FEDERAL TRADE COMMISSION

____________________________________________________________________

DISCLOSURE REQUIREMENTS AND PROHIBITIONS

 CONCERNING FRANCHISING

Staff Report to the Federal Trade Commission and

 Proposed Revised Trade Regulation Rule

(16 CFR Part 436)

__________________________________________________________________

BUREAU OF CONSUMER PROTECTION

AUGUST 2004
Disclosure Requirements and Prohibitions Concerning Franchising

Staff Report to the Federal Trade Commission and

Proposed Revised Trade Regulation Rule

(16 CFR Part 436)

Steven Toporoff

Attorney

Eileen Harrington

Associate Director

Division of Marketing Practices

J. Howard Beales, III

Director

Bureau of Consumer Protection

This Report, as required by Section 1.13(f) of the Commission’s Rules of Practice,

contains the staff’s analysis of the rule amendment record and its recommendations as to the

form of the final revised Franchise Rule. The Report has not been reviewed or adopted by the

Commission. The Commission’s final determination in this matter will be based upon the record

taken as a whole, including the Report and comments on the Report received during the 75-day

period after the Report is placed on the public record.
i

SUMMARY OF CHAPTERS

I. Background

II. Organization of the Report

III. Continuing Need for the Franchise Rule

IV. Proposed Section 436.1: Definitions

V. Proposed Section 436.2: Obligation to Furnish Documents

VI. Proposed Sections 436.3-436.5: The Disclosure Document

VII. Proposed Section 436.6: General Instructions

VIII. Proposed Section 436.7: Updating Requirements

IX. Proposed Section 436.8: Exemptions

X. Proposed Section 436.9: Additional Prohibitions

XI. Proposed Sections 436.10- 436.11: Other Laws, Rule, Orders, and Severability

XII. Conclusions

Attachment A: Table of Commenters

Attachment B: Proposed Revised Rule

Attachment C: Notice of Proposed Rulemaking 

Attachment D: Comparison: Proposed Rule and Proposed Revised Rule
ii

TABLE OF CONTENTS

I. BACKGROUND ........................................................ 2

II. ORGANIZATION OF THE REPORT ....................................... 4

III. CONTINUING NEED FOR THE FRANCHISE RULE .......................... 5

A. The Commission Should Retain the Franchise Rule ....................... 5

B. The Rule Should Be Narrowed To Focus On Franchises Exclusively. ........ 12

C. The Commission Should Revise the Franchise Rule’s Disclosures Based

On The UFOC Guidelines Model. .................................... 14

IV. PROPOSED SECTION 436.1: DEFINITIONS ............................... 16

A. Proposed Section 436.1(a): Action ................................... 18

1. Background ............................................... 18

2. The record and recommendations .............................. 19

B. Proposed Section 436.1(b): Affiliate ................................. 20

1. Background ............................................... 20

2. The record and recommendations .............................. 21

C. Proposed Section 436.1(c): Confidentiality Clause ...................... 21

1. Background ............................................... 21

2. The record and recommendations .............................. 22

D. Proposed Section 436.1(e): Financial Performance Representation .......... 24

1. Background ............................................... 24

2. The record and recommendations .............................. 25

a. Implied representations ................................ 26

b. Expense information .................................. 26

c. General media and Internet representations ................. 28
iii

E. Proposed Section 436.1(g): Fractional franchise ........................ 33

1. Background ............................................... 33

2. The record and recommendations .............................. 33

F. Proposed Section 436.1(h): Franchise ................................ 35

1. Background ............................................... 35

2. The record and recommendations .............................. 37

a. State definitions of franchise ............................ 37

b. Significant control and assistance ........................ 41

c. Required payment .................................... 43

d. Offers having the characteristics of a franchise .............. 44

G. Proposed Section 436.1(i): Franchise seller ............................ 45

1. Background ............................................... 45

2. The record and recommendation ............................... 45

H. Proposed Section 436.1(j): Franchisee ................................ 49

1. Background ............................................... 49

2. The record and recommendations .............................. 49

I. Proposed Section 436.1(k): Franchisor ................................ 50

1. Background ............................................... 50

2. The record and recommendations .............................. 50

J. Proposed Section 436.1(l): Leased Departments ........................ 52

1. Background ............................................... 52

2. The record and recommendations .............................. 52

K. Proposed Section 436.1(m): Parent ................................... 54

L. Proposed Section 436.1(n): Person ................................... 55

1. Background ............................................... 55

2. The record and recommendations .............................. 55
iv

M. Proposed Section 436.1(p): Predecessor ............................... 56

1. Background ............................................... 56

2. The record and recommendations .............................. 56

N. Proposed Section 436.1(r): Prospective Franchisee ...................... 58

1. Background ............................................... 58

2. The record and recommendations .............................. 58

O. Proposed Section 436.1(s): Required Payment ......................... 59

1. Background ............................................... 59

2. The record and recommendations .............................. 59

a. Royalty payments ..................................... 59

b. Obtaining or commencing operation ...................... 60

c. Payments for inventory ................................ 61

d. Payments to third parties ............................... 62

P. Proposed Section 436.1(t): Sale of a Franchise ......................... 63

1. Background ............................................... 63

2. The record and recommendations .............................. 64

Q. Proposed Section 436.1(u): Signature ................................. 67

1. Background ............................................... 67

2. The record and recommendations .............................. 67

R. Deleted Definitions ............................................... 67

1. Background ............................................... 67

2. The record and recommendations .............................. 67

a. Proposed “Internet” definition ........................... 67

b. Proposed “material” definition .......................... 68

c. Proposed “officer” definition ............................ 69
v

V. PROPOSED SECTION 436.2: OBLIGATION TO FURNISH DOCUMENTS ...... 72

A. Proposed Section 436.2: International Application of the Rule ............. 72

1. Background ............................................... 72

2. The record and recommendations .............................. 72

B. Proposed Section 436.2(a): Timing For Making Disclosures .............. 75

1. Background ............................................... 75

2. The record and recommendations .............................. 76

a. First personal meeting ................................. 76

b. Fourteen calendar days ................................. 78

c. Third-party payments and agreements ..................... 78

C. Proposed Section 436.2(b):

Modified contract review period ..................................... 80

1. Background ............................................... 80

2. The record and recommendations .............................. 80

D. Proposed Section 436.2(c): Furnishing Disclosures ..................... 82

1. Background ............................................... 82

2. The record and recommendations .............................. 83

E. Proposed Sections 436.2(d): Liability ................................. 84

1. Background ............................................... 84

2. The record and recommendations .............................. 85

a. Liability for furnishing disclosures ....................... 85

b. Liability for content ................................... 85

VI. PROPOSED SECTIONS 436.3-436.5: THE DISCLOSURE DOCUMENT ......... 86

A. Proposed Section 436.3: Cover Page ................................. 86

1. Background ............................................... 86

2. The record and recommendations .............................. 89

a. Additional information ................................. 90

b. Electronic disclosures ................................. 90
vi

c. References to Item 5 and Item 7 fees ...................... 91

d. Risk factors ......................................... 92

B. Proposed Section 436.4: Table of Contents ............................ 93

1. Background ............................................... 93

2. The record and recommendations ............................. 93

C. Proposed Section 436.5(a)

Item 1: The Franchisor and any Parent, Predecessors, and Affiliates ......... 94

1. Background ............................................... 94

2. The record and recommendation ........................... 95

a. Parent information .................................... 95

b. Predecessor disclosures ................................ 97

c. Competition ......................................... 98

D. Proposed Section 436.5(b)

Item 2: Business Experience ........................................ 99

1. Background ............................................... 99

2. The record and recommendations .............................. 99

a. Parents and affiliates .................................. 99

b. Brokers ............................................ 102

E. Proposed Section 436.5(c)

Item 3: Litigation ............................................... 103

1. Background .............................................. 103

2. The record and recommendations ............................. 103

a. Parents, predecessors, and affiliates ...................... 103

b. Prior civil litigation .................................. 105

c. Settlements ...................................... 106

d. Franchisor-initiated litigation ........................... 109

F. Proposed Section 436.5(d)

Item 4: Bankruptcy .............................................. 118

1. Background .............................................. 118

2. The record and recommendations ............................. 118
vii

G. Proposed Section 436.5(e)

Item 5: Initial Fees .............................................. 120

1. Background .............................................. 120

2. The record and recommendations ............................. 120

H. Proposed Section 436.5(f)

Item 6: Other Fees ............................................... 124

1. Background .............................................. 124

2. The record and recommendations ............................. 125

I. Proposed Section 436.5(g)

Item 7: Estimated Initial Investment ................................. 126

1. Background .............................................. 126

2. The record and recommendations ............................. 127

J. Proposed Section 436.5(h)

Item 8: Restrictions on Sources of Products and Services ................ 129

1. Background .............................................. 129

2. The record and recommendations ............................. 129

K. Proposed Section 436.5(i)

Item 9: Franchisee’s Obligations ................................... 132

1. Background .............................................. 132

2. The record and recommendations ............................. 132

L. Proposed Section 436.5(j)

Item 10: Financing .............................................. 133

1. Background .............................................. 133

2. The record and recommendations ............................. 134
viii

M. Proposed Section 436.5(k)

Item 11: Franchisor’s Assistance, Advertising, Computer Systems, 

and Training ................................................... 135

1. Background .............................................. 135

2. The record and recommendations ............................. 137

N. Proposed Section 436.5(l)

Item 12: Territory ............................................... 140

1. Background .............................................. 140

2. The record and recommendations ............................. 140

a. Encroachment ...................................... 141

b. Scope of the disclosure ............................... 142

c. Market area ........................................ 145

d. Warning ........................................... 146

O. Proposed Section 436.5(m)

Item 13: Trademarks ............................................. 148

1. Background .............................................. 148

2. The record and recommendations ............................. 148

P. Proposed Section 436.5(n)

Item 14: Patents, Copyrights, and Proprietary Information ............... 150

1. Background .............................................. 150

2. The record and recommendations ............................. 150

Q. Proposed Section 436.5(o)

Item 15: Obligation to Participate in the Actual Operation of the

Franchise Business .............................................. 151

1. Background .............................................. 151

2. The record and recommendations ............................. 151

R. Proposed Section 436.5(p)

Item 16: Sales Restrictions ........................................ 151

1. Background .............................................. 151

2. The record and recommendations ............................. 152
ix

S. Proposed Section 436.5(q)

Item 17: Renewal, Termination, Transfer, and Dispute Resolution ......... 152

1. Background .............................................. 152

2. The record and recommendations ............................. 153

T. Proposed Section 436.5(r)

Item 18: Public Figures ........................................... 156

1. Background .............................................. 156

2. The record and recommendations ............................. 157

U. Proposed Section 436.5(s)

Item 19: Financial Performance Representations ....................... 158

1. Background .............................................. 158

2. The record and recommendations ............................. 159

a. Voluntary financial performance disclosures .............. 159

b. Geographic relevance and subgroups ..................... 162

c. GAAP ............................................. 166

d Preambles .......................................... 167

V. Proposed Section 436.5(t)

Item 20: Outlets and Franchisee Information .......................... 172

1. Background .............................................. 172

2. The record and recommendations ............................. 173

a. Double-counting .................................... 173

b. Confidentiality clauses ................................ 181

c. Franchisee associations ............................... 191

W. Proposed Section 436.5(u)

Item 21: Financial Statements ...................................... 198

1. Background .............................................. 198

2. The record and recommendations ............................. 198

a. Parent financial information ........................... 198

b. Audited financial statements ........................... 200

c. Phase-in of audited financial statements .................. 202
x

X. Proposed Section 436.5(v)

Item 22: Contracts .............................................. 204

1. Background .............................................. 204

2. The record and recommendations ............................. 205

Y. Proposed Section 436.5(w)

Item 23: Receipt ................................................ 205

1. Background .............................................. 205

2. The record and recommendations ............................. 206

VII. PROPOSED SECTION 436.6: GENERAL INSTRUCTIONS .................. 208

A. Background .................................................... 208

B. Effect of E-SIGN ................................................ 210

C. The record and recommendations ................................... 210

1. Proposed section 436.6(a): Form of disclosures .................. 210

2. Proposed section 436.6(b): Responses ......................... 211

3. Proposed section 436.6(c): Additional materials ................. 211

4. Proposed section 436.6(d): Multi-state documents ................ 214

5. Proposed section 436.6(e): Subfranchisor disclosures ............. 214

6. Proposed section 436.6(f): Disclosure of any prerequisites to

receiving or reviewing disclosure documents .................... 216

7. Proposed section 436.6(g): Disclosure Document Recordkeeping .... 217

8. Proposed section 436.6(h): Receipt Recordkeeping ............... 218

VIII. PROPOSED SECTION 436.7: UPDATING REQUIREMENTS. ................ 218

A. Background .................................................... 218

B. The Record and Recommendations .................................. 219

1. Proposed section 436.7(a): Annual updates ..................... 219

2. Proposed sections 436.7(b)-(c): Quarterly updates ................ 219

3. Proposed section 436.7(d): Material change disclosures ........... 221

IX. PROPOSED SECTION 436.8: EXEMPTIONS .............................. 225

A. Background .................................................... 225
xi

B. The Record and Recommendations .................................. 226

1. Proposed section 436.8(a)(1):

Minimum payment exemption ................................ 227

a. Background ........................................ 227

b. The record and recommendations ....................... 227

2. Proposed section 436.8(a)(4):

Petroleum marketers and resellers exemption .................... 229

3. Proposed section 436.8(a)(5):

Sophisticated investor exemptions ............................. 231

a. Background ........................................ 231

b. The record and recommendations ....................... 231

c. Proposed section 436.8(a)(5)(i):

 Large investment exemption ........................... 235

i. Proposed threshold ............................. 238

ii. Meaning of “investment” ........................ 241

iii. Offers of franchisor financing .................... 243

iv. Acknowledgment .............................. 244

d. Proposed section 436.8(a)(5)(ii):

Large franchisee exemption ............................ 245

i. Entities covered by the exemption ................. 246

ii. Net worth and prior experience ................... 247

e. Proposed section 436.8(a)(6):

Officers, owners, and managers exemption ................ 249

4. Proposed section 436.8(b): Inflation adjustment ................. 250

5. Exclusions ............................................... 251

X. PROPOSED SECTION 436.9: ADDITIONAL PROHIBITIONS ................ 252

A. Background .................................................... 252

B. The Record and Recommendations .................................. 254

1. Proposed section 436.9(b): Shills ............................. 254
xii

2. Proposed section 436.9(i): Disclaimers and contract negotiations .... 255

a. Integration clauses and waivers ......................... 255

i. Third-party statements .......................... 258

ii. Statements outside the disclosure document ......... 258

iii. Disclosures other than contractual terms ............ 258

iv. Contractual terms .............................. 260

b. Contract negotiations ................................. 261

3. Proposed section 436.9 (j): Refunds ........................... 263

4. Summary of additional prohibition recommendations .............. 264

a. Proposed section 436.9(e): Prohibition on failing to furnish 

disclosures to a prospective franchisee early in the sale 

process, upon reasonable request ........................ 264

b. Proposed section 436.9(f): Prohibition on failing to furnish

existing disclosures to a prospective purchaser of an existing

outlet, upon reasonable request ......................... 264

c. Proposed section 436.9(g): Prohibition on failing to furnish 

updated disclosures to a prospective franchisee, upon 

reasonable request ................................... 264

d. Proposed section 436.9(h): Prohibition on failing to note 

contract revisions. ................................... 265

XI. PROPOSED SECTIONS 436.10 and 436.11: OTHER LAWS, RULES, ORDERS, AND

SEVERABILITY ...................................................... 265

A. Background .................................................... 265

B. The Record and Recommendations .................................. 266

1. Proposed section 436.10(a):

Legality of practices ........................................ 266
xiii

2. Proposed section 436.10(c):

Preemption ......................................... 268

XII. CONCLUSION ....................................................... 271
 

1

16 C.F.R. Part 436.

 

2 A list of the commenters to date, and the abbreviations used to identify each, is attached

as Attachment A.

 

3 References to the rulemaking record are cited as follows:

Source Citation Format Example

NPR Comments [commenter], Comment

[comment number]

NASAA, Comment 17

ANPR Comments [commenter], ANPR

[comment number]

NASAA, ANPR 120

ANPR Transcripts [commenter], ANPR, [date]

Tr

Bundy, ANPR, 6Nov97 Tr

Rule Review Comments [commenter], RR [comment

number]

NASAA, RR 43

Rule Review Transcripts [commenter], RR, [Sept95 or

Mar96] Tr

D’Imperio, RR, Sept95 Tr

1

Since 1995, the Commission has considered amending its trade regulation rule entitled

“Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity

Ventures” (“Franchise Rule” or “Rule”)1to ensure that it continues to be relevant in today’s

marketplace and reflects our law enforcement experience over the last twenty years. The

amendment process began with a regulatory review of the Rule in 1995, which was followed by

the publication of an Advance Notice of Proposed Rulemaking (“ANPR”) in 1997 and most

recently by a Notice of Proposed Rulemaking (“NPR”) in 1999. In general, there is substantial

support for the Rule, although many commenters2 believe that the Commission should reduce

inconsistencies between federal and state pre-sale disclosure laws, update the Rule to address

international franchise sales and new technologies such as the Internet, and expand the Rule’s

disclosures to address franchisees’ concerns about the underlying franchise relationship. This

report analyzes the rulemaking record to date3 and sets forth the staff’s recommendations for the

final revised Rule.
 

4

60 Fed. Reg. 17,656 (Apr. 7, 1995).

 

5 The UFOC Guidelines disclosure format is similar in many respects to the Franchise

Rule’s disclosure requirements. To reduce compliance costs and burdens, the Commission

permits franchisors to use the UFOC Guidelines format, as long as they do so completely and

accurately. See 60 Fed. Reg. 51,895 (Oct. 4, 1995) (authorizing states to use revised UFOC

Guidelines). A copy of the UFOC Guidelines can be found at the corporate finance section of the

North American Securities Administrators Association Web site: www.nasaa.org.

 

6

62 Fed. Reg. at 9,115 (Feb. 28, 1997).

 

7

In general, the first day of each public workshop conference discussed specific issues

announced in advance. Participants at these meetings were selected based upon their comments

or interest in the subject matter. The second day of each conference was an open forum in which

the public was invited to express their views on any franchise or business opportunity issue. 

2

I. BACKGROUND

In 1995, the Commission conducted a regulatory review of the Franchise Rule,4 in which

it sought public comment on whether there was a continuing need for the Rule and, if so, how to

improve the Rule in light of industry changes since its promulgation in the late 1970s. In

response, the Commission received 75 written comments. In addition, the Commission staff held

two public workshop conferences, in which a total of fifty individuals participated. The first

conference – held on September 11-13, 1995, in Bloomington, Minnesota – discussed the

comments on the Rule, in particular whether the Commission should reduce inconsistencies

between federal and state pre-sale disclosure law by incorporating the Uniform Franchise

Offering Circular (“UFOC”) Guidelines adopted by each of the fifteen states with franchise

disclosure laws.5 Participants also discussed issues arising from business opportunity sales. The

second conference – held on March 11, 1996, in Washington, D.C. – discussed the Franchise

Rule’s application to international franchise sales. 

Following the Rule Review, the Commission decided to amend the Franchise Rule and to

that end published an Advance Notice of Proposed Rulemaking (“ANPR”).6 The ANPR

solicited comment on several proposed Rule modifications, including creating a separate trade

regulation for business opportunity sales, revising the Rule’s disclosures to mirror those of the

UFOC Guidelines, limiting the Rule’s application to sales of franchises to be located in the

United States, and permitting electronic disclosure. In response, the Commission received 166

written comments. The staff also held six public workshop conferences on the issues raised in

the comments, as set forth below:7
 

8

64 Fed. Reg. 57,294 (Oct. 22, 1999). 

 

9 Many commenters enthusiastically supported the Commission’s overall approach to

revising the Rule. E.g., IL AG, Comment 3, at 10 (“The work done so far to revise the FTC

Franchise Rule has been appropriately careful, deliberate and effective.”); PMR&W, Comment 4,

at 1 (“[W]e would like to compliment the FTC for its forward-thinking and practical approach in

a number of areas covered in the NPR.”); Holmes, Comment 8, at 1 (“We would like to

congratulate the Commission and its staff on the proposal.”); H&H, Comment 9, at 2 (“Hogan &

Hartson applauds the FTC’s efforts at improving franchise regulation by updating disclosure

requirements to reflect common industry practices and embracing modern communications

3

Conf. Topic(s) Location Dates

1 Trade Show Promoters Washington, DC July 28-29, 1997

2 Business Opportunities Chicago, IL August 21-22, 1997

3 UFOC, Internet, International, 

Co-branding, Alternatives to

Traditional Law Enforcement

New York, NY September 18-19,

1997

4 Business Opportunities Dallas, TX October 20-21, 1997

5 UFOC, Internet, International,

Co-branding, Alternatives to

Traditional Law Enforcement

Seattle, WA November 6-7, 1997

6 Business Opportunities Washington, DC November 20-21,

1997

Sixty-five individuals participated in the ANPR public workshops, including franchisees,

franchisors, business opportunity sellers and their representatives, state franchise and business

opportunity regulators, and computer consultants.

The next step in the rule amendment process was the publication of a Notice of Proposed

Rulemaking (“NPR”) in October 1999.8 The NPR included a proposed revised Rule and a

detailed discussion of each proposed Rule revision. Among other things, the NPR addressed:

(1) the international application of the Rule; (2) the scope of certain existing disclosure

requirements, such as the litigation and franchisee statistics disclosures; (3) new disclosures, such

as those for franchisee associations; and (4) new instructions permitting disclosure via the

Internet. It also proposed creating exemptions to the Rule for sophisticated prospective

franchisees.

In response to the NPR, the Commission received 40 comments. Overwhelmingly, the

comments supported the proposed revised Rule, albeit with fine-tuning.9 No commenter
technology.”); Baer, Comment 11, at 1 (“The Commission has done a remarkably good job

overall of addressing many of the deficiencies in the current UFOC Guidelines and proposing in

many cases appropriate revisions.”); NFC, Comment 12, at 2 (“The FTC’s NPR creates a superb

platform for calibrating the FTC Franchise Rule to the realities of a robust franchise marketplace

which is much different from that of 1979, when the Franchise Rule was promulgated.”); Lewis,

Comment 15, at 1 (“We support your effort to update and revise the rule.”); IFA, Comment 22, at

3 (“The FTC staff has . . . proposed a number of excellent revisions to the Rule.”); AFC,

Comment 30, at 3 (“AFC would like to commend the FTC and its staff for its franchisors and

franchisees today.”); J&G, Comment 32, at 1 (“We commend the Commission and its Staff for

the work that has gone into the revision and for the many very positive changes that the Proposed

Rule reflects.”); Tricon, Comment 34, at 1 (“We believe that the Commission has done an

excellent job of revising the Franchise Rule.”); Marriott, Comment 35, at 2 (“Marriott strongly

supports the efforts of the Commission in revising the Rule and the overall direction of the

Proposal.”).

 

10 See 64 Fed. Reg. at 57,324; 15 U.S.C. § 57a(c).

 

11 E.g., Bundy, Comment 18, at 16; Marriott, Comment 35, at 4.

 

12 E.g., PMR&W, Comment 4, at 17; H&H, Comment 9, at 25; Baer, Comment 11, at 17;

IFA, Comment 22, at 12-13.

4

specifically requested a hearing, as permitted in the NPR.10 A few comments, however,

suggested that public workshop conferences might be warranted,11 or expressed interest in

participating in them, if the Commission staff decided to hold one or more.12 We believe that the

current record is sufficient to address the proposed Rule revisions, and we do not contemplate

any more hearings or public workshop conferences.

II. ORGANIZATION OF THE REPORT

The Report analyzes the rulemaking record to date, including the comments on the NPR,

and sets forth our recommendations regarding the final revised Rule. We first discuss the

continuing need for the Rule. Included in that discussion is whether the Commission should

revise the Rule’s disclosure requirements by incorporating the UFOC Guidelines, as well as

modify the Rule’s scope by focusing exclusively on franchises, leaving business opportunities to

a separate trade regulation rule. 

We then turn to the substantive Rule provisions, beginning with our analysis of the

proposed definitions. Next, we address franchisors’ obligation to furnish disclosure documents,

including a discussion of the Rule’s international application, as well as the Rule’s disclosure

trigger provisions. This is followed by a discussion of the disclosure document cover page, table

of contents, and the substantive disclosure requirements. We then turn to instructions for
 

13 The comparison chart also notes whether NPR proposals have been retained, revised,

and/or renumbered. The chart does not note minor, non-substantive edits.

 

14 62 Fed. Reg. at 9,120.

 

15 E.g., H&H, ANPR 28, at 2; Kaufmann, ANPR 33, at 2; NCL, ANPR 35, at 2; SBA

Advocacy, ANPR 36, at 2-3; IL AG, ANPR 77, at 1. Other ANPR commenters did not

specifically address this issue, but we can infer from their general comments that they continued

to support pre-sale disclosure. See, e.g., Murphy, ANPR 2, at 1; Brown, ANPR 4 & 6; Cory,

ANPR 12. A few ANPR commenters, however, urged the Commission to streamline the Rule

and to create greater uniformity with state franchise regulations. E.g., Bruce, ANPR 3;

Kaufmann, ANPR 33, at 3; Kestenbaum, ANPR 40, at 1; IL AG, ANPR 77, at 5; Cendant,

ANPR 140, at 2. As explained below, franchisees generally did not focus on pre-sale disclosure,

but on what they believe to be more pressing substantive relationship issues. 

5

preparing and updating disclosures. Finally, we discuss exemptions, prohibitions, and the Rule’s

effect on other Commission laws, rules, and orders.

The discussion follows the order of the staff’s recommended revised Rule. In each

section, we explain how the proposed Rule provision is similar to or different from the current

Rule and/or UFOC Guidelines provision. If a proposed section generated any relevant

comments, we summarize the comments, and offer our final recommendations. At the

conclusion of the Report, we have attached a proposed revised Rule that incorporates our various

recommendations (Attachment B). To assist the reader in reviewing our analysis and

recommendations, we have also attached a copy of the NPR’s proposed Rule (Attachment C) and

a table comparing citations to the NPR and the proposed revised Rule (Attachment D).13

III. CONTINUING NEED FOR THE FRANCHISE RULE

The staff recommends that the Commission retain a pre-sale disclosure law for

franchising. However, we believe the Franchise Rule should be revised to focus exclusively on

franchise sales, leaving consideration of business opportunity sales issues to a separate trade

regulation rule. Further, we recommend that the Commission revise the Rule’s disclosures based

upon the UFOC Guidelines model in order to reduce inconsistencies with state pre-sale

disclosure laws. 

A. The Commission Should Retain the Franchise Rule

During the Rule amendment process, the Commission asked whether the Franchise Rule

continues to serve a useful purpose.14 The commenters who addressed this issue overwhelmingly

urged the Commission to retain the Rule.15 These commenters included many interests, such as

the North American Security Administrators Association (“NASAA”), the International

Franchise Association (“IFA”), the American Bar Association’s Antitrust Section, and major
 

16 Other franchisors supporting the Rule include: Better Homes & Gardens Real Estate

Service, Re/Max Corporation, and The Prudential Real Estate Affiliates, Inc., RR 24; Snap-On,

Inc., RR 27; Little Ceasars, RR 31; The Southland Corporation (7-Eleven), RR 47; Medicap

Pharmacies, RR 48; Forte Hotels, RR 52; Pepsico Restaurants (Pizza Hut, Taco Bell, KFC, Inc.),

RR 62; Atlantic Richfield Company (ARCO), RR 64; and Papa John’s Pizza, RR 74.

 

17 E.g., Marks, ANPR, 19Sept97 Tr, at 8-9, 29; Wieczorek, RR, Sept95 Tr, at 62-63.

 

18 E.g., H&H, ANPR 28, at 2; SBA Advocacy, ANPR 36, at 2; Zarco & Pardo, ANPR 134,

at 1; ABA Antitrust, RR 22, at 7.

 

19 E.g., WA Securities, ANPR 117; Shay, RR, Sept95 Tr, at 104. 

 

20 E.g., Kaufmann, ANPR 33, at 3.

6

franchisors such as Cendant, a publicly traded company that owns several franchise systems

including Howard Johnson, Ramada, Century 21, Coldwell Banker, ERA, and Avis Rent-ACar.16

The commenters maintained that pre-sale disclosure is a cost-effective way to provide

material information to prospective franchisees so they can assess the costs, benefits, and

potential financial risks involved in entering into a franchise relationship. In particular, pre-sale

disclosure enables prospective franchisees to investigate the franchise offering by providing

information that is not readily available, such as the franchisor’s litigation history and franchisee

failure rates.17

Other commenters emphasized that pre-sale disclosure is necessary to prevent fraud. For

example, franchisor attorney David Kaufmann stated that the Rule has reduced fraud, thereby

making it easier for legitimate franchisors to flourish: “Both the Rule and . . . state franchise

laws have gone a long way toward eradicating massive franchise frauds and, by doing so, has

restored franchising’s reputation for integrity and thus cleared the marketplace for the offerings

of legitimate franchisors.” Kaufmann, ANPR 33, at 3. Other commenters noted that pre-sale

disclosure helps franchisees more fully understand the franchise relationship they are entering, 

as well as the financial and legal commitments they are undertaking,18 thereby reducing conflicts

in franchise systems and potential litigation costs. Indeed, some commenters emphasized that

repeal of the Franchise Rule might actually increase franchisors’ costs and compliance burdens

by opening the door for individual states to enact franchise disclosure laws that may be

inconsistent, making it difficult for franchisors to conduct business on a national basis.

19 On the

other hand, uniform disclosures would enable prospective franchisees to comparison shop for the

best franchise offering,20 while reducing costs to franchisors. In fact, several franchisors and
 

21 E.g., PMR&W, Comment 4, at 7-8; Baer, Comment 11, at 2; Snap-On, Comment 16, at

1; Cendant, ANPR 140, at 3. See also ABA Antitrust, RR 22, at 5. We address preemption

below at section XI.B.2.

 

22 E.g., Brown, ANPR 4, at 2; Manuszak, ANPR 13; S. Sibent, ANPR 41; Purvin, ANPR

81, at 4; Zarco & Pardo, ANPR 134.

 

23 E.g., Brown, ANPR 4, at 3; AFA, ANPR 62, at 3; Slimak, ANPR 130; Leap, ANPR 147,

at 1-2; Vidulich, ANPR, 22Aug97 Tr, at 21.

 

24 E.g., Brown, ANPR 4, at 2; Donafin, ANPR 14; AFA, ANPR 62, at 1; Buckley, ANPR

97; Zarco & Pardo, ANPR 134, at 2.

 

25 E.g., Brown, ANPR 4, at 2; Weaver, ANPR 17; Colenda, ANPR 71; Haines, ANPR 100,

at 3; Chiodo, ANPR, 21Nov97 Tr, at 293-94.

 

26 E.g., Brown, ANPR 4, at 3; Bell, ANPR 30; D. Iuliano, ANPR 56; AFA, ANPR 62, at 3;

Johnson, ANPR 67.

 

27 See AFA, ANPR 62, at 1 (“Our members feel so strongly about the Commission’s

inability to deal with substantive issues of concern to them, they would rather work to abolish the

FTC rule than suffer the abuses of both a government agency and their franchisors.”).

7

their representatives urged the Commission not only to retain the Franchise Rule, but to preempt

the field of franchise pre-sale disclosure law.21

While franchisors who commented in the rulemaking uniformly supported the Rule, most

franchisees and their advocates criticized the Rule for not going far enough. They want the Rule

to address what they believe to be the greatest problem in franchising today: post-sale “abusive

franchise relationships.”22 Specifically, they urged the Commission to use its Section 5

unfairness authority to prohibit post-contract covenants not to compete,23 encroachment of

franchisees’ market territory,24 and restrictions on the sources of products or services,25 among

other practices. They also urged the Commission to prohibit franchisors from impeding

franchisees from pursuing their legal rights when disputes arise. For example, they would ban

franchisors from including in franchise agreements mandatory arbitration and jury trial waiver

provisions, as well as choice of venue and choice of law provisions that either impede a

franchisee from bringing suit or arguably favor the franchisor in litigation.26 Indeed, some

franchisees asserted that if the Rule cannot address post-sale relationship issues, then the

Commission should abolish the Rule.27
 

28 As of the date of this Report, the Commission has filed more than 200 suits against more

than 650 defendants (both franchises and business opportunities) for Franchise Rule violations

since the Rule was promulgated in the late 1970s.

 

29 It is not uncommon for franchisees to lose several hundred thousand dollars or more in

bad franchise investments. E.g., Slimak, ANPR, 22Aug97 Tr, at 26 and ANPR 130 ($289,000

loss); Lundquist, ANPR, 22Aug97 Tr, at 48 (half a million dollar loss). Susan Kezios, the

President of the American Franchisee Association, noted that a study conducted by Dr. Timothy

Bates found that 38% of new franchises failed within a ten year period (1986-87 through 1996),

as opposed to 32% of independent businesses. Further, based upon “industry statistics,” 180 new

franchises open each day, at a cost of approximately $18 million ($100,000 per franchise). 

Applying Mr. Bates’ figures, she estimated that each day franchisees lose approximately $7

million (38% of $18 million). Kezios, ANPR, 22Aug97 Tr, at 64-66. See also Staff of the

Bureau of Consumer Protection, Franchise and Business Opportunity Program Review 1993-

2000: A Review of Complaint Data, Law Enforcement and Consumer Education (June 2001)

(“Staff Program Review”), at 16 (Chart C.4.) (87 franchise complaints alleged injury over

$10,000, 11 of those alleged injury over $100,000); House Committee on Small Business,

Franchising in the U.S. Economy: Prospects and Problems, 101st Cong. 2nd Sess. (1990), at 23

(citing joint report from NASAA and Council of Better Business Bureaus estimating that “tens of

thousands of individuals continue to lose as much as $500 million annually in franchise and

business opportunity fraud.”). See generally Timothy Bates, Survival Patterns Among

Newcomers to Franchising (Nov. 1996) (reprinted at ANPR 143).

8

Based upon the record and the Commission’s law enforcement experience over the last

twenty years,28 the staff is persuaded that pre-sale disclosure is warranted to protect prospective

franchisees from fraudulent and deceptive franchise sales practices. Pre-sale disclosure also

enables a prospective franchisee to conduct his or her own due diligence investigation of the

franchise offering, thereby giving the prospect a better understanding of the significant financial

risks and legal obligations involved in purchasing a franchise. Indeed, franchisee concerns about

various relationship issues further persuades us that pre-sale disclosure remains necessary to

ensure that prospective franchisees are fully informed about the relationships that they will be

entering, including issues such as source restrictions and any rights to protected territories.

At the same time, the staff recognizes that pre-sale disclosure addresses only some of the

issues franchisees may face in owning and operating their franchises. From the comments and

statements submitted by franchisees, there is little doubt that some franchisees are dissatisfied

with their franchise purchase. Others asserted that, despite the Rule, a serious power imbalance

continues to exist between franchisors and franchisees and that franchise contracts are

oppressive. They urged the Commission to address post-sale franchise relationship issues

directly through its Section 5 unfairness jurisdiction.29
 

30 64 Fed. Reg. at 57,296.

 

31 The Commission’s “unfairness” jurisdiction generally does not authorize the Commission

to dictate the terms and conditions of private franchise agreements. For example, the

Commission’s Funeral Rule, 16 C.F.R. Part 453, requires funeral homes to disclose pre-sale the

cost of its goods and services, but does not regulate the terms and conditions of private funeral

services contracts. Similarly, the Used Car Rule, 16 C.F.R. Part 455, requires used car sellers to

disclose pre-sale whether the car comes with a warranty, but does not regulate the terms and

conditions of private used car sales. To the contrary, “unfairness” enables the Commission to

hold a company to the contractual terms it freely selects when it seeks to modify its contract

unilaterally. In the seminal “unfairness” case involving contract performance, Orkin

Exterminating Co. v. FTC, 849 F.2d 1354 (11th Cir. 1988), cert. denied, 488 U.S. 1041 (1989),

the Eleventh Circuit upheld the Commission’s finding that Orkin engaged in unfair conduct in

violation of Section 5 by unilaterally modifying its contracts with over 200,000 consumers. 849

F.2d at 1364-66. In that case, the Commission did not exercise its unfairness jurisdiction to

revise Orkin’s contracts or to dictate substantive contractual terms. Rather, the Commission

required Orkin to honor the contractual terms that Orkin freely chose and offered to the public. 

Cf. Shute v. Carnival Cruise Lines, 897 F.2d 377 (9th Cir. 1990), rev’d 499 U.S. 585 (1991)

(upholding choice of forum clause against “fundamental fairness” challenges on the grounds that

the parties had notice of the provisions, the absence of fraud, and the existence of countervailing

benefits).

9

For the reasons stated in the NPR, however, the Commission lacks the statutory ability to

broaden the Rule to address post-sale franchise relationship issues.30 As an initial matter,

franchise relationships are private, contractual matters that are regulated at the state level. 

Indeed, absent specific statutory authority, the Commission traditionally has not sought to

regulate or set the terms of private contracts in any economic sector.31 More important, a

widespread misconception exists about the scope of the Commission’s Section 5 “unfairness”

jurisdiction. In 1994, Congress amended Section 5 of the FTC Act, adopting the following

definition of unfairness:

The Commission shall have no authority . . . to declare unlawful an act or practice

on the grounds that such act or practice is unfair unless the act or practice causes

or is likely to cause substantial injury to consumers which is not reasonably

avoidable by consumers themselves and not outweighed by countervailing

benefits to consumers or to competition. In determining whether an act or

practice is unfair, the Commission may consider established public policies as

evidence to be considered with all other evidence. Such public policy

considerations may not serve as a primary basis for such determination.
 

32 See also FTC v. J.K. Publ’ns, Inc., 99 F. Supp.2d 1176, 1201 (C.D. Cal. 2000).

 

33 In its recent audit of the Commission’s Franchise Rule Program, the General Accounting

Office (“GOA”) concluded that there are “no readily available, statistically reliable data on the

overall extent and nature of [franchise relationship] problems.” U.S. General Accounting Office,

GAO Report to Congressional Requesters, Federal Trade Commission Enforcement of the

Franchise Rule, GAO-01-776 (July 31, 2001) at 29.

 

34 See J.K. Publ’ns, 99 F. Supp.2d at 1201 (“With regard to [avoidability], the focus is on

‘whether consumers had a free and informed choice that would have enabled them to avoid the

unfair practice.’”).

10

15 U.S.C. § 45(n).32 The evidence in the ongoing rulemaking proceeding fails to establish that

post-sale franchise relationships are legally “unfair,” as defined above. 

There is no question that the record reveals that some franchisees have suffered harm in

the course of operating their franchises. However, we have no basis to quantify the level of

harm. Specifically, we cannot determine how much of the injury is attributable to actions taken

by the franchisor, by franchisees, or to other factors, such as downturns in the economy or

shifting consumer preferences. In the absence of such data, we cannot conclude that the level of

harm suffered by individual franchisees as a result of the franchise relationship rises throughout

franchising to the statutory “substantial injury” level.33 Further, we have no basis to conclude

that any such injuries to individual franchisees outweigh countervailing benefits to the public at

large or to competition. 

Most important, in many instances injury to franchisees can reasonably be avoided. A

franchise purchase is entirely voluntary. Prospective franchisees can avoid harm by comparison

shopping for a franchise system that offers more favorable terms and conditions, or by

considering alternatives to franchising as a means of operating a business. Further, the Franchise

Rule ensures that each prospective franchisee receives disclosures that explain the terms and

conditions under which the franchise will operate. Prospective franchisees are also free to

discuss the nature of the franchise system with existing and former franchisees. Under these

circumstances, the Commission can hardly conclude that prospective franchisees who voluntarily

enter into franchise agreements after receiving full disclosure, nonetheless cannot reasonably

avoid harm resulting from a franchisor enforcing the terms of the franchise agreement.34 As a

result, the Commission has no authority to engage in a far-reaching rulemaking that would

mandate the substantive terms of all private franchise contracts. 

Our conclusion that substantive franchise rulemaking is unwarranted is also supported by

a staff review of post-sale franchise relationship issues, as reflected in the Commission’s

complaint database – the Consumer Information System (“CIS”). During the period 1993
 

35 This number excludes seventeen complaints that did not identify a specific franchisor.

 

36 See Bond’s Franchise Guide (11th ed. 1998) at 9, 25 (estimating there are 2,500

American and Canadian franchisors). Currently, Bond’s maintains a database of 2,500 North

American franchisors, and its Franchise Guide (13th ed. 2001) provides information on

approximately 2,150 of those systems, that in its view, are actively engaged in franchising.

 

37 See Staff Program Review at 42.

11

through June 1999, franchisees raised post-sale relationship issues involving 110 companies.35

This means that about 95% of the approximately 2,50036 franchise systems operating in North

America at that time did not generate even a single relationship complaint to the Commission. 

Moreover, the vast majority of companies that were the subject of a complaint generated only

one complaint,37 as illustrated below:

Franchise Complaints 

Number of Complaints Franchisors Generating The Specified

Number of Complaints

One complaint 91 companies

Two complaints 12 companies

Three complaints 6 companies

Four complaints 2 companies

Five complaints 1 company

Six complaints 0 companies

Seven complaints 0 companies

Eight complaints 1 company

Nonetheless, we believe the record is sufficient to show that information about the state

of the franchise relationship is material and more disclosure is warranted to ensure that

prospective franchisees understand the quality of the franchise relationship before they commit to

buying a franchise. To that end, we recommend that the Commission expand the Rule’s pre-sale

disclosures in a few instances to address relationship issues. This approach is consistent with the

Commission’s long-held view that free and informed consumer choice is the best regulator of the

market.
 

38 62 Fed. Reg. at 9,120 (ANPR); 60 Fed. Reg. at 17,657-58 (Rule Review).

 

39 64 Fed. Reg. at 57,296.

 

40 E.g., PMR&W, Comment 4, at 2; 7-Eleven, Comment 10, at 2; IFA, Comment 22, at 4;

Stadfeld, Comment 23, at 3-4; Caffey, ANPR 94; Jeffers, ANPR 116, at 2; NASAA, ANPR 120,

at 4-5. Several commenters suggested that the Commission should create a separate business

opportunity rule along the lines of state business opportunity disclosure acts. E.g., Muncie,

ANPR 15, at 1 (suggesting the Commission follow the California Seller Assisted Marketing Plan

Act); WA Securities, ANPR 117, at 2 (suggesting the Commission follow the NASAA Model

Business Opportunity Act). NCL, however, took the contrary view:

While there may be clear distinctions with those involved in the trade for

franchises and business opportunities, the consumers who contact the NFIC are

unaware of the differences. Moreover, a review of the NFIC complaints received

in 1996 reveals that more involve business opportunities than franchises. This

indicates that the same pre-sale disclosures are needed for business opportunities

as for franchises.

NCL, ANPR 35, at 3.

12

B. The Rule Should Be Narrowed To Focus On Franchises Exclusively

While we recommend that the Commission retain the Rule, we believe the scope of the

Rule should be limited to focus exclusively on franchise sales. Throughout the Rule amendment

process, the Commission has proposed separating the disclosure requirements for franchises from

those for business opportunities.38 Indeed, the NPR did not address the issue of business

opportunities at all. Rather, the Commission proposed addressing business opportunity sales in a

separate rulemaking.39

 Commenters who addressed this issue agreed that there should be a separate rule for

business opportunity sales, stressing that franchises and business opportunities are distinct

business arrangements.40 David Muncie, a business opportunity seller, succinctly described the

disadvantages of addressing business opportunities and franchises under the same rule as

follows:

It would be extremely unwise to attempt to lump business opportunities into the

same category as franchises. They are entirely different business arrangements. 

Business opportunities do not demand or extract a percentage of income from the

purchaser to use for national advertising or mere profit overrides, nor does the

purchaser of a business opportunity use the same name or trade name as does a

franchisee. There is also a far greater amount of training which is provided to

franchisees by franchisors. Furthermore, franchisers exert a far greater degree of 
 

41 See also PMR&W, Comment 4, at 2 (“Purchasers of franchises, compared to purchasers

of business opportunities, typically are better educated, better financed, have greater business

experience, make a larger investment, and are more likely to evaluate their proposed investment

with the assistance of other knowledgeable professionals such as attorneys, accountants, and

officers of lending institutions.”).

 

42 A few commenters urged the Commission to continue to enforce the current Franchise

Rule for business opportunities until such time as the new Business Opportunity Rule is

promulgated. E.g., IL AG, Comment 3, at 9. We agree. Accordingly, we recommend that the

Commission publish, along with the revised Franchise Rule, an amended and renumbered

version of the current Rule limited to business opportunities only.

 

43 Other examples of business opportunity related sweeps include: Project Buylines (1996); 

Project Missed Fortune (1996), Project Trade Name Games (1997), Project Vend-Up Broke

(1998); Project “Biz-illions” (2000); and Project Busted Opportunities (2002).

13

control over the operation of the business than do business opportunity vendors. 

Business opportunities are also sold at a much cheaper price. Lumping them

together in one category would spell the death knell for legitimate business

opportunity vendors. They would not be able to comply with the requirements

and still market their product to those who are not capable of raising extremely

large sums of money, often in the hundreds of thousands of dollars, as required to

purchase most legitimate franchises. It would not, however, have any effect on the

. . . sleazeball vendors who neglect to and refuse to follow existing federal and

state legislation and who will continue to do the same with any changes you

institute. Therefore I see no value in lumping the two entirely different business

arrangements into one category. It would only serve to drive legitimate

companies out of the marketplace, thereby harming consumers.

Muncie, ANPR 15, at 2 (emphasis in original).41 

We agree that business opportunities and franchises are distinct business arrangements

that warrant different disclosure approaches.42 For example, many of the Rule’s pre-sale

disclosures, in particular those pertaining to the parties’ detailed contractual relationship, do not

apply to most business opportunity sales, which typically involve fairly simple contracts or

purchase agreements. The Rule’s detailed disclosure obligations may also create barriers to entry

for legitimate business opportunity sellers by imposing compliance costs that are not likely to be

recovered by the sale. Moreover, our principal concern about business opportunities sales is

outright fraud. A string of business opportunity related law enforcement sweeps – beginning

with Project Telesweep in 199543 – illustrates that fraud artists often take advantage of relatively
 

44 During our review of the Franchise and Business Opportunity Program, we found that

75% of the 4,512 complaints in the staff’s franchise and business opportunity database (3,392

complaints) pertained to business opportunities, while only slightly more than 6% concerned

franchisors.

 

45 We are assisted in this effort by a NASAA document entitled “Comparison of UFOC and

Proposed FTC Disclosure Requirements” (“NASAA Comparison”) (Jan. 8, 2002). A copy of

this document has been placed on the rulemaking record and is also available at NASAA’s

website: www.NASAA.org. Several commenters also urged the Commission to adopt the

UFOC Guidelines’ instructions and sample answers, as well as periodic commentaries. E.g., IL

AG, Comment 3, at 1; PMR&W, Comment 4, at 7; NASAA, Comment 17, at 4; J&G, Comment

32, at 2. To the extent that the UFOC Guidelines’ text, instructions, sample answers, and

commentaries are substantive, we agree and have considered them for inclusion in the Rule. 

However, we believe purely explanatory materials in the UFOC Guidelines and NASAA

Commentary are better placed in a Compliance Guide that will accompany the revised Rule,

where the issues involved can be discussed at length. This is consistent with the Commission’s

prior practice in issuing Final Interpretive Guides along with the Rule.

 

46 E.g., PMR&W, Comment 4, at 1; H&H, Comment 9, at 2; 7-Eleven, Comment 10, at 2;

NFC, Comment 12, at 2; Lewis, Comment 15, at 5; NASAA, Comment 17, at 3-4; Bundy,

Comment 18, at 6; Gurnick, Comment 21, at 2; IFA, Comment 22, at 4-5; Stadfeld, Comment

23, at 2; J&G, Comment 32, at 2; Marriott, Comment 35, at 2; Brown, ANPR 4, at 1; Duvall,

ANPR 19, at 1; Baer, ANPR 25, at 2; Kaufmann, ANPR 33, at 3; SBA Advocacy, ANPR 36, at

3; Kestenbaum, ANPR 40, at 1; AFA, ANPR 62, at 2; IL AG, ANPR 77, at 1, WA Securities,

14

unsophisticated business opportunity buyers.44 To combat such fraud, the staff recommends that

the Commission promulgate a separate business opportunity rule containing a few, narrowlytailored disclosures to give prospective buyers material information about the offer, as well as

appropriate prohibitions targeting specific fraudulent practices.

C. The Commission Should Revise the Franchise Rule’s

Disclosures Based On The UFOC Guidelines Model

The primary goal of the Rule revision is to ensure that the Franchise Rule continues to

provide material information to prospective franchisees so they can make an informed

investment decision, while reducing unnecessary costs and burdens on franchisors. One of the

chief avenues to reducing compliance costs and burdens is to adopt, where warranted, the UFOC

Guidelines disclosure format. Indeed, many franchisors are familiar with the Guidelines and

have prepared UFOCs for a number of years. Our recommendations, therefore, strive to reduce

unnecessary inconsistencies between federal and state franchise disclosure law.45

Without exception, commenters who addressed the issue – franchisors and franchisees

alike – urged the Commission to revise the Rule to mirror the UFOC Guidelines’ disclosures.46
ANPR 117, at 1; Selden, ANPR 133, at 1; Zaco & Pardo, ANPR 134, at 1; Cendant, ANPR 140,

at 2.

 

47 E.g., 7-Eleven, Comment 10, at 2; NASAA, 17, at 3-4; Kaufmann, ANPR 33, at 3; AFA,

ANPR 62, at 2; IL AG, ANPR 77, at 1; WA Securities, ANPR 117, at 1. 

 

48 E.g., H&H, ANPR 28, at 5-6; Kaufmann, ANPR 33, at 3; Kestenbaum, ANPR 40, at 1;

WA Securities, ANPR 117, at 1.

 

49 E.g., IFA, Comment 22, at 4-5; Stadfeld, Comment 23, at 2; Karp, ANPR, 19Sept97 Tr,

at 90.

 

50 E.g., AFA, ANPR 62, at 2; WA Securities, ANPR 117, at 1; NASAA, ANPR 120, at 3.

 

51 IL AG, Comment 3, at 1; Kaufmann, ANPR 33, at 3; ABA Antitrust, RR 22, at 7.

 

52 NASAA, ANPR 120, at 2. See also WA Securities, ANPR 117, at 1.

 

53 Frandata, for example, proposed that the Commission restructure several of the Rule’s

disclosures to create standardized “fill-in the blank” provisions. For instance, rather than a

narrative describing the franchisor’s background, Frandata suggested that the franchisor complete

specific sentences such as: “(i) The year we began conducting a business of the type to be

operated by franchisees was _____. (ii) The year we began to offer the sale of franchises of the

type to be operated by franchisees was _____.” Frandata, Comment 29, at 7.

15

These commenters emphasized that the UFOC Guidelines have more expanded disclosures than

the current Rule,47 are already used by the vast majority of franchisors,48 and, in fact, are the

national industry standard.49 Uniformity between federal and state franchise laws will also help

to reduce compliance costs

50 and facilitate comparison shopping among franchise systems.51

Moreover, as NASAA noted, the UFOC Guidelines were developed with significant input from

franchisors, franchisees, and franchise administrators, and were subject to public hearings and

notice and comment.52 Therefore, the UFOC Guidelines reflect a balance of interests among all

effected parties.

To that end, the proposed revised Rule adopts many of the UFOC Guidelines without 

change or with minor edits. Indeed, the proposed revised Rule will look familiar to franchise

practitioners. To reduce inconsistencies, we have rejected isolated suggestions to reduce,

expand, or restructure the UFOC Guidelines.53 No doubt, eliminating certain disclosures might

reduce franchisors’ compliance costs and burdens, while expanding disclosures might afford

some additional franchisee protections. In most instances, however, such steps would not

outweigh the benefits of reducing inconsistencies between federal and state law. 

At the same time, the proposed revised Rule is not identical to the UFOC Guidelines. 

The revised Rule diverges from the UFOC Guidelines in two respects. First, in a few instances,
 

54 See section VIII.B.1. below.

 

55 16 C.F.R. § 436.2(f).

 

56 Id. at § 436.2(g). 

 

57 Id. at § 436.2(o). Franchisors currently must provide disclosure documents at the earlier

of the first “personal meeting” or “the time for making disclosures,” which generally means 10

business days before the prospective franchisee pays any fee or signs any contract in connection

with the franchise sale. As part of our effort to streamline the Rule, we recommend eliminating

these timing provisions in favor of a clear, bright-line 14-day provision. See 64 Fed. Reg. at

57,300-01. If this recommendation were adopted, the terms “time for making disclosures”

16

we have eliminated or streamlined a UFOC Guideline disclosure that is unnecessary or is overly

burdensome. In the same vein, we also deviate from the UFOC Guidelines where the record

shows that a UFOC Guidelines’ disclosure is broken and needs to be fixed. 

Second, the proposed revised Rule deviates from the UFOC Guidelines by adding a few

narrowly tailored disclosures based upon the Commission’s law enforcement experience and to

shed additional light on the quality of the franchise relationship. For example, we propose that

the Commission expand the Item 3 litigation disclosures to include franchisor-initiated litigation,

as well as expand the Item 20 franchisee statistics to include information about confidentiality

clauses and trademark-specific franchisee associations.

Further, we note that the UFOC Guidelines focus primarily on disclosures. They do not

address issues such as the timing of making disclosures, liability for Rule violations, exemptions,

or prohibitions. Such provisions are typically addressed in state statutes or regulations, which

often vary. Accordingly, our goal of reducing inconsistencies between federal and state law is

limited primarily to disclosures, with the exception of some definitions and instructions for

preparing disclosures that exist in the UFOC Guidelines. Nonetheless, our proposals incorporate

several state franchise law principles, such as permitting a 120-day annual update requirement.54 

In all other respects, our recommendations are based upon the record and our law enforcement

experience.

IV. PROPOSED SECTION 436.1: DEFINITIONS

Currently, the Franchise Rule places the definitions after the substantive disclosure

requirements, in no apparent order. In the NPR, the Commission proposed making the Rule

more user-friendly by placing the definitions in alphabetical order at the beginning of the Rule. 

For the most part, the proposed definitions are similar to those already contained in either the

Rule or UFOC Guidelines. The NPR, however, proposed eliminating four current definitions

that we believe no longer serve a useful purpose: (1) “business day”;55 (2) “time for making of

disclosures”;56 (3) “personal meeting”;57 and (4) “cooperative association.”58 At the same time it
“personal meeting” and “business day” would become obsolete.

 

58 16 C.F.R. at § 436.2(l). Cooperative associations are one of four non-franchise

relationships that the Commission has excluded from the Rule. Unlike Rule exemptions (which

are substantive limitations on the Rule’s reach), the exclusions are explanatory, helping the

public better distinguish between franchise and non-franchise relationships. The NPR proposed

streamlining the Rule by eliminating these exclusions on the grounds that they no longer serve a

useful purpose. See 64 Fed. Reg. at 57,319. As explained below at section IX.B.5 of this Report,

some commenters continue to believe that the four exclusions are necessary to help understand

the Rule’s scope. To the extent that the four exclusions are explanatory, we propose that they be

placed in the Compliance Guides that will accompany the revised Rule.

 

59 64 Fed Reg. at 57,332. “‘Disclose’ means to state all material facts accurately, clearly,

concisely, and legibly in plain English.” See UFOC Guidelines, General Instruction 150. 

Because the proposed Rule also uses similar terms – state, describe, and list – we recommend

that the Commission add those terms to the definition of “disclose” as well. Accordingly, the

proposed definition of “disclose” now would read “disclose, state, describe, and list mean to

present all material facts accurately, clearly, and concisely, and legibly in plain English.” We

also recommend that the Commission make clear in the Compliance Guides that clear,

conspicuous, and legible requires that disclosures be made in at least 12 point upper and lower

case type. This is consistent with the current Commission approach. See, e.g., 16 C.F.R.

§ 436.1(b)(4) (“clearly and conspicuously disclosed . . . in not less than twelve point upper and

lower case . . . type.”).

 

60 64 Fed. Reg. at 57, 332. “Fiscal year” refers to the franchisor’s fiscal year. See 16 C.F.R.

§ 436.2(m).

 

61 64 Fed. Reg. at 57,332. The definition of “plain English” would be new, accompanying a

new requirement that disclosure documents be prepared in “plain English.” “‘Plain English’”

means the organization of information and language usage understandable by a person unfamiliar

with the franchise business. It incorporates the following six principles of clear writing: short

sentences; definite, concrete, everyday language; active voice; tabular presentation of

information; no legal jargon or highly technical business terms; and no multiple negatives.” See

Registration Form Used by Open-Ended Management Investment Companies, SEC Release No.

33-7512, 17 C.F.R. 274.11A. See also UFOC Guidelines, General Instruction 150. 

 

62 64 Fed. Reg. at 57,332. “‘Principal business address’ means the street address of the

franchisor’s home office in the United States. A principal business address cannot be a post

office box or private mail drop.” See UFOC Guidelines, Item 1C Instructions, i.

17

would add several new definitions for the terms “action,” “confidentiality clause,” “financial

performance representation,” “Plain English,” “predecessor,” “principal business address,”

“signature,” “trademark,” and “written.” Six of the definitions proposed in the NPR generated no

comment: “disclose,”59 “fiscal year,”60 “plain English,”61 “principal business address,”62
 

63 64 Fed. Reg. at 57,333. “‘Trademark’ includes trademarks, service marks, names, logos,

and other commercial symbols.” See Final Interpretive Guides, 44 Fed. Reg. at 49,966. See also

UFOC Guidelines, Item 13 Instructions, i.

 

64 64 Fed. Reg. at 57,333. The proposed definition of “written” would update the Rule to

include electronic disclosures: “‘Written’ or ‘in writing’ means any document or information in

printed form or in any form capable of being preserved in tangible form and read. It includes:

type-set, word processed, or handwritten documents; information on computer disk or CD Rom;

information sent via email; or information posted on the Internet. It does not include mere oral

statements.” 

 

65 Id. at 57,332.

 

66 Id.

 

67 Id.

 

68 Id. at 57,334. See also 16 C.F.R. § 436.1(a)(4).

 

69 See also UFOC Guidelines, Item 3 Definitions, ii. 

18

“trademark,”63 and “written.”64 We recommend, therefore, that the Commission adopt these six

definitions in the final revised Rule. Based upon the comments received, we further recommend

fine-tuning several proposed definitions, as explained below. Specifically, we recommend that

the Commission eliminate three definitions that appeared in the NPR: “Internet,”65 “material,”66

and “officer.”67 Finally, we recommend that the Commission add a definition for the term

“parent.”

A. Proposed Section 436.1(a): Action

1. Background

Consistent with the current Rule, proposed Item 3 of the NPR would require the

disclosure of certain legal actions involving the franchisor and certain directors and officers.68

The Rule, however, currently does not define the term “action.” 

In the NPR, the Commission proposed adopting the UFOC Guidelines’ definition of the

term “action”: “Action includes complaints, cross claims, counterclaims, and third-party

complaints in a judicial proceeding, and their equivalents in an administrative action or

arbitration proceeding.” 64 Fed. Reg. at 57,331.69 This proposed definition is consistent with the
 

70 44 Fed. Reg. 49,966, 49,973 (Aug. 24, 1979). 

 

71 NFC, Comment 12, at 25. See generally, e.g., Detroit Auto. Inter-Insurance Exch. v.

Gavin, 416 Mich 407, 331 N.W. 2d 418 (1981); Spitcaufsky v. Hatten, 353 Mo. 94, 182 S.W. 2d

86 (1944); Dzubin v. Dzubin, 121 Conn. 646, 186 A. 652 (1936). 

 

72 Lewis, Comment 15, at 7.

 

73 The issue of lack of knowledge of filed complaints does not appear to be a significant

concern. In more than 20 years enforcing the Rule, we are unaware of any instance in which a

franchisor was charged with violating the Rule by failing to disclose litigation where it had not

yet been served with a complaint. Further, as we propose below, an individual franchise seller

will be held liable for a disclosure violation only if he or she knew or should have known that a

disclosure was incomplete or inaccurate. This goes a long way to ensuring that franchisors and

individual franchise sellers will not be held liable for failures to disclose where they are unaware

of the underlying facts. Also, unlike the states, the Commission does not have an immediate

updating requirement. The Rule’s annual and quarterly update provisions discussed below, in

most instances give the franchisor reasonable time to learn about any such complaints and to

update their disclosures accordingly. 

19

Commission’s interpretation of the term “action,” as discussed in the Final Interpretive Guides to

the Franchise Rule.70

2. The record and recommendations

The NPR’s proposed definition of “action” generated two comments. First, the NFC

urged the Commission to modify the definition to read “judicial action or proceeding,” rather

than just “judicial proceeding.” It observed that in some states a “judicial action” is an action at

law, while a “proceeding” is equitable.71 Second, Warren Lewis recommended that the

definition’s reference to complaints be limited to “served complaints.” He asserted that a

franchisor should not have to disclose actions filed against it unless the franchisor has actually

been served with a complaint.72 

The staff recommends that the Commission modify the NPR proposal by adopting the

NFC’s suggestion that the term “action” reference both judicial actions and proceedings. This

approach is consistent with the practice in some states. Accordingly, the revised definition of 

“action” would read: “Action includes complaints, cross claims, counterclaims, and third-party

complaints in a judicial action or proceeding, and their equivalents in an administrative action or

arbitration.” 

However, we do not agree with Mr. Lewis that the definition of “action” should be

limited to only “served complaints.”73 Such a narrowing of the definition would effectively

enable a franchisor to avoid disclosing potentially material litigation, even though it had notice of
 

74 It is not uncommon in the Commission’s law enforcement experience for defendants to

know that a Commission action was filed prior to service either by learning of the suit from codefendants or as a result of an asset freeze. E.g., FTC v. Joseph Hayes, No. 4:96CV02162SNL

(E.D. Mo. 1996).

 

75 E.g., Item 1; Items 3-6; Item 8; and Item 10.

 

76 See NASAA Commentary on the Uniform Franchise Offering Circular Guidelines (1999),

Bus. Franchise Guide (CCH), ¶ 5790, at 8,466 (“NASAA Commentary” or “Commentary”). The

Commentary notes that this general definition of affiliate should be used throughout a UFOC,

unless a particular disclosure Item defines it differently or limits its use. For example, for

purposes of Item 1, the definition of affiliate is narrowed to an affiliate “which is offering

franchises in any line of busines or is providing products or services to the franchisees of the

franchisor.” See UFOC Guidelines, Item 1 Instructions, v.

 

77 64 Fed. Reg. at 57,332.

20

an action, merely because it has not been served with the papers yet or has successfully avoided

service of process.74 In short, a franchisor has no reason to conceal a known, but unserved,

complaint.

B. Proposed Section 436.1(b): Affiliate

1. Background

Many of the proposed revised Rule’s disclosures would pertain to the franchisor and its

affiliates alike.75 The Franchise Rule currently defines the term “affiliated person” to mean a

person:

(1) Which directly or indirectly controls, is controlled by, or is under common control 

with, a franchisor; or

(2) Which directly or indirectly owns, controls, or holds with power to vote, 10

percent or more of the outstanding voting securities of a franchisor; or

(3) Which has, in common with a franchisor, one or more partners, officers,

directors, trustees, branch managers, or other persons occupying similar status or

performing similar functions.

16 C.F.R. § 436.2(i). In the NPR, the Commission proposed that the Rule adopt the UFOC

Guideline’s streamlined definition of the term affiliate:76 “Affiliate means an entity controlled by,

controlling, or under common control with, the franchisor.”77 
 

78 Triarc, Comment 6, at 2.

 

79 See 64 Fed. Reg. at 57,321.

 

80 Triarc, Comment 6, at 2.

 

81 This definition would include a subsidiary of the franchisor, a parent of the franchisor, as

well as “sister” subsidiaries of a franchisor.

 

82 We discuss the merits of this proposal below at section VI.V.2.b.

21

2. The record and recommendations

Only one commenter raised any concern about the NPR’s proposed “affiliate” definition. 

Triarc would broaden the proposed definition to reference affiliates of franchisees.78 This

suggestion relates to the NPR’s proposed Rule exemption for sophisticated franchisees with five

years of prior experience and $5 million in assets.79 As discussed in the exemptions section

below, we recommend that the Commission permit consideration of a franchisee-affiliates’ assets

and prior experience in satisfying the proposed exemption’s prior experience and monetary

thresholds.80 For example, a franchisor selling a franchise to a new subsidiary of a corporatefranchisee should be able to rely on the subsidiary’s parent’s assets and net worth in qualifying

for the sophisticated franchisee exemption. If so, then we agree that the definition of “affiliate”

should be expanded to reference entities controlled by a franchisee. The revised definition would

read: 

Affiliate means an entity controlled by, controlling, or under common control

with, the franchisor or a franchisee.81

C. Proposed Section 436.1(c): Confidentiality Clause

1. Background

In the NPR, the Commission proposed a new disclosure to address contractual provisions

that prohibit or restrict existing or former franchisees from discussing their experience with

prospective franchisees.82 To that end, the NPR proposed using the term “gag clause,” which it

defined as follows:

any contractual provision entered into by a franchisor and a current or former

franchisee that prohibits or restricts that franchisee from discussing his or her

personal experience as a franchisee within the franchisor’s system. It does not
 

83 In the ANPR, the Commission used the term “gag order.” During the New York public

workshop conference, several panelists were confused by the word “order,” noting that it implied

a court mandate. Forseth, ANPR, 18Sept97 Tr, at 40; Zaslav, id, at 55. To correct this

confusion, the term “gag clause” was introduced in the NPR to avoid any implication that the

Commission is concerned with only court-imposed speech restrictions. 

 

84 NFC, Comment 12, at 26.

 

85 Lewis, Comment 15, at 9.

 

86 BI, Comment 28, at 10.

 

87 PMR&W, Comment 4, at 15.

 

88 H&H, Comment 9, at 15.

 

89 Tricon, Comment 34, at 3.

22

include confidentiality agreements that protect franchisor’s trademarks or other

proprietary information.

64 Fed Reg. at 57,332.83

2. The record and recommendations

Several commenters opposed the term “gag clause” because, in their view, it is pejorative. 

They prefer a neutral term, such as “confidentiality agreement,”84 “confidentiality clause,”

“nondisclosure clause,”85 or “privacy clause.”86 We agree and recommend that the Commission 

revise the NPR by adopting the term “confidentiality clause.” 

Other commenters questioned the scope of the proposed definition. PMR&W, for

example, would limit the definition to broad speech restrictions (“no-communications” clauses)

that would prohibit existing or former franchisees from discussing any matters about the

franchise system whatsoever.87 H&H suggested that the definition be limited to those

confidentiality clauses that bar franchisees from discussing matters specifically with prospective

franchisees.88 The NFC would go further, limiting the definition to instances “where either all

franchisees, or at least twenty percent of the franchisee population, is barred from

communicating with third parties.” NFC, Comment 12, at 33. Tricon questioned whether an

agreement that restricts disclosure of only the monetary terms in a settlement should trigger the

proposed Item 20 disclosure about the use of such clauses.89

Several franchisee advocates voiced concern about the last part of the proposed

definition, the proprietary information exclusion. Howard Bundy, for example, feared that a

franchisor could avoid the Rule simply by requiring a franchisee to sign a contractual provision
 

90 See also Karp, Comment 24, at 21-22.

 

91 E.g., Baer, ANPR 25, at 3; AFA, ANPR 62, at 3; Zarco & Pardo, ANPR 134, at 4.

23

agreeing that the existence of a confidentiality clause itself is proprietary information. He

suggested that the “better approach would be to exclude confidentiality agreements that ‘only’ or

‘merely’ protect . . . proprietary information and then specifically state that [confidentiality]

clauses, themselves, can never be proprietary information.” Bundy, Comment 18, at 3.90

We agree with H&H that the NPR’s proposed definition may be broader than warranted. 

As explained below, this proposed disclosure is intended to aid prospective franchisees’ due

diligence investigation. Accordingly, it is unnecessary to address confidentiality clauses directed

at persons other than prospective franchisees, such as the media. At the same time, narrowing 

the definition to clauses that specifically restrict speech with prospective franchisees goes too far. 

A franchisor could easily avoid the proposed confidentiality clause disclosure by simply using a

broader clause (such as a “no communications with anyone” clause). Rather, we believe the

definition of confidentiality clause should cover all confidentiality clauses that have the net effect

of restricting speech with prospective franchisees. To that end, we recommend the language 

“directly or indirectly restricts a current or former franchisee from discussing his or her personal

experience as a franchisee in the franchisor’s system with any prospective franchisee.” 

Similarly, we agree with Tricon that a confidentiality clause disclosure should not cover

specific settlement terms if the franchisee is free to discuss his or her experience within the

franchise system. Because this would aid in explaining the scope of the definition, we believe

this issue would be most appropriately addressed in the Compliance Guides. 

We reject, however, suggestions that the Commission significantly narrow the definition

to cover only broad “no-communications clauses” or only circumstances where all or at least

20% of franchisees are under speech restrictions. Specifically, as in other sections of this Report,

we reject thresholds in favor of bright-line provisions that enable franchisors, prospective

franchisees, and law enforcers to know when a Rule provision applies, without resort to factfinding. Further, these proposals are narrower than necessary and would defeat the very purpose

of the proposed confidentiality clause disclosure.

Finally, we believe Mr. Bundy’s suggestion goes too far. Many ANPR commenters – 

both franchisor and franchisee representatives – agreed that proprietary information should be

exempted from the definition of confidentiality clause because a franchisor has a reasonable and

legitimate concern about protecting its trademark and business secrets.91 We believe attempts to

expand the concept of proprietary information to include confidentiality clauses would fail

because the Commission would apply an objective standard in determining what is “proprietary,”

that is, whether a particular confidentiality clause protects information that would normally be

regarded as proprietary, such as trade secrets. For this reason, we believe the proposed definition

is sufficient to address this concern.
 

92 See UFOC Guidelines, Item 19 Instructions, i.

 

93 See, e.g., 16 C.F.R. § 436.(1)(b).

24

For these reasons, we recommend that the Commission revise the NPR’s proposed

definition of “gag clause” as follows:

Confidentiality clause means any contract, order, or settlement provision that

directly or indirectly restricts a current or former franchisee from discussing his or

her personal experience as a franchisee in the franchisor’s system with any

prospective franchisee. It does not include confidentiality clauses that protect a

franchisor’s trademarks or other proprietary information. 

D. Proposed Section 436.1(e): Financial Performance Representation

1. Background

One of the most important sections of the proposed revised Rule is Item 19, which

addresses the making of financial performance representations. Currently, the Rule describes

performance information as “any oral, written, or visual representation to a prospective

franchisee which states a specific level of potential sales, income, gross, or net profit for the

prospective franchisee, or which states other figures which suggest such a specific level.” 16

C.F.R. §§ 436.1(b) and (c). This is similar to the UFOC Guidelines’ definition of “earnings

claim.”92

In the NPR, the Commission proposed defining the term “financial performance

representation” explicitly, borrowing from both the current Rule and UFOC Guidelines’

definitions, as follows:

Financial performance representation means any oral, written, or visual

representation to a prospective franchisee, including a representation disseminated

in the general media and Internet, that states or suggests a specific level or range

of potential or actual sales, income, gross profits, or net profits. A chart, table, or

mathematical calculation that demonstrates possible results based upon a

combination of variables is a financial performance representation.

64 Fed. Reg. at 57,332.

This proposed definition incorporates the current Rule’s approach that an “oral, written

and visual” representation will constitute a financial performance representation.93 To ensure
 

94 The proposed definition also uses the more exclusive term “financial performance”

representation, rather than the limited term “earnings claim.” Some industries, such as hotels, 

use variables other than earnings to measure performance, such as room occupancy rates. See 64

Fed. Reg. at 57,297.

 

95 The UFOC Guidelines use the term “earnings claims,” which is defined as: 

information given to a prospective franchisee by, on behalf of or at the direction

of the franchisor or its agent, from which a specific level or range of actual or

potential sales, costs, income or profit from franchised or non-franchised units

may be easily ascertained.

