concern. To prevent a document on the Internet were
franchisor from substituting at the last prospective franchisee. . .’’279 Marriott
contended that the original language— provided to the prospective
minute provisions that differ materially franchisee by the required date; or
from those in the agreements previously ‘‘result solely from negotiations initiated
attached to the disclosure document, the by the prospective franchisee’’—could (3) A paper or tangible electronic
final amended Rule includes two copy (for example, computer disk or
safeguards. First, section 436.2(b) 276See Gust Rosenfeld, at 3; IL AG, NPR 3, at 5; CD–ROM) was sent to the address
Stadfeld, NPR 23, at 4. specified by the prospective
retains a mandatory contract review 277 J&G questioned whether ‘‘fill-in-the-blank’’
period of seven full days275 in situations franchisee by first-class United
provisions include ‘‘things such as the specific
radius or geographic area comprising a protected States mail at least three calendar
274See Gust Rosenfeld, at 3. Gust Rosenfeld noted, territory, or the actual number of stores to be days before the required date.280
however, that while the original Rule referred to opened pursuant to an area development
franchise and related agreements, the Staff Report’s agreement, . . . or the specific interest rate payable 280 One commenter urged the Commission to
proposed Rule focused narrowly on franchise by the franchisee.’’ J&G at 3. The Commission will require franchisors to prove that an electronic
agreements. Id. See also J&G, at 3. The final interpret ‘‘fill-in-the-blank’’ provisions narrowly to disclosure document was actually delivered.
amended Rule appropriately broadens the contract include non-contractual items, such as the parties’ Bundy, at 4. He fears that a franchisor could furnish
review provision to refer to franchise and related names, addresses, and dates. To the extent that a disclosure document using slow bandwidth or
agreements. substantive contractual details—such as geographic other procedures, making it difficult for a franchisee
275 As previously noted, part 436 of the final area of a protected territory and interest rates—are to actually read the disclosure document. In the
amended Rule provision substitutes ‘‘seven not disclosed in the basic disclosure document or same vein, another commenter also urged the
calendar-days’’ for the Franchise NPR provision’s its attachments, then the completed document must Commission to spell out what specific documents
‘‘five days’’ to be consistent with the revision of the be disclosed seven calendar days before signing. or types of evidence would qualify as valid
278 Gust Rosenfeld, at 3.
former 10 business-day disclosure trigger to 14 evidence of the mailing date. BI, NPR 28, at 4–5.
calendar-days. 279 Marriott, at 4–5. See also Spandorf, at 2. Continued
The basic concepts of the final cover page requirement fall into four Third, final amended Rule section
amended Rule provision track those in broad categories. First, final amended 436.3, like the proposed version
the corresponding provision proposed Rule section 436.3(e)(4) requires that the published in the Franchise NPR,
in the Franchise NPR, but the language cover page reference sources of eliminates information from the original
has been revised, reorganized, and in additional background information that Rule’s cover page that might be
some cases, expanded, to achieve prospective franchisees can use in misinterpreted as implying greater
greater clarity and specificity.281 conducting their due diligence Commission oversight of franchising
investigations, such as the FTC’s than is the case. Several franchisees
C. Sections 436.3–436.5: The Disclosure
website and its Consumer Guide to contended that phrases in the original
Document
Buying a Franchise.285 This will enable cover page—such as ‘‘information . . .
Sections 436.3–436.5 of part 436 set prospective franchisees to find required by the Federal Trade
forth the substantive disclosures and additional background information on Commission’’ and ‘‘to protect you’’—are
attachments that franchisors must franchising, including information on misleading because they imply greater
include in their disclosure documents, how to use a disclosure document. federal oversight of franchise offerings
beginning with the cover page. Second, final amended Rule section than actually exists.287
1. Section 436.3: Cover page 436.3(b) updates the cover page to Fourth, to promote greater uniformity
embrace electronic disclosure. It with state disclosure laws, final
The cover page informs prospective requires franchisors to include on the amended Rule section 436.3 has been
franchisees that the disclosure cover page their email and primary revised to track more closely the UFOC
document they are receiving contains home page addresses, so that Guidelines’ cover page elements.288 For
important information about the prospective franchisees can example, section 436.3 includes the
franchise offer. The proposed Rule communicate with the franchisor franchisor’s name, logo, brief
published in the Franchise NPR electronically. In the same vein, section description of the franchised business,
incorporated each item of information 436.3(f) permits franchisors to state on total purchase price as reflected in Item
required in the original Rule’s the cover page how prospective 5 (initial fees) and in Item 7 (estimated
counterpart,282 with a few exceptions franchisees may receive a copy of the initial investment), and a notice that
discussed below.283 The final amended disclosure document in an alternative states may be able to provide sources of
Rule provision follows the cover page medium.286 information about franchising.
proposed in the Franchise NPR, with With respect to cover page disclosure
minor editing for clarity. text now specifies that the various required of the total purchase price, final
The proposed cover page set forth in elements of the cover page are to be presented ‘‘in amended section 436.3(e)(1) revises
the Franchise NPR generated little the order and form as follows.’’ Similarly, section
slightly the comparable UFOC
comment. The few comments received 436.3(a) now specifically instructs franchisors that
the title is to appear ‘‘in capital letters and bold Guidelines requirement,289 based on the
generally suggested various type,’’ not merely giving franchisors a model that record developed here. Specifically, BI
improvements to the text of the cover depicts the words ‘‘FRANCHISE DISCLOSURE asserted that the total purchase price
page, many of which have been DOCUMENT’’ in capitals in the Rule’s text, as
proposed in the Franchise NPR. In addition, the disclosure on the UFOC Guidelines
incorporated into the final amended
cover page disclosure informing the prospective cover page can be misleading.
Rule.284 The substantive revisions to the franchisee that he or she must be given 14 days to According to the firm, the cover page
review the document has been conformed to the should put prospects on notice of the
As an initial matter, franchisors always have the convention, adopted elsewhere in the Rule text, to
burden of proof to show that they have complied state time frames in calendar days. See section initial franchise fee that must be paid
with the Rule’s obligation to furnish disclosures. 436.2(a) (setting forth the 14 calendar-day time for the right to commence business
We also believe that the Rule should be as flexible frame within which a franchisor must provide under the mark. BI argued that the
as possible, allowing franchisors to keep records disclosure documents). Thus, the required cover
and to offer proof, in the format that is most
inclusion of the broader Item 5 initial
page disclosure now states that a franchisor must
convenient to them. Nonetheless, to prevent any furnish its disclosures at least 14 calendar-days fees would cloud the issue, making
potential abuse in this area, the final amended Rule before the prospective franchisee signs a binding comparisons of initial franchise fees
sets forth several safeguards. Among other things, agreement with, or makes any payment to, the among competitors difficult: ‘‘For
a franchisor must notify the prospective franchisee franchisor or an affiliate in connection with the
in advance of any prerequisites for obtaining a example, in cases where a franchisor
proposed franchise sale. See J&G, at 4 (noting a
disclosure document. Section 436.6(g). That would wording inconsistency in the Staff Report’s sells or leases the premises of the
include any unusual bandwidth requirements. In recommended Rule text between the cover page franchised business to the franchisee,
addition, the franchisor must ensure that its disclosure and the substantive timing requirement). this payment would need to be included
disclosures not only can be downloaded, but Similarly, the Commission has adopted the staff
preserved for future use. Section 436.6(b). Finally, in Item 5, but would severely distort the
recommendation to adapt the UFOC Guidelines
the final amended Rule retains a receipt cover page disclosure requirement on the total amount of the initial franchise fee
requirement, which will effectively prove delivery. investment necessary to begin operations (as disclosed on the cover page.’’290
Section 436.5(w). explained more fully in the text), but has modified The Commission’s view, however, is
281 For example, where the Franchise NPR
the staff’s recommended version by changing the that the purpose of the cover page’s
version said ‘‘has been delivered,’’ the final Rule phrase ‘‘including [the total amount in Item 5] that
provision says ‘‘was hand-delivered, faxed, must be paid to the franchisor’’ to ‘‘This includes
emailed, or otherwise delivered,’’ to remove any [the total amount in Item 5 (§ 436.5(e))] that must formatted disclosure document. NFC, NPR 12, at 27.
doubt that the alternative modes of delivery are be paid to the franchisor or affiliate.’’ See NASAA; To provide as much flexibility as possible, the
acceptable. Similarly, where the Franchise NPR WA Securities (noting a wording inconsistency in provision permits franchisors to designate either a
version said ‘‘if a copy has been sent . . . by first the Staff Report’s recommended Rule text between specific individual or office as a contact.
class mail,’’ the final amended provision states ‘‘a the cover page disclosure of total investment 287 Kezios, ANPR, 18 Sept. 97 Tr., at 10. See also
paper or tangible electronic copy (for example, necessary to begin operation and Item 5 initial fee Karp, ANPR, 19 Sept. 97 Tr., at 89–90.
computer disk or CD–ROM) was sent . . . by first- disclosure requirements in proposed section 288See generally UFOC Guidelines, Cover Page,
class United States mail’’ to make it clear that a 436.5(e)). Instructions. As explained below, however, the
disclosure document in an electronic format is 285See Heron, ANPR 80. A copy of the Consumer Commission has not adopted the UFOC Guidelines’
considered equivalent to paper. Guide to Buying a Franchise is currently available cover page risk factors.
282 16 CFR 436.1(a)(21).
at the Commission website: www.ftc.gov. 289 UFOC Guidelines, Cover Page, 5 (requiring
283 Franchise NPR, 64 FR at 57302. 286 In drafting this provision, we have recognized franchisors to state the total amounts in Item 5
284 In addition, some non-substantive refinements the NFC’s concern that franchisors have flexibility (initial fees and payments to the franchisor) and
have been made to improve the clarity, consistency, in directing prospects to particular individuals who Item 7 (initial investment).
and organization of the Rule’s text. For example, the can assist the prospects in receiving an alternatively 290 BI, NPR 28, at 5.
price disclosure is not simply to Nonetheless, section 436.3(g) of the final franchising. However, the appropriate
indicate the fee paid to the franchisor amended Rule expressly permits vehicle for educating prospects is
for using the franchisor’s mark, but to franchisors to ‘‘include additional through educational materials, not the
disclose the total costs paid to the disclosures on the cover page . . . to final amended Rule itself. Indeed, the
franchisor associated with commencing comply with state pre-sale disclosure cover page advances this goal because it
business operations. In fact, limiting the laws.’’ This provision effectively will reference the Commission’s
disclosure to the initial franchise fee permits franchisors to include state Consumer Guide to Buying a Franchise,
alone could be misleading because that mandated risk factors on the cover page, which contains the advice the AFA
could understate the totality of fees that without adopting risk factor wants communicated.
must be paid to the franchisor in order requirements into the final amended
2. Section 436.4: Table of contents
to start the business. The cover page Rule.295
price disclosures will better enable The Commission has decided not to The final amended Rule section 436.4
prospective franchisees to assess their make further revisions in the cover page retains the original Rule’s requirement
full potential business costs, and requirements that would call for for a table of contents, but, like the
ultimately their financial risk, than a additional education messages, version of this provision proposed in
disclosure limited to the initial notwithstanding several comments the Franchise NPR, conforms to the
franchise fee alone.291 Nevertheless, the urging us to do so. For example, the UFOC Guidelines in the wording and
Commission recognizes that it is AFA suggested that the Commission the ordering of required disclosure
possible to achieve the goal of informing warn prospective franchisees that they items listed.297 This provision generated
prospective franchisees about the are not purchasing their own business. minimal comment.
investment by referring to Item 7 To that end, the AFA would include the The final amended provision revises
alone—Initial Investment. Indeed, Item following warning on the cover page: the proposed Rule provision’s use of the
5 is basically a subset of Item 7. ‘‘You will not own your own business. UFOC Guidelines headings in only a
Therefore, to maximize consistency You will lease the rights to sell few instances to reflect more accurately
between federal and state law, section [company’s name] goods [services] to the Rule requirements, as follows:
436.3 incorporates a modified version of the public under the [company’s name] (1) Item 1 is changed from ‘‘The
the UFOC cover page references to Item tradename and trademarks. This Franchisor, its Predecessors, and
5 and Item 7, as follows: ‘‘The total agreement will expire and you will have Affiliates’’ to ‘‘The Franchisor and any
investment necessary to begin operation no rights to continue in operation upon Parents, Predecessors, and
of a [franchise system name] franchise is expiration.’’296 Affiliates;’’298 (2) Item 5 is changed
[the total amount of Item 7 (§ 436.5(g))]. The Commission agrees in principle from ‘‘Initial Franchise Fees’’ to ‘‘Initial
This includes [the total amount in Item with the AFA’s broad point that Fees;’’299 (3) Item 7 is changed from
5 (§ 436.5(e))] that must be paid to the prospective franchisees should be fully ‘‘Initial Investment’’ to ‘‘Estimated
franchisor or affiliate.’’ informed about the nature of Initial Investment;’’ (3) Item 11 is
In addition, section 436.3 diverges changed from ‘‘Franchisor’s
from the UFOC Guidelines in that it franchisee’s territory—is a risk that might severely Obligations’’ to ‘‘Franchisor’s
does not call for the two cover page risk affect a franchised outlet’s performance. Michael Assistance, Advertising, Computer
Garner would require franchisors to disclose how Systems, and Training;’’ (4) Item 19 is
factor disclosures required by the UFOC their contracts may be imbalanced: ‘‘[I]sn’t it better
Guidelines regarding choice of venue to have an unbalanced franchisor/franchisee changed from ‘‘Earnings Claims’’ to
and choice of law.292 These two risk relationship disclosed as such early on rather than ‘‘Financial Performance
buried in the legalese of a franchise agreement?’’ Representations;’’ (5) Item 20 is
factors essentially repeat what Dady & Garner, ANPR 127, at 3. Mr. Garner
franchisors already must disclose in recommended that franchisors disclose up-front on
changed from ‘‘List of Outlets’’ to
Item 17 of the disclosure document.293 the cover page: (1) if franchisees have no protected ‘‘Outlets and Franchisee Information;’’
Moreover, mandating the disclosure of territory; (2) if franchisees can be terminated upon and (6) Item 23 is changed from
failing to comply with the franchise agreement; (3) ‘‘Receipt’’ to ‘‘Receipts.’’
these two risk factors on the cover page if franchisees cannot transfer without prior
might incorrectly signal prospective approval; and (4) if the franchisor reserves the right 3. Section 436.5(a) (Item 1): The
franchisees that these are the most to receive royalty payments even if it breaches franchisor and any parents,
important risk factors to consider.294 obligations to provide support services. Dady &
Garner, ANPR 127, at 3. We conclude that each of predecessors, and affiliates
these issues, for the most part, already is addressed Section 436.5(a) of part 436 sets forth
291 BI’s concern would be valid if the cover page
in the substantive rule disclosure items, or is better
required the disclosure of only Item 5 (initial fees), handled in Commission consumer education
the first of the final amended Rule’s
but not Item 7 (estimated initial investment). For materials. substantive disclosure requirements. As
example, in such a scenario, a franchisor who 295See NASAA, at 3–4; WA Securities, at 2
leased premises to a franchisee would include the (Commission should permit state risk factors). See 297 In the original Rule, the table of contents was
lease payment in the Item 5 initial fees, whereas a also Tifford, ANPR, 18 Sept. 97 Tr., at 15–16 set forth in a footnote at the back of the Rule. See
franchisor who required a franchisee to lease (suggesting that the Commission accommodate risks 16 CFR Part 436, note 3.
premises from a third party would not include such factors developed by the individual states). One 298 This recognizes the final amended Rule’s
payment in Item 5. Arguably, this would distort the commenter, GPM, opposed permitting states to add retention of parent disclosures from the original
first franchisor’s Item 5 initial fees. However, lease additional risk factors on the cover page. The firm Rule. See discussion of section 436.5(a)(1) below.
payments to third parties would nonetheless appear suggested that a state should be permitted to require 299 Responding to a comment urging that the title
in Item 7. Accordingly, Item 5 and Item 7, additional information only in a state-specific of Item 5 be changed from ‘‘Initial Franchise Fee’’
considered together, enable prospective franchisees addendum. GPM, NPR Rebuttal 40, at 4. We reject (as proposed in the Franchise NPR) to ‘‘Initial Fees’’
to compare initial expenses across franchise this suggestion. As discussed below, the final so that it would more accurately describe the actual
systems. amended Rule does not preempt state laws that
292 See UFOC Guidelines, Cover Page,
subject matter of the Item, the Staff Report
afford greater or equal protection to prospective recommended that the title of Item 5 be ‘‘Initial
Instructions, iv. franchisees. Indeed, states enjoy great latitude in Fees Paid to the Franchisor.’’ Staff Report, at 121.
293 See Cendant, ANPR 140, at 3 (suggesting that fashioning franchise disclosure laws, including how However, Howard Bundy’s Staff Report comment
risk factors belong in the Item 17 disclosures on and when state-specific information is to be correctly noted that the recommended reference to
franchise relationship issues). included in disclosure documents. Therefore, ‘‘franchisor’’ is inaccurate because the disclosure
294 Other commenters suggested additional risk franchisors must be permitted to add to an FTC applies to fees paid to affiliates as well.
factors. For example, Greg Gaither, a GNC disclosure document in order to comply with non- Accordingly, the final amended Rule deletes the
franchisee, suggested that the cover page include a preempted state law. phrase ‘‘paid to the franchisor’’ in favor of simply
warning that encroachment—marketing in a 296 AFA, NPR 14, at 4. ‘‘initial fees.’’
proposed in the Franchise NPR,300 it ensures that the prospective franchisee a. Parent disclosures
retains the original Rule’s requirement can understand the likely economic The retention of the original Rule’s
that franchisors disclose background risks in purchasing a franchise.308 parent disclosure requirement was not
information on the franchisor and any The final amended rule provision
controversial for the vast majority of
parents and affiliates.301 It also expands tracks the proposed Rule published in
commenters, including NASAA.310 A
the original Rule in three respects to the Franchise NPR, but is more
few comments, however, raised two
maximize consistency with the UFOC narrowly tailored in its treatment of
concerns about it. First, a few franchisor
Guidelines.302 First, franchisors must required disclosures about affiliates.
representatives asserted that a separate
now disclose information about their Slight non-substantive modifications in
parent disclosure is unnecessary
predecessors for the 10-year period the provision’s language and
because a parent, in most instances,
immediately before the close of the organization have also been made to
would already be covered by the Rule’s
franchisor’s most recent fiscal year.303 improve clarity and precision. Two
broad definition of ‘‘affiliate’’311— ‘‘an
This will prevent unscrupulous aspects of section 436.5(a) that
entity controlled by, controlling, or
franchisors from hiding prior prompted comment are discussed in the
following sections: the required parent under common control with another
misconduct and avoiding disclosure entity.’’312 Other commenters
obligations simply by assuming a new disclosures, and the required
predecessor disclosures. Finally, various questioned the relevance of a parent’s
corporate identity.304 Second, information, asserting that a parent is a
franchisors must disclose any suggestions advanced by commenters
but not adopted in the final amended legally distinct entity and that
regulations specific to the industry in disclosing a parent may mislead
which the franchise business operates, Rule are discussed in the final part of
this section.309 prospective franchisees into believing
such as any necessary licenses or that the parent exercises greater
permits,305 that may affect the oversight or gives financial backing to
franchisee’s operating costs and ability competes, an estimate of the number of competitors,
and the registrant’s competitive position, if known the franchisor than actually exists.
to conduct business.306 Third, or reasonably available to the registrant.’’). This These commenters add that a parent
franchisors must describe the general disclosure is intended to aid prospective disclosure simply clutters an already
competition prospective franchisees are franchisees in their decision whether to enter a
proposed relationship. It is neither intended nor lengthy disclosure document.313
likely to face.307 This disclosure better interpreted to be a complete antitrust analysis. On the other hand, the materiality of
Indeed, such a goal would be impractical in light parent information was demonstrated by
300 Franchise NPR, 64 FR at 57302–03. of the number and variety of relevant local antitrust Dr. Spencer Vidulich, a Pearle Vision
301 See 16 CFR 436.1(a)(1), (3), and (6). The markets that might be involved.
Commission historically has emphasized the 308 Franchisors need only state the types of franchisee. He related that his franchisor
materiality of franchisor background information. In businesses that sell competing goods or services. was bought by Cole National
the original SBP, the Commission concluded that: They need not identify specific businesses. See Corporation, which operates company-
‘‘the failure to disclose such material information UFOC Guidelines, Item 1, Sample Answer 1 (‘‘Your owned optical departments in Sears
. . . may mislead the franchisee as to the business competitors include department store service
experience of the parties with whom he or she is departments, service stations, and other national stores. In this instance, the disclosure of
dealing and . . . could readily result in economic chains of muffler shops.’’). This provision is parent information would have alerted
injury to the franchisee because of the franchisee’s designed to prevent deception by ensuring that prospective Pearle Vision franchisees
dependence upon the business experience and prospective franchisees understand whether the that their franchisor is owned by a
expertise of the franchisor.’’ business they are entering is unique. While the
potential benefit of this provision is limited, the company that operates competing
Original SBP, 43 FR at 59642.
302 The final amended Rule also corrects an compliance burden is small. Throughout the outlets.314
apparent oversight in the UFOC Guidelines. Item 1 original SBP, the Commission emphasized that Also, contrary to some commenters’
requires franchisors to disclose the address of the potential economic risks to prospective franchisees assertions, part 436 will not reach all
are material. E.g., Original SBP, 43 FR at 59650–651
franchisor’s agent, but does not specifically require parents when, for example, section
(bankruptcy); at 59662 (sales restrictions); at 59668
the franchisor to identify the agent. IL AG, at 4.
Section 436.5(a)(4) of the final amended Rule now
(post-term covenants not to compete). A 436.5(a) reaches only those affiliates
competition disclosure is also warranted in light of that ‘‘offer franchises in any line of
requires franchisors to both identify the agent and
several franchisee comments about competition
state the agent’s principal business address.
issues. E.g., Packer, ANPR 10 (franchisor has
business or provide products or services
303See UFOC Guidelines, Item 1.
opened franchisor-owned stores to compete with its to the franchisees of the franchisor.’’ As
304See FTC v. Morrone’s Water Ice, Inc., No. 02–
own franchisees); Manuszak, ANPR 13 (competition Dr. Vidulich suggested, it is possible
3720 (E.D. Pa. 2002) (company allegedly from encroachment); Gray, ANPR 22 (franchisor
reincorporated as a ‘‘licensor’’ following an adverse
that a parent does not sell franchises at
sold to competing system); Lopez, ANPR 123
arbitration decision); FTC v. Inv. Dev., Inc., Bus. (competition from franchisor’s co-branded outlets).
all—falling outside the scope of the
Franchise Guide (CCH), ¶ 9326 (E.D. La. 1989) 309 The Commission declines to adopt one section’s coverage of ‘‘affiliates’’—but
(company allegedly reincorporated after filing of additional recommendation in the Staff Report. nonetheless could operate competing
Commission law enforcement action). Cf. FTC. v.
Jani-King, Int’l, No. 3–95–CV–1492–G (N.D. Tex.
Specifically, staff recommended that, in addition to company-owned outlets. A requirement
the disclosure of the general competition a
1995) (company allegedly conducted business franchisor may face, the Rule should also require 310See 16 CFR 436.1(a)(1)(i). The Commission
through multiple regional corporations thereby franchisors to disclose ‘‘any competition from any
avoiding certain disclosures). stated in the original SBP that parent information
entity in which an officer of the franchisor owns an
305See UFOC Guidelines, Item 1E Instructions, vi. is material and that it would require the disclosure
interest.’’ Staff Report, at 98. The purpose of this
306E.g., FTC v. Car Checkers of Am., Inc., No. 93– of information about a parent, even though it
recommendation was to require franchisors to
623 (mlp) (D.N.J. 1993) (failure to disclose state recognized that the UFOC Guidelines contained no
disclose any potential conflicts of interest by their
restrictions on the sale of service contracts); United comparable disclosure requirement. Original SBP,
officers. See Bundy, NPR 18, at 6. But see Piper
States v. Lifecall Sys., Inc., No. 90–3666 (D.N.J. 43 FR at 59639.
Rudnick, at 5 (contending that such a provision 311 Gust Rosenfeld, at 2; PMR&W, NPR 4, at 9;
1990) (failure to disclose state registration would be overbroad, sweeping in even minority
requirements). Cf. Funeral Rule, 16 CFR 453.3 (it is ownership of mutual funds); J&G, at 4 (suggesting H&H, NPR 9, at 15–16; J&G, NPR 32, at 9.
312 Section 436.1(b).
a misrepresentation to mischaracterize state or local that such a provision would be overbroad, and
funeral industry laws). should be limited to only ‘‘material interests’’ in a 313E.g., IFA, at 3; Prudential Financial, at 1;
307 UFOC Guidelines, Item 1E Instructions, v. Cf. competitor). However, the Commission believes Spandorf, at 3.
SEC Regulations-K (Standard Instructions for Filing that ordinary corporate fiduciary and conflicts of 314 Vidulich, ANPR, 22 Aug. 97 Tr., at 16–17.
Forms Under Securities Act of 1933, Securities Act interest law principles are sufficient to resolve any Similarly, a franchise system with a poor financial
of 1934, and Energy Policy and Conservation Act potential harm when officers of a franchisor own record or significant litigation could, for example,
of 1975), 17 CFR 229.101(c)(1)(x) (requiring interests in competitors. See generally American seek to shield itself from disclosure by establishing
registrants to list, where material, ‘‘the identity of Law Institute, Principles of Corporate Governance: a new subsidiary that will offer identical franchises,
the particular market in which the registrant Analysis and Recommendations (2005). but under a different trademark.
that a franchisor identify any parent, rulemaking process, no commenters introduce an inconsistency with the
therefore, is necessary to ensure that any objected to the basic principle that Guidelines on this point.
parent not falling within Item 1’s predecessor information should be Finally, IL AG suggested that a
limited use of affiliate will be disclosed. disclosed.319 A few commenters, description of the competition should
Moreover, the Item 1 parent however, questioned the scope of the include competitors of the franchisor’s
disclosure is significantly limited: disclosure. One commenter asserted that affiliates.324 We note that the UFOC
franchisors must simply identify a the 10-year reporting period is too long, Guidelines require only a ‘‘general
parent.315 In contrast with the Item 1 noting that Item 2 establishes only a description of the competition.’’
disclosures for affiliates and five-year disclosure period for business Depending upon the franchise system,
predecessors,316 a franchisor need not experience of company officers and competition of affiliates could be
disclose, for example, the parent’s managers.320 Another commenter urged sizeable, especially with respect to
business background, length of time the Commission to narrow the focus of large, publicly traded franchisors. We
selling franchises or engaging in other Item 1 to require the disclosure of are not inclined to diverge from the
lines of business.317 The Commission UFOC Guidelines in the absence of
information about only any immediate
concludes that this limited disclosure evidence showing a problem on this
predecessor.321 The Commission is not
will, at most, impose a minor burden for point.
convinced, however, that the burden of
most franchise systems that is
outweighed by the potential benefit to supplying 10 years of predecessor 4. Section 436.5(b) (Item 2): Business
prospective franchisees. information—as the majority of experience
franchisors already do to comply with Consistent with the original Rule and
b. Predecessor disclosures the UFOC Guidelines—is so great as to UFOC Guidelines, section 436.5(b) of
Part 436 of the final amended Rule justify deviating from the UFOC the final amended Rule requires the
adopts the UFOC Guidelines’ Guidelines on this issue. disclosure of the business experience of
requirement that franchisors disclose c. Suggestions for additional disclosure the franchisor’s directors, trustees,
background information about any general partnerships, and certain
requirements that the Commission has
predecessors for 10 years.318 During the executives.325 It differs from the UFOC
not adopted
Guidelines’s Item 2, however, in two
315 Section 436.5(a)(1). IL AG urged the Commission to respects. First, it does not require a
316 Section 436.5(a)(7). franchisor to disclose brokers.326
317 Despite the narrow Item 1 parent disclosure
expand the scope of Item 1 in several
in section 436.5(a)(1), one commenter asserted that respects. First, IL AG would expand the Second, it expands the original Rule and
the parent disclosure could be a significant burden types of business organizations that UFOC Guidelines to prevent fraud by
on some franchisors with elaborate corporate must be disclosed under section requiring the disclosure of prior
structures. Spandorf, at 3. She contended that the experience of not only directors and
final amended Rule would require a franchisor to
436.5(a)(5) to include ‘‘members with a
disclose ‘‘all non-affiliate parents, including all controlling interest in the franchisor.’’ executives, but other individuals who
intermediate parents, not just the ultimate parent.’’ In its view, this is necessary to cover do not necessarily possess a title, but
Id. Accordingly, she urged the Commission to limit limited liability companies.322 The nonetheless will exercise management
the parent disclosure to those parents with ultimate responsibility relating to the sale or
control ‘‘and any intermediate parent that Commission declines to adopt this
guarantees the franchisor’s obligations to suggestion because the examples of operation of franchises being offered for
franchisees.’’ Id. The Commission rejects these different types of entities included there sale. Additionally, this final amended
suggestions. Item 1 requires franchisors to disclose is intended to be illustrative, not Rule provision is narrower than its
the identity of parents to ensure that a prospective
franchisee understands who may control or exhaustive, and additional examples of counterpart as proposed in the
influence the franchisor’s operations. As noted business organizations are unnecessary. Franchise NPR, in that it deletes the
above in the example of Pearle Vision, it is highly proposed requirement to disclose prior
material to a prospective Pearle Vision franchisee In addition, IL AG suggested that Item
experience of the officers or executives
that Pearle Vision is owned and controlled by a 1 be expanded to include the date when
competing system—Cole Vision. That information the franchisor was organized.323 The
would escape disclosure, however, if Cole Vision
324 IL AG, at 4.
did not guarantee Pearle Vision’s performance or if
Commission also declines to adopt this 325See 16 CFR 436.1(a)(2). In the original SBP, the
Cole Vision were, in turn, a subsidiary of a larger suggestion. The franchisor already must Commission explained that a franchisor’s failure to
corporate parent. disclose how long it has been in disclose its business experience violates Section 5
318 One commenter suggested that the
business and has offered franchises. We because ‘‘it (1) misleads the prospective franchisees
Commission address in the Compliance Guides an as to the business experience of the parties with
inconsistency between the Item 1 disclosure set
believe that time period, not the date of whom they are dealing, and (2) could readily result
forth in the Staff Report and the UFOC Guidelines’ organization, is most relevant to a in economic injury to franchisees due to their heavy
Item 1 disclosure. Whereas the UFOC Guidelines prospective franchisee. Moreover, dependence upon the experience of those persons
clearly limit the predecessor disclosures—the associated with the franchisor.’’ Original SBP, 43
neither the original Rule nor the UFOC FR at 59642. See Buckley, ANPR 97, at 1
predecessor’s name and address and prior
experience—to a 10-year reporting period, the Staff Guidelines requires this information, (‘‘franchisor represented his company as highly
Report’s proposed revised Rule could have been and the Commission is reluctant to trained in all phases of the business and capable of
read as limiting the application of the time period supporting a franchise system’’); FTC v. Nat’l
to only the predecessor’s name and address. Piper 319 As noted above, this provision prevents
Consulting Group, Inc., Bus. Franchise Guide (CCH)
Rudnick, at 5. The Commission agrees that the 10- ¶ 11335 (N.D. Ill. 1998) (claims regarding medical
franchisors from hiding prior misconduct and billing expertise and contacts with medical
year reporting should also limit the reporting of a
avoiding disclosure obligations simply by assuming community are material); FTC v. Richard L.
predecessor’s experience, and the final amended
a new corporate identity. See FTC v. Morrone’s Levinger, No. 94–0925–PHX RCB (D. Ariz. 1994)
Rule is revised accordingly by adding a cross-
Water Ice, Inc., No. 02–3720 (E.D. Pa. 2002) (earnings claims tied to purported expertise in the
reference that limits the applicability of the
(company allegedly reincorporated as a ‘‘licensor’’ restaurant industry are material); FTC v. Car
experience disclosures in section 436.5(a)(7) to only
following an adverse arbitration decision); FTC v. Checkers of Am., Inc., No. 93–623 (mlp) (D.N.J.
those predecessors covered by section 436.5(a)(2).
Inv. Dev., Inc., Bus. Franchise Guide (CCH), ¶ 9326 1993) (claims regarding car inspection business
The commenter also suggested that the prior
(E.D. La. 1989) (company allegedly reincorporated
experience of affiliates should similarly be limited expertise are material). Cf. FTC v. Goddard Rarities,
after filing of Commission law enforcement action). Inc., No. CV93–4602–JMI (C.D. Cal. 1993)
to 10 years. Id. This suggestion goes too far and 320 H&H, NPR 9, at 16.
would introduce an unnecessary inconsistency (representations of expertise in coin investments are
321 GPM, NPR Rebuttal 40, at 4.
between the final amended Rule and the UFOC material).
322 IL AG, at 4.
Guidelines, which does not so limit affiliate 326See UFOC Guidelines, Item 2 and Instructions,
disclosures. 323 IL AG, at 4. v.
of any parent of the franchisor. Each of franchisees need to know the identity operation of franchises offered by this
these issues is discussed in detail and business experience of the document.’’332 Individuals listed in Item
below. individuals in command of the 2 must also disclosure their litigation
franchisor in order to assess whether (Item 3) and bankruptcy (Item 4)
a. Brokers
these individuals are likely to be able to histories as well. This provision ensures
The original Rule did not require perform as promised under the that franchisors cannot conceal a
disclosure of brokers. The proposed franchise agreement. Unlike franchisors, manager’s lack of experience, prior
Rule, however, tracking the UFOC brokers do not create or implement litigation, or bankruptcy history by
Guidelines, required that franchisors franchisor policy, nor do they oversee simply avoiding giving the manager a
‘‘list all brokers.’’327 As noted above, performance of post-sale obligations to formal title.333 Although the language
based upon the comments, the final the franchisee. Accordingly, prospective has been revised to achieve greater
amended Rule does not include the franchisees are less likely to give clarity and specificity, this aspect of this
UFOC Guidelines’ provision that decisive weight to an individual provision is conceptually very similar to
franchisors identify its brokers in Item broker’s expertise or background in the rule as proposed in the Franchise
2.328 During the Rule amendment assessing the merits of purchasing a NPR.334 The breadth of this provision is
proceeding, a few commenters asserted franchise. intended to leave no doubt that
that such disclosure is unnecessary.329 Moreover, even if a broker were to franchisors must disclose all individuals
For example, Frannet, a franchise make false claims, the prospective who in fact exercise management
broker, voiced concern that the franchisee has the benefit of the responsibility over the sale or operation
proposed inclusion of brokers in Item 2 franchisor’s disclosure document to of franchises being offered for sale,
would require franchisors to disclose assess those claims before purchasing a regardless of any formal title.335
immaterial information about ‘‘literally franchise. For example, a franchisor
hundreds of business brokers each of statement in Item 19 that it does not 332 One commenter voiced concern that Item 2
whom will receive a commission in the authorize the making of financial could be misinterpreted to include owners with a
event that a prospect referred by any controlling interest and asked the Commission to
performance claims should raise doubts clarify this point in the Compliance Guides. Gust
such person ultimately purchases a about a broker’s veracity if the broker Rosenfeld, at 3–4. We note that neither the original
franchise,’’ resulting in a ‘‘voluminous’’ were to make his or her own Rule nor the final amended Rule focuses on
UFOC, with ‘‘no value to the performance claims. Similarly, a ownership. Rather, the determining factor is control
prospective franchisee.’’330 over the franchise operations. Accordingly, an
franchisor’s statement in Item 3 that it owner/investor in a franchise system would not
On the other hand, Michael Seid, a has been sued by franchisees would ordinarily have to be disclosed in Item 2, unless
franchise industry consultant, strongly dispel any claim by a broker that the that owner/investor also manages or otherwise
objected to the deletion of broker franchisor has not been previously sued. exercises control over the franchise operation.
information from Item 2 because The counteractive effect of the
333See FTC v. P.M.C.S., Inc., No. 96–5426
prospective franchisees often rely on (E.D.N.Y. 1996) (franchisor failed to disclose control
disclosure document gives the figure with prior bankruptcy); FTC v. The Building
statements made by brokers in deciding Commission reason to doubt that the Inspector of Am., Inc., No. 93–10838Y (D. Mass.
whether to purchase a franchise. In his inclusion of broker information among 1993) (alleging that the franchisor failed to disclose
view, prospective franchisees perceive the required Item 2 disclosures would the franchisor’s current executive officers and their
brokers as being independent, third- business experience, litigation history concerning
yield more than a scant benefit to fraud or misrepresentation, and bankruptcy
party experts. He opined that listing prospective franchisees. Further, the history); FTC v. Why USA, Inc., No. 92–1227–PHX–
them in a disclosure document would disclosure of brokers would also be SMM (D. Ariz. 1992) (alleging that franchisor failed
dispel that notion, making it clear that cumbersome, especially for large to disclose officers and their prior litigation).
brokers are authorized agents of the During the Chicago public workshop, a former
franchise systems that may employ franchisee related that his franchisor did not
franchisor.331 hundreds of brokers nationally. Thus, disclose that the franchisor’s director of franchising
Some prospective franchisees may the Commission concludes that this (who was not a titled corporate officer) had been
rely on a broker’s statements in the benefit would not likely outweigh the discharged in bankruptcy. The franchisee stated
course of purchasing a franchise, and that, because the franchisor was small, operated by
corresponding compliance costs and only five or six people, such a disclosure was
some brokers may make false claims— burdens. ‘‘critical, even though this person was not formally
such as false financial performance Finally, the deletion of brokers from an officer.’’ Lay, ANPR, 22 Aug. 97 Tr., at 6. See
representations. Nonetheless, the Item 2 as had been proposed in the also NASAA, NPR 17, at 3 (‘‘The law enforcement
Commission is not convinced that experience of some members of the [NASAA]
Franchise NPR obviously does not Franchise Project Group reflects that franchisors
broker disclosures are warranted in a curtail brokers’ liability for false claims. and sellers of business opportunities have
franchise disclosure document. Franchise brokers, like virtually all attempted to avoid litigation disclosures
Item 2 appropriately requires other individuals conducing interstate . . . by purposefully not giving the title ‘officer’
franchisors to disclose the background commerce, remain liable under Section to individuals who, in fact, exercise significant
of those individuals who control the management responsibility over a business.’’). Cf.
5 of the FTC Act for their own FTC v. Netfran Dev. Corp., No. 05–CV–22223 (S.D.
franchisor and those who actually misrepresentations. In short, while the Fla. 2005) (failure to disclose that executive was
manage franchisees. That information is Commission favors adopting UFOC subject to a Commission order involving fraud or
material because prospective Guidelines approach to the fullest
deceptive practices); FTC v. Int’l Bartending Inst.,
No. 94–1104–A (E.D. Va. 1994) (franchisor failed to
extent possible, we believe this is one disclose that chairman was subject to a Commission
327 Franchise NPR, 64 FR at 57334.
area where an exception is warranted. order involving fraud or deceptive practices).
328 Franchisors, of course, would still be required 334 The Franchise NPR’s version of Item 2 also
to include broker information, if mandated by state b. Individuals with management referenced subfranchisors. As one commenter
law.
329 E.g., Gust Rosenfeld, at 4; J&G, NPR 32, at 10.
responsibility noted, however, a reference to subfranchisors is
unnecessary because the term ‘‘franchisor,’’ as set
330 Frannet, NPR 2, at 2. In this regard, it is Section 436.5(b) of part 436 requires forth in the Rule’s definitions (and the UFOC
noteworthy that, had the broker disclosure a franchisor to disclose not only the Guidelines’ definition), already includes the term
requirement been retained in the final amended background of the franchisor’s directors ‘‘subfranchisor.’’ Gust Rosenfeld, at 4. Therefore,
Rule, broker information also would have been that reference has been deleted.
required in Items 3 and 4 disclosures. See Staff and executives, but also ‘‘individuals 335See Staff Report, at 101–02. In the Franchise
Report, at note 320. who will have management NPR, the Commission proposed achieving this goal
331 Seid, at 5–7. See also IL AG, at 4. responsibility relating to the sale or by including within the definition of ‘‘officer,’’ any
c. Parents amended Rule requires disclosure, in (5) whether and to what extent
Part 436 as proposed in the Franchise some instances, of litigation involving disclosure of franchisor-initiated
NPR required franchisors to disclose the the franchisor’s parent.338 Consistent litigation would be required. Each of
prior experience of a parent’s officers or with the UFOC Guidelines, however, these topics is discussed in the sections
executives.336 This proposal, however, part 436 expands on the original Rule by that follow.
was criticized on the grounds that such requiring franchisors to disclose actions
involving not only the franchisor, its a. Parent disclosures
a broad disclosure about directors and
officers of a parent would clutter Item directors and officers, and affiliates, but The original Rule required the
2 with information ‘‘of marginal predecessors as well.339 In addition, disclosure of litigation relating to a
relevance and importance to prospective section 436.5(c)(1)(i)(B), in accord with franchisor’s parent.341 Part 436 as
franchisees.’’337 In response to the UFOC Guidelines, now requires the
proposed in the Franchise NPR retained
commenters’ persuasive arguments, the disclosure of routine litigation that may
this broad approach. The Commission,
Commission has determined to omit the impact the franchisor’s financial
however, has decided that the final
requirement from section 436.5(b). condition or ability to operate the
amended Rule should narrow
The Commission has come to the business.340 At the same time, as also
proposed in the Franchise NPR, the considerably the scope of the
view that the disclosure of prior franchisor’s obligation to disclose
experience of individuals associated Commission has determined that
section 436.5(c)(1)(B)(ii) of the final litigation relating to a parent. As
with a parent of a franchisor is generally recommended in the Staff Report, the
unnecessary. While in many instances a amended Rule should expand on both
the original Rule and UFOC Guidelines final amended Rule requires the
parent’s officers may exercise general disclosure of litigation relating to a
management responsibilities that may by requiring franchisors to disclose
material franchisor-initiated litigation franchisor’s parent only in the case of a
affect the franchisor, they are not ‘‘parent . . . who guarantees the
necessarily involved in managing the against franchisees involving the
franchise relationship. franchisor’s performance.’’342
franchisor or its franchises. Because of
their lack of direct control over the The comments on Item 3 focused on The narrowed scope of the parent
franchisor, background information on five broad topics: (1) whether and to litigation disclosure responds to
them is unlikely to be material to a what extent disclosures about a persuasive comments challenging the
prospective franchisee. Accordingly, the franchisor’s parent should be required; value of broad parent litigation
minimal benefit that might accrue to (2) to what extent disclosures about a disclosures to prospective purchasers
prospective franchisees from a franchisor’s affiliates should be and complaining of the burden to
disclosure of the prior experience of required; (3) whether disclosure about franchisors. Typical of these comments
individuals associated with the out-of-court settlements favorable to the are those submitted by PMR&W, arguing
franchisor’s parent would not likely franchisor or settlements that by their that the parent litigation disclosure is
outweigh the compliance costs and terms are confidential should be confusing at best and offers little if any
burdens. required; (4) whether the Rule as benefit to prospective franchisees, and
proposed in the Franchise NPR needed noting that a publicly-traded parent may
5. Section 436.5(c) (Item 3): Litigation clarification to avoid implying that face countless securities fraud claims,
Section 436.5(c) of the final amended dismissed actions should be disclosed for example, that would have to be
Rule retains the original Rule’s in cases when no liability is imposed disclosed, ‘‘overflowing [the disclosure
requirements to disclose certain upon or accepted by the franchisor; and document] with largely irrelevant parent
pending and prior litigation, as well as litigation summaries, obscuring and
338See 16 CFR 436.1(a)(4). In the original SBP, the
current injunctive or restrictive orders. diverting readers from the more
Commission stated that a franchisor’s litigation
Like the original Rule, the final history is material because it bears directly on the important disclosures of franchisor
‘‘integrity and financial standing of the franchisor.’’ litigation, and greatly increasing
‘‘de facto officer,’’ ‘‘namely any individual with Original SBP, 43 FR at 59649. See, e.g., United compliance burdens and costs.’’343
significant management responsibility for the States v. We The People Forms and Serv. Centers
marketing and/or servicing of franchisees whose USA, Inc., No. CV 04 10075 GHK FMOx (C.D. Cal. Based upon review of the record,
title does not reflect the nature of the position.’’ 2004) (full disclosure would have revealed lawsuits including the Staff Report, the
Franchise NPR, 64 FR at 57332. Some commenters and injunctions involving the franchisor’s Commission is persuaded that litigation
agreed with the Commission that it is necessary to bankruptcy petition preparation services); FTC v.
capture individuals who, without an appropriate WhiteHead, Ltd., Bus. Franchise Guide (CCH) ¶ involving a parent (which may be
title, in fact function as officers or directors. E.g., 10062 (D. Conn. 1992) (full disclosure would have voluminous in the case of a publicly-
NASAA, NPR 17, at 3. Others asserted that the term revealed a $10 million judgment in a fraud action traded parent) may have little bearing
‘‘de facto officer’’ is ‘‘nebulous,’’ creating more brought by former franchisees); FTC v. Joseph on the operation of the franchise system
problems than it would solve. E.g., Snap-on, NPR Hayes, No. 4:96CV02162SNL (E.D. Mo. 1996) (full
16, at 2; Gurnick, NPR 21, at 3–4; J&G, NPR 32, at disclosure would have revealed prior state fines and itself. Yet, the Commission does not
8; Marriott, NPR 35, at 12. Another voiced concern injunctions); FTC v. Inv. Dev., Inc., Bus. Franchise believe that complete elimination of the
about application to large corporations, where there Guide (CCH) ¶ 9326 (full disclosure would have parent litigation disclosure is justified.
may be many directors or managers, each of whom revealed insurance fraud convictions). See also Rather, the Commission has determined
would now have to be disclosed. Tricon, NPR 34, Marks, ANPR, 19 Sept. 97 Tr., at 8 (‘‘I always
at 3. Based upon the Franchise NPR comments, the counsel clients . . . to look at the litigation section to narrowly tailor the parent litigation
Commission has determined to delete the term and among one of the first sections.’’). disclosure to those circumstances where
description of ‘‘de facto officer’’ from the final 339 See UFOC Guidelines, Item 3. See AFA, at 2. the parent guarantees the franchisor’s
amended Rule. At the same time, Item 2 requires 340 See UFOC Guidelines, Item 3 A. See also
performance, as recommended in the
a franchisor to identify all individuals who have AFA, at 2. Under this provision, a fast-food
management responsibility over the franchises, restaurant franchisor, for example, would have to
regardless of any formal title. This is true even if disclose a product liability class action suit that, if
341 As noted previously, this is one area where
the individual happens to be an officer of a parent successful, might materially affect its financial the original Rule was broader than the UFOC
or an affiliate. condition or ability to maintain its business Guidelines, which require no disclosure of parent
operations. This disclosure is consistent with long- information, unless the parent is an affiliate.
337 Lewis, NPR 15, at 12. See also Gust Rosenfeld, 342 Staff Report, at 104.
standing Commission policy that a franchisor’s
at 4. BI, NPR 28, at 5. But see Bundy, NPR 18, at continued financial viability and ability to perform 343 PMR&W, NPR 4, at 9. See also IFA, at 3;
6–7 (Item 2 should cover not only officers and as promised is material to a potential investor. See, PREA, at 1–2; Spandorf, at 4; Triarc, NPR 6, at 2;
executives of parents, but affiliates as well). e.g., Original SBP, 43 FR at 59649. NFC, NPR 12, at 28; PREA, NPR 20, at 1.
Staff Report.344 Where a parent, for involving not only affiliates who offer concerns documented in the record,
whatever reason, induces franchise sales franchises under the franchisor’s would be burdensome, especially for
by promising to back the franchisor principal trademark, but also any large companies with multiple brands,
financially or otherwise guarantees the affiliate who ‘‘guarantees the and would not likely yield
franchisor’s performance, the parent’s franchisor’s performance;’’ and (2) with commensurate benefits to prospective
prior litigation history becomes material respect to the requirement to disclose franchisees.
to the prospective franchisee and must government injunctions or restrictive Nevertheless, as noted above, the
be disclosed.345 As noted throughout orders, actions involving an affiliate Commission has determined to expand
this document, background information ‘‘who has offered or sold franchises in the requirement to disclose affiliate
on all parties having post-sale any line of business within the last 10 litigation in two respects in order to
performance obligations is material to a years.’’346 provide prospects with material
prospective franchisee. There is no The affiliate litigation disclosure information. First, for currently effective
meaningful distinction between parents provision generated limited government injunctive or restrictive
who make performance guarantees and comment.347 One commenter urged the orders delineated in section 436.5(c)(2),
franchisors with various contractual Commission to broaden Item 3’s scope the final amended Rule adopts the Staff
performance obligations. to include litigation involving all Report recommendation to broaden Item
affiliates, not just those under the 3 affiliate coverage to include any
b. Affiliates franchisor’s principal trademark. The affiliate who has offered or sold
As noted, the original Rule did not UFOC Guidelines’ narrow reach extends franchises in any line of business within
require the disclosure of litigation only to instances where affiliates offer the last 10 years.348 In the Commission’s
involving a franchisor’s affiliate. The franchises under the franchisor’s view, a government injunction or
proposed rule published in the principal trademark. Arguably, this comparable order349 (with or without a
Franchise NPR incorporated the UFOC restrictive approach could allow a civil penalty or other redress), may be
Guidelines’ requirement that franchisors franchise system to hide derogatory an indicator of fraud or other unlawful
disclose litigation involving an ‘‘affiliate facts about its litigation history by conduct.350 Accordingly, a franchisor
who offers franchises under the acquiring and operating a competing with a history of fraud or Rule
franchisor’s principal trademark.’’ franchise system that uses a different violations should not be able to avoid
Section 436.5(c) of the final amended mark. In such an instance, the newly- disclosure of government actions against
Rule retains this concept, but modestly acquired franchisor would have no it merely by establishing a new
broadens the requirement, consistent obligation to disclose its past litigation, corporation or switching trademarks.
with the Staff Report and Staff Report falling outside the definition of both We believe this approach will result in
comments, to encompass: (1) litigation ‘‘predecessor’’ and ‘‘affiliate.’’ On the the disclosure of material litigation
other hand, the record contains no history, without unduly burdening
344 See Staff Report, at 104. The Staff Report
suggestion that such instances are large, multi-brand franchise networks.
recommendation that the parent litigation
disclosure be narrowed to instances where the common. Thus, the Commission does Second, section 436.5(c)(1) of the final
parent guarantees the franchisor’s performance not believe it warranted to require amended Rule requires franchisors to
prompted few comments. PREA and Spandorf franchisors to disclose all affiliate
opined that parent disclosures have merit where the
disclose litigation involving not only
franchisor has few assets or a prior history such that
litigation to address that hypothetical affiliates that offer franchises under the
the prospect is looking to the parent for assurance concern. Such a measure would be franchisor’s principal trademark, but
of continued financial viability, and advocated an broader than necessary to address also any affiliate that guarantees
exemption from the Item 3 parent litigation
disclosure if the franchisor has sufficient net worth performance. This responds to
346 Item 3 of the proposed Rule published in the
and experience. They proposed a net worth of not NASAA’s comment, urging the
less than $5 million and a requirement that the Franchise NPR required disclosure of government
enforcement actions only for an affiliate ‘‘who offers Commission to make clear that the term
franchisor has had at least 25 franchisees for each
of the preceding five years. PREA, at 1–2; Spandorf, franchises under the franchisor’s principal ‘‘affiliate’’ in Item 3 includes those
at 4–7. See also PREA, NPR 20, at 1. The trademark.’’ The final amended Rule requires such guaranteeing performance, similar to the
Commission finds this suggestion unworkable. As disclosure for ‘‘an affiliate who has offered or sold parent disclosure noted above.351 As
noted throughout this document, the Commission franchises in any line of business within the last 10
years.’’ Section 436.5(c)(2) (emphasis added). NASAA noted, there is no practical
favors bright-line provisions that enable franchisors
to determine easily where the Rule applies to a 347 Piper Rudnick urged the Commission to distinction between a parent and an
franchise sale. Moreover, the Commission is clarify in the Compliance Guides that disclosures affiliate who guarantees performance. In
disinclined to adopt exemptions from specific involving affiliates and predecessors—in Items 1, 3 both instances, the prospective
required disclosures—as opposed to exemptions and 4 —should be limited to the time period when
the affiliates or predecessors were ‘‘associated’’ or
franchisee may rely on the guarantee in
from the Rule itself. On balance, the Commission
believes that the narrowly-tailored parent litigation ‘‘affiliated with the franchisor.’’ Piper Rudnick, at considering whether to purchase the
disclosure included in the final amended Rule 5–6. The Commission disagrees. As an initial franchise. Therefore, the litigation
strikes the appropriate balance, reducing matter, depending upon the facts, a predecessor history of both parents and affiliates
compliance costs and burdens without depriving entity and successor franchisor may not exist
prospective franchisees of material information contemporaneously and thus may never be
‘‘associated’’ or ‘‘affiliated’’ with each other. As for
348 Staff Report, at 104–5.
necessary to make an informed investment
decision. affiliates, Piper Rudnick’s suggestion could
349 The Item 3 disclosure of currently effective
345 But see PREA, at 1–2; Spandorf, 4–7 (asserting seriously undermine the very purpose for the injunctive or restrictive orders and decrees is also
that prior litigation of a parent who guarantees disclosure itself. The affiliate disclosures in Items broader than the other Item 3 disclosures in that it
performance may be irrelevant, and urging the 1, 3, and 4 ensure that a prospective franchisee covers Canadian orders and decrees. This is
Commission to adopt a net worth standard). As an understands fully the background of the consistent with the UFOC Guidelines. See UFOC
alternative, PREA and Spandorf suggested that the franchisor’s affiliates. Significant litigation or a Guidelines, Item 3, C.
350 We note that there is no private right of action
Commission adopt an approach similar to that of prior bankruptcy, for example, may signal that the
the SEC for the disclosure of legal proceedings to affiliate lacks business acumen and, therefore, poses to enforce the Franchise Rule. See, e.g., Holloway
securities investors: a guarantor need only disclose a potential risk, especially if franchisees of the v. Bristol-Meyers Corp., 485 F.2d 986 (D.C. Cir.
material legal proceedings other than ordinary system are contractually required to conduct 1973) (no implied private right of action under the
routine litigation. PREA, at 2. We noted, however, business with the affiliate. For that reason, the FTC Act); Days Inn of Am. Franchising, Inc., v.
that Item 3 is already limited to material suits, or history of the affiliate as a business entity, not its Windham, 699 F. Supp. 1581 (N.D. Ga. 1988) (no
individual suits which, in the aggregate, are history of association with the franchisor, is private right of action exists to enforce the
material. This is sufficient to limit Item 3’s reach material to a prospective franchisee and should be Franchise Rule).
with respect to guarantors. disclosed. 351 NASAA, at 5.
who guarantee performance is material Confidential Settlements. With policy on the state level for more than
and should be disclosed. respect to the disclosure of confidential 10 years, apparently without much
settlements, David Gurnick commented hardship.
c. Settlements Further, NASAA has recognized that
that the disclosure of any settlement
With respect to settled actions, the terms that the parties agreed to keep the disclosure requirements concerning
original Rule required disclosure of any confidential is bad policy because confidential settlements might raise
civil action a person subject to the confidential settlements benefit both breach of contract issues. Accordingly,
provision ‘‘has settled out of court’’ in parties and the ‘‘opportunity for the NASAA Commentary on the UFOC
the previous seven fiscal years. It did confidentiality is often an important Guidelines specifically limited the
not distinguish between confidential dynamic to resolve a dispute.’’358 He disclosure to those settlements that were
and nonconfidential settlements.352 urged that the Rule permit the entered into after the adoption of the
Consistent with the UFOC Guidelines, disclosure of material facts about UFOC Guideline revisions on April 25,
the Franchise NPR proposed that confidential settlements in the 1993. Item 3 of the final amended Rule
franchisors disclose the terms of any aggregate, so that the franchisor could incorporates a similar concept. The
settled actions, expressly including make the disclosure about a group of Commission recognizes that some small
confidential settlements.353 Several cases, without violating the or regional franchisors who use the
commenters voiced concern about the confidentiality of any one or more cases. Franchise Rule format exclusively have
requirement to disclose settlements— For example, a franchisor could state: not had the opportunity to phase-in
including confidential settlements. ‘‘we have settled 10 cases with confidential settlement disclosures.
Settlements Favorable to the confidentiality agreements. In each of Based on this consideration, the
Franchisor. PMR&W and Warren Lewis these cases, we made payments to the Commission has added a footnote 2 to
observed that Item 3 in the Rule as franchisee in the mid five figure section 436.5(c)(3)(ii) of the final
proposed in the Franchise NPR did not range.’’359 amended rule that specifies that ‘‘any
allow franchisors to omit settled Similarly, John Baer questioned the franchisor who has historically used
litigation where the settlement is disclosure of exact dollar amounts or only the Franchise Rule format, or who
favorable to the franchisor or neutral.354 other confidential settlement terms. is new to franchising, need not disclose
Both commenters cited to the UFOC ‘‘This often can expose the franchisor to confidential settlements entered prior to
Guidelines,355 which state that the choice of not being able to register the effective date of this Rule.’’ Thus,
‘‘settlement of an action does not its franchise in a particular state or franchisors historically using only the
diminish its materiality if the franchisor making a disclosure and possibly Franchise Rule format need not disclose
agrees to pay material consideration or breaching the terms of the confidential confidential settlements entered into
agrees to be bound by obligations which settlement agreement.’’360 He suggested prior to the effective date of the final
are materially adverse to its that the Commission allow franchisors amended Rule, and only franchisors
interests.’’356 The point these to disclose approximate dollar amounts, who have used the UFOC Guidelines
commenters were making is that the such as ‘‘the low four figures,’’ or, in the format in the past must continue to
UFOC Guidelines, by implication, alternative, a range of figures.361 disclose confidential settlements, as is
would deem favorable or neutral In keeping with the goal of reducing the current practice.
settlements to a franchisor not material inconsistencies with the UFOC John Baer raised a related point that
and would not call for their disclosure. Guidelines, the Commission is the Commission finds persuasive. He
The Commission believes this disinclined, based on this record, to asserted that it would be unfair to
interpretation is correct, and intends deviate from the UFOC Guidelines with require the disclosure of confidential
that result in adopting the final version respect to the scope of the confidential settlement agreements ‘‘if they were
of this provision. Item 3, therefore, settlements disclosure. This issue was entered into by a company at a time
permits franchisors to omit settled debated when NASAA revised the when it was not yet engaged in
litigation where a settlement is favorable UFOC Guidelines in 1993, with input franchise activities.’’362 It would be
to the franchisor or otherwise neutral.357 from many interested parties. Moreover, unreasonable to expect a non-franchisor
franchisors using the UFOC Guidelines to negotiate settlements with an eye
352 16 CFR at 436.1(a)(4)(ii). format have been living under this toward the possibility that it may engage
353 Footnote 4 in the proposed Rule stated, in in franchise sales in the future.
relevant part: ‘‘If a settlement agreement must be the person must pay money or other consideration, Accordingly, footnote 2 to section
disclosed in this Item, all material settlement terms must reduce an indebtedness by the amount of an
must be disclosed, whether or not the agreement is award, cannot enforce its rights, or must take action
436.5(c) of the final amended Rule
confidential.’’ Franchise NPR, 64 FR at 57334. See adverse to its interests.’’ In other words, a provides that ‘‘franchisors need not
also NASAA Commentary, Item 3. franchisor need not disclose a settlement if the disclose the terms of confidential
354 Footnote 2 in the proposed rule stated: franchisor neither pays any material consideration, settlements entered into before
‘‘Franchisors are not required to disclose actions nor is bound by obligations that are materially
adverse to its interests.
commencing franchise sales.’’
that were dismissed by final judgment without
liability or entry of an adverse order. However, 358 Gurnick, NPR 21, at 4. See also J&G, NPR 32,
d. Dismissed actions
franchisors must disclose dismissal of a material at 10–11; Marriott, NPR 35, at 15.
action in connection with a settlement.’’ Franchise 359 Gurnick, NPR 21, at 5. But see Stadfeld, NPR As noted above, Item 3 requires a
NPR, 64 FR at 57334. As explained in the text 23, at 12 (urging the Commission to keep the UFOC franchisor to disclose certain prior
above, this footnote has been deleted from the final requirement of disclosing specific payments in actions in which it has been ‘‘held
amended Rule. settlements regardless of confidentiality
355 UFOC Guidelines, Item 3 Definitions, iv. agreements).
liable.’’ Under this standard, a dismissal
356 PMR&W, NPR 4, at 10; Lewis, NPR 15, at 13. 360 Baer, NPR 11, at 11. without any imposition or acceptance of
According to Mr. Lewis, without such a limitation, 361 Mr. Baer also suggested that where a case has liability on the franchisor’s part, would
the Rule would penalize franchisors and been settled by purchase or re-purchase of a not have to be disclosed.363
subfranchisors who achieve favorable settlements, franchised business and the amount does not In response to the Staff Report, two
thereby discouraging settlement of litigation. See exceed the fair market value of the business, a
also Snap On, NPR 16, at 3. franchisor should be permitted to state: ‘‘The
commenters observed that this
357 Section 436.5(c)(1)(iii)(B) of the final amended settlement included a purchase of the franchise . . .
Rule specifies that ‘‘held liable’’ as used in Item 3 for an amount which, in our judgment, does not 362 Baer, NPR 11, at 11.
means that ‘‘as a result of claims or counterclaims, exceed its fair market value.’’ Baer, NPR, 11, at 11. 363 See Franchise NPR, 64 FR at 57334, note 2.
limitation on prior actions is undercut e. Franchisor-initiated litigation UFOC Guidelines compelled franchisors
by the inclusion in the proposed One of the most important ways part to disclose franchisor-initiated litigation
Franchise NPR version of Item 3 of a 436 of the final amended Rule differs only if a franchisee subsequently filed a
broad provision requiring franchisors from both the original Rule and the counterclaim. Yet, as these commenters
and others to disclose if they have ‘‘been UFOC Guidelines is that part 436 noted, franchisees often do not have the
a defendant in a material action.’’ They includes a requirement that franchisors financial resources to initiate a suit or
observed that while dismissals without disclose franchisor-initiated to pursue a counterclaim.373 Therefore,
liability need not be disclosed under the litigation.368 Specifically, section according to their argument, disclosure
‘‘held liable’’ requirement of Item 3, 436.5(c)(1)(ii) requires a franchisor to of franchise relationship litigation
they would have to be disclosed under disclose litigation in which it: should not depend upon which party
the second more general ‘‘defendant in happens to have the resources to file a
a material action’’ requirement. They was a party to any material civil suit. Typical of these comments is the
urged the Commission to delete the action involving the franchise one submitted by NFA, an association of
relationship in the last fiscal year.
‘‘defendant in a material action’’ Burger King franchisees, stating that the
For purposes of this section,
element of Item 3, to limit prior disclosure of such information:
‘‘franchise relationship’’ means
litigation disclosures to only those would be beneficial to potential
contractual obligations between the
actions in which the defendant incurred franchisees, as it would allow such
franchisor and franchisee directly
liability.364 In response to these franchisees to be aware of any
relating to the operation of the
comments, the Staff Report concluded difficulties current or prior
franchised business (such as royalty
that the drafting of the Franchise NPR’s franchisees have encountered with
payment and training obligations).
version of Item 3 resulted in the franchisor. In addition, the
It does not include suits involving
overbreadth, and therefore required disclosure of franchisor-
suppliers or other third parties, or
recommended that Item 3 be narrowed indemnification for tort liability.369 initiated litigation would further
accordingly.365 aid potential franchisees by serving
The Commission has carefully This final amended Rule provision is
substantially the same as its counterpart as an indicator of how franchisors
considered this point. As noted above, resolve their disputes, and whether
the UFOC Guidelines clearly permit proposed in the Franchise NPR.370
Throughout the Rule amendment or not such franchisors are quick to
franchisors to limit the disclosure of resort to litigation in order to
prior actions to matters in which they proceeding, franchisees and their
representatives,371 as well as the Small resolve disputes. The possibility of
were ‘‘held liable.’’ This approach is extensive litigation is important to
also consistent with the original Rule, Business Administration,372 urged the
Commission to adopt such a a potential franchisee, as it may
which limited prior litigation to matters affect the calculation of costs
in which the franchisor ‘‘has been held requirement, asserting that franchisor-
initiated litigation is material because it involved in acquiring such a
liable . . . resulting in a final judgment franchise. In addition, the
or has settled out of court.’’366 is a clear indicator of: (1) the quality of
the franchisor-franchisee relationship; continued threat of litigation from
Moreover, the language ‘‘been a the franchisor may well affect later
defendant in a material action’’ is and (2) the extent to which the
franchisor may be litigious. Others dealings between the parties, and as
arguably redundant: if a defendant was such is critical information of
not held liable in a prior action, then the added that the original Rule and the
which the franchisee should be
underlying suit was not material. For aware.374
however, states have the power to include
these reasons, the phrase ‘‘been a additional disclosures, if they so choose, provided
defendant in a material action’’ it is possible simultaneously to comply with both
A few commenters also maintained
included in the proposed Rule the state rule and a corresponding final amended that compliance costs arising from such
published in the Franchise NPR has Rule provision. a disclosure are not great. For example,
been deleted from the final amended
368 Section 436.5(c)(1)(ii) requires disclosure of
Seth Stadfeld observed that ‘‘once the
litigation to which a covered person ‘‘was a party,’’ initial changes are made [to the
Rule.367 and therefore reaches more than just actions where
the franchisor or other covered person was a disclosure document], all that must be
364 Piper Rudnick, at 1; Duvall, at 1. plaintiff. As a practical matter, however, because done is to update the disclosed
365 Additionally, H&H opined that Item 3 of the other elements of Item 3 cover various actions litigation annually or sooner if material
proposed Rule published in the Franchise NPR where the franchisor or other covered person was changes take place.’’375 The AFA was
seemed to suggest that a franchisor must disclose or is the defendant, the significance of this new part
436 section is that it reaches actions initiated by the more blunt in its assessment:
all material civil litigation in which the defendant
was held liable in the 10-year time period, but only franchisor or other covered person. The Commission has a choice. It
369 See Cendant, ANPR 140, at 3 (noting that in
the enumerated list of actions if named in civil can save franchisors a few pennies
litigation. H&H suggested that the disclosure of civil vicarious liability cases—where a customer sues the
litigation should be limited to the enumerated list franchisor for alleged wrongdoing by the individual on a slightly larger offering circular
regardless of whether the franchisor was named or franchisee—the franchisor often must sue the
was held liable in a prior suit. H&H, NPR 9, at 17– franchisee to protect its interests and to obtain 373 Peter Lagarias observed that ‘‘[f]ranchisors are
18. See also NFC, NPR 12, at 28. H&H also indemnification. Such suits, therefore, are often able to wield the threat of litigation, especially
suggested that the word ‘‘material’’ be substituted essentially between the customer and the franchisee by threatening to seek attorneys’ fees, to deter
for ‘‘significant.’’ H&H, NPR 9, at 18. The final and are not indicative of franchise system franchisees from suing or maintaining lawsuits
amended Rule incorporates these suggestions. performance.). against them. Thus while loss of a single lawsuit is
366 16 CFR 436.1(a)(4)(ii). 370 The only difference is that the time frame of seldom significant to franchisors, loss of a lawsuit
367 IL AG asserted that franchisors should be the requirement has been tightened, now covering against their franchisor is often fatal for
permitted to disclose settled litigation in its favor only actions ‘‘within the past fiscal year,’’ instead franchisees.’’ Lagarias, ANPR 125, at 3. See also
or which is neutral. It explains that a state franchise of ‘‘pending actions.’’ This topic is addressed in Merret, ANPR 126; Brandt, ANPR 137; Doe, ANPR,
examiner would question why a case previously greater detail near the end of the Item 3 discussion. 7 Nov. 97 Tr., at 267.
371See AFA, at 2; Gee, at 2; Bundy, at 5; Karp, 374 NFA, NPR 27, at 2. See also AFA, NPR 14,
listed as pending in one version of a disclosure
document would then disappear upon settlement or at 2; AFA, ANPR 62, at 2; Lagarias, ANPR 125, at at 4; NASAA, NPR 17, at 4; Bundy, NPR 18, at 7;
dismissal from later versions without explanation. 3; Selden, ANPR 133, Attachment at 2; Karp, ANPR, Stadfeld, NPR 23, at 11; Karp, NPR 24, at 19.
IL AG, at 5. We do not find this rationale sufficient 19 Sept. 97 Tr., at 98. 375 Stadfeld, NPR 23, at 11. See also Karp, NPR
to justify retaining a redundancy in the final 372 SBA, ANPR 36, at 5–6. See also IL AG, ANPR 24, at 20 (disclosure costs pale in comparison with
amended Rule. As noted throughout this document, 77, at 2. litigation costs).
or save a franchisee from investing Indeed, some franchisors argued that the franchisor, as well as litigation
hundreds of thousands of dollars in disclosure could be misleading, wrongly involving affiliates and third-party
a franchise that he/she might not implying that the franchisor has suppliers.385 The core concern
have invested in if he/she would engaged in illegal or other underlying the franchisor-initiated
have known all of the franchisor- misconduct.382 In the same vein, some litigation requirement is the status of the
initiated lawsuits against its own franchisors feared that a mandatory relationship between the franchisor and
franchisees.376 franchisor-initiated litigation disclosure its franchisees in the offered system.386
In contrast, franchisors generally might actually discourage franchisors Accordingly, the Commission has
opposed the disclosure of franchisor- from bringing suits, even meritorious weighed the modest potential benefit of
initiated litigation. Among other things, suits, that are needed to maintain the a broader litigation disclosure against
they asserted that franchisor-initiated integrity of the franchise system.383 the compliance costs and burdens, and
litigation is immaterial377 and would Based upon the record developed in decided not to require disclosures about
unnecessarily ‘‘bulk up’’ disclosure this proceeding, the Commission is litigation initiated by the franchisor’s
documents, thereby increasing convinced that franchisor-initiated affiliates, third-party suppliers, or other
compliance costs.378 Others opined that litigation is material information that systems.
the disclosure was unnecessary because, prospective franchisees need in order to At the same time, the Commission
in their view, a franchisee aggrieved by assess a critical aspect of the franchise also has considered various alternatives
a franchisor-initiated suit will surely file relationship—the nature of disputes and that franchisors assert would reduce
a counterclaim, which clearly must be the level of litigation within a franchise franchisors’ compliance burdens. The
disclosed under the original Rule.379 system.384 We recognize that the UFOC alternative that garnered the most
Other franchisors asserted that the Guidelines’ Item 3, in limiting required support was to tie the disclosure to a
disclosure document already informs disclosures to instances where a threshold level of suits.387 For example,
prospective franchisees about the state franchisee has filed a counterclaim, may John Baer suggested a 5% threshold,
of the relationship.380 Still others have focused more narrowly on suits under which a franchisor would not
asserted that Item 3 litigation should be where arguably there was a greater
limited to suits that imply wrongdoing probability of wrongdoing on a 385 See Bundy, NPR 18, at 7; Stadfeld, NPR 23,
franchisor’s part. We now believe that at 13. Eric Karp urged the Commission to broaden
on the franchisor’s part: franchisor- the disclosure further to include franchisor-initiated
initiated suits simply demonstrate that this should be broadened to include litigation against third-party suppliers: ‘‘If a
the franchisor is enforcing its rights additional information about the state of franchisor were to sue a supplier of goods or
under the franchise agreement.381 the franchise relationship. For example, services it sells to franchisees, over issues relating
we agree with the commenters who to quality or efficiency of supply or to block sales
not authorized by the franchisor, the prospective
376 AFA, NPR 14, at 4. made the point that franchisor suits to franchisee would have good reason to want to know
377 H&H, NPR 9, at 17 (little value in requiring enforce system standards could be about the claim.’’ Karp, NPR 24, at 20. The
franchisors to disclose garden variety litigation viewed as a positive attribute, showing Commission has rejected this suggestion because it
involving franchisees, such as debt collection that the franchisor is willing to maintain goes beyond the goal of providing material
actions). See also Cendant, at 3; Quizno’s, NPR 1, information to prospective franchisees about the
at 1; Gurnick, NPR 21, at 5; Kaufmann, ANPR 33, uniformity for the benefit of the entire quality of the franchisor-franchisee relationship.
at 4. system. A franchisor’s willingness to 386 Piper Rudnick also urged the Commission to
378 E.g., Baer, ANPR 25, at 3; Kaufmann, ANPR protect its system is a material fact clarify in the Compliance Guides the definition of
33, at 4; Jeffers, ANPR 116, at 1–2; Forseth, ANPR, about the franchise relationship that the term ‘‘franchisor relationship.’’ In particular, the
18 Sept. 97 Tr., at 20. In addition, several firm would limit ‘‘franchise relationship’’ to a
franchisors voiced concern about the interplay
should be disclosed to prospective matter arising from the franchise contract. Piper
between the franchisor-initiated litigation franchisees. Rudnick, at 6. We believe a definition is
disclosure and state registration laws. Specifically, Nevertheless, the Commission unnecessary. Since the promulgation of the original
they opposed the disclosure because it might trigger declines to broaden further the Rule, franchisors have had to disclose franchisee-
burdensome state updating requirements. For initiated litigation and counterclaims involving the
example, Quizno’s asserted that if the disclosure of
franchisor-initiated litigation disclosure franchise relationship. Accordingly, such
franchisor-initiated litigation is deemed material by of part 436, as some have suggested, to disclosures are not new. Moreover, we disagree that
the Commission, it also would be deemed material include litigation involving another the franchise relationship is as narrow as Piper
by the states and, therefore, franchisors would have franchise system owned by the Rudnick suggests. Surely, a dispute that arises from
to stop selling in a state every time they filed a suit a lease agreement or promissory note, for example,
until they could amend their registrations. falls within the purview of a relationship issue that
Quizno’s, NPR 1, at 1. See also Lewis, NPR 15, at absence of a relevant counterclaim, does not reflect should be disclosed.
13 (franchisor would have to amend their any adverse conduct by the franchisor.’’ 387 Other suggested alternatives failed to garner
disclosure documents); J&G, NPR 32, at 10 (would PMR&W, NPR 4, at 10. See also Winslow, at 77; significant support, including the following.
prevent sales in states that require sales to stop H&H, NPR 9, at 17; J&G, NPR 32, at 10; Marriott, PMR&W suggested requiring a franchisor to
until amendments are filed and approved). NPR 35, at 14. But see Jeffers, ANPR 116, at 1–2 disclose, on an annual basis, the number of
379 E.g., Quizno’s NPR 1, at 1; PMR&W, NPR 4, (franchisor-initiated suits could be viewed as a litigation and arbitration proceedings it has pending
at 9; Holmes, NPR 8, at 4; Quizno’s, ANPR 16, at ‘‘positive attribute,’’ showing that the franchisor is against franchisees, along with a general summary
1; Kaufmann, ANPR 33, at 4; IFA, ANPR 82, at 1– willing to enforce its standards and trademark, and of the types of claims involved. PMR&W, NPR 4, at
2; Cendant, ANPR 140, at 3. But see Lagarias, ANPR is willing to aggressively eliminate continuing 10. Wendy’s suggested that the disclosure should be
125, at 3. violations of its franchise agreement). limited to ‘‘specifically enumerated types of claims
380 J&G, for example, contended that any material 382 Snap-On, NPR 16, at 2. See also, e.g., Gurnick,
which are significant to the entire franchised
information about the franchise relationship can be NPR 21, at 5; NaturaLawn, NPR 26, at 1; J&G, NPR system,’’ as well as a significant dollar amount.
determined from the Item 20 termination rates, as 32, at 10; GPM, NPR Rebuttal 40, at 4–5; Kaufmann, Wendy’s, NPR 5, at 2. Wendy’s, however, failed to
well as through the franchisor’s financial ANPR 33, at 4; Tifford, ANPR 78, at 3; Cendant, identify a list of appropriate types of suits or an
statements. J&G, NPR 32, at 10. See also GPM, NPR ANPR 140, at 3. appropriate dollar figure. David Holmes would
Rebuttal 40, at 4–5. 383 PMR&W, NPR 4, at 9. See also Snap-On, NPR
limit the disclosure by eliminating counterclaims
381 E.g., Kestenbaum, ANPR 40, at 1; Tifford, 16, at 2; J&G, NPR 32, at 10; Marriott, NPR 35, at filed by a franchisor merely in response to a
ANPR 78, at 3. PMR&W asserted that Item 3 has a 14. franchisee-initiated suit. In his view, this is
limited intent, namely, to: 384 For example, a pattern of franchisor-initiated appropriate if the Commission’s concern is ‘‘with
‘‘inform the franchisee about proven or alleged lawsuits, such as royalty collection suits, may franchisors having a practice of suing their
franchisor actions which may reflect poorly on the indicate franchisees’ unwillingness or inability to franchisees, not merely defending themselves.’’
franchisor; disclosure also is required for pay. Such information would be material to a Holmes, NPR 8, at 4–5. We disagree because a
franchisor-initiated litigation where a defendant prospective franchisee because it may be an counterclaim may shed light on issues in the
files a counterclaim containing specified claims. A indicator of risk in purchasing a franchise and in franchise relationship to the same extent as the
franchisor’s lawsuit against the franchisee, in the the quality of the relationship with the franchisor. franchisee’s complaint.
have to disclose litigation it initiated compliance costs.394 First, in order to would have the additional benefit of
unless it has filed suit against at least minimize compliance burdens, the reducing more frequent quarterly
5% of the franchisees in its system.388 franchisor-initiated litigation disclosure updating, which may be burdensome
Others suggested a higher percentage, requirement is limited to suits filed in and perhaps impracticable in franchise
such as 10%,389 15%,390 or 20%,391 the previous one-year period.395 We registration states with more frequent
while the IL AG suggested a lower believe this ‘‘snap-shot’’ in time is updating requirements.398
percentage, such as 2%.392 sufficient to reveal the franchisor’s Third, Item 3 incorporates a
The Commission is reluctant to tie the practice of initiating litigation, as well ‘‘materiality’’ standard.399 This is
franchisor-initiated litigation disclosure as to reveal the types of franchise consistent with both the original Rule
of part 436 to a threshold. We believe relationship problems that typically and UFOC Guidelines.400 Indeed,
it is impossible, given the limited record arise in the franchise system.396 immaterial information, by definition, is
on this issue, to fashion a ‘‘one size fits Second, Item 3 permits franchisors to unlikely to influence a prospective
all’’ approach for every franchise system report franchisor-initiated litigation franchisee’s investment decision, while
in all industries. Moreover, any annually, not quarterly. That is, a imposing unwarranted costs and
threshold would focus on the quantity franchisor would disclose all material unnecessarily lengthening disclosure
of suits, suggesting that the sole purpose litigation to which it was a party in the documents.
of the provision is to reveal last fiscal year. This is intended to make
As noted above in the discussion of
litigiousness. When it comes to the state it clear that quarterly updating
section 436.1(d), materiality is
of the relationship, however, even a requirements do not demand disclosure
of franchisor-initiated actions filed in determined from the viewpoint of the
small number of suits initiated by a reasonable prospective franchisee.
the 12 months prior to the date of the
franchisor could be material to a Accordingly, any franchisor-initiated
updated document. This approach
prospective franchisee because they litigation that goes to the quality of the
improves on the proposed Rule’s
may reveal the nature of problems in the franchise relationship being offered for
‘‘pending litigation’’ approach.397 It also
franchise system or show the sale is likely to be material. Indeed, the
franchisor’s willingness to enforce 394 In addition to the refinements noted below, Commission intends the disclosure of
system standards.393 With full the Commission considered, but rejected, several franchisor-initiated litigation to be
disclosure, prospects can review the others that find no additional support in the interpreted broadly to cover most suits.
number and types of franchisors’ suits rulemaking record and which would be Nonetheless, we believe a requirement
unnecessarily inconsistent with the UFOC
for themselves and draw their own Guidelines. For example, Duvall urged limiting the that franchisors disclose literally all
conclusions about whether those suits disclosure of pending actions to franchise disputes franchisor-initiated suits goes too far.
are significant. only, eliminating the reference to actions for fraud, There may be instances where a
unfair and deceptive trade practices, and the like. franchisor-initiated suit might have no
Turning more generally to Item 3 of Duvall, at 1. IL AG urged expansion of the scope
the final amended Rule, it includes of the affiliate disclosure to cover all affiliates in bearing on the specific franchise
several refinements to the proposed rule any line of business. IL AG, at 5. Pu advocated a relationship being offered for sale. For
that were offered during the proceeding, requirement to disclose the name, address, and example, franchisors may offer for sale
telephone number of the lawyer for the franchisee
and that were recommended in the Staff in any litigation. Pu, at 1.
‘‘non-traditional’’ outlets operating a
Report. These refinements preserve the 395 Initially, the Commission proposed that the unique franchise agreement—such as
utility of the disclosure, while reducing disclosure of franchisor-initiated litigation be the operation of an outlet on a military
limited to pending litigation. Franchise NPR, 64 FR base. Franchisor-initiated litigation
388 Baer, NPR 11, at 11. See also Lewis, NPR 15,
at 57303–04. Several commenters opposed that involving unique franchise agreements
approach. For example, Howard Bundy would
at 12; BI, NPR 28, at 11; Tricon, NPR 34, at 6. require the disclosure of all franchise relationship may be immaterial to the sale of
NASAA stated that if the Commission were to limit suits by the franchisor or an affiliate commenced ‘‘traditional’’ outlets operating under the
the disclosure by imposing a threshold, it would
support a 5% threshold. NASAA, NPR 17, at 4. Not
during at least the last three years. ‘‘Just giving the franchisor’s standard franchise
‘pending’ cases is like giving only one month of agreement. A blanket provision
everyone agreed, however, on the proposal to financial statements. It does not permit the prospect
establish a threshold. Eric Karp, for example, stated: to see and evaluate trends and developments.’’ requiring disclosure of suits involving
‘‘the prospective franchisee should make his or her Bundy, NPR 18, at 7. See also Stadfeld, NPR 23, at unique agreements might be overbroad
own determination as to whether the number of
lawsuits is at a level that indicates a problematic
13. We agree that focusing on pending litigation is and might unnecessarily increase the
insufficient to achieve the goal of shedding light on size of the Item 3 disclosure to the
franchise system.’’ Karp, NPR 24, at 19–20. the quality of the franchise relationship. However,
According to Howard Bundy, the imposition of a we believe that a one-year time period is sufficient disadvantage of both prospective
threshold number of cases before an obligation to for that purpose, giving a prospective franchisee a franchisees who must read it, as well as
disclose arises ‘‘invites abuse.’’ Bundy, NPR 18, at
7. Seth Stadfeld also argued that a threshold
snap-shot in time of the franchise system. But see the franchisors who must prepare the
Karp, at 2 (contending that suits filed in one year disclosure. A ‘‘materiality’’ standard,
prerequisite would ‘‘discriminate[] arbitrarily in are not necessarily representative of the problems
favor of large mature franchise systems to the that arise in the system or the propensity of the therefore, will ensure that only suits
detriment of small franchise systems.’’ Stadfeld, franchisor to sue its franchisees). shedding light on the type of
NPR 23, at 13.
389 NFC, NPR 12, at 28.
396 One commenter suggested that the relationship being offered for sale must
Commission permit a franchisor to explain in Item be disclosed.
390 Holmes, NPR 8, at 4.
3 that this disclosure is limited to only certain types
391 AFC, NPR 30, at 3.
of actions and only updated annually. Gust
392 IL AG, NPR 3, at 6 (also recommending no 398 States typically require immediate updating
Rosenfeld, at 4. To the extent that a franchisor finds
threshold for smaller systems, such as those with that its compliance with any particular disclosure upon a material change.
fewer than 25 franchisees). item may result in inaccurate or misleading 399 The Commission declines to adopt suggested
393 One commenter asserted that the Commission information being furnished to a prospective expansion of section 436.5(c)(1)(ii) to encompass all
should require litigation disclosures only when franchisee, the franchisor may add footnotes to suits, regardless of their materiality. Stadfeld, NPR
there have been three consecutive fiscal years of ensure accuracy or to avoid misleading statements. 23, at 13.
lawsuits, regardless of the number of such suits. This applies to any misleading Item 3 litigation 400 See 16 CFR 436.1(a)(4) (only material actions
NaturaLawn, NPR 26, at 1. The purpose of the disclosure as well. need be disclosed); UFOC Guidelines, Item 3
disclosure, however, is not limited to litigiousness. 397 This disclosure approach also would be more Definitions at iii (‘‘Included in the definition of
As discussed above, any number of suits initiated representative of franchisor-initiated litigation than material is an action or an aggregate of actions if
by the franchisor against its franchisees is material ‘‘pending litigation,’’ which would omit suits that a reasonable prospective franchisee would consider
because it sheds light on the quality of the franchise may have been settled during the year, or which it important in making a decision about the
relationship. took less than a year to resolve. franchised business.’’).
Fourth, as recommended in the Staff more specific disclosures (e.g., Guidelines.408 We agree. It is clear that
Report, Item 3 permits a franchisor to summaries of legal and factual claims, the UFOC Guidelines require
provide basic, summary information on relief sought, conclusions of law) that franchisors to disclose the bankruptcy of
its initiated litigation, without the need pertain to all suits, except for any affiliate of the franchisor, not just
for long discussions on each and every franchisor-initiated litigation, which is those affiliates who offer franchises
case.401 In addition, franchisors may list covered in a separate section (section under the franchisor’s principal
individual suits under one common 436.5(c)(4)). Any counterclaim filed by mark.409 In order to reduce
heading, which will serve as the a franchisee in a suit would be covered inconsistencies between part 436 and
summary (for example, royalty by the section 436.5(c)(3) disclosure the UFOC Guidelines, we have revised
collection suits). The franchisor would requirements. the disclosure of an affiliate’s
then merely list each applicable suit The next section—section bankruptcy accordingly.410
(case name, court, file number), without 436.5(c)(4)—sets forth the instructions In its response to the Staff Report, J&G
the need to provide any additional for ‘‘any other franchisor-initiated suit also contended that the introductory
explanation. identified’’ in Item 3.404 The use of the paragraph of both the proposed Rule in
Fifth, and finally, the final amended phrase ‘‘any other franchisor-initiated the Franchise NPR and the Staff Report
Rule clarifies the relationship between suit’’ is intended to limit the provision are unclear.411 As recommended in the
the disclosure of franchisor-initiated to suits in which no franchisee Staff Report, for example, this paragraph
litigation and the disclosure of counterclaim has been filed. This would require a franchisor to disclose
counterclaims. Staff Report comments section makes clear that, in lieu of the ‘‘whether the franchisor, any parent,
by Wiggin & Dana noted that the rule more comprehensive disclosure predecessor, affiliate, officer, general
proposed in the Franchise NPR did not instructions of section 436.5(c)(3), a partner . . . filed for bankruptcy.’’412
explicitly address the filing of a franchisor may disclose franchisor- J&G contended that it is unclear whether
franchisee counterclaim after a initiated litigation ‘‘by listing individual this language requires a franchisor to
franchisor initiates a suit.402 The firm suits under one common heading.’’ disclose the bankruptcy history of
questioned whether a franchisor- Accordingly, Item 3 affords the officers or affiliates of a predecessor, as
initiated case followed by a franchisor flexibility, permitting the well as officers of a parent or affiliate.
counterclaim would be treated as a disclosure of franchisor-initiated To eliminate confusion on this point,
franchisor-initiated case only—receiving litigation either through the the final amended Rule reads as follows:
the more narrow disclosure treatment— comprehensive disclosures of section
or whether the counterclaim would be 436.5(c)(3) or the more abbreviated 408 Bundy, NPR 18, at 7. See NASAA
considered like all other disclosures of section 436.5(c)(4). Comparison, at 6.

