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A Practical Guide to U.S. Franchise Sales Laws & Franchise

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A Practical Guide to U.S. Franchise Sales Laws & Franchise A Practical Guide to U.S. Franchise Sales Laws & Franchise Relationships March 2015 Japan External Trade Organization (JETRO) LOS ANGELES Prepared by Rochelle B. Spandorf, Esq. Partner, Davis Wright Tremaine, Los Angeles, California [email protected] 213/633-6898 © 2015 DAVIS WRIGHT TREMAINE LLP Introduction The United States is the “franchising capital of the world.”1 From about 100 franchising companies in 1950 to an estimated 3,000 franchisors today - in the United States alone – the business model known as “franchising” continues to grow in the United States. A recent study of franchised businesses across 10 broad business lines reveals impressive statistics and a con- tinued positive outlook for U.S. franchising:2 • Nearly 770,000 franchised outlets were operating in the U.S. at the end of 2014, with this figure projected to grow by over 12,000 new franchised outlets in 2015. • Both the quick service and full service segments of the restaurant industry experienced strong growth in 2014, with the same forecasted for 2015. Franchising’s successful track record here has spawned numerous foreign “home-grown” franchise concepts that operate entirely in local or overseas markets. Universally, however, to foreign franchisors, the U.S. market is the “holy grail,” a market 3 with unbounded opportunity offering foreign brands access to a vast consumer population. It is challenging for any franchisor, even U.S.-based companies, to expand their franchise system in a new country, and this is particularly true for foreign franchisors entering the U.S. Not only must foreign brands adjust their concepts to American tastes and customs, but foreign franchisors must understand and comply with complicated U.S. franchise laws. While the U.S., comparatively-speaking, is more hospitable than some countries in not limiting foreign business ownership or expatria- tion of profits from U.S.-based activities, foreign franchisors will likely find more cumbersome franchise sales laws here than elsewhere. Furthermore, the scope of required pre-sale franchise disclosures in the U.S. is considerably broader than in other countries and takes many foreign franchisors by surprise. The Guide provides practical guidance to Japanese companies about the legal regulation of franchise sales in the U.S. The Guide introduces U.S. franchise sales laws without bogging the reader down with too much detail. While the Guide assumes the reader currently operates a franchise business in Japan, it will be useful to companies that do not currently operate a franchise program overseas, but are considering launching one in the U.S. The Guide highlights essential information that ev- ery foreign franchisor should know about bringing a franchise concept to the U.S. or starting a franchise program in the U.S.4 Besides federal and state franchise sales laws, there are other types of franchise and generally-applicable statutes that po- tentially regulate franchise relationships, and judicial-based or “common law” that may regulate franchise parties. The Guide only briefly addresses other laws; the main focus is to explain what a foreign franchisor can expect in order to sell franchises lawfully in the U.S.5 1 http://www.entrepreneur.com/article/226135 (March _ _ _ 2015). 2 The 10 industry lines examined in the January, 2015 report prepared by IHS Economics for the International Franchise Association Educational Foundation were automotive, business services, commercial and residential services, lodging, personal services, quick service restaurants, real estate, retail food, retail products and services, and table/full service restaurants. See http://emarket.franchise.org/FranchiseBizOutlook2015.pdf (March _ _ , 2015). 3 http://www.entrepreneur.com/article/226135 (March _ _ _ 2015). 4 The Guide assumes the reader has a general understanding of business format franchising and the typical role of the franchisor and franchisee. The Guide only focuses on franchise sales laws and does not address business considerations for bringing a foreign franchise concept to the U.S. 5 Franchise sales laws apply to the sale of business arrangements that fall within the legal definition of a “franchise.” The term “franchise” is a technical term. Whether a business arrangement is a “franchise” depends on its unique facts and whether those facts satisfy the applicable statutory definition of a “franchise.” Federal and state franchise laws do not define “franchise” uniformly. Sometimes it is possible to structure a distribution program to lawfully avoid some or all franchise sales laws. However, there are few structural solutions available to franchisors of restaurant concepts. A franchisee cannot waive the statutory protections of franchise laws even if it wants to. This Guide does not discuss the question, “what is a franchise,” the legal definitions, or potential structuring solutions for lawfully avoiding U.S. franchise laws, but this is