A chart, table or mathematical calculation presented to demonstrate possible

results based upon a combination of variables (such as multiples of price and

quantity to reflect gross sales ) is an earnings claim subject to this item.

UFOC Guidelines, Item 19 Instructions, i.

 

96 This would streamline the current Rule, which addresses historical performance

representations and projections in two distinct Rule provisions, 16 C.F.R. §§ 436.1(b)

(projections) and 436.1(c) (historical information).

 

97 The staff has adopted the same position in informal advisory opinions. E.g., Handy

Hardware Centers, Bus. Franchise Guide (CCH) ¶ 6,426 (1980) (The Rule’s “earnings claim

requirements are application to ‘any oral, written, or visual representation.’”); Diet Center, Inc.,

Bus. Franchise Guide (CCH) ¶ 6,437 (1983) (table with arithmetic calculations uniformly

demonstrating net profits constitutes a financial performance representation).

25

that the Rule covers implied financial performance representations, the definition also retains the

phrase “or which states other figures which suggest such a specific level.” Id.94

 The proposed definition also incorporates references in the comparable UFOC

Guidelines’ definition95 to “actual” and “potential” performance, capturing both historical

financial performance and projections96 as well as the use of charts, tables, and mathematical

calculations.97 Finally, the proposed definition updates the Rule by clarifying that financial

performance representations made in the general media include those representations made

through the Internet.

2. The record and recommendations

In response to the NPR, commenters raised essentially three concerns: (1) whether the

proposed financial performance definition adequately addresses implied performance

representations; (2) whether the definition should exclude cost information; and (3) whether the
 

98 See Final Interpretive Guides, 44 Fed. Reg. at 49,982.

 

99 Id.

 

100 See, e.g., FTC v. Advanced Pub. Communications Corp., 00–00515 CIV-Ungaro-Benages

(S.D. Fla. 2000) (charging defendants with representing, expressly or by implication, that

purchasers of their opportunity would earn in excess of $300 per payphone per month); FTC v.

Innovative Prods., 3:00-CV-0312-D (N.D. Tex 2000) (charging defendants with representing,

expressly or by implication, that purchasers of their opportunity would earn a substantial amount

of money after sending in a registration fee); FTC v. Star Publ’g Group, Inc., 00CV 023D (D.

Wyo. 2000) (charging defendants with representing, expressly or by implication, that purchasers

of their refund tracer opportunity would earn substantial income).

26

Rule’s requirements for general media performance representations should extend to

representations made via the Internet. We address each of these issues below.

a. Implied representations

As noted above, the NPR’s proposed definition of “financial performance representation”

would capture implied performance representations by retaining the currently used word

“suggests.” According to Howard Bundy, a franchisee advocate, the “suggests” language in the

definition of “financial performance representation” is flawed: it would not address the

furnishing of fragments of financial data from which a prospect may readily estimate or calculate

earnings. He would add language such as “or from which a prospective franchisee could readily

estimate or calculate” following the word “suggests.” Bundy, Comment 18, at 1.

The staff agrees that this part of the NPR’s proposed “financial performance

representation” definition could be more precise. There is no doubt that a franchisor can imply

that a prospect can earn a specific level of income, such as by using a proxy for earnings (for

example, “You will do so well that you can buy that Porsche.”).98 A franchisor can also imply a

performance claim by giving a prospect a few pieces of financial information from which the

prospect can fill in the blanks and draw his or her own conclusion about a specific level of

potential earnings.99 We believe both types of implied claims constitute financial performance

representations that are, and should be, covered by the Rule. To clarify this policy, the staff

recommends that the Commission replace the word “suggests” currently used in the Rule with

the more precise phrase “states, expressly or by implication,” language that is widely used, for

example, in franchise and related Section 5 matters.100

b. Expense information

One area where the NPR’s proposed definition of “financial performance” would differ

from the comparable UFOC Guidelines’ definition is the exclusion of expense or cost

information. In the NPR, the Commission proposed that a franchisor’s dissemination of expense
 

101 64 Fed. Reg. at 57,328-29. This approach would change the Commission’s original

policy. In the Final Interpretive Guides, the Commission took the position that cost information

alone could be a financial performance claim because a prospective franchisee could use such

information to calculate likely profits by simply selecting arbitrary sales figures. 44 Fed. Reg. at

49,982.

 

102 64 Fed. Reg. at 57,328-29.

 

103 E.g., IL AG, Comment 3, at 8-9; Baer, Comment 11, at 7; NFC, Comment 12, at 13;

NASAA, Comment 17, at 2; BI, Comment 28, at 10. But see Bundy, Comment 18, at 2 (arguing

that expense disclosures inevitably will lead prospective franchisees to extrapolate earnings,

without the protection of an Item 19 disclosure).

 

104 See also Baer, Comment 11, at 7. 

 

105 NFC, Comment 12, at 13. The NFC also suggested that the Commission modify the Rule

to exclude from the definition of “financial performance representation” financial data furnished

to existing franchisees. “[E]xisting franchisees’ experience, prior investment and routine

communications with other franchisees suggests that their franchisor’s dissemination of what

would otherwise be illegal financial performance representations would result in no harm to such

franchisees but could actually be of significant help.” Id. The NFC contended that existing

27

information alone should not be deemed the making of a financial performance claim.101 At the

same time, the NPR raised the concern that some might draw the conclusion that the required

disclosure of expense information in Items 5-7 of the Rule (initial fees and initial investment)

could be interpreted as implying a performance claim, such as a break-even point, thereby

compelling the franchisor to prepare an Item 19 financial performance disclosure. To remove

any doubt that expense information alone does not constitute a financial performance

representation, the Commission proposed excluding expense information from the “financial

performance” definition. The Commission, however, questioned: (1) whether the omission of

expense information is sufficient to clarify that compliance with the Rule’s expense disclosure

obligations would not trigger the Rule’s Item 19 obligations; and (2) whether the proposed

definition could inadvertently enable franchisors to make “back-door” financial performance

representations by casting such representations as additional expense information.102

Most commenters who addressed this issue supported eliminating expense information

from the definition of financial performance information.103 Some, however, sought additional

clarification. For example, the IL AG urged the Commission to modify the proposed definition

of “financial performance representation” expressly to exclude Items 5-7 expense information,

offering the following additional sentence: “Expenses required in Items 5, 6, and 7 of the

disclosure document are not to be considered performance claims and do not contradict Item 19

requirements.” IL AG, Comment 3, at 8-9.104 Others would go further, arguing that the

dissemination of any expense information should not trigger the Item 19 disclosure

requirements.105
franchisees would be protected because misrepresented financial performance claims still violate

Section 5. Id. 

We believe that the Rule need not be revised to address this issue. A franchisor is always

free to furnish truthful information about its system to existing franchisees, especially if no

additional franchise sale is contemplated. If, however, the franchisor contemplates an additional

franchise sale under materially different terms and conditions than the franchisee’s original

purchase, then the existing franchisee, like any prospective franchisee, could be misled and

therefore should receive financial performance disclosures in the form of an Item 19. For

example, an Item 19 will assist an existing franchisee operating in a shopping mall or urban area

in the northeast to understand an earnings projection for an additional stand-alone outlet or outlet

to be located in a rural section of the southwest.

 

106 BI, Comment 26, at 10.

 

107 See 16 C.F.R. §§ 436.1(b)(5)(i); 436.1(c)(6)(i); 436.1(e)(5)(ii).

28

NASAA and BI added that excluding expense information is not likely to lead to backdoor earnings claims. NASAA, for example, observed that “franchisors that make unlawful

representations of financial performance generally make representations about earnings and

rarely limit their representations to expense information alone.” NASAA, Comment 17, at 2. BI

further observed that any franchisor who uses cost or expense information to imply earnings

would fall under the ambit of the Rule’s implied financial performance claim.106

In light of these comments, the staff recommends that the Commission eliminate

references to expense information from the definition of the term “financial performance

representation.” The experience of NASAA’s members tends to confirm that franchisors do not

routinely disseminate expense information to prospects. Moreover, we are persuaded that

expense information alone is insufficient to enable prospects to gauge their potential earnings

with any degree of specificity. Therefore, when compared with gross or net revenue data, for

example, expense information is not likely to mislead prospective franchisees about their

potential success or risk in purchasing a franchise. To avoid any possible confusion in this area,

we further recommend that the Commission make clear in the Compliance Guides that the Rule’s

cost disclosures (Items 5-7) alone do not constitute the making of a financial performance

representation.

c. General media and Internet representations

The current Rule also governs the making of financial performance representations in the 

general media. Like other financial performance claims, a general media claim must have a

reasonable basis and state the number and percentage of outlets earning the claimed amount,

among other substantiation and disclosure requirements.107 A general media claim, however,
 

108 See id. at § 436.1(e). 

 

109 Although the UFOC Guidelines do not address general media claims, many of the states

with disclosure laws require franchisors to register their advertisements in advance of their use. 

E.g., Cal. Corp. Code § 31156 (1997) (franchisor must register advertising at least three business

days before first publication); Md. Code Ann., Bus. Reg. § 14-225 (1998) (franchisor must

register advertising at least seven business days before publication).

 

110 64 Fed. Reg. at 57,297.

 

111 E.g., PMR&W, Comment 4, at 16; H&H, Comment 9, at 14; NFC, Comment 12, at 23-

24.

 

112 E.g., Quizno’s, Comment 1, at 3; PRM&W, Comment 4, at 16; NFC, Comment 12, at 24;

BI, Comment 28, at 9.

 

113 E.g., Quizno’s, Comment 1, at 3. See also BI, Comment 28, at 9.

 

114 E.g., Quizno’s, Comment 1, at 3; PMR&W, Comment 4, at 16; H&H, Comment 9, at 14;

BI, Comment 28, at 9.

29

need not be geographically relevant to the market in which franchises are being offered for

sale.108 There is no comparable provision in the UFOC Guidelines.109 

In the NPR, the Commission proposed updating the Rule by clarifying that the definition

of financial performance representations covers general media representations, including those

representations made via the Internet.

110 The majority of commenters who addressed this issue

questioned whether online financial performance representations should be considered general

media claims.111 These commenters asserted that the Commission should not deem financial

performance information on a franchisor’s Web site to be representations directed at prospective

franchisees, unless the information is located in a section of a Web site that solicits franchise

purchases or otherwise specifically targets prospective franchisees.112 In their view, financial

performance information on a franchisor’s Web site – including links to press releases,

interviews, or articles – is intended to educate the general public about the company, rather than

to attract prospective franchisees.113 Indeed, some posted information may consist of copies of

publicly filed reports, such as 10-Qs and 10-Ks, that are submitted to the Securities and

Exchange Commission (“SEC”).114 At least one commenter feared that equating online financial

performance representations with general media representations would have a chilling effect,

unreasonably restricting the kinds of materials a franchisor could have on its Web site: “Does

this mean that a franchise company, unlike any other business, must choose between taking

advantage of articles or press releases about itself on its own web site page or risk the claim that

a prospective franchisee has been given unauthorized non-Item 19 financial data?” Quizno’s,

Comment 1, at 3.
 

115 This would include other electronic financial performance representations such as those

in unsolicited commercial email, and banner or “pop-up” ads.

 

116 Final Interpretive Guides, 44 Fed. Reg. at 49,984-85.

 

117 Further, the Rule permits a franchisor to disseminate truthful information to a prospective

franchisee outside of a disclosure document provided that such information does not contradict

statements made in the disclosure document itself. 16 C.F.R. § 436.1(f). Clearly, a franchisor

Web site containing performance data would contradict an Item 19 that said nothing.

 

118 In many instances, a Web site is also longer-lasting than an isolated news release. A

prospective franchisee surfing the Internet has the potential of retrieving archives of company

releases and speeches, which otherwise would not be readily available. Such information, in

aggregate, may induce reliance more than an isolated release or speech.

30

The staff believes the proposition that general media representations may include Internet

representations is sound.115 First, online performance representations fit squarely in the current

definition of “general media.” The current general media claims provision is broad, covering any

“oral, written, or visual representation for general dissemination.” 16 C.F.R. § 436.1(e). Further,

a general media claim is not limited to advertising. Indeed, the Commission stated that general

media claims include not only advertising (radio, television, magazines, newspapers, billboards,

etc.), but also statements made in speeches or press releases.116 The only stated exceptions are

for “communications to financial journals or the trade press in connection with bona fide news

stories, or directly to lenders in connection with arranging financing for the franchisee.” Final

Interpretive Guides, 44 Fed. Reg. at 49,984-85. Accordingly, it is clear that under the current

Rule general media is a broad concept, encompassing more than just promotional materials

specifically aimed at prospective franchisees.117 If not, a franchisor could always skirt the Rule’s

Item 19 protections by simply releasing performance data to the public.

Second, we see no reason to distinguish between the Internet and other forms of media. 

Specifically, a franchisor’s Web site is indistinguishable from a company speech or press release. 

Both offer information designed to educate the public about the company. A franchisor may

publish its own newsletter or series of press releases to disseminate such information, or a

company may choose to do so through a Web site. Either way, the franchisor cannot control who

will have access to the information once it is released. Indeed, an argument can be made that

posting information on a general Web site (as opposed to an Intranet or other restricted or

protected site) is even more of a public dissemination than a speech or press release because a

general Web site is readily accessible to anyone who surfs or searches for information on the

particular company, including prospective franchisees.118 

While we believe the Internet is a form of general media, we recognize the commenters’

concerns about publicly filed reports required by the SEC. We agree that such filings are already

publicly available and, more important, have indicia of reliability. Indeed, the dissemination of
 

119 Indeed, the staff has previously advised that the dissemination of financial data through

bona fide news stories may generate benefits to the public that outweigh potential harm to

prospective franchisees. “For example, such information may be useful to potential suppliers

seeking growing businesses as customers; shopping center or mall developers seeking promising

franchised systems as tenants; and financial analysts who follow market or industry trends. 

Accordingly, the exemption from the general media earnings claims disclosure requirements

ensures that the Rule does not chill the free flow of newsworthy information about franchising or

particular franchise systems.” Advisory 97-5, Bus. Franchise Guide (CCH) ¶ 6485 at 9687 (July

31, 1997). 

 

120 44 Fed. Reg. at 49,984-85 (“‘General media claim’ does not include communications to

financial journals or the trade press in connection with bona-fide news stories, or directly to

lenders in connection with arranging financing for franchisees.”).

 

121 Franchisors could easily avoid making a general media claim by restricting its posting of

SEC filings to its Web site’s investor information page. In contrast, a franchisor that places such

filings, or provides links to such filings, on its franchise offering section would be deemed to

make a general media claim. See Advisory 97-5, Bus. Franchise Guide (CCH) at 9687 (“By

disseminating copies of [news articles containing earnings claims], the franchisor effectively

ratifies the journalist’s words at its own and, in so doing, converts the article into an advertising

piece designed to solicit prospective franchisees.”). In other scenarios, we believe the franchisor

takes the risk that its financial information might be deemed a general media claim. Such

determination can be made only on a case-by-case basis, with the primary consideration being

31

false financial data statements could lead to shareholder suits. We also agree that in some

instances the dissemination of financial data online is for the benefit of investors and the general

public, not for prospective franchisees.119 

To address this issue, we propose a balanced approach. First, we recommend that the

Commission delete the proposed reference to the Internet from the definition of financial

performance representation. We believe a blanket reference to the Internet would be too broad, 

sweeping in all online financial data within the definition of a financial performance

representation, even those not aimed at prospective franchisees. Rather, we believe the

Commission should explain the relationship between general media claims and the Internet in the

Compliance Guides, where the issue can be more fully addressed with appropriate examples.

Second, we recommend that the Commission retain and expand the exclusions from

general media claims currently set forth in the Final Interpretive Guides120 to include financial

data filed with the SEC. Specifically, we recommend that the Commission make clear in the

Compliance Guides that franchisors will not be deemed to make a financial performance claim

merely by posting online a press release about its financial status or other financial data filed with

the SEC. However, where a franchisor uses such data as a marketing tool for the sale of

franchises, it will be deemed to have made a general media claim.121
whether, given all the facts, the financial information is disseminated for the benefit of

prospective franchisees. If so, the posting must contain the disclosures for general media claims

and the franchisor must include an Item 19 financial performance claim in its disclosures. 

 

122 We further recommend that the Commission take the opportunity to clarify in the

Compliance Guides the relationship between the making of general media claims and Item 19

disclosure obligations. Consistent with the current Rule, the revised Rule would require a

franchisor making a general media claim to include that claim, as well as the bases and

assumptions (among other substantiation) in the disclosure document. However, there currently

exists no guidance on compliance, such as what happens if the franchisor stops running an

advertisement or changes the claims made in an advertisement. We believe the Compliance

Guides should make clear that a franchisor running an advertisement containing financial

performance claims must make the required disclosures at the very least while the advertisement

is running. If a franchisor stops running the advertisement and makes no additional claims, it

nonetheless must continue to make disclosures for a reasonable period of time, not less than six

months. Where a franchisor replaces an advertisement with a new one containing updated

financial information, the franchisor may provide the updated information in its disclosure

documents. Updated information is clearly more relevant to a prospective franchisee than older,

possibly stale, information. Finally, where a franchisor runs multiple advertisements containing

different types of financial performance claims, we would expect the franchisor to disclose and

provide documentation for each type of claim in its Item 19. 

 

123 We also recommend that the Commission make clear in the Compliance Guides that the

term “general media” includes other forms of electronic online advertising such as unsolicited

commercial email and banner or “pop-up” advertising.

32

In summary, we recommend that the Commission address the issues of implied

representations, expenses, and general media claims122 by adopting the following definition of

“financial performance representation”:

Financial performance representation means any oral, written, or visual

representation to a prospective franchisee, including a representation in the

general media, that states, expressly or by implication, a specific level or range of

actual or potential sales, income, gross profits, or net profits.123 A chart, table, or

mathematical calculation that shows possible results based on a combination of

variables is a financial performance representation. 
 

124 See 16 C.F.R. § 436.2(a)(3)(i). The term “fractional franchise” is defined in the current

Rule at § 436.2(h) as: 

any relationship . . . in which the person described therein as a franchisee, or any

of the current directors or executive officers thereof, has been in the type of

business represented by the franchise relationship for more than 2 years and the

parties anticipated, or should have anticipated, at the time the agreement

establishing the franchise relationship was reached, that the sales arising from the

relationship would represent no more than 20 percent of the sales in dollar volume

of the franchisee.

 

125 In the Statement of Basis and Purpose (“SBP”) accompanying the Rule, the Commission

recognized that pre-sale disclosure is unwarranted where the prospective franchisee already is

familiar with the products and services to be sold through the franchise and where the

prospective franchisee faces a minimal investment risk. 43 Fed. Reg. 59,614, 59,707 (Dec. 21,

1978). 

 

126 64 Fed. Reg. at 57,297. See also Final Interpretive Guides, 44 Fed. Reg. at 49,968.

33

E. Proposed Section 436.1(g): Fractional franchise

1. Background

A fractional franchise is one of several franchise relationships currently exempted from

the Rule.124 In most instances, the fractional franchise exemption arises where an existing

business seeks to expand its product line through a franchise relationship with a manufacturer. 

The exemption is available if the franchisee has two years of experience in the same business and

its sales from the new line of business do not exceed 20% of its total sales.125

In the NPR, the Commission proposed retaining, but modifying, the current definition of

fractional franchise. Specifically, the NPR proposed that the definition incorporate the

Commission’s long-standing policy that the parties must anticipate that the additional sales will

not exceed 20% of total sales within the first year of operation. It would also make explicit what

previously has been only implied: that the parties must have a reasonable basis to assert the

exemption.126

2. The record and recommendations

In response to the NPR, three commenters recommended changes to the definition of

fractional franchise. H&H suggested that the Commission broaden the first prong – “experience

in the same type of business” – to exempt franchisees with experience selling similar or
 

127 H&H, Comment 9, at 4.

 

128 J&G, Comment 32, at 3.

 

129 Tricon, Comment 34, at 2-3.

34

complementary goods or services.127 J&G would broaden the exemption further. Focusing on

the second prong of the exemption, the firm recommended that any franchise arrangement that

accounts for less than 25% of the franchisee’s business in the next year should be exempt from

the Rule, regardless of the products or services previously sold.128 Third, Tricon urged the

Commission to clarify how franchisors should calculate a potential fractional franchisee’s total

dollar volume in sales. Tricon noted that a fractional franchisee’s total sales could be calculated

in one of four ways. Specifically, the increase in product sales attributed to the fractional

franchise relationship could be measured against: (1) the fractional franchisee’s total sales for

that type of product; (2) the fractional franchisee’s total sales at the store where the new product

is sold; (3) the fractional franchisee’s total sales at all franchised units; or (4) the fractional

franchisee’s total sales from all businesses (franchise and non-franchised), regardless of the

source.129

For the following reasons, the staff recommends that the Commission adopt the fraction

franchise definition, as proposed in the NPR. First, we believe the suggestion that fractional

franchises include the sale of complementary goods goes too far. The current requirement that a

fractional franchisee have prior experience in the same line of business reduces the likelihood of

fraud because the fractional franchisee will likely be familiar with the products to be offered for

sale through the franchise relationship. As explained in the Interpretive Guides, “the required

experience may be in the same business selling competitive goods or in a business that would

ordinarily be expected to sell the type of goods to be distributed under the franchise.” 44 Fed.

Reg. at 49,968. Thus, the Commission does not require experience in the “identical type of

business”; rather, the sale of similar goods may qualify for the exemption. This approach is

reasonable because a prospective franchisee who is already familiar with the goods or services of

the franchise can better assess the financial risk involved in entering into a relationship with the

franchisor.

The analysis, however, may not be the same for complementary goods. What may be

viewed as “complementary goods” in any particular line of business may be quite subjective. For

example, reasonable minds may differ whether the introduction of ice cream sales at a

donut/coffee shop is “complementary.” While certain products make complementary sales

combinations – such as ice cream and donuts – it does not necessarily follow that a donut shop

franchisee is experienced with the risks involved with marketing and selling ice cream. H&H

has offered no definition of “complementary” that would ensure the requisite knowledge, nor do

we believe such a definition is available.
 

130 In the alternative, an individual prospective franchisee conducting business as an entity

could qualify for the proposed large franchisee exemptions, as discussed below at section

IX.B.3.c.

 

131 16 C.F.R. §§ 436.2(a)(1)(i) and 436.2(a)(2). The UFOC Guidelines do not define what

constitutes a franchise. Rather, definitions of the term “franchise” are set forth in individual state

statutes. For a discussion of state definitions of the term “franchise,” see section IV.F.2.a, below.

35

Second, we also reject J&G’s suggestion that the fractional franchise exemption focus

exclusively on the second prong – the franchisee’s level of investment. As a preliminary matter,

we agree that the amount a prospective franchisee can invest in a franchise is a measure of

sophistication. Recognizing that, the proposed Rule sets forth a new exemption for large

investments, as discussed below. The fractional franchise exemption, however, is different

because it may apply where the franchisee’s investment is not necessarily large. As an

alternative to a large investment, the fractional franchise exemption focuses on minimal financial

risk: a fractional franchisee will be exempt from the Rule where his or her financial risk is

minimal both because the investment represents only a small part of expected income and

because of prior experience in the field.130 We believe this is a sound approach. Accordingly, we

recommend that the fractional franchise exemption retain the prior experience prerequisite.

Finally, we agree with Tricon that the current Rule does not sufficiently explain how to

calculate total sales for purposes of the fractional franchise exemption. As noted above, the

exemption’s minimum sales threshold for new products or services better ensures that the

fractional franchisee faces only a minimal financial risk. In that light, we believe that it is proper

for the parties to measure incremental sales resulting from the fractional franchise against total

sales at all stores owned by the franchisee (franchised or non-franchised). For example, an

individual owning several hardware stores may introduce a new product at one store only. The

store owner, in our view, should measure the increase in sales attributed to the new product

against the aggregate total sales volume for all products sold through his or her businesses. We

propose that the Commission include this explanation of the fractional franchises’ second prong

in the Compliance Guides that will accompany the revised Rule.

F. Proposed Section 436.1(h): Franchise

1. Background

Currently, the Franchise Rule defines “franchise” broadly to encompass both franchises

and business opportunity ventures. A franchisor is covered by the Rule if the franchisor satisfies

the following three elements: (1) permits the use of its trademark; (2) imposes significant control

over the franchise operation or provides significant assistance to the franchisee; and (3) charges a

required payment.131 A business opportunity is also be covered by the Rule if the seller satisfies

these three elements: (1) the seller or an affiliate supplies the buyer with goods or services to
 

132 16 C.F.R. §§ 436.2(a)(1)(ii) and 436.2(a)(2).

 

133 See 64 Fed. Reg. at 57,296.

 

134 Id. at 57,297. As part of our overall effort to streamline the Rule, we also recommend

eliminating one alternative element of the current definition of “franchise,” namely that the

franchisee “indirectly or directly [is] required to meet the quality standards prescribed by [the

franchisor.]” 16 C.F.R. § 436.2(a)(1)(i)(A)(2). As discussed in the NPR, quality standards are

simply one type of control that a franchisor may impose on a franchisee. As long as the Rule

retains a broad “control” element, the more specific “quality standards” alternative is

unnecessary. Id. at 57,298.

 

135 Id. at 57,297.

 

136 Id. at 57,298.

 

137 We also recommend that the Rule adopt the Commission’s policy that the “payment”

element can be satisfied either by contract or by practical necessity. However, as discussed

below at section IV.O., we recommend that this policy be included in the definition of “required

payment,” rather than in the definition of “franchise.”

 

138 See Final Interpretive Guides, 44 Fed. Reg. at 49,966. See also FTC v. Marrone’s Water

Ice, Inc., No. 92-3720 (E.D. Pa. 2002). The staff has provided the same advice in several

informal advisory opinions. E.g., Con-Wall Corp. Bus. Franchise Guide (CCH) ¶ 6,427 (1981). 

36

market to the public; (2) provides location assistance or accounts for vending machines or other

equipment; and (3) charges a required payment.132

In the NPR, the Commission proposed a revised definition of “franchise” that would

focus exclusively on franchise sales. In light of the NPR’s recommendation to create a separate

trade regulation rule for business opportunity sales,133 a narrower definition is necessary to ensure

that ordinary business opportunities no longer fall within the Franchise Rule’s purview. 

Specifically, the NPR proposed narrowing the definition by focusing on the second element of

the definition – significant control or assistance.134 The franchisor would have to exert or have

the authority to exert significant “continuing control” over the franchisees’ method of

operation.135 In the alternative, the franchisor would have to offer significant assistance

“extending beyond the start of the business operation.”136 These modifications would clarify the

distinction between franchises and business opportunities, where any control or assistance is

typically limited to the initial phase of the business. 

In addition to eliminating business opportunities from the definition of “franchise,” the

NPR also proposed updating the Rule by incorporating two long-standing Commission

policies.137 First, a relationship will be deemed a franchise if it meets the three elements of a

franchise, regardless of whatever it may be called.138 Second, a business relationship will be
 

139 SBP, 43 Fed. Reg. at 59,699-70. See also U.S. v. Protocol, Inc., Bus. Franchise Guide

(CCH)[1996-97 Transfer Binder], ¶ 11,184 at 29,550, 29-555 (D. Minn. 1997); FTC v. Wolf,

1996 WL 812940, *7n.2; FTC v. Int’l Computer Concepts, 1994-2 Trade Cases, ¶ 70,798 at

73,403; FTC v. Sage Seminars, Inc., 1995 WL 798938, *7 (N.D. Cal). Commission staff has

provided the same advice in several informal advisory opinions. E.g., Real America Real Estate

Corp., Bus. Franchise Guide (CCH) ¶ 6,428 (1982) (“the applicability of the rule will not be

defeated by a franchisor’s subsequent failure to live up to any such commitment.”).

 

140 Baer, Comment 11, at 7. See generally Cal. Corp. Code §§ 31000-31516 (1997).

 

141 See Cal. Corp. Code at § 31005(a)(1); 815 Ill. Comp. Stat. 705/3(1)(a) (1999); Ind. Code

Ann. § 23-2-2.5-1(a)(1) (1999); Md. Code Ann., Bus. Reg. § 14-201(e)(1)(i); Mich. Comp. Laws

§ 445.1502(3)(a) (1989); N.D. Cent. Code § 51-19-02.5.a(1) (1999); Or. Rev. Stat.

§ 650.005(4)(a)(2001); R.I. Gen. Laws § 19-28.1-3(7)(i)(A) (1998); Va. Code Ann. § 13.1-

559A(b)(1)(2001); Wash. Rev. Code § 19.100.010(4)(a)(i) (1999); Wis. Stat. Ann.

§ 553.03(4)(a)(1) (1998). In New York, a business will also be deemed a franchise even though

there is no marketing plan if a franchisee is permitted to sell trademarked goods or services. 

37

deemed a franchise if it is offered or represented as having the characteristics of a franchise,

regardless of any failure on the franchisor’s part to perform as promised.139

2. The record and recommendations

In response to the NPR, no commenters objected to narrowing the definition of franchise

to eliminate coverage of business opportunities. However, the proposed definition generated

four suggestions: (1) the Commission should adopt the states’ definition of “franchise”; (2) the

Commission should fine-tune the second definitional element – “significant control and

assistance”; (3) the Commission should fine-tune the third definitional element – required

payment; and (4) the Commission should reconsider its policy concerning business relationships

represented as having the characteristics of a franchise. Below, we address each of these

suggestions.

a. State definitions of franchise

John Baer suggested that the Commission abandon the proposed definition of franchise in

favor of one commonly used by the states, pointing to California’s definition as a model.140 We

reject this suggestion. 

We begin by noting that the definition of “franchise” has been used by the Commission

for over 20 years and is well known in the franchise community, especially in the 35 states

without any franchise pre-sale disclosure statute. Moreover, there is no single state definition of

the term “franchise.” The states define “franchise” in basically two ways: some refer to selling

goods or services according to a marketing plan,141 while others refer to a community of interests
N.Y. Gen. Bus. Law, § 681(3)(a) (1996) (marketing plan) or § 681(3)(b) (trademarked goods or

services).

 

142 Haw. Rev. Stat. Ann. § 482E-2 (1998); Minn. Stat. § 80C.01.4(2) (1999); S.D. Codified

Laws, § 37-5A-1(2) (2000). 

 

143 Cal. Corp. Code at § 31005(a)(1); Ind. Code Ann. at § 23-2-2.5-1(a)(3); Md. Code Ann.,

Bus. Reg. § 14-201(e)(1)(i); Mich. Comp. Laws § 445.1502(3)(a); N.Y. Gen. Bus. Law,

§ 681(3)(a) (1996); N.D. Cent. Code § 51-19-02.5.a(1); Or. Rev. Stat. § 650.005(4 a); Va. Code

Ann. § 13.1-559A(b)(1).

 

144 815 Ill. Comp. Stat. at § 705/3(1)(a); R.I. Gen. Laws § 19-28.1-3(7)(i)(A); Wash. Rev.

Code § 19.100.010(4)(a)(i); Wis. Stat. Ann. § 553.03(4)(a)(1).

 

145 Cal. Corp. Code at § 31005(a)(3); Haw. Rev. Stat. Ann. at § 482E-2; Ind. Code Ann.

§ 23-2-2.5-2(a)(3); Md. Code Ann., Bus. Reg. § 14-201(e)(iii); Mich. Comp. Laws

§ 445.1502(3)(c); Minn. Stat. § 80C.01(4)(3); N.Y. Gen. Bus. Law, § 681(3)(b); N.D. Cent. Code

§ 51-19-02.5.a(1); S.D. Codified Laws § 37-5A-1(3); Wash. Rev. Code § 19.100.010(4)(a)(iii);

Wis. Stat. Ann. § 553.03(4)(a)(3).

 

146 815 Ill Comp. Stat. at § 705/3(1)(c); R.I. Gen. Laws § 19-28.1-3(7)(B); Va. Code Ann.

§ 13.1-559(b)(3).

 

147 Or. Rev. Stat. § 650.005(4)(c).

 

148 Haw. Rev. Stat. Ann. at § 482E-2; Minn. Stat. § 80C.01(4)(1); S.D. Codified Laws, § 37-

5A-1(1).

38

in the marketing of goods or services.142 Even within these two broad categories, there are

differences. California, Indiana, Maryland, Michigan, New York, North Dakota, Oregon, and

Virginia define “franchise” in relevant part as: “A franchisee is granted the right to engage in the

business of offering, selling or distributing goods or services at retail under a marketing plan or

system prescribed in substantial part by a franchisor.”143 On the other hand, Illinois, Rhode

Island, Washington, and Wisconsin have adopted a broader definition, modifying the sentence

above to read: “a marketing plan or system prescribed or suggested in substantial part by a

franchisor.”144 There are other differences as well. Some states require the payment of any

franchise fee,145 while others require a payment of at least $500.146 Oregon requires the

franchisee to pay “valuable consideration.”147 States also differ regarding the trademark

requirement. New York, for example, does not require the use of a trademark at all. Rather, a

business arrangement will constitute a franchise if either the franchisor offers a marketing plan or

permits the sale of trademarked goods or services. In Hawaii, Minnesota, and South Dakota, it is

sufficient for a franchisor to grant the franchisee the right to use the franchisor’s trademark.148 In
 

149 Cal. Corp. Code at § 31005(a)(2); 815 Ill. Comp. Stat. at § 705/3(1)(b); Ind. Code Ann. at

§ 23-2-2.5-1(a)(2); Md. Code Ann., Bus. Reg. § 14-201(e)(ii); Mich. Comp. Laws

§ 445.1502(e)(b); R.I. Gen. Laws § 19-28-1-3(7)(C); N.D. Cent. Code § 51-19-02.5.a(2); Or.

Rev. Stat. § 650.005(4)(b); Va. Code Ann. § 13.1-559(b)(2); Wash. Rev. Code

§ 19.100.010(4)(a)(ii); Wis. Stat. Ann. § 553.03(4)(a)(2).

 

150 The Staff Review found franchisee complaints about the lack of promised support,

training, and other support problems generated 39 complaints, while no complaint addressed the

lack of system controls. See Staff Review at 25. Similarly, misrepresentations about promised

assistance are the fourth most common complaint allegation (17 allegations) in Commission

franchise and business opportunity cases, after earnings claims (94 allegations), false testimonials

or references (28 allegations), and location misrepresentations (24 allegations). Id. at 39. In

contrast, the Commission has never brought a case in which the franchisor misrepresented its

control over the system or the nature of system standards.

39

the other states, the franchisee must sell goods “substantially associated” with the franchisor’s

trademark.149

At the same time, we note that the Rule’s use of the terms “control” and “assistance” is

not dissimilar from the majority of the states’ “marketing plan or prescribed system” approach. 

A marketing plan or prescribed system is essentially a series of controls that enable investors to

operate a business under uniform standards. For example, in its interpretation of the California

Franchise Act, the California Department of Corporations states: 

Control reserved over terms of payment by customers, credit practices, warranties

and representations in dealings between franchisees and their customers, suggest a

uniform marketing plan. Provisions concerning collateral services, which may or

may not be rendered, or prohibiting or limiting the sale of competitive or noncompetitive goods are consistent with, though certainly not in and of themselves

determinative of, a prescribed marketing plan. Significance attaches to provisions

imposing a duty of observing the licensor’s directions or obtaining the licensor’s

approval with respect to selection of locations, the use of trade names, advertising,

signs, sales pitches, and sources of supply, or concerning the appearance of the

licensee’s business premises and the fixtures and equipment utilized therein,

uniforms of employees, hours of operation, housekeeping, and similar

decorations.

California Department of Corporations, Release 3-F (Revised) at B(2)(c) (June 22, 1994) (“CA

Release 3-F”), reprinted at www.corp.ca.gov/commiss/rel3f.htm.

Further, we believe the reference to “assistance” is necessary in those situations where

franchisors, especially low-cost franchisors, do not sell a prescribed plan or impose system

standards on their franchises.150 Rather, they focus on the offer of assistance in order to attract
 

151 See, e.g., U.S. v. Lifecall Sys. Inc., No. 90-3666 (D. N.J. 1990); FTC v. McKleans, Inc.,

Bus. Franchise Guide (CCH), ¶ 9853 (D. Conn. 1989); FTC v. The Kis Corp., No. C88-1494 (D.

Wash. 1983). The inclusion of an assistance element in the Rule is substantially similar to the

minority of states whose franchise laws include prescribed or suggested marketing plans, as

explained above.

 

152 See also SBP, 43 Fed. Reg. at 59,701 n. 37 (commenters suggesting that the franchise

definition reference control and assistance).

40

prospective franchisees, especially individuals without prior business experience.151 In the SBP,

the Commission recognized that the original rulemaking record strongly supported the inclusion

of an alternative “assistance” element in the definition of “franchise,” stating:

While a franchise agreement may expressly reject the franchisor’s right to control

the methods of operation of the franchisee, the franchisee may as a practical

matter remain entirely dependent on the franchisor’s direct “assistance.” In a

“control” situation, the franchisor reduces the franchisee’s risk of doing business,

simply by directing the franchisee’s actions. In an “assistance” agreement, the

franchisor reduces the franchisee’s risk of doing business by training or otherwise

assisting the franchisee to make the right business decisions. In both cases, the

franchisee is dependent on the franchisor’s superior knowledge and expertise.

SBP, 44 Fed. Reg. at 59,702 n. 43.152

 Apparently, the states agree, recognizing that a franchise may be found on the basis of

assistance. For example, California recognizes a “marketing plan prescribed by implication”:

A marketing plan or system may be “prescribed” . . . where a specific sales

program is outlined, suggested, recommended, or otherwise originated by the

franchisor. Thus, a sales program may be “prescribed” by the franchisor where

the franchisor supplies the franchisee with sales aids or props, such as

demonstration kits, films, or detailed instructions for personal introduction and

presentation of the product, possibly including the text of a sales pitch and

especially where such a program is supported by training materials, courses, or

seminars.

CA Release 3-F at B(2)(e). Other states, as noted above, address assistance indirectly by adding

the word “suggested” to their franchise definition: “a marketing plan or system prescribed or

suggested in substantial part by a franchisor.” In short, we see little substantive difference

between the Rule and state approaches. Accordingly, we recommend that the Commission

address these issues directly by using the words “control” and “assistance,” consistent with the

current Rule.
 

153 See CA Release 3-F at 3 (“[I]f the franchisee is granted the right to use the franchisor’s

symbol, that part of the franchise definition is satisfied even if the franchisee is not obligated to

display the symbol.”).

 

154 BI, Comment 28, at 1.

 

155 Baer, Comment 11, at 9.

 

156 NFC, Comment 12, at 26 (“[T]he federal government’s defining a franchise relationship

as one in which the franchisor ‘exerts or has authority to exert a significant degree of continuing

control of the franchisee’s method of operation’ can only create vicarious liability mischief for

franchisors where none was intended.”).

41

The current Rule and state approaches are also similar regarding the trademark element.

As previously noted, the current Rule uses the phrase “identified or associated with” the

franchisor’s mark. This is similar to the states that require that the franchisee obtain the right to

use the franchisor’s mark. For example, a service-oriented franchise operated out of a home, as

opposed to a storefront, might not have a sign with the franchisor’s logo, or unique uniforms

associated with the franchisor. Although the franchisee’s “association” with the franchisor’s

mark may be limited (such as the right to use the franchisor’s mark on business cards,

advertising, and in yellow page listings), it is sufficient to trigger the Rule’s disclosure

obligations: in such circumstances, the use of the franchisor’s trademark leads consumers to

identify the business with the franchisor. Even California, which uses the phrase “substantial

association” with the mark, recognizes that the grant of permission to use a franchisor’s

trademark in the operation of a business would constitute “substantial association” with the

mark.153 

Finally, we note that adopting a “substantial association” criterion – as Mr. Baer seems to

suggest – might unnecessarily impose a new burden of proof in Commission law enforcement

actions. Not only would the Commission have to show that the franchisor granted a prospective

franchisee the right to use its trademark, but that the trademark use was “substantial.” We

believe this construction goes too far. For these reasons, we believe the Commission should

retain its definition of the term “franchise,” as modified below.

b. Significant control and assistance

Several commenters addressed the second definitional element – significant control or

assistance. BI suggested that the “franchise” definition should include the Commission’s policy,

as stated in the Interpretive Guides, that assistance and control must relate to the entire business

operation.154 John Baer recommended that significant assistance, like “control,” ought to be

continuing.155 The NFC would substitute the word “influence” for “control,” maintaining that the

word “control” implies vicarious liability for franchisee actions.156
 

157 Final Interpretive Guides, 44 Fed. Reg. at 49,967 (“[I]t should be emphasized that in

order to be deemed ‘significant’ the controls or assistance must be related to the franchisee’s

entire method of operation – not its method of selling a specific product or products which

represent a small portion of the franchisee’s business.”).

 

158 In addition, a franchisor’s fulfillment of contractual obligations to provide inventory

would not be deemed “assistance.”

42

We agree with BI that control and assistance must relate to the franchisee’s overall

business operation. This is consistent with long-held Commission policy.157 However, we

decline to incorporate the term “entire method of operation” into the Rule’s franchise definition. 

Read literally, it would require control by the franchisor over every conceivable aspect of the

business operation. In other words, every franchisor could avoid Rule coverage simply by not

controlling one aspect of the business. Rather, we believe that the Commission meant that

control must be over a substantial portion of the franchisee’s business. We recommend that the

Commission make this point clear in the Compliance Guides. 

Upon further reflection, we also believe that the NPR’s proposed language “significant

assistance extending beyond the start of the business operation” is too broad, unintentionally

sweeping in some business opportunities that provide services beyond just the initial start-up

period, such as providing locations or supplies on a long-term basis. In short, when a promoter

furnishes promised assistance is not necessarily helpful in distinguishing between franchises and

business opportunities. We recommend, therefore, that the Commission retain the original

Rule’s “significant assistance” language, but provide in the Compliance Guides examples of

what is and is not significant. In short, significant control has a quantitative and qualitative

component: to be “significant,” control must cover a substantial portion of the franchisee’s

business operation, as noted above, and it must be the type of assistance that is material to a

prospective franchisee. For example, absent the presence of other controls or assistance, the

following alone would not be deemed “significant”: promotional assistance, location or account

assistance, and equipment maintenance and/or repair assistance.158

Finally, we reject the suggestion that the Commission replace “control” with “influence”

in the proposed definition’s second element. The Commission has used the term “control” since

the inception of the Rule, and we believe that term is accurate. The suggested term “influence,”

on the other hand, would be misleading because it connotes that a franchisor only makes

suggestions to a franchisee in how to conduct business. In fact, through their contracts, many

franchisors impose, not suggest, system standards, which many franchise systems rigorously

enforce. We are unpersuaded that the Commission should adopt a less accurate term in the

Franchise Rule in anticipation that some courts might misapply the definition in a tort law

context.
 

159 Gurnick, Comment 21A, at 4-5. See also Baer, Comment 11, at 7. 

 

160 Gurnick, Comment 21A, at 4-6. Mr. Gurnick did not elaborate on this point. 

Presumably, by not using the precise term “required payment,” the proposal could be interpreted

as implying that any payment, such as a voluntary payment for supplies, is sufficient to trigger

the Rule. This interpretation is strengthened by the absence of an inventory exemption in both

the NPR’s definition of the term “franchise” and “required payment.”

43

c. Required payment

David Gurnick raised several technical issues concerning the proposed third element,

which is commonly known as the required payment element. As proposed in the NPR, the third

element would read: “As a condition of obtaining or commencing operation of the business, the

franchisee is required by contract or by practical necessity to make a payment, or a commitment

to pay, to the franchisor or a person affiliated with the franchisor.” 64 Fed. Reg. at 47,332. 

Mr. Gurnick observed that the proposed third definitional element does not actually use the term

“required payment.”159 Moreover, the indirect reference to a required payment in the NPR

proposal is itself different from the “required payment” definition, which reads as follows:

Required payment means all consideration that the franchisee must pay to the

franchisor or its affiliate, either by contract or by practical necessity, as a

condition of obtaining or commencing operation of the franchise.

64 Fed. Reg. at 57,332. Whereas the “required payment” definition refers to the “franchisor or

its affiliate,” the franchise definition refers to “a person affiliated with the franchisor.” Also, the

“required payment” definition refers to “operation of the franchise,” while the “franchise”

definition refers to “operation of the business.” Finally, Mr. Gurnick observed that the third

definitional element would seem to capture ordinary distributorships.160 

We agree that the third element of the franchise definition – payment – should be finetuned. Specifically, we agree that the definition of “franchise” should reference the term

“required payment,” as Mr. Gurnick suggested, and the language of the third element should be

consistent with that of the required payment definition. So revised, the third element of the

“franchise” definition would state:

As a condition of obtaining or commencing operation of the franchise, the

franchisee makes a required payment or commits to make a required payment to

the franchisor or its affiliate.

We also agree that the third element could be interpreted to include ordinary distributorships. 

This was not our original intent, and we recommend that the Commission address this issue
 

161 We discuss other suggested revisions to the term “required payment” below at section

IV.N of this Report.

 

162 E.g., Holmes, Comment 8, at 1-2. See also Gurnick, Comment 21A, at 5; IL AG,

Comment 3, at 3.

 

163 Holmes, Comment 8, at 2.

44

directly by revising the separate “required payment” definition, as discussed later, to incorporate

the inventory exemption, under which many distributorship arrangements fall.161

d. Offers having the characteristics of a franchise

David Holmes voiced concern over the Commission’s policy that a business relationship

will be deemed a franchise if it is offered or represented as having the characteristics of a

franchise, regardless of any failure to perform as promised on the franchisor’s part.162 He stated

that a relationship should not be deemed a franchise merely because the parties call it a franchise. 

In short, a description of the business arrangement should not rise above the substance of the

relationship.163

We believe that the proposed “franchise” definition correctly incorporates the

Commission’s policy that a franchise relationship may exist based upon the seller’s

representations at the time of sale. However, it is clear from the comments received that this

policy is not fully understood.

The commenters correctly asserted that the Rule should not cover situations where the

parties mistakenly use the term “franchise” to describe their business relationship. We agree that

a business relationship constitutes a franchise only if, as represented, it satisfies the three

elements of the term “franchise,” and nothing in the proposed definition is to the contrary. The

question is when should that determination be made. The Commission’s policy merely states

that whether a franchise arrangement exists shall be determined based upon the representations

made to the prospective buyer at the time of sale. For example, a start-up company may seek to

sell its first franchised outlet, advertising that, for a $500 fee, it will license its mark and provide

significant assistance to buyers. Under these circumstances, a prospect should receive a

disclosure document at the time of sale because, as represented, the business offered satisfies

each of the three elements of a franchise. This is true, even if the franchisor, in fact, lied and has

no ability to perform as promised, such as having no right to the trademark offered or having no

staff to provide promised assistance. In short, the seller should not be able to raise as a defense

to a Rule violation that it, in fact, offered a non-franchise business arrangement if, at the time of

sale, its representations satisfied the definition of a franchise.
 

164 64 Fed. Reg. at 57,298. If adopted, this proposal would have no substantive effect.

Currently, the Rule uses the terms “franchisor” and “franchise broker” throughout the Rule, and,

in some instances, references employees and agents. The proposed term “franchise seller” would

streamline the Rule by referencing all such individuals, where appropriate, by using only one

term.

 

165 See Final Interpretative Guides, 44 Fed. Reg. at 49,969.

 

166 Lewis, Comment 15, at 8. Mr. Lewis proposed that the definition read: “It includes the

franchisor or subfranchisor, and its employees, representatives, agents, and brokers, unless the

franchisor or subfranchisor has, and is exercising, a right to approve or disapprove a franchisee’s

sale or transfer of its own outlet to another person and is not otherwise significantly involved in

the sale or transfer.” Lewis, Comment 15, at 8. We address transfers, however, in the definition

of “franchise sale,” as noted below. See also IL AG, Comment 3, at 3.

 

167 J&G, Comment 32, at 9-10. 

45

G. Proposed Section 436.1(i): Franchise seller

1. Background

In the NPR, the Commission introduced a new term – “franchise seller.” This term and

its definition are needed in order to delineate easily all parties having obligations under the

Rule.164 Consistent with long-standing Commission policy, the NPR’s proposed definition

would also make explicit that an individual franchisee seeking to sell his or her own outlet is not

covered by the Rule:165 

Franchise seller means a person that offers for sale, sells, or arranges for the sale

of an interest in a franchise. It includes the franchisor and its employees,

representatives, agents, and third-party brokers. It does not include franchisees

who sell only their own outlets.

64 Fed. Reg. at 57,332.

2. The record and recommendation

In response to the NPR, six commenters addressed the scope of the proposed definition of

“franchise seller.” Warren Lewis suggested that the definition specifically reference

subfranchisors.166 J&G commented that the definition refers to, but does not define, franchise

brokers. The firm would limit the definition of brokers to individuals who: (1) are not employed

by franchisors or subfranchisors; (2) are compensated pursuant to a written agreement for

qualifying prospects; and (3) are active participants in the sales process.167 The firm also

proposed that the definition specifically exclude certain individuals who arguably might be
 

168 See also Lewis, Comment 15, at 8 (“broker” definition should not “include a franchisee

merely because the franchisee receives a payment from the franchisor or subfranchisor in

consideration of the referral or a prospective franchisee to the franchisor or subfranchisor, if the

franchisee does not otherwise participate in the sale of the franchise to the prospective franchisee. 

A franchisee does not participate in the sale of a franchise merely by participating in initial

conversations or communications with a prospective franchisee about a franchise.”).

 

169 Frannet, Comment 2, at 1.

46

involved in a franchise sale, including franchisees,168 trade show promoters, Web site owners, the

mass media, or others who may be paid for referrals, but “who do not spend more than an hour

with a prospective franchisee, or engage in substantive discussions with a prospective franchisee

about the terms of a franchise agreement.” J&G, Comment 32, at 10. On the other hand, John

Baer questioned whether the Commission should ever distinguish between a franchisor and

broker, asserting: “If any party offers to sell a franchise on behalf of a franchisor, that person

should be considered a franchise seller.” Baer, Comment 11, at 9.

Tricon voiced concern that the proposed definition would extend to all employees, even if

they are not actively involved in franchise sales. The company would revise the definition to

read: “It consists of the franchisor, the franchisor’s third-party brokers, and those of the

franchisors’ employees, representatives, or agents who are involved in franchise sales activities.” 

Tricon, Comment 34, at 3.

Frannet, a franchise referral company, urged the Commission to distinguish between

franchise brokers and middlemen. The company agreed that anyone who sells franchises should

be included in the definition of a franchise seller.169 However, it insisted that the phrase

“arranges for the sale” is undefined and goes beyond the commonly accepted definition of a

broker. According to Frannet, middlemen or finders who just arrange for prospects to meet

franchisors – but do not negotiate price or terms for the franchisor, or sign franchise agreements

on behalf of a franchisor – should not be deemed brokers. 

Frannet also voiced concern that the Commission’s broad concept of a “broker” will have

a direct impact upon a franchisor’s Item 2 disclosures. As proposed in the NPR, Item 2 would

require franchisors to disclose all brokers, and include their prior employment history. If so, the

Commission’s approach:

would force a franchisor who has a referral agreement with an organization such

as Frannet and each of its 57 Associates or with Tom Miller Associates who has

agreements with literally hundreds of business brokers each of whom will receive

a commission in the event that a prospect referred by any such person ultimately

purchases a franchise, to disclose information about each of the hundreds of such
 

170 We agree with Frannet that the Item 2 brokers disclosure is unnecessary. For a more

detailed discussion of this issue, see section VI.D.2.b. below.

 

171 In the Final Interpretive Guides, the Commission stated that franchisors and their

subfranchisors who also sell franchises are jointly and severally liable for each other’s disclosure

obligations. 44 Fed. Reg. at 49,969.

 

172 The UFOC Guidelines provide that “[i]n offerings by a subfranchisor, ‘franchisor’ means

both the franchisor and subfranchisor.” UFOC Guidelines, General Instructions 240.

 

173 SBP, 43 Fed. Reg. at 59,717 & nn. 176 and 178. In staff advisory opinions we have

interpreted the term “arranges” to include, for example, discussions with prospective franchisees

about their specific business interests, pre-screening prospects through interest questionnaires,

recommending specific franchise options, and assisting prospects in completing a franchisor’s

application form. Our view was based upon the SBP, in which the Commission took the position

47

people and provide in the UFOC the information necessitated by Item 2. This is

cumbersome, could cause the UFOC to be voluminous, and more importantly, be

of no value to the prospective franchisee.

Frannet, Comment 2, at 2.170 In short, Frannet asserted that only those individuals who have the

authority to negotiate prices and terms on behalf of the franchisor should be deemed to be a

broker under the Rule.

Finally, Howard Bundy raised another issue: the exemption for existing franchisees. 

According to Mr. Bundy, a franchisor may seek to evade disclosure requirements by having

franchisees pose as “agents” who repeatedly establish and sell their own outlets. He would limit

the exemption to “franchisees, who are not otherwise franchise sellers or affiliated with or under

any other contractual relationship with the franchisor who sell their complete interest in all of

their own outlets.” Bundy, Comment 18, at 3.

As expressed in the NPR, the staff believes the term “franchise seller” is necessary as

short-hand for referring, where appropriate, to all persons having obligations under the Rule. We

agree, however, that the Commission should extend the list of franchise sellers to include

subfranchisors. This is consistent with current Commission policy171 and the UFOC

Guidelines.172

We reject, however, the view that the Commission should distinguish between brokers

and middlemen or finders. When promulgating the Rule, the Commission defined the term 

“broker” broadly to mean “any person other than a franchisor or a franchisee who sells, offers for

sale, or arranges for the sale of a franchise.” 16 C.F.R. § 436.2(j). Similarly, in the Statement of

Basis and Purpose accompanying the Rule, the Commission clarified that a broker acts on behalf

of a franchisor and receives compensation for arranging a franchise sale.173 The term “broker,”
that group discussions about franchising and pre-screening of prospects may constitute a first

personal meeting that would require a franchisor or broker to furnish disclosure documents. See

Informal Staff Advisories 99-6 and 99-7, Bus. Franchise Guide (CCH), ¶¶ 6503-04 (1999). 

 

174 We note that the Commission has entered into consent agreements with several trade

show promoters to resolve allegations that they, as brokers, were jointly and severally liable with

the franchisor-exhibitors for making financial performance claims on trade show floors without

providing the required earnings claim disclosures. See FTC v. Entrepreneur Media, Inc., Bus.

Franchise Guide (CCH), ¶ 10,583 (C.D. Cal. 1994); FTC v. Shulman Promotions, Bus. Franchise

Guide (CCH), ¶ 10,584 (S.D. Ohio 1994). Pursuant to Commission policy, however, trade show

promoters are conditionally exempt from the Rule as brokers, if they furnish show attendees with

specific consumer education notices. See 46 Fed. Reg. 52,327 (Oct. 27, 1981).

 

175 This proposal is sufficiently narrow to exclude existing franchisees who may refer

potential franchisees to the franchisor because they are not under contract with the franchisor to

sell franchises. In most instances, it would also exclude trade show promoters and the media

who, typically, are not under contract with the franchisor, do not receive compensation from the

franchisor for franchise selling, and who do not pre-screen or otherwise assist prospects in

identifying specific franchise systems, or otherwise advance the franchise sale. 

48

therefore, is not limited to those persons who negotiate contract terms or sign franchise

agreements and accept payments on behalf of a franchisor.174 We agree.

Nonetheless, because the term “broker” does not appear in the Rule outside the definition

of “franchise seller,” we believe a separate Rule definition of “broker” within the Rule is

unnecessary. Rather, we recommend explaining the concept of brokers more fully in the

Compliance Guides. Specifically, we recommend that the Commission explain that a broker is a

person who: (1) is under contract with the franchisor; (2) receives compensation from the

franchisor; and (3) arranges franchise sales by assisting prospective franchisees in the sales

process.

175

 

Finally, we find some merit in Mr. Bundy’s concern about the existing franchisee

exemption. The exemption is intended to apply in those situations where an existing franchisee

transfers ownership in his or her unit to another party without any continuing obligation to the

purchaser. If, as Mr. Bundy suggested, an existing franchisee is engaged in repeated franchise

sales, however, then that individual would be covered by the Rule either as the franchisor’s

agent, broker, or subfranchisor. Nonetheless, to clarify this point, we recommend that the

Commission narrow the existing franchisee exemption to those existing franchisees who are not

otherwise engaged in franchise sales on behalf of the franchisor. 

Accordingly, we recommend that the Commission revise the NPR’s proposed definition

of “franchise seller” to read:
 

176 See also BI, Comment 28, at 2.

 

177 See, e.g., Mich. Comp. Laws, § 445.1502(4); Wis. Stat. Ann. § 553.03(5).

 

178 See proposed officers and owners exemption discussed at section IX.B.3.e below.

49

Franchise seller means a person that offers for sale, sells, or arranges for the sale

of a franchise. It includes the franchisor, and the franchisor’s employees,

representatives, agents, subfranchisors, and third-party brokers who are involved

in franchise sales activities. It does not include existing franchisees who sell only

their own outlet and who are otherwise not engaged in franchise sales on behalf of

the franchisor.

H. Proposed Section 436.1(j): Franchisee

1. Background

The current Rule defines “franchisee” as: “any person (1) who participates in a franchise

relationship as a franchisee, . . . or (2) to whom an interest in a franchise is sold.” 16 C.F.R.

§ 436.2(d). In the NPR, the Commission proposed streamlining the definition to read simply: 

“Franchisee means any person who is granted an interest in a franchise.” 64 Fed. Reg. at 57,298. 

2. The record and recommendations

In response to the NPR, a few commenters voiced concern that the phrase “granted an

interest in a franchise” is too broad. According to H&H, for example, the word “an interest in a

franchise” is unnecessarily confusing, and it could be interpreted to encompass shareholders and

other investors. H&H suggested that “franchisee” be defined simply as “any person who is

granted a franchise.”176 H&H, Comment 9, at 25. BI also urged the Commission to clarify that:

“there is no requirement that a disclosure document be furnished between affiliated companies. 

Because such transactions typically involve affiliated companies that are controlled by the same

individuals or entities, the need to provide disclosures is not necessary for the protection of the

affiliated company being granted the franchise.” BI, Comment 28, at 2.

We agree that the proposed definition of “franchisee” should be revised. The phrase

“interest in a franchise” is unnecessary and may have unintended consequences, as H&H

suggested. A revised definition focusing on the grant of a franchise (as opposed to an interest in 

a franchise) is also consistent with the states’ approach.177 Accordingly, we recommend that the

Commission adopt the following definition of franchisee: “Franchisee means any person who is

granted a franchise.” Finally, we find some merit in the argument that a franchisor’s affiliates

should not necessarily be considered franchisees. We address this issue below in our discussion

of the Rule’s exemptions.178
 

179 BI, Comment 28, at 2. 

 

180 NASAA, Comment 17, at 3.

 

181 E.g., Mich. Comp. Laws. § 445.1502(5); Wash. Rev. Code § 19.100.010(8).

50

I. Proposed Section 436.1(k): Franchisor

1. Background

The current Rule defines “franchisor” as: “any person who participates in a franchise

relationship as a franchisor, as denoted in paragraph (a) of this subsection.” 16 C.F.R. § 436.2

(c). In the NPR, the Commission sought to streamline the current definition to mean “any

person who grants an interest in a franchise and participates in the franchise relationship.” 64

Fed. Reg. 57,332.

2. The record and recommendations

The proposed “franchisor” definition generated three comments. First, BI stated that the

language “grants an interest” is too broad, arguably including a franchisee who sells an

ownership interest in her own business. The firm would adopt the language used in several state

franchise statutes, namely “grants a franchise,” or “grants or offers to grant a franchise.”179

Second, Warren Lewis suggested that the definition address “subfranchisors,” noting

comparable language in the Illinois and California Franchise Acts. He would add to the proposed

definition: “It includes a subfranchisor unless otherwise stated.” Lewis, Comment 15, at 11. 

Finally, NASAA urged the Commission to expand the definition to include shareholders

of privately-held corporations.180 Although NASAA did not elaborate, its suggestion is

apparently designed to make it easier to hold principals of closely-held corporations liable for

Rule violations. 

As explained in our discussion above concerning the “franchisee” definition, we agree

that the term “interest in a franchise” is overly broad and unnecessary. Instead, the phrase 

“grants a franchise” would make the definition consistent with state law.181 At the same time, it

is important to make clear that a franchisor not only grants a franchise, but also participates in the

franchise relationship. 

As discussed below, there are two primary disclosure obligations under the Rule: (1) to

make disclosures; and (2) to furnish disclosure documents. While the granting of a franchise is

sufficient to trigger the obligation to furnish disclosure documents, it should be insufficient to

compel the making of disclosures. For example, a third-party broker may grant a franchise on

behalf of a franchisor, but otherwise have no obligation to perform under the franchise
 

182 See UFOC, General Instruction 230 (information about the subfranchisor should be

disclosed, where applicable, the same as for the franchisor).

 

183 Pursuant to Section 18(d)(3) of the FTC Act, 15 U.S.C. § 57a(d)(3), and 16 C.F.R.

§ 436.1, violations of the Franchise Rule constitute unfair or deceptive acts or practices in or

affecting commerce, in violation of Section 5(a) of the FTC Act, 15 U.S.C. § 45(a). See also

discussion of liability below at section V.E.

 

184 E.g., FTC v. Morrone’s Water Ice, Inc., No. 92-3720 (E.D. Pa. 2002) (naming Stephen D.

Aleardi and John J. Morrone, III, individually and as officers of corporate defendants); FTC v.

Car Wash Guys Int’l, Inc., No. 00-8197 ABC (RNBx) (C.D. Cal. 2000) (naming Lance Winslow,

III, individually and as an officer of the corporate defendants).

51

agreement. Under the circumstances, the granting of a franchise alone should be insufficient to

compel the third-party broker to disclose information about him or herself, such as prior litigation

or a bankruptcy. On the other hand, a purported broker may not only sell franchises, but perform

on behalf of a franchisor as well (such as providing promised training). In such instances, the

broker is essentially a subfranchisor and should be covered by the Rule’s obligation to make

disclosures. To indicate that the term “franchisor” applies to a person who has both the

obligation to furnish disclosures and to make disclosures, the definition of “franchisor” must

reference both the granting of a franchise and participation in the franchise relationship.182 

In the same vein, we agree with Warren Lewis that the definition of “franchisor” should

be clarified expressly to include “subfranchisors.” This is similar to the UFOC Guidelines

approach, as noted above. The term “subfranchisor” as used in the Rule, therefore, means a

person who functions as a franchisor, meaning a person who both engages in pre-sale activities

and who has post-sale performance obligations. Accordingly, we recommend that the

Commission revise the NPR’s definition of “franchisor” to mean: “any person who grants a

franchise and participates in the franchise relationship. Unless otherwise stated, it includes

subfranchisors.” 

We reject, however, NASAA’s suggestion that the term “franchisor” include shareholders

of privately-held entities. We believe it is inappropriate to hold persons individually liable under

the Rule without satisfying the Section 5 liability standard.183 In our experience, owners and

officers of privately-held corporations, partnerships, and other entities are often indistinguishable

from the corporate entity itself, making policy, and directing the franchise operations. In such

circumstances, Section 5 of the FTC Act is sufficient to enable the Commission to hold such

individuals liable for a corporation’s Rule violations if the principals involved control or direct

the corporation and have knowledge of the acts that constitute the corporation’s misconduct.184 

Accordingly, further extension of the “franchisor” definition is unnecessary.
 

185 In the SBP, the Commission determined that these types of relationships need not be

protected by the Rule because the retailer-lessee typically is experienced and can assess the value

of the location and because the retailer-lessee’s financial liability to the retailer-grantor is limited

to rent. SBP, 43 Fed. Reg. at 59,708.

 

186 J&G, Comment 32, Attachment, at 6, 13.

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J. Proposed Section 436.1(l): Leased Departments

1. Background

One of the current Rule’s exemptions pertains to leased department arrangements. A

leased department is created when a retailer rents space from a larger retailer in order to conduct

business. For example, a jeweler may rent space from a department store to sell jewelry and

watches. Technically, this relationship may be a franchise because the jeweler becomes

associated with the department store’s trademark, and the department store may impose conduct

standards on the jeweler, such as operating hours. The Rule currently defines such arrangements

as follows:

Where pursuant to a lease, license, or similar agreement, a person offers, sells, or

distributes goods, commodities, or services on or about premises occupied by a

retailer-grantor primarily for the retailer-grantor’s own merchandising activities,

which goods, commodities, or services are not purchased from the retailer-grantor

or persons whom the lessee is directly or indirectly (A) required to do business

with by the retailer-grantor or (B) advised to do business with by the retailergrantor where such person is affiliated with the retailer-grantor

16 C.F.R. § 436.2(a)(3)(ii).185

In the NPR, the Commission proposed retaining, but streamlining, the leased department

exemption as follows:

Leased department means an arrangement whereby a retailer licenses or otherwise

permits an independent seller to conduct business from the retailer’s premises.

64 Fed. Reg. 57,332.

2. The record and recommendations

Only one commenter, J&G, raised any concern about the proposed revised leased

department definition. First, the firm asserted that the Commission has expanded the definition

of leased department by eliminating the portion of the current definition covering the source of

the lessee’s goods.186 Presumably, under the NPR proposal, a leased department would now be
 

187 Co-branding, a relatively new marketing development in franchising, enables a franchisee

to use the trademarks and sell the goods or services of more than one franchise system. For

example, an outlet that sells Taco Bell foods might also sell Pizza Hut pizza, or a gasoline

franchise, such as Shell, may operate an on-site Subway Shop or 7-Eleven store.

 

188 Similarly, H&H suggested that the Commission address co-branding in the Rule’s

instructions for the preparation of disclosures by subfranchisors:

We believe that the Proposed Rule should state that, in the context of

subfranchising and co-branding, required information should be included about

the franchisor and subfranchisor, and the anchor franchisor and host franchisor,

respectively, to the extent applicable. This will provide the necessary flexibility to

prepare disclosure documents that are relevant to the particular structure, while

providing prospective franchisees with all material information.

H&H, Comment 9, at 6.

 

189 In the ANPR, the Commission stated that it was uncertain whether the purchaser of a cobranded franchise acquires two individually-trademarked franchises (and thus should receive

separate disclosures from each franchisor) or acquires a hybrid franchise arrangement that has its

53

exempt from the Rule even if the retailer-grantor required the retailer-lessee to purchase goods

from, for example, a specific third-party supplier. Second, the firm urged the Commission to

expand the definition of leased department to include “co-branding” arrangements187 where a

department is licensed or leased to the same person who owns the interest in the real property

from which another business will continue to operate. Id.

188

The staff recommends that the Commission revise the proposed definition of “leased

department” further to avoid any misinterpretation about its scope. We believe that the

Commission did not intend to broaden the “leased department” exemption, as J&G suggested. 

Rather, the proposed definition was an attempt to streamline the current Rule’s lengthy and

unnecessarily confusing definition. To avoid any misinterpretation of the exemption’s scope, we

propose retaining the original Rule definition with some minor editing:

Leased department means an arrangement whereby a retailer licenses or otherwise

permits a seller to conduct business from the retailer’s location where the seller

purchases no goods, services, or commodities directly or indirectly from: (1) the

retailer; (2) a person the retailer requires the seller to do business with; or (3) a

retailer-affiliate if the retailer advises the seller to do business with the affiliate.

We reject, however, any suggestion that the definition of “leased department” be

broadened to address co-branding. The issue of Rule compliance in co-branded arrangements

was addressed in the ANPR189 and at the New York public workshop conference on September
own risks and, thus, should receive a single unified document that discloses information specific

to the co-branding arrangement. The ANPR asked whether franchisors have sufficient guidance

under the Rule to determine their disclosure obligations with respect to the sale of co-branded

franchises and whether new or different disclosures should apply to the sale of co-branded

franchises. 62 Fed. Reg. at 9,122. Ten ANPR commenters addressed co-branding. Quizno’s,

ANPR 16, at 2; Baer, ANPR 25, at 7; H&H, ANPR 28, at 9; Kaufmann, ANPR 33, at 16;

Kestenbaum, ANPR 40, at 2-3; IL AG, ANPR 77, at 4-5; IFA, ANPR 82, at 4; Kirsch, ANPR 98;

Jeffers, ANPR 116, at 9; WA Securities, ANPR 117, at 4. With the exception of Quizno’s, the

ANPR commenters maintained that the Commission’s current pre-sale disclosure approach is

sufficient to address co-branded franchise arrangements. See Quizno’s, ANPR 16, at 2

(sufficient guidance does not exist with respect to co-branding arrangements).

 

190 E.g., Kirsch, ANPR, 18Sept97 Tr, at 176; Wieczorek, id., at 177-78; Kestenbaum, id., at

178-79; Simon, id., at 179.

 

191 Dale Cantone, of Maryland Securities, stated: “We haven’t had too many problems on

the issue of co-branding. We’ve had franchisors file disclosures and we really haven’t had too

many issues with it.” Cantone, ANPR, 18Sept97 Tr, at 182.

 

192 E.g., PMR&W, Comment 4, at 9; H&H, Comment 9, at 12.

 

193 E.g., Baer, Comment 11, at 10-11. 

54

18, 1997. The commenters generally agreed that the Commission need not address co-branding,

and none suggested any exemption from disclosure for co-branded franchises. Similarly, the

New York workshop participants generally agreed that the current Rule is sufficient to address

co-branding arrangements.190 Neither franchisee advocates nor state regulators voiced any

concerns to the contrary.191 For that reason, the NPR contained no provisions directed at cobranding. We continue to believe that no compelling reason exists to address co-branding in the

Rule. Even if we were to consider addressing co-branding, the record is insufficient for us to

make any recommendation on how to address the issue through a rulemaking, and J&G has

offered no detailed proposal for the Commission’s consideration.

K. Proposed Section 436.1(m): Parent

Several commenters noted that the NPR did not define the term “parent.”192 A few

commenters suggested that because several Rule provisions address parent disclosures, the

Commission should expressly define that term.193 For example, Warren Lewis recommended

that the Commission adopt the following definition: “Parent means an entity that directly or

indirectly has an 80% or greater ownership interest in the franchisor.” Lewis, Comment 15, at 9.

We recommend that the Commission adopt the definition of parent set forth in the Final

Interpretive Guides: “an entity that controls the franchisor directly, or indirectly through one or
 

194 This is similar to the proposed “affiliate” definition. See proposed section 436.1(b)

above.

 

195 See also 16 C.F.R. § 436.2(b). 

 

196 J&G, Comment 32, Attachment, at 14.

55

more subsidiaries.” 44 Fed. Reg. at 49,972. We believe that the essence of the parent-subsidiary

relationship is one of control.194 In that regard, we note that Mr. Lewis does not state the basis

for his recommendation that the Commission adopt an 80% ownership interest test. One

possibility is that he borrowed from the following language in UFOC Item 21: “a company

controlling 80% or more of a franchisor may be required to include its financial statements.” 

Item 21, however, does not specifically purport to define the term “parent.” Rather, it merely

suggests that a large controlling interest may give rise to financial disclosure obligations. Indeed,

in promulgating the Rule, the Commission did not adopt any specific level of control test. To the

contrary, the Commission defined parent “broadly,” as noted above. We believe that is the

proper approach.

L. Proposed Section 436.1(n): Person

1. Background

In the NPR, the Commission proposed retaining the current Rule’s definition of “person”

as follows: “person means any individual, group, association, limited or general partnership,

corporation, or any other business entity.” 64 Fed. Reg. at 57,332.195 

2. The record and recommendations

In response to the NPR, Warren Lewis suggested that the Commission change “other

business entity” to simply “other entity” and add the following: “An individual is not an entity.” 

Lewis, Comment 15, at 10. Mr. Lewis maintained that these changes will make it clear

throughout the Rule that “person” means an individual or business entity; while entity means

only a business entity. Id. J&G also suggested that the definition of person include limited

liability companies.196

Based upon the comments, we propose that the Commission revise the definition of

“person” in part. “Person” is a term of art used in many Commission rules to refer to a party,

regardless of whether the party is an individual, organization, or business entity. Where

necessary, the Commission can distinguish between parties by using more specific terms –

individual, organization, or entity. We believe that these more specific terms are clear, and,

therefore, we need not distinguish between individuals and entities, as suggested. Nonetheless,

we agree with Mr. Lewis that, in context, the word “business” attached to “entity” in the

proposed definition is unnecessary. On the other hand, we find that the term “entity” is sufficient
 

197 See also NASAA Commentary, Bus. Franchise Guide (CCH), ¶ 5790, at 8,465 (“The

definition of predecessor in instruction iii to Item 1 should be applied throughout the UFOC.”).