409 As previously noted, the definition of
counterclaims—receiving the more
6. Section 436.5(d) (Item 4): Bankruptcy ‘‘affiliate’’ in the UFOC Guidelines varies for
extensive disclosure treatment.403 purposes of specific disclosure items. For example,
The Commission intends the Section 436.5(d) of the final amended ‘‘affiliate’’ for Item 3 (litigation) purposes is limited
franchisor-initiated litigation provision Rule retains the original Rule’s to ‘‘an affiliate offering franchises under the
of the final amended Rule to expand disclosure of prior bankruptcies, franchisor’s principal trademark.’’ UFOC
Guidelines, Item 3. The more limited Item 3
upon the approach taken by the original including any parent’s bankruptcy.405 definition of affiliate reduces franchisors’
Rule, not constrict it. Accordingly, Consistent with the UFOC Guidelines, it compliance burdens significantly. A franchisor may
franchisors must disclose any extends the original Rule by requiring have numerous affiliates, any of which may have
counterclaims in the same manner as franchisors to disclose bankruptcy been involved in, or is currently involved in,
litigation. The disclosure of such affiliate
they would have done under the information about predecessors and information arguably might impose significant
original Rule, providing complete case affiliates, to disclose foreign compliance costs that may not outweigh any
summaries. Only in those instances proceedings comparable to bankruptcy, benefits to prospective franchisees. Therefore, the
where a franchisor initiates a suit— and to make bankruptcy disclosures for Item 3 litigation disclosure—limited to affiliates
offering franchises under the franchisor’s principal
absent the filing of any subsequent 10 years, instead of the original Rule’s trademark—strikes the right balance between pre-
counterclaim filed by the franchisee— seven years limitation.406 sale disclosure and costs. On the other hand, where
does the franchisor-initiated litigation Item 4 of the final amended Rule also any affiliate has a current or prior bankruptcy, that
disclosure requirement apply. incorporates several refinements based fact is highly material because the affiliate’s parent
upon the record developed in this may wish to divert funds away from the franchisor
The final amended Rule makes this to the affiliate, thereby depriving the franchisor of
point clear as follows. First, section proceeding. The Rule as proposed in the advertisements, training, or other services. Under
436.5(c)(3) provides instructions for all Franchise NPR, at Item 4, would have the circumstances, a broader definition of affiliate
litigation that must be disclosed in Item required the disclosure of an affiliate’s in the Item 4 bankruptcy disclosure is warranted.
410 Consistent with Item 2, the final amended
3. It requires, for each suit, the prior bankruptcy only if the affiliate
Rule at Item 4 also extends the UFOC Guidelines
disclosure of the case title, number or currently offers franchises under the by requiring the bankruptcy disclosures not only for
citation, initial filing date, names of the franchisor’s trademark.407 One officers or general partners, but for any ‘‘other
parties, the forum, and the relationship commenter suggested that the individual who will have management
of the opposing party to the franchisor. bankruptcy disclosure should apply to responsibility relating to the sale or operation of
franchises offered by this document.’’ This is
Following these basic disclosures are all affiliates, consistent with the UFOC necessary to prevent franchisors from hiding prior
bankruptcies of individuals who in fact will manage
401 See Staff Report, at 117–18. The Staff Report 404 See Wiggin & Dana, at 2. the franchises, but who do not have a formal title.
proposal permitting franchisors to limit the 405 See 16 CFR 436.1(a)(5). In the original SBP, 411 J&G, at 4. IL AG advocated that the
description of each disclosed suit generated no the Commission found that bankruptcy information Commission deviate from the UFOC Guidelines by
comment. is material because it bears directly on the including in the list of persons needing to disclose
402 Under the original Rule, a counterclaim must ‘‘integrity and managerial ability of the parties with bankruptcy information ‘‘members,’’ to make it
be disclosed for 10 years and the franchisor must whom [the franchisee] is dealing and . . . could clear that limited liability companies are included.
provide more detailed information about the nature readily result in drastic economic injury to the IL AG, at 5. This is also unnecessary because
and status of the action. 16 CFR 436.1(a)(4)(ii) franchisee because it could lead him or her to invest nothing in part 436 would prevent a limited
(actions ‘‘brought by a present or former franchisee substantial amounts of money in a bankrupt liability company from qualifying as a parent,
or franchisees and which involves or involved the business.’’ Original SBP, 43 FR at 59650–51. predecessor, or affiliate, as those terms are used in
franchise relationship’’). 406 See UFOC Guidelines, Item 4. part 436.
403 Wiggin & Dana, at 1–2. 407 Franchise NPR, 64 FR at 57304. 412See Staff Report, proposed section 436.5(d)(1).
‘‘Disclose whether the franchisor; any issues, or insurance claims.416 The Consistent with that revision, references
parent; predecessor; affiliate; officer, or Commission believes that the disclosure to ‘‘fee’’ in Item 5 have been revised as
general partner of the franchisor, or any of personal bankruptcy information is follows: (1) ‘‘these fees are refundable,’’
other individual who will have necessary to prevent deception or fraud. in place of ‘‘this fee is refundable;’’ and
management responsibility relating to In many instances, prospective (2) ‘‘Initial fees mean,’’ in place of
the sale or operation of franchises franchisees entrust considerable initial ‘‘initial fee means.’’419
offered by this document . . .’’ fees and ongoing funds to franchise Second, another commenter correctly
The Commission has rejected, managers for training and advertising, noted that the Franchise NPR version of
however, other suggestions to modify among other forms of post-sales Item 5 did not expressly define ‘‘initial
Item 4. Several commenters questioned assistance. Accordingly, prospective fees’’ to include commitments to make
the need to require predecessor and franchisees may rely to their detriment payments to the franchisor. Rather, Item
parent bankruptcy disclosures. They on claims made by such managers. The 5 as proposed in the Franchise NPR
asserted that the additional disclosure disclosure of a franchisor manager’s would have defined an initial fee only
burden is not outweighed by any benefit bankruptcy, therefore, would shed light in terms of cash actually paid at the
to prospective franchisees.413 Consistent on that manager’s ability to safeguard time of the sale.420 The commenter’s
with our discussions in connection with and use those funds properly. Under the point is well-taken. The ‘‘initial fees’’
Items 1–3, we believe that information circumstances, we see no compelling disclosure requirements of Item 5 relate
about predecessors and parents is reason to omit a personal bankruptcy, to the required payment element in the
material and should be disclosed. especially since such an approach definition of the term ‘‘franchise.’’421
Where a parent is in bankruptcy, for would also deviate from the UFOC Under that definition, a ‘‘required
example, its assets include any Guidelines. payment’’ is not limited to cash, but
franchisor-subsidiary. Under such expressly includes commitments to
7. Section 436.5(e) (Item 5): Initial fees make payments to the franchisor at a
circumstances, a prospective franchisee
should be made aware that the Section 436.5(e) of the final amended later date. Otherwise, a franchisor could
franchisor in which it is considering Rule requires the disclosure of initial seriously undercut the Item 5 cost
investing might be sold, possibly to a fees.417 This disclosure is substantively disclosure by requiring prospects to sign
competitor or to a company lacking similar to the comparable disclosure notes or other obligations in lieu of
prior franchise experience. provision found in the original Rule at immediate payment. Accordingly, Item
Further, David Gurnick suggested that 16 CFR 436.1(a)(7). The final amended 5 of the final amended Rule expressly
the time period for reporting a Rule, like the proposed Rule published includes not just fees that are actually
bankruptcy should be reduced from 10 in the Franchise NPR, follows the UFOC paid, but commitments to pay as
to five years.414 J&G also observed that Guidelines in explicitly permitting well.422
a 10-year obligation would compel the franchisors to provide a range of fees, Commenters also offered various
disclosure of a bankruptcy that was whereas the original Rule implicitly proposals for modifying Item 5 that we
actually filed significantly earlier: contemplated a fixed fee. believe are unwarranted. While Item 5
Item 5 of the final amended Rule is requires disclosure of ‘‘the range or
[I]t would seem that ten years from formula used to calculate the initial fees
the date of the filing of a petition substantially similar to Item 5 in the
proposed Rule published in the paid in the fiscal year before the
would be the appropriate beginning issuance date,’’ Howard Bundy urged
date. We are aware of one case in Franchise NPR, but it incorporates
several technical revisions that the that it require the disclosure of any
which an officer was involved with contractual formulas for determining the
a company when a petition was commenters suggested. One commenter
recommended that the title of Item 5 current initial fee. Mr. Bundy opined
filed in 1986, and the bankruptcy that it is ‘‘important to have disclosure
proceeding is still pending. Were it should refer to ‘‘Initial Fees’’ instead of
the proposed title, ‘‘Initial Franchise of any contractual formulas that will
settled this month (December 1999),
disclosure of that event would be Fee,’’ recognizing that a prospective
received from the franchisor before the franchisee’s
required for a total of 23 years!415 franchise may pay more than just one business opens.’’ UFOC, Item 5. Accordingly, the
fee in order to acquire a franchise.418 Item 5 disclosure is not limited to payments marked
Although the 10-year reporting period ‘‘franchise fee.’’ We decline to introduce a
may, in rare instances, result in the 416 NaturaLawn, NPR 26, at 1. distinction between ‘‘initial fees’’ and ‘‘initial
disclosure of a bankruptcy filed more 417 In the original SBP, the Commission franchise fees,’’ as CA Bar suggested, which would
recognized that the disclosure of complete and be inconsistent with the UFOC Guidelines.
than 10 years earlier, the Commission 419 Lewis, NPR 15, at 14. But see Gust Rosenfeld,
accurate information about initial franchise fees is
has determined that the 10-year material. The failure to disclose such information at 8 (suggesting the broader ‘‘initial payments’’ than
reporting period is reasonable in order pre-sale is deceptive because ‘‘it (1) misleads, or at ‘‘fees,’’ which may be misconstrued narrowly to
to give prospective franchisees a least confuses prospective franchisees as to the refer only to any upfront franchise fee).
420 Bundy, NPR 18, at 7. (‘‘It should include any
complete picture of the franchisor’s amount of the required initial franchise investment
and (2) could readily result in economic injury to amounts that the franchisee becomes obligated to
bankruptcy history. We are not inclined a franchisee unable to fully obtain all such funds pay before entering into the franchise. For example,
to deviate from the UFOC Guidelines on or unable to recoup the full amount of such funds if the entire initial franchise fee is deferred into a
this point. in the course of the franchise business.’’ Original promissory note, that does not change the fact that
Finally, NaturaLawn urged the SBP, 43 FR at 59653. it is an ‘initial fee.’’’).
418 Lewis, NPR 15, at 14. CA Bar, however, 421 Section 436.1(h).
Commission to exclude from Item 4 the
asserted that the term ‘‘initial fee,’’ as opposed to 422 The Commission has also clarified the
disclosure of personal bankruptcies. The ‘‘initial franchise fee’’ may have negative language of Item 5 in two respects. First, the final
company noted that personal consequences for franchisors selling company- amended Rule makes clear that the term ‘‘initial
bankruptcies can be filed for a variety of owned stores. CA Bar explained that ‘‘initial fees’’ fees’’ includes payments or commitments to pay an
reasons, such as divorces, medical or ranges of ‘‘initial fees’’ paid to a franchisor for affiliate of the franchisor. See NASAA, at 3. This
a company-owned store may be proprietary is consistent with the NASAA Commentary on the
information, especially if fees charged are not UFOC Guidelines. See also NASAA Comparison, at
413 J&G, NPR 32, at 11; Marriott, NPR 35, at 15;
uniform. CA Bar, at 9. We disagree. Under the 7. Second, the final amended Rule adds, at the end
GPM, NPR Rebuttal 40, at 5. current UFOC Item 5, all franchisors must disclose of Item 5, the following sentence: ‘‘Disclose
414 Gurnick, NPR 21, at 6.
the ‘‘initial franchise fee,’’ which is defined to installment payment terms in this subsection or in
415 J&G, NPR 32, at 11. include ‘‘all fees and payments for services or goods paragraph 436.5(j) of this section.’’
result in this prospect paying a different disclosed.427 The Commission’s view, prospective franchisees’ independence
initial fee than the historic information however, is that providing a range of in operating the offered franchise, as
would suggest.’’423 fees, regardless of how or why these well as the total costs of doing so.
The Commission’s view, however, is ranges came about, is useful to The Commission has determined to
that as long as the prospect is aware of prospective franchisees in the adopt proposed Item 6 from the
the amount to be paid before the sale, negotiation process. Such disclosure Franchise NPR, with some fine tuning.
the method the franchisor used to derive compels neither party to reach Accordingly, Item 6 of the final
that amount is not necessarily material. agreement on unacceptable terms: amended Rule incorporates a suggestion
The Commission notes that Item 5 franchisors and prospective franchisees from both Warren Lewis and NASAA
ensures that a prospective franchisee remain free to negotiate in and outside that the proposed title of Item 6 taken
knows whether fees are uniform and, of any disclosed range. Accordingly, we from the UFOC Guidelines (‘‘Recurring
where they are not, enables the prospect see no reason to deviate from the UFOC or Occasional Fees’’) be replaced with
to bargain for a lower rate. Item 5 Item 5 approach in this regard.428 ‘‘Other Fees,’’ the term actually used
supplies the prospect with some throughout the disclosure.430 The
8. Section 436.5(f) (Item 6): Other fees
historical information that can aid in Commission believes this change
gauging the parameters of the Section 436.5(f) of the final amended improves the clarity of the Rule’s text
franchisor’s willingness to negotiate Rule requires franchisors to disclose and Item 6.
fees. We believe that this is more useful recurring or occasional fees associated In addition, to conform more closely
by far than including in the disclosure with operating a franchise (e.g., to the UFOC Guidelines, Item 6 of the
document current contractual formulas. royalties, advertising fees, and transfer final amended Rule requires that
Thus, there is no reason to diverge from fees). This requirement recognizes that a franchisors state explicitly what fees are
the UFOC Guidelines on this issue. prospective franchisee’s investment is non-refundable (rather than just stating
Three other commenters voiced not limited to the initial franchise fee the conditions when a fee is
concern about Item 5 as it relates to the alone. Rather, a franchisee may incur refundable).431 Again, to conform more
negotiation of fees. The NFC asserted considerable costs in the operation of closely with the UFOC Guidelines, Item
that Item 5 implies that a franchisee can the business, which will significantly 6 requires franchisors to disclose
seek to negotiate initial fees only if the impact upon his or her ability to whether continuing fees currently being
franchisor already disclosed in its Item continue in business and ultimately be charged are uniformly imposed on all
5 a range of previously accepted fees. successful. This provision covers franchisees.432
Such a result, in its view, restricts payments made directly to the
The Staff Report recommended
prospective franchisees’ ability to franchisor or an affiliate, or collected by
expansion of Item 6 to require
initiate fee negotiations.424 The the franchisor or affiliate for the benefit
franchisors to disclose required
Commission’s intention is to promote of a third party. This disclosure is
payments made to third parties.433 The
the parties’ ability to negotiate terms substantially similar to the comparable
Commission has decided not to adopt
and conditions, including fees and other original Rule disclosure found at 16 CFR
that recommendation. Early in the Rule
costs. Full and accurate prior disclosure 436.1(a)(8).429 Following the UFOC
amendment proceeding, NASAA urged
furthers that goal. Accordingly, nothing Guidelines, the Rule, as proposed in the
this expansion of Item 6.434 Another
in Item 5 or any other provision of part Franchise NPR, expanded the scope of
commenter supported this suggestion,
436 of the final amended Rule prevents this original Rule provision by requiring
a disclosure about the existence of noting that in the ‘‘vast majority of the
the parties from negotiating fees. franchise cases we see, the franchisee’s
David Gurnick suggested that the Rule advertising and purchasing cooperatives
from which franchisees may be required ongoing legal obligations to third parties
permit a franchisor to disclose whether far exceed the franchisee’s ongoing legal
or not it will negotiate fees, and if it to purchase goods or services. The
proposed Rule also required disclosure obligations to the franchisor. However,
does so, permit disclosure of the the franchisee cannot obtain the
conditions that may affect the about the voting power of any
franchisor-owned outlets in the franchise without incurring the third-
negotiation.425 Similarly, BI urged that party obligations.’’435
franchisors be permitted to disclose that cooperative and, if company store
voting power is controlling, the range of Eight Staff Report comments,
they may lower the initial fees.426 however, opposed the proposed
As noted above, however, Item 5 required fees charged by the
cooperative. This is material expansion of Item 6 to require the
ensures that prospects know when fees
may vary. This is sufficient to prompt information about restrictions on 430 Lewis, NPR 15, at 14; NASAA, NPR 17, at 4.
them, if they wish, to negotiate for a fee 431 As previously noted, NASAA has urged the
427Id.
level that suits them. A more extensive 428 The Commission has decided not to adopt
Commission throughout the Rule amendment
or detailed disclosure on this issue proceeding to reduce inconsistencies with the
various suggested revisions to Item 5 offered by the UFOC Guidelines to the fullest extent possible. To
would only introduce needless IL AG. For example, IL AG suggested that the Rule that end, it has submitted into the record a
nonconformity with the UFOC require franchisors to disclose specific information comparison between the original Rule and UFOC
about the amount of fees that are refundable. IL AG,
Guidelines without producing any at 5. The Commission believes that Item 5
Guidelines. See NASAA Comparison, at 8; UFOC
appreciably increased benefit to Guidelines, Item 6, Instructions vi. As noted
adequately covers this by requiring a franchisor to
throughout this Statement, a primary objective in
prospective franchisees. state ‘‘any conditions under which these fees are
revising this Rule is to align it more closely with
BI also urged that when the initial fee refundable.’’ Clearly, this language is flexible
the UFOC Guidelines.
enough to permit a franchisor to state in its Item
is negotiated rather than established by 5 disclosure whether it offers a full or partial
432 See NASAA Comparison, at 8.
applying a formula or fixed calculation, refund.

433 Staff Report, at 126.
the range of such negotiated initial fees 429 In the original SBP, the Commission noted 434 NASAA, NPR 17, at 4.
435 Bundy, NPR 8, at 8. Mr. Bundy also suggested
in the prior fiscal year need not be that the failure to disclose continuing costs violates
Section 5 because it ‘‘(1) misleads or at least that franchisees need to understand that third-party
confuses the franchisee as to the required amount obligations continue even if the franchise is
423 Bundy, NPR 18, at 7. of his or her total investment; and (2) could readily terminated. Id. We agree, but believe that this raises
424 NFC, NPR 12, at 10–11. result in economic injury to the franchisee unable a consumer education issue, not a pre-sale
425 Gurnick, NPR 21, at 6.
to meet such continuing obligations.’’ Original SBP, disclosure one, that is best handled by Commission
426 BI, NPR 28, at 6. 43 FR at 59654–55. and industry educational efforts.
disclosure of payments made to third computer hardware and software, and range, if appropriate) of all
parties. Gust Rosenfeld’s comment is real estate. The Commission is obligations to third parties during
typical, noting that a franchisor may persuaded that the Item 7 and Item 8 the entire initial term of the
require franchisees to lease premises, part 436 disclosures are more than franchise that will be necessary to
obtain necessary licenses, and operate sufficient to advise prospective operate the franchised business
in compliance with applicable laws. franchisees of the likely purchase (including real estate leases and
‘‘All of the payments to do these things obligations incurred in operating a equipment leases) that the
are technically ‘required,’ but they are franchise. franchisee may be required to
generally applicable to all businesses, personally guaranty.444
9. Section 436.5(g) (Item 7): Estimated
and the franchisor does not control
initial investment The Commission declines to adopt
when they are made, to whom they are
made, or what the amount is.’’436 Section 436.5(g) of the final amended this proposal. By its terms, Item 7 of the
Similarly, Piper Rudnick and IFA Rule requires franchisors to set out in an UFOC Guidelines is designed to furnish
asserted that a required listing of all easy-to-read table all the expenses prospective franchisees with material
possible third-party suppliers of goods necessary to commence business (e.g., information about the likely expenses
or services would expose a franchisor to rent, equipment, and inventory)—not faced in the start-up phase of the
liability if it forgot to include one or just the initial fees covered by Item 5 franchise. Armed with such
more.437 and other fees covered by Item 6. It also information, a prospective franchisee
The Commission agrees that the requires franchisors to disclose any will know whether or not he or she has
disclosure of third-party fees in Item 6 refund conditions. Comparable cost the financial ability to get the franchised
would be overbroad, resulting in the disclosures are found in the original outlet operational. Item 7 is not
mandatory disclosure of information Rule at 16 CFR 436.1(a)(7).440 Consistent intended to capture all expenses made
that might not be readily obtainable by with the UFOC Guidelines,441 Item 7 over the life of the franchise, which may
the franchisor and unnecessarily also extends the original Rule by vary depending upon such factors as the
increasing franchisor’s compliance requiring a franchisor to disclose not franchisee’s choice of suppliers and the
burden without any commensurate only payments that the franchisee must terms he or she negotiates with them.
benefit to prospective franchisees. make to the franchisor or its affiliates, For example, Item 7 recognizes that a
Moreover, estimates of initial payments but also estimated payments the franchisor may not know the exact
to third parties are already covered by franchisee must make to third parties in amount of real property expenses.
Items 7 and 8, as discussed below. some instances. For example, Rather than requiring an exact figure,
Specifically, Item 7 requires franchisors franchisors must estimate payments for Item 7 permits franchisors to give an
to disclose estimates of pre-sale utility deposits and business licenses. It
estimate or a low-high range. If neither
expenses paid during the initial also requires franchisors to include an
can be determined, Item 7 permits
period—typically the first three ‘‘additional funds’’ category442 that
franchisors to simply describe property
months—and also requires franchisors captures other expenses franchisees will
requirements, such as property size and
to ‘‘[l]ist separately and by name any incur during the ‘‘initial period’’ of
type, and location. Moreover,
other specific required payments (for operations.443
Item 7 generated little comment. In prospective franchisees may be able to
example, additional training, travel, or get more detailed estimates of long-term
advertising expenses) that the franchisee response to the Staff Report, Howard
Bundy asserted that Item 7 is expenses by speaking directly with
must make to begin operations.438 existing franchisees in their location, or
Franchisors must also include an insufficient, failing to reveal a
franchisee’s total initial investment with trademark-specific franchisee
‘‘additional funds’’ category to capture associations. For these reasons, the
‘‘any other required expenses the because it does not include various
payments to third parties beyond the Commission is not inclined to deviate
franchisee will incur before operations from the UFOC Guidelines Item 7 on
begin and during the initial phase of first 90 days. Specifically, it misses real
estate costs and equipment financing this issue.
operations.’’439 Item 8 already requires
franchisors to disclose franchisee and leasing. Mr. Bundy urged the Item 7 of the final amended Rule is
Commission to adopt the following: substantially similar to its counterpart
obligations to make purchases from
Disclose the total amount (in a in the Franchise NPR, but has been
required or approved suppliers. These
modified in a number of ways to adhere
include obligations to purchase items
440 ‘‘Since . . . fees frequently involve substantial more closely to the UFOC Guidelines.
such as supplies, equipment, inventory,
sums of money, it must be assumed that if they For example, the Franchise NPR
were fully disclosed, they would play a significant proposed that the Item 7 table be titled:
436 Gust Rosenfeld, at 4–5. See also Wiggin &
role in a prospective franchisee’s decision of
Dana, at 2 (questioning whether the proposed whether to enter into a franchise relationship.’’
‘‘YOUR ESTIMATED INITIAL
disclosure of payments to third parties in Item 6 Original SBP, 43 FR at 59652. The ‘‘[f]ailure to INVESTMENT FOR THE FIRST
would cover employee wages, uniform dry disclose material information as to the true cost of [REASONABLE INITIAL PHASE]
cleaning, or accountant fees to prepare taxes). the franchise’’ is an unfair and deceptive trade
Several commenters recommended that Item 6 be
MONTHS.’’445 As one commenter
practice in violation of Section 5. Id., at 59653.
limited to ongoing payment made to the franchisor 441 UFOC Guidelines, Item 7.
noted, however, the language proposed
or its affiliates. Piper Rudnick, at 2; Spandorf, at 7. 442 PMR&W asserted that the additional funds in the Franchise NPR is unnecessarily
437 Piper Rudnick, at 2; IFA, at 3. See also J&G,
category is too broad. Citing the NASAA inconsistent with title of Item 7 table of
at 5 (asserting that the provision would cover not Commentary, the firm noted that owners’ salary, for the UFOC Guidelines, which is titled
only garden variety fees, but an ‘‘infinite plethora example, should be excluded. PMR&W, NPR 4, at
of potential and unpredictable (or unknowable as a ‘‘YOUR ESTIMATED INITIAL
10–11. We agree, but believe this issue is best
practical matter) payments and fees that may vary addressed by staff in the Compliance Guides, which INVESTMENT.’’446 Moreover, the
by locality, such as license and permit fees, or may will explain the term ‘‘additional funds’’ in greater ‘‘initial phase’’ referenced in UFOC
arise due to unpredictable events.’’); Duvall, at 1– detail. Guidelines Item 7 pertains only to the
2 (a franchisor cannot know all the required 443 The term ‘‘initial period’’ means at least three
payments made to hundreds of vendors and months or some other reasonable period for the
accounts). industry. A franchisor seeking to apply an initial
444Bundy, at 5.
438 Section 436.5(g)(1)(ii). 445Franchise NPR, 64 FR at 57335.
phase other than three months has the burden of
439 Section 436.5(g)(1)(iii). showing the reasonableness of the phase selected. 446See PMR&W, NPR 4, at 10–11.
‘‘additional funds’’ category, not to the suppliers available to franchisees.452 In The company retains the right to
entire table.447 addition, franchisors must state approve all outside vendors
In addition, Item 7 as proposed in the whether, by contract or practice, the supplying products to the
Franchise NPR would have required franchisor provides material benefits to franchisees. Our criteria generally
franchisors to disclose ‘‘additional franchisees who use designated or focus on quality and concept-
funds’’ required before operations begin approved suppliers (e.g., permitting uniformity, but we reserve the right
and during the initial phase of the renewals or additional outlets). Finally, to modify the criteria for approving
franchise.’’448 The Commission noted in it requires franchisors to disclose the suppliers at any time. Additionally,
the Franchise NPR that this language existence of purchasing or distribution there are no time limitations as to
was intended to require a working cooperatives, and whether the how long the review/approval of
capital disclosure that could assist franchisor negotiates purchase franchisee-endorsed vendors may
prospective franchisees in agreements with suppliers on behalf of take.456
understanding their break-even point. franchisees. These highly material
Several commenters opposed the disclosures inform prospective The Commission agrees that full
Franchise NPR’s intention to capture franchisees about critical restrictions on disclosure of source restrictions and
working capital and a break-even point; how they will have to operate the purchasing obligations is warranted. To
they pointed out that such an approach franchise, which comprise a vitally that end, the final amended Rule adopts
goes beyond what the UFOC Guidelines important aspect of the franchise the broader UFOC Guidelines’ Item 8
require and asserted that this could be relationship. disclosures. Item 8 strikes the right
misleading without more detailed During the course of the Rule balance between pre-sale disclosure and
earnings information, such as in an amendment proceeding, franchisee compliance costs and burdens. It is
earnings claim statement.449 Indeed, one advocates raised various concerns about sufficient to warn prospective
commenter argued persuasively that the Item 8. For example, several franchisees franchisees about source restrictions,
Franchise NPR’s proposal could create a voiced concern about source restrictions purchase obligations, and approval of
‘‘back-door’’ mandatory earnings claim, that prevent them from obtaining alternative suppliers, without requiring
a position contrary to the Commission’s supplies at lower market rates.453 franchisors to disclose their past
view that earnings claims should be Commenters generally did not allege practices regarding approving
voluntary.450 The Commission finds that franchisors fail to disclose source alternative suppliers (which may be
these arguments persuasive. restrictions, but complained about the irrelevant to their current practices) or
Accordingly, the final amended Rule ‘‘abusive nature’’ of such restrictions.454 their future intentions (which may be
tracks the language of UFOC Guidelines Nevertheless, franchisee advocates proprietary information or misleading if
Item 7 more closely, eliminating any questioned the sufficiency of the Item 8 the franchisor abandons the intended
implication that the Commission disclosures. Specifically, Andrew direction). Moreover, prospective
intends for franchisors to disclose either Selden urged the Commission to expand franchisees can always ask existing
a working capital or breakeven point. the disclosure of supplier restrictions to franchisees or trademark-specific
require franchisors to disclose more franchisee associations about a
10. Section 436.5(h) (Item 8): information about their practices and
Restrictions on sources of products and franchisor’s history of approving
intentions with respect to the provision alternative suppliers, if this issue is
services of competitive alternative sources of important in their decision-making
The original Rule required franchisors supply.455 Mr. Selden, however, offered process.
to disclose obligatory purchases, no specific language for the
Commission’s consideration. Robert With respect to the disclosure of
restrictions on sources of products and
services, and the amount of any revenue Zarco urged the Commission to require revenues received from suppliers,
the franchisor may receive from franchisors to warn prospective Howard Bundy suggested that
required suppliers.451 The final franchisees that: franchisors should disclose the dollar
amended Rule requires more detailed amount of any revenues received during
and extensive disclosures on these 452 In the Franchise NPR, the Commission some stated period, such as during the
topics, consistent with the UFOC proposed that franchisors disclose the actual
criteria for evaluating, approving, or disapproving 456 Zarco & Pardo, ANPR 134, at 2. In the same
Guidelines. Specifically, section of alternative suppliers. Franchise NPR, 64 FR at vein, the AFA asserted that it is insufficient to
436.5(h) of the final amended Rule 57336. Two Franchise NPR commenters voiced require a franchisor to disclose whether a franchisee
requires franchisors to disclose whether concern that this proposal goes well beyond what can purchase products from unaffiliated suppliers.
it makes the criteria for approving the UFOC Guidelines require, forcing franchisors to It urged the Commission to require franchisors to
disclose proprietary information. PMR&W, NPR 4, disclose how long it actually takes for the franchisor
at 1; NFC, NPR 12, at 29. See also Staff Report, at to approve alternative suppliers, by stating the
447Id.
130–31. The Commission agrees. Consistent with following:
448 Franchise NPR, 64 FR at 57305. the UFOC Guidelines Item 8, the final amended ‘‘We have been known to take up to one year or
449 Lewis, NPR 15; Snap-On, NPR 16, at 3; Rule requires franchisors to disclose only a general more to approve a non-franchisor-affiliated vendor;
Holmes, NPR 8, at 6. description of its selection criteria. or We have been known to change the
450 Homes, NPR 8, at 6. See Staff Report, at 159– 453E.g., Manuszak, ANPR 13; Weaver, ANPR 17;
specifications for [specific product] during the
62. Mueller, ANPR 29; Colenda, ANPR 71; Gagliati, approval process. This has caused delays of
451See 16 CFR 436.1(a)(9)–(11). In the original ANPR 72; Buckley, ANPR 97; Haines, ANPR 100; between [number of days/weeks/months/years] to
SBP, the Commission noted that buying restrictions Myklebust, ANPR 101; Rafizadeh, ANPR, 7 Nov. 97, [number of days/weeks/months/years].’’
are common in franchise agreements and are at 288–89; Slimak, ANPR, 22 Aug. 97 Tr., at 26. See AFA, NPR 14, at 4. While the Commission
material because they will ‘‘have a significant also Kezios, ANPR 64. understands that some franchisees have
454E.g., Brickner, ANPR 128; Buckley, ANPR 97,
impact on the sources of supplies and prices which experienced difficulties in obtaining franchisor
a franchisee will pay for his or her supplies and at 3; Myklebust, ANPR 101. A few franchisees approval to use alternative supply sources, the
thus also on the profitability of the franchise.’’ reported that their franchisor failed to approve record is insufficient to justify a sweeping
Original SBP, 43 FR at 59655. Similarly, required alternative suppliers or made it difficult for consumer warning that assumes delay in the
purchases ‘‘limit the independence of the franchisees to find alternative sources of supplies. approval process as a matter of course. Rather,
franchisee, affect the profitability of the franchisee, E.g., Chiodo, ANPR, 21 Nov. 97 Tr., at 308; Hockert- advice concerning the approval of alternative
and constitute a potential source of hidden profit Lotz, id., at 325–27. suppliers can be addressed in consumer education
for the franchisor.’’ Id., at 59656–57. 455 Selden, ANPR 133, Appendix B, at 1. materials.
last year.457 The disclosure of revenues may derive revenue or other material that franchisors use a remarks column to
from suppliers serves an ‘‘anti-conflict consideration from required purchases describe briefly the nature of each
of interest’’ purpose, putting prospective or leases by franchisees,’’ and ‘‘if so obligation.
franchisees on notice that the describe the precise basis by which the The Commission believes that Item 9
franchisor, by benefitting materially franchisor or its affiliates will or may serves a useful purpose. As stated
from a relationship with a supplier, may derive that consideration by stating throughout this document, franchisee
be motivated to require franchisees . . .’’ Footnote 5 added: ‘‘Take figures complaints submitted during the Rule
obtain goods or services from that from the franchisor’s recent annual amendment proceeding supported better
supplier. Accordingly, the highly audited financial statement . . . If pre-sale disclosure about the nature of
material fact is that the franchisor audited statements are not yet required, the franchise relationship.466 Item 9
receives revenues from suppliers it or if the entity deriving the income is an addresses that concern by providing a
requires franchisees to use, not the exact affiliate, disclose the sources of detailed table of contents to the
dollar amount received. By requiring information used in computing franchise agreement, with the additional
franchisors to disclose the percentage of revenues.’’ NASAA observed that the benefit of cross references to the
revenue derived from suppliers, Item 8 footnote incorrectly seems to modify relevant sections of the disclosure
achieves that purpose, consistent with ‘‘precise basis,’’ when it should modify document. It facilitates review of a
the UFOC Guidelines. ‘‘franchisor’s total revenue.’’ It franchise offering by enabling a
Finally, in response to the Staff suggested moving the footnote to the prospective franchisee to find and
Report, a few commenters offered end of section 436.5(h)(6)(i) so that it review the contractual provisions
various technical refinements to Item will modify ‘‘the franchisor’s total detailing their legal obligations, better
8.458 First, Piper Rudnick noted that revenue.’’461 The final amended Rule ensuring that prospective franchisees
Item 8 of the Staff Report would require adopts that suggestion. are not mislead about the nature of the
disclosures about purchases from franchise relationship. Moreover, many
‘‘suppliers . . . under the franchisor’s 11. Section 436.5(i) (Item 9): franchisors already use the UFOC
specifications[, including] obligations to Franchisee’s Obligations Guidelines and prepare an Item 9 table.
purchase imposed by written agreement Section 436.5(i) of the final amended Further, Item 9 should impose few costs
or by the franchisor’s practice.’’ The Rule adopts UFOC Item 9, as proposed or compliance burdens because
firm interpreted the phrase ‘‘imposed by in the Franchise NPR.462 This disclosure franchisors need only reference existing
written agreement’’ as modifying the gives prospective franchisees an easy-to- materials, most likely the franchise
word ‘‘supplier.’’ If so, it maintained understand guide to 25 enumerated agreement and disclosure document. To
that a franchisor would have no reason contractual obligations that are common the extent that legal obligations are
to know if a supplier has a written in franchise relationships, with cross spelled out in any ancillary agreements,
agreement.459 We believe this is a references to the specific sections of the franchisors must direct prospects to
strained reading of the provision: franchise agreement and disclosure those provisions as well.467
‘‘written agreement’’ is intended to refer document that discuss each obligation 12. Section 436.5(j) (Item 10): Financing
to ‘‘franchisor,’’ not to a ‘‘supplier.’’ in greater detail. There is no counterpart
Nevertheless, in order to avoid any in the original Rule. Consistent with the UFOC Guidelines
confusion, we have modified Item 8 in Item 9 generated only a few comments Item 10, section 436.5(j) of the final
the final amended Rule now to read as during the Rule amendment proceeding. amended Rule requires a franchisor to
follows: ‘‘Include obligations to One franchisor representative disclose all the material terms and
purchase imposed by the franchisor’s maintained that the disclosure is conditions of any financing agreements,
written agreement or by the franchisor’s unnecessary. He urged that a franchisor which encompass: the rate of interest,
practice.’’460 be permitted to opt out of Item 9 if the plus finance charges, expressed on an
Second, NASAA addressed the franchisor provides prospective annual basis; the number of payments;
placement of footnote 5. Item 8, as franchisees with a detailed table of penalties upon default; and any
proposed in the Staff Report, would contents or index to its franchise consideration received by the franchisor
require franchisors to disclose ‘‘whether agreement.463 Similarly, another for referring a prospective franchisee to
the franchisor or its affiliates will or franchisor representative suggested that a lender. This disclosure is comparable
the Item 9 disclosures should apply to the original Rule provision found at
457 Bundy, NPR 18, at 8. See also Brown, ANPR
only to franchise agreements, but not to 16 CFR 436.1(a)(12).468 The final
4, at 3 (urging the Commission to prohibit direct
and indirect ‘‘kick-backs’’ from third-party vendors
any accompanying ‘‘licenses, leases, 466 Item 9 is consistent with other trade
to the franchisor). subleases, guarantees, security regulation rules where the Commission has
458 The IL AG also urged the Commission to add agreement, load documents, software recognized that information about legal risks to
‘‘affiliates’’ to the list of suppliers. IL AG, at 5. This agreements, etc.’’464 According to this consumers is material. E.g., Negative Option Rule,
is unnecessary. Franchisors already must disclose commenter, references to these ancillary 16 CFR 425.1(a)(ii) (minimum purchase
purchasers from ‘‘the franchisor, its designee, or obligations); Door-to-Door Sales Rule, 16 CFR 429.1
suppliers approved by the franchisor, or under the agreements are burdensome and of little (obligations regarding cancellations).
franchisor’s specifications.’’ Accordingly, value to prospective franchisees. On the 467 The UFOC Guidelines clearly contemplate
‘‘designee, or suppliers approved by the franchisor’’ other hand, a franchisee representative that franchisors should reference other ancillary
would cover any required purchases from affiliates. asserted that Item 9 does not go far agreements, where appropriate. For example, the
459 Piper Rudnick, at 6. beginning of UFOC Item 9 reads: ‘‘Disclose the
460 Piper Rudnick also recommended that the
enough: ‘‘As currently structured, this principal obligations of the franchisee under the
Compliance Guides clarify the phrase ‘‘obligations disclosure is not worth the time and franchise and other agreements after the signing of
to purchase imposed by . . . the franchisor’s effort largely because it provides no these agreements.’’ The express reference to ‘‘other
practice.’’ Piper Rudnick, at 6. As far as we are benefit to the prospect.’’465 He suggested agreements’’ and the use of the words ‘‘these
aware, this phrase, taken from the UFOC agreements,’’ clearly indicate that the drafters
Guidelines, has not previously raised any directed franchisors to reference all applicable
461 NASAA, at 5. See also WA Securities, at 3. agreements. We see no compelling reason to deviate
interpretive issues. At the very least, ‘‘franchisor’s
practice’’ may include purchases that are
462 Franchise NPR, 64 FR at 57305. from the UFOC Guidelines on this point.
463 Duvall, ANPR 19, at 2.
recommended by the franchisor, or purchases that 468 In the original SBP, the Commission found
464 J&G, NPR 32, at 11.
are prevalent among franchisees, even if not that a prospective franchisee’s ability to obtain
required by contract. 465 Stadfeld, NPR 23, at 14. sufficient funding on reasonable terms is a critical
amended Rule’s Item 10 closely tracks called ‘‘‘finance leases,’ a well- Guidelines’ more detailed assistance
the version of this provision as established term in commercial law.’’472 disclosure requirements, including
proposed in the Franchise NPR, revised The Commission declines to adopt this disclosures relating to advertising
to improve the clarity and overall suggestion. While ‘‘finance leases’’ may assistance and computer system
consistency of the Rule.469 be a term of art used in commercial law, requirements.476
Section 436.5(j), like UFOC we do not believe that the UFOC Section 436.5(k) requires franchisors
Guidelines Item 10, extends the original Guidelines Item 10—upon which to begin their Item 11 disclosure with
Rule disclosures by requiring section 436.5(j) is based—is ambiguous the statement, in bold type, that
franchisors to disclose any interest on or otherwise unclear. Deviating from the ‘‘[e]xcept as listed below, [the
the financing in terms of the rate of UFOC Guidelines on this point, franchisor] is not required to provide
interest, plus finance charges, expressed therefore, is unwarranted. you with any assistance.’’ This alert
on an annual basis, consistent with such Second, David Gurnick suggested that counters any express misrepresentations
disclosures required in consumer credit the Rule expressly permit negotiation of to the contrary and corrects any
transactions.470 It also requires more financial terms, and require disclosure misconception on the prospective
disclosure than the original Rule about indicating ‘‘that there are other sources franchisee’s part that a minimum degree
what the financing covers, waiver of of financing, such as banks, which the of assistance is inherent in any franchise
defenses, and the franchisor’s practice franchisee should consider.’’473 The offer.477 Item 11 also requires
or intent to sell or assign the obligation Commission, of course, intends that franchisors to explain in detail the
to a third party.471 franchisees be free to negotiate franchisor’s site selection criteria and
Three commenters voiced concerns financing terms. The Commission does the franchisor’s training program. As
about Item 10. First, H&H suggested that not believe that the text of the final noted above, this provision also requires
leases referred to in Item 10 should be amended Rule at Item 10 can be read to franchisors to disclose the extent of any
imply that negotiation of financial terms advertising assistance and the operation
element in determining whether to enter into a is not permitted, or that Item 10 of local, regional, and national
franchise relationship. Accordingly, it concluded advertising councils or co-ops. These
that it is both unfair and deceptive for a franchisor contemplates any restriction of a
to fail to disclose or misrepresent financing terms franchisee’s choice of lender. Therefore, disclosures address a common
and conditions, and to fail to disclose rebates we believe it unnecessary to deviate franchisee complaint, namely, that
received in connection with franchise financing. from the UFOC Guidelines on this franchisees do not get the quality or
Original SBP, 43 FR at 59659–60. quantity of advertising they pay for.478
469 The disclosures required by Item 10 are point.474
modeled on the disclosures lenders make under the Finally, in response to the Staff
476See UFOC Guidelines, Item 11.
Federal Reserve’s Regulation M (Consumer Report, IL AG raised a technical issue
Leasing),12 CFR Part 213, and Regulation Z (Truth about the sample Item 10 Financing
477 Our law enforcement experience demonstrates
in Lending), 12 CFR Part 226. Because these that misrepresentation about the level of support
regulations cover personal property leases and
Table, noting that ‘‘Equip. Lease’’ and and assistance is one of the most common problems
credit transactions that are ‘‘primarily for personal, ‘‘Equip. Purchase’’ have separate lines, in franchise cases. See Staff Program Review, at 24–
family, or household purposes,’’ however, they while ‘‘Land/Constr.’’ has a single line. 26 (next to earnings claims, support problems are
generally do not apply directly with respect to lease The form of the Item 10 Financing Table the second most frequent issue raised by franchisee
and financing transactions undertaken in complainants). E.g., FTC v. Car Wash Guys Int’l,
connection with the purchase of a franchise. Sales
in the final amended Rule, however, is Inc., No. 00–8197 ABC (RNBx) (C.D. Cal. 2000); FTC
of franchises generally are not undertaken to taken directly from the UFOC v. Indep. Travel Agencies of Am., Inc., No. 95–
advance personal, family, or household purposes. Guidelines, and the record does not 6137–CIV Gonzalez (S.D. Fla. 1995); FTC v. Sage
The version of Item 10 proposed in the NPR, Seminars, Inc., No. C–95–2854–SBA (N.D. Cal.
reflect that this format has caused 1995); FTC v. Skaife, Bus. Franchise Guide (CCH)
following Item 10 in the UFOC Guidelines,
expressly referenced the Consumer Credit difficulty for franchisors or confusion ¶ 9555 (C.D. Cal. 1990).
Protection Act’s Truth in Lending (‘‘TILA’’) on the part of prospective franchisees. Indeed, misrepresentations about support and
provisions, 15 U.S.C. 1605–1606. While not We therefore decline to deviate from the assistance continue to be a source of numerous
intending to depart unnecessarily from the UFOC UFOC Guidelines on this point. franchisee complaints. For example, one franchisee-
Guidelines, the Commission believes that this commenter reported that her outlet failed, in part,
reference is potentially confusing, because the TILA 13. Section 436.5(k) (Item 11): because the franchisor did not adhere to its own
likely does not apply to transactions within the criteria in selecting a store. Based upon her
scope of the amended Rule. Nevertheless,
Franchisor’s assistance, advertising, experience, she asserted that it is very important to
franchisors can look to TILA and to the Consumer computer systems, and training have full disclosure on site selection criteria.
Leasing Act for guidance in crafting their Lundquist, ANPR, 22Aug. 97 Tr., at 45. See also
disclosures under Item 10. The Commission
Section 436.5(k) retains the original Dady & Garner, ANPR 127, at 4; Mousey, ANPR, 29
anticipates that staff Compliance Guides will Rule’s disclosure of franchisor’s July 97 Tr., at 4–7.
illuminate this topic further. assistance obligations, including pre- 478See, e.g., FTC v. Car Checkers of Am., Inc., No.
470 It is worth noting that interest rates or finance
opening assistance (e.g., site selection), 93–623 (mlp) (D.N.J. 1993) (misrepresenting that
charges may fluctuate between the time when the as well as ongoing assistance (e.g., advertising expenses would be minimal or low);
prospective purchaser receives the disclosure United States v. Fed. Energy Sys., Inc., Bus.
document and the time when he or she actually training).475 Item 11 of the final Franchise Guide (CCH) ¶ 8180 (C.D. Cal. 1984)
executes the financing agreement. Section amended Rule expands the original (misrepresenting extent of company advertising
436.5(j)(1)(iv) requires disclosure of what the rate of Rule, however, based upon the UFOC assistance); United States v. Ferrara Foods, Inc.,
interest, plus finance charges, expressed on an Bus. Franchise Guide (CCH) ¶ 7926 (W.D. Mo.
annual basis, was on a specified recent date. In 1983) (misrepresenting availability of national
situations where the rate may change during the life
472 H&H, NPR 9, at 18. media advertising). The issue of advertising funds
of the loan, disclosure of this fact would be required 473 Gurnick, NPR 21, at 6–7. continues to generate concerns on the part of
474 The Commission will ensure that the
under the catch-all requirement of section franchisees and their advocates. E.g., Brown, ANPR
436.5(j)(x), which calls for disclosure of ‘‘other Compliance Guides reiterate the point made here: 4, at 3 (favoring restrictions on franchisor’s
material financing terms.’’ Of course, Item 22— nothing in Item 10 restricts the parties’ ability to unreasonable use of advertising funds); Manuszak,
section 436.5(v)—requires that any financing negotiate over financing terms. ANPR 13 (franchisor refuses to account for use of
agreement be attached to the disclosure document, 475See 16 CFR 436.1(a)(17) and (18). The offer of franchisees’ advertising funds); Weaver, ANPR 17
and the Item 10 disclosures merely summarize key business assistance is one of the hallmarks of a (no discretion on use of advertising funds); Rachide,
terms. franchise system. In the original SBP, the ANPR 32 (mismanagement of advertising funds);
471 The introduction to UFOC Item 10 makes Commission stated that promises of assistance Colenda, ANPR 71 (alleging inappropriate use of
clear that franchisors are permitted to provide this made to induce prospective franchisees to purchase advertising payments); Zarco & Pardo, ANPR 134,
information in summary table format, and a franchise are material, especially to those at 5 (‘‘A franchisor should be required to disclose
Appendix A to the final amended Rule offers a prospects with ‘‘little or no experience at running the extent of its veto power over the allocation of
sample table. a business.’’ Original SBP, 43 FR at 59676–77. Continued
Section 436.5(k) also addresses major The Commission believes that Item We are persuaded that it is sufficient for
technological changes in franchising 11’s computer systems disclosures, franchisors to describe generally the
since the original Rule was promulgated which track the UFOC Guidelines’ computer systems to be used, if any; any
in 1978. Based upon UFOC Item 11, this disclosures, serve a useful purpose. required purchase and maintenance
provision requires material disclosure There is no question that the costs a costs and obligations; and whether the
about the required use of computers and franchisee must incur to purchase or franchisor will have access to
electronic cash registers.479 For lease computer and related equipment information contained in those systems.
example, it requires franchisors to or software, as well as any continuing This information not only will enable
disclose whether they will have maintenance or upgrade obligations and prospects to weigh the costs and
independent access to information and their associated costs, comprise benefits of purchasing a specific
data stored on electronic cash register information that is material to the franchise, but will better enable
systems or software programs that the prospective franchisee’s purchasing prospects to learn if they will be at a
franchisee is required to use or buy.480 decision. Information about whether the technological disadvantage compared to
Item 11, as proposed in the Franchise franchisor will have access to other franchise systems in the industry.
NPR, would have adopted the UFOC information stored on the franchisee’s On the other hand, one franchisee
Guidelines requirement that franchisors computers or electronic cash registers advocate, Howard Bundy, firmly
identify each piece of hardware and also is material, because such access defended the materiality and usefulness
software by brand, type, and principal very likely would be a key component of detailed itemized disclosures about
function, or to identify compatible of the relationship between the required computer systems.
equivalents and whether they have been franchisor and franchisee. As noted Specifically, Mr. Bundy voiced concern
approved by the franchisor.481 The throughout this document, the about franchisors that require
computer system disclosure was the Commission is convinced that franchisees to use proprietary
only Item 11 issue that generated additional disclosures are warranted technology that the franchisor has
significant comment during the Rule where they will likely prevent developed or plans to develop. Mr.
amendment proceeding. Several deception about the nature of the Bundy asserted that this may negatively
comments asserted that the UFOC franchise relationship a prospective impact upon franchisees’ ability to fix
Guidelines Item 11 computer system franchisee is deciding to enter. flaws in software, for example. He
disclosures are burdensome, not helpful Nonetheless, the computer usage contended that prospective franchisees
to prospective franchisees, and are disclosures as set forth in the UFOC should have the right to know whether
unnecessary because the costs Guidelines appear to go beyond what is they can use ‘‘off-the-shelf’’ products,
associated with purchasing computers material in some instances and likely and whether software can interface with
and related equipment are already would impose unwarranted compliance common systems such as Microsoft
disclosed in Items 5, 7, and 8.482 burdens. Specifically, we are Office or Outlook. Similarly, they
Marriott, for example, explained that its disinclined to require a franchisor to should know whether accounting
Item 11 computer usage disclosure identify each and every piece of software complies with IRS standards or
‘‘results in four to five pages of hardware and software by brand, type, if they will get periodic updates.486
disclosure in each of Marriott’s offering and principal function, or to identify Mr. Bundy’s concern about the
circulars yet provides little or no benefit compatible equivalents and whether potential limitations of franchisor-
to franchisees.’’483 In addition, one they have been approved by the developed software has merit. However,
franchisor representative noted that franchisor. We agree with the Franchise we believe the final amended Rule
many start-up franchisors are ‘‘not NPR commenters who observed that already addresses this issue. As noted
certain which computer system or some franchisors (start-up franchisors in above, section 436.5(k) requires
particular) may not have decided upon franchisors to ‘‘describe the systems
software they expect to have the
specific systems at the time of sale or, (which includes hardware and software
franchisees use. Provision should be
even if they did, that the technology components) generally in non-technical
made for these new franchisors.’’484
very likely will change over the course language, including the types of data to
any franchisee-generated funds, such as advertising of the franchise agreement. Thus, the be generated or stored in these
cooperatives.’’). compliance burden to prepare systems.’’ Thus, the ‘‘general
479 In response to the ANPR, a few commenters component-specific disclosures would description’’ requirement is broad
voiced concerns about obligations to purchase not likely outweigh any tangible enough to cover proprietary systems
computers or related equipment. E.g., Fetzer, ANPR, benefits to prospective franchisees.485 that can be obtained only from the
19 Sept. 97 Tr., at 42 (needed to purchase a
computer converter, an additional $7,000 expense); franchisor. Moreover, section 436.5(k)
Rafizadeh, ANPR, 7 Nov. 97 Tr., at 292 (GNC suggested that a franchisor should be permitted to will require the franchisor to disclose
unilaterally forcing franchisees to pay a new $80 satisfy the Item 11 requirements by disclosing that any obligation to provide ongoing
monthly maintenance fee on computer equipment specifications are not known or available. H&H,
NPR 9, at 23. Cf. Bundy, NPR 18, at 9 (suggesting
maintenance, repair, upgrades, or
purchased from GNC).
480See NCA 7-Eleven Franchisees, ANPR 113, at that a start-up franchisor disclose some guidelines updates. Taken together, these
2 (noting 7-Eleven’s use of ‘‘point-of-sale’’ cash it will follow in selecting a computer system). We provisions are sufficient to capture
registers, which enable headquarters to monitor agree. Accordingly, the Commission intends that, instances where franchisors require the
for start-up franchisors, the computer system
sales).
disclosures of Item 11 should be read to allow use of their own software.
flexibility: a start-up franchisor may indicate that Finally, we note that in response to
482 Baer, NPR 11, at 13; J&G, NPR 32, at 11.
computer requirements are yet unknown, or the Staff Report, Gust Rosenfeld raised
483 Marriott, NPR 35, at 15–16.
otherwise state its policy concerning computer a technical point about the Item 11
484 Kestenbaum, ANPR 40, at 2. In response to the usage, as is warranted. As Mr. Bundy noted, the
Franchise NPR—which proposed adopting the lack of selected computer systems by the franchisor disclosure of the franchisor’s operating
UFOC Item 11’s detailed computer systems itself reveals material information: that the manual. The firm noted that, under the
disclosures—H&H suggested that a franchisor franchisor is not yet computerized, which may UFOC Guidelines, franchisors must
should be required to disclose the specifications of ‘‘plac[e] the franchisee at a disadvantage in many, include the Table of Contents of the
any mandatory computer system to the extent if not most industries.’’ Bundy, NPR 18, at 9.
known or available, observing that start-up 485See Staff Report, at 137–38. It is noteworthy operating manual in the disclosure
franchisors may not have identified software that NASAA has not opposed this substantive
systems before they start franchising. The firm revision to Item 11 of the UFOC Guidelines. 486 Bundy, at 6–7.
document, unless ‘‘the prospective and the franchisee’s establishment of address ‘‘encroachment.’’490 The
franchisee views the manual before additional outlets; (2) any present plans commenters contended that
purchase of the franchise.’’487 The firm on the part of the franchisor to operate encroachment may have a devastating
asserted that the Staff Report erred in a competing franchise system offering effect upon an individual franchisee
recommending that the alternative to similar goods or services; and (3) in who does not have a contractually
providing the Table of Contents be instances when a franchisor does not protected exclusive territory,491 and
revised to permit a franchisor to ‘‘offer offer an exclusive territory, a prescribed some urged the Commission to ban
a prospective franchisee the opportunity warning about the consequences of encroachment as ‘‘an abusive and
to review the manual before buying the purchasing a non-exclusive territory. In unfair’’ trade practice under Section 5 of
franchise.’’ response to some comments, the the FTC Act.492
The Commission believes the Staff Commission also has decided to make
Report is correct. As a practical matter, The Commission’s view is that the
additional modifications to the text of
we question how it could be proven that granting of a protected territory is
Item 12 in order to update both the
a prospective franchisee actually fundamentally a private contractual
original Rule and the UFOC Guidelines
reviewed a manual. Even if a franchisor matter for the parties to determine for
to address new technologies and market
had a prospective franchisee initial each developments, such as the Internet and themselves.493 While the record
page of a manual, there is no assurance alternative channels for distributing a establishes franchisees’ concerns about
that the prospect actually ‘‘reviewed’’ franchisor’s goods.489 encroachment, it falls far short of
the manual. For that reason, at most we supporting a conclusion that not
can require a franchisor to afford a The Item 12 territory disclosures granting a protected territory in a
prospective franchisee the opportunity generated several comments. First, franchise agreement constitutes an
to review the manual. At the same time, franchisees and their advocates urged unfair practice within the meaning of
we stress that the ‘‘opportunity to the Commission to address the FTC Act. Nor does the record
review’’ a manual must be a reasonable ‘‘encroachment,’’ the practice by which support a conclusion that a franchisor’s
one. A franchisor would not satisfy its a franchisor essentially competes with expansion where there are existing
disclosure obligation if, for example, it its franchisees by establishing franchisees is an unfair practice.
offered to show the manual to a franchisor-owned or new franchised-
prospect only if the prospect agreed to outlets in the same market territory, by Section 5(n) of the FTC Act provides
fly across country to the franchisor’s purchasing and operating a competing that an ‘‘unfair’’ practice is one that
corporate headquarters. In that regard, franchise system, or by selling the same ‘‘causes or is likely to cause substantial
the opportunity to review a manual goods or services through alternative injury to consumers which is not
means that the franchisor must show the channels of distribution. Second, other reasonably avoidable by consumers
manual to the prospect (for example in commenters questioned the scope of themselves and not outweighed by
person or online) and permit the Item 12, urging the Commission to countervailing benefits to consumers or
prospect sufficient time to review it. require franchisors to disclose more to competition.’’ While the record
information about their past expansion suggests that some franchisees in several
14. Section 436.5(l) (Item 12): Territory franchise systems may have been
practices, as well as future expansion
Section 436.5(l) of the final amended plans. Third, some commenters harmed by franchisor encroachment, the
Rule retains the original Rule’s questioned the terminology used to record leaves open the question whether
disclosures concerning exclusive describe territories, urging the encroachment is prevalent and whether
territories and sales restrictions.488 Like Commission to avoid implying that a the injury resulting from encroachment
the proposed Rule published in the protected territory is inherent in the is substantial, when viewed from the
Franchise NPR, the final amended Rule concept of franchising. Finally, several standpoint of the franchising industry as
is closely modeled on the UFOC commenters offered different views on
Guidelines. It therefore expands the the form of warning that might be 490E.g., Brown, ANPR 4, at 2; Packer, ANPR 10;
original Rule’s disclosure requirements appropriate where a franchisor sells Manuszak, ANPR 13; Donafin, ANPR 14; Weaver,
regarding territories in several respects. ANPR 17; Rachide, ANPR 32, at 3; AFA, ANPR 62,
franchises without an exclusive at 1; Orzano, ANPR 73; Buckley, ANPR 97, at 3;
These new disclosure requirements
territory. Each of these issues is Marks, ANPR 107, at 2; Zarco & Pardo, ANPR 134,
cover: (1) the conditions, if any, under
discussed below. at 2.
which a franchisor will approve the 491 For example, Laurie Gaither, an owner of a
relocation of the franchisee’s business a. Encroachment GNC franchise, reported that the company opened
a franchisor-owned outlet in a mall within two
487 Gust Rosenfeld, at 5 (citing UFOC Guidelines, Throughout the Rule amendment miles from her store. She claimed that this
Item 11, at B. vii.). proceeding, franchisees and their development has reduced her profits by 50%. L.
488See 16 CFR 436.1(a)(13). In the original SBP, Gaither, ANPR 68.
advocates urged the Commission to 492E.g., AFA, ANPR 62, at 1 (putting up a new
the Commission recognized that sales restrictions
and limited territories affect a franchisee’s ability to outlet to compete with an existing franchisee is an
conduct business and are, therefore, material. 489 Specifically, Item 12 of the final amended unfair trade practice); Bell, ANPR 30 (FTC needs to
Original SBP, 43 FR at 59662. See, e.g., FTC v. Am. Rule extends the original Rule by providing a prohibit franchisors from devaluing assets through
Legal Distrib., Inc., Bus. Franchise Guide (CCH) prospective franchisee with material information encroachment); Rachide, ANPR 32 (encroachment
[1987–1989 Transfer Binder] ¶ 9090 (N.D. Ga. about competition not only through outlets within among practices that FTC should prohibit); Marks,
1988); United States v. C.D. Control Tech. Inc., Bus. the prospective franchisee’s intended location, but ANPR 107 (FTC should consider prohibiting
Franchise Guide (CCH), ¶ 9851 (E.D.N.Y. 1985); through alternative channels of distribution, such as franchisor encroachment, unless franchisee
United States v. Fed. Energy Sys, Inc., Bus. the Internet, catalog sales, telemarketing, and direct compensated).
Franchise Guide (CCH) [1983–85 Transfer Binder] marketing. In the same vein, it addresses any 493 Absent an express grant of a protected
¶ 8180 (C.D. Cal. 1984); FTC v. Nat’l Bus. restrictions on a franchisee’s ability to conduct territory, a franchisor is generally free to establish
Consultants, Inc., Bus. Franchise Guide (CCH) ¶ business outside of his or her territory through as many outlets (franchisor-owned or franchised) in
9365 (E.D. La. 1989). Cf. FTC v. Vendors Fin. Serv., traditional sales and alternative channels of any particular market as it wishes. A few state
Inc., No. 98–N–1832 (D. Colo. 1998); FTC v. Int’l distribution. The Staff Report recommended this courts (or federal courts applying state law),
Computer Concepts, Inc., No. 1:94cv1678 (N.D. modification to the proposed Rule. Staff Report, at however, have held that encroachment violates
Ohio 1994); FTC v. O’Rourke, Bus. Franchise Guide 144–45. See PRM&W, NPR 4, at 11 (supporting need state implied covenants of good faith and fair
(CCH) ¶ 10243; FTC v. Am. Safe Mktg., Inc., Bus. to update the original Rule to address new dealing. See, e.g., In re Vylene Enterprises, Inc., 90
Franchise Guide (CCH) ¶ 9350 (N.D. Ga. 1989). technologies and marketing practices). F.3d 1472 (9th Cir. 1996).
a whole,494 not just from a few franchise disadvantage if they were to be made competition because any prospective
systems.495 Second, assuming a publicly available.’’498 The firm also franchisee who buys a franchise without
regulatory regime of full and truthful stressed that franchisors need flexibility any protected territory is essentially
pre-sale disclosure on the issue of to adapt development plans to market taking the risk that the franchisor will
territories, prospective franchisees can realities. ‘‘Disclosure of development further develop the market area. For
avoid potential harm from plans could lead to possible claims by these reasons, we have determined not
encroachment by shopping for a franchisees who anticipated greater or to deviate from the UFOC Guidelines on
franchise opportunity that offers an lesser franchise development in a this point.
exclusive territory. Finally, the record particular area.’’499 c. Terminology
does not support a finding that harm to Based on review of the record as a
franchisees resulting from whole, the Commission has determined The final amended Rule fine-tunes the
encroachment necessarily outweighs that requiring disclosure of past and terminology and organization of Item
potential benefits (expansion of markets planned future expansion is 12. As proposed in the Franchise NPR,
and increased consumer choice) to unwarranted. With respect to past Item 12 would have required that
consumers or to competition. For these expansion, prospective franchisees franchisors disclose information
reasons, the Commission has arguably can discover such information ‘‘concerning the franchisee’s market
determined that the criteria for an on their own by directly observing the area with or without an exclusive
industry-wide prohibition on number and location of outlets in their territory.’’ It also referred to the
encroachment has not been met. Thus, community and by speaking with franchisee’s ‘‘defined area.’’502 Several
the Commission declines to mandate current and former franchisees. commenters raised concerns about the
specific contractual terms regarding Moreover, past practices are not use of these terms.
territories. necessarily a predictor of future intent. First, BI opposed the use of the term
‘‘exclusive territory’’ in the Franchise
b. Scope of the Item 12 disclosures It is also unreasonable to require
NPR, urging the Commission to use the
franchisors to disclose hypothetical
A few commenters urged the term ‘‘protected territory’’ instead. It
possibilities about their future
Commission to require franchisors to asserted that the term ‘‘protected
expansion. Indeed, by not granting an
disclose more information about their territory’’ is more descriptive of a
exclusive territory, the franchisor has
past practices with regard to expansion franchisee’s typical contractual rights
effectively reserved to itself the
into franchisees’ areas or their future regarding its territory, if any.503
unrestricted right to expand into new or
plans to do so.496 For example, Andrew Similarly, the firm opposed the use of
existing locations or to sell its products
Selden, a franchisee representative, the term franchisee’s ‘‘market area.’’ It
or services via alternative channels of
suggested that ‘‘Item 12 should be maintained that the term ‘‘market area’’
distribution. is undefined and imprecise. BI
elaborated to require full disclosure of
The UFOC Guidelines require a advocated use of the term ‘‘location.’’504
past practice, current intention or future
franchisor to disclose only if the The NFC agreed, asserting that the
possibility of franchisor-sponsored
franchisor ‘‘may establish’’ other outlets term ‘‘market area’’ is a ‘‘charged
competitive activities that have the
in the area; it does not require the word.’’505 According to the NFC, under
prospect of impacting the franchisee’s
franchisor to disclose its specific plans franchisee agreements, franchisees have,
business.’’497
Franchisors addressing current for the franchisee’s territory. at most, a right only to a specified
development plans uniformly opposed Franchisors need to elaborate on their location or narrowly defined geographic
any disclosure. H&H’s comment is expansion plans only if they have area. Use of the term ‘‘market area’’ may
typical. Most franchisors consider ‘‘present plans to operate or franchise a advance the false notion that the grant
current development plans to be business under a different trademark of a franchise inherently ‘‘confers upon
proprietary information ‘‘that would and that business sells goods or services a franchisee exclusive rights within the
place them at a competitive similar to those to be offered by the franchisee’s economic ‘market area,’
franchisee.’’500 Moreover, the despite the terms of the subject
494 As discussed above in the overview of the Commission is inclined to the view that franchise agreement.’’506 Similarly, the
final rule above (section I.D. of this document), the a franchisor’s development plan is NFC opposed the use of the term
Commission has voiced concern that government- proprietary information that a franchisor ‘‘defined area.’’ In its view, the
mandated contractual terms may result in should not be required to make
affirmative harm to consumer welfare. Accordingly, appropriate term should be ‘‘limited
the Commission has authorized staff to file a public.501 It could also subject protected territory,’’ noting that an area
number of advocacy comments recommending franchisors to future liability for fraud is almost never granted unconditionally
against proposed state bills that would have unduly or misrepresentation should the by a franchisor. The NFC advised that
limited manufacturers in managing their franchisor alter, abandon, or delay its
distribution systems, such as by requiring exclusive by using the phrase ‘‘limited protected
territories. stated expansion plans. Further, territory’’ in lieu of ‘‘defined area,’’ the
495See Staff Program Review, at 59. requiring a franchisor to disclose plans Commission could ‘‘actually reduce the
496 One commenter in the Rule amendment to develop a territory may be costly and misconception which otherwise may be
proceeding advocated broadening the scope of the burdensome because the franchisor engendered in the minds of prospective
Rule to require more expanded disclosures covering conceivably would have to prepare
competition by affiliates, the franchisor’s officers, franchisees over what territorial
and franchise sellers. Bundy, NPR 18, at 9. In the multiple Item 12 disclosures to focus on protections, if any, they can expect to
absence of persuasive record evidence that each franchise location. The disclosures receive.’’507
competition by franchisor officers or sellers is a already contained in Item 12 are
prevalent problem, however, the Commission has sufficient to warn prospects about likely 502 Franchise NPR, 64 FR at 57339.
determined not to deviate from the UFOC
Guidelines on this issue.
503 BI, NPR 28, at 6 (‘‘[E]xclusive . . . is
ambiguous and often misleading.’’).
497 Selden, ANPR 133, Appendix B. See also