a question that a foreign franchisor may want to ask its U.S. legal counsel in planning its expansion into the U.S. 3 © 2015 DAVIS WRIGHT TREMAINE LLP The sample Franchise Disclosure Document, Franchise Agreement and Area Development Agreement that accompany the Guide represent a typical set of U.S. franchise documents for a casual dining concept requiring 2,000 square feet of interior space (including dining area and food preparation area). These franchise documents are not offered as a “template” and should not be copied. The sample documents reflect care- ful decisions that a franchisor entering the U.S. would make in consultation with an experienced U.S. franchise attorney and business advisor taking into account factors unique to the franchisor including the franchisor’s prior franchising experience in its home country, financial condition, expansion strategy, competitive concepts in the U.S., U.S. market conditions, tax treaties, U.S. immigration laws, home-country laws that may affect U.S. operations, and U.S. laws that may affect the export/ import of any proprietary products essential to U.S. operations. Franchise documents are not “one size fits all.” A foreign franchisor should resist the temptation to take the sample documents and make simple adjustments to them for its own use in the U.S. These documents should be considered tools to aid a foreign franchisor’s due diligence investigation into the feasibility of expanding its brand into the U.S. market. The Guide and accompanying franchise documents are not intended to provide specific legal advice nor substitute for direct counsel between attorneys and clients. Not only must franchise documents reflect each franchisor’s unique business strate- gies, but the application of franchise laws is an intensely fact-specific process. Engaging experienced franchise legal counsel and business advisors is an essential first step for any foreign company planning to franchise in the U.S. U.S. franchise sales laws may change over time. The Guide is prepared based on the laws in effect and best practices ob- served by franchisors at the time of its publication, March 31, 2015. 4 © 2015 DAVIS WRIGHT TREMAINE LLP Table of Contents What U.S. Laws Govern Franchise Sales Activities? . 7 1. Federal Law: . 7 2. State Laws: . 7 3. Do U.S. Franchise Sales Laws Apply To Foreign Franchisors? . 8 Jurisdiction – When Does A Particular State Law Apply? . 8 4. What Activities Determine A State Law’s Jurisdiction? . 8 5. What Are Exemptions . 10 6. Must A Franchisor Register In A Franchise Registration State Before A Franchisor May Advertise For Franchisees? . 10 7. Must A Franchisor Register In A Franchise Registration State Before A Franchisor May Advertise For Franchisees? . 11 Franchise Disclosure Document (“FDD”) . 11 8. What Is The Purpose Of The FDD? . 11 9. What Is The Purpose Of The FDD? . 12 Franchise Sellers . 21 10. Who May Offer Or Sell Franchises For A Franchisor? . 21 The Disclosure Process . 22 11. When And How Must The FDD Be Delivered To A Candidate? . 22 The Franchise Registration Process . 23 12. What Does Registration Entail? . 23 13. What About Material Changes? . 25 Waivers . 26 14. May A Prospective Franchisee Waive Franchise Laws? . 26 Document Retention . 26 15. How Long Must A Franchisor Retain Franchise Records? . 26 5 © 2015 DAVIS WRIGHT TREMAINE LLP Liability – Potential Consequences . 26 16. What Remedies Exist For Franchise Law Violations? . 26 17. How May A Franchisor Prevent Franchise Sales Violations? . 28 18. What Other Laws Govern The Franchise Relationship? . 28 Structuring The Franchise Business Relationship . 29 19. Types Of Franchise Structures . 29 20. Key Contracts That Document The Franchise Relationship . 32 21. Key Decisions For Area Development Agreements . 34 22. Key Decisions For Franchise Agreements . 36 6 © 2015 DAVIS WRIGHT TREMAINE LLP What U.S. Laws Govern Franchise Sales Activities? 1. Federal Law: 1.1 All franchise sales in the United States are subject to a federal law that is administered by the Federal Trade Commission (“FTC”), an independent agency of the U.S. government whose prin- cipal mission is to promote consumer protection and eliminate and prevent unfair and anticompet- itive business practices. The federal franchise law is commonly referred to as the “Amended FTC Rule.” 1.2 The Amended FTC Rule regulates franchise sales in all 50 states, including transactions that take place entirely within the same state (for example, where the franchisee operates in the same state where the franchisor has its headquarters). 1.3 The basic requirement of the Amended FTC Rule is that a franchisor must deliver a disclo- sure document (called a Franchise Disclosure Document or FDD) containing specific information about the franchisor and franchise opportunity to each franchisee candidate a minimum period of time before the franchisee may sign any binding agreement to buy a franchise or may pay the franchisor any money for the franchise opportunity. 1.4 The Amended FTC Rule does not require a franchisor to file or register its FDD with any federal agency.
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