 

198 E.g., H&H, Comment 9, at 15; BI, Comment 28, at 2.

 

199 E.g., PMR&W, Comment 4, at 8; Baer, Comment 11, at 11; Snap-On, Comment 16, at 2.

56

to cover limited liability companies or similar business arrangements. Accordingly, we

recommend that the Commission revise the definition of “person” to mean: “any individual,

group, association, limited or general partnership, corporation, or any other entity.”

M. Proposed Section 436.1(p): Predecessor

1. Background

Several of the proposed Rule disclosures pertain to the franchisor’s predecessor, such as

Item 3 litigation and Item 4 bankruptcies. The current Rule does not require the disclosure of

predecessor information, and therefore, does not define that term. Item 1 of the UFOC

Guidelines, however, defines predecessor as “a person from whom the franchisor acquired

directly or indirectly the major portion of the franchisor’s assets.” UFOC Guidelines, Item 1

Instructions, iii.197 In the NPR, the Commission proposed a broad definition of “predecessor”

that would expand the UFOC Guidelines’ definition, as follows:

Predecessor means a person from whom the franchisor acquired, directly or

indirectly, the major portion of the franchisor’s assets or from whom the

franchisor obtained a license to use the trademark or trade secrets in the franchise

operation 

64 Fed. Reg. 57,332.

2. The record and recommendations

Eleven commenters opposed the NPR’s proposed “predecessor” definition. They asserted

that the definition’s references to the company from whom the trademark was acquired is too

broad,198 and would result in burdensome disclosures that are immaterial to prospective

franchisees.199 The NFC, for instance, noted that many large corporations, especially those with a

foreign presence, use a series of corporations to “funnel their marks to the franchisor.” NFC,

Comment 12, at 3-4. This is done for tax purposes and foreign ownership requirements. 

According to the NFC, these corporations are often dormant, and are “never involved with the

solicitation of franchisees, the sale of franchises, or administration of the franchise network.” Id.

Similarly, Marriott questioned the relevance of information about the original licensor

from whom the franchisor obtained the use of the trademark:
 

200 See also, e.g., PMR&W, Comment 4, at 8; J&G, Comment 32, at 9. Commenters also

observed that information about the franchisor’s trademark is already disclosed in Items 12-13. 

E.g., Baer, Comment 11, at 10; Lewis, Comment 15, at 10.

 

201 See also, e.g., AFC, Comment 30, at 2; Marriott, Comment 35, at 14.

 

202 See discussion of Item 1 below at section VI.C.

 

203 See n.197 above.

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The Proposal would require disclosures in Item 1, 3 and 4 about entities which

license any trademarks or trade secrets used in the “franchise operation.” The

term is not limited to principal trademarks, but even if it were so limited, it is not

clear why, for example, disclosure of such information about the late Roy Rogers

or King Features Syndicate, the licensor of “Popeye’s” trademark, is relevant or desirable

to the prospective purchasers of a Roy Rogers or Popeye’s franchises.

Marriott, Comment 35, at 13-14.200 

Finally, commenters asserted that it would be burdensome to obtain background

information from original licensors: “Obtaining accurate and complete information on this new

proposed class of predecessors, licensors, would be . . . difficult, but would not result in the

disclosure of significant new information to prospective franchisees.” Lewis, Comment 15, at

10.201

The staff believes that information about predecessors is essential in order to avoid

fraudulent franchise sales. Our law enforcement experience demonstrates that, in some

instances, franchisors reincorporate under a new name as a simple way to avoid disclosing

damaging information, such as prior litigation or a bankruptcy.202 Nonetheless, we agree with the

NPR commenters that the reference to original license holder is broader than necessary to prevent

fraud and would require franchisors to obtain information from companies over which they have

no control. Moreover, this information may be immaterial to a prospective franchisee because

the original trademark licensor may have no legal responsibilities to the prospective franchisee. 

Disclosures about original license holders could also be misleading, especially if the license

holder is the franchisor’s parent company: they could imply a greater degree of oversight of the

franchisor, as well as the franchisor’s prior experience and financial stability. For these reasons,

the staff recommends that the Commission adopt the UFOC Guidelines’ limited definition of

predecessor, as noted above.203
 

204 The UFOC Guidelines do not specifically define the term “prospective franchisee.”

 

205 BI, Comment 28, at 3.

 

206 J&G, Comment 32, at 7.

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N. Proposed Section 436.1(r): Prospective Franchisee

1. Background

Under the current Rule, franchisors must furnish disclosure documents to prospective

franchisees only. The Rule defines the term “prospective franchisee” as “any person, including

any representative, agent, or employee of that person, who approaches or is approached by a

franchisor or franchise broker, or any representative, agent, or employee thereof, for the purpose

of discussing the establishment, or possible establishment, of a franchise relationship involving

such a person.” 16 C.F.R. § 436.2(e).204 In the NPR, the Commission proposed adopting the

current definition, with minor editing. Specifically, the phrase “franchisor or franchise broker”

would be replaced with the inclusive term “franchise seller,” as discussed above: 

any person (including any agent, representative, or employee) who approaches or

is approached by a franchise seller to discuss the possible establishment of a

franchise relationship. 

64 Fed. Reg. at 57,332.

2. The record and recommendations

In response to the NPR, BI voiced concern about who may receive a disclosure document,

and suggested revising the definition to provide that it is sufficient for any representative of the

franchisee to receive the disclosures.205 J&G also questioned the use of the word “approaches” in

the definition. Specifically, the firm feared that the definition would include someone surfing the

Internet who “approaches” a franchisor’s Web site.206

The staff recommends that the Commission retain the definition of “prospective

franchisee,” as proposed in the NPR. We agree with BI that the Rule should permit a

franchisee’s representative to accept delivery of the disclosure document. We recognize that in

some instances a prospective franchisee can be a corporation or other entity, not an individual. 

Thus, delivery in such circumstances can only be made upon a representative. Even an

individual may wish to have his or her attorney or other agent receive the disclosures on their

behalf, and the Rule should accommodate that possibility. We recommend, therefore, that the 

Compliance Guides make clear that a representative can accept disclosures on behalf of a

prospective franchisee.
 

207 16 C.F.R. § 436.2(a)(2).

 

208 See Final Interpretive Guides, 44 Fed. Reg. at 49,967. The staff has provided the same

advice in several informal advisory opinions. E.g., Chrysler Corp., Bus. Franchise Guide (CCH)

¶ 6,383 (1979). 

59

We believe J&G’s concern that Internet surfers might be deemed prospective franchisees,

however, is unwarranted. The proposed “prospective franchisee” definition states that the parties

must “discuss the possible establishment of a franchise relationship.” This limiting language

makes clear that for an individual to become a “prospective franchisee” he or she must intend to

engage in some dialogue about a franchise offering. Unilateral surfing of a franchisor’s Web site

hardly rises to the level of a “discussion.” Therefore, merely perusing a franchisor’s Web site

alone does not turn an ordinary Internet surfer into a prospective franchisee. 

O. Proposed Section 436.1(s): Required Payment 

1. Background 

Under the current Rule, the making of a “required payment” (or a commitment to make a

“required payment”) is one of the definitional elements of the term “franchise.”207 The Rule,

however, currently does not define the term “required payment.” In the NPR, the Commission

proposed the following definition: “Required payment means all consideration that the franchisee

must pay to the franchisor or its affiliate, either by contract or by practical necessity, as a

condition of obtaining or commencing operation of the franchise.” 64 Fed. Reg. at 57,332. The

proposed definition would incorporate the Commission’s long-standing policy that a payment

can be required by contract or by practical necessity.208

2. The record and recommendations

In response to the NPR, several commenters raised concerns about the scope of the

“required payment” definition. Specifically, commenters voiced concern whether the definition:

(1) covers royalty payments; (2) is limited to payments for the right to enter into the franchise

relationship; (3) excludes payments for inventory; and (4) includes payments to third parties. We

address each issue below.

a. Royalty payments

As noted above, the NPR defined the term “required payment” using the phrase

“consideration that the franchisee must pay.” 64 Fed. Reg. at 57,332. The IL AG interpreted the

word “consideration” as excluding royalty payments. It urged the Commission to clarify that
 

209 See also J&G, Comment 32, Attachment, at 15 (questioning whether “consideration”

excludes royalty payments).

 

210 See Final Interpretive Guides, 44 Fed. Reg. at 49,967 (“Among the forms of required

payments are . . . continuing royalties on sales.”). If not, a franchisor could easily avoid Rule

coverage by forgoing an up-front fee in favor of larger royalty payments during the course of the

franchise agreement.

60

royalties can constitute a required fee. Otherwise, “it will be too simple, even for traditional

franchisors, to evade franchise laws.” IL AG, Comment 3, at 5.209

The Commission has always considered royalty payments to be a form of required

payment under the Rule.210 We believe this policy is sound because royalty payments are clearly

a direct form of revenue flowing to the franchisor in exchange for the ability to conduct business. 

Indeed, if royalties were excluded from the required payment definition, then any franchisor

could avoid Rule coverage by charging a large post-sale royalty fee in lieu of an initial franchise

or related fee. The NPR used the term “consideration” not to imply that only an upfront

franchise fee constituted a required payment under the Rule, but to avoid the circular use of the

word “payment” in the definition of “required payment.” Also, alternatives such as “funds, or

moneys” are too limited because they would preclude payments in-kind. Accordingly, we

recommend that the Commission clarify in the Compliance Guides that the term “consideration”

includes post-sale payments such as royalties.

b. Obtaining or commencing operation

John Baer voiced concern that the definition would cover payments made “as a condition

of obtaining or commencing operation of the franchise.” Baer, Comment 11, at 8. He urged the

Commission to clarify that a payment must be made “for the right to enter into the franchise

relationship,” asserting that courts have distinguished between a “fee paid for the right to do

business” and “fees paid in the course of business.” Id. 

We decline to adopt this suggestion. In the Interpretive Guides, the Commission used

two phrases to describe the required payment element. First, the Commission stated that: “The

franchisee must be required to pay to the franchisor . . . as a condition of obtaining or

commencing the franchise operation.” Final Interpretive Guides, 44 Fed. Reg. at 49,967

(emphasis added). Later in the same section, the Commission stated that the term “required

payment” captures “all sources of revenue which the franchisee must pay to the franchisor or its

affiliate for the right to associate with the franchisor and market its goods or services.” Id.

(emphasis added). While both phrases are substantially similar, and arguably interchangeable,

we believe the former describes the payment requirement more precisely. 

The “right to associate” language could be misinterpreted as limiting the required

payment element to payments made solely for the right to enter into the business, such as an up-
 

211 See SBP, 43 Fed. Reg. at 59,703 and n. 51 (discussing problem of “indirect or disguised”

franchise fees).

 

212 See Final Interpretive Guides, 44 Fed. Reg. at 49,967. In the NPR, the Commission

proposed incorporating the inventory exemption in the current minimum payment exemption. 

See 64 Fed. Reg. at 57,345. However, because the inventory exemption helps to define what

constitutes a required payment, we recommend that it be included in the definition of “required

payment.”

 

213 Gurnick, Comment 21A, at 10.

 

214 Baer, Comment 11, at 8.

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front franchise fees. However, the Commission has made clear that the required payment

element is not limited to up-front fees alone: “Often, required payments are not limited to a

simple franchise fee, but entail other payments which the franchisee is required to pay to the

franchisor or an affiliate.” Id. Accordingly, we believe that expenses made in the ordinary

course of business to a franchisor or its affiliate may constitute a required payment, as

demonstrated by the illustrative examples of required payments in the Final Interpretive Guides,

which include equipment rentals and real estate leases. Id. If not, franchisors could easily

circumvent the Rule by refraining from imposing any up-front fee in favor of charging for

ordinary business expenses, such as training or other services, or purchases of equipment or

unreasonable amounts of inventory.211 

c. Payments for inventory

Two commenters addressed the issue of payments for inventory. Under the current Rule,

reasonable amounts of inventory purchased at bona fide wholesale prices do not constitute a

“required payment” as a matter of Commission policy.212 This is commonly referred to as “the

inventory exemption.” David Gurnick urged the Commission to update the Rule by

incorporating the inventory exemption into the definition of required payment itself.213 John

Baer agreed and would expand the exemption to include not only inventory for resale, but

inventory for lease. Otherwise, the situation could arise where inventory obtained from a

company is intended for resale – thus taking it outside of the Rule – but later on leased to a

customer – thus creating a franchise relationship retroactively.214

Based upon the record, we recommend that the Commission revise the proposed

definition of “required payment” to include the inventory exemption. As the Commission stated

in the Final Interpretive Guides, it is “virtually impossible to draw a clear line between start-up

inventory that is purchased at the franchisee’s option, and that which is purchased as a matter of

practical or contractual necessity.” 44 Fed. Reg. at 49,967. Accordingly, since the late 1970s,

the Commission has determined that reasonable purchases of inventory for resale at bona fide

wholesale prices should not be construed as a “required payment.” We believe this policy is
 

215 Mr. Gurnick also disputed the view that franchisors entice prospects to incur costs, such

as airline tickets. “No data is [sic] provided to support this claim, and frankly I question whether

companies really have an interest in enticing prospects to buy, for example, airline tickets.” Id. at

4.

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sound. As suggested, we further recommend that the Commission expand the inventory

exemption to include inventory purchased for lease. We see no practical distinction between

purchase for resale and purchase for lease, as urged above.

d. Payments to third parties

Finally, Howard Bundy urged the Commission to expand the concept of “required

payment” to include payments made to third parties. According to Mr. Bundy, franchisors can

effectively “hook” a prospective franchisee if they can get the prospect to expend funds early in

the sales process, such as paying travel expenses:

In franchising, it has become common to use the “takeaway close” to entice

prospects to travel to the franchisor’s headquarters as a condition precedent to

receiving a disclosure document. Likewise, we see instances of franchisors

requiring a franchisee to contract with or pay for demographic or real estate

services with technically “unaffiliated” entities as a condition precedent to being

“approved” as a franchisee.

Bundy, Comment 18, at 4. To address this concern, Mr. Bundy suggested that the Commission

modify the proposed definition of “required payment” to include, after the word affiliate: 

“or to a vendor, financing provider or other third party that the prospective franchisee is required

to deal with either by contract or practical necessity or to any third party as a condition precedent

to obtaining the Franchise Disclosure Document.” Id.

Mr. Bundy’s suggested expansion of the “required payment” definition to include

payments to third parties generated one rebuttal comment. Mr. Gurnick observed that defining

required payment to include third-party payments would be: “a radical departure from the

Commission’s long-standing policy regarding the definition of a franchise, would create a major

inconsistency between the Franchise Rule and the state franchise laws, and would extend

coverage to arrangements which the Rule was never intended to regulate.” Gurnick Rebuttal,

Comment 36, at 2. Observing that all businesses make payments to vendors and service

providers, he also asserted that the Bundy proposal would be overbroad: “For example,

‘practical necessity’ may dictate that a business use a Microsoft software product or that an

employee of the business fly to an airport that is served by only one airline.” Id. at 3. Mr.

Gurnick added that if a franchisor establishes a company to receive some monetary benefit from

prospects, those funds would already fall within the “required payment” definition as a payment

to an affiliate. Id. at 3-4.215
 

216 See Final Interpretive Guides, 44 Fed. Reg. at 49,967. 

 

217 See section X.B.4. below.

63

Mr. Gurnick correctly noted that the Commission has never considered ordinary business

payments to third parties as a required payment under the Rule. Indeed, doing so would sweep

all sorts of non-franchise relationships into the Rule. Ordinary business expenses paid to third

parties, such as the cost of installing telephone lines, insurance, and occupancy fees – expenses

typically incurred by all businesses – can hardly be deemed a precondition imposed by the

franchisor for commencing or operating the franchise. Rather, a third-party payment would be

deemed a required payment only if the third party collects and remits the payment on behalf of

the franchisor.216

Nonetheless, we believe there is merit in Mr. Bundy’s observation that a franchisor may

direct or encourage a prospective franchisee to incur some costs in order to advance the franchise

sale. These payments are often made by the prospective franchisee without the benefit of presale disclosures. For example, a franchisor might encourage a prospect to fly across the country

to visit its headquarters. If the prospective franchisee knew, for example, that the franchisor was

involved in significant litigation with its franchisees, or was under a Commission order for fraud,

he or she might decline the invitation. We also believe that encouraging a prospect to incur

expenses to advance the franchise sale might “hook” or “pre-condition” the prospect, making it

more likely that he or she will go through with the deal without a thorough due-diligence

investigation. 

Rather than recommending that the Commission modify the “required payment”

definition to address this concern, we propose an alternative approach: an express prohibition

barring a franchisor from failing to furnish a copy of its disclosure document to a prospective

franchisee early in the sales process, upon reasonable request.

217 If this prohibition were adopted,

then a prospective franchisee could ask to see a copy of the franchisor’s disclosure document

before agreeing to travel to company headquarters or purchase demographic data, for example. 

We believe this approach would effectively address the commenters’ concern about predisclosure third-party payments without changing the Commission’s long-held interpretation of

the term “required payment.”

P. Proposed Section 436.1(t): Sale of a Franchise

1. Background

The Franchise Rule’s disclosure obligations are triggered only if there is a franchise sale. 

The current Rule defines the term “sale of a franchise” as:

including a contract or agreement whereby a person obtains a franchise or interest

in a franchise for value by purchase, license, or otherwise. This term shall not be
 

218 See 64 Fed. Reg. at 57,332.

 

219 H&H, Comment 9, at 9-10. 

 

220 Id. at 10.

64

deemed to include the renewal or extension of an existing franchise where there is

no interruption in the operation of the franchised business by the franchisee,

unless the new contracts or agreements contain material changes from those in

effect between the franchisor and franchisee prior thereto.

16 C.F.R. § 436.2(k). In the NPR, the Commission proposed retaining the current definition of

“sale of a franchise,” with some minor editing.218

2. The record and recommendations

In response to the NPR, one commenter, H&H, raised several concerns about the

proposed definition’s scope. First, the firm urged the Commission to exclude from the 

definition the modification of an existing franchise agreement where there is no interruption in

the franchisee’s business operation.219 The firm observed that material modifications to existing

franchise agreements typically arise in two situations: (1) a settlement of litigation or other

disputes with franchisees, in which the franchisor makes concessions; and (2) management

initiative with the involvement of independent franchisee associations or franchisee advisory

councils.

220 According to H&H, these modifications typically entail no new investment and both

sides are familiar with the franchise terms: “An offer to exchange different forms of agreement

or add an addendum to existing franchise agreements does not establish a new franchise

relationship – that relationship already exists and will continue regardless of the decision the

franchisee makes.” H&H, Comment 9, at 10. 

H&H further contended that disclosure is unwarranted for renewals in all circumstances,

asserting that a renewing franchisee makes no investment decision: “His decision relates to

whether to continue a relationship, with which he should be intimately familiar at that point,

under the terms of a new form of franchise agreement. The UFOC does little to help him

understand the terms of that agreement.” Id. at 11.

Finally, H&H maintained that the Commission’s proposed definition of “sale of a

franchise” may have unintentionally increased disclosure requirements in connection with

transfers. Under the current Rule, if a franchisor’s role in a transfer is limited to approving or

disapproving of a transferee, then the franchisor need not provide the prospective transferee with

a disclosure document. Yet, the NPR’s proposed definition of “sale of a franchise” is drafted

broadly, encompassing all transfers. Further, the definition of “franchise seller” exempts a

franchisee who sells a franchise, but fails to address the franchisor’s disclosure obligation during

the transfer. “In other words, in any transfer of a franchise (regardless of the franchisor’s role),
 

221 See NPR, 64 Fed. Reg. at 57,308-09.

 

222 This assumes, of course, that there is a “sale,” meaning the existing franchisee makes a 

required payment for the right to enter into a new franchise agreement. Entering into a new

franchise agreement without any required payment or extending an existing franchise agreement

for a fee would not be deemed a “sale of a franchise” for Rule purposes.

65

the transferring franchisee has no obligation to provide the disclosure document, but the

franchisor always does.” Id. at 11. H&H suggested that the “sale of a franchise” definition

should be modified so that it does not “encompass the transfer of a franchise by an existing

franchisee where the prospective franchisee has no significant contact with the franchisor. 

Actions of the franchisor in approving or disapproving the purchaser should not be deemed to be

significant contact.” Id.

As an initial matter, we do not agree with H&H’s suggestion that renewals should always

be excluded from the definition of “sale of a franchise.” As discussed in section VI.S. of this

Report, franchisees and their representatives have voiced concern about renewals, arguing that

franchisors control the governing terms and conditions and offer renewals on a take-it or leave-it

basis. Franchisees, they have asserted, not only lack bargaining power over the renewal

agreement, but also often must accept even onerous terms because they are frequently subject to

covenants not to compete that effectively prevent them from continuing in the same business

independently.221 Especially in an age of new technologies and changes in franchise marketing,

renewal contracts may be significantly different from original contracts that franchisees signed 10

to 20 years ago. A renewing franchisee, for example, may wish to see Item 20 closure rates for

franchises operating under the new franchise agreement. Under such circumstances, we believe

that the renewing franchisee should receive disclosures in order to make an informed renewal

decision.222 

On the other hand, we agree with H&H that the NPR’s proposed “sale of franchise”

definition could be read as compelling franchisors to furnish disclosures during private, voluntary

transfers by existing franchisees in all instances. Under current Commission policy, a franchisor

or subfranchisor must provide disclosures to prospective franchisees only. “[A] person who

purchases a franchise directly from an existing franchisee, without significant contact with the

franchisor, is not a prospective franchisee.” Final Interpretive Guides, 44 Fed. Reg. at 49,969. 

Where an existing franchisee sells his or her own outlet with no continuing obligation to the

purchaser, the franchisee does not function as a franchisor because it has no continuing

contractual obligations to the purchaser. In such circumstances, the purchaser is not relying on

any sales representations of the franchisor, but on the terms and conditions spelled out in the

existing contract. If there is any fraud in the sale, it would be by the existing franchisee, and presale disclosure by the franchisor is not likely to prevent it. 

In contrast, a franchisor who actively participates in a franchise transfer should be

obligated to make disclosures to a potential transferee, no less than to a prospective franchisee. 
 

223 If further explanation is desirable, we can address this issue more fully in the Compliance

Guides.

66

In such events, the prospective transferee may rely on the franchisor’s representations in deciding

to purchase the franchise, and therefore, should receive the benefit of pre-sale disclosure. To that

end, we recommend that the Commission exclude transfers from the definition of “sale of a

franchise” where the franchisor has had no significant involvement. 

At the same time, we recognize that an argument can be made that all prospective

transferees should be entitled to the benefits of pre-sale disclosure in order to make an informed

investment opportunity. However, we would not go that far. For example, a franchisor may

have stopped selling franchises when an existing franchisee decides to sell his or her unit. If so,

it would be unreasonable to compel a franchisor to incur the costs of creating a disclosure

document solely to assist an existing franchisee in selling his or her unit. Rather, we believe that

a better approach would be to create a new prohibition barring franchisors from failing to furnish

a prospective transferee with a copy of an existing disclosure document upon reasonable request.

 

Finally, we agree in theory that disclosure may be unwarranted where an existing

franchisee and the franchisor merely seek to amend their ongoing contractual relationship. In

such circumstances, the material information the franchisee needs is the actual revised franchise

agreement itself that spells out the terms and conditions that will govern the parties’ ongoing

relationship. Under the UFOC Guidelines approach – and by extension, the proposed revised

Rule approach – the disclosure document merely summarizes the relevant contractual provisions

with references to the sections of the contract that govern a party’s obligations. We believe that 

requiring franchisors to furnish a new disclosure document whenever there may exist agreed

upon material changes in a contract is likely to be an unwarranted formality that is probably not

outweighed by any tangible benefit to the existing franchisee. Nevertheless, we do not consider

franchise agreement modifications, especially those without any new payment, to constitute a

“sale.” The definition of “sale of a franchise,” therefore, need not be revised to address this

concern.223 

For the reasons stated above, we recommend that the Commission modify the NPR’s

proposed definition of “sale of a franchise” as follows:

Sale of a franchise includes an agreement whereby a person obtains a franchise

from a franchise seller for value by purchase, license, or otherwise. It does not

include extending or renewing an existing franchise agreement where there has

been no interruption in the franchisee’s operation of the business, unless the new

agreement contains terms and conditions that differ materially from the original

agreement. It also does not include the transfer of a franchise by an existing

franchisee where the franchisor has had no significant involvement with the

prospective transferee. A franchisor’s approval or disapproval of a transfer alone

is not deemed to be significant involvement.
 

224 See also 64 Fed. Reg. at 57,298.

67

Q. Proposed Section 436.1(u): Signature

1. Background

To facilitate the use of electronic signatures, the NPR proposed a flexible definition of

“signature” that would include security codes, passwords, and digital signatures: “Signature

means a person’s affirmative steps to authenticate his or her identity. It includes a person’s use

of security codes, passwords, digital signatures, and similar devices.” 64 Fed. Reg. at 57,333.

2. The record and recommendations

No comments were submitted in response to the NPR proposal. Nonetheless, we

recommend minor revisions to the proposed “signature” definition. Specifically, we propose

including a reference to the standard handwritten signature, which was inadvertently excluded, as

well as broadening the definition by substituting the word “electronic” for “digital.”

R. Deleted Definitions

1. Background

In the NPR, the Commission also proposed to define three additional terms: “Internet,”

“material,” and “officer.” For the following reasons, we recommend that the Commission delete

these three definitions from the final revised Rule.

2. The record and recommendations

a. Proposed “Internet” definition

The NPR proposed to update the Rule’s definitions by adding a broad definition of the

term “Internet” to capture all computer-to-computer communications, including telephones and

facsimiles:

Internet means all communications between computers and between computers

and television, telephone, facsimile, and similar communications devices. It

includes the World Wide Web, proprietary online services, E-mail, newsgroups,

and electronic bulletin boards.

64 Fed. Reg. at 57, 332.224 

John Baer found it “strange” that the definition of “Internet” includes communications

between computers and telephones and facsimiles. He would prefer to use the term “computer
 

225 The UFOC Guidelines do not specifically define “material.” Rather, in discussing the

term “action,” the Guidelines state “Included in the definition of material is an action or an

aggregate of actions if a reasonable prospective franchisee would consider it important in making

a decision about the franchised business.” UFOC Guidelines, Item 3 Definitions, iii.

68

communications.” Baer, Comment 11, at 9. Howard Bundy also saw several problems with the

proposed definition of “Internet.” He urged the Commission to keep in mind that “with evolving

technologies and our propensity for re-naming things where there is even a slight change, the

term ‘Internet’ may become as obsolete within five years as the term ‘floppy disk.’” Bundy,

Comment 18, at 3-4. Further, he argued that the proposed definition may not encompass

personal communications devices such as Palm Pilots or “Internet ready cellular telephones.” 

Rather than use the term “Internet,” he would use “electronic communication.” Id.

Upon further consideration, the staff believes that a specific definition of the term

“Internet” is unwarranted. First, the term “Internet” is commonly understood today. Second, we

agree that it would be counterproductive to attempt to define the term (or an alternative such as

“electronic communication”), when communications technology is evolving so rapidly. 

Accordingly, we propose to delete the proposed “Internet” definition from the final revised Rule. 

If any additional clarification is necessary, we can address it in the Compliance Guides.

b. Proposed “material” definition

The current Rule defines “material, material fact, and material change” as any:

fact, circumstance, or set of conditions which has a substantial likelihood of

influencing a reasonable franchisee or a reasonable prospective franchisee in the

making of a significant decision relating to a named franchise business or which

has any significant financial impact on a franchisee or prospective franchisee.

16 C.F.R. § 436.2(n).225

In the NPR, the Commission proposed to streamline, but not substantively change, the

current definition as follows:

Material, material fact, and material change includes any fact, circumstance, or

set of conditions that has a substantial likelihood of influencing a reasonable

franchisee or prospective franchisee in making a significant decision.

64 Fed. Reg. at 57,332.

In response to the NPR, no commenters raised any concerns about the proposed revised

definition. Nonetheless, the staff recommends that the Commission delete the definition of 

“material” due to the following policy concerns. First, the current and proposed Rule use the
 

226 The UFOC Guidelines are similar: “Principal officers include the chief executive and

chief operating officer, the present, financial, franchise marketing, training and franchise

operations officers.” UFOC Guidelines, Item 2 Instructions, i. See also NASAA Commentary,

Bus. Franchise Guide (CCH) ¶ 5,800, at 8,466 (Item 4 bankruptcy disclosures).

 

227 During the Chicago public workshop conference, a former franchisee, Charles Lay, told

us that his franchisor did not disclose pre-sale that the franchisor’s director of franchising (who

was not a titled corporate officer) had been discharged in bankruptcy. Mr. Lay stated that,

because the franchisor was small, operated by only five or six people, such a disclosure was

“critical, even though this person was not formally an officer.” Lay, ANPR, 22Aug97 Tr, at 6. 

See also, e.g., FTC v. P.M.C.S., Inc., No. 96-5426 (E.D.N.Y. 1996) (franchisor failed to disclose

“silent partner” with prior bankruptcy); FTC. v. Why USA, Inc., No. 92-1227-PHX-SMM (D.

69

term material in at least two different ways. “Material” means influencing the purchaser’s

decisionmaking process, such as the proposed Item 3 disclosure of “material litigation.” At other

times, the Rule uses “material” to mean “significant” or “important” generally. For example,

franchisors would disclose in Item 8 whether the franchisor provides material benefits to a

franchisee based on a franchisee’s purchase of particular products or services. Given the

different uses of the term “material,” we believe the single, proposed definition would be

inaccurate. More important, the term “material” is already defined by Commission case law and

may evolve. We believe it is important that the Commission maintain a consistent interpretation

and application of “material” over time in all realms and not carve out specific definitions for

individual Rules or orders.

c. Proposed “officer” definition

The current Rule does not specifically define the term “officer.” Rather, in the prior

business experience disclosure the Rule provides that an officer includes “the chief executive and

chief operating officer, financial, franchise marketing, training, and service officers.” 16 C.F.R.

§ 436.1(a)(2).226 In the NPR, the Commission proposed adding a new definition – “officer,”

explicitly defining the term as follows:

Officer means any individual with significant management responsibility for the

marketing and/or servicing of franchises, such as the chief executive and chief

operating officers, and the financial, franchise marketing, training, and service

officers. It also includes a de facto officer, namely an individual with significant

management responsibility for the marketing and/or servicing of franchises whose

title does not reflect the nature of the position.

64 Fed. Reg. at 57,332. The Commission explained that this definition is necessary “to eliminate

any doubt that the Rule is to be read broadly, capturing all individuals who function as officers, 

whether or not they are named in the franchisor’s incorporation papers or carry a particular

corporate title.” Id. at 57,299.227 
Ariz 1992) (alleging that franchisor failed to disclose officers and their prior litigation).

 

228 Snap-On, Comment 16, at 2.

 

229 J&G, Comment 32, at 8; Marriott, Comment 35, at 12.

 

230 J&G, Comment 32, at 8.

 

231 See also Baer, Comment 11, at 9; Marriott, Comment 35, at 12.

70

In response to the NPR, NASAA strongly supported the inclusion of de facto officers in

the proposed “officer” definition, asserting it is necessary for effective law enforcement:

The law enforcement experience of some members of the Franchise Project Group

reflects that franchisors and sellers of business opportunities have attempted to

avoid litigation disclosures under the FTC Franchise Rule or comparable state

disclosure laws by purposely not giving the title “officer” to individuals who, in

fact, exercise significant management responsibility over a business.

NASAA, Comment 17, at 3. 

Other commenters agreed that the Rule should require the disclosure of information about

those with management responsibilities, but opposed the term “de facto officer.” In their view,

the term “de facto officer” is “nebulous,”228 would create more problems than it would solve,229

and would unnecessarily expand the business background, litigation, and bankruptcy disclosures

required by Items 2-4.230 

PMR&W asserted that a corporate title almost always is a meaningful indicator of a

person’s responsibilities and authority. The firm urged the Commission to adopt the UFOC

Guidelines approach by focusing on Item 2, adding after “parent” in the second line “and any

other person.” PMR&W, Comment 4, at 8.231 So revised, Item 2 would read, in relevant part: 

Disclose the position and name of the directors, trustees, general partners, officers,

and subfranchisors of the franchisor or any parent and any other person who will

have management responsibility relating to the offered franchises . . . . 

The NFC opposed the term “de facto officer” on other grounds. The association noted

that many states have statutes that impose certain duties, responsibilities, and liabilities upon

officers. It feared that the proposed definition would “upset traditional notions of what an officer

is under state and federal law.” NFC, Comment 12, at 2-3. 

In a similar vein, David Gurnick stated that the term “de facto officer” is a vague standard

that would open the door to future litigation. The term arguably could apply to wives, spouses,
 

232 Tricon, Comment 34, at 3.

71

and others who never agreed to serve as officers of a franchisor. He suggested that:

The persons whose backgrounds need to be disclosed are anyone with

management authority for the franchise program, whether or not they are officers. 

The FTC can accomplish this goal by requiring disclosure of anyone with

management authority; but not broadening the disclosure to create a new concept

of de facto officer.

Gurnick, Comment 21, at 3-4. Tricon also voiced concern that there may be many directors or

managers in large organizations, each of whom would now have to be disclosed. This would

lengthen the disclosures and require more frequent updating.232 Howard Bundy offered an

alternative definition, based upon Washington law:

Instead of creating room to argue forever over whether a person has ‘significant

management responsibility . . . whose title does not reflect the nature of the

position,’ which appears to virtually require proof of fraud, I suggest simply

replacing the awkward language with the simple concept that an officer includes any

person in active control of the relevant functions of the entity.

Bundy, Comment 18, at 4.

Based upon the NPR comments, we have reconsidered the need to define the term

“officer” in the Rule. As a preliminary matter, we continue to believe that individuals with

management responsibility should disclose information about themselves under the Rule, even if

they have not been assigned a specific corporate title. Indeed, tying Rule obligations to corporate

titles would give license to scam artists to hide their identities and backgrounds by simply

avoiding formal corporate titles. While this may lengthen disclosure documents for very large

systems, we believe the benefits of the disclosure outweigh the costs. Nonetheless, we believe a

simpler approach is warranted: we are persuaded that, in lieu of a definition of “officer,”

franchisors should disclose information about controlling company personnel directly in Item 2

itself, as PMR&W suggested above: “Disclose the position and name of the directors, trustees,

general partners, officers, subfranchisors, and any other person who has or will have management

responsibility relating to the offered franchises.” This approach would streamline the Rule’s

definitions, while ensuring that all persons with management responsibility will make the

appropriate disclosures, regardless of the presence or absence of a corporate title.
 

233 Id.

 

234 64 Fed. Reg. at 57,299-300. 

 

235 E.g., PMR&W, Comment 4, at 1; 7-Eleven, Comment 10, at 2; IFA, Comment 22, at 5;

AFC, Comment 30, at 1-2; Duvall, ANPR 19, at 2-3; SBA Advocacy, ANPR 36, at 9; Tifford,

ANPR 78, at 7; NASAA, ANPR 120, at 8-9. See generally RR, Mar96 Tr.

 

236 See Stadfeld, Comment 23, at 3; Brown, ANPRs 4, 6, 96, and 103; Stubbings, ANPR 21;

Argentine Embassy, ANPR 132; Selden, ANPR 133, at 2-3.

72

V. PROPOSED SECTION 436.2: OBLIGATION TO FURNISH DOCUMENTS

Proposed section 436.2 of the final revised rule would address the scope of the Rule and

franchisor’s basic disclosure obligations, including the timing for making disclosures. It also

would address liability for Rule violations. 

A. Proposed Section 436.2: International Application of the Rule

1. Background

Currently, the Franchise Rule does not address whether pre-sale disclosure is required in

international franchise sales. To clarify the issue, the Commission staff held a one-day, Rule

Review public workshop conference on the international application of the Rule. The workshop

participants generally agreed that the Commission should not seek to apply the Rule

internationally. Accordingly, in the ANPR, the Commission stated that the “Rule Review record

strongly supports modification of the Rule to clarify that international franchise sales are not

within its purview.” 62 Fed. Reg. at 9,119. Among other things, the Commission noted that: 

(1) the Commission did not contemplate international franchising when it promulgated the Rule;

(2) the Rule’s disclosures are aimed at the domestic market; (3) foreign franchise purchasers are

sophisticated and do not need the Rule’s protections; (4) attempting to comply with the Franchise

Rule in foreign markets might result in franchisors disseminating inaccurate or misleading

information; and (5) application of the Franchise Rule to international sales would unnecessarily

impede competition.233 In the NPR, the Commission adopted the same position, proposing to

limit franchisors’ disclosure obligations to “the offer or sale of a franchise to be located in the

United States of America, its territories, or possessions.”234

2. The record and recommendations

The commenters who addressed this issue overwhelmingly urged the Commission to

limit the international application of the Rule for the reasons outlined in the ANPR.235 Five

commenters, however, would have the Commission enforce the Rule internationally,236 raising 

essentially three points. First, many American foreign franchise sales contracts require disputes
 

237 Brown, ANPR 6, at 2; Argentine Embassy, ANPR 132; Selden, ANPR 133, at 2-3.

 

238 Stadfeld, Comment 23, at 3; Selden, ANPR 133, at 2. See also Stubbings, ANPR 21. 

 

239 Brown, ANPRs 4, at 3; 6 at 2; 103, at 15-16.

 

240 J&G, Comment 32, at 3; Marriott, Comment 35, at 4-5.

 

241 Marriott, Comment 35, at 4-5.

 

242 For a more detailed discussion of the international sales issue, see NPR at 64 Fed. Reg. at

57,299-300.

 

243 After reviewing the Commission’s Rule and UFOC Guidelines, H&H observed that many

of the provisions are limited to disclosures involving the domestic market. For example, UFOC

73

to be resolved in the United States. It would be inconsistent for a franchisor to subject a

foreigner to American law and American courts without simultaneously extending the benefits of

American law, namely pre-sale disclosure.237 Second, limiting the Rule’s applicability to

domestic franchise sales would mean that American citizens who purchase a franchise abroad

from an American franchisor would not be protected by American law.238 Third, the

Commission has jurisdiction over foreign franchise sales and should not willingly restrict its own

jurisdiction.239

In contrast, two commenters urged the Commission to limit the scope of the Rule even

further to exclude franchise sales in American possessions and territories.240 For example,

Marriott asserted that the same policy concerns raised in the ANPR about applying the Rule

internationally are also relevant to American possessions and territories such as Puerto Rico. 

Marriott apparently treats such locations as foreign countries. It contended that furnishing

prospective franchisees in this context with a copy of the franchisor’s disclosure document may

be irrelevant or misleading.241

Based upon the record, the staff recommends that the Commission limit the international

scope of the Rule as proposed in the NPR. Nothing in the record to date negates the

Commission’s tentative findings, as set forth in the ANPR and NPR, that the Rule’s disclosure

obligations in the international sales context are unnecessary, may be misleading, and may

impede competition. For example, none of the commenters have identified specific problems or

offered evidence showing that American companies selling franchises internationally engage in

fraud or deception that would require Commission intervention. To the contrary, the record

strongly supports the view that foreign franchise sales generally involve sophisticated investors

who are represented by counsel or who otherwise can protect their own interests.242 

It is also clear that the Commission developed the Franchise Rule in response to problems

occurring in the domestic market.243 There is no evidence in the record that a disclosure
Item 20 refers to the number of franchise sales “in this state.” The firm added: “Other disclosures

about the franchise offering, including litigation and bankruptcy history, franchisor’s and

franchisee’s obligations, royalty rates, initial investment, fees, and trademarks, are U.S.-specific.”

H&H, ANPR 28, at 3-4.

 

244 E.g., Miolla, 11Mar96 Tr, at 74-79; Shay, id. at 84-85; Forseth, id. at 103; Papadakis, id.

at 139; Zwisler, id. at 163-64. See also Konigsberg, id. at 97 (franchisees in foreign countries

look to their own laws, not to anything contained in a U.S. disclosure document).

 

245 See Cendant, ANPR 140, at 4-5 (“Creating a disclosure document for . . . international

master license transactions . . . would be nightmarish. . . . The cost of compliance would be high

and American franchisors placed at an extreme disadvantage when competing with foreign

franchisors.”).

 

246 See also, e.g., Telephone Disclosure and Dispute Resolution Act, 15 U.S.C. § 5714(3)

(“‘State’ means any state of the United States, the District of Columbia, Puerto Rico, The

74

document addressing the American market would benefit prospective investors operating

overseas. Just the opposite appears to be true: such disclosures may be irrelevant and potentially

misleading when applied to a foreign franchise purchase due to the vast differences between

American and foreign markets, cultures, and legal systems.244 Risks to the investor would arise

primarily from economic conditions and cultural values in those countries, not in the United

States. To be relevant, a franchisor arguably would have to prepare individual disclosure

documents tailored to each specific foreign market. Not only would such a requirement put

American franchisors at a competitive disadvantage with franchisors from countries lacking

comparable disclosure regulations, the minimal benefits of such a requirement are not likely to

outweigh the extraordinary costs and burdens involved.245

At the same time, we reject the suggestion that franchise sales in American territories and

possessions should fall outside the Rule’s ambit. Section 4 of the FTC Act defines “commerce”

to mean:

commerce among the several states or with foreign nations, or in any territory of

the United States or in the District of Columbia, or between any such territory and

another, or between any such territory and any state or foreign nation, or between

the District of Columbia and any state or territory or foreign nation.

15 U.S.C. § 44. Further, in various enabling statutes giving the Commission rulemaking

authority, Congress specifically defined “state” to include Puerto Rico and other territories and

possessions. For example, the Telemarketing And Consumer Fraud and Abuse Prevention Act,

defines the term “state” to mean “any State of the United States, the District of Columbia, Puerto

Rico, the Northern Mariana Islands, and any territory or possession of the United States.” 

15 U.S.C. § 6106(3).246 In light of Congress’ intent to cover American possession and territories
Northern Mariana Islands, and any territory or possession of the United States.”); MagnusonMoss Warranty Act, 15 U.S.C. § 2301(15) (“The term ‘state’ means a State, the District of

Columbia, the Commonwealth of Puerto Rico, the Virgin Islands, Guam, the Canal Zone, or

American Samoa.”); Consumer Credit Protection Act, 15 U.S.C. § 1602(r) (“The term ‘state’

refers to any State, the Commonwealth of Puerto Rico, the District of Columbia, and any territory

or possession of the United States.”).

 

247 Franchises located in possessions and territories are also governed by American tax law

and accounting principles. Franchise sales in the territories, therefore, have more in common

with those in the fifty states, than with sales in foreign countries. Exempting franchise sales in

American territories and possessions, moreover, could lead to the creation of conflicting laws,

which clearly cuts against Congressional intent in this field.

 

248 16 C.F.R. §§ 436.1(a), 436.2(g), and 436.2(o). 

 

249 64 Fed. Reg. at 57,300.

 

250 Id. at 57,301. 

 

251 Id.

75

in trade regulation rules, there are no compelling grounds to carve out an exception for the

Franchise Rule.247 Moreover, American possessions and territories rely on American law for

protection, and coverage of the Franchise Rule is part of that protection.

B. Proposed Section 436.2(a): Timing For Making Disclosures 

1. Background

Under the current Rule, franchisors and brokers must furnish prospective franchisees with

disclosure documents at the earlier of two time periods: (1) the first personal meeting; or (2) “the

time for making disclosures,” which is defined as 10 business days before the execution of the

franchise agreement or payment of any fees in connection with the franchise sale.248 In the NPR,

the Commission proposed to streamline this provision in two ways. First, the Commission

proposed eliminating the first personal (face-to-face) meeting disclosure trigger.249 The

Commission reasoned that the first personal meeting trigger is obsolete in “the communications

age where prospective sellers now communicate with buyers through a wide array of

communications media, including facsimile machine, E-mail, and the Internet.” 64 Fed. Reg. at

57,301. Second, it proposed to replace the current 10 business day trigger with a 14 calendar-day

disclosure trigger.250 The Commission noted that the term “10 business days” may be

unnecessarily confusing because franchisors must remember to exclude all federal holidays,

some of which are not observed in every state. Moreover, in most instances, 10 business days as

a practical matter will amount to 14 calendar days.251
 

252 See, e.g., PMR&W, Comment 4, at 1; Holmes, Comment 8, at 3; NFC, Comment 12, at

13; NASAA, Comment 17, at 3; Marriott, Comment 35, at 9. See also Duvall, ANPR 19, at 3;

Baer, ANPR 25, at 6; Tifford, ANPR, 18Sept97 Tr, at 158-59.

 

253 E.g., IFA, Comment 22, at 9; Stadfeld, Comment 23, at 4. Kennedy Brooks, a participant

at the staff’s New York City public workshop conference, observed that franchise sales can occur

entirely electronically “where the contact is made over the Web, where E-mail is exchanged,

where telephone [calls] are exchanged, where documents are sent out by Federal Express, and

where, in fact, there never is a face-to-face meeting.” Brooks, ANPR, 18Sept97 Tr, at 160. See

also NCL, ANPR 35, at 4-5; SBA Advocacy, ANPR 36, at 9; IL AG, ANPR 77, at 3-4.

76

2. The record and recommendations

a. First personal meeting

Franchisors and their representatives overwhelmingly supported eliminating the current

Rule’s first personal meeting disclosure trigger.252 These commenters asserted that the first

personal meeting trigger has become obsolete in the electronic age, where even large investments

are made by telephone or via the Internet.

253 In contrast, franchisee advocates favored retaining

the first personal meeting requirement. For example, Alaska Turner observed that:

The ability to obtain disclosure early on in the purchase process is almost the only

point of strength that a prospective franchisee has in the negotiation process. The

ability to request a UFOC or disclosure document for review at an early stage in

the negotiation, and thereby control at least the beginning of the timing of the

sales process, is the only potential advantage that a prospective franchisee may

get.

Turner, Comment 13, at 1. She urged the Commission to require disclosure after the franchisor

has spent a set amount of time with a prospective franchisee. Id. at 2. 

Eric Karp, a franchisee advocate, added that there is no basis to believe that personal

meetings will completely become a thing of the past. According to Mr. Karp, eliminating the

current first personal meeting disclosure trigger:

is a dangerous and unnecessary move that will increase the opportunities for fraud

in the sales process. It will allow the franchisor to conduct discussions with a

franchisee about the purchase of a franchise over an extended and theoretically

unlimited period of time . . . . During this period, the franchisee is likely to

become heavily invested in the transaction and will be induced to make the 

purchase decision without the disclosure document. The 14 day cooling off

period will then start when the franchisee has already decided to make the

investment.
 

254 In the Final Interpretive Guides, the Commission acknowledged that the term “first

personal meeting” is imprecise:

Even where a face to face meeting occurs, it is not necessarily a “first” personal

meeting. In interpreting this term, the Commission will consider such factors as

whether the franchisor clearly indicated at the outset of the discussion that it was

not prepared to discuss the possible sale of a franchise at that time, whether the

meeting was initiated by the prospective franchisee rather than the franchisor,

whether the meeting was limited to a brief and generalized discussion and whether

earnings claims were made. The Commission believes that by using common

sense precautions, franchisors can defer the first personal meeting until such time

as they are prepared to provide the required disclosures.

44 Fed. Reg. at 49,970.

 

255 See also SBP, 43 Fed. Reg. at 59,639 (“[O]nce a prospect has been ‘hooked,’ it is

difficult, if not impossible, to ‘extricate himself.’”).

77

Karp, Comment 24, at 5-6. 

Howard Bundy, who also opposed the elimination of the first personal meeting trigger,

suggested an alternative approach: “the Commission should require franchisors to furnish

prospects with a summary disclosure document at the first written communication.” Bundy,

Comment 18, at 5-6. 

The staff recommends that the Commission eliminate the personal meeting trigger, as

proposed in the NPR. We believe that the Rule should contain a bright-line disclosure trigger so

that franchisors do not have to guess when they must furnish disclosures. The proposed 14-day

trigger would accomplish that goal. In reaching this conclusion, we note that the personal

meeting trigger alone does little to ensure that a prospective franchisee will receive disclosures

early in the sales process.254 While at the time the Rule was promulgated it may have been

routine, or perhaps necessary, to have a face-to-face meeting early on, that is no longer true.

Nowadays, a franchisor and a prospect may have numerous telephone conversations or send

documents to each other via fax or mail long before any personal meeting takes place. 

Nonetheless, we have considered the commenters’ arguments supporting early disclosure,

as well as their fears about “pre-conditioning” of prospective franchisees.255 To address these

concerns, we believe another approach is warranted. We recommend that the Commission adopt

a new prohibition barring franchise sellers from refusing to honor a prospective franchisee’s 

reasonable request for a copy of the franchisor’s disclosure document during the sales process. 

We are not suggesting that a franchisor must tender a disclosure document to any consumer who

may desire a copy. Rather, this prohibition would apply where the parties have already

conducted specific discussions or negotiations or otherwise taken steps to begin the sales process.
 

256

 E.g., Baer, Comment 11, at 10; NFC, Comment 12, at 13; AFC, Comment 30, at 2;

Marriott, Comment 35, at 9.

 

257 See also Baer, Comment 11, at 10.

 

258 This approach is consistent with current industry practice. See, e.g., “calendar” at

www.msaworldwide.com (Aug.12, 2003).

78

We believe this approach would preserve the goal of early disclosure in the sales process without

reliance on the obsolete personal meeting trigger. It also would likely impose only a de minimis

burden, if any, on franchisors, who presumably would have a disclosure document already

prepared when discussing a sale with a prospective franchisee.

b. Fourteen calendar days

Commenters who addressed this issue unanimously agreed that the proposed 14-day

disclosure trigger is clearer than the current 10 business day trigger.256 Accordingly, we

recommend that the Commission substitute the term “14 days” for “10 business days,” as

proposed in the NPR. David Holmes, however, urged the Commission to clarify further how to

count the 14 days to “resolve any question as to whether or not the day on which the documents

are delivered, or the day on which they are signed, may be counted for purposes of compliance

with the Rule.” Holmes, Comment 8, at 3.257 We propose that the Commission address this

concern in the Compliance Guides. Specifically, the 14 days commence the day after delivery of

the disclosure document and that the signing of any agreement or receipt of payment can take

place 15 days later, essentially guaranteeing prospective franchisees at least a full 14 days in

which to review the disclosures.258

c. Third-party payments and agreements

Under the NPR proposal, franchisors would furnish their disclosures at least 14 days

“before the prospective franchisee signs a binding agreement or pays any fee in connection with

the proposed franchise sale.” 64 Fed. Reg. at 57,333. A few commenters voiced concern about

the meaning of the terms “binding agreement” and “pays any fee.”

In his comment, Howard Bundy urged the Commission to broaden the Rule so that any

payment made by a prospective franchisee in connection with the franchise sale, such as travel

expenses, would trigger the franchisor’s disclosure obligation. He voiced concern that

prospective franchisees may risk losing significant sums of money to pursue a franchise before

they receive any disclosures about the franchise offer. Mr. Bundy would modify the proposed

disclosure trigger to require franchisors to furnish disclosure documents at least 14 days before

the prospective franchisee signs a binding agreement, pays any fee in connection with the

proposed franchise sale, or is required to travel or make other financial commitments as a

precondition to receiving additional information. According to Mr. Bundy, this would:
 

259 Tricon, Comment 34, at 3-4.

 

260 See also Final Interpretive Guides, 44 Fed. Reg. at 49,970.

79

further the goal of the Commission of providing meaningful disclosure before the

prospective franchisee makes an investment decision. When cash is flowing from

a prospective investor’s pocket at the direction of a franchisor or franchise seller,

it matters not that it is flowing to some third party. It is still a required investment

of resources as a condition of obtaining the perceived valuable franchise rights.

Bundy, Comment 18, at 5.

On the other hand, H&H and Tricon urged the Commission to narrow the 14-day trigger. 

Focusing on the “binding agreement” prong, they maintained that the disclosure obligation

should commence 14 days before the prospective franchisee signs a binding agreement “with the

franchisor or an affiliate of the franchisor.” H&H, for example, stated that these limiting words

are needed because “the franchisor cannot control whether a prospective franchisee proceeds to

commit with independent third parties (e.g., lessor of real estate) before expiration of the cooling

off period.” H&H, Comment 9, at 21.259

Based upon the record, we recommend that the Commission revise the proposed 14-day

disclosure trigger as follows. First, we recognize that the current Rule defines “time of making

of disclosures,” in relevant part as: 

ten (10) business days prior to the earlier of (1) the execution by a prospective

franchisee of any franchise agreement or any other agreement imposing a binding

legal obligation on such prospective franchisee, about which the franchisor,

franchise broker, or any agent, representative, or employee thereof, knows or

should know, in connection with the sale or proposed sale of a franchise, or (2)

the payment by a prospective franchisee, about which the franchisor, franchise

broker, or any agent, representative, or employee thereof, knows or should know,

of any consideration in connection with the sale or proposed sale of a franchise.

16 C.F.R. § 436.2(g). Thus, under the current Rule franchisors must make disclosure not only if

they sign agreements with a prospective franchisee or direct a prospective franchisee to pay a

third party, but if they know that a prospective franchisee will sign an agreement with, or make a

payment to, a third party.260 

In light of our proposal that the Commission prohibit franchisors from failing to furnish

disclosures earlier in the sales process upon reasonable request, we find the current, broad

disclosure trigger no longer necessary. If a prospective franchisee is directed to make third-party

payments or enter into third-party agreements to advance the franchise sale, the prospect can

always ask for a disclosure document before undertaking such obligations. Accordingly, we
 

261 16 C.F.R. § 436.1(g).

 

262 At the same time, the NPR solicited comment on whether a five-day contract review

period would provide prospective franchisee with a sufficient opportunity to review the contract. 

64 Fed. Reg. at 57,329.

80

agree with H&H and Tricon that the disclosure trigger should be limited to where the franchisor

directs prospective franchisees to make payments or enter into agreement with the franchisor or

an affiliate to advance the franchise sale. 

C. Proposed Section 436.2(b):

Modified contract review period

1. Background

The Franchise Rule currently requires franchisors and brokers to furnish prospective

franchisees with a copy of the completed franchise agreement at least five business days before

the date of execution.261 In the NPR, the Commission proposed retaining the franchise agreement

disclosure requirement, while reducing the number of days to just “five days.”262 

2. The record and recommendations

In response to the NPR, commenters generally voiced two views. Franchisees and their

supporters, as well as the IL AG, generally favored the franchise agreement disclosure

requirement, but urged the Commission to adopt a longer time period, such as seven days. The

IL AG, for example, maintained that “[it] is not just the review time that is important, it is having

time to contact the prospect’s advisor and schedule a meeting.” IL AG, Comment 3, at 5. 

Similarly, Seth Stadfeld stated his belief that a prospect should have “the full week of

consideration that they have enjoyed in the past.” Stadfeld, Comment 23, at 4. He saw “no

benefit to them to cut down on the time that they had to assess whether or not to proceed with the

franchise transaction and any drawback for franchisors is de minimis.” Id.

On the other hand, some franchisors and their supporters, as well as NASAA, urged the

Commission to eliminate the contract review period altogether. PMR&W, among others,

asserted that the resulting delay from the mandatory disclosure period often harms prospective

franchisees:

In practice, the 5-day rule typically hurts rather than aids franchisees, since the

“price” of an additional concession by the franchisor is an additional 5-day delay. 

Franchisees often are more time sensitive than franchisors, either because of a

financing commitment or a lease option that might be expiring or the need to

attend a training program. As a result, the 5-day rule can discourage a franchisee

from requesting last-minute changes. Thus, the current provision, especially now
 

263 See also IFA, Comment 22, at 9; J&G, Comment 32, at 6; Marriott, Comment 35, at 9;

GPM Rebuttal, Comment 40, at 2.

 

264 If the Commission decides to retain a contract review provision, then several franchisor

supporters would support a five-day period. E.g., PMR&W, Comment 4, at 4; NFC, Comment

12, at 13; BI, Comment 28, at 3; AFC, Comment 30, at 2.

81

that business opportunities are not covered, has little potential benefit to either

franchisor or franchisee and may, in fact, discourage, rather than promote, last

minute negotiations.

PMR&W, Comment 4, at 4.263 Similarly, Marriott noted that the timing of closing the deal is

often critical to the franchisee:

as loan commitments may expire, options to acquire sites may expire or financial

commitments may be required to prevent the site from being sold or leased to a

different entity. Securities offerings may be held up until franchise agreements

are executed. Interest rates may change so as to make a project unavailable unless

commitments are promptly made.

Marriott, Comment 35, at 9-10. For similar reasons, the NFC urged the Commission to clarify

the five-day provision to exclude changes to the franchise agreement made “less than five days

prior to the execution thereof at the request of the franchisee.” NFC, Comment 12, at 14.264 

Upon further reflection, the staff recommends that the Commission eliminate the contract

review period, except in limited circumstances. In our view, the current franchise agreement

disclosure period was intended to advance two goals. First, it better ensures that prospective

franchisees will have time to review and understand the franchise agreement before they

undertake significant financial and legal obligations. Second, it prevents fraud by discouraging a

franchisor from unilaterally substituting pages or otherwise altering the contract presented to the

prospective franchisee for signing.

We find that the first concern – providing time to study the franchise agreement – is

already served by the Rule’s basic disclosure requirement. Attached to each disclosure document

is a copy of the franchisor’s basic agreement. At the very least, this document enables prospects

to become familiar with the basic terms and conditions governing the franchise system. Based

upon our law enforcement experience, it also appears that franchisors routinely use standardized

franchise agreements. Last-minute changes to a franchise agreement, therefore, most likely arise

at the franchisee’s initiation. When a prospective franchisee is the party introducing contract

modifications, re-disclosure by the franchisor is hardly warranted. 

Further, we do not believe that the Rule should impede a prospective franchisee’s ability

to negotiate agreement changes. The delay inherent in a mandatory contract review period may
82

discourage negotiations if a prospective franchisee believes that he or she will suffer as a result of

the delay. As Marriott noted, the timely signing of a franchise agreement may be a prerequisite

for other parts of the overall deal, such as obtaining leases and loans. Indeed, in most instances a

prospective franchisee is in the best position to judge how much review time is warranted and

can demand additional review time, if desired. 

Nonetheless, we are concerned about the second reason for advanced disclosure of the

franchise agreement – fraud. A franchisor should not be able to substitute at the last minute

provisions that differ from those in the agreement previously attached to the disclosure

document. To address potential fraud, we propose two solutions. First, we recommend that the

Commission limit the contractual review provision to situations where the franchisor has

materially altered the terms and conditions of the standard contract attached to the disclosure

document. This would exclude situations where the only differences between the standard

contract and the completed contract are “fill-in the blank” provisions, such as the date, name, and

address of the franchisee. It would also exclude instances where deviations from the standard

contract were initiated at the prospective franchisee’s request. Further, where the contract review

period applies, we also agree with the commenters above that the review period should be a full

seven days. Accordingly, we recommend that the Commission substitute “seven days,” for “five

business days,” paralleling our recommendation above to substitute 14 calendar-days for “10

business days.”

Second, we recommend that the Commission target potential fraud directly by adopting a

new prohibition. Specifically, we propose prohibiting a franchisor from unilaterally substituting

provisions or pages in a franchise agreement, unless the franchisor first alerts prospective

franchisee’s about the changes in a reasonable time before he or she signs the agreement. 

Accordingly, we recommend that the Commission revise the contract review period requirement

to read:

[It is an unfair or deceptive practice] for any franchisor to alter unilaterally and

materially the terms and conditions of the basic franchise agreement attached to the

disclosure document without furnishing the prospective franchisee with a copy of

the revised franchise agreement, and any related agreements, at least seven days

before the prospective franchisee signs the revised franchise agreement. Changes

to a franchise agreement that result solely from negotiations initiated by the

prospective franchisee do not trigger this seven-day period.

D. Proposed Section 436.2(c): Furnishing Disclosures

1. Background

In the NPR, the Commission proposed including additional guidance in the Rule on what

constitutes “furnishing” disclosures. Such guidance is needed given the wide array of disclosure

formats and delivery mechanisms in the current marketplace. Among other things, the NPR
 

265 As noted above, we also recommend that the Compliance Guides clarify that a

representative may accept delivery of a disclosure document on behalf of a prospective

franchisee.

83

proposed that franchise sellers wishing to send documents by mail should send them by first class 

mail and add three days to ensure timely delivery: 

For purposes of this section, a franchise seller will be considered to have

furnished the documents by the required date if a copy of the document – either a

paper copy or, with the consent of the prospective franchisee, an electronic copy –

has been delivered to the prospective franchisee by that date, or if a copy has been

sent to the address by first-class mail at least three days prior to the specified date. 

Documents shall also be considered to have been furnished by the required date if

a copy has been sent by electronic mail or if directions for accessing the document

on the Internet have been provided to the prospective franchisee by that date.

64 Fed. Reg. at 57,333.

2. The record and recommendations

The NPR proposal generated only limited comment. BI observed that the term “first

class” mail is undefined, and it suggested that the Commission clarify the provision to read “first

class U.S. mail.” BI, Comment 28, at 4-5. The firm also suggested that the Rule specify the

delivery requirements for private couriers (such as Federal Express) and telefax machines. BI

also noted that franchisors will want to retain some proof of delivery in case of a dispute. To that

end, the firm urged the Commission to “specify any specific documents or types of evidence

which would qualify as valid evidence of the mailing date.” Id. Finally, BI would revise the

NPR provision to read “or if a copy has been sent to the address specified by the prospective

franchisee by first-class mail at least three days prior to the required date.” Id. The firm also

suggested that the Commission use the phrase “required date” consistently, rather than the term

“specified date.” Id.

The staff agrees that the Commission should broaden this Rule section to address other

delivery mechanisms, such as private couriers and fax machines.265 While we believe the term 

“hand-delivery” already includes couriers, we find it desirable to reference facsimile. In addition,

the proposed Rule provision should use the phrase “required date” consistently. However, we

stop short of recommending that the Rule set forth specific proof of delivery guidelines. A

franchisor always has the burden of proof to show that it has complied with the Rule’s obligation

to furnish disclosures. The Rule should be as flexible as possible, allowing franchisors to keep

records, and to offer proof, in the format that is most convenient to them. 

Finally, the staff also proposes an additional modification to the NPR proposal. 

Specifically, we recommend that the Commission revise the NPR proposal to eliminate the
 

266 16 C.F.R. § 436.1(a). See also Final Interpretive Guides, 44 Fed. Reg. at 49,969. 

 

267 64 Fed. Reg. at 57,301; 57,333.

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reference to the consent of the prospective franchisee in connection with electronic disclosures. 

This is in keeping with our recommendations concerning electronic disclosures generally, as

discussed below in section VII. So revised, proposed section 436.2(c) of the proposed revised

Rule would provide:

The franchisor has furnished the documents by the required date if: (1) a copy of

the document was hand-delivered, faxed, emailed, or otherwise delivered to the

prospective franchisee by the required date; (2) directions for accessing the

document on the Internet were provided to the prospective franchisee by the

required date; or (3) a paper or tangible electronic copy (for example, computer

disk or CD-ROM) was sent to the address specified by the prospective franchisee

by first-class U.S. mail at least three days before the required date. 

E. Proposed Section 436.2(d): Liability

1. Background

Under the current Rule, franchisors and brokers are jointly and severally liable for

furnishing disclosures.266 The NPR proposed retaining the same standard:

In connection with the offer or sale of a franchise . . . it is an unfair or deceptive

act or practice in violation of Section 5 of the Federal Trade Commission Act:

(a) For any franchise seller to fail to furnish a prospective franchisee with the following

documents within the following time frames. The obligations in this subsection are

satisfied if either the franchisor or other franchise seller furnishes the required documents

to the prospective franchisee.

64 Fed. Reg. at 57,333. 

The current Rule, however, does not specifically address liability for a disclosure

document’s content. Given that franchisors and franchise brokers currently are jointly and

severally liable for furnishing disclosures, it is reasonable to assume that both franchisors and

franchise brokers are also equally liable for ensuring that the contents of disclosure documents

are complete and accurate. In the NPR, the Commission proposed to clarify the issue, stating

that franchise sellers would be liable for the contents of a disclosure document if they knew or

should have known of the violation.267
 

268 Franchise sellers would still be liable under Section 5 for their own misrepresentations, as

well as subject to certain prohibitions, as discussed below at section X of this Report.

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2. The record and recommendations

a. Liability for furnishing disclosures

Except as previously noted above in our discussion of the “franchise seller” definition, 

no commenters voiced concern about liability for furnishing disclosures. Nonetheless, we

recommend that the Commission narrow the scope of liability in the final revised Rule. When

the Rule was promulgated, it was reasonable to hold brokers liable along with the franchisor for

failing to furnish disclosures because brokers often made the first personal contact with

prospective franchisees. Given our proposal eliminating the first personal meeting disclosure

trigger, we believe it is no long necessary to retain the broker disclosure liability provision. In

short, it is the franchisor that always retains ultimate liability for ensuring that prospective

franchisees receive disclosures required by the Rule.268 This proposal would also reduce

inconsistencies with state law, which generally limits disclosure obligations to the franchisor.

b. Liability for content

A few commenters voiced concern about the NPR’s proposed liability standard for the

content of disclosure documents. John Baer, for example, stated that the NPR proposal imposes

an “impossible” standard of liability:

As anyone who has drafted an Offering Circular can testify, there is no certainty

as to the nature of the information that has to be included in the various disclosure

sections of the Offering Circular and reasonable persons often differ in good faith

as to what has to be disclosed.

Baer, Comment 11, at 10. He suggested that the Commission revise the standard to “make it a

violation for a franchisor to fail to use ‘commercially reasonable good faith efforts’ to disclose

the required information.” Id.

Similarly, Tricon stated that the proposal would result in all employees being potentially

liable for Rule violations, even those employees who are not involved in any franchise sales. 

According to Tricon, an employee should not be liable, even if that person had actual knowledge,

unless that person:

(a) knew (or should have known) the legal significance of those facts, and (b) was

in a position to influence the outcome of the matter. For example, a secretary

could “know” that financial performance data was routinely provided to buyers,

but neither know the significance of doing so nor be in a position to stop the

practice. 
 

269 See also Baer, Comment 11, at 10.

 

270 E.g., FTC v. Amy Travel Servs., Inc., 875 F.2d 564, 573 (7th Cir.), cert denied, 439 U.S.

954 (1989); FTC v. Atlantex Assos., 1987-2 Trade Case. (CCH), ¶ 67,788 at 59,255 (S.D. Fla.

1978), aff’d, 872 F.2d, 966 (11th Cir. 1989); FTC v. Kitco of Nevada, 612 F. Supp. 1282, 1292

(D. Minn. 1985). Under Section 5 case law, it is also clear that individual franchise salespersons

are also directly liable for their own misrepresentations in connection with franchise sales. See,

e.g., J.K. Publ’ns, 99 F. Supp. 2d at 1203 and n.67. 

 

271 16 C.F.R. § 436.1(a)(21). See also UFOC Guidelines, Cover Page Instructions.

86

Tricon, Comment 34, at 6.269 

In contrast, NASAA supported the view that franchisors and individual owners of

franchisors should be held liable for Rule violations “regardless of whether they knew or should

have known of the violation.” NASAA, Comment 17, at 3.

The staff recommends that the Commission revise the content liability standard as

follows. We first note that all Commission trade regulation rules implement Section 5 of the

FTC Act and, therefore, should incorporate the standard of liability developed in Section 5 cases. 

Under Section 5 law, individuals will be held liable for a corporation’s law violations if they

participated directly in them or had the authority to control them.270 Applying this principle to

the Franchise Rule, we recommend that franchise sellers (for example, third-party brokers and

franchisor employees) be liable for the content of a disclosure document if they either directly

participated in the document’s creation or had authority to control it.

VI. PROPOSED SECTIONS 436.3 - 436.5: THE DISCLOSURE DOCUMENT

The next sections of the Rule – proposed sections 436.3 - 436.5 – would set forth the

substantive disclosures and attachments that franchisors must include in their disclosure

documents. They begin with the cover page.

A. Proposed Section 436.3: Cover Page

1. Background

Under the Franchise Rule, a disclosure document begins with a cover page.271 Among

other things, the cover page informs prospective franchisees that they are receiving important

information about the franchise offering and that they should seek advice from an advisor, such
 

272 In the SBP, the Commission found that the burdens imposed by the cover page

requirements are “minimal, that the benefits to be derived by prospective franchisees are great in

terms of both putting prospective franchisees on notice as to the required disclosure obligations

of franchisors and advising such franchisees as to the status of the disclosure statement (i.e., that

it has not been reviewed by the Commission and may contain erroneous and/or incomplete

information).” 43 Fed. Reg. at 59,683.

 

273 Heron, ANPR 80.

 

274 See also Murphy, ANPR 2, at 2; Maloney, ANPR 38, at 1; Karp, ANPR, 19Sept97 Tr, at

89-90.

 

275 See also Karp, ANPR, 19Sept97 Tr, at 89-90.

87

as a lawyer or an accountant. It also makes clear that the Commission has not checked the

accuracy of any of the disclosures.272

During the ANPR proceeding, a few commenters offered various suggestions on how to

improve the existing cover page. Teresa Heron, a “My Favorite Muffin” franchisee, suggested

that the cover page include more background information on franchising, and on applicable

franchise laws and enforcement policies. For example, the cover page would include a

discussion of Section 5 (including the Commission’s unfairness jurisdiction), state registration

laws, the FTC’s case selection criteria, and the absence of a private right of action to enforce the

Rule. Ms. Heron would also insert additional sources of information on franchising, such as a

reference to the FTC’s home page.273

Several franchisees also contended that phrases in the current cover page – such as

“information . . . required by the Federal Trade Commission” and “to protect you” – are

misleading because they imply greater federal oversight of franchise offerings than actually

exists. For example, Ms. Heron stated that the cover page’s language “to protect you,” implies

“legitimacy, reliance, and veracity of the information contained in the disclosure document.” 

Heron, ANPR 80, at 1.274 Similarly, at the New York workshop conference, the AFA’s

President, Susan Kezios, asserted:

I’d just like to support what you said about taking out the language to protect you

because in many UFOCs and many FTC documents the only misrepresentation

from many of our members’ eyes is the implied promise on that FTC cover sheet

saying we’re going to help you out. There’s an implied promise that the FTC is

going to do something when, in fact, that’s not what happens.

Kezios, ANPR, 18Sept97 Tr, at 10.275
 

276 G. Gaither, ANPR 69, at 1. See also Kezios, 6Nov97 Tr, at 142 (suggesting that any

disclosures about encroachment risks should be placed on the cover page).

 

277 Dady & Garner, ANPR 127, at 3. See also Punturo, ANPR, 18Sept97 Tr, at 15 (“[I]t’s

important that when a prospective franchisee picks up a prospectus that risk factors are there

right in the front so they can immediately see what concerns the regulators have had.”).

 

278 64 Fed. Reg. at 57,301-02; 57,333.

 

279 Id. at 57,302; 57,333.

 

280 Id.

 

281 Id. at 57,302.

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In addition, a few ANPR commenters urged the Commission to adopt various cover page

risk factors. For example, Greg Gaither, a GNC franchisee, suggested that the cover page include

a warning that encroachment – marketing in a franchisee’s territory – is a risk that might severely

affect a franchised outlet’s performance.276 Michael Garner would require franchisors to disclose

how their contracts may be imbalanced: “[I]sn’t it better to have an unbalanced franchisor/

franchisee relationship disclosed as such early on rather than buried in the legalese of a franchise

agreement?” Dady & Garner, ANPR 127, at 3. Mr. Garner recommended that franchisors

disclose up-front on the cover page: (1) if franchisees have no protected territory; (2) if

franchisees can be terminated upon failing to comply with the franchise agreement; (3) if

franchisees cannot transfer without prior approval; and (4) if the franchisor reserves the right to

receive royalty payments even if it breaches obligations to provide support services.277

The NPR adopted several of these suggestions. The NPR proposed cover page would

differ from the current cover page in four respects. First, the NPR cover page included additional

background information for prospective franchisees to use in conducting their own due diligence

investigation, such as references to the FTC’s Web site and the Commission’s Consumer Guide

to Buying a Franchise.