498 H&H, NPR 9, at 23.
499Id. 504Id.
Dady & Garner, ANPR 127, at 4 (‘‘Explicit See also Wendy’s, NPR 5, at 2; Baer, NPR
statements about the nature and extent of protection 11, at 13 ; Lewis, NPR 15, at 15; BI, NPR 28, at 11; 505 NFC, NPR 12, at 19.
against same-brand competition that will or will not J&G, NPR 32, at 12; GPM, NPR Rebuttal 40, at 6. 506 NFC, NPR 12, at 19. See also J&G, NPR 32,
500 UFOC Item 12C (emphasis added). at 12.
be provided is essential to an informed buying
decision.’’). 501E.g., Wendy’s, NPR 5, at 2. 507Id. See also J&G, NPR 32, at 12.
The Commission agrees that terms generally disfavors the use of warnings that reason, trademark usage is one of
such as ‘‘market area’’ and ‘‘defined that merely repeat what is already three definitional elements of the term
area’’ are potentially misleading. Such expressly stated in the franchise franchise. Any pending litigation,
terms inaccurately imply an inherent agreement, but believes that a specific settlement restrictions, or other
right to a territory, where, in fact, the warning regarding exclusive territories potential limitations on the use of the
right to a territory, protected or is warranted in light of the volume and trademark are material because they will
otherwise, is purely a matter of contract. persuasiveness of franchisee complaints necessarily affect the value of the
Accordingly, we believe the term regarding territory issues.512 As noted trademark to a prospective franchisee
‘‘exclusive territory’’—as used in the previously, the Commission is and ultimately may impact the
UFOC Guidelines508—is more precise. convinced that additional disclosures franchisee’s ability to continue
While the term ‘‘exclusive territory’’ is, are warranted where they will likely operating the business.
perhaps, not as ‘‘descriptive’’ as the prevent deception about the nature of Item 13 generated little comment.
terms ‘‘protected area,’’ or ‘‘limited the franchise relationship. Howard Bundy suggested that
protected territory,’’ its use is clarified franchisors should disclose not only
15. Section 436.5(m) (Item 13): pending trademark litigation, but all
for prospective franchisees through the Trademarks
disclosures set forth in paragraphs (5) such litigation in the last 10 years.515
and (6) of section 436.5(l). Accordingly, The original Rule required a The Commission declines to adopt this
in the absence of a stronger showing franchisor to list the trademark suggestion. The fact that the franchisor
that alternatives to ‘‘exclusive territory’’ identifying the goods or service to be may have been involved in a trademark
are more accurate, the Commission has sold by the prospective franchisee.513 dispute a decade ago is not inherently
determined to revise Item 12 to adhere Consistent with the UFOC Guidelines, material.516 What influences a decision
more closely to the UFOC Guidelines on section 436.5(m) of the final amended to purchase a franchise is whether there
this point, as recommended in the Staff Rule requires franchisors to disclose are any current restrictions or disputes
Report.509 Thus, the final amended Rule whether the trademark is registered with over the trademark license. Obviously,
substitutes the words ‘‘location’’ or the United States Patent & Trademark any existing trademark restrictions or
‘‘exclusive territory’’ for ‘‘market area,’’ Office; the existence of any pending challenges not only may decrease the
‘‘area,’’ and ‘‘defined’’ area, as litigation, settlements, agreements, or value of the mark and the goodwill
appropriate. superior rights that may limit the associated with it, but may increase
franchisee’s use of the trademark; and franchisees’ costs if they must switch to
d. Warning any contractual obligations to protect a different mark. Accordingly, we
the franchisee’s right to use the mark decline to deviate from the UFOC
Item 12 of the final amended Rule against claims of infringement or unfair Guidelines by requiring more extensive
fine-tunes and expands slightly the competition. disclosures on this point.
standard warning proposed in the These expanded disclosures are The Commission has determined to
Franchise NPR that is required in those consistent with the Commission’s long- adopt staff’s recommendation to adhere
instances when franchisors do not offer standing policy of requiring franchisors more closely to the UFOC Guidelines on
exclusive territories: ‘‘You will not to disclose the material costs and Item 13 than did the proposed Rule on
receive an exclusive territory. You may benefits of the franchise sale. One of the two points. First, the Franchise NPR
face competition from other franchisees, principal reasons that one may wish to proposed that franchisors disclose how
from outlets that we own, or from other purchase a franchise—as opposed to any infringement, opposition, or
channels of distribution or competitive starting one’s own business—is the right cancellation proceeding ‘‘affects the
brands that we control.’’510 to use the franchisor’s mark, which franchised business.’’517 This is
Given the potential financial risks presumably creates an instant market for unnecessarily inconsistent with the
associated with a non-exclusive the franchisees’ goods or services.514 For wording of the UFOC Guidelines, which
territory, the Commission believes that state: ‘‘affects the ownership, use, or
franchisors who do not offer an ‘‘The company reserves the right to increase the licensing’’ of the trademark.518
number of franchised or company-owned units in
exclusive territory should warn an area. In the past, we have been known to put
Second, the Franchise NPR included
prospective franchisees about such another outlet in close proximity to an existing unit. a footnote addressing the use of
possible risks.511 The Commission This action generally has a negative impact on the summary opinions of counsel:
gross and/or net sales of the pre-existing unit.’’ ‘‘Franchisors may include a summary
508 See, e.g., UFOC Item 12 (‘‘Describe any Zarco & Pardo, ANPR 134, at 2. See also Dady & opinion of counsel concerning any
Garner, ANPR 127, at 3 (suggesting: ‘‘You have no
exclusive territory granted the franchisee. action if a consent to use the summary
protected area. Your franchisor, without any
Concerning the franchisee’s location (with or
without exclusive territory, disclose . . .’’). See also
compensation to you, may place another store in a opinion is included as part of the
location that may completely erode your disclosure document.’’519 The footnote,
NASAA Comparison at Item 12.
profitability.’’).
509 In response to the Staff Report, no
512 E.g., Brown, ANPR 4, at 2; Parker, ANPR 10;
however, did not address the
commenters raised any concerns about the Manusak, ANPR 13, at 1; Donaphin, ANPR 14; discretionary use of a full opinion letter,
recommended choice of terminology used in Item Weaver, ANPR 17; Rachide, ANPR 32, at 3; AFA, nor the need to attach the full opinion
12. ANPR 62, at 1; L. Gaither, ANPR 68; Orzano, ANPR
510 This language, with minor editing, was
letter if a summary is used. On this
73, at 1; Buckely, ANPR 97, at 3; Marks, ANPR 107,
suggested by PMR&W, which observed that the at 2; Zarco & Pardo, ANPR 134, at 2; Vidulich, 22
point, the UFOC Guidelines state:
proposed version of the warning focused only on Aug. 97 Tr., at 17; Christiano, 19 Sept. 97 Tr., at the franchisor may include an
sales from outlets. PMR&W argued convincingly 50; Bundy, 6 Nov. 97 Tr., at 135; Cordell, 6 Nov.
that such a warning could be misleading because it 97 Tr., at 136; Kezios, 6 Nov. 97 Tr., at 142. See
fails to take into consideration competition from also FTC v. Fax Corp. of Am., Inc., No. 90–983 (D.
515 Bundy, NPR 18, at 9.
other sources, such as the Internet, direct mail, and N.J. 1990); FTC v. Nat’l Bus. Consultants, Inc., No.
516 On this issue, the UFOC Guidelines
mail order. PMR&W, NPR 4, at 11. See also J&G, 89–1740 (E.D. La.1989); FTC v. Am. Legal Distrib., specifically note that a franchisor need not disclose
NPR 32, at 12; IL AG, NPR Rebuttal 38, at 3. Inc., No. 1:89–CV–462–RLV (N.D. Ga. 1989). historical challenges to registrations of trademarks
511 Indeed, several franchisee advocates urged the 513See 16 CFR 436.1(a)(1)(iii). that were resolved in the franchisor’s favor. UFOC
Commission to strengthen the existing UFOC 514 In the original SBP, for example, the Guidelines, Item 13B Instructions, iv.
Guidelines’ encroachment risk factor. For example, Commission noted that a key feature of franchising
518See NASAA Comparison, at 17.
Robert Zarco suggested that franchisors be required is the right to use the franchisor’s trademark.
to state: Original SBP, 43 FR at 59623. 519 Franchise NPR, 64 FR at 57339.
attorney’s opinion relative to the such property.523 If counsel permits, States Patent and Trademark Office or
merits of litigation or of an action Item 14 allows a franchisor to include any court.’’
if the attorney issuing the opinion a counsel’s opinion or a summary of the Finally, Item 14, as proposed in the
consents to its use. The text of the opinion about legal actions, if the full Franchise NPR, would have required
disclosure may include a summary opinion is attached.524 franchisors to disclose the ‘‘length of
of the opinion if the full opinion is The final amended Rule differs from time of any infringement.’’ However, it
attached and the attorney issuing the Franchise NPR proposal, however, is possible that a franchisor may not
the opinion consents to the use of in several non-substantive respects to know how long a third party has been
the summary.520 infringing its rights. Accordingly, Item
add precision and improve organization
The Commission adopts the UFOC of the provision. Specifically, Item 14 of 14 of the final amended Rule adds the
Guidelines language in both instances. the final amended Rule separates those qualifying phrase ‘‘to the extent
In addition, the final amended Rule disclosures pertaining to patents from known.’’
improves on the clarity and precision of those pertaining to patent applications. 17. Section 436.5(o) (Item 15):
the proposed Rule’s standard disclosure At the same time, it also groups closely Obligation to participate in the actual
required when the franchisor’s related disclosures—those for patents, operation of the franchise business
trademark is not registered on the patent applications, and copyrights—
Principal Register of the United States under a single common direction. For Section 436.5(o) of the final amended
Patent and Trademark Office. The example, section 436.5(n)(1) of the Rule retains the original Rule
proposed disclosure reads as follows: ‘‘If Franchise NPR stated: ‘‘For each patent requirement that franchisors disclose
the trademark is not registered on the or copyright: (i) Describe the patent or whether franchisees are required to
Principal Register of the U.S. Patent and copyright and its relationship to the participate personally in the direct
Trademark Office, state: ‘By not having franchisee; (ii) State the duration of the operation of the franchise.525 Like the
a Principal Register federal registration patent of copyright.’’ Section 436.5(n)(1) corresponding provision in the
for [name or description of symbol], of the final amended Rule simplifies Franchise NPR’s proposed rule, this
[name of franchisor] does not have this language by eliminating the use of section of the final amended Rule
certain presumptive legal rights granted multiple directions. Instead, it says: ‘‘(1) closely tracks the UFOC Guidelines’
by a registration.’’’521 Disclose whether the franchisor owns Item 15. It therefore expands the
The final amended Rule’s disclosure rights in, or licenses to, patents or original Rule on this point by requiring
is: copyrights that are material to the franchisors to disclose: (1) participation
franchise. Also, disclose whether the obligations arising not only from the
We do not have a federal
franchisor has any pending patent parties’ franchise agreement, but from
registration for our principal
applications that are material to the other agreements or as a matter of
trademark. Therefore, our
franchise. If so, state . . .’’ followed by practice; (2) whether direct participation
trademark does not have as many
the specific disclosure requirement for is recommended; and (3) any limitations
legal benefits and rights as a
patents, patent applications, and on whom the franchisee can hire as a
federally registered trademark. If
copyrights. supervisor and any restrictions that the
our right to use the trademark is
franchisee must place on his or her
challenged, you may have to change Similarly, section 436.5(n)(1), as manager. If the franchisee operates as a
to an alternative trademark, which proposed in the Franchise NPR, referred business entity, the franchisor must also
may increase your expenses.522 to the ‘‘issue date.’’ The final amended disclose the amount of equity interest, if
16. Section 436.5(n) (Item 14): Patents, Rule instead uses the correct language: any, that the supervisor must have in
copyrights, and proprietary information ‘‘issuance date.’’ In the same vein, Item the franchise.
14 of the final amended Rule corrects
Section 436.5(n) of the final amended imprecise language that would have Item 15 generated little comment. In
Rule adopts the UFOC Guidelines’ required the disclose of material response to the Staff Report, NASAA
requirement for disclosure of determinations pending in ‘‘the U.S. and Washington Securities noted an
information about the franchisor’s Patent and Trademark Office or the U.S. inconsistency between the proposed
intellectual property. There is no Court of Appeals for the Federal final amended Rule and the UFOC
comparable provision in the original Circuit.’’ In fact, patent and copyright Guidelines on the disclosure of whom a
Rule. Item 14 elicited no comment determinations can be made in courts franchisee may hire as an on-premises
during the amendment proceeding. other than the U.S. Court of Appeals for supervisor and that person’s training.
Item 14 requires franchisors to the Federal Circuit, as noted in other Whereas the UFOC Guidelines provide
describe in general terms the types of sections of Item 14 (‘‘Describe any that these disclosures pertain to all
intellectual property involved in the current material determination of the franchisees, the Franchise NPR
franchise and any legal proceedings, United States Patent and Trademark suggested that these disclosures should
settlements, and restrictions that may Office, the United States Copyright be limited to franchisees who are
impact the franchisee’s ability to use office, or a court regarding the patent or individuals, but not to business
copyright.’’). The language now reads entities.526 We agree with the
520 UFOC Guidelines, Item 13B Instructions, v.
more broadly ‘‘pending in the United commenters that the Franchise NPR’s
521 Franchise NPR, 64 FR at 57339. proposed limitation was based upon an
522 Arguing that many prospective franchisees
523 Restrictions on the use of the franchisor’s
erroneous reading of the UFOC
would not understand the standard disclosure
prescribed in the Franchise NPR’s proposed Rule— intellectual property are material because they not
particularly the phrase ‘‘presumptive legal rights’’— only may seriously diminish the value of the 525 See 16 CFR 436.1(a)(14). In the original SBP,
the Staff Report recommended that the Commission franchise, but could undermine the franchisee’s the Commission noted that the degree of personal
simplify it. The simplified version recommended by ability to operate the business. Item 14 also may participation required of a franchisee is a material
staff, however, was criticized by two commenters improve the relationship between franchisors and fact in the franchise relationship. Accordingly, the
on the ground that it was not entirely accurate from franchisees by preventing any misunderstanding omission of such information is an unfair or
a legal standpoint. Gust Rosenfeld, at 6; Piper about the value or use of the franchisors’ deceptive practice in violation of Section 5.
Rudnick, at 2. The version adopted here corrects the intellectual property. Original SBP, 43 FR at 59663.
problems pointed out by these commenters. 524See NASAA Comparison, at 20. 526 NASAA, at 5; WA Securities, at 3–4.
Guidelines, and the final amended Rule Guidelines, Item 16 also extends the therefore, reduces compliance burdens,
makes the appropriate correction. original Rule disclosures by requiring a while providing prospective franchisees
NASAA also urged the Commission to franchisor to disclose whether the with a detailed road map to the
consider expanding Item 15 to include franchisor has the right to change the franchise contract, where they can read
the disclosure of ‘‘operating hours and types of goods or services authorized for the various provisions in greater detail.
the method used by franchisors to notify sale, as well as any limits on the At the same time, Item 17 expands on
franchisees of changes in required franchisor’s right to make such changes. the original Rule by requiring
operating hours.’’527 The Commission, These disclosures better enable a disclosures pertaining to dispute
however, declines to adopt this prospective franchisee to understand resolution, including any arbitration or
suggestion. While this information the extent to which the franchisor has mediation requirements, as well as
might be useful for prospective the contractual right to control sales, forum-selection and choice of law
franchisees, it does not rise to the level which may directly affect the prospect’s provision disclosures. For each
of materiality such that non-disclosure ability to conduct business, its enumerated contract term, the
of it may put prospective franchisees in independence from the franchisor, and franchisor must cross reference the
jeopardy of being deceived. Moreover, ultimately, its profitability. No applicable franchise agreement
no other commenter raised this point, comments were submitted on the Item provisions and briefly summarize the
and in the absence of a record dictating 16 sales restrictions disclosures, and the governing terms.532
that we deviate from the UFOC adopted version is almost identical to Most of the comments submitted on
Guidelines, the Commission is reluctant the version proposed in the Franchise Item 17 concerned the use of the term
to do so. NPR.530 ‘‘renewal.’’ Franchisee advocates
Finally, NASAA and Washington asserted that the term ‘‘renewal’’ is
19. Section 436.5(q) (Item 17): Renewal, misleading.533 In their view, the term
Securities recommended that the termination, transfer, and dispute
Commission require franchisors to implies that a franchisee, upon
resolution expiration of the franchise term, can
disclose in Item 15 all agreements
regarding the franchise that apply to the Section 436.5(q) adopts UFOC Item continue operating the franchise under
owners of the franchise.528 While this 17, which requires franchisors to substantially similar terms and
suggestion is rooted in the NASAA summarize in tabular form 23 conditions. They observed, that in
Commentary on the UFOC Guidelines, enumerated terms and conditions of a practice, franchisees who wish to
nothing in Item 15 of the UFOC typical franchise relationship, such as continue operating their franchises at
the duration of the franchise agreement, the end of the franchise term must often
Guidelines says that franchisors must
rights and obligations upon expiration sign new contracts that impose
present copies of the actual agreements
of the franchise agreement, post-term materially different terms and
to prospective franchisees. The
covenants not to compete, and conditions, such as higher royalty
Commission believes such a
assignment and transfer rights. The final payments or the elimination of an
requirement would be duplicative and
amended Rule provision is almost exclusive territory. They asserted that
burdensome. Franchisors already must
identical to the proposed rule in the renewing franchisees, in many
include in Item 22 copies of ‘‘all
Franchise NPR, with only a slight instances, have no choice but to sign
agreements proposed for use or in use
modification, described below, with even the most abusive, one-sided
. . . regarding the offering of a
respect to the treatment of the term renewal contracts because they have a
franchise, including the franchise ‘‘renewal.’’
agreement, leases, options, and substantial economic investment in
The approach taken in the final their franchises and simply cannot walk
purchase agreements.’’ Presumably, amended Rule greatly streamlines the
contracts with franchise owners would away without incurring significant
original Rule, which required economic loss.534 Worse, when a
already be disclosed in Item 22. Thus, franchisors to detail the rights and
this suggested modification is obligations already spelled out in the 532 In the original SBP, the Commission stated
unnecessary. franchise agreement.531 Item 17, that the terms and conditions of the franchise
18. Section 436.5(p) (Item 16): Sales relationship—such as those governing transfers,
services. E.g., Telemarketing Sales Rule, 16 CFR renewals, and terminations—are material because
restrictions they ‘‘may limit what the franchisee may do with
310.3(a)(1) (requiring disclosure of all material
Section 436.5(p) of part 436 retains restrictions, limitations, or conditions to purchase, his or her capital asset.’’ Original SBP, 43 FR at
receive, or use the goods or services); Negative 59664. Given the length and complexity of the
the original Rule’s disclosures on sales typical franchise agreement, prospective franchisees
Option Rule, 16 CFR 425.1(a)(1)(ii) (requiring
restrictions. Like other disclosure disclosure of post-sale minimum purchase may overlook, or do not fully appreciate, such terms
requirements addressing how a requirements); Disclosure of Warranty Terms and and conditions. Id.
533 For example, the AFA stated:
franchisee may conduct business, this Conditions, 16 CFR 701.3(a)(8) (requiring material
provision requires franchisors to disclosures of limitations and exclusions on ‘‘‘Renewal’ is a misnomer. ‘Re-license,’ ‘rewrite’
warranty coverage). or even ‘re-franchise’ is a more accurate description
disclose any restrictions limiting the 530 The final amended Item 16 is reorganized for of what actually happens at the end of the initial
goods or services that the franchisee greater precision and uses more precise language. contract term. Most franchisees find that when it is
may offer for sale or the customers to For example, the final amended Item 16 eliminates time to ‘renew,’ they are not ‘renewing’ their
whom a franchisee may sell goods or a redundancy in the Franchise NPR regarding the existing franchise agreement, but are entering into
disclosure of any restrictions on customers, which a wholly new franchise agreement, often with
services.529 Consistent with UFOC appeared in both the introduction to the Item materially different financial and operational terms.
(disclose . . . any franchisor-imposed restrictions They are presented these ‘renewal’ contracts on a
527 NASAA, NPR 17, at 4. . . . that limit the franchisee’s customers) and in ‘take it or leave it’ basis and are under enormous
528 NASAA, at 5; WA Securities, at 3–4. the main text (disclose . . . any restrictions on the coercion pressures to sign—especially if the old
529See 16 CFR 436.1(a)(13). In the original SBP, franchisee’s customers). The final amended Item 16 agreement contains a post-termination covenant not
the Commission recognized that sales restrictions also uses more precise language, substituting to compete. This is truly ‘holding a gun to the head’
are material because they can limit the scope of the ‘‘disclose [any restrictions] . . . that limit access to of the ‘renewing’ franchisee.’’
franchisee’s market and ultimately the franchisee’s customers,’’ rather than the Franchise NPR’s AFA, ANPR 62, at 2.
profitability. Original SBP, 43 FR at 59661. The inaccurate language ‘‘any restrictions on the 534E.g., AFA, NPR 14, at 5; Bundy, NPR 18, at 4;
sales restriction disclosures are comparable to other franchisee’s customers.’’ Karp, NPR 24, at 20–21; Morrell, NPR 31, at 2;
Commission trade regulation disclosures 531See 16 CFR 436.1(a)(15) (requiring franchisors Bores, ANPR 9, at 1; Rachide, ANPR 32; Chabot,
concerning restrictions on the use of goods and to describe 14 categories of terms and conditions). Continued
franchisee does walk away, he or she is While the record reveals that there each franchisor.542 If applicable, the
often bound by a covenant not to may be confusion over the use of the franchisor must also state that
compete, which restricts his or her term ‘‘renewal,’’ it does not show that franchisees ‘‘may be asked to sign a
ability to operate a similar business for use of the term is inherently deceptive. contract with materially different terms
a number of years. The Commission concludes that the and conditions than their original
Several franchisor representatives term ‘‘renewal’’ is a franchising term of contract.’’543 While we are reluctant to
supported the view that the term art, meaning that upon the expiration of add consumer education notices to the
‘‘renewal’’ may be inappropriate. The a contract, the franchisees may have the disclosure document, especially where
NFC, for example, stated that the term right to enter into a new contract, where the UFOC Guidelines require no parallel
‘‘renewal’’ is somewhat ambiguous: it materially different terms and notice, we believe it is warranted in this
could mean either ‘‘a simple extension conditions may apply. Moreover, as instance, given the continued concern
of the existing agreement under the several commenters noted, the term raised by franchisee advocates and
same terms or—as is far more ‘‘renewal’’ is used in various state others about renewals.544
common—the grant of a ‘successor relationship laws, in addition to the
franchisor’ under the terms being 20. Section 436.5(r) (Item 18): Public
UFOC Guidelines. In light of that
offered at the time that the existing figures
background, the Commission is
agreement expires.’’535 However, the disinclined to mandate use of a different Consistent with the UFOC Guidelines,
NFC did not believe that the term term or prohibit use of ‘‘renewal.’’ At Item 18 requires franchisors to disclose
‘‘renewal’’ is misleading, and it was any rate, a prospective franchisee may the involvement of a public figure in the
uncertain whether the ambiguity be just as prone to misinterpret the franchise system, including his or her
compels a revision of the Rule. J&G substitute language (e.g., ‘‘re-license’’) as management responsibilities, total
asserted that the term is potentially the term ‘‘renewal.’’ It short, any term investment made in the franchise
misleading,536 and Tricon urged the may be misleading if prospective system, and compensation, if any. This
Commission to avoid its use entirely.537 franchisees fail to understand the section is substantively similar to the
On the other hand, several underlying concept that a franchisor comparable disclosure provision of the
commenters maintained that the term may require a change in contract terms original Rule found at 16 CFR
‘‘renewal’’ is clear and requires no and conditions upon expiration of the 436.1(a)(19).545 The final amended Rule
modification. For example, John Baer original agreement as a condition of adopts Item 18 as proposed, with only
stated that ‘‘renewal’’ is a term of art in renewal. Therefore, the Commission has minor language changes for the sake of
franchising and should not be changed. determined not to introduce clarity and improved organization.546
He also observed that the various state nonconformity between federal and Item 18 generated few comments
relationship laws use that term and ‘‘to state approaches on the use of this term. during the Rule amendment proceeding.
revise it for disclosure purposes is likely Nonetheless, the record is persuasive
to cause more confusion than that many prospective franchisees may 542 One example of a renewal explanation may
clarity.’’538 Seth Stadfeld, a franchisee be: ‘‘If you seek to renew your franchise agreement
not appreciate the legal import of the upon expiration, know that royalty payments and
advocate, agreed, explaining that the term ‘‘renewal.’’ Indeed, franchisees the size of your exclusive territory may change’’ or
term ‘‘renewal’’ refers to the often are surprised to discover that ‘‘Upon expiration, you will renegotiate the terms
relationship between the franchisor and ‘‘renewal’’ means the continuation of and conditions of your contract. Be aware that these
franchisee, not to the underlying terms and conditions may be different from those
their franchise relationship under in your original agreement.’’
contract. He also shared Mr. Baer’s potentially vastly different terms. To 543 Section 436.5(q)(3).
concern that the term is used in state prevent potential deception with respect 544 In response to the Staff Report, Howard Bundy
relationship statutes and should not to use of the term ‘‘renewal,’’ Item 17 of urged the Commission to adopt a negative
readily be changed.539 the final amended Rule requires disclosure whenever a franchisor does not offer
Several commenters suggested that franchisors to explain their renewal renewal on the same exact terms as the original
agreement: ‘‘We do not give you the right to renew
the Commission adopt various policy in the summary field for or extend your franchise on the same terms as your
disclosures or warnings for prospective provision Item 17(c) (requirements for current franchise agreement. You should consult
franchisees that would explain the franchisee to renew or extend).541 We your franchise attorney about the consequences of
concept of renewal in greater detail. The do not suggest any particular form of this.’’ Bundy, at 7. We believe the Item 17
requirement that franchisors explain what they
IL AG, for example, suggested that explanation, however, because that will mean by ‘‘renewal’’ is sufficient to address this
franchisors make the following depend upon the individual policies of concern.
statement: ‘‘You should learn what 545 In the original SBP, the Commission stated
changes in your agreement might occur public under our trade name. At the end of your that this information is material because it helps
and what rights you have when your initial [number of years] term, your current contract prospective franchisees understand the extent of
will expire [terminate]. You will have the choice of any financial and managerial commitments from
contract expires. Renewal may change signing a new contract written by us at the time of the public figure, as well as any obligations to the
important contract terms.’’540 expiration [termination]. The new contract will be public figure. Prospective franchisees can then
written by us with no input from you and will decide for themselves whether an association with
ANPR 37; Rich, ANPR 65; Orzano, ANPR 73; contain materially different financial and a public figure is valuable to them. Original SBP,
Geiderman, ANPR 131; Karp, ANPR, 19 Sept. 97 operational terms.’’ 43 FR at 59677–78.
AFA, NPR 14, at 5. See also Bundy, at 7; Bundy, 546 For example, Item 18 of the Franchise NPR
Tr., at 83; Chiodo, ANPR, 21 Nov. 97 Tr., at 303–
04. NPR 18, at 5 (urging the Commission to require used the language: ‘‘Disclose . . . any
535 NFC, NPR 12, at 30. franchisors to disclose the consequences of compensation paid or promised to the public
536 J&G, NPR 32, at 13. renewal). figure.’’ The final amended Rule substitutes the
537 Tricon, NPR 34, at 6–7.
541 In response to the Staff Report, Spandorf word ‘‘given’’ for ‘‘paid,’’ recognizing that a public
538 Baer, NPR 11, at 13. See also IL AG, NPR 3,
opined that Item 17 as recommended by staff was figure may be ‘‘given’’ tangible benefits, such as a
still confusing, asserting that it could mean that a car, not just a cash payment. Accordingly, the term
at 7. franchisor would have to make the statement about ‘‘given’’ is more precise and broader. The final
539 Stadfeld, NPR 23, at 15–16. See also

renewal even if the franchisor does not offer amended Rule also improves the organization of
NaturaLawn, NPR 26, at 2. renewals. Spandorf, at 7. We do not believe this is Item 18. As proposed in the Franchise NPR, Item
540 IL AG, NPR 3, at 7. Similarly, the AFA urged
a serious concern. Item 17 clearly states that 18 included the definition of ‘‘public figure’’
the Commission to adopt the following warning: franchisors need only address those issues listed in upfront, where it interrupted the flow of the basic
‘‘You do not own your own business. You are Item 17 if applicable. ‘‘If a particular item is not disclosure requirements. Accordingly, Item 18 of
leasing the rights to sell our goods/services to the applicable, state ‘Not Applicable.’’’ the final amended Rule is easier to read.
Two commenters questioned the utility representations.548 Consistent with the For the reasons explained below, the
of the disclosure. H&H noted that this original Rule and the UFOC Guidelines, final amended Rule provision, however,
Item is seldom, if ever, applicable and the final amended Rule permits, but diverges from Item 19 of the UFOC
urged the Commission to delete it.547 does not require, franchisors to make Guidelines by permitting greater
The Commission has determined that such representations under limited disclosure of financial information
the information required under Item 18 circumstances. When a franchisor elects about subsets of franchisor-owned or
remains material in those instances, to make a financial performance claim, franchised outlets, provided the
relatively uncommon though they may the franchisor must, among other things, franchisor discloses specified
be, when a public figure creates his or have a reasonable basis for the information about the subset at issue.
her own franchise system or when a representation549 and disclose the basis With certain additional refinements
franchisor uses a public figure and assumptions underlying the described in the following paragraphs of
pitchman. A public figure’s ownership representation.550 Franchisors also must this section, including the preamble
or management of a franchise system include an admonition that a requirements, Item 19 of the final
could create the impression of greater prospective franchisee’s actual earnings amended Rule closely tracks Item 19 as
oversight or influence in the operation may differ.551 proposed in the Franchise NPR.557
of the system, making the franchise Bringing the original Rule’s Nearly all comments on the Item 19
offering appear to be a less risky provisions on financial performance disclosure requirements focused on four
investment. Similarly, a public figure representations into closer alignment issues: (1) whether financial
pitchman’s endorsement of a franchise with the UFOC Guidelines entailed performance disclosures should be
system may create the impression that several deletions or departures from the mandatory or voluntary; (2) whether the
the franchise system is sound or a low original Rule. Specifically, the final Rule should permit disclosure of
risk. How much weight a prospect may amended Rule differs from the original financial performance information about
give a public figure endorser’s pitch Rule in that: geographical or other subsets of
may vary with the level of • It eliminates the requirement that franchisor-owned or franchised outlets;
compensation received from the franchisors who decide to make (3) whether the Rule should retain the
franchisor. If, for example, a pitchman financial performance claims provide requirement that historical financial
is paid a nominal sum, then a prospective franchisees with a separate performance data be prepared according
prospective franchisee may be inclined financial performance claim to GAAP; and (4) whether the Rule
to give the pitch more weight because document.552 Instead, consistent with should require prescribed preambles.
the pitchman has little to gain the UFOC Guidelines, it requires any Each of these issues is discussed in the
financially and thus little motive to performance claim to appear in Item 19 sections immediately below.558
fabricate his or her pitch. Accordingly, of the disclosure document itself;
• It eliminates the requirement that all a. Voluntary disclosure of financial
the public figure disclosures concerning performance information
level of involvement and compensation financial performance claims be
are material and their potential benefits geographically relevant to the franchise The Franchise NPR proposed that the
to prospective franchisees would offered for sale;553 making of financial performance
outweigh their costs. To that limited • It eliminates the requirement that representations remain voluntary, as
degree, these disclosures still serve a any historical financial performance was the case under the original Rule559
useful purpose. In those more typical claims must be based upon generally and UFOC Guidelines.560 Many
instances when no public figure is accepted accounting principles
involved, Item 18 entails no additional (‘‘GAAP’’);554 557 The greatest difference between Item 19 as
compliance burden. On balance, • It permits franchisors, under specific proposed in the Franchise NPR and Item 19 in the
therefore, the Commission is disinclined circumstances, to disclose, apart from final amended Rule is the elimination of the GAAP
the disclosure document, the actual requirement, discussed in greater detail, infra.
to deviate from the UFOC Guidelines on 558 Piper Rudnick’s comment on the Staff Report
this point. operating results of a specific unit being
raised an issue on a separate topic that the
offered for sale;555 and Commission has decided to address. The firm noted
21. Section 436.5(s) (Item 19): Financial • It permits franchisors to furnish that there is a problem with section
performance representations supplemental performance information 436.5(s)(3)(ii)(A) as proposed in the Franchise NPR
directed at a particular location or (and as recommended in the Staff Report).
Section 436.5(s) of part 436, a key circumstance.556
Specifically, that provision required that the
anti-fraud provision, addresses the material bases for a financial performance
representation include a statement of ‘‘the degree of
making of financial performance 548 In the original SBP, the Commission found competition in the market area.’’ Piper Rudnick
that one of the most frequent abuses occurring in observed that there may be no single ‘‘market.’’ If
547 H&H, NPR 9, at 18. Howard Bundy agreed, the marketing of franchises is the use of deceptive national performance claims are made, it would be
proposing instead that the space be used for more past and potential franchise sales, income, and extremely difficult to describe the ‘‘market.’’ As a
important issues: ‘‘It would make more sense to profits claims. Indeed, the Commission stated that result, franchisors are likely to adopt ‘‘some
elevate the renewal issue, the gag order issue, and the ‘‘use of deceptive and inaccurate profit and loss meaningless boilerplate’’ to comply. Accordingly,
the integration clause issue, and perhaps even the statements by franchisors has resulted in a legion the firm recommended dropping the entire quoted
arbitration clause issue to full Item status and move of ‘horror stories.’’’ Original SBP, 43 FR at 59684. phrase. Piper Rudnick, at 3. The Commission has
the public figure information elsewhere.’’ Bundy, 549See 16 CFR 436.(1)(b)(2); 436.(1)(c)(2); carefully considered this point, and has determined
NPR 18, at 10. Of the franchisees who participated 436.1(e)(2); UFOC Guidelines, Item 19A. that competition is a factor that may impact upon
in the Rule amendment proceedings, only one 550See 16 CFR 436.1(b)(3); 436.1(c)(3); a prospective franchisee’s ability to achieve
voiced concerns about a public figure. Dianne represented financial performance. A reference to
436.1(e)(5)(i); UFOC Guidelines, Item 19B.
Mousley purchased a Mike Schmidt’s Philadelphia 551See 16 CFR 436.1(b)(4); 436.1(c)(5);
competition generally, therefore, is warranted.
Hoagies franchise, in part based upon the Nevertheless, the phrase ‘‘market area’’ may be so
436.1(e)(5)(iii); UFOC Guidelines, Item 19B problematic as to render the particular disclosure
representation that Mike Schmidt, a former baseball Instructions, (c).
player, would be actively involved in the franchise element meaningless, as the firm predicts.
552See 16 CFR 436.1(d).
system. However, Ms. Mousley’s primary concerns Therefore section 436.5(s)(3)(ii)(A) of Item 19 as
553See 16 CFR 436.1(b)(1); 436.1(c)(1).
did not involve Mr. Schmidt. Rather, she adopted refers simply to ‘‘degree of competition,’’
554See 16 CFR 436.1(c)(4); 436.1(e)(2). without reference to a ‘‘market area.’’
complained about delays in constructing the store
555See UFOC Guidelines, Item 19 Instructions i. 559 Franchise NPR, 64 FR 57309–10.
and lack of promised training and support. See
generally Mousley, 29 July 97 Tr., at 1–32. 556See UFOC Guidelines, Item 19 Instructions ii. 560 UFOC Guidelines, Item 19.
franchisees and their representatives, Based upon its assessment of the by failing to furnish accurate financial
however, urged the Commission to record as a whole, the Commission performance data.
mandate the disclosure of financial concludes that financial performance Further, the record reveals that
performance information.561 In support representations should remain approximately 20% or more of
of this recommendation, these voluntary. In reaching this conclusion, franchisors choose to make financial
commenters advanced a number of we recognize that false or misleading performance disclosures.566
arguments: (1) that financial financial performance claims are the Accordingly, prospective franchisees
performance information is the most most common allegation in Commission can find franchise systems that
material information prospective franchise law enforcement actions.565 voluntarily disclose such information. If
franchisees need to make an informed However, there is no assurance that prospective franchisees were to seek out
investment decision;562 (2) that mandating performance claims will in such franchise systems, or demand the
franchisors already have performance fact reduce the level of false claims. disclosure of such information from
information and it is a deceptive Given that many different industries are franchisors, ordinary market forces
omission for them to fail to disclose this affected by part 436, what makes a might compel an increasing number of
information; (3) that franchisors are in financial performance disclosure franchisors to disclose earnings
the best position to collect and reasonable, complete, and accurate is information voluntarily, without a
disseminate performance information; quite varied. Thus, the Commission will federal government mandate. More
(4) that a mandated financial not mandate a particular set of financial important, a disclosure document is not
performance disclosure would reduce performance disclosures. However, if a the only potential source of financial
the level of false and unsubstantiated franchisor chooses to make such performance information. Prospective
oral and written financial performance disclosures, they, of course, must be franchisees can obtain financial
claims; and (5) that more disclosure reasonable, non-misleading, and performance information from a variety
regarding performance would benefit accurate. of third-party sources. For example,
the marketplace and competition.563 Mandating financial performance typical expenses, such as labor and rent,
In contrast, franchisors and their disclosures would also impose may be available from industry trade
advocates uniformly opposed substantial new accounting, data associations and industry trade press.
mandatory financial performance collection, and review costs on all Prospective franchisees may be able to
disclosures, based on the following franchise systems. At the same time, it discuss earnings and other financial
arguments: (1) it is impossible for the potentially could expose existing performance issues directly with current
Commission to create a single franchisees, upon whose data the and former franchisees, as well as with
performance disclosure format that will franchisor would rely, to more extensive trademark-specific franchisee
be relevant for all industries; (2) not all audits. In addition, existing franchisees associations. For these reasons, we
franchisors have the contractual right to might be subject to potential liability for conclude that financial performance
collect extensive financial information indemnification should a franchisor, representations should remain
with which to prepare a reasonable relying on the franchisees’ performance voluntary, consistent with the original
performance disclosure; (3) financial data, be found to have violated the Rule Rule and UFOC Guidelines.
performance data collected from
existing franchisees is not necessarily ANPR 33, at 7; Tifford, ANPR 78, at 5; Jeffers, ANPR
b. Geographic relevance and subgroups
complete and accurate; (4) a mandatory 116, at 5. See also 7-Eleven, NPR 10, at 3 As noted above, Item 19 of the final
performance disclosure would be (suggesting that a typical franchisor would be hard- amended Rule eliminates the original
pressed to generate financial performance
misinterpreted as a guarantee of future information without ‘‘very extensive and significant Rule’s geographic relevance requirement
performance, thus increasing litigation; effort.’’). In addition, a few commenters urged the for financial performance
and (5) mandating financial Commission to coordinate its financial performance representations.567 This brings the
performance disclosures would have a disclosure policy with NASAA to promote Rule’s financial performance disclosure
uniformity. For example, John Tifford stated:
negative impact upon the franchisor- ‘‘Federal and state regulators must develop a requirements into closer alignment with
franchisee relationship, subjecting coherent and compatible earnings claim policy in Item 19 of the UFOC Guidelines,568 as
franchisees to more extensive order to ensure that franchisors will not be exposed proposed in the Franchise NPR.569
accounting oversight and audits.564 to risks caused by inconsistent and uncoordinated At the same time, the final amended
federal and state policies.’’ Tifford, ANPR 78, at 6.
See also AFA, ANPR 62, at 4; IL AG, ANPR 77, at Rule deviates from the Franchise NPR
561E.g., AFA, at 2; Bundy, at 7–8; Karp, at 3;
2; IFA, ANPR 82, at 3. On the other hand, Cendant, by omitting the UFOC Guidelines’
Selden, at 2; Haff, at 2; Blumenthal, at 1. representing several major franchise systems, requirement that franchisors disclose
562 Karp, ANPR, 19 Sept. 97 Tr., at 100–03.
suggested that the FTC prohibit states from the number and percentage of all
Quoting several business texts, Mr. Karp asserted mandating financial performance disclosures by
that historical financial performance information is preempting the field. Cendant, ANPR 140, at 2.
566See, e.g., Bortner, ANPR 37, at 3; NASAA,
critical to any evaluation of a business. Internal 565See, e.g., FTC v. Minuteman Press, Int’l, 93–
Revenue Service Ruling 59–60, Item D, for example, CV–2494 (DRH) (E.D.N.Y.) (1998 Order) (finding ANPR 43, at 3.
provides that: ‘‘detailed profit and loss statements that the making of false gross sales and profit
567See 16 CFR 436.1(b)(1); 436.1(c)(1). The
should be obtained and considered for a representations to prospective franchisees was original Rule’s geographic relevance prerequisite
representative period immediately prior to the pervasive in the Minuteman and Speedy Sign-A- was designed to ensure that a financial performance
required date of appraisal, preferably five or more Rama franchise systems). See also, e.g., FTC v. Car representation was reasonable in light of the
years.’’ According to Mr. Karp, the failure of Wash Guys, Int’l, No. 00–8197 ABD (RNBx) (C.D. opportunity being offered for sale. In short,
franchisors to disclose historical performance Cal. 2000); FTC v. Tower Cleaning Sys., Inc., No. 96 geographic relevance ‘‘helps to ensure that the
information deprives prospects of material 58 44 (E.D. Pa. 1996); FTC v. Majors Med. Supply, representation reflects what the franchisee is likely
information that is essential in evaluating the No. 96–8753–Zloch (S.D. Fla. 1996); FTC v. Indep. to achieve.’’ Original SBP, 43 FR at 59691.
franchise offering. Travel Agencies of Am., Inc., No. 95–6137–CIV– 568 The UFOC Guidelines, for example, permit a
563See Staff Report, at 159–60; ANPR, 62 FR at franchisor selling a franchise in Florida to disclose
Gonzalez (S.D. Fla. 1995); FTC v. Mortgage Serv.
9118. See also Brown, ANPR 4, at 4; SBA Advocacy, Assoc., Inc., No. 395–CV–1362 (AVC) (D. Conn. that franchised outlets in urban areas of Oregon and
ANPR 36, at 8; Purvin, ANPR 79; Lagarias, ANPR 1995); FTC v. Robbins Research Int’l, Inc., No. 95– Washington have averaged a specific profit level. In
125, at 1–2; Dady & Garner, ANPR 127, at 1–2; and CV–627–H(AJB) (S.D. Cal. 1995); FTC v. Sage contrast, the original Rule barred such a
Selden, ANPR 133, at 1–2 and Appendix C; Seminars, Inc., No. C–95–2854–SBA (N.D. Cal. performance claim because such claim is not
Lundquist, ANPR, 22 Aug. 97 Tr., at 46–47. 1995). See generally Vidulich, 22 Aug. 97 Tr., at 18– geographically relevant to the prospective
564See Staff Report, at 161–62. E.g., Gust 19; Marks, 19 Sept. 97 Tr., at 2–3; Fetzer, 19 Sept. franchisee’s territory—Florida.
Rosenfeld, at 6; Duvall, ANPR 19, at 2; Kaufmann, 97 Tr., at 40–41. 569 Franchise NPR, 64 FR at 57310.
existing outlets known to have attained of the universe of outlets measured; (2) performance of subgroups, will remove
a represented performance level.570 the total number of outlets in the obstacles that discourage franchisors
Rather, for the reasons explained below, universe measured; (3) the number of from making financial performance data
Item 19 of the amended Rule is outlets from the universe that were available to prospective franchisees. At
consistent with the original Rule in actually measured; and (4) any the same time, Item 19 prevents
requiring franchisors to disclose the characteristics of the measured outlets franchisors from ‘‘cherry picking’’ their
number and percentage of existing that may differ materially from the best locations as a basis for financial
outlets known to have attained the outlet offered to the prospective performance representations.
represented performance level in the franchisee (e.g., location, years in Specifically, Item 19’s substantiation
area that formed the basis for the operation, franchisor-owned or requirements ensure that franchisors
representation.571 franchisee-owned, and likely disclose how they derived the
The UFOC Guidelines require a competition).573 performance results of subgroups, so
franchisor to compare the number of Few commenters addressed the that prospective franchisees can assess
franchisees who have performed at a revision of Item 19. Among those that for themselves the sample size, the
claimed level against all franchisees in commented on Item 19, a few number of franchisees responding, and
its system, not just against franchisees it specifically supported the elimination the weight of the results. In addition,
has measured or against franchisees in of the separate geographic relevance these provisions require franchisors to
a subgroup. For example, a franchisor prerequisite.574 On the other hand, IL disclose the material differences
may have statistics showing that nine AG voiced concern that eliminating the between the subgroup-units tested and
out of 10 franchised stores in a geographic relevance requirement the units being offered for sale, so that
particular location (such as Seattle) would not prevent franchisors from prospects can avoid drawing
average $100,000 net profit a year. Yet, ‘‘cherry picking’’ their best performing unreasonable inferences from the
the UFOC Guidelines prevent the franchise locations and then allowing representations.
franchisor from disclosing truthful prospects to assume that their
information about the universe the performance results will be similar.575 c. GAAP
franchisor had measured—the 10 At the same time, other commenters As noted, Item 19 of the final
franchised outlets in Seattle. Rather, the supported allowing financial amended Rule eliminates the original
franchisor would be forced instead to performance claims based on franchisee Rule requirement that historical
state 9 out of the entire number of all subgroups with the specified financial performance data must be
franchises nationwide (e.g., 9 out of substantiation requirements. John Baer, prepared according to GAAP.578 The
1,000) have earned the $100,000 for example, maintained that the Franchise NPR proposed retention of
claimed. This approach can mislead a disclosures for subgroups ‘‘provide this requirement.579 Without exception,
prospective franchisee because it franchisors with sufficient guidance the commenters who addressed this
suggests that the franchisor has in fact about what characteristics of the outlets issue opposed the GAAP requirement.
measured the financial performance of must be disclosed and how they may For example, NASAA advised that
all franchisees, when that may not be differ materially from outlets offered to GAAP goes beyond what the UFOC
true. It also may deflate franchisees’ a prospective franchisee.’’576 Similarly, Guidelines require and the accounting
actual performance records. More Marriott observed that allowing rules would discourage the making of
important, a franchisor may decline to disclosure of subgroup performance is financial performance representations:
disclose performance information if, in laudable ‘‘especially when franchisors Based upon the experience of states
order to do so, it must first incur the are frequently adopting new business that register franchise offerings,
expense of conducting a system-wide strategies which may result in different many franchisors that currently
franchisee performance analysis. [financial performance representations], include historical financial
To correct this problem, Item 19 of the depending upon whether the old or new performance data in UFOC Item 19
revised Rule permits franchisors to system format is followed by the may not prepare them according to
disclose truthful financial performance franchisees.’’577 GAAP. In some instances, a
information about a subgroup of existing Based upon the record, the
franchisees under limited conditions.572 Commission has concluded that 578 See 16 CFR 436.1(c)(4) and 436.1(e)(2). The
Specifically, the financial information eliminating the geographic relevance Commission adopted the original GAAP
furnished to prospective franchisees requirement, coupled with permitting requirement to address concerns about the validity
must have a reasonable basis and the broader disclosure of financial of franchisee financial statements used by
franchisors to make historical financial performance
franchisor must disclose: (1) the nature representations. Not only may some franchisees
573See Gust Rosenfeld, at 6 (supporting option of
understate profits, but each could have his or her
570 Item 19B ii of the UFOC Guidelines marking financial performance representations own accounting system. ‘‘Differences between
instructions requires ‘‘a concise summary of the based upon sub-group data). franchisees also occur due to such factors as
574 ‘‘[T]he omission of the geographic relevancy
basis for the claim including a statement of whether variations in the drawing accounts of principals,
the claim is based upon actual experience of requirement represents the removal of a substantial fringe benefits of principals, salaries charged to
franchised units and, if so, the percentage of impediment to franchisors who might wish to income, and preparation of statements on a cash
franchised outlets in operation for the period provide financial performance data to prospective rather than an accrual basis.’’ Original SBP, 43 FR
covered by the earnings claims that have actually franchisees, because it will lower the obstacles to, at 59691. To minimize the potential dangers
attained or surpassed the stated results.’’ The and cost of, compiling the data necessary to inherent in using franchisee performance data, the
original Rule did not include any counterpart produce a meaningful representation. We believe it Commission determined that historical performance
requirement. The original Rule contained the same is unlikely to have any material effect on the quality claims and the data underlying them must have
broad number and percentage requirements only for of such representation, as geographic relevancy is been prepared according to GAAP.
financial performance claims made in the general often quite attenuated.’’ BI, NPR 28, at 11. See also 579 Franchise NPR, 64 FR at 57341, note 13: ‘‘If
media. 16 CFR 436.1(e)(5)(ii). Baer, NPR 11, at 13. a financial performance representation is a
571 16 CFR 436.1(b)(5)(i); 16 CFR 436.1(c)(6)(i). 575 IL AG, NPR 3, at 7.

representation concerning historical financial
572 This approach to financial performance 576 Baer, NPR 11, at 14.
performance or if historical financial performance
substantiation, as proposed in the Franchise NPR 577 Marriott, NPR 35, at 11. But see PMR&W, NPR data are used as the basis for a forecast of future
and recommended in the Staff Report, prompted 4 (suggesting that these provisions may deter the earnings, the historical data must be prepared
few comments from any of the participants in this dissemination of financial performance according to U.S. generally accepted accounting
proceeding. information). principles.’’
franchisor’s historical financial requirements address two concerns. Several commenters supported the
performance data presented may be First, there is evidence in the record that inclusion of preambles in Item 19 in
accurate and material, yet may not some franchisors falsely state that the order to clarify the state of the law
be presented according to GAAP. In Commission or the Franchise Rule regarding the making of financial
many other instances, the prohibits franchisors from making performance representations. In
franchisor may not be aware financial information available.582 particular, the first preamble would
whether the data presented is Second, our law enforcement correct the common misstatement that
according to GAAP. This experience tells us that prospective the Rule actually prohibits the making
requirement would discourage franchisees may rely on unsubstantiated of such representations. According to
franchisors that have a factual basis financial performance the AFA, for example, a clarification of
for making financial performance representations.583 the law is crucial: ‘‘[T]he great untruth
disclosures from doing so. In To prevent deception arising from that franchise salespeople have been
addition, this requirement likely these two practices, Item 19 requires allowed to perpetrate over the years is
would increase costs to franchisors franchisors to include in their Item 19 the following statement in one form or
who do choose to make historical disclosures a prescribed preamble another—the federal government
financial performance disclosures stating that the Rule permits the making prohibits us from giving you
by requiring them to obtain an of financial performance information regarding the financial
accountant’s opinion as to whether representations, if the representations performance of [name of our]
their data is presented according to are set forth in the franchisor’s franchises.’’586
GAAP.580 disclosure document.584 This statement Other commenters asserted that the
Based upon an assessment of the counters any suggestion that the preambles, coupled with market forces,
record, the Commission has determined Franchise Rule prohibits franchisors will encourage the disclosure of
that the GAAP requirement is from disclosing financial performance financial data. For example, 7-Eleven
unnecessary and may impede information. Armed with such material stated: ‘‘We believe this approach—
franchisors’ ability to disclose information, prospective franchisees affirmatively informing would-be
performance information, to the could question why a franchisor does investors about the requirements under
detriment of both franchisors and not provide financial performance data, the Rule and the manner in which such
prospective franchisees. GAAP is not if they wish, or shop for a system that information should be disclosed—when
the only approach to ensure the discloses financial performance combined with the competitive force of
accuracy of historic performance data. information. In addition, this preamble the marketplace, ensures that earnings
Franchisors making historical will discourage prospects from relying information can be identified and
performance representations should on unauthorized financial performance properly appraised by franchise
have the flexibility to formulate such claims made outside of the disclosure investors.’’587
representations, provided that such document.
representations are truthful and For those franchisors who elect not to ‘‘We do not make any representations about a
reasonable. Indeed, franchisors always disclose financial performance franchisee’s future financial performance or the past
financial performance of company-owned or
have the burden to establish that any information, Item 19 requires a second franchised outlets. We also do not authorize our
financial performance representations preamble, warning prospective employees or representatives to make any such
are reasonable. Moreover, it is apparent franchisees not to rely on unauthorized representations either orally or in writing. If you are
that some franchisors using the UFOC performance representations and to purchasing an existing outlet, however, we may
provide you with the actual records of that outlet.
format have disseminated non-GAAP report the making of such unauthorized If you receive any other financial performance
compliant historic performance representations to the franchisor, the information or projections of your future income,
representations, without any pattern of Commission, and appropriate state you should report it to the franchisor’s management
deception identified by the states. agencies.585 by contacting [name and address], the Federal
Trade Commission, and the appropriate state
Finally, eliminating the GAAP regulatory agencies.’’
requirement is likely to reduce overall clarity and consistency, and the sentence ‘‘If 586 AFA, NPR 14, at 3. Several commenters
compliance burdens, while bringing you are purchasing an existing outlet, however, we confirmed that such misrepresentations are
may provide you with the actual records of that prevalent and urged the Commission to clarify the
greater uniformity to federal and state outlet,’’ to conform with the Rule’s substantive Rule to combat them. For example, the CA BLS
disclosure law. liberalization on this point. stated:
582E.g., Bundy, at 7; CA BLS, ANPR 124, at 1;
d. Preambles ‘‘Franchisees have reported to certain members of
Lagarias, ANPR 125, at 4. See also H&H, ANPR 28, the California Franchise Legislative Committee that
As noted above, Item 19 of the final at 8; SBA Advocacy, ANPR 36, at 8; AFA, ANPR franchisor salespersons informed them during the
62, at 5; Purlin, ANPR 79, at 2; Jeffers, ANPR 116,
amended Rule differs from the original at 5.
pre-sale discussions in the offer and sale of a
Rule and the UFOC Guidelines by franchise that the FTC Rule prohibited them from
583E.g., FTC v. Minuteman Press, Int’l, No. 93–
making earnings claims. Based on these reports, we
requiring franchisors to include CV–2494 (DRH) (E.D.N.Y. 1998). See also Franchise agree that there is a need to clarify the Rule to make
prescribed preambles in their Item 19 NPR, 64 FR at 57311; ANPR, 62 FR at 9118. clear that neither the Commission nor the Rule
584 The first preamble reads:
disclosures. The preamble requirements prohibits franchisors from making earnings
are incorporated in Item 19 as proposed ‘‘The FTC’s Franchise Rule permits a franchisor representations.’’
to provide information about the actual or potential CA BLS, ANPR 124, at 1. Peter Lagarias, a
in the Franchise NPR.581 The preamble financial performance of its franchised and/or franchisee representative, similarly told us: ‘‘I am
franchisor-owned outlets, if there is a reasonable personally aware of franchisors (and sometimes
580 NASAA, NPR 17, at 5. See also Bundy, at 7; basis for the information, and if the information is even their lawyers) stating that earnings claims are
Gust Rosenfeld, at 6; PMR&W, NPR 4, at 12; H&H, included in the disclosure document. Financial forbidden by the Commission’s Rule. The
NPR 9, at 13; NFC, NPR 12, at 31; Lewis, NPR 15, performance information that differs from that Commission should clarify in the Rule that the
at 15; Snap-On, NPR 16, at 3; J&G, NPR 32, at 7; included in Item 19 may be given only if: (1) a franchisor could elect to make earnings claims but
Marriott, NPR 35, at 12; IL AG, Rebuttal NPR 38, franchisor provides the actual records of an existing has elected not to make earnings claims.’’ Lagarias,
at 5. Based on the comments, particularly those outlet you are considering buying; or (2) a ANPR 125, at 4.
submitted by NASAA, the Staff Report franchisor supplements the information provided in 587 7-Eleven, NPR 10, at 3. See also IFA, NPR 22,
recommended elimination of the GAAP this Item 19, for example, by providing information at 11; Stadfeld, NPR 23, at 17; H&H, ANPR 28, at
requirement. Staff Report, at 166–67. about possible performance at a particular location 8; Duvall, ANPR 19, at 2; Jeffers, ANPR 116; CA
581 Franchise NPR, 64 FR 57311 and 57341. Slight or under particular circumstances.’’ BLS, ANPR 124, at 2; Zarco & Pardo, ANPR 134,
wording changes have been made to improve 585 The second preamble reads: at 6. But see J&G, NPR 32, at 7 (admonition to
At the same time, the Commission has the final amended Rule more closely to specific franchisee associations.593 We
rejected various suggestions to require the UFOC guidelines, it also extends the address each of these issues below.
more strongly worded preambles. For original Rule by requiring franchisors to
a. Double-counting
example, Eric Karp would amplify the disclose the names, business addresses,
second preamble to warn prospects that, and business telephone numbers of at As proposed in the Franchise NPR,
although the franchisor collects least 100 current franchised outlets (as the final amended rule avoids a problem
financial information, it does not opposed to the original Rule with the UFOC Guidelines’ version of
disclose any, and he suggested requirement of at least 10 franchised Item 20.594 Like the UFOC Guidelines,
including the phrase, ‘‘Consider why we outlets).590 It also requires the the final amended Rule Item 20 requires
are unwilling to do so.’’588 In effect, disclosure of some contact information disclosure of information about
these commenters would turn the for former franchisees591 who have left franchisees who have recently left the
absence of a financial performance the franchise system in the last fiscal franchise system, as well as changes in
claim into a risk factor. The Commission year. Finally, it also makes the ownership of franchised outlets. During
rejects this approach. It does not disclosure more user-friendly than it the Rule amendment proceeding, no
necessarily follow that the absence of a was in the original Rule by requiring the commenters opposed this requirement
financial performance disclosure statistical information to be presented in in principle, but commenters almost
necessarily signals a riskier investment. a tabular format. unanimously voiced concern that UFOC
It could well be that a company bent on Item 20 of the final amended Rule Item 20 is seriously flawed and needs to
defrauding prospective franchisees differs from the UFOC Guidelines model be fixed.595 Specifically, UFOC Item 20
would manipulate its numbers to create in several respects. First, it corrects a often results in franchisors ‘‘double-
a stronger success image, while a double-counting problem brought to the counting’’ changes in franchised outlet
successful but punctilious system might Commission’s attention during the Rule ownership, resulting in inflated
choose not to disclose numbers because Review. Second, it requires more turnover rates.
it may not believe that it can make a limited disclosure of personal contact The Commission believes that the
reasonable disclosure that would be information of former franchisees.592 UFOC Guidelines’ ‘‘double-counting’’
applicable to all potential buyers. In problem is attributable to at least two
Third, when a franchisor resells a
addition, any concern that prospective factors. First, UFOC Item 20 requires
specific outlet it has reacquired, it
franchisees need to see actual earnings franchisors to report changes in
mandates that the franchisor disclose
figures in order to judge success is the outlet’s prior franchisee-owners 593 The provision does not require franchisors to
mitigated by Item 20, which compels during the franchisor’s last five fiscal disclose the existence of broad-based organizations
the disclosure of franchise turnover years. Fourth, it addresses franchisors’ that represent franchisee interests generally, such as
rates, as well as the names and use of ‘‘confidentiality clauses,’’ which the American Franchisee Association, the American
addresses of current and former effectively restrict franchisees from Association of Franchisees & Dealers, or the
franchisees, who can be contacted for International Franchise Association.
discussing their experiences with 594 The problems with the UFOC Guidelines’ Item
information. prospective franchisees. Finally, it 20 first surfaced during the Rule review that
22. Section 436.5(t) (Item 20): Outlets requires the disclosure of trademark- preceded initiation of the rule amendment
proceeding. Simon, RR Tr., at 223–24; Maxey, RR
and franchisee information Tr., at 224–25. To develop a record on this issue,
prospective franchisee with an accurate statement the ANPR solicited comment on whether UFOC
Section 436.5(t) of the final amended of the number of units operated by his or her Guidelines Item 20 accurately reflects franchisees’
Rule retains the original Rule’s franchisor will convey information relating to the performance history and, if it does not, how the
requirement that franchisors disclose financial success of the particular franchise Commission could modify the Item 20 disclosures
the number of franchised and business since the franchisee’s ultimate success to reflect performance history more accurately.
depends in large measure on public recognition of ANPR, 62 FR at 9116. In response to the ANPR,
franchisor-owned outlets; the names, the franchisor’s name.’’ Original SBP, 43 FR at several commenters confirmed that Item 20 results
business addresses, and business 59670. See also ANPR, in ‘‘double-counting’’ of franchise turnover rates.
telephone numbers of current 62 FR at 9118. In addition, the disclosure of E.g., H&H, ANPR 28, at 6; AFA, ANPR 62, at 3; IL
franchised outlets, and statistical contact information for current franchisees prevents AG, ANPR 77, at 2; Tifford, ANPR 78, at 4; IFA,
fraud by arming prospects with a valuable ANPR 82, at 2; Cendant, ANPR 140, at 3; Karp, 19
information on franchise turn-over rates, alternative source of information with which to Sept. 97 Tr., at 91. Accordingly, in the Franchise
in particular the number of franchises verify franchisor’s representations. Id. NPR, the Commission attempted to address the
voluntarily and involuntarily 590 UFOC Guidelines, Item 20B.
identified problems with the UFOC version.
terminated, not renewed, and 591 Current and former franchisees often have Franchise NPR, 64 FR at 57342–44. However,
reacquired by the franchisor.589 To align widely different experiences. For that reason, in commenters criticized proposed Item 20 of the
Blenheim Expositions, Inc., 120 FTC 1078 (1995), Franchise NPR as inadequate to solve the problem.
the Commission challenged as a violation of Section E.g., IL AG, NPR 3, at 7; PMR&W, NPR 4, at 13–
prospective franchisees to notify the FTC and an 5, franchisee success claims based upon a Gallup 14; H&H, NPR 9, at 19; Snap-On, NPR 16, at 4;
appropriate state agency of an unauthorized Poll study of current franchisees only. NASAA, NPR 17, at 5; Karp, NPR 24, at 11;
earnings claim seems a bit excessive). 592 The UFOC Guidelines require the disclosure Frandata, NPR 29, at 10. At that time, NASAA, in
588 Karp, at 3. In the same vein, Howard Bundy
of names, last known home address, and telephone consultation with an Industry Advisory Committee,
would strengthen the second preamble to read: number of each franchisee who left the system developed a comprehensive revamping of Item 20,
‘‘Financial Performance Information is material to within the last fiscal year. UFOC Guidelines, Item which it submitted in its Franchise NPR comments.
any decision to invest. [Franchisor] does not 20E. The purpose of the disclosure is to reduce NASAA, NPR 17, at 5–10. Several additional
provide you with Financial Performance fraud by enabling prospective franchisees to learn commenters either submitted the same proposal or
Information. The absence of such information about the nature of the franchise system and, most endorsed the NASAA proposal. PMR&W, NPR 4, at
makes it very difficult for you to estimate your important, the nature of the franchise relationship 14–66 and Exhibit A; NPC, NPR 12, at 31–32;
prospects of success in the business. You should from those who recently exited the system, Frandata, NPR 29, at 11. The Staff Report
proceed with caution and consult your franchise voluntarily or involuntarily. To reduce recommended adoption of NASAA’s suggested
attorney and other business advisors.’’ inconsistencies between with the UFOC Guidelines, revamping of Item 20. Staff Report, at 180. No Staff
Bundy, NPR 18, at 10. the Franchise NPR followed the same approach. Report comments offered further criticism of the
589See 16 CFR 436.1(a)(16). In the original SBP, Franchise NPR, 64 FR at 57343. As explained staff’s recommendation for revising Item 20.
the Commission explained that the required below, however, Item 20, as proposed in the 595E.g., H&H, ANPR 28, at 6; AFA, ANPR 62, at
statistical information gives prospective franchisees Franchise NPR, would require the disclosure of 3; IL AG, ANPR 77, at 2; Tifford, ANPR 78, at 4;
material information about the size of the franchise personal information, raising privacy concerns. For IFA, ANPR 82, at 2; Cendant, ANPR 140, at 3; Karp,
system they are contemplating joining and goes to that reason, the Commission has adopted a more ANPR, 19 Sept. 97 Tr., at 91; Simon, RR, Sept.95
the prospect’s likelihood of success. ‘‘Providing a limited approach in the final amended Rule. Tr., at 223–24.
franchised outlet ownership according consideration to the franchisee (whether approach suggested by NASAA garnered
to five enumerated categories: (1) by payment or forgiveness or the most support. NASAA asserted that
transferred; (2) canceled or terminated; assumption of debt).’’ ‘‘Non-renewal’’ UFOC Item 20 needs to be revised in its
(3) not renewed; (4) reacquired by the occurs ‘‘when the franchise agreement entirety and, as noted above, submitted
franchisor; or (5) reasonably known to for a franchised outlet is not renewed at for the Commission’s consideration an
have ‘‘ceased to do business.’’ The terms the end of its term.’’ ‘‘Reacquisition’’ alternative that was produced with the
describing these categories, however, means ‘‘the franchisor’s acquisition of assistance of an Industry Advisory
are undefined. The absence of precise an outlet for consideration (whether by Committee.601 Several other
definitions blurs the line between payment or forgiveness or assumption of commenters submitted the same
categories, resulting in a double- debt) of a franchised outlet during its proposal or endorsed the NASAA
counting of outlet closures.596 For term.’’ ‘‘Transfer’’ means ‘‘the proposal.602 The Staff Report
example, a single transaction can quite acquisition of a controlling interest in a recommended that the NASAA
correctly be characterized as either a franchised outlet during its term by a suggestion be incorporated into the final
transfer or a reacquisition. They are person other than the franchisor or an amended Rule. After careful
often two sides of the same coin: a affiliate.’’599 consideration, the Commission has
franchisor’s assumption of control of a Beyond better defined reporting determined to adopt NASAA’s proposal.
franchised outlet that has gone out of categories, commenters offered various It is the best way to solve the Item 20
business reasonably could be captured suggestions to improve Item 20.600 The double-counting problem. It will be
either as a transfer by the franchisee, or easily understood by those in the
as a reacquisition by the franchisor. 599 Staff Report, at 48–53. The definitions of the
industry, and it will provide prospective
Second, even if the definitions were terms ‘‘transfer’’ and ‘‘reacquisition’’ are the same franchisees with the information they
as those proposed in the Franchise NPR, with minor
clear, UFOC Item 20 can be interpreted reorganization for clarity. The definitions of the need without imposing undue
to require the disclosure of each of a terms ‘‘termination’’ and ‘‘non-renewal,’’ however, compliance burdens on franchisors.
series of events associated with a single have been revised for greater precision. Specifically, Accordingly, Item 20 of the final
outlet ownership change.597 For the Franchise NPR defined the terms ‘‘termination’’ amended Rule contains five tables.
and ‘‘non-renewal’’ as occurring when the
example, after terminating a franchise franchisor sends out an ‘‘unconditional notice of Table No. 1 indicates the status of a
agreement, the franchisor may reacquire intent’’ to exercise its rights to terminate or not to franchisor’s system. It shows the
the outlet. The franchisor could then renew, respectively. Franchise NPR, 64 FR at 57343. number of franchised and company-
either operate the outlet as a franchisor- One commenter noted, however, that these owned outlets at the beginning and end
proposed definitions are inaccurate, noting that
owned store, or sell it to a new ‘‘intent to exercise’’ rights does not ‘‘necessarily of each of the last three fiscal years, and
franchisee. In such a case, UFOC Item result in the completion of the event.’’ PMR&W, the total net change.603
20 arguably calls for the franchisor to NPR 4, at 13. The Commission agrees. In addition, Table No. 2 shows transfers, treating
report a termination followed by a the final amended Rule deletes the proposed them separately from terminations and
definition for ‘‘cancellation’’—which would have
reacquisition as two separate events. been similar to the definition for ‘‘termination’’—
non-renewals. This is appropriate
Similarly, a franchisee may abandon an because the ‘‘cancellation’’ reporting category has because, as NASAA observed, transfers
outlet, and, in response, the franchisor been deleted from Item 20 because it is duplicative do not affect the total number of outlets
may send the franchisee a termination of other reporting categories (termination, non- in a franchise system, and the mere fact
renewal, or ceased operations). No commenters
letter, reacquire the outlet, and then raised any concerns in response to the Staff Report’s that an outlet has been transferred tells
transfer it to a new franchisee. Although revised definitions of the terms ‘‘termination’’ and nothing about the reason for the
the outlet has changed franchisee- ‘‘non-renewal.’’ transfer: ‘‘While some transfers are
600 Three commenters suggested that the
ownership only once, the franchisor
Commission address double-counting by adding
conceivably would report this event additional reporting categories to the Item 20
reacquisitions—which are the consequence of an
four times as a ceased to do business, outlet closure—be offset from the outlet closing
disclosure. For example, Robert Zarco
statistics. To that end, he proposed that transfers be
termination, reacquisition, and recommended that the Commission create multiple
removed from the main body of the franchisee
transfer.598 categories to capture various combinations of
statistics table and placed in a separate column
The final amended Rule remedies the ownership changes. Transfers, for instance, would
located on the side of the franchisee statistics table.
be divided into four distinct categories: (1) transfers
imprecision that characterized the by the franchisee to the franchisor; (2) transfers by
Further, he suggested that reacquisitions should be
delineated reporting categories. Item 20 moved to the second Item 20 table concerning
franchisees to the franchisor, but ultimately re-
franchisor-owned outlets. Wieczorek, ANPR 122, at
of the final amended Rule sets forth franchised; (3) transfers by franchisee directly to
3–4. Mr. Wieczorek attached sample tables for the
precise definitions to avoid overlapping new franchisee; and (4) transfers by franchisee
directly to new franchisee more than once. Zarco Commission’s consideration. Id.
categories. Specifically, ‘‘termination’’ & Pardo, ANPR 134, at 6–7. See also Karp, ANPR
601 NASAA, NPR 17, at 5–10.
means ‘‘the franchisor’s termination of a 136 (suggesting that the Commission add columns 602See, e.g., Gust Rosenfeld, at 6; PMR&W, NPR
franchise agreement prior to the end of for newly developed outlets and outlets converted 4, at 14–66 and Exhibit A; NFC, NPR 12, at 31–32;
from franchisor-owned, as well as distinguish Frandata, NPR 29, at 11.
its term and without paying
between units not renewed by franchisor and units 603 The instructions to Table No. 1—section
not renewed by franchisee). Similarly, the AFA 436.5(t)(1)—defines ‘‘outlet’’ to include ‘‘outlets of
596See UFOC Item 20D. See also Wieczorek,
recommended that franchisors create as many a type substantially similar to that offered to the
ANPR, 18 Sept. 97 Tr., at 31. categories as needed to capture all combinations of prospective franchisee.’’ Piper Rudnick urged the
597 For a detailed discussion of this issue, see ownership changes that might occur at each outlet Commission to clarify the phrase ‘‘substantially
Franchise NPR, 64 FR at 57312; Staff Report, at during the course of the year. For example, a similar’’ further in the Compliance Guides.
173–77. termination followed by a transfer to a new owner Specifically, the firm recommended that
598 While the UFOC Item 20 instructions provide would be reported as a ‘‘termination and transfer,’’ ‘‘substantially similar’’ should be limited to where
that the franchisor can add footnotes to clarify the while a termination followed by a reacquisition to the outlet does ‘‘business under the same trademark
numbers, the use of multiple explanatory footnotes the franchisor and then a transfer to a new and system.’’ Piper Rudnick, at 6. We disagree.
removes the benefit of presenting information in a franchisee would be reported as a ‘‘termination, Section 436.5(t)(1)’s ‘‘substantially similar’’ outlet
readily accessible tabular format. In addition, reacquisition, transfer.’’ AFA, ANPR 62, at 3. disclosure serves an important anti-fraud purpose,
prospective franchisees may not read or fully Another franchisor representative opined that most ensuring that a franchise system does not simply
appreciate the import of the footnotes. See Zarco & double-counting problems are attributable to the sell outlets under a new name in order to hide a
Pardo, ANPR 134, at 6–7 (‘‘If the [Item 20] inclusion of transfers and reacquisitions in the table poor growth record or high turnover history. For
information becomes too complicated, the potential summarizing the status of franchised outlets. He that reason, the focus of the disclosure is properly
franchisee will not know how to interpret the data advised that transfers and reacquisitions usually on the similarities between the goods or services
and thus, derive no benefit from the increased follow an initial closing, such as a termination or sold at the outlets, not the name under which the
efforts at meaningful disclosure.’’). non-renewal. He suggested that transfers and outlets conduct business.
problematic for franchisees or prompted Commission’s consideration that would Guidelines.608 This disclosure, like the
from disputes, many other transfers greatly expand the NASAA proposal. parallel disclosure of contact
simply reflect a desire on the part of the For example, according to the Karp information for current franchisees,
franchisee to cease operating a franchise proposal, Table No. 2 would require prevents fraud by giving prospective
or to pursue other opportunities.’’604 franchisors to disclose not only the franchisees additional sources of
Nonetheless, the total number of number of transfers in each of the last material information about the
transfers within a system is material three fiscal years, but also the number franchisor, the nature of the franchise
because it goes to the stability within of completed transfers, requests for system and the franchisor-franchisee
the franchise system over time. Table transfer that were denied, and those relationship. As explained below, the
No. 2 indicates the number of franchise transfers in progress at the end of the final amended Rule provision differs
transfers in each state over the last three fiscal year. His Table No. 3 would from the UFOC Guidelines and the
fiscal years. divide new outlets into two categories: Franchise NPR proposal, however, to
Table No. 3 tracks the turnover rate of new outlets that are newly developed address privacy concerns regarding the
franchised outlets.605 Franchisors must and new outlets that were purchased disclosure of personal contact
report, by state and for each of the last from a franchisor. Mr. Karp also information.609
three fiscal years, the outlets at the start proposed a new table that would The Franchise NPR, incorporating
of the year, new outlets opened, calculate a specific turnover rate, UFOC Guidelines Item 20, would have
terminations, non-renewals, expressed as a percentage, by comparing required franchisors to disclose the
reacquisitions by the franchisor, outlets the number of outlets at the beginning name and last known home address and
that ceased to do business,606 and of a fiscal year with the number of telephone number of every franchisee
outlets at the end of the year. that exited the system within the last
outlets during the year that were
Table No. 4 tracks the turnover at fiscal year.610 While the Commission
company-owned outlets. Franchisors terminated by the franchisor, non-
believes that such information serves a
must disclose, for each of the last three renewed, repurchased by the franchisor,
valuable anti-fraud purpose—enabling
fiscal years, the number of their outlets transferred to another franchisee, or
prospective franchisees to obtain
at the start of the year, new outlets, ceased operations for other reasons. material information from those with
reacquired outlets, closed outlets, Finally, Mr. Karp would revise the new hands-on experience with the franchise
outlets sold to franchisees, and outlets growth projection chart, requiring system—it can be achieved in a more
at the end of the year. franchisors to disclose for each of the limited fashion that also protects former
Finally, Table No. 5 retains the last three fiscal years: previously franchisees’ privacy—notwithstanding
current UFOC projected openings table. projected franchised new outlets; actual that this type of information may be
This table gives prospective franchisees number of franchised new outlets; available in the public domain from
insight into anticipated growth within franchise agreements signed but outlets such sources as telephone directories.
the system by requiring the disclosure of not in operation; and projected To that end, the final amended Rule
both projected franchised and company- franchised new outlets for next fiscal provision requires franchisors to
owned openings in the next fiscal year. year.607 disclose only the name, city and state,
It also reveals the number of franchise The Commission is not persuaded to and current business telephone number,
agreements signed in the previous year expand Item 20 as Mr. Karp suggested. or, if unknown, the last known home
where a store has not yet been opened. The additional proposed disclosures telephone number of former franchisees.
This information is material because it would greatly increase the size of the Further, to give prospective franchisees
enables a prospective franchisee to already extensive Item 20 disclosure, notice that their contact information
gauge how long it may take before his potentially overwhelming prospective may be disclosed even after they leave
or her store actually becomes franchisees while increasing franchisor the franchise system, franchisors must
operational. compliance costs. Further, to streamline state the following language in
During the Rule amendment immediate conjunction with the list of
the Rule and reduce inconsistencies
proceeding, Eric Karp submitted a former franchisees: ‘‘If you buy this
with the UFOC Guidelines, we are
variation of the NASAA proposal for the franchise, your contact information may
disinclined to add new Item 20 charts
that merely restate information that can be disclosed in the future to other
604 NASAA, NPR 17, at 8. buyers when you leave the franchise
605 To reduce double-counting, Item 20 specifies already be gleaned from the existing
that multiple events are to be reported using a ‘‘last- charts. For example, the amended Item system.’’611 To allow for greater
in-time’’ approach. See PMR&W, NPR 4, at 13–14. 20 disclosures enables prospective flexibility, footnote 10 to the final
See also NASAA, NPR 17, at 5–10; Frandata, NPR franchisees to calculate turnover rates amended Rule provides that franchisors
29, at 11. During the Rule amendment proceeding, may substitute alternative contact
other commenters offered other options, such as a for themselves from the data contained
‘‘first-in-time’’ approach, or establishing an order of in Tables 1 and 3 by comparing outlets 608 UFOC Guidelines Item 20 E. In contrast, the
priority among events. We are persuaded that a last- at the beginning of a fiscal year with the
in-time approach is appropriate, for the reasons comparable provision of the original Rule required
noted in the PMR&W comment: ‘‘A last-in-time
number of outlets closed during the the disclosure of only the number of franchisees
prioritization is appropriate for at least three year. who left the system within the last fiscal year. 16
reasons: (1) it allows for an easily ascertainable CFR 436.1(a)(16).
confirmation of the event; (2) it represents a fact, b. Identification of former franchisees 609 No commenter—including current and former
rather than an intention (e.g., a termination notice) franchisees—raised any privacy concerns during
or a proposal (e.g., a transfer rather than request); Section 436.5(t)(5) of the final the course of the Rule amendment proceeding.
(3) in dispute situations, it labels the event in a amended Rule adopts the Franchise Accordingly, this was not addressed in the Staff
manner consistent with the parties’ settlement of Report.
their dispute.’’ PMR&W, NPR 4, at 13–14.
NPR proposal that franchisors disclose 610 In contrast, the disclosure of current
606 The instructions accompanying Table No. 3 contact information for franchisees who franchisees’ contact information is limited to their
include the statement that the franchisor must, in have exited the franchise system in the business address and business telephone number.
column 8 of the table, ‘‘state the total number of most recently completed fiscal year, 611 This approach is similar to the proposed
outlets in each state not operating as one of the consistent with the UFOC disclosure of current business opportunity buyers’
franchisor’s outlets at the end of each fiscal year for contact information in recently published Business
reasons other than termination, non-renewal, or Opportunity Rule Notice of Proposed Rulemaking,
reacquisition by the franchisor.’’ 607 Karp, at 4; Karp, NPR 24, at 14-19. 71 FR 19054, 19071 (Apr. 12, 2006).
information at the request of the former reasons previous franchisees departed would trigger an additional 14 days
franchisee, such as a home address, post from that site.’’614 before signing the agreement.616
office address, or a personal or business The Commission agrees, but is The commenters urged that a
email address. convinced that a five-year reporting franchisor be permitted to furnish the
period is warranted in order to allow unit-specific disclosures outside the
c. Identification of former franchisee- disclosure document, just as a
sufficient time to identify a trend.615 As
owners of a specific outlet being resold franchisor may make supplemental
noted throughout this document, the
Section 436.5(t)(6) of the final Commission believes that more financial performance claims outside of
amended Rule extends the original Rule disclosure is warranted to give the disclosure document without
and UFOC Guidelines Item 20 by prospective franchisees information triggering a redisclosure obligation.617
addressing turnover at a specific outlet. about the quality of the relationship The Commission believes these
When a franchisor resells an outlet between the franchisor and franchisee. comments are well-taken. The purpose
under its control that was previously Information about franchise operations of this provision is to provide
owned by a franchisee,612 Item 20 at a specific unit advances that goal. prospective franchisees with material
requires the franchisor to disclose Surely, significant turnover at a information about a specific unit being
contact information for each previous particular location might indicate a lack considered for purchase. The need for
owner of that outlet, the time period of promised support for the location, or furnishing this information must be
when the previous owner controlled the worse, as the IL AG explained, a balanced against the legitimate concerns
outlet; the reason for each previous possible franchisor strategy to have the of franchisors about compliance costs.
ownership change; and the time franchisee fail in order to resell the unit. On balance, the Commission is
period(s) when the franchisor retained We believe any compliance costs to the persuaded that a franchisor who
control of the outlet. As explained franchisor, therefore, are outweighed by recommends a specific unit after having
below, this provision is designed to the countervailing benefits to made proper disclosure should have the
prevent fraud in the resale of a specific prospective franchisees. option of providing the unit-specific
franchised outlet, by giving prospective In response to the Staff Report, two information in a supplement to the
purchasers of that outlet sources of commenters raised questions about the disclosure document, if it so chooses.
information with hands-on experience application of this provision. Accordingly, Item 20 provides: ‘‘This
operating the outlet.613 Specifically, they observed that a information may be attached as an
During the Rule amendment franchisor might not have a particular addendum to a disclosure document, or,
proceeding, the IL AG asserted that a unit in mind when it begins if disclosure has already been made,
number of successive sales of a negotiations with a prospective then in a supplement to the previously
franchised outlet could indicate franchisee. They speculated as to furnished disclosure document.’’618
‘‘churning,’’ the practice whereby a whether this provision would be d. Confidentiality clauses
franchisor turns a blind eye to triggered if a franchisor were to direct a
franchisee failures—or worse, prospect to a particular unit after the Section 436.5(t)(7) addresses
encourages them—in order to sell the franchisor has furnished the prospect franchisors’ uses of confidentiality
same outlet repeatedly. The IL AG urged with a disclosure document. In clauses, as proposed in the Franchise
the Commission to require franchisors particular, they noted that it would be NPR.619 This is a new provision that is
to provide a prospect with a detailed an open question under state law as to not in the original Rule or UFOC
site history when a buyer is being whether a franchisor would have to Guidelines. If, during the last three
directed to a particular location. ‘‘This redisclose including unit-specific fiscal years, franchisees signed a
could be a three year history that would disclosures, and whether redisclosure confidentiality clause in a franchise
chart prior franchisees, their dates of agreement, settlement, or in any other
operation, dates of store management by 614 IL AG, NPR 3, at 7. See also Singler, at 1. This contract with the franchisor, the
the franchisor for the site, and the provision also complements Item 19 provision that franchisor must insert in their Item 20
permits a franchisor to provide supplemental disclosure the following prescribed
financial performance information about a specific statement: ‘‘In some instances, current
612 This modifies slightly the version of Item 20 unit being offered for sale. In order to prevent
set forth in the Staff Report, which stated: ‘‘If a misrepresentation, a prospective franchisee should and former franchisees sign provisions
franchisor is selling an existing franchised outlet, be able to speak with former owners of a specific restricting their ability to speak openly
disclose the following additional information . . .’’ unit being offered for sale when a franchisor about their experience with [name of
Staff Report, at 181 and proposed revised Rule, 64 provides financial performance information about franchise system]. You may wish to
FR at 57342–44. Two commenters correctly noted that specific unit.
that this language is ambiguous because ordinarily 615 We note that the Staff Report urged the
a franchisor does not sell an existing franchised Commission to adopt a three-year reporting period,
616 Wiggin & Dana, at 4; J&G, at 6.
outlet. Rather, a franchisor may sell an outlet in its while the text of the proposed revised Rule attached
617 Wiggin & Dana, at 4.
control that was previously owned by a franchisee. to the Staff Report stated a five-year reporting 618 Indeed, this approach is consistent with
Wiggin & Dana, at 3; J&G, at 6. We agree. This period. Compare Staff Report, at 181 with proposed UFOC Guidelines Item 19, which permits
provision applies only where the franchisor has revised Rule, at 56. Some commenters urged the franchisors who have made an Item 19 financial
reacquired or otherwise gained control of an outlet. Commission to adopt a three year reporting period, performance disclosure to provide prospective
It would not apply where an existing franchisee Wiggin & Dana, at 3, while others said that even a franchisees with supplemental data ‘‘directed to a
merely asks for the franchisor’s assistance in five-year period is insufficient to ‘‘discern the most particular location or circumstance, apart from the
transferring an outlet to a new owner. egregious trends’’). Singler, at 2. We are convinced [disclosure document.]’’ UFOC Guidelines, Item
613 As discussed in the previous section in that a three-year reporting period is too short to 19A, Instructions (ii).
connection with the disclosure of contact expose a trend of specific unit sales. For example, 619 Franchise NPR, 64 FR at 57312–14. As set
information for former franchisees, the disclosure of a single unit could be resold three times: once forth in the definitions section, the term
contact information for former franchisees of a immediately before a three-year reporting period, a ‘‘confidentiality clause’’ means ‘‘any contract,
specific outlet differs from the Franchise NPR second time during a three-year period, and a third order, or settlement provision that directly or
proposal to address privacy issues. To protect the time immediately after the three-year period. In indirectly restricts a current or former franchisee
privacy of former franchisee-owners of a specific such a scenario, a three-year reporting period would from discussing his or her personal experience as
outlet, the amended Item 20 requires the disclosure capture only one resale. We believe a five-year a franchisee in the franchisor’s system with any
of only the name, city and state, business telephone reporting period strikes the right balance between prospective franchisee. It does not include clauses
number, or, if unknown, last known home ensuring material disclosure and reducing that protect franchisor’s trademarks or other
telephone number of the former franchisee-owners. compliance burdens. proprietary information.’’ Section 436.1(c).
speak with current and former urged the Commission to ban the use of disgruntled.625 Indeed, a franchisor, if it
franchisees, but be aware that not all confidentiality clauses as a deceptive or wished to do so, could attempt to use
such franchisees will be able to unfair trade practice.623 confidentiality provisions to ensure that
communicate with you.’’ In addition, a Other opponents of confidentiality prospects speak with only those
franchisor may, at its option, also clauses—including state regulators and franchisees who are successful or
disclose the number and percentage of some franchisors—asserted that such otherwise inclined to give a positive
current and former franchisees who provisions inhibit prospective report.626 In addition, one franchisee
signed confidentiality agreements, as franchisees from learning the truth as representative, contended that the harm
well as the circumstances under which they conduct their due diligence flowing from confidentiality provisions
such clauses were signed. investigation of a franchise offer. As goes beyond individual franchise sales,
This provision was prompted by noted above, current and former noting that such provisions intimidate
numerous comments from franchisees franchisees are often a valuable source franchisees into not testifying before
and their advocates urging the of information about the franchise legislative committees and public
Commission to address the use of investment and can often verify or agencies, such as the Federal Trade
confidentiality clauses in franchising. discredit the franchisor’s claims, Commission.627
Indeed, one quarter of the ANPR especially financial performance On the other hand, several franchisors
commenters (42 out of 166 commenters) representations.624 Attempts to restrict and their representatives opposed
and several speakers at public workshop franchisee speech through banning the use of confidentiality
conferences addressed the confidentiality provisions may deceive clauses. For example, David Kaufmann
confidentiality clause issue, the majority prospects by effectively eliminating one asserted that confidentiality provisions
opposing their use.620 The most crucial source of information, namely prevent disgruntled franchisees from
poignant example was a franchisee of an those current and former franchisees inflaming others and enable franchisors
undisclosed franchise system who who may have a dispute with the to end bad relationships with problem
related that she had to speak quickly franchisor or are otherwise franchisees without spending
because she was on her way to sign a considerable resources. He contended
final agreement terminating her insisted that confidentiality clauses are rare. E.g., that banning confidentiality provisions
relationship with her franchisor. The Tifford, ANPR 78, at 3; Duvall, ANPR, 6 Nov. 97
Tr., at 240. would discourage informal settlements
agreement she was about to sign with franchisees.628 Others added that
It is apparent that franchisee and franchisor
included a confidentiality clause.621 commenters addressed two different types franchisors must have the ability to
These commenters complained that the confidentiality clauses: pre-sale and post-sale protect their trade secrets from
use of confidentiality clauses is confidentiality clauses. The record indicates that
disclosure.629
widespread,622 and several commenters franchisors do not routinely require franchisees to
sign confidentiality agreements at the time of sale. The Commission believes that the
See Wieczorek, ANPR, 18 Sept. 97 Tr., at 50. record does not support an outright ban
620E.g., Manuszak, ANPR 13; Paquet, ANPR 18;
Indeed, no franchisees who commented on
Rachide, ANPR 32; Sibent, ANPR 41 (and 19 confidentiality clauses reported that they were 625 For example, Roger Haines, a Scorecard Plus
identical ANPR commenters); AFA, ANPR 62, at 3; required to sign a confidentiality provision in their
Buckley, ANPR 97; Marks, ANPR 107, at 2; NASAA, franchisee, related:
initial franchise agreement. Nonetheless, it is clear
ANPR 120, at 4; Dady & Garner, ANPR 127, at 2; that franchisors often require franchisees to sign ‘‘I had spoken to some of the franchisees that had
Karp, ANPR, 19 Sept. 97 Tr., at 95. Opponents post-sale confidentiality provisions in dispute left the system. I now feel certain that they painted
included several franchisor representatives. E.g., settlements or as a condition to termination. See, a picture that was not close to being the truth based
Kestenbaum, ANPR 40, at 2. Cendant opposed the e.g., Slimak, NPR 130; Maloney, ANPR 38, at 2; on the gag order that [the franchisor] imposed. Had
use of confidentiality clauses, except to protect D’Alessandro, ANPR, 22 Aug. 97 Tr., at 40; AFA, I gotten the truth from these people, my decision
trade secrets or other proprietary information. ANPR 62, at 3; Doe, ANPR, 7 Nov. 97 Tr., at 276; certainly would have been different. Every
Cendant, ANPR 140, at 3. Rafizadeh, id., at 299–300; Lundquist, ANPR, 22 franchisee leaving the system has had a gag order
621 The franchisee stated: Aug. 97 Tr., at 42–43; Lagarias, ANPR 125, at 3. placed on them, making it impossible for current
‘‘I am at this point not going to state the franchise Franchisors’ forceful defense of confidentiality and future franchisees to get the facts.’’
because I am on my way at 1:00 to sign the final clauses on the grounds that they promote informal Haines, ANPR 100, at 2. See also Cantone, ANPR,
divorce papers, as such, the papers that separate us settlement of disputes also tends to support the 18 Sept. 97 Tr., at 50 (‘‘[T]he whole concept of a
legally. There’s a gag order there. So, if you are view that such clauses are common in settlements. gag order is really destructive and . . . needs to be
planning on putting this on the Internet, that could See Forseth, ANPR, 18 Sept. 97 Tr., at 40. See also addressed.’’).
626See NASAA, ANPR 120, at 4.
be a problem. . . [T]he gag order . . . prohibits me Marks, ANPR, 19 Sept. 97 Tr., at 8-9.
from being able to answer questions, you know, and 623See IL AG, NPR 3, at 3 (‘‘The ability of a 627 Selden, ANPR 133, Appendix B.
give cautionary remarks to other people who might prospective franchisee to freely discuss a present or 628 E.g., Kaufmann, ANPR 33, at 5–6. See also,
be considering the franchise that I was with.’’ former franchisee’s experience with the franchisor e.g., Quizno’s, NPR 1, at 2; H&H, NPR 9, at 20; Baer,
Lundquist, ANPR, 22 Aug. 97 Tr., at 42–43. See may be the single most important step in a buyer’s NPR 11, at 14; NaturaLawn, NPR 26, at 2; Marriott,
also Maloney, ANPR 38, at 2 (‘‘When it became due diligence investment evaluation.’’). See also IL NPR 35, at 16; Snap-On, NPR 16, at 4 (urging the
apparent to both me and Southland Corporation AG, NPR Rebuttal 38, at 3; Manuszak, ANPR 13, at Commission either not to adopt the proposed
that it was time to terminate our business 1; Rachide, ANPR 32, at 3; Sibent, ANPR 41, at 1 disclosure or to revise it in a manner to
relationship, we began negotiating my exit from the (and 19 identical ANPR comments). Three accommodate franchisors’ interests in fostering
system. We came to a mutually acceptable franchisees— Raymond Buckley, Roger C. Haines, early and amicable settlements). J&G added that a
agreement, however, the agreement contained a and David E. Myklebust—believed that they were confidentiality clause disclosure is unnecessary
confidentiality clause. Even if my name appears in kept in the dark about the failure of their because the Rule already sheds light on the
a UFOC as a former Franchisee, how much help can franchisor’s system due to confidentiality clauses franchise relationship. ‘‘If efforts at obtaining
I give to anyone asking a question?’’). imposed on current and former franchisees. additional information are unsuccessful because of
622 For example, Susan Kezios of the AFA stated Buckley, ANPR 97, at 1; Haines, ANPR 100, at 2; confidentiality agreements, a reasonable
that ‘‘the use of gag orders is almost 100 percent in Myklebust, ANPR 101, at 1. prospective franchisee should be able to take that
some franchise systems.’’ Kezios, ANPR, 6 Nov. 97 624 For example, the AFA stressed that fact into its evaluation of whether to buy the
Tr., at 241. See also NASAA, at 6 (noting confidentiality clauses ‘‘typically release the franchise. And additional disclosure about ‘gag
‘‘continued prevalence of confidentiality clauses in franchisor from legal liability and bar the franchisee clauses’ is not helpful.’’ J&G, NPR 32, at 14.
franchising’’); Lagarias, ANPR 125, at 3 (‘‘I have (under threat of legal action) from making any oral 629E.g., Baer, ANPR 25, at 3. Franchisee advocates
found that in most of the actions I have settled, the or written statements about the franchise system or also recognized franchisor’s legitimate need for
defendant franchisors and their counsel insist on their experience with the franchised business. The trademark protection. E.g., Singler, at 2; AFA,
confidentiality.’’); Selden, ANPR 133, at Appendix purpose of such clauses is to shut down any ANPR 62, at 3; Dady & Garner, ANPR 127, at 2;
B (‘‘[Confidentiality clauses] are becoming negative public comment about the franchise Zarco & Pardo, ANPR 134, at 4. For that reason, the
increasingly problematic to franchisees.’’). See also system.’’ AFA, NPR 14, at 3. See also, NCL, ANPR definition of ‘‘confidentiality clause’’ specifically
Karp, ANPR, 19 Sept. 97 Tr., at 92–93. Several 35, at 3; Baer, ANPR 25, at 3; Karp, ANPR, 19 Sept. excludes confidentiality agreements to protect
franchisor representatives, on the other hand, 97 Tr., at 95–96. trademarks and other proprietary information.
on confidentiality clauses. Clearly there Other than the required statement persuaded that this suggestion goes
are instances where both franchisors explaining the nature of confidentiality beyond what is reasonably necessary to
and franchisees enter into such clauses clauses to prospects who may be address the use of confidentiality
voluntarily. As Marriott noted, unfamiliar with their use, any other clauses. No doubt a prospective
franchisees in contract modification disclosures—such as number and franchisee’s due diligence investigation
negotiations may seek or at least agree percentage or the reasons for the of the franchise offering would be more
to confidentiality in order to gain clauses—are entirely voluntary.633 efficient if the prospect could eliminate
certain advantages.630 Under the Moreover, we are unpersuaded that this from its contact list those franchisees
circumstances, we cannot conclude that approach would discourage settlements. under a confidentiality agreement.
harm to franchisees from confidentiality Franchisors opting to pursue litigation However, we believe this approach
clauses necessarily outweighs the in lieu of settlement in order to avoid would impose an unnecessary burden
potential benefits to franchisees, as well the confidentiality disclosure would on those franchise systems that list all
as franchisors. Nevertheless, based upon most likely have to disclose even more of their franchisees in Item 20 on a
the record, the Commission is revealing information about the suit in national basis. Presumably, franchisors
persuaded to adopt a balanced provision their Item 3 disclosure. would have to update records
requiring franchisors to disclose their Further, the confidentiality disclosure continually on each individual
use of confidentiality clauses over the does not reach confidentiality clauses franchisee. Moreover, a requirement that
last three years. The Commission is addressing specific contract negotiation franchisors note which specific
convinced that franchisees often sign terms and conditions.634 We recognize franchisees are subject to a
post-sale agreements containing that there may be instances where both confidentiality clause may have the
confidentiality clauses in connection franchisors and franchisees may not unintended consequence of actually
with dispute settlements and wish to discuss specific terms of an encouraging large franchisors to
terminations. This practice may impede arrangement, such as the price paid for eliminate from their list of 100
prospective franchisees’ ability to a franchise, or other concessions made franchisees those who are subject to
conduct due diligence investigations of to a franchisee. The confidentiality confidentiality clauses, thereby leaving
franchise offerings, undercutting the clause disclosure would be a biased list of only those franchisees
primary goal of pre-sale disclosure.631 unwarranted, therefore, where the who are most successful or satisfied
parties agree to a limited restriction that with the system.
The Commission believes that the still enables franchisees to discuss their We also reject suggestions to limit the
final amended Rule’s confidentiality overall experience in the franchise disclosure to only those circumstances
clause disclosure requirement strikes system.635 where franchisees have signed broad
the appropriate balance between In reaching our conclusion to adopt provisions restricting all speech637 or
informing prospective franchisees that the confidentiality clause disclosure, we
franchisees in the system may not be where a threshold level of franchisees
have carefully weighed suggestions to have signed confidentiality clauses.638 If
able to share information with them, expand or to narrow the disclosure
and minimizing compliance burdens. Of the purpose of the confidentiality clause
requirement. For example, we reject the disclosure were primarily to shed light
the various proposals offered by the suggestion that franchisors identify
commenters, a general disclosure on the extent of problems in the
specific individual franchisees listed in franchise relationship, then we might
notifying prospects about the Item 20 who are subject to a
franchisor’s use of a confidentiality agree. As noted above, however, the
confidentiality clause.636 We are disclosure aims to make prospective
provision garnered the most support.
For example, Howard Bundy told us franchisees aware of the use of
633 Several commenters generally supported this
that ‘‘[i]n a perfect world I would have provision. See NFA, NPR 27, at 1. See also AFA,
confidentiality clauses. Armed with
a list of those that are subject to NPR 14, at 3; Bundy, NPR 18, at 3; Stadfeld, NPR such knowledge, prospective
[confidentiality provisions], so I didn’t 23, at 5; Karp, NPR 24, at 21–22. But see NASAA, franchisees would understand that: (1) a
at 6; WA Securities, at 4–5; Singler, at 2 (asserting refusal by one or more existing
have to make all those extra 75 calls. that franchisor should be required to disclose
But I could live with or without that. It’s number and percentage information concerning
franchisees to speak is not necessarily
more important to disclose the fact that their use of confidentiality agreements). benign; and (2) that the sample of
634See Tricon, NPR 34, at 3 (urging the
they do exist.’’632
Commission to exclude settlement details—such as AFA, NPR 14, at 3; Stadfeld, NPR 23, at 6; Cordell,
the price paid to reacquire a franchised outlet— ANPR, 6 Nov. 97 Tr., at 247–48; Kezios, id., at 256.
630 Marriott, NPR 35, at 16. But see Karp, at 8 (‘‘It from the disclosure if the franchisee is otherwise But see GPM, NPR Rebuttal 40, at 7 (opposing
incorrectly implies that the franchisee that signed free to discuss his or her personal experience as a release of names); Wieczorek, ANPR, 6 Nov. 97 Tr.,
the confidentiality provision had a choice whether franchisee). See also Quizno’s, NPR 1, at 2; Marriott, at 258–59 (this approach would be unnecessarily
to do so or not.’’). NPR 35, at 16. Marriott asserted that the disclosure burdensome: franchisors would have to update
631See AFA, at 3; Karp, at 8. See also FTC v. will create a disincentive for franchisors to their disclosures more frequently, especially in
Orion Prods., Bus. Franchise Guide (CCH) ¶ 10970 accommodate franchisees’ needs in non-standard franchise registration states).
(N.D. Cal. 1997) and United States v. Tutor Time deals. It noted that franchisors ‘‘make a variety of 637 PMR&W, for example, ‘‘acknowledge[s] the
Child Care Sys., Inc., No. 96–2603 (N.D. Cal. 1996). concessions to franchisees in connection with FTC’s concern about prospects being unable to raise
While in these two cases the Commission did not workouts or in connection with sales, or purchasing questions with current or former franchisees who
challenge the defendants’ use of confidentiality or conversion of multiple units, among others, in are subject to confidentiality requirements. The
clauses as either a Rule or Section 5 violation in its exchange for which the franchisor will request the FTC’s position is particularly understandable if a
complaints, it did obtain fencing-in provisions in terms of such arrangements to be kept gag clause prevents all franchisee communication
settlements that prohibited the defendants from confidential.’’ Id. about the franchise system.’’ PMR&W, NPR 4, at 15.
enforcing or entering into confidentiality provisions 635 The extent to which franchisors must disclose Rather, the firm urged the Commission to limit the
for a limited time. confidential settlement terms and conditions is disclosure’s application to only broad ‘‘non-
632 Bundy, ANPR, 6 Nov. 97 Tr., at 249. See also spelled out in Item 3. communication on any subject’’ prohibitions. Id.
AFA, at 3; Gee, at 2; Pu, at 1–2; Selden, ANPR 133, 636 Commenters maintained that such a 638 The NFC advised that the disclosure should
Appendix B; Zarco & Pardo, ANPR 134, at 4; Jeffers, requirement would accomplish two goals apply ‘‘where either all franchisees, or at least
ANPR, 6 Nov. 97 Tr., at 251–52; Wieczorek, ANPR, simultaneously. It would alert prospective twenty percent of the franchisee population, is
6 Nov. 97 Tr., at 260. But see Singler, at 2 franchisees that the franchisor may require barred from communicating with third parties.’’
(permitting disclosure, but accepting that franchisees to sign a confidentiality provision and NFC, NPR 12, at 33. See Bundy, ANPR, 6 Nov. 97
individuals may be contractually forbidden to would save prospects the time and trouble of trying Tr., at 249 and Jeffers, id., at 251–52 (arguing in
discuss the franchisor makes little sense). to contact franchisees who are not free to speak. See favor of a threshold).
franchisees listed in the disclosure identifying information must disclosed to disclose all independent franchisee
document might actually be skewed. only if the independent association: associations. In their view, independent
More important, adopting a threshold is incorporated or otherwise associations are often small, informal
would not address the use of organized under state law and asks groups of individual franchisees that
confidentiality clauses to restrict speech the franchisor to be included in the may come and go at any time, and are
by a minority of franchisees (such as franchisor’s disclosure document often formed on the local or regional
franchisees located in a particular city), during the next fiscal year. Such level without the knowledge or
which might be the most relevant organizations must renew their involvement of the franchisor.642 In
universe of existing franchisees to an request on an annual basis by short, they fear liability for failing to
individual prospective franchisee. submitting a request no later than disclose a franchisee association that
60 days after the close the they did not know exists.
e. Franchisee associations Based upon the record developed in
franchisor’s fiscal year.640
this proceeding, the Commission is
One important difference between the During the Rule amendment convinced that a trademark-specific
original Rule and UFOC Guidelines, on proceeding, several franchisees and association disclosure is warranted
the one hand, and the final amended their representatives urged the under certain circumstances. The
Rule, on the other, is the new Commission to adopt a trademark- disclosure of trademark-specific
requirement that franchisors disclose specific franchisee association franchisee associations—both those
trademark-specific franchisee disclosure requirement. For example, sponsored or endorsed by the franchisor
associations.639 The obligation to one franchisee representative stated: and independent franchisee
disclose such associations differs The UFOC Guidelines currently associations—will greatly assist
depending upon whether the require disclosure of the existence prospective franchisees in their due
association is sponsored or endorsed by of purchasing cooperatives known diligence investigation of the franchise
the franchisor or is an independent to the franchisor, but this is not offering, thereby preventing
association. Section 436.5(t)(8) provides adequate disclosure of a fact of misrepresentations in the offer and sale
that identifying information—name, growing importance to franchisees, of franchises. We recognize that Item 20
address, telephone number, email which is the existence, or non- already requires franchisors to disclose
address and Web address, to the extent existence, of an autonomous the names of, and some contact
known—must be included for each franchisee association representing information for, franchisees in their
association ‘‘created, sponsored, or franchisees in that particular systems. This disclosure requirement,
endorsed by the franchisor.’’ For franchise organization. When an however, is limited to not more than
independent associations, the same organization represents a 100 franchisees. This is true even for
substantial plurality of franchisees medium and large franchise systems
639 The growth of trademark-specific system in the system, perhaps over 30%, with several hundred, if not several
franchisee associations is a recent development in and its existence is known to the thousand, franchisees. Therefore, it is
franchising. These associations are comprised of franchisor, that fact should be possible for some franchisors to hand-
franchisees who operate a franchisor’s particular
brand. In some instances, these associations are
disclosed, possibly by an additional select franchisees listed in their
franchisor sponsored or endorsed councils, where category in the list of existing disclosure documents, revealing only
franchisee-participants are either selected by the franchisees required in Item 20, as successful franchisees who maintain a
franchisor or are elected by franchisees themselves. an additional and critical source of good relationship with their
In other instances, the associations are independent franchisor.643 Moreover, a franchisor
of the franchisor. The emergence of independent
information about the franchise
franchisee associations is not always well-received opportunity.641
642See Baer, NPR 11, at 14; Shay, ANPR, 18 Sept.
by the franchisor. See Winslow, at 141 (‘‘I believe
franchisors ought to be allowed to put in the
Some franchisors did not oppose a 97 Tr., at 71; Wieczorek, ANPR, 6 Nov. 97 Tr., at
contract that if any franchisees get together and disclosure of franchisee associations, 169–70; Duvall, id., at 171. J&G asserted that
form a franchise association to use as a collective especially franchisor-sponsored independent franchisee associations should qualify
bargaining power against the franchisor, other than franchisee advisory councils. However, for inclusion only if they are representative of
an association approved by the franchisor, then the system franchisees and meet or communicate with
franchisor should have the right to terminate the
they voiced concern about any mandate the franchisor at least twice annually for the
franchise contract with all franchisees in that region purpose of addressing franchise relationship issues.
immediately and shut down further operations 640 As discussed below, section 436.5(t)(8) also Further, the firm would require the association to:
under the brand name in that area indefinitely.’’). makes clear that the franchisor has no obligation to ‘‘provide written notice to the franchisor no later
Some commenters reported that, in some instances, verify the association’s continued existence at the than 30 days after the close of the franchisor’s fiscal
franchisors have filed suit to stop the formation of end of each fiscal year. Franchisors may also year end identifying the organization, its mission,
an independent group or have retaliated against include the following statement in conjunction with its form of organization and the number of
individuals who have participated in such groups. the disclosure of independent franchisee franchisees and franchised units which are dues-
E.g., Donafin, ANPR 14 (noting pending federal associations: ‘‘The following independent paying members or otherwise accredited members
lawsuit alleging franchisor interference with franchisee associations have asked to be included of the organization. If some franchisees are not
franchisees’ right to form organizations). Cf. in this disclosure document.’’ dues-paying members, standards used for
Mueller, ANPR 29 (‘‘The FTC should take actions 641 Selden, ANPR 133, Appendix B. Similarly, accreditation should be enclosed in the notice.’’
against franchisors who intimidate or retaliate Martin Cordell, a franchise examiner for the State J&G, NPR 32, at 13. See also PMR&W, NPR 4, at
against franchisees for getting together for any of Washington, observed that disclosing trade 15; Marriott, NPR 35, at 16.
legitimate business purpose.’’); Rachide, ANPR 32 associations could ‘‘be a much more ready source 643 While 100 franchisees may know about
(‘‘[The FTC should prohibit [t]he use of retaliation of information as opposed to individual franchisees franchisor-sponsored associations, they would not
against franchisees involved in franchisee who have to take time out of their businesses to necessarily know about independent associations,
organizations that work to educate or rally the share information with the prospective franchisee.’’ such as those in particular locations, or about
franchise group.’’). See also Karp, at 4; Karp, NPR Cordell, ANPR, 6 Nov. 97 Tr., at 168-69. Susan associations for specific-use franchisee groups (e.g.,
24, Appendix A (listing cases addressing franchisee Kezios of the AFA added that these associations those operating kiosks in malls). Further, there is
organizations). A few states, including California, ‘‘have a collective memory of what has been going also evidence in the record that franchisors do not
Illinois, and Washington, have addressed this issue on historically in the franchise system that one or readily inform prospects about the existence of
by specifically prohibiting franchisors from another individual franchisees may or may not independent associations. For example, Michael W.
restricting franchisees from freely associating or have.’’ Id., at 176. See also, NFA, NPR 27, at 2; Chiodo, the executive director of the Domino’s
joining franchisee organizations. See Cal. Corp. Stadfeld, NPR 23, at 14; Karp, NPR 24, at 9; Bundy, Franchisee Organization, explained that Domino’s
Code 31220; 815 Ill. Comp. Stat. 705/17; Wash. Rev. ANPR, 6 Nov. 97 Tr., at 173; Manuszak, ANPR 13; does not inform franchisees about the existence of
Code 19.100.180(2)(a). Zarco & Pardo, ANPR 134, at 3. Continued
could use confidentiality clauses to disclosure document independent document.648 Accordingly, any
achieve the same goal. Therefore, the trademark-specific associations only to organized independent association—
Item 20 list of franchisees may not be a the extent such associations make their whether it is incorporated, a
random sample or otherwise existence known to the franchisor on an partnership, limited liability company,
representative of franchisees within a annual basis. This will reduce or trust, among other forms of
particular system. One approach to franchisors’ burdens by requiring association—qualifies for inclusion
counter any franchisor-bias in Item 20 is franchisors to disclose only those under Item 20.
to require that franchisors disclose the independent associations actually Item 20 of the final amended Rule
existence of certain franchisee known to them. It requires no special makes explicit that an independent
associations, providing prospective research or recordkeeping or updating franchisee association’s request for
franchisees with an alternative view of requirements on a franchisor’s part. inclusion in a disclosure document
the franchise system. Accordingly, the compliance burden must be renewed annually by
The record also suggests that imposed by disclosing independent submitting a request for inclusion no
individual franchisees often are franchisee associations is minimal. later than 60 days after the close of the
reluctant to share information with The final Rule amendment differs franchisor’s fiscal year. This is more
prospective franchisees. For example, from the Franchise NPR, however, to precise than the Franchise NPR, which
Howard Bundy told us that he often add more precision. Specifically, Item contains no specific time frame during
instructs his franchisee-clients to state 20 of the final amended Rule: (1) which independent associations should
only their ‘‘name, rank, and serial broadens the types of associations that submit their request to the franchisor.649
number and refer [the prospect] back to qualify for inclusion as a trademark- Third, Item 20 of the final amended
the franchisor for everything else.’’644 In specific franchisee association; (2) Rule permits franchisors to include a
his view, franchisees who speak in requires franchisee associations to limited disclaimer, if they wish.
connection with a franchise sale might request inclusion in the franchisor’s Specifically, Item 20 provides that a
be deemed franchise brokers under state disclosure document within 60 days of franchisor can add to the independent
law and could be liable for any claims the end of the franchisor’s fiscal year franchisee association disclosure the
or damages resulting from the sale. end; and (3) permits franchisors to add following statement: ‘‘The following
Franchisees who volunteer information qualifying language alerting prospective independent franchisee associations
also might be subject to a defamation franchisees that the associations listed have asked to be included in this
suit by the franchisor.645 The trademark- in its disclosure document are disclosure document.’’650 We believe
specific franchisee association independent associations. Each of these
648 In response to the Staff Report, AAFD, in
disclosure, therefore, is an important modifications is discussed in the section
particular, noted that it is organized as a trust and
alternative source of information about immediately below. its member franchisee associations form as chapters
the franchise system.646 Item 20 of the final amended Rule of that trust. It asserted that such association
Finally, a franchisee association requires franchisors to disclose only members, although not incorporated, are organized
disclosure is particularly important those independent franchisee and should qualify for inclusion in a disclosure
document. AAFD. See also IL AG, at 8.
given that the final amended Rule does associations that are incorporated or 649 The Staff Report recommended that the
not mandate financial performance otherwise organized under state law. Commission add precision to the Rule by requiring
disclosures. One rationale for not This differs slightly from the Franchise franchisee associations to submit their requests 90
mandating performance information is NPR and Staff Report, which days after the close of the franchisor’s fiscal year.
that prospects can contact franchisees recommended that only incorporated Staff Report, at 197. The staff’s thinking was that
a 90-day period would afford franchisors sufficient
directly to obtain such information. franchisee associations qualify for time to include any franchisee association
Indeed, franchisees are the best source inclusion in a disclosure document.647 information well before the expiration of the 120-
of information about their own earnings. The Commission is persuaded that day annual update period. Id. This view, however,
If true, then prospective franchisees, at was based on the assumption that a significant
informal, unorganized groups of number of franchisors need 120 days to complete
the very least, should be able to contact franchisees are more akin to individual their annual updates. One commenter, however,
as many existing and former franchisees franchisees, than an association. In such argued that 60 days would be sufficient, noting that
as possible to learn about franchisee instances, additional disclosure is many franchisors complete their annual updates
performance. A franchisee association earlier than 120 days. Wiggin & Dana, at 4. In
unwarranted because a prospective determining the appropriate time period for
disclosure may greatly assist franchisee can already speak with inclusion requests, it is appropriate not to interfere
prospective franchisees in their effort to individual franchisees, whose contact with franchisor’s ordinary business practices. In
obtain and review franchisees’ financial information is also provided in Item 20. particular, requiring franchisors ready to
performance by providing an disseminate their updated disclosure documents to
At the same time, the Commission wait 90 days on the mere chance that a franchisee
independent source of information. agrees with Staff Report commenters association may ask for inclusion in their document
At the same time, the disclosure of that Item 20 should be read broadly to is unwarranted. Independent franchisee
franchisee associations is very narrowly enable any organized independent associations seeking inclusion should make their
tailored to address franchisors’ concerns requests known to the franchisor as soon as
franchisee association to seek inclusion possible. Surely, a franchisee association can
about the disclosure of independent in the franchisor’s disclosure submit its request before the close of the
franchisee associations. Specifically, franchisor’s fiscal year or soon thereafter. We are
Item 20 of the final amended Rule 647 Franchise NPR, 64 FR at 57344; Staff Report, convinced that a 60-day period is a more balanced
provides that a franchisor must list in its at 58. The original approach was taken in response approach, enabling franchisee associations to
to commenters’ concerns that requiring the request inclusion, while minimizing franchisor’s
disclosure of independent associations would be compliance burden.
the Organization, nor does Domino’s inform the too broad, requiring the disclosure of even informal 650 This revises the disclaimer recommended in
Organization about new franchisees. Chiodo, ANPR, groups of franchisees, as noted above. However, the Staff Report, which added the following
21 Nov. 97 Tr., at 294-95. several comments contended that the incorporation additional sentence: ‘‘We do not endorse these
644 Bundy, ANPR, 6 Nov. 97 Tr., at 236–37. See

