Research Center & FAQ

FTC Announces New Franchise Rule

Dear Franchisor,

As the oldest active provider of UFOC electronic disclosure and automated receipt services (Franchise E-Disclosure™) tailored to the franchise industry, Franchise.com is pleased to provide you with a critical franchise regulatory update from David Holmes, Holmes & Lofstrom, LLP.

David has twice been the Co-Chair of the California State Bar Franchise Law Committee and is currently the Vice-Chair of the Commission charged with establishing Franchise and Distribution Law as a certified specialty in California. Lori Lofstrom is also a past Co-Chair of the California State Bar Franchise Law Committee and has spoken widely on the subjects of franchising and franchise law.

Franchise.com is currently programming an Item 20 Solution to assist franchise systems address and rapidly make their systems compliant with the FTC requirement to change the methodology of Item 20 reporting as outlined in the new FTC. We look forward to announcing this new product to you in a news flash in a couple weeks!

 

New FTC Rule and UFOC Changes Announced

by

David E. Holmes, Holmes & Lofstrom, LLP

On Tuesday, January 23, the Federal Trade Commission announced approval of a new FTC Franchise Rule. This long-anticipated and important development will involve revisions to nearly every UFOC disclosure item and, we believe, brings franchise regulation forward into the 21st Century. As an aside, the FTC's explanation and presentation of the new Rule (including the "Statement of Basis and Purpose") is over 390 pages long, with extensive footnotes! In general, suggestions from members of the professional franchising community have been widely adopted in the new Rule.

This new Rule is effective as of July 1, 2007, but Franchisors can “phase in” the new Rule and use their current UFOC format or the new FTC Rule format for one year from this effective date. As of July 1, 2008, franchises can only be offered using the new FTC Rule format, subject to minor changes to conform with state requirements.

We anticipate that Franchisors with a 12/31/06 fiscal year will generally use the current UFOC for all of 2007, and will begin to work toward converting to the new format in late 2007 to prepare for filings consistent with the New Rule in the Spring of 2008.

In the interim, we look to registration states to mirror the revisions to the FTC Rule in their disclosure requirements and hope that greater disclosure requirement uniformity will be the net result, although that hope has not always been fulfilled in the past!

The changes to the UFOC and related practices are many, but highlights include the following:

  • The first personal meeting "trigger" for providing a UFOC will no longer be present in federal law (but may remain in state regulations), allowing Franchisors to have face-to-face discussions without the need to deliver a UFOC.

  • The 10-business day pre-sale disclosure requirement (sometimes confusing to apply) has been converted to a 14 calendar day requirement, subject to a prospective Franchisee's request for earlier delivery. The completed agreement must now be in the prospective Franchisee's hands 7 calendar days before signing or paying funds.

  • All Franchisors will be allowed to use electronic means for delivery of the disclosure document.

  • Item 3 (Litigation) will include litigation filed by a Franchisor against its Franchisees.

  • Earnings claims (now called Financial Performance Representations) will remain optional.

  • Exemptions have been expanded, including:
     - the sale of franchises located outside the U.S.
     - franchises involving investments of at least US$1,000,000 (excluding unimproved land and amounts financed by the Franchisor).
     - investments to sophisticated individuals - net worth over US$5,000,000 and with over 5 years experience.
     - sales to selected officers, etc. of the Franchisor.
    (many of these exemptions are similar to ones adopted by California in the last few years)

  • Disclosures re brokers are eliminated from Item 2.

  • "Risk Factors" on the cover page regarding choice of law or venue are no longer required (but may still be wise under state law).

  • Information must be supplied re "trademark-specific" independent Franchisee associations.

  • Item 20 as been revised to help resolve certain "double counting" issues which could have the effect of inflating apparent system turnover. (We understand that Franchise.com is currently programming an online application that will dynamically compile Item 20 figures and tables compliant with the new Rule, who maintain the status of their units on its servers - this may be very helpful from a practical standpoint).

There will be significant implications for Franchisors in transitioning to the new format, but ultimately aspects of the new FTC Franchise Rule will be beneficial to both Franchisors and Franchise investors. The IFA will be reviewing the final amendments to the Rule in the next few days and provide additional guidance, as well as announce dates and locations of regional Legal Roundtable programs that will help clarify the New Rule. Holmes & Lofstrom also anticipates counseling clients as to activities they may want to undertake in the short term in order to make the transition to the new Rule format an easier one. A press release explaining the Commission's decision and an embedded link to the new Franchise Rule can be found at the FTC's website (www.ftc.gov).

If you have any questions as to how this may affect your franchise system, please contact any of the franchise attorneys at Holmes & Lofstrom, who worked along with many colleagues to provide comments and suggestions which were incorporated by the FTC in the New Franchise Rule.