278 This would enable prospective franchisees to find additional

background information on franchising, pre-sale disclosure, and the Commission’s law

enforcement history. 

Second, contemplating electronic disclosure, the NPR proposed that franchisors include

on the cover page their principal email and home page addresses.279 It would also require

franchisors wishing to make disclosures electronically to add to the cover page a statement

advising prospective franchisees to download the document for future reference, as well as how

to receive a paper copy.280 

Third, the NPR proposed eliminating information from the current cover page that might

be misinterpreted as implying greater Commission oversight of franchising than is the case.281
 

282 See generally, UFOC Guidelines, Cover Page, Instructions.

 

283 64 Fed. Reg. at 57,301; 57,333.

 

284 Id. at 57,301-02; 57,333. See also Tifford, ANPR, 18Sept97 Tr, at 15-16 (suggesting that

the Commission accommodate risks factors developed by the individual states).

 

285 64 Fed. Reg. at 57,301-02. See also UFOC Guidelines, Cover Page, Instructions, iv.

 

286 64 Fed. Reg. at 57,301. See Cendant, ANPR 140, at 3 (suggesting that risk factors belong

in the Item 17 disclosures on franchise relationship issues). 

 

287 64 Fed. Reg. at 57,302.

 

288 We recommend, however, that the Commission modify the current Rule requirement that

franchisors state that the Commission has not checked the disclosures for accuracy. We would

broaden the statement to “no government agency has verified the information in this document.”

This statement, warning prospective franchisees not to take the disclosures at face value,

references both state and federal approaches.

89

Fourth, to promote greater uniformity with state disclosure laws, the NPR proposed that we adopt

the UFOC Guidelines’ cover page requirements,282 in part. For example, the cover page would

include the franchisor’s name, logo, brief description of the franchised business, total purchase

price as reflected in Item 5 (initial fees) and in Item 7 (estimated initial investment), and a notice

that comparative information about franchising is available.

283

Finally, in the NPR the Commission proposed permitting franchisors to include risk

factors on the cover page, if required to do so under state law.284 However, the Commission

declined to adopt the two required UFOC Guidelines risk factors for choice of venue and choice

of law.285 The Commission observed that these two risk factors essentially repeat what

franchisors already must disclose in Item 17 of the disclosure document.286 Moreover, mandating

the disclosure of these two risk factors on the cover page might incorrectly signal prospective

franchisees that these are the most important risk factors to consider.287 

2. The record and recommendations

The NPR’s proposed cover page generated limited comment. For example, no

commenters raised any concerns about: (1) adopting elements of the UFOC Guidelines’ cover

page; (2) requiring franchisors to include, if applicable, their email and primary home page

addresses; or (3) eliminating arguably misleading information.288 We, therefore, recommend that

the Commission adopt these proposals in the final revised Rule. However, some commenters

suggested the possible need for additional information. Others addressed electronic disclosures,

references to Items 5 and 7, and risk factors. We address each of these issues below.
 

289 See also Murphy, ANPR 2, at 2.

90

a. Additional information

In response to the NPR, the AFA suggested that the Commission warn prospective

franchisees that they are not purchasing their own business. To that end, the AFA would include

the following warning on the cover page: “You will not own your own business. You will lease

the rights to sell [company’s name] goods [services] to the public under the [company’s name]

tradename and trademarks. This agreement will expire and you will have no rights to continue in

operation upon expiration.” AFA, Comment 14, at 4. 

The AFA also urged the Commission to strengthen the language advising prospects to

show the disclosures to an advisor, offering the more emphatic language: “Show your contract

and this disclosure document to an attorney, preferably one who practices franchise law. Show

the disclosure document, in particular the sections regarding your financial obligations and the

franchisor’s financial statements, to an accountant.” Id. at 4.289

We agree in principle with the AFA’s suggestion that prospective franchisees should be

better informed about the nature of franchising. However, the appropriate vehicle for educating

prospects is through consumer education materials, not the Rule itself. In order to streamline the

Rule, while reducing inconsistencies between federal and state disclosure laws, we have carefully

weighed all suggestions to expand the Rule. In general, where we can advance our goals through

increased consumer education, we see no reason to broaden the Rule itself. This is particularly

true in the case of the cover page because it will reference the Commission’s Consumer Guide to

Buying a Franchise, which already includes the advice the AFA has suggested.

b. Electronic disclosures

As noted above, the NPR proposed that a franchisor wishing to make disclosures 

electronically should insert the following additional statement in the cover page:

You may have elected to receive an electronic version of your disclosure

document. If so, you may wish to print or download the disclosure document for

future reference. You have the right to receive a paper copy of the disclosure

document up until the time of sale. To obtain a paper copy, contact [name] at

[address] and [telephone number].

64 Fed. Reg. at 57,333.

In response to the NPR, the NFC voiced concern that this proposal would require

franchisors to provide the name, address, and telephone number of a particular employee who

could be contacted for a paper copy of the disclosure document. The NFC stated that a number of
 

290 NFC, Comment 12, at 27.

 

291 See below at section VII.

 

292 See also UFOC Guidelines, Cover Page, 5.

91

employees may serve that purpose and suggested, instead, that franchisors disclose the title of the

position, rather than name of an individual.290

As discussed later in this Report, we have revised our views concerning electronic

disclosures generally, concluding, among other things, that creating a right to obtain a paper copy

of a disclosure document is unwarranted.291 We agree with the commenters who suggested that

the Commission permit franchise sales entirely through electronic means, without resorting to

paper transactions. At the same time, we recommend that the Commission permit franchisors

voluntarily to state if they make disclosures available to prospective franchisees in other media. 

Specifically, we recommend that the Commission permit franchisors to include the following

statement in their cover pages: “You may wish to receive your disclosure document in another

format that is more convenient for you. To discuss the availability of disclosures in different

formats, contact [name or office] at [address] and [telephone number].” In drafting this proposal,

we have recognized the NFC’s concern that there may be a number of individuals within a

franchise system that might be able to assist a prospect in receiving a disclosure document. To

provide as much flexibility as possible, we recommend that the Commission permit franchisors to

designate either a specific individual or office as a contact.

c. References to Item 5 and Item 7 fees

In the NPR, the Commission proposed that the cover page adopt the UFOC Guidelines’

requirement that franchisors refer to “the total amounts in Item 5 (Initial Fees) and Item 7

(Estimated Initial Investment) of the disclosure document.” 64 Fed. Reg. at 57,301.292 This

would provide prospective franchisees up-front with a summary of their expected investment.

In response to the NPR, BI stated that it is misleading to reference Item 5 on the cover

page. According to the firm, the cover page should put prospects on notice of the initial franchise

fee that must be paid for the right to commence business under the mark. BI suggested that the

inclusion of the broader Item 5 initial fees would cloud the issue, making comparisons of initial

franchise fees among competitors difficult: “For example, in cases where a franchisor sells or

leases the premises of the franchised business to the franchisee, this payment would need to be

included in Item 5, but would severely distort the amount of the initial franchise fee disclosed on

the cover page.” BI, Comment 28, at 5.

 We believe the proposed cover page’s reference to Item 5 fees is proper. The purpose of

cover page’s cost disclosure is not simply to indicate the fee paid to the franchisor for using the

franchisor’s mark, but to disclose the total costs paid to the franchisor associated with
 

293 For the same reason, we also recommend that the title of Item 5 be revised to read “Initial

Fees Paid to the Franchisor,” as discussed below at section VI.G.

 

294 BI’s concern would be valid if the cover page required the disclosure of only Item 5

(initial fees), but not the Item 7 (estimated initial investment). For example, a franchisor who

leases premises to a franchisee would include the lease payment in the Item 5 initial fees,

whereas a franchisor who requires a franchisee to lease premises from a third party would not

include such payment in Item 5. Arguably, this would seem to inflate the first franchisor’s Item 5

initial fees. However, lease payments to third–parties would nonetheless appear in Item 7. 

Accordingly, Item 5 and Item 7, considered together, enable prospective franchisees to compare

initial expenses across franchise systems.

 

295 GPM Rebuttal, Comment 40, at 4.

92

commencing business operations.293 In fact, limiting the disclosure to the initial franchise fee

alone could be misleading because it may understate the totality of fees that must be paid to the

franchisor in order to start the business. We believe that the proposed cover page cost disclosures

will better enable prospective franchisees to assess their full potential business costs, and

ultimately their financial risk, than a disclosure limited to the initial franchise fee alone.294

At the same time, we recognize that it is possible to achieve the goal of informing prospective

franchisees about the investment by referring to Item 7 alone – Initial Investment. Indeed, Item 5

is basically a subset of Item 7. Nonetheless, in an effort to reduce inconsistencies between federal

and state law, we recommend that the Commission adopt a modified version of the UFOC cover

page reference to Item 5 and Item 7, as follows: “The total investment necessary to begin

operation of a [franchise system name] franchise is [the total amount of Item 7], including [the

total amount in Item 5] that must be paid to the franchisor.”

d. Risk factors

Finally, GPM opposed the NPR proposal that would permit states to impose additional

risk factors on the cover page.

295 The firm suggested that a state should be permitted to require

additional information only in a state-specific addendum. 

We reject GPM’s suggestion that the Commission preempt state risk factors or otherwise

permit them only in a state-specific addendum. Below at section XI, we address preemption,

concluding that the Commission should permit the states the greatest latitude in fashioning

franchise disclosure laws. In keeping with that goal, we believe that it is proper to permit

franchisors to add to an FTC disclosure document in order to comply with non-preempted state

law. We also believe that it is proper to permit the states and franchisors the greatest flexibility

concerning how to include state-specific information, be it in an addendum, separate cover page,

or otherwise.
 

296 Currently, the table of contents is set forth in a footnote at the back of the Rule. See 16

C.F.R. Part 436, note 3.

 

297 We also recommend that the title to Item 1 (“The Franchisor, its Parent, Predecessors, and

Affiliates”) be changed to “The Franchisor, and any Parent, Predecessors, and Affiliates.”

 

298 Lewis, Comment 15, at 11.

 

299 NASAA, Comment 17, at 4.

93

B. Proposed Section 436.4: Table of Contents

1. Background

In the NPR, the Commission proposed a table of contents that would track the text and

order set forth in the UFOC Guidelines.296 The Commission, however, proposed modifying the

titles of four disclosure items as follows: (1) Item 7 would be changed from “Initial Investment”

to “Estimated Initial Investment”; (2) Item 11 would be changed from “Franchisor’s Obligations”

to “Franchisor’s Assistance, Advertising, Computer Systems, and Training”; (3) Item 19 would be

changed from “Earnings Claims” to “Financial Performance Representations; ”and (4) Item 20

would be changed from “List of Outlets” to “Outlets and Franchisee Information.” 64 Fed. Reg.

at 57,302.

2. The record and recommendations 

In response to the NPR, no commenters raised any concerns about these four proposed

changes to table of contents. Therefore, we recommend that the Commission adopt them in the

proposed final revised Rule. We further recommend an additional three modifications to the table

of contents based upon the NPR comments.

297

 

Warren Lewis recommended that the Commission change the title of Item 5 from “Initial

Franchise Fee” to “Initial Fees” so that the title will more accurately describe the actual subject

matter of the Item.298 Mr. Lewis further suggested that the title of Item 23 be changed from

“Receipt” to “Receipts” (one for the franchisee and one for the franchisor). Further, NASAA

observed that Item 6 is labeled “Other Fees,” yet the text of Item 6 says “Recurring or Occasional

Fees.” It recommended the Commission use the phrase “other fees” consistently throughout the

Rule.299 The staff believes that these additional revisions are sound and recommends that the

Commission adopt them in the final revised Rule as well. However, with respect to Item 5, we

would take the additional step of clarifying that the initial fees under discussion are those “paid to

the franchisor.”
 

300 See 16 C.F.R. §§ 436.1(a)(1), (3), and (6). The Commission has long recognized the

materiality of franchisor background information. In the SBP, the Commission concluded that:

the failure to disclose such material information . . . may mislead the franchisee

as to the business experience of the parties with whom he or she is dealing and . . .

could readily result in economic injury to the franchisee because of the

franchisee’s dependence upon the business experience and expertise of the

franchisor.

43 Fed. Reg. at 59,642. Other Commission trade regulation rules similarly require identity

disclosures. E.g., Wool Products Labeling Act, 16 C.F.R. § 300.14 (recognizing that names on a

label may mislead consumers about the actual manufacturer); Fur Products Labeling Act, 16

C.F.R. § 301.43 (recognizing that corporate name may mislead consumers about the character of

the product).

 

301 64 Fed. Reg. at 57,302.

 

302 See UFOC Guidelines, Item 1. 

 

303 See FTC v. Morrone’s Water Ice, Inc., No. 92-3720 (E.D. Pa. 2002) (company allegedly

reincorporated as a “licensor” following an adverse arbitration decision). See also FTC v. Wolf,

Bus. Franchise Guide (CCH) ¶ 10,401 (S.D. Fla. 1994); FTC v. Inv. Dev. Inc., Bus. Franchise

Guide (CCH), ¶ 9,326 (E.D. La. 1989). Cf. FTC. v. Jani-King, Int’l, No. 3-95-CV-1492-G (N.D.

Tex. 1995) (company allegedly conducted business through multiple regional corporations

thereby avoiding certain disclosures).

 

304 See UFOC Guidelines, Item 1E Instructions, vi. In the NPR, the Commission attached a

footnote to this proposal that would explain in greater detail the types of laws that franchisors

94

C. Proposed Section 436.5(a)

Item 1: The Franchisor and any Parent, Predecessors, and Affiliates

1. Background

Currently, the Franchise Rule requires the disclosure of background information on the

franchisor, as well as any parent and affiliates.300 The NPR proposed revising these disclosures to

mirror Item 1, the parallel UFOC Guidelines’ disclosure.301 So revised, the NPR would expand 

the current Rule disclosures in three material respects. First, franchisors would disclose

information about their predecessors for the 10-year period immediately before the close of the

franchisor’s most recent fiscal year.302 This would prevent franchisors from hiding prior

misconduct and avoiding disclosure obligations simply by assuming a new corporate identity.303

Second, franchisors would disclose any regulations specific to the industry in which the franchise

business operates, such as any necessary licenses or permits,304 which may affect the franchisee’s
must disclose under this provision. No comments were submitted in response to this proposal. 

Nonetheless, the staff recommends that the proposed explanatory footnote be deleted and moved

to the Compliance Guides, where the issue can be discussed in full. This approach is consistent

with our goal of streamlining the Rule, where possible.

 

305 E.g., FTC v. Car Checkers of Am., Inc., Bus. Franchise Guide (CCH) ¶ 10,163 (D.N.J.

1993) (failure to disclose state restrictions on the sale of service contracts); U.S. v. Lifecall Sys.

Inc., No. 90-3666 (D.N.J. 1990) (failure to disclose state registration requirements). Cf. Funeral

Rule, 16 C.F.R. § 453.3 (it is a misrepresentation to mischaracterize state or local funeral

industry laws). 

 

306 See UFOC Guidelines, Item 1E Instructions, v. Throughout the SBP, the Commission

recognized that potential economic risks to consumers are material. E.g., 43 Fed. Reg. at 59,650-

51 (bankruptcy); at 59,662 (sales restrictions); at 59,668 (post-term covenants not to compete). 

A competition disclosure also appears to be warranted in light of several franchisee complaints

about competition issues. E.g., Packer, ANPR 10 (franchisor has opened franchisor-owned

stores to compete with its own franchisees); Manuszak, ANPR 13 (competition from

encroachment); Gray, ANPR 22 (franchisor sold to competing system); Lopez, ANPR 123

(competition from franchisor’s co-branded outlets). 

 

307 16 C.F.R. § 436.1(a)(1)(i). As explained in the NPR, the Commission believes that

information about a franchisor’s parent may be material to a prospective franchisee. 64 Fed.

Reg. at 57,302-03. For that reason, the Commission stated in the SBP that it would require the

disclosure of information about a parent, even though it recognized that the UFOC Guidelines

contained no comparable disclosure requirement. See 43 Fed. Reg. at 59,639.

95

operating costs and ability to conduct business.305 Third, franchisors would describe the general

competition prospective franchisees are likely to face. This disclosure would better ensure that

the prospective franchisee can understand the likely economic risks in purchasing a franchise.306

At the same time, proposed Item 1 would differ from UFOC Item 1 by retaining the current Rule’s

disclosure of parent information.307

2. The record and recommendation

In response to the NPR, a few commenters questioned the scope of proposed Item 1. 

Specifically, commenters voiced concern about the proposed disclosure of parents, predecessors,

and competition. We address each of these issues below.

a. Parent information

The NPR’s proposal to retain the disclosure of parent information generated several

comments, both in support and opposition. Dr. Spencer Vidulich, a Pearle Vision franchisee, told

us that such a disclosure is material to prospective investors. He related that his franchisor was
 

308 Vidulich, ANPR, 22Aug97 Tr, at 16-17. Similarly, a franchise system with a poor

financial record or significant litigation could, for example, seek to shield itself from disclosure

by establishing a new subsidiary that will offer identical franchises, but under a different

trademark.

 

309 PMR&W, Comment 4, at 9; H&H, Comment 9, at 15-16; J&G, Comment 32, at 9. The

NPR proposed that “affiliate” for Item 1 purposes means “an entity controlled by, controlling, or

under common control with the franchisor, that offers franchises in any line of business or is

providing products or services to the franchisees of the franchisor.” 64 Fed Reg. at 57,334.

 

310 E.g., Triarc, Comment 6, at 3.

 

311 See UFOC Guidelines, Item 1E Instructions; 64 Fed. Reg. at 57,334.

96

bought by Cole National Corporation, which operates leased optical departments in Sears stores. 

In this instance, the disclosure of parent information would alert prospective Pearle Vision

franchisees that their franchisor is owned by a company that operates competing outlets.308

Franchisor representatives – including PMR&W, H&H, and J&G – did not deny that the

disclosure of parent information may be material; rather, they asserted that a separate disclosure is

unnecessary given the NPR’s broad definition of “affiliate.”309

The staff recommends that the Commission retain the current Rule’s parent disclosure 

requirement. As a preliminary matter, we acknowledge arguments to the contrary. First, a

parent’s activities are often distinct from those of the franchisor: indeed, a parent may not engage

in franchising at all. In addition, a parent disclosure arguably may be misleading because a

prospective franchisee might incorrectly infer from the existence of a parent increased

sophistication, financial security, and expertise on the franchisor’s part.310 We also recognize that

where a parent sells franchises or provides products or services to a franchisee it would already

fall within the proposed Rule’s definition of “affiliate.” Under the UFOC Guidelines and the

proposed revised Rule, a parent-affiliate must disclose whether it operates franchises in the same

or in other lines of business.311 Accordingly, in such instances no additional, parent-specific

disclosure is warranted. 

Nonetheless, we believe the revised Rule should reference parents, consistent with current

practice. We first note that affiliates in Item 1 would not include parents in all instances. For

Item 1 purposes, “affiliate” is limited to those affiliates that sell franchises or provide services to

franchisees only. As Dr. Vidulich observed, however, it is possible that a parent is a nonfranchisor. A reference to parent, therefore, ensures that non-affiliate parents will be disclosed.

Moreover, our proposal would require franchisors only to identify the existence of a non-affiliate

parent: it would not require a franchisor to disclose such a parent’s prior business history, in
 

312 If a parent qualifies as an affiliate under Item 1, however, then its information would be

disclosed the same as all other affiliates. 

 

313 The disclosure of predecessor information will help to reduce fraud by ensuring that a

franchisor cannot avoid disclosure obligations simply by assuming a new corporate identity. 

This is particularly a problem in the sale of business opportunities, where scam artists often

change names repeatedly in order to avoid detection. E.g., FTC v. Wolf, Bus. Franchise Guide

(CCH) ¶ 10,401 (S.D. Fla. 1994). For example, in FTC v. Inv. Dev., Inc., Bus. Franchise Guide

(CCH) ¶ 9,326 (E.D. La. 1989), the staff obtained a series of orders to stop the defendants’

fraudulent evolving scheme under various corporate names.

97

contrast to the Item 1 disclosures for affiliates and predecessors.312 Accordingly, requiring a

franchisor simply to identify its non-affiliate parent would impose at most a minor burden that is

outweighed by the potential benefit to prospective franchisees.

b. Predecessor disclosures

In response to the NPR, no commenters questioned the basic principle that predecessor

information should be disclosed.313 However, two commenters, H&H and GPM, raised concerns

about the parameters of the proposal, as stated in the NPR. H&H told us that the proposed

disclosure period – 10 years – is too long, noting that Item 2 establishes only a five-year

disclosure period for business experience of actual company managers. A shorter reporting period

would provide an “ample period of time for a prospective franchisee to determine if a system has

merely changed its name to escape bad press or a bad reputation.” H&H, Comment 9, at 16. 

Further, a longer reporting period is likely to produce irrelevant information that is both costly and

burdensome to prepare. In a similar vein, GPM would narrow proposed Item 1's focus to require

the disclosure of information about only any immediate predecessor: 

In an era of constant mergers, consolidations, acquisitions, and other fundamental

structural changes, it does not make sense to require franchisors to provide a 10- 

year predecessor history – or a detailed history of every officers’ business dealings

for that matter – which history will often have no bearing on the currently proposed

sale.

GPM Rebuttal, Comment 40, at 4.

The staff rejects the view that predecessor disclosures should be limited to five years or to

information about the franchisor’s immediate predecessor. Franchisors that merge, consolidate, or

otherwise restructure are likely to be sophisticated companies, well-represented by counsel. Most

likely, these franchisors obtain background information on company predecessors as part of their

due diligence review. We doubt, therefore, that requiring franchisors to supply 10 years of

predecessor information would be unduly burdensome. Moreover, the benefit of preventing

companies from merely changing their names to avoid damaging disclosures (e.g., prior litigation,
 

314 Moreover, deviating from the UFOC Guidelines is unlikely to reduce the compliance

burden because many franchisors will have to follow the UFOC Guidelines’ 10-year provision in

the registration states.

 

315 For the same reasons, we also support a comparable disclosure for suppliers in which a

company officer has an interest, but believe this issue is best addressed in section VI.J.

concerning suppliers.

98

bankruptcies, or a significant number of failed franchisees) will likely outweigh any costs. At the

very least, we are unconvinced that the burden of supplying 10 years of predecessor information is

so great as to justify deviating from the UFOC Guidelines on this issue.314

c. Competition

Finally, Howard Bundy suggested that the Commission broaden Item 1 to require the

disclosure of business dealings involving companies owned by company officers. According to

Mr. Bundy, “sweetheart” deals involving companies owned by officers are “ripe for abuse”:

[D]o the officers’ companies have the ability to compete with the franchisees? Are

the officers’ companies designated vendors? Keep in mind that a company owned

by an officer and his spouse who are not majority shareholders of the franchisor

probably is not within the definition of an “affiliate.” Failing to close that

informational gap will give the scam artists a good road map for taking unfair

advantage of franchisees.

Bundy, Comment 18, at 6.

We agree, but perhaps for a different reason. A company officer’s interests in outside

entities may create a conflict of interest, influencing the franchisor’s business, possibly against the

interests of existing and prospective franchisees. Such conflicts of interest would go to the very

heart of the relationship between the franchisor and franchisee, and therefore, are material and

should be disclosed. Consistent with our view that the Commission should expand the Rule’s

disclosures to shed additional light on the nature of franchisor-franchisee relationships, we

recommend that the Commission expand Item 1 to require the disclosure of “competition from

any entity in which a company officer owns an interest.”315
 

316 See 16 C.F.R. § 436.1(a)(2). In the SBP, the Commission explained that a franchisor’s

failure to disclose its business experience violates Section 5 because “it (1) misleads the

prospective franchisees as to the business experience of the parties with whom they are dealing,

and (2) could readily result in economic injury to franchisees due to their heavy dependence upon

the experience of those persons associated with the franchisor.” 43 Fed. Reg. at 59,642. See

Buckley, ANPR 97, at 1 (“franchisor represented his company as highly trained in all phases of

the business and capable of supporting a franchise system”); FTC v. Nat’l Consulting Group,

Inc., Bus. Franchise Guide (CCH) ¶ 11,335 (N.D. Ill. 1998) (claims regarding medical billing

expertise and contacts with medical community are material); FTC v. Levinger, Bus. Franchise

Guide (CCH) ¶ 10,438 (D. Ariz. 1994) (earnings claims tied to purported expertise in the

restaurant industry are material); Car Checkers of Am., Bus. Franchise Guide (CCH) ¶ 10,163 at

24043 (claims regarding car inspection business expertise are material). Cf. FTC v. Goddard

Rarities, Inc., No. CV93-4602-JMI (C.D. Cal. 1993) (representations of expertise in coin

investments are material). 

99

D. Proposed Section 436.5(b)

Item 2: Business Experience

1. Background

The current Rule requires the disclosure of the business experience of the franchisor’s

directors and certain executives.316 In the NPR, the Commission proposed adopting the

comparable disclosure provisions found in UFOC Guidelines Item 2. However, as proposed in

the NPR, Item 2 would differ from UFOC Item 2 in two respects. First, proposed Item 2 could

cover “de facto” officers, namely individuals who in fact function as corporate officers, but who

do not have an official corporate officer title. Second, proposed Item 2 would require the

disclosure of the business experience of a parent’s managers.

2. The record and recommendations

a. Parents and affiliates 

In the NPR, the Commission proposed the following disclosure requirement: “Disclose

the position and name of the directors, trustees, general partners, officers, and subfranchisors of

the franchisor or any parent who will have management responsibility relating to the offered

franchises.” 64 Fed. Reg. at 57, 334. The NPR’s reference to the franchisor’s parent generated

several comments. 

Warren Lewis asserted that, if adopted, this provision would:

cause many franchisors and subfranchisors with parents to disclose information on

all of their parents’ directors, officers and similar executives, since all of those
 

317 See discussion of “officer” definition at section IV.R.2.c. above.

100

persons at least arguably have management responsibility relating to the franchises

offered by their companies’ subsidiaries. This would clutter their Item 2s with

information of marginal relevance and importance to prospective franchisees.

Lewis, Comment 15, at 12.

Similarly, BI contended that if a franchisor is truly distinct from its parent, then directors

and officers, for example, will have minimal involvement with the franchise and, therefore,

should not be listed. “In addition, their inclusion in the document blurs the line separating the

franchisor and parent, arguably exposing the parent, unfairly, to liability arising from the franchise

activity.” BI, Comment 28, at 5. 

H&H suggested that the Commission revise the first sentence of the NPR proposal,

offering the follow language:

Disclose the position and name of the directors, trustees, general partners, and

officers of the franchisor and the subfranchisor [footnote], if applicable, who will

have management responsibility relating to the offered franchisees. [Text of

footnote: A franchisor need only provide disclosures with respect to the

subfranchisor(s) that will provide services to the prospective franchisee. At the

franchisor’s discretion, it may include disclosures with respect to other

subfranchisors, as well.]

H&H, Comment 9, at 16. The firm asserted that its suggested rephrasing would clarify that a

franchisor need only disclose names and positions of all persons with management responsibility. 

It would avoid references to officers of any parent and avoid the need to include de facto officers

in the definition of “officer,” as originally proposed.317 Further, the suggested language would:

clarify [that f]ranchisors should only be required to furnish information about

subfranchisors that will provide services to the prospective franchisees. For

example, a prospective franchisee in the United States would not need to know

about subfranchisors located in foreign countries. However, where a franchisor has

multiple domestic subfranchisors and wants to create one UFOC for all prospective

franchisees, it should be allowed to include information on all its domestic

subfranchisors. [This would] reduce compliance costs by creating one

comprehensive UFOC, rather than creating a different UFOC for each

subfranchisor.
 

318 We also note that David Gurnick questioned the breadth of proposed Item 2. He

observed that board members and officers – especially of large, publicly traded corporations –

may change. He recommended that the Commission adopt a materiality standard so that

franchisors need not update their UFOCs due to an addition or departure of board members or

officers “that is rarely likely to be material to a prospective franchisee.” Gurnick, Comment 21,

at 3. We believe that the Rule’s updating requirements address this issue sufficiently.

 

319 See U.S. v. Perfumes Unlimited, No. 02-21767-CIV-Huck (S.D. Fla. 2002). We also

believe there is merit in H&H’s suggestion that franchisors be permitted to include, at their

discretion, a list of subfranchisors on a national basis. However, the final revised Rule already

contemplates that franchisors can aggregate information in their disclosure documents in order to

have a single, multi-state document. See below at section VII. Therefore, no revision of Item 2

is necessary to address this issue.

101

Id. at 17.318

Howard Bundy, in contrast, argued in favor of an expanded Item 2. He would add the

phrase “or affiliates” after the word “parent” in Item 2. Mr. Bundy maintained that, without

specific coverage of affiliates, “someone who wanted to hide a personal history that was less than

exemplary could have that person separately employed as an officer of an affiliate and then cause

the affiliate to perform the services for the company under contract.” Bundy, Comment 18, at 

6-7.

Based upon the comments, we recommend that the Commission modify Item 2's scope as

follows. We agree with the commenters that franchisors, as a general proposition, need not

disclose information about all parent officers. While in many instances a parent’s officers may

exercise general management responsibilities that affect the franchisor, they are not necessarily

involved in managing the franchisor or its franchises. In such instances, their background

information is unlikely to be material to a prospective franchisee. Accordingly, we recommend

that the Commission delete the proposed reference to parents in Item 2. 

At the same time, we believe a franchisor should identify all individuals who control the

franchisor, regardless of any formal title. This is true even if the individual is an officer of a

parent or an affiliate.319 As long as the individual exercises control over the franchisor, then his or

her background information should be disclosed, no less than officers of the franchisor itself. To

that end, we recommend that the Commission require franchisors to disclose “the franchisor’s

directors, trustees, general partners, principal officers, and any other individuals who occupy a

similar status or perform similar functions.”

 

Consistent with the UFOC Guidelines, other executives and subfranchisors should be

disclosed only if they exercise management responsibilities relating to franchising specifically. 

Nonetheless, we would modify the UFOC Item 2 language slightly. UFOC Item 2 limits the

disclosure to those executives and subfranchisors who will have “management responsibility
 

320 64 Fed. Reg. at 57,334. Because brokers are listed in Item 2, their litigation and

bankruptcy histories would also necessarily have to be disclosed in Items 3 and 4. 

 

321 Franchisors, of course, would still be able to include broker information, if required by 

state law.

102

relating to the franchises offered by this offering circular.” This language is not entirely clear. 

The term “relating to the franchises offered” could mean relating to franchise sales activities, postsale franchise operations, or both. We believe that the intent of the UFOC Guidelines was to

cover both franchises sales and post-sale operations. We recommend, therefore, that the

Commission use the phrase “management responsibility relating to the sale or operation of

franchises offered by this document.” So revised, the first part of proposed Item 2 would read as

follows: “Disclose by name and position the franchisor’s directors, trustees, general partners, 

principal officers, and any other individuals who occupy a similar status or perform similar

functions. In addition, disclose other executives or subfranchisors who will have management

responsibility relating to the sale or operation of franchises offered by this document.” 

b. Brokers

By adopting UFOC Guidelines Item 2, the NPR effectively incorporated the requirement

that a franchisor “list all franchise brokers.”320 As noted in our discussion of the proposed 

“franchise seller” definition, a few commenters asserted that the Item 2 broker disclosures are

unnecessary. For example, J&G questioned the inclusion of broker information in Item 2, stating

that requiring “detailed information about every corporate employee of a broker . . . is extremely

cumbersome and of little use to prospective franchisees.” J&G, Comment 32, at 10. 

We agree. The disclosure of broker information serves no real purpose under the

Commission’s pre-sale disclosure approach, and imposes unwarranted compliance costs. Item 2

requires the disclosure of the background of those individuals who control the franchisor, as well

as those who actually manage franchisees. That information is material because prospective

franchisees need to know with whom they will be dealing and whether such individuals are likely

to perform as promised in the franchise agreement. However, brokers are not parties to the

franchise agreement. Accordingly, prospective franchisees do not rely on brokers to perform

under the agreement and, therefore, a broker’s business background has little bearing on the

likelihood of a franchisee’s success. In practical terms, the disclosure of brokers would also be

cumbersome, especially for large franchise systems that may employ hundreds of brokers

nationally.321 While we strongly favor adopting the UFOC Guidelines approach to the fullest

extent possible, we believe that this is one area where an exception is warranted. The Item 2

broker disclosures are unnecessary and should be deleted from the final revised Rule.
 

322 See 16 C.F.R. § 436.1(a)(4). In the SBP, the Commission stated that a franchisor’s

litigation history is material because it bears directly on the “integrity and financial standing of

the franchisor.” 43 Fed. Reg. at 59,649. See, e.g., FTC v. WhiteHead, Ltd., Bus. Franchise

Guide (CCH) ¶ 10,062 (D. Conn. 1992) (full disclosure would have revealed a $10 million

judgment in a fraud action brought by former franchisees); Joseph Hayes, No. 4:96CV02162SNL

(E.D. Mo. 1996) (full disclosure would have revealed prior state fines and injunctions); Inv. Dev.,

Inc., Bus. Franchise Guide (CCH) ¶ 9,326 (full disclosure would have revealed arson and

insurance fraud convictions). See also Marks, ANPR, 19Sept97 Tr, at 8 (“I always counsel

clients . . . to look at the litigation section among one of the first sections.”).

 

323 Under this provision, a fast-food restaurant franchisor, for example, would have to

disclose a product liability class action suit that, if successful, might materially affect its financial

condition or ability to maintain its business operations. This disclosure is entirely consistent with

long-standing Commission policy that a franchisor’s continued financial viability and ability to

perform as promised is material to a potential investor. See, e.g., SBP, 43 Fed. Reg. at 59,649.

 

324 64 Fed. Reg. at 57,303. Cf. U.S. v. Jani-King Int’l, Inc., Bus. Franchise Guide (CCH)

¶ 10,711 (N.D. Tex. 1995) (franchisor disclosed only litigation of subfranchisor, not parent

company).

103

E. Proposed Section 436.5(c)

Item 3: Litigation 

1. Background

Currently, the Franchise Rule requires franchisors to disclose certain litigation involving

the franchisor and its officers, affiliates, and parents.322 In the NPR, the Commission proposed 

expanding this disclosure in several material respects. Consistent with UFOC Guidelines Item 3,

proposed Item 3 would require franchisors to disclose actions involving predecessors, as well as

routine litigation that may impact upon the franchisor’s financial condition or ability to operate

the business.323 At the same time, proposed Item 3 would differ from the UFOC Guidelines by

retaining the current disclosure of actions involving parents. Most important, proposed Item 3

would expand both the Rule and UFOC Guidelines by requiring franchisors to disclose material

franchisor-initiated litigation against franchisees involving the franchise relationship. 

2. The record and recommendations

a. Parents, predecessors, and affiliates

As noted above, the NPR proposed retaining the disclosure of parent litigation on the

grounds that it is necessary to prevent fraud.324 In response, several franchisor representatives

opposed the parent litigation disclosure. Their comments parallel the discussion of parent

disclosures in Items 1-2 discussed above. For example, PMR&W maintained that the parent
 

325 See also Triarc, Comment 6, at 2; NFC, Comment 12, at 28; PREA, Comment 20, at 1.

 

326 PREA, Comment 20, at 1.

 

327 See PREA, Comment 20, at 1.

 

328 See discussion of parent, predecessors, and affiliates at 64 Fed. Reg. at 57,302.

104

litigation disclosure is confusing at best and offers little if any benefit to prospective franchisees. 

A publicly-traded parent may face any number of securities fraud claims, for example, that would

have to be disclosed, “overflowing [the disclosure document] with largely irrelevant parent

litigation summaries, obscuring and diverting readers from the more important disclosures of

franchisor litigation, and greatly increasing compliance burdens and costs.” PMR&W, Comment

4, at 9.325 

PREA added that parent disclosures have merit where the franchisor has few assets or a

prior history such that the prospect is looking to the parent for assurance of continued financial

viability. It suggested that the Commission create an exemption from Item 3 for parent

disclosures if the franchisor has sufficient net worth and experience. It proposed a net worth of

not less than $5 million and a requirement that the franchisor has had at least 25 franchisees for

each of the preceding five years.326

On the other hand, Seth Stadfeld urged the Commission to broaden Item 3's scope. He

would require the disclosure of litigation involving all affiliates, not just those under the

franchisor’s principal trademark. “Frequently, franchisors set up corporate structures where

affiliated companies deal with franchisees in the capacities of landlord, supplier, insurer,

financier, and otherwise.” Stadfeld, Comment 23, at 11.

After reviewing the record, the staff agrees that the NPR’s coverage of parent and affiliate

litigation should be revised. First, we are persuaded that litigation involving a parent (which may

be sizeable in the case of a publicly-traded parent) may have little bearing on the operation of the

franchise system itself. Yet, we do not recommend eliminating the disclosure completely. 

Rather, we would limit the parent litigation disclosure to those circumstances where the parent

guarantees the franchisor’s performance.327 Where a parent induces franchise sales by promising

to back the franchisor financially or otherwise guarantee performance, the parent’s prior litigation

history is material and should be disclosed.

At the same time, we recommend that the Commission broaden the types of affiliates

about whom it is necessary to disclose litigation brought by governmental entities. As noted

above, for Item 3 purposes, the UFOC Guidelines limit disclosures about litigation to affiliates

offering franchises under the franchisor’s principal trademark. We believe this is too narrow. Our

concern is that a fraudulent franchisor system could continue to perpetuate a fraud by closing

shop, moving, and establishing a new franchise system that uses a different mark.328 For example,
 

329 We also note that Item 1 of the proposed revised Rule, like the current UFOC Guidelines,

requires the disclosure of all affiliates offering any franchises or offering products or services to

franchisees of the franchisor. Armed with such information, a prospective franchisee has the

ability to discover broader affiliate litigation, if he or she so chooses.

 

330 We note that there is no private right of action to enforce the Franchise Rule. See, e.g.,

Holloway v. Bristol-Meyers Corp., 485 F.2d 986 (D.C. Cir. 1973) (no implied private right of

action under the FTC Act); Days Inn of Am. Franchising, Inc., v. Windham, 699 F. upp. 1581

(N.D. Ga. 1988) (no private right of action exists to enforce the Franchise Rule).

 

331 The enumerated actions include those alleging “a violation of a franchise, antitrust, or

securities law, or alleging fraud, unfair or deceptive practices, or comparable allegations.” See

UFOC Item 3 at A.

105

a fraudulent system could go out of business, acquire a competitor, and then continue in business

unabated under a different trade name. In such an instance, the franchisor would have no

obligation to disclose its past, falling outside the definition of both predecessor and affiliate. On

the other hand, we recognize that requiring franchisors to disclose all affiliate litigation would be

too broad and burdensome, especially for large companies with multiple brands.

Accordingly, we propose the following solution. For purposes of pending and prior civil

and criminal actions, we recommend that the Commission adopt the UFOC Guidelines approach,

limiting affiliate disclosures to those selling franchises under the franchisor’s principal trademark. 

This would compel the disclosure of prior history of fraud by the franchisor in most instances

without overburdening franchisors or unnecessarily complicating the disclosure document for

prospective franchisees.329 However, for government actions delineated in Item 3, we would

broaden affiliate coverage to include any affiliate who has offered or sold franchises in any line of

business within the last 10 years. In our view, the strongest indicator of fraud and history of Rule

violations is a government action for injunction (with or without a civil penalty or other

redress).330 Under this proposal, a franchisor with a history of fraud or Rule violations could not

avoid government action disclosures merely by establishing a new corporation or switching

trademarks. We believe this is a balanced approach that would result in the disclosure of material

litigation history, without unduly burdening large, multi-brand franchise networks. 

b. Prior civil litigation

In its comment, H&H noted that the NPR seemed to suggest that a franchisor must

disclose all material civil litigation in which the defendant was held liable in the 10-year time

period, but only the enumerated list of actions if named in civil litigation.331 H&H suggested that
 

332 H&H, Comment 9, at 17-18. See also NFC, Comment 12, at 28. H&H also questioned

whether the term “ordinary routine litigation” will be defined in accordance with the current

UFOC Guidelines and suggested that the word “material” be substituted for “significant.” H&H,

Comment 9, at 18.

 

333 This does not mean that a franchisor can hide significant litigation that is not included in

the enumerated list of actions. Consistent with the UFOC Guidelines, proposed Item 3 would

require a franchisor to disclose “civil actions, other than ordinary routine litigation incidental to

the business, which are significant in the context of the number of franchisees and the size,

nature, or financial condition of the franchise system or its business operations.” 

 

334 We also note that the NPR included a footnote that explained that franchisors need not

disclose settlements which are favorable to the franchisor or are otherwise not materially adverse

to the franchisor’s interests, nor actions dismissed without liability or entry of an adverse order. 

64 Fed. Reg. at 57,334 at n.2. To streamline the Rule, we recommend that this explanation be

placed in the Compliance Guides.

 

335 64 Fed. Reg. at 57,334. See also NASAA Commentary, Item 3.

 

336 16 C.F.R. at § 436.1(a)(4)(ii).

106

the disclosure of civil litigation should be limited to the enumerated list regardless of whether the

franchisor was named or was held liable in a prior suit.332

The staff agrees that the NPR’s proposed litigation disclosure was overbroad and should

be revised. H&H correctly observed that the NPR failed to limit the disclosure of prior civil

actions in which the defendant was held liable to those suits involving the traditional enumerated

list of classes, such as Franchise Rule violations and fraud.333 So revised, proposed Item 3 would

require the disclosure of actions where the defendant, within the 10-year period immediately

before the disclosure document’s issuance date, was held “liable in a civil action, or been a

defendant in a material action” involving the enumerated list of actions.334

c. Settlements

Consistent with the UFOC Guidelines, the NPR proposed that franchisors disclose the

terms of any settled actions, including confidential settlements.335 The current Rule similarly

requires the disclosure of settlements, but does not distinguish between confidential and nonconfidential settlements.336

A few franchisors questioned this proposed disclosure. For example, PMR&W and

Warren Lewis observed that there is no provision in the NPR proposal allowing for the omission

of settled litigation where the settlement is favorable to the franchisor or otherwise neutral. Both
 

337 UFOC Guidelines, Item 3 Definitions, iv.

 

338 PMR&W, Comment 4, at 10; Lewis, Comment 15, at 13. Accordingly to Mr. Lewis, 

without such a limitation, the proposed Rule would penalize franchisors and subfranchisors who

achieve favorable settlements, thereby discouraging settlement of litigation. See also Snap On,

Comment 16, at 3.

 

339 See also J&G, Comment 32, at 10-11; Marriott, Comment 35, at 15.

 

340 But see Stadfeld, Comment 23, at 12 (urging the Commission to keep the UFOC

requirement of disclosing specific payments in settlements regardless of confidentiality

agreements).

 

341 Mr. Baer also suggested that where a case has been settled by purchase or re-purchase of

a franchised business and the amount does not exceed the fair market value of the business, a

franchisor should be permitted to state: “The settlement included a purchase of the franchise . . .

for an amount which, in our judgment, does not exceed its fair market value.” Id., at 12.

107

commenters cited to the UFOC Guidelines337 which state that “settlement of an action does not

diminish its materiality if the franchisor agrees to pay material consideration or agrees to be bound

by obligations which are materially adverse to its interests.”338 By implication, favorable or

neutral settlements to a franchisor are not material and need not be disclosed.

Several franchisors also questioned the inclusion of confidential settlements. According to

John Baer, it is unfair to require the disclosure of confidential settlement agreements “if they were

entered into by a company at a time when it was not yet engaged in franchise activities.” Baer,

Comment 11, at 11. David Gurnick commented that the disclosure of any settlement terms that

the parties agreed to keep confidential is bad policy. According to Mr. Gurnick, confidential

settlements benefit both parties and the “opportunity for confidentiality is often an important

dynamic to resolve a dispute.” Gurnick, Comment 21, at 4.339 He would permit the disclosure of

material facts about confidential settlements in the aggregate, so that the franchisor could make

the disclosure about a group of cases, without violating the confidentiality of any one or more

cases. For example, a franchisor could state: “we have settled 10 cases with confidentiality

agreements. In each of these cases, we made payments to the franchisee in the mid five figure

range.” Id., at 5.340 

Mr. Baer also questioned the disclosure of exact dollar amounts or other confidential

settlement terms. “This often can expose the franchisor to the choice of not being able to register

its franchise in a particular state or making a disclosure and possibly breaching the terms of the

confidential settlement agreement.” Baer, Comment 11, at 11. He suggested that the Commission

allow franchisors to disclose approximate dollar amounts, such as “the low four figures, ” or, in

the alternative, a range of figures. Id.341
 

342 For purposes of Item 3, the definition of “held liable” would mean that “as a result of

claims or counterclaims, the franchisor must pay money or other consideration, must reduce an

indebtedness by the amount of an award, cannot enforce its rights, or must take action adverse to

its interests.” In other words, a franchisor need not disclose a settlement if the franchisor neither

pays any material consideration, nor is bound by obligations that are materially adverse to its

interests.

108

The staff recommends that the Commission retain the proposed settlement disclosures, as

modified below. First, we agree with Mr. Baer that it is unfair to compel a franchisor to disclose

confidential settlements entered into before it began franchise sales. It is unreasonable to expect a

non-franchisor to negotiate settlements with an eye toward the possibility that it may engage in

franchise sales in the future. Accordingly, we recommend that the Commission limit the

confidential settlement disclosure to those settlements entered into after commencing franchise

sales activities. Second, Item 3 should permit franchisors to omit settled litigation where the

settlement is favorable to the franchisor or otherwise neutral.342 This is the clear intent of the

UFOC Guidelines. 

Third, we recommend that the Commission retain the disclosure of confidential

settlements, but modify the disclosure requirement for those franchisors who have historically

used the Franchise Rule’s disclosure format. As a preliminary matter, we recognize that the

disclosure of confidential settlement terms may be unpopular. However, this issue was debated

when NASAA revised the UFOC Guidelines in 1993, with input from many interested parties. 

Recognizing that the disclosure requirements concerning confidential settlements might raise

breach of contract issues, the NASAA Commentary on the UFOC Guidelines specifically limited

the disclosure to those settlements that were entered into after the adoption of the UFOC

Guideline revisions on April 25, 1993. Franchisors using the UFOC Guidelines format have been

living under this policy on the state level for more than nine years, apparently without much

hardship. Under the circumstances, we find no compelling reasons in the record to deviate from

the UFOC Guidelines on this point. 

At the same time, we recognize that some small or regional franchisors who use the

Franchise Rule format have not had the opportunity to phase-in confidential settlement

disclosures. Accordingly, we recommend that franchisors who have used the UFOC Guidelines

format in the past continue to disclose confidential settlements, as is the current practice. 

However, franchisors historically using only the Franchise Rule format, as well as companies new

to franchising, need not disclose confidential settlements entered into prior to the effective date of

the revised Rule.
 

343 62 Fed. Reg. at 9,116, 9,120-21.

 

344 See AFA, ANPR 62, at 2; Lagarias, ANPR 125, at 3; Selden, ANPR 133, Attachment at

2; Karp, ANPR, 19Sept97 Tr, at 98.

 

345 SBA, ANPR 36, at 5-6. See also IL AG, ANPR 77, at 2.

 

346 Peter Lagarias observed that “[f]ranchisors are often able to wield the threat of litigation,

especially by threatening to seek attorneys’ fees, to deter franchisees from suing or maintaining

lawsuits against them. Thus while loss of a single lawsuit is seldom significant to franchisors,

loss of a lawsuit against their franchisor is often fatal for franchisees.” Lagarias, ANPR 125, at

3. See also Merret, ANPR 126; Brandt, ANPR 137; Doe, ANPR, 7Nov97 Tr, at 267.

 

347 E.g., Kaufmann, ANPR 33, at 4.

 

348 E.g., Quizno’s, ANPR 16, at 1; Kaufmann, ANPR 33, at 4; IFA, ANPR 82, at 1-2;

Cendant, ANPR 140, at 3.

 

349 E.g., Kestenbaum, ANPR 40, at 1; Tifford, ANPR 78, at 3. But see Jeffers, ANPR 116, at

1-2 (franchisor-initiated suits could be viewed as a “positive attribute,” showing that the

franchisor is willing to enforce its standards and trademark, and is willing to aggressively

eliminate continuing violations of its franchise agreement). As discussed below, we agree that

litigation can be viewed as a positive attribute and its disclosure is consistent with pre-sale

disclosure.

109

d. Franchisor-initiated litigation

In the ANPR, the Commission asked whether Item 3 should be expanded to require

franchisors to disclose franchisor-initiated litigation.343 Franchisees and their representatives,344 as

well as the Small Business Administration,345 supported the proposal, asserting that franchisorinitiated litigation is material because it sheds light on: (1) the quality of the franchisor-franchisee

relationship; and (2) the extent to which the franchisor may be litigious. Others added that

franchisors currently must disclose franchisor-initiated litigation only if a franchisee files a

counterclaim. Yet, franchisees often do not have the financial resources to initiate a suit or to

pursue a counterclaim.346 Therefore, the disclosure of franchise relationship litigation should not

depend upon which party happens to have the resources to file a suit. 

In contrast, franchisors generally asserted that franchisor-initiated litigation is

immaterial.347 To the extent that a franchisee is aggrieved by a franchisor-initiated suit, the

franchisee, in their view, will surely file a counterclaim, which clearly must be disclosed under

current law.348 Further, in their view litigation should be limited to suits that imply wrongdoing

on the franchisor’s part: franchisor-initiated suits simply demonstrate that the franchisor is

enforcing its rights under the franchise agreement.349 They voiced concern that disclosing such
 

350 E.g., Kaufmann, ANPR 33, at 4; Tifford, ANPR 78, at 3; Cendant, ANPR 140, at 3.

 

351 E.g., Baer, ANPR 25, at 3; Kaufmann, ANPR 33, at 4; Jeffers, ANPR 116, at 1-2;

Forseth, ANPR, 18Sept97 Tr, at 20.

 

352 Baer, ANPR 25, at 3.

 

353 64 Fed. Reg. at 57,303.

 

354 See Quizno’s, ANPR 16 (suggesting that the materiality standard should be maintained).

 

355 See Cendant, ANPR 140, at 3 (noting that in vicarious liability cases – where a customer

sues the franchisor for alleged wrongdoings by the individual franchisee – the franchisor often

must sue the franchisee to protect its interests and to obtain indemnification; such suits,

therefore, are really between the customer and the franchisor and are not indicative of franchise

system performance).

110

litigation would imply some wrongdoing by the franchisor.350 Finally, they asserted that an

expanded Item 3 would “bulk up” disclosure documents, thereby increasing compliance costs.351

One franchisor representative, suggested that if the Commission were to require such a disclosure,

it should consider establishing a threshold trigger: a franchisor would not have to make the

disclosure unless it has sued at least a certain percentage (e.g., 5%) of the franchisees in its

system.352

In the NPR, the Commission tentatively concluded that franchisor-initiated suits may

reveal material information to a prospective franchisee.353 For example, a pattern of franchisorinitiated lawsuits, such as royalty collection suits, may be highly material to a prospective

franchisee because it is another source of information from which prospective franchisees can

assess the risks in purchasing a franchise and the quality of the relationship with the franchisor. 

The Commission recognized, however, that the proposed Item 3 disclosure may increase

compliance costs. Therefore, the Commission proposed limiting the franchisor-initiated litigation

disclosure to pending, “material” franchisor-initiated law suits354 involving the franchise

relationship. Under this proposal, franchisors would disclose if they are:

a party to any pending material civil action involving the franchise relationship. 

For purposes of this paragraph, “franchise relationship” means contractual

obligations between the franchisor and franchisee directly relating to the operation

of the franchisee business (E.g., royalty payment and training obligations). It does 

not include suits involving third parties such as suppliers or indemnification for

tort liability.355
 

356 The NPR also explored whether the disclosure should be tied to a threshold number of

suits, such as actions filed against 5% of system franchisees. 64 Fed. Reg. at 57,329.

 

357 See also AFA, Comment 14, at 4; NASAA, Comment 17, at 4; Bundy, Comment 18, at 7; 

Stadfeld, Comment 23, at 11; Karp, Comment 24, at 19. But see NaturaLawn, Comment 26, at 1

(asserting that if the Commission wants to address whether a franchisor it litigious, then it should

require litigation disclosures only when there have been three consecutive fiscal years of

lawsuits, regardless of the number of such suits).

111

64 Fed. Reg. at 57,334.356

Franchisee advocates and state regulators uniformly supported the expanded litigation

disclosure for the reasons stated in the NPR: the disclosure of franchisor-initiated litigation would

reveal material information about the quality of the franchise relationship, as well as the extent to

which the franchisor is litigious. Typical of these comments is the one submitted by NFA, an

association of Burger King franchisees, stating that the proposed disclosure:

would be beneficial to potential franchisees, as it would allow such franchisees to

be aware of any difficulties current or prior franchisees have encountered with the

franchisor. In addition, the required disclosure of franchisor-initiated litigation

would further aid potential franchisees by serving as an indicator of how

franchisors resolve their disputes, and whether or not such franchisors are quick to

resort to litigation in order to resolve disputes. The possibility of extensive

litigation is important to a potential franchisee, as it may affect the calculation of

costs involved in acquiring such a franchise. In addition, the continued threat of

litigation from the franchisor may well affect later dealings between the parties,

and as such is critical information of which the franchisee should be aware.

NFA, Comment 27, at 2.357

A few commenters also maintained that the proposed disclosure need not be costprohibitive. For example, Seth Stadfeld observed that “once the initial changes are made, all that

must be done is to update the disclosed litigation annually or sooner if material changes take

place.” Stadfeld, Comment 23, at 11. The AFA was more blunt in its assessment:

The Commission has a choice. It can save franchisors a few pennies on a slightly

larger offering circular or save a franchisee from investing hundreds of thousands

of dollars in a franchise that he/she might not have invested in if he/she would have

known all of the franchisor-initiated lawsuits against its own franchisees.
 

358 See also Karp, Comment 24, at 20 (disclosure costs pale in comparison with litigation

costs).

 

359 See also Stadfeld, Comment 23, at 13.

 

360 Mr. Stadfeld would define “franchise relationship” as “contractual obligations between a

franchisor and franchisee relating to a franchised business.” Stadfeld, Comment 23, at 12.

112

AFA, Comment 14, at 4.358

Several franchisee advocates, however, asserted that the proposed franchisor-initiated

litigation disclosure does not go far enough. Specifically, Howard Bundy would eliminate the

restriction limiting the disclosure to “pending” litigation. He would require the disclosure of all

franchise relationship suits by the franchisor or an affiliate commenced during at least the last

three years. “Just giving the ‘pending’ cases is like giving only one month of financial statements. 

It does not permit the prospect to see and evaluate trends and developments.” Bundy, Comment

18, at 7.359 

Seth Stadfeld would eliminate the materiality element altogether, requiring franchisors to

disclose all of their initiated litigation. A materiality standard would enable a franchisor “to

exercise discretion and not disclose matters that in all probability would interest prospective

franchisees greatly.” Stadfeld, Comment 23, at 13. Rather than limit the disclosure, he would

permit the franchisor to explain its rationale for bringing the suits. Id. Mr. Stadfeld also would

require the disclosure of all litigation involving the franchisor and its relationships with

franchisees, not just those involving the franchise system being offered for sale:

Just as the disclosures in Item 1 call for disclosure of information involving other

franchise systems that the franchisor or its predecessors have been affiliated with

so too, Item 3 should furnish prospects with information on material litigation

involving any franchise system or business opportunity program the franchisor or

its affiliates have been affiliated with.

Id. at 12.360

Finally, Eric Karp urged the Commission to broaden the proposed disclosure to include

franchisor initiated litigation against third-party suppliers: “If a franchisor were to sue a supplier

of goods or services it sells to franchisees, over issues relating to quality or efficiency of supply or

to block sales not authorized by the franchisor, the prospective franchisee would have good reason

to want to know about the claim.” Karp, Comment 24, at 20.

Consistent with their ANPR comments, franchisors and their representatives uniformly

opposed the disclosure of franchisor-initiated litigation. In fact, several commenters questioned

the very purpose of the proposed expansion. For example, PMR&W asserted that Item 3 has a
 

361 See also H&H, Comment 9, at 17; J&G, Comment 32, at 10; Marriott, Comment 35, at

14. Several franchisors also agreed that a franchisor-initiated litigation disclosure is unnecessary

because if there are problems in a system, the franchisee will surely file a counterclaim, which all

agree must be disclosed. E.g., Quizno’s, Comment 1, at 1; PMR&W, Comment 4, at 9; Holmes,

Comment 8, at 4. 

 

362 See also, e.g., Gurnick, Comment 21, at 5; NaturaLawn, Comment 26, at 1; J&G,

Comment 32, at 10; GPM Rebuttal, Comment 40, at 4-5.

 

363 H&H, Comment 9, at 17. See also Quizno’s, Comment 1, at 1; Gurnick, Comment 21, at

5.

 

364 See also Quizno’s, Comment 1, at 1.

113

limited intent, namely, to: 

inform the franchisee about proven or alleged franchisor actions which may reflect

poorly on the franchisor; disclosure also is required for franchisor-initiated

litigation where a defendant files a counterclaim containing specified claims. A

franchisor’s lawsuit against the franchisee, in the absence of a relevant

counterclaim, does not reflect any adverse conduct by the franchisor.

PMR&W, Comment 4, at 10.361 

Indeed, some franchisors argued that the disclosure could be misleading, wrongly implying

that the franchisor has engaged in illegal or other misconduct. For example, Snap-On voiced

concern that:

When a franchisee reviews an Offering Circular litigation disclosure, it is unclear

whether a franchisee will read all of the specific litigation summaries contained in

the Offering Circular or is influenced merely by the number of entries made. They

may not be focusing on whether or not the litigation is against the franchisor or is

litigation that the franchisor has brought that does not involve a discloseable claim

by a franchisee.

Snap-On, Comment 16, at 2.362

Similarly, H&H contended that there is little value in requiring franchisors to disclose

garden variety litigation involving franchisees, such as debt collection actions.363 In its view, the 

disclosure would mean nothing more than that the franchisor is enforcing its contract.364 Worse, 

some franchisors feared that a mandatory franchisor-initiated litigation disclosure might actually

discourage franchisors from bringing suits, even meritorious suits, that are needed to maintain the

integrity of the franchise system. PMR&W, for example, asserted that the proposed disclosure
 

365 See also Snap-On, Comment 16, at 2; J&G, Comment 32, at 10; Marriott, Comment 35,

at 14. 

 

366 J&G, Comment 32, at 10. See also GPM Rebuttal, Comment 40, at 4-5.

 

367 Quizno’s, Comment 1, at 1. See also Lewis, Comment 15, at 13 (franchisor would have

to amend their disclosure documents); J&G, Comment 32, at 10 (would prevent sales in states

that require sales to stop until amendments are filed and approved).

114

may . . . dissuade a franchisor from filing litigation to protect the system and its

brand image. This inhibition is not only a result of the need to include a new

disclosure; it also arises from the obligation to cease sales while the disclosure

document is amended and, in some states, while the amendment filing is processed

and reviewed.

PMR&W, Comment 4, at 9.365

Other franchisors asserted that the disclosure document already informs prospective

franchisees about the state of the relationship. J&G, for example, contended that any material

information about the franchise relationship can be determined from the Item 20 termination rates,

as well as through the franchisor’s financial statements.366

Further, several franchisors voiced concern about the relationship between the proposed

franchisor-initiated litigation disclosure and state registration laws. Specifically, they opposed the

disclosure because it might trigger burdensome state updating requirements. For example,

Quizno’s asserted that if the disclosure of franchisor-initiated litigation is deemed material by the

Commission, it would also be deemed material by the states and, therefore, franchisors would

have to stop selling in a state every time they filed a suit until they could amend their

registrations.367 Other franchisors suggested ways to limit the proposed disclosure, including

requiring: (1) a threshold number of suits; (2) a threshold dollar amount; (3) limitations on

franchisor counterclaims; and (4) greater use of summary data.

John Baer and others urged the Commission to consider limiting the disclosure to where

this is a significant number of suits. Mr. Baer suggested a 5% threshold, under which a franchisor

would not have to disclose its initiated litigation unless it has filed suit against at least 5% of the
 

368 Baer, Comment 11, at 11. See also NFC, Comment 12, at 28; Lewis, Comment 15, at 13;

BI, Comment 28, at 11; Tricon, Comment 34, at 6. NASAA stated that if the Commission were

to limit the disclosure by imposing a threshold, it would support a 5% threshold. NASAA,

Comment 17, at 4. 

 

369 NFC, Comment 12, at 28.

 

370 Holmes, Comment 8, at 4.

 

371 AFC, Comment 30, at 3.

 

372 IL AG, Comment 3, at 6 (also recommending no threshold for smaller systems, such as

those with fewer than 25 franchisees).

 

373 Seth Stadfeld also argued that a threshold prerequisite would “discriminate[] arbitrarily in

favor of large mature franchise systems to the detriment of small franchise systems.” Stadfeld,

Comment 23, at 13. Apparently, Mr. Stadfeld thinks that it is unfair to apply the same

percentage threshold for large and small franchise systems because a uniform percentage would

equal different numbers of actual suits that would trigger the disclosure.

 

374 PMR&W, Comment 4, at 10. See also IL AG, Comment 3, at 2. 

 

375 See also Gurnick, Comment 21, at 5.

115

franchisees in its system.368 Others suggested a higher percentage, such as 10%,369 15%,370 or

20%,371 while the IL AG suggested a lower percentage, such as 2%.372

The proposal to establish a threshold, however, did not garner universal support. Eric

Karp, for example, stated: “The prospective franchisee should make his or her own determination

as to whether the number of lawsuits is at a level that indicates a problematic franchise system.” 

Karp, Comment 24, at 19-20. According to Howard Bundy, the imposition of a threshold number

of cases before an obligation to disclose arises “invites abuse.” Bundy, Comment 18, at 7.373

PMR&W suggested another alternative: the Commission should consider requiring a

franchisor to disclose, on an annual basis, the number of litigation and arbitration proceedings it

has pending against franchisees, along with a general summary of the types of claims involved.374

In contrast, NASAA argued that a mere listing of number of suits “is insufficient to inform a

prospective franchisee of this potentially material information.” NASAA, Comment 17, at 4.

Wendy’s suggested that the Commission limit the disclosure of franchisor-initiated

litigation to “specifically enumerated types of claims which are significant to the entire franchised

system,” as well as a significant dollar amount. Wendy’s, Comment 5, at 2. This would eliminate

the burden of having to disclose small cases involving, for example, insignificant breaches of

contract and indemnity suits. Id.375
 

376 Gurnick, Comment 21, at 5.

 

377 As noted throughout the rulemaking process, we find no basis to recommend that the

Commission engage in a sweeping rulemaking that would dictate the substantive terms of

franchise contracts. Nevertheless, we believe there is sufficient evidence in the record to support

the proposition that information about the state of the relationship between a franchisor and its

franchisees is material and, therefore, should be disclosed.

 

378 16 C.F.R. § 436.1(a)(4) (only material actions need be disclosed); UFOC Guidelines,

Item 3 Definitions at iii (“Included in the definition of material is an action or an aggregate of

actions if a reasonable prospective franchisee would consider it important in making a decision

about the franchised business.”).

116

David Holmes would limit the proposed disclosure by eliminating counterclaims filed by a

franchisor merely in response to a franchisee-initiated suit. In his view, this is appropriate if the

Commission’s concern is “with franchisors having a practice of suing their franchisees, not

merely defending themselves.” Holmes, Comment 8, at 4-5. 

Finally, David Gurnick suggested that the Commission permit a franchisor to disclose a

general description of the type of case, accompanied by a list of the case titles, case numbers, and

status. This would eliminate duplicative information.376

For the following reasons, we recommend that the Commission retain the proposed

franchisor-initiated litigation disclosure. Based upon the record, including comments from the

AFA and other franchisee advocates, we are convinced that this information is material to

prospects in order to assess the nature of disputes and the level of litigation within a franchise

system. We recognize that Item 3, to date, may have focused narrowly on suits showing

wrongdoing on a franchisor’s part. We now believe that this should be broadened specifically to

reveal more information about the state of the franchise relationship. For example, we agree with

the commenters that franchisor suits to enforce system standards could be viewed as a positive

attribute, showing that the franchisor is willing to maintain uniformity for the benefit of the entire

system. A franchisor’s willingness to protect its system is a material fact about the franchise

relationship that should be disclosed to prospective franchisees.377 

At the same time, we reject arguments to broaden the proposed franchisor-initiated

litigation disclosure, as some have suggested. In order to minimize compliance burdens, we

believe that the Commission should limit the disclosure to a “snap-shot” in time, sufficient to

reveal the franchisor’s practice of initiating litigation, as well as reveal the types of franchise

relationship problems arising in the franchise system. A three-year period appears to be excessive

for this purpose. Similarly, we agree that a “materiality” standard should apply. This is consistent

with both the current Rule and UFOC Guidelines approach to litigation disclosures.378 Indeed,

immaterial information, by definition, is unlikely to influence a prospective franchisee’s
 

379 See also Quizno’s, Comment 1, at 2.

 

380 This disclosure approach would also be more representative of franchisor-initiated

litigation than pending litigation, which would weed out suits that may have been settled during

the year, or which took less than a year to resolve. 

117

investment decision, while imposing unwarranted costs and unnecessarily lengthening disclosure

documents. 

Further, there may be some merit to the argument that the franchisor should disclose all

relationship litigation, including litigation involving the franchise being offered, litigation

involving another franchise system owned by the franchisor, as well as litigation involving

affiliates and third-party suppliers. We are not prepared to make such a recommendation,

however. The core concern underlying the proposed franchisor-initiated litigation requirement is

the status of the relationship between the franchisor and its franchisees, and the proposed

disclosure is designed to address that issue. We must weigh the marginal benefit of expanding the

litigation disclosure against the compliance costs and burdens, as well as legitimate concerns

about bulking up a disclosure document beyond the point where a prospect would be inclined to

read it. On balance, we do not believe further expansion of the litigation disclosure is warranted.

In reaching our recommendation to retain the franchisor-initiated litigation disclosure, we

have also considered the various suggested alternatives that would reduce franchisors’ compliance

burdens. We do not adopt the suggestion that the Commission tie the disclosure to a threshold. 

We recognize that a bright-line threshold (such as the number or percentage of suits) might be

useful, but we believe it is impossible, based upon the record, to fashion a “one size fits all”

approach for every franchise system in all industries. Moreover, a threshold focuses on the

quantity of suits and, therefore, would be most useful in determining litigiousness. However,

application of a threshold might enable franchisors to avoid disclosing suits that shed light on the

more pressing concern – the state of the relationship. When it comes to the state of the

relationship, even a small number of suits initiated by a franchisor could be material to a

prospective franchisee because they may reveal the nature of problems in the franchise

relationship or show the franchisor’s willingness to enforce system standards. As Eric Karp

stated, the prospect can then determine for himself or herself whether the numbers revealed are

significant.

Finally, we believe that Mr. Gurnick has raised some useful suggestions about the form of

the disclosure that, if adopted, could reduce costs without greatly compromising the underlying

purpose of the proposed disclosure. In order to streamline the Rule, we recommend that a

franchisor report its litigation on an annual basis only.379 Specifically, a franchisor would disclose

all material litigation to which it was a party in the last fiscal year.380 This approach, we believe,

is clearer than the NPR’s proposed “pending litigation” snap-shot. It also would have the

additional benefit of reducing more frequent quarterly updating, which may be burdensome and
 

381 States typically require immediate updating upon a material change.

 

382 See 16 C.F.R. § 436.1(a)(5). In the SBP, the Commission found that bankruptcy

information is material because it bears directly on the “integrity and managerial ability of the

parties with whom [the franchisee] is dealing and . . . could readily result in drastic economic

injury to the franchisee because it could lead him or her to invest substantial amounts of money

in a bankrupt business.” 43 Fed. Reg. at 59,650-51.

 

383 64 Fed. Reg. at 57,304.

 

384 Id.

 

385 J&G, Comment 32, at 11; Marriott, Comment 35, at 15; GPM Rebuttal, Comment 40, at

5.

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perhaps impracticable in franchise registration states with more frequent updating requirements.381

Further, we agree that a franchisor should be able to provide basic, summary information on its

initiated litigation, without the need for long discussions on each and every case. Accordingly, we

propose that “franchisors may list individual suits under one common heading, which will serve

as the summary (for example, royalty collection suits).” The franchisor would then merely list

each applicable suit (case name, court, file number), without the need to provide any additional

explanation. 

F. Proposed Section 436.5(d)

Item 4: Bankruptcy

1. Background

As proposed in the NPR, Item 4 would extend the current Rule’s bankruptcy

disclosures.382 Consistent with the UFOC Guidelines, the NPR proposed that Item 4 require

franchisors to disclose bankruptcy information about predecessors and affiliates, to disclose

foreign proceedings comparable to bankruptcy, and to make bankruptcy disclosures for 10 years,

instead of the current seven years.383 At the same time, Item 4 would retain the current Rule

requirement that franchisors disclose their parent’s bankruptcy history.384

2. The record and recommendations

A few commenters addressed the NPR proposal that franchisors disclose predecessor and

parent bankruptcies. J&G, Marriott, and GPM asserted that the additional disclosure burden is not

outweighed by any benefit to prospective franchisees.385 Consistent with our previous

discussions, we continue to believe that information about predecessors and parents is material

and should be disclosed. Where a parent is in bankruptcy, for example, its assets include any

franchisor-subsidiary. Under such circumstances, a prospective franchisee should be made aware
 

386 NaturaLawn, Comment 26, at 1.

 

387 The more limited Item 3 definition of affiliate reduces franchisors’ compliance burdens

significantly. A franchisor may have numerous affiliates, any of which may have been involved

in, or is currently involved in, material litigation. The disclosure of such affiliate information

119

that the franchisor in which it is considering investing might be sold, possibly to a competitor or

to a company lacking prior franchise experience.

Several commenters also voiced concern about other aspects of proposed Item 4. First,

David Gurnick suggested that the time period for reporting a bankruptcy should be reduced from

10 to five years. “Five years following a bankruptcy, an individual[’s] or business’s

circumstances can dramatically change. A bankruptcy more than five years old is not a predictor

of anything.” Gurnick, Comment 21, at 6. Second, J&G raised another timing issue. As

proposed, a franchisor would have to disclose a bankruptcy if certain events (such as discharge in

bankruptcy) occurred within the last 10 years. J&G observed that this timing provision would

compel the disclosure of a bankruptcy that was actually filed significantly earlier:

[I]t would seem that ten years from the date of the filing of a petition would be the

appropriate beginning date. We are aware of one case in which an officer was

involved with a company when a petition was filed in 1986, and the bankruptcy

proceeding is still pending. Were it settled this month (December 1999),

disclosure of that event would be required for a total of 23 years!

J&G, Comment 32, at 11.

Third, Howard Bundy urged the Commission to expand the scope of the disclosure. As

proposed in the NPR, Item 4 would require the disclosure of an affiliate’s prior bankruptcy only if

the affiliate currently offers franchises under the franchisor’s trademark. Mr. Bundy would add

the word “or has offered” after the word “offers.” “Without this, so long as the affiliate does not

at the moment offer franchises under the principal trademark, there would be no obligation to

disclose a bankruptcy of the affiliate. . . . If the affiliate is involved, the affiliate should be

required to disclose its bankruptcy.” Bundy, Comment 18, at 7. Finally, NaturaLawn would

exclude the disclosure of personal bankruptcies. The company noted that personal bankruptcies

can be filed for a variety of reasons, such as divorces, medical issues, or insurance claims.386

We agree with Mr. Bundy that the disclosure of affiliate bankruptcies should be expanded. 