requirement was too restrictive, asserting that the associations and their members may not represent
also, e.g., Hayden, RR 42; Spencer, RR, Sept.95 Tr., Commission should permit the inclusion of all all franchisees in the [name of franchisor] franchise
at 74. franchisee association that make their existence system.’’ Several commenters criticized this
645 Bundy, ANPR, 6 Nov. 97 Tr., at 237.
known to the franchisor. Bundy, at 9; Gust additional statement on the grounds that no
646 Chiodo, ANPR, 21 Nov. 97 Tr., at 294–95. See Rosenfeld, at 6–7; Singler, at 2–3; Stadfield, NPR association is going to represent 100% of all
also Galloway, id., at 317–18; Manuszak, ANPR 13. 23. franchisees in a system. AFA, at 3–4. The
this statement makes clear that the system. Rather, prospective franchisees Four aspects of section 436.5(u) that
franchisor is not necessarily endorsing can determine for themselves whether prompted comment are discussed in the
or supporting the associations listed. to contact independent franchisee following section: (1) the required use of
This statement, coupled with the associations and what weight to give GAAP in preparing financial statements;
requirement that only an organized any information such associations (2) the scope of a parent’s obligation to
independent association must be provide. disclose financial information; (3) the
disclosed and only upon the obligation of subfranchisors to disclose
23. Section 436.5(u) (Item 21): Financial
association’s request, strikes the right financial information; and (4) the phase-
statements
balance between pre-sale disclosure and in of audited financial statements. We
compliance burdens. Section 436.5(u) of the final amended
discuss each of these issues below.
At the same time, the Commission has Rule retains the original Rule’s basic
rejected the suggestion offered by some requirement that franchisors disclose a. The requirement to prepare financial
commenters that independent three years of audited financial statements according to GAAP
franchisee associations seeking statements prepared according to
inclusion in the franchisor’s disclosure generally accepted accounting Section 436.5(u)(1) of the final
document should be representative of a principals (‘‘GAAP’’).653 To maximize amended Rule requires franchisors to
significant number of franchisees in the consistency with the UFOC Guidelines, prepare financial statements according
franchise system.651 These commenters it expands the original Rule by to ‘‘United States generally accepted
urged the Commission to apply a incorporating the UFOC Guidelines’ accounting principles, as revised by any
threshold qualification test whereby a requirement that financial disclosures future government mandated accounting
franchisor would not have to disclose an be in a tabular format that compares at principles, or as permitted by the
independent franchisee association least two fiscal years. This provides Securities and Exchange Commission.’’
unless the association represented a prospective franchisees with This differs from the Franchise NPR,
portion of system franchisees, such as information with which to assess which proposed that franchisors use
25% of system franchisees.652 financial trends, rather than just an United States GAAP only in preparing
The Commission recognizes that Item isolated snap-shot of the franchisor’s their financial statements, consistent
20 may result in the disclosure of finances. with the original Rule and UFOC
independent franchisee associations The final amended Rule provision
Guidelines.655
that are not necessarily representative of differs from UFOC Guidelines Item 2,
franchisees as a whole. However, we however, in three respects. First, while During the Rule amendment
believe there is value in enabling it requires the use of GAAP, it also proceeding, a few commenters opposed
prospective franchisees to speak with an recognizes that what currently is the Franchise NPR’s proposed
association representing similar ‘‘GAAP’’ may change by federal requirement that foreign franchisors
interests, even if not representative of government oversight of the accounting prepare financial statements according
the entire system. For example, a small profession. Accordingly, it provides that to United States GAAP only. These
independent association of franchisees franchisors must use GAAP, as revised commenters asserted that this
in Anchorage, Alaska, might provide by any future government mandated requirement would impose expenses
prospective franchisees with valuable accounting principles. It also allows and burdens on foreign corporations
information about local labor costs, flexibility by permitting accounting entering the American market. H&H’s
financial performance data, as well as standards recognized by the Securities comment was typical: ‘‘For companies
information about third-party suppliers. and Exchange Commission. Second, located in many foreign countries, . . .
For this reason, we reject the notion that consistent with other provisions of the a requirement to convert to US
an independent association should be final amended Rule, it requires the accounting standards would be
forced to establish that they represent a disclosure of a parent’s financial enormously expensive.’’656 H&H urged
specific percentage of franchisees in a information in limited circumstances. the Commission to permit foreign
Specifically, a franchisor must include a franchisors to prepare financial
commenters also noted that the proposed additional parent’s financial statements if the statements that ‘‘conform to U.S. GAAP
sentence is unnecessarily negative in tone. It should parent has post-sale performance
suffice that a franchisor simply notes that the or otherwise to generally accepted
independent associations have asked to be
obligations or guarantees the accounting principles established in the
included, without implying that the independent franchisor’s performance. Third, Item 23 country of the company’s domicile.’’657
association is a renegade group. AFA, at 3–4; retains the Commission’s long-standing IL AG, however, argued that foreign
Blumenthal, at 1–2; Bundy, at 9; Karp, at 5. While policy of permitting franchisors to
we are persuaded that an introductory statement companies should follow United States
may be warranted before listing independent
phase-in audited financial statements GAAP or be permitted to reconcile their
associations—to distinguish them from franchisor over three years.654 financial statements to United States
endorsed or sponsored associations—the statement
should be neutral and not imply any opinion on the 653 16 CFR 436.1(a)(20). In the original SBP, the
merits of the independent associations. This is the Commission noted that a franchisee is purchasing, policy, franchisors can use unaudited financials
same approach taken with respect to franchisor- ‘‘along with the franchise itself, some assurance of during a phase-in period. Id., at 59681.
endorsed or sponsored associations, where no such the financial stability of the franchisor, of the 655 Franchise NPR, 64 FR at 57344. See 16 CFR
disclaimer is required. Accordingly, Item 20 of the franchisor’s ultimate ability to meet its obligations 436.1(a)(20); UFOC Item 21. See also Advisory 02–
final amended Rule deletes the last sentence from to its franchisees.’’ Original SBP, 43 FR at 59679. 4, Bus. Franchise Guide (CCH), ¶ 6515 (Nov. 18,
the Staff Report’s version of the trademark-specific For that reason, the Commission concluded that the 2002).
franchisee association voluntary disclaimer. disclosure of basic financial information by all 656 H&H, NPR 9, at 13. See also NFC, NPR 12,
651See PMR&W, NPR 4, at 15; BI, NPR 28, at 13. franchisors ‘‘is essential.’’ at 33.
652 Stadfeld, NPR 23, at 14–15. See also H&H, 654 ‘‘Without the auditing requirement, the 657 H&H, NPR 9, at 13. Warren Lewis suggested
NPR 9, at 20–21 (if the organization represents 30% financial statements remain nothing more than the that the Commission permit foreign franchisors to
of franchisees); NFC, NPR 12, at 33 (if the franchisor’s own representation of its financial ‘‘use financial statements prepared according to
organization represents 20% of the franchisees); BI, condition.’’ Original SBP, 43 FR at 59679-680. their countries’ GAAPs, provided that those GAAPs
NPR 28 (unspecified threshold). But see IL AG, NPR Nonetheless, the costs associated with preparing are comparable to US GAAP.’’ Lewis, NPR 15, at 17.
Rebuttal 38, at 4 (‘‘Setting a minimum percentage audited financial statements might create a barrier Mr. Lewis, however, provided no criteria or
of franchisees to be a qualified association is to entry by start-up franchisors. In the original SBP, examples that would help us determine what GAAP
virtually unworkable.’’). the Commission made it clear that, as a matter of are or are not ‘‘comparable.’’
GAAP through footnotes and disclose the specific comprehensive b. Parent financial information
explanations.658 body of accounting principles used to Section 436.5(u)(iv) of the final
As noted in our discussion of section prepare the statements and explain amended Rule requires a franchisor to
436.2 concerning the scope of the Rule, material differences between the disclose a parent’s financial statements
the sale of franchises outside the United principles and United States GAAP. The in two circumstances: (1) when the
States was not an important issue when company must also reconcile its parent commits to perform post-sale
the Commission promulgated the statements with United States GAAP. obligations for the franchisor; or (2)
Franchise Rule in 1978. The For example, through additional notes, when the parent guarantees obligations
Commission recognizes, however, that franchisors must reconcile figures for of the franchisor. This narrows the
application of only United States GAAP net income and total shareholders’ Franchise NPR proposal, which would
in today’s global economy may impede equity for the period presented. Finally, have required disclosure of parent
competition from foreign franchisors. the statements must provide all financial information in all instances.664
Accordingly, a more flexible approach is additional disclosures required by As with other Rule provisions, several
warranted, especially in the absence of United States GAAP and applicable SEC commenters questioned the routine
any evidence in the record that financial regulations.661 inclusion of parent information in a
statements prepared by foreign The Staff Report recommended that
disclosure document. For example,
franchisors to date have been deceptive the final amended Rule permit foreign
PMR&W observed that the UFOC
or misleading. financial statements that satisfy the SEC
Guidelines specify only that state
In determining whether to maintain criteria. The Commission has
examiners may ask for audited
the original Rule’s stance on the use of determined that that recommendation is
financials of a parent, but the
GAAP in Item 21 financial statements, sound. As a starting point, application
Guidelines do not mandate it. In its
the Commission focuses strongly on the of the SEC accounting standards ensures
view, parent financial statements are not
primary purpose of a disclosure against deception by requiring foreign
relevant and are rarely requested.665
document, which is to provide franchisors to establish that their
Warren Lewis suggested that the
prospective franchisees with material financials are prepared ‘‘according to a
Commission require the disclosure of
information in a clear and conspicuous comprehensive body of accounting
parent financial statements ‘‘only if (i)
manner. Consistent with that principle, principles.’’ Further, it adds flexibility
the company with the control chooses to
the Commission believes that and minimizes costs and burdens on
guarantee the obligations of the
franchisors must present financial data foreign franchisors, while ensuring that
franchisor or subfranchisor to the
in a format that is meaningful to prospective franchisees receive the same
franchisee in writing, and (ii) a copy of
American prospective franchisees, as material financial information as they
the written guarantee is included in
well as to their advisors. To that end, would receive from a domestic
Item 21 or an exhibit.’’666
the suggestion offered by IL AG—that franchisor. The Commission has
foreign franchisors use United States determined to adopt this flexible revised by any future government mandated
GAAP or reconcile their financial approach, given the absence of any accounting principles—was a third option distinct
statements to United States GAAP— showing or suggestion in the record that from the other two. Piper Rudnick, at 3–4. The
adds needed flexibility, while reducing reconciled foreign financial statements language ‘‘or as revised by any future government
mandated accounting principles’’ recognizes that
costs and burdens on foreign are inherently deceptive or what is currently considered United States GAAP
franchisors. As noted in the Staff misleading.662 At the same time, we may be modified in the future by government
Report, this is the very position adopted recognize the possibility exists that mandate, especially by regulations or rulings of the
by the SEC for the registration of American accounting principles may Federal Accounting Standards Board. Accordingly,
it is not intended to comprise a separate option, but
securities by foreign companies.659 evolve over time. Under the should be read to modify ‘‘United States generally
The SEC permits foreign companies circumstances, Item 21 updates the accepted accounting principles.’’ The final
registering securities to prepare original Rule by adding language amended Rule adopts this revised language.
financial statements using accounting designed to ensure that financial 664 Franchise NPR, 64 FR at 57315. We also note
procedures other than United States statements are prepared according to that the Staff Report recommended that franchisors
disclose financial statements of any parent ‘‘or other
GAAP under limited circumstances. The United States GAAP, ‘‘as revised by any entity’’ with post-sale performance obligations or
first prerequisite is that such statements future government mandated accounting which guarantees the franchisor’s performance. The
be prepared ‘‘according to a principles, or as permitted by the inclusion of the phrase ‘‘other entity’’ prompted
comprehensive body of accounting Securities and Exchange three comments voicing concern that it would
sweep in suppliers that provide goods or services
principles.’’660 The company must also Commission.’’663 to franchisees. Piper Rudnick, at 3; Spandorf, at 8–
9; Starwood, at 3. The Commission agrees that a
658 IL AG, NPR Rebuttal 38, at 5. 661 See SEC Form 20–F, Part III, Items 17 and 18. reference to ‘‘other entity’’ would be an
659 Staff Report, at 201. The SEC has also made clear that even if a foreign unwarranted expansion of Item 21. According, the
660 We noted that NASAA, in response to the company reconciles its financial statements to reference to ‘‘other entity’’ has been deleted from
Staff Report, suggested that the Rule simply United States GAAP, it must audit the financials the final amended Rule.
mandate United States GAAP, or a reconciliation to according to United States generally accepted 665 PMR&W, NPR 4, at 16. See also Lewis, NPR
United States GAAP, without referencing the SEC. auditing standards (United States GAAS) and the 15, at 18; Snap-On, NPR 16, at 4; PREA, NPR 20,
NASAA, at 7. See also WA Securities, at 5. The auditor must comply with the United States at 2; Marriott, NPR 35, at 17. Similarly, J&G
Commission concludes that referencing the SEC is standards for auditor independence. See Id., opposed consolidated financial statements of
appropriate. Given the absence of any indication in General Instruction E(c). affiliates where the franchisor has included its own
662 Of course, the Commission retains its Section financial statements. ‘‘The increased cost and
the record that foreign accounting principles are
inherently deceptive, flexibility in preparing 5 authority to challenge any deceptive foreign potential liability of other affiliates is
financial statements is warranted. As long as the statements. unwarranted.’’ J&G, NPR 32, at 13.
SEC would permit foreign accounting standards or 663 This modifies the version of Item 21 in the 666 Lewis, NPR 15, at 18. See also Baer, NPR 11,
foreign financial statements, we see no policy Staff Report, which would permit financial at 5; IL AG, NPR Rebuttal 38, at 4. In the same vein,
reason to differ. This is particularly true of financial statements prepared according to ‘‘United States Howard Bundy suggested that a franchisor should
statements prepared according to Canadian GAAP, generally accepted accounting principles, or as be permitted to use an affiliate’s financial
which receives more lenient treatment under SEC permitted by the Securities and Exchange statements only ‘‘if the affiliate guarantees all of the
law. See Spandorf, at 8 (recommending an Commission, or as revised by any future duties and obligations of the franchisor in writing
accommodation to permit the use of Canadian government mandated accounting principles.’’ One and for the entire term of the franchise, including
GAAP). comment questioned whether the third part— any renewals and extensions’’ and a copy of the
The Commission believes these points commenters opined that it is would not end until December 31, 2007,
are well-taken and are consistent with unnecessary to require routine financial because the phase-in uses the language
our view expressed in other sections of statements of subfranchisors: financial ‘‘first full fiscal year’’ after starting to
this document that a franchisor need not statements should be provided only by sell franchises.673
disclose parent information in all the entity with whom the franchisee To clarify the timing of the phase-in,
instances. Therefore, proposed Item 21 will have a contractual relationship.669 section 436.5(u)(2) of the final amended
has been modified to limit a parent’s The commenters, however, interpreted Rule replaces the word ‘‘full’’ with ‘‘first
financial information to those the term ‘‘subfranchisor’’ more broadly partial or full fiscal year’’ so that a
circumstances when the parent either: than it is used in the final amended franchisor’s first fiscal year will end
(1) commits to perform post-sale Rule. As noted in our discussion of the consistent with its general accounting
obligations for the franchisor; or (2) term ‘‘franchisor’’ above, the term practices, regardless of when the
guarantees obligations of the franchisor. ‘‘subfranchisor’’ is limited in the Rule to franchisor may have started offering
To the extent that a prospective circumstances where the subfranchisor franchises within that year.674 Under
franchisee is asked to rely on a parent steps into the shoes of the franchisor by this revised approach, the Commission
to perform post-sale contractual selling and performing post-sale will look to the close of the franchisor’s
obligations,667 or relies on a parent’s obligations. It does not reach those first fiscal year after selling franchises,
guarantee, the financial stability of the individuals who may be called regardless of whether that time period
parent becomes a material fact that ‘‘subfranchisors,’’ but who act like was a partial or full year.675
should be disclosed.668 brokers, having no post-sale The phase-in of audited financial
commitments to franchisees.670 Where a statements generated little comment
c. Subfranchisor financial information
person—be it subfranchisor or parent during the Rule amendment proceeding.
Section 436.5(u)(iv) of the final —commits to perform under the Franchisors, the AFA, and IL AG
amended Rule also requires the franchise agreement, its financial supported the phase-in.676 One
disclosure of financial information of information becomes material in order franchisee advocate, however, noted,
any subfranchisor. During the Rule to provide prospective franchisees with among other things, that the states do
amendment proceeding, a few the opportunity to assess the person’s not have a comparable provision. He
financial stability before risking their also cited Small Business
written guarantee is included in the disclosure own investment.
document. Bundy, NPR 18, at 11 (emphasis in Administration statistics showing that
original). d. Phase-in of audited financial only 25% of franchisors survive five
667 Two commenters voiced concern about the
statements years. ‘‘If we excuse audited financial
‘‘post-sale performance obligation’’ language set statements for the first two years, for all
forth in the Staff Report. Specifically, they Section 436.5(u)(2) of the final
contended that sections 436.5(u)(1)(ii) and
practical purposes, even more investors
amended Rule retains the original Rule
436.5(u)(1)(iv) of the Staff Report are inconsistent. will risk losing everything.’’677 On the
provision permitting start-up franchise
In their view, section 436.5(u)(1)(iv) requires a other hand, John Baer not only
franchisor to furnish financial statements if the systems to phase-in audited financial
supported the phase-in, as drafted in the
franchisor has post-sale performance obligations. statements within three years.671
They then noted that is it highly unlike that a Franchise NPR, but urged the
However, the final amended Rule
franchisor would ever enter into a franchise Commission to make it preemptive.678
streamlines the phase-in. Under the
relationship without some post-sale obligations to NASAA supported the phase-in
the franchisee. The commenters concluded original Rule’s phase-in, a franchisor
could furnish a balance sheet for ‘‘the generally, but raised two concerns. First,
therefore that section 436.5(u)(1)(iv) requires
franchisor financials in all instances. This first full fiscal year following the date NASAA observed that the phase-in
interpretation is in direct conflict with section
on which the franchisor must first section of the Rule does not specifically
436.5(u)(1)(ii), however, that expressly permits a reference GAAP, possibly leading
franchisor to use the financials of an affiliate- comply with [the Rule.]’’672 This can be
guarantor. Piper Rudnick, at 3–4; Spandorf, at 8–9. problematic because it is often unclear franchisors to conclude that unaudited
The commenters misread section 436.5(u)(1)(iv) of when the franchisor’s first fiscal year financial statements need not be
the Staff Report. Under that section of the Staff
ends. For example, a franchisor may prepared according to GAAP. It urged
Report, a franchisor must provide financial
statements ‘‘for the franchisor, subfranchisor, and have started selling franchises three 673Id.
any parent . . . that commits to perform post-sale months into its first fiscal year (e.g., in 674See Franchise NPR, 64 FR at 57315.
obligations for the franchisor or guarantees the March 1, 2006, using a calendar fiscal
franchisor’s obligations.’’ The reference to ‘‘post-
675 No comments were submitted on this
sale obligations’’ refers to ‘‘parent,’’ not to the
year). At the conclusion of that fiscal modification of the original Rule’s phase-in of
‘‘franchisor.’’ If the commenter’s reading of section year (December 31, 2006), the franchisor audited financial statements.
436.5(u)(1)(iv) were correct, then the section would would have sold franchises for ten 676E.g., Duvall, ANPR 19, at 1; Baer, ANPR 25, at
have the following absurd meaning: ‘‘a franchisor months. Yet, under the original Rule’s 4; Kaufmann, ANPR 33, at 6; Kestenbaum, ANPR
must provide financial statements for the franchisor 40, at 2; AFA, ANPR 62, at 3; IL AG, ANPR 77, at
. . . that commits to perform post-sale obligations
phase-in, the franchisor’s first fiscal year 3; Tifford, ANPR 78, at 4; IFA, ANPR 82, at 1;
for the franchisor.’’ To avoid any confusion on this Jeffers, ANPR 116, at 2.
669 Bundy, at 9; H&H, NPR 9, at 21; Lewis, NPR
point, section 436.5(u)(1)(iv) of the final amended 677 Bundy, NPR 18, at 11. Mr. Bundy also noted
Rule has been revised to read: ‘‘Include separate 15, at 17. that an audit gives a franchisee a potential remedy
financial statements for the franchisor and 670 This approach parallels the UFOC Guidelines, that otherwise would be unavailable. ‘‘[T]here is no
subfranchisor, as well as for any parent that which require subfranchisor financial statements doubt that the auditor has liability to the franchisee
commits to perform post-sale obligations for the only when the subfranchisor is the applicant for if the auditor did not follow proper procedures and
franchisor or guarantees the franchisor’s franchise registration. provide the appropriate warnings—including notes
obligations.’’ 671 There is no comparable provision in the to the effect that the company may not be solvent
668 Where a parent guarantees performance, Item UFOC Guidelines. The extent to which any state or may be reliant upon selling more franchises for
21 also requires a franchisor to attach a copy of the may permit a phase-in of audited financial its economic survival.’’ Bundy, NPR 18, at 11.
guarantee to the disclosure document. Although the statements is a matter of individual state law. For 678 ‘‘The Commission should be aware that
UFOC Guidelines are not clear on this point, we example, California and Illinois permit a phase-in several of the states require the use of audited
believe that Item 21, Instruction v. contemplates of audited financial statements under limited opening balance sheets in order to register a start-
this requirement. Moreover, it is sound policy. conditions set forth in their franchise regulations. up franchisor. We believe that this is another
Before a prospective franchisee is asked to invest On the other hand, Virginia and Minnesota, for example of why the Franchise Rule should preempt
in a franchise, he or she should be able to assess example, always require audited financial inconsistent state law requirements. One set of
the extent of any performance or financial statements. financials should be acceptable throughout the
guarantees. 672 16 CFR 436.1(a)(20)(ii). country.’’ Baer, NPR 11, at 15.
the Commission to apply GAAP to all The Commission believes NASAA’s time of the sale. Clearly, franchisors
financial statements, audited or point is well-taken, and, therefore we cannot disclose something that may
unaudited.679 We agree. There are two wish to clarify that for Item 21 purposes, only exist at some future date.
prerequisites for financial statements: the term ‘‘start-up’’ is to be read Therefore, we decline to revise Item 22,
(1) the data underlying the statement narrowly, meaning entities that are new as this commenter suggested.
must be prepared according to GAAP (or to franchising and that ordinarily have
25. Section 436.5(w) (Item 23): Receipts
according to SEC standards), and (2) the not prepared audited financials
financials must be audited according to statements to date. Any non-franchise Section 436.5(w) of the final amended
United States generally accepted company that has prepared audited Rule reduces inconsistencies with the
audited standards (‘‘GAAS’’).680 The financials in the ordinary course of UFOC Guidelines by adopting the UFOC
phase-in of audited financials addresses business must include such audited Guidelines Item 23 requirement that
only the second prerequisite—audits. financials in its disclosure documents if franchisors include an acknowledgment
Where a franchisor takes advantage of it decides to begin offering of receipt in the disclosure
the phase-in, it nonetheless must satisfy franchises.684 The phase-in is also not document.688 The original Rule has no
the first prerequisite, preparing its intended for spin-offs, affiliates, or counterpart. Like the cover page, the
financial data according to GAAP (or subsidiaries of a franchisor, where the receipt serves an important educational
SEC standards). franchisor has been engaged in purpose,689 informing prospects that
Nevertheless, we believe that the final franchising or has prepared audited they have 14 calendar-days to review
amended Rule already is clear on this financial statements for any other the disclosures, that they should receive
point. As noted above, the introduction purpose. certain attachments, and that they can
to Item 21 starts with the first report possible law violations.690
prerequisite—that financial statements 24. Section 436.5(v) (Item 22): Contracts At the same time, Item 23 is flexible,
must be prepared according to ‘‘United Consistent with the UFOC Guidelines, affording franchisors and franchisees
States generally accepted accounting section 436.5(v) requires franchisors to greater latitude in demonstrating receipt
principles, as revised by any future attach to the disclosure document a than the comparable UFOC Guidelines
government mandated accounting copy of all relevant agreements, such as provision. Whereas UFOC Item 23
principles, or as permitted by the the franchise agreement, leases, options, requires franchisors to acknowledge
Securities and Exchange Commission.’’ or purchase agreements.685 This is receipt with a handwritten signature,
Item 21 then discusses the second substantively similar to the original Item 23 updates the Rule by allowing
prerequisite—audits: with the exception Rule requirement that franchisors the parties to use electronic
of the phase-in of audited financials, provide prospective franchisees with acknowledgments of receipt. As
‘‘financial statements must be audited copies of relevant documents at least discussed in the definitions section
. . . using generally accepted United five business days prior to the date of above, the term ‘‘signature’’ includes not
States auditing standards.’’ Thus, the execution.686 The final amended Rule’s only written signatures, but electronic
Rule makes clear that the phase-in Item 22 is identical to the Item 22
modifies the GAAS prerequisite only; proposed in the Franchise NPR. 688 Item 23 of the final amended Rule differs from
Only one comment was submitted on the Franchise NPR in one respect. It deletes the
the accounting prerequisite still Franchise NPR proposal that franchisors obtain a
continues to apply to all financial Item 22. In response to the Franchise signed copy of the Item 23 receipt five days in
statements prepared under Item 21.681 NPR, David Gurnick expressed concern advance of a prospective franchisee’s signing the
NASAA also questioned the reference that the term ‘‘contract’’ could be franchise agreement or payment of a fee in
misinterpreted to suggest that Item 22 connection with the franchise sale. Franchise NPR,
to ‘‘start-ups’’ in the phase-in provision. 64 FR at 57344. The Commission proposed this
It voiced concern that: ‘‘[i]f a major requires the disclosure of post-sale requirement in the Franchise NPR to ensure that the
corporation that has been in business for settlement agreements. He suggested prospective franchisee in fact received the
many years and then begins to that Item 22 should expressly state that disclosures before the franchisor finalized the
‘‘the contracts to be attached do not franchise sale. This proposal prompted comments
franchise, that corporation should not both for and against the proposal. Compare
enjoy the same exemption from include forms of negotiated settlement PMR&W, NPR 4, at 5 with Baer, NPR 11, at 15. The
disclosing audited financial statements agreements,’’ especially since the terms Staff Report recommended that this provision be
as a new company that just organized as of any such agreements are unknown at deleted. Staff Report, at 207–08. For the reasons
the time of sale.687 While it is possible stated in the Staff Report, we agree. Franchisors
a true ‘start up’ franchise system.’’682 always have the burden of proof to establish
The NASAA Project Group suggested that a franchisor may misread Item 22 compliance with the Rule’s disclosure and timing
that franchisors that have been in any to include future settlement provisions. In addition, the amended Rule’s general
type of business for three years or more, negotiations, we do not believe this is recordkeeping requirements at section 436.6—
likely. Item 22 refers to those contracts requiring franchisors to retain a copy of each signed
not just the business of selling receipt for at least three years—are sufficient to
franchises, should be required to that involve the franchise offering at the prove compliance. Finally, given the elimination of
provide audited financial statements.683 the automatic contract review waiting period from
684See Interpretive Guides, 44 FR at 49981 the final amended Rule, the addition of another
(‘‘Franchisors may use unaudited financial waiting period would add an unnecessary
679 NASAA, at 7. See also WA Securities, at 6;
statements . . . if they lack audited statements for compliance burden.
CA Dept of Corps., at 2. the fiscal years to be reported when they are first 689 Other Commission trade regulation rules
680 16 CFR 436.1(a)(20)(i) (‘‘such statements are required to furnish a basic Disclosure Document.’’). contain similar messages. E.g., Energy Guides, 16
required to have been examined in accordance with 685 UFOC Guidelines, Item 22.
CFR Part 305, App. L. (‘‘Compare the energy use
generally accepted auditing standards by an 686 See 16 CFR 436.1(g). The attached documents . . . with others before you buy.’’); Cooling-Off
independent certified or licensed public would enable prospective franchisees to compare a Rule, 16 CFR 429.1 (Notice of right to cancel); Used
accountant). See also IL AG, at 9. franchisor’s disclosure about the parties’ legal Car Rule, 16 CFR 455.2 ( ‘‘Below is a list of some
681 NASAA also noted that the Staff Report
obligations with the actual agreements that will major defects that may occur in used motor
referred incorrectly to ‘‘United States auditing govern the franchise relationship. In the original vehicles.’’).
principles,’’ when the proper accounting term is SBP, the Commission recognized that this 690See IL AG, NPR 3, at 9 (‘‘If no disclosure
‘‘United States auditing standards’’ or ‘‘GAAS.’’ requirement ‘‘will therefore have a remedial effect document is provided we would hope it would
NASAA, at 7-8. See also WA Securities, at 6. Item in that it will encourage accurate discussion of the make the franchisee refuse to sign the receipt. . . .
21 of the amended Rule makes that correction. required information in the disclosure statement.’’ [T]he receipt is an extremely important document
682 NASAA, NPR 17, at 11. Original SBP, 43 FR at 59696. when a franchisee later alleges that disclosure was
683Id. 687 Gurnick, NPR 21, at 7. never effected.’’). See also Baer, NPR 11, at 15.
signatures, passwords, security codes, this approach and have revised Item 23 NPR, the Commission proposed two
and other devices that enable a of the final amended Rule new sections that would set forth the
prospective franchisee to easily accordingly.696 basic instructions for preparing a
acknowledge receipt, confirm his or her At the same time, we reject several disclosure document. The first section—
identity, and submit the information to suggestions offered in response to the Franchise NPR section 436.6—set forth
the franchisor.691 Staff Report to modify Item 23. Four general instructions applicable to all
Item 23 of the final amended Rule commenters noted that Item 23, as disclosure documents.700 Specifically,
also incorporates several suggestions recommended in the Staff Report, the Franchise NPR proposed retaining
offered by commenters. For example, requires franchisors to state the name, the original Rule’s three basic
Warren Lewis advised that the title of principal business address, and instructions: (1) that disclosures be
Item 23 should be ‘‘receipts,’’ observing telephone number of each ‘‘franchise prepared clearly, legibly, and concisely
that the current industry practices is to seller’’ in the receipt.697 These in a single document; (2) that
have two receipts at the end of the commenters maintained that this franchisors respond positively or
disclosure document, one the franchisee disclosure requirement is a carry-over negatively to each disclosure item; and
retains as part of the disclosure from the UFOC Item 2 requirement, now (3) that franchisors do not add any
document and the other returned to the eliminated in the final amended Rule, materials to a disclosure document,
franchisor.692 He also urged the that franchisors disclose brokers. They except for information required or
Commission to replace ‘‘franchisee’s urged the Commission to delete the permitted by non-preempted state law.
signature’’ used in the Franchise NPR reference to ‘‘sellers’’ in Item 23 as well, The proposed instructions also
version of Item 23 with ‘‘prospective asserting that this requirement would contained the Commission’s current
franchisee’s signature,’’ noting that result in franchisors having to disclose policy that subfranchisors should
some prospective franchisees object to potentially hundreds of names.698
provide disclosures about the
signing receipts as ‘‘franchisees,’’ since As a preliminary matter, we note that
franchisor, and, to the extent applicable,
this designation is inaccurate until they UFOC Item 2 requires not only the
naming of brokers, but a statement about about themselves. Consistent with the
have actually signed the franchise UFOC Guidelines, disclosure
agreement.693 NASAA also suggested their prior experience. Also, once an
individual is named in Item 2, the documents would also have to be
that the Commission clarify that the written in plain English.701 None of
acknowledgment page must be placed as franchisor must also disclose their
litigation history in UFOC Item 3 and these basic instructions generated any
the last two pages of the disclosure significant comment in response to the
document. It observed that ‘‘[t]he States their bankruptcy history in UFOC Item
4. As discussed previously, we believe Franchise NPR or Staff Report.
that review franchise offerings have
noted many instances where this page such extensive disclosures are In a second section—Franchise NPR
was buried in the middle of the unnecessary with respect to brokers. section 436.7—the Franchise NPR
disclosure document.’’694 We believe Nonetheless, we believe that a proposed specific instructions
these suggestions are sound, and Item prospective franchisee should have pertaining to electronic disclosures.702
23 of the final amended Rule reflects contact information for any seller with In order to prevent fraud and
these changes. whom he or she is dealing.699 circumvention of the Rule’s pre-sale
Another commenter addressed the Accordingly, the disclosure of ‘‘sellers’’ disclosure requirements, the Franchise
second paragraph of the Item 23 receipt. in the Item 23 receipt is to be read NPR proposed, among other things, that:
As proposed in the Franchise NPR, this narrowly, referring to the specific (1) prospective franchisees consent to
paragraph stated, in relevant part: ‘‘If individual(s) dealing with the receiving electronic disclosures; and (2)
[name of the franchisor] offers you a prospective franchisee. This approach is franchisors using electronic media
franchise, it must provide this also helpful for law enforcement provide prospective franchisees with a
disclosure document to you 14 days purposes, identifying who may be paper summary document containing an
before the earlier of: (1) the signing of responsible for furnishing the expanded cover page, table of contents,
a binding agreement; or (2) any payment disclosures. Accordingly, we believe and acknowledgment of receipt. In
to [name of franchisor or affiliate].’’ there are sufficient grounds for retaining addition, it called for all disclosures to
H&H urged the Commission to the seller disclosure in Item 23. be in a form that would permit each
substitute ‘‘binding agreement’’ with prospective franchisee to download,
D. Section 436.6: General Instructions
‘‘binding agreement with the franchisor print, or otherwise maintain the
Section 436.6 of part 436 sets forth the document for future reference.
or any of its affiliates.’’ The firm
basic instructions for preparing a Multimedia features—such as audio,
asserted that the franchisor cannot
disclosure document. In the Franchise video, ‘‘pop-up’’ screens, and external
control whether a prospective
franchisee proceeds to commit with links—would be prohibited in all
696 At the same time, the final amended Rule
independent, third parties before disclosure documents. In order to
prohibits a franchisor from failing to furnish
expiration of the 14 day period.695 As disclosures earlier in the sale process, upon
facilitate the reading of an electronic
noted in our discussion of the reasonable request. See section 436.9(e). disclosure document, however, the
disclosure trigger above, we agree with 697 The version of Item 23 proposed in the Franchise NPR proposed permitting
Franchise NPR referenced ‘‘any subfranchisor or franchisors to include navigational
broker.’’ Staff recommended instead ‘‘franchise tools, such as internal links, scroll bars,
691 Item 23 also provides that franchisors may
seller,’’ and the Commission has adopted this
include specific instructions on how prospects approach. and search features. Finally, the
should submit the receipt, such as via facsimile or 698 Wiggin & Dana, at 4; Piper Rudnick, at 4; J&G, Franchise NPR proposed that
email. This enables the parties to determine for at 7; Duvall, at 2. franchisors furnishing disclosure
themselves the most efficient and cost-effective way
for the prospective franchisee to transmit the
699 This does not mean that a franchisor must
documents electronically retain a
create individualized disclosure documents for

acknowledgment.
each franchise sale. Clearly, a franchisor could
create a receipt with a fill-in-the-blank for the
seller’s information. The company or its agent could 701 The Staff Report proposed the same general
694 NASAA, NPR 17, at 11. instructions. Staff Report, at 208–09.
fill in the blank with the appropriate information
695 H&H, NPR 9, at 21. prior to furnishing the disclosure document. 702 Franchise NPR, 64 FR at 57345.
specimen copy of their disclosures for a furnishing disclosure documents. noted that all Commission trade
period of three years. However, it did not specifically address regulation rules implement Section 5 of
On June 30, 2000, Congress enacted who would be liable for a disclosure the FTC Act and, therefore, the final
the Electronic Signatures in Global and document’s content. During the Rule amended Rule should incorporate the
National Commerce Act (‘‘E–SIGN’’).703 amendment proceeding, the standard of liability developed in
E–SIGN eliminates barriers to Commission sought to clarify liability Section 5 cases. Under Section 5 law,
ecommerce by, among other things, for preparing disclosures, proposing in individuals can be enjoined in
giving legal effect to electronic the Franchise NPR that franchise sellers connection with a corporation’s law
transactions, including pre-sale would be liable for the contents of a violations if they participated directly in
disclosure, and permitting electronic disclosure document if they knew or them or had the authority to control
signatures. Further, E–SIGN preserves should have known of the violation.706 them.711 Applying this standard to the
certain consumer rights. Specifically, it A few commenters voiced concern Franchise Rule, the Staff recommended
provides that consumers must give their about the proposed standard. John Baer, that franchise sellers (for example,
informed consent before engaging in for example, stated that the Franchise third-party brokers and franchisor
electronic transactions and requires NPR proposal imposed an ‘‘impossible’’ employees) be liable for the content of
companies to disclose any rights standard of liability: a disclosure document if they either
consumers may have to receive paper As anyone who has drafted an directly participated in the document’s
records and to withdraw previously- Offering Circular can testify, there creation or had authority to control it.
given consent to receive electronic is no certainty as to the nature of Several commenters voiced concern
records. E–SIGN, however, limits such the information that has to be about the Staff Report’s proposed
rights to ‘‘consumer’’ transactions, included in the various disclosure ‘‘direct participation or control’’ liability
defining ‘‘consumer’’ to mean an sections of the Offering Circular and standard. In particular, the commenters
‘‘individual who obtains, through a reasonable persons often differ in asserted that the ‘‘authority to control’’
transaction, products or services which good faith as to what has to be language is too broad. For example,
are used primarily for personal, family, disclosed.707 David Kaufmann noted that all senior
or household purposes.’’704 Thus, by its officers of a corporate franchisor
He suggested that the Commission technically could be deemed to have the
terms, E–SIGN may have prohibited
revise the standard to ‘‘make it a authority to control the contents of a
restrictions such as those proposed in
violation for a franchisor to fail to use disclosure document and, therefore,
the Franchise NPR for electronic
‘commercially reasonable good faith could be deemed liable, even if they
franchise disclosure.
In light of E–SIGN, the Commission efforts’ to disclose the required were unaware of the particular
has reconsidered the Franchise NPR information.’’708 Similarly, Tricon violation, or had no responsibility for
proposals. As explained below, the final stated that the proposal would result in it.712 Mr. Kaufmann opined, however,
all employees being potentially liable that it is appropriate to hold an
amended Rule eliminates the Franchise
for Rule violations, even those individual liable for directly
NPR’s proposed electronic disclosure
employees who are not involved in any participating in a content violation.713
instructions—Franchise NPR section
franchise sales. According to Tricon, an J&G criticized the Staff Report’s
436.7. In lieu of specific electronic
employee should not be liable, even if proposed liability standard as imposing
disclosure instructions, the final
that person had actual knowledge, strict liability for all sellers even where
amended Rule contains a broad general
unless that person: their ‘‘control’’ is limited, attenuated, or
instructions section that covers the
furnishing of all disclosure documents, (a) knew (or should have known) indirect. According to J&G, under the
paper and electronic alike. We discuss the legal significance of those facts, standard recommended in the Staff
each general instruction immediately and (b) was in a position to Report, liability could be found for
below. influence the outcome of the matter. employees, advisors, consultants,
For example, a secretary could attorneys, and accountants of a
1. Section 436.6(a): Requirement to ‘‘know’’ that financial performance franchisor who ‘‘participate’’ in the
follow the Rule’s disclosure and data was routinely provided to preparation of a disclosure document or
updating provisions buyers, but neither knew the in the sales process in some manner.
Section 436.6(a) of the final amended significance of doing so nor be in a Outside consultants, advisors, and
Rule provides that it is an ‘‘unfair or position to stop the practice.709 attorneys could be held liable even if
deceptive act or practice in violation of In contrast, NASAA supported the view 711E.g., FTC v. Amy Travel Servs., Inc., 875 F.2d
Section 5 of the FTC Act for any that franchisors and individual owners 564, 573 (7th Cir.), cert denied, 439 U.S. 954 (1989);
franchisor to fail to include the of franchisors should be held liable for FTC v. Atlantex Assocs., 1987–2 Trade Cas. (CCH),
information and follow the instructions Rule violations ‘‘regardless of whether ¶ 67788 at 59255 (S.D. Fla. 1978), aff’d, 872 F.2d
for preparing disclosure documents set they knew or should have known of the 966 (11th Cir. 1989); FTC v. Kitco of Nevada, 612
out in Subpart C (basic disclosure F. Supp. 1282, 1292 (D. Minn. 1985). Under Section
violation.’’710 5 case law, it is also clear that individual franchise
requirements) and Subpart D (updating Based upon the comments, the staff salespersons are also directly liable for their own
requirements) of the Rule. The recommended a revised liability misrepresentations in connection with franchise
Commission will enforce this provision standard in the Staff Report. The staff sales. See, e.g., FTC v. J.K. Publ’ns, Inc., 99 F. Supp.
according to the standards of liability 2d 1176, 1203 and note 67 (C.D. Cal. 2000).
712 Mr. Kaufmann observed that the New York
applicable in actions under Sections 5, 706 Franchise NPR, 64 FR at 57301, 57333. A
Franchise Act imposes liability upon any officer,
13(b), and 19 of the FTC Act.’’705 showing of knowledge is necessary when seeking to director, or management employee who materially
The original Rule specified that hold an individual liable for redress for a aids in the act or transaction constituting the
corporation’s law violations in Section 5 matters, as violation of the Act. Lack of knowledge after due
franchisors and franchise brokers are discussed further below.
diligence is a defense. Kaufmann, at 7–8.

jointly and severally liable for 707 Baer, NPR 11, at 10.
713See also Cendant, at 2–3 (suggesting that the
708Id.
following liability standard: ‘‘Any other franchise
703 15 U.S.C. 7001. 709 Tricon, NPR 34, at 6. See also Baer, NPR 11,
seller will be liable for the violations . . . if he or
704 15 U.S.C. 7006(1). at 10. she directly participated in preparation of the
705 15 U.S.C 45(a); 53(b); 57b. 710 NASAA, NPR 17, at 3. disclosure document.’’).
they had no knowledge of the facts Commission may establish the requisite must be prepared using plain English. It
underlying the violation.714 knowledge by showing that the also updates the UFOC Guidelines to
On the other hand, Howard Bundy individual had ‘‘actual knowledge of address electronic disclosure: section
argued that those in a corporate material misrepresentations, or an 436.6(b) provides that disclosures must
structure who have ‘‘authority to awareness of a high probability of fraud be in a form that ‘‘permits each
control’’ content should be liable for along with an intentional avoidance of prospective franchisee to store,
conduct of the corporation. ‘‘This is the truth.’’719 For example, an officer or download, print, or otherwise maintain
consistent with what Congress and the director of a franchisor would be liable the document for future reference.’’ This
SEC have mandated in the post-Enron for redress if he or she directed the prevents deception, ensuring that
world with regard to officers of a public franchisor’s employees to prepare false prospective franchisees can review the
corporation.’’715 Mr. Bundy stated that a or misrepresented disclosures, or failed disclosure document at will, as well as
broad standard is important to force to stop the company from using a faulty show a copy of the disclosure document
responsibility for accuracy and disclosure document that one or more to their advisors, if they wish to do
completeness to the highest levels in the states had previously rejected as so.723 Thus, for example, a franchisor
franchisor’s organization. insufficient.720 Similarly, a franchisor’s would violate section 436.6(b) if it
Because violations of part 436 sales manager could be held sought to provide disclosures merely by
constitute violations of Section 5, the individually liable for redress where the permitting a prospect to glance at a
Commission is persuaded that liability sales manager has authority to control paper copy of its disclosure document,
for the content of a disclosure document those preparing disclosure documents, providing a continuous loop video of its
must be based upon liability standards and has knowledge that the disclosures disclosure document at a trade show, or
applicable in FTC enforcement actions are false, or otherwise inaccurate.721 transmitting its disclosures via email or
under Sections 5, 13(b), and 19. In that the Internet in a format that was
regard, there is a distinction between 2. Section 436.6(b): Formatting
requirements incapable of being downloaded or
the standard of liability for injunctive
printed. No comments addressed this
relief and that for redress. In general, As proposed in the Franchise NPR, issue. Accordingly, the final amended
case law establishes that an individual section 436.6(b) of the final amended Rule adopts this provision as proposed
may be enjoined for corporate Rule specifies that all disclosures must in the Franchise NPR.
misconduct if he or she participated be prepared ‘‘clearly, legibly, and
directly in the wrongful practice or had concisely in a single document.’’722 At 3. Section 436.6(c): Affirmative
the authority to control the corporate the same time, it includes the UFOC responses
defendant.716 In the franchise context, Guidelines requirement that disclosures
an officer or director of a franchisor may Consistent with the original Rule and
be enjoined against violating the Rule if 1176 at 1204; FTC v. Atlantex Assocs., 1987–2 Franchise NPR, section 436.6(c) of the
the officer or director, for example, has Trade Cas. ¶ 67788; FTC v. Kitco of Nevada, Inc., final amended Rule specifies that
authority to control or directly prepared, 612 F. Supp. at 1282. For the Commission to obtain franchisors must respond affirmatively
civil penalties against a defendant, the standard of
or directed others to prepare, false or knowledge is even higher: ‘‘actual knowledge or
or negatively to each disclosure item.724
otherwise inaccurate disclosure knowledge fairly implied on the basis of objective If a disclosure item is not applicable,
documents.717 circumstances that [the] act or practice is unfair or then the franchisor must respond
In order to hold an individual liable deceptive and is prohibited by such rule.’’ 15 U.S.C. negatively, including a reference to the
45(m)(1)(A).
to pay consumer redress, however, the 719FTC v. Publ’g Clearing House,104 F.3d at 1171;
type of information required to be
Commission must show more than just FTC v. Am. Standard Credit Sys., Inc., 874 F. Supp. disclosed by the Item. For example, a
authority to control the corporation. It at 1089; FTC v. Minuteman Press, Int’l, 53 F. Supp. franchisor without any litigation would
must show the individual possessed 2d 248, 259–260 (E.D.N.Y. 1998); FTC v. Int’l state something to the effect: ‘‘The
some level of knowledge or awareness Diamond Corp., 1983–2 Trade Cas., ¶ 65725 at franchisor has no litigation required to
69707 (N.D. Cal. 1983). It is axiomatic that the
of the misrepresentations.718 The Commission need not show intent to defraud, or be disclosed by Item 3.’’ In addition,
bad faith. See, e.g., FTC v. World Travel Vacation each disclosure item must contain the
714 J&G, at 3–4. Brokers, Inc., 861 F.2d 1020, 1029 (7th Cir. 1988) appropriate heading.725 No comments
715 Bundy, at 2. (citing Beneficial Corp. v. FTC, 542 F.2d 611, 617 addressed this issue. Accordingly, the
716FTC v. Publ’g Clearing House, Inc., 104 F.3d (3rd Cir. 1976), cert denied, 430 U.S. 983 (1977));
Removatron Int’l Corp. v. FTC, 884 F.2d 1489, 1495 final amended Rule adopts this
1168, 1170 (9th Cir. 1997). See also FTC v. J.K.
Publ’ns, Inc., 99 F. Supp. 2d at 1203; FTC v. Am. (1st Cir. 1989) (citing Chrysler Corp. v. FTC, 561 provision as proposed in the Franchise
Standard Credit Sys., Inc., 874 F. Supp. 1080, 1087 F.2d 357, 363 (D.C. Cir. 1977)); Regina Corp. v. FTC, NPR.
(C.D. Cal. 1994). Authority to control the company 322 F.2d 765, 768 (3rd Cir. 1963); FTC v. Patriot
can be evidenced by active involvement in business Alcohol Testers, Inc., 798 F. Supp. 851, 855 (D. 4. Section 436.6(d): Additional materials
affairs and the making of corporate policy, Mass. 1992).
including assuming the duties of a corporate officer. 720See, e.g., FTC v. Five-Star Auto Club, 97 F.
The final amended Rule retains the
FTC v. Amy Travel Serv., Inc., 875 F.2d at 573. Supp. 2d at 501 (failure to reform program in light original Rule’s policy prohibiting
Similarly, an individual’s status as a corporate of extensive state law enforcement cease and desist
officer and authority to sign documents on behalf orders shows reckless indifference to the truth, or franchisors from including additional
of the corporate defendant can be sufficient to an awareness of high probability of fraud coupled materials in their disclosures, except for
demonstrate the requisite control. FTC v. Publ’g with an intentional avoidance of the truth); FTC v. information ‘‘required or permitted by
Clearing House, Inc., 104 F.3d at 1170. Safety Plus, Inc., No. 91–352 (E.D. Ky. 1992) (taking this Rule or by state law not pre-empted
717See FTC v. Five-Star Auto Club, Inc., 97 F. affirmative steps to remedy deceptive practices
Supp. 2d 501 (S.D.N.Y. 2000) (individual defendant shows knowledge of the deceptive practices).
723See Bundy, ANPR, 6 Nov. 97 Tr., at 129
participated directly in the deceptive acts or 721See FTC. v. H.N. Singer, Inc., 668 F.2d 1107
practices by, among other things, drafting and/or (9th Cir. 1982) (sales manager liable for restitution (disclosures need to be either downloaded onto disk
approving marketing materials); FTC v. Atlantex because of his authority to control and knowledge or provided in paper form).
Assocs.,1987–2 Trade Cas. (CCH), ¶ 67788 of the deceptive acts and practices of his 724 Franchise NPR, 64 FR at 57345. See 16 CFR
(individual defendant liable because he had the salespeople). 436.1(a)(24). This instruction is intended to ‘‘aid the
authority to control the company’s actions, 722 Franchise NPR, 64 FR at 57345. See 16 CFR franchisee in using the disclosure document and
including the authority to control representations 436.1(a) and 436.1(a)(21). The ‘‘single document’’ [is] intended as a remedial measure to prevent
made by salespeople). requirement prevents ‘‘piecemeal and confusing franchisors’ violations of the rule and the [FTC]
718FTC v. Amy Travel Serv., Inc., 875 F.2d at 574. disclosures by the franchisor.’’ Original SBP, 43 FR Act.’’ Original SBP, 43 FR at 59684.
See also FTC v. J.K. Publ’ns, Inc., 99 F. Supp. 2d at 59682. 725See 16 CFR 436.1(a)(24).
by this Rule.’’726 This prohibition is To that end, the final amended Rule, purpose in an electronic environment,
necessary to ensure that franchisors do consistent with the Franchise NPR, and the final amended Rule specifically
not include information that is non- specifically permits the use of ‘‘scroll permits their use.732
material, confusing, or distracting from bars, internal links, and search In reaching this conclusion, we agree
the core disclosures.727 As proposed in features.’’ with the commenters’ concern that it
the Franchise NPR, the final amended The prohibition against adding to a may be desirable to include additional
Rule also updates the original Rule by disclosure document generated a material information in a disclosure
prohibiting the use of new technological number of comments during the Rule document to ensure that required
developments, such as audio, video, and amendment proceeding. Several disclosures are accurate. The
‘‘pop-up’’ screens, and external links,728 commenters voiced concern that the prohibition on adding to a disclosure
which could be used to call attention to prohibition against adding to a document should be read narrowly to
favorable portions of a disclosure disclosure document ‘‘is an unfair trap prohibit the inclusion of materials that
document or to distract prospective for franchisors and subfranchisors.’’ For are not specifically required or
franchisees from damaging example, Warren Lewis asserted: permitted by the Rule.733 Where the
disclosures.729 The Commission Rule requires a franchisor to make a
[W]e note that a franchisor or
recognizes, however, that navigational disclosure, however, the franchisor
features may benefit prospective subfranchisor sometimes needs to
include information in a disclosure always may add brief footnotes or other
franchisees by making it easier to read clarifications to ensure that the
an electronic disclosure document.730 document that it believes is
material or possibly material (even disclosure is complete and not
though the information is not misleading.
726 Franchise NPR, 64 FR at 57345. See 16 CFR
required or permitted under federal Finally, in response to the Staff
436.1(a)(21). The Franchise NPR referred to ‘‘any
materials or information other than that required by or state law) or that it believes will Report, David Kaufmann asserted that
this Rule or by state law not preempted by this help a prospect to better understand the prohibition against adding to a
Rule.’’ One commenter noted that because some of disclosure document set forth at section
the proposed Rule’s disclosures are optional (such required information or its
as the Item 19 financial performance disclosures), significance. Providing 436.6(d) creates an inconsistency with
the prohibition on additional information should supplementary or explanatory state anti-fraud laws that require a
read ‘‘any materials or information other than that information of this type should not disclosure document to contain all
required or permitted by this Rule . . .’’ Lewis, material information.734
NPR 15, at 19. We agree, and the final amended be a rule violation, unless the
Rule reflects this change. information is excessive, Section 436.6(d) is not intended to
727See Original SBP, 43 FR at 59682. Accordingly,
misleading, or intentionally preempt state law. As previously
franchisors may include information expressly diversionary.731 discussed, a franchisor can always
required or expressly permitted by state law or include information in a disclosure
information requested by a state franchise The Commission believes that its document that is required by state law.
examiner. This provision is not intended to permit long-standing policy limiting
franchisors to include any information (such as Typically, such state disclosures will
testimonials or general promotional materials) in a disclosures to only authorized or arise in two circumstances. First, state
disclosure document on the ground that it is not permitted materials is sound. As law may require specific disclosures
specifically prohibited by state law. discussed above, this limitation is that go beyond those required by the
728 The prohibition on external links, like the
necessary to ensure that a franchisor Franchise Rule, or may contain a broad
requirement that a disclosure be a single document,
effectively prevents franchisors from furnishing
does not bulk-up a disclosure document anti-fraud provision requiring
disclosures through a series of linked, but separate, with unnecessary information or franchisors to include in their
documents. This ensures that electronic features that will discourage a disclosure document all material
disclosures, in particular, can be downloaded and prospective franchisee from reading the
printed in their entirety. See Bundy, NPR 18, at 13 information. Second, a state franchise
(suggesting that the Rule should expressly require
document or distract a prospective examiner may require, as a matter of
that all exhibits and attachments must be part of the franchisee’s attention from negative discretion, on a case-by-case basis, a
single disclosure document and it should prohibit disclosures. For example, it is entirely particular disclosure in order to prevent
external links). If not, a prospective franchisee proper to prohibit a franchisor from
downloading or printing an electronic disclosure deception by a franchisor. In either
document may only capture isolated sections. This
including general advertising, instance, the final amended Rule
would violate the very concept of full disclosure testimonials, or— in the case of accommodates state interests by
underlying the Rule. electronic media— multimedia tools, in permitting the franchisor to add state
729 BI commented that a prohibition on the use
its disclosure documents. On the other
of multimedia features ‘‘appears to be overly hand, the Commission recognizes that 732 Section 436.6(d), however, makes clear that
broad.’’ BI, NPR 28, at 8. It proposed that the
Commission consider that some features may assist unique features of electronic media, navigational tools must be for the prospective
a prospective franchisee in reading a disclosure such as scroll bars, internal links, and franchisee’s benefit. Accordingly, a franchisor’s
document. BI, however, did not specify which search features that may aid prospective selective use of navigational tools for its own
features it had in mind or how those features might benefit (i.e., to draw the prospect’s attention to, or
franchisees in reviewing their away from, certain disclosure items) is prohibited.
assist prospective franchisees.
730 Frandata, for example, observed that internal disclosures. Such features serve a useful 733 We note that nothing in the Rule prohibits a
links will enable a prospective franchisee to shift franchisor from furnishing prospective franchisees
between the disclosure document and the disclosure document might predispose a with non-deceptive and non-contradictory
corresponding agreement provisions, ‘‘thus prospect to envision that all electronic versions information outside of its disclosure document. See
affording a franchisee a more intelligent and contained such a feature, and would therefore 16 CFR 436.1(a)(21) (‘‘This does not preclude
efficient review of a disclosure document.’’ create a negative impression (or customer service franchisors . . . from giving other nondeceptive
Frandata, NPR 29, at 4. Indeed, Frandata suggested issues) for other systems which have not information orally, visually, or in separate literature
that the Commission formulate a specific set of incorporated such a feature, while simultaneously so long as such information is not contradictory to
cross-links and features in order to ensure that all confusing the prospect.’’ Id. We would not go so far. the information in the disclosure statement.’’).
electronic disclosure documents are uniform. In its Rather than dictate the features that a franchisor 734 Kaufmann, Attachment 1, at 10–11. In the
view, uniformity would foster comparison shopping should use in preparing disclosure documents, we same vein, Howard Bundy recommended that the
among franchise offers. In addition, it would avoid believe the Rule should allow for maximum Commission create a separate, miscellaneous
stigmatizing those franchise systems that fail to flexibility, enabling franchisors to incorporate those section of a disclosure document, where a
incorporate features in their electronic disclosure navigational features it believes are warranted. franchisor can add other material disclosures
documents. ‘‘For example, viewing a document 731 Lewis, NPR 15, at 19. See also Holmes, NPR necessary to make the disclosure document non-
with extensive search features keyed to words in 8, at 9; Stadfeld, NPR 23, at 15; BI, NPR 28, at 8. deceptive. Bundy, at 2-3.
information to its basic disclosure functions to the subfranchisor. In the ensuring that prospective franchisees,
document. first ‘‘example, the proposed prior to disclosure, know whether or not
[disclosure] requirement may lead to they will receive a disclosure document
5. Section 436.6(e): Multi-state
disclosure about the franchisor in a in a form they can easily review.742 For
documents
subfranchise offering that is irrelevant example, a franchisor would disclose if
As proposed in the Franchise NPR, and, in some circumstances, could be it furnishes disclosures via CD-ROM
section 436.6(e) of the final amended misleading to prospective only. In addition, the franchisor must
Rule permits franchisors to ‘‘prepare franchisees.’’738 As discussed above in disclose if there are any special
multi-state disclosure documents by connection with the definition of conditions to reviewing a disclosure
including non-preempted, state-specific ‘‘franchisor,’’ subfranchisors are treated document. The franchisor would
information in the text of the document the same as franchisors under the Rule disclose, for example, whether the
or in Exhibits attached to the disclosure in narrow circumstances only: where prospective franchisee’s computer must
document.’’735 This instruction will the subfranchisor steps into the shoes of be capable of reading pdf files or
decrease compliance costs significantly, the franchisor by both granting whether any specific applications are
by enabling franchisors to use one, franchises, as well as by performing necessary to view the disclosures (such
united disclosure document for both post-sale disclosure obligations.739 as Windows 2000 or DOS, or a
federal and state purposes. No Accordingly, we believe that the particular Internet browser). No
comments were submitted on this issue. subfranchisor instructions set forth at comments were submitted on this
Accordingly, the final amended Rule section 436.6(f) are clear and no proposed Rule amendment.
adopts this provision, as proposed in additional revision is necessary.
the Franchise NPR. Accordingly, the Commission adopts
7. Section 436.6(g): Disclosure of any this provision in the final amended
6. Section 436.6(f): Subfranchisor prerequisites to receiving or reviewing Rule.743
disclosures disclosure documents
8. Section 436.6(h): Disclosure
Consistent with the original Rule, Section 436.6(g) requires that, before document recordkeeping
section 436.6(f) makes clear that a franchisor furnishes a disclosure
subfranchisors must disclose the document, it must ‘‘advise the Section 436.6(h) of the final amended
required information about the prospective franchisee of the formats in Rule requires franchisors to ‘‘retain, and
franchisor, and, to the extent applicable, which the disclosure document is made make available to the Commission upon
the same information concerning the available, any prerequisites for request, a sample copy of each
subfranchisor.736 obtaining the disclosure document in a materially different version of their
The Franchise NPR proposed that particular format, and any conditions disclosure documents for three years
subfranchisors ‘‘should’’ disclose the necessary for reviewing the disclosure after the close of the fiscal year when it
required information. Howard Bundy document in a particular format.’’740 was last used.’’ This provision modifies
suggested that the subfranchisor This provision was not previously slightly the language used in the
instructions be revised to replace noted in the Franchise NPR.741 It is Franchise NPR—which limited the
‘‘should disclose’’ with ‘‘shall intended to prevent deception, by recordkeeping instruction to electronic
disclose.’’737 He noted that the word disclosure documents.744 Section
‘‘should’’ implies an advisory only, that 738 H&H, NPR 9, at 6. 436.6(h) now applies to all disclosure
is, that a subfranchisor has the 739 In our view, a new definition to address documents, regardless of the medium
discretion to include its own subfranchising is unnecessary because the term
‘‘franchisor’’ adequately addresses the issue. The
information in the disclosure document. Commission anticipates that staff will also explain 742 This is consistent with section 436.3(f) of the
We agree, and section 436.6(f) of the subfranchising more fully in the Compliance final amended Rule, allowing franchisors to state in
final amended Rule is revised Guides, with hypothetical examples. the cover page whether alternative disclosure
accordingly. 740 This instruction is an alternative to the formats are available and how prospective
At the same time, H&H voiced originally proposed prior-consent mandate for franchisees may obtain one.
electronic disclosures. Several commenters opposed 743 One commenter, however, observed that this
concern about subfranchisors’ a prior consent requirement. See NFC, NPR 12, at section does not specify how or when the franchisor
disclosure obligations, correctly 15; Frandata, NPR 29, at 5; AFC, NPR 30, at 2. The should communicate this information to the
observing that ‘‘subfranchising’’ takes NFC, for example, feared that an advance consent prospect. Kaufmann, at 3. He suggested that the
many different forms. For example, a precondition would stifle new technological Commission advise in the Compliance Guides that
advances that would enable franchisors and franchisors may communicate this information in
subfranchisor may in fact function as a prospective franchisees to conduct business online any fashion and at any time prior to furnishing the
franchisor by signing a franchise ‘‘seamlessly,’’ without any additional contacts or disclosure document it chooses— in person,
agreement with a subfranchisee, or the discussions. NFC, NPR 12, at 15. See also telephonically, in writing, in email, in its marketing
franchisor may sign the franchise McDonalds, NPR 7, at 2. We agree. Section 436.6 materials, or applications. Id. But see Bundy, at 10
permits a wide variety of disclosure formats, (asserting that the provision does not provide
agreement, but delegate many support provided that the prospective franchisee is made sufficient guidance, recommending that the
aware of any prerequisites to using them. Commission specify which formats are preferred).
735 Franchise NPR, 64 FR at 57345. 741 As noted above, the Franchise NPR proposed We agree that the final amended Rule should be as
736See Interpretive Guides, 44 FR at 49969. While flexible as possible. Section 436.6(g) is not intended
a new section—section 436.7—that set forth
the Commission has allowed some flexibility in comprehensive electronic disclosure instructions. to be a new trigger or timing for disclosures
how franchisors and subfranchisors should prepare Among other things, that proposed section would provision. As long as the franchisor has
disclosure documents, it also made clear that both have permitted prospective franchisees to furnish communicated this information before the 14
‘‘the franchisor and the subfranchisor are disclosures electronically only with the prospective calendar-days for disclosure starts running, the
responsible for each other’s compliance with the franchisee’s ‘‘express consent.’’ Proposed section franchisor has complied with this provision.
rule, and are jointly and severally liable for each 436.7(a). While an ‘‘express consent’’ requirement Flexibility is also called for, provided that the
other’s violations.’’ Id. The Commission also stated is now prohibited by E–SIGN, the underlying franchisor can demonstrate that it has
that it expects franchisors and subfranchisors to concepts—that a prospective franchisee should communicated the required information. For many
provide the required background information, know the formats in which disclosure documents systems, the easiest way to impart this information
litigation, and bankruptcy disclosures of both will be provided, and any prerequisites to obtaining will be in the franchisor’s initial application form,
parties, and that subfranchisors should provide one—nonetheless continue to apply, regardless of or in the first written contact after acceptance of the
franchisee statistical information in all instances. the media (i.e., paper document or electronic application when the issue of furnishing the
Id. document) selected by the franchisor to comply disclosure document first arises.
737 Bundy, NPR 18, at 11. with the final amended Rule. 744 Franchise NPR, 64 FR at 57345.
used.745 This is consistent with E–SIGN, statute of limitations for trade regulation 1. Section 436.7(a): Annual updates
which generally prohibits rule enforcement actions brought under As noted above, section 436.7(a)
discriminating between paper and Section 19 of the FTC Act.749 Further, expands the time period proposed in the
electronic commerce. It is also many franchise registration states Franchise NPR for making annual
consistent with standard business already require franchisors to maintain updates from 90 to 120 days after the
practices and state law requirements, complete records involving each close of the franchisor’s fiscal year.755 In
and, therefore, should impose only a de franchise sales transaction.750 Therefore, response to the Franchise NPR, several
minimis burden on franchisors. At the franchisors routinely ask for and retain commenters urged the Commission to
same time, a three-year recordkeeping some kind of receipt in the ordinary adopt a 120-day requirement. For
provision will greatly assist the course of business to protect themselves example, PMR&W stated that many
Commission in its law enforcement from any future allegations that they franchisors have difficultly obtaining
work, by ensuring the availability of sold franchises without disclosure. annual audited financial statements
evidence in rule enforcement actions.746 Thus, a recordkeeping requirement is from their auditors within the current
During the Rule amendment likely to foster compliance with the
proceeding, a few commenters urged the 90-day period. Because most franchisors
Rule’s disclosure obligation without use the calendar fiscal year, company
Commission to adopt a longer imposing significant compliance
recordkeeping requirement.747 A longer auditors are usually overwhelmed at the
costs.751 beginning of the fiscal year, given the
recordkeeping provision, no doubt,
might also assist franchisees who wish E. Section 436.7: Updating busy tax season. Recognizing this
to bring common law actions with Requirements problem, many state franchise regulators
longer limitations periods. However, we allow franchisors 120 days to prepare
Section 436.7 of the final amended
believe such a step is unnecessary in updated disclosures.756 For these
Rule specifies three updating
light of the other Rule instructions reasons, the Commission is persuaded
requirements to ensure that franchisors’
ensuring that prospective franchisees that the updating requirement should be
disclosures are timely. In most respects,
can retain copies of their disclosures for expanded from the original Rule’s 90
the updating requirements are identical
future reference. In short, franchisees days to 120 days. This revision has the
to those set forth in the original Rule
should safeguard their disclosure potential of reducing franchisors’
and Franchise NPR, and have generated
documents post-sale, and the Rule compliance burdens, while potentially
few comments.
instructions, as noted above, First, section 436.7(a) of the final reducing inconsistencies with state
accommodate that interest. amended Rule retains the current updating policies.757
9. Section 436.6(i): Receipt requirement that franchisors prepare 2. Sections 436.7(b)–(c): Quarterly
recordkeeping annual updates after the close of their updates
fiscal year,752 but it has expanded the
Finally, section 436.6(i) of the final Sections 436.7(b) and (c) of the final
number of days in which franchisors are
amended Rule requires franchisors to amended Rule retain the original Rule
permitted to prepare updates from 90 to
‘‘retain a copy of the signed receipt for and Franchise NPR requirement that
120 days.
at least three years.’’748 This section was franchisors update their disclosures at
Second, sections 436.7(b) and (c)
proposed in the Franchise NPR in least quarterly to reflect any material
retain the requirement that franchisors
connection with the Item 23 receipt changes.758 This requirement generated
update their disclosures within a
requirement. However, because this no significant comment during the Rule
reasonable time after the close of each
recordkeeping requirement is not a amendment proceeding.759 We believe it
quarter to reflect any material
disclosure, but is more akin to an changes.753
instruction, it has been moved to the document need not be re-audited on a quarterly
Third, section 436.7(d) continues the basis. Rather, a franchisor can update its audited
final amended Rule’s general original Rule’s policy that franchise disclosures by including unaudited information,
instructions section. sellers, when furnishing their provided the franchisor discloses that the
Section 436.6(i)’s three-year record disclosures, must notify prospective information is unaudited. See 16 CFR 436.1(22).
retention period is consistent with the franchisees of any material changes that
755 Franchise NPR, 64 FR at 57345 (retaining the
original Rule’s 90-day annual update requirement).

