Long Awaited FTC Rule: Highlights of the Revisions
By: EMILY E. DUKE & DAVID P. WEBER
The Federal Trade Commission (“FTC”) adopted a new rule governing the offering of franchises that will take effect July 1, 2007. However, franchisors may continue to use the old rule until July 1, 2008. Thereafter, all franchises must be offered in compliance with the new rule. The new rule provides several significant changes, but leaves much of the current Uniform Franchise Offering Circular (“UFOC”) format intact. The newly required disclosure document is typically referred to as “UFOC Plus.”
One primary change in the FTC Rule can be implemented immediately, even with the old UFOC: electronic disclosure. In addition, the UFOC Plus has new disclosures: material franchisor-initiated litigation such as collection of royalties; the existence of confidentiality agreements with franchisees; certain franchisee associations; possible intrabrand competition in cases where there is no exclusive territory; and additional statistics relating to transfer and turnover of units. However, franchisors will also find relief from some obligations. Three more categories of investors will now be exempt from disclosure obligations. In addition, annual updates will be due 30 days later (120 days after the fiscal year end rather than the current 90 days), and the UFOC holding period and certain earnings claims will be simplified. These changes are explained in more detail below.
- Electronic disclosure is now expressly considered valid. There are, however, certain requirements that must be met in order to disclose electronically:
- The franchisors must provide notice to the franchisees that they are entitled to receive the document in another format (i.e. paper).
- Prospective franchisees must be able to “store, download, print, or otherwise maintain the document for future reference.”
- The electronic form must be a single document.
- The franchisor must require a form of receipt. A good practice would be to keep the receipt as part of the electronic document and require the franchisees to print the receipt page, sign it, and send it to you. By doing so, they acknowledge that: (i) they received the UFOC; (ii) they were able to open it; and (iii) they were able to navigate through and print off a specific page.
- The document may contain only scrollbars, internal links, and search features (no pop-ups or any additional information not contained in the UFOC).
- The amended Rule expands the UFOC Guidelines by requiring franchisors to disclose material franchisor-initiated litigation involving the franchise relationship. Litigation filed by or against the franchisor’s parent or affiliate must also be disclosed if the parent or affiliate guarantees the franchisor’s performance. Franchisors must disclose suits they have filed or pending for the previous 1-year period. However, this information may be presented in summary fashion, in such groupings as “royalty collection suits,” etc. The FTC views such disclosure as material to a prospective franchisee’s decision to enter a franchise system.
- Franchisor-formed franchisee associations must be disclosed (i.e. name, address, telephone, etc.) and any other franchisee association formally organized under a state law.
- Franchisors will be required to disclose whether or not they have entered into any confidentiality agreements in the prior three fiscal years with franchisees (specifically aimed at those agreements that would limit a franchisee’s ability to communicate with a prospective franchisee regarding its overall experience in the system).
- Franchisees must be warned of possible intrabrand competition in Item 12 if there is no exclusive territory.
- Five tables are now required in Item 20 instead of the previous three:
- Status of the franchisor’s system, including the number of company and franchisee-owned outlets for the past three years;
- Franchise transfers;
- Turnover rate of franchised outlets, including outlets at the start of the year, openings, terminations, non-renewals, re-acquisitions by the franchisor, outlets that ceased to do business, and outlets at the end of the year;
- Turnover rate at company-owned outlets; and
- Projected openings.
- In connection with the sale of company units, you will have to disclose the names, addresses, and telephone numbers of each owner for the last five years and the reasons for the ownership changes.
- There are three categories of people who no longer need to receive a disclosure document. Disclosure exemptions have been added for the following:
- Franchisor company insiders;
- Large franchisees who have been in any business for at least five years and have a net worth of at least $5 million; and
- Sales where the initial investment totals at least $1 million (excluding the cost of unimproved land), provided however, that at least one investor or the single owner of an LLC contributes over $1 million (i.e. cannot be a group of 20 people each contributing over $50,000).
- Annual updates will not be necessary until 120 days after fiscal year end instead of 90 days (i.e. April 30 becomes the new March 31).
- The UFOC holding period rules will change from 10 business days to 14 calendar days. Moreover, the first personal meeting requirement will be eliminated. The 5-day requirement will also be eliminated (unless there is a franchisor-initiated unilateral material change, in which case the holding period will now be 7 calendar days). However, a franchisor’s filling in blanks from pre-disclosed ranges are not considered “material” for purposes of the new 7-calendar-day periods. Negotiated changes initiated by the franchisee do not require a 7-calendar-day waiting period.
- Earnings claims can now be made in subgroups. The mere disclosure of cost information will not count as an earnings claims.
- Foreign franchisors will be able to use foreign financials that satisfy SEC criteria.
- A parent’s financial information will need to be disclosed if the parent commits to perform post-sale obligations for the franchisor; or guarantees the obligations of the franchisor.
- THE NEW RULE DOESN’T PREEMPT STATE LAW – THEREFORE, IF STATES RETAIN CERTAIN REQUIREMENTS (e.g., THE 5-DAY OR FIRST PERSONAL MEETING RULE) THOSE REQUIREMENTS MUST STILL BE FOLLOWED.
For those franchisors who do not wish to implement the UFOC Plus immediately, the benefits of UFOC Plus will have to wait too. Nevertheless, electronic disclosure – and its attendant cost savings and “green” benefits – can be immediately implemented under either the old or new UFOC format. Regardless of whether franchisors choose to change now or wait until 2008, information-gathering and compilation of statistics for the newly-required reporting are best started now.