After revisiting this issue, it is clear that the UFOC Guidelines require franchisors to disclose the

bankruptcy of any affiliate of the franchisor, not just those affiliates who offer franchises under

the franchisor’s principal mark. As previously noted, the definition of “affiliate” in the UFOC

Guidelines varies for purposes of specific disclosure items. For example, “affiliate” for Item 3

(litigation) purposes is limited to “an affiliate offering franchises under the franchisor’s principal

trademark.” UFOC Guidelines Item 3.387 In the NPR, the Commission adopted similar language
arguably might impose significant compliance costs that may not outweigh any benefits to

prospective franchisees. Therefore, the Item 3 litigation disclosure limited to affiliates offering

franchises under the franchisor’s principal trademark strikes the right balance between disclosure

and costs. On the other hand, a franchisor and its affiliates presumably have few prior or current

bankruptcies. Under the circumstances, a broader definition of affiliate in the Item 4 bankruptcy

disclosure is not likely to impose unwarranted costs.

 

388 NASAA Comparison, at 6. NASAA also noted one additional inconsistency between the

UFOC Guidelines and the NPR: the UFOC Guidelines require a franchisor to state the material

facts pertaining to a bankruptcy. Id. See also UFOC Guidelines, Item 4. We agree. 

Accordingly, we recommend that the Commission add this provision to the final revised Rule,

consistent with the UFOC Guidelines.

 

389 Consistent with Item 2, proposed revised Item 4 would also extend the UFOC Guidelines

by requiring the bankruptcy disclosures not only for officers or general partners, but for any

“other individual who occupies a similar status or performs similar functions.” This is necessary

to prevent franchisors from hiding prior bankruptcies of individuals who function as officers

without a formal title.

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for the Item 4 bankruptcy disclosure. However, in its comparison between the NPR and UFOC

Guidelines, NASAA notes that the Item 4 Bankruptcy disclosure is not so limited.388 In order to

reduce inconsistencies between the Rule and the UFOC Guidelines, we recommend that the

Commission use the general, broad definition of “affiliate” in Item 4 as well.

389

We reject, however, other suggestions to modify proposed Item 4. We recognize that the

10-year reporting period may result in rare instances in the disclosure of a bankruptcy filed more

than 10 years earlier. Nonetheless, we have to draw a line at some point, and we believe that the

proposed 10-year reporting period is reasonable in order to give prospective franchisees a

complete picture of the franchisor’s bankruptcy history. We find no compelling reason to deviate

from the UFOC Guidelines on this point. Similarly, we see no compelling reason to omit a

personal bankruptcy. In many instances, franchisees entrust initial fees and ongoing funds to

franchise managers for training and advertising, among other forms of assistance. The disclosure

of a franchisor manager’s bankruptcy would shed light on that manager’s ability to safeguard and

use those funds properly. Accordingly, we believe personal bankruptcies are material and should

be disclosed.

G. Proposed Section 436.5(e)

Item 5: Initial Fees

1. Background

In the NPR, the Commission proposed the following initial fee disclosure based upon Item

5 of the UFOC Guidelines:
 

390 Pre-sale disclosure of cost information is prevalent in Commission trade regulation rules. 

E.g., 900 Number Rule, 16 C.F.R. § 308.3(b) (requiring pre-sale disclosure of the cost of the

call); Telemarketing Sales Rule, 16 C.F.R. § 310.3 (requiring pre-sale disclosure of the “total

costs to purchase, receive, or use” the goods or services); Funeral Rule, 16 C.F.R. § 453.2

(requiring pre-sale disclosure of price information for funeral goods and services). 

 

391 In the SBP, the Commission recognized that the disclosure of complete and accurate

information about the initial franchise fee is material. The failure to disclose such information

pre-sale is deceptive because “it (1) misleads, or at least confuses prospective franchisees as to

the amount of the required initial franchise investment and (2) could readily result in economic

injury to a franchisee unable to fully obtain all such funds or unable to recoup the full amount of

such funds in the course of the franchise business.” 43 Fed. Reg. at 59,653.

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(e) Item 5: Initial Franchise Fee.

Disclose the initial franchise fee and the conditions under which this fee is

refundable. If the initial fee is not uniform, disclose the range or the formula used

to calculate the initial fees paid in the fiscal year before the issuance data and the

factors that determined that amount. For purpose of this Item, “initial fee” means

all fees and payments for services or goods received from the franchisor before the 

franchisee’s business opens, whether payable in lump sum or installments.

64 Fed. Reg. at 57,335.390 This disclosure is substantially similar to the comparable Rule

disclosure provision found at 16 C.F.R. § 436.1(a)(7).391 Proposed Item 5, however, would extend

the Rule’s current disclosures by enabling franchisors to provide a range of fees, instead of a fixed

fee.

2. The record and recommendations

The NPR’s proposed Item 5 generated two technical comments. First, Warren Lewis

focused on the use of the phrase “initial franchise fee.” Recognizing that a prospective franchisee

may pay more than just one fee in order to acquire a franchise, Mr. Lewis recommended that: (1)

the title be changed from “Initial Franchise Fee” to “Initial Fees”; (2) “this fee is refundable”

should be changed to “these fees are refundable”; and (3) “initial fee means” should be changed to

“initial fees mean.” Lewis, Comment 15, at 14. We agree. 

Second, Howard Bundy correctly noted that the definition of “initial fee” in the NPR does

not expressly include commitments to make payments to the franchisor. As drafted, proposed

Item 5 defines an initial fee only in terms of cash actually paid. “It should include any amounts

that the franchisee becomes obligated to pay before entering into the franchise. For example, if

the entire initial franchise fee is deferred into a promissory note, that does not change the fact that

it is an ‘initial fee.’” Bundy, Comment 18, at 7. 
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We agree. The Item 5 “initial fees” disclosures are comparable to the required payment

element in the definition of the term franchise. A “required payment” is not limited to cash, but

includes commitments to make payments to the franchisor at a later date. If not, then a franchisor

could seriously undercut the Item 5 cost disclosure by requiring prospects to sign notes or other

obligations in lieu of immediate payment. Accordingly, Item 5 should include not just fees that

are actually paid, but commitments to pay as well. 

Mr. Bundy also urged the Commission to require the disclosure of any contractual

formulas for determining the current initial fee:

Historic fee ranges and factors may provide some information, but, particularly

with a start-up franchisor, there is a tendency to reduce initial fees in the early

stages to entice people to sign up. It is important to have that disclosed, and the

proposed rule does it. However, it is equally or more important to have disclosure

of any contractual formulas that will result in this prospect paying a different initial

fee than the historic information would suggest.

Bundy 18, at 7. 

Mr. Bundy is correct that proposed Item 5 would require franchisors to disclose how they

calculated initial fees over the last fiscal year, but would not require franchisors to disclose the

specific formula used to calculate an individual prospective franchisee’s current initial fees. It is

also true that in some instances the historical calculations may not be consistent with those set

forth in the franchisor’s current contract. Nonetheless, we believe that there is not a record of

abuse sufficient to deviate from the UFOC Guidelines on this point. As long as the prospect is

aware of the amount to be paid before the sale, how the franchisor derives that amount is not

necessarily material. On the other hand, it is highly material for a prospective franchisee to know

whether fees are uniform, because if they are not, the prospect may be able to bargain for a lower

rate. Under the circumstances, the prospect should receive some historical information with

which to gauge the parameters of the franchisor’s willingness to negotiate fee changes. We

believe that the historical overview required by proposed Item 5 is sufficient to accomplish that

goal.

Finally, three commenters voiced concern about negotiated prices. The NFC, for example,

asserted that the NPR implies that a franchisee can seek to negotiate initial fees only if the

franchisor already disclosed in its Item 5 a range of previously accepted fees. Such a result would

restrict prospective franchisees’ ability to initiate fee negotiations:

[I]t frequently makes sense for the franchisor to offer reduced initial and/or

ongoing fees to the prospective franchisee. And, naturally, such an arrangement

would be highly desirable to that prospective franchisee. Accordingly, the FTC

should support this marketplace practice and make clear in its forthcoming

commentary to the revised FTC Franchise Rule that such negotiations are, in fact,

permissible and not in violation of the Rule (provided that following such a
 

392 Gurnick, Comment 21, at 6.

 

393 BI, Comment 28, at 6.

 

394 Proposed revised Item 5 would also clarify the NPR proposal in two additional ways. 

First, it would make clear that the definition of “initial fees” includes payments or commitments

to pay an affiliate of the franchisor. This is consistent with the NASAA Commentary. See also

NASAA Comparison, at 7. Further, the NPR failed to include the UFOC Guidelines provision

that franchisors must disclose installment payment terms in either Item 5 or in Item 10. NASAA

Comparison, at 7.

123

negotiated transaction, the subject franchisor discloses that from time to time it

discounts the initial and/or ongoing fees and under what circumstances it may do

so).

NFC, Comment 12, at 10-11.

David Gurnick also suggested that the Rule permit a franchisor to disclose whether or not

it will negotiate fees, and if it does so, permit disclosure of the conditions that may affect the

negotiation.392 BI would permit franchisors to disclose that it may lower the initial fees. 

However, the firm contended that where the initial fee is determined through negotiation, as

opposed to the result of a formula or fixed calculation, the franchisor need not disclose the range

of such negotiated initial franchise fees in the prior fiscal year.393

As an initial matter, we recognize that the Rule could be interpreted as prohibiting contract

negotiations because the final terms and conditions agreed upon would not be reflected in the

franchisor’s disclosure document. We believe this is absurd. The Commission has every interest

in ensuring the parties’ ability to negotiate terms and conditions, including fees and other costs. 

We would be hard-pressed to conclude that a prospective franchisee did not get full disclosure

when that very prospect engaged in the negotiation process. We therefore recommend that the

Commission make clear in the Compliance Guides that a franchisor may negotiate fees without

violating the Rule.

At the same time, we believe that Item 5, consistent with UFOC Item 5, should require

franchisors to state a range of fees accepted in the previous fiscal year. The UFOC Guidelines do

not distinguish between ranges of fees based upon contractual formulas, on the one hand, and

negotiations on the other. Providing a range of fees, regardless of how or why these ranges came

about, is useful information in the negotiation process. Such disclosure compels neither party to

reach agreement on unacceptable terms: franchisors and prospective franchisees remain free to

negotiation in and outside of any disclosed range. Accordingly, we see no reason to deviate from

the UFOC Item 5 approach in this regard. Therefore, we recommend that the Commission adopt a

revise Item 5 as follows:394
 

395 64 Fed. Reg. at 57,335. This disclosure recognizes that a prospective franchisee’s

investment is not limited to the initial franchise fee alone. Rather, a franchisee may incur

considerable costs in the operation of the business, which will significantly impact upon his or

her ability to continue operations and ultimately be successful. In the SBP, the Commission

noted that the failure to disclose continuing costs violates Section 5 because it “(1) misleads or at

least confuses the franchisee as to the required amount of his or her total investment; and (2)

could readily result in economic injury to the franchisee unable to meet such continuing

obligations.” 43 Fed. Reg. at 59,654-55.

 

396

 E.g., Telemarketing Sales Rule, 16 C.F.R. § 310.3 (requiring disclosure of the total

costs, material restrictions, limitations, or conditions to purchase, receive, or use goods or

services); Appliance Labeling Rule, 16 C.F.R. § 305.1(a) (requiring disclosures of yearly energy

use); 900 Number Rule, 16 C.F.R. § 308.3 (requiring disclosure of any other fees that will be

charged for the service).

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(e) Item 5: Initial Fees.

Disclose the initial fees and any conditions under which these fees are refundable. 

If the initial fees are not uniform, disclose the range or formula used to calculate

the initial fees paid in the fiscal year before the issuance date and the factors that

determined the amount. For this section, “initial fees” means all fees and

payments, or commitments to pay, for services or goods received from the

franchisor or any affiliate before the franchisee’s business opens, whether payable in

lump sum or installments. Disclose installment payment terms in this subsection or in

[Item 10] of this section.

H. Proposed Section 436.5(f)

Item 6: Other Fees

1. Background

In the NPR, the Commission proposed that franchisors disclose in Item 6 recurring or

occasional fees associated with operating a franchise (e.g., royalties, advertising fees, and transfer

fees).395 This disclosure is substantially similar to the comparable Rule disclosure provisions

currently found at 16 C.F.R. § 436.1(a)(8). It is also consistent with many Commission trade

regulation rules that require sellers to disclose post-sale costs and conditions that will ultimately

affect the total costs incurred in using a product or service.396

Consistent with the UFOC Guidelines, the NPR’s proposed Item 6 would also extend the

current Rule by adding a disclosure about the existence of advertising and purchasing

cooperatives from which franchisees may be required to purchase services or goods. The

franchisor would also disclose the voting power of any franchisor-owned outlets in the

cooperative and, if company store voting power is controlling, the range of required fees charged
 

397 Lewis, Comment 15, at 14; NASAA, Comment 17, at 4.

 

398 See NASAA Comparison at 8; UFOC Guidelines, Item 6, Instructions vi.

 

399 See NASAA Comparison at 8.

 

400 Mr. Bundy also suggested that franchisees need to understand that third-party obligations

continue even if the franchise is terminated. Id. We agree, but believe that this raises a

125

by the cooperative. These additional disclosures would better enable prospective franchisees to

understand restrictions on their independence, as well as the total costs of conducting business. 

2. The record and recommendations

In response to the NPR, Warren Lewis and NASAA raised a technical issue. As drafted, 

Item 6 is titled “Recurring or Occasional Fees.” They suggested that the Commission use the

term “Other Fees” in the title and throughout the disclosure.397 We agree. We also recommend

that the Commission adopt two UFOC Guidelines policies that were missing from the NPR

proposal: (1) that franchisors state explicitly whether any fees are non-refundable (rather than

just stating the conditions when a fee is refundable);398 and (2) that franchisors disclose whether

continuing fees currently being charged are uniformly imposed.399

Further, the NPR proposed that franchisors be required to disclose recurring or occasional

fees that the franchisee must pay to “the franchisor or its affiliates, or that the franchisor or its

affiliates impose or collect in whole or in part on behalf of a third party.” 64 Fed. Reg. at 57,335. 

This proposal is consistent with the current Rule, which requires the disclosure of third-party

payments only to the extent the franchisor imposes or collects them for the third party. NASAA

and Howard Bundy raised concerns about direct payments to third parties. 

NASAA urged the Commission to expand Item 6 to include not only other fees paid to

the franchisor (or to affiliates), but required payments made directly to third parties:

The FTC should consider closing a gap in the UFOC Guidelines by requiring

disclosure of required fees paid directly to third parties, e.g., local advertising

requirements, yellow page advertising expenses, costs of attending training and

conventions, fees for obtaining audited financial statements and mandatory store

updates and remodeling. These fees are not required to be disclosed in UFOC

Item 6 and may reflect a material ongoing expense for franchisees.

NASAA, Comment 17, at 4. In the same vein, Howard Bundy added that in the “vast majority of

the franchise cases we see, the franchisee’s ongoing legal obligations to third parties far exceed

the franchisee’s ongoing legal obligations to the franchisor. However, the franchisee cannot

obtain the franchise without incurring the third-party obligations.” Bundy, Comment 18, at 8.400
consumer education issue, not a pre-sale disclosure one, that is best handled by prospective

franchisees’ advisors and through Commission and industry educational efforts.

 

401 E.g., SPB, 43 Fed. Reg. at 59,653.

 

402 64 Fed. Reg. at 57,335-36.

 

403 “Since . . . fees frequently involve substantial sums of money, it must be assumed that if

they were fully disclosed, they would play a significant role in a prospective franchisee’s decision

of whether to enter into a franchise relationship.” SBP, 43 Fed. Reg. at 59,652. The “[f]ailure to

disclose material information as to the true cost of the franchise” is an unfair and deceptive trade

126

We find merit in the arguments raised by NASAA and Mr. Bundy. The Commission has

long held that a prospective franchisee should have a sound understanding of all financial

commitments before he or she decides to purchase a franchise.401 Nonetheless, we have several

concerns about expanding Item 6 to include direct third-party payments. 

As noted above, under the current UFOC Guidelines approach, a franchisor must disclose

only those payments it imposes and collects directly or indirectly from third parties. Presumably,

under such circumstances, the franchisor is aware of the amount of these fees at the time of the

sale. A franchisor, however, may be unaware of the extent of payments made directly to third

parties. For example, a franchisor might require a prospective franchisee to obtain insurance or

Internet service, the cost for which may vary widely depending upon which carrier the franchisee

selects. Similarly, a franchisor may require store updating and remodeling, even mandating

certain specifications. Yet, remodeling costs may vary depending upon the contractor the

franchisee selects and local construction material and labor costs. 

In short, we believe that it is unreasonable to expect a franchisor to be able to disclose

completely and accurately in all instances fees paid directly to third parties. Rather, we believe a

more limited approach is warranted. We recommend that a franchisor list all required payments

made directly to third parties and then state either the amount of the fee or that “the amount of

the fee is unknown and may vary depending upon factors, such as the third-party supplier

selected.”

I. Proposed Section 436.5(g)

Item 7: Estimated Initial Investment

1. Background

Proposed Item 7 of the NPR would require franchisors to disclose additional expenses

necessary to commence business (e.g., rent, equipment, and inventory) in an easy-to-read table. 

It would also require franchisors to disclose any refund conditions.402 Comparable cost

disclosures are currently found at 16 C.F.R. § 436.1(a)(7).403 
practice in violation of Section 5. Id. at 59,653.

 

404 The NPR used the terms “additional expense” and “other payments,” 64 Fed. Reg. at

57,335, while the Commission’s explanation of Item 7 referred to “additional funds.” Id. at

57,304. We believe the term “additional funds” should be used, consistent with the UFOC

Guidelines. See UFOC Guidelines, Item 7.E and Sample Answer 7.

 

405 The UFOC Guidelines define the term “initial phase” to mean at least three months or a

reasonable period for the industry. UFOC Item 7, Instructions, ii.

 

406 See, e.g., Lewis, Comment 15, at 14-15; Snap-On, Comment 16, at 3.

127

Proposed Item 7, however, would extend the current Rule provision by requiring a

franchisor to disclose required payments made not just to the franchisor and its affiliates, but also

to some third parties. It would also require franchisors to disclose additional expenses or funds404

needed before operations begin and during the initial phase of the franchise.405 The Commission

suggested that this disclosure would essentially require franchisors to disclose the working

capital a franchisee needs to start operations, as well as a break-even point. Specifically, the

Commission stated that franchisors must: 

disclose “additional funds” required before operations begin and “during the

initial phase of the franchise.” This information is essentially the same as a

working capital disclosure. . . . Franchisor must also identify the factors, basis,

and experience they have considered in determining the level of additional funds. 

These disclosures assist prospective franchisees to understand not only the costs

of entering into the business, but their likely operational costs until they can break

even.

64 Fed. Reg. at 57,305.

2. The record and recommendations

Several commenters opposed the NPR’s references to “working capital” and “breakeven” point.406 In their view, this NPR proposal is inconsistent with the UFOC Guidelines and

would inappropriately mandate a financial performance disclosure. For example, David Holmes

asserted that:

What’s critical to understand is that it is impossible to provide a meaningful

estimate of working capital requirements without making assumptions as to total

revenues (and related costs), which is functionally equivalent to a representation

as to financial performance. . . . [S]uch a representation is otherwise forbidden
 

407 PMR&W, Comment 4, at 10-11. But see J&G, Comment 32, at 11 (“We applaud the

addition of the language which defines ‘initial phase’ as ‘your estimated investment for the first

___ months.’ This provides clarity for franchisors and prospective franchisees.”). 

 

408 We recommend that the Commission also make clear in the Compliance Guides that a

franchisor seeking to apply an initial phase other than three months has the burden of showing

the reasonableness of the phase selected.

 

409 PMR&W, Comment 4, at 10-11.

128

unless made in accordance with Item 19. . . . [A] “disclosure” of working capital

requirements is, from an intellectual standpoint, a “back door” method of

providing representations as to financial performance.

Holmes, Comment 8, at 6. Mr. Holmes went so far as to suggest that the Commission expressly

ban the disclosure of an estimate of working capital or other funds needed “during the initial

phase” unless there has been related compliance with Item 19. Id. PMR&W echoed David

Holmes’ concerns and raised an additional issue: the term “initial phase” in the NPR is

undefined. PMR&W observed that the Commission should expressly incorporate into Item 7 the

UFOC Guidelines standard that a three-month initial phase is reasonable.407

After reviewing the record, we agree that the NPR was unnecessarily inconsistent with

the UFOC Guidelines. The NPR would have required franchisors to disclose all expenses for the

entire initial period. Under UFOC Item 7, however, franchisors must disclose only start-up

expenses needed to open the business: the only instance in which franchisors must disclose

required expenses for the initial period (defined as three months or other reasonable period in the

industry) is in the Item 7 “additional funds” category. 

Therefore, we recommend that the Item 7 chart be renamed: “Your Estimated Initial

Investment.” Similarly, we recommend that the Commission make clear that only the “additional

funds” category must list expenses for the initial period and that “a reasonable initial period”

should be at least three months or some other reasonable period for the industry.408 More

important, we further agree that references to a break-even point should be deleted. The UFOC

Guidelines do not require any disclosure of a break-even point, and a mandatory break-even

disclosure would essentially force many franchisors to make a financial performance claim,

contrary to the voluntary approach of Item 19.

Finally, PMR&W asserted that the additional funds category is too broad. Citing the

NASAA Commentary, the firm notes that owners’ salary, for example, should be excluded.409

We believe this issue is best addressed in a Compliance Guides, where the Commission can

explain the term “additional funds” in greater detail. Specifically, we recommend that the

Compliance Guide adopt the NASAA Commentary’s view that franchisors may exclude

franchisee-owner’s salary from the additional funds list. The Compliance Guide should also
 

410 See 16 C.F.R. §§ 436.1(a)(9)-(11). In the SBP, the Commission noted that buying

restrictions are common in franchise agreements and are material because they will “have a

significant impact on the sources of supplies and prices which a franchisee will pay for his or her

supplies and thus also on the profitability of the franchise.” 43 Fed. Reg. at 59,655. Similarly,

required purchases “limit the independence of the franchisee, affect the profitability of the

franchisee, and constitute a potential source of hidden profit for the franchisor.” Id. at 59,656-67.

 

411 64 Fed. Reg. at 57,336.

 

412 Id.

 

413 E.g., Manuszak, ANPR 13; Weaver, ANPR 17; Mueller, ANPR 29; Colenda, ANPR 71;

Gagliati, ANPR 72; Buckley, ANPR 97; Haines, ANPR 100; Myklebust, ANPR 101; Rafizadeh,

ANPR, 7Nov97, at 288-89; Slimak, ANPR, 22Aug97 Tr, at 26. See also Kezios, ANPR 64.

129

state the Commission’s intent that franchisors have flexibility in listing expenses in order to

present a complete and accurate picture, while avoiding the making of financial performance

representations, which, if made at all, must be included in Item 19.

J. Proposed Section 436.5(h)

Item 8: Restrictions on Sources of Products and Services

1. Background

The Franchise Rule currently requires franchisors to disclose obligatory purchases,

restrictions on sources of products and services, and the amount of any rebates the franchisor

may receive from required suppliers.410 In the NPR, the Commission proposed to adopt the more

comprehensive disclosures found in Item 8 of the UFOC Guidelines.411 Specifically, proposed

Item 8 would extend the current Rule by requiring franchisors to disclose the criteria for

evaluating, approving, or disapproving of alternative suppliers. In addition, franchisors must

state whether, by contract or practice, the franchisor provides material benefits to franchisees

who use designated or approved suppliers (e.g., renewals or additional outlets). It also would

require franchisors to disclose the existence of purchasing or distribution cooperatives, and

whether the franchisor negotiates purchase agreements with suppliers on behalf of franchisees.412

These additional disclosures will enable the prospective franchisee to assess their likely costs and

benefits, as well as their independence from the franchisor.

2. The record and recommendations

During the ANPR proceeding, several franchisees voiced concern about source

restrictions that prevent them from obtaining supplies at cheaper rates.413 These commenters

generally did not allege that franchisors fail to disclose source restrictions, but complained about

the “abusive nature” of such restrictions. For example, Jeff Brickner stated: 
 

414 Mr. Brickner added that he also must purchase specific equipment from only one

manufacturer and the franchisor is the only supplier. Id. See also Buckley, ANPR 97 at 3;

Myklebust, ANPR 101. A few franchisees reported that their franchisor failed to approve

alternative suppliers or made it difficult for franchisees to find alternative sources of supplies. 

E.g., Chiodo, ANPR, 21Nov97 Tr, at 308; Hockert-Lotz, id., at 325-27.

 

415 64 Fed. Reg. at 57,305.

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[I]t seems like once a lot of franchise companies get a lot of units open, they

decide that they have a captive audience and they limit the suppliers who you can

purchase from. Generally, all the way to being able to purchase only from their

distribution center. And then they put you at an uncompetitive situation with

other people in the same business because you are paying higher than fair market

value for the price of the goods that you receive from them.

Brickner, ANPR 128.414 

In addition, two franchisee advocates questioned the sufficiency of the UFOC Guidelines’

Item 8. Andrew Selden urged the Commission to adopt and expand Item 8 to require franchisors

to disclose more information about “their practices and intentions with respect to the provision of

competitive alternative sources of supply.” Selden, ANPR 133, Appendix B, at 1. Mr. Selden,

however, offered no specific language for the Commission’s consideration. Robert Zarco,

however, urged the Commission to require franchisors to include the following caution in their

Item 8 disclosure:

The company retains the right to approve all outside vendors supplying products

to the franchisees. Our criteria generally focus on quality and concept-uniformity,

but we reserve the right to modify the criteria for approving suppliers at any time. 

Additionally, there are no time limitations as to how long the review/approval of

franchisee-endorsed vendors may take.

Zarco & Pardo, ANPR 134, at 2.

In the NPR, the Commission agreed that full disclosure of source restrictions and

purchasing obligations is warranted. To that end, it proposed adopting the broader UFOC

Guidelines’ Item 8 disclosures.415 The Commission found that proposed Item 8 “strikes the right

balance between pre-sale disclosure and compliance costs and burdens, and is sufficient to warn

prospective franchisees about source restrictions, purchase obligations, and approval of

alternative suppliers.” 64 Fed. Reg. at 57,305.

The NPR generated only a few comments. First, PMR&W and the NFC voiced concern

about the proposed requirement that franchisors disclose the criteria for evaluating, approving, or

disapproving of alternative suppliers. The NFC, for example, stated that the UFOC Guidelines
 

416 NFC, Comment 12, at 29. See also PMR&W, Comment 4, at 11. 

 

417 At the same time, we recommend one change in the UFOC Guidelines approach. As

noted above in our discussion of Item 1, we believe the franchisor should disclose any supplier in

which a franchisor’s officer owns an interest. This information is material because it alerts the

prospective franchisee to any potential conflict of interest on the franchise officer’s part. 

 

418 Similarly, Harold Brown, a franchisee advocate, urged the Commission to prohibit direct

and indirect “kick-backs” from third-party vendors to the franchisor. Brown, ANPR 4, at 3. The

staff believes that proposed section 436.5(h)(5), requiring the disclosure of revenue to the

franchisor from franchisee purchases, is sufficient to address this issue.

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require only that franchisors disclose whether the franchisor’s criteria for supplier approval are

available to franchisees. It asserted that a franchisor’s specific approval criteria is proprietary

information. Rather, a franchisor should have to disclose only a general description of its

selection criteria.416 The staff agrees that the NPR is unnecessarily inconsistent with the UFOC

Guidelines. Under the UFOC approach, a franchisor need only disclose the general process for

approving or disapproving alternative suppliers, but not the exact selection criteria themselves. 

We recommend, therefore, that the Commission revise the proposed Rule to conform with the

UFOC Guidelines.417 

A few franchisee advocates maintained that the proposed NPR disclosure does not go far

enough. According to the AFA, it is insufficient to require a franchisor to disclose whether a

franchisee can purchase products from suppliers not affiliated with the franchisor:

Full and complete disclosure requires franchisees be told what really happens

when they bring a product/item to be approved under the franchisor’s approval

process. The following examples should be disclosed to the prospective

franchisee in Item 8: “We have been known to take up to one year or more to

approve a non-franchisor-affiliated vendor;” or “We have been known to change

the specifications for [specific product] during the approval process. This has

caused delays of between [number of days/weeks/months/years] to [number of

days/weeks/months/years].”

AFA, Comment 14, at 4.

Howard Bundy also suggested that franchisors should disclose the dollar amount of any

rebates received during some stated period, such as during the last year. The current UFOC

approach, adopted in the NPR, requires franchisors to disclose only the percentage of revenue

derived from such rebates. Words such as “‘only 1%’ may not alert the prospect to the reality

that it amounts to hundreds of thousands of dollars over a year of individual small transactions.” 

Bundy, Comment 18, at 8.418 Mr. Bundy also urged the Commission to require franchisors to

disclose whether participation in cooperatives is mandatory and the terms of such mandatory
 

419 64 Fed. Reg. at 57,305-06.

 

420 Duvall, ANPR 19, at 2. 

 

421 Id.

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participation. “Otherwise, it is possible to structure a cooperative so that the franchisor or one of

its officers has effective control and can use the cooperatives to extract extra money from the

franchisee that no one disclosed.” Id. at 8-9. 

We find some merit in the observations of these franchisee advocates. Nonetheless we

reject their suggestions that proposed Item 8 be expanded. In keeping with our goal of

minimizing federal and state differences, we do not believe these suggestions are so compelling

as to warrant deviating from UFOC Guidelines. 

K. Proposed Section 436.5(i)

Item 9: Franchisee’s Obligations

1. Background

In the NPR, the Commission proposed adopting UFOC Item 9.419 This disclosure gives 

prospective franchisees an easy-to-understand guide to 25 enumerated contractual obligations

that are common in franchise relationships, with references to the sections of the franchise

agreement and disclosure document that discuss each obligation in greater detail. There is no

counterpart in the current Rule.

2. The record and recommendations

Proposed Item 9 generated only a few comments. Gary Duvall maintained that the

disclosure is unnecessary. He would permit a franchisor to opt out of Item 9 if it provides

prospective franchisees with a detailed table of contents or index to their franchise agreement.420

On the other hand, Seth Stadfeld asserted that the disclosure does not go far enough: “As

currently structured, this disclosure is not worth the time and effort largely because it provides no

benefit to the prospect.” Stadfeld, Comment 23, at 14. He suggested that franchisors use a

remarks column to describe briefly the nature of each obligation. Id. Finally, J&G suggested

that the Item 9 disclosures should apply only to franchise agreements, but not to any

accompanying “licenses, leases, subleases, guarantees, security agreement, load documents,

software agreements, etc.” J&G, Comment 32, at 11. According to J&G, references to these

ancillary agreements are burdensome and of little value to prospective franchisees.421 

The staff recommends that the Commission adopt UFOC Item 9 in its entirety, as set

forth in the NPR. We believe that Item 9 serves a useful purpose. Franchisee complaints

submitted during the Rule amendment process tended to support the need for better pre-sale
 

422 E.g., 900 Number Rule, 16 C.F.R. § 308.7 (obligations concerning billing disputes);

Negative Option Rule, 16 C.F.R. § 425.1(a)(ii) (minimum purchase obligations); Door-to-Door

Sales Rule, 16 C.F.R. § 429.1 (obligations regarding cancellations); Warranty Disclosures, 

16 C.F.R. § 701.3(a)(5) (obligations to obtain performance).

 

423 The UFOC Guidelines clearly contemplate that franchisors should reference other

ancillary agreements, where appropriate. For example, the beginning of UFOC Item 9 reads: 

“Disclose the principal obligations of the franchisee under the franchise and other agreements

after the signing of these agreements.” The express reference to “other agreements” and the use

of the words “these agreements,” clearly indicates that the drafters directed franchisors to

reference all applicable agreements. We see no compelling reason to deviate from the UFOC

Guidelines in this instance.

 

424 See 64 Fed. Reg. at 57,306.

 

425 In the SBP, the Commission found that a prospective franchisee’s ability to obtain

sufficient funding on reasonable terms is a critical element in determining whether to enter into a

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disclosure about franchisees’ legal obligations and the nature of the franchise relationship. 

Proposed Item 9 is essentially a detailed table of contents to the franchise agreement, with the

additional benefit of cross references to the relevant sections of the disclosure document. It can

increase the likelihood that a prospective franchisee will actually find and review the contractual

provisions detailing their legal obligations, better ensuring that prospective franchisees

understand fully the nature of the franchise relationship. Further, proposed Item 9 is entirely

consistent with other trade regulation rules where the Commission has recognized that

information about legal risks to consumers is material.

422 Moreover, many franchisors already

use the UFOC Guidelines and prepare an Item 9 table. In addition, Item 9 should impose few

costs or compliance burdens because franchisors need only reference existing materials, most

likely the franchise agreement and disclosure document. To the extent that legal obligations are

spelled out in any ancillary agreements, it is reasonable for franchisors to direct prospects to

those provisions as well.423 

L. Proposed Section 436.5(j)

Item 10: Financing

1. Background

Consistent with Item 10 of the UFOC Guidelines, NPR Item 10 would require a

franchisor to disclose all the material terms and conditions of any financing agreements,

including the annual percentage rate, the number of payments, penalties upon default, and any

consideration received by the franchisor for referring a prospective franchisee to a lender.424 This

disclosure is similar to the comparable Rule disclosure provisions found at 16 C.F.R.

§ 436.1(a)(12).425 For the most part, proposed Item 10 is comparable to the disclosures lenders
franchise relationship. Accordingly, it concluded that it is both unfair and deceptive for a

franchisor to fail to disclose or misrepresent financing terms and conditions, and to fail to

disclose rebates received in connection with franchise financing. 43 Fed. Reg. at 59,659-60. 

Indeed, the Commission has long recognized that financing arrangements have the potential to

injure unsuspecting consumers and are therefore material. See Preservation of Consumers’

Claims and Defenses, 16 C.F.R. Part 433 (protecting consumer’s claims and defenses); Credit

Practices Rule, 16 C.F.R. Part 444 (restricting use of waivers, security interests, co-signers, late

charges). Cf. Fair Credit Reporting Act, 15 U.S.C. § 1681 et seq.

 

426 12 C.F.R. Part 213.

 

427 12 C.F.R. Part 226. 

 

428 The introduction to UFOC Item 10 makes clear that franchisors may provide this

information in summary table format, and Appendix A to the proposed Rule offers a sample

table.

 

429 We note, however, that the NPR included a footnote stating that franchisors need not

disclose in Item 10 payments due within 90 days on open account financing. 64 Fed. Reg. at

57,337 n.8. We recommend that this explanation be placed in the Compliance Guides. 

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must make under the Federal Reserve’s Regulation M (Consumer Leasing),426 and Regulation Z

(Truth in Lending).427 Proposed Item 10 would also extend the current Rule disclosure by

requiring franchisors to disclose any interest on the financing in terms of an annual percentage

rate, consistent with other consumer credit transactions. It would also require more disclosure

about what the financing covers, waiver of defenses, and the franchisor’s practice or intent to sell

or assign the obligation to a third party.428

2. The record and recommendations

Two commenters voiced concerns about Item 10, as proposed in the NPR. First, H&H

suggested that leases referred to in Item 10 should be called “‘finance leases,’ a well-established

term in commercial law.” H&H, Comment 9, at 18. Second, David Gurnick suggested that the

Rule permit negotiation of financial terms: “The franchisor should be expressly permitted to

disclose a range within each of the categories in the Item 10 table. The Commission may wish to

provide that if a franchisor negotiates financing terms, the franchisor must disclose that there are

other sources of financing, such as banks, which the franchisee should consider.” Gurnick,

Comment 21, at 6-7.

The staff recommends that the Commission adopt proposed Item 10, as set forth in the

NPR.429 While “finance leases” may be a term of art used in commercial law, we do not believe

that the UFOC Guidelines, upon which proposed Item 10 is based, are ambiguous or otherwise

unclear. Accordingly, we believe deviating from the UFOC Guidelines on this point is

unwarranted. Mr. Gurnick’s concern about negotiating franchise terms, however, has substantial
 

430 See 16 C.F.R. §§ 436.1(a)(17) and (18). The offer of business assistance is one of the

hallmarks of a franchise system. In the SBP, the Commission stated that promises of assistance

made to induce prospective franchisees to purchase a franchise are material, especially to those

prospects with “little or no experience at running a business.” 43 Fed. Reg. at 59,676-77. 

 

431 We believe that the purpose of Item 11 is not to explain the contract, but to give

prospective franchisees information with which to conduct a due diligence investigation of the

franchise offering. If for any reason a prospective franchisee finds the franchise agreement

unclear, or otherwise unfavorable, he or she need not sign it.

135

merit. We, therefore, recommend that the Commission explain in the Compliance Guides that

nothing in proposed Item 10 restricts the parties’ ability to negotiate over financing terms.

Finally, we also find merit in Mr. Gurnick’s suggestion that a franchisor who negotiates

financing terms should disclose that other sources of financing are available. However, we are

reluctant to expand the Rule to compel franchisors to dispense general advice, absent compelling

circumstances. Rather, we believe suggestions such as this one are best handled in Commission

consumer education materials.

M. Proposed Section 436.5(k)

Item 11: Franchisor’s Assistance, Advertising, Computer Systems, and

Training

1. Background

The Franchise Rule currently requires franchisors to disclose their obligations to

franchisees with respect to pre-opening assistance (e.g., site selection), as well as

ongoing assistance (e.g., training, and advertising).430 More comprehensive disclosures are found

in Item 11 of the UFOC Guidelines.

During the ANPR proceeding, two commenters raised concerns about UFOC Item 11,

upon which proposed Item 11 is based. UFOC Item 11 enables franchisors to describe their preopening contractual obligations in tabular form, with cross references to the corresponding

provisions of the contract. In that regard, it parallels proposed Item 9 (franchisee’s obligations),

described above. Harold Brown, a franchisee advocate, contended that short-hand references to

the contract “offend[s] the basic purpose of the disclosure statement, namely, to provide the

prospective franchisee with a reliably complete description of what is being purchased.” Brown,

ANPR 4, at 5. Mr. Brown urged the Commission to require a franchisor to provide prospective

franchisees with a more in-depth analysis of each of the franchisor’s obligations. Id.431

In addition, Harold Kestenbaum, a franchisor representative, raised a concern about the

disclosures for computer systems. UFOC Item 11 requires franchisors to disclose information

about the nature of their computer systems and any assistance available to franchisees concerning
 

432 64 Fed. Reg. at 57,306.

 

433 Our law enforcement experience demonstrates that misrepresentations about the level of

support and assistance is one of the most common problems in franchise cases. See Staff

Program Review at 24-26 (next to earnings claims, support problems are the second most

frequent issue raised by franchisee complainants). E.g., FTC v. Car Wash Guys Int’l, Inc., No.

00-8197 (C.D. Cal. 2000); FTC v. Indep. Travel Agencies of Am. Assoc., Inc., No. 95-6137-CIV

Gonzalez (S.D. Fla. 1995); FTC v. Sage Seminars, Inc., No. C95-2854-SBA (N.D. Cal. 1995);

FTC v. Skaife, Bus. Franchise Guide (CCH) ¶ 9555 (C.D. Cal. 1990).

Indeed, misrepresentations about support and assistance continue to be a source of

numerous franchisee complaints. For example, Marge Lundquist told us that her outlet failed, in

part, because the franchisor did not adhere to its own criteria in selecting a store. Based upon her

experience, she asserted that it is very important to have full disclosure on site selection criteria. 

Lundquist, ANPR, 22Aug97 Tr, at 45. See also Dady & Garner, ANPR 127, at 4; Mousey,

ANPR, 29July97 Tr, at 4-7.

 

434 See, e.g., Car Checkers of Am., Bus. Franchise Guide (CCH) ¶ 10,163 (misrepresenting

that advertising expenses would be minimal or low); U.S. v. Fed. Energy Sys., Inc., Bus.

Franchise Guide (CCH) ¶ 8,180 (C.D. Cal. 1984) (misrepresenting extent of company advertising

assistance); U.S. v. Ferrara Foods, Inc., Bus. Franchise Guide (CCH) ¶ 7,926 (W.D. Mo. 1983)

(misrepresenting availability of national media advertising). The issue of advertising funds

continues to generate concerns on the part of franchisees and their advocates. E.g., Brown,

ANPR 4, at 3 (favoring restrictions on franchisor’s unreasonable use of advertising funds);

Manuszak, ANPR 13 (franchisor refuses to account for use of franchisees’ advertising funds);

136

such systems. Mr. Kestenbaum did not disagree with the need for the disclosure, but noted that

many start-up franchisors are “not certain which computer system or software they expect to have

the franchisees use. Provision should be made for these new franchisors.” Kestenbaum, ANPR

40, at 2.

In the NPR, the Commission proposed expanding the current Rule provisions in several

respects, consistent with the UFOC Guidelines.432 First, proposed Item 11 would alert

prospective franchisees that the franchisor is not obligated to provide any assistance except as

specified in the disclosure document. This alert is necessary to counter any oral

misrepresentations to the contrary and to correct any misconception on the prospective

franchisee’s part that some degree of assistance is inherent in each franchise offer.433

 

Second, the NPR would require a franchisor to explain in greater detail the franchisor’s

site selection criteria, as well as the nature of the franchisor’s training program. It would also

require additional disclosures concerning the extent of advertising assistance and the operation of

local, regional, and national advertising co-ops. These disclosures address a common franchisee

complaint, namely, that franchisees do not get the quality or quantity of advertising they pay

for.434 
Weaver, ANPR 17 (no discretion of use of advertising funds); Rachide, ANPR 32

(mismanagement of advertising funds); Colenda, ANPR 71 (alleging inappropriate use of

advertising payments); Zarco & Pardo, ANPR 134, at 5 (“A franchisor should be required to

disclose the extent of its veto power over the allocation of any franchisee-generated funds, such

as advertising cooperatives.”). 

 

435 In response to the ANPR, a few commenters voiced concerns about obligations to

purchase computers or related equipment. E.g., Fetzer, ANPR, 19Sept97 Tr, at 42 (needed to

purchase a computer converter, an additional $7,000 expense); Rafizadeh, ANPR, 7Nov97 Tr, at

292 (GNC unilaterally forcing franchisees to pay a new $80 monthly maintenance fee on

computer equipment purchased from GNC). See also NCA 7-Eleven Franchisees, ANPR 113, at

2 (noting 7-Eleven’s use of “point-of-sale” cash registers, which enable headquarters to monitor

sales).

 

436 64 Fed. Reg. at 57,338.

 

437 Id. at 57,306 and 57,330.

 

438 In addition to these comments, the AFA urged the Commission to require a disclosure

about the extent to which franchisors can withhold assistance from its franchisees. It suggested

the inclusion of the following statement: “Your franchisor, regardless of what it has told you,

reserves the right to receive your [number] percentage royalty [gross margin] payment while

providing you with absolutely no franchise services.” AFA, Comment 14, at 5. While we agree

with the AFA that contractual obligations are generally separate and distinct under the common

law of contracts, we believe that this is another example of an issue that is best addressed through

consumer education.

 

439 Baer, Comment 11, at 13; J&G, Comment 32, at 11; Marriott, Comment 35, at 15-16.

137

Third, proposed Item 11 would address major technological changes in franchising since

the Rule was promulgated in the late 1970s. Specifically, it would entail greater disclosure about

the required use of computers and electronic cash registers.435 For example, it would require

franchisors to disclose whether they will have independent access to information and data stored

on electronic cash register systems or software programs.436 On the other hand, the Commission

expressed concern that the detailed disclosures concerning computer systems may not provide

adequate guidance to start-up systems. The Commission solicited additional comment on

whether the proposed Item 11 computer disclosures are unduly burdensome, particularly on startup systems, and it solicited alternative disclosures.437

2. The record and recommendations

Proposed Item 11's computer system disclosures generated six comments.438 Some

franchisors asserted that the computer system disclosures are burdensome and not helpful to

prospective franchisees.439 Marriott, for example, explained that its Item 11 computer usage
 

440 H&H, Comment 9, at 23.

138

disclosure “results in four to five pages of disclosure in each of Marriott’s offering circulars yet

provides little or no benefit to the franchisee.” Marriott, Comment 35, at 15-16. These

commenters also maintained that the Item 11 computer disclosures are unnecessary because the

costs associated with purchasing computers and related equipment are already disclosed in Items

5, 7, and 8.

This view, however, was not universally shared by all franchisor representatives. 

According to BI, the disclosures for cash registers and computers are not unduly burdensome for

franchisors, including start-up franchisors. “In such instances, [start-up] franchisors simply

provide disclosure as to current and possible future requirements.” BI, Comment 28, at 11.

Further, one franchisee advocate, Howard Bundy, disputed the view that computer system

disclosures are immaterial. According to Mr. Bundy, it is important for a prospective franchisee

to know what equipment they will have to purchase, as well as maintenance and upkeep costs. A

franchisor could comply with Item 11 by simply stating that it has not yet selected a computer

system, but intends to do so in the future. Mr. Bundy asserted that this uncertainty creates an

issue the prospective franchisee should consider. He further described how a franchisor could

comply with the Rule:

The franchisor might go on to articulate some guidelines it will follow in selecting

a system – for example, franchisee input, non-proprietary operating systems,

security concerns, remote access, and similar matters. A franchisor might even

place a monetary cap on the cost of the system to the franchisee. Thus, even

without knowing what precise hardware and software he or she would be required

to invest in, the franchisee learned a lot – most importantly that the franchisor is

not yet computerized, in itself placing the franchisee at a disadvantage in many, if

not most, industries. With full disclosure, even the absence of information, the

franchisee can make an informed decision.

Bundy, Comment 18, at 9. 

Further, as an alternative to the current UFOC Guidelines computer systems disclosures,

two commenters offered similar proposals. H&H suggested that a franchisor should be required

to disclose the specifications of any mandatory computer system to the extent known or

available. The firm agreed that start-up franchisors may not have identified software systems

before they start franchising. The firm suggested that a franchisor should be permitted to satisfy

the Item 11 requirements by disclosing that specifications are not known or available.440 In a

similar vein, John Baer suggested that: 

[i]f the Commission believes this type of detailed information is useful, the

proposed Franchise Rule should be revised to provide simply that the franchisor

disclose in writing to the prospective franchisee prior to signing the contract the
 

441 As suggested above, we also recommend that the Compliance Guides make clear that a

start-up franchisor can indicate that computer requirements are yet unknown, or otherwise state

its policy concerning computer usage, as is warranted.

 

442 In addition to the recommended modification of the Item 11 computer disclosures, we

also recommend a minor clarification of the Item 11 disclosures regarding the franchisor’s

operating manual. Under the UFOC Guidelines, a franchisor must disclose the table of contents

of its operating manual unless “the prospective franchisee views the manual before purchase of

the franchise.” UFOC Guidelines, Item 11, at B. vii. Because a franchisor is not likely to know

whether a prospective franchisee has in fact viewed the manual, we can assume that many

franchisors will elect to disclose the table of contents in all instances. Rather, to make this option

meaningful, we believe the franchisor should be able to opt out of this disclosure if it provides a

prospective franchisee with the opportunity to review the operating manual.

139

electronic cash registers, computer equipment and software that will be required

to be used in the franchisee’s business.

Baer, Comment 11, at 13.

We are persuaded that proposed Item 11's computer systems disclosures serve a useful

purpose. There is no question that prospective franchisees should be informed of the costs to

purchase or lease computer and related equipment or software, as well as any continuing

maintenance or upgrade obligations and their associated costs. We also believe that prospective

franchisees should understand before the purchase whether the franchisor will have access to

information stored on computers or electronic cash registers. Such access very likely would be a

key component of the relationship between the franchisor and franchisee. 

Nonetheless, the computer usage disclosures as set forth in the UFOC Guidelines appear

to go beyond what is material in most instances and may impose unwarranted compliance

burdens. Specifically, we are disinclined to require a franchisor to identify each and every piece

of hardware and software by brand, type, and principal function, or to identify compatible

equivalents and whether they have been approved by the franchisor. We agree with the

commenters who noted that some franchisors (start-up franchisors in particular) may not have

decided upon specific systems at the time of sale or, even if they did, that the technology very

likely will change over the course of the franchise agreement. Thus, the compliance burden to

prepare component-specific disclosures may not be outweighed by any tangible benefits to

franchisees. We believe that it should suffice for franchisors to describe generally the computer

systems to be used, if any; any required purchase and maintenance costs and obligations; and

whether the franchisor will have access to information contained in those systems.441 This

information not only will enable prospects to weigh the costs and benefits of purchasing a

specific franchise, but will better enable prospects to learn if they will be at a technological

disadvantage compared to other franchise systems in the industry.442
 

443 64 Fed. Reg. at 57,339. See also 16 C.F.R. §§ 436.1(a)(3) and (a)(13). In the SBP, the

Commission recognized that sales restrictions and limited territories impact upon a franchisee’s

ability to conduct business and are, therefore, material. 43 Fed. Reg. at 59,662. See, e.g., U.S. v.

C.D. Control Tech. Inc., Bus. Franchise Guide (CCH), ¶ 9851 (E.D.N.Y. 1985); U.S. v. Fed.

Energy Sys, Inc., Bus. Franchise Guide (CCH) [1983-85 Transfer Binder] ¶ 8180 (C.D. Cal.

1984); FTC v. Nat’l Bus. Consultants, Inc., Bus. Franchise Guide (CCH) ¶ 9,365 (E.D. La.

1989). Cf. FTC v. Vendors Fin. Serv., Inc., No. 98-N-1832 (D. Colo. 1998); Int’l Computer

Concepts, Inc., Bus. Franchise Guide (CCH) ¶ 10,513; O’Rourke, Bus. Franchise Guide (CCH)

¶ 10,243; FTC v. Am. Safe Mktg., Inc., Bus. Franchise Guide (CCH) ¶ 9,350 (N.D. Ga. 1989).

 

444 See UFOC Item 12, Instructions ix, and Sample Answer 12-1.

140

N. Proposed Section 436.5(l)

Item 12: Territory

1. Background

In the NPR, the Commission proposed retaining the current disclosures concerning

exclusive territories and sales restrictions.443 Consistent with the UFOC Guidelines, however,

proposed Item 12 would expand these disclosures in several respects, including requiring a

franchisor to disclose: (1) the conditions, if any, under which it will approve the relocation of the

franchisee’s business and the franchisee’s establishment of additional outlets; (2) any restrictions

on a franchisee from conducting business outside of his or her territory; and (3) any present plans

to operate a competing franchise system offering similar goods or services. In addition, proposed

Item 12 would warn prospects about the consequences of purchasing a non-exclusive territory,

namely, that the franchisor may establish other franchised or company-owned outlets that may

compete with the prospective franchisee’s location.444 

2. The record and recommendations

Throughout the Rule amendment process, the territory disclosures have generated a

number of concerns. First, franchisees and their advocates have complained about

“encroachment,” the practice by which a franchisor essentially competes with its franchisees by

establishing franchisor-owned or new franchised-outlets in the same market territory, or by

selling the same goods through alternative channels of distribution. In other instances,

franchisors may compete with their franchisees by purchasing and operating a competing

franchise system. Second, some commenters asserted that the UFOC Item 12 territory

disclosures do not go far enough. They would like to see Item 12 require franchisors to disclose

more information about their past expansion practices, as well as future expansion plans. Third,

some commenters questioned the language used to describe territories, urging the Commission to

avoid implying that a protected territory is inherent in the concept of franchising. Finally, several

commenters offered different views on the form of the proposed warning. We discuss each of

these issues below.
 

445 E.g., Brown, ANPR 4, at 2; Packer, ANPR 10; Manuszak, ANPR 13; Donafin, ANPR 14;

Weaver, ANPR 17; Rachide, ANPR 32, at 3; AFA, ANPR 62, at 1; Orzano, ANPR 73; Buckley,

ANPR 97, at 3; Marks, ANPR 107, at 2; Zarco & Pardo, ANPR 134, at 2.

 

446 For example, Laurie Gaither, an owner of a GNC franchise, reported that the company

opened a franchisor-owned outlet in a mall within two miles from her store. She claimed that

this development has reduced her profits by 50%. L. Gaither, ANPR 68.

 

447 64 Fed. Reg. at 57,306-07.

 

448 In response to the NPR, no commenter questioned the basic assertion that franchisors

should disclose information about protected territories.

141

a. Encroachment

During the Rule Review and ANPR proceedings, franchisees and their advocates

complained about “encroachment.”445 They contended that encroachment may have a

devastating effect upon an individual franchisee who does not have a contractually protected

exclusive territory.446 One particular commenter, a Supercuts franchisee, expressed the issue this

way:

Over the past five years, my Franchisor has changed its focus from “Parent of

Franchisees” to “operator of company owned stores.” The Franchisor is now

opening company owned stores to compete with its own Franchisees. In this way,

the Franchisor cashes in on the name recognition built by the very Franchisees its

predatory practices now harm. This practice is predatory because the primary

banner under which the Franchisor solicited our money and legal commitment

was the growth and well-being of the Franchisee body. But the opening of

company owned stores to the detriment of established, successful Franchisee

locations demonstrates that existing Franchisees live in a marketplace where, if

they are successful, the Franchisor will invariably find the temptation to enter the

market as a competitor to[o] great to resist. At that point, the constructive

agreements which described the initial relationship no longer protect the

Franchisee from the challenges of the better financed Franchisor with in-house

legal staffs. 

Packer, ANPR 10. Franchisees and their advocates maintained that encroachment is an abusive

and unfair trade practice that should be banned under Section 5 of the FTC Act.

In the NPR, the Commission recognized that proposed Item 12 is one of the most

important disclosure items, preventing fraud and misleading statements concerning protected

territories and competition.447 To address “encroachment,” the Commission proposed adopting

the UFOC Item 12 approach, requiring franchisors to disclosure any rights a franchisee may have

to an exclusive territory.448
 

449 Absent an express grant of a protected territory, a franchisor is generally free to establish

as many outlets (franchisor-owned or franchised) in any particular market as it wishes. A few

state courts (or federal courts applying state law), however, have held that encroachment violates

state implied covenants of good faith and fair dealing. See, e.g., In re Vylene Enterprises, Inc.,

90 F.3d 1472 (9th Cir. 1996).

 

450 For a discussion of the statutory “unfairness” criteria, see above at section III.A.

 

451 Staff Program Review at 59. 

 

452 Staff Program Review, Chart E.2, at 25. See also id. at 39 (Commission complaints in

franchise and business opportunity law enforcement actions during the relevant period contained

10 allegations of exclusive territory misrepresentations). 

142

We continue to recommend that the Commission address issues involving territories

through pre-sale disclosure. Whether or not a franchisee should have a protected territory is

fundamentally a contractual matter for the parties to determine for themselves.449 While the

record establishes franchisees’ concerns about encroachment, there has been no showing made

that either a franchisor’s expansion within a franchisee’s territory or a franchisor’s failure to

grant protected territories in their franchise agreements constitutes an “unfair” practice, as

“unfairness” is defined in Section 5 of the FTC Act.450 First, the level of harm to individual

franchisees as a result of encroachment is far from clear. The Staff Program Review, for

example, found only isolated instances of “encroachment” reported to the Commission during

1993-2000. In analyzing franchise complaints allegations, the staff found only six specific

encroachment allegations.451 In addition, five franchisee complaints alleged “no promised

locations,” and an additional five alleged “misrepresented exclusive territory.”452 Second, there

is no record suggesting that harm to individual franchisees as a result of encroachment outweighs

potential benefits (expansion of markets and increased consumer choice) to consumers or to

competition. Finally, prospective franchisees can avoid potential harm from encroachment by

shopping for a franchise opportunity that offers an exclusive territory. For these reasons, the

Commission lacks the statutory authority necessary to deem “encroachment” a per se unfair

practice in violation of Section 5, or to take the drastic step of intervening in private franchisorfranchisee relationships to dictate specific contractual terms regarding territories.

b. Scope of the disclosure

During the ANPR proceeding, a few commenters suggested that the Commission 

broaden the scope of proposed Item 12. Specifically, these commenters urged the Commission to

require greater disclosures about the franchisor’s past and future plans to expand markets. For

example, Andrew Selden, a franchisee representative, suggested that “Item 12 should be

elaborated to require full disclosure of past practice, current intention or future possibility of
 

453 See also Dady & Garner, ANPR 127, at 4 (“Explicit statements about the nature and

extent of protection against same-brand competition that will or will not be provided is essential

to an informed buying decision.”).

 

454 64 Fed. Reg. at 57,330.

 

455 Bundy, Comment 18, at 9.

 

456 See also Wendy’s, Comment 5, at 2; Baer, Comment 11, at 13 ; Lewis, Comment 15, at

15; BI, Comment 28, at 11; J&G, Comment 32, at 12; GPM Rebuttal, Comment 40, at 6.

 

457 We also find no compelling reason to deviate from the UFOC Guidelines to broaden the

scope of the Rule to require more expanded disclosures covering competition by officers and

franchise sellers, as some would suggest. This is particularly true in the absence of evidence in

the record demonstrating that officer and franchise sellers competition is a prevalent problem

resulting in demonstrated injury to franchisees.

143

franchisor-sponsored competitive activities that have the prospect of impacting the franchisee’s

business.” Selden, ANPR 133, Appendix B.453 

In the NPR, the Commission declined to broaden Item 12 as suggested, but solicited

additional comment on whether franchisors should disclose current expansions plans, as well as

the costs and benefits of such a disclosure.454 In response, Howard Bundy urged the Commission

to require franchisors to disclosure not only competition by the franchisor, but by affiliates, the

franchisor’s officers, and franchise sellers. According to Mr. Bundy, it is much more likely that

such persons will be involved in competitive activities compared to the franchisor itself.455

Without exception, franchisors addressing this issue opposed any disclosure of their

current development plans. H&H’s comment is typical. Most franchisors consider current

development plans to be proprietary information “that would place them at a competitive

disadvantage if they were to be made publicly available.” H&H, Comment 9, at 23. The firm

also stressed that franchisors need flexibility to adapt development plans to market realities. 

“Disclosure of development plans could lead to possible claims by franchisees who anticipated

greater or lesser franchise development in a particular area.” Id.456

We recommend that the Commission reject suggestions to broaden Item 12. Disclosure

of past expansion practices, in particular, is unwarranted. Prospective franchisees arguably can

discover such information on their own by directly observing the number and location of outlets

in their community and by speaking with current and former franchisees. Moreover, past

practices are not necessarily a predictor of future intent. We also believe that it is unreasonable

to require franchisors to disclose hypothetical possibilities about their future expansion. Indeed,

by not granting an exclusive territory, the franchisor has effectively reserved to itself the

unrestricted right to expand into new or existing locations or to sell its products or services via

alternative channels of distribution.457
 

458 For example, Dr. Spencer Vidulich, a Pearle Vision franchisee, told us that many

franchisees were not told that Pearle Vision was going to be purchased by a competing optical

chain. “Had they known they were going to be in competition with their franchisor, many of

them may have thought differently about purchasing stores. At the very least, I think that would

have been information that may have figured into their equation of buying stores.” Vidulich,

ANPR, 22Aug97 Tr, at 17. See also Gray, ANPR 22 (franchisor sold to competitor); Doe,

ANPR, 7Nov97 Tr, at 268-70 (franchisor sold to larger company that is now competing in the

same market).

 

459 E.g., Wendy’s, Comment 5, at 2.

144

Whether a franchisor should disclose more information about any current policy to

develop a franchisee’s market area presents a more difficult issue. With respect to expansion, the

UFOC Guidelines require a franchisor to disclose only if the franchisor “may establish” other

outlets in the area; it does not require the franchisor to disclose its specific plans for the

franchisee’s territory. Franchisors need to elaborate on their expansion plans only if they have

“present plans to operate or franchise a business under a different trademark and that business

sells goods or services similar to those to be offered by the franchisee.” UFOC Item 12C.

(emphasis added). 

We recognize that prospective franchisees are very likely interested in the franchisor’s

expansion plans and the competition such expansion may bring. Indeed, the prospective

franchisee’s profit levels and ultimately their ability to succeed in business may be tied to

competition in their location. While a prospective franchisee may be able to measure existing

competition by visiting the intended outlet’s location, he or she is unlikely to be able to

determine the franchisor’s plans to develop the market or otherwise to compete with its

franchisees.458 

We are convinced, however, that a franchisor’s development plan is proprietary

information that a franchisor should not be required to make public.459 A requirement to disclose

such information in fact might harm the franchise system, including its existing franchisees, by

discouraging the very expansion and development contemplated. It could also subject

franchisors to future liability for fraud or misrepresentation should the franchisor alter, abandon,

or delay its stated expansion plans. Further, requiring a franchisor to disclose plans to develop a

territory may be costly and burdensome because the franchisor conceivably would have to

prepare multiple Item 12 disclosures to focus on each franchise location. The disclosures already

contained in Item 12 are sufficient to warn prospects about likely competition because any

prospective franchisee who buys a franchise without any protected territory is essentially taking

the risk that the franchisor will further develop the market area.

Nonetheless, the staff recommends that the Commission update the scope of the Rule’s

territory disclosures to address changes in the marketplace, such as ecommerce and alternative

channels of distributing the franchisor’s goods. Currently, the Rule focuses on the extent to

which a franchisee has exclusive rights to a particular geographic location and competition from
 

460 16 C.F.R. § 436.1(a)(13).

 

461 E.g., PRM&W, Comment 4, at 11.

145

franchised or company-owned outlets.460 Proposed Item 12's focus on potential competition from

other outlets is, therefore, potentially misleading because it fails to disclose the extent to which a

franchisor may compete with a franchisee through alternative means, in particular through the

Internet.461 Accordingly, we recommend that the Commission broaden Item 12 of the NPR for

the limited purpose of providing prospective franchisees with material information about

competition not only through outlets within the prospective franchisee’s intended location, but

through alternative channels of distribution, such as the Internet, catalog sales, telemarketing, and

other direct marketing. 

To that end, we recommend that the Commission revise Item 12 to require franchisors to

disclose, among other things, the franchisor’s right to conduct business within the franchisee’s

territory, including through traditional and alternative methods of distribution, such as though the

Internet, catalog sales, telemarketing, or other direct marketing sales. Similarly, the franchisor

would disclose any restrictions on the franchisee from conducting business outside of his or her

territory through traditional sales and alternative channels of distribution. We believe the

amended proposal strikes the correct balance between the franchisor’s right to maintain

proprietary information and the prospective franchisee’s right to know the limitations of the

franchise they may purchase. 

c. Market area

In the NPR, the Commission proposed that franchisors disclose information “concerning

the franchisee’s market area with or without an exclusive territory.” It also referred to the

franchisee’s “defined area.” 64 Fed. Reg. at 57,339. Several commenters raised concerns about

the use of these terms.

First, BI opposed the use of the term “exclusive territory,” urging the Commission to use

the term “protected territory” instead. “We believe ‘protected territory’ is simply more

descriptive of a franchisee’s typical contractual rights regarding its territory, if any. . . . 

[E]xclusive . . . is ambiguous and often misleading.” BI, Comment 28, at 6. Similarly, the firm

opposed the use of the term franchisee’s “market area.” It maintained that the term “market area”

is undefined and imprecise. Id. at 6-7. BI would prefer the word “location.” 

The NFC agreed, asserting that the term “market area” is a “charged word.” NFC,

Comment 12, at 29. According to the NFC, under franchisee agreements, franchisees have, at

most, a right only to a specified location or narrowly defined geographic area. Use of “market

area” may advance the false notion that the grant of a franchise inherently “confers upon a

franchisee exclusive rights within the franchisee’s economic ‘market area,’ despite the terms of
 

462 See also J&G, Comment 32, at 12.

 

463 See also id.

 

464 See, e.g., UFOC Item 12 (“Describe any exclusive territory granted the franchisee.

Concerning the franchisee’s location (with or without exclusive territory, disclose . . .”). See also

NASAA Comparison at Item 12.

 

465 64 Fed. Reg. at 57,330.

 

466 Baer, Comment 11, at 13. See also NFC, Comment 12, at 30.

146

the subject franchise agreement.” Id.462 Similarly, the NFC opposed the use of the term “defined

area.” In its view, the appropriate term should be “limited protected territory,” noting that an

area is almost never granted unconditionally by a franchisor. The NFC advised us that by using

the phrase “limited protected territory” in lieu of “defined area,” the Commission could “actually

reduce the misconception which otherwise may be engendered in the minds of prospective

franchisees over what territorial protections, in any, they can expect to receive.” Id. at 30.463

The staff agrees that the language of proposed Item 12 could be clearer. The term

“market area” could inaccurately imply an inherent right to a territory, where, in fact, the right to

a territory, protected or otherwise, is purely a matter of contract. We also recognize that some

commenters opposed the use of the term “exclusive territory.” However, that is the term used in

the UFOC Guidelines,464 and we see no compelling reasons to deviate from its use in the revised

Rule. In conclusion, we recommend that in the final revised Rule the Commission substitute the

words “location” or “exclusive territory” for “market area,” “area,” and “defined” area, as

appropriate.

d. Warning

In the NPR, the Commission supported the inclusion of the following warning in the Item

12 disclosure where franchisors do not offer protected territories: “You will not receive an

exclusive territory. [Franchisor] may establish other franchised or franchisor-owned outlets that

may compete with your location.” 64 Fed. Reg. at 57,339. At the same time, the Commission

inquired into the adequacy of the proposed warning and solicited alternatives.465

Comments on the NPR’s proposed warning were mixed. John Baer, for example, opined 

that the proposed warning is adequate to alert prospects about potential competition from within

the system.466 Others, however, advised that the warning, as drafted, has the potential for

misleading prospects because it narrowly focuses on competition within the franchisee’s

location, but ignores potentially more significant competition from other sources, such as the

Internet, direct mail, and mail order: 
 

467 See, e.g., J&G, Comment 32, at 12. See also IL AG Rebuttal, Comment 38, at 3.

 

468 Indeed, several franchisee advocates urged the Commission to strengthen the existing

UFOC Guidelines’ encroachment risk factor. For example, Robert Zarco suggested that

franchisors be required to state: 

The company reserves the right to increase the number of franchised or companyowned units in an area. In the past, we have been known to put another outlet in

close proximity to an existing unit. This action generally has a negative impact on

the gross and/or net sales of the pre-existing unit.

Zarco & Pardo, ANPR 134, at 2. See also Dady & Garner, ANPR 127, at 3 (suggesting: “You

have no protected area. Your franchisor, without any compensation to you, may place another

store in a location that may completely erode your profitability.”).

 

469 See UFOC Item 12, Sample Answer 12-1.

147

[W]hat about competition from alternative channels of distribution, such as mail

order or Internet sales, or competition from an affiliated company using a different

brand name for a similar or competitive concept? Do these alternative forms of

competition render a territory something less than “exclusive”? Such competition

may actually have more impact than the development of a new same-brand outlet

near the franchisee’s outlet.

PMR&W, Comment 4, at 11.467 PMR&W offered the following alternative warning: “You will

not receive an exclusive territory. You may face competition from other franchisees or

franchisor-owned outlets or from other channels of distribution or competitive brands that we

control.” Id.

Given the potential financial risks associated with a non-protected territory, the staff

believes that franchisors who offer no exclusive territory should warn prospective franchisees

about the consequences.468 While we generally disfavor the use of warnings that merely repeat

what is already expressly stated in the franchise agreement, we believe that a specific warning

regarding exclusive territories is warranted in light of franchisee complaints regarding territory

issues. Moreover, this approach is entirely consistent with the UFOC Guidelines.469

Nonetheless, we agree that the warning should be broad enough not only to cover competition

directly in the territory, but from other sources. Accordingly, we recommend that the

Commission adopt the language offered by PMR&W, as noted above.
 

470 64 Fed. Reg. at 57,307.

 

471 16 C.F.R. § 436.1(a)(1)(iii).

 

472 UFOC Guidelines Item 13 provides that if the mark is not registered, the franchisor must

include the following warning: “By not having a Principal Register federal registration for (name

or description of symbol), (Name of Franchisor) does not have certain presumptive legal rights

granted by a registration.” UFOC Item 13A, Instructions, iii. We doubt many prospective

franchisees will understand this provision, in particular the phrase “presumptive legal rights.” 

Accordingly, we propose substituting the following simpler warning: “Our trademark is

unregistered. Therefore, our right to use the trademark may be challenged. If so, franchisees

may have to change to an alternative trademark, which may increase your operating costs.”

148

O. Proposed Section 436.5(m)

Item 13: Trademarks

1. Background

In the NPR, the Commission proposed expanding the disclosure of trademark

information.470 Under the current Rule, a franchisor need only note its trademark.471 Consistent

with the UFOC Guidelines, proposed Item 13 would extend the current Rule by requiring

franchisors to disclose whether the trademark is registered with the U.S. Patent & Trademark

Office;472 the existence of any pending litigation, settlements, agreements, or superior rights that

may limit the franchisee’s use of the trademark; and any contractual obligations to protect the

franchisee’s right to use the mark against claims of infringement or unfair competition.

2. The record and recommendations

Only one commenter voiced any concern about proposed Item 13, as proposed in the

NPR. Howard Bundy suggested that franchisors should disclose not only pending trademark

litigation, but all such litigation in the last 10 years. “Lets close the loop and require disclosure

of any material adverse trademark litigation outcomes, including settlements and arbitration

awards.” Bundy, Comment 18, at 9.

Based upon the record, the staff recommends that the Commission adopt proposed Item

13, as set forth in the NPR, with two minor corrections consistent with the UFOC Guidelines. 

As a preliminary matter, we believe the NPR’s proposed expansion of the trademark disclosures

is consistent with the Commission’s long-standing policy of requiring franchisors to disclose the

material costs and benefits of the franchise sale. One of the principal reasons that a consumer

may wish to purchase a franchise – as opposed to starting their own business – is the right to use

the franchisor’s mark, which presumably creates an instant market for the franchisee’s goods or
 

473 In the SBP, for example, the Commission noted that a key feature of franchising is the

right to use the franchisor’s trademark. 43 Fed. Reg. at 59,623.

 

474 The proposed Item 3 litigation disclosure provision ordinarily does not address trademark

litigation. Similarly, the proposed Item 9 and 11 disclosures concerning franchisor obligations

do not address the franchisor’s obligation to defend the trademark.

 

475 See NASAA Comparison, at 17.

 

476 See also id.

149

services.473 For that reason, trademark usage is one of three definitional elements of the term

franchise. Any pending litigation, settlement restrictions, or other potential limitations on the use

of the trademark are material because they will necessarily affect the value of the trademark to a

prospective franchisee and ultimately may impact upon the franchisee’s ability to continue

operating the business.474

Nonetheless, we would modify proposed Item 13 in two respects. First, the NPR

proposed that franchisors disclose how any infringement, opposition, or cancellation proceeding

“affects the franchised business.” 64 Fed. Reg. at 57,339. This is unnecessarily inconsistent

with the wording of the UFOC Guidelines, which state “affects the ownership, use, or licensing”

of the trademark.475 Second, the NPR included a footnote addressing the use of summary

opinions of counsel: “Franchisors may include a summary opinion of counsel concerning any

action if a consent to use the summary opinion is included as part of the disclosure document.” 

64 Fed. Reg. at 57,339. The footnote, however, did not address the discretionary use of a full

opinion letter, nor the need to attach the full opinion letter if a summary is used. On this point,

the UFOC Guidelines state:

The franchisor may include an attorney’s opinion relative to the merits of

litigation or of an action if the attorney issuing the opinion consents to its use. 

The text of the disclosure may include a summary of the opinion if the full

opinion is attached and the attorney issuing the opinion consents to the use of the

summary.

UFOC Guidelines, Item 13B Instructions, v.476 We recommend that the Commission adopt the

UFOC Guidelines’ language in both instances.

We reject, however, the assertion made by Mr. Bundy that prior trademark litigation is

necessarily material to prospective franchisees. What influences an investment decision is

whether there are any current restrictions or disputes over the trademark license. Obviously, any

existing trademark restrictions or challenges not only may decrease the value of the mark and the

goodwill associated with it, but may increase franchisees costs if they must switch to a different

mark. The fact that the franchisor may have been involved in trademark litigation in the past is 
 

477 On this issue, the UFOC Guidelines specifically note that a franchisor need not disclose

historical challenges to registrations of trademarks that were resolved in the franchisor’s favor. 

UFOC Guidelines, Item 13B Instructions, iv.

 

478 64 Fed. Reg. at 57,307-08.

 

479 Restrictions on the use of the franchisor’s intellectual property are material because they 

not only may seriously diminish the value of the franchise, but could undermine the franchisee’s

ability to operate the business. Proposed Item 14 also may improve the relationship between

franchisors and franchisees by preventing any misunderstanding about the value or use of the

franchisors’ intellectual property.