745 Many states require franchisors to keep
the seller knows or should have known 756 PMR&W, NPR 4, at 5. See also Baer, NPR 11,
records on franchise sales transactions. E.g., Cal.

in any Item 19 financial performance at 4; Lewis, NPR 15, at 19–20; IFA, NPR 22, at 11;
Corp. Code at 31150; Haw. Rev. Stat. at 482E–5; 815 representations.754 We discuss each of J&G, NPR 32, Attachment, at 3.
757 In response to the Staff Report, however, Gust
Ill. Comp. Stat. at 705/36; Md. Code Ann, Bus. Reg. these provisions immediately below.
at 14–224; Minn. Stat. at 80C.10; N.D. Cent. Code Rosenfeld suggested that ‘‘120 days’’ should be
at 51–19–16; Or. Rev. Stat. at 650.010; R.I. Gen. 749 Several Commission trade regulation rules
expressed as ‘‘four months.’’ The firm noted that
Laws at 19–28.1–13; Wash. Rev. Code at 19.100.150. during leap years, 120 days would fall on April 29,
746 Rule enforcement actions brought under
also require a three-year recordkeeping or if the franchisor’s fiscal year end is June 30th, 120
requirement. See, e.g., Wool Labeling Rule, 16 CFR days would fall on October 28. Gust Rosenfeld, at
Section 19 of the FTC Act have a three-year statute 300.31(c); Fur Labeling Rule, 16 CFR 301.41(b);
of limitations. 15 U.S.C. 57b. Reliance on 7. While we recognize there may be rare instances
Textile Labeling Rule, 16 CFR 303.39(c); Alternative where 120 days does not fall at the end of a month,
franchisees for copies of disclosure documents in
Fuel Labeling Rule, 16 CFR 309.23; R-Value Rule, we are reluctant to change the language of section
law enforcement work is impracticable. Franchisees
16 CFR 460.9. 436.7(a) to be inconsistent with state law.
may not retain copies or may not have complete 750E.g., Cal. Corp. Code at 31150; Haw. Rev. Stat.
copies. Moreover, large franchise systems may use 758 Franchise NPR, 64 FR at 57345. See also 16
multiple versions of their disclosures over time and at 482E–5; 815 Ill. Comp. Stat. at 705/36; Md. Code CFR 436.1(a)(22).
in different states. Obtaining all relevant copies Ann, Bus. Reg. at 14–224; Minn. Stat. at 80C.10; 759 PMR&W, for example, noted that the original
from franchisees may be unworkable. Therefore, for N.D. Cent. Code at 51–19–16; Or. Rev. Stat. at
Rule’s quarterly update requirement is a bright-line
law enforcement purposes, it is essential that 650.010; R.I. Gen. Laws at 19–28.1–13; Wash. Rev.
rule that ‘‘is clear and intelligible to franchisors and
franchisors retain copies of their disclosures for Code at 19.100.150.
751 No comments were submitted on this
their counsel.’’ PMR&W, NPR 4, at 6. Similarly, the
some length of time, consistent with state practices. NFC states that a quarterly update requirement is
747 Bundy, NPR 18, at 13; Stadfeld, NPR 23, at proposed Rule section. consistent with long-standing Commission policy.
752See 16 CFR 436.1(a)(22).
5. NFC, NPR 12, at 16. One commenter, responding to
753See 16 CFR 436.1(a)(22).
748See BI, NPR 28, at 7–8 (This ‘‘provides useful the comparable provision in the Staff Report, noted
clarification regarding the minimum time period 754See 16 CFR §§ 436.1(d)(2) and (e)(6). Section that the Franchise NPR would have required a
the Commission expects franchisors to maintain 436.7(e) also retains the Commission’s current franchisor to update information quarterly ‘‘relating
such records.’’). policy that audited information in a disclosure to the franchise business of the franchisor.’’ J&G, at
strikes the right balance between worked well and has generated few, if and quarterly update requirements is
ensuring the timeliness of disclosures any, complaints during the 20 years that warranted. To that end, section 436.7(c)
and reducing compliance burdens. the Rule has been in existence. provides that a franchisor’s annual
Franchisors need to prepare quarterly Section 436.7(c) modifies the update (120 days after the close of the
updates only if there is a material quarterly update provision proposed in fiscal year) ‘‘shall include the
change, and they may include the the Franchise NPR, however, to franchisor’s first quarterly update, either
quarterly update in an addendum. In accommodate the extension of the by incorporating the quarterly update
short, franchisors need not prepare new annual update from 90 to 120 days, as information into the disclosure
previously discussed. The obligation to
disclosure documents each quarter as a document itself, or through an
update disclosures quarterly necessarily
matter of course. We believe the current addendum.’’ The following tables
precedes the conclusion of the 120-day
quarterly update requirement annual update period. Accordingly, illustrate the point, by comparing
establishes a clear, bright line tied to additional clarification of the procedures under the original Rule with
each franchisor’s fiscal year. It has interrelationship between the annual those under section 436.7(c).
HYPOTHETICAL USING PROCEDURES UNDER THE ORIGINAL RULE

December 31, 2005 ........................................... Fiscal year ends.
January-March, 2006 ......................................... First quarter of new fiscal year.
April 1, 2006 ....................................................... Franchisor must use annual updated disclosure document.
Reasonable time after April 1, 2006 .................. Franchisor amends annual update with a quarterly update, if warranted.
Reasonable time after July 1, 2006 ................... Franchisor amends annual update (and any previous quarterly update) with a quarterly update,
if warranted.
Reasonable time after October 1, 2006 ............ Franchisor amends annual update (and any previous quarterly update(s)) with a quarterly up-
date, if warranted.
Reasonable time after January 1, 2007 ............ Franchisor amends 2006 annual update (and any previous quarterly updates(s)) with a quar-
terly update, if warranted.
HYPOTHETICAL USING FINAL AMENDED RULE PROCEDURES

December 31, 2005 ........................................... Fiscal year ends.
January-March, 2006 ......................................... First quarter of new fiscal year.
May 1, 2006 ....................................................... Franchisor must use annual updated disclosure document containing any first quarter update
either integrated in the body of the disclosure document itself or in an addendum.
Reasonable time after July 1, 2006 ................... Franchisor amends annual update with a quarterly update, if warranted.
Reasonable time after October 1, 2006 ............ Franchisor amends annual update (and any previous quarterly update(s)) with a quarterly up-
date, if warranted.
Reasonable time after January 1, 2007 ............ Franchisor amends annual update (and any previous quarterly updates(s)) with a quarterly up-
date, if warranted.
3. Section 436.7(d): Material changes to supporting and opposing the expanded the uncertainty of what constitutes ‘any
financial performance information updating proposal. material change’ and the requirement of
IL AG and Howard Bundy favored the ‘real time’ ongoing disclosure.’’763
Section 436.7(d) retains the original broader updating requirement, but they Marriott would eliminate the proposed
Rule requirement that a franchisor would require all such updates to be in expanded update provision in its
notify prospective franchisees of any writing. The IL AG, for example, stated entirety.764
material changes to previously that ‘‘[o]ral notification is the PMR&W and the NFC advised that the
furnished financial performance ammunition for rescission litigation.’’762 proposal is confusing. In particular,
information.760 The Franchise NPR On the other hand, several franchisors PMR&W found the relationship between
proposed a broader updating opposed the updating requirement for the basic quarterly update provision and
requirement that would have compelled various reasons. Marriott, for example, the proposed continuing update
franchisors to notify prospects of any asserted the proposal would be provision less than clear:
material changes before delivery of the extremely burdensome, imposing ‘‘an It is unclear whether these
disclosure document.761 This proposal impossible burden on large franchisors, ‘‘material changes’’ must be more
generated several comments, both especially if they actually operate the ‘‘material’’ than any changes
business that they franchise because of disclosable in the quarterly updates.
7. The firm asserted that this language could require permitting notification by any means. NFC, NPR 12, particular subject in the training program) . . . to
the disclosure of more information than is required at 16. contact Legal and for Legal to determine if the
by the actual disclosure Items. It suggested that the 763 Marriott, NPR 35, at 3–4. Marriott noted that change is material and to then contact development
Commission adopt the alternative language: any it, and other large corporations, may have several to make sure before the closing of every franchise
material change to ‘‘the disclosures included, or thousand employees in different departments. Each deal that there is not a particular piece of
required to be included, in the disclosure department (e.g., training, legal, advertising, information that must be notified to a franchisee.
marketing) may have a different person responsible This requirement will cause complete havoc in the
document.’’ We agree, and section 436.7(b) of the
for a portion of the information that is in a franchise sales process. Franchisors will not be able
final amended Rule reflects that change.
disclosure document for each different brand to close sales without notifying every department
760 16 CFR 436.1(d)(2) and 436.1(e)(6).
offered. A continuous updating requirement: out of fear that some minute change in fact may
761 NPR, 64 at 57319.
‘‘would place an unfair burden on franchisors later be deemed to be material.’’
762 IL AG, NPR 3, at 4. See also Bundy, NPR 18, Marriott, NPR 35, at 4.
like Marriott. For example, it will be virtually
at 13; BI, NPR 28, at 8–9. On the other hand, the impossible for the Training Department (every time 764 Marriott, NPR 35, at 4. See also PMR&W, NPR
NFC praised the Commission’s flexibility in they change a subject or the hours allotted to a 4, at 6.
Depending on the answer to this business. With the advent of electronic to a separate ‘‘exemptions’’ section in
question, is there any need to communications, emailing a copy of the the final amended Rule.772
require quarterly updates when updated disclosure document to a Section 436.8 retains the original Rule
immediate updates are mandated; prospective franchisee, or otherwise exemptions for: (1) franchise sales under
i.e., does the immediate update rule permitting a prospective franchisee to $500;773 (2) fractional franchises;774 (3)
preclude the need for the quarterly see a copy of the updated disclosure leased departments;775 and (4) oral
update?765 document on the franchisor’s website, contracts.776 Section 436.8 also adds
In a similar vein, the NFC questioned would impose only a small cost. two new exemptions, one for franchise
whether a franchisor must provide a sales involving petroleum marketers,
At the same time, we are persuaded and one for three categories of
prospective franchisee with each and that the final amended Rule should
every quarterly update, as long as the ‘‘sophisticated investors.’’ Finally, the
retain the original Rule’s continuing final amended Rule deletes the original
prospect is in the sales cycle. If so, it update requirement for financial
asked how franchisors should determine Rule’s four exclusions found at 16 CFR
performance information.768 The 436.2(a)(4)(i)-(iv) for non-franchise
whether prospects are no longer in the
original Rule required franchisors to relationships involving: (1) employer-
sales cycle.766
notify prospective franchisees of any employees and general partnerships; (2)
It is clear from the comments that material changes in a financial cooperative organizations; (3) testing or
there are two competing concerns. On performance representation before the certification services; and (4) single
the one hand, prospective franchisees prospective franchisee pays a fee or trademark licenses.777
should have all material information signs the franchise agreement.769 We The final amended Rule section 436.8
they need to make an informed believe this provision is sound, is substantially similar in both form and
purchase decision, regardless of when recognizing the particular materiality of content to its counterpart proposed in
they entered the sales process. On the financial data to prospective the Franchise NPR.778 The principal
other hand, there are practical franchisees. Any false impression difference is a lowering of the dollar
considerations, including the costs and created by stale data at the time of sale threshold for the sophisticated investor
burdens on franchisors to update each
is likely to cause significant injury to ‘‘large investment’’ exemption from $1.5
franchisee on a continuing basis, as
prospective franchisees who rely on million to $1 million. This and the other
Marriott observed. Indeed, at some
financial data in making their substantive differences between the
point, the burden and cost to franchisors
investment decision.770 proposed and final amended Rules are
(which inevitably will be passed along
explained below.
to prospective franchisees or other F. Section 436.8: Exemptions
consumers) outweighs the potential 1. Section 436.8(a)(1): Minimum
benefit of more frequent updating. Section 436.8 of part 436 sets forth payment exemption
Based upon the record, the exemptions from the final amended
Section 436.8(a)(1) retains the original
Commission is persuaded that, on Rule. In the original Rule, the Rule’s $500 required minimum payment
balance, a continuing update exemptions were set out in the middle exemption found at 16 CFR
requirement is unwarranted. We are of the Rule’s definitions, where they 436.2(a)(3)(iii). This exemption ensures
convinced that franchisors should have modified the term ‘‘franchise.’’771 To that the Rule ‘‘focus[es] upon those
a bright-line directive when they can be make the exemptions easier to find, the franchisees who have made a personally
assured that they have complied with Commission has decided to move them significant monetary investment and
the Rule’s disclosure requirements. We
believe that the original Rule’s quarterly who cannot extricate themselves from
768 But see IL AG, at 10 (suggesting that the Rule
update requirement is sufficient to the unsatisfactory relationship without
state that franchisors may have other disclosure
ensure timely disclosures, while obligations under Section 5 of the FTC Act); Bundy, suffering a financial setback.’’779 As
minimizing compliance costs. at 3 (suggesting a continuous updating requirement explained below, the Commission
Further, any prospective franchisee for ‘‘materially adverse events.’’). The quarterly believes the exemption and its $500
update provision specifies when a franchisor must
who has been in the sales cycle can prepare revised disclosures to ensure that they are 772 This approach is consistent with other
always request a copy of the franchisor’s timely. It does not address whether a franchisor
Commission rules, including the Telemarketing
most recent disclosure document before may have other obligations to notify prospective
Sales Rule, 16 CFR 310.6; the Care Labeling Rule,
he or she agrees to execute the franchise franchisees of material changes under state common
16 CFR 423.8, and the Cooling-Off Period Rule, 16
law fraud or misrepresentation principles.
agreement. To facilitate that goal, the 769See 16 CFR 436.1(d)(2) and 436.1(e)(6). Like
CFR 429.3. The UFOC Guidelines do not contain
Commission has adopted a new any exemptions. Rather, at most, some of the 15
the original Rule, the final amended Rule requires franchise disclosure states may exempt franchisors
prohibition that would bar franchisors the franchisor to ‘‘notify’’ the prospective franchisee from registration requirements as a matter of statute
from failing to honor a prospective of any material change in financial performance or regulation. See generally Duvall & Mandel, ANPR
information. It does not require a franchisor to
franchisee’s reasonable request for a update its disclosures more often than quarterly,
114. Thus, franchisors exempted from disclosure
copy of the franchisor’s most recent under the final amended Rule may nonetheless
nor does it require a franchisor to re-disclose to a have to prepare and disseminate UFOCs for state
disclosure document and/or quarterly prospective franchisee. Rather, ‘‘notification’’ law purposes.
update before he or she signs a franchise means that the franchisor must inform the 773See 16 CFR 436.2(a)(3)(iii).
prospective franchisee, which can be accomplished
agreement.767 We believe this outside of the disclosure document. How a
774See 16 CFR 436.2(a)(3)(i).
prohibition is unlikely to increase franchisor ‘‘notifies’’ a prospective franchisee is

775See 16 CFR 436.2(a)(3)(ii).
franchisor’s compliance costs and within the sound discretion of the franchisor. 776See 16 CFR 436.2(a)(3)(iv).
burdens. Franchisors most likely will Notification can be made in writing, or by 777 As discussed below, although the Commission
have updated disclosures documents telephone call, email, or other electronic is deleting the exclusions from the final amended
transmission, provided that the franchisor can Rule text, it is retaining the exclusions as a matter
prepared in the ordinary course of their prove that it has informed the prospective of policy and incorporating them by reference in
franchisee about the material change to the this Document.

765 PMR&W, NPR 4, at 6. performance data. 778 Franchise NPR, 64 FR at 57345. The final
766 NFC, NPR 12, at 16. 770But see J&G, at 11 (asserting that financial amended Rule provision, however, has been
767See section 436.9(f). This provision also performance information should be updated only renumbered as section 436.8. In the Franchise NPR,
address the commenters’ concerns about permitting quarterly). it was numbered section 436.9.
franchisors to furnish updates orally. 771 16 CFR 436.2(a)(3). 779 Original SBP, 43 FR at 59704.
threshold continue to serve a useful with the extraction of business covered by the Petroleum Marketing
purpose. opportunity regulation to a new rule Practices Act (‘‘PMPA’’).789 Although
During this Rule amendment separate from the Franchise Rule, it can this exemption was not part of the
proceeding, no commenter be argued that any investment in a original Rule, in 1980 the Commission
recommended eliminating or reducing franchise, as a practical matter, will be granted a petition for an exemption from
the $500 minimum payment threshold. a significant investment risk. This may the Rule filed by several oil companies
Several commenters, however, urged the suggest that the exemption may no and oil jobbers, pursuant to Section
Commission to raise the $500 minimum longer serve a useful purpose. 18(g) of the FTC Act.790
threshold, with some commenters We note that the Staff Report In considering the petition, the
suggesting a $1,000 threshold,780 while described research exploring the Commission noted that the most
others suggested a $2,500,781 or a $5,000 relevance of the $500 threshold to the frequently cited complaint about the
threshold.782 These commenters amounts actually charged for initial petroleum franchise industry concerned
maintained that an upward adjustment franchise fees in the current market. The termination and renewal practices. The
is warranted to reflect the increase in staff examined over 1,000 franchise Commission also noted that, after the
costs since the Rule was promulgated in profiles listed in Bond’s Franchise close of the original franchise
1978. In addition, two commenters also Guide (13th ed. 2001).786 All but 41 of rulemaking record, Congress had passed
urged the Commission to increase the the franchise systems responding to the PMPA, which specifically addressed
thresholds periodically, perhaps every Bond’s survey reported initial franchise those complaints, requiring, among
four years, to reflect the rate of fees of $5,000 or more (approximately other things, pre-sale disclosure of
inflation.783 96% of reporting systems). Indeed, only franchisees’ termination and renewal
In contrast, the IL AG urged the 22 systems reported that an initial fee rights. In light of that legislation, the
Commission to retain the $500 was ‘‘not applicable,’’ or that they Commission concluded that the
threshold in order to protect small charged an initial franchisee fee of Franchise Rule was largely duplicative
investors.784 In a similar vein, a $1,000 or less.787 Thus, even a $5,000 of the PMPA and related federal
franchisee representative urged the threshold would not reduce regulations.
Commission to modify the minimum significantly the number of franchisors In granting the petition, the
payment exemption to provide that the that must comply with the Rule’s Commission stated that the Rule ‘‘shall
$500 threshold includes ‘‘both amounts disclosure obligations. not apply to the advertising, sale or
the franchisee actually pays, but also Given the significant investment other promotion of a [petroleum]
any amounts that the franchisee, during required to purchase nearly any ‘franchise,’ as the term ‘franchise’ is
the first six months, agrees to pay in the franchise, a plausible argument could be defined by the [PMPA].’’791 The final
future—either by contract or by made for eliminating the threshold amended Rule incorporates the 1980
practical necessity.’’785 altogether. However, the minimum exemption as an express Rule
The Commission has determined to payment exemption continues to serve a exemption.
retain the original Rule’s $500 minimum very narrow, but important, purpose: To Two commenters voiced concern
payment exemption. The original Rule the extent that a less complex business about this exemption. J&G maintained
included a threshold dollar amount to opportunity might come close to that the exemption leaves unanswered
exclude transactions where the satisfying the elements of a franchise, whether disclosure is warranted when
prospective franchisee was at risk to the $500 threshold would help to make other businesses—such as convenience
lose an amount of money too small to it clear that such opportunities are stores, fast food, and ice cream shops—
justify imposition of the expense and exempt from the Franchise Rule. Thus, operate in these exempt gasoline
burden of preparing a disclosure the final amended Rule retains the franchise establishments.792 In the same
document upon sellers. This is minimum payment exemption.788 vein, Chevron noted that the PMPA
particularly true with less complex 2. 436.8(a)(4): Petroleum marketers and covers agreements not only for gasoline
business opportunities, which, even resellers exemption sales, but for other refiner-branded
today, may cost under $500. However, services or products at a gasoline
Section 436.8(a)(4) of the final
station. For example, a Chevron gasoline
780 Typical of these comments was H&H, which amended Rule expressly exempts
station may also have a Chevron
urged the Commission to raise the threshold to petroleum marketers and resellers
$1,000 in order to recognize the fact that costs in branded (or no brand) car wash, repair
general have increased substantially since the Rule 786 Bond’s keeps files on 2,500 American and
was initially promulgated. H&H, NPR 9, at 4. See Canadian franchise systems. Of these, Bond’s
789 15 U.S.C. 2801.
also Gurnick, NPR 21A, at 8; GPM, NPR Rebuttal surveyed 2294 systems that it identified as current
790 45 FR 51765 (Aug. 5, 1980).
40, at 9. and active. Detailed profiles of the 1050 systems 791 45 FR at 51766. In reaching its conclusion, the
781 Baer, NPR 11, at 15-16. In the alternative, Mr.
responding to the survey appear in Bond’s 2001 Commission nonetheless recognized that
Baer suggested that the threshold should be set at edition. circumstances may change in the industry that
1% of the amount of average retail sales achieved 787 The Staff Report noted that Bond’s does not would warrant a fresh review:
by outlets using the franchise system in the United report ‘‘required payments,’’ but initial franchisees ‘‘[I]f circumstances change in the future and
States in the most recent year for which data is fees and total investments. Therefore, it is likely evidence of renewed misrepresentations in the sale
available. Mr. Baer asserted that if ‘‘a system has that at least some franchise systems charging a of petroleum franchises reappears on a significant
average retail sales of $1 million, $10,000 is not a minimum fee or even no initial fee (14 systems) scale, a new rulemaking proceeding may be
number which should trigger concerns. There is no actually collect other required payments (e.g., undertaken that is tailored to the specific needs of
need for the Commission to regulate de minimis royalties, equipment), making the overall financial the industry. In the interim, if isolated abuses
investments with this type of burdensome and risk in purchasing a franchise significant. occur, they will be subject to the adjudicative
costly disclosure obligation.’’ Id. 788 Howard Bundy opined that the $500 procedures and remedies provided by Section 5 of
782 J&G, NPR 32, at 14.
minimum payment exemption should reference the FTC Act.’’
783See H&H, NPR 9, at 4; Baer, NPR 11, at 15-16.
payments by contract or by practical necessity. 45 FR at 51766. Since 1980, the Commission has
784 IL AG, NPR Rebuttal 38, at 2 (‘‘To exempt received only isolated complaints regarding abuses
Bundy, NPR 18, at 4. The $500 minimum payment
franchises that do not have an initial fee, or ones exemption, however, already references the term in the relationship between petroleum company
that have what appears to be a modest fee of $1,000 ‘‘required payment,’’ which in turn is defined to franchisors and their franchisees, and has no reason
or $2,500, would put too many ‘‘small’’ investors include both payments by contract and by practical to believe that a pattern of abuse is likely to develop
at risk.’’). necessity. Accordingly, no further refinement of the in the near future.
785 Bundy, NPR 18, at 14. Rule is necessary on this point. 792 J&G, NPR 32, Attachment at 6.
center, or mart. According to Chevron, information from the franchisor that excluding the cost of unimproved
all of these services or products are sold equals or exceeds the disclosures land.799 To ensure that the large
as part of a unified deal when the required by the Rule. These commenters investment exemption is not overly
prospective franchisee purchases the asserted that such business broad and does not create a loophole,
franchised gasoline outlet. Therefore, arrangements are not the kinds of section 436.8(a)(5)(i) sets forth
the Commission should also exempt the franchise sales that the Commission additional safeguards beyond the $1
sale of such tangential services or goods originally intended to cover. million threshold to preserve protection
sold along with a gasoline station under On the other hand, several franchisees for the average investor.800 First, section
a unified agreement.793 and their advocates opposed the 436.8(a)(5)(i) makes clear that funds
In response to these comments, the exemptions, or expressed reservations obtained from the franchisor (or an
Commission intends that it be clear that about them.796 Some feared that while affiliate) cannot be counted toward the
the PMPA exemption should be read prospective franchisees may appear to $1 million initial investment threshold.
broadly to cover other branded services be sophisticated—either because of their Second, section 436.8(a)(5)(i) requires
and products (such as a car wash or net worth or general prior business the prospective franchisee to sign an
mart) sold to the prospective franchisee experience—they actually may have acknowledgment that the franchise sale
under the same franchise agreement as limited knowledge of the risks inherent is exempt from the Franchise Rule
the gasoline station. The Commission in operating the specific franchise being because the prospective franchisee will
believes that, as a practical matter, it offered. In short, these commenters be making an initial investment of at
may be impossible to divide a single advised the Commission to protect the least $1 million.
franchise agreement for gasoline and wealthy, but inexperienced.797
Section 436.8(a)(5)(i)—the ‘‘large i. Need for the large initial investment
other services into its component parts exemption
for disclosure purposes, and such an franchise investment’’ exemption—
approach is inconsistent with the exempts franchise sales where the As noted above, franchisors urged the
PMPA. Nevertheless, separate or initial investment is at least $1 million, Commission to adopt a large initial
subsequent sales of a franchise to a exclusive of unimproved land and investment exemption,801 while
gasoline station owner, such as a 7- franchisor financing. Section franchisees either opposed it or offered
Eleven or Subway outlet, fall outside of 436.8(a)(5)(ii)—the ‘‘large franchisee’’ suggestions to limit it.802 Specifically,
the exemption. An individual who exemption—exempts franchise sale to several franchisee commenters asserted
operates a gasoline station is just as ongoing entities—such as airports, that wealth or ability to make a large
much in need of pre-sale disclosure for hospitals, and universities—with at franchise investment does not
the purchase of a non-related franchise, least $5 million net worth and five years necessarily equate with business
such as an ice cream store, as any other of prior business experience. Section sophistication. They urged the
prospective franchisee. 436.8(a)(6)—the ‘‘insiders’’ exemption— Commission to focus instead on the
exempts franchise sales to the owners, investor and his or her business
3. Sections 436.8(a)(5) and (a)(6): directors, and managers of an entity background, rather than ability to pay
Sophisticated investor exemptions before it becomes a franchisor.798 Each alone.803
Sections 436.8(a)(5) and (a)(6) add of these exemptions is discussed in the For example, Eric Karp criticized the
three new exemptions to the final section below. notion of a large investment exemption
amended Rule, collectively referred to because it does not consider the source
a. Section 436.8(a)(5)(i): Large of the prospective franchisee’s funds:
as the ‘‘sophisticated investor investment exemption
exemptions.’’ As noted, the Did she re-mortgage her residence?
sophisticated investor exemptions as Section 436.8(a)(5)(i) exempts from Did he borrow from a friend or
adopted are substantially similar to their the Rule franchise sales where the relative? Did they cash in their
counterparts as proposed in the prospective franchisee makes an initial retirement fund? The investment
Franchise NPR.794 investment totaling at least $1 million, standard also does not consider
Franchisors enthusiastically what other assets, liabilities, and
796See, e.g., Bundy, NPR 18, at 14; Stadfeld, NPR
supported the creation of sophisticated
23, at 7-8; Karp, NPR 24, at 6-8. But see Caruso,
investor exemptions.795 They ANPR 118 (‘‘[F]ranchisees in the larger successful
799 At least two states provide some form of
maintained that franchising today often systems are themselves fairly sophisticated and in exemption for transactions involving large initial
involves heavily-negotiated, multi- less need of protection by the FTC or any other investments. Illinois permits a franchisor to apply
government agency.’’). for an exemption from both registration and
million dollar deals between franchisors disclosure where the investment for a single
797See Selden, at 1; Gee, at 2; Karp, at 6-7; Pu,
and highly sophisticated individuals at 2; Zarco & Pardo, ANPR 134, at 4-5; Kezios, franchise unit exceeds $1 million. Maryland
and corporate franchisees with highly ANPR, 6 Nov. 97 Tr., at 47-48; Bundy, id., at 48- exempts franchises that require an initial
competent counsel. In the course of 49; Stadfeld, NPR 23, at 8; Karp, NPR 24, at 6-8; investment of $750,000 or more from registration,
NFA, NPR 27, at 3. See also NADA (urging the but not from disclosure.
such deals, prospective franchisees 800 These safeguards were included in the
Commission to consider exemptions on a case-by-
often demand and receive material case basis only). proposed version of this provision. Franchise NPR,
798 Two commenters noted that the inclusion of 64 FR at 57321 and 57345.
793See Pillsbury Winthrop (on behalf of Chevron 801E.g., PMRW, NPR 4, at 3; Wendy’s, NPR 5, at
the three sophisticated investor exemptions in the
U.S.A. Inc.). final amended Rule could be misleading because a 2; McDonalds, NPR 7, at 2; H&H, NPR 9, at 4; Baer,
franchisor may still have obligations to make NPR 11, at 16; NFC, NPR 12, at 20. Marriott, for
795E.g., Gust Rosenfeld, at 7; J&G, at 7; Marriott, disclosures under state law. Bundy, at 3; IL AG, at example, stated that not only are sophisticated
at 2-4; Starwood, at 2-3; 7-Eleven, NPR 10, at 2; 10. Howard Bundy, for example, urged the franchisees able to protect their own interests, but
NFC, NPR 12, at 17; IFA, NPR 22, at 7; AFC, NPR Commission to include a warning in the final the self-interest of others involved in the project,
30, at 2-3; Marriott, NPR 35, at 6. See also amended Rule itself that exemption from the such as bankers, is sufficient to protect those
Kaufmann, ANPR, 18 Sept. 97 Tr., at 165; Franchise Rule does not necessarily mean interests as well. Marriott, NPR 35, at 6. See, e.g.,
Wieczorek, id., at 187-88; Tifford, id., at 194 (noting exemption from state disclosure law. While this Baer, NPR 11, at 16; Gurnick, NPR 21, at 3; J&G,
that the Rule imposes unnecessary costs on observation is true, the Commission believes the NPR 32, at 3.
802 Stadfeld, NPR 23, at 8; Karp, NPR 24, at 6.
sophisticated franchisees and adds unwarranted appropriate place to delineate the relationship
delay in the high-paced negotiation process, where between the final amended Rule and state law is in 803 Karp, at 7; Karp, NPR 24, at 6-7. See also
parties often are anxious to cement their deals anticipated Compliance Guides and other business Stadfeld, NPR 23, at 7-8 (‘‘Being wealthy should not
quickly to beat out the competition). and consumer education materials. be a basis for being screwed.’’).
income the prospective franchisee investors or the use of independent decision regardless of the application of
has from which one can estimate business advisors, and an extended the Rule. Where prospective franchisees
his or her financial sophistication period of negotiation. The record is are likely to demand and obtain pre-sale
and tolerance of risk.804 consistent with the conclusion that material information regardless of
In lieu of the ‘‘investment’’ model the transactions negotiated by such external prompting or compulsion, then
offered by the Commission, Mr. Karp knowledgeable investors over time the case for federal intervention is not
urged the Commission to consider SEC and with the aid of business compelling.
advisors produce the pre-sale Further, the Rule’s costs and burdens
Regulation D,805 which ‘‘properly
information disclosure necessary to are unwarranted in situations where the
focuses on the qualifications of the
ensure that investment decisions likelihood of abuse is low. This concept
investor, not the size of the investment.’’
are the product of an informed is incorporated into the statutory
In his view, the large franchise
assessment of the potential risks provision of the FTC Act that gives
exemption does the opposite. ‘‘The fact
and benefits of the proposed franchisors the right to petition the
that a franchisee may be ready to invest
investment.808 Commission for a trade regulation rule
a highly leveraged $1.5 million
exemption, including an exemption
franchise investment does not prove Accordingly, it is clear that investment limited to a specific set of facts.809 Thus,
that such a person is so sophisticated level is one indicium of sophistication. a franchisor, if it wished, could petition
that a disclosure document would be of More important, we are convinced
the Commission for an exemption only
no benefit.’’806 that franchisors should have a bright-
for sales above a certain dollar figure
Mr. Karp also discounted the line standard that will clearly indicate (although to date none has done so). The
potential benefit of the large investment when and under what circumstances the large investment exemption need not be
exemption to franchisors. According to sophisticated investor exemption will ‘‘all or nothing’’ to benefit franchisors.
Mr. Karp, the exemption would be of apply. An exemption based upon the The very fact that franchisors uniformly
little benefit to the franchisor unless specific business experience of each supported the large investment
100% of its franchise sales involved individual prospective franchisee would exemption tends to confirm that it will
transactions over the threshold level. If be burdensome to administer. For provide them with some desired
so, he insisted, there is no additional example, in some instances franchisors regulatory relief. On balance, we believe
compliance burden imposed by would not be able to take advantage of that a narrowly crafted large investment
requiring disclosures be given to all the exemption unless they first verified exemption offers the potential for
prospective franchisees because the each prospective franchisee’s business reducing franchisors’ regulatory burdens
franchisor has to prepare the disclosures background. Similarly, absent such and preserving Commission resources
in any event.807 verification, law enforcers would not be by reducing the number of exemption
After reviewing the comments, we are able to discern whether any specific petitions, without sacrificing
persuaded that a large investment franchise relationship was covered by protections for the average investors the
exemption is warranted. Since the the Rule. This approach could create a Franchise Rule was originally
Rule’s inception, the Commission has regulatory nightmare for both promulgated to protect.
considered a prospective franchisee’s franchisors and franchise law enforcers.
level of investment as one measure of We are also convinced that the large ii. The $1 million investment threshold
sophistication. For example, in granting investment exemption offers tangible Section 436.8(a)(5)(i) provides that
the Automobile Importers of America’s benefits to franchisors. Clearly, there are franchise sales involving an investment
petition for exemption from the Rule franchise systems, such as lodging, of $1 million —excluding the cost of
under Section 18(g), the Commission where the typical franchise investment unimproved land and franchisor
observed: is likely to exceed the large investment financing—qualify for the large
Prospective motor vehicle dealers exemption’s monetary threshold. investment exemption. We are
make extraordinarily large Accordingly, the large investment convinced that a $1 million threshold
investments. As a practical matter, exemption will provide regulatory relief strikes the right balance between
investments of this size and scope at least in those instances. We recognize providing relief for sophisticated
involve relatively knowledgeable that the large franchise investment investors and protecting consumers.
exemption, however, will provide only The large investment exemption
804 Karp, NPR 24, at 7. See also Selden, at 2 (‘‘The limited relief for franchisors that sell proposed in the Franchise NPR
idea that disclosure becomes unnecessary when the franchises both above and below the incorporated a higher $1.5 million
investment exceeds an arbitrary threshold, because threshold. In such instances, the threshold, based upon the Commission
scale is a proxy for sophistication or bargaining staff’s analysis of the costs to purchase
power, is an oxymoron.’’); Gee, at 3 (‘‘The FTC
franchisor must prepare disclosure
should focus on the capabilities of the investor as documents in order to sell at levels more than 1,350 franchises listed in
opposed to the size of the investment.’’). Mr. Selden below the threshold. Accordingly, the various trade publications, including
also asserted that franchisors are not always costs of providing disclosures to all Enterprise Magazine’s The Franchise
forthcoming with information, suggesting that had
the Commission solicited the views of franchisees
franchisees, including those above the
809 Section 18(g) of the FTC Act. 15 U.S.C. 57a(g).
of large hotel systems, for example, we would have threshold, may not be large, but neither
One commenter observed that while franchisors can
a different impression. Id. We note, however, that is the potential benefit to the purchaser. file individual petitions for exemptions from the
not a single hotel franchisee or large restaurant Indeed, the argument that sophisticated Rule under Section18(g) of the FTC Act, the process
franchisee submitted any comment in response to
the large investment exemption discussed in the
investors could benefit from disclosure is costly and the delay involved often renders this
misses the mark. The basis for the large approach an unviable option. Duvall & Mandel,
ANPR, NPR, and Staff Report. Accordingly, we are ANPR 114, at 16. Section 18(g) of the FTC Act
unconvinced that Mr. Selden’s concerns raise a investment exemption is not that provides a mechanism for parties to petition for
serious issue. ‘‘sophisticated’’ investors do not need relief from Commission trade regulation rules
805See 17 CFR 230.501(5), (6), and (8). See also

pre-sale disclosure, but that they will where potential abuse is unlikely. Section 18(g)
Wendy’s, NPR 5, at 2. exemption petitions are placed on the public record
806 Karp, NPR 24, at 8.
demand and obtain material information
for comment. The entire process of reviewing and
807 Karp, NPR 24, at 6. See also Bundy, ANPR, with which to make an investment granting such a petition may take several months
6 Nov. 97 Tr., at 21-22; Jeffers, id., at 23-24; to more than one year, depending on any comments
Stadfeld, NPR 23, at 8. 808 45 FR 51763-64 (Aug. 5, 1980). received.
Handbook; (‘‘Franchise Handbook’’); Other commenters urged the The Commission gives particular
Entrepreneur Magazine’s Franchise 500, Commission to increase the threshold. weight to the statements offered by
and the International Franchise For example, NASAA recommended a franchisors such as McDonald’s and
Organization’s Franchise Opportunities $3 million threshold. In its view, a $1.5 Marriott that, in their experience, a $1
Guide.810 million threshold may place too many million investment is likely to involve
Very few single-unit franchises cost transactions outside the Rule’s sophisticated investors.820 The
more than $1.5 million: the maximum protections, because, according to Commission believes that a $3 million
estimated cost of establishing a NASAA, even unsophisticated investors dollar threshold would be too high,
franchise exceeded $1.5 million in only may have access to $1.5 million to effectively restricting the exemption to
about 3% of the listed systems. Thus, an invest in a franchise.814 On the other only the rarest of instances, mostly large
investment of $1.5 million most likely hand, several commenters suggested hotel franchises. On the other hand, the
would involve the purchase of several that the threshold should be lower. For suggested $500,000 threshold, in our
units. For example, more than 90% of example, McDonald’s suggested that the view, is too low. There is insufficient
the franchise systems listed in the cited threshold should be set at $1 million.815 record support for the proposition that
sources involve a maximum investment The IFA proposed a variation on this investors at the $500,000 level are
totaling less than $500,000. Thus, in theme. It supported a $1 million sophisticated. Thus, the Commission
order to qualify for the $1.5 million threshold, excluding land.’’816 It has adopted a $1 million threshold for
exemption, an investment in the vast observed that a 1997 update to the the exemption.
majority of systems would involve the Profile of Franchising identified 52 Exclusion of unimproved land. The $1
purchase of either a single large franchise companies offering franchises million threshold for the large
franchise—such as a hotel or the most with an initial investment exceeding $1 investment exemption excludes
expensive restaurant location—or million, excluding land. This equates to payments for unimproved land. The
multiple units.811 Of the 12 restaurant 4.4% or less of all franchise systems.817 Commission believes that the inclusion
systems listed in the Franchise Thus, at a $1 million threshold for the of unimproved land in the exemption
Handbook with maximum investments exemption, more than 95% of all would have two negative consequences.
of $1.5 million or above, all listed a franchise systems would remain within First, inclusion of unimproved land
minimum investment below $1.5 the ambit of the Rule.818 Some would tend to inflate the initial cost of
million to establish a location. Three commenters recommended an even a franchise investment and place too
listed less than $1 million as the lower threshold. PMR&W, for example, many transactions outside the ambit of
minimum investment, and seven recommended $500,000.819 the Rule’s protections. As the IFA noted,
estimated the minimum investment to approximately 52 franchise systems, or
be between $1 million and $1.2 million, 814 NASAA, NPR 17, at 12. Seth Stadfeld added less than 5% of the universe of franchise
or the purchase of three or more that it is not difficult to invest $1.5 million when systems, would qualify for an
there is a down payment plus financing of a
units.812 substantial portion of the investment. ‘‘Indeed,
exemption with a threshold investment
During this proceeding no consensus because they are taking on larger obligations, there of $1 million, excluding unimproved
emerged on the appropriate investment is all the more reason and urgency why they should land.
threshold for the large investment get the material, factual and contractual information Second, the Commission has a strong
exemption. Several commenters that is otherwise available under the Rule.’’
Stadfeld, NPR 23, at 8. See also NFA, NPR 27, at
preference for a bright-line standard that
supported the Franchise NPR’s 3. can be readily applied across franchise
proposed $1.5 million threshold.813 815 ‘‘In our considerable experience, individuals systems. It seems unworkable to require
purchasing franchises involving a $1 million a franchisor to calculate on an offer-by-
810 For a detailed discussion of staff’s analysis, investment have a clear understanding of the terms
see Staff Report, at 238. and conditions of the business arrangements and
have obtained professional financial and/or legal specifying an amount); Duvall & Mandel, ANPR
811 In light of the management demands on
advice before entering into the franchise 114, at 21 (suggesting a $250,000 threshold
operating multiple units, it is reasonable to believe provided there is a showing that the purchaser,
that purchasers of multiple units may be persons agreement.’’ McDonald’s, NPR 7, at 2. See also 7-
Eleven, NPR 10, at 3; NFC, NPR 12, at 20; BI, NPR alone or with counsel, can understand the merits
with significant prior business experience. and risks of the investment). The Commission
812 We also assume that in many instances this 28, at 13. Wendy’s suggested that the threshold be
lowered, but did not offer any specific amount. rejects this approach as unworkable, because it
universe of sophisticated investors will include would require franchisors to make subjective
existing franchisees with significant ‘‘hands-on’’ Wendy’s, NPR 5, at 2.
816 As discussed below, IFA initially stated that judgments about each purchaser’s business acumen.
experience with the franchisor. In its Franchise 820 The Commission has a history of considering
NPR comment, NFC describes at length the ‘‘real estate’’ should be excluded in calculating the
large investment threshold. IFA, NPR 22, at 7. In its and granting petitions for exemption to the
changing nature of franchising in the United States. Franchise Rule under section 18(g) of the FTC Act.
Specifically, NFC notes that: Staff Report comment, however, the IFA clarified
that by ‘‘real estate,’’ it mean raw, unimproved land. In numerous exemption petition proceedings, the
‘‘While franchising’s roots may be traced to the Commission has considered the size of investment
grant of an individual franchise to one entrepreneur See IFA, at 3.
817 IFA, NPR 22, at 7. as an indicium of sophistication. E.g., Paccar, Inc.,
(or a small group of entrepreneurs) possessing no 68 FR 67442 (Dec. 2, 2003); Rolls-Royce Corp., 68
818 The Staff Report recommended a $1 million
prior knowledge of or experience in the subject FR 67443 (Dec. 2, 2003); Austin Rover Cars of North
industry . . . it is nevertheless the case that over threshold for the exemption, excluding land and America, 52 FR 6612 (Mar. 4, 1987); Volkswagen of
the decade many of America’s oldest and largest franchisor financing, as discussed below. Staff America, Inc., 49 FR 13677 (Apr. 6, 1984);
franchisors do not follow that paradigm. Instead, Report, at 240. Automobile Importers of America, Inc., 45 FR
they find it far more efficient and profitable for all 819 PMR&W opined that the $1.5 million
51783 (Aug. 5, 1980). Based upon this experience
concerned to largely restrict the grant of United threshold would benefit only: in analyzing various franchise systems, the
States franchises to: (i) sophisticated corporations ‘‘a very few franchised businesses, typically Commission believes that a large investment
with the resources and background necessary to lodging facilities and perhaps the most expensive typically entails a sophisticated purchaser: ‘‘As a
optimally operate subject franchises and (ii) restaurant franchises. We suggest a $500,000 practical matter, investments of this size and scope
existing franchisees whose experience, profitability, threshold as a more reasonable alternative based on typically involve knowledgeable investors, the use
and mastery of the franchisor’s system strongly the franchisee’s likely resort to sophisticated of independent business and legal advisors, and an
suggest future success.’’ advisory services from accountants and/or attorneys extended period of negotiation that generates the
NFC, NPR 12, at 17. Accordingly, at least some and the probable need for financing, and resulting exchange of information necessary to ensure that
franchisees purchasing multiple units are existing due diligence oversight, from a financial investment decisions are the product of an
franchisees with prior ‘‘hands-on’’ experience with institution.’’ informed assessment of the potential risks and
the franchisor. PMR&W, NPR 4, at 3. See also Cendant, ANPR benefits.’’ Mercedes-Benz of North America, Inc., 57
813E.g., Baer, NPR 11, at 16; Gurnick, NPR 21, at 140, at 4 (suggesting a $750,000 threshold); H&H, FR 1745 (Jan. 15, 1992) (granting petition for
3; Marriott, NPR 35, at 6. NPR 9, at 4 (advocating a lowered threshold, but not exemption).
offer basis the cost of land, which could or other assets. Accordingly, excluding franchise offering. Indeed, by involving
vary widely depending on local market unimproved land from the large a lender, the prospective franchisee
conditions. A single, clear threshold is investment exemption’s $1 million effectively ensures that there is an
vastly superior, in our view. threshold strikes the appropriate independent, sophisticated entity
Accordingly, for these reasons, we balance between providing franchisors inserted into the sales process. This
believe that $1 million, excluding with a clear threshold, while ensuring additional safeguard would be lost if
unimproved land, strikes the regulatory relief for large investments. sources of financing for purposes of the
appropriate balance. Exclusion of franchisor financing. exemption included the franchisor and
Finally, we note that the Staff Report, Section 436.8(5)(i) does not count its affiliates.
adopting language offered by the IFA in monies that are obtained through
response to the Franchise NPR, iii. Acknowledgment
franchisor (or affiliate) financing toward
proposed to exclude ‘‘real estate.’’ In the large initial investment exemption’s To take advantage of the large
response to the Staff Report, three $1 million threshold. The exclusion of investment exemption, section
commenters urged the Commission to franchisor financing adds a measure of 436.8(5)(i) requires the franchisor to
clarify the meaning of the term ‘‘real protection to the prospective franchisee obtain the prospective franchisee’s
estate’’ either in the Rule or in because traditional lenders are very signed acknowledgment that the
Compliance Guides. The IFA, for likely to require a due diligence investment satisfies the $1 million
example, noted that the term ‘‘real investigation of the offering, whereas threshold. This will reduce the
estate’’ may encompass ‘‘raw land, the franchisor or its affiliate likely opportunity for fraud by enabling the
buildings, leasehold improvements, would not. prospect to verify that the investment
fixtures, and the like.’’821 The IFA A few commenters opposed the meets or exceeds the exemption
asserted that the value of the exemption exclusion of franchisor-financing when threshold. Therefore, it will reduce the
would be diminished if all such items calculating a prospective franchisee’s probability that the franchisor will
were excluded from consideration in initial investment. For example, misrepresent the initial cost of the
determining whether an initial Marriott asserted that it does not believe franchise to qualify for the exemption,
investment totals $1 million. It that there are inherent risks that would as well as provide a paper trail in the
suggested that the term ‘‘real estate’’ be justify excluding financing from the event an enforcement action becomes
defined to exclude only the franchisee’s franchisor. Indeed, it feared that this necessary.
investment in unimproved land.822 exclusion might have the unintended Several commenters failed to
Similarly, Starwood urged that only effect of harming franchisees by understand the purpose of the
‘‘land’’ should be excluded, but ‘‘all real discouraging franchisors from offering acknowledgment or believed that it
estate improvements and fixtures financing to prospects in order to would serve no useful purpose. For
should be counted in the sum qualify for the exemption.825 example, BI stated: ‘‘We do not
invested.’’823 Piper Rudnick offered yet After careful assessment of the understand the purpose or the
a different version: ‘‘any real property comments, the Commission has importance of the acknowledgment by
acquired to establish and operate the concluded that financing obtained from the prospective franchisee of the
franchised business.’’824 the franchisor or an affiliate should not application of the exemption. The
After considering the comments, the be counted toward the large investment acknowledgment does not protect the
Commission has concluded that the exemption threshold. Otherwise, a prospective franchisee, except, perhaps
phrase ‘‘unimproved land’’ is more franchisor could be tempted to increase to put the prospect on notice that it may
appropriate than ‘‘real estate.’’ As IFA the cost of the initial investment to be entitled to receive a disclosure
noted, the exclusion of fixtures, qualify for the large investment document.’’827
equipment, and other improvements to Seth Stadfeld asserted that the
exemption, while simultaneously
property from the $1 million threshold acknowledgment requirement could be
offering to finance the deal itself, all
would leave the exemption so narrow, abused. ‘‘[F]ranchisors could further a
without proper pre-sale disclosures. In
that it would be useless in all but the fraud by playing up to and flattering the
that regard, the Commission agrees with
most expensive franchise offerings, prospective franchisee into thinking that
Eric Karp, who observed that the
defeating the very purpose of the he is so sophisticated that he doesn’t
assumption that a prospective
exemption. Excluding ‘‘real estate’’— need the disclosures that the little
franchisee will have a sufficient level of
which is significantly broader than the people need.’’828 On the other hand,
equity tends to disappear ‘‘where a
more limited term ‘‘unimproved Howard Bundy advised that the
franchisee obtains financing from the
land’’—would also impact acknowledgment should be expanded.
franchisor or its affiliates or from a
disproportionately real estate-intensive He would revise the Rule to read: ‘‘The
selling franchisee; in such instances, far
companies—such as hotels and franchisee’s estimated investment,
less equity may be required.’’826
restaurants. The justification for a large excluding any affiliate financing, totals
Further, it is reasonable to assume
investment exemption is that at least $1.5 million and the prospective
that a lender, in order to minimize its
individuals investing $1 million or more franchisee signs an acknowledgment
own financial risk, will ensure that a
are sufficiently sophisticated that they stating the basis for the exemption from
prospective franchisee will conduct a
do not need the Rule’s protections. This the Rule and providing the CFR citation
due diligence investigation of the
rationale applies equally whether the to the Rule and verifying the grounds for
prospective franchisee invests $1 825 Marriott, NPR 35, at 6. See also J&G, NPR 32, the exemption . . .’’829
million to purchase a building or the at 4. At the same time, Eric Karp disputed the view The Commission is convinced that the
prospective franchisee buys equipment expressed in the Franchise NPR that lenders may acknowledgment requirement serves a
act as an effective check, requiring a prospect to useful purpose. As previously noted, the
have sufficient equity capital before granting a loan.

821 IFA, at 3. He contended that there is ‘‘no support in the
acknowledgment will ensure that a
822 IFA, NPR 22, at 7. record as to what amount of equity a bank might
823 Starwood, at 2. See also Marriott, at 2 (an require on a franchise investment of $1.5 Million.’’ 827 BI, NPR 28, at 13.
‘‘investment’’ should include buildings). Karp, NPR 24, at 7. 828 Stadfeld, NPR 23, at 8.
824 Piper Rudnick, at 6-7. 826 Karp, NPR 24, at 7. 829 Bundy, NPR 18, at 14.
prospective franchisee receives notice brings needed certainty to all parties, contrast, Marriott asserted that
that the transaction is exempt from the while ensuring that the exemption is franchisees in large transactions
Rule. This would tend to prevent fraud narrowly focused to protect prospective typically form joint ventures or obtain
by enabling the prospective franchisee franchisees making smaller investments. financing from outside equity investors.
to verify the applicability of the It is not farfetched to assume that a large Marriott maintained that there is little
exemption. Further, we believe that universe of franchisees investing benefit in requiring a franchisee to break
abuse of the acknowledgment $100,000 or less today might actually down the relative financial
requirement is unlikely. A prospective pay more than $1 million (excluding responsibilities of each equity investor
franchisee’s signing of the unimproved land) to the franchisor in order to determine the application of
acknowledgment does not give rise to during the course of a lengthy franchise the large investment exemption.836
the exemption. A franchisor must agreement, especially when royalty and Marriott also noted that the list of
furnish disclosures unless the specific advertising fees, as well as ongoing investors may change over the course of
criteria for the exemption is satisfied. product purchases, are considered. For contract negotiations, making it difficult
Thus, whether a prospective franchisee that reason, a broad large investment to determine at the time of sale whether
is flattered into signing an exemption would effectively eviscerate any single investor qualifies for the
acknowledgment is irrelevant. At the the Rule’s protection.832 exemption.
same time, we agree with Mr. Bundy The term ‘‘initial investment,’’ The Commission has concluded,
that the acknowledgment should however, need not be limited to a single however, that the limitation in footnote
reference the Franchise Rule itself. This unit. The Commission notes with 11 is necessary to ensure that the large
would enable a prospective franchisee approval the comments of H&H and the investment exemption strikes the right
to review the Rule, understand the NFC, urging revision of the Rule to balance between providing relief for
exemption, and, ultimately, verify the clarify that the threshold includes the franchisors where the likelihood of
exemption’s application. Accordingly, total projected investment, whether in abuse is reduced, and ensuring
the acknowledgment requirement of the single- or multiple-unit transactions. As continued protection for those
final amended Rule has been revised to the NFC noted: ‘‘A multi-unit franchisee prospective franchisees who, although
incorporate these revisions. investing the threshold amount (or wealthy, may lack business experience.
more) in a number of units is just as As explained above, the large
iv. Meaning of ‘‘initial investment’’ sophisticated as another franchisee investment exemption is premised on
During the Rule amendment investing a like amount in a single the Commission’s assumption that
proceeding, several commenters voiced unit.’’833 ability to pay indicates sophistication.
concerns about how to define The Commission has carefully That assumption fails when no one
‘‘investment’’ for purposes of the large considered the Staff Report investor standing alone is investing at
investment exemption. For example, recommendation to place limits on the the requisite threshold level. In short,
J&G questioned: ‘‘Is it the initial large investment exemption to protect sophistication does not arise merely by
investment described in Item 7? Is it the investors who pool their resources to aggregating otherwise unsophisticated
amount of the investment over the term purchase a franchise at or above the investors.
of the franchise? Or is it some other threshold level.834 The Commission
v. Conversion franchises and transfers
calculation?’’830 The NFC voiced similar shares the staff’s concern. Clearly there
concerns and urged the Commission to is a significant difference between a During this proceeding, several
clarify that the term ‘‘investment’’ single individual purchasing a franchise commenters questioned whether the
means the franchisee’s estimated for $1 million, versus a group of 10, for large investment exemption would
investment, as set out in Item 7 of the instance, each contributing $100,000. cover business arrangements such as
disclosure document.831 Obviously, the larger the group of conversion franchises and transfers. In a
The Commission’s intent is that, for investors, the smaller each individual conversion franchise, a business owner
purposes of the large investment investor’s risk. In such a circumstance, has already invested in his or her
exemption, the level of a prospective the level of each individual investment existing business and now seeks to
franchisee’s investment should be provides no indicium of sophistication. associate with a particular franchisor’s
limited to the ‘‘initial investment,’’ as Accordingly, the Commission has added brand by entering into a franchise
set forth in Item 7. For that reason, the footnote 11 to the Rule to provide that agreement with that franchisor. H&H
phrase ‘‘estimated investment’’ has been the large franchise exemption applies stated that the term ‘‘‘investment’
replaced in the Rule’s text with the only if at least one individual in an should include the fair market value of
phrase ‘‘initial investment.’’ Focusing investor-group qualifies as an existing facility as part of the
on Item 7 when applying the exemption ‘‘sophisticated’’ by investing at the investment, so as to include an existing
threshold level. facility that is being converted to the
830 J&G, NPR 32, Attachment, at 6. Several commenters assessed this franchise system.’’837
831 NFC, NPR 12, at 20. See also CA Bar, at 7; issue differently. IL AG suggested that In a similar vein, the NFC questioned
Marriott, at 2; Marriott, NPR 35, at 6 (‘‘‘Investment’ whether a transfer of a franchise directly
for purposes of the exemption should be defined as
each member of an investment group
the initial investment as set forth in Item 7, plus should be required to satisfy the $1 from a franchisee to a new purchaser
credit extended by any lender and commitments for million investment threshold in order to
real property (not just mortgage or lease payments be deemed ‘‘sophisticated.835 In 836 Marriott, at 3. See also Starwood, at 2.
for the first few months.’’)). Others raised 837 H&H, NPR 9, at 4. The NFC noted that
alternative calculation approaches. For example, 832 CA Bar, at 7 (including expenses over the life
conversion franchise activity is the ‘‘dominant form
Wendy’s observed that the focus on the franchisee’s of franchise activity extant in the guest lodging and
investment should ‘‘exclude those expenses to be of the franchise term ‘‘would likely render the $1 real estate brokerage arenas, and is common in
incurred during the first three months of operation million threshold meaningless . . . because the other sectors as well. While new construction of
which are not offset by sales. . . . [This] artificially accumulated expenditures over a 10 or 20 year franchised hotels does transpire, much franchising
raises the threshold.’’ Wendy’s, NPR 5, at 2. period could easily exceed $1 million dollars.’’). activity in the guest lodging sector involves the
833 NFC, NPR 12, at 21. See also H&H, NPR 9,
Similarly, J&G urged the Commission to include all conversion of existing hotels . . . to the name,
commitments for real property over the life of the at 4. mark, and system of a guest lodging franchisor.’’
834 Staff Report, at 243.
contract, not just mortgage or lease payments for the NFC, NPR 12, at 20. See also Starwood, at 2; PREA,
first few months. J&G, NPR 32, at 4. 835 IL AG, at 11. NPR 20, at 3; Marriott, NPR 35, at 6.
can qualify for the exemption. It urged franchisees.840 For example, a fast food criticized its narrow application.844
the Commission to include transfers in franchisor may sell a number of Specifically, several commenters urged
the definition of ‘‘investment,’’ where franchised outlets to a hotel chain. Such the Commission to consider exempting
the purchasing franchisee pays an transactions often are heavily negotiated other large entities, such as
existing franchisee the threshold by sophisticated counsel who have partnerships, finding no rationale for
amount and then enters into a new significant experience in the franchise restricting the exemption only to
franchise agreement with the franchisor. industry. Even if a large entity does not corporations. The Commission agrees,
‘‘[W]e . . . submit that franchisees have prior experience in franchising, or and has expanded the provision in the
making such an investment prior to the in the franchised business in particular, final amended Rule to encompass
execution of the subject franchise it is reasonable to assume that it can corporations, partnerships, and similar
agreement are as ‘sophisticated’ as their nevertheless protect its own interests arrangements.845
brethren who make the investment after when negotiating a franchise deal. iii. Net worth
executing that agreement.’’838 Indeed, the Commission stated in the
The Commission’s view is that the To qualify for the large franchisee
Franchise NPR that a large franchisee
definition of ‘‘initial investment’’ is exemption, section 436.8(a)(5)(ii)
exemption is a logical extension of the
broad enough to include conversion specifies that the prospective
original Rule’s fractional franchise
franchises and transfers without franchisee-entity must have a net worth
exemption. To qualify as a fractional
sacrificing necessary protection for of $5 million.846 During the Rule
franchisee, among other things, a
franchise purchasers. Specifically, when amendment proceeding, several
prospect must have two years of
considering a conversion franchisee’s commenters opined that the
experience in the same line of business.
‘‘initial investment’’ in a franchise, it is exemption’s net worth prerequisite is
Thus, the fractional franchise exemption
reasonable to consider the conversion overly restrictive.847 H&H, for example,
is very narrowly tailored, focusing only contended that a $5 million net worth
franchisee’s previous investment in the on persons who wish to expand their
unit. Indeed, a strong argument can be threshold is too high, limiting the
existing product lines. While the exemption to a small number of
made that a conversion franchisee is fractional franchise exemption is
even more sophisticated than a new publicly-traded companies. ‘‘Many
appropriate for individuals and small successful private companies do not
franchisee, having worked in the businesses seeking to expand, it may be
business for a period of time. Similarly, seek to accumulate equity, but instead
unnecessarily narrow for larger, more to maximize cash flow to their owners.
the sale of an existing franchise would sophisticated corporations seeking to Thus, such a high net worth
qualify for the large investment become franchisees.841 requirement would prevent the
exemption in a transfer. The fact that a The Staff Report proposed a large exemption of many sophisticated
transferee will assume an existing franchisee exemption identical to that in investors.’’848 The firm urged a net
contract or may renegotiate an existing the Franchise NPR. Five franchisor worth requirement of $1 million.849 On
contract with the franchisor should have representatives continued to support the the other hand, Howard Bundy asserted
no bearing on his or her level of proposed exemption,842 while three that the $5 million net worth
sophistication as an investor, as long as franchisees opposed it for the same requirement is too low, sweeping in
he or she satisfies the monetary reasons previously voiced in response to many very small companies. ‘‘That is a
threshold. the Franchise NPR.843
b. Section 436.8(a)(5)(ii): Large ii. Covered entities
844E.g., IL AG, NPR 3, at 2; PMR&W, NPR 4, at
franchisee exemption 3; Wendy’s, NPR 5, at 3; Triarc, NPR 6, at 1; H&H,

NPR 9, at 5; Baer, NPR 11, at 16; NFC, NPR 12, at
The large franchisee exemption is 22; BI, NPR 28, at 14; Tricon, NPR 34, at 7; Marriott,
Section 436.8(a)(5)(ii) exempts from
intended to cover franchisees that are NPR 35, at 7.
the final amended Rule franchise sales
‘‘entities.’’ In the Franchise NPR, the 845 Nothing prevents an ‘‘entity’’ under this
to large entities; namely, those who provision from being an individual, but most
Commission proposed that the large
have been in any business for at least individuals who have been in business for at least
franchisee exemption be limited to five years and have generated an individual net
five years and have a net worth of at
corporations. Many commenters worth of at least $5 million are likely to have
least $5 million.839 The Commission is
supported the proposed exemption, but created a corporation or other formal organization
persuaded that large entities negotiating through which to conduct business.
franchise deals—such as airports, 840 Franchise NPR, 64 FR at 57321. See
846 Net worth of an entity can readily be
hospitals, and universities—can obtain determined from the entity’s balance sheet or other
Kaufmann, ANPR, 18 Sept. 97 Tr., at 190. But see financial information, typically submitted as part
the benefits of the amended Rule Kezios, 18 Sept. 97 Tr., at 191-92 (opposing the application process.
without federal government exemption for large institutions, suggesting that 847 At the same time, several franchisee
intervention. they need franchise advice and counsel as well). representatives criticized the large franchisee
841 For example, in 1997, FTC staff was asked for
exemption as inappropriate. For example, Andrew
i. Need for the large franchisee an advisory opinion on whether a travel services Selden asserted that the large franchisee exemption
exemption company would be covered by the Rule if it sold will ‘‘sweep in thousands of small business
outlets to hospitals. The staff advised that the entrepreneurs who own three or four units or
In the Franchise NPR, the hospital could not qualify as a fractional franchisee independent businesses, or perhaps unrelated
Commission proposed exempting because it did not have the requisite two years of family wealth. Personal net worth has no
experience in providing travel-related services. correlation whatsoever with the need for
franchise sales to large ‘‘corporate’’ Advisory 97-7, Bus. Franchise Guide (CCH) ¶ 6487 information to make an informed business
(1997). Hospitals and other large institutions such investment decision in respect to an unfamiliar
838 NFC, NPR 12, at 21. as airports and universities, however, are hardly franchise.’’ Selden, at 1. As noted above, however,
839 No state has a comparable disclosure unsophisticated prospective franchisees. the sophisticated investor exemptions are premised
exemption. Several states—including California, 842 Gust Rosenfeld, at 7; J&G, at 7; Marriott, at 2; not on the notion that sophisticated investors do
Indiana, Maryland, New York, North Dakota, Rhode Piper Rudnick, at 6-7; Starwood, at 3. not need pre-sale disclosure, but that they are able
Island, South Dakota, and Washington—have an 843 Selden, at 1 (large franchisee exemption to obtain such information, or greater information,
exemption from registration for ‘‘experienced thresholds are too low); Gee, at 2; Pu, at 2 without federal government intervention. This is
franchisors.’’ To qualify for the exemption, a (Commission should focus on capabilities of particularly true of large franchisees, such as
franchisor must typically have a net worth of at franchisee, not size of investment). Two franchisee hospitals, airports, and universities, among others.
848 H&H, NPR 9, at 5.
least $5 million and have had 25 franchise locations associations—the AAFD and the AFA—did not
in operation during the previous five years. comment on this issue. 849Id.
small enough net worth to not be inference, limited prior success. For franchisee assets in determining the
indicative of the level of sophistication example, a small sandwich shop availability of the large entity
that would indicate no need for franchisee is not necessarily exemption:856
mandatory disclosures.’’850 The sophisticated enough to purchase a The franchisee (or its parent and
Commission believes that the $5 million hotel merely because the franchisee has any affiliates) is an entity that has
net worth requirement strikes the right operated one or more sandwich shops been in business for at least five
balance, granting relief to sophisticated for five years. Similarly, several wealthy years and has a net worth of at least
entities, while protecting those entities individuals who form a partnership $5 million.857
for whom the purchase of a franchise without any prior business experience
would be a significant financial risk. are not necessarily sophisticated merely c. Section 436.8(a)(6): Officers, owners,
because of their net worth. Both and managers exemption
iv. Prior experience prerequisites are necessary to ensure Section 436.8(a)(6) of the final
In addition to requiring $5 million net that the large franchisee exemption does amended Rule adds a new exemption
worth, section 436.8(a)(5)(ii) requires not create a loophole, putting small and for officers, owners,858 and managers of
large franchisees to have five years of unsophisticated entities at an a business before it becomes a
prior business experience in any line of unacceptable financial risk. franchisor.859 In such circumstances, it
business, as proposed in the Franchise reasonably can be assumed that the
v. Affiliates and parents
NPR. A few commenters opined that the prospective franchisee already is
prior experience prerequisite is Finally, section 436.8(a)(5)(ii) refines familiar with every aspect of the
unnecessary, and urged the Commission the proposed exemption published in business system and the associated
to focus only on the large franchisee’s the Franchise NPR, which used the term risks. Thus, disclosure would serve little
net worth. The NFC, for example, ‘‘corporation’’ and made no mention of purpose. Indeed, in some instances, a
asserted that: ‘‘Even if a large parents or affiliates. As revised, a company may wish to offer units only
corporation does not have prior franchisor may consider the prior to its owners, officers, and managers. If
experience in franchising specifically, it experience and net worth of the not exempt from the Rule, these
is reasonable to assume that it can franchisee’s affiliates and parents when companies would have to go through
protect its own interests when determining whether the franchisee the burden and expense of creating a
negotiating for the purchase of a qualifies as a ‘‘large franchisee.’’ disclosure document for isolated sales
franchise.’’851 A few commenters noted that the to company insiders. To ensure that
On the other hand, Triarc urged the prior experience and net worth individuals qualifying for the exemption
Commission to focus on prior prerequisites would essentially have recent and sufficient experience
experience in lieu of net worth. It noted disqualify new corporations. They with the business, however, section
that it is possible that a franchisee with asserted that there are legitimate tax and 436.8(a)(6) is limited to individuals who
10 years of experience and 50 units may liability reasons why an experienced have been associated with the company
wish to finance its operation with debt franchisee may wish to establish a within 60 days of the sale and who have
rather than equity. Under the separate corporation for a particular been involved for at least two years with
circumstances, this presumably franchise transaction. For example, the company.
sophisticated franchisee would fail the according to Marriott, it is not unusual Section 436.(8)(a)(6) refines the
net worth test: in the lodging and restaurant industries proposed Rule’s ‘‘insiders’’ exemption
to form ‘‘special purpose entities (SPEs) which would have limited the
What if a large corporate franchisee . . . to insulate either a parent company
with $20.0 million of net worth exemption to owners and officers.
or the individual investors from During the Rule amendment proceeding,
declares a $16.0 million dividend to liability.’’853 If so, then such a new
its shareholders or otherwise does a several commenters urged the
corporation would not meet the Commission to broaden the exemption
recapitalization which takes its net exemption’s net worth and prior
worth below the threshold? Over to include ‘‘trustees, general partners
experience prerequisites.854 These and any individual who has or had
the years, some gigantic companies commenters urged the Commission to
that are financially healthy have management responsibility for the offer
permit the franchisor to consider the
had huge negative net worths and consolidated net worth and experience 856 In the same vein, the definition of ‘‘affiliate’’
negative earnings. . . . We would of franchisee affiliates and parents.855 covers both franchisee and franchisor affiliates, as
suggest that net worth is often an The Commission is persuaded that the noted in our discussion of the definitions, above.
indicator of how a company net worth and prior experience 857 This modifies slightly an earlier version of the
chooses to finance itself rather than prerequisites may not make sense when large franchisee exemption which would have
of sophistication.852 required the purchaser and its parent or affiliates
applied to franchisee spin-off to satisfy the net worth and prior experience
After considering these arguments, subsidiaries or affiliates that are formed prerequisites. See Marriott, at 3-4; J&G, at 7.
the Commission concludes that both the primarily for tax or limited-liability 858 CA Bar would limit this exemption to those
$5 million net worth and five years purposes. Accordingly, section with an equity ownership in the company. In its
436.8(5)(ii) makes clear that a franchisor view, those with a non-equity interest, such as a
experience prerequisites are necessary lender, typically do not participate in the business,
to ensure that the Rule continues to may aggregate commonly-owned in contrast to an equity owner, and therefore should
protect businesses with limited be excluded from the exemption. CA Bar, at 8.
853 Marriott, NPR 35, at 7. While CA Bar’s observation is correct, the Rule
experience, limited assets, and, by 854See need not be revised to address this issue. A lender
also, e.g., NFC, NPR 12, at 22; J&G, NPR
32, at 4; H&H, NPR 9, at 5. Triarc, for example, or other non-equity interest owner will be excluded
850 Bundy, NPR 18, at 14. noted that one Arby’s franchisee owns 700 units from the exemption because he or she will not
851 NFC, NPR 12, at 21-22. Similarly, J&G and is one of the largest privately owned restaurant satisfy the exemption’s prior experience
maintained that any ‘‘entity or group of entities operators in the world. It asked ‘‘why should we prerequisite.
with a $5 million or more net worth should, by have to give disclosure to that franchisee merely 859 The ‘‘insider’’ exemption is modeled after
definition, be deemed to have the requisite because he sets up a new corporate entity to own nearly identical language in California’s statute.
sophistication to satisfy the exclusion or his next Arby’s store?’’ Triarc, NPR 6, at 1-2. Washington and Rhode Island have similar
exemption.’’ J&G, NPR 32, at 4. 855 Starwood, at 3; NFC, NPR 12, at 22; J&G, NPR exemptions. See Duvall & Mandel, ANPR 114, at 21
852 Triarc, NPR 6, at 2. 32, at 4; H&H, NPR 9, at 5. (suggesting a narrower approach).
and sale of the franchisor’s franchises or in one of the enumerated positions for The Commission is persuaded that the
the administration of the franchised at least two years. Moreover, their final amended Rule should contain
network.’’860 In short, these comments relationship with the company must be bright-line thresholds that are clear to
urged that the exemption parallel the current: within 60 days of the sale. both franchisor and franchisee alike.
list of company insiders disclosed in These prerequisites are likely to ensure Thus, any adjustment to the Rule
Item 2. Seth Stadfeld, however, that the prospect is in fact a bona fide thresholds should be imposed only after
questioned the need for the exemption officer or owner. an announcement to the public, where
if the company is already providing the effective date of the adjustment and
d. Section 436.8(b): Inflation adjustment
disclosures to others.861 Howard Bundy the adjustment amount is clear. The
urged the Commission to limit the Section 436.8(b) of the final amended most effective way to provide such
exemption to bona fide officers, fearing Rule provides that the Commission shall notice is through Federal Register
that a franchisor could attempt to skirt adjust the size of the monetary announcements and that the
disclosure obligations by putting a thresholds for the exemptions listed in adjustments should be based upon a
prospective franchisee on the board of section 436.8 every fourth year based clear standard—the Consumer Price
directors, for example, for a few days or upon the Consumer Price Index.865 This Index.869 Accordingly, the Commission
weeks before the sale and removing him would affect the minimum payment intends to publish every fourth year
or her shortly thereafter.862 exemption,866 as well as the three adjustments to the amended final Rule’s
Based upon the record, the sophisticated investor exemptions. As monetary thresholds based upon the
Commission has adopted the NFC’s explained below, this approach differs Consumer Price Index. Finally, to add
suggestion that the exemption should from the proposed inflation adjustment greater specificity, the final amended
cover not just owners and officers of a published in the Franchise NPR in two Rule makes clear that the term
franchise system, but others with direct respects: (1) it sets a specific time period ‘‘Consumer Price Index’’ means ‘‘the
management experience.863 It is when the adjustments must occur (every Consumer Price Index for all urban
reasonable to assume that managers and fourth year); and (2) adds specificity by consumers published by the Department
others with at least two years of direct tying the adjustment to the Consumer of Labor.’’870
experience in the business should be Price Index.
well-informed about its operations.864 In the Franchise NPR, the 4. Exclusions
Where a non-franchised company Commission proposed revising the Finally, the final amended Rule
wishes to sell a limited number of amended Rule’s monetary thresholds removes the four exclusions for non-
outlets to experienced company once every four years to adjust for franchise relationships found in the
personnel only, it would be overly inflation.867 The Commission believed original Rule: (1) employer-employee
burdensome to force the company to that a four-year adjustment is necessary and general partners; (2) cooperative
create a disclosure document when the to ensure that the thresholds reasonably associations; (3) certification and testing
only beneficiaries of the disclosures are keep up with inflation. services; and (4) single trademark
already knowledgeable individuals. The The Franchise NPR proposal garnered licenses.871 In the original SBP, the
Commission notes that the exemption is three comments. PMR&W and John Bear Commission stressed that these four
company-specific: we do not mean to agreed with the need for a threshold relationships are not franchises, but
suggest that a manager of one company adjustment and supported the Franchise might be perceived as falling within the
is deemed sophisticated for all franchise NPR proposal. The NFC supported the definition of a franchise.872 To avoid
sales. Rather, the exemption would inflation adjustment, but offered a any confusion, the Commission
apply only to a manager or other officer slightly different approach. It suggested expressly excluded these four
seeking to purchase a franchise of that that the Commission tie the threshold relationships from Rule coverage.
very company. amounts automatically to reflect During the Rule amendment
Howard Bundy’s concern that increases in the Consumer Price Index, proceeding, several commenters
franchisors may abuse the exemption in while placing the burden on the opposed the removal of the exclusion
an effort to skirt the Rule is adequately franchisor to prove that it qualified for for cooperatives for various reasons.873
addressed. Specifically, in order to the exemption at the time in According to these commenters, the
qualify for the exemption, the question.868 exclusion helps to distinguish between
prospective franchisee must have served
865 This approach is also consistent with the
franchises and cooperatives, a
860 NFC, NPR 12, at 23. See also AFC, NPR 30, Commission’s procedures for adjusting thresholds
distinction that may not be apparent to
at 3. or other information in Commission enforced new cooperative members.874 Second,
861 Stadfeld, NPR 23, at 9. statutes. Under the Debt Collection Improvement removing the cooperative exclusion
862 Bundy, NPR 18, at 14. Act of 1996, the Commission adjusted civil penalty from the Rule could lead to costly
863 For that reason, we decline to include amounts from $10,000 to $11,000 per violation to
‘‘trustees.’’ Nothing in the designation ‘‘trustee’’ account for inflation. Those amounts must be
869 The Staff Report made the same
ensures that the individual will have an adequate adjusted at least once every four years. See 61 FR
54549 (Oct. 21, 1996). Similarly, the Appliance recommendation. Staff Report, at 250-51. No
level of experience within the system to justify an comments were submitted on this recommendation.
exemption from receiving pre-sale disclosures. On Labeling Rule, 16 CFR Part 305, sets forth ranges
870 See Federal Maritime Commission, Civil
the other hand, if a trustee functions as an officer of estimated annual energy costs and consumption
or manages the franchise systems, he or she will for various appliances. Because energy cost and Monetary Penalty Inflation Adjustment, 46 CFR
qualify for the exemption as either an officer or appliance efficiencies fluctuate, the Commission 506.2(c) (‘‘‘Consumer Price Index’ means the
manager. adjusts the label requirements periodically by Consumer Price Index for all urban consumers
864 CA Bar observed that section 436.8(a)(6) refers publishing in the Federal Register new costs and published by the Department of Labor.’’).
to ‘‘purchasers’’ It questioned whether the insider ranges, which then become part of that rule’s 871 See 16 CFR 436.2(a)(4).
exemption is limited to individual insiders only, or labeling requirements. The Commission also 872 43 FR at 59708.
to entities formed by individual-insiders. It publishes in the Federal Register adjustments for 873E.g, Spandorf, at 12.; Duvall, at 2-3; AMF; CHS;
correctly observed that insiders who are likely to determining illegal interlocking directorates in IDS.
purchase a franchise are likely to do so by forming connection with Section 19(a)(5) of the Clayton Act. 874E.g., CHS, at 1-2; IDS, at 2; NCBA, at 2. See
866See, e.g., H&H, NPR 9, at 4; Baer, NPR 11, at
a partnership, corporation, or other entity through also J&G, NPR 32, Attachment, at 9; TruServ, NPR
which to conduct business. We believe the term 15-16. 33, at 2; Baer, NPR 11, at 5; IL AG, NPR 3, at 3;
867 Franchise NPR, 64 FR at 57321-22.
‘‘purchaser’’ is broad enough to include an PMR&W, NPR 4, at 3; H&H, NPR 9, at 3; Gurnick,
individual who intends to operate as an entity. 868 NFC, NPR 12, at 22. NPR 21, at 7.
litigation over Rule coverage issues.875 and cooperatives, during the entire Rule in the sales process who has already
Third, retaining an express exclusion in amendment proceeding. Under the received the basic disclosure document
the Rule itself is needed to ensure that circumstances, the proper forum to with a copy of any updated disclosure
the Commission does not change its discuss limits to the definition of the document or quarterly update to an
view and seek to enforce the Rule term ‘‘franchise’’ is in this document existing disclosure document, upon
against cooperatives in the future.876 and in future Compliance Guides. To reasonable request, before the
Fourth, the value of retaining the that end, the Commission reaffirms the prospective franchisee signs a franchise
exclusion outweighs any benefit from four exclusions and specifically adopts agreement.883
streamlining the Rule.877 the discussion of the exclusions set Third, the final amended Rule adds
The Commission appreciates the forth in the original SBP at 43 FR 59708- two anti-fraud prohibitions designed to
concern raised by these commenters. 10. preserve the integrity of the disclosure
Nonetheless, we see no compelling document and franchise agreement.
G. Section 436.9: Additional Section 436.9(g) prohibits franchise
reason to keep the exclusions in the
Prohibitions sellers from materially altering the terms
Rule itself. As a preliminary matter,
removing the exclusions from the Rule The final amended Rule prohibits and conditions of any franchise
should not be equated with expanding nine acts or practices that violate agreement presented to a prospective
the scope of part 436 to cover entities Section 5 of the FTC Act. The original franchisee for signing, unless the seller
currently dealt with in these exclusions: Rule contained four of them, namely, informs the prospective franchisee of
the Commission continues to hold that prohibitions against: (1) making the changes seven days before execution
these business relationships do not meet statements that contradict the of the agreement. Section 436.9(h)
the criteria for such coverage. They franchisor’s disclosures;879 (2) making prohibits franchise sellers from
simply do not satisfy the definitional financial performance representations disclaiming or requiring a franchisee to
elements of the term ‘‘franchise.’’ without a reasonable basis and without waive reliance on any representation
Removal of the exclusions from the Rule written substantiation for the made in a disclosure document or its
is part of the Commission’s effort to representation at the time the exhibits or attachments.
streamline the Rule. representation is made;880 (3) failing to Finally, section 436.9, based upon our
Nevertheless, the Commission make available written substantiation law enforcement history and the
included the exclusions in the original for any financial performance obviously deceptive nature of the
Rule to clarify the limits of the term representations;881 and (4) failing to practice, adds a new anti-shill
‘‘franchise,’’ and for that reason the make promised refunds.882 prohibition designed to prevent the use
concepts embodied in the exclusions Second, the final amended Rule adds of paid testimonials or shill references.
continue to serve a valuable consumer two new prohibitions concerning the Specifically, section 436.9(b) prohibits
education function.878 However, as with furnishing of disclosures. Specifically, franchise sellers from misrepresenting
other sections of this document, we are section 436.9(e) prohibits franchise that any person has purchased a similar
disinclined to include general consumer sellers from failing to furnish a copy of franchise or operated a similar franchise
education materials in the text of the the basic disclosure documents to
final amended Rule itself, absent prospective franchisees early in the 883 We decline to adopt a third prohibition
sales process, upon reasonable request. recommended in the Staff Report that would have
compelling evidence that such messages prohibited franchisors from failing to furnish a
are warranted to address specific Section 436.9(f) prohibits franchise prospective transferee of an existing franchised
problems identified in the record. While sellers from failing to furnish a prospect outlet with a copy of an existing disclosure
the commenters asserted that confusion document of the franchisor, upon request. As
879See 16 CFR 436.1(f). ‘‘Without this provision, recommended in the Staff Report, this prohibition
exists over the definition of the term would not have required a franchisor to prepare a
the Commission believes that the disclosures
‘‘franchise,’’ not a single individual required by the rule could be contradicted in oral current disclosure document solely for the benefit
cooperative member voiced any sales presentations and rendered of little value of a transferee. Rather, a franchisor would have
been permitted to give a prospective franchisee a
confusion over the scope of the without violating the rule.’’ Original SBP, 43 FR at
copy of its most recent disclosure document. For
‘‘franchise’’ definition, nor any concern 59695.
880See 16 CFR 436.1(b)(2) and (c)(2); UFOC Item
example, a franchisor who stopped selling
about the distinction between franchises 19. Original SBP, 43 FR at 59684-690 (The earnings
franchises and no longer possessed a current
disclosure document could have complied with this
representation standards are ‘‘intended to prevent prohibition by giving a prospective transferee a
875E.g., NCBA, at 4; NCFC, at 2. or minimize potential misrepresentations or copy of its most recent disclosure document, even
876E.g., AMF; CHS; NCBA, at 5. distortions in the representations made by if that document were at the time out-of-date. See
877E.g., Spandorf, at 12; CHS; Reizman Burger, at franchisors, while at the same time permitting Staff Report, at 264. In response to the Staff Report,
3-4. franchisors to use informative representations as five commenters opined that this proposed
878 We also note that there are many other part of their marketing scheme.’’). prohibition would have resulted in franchisors
881See 16 CFR 436.1(b)(2) and (c)(2); UFOC Item
business relationships that share some similarities being forced to disclose information that could have
with franchises, such as distributorships, multilevel 19. In the original SBP, the Commission rejected the been misleading to the prospective transferee,
marketing programs, and some work-at-home idea that franchisors should always provide a copy subjecting the franchisor to potential liability. CA
schemes. Yet, these arrangements were not of their substantiation of financial performance Bar, at 10; Kaufmann, at 6; Seid, at 7; Spandorf, at
expressly excluded from the Rule. Rather, the claims to the prospective franchisee. At the same 10-11; Wiggin and Dana, at 5. We agree. An
definition of the term ‘‘franchise’’ is sufficient to set time, it found that ‘‘the benefit to be derived from ‘‘existing’’ disclosure document would have no
out the parameters of the Rule’s scope. To the permitting those prospective franchisees who so relevance to a transfer unless the document were
extent that these relationships may be confused wish to review the franchisor’s substantiation far current. Moreover, a current disclosure document
with franchises, the Commission has provided outweighs speculative harms that could arise from may not accurately portray the business
needed clarification in the Final Interpretative such disclosure.’’ Original SBP, 43 FR at 59691. arrangement entailed in the transfer, because it
Guides. The same approach is warranted for 882See 16 CFR 436.1(h). In the original SBP, the would explain the terms and conditions of the
cooperatives. Nonetheless, based upon the Commission observed that numerous consumers franchisor’s current franchise agreement, while a
comments, the Commission specifically reaffirms complained about the difficulty they experienced transferee assumes the terms and conditions of an
the four exemptions in this Statement and when they attempted to obtain refunds from their ongoing franchise agreement. Moreover, to the
anticipates that future Compliance Guides will do franchisors. ‘‘It is clear from the record that all extent that a potential transferee wishes to see a
the same. As in other areas of Rule interpretation, franchisors do not adequately adhere to the refund copy of the franchisor’s disclosure document, he or
the staff of the Commission can also address future policies they themselves agree to in their she can obtain a copy from a commercial service,
questions concerning the definition of the term contracts.’’ Original SBP, 43 FR at 59696-97. See from a franchise registration state, and more
‘‘franchise’’ on a case-by-case basis through also Staff Review, at 29 (some franchisees continue frequently online (such as through California’s Cal-
informal advisory opinions. to experience problems with obtaining refunds). Easi website). But see Bundy, at 10.
from the franchisor, or that any person performance claims, yet give The anti-shill provision generated
can provide an independent and reliable prospective franchisees false or only one comment. J&G expressed
report about the franchise or the misleading financial performance data concern that actors or public figures
experiences of any current or former outside of the disclosure document. used in a franchisor’s advertising
franchisees. Each of these prohibitions Thus, the purpose of this prohibition is campaigns ‘‘will need to exercise
is discussed in the following sections. to prevent deception and to preserve the caution when making endorsements of
integrity of the information franchises so as not to run afoul of
1. Section 436.9(a): Inconsistent disseminated to prospective franchisees prohibitions against misrepresenting
statements by ensuring that all required that they are able to provide ‘an
Section 436.9(a) of the final amended information will be disclosed in the independent and reliable report about
Rule retains the original Rule form of the disclosure document.886 the franchise or the experiences of any
prohibition against making statements current or former franchisees.’’’890
that contradict the information required 2. Section 436.9(b): Shills The Commission finds the rulemaking
to be disclosed in the disclosure Section 436.9(b) of the final amended record lacks any evidence that would
document. Such prohibited Rule prohibits the use of fictitious shed light on the extent to which
contradictory statements include those references or ‘‘shills.’’887 Specifically, it franchisors use actors or public figures
made orally, visually, or in writing. prohibits franchise sellers from to sell franchises, as opposed to selling
Because the information in the misrepresenting that any person has products and services to the end-user.
disclosure document must be complete actually purchased or operated one of Based upon our law enforcement
and accurate, any statements the franchisor’s franchises or that any experience, we believe such practices
contradicting that information would be person can give an independent and are rare. More important, our primary
false or likely to mislead prospective reliable report about the experience of concern is with preventing deception:
franchisees. Moreover, such statements any current or former franchisee. we see little difference between a
would likely influence the purchasing Because information provided by shills franchisor paying (or otherwise
decision of a prospect giving reasonable is inherently false, it is likely to mislead inducing) unknown individuals to
interpretation to such statements. prospective purchasers. Yet, a deceive prospective franchisees, on the
This is particularly true of financial reasonable prospective purchaser would one hand, and paying (or otherwise
performance representations. Our law have no reason to doubt the shill’s inducing) actors or celebrities to deceive
enforcement experience884 and the statements. Also, because shills are prospective franchisees, on the other. In
record885 show that franchisors often represented as having experience with each case, a franchisor should not be
state in their disclosure document that the franchisor or otherwise able to give able to pay (or otherwise induce)
they do not furnish financial an independent and reliable report individuals to lie about their purported
about the franchisor, their statements experience in order to lure unsuspecting
884E.g., FTC v. Netfran Dev. Corp., No. 05-CV- are likely to influence the prospect’s consumers to buy a franchise.891 We are
22223 (S.D. Fla. 2005); FTC v. Morrone’s Water Ice, purchasing decision. Indeed, the persuaded, therefore, that the anti-shill
Inc., No. 02-3720 (E.D. Pa. 2002). Commission’s law enforcement
885 For example, Peter Lagarias stated: ‘‘In my
prohibition is entirely proper.
experience, the providing of earnings claims in
experience888 shows that shills are often
the glue that holds a scam together by 3. Section 436.9(c): Financial
contravention of . . . [Item 19] often occurs both
orally and in writing. The most common written allaying consumers’ concerns about the performance representations
method of earnings claims is by newspaper or investment risks.889 Section 436.9(c) of the final amended
magazine articles about the franchise system which
contain the earnings claims. These news articles are
Rule retains the original Rule’s
reproduced and provided to prospective franchisees
886 Of course, franchisors are always free to
prohibition on the making of financial
in contravention of the Rule.’’ Lagarias, RR 13, at disseminate additional truthful information to a performance representations, unless the
2. See also Brown, ANPR 4, at 4 (‘‘There have prospective franchisee. See 16 CFR 436.1(a)(21)
(franchisors are not precluded from giving other franchisor has a reasonable basis and
therefore been endless variations of supposedly
‘indirect’ franchisor representations of profitability, nondeceptive information orally, visually, or in written substantiation for the
[ranging] from the proverbial notation on a napkin separate literature so long as such information is representation at the time the
or envelope, to prearranged referrals to ‘typical’’ not contradictory to the information in the representation is made. As discussed
franchisees, to use of ‘company store’ figures with disclosure document).
887 The anti-shill prohibition is also broad enough
above in connection with Item 19, false
plain implications of comparability, and to the
required preparation of a ‘business plan’ by the to cover the use of ‘‘institutional shills,’’ companies and unsubstantiated financial
prospective franchisee and its ‘review’ and ‘oral that purport to act like a Better Business Bureau performance claims have been prevalent
adjustment’ by franchisor or personnel.’’); Bundy, that provide consumers with ‘‘independent’’ reports in fraudulent sales, are highly material,
ANPR 119, at 1 (‘‘I have never met a franchisee who on its members. See FTC v. United States Bus.
Bureau, Bus. Franchise Guide (CCH) ¶ 10865 (S.D.
and are inherently likely to mislead
had been in operation more than a few weeks who
did not receive earnings claims before investing in Fla. 1995).
a franchise. It simply does not happen. They either 888 Scam franchisors frequently use shill references is the second most common Section 5
have received them from the franchisor or its agent references in order to bolster their financial allegation (28 counts) in Commission business
directly (often in writing or on floppy disk) or from performance and success claims. E.g., FTC v. Car opportunity and franchise cases).
890 J&G, NPR 32, Appendix, at 9.
third parties to whom they have been directed.’’); Checkers of Am., Inc., No. 93-623 (mlp) (D.N.J.
IL AG, RR 25, at 2 (‘‘The most common situation 1993); FTC v. Am. Legal Distrib., Inc., No. 1:88-CV- 891 This view is consistent with the Commission’s
and opportunity for abuse is the franchisor sales 519-MHS (N.D. Ga. 1988). Harm resulting from the Guides Concerning The Use of Endorsements and
representative who makes oral representations as to use of shills is also demonstrated by numerous Testimonials In Advertising, 16 CFR 255. These
earnings potential when talking with prospects.’’); Commission business opportunity law enforcement guides require that any representation in an ad that
WA Securities, RR 37, at 3 (‘‘Our fraud actions. E.g., FTC v. Am. Entertainment Distrib., purports to represent the view of a consumer must,
investigations reveal that a substantial number of Inc., No. 04-22431 CIV-Huck (S.D. Fla. 2004); FTC in fact, reflect the consumer’s actual views or
franchisors or their sales representatives are making v. Hart Mktg. Enter., No. 98-222-CIV-T-23 E (M.D. experience:
written or oral earnings claims to prospective Fla. 1998); FTC v. Unitel Sys., Inc., No. 3- ‘‘Endorsements must always reflect the honest
franchisees even when the disclosure document 97CV18780-D (N.D. Tex. 1997). opinions, findings, beliefs, or experience of the
states that no earnings claims are made.’’); AAFD, 889 The NCL reported that complaints about fake endorser. Furthermore, they may not contain any
RR 39, at 6 (‘‘Probably less than 2% of franchisors references are among the most common franchisee representations which would deceive, or could not
make formal earnings disclosures, [while] the vast and business opportunity complaints it receives. be substantiated if made directly by the advertiser.’’
majority of franchisees claim they have received NCL, ANPR 35, at 2. See also Staff Program Review 16 CFR at 255.2(a). Therefore, any actor or public
oral (and often informal written) earnings claims at 39 (showing that false or deceptive figure who might run afoul of this provision in the
and projections.’’). representations pertaining to testimonials and Franchise Rule already risks violating the FTC Act.
prospective franchisees acting 5. Section 436.9(e): Earlier disclosure To address these concerns, we are
reasonably under the circumstances.892 upon request persuaded that it is proper to require
Indeed, our law enforcement experience Section 436.9(e) of the final amended franchise sellers to furnish disclosures
demonstrates that prospects rely on Rule prohibits a franchise seller from earlier than the standard 14 calendar-
financial performance claims in making failing to furnish a copy of the days disclosure trigger, upon the
their investment decision.893 Thus, this franchisor’s disclosure document to a franchisee’s reasonable request.897 The
prohibition is necessary to prevent prospective franchisee earlier than Commission believes this prohibition
deception. required, upon request.895 Accordingly, strikes the right balance between
Section 436.9(c) of the amended Final any prospective franchisee in the sales relieving franchisors of the burden to
Rule revises the original Rule, however, process can obtain a copy of the furnish disclosures at the first face-to-
by permitting the franchisor to make franchisor’s disclosure document before face meeting in all instances, and the
financial representations in Item 19 of the standard 14-day time for making prospective franchisee’s desire to review
the disclosure document. This achieves disclosures set out in section 436.2 (14 disclosures early in the sales process
greater uniformity with the UFOC calendar-days before the signing of a before investing significant time, effort,
Guidelines, by eliminating the original franchise agreement or payment of any and money in considering the franchise
Rule’s requirement that a franchisor fee in connection with the franchise offering.898
making financial performance claims sale). Because prospects may incur a 6. Section 436.9(f): Furnishing updated
furnish prospects with a separate variety of costs in determining whether disclosures
earnings disclosure document. to consider a particular franchise
Section 436.9(f) prohibits a franchisor
offering, a franchisor’s withholding of
4. Section 436.9(d): Availability of from failing to furnish a prospective
its disclosure document can result in
financial performance substantiation franchisee who has received a basic
economic injury. For example, as
disclosure document with updated
Section 436.9(d) of the final amended discussed above in connection with the
disclosures, upon the prospect’s
Rule also retains the original Rule’s timing of making disclosures, early
reasonable request. Specifically, it
prohibition against failing to make disclosure may prevent injury by
prohibits the franchisor from failing to
available to prospective franchisees and enabling prospects to review the
furnish ‘‘the franchisor’s most recent
to the Commission, upon reasonable franchisor’s disclosure document before
disclosure document and any quarterly
request, written substantiation for any agreeing to pay money to advance the
updates to a prospective franchisee,
financial performance representation sale, such as incurring travel expenses
upon reasonable request, before the
to visit company headquarters.
made in Item 19.894 This prohibition is prospective franchisee signs a franchise
Further, the Commission is convinced
tied to the previous prohibition against agreement.’’
that this prohibition is also necessary in
the making of unreasonable and
light of our decision to eliminate the
unsubstantiated financial performance 897 IFA urged the Commission to define the term
original Rule’s mandatory face-to-face ‘‘reasonable request.’’ IFA, at 3. We note that the
representations. The prohibition against
disclosure trigger. As discussed in similar term ‘‘reasonable demand’’ has long been
failing to make available written
connection with section 436.2 above, part of the original Rule in connection with the
substantiation ensures that prospective provision of written substantiation for financial
the Commission is persuaded that the
franchisees and the Commission can performance representations. 16 CFR 436.1(b)(2)
face-to-face meeting trigger is and 1(c)(2) (‘‘such material is made available to any
review and verify the data underlying
unnecessary given the explosion of prospective franchisee and to the Commission or its
any performance representation, while staff upon reasonable demand.’’). Similarly, the
alternative media since the original Rule
relieving franchisors of the burden of UFOC Guidelines provide that a franchisor making
was promulgated in the 1970s. financial performance claims must include a
having to present what could be
Nonetheless, the Commission statement in its Item 19 disclosure that
voluminous data in the disclosure
recognizes that several commenters ‘‘substantiation of the data used in preparing the
document itself. Knowing that their earnings claim will be made available to the
voiced concern that, absent early
financial performance claims are subject prospective franchisee on reasonable request.’’
disclosure, a franchise seller could UFOC, Item 19d. There is no indication in the
to Commission review—coupled with
influence a prospective franchisee’s record that the use of the terms ‘‘reasonable
the Commission’s authority to bring request’’ or ‘‘reasonable demand’’ has been
investment decision well before the
Rule enforcement actions for false or confusing or otherwise unclear. We believe
prospect could verify the franchisor’s determinations about ‘‘reasonableness’’ can be
unsubstantiated claims—helps
claims through the disclosure made only on a case-by-case basis. At a minimum,
discourage the making of
document, or before the prospect we will consider whether a request is ‘‘reasonable’’
unsubstantiated claims, thus ultimately based upon the timing and manner in which the
expends funds reviewing the offering.896
preventing fraud. request has been made. For example, it may be
unreasonable for a prospective franchisee to request
895 The prohibition on failing to give out
892E.g.,
a copy of the disclosure document on the morning
original SBP, 43 FR at 59684-85 (‘‘The use disclosures earlier in the sales process pertains to of the day a franchisor’s representative flies to the
of deceptive and inaccurate profit and loss ‘‘prospective franchisees’’ only. A franchisor has no prospect’s city for a meeting. Similarly, it may not
statements by franchisors has resulted in a legion obligation to furnish disclosures to competitors, the be reasonable for a prospective franchisee to make
of ‘horror stories.’’). See also Staff Review, at 25 media, academicians, or researchers. It applies to the request by leaving a message with the doorman
(earnings claims most frequently reported franchise prospective franchisees already in the sales process. at the franchisor’s headquarters, or at the hotel
problem). Accordingly, a franchisor need not furnish a copy where a franchisor’s representative is staying.
893E.g., FTC v. Netfran Dev. Corp., No. 05-CV- of its disclosures to individuals seeking general 898 It is noteworthy that state franchise laws, at
22223 (S.D. Fla. 2005); United States v. Robert information on the franchisor or who do not qualify the very least, require franchisors to file current
Lasseter, No. 3:03-1177 (M.D. Tenn. 2003); FTC v. to purchase a franchise. We would expect a disclosure documents before franchisors may offer
Morrone’s Water Ice, Inc., No. 02-3720 (E.D. Pa. franchisor to furnish disclosures, upon request, to franchises for sale. Franchisors typically have
2002); FTC v. Car Wash Guys Int’l., Inc., No. 00- any prospective franchisees who have submitted a disclosure documents available at the time they
8197 ABC (RNBx) (C.D. Cal.); FTC v. Tower franchise application and who have been notified make franchise offerings. Accordingly, this new
Cleaning Sys., Inc., No. 96 58 44 (E.D. Pa. 1996); that they qualify to purchase a franchise. See IFA, prohibition imposes no requirement that did not
United States v. Tutor Time Child Care Sys., Inc., at 3. See also Winslow, at 91. already exist under the original Rule’s first face-to-
No. 96-2603 (N.D. Cal. 1996); FTC v. Mortgage Serv. 896 Turner, NPR 13, at 1; Karp, NPR 24, at 5-6; face meeting disclosure requirement and under
Assocs., Inc., No. 395-CV-1362 (AVC) (D. Conn. Bundy, NPR 18, at 5-6. See also original SBP, 43 state franchise filing laws. But see Duvall, at 2 (this
1995); FTC v. Sage Seminars, Inc., C-95-2854-SBA FR at 59639 (‘‘[O]nce a prospect has been ‘hooked,’ prohibition negates any benefit gained from
(N.D. Cal. 1995). it is difficult, if not impossible, to ‘extricate eliminating the ‘‘first personal meeting
894 16 CFR 436.1(b)(2); 436.1(c)(2). himself.’’’). requirement’’).
Section 436.9(f) recognizes that the original standard contract attached to enabling franchisors to make
information contained in a disclosure the disclosure document. To prevent incomplete, inaccurate, or even false
document may become out-of-date by such deception, we adopt a new statements in their disclosure
the time a prospect who relies on such prohibition barring franchise sellers documents, while prospects effectively
information is ready to sign a franchise from substituting provisions or pages in waive reliance on any such statements
agreement.899 It prevents deception by the agreement without first bringing by signing the franchise agreement.
enabling such prospective franchisees, if such changes to the prospective To remedy this problem, several
they wish, to get any updated franchisee’s attention at least seven days franchisee advocates and state
disclosures prepared by the franchisor. before execution of the agreement. regulators urged the Commission to
At the same time, section 436.9(f) prohibit the use of contract integration
8. Section 436.9(h): Disclaimers and
imposes no continuous updating clauses as a means of disclaiming
waivers
requirement on franchisors.900 Rather, it statements made in a disclosure
strikes the appropriate balance, Section 436.9(h) prohibits franchise document.903 The IL AG, for example,
preventing deception by enabling a sellers from disclaiming or requiring ‘‘a asserted that such a prohibition would
prospective franchisee to gain access to prospective franchisee to waive reliance be a valuable addition to the Rule,
the most current updated disclosures on any representation made in the noting that franchisees signing a
prepared by the franchisor, while disclosure document or in its exhibits or franchise agreement may have no idea
imposing no new affirmative disclosure amendments.’’ This prohibition is that they are waiving reliance on the
obligations on the franchisor.901 intended to prevent fraud by preserving disclosure document.904 Similarly, the
the completeness and accuracy of AFA stated:
7. Section 436.9(g): Unilateral information contained in disclosure
modifications documents. The integrity of a franchisor’s
The Franchise NPR proposal to disclosure document is critical to
As previously discussed, the final
prohibit the use of disclaimers and prospective franchisees. The
amended Rule eliminates the original
waivers prompted comment on three prevalent use of integration clauses
Rule’s requirement that franchisors in
issues: (1) the need for the prohibition; to disclaim liability for required
every case afford a prospective
(2) the scope of the prohibition; and (3) disclosures undermines the very
franchisee five business days to review
the effect of the prohibition on parties’ purpose of the Rule, which is to
the completed franchise agreement. The
ability to negotiate contract terms. The prevent fraud and
Commission concluded that the review
following section discusses each of misrepresentation in the pre-sale
period is unnecessary, provided that the
these issues in detail. process by ensuring prospective
franchise seller does not make any
franchisees have complete and
unilateral modifications to the basic a. Section 436.9(h) is necessary to truthful information from which to
form of the franchise agreement prevent fraud by preserving the make sound investment
previously furnished to the prospective truthfulness of information contained in decisions.905
franchisee at the time of furnishing its a disclosure document A few commenters urged the
disclosure document. Unilateral Commission to expand on the
During the Rule amendment
modifications of material contract terms prohibition that was proposed in the
proceeding, several franchisees and
by the franchise seller without notice to Franchise NPR. Howard Bundy, for
their representatives observed that
the prospective franchisee are likely to example, urged prohibiting franchisors
franchisors routinely seek to disclaim
mislead a prospect who has been relying from disclaiming liability for any
liability for statements made in their
on a previous draft as setting forth the authorized statements, including those
disclosure documents through the use of
parties’ agreement. made in their written marketing
Indeed, a franchise seller could contract integration clauses in their
franchise agreements. By signing a material.906 Seth Stadfeld advocated a
commit fraud at the time of executing a
franchise agreement containing such a ban on integration clauses in franchise
franchise agreement by substituting
clause, franchisees effectively waive any agreements altogether. He asserted that
material contract provisions, without
rights they may have to rely on such clauses are ‘‘the single greatest tool
notice to the prospective franchisee, that
information contained in the disclosure used by franchisors to evade
differ materially from those in the
document.902 The use of such clauses, responsibility for misrepresentations
899 For example, a franchisor may have filed for therefore, may lead to deception by and omissions of material facts that take
bankruptcy after having furnished disclosures to a place in a franchise marketing
prospective franchisee. A bankruptcy filing, as 902 For example, Peter Lagarias, a franchisee program.’’907
discussed above, is clearly material because it calls advocate, asserted: Franchisors, on the other hand, either
into question the franchisor’s continued financial ‘‘In virtually every lawsuit I have filed for opposed the prohibition on disclaimers
viability and, thus, ability to perform its obligations franchisees alleging fraud, franchise disclosure, or
under the franchise agreement. unfair or deceptive practices (under California law
or urged limitation on the prohibition’s
900 This is consistent with the original Rule, since the FTC rule does not provide a private right scope. Several franchisors strongly
which required franchisors to update their of action), counsel for the franchisor defendants asserted that integration clauses are
disclosures to ensure accuracy of its current have defended the action on lack of justified necessary for two purposes. First, as J&G
disclosure document used with new prospects, but reliance. Franchisors and their counsel have
did not require re-disclosure to prospective systemically written the agreements to strip 903E.g., AFA, at 4; Bundy, 11-12; Haff, at 3; Karp,
franchisees who have already received a basic franchisees of all fraud claims and rights the minute
disclosure document. 16 CFR 436.1(a)(22) (setting the agreement is signed by sophisticated at 7; Lagarias, at 1-3.
904 IL AG, NPR 3, at 6; IL AG, NPR Rebuttal 38,
forth two update requirements: (1) the annual integration, no representation, and no reliance
update after the close of the franchisor’s fiscal year; clauses. . . . The Commission should provide that at 3.
905 AFA, NPR 14, at 6.
and (2) quarterly updates if there is a material reliance on the disclosure document and other
change). representations made in the sale of a franchise is 906 Bundy, NPR 18, at 14. See also Haff, at 3;
901 Franchise sellers other than the franchisor can per se justified.’’ Singler, at 3; IL AG, NPR 3, at 6.
satisfy their obligation to provide updated Lagarias, ANPR 125, at 4. See also, e.g., 907 Stadfeld, NPR 23, at 9-10. In the alternative,
disclosures by promptly forwarding a prospective Manuszak, ANPR 13; Bell, ANPR 30; Sibent, ANPR Mr. Stadfeld suggested that the cover sheet contain
franchisee’s request to the franchisor, provided that 41 (and 19 identical ANPR comments); AFA, ANPR an explicit warning that anything stated by the
the franchisor has promised to fulfill any such 62, at 3; Bundy, ANPR 119, at 2; Selden, ANPR 133, franchisor that is not in the contract should not be
requests promptly. Appendix B, at 2; Zarco & Pardo, ANPR 134, at 3. relied upon in any way. Id., at 10.
explained, franchisors have to be able to relies solely on information authorized disclaim statements in the disclosure
rely on the final franchise agreement as by the franchisor or within the document that the franchisor authorizes
the manifestation of the intent of the franchisor’s control in making an would undermine the Rule’s very
parties. Second, franchisors must be investment decision. For example, a purpose by signaling to prospective
able to disclaim liability for franchisor reasonably may seek to franchisees that they cannot trust or rely
unauthorized statements made by a disclaim responsibility for unauthorized upon the disclosure document.916
rogue salesman, such as unauthorized claims made by former or existing It is true that the Commission can
earnings claims.908 franchisees, or unattributed statements bring law enforcement actions against
PMR&W asserted that the prohibition found in the trade press. Therefore, at false or deceptive disclosures, regardless
would effectively ban the use of the very least, integration clauses and of any contract integration clause or
integration clauses. The firm, however, waivers protect a franchisor from waiver. This encourages complete and
suggested that the Commission could unauthorized statements or accurate disclosure. Nevertheless, we
limit the prohibition by applying it only representations made by non-agent, believe that franchisees should not have
‘‘if an integration clause or other third parties.913 to rely on Commission action post-sale
contract provision specifically disclaims At the same time, we are persuaded to resolve conflict between a disclosure
representations made in the disclosure that franchise sellers should not be able document and franchise agreement.
document. Alternatively, or perhaps to use integration clauses or waivers to Rather, we believe that section 436.9(h)
additionally, require a representation by insulate themselves from false or will prevent pre-sale deception by
the franchisor at the end of Item 17 that deceptive statements made in a encouraging franchisors to review their
the information contained in the franchisor’s disclosure document. This disclosures for accuracy prior to use,
disclosure document is unaffected by is particularly true of those sections of thereby avoiding post-sale conflicts and
any integration clause.’’909 the disclosure document pertaining to litigation.
CA Bar observed that the disclaimer matters other than the terms of the Further, courts have limited the
prohibition is likely to increase the use franchise agreement that cannot be circumstances where integration clauses
of legalese in disclosure documents. It negotiated, such as the franchisor’s prior have the most potential for harm. Where
opined that, if the prohibition is business experience, litigation history, there is fraud in the inducement, courts
adopted, franchisors are likely to import financial performance representations, are likely to void the contract, regardless
legalese from their franchise agreements and financial statements. The of any integration clause or waiver.917
to the disclosure document in order to Commission has long recognized that
avoid any conflicting language. On the the integrity of a franchisor’s disclosures 455.3(b), requires used car sellers to incorporate the
other hand, ‘‘[i]f the franchisor is able to is critical to prospective franchisees Buyers Guide into their sales contracts. This
ensures that used car sellers cannot technically
include (and rely upon) an integration who rely on such information in making comply with the Rule by affixing the Buyers Guide
clause, it decreases that potential for their investment decision. For that to a car window, and then turn around and require
problems arising from unintentional reason, disclosure documents must be consumers to waive the very rights granted them
inconsistency.’’910 complete, accurate, legible, and current. under the Rule. Similar anti-waiver provisions can
Finally, a few franchisors suggested be found in the Credit Practices Rule, 16 CFR 444.2
Further, as discussed above, the (barring certain waivers in credit transactions),
that the disclaimer prohibition is original914 and final amended Rules also Cooling-Off Period Rule, 16 CFR 429.1(d) (barring
unnecessary. According to John Baer, prohibit franchisors from making inclusion in any door-to-door contract of any
for example, the Commission could statements that contradict those in their confession of judgment or ‘‘any waiver of any rights
always take action if a franchisor’s disclosure documents. The use of to which the buyer is entitled under this section’’),
and Ophthalmic Practices Rule, 16 CFR 456.2(d)
disclosure document contains false integration clauses or waivers915 to (barring efforts to have a patient waive or disclaim
information.911 In the same vein, J&G the liability or responsibility of the ophthalmologist
asserted that the basis for the 913 The Staff Report stated that integration clauses or optometrist for the accuracy of the eye
prohibition is that integration clauses may be warranted to enable franchisors to disclaim examination).
may deny a franchisee a remedy when liability for statements made by a ‘‘rogue salesman.’’ 916 Prospective franchisees often rely on the
Staff Report, at 258. This statement generated disclosures in making their investment decision,
franchisees litigate against franchisors. significant comment by franchisee representatives especially when such disclosures appear to have
The firm noted, however, that only the asserting that franchisors should always be liable the backing of the Federal Trade Commission. Cf.
FTC is authorized to bring a claim for for statements made by their sales force. E.g., AFA, FTC v. Minuteman Press, Int’l, No. 93-CV-2494
violation of the Franchise Rule; the at 4 (‘‘The franchisor must accept responsibility for (DRH) (E.D.N.Y. 1998) (holding that a reasonable
the person who it authorized and directed to sell consumer could ‘‘legitimately conclude that he or
Commission’s ability to address false franchises to prospective franchisees.’’); Bundy, at she was being furnished important specific earnings
representations in a disclosure 12 (‘‘No one can reasonably argue that the information . . . notwithstanding . . . general
document will survive any integration franchisor should be able to disclaim statements disclaimers in the UFOC’’).
clause between the franchisor and made by its employees or agents within the scope 917E.g., Cummings v. HPG Int’l, Inc., 244 F.3d 16,
of their agency.’’); Gee, at 2 (‘‘Sales staff puff, 21 (1st Cir. 2001) (a party cannot induce a contract
franchisee.912 exaggerate, and outright misrepresent the terms of by fraudulent misrepresentations and then use
After carefully reviewing the record, the agreement. . . . Appropriate protection . . . for contractual devices to escape liability); Betz Labs.
the Commission is persuaded that a such abuses is essential.’’); Haff, at 3 (‘‘That v. Hines, 647 F.2d 402 (3d Cir. 1989) (integration
limited disclaimer prohibition, rather salesperson is often the franchisee’s only clause is part of the contract and if fraud taints the
connection to the franchisor.’’); Lagaria, at 2 (‘‘A relationship between the parties, the integration
than a total ban, is warranted. As an franchisor should remain liable for misconduct in
initial matter, the Commission is clause itself is struck down); Tibo Software, Inc. v.
the sales process, particularly by its own employees Gordon Food Serv., Inc., 51 U.C.C. Rep. Serv. 2d,
convinced that integration clauses and and agents.’’); Pu, at 2 (‘‘The FTC should not permit 2003 U.S. Dist. LEXIS 12020 (W.D. Mich. 2003) (An
waivers serve valid purposes, including franchisors to disclaim responsibility for the explicit integration clause bars parol evidence with
ensuring that a prospective franchisee statements of rogue salespeople.’’). While we agree the exception of fraud or other grounds sufficient
that franchisors in most instances are responsible to set aside a contract); Jones Distrib. Co. v. White
for statements made by their sales force, there may Consol. Indus., 943 F. Supp. 1445, 1470-71 (N.D.
908 J&G, NPR 32, at 4-5. See also Marriott, NPR
be exceptions that can be only be determined based Iowa 1996) (fine-print, boiler-plate integration
35, at 8; GPM, NPR Rebuttal 40, at 10-11.
upon the particular facts on a case-by-case basis, in provision is not legally enforceable when there has
909 PMR&W, NPR 4, at 17.
light of agency law and Section 5 of the FTC Act. been fraud that has induced the making of the
910 CA Bar, at 10. 914See 16 CFR 436.1(f).
contract); Ron Greenspan Volkswagen v. Ford Motor
911 Baer, NPR 11, at 16-17. 915 Waivers of rights afforded by Commission Land Dev. Corp., 38 Cal. Rptr. 2d 783, 790 (Ct. App.
912 J&G, NPR 32, at 4-5. See also Marriott, NPR trade regulation rules are disfavored. For example, 1995) (merger clause will not insulate a seller from
35, at 7-8. section 455.3(b) of the Used Car Rule, 16 CFR liability for misrepresentations, even if the clause
Finally, integration clauses or waivers the reliability and integrity of course of franchise sales negotiations.’’
are not likely to protect franchisors from substantive disclosures outweighs any This proviso is necessary because, in its
private suits based upon fraudulent possible loss of clarity in how the absence, a franchisor might conclude
statements made in a disclosure disclosures are presented. that it is prohibited from agreeing to any
document, even without Commission terms or conditions not spelled out in
b. Scope of section 436.9(h)
intervention.918 the standard agreement attached as an
The Commission recognizes that an As noted above, section 436.9(h) is exhibit to its disclosure document.923
integration clause or waiver may be one designed to address a specific problem Clearly, franchise sellers and
way for a franchisor to narrow its brought to our attention during the Rule prospective franchisees should be free
disclosures efficiently in unique amendment proceeding: franchisors’ use to negotiate the terms of the franchise
circumstances. For example, an ice of integration clauses to disclaim agreement, as in all other commercial
cream store franchisor may make an authorized statements made in transactions. The Commission has no
Item 19 financial performance disclosure documents or in their interest in preventing the parties from
representation pertaining to units based exhibits or attachments. By prohibiting seeking the best deal possible, as long as
in Florida. If the franchisor sells units this practice, the disclaimer prohibition the prospective franchisee understands
in southern states, the Florida-based preserves the integrity of the material in advance of the sale how the terms
representation would be reasonable. information disclosed in a franchisor’s and conditions differ from the standard
However, if the franchisor were to sell disclosure document, thus preventing ones set forth in the disclosure
a unit in Alaska, the franchisor might deception. By its terms, section 436.9(h) document and has the opportunity to
wish to use a contract integration clause does not reach statements made in a review the actual franchise agreement
to ensure that the financial performance franchisor’s advertising materials. prior to the sale.
representation is inapplicable to the A few commenters urged the In response to the Staff Report,
particular sale in Alaska.919 Commission to adopt a broader Howard Bundy voiced concern that the
Nevertheless, franchisors could prohibition that would prevent section 436.9(h) contract negotiation
protect themselves from liability franchisors from disclaiming any proviso is too broad and could subsume
without resort to integration clauses or authorized statement—whether in a the Rule.924 He feared that a franchisor
waivers. For example, the ice cream disclosure document or promotional could initiate negotiations and permit a
store franchisor noted above, at the very materials.921 However, the Commission person to become a franchisee only if he
least, could provide the prospective is persuaded that a broader prohibition or she agrees to waive essential terms.
Alaskan franchisee with a disclosure would go beyond what is necessary to Mr. Bundy urged the Commission to
document that deletes the Item 19 address the underlying issue identified limit the proviso ‘‘to negotiations
representation. In the alternative, the in the record—the need to prevent initiated by the prospective franchisee
statement of bases and assumptions deceptive disclosure documents. and that result in changes that are no
attached to the disclosure document Further, franchise advertisements, like less favorable to the franchisee than the
could make clear that the financial other industry advertisements, are standard terms.’’925
performance representation pertains to already subject to Commission The Commission recognizes that an
Florida or other southern states only. substantiation and anti-deception integration clause may facilitate
Nothing in section 436.9(h) would requirements under Section 5 of the negotiations by releasing the parties
prevent a franchisor from having a FTC Act. Moreover, any franchisor who from restraints imposed by the
prospective franchisee sign a clear and makes statements in promotional contractual terms previously disclosed
conspicuous acknowledgment that the literature that are inconsistent with the in the disclosure document. The use of
Florida-based performance disclosure document and franchise an integration or waiver clause,
representation does not apply to states agreement would violate the section however, is unnecessary to permit
such as Alaska. 436.9(a) ban on the making of contract negotiations. As previously
Finally, we recognize the possibility contradictory statements.922 discussed, the final amended Rule
that some franchisors may be tempted to Accordingly, a broader disclaimer addresses how franchisors and
import into their disclosure documents prohibition is unwarranted to achieve prospective franchisees may negotiate
legalese from their franchise the goal of preserving the integrity of contracts without violating the Rule.
agreements, in an effort to avoid having franchisors’ disclosures. Specifically, section 436.2(b) provides
conflicting provisions. Such a that no mandatory contract review
possibility, however, is addressed by the c. Effect of section 436.9(h) on parties’ period is necessary where changes are
Rule’s requirement that disclosure ability to negotiate contracts made at the request of the prospective
documents be prepared in plain Section 436.9(h) states that the franchisee. This recognizes that where
English.920 On balance, however, we are disclaimer prohibition ‘‘is not intended the prospective franchisee is fully
persuaded that the benefit of promoting to prevent a prospective franchisee from informed about the contractual terms
voluntarily waiving specific contract
specifically disclaims such misrepresentations); terms and conditions set forth in his or 923 Two franchisor representatives specifically
Nobles v. Citizens Mortgage Corp., 479 So.2d 822 urged the Commission to clarify the Rule to ensure
(Fla. Dist. Ct. App. 1985) (under Florida law, a
her disclosure document during the
that the parties are free to negotiate contract terms.
merger or integration clause will not bar evidence See Baer, ANPR 25, at 4-5; Duvall & Mandel, ANPR
of fraud in the inducement). 921 Haff, at 3; Singler, at 3. Mr. Haff, for example,
114, at 22. They feared that if the franchisor
918 For example, in Alphagraphics Franchising, asserted that it is unconscionable for the FTC to negotiates with a prospective franchisee for
Inc., v. Whaler Graphics, Inc., 840 F. Supp. 708 (D. permit a franchisor to disclaim its own materials different terms than what appears in the disclosure
Ariz. 1993), the court held that there was fraud in through a franchise agreement integration clause. document, (e.g., a different initial franchise fee or
the inducement regarding an arbitration forum Haff, at 3. royalty payment), the franchisor will effectively
selection clause, despite the presence of an 922 For example, a franchisor would be liable for violate the Rule because the franchisor will not
integration clause in the franchise contract. ‘‘It is a Rule violation if its promotional literature made have furnished the prospective franchisee with a
well-settled that a party cannot free himself from financial performance claims, while its Item 19 said disclosure document spelling out the specific
fraud by incorporating [an integration clause] in a that no such claims are authorized, or its agreed-upon terms and conditions in advance of the
contract.’’ Id., at 711 (citations omitted). promotional literature stated that exclusive sale.
919See J&G, NPR 32, at 5. 924 Bundy, at 11.
territories are available, while its disclosure
920 Section 436.6(b). document offered no such benefit. 925Id., at 12.
that will govern the relationship before do so either in the franchise agreement, During the Rule amendment
signing the contract, no harm can result. or in a separate contract or letter of proceeding, the NFC focused on the
Where changes to the contract are understanding. The harm resulting from sentence that the ‘‘Commission also
initiated by the franchisor, however, the failure to honor a promised refund intends to enforce all applicable statutes
section 436.9(g) prohibits the franchisor is the same, regardless of where that and trade regulation rules.’’ The NFC
from failing to point out the changes, promise is written. Accordingly, section contended that, under more recent case
and section 436.2(b) provides for a 436.9(i) makes clear that the failure to law, disclosure in some instances may
limited contract review period. These honor any written refund promise will shield a practice that otherwise might be
Rule provisions are sufficient to prevent constitute a Rule violation.928 a law violation. According to the NFC,
fraud in the negotiation process, while a franchisor’s disclosure of certain
preserving the integrity of the H. Sections 436.10 and 436.11: Other
product or sourcing restrictions, for
franchisor’s disclosures. Laws and Rules, and Severability
example, may relieve the franchisor
The last sections of the final amended from antitrust ‘‘tying’’ liabilities.933
9. Section 436.9 (i): Refunds Rule address three additional issues: (1) The NFC’s concerns are misplaced.
Section 436.9(i) prohibits franchisors the final amended Rule’s effect on other Section 436.10 restates the general
from failing to make refunds as Commission laws and rules; (2) policy that disclosure alone does not
promised in their disclosure document preemption of state franchise laws that shield a franchisor from otherwise
or in a franchise or other agreement. The may be inconsistent with the Rule; and illegal conduct. Section 436.10(a) does
failure to honor refund promises is an (3) ‘‘severability.’’ Each of these issues nothing more than state that the
unfair practice in violation of Section is addressed below. Commission will continue to enforce
5.926 It often results in substantial injury the laws it administers in accordance
to franchisees that they cannot 1. Section 436.10(a): Relationship to
other laws and rules with its legal authority. If a disclosure
reasonably avoid.927 Moreover, the makes conduct legal, as the NFC
record is devoid of any evidence The first part of section 436.10(a)
asserted, then the Commission
suggesting that this harm is outweighed provides that the Commission does not
obviously would have no reason to
by any countervailing benefits. approve or express any opinion on the
believe the franchisor has committed a
Section 436.9(i) retains, but slightly legality of any matter a franchisor may
revises, the original Rule’s prohibition law violation.
be required to disclose by the Rule. At
against failing to make promised The second part of section 436.10(a)
the same time, it makes clear that the
refunds. As set forth at 16 CFR 436.1(h), provides that ‘‘franchisors may have
Commission intends to enforce all
the original Rule prohibited franchisors additional obligations to impart material
applicable statutes and rules.929 This is
and brokers from failing ‘‘to return any information to prospective franchisees
slightly broader than the same provision
funds or deposits in accordance with outside of the disclosure document
in the proposed Rule, which was
any conditions disclosed pursuant to under Section 5 of the Federal Trade
limited to ‘‘trade regulation rules.’’930
paragraph (a)(7) of this section.’’ This This provision clarifies the Commission Act.’’934 During the Rule
provision was limited to instances relationship between Franchise Rule
representing to any person that the Commission has
where the franchisor or broker makes an disclosure and other statutes and rules reviewed or approved the form or content of any
express refund promise in the enforced by the Commission. As stated disclosure document. Bundy, NPR 18, at 15. While
disclosure document itself. It is in the original SBP, some of the Rule’s we agree with Mr. Bundy, in principle, we are not
possible, however, that a franchise seller provisions may require franchisors to persuaded that a new prohibition is warranted. The
final amended Rule already mandates that
may not make any specific promise in disclose practices that may raise legal franchisors state expressly on their disclosure
the disclosure document itself, but may issues, such as antitrust issues.931 By document cover page that the Commission has not
requiring disclosure, the Commission reviewed or approved of the disclosures. This
926See FTC v. Hillary’s Servs., Inc., No. 94-CV-
does not approve of practices that might should be sufficient to correct any
2312 (E.D. Pa. 1994); FTC v. Richard L. Levinger, misrepresentation to the contrary. Moreover, any
No. 94-0925-PHXRCB (D. Ariz. 1994); FTC v.
violate other Commission laws. In short, misrepresentation about Commission approval of a
McKleans, Inc., Bus. Franchise Guide (CCH) ¶ 9853 pre-sale disclosure does not create a safe disclosure document is already actionable as a
(D. Conn. 1989) (franchisors violated the Franchise harbor for franchisors engaging in violation of Section 5 of the FTC Act.
Rule by, among other things, failing to provide otherwise unlawful conduct.932 933 NFC, NPR 12, at 24.
promised refunds). See also FTC v. William A. 934 For example, under the original Rule, no
Skaife, Bus. Franchise Guide (CCH) [1989-1990 928 One commenter, Dady & Garner, suggested disclosure of state or local licensing provisions was
Transfer Binder] ¶ 9555 (C.D. Cal. 1990); FTC v. required. Nonetheless, in United States v. Lifecall
Nat’l Bus. Consultants, Inc., Bus. Franchise Guide that franchisees should always receive a refund
Sys., Inc., No. 90-3666 (D.N.J. 1990), the
(CCH) ¶ 9385 (E.D. La. 1989); FTC v. Am. Legal (excluding actual costs) if they never actually open
Commission alleged that the defendants violated
Distrib., Inc., No. 1:88-CV-519-MHS (N.D. Ga. 1988); or operate an outlet. Dady & Garner, ANPR 127, at
Section 5 by misrepresenting that purchasers of
United States v. Tuff-Tire Am., Inc., Bus. Franchise 4. We believe the substantive terms and conditions
their emergency alert system franchises would not
Guide (CCH) [1985-1986 Transfer Binder] ¶ 8353 of refunds are a matter of contract between the
have to register with state or local authorities. See
(M.D. Fla. 1985); United States v. Fed. Energy Sys., parties, provided the terms and conditions of any
also FTC v. Car Checkers of Am., Inc., No. 93-623
Inc., Bus. Franchise Guide (CCH) [1983-85 Transfer refund policy are spelled out in the disclosure
(mlp) (D.N.J. 1993) (alleging that defendants
Binder] ¶ 8180 (C.D. Cal. 1984) (franchisors document or franchise agreement. No other
violated Section 5 by failing to disclose state
misrepresented refund policy in violation of comments were submitted in connection with the
insurance licensing requirements); FTC v. Claude
Section 5); FTC v. Nat’l Audit Defense Network, Franchise NPR’s proposed retention of the refund
Blanc, Bus. Franchise Guide (CCH) ¶ 10032
Inc., No. CV-S-02-0131 LRH-PAL (D. Nev. 2002); prohibition.
929 This is slightly broader than the same
(alleging that defendants violated Section 5 by
FTC v. Travel Bahamas Tours, Inc., No. 97-6181- misrepresenting availability of medical insurance).
CIV-Ferguson (S.D. Fla. 1997) (companies provision in the original Rule set forth at 16 CFR Cf. FTC v. Carribean Clear, Inc., Bus. Franchise
misrepresented refund policy in violation of 436.3, which is limited to enforcement of statutes: Guide (CCH) ¶ 10029 (D.S.C. 1992) (permanent
Section 5 of the FTC Act). Cf. Philips Elecs. N. Am. ‘‘A provision for disclosure should not be construed injunction included prohibition against future
Corp., FTC No. 022-3095 (2002); Tim R. Wofford, as . . . an indication of the Commission’s intention misrepresentations of the effectiveness and safety of
FTC No. 012 3191 (2002) (the failure to honor rebate not to enforce any applicable statute.’’ The revised defendants’ swimming pool water purifier).
offers as promised violates Section 5 of the FTC language of final amended Rule is also clearer, Similarly, a practice may violate the Rule and
Act). eliminating the use of double negatives. Section 5 simultaneously. For example, in
927See original SBP, 43 FR at 59696 (‘‘Numerous 930 Franchise NPR, 64 FR at 57346.
numerous Franchise Rule cases the Commission has
931 Original SBP, 43 FR at 59719.
consumers complained about the difficulty they alleged that the defendants violated Section 5 by
experienced when they attempted to obtain refunds 932 Howard Bundy urged the Commission to add using shills (fictitious references), even though that
from their franchisors.’’). a separate prohibition against a franchisor conduct also violated the Rule’s mandate to
amendment proceeding, a few national, disclosure standard.938 The full purposes and objectives of
franchisors voiced concern that this preemptive effect of the final amended Congress.’’945
provision does not give any guidance to Rule, however, is not a subject of The Federal Trade Commission Act
franchisors about what specific Commission discretion. Rather, the does not include any clause directly
information needs to be disclosed. For preemptive effect of any federal law is preempting state law or authorizing the
example, Piper Rudnick stated that ‘‘no fundamentally a question of Commission to do so. Furthermore, the
matter how thorough or detailed the Congressional intent.939 legislative history of the Act and of the
franchise offering circular may be, this 1975 amendments to the Act
First, Congress can define explicitly establishing the Commission’s
sentence places all franchisors at risk of
the extent to which federal law rulemaking authority indicate that
violating the Revised Rule by not also
making whatever disclosure may be preempts state law.940 If Congress has Congress did not intend the Act to
required by this open-ended and explicitly addressed the issue of occupy the field of consumer protection
ambiguous disclosure obligation.’’935 preemption in a statute, then the regulation.946 Any preemptive effect of
No franchisor need worry that it may statutory language governs and no the Franchise Rule, therefore, is limited
violate the Rule for failing to include further analysis is required.941 Even in to instances where it is impossible for
material information not specifically the absence of explicit statutory a private party to comply with both state
required or permitted by the Rule or language, state law is preempted where and the Commission regulations, or
state law. As for every other person over it regulates conduct in a field that where application of state regulations
which the Commission has jurisdiction, Congress intended the federal would frustrate the purposes of the
franchisors must not engage in unfair or government to occupy exclusively. Franchise Rule.947 In this regard, the
deceptive acts or practices. For example, Congressional intent to occupy a field Commission generally has declared the
Section 5 would prohibit a used car may be inferred from a ‘‘scheme of preemptive effect of Commission rules
seller from misrepresenting a rebate federal regulation . . . so pervasive as to to be limited to the extent of an
program or from misrepresenting make reasonable the inference that inconsistency only.948 Accordingly, the
whether a used car had previous Congress left no room for the States to amended Franchise Rule would not
damage, even though the seller may supplement it,’’ or where an act of affect state laws providing greater
otherwise comply with the Used Car Congress ‘‘touch[es] a field in which the consumer protection.949
Rule’s warranty disclosures. federal interest is so dominant that the We further note that preemption of
federal system will be assumed to state franchise disclosure laws would be
2. Section 436.10(b): Preemption inconsistent with the current policy on
preclude enforcement of state laws on
Section 436.10(b) retains the original the same subject.’’942 In addition, federalism, as announced in Executive
Rule’s preemption statement found at Congress may choose to grant Order 13132 on August 4, 1999.950
footnote 2:936 sufficiently broad regulatory authority 945English, 496 U.S. at 79; Gade v. Nat’l Solid
The FTC does not intend to to a federal agency as to permit the Wastes Mgmt. Ass’n, 505 U.S. 88, 98-99 (1992);
preempt the franchise practice laws agency itself, by regulation, to provide Hines v. Davidowitz, 312 U.S. 52, 67 (1941). These
of any state or local government, expressly for the preemption of state standards apply to federal regulations as well as
except to the extent of any law.943 federal statutes. E.g., Fid. Fed. Sav. & Loan Ass’n
v. de la Cuesta, 458 U.S. 141, 153 (1982).
inconsistency with this Rule. A law Finally, state law is preempted to the 946E.g., Am. Fin. Servs. Ass’n v. FTC, 767 F.2d
is not inconsistent with this Rule if extent that it actually conflicts with 957, 989 (1985). See also Paul R. Verkuil,
it affords prospective franchisees federal law. Thus, federal law will Preemption of State Law by the Federal Trade
equal or greater protection, such as Commission, 1976 Duke L.J. 225.
preempt state law where it is impossible 947 Preemption would occur where there is an
registration of disclosure for a private party to comply with both ‘‘actual conflict between the two schemes of
documents or more extensive state and federal requirements.944 In regulation [such] that both cannot stand in the same
disclosures. addition, preemption occurs where state area.’’ Fla. Lime & Avocado Growers, 373 U.S. at
141. See also, Am. Fin. Servs., 767 F.2d 957 (Credit
16 CFR Part 436, note 2.937 law ‘‘stands as an obstacle to the Practices Rule); Harry and Bryant Co. v. FTC, 726
During the Rule amendment accomplishment and execution of the F.2d 993 (4th Cir. 1984) (Funeral Rule); Am.
proceeding, several franchisors urged Optometric Assoc. v. FTC, 626 F.2d 896 (D.C. Cir.
the Commission to preempt the field of 938E.g., IFA, at 4; Kaufmann, at 9-10; Spandorf,
1980) (Opthalmic Practices Rule).
948E.g., Mail or Telephone Order Merchandise
pre-sale disclosure to ensure a single, at 10; PMR&W, NPR 4, at 7-8; Baer, NPR 11, at 2;
Rule, 16 CFR 435.3; R-Value Rule, 16 CFR 460.23.
Snap-On, NPR 16, at 2; GPM, NPR Rebuttal 40, at 949 When promulgating the original Rule, the
disclose completely and accurately information 8. But see IL AG, NPR Rebuttal 38, at 1-2
(‘‘federalism has served the public well’’). Commission authorized franchisors to use the
about existing franchisees. See 16 CFR 436.1(a)(16). UFOC Guidelines to comply with the original
939English v. Gen. Elec. Co., 496 U.S. 72, 78
935 Piper Rudnick, at 4. See also Kaufmann,
Rule’s disclosure requirements on the grounds that
Attachment 1, at 9-10; H&H, NPR 9, at 8. (1990); Schneidewind v. ANR Pipeline Co., 485 U.S.
the UFOC Guidelines, taken in their entirety,
936 Elevating the preemption discussion from a 293, 299 (1988).
940Shaw v. Delta Air Lines, Inc., 463 U.S. 85, 95-
provide equal or greater consumer protection as the
footnote to a Rule section is consistent with other original Rule. See Interpretive Guides, 44 FR at
Commission trade regulations rules. See, e.g., 98 (1983). 49970-71. The Commission ratified this position
941Cipollone v. Liggett Group, 505 U.S. 504, 517
Appliance Labeling Rule, 16 CFR Part 305.17; following subsequent amendments to the UFOC
Cooling-Off Rule, 16 CFR 429.2; Mail Order Rule, (1992). requirements by the NASAA, most recently in 1993,
942English, 496 U.S. at 79; Rice v. Santa Fe
16 CFR 435.3(b)(2); R-Value Rule, 16 CFR 460.23. 58 FR 69224 (Dec. 30, 1993). Examples of state and
937 As noted previously, starting on July 1, 2007, Elevator Corp., 331 U.S. 218, 230 (1947). Where the local laws not preempted by the original or
franchisors have the option of complying with field in question has been traditionally occupied by amended Rule include registration of franchisors
either part 436 of the final amended Rule, the UFOC the states, congressional intent to supersede state and franchise salespersons, escrow or bonding
Guidelines, or the original Franchise Rule. laws much be ‘‘clear and manifest.’’ Jones v. Rath requirements, substantive regulation of the
Beginning on July 1, 2008, however, franchisors Packing Co., 430 U.S. 519, 525 (1977) (quoting Rice, franchisor-franchisee relationship (e.g., termination
may use part 436 of the final amended Rule only. 331 U.S. at 230). practices, contract provisions, and financing
943City of New York v. FCC, 486 U.S. 57, 62-68 arrangements), and disclosure laws requiring more
Permission to use the UFOC Guidelines will be
withdrawn on that date because those Guidelines (1988) (upholding FCC regulations preemping state extensive disclosures than those provided by the
will no longer afford prospective franchisees equal and local standards for the quality of cable amended Rule.
or greater protection as part 436. This would not television signals). 950 Although the Executive Order is not binding
preclude consideration of any new or revised UFOC 944English, 496 U.S. at 79; Fla. Lime & Avocado on independent agencies, such as the Federal Trade
Guidelines promulgated by the states in the future. Growers, Inc., v. Paul, 373 U.S. 132, 141 (1963). Continued
Among other things, the Executive A. New definition for ‘‘business obtaining or commencing the business
Order provides that federal agencies opportunity’’ opportunity operation to make a
should carefully assess the necessity of Section 437.2(a) of the final amended payment or a commitment to pay to the
limiting the policymaking discretion of Rule defines the term ‘‘business business opportunity seller, or to a
the states and such actions should be opportunity’’ consistent with the person affiliated with the business
taken ‘‘only where there is original Rule’s business opportunity opportunity seller.
constitutional and statutory authority definitional elements. In so doing, it B. Eliminating other references to
for the action and the national activity eliminates references to franchising, franchising
is appropriate in light of the presence of which are now addressed in part 437 of
a problem of national significance.’’ It Part 437 of the final amended Rule
the final amended Rule. First, the term further eliminates all other references to
also encourages agencies, in appropriate ‘‘franchise’’ in the original Rule franchising, by substituting for the terms
circumstances, to defer to the states to definitions has been eliminated and ‘‘franchisor,’’ ‘‘franchisee,’’ and
establish standards. As noted above, substituted with the term ‘‘business ‘‘franchise’’ used throughout part 437
there is no statutory basis for opportunity.’’ Second, the franchise the terms ‘‘business opportunity seller,’’
preempting the states in the franchise definitional elements of the original ‘‘business opportunity purchaser,’’ and
pre-sale disclosure arena, nor do we Rule’s ‘‘franchise’’ definition have been ‘‘business opportunity.’’ This ensures
find any compelling reason to limit the eliminated. Accordingly, the that part 437 will cover only the offer
states’ discretion in this field. Rather, by definitional elements of the term and sale of business opportunities. For
adopting the UFOC Guidelines in large ‘‘business opportunity’’ are now example, section 437.2(a)(3) retains, but
measure, which the commenters agreed identical to those set forth in the modifies, the original Rule’s exemption
is superior to the current Franchise original Rule: for fractional relationships to cover
Rule, the states have taken a leadership (a) The term business opportunity business opportunities only: the term
role in this field. Under the means any continuing commercial ‘‘fractional franchise’’ is replaced by the
circumstances, we must reject any relationship created by any arrangement term ‘‘fractional business opportunity.’’
suggestion that the Commission expand or arrangements whereby:
the Franchise Rule’s preemptive effect. (1) A person (hereinafter ‘‘business C. Franchise exemption
There simply is no legal or policy basis opportunity purchaser’’) offers, sells, or Section 437.2(a)(3)(v) adds a new
for such an expansion. distributes to any person other than a exemption to part 437 of the final
‘‘business opportunity seller’’ (as amended Rule for those business
3. Section 436.11: Severability hereinafter defined), goods, arrangements that comply with the
commodities, or services which are: Franchise Rule, or are exempt from
Finally, as proposed in the Franchise
(i)(A) Supplied by another person compliance with the Franchise Rule, as
NPR,951 section 436.11 contains a
(hereinafter ‘‘business opportunity set forth in part 436. Accordingly, it is
standard severability provision, stating seller’’); or designed to eliminate potential overlap
that if any provision of this regulation (B) Supplied by a third person (e.g., and duplicative compliance burdens
is stayed or held invalid, the remainder a supplier) with whom the business between the franchise rule and the
will stay in force.952 This provision is opportunity purchaser is directly or business opportunity rule, parts 436 and
comparable to the severability indirectly required to do business by 437, respectively. Specifically, section
provisions in other Commission trade another person (hereinafter ‘‘business 437.2(a)(3)(v) exempts from coverage of
regulation rules.953 This provision opportunity seller’’); or part 437 all business arrangements that
generated no comments in response to (C) Supplied by a third person (e.g., comply with part 436, or that satisfy one
both the Franchise NPR and Staff a supplier) with whom the business or more exemptions to part 436. For
Report. Accordingly, the amended Rule opportunity purchaser is directly or example, businesses exempt from part
adopts the severability provision indirectly advised to do business by 436 coverage pursuant to the fractional
proposed in the Franchise NPR. another person (hereinafter ‘‘business franchise exemption would not be
IV. SECTION-BY-SECTION ANALYSIS opportunity seller’’) where such third subjected to coverage under part 437.
OF PART 437 person is affiliated with the business This is an appropriate result because the
opportunity seller; and same rationale underlying exemption of
As noted above, part 437 of the final (ii) The business opportunity seller: these types of businesses from part 436
amended Rule continues to cover the (A) Secures for the business would also dictate that they not be
offer and sale of business opportunities, opportunity purchaser retail outlets or covered by part 437— i.e., in the case
such as vending machine and rack accounts for said goods, commodities, of a fractional franchise, the franchisor
display promotions.954 Except for the or services; or is not likely to deceive the prospective
three changes discussed immediately (B) Secures for the business franchisee or to subject the prospective
below, part 437 is identical to the opportunity purchaser locations or sites franchisee to significant investment risk.
original Rule, imposing no new for vending machines, rack displays, or Therefore, imposing the requirements of
substantive disclosure requirements or any other product sales displays used by either part 436 or part 437 would not be
prohibitions. the business opportunity purchaser in justified.
the offering, sale, or distribution of said
goods, commodities, or services; or V. REGULATORY ANALYSIS AND
Commission, it nonetheless sets forth principles REGULATORY FLEXIBILITY ACT
that the Commission might consider in determining (C) Provides to the business
the preemptive effect of its regulations. opportunity purchaser the services of a REQUIREMENTS
person able to secure the retail outlets, Under section 22 of the FTC Act,955
952See 16 CFR 436.3.

accounts, sites, or locations referred to the Commission must issue a regulatory
953E.g., Pay-Per-Call Rule, 16 CFR 308.8; Used Car
in paragraphs (a)(ii)(A) and (B) of this analysis for a proceeding to amend a
Rule, 16 CFR 455.7
954See Interpretive Guides, at 49968. See section; and rule only when it: (1) estimates that the
generally Business Opportunity NPR, 71 FR at (2) The business opportunity
19054-57. purchaser is required as a condition of 955 15 U.S.C. 57b.
amendment will have an annual effect adverse economic or other effects, if to reduce compliance costs, which will
on the national economy of any, of the amendments; the reasons benefit small business franchisors in
$100,000,000 or more; (2) estimates that that the final amendments will attain particular. For example, in considering
the amendment will cause a substantial their intended objectives in a manner the disclosure of computer systems, the
change in the cost or price of certain consistent with applicable law; the Commission declined to adopt the
categories of goods or services; or (3) reasons for the particular amendments states’ sweeping disclosure of computer
otherwise determines that the that the agency has adopted; and the system requirements, in favor of a more
amendment will have a significant effect significant issues raised by public limited disclosure. In addition, the
upon covered entities or upon comments, including the Commission’s Commission will permit electronic
consumers. assessment of and response to those compliance with the Franchise Rule,
In general, the commenters supported comments on those issues. which holds the promise of reducing
the proposed franchise amendments The Regulatory Flexibility Act costs for all franchisors, including small
because they reduce inconsistencies (‘‘RFA’’),958 requires that the agency business franchisors.
with state franchise disclosure laws, conduct an analysis of the anticipated In a few instances, the part 436
reduce compliance burdens on economic impact of proposed rule amendments will impose new
franchisors that are not likely to engage amendments on small businesses. The disclosure requirements on all
in abusive practices that the Rule was purpose of a regulatory flexibility franchisors. These amendments are
intended to prevent, and update the analysis is to ensure that the agency designed to provide prospective
original Rule to address new considers the impact on small entities franchisees with more information
technologies. Only one commenter and examines regulatory alternatives about the quality of the franchise
addressed the economic impact of part that could achieve the regulatory relationship. In these instances, the
436, voicing concern generally that the purpose while minimizing burdens on Commission has taken great care to keep
original and amended Franchise Rule small entities. Section 605 of the RFA compliance costs to a minimum. For
impose unnecessary costs.956 No provides that such an analysis is not example, with respect to the new
commenter, however, indicated that the required if the agency head certifies that franchisor-initiated litigation disclosure,
amendments would have an annual the regulatory action will not have a franchisors need only report such
impact of more than $100,000,000, significant economic impact on a litigation for a period of one year. This
cause substantial change in the cost of substantial number of small entities.959 contrasts with the original Rule’s seven-
goods or services, or otherwise have a The Commission believes that none of year reporting period (and the UFOC
significant effect upon covered entities the amendments to the original Guidelines 10-year reporting period) for
or consumers.957 Franchise Rule is likely to have a prior litigation against the franchisor.
At the same time, some commenters significant impact on small businesses. Similarly, a franchisor may disclose
questioned whether particular rule Most small businesses covered by the franchisor-initiated litigation by
amendments pertaining to franchising original Franchise Rule are likely to be grouping any suits under a single
might be unnecessary, or offered business opportunity sellers, such as heading, as opposed to the original Rule
alternatives. Section III of this document vending machine and rack display route and UFOC Guidelines approach for
analyzes these comments in detail. After sellers. These small businesses will other litigation, which requires full case
careful consideration of the comments, continue to be covered by the same summaries.
and the record as a whole, the substantive provisions of the original Similarly, the Commission has
Commission has determined that there Rule, through part 437. On the other narrowed the new disclosure of
are no facts in the record, or other hand, the numerous amendments to the independent trademark-specific
reasons to believe, that the part 436 original Franchise Rule that pertain to franchisee associations. Franchisors
amendments will have significant franchising—set out in part 436—will need not make this disclosure unless the
effects on the national economy, on the not apply to the offer or sale of business association specifically asks to be
cost of goods or services, or on covered opportunities. In short, none of the included in the franchisor’s disclosure
parties or consumers. In any event, to amendments to the original Franchise document. Further, such requests must
the extent, if any, these final rule Rule are likely to affect a substantial be renewed by the association on an
amendments will have such effects, the number of small businesses. annual basis. In addition, franchisors
Commission has previously explained Accordingly, the Commission has no need not update this disclosure on a
above the need for, and the objectives reason to believe that the amendments quarterly basis. The Commission
of, the final amendments; the regulatory will have a significant impact upon believes that these, and other efforts to
alternatives that the Commission has such entities. narrow amendments to the Rule
considered; the projected benefits and Moreover, the Commission is discussed throughout this document,
adopting amendments that in large will result in the easing of compliance
956See generally Winslow. However, this measure reduce inconsistencies with burdens for all franchisors, especially
commenter did not quantify the additional cost state law. In many instances, small small business franchisors.
burdens arising as a result of the Rule businesses that sell franchises, Accordingly, the Commission
amendments—as opposed to those imposed by the concludes that the amendments to the
original Rule or by state law—nor provide any data especially those conducting business on
or statistics supporting his view, that would permit a national basis, already comply with original Franchise Rule will not have a
us to assess the economic impact of the Rule state disclosure laws in the form of the significant or disproportionate impact
amendments. UFOC Guidelines. Accordingly, many of on the costs of small business, whether
957 As previously noted, part 437 of the final
the amendments will impose no new they sell franchises or business
amended rule (the business opportunity section) is
substantively identical to the business opportunity compliance costs on either small or opportunities. Based on available
coverage of the original Rule. Part 437 imposes no large businesses. Further, in some information, therefore, the Commission
additional disclosures, recordkeeping requirements, instances, the Commission has certifies that the Franchise Rule
or prohibitions on business opportunity sellers. amendments published in this
Accordingly, the part 437 amendments impose no
specifically narrowed a UFOC provision
economic costs or compliance burdens on business
document will not have significant
opportunities covered by the original Franchise 958 5 U.S.C. 601- 612. economic impact on a substantial
Rule. 959 5 U.S.C. 605. number of small businesses.
Nonetheless, to ensure that no such documents electronically, which holds relevant SBA standards pertaining to
impact, if any, has been overlooked, the the promise of reducing costs for all franchising are arguably those for the
Commission has conducted the franchisors, including small business retail sales industry. The most common
following final regulatory flexibility franchisors. ‘‘small business’’ threshold (measured
analysis, as summarized below. Where part 436 of the final amended in receipts) for the retail trade industry
A. Need For And Objective Of The Rule Rule imposes new disclosure is $6 million.961 However, these
requirements, the Commission has standards apply to franchisees engaging
As previously discussed, the carefully considered approaches that in retail sales activities, not to the
Commission is issuing these rule will reduce compliance burdens, franchisors that sell the underlying
amendments to achieve four goals: (1) to especially on small businesses. For franchised units.962
reduce inconsistencies with state example, with respect to the new Nonetheless, in the Franchise NPR the
franchise disclosure laws; (2) to respond franchisor-initiated litigation disclosure, Commission estimated that there are
to changes in the marketing of franchisors need only report such 2,500 business format and product
franchises and new technological litigation for a period of one year. This franchisors and 2,500 business
developments, in particular electronic contrasts with the original Rule’s seven- opportunities covered by the original
communications; (3) to reduce year reporting period (and the UFOC Rule.963 The Commission estimated that
compliance costs where the record and Guidelines 10-year reporting period) for as many as 70% of those 5,000
the Commission’s law enforcement prior litigation against the franchisor. franchisors are small entities, including
experience shows that the abuses the Similarly, a franchisor may disclose some start-up franchise systems and
Rule was intended to address are not franchisor-initiated litigation by most business opportunities.964 The
likely to occur; and (4) to address the grouping any suits under a single Franchise NPR specifically asked for
need for franchisors to disclose material heading, as opposed to the original Rule comment on these estimates. No
information about the quality of the and UFOC Guidelines approach for comments were submitted. Accordingly,
franchise relationship, the absence of other litigation, which requires full case our best estimate is that 3,500
which the record shows is a prevalent summaries. Similarly, the Commission franchisors covered by the original Rule
problem. has narrowed the new disclosure of were small businesses, 2,500 of which
B. Significant Issues Raised By Public independent trademark-specific were business opportunities.
Comment, Summary Of The Agency’s franchisee associations. Franchisors Once business opportunity ventures
Comment, Summary Of The Agency’s need not make this disclosure unless the are no longer covered by part 436 of the
Assessment Of These Issues, And association specifically asks to be final amended Rule, the number of
Changes, If Any, Made In Response To included in the franchisor’s disclosure
Such Comments document. Further, such requests must affiliate, agent, or other entity. For the same reason,
it is difficult to estimate the number of small
The Commission has reviewed the be renewed by the association on an entities that will be subject to the business
comments received during the Rule annual basis. In addition, franchisors opportunity requirements set forth at part 437.
amendment proceeding and has made need not update this disclosure on a 961 See generally 13 CFR Part 121. According to
changes to the original Rule, as quarterly basis. The Commission the SBA standards, the $6 million receipts
believes that these, and other efforts to threshold applies to retailers as diverse as
appropriate. Section III of this document automotive parts and tire stores; floor coverings and
contains a detailed discussion of the narrow amendments to the original window treatment stores; camera and photography
comments and the Commission’s Franchise Rule discussed throughout stores; hardware and garden suppliers; many food
responses. Among other things, the this document, will result in the easing stores; health care product stores; many clothing
of compliance burdens for all stores; sporting good stores; florists; and pet supply
Commission, based upon the record, has stores. The $6 million threshold also is applicable
narrowed the scope of part 436—the franchisors, especially small business to hotels; restaurants; automotive repair centers; car
franchise section—by eliminating franchisors. washes; and laundry services. While the $6 million
threshold is typical of a wide cross-section of small
coverage of business opportunities, C. Description And Estimate Of Number businesses, some of which may be franchises, it
many of which are small businesses. In Of Small Entities Subject To The Final sheds no light on the number of franchisors that are
addition, part 436 will apply only to the Rule Or Explanation Why No Estimate small businesses.
sale of franchises to be located in the Is Available
962 Industry data are also difficult to come by. In
United States. the 1990’s, the International Franchise Association