 

480 See NASAA Comparison, at 20.

150

not inherently material.477 Accordingly, we believe that there is no compelling reason to deviate

from the UFOC Item 13 model in this instance.

P. Proposed Section 436.5(n)

Item 14: Patents, Copyrights, and Proprietary Information

1. Background

In the NPR, the Commission proposed adopting UFOC Item 14, ensuring that franchisors

disclose information about their intellectual property.478 Specifically, proposed Item 14 would

require franchisors to describe in general terms the types of intellectual property involved in the

franchise and any legal proceedings, settlements, and restrictions that may impact the

franchisee’s ability to use such intellectual property. There is no comparable disclosure

provision in the current Rule.479

2. The record and recommendations

In response to the NPR, no commenters raised any concerns about proposed Item 14. 

Accordingly, the staff recommends that the Commission adopt proposed Item 14, as drafted in

the NPR, with one minor charge. Specifically, we recommend that the Commission revise the

provision concerning the use of a counsel’s opinion. Proposed NPR Item 14 referred only to a

summary opinion. Consistent with the UFOC Guidelines and proposed Item 13 above, the Rule

should state: “If counsel consents, the franchisor may include a counsel’s opinion or a summary

of the opinion if the full opinion is attached.”480
 

481 64 Fed. Reg. at 57,308. See 16 C.F.R. § 436.1(a)(14). In the SBP, the Commission noted

that the degree of personal participation required of a franchisee is a material fact in the franchise

relationship. Accordingly, the omission of such information is an unfair or deceptive practice in

violation of Section 5. 43 Fed. Reg. at 59,663. 

151

Q. Proposed Section 436.5(o)

Item 15: Obligation to Participate in the Actual Operation of the

Franchise Business 

1. Background

As proposed in the NPR, Item 15 would require franchisors to disclose whether

franchisees are required to participate personally in the direct operation of the franchise.481 

Consistent with UFOC Item 15, proposed Item 15 would expand the current Rule disclosures by

requiring franchisors to disclose: (1) participation obligations arising not only from the parties’

franchise agreement, but from other agreements or as a matter of practice; (2) whether direct

participation is recommended; and (3) any limitations on whom the franchisee can hire as a

supervisor and any restrictions that the franchisee must place on his or her manager. If the

franchisee operates as a business entity, the franchisor must also disclose the amount of equity

interest, if any, that the supervisor must have in the franchise.

2. The record and recommendations

Proposed Item 15 generated one comment. NASAA urged the Commission to consider

expanding Item 15 to “include operating hours and the method used by franchisors to notify

franchisees of changes in required operating hours.” NASAA, Comment 17, at 4. While we

believe NASAA’s suggestion has merit, we are reluctant to recommend that the Commission

adopt it. While information about operating hours may be useful information for prospective

franchisees, we do not believe that the need for a new disclosure is so compelling as to justify an

inconsistency between the Rule and UFOC Guidelines on this issue. We conclude, therefore,

that the Commission should retain Item 15, as proposed in the NPR.

R. Proposed Section 436.5(p)

Item 16: Sales Restrictions

1. Background

Proposed Item 16 would retain the current Rule’s disclosures on sales restrictions. Like

other Rule provisions addressing how a franchisee may conduct business, it requires franchisors

to disclose any restrictions limiting the goods or services that the franchisee may offer for sale or
 

482 64 Fed. Reg. at 57,308. See also 16 C.F.R. § 436.1(a)(13). In the SBP, the Commission

recognized that sales restrictions are material because they can limit the scope of the franchisee’s

market and ultimately the franchisee’s profitability. 43 Fed. Reg. at 59,661. The proposed sales

restriction disclosures are comparable to other Commission trade regulation disclosures

concerning restrictions on the use of goods and services. E.g., Telemarketing Sales Rule, 16

C.F.R. § 310.3(a)(1) (requiring disclosure of all material restrictions, limitations, or conditions to

purchase, receive, or use the goods or services); Negative Option Rule, 16 C.F.R.

§ 425.1(a)(1)(ii) (requiring disclosure of post-sale minimum purchase requirements); Disclosure

of Warranty Terms and Conditions, 16 C.F.R. § 701.3(a)(8) (requiring material disclosures of

limitations and exclusions on warranty coverage).

 

483 64 Fed. Reg. at 57,308.

 

484 In the SBP, the Commission stated that the terms and conditions of the franchise

relationship – such as those governing transfers, renewals, and terminations – are material

because they “may limit what the franchisee may do with his or her capital asset.” 43 Fed. Reg.

at 59,664. Given the length and complexity of the typical franchise agreement, prospective

152

the customers to whom a franchisee may sell.482 Consistent with UFOC Item 16, proposed Item

16 would also extend the current Rule disclosures by requiring a franchisor to disclose whether

the franchisor has the right to change the types of goods and services authorized for sale, as well

as any limits on the franchisor’s right to make such changes. These disclosures better enable a

prospective franchisee to understand the extent to which the franchisor has the contractual right

to control sales, which may directly affect the prospect’s ability to conduct business, its

independence from the franchisor, and ultimately, its profitability.

2. The record and recommendations

In response to the NPR, no commenters raised any concerns about proposed Item 16. The

staff, therefore, recommends that the Commission adopt proposed Item 16, as set forth in the

NPR.

S. Proposed Section 436.5(q)

Item 17: Renewal, Termination, Transfer, and Dispute Resolution

1. Background

In the NPR, the Commission proposed adopting UFOC Item 17, which requires

franchisors to summarize in tabular form 23 enumerated terms and conditions of a typical

franchise relationship, such as the duration of the franchise agreement, rights and obligations

upon expiration of the franchise agreement, post-term covenants not to compete, and assignment

and transfer rights.483 For each category, the franchisor must reference the applicable franchise

agreement provisions and briefly summarize the governing terms.484 This approach would
franchisees may overlook, or do not fully appreciate, such terms and conditions. Id. Indeed, as

noted above at section III, the overwhelming number of ANPR comments were submitted by

franchisees voicing various franchise relationship concerns. These relationship concerns support

the continuing need for complete and clear disclosure about the basic franchise relationship terms

and conditions.

 

485 See 16 C.F.R. § 436.1(a)(15) (requiring franchisors to describe 14 categories of terms and

conditions).

 

486 E.g., AFA, Comment 14, at 5; Bundy, Comment 18, at 4; Karp, Comment 24, at 20-21;

Morrell, Comment 31, at 2; Bores, ANPR 9, at 1; Rachide, ANPR 32; Chabot, ANPR 37; Rich,

ANPR 65; Orzano, ANPR 73; Geiderman, ANPR 131; Karp, ANPR, 19Sept97 Tr, at 83;

Chiodo, ANPR, 21Nov97 Tr, at 303-04. 

153

greatly streamline the Rule, which currently requires franchisors to detail the rights and

obligations already spelled out in the franchise agreement.485 It should also reduce compliance

burdens, while providing prospective franchisees with a detailed road map to the contract, where

they can read the various provisions in greater detail. At the same time, proposed Item 17 would

extend the current Rule by requiring dispute resolution disclosures, including any arbitration or

mediation requirements, as well as forum-selection and choice of law provision disclosures.

2. The record and recommendations

Most of the comments submitted on proposed Item 17 concerned the use of the term

“renewal.” Franchisee advocates asserted that the term “renewal” is misleading. In their view,

the term implies that a franchisee, upon expiration of the franchise term, can continue operating

the franchise under substantially similar terms and conditions. They observed, however, that

franchisees who wish to continue operating their franchises at the end of the franchise term must

often sign new contracts that impose substantially different terms and conditions, such as higher

royalty payments or the elimination of an exclusive territory. They asserted that franchisees, in

many instances, have no choice but to sign even the most abusive, one-sided renewal contracts

because they have a substantial economic investment in their franchises and simply cannot walk

away without incurring significant economic loss.486 Worse, when a franchisee does walk away,

he or she is often bound by a covenant not to compete, which restricts his or her ability to operate

a similar business for a number of years. For example, the AFA stated:

“Renewal” is a misnomer. “Re-license,” “rewrite” or even “re-franchise” is a

more accurate description of what actually happens at the end of the initial

contract term. Most franchisees find that when it is time to “renew,” they are not

“renewing” their existing franchise agreement, but are entering into a wholly new

franchise agreement, often with materially different financial and operational

terms. They are presented these “renewal” contracts on a “take it or leave it” basis

and are under enormous coercion pressures to sign – especially if the old
 

487 One franchisee, John Rachide, suggested that during renewal, franchisors should be

required to disclose copies of all contracts currently being used. “This would allow prospective

and renewing franchisees the opportunity to learn the real world environment of the franchisor’s

system.” Rachide, ANPR 32, at 4. Under the current and proposed Rule, an existing franchisee

would receive disclosures only if he or she enters into a new franchise relationship under

materially different terms and conditions. See, e.g., Final Interpretive Guides, 44 Fed. Reg. at

49,969. However, a renewing franchisee, like a prospective franchisee, would receive only a

copy of the specific contract that would govern his or her relationship with the franchisor. The

staff believes that Mr. Rachide’s suggested disclosure requirement would be overly burdensome,

requiring franchisors to add multiple exhibits to what already can be a lengthy disclosure

document. Moreover, franchisees seeking to extend their contracts or enter into a new contract

upon expiration can readily speak with other existing franchisees to discover the variations

among the franchisor’s contracts. 

 

488 The staff also notes that various franchise contracts examined in the course of franchise

investigations routinely state the renewal will be pursuant to the “then current franchise

agreement.” Use of this or comparable phrases should put prospective franchisees on notice that

the terms and conditions under which they will operate their franchise may change if granted a

renewal upon expiration of the original agreement.

 

489 J&G, Comment 32, at 13.

 

490 Tricon, Comment 34, at 6-7.

154

agreement contains a post-termination covenant not to compete. This is truly

“holding a gun to the head” of the “renewing” franchisee.

AFA, ANPR 62, at 2.487

The view that the term “renewal” may be inappropriate was supported by some franchisor

representatives. The NFC, for example, told us that the term “renewal” is somewhat ambiguous: 

it could mean either “a simple extension of the existing agreement under the same terms or – as

is far more common – the grant of a ‘successor franchisor’ under the terms being offered at the

time that the existing agreement expires.” NFC, Comment 12, at 30.488 However, the NFC did

not believe that the term “renewal” is misleading, and it was uncertain whether the ambiguity

compels a revision of the Rule. On the other hand, J&G asserted that the term is potentially

misleading,489 and Tricon urged the Commission to avoid its use entirely.490

Several commenters, however, maintained that the term “renewal” is clear and requires

no modification. For example, John Baer stated that “renewal” is a term of art in franchising and

should not be changed. He also observed that the various state relationship laws use that term

and “to revise it for disclosure purposes is likely to cause more confusion than clarity.” Baer,

Comment 11, at 13. Seth Stadfeld, a franchisee advocate, agreed, explaining that the term
 

491 Stadfeld, Comment 23, at 15-16. See also NaturaLawn, Comment 26, at 2.

155

“renewal” refers to the relationship between the franchisor and franchisee, not to the underlying

contract. He also shared Mr. Baer’s concern that the term is used in state relationship statues and

should not readily be changed.491

Several commenters suggested that the Commission adopt various disclosures or

warnings for prospective franchisees that would explain the concept of renewal in greater detail. 

The IL AG, for example, suggested that franchisors make the following statement: “You should

learn what changes in your agreement might occur and what rights you have when your contract

expires. Renewal may change important contract terms.” IL AG, Comment 3, at 7. Similarly,

the AFA urged the Commission to include the following warning:

You do not own your own business. You are leasing the rights to sell our

goods/services to the public under our trade name. At the end of your initial

[number of years] term, your current contract will expire [terminate]. You will

have the choice of signing a new contract written by us at the time of expiration 

[termination]. The new contract will be written by us with no input from you and

will contain materially different financial and operational terms.

AFA, Comment 14, at 5. Howard Bundy suggested that franchisors explain the consequences of

a renewal, by including a statement akin to the following:

[Franchisor] does not agree to continue your franchise agreement on the same

terms and conditions after the end of the initial term. As a condition of remaining

a franchisee, [franchisor] may require you to agree to a different territory, to a

change in mandatory or prohibited goods or services, to change vendors, to pay

additional or different fees, to make additional capital investments, and otherwise

to agree to disadvantageous contract terms. If you cannot or will not agree to the

new terms, you may lose substantially all of your investment. Because there is an

agreement to not compete with [the franchisor] you may not be able to continue in

the same line of business.

Bundy, Comment 18, at 5.

Based upon the record, the staff recommends only a modest revision of proposed Item 17.

We continue to believe that the term “renewal” is a franchising term of art. It generally means

that upon the expiration of a contract, the franchisees may have the right to enter into a new

contract, where different terms and conditions may apply. Additionally, as several commenters

noted, the term “renewal” is used in various state relationship laws, in addition to the UFOC

Guidelines. In light of that background, we are reluctant to recommend changing that term,

thereby introducing a conflict between federal and state approaches.
 

492 An example of a renewal explanation may include a statement such as: “If you seek to

renew your franchise agreement upon expiration, your contract terms and conditions are likely to

change significantly,” or “Upon expiration, you will be offered the opportunity to sign a new

franchise agreement with the then current terms and conditions. Be aware that these terms and

conditions may be different from those in your original agreement.”

 

493 64 Fed. Reg. at 57,309.

 

494 In the SBP, the Commission stated that this information is material because it helps

prospective franchisees understand the extent of any financial and managerial commitments from

the public figure, as well as any obligations to the public figure. Prospective franchisees can then

decide for themselves whether an association with a public figure is valuable to them. 43 Fed.

156

Regardless, it is clear that many prospective franchisees may not appreciate the legal

import of the term “renewal.” As Mr. Bundy noted, franchisees often are surprised to discover

that “renewal” means the continuation of their franchise relationship under potentially vastly

different terms. We are reluctant, however, to substitute another word, such as “re-license.” A

prospective franchisee may be just as prone to misinterpret the substitute language (e.g., 

“re-license”) as the term “renewal.” It short, any term may be misleading if prospective

franchisees fail to understand the underlying concept that a franchisor may require a change in

contract terms and conditions upon expiration of the original agreement as a condition of

renewal.

To address the issue of renewals, we recommend that the Commission revise Item 17

slightly to require franchisors to explain their renewal policy in the summary field for provision

(c) (requirements for franchisee to renew or extend). If applicable, the franchisor would also

state that “franchisees may be asked to sign a contract with different terms and conditions than

their original contract.” While we are reluctant to add consumer education notices to the

disclosure document, especially where the UFOC Guidelines require no parallel notice, we

believe it is warranted in this case given the continued concern raised by franchisee advocates

and others. We do not suggest any particular form of explanation because that will depend upon

the individual policies of each franchisor. Nonetheless, we propose to offer several examples in

the accompanying Compliance Guides.492

T. Proposed Section 436.5(r)

Item 18: Public Figures

1. Background

Consistent with UFOC Item 18, proposed Item 18 would require franchisors to disclose

the involvement of a public figure in the franchise system, including his or her management

responsibilities, total investment made in the franchise system, and compensation, if any.493 This

section is substantially similar to the current Rule provision found at 16 C.F.R. § 436.1(a)(19).494
Reg. at 59,677-78.

 

495 H&H, Comment 9, at 18.

 

496 Of the franchisees who participated in the Rule Review and ANPR proceedings, only one

voiced concerns about a public figure. Dianne Mousley purchased a Mike Schmidt’s

Philadelphia Hoagies franchise, in part based upon the representation that Mike Schmidt, a

former baseball player, would be actively involved in the franchise system. However, 

Ms. Mousley’s primary concerns did not involve Mr. Schmidt. Rather, she complained about

delays in constructing the store and lack of promised training and support. See generally,

Mousley, 29July97 Tr, at 1-32.

 

497 It is possible that the Rule itself discourages the use of public figure endorsers. Arguably,

franchisors would rather avoid the use of public figures than incur the compliance costs and

disclosure burdens imposed by the Rule’s public figure disclosure provisions.

157

2. The record and recommendations

In response to the NPR, two commenters questioned the utility of the proposed

disclosure. H&H noted that this Item is seldom, if ever, applicable and urged the Commission to

delete it.

495 Howard Bundy agreed, proposing instead that the space be used for more important

issues: “It would make more sense to elevate the renewal issue, the gag order issue, and the

integration clause issue, and perhaps even the arbitration clause issue to full Item status and

move the public figure information elsewhere.” Bundy, Comment 18, at 10. 

The staff agrees that proposed Item 18 is arguably the least important disclosure item. 

Since the Rule was promulgated in the late 1970s, the Commission has brought no action under

the Rule or Section 5 alleging misrepresentations about a public figure’s involvement in a

franchise system. Further, the staff rarely, if ever, receives complaints on this issue.496 

Nonetheless, the disclosure is material in those instances, rare though they may be, when

a public figure creates his or her own franchise system or when a franchisor uses a public figure

pitchman.497 Conceivably, a celebrity’s involvement in, or endorsement of, a franchise system

could create the impression that the franchise is a less risky investment. In that instance, the

public figure disclosures are material and their potential benefits to prospective franchisees

would outweigh their costs. To that limited degree, these disclosures still serve a useful purpose. 

On balance, we find no compelling reason to justify deviating from the UFOC Guidelines on this

point.
 

498 64 Fed. Reg. at 57,309-10. In the SBP, the Commission found that one of the most

frequent abuses occurring in the marketing of franchises is the use of deceptive past and potential

franchise sales, income, and profits claims. Indeed, the Commission stated that the “use of

deceptive and inaccurate profit and loss statements by franchisors has resulted in a legion of

‘horror stories.’” 43 Fed. Reg. at 59,684.

 

499 16 C.F.R. §§ 436.(1)(b)(2); (1)(c)(2); 1(e)(2); UFOC Guidelines, Item 19A.

 

500 16 C.F.R. §§ 436.1(b)(3); 1(c)(3); 1(e)(5)(i); UFOC Guidelines, Item 19B. 

 

501 16 C.F.R. §§ 436.1(b)(4); 1(c)(5); 1(e)(5)(iii); UFOC Guidelines, Item 19B Instructions,

(c).

 

502 16 C.F.R. §§ 436.1(b)(1); 1(c)(1). 

 

503 Id. at §§ 436.1(b)(5)(i); 436.1(c)(6)(i); 436.1(e)(5)(ii). 

 

504 Id. at §§ 436.1(c)(4); 436.1(e)(2). 

 

505 64 Fed. Reg. at 57,310.

158

U. Proposed Section 436.5(s)

Item 19: Financial Performance Representations

1. Background

Perhaps the most important anti-fraud disclosure, proposed Item 19 of the NPR, addresses 

the making of financial performance representations.498 Both the current Rule and UFOC

Guidelines permit, but do not require, franchisors to make such representations under limited

circumstances. Among other things, the franchisor must have a reasonable basis for the

representation499 and disclose the basis and assumptions that underlie the representation.500

Franchisors also must include an admonition that a prospective franchisee’s actual earnings may

differ.501 Under current Commission law, a financial representation must also be geographically

relevant to the market where the offered franchise is to be located,502 the franchisor must state the

number and percentage of those franchisees who have actually earned the claimed amount in the

stated time frame,503 and any historical financial performance claims must be based upon

Generally Accepted Accounting Principles (“GAAP”).504

As proposed in the NPR, Item 19 would harmonize the current Rule approach with the

UFOC Guidelines approach in several respects. First, it would eliminate the current Rule’s

requirement that franchisors provide prospective franchisees with a separate earnings claims

document.

505 Rather, any performance claims and their substantiation would appear in the text of

the disclosure document. Second, the Commission proposed eliminating the current requirement

that all financial performance claims be geographically relevant to the franchise offered for
 

506 Id. 

 

507 UFOC Guidelines, Item 19 Instructions i.

 

508 Id. at Item 19 Instructions ii.

 

509 64 Fed Reg. at 57,310.

 

510 Id. at 57,341 n.13.

 

511 Id. at 57,311

 

512 Among other things, staff sought information on: (1) the extent to which franchisors

provide financial performance information; (2) the extent to which financial performance

information is available to franchisors and whether such information is reliable and accurate; 

(3) the extent to which current Rule and UFOC Guidelines provisions may inhibit franchisors

from disclosing financial performance information; and (4) whether the Commission should

consider mandating a uniform, national financial performance disclosure standard. 60 Fed. Reg.

at 17,658-59.

 

513 62 Fed. Reg. at 9,118

159

sale.506 Third, proposed Item 19 would permit franchisors, under specific circumstances, to

disclose, apart from the disclosure document, the actual operating results of a specific unit being

offered for sale.507 Finally, proposed Item 19 would permit franchisors to furnish supplemental

performance information directed at a particular location or circumstance.508

At the same time, proposed Item 19 of the NPR would differ from the UFOC Guidelines

in three ways. First, it would revise the substantiation required for historical financial

performance, permitting greater disclosure of financial information about subsets of franchisorowned or franchised outlets.509 Second, proposed Item 19 would retain the current Rule

requirement that historical performance claims be prepared according to GAAP.510 Third, it

would require franchisors to include specific preambles in Item 19 that, among other things,

would warn prospective franchisees not to rely on unauthorized performance claims.511

2. The record and recommendations

a. Voluntary financial performance disclosures 

During the Rule Review, the staff raised the issue whether the Commission should

mandate the disclosure of financial performance information.512 After considering the comments,

the Commission stated in the subsequent ANPR that it was inclined to leave financial

performance disclosures voluntary.513 While the Commission recognized that financial

performance information is material to prospective franchisees, it rejected mandating such
 

514 Id. 

 

515 Quoting several business texts, Mr. Karp asserted that historical financial performance

information is critical to any evaluation of a business. Internal Revenue Service Ruling 59-60,

Item D, for example, provides that: “detailed profit and loss statements should be obtained and

considered for a representative period immediately prior to the required date of appraisal,

preferably five or more years.” According to Mr. Karp, the failure of franchisors to disclose

historical performance information deprives prospects of material information that is essential in

evaluating the franchise offering. Karp, ANPR, 19Sept97 Tr, at 100-03.

 

516 See ANPR, 62 Fed. Reg. at 9,118. See also Brown, ANPR 4, at 4; SBA Advocacy,

ANPR 36, at 8; Purvin, ANPR 79; Lagarias, ANPR 125, at 1-2; Dady & Garner, ANPR 127, at

1-2; and Selden, ANPR 133, at 1-2 and Appendix C; Lundquist, ANPR, 22Aug97 Tr, at 46-47.

160

disclosures in favor of a free market approach. The Commission noted that approximately 20%

of franchisors choose to make financial performance disclosures and that prospective franchisees,

in theory, can find franchise systems that voluntarily disclose such information. “If prospective

franchisees were to seek out such franchise systems, or demand the disclosure of such

information from franchisors, ordinary market forces may compel an increasing number of

franchisors to disclose earnings information voluntarily, without Federal government

intervention.” 62 Fed. Reg. at 9,118. 

The Commission also observed that prospective franchisees can obtain financial

performance information from a variety of sources. “For example, typical expenses, such as

labor and rent, may be available from industry trade associations and industry trade press.” Id.

In addition, prospective franchisees are free to discuss earnings and other financial performance

issues with former and current franchisees. Perhaps most important, the Commission noted that

the record does not provide a sufficient basis for the Commission to formulate a financial

performance disclosure that would both be useful and not misleading to prospective franchisees. 

Finally, the Commission noted that mandating financial performance disclosures might impose

burdens and costs on existing franchisees without any support in the record showing that such

increased burdens and costs are outweighed by benefits to prospective franchisees.514

In response to the ANPR, franchisees and their advocates maintained that: 

(1) performance information is the most material information prospective franchisees need to

make an informed investment decision;515 (2) franchisors already have performance information

and it is a deceptive omission for them to fail to disclose this information; (3) franchisors are in

the best position to collect and disseminate performance information; (4) a mandated financial

performance disclosure will reduce the level of false and unsubstantiated oral and written

financial performance claims; and (5) more disclosure regarding performance will benefit the

marketplace and competition.516
 

517 E.g., Duvall, ANPR 19, at 2; Kaufmann, ANPR 33, at 7; Tifford, ANPR 78, at 5; Jeffers,

ANPR 116, at 5. See also 7-Eleven, Comment 10, at 3 (suggesting that a typical franchisor

would be hard-pressed to generate financial performance information without “very extensive

and significant effort.”).

 

518 See also AFA, ANPR 62, at 4; IL AG, ANPR 77, at 2; IFA, ANPR 82, at 3.

 

519 Cendant, ANPR 140, at 2. 

 

520 Franchisees continued to argue that performance information is material, that mandating

performance disclosures will curb deceptive or false performance claims already being made, and

that it is a material omission for franchisors to fail to disclose performance information they

possess. See, e.g., AFA, Comment 14, at 2; Bundy, Comment 18, at 1-2; Karp, Comment 24, at

24-25; Morrill, Comment 31, at 1. In their view, prospects also need historical financial

performance information in order to conduct a due diligence investigation of the franchise

offering. E.g., Karp, Comment 24, at 24. On the other hand, franchisors continued to oppose

mandatory financial performance disclosures, maintaining that performance information obtained

from franchisees is often unavailable or unreliable, that mandating performance disclosures will

161

Franchisors and their advocates, in contrast, uniformly opposed mandatory financial

performance disclosures. They contended that: (1) it is impossible for the Commission to create

a single performance disclosure format that will be relevant for all industries; (2) not all

franchisors have the contractual right to collect extensive financial information with which to

prepare a performance disclosure; (3) financial performance data collected from existing

franchisees is not necessarily complete and accurate; (4) a mandatory performance disclosure will

be misinterpreted as a guarantee of future performance, thus increasing litigation; and (5)

mandating financial performance disclosures will have a negative impact upon the franchisorfranchisee relationship.517

In addition, a few commenters urged the Commission to coordinate its financial

performance disclosure policy with NASAA to promote uniformity. For example, John Tifford

stated: “Federal and state regulators must develop a coherent and compatible earnings claim

policy in order to ensure that franchisors will not be exposed to risks caused by inconsistent and

uncoordinated federal and state policies.” Tifford, ANPR 78, at 6.518 On the other hand,

Cendant, representing several major franchise systems, suggested that the FTC prohibit states

from mandating financial performance disclosures by preempting the field.519

In the NPR, the Commission adopted the same approach as in the ANPR. It reiterated its

belief that “financial performance disclosures should remain voluntary and that ordinary market

forces are sufficient to provide an incentive for franchise systems to make performance

information available to prospective franchisees.” 64 Fed. Reg. at 57,310. In general, no new

arguments were raised in response to the NPR either supporting or opposing the mandatory

financial performance disclosures.520
increase litigation, and that prospects can often obtain financial information directly from current

and former franchisees. See, e.g., PMR&W, Comment 4, at 2; H&H, Comment 9, at 13; 7-

Eleven, Comment 10, at 3; NFC, Comment 12, at 11; IFA, Comment 22, at 10; AFC, Comment

30, at 2; J&G, Comment 32, at 6; Marriott, Comment 35, at 11; GPM, Comment 40, at 6-7.

 

521 See, e.g., FTC v. Minuteman Press, Int’l, 93-CV-2494 (DRH) (E.D.N.Y.) (1998 Order)

(finding that the making of false gross sales and profit representations to prospective franchisees

was pervasive in the Minuteman and Speedy Sign-A-Rama franchise systems). See also, e.g.,

FTC v. Car Wash Guys, Int’l, No. 00-8197 (C.D. Cal. 2000); FTC v. Tower Cleaning Sys, No. 96

58 44 (E.D. Pa. 1996); FTC v. Majors Med. Supply, No. 96-8753-Zloch (S.D. Fla. 1996); FTC v.

Indep. Travel Agencies of Am. Assoc., No. 95-6137-CIV-Gonzalez (S.D. Fla. 1995); FTC v.

Mortgage Serv. Assoc., No. 395-CV-1362 (AVC) (D. Conn. 1995); FTC v. Robbins Research

Int’l, Inc., No. 95-CV-627-H(AJB) (S.D. Cal. filed May 16, 1995); FTC v. Sage Seminars, Inc., 

No. C95-2854-SBA (N.D. Cal. filed Aug. 10, 1995). See generally, Vidulich, 22Aug97 Tr, at

18-19; Marks, 19Sept97 Tr, at 2-3; Fetzer, 19Sept97 Tr, at 40-41. 

 

522 64 Fed. Reg. at 57,310. 

162

Based upon the record, the staff continues to recommend that financial performance

representations remain voluntary. In reaching this conclusion, we recognize that false or

misleading financial performance claims represent the most common allegation in Commission

franchise law enforcement actions.521 However, there is no assurance that mandating

performance claims will in fact reduce the level of false claims. Indeed, a mandated financial

performance requirement might have the unintended effect of forcing honest franchisors to

disclose financial information that they believe is unreasonable, incomplete, or inaccurate, while

doing little to deter franchisors bent on misrepresenting their performance history. In addition,

mandating financial performance disclosures is not cost free. Such a requirement would impose

substantial new accounting, data collection, and review costs on all franchise systems, while

potentially exposing existing franchisees, upon whose data the franchisor would rely, to more

extensive audits. In addition, existing franchisees might be subject to potential liability for

indemnification should a franchisor relying on the franchisees’ performance data be found to

have violated the Rule by failing to furnish accurate financial performance data. No new data,

policies, or arguments have been raised in response to the NPR that would lead us to a different

conclusion. Accordingly, for the reasons articulated in the ANPR and NPR, we are persuaded

that financial performance representations should remain voluntary, consistent with the current

Rule and UFOC Guidelines.

b. Geographic relevance and subgroups

In the NPR, the Commission proposed eliminating the current geographic relevance

requirement for financial performance representations.522 This would make the Rule’s financial
 

523 The UFOC Guidelines, for example, permit a franchisor selling a franchise in Florida to

disclose that franchised outlets in urban areas of Oregon and Washington have averaged a

specific profit level. The current Rule, however, does not permit such a performance disclosure

because it is not geographically relevant to the prospective franchisee’s territory – Florida. 

 

524 64 Fed. Reg. at 57,310-11.

 

525 Id.

163

performance disclosure requirements consistent with the UFOC Guidelines.523 At the same time,

the Commission proposed revising the current requirement that franchisors disclose the number

and percentage of existing outlets known to have attained a represented performance level.524 

The current number and percentage disclosure may be misleading and may actually

discourage franchisors from furnishing financial performance information. Under the Rule and

UFOC Guidelines, a franchisor must compare the number of franchisees who have performed at

a claimed level against all franchisees in its system, not just against franchisees it has measured

or against franchisees in a subgroup:

For example, a franchisor may have statistics showing that 9 out of 10 franchised

stores in a particular location (such as Seattle) average $100,000 net profit a year. 

Yet, the current UFOC and Rule requirements would prevent the franchisor from

disclosing truthful information about the universe the franchisor has measured –

the 10 franchised outlets in Seattle. Rather, the franchisor would be forced

instead to state 9 out of the entire number of all franchises nationwide (e.g., 9 out

of 1,000) have earned the $100,000 claimed.

64 Fed. Reg. at 57,311. This approach can mislead a prospective franchisee because it suggests

that the franchisor has in fact measured the financial performance of all franchisees, when that

may not be true. It also may deflate franchisees’ actual performance record. More important, a

franchisor may decline to include performance information in its UFOC if, in order to do so, it

must first incur the expense of conducting a system-wide franchisee performance analysis.

Instead, the Commission proposed in the NPR that franchisors be permitted to disclose 

truthful financial performance information about a subgroup of existing franchisees, provided

that the information has a reasonable basis and the franchisor discloses: (1) the nature of the

universe of outlets measured; (2) the total number of outlets in the universe measured; (3) the

number of outlets from the universe that were actually measured; and (4) any characteristics of

the measured outlets that may differ materially from the outlet offered to the prospective

franchisee (e.g., location, years in operation, franchisor-owned or franchisee-owned, likely

competition).525
 

526 See also Baer, Comment 11, at 13.

 

527 IL AG, Comment 3, at 7.

 

528 PMR&W, Comment 4, at 12-13. 

 

529 Mr. Baer, however, questioned the usefulness of a disclosure regarding competition in the

market area. Id. We note that an existing subgroup of franchisees in a particular location may

differ considerably from an offered site in another location in terms of likely competition,

making it difficult to compare the two. For example, it could be misleading for a franchisor to

use as a test market a rural location with few competitors, if it is selling units in an urban

environment. If a franchisor wants to disclose financial data from the rural location, it may do so

(assuming it is truthful), but it must also disclose the differences in competition that set the units

apart.

164

The NPR proposal generated several, mostly favorable, comments. For example,

according to BI:

[T]he omission of the geographic relevancy requirement represents the removal of

a substantial impediment to franchisors who might wish to provide financial

performance data to prospective franchisees, because it will lower the obstacles to,

and cost of, compiling the data necessary to produce a meaningful representation. 

We believe it is unlikely to have any material effect on the quality of such

representation, as geographic relevancy is often quite attenuated.

BI, Comment 28, at 11.526 On the other hand, the IL AG voiced concern that eliminating the

geographic relevance requirement would not prevent franchisors from “cherry picking” their best

performing franchise locations and then allowing prospects to assume that their performance

results will be similar.527

Other commenters addressed the proposed substantiation requirements for franchisee

subgroups. PMR&W urged the Commission to re-examine the need for the proposed subset

disclosures set forth in the NPR. The firm did not necessarily disagree with the requirements in

principle, but stated that they may deter the dissemination of financial performance

information.528 This view, however, was not universally held. John Baer, and others, maintained

that the proposed disclosures for subgroups “provide franchisors with sufficient guidance about

what characteristics of the outlets must be disclosed and how they may differ materially from

outlets offered to a prospective franchisee.” Baer, Comment 11, at 14.529 Similarly, Marriott

observed that allowing disclosure of subgroup performance is laudable “especially when

franchisors are frequently adopting new business strategies which may result in different

[financial performance representations], depending upon whether the old or new system format is

followed by the franchisees.” Marriott, Comment 35, at 11.
 

530 See 64 Fed. Reg. at 57,342 and n.15.

 

531 We believe the same would hold true for footnote 16 of the NPR, which addresses

franchisors’ obligation to make available written substantiation for any financial performance

representations.

165

Finally, H&H raised a related issue regarding subgroups. Footnote 15 of the NPR states

that a historical financial performance representation would have a reasonable basis if it is

representative of the usual experience of the system’s outlets or a subset of those outlets. The

footnote adds that a representation would not have a reasonable basis if, for example, only a

small minority of the stated set of franchisees earn such an amount, if profits were due to

nonrecurring conditions, or if the franchisees used inconsistent systems for reporting financial

performance information.530 Focusing on the last part (“if the franchisees used inconsistent

systems”), H&H maintained that this statement is too restrictive, asserting that a franchisor might

be able to overcome inconsistent franchisee statements to prepare a reliable financial

performance representation. “The burden of the reasonableness of such a representations lies

with the franchisor, and the FTC should permit a franchisor to judge what information it is

willing to rely on.” H&H, Comment 9, and 13-14. H&H urged the Commission to change the

language of the footnote to read “may not have a reasonable basis.” Id.

Based upon the record, we are convinced that the geographic relevance requirement,

coupled with the requirement that franchisors disclose number and percentage data based upon

all of their outlets, is unnecessarily restrictive, preventing franchisors from sharing material,

truthful performance information about subgroups of existing franchisees. Our recommendation

to eliminate the geographic relevance requirement and revise the disclosures for subgroups will

remove obstacles to making financial performance data available to prospective franchisees,

while preventing franchisors from “cherry picking” their best locations. Specifically, the

proposal will ensure that franchisors disclose how they derived the performance results of

subgroups, so that prospective franchisees can assess for themselves the sample size, the number

of franchisees responding, and the weight of the results. In addition, these provisions will better

ensure that prospects do not draw unreasonable inferences by requiring franchisors to disclose

the material differences between the subgroup-units tested and the units being offered. Finally,

we agree with H&H that a franchisor should be permitted to show the reasonableness of financial

performance information even if the contributing franchisee data are inconsistent. We

recommend modifying the discussion of the reasonableness of historical financial performance

representations, as H&H suggested. In an effort to streamline the Rule, however, we would

remove the footnote from the Rule and place it in the Compliance Guides, where it can be

addressed in greater detail.531
 

532 64 Fed. Reg. at 57,341 and n. 13. See also 16 C.F.R. §§ 436.1(c)(4) and 436.1(e)(2).

 

533 See SBP, 43 Fed. Reg. at 59,691.

 

534 See also PMR&W, Comment 4, at 12; H&H, Comment 9, at 13; NFC, Comment 12, at

31; Lewis, Comment 15, at 15; Snap-On, Comment 16, at 3; J&G, Comment 32, at 7; Marriott,

Comment 35, at 12; IL AG Rebuttal, Comment 38, at 5.

166

c. GAAP

In the NPR, the Commission proposed that the Rule retain the current requirement that

historical financial performance data be prepared according to GAAP.532 The Commission

adopted the current GAAP requirement to address concerns about the validity of franchisee

financial statements used by franchisors to make historical financial performance

representations.533 Not only may some franchisees understate profits, but each could have his or

her own accounting system. “Differences between franchisees also occur due to such factors as

variations in the drawing accounts of principals, fringe benefits of principals, salaries charged to

income, and preparation of statements on a cash rather than an accrual basis.” SBP, 43 Fed. Reg.

at 59,691. To minimize the potential dangers inherent in using franchisee performance data, the

Commission determined that historical performance claims and the data underlying them must

have been prepared according to GAAP.

Without exception, the commenters who addressed this issue opposed the GAAP

requirement. For example, NASAA advised that GAAP goes beyond what the UFOC Guidelines

require and would discourage the making of financial performance representations:

Based upon the experience of states that register franchise offerings, many

franchisors that currently include historical financial performance data in UFOC

Item 19 may not prepare them according to GAAP. In some instances, a

franchisor’s historical financial performance data presented may be accurate and

material, yet may not be presented according to GAAP. In many other instances,

the franchisor may not be aware whether the data presented is according to

GAAP. This requirement would discourage franchisors that have a factual basis

for making financial performance disclosures from doing so. In addition, this

requirement likely would increase costs to franchisors who do choose to make

historical financial performance disclosures by requiring them to obtain an

accountant’s opinion as to whether their data is presented according to GAAP.

NASAA, Comment 17, at 5.534

Based upon the record, we are convinced that the GAAP requirement is unnecessary and

may impede franchisors’ ability to disclose performance information, to the detriment of both

franchisors and prospective franchisees. GAAP is one, but not the exclusive approach, to
 

535 We continue to believe that earnings projections prepared in compliance with American

Institute of Certified Public Accountants’ standards for financial forecasts are presumed to be

reasonable. This policy was set forth in footnote 14 to the NPR. In an effort to streamline the

Rule, we propose that this policy be placed in the Compliance Guides.

 

536 64 Fed. Reg. at 57,311.

 

537 E.g., CA BLS, ANPR 124, at 1; Lagarias, ANPR 125, at 4. See also H&H, ANPR 28, at

8; SBA Advocacy, ANPR 36, at 8; AFA, ANPR 62, at 5; Purlin, ANPR 79, at 2; Jeffers, ANPR 

116, at 5.

 

538 E.g., FTC v. Minuteman Press, Int’l, No. 93-CV-2494 (DRH) (E.D.N.Y.) (1998). See

also 64 Fed. Reg. at 57,311; ANPR, 62 Fed. Reg. at 9,118.

 

539 As proposed in the NPR, the first preamble would read:

The FTC’s Franchise Rule permits a franchisor to provide information about the

actual or potential financial performance of its franchised and/or franchisor-owned

outlets, if there is a reasonable basis for the information, and if the information is

included in the disclosure document. Financial performance information that

differs from that included in Item 19 may be given only where: a franchisor

167

ensuring the accuracy of historic performance data. Franchisors making historical performance

representations should have the flexibility to formulate such representations, provided that such

representations are reasonable. Indeed, franchisors always have the burden to establish that any

financial performance representations are reasonable. Moreover, it is apparent that some

franchisors using the UFOC format have disseminated non-GAAP compliant historical

performance representations, without concern on the part of the states. Finally, eliminating the

GAAP requirement might reduce compliance burdens, while bringing greater uniformity to

federal and state disclosure law.535 

d. Preambles

In the NPR, the Commission proposed that franchisors include preambles in their Item 19

disclosures providing prospective franchisees with information about the dissemination of

financial performance data.536 This proposal would address two concerns. First, there is

evidence in the record that some franchisors falsely state that the Commission or the Franchise

Rule prohibits franchisors from making financial information available.

537 Second, our law

enforcement experience tells us that prospective franchisee may rely on unsubstantiated financial

performance representations.538 

To address these concerns, the Commission proposed that franchisors include in their

Item 19 disclosures a prescribed preamble stating that the Rule permits the making of financial

performance representations, but only if set forth in the franchisor’s disclosure document.539
provides the actual records of an existing outlet you are considering buying; or a

franchisor provides financial performance information in paragraph (s) of this

section and supplements that information by providing, for example, information

about possible performance at a particular location.

64 Fed. Reg. at 57,341.

 

540 As proposed in the NPR, the second preamble would read:

This franchisor does not make any representations about a franchisee’s financial

performance. We also do not authorize our employees or representatives to make

any such representations either orally or in writing. If you receive any financial

performance information or projections of your future income, you should report

it to the franchisor’s management by contacting [name and address of person to be

notified], the Federal Trade Commission, and the appropriate State regulatory

agencies.

Id.

 

541 Several commenters confirmed that such misrepresentations are prevalent and urged the

Commission to clarify the Rule to combat such misrepresentations. For example, the California

Bar’s Business Law Section stated:

Franchisees have reported to certain members of the California Franchise

Legislative Committee that franchisor salespersons informed them during the presale discussions in the offer and sale of a franchise that the FTC Rule prohibited

168

Prospective franchisees could then ask for such information, if they wish, or shop for a system

that discloses such information. Further, it would discourage prospects from relying on

unauthorized financial performance claims. To drive home these messages, the Commission also

proposed that franchisors who do not disclose financial performance information in an Item 19

include a second preamble warning prospective franchisees not to rely on unauthorized

performance representations and to report the making of such unauthorized representations to the

franchisor, the Commission, and appropriate state agencies.540

Several commenters supported the inclusion of preambles in Item 19 in order to clarify

the state of the law regarding the making of financial performance representations. In particular,

the first preamble would correct the common misstatement that the Rule actually prohibits the

making of such representations. According to the AFA, for example, a clarification of the law is

crucial: “[T]he great untruth that franchise salespeople have been allowed to perpetrate over the

years is the following statement in one form or another – the federal government prohibits us

from giving you information regarding the financial performance of [name of our] franchises.”

AFA, Comment 14, at 3.541
them from making earnings claims. Based on these reports, we agree that there is

a need to clarify the Rule to make clear that neither the Commission nor the Rule

prohibits franchisors from making earnings representations.

CA BLS, ANPR 124 at 1. Peter Lagarias, a franchisee representative, similarly told us: “I am

personally aware of franchisors (and sometimes even their lawyers) stating that earnings claims

are forbidden by the Commission’s Rule. The Commission should clarify in the Rule that the

franchisor could elect to make earnings claims but has elected not to make earnings claims.” 

Lagarias, ANPR 125, at 4.

 

542 See also IFA, Comment 22, at 11; Stadfeld, Comment 23, at 17; H&H, ANPR 28, at 8;

Duvall, ANPR 19, at 2; Jeffers, ANPR 116; CA BLS, ANPR 124, at 2; Zarco & Pardo, ANPR

134, at 6. But see J&G, Comment 32, at 7 (admonition to prospective franchisees to notify the

FTC and an appropriate state agency of an unauthorized earnings claim seems a bit excessive).

169

Other commenters asserted that the preambles, coupled with market forces, will

encourage the disclosure of financial data. For example, 7-Eleven stated: “We believe this

approach – affirmatively informing would-be investors about the requirements under the Rule

and the manner in which such information should be disclosed – when combined with the

competitive force of the marketplace, ensures that earnings information can be identified and

properly appraised by franchise investors.” 7-Eleven, Comment 10, at 3.542 

A few commenters, however, offered various suggestions for improving the preambles

proposed in the NPR. For example, the NFC suggested that the first preamble be revised to read:

The FTC’s Franchise Rule permits a franchisor to include in this disclosure

document information about the actual or potential performance of its franchised

and/or franchisor-owned outlets . . . or (ii) a franchisor provides financial

performance information in this Item 19 and supplements that information by

providing, for example, information about possible performance at a particular

location or under particular circumstances.

NFC, Comment 12, at 11. The NFC stated that these changes are warranted to ensure that

franchisors and franchisees alike do not misconstrue the Rule to mean that franchisors are

permitted to provide financial performance information generally, without an Item 19 disclosure. 

Howard Bundy advised the Commission to delete the word “possible” in the second

section of the first proposed preamble. “There is no reason to open the door to guessing and

speculation about how good the location could ‘possibly’ be or become. Such information is

predictably unreliable and subjective.” Bundy, Comment 18, at 10.

A few commenters also offered suggested changes to the second preamble, which

franchisors would provide in the event they chose not to disclose financial performance data in
 

543 See also Baer, Comment 11, at 14; J&G, Comment 32, at 7.

170

an Item 19. For example, the AFA maintained that the preamble should emphasize that the

franchisor has chosen not to make financial performance disclosures, suggesting the following

language: “Financial performance information is a voluntary disclosure. Our chain, [name of

franchise system], has volunteered NOT to disclose that information.” AFA, Comment 14, at 3. 

The NFC offered the following clarification: “We do not make any representations about your

franchise’s future financial performance or the past financial performance of our company-owned

or franchised units.” NFC, Comment 12, at 11. Howard Bundy would strengthen the second

preamble further to read:

Financial Performance Information is material to any decision to invest. 

[Franchisor] does not provide you with Financial Performance Information. The

absence of such information makes it very difficult for you to estimate your

prospects of success in the business. You should proceed with caution and

consult your franchise attorney and other business advisors.

Bundy, Comment 18, at 10.

Finally, some commenters urged the Commission to include a general warning about

financial performance information, regardless of whether or not the franchisor voluntarily makes

an Item 19 performance disclosure. For example, David Holmes stated that:

Given the almost universal agreement among franchise practitioners that

undocumented earnings claims are generally unreliable and the source of

inappropriate expectations by prospective Franchisees, it seems prudent, for the

protection of prospective Franchisees, to include express language making it clear

what all agree on: unsubstantiated earnings claims are not reliable and should not

be relied on.

Holmes, Comment 8, at 7. He suggested that the Commission adopt the following disclaimer:

“Any financial performance information (or projections) which is not contained in the disclosure

document is unreliable and you shouldn’t rely on it. Past results are no guarantees as to future

results. While some units have reported the results shown in this disclosure document, there’s no

guarantee you’ll do as well.” Id.

543

Based upon the comments, the staff makes the following recommendations. Regarding

the first preamble, we agree with the NFC’s suggestions that the Commission clarify the

preamble to ensure that parties understand that any financial performance claims must be made in

an Item 19. We also agree with Howard Bundy that the use of the word “possible” is

inappropriate. So revised, the first Item 19 proposed preamble would read:
171

The FTC’s Franchise Rule permits a franchisor to disclose information about the

actual or potential financial performance of its franchised and/or franchisor-owned

outlets, if there is a reasonable basis for the information, and the information is

included in the disclosure document. Financial performance information that

differs from that included in Item 19 may be given only if: (1) a franchisor

provides the actual records of an existing outlet you are considering buying; or (2)

a franchisor supplements the information provided in this Item 19, for example, 

by providing information about performance at a particular location or under

particular circumstances.

With respect to the second preamble, we also agree with the NFC’s suggestion that the

Commission clarify the meaning of “financial performance” by including the phase “franchise’s

future financial performance or the past financial performance of company-owned or franchised

units.” We also believe the second preamble should make clear that franchisors who do not

make an Item 19 financial performance claim, nonetheless may provide prospective franchisees

with actual records of an existing outlet offered for sale. The revised second preamble, therefore,

would read:

This franchisor does not make any representations about a franchisee’s future financial

performance or the past financial performance of company-owned or franchised outlets.

We also do not authorize our employees or representatives to make any such

representations either orally or in writing. If you are purchasing an existing outlet,

however, we may provide you with the actual records of that outlet. If you receive any

other financial performance information or projections of your future income, you should

report it to the franchisor’s management by contacting [name and address], the Federal

Trade Commission, and the appropriate state regulatory agencies.

In revising the second preamble, however, we reject the suggestion that the second

preamble be turned into a risk factor, as Mr. Bundy and others would suggest. We believe that a

broader discussion of financial performance representations is more appropriate in a consumer

education context where the issues can be addressed at length. Moreover, we do not share 

Mr. Bundy’s view that the absence of a financial disclosure necessarily signals a riskier

investment. It could well be that a company bent on defrauding prospective franchisees

manipulates its numbers to create a stronger success image, while a successful system may

choose not to disclose numbers because it may not believe that it can make a reasonable

disclosure that would be applicable to all potential buyers. In addition, any concern that

prospective franchisees need to see actual earnings figures in order to judge success is mitigated

by Item 20, which compels the disclosure of franchise failures. Finally, we recommend retaining

the admonition requirement in which franchisors making financial performance representations

caution that individual performance results may differ. We believe that this admonition, coupled

with the second preamble, is sufficient to warn all prospective franchisees about the need to be

cautious of unsubstantiated earnings representations. We propose that additional guidance on the

subject also be addressed in consumer education materials.
 

544 64 Fed. Reg. at 57,311-12. See also 16 C.F.R. § 436.1(a)(16). In the SBP, the

Commission explained that the required statistical information gives prospective franchisees

material information about the size of the franchise system they are contemplating joining and

sheds light on the prospect’s likelihood of success. “Providing a prospective franchisee with an

accurate statement of the number of units operated by his or her franchisor will convey

information relating to the financial success of the particular franchise business since the

franchisee’s ultimate success depends in large measure on public recognition of the franchisor’s

name.” 43 Fed. Reg. at 59,670. More important, the disclosure of current and former

franchisees’ names and addresses prevents fraud by arming prospects with a valuable, alternative

source of information with which to verify franchise sellers’ representations. Id. at 59,671. For

example, current and former franchisees often can verify or discount a seller’s representations, in

particular financial performance claims. Indeed, one reason the staff rejects mandating financial

performance disclosures is that franchisees are the best source of information about their own

earnings. See ANPR, 62 Fed. Reg. at 9,118.

 

545 Current and former franchisees often have widely different experiences. For that reason,

in In Re: Blenheim Expositions, Inc., 120 F.T.C. 1078 (1995), the Commission challenged

franchisee success claims based upon a Gallup Poll study of current franchisees only.

 

546 The NPR used the term “gag clauses.” However, for the reasons noted above in the

definitions section, we prefer the term “confidentiality clause.”

172

V. Proposed Section 436.5(t)

Item 20: Outlets and Franchisee Information

1. Background

Proposed Item 20 of the NPR would retain the current Rule requirement that franchisors

disclose the number of franchised and franchisor-owned outlets, the names and addresses of

current franchisees, as well as statistical information on franchise turn-over rates, in particular the

number of franchises voluntarily and involuntarily terminated, not renewed, cancelled, and

reacquired by the franchisor.544 Proposed Item 20 would also streamline the current Rule by

requiring franchisors to disclose the statistical information in tabular form. It would also extend

the current Rule by requiring franchisors to disclose the names, addresses, and telephone

numbers of at least 100 current franchisees (as opposed to the current Rule requirement of at

least 10 franchisees), as well as the names, addresses, and telephone numbers of those

franchisees who have left the system within the last fiscal year.

545

 

Although based upon UFOC Guidelines Item 20, proposed NPR Item 20 would differ

from the UFOC Guidelines model in several respects. First, proposed Item 20 would correct a

double-counting problem brought to the Commission’s attention during the Rule Review. In

addition, proposed Item 20 would require disclosure about franchisors’ use of “confidentiality

clauses,”546 which effectively restrict franchisees from discussing their experiences with
 

547 The proposal would not require franchisors to disclose the existence of broad-based

organizations that represent franchisee interests generally, such as the American Franchisee

Association, the American Association of Franchisees & Dealers, or the International Franchise

Association.

 

548 E.g., Kaufmann, RR 33, at 4; AFA, RR 62, at 3; Simon, RR, Sept95 Tr, at 223-24.

 

549 UFOC Item 20D. See 64 Fed. Reg. at 57,312. See also Wieczorek, ANPR, 18Sept97 Tr,

at 31.

 

550 See 64 Fed. Reg. at 57,312.

173

prospective franchisees. Proposed Item 20 would also require the disclosure of trademarkspecific franchisee associations.547 There are no comparable disclosures in either the current

Rule or UFOC Guidelines. We address each of these issues below.

2. The record and recommendations

a. Double-counting

As noted above, proposed Item 20 would incorporate the UFOC Guideline’s Item 20

disclosure of information about franchisees who have recently left the franchise system, as well

as changes in ownership of franchised outlets. During the Rule amendment process, no

commenters opposed this disclosure in principle. However, commenters universally voiced

concern that UFOC Item 20 is flawed and needs to be fixed.548 Specifically, UFOC Item 20

results in franchisors “double-counting” changes in franchised outlet ownership, resulting in

inflated turnover rates. 

In the NPR, the Commission observed that the “double-counting” problem is attributable

to at least two factors. First, UFOC Item 20 requires franchisors to report changes in franchised

outlets ownership according to five enumerated categories: (1) transfers; (2) canceled or

terminated; (3) not renewed; (4) reacquired by the franchisor; or (5) reasonably known to have

“ceased to do business.” The absence of precise definitions, however, may lead to overlapping

reporting categories, resulting in a double-counting of outlet closures.549 For example, transfers

and reacquisitions are often two sides of the same coin. If a franchised outlet goes out of

business and the franchisor assumes control, that single event could reasonably be captured either

as a transfer by the franchisee, or as a reacquisition by the franchisor.

Second, even if the definitions were clear, UFOC Item 20 can be interpreted to require the

disclosure of each of a series of events associated with a single outlet ownership change.

550 For

example, after terminating a franchise agreement, the franchisor may reacquire the outlet. The

franchisor could then either operate the outlet as a franchisor-owned store, or sell it to a new

franchisee. Arguably, under UFOC Item 20, a franchisor would report a termination followed by
 

551 From these examples, one can readily understand franchisors’ concerns that UFOC Item

20 may greatly inflate outlet failure rates. See Zarco & Pardo, ANPR 134, at 6 (“If the [Item 20]

information becomes too complicated, the potential franchisee will not know how to interpret the

data and thus, derive no benefit from the increased efforts at meaningful disclosure.”). While the

UFOC Item 20 instructions provide that the franchisor can add footnotes to clarify the numbers,

this solution may be burdensome. In addition, prospective franchisees may not read or fully

appreciate the import of the footnotes. 

 

552 62 Fed. Reg. at 9,121. 

 

553 E.g. H&H, ANPR 28, at 6; AFA, ANPR 62, at 3; IL AG, ANPR 77, at 2; Tifford, ANPR

78, at 4; IFA, ANPR 82, at 2; Cendant, ANPR 140, at 3; Karp, ANPR, 19Sept97 Tr, at 91.

 

554 Zarco & Pardo, ANPR 134, at 6-7. See also Karp, ANPR 136 (suggesting that the

Commission add columns for newly developed outlets and outlets converted from franchisorowned, as well as distinguish between units not renewed by franchisor and units not renewed by

franchisee). 

174

a reacquisition as two separate events. Similarly, a franchisee may abandon an outlet, and, in

response, the franchisor may send the franchisee a formal termination letter, reacquire the outlet,

and then transfer it to a new franchisee. Although the outlet has changed hands only once, the

franchisor conceivably would report this event four times as a ceased to do business, termination,

reacquisition, and transfer.551

In the ANPR, the Commission acknowledged the franchise industry’s concern about the 

double-counting problem and solicited comment on how Item 20 could be improved.552 In

response, several commenters confirmed the double-counting problem,553 but only a few offered

concrete solutions, and no consensus emerged on how to correct the problem. 

Three commenters suggested that the Commission address double-counting by adding

additional categories to the Item 20 disclosure. For example, Robert Zarco recommended that

the Commission create multiple categories to capture various combinations of ownership

changes. Transfers, for instance, would be divided into four distinct categories: (1) transfers by

the franchisee to the franchisor; (2) transfers by franchisees to the franchisor, but ultimately refranchised; (3) transfers by franchisee directly to new franchisee; and (4) transfers by franchisee

directly to new franchisee more than once.554 

Similarly, the AFA recommended that franchisors create as many categories as needed to

capture all combinations of ownership changes that might occur at each outlet during the course

of the year. For example, a termination followed by a transfer to a new owner would be reported
 

555 AFA, ANPR 62, at 3.

 

556 Wieczorek, ANPR 122. Mr. Wieczorek has attached sample tables for the Commission’s

consideration. Id. at 3-4. 

 

557 Id. at 2.

 

558 Simon, ANPR, 18Sept97 Tr, at 23-24; Tifford, id. at 25. See also Bundy, ANPR,

6Nov97 Tr, at 230.

 

559 64 Fed. Reg. at 57,312.

175

as a “termination and transfer,” while a termination followed by a reacquisition to the franchisor

and then a transfer to a new franchisee would be reported as a “termination, reacquisition,

transfer.”555 

Dennis Wieczorek, a franchisor representative, opined that most double-counting

problems are attributable to the inclusion of transfers and reacquisitions in the table summarizing

the status of franchised outlets. According to Mr. Wieczorek, transfers and reacquisitions usually

follow an initial closing, such as a termination or non-renewal. He suggested that transfers and

reacquisitions – which are the consequence of an outlet closure – be offset from the outlet closing

statistics. To that end, he proposed that transfers be removed from the main body of the

franchisee statistics table and placed in a separate column located on the side of the franchisee

statistics table. Further, reacquisitions should be moved to the second Item 20 table concerning

franchisor-owned outlets.556 

Finally, Mr. Wieczorek suggested that double-counting could be reduced by requiring

franchisors to report only the change in ownership event that occurs first in time. Thus, for

example, a termination followed by a reacquisition would be reported only as a termination.557 In

contrast, a few commenters suggested that the Commission require franchisors to report multiple

events according to a predetermined order of priority, rather than by chronological order.558 For

example, the Commission could require franchisors to report multiple ownership changes only

once, eliminating “picking and choosing” of categories, by assigning a specific order of priority

such as termination, non-renewal, reacquisition, and transfer. Under this approach, a franchisor

would report an ownership change as a termination, regardless of what other events may have

occurred before (e.g., abandonment of the property) or after (e.g., reacquisition or transfer). 

In the NPR, the Commission proposed fixing the double-counting problem as follows:559

As an initial matter, the Commission proposed a new Item 20 table to capture changes in outlet

ownership, containing 10 columns:
 

560 For example, several commenters urged the Commission to define the terms “transfers”

and “reacquisitions” more precisely. Tifford, ANPR 78, at 4; Wieczorek, ANPR 122, at 1-2.

 

561 64 Fed. Reg. at 57,312.

 

562 While the Commission tentatively adopted the proposed “first-in-time” approach, it

recognized that the alternative “order of priority” approach might have merit. In order to give

this proposal an adequate review, the Commission explored the issue further in the NPR by

soliciting specific order of priority proposals. Id. at 57,312 and 57,330.

 

563 See Wieczorek, ANPR 122, at 2; ANPR, 6Nov97, Tr, at 225-26.

 

564 To reduce compliance burdens and to foster uniformity with the UFOC Guidelines, the

staff has rejected the suggestion that Item 20 be expanded to include additional reporting

categories. While the record indicates that Item 20 needs to be fixed to address the doublecounting problem, it does not support a de novo rewrite of Item 20. Expanded reporting

categories arguably would provide prospects with more information; however, the staff is

unconvinced that such additional information is necessarily material. See Tifford, ANPR, 

18Sept97 Tr, at 35-36 (asserting that the Item 20 franchisee table already contains the categories

176

Column 1 would disclose the states where the franchisor has outlets;

Column 2 would state the number of outlets opened at the beginning of the year;

Column 3 would state the number of outlets with the same ownership at the end of the

year;

Columns 4-6 would state the number of outlets changing hands because of a termination,

reacquisition, and transfer, respectively;

Column 7 would state the number of outlets that were not renewed at the end of the

franchise term;

Column 8 would state the number of outlets that ceased operation or closed for other

reasons;

Column 9 would report the total number of outlets discontinued during the year; and

Column 10 would report the total number of outlets in operation at the end of the year.

In addition, the NPR’s proposed Item 20 would address the core source of doublecounting – imprecise reporting categories.560 The Commission proposed defining the three terms

“termination,” “reacquisition.” and “transfer,” creating mutually exclusive categories.561 The

Commission also proposed reducing double-counting of turnover information by adopting a

“first-in-time” approach:562 when an ownership change involves two or more events, the

franchisor reports only the change that occurs first in time.563 For example, if a franchisor

terminates an outlet and then reacquires it, the “first-in-time” instruction would require the

franchisor to report this event as a termination because the franchisor terminated the outlet before

reacquiring it or transferring it to a new owner. The Commission believed that this approach,

coupled with precise definitions as set out above, would reduce the opportunity that franchisors

would pick and choose among reporting categories.

564
needed to capture changes in ownership). Moreover, a prospective franchisee may be less

inclined to review Item 20 if he or she must wade through an endless stream of statistics. See

Simon, ANPR, 18Sept97 Tr, at 23 (asserting that expanded disclosures would be denser and less

meaningful); Cantone, id., at 25 (“I think it’s critical that the disclosures have got to stay simple

to be meaningful.”).

 

565 E.g., IL AG, Comment 3, at 7; Snap-On, Comment 16, at 4; NASAA, Comment 17, at 5;

Karp, Comment 24, at 11. 

 

566 E.g., IL AG, Comment 3, at 7; PMR&W, Comment 4, at 13; NFC, Comment 12, at 31;

Lewis, Comment 15, at 16; NASAA, Comment 17, at 6; Bundy, Comment 18, at 10-11;

NaturaLawn, Comment 26, at 1; BI, Comment 28, at 12.

 

567 E.g., H&H, Comment 9, at 19 (NPR overlooks number of new outlets opened or acquired

by franchisees in the fiscal year); Tricon, Comment 34, at 4-5 (NPR lacks a column to report

newly-operated outlets or outlets acquired by a franchisee from a franchisor). 

 

568 E.g., H&H, Comment 9, at 19 (NPR equates outlet transfer with an outlet closing); NFC,

Comment 12, at 32 (NPR confuses changes in ownership with changes involving discontinuance

of a location); Frandata, Comment 29, at 10 (NPR confuses changes affecting the franchisee with

changes affecting the location).

 

569 E.g., PMR&W, Comment 4, at 13 (NPR states that terminations and non-renewals are

fully completed upon the sending of an “unconditional notice.” “[E]ven if franchisors send such

notices, they do not necessarily result in completion of the event described in the notice.”). 

177

While the NPR comments continued to support the need to correct the double-counting

problem,565 several commenters believed that the NPR’s proposed fix falls short. Some

commenters advised that the NPR proposal is too complex and difficult to understand.566 Eric

Karp, for example, stated that the proposed NPR fix “does not fully resolve the double-counting

issue and does not go far enough in utilizing important data that prospective franchisees should

have at their disposal.” Karp, Comment 24, at 11. Others asserted that the NPR proposal 

overlooks categories,567 equates categories that should be separate,568 and, in a few instances, uses

inaccurate definitions.569 

Further, some commenters opposed particular details of the proposal, such as the

proposed “first in time” approach. For example, PMR&W suggested that a “last in time”

approach for categorizing multiple events would be more accurate:

A last-in time prioritization is appropriate for at least three reasons: (1) it allows

for an easily ascertainable confirmation of the event; (2) it represents a fact, rather

than an intention (e.g., a termination notice) or a proposal (e.g., a transfer rather

than request); (3) in dispute situations, it labels the event in a manner consistent

with the parties settlement of their dispute.
 

570 See also IL AG, Comment 3, at 8; NASAA, Comment 17, at 6; Frandata, Comment 29,

at 10.

 

571 NASAA, Comment 17, at 5-10. See also, e.g., PMR&W, Comment 4, at 14-66 and

Exhibit A; NFC, Comment 12, at 31-32; Frandata, Comment 29, at 11.

 

572 Karp, Comment 24, at 11-18.

 

573 NASAA’s comment actually mentioned four tables: it did not discuss the current table

for estimated franchise outlet openings. We assume that NASAA favors retaining this table

(which would be Table No. 5), but did not mention it because it does not involve the doublecounting issue.

178

PMR&W, Comment 4, at 13-14.570

Most important, NASAA suggested that UFOC Item 20 needs to be revised in its entirety

and submitted for the Commission’s consideration an alternative that was produced with the

assistance of an Industry Advisory Committee. Several of the commenters have submitted the

same proposal or have endorsed the NASAA proposal.571 Additionally, Eric Karp, a member of

the Industry Advisory Committee, has submitted a modification of the NASAA approach for the

Commission’s consideration.572

NASAA’s proposed Item 20 would contain five tables.573 Table No. 1 would indicate the

status of a franchisor’s system. It would show the number of franchised and company-owned

outlets at the beginning and end of each of the last three fiscal years, and the total net change.

Table No. 2 would indicate transfers. NASAA suggested that transfers should be

reported separately from terminations and non-renewals. It observed that transfers do not affect

the total number of outlets in a franchise system. Further, a transfer by itself tells little about the

underlying cause: “While some transfers are problematic for franchisees or prompted from

disputes, many other transfers simply reflect a desire on the part of the franchisee to cease

operating a franchise or to pursue other opportunities.” NASAA, Comment 17, at 8. 

Nonetheless, the total number of transfers within a system appears to be material. Table No. 2

would indicate the number of franchise transfers in each state over the last three fiscal years.

Table No. 3 would track the franchisor’s turnover rate of franchised outlets. It would use

a “last in time” approach to resolve double-counting problems, for the reasons cited above. 

Franchisors would report, for each of the last three fiscal years, the outlets at the start of the year,

new outlets opened, terminations, non-renewals, reacquisitions by franchisor, outlets that ceased

to do business, and outlets at the end of the year. 
 

574 See also Karp, Comment 24, at 19.

 

575 Id. at 14.

179

Table No. 4 would track the turnover at company-owned stores. Franchisors would

disclose, for each of the last three fiscal years, their outlets at the start of the year, new outlets,

reacquired outlets, closed outlets, outlets sold to franchisees, and outlets at the end of the year.

Presumably, NASAA would also retain as Table No. 5 the current projected openings

table. This table gives prospective franchisees insight into anticipated growth within the system

by requiring the disclosure of both projected franchised and company-owned openings in the next

fiscal year. It also reveals the number of franchise agreements signed in the previous year where

a store has not yet been opened. This information is material because it enables a prospective

franchisee to gauge how long it may take before his or her store actually becomes operational.

In a related matter, NASAA urged the Commission to consider requiring franchisors to

state the reason why each of the franchisees disclosed on its Item 20 list of former franchisees left

the system (e.g., terminated, non-renewed, or otherwise voluntarily or involuntarily ceased to do

business): “This information is clearly material. In some cases, prospective franchisees may not

be able to contact the franchisees named in this list. In some cases, those franchisees may be

unwilling or unable to provide this information to prospective franchisees.” 

NASAA, Comment 17, at 10.574

As noted above, Eric Karp submitted a variation of the NASAA proposal for the

Commission’s consideration. He would greatly expand the NASAA proposal in the following

respects. First, Mr. Karp would add more detail to NASAA’s proposed transfer table, Table No.

2. Franchisors would disclose not only the number of transfers in each of the last three fiscal

years, but also the number of completed transfers, requests for transfer that were denied, and

those transfers in progress at the end of the fiscal year. 

Second, in Table No. 3, Mr. Karp suggested that new outlets be divided into two

categories: new outlets that are newly developed and new outlets that were purchased from a

franchisor.575 NASAA’s proposal combines all new outlets in one “new outlet” category.

Third, Mr. Karp urged the Commission to adopt a new table addressing turn-over rates. 

To that end, Mr. Karp proposed a new table that would calculate a specific turnover rate,

expressed as a percentage, by comparing the number of outlets at the beginning of a fiscal year

with the number of outlets during the year that were terminated by the franchisor, non-renewed,

repurchased by the franchisor, transferred to another franchisee, or ceased operations for other

reasons. 

Fourth, Mr. Karp proposed revising the new growth projection chart (Table No. 6). 

Specifically, franchisors would disclose for each of the last three fiscal years: previously
 

576 Id. at 17.

 

577 We also recommend that the Commission revise the scope of terms used in Item 20 to

avoid overlapping categories. Specifically, “termination” would mean the franchisor’s

termination of a franchise agreement prior to the end of its term without paying consideration to

the franchisee (whether by payment or forgiveness or assumption of debt. “Non-renewal” would

occur when the franchise agreement for a franchised outlet is not renewed at the end of its term. 

“Reacquisition” would mean the franchisor’s acquisition of an outlet prior to the end of its term

for consideration (whether by payment or forgiveness or assumption of debt). “Transfer” would

mean the acquisition of a controlling interest in a franchised outlet during its term by a person

other than the franchisor or an affiliate. See Wieczorek, ANPR Comment 122, at 2. 

 

578 In order to streamline the Rule and reduce inconsistencies with the UFOC Guidelines, we

also reject suggestions to add new Item 20 charts that merely restate information that can already

be gleaned from the existing charts. For example, if the NASAA proposed Item 20 is adopted,

prospective franchisees will be able to calculate turnover rates themselves from the data

contained in Tables 1 and 3 by comparing outlets at the beginning of a fiscal year with the

180

projected franchised new outlets, actual number of franchised new outlets; franchise agreements

signed but outlet not in operation. and projected franchised new outlets for next fiscal year. 

According to Mr. Karp, this approach would enable prospective franchisors to assess the

accuracy of franchisor’s growth projections.576

Finally, the IL AG submitted an additional suggestion about turnover rates. It asserted

that a number of successive franchises at the same location could indicate “churning,” the

practice whereby a franchisor turns a blind eye to franchisee failures – or worse, encourages them

– in order to sell the same location repeatedly. The IL AG urged the Commission to require

franchisors to provide a prospect with a detailed site history when a buyer is being directed to a

particular location. “This could be a three year history that would chart prior franchisees, their

dates of operation, dates of store management by the franchisor for the site, and the reasons

previous franchisees departed from that site.” IL AG, Comment 3, at 7.

After careful consideration, the staff recommends that the Commission address the Item

20 double-counting problem by adopting the NASAA proposal.

577 We are persuaded that the

NPR’s proposed Item 20 double-counting fix is too complex and difficult to understand. In

considering an appropriate fix, we give great weight to the fact that several commenters have

supported the NASAA alternative proposal. Furthermore, we believe that this proposal will be

easily understood by those in the industry, solve the double-counting problem, and provide

prospective franchisees with the information they need without imposing undue compliance

burdens on franchisors. We do not recommend adopting the expanded disclosures suggested by

Mr. Karp. The additional proposed disclosures would greatly increase the size of the Item 20,

potentially overwhelming prospective franchisees while increasing franchisor compliance

costs.578
number of outlets closed during the year.

 

579 This proposal is somewhat analogous to the Item 19 provision that would allow a

franchisor to provide supplemental financial performance information about a specific unit being

sold. Indeed, we believe that if a franchisor could use the prior performance history of an

existing unit to its advantage as a marketing tool, then the prospective franchisee should also be

able to obtain comparable turnover rate information in his or her due diligence review of the

offer.

 

580 The ANPR was not the Commission’s first involvement with confidentiality provisions in

franchise matters. In 1996, the Commission addressed this issue in FTC v. Orion Prods., Bus.

Franchise Guide (CCH) ¶ 10,970 (N.D. Cal. 1997) and FTC v. Tutor Time Child Care Sys. Bus.