Further, part 436 of the final amended The Commission cannot readily produced a series of reports called The Profile of
estimate the number of small entities Franchising that sought to quantify and describe
Rule reduces many inconsistencies with franchise systems in the United States. While these
state franchise laws that use the UFOC subject to the final amended Rule. reports shed light on numerous aspects of
Guidelines format. Accordingly, many Franchising is a method of distribution, franchising—such as the number of franchise
of the rule amendments will impose no not an industry, nor an economic sector. systems in various economic sectors, how long
Accordingly, businesses in a wide array companies were in business before beginning to
new compliance costs on small franchise, and how many franchisees are in the
businesses, especially those that of industries engage in the distribution system—the reports did not purport to examine the
conduct, or plan to conduct, business on of products or services through number of staff employed by the franchisors nor
a national basis. Further, in some franchising, and the number of franchisors’ annual receipts, factors used in a
franchisors in any one economic sector regulatory flexibility analysis. More recently, in
instances, the Commission has 2004, the International Franchise Association
specifically narrowed a UFOC provision is constantly changing. produced a study called Economic Impact of
to reduce compliance costs, which will Moreover, the SBA’s standards for Franchised Businesses. This study examined the
benefit small businesses in particular. determining size—based on either economic impact that franchised units have in the
number of employees or annual marketplace, for example, the number of
For example, based upon the comments, individuals employed by franchised units. This
the Commission declined to adopt the receipts—are inapplicable to study, like the Profiles of Franchising, is not useful
franchising.960 For example, the most
states’ sweeping disclosure of computer in determining the number of franchisors that are
small businesses and subject to the final amended
system requirements, in favor of a more 960 The SBA size thresholds set forth what Rule.
limited disclosure. Most important, part constitutes a small entity in a particular line of 963 Franchise NPR, 64 FR at 57325. See also 70
436 of the final amended Rule permits business, regardless of whether the entity is a FR 51817, 51818-20 (Aug. 31, 2005).
franchisors to furnish disclosure franchisor, licensee, contractor, parent corporation, 964 Franchise NPR, 64 FR at 57325.
‘‘small businesses’’ subject to the Rule E. Steps The Agency Has Taken To commenters urged the Commission to
amendments will be greatly reduced. Of Minimize Any Significant Economic mandate the disclosure of financial
the remaining 2,500 franchisors covered Impact On Small Entities, Consistent performance data. Other commenters
by part 436 of the final amended Rule, With The Stated Objectives Of The urged the Commission to expand greatly
many are mature, well-established Applicable Statutes, Including The the reporting of franchise turnover rates.
franchise systems, including many Factual, Policy, And Legal Reasons For Further, commenters suggested that the
publicly traded companies. In the Selecting The Alternative(s) Finally Commission incorporate into the
absence of additional information on the Adopted, And Why Each Of The disclosure document various risk factors
size of franchisors, we will estimate for Significant Alternatives, If Any, Was or consumer education notices to
purposes of this analysis that 1,000 Rejected prospective franchisees. As discussed
franchisors (3,500 covered by the As discussed throughout this above in Section III, the Commission
original Rule minus the exclusion of document, the Commission has finds that the benefits of these suggested
considered all alternatives that would amendments would not outweigh the
2,500 business opportunities) will
reduce compliance costs on all compliance costs.
qualify as small businesses subject to
franchisors, including small business Finally, the Commission has
the part 436 amendments. At the same determined to give franchisors ample
time, each of the 2,500 business franchisors, while achieving the
intended objectives of the Rule. For time to come into compliance with the
opportunities covered by the original final amended Rule. To that end,
Rule—most likely small entities—will example, part 436 of the final amended
Rule narrows the scope of the original franchisors can start using the final
remain covered by the identical amended Rule on July 1, 2007, if they
disclosure requirements, as set forth in Rule by eliminating coverage of
business opportunities, many of which so choose. At the very latest, all
part 437. franchisors must come into compliance
are small businesses. Part 436 of the
D. Description Of The Projected final amended Rule, while reducing with the final amended Rule by July 1,
Reporting, Recordkeeping, And Other compliance with state pre-sale 2008. This approach will benefit large
disclosure laws, minimizes compliance and more seasoned franchisors that
Compliance Requirements Of The Rule,
costs where possible. For example, part wish to take advantage of the
Including An Estimate Of The Classes
436 of the final amended Rule narrows improvements incorporated in part 436
Of Small Entities That Will Be Subject
the disclosure of computer system of the final amended Rule. At the same
To The Rule And The Type Of time, it permits small business
Professional Skills That Will Be requirements. Where a part 436 rule
amendment expands the original Rule, franchisors, in particular, ample
Necessary To Comply opportunity to consider the best and
it does so in a fashion designed to
As discussed in the Paperwork minimize compliance burdens. This is most cost-effective means to comply
Reduction Act analysis of this notice most evident regarding the new with part 436 of the final amended Rule.
(Section VI), the amendments will disclosures pertaining to franchisor- VI. PAPERWORK REDUCTION ACT
impose compliance requirements (e.g., initiated litigation and independent,
trademark-specific franchisee In accordance with the Paperwork
disclosure) and minor recordkeeping Reduction Act, as amended, 44 U.S.C.
requirements on franchisors. This may associations, as discussed above.
Further, in many instances part 436 of 3501-3520, the Office of Management
affect some small business franchisors. and Budget (‘‘OMB’’) has approved the
No additional recordkeeping or the final amended Rule permits
franchisors the flexibility to comply information collection requirements
disclosure requirements are imposed on contained in the amended Rule through
business opportunities that remain with Rule provisions in a manner that
makes the most sense for their particular October 31, 2008, and has assigned
covered under part 437. The OMB control number 3084-0107.
business. For example, franchisors can
incremental cost of the part 436 No comments were received in
determine the best medium in which to
amendments on franchisors is difficult response to the Franchise NPR
furnish their disclosures, as well as to
to estimate. As suggested by the lack of receive receipts from prospective addressing the Commission’s paperwork
comment on the subject, the franchisees. burden estimates. Nonetheless, the
Commission expects that the added Moreover, part 436 of the final Commission staff revised its approach to
costs of the amendments will be small. amended Rule permits disclosure and calculating the burden when seeking to
Finally, compliance with the amended recordkeeping electronically. This offers extend the clearance for the Rule in
Rule will require, in many instances, the the promise of greatly reducing 2002.966 Specifically, taking into
professional assistance of an attorney to compliance costs, especially for small account that new entries are more likely
prepare disclosure documents.965 businesses. All franchisors, including to require additional time to prepare
However, franchisors (and business small businesses, may furnish disclosures than their more seasoned
opportunity sellers) typically need such disclosures using the approach that is counterparts, the Commission staff
professional assistance in order to most economical for their business, distinguished between existing entities
comply with state franchise and whether that means furnishing a paper covered by the Rule and the likely
document, an electronic disclosure number of new entries when calculating
business opportunity disclosure laws, in
document made available to prospective compliance burdens.967 This burden
particular the preparation of required
franchisees through a password- analysis approach was retained when
financial statements. Accordingly, no Commission staff sought an extension of
new or additional professional skills are protected website, or through email or
CD-ROM. the clearance for the Rule in 2005.968 As
required as a result of amendments to with the Franchise NPR, no paperwork
the original Rule. At the same time, the Commission has
rejected numerous suggestions to revise 966See 67 FR 21243 (Apr. 30, 2002); 67 FR 45734
the original Rule that would result in (July 10, 2002) (‘‘2002 Notices’’).
965 In preparing disclosure documents for
franchisor clients, attorneys may also arrange for significantly increased costs for all 967 67 FR at 21245; 67 FR at 45736.
the assistance of accountants, especially to prepare franchisors, in particular small business 968See 70 FR 28937, 28940 (May 19, 2005); 70 FR
audited financial statements. franchisors. For example, several 51817, 51819 (Aug. 31, 2005) (‘‘2005 Notices’’).
related comments were received in becomes familiar. Accordingly, during beyond the information requirements
response to the Commission’s 2002 and the remaining two years of the imposed by states.
2005 Notices.969 clearance, staff estimates it will take As set forth in the 2005 Notices, staff
As set forth in the 2005 Notices, based three hours for established franchisors estimates that an attorney will prepare
on a review of trade publications and to update their existing disclosure the disclosure document at $250 per
information from state regulatory document (same as the original Rule). hour. Accordingly, staff estimates that
authorities, staff believes that, on Thus, the average annual hours burden 250 new franchisors will annually each
average, from year to year, there are for established franchisors during the incur $8,000 in labor costs (32 hours x
approximately 5,000 American three-year clearance period will be $250 per hour) and, during the first year
franchise systems, consisting of about approximately 4 hours ((6 hours during of the clearance, established franchisors
2,500 business format franchises and first year of clearance + 3 hours during will each incur $1,500 in labor costs (6
2,500 business opportunity sellers, with second year of clearance + 3 hours hours x $250). During the remaining two
perhaps about 10% of that total (500) during third year of clearance) ÷ 3 years of clearance, staff estimates
reflecting an equal amount of new and years). established franchisors will annually
departing business entrants.970 As set forth in the 2005 Notices, each incur $750 in labor costs (3 hours
A. Part 436 under the original Rule, covered x $250 per hour). Thus, the average
franchisors may need to maintain annual labor cost estimate for
Staff has calculated burdens based on established franchisors during the three-
additional documentation for the sale of
the above estimates. Some franchisors, year clearance period will be
franchises in non-registration states,
however, for various reasons, are not approximately $1,000 (($1,500 in labor
which could take up to an additional
covered by the Rule in certain situations costs during first year of clearance +
hour of recordkeeping per year. This
(e.g., when a franchisee buys bona fide $750 in labor costs during second year
yields a cumulative total of 2,500 hours
inventory but pays no franchisor fees). of clearance + $750 in labor costs during
per year for covered franchisors (1 hour
Moreover, 15 states have franchise third year of clearance) ÷ 3 years).
x 2,500 franchisors).
disclosure laws similar to the Rule. Further, staff anticipates that
Part 436 of the amended Rule would
These states use a disclosure document recordkeeping under part 436 will be
also increase franchisors’ recordkeeping
format known as the Uniform Franchise performed by clerical staff at
obligations. Specifically, a franchisor
Offering Circular (‘‘UFOC’’). In order to approximately $13 per hour. Thus, at
would be required to retain copies of
ease compliance burdens on the 2,500 hours of recordkeeping burden
receipts for disclosure documents, as
franchisor, the Commission has per year for all covered franchisors will
well as materially different versions of
authorized use of the UFOC in lieu of amount to a total annual cost of $32,500
its disclosure documents. Such
its own disclosure format to satisfy the (2,500 hours x $13 per hour).
recordkeeping requirements, however,
Rule’s disclosure requirements. Staff Thus, the total estimated labor costs
are consistent with, or less burdensome,
estimates that about 95 percent of all under part 436 is $4,282,500 (($8,000
than those imposed by the states.
franchisors use the UFOC format. As attorney costs x 250 new franchisors) +
noted throughout this document, Thus, staff estimates the average
hours burden for new and established ($1,000 attorney costs x 2,250
revised part 436 tracks the UFOC established franchisors) + ($13 clerical
Guidelines in large measure. franchisors during the three-year
clearance period will be 19,500 ((32 costs x 2,500 franchisors)).
Accordingly, the burden hours stated
below reflects staff’s estimate of the hours of annual disclosure burden x 250 Estimated non-labor costs for part 436:
incremental burden that part 436 may new franchisors) + (4 hours of average $8,000,000.
impose beyond information annual disclosure burden x 2,250 In response to the Staff Report, Mr.
requirements imposed by states and/or established franchisors) + (1 hour of Winslow stated that the costs of printing
followed by franchisors who use the annual recordkeeping burden x 2,500 documents for his franchise system
UFOC. franchisors)). exceed $24,000 without postage.972 Mr.
Estimated annual labor cost burden for Winslow further indicated that the
Estimated annual hours burden for part
part 436: $4,282,500. number of disclosure documents sent
436: 19,500 hours.
out each year will increase under the
As set forth in the 2005 Notices, staff One commenter, Lance Winslow, amended Rule.973 Finally, Mr. Winslow
estimates that, during the first year of stated in response to the Staff Report stated that franchisors will incur
clearance, the 250 or so new franchisors that the average total cost to prepare a significant costs if they send disclosure
will require 32 hours to prepare their franchise disclosure document is documents electronically, including
disclosure document (two more hours $25,000-35,000.971 The Commission bandwidth fees and fees associated with
than under the original Rule) and the agrees that many franchisors typically hiring a contractor to create a searchable
remaining 2,250 established franchisors spend $25,000-35,000 on disclosure website.974
will require six hours to update their documents. Much of these costs, As an initial matter, in developing
existing disclosure document (three however, are not imposed by part 436, cost estimates, Commission staff
more hours than under the original but by state law. For example, a large consulted with practitioners who
Rule). After the first year, however, the portion of the costs that franchisors prepare disclosure documents for a
time required for established franchisors typically pay for disclosures is the result cross-section of franchise systems.
should be the same as under the original of audited financial requirements and Accordingly, the Commission believes
Rule, as the new disclosure format state registration requirements, costs that its cost estimates are representative
that would continue to exist whether or of the costs incurred by franchise
969 One Staff Report commenter voiced concern not the Commission adopted the systems generally. In addition, Mr.
that the Franchise Rule imposed unnecessary amended Rule. As stated above, staff’s Winslow fails to provide a basis for his
burdens. See generally Winslow. Mr. Winslow’s burden estimates reflect the incremental
concerns are addressed below.
970 Unless otherwise noted, ‘‘franchisors’’ as used
burden that part 436 may impose 972 Winslow at 28.
in this document solely pertains to business format 973 Winslow at 31, 93.
franchisors. 971 Winslow, at 23-35. 974 Winslow at 28.
assertion that the demand for disclosure imposes no additional disclosures, recordkeeping burden for all business
documents will increase as a result of recordkeeping, or prohibitions.975 opportunity sellers)).
the amended Rule. Finally, many
Estimated annual hours burden for part Estimated annual labor cost burden for
franchisors establish and maintain
437: 16,750 hours. part 437: $3,595,000.
websites for ordinary business purposes,
including advertising their goods or The burden estimates for compliance Labor costs are determined by
services and to facilitate communication with part 437 will vary depending on applying applicable wage rates to
with the public. Accordingly, any costs the business opportunity sellers’ prior associated burden hours. Staff presumes
franchisors would incur specifically as experience with the Franchise Rule. As an attorney will prepare or update the
a result of electronic disclosure under set forth in the 2005 Notices, staff disclosure document at $250 per hour.
part 436 appear to be low. estimates that 250 or so new business Accordingly, staff estimates that
As set forth in the 2005 Notices, staff opportunity sellers will enter the market business opportunity sellers incur
estimates that the non-labor burden each year, requiring approximately 30 approximately $3,562,500 in labor costs
incurred by franchisors under part 436 hours each to develop a Rule-compliant due to compliance with the Rule’s
will differ based on the length of the disclosure document. Thus, staff disclosure requirements ((250 new
disclosure document and the number of estimates that the cumulative annual business opportunity sellers x $250 per
disclosure documents produced. Staff disclosure burden for new business hour x 30 hours per business
estimates that 2,000 franchisors (80% of opportunity sellers will be opportunity) + (2,250 established
total franchisors covered by the Rule) approximately 7,500 hours (250 new business opportunity sellers x $250 per
will print 100 disclosure documents at business opportunity sellers x 30 hours). hour x 3 hours per business
$35 each. Thus, staff estimates that 80% Staff further estimates that the opportunity)).
of covered franchisors will each incur Staff anticipates that recordkeeping
remaining 2250 established business
$3,500 in printing and mailing costs would be performed by clerical staff at
opportunity sellers will require no more
($35 for printing and mailing x 100 approximately $13 per hour. At 2,500
than approximately 3 hours each to
disclosure documents). Staff estimates hours per year for all affected business
update the disclosure document.
that the remaining 20% of franchisors opportunities, this would amount to a
Accordingly, staff estimates that the
(500) will send 50% of the 100 total cost of $32,500 (2,500 hours for
cumulative annual disclosure burden recordkeeping x $13 per hour). Thus,
documents electronically, with a cost of for established business opportunity
$5 per electronic disclosure. Thus, staff the combined labor costs for
sellers will be approximately 6,750 recordkeeping and disclosure for
estimates that 20% of covered hours (2250 established business
franchisors will each incur $2,000 in business opportunity sellers is
opportunity sellers x 3 hours). approximately $3,595,000 ($3,562,500
distribution costs (($250 for electronic
disclosure [$5 for electronic disclosure Business opportunity sellers may for disclosures + $32,500 for
x 50 disclosure documents] + $1,750 for need to maintain additional recordkeeping).
printing and mailing [$35 for printing documentation for the sale of business
opportunities in some states, which Estimated non-labor cost for part 437:
and mailing x 50 disclosure $3,887,500.
documents])). could take up to an additional hour of
Thus, the cumulative annual hours recordkeeping per year. Accordingly, Business opportunity sellers must
burden for part 436 of the amended Rule staff estimates that business opportunity also incur costs to print and distribute
is approximately 19,500 hours ((32 sellers will cumulatively incur the disclosure document. These costs
hours of annual disclosure burden x 250 approximately 2,500 hours of record vary based upon the length of the
new franchisors) + (4 hours of average keeping burden each year (2,500 disclosures and the number of copies
annual disclosure burden x 2,250 business opportunity sellers x 1 hour). produced to meet the expected demand.
established franchisors) + (1 hour of Thus, the total burden for business Staff estimates that 2,500 business
annual recordkeeping burden x 2,500 opportunity sellers is approximately opportunity sellers print and mail 100
total business format franchisors)). The 16,750 hours ((7,500 hours of disclosure documents per year at a cost of $15 per
cumulative annual labor costs for part burden for new business opportunity document, for a total cost of $3,750,000
436 of the amended Rule is sellers + 6,750 hours of disclosure (2,500 business opportunity sellers x
approximately $4,282,500 (($8,000 burden for established business 100 documents per year x $15 per
attorney costs x 250 new franchisors) + opportunity sellers + 2,500 of document).
($1,000 attorney costs x 2,250 Business opportunity sellers must
established franchisors) + ($13 clerical 975 In April 2006, the Commission published the also complete and disseminate an FTC-
costs x 2,500 total business format Business Opportunity NPR, 71 FR 19054 (Apr. 12, required cover sheet that identifies the
2006). Among other things, the proposed Business business opportunity seller, the date the
franchisors)). Finally, the cumulative Opportunity Rule would amend part 437
annual non-labor costs for part 436 of substantially, reducing the number of disclosures
document is issued, a table of contents,
the amended Rule is approximately pertaining to business opportunities. At the same and a notice that tracks the language
$8,000,000 (($3,500 printing and time, the proposed Business Opportunity Rule specifically provided in part 437 of the
would expand part 437 to include a broader array Rule. Although some of the language in
mailing costs x 2,000 franchisors) + of business opportunities than covered by the
(($250 electronic distribution costs + original Franchise Rule. In response to the business
the cover sheet is supplied by the
$1,750 printing and mailing costs) x 500 opportunity NPR, the Commission received over government for the purpose of
franchisors)). 17,000 comments, many opposing the inclusion of disclosure to the public, and is thus
multilevel marketing companies under the excluded from the definition of
B. Part 437 proposed rule. Several comments specifically
‘‘collection of information’’ under the
questioned the paperwork burdens that might be
As noted throughout this document, imposed by the part 437 amendments. E.g., DSA, PRA, see 5 CFR 1320.3(c)(2), there are
business opportunities covered by the Business Opportunity NPR. Commission staff is residual costs to print and mail these
original Franchise Rule will remain currently analyzing the comments. For now, cover sheets, including within them the
however, only those businesses opportunities
covered, without any substantive covered by the original Franchise Rule—such as
presentation of related information
change, under part 437 of the amended vending machine and rack display opportunities— beyond the supplied text. Staff estimates
Rule. Part 437 of the amended Rule remain covered under part 437. that 2,500 business opportunity sellers
complete and disseminate 100 cover Subpart D—Instructions (f) Fiscal year refers to the franchisor’s
sheets per year at a cost of 436.6 Instructions for preparing disclosure fiscal year.
approximately $0.55 per cover sheet, or documents. (g) Fractional franchise means a
a total cost of approximately $137,500 436.7 Instructions for updating disclosures. franchise relationship that satisfies the
(2,500 business opportunity sellers x Subpart E—Exemptions following criteria when the relationship
100 cover sheets per year x $0.55 per is created:
436.8 Exemptions. (1) The franchisee, any of the
cover sheet).
Subpart F—Prohibitions franchisee’s current directors or officers,
Accordingly, the cumulative non-
436.9 Additional prohibitions. or any current directors or officers of a
labor cost incurred by business
parent or affiliate, has more than two
opportunity sellers each year due to Subpart G—Other Provisions years of experience in the same type of
compliance with part 437 will be 436.10 Other laws and rules. business; and
approximately $3,887,500 ($3,750,000 436.11 Severability. (2) The parties have a reasonable basis
for printing and mailing documents + Appendix A to Part 436—Sample Item 10 to anticipate that the sales arising from
$137,500 for completing and mailing Table—Summary of Financing Offered the relationship will not exceed 20% of
cover sheets). Appendix B to Part 436—Sample Item 20(1) the franchisee’s total dollar volume in
Thus, the cumulative annual hours Table—Systemwide Outlet Summary sales during the first year of operation.
burden for part 437 of the amended Rule Appendix C to Part 436—Sample Item 20(2)
(h) Franchise means any continuing
Table —Transfers of Franchised Outlets
is approximately 16,750 hours ((30 Appendix D to Part 436—Sample Item 20(3) commercial relationship or
hours of average annual disclosure Table—Status of Franchise Outlets arrangement, whatever it may be called,
burden x 250 new business opportunity Appendix E to Part 436—Sample Item 20(4) in which the terms of the offer or
sellers) + (3 hours of annual disclosure Table—Status of Company-Owned contract specify, or the franchise seller
burden x 2,250 established business Outlets promises or represents, orally or in
opportunity sellers) + (1 hour of annual Appendix F to Part 436—Sample Item 20(5) writing, that:
recordkeeping burden x 2,500 total Table—Projected New Franchised (1) The franchisee will obtain the
business opportunity sellers)). The Outlets right to operate a business that is
cumulative annual labor costs for part identified or associated with the
Authority: 15 U.S.C. 41-58.
437 of the amended Rule is franchisor’s trademark, or to offer, sell,
approximately $3,595,000 (($7,500 Subpart A—Definitions or distribute goods, services, or
attorney costs x 250 new business commodities that are identified or
opportunity sellers) + ($750 attorney § 436.1 Definitions. associated with the franchisor’s
costs x 2,250 established business Unless stated otherwise, the following trademark;
opportunity sellers) + ($13 clerical costs definitions apply throughout part 436: (2) The franchisor will exert or has
x 2,500 total business opportunity (a) Action includes complaints, cross authority to exert a significant degree of
sellers)). Finally, the cumulative annual claims, counterclaims, and third-party control over the franchisee’s method of
non-labor costs for part 437 of the complaints in a judicial action or operation, or provide significant
amended Rule is approximately proceeding, and their equivalents in an assistance in the franchisee’s method of
$3,887,500 (($1,500 printing and administrative action or arbitration. operation; and
mailing costs x 2,500 business (b) Affiliate means an entity (3) As a condition of obtaining or
opportunity sellers) + ($55 cover sheet controlled by, controlling, or under commencing operation of the franchise,
costs x 2500 business opportunity common control with, another entity. the franchisee makes a required
sellers)). (c) Confidentiality clause means any payment or commits to make a required
contract, order, or settlement provision payment to the franchisor or its affiliate.
List of Subjects in 16 CFR Part 436 and that directly or indirectly restricts a (i) Franchisee means any person who
437 current or former franchisee from is granted a franchise.
discussing his or her personal (j) Franchise seller means a person
Advertising, Business and industry, that offers for sale, sells, or arranges for
experience as a franchisee in the
Franchising, Trade practices. the sale of a franchise. It includes the
franchisor’s system with any
VII. FINAL RULE LANGUAGE prospective franchisee. It does not franchisor and the franchisor’s
include clauses that protect franchisor’s employees, representatives, agents,
■ For the reasons set out in this trademarks or other proprietary subfranchisors, and third-party brokers
document, the Commission revises 16 information. who are involved in franchise sales
CFR Part 436 as follows: (d) Disclose, state, describe, and list activities. It does not include existing
each mean to present all material facts franchisees who sell only their own
PART 436—DISCLOSURE accurately, clearly, concisely, and outlet and who are otherwise not
REQUIREMENTS AND PROHIBITIONS legibly in plain English. engaged in franchise sales on behalf of
CONCERNING FRANCHISING (e) Financial performance the franchisor.
representation means any (k) Franchisor means any person who
Subpart A—Definitions representation, including any oral, grants a franchise and participates in the
Sec. written, or visual representation, to a franchise relationship. Unless otherwise
436.1 Definitions. prospective franchisee, including a stated, it includes subfranchisors. For
Subpart B—Franchisor’s Obligations representation in the general media, that purposes of this definition, a
states, expressly or by implication, a ‘‘subfranchisor’’ means a person who
436.2 Obligation to furnish documents.
specific level or range of actual or functions as a franchisor by engaging in
Subpart C—Contents of a Disclosure potential sales, income, gross profits, or both pre-sale activities and post-sale
Document net profits. The term includes a chart, performance.
436.3 Cover page. table, or mathematical calculation that (l) Leased department means an
436.4 Table of contents. shows possible results based on a arrangement whereby a retailer licenses
436.5 Disclosure items. combination of variables. or otherwise permits a seller to conduct
business from the retailer’s location franchisor’s approval or disapproval of (2) Directions for accessing the
where the seller purchases no goods, a transfer alone is not deemed to be document on the Internet were provided
services, or commodities directly or significant involvement. to the prospective franchisee by the
indirectly from the retailer, a person the (u) Signature means a person’s required date; or
retailer requires the seller to do business affirmative step to authenticate his or (3) A paper or tangible electronic copy
with, or a retailer-affiliate if the retailer her identity. It includes a person’s (for example, computer disk or CD-
advises the seller to do business with handwritten signature, as well as a ROM) was sent to the address specified
the affiliate. person’s use of security codes, by the prospective franchisee by first-
(m) Parent means an entity that passwords, electronic signatures, and class United States mail at least three
controls another entity directly, or similar devices to authenticate his or calendar days before the required date.
indirectly through one or more her identity.
subsidiaries. (v) Trademark includes trademarks, Subpart C—Contents of a Disclosure
(n) Person means any individual, service marks, names, logos, and other Document
group, association, limited or general commercial symbols.
partnership, corporation, or any other § 436.3 Cover page.
(w) Written or in writing means any Begin the disclosure document with a
entity.
(o) Plain English means the document or information in printed cover page, in the order and form as
organization of information and form or in any form capable of being follows:
language usage understandable by a preserved in tangible form and read. It (a) The title ‘‘FRANCHISE
person unfamiliar with the franchise includes: type-set, word processed, or DISCLOSURE DOCUMENT’’ in capital
business. It incorporates short handwritten document; information on letters and bold type.
sentences; definite, concrete, everyday computer disk or CD-ROM; information (b) The franchisor’s name, type of
language; active voice; and tabular sent via email; or information posted on business organization, principal
presentation of information, where the Internet. It does not include mere business address, telephone number,
possible. It avoids legal jargon, highly oral statements. and, if applicable, email address and
technical business terms, and multiple primary home page address.
Subpart B—Franchisors’ Obligations (c) A sample of the primary business
negatives.
(p) Predecessor means a person from § 436.2 Obligation to furnish documents. trademark that the franchisee will use in
whom the franchisor acquired, directly its business.
In connection with the offer or sale of (d) A brief description of the
or indirectly, the major portion of the a franchise to be located in the United
franchisor’s assets. franchised business.
States of America or its territories, (e) The following statements:
(q) Principal business address means
unless the transaction is exempted (1) The total investment necessary to
the street address of a person’s home
under Subpart E of this part, it is an begin operation of a [franchise system
office in the United States. A principal
unfair or deceptive act or practice in name] franchise is [the total amount of
business address cannot be a post office
violation of Section 5 of the Federal Item 7 (§ 436.5(g))]. This includes [the
box or private mail drop.
(r) Prospective franchisee means any Trade Commission Act: total amount in Item 5 (§ 436.5(e))] that
person (including any agent, (a) For any franchisor to fail to furnish must be paid to the franchisor or
representative, or employee) who a prospective franchisee with a copy of affiliate.
approaches or is approached by a the franchisor’s current disclosure (2) This disclosure document
franchise seller to discuss the possible document, as described in Subparts C summarizes certain provisions of your
establishment of a franchise and D of this part, at least 14 calendar- franchise agreement and other
relationship. days before the prospective franchisee information in plain English. Read this
(s) Required payment means all signs a binding agreement with, or disclosure document and all
consideration that the franchisee must makes any payment to, the franchisor or accompanying agreements carefully.
pay to the franchisor or an affiliate, an affiliate in connection with the You must receive this disclosure
either by contract or by practical proposed franchise sale. document at least 14 calendar-days
necessity, as a condition of obtaining or (b) For any franchisor to alter before you sign a binding agreement
commencing operation of the franchise. unilaterally and materially the terms with, or make any payment to, the
A required payment does not include and conditions of the basic franchise franchisor or an affiliate in connection
payments for the purchase of reasonable agreement or any related agreements with the proposed franchise sale. [The
amounts of inventory at bona fide attached to the disclosure document following sentence in bold type] Note,
wholesale prices for resale or lease. without furnishing the prospective however, that no governmental agency
(t) Sale of a franchise includes an franchisee with a copy of each revised has verified the information contained
agreement whereby a person obtains a agreement at least seven calendar-days in this document.
franchise from a franchise seller for before the prospective franchisee signs (3) The terms of your contract will
value by purchase, license, or otherwise. the revised agreement. Changes to an govern your franchise relationship.
It does not include extending or agreement that arise out of negotiations Don’t rely on the disclosure document
renewing an existing franchise initiated by the prospective franchisee alone to understand your contract. Read
agreement where there has been no do not trigger this seven calendar-day all of your contract carefully. Show your
interruption in the franchisee’s period. contract and this disclosure document
operation of the business, unless the (c) For purposes of paragraphs (a) and to an advisor, like a lawyer or an
new agreement contains terms and (b) of this section, the franchisor has accountant.
conditions that differ materially from furnished the documents by the (4) Buying a franchise is a complex
the original agreement. It also does not required date if: investment. The information in this
include the transfer of a franchise by an (1) A copy of the document was hand- disclosure document can help you make
existing franchisee where the franchisor delivered, faxed, emailed, or otherwise up your mind. More information on
has had no significant involvement with delivered to the prospective franchisee franchising, such as ‘‘A Consumer’s
the prospective transferee. A by the required date; Guide to Buying a Franchise,’’ which
can help you understand how to use Exhibits (C) The length of time each has
this disclosure document, is available A. Franchise Agreement offered franchises in each other line of
from the Federal Trade Commission. business.
You can contact the FTC at 1-877-FTC- § 436.5 Disclosure items. (b) Item 2: Business Experience.
HELP or by writing to the FTC at 600 (a) Item 1: The Franchisor, and any Disclose by name and position the
Pennsylvania Avenue, NW., Parents, Predecessors, and Affiliates. franchisor’s directors, trustees, general
Washington, D.C. 20580. You can also Disclose: partners, principal officers, and any
visit the FTC’s home page at (1) The name and principal business other individuals who will have
www.ftc.gov for additional information. address of the franchisor; any parents; management responsibility relating to
Call your state agency or visit your and any affiliates that offer franchises in the sale or operation of franchises
public library for other sources of any line of business or provide products offered by this document. For each
information on franchising. or services to the franchisees of the person listed in this section, state his or
(5) There may also be laws on franchisor. her principal positions and employers
franchising in your state. Ask your state (2) The name and principal business during the past five years, including
agencies about them. address of any predecessors during the
each position’s starting date, ending
(6) [The issuance date]. 10-year period immediately before the
date, and location.
(f) A franchisor may include the close of the franchisor’s most recent
(c) Item 3: Litigation. (1) Disclose
following statement between the fiscal year.
(3) The name that the franchisor uses whether the franchisor; a predecessor; a
statements set out at paragraphs (e)(2) parent or affiliate who induces franchise
and any names it intends to use to
and (3) of this section: ‘‘You may wish sales by promising to back the
conduct business.
to receive your disclosure document in (4) The identity and principal franchisor financially or otherwise
another format that is more convenient business address of the franchisor’s guarantees the franchisor’s performance;
for you. To discuss the availability of agent for service of process. an affiliate who offers franchises under
disclosures in different formats, contact (5) The type of business organization the franchisor’s principal trademark;
[name or office] at [address] and used by the franchisor (for example, and any person identified in § 436.5(b)
[telephone number].’’ corporation, partnership) and the state of this part:
(g) Franchisors may include in which it was organized. (i) Has pending against that person:
additional disclosures on the cover (6) The following information about (A) An administrative, criminal, or
page, on a separate cover page, or the franchisor’s business and the material civil action alleging a violation
addendum to comply with state pre-sale franchises offered: of a franchise, antitrust, or securities
disclosure laws. (i) Whether the franchisor operates law, or alleging fraud, unfair or
§ 436.4 Table of contents.
businesses of the type being franchised. deceptive practices, or comparable
(ii) The franchisor’s other business allegations.
Include the following table of activities. (B) Civil actions, other than ordinary
contents. State the page where each (iii) The business the franchisee will routine litigation incidental to the
disclosure Item begins. List all exhibits conduct. business, which are material in the
by letter, as shown in the following (iv) The general market for the context of the number of franchisees
example. product or service the franchisee will and the size, nature, or financial
Table of Contents offer. In describing the general market, condition of the franchise system or its
consider factors such as whether the business operations.
1. The Franchisor and any Parents,
Predecessors, and Affiliates market is developed or developing, (ii) Was a party to any material civil
2. Business Experience whether the goods will be sold action involving the franchise
3. Litigation primarily to a certain group, and relationship in the last fiscal year. For
4. Bankruptcy whether sales are seasonal. purposes of this section, ‘‘franchise
5. Initial Fees (v) In general terms, any laws or relationship’’ means contractual
6. Other Fees regulations specific to the industry in obligations between the franchisor and
7. Estimated Initial Investment which the franchise business operates.
8. Restrictions on Sources of Products and franchisee directly relating to the
(vi) A general description of the
Services operation of the franchised business
competition.
(such as royalty payment and training
(7) The prior business experience of
9. Franchisee’s Obligations obligations). It does not include actions
the franchisor; any predecessors listed
10. Financing involving suppliers or other third
11. Franchisor’s Assistance, Advertising,
in § 436.5(a)(2) of this part; and any
parties, or indemnification for tort
Computer Systems, and Training affiliates that offer franchises in any line
liability.
12. Territory of business or provide products or
services to the franchisees of the (iii) Has in the 10-year period
13. Trademarks
14. Patents, Copyrights, and Proprietary franchisor, including: immediately before the disclosure
Information (i) The length of time each has document’s issuance date:
conducted the type of business the (A) Been convicted of or pleaded nolo
15. Obligation to Participate in the Actual franchisee will operate. contendere to a felony charge.
Operation of the Franchise Business (ii) The length of time each has (B) Been held liable in a civil action
16. Restrictions on What the Franchisee May offered franchises providing the type of involving an alleged violation of a
Sell franchise, antitrust, or securities law, or
business the franchisee will operate.
17. Renewal, Termination, Transfer, and involving allegations of fraud, unfair or
Dispute Resolution
(iii) Whether each has offered
franchises in other lines of business. If deceptive practices, or comparable
18. Public Figures
19. Financial Performance Representations so, include: allegations. ‘‘Held liable’’ means that, as
20. Outlets and Franchisee Information (A) A description of each other line of a result of claims or counterclaims, the
21. Financial Statements business. person must pay money or other
22. Contracts (B) The number of franchises sold in consideration, must reduce an
23. Receipts each other line of business. indebtedness by the amount of an
award, cannot enforce its rights, or must conviction, and the sentence or penalty of the debtor to the franchisor (for
take action adverse to its interests. imposed. example, affiliate, officer).
(2) Disclose whether the franchisor; a (4) For any other franchisor-initiated (iii) The date of the original filing and
predecessor; a parent or affiliate who suit identified in paragraph (c)(1)(ii) of the material facts, including the
guarantees the franchisor’s performance; this section, the franchisor may comply bankruptcy court, and the case name
an affiliate who has offered or sold with the requirements of paragraphs and number. If applicable, state the
franchises in any line of business within (c)(3)(i) through (iv) of this section by debtor’s discharge date, including
the last 10 years; or any other person listing individual suits under one
discharges under Chapter 7 and
identified in § 436.5(b) of this part is common heading that will serve as the
confirmation of any plans of
subject to a currently effective case summary (for example, ‘‘royalty
injunctive or restrictive order or decree reorganization under Chapters 11 and
collection suits’’).
resulting from a pending or concluded (d) Item 4: Bankruptcy. (1) Disclose 13 of the Bankruptcy Code.
action brought by a public agency and whether the franchisor; any parent; (3) Disclose cases, actions, and other
relating to the franchise or to a Federal, predecessor; affiliate; officer, or general proceedings under the laws of foreign
State, or Canadian franchise, securities, partner of the franchisor, or any other nations relating to bankruptcy.
antitrust, trade regulation, or trade individual who will have management (e) Item 5: Initial Fees. Disclose the
practice law. responsibility relating to the sale or initial fees and any conditions under
(3) For each action identified in operation of franchises offered by this which these fees are refundable. If the
paragraphs (c)(1) and (2) of this section, document, has, during the 10-year initial fees are not uniform, disclose the
state the title, case number or citation, period immediately before the date of range or formula used to calculate the
the initial filing date, the names of the this disclosure document: initial fees paid in the fiscal year before
parties, the forum, and the relationship (i) Filed as debtor (or had filed against the issuance date and the factors that
of the opposing party to the franchisor it) a petition under the United States determined the amount. For this
(for example, competitor, supplier, Bankruptcy Code (‘‘Bankruptcy Code’’). section, ‘‘initial fees’’ means all fees and
lessor, franchisee, former franchisee, or (ii) Obtained a discharge of its debts payments, or commitments to pay, for
class of franchisees). Except as provided under the Bankruptcy Code. services or goods received from the
in paragraph (c)(4) of this section, (iii) Been a principal officer of a franchisor or any affiliate before the
summarize the legal and factual nature company or a general partner in a franchisee’s business opens, whether
of each claim in the action, the relief partnership that either filed as a debtor payable in lump sum or installments.
sought or obtained, and any conclusions (or had filed against it) a petition under Disclose installment payment terms in
of law or fact.1 In addition, state: the Bankruptcy Code, or that obtained a this section or in § 436.5(j) of this part.
(i) For pending actions, the status of discharge of its debts under the
the action. Bankruptcy Code while, or within one (f) Item 6: Other Fees. Disclose, in the
(ii) For prior actions, the date when year after, the officer or general partner following tabular form, all other fees
the judgment was entered and any held the position in the company. that the franchisee must pay to the
damages or settlement terms.2 (2) For each bankruptcy, state: franchisor or its affiliates, or that the
(iii) For injunctive or restrictive (i) The current name, address, and franchisor or its affiliates impose or
orders, the nature, terms, and conditions principal place of business of the collect in whole or in part for a third
of the order or decree. debtor. party. State the title ‘‘OTHER FEES’’ in
(iv) For convictions or pleas, the (ii) Whether the debtor is the capital letters using bold type. Include
crime or violation, the date of franchisor. If not, state the relationship any formula used to compute the fees.3
ITEM 6 TABLE
OTHER FEES
Column 1 Column 2 Column 3 Column 4

Type of fee Amount Due Date Remarks
(1) In column 1, list the type of fee (3) In column 3, state the due date for (i) Whether the fees are payable only
(for example, royalties, and fees for each fee. to the franchisor.
lease negotiations, construction, (4) In column 4, include remarks, (ii) Whether the fees are imposed and
remodeling, additional training or collected by the franchisor.
definitions, or caveats that elaborate on (iii) Whether the fees are non-
assistance, advertising, advertising the information in the table. If remarks
cooperatives, purchasing cooperatives, refundable or describe the
are long, franchisors may use footnotes circumstances when the fees are
audits, accounting, inventory, transfers, instead of the remarks column. If refundable.
and renewals). applicable, include the following (iv) Whether the fees are uniformly
(2) In column 2, state the amount of information in the remarks column or in imposed.
the fee. a footnote: (v) The voting power of franchisor-
owned outlets on any fees imposed by
1 Franchisors may include a summary opinion of confidential. However, franchisors need not 3 If fees may increase, disclose the formula that
counsel concerning any action if counsel consent to disclose the terms of confidential settlements determines the increase or the maximum amount of
use the summary opinion and the full opinion is entered into before commencing franchise sales. the increase. For example, a percentage of gross
attached to the disclosure document. Further, any franchisor who has historically used sales is acceptable if the franchisor defines the term
only the Franchise Rule format, or who is new to
2 If a settlement agreement must be disclosed in ‘‘gross sales.’’
franchising, need not disclose confidential
this Item, all material settlement terms must be settlements entered prior to the effective date of this
disclosed, whether or not the agreement is Rule.
cooperatives. If franchisor-owned (g) Item 7: Estimated Initial in capital letters using bold type.
outlets have controlling voting power, Investment. Disclose, in the following Franchisors may include additional
disclose the maximum and minimum tabular form, the franchisee’s estimated expenditure tables to show expenditure
fees that may be imposed. initial investment. State the title ‘‘YOUR variations caused by differences such as
ESTIMATED INITIAL INVESTMENT’’ in site location and premises size.
ITEM 7 TABLE:
YOUR ESTIMATED INITIAL INVESTMENT
Column 4
Column 1 Column 2 Column 3 Column 4 To whom payment is to be
Type of expenditure Amount Method of payment When due made
Total.
(1) In column 1: (4) In column 4, state the due date. (i) Whether the franchisor’s criteria
(i) List each type of expense, (5) In column 5, state to whom for approving suppliers are available to
beginning with pre-opening expenses. payment will be made. franchisees.
Include the following expenses, if (6) Total the initial investment, (ii) Whether the franchisor permits
applicable. Use footnotes to include incorporating ranges of fees, if used. franchisees to contract with alternative
remarks, definitions, or caveats that (7) In a footnote, state: suppliers who meet the franchisor’s
elaborate on the information in the (i) Whether each payment is non- criteria.
Table. refundable, or describe the (iii) Any fees and procedures to
(A) The initial franchise fee. circumstances when each payment is secure approval to purchase from
(B) Training expenses. refundable. alternative suppliers.
(C) Real property, whether purchased (ii) If the franchisor or an affiliate (iv) The time period in which the
or leased. finances part of the initial investment, franchisee will be notified of approval
(D) Equipment, fixtures, other fixed the amount that it will finance, the or disapproval.
assets, construction, remodeling, required down payment, the annual (v) How approvals are revoked.
leasehold improvements, and decorating interest rate, rate factors, and the (5) Whether the franchisor issues
costs, whether purchased or leased. estimated loan repayments. Franchisors specifications and standards to
(E) Inventory to begin operating. may refer to § 436.5(j) of this part for franchisees, subfranchisees, or approved
(F) Security deposits, utility deposits, additional details. suppliers. If so, describe how the
business licenses, and other prepaid (h) Item 8: Restrictions on Sources of franchisor issues and modifies
expenses. Products and Services. Disclose the specifications.
(ii) List separately and by name any franchisee’s obligations to purchase or (6) Whether the franchisor or its
other specific required payments (for lease goods, services, supplies, fixtures, affiliates will or may derive revenue or
example, additional training, travel, or equipment, inventory, computer other material consideration from
advertising expenses) that the franchisee hardware and software, real estate, or required purchases or leases by
must make to begin operations. comparable items related to establishing franchisees. If so, describe the precise
(iii) Include a category titled or operating the franchised business basis by which the franchisor or its
‘‘Additional funds— [initial period]’’ for either from the franchisor, its designee, affiliates will or may derive that
any other required expenses the or suppliers approved by the franchisor, consideration by stating:
franchisee will incur before operations or under the franchisor’s specifications. (i) The franchisor’s total revenue.5
begin and during the initial period of Include obligations to purchase imposed (ii) The franchisor’s revenues from all
operations. State the initial period. A by the franchisor’s written agreement or required purchases and leases of
reasonable initial period is at least three by the franchisor’s practice.4 For each products and services.
months or a reasonable period for the applicable obligation, state: (iii) The percentage of the franchisor’s
industry. Describe in general terms the (1) The good or service required to be total revenues that are from required
factors, basis, and experience that the purchased or leased. purchases or leases.
franchisor considered or relied upon in (2) Whether the franchisor or its
(iv) If the franchisor’s affiliates also
formulating the amount required for affiliates are approved suppliers or the
sell or lease products or services to
additional funds. only approved suppliers of that good or
franchisees, the affiliates’ revenues from
(2) In column 2, state the amount of service.
(3) Any supplier in which an officer those sales or leases.
the payment. If the amount is unknown, (7) The estimated proportion of these
of the franchisor owns an interest.
use a low-high range based on the required purchases and leases by the
(4) How the franchisor grants and
franchisor’s current experience. If real franchisee to all purchases and leases by
revokes approval of alternative
property costs cannot be estimated in a the franchisee of goods and services in
suppliers, including:
low-high range, describe the establishing and operating the
approximate size of the property and 4 Franchisors may include the reason for the franchised businesses.
building and the probable location of requirement. Franchisors need not disclose in this
the building (for example, strip Item the purchase or lease of goods or services 5 Take figures from the franchisor’s most recent
shopping center, mall, downtown, rural, provided as part of the franchise without a separate annual audited financial statement required in
charge (such as initial training, if the cost is § 436.5(u) of this part. If audited statements are not
or highway). included in the franchise fee). Describe such fees yet required, or if the entity deriving the income is
(3) In column 3, state the method of in Item 5 of this section. Do not disclose fees an affiliate, disclose the sources of information used
payment. already described in § 436.5(f) of this part. in computing revenues.
(8) If a designated supplier will make (10) Whether the franchisor negotiates a list of the franchisee’s principal
payments to the franchisor from purchase arrangements with suppliers, obligations. State the title
franchisee purchases, disclose the basis including price terms, for the benefit of ‘‘FRANCHISEE’S OBLIGATIONS’’ in
for the payment (for example, specify a franchisees. capital letters using bold type. Cross-
percentage or a flat amount). For (11) Whether the franchisor provides reference each listed obligation with any
purposes of this disclosure, a material benefits (for example, renewal applicable section of the franchise or
‘‘payment’’ includes the sale of similar or granting additional franchises) to a other agreement and with the relevant
goods or services to the franchisor at a franchisee based on a franchisee’s disclosure document provision. If a
lower price than to franchisees. purchase of particular products or particular obligation is not applicable,
services or use of particular suppliers.
(9) The existence of purchasing or (i) Item 9: Franchisee’s Obligations. state ‘‘Not Applicable.’’ Include
distribution cooperatives. Disclose, in the following tabular form, additional obligations, as warranted.
ITEM 9 TABLE:
FRANCHISEE’S OBLIGATIONS
[In bold] This table lists your principal obligations under the franchise and other agreements. It will help you find more detailed
information about your obligations in these agreements and in other items of this disclosure document.
Obligation Section in agreement Disclosure document item
a. Site selection and acquisition/lease
b. Pre-opening purchase/leases
c. Site development and other pre-opening requirements
d. Initial and ongoing training
e. Opening
f. Fees
g. Compliance with standards and policies/operating manual
h. Trademarks and proprietary information
i. Restrictions on products/services offered
j. Warranty and customer service requirements
k. Territorial development and sales quotas
l. Ongoing product/service purchases
m. Maintenance, appearance, and remodeling requirements
n. Insurance
o. Advertising
p. Indemnification
q. Owner’s participation/management/staffing
r. Records and reports
s. Inspections and audits
t. Transfer
u. Renewal
v. Post-termination obligations
w. Non-competition covenants
x. Dispute resolution
y. Other (describe)
(j) Item 10: Financing. (1) Disclose the defenses or other legal rights (for (iv) Hiring and training employees.
terms of each financing arrangement, example, confession of judgment), or (v) Providing for necessary
including leases and installment bars franchisees from asserting a defense equipment, signs, fixtures, opening
contracts, that the franchisor, its agent, against the lender, the lender’s assignee inventory, and supplies. If any such
or affiliates offer directly or indirectly to or the franchisor. If so, describe the assistance is provided, state:
the franchisee.6 The franchisor may relevant provisions. (A) Whether the franchisor provides
summarize the terms of each financing (3) Disclose whether the franchisor’s these items directly or only provides the
arrangement in tabular form, using practice or intent is to sell, assign, or names of approved suppliers.
footnotes to provide additional discount to a third party all or part of (B) Whether the franchisor provides
information. For a sample Item 10 table, the financing arrangement. If so, state: written specifications for these items.
see Appendix A of this part. For each (i) The assignment terms, including (C) Whether the franchisor delivers or
financing arrangement, state: whether the franchisor will remain installs these items.
(i) What the financing covers (for primarily obligated to provide the (2) Disclose the typical length of time
example, the initial franchise fee, site financed goods or services; and between the earlier of the signing of the
acquisition, construction or remodeling, (ii) That the franchisee may lose all its franchise agreement or the first payment
initial or replacement equipment or defenses against the lender as a result of of consideration for the franchise and
fixtures, opening or ongoing inventory the sale or assignment. the opening of the franchisee’s business.
or supplies, or other continuing (4) Disclose whether the franchisor or Describe the factors that may affect the
expenses).7 an affiliate receives any consideration time period, such as ability to obtain a
(ii) The identity of each lender for placing financing with the lender. If lease, financing or building permits,
providing financing and their such payments exist: zoning and local ordinances, weather
relationship to the franchisor (for (i) Disclose the amount or the method conditions, shortages, or delayed
example, affiliate). of determining the payment; and installation of equipment, fixtures, and
(iii) The amount of financing offered (ii) Identify the source of the payment signs.
or, if the amount depends on an actual and the relationship of the source to the (3) Disclose the franchisor’s
cost that may vary, the percentage of the franchisor or its affiliates. obligations to the franchisee during the
cost that will be financed. (k) Item 11: Franchisor’s Assistance, operation of the franchise, including
(iv) The rate of interest, plus finance Advertising, Computer Systems, and any assistance in:
charges, expressed on an annual basis. Training. Disclose the franchisor’s (i) Developing products or services
If the rate of interest, plus finance principal assistance and related the franchisee will offer to its
charges, expressed on an annual basis, obligations of both the franchisor and customers.
may differ depending on when the franchisee as follows. For each (ii) Hiring and training employees.
financing is issued, state what that rate obligation, cite the section number of (iii) Improving and developing the
was on a specified recent date. the franchise agreement imposing the franchised business.
(v) The number of payments or the obligation. Begin by stating the (iv) Establishing prices.
period of repayment. following sentence in bold type: (v) Establishing and using
(vi) The nature of any security interest ‘‘Except as listed below, [the franchisor] administrative, bookkeeping,
required by the lender. is not required to provide you with any accounting, and inventory control
(vii) Whether a person other than the procedures.
assistance.’’
franchisee must personally guarantee (1) Disclose the franchisor’s pre- (vi) Resolving operating problems
the debt. opening obligations to the franchisee, encountered by the franchisee.
(viii) Whether the debt can be prepaid (4) Describe the advertising program
including any assistance in:
and the nature of any prepayment
(i) Locating a site and negotiating the for the franchise system, including the
penalty.
purchase or lease of the site. If such following:
(ix) The franchisee’s potential
assistance is provided, state: (i)The franchisor’s obligation to
liabilities upon default, including any:
(A) Accelerated obligation to pay the (A) Whether the franchisor generally conduct advertising, including:
entire amount due; owns the premises and leases it to the (A) The media the franchisor may use.
(B) Obligations to pay court costs and franchisee. (B) Whether media coverage is local,
attorney’s fees incurred in collecting the (B) Whether the franchisor selects the regional, or national.
debt; site or approves an area in which the (C) The source of the advertising (for
(C) Termination of the franchise; and franchisee selects a site. If so, state example, an in-house advertising
(D) Liabilities from cross defaults further whether and how the franchisor department or a national or regional
such as those resulting directly from must approve a franchisee-selected site. advertising agency).
non-payment, or indirectly from the loss (C) The factors that the franchisor (D) Whether the franchisor must
of business property. considers in selecting or approving sites spend any amount on advertising in the
(x) Other material financing terms. (for example, general location and area or territory where the franchisee is
(2) Disclose whether the loan neighborhood, traffic patterns, parking, located.
agreement requires franchisees to waive size, physical characteristics of existing (ii) The circumstances when the
buildings, and lease terms). franchisor will permit franchisees to use
6 Indirect offers of financing include a written (D) The time limit for the franchisor their own advertising material.
arrangement between a franchisor or its affiliate and to locate or approve or disapprove the (iii) Whether there is an advertising
a lender, for the lender to offer financing to a
franchisee; an arrangement in which a franchisor or
site and the consequences if the council composed of franchisees that
its affiliate receives a benefit from a lender in franchisor and franchisee cannot agree advises the franchisor on advertising
exchange for financing a franchise purchase; and a on a site. policies. If so, disclose:
franchisor’s guarantee of a note, lease, or other (ii) Conforming the premises to local (A) How members of the council are
obligation of the franchisee. selected.
7 Include sample copies of the financing
ordinances and building codes and
documents as an exhibit to § 436.5(v) of this part. obtaining any required permits. (B) Whether the council serves in an
Cite the section and name of the document (iii) Constructing, remodeling, or advisory capacity only or has
containing the financing terms and conditions. decorating the premises. operational or decision-making power.
(C) Whether the franchisor has the (C) Whether the franchisor-owned ongoing maintenance, repairs, upgrades,
power to form, change, or dissolve the outlets must contribute to the fund and, or updates.
advertising council. if so, whether it is on the same basis as (iii) Any obligations of the franchisee
(iv) Whether the franchisee must franchisees. to upgrade or update any system during
participate in a local or regional (D) Who administers the fund. the term of the franchise, and, if so, any
advertising cooperative. If so, state: (E) Whether the fund is audited and contractual limitations on the frequency
(A) How the area or membership of when it is audited. and cost of the obligation.
the cooperative is defined.
(B) How much the franchisee must (F) Whether financial statements of (iv) The annual cost of any optional
contribute to the fund and whether the fund are available for review by the or required maintenance, updating,
other franchisees must contribute a franchisee. upgrading, or support contracts.
different amount or at a different rate. (G) How the funds were used in the
(v) Whether the franchisor will have
(C) Whether the franchisor-owned most recently concluded fiscal year,
independent access to the information
outlets must contribute to the fund and, including the percentages spent on
that will be generated or stored in any
if so, whether those contributions are on production, media placement,
electronic cash register or computer
the same basis as those for franchisees. administrative expenses, and a
system. If so, describe the information
(D) Who is responsible for description of any other use.
that the franchisor may access and
administering the cooperative (for (vi) If not all advertising funds are whether there are any contractual
example, franchisor, franchisees, or spent in the fiscal year in which they limitations on the franchisor’s right to
advertising agency). accrue, how the franchisor uses the access the information.
(E) Whether cooperatives must remaining amount, including whether
operate from written governing franchisees receive a periodic (6) Disclose the table of contents of
documents and whether the documents accounting of how advertising fees are the franchisor’s operating manual
are available for the franchisee to spent. provided to franchisees as of the
review. (vii) The percentage of advertising franchisor’s last fiscal year-end or a
(F) Whether cooperatives must funds, if any, that the franchisor uses more recent date. State the number of
prepare annual or periodic financial principally to solicit new franchise pages devoted to each subject and the
statements and whether the statements sales. total number of pages in the manual as
are available for review by the (5) Disclose whether the franchisor of this date. This disclosure may be
franchisee. omitted if the franchisor offers the
requires the franchisee to buy or use
(G) Whether the franchisor has the prospective franchisee the opportunity
electronic cash registers or computer
power to require cooperatives to be to view the manual before buying the
formed, changed, dissolved, or merged. systems. If so, describe the systems
generally in non-technical language, franchise.
(v) Whether the franchisee must
including the types of data to be (7) Disclose the franchisor’s training
participate in any other advertising
generated or stored in these systems, program as of the franchisor’s last fiscal
fund. If so, state:
(A) Who contributes to the fund. and state the following: year-end or a more recent date.
(B) How much the franchisee must (i) The cost of purchasing or leasing (i) Describe the training program in
contribute to the fund and whether the systems. the following tabular form. Title the
other franchisees must contribute a (ii) Any obligation of the franchisor, table ‘‘TRAINING PROGRAM’’ in
different amount or at a different rate. any affiliate, or third party to provide capital letters and bold type.
ITEM 11 TABLE
TRAINING PROGRAM

Subject Hours of Classroom Training Hours of On-The-Job Training Location
(A) In column 1, state the subjects experience relevant to the subject taught (E) Whether additional training
taught. and the franchisor’s operations. programs or refresher courses are
(B) In column 2, state the hours of (C) Any charges franchisees must pay required.
classroom training for each subject. for training and who must pay travel (l) Item 12: Territory.
(C) In column 3, state the hours of on- and living expenses of the training Disclose:
the-job training for each subject. program enrollees.
(D) In column 4, state the location of (1) Whether the franchise is for a
the training for each subject. (D) Who may and who must attend specific location or a location to be
(ii) State further: training. State whether the franchisee or approved by the franchisor.
(A) How often training classes are other persons must complete the (2) Any minimum territory granted to
held and the nature of the location or program to the franchisor’s satisfaction. the franchisee (for example, a specific
facility where training is held (for If successful completion is required, radius, a distance sufficient to
example, company, home, office, state how long after signing the encompass a specified population, or
franchisor-owned store). agreement or before opening the another specific designation).
(B) The nature of instructional business the training must be (3) The conditions under which the
materials and the instructor’s completed. If training is not mandatory, franchisor will approve the relocation of
experience, including the instructor’s state the percentage of new franchisees the franchised business or the
length of experience in the field and that enrolled in the training program franchisee’s establishment of additional
with the franchisor. State only during the preceding 12 months. franchised outlets.
(4) Franchisee options, rights of first (iii) If the franchisor or an affiliate federally registered trademark. If our
refusal, or similar rights to acquire operates, franchises, or has plans to right to use the trademark is challenged,
additional franchises. operate or franchise a business under a you may have to change to an
(5) Whether the franchisor grants an different trademark and that business alternative trademark, which may
exclusive territory. sells or will sell goods or services increase your expenses.’’
(i) If the franchisor does not grant an similar to those the franchisee will offer, (5) Disclose any currently effective
exclusive territory, state: ‘‘You will not describe: material determinations of the United
receive an exclusive territory. You may (A) The similar goods and services. States Patent and Trademark Office, the
face competition from other franchisees, (B) The different trademark. Trademark Trial and Appeal Board, or
from outlets that we own, or from other (C) Whether outlets will be franchisor any state trademark administrator or
channels of distribution or competitive owned or operated. court; and any pending infringement,
brands that we control.’’ (D) Whether the franchisor or its opposition, or cancellation proceeding.
(ii) If the franchisor grants an franchisees who use the different Include infringement, opposition, or
exclusive territory, disclose: trademark will solicit or accept orders cancellation proceedings in which the
(A) Whether continuation of territorial within the franchisee’s territory. franchisor unsuccessfully sought to
exclusivity depends on achieving a (E) The timetable for the plan. prevent registration of a trademark in
certain sales volume, market (F) How the franchisor will resolve order to protect a trademark licensed by
penetration, or other contingency, and conflicts between the franchisor and the franchisor. Describe how the
the circumstances when the franchisee’s franchisees and between the franchisees determination affects the ownership,
territory may be altered. Describe any of each system regarding territory, use, or licensing of the trademark.
sales or other conditions. State the customers, and franchisor support. (6) Disclose any pending material
(G) The principal business address of federal or state court litigation regarding
franchisor’s rights if the franchisee fails
the franchisor’s similar operating the franchisor’s use or ownership rights
to meet the requirements.
business. If it is the same as the in a trademark. For each pending action,
(B) Any other circumstances that
franchisor’s principal business address disclose:8
permit the franchisor to modify the (i) The forum and case number.
stated in § 436.5(a) of this part, disclose
franchisee’s territorial rights (for (ii) The nature of claims made
whether the franchisor maintains (or
example, a population increase in the opposing the franchisor’s use of the
plans to maintain) physically separate
territory giving the franchisor the right trademark or by the franchisor opposing
offices and training facilities for the
to grant an additional franchise in the another person’s use of the trademark.
similar competing business.
area) and the effect of such (m) Item 13: Trademarks. (1) Disclose (iii) Any effective court or
modifications on the franchisee’s rights. each principal trademark to be licensed administrative agency ruling in the
(6) For all territories (exclusive and to the franchisee. For this Item, matter.
non-exclusive): ‘‘principal trademark’’ means the (7) Disclose any currently effective
(i) Any restrictions on the franchisor primary trademarks, service marks, agreements that significantly limit the
from soliciting or accepting orders from names, logos, and commercial symbols franchisor’s rights to use or license the
consumers inside the franchisee’s the franchisee will use to identify the use of trademarks listed in this section
territory, including: franchised business. It may not include in a manner material to the franchise.
(A) Whether the franchisor or an every trademark the franchisor owns. For each agreement, disclose:
affiliate has used or reserves the right to (2) Disclose whether each principal (i) The manner and extent of the
use other channels of distribution, such trademark is registered with the United limitation or grant.
as the Internet, catalog sales, States Patent and Trademark Office. If (ii) The extent to which the agreement
telemarketing, or other direct marketing so, state: may affect the franchisee.
sales, to make sales within the (i) The date and identification number (iii) The agreement’s duration.
franchisee’s territory using the (iv) The parties to the agreement.
of each trademark registration. (v) The circumstances when the
franchisor’s principal trademarks. (ii) Whether the franchisor has filed
(B) Whether the franchisor or an agreement may be canceled or modified.
all required affidavits. (vi) All other material terms.
affiliate has used or reserves the right to (iii) Whether any registration has been (8) Disclose:
use other channels of distribution, such renewed. (i) Whether the franchisor must
as the Internet, catalog sales, (iv) Whether the principal trademarks protect the franchisee’s right to use the
telemarketing, or other direct marketing, are registered on the Principal or principal trademarks listed in this
to make sales within the franchisee’s Supplemental Register of the United section, and must protect the franchisee
territory of products or services under States Patent and Trademark Office. against claims of infringement or unfair
trademarks different from the ones the (3) If the principal trademark is not competition arising out of the
franchisee will use under the franchise registered with the United States Patent franchisee’s use of the trademarks.
agreement. and Trademark Office, state whether the (ii) The franchisee’s obligation to
(C) Any compensation that the franchisor has filed any trademark notify the franchisor of the use of, or
franchisor must pay for soliciting or application, including any ‘‘intent to claims of rights to, a trademark identical
accepting orders from inside the use’’ application or an application based to or confusingly similar to a trademark
franchisee’s territory. on actual use. If so, state the date and licensed to the franchisee.
(ii) Any restrictions on the franchisee identification number of the (iii) Whether the franchise agreement
from soliciting or accepting orders from application. requires the franchisor to take
consumers outside of his or her (4) If the trademark is not registered
territory, including whether the on the Principal Register of the United 8 The franchisor may include an attorney’s
franchisee has the right to use other States Patent and Trademark Office, opinion relative to the merits of litigation or of an
channels of distribution, such as the state: ‘‘We do not have a federal action if the attorney issuing the opinion consents
to its use. The text of the disclosure may include
Internet, catalog sales, telemarketing, or registration for our principal trademark. a summary of the opinion if the full opinion is
other direct marketing, to make sales Therefore, our trademark does not have attached and the attorney issuing the opinion
outside of his or her territory. many legal benefits and rights as a consents to the use of the summary.
affirmative action when notified of these Patent and Trademark Office, the United or trade secrets, describe in general
uses or claims. States Copyright Office, or a court terms the proprietary information
(iv) Whether the franchisor or regarding the patent or copyright. communicated to the franchisee and the
franchisee has the right to control any Include the forum and matter number. terms for use by the franchisee. The
administrative proceedings or litigation Describe how the determination affects franchisor need only describe the
involving a trademark licensed by the the franchised business. general nature of the proprietary
franchisor to the franchisee. (3) State the forum, case number, information, such as whether a formula
(v) Whether the franchise agreement claims asserted, issues involved, and or recipe is considered to be a trade
requires the franchisor to participate in effective determinations for any material secret.
the franchisee’s defense and/or proceeding pending in the United States (o) Item 15: Obligation to Participate
indemnify the franchisee for expenses Patent and Trademark Office or any in the Actual Operation of the Franchise
or damages if the franchisee is a party court.9 Business. (1) Disclose the franchisee’s
to an administrative or judicial (4) If an agreement limits the use of obligation to participate personally in
proceeding involving a trademark the patent, patent application, or the direct operation of the franchisee’s
licensed by the franchisor to the copyright, state the parties to and business and whether the franchisor
franchisee, or if the proceeding is duration of the agreement, the extent to recommends participation. Include
resolved unfavorably to the franchisee. which the agreement may affect the obligations arising from any written
(vi) The franchisee’s rights under the franchisee, and other material terms of agreement or from the franchisor’s
franchise agreement if the franchisor the agreement. practice.
requires the franchisee to modify or (5) Disclose the franchisor’s obligation (2) If personal ‘‘on-premises’’
discontinue using a trademark. to protect the patent, patent application, supervision is not required, disclose the
(9) Disclose whether the franchisor or copyright; and to defend the following:
knows of either superior prior rights or franchisee against claims arising from (i) If the franchisee is an individual,
infringing uses that could materially the franchisee’s use of patented or whether the franchisor recommends on-
affect the franchisee’s use of the copyrighted items, including: premises supervision by the franchisee.
principal trademarks in the state where (i) Whether the franchisor’s obligation (ii) Limits on whom the franchisee
the franchised business will be located. is contingent upon the franchisee can hire as an on-premises supervisor.
notifying the franchisor of any (iii) Whether an on-premises
For each use of a principal trademark
infringement claims or whether the supervisor must successfully complete
that the franchisor believes is an
franchisee’s notification is the franchisor’s training program.
infringement that could materially affect (iv) If the franchisee is a business
the franchisee’s use of a trademark, discretionary.
(ii) Whether the franchise agreement entity, the amount of equity interest, if
disclose: any, that the on-premises supervisor
(i) The nature of the infringement. requires the franchisor to take
affirmative action when notified of must have in the franchisee’s business.
(ii) The locations where the (3) Disclose any restrictions that the
infringement is occurring. infringement.
(iii) Who has the right to control any franchisee must place on its manager
(iii) The length of time of the (for example, maintain trade secrets,
infringement (to the extent known). litigation.
(iv) Whether the franchisor must covenants not to compete).
(iv) Any action taken or anticipated (p) Item 16: Restrictions on What the
by the franchisor. participate in the defense of a franchisee
or indemnify the franchisee for Franchisee May Sell. Disclose any
(n) Item 14: Patents, Copyrights, and franchisor-imposed restrictions or
Proprietary Information. (1) Disclose expenses or damages in a proceeding
involving a patent, patent application, conditions on the goods or services that
whether the franchisor owns rights in, the franchisee may sell or that limit
or licenses to, patents or copyrights that or copyright licensed to the franchisee.
(v) Whether the franchisor’s access to customers, including:
are material to the franchise. Also, (1) Any obligation on the franchisee to
disclose whether the franchisor has any obligation is contingent upon the
franchisee modifying or discontinuing sell only goods or services approved by
pending patent applications that are the franchisor.
material to the franchise. If so, state: the use of the subject matter covered by
(2) Any obligation on the franchisee to
(i) The nature of the patent, patent the patent or copyright.
(vi) The franchisee’s rights under the sell all goods or services authorized by
application, or copyright and its the franchisor.
franchise agreement if the franchisor
relationship to the franchise. (3) Whether the franchisor has the
(ii) For each patent: requires the franchisee to modify or right to change the types of authorized
(A) The duration of the patent. discontinue using the subject matter goods or services and whether there are
(B) The type of patent (for example, covered by the patent or copyright. limits on the franchisor’s right to make
mechanical, process, or design). (6) If the franchisor knows of any
changes.
(C) The patent number, issuance date, patent or copyright infringement that (q) Item 17: Renewal, Termination,
and title. could materially affect the franchisee, Transfer, and Dispute Resolution.
(iii) For each patent application: disclose: Disclose, in the following tabular form,
(A) The type of patent application (for (i) The nature of the infringement.
a table that cross-references each
(ii) The locations where the
example, mechanical, process, or enumerated franchise relationship item
infringement is occurring.
design). (iii) The length of time of the with the applicable provision in the
(B) The serial number, filing date, and franchise or related agreement. Title the
infringement (to the extent known).
title. (iv) Any action taken or anticipated table ‘‘THE FRANCHISE
(iv) For each copyright: by the franchisor. RELATIONSHIP’’ in capital letters and
(A) The duration of the copyright. (7) If the franchisor claims proprietary bold type.
(B) The registration number and date. rights in other confidential information (1) Describe briefly each contractual
(C) Whether the franchisor can and provision. If a particular item is not
intends to renew the copyright. 9 If counsel consents, the franchisor may include applicable, state ‘‘Not Applicable.’’
(2) Describe any current material a counsel’s opinion or a summary of the opinion if (2) If the agreement is silent about one
determination of the United States the full opinion is attached. of the listed provisions, but the
franchisor unilaterally offers to provide (3) In the summary column for Item contract with materially different terms
certain benefits or protections to 17(c), state what the term ‘‘renewal’’ and conditions than their original
franchisees as a matter of policy, use a means for your franchise system, contract.
footnote to describe the policy and state including, if applicable, a statement that
whether the policy is subject to change. franchisees may be asked to sign a
ITEM 17 TABLE:
THE FRANCHISE RELATIONSHIP
[In bold] This table lists certain important provisions of the franchise and related agreements. You should read these provisions in the
agreements attached to this disclosure document.
Section in franchise or other

Provision Summary
agreement
a. Length of the franchise term
b. Renewal or extension of the term
c. Requirements for franchisee to renew or extend
d. Termination by franchisee
e. Termination by franchisor without cause
f. Termination by franchisor with cause
g. ‘‘Cause’’ defined—curable defaults
h. ‘‘Cause’’ defined—non-curable defaults
i. Franchisee’s obligations on termination/non-renewal
j. Assignment of contract by franchisor
k. ‘‘Transfer’’ by franchisee—defined
l. Franchisor approval of transfer by franchisee
m. Conditions for franchisor approval of transfer
n. Franchisor’s right of first refusal to acquire franchisee’s business
o. Franchisor’s option to purchase franchisee’s business
p. Death or disability of franchisee
q. Non-competition covenants during the term of the franchise
r. Non-competition covenants after the franchise is terminated or expires
s. Modification of the agreement
t. Integration/merger clause
u. Dispute resolution by arbitration or mediation
v. Choice of forum
w. Choice of law
(r) Item 18: Public Figures. public figure’s position and duties in generally known to the public in the
Disclose: the franchisor’s business structure. geographic area where the franchise will
(1) Any compensation or other benefit (3) The public figure’s total be located.
investment in the franchisor, including (s) Item 19: Financial Performance
given or promised to a public figure
the amount the public figure Representations.
arising from either the use of the public
contributed in services performed or to (1) Begin by stating the following:
figure in the franchise name or symbol,
or the public figure’s endorsement or be performed. State the type of The FTC’s Franchise Rule permits a
recommendation of the franchise to investment (for example, common stock, franchisor to provide information about
promissory note). the actual or potential financial

prospective franchisees.
performance of its franchised and/or
(2) The extent to which the public (4) For purposes of this section, a franchisor-owned outlets, if there is a
figure is involved in the management or public figure means a person whose reasonable basis for the information, and
control of the franchisor. Describe the name or physical appearance is if the information is included in the
disclosure document. Financial (ii) If the representation relates to past franchisee’s sales, the cost of goods or
performance information that differs performance of the franchise system’s services sold, and operating expenses.
from that included in Item 19 may be existing outlets, the material bases for (iv) A clear and conspicuous
given only if: (1) a franchisor provides the representation, including:
the actual records of an existing outlet admonition that a new franchisee’s
(A) Whether the representation relates individual financial results may differ
you are considering buying; or (2) a
franchisor supplements the information
to the performance of all of the franchise from the result stated in the financial
provided in this Item 19, for example, by system’s existing outlets or only to a performance representation.
providing information about possible subset of outlets that share a particular (v) A statement that written
performance at a particular location or set of characteristics (for example, substantiation for the financial
under particular circumstances. geographic location, type of location performance representation will be
(2) If a franchisor does not provide (such as free standing vs. shopping made available to the prospective
any financial performance center), degree of competition, length of franchisee upon reasonable request.
representation in Item 19, also state: time the outlets have operated, services
or goods sold, services supplied by the (4) If a franchisor wishes to disclose
We do not make any representations franchisor, and whether the outlets are only the actual operating results for a
about a franchisee’s future financial franchised or franchisor-owned or specific outlet being offered for sale, it
performance or the past financial
operated). need not comply with this section,
performance of company-owned or provided the information is given only
(B) The dates when the reported level
franchised outlets. We also do not to potential purchasers of that outlet.
authorize our employees or of financial performance was achieved.
(C) The total number of outlets that (5) If a franchisor furnishes financial
representatives to make any such
representations either orally or in existed in the relevant period and, if performance information according to
writing. If you are purchasing an existing different, the number of outlets that had this section, the franchisor may deliver
outlet, however, we may provide you the described characteristics. to a prospective franchisee a
with the actual records of that outlet. If (D) The number of outlets with the supplemental financial performance
you receive any other financial described characteristics whose actual representation about a particular
performance information or projections financial performance data were used in location or variation, apart from the
of your future income, you should report arriving at the representation. disclosure document. The supplemental
it to the franchisor’s management by (E) Of those outlets whose data were representation must:
contacting [name, address, and used in arriving at the representation,
telephone number], the Federal Trade (i) Be in writing.
the number and percent that actually (ii) Explain the departure from the
Commission, and the appropriate state
regulatory agencies.
attained or surpassed the stated results. financial performance representation in
(F) Characteristics of the included the disclosure document.
(3) If the franchisor makes any outlets, such as those characteristics
financial performance representation to noted in paragraph (3)(ii)(A) of this (iii) Be prepared in accordance with
prospective franchisees, the franchisor section, that may differ materially from the requirements of paragraph (s)(3)(i)-
must have a reasonable basis and those of the outlet that may be offered (iv) of this section.
written substantiation for the to a prospective franchisee. (iv) Be furnished to the prospective
representation at the time the (iii) If the representation is a forecast franchisee.
representation is made and must state of future financial performance, state (t) Item 20: Outlets and Franchisee
the representation in the Item 19 the material bases and assumptions on Information. (1) Disclose, in the
disclosure. The franchisor must also which the projection is based. The following tabular form, the total number
disclose the following: material assumptions underlying a of franchised and company-owned
(i) Whether the representation is an forecast include significant factors upon outlets for each of the franchisor’s last
historic financial performance which a franchisee’s future results are three fiscal years. For purposes of this
representation about the franchise expected to depend. These factors section, ‘‘outlet’’ includes outlets of a
system’s existing outlets, or a subset of include, for example, economic or type substantially similar to that offered
those outlets, or is a forecast of the market conditions that are basic to a to the prospective franchisee. A sample
prospective franchisee’s future financial franchisee’s operation, and encompass Item 20(1) Table is attached as
performance. matters affecting, among other things, a Appendix B to this part.
ITEM 20 TABLE NO. 1

Systemwide Outlet Summary
For years [ ] to [ ]
Column 3 Column 4
Column 1 Column 2 Column 5
Outlets at the Start of the Outlets at the End of the
Outlet Type Year Net Change
Year Year
Franchised 2004
2005
2006
Company-Owned 2004
2005
2006
ITEM 20 TABLE NO. 1—Continued

Column 3 Column 4
Year Year
Total Outlets 2004
2005
2006
(i) In column 1, include three outlet (2) Disclose, in the following tabular describe the types of changes involved
categories titled ‘‘franchised,’’ form, the number of franchised and and the order in which the changes
‘‘company-owned, and ‘‘total outlets.’’ company-owned outlets and changes in occurred.
(ii) In column 2, state the last three the number and ownership of outlets (i) Disclose, in the following tabular
fiscal years. located in each state during each of the
(iii) In column 3, state the total form, the total number of franchised
last three fiscal years. Except as noted, outlets transferred in each state during
number of each type of outlet operating each change in ownership shall be
at the beginning of each fiscal year. each of the franchisor’s last three fiscal
(iv) In column 4, state the total reported only once in the following years. For purposes of this section,
number of each type of outlet operating tables. If multiple events occurred in the ‘‘transfer’’ means the acquisition of a
at the end of each fiscal year. process of transferring ownership of an controlling interest in a franchised
(v) In column 5, state the net change, outlet, report the event that occurred outlet, during its term, by a person other
and indicate whether the change is last in time. If a single outlet changed than the franchisor or an affiliate. A
positive or negative, for each type of ownership two or more times during the sample Item 20(2) Table is attached as
outlet during each fiscal year. same fiscal year, use footnotes to Appendix C to this part.
ITEM 20 TABLE NO. 2
Transfers of Outlets from Franchisees to New Owners (other than the Franchisor)

State Year Number of Transfers
2004
2005
2006
2004
2005
2006
Total 2004
2005
2006
(A) In column 1, list each state with (C) In column 3, state the total outlets located in each state for each of
one or more franchised outlets. number of completed transfers in each the franchisor’s last three fiscal years. A
(B) In column 2, state the last three state during each fiscal year. sample Item 20(3) Table is attached as
(ii) Disclose, in the following tabular Appendix D to this part.
fiscal years.
form, the status of franchisee-owned
ITEM 20 TABLE NO. 3

Status of Franchised Outlets
Column 8 Column 9
Column 1 Column 2 Column 5 Ceased Oper- Outlets at
Outlets at Outlets Non-Renew- Reacquired by
State Year Terminations ations-Other End of the
Start of Year Opened als Franchisor Reasons Year
2004
2005
2006
2004
2005
2006
Totals 2004
2005
2006
(A) In column 1, list each state with ‘‘termination’’ means the franchisor’s forgiveness or assumption of debt) of a
one or more franchised outlets. termination of a franchise agreement franchised outlet during its term. (Also
(B) In column 2, state the last three prior to the end of its term and without report franchised outlets reacquired by
fiscal years. providing any consideration to the the franchisor in column 5 of Table 4).
(C) In column 3, state the total franchisee (whether by payment or (H) In column 8, state the total
number of franchised outlets in each forgiveness or assumption of debt). number of outlets in each state not
state at the start of each fiscal year. operating as one of the franchisor’s
(D) In column 4, state the total (F) In column 6, state the total number
of non-renewals in each state during outlets at the end of each fiscal year for
number of franchised outlets opened in
each fiscal year. For purposes of this reasons other than termination, non-
each state during each fiscal year.
section, ‘‘non-renewal’’ occurs when the renewal, or reacquisition by the
Include both new outlets and existing
franchise agreement for a franchised franchisor.
company-owned outlets that a
franchisee purchased from the outlet is not renewed at the end of its (I) In column 9, state the total number
franchisor. (Also report the number of term. of franchised outlets in each state at the
existing company-owned outlets that are (G) In column 7, state the total end of the fiscal year.
sold to a franchisee in Column 7 of number of franchised outlets reacquired (iii) Disclose, in the following tabular
Table 4). by the franchisor in each state during form, the status of company-owned
(E) In column 5, state the total number each fiscal year. For purposes of this outlets located in each state for each of
of franchised outlets that were section, a ‘‘reacquisition’’ means the the franchisor’s last three fiscal years. A
terminated in each state during each franchisor’s acquisition for sample Item 20(4) Table is attached as
fiscal year. For purposes of this section, consideration (whether by payment or Appendix E to this part.
ITEM 20 TABLE NO. 4

Status of Company-Owned Outlets
Column 8
Column 1 Column 2 Column 4 Column 6 Outlets at
Outlets at Outlets Reacquired Outlets Sold to
State Year Outlets Opened Outlets Closed End of the
Start of Year From Franchisee Franchisee Year
2004
2005
2006
2004
2005
2006
Totals 2004
ITEM 20 TABLE NO. 4—Continued

Column 8
Start of Year From Franchisee Franchisee Year
2005
2006
(A) In column 1, list each state with franchisees in each state during each to franchisees in each state during each
one or more company-owned outlets. fiscal year. fiscal year.
(B) In column 2, state the last three (F) In column 6, state the total number (H) In column 8, state the total
fiscal years.
(C) In column 3, state the total of company-owned outlets closed in number of company-owned outlets
number of company-owned outlets in each state during each fiscal year. operating in each state at the end of
each state at the start of the fiscal year. Include both actual closures and each fiscal year.
(D) In column 4, state the total instances when an outlet ceases to (3) Disclose, in the following tabular
number of company-owned outlets operate under the franchisor’s form, projected new franchised and
opened in each state during each fiscal trademark. company-owned outlets. A sample Item
year. (G) In column 7, state the total 20(5) Table is attached as Appendix F
(E) In column 5, state the total number number of company-owned outlets sold to this part.
of franchised outlets reacquired from
ITEM 20 TABLE NO. 5

Projected Openings As Of [Last Day of Last Fiscal Year]

Column 1 Franchise Agreements Signed But Projected New Franchised Outlet Projected New Company-Owned
State Outlet Not Opened In The Next Fiscal Year Outlet In the Next Fiscal Year
Total
(i) In column 1, list each state where closest states until at least 100 information may be attached as an
one or more franchised or company- franchised outlets are listed. addendum to a disclosure document, or,
owned outlets are located or are (5) Disclose the name, city and state, if disclosure has already been made,
projected to be located. and current business telephone number, then in a supplement to the previously
(ii) In column 2, state the total or if unknown, the last known home furnished disclosure document.
number of franchise agreements that telephone number of every franchisee (i) The name, city and state, current
had been signed for new outlets to be who had an outlet terminated, canceled, business telephone number, or if
located in each state as of the end of the not renewed, or otherwise voluntarily or unknown, last known home telephone
previous fiscal year where the outlet involuntarily ceased to do business number of each previous owner of the
had not yet opened. under the franchise agreement during outlet;
the most recently completed fiscal year (ii) The time period when each
(iii) In column 3, state the total or who has not communicated with the previous owner controlled the outlet;
number of new franchised outlets in franchisor within 10 weeks of the (iii) The reason for each previous
each state projected to be opened during disclosure document issuance date.10 change in ownership (for example,
the next fiscal year. State in immediate conjunction with termination, non-renewal, voluntary
(iv) In column 4, state the total this information: ‘‘If you buy this transfer, ceased operations); and
number of new company-owned outlets franchise, your contact information may (iv) The time period(s) when the
in each state that are projected to be be disclosed to other buyers when you franchisor retained control of the outlet
opened during the next fiscal year. leave the franchise system.’’ (for example, after termination, non-
(4) Disclose the names of all current (6) If a franchisor is selling a renewal, or reacquisition).
franchisees and the address and previously-owned franchised outlet now (7) Disclose whether franchisees
telephone number of each of their under its control, disclose the following signed confidentiality clauses during
outlets. Alternatively, disclose this additional information for that outlet for the last three fiscal years. If so, state the
the last five fiscal years. This
information for all franchised outlets in following: ‘‘In some instances, current
the state, but if these franchised outlets 10 Franchisors may substitute alternative contact
and former franchisees sign provisions
total fewer than 100, disclose this information at the request of the former franchisee,
restricting their ability to speak openly
information for franchised outlets from such as a home address, post office address, or a about their experience with [name of
contiguous states and then the next personal or business email address. franchise system]. You may wish to
speak with current and former has no obligation to verify the franchisor may include financial
franchisees, but be aware that not all organization’s continued existence at statements of any of its affiliates if the
such franchisees will be able to the end of each fiscal year. Franchisors affiliate’s financial statements satisfy
communicate with you.’’ Franchisors may also include the following paragraphs (u)(1)(i) and (ii) of this
may also disclose the number and statement: ‘‘The following independent section and the affiliate absolutely and
percentage of current and former franchisee organizations have asked to unconditionally guarantees to assume
franchisees who during each of the last be included in this disclosure the duties and obligations of the
three fiscal years signed agreements that document.’’ franchisor under the franchise
include confidentiality clauses and may (u) Item 21: Financial Statements. (1) agreement. The affiliate’s guarantee
disclose the circumstances under which Include the following financial must cover all of the franchisor’s
such clauses were signed. statements prepared according to United obligations to the franchisee, but need
(8) Disclose, to the extent known, the States generally accepted accounting not extend to third parties. If this
name, address, telephone number, email principles, as revised by any future alternative is used, attach a copy of the
address, and Web address (to the extent United States government mandated guarantee to the disclosure document.
known) of each trademark-specific accounting principles, or as permitted (iv) When a franchisor owns a direct
franchisee organization associated with by the Securities and Exchange or beneficial controlling financial
the franchise system being offered, if Commission. Except as provided in interest in a subsidiary, its financial
such organization: paragraph (u)(2) of this section, these statements should reflect the financial
(i) Has been created, sponsored, or financial statements must be audited by condition of the franchisor and its
endorsed by the franchisor. If so, state an independent certified public subsidiary.
the relationship between the accountant using generally accepted
organization and the franchisor (for (v) Include separate financial
United States auditing standards.
example, the organization was created statements for the franchisor and any
Present the required financial
by the franchisor, sponsored by the subfranchisor, as well as for any parent
statements in a tabular form that
franchisor, or endorsed by the that commits to perform post-sale
compares at least two fiscal years.
franchisor). (i) The franchisor’s balance sheet for obligations for the franchisor or
(ii) Is incorporated or otherwise the previous two fiscal year-ends before guarantees the franchisor’s obligations.
organized under state law and asks the the disclosure document issuance date. Attach a copy of any guarantee to the
franchisor to be included in the (ii) Statements of operations, disclosure document.
franchisor’s disclosure document during stockholders equity, and cash flows for (2) A start-up franchise system that
the next fiscal year. Such organizations each of the franchisor’s previous three does not yet have audited financial
must renew their request on an annual fiscal years. statements may phase-in the use of
basis by submitting a request no later (iii) Instead of the financial audited financial statements by
than 60 days after the close of the disclosures required by paragraphs providing, at a minimum, the following
franchisor’s fiscal year. The franchisor (u)(1)(i) and (ii) of this section, the statements at the indicated times:
(i) The franchisor’ first partial or full fiscal year selling franchises. An unaudited opening balance sheet.
(ii) The franchisor’ second fiscal year selling franchises. Audited balance sheet opinion as of the end of the first partial or full
fiscal year selling franchises.
(iii) The franchisor’ third and subsequent fiscal years selling franchises. All required financial statements for the previous fiscal year, plus any
previously disclosed audited statements that still must be disclosed
according to paragraphs (u)(1)(i) and (ii) of this section.
(iv) Start-up franchisors may phase-in following form as the last pages of the (2) Disclose the name, principal
the disclosure of audited financial disclosure document: business address, and telephone number
statements, provided the franchisor: (1) State the following: of each franchise seller offering the
(A) Prepares audited financial Receipt franchise.
statements as soon as practicable. (3) State the issuance date.
(B) Prepares unaudited statements in This disclosure document summarizes
a format that conforms as closely as certain provisions of the franchise (4) If not disclosed in paragraph (a) of
agreement and other information in plain this section, state the name and address
possible to audited statements.
language. Read this disclosure document of the franchisor’s registered agent
(C) Includes one or more years of
and all agreements carefully.
unaudited financial statements or authorized to receive service of process.
clearly and conspicuously discloses in If [name of franchisor] offers you a
(5) State the following:
this section that the franchisor has not franchise, it must provide this disclosure
I received a disclosure document dated
document to you 14 calendar-days before
been in business for three years or more, lllll that included the following
you sign a binding agreement with, or
and cannot include all financial make a payment to, the franchisor or an
Exhibits:
statements required in paragraphs affiliate in connection with the proposed (6) List the title(s) of all attached
(u)(1)(i) and (ii) of this section. franchise sale. Exhibits.
(v) Item 22: Contracts. Attach a copy
of all proposed agreements regarding the If [name of franchisor] does not deliver (7) Provide space for the prospective
this disclosure document on time or if it franchisee’s signature and date.
franchise offering, including the contains a false or misleading statement,
franchise agreement and any lease, or a material omission, a violation of

(8) Franchisors may include any
options, and purchase agreements. federal law and state law may have specific instructions for returning the
(w) Item 23: Receipts. Include two occurred and should be reported to the receipt (for example, street address,
copies of the following detachable Federal Trade Commission, Washington, email address, facsimile telephone
acknowledgment of receipt in the D.C. 20580 and [state agency]. number).
Subpart D—Instructions after the close of the fiscal year when it (4) The franchise relationship is
was last used. covered by the Petroleum Marketing
§ 436.6 Instructions for preparing (i) For each completed franchise sale, Practices Act, 15 U.S.C. 2801.
disclosure documents. franchisors shall retain a copy of the (5)(i) The franchisee’s initial
(a) It is an unfair or deceptive act or signed receipt for at least three years. investment, excluding any financing
practice in violation of Section 5 of the received from the franchisor or an
FTC Act for any franchisor to fail to § 436.7 Instructions for updating
disclosures.
affiliate and excluding the cost of
include the information and follow the unimproved land, totals at least $1
instructions for preparing disclosure (a) All information in the disclosure million and the prospective franchisee
documents set forth in Subpart C (basic document shall be current as of the
signs an acknowledgment verifying the
disclosure requirements) and Subpart D close of the franchisor’s most recent
grounds for the exemption. The
(updating requirements) of part 436. The fiscal year. After the close of the fiscal
acknowledgment shall state: ‘‘The
Commission will enforce this provision year, the franchisor shall, within 120
franchise sale is for more than $1
according to the standards of liability days, prepare a revised disclosure
million—excluding the cost of
under Sections 5, 13(b), and 19 of the document, after which a franchise seller
unimproved land and any financing
FTC Act. may distribute only the revised
received from the franchisor or an
(b) Disclose all required information document and no other disclosure
affiliate— and thus is exempted from
clearly, legibly, and concisely in a single document.
(b) The franchisor shall, within a the Federal Trade Commission’s
document using plain English. The Franchise Rule disclosure requirements,
disclosures must be in a form that reasonable time after the close of each
quarter of the fiscal year, prepare pursuant to 16 CFR 436.8(a)(5)(i)’’;11 or
permits each prospective franchisee to (ii) The franchisee (or its parent or
store, download, print, or otherwise revisions to be attached to the
disclosure document to reflect any any affiliates) is an entity that has been
maintain the document for future in business for at least five years and
reference. material change to the disclosures
included, or required to be included, in has a net worth of at least $5 million.
(c) Respond fully to each disclosure (6) One or more purchasers of at least
Item. If a disclosure Item is not the disclosure document. Each
prospective franchisee shall receive the a 50% ownership interest in the
applicable, respond negatively, franchise: within 60 days of the sale, has
including a reference to the type of disclosure document and the quarterly
revisions for the most recent period been, for at least two years, an officer,
information required to be disclosed by director, general partner, individual
the Item. Precede each disclosure Item available at the time of disclosure.
(c) If applicable, the annual update with management responsibility for the
with the appropriate heading. offer and sale of the franchisor’s
(d) Do not include any materials or shall include the franchisor’s first
quarterly update, either by franchises or the administrator of the
information other than those required or franchised network; or within 60 days of
permitted by part 436 or by state law not incorporating the quarterly update
information into the disclosure the sale, has been, for at least two years,
preempted by part 436. For the sole an owner of at least a 25% interest in
purpose of enhancing the prospective document itself, or through an
addendum. the franchisor.
franchisee’s ability to maneuver through (7) There is no written document that
an electronic version of a disclosure (d) When furnishing a disclosure
document, the franchise seller shall describes any material term or aspect of
document, the franchisor may include the relationship or arrangement.
scroll bars, internal links, and search notify the prospective franchisee of any
material changes that the seller knows (b) For purposes of the exemptions set
features. All other features (e.g., forth in this section, the Commission
multimedia tools such as audio, video, or should have known occurred in the
information contained in any financial shall adjust the size of the monetary
animation, pop-up screens, or links to thresholds every fourth year based upon
external information) are prohibited. performance representation made in
Item 19 (section 436.5(s)). the Consumer Price Index. For purposes
(e) Franchisors may prepare multi- of this section, ‘‘Consumer Price Index’’
state disclosure documents by including (e) Information that must be audited
pursuant to § 436.5(u) of this part need means the Consumer Price Index for all
non-preempted, state-specific urban consumers published by the
information in the text of the disclosure not be audited for quarterly revisions;
provided, however, that the franchisor Department of Labor.
document or in Exhibits attached to the
disclosure document. states in immediate conjunction with
Subpart F—Prohibitions
(f) Subfranchisors shall disclose the the information that such information
required information about the was not audited. § 436.9 Additional prohibitions.
franchisor, and, to the extent applicable, It is an unfair or deceptive act or
Subpart E—Exemptions
the same information concerning the practice in violation of Section 5 of the
subfranchisor. § 436.8 Exemptions. Federal Trade Commission Act for any
(g) Before furnishing a disclosure (a) The provisions of part 436 shall franchise seller covered by part 436 to:
document, the franchisor shall advise not apply if the franchisor can establish (a) Make any claim or representation,
the prospective franchisee of the formats any of the following: orally, visually, or in writing, that
in which the disclosure document is (1) The total of the required payments, contradicts the information required to
made available, any prerequisites for or commitments to make a required be disclosed by this part.
obtaining the disclosure document in a payment, to the franchisor or an affiliate (b) Misrepresent that any person:
particular format, and any conditions that are made any time from before to (1) Purchased a franchise from the
necessary for reviewing the disclosure within six months after commencing franchisor or operated a franchise of the
document in a particular format. operation of the franchisee’s business is type offered by the franchisor.
(h) Franchisors shall retain, and make less than $500. 11 The large franchise exemption applies only if
available to the Commission upon (2) The franchise relationship is a
at least one individual prospective franchisee in an
request, a sample copy of each fractional franchise. investor-group qualifies for the exemption by
materially different version of their (3) The franchise relationship is a investing at the threshold level stated in this
disclosure documents for three years leased department. section.
(2) Can provide an independent and prospective franchisee earlier in the document, franchise agreement, or any
reliable report about the franchise or the sales process than required under related document.
experiences of any current or former § 436.2 of this part, upon reasonable
franchisees. request. Subpart G—Other Provisions
(c) Disseminate any financial (f) Fail to furnish a copy of the
performance representations to franchisor’s most recent disclosure § 436.10 Other laws and rules.
prospective franchisees unless the document and any quarterly updates to (a) The Commission does not approve
franchisor has a reasonable basis and a prospective franchisee, upon or express any opinion on the legality of
written substantiation for the reasonable request, before the any matter a franchisor may be required
representation at the time the prospective franchisee signs a franchise to disclose by part 436. Further,
representation is made, and the agreement. franchisors may have additional
representation is included in Item 19 (g) Present for signing a franchise obligations to impart material
(§ 436.5(s)) of the franchisor’s disclosure agreement in which the terms and information to prospective franchisees
document. In conjunction with any such conditions differ materially from those outside of the disclosure document
financial performance representation, presented as an attachment to the under Section 5 of the Federal Trade
the franchise seller shall also: disclosure document, unless the Commission Act. The Commission
(1) Disclose the information required franchise seller informed the intends to enforce all applicable statutes
by §§ 436.5(s)(3)(ii)(B) and (E) of this prospective franchisee of the differences and rules.
part if the representation relates to the at least seven days before execution of
past performance of the franchisor’s the franchise agreement. (b) The FTC does not intend to
outlets. (h) Disclaim or require a prospective preempt the franchise practices laws of
(2) Include a clear and conspicuous franchisee to waive reliance on any any state or local government, except to
admonition that a new franchisee’s representation made in the disclosure the extent of any inconsistency with
individual financial results may differ document or in its exhibits or part 436. A law is not inconsistent with
from the result stated in the financial amendments. Provided, however, that part 436 if it affords prospective
performance representation. this provision is not intended to prevent franchisees equal or greater protection,
(d) Fail to make available to a prospective franchisee from such as registration of disclosure
prospective franchisees, and to the voluntarily waiving specific contract documents or more extensive
Commission upon reasonable request, terms and conditions set forth in his or disclosures.
written substantiation for any financial her disclosure document during the § 436.11 Severability.
performance representations made in course of franchise sale negotiations.
Item 19 (§ 436.5(s)). (i) Fail to return any funds or deposits If any provision of this part is stayed
(e) Fail to furnish a copy of the in accordance with any conditions or held invalid, the remainder will stay
franchisor’s disclosure document to a disclosed in the franchisor’s disclosure in force.
APPENDIX A TO PART 436—SAMPLE ITEM 10 TABLE

SUMMARY OF FINANCING OFFERED
Loss of
Liability
Item Source of Down Amount Term Interest Monthly Prepay Security Legal
Upon
Financed Financing Payment Financed (Yrs) Rate Payment Penalty Required Right on
Default Default
Initial Fee
Land/Constr
Leased
Space
Equip.
Lease
Equip.
Purchase
Opening
Inventory
Other
Financing
APPENDIX B TO PART 436—SAMPLE ITEM 20(1) TABLE

For years 2004 to 2006
Column 3 Column 4

Year Year
Franchised 2004 859 1,062 +203
APPENDIX B TO PART 436—SAMPLE ITEM 20(1) TABLE—Continued

Column 3 Column 4
Year Year
2005 1,062 1,296 +234
2006 1,296 2,720 +1,424
Company Owned 2004 125 145 +20
2005 145 76 -69
2006 76 141 +65
Total Outlets 2004 984 1,207 +223
2005 1,207 1,372 +165
2006 1,372 2,861 +1,489
APPENDIX C TO PART 436—SAMPLE ITEM 20(2) TABLE

Transfers of Franchised Outlets from Franchisees to New Owners (other than the Franchisor)

State Year Number of Transfers
NC 2004 1
2005 0
2006 2
SC 2004 0
2005 0
2006 2
Total 2004 1
2005 0
2006 4
APPENDIX D TO PART 436—SAMPLE ITEM 20(3) TABLE

Status of Franchise Outlets

Column 1 Column 2 Outlets at Column 4 Ceased Oper- Outlets at
Termi- Non-Renew- Reacquired by
State Year Start of Outlets Opened ations-Other End of the
nations als Franchisor
Year Reasons Year
AL 2004 10 2 1 0 0 1 10
2005 11 5 0 1 0 0 15
2006 15 4 1 0 1 2 15
AZ 2004 20 5 0 0 0 0 25
2005 25 4 1 0 0 2 26
2006 26 4 0 0 0 0 30
Totals 2004 30 7 1 0 0 1 35
2005 36 9 1 1 0 2 41
APPENDIX D TO PART 436—SAMPLE ITEM 20(3) TABLE—Continued

Status of Franchise Outlets

Column 1 Column 2 Outlets at Column 4 Ceased Oper- Outlets at
Termi- Non-Renew- Reacquired by
State Year Start of Outlets Opened ations-Other End of the
nations als Franchisor
Year Reasons Year
2006 41 8 1 0 1 2 45
APPENDIX E TO PART 436—SAMPLE ITEM 20(4) TABLE

Column 8
Start of Year From Franchisees Franchisees Year
NY 2004 1 0 1 0 0 2
2005 2 2 0 1 0 3
2006 3 0 0 3 0 0
OR 2004 4 0 1 0 0 5
2005 5 0 0 2 0 3
2006 3 0 0 0 1 2
Totals 2004 5 0 2 0 0 7
2005 7 2 0 3 0 6
2006 6 0 0 3 1 2
APPENDIX F TO PART 436—SAMPLE ITEM 20(5) TABLE

Projected New Franchised Outlets
As of December 31, 2006

Column 1 Franchise Agreements Signed But Projected New Franchised Outlets Projected New Company-Owned
State Outlet Not Opened in the Next Fiscal Year Outlets in the Current Fiscal Year
CO 2 3 1
NM 0 4 2
Total 2 7 3
■ Add a new part 437 as follows: the Federal Trade Commission Act, of (1)(i) The official name and address
any business opportunity, or any and principal place of business of the
PART 437—DISCLOSURE relationship which is represented either business opportunity seller, and of the
REQUIREMENTS AND PROHIBITIONS orally or in writing to be a business parent firm or holding company of the
CONCERNING BUSINESS opportunity, it is an unfair or deceptive business opportunity seller, if any;
OPPORTUNITIES act or practice within the meaning of (ii) The name under which the
Sec. Section 5 of that Act for any business business opportunity seller is doing or
437.1 The Rule. opportunity seller or business intends to do business; and
437.2 Definitions. opportunity broker:
437.3 Severability. (iii) The trademarks, trade names,
(a) To fail to furnish any prospective service marks, advertising or other
Authority: 15 U.S.C. 41-58. business opportunity purchaser with the commercial symbols (hereinafter
§ 437.1 The Rule. following information accurately, collectively referred to as ‘‘marks’’)
clearly, and concisely stated, in a which identify the goods, commodities,

In connection with the advertising, legible, written document at the earlier
offering, licensing, contracting, sale, or or services to be offered, sold, or
of the ‘‘time for making of disclosures’’ distributed by the prospective business
other promotion in or affecting or the first ‘‘personal meeting’’:
commerce, as ‘‘commerce’’ is defined in opportunity purchaser, or under which
the prospective business opportunity which, irrespective of the materiality of conditions, these conditions shall be set
purchaser will be operating. any single such action, in the aggregate forth; and if not returnable, such fact
(2) The business experience during is material; shall be disclosed.
the past 5 years, stated individually, of (iii) Is subject to any currently (8) A statement describing any
each of the business opportunity seller’s effective State or Federal agency or recurring funds required to be paid, in
current directors and executive officers court injunctive or restrictive order, or connection with carrying on the
(including, and hereinafter to include, is a party to a proceeding currently business opportunity business, by the
the chief executive and chief operating pending in which such order is sought, business opportunity purchaser to the
officer, financial, business opportunity relating to or affecting business business opportunity seller or to a
marketing, training and service officers). opportunity activities or the business person affiliated with the business
With regard to each person listed, those opportunity seller-purchaser opportunity seller, or which the
persons’ principal occupations and relationship, or involving fraud business opportunity seller or such
employers must be included. (including violation of any business affiliated person imposes or collects in
(3) The business experience of the opportunity law, or unfair or deceptive whole or in part on behalf of a third
business opportunity seller and the practices law), embezzlement, party, including, but not limited to,
business opportunity seller’s parent firm fraudulent conversion, royalty, lease, advertising, training, and
(if any), including the length of time misappropriation of property, or sign rental fees, and equipment or
each: (i) Has conducted a business of the restraint of trade. inventory purchases.
type to be operated by the business Such statement shall set forth the (9) A statement setting forth the name
opportunity purchaser; (ii) has offered identity and location of the court or of each person (including the business
or sold a business opportunity for such agency; the date of conviction, opportunity seller) the business
business; (iii) has conducted a business judgment, or decision; the penalty opportunity purchaser is directly or
or offered or sold a business opportunity imposed; the damages assessed; the indirectly required or advised to do
for a business (A) operating under a terms of settlement or the terms of the business with by the business
name using any mark set forth under order; and the date, nature, and issuer opportunity seller, where such persons
paragraph (a)(1)(iii) of this section, or of each such order or ruling. A business are affiliated with the business
(B) involving the sale, offering, or opportunity seller may include a opportunity seller.
distribution of goods, commodities, or summary opinion of counsel as to any (10) A statement describing any real
services which are identified by any pending litigation, but only if counsel’s estate, services, supplies, products,
mark set forth under paragraph (a)(1)(iii) consent to the use of such opinion is
of this section; and (iv) has offered for inventories, signs, fixtures, or
included in the disclosure statement. equipment relating to the establishment
sale or sold business opportunities in (5) A statement disclosing who, if any,
other lines of business, together with a or the operation of the business
of the persons listed in paragraphs (a) opportunity business which the
description of such other lines of (2) and (3) of this section at any time
business. business opportunity purchaser is
during the previous 7 fiscal years has: directly or indirectly required by the
(4) A statement disclosing who, if any, (i) Filed in bankruptcy;
of the persons listed in paragraphs (a) (ii) Been adjudged bankrupt; business opportunity seller to purchase,
(2) and (3) of this section: (iii) Been reorganized due to lease or rent; and if such purchases,
(i) Has, at any time during the insolvency; or leases or rentals must be made from
previous seven fiscal years, been (iv) Been a principal, director, specific persons (including the business
convicted of a felony or pleaded nolo executive officer, or partner of any other opportunity seller), a list of the names
contendere to a felony charge if the person that has so filed or was so and addresses of each such person.
felony involved fraud (including adjudged or reorganized, during or Such list may be made in a separate
violation of any business opportunity within 1 year after the period that such document delivered to the prospective
law, or unfair or deceptive practices person held such position in such other business opportunity purchaser with the
law), embezzlement, fraudulent person. If so, the name and location of prospectus if the existence of such
conversion, misappropriation of the person having so filed, or having separate document is disclosed in the
property, or restraint of trade; been so adjudged or reorganized, the prospectus.
(ii) Has, at any time during the date thereof, and any other material (11) A description of the basis for
previous seven fiscal years, been held facts relating thereto, shall be set forth. calculating, and, if such information is
liable in a civil action resulting in a (6) A factual description of the readily available, the actual amount of,
final judgment or has settled out of business opportunity offered to be sold any revenue or other consideration to be
court any civil action or is a party to any by the business opportunity seller. received by the business opportunity
civil action (A) involving allegations of (7) A statement of the total funds seller or persons affiliated with the
fraud (including violation of any which must be paid by the business business opportunity seller from
business opportunity law, or unfair or opportunity purchaser to the business suppliers to the prospective business
deceptive practices law), embezzlement, opportunity seller or to a person opportunity purchaser in consideration
fraudulent conversion, affiliated with the business opportunity for goods or services which the business
misappropriation of property, or seller, or which the business opportunity seller requires or advises
restraint of trade, or (B) which was opportunity seller or such affiliated the business opportunity purchaser to
brought by a present or former business person imposes or collects in whole or obtain from such suppliers.
opportunity purchaser or business in part on behalf of a third party, in (12)(i) A statement of all the material
opportunity purchasers and which order to obtain or commence the terms and conditions of any financing
involves or involved the business business opportunity operation, such as arrangement offered directly or
opportunity relationship; Provided, initial business opportunity fees, indirectly by the business opportunity
however, That only material individual deposits, down payments, prepaid rent, seller, or any person affiliated with the
civil actions need be so listed pursuant and equipment and inventory business opportunity seller, to the
to this paragraph (4)(ii) of this section, purchases. If all or part of these fees or prospective business opportunity
including any group of civil actions deposits are returnable under certain purchaser; and
(ii) A description of the terms by (v) The conditions under which the (iii) The names, addresses, and
which any payment is to be received by business opportunity seller may telephone numbers of (A) The 10
the business opportunity seller from (A) terminate; business opportunity outlets of the
any person offering financing to a (vi) the obligations (including lease or named business opportunity business
prospective business opportunity sublease obligations) of the business nearest the prospective business
purchaser; and (B) any person arranging opportunity purchaser after termination opportunity purchaser’s intended
for financing for a prospective business of the business opportunity by the location; or (B) all business opportunity
opportunity purchaser. business opportunity seller, and the purchasers of the business opportunity
(13) A statement describing the obligations of the business opportunity seller; or (C) all business opportunity
material facts of whether, by the terms purchaser (including lease or sublease purchasers of the business opportunity
of the business opportunity agreement obligations) after termination of the seller in the State in which the
or other device or practice, the business business opportunity by the business prospective business opportunity
opportunity purchaser is: opportunity purchaser and after the purchaser lives or where the proposed
(i) Limited in the goods or services he expiration of the business opportunity; business opportunity is to be located,
or she may offer for sale; (vii) The business opportunity Provided, however, That there are more
(ii) Limited in the customers to whom purchaser’s interest upon termination of than 10 such business opportunity
he or she may sell such goods or the business opportunity, or upon purchasers. If the number of business
services; refusal to renew or extend the business opportunity purchasers to be disclosed
(iii) Limited in the geographic area in opportunity, whether by the business pursuant to paragraph (a)(16)(iii)(B) or
which he or she may offer for sale or sell opportunity seller or by the business (C) of this section exceeds 50, such
goods or services; or opportunity purchaser; listing may be made in a separate
(iv) Granted territorial protection by (viii) The conditions under which the document delivered to the prospective
the business opportunity seller, by business opportunity seller may business opportunity purchaser with the
which, with respect to a territory or repurchase, whether by right of first prospectus if the existence of such
area, (A) the business opportunity seller refusal or at the option of the business separate document is disclosed in the
will not establish another, or more than opportunity seller (and if the business prospectus;
any fixed number of, business opportunity seller has the option to (iv) The number of business
opportunities or company-owned repurchase the business opportunity, opportunities voluntarily terminated or
whether there will be an independent not renewed by business opportunity
outlets, either operating under, or
appraisal of the business opportunity, purchasers within, or at the conclusion
selling, offering, or distributing goods,
whether the repurchase price will be of, the term of the business opportunity
commodities or services, identified by
determined by a predetermined formula agreement, during the preceding fiscal
any mark set forth under paragraph
and whether there will be a recognition year;
(a)(1)(iii) of this section; or (B) the (v) The number of business
business opportunity seller or its parent of goodwill or other intangibles
associated therewith in the repurchase opportunities reacquired by purchase by
will not establish other business the business opportunity seller during
opportunities or company-owned price to be given the business
opportunity purchaser); the term of the business opportunity
outlets selling or leasing the same or agreement, and upon the conclusion of
similar products or services under a (ix) The conditions under which the
business opportunity purchaser may sell the term of the business opportunity
different trade name, trademark, service agreement, during the preceding fiscal
mark, advertising or other commercial or assign all or any interest in the
ownership of the business opportunity, year;
symbol. (vi) The number of business
(14) A statement of the extent to or of the assets of the business
opportunity business; opportunities otherwise reacquired by
which the business opportunity seller the business opportunity seller during
(x) The conditions under which the
requires the business opportunity the term of the business opportunity
business opportunity seller may sell or
purchaser (or, if the business agreement, and upon the conclusion of
assign, in whole or in part, its interest
opportunity purchaser is a corporation, the term of the business opportunity
under such agreements;
any person affiliated with the business agreement, during the preceding fiscal
(xi) The conditions under which the
opportunity purchaser) to participate year;
business opportunity purchaser may
personally in the direct operation of the (vii) The number of business
modify;
business opportunity. (xii) The conditions under which the opportunities for which the business
(15) A statement disclosing, with business opportunity seller may modify; opportunity seller refused renewal of
respect to the business opportunity (xiii) The rights of the business the business opportunity agreement or
agreement and any related agreements: opportunity purchaser’s heirs or other agreements relating to the
(i) The term (i.e., duration of personal representative upon the death business opportunity during the
arrangement), if any, of such agreement, or incapacity of the business preceding fiscal year; and
and whether such term is or may be opportunity purchaser; and (viii) The number of business
affected by any agreement (including (xiv) The provisions of any covenant opportunities that were canceled or
leases or subleases) other than the one not to compete. terminated by the business opportunity
from which such term arises; (16) A statement disclosing, with seller during the term of the business
(ii) The conditions under which the respect to the business opportunity opportunity agreement, and upon
business opportunity purchaser may seller and as to the particular named conclusion of the term of the business
renew or extend; business being offered: opportunity agreement, during the
(iii) The conditions under which the (i) The total number of business preceding fiscal year.
business opportunity seller may refuse opportunity purchasers operating at the With respect to the disclosures
to renew or extend; end of the preceding fiscal year; required by paragraphs (a)(16) (v), (vi),
(iv) The conditions under which the (ii) The total number of company- (vii), and (viii) of this section, the
business opportunity purchaser may owned outlets operating at the end of disclosure statement shall also include
terminate; the preceding fiscal year; a general categorization of the reasons
for such reacquisitions, refusals to (ii) The total investment of the public conspicuously showing the name of the
renew or terminations, and the number figure in the business opportunity business opportunity seller, the date of
falling within each such category, operation; and issuance of the disclosure statement,
including but not limited to the (iii) The amount of any fee or fees the and the following notice imprinted
following: failure to comply with business opportunity purchaser will be thereon in upper and lower case bold-
quality control standards, failure to obligated to pay for such involvement or face type of not less than 12 point size:
make sufficient sales, and other assistance provided by the public figure. Information for Prospective Business
breaches of contract. (20)(i) A balance sheet (statement of Opportunity Purchasers Required by Federal
(17)(i) If site selection or approval financial position) for the business Trade Commission
thereof by the business opportunity opportunity seller for the most recent * * * * *
seller is involved in the business fiscal year, and an income statement To protect you, we’ve required your
opportunity relationship, a statement (statement of results of operations) and business opportunity seller to give you this
disclosing the range of time that has statement of changes in financial information. We haven’t checked it, and
elapsed between signing of business position for the franchisor for the most don’t know if it’s correct. It should help you
opportunity agreements or other recent three fiscal years. Such make up your mind. Study it carefully.
agreements relating to the business statements are required to have been While it includes some information about
opportunity and site selection, for examined in accordance with generally your contract, don’t rely on it alone to
accepted auditing standards by an understand your contract. Read all of your
agreements entered into during the
independent certified or licensed public contract carefully. Buying a business
preceding fiscal year; and opportunity is a complicated investment.
(ii) If operating business opportunity accountant. Take your time to decide. If possible, show
outlets are to be provided by the Provided, however, That where a your contract and this information to an
business opportunity seller, a statement business opportunity seller is a advisor, like a lawyer or an accountant. If
disclosing the range of time that has subsidiary of another corporation which you find anything you think may be wrong
elapsed between the signing of business is permitted under generally accepted or anything important that’s been left out,
opportunity agreements or other accounting principles to prepare you should let us know about it. It may be
agreements relating to the business financial statements on a consolidated against the law.
opportunity and the commencement of or combined statement basis, the above There may also be laws on business
the business opportunity purchaser’s information may be submitted for the opportunities in your state. Ask your state
business, for agreements entered into parent if (A) the corresponding agencies about them.
during the preceding fiscal year. unaudited financial statements of the Federal Trade Commission,
With respect to the disclosures business opportunity seller are also Washington, D.C.
required by paragraphs (a)(17) (i) and provided, and (B) the parent absolutely
and irrevocably has agreed to guarantee Provided, That the obligations to
(ii) of this section, a business
all obligations of the subsidiary; furnish such disclosure statement shall
opportunity seller may at its option also
(ii) Unaudited statements shall be be deemed to have been met for both the
provide a distribution chart using
used only to the extent that audited business opportunity seller and the
meaningful classifications with respect
statements have not been made, and business opportunity broker if either
to such ranges of time.
(18) If the business opportunity seller provided that such statements are such party furnishes the prospective
offers an initial training program or accompanied by a clear and business opportunity purchaser with
informs the prospective business conspicuous disclosure that they are such disclosure statement.
opportunity purchaser that it intends to unaudited. Statements shall be prepared (22) All information contained in the
provide such person with initial on an audited basis as soon as disclosure statement shall be current as
training, a statement disclosing: practicable, but, at a minimum, of the close of the business opportunity
(i) The type and nature of such financial statements for the first full seller’s most recent fiscal year. After the
training; fiscal year following the date on which close of each fiscal year, the business
(ii) The minimum amount, if any, of the business opportunity seller must opportunity seller shall be given a
training that will be provided to a first comply with this part shall contain period not exceeding 90 days to prepare
business opportunity purchaser; and a balance sheet opinion prepared by an a revised disclosure statement and,
(iii) The cost, if any, to be borne by independent certified or licensed public following such 90 days, may distribute
the business opportunity purchaser for accountant, and financial statements for only the revised prospectus and no
the training to be provided, or for the following fiscal year shall be fully other. The business opportunity seller
obtaining such training. audited. shall, within a reasonable time after the
(19) If the name of a public figure is (21) All of the foregoing information close of each quarter of the fiscal year,
used in connection with a in paragraphs (a) (1) through (20) of this prepare revisions to be attached to the
recommendation to purchase a business section shall be contained in a single disclosure statement to reflect any
opportunity, or as a part of the name of disclosure statement or prospectus, material change in the business
the business opportunity operation, or if which shall not contain any materials or opportunity seller or relating to the
the public figure is stated to be involved information other than that required by business opportunity business of the
with the management of the business this part or by State law not preempted business opportunity seller, about
opportunity seller, a statement by this part. This does not preclude which the business opportunity seller or
disclosing: business opportunity sellers or brokers broker, or any agent, representative, or
(i) The nature and extent of the public from giving other nondeceptive employee thereof, knows or should
figure’s involvement and obligations to information orally, visually, or in know. Each prospective business
the business opportunity seller, separate literature so long as such opportunity purchaser shall have in his
including but not limited to the information is not contradictory to the or her possession at the ‘‘time for
promotional assistance the public figure information in the disclosure statement making of disclosures,’’ the disclosure
will provide to the business opportunity required by paragraph (a) of this section. statement and quarterly revision for the
seller and to the business opportunity This disclosure statement shall carry a period most recent to the ‘‘time for
purchaser; cover sheet distinctively and making of disclosures’’ and available at
that time. Information which is required assumptions therefor in a single legible states a specific level of sales, income,
to be audited pursuant to paragraph written document whose text gross or net profits of existing outlets
(a)(20) of this section is not required to accurately, clearly and concisely (whether business opportunity
be audited for quarterly revisions. discloses such information, and none purchaser-owned or company-owned) of
Provided, however, That the unaudited other than that provided for by this part the named business opportunity
information is accompanied by a or by State law not preempted by this business, or which states other facts
statement in immediate conjunction part. Each prospective business which suggest such a specific level,
therewith that clearly and opportunity purchaser to whom the unless:
conspicuously discloses that such representation is made shall be (1) At the time such representation is
information has not been audited. furnished with such document no later made, such representation is relevant to
(23) A table of contents shall be than the ‘‘time for making of the geographic market in which the
included within the disclosure disclosure’’; Provided, however, That if business opportunity is to be located;
statement. the representation is made at or prior to (2) At the time such representation is
(24) The disclosure statement shall a ‘‘personal meeting’’ and such meeting made, a reasonable basis exists for such
include a comment which either occurs before the ‘‘time for making of representation and the business
positively or negatively responds to disclosures’’, the document shall be opportunity seller has in its possession
each disclosure item required to be in furnished to the prospective business material which constitutes a reasonable
the disclosure statement, by use of a opportunity purchaser to whom the basis for such representation, and such
statement which fully incorporates the representation is made at that ‘‘personal material is made available to any
information required by the item. Each meeting’’; prospective business opportunity
disclosure item therein must be (4) The following statement is clearly purchaser and to the Commission or its
preceded by the appropriate heading, as and conspicuously disclosed in the staff upon reasonable demand,
set forth in Note 3 of this part. document described by paragraph (b)(3) Provided, however, That in immediate
(b) To make any oral, written, or of this section in immediate conjunction conjunction with such representation,
visual representation to a prospective with such representation and in not less
business opportunity purchaser which the business opportunity purchaser
than twelve point upper and lower-case discloses in a clear and conspicuous
states a specific level of potential sales, boldface type:
income, gross or net profit for that manner that such material is available to
prospective business opportunity CAUTION the prospective franchisee; and
purchaser, or which states other facts These figures are only estimates of what
Provided, further, That no provision
which suggest such a specific level, we think you may earn. There is no within paragraph (c) of this section shall
unless: assurance you’ll do as well. If you rely upon be construed as requiring the disclosure
(1) At the time such representation is our figures, you must accept the risk of not to any prospective business opportunity
made, such representation is relevant to doing as well. purchaser of the identity of any specific
the geographic market in which the (5) The following information is business opportunity purchaser or of
business opportunity is to be located; clearly and conspicuously disclosed in information reasonably likely to lead to
(2) At the time such representation is the document described by paragraph the disclosure of such person’s identity;
made, a reasonable basis exists for such (b)(3) of this section in immediate and Provided, further, That no
representation and the business conjunction with such representation: additional representation as to the sales,
opportunity seller has in its possession (i) The number and percentage of income, or gross or net profits of
material which constitutes a reasonable outlets of the named business existing outlets (whether business
basis for such representation, and such opportunity business which are located opportunity purchaser-owned or
material is made available to any in the geographic markets that form the company-owned) of the named business
prospective business opportunity basis for any such representation and opportunity business may be made later
purchaser and to the Commission or its which are known to the business than the ‘‘time for making of
staff upon reasonable demand. opportunity seller or broker to have disclosures’’;
Provided, further, That in immediate earned or made at least the same sales, (3) Such representation is set forth in
conjunction with such representation, income, or profits during a period of detail along with the material bases and
the business opportunity seller shall corresponding length in the immediate assumptions therefor in a single legible
disclose in a clear and conspicuous past as those potential sales, income, or written document which accurately,
manner that such material is available to profits represented; and clearly and concisely discloses such
the prospective business opportunity (ii) The beginning and ending dates information, and none other than that
purchaser; and Provided, however, That for the corresponding time period provided for by this part or by State law
no provision within paragraph (b) of referred to by paragraph (b)(5)(i) of this not preempted by this part. Each
this section shall be construed as section, Provided, however, That any prospective business opportunity
requiring the disclosure to any business opportunity seller without purchaser to whom the representation is
prospective business opportunity prior business opportunity experience made shall be furnished with such
purchaser of the identity of any specific as to the named business opportunity document no later than the ‘‘time for
business opportunity purchaser or of business so indicate such lack of making of disclosures,’’ Provided,
information reasonably likely to lead to experience in the document described however, That if the representation is
the disclosure of such person’s identity; in paragraph (b)(3) of this section. made at or prior to a ‘‘personal meeting’’
and Provided, further, That no Except, That representations of the and such meeting occurs before the
additional representation as to a sales, income or profits of existing ‘‘time for making of disclosures,’’ the
prospective business opportunity business opportunity outlets need not document shall be furnished to the
purchaser’s potential sales, income, or comply with paragraph (b) of this prospective business opportunity
profits may be made later than the ‘‘time section. purchaser to whom the representation is
for making of disclosures’’; (c) To make any oral, written, or made at that ‘‘personal meeting’’;
(3) Such representation is set forth in visual representation to a prospective (4) The underlying data on which the
detail along with the material bases and business opportunity purchaser which representation is based have been
prepared in accordance with generally and figures carefully. If possible, show them sales, income or profits, the following
accepted accounting principles; to someone who can advise you, like a statement shall be clearly and
(5) The following statement is clearly lawyer or an accountant. Then take your conspicuously disclosed:
and conspicuously disclosed in the time and think it over. CAUTION
document described by paragraph (c)(3) If you find anything you think may be These figures are only estimates; there is
of this section in immediate conjunction wrong or anything important that’s been left no assurance you’ll do as well. If you rely
with such representation, and in not out, let us know about it. It may be against upon our figures, you must accept the risk of
the law. not doing as well.
less than twelve point upper and lower
case boldface type: There may also be laws on business Provided, however, That if such
opportunities in your State. Ask your State representation is not based on actual
CAUTION agencies about them. experience of existing outlets of the
Some outlets have [sold] [earned] this named business opportunity business,
Federal Trade Commission,
amount. There is no assurance you’ll do as
Washington, D.C. that fact also should be disclosed;
well. If you rely upon our figures, you must
accept the risk of not doing as well. (2) A table of contents. (5) No later than the earlier of the first
Provided, however, That each ‘‘personal meeting’’ or the ‘‘time for
(6) The following information is making of disclosures,’’ each
clearly and conspicuously disclosed in prospective business opportunity
purchaser to whom the representation is prospective business opportunity
the document described by paragraph purchaser shall be given a single, legible
(c)(3) of this section in immediate made shall be notified at the ‘‘time for
making of disclosures’’ of any material written document which accurately,
conjunction with such representation: clearly and concisely sets forth the
(i) the number and percentage of change (about which the business
opportunity seller, broker, or any of the following information and materials
outlets of the named business (and none other than that provided for
opportunity business which are located agents, representations, or employees
thereof, knows or should know) in the by this part or by State law not
in the geographic markets that form the preempted by this part):
basis for any such representation and information contained in the
document(s) described by paragraphs (i) The representation, set forth in
which are known to the business detail along with the material bases and
opportunity seller or broker to have (b)(3) and (c)(3) of this section.
(e) To make any oral, written, or assumptions therefor;
earned or made at least the same sales, (ii) the number and percentage of
income, or profits during a period of visual representation for general
dissemination (not otherwise covered by outlets of the named business
corresponding length in the immediate opportunity business which the
past as those potential sales, income, or paragraph (b) or (c) of this section)
which states a specific level of sales, business opportunity seller or broker
profits represented; and knows to have earned or made at least
(ii) The beginning and ending dates income, gross or net profits, either
actual or potential, of existing or the same sales, income or profits during
for the corresponding time period a period of corresponding length in the
referred to by paragraph (c)(6)(i) of this prospective outlets (whether business
opportunity purchaser-owned or immediate past as those sales, income,
section, Provided, however, That any or profits represented, and the
business opportunity seller without company-owned) of the named business
opportunity business or which states beginning and ending dates for said
prior business opportunity experience time period;
as to the named business opportunity other facts which suggest such a specific
level, unless: (iii) With respect to each such
business so indicate such lack of representation of sales, income, or
experience in the document described (1) At the time such representation is
made, a reasonable basis exists for such profits of existing outlets, the following
in paragraph (c)(3) of this section. statement shall be clearly and
(d) To fail to provide the following representation and the business
opportunity seller has in its possession conspicuously disclosed in immediate
information within the document(s) conjunction therewith, printed in not
required by paragraphs (b)(3) and (c)(3) material which constitutes a reasonable
basis for such representation and which less than 12 point upper and lower case
of this section whenever any boldface type:
representation is made to a prospective is made available to the Commission or
business opportunity purchaser its staff upon reasonable demand; CAUTION
regarding its potential sales, income, or (2) The underlying data on which Some outlets have [sold] [earned] this
profits, or the sales, income, gross or net each representation of sales, income or amount. There is no assurance you’ll do as
profits of existing outlets (whether profit for existing outlets is based have well. If you rely upon our figures, you must
business opportunity purchaser-owned been prepared in accordance with accept the risk of not doing as well.
or company-owned) of the named generally accepted accounting (iv) With respect to each such
business opportunity business: principles; representation of potential sales,
(1) A cover sheet distinctively and (3) In immediate conjunction with income, or profits, the following
conspicuously showing the name of the such representation, there shall be statement shall be clearly and
business opportunity seller, the date of clearly and conspicuously disclosed the conspicuously disclosed in immediate
issuance of the document and the number and percentage of outlets of the conjunction therewith, printed in not
following notice imprinted thereon in named business opportunity business less than 12 point upper and lower case
upper and lower case boldface type of which the business opportunity seller or boldface type:
not less than twelve point size: broker knows to have earned or made at
least the same sales, income, or profits CAUTION
Information for Prospective Business
Opportunity Purchasers About Business during a period of corresponding length These figures are only estimates. There is
Opportunity [Sales] [Income] [Profit] in the immediate past as those sales, no assurance you’ll do as well. If you rely
upon our figures, you must accept the risk
Required by the Federal Trade Commission. income, or profits represented, and the
beginning and ending dates for said of not doing as well.
To protect you, we’re required the
business opportunity seller to give you this time period; (v) If applicable, a statement clearly
information. We haven’t checked it and (4) In immediate conjunction with and conspicuously disclosing that the
don’t know if it’s correct. Study these facts each such representation of potential business opportunity seller lacks prior
business opportunity experience as to § 437.2 Definitions. purchased from the retailer-grantor or

the named business opportunity As used in this part, the following persons whom the lessee is directly or
business; definitions shall apply: indirectly (A) required to do business
(vi) If applicable, a statement clearly (a) The term business opportunity with by the retailer-grantor or (B)
and conspicuously disclosing that the means any continuing commercial advised to do business with by the
business opportunity seller has not been relationship created by any arrangement retailer-grantor where such person is
in business long enough to have actual or arrangements whereby: affiliated with the retailer-grantor; or
business data; (1) A person (hereinafter ‘‘business (iii) Where the total of the payments
(vii) A cover sheet, distinctively and opportunity purchaser’’) offers, sells, or referred to in paragraph (a)(2) of this
conspicuously showing the name of the distributes to any person other than a section made during a period from any
business opportunity seller, the date of ‘‘business opportunity seller’’ (as time before to within 6 months after
issuance of the document, and the hereinafter defined), goods, commencing operation of the business
following notice printed thereon in not commodities, or services which are: opportunity purchaser’s business, is less
less than 12 point upper and lower case (i)(A) Supplied by another person than $500; or
boldface type: (hereinafter ‘‘business opportunity (iv) Where there is no writing which
seller’’); or evidences any material term or aspect of
Information for Prospective Business (B) Supplied by a third person (e.g.,
Opportunity Purchasers About Business
the relationship or arrangement; or
Opportunity [Sales] [Income] [Profit]
a supplier) with whom the business (v) Which complies with the franchise
Required by the Federal Trade Commission opportunity purchaser is directly or disclosure requirements set forth at part
indirectly required to do business by 436 or falls under one or more of the
To protect you, we’ve required the
business opportunity seller to give you this
another person (hereinafter ‘‘business exemptions set forth at § 436.8 of part
information. We haven’t checked it and opportunity seller’’); or 436.
don’t know if it’s correct. Study these facts (C) Supplied by a third person (e.g., (4) Exclusions. The term ‘‘business
and figures carefully. If possible, show them a supplier) with whom the business opportunity’’ shall not be deemed to
to someone who can advise you, like a opportunity purchaser is directly or include any continuing commercial
lawyer or an accountant. If you find indirectly advised to do business by relationship created solely by:
anything you think may be wrong or another person (hereinafter ‘‘business (i) The relationship between an
anything important that’s been left out, let us opportunity seller’’) where such third employer and an employee, or among
know about it. It may be against the law. person is affiliated with the business general business partners; or
There may also be laws about business opportunity seller; and (ii) Membership in a bona fide
opportunities in your State. Ask your State ‘‘cooperative association’’; or
(ii) The business opportunity seller:
agencies about them.
(A) Secures for the business (iii) An agreement for the use of a
Federal Trade Commission, opportunity purchaser retail outlets or trademark, service mark, trade name,
Washington, D.C. accounts for said goods, commodities, seal, advertising, or other commercial
(viii) A table of contents; or services; or symbol designating a person who offers
(6) Each prospective business (B) Secures for the business on a general basis, for a fee or otherwise,
opportunity purchaser shall be notified opportunity purchaser locations or sites a bona fide service for the evaluation,
at the ‘‘time for making of disclosures’’ for vending machines, rack displays, or testing, or certification of goods,
of any material changes that have any other product sales displays used by commodities, or services; or
occurred in the information contained the business opportunity purchaser in (iv) An agreement between a licensor
in this document. the offering, sale, or distribution of said and a single licensee to license a
goods, commodities, or services; or trademark, trade name, service mark,
(f) To make any claim or
(C) Provides to the business advertising or other commercial symbol
representation which is contradictory to
opportunity purchaser the services of a where such license is the only one of its
the information required to be disclosed
person able to secure the retail outlets, general nature and type to be granted by
by this part.
accounts, sites or locations referred to in the licensor with respect to that
(g) To fail to furnish the prospective paragraphs (a)(ii)(A) and (B) of this trademark, trade name, service mark,
business opportunity purchaser with a section; and advertising, or other commercial
copy of the business opportunity seller’s (2) The business opportunity symbol.
business opportunity agreement and purchaser is required as a condition of (4) Any relationship which is
related agreements with the document, obtaining or commencing the business represented either orally or in writing to
and a copy of the completed business opportunity operation to make a be a business opportunity (as defined in
opportunity and related agreements payment or a commitment to pay to the paragraph (a) of this section) is subject
intended to be executed by the parties business opportunity seller, or to a to the requirements of this part.
at least 5 business days prior to the date person affiliated with the business (b) The term person means any
the agreements are to be executed. opportunity seller. individual, group, association, limited
Provided, however, That the (3) Exemptions. The provisions of this or general partnership, corporation, or
obligations defined in paragraphs (b) part shall not apply to a business any other business entity.
through (g) of this section shall be opportunity: (c) The term business opportunity
deemed to have been met for both the (i) Which is a ‘‘fractional business seller means any person who
business opportunity seller and the opportunity’’; or participates in a business opportunity
broker if either such person furnishes (ii) Where pursuant to a lease, license, relationship as a business opportunity
the prospective business opportunity or similar agreement, a person offers, seller, as denoted in paragraph (a) of
purchaser with the written disclosures sells, or distributes goods, commodities, this section.
required thereby. or services on or about premises (d) The term business opportunity
(h) To fail to return any funds or occupied by a retailer-grantor primarily purchaser means any person (1) who
deposits in accordance with any for the retailer-grantor’s own participates in a business opportunity
conditions disclosed pursuant to merchandising activities, which goods, relationship as a business opportunity
paragraph (a)(7) of this section. commodities, or services are not purchaser, as denoted in paragraph (a)
of this section, or (2) to whom an (2) Which directly or indirectly owns, practice is held invalid, the remainder
interest in a business opportunity is controls, or holds with power to vote, 10 of the part or the application of its
sold. percent or more of the outstanding provisions to any person, act, or practice
(e) The term prospective business voting securities of a business shall not be affected thereby.
opportunity purchaser includes any opportunity seller; or Note 1: The Commission expresses no
person, including any representative, (3) Which has, in common with a opinion as to the legality of any practice
agent, or employee of that person, who business opportunity seller, one or more mentioned in this part. A provision for
approaches or is approached by a partners, officers, directors, trustees, disclosure should not be construed as
business opportunity seller or broker, or branch managers, or other persons condonation or approval with respect to the
any representative, agent, or employee occupying similar status or performing matter required to be disclosed, nor as an
similar functions. indication of the Commission’s intention not
thereof, for the purpose of discussing
(j) The term business opportunity to enforce any applicable statute.
the establishment, or possible
establishment, of a business opportunity broker means any person other than a Note 2: By taking action in this area, the
relationship involving such a person. business opportunity seller or a Federal Trade Commission does not intend to
(f) The term business day means any business opportunity purchaser who annul, alter, affect, or exempt any person
day other than Saturday, Sunday, or the sells, offers for sale, or arranges for the subject to the provisions of this part from
following national holidays: New Year’s sale of a business opportunity. complying with the laws or regulations of
(k) The term sale of a business any State, municipality, or other local
Day, Washington’s Birthday, Memorial
opportunity includes a contract or government with respect to business
Day, Independence Day, Labor Day, opportunity practices, except to the extent
Columbus Day, Veterans’ Day, agreement whereby a person obtains a
that those laws or regulations are
Thanksgiving, and Christmas. business opportunity or an interest in a
inconsistent with any provision of this part,
(g) The term time for making of business opportunity for value by and then only to the extent of the
disclosures means ten (10) business purchase, license, or otherwise. This inconsistency. For the purposes of this part,
days prior to the earlier of (1) the term shall not be deemed to include the a law or regulation of any State,
execution by a prospective business renewal or extension of an existing municipality, or other local government is
opportunity purchaser of any business business opportunity where there is no not inconsistent with this part if the
interruption in the operation of the protection such law or regulation affords any
opportunity agreement or any other prospective business opportunity purchaser
agreement imposing a binding legal business opportunity business by the
business opportunity purchaser, unless is equal to or greater than that provided by
obligation on such prospective business this part. Examples of provisions that provide
opportunity purchaser, about which the the new contracts or agreements contain protection equal to or greater than that
business opportunity seller, broker, or material changes from those in effect provided by this part include laws or
any agent, representative, or employee between the business opportunity seller regulations which require more complete
thereof, knows or should know, in and business opportunity purchaser record keeping by the business opportunity
connection with the sale or proposed prior thereto. seller or the disclosure of more complete
sale of a business opportunity, or (2) the (l) A cooperative association is either information to the business opportunity
(1) an association of producers of purchaser.
payment by a prospective business
opportunity purchaser, about which the agricultural products authorized by
section 1 of the Capper-Volstead Act, 7 Note 3: [As per § 437.1(a)(24) of this part]:
business opportunity seller, broker, or
any agent, representative, or employee U.S.C. 291; or (2) an organization DISCLOSURE STATEMENT
thereof, knows or should know, of any operated on a cooperative basis by and
for independent retailers which Pursuant to 16 CFR 437.1 et seq., a Trade
consideration in connection with the Regulation Rule of the Federal Trade
sale or proposed sale of a business wholesales goods or furnishes services Commission regarding Disclosure
opportunity. primarily to its member-retailers. Requirements and Prohibitions Concerning
(m) The term fiscal year means the Business Opportunities, the following
(h) The term fractional business
business opportunity seller’s fiscal year. information is set forth on [name of business
opportunity means any relationship, as (n) The term material, material fact, opportunity seller] for your examination:
denoted by paragraph (a) of this section, and material change shall include any 1. Identifying information as to the
in which the person described therein fact, circumstance, or set of conditions business opportunity seller;
as a business opportunity purchaser, or that has a substantial likelihood of 2. Business experience of the business
any of the current directors or executive influencing a reasonable business opportunity seller’s directors and executive
officers thereof, has been in the type of opportunity purchaser in the making of officers.
business represented by the business a significant decision relating to a 3. Business experience of the business
opportunity relationship for more than opportunity seller.
named business opportunity business or 4. Litigation history.
2 years and the parties anticipated, or that has any significant financial impact
should have anticipated, at the time the 5. Bankruptcy history.
on a business opportunity purchaser or 6. Description of business opportunity.
agreement establishing the business prospective business opportunity 7. Initial funds required to be paid by a
opportunity relationship was reached, purchaser. business opportunity purchaser.
that the sales arising from the (o) The term personal meeting means 8. Recurring funds required to be paid by
relationship would represent no more a face-to-face meeting between a a business opportunity purchaser.
than 20 percent of the sales in dollar business opportunity seller or broker (or 9. Affiliated persons the business
volume of the business opportunity any agent, representative, or employee opportunity purchaser is required or advised
purchaser. to do business with by the business
thereof) and a prospective business opportunity seller.
(i) The term affiliated person means a opportunity purchaser which is held for
person (as defined in paragraph (b) of 10. Obligations to purchase.
the purposes of discussing the sale or 11. Revenues received by the business
this section): possible sale of a business opportunity. opportunity seller in consideration of

(1) Which directly or indirectly purchases by a business opportunity
controls, is controlled by, or is under § 437.3 Severability. purchaser.
common control with, a business If any provision of this part or its 12. Financing arrangements.
opportunity seller; or application to any person, act, or 13. Restriction on sales.
14. Person participation required of the RR 24. Real Estate National Nework RR 60. Wieczorek (see supra, RR 23)
business opportunity purchaser in the (‘‘RENN’’) RR 61. Enrique A. Gonzalez, Gonzalez
operation of the business opportunity. RR 25. Attorney General Jim Ryan Cavillo Y Forastierei (‘‘Gonzalez’’)
15. Termination, cancellation, and renewal (‘‘General Ryan’’), State of Illinois RR 62. Pepsico Restaurants
of the business opportunity. RR 26. Alan S. Nopar (‘‘Nopar’’) (‘‘Pepsico’’)
16. Statistical information concerning the
RR 27. Snap-On, Inc. (‘‘Snap-On’’) RR 63. IFA (see supra, RR 32)
number of business opportunity purchasers
(and company-owned outlets).
RR 28. Steven Rabenberg, Explore St. RR 64. Atlantic Richfield Co
17. Site selection. Louis (‘‘Rabenberg’’) (‘‘ARCO’’)
18. Training programs. RR 29. Douglas M. Brooks, Martland RR 65. David Clanton (‘‘Clanton’’)
19. Public figure involvement in the & Brooks (‘‘Brooks’’) RR 66. Leonard Swartz, Arthur
business opportunity. RR 30. Robert N. McDonald Andersen & Co. (‘‘Swartz’’)
20. Financial information concerning the (‘‘Commissioner McDonald’’), Securities RR 67. John R.F. Baer, Keck, Mahin &
business opportunity seller. Commissioner, State of Maryland Cate (‘‘Baer’’)
By direction of the Commission. RR 31. Little Ceasars (‘‘Little Ceasars’’) RR 68. Lynn Scott (‘‘Scott’’)
RR 32. International Franchise RR 69. Eversheds (‘‘Eversheds’’)
Donald S. Clark,
Association (‘‘IFA’’) RR 70. Brownstein Zeidman (see
Secretary. RR 33. Brownstein, Zeidman & Lore supra, RR 33)
Note: Attachment A is published for (‘‘Brownstein Zeidman’’) RR 71. Penny Ward, Baker &
information purposes only and will not be RR 34. Jere W. Glover (‘‘Glover’’), McKenzie (‘‘Ward’’)
codified in Title 16 of the Code of Federal Counsel for Advocacy, U.S. Small RR 72. Matthias Stein (‘‘Stein’’)
Regulations. Business Administration (‘‘SBA RR 73. Byron Fox, Hunton & Williams
Advocacy’’) (‘‘Fox’’)
ATTACHMENT A. RR 35. Jan Meyers, Chair, House RR 74. Papa John’s Pizza (‘‘Papa
TABLE OF COMMENTERS Committee on Small Business Johns’’)
(‘‘Representative Myers’’) RR 75. Harold L. Kestenbaum (see
Rule Review Commenters RR 36. Neil A. Simon, Hogan and supra, RR 14)
RR 1. Robert E. Mulloy, Jr. (‘‘Mulloy’’) Hartson (‘‘Simon’’)
RR 2. Stanley M. Dub, Dworken & RR 37. Deborah Bortner (‘‘Bortner’’), Rule Review September 1995 Public
Bernstein (‘‘Dub’’) Washington State Department of Workshop Conference
RR 3. Marvin J. Migdol, Nationwide Financial Institutions, Securities Panelists
Franchise Marketing Services Division Harold Brown, Brown & Stadfeld
(‘‘Migdol’’) RR 38. American Franchisee (‘‘Brown’’)
RR 4. SCPromotions, Inc. Association (‘‘AFA’’) Sam Damico, Q.M. Marketing, Inc.
(‘‘SCPromotions’’) RR 39. American Association of (‘‘Damico’’)
RR 5. R. Dana Pennell (‘‘Pennell’’) Franchisees & Dealers (‘‘AAFD’’) Connie B. D’Imperio, Color Your
RR 6. Robin Day Glenn (‘‘Glenn’’) RR 40. Warrren Lewis, Lewis &
RR 7. Jack McBirney, McGrow Carpet, Inc. (‘‘D’Imperio’’)
Trattner (‘‘Lewis’’) Eric Ellman (‘‘Ellman’’), Direct Selling
Consulting (‘‘McBirney’’) RR 41. Century 21 Real Estate Corp.
RR 8. SRA International (‘‘SRA Assocation (‘‘DSA’’)
(‘‘Century 21’’) Mark B. Forseth, Locke Purnell Rain
International’’) RR 42. John Hayden (‘‘Hayden’’)
RR 9. Harold Brown, Brown & Harrell (‘‘Forseth’’)
RR 43. North American Securities
Stadfeld (‘‘Brown’’) Mike Gason, Barkely & Evergreen
Administrators Association (‘‘NASAA’’)
RR 10. Ronald N. Rosenwasser RR 44. Robert L. Perrry (‘‘Perry’’) (‘‘Gaston’’)
(‘‘Rosenwasser’’) RR 45. The State Bar of California, Susan Kezios, American Franchisee
RR 11. Louis F. Sokol (‘‘Sokol’’) Business Law Section (‘‘CA BLS’’) Association (‘‘AFA’’) (‘‘Kezios’’)
RR 12. J. Howard Beales III, Professor, RR 46. Mike Gaston, Barkely & William Kimball, Iowa Coalition for
George Washington University Evergreen (‘‘Gaston’’) Responsible Franchising (‘‘Kimball’’)
(‘‘Beales’’) RR 47. The Southland Corp. Warren Lewis, Lewis & Trattner
RR 13. Peter Lagarias (‘‘Lagarias’’) (‘‘Southland’’) (‘‘Lewis’’)
RR 14. Harold L. Kestenbaum RR 48. Medicap Pharmacies, Inc. Steven Maxey (‘‘Maxey’’), North
(‘‘Kestenbaum’’) (‘‘Medicap’’) American Securities Administrators
RR 15. Walter D. Wilson, Better RR 49. Rochelle B. Spandorf Association (‘‘NASAA’’)
Business Bureau of Central Georgia, Inc. (‘‘Spandorf’’), ABA Forum on Joyce G. Mazero, Locke Purnell Rain
(‘‘Wilson’’) Franchising, Andrew C. Selden Harrell (‘‘Mazero’’)
RR 16. Connie B. D’Imperio, Color (‘‘Selden’’), David J. Kaufman Barry Pineles (‘‘Pineles’’), U.S. Small
Your Carpet, Inc. (‘‘D’Imperio’’) (‘‘Kaufmann’’) Business Administration (‘‘SBA
RR 17. Q.M. Marketing, Inc (‘‘Q.M. RR 50. Joyce G. Mazero, Locke Pernell Advocacy’’)
Marketing’’) Rain Harrell (‘‘Mazero’’) Robert Purvin, American Association
RR 18. David Gurnick, Kindel & RR 51. Mark B. Forseth, Locke Pernell of Franchisees & Dealers (‘‘AAFD’’)
Anderson (‘‘Gurnick’’) Rain Harrell (‘‘Forseth’’) (‘‘Purvin’’)
RR 19. U-Save Auto Rental (‘‘U-Save RR 52. Forte Hotels (‘‘Forte Hotels’’) Steven Rabenberg, Explore St. Louis
Auto Rental’’) RR 53. R.A. Politte (‘‘Politte’’) (‘‘Rabenberg’’)
RR 20. The Longaberger Co. RR 54. Politte (see supra, RR 53). Matthew R. Shay (‘‘Shay’’),
(‘‘Longaberger’’) RR 55. Brown (see supra, RR 9). International Franchise Association
RR 21. Direct Selling Association RR 56. Wieczorek (see supra, RR 23). (‘‘IFA’’)
(‘‘DSA’’) RR 57. Scott Shane, Georgia Institute Neil A. Simon, Hogan & Hartson
RR 22. American Bar Association, of Technology (‘‘Shane’’) (‘‘Simon’’)
Section on Antitrust Law (‘‘ABA AT’’) RR 58. Friday’s (‘‘Friday’s’’) Robin Spencer (‘‘Spencer’’),
RR 23. Dennis E. Wieczorek, Rudnick RR 59. Carl E. Zwisler, Keck, Mahin representing American Franchisee
& Wolfe (‘‘Wieczorek’’) & Cate (‘‘Zwisler’’) Association
Leonard Swartz, Arthur Anderson & Greg L. Walther, Outback Steakhouse ANPR 28. Neil Simon & Erik Wulff,
Co. (‘‘Swartz’’) Intl (‘‘Walther’’) Hogan & Hartson (‘‘H&H’’)
John Tifford, Brownstein Zeidman & Dennis E. Wieczorek, Rudnick & ANPR 29. Glenn A. Mueller,
Lore Wolfe (‘‘Wieczorek’’) Domino’s Pizza Franchisee (‘‘Mueller’’)
Ronnie Volkening (‘‘Volkening’’), The Erik B. Wulff, Hogan & Hartson ANPR 30. Doug Bell et al. Supercuts
Southland Corp. (‘‘Southland’’) (‘‘Wulff’’) Franchisees (‘‘Supercut Franchisees’’)
Dennis E. Wieczorek, Rudnick & Philip F. Zeidman (‘‘Zeidman’’) ANPR 31. Michael L. Bennett,
Wolfe (‘‘Wieczorek’’) Carl Zwisler, Keck, Mahin & Cate Longaberger Co. (‘‘Longaberger’’)
William J. Wimmer (Wimmer’’), Iowa (‘‘Zwisler’’) ANPR 32. John Rachide, Domino’s
Coalition for Responsible Franchising Pizza Franchisee (‘‘Rachide’’)
Public Participants ANPR 33. David J. Kaufmann,
Public Participants Jeff Brams, Sign-A-Rama and Kaufmann, Feiner, Yamin, Gildin &
Peter Denzen (‘‘Denzen’’) Shipping Connections (‘‘Brams’’) Robbins (‘‘Kaufmann’’)
Bob Hessler, Wendy’s (‘‘Hessler’’) Pamela Mills, Baker & McKenzie ANPR 34. Joseph N. Mariano, Direct
Chris Huke, SC Promotions (‘‘Huke’’) (‘‘Mills’’) Selling Association (‘‘DSA’’)
Michael Jorgensen (‘‘Jorgensen’’) ANPR 35. Linda F. Golodner & Susan
Advance Notice of Proposed
Robert L. Perry (‘‘Perry’’) Grant, National Consumers League
Rulemaking Commenters
Brian Schnell, Gray, Plant Mooty (‘‘NCL’’)
(‘‘Schnell’’) ANPR 1. Kevin Brendan Murphy, Mr. ANPR 36. Jere W. Glover & Jennifer A.
Franchise (‘‘Murphy’’) Smith, U.S. Small Business
March 1996 Public Workshop ANPR 2. Murphy (see supra, ANPR Administration Office of Chief Counsel
Conference 1). for Advocacy (‘‘SBA Advocacy’’)
Panelists ANPR 3. Mike Bruce, The Michael ANPR 37. Robert Chabot, Domino’s
Kay M. Ainsley, Ziebart Intl, Corp. Bruce Fund (‘‘Bruce’’) Pizza Franchisee (‘‘Chabot’’)
ANPR 4. Harold Brown, Brown & ANPR 38. Teresa Maloney, National
(‘‘Ainsley’’)
Stadfeld (‘‘Brown’’) Coalition of 7-Eleven Franchisees
John R.F. Baer, Keck, Mahin & Cate
ANPR 5. Frances L. Diaz (‘‘Diaz’’) (‘‘Maloney’’)
(‘‘Baer’’)
ANPR 6. Brown (see supra, ANPR 4). ANPR 39. BLANK
Michael Brennan, Rudnick & Wolfe ANPR 40. Harold L. Kestenbaum
(‘‘Brennan’’) ANPR 7. Diaz (see supra, ANPR 5).
ANPR 8. Marian Kunihisa (‘‘Kestenbaum’’)
Joel R. Buckberg, HFA, Inc. ANPR 41. Samuel L. Sibent, KFC
(‘‘Buckberg’’) (‘‘Kunihisa’’)
ANPR 9. Kevin Bores, Domino’s Pizza Franchisee (‘‘Sibent’’)
David A. Clanton, Baker & McKenzie ANPR 42. Oren C. Crothers, KFC
(‘‘Clanton’’) Franchisee (‘‘Bores’’)
ANPR 10. Terrence L. Packer, Franchisee (‘‘Crothers’’)
Kenneth R. Costello, Loeb & Loeb ANPR 43. Matthew Jankowski, KFC
(‘‘Costello’’) Supercuts Franchisee (‘‘Packer’’)
ANPR 11. John Delasandro Franchisee (‘‘Jankowski’’)
Edward J. Fay, Kwik Kopy Corp. ANPR 44. Rodney A. DeBoer, KFC
(‘‘Delasandro’’)
(‘‘Fay’’) Franchisee (‘‘DeBoer’’)
ANPR 12. William Cory (‘‘Cory’’)
Mark B. Forseth, Locke Purnell Rain ANPR 45. Liesje Bertoldi, KFC
ANPR 13. Joseph Manuszak,
Harrell (‘‘Forseth’’) Franchisee (‘‘L. Bertoldi)’’
Domino’s Franchisee (‘‘Manuszak’’)
Byron E. Fox, Hunton & Willaims ANPR 46. Steve Bertoldi, KFC
ANPR 14. Daryl Donafin, Taco Bell
(‘‘Fox’’) Franchisee (‘‘S. Bertoldi’’)
Franchisee (‘‘Donafin’’)
Bruce Harsh, International Trade ANPR 47. Charles Buckner, KFC
ANPR 15. David Muncie, National
Specialist, U.S. Department of Franchisee (‘‘Buckner’’)
Claims Service, Inc. (‘‘Muncie’’)
Commerce (‘‘Harsh’’) ANPR 48. Walter J. Knezevich, KFC
ANPR 16. Patrick E. Meyers, The
Arnold Janofsky, Precision Tune Franchisee (‘‘Knezevich’’)
Quizno’s Corp. (‘‘Quizno’s’’) ANPR 49. Jeffrey W. Gray, KFC
(‘‘Janofsky’’)
ANPR 17. David Weaver, Domino’s Franchisee (‘‘J. Gray’’)
Susan P. Kezios (‘‘Kezios’’), American
Pizza Franchisee (‘‘Weaver’’) ANPR 50. Fred Jackson, KFC
Franchisee Association (‘‘AFA’’)
ANPR 18. Karen M. Paquet, Domino’s Franchisee (‘‘Jackson’’)
Alex S. Konigsberg, QC
Pizza Franchisee (‘‘Paquet’’) ANPR 51. Ronald L. Rufener, KFC
(‘‘Konigsberg’’), Lapoint Rosenstein
ANPR 19. Gary R. Duvall Graham & Franchisee (‘‘Rufener’’)
Andrew P. Loewinger, Abraham
Dunn (‘‘Duvall’’) ANPR 52. Tim Morris, KFC
Pressman & Bauer (‘‘Loewinger’’)
ANPR 20. Andrew J. Sherman, Franchisee (‘‘Morris)’’
H. Bret Lowell, Brownstein Zeidman
Greenberg & Tauris (‘‘Sherman’’) ANPR 53. Scarlett Norris Adams, KFC
(‘‘Lowell’’) ANPR 21. S. Beavis Stubbings
John Melle, Office of U.S. Trade Franchisee (‘‘Adams’’)
(‘‘Stubbings’’) ANPR 54. Calvin G. White, KFC
Representative (‘‘Melle’’) ANPR 22. Jim & Evalena Gray, Pearle
Raymond L. Miolla, Burger King Corp. Franchisee (‘‘White’’)
Vision Franchisee (‘‘J&E Gray’’) ANPR 55. Nick Iuliano, KFC
(‘‘Miolla’’) ANPR 23. Ernest Higginbotham
Alex Papadakis, Hurt Sinisi Papadakis Franchisee (‘‘N. Iuliano’’)
(‘‘Higginbotham’’) ANPR 56. Dolores Iuliano, KFC
(‘‘Papadakis’’) ANPR 24. Henry C. Su & Bryon Fox
Matthew R. Shay (‘‘Shay’’), Franchisee (‘‘D. Iuliano’’)
(‘‘Su’’) ANPR 57. Ralph A Harman, KFC
International Franchise Association ANPR 25. John R. F. Baer, Keck, Franchisee (‘‘R. Harman’’)
(‘‘IFA’’) Mahin & Cate (‘‘Baer’’) ANPR 58. Saundra S. Harman, KFC
Neil A. Simon, Hogan & Hartson
ANPR 26. Clay Small & Lowell Dixon, Franchisee (‘‘S. Harman’’)
(‘‘Simon’’) Nat’l Franchise Mediation Program ANPR 59. Richard Braden, KFC
Leonard Swartz, Arthur Anderson & Steering Committee (‘‘NFMP’’) Franchisee (‘‘Barden’’)
Co. (‘‘Swartz’’) ANPR 27. Richard T. Catalano ANPR 60. K.F. C. of Pollys, KFC
(‘‘Catalano’’) Franchisee (‘‘Pollys’’)
ANPR 61. Joan Fiore, McDonalds ANPR 95. Entrepreneur Media, Inc. ANPR 127. W. Michael Garner, Dady
Franchisee (‘‘Fiore’’) (‘‘Entrepreneur’’) & Garner (‘‘Garner’’)
ANPR 62. Susan P. Kezios, American ANPR 96. Brown (see supra, ANPR 4) ANPR 128. Jeff Brickner (‘‘Brickner’’)
Franchisee Association (‘‘AFA’’) ANPR 97. Raymond & Robert Buckley, ANPR 129. Bernard A. Brynda, Baskin
ANPR 63. Kenneth R. Costello, Loeb Scorecard Plus Franchisees (‘‘Buckley’’) & Robbins Franchisee (‘‘Brynda’’)
& Loeb (‘‘Costello’’) ANPR 98. Mark A. Kirsch, Rudnick, ANPR 130. Caron B. Slimak, Jacadi
ANPR 64. AFA (see supra, ANPR 62) Wolfe, Epstien & Zeidman (‘‘Kirsch’’) USA Franchisee (‘‘Slimak’’)
ANPR 65. Susan Rich, KFC ANPR 99. Dale E. Cantone, Maryland ANPR 131. Dr. Ralph Geiderman,
Franchisee (‘‘Rich’’) Division of Securities, Office of the Pearl Vision Franchisee (‘‘Geiderman’’)
ANPR 66. Fiore (see supra, ANPR 61) Attorney General (‘‘Md Securities’’) ANPR 132. Felipe Frydmann,
ANPR 67. Mike Johnson, Subway ANPR 100. Roger C. Haines, Minister of Economic & Trade Affairs,
Franchisee (‘‘Johnson’’) Scorecard Plus Franchisee (‘‘Haines’’) Embassy of the Argentine Republic
ANPR 68. Laurie Gaither, GNC ANPR 101. David E. Myklebust, (‘‘Argentine Embassy’’)
Franchisee (‘‘L. Gaither’’) Scorecard Plus Franchisee ANPR 133. Andrew C. Selden, Briggs
ANPR 69. Greg Gaither, GNC (‘‘Myklebust’’) & Morgan (‘‘Selden’’)
Franchisee (‘‘G. Gaither’’) ANPR 102. Robert Larson (‘‘Larson’’) ANPR 134. Robert Zarco, Zarco &
ANPR 70. Greg Suslovic, Subway ANPR 103. Brown (see supra, ANPR Pardo (‘‘Zarco & Pardo’’)
Franchisee (‘‘Suslovic’’) 4) ANPR 135. Jason H. Griffing, Baskin
ANPR 71. Richard Colenda, GNC ANPR 104. Mark B. Forseth, CII & Robbins Franchisee (‘‘Griffing’’)
Franchisee (‘‘Colenda’’) Enterprises (‘‘CII’’) ANPR 136. Erik H. Karp, Witmer,
ANPR 72. Bob Gagliati, GNC ANPR 105. Bertrand T. Unger, PR One Karp, Warner & Thuotte (‘‘Karp’’)
Franchisee (‘‘Gagliati’’) (‘‘Pr One’’) ANPR 137. William D. Brandt, Ferder,
ANPR 73. Pat Orzano, 7-Eleven ANPR 106. Dennis E. Wieczorek, Brandt, Casebeer, Copper, Hoyt &
Franchisee (‘‘Orzano’’) Rudnick & Wolfe (‘‘Wieczorek’’) French (‘‘Brandt’’)
ANPR 74. Linda Gaither, GNC ANPR 107. Gerald A. Marks, Marks & ANPR 138. Robert S. Keating, Baskin
Franchisee (‘‘Li Gaither’’) Krantz (‘‘Marks’’) & Robbins Franchisee (‘‘Keating’’)
ANPR 75. Kevin 100 (‘‘Kevin 100’’) ANPR 108. Brown (see supra, ANPR ANPR 139. A. Patel, Baskin & Robbins
ANPR 76. Robert James, Florida 4) Franchisee (‘‘A. Patel’’)
Department of Agriculture & Consumer ANPR 109. Everett W. Knell (‘‘Knell’’) ANPR 140. Joel R. Buckberg, Cendant
ANPR 110. Anne Crews, Mary Kay, Corporation (‘‘Cendant’’)
Services (‘‘James’’)
ANPR 77. Robert A. Tingler, Office of Inc. (‘‘Mary Kay’’) ANPR 141. Duvall (see supra, ANPR
ANPR 111. Carl Letts, Domino’s Pizza 19)
the Attorney General, State of Illinois
Franchisee (‘‘Letts’’) ANPR 142. NCL (see supra, ANPR 35)
(‘‘IL AG’’) ANPR 112. Kat Tidd (‘‘Tidd’’)
ANPR 78. John M. Tifford, Rudnick, ANPR 143. AFA (see supra, ANPR 62)
ANPR 113. Ted Poggi, National ANPR 144. Catalano (see supra, ANPR
Wolfe, Epstien & Zeidman (‘‘Tifford’’) Coalition of Associations of 7-Eleven 27)
ANPR 79. Robert L. Purvin, Jr. Franchisees (‘‘NCA 7-Eleven ANPR 145. DSA (see supra, ANPR 34)
(‘‘Purvin’’) Franchisees) ANPR 146. Keating (see supra, ANPR
ANPR 80. Teresa Heron, My Favorite ANPR 114. Gary R. Duvall & Nadine 139)
Muffin Franchisee (‘‘Heron’’) C. Mandel (‘‘Duvall & Mandel’’) ANPR 147. Kathie & David Leap,
ANPR 81. Purvin (see supra, ANPR ANPR 115. Sherry Christopher, Baskin & Robbins Franchisee (‘‘Leap’’)
79) Christopher Consulting, Inc. ANPR 148. Ted D. Kuhn, Baskin &
ANPR 82. Matthew R. Shay, (‘‘Christopher’’) Robbins Franchisee (‘‘Kuhn’’)
International Franchise Association ANPR 116. Carl C. Jeffers, Intel ANPR 149. Mike S. Lee, Baskin &
(‘‘IFA’’) Marketing Systems, Inc. (‘‘Jeffers’’) Robbins Franchisee (‘‘Lee’’)
ANPR 83. Duvall (see supra, ANPR ANPR 117. Deborah Bortner, State of ANPR 150. R. Deilal, Baskin &
19) Washington, Department of Financial Robbins Franchisee (‘‘Deilal’’)
ANPR 84. Lance Winslow, Car Wash Institutions, Securities Divisions (‘‘WA ANPR 151. Frank J. Demotto, Baskin
Guys (‘‘Winslow’’) Securities’’) & Robbins Franchisee (‘‘Demotto’’)
ANPR 85. Winslow (see supra, ANPR ANPR 118. Carmen D. Caruso, ANPR 152. Thomas Hung, Baskin &
84) Noonan & Caruso (‘‘Caruso’’) Robbins Franchisee (‘‘Hung’’)
ANPR 86. Rick Gue, The Pampered ANPR 119. Howard Bundy, Bundy & ANPR 153. Jean Jones, Baskin &
Chef, (‘‘Pampered Chef’’) Morrill, Inc.(‘‘Bundy’’) Robbins Franchisee (‘‘Jones’’)
ANPR 87. John M. Tifford, Coverall ANPR 120. Franchise & Business ANPR 154. Hang, Baskin & Robbins
North America (‘‘Coverall’’) Opportunity Committee, North Franchisee (‘‘Hang’’)
ANPR 88. John M. Tifford, American Securities Administrations ANPR 155. Dilip Patel, Baskin &
Merchandise Mart Properties Association (‘‘NASAA’’) Robbins Franchisee (‘‘D. Patel’’)
(‘‘Merchanise Mart’’) ANPR 121. Tifford (see supra, ANPR ANPR 156. Terry L. Glase, Baskin &
ANPR 89. Dirk C. Bloemendaal, 78) Robbins Franchisee (‘‘Glase’’)
Amway Corproation (‘‘Amway’’) ANPR 122. Wieczorek (see supra, ANPR 157. R.E. Williamson, Baskin &
ANPR 90. Winslow (see supra, ANPR ANPR 106) Robbins Franchisee (‘‘Williamson’’)
84) ANPR 123. John & Debbie Lopez, ANPR 158. R. M Valum, Baskin &
ANPR 91. Winslow (see supra, ANPR Baskin & Robbins Franchisee (‘‘Lopez’’) Robbins Franchisee (‘‘Valum’’)
84) ANPR 124. Susan R. Essex & Ted ANPR 159. Rajendra Patel, Baskin &
ANPR 92. Winslow (see supra, ANPR Storey, California Bar, Business Law Robbins Franchisee (‘‘R. Patel’’)
84) Section (‘‘CA BLS’’) ANPR 160. Jerry & Debbie Robinett,
ANPR 93. Winslow (see supra, ANPR ANPR 125. Peter C. Lagarias, The Baskin & Robbins Franchisee
84) Legal Solutions Group (‘‘Lagarias’’) (‘‘Robinett’’)
ANPR 94. Andrew A. Caffey ANPR 126. James G. Merret, Jr. ANPR 161. Ronald J. Rudolf, Baskin &
(‘‘Caffey’’) (‘‘Merret’’) Robbins Franchisee (‘‘Rudolf’’)
ANPR 162. Kamlesh Patel, Baskin & Thomas Hoar, Hanes Franchisee (‘‘T. Barry Zaslav, Coverall North America
Robbins Franchisee (‘‘K. Patel’’) Hoar’’) (‘‘Zaslav’’)
ANPR 163. Nicholas & Marilyn Nelson Hockert-Lotz, Domino’s Pizza Franchise Rule Notice of Proposed
Apostal, Baskin & Robbins Franchisee Franchisee (‘‘Hockert-Lotz’’) Rulemaking Commenters
(‘‘Apostal’’) Tee Houston-Aldridge, World
ANPR 164. Patrick Sitin, Baskin & Inspection Network (‘‘Houston- NPR 1. Patrick E. Meyers, The
Robbins Franchisee (‘‘Sitin’’) Aldridge’’) Quizno’s Corporation (‘‘Quizno’s’’)
ANPR 165. Paul & Lisa SeLander, Robert James, Florida Dept. of NPR 2. Steven A. Rosen, Frannet
Baskin & Robbins Franchisee Agriculture & Consumer Services (‘‘Frannet’’)
(‘‘SeLander’’) (‘‘James’’) NPR 3. Robert Tingler, Franchise
ANPR 166. S. Bhilnym, Baskin & Carl Jeffers, Intel Marketing Systems Bureau Chief, Illinois Attorney General
Robbins Franchisee (‘‘Bhilnym’’) (‘‘Jeffers’’) (‘‘IL AG’’)
ANPR 167. Mike & Kathy Denino, Erik Karp, Witmer, Karp, Warner & NPR 4. Dennis E. Wieczorek, Piper
Baskin & Robbins Franchisee Thuotte (‘‘Karp’’) Marbury Rudnick & Wolfe (‘‘PMR&W’’)
(‘‘Denino’’) David Kaufmann, Kaufmann, Feiner, NPR 5. Jack Schuessler, Wendy’s Intl,
ANPR Workshop Participants Yamin, Gildin & Robbins (‘‘Kaufmann’’) Inc. (‘‘Wendy’s’’)
Harold Kestenbaum, Hollenbrug, NPR 6. Curtis S. Gimson, Triarc
Michael Bennett, Longaberger Bleven, Solomon, Ross (‘‘Kestenbaum’’) Restaurant Group (‘‘Triarc’’)
Company (‘‘Bennett’’) Susan Kezios, American Franchisee NPR 7. Eugene Stachowiak,
Kennedy Brooks (‘‘Brooks’’) Association (‘‘Kezios’’) McDonald’s (‘‘McDonalds’’)
John Brown, Amway Corporation (‘‘J. Mark Kirsch, Rudnick Wolfe, Epstien NPR 8. David E. Holmes (‘‘Holmes’’)
Brown’’) & Zeidman (‘‘Kirsch’’) NPR 9. Erik B. Wulff, John F. Dienelt,
Howard Bundy, Bundy & Morrill Charles Lay, Brite Site Franchisee Hogan & Hartson (‘‘H&H’’)
(‘‘Bundy’’) (‘‘Lay’’) NPR 10. Ronnie R. Volkening, 7-
Delia Burke, Jenkins & Gilchrist Mike Ludlum, Entreprenuer Media Eleven, Inc. (‘‘7-Eleven’’)
(‘‘Burke’’) (‘‘Ludlum’’) NPR 11. John R.F. Baer, Robert T.
Andrew Caffey, Esq. (‘‘Caffey’’) Marge Lundquist, Franchisee Joseph, Alan H. Silberman,
Dale Catone, Office of the Maryland Sonnenschein Nath & Rosenthal
(‘‘Lundquist’’)
Attorney General (‘‘Cantone’’) (‘‘Baer’’)
Gerald Marks, Marks & Krantz
Emilio Casillas, Washington State NPR 12. Morton A. Aronson, Neil A.
(‘‘Marks’’)
Securities Division (‘‘Casillas’’) Simon, David J. Kaufmann, National
Richard Catalano, Esq. (‘‘Catalano’’) Philip McKee, National Consumers
League (‘‘McKee’’) Franchise Council (‘‘NFC’’)
Sherry Christopher, Esq.
Dianne Mousley, Mike Schmidt’s NPR 13. Alaska Turner (‘‘Turner’’)
(‘‘Christopher’’)
Michael W. Chiodo, Domino’s Phil. Hoagies Franchisee (‘‘Mousley’’) NPR 14. Susan P. Kezios, American
Franchisee (‘‘Chiodo’’) Joseph Punturo, Office of the New Franchisee Association (‘‘AFA’’)
Martin Cordell, Washington State York Attorney General (‘‘Punturo’’) NPR 15. Warren L. Lewis, Lewis &
Securities Division (‘‘Cordell’’) Mehran Rafizadeh, GNC Franchisee Kolton (‘‘Lewis’’)
Joseph Cristiano, Carvel Franchisee (‘‘Rafizadeh’’) NPR 16. John W. Regnery, Snap-On
(‘‘Cristiano’’) David R. Raymond, Esq. (‘‘Raymond’’) Inc. (‘‘Snap-On’’)
John D’Alessandro, Quaker State Lube Iris Sandow, Blimpie Franchisee NPR 17. Dale E. Cantone, Stephen W.
Distributor (‘‘D’Alessandro’’) (‘‘Sandow’’) Maxey, Joseph J. Punturo, NASAA
Mark Deutsch, former franchisee Philip Sanson, Illinois Securities Franchise and Business Opportunity
(‘‘Deutsch’’) Department (‘‘Sanson’’) Project Group (‘‘NASAA’’)
Steve Doe, Franchisee (‘‘Doe’’) Matthew Shay, International NPR 18. Howard E. Bundy, Bundy &
Gary Duvall, Graham & Dunn Franchise Association (‘‘IFA’’) Morrill, Inc. (‘‘Bundy’’)
(‘‘Duvall’’) David Silverman, Sportworld Int’l NPR 19. Laurie Taylor (‘‘Taylor’’)
Eric Ellman, Direct Selling (‘‘Silverman’’) NPR 20. Jonathan Hubbell, Prudential
Association (‘‘Ellman’’) Neil Simon, Hogan & Hartson Real Estate Affiliates (‘‘PREA’’)
Debbie Fetzer, Snap-On Franchisee (‘‘Simon’’) NPR 21. David Gurnick, Arter &
(‘‘Fetzer’’) Caron Slimak (‘‘Slimak’’), Jacadi USA Hadden (‘‘Gurnick’’)
David Finigan, Illinois Securities Franchisee NPR 22. Don J. DeBolt, Matthew R.
Department (‘‘Finigan’’) J. H. Snow, Jenkens & Gilcrist Shay, International Franchise
Mark B. Forseth, Jenkens & Gilchrist (‘‘Snow’’) Association (‘‘IFA’’)
(‘‘Forseth’’) Adam Sokol, Illinois Attorney NPR 23. L. Seth Stadfeld, Weston,
Richard W. Galloway, Domino’s Pizza General’s Office (‘‘Sokol’’) Patrick, Willard & Redding (‘‘Stadfeld’’)
Franchisee (‘‘Galloway’’) Kat Tidd, Esq. (‘‘Tidd’’) NPR 24. Eric H. Karp, Witmer, Karp,
Elizabeth Garceau, Pro Design (‘‘E. John Tifford, Rudnick Wolfe, Epstien Warner & Thuotte (‘‘Karp’’)
Garceau’’) & Zeidman, (‘‘Tifford’’) NPR 25. Janet L. McDavid, American
Michael Garceau, Pro Design (‘‘M. Robert Tingler, Franchise Bureau Bar Association, Section of Antitrust
Garceau’’) Chief. Illinois Attorney General’s Office Law (‘‘ABA AT’’)
Roger Gerdes, Microsoft Corp. (‘‘Tingler’’) NPR 26. Randall Loeb, NaturaLawn of
(‘‘Gerdes’’) Bertrand Unger, PR One (‘‘Unger’’) America (‘‘NaturaLawn’’)
Rick Geu, The Pampered Chef (‘‘Geu’’) Dr. Spencer Vidulich, Pearle Vision NPR 27. Tony Rolland, National
Judy Gitterman, Jenkens & Gilchrist Franchisee (‘‘Vidulich’’) Franchisee Association (‘‘NFA’’)
(‘‘Gitterman’’) Dick Way, PR One (‘‘Way’’) NPR 28. Andrew P. Loewinger,

Susan Grant, National Consumers Dennis Wieczorek, Rudnick & Wolfe Buchannan Ingersoll (‘‘BI’’)
League (‘‘Grant’’) (‘‘Wieczorek’’) NPR 29. Jeffrey E. Kolton, Frandata
Bruce Hoar, Hanes Franchisee (‘‘B. Erik Wulff, Hogan & Hartson (‘‘Frandata’’)
Hoar’’) (‘‘Wulff’’) NPR 30. AFC Enterprises (‘‘AFC’’)
NPR 31. Howard Morrill, Bundy & Bundy & Morrill, Inc. (‘‘Bundy’’) National Council of Farmer
Morrill, Inc. (‘‘Morrill’’) Car Wash Guys (‘‘Winslow’’) Cooperatives (‘‘NCFC’’)
NPR 32. Carl E. Zwisler, Jenkens & Cendant Corp. (‘‘Cendant’’) National Grocers Assoc. (‘‘NGA’’)
Gilchrist (‘‘J&G’’) CHS, Inc. (‘‘CHS’’)
Gary Duvall (‘‘Duvall’’) North American Securities
NPR 33. Diane T. Nauer, TruServ Administrators Association (‘‘NASAA’’)
Corporation (‘‘TruServ’’) Frost Brown Todd (‘‘Graber’’)
David Gurnick (‘‘Gurnick’’) Pillsbury Winthrop (‘‘Chevron’’)
NPR 34. Brian H. Cole, Tricon
Gust Rosenfeld (‘‘Gust Rosenfeld’’) Pillsbury Winthrop (‘‘Pillsbury
(‘‘Tricon’’)
Illinois Attorney General (‘‘IL AG’’) Winthrop’’)
NPR 35. Steven Goldman, Mark Independent Distributors Cooperative
Forseth, Marriott Corp. (‘‘Marriott’’) Piper Rudnick (‘‘Piper Rudnick’’)
(‘‘IDC’’)
NPR Rebuttal 36. Gurnick (see supra, International Franchise Association Prudential Real Estate Affiliates
FR-NPR 21) (‘‘IFA’’) (‘‘PREA’’)
NPR Rebuttal 37. Kezios (see supra, Jeffrey S. Haff (‘‘Haff’’) Richard Pu (‘‘Pu’’)
FR-NPR 14) Jenkens & Gilchrist (‘‘J&G’’) Riezman Berger (‘‘Riezman Berger’’)
NPR Rebuttal 38. IL AG (see supra, Johnson, Hearn, Vinegar, Gee & Spandorf, Silberman, Joseph, and
FR-NPR 3) Mercer (‘‘Gee’’) Baer (‘‘Spandorf’’)
NPR Rebuttal 39. Bundy (see supra, Kaufmann, Feiner, Yamin, Gildin &
FR-NPR 18) Starwood (‘‘Starwood’’)
Robbins (‘‘Kaufmann’’)
NPR Rebuttal 40. John W. Fitzgerald, A. Koutsoulis (‘‘Koutsoulis’’) State Bar of California—Franchise
Gray, Plant, Mooty, Mooty & Bennett Law Office of Marc N. Blumenthal Law Committee (‘‘CA Bar’’)
(‘‘GPM’’) (‘‘Blumenthal’’) State of California Department of
Staff Report Law Office of Peter A. Singler Corporations (‘‘CA Dep’t of Corps’’)
(‘‘Singler’’) Paul Steinberg (‘‘Steinberg’’)
Affiliated Foods Midwest (‘‘Affiliated Legal Solutions Group (‘‘Lagarias’’) Washington State Department of
Foods’’) Marks & Associates (‘‘Marks’’) Financial Institutions (‘‘WA Securities’’)
American Association of Franchisees Michael H. Seid & Assoc. (‘‘Seid’’)
and Dealers (‘‘AAFD’’) National Automobile Dealers Assoc. Wiggin & Dana (‘‘Wiggin & Dana’’)
American Franchisee Association (‘‘NADA’’) Witmer, Karp & Warner (‘‘Karp’’)
(‘‘AFA’’) National Cooperative Business Assoc. [FR Doc. E7–5829 Filed 3–29–07; 8:45 am]
Briggs & Morgan (‘‘Selden’’) (‘‘NCBA’’) BILLING CODE 6750–01–S

Rule: Trade Regulation Rules: Franchising and Business Opportunities Disclosure Requirements and Prohibitions

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Rule: Trade Regulation Rules: Franchising and Business Opportunities Disclosure Requirements and Prohibitions

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Friday,

March 30, 2007

Division of Marketing Practices, Room UFOC Guidelines by NASAA’s submission of a

Topic(s) Location Dates

Trade Show Promoters Washington, D.C. July 28–29, 1997

Business Opportunities Chicago, IL August 21–22, 1997

Business Opportunities Dallas, TX October 20–21, 1997

Topic(s) Location Dates

Business Opportunities Washington, D.C. November 20–21, 1997

Part 436 of the final amended Rule misrepresented or failed to disclose

involvement by the franchisor in maintaining non-franchise relationships. Accordingly, the

82 At the same time, the confidentiality clause

88 This presentation requirement would be unnecessary confusion. Staff Report, at 68–9.

franchisor’s agent, broker, or separate definition of ‘‘franchisor,’’ to whom the

239See section 436.6 of the final amended Rule.

253 15 U.S.C. 44.

disclosures. 323 IL AG, at 4. v.

considered like all other disclosures of section 436.5(c)(4). Comparison, at 6.

applying a formula or fixed calculation, refund.

497 Selden, ANPR 133, Appendix B. See also

539 Stadfeld, NPR 23, at 15–16. See also

571 16 CFR 436.1(b)(5)(i); 16 CFR 436.1(c)(6)(i). 575 IL AG, NPR 3, at 7.

644 Bundy, ANPR, 6 Nov. 97 Tr., at 236–37. See

create individualized disclosure documents for

diligence is a defense. Kaufmann, at 7–8.

original Rule’s 90-day annual update requirement).

records on franchise sales transactions. E.g., Cal.

HYPOTHETICAL USING PROCEDURES UNDER THE ORIGINAL RULE

HYPOTHETICAL USING FINAL AMENDED RULE PROCEDURES

prohibition is unlikely to increase franchisor ‘‘notifies’’ a prospective franchisee is

franchisee about the material change to the this Document.

805See 17 CFR 230.501(5), (6), and (8). See also

have sufficient equity capital before granting a loan.

franchisee exemption 3; Wendy’s, NPR 5, at 3; Triarc, NPR 6, at 1; H&H,

952See 16 CFR 436.3.

United States. the 1990’s, the International Franchise Association

Column 1 Column 2 Column 3 Column 4

Obligation Section in agreement Disclosure document item

a. Site selection and acquisition/lease

c. Site development and other pre-opening requirements

d. Initial and ongoing training

g. Compliance with standards and policies/operating manual

h. Trademarks and proprietary information

i. Restrictions on products/services offered

j. Warranty and customer service requirements

k. Territorial development and sales quotas

l. Ongoing product/service purchases

m. Maintenance, appearance, and remodeling requirements

r. Records and reports

s. Inspections and audits

Column 1 Column 2 Column 3 Column 4

Section in franchise or other

a. Length of the franchise term

b. Renewal or extension of the term

c. Requirements for franchisee to renew or extend

e. Termination by franchisor without cause

f. Termination by franchisor with cause

g. ‘‘Cause’’ defined—curable defaults

h. ‘‘Cause’’ defined—non-curable defaults

i. Franchisee’s obligations on termination/non-renewal

j. Assignment of contract by franchisor

l. Franchisor approval of transfer by franchisee

m. Conditions for franchisor approval of transfer