Franchise Guide (CCH) ¶ 10,971 (N.D. Cal. 1997). While the Commission did not challenge

these defendants’ use of confidentiality clauses as either a Rule or Section 5 violation in its

181

We also agree with the IL AG about the potential problem of “churning.” To address this

concern, we recommend that the Commission include a new provision in Item 20 that would

require a franchisor selling a specific existing unit to provide the prospective franchisee with a

history of that unit, including the names, addresses, and telephone numbers of each previous

owner and the reasons for the change in ownership.579 Consistent with the IL AG’s proposal, we

recommend that this information be disclosed for the last three fiscal years in order to present a

more accurate snap-shop of the unit’s history. This type of information should be readily

available to the franchisor and its disclosure should impose minimal costs. More important, the

disclosure of this information is critical if a prospective franchisee interested in buying a specific

outlet is to conduct a thorough due diligence investigation. We believe any minimal costs to the

franchisor, therefore, are outweighed by the countervailing benefits to prospective franchisees.

b. Confidentiality clauses

In the ANPR, the Commission recognized that confidentiality provisions may harm

prospective franchisees by limiting their ability to speak with former and current franchisees

during their due diligence investigation of the franchise offering. Accordingly, the Commission

solicited comment on the use of confidentiality clauses as follows:

To what extent do franchisors use “gag orders” to inhibit former or existing

franchisees from speaking with prospective franchisees or other parties? Should

the Commission modify the Rule to prohibit franchisors from using gag order

provisions and, if so, how? What alternatives would ensure that prospective

franchisees can freely obtain information from former and existing franchisees

about their experience with the franchise system? What would be the costs and

benefits of such alternatives?

62 Fed. Reg. at 9,121.580
complaints, it did obtain fencing-in provisions in settlements that prohibited the defendants from

enforcing or entering into confidentiality provisions for a limited time. 

 

581 Lagarias, ANPR 125, at 3 (“I have found that in most of the actions I have settled, the

defendant franchisors and their counsel insist on confidentiality.”); Selden, ANPR 133, at

Appendix B (“[Confidentiality clauses] are becoming increasingly problematic to franchisees.”). 

See also Karp, ANPR, 19Sept97 Tr, at 92-93.

 

582 See also Karp, ANPR, 19Sept97 Tr, at 93-94.

 

583 See also Marks, ANPR, 19Sept97 Tr, at 33-34.

 

584 E.g., Tifford, ANPR 78, at 3; Duvall, ANPR, 6Nov97 Tr, at 240.

 

585 E.g., D’Alessandro, ANPR, 22Aug97 Tr, at 40; Doe, ANPR, 7Nov97 Tr, at 276 Lagarias,

ANPR 125, at 3. For example, Caron Slimak, a Jacadi USA franchisee, told us that an agreement

she signed upon termination contains the following clause:

The Slimak Parties shall not make any derogatory or disparaging action or make

any false, derogatory, or disparaging comment, publicly or privately, concerning

the Jacadi parties, or any of the directors, officers, shareholders, affiliates,

employees, agents, consultants, successors or assigns or Jacadi products. . . . If

questioned by any third party as to the circumstances surrounding the termination

of the franchise agreement, The Slimak Parties shall state only that the parties

mutually agreed to terminate their commercial relationship.

Slimak, Comment 130. Franchisors’ forceful defense of confidentiality clauses on the grounds

that they promote informal settlement of disputes also tends to support the view that such clauses

are common in settlements. See Forseth, ANPR, 18Sept97 Tr, at 40. See also Marks, ANPR,

182

The ANPR comments revealed no consensus on the extent to which franchisors use

confidentiality clauses. Several franchisee representatives contended that the use of

confidentiality clauses is widespread.581 For example, Susan Kezios of the AFA stated that “the

use of gag orders is almost 100 percent in some franchise systems.” Kezios, ANPR, 6Nov97 Tr,

at 241.582 This view, however, was not universally shared, even by franchisee advocates. 

Howard Bundy reported that he does not “see very many of them in practice.” Bundy, Id., at

236.583 On the other hand, several franchisor representatives insisted that confidentiality clauses

are rare.584

 This apparent lack of consensus among ANPR commenters was understandable for two

reasons. First, these commenters addressed two different confidentiality clause uses: franchisees

addressed post-sale confidentiality clauses, while franchisors apparently addressed pre-sale

clauses. It is clear from statements in the record that franchisees in many instances sign post-sale

confidentiality provisions in settlements585 and as a condition of termination.586 On the other
19Sept97 Tr, at 8-9. 

 

586 Several franchisees reported that franchisors routinely require franchisees to sign

confidentiality clauses upon termination. E.g., Maloney, ANPR 38, at 2; Doe, ANPR, 7Nov97

Tr, at 276-79; Rafizadeh, id. at 299-300; Slimak, ANPR 130; Lundquist, ANPR, 22Aug97 Tr, at

42-43. Others urged the Commission to prohibit the practice. See Manuszak, ANPR 13, at 1;

Rachide, ANPR 32, at 3; Sibent, ANPR 41, at 1 (and 19 identical ANPR comments). Three

franchisees – Raymond Buckley, Roger C. Haines, and David E. Myklebust – believed that they

were kept in the dark about the failure of their franchisor’s system due to confidentiality clauses

imposed on current and former franchisees. Buckley, ANPR 97, at 1; Haines, ANPR 100 at 2;

Myklebust, ANPR 101, at 1.

 

587 See Wieczorek, ANPR, 18Sept97 Tr, at 50.

 

588 For that reason, the NPR used the term “gag clause.” See 64 Fed. Reg. at 57,312-13.

 

589 Wieczorek, ANPR, 18Sept97 Tr, at 51; Kaufmann, id. at 58-60. See also Duvall, 6Nov97

Tr, at 247. Franchisees and their advocates, however, strongly opposed the view that

confidentiality clauses are freely negotiated in many instances. They contended that franchisees

who are being terminated or seek to resolve a dispute have essentially no choice but to sign a

confidentiality clause. Either they sign, or risk losing their investment. E.g., AFA, ANPR

Comment 62, at 3. For example, each of the franchisees noted above who described their

experiences with confidentiality clauses stated that they believed that they had no choice but to

sign.

183

hand, it appears that franchisors generally do not include pre-sale confidentiality clauses in their

initial franchise agreements.587 Indeed, no franchisees who commented on this issue stated that

they were required to sign a confidentiality provision in their initial franchise agreement.

Second, some confusion about confidentiality clause usage stemmed from how this issue

was framed in the ANPR. The ANPR used the term “gag order,” which apparently implied that

the Commission was limiting its inquiry to confidentiality orders issued by a court in a legal

proceeding.588 In addition, the ANPR may have implied that “gag orders” are imposed by the

franchisor. Some franchisors insisted, however, that confidentiality provisions are not imposed,

but are mutually agreed upon covenants.589 Under the circumstances, it is understandable that

commenters believed that franchisor-imposed or court-ordered confidentiality provisions are rare. 

Nonetheless, the record shows that confidentiality clauses – regardless of what they are called

and whether they are imposed or mutually agreed upon – are used at least in dispute settlements

and when franchisees seek termination.

The ANPR comments also revealed no consensus on whether confidentiality clauses

serve a useful purpose. One quarter of the ANPR commenters (42 out of 166 commenters)
 

590 E.g., Manuszak, ANPR 13; Paquet, ANPR 18; Rachide, ANPR 32; Sibent, ANPR 41

(and 19 identical ANPR commenters); AFA, ANPR 62, at 3; Buckley, ANPR 97; Marks, ANPR

107, at 2; NASAA, ANPR 120, at 4; Dady & Garner, ANPR 127, at 2; Karp, ANPR, 19Sept97

Tr, at 95. Opponents included several franchisor representatives. E.g., Kestenbaum, ANPR 40,

at 2. Cendant opposed the use of confidentiality clauses, except to protect trade secrets or other

proprietary information. Cendant, ANPR 140, at 3.

 

591 Similarly, Teresa Maloney, a 7-Eleven franchisee, stated:

When it became apparent to both me and Southland Corporation that it was time

to terminate our business relationship, we began negotiating my exit from the

system. We came to a mutually acceptable agreement, however, the agreement

contained a confidentiality clause. Even if my name appears in a UFOC as a

former Franchisee, how much help can I give to anyone asking a question?

Maloney, ANPR 38, at 2.

 

592 The National Consumers League, for example, stated: “Because the experience of others

who have purchased a franchise or business opportunity is the best indicator of potential earnings

and other factors for prospective buyers, ‘gag orders’ that prohibit people from sharing their

184

addressed the confidentiality clause issue, the majority opposing their use.590 In addition, several

participants at the staff’s six ANPR public workshop conferences identified confidentiality

provisions as a problem. The most poignant example was Marge Lundquist, a franchisee of an

undisclosed franchise system, who attended the Chicago conference. She told us that she had to

speak quickly because she was on her way to sign a final agreement terminating her relationship

with her franchisor. The agreement she was about to sign included a confidentiality clause. 

Ms. Lundquist stated:

I am at this point not going to state the franchise because I am on my way at 1:00

to sign the final divorce papers, as such, the papers that separate us legally. 

There’s a gag order there. So, if you are planning on putting this on the Internet,

that could be a problem. . . [T]he gag order . . . prohibits me from being able to

answer questions, you know, and give cautionary remarks to other people who

might be considering the franchise that I was with.

Lundquist, ANPR, 22Aug97 Tr, at 42-43.591 

Other opponents of confidentiality clauses – including state regulators and some

franchisors – asserted that such provisions inhibit prospective franchisees from learning the truth

as they conduct their due diligence investigation. As noted above, current and former franchisees

are often a valuable source of information about the franchise investment and can often verify or

discredit the franchisor’s claims, especially financial performance representations.592 Attempts to
experience with others should be prohibited.” NCL, ANPR 35, at 3. See also Baer, ANPR 25, at

3; Karp, ANPR, 19Sept97 Tr, at 95-96.

 

593 For example, Roger Haines, a Scorecard Plus franchisee, told us: 

I had spoken to some of the franchisees that had left the system. I now feel certain

that they painted a picture that was not close to being the truth based on the gag

order that [the franchisor] imposed. Had I gotten the truth from these people, my

decision certainly would have been different. Every franchisee leaving the system

has had a gag order placed on them, making it impossible for current and future

franchisees to get the facts.

Haines, ANPR 100, at 2. See also Cantone, ANPR, 18Sept97 Tr, at 50 (“[T]he whole concept of

a gag order is really destructive and . . . needs to be addressed.”).

 

594 See NASAA, ANPR 120, at 4.

 

595 Selden, ANPR 133, Appendix B. The staff has also found that current and former

franchisees may be reluctant to cooperate in an investigation because they have signed an

agreement containing a confidentiality clause.

 

596 E.g., Kaufmann, ANPR 33, at 5-6; Tifford, ANPR 78, at 3; IFA, ANPR 82, at 2; Duvall,

ANPR, 6Nov97 Tr, at 247; Gitterman, id., at 250-51. 

 

597 E.g., Baer, ANPR 25, at 3. Franchisee advocates also recognized franchisor’s legitimate

need for trademark protection. E.g., AFA, ANPR 62, at 3; Dady & Garner, ANPR 127, at 2;

185

restrict franchisee speech through confidentiality provisions may deceive prospects by effectively

eliminating one crucial source of information, namely those current and former franchisees who

may have a dispute with the franchisor or are otherwise disgruntled.593 Indeed, a franchisor, if it

wished to do so, could attempt to use confidentiality provisions to ensure that prospects speak

with only those franchisees who are successful or otherwise inclined to give a positive report.594

In addition, one commenter, Andrew Selden, a franchisee representative, contended that the harm

flowing from confidentiality provisions goes beyond individual franchise sales, noting that such

provisions intimidate franchisees into not testifying before legislative committees and public

agencies, such as the Federal Trade Commission.595

On the other hand, several franchisors and their representatives opposed banning the use

of confidentiality clauses. For example, David Kaufmann stated that confidentiality provisions

prevent disgruntled franchisees from inflaming others and enable franchisors to end bad

relationships with problem franchisees without spending considerable resources. He contended

that banning confidentiality provisions would discourage informal settlements with

franchisees.596 Others added that franchisors must have the ability to protect their trade secrets

from disclosure.597
Zarco & Pardo, ANPR 134, at 4. In the NPR, the Commission agreed. For that reason, the

NPR’s proposed definition of “gag clause” specifically excluded confidentiality agreements to

protect trademark and other proprietary information.

 

598 See Cordell, ANPR, 6Nov97 Tr, at 247-48; Kezios, id. at 256. See also NASAA, ANPR

120, at 4.

 

599 Wieczorek, ANPR, 6Nov97 Tr, at 258-59. Presumably, franchisors also would have to

maintain records on each individual franchisee subject to a confidentiality clause provision. In

addition, a requirement that franchisors note which specific franchisees are subject to a

confidentiality clause may have the unintended consequence of actually encouraging franchisors

to eliminate from their list of 100 franchisees those who are subject to confidentiality clauses,

thereby leaving a biased list of only those franchisees who are most successful or satisfied with

the system.

 

600 See also Selden, ANPR 133, Appendix B; Jeffers, ANPR, 6Nov97 Tr, at 251-52;

Wieczorek, ANPR, 6Nov97 Tr, at 260.

186

Several commenters offered a variety of suggestions on how the Commission might

address the use of confidentiality clauses short of an outright ban. For example, a few

commenters suggested that the Commission require franchisors to note which of the current and

former franchisees listed in their Item 20 disclosures are subject to a confidentiality provision. 

Such a requirement would accomplish two goals simultaneously. It would alert prospective

franchisees that the franchisor may require franchisees to sign a confidentiality provision and

would save prospects the time and trouble of trying to contact franchisees who are not free to

speak.598 In response, however, Dennis Wieczorek insisted that this approach would be

unnecessarily burdensome: franchisors would have to update their disclosures more frequently,

especially in franchise registration states.599

Of the various proposals suggested in response to the ANPR, a general disclosure about

the use of confidentiality provisions garnered the most support. For example, Zarco & Pardo

stated:

We suggest that the company’s policy and use of gag rules should be disclosed, as

well as the current percentages regarding their use, i.e., 50% of our non-renewed

franchisees in the year 1997 were prohibited from discussing their relationship

with the Franchise Co. If franchisors know that they will be required to disclose

their percentages in this way, the company may well rethink its policy of requiring

gag rules as a matter of course. Potential franchisees, in turn, will be alerted to the

potential problems in a system that forbids any or a substantial percentage of its

former franchisees from speaking about their experience with the company.

Zarco & Pardo, ANPR 134, at 4.600 
 

601 64 Fed. Reg. at 57,312-23. As noted above, the term “confidentiality provision” would

be defined as “any contractual provision entered into by a franchisor and a current or former

franchisee that prohibits or restricts the franchisee from discussing his or her personal experience

as a franchisee within the franchisor’s system. It does not include confidentiality agreements that

protect franchisors’ trademarks or proprietary information.”

 

602 Id. at 57,344. See Bundy, ANPR, 6Nov97 Tr, at 257 (arguing in favor of data for more

than one year in order to show any trends).

 

603 64 Fed. Reg. at 57,344.

 

604 See also IL AG Rebuttal, Comment 38, at 3.

 

605 NFA, Comment 27, at 1. See also AFA, Comment 14, at 3; Bundy, Comment 18, at 3;

Stadfeld, Comment 23, at 5; Karp, Comment 24, at 21-22.

 

606 Several commenters also urged the Commission to stress that franchisors must disclose

litigation and settlements in Item 3, regardless of the presence of any confidentiality clauses. IL

AG, Comment 3, at 4; Stadfeld, Comment 23, at 5; 

187

Similarly Howard Bundy told us that “[i]n a perfect world I would have a list of those that

are subject to [confidentiality provisions], so I didn’t have to make all those extra 75 calls. But I

could live with or without that. It’s more important to disclose the fact that they do exist.” 

Bundy, ANPR, 6Nov97 Tr, at 249.

Based upon the ANPR comments, the Commission proposed in the NPR a modest new

disclosure to address confidentiality clauses.601 Specifically, if a franchisee signed a contract

containing a confidentiality clause in the last three fiscal years, then the franchisor would state in

its Item 20 disclosure: “In some instances, current and former franchisees sign provisions

restricting their ability to speak openly about their experiences with [name of franchise system].

While we encourage you to speak with current and former franchisees, be aware that not all such

franchisees will be able to communicate with you.”602 In addition, franchisors may, at their own

discretion, disclose the number and percentage of current and former franchisees who have

signed confidentiality provisions and the circumstances under which such provisions were

signed.603 

The NPR comments on the confidentiality clause issue ran the gamut between those who

would ban such clauses to those who urged the Commission to drop the proposal altogether. The 

IL AG favored an out-right ban on non-proprietary confidentiality provisions. “The ability of a

prospective franchisee to freely discuss a present or former franchisee’s experience with the

franchisor may be the single most important step in a buyer’s due diligence investment

evaluation.” IL AG, Comment 3, at 3.604 Some franchisee advocates, such as the NFA, generally

supported the NPR proposal,605 while others would strengthen the proposal.606 Seth Stadfeld, for

example, would add a warning, putting prospects on notice that “important adverse information
 

607 AFA, Comment 14, at 3; Stadfeld, Comment 23, at 6. But see GPM Rebuttal, Comment

40, at 7 (opposing release of names).

 

608 Stadfeld, Comment 23, at 6.

 

609 The AFA also stressed that confidentiality clauses “typically release the franchisor from

legal liability and bar the franchisee (under threat of legal action) from making any oral or written

statements about the franchise system or their experience with the franchised business. The

purpose of such clauses is to shut down any negative public comment about the franchise

system.” AFA, Comment 14, at 3.

 

610 E.g., Quizno’s, Comment 1, at 2; H&H, Comment 9, at 20; Baer, Comment 11, at 14;

NaturaLawn, Comment 26, at 2; Marriott, Comment 35, at 16. See also Snap-On, Comment 16,

at 4 (urging the Commission either to not adopt the proposed disclosure or to revise it in a

manner to accommodate franchisors’ interests in fostering early and amicable settlements). But

see Bundy Rebuttal, Comment 29, at 2-3 (proposal would not discourage settling disputes).

 

611 J&G explained further that the Rule’s disclosures already shed light on the franchise

relationship. “If efforts at obtaining additional information are unsuccessful because of

confidentiality agreements, a reasonable prospective franchisee should be able to take that fact

into its evaluation of whether to buy the franchise. And additional disclosure about ‘gag clauses’

is not helpful.” J&G, Comment 32, at 14.

188

is being held back from them willfully.” Stadfeld, Comment 23, at 6. The AFA and Stadfeld

would also require franchisors to identify which franchisees are subject to a confidentiality

provision.607 Mr. Stadfeld also opposed the three year limit; he would favor a 10 year reporting

 requirement.608 The AFA also urged the Commission to address confidentiality clauses in Item

17, which addresses terminations and renewals. In its view, franchisors should include in Item

17 a statement such as:

Upon expiration/termination/non-renewal of your franchise we may [will] require

that you sign a confidentiality statement agreeing not to talk about your

experience in the [name of] franchise system, whether positive or negative, with

anyone outside of the [name of] franchise system including the public, the media

or the government.

AFA, Comment 14, at 3.609

In contrast, franchisors and their representatives either opposed the proposed

confidentiality clause disclosure as unnecessary, or they would narrow it.610 J&G, for example,

insisted that the proposed disclosure is “offensive.” J&G, Comment 32, at 14.611 Others do not

go that far. PMR&W, for example, “acknowledge[s] the FTC’s concern about prospects being

unable to raise questions with current or former franchisees who are subject to confidentiality

requirements. The FTC’s position is particularly understandable if a gag clause prevents all
 

612 BI, Comment 28, at 13.

 

613 See Bundy, ANPR, 6Nov97 Tr, at 249 and Jeffers, id, at 251-52 (arguing in favor of a

threshold).

 

614 Tricon, Comment 34, at 3. See also Quizno’s, Comment 1, at 2; Marriott, Comment 35,

at 16. Marriott asserted that the disclosure will create a disincentive for franchisors to

accommodate franchisees’ needs in non-standard deals. It noted that franchisors “make a variety

of concessions to franchisees in connection with workouts or in connection with sales, or

purchasing or conversion of multiple units, among others, in exchange for which the franchisor

will request the terms of such arrangements to be kept confidential.” Id. 

189

franchisee communication about the franchise system.” PMR&W, Comment 4, at 15. Rather,

the firm urged the Commission to limit the disclosure’s application to only broad “noncommunication on any subject” prohibitions. Id. 

In a similar vein, BI would limit the disclosure to confidentiality clauses in franchise

agreements and other contracts signed in connection with the grant of a franchise, but would

exclude settlement agreements.612 The NFC advised that the disclosure should apply “where

either all franchisees, or at least twenty percent of the franchisee population, is barred from

communicating with third parties.” NFC, Comment 12, at 33.613 Tricon raised a different

possible limitation. It noted that when a franchisor buys back a franchised unit, it may wish to

include a confidentiality clause relating to the purchase price. It urged the Commission to

exclude such details from the disclosure if the franchisee is otherwise free to discuss his or her

personal experience as a franchisee.

614

Finally, H&H opposed the three-year disclosure requirement. In its view, most

prospective franchisees would want to know the extent of confidentiality provisions within the

last fiscal year. “The fact that two or three years prior thereto franchisees or former franchisees

may have been subject to a gag clause would appear to be irrelevant to a prospective franchisee.” 

H&H, Comment 9, at 20.

Based upon the record, it appears that franchisees often sign post-sale agreements

containing confidentiality clauses in connection with dispute settlements and terminations. We

are convinced that this practice may impede prospective franchisees’ ability to conduct due

diligence investigations of franchise offerings, undercutting the primary goal of pre-sale

disclosure. We believe that the NPR’s approach appropriately addresses this issue. Accordingly,

we recommend that the Commission adopt the confidentiality clause disclosure set forth in the

NPR.

 

As an initial matter, we reject the extreme positions that the Commission should ban

confidentiality clauses, on the one hand, or eliminate the proposed disclosure, on the other. The

record does not support an outright ban on confidentiality clauses. Clearly there are instances
190

where both franchisors and franchisees enter into such clauses voluntarily. As Marriott noted,

franchisees in contract modification negotiations may seek or at least agree to confidentiality in

order to gain certain advantages. Under the circumstances, we cannot conclude that any potential

harm to prospective franchisees from confidentiality clauses necessarily outweighs the potential

benefits to franchisees. 

At the same time, the compliance burden imposed by the new confidentiality clause

disclosure is likely to be minimal. Other than the required statement explaining the nature of

confidentiality clauses to prospects who may be unfamiliar with their use, any other disclosures –

such as number and percentage or the reasons for the clauses – are entirely voluntary. Moreover,

we are unpersuaded that this proposal would discourage settlements. Franchisors opting to

pursue litigation in lieu of settlement in order to avoid the confidentiality disclosure would most

likely have to disclose even more revealing information about the suit in their Item 3 disclosure.

We also reject most commenters’ suggestions either to expand or to narrow the proposed

confidentiality clause disclosure. For example, we reject the suggestion that franchisors identify

individual franchisees who have signed confidentiality clauses. No doubt, this would make

prospective franchisee’s due diligence investigation more efficient. However, we believe it

would create an enormous burden on those franchise systems that list all of their franchisees in

Item 20 on a national basis. It might also require more frequent updating of Item 20 disclosures

than is warranted. 

We further reject suggestions that the proposed disclosure be limited to only those

circumstances where franchisees have signed broad provisions restricting all speech or where a

threshold level of franchisees have signed confidentiality clauses. If the purpose of the proposed

disclosure were primarily to shed light on the extent of problems in the franchise relationship,

then we might agree. As noted above, however, the proposal aims to make prospective

franchisees aware of the use of confidentiality clauses. Armed with such knowledge, prospective

franchisees would understand that: (1) a refusal by one or more existing franchisees to speak is

not necessarily benign; and (2) that the sample of franchisees listed in the disclosure document

could actually be skewed. These aims would apply regardless of the scope of the speech

restriction used by the franchisor or the number of franchisees subject to such restrictions. More

important, adopting a threshold would not address the use of confidentiality clauses to restrict

speech by a minority of franchisees (such as franchisees located in a particular city), which might

be the most relevant universe of existing franchisees to an individual prospective franchisee.

Nonetheless, we agree that the proposal should not reach confidentiality clauses

addressing specific contract negotiation terms and conditions. We recognize that there may be 

instances where both franchisors and franchisee may not wish to discuss specific terms of an

arrangement, such as the price paid for a franchise, or other concessions made to a franchisee. 

The proposed confidentiality clause disclosure would be unwarranted, therefore, where the

parties agree to a limited restriction that still enables franchisees to discuss their overall
 

615 The extent to which franchisors must disclose confidential settlement terms and

conditions is spelled out in Item 3.

 

616 The growth of system franchisee organizations is a recent development. In some

instances, these organizations are franchisor sponsored or approved councils, where franchiseeparticipants are either selected by the franchisor or are elected by franchisees themselves. In

other instances, the organizations are independent of the franchisor. The emergence of

independent franchisee organizations is not always well-received by the franchisor. Some

commenters have told us that, in some instances, franchisors have filed suit to stop the formation

of an independent group or have retaliated against individuals who have participated in such

groups. E.g., Donafin, ANPR 14 (noting pending federal lawsuit alleging franchisor interference

with franchisees’ right to form organizations). Cf. Mueller, ANPR 29 (“The FTC should take

actions against franchisors who intimidate or retaliate against franchisees for getting together for

any legitimate business purpose.”); Rachide, ANPR 32, at 3 (“[The FTC should prohibit [t]he

use of retaliation against franchisees involved in franchisee organizations that work to educate or

rally the franchise group.”). A few states, including California, Illinois, and Washington have

addressed this issue by specifically prohibiting franchisors from restricting franchisees from

freely associating or joining franchisee organizations. See Cal. Corp. Code § 31220; 815 Ill.

Comp. Stat. 705/17; Wash. Rev. Code 19.100.180(2)(a).

191

experience in the franchise system.615 While we believe that the proposed definition of

confidentiality clause discussed above is sufficient to limit the proposed disclosure’s scope, we

recommend additional clarification in the Compliance Guides.

c. Franchisee associations

During the ANPR proceeding, several franchisees and their advocates urged the

Commission to require franchisors to disclose the existence of trademark-specific franchisee

organizations.616 For example, Andrew Selden stated: 

The UFOC Guidelines currently require disclosure of the existence of purchasing

cooperatives known to the franchisor, but this is not adequate disclosure of a fact

of growing importance to franchisees, which is the existence, or non-existence, of

an autonomous franchisee association representing franchisees in that particular

franchise organization. When an organization represents a substantial plurality of

franchisees in the system, perhaps over 30%, and its existence is known to the

franchisor, that fact should be disclosed, possibly by an additional category in the

list of existing franchisees required in Item 20, as an additional and critical source

of information about the franchise opportunity.

Selden, ANPR 133, Appendix B. at 1. Similarly, Martin Cordell, a franchise examiner for the

State of Washington, observed that disclosing trade associations could “be a much more ready

source of information as opposed to individual franchisees who have to take time out of their
 

617 Shay, ANPR, 18Sept97 Tr, at 71; Wieczorek, ANPR, 6Nov97 Tr, at 169-70; Duvall, id.

at 171.

 

618 Wieczorek, ANPR, 18Sept97 Tr, at 74.

 

619 64 Fed. Reg. at 57,314.

 

620 See e.g., AFA, Comment 14, at 5; NFA, Comment 27,at 2; Stadfeld, Comment 23, at 14;

Karp, Comment 24, at 9; Bundy, ANPR, 6Nov97 Tr, at 173; Manuszak, ANPR 13; Zarco &

Pardo, ANPR 134, at 3. Eric Karp also asserted that franchisors generally are hostile to

independent trademark franchisee organizations, implying that franchisors ordinarily would not

disclose their existence voluntarily. See Karp, Comment 24, at Appendix A (listing cases

involving franchisee organizations). 

192

businesses to share information with the prospective franchisee.” Cordell, ANPR, 6Nov97 Tr, at

168-69. Susan Kezios of the AFA added that these associations “have a collective memory of

what has been going on historically in the franchise system that one or another individual

franchisees may or may not have.” Id. at 176.

Franchisors’ reaction to the proposed disclosure was mixed. Some did not oppose a

disclosure for trademark-specific franchisee organizations, especially franchisor-sponsored

franchisee advisory councils or endorsed independent franchisee organizations. However, they

voiced concern about any mandate to disclose all independent franchisee organizations. In their

view, independent organizations are often small, informal groups of individual franchisees that

may come and go at any time, or are often formed on the local or regional level without the

knowledge or involvement of the franchisor.617 In short, they fear liability for failing to disclose

a franchisee organization that they did not know exists.618

In the NPR, the Commission tentatively adopted the trademark-specific franchisee

association disclosure. The Commission stated that such a disclosure would give franchisees an

additional source of material information from which they could learn about the system. The

Commission added that this disclosure is “particularly important if individual former and

existing franchisees . . . are subject to a [confidentiality] clause or are otherwise reluctant to talk

with a prospective franchisee.” 64 Fed. Reg. at 57,314. The Commission also addressed

franchisors concerns about informal or unrepresentative groups of franchisees by proposing that

only incorporated, independent trademark-specific associations need be disclosed and only to the

extent such organizations make their existence known to the franchisor on an annual basis.619 

In response to the NPR, franchisees and their advocates unanimously supported the

proposal.

620 Seth Stadfeld, however, questioned why the proposed disclosure of independent

trademark associations should be limited to “incorporated” associations. In his view, all such

associations should be disclosed, whether incorporated or not. Mr. Stadfeld proposed that it

should be enough that the group represent a significant segment of the franchisee population,
 

621 Stadfeld, Comment 23, at 14-15.

 

622 E.g., Baer, Comment 11, at 14.

 

623 See also NFC, Comment 12, at 32-33.

 

624 See PMR&W, Comment 4, at 15.

193

such as 25%.621 The IL AG offered an opposing view, however, asserting that the benefits of this

disclosure may be lost if the Commission imposed a threshold:

While trying to design a workable association rule, please consider the mindset of

most franchisees, which is an extreme fear of retaliation for belonging to an

association not sponsored by the franchisor. Even in systems where this fear is

unjustified, franchisees are still afraid to be identified with people or groups that

may from time to time oppose policies of the franchisor. Setting a minimum

percentage of franchisees to be a qualified association is virtually unworkable, but

if this approach is used the threshold should be set very low. Five percent of a

system’s franchisees who are willing to be known as members of a franchisee

association may be accompanied by 25% of the franchisees that are of like mind,

but afraid to reveal their membership.

IL AG Rebuttal, Comment 38, at 4.

On the other hand, franchisors and their advocates generally opposed the disclosure of

independent trademark-specific franchisee associations.622 For example, the NFC maintained

that the required list of franchisees is enough to determine the state of franchise relations in the

system. “The due diligence short-cut proposed in the NPR could lead to the dissemination of

misinformation by non-representative groups with narrow agendas and turn franchisors’ offering

circulars into political footballs.” NFC, Comment 12, at 33. H&H feared that franchisee rights

advocates will simply “incorporate an organization to promote their anti-franchisor agenda to

prospective franchisees.” H&H, Comment 9, at 20-21.623 These and other commenters

cautioned that the disclosure may create the false illusion that each and every disclosed

organization is representative of the body of franchisees, when in fact such groups may represent

only a few franchisees.624 

Several franchisor representatives urged the Commission to restrict the proposed

disclosure further to ensure that the organizations disclosed will be fairly representative of the

franchisees in the system. For example, BI stated the proposed disclosure would include “every

incorporated franchisee organization requesting it, no matter how many such organizations exist

and have requested inclusion, and no matter how few franchisees may actually be members of

any such organization.” BI, Comment 28, at 13. J&G would require that the association be
 

625 See also H&H, Comment 9, at 21 (if the organization represents 30% of franchisees);

NFC, Comment 12, at 33 (if the organization represents 20% of the franchisees); Stadfeld,

Comment 23, at 14-15 (if the organization represents 25% of franchisees); BI, Comment 28, at

13 (unspecified threshold).

 

626 See also PMR&W, Comment 4, at 15; Marriott, Comment 35, at 16. But see Karp,

Comment 24, at 10 (The Rule should require franchisor to accept the representation of the

organization that it is incorporated and may not require any collateral document.).

 

627 BI, Comment 28, at 7. See also J&G, Comment 32, at 12-13; Marriott, Comment 35, at

16.

 

628 IL AG, Comment 3, at 9.

 

629 Stadfeld, Comment 23, at 14. 

 

630 Karp, Comment 24, at 9. See also AFA, Comment 14, at 5 (franchisors should disclose

the name of independent franchisee organizations affiliated with the chain, the contact person’s

name, address, and telephone, facsimile and email numbers).

194

comprised of a substantial number of franchisees625 and meet or communicate with the franchisor

at least twice annually for the purpose of addressing franchise relationship issues. Further, the

firm would require the association to: 

provide written notice to the franchisor no later than 30 days after the close of the

franchisor’s fiscal year end identifying the organization, its mission, its form of

organization and the number of franchisees and franchised units which are duespaying members or otherwise accredited members of the organization. If some

franchisees are not dues-paying members, standards used for accreditation should

be enclosed in the notice. 

J&G, Comment 32, at 13.626

Finally, several commenters offered various suggestions to improve the proposed

disclosure. In the NPR, the Commission proposed that the trademark association disclosure 

include those associations that have been “created, supported, or recognized by the franchisor.” 

64 Fed Reg. at 57,344. BI, among other commenters, stated that the term “recognized” is

ambiguous and should be clarified.627 Similarly, the IL AG recommended that the Commission

specifically define the term “trademark-specific franchisee association.”628 Seth Stadfeld would

have franchisors disclose, where possible, the name, address, and telephone number of the

organization and those of its officers, if known.629 Eric Karp would require the disclosure of the

trade organization’s fax number, email address, and Internet home page, if provided by the

association.630 He also advised the Commission to clearly state that the request for inclusion
 

631 Franchisors would disclose the name, address, telephone number, and email address of

the association, and state if the association is franchisor-sponsored.

 

632 See, e.g., A Consumer Guide To Buying A Franchise, at 16-17.

 

633 While 100 franchisees may know about franchisor-sponsored associations, they would

not necessarily know about independent associations, in particular those in particular locations,

or about associations for specific-use franchisee groups (e.g., those operating kiosks in malls).

 

634 See, e.g., Hayden, RR 42; Spencer, RR, Sept95 Tr, at 74.

195

must be renewed on an annual basis within 90 days prior to the anniversary of each 12-month

period.

Based upon the record, the staff recommends that the Commission retain the proposed

trademark-specific association disclosure.631 We are persuaded that the proposed trademarkspecific franchisee association disclosure would advance two important goals: it would provide

prospective franchisees with an additional source of information from which they could verify

the franchisor’s claims, and it would shed light on the quality of the franchise relationship. As

the Commission noted in the NPR, the names and addresses of current franchisees is material

information, enabling prospective franchisees to conduct their own due diligence investigation of

the franchise system. In addition, the staff often advises prospective franchisees to contact as

many existing franchisees as possible to verify the franchisor’s claims and to seek additional

information about the franchisor and its system.632 Providing information about an organized

group of franchisees fits squarely within this advice. 

We also note that proposed Item 20 requires franchisors to disclose the names and

addresses of only a limited number of franchisees in their systems. Franchisors need not disclose

more than 100 franchisees. This is true even for medium and large franchise systems with

several hundred, if not several thousand, franchisees. Therefore, it is possible for some

franchisors to hand-select franchisees listed in their disclosure documents, revealing only

successful franchisees who maintain a good relationship with their franchisor.633 Moreover, a

franchisor could use confidentiality clauses to achieve the same goal. Therefore, the Item 20 list

of franchisees may not be a random sample or otherwise representative of franchisees within a

particular system. One approach to counter any franchisor-bias is to require that franchisors 

disclose the existence of franchisee organizations, providing prospective franchisees with an

alternative view of the franchise system.

There is also evidence in the record that individual franchisees often are reluctant to share

information with prospective franchisees either because they do not have the time, or because

they fear retaliation from their franchisor. For example, Howard Bundy told us that he often

instructs his franchisee-clients to state only their “name, rank, and serial number and refer [the

prospect] back to the franchisor for everything else.” Bundy, ANPR, 6Nov97 Tr, at 236-37.634 In
 

635 Bundy, ANPR, 6Nov97 Tr, at 237.

 

636 Chiodo, ANPR, 21Nov97 Tr, at 294-95. See also Galloway, id. at 317-18. See also

Manuszak, ANPR 13.

196

his view, franchisees who make statements in connection with a franchise sale might be deemed

franchise brokers under state law and could be liable for any claims or damages resulting from

the sale. Franchisees who volunteer information also might be subject to a defamation suit by the

franchisor.635 The proposed trademark-specific franchisee association disclosure, therefore,

would be an important alternative source of information, especially if numerous individual

former and existing franchisees of a system are subject to confidentiality clauses.

There is also evidence in the record that franchisors do not readily inform prospects about

the existence of independent organizations. For example, at the sixth public workshop

conference, Michael W. Chiodo, the executive director of the Domino’s Franchisee Organization,

explained that Domino’s does not inform franchisees about the existence of the Organization, nor

does Domino’s inform the Organization about new franchisees.636

Finally, a franchisee association disclosure is particularly important if, as the staff

recommends, the Commission does not mandate financial performance disclosures. One

rationale for not mandating performance information is that prospects can contact franchisees

directly to obtain such information. Indeed, franchisees are the best source of information about

their own earnings. If true, then prospective franchisees, at the very least, should be able to

contact as many existing and former franchisees as possible. A franchisee association disclosure

may greatly assist prospective franchisees in their due diligence investigation of franchisees’

financial performance by providing an independent source of information. 

In reaching our conclusion, we are mindful of the view that the proposed disclosure is

overly broad and burdensome. The proposal, however, requires franchisors to disclose only

those organizations whose existence is actually known to them. It requires no special research or

recordkeeping on a franchisor’s part. In particular, franchisors are to disclose the existence of

independent associations on an annual basis only and then only if that the association renews its

request for inclusion in the disclosure document in a timely manner. We believe these

limitations will reduce franchisor’s compliance burdens and potential liabilities. 

We also recognize that the proposal may result in the disclosure of associations that are

not necessarily representative of franchisees as a whole. However, we believe there is value in

enabling prospective franchisees to speak with an association representing similar interests, even

if not representative of the entire system. For example, a small association of franchisees in

Anchorage, Alaska, might provide prospective franchisees with valuable information about local

labor costs, financial performance data, as well as information about third-party suppliers. For

this reason, we reject the notion that an independent organization should be forced to establish

that they represent a specific percentage of franchisees in a system. 
 

637 See below at section VIII.B.1.

197

Nonetheless, we believe some limitation on independent associations is warranted. 

Accordingly, we recommend that, at the very least, the association be incorporated. The

proposed incorporation requirement would exclude unorganized groups of isolated franchisees,

while increasing the odds that relevant associations with an institutional history, structure, and

willingness to discuss issues with prospects will be included. We also believe it is proper to

permit franchisors to include a disclaimer, if they wish. The disclaimer would read: “The

following independent franchisee organizations have asked to be included in this disclosure

document. We do not endorse these organizations and their members may not represent all

franchisees in the [name of franchisor] franchise system.” We believe the proposed

incorporation limitation coupled with the proposed voluntary disclaimer strikes the right balance

between pre-sale disclosure and compliance burdens.

 

Finally, we recommend that the Commission revise the proposed trademark-specific

franchisee association disclosure to incorporate several commenters’ suggestions. First, we

recommend that the Commission use the term “sponsored or endorsed” association, rather than

the arguably ambiguous term “recognized” association. Second, we would clarify the time

period in which independent associations can seek inclusion in a franchisor’s disclosure

document, making explicit that requests must be renewed annually and within 90 days after the

close of the franchisor’s fiscal year. As noted above, we recommend that the Commission extend

the annual update period to 120 days637 A 90-day franchisee association renewal period would

afford franchisors sufficient time to prepare the disclosure before the expiration of the 120-day

annual update period. We also believe that email and web page addresses should be provided for

all disclosed associations, if known. As with the cover page, this information will assist

prospective franchisees in contacting the organization before and after the franchise sale.

So revised, the proposed trademark-specific franchisee association disclosure would read

as follows:

(8) Disclose the name, address, telephone number, email address, and Web

address, to the extent known, of each trademark-specific franchisee organization

associated with the franchise system being offered, if such organization:

(i) Has been created, sponsored, or endorsed by the franchisor; or

(ii) Is incorporated and asks the franchisor to be included in the franchisor’s

disclosure document during the next fiscal year. Such organizations must renew

their request for inclusion in the disclosure document annually and within 90 days

after the close of the franchisor’s fiscal year. The franchisor has no obligation to

verify the organization’s continued existence at the end of each fiscal year. 

Franchisors may also include the following statement: “The following

independent franchisee associations have asked to be included in this disclosure

document. We do not endorse these organizations and their members may not

represent all franchisees in the [name of franchisor] franchise system.”
 

638 64 Fed. Reg. at 57,315. In the SBP, the Commission noted that a franchisee is

purchasing, “along with the franchise itself, some assurance of the financial stability of the

franchisor, of the franchisor’s ultimate ability to meet its obligations to its franchisees.” 43 Fed.

Reg. at 59,679. For that reason, the Commission concluded that the disclosure of basic financial

information by all franchisors “is essential.”

 

639 16 C.F.R. § 436.1(a)(20).

 

640 “Without the auditing requirement, the financial statements remain nothing more than the

franchisor’s own representation of its financial condition.” 43 Fed. Reg. at 59,679-80. 

Nonetheless, the costs associated with preparing audited financial statements might create a

barrier to entry by start-up franchisors. In the SBP, the Commission made it clear that, as a

matter of policy, franchisors can use unaudited financials during a phase-in period. Id. at 59,681.

 

641 64 Fed. Reg. at 57,315.

198

W. Proposed Section 436.5(u)

Item 21: Financial Statements

1. Background

Proposed Item 21 of the NPR would require franchisors to disclose three years of audited

financial information based upon generally accepted accounting principles.638 It would improve

the current Rule provision639 by incorporating the UFOC Guidelines’ requirement that financial

disclosures be in a tabular format that compares at least two fiscal years. This provides

prospective franchisee’s with information with which to assess financial trends, rather than just

an isolated snap-shot of the franchisor’s finances. As proposed in the NPR, however, Item 21 

would differ from UFOC Item 21 in two respects. First, consistent with other provisions of the

proposed revised Rule, it would require the disclosure of a parent’s financial information. 

Second, it would retain the Commission’s long-standing policy of permitting franchisors to

phase-in audited financial statements over three years.640 

2. The record and recommendations

a. Parent financial information

In the NPR, the Commission proposed that Item 21 require franchisors to disclose a

parent’s financial information.641 As with other sections of the proposed Rule, several

commenters questioned the routine inclusion of parent information. For example, PMR&W

observed that the UFOC Guidelines specify only that state examiners may ask for audited

financials of a parent, but the Guidelines do not mandate it. In its view, parent financial
 

642 PMR&W, Comment 4, at 16. See also Lewis, Comment 15, at 18; Snap-On, Comment

16, at 4; PREA, Comment 20, at 2; Marriott, Comment 35, at 17. Similarly, J&G opposed

consolidated financial statements of affiliates where the franchisor has included its own financial

statements. “The increased cost and potential liability of other affiliates is unwarranted.” J&G,

Comment 32, at 13.

 

643 See also Baer, Comment 11, at 5; IL AG Rebuttal, Comment 38, at 4. In the same vein,

Howard Bundy suggested that a franchisor should be permitted to use an affiliate’s financial

statements only “if the affiliate guarantees all of the duties and obligations of the franchisor in

writing and for the entire term of the franchise, including any renewals and extensions” and a

copy of the written guarantee is included in the disclosure document. Bundy, Comment 18, at 11

(emphasis in original).

 

644 H&H, Comment 9, at 21, Lewis, Comment 15, at 17.

 

645 This differs from the UFOC Guidelines approach, which requires subfranchisor financial

statements only when the subfranchisor is the applicant for franchise registration.

199

statements are not relevant and are rarely requested.642 Warren Lewis suggested that the

Commission require the disclosure of parent financial statements “only if (i) the company with

the control chooses to guarantee the obligations of the franchisor or subfranchisor to the

franchisee in writing, and (ii) a copy of the written guarantee is included in Item 21 or an

exhibit.” Lewis, Comment 15, at 18.643 In a similar vein, H&H and Warren Lewis opined that it

is unnecessary to require routine financial statements of subfranchisors: financial statements

should be provided only by the entity with whom the franchisee will have a contractual

relationship.644

Consistent with our view expressed in other sections of this Report, we believe that

parents should not have to disclose financial information in all instances. Rather, we recommend

that Item 21 compel the disclosure of a parent’s financial information only in two circumstances: 

where the parent: (1) commits to perform post-sale obligations for the franchisor; or (2)

guarantees obligations of the franchisor. On the other hand, we recommend that the Commission

require subfranchisors to furnish financial disclosures in all instances.

645 As noted in our

discussion of the term “franchisor” above, the term “subfranchisor” is limited to circumstances

where the subfranchisor steps into the shoes of the franchisor by selling and performing post-sale

obligations. It does not reach those individuals who act like brokers, without any post-sale

commitments. Where a person – be it subfranchisor or parent, as previously noted – commits to

perform under the franchise agreement, their financial information becomes material in order to

provide prospective franchisees with the opportunity to assess the person’s financial stability

before risking their own investment.

Finally, we recommend that Item 21 require franchisors to attach a copy of any guarantee

in their disclosures. Although the UFOC Guidelines are less than clear on this point, we believe
 

646 16 C.F.R. § 436.1(a)(20); UFOC Item 21. See also 43 Fed. Reg. at 59,680 (without

auditing “the financial statements remain nothing more than the franchisor’s own representation

of its financial condition”).

 

647 64 Fed. Reg. at 57,315.

 

648 This is entirely consistent with the staff of the Commission’s view that the current Rule

requires all franchisors – foreign and domestic – to prepare financial statements using U.S.

GAAP only. See generally, Advisory 02-4, Bus. Franchise Guide (CCH), ¶ 6515 (Nov. 18,

2002).

 

649 See also NFC, Comment 12, at 33.

 

650 Warren Lewis suggested that the Commission permit foreign franchisors to “use financial

statements prepared according to their countries’ GAAPs, provided that those GAAPs are

comparable to US GAAP.” Lewis, Comment 15, at 17. Mr. Lewis, however, provided no

criteria or examples that would help us determine what GAAP are or are not “comparable.”

200

that Instruction v. contemplates such a disclosure. Moreover, it is sound policy. Before a

prospective franchisee is asked to invest in a franchise, it should be able to assess the extent of

any performance or financial guarantees by a parent or subfranchisor.

So revised, proposed Item 21 would read: “Include separate financial statements for the

franchisor, subfranchisor, and any parent or other entity that commits to perform post sale

obligations for the franchisor or guarantees the franchisor’s obligation. Attach a copy of any

guarantee to the disclosure document.”

b. Audited financial statements

The current Rule and UFOC Guidelines require franchisors to make audited financial

disclosures prepared according to generally accepted accounting principles (“GAAP”) and

auditing standards by an independent certified or licensed public accountant.646 In the NPR, the

Commission proposed retaining the GAAP requirement.647 At the same time, the NPR added

clarity by referring to “GAAP” as “generally accepted United States accounting principles.” Id.

at 57,344.648

In response to the NPR, a few commenters opposed the required use of U.S. GAAP by

foreign franchisors. These commenters observed that this requirement would impose expenses

and burdens on foreign corporations entering the American market. H&H’s comment is typical: 

“For companies located in many foreign countries, . . . a requirement to convert to US accounting

standards would be enormously expensive.” H&H, Comment 9, at 13.649 H&H urged the

Commission to permit foreign franchisors to prepare financial statement that “conform to U.S.

GAAP or otherwise to generally accepted accounting principles established in the country of the

company’s domicile.” Id.650 This view, however, was not universally shared. The IL AG argued
 

651 IL AG Rebuttal, Comment 38, at 5.

 

652 See SEC Form 20-F, Part III, Items 17 and 18. The SEC has also made clear that even if

a foreign company reconciles its financial statements to U.S. GAAP, it must audit the financials

according to U.S. generally accepted auditing standards and the auditor must comply with the

U.S. standards for auditor independence. See Id., General Instruction E(c).

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that foreign companies should follow U.S. GAAP or be permitted to reconcile their financial

statements to U.S. GAAP through footnotes and explanations.651

NASAA raised a slightly different concern. It observed that the Commission requires

GAAP only for audited financial statements. It urged the Commission to apply GAAP to all

financial statements, audited or unaudited. “The Project Group suggests that because financial

statements are required of all franchisors, those statements should be prepared according to

 GAAP.” NASAA, Comment 17, at 11.

As noted in our discussion above concerning the scope of the Rule, the sale of franchises

internationally was not an issue that loomed large when the Commission promulgated the

Franchise Rule in the 1970s. We recognize that application of only U.S. GAAP in today’s global

economy may impede competition from foreign franchisors. Accordingly, we believe a more

flexible approach is warranted, especially in the absence of any evidence in the record that

financial statements prepared by foreign franchisors to date have been deceptive or misleading.

As an initial matter, there is no question that the primary purpose of a disclosure

document is to provide prospective franchisees with material information in a clear and

conspicuous manner. Consistent with that principle, franchisors should present financial data in

a format that is meaningful to American prospective franchisees, as well as to their advisors. We

believe the suggestion offered by IL AG – that foreign franchisors use U.S. GAAP or reconcile

their financial statements to U.S. GAAP – adds needed flexibility, while reducing costs and

burdens on foreign franchisors. Indeed, this is the very position adopted by the Securities and

Exchange Commission (“SEC”) for the registration of securities by foreign companies.

 

The SEC permits foreign companies registering securities to prepare financial statements

using accounting procedures other than U.S. GAAP under limited circumstances. The first

prerequisite is that such statements be prepared “according to a comprehensive body of

accounting principles.” The company must also disclose the specific comprehensive body of

accounting principles used to prepare the statements and explain material differences between the

principles and U.S. GAAP. The company must also reconcile its statements with U.S. GAAP. 

For example, through additional notes, franchisors must reconcile figures for net income and

total shareholders’ equity for the period presented. Finally, the statements must provide all

additional disclosures required by U.S. GAAP and applicable SEC regulations.652
 

653 We agree with the NASAA that, to prevent fraud, the accounting standard adopted should

apply to both audited and unaudited financial statements.

 

654 Of course, the Commission retains its Section 5 authority to challenge any deceptive

foreign statements prepared according to the SEC standard.

 

655 62 Fed. Reg. at 9,121.

 

656 E.g., Duvall, ANPR 19, at 1; Baer, ANPR 25, at 4; Kaufmann, ANPR 33, at 6;

Kestenbaum, ANPR 40, at 2; AFA, ANPR 62, at 3; IL AG, ANPR 77, at 3; Tifford, ANPR 78, at

4; IFA, ANPR 82, at 1; Jeffers, ANPR 116, at 2. 

 

657 64 Fed. Reg. at 57,315.

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 We recommend that the Commission accept foreign financials that satisfy the SEC

criteria.653 As a starting point, the SEC standard would ensure against deception by requiring

foreign franchisors to establish that their financials are prepared “according to a comprehensive

body of accounting principles.” Further, it would add flexibility and minimize costs and burdens

on foreign franchisors, while ensuring that prospective franchisees receive the same material

financial information as they would receive from a domestic franchisor. We believe this flexible

approach is warranted especially given the absence of any showing or suggestion in the record

that reconciled, foreign financial statements are inherently deceptive or misleading.654 At the

same time, we recognize the possibility exists that American accounting principles are likely to

change. Under the circumstances, we recommend that the Commission update Item 21 to ensure

that financial statements must be prepared according to U.S. GAAP or as permitted by the SEC,

as revised by any future government mandated accounting principles. 

c. Phase-in of audited financial statements

During the Rule Review, commenters representing all affected interests urged the

Commission to retain the three-year phase-in of audited financial statements for start-up

franchise systems. To that end, the Commission solicited in the ANPR additional comment on

this issue.655 All of the commenters who responded urged the Commission to retain the threeyear phase-in.656 No commenter offered any refinements or alternatives to the Commission’s

current approach. 

In the NPR, the Commission tentatively adopted the three-year phase-in, recognizing that 

new franchise systems may not have three years of financial information with which to make the

Item 21 disclosure.657 Support for the NPR’s phase-in proposal, however, was not unanimous. 

Howard Bundy opposed a phase-in, noting, among other things, that the states do not have a

comparable provision. He also cited Small Business Administration statistics showing that only

25% of franchisors survive five years. “If we excuse audited financial statements for the first two
 

658 Mr. Bundy also noted that an audit gives a franchisee a potential remedy that otherwise

would be unavailable. “[T]here is no doubt that the auditor has liability to the franchisee if the

auditor did not follow proper procedures and provide the appropriate warnings – including notes

to the effect that the company may not be solvent or may be reliant upon selling more franchises

for its economic survival.” Bundy, Comment 18, at 11.

 

659 See 64 Fed. Reg. at 57,315.

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years, for all practical purposes, even more investors will risk losing everything.” Bundy,

Comment 18, at 11.658

On the other hand, John Baer not only supported the phase-in, as drafted in the NPR, but

went so far as to urge the Commission to make it preemptive: “The Commission should be

aware that several of the states require the use of audited opening balance sheets in order to

register a start-up franchisor. We believe that this is another example of why the Franchise Rule

should preempt inconsistent state law requirements. One set of financials should be acceptable

throughout the country.” Baer, Comment 11, at 15.

While NASAA supported the proposal generally, it questioned the reference to “startups” in the phase-in provision. It noted that: “[i]f a major corporation that has been in business

for many years and then begins to franchise, that corporation should not enjoy the same

exemption from disclosing audited financial statements as a new company that just organized as

a true ‘start up’ franchise system.” NASAA, Comment 17, at 11. The NASAA Project Group

suggested that franchisors that have been in any type of business for three years or more, not just

the business of selling franchises, should be required to provide audited financial statements. Id.

The staff continues to believe that a phase-in of audited financial statements is desirable,

for the reasons noted above. Nonetheless, we recommend that the current phase-in be fine-tuned,

as proposed in the NPR. The staff often receives inquiries from attorneys attempting to make

sense of the current phase-in schedule. Under the current phase-in, a franchisor may furnish a

balance sheet for “the first full fiscal year following the date on which the franchisor must first

comply with [the Rule.]” 16 C.F.R. § 436.1(a)(20)(ii). It is often unclear when the franchisor’s

first fiscal year ends. For example, a franchisor may have started selling franchises three months

into its first fiscal year (e.g., in March 1, 2002, using a calendar fiscal year). At the conclusion of

that fiscal year (December 31, 2002), the franchisor would have sold franchises for nine months. 

Yet, under the current phase-in, the franchisor’s first fiscal year would not end until December

31, 2003, because the phase-in uses the language “first full fiscal year” after starting to sell

franchises. We recommend that the Commission replace the word “full” with “first partial or

full fiscal year” so that a franchisor’s first fiscal year will end consistent with its general

accounting practices, regardless of when the franchisor may have started offering franchises

within that year.659 Under this revised approach, the Commission will look to the close of the

franchisor’s first fiscal year after selling franchises, regardless of whether that time period was a

partial or full year. No comments were submitted concerning the NPR’s first-year calculation
 

660 See Final Interpretive Guides, 44 Fed. Reg. at 49,981 (“Franchisors may use unaudited

financial statements . . . if they lack audited statements for the fiscal years to be reported when

they are first required to furnish a basic Disclosure Document.”). 

 

661 64 Fed. Reg. at 57,315. See UFOC Guidelines, Item 22.

 

662 See 16 C.F.R. § 436.1(g). These attachments would enable prospective franchisees to

compare a franchisor’s disclosure about the parties’ legal obligations with the actual agreements

that will govern the franchise relationship. In the SBP, the Commission recognized that this

requirement “will therefore have a remedial effect in that it will encourage accurate discussion of

the required information in the disclosure statement.” 43 Fed. Reg. at 59,696. 

204

proposal. Therefore, we recommend that the Commission adopt the NPR’s proposed revised

phase-in of audited financial statements in the final revised Rule.

We also find merit in NASAA’s comment. The term “start-up” may be overly broad,

effectively permitting companies that have prepared audited financial statements to avoid

including them in their disclosure documents. Indeed, any franchisor could attempt to avoid

disclosing bad financial data by reincorporating and selling franchises under a new name. 

Nonetheless, we do not recommend further revision of proposed Item 21. Rather, we

recommend that the Compliance Guides accompanying the Rule explain the meaning of “startup,” as NASAA suggested. In short, the Compliance Guide will make clear that the audited

financial statement phase-in is available only to entities that are new to franchising and that

ordinarily have not prepared audited financials statements to date. Any non-franchise company

that has prepared audited financials in the ordinary course of business must include such audited

financials in its disclosure documents if it decides to begin offering franchises.660 The phase-in is

also not intended for spin-offs, affiliates, or subsidiaries of a franchisor, where the franchisor has

been engaged in franchising or has prepared audited financial statements for any other purpose. 

X. Proposed Section 436.5(v)

Item 22: Contracts 

1. Background

Proposed Item 22 of the NPR would adopt the UFOC Guidelines requirement that

franchisors attach a copy of all relevant agreements to the disclosure document, such as the

franchise agreement, leases, options, or purchase agreements.661 This is similar to the current

Rule requirement that franchisors provide prospective franchisees with copies of relevant

documents at least five business days prior to the date of execution.662 Arguably, proposed Item

22 is not a disclosure item at all, but an instruction on how to prepare a disclosure document. For

that reason, the requirement logically could appear in the revised Rule’s general instructions

section. In an effort to reduce inconsistencies between federal and state law, however, the staff
 

663 64 Fed. Reg. at 57,344.

 

664 Id. at 57,315 and 57,344.

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recommends that the Commission follow the UFOC’s Guidelines approach of including this

requirement among the Rule’s disclosure items. 

2. The record and recommendations

Only one comment was submitted concerning Item 22. David Gurnick expressed concern

that the term “contract” could be misinterpreted to suggest that Item 22 requires the disclosure of

post-sale settlement agreements. He suggested that Item 22 expressly state that “the contracts to

be attached do not include forms of negotiated settlement agreements,” especially since the terms

of any such agreements are unknown at the time of sale. Gurnick, Comment 21, at 7.

We suppose it is possible for a franchisor to misread proposed Item 22 as including future

settlement negotiations. However, we do not believe this is likely. Item 22 refers to those

contracts that involve the franchise offering at the time of the sale. Clearly, franchisors cannot

disclose something that may only exist at some future date. Therefore, we do not believe that

proposed Item 22 needs to be revised.

Y. Proposed Section 436.5(w)

Item 23: Receipt

1. Background

Based upon UFOC Item 23, proposed Item 23 of the NPR would require prospective

franchisees to acknowledge receipt of the disclosure document. At the same time, it would

afford franchisors and franchisees wider latitude in demonstrating acknowledgment of receipt

than the comparable UFOC Guidelines provision.663 Whereas UFOC Item 23 requires

franchisors to acknowledge receipt with a handwritten signature, proposed Item 23 would allow

prospective franchisees to acknowledge receipt through a “signature,” which, as explained in the

definitions above, would include not only written signatures, but electronic signatures,

passwords, security codes, and other devices that enable a prospective franchisee to easily

acknowledge receipt, confirm his or her identity, and submit the information to the franchisor. 

Proposed Item 23 would also provide that franchisors may include specific instructions on how

to submit the receipt, such as via facsimile.664 This would enable the parties to determine for

themselves the most efficient and cost-effective way for the prospective franchisee to transmit

the receipt acknowledgment. 
 

665 Other Commission trade regulation rules contain provisions that serve a similar

educational function. E.g., Energy Guides, 16 C.F.R. Part 305, App. L. (“Compare the energy

use . . .with others before you buy.”); Cooling-Off Rule, 16 C.F.R. § 429.1 (Notice of right to

cancel); Used Car Rule, 16 C.F.R. § 455.2 ( “Below is a list of some major defects that may

occur in used motor vehicles.”). 

 

666 Lewis, Comment 15, at 18. 

 

667 Id. 

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2. The record and recommendations

Several commenters supported the proposed receipt requirement. According to IL AG, 

the receipt page serves as an important reminder to the prospect that he or she is supposed to

receive a disclosure document. “If no disclosure document is provided we would hope it would

make the franchisee refuse to sign the receipt. . . . [T]he receipt is an extremely important

document when a franchisee later alleges that disclosure was never effected.” IL AG, Comment

3, at 9. John Baer similarly stated that requiring franchisors to prove receipt is “useful for both

franchisors and franchisees.” Baer, Comment 11, at 15. 

We agree that the proposed receipt requirement benefits both prospective franchisees and

franchisors. Like the cover page, the proposed receipt serves an important consumer education

function,665 informing prospects that they have 14 days to review the disclosures, that they should

receive certain attachments, and that they can report possible law violations. At the same time, it

enables franchisors to provide proof of delivery. This is especially important if, as proposed

below, the Commission permits franchisors to furnish disclosures electronically.

Nonetheless, we note that a few commenters suggested that the proposed Item 23 should

be fine-tuned. Warren Lewis, for example, advised us that the title of Item 23 should be changed

from “receipt” to “receipts,” observing that the current industry practices is to have two receipts

at the end of the disclosure document, one the franchisee retains as part of the disclosure

document and the other returned to the franchisor.666 He would also change the reference to

“franchisee’s signature” to the words “prospective franchisee’s signature,” noting that some

prospective franchisees object to signing receipts as “franchisees,” since this designation is

inaccurate until they have signed the franchise agreement.667 NASAA also suggested that the

Commission clarify that the acknowledgment page must be placed as the last two pages of the

disclosure document. In support, it observed that “[t]he States that review franchise offerings

have noted may instances where this page was buried in the middle of the disclosure document.” 

NASAA, Comment 17, at 11. We believe these suggestions are sound and recommend that the

Commission adopt them.

We also note that H&H would revise the second paragraph. As drafted in the NPR, this

paragraph states, in relevant part: “If [name of the franchisor] offers you a franchise, it must
 

668 See section V.B.2.c. 

 

669 At the same time, we recommend that the Commission prohibit a franchisor from failing

to furnish disclosures earlier in the sale process, upon reasonable request. 

 

670 64 Fed. Reg. at 57,315.

 

671 PMR&W, Comment 4, at 5.

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provide this disclosure document to you 14 days before the earlier of: (1) the signing of a

binding agreement; or (2) any payment to [name of franchisor or affiliate].” H&H would modify

“binding agreement” to read “binding agreement with the franchisor or any of its affiliates.” The

firm asserted that the franchisor cannot control whether a prospective franchisee proceeds to

commit with independent, third parties before expiration of the 14 day period.” H&H, Comment

9, at 21. As noted in our discussion of the disclosure trigger above, 668 we agree, concluding that

franchisors must furnish disclosures 14 days before the prospective franchisee makes a payment

to, or signs an agreement with, the franchisor or an affiliate.669 Accordingly, we recommend 

modifying the proposed receipt as H&H suggested.

Finally, we note that a few commenters addressed a proposal in the NPR that franchisors

obtain a signed copy of the Item 23 receipt five days in advance of a prospective franchisee’s

signing the franchise agreement or payment of a fee in connection with the franchise sale. The

Commission proposed this requirement in the NPR to ensure that the prospective franchisee in

fact received the disclosures before the franchisor finalized the franchise sale.670 PMR&W, for

example, questioned the need for this provision, asserting that there is no record of abusive

practices in this area. According to the firm, as long as the franchisor obtains the receipt and

retains it for the necessary recordkeeping period, no other requirement should be imposed.671 On

the other hand, John Baer supported the proposal: “Requiring franchisors to prove that

prospective franchisees actually received a disclosure document is useful for both franchisors and

prospective franchisees. For the franchisor, it is a consistent reminder of the need to comply with

the 14 day disclosure rule.” Baer, Comment 11, at 15.

We are persuaded that the proposed five-day period is unnecessary and should be deleted

from the final revised Rule. A franchisor always has the burden of proving that it in fact has

complied with the Rule’s disclosure and timing provisions. We are reluctant, therefore, to

 impose a new, timing provision. In those instances where franchisors never furnish disclosures 

-- or furnished incomplete or inaccurate disclosures -- the proposed revised Rule’s 14-day trigger

and the substantive disclosure obligations are sufficient to address the problem. Moreover, we

find that proposed Item 23's general recordkeeping provision obviates the need for a more

specific requirement that franchisors obtain a copy of the receipt at least five days in advance of

the sale. Further, the Commission proposed a five-day post-receipt waiting period in part

because franchisors, under the current Rule, already must wait five days for the prospective

franchisee to review the completed franchise agreement. However, as noted above, we
 

672 64 Fed. Reg. at 57,315-16. See also 16 C.F.R. at §§ 436.1(a) and 436.1(a)(21). The

“single document” requirement prevents “piecemeal and confusing disclosures by the

franchisor.” SBP, 43 Fed. Reg. at 59,682. No comments were submitted in response to this

instruction, and we, therefore, recommend that the Commission adopt it in the final revised Rule. 

 

673 64 Fed. Reg. at 57,316. See also 16 C.F.R. at § 436.1(a)(24). This instruction is intended

to “aid the franchisee in using the disclosure document and [is] intended as a remedial measure to

prevent franchisors’ violations of the rule and the [FTC] Act.” SBP, 43 Fed. Reg. at 59,684. No

comments were submitted on this proposal, and we recommend that the Commission adopt it in

the final revised Rule.

 

674 64 Fed. Reg. at 57,316. See also 16 C.F.R. at § 436.1(a)(21). This instruction prevents

“the franchisor from ‘explaining away’ the required disclosures or ‘burying’ the material

information in a mass of less important information.” SBP, 43 Fed. Reg. at 59,682. 

 

675 Final Interpretive Guides, 44 Fed. Reg. at 49,969.

 

676 64 Fed. Reg. at 57,315-16. See also UFOC Guidelines, General Instruction 150.

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recommend that the five-day review period be deleted from the Rule, except in those instances

where the franchisor initiates changes in the basic contract. Because the five-day agreement

review period no longer applies as a matter of course in all franchise sales, we are reluctant to

recommend retaining the five-day period just for receipts in the absence of evidence showing a 

widespread problem in this area.

VII. PROPOSED SECTION 436.6: GENERAL INSTRUCTIONS

A. Background

In the NPR, the Commission proposed two new sections that would set forth the basic

instructions for preparing a disclosure document. The first section (NPR section 436.6) would

set forth general instructions for preparing all disclosure documents. Specifically, the NPR

proposed retaining the current Rule’s three basic instructions for preparing a disclosure

document: (1) that disclosures be prepared clearly, legibly, and concisely in a single

document;

672 (2) that franchisors respond affirmatively or negatively to each disclosure item;673

and (3) that franchisors do not add any materials to a disclosure document, except for

information required by non-preempted state law.674 The proposed instructions would also adopt

the Commission’s current policy that subfranchisors should provide disclosures about the

franchisor, and to the extent applicable, about themselves.675 Consistent with the UFOC

Guidelines, disclosure documents would also have to be written in plain English.676
 

677 64 Fed. Reg. at 57,316-19. Several commenters urged the Commission to permit

franchisors to comply with the Rule electronically. E.g., PMR&W, Comment 4, at 2;

McDonalds, Comment 7, at 2; H&H, Comment 9, at 2-3; 7-Eleven, Comment 10, at 2; IFA,

Comment 22, at 5-6; Stadfeld, Comment 23, at 4; Frandata, Comment 29, at 1; AFC, Comment

30, at 2. For example, the NFC told us that electronic disclosure will greatly reduce compliance

costs, while affording prospective franchisees the opportunity to obtain disclosure documents

quickly and to review them “more intelligently” through the use of internal links. NFC,

Comment 12, at 14. This will better enable prospective franchisees to comparison shop,

improving “the functioning of an already robust marketplace.” Id. at 15. Frandata estimates that

the current cost to print and mail one domestic disclosure document averages about $40. Other

administrative expenses (such as those to mail and review application forms, respond to

inquiries, and recordkeeping) raise the total cost associated with moving a prospective franchisee

through the sales process to nearly $100. Ultimately, electronic disclosure is likely to reduce

printing and mailing costs to about $5-10 per document. However, that figure does not include

the actual cost to develop, implement, and maintain an electronic disclosure system, which, in

Frandata’s view, can range from $2,500-$10,000 per year. Nonetheless, Frandata reported that

“even with these additional costs, electronic delivery will still dramatically reduce the overall

cost of the sales and delivery process.” Frandata, Comment 29, at 3-4.

 

678 64 Fed. Reg. at 57,316.

 

679 See id. at 57,317. The proposed summary disclosure document proposal generated

mostly negative comments. PMR&W, for example, opined that the paper summary requirement

may be unnecessary in a few years due to advances in confirmation technology. PMR&W,

Comment 4, at 4. But see Stadfeld, Comment 23, at 15 (supporting summary document

proposal). Others believed the summary document proposal is inefficient or burdensome,

asserting that franchisors should be able to use electronic means exclusively for Rule

compliance. For example, McDonald’s urged the Commission to permit “exclusive use of

electronic means to communicate all disclosure information.” McDonald’s, Comment 7, at 2. 

See also 7-Eleven, Comment 10, at 2; GPM Rebuttal, Comment 40, at 8-9.

 

680 64 Fed. Reg. at 57,318.

209

In the second section (NPR section 436.7), the NPR proposed specific instructions

pertaining to electronic disclosures.677 In order to prevent fraud and circumvention of the Rule’s

pre-sale disclosure requirements, the NPR proposed, among other things, that: (1) prospective

franchisees consent to receiving electronic disclosures;678 and (2) franchisors using electronic

media provide prospective franchisees with a paper summary document containing an expanded

cover page, table of contents, and acknowledgment of receipt.679 In addition, all disclosures must

be in a form that permits each prospective franchisee to download, print, or otherwise maintain

the document for future reference.680 Multimedia features – such as audio, video, and “pop-up”

screens, and external links – would be prohibited in all disclosure documents. In order to

facilitate the reading of an electronic disclosure document, however, the NPR proposed
 

681 See id.

 

682 Id. at 57,319.

 

683 15 U.S.C. § 7001.

 

684 15 U.S.C. § 7006(1). The narrow definition of “consumer” is not unique. See

Magnuson-Moss Warranty Act, 15 U.S.C 2301(1) (defining “consumer product” as “tangible

personal property . . . which is normally used for personal, family, or household purposes.”).

210

permitting franchisors to include navigational tools, such as internal links, scroll bars, and search

features.681 Finally, the NPR proposed that franchisors furnishing disclosure document

electronically retain a specimen copy of their disclosures for a period of three years.682

B. Effect of E-SIGN

On June 30, 2000, Congress enacted The Electronic Signatures in Global and National

Commerce Act (“E-SIGN”).683 E-SIGN seeks to eliminate barriers to e-commerce by, among

other things, giving legal effect to electronic transactions, including pre-sale disclosure, and

permitting electronic signatures. Further, E-SIGN also preserves certain consumer rights. 

Specifically, it provides that consumers must give their informed consent before engaging in

electronic transactions and requires companies to disclose any rights consumers may have to

receive paper records and to withdraw previously-given consent to receive electronic records. 

E-SIGN, however, limits such rights to “consumer” transactions, which it defines as an

“individual who obtains, through a transaction, products or services which are used primarily for

personal, family, or household purposes.”684 Thus, by its terms, E-SIGN may have rejected

restrictions such as those proposed in the NPR for electronic franchise disclosure. 

In light of E-SIGN, the staff has reconsidered the NPR proposals. As explained below,

we recommend that the Commission eliminate the NPR’s proposed electronic disclosure

instructions (NPR section 436.7). In lieu of specific electronic disclosure instructions, we

recommend that the Commission broaden the proposed revised Rule’s general instructions (NPR

section 436.6) to cover the furnishing of all disclosure documents, paper and electronic alike. 

Below we set forth our recommendations for a single, expanded general instructions section,

incorporating comments submitted on the original NPR proposals (proposed revised section

436.6).

C. The record and recommendations

1. Proposed section 436.6(a): Form of disclosures

As noted above, the NPR proposed that electronic disclosures “must be capable of being

printed, downloaded onto computer disk, or otherwise preserved . . . as one single document.” 
 

685 See Bundy, ANPR, 6Nov97, at 129 (disclosures need to be either downloaded onto disk

or provided in paper form).

 

686 64 Fed. Reg. at 57,325. See also 16 C.F.R. § 436.1(a)(24).

 

687 64 Fed. Reg. at 57,316. See also 16 C.F.R. § 436.1(a)(21). 

211

64 Fed. Reg. at 57,345. No significant comments were submitted on this proposal and, therefore,

we recommend its adoption in the final revised Rule. However, consistent with E-SIGN, we

recommend that the Commission expand the NPR proposal to ensure that all disclosure

documents can be stored and preserved, paper and electronic disclosures alike, as follow:

(a) Disclose the information required in (sections 436.3 - 436.5) clearly,

legibly, and concisely in a single document using plain English. The disclosures

must be in a form that permits each prospective franchisee to store, download,

print, or otherwise maintain the document for future reference.

By instructing that all disclosures must be capable of being stored, downloaded, printed,

or otherwise maintained, the revised Rule would ensure that prospective franchisees can retain a

copy for future reference, as well as ensure that prospective franchisees can show a copy to their

advisors, if they wish to do so.685 Indeed, inherent in the concept of furnishing disclosures is the

prospective franchisee’s ability to review the document at will, now and in the future. Thus, for

example, a franchisor would fail to furnish disclosures in violation of the revised Rule if it sought

to provide disclosures merely by permitting a prospect to glance at a paper copy of its disclosure

document, providing a continuous loop video of its disclosure document at a trade show, or

transmitting its disclosures via email or the Internet in a format that was incapable of being

downloaded or printed. 

2. Proposed section 436.6(b): Responses

The NPR’s general instructions retained the current Rule provision that franchisors must

respond fully to each disclosure Item. If a disclosure item is not applicable, then the franchisor

must respond negatively, including a reference to the type of information required to be disclosed

by the Item. In addition, each disclosure item must contain the appropriate heading.686 No

commenters raised any concerns about this proposed instruction. Accordingly, we recommend

that the Commission retain it in the final revised Rule.

3. Proposed section 436.6(c): Additional materials

In the NPR, the Commission proposed retaining the Commission’s current policy

prohibiting franchisors from including additional materials in their disclosures, except for

information required or permitted by non-preempted state law.687 This prohibition is necessary to

ensure that franchisors do not include information that is non-material, confusing, or distracting
 

688 64 Fed. Reg. at 57,318. The requirement that a disclosure document be a single

document also effectively prohibits franchisors furnishing disclosures via the Internet through a

series of linked, but separate, documents. This ensures that an electronic document can be

downloaded and printed in its entirety. See Bundy, Comment 18, at 13 (suggesting that the Rule

should expressly require that all exhibits and attachments must be part of the single disclosure

document, and it should prohibit external links). If not, a prospective franchisee downloading or

printing an electronic disclosure document may only capture isolated sections of the disclosure

document. This would violate the very concept of full disclosure underlying the Rule.

 

689 Frandata, for example, observed that internal links will enable a prospective franchisee to

shift between the disclosure document and corresponding agreement provisions, “thus affording

a franchisee a more intelligent and efficient review of a disclosure document.” Frandata,

Comment 29, at 4. Indeed, Frandata suggested that the Commission formulate a specific set of

cross-links and features in order to ensure that all electronic disclosure documents are uniform. 

In its view, uniformity would foster comparison shopping among franchise offers. In addition, it

would avoid stigmatizing those franchise systems that fail to incorporate features in their

electronic disclosure documents. “For example, viewing a document with extensive search

features keyed to words in the disclosure document might predispose a prospect to envision that

all electronic versions contained such a feature, and would therefore create a negative impression

(or customer service issues) for other systems which have not incorporated such a feature, while

simultaneously confusing the prospect.” Id. We would not go so far. Rather than dictate the

features that a franchisor should use in preparing disclosure documents, we believe the Rule

should allow for maximum flexibility, enabling franchisors to incorporate those features it

believes are warranted in light of market forces.

 

690 64 Fed. Reg. at 37,518.

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from the core disclosures. In the proposed electronic disclosure instructions, the Commission

also proposed updating the instructions to prohibit the use of new technological developments,

such as audio, video, and “pop-up” screens, and external links,688 which could be used to call

attention to favorable portions of a disclosure document or to distract prospective franchisees

from damaging disclosures. However, the Commission recognized that navigational features

may benefit prospective franchisees by making it easier to read an electronic disclosure

document.

689 To that end, the NPR proposed that the Rule specifically permit the use of scroll

bars, internal links, and search features.690

The NPR’s proposed prohibition against adding materials to a disclosure document

generated a few comments. As an initial matter, Warren Lewis suggested a minor revision to the

proposed exemption for “any materials or information other than that required by this Rule or by

State law not preempted by this Rule.” He noted that because some of the proposed Rule’s

disclosures are optional (such as the Item 19 financial performance disclosures), the prohibition

on additional information should read “any materials or information other than that required or
 

691 See also Holmes, Comment 8, at 9; Stadfeld, Comment 23, at 15; BI, Comment 28, at 8. 

 

692 H&H, Comment 9, at 8.

 

693 In response to the same proposal in the NPR, BI told us that the proposed prohibition on

the use of multimedia features “appears to be overly broad.” BI, Comment 28, at 8. It proposed

that the Commission consider that some features may assist a prospective franchisee in reading a

disclosure document. BI, however, did not specify which features it had in mind or how those

features might assist prospective franchisees. 

 

694 The proposed revisions, however, make clear that permission to use navigational tools is

for the prospective franchisee’s benefit. Accordingly, a franchisor’s selective use of navigational

tools for its own benefit (i.e., to draw the prospect’s attention to, or away from, certain disclosure

items) would be prohibited.

213

permitted by this Rule . . . .” Lewis, Comment 15, at 19. We agree and recommend that the text

of the Rule be modified accordingly.

At the same time, Mr. Lewis maintained that the proposed prohibition “is an unfair trap

for franchisors and subfranchisors,” asserting:

[W]e note that a franchisor or subfranchisor sometimes needs to include

information in a disclosure document that it believes is material or possibly

material (even though the information is not required or permitted under federal or

state law) or that it believes will help a prospect to better understand required

information or its significance. Providing supplementary or explanatory

information of this type should not be a rule violation, unless the information is

excessive, misleading, or intentionally diversionary.

Lewis, Comment 15, at 19.691 In the same vein, H&H noted that the Commission proposed in the

NPR that franchisors may have other obligations under Section 5 of the FTC Act to disclose 

material information beyond that required by the Rule.692 According to the firm, this leaves the

franchise community without clear guidance on what is expected in a disclosure document.

The staff recommends that the Commission continue its long-standing policy of

instructing franchisors to include only authorized materials in their basic disclosure document,

whether in paper or electronic form. For example, a franchisor would be prohibited from

including general advertising, testimonials, or – in the case of electronic media – multimedia

tools, in their disclosure documents.693 On the other hand, the Commission recognized in the

NPR the unique features of electronic media, such as scroll bars, internal links, and search

features that may aid prospective franchisees in reviewing their disclosures. We continue to

agree that such navigational tools serve a useful purpose in an electronic environment and

recommend that the Commission specifically authorize the use of such features.694
 

695 See 16 C.F.R. § 436.1(a)(21) (“This does not preclude franchisors . . . from giving other

nondeceptive information orally, visually, or in separate literature so long as such information is

not contradictory to the information in the disclosure statement.”).

 

696 64 Fed. Reg. at 57,316.

214

In reaching this conclusion, we recognize the commenter’s concern that it may be

desirable to include additional material information in a disclosure document. To that end, we

recommend that the Commission clarify in the Compliance Guides that a franchisor can add brief

footnotes or other clarifications to ensure that a required disclosure is complete and not

misleading. However, we believe it is otherwise inappropriate for a franchisor to add

unauthorized information to a disclosure document. This could unnecessarily bulk-up the

disclosures, or offer an opportunity to distract attention away from potentially negative

disclosures. Finally, we note that the prohibition on adding to a disclosure document is a narrow

one. Franchisors are always free to provide prospective franchisees with non-deceptive and noncontradictory information outside of a disclosure document.695

 

So revised, the general “additional material” instruction to the final revised Rule would

read:

(c) Do not include any materials or information other than those required or

permitted by this Rule or by state law not preempted by this Rule. For the sole

purpose of enhancing the prospective franchisee’s ability to maneuver through an

electronic version of a disclosure document, the franchisor may include scroll

bars, internal links, and search features. All other features (e.g., multimedia tools

such as audio, video, animation, or pop-up screens) are prohibited.

4. Proposed section 436.6(d): Multi-state documents

In the NPR, the Commission proposed permitting franchisors to prepare multi-state

documents to include state-specific information either in the text of the disclosure document or in

exhibits attached to the disclosure document.696 In effect, this instruction provides additional

guidance on how franchisors may incorporate state-specific information into their disclosures. It

also would decrease compliance costs significantly, by enabling franchisors to use one, united

disclosure document for both federal and state purposes. No commenters raised any concerns

about this proposal. Accordingly, we recommend that the Commission adopt the multi-state

instruction in the final revised Rule.

5. Proposed section 436.6(e): Subfranchisor disclosures

The NPR also addressed disclosures by subfranchisors. As proposed in the NPR,

“[s]ubfranchisors should disclose the required information about the franchisor, and, to the extent
 

697 Final Interpretive Guides, 44 Fed. Reg. at 49,969. While the Commission has allowed

some flexibility in how franchisors and subfranchisors should prepare disclosure documents, it

also made clear that both “the franchisor and the sub-franchisor are responsible for each other’s

compliance with the rule, and are jointly and severally liable for each other’s violations.” Id.

The Commission also stated that it expects franchisors and subfranchisors to provide the required

background information, litigation, and bankruptcy disclosures of both parties, and that

subfranchisors should provide franchisee statistical information in all instances. Id.

 

698 In our view, a new definition to address subfranchising is unnecessary because the term

“franchisor” adequately addresses the issue. We further propose to explain subfranchising more

fully in the Compliance Guides, with hypothetical examples.

215

applicable, the same information concerning the subfranchisor.” 64 Fed. Reg. at 57,316. This

language is consistent with current Commission policy.697

In response to the NPR, Howard Bundy suggested that the proposed subfranchisor

instructions be revised to replace “should disclose” with “shall disclose.” Bundy, Comment 18,

at 11. He noted that the word “should” implies an advisory only, that is, that a subfranchisor has

the discretion to include its own information in the disclosure document. He further

recommended that the instructions should use the term “seller” in lieu of “subfranchisor.”

“Alternatively, the Commission should add a definition of the term ‘subfranchisor’ and explain

what it is limited to in this context.” Id.

H&H, however, observed that “subfranchising” takes many different forms. For

example, a subfranchisor may in fact function as a franchisor by signing a franchise agreement

with a subfranchisee, or the franchisor may sign the franchise agreement, but delegate many

support functions to the subfranchisor. In the first “example, the proposed [disclosure]

requirement may lead to disclosure about the franchisor in a subfranchise offering that is

irrelevant and, in some circumstances, could be misleading to prospective franchisees.” H&H,

Comment 9, at 6. 

We agree with Mr. Bundy that the Rule should contain a clear disclosure mandate. 

Therefore, we recommend that the Commission substitute the word “shall” for “should,” as

suggested above. At the same time, we recognize H&H’s concern. The term “subfranchisor”

could be used to describe persons who participate in an array of franchising activities. Indeed,

the term is often confused with “brokers” or other franchisor agents. However, as discussed

above in connection with the proposed “franchisor” definition, subfranchisors are treated the

same as franchisors under the Rule in narrow circumstances only: where the subfranchisor steps

into the shoes of the franchisor by both granting franchises, as well as by performing post-sale

disclosure obligations.698 

For the same reason, we are disinclined to recommend that the Commission replace the

term “subfranchisor” with “seller” in this context. Such a modification would mean that all
 

699 We further find that this new instruction is a good alternative to a prior consent

requirement. Several commenters opposed a prior consent requirement, as proposed in the NPR. 

See NFC, Comment 12, at 15; Frandata, Comment 29, at 5; AFC, Comment 30, at 2. The NFC,

for example, feared that an advance consent precondition would stifle new technological

advances that would enable franchisors and prospective franchisees to conduct business online

“seamlessly,” without any additional contacts or discussions. NFC, Comment 12, at 15. See also

McDonalds, Comment 7, at 2. We agree. Accordingly, we recommend that the Commission

permit a wide variety of disclosure formats, provided that the prospective franchisees is made

aware of any prerequisites to using them. 

 

700 This is consistent with our proposal that franchisors be permitted to state in the cover

page whether alternative disclosure formats are available and how to obtain one. See section

VI.A above.

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sellers – including even those franchise brokers who do not perform under the franchise

agreement – would be responsible for making their own disclosures, as well as those of the

franchisor. That would unnecessarily broaden the Rule’s scope. As discussed above in our

analysis of Item 2, we have rejected the view that broker information is material and should be

included in a franchisor’s disclosure document in all instances. Rather, we believe that proposed

instruction properly focuses on subfranchisors who sell and perform under the franchise

agreement. 

6. Proposed section 436.6(f): Disclosure of any prerequisites to 

receiving or reviewing disclosure documents

We recommend that the Commission adopt a new instruction not previously raised in the

NPR. Before a franchisor furnishes a disclosure document, the franchisor would be required to

advise prospective franchisees of the formats in which the disclosure document will be made

available, any prerequisites for obtaining the disclosure document in a particular format, and any

conditions necessary for reviewing the disclosure document in a particular format.699 This new

instruction would ensure that prospective franchisees, prior to disclosure, know whether or not

they will receive a disclosure document in a form they can easily use.

700 A franchisor would

disclose if it furnishes disclosures, for example, via CD Rom only. In addition, the franchisor

must disclose if there are any special conditions to reviewing a disclosure document. For

example, the franchisor would disclose whether the prospective franchisee’s computer must be

capable of reading pdf files or whether any specific applications are necessary to view the

disclosures (such as Windows 2000 or DOS, or a particular Internet browser).
 

701 64 Fed. Reg. at 57,319. The Commission recognized that franchisors might not 

ordinarily retain old electronic documents. At the same time, any costs associated with the

proposed recordkeeping requirement would be substantially outweighed by the vast savings in

reduced, or eliminated, printing and distribution costs associated with disseminating paper

disclosure documents. Id.

 

702 Stadfeld, Comment 23, at 5.

 

703 Rule enforcement actions brought under Section 19 of the FTC Act have a three-year

statute of limitations. 15 U.S.C. § 57b. Reliance on franchisees for copies of disclosure

documents in law enforcement work is impracticable. Franchisees may not retain copies or may

not have complete copies. Moreover, large franchise systems may use multiple versions of their

disclosures over time and in different states. Obtaining all relevant copies from franchisees may

be unworkable. Therefore, for law enforcement purposes, it is essential that franchisors retain

copies of their disclosures for some length of time, consistent with state practices. 

217

7. Proposed section 436.6(g): Disclosure document recordkeeping

In the NPR, the Commission proposed a recordkeeping requirement for electronic

disclosure only.701 Specifically, franchisors making disclosure electronically would retain, and

make available to the Commission upon request, a sample copy of each materially different

version of their disclosure documents for a period of three years. In response to the NPR,

Howard Bundy urged the Commission to revise the recordkeeping requirement to three years, “or

any longer period that the franchisor retains a copy for any purpose.” Bundy, Comment 18, at 13. 

Seth Stadfeld suggested a six-year record retention period, noting that cases involving franchise

documents sometimes occur five or even ten years after the initial sale.702

As an initial matter, we recommend that the Commission revise the NPR’s proposed

recordkeeping provision to cover all disclosure documents, regardless of the medium used. This

is consistent with E-SIGN, which generally prohibits discriminating between paper and

electronic commerce. It is also consistent with standard business practices and state law

requirements, and, therefore, should impose only a de minimis burden on franchisors. At the

same time, a three-year recordkeeping provision will greatly assist the Commission in its law

enforcement work, by ensuring the availability of evidence in rule enforcement actions.703 A

longer recordkeeping provision, no doubt, might also assist franchisees who wish to bring

common law actions with longer limitations periods. However, we believe such a step is

unnecessary in light of the other proposed Rule instructions ensuring that prospective franchisees

can retain copies of their disclosures for future reference. In short, it is the responsibility of

franchisees to safeguard their disclosure documents post-sale and the Rule instructions, as noted

above, accommodate that interest. So revised, the recordingkeeping provision would read:
 

704 64 Fed. Reg. at 57,315 and 57,344. Several Commission trade regulation rules also

require a three-year recordkeeping requirement. See, e.g., Wool Labeling Rule, 16 C.F.R. at

§ 300.31(c); Fur Labeling Rule, 16 C.F.R. at § 301.41(b); Textile Labeling Rule, 16 C.F.R. at

§ 303.39(c); Alternative Fuel Labeling Rule, 16 C.F.R. at § 309.23; R-Value Rule, 16 C.F.R. at

§ 460.9. Cf. Magnuson-Moss Warranty Act Regulations, 16 C.F.R. at § 703.6(f) (4 year

recordkeeping provision). But see Automotive Fuel Rating Rule, 16 C.F.R. at § 306.7 (one year

recordkeeping provision); Telemarketing Sales Rules, 16 C.F.R. at § 310.5(a) (24 month

recordkeeping provision); Funeral Rule, 16 C.F.R. at § 453.6 (one year recordkeeping provision).

 

705 E.g., Cal. Corp. Code at § 31150; Haw. Rev. Stat. at § 482E-5; 815 Ill. Comp. Stat. at

§ 705/36; Md. Code Ann, Bus. Reg. at § 14-224; Minn. Stat. at § 80C.10; N.D. Cent. Code at

§ 51-19-16; Or. Rev. Stat. at § 650.010; R.I. Gen. Laws at § 19-28.1-13; Wash. Rev. Code at

§ 19.100.150.

218

(g) Franchisors shall retain, and make available to the Commission upon

request, a sample copy of each materially different version of their disclosure

documents for three years after the close of the fiscal year when it was last used.

8. Proposed section 436.6(h): Receipt recordkeeping

In the NPR, the Commission also proposed, in connection with Item 23, that franchisors

retain a copy of any receipt involving a completed franchise sale for three years, the statute of

limitations for trade regulation rule enforcement actions brought under Section 19 of the FTC

Act.704 There are no comparable provisions in the current Rule. This proposal generated one

comment: BI expressed the view that the proposal “provides useful clarification regarding the

minimum time period the Commission expects franchisors to maintain such records.” BI,

Comment 28, at 7-8.

We continue to support a recordkeeping requirement for receipts, but recommend that it

be moved from Item 23 to the Rule’s instructions section, where it supplements the general

disclosure document recordkeeping requirement. Many franchise registration states already

require franchisors to maintain complete records involving each franchise sales transaction.705

Therefore, franchisors routinely ask for and retain some kind of receipt in the ordinary course of

business to protect themselves from any future allegations that they sold franchises without

disclosure. Thus, a recordkeeping requirement is likely to foster compliance with the Rule’s

disclosure obligation without imposing significant compliance costs. 

VIII. PROPOSED SECTION 436.7: UPDATING REQUIREMENTS.

A. Background

In most respects, the NPR’s proposed updating requirements are identical to those set

forth in the current Rule. Specifically, the NPR retained the current requirement that franchisors
 

706 64 Fed. Reg. at 57,319. See also16 C.F.R. § 436.1(a)(22).

 

707 64 Fed. Reg. at 57,319. No comments were submitted on this issue and we therefore

recommend that the Commission retain it in the final revised Rule.

 

708 64 Fed. Reg. at 57,319.

 

709 PMR&W, Comment 4, at 5. See also Baer, Comment 11, at 4; Lewis, Comment 15, at

19-20; IFA, Comment 22, at 11; J&G, Comment 32, Attachment, at 3. 

219

prepare annual updates within 90 days of the close of their fiscal year and quarterly updates, if

applicable, thereafter.706 The proposed updating requirements would also retain the

Commission’s current policy that audited information in a disclosure document need not be reaudited on a quarterly basis. Rather, a franchisor can update its audited disclosures by including

unaudited information, provided the franchisor discloses that the information is unaudited.707 

The updating requirements of the NPR differ from those of the current Rule, however, in

one important respect. As proposed in the NPR, franchisors would have a continuing update

requirement. Specifically, when furnishing disclosures, franchisors would be required to notify a

prospective franchisee of any additional material changes that occurred since the last quarterly

update. Similarly, when delivering the franchisee agreement, the franchisor would be required to

notify the prospective franchisee of any other known material changes “in the franchisor, the

franchise business, or franchise agreement.” 64 Fed. Reg. at 57,345.

B. The Record and Recommendations

1. Proposed section 436.7(a): Annual updates

As noted above, the NPR proposed retaining the current 90-day annual update

requirement.708 In response, several commenters urged the Commission to adopt a 120-day

requirement. For example, PMR&W told us that many franchisors have difficultly obtaining

annual audited financial statements from their auditors within the current 90-day period. Because

most franchisors use the calendar fiscal year, company auditors are usually overwhelmed at the

beginning of the fiscal year, given the busy tax season. Recognizing this problem, many state

franchise regulators allow franchisors 120 days to prepare updated disclosures.709 For these

reasons, the staff recommends that the Commission revise the Rule to extend the annual updating

period to 120 days. This revision has the potential of reducing franchisors’ compliance burdens,

while potentially reducing inconsistencies with state updating provisions.

2. Proposed sections 436.7(b)-(c): Quarterly updates

In the NPR, the Commission proposed retaining the quarterly update requirement. The

proposed basic quarterly update requirement generated no significant comment. PMR&W, for
220

example, noted that the current quarterly update requirement is a bright-line rule that “is clear

and intelligible to franchisors and their counsel.” PMR&W, Comment 4, at 6. Similarly, the

NFC states that it is “in accord with the Commission’s post-quarterly update ‘material change’

disclosure requirement.” NFC, Comment 12, at 16. 

We agree. The quarterly update requirement strikes the right balance between ensuring

the timeliness of disclosures and reducing compliance burdens. Franchisors need to prepare

quarterly updates only if there is a material change, and they may include the quarterly update in

an addendum. In short, franchisors need not prepare new disclosure documents each quarter as a

matter of course. We believe the current quarterly update requirement establishes a clear, bright

line tied to each franchisor’s fiscal year. It has worked well and has generated few, if any, 

complaints during the 20 years that the Rule has been in existence. Accordingly, we recommend

that the Commission retain the quarterly update requirement. 

Nonetheless, the staff recommends that the Commission modify the quarterly update

provision if the Commission ultimately adopts the proposed 120-day annual update period. A

120-day period would overlap a quarterly (typically 90 days) update period: indeed, the

obligation to update disclosures quarterly would precede the conclusion of the 120 days. 

Accordingly, additional clarification of the interrelationship between the annual and quarterly

update requirements is warranted. 

We recommend that a franchisor’s annual update (120 days after the close of the fiscal

year) also include any first quarterly update information (90 days), either by integrating the

quarterly updated information into the body of the disclosure document or by attaching an

addendum. The following tables will illustrate the point, by comparing procedures under the

current Rule with those under the staff’s recommended revision.
 

710 64 Fed. Reg. at 57,319.

221

Hypothetical Using Procedures Under the Current Rule

December 31, 2002 Fiscal year ends

January-March, 2003 First quarter of new fiscal year

April, 1, 2003 Franchisor must use annual updated disclosure

document

Reasonable time after April 1, 2003 Franchisor amends annual update with a quarterly

update, if warranted.

Reasonable time after July 1, 2003 Franchisor amends annual (and any previous

quarterly update) with a quarterly update, if

warranted.

Reasonable time after October, 1, 2003 Franchisor amends annual update (and any previous

quarterly update(s)) with a quarterly update, if

warranted.

Reasonable time after January 1, 2004 Franchisor amends 2003 annual update (and any

previous quarterly updates(s)) with a quarterly

update, if warranted.

Hypothetical Using Proposed Revised Procedures

December 31, 2002 Fiscal year ends

January-March, 2003 First quarter of new fiscal year

May, 1, 2003 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, 2003 Franchisor amends annual update with a 

quarterly update, if warranted.

Reasonable time after October 1, 2003 Franchisor amends annual update (and any previous

quarterly update(s)), with a quarterly update, if

warranted.

Reasonable time after January 1, 2004 Franchisor amends annual update (and any previous

quarterly updates(s)), with a quarterly update, if

warranted.

3. Proposed section 436.7(d):

Material change disclosures

As discussed above, the NPR proposed a limited continuing disclosure obligation. 

Specifically, franchise sellers would notify prospective franchisees of any material changes when

furnishing disclosures and when presenting the completed franchise agreement.710 This proposal
 

711 Id.

 

712 See also Bundy, Comment 18, at 13; BI, Comment 28, at 8-9. On the other hand, the

NFC praised the Commission’s flexibility in permitting notification by any means:

The Commission’s proposed paradigm enabling franchisors to communicate such

post-quarterly update “material changes” to prospective franchisees without the

need to amend their disclosure document will respond to the needs of the

marketplace without reducing the quantum of pre-sale disclosure furnished to

franchisees. The Commission is to be commended for taking this enlightened

approach.

NFC, Comment 12, at 16. 

222

would not require franchisors to amend their disclosure document, which might impose

unwarranted costs. Rather, the franchisor would simply notify the prospective franchisee of the

material change. An oral statement or a faxed letter, for example, would suffice. 

In the NPR, the Commission explained the purpose of the proposed expanded updating

requirement as follows. A franchise system may change considerably after a prospective

franchisee receives his or her disclosure document. For example, the franchisor may file for

bankruptcy or lose a class action suit that affects its ability to continue in business. Yet, a

prospective franchisee who receives disclosures in the quarter in which such an event occurs

might not learn of those material changes. Under the circumstances, it could be an omission of

material information in violation of Section 5 for a franchisor to fail to alert prospective

franchisees about recent material changes when it knows that prospects are relying on incomplete

or inaccurate information contained in the previously issued disclosure document.711

The NPR generated several comments, both supporting and opposing the expanding

updating proposal. The IL AG and Howard Bundy favored the continuing update requirement,

but they would require all such updates to be in writing. The IL AG, for example, stated that

“[o]ral notification is the ammunition for rescission litigation.” IL AG, Comment 3, at 4.712 On

the other hand, several franchisors opposed the updating requirement for various reasons. 

Marriott, for example, asserted the proposal is extremely burdensome, imposing “an impossible

burden on large franchisors, especially if they actually operate the business that they franchise

because of the uncertainty of what constitutes ‘any material change’ and the requirement of ‘real
 

713 Marriott noted that it, and other large corporations, may have several thousand employees

in different departments. Each department (e.g., training, legal, advertising, marketing) may have

a different person responsible for a portion of the information that is in a disclosure document for

each different brand offered. A continuous updating requirement:

would place an unfair burden on franchisors like Marriott. For example, it will be

virtually impossible for the Training Department (every time they change a

subject or the hours allotted to a particular subject in the training program) . . . to

contact Legal and for Legal to determine if the change is material and to then

contact development to make sure before the closing of every franchise deal that

there is not a particular piece of information that must be notified to a franchisee. 

This requirement will cause complete havoc on the franchise sales process. 

Franchisors will not be able to close sales without notifying every department out

of fear that some minute change in fact may later be deemed to be material.

Marriott, Comment 35, at 4.

 

714 Id. See also PMR&W, Comment 4, at 6.

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time’ ongoing disclosure.” Marriott, Comment 35, at 3-4.713 Marriott would eliminate the

proposed expanded updated provision in its entirety.714

PMR&W and the NFC advised that the proposal is confusing. In particular, PMR&W

found the relationship between the basic quarterly update provision and the proposed continuing

update provision less than clear:

It is unclear whether these “material changes” must be more “material” than any

changes disclosable in the quarterly updates. Depending on the answer to this

question, is there any need to require quarterly updates when immediate updates

are mandated; i.e., does the immediate update rule preclude the need for the

quarterly update?

PMR&W, Comment 4, at 6.

In a similar vein, the NFC questioned whether a franchisor must provide a prospective

franchisee with each and every quarterly update, as long as the prospect is in the sales cycle. If

so, it asked how franchisors should determine whether prospects are no longer in the sales cycle. 

“It is unclear whether franchisors must notify such ‘deleted prospects’ in order to avoid noncompliance.” NFC, Comment 12, at 16.

Based upon the comments, it is clear that there are two competing concerns that defy easy

resolution. On the one hand, prospective franchisees should have all material information they

need to make an informed purchase decision, regardless of when they entered the sales process. 
 

715 We recognize that the proposed quarterly update requirement may be misinterpreted as

implying that franchisors must provide each prospective franchisees with each quarterly update

that is generated throughout the sales cycle. We do not believe that was the Commission’s

intention. Rather, the Commission intended that prospective franchisees should receive the basic

disclosure document and any quarterly updates that exist at the time the prospect is to receive

disclosures. There is no continuing obligation on the franchisor’s part to provide quarterly

updates to a prospective franchisee throughout the sales cycle. The staff recommends that the

Commission make this point clear in the Compliance Guides.

 

716 Franchisors also have similar obligations to disclose under common law fraud and

misrepresentation principles.

 

717 This proposal would also address the commenters’ concerns about permitting franchisors

to furnish updates orally. 

224

On the other hand, there are practical considerations, including the costs and burdens on

franchisors to update each franchisee on a continuing basis, as Marriott observed. Indeed, at

some point, the burden and cost to franchisors (which inevitably will be passed along to

prospective franchisees or other consumers), outweighs the potential benefit of more frequent

updating. 

After reviewing the comments and considering the competing concerns, the staff

concludes that, on balance, the NPR’s proposed continuing update requirement is largely

unwarranted, with the exception of financial performance representations. We are convinced that

franchisors should have a bright-line directive when they can be assured that they have complied

with the Rule’s disclosure requirements. We believe that the traditional quarterly update

requirement is sufficient to ensure timely disclosures,715 while minimizing compliance costs. At

the same time, we note that a general continuing update requirement may be unwarranted in light

of Section 5 of the FTC Act. As explained in section V above, a franchise seller’s compliance

with the Franchise Rule does not alone shield the seller from Section 5's prohibition against

deceptive conduct, such as misrepresenting its offering or omitting material information to

prospective franchisees. Accordingly, franchise sellers may have an obligation to alert

prospective franchisees about recent changes not reflected in their quarterly updates.716

Further, any prospective franchisee who has been in the sales cycle can always request a

copy of the franchisor’s most recent disclosure document before he or she agrees to execute the

franchise agreement. To that end, we further recommend that the Commission adopt a new

prohibition that would bar franchisors from failing to honor a prospective franchisee’s reasonable

request for a copy of the franchisor’s most recent disclosure document and/or quarterly update

before he or she signs a franchise agreement.717 We believe this proposed new prohibition is

unlikely to increase franchisor’s compliance costs and burdens. Franchisors most likely will
 

718 This revised proposal would require franchisors to do nothing more than furnish updated

copies of its disclosures documents to prospective franchisees, upon request before the signing of

the franchise agreement. Therefore, the proposal also renders moot commenters’ concerns about

inconsistencies in the scope of the information that franchisors would need to update.

 

719 16 C.F.R. §§ 436.1(d)(2) and 436.1(e)(6). 

 

720 No commenters raised any concerns about the obligation to update information pertaining

to financial performance. Accordingly, we propose that the Commission retain this provision in

the final revised Rule.

 

721 See 16 C.F.R. § 436.2(a)(3). The UFOC Guidelines do not contain any exemptions. 

Rather, at most, some of the 15 franchise disclosure states may exempt franchisors from

registration requirements, as a matter of statute or regulation. See generally, Duvall & Mandel,

ANPR 114. Thus, franchisors exempted from disclosure under the revised Rule would

nonetheless have to prepare and disseminate UFOCs in the 15 franchise registration states. 

 

722 64 Fed. Reg. at 57,319-22. This approach is consistent with other Commission

rulemakings, including the Telemarketing Sales Rule, 16 C.F.R. § 310.6; the Care Labeling

Rule, 16 C.F.R. § 423.8, and the Cooling-Off Period Rule, 16 C.F.R. § 429.3. 

225

have updated disclosures documents prepared in the ordinary course of their business.718 With

the advent of electronic communications, emailing a copy of the updated disclosure document to

a prospective franchisee, or otherwise permitting a prospective franchisee to see a copy of the

updated disclosure document on the franchisor’s website, would impose only a small cost.

Nonetheless, we recommend that the Commission retain the continuing update

requirement for financial performance information. Currently, the Rule requires franchisors to

notify prospective franchisees of any changes in financial performance representation before the

prospective franchisee pays a fee or signs the franchisee agreement.719 We believe this provision

is sound, recognizing the particular materiality of financial data to prospective franchisees. Any

false impression created by stale data at the time of sale is likely to cause significant injury to

prospective franchisees who rely on them in making their investment decision.720

IX. PROPOSED SECTION 436.8: EXEMPTIONS

A. Background

We now turn to the next section of the proposed final revised Rule – exemptions.

Currently, the exemptions are set out in the middle of the Rule’s definitions, where they modify

the term “franchise.”721 To make the exemptions easier to find, the Commission proposed

creating a distinct exemptions section in the NPR.722 The NPR proposed retaining the current
 

723 64 Fed. Reg. at 57,320. See also 16 C.F.R. § 436.2(a)(3)(i).

 

724 64 Fed. Reg. at 57,320. See also 16 C.F.R. at § 436.2(a)(3)(ii).

 

725 64 Fed. Reg. at 57,322. See also 16 C.F.R. at § 436.2(a)(3)(iv).

 

726 64 Fed. Reg. at 57,320. See also 16 C.F.R. at § 436.2(a)(3)(iii).

 

727 The NPR also implied that the exemptions apply only to the Rule’s pre-sale disclosure

obligations. 64 Fed. Reg. at 57,345. If so, franchisors exempt from the Rule’s disclosure

requirements nonetheless would be covered by the Rule’s prohibitions. See Baer, Comment 11,

at 15; Gurnick, Comment 21A, at 7-8. We do believe such an approach is unsound. Many of the

Rule’s prohibitions are tied directly to franchisors’ disclosure obligations, such as the prohibition

on making contradictory statements. It would be inconsistent to exempt a franchisor from

disclosure while prohibiting the same franchisor from making statements contrary to its

disclosures. Similarly, it would be inconsistent to exempt a franchisor from financial

performance disclosures while prohibiting the franchisor from making financial performance

disclosures without an Item 19. To avoid such inconsistencies, we propose that the Rule make

clear that the exemptions apply to Rule sections. Of course, franchisors nonetheless may still be

held liable under Section 5 for false and deceptive statements and omissions.

 

728 64 Fed. Reg. at 57,320-22.

 

729 Id. at 57,319.

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Rule exemptions for: (1) fractional franchises;723 (2) leased departments;724 (4) oral contracts;725

and (5) franchise sales under $500.726 At the same time, the NPR proposed adding several new

exemptions.727 Specifically, the NPR would exempt franchise sales involving petroleum

marketers and sophisticated investors.728 Finally, the NPR proposed eliminating the four

exclusions current found at 16 C.F.R. § 436.2(a)(4)(i)-(iv) for relationships involving: (1)

employer-employees and general partnerships; (2) cooperative organizations; (3) testing or

certification services; and (4) “single” licenses.729 

B. The Record and Recommendations

Except as already discussed in the definitions sections below, no commenters raised any

additional concerns about exemptions for fractional franchises, leased departments, or oral

contracts. We recommend, therefore, that the Commission retain them in the final revised Rule.

A few commenters, however, raised concerns about the current Rule’s $500 required minimum

payment exemption found at 16 C.F.R. § 436.2(a)(3)(iii). 
 

730 64 Fed. Reg. at 57,320.

 

731 See also Gurnick, Comment 21A, at 8; GPM Rebuttal, Comment 40, at 9 (at least

$1,000).

 

732 J&G, Comment 32, at 14.

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1. Proposed section 436.8(a)(1):

Minimum payment exemption

a. Background

In the NPR, the Commission proposed retaining the current Rule’s $500 required

minimum payment exemption found at 16 C.F.R. § 436.2(a)(3)(iii).730 This exemption ensures

that the Rule “focus[es] upon those franchisees who have made a personally significant monetary

investment and who cannot extricate themselves from the unsatisfactory relationship without

suffering a financial setback.” SBP, 43 Fed. Reg. at 59,704. At the same time, the Commission

asked whether the current $500 threshold would continue to serve a useful purpose if the

Commission were to create a separate business opportunity rule. It also asked what threshold is

appropriate to ensure that the Rule continues to cover transactions involving a “personally

significant monetary investment?” 64 Fed. Reg. at 57,331. 

b. The record and recommendations

In response to the NPR, several commenters urged the Commission to raise the $500

minimum threshold, while one favored retaining the current $500 threshold. None recommended

eliminating or reducing the threshold. Specifically, H&H urged the Commission to raise the

threshold to $1,000731 in order to recognize the fact that costs in general have increased

substantially since the Rule was initially promulgated. The firm also suggested that the threshold

be increased “perhaps every 4 years to reflect a reasonable rate of inflation.” H&H, Comment 9,

at 4. 

John Baer suggested that the level be set at $2,500, with an inflation adjuster. In the

alternative, he suggested that the threshold should be set at “1% of the amount of average retail

sales achieved by outlets using the franchise system in the United States in the most recent year

for which data is available.” Baer, Comment 11, at 15-16. Mr. Baer asserted that if “a system

has average retail sales of $1 million, $10,000 is not a number which should trigger concerns. 

There is no need for the Commission to regulate de minimis investments with this type of

burdensome and costly disclosure obligation.” Id. J&G recommended increasing the threshold

to $5,000.732

In contrast, the IL AG urged the Commission to retain the $500 threshold in order to

protect small investors:
 

733 Bond’s keeps files on 2,500 American and Canadian franchise systems. Of these, Bond’s

surveyed 2294 systems that it identified as current and active. Detailed profiles of the 1050

systems responding to the survey appear in Bond’s 2001 edition. 

 

734 We note that Bond’s does not report “required payments,” but initial franchisees fees and

total investments. Therefore, it is likely that at least some franchise systems charging a minimum

fee or even no initial fee (14 systems) actually collect other required payments (e.g., royalties,

equipment), making the overall financial risk in purchasing a franchise significant.

228

The best solution is to leave this almost universal element of the franchise

definition as is. The reality is that a $500 up-front investment, is only the tip of

the iceberg in virtually every franchise system. Royalties, equipment purchases,

leases, inventory, and myriad other payments and contractual obligations put most

franchisees at great financial risk while having little or no direct experience to

make life-changing decisions. To exempt franchisees that do not have an initial

fee, or ones that have what appears to be a modest fee of $1,000 or $2,500, would

put too many “small” investors at risk.

IL AG Rebuttal, Comment 38, at 2. 

In a similar vein, Howard Bundy urged the Commission to modify the minimum payment

exemption to provide that the $500 threshold includes “both amounts the franchisee actually

pays, but also any amounts that the franchisee, during the first six months, agrees to pay in the

future – either by contract or by practical necessity.” Bundy, Comment 18, at 14.

For the following reasons, the staff recommends that the Commission retain the current

minimum payment exemption. We begin our analysis by noting that there is no question that the

Commission included a threshold dollar amount in the original Rule to exclude small

investments, where the financial risk does not warrant the expense and burden of preparing a

disclosure document. This is particularly true with low-end business opportunities, which, even

today, may cost under $500. However, with the separation of business opportunities from the

Franchise Rule, a strong argument can be made that any investment in a franchise, as a practical

matter, will be a significant investment risk, suggesting that the exemption may no longer serve a

useful purpose.

In order to gain a handle on the cost of purchasing a franchise, the staff examined over

1,000 franchise profiles listed in Bond’s Franchise Guide (13th ed. 2001).733 Except for 41

systems, all of the franchise systems responding to Bond’s survey reported initial franchise fees

of $5,000 or more (approximately 96% of reporting systems). Indeed, only 22 systems reported

an initial fee was “not applicable,” or charged an initial franchisee fee of $1,000 or less.734 Under

the circumstances, even a $5,000 threshold would not reduce significantly the number of

franchisors that must comply with the Rule’s disclosure obligations.
 

735 See section IV.O. below.

 

736 This issue has been discussed at length in several staff advisory opinions. See Advisory

99-1 (Mar. 30, 1999), Bus. Franchise Guide (CCH) ¶ 6498 at 9710 (distinguishing between

speculative obligations to make a payment and obligations to make a payment of an uncertain

amount); Advisory 97-9 (Dec. 18, 1997), Bus. Franchise Guide (CCH) ¶ 6489 at 9694

(speculative future payments not included in determining applicability of exemption); Advisory

98-5 (June 24, 1998), Bus. Franchise Guide (CCH) ¶ 6494 at 9707 (Rule does not require amount

to be fixed at time of sale); Advisory 93-12 (Jan. 28, 1994), Bus. Franchise Guide (CCH) ¶ 6465

at 9635-6 (setting forth criteria for analyzing future payments). 

 

737 64 Fed. Reg. at 57,320.

 

738 15 U.S.C. § 2801.

229

 Under the circumstances, a plausible argument could be made for eliminating the

threshold altogether. However, we would not go that far. We believe that the minimum payment

exemption continues to serve a very narrow, but important, purpose: to further distinguish

between franchises and business opportunities. While we believe the proposed definition of

“franchise” set out in this Staff Report is sufficient to distinguish between franchise and business

opportunity arrangements in most instances, we recognize that the distinction between a

franchise and business opportunity may not be apparent in all scenarios. To the extent that a lowend business opportunity might come close to satisfying the elements of a franchise, the $500

threshold would help to make it clear that such opportunities are exempt from the Franchise

Rule. 

At the same time, we agree with Mr. Bundy that the $500 minimum payment exemption

should reference payments by contract or by practical necessity. However, the $500 minimum

payment exemption already references the term “required payment,” which in turn is defined to

include both payments by contract and by practical necessity.735 Accordingly, no further revision

is necessary. In addition, we would stop short of adopting Mr. Bundy’s suggestion that the

required payments include amounts “the franchisee . . . during the first six months, agrees to pay

in the future.” While we believe the exact amount of required payments need not be fixed at the

time of the franchise sale – such as future royalties – purely speculative post-sale commitments

to make payments are too uncertain to trigger a franchisor’s pre-sale disclosure obligation.736

2. Proposed section 436.8(a)(4):

Petroleum marketers and resellers exemption

As noted above, the NPR737 proposed adding a new exemption for petroleum marketers

and resellers covered by the Petroleum Marketing Practices Act (“PMPA”).738 In 1980, the

Commission granted a petition for an exemption from the Rule filed by several oil companies
 

739 45 Fed. Reg. 51,765 (Aug. 5, 1980).

 

740 In considering the petition, the Commission noted that the most frequently cited

complaint about the petroleum franchise industry concerned termination and renewal practices. 

After the close of the Commission’s franchise rulemaking record, Congress passed the PMPA,

which specifically addressed those complaints, requiring, among other things, pre-sale disclosure

of franchisees’ termination and renewal rights. In light of that legislation, the Commission

concluded that the Franchise Rule was largely duplicative of the PMPA and related federal

regulations. In reaching its conclusion, the Commission nonetheless recognized that

circumstances may change in the industry that would warrant a fresh review:

[I]f circumstances change in the future and evidence of renewed

misrepresentations in the sale of petroleum franchises reappears on a significant

scale, a new rulemaking proceeding may be undertaken that is tailored to the

specific needs of the industry. In the interim, if isolated abuses occur, they will be

subject to the adjudicative procedures and remedies provided by Section 5 of the

FTC Act.

Id.

 

741 Id.

 

742 64 Fed. Reg. at 57,320.

 

743 J&G, Comment 32, Attachment at 6.

230

and oil jobbers, pursuant to Section 18(g) of the FTC Act.739 Specifically, the Commission stated

that the Rule “shall not apply to the advertising, sale or other promotion of a [petroleum]

‘franchise,’ as the term ‘franchise’ is defined by the [PMPA].” 45 Fed. Reg. at 51,766.740

As explained in the NPR, since 1980, the Commission has received only isolated

complaints regarding abuses in the relationship between petroleum company franchisors and

their franchisees, and we have no reason to believe that a pattern of abuse is likely to develop in

the near future. Moreover, in granting the petition, the Commission committed itself to handling

any abuses in this field through an industry-specific rulemaking.741 For these reasons, the NPR

proposed that the Commission incorporate its 1980 policy exemption into the Rule as an express

Rule exemption.742

In response, only one commenter voiced any concerns. J&G maintained that the proposal

leaves unanswered whether disclosure is warranted when other businesses – such as convenience

stores, fast food, and ice cream shops – operate in these exempt gasoline franchise

establishments.743 While we recommend that the Commission adopt the proposed petroleum

marketers exemption as set forth in the NPR, we reject the suggestion that non-petroleum
 

744 64 Fed. Reg. at 57,320-22.

 

745 See, e.g., PMR&W, Comment 4, at 2; 7-Eleven, Comment 10, at 2; NFC, Comment 12,

at 17; IFA, Comment 22, at 7; AFC, Comment 30, at 2-3; Marriott, Comment 35, at 6; GPM

Rebuttal, Comment 40, at 9-10; Tifford, ANPR 78, at 2-3; Duvall & Mandel, ANPR 114, at 2-3;

Cendant, ANPR 140, at 2; Kaufmann, ANPR, 18Sept97 Tr, at 190; Wieczorek, id. at 192;

Forseth, id. at 194-95. .

 

746 See, e.g., Bundy, Comment 18, at 14; Stadfeld, Comment 23, at 7-8; Karp, Comment 24,

at 6-8. But see Caruso, ANPR 118 (“[F]ranchisees in the larger successful systems are

themselves fairly sophisticated and in less need of protection by the FTC or any other

government agency.”).

231

businesses should be included in the exemption. The Commission’s policy exemption for

petroleum franchises was based on the finding that any problems in that specific industry were

addressed by the PMPA. The PMPA has not been revised to extend to non-petroleum

businesses, nor are we aware of any other applicable legislation. Indeed, in the absence of any

additional information in the record, it would appear that an individual who operates a gasoline

station is just as much in need of pre-sale disclosure for the purchase of a non-related franchise,

such as an ice cream store, as any other member of the public. We believe the fractional

franchise exemption, coupled with the sophisticated investor exemptions discussed below, are

the appropriate vehicles for limiting the Rule’s scope in this arena.

3. Proposed sections 436.8(a)(5)

Sophisticated investor exemptions

a. Background

In the NPR, the Commission proposed adopting three new exemptions, which

collectively can be referred to as the “sophisticated investor” exemptions: (1) the large

investment exemption; (2) the large corporate-franchisee exemption; and (3) the officer and

owner exemption.744 Below, we first analyze the record on the proposal to create sophisticated

investor exemptions, and then we turn to the merits of each of the three specific exemption

proposals noted above. 

b. The record and recommendations

 During the ANPR and NPR proceedings franchisors supported sophisticated investor

exemptions,745 while franchisees and their advocates opposed them, or expressed reservations.

746

In support, franchisors raised essentially two points: (1) the Rule’s disclosure requirements are

unnecessary when it comes to sophisticated investors; and (2) the Rule’s procedures make it

difficult for sophisticated investors to conduct business. On the first point, commenters noted

that franchising today often involves heavily-negotiated, multi-million dollar deals between
 

747 E.g., NFC, Comment 12, at 17; Marriott, Comment 35, at 6. GPM observed that the

Rule’s purpose was to level the playing field between the franchisor and franchisee. “Where the

playing field is already level . . . no such need [for disclosure] exists.” GPM Rebuttal, Comment

40, at 9-10. 

 

748 See Kaufmann, ANPR, 18Sept97 Tr, at 165; Wieczorek, id. at 187-88; Tifford, id. at 194.

 

749 Duvall & Mandel, ANPR 114, at 16. Section 18(g) of the FTC Act provide a mechanism

for parties to petition for relief from Commission trade regulation rules where potential abuse is

unlikely. Section 18(g) exemptions petitions are placed on the public record for comment. The

entire process of reviewing and granting such a petition may take over one year. 

232

franchisors and highly sophisticated individuals and corporate franchisees who are represented by

counsel. In the course of such deals, franchisees often demand and receive information from the

franchisor that equals or exceeds the disclosures required by the Rule. These commenters

asserted that these are not the kinds of franchise sales that the Commission originally intended to

cover.747

For example, the NFC observed that the face of franchising has changed over the last

decade, rendering a Rule of broad applicability unwarranted:

While franchising’s roots may be traced to the grant to an individual franchise to

one entrepreneur (or a small group of entrepreneurs) possessing no prior

knowledge of or experience in the subject industry . . . it is nevertheless the case

that over the past decade many of America’s oldest and largest franchisors do not

follow that paradigm. Instead, they find it far more efficient and profitable for all

concerned to largely restrict the grant of United States franchises to: (i)

sophisticated corporations with the resources and background necessary to

optimally operate subject franchisees, and (ii) existing franchisees whose

experience, profitably and mastery of the franchisor’s system strongly suggest

future success.

NFC, Comment 12, at 17. 

 On the second point, some commenters asserted that the Rule’s mandatory waiting

requirements to review disclosure documents and contracts impose unnecessary costs on

sophisticated franchisees and add unwarranted delay in the high-paced negotiation process,

where parties often are anxious to cement their deals quickly to beat out the competition.748 One

commenter observed that while franchisors can file individual petitions for exemptions to the

Rule under Section18(g) of the FTC Act, the process is costly and the delay involved often

renders this approach an unviable option.749
 

750 NFC, Comment 12, at 18-19. See also BI, Comment 28, at 4 (FTC should exempt

individuals with 5 years of experience in the industry).

 

751 See Zarco & Pardo, ANPR 134, at 4-5; Kezios, ANPR, 6Nov97 Tr, at 47-48; Bundy, id.,

at 48-49; Stadfeld, Comment 23, at 8; Karp, Comment 24, at 6-8; NFA, Comment 27, at 3.

 

752 E.g., Tifford, ANPR 78, at 2; Duvall & Mandel, ANPR 114, at 21-22. Mr. Tifford also

suggested that the Commission adopt additional exemptions recognized under state law,

including exemptions for franchise sales to financial institutions and sales by fiduciaries or court

officials. Tifford, ANPR 78, at 2-3. After considering this issue, we conclude that additional

233

Several commenters urged the Commission to go further and create additional

sophisticated investor exemptions. For example, McDonald’s believed that sophisticated

investors should include “individuals who own two or more franchises or multiple outlets under

one franchise.” McDonald’s, Comment 7, at 2. In its view, such individual’s actual experience

may serve as the basis for their decision to enter into additional franchise agreements or open

additional outlets. Similarly, the NFC proposed that existing franchisees who have operated

units for at least two years should be exempt. It noted that several states have such exemptions

from registration, including, for example, California (an additional franchise offer) and New

York (franchisee already operating a franchise for 18 months).750

Support for creating sophisticated investor exemptions, however, was not unanimous.

Several franchisee representatives feared that while prospective franchisees may appear to be

sophisticated because of their net worth or general prior business experience, they actually may

have limited knowledge of the risks inherent in operating the specific franchise being offered. In

short, these commenters advised the Commission to protect the wealthy, but inexperienced.751

After considering the comments, the staff recommends that the Commission adopt the

NPR’s proposed sophisticated investor exemptions, albeit with some modifications. We are

convinced that the Rule’s costs and burdens are unwarranted in situations where the potential for

abuse is unlikely. This view finds support in Section 18(g) of the FTC Act. We believe Rule

exemptions for sophisticated investors are entirely consistent with this statutory scheme. The

Section 18(g) process, however, may be an ineffective means of providing such relief as a

practical matter in the franchise context. The lengthy petition process may impose significant

costs on franchisors and, perhaps more important, the petition review process often diverts scarce

Commission resources away from traditional law enforcement. On balance, we believe that

sufficiently limited sophisticated investor exemptions offer the potential for reducing franchisors’

regulatory burdens and preserving Commission resources without sacrificing protections for the

average investors the Franchise Rule was originally promulgated to protect.

In reaching our conclusion, we have considered, but rejected, expanding the NPR’s

proposed exemptions to include sales both to existing franchisees who renew or extend their

contract or to existing franchisees who purchase additional outlets.752 We believe these
exemptions are unwarranted. First, financial institutions will probably qualify for the large

corporation exemption detailed below. Second, the definition of “franchise seller” includes the 

franchisor and those in a business relationship with the franchisor (e.g., brokers and agents). By

implication, it excludes judicial officers, such as a receiver.

 

753 Final Interpretive Guides, 44 Fed. Reg. at 49,969.

 

754 E.g., Bores, ANPR 9, at 1; Paquet, ANPR 18, at 1; Bell, ANPR 30, at 1; Rachide, ANPR

32, at 1; Chabot, ANPR 37, at 1; Rich, ANPR 65, at 1; Orzano, ANPR 73, at 1; Zarco & Pardo,

ANPR 134, at 4; AFA, Comment 14, at 5; Bundy, Comment 18, at 9; Morrill, Comment 31, at 2.

 

755 For example, Baskin Robbins franchisees submitted several comments stating that their

franchisor often requires them to open additional units and, if they choose not to expand, they

may face the loss of their existing units. E.g., Keating, ANPR 146 at 1-2.

234

suggested exemptions are unwarranted. It is already Commission policy that franchisors need

not make disclosures to existing franchisees who renew or extend their franchise agreements,

unless there has been a material change in the terms and conditions of the proposed franchise

agreement.753 While an argument could be raised that renewing franchisees already are familiar

with the franchise system, that argument is undercut by the repeated submission of franchisee 

comments voicing concerns about renewal terms and conditions.754 It is clear from the record

that renewal terms can differ considerably from the franchisee’s original contract and could

create a business environment significantly different from the one in which the renewing

franchisee has conducted business. On balance, we find that the benefit of disclosure to

renewing franchisees under materially different terms outweighs the potential costs. 

For similar reasons, we see little benefit in adopting a broad exemption for additional

franchise sales to existing franchisees. A franchisee’s experience within a franchise system alone

is an insufficient basis to avoid pre-sale disclosure. In our experience, many franchise owners are

not necessarily sophisticated about their franchisor, or are too busy operating their individual

outlets to pay attention to developments within their franchise system. Some franchisees also

report that franchisors encourage poorly-performing franchisees to open additional units in order

to become successful, asserting that economies of scale will reduce overall costs and promote

growth.755 These are among the very consumers the Rule should protect – vulnerable small

franchise owners. In those instances where a franchise-owner is truly sophisticated and is

purchasing multiple units, the proposed large investment exemption described below should

provide sufficient relief from Rule coverage.
 

756 64 Fed. Reg. at 57,320-21. No state has a similar exemption. However, two states

provide some form of exemption for transactions involving large initial investments. Illinois

permits a franchisor to apply for an exemption from both registration and disclosure where the

investment for a single franchise unit exceeds $1 million. Maryland exempts franchises that

require an initial investment of $750,000 or more from registration, but not from disclosure. 

 

757 See also Wieczorek, ANPR, 6Nov97 Tr, at 43 (suggesting that net wealth can be a proxy

for experience).

 

758 64 Fed. Reg. at 37,321.

 

759 Id.

 

760 Marriott, Comment 35, at 6. See e.g., Baer, Comment 11, at 16; Gurnick, Comment

Comment 21, at 3; J&G, Comment 32, at 3.

235

c. Proposed section 436.8(a)(5)(i):

Large investment exemption

In the NPR, the Commission proposed exempting franchise sales where the investment

totals at least $1.5 million.756 As noted in the NPR, very few consumers are likely to have $1.5

million available to invest in a franchise, and the few who do are likely to be experienced

business persons.757 Moreover, the proposed large investment exemption has additional

safeguards beyond the $1.5 million threshold to ensure that the exemption covers only the truly

sophisticated. First, the proposed exemption makes clear that funds obtained from the franchisor

(or an affiliate) cannot be counted toward the $1.5 million threshold. Most purchasers of a

franchise, or group of franchises, that requires a $1.5 million investment will have to turn to

bankers or other sources of financing. Lenders are likely to ensure that the investor has

conducted a due diligence investigation of the offering before approving any loan.758 Second, the

proposed large investment exemption requires the prospective franchisee to sign an

acknowledgment that the franchise sale is exempt from the Franchise Rule because the

prospective franchisee will be investing more than $1.5 million. This requirement would reduce

the probability that the franchisor will misrepresent the cost of the franchise to qualify for the

exemption, as well as provide a paper trail in the event an enforcement action becomes

necessary.759

The comments submitted in response to the proposed large investment exemption were

predictably split between franchisor and franchisee interests. In general, franchisors

enthusiastically welcomed the proposed exemption. Marriott, for example, stated that not only

are sophisticated franchisees able to protect their own interest, but the self-interest of others

involved in the project, such as bankers, are sufficient to protect those interests as well.760

Franchisees, on the other hand, were less enthusiastic about the proposed exemption, either

opposing it or offering suggestions to limit it on two grounds: (1) wealth alone does not equate
 

761 Stadfeld, Comment 23, at 8; Karp, Comment 24, at 6.

 

762 Id. See also NFA, Comment 27, at 3 (suggesting that the FTC “go the extra mile” to

ensure that small, potential franchisees receive adequate information).

 

763 Karp, Comment 24, at 6-7. See also Stadfeld, Comment 23, at 7-8 (“Being wealthy

should not be a basis for being screwed.”). 

 

764 See also Wendy’s, Comment 5, at 2.

 

765 See 17 C.F.R. §§ 230.501(5), (6), and (8). 

236

with sophistication;761 and (2) the exemption would offer little benefit to most franchisors.

762

Eric Karp, specifically, opposed the notion of using the investment amount or equity as a proxy

for sophistication.763 In his view, an “investment standard” does not consider the source of the

prospective franchisee’s funds: 

Did she re-mortgage her residence? Did he borrow from a friend or relative? Did

they cash in their retirement fund? The investment standard also does not

consider what other assets, liabilities, and income the prospective franchisee has

from which one can estimate his or her financial sophistication and tolerance of

risk.

Karp, Comment 24, at 7.

In lieu of the “investment” model offered by the Commission, Mr. Karp urged the

Commission to consider SEC Regulation D, 17 C.F.R. §§ 230.501-508, as a model.764 The SEC

uses the concept of an “accredited investor,” which is defined to include the following:

A person whose individual net worth, or joint net worth with that person’s spouse,

at the time of the purchase, exceeds $1,000,000; 

A person with individual income of more than $200,00 over the previous two

years, or joint income with that person’s spouse of more than $300,000 in each of

those years and has a reasonable expectation of reaching the same level of income

in the current year; and 

An entity where all the equity owners are accredited investors.765

Mr. Karp asserted that the SEC approach “properly focuses on the qualifications of the

investor, not the size of the investment.” In his view, the NPR does the opposite. “The fact that

a franchisee may be ready to invest a highly leveraged $1.5 million franchise investment does not

prove that such a person is so sophisticated that a disclosure document would be of no benefit.” 
 

766 Karp, Comment 24, at 6. See also Bundy, ANPR, 6Nov97 Tr, at 21-22; Jeffers, id. at 23-

24; Stadfeld, Comment 23, at 8. 

237

Karp, Comment 24, at 8. Mr. Karp further noted that the accredited investor exemption is not a

“carte blanche” to engage in an unlimited number of securities sales without registration. Rules

405 and 406 limit the aggregate dollar value of sales made to accredited investors to limits of

$1,000,000 and $5,000,000 respectively. “The NPR places no limits on the number of franchises

that can be sold under the proposed exemption.” Id. 

Finally, Mr. Karp discounted the potential benefit of the proposed large investment

exemption to franchisors. According to Mr. Karp, the exemption would be of little benefit to the

franchisor unless 100% of its franchise sales involved transactions over $1.5 million. If so, he

insisted, there is no additional compliance burden imposed by requiring disclosures be given to

all prospective franchisees because the franchisor has to prepare the disclosures in any event.766

After reviewing the comments, we continue to recommend that the Commission adopt a

large investment exemption. Since the Rule’s inception, the Commission has considered

investment level as one indicia of sophistication. For example, in granting the Automobile

Importers of America’s petition for exemption from the Rule under Section 18(g), the

Commission observed:

Prospective motor vehicle dealers make extraordinarily large investments. As a

practical matter, investments of this size and scope involve relatively

knowledgeable investors or the use of independent business advisors, and an

extended period of negotiation. The record is consistent with the conclusion that

the transactions negotiated by such knowledgeable investors over time and with

the aid of business advisors produce the pre-sale information disclosure necessary

to ensure that investment decisions are the product of an informed assessment of

the potential risks and benefits of the proposed investment.

45 Fed. Reg. 51,763-64 (Aug. 5, 1980). Accordingly, we give great weight to prior Commission

findings that a franchisee’s level of investment is one indicium of sophistication.

More important, we believe that franchisors should have a bright-line standard that will

clearly indicate when and under what circumstances the sophisticated investor exemption will

apply. An exemption based upon the particular net worth of each individual prospective

franchisee would be extremely burdensome to administer. For example, in some instances

franchisors would not be able to take advantage of the exemption unless they first verified each

prospective franchisee’s financial information. Similarly, absent such verification, law enforcers

would not be able to discern whether any specific franchise relationship was covered by the Rule. 

This approach would create a regulatory nightmare for both franchisors and franchise law

enforcers.
 

767 Where the listings in the Franchise Handbook provided data on the investment required,

we used those figures. Where the Franchise Handbook provided no data, we sought data on the

total investment from alternative sources, such as Entrepreneur Magazine’s Franchise 500 and

the International Franchise Organization’s Franchise Opportunities Guide. Even after consulting

all three of these sources, we could not find data on the requirement investment for about 90

franchise systems. 

238

We also reject Mr. Karp’s conclusion that the proposed exemption may offer little benefit

to franchisors. As a preliminary matter, there are franchise systems, such as lodging, where the

typical franchise investment is likely to exceed whatever exemption threshold the Commission

may adopt. Accordingly, the proposed large investment exemption would provide regulatory

relief in those instances. Mr. Karp’s concern will arise in instances where a franchisor typically

sells outlets at levels below and above the threshold. We agree that franchisors in such instances

must prepare disclosure documents in order to sell at levels below the threshold. According, the

costs of providing disclosures to all franchisees, including those above the proposed threshold,

may not be large. However, neither is the potential benefit. Indeed, the argument that

sophisticated investors could benefit from disclosure misses the mark. The basis for the large

investment exemption is not that “sophisticated” investors do not need pre-sale disclosure, but

that they will demand and obtain material information with which to make an investment

decision regardless of the application of the Rule. Where prospective franchisees are likely to

obtain pre-sale material information by themselves, then the need for federal intervention is less

compelling. 

This view is also entirely consistent with the statutory approach set forth in Section 18(g)

of the FTC Act, which gives franchisors the right to petition the Commission for a trade

regulation rule exemption limited to a specific set of facts. Thus, a franchisor, if it wished, could

petition the Commission for an exemption only for sales above a certain dollar figure. By

analogy, the proposed large investment exemption need not be “all or nothing” to benefit

franchisors. The very fact that franchisors almost uniformly supported the proposed large

investment exemption would tend to confirm that it would provide them with some desired

regulatory relief. Nonetheless, while we believe an exemption tied to the level of investment is

appropriate, we propose further refinements based upon the comments. Below, we analyze these

comments and offer our recommendations.

i. Proposed threshold

The NPR’s proposed $1.5 million threshold was based upon the staff’s examination of

the costs to purchase more than 1,350 franchises listed in Enterprise Magazine’s The Franchise

Handbook (Spring 1998) (“Franchise Handbook). Very few franchises cost in excess of $1.5

million: the maximum estimated cost of establishing a franchise exceeds $1.5 million in just

over 3% of the listed systems.767 Rather, an investment of $1.5 million most likely would

involve the purchase of several units. For example, more than 90% of the franchise systems

listed have a maximum investment of less than $500,000. Thus, in order to qualify for the
 

768 Of the 12 restaurant systems listed in the Franchise Handbook with maximum

investments of $1.5 million or above, all listed minimum investments to establish a location

below the $1.5 million threshold, with three listing minimum investments of less than $1 million

and seven estimating the minimum investment to be between $1 million and $1.2 million. 

 

769 64 Fed. Reg. at 57,321.

 

770 NASAA, Comment 17, at 12. Seth Stadfeld added that it is not difficult to invest $1.5

million when there is a down payment plus financing of a substantial portion of the investment. 

“Indeed, because they are taking on larger obligations, there is all the more reason and urgency

why they should get the material, factual and contractual information that is otherwise available

under the Rule.” Stadfeld, Comment 23, at 8. See also NFA, Comment 27, at 3.

 

771 E.g., Baer, Comment 11, at 16; Gurnick, Comment 21, at 3; Marriott, Comment 35, at 6.

 

772 See also 7-Eleven, Comment 10, at 3; NFC, Comment 12, at 20; BI, Comment 28, at 13. 

Wendy’s suggested that the threshold be lowered, but did not offer any specific amount. 

Wendy’s, Comment 5, at 2.

239

proposed $1.5 million exemption, the investment would involve either the purchase of a single

large franchise – such as a hotel or the most expensive restaurant location768 – or the purchase of

three or more units. As the Commission stated in the NPR, purchasers of multiple units are more

likely to be persons with significant business experience in light of the management demands of

operating multiple units.769 We also assume that in many instances this universe of sophisticated

investors will include existing franchisees with significant “hands-on” experience with the

franchisor: these experienced investors are not likely to purchase a franchise on impulse, are

more likely to negotiate over the terms of any contract, and are more resistant to high-pressure

sales representations.

The NPR comments, however, reveal no consensus on whether a threshold of $1.5

million is most appropriate. For example, NASAA urged the Commission to increase the

threshold to $3 million. In its view, $1.5 million may be inadequate because even

unsophisticated investors may have access to $1.5 million to invest in a franchise.770 Several

commenters supported the $1.5 threshold, as proposed in the NPR.771 Others believed that the

threshold should be even lower. 

McDonald’s suggested that the threshold should be set at $1 million: “In our considerable

experience, individuals purchasing franchises involving a $1 million investment have a clear

understanding of the terms and conditions of the business arrangements and have obtained

professional financial and/or legal advice before entering into the franchise agreement.” 

McDonald’s, Comment 7, at 2.772 The IFA proposed a variation on this theme. It supported a $1

million threshold, excluding real estate costs. It observed that a 1997 update to the Profile of

Franchising identified 52 franchise companies offering franchises with an initial investment
 

773 IFA, Comment 22, at 7. 

 

774 See Cendant, ANPR 140, at 4 (suggesting the Commission adopt a $750,000 threshold

exemption). H&H stated that the threshold should be lowered, but didn’t offer a specific amount.

H&H, Comment 9, at 4. Gary Duvall suggested a $250,000 threshold provided there is a

showing that the purchaser, alone or with counsel, can understand the merits and risks of the

investment. Duvall & Mandel, ANPR 114, at 21. We reject this suggestion as unworkable, 

because it would require franchisors to make subjective judgments about the purchasers’

business acumen.

240

exceeding $1 million, excluding real estate. This equates to 4.4% or fewer of all franchise

systems.773 

PMR&W would lower the threshold to $500,000:

[The $1.5 million] threshold essentially eliminates all but a very few franchised

businesses, typically lodging facilities and perhaps the most expensive restaurant

franchises. We suggest a $500,000 threshold as a more reasonable alternative

based on the franchisee’s likely resort to sophisticated advisory services from

accountants and/or attorneys and the probable need for financing, and resulting

due diligence oversight, from a financial institution.

PMR&W, Comment 4, at 3.774 

We believe a $3 million dollar threshold would be too high, effectively restricting the

exemption to only the rarest of instances, mostly large hotel franchises. On the other hand, the

suggested $500,000 threshold, in our view, is too low. There is insufficient record support for

the proposition that investors at the $500,000 level are sophisticated. We would rather err on the

side of caution to ensure that prospective franchisees in need of the Rule’s protection receive

adequate disclosure. A harder decision is whether to retain the proposed $1.5 million threshold,

reduce it to $1 million, or to $1 million excluding real estate costs. After further consideration, 

we recommend that the Commission adopt the $1 million excluding real estate costs, as proposed

by the IFA.

In reviewing the NPR comments, we give considerable weight to the statements offered

by franchisors such as McDonald’s and Marriott that, in their experience, a $1 million investment

is likely to involve sophisticated investors. At the same time, we share IFA’s concern that the

inclusion of real estate costs would tend to inflate the initial cost of a franchise investment, and

perhaps such costs should be excluded from the threshold. As the IFA noted, a $1 million

(excluding real estate) would encompass approximately 52 franchise systems, or under 5% of the

universe of franchise systems. We also believe that the Rule should set forth a bright-line

standard that can be readily applied across franchise systems. Rather than requiring a franchisor

to calculate real estate costs in each offering, which could vary widely among franchised outlets
 

775 We noted that the UFOC Guidelines recognize the difficulty of determining real estate

costs in advance. For example, the Item 7 Sample Answer addressing real estate provides a

range of rents ($12,000-20,000) “depending on factors such as size, condition, and location of the

leased premises.” UFOC Guidelines, Item 7, Sample Answer at note 2.

 

776 NFC, Comment 12, at 20. See also Marriott, Comment 35 at 6 (“‘Investment’ for

purposes of the exemption should be defined as the initial investment as set forth in Item 7, plus

credit extended by any lender and commitments for real property (not just mortgage or lease

payments for the first few months.”).

 

777 J&G, Comment 32, at 4.

 

778 See also H&H, Comment 9, at 4.

241

even in the same system,775 we would prefer a single, clear threshold. Accordingly, we believe

that the proposed $1 million, excluding real estate, would strike the appropriate balance.

ii. Meaning of “investment”

Several commenters voiced concerns about how the investment threshold should be

calculated. For example, J&G questioned: “ Is it the initial investment described in Item 7? Is it

the amount of the investment over the term of the franchise? Or is it some other calculation?” 

J&G, Comment 32, Attachment, at 6. The NFC voiced similar concerns and urged the

Commission to clarify the term “investment” to mean the franchisee’s estimated investment, as

set out in Item 7 of the disclosure document.776

Others raised alternative calculation approaches. For example, Wendy’s observed that

the NPR, by focusing on investment, “exclude[s] those expenses to be incurred during the first

three months of operation which are not offset by sales. . . . [This] artificially raises the

threshold.” Wendy’s, Comment 5, at 2. Similarly, J&G urged the Commission to include all

commitments for real property over the life of the contract, not just mortgage or lease payments

for the first few months.777 

H&H and the NFC would revise the Rule to make clear that the threshold includes the

total projected investment, whether in single- or multiple-unit transactions. As the NFC noted:

“A multi-unit franchisee investing the threshold amount (or more) in a number of units is just as

sophisticated as another franchisee investing a like amount in a single unit.” NFC, Comment 12,

at 21.778

Several commenters also urged the Commission to include in the threshold prior

investments made in a conversion franchise and investments made through transfers. For

example, H&H stated that the term “‘investment’ should include the fair market value of an

existing facility as part of the investment, so as to include an existing facility that is being
 

779 A conversion franchise occurs when existing, independent businesses decide to associate

with a franchise system. The NFC noted that conversion franchise activity is the “dominant form

of franchise activity extant in the guest lodging and real estate brokerage arenas, and is common

in other sectors as well. While new construction of franchised hotels does transpire, much

franchising activity in the guest lodging sector involves the conversion of existing hotels . . . to

the name, mark, and system of a guest lodging franchisor.” NFC, Comment 12, at 20. See also

PREA, Comment 20, at 3; Marriott, Comment 35, at 6. 

242

converted to the franchise system.” H&H, Comment 9, at 4.779 In a similar vein, the NFC

questioned whether a transfer of a franchise can qualify for the exemption. It urged the

Commission to include in the proposed exemption’s “investment” requirement a transfer, where

the franchisee pays an existing franchisee the threshold amount and then enters into a new

franchise agreement with the franchisor. “[W]e . . . submit that franchisees making such an

investment prior to the execution of the subject franchise agreement are as ‘sophisticated’ as their

brethren who make the investment after executing that agreement.” NFC, Comment 12, at 21. 

For the following reasons, the staff recommends that the Commission use the Compliance

Guides to explain in greater detail what constitutes an “investment” for purposes of the large

investment exemption. We begin our analysis by rejecting the suggestion offered by several

commenters that the Commission adopt a very broad definition of the term “investment” that

would include post-sale expenses. We are convinced that the threshold should be determined by

the investment made at the time of sale. It is not farfetched to assume that a large universe of

franchisees investing $100,000 or less today might actually pay to the franchisor more than $1

million (excluding real estate) during the course of a lengthy franchise agreement, especially

when we consider royalty and advertising fees, as well as ongoing product purchases. For that

reason, a broad large investment exemption would effectively eviscerate the Rule’s protection. 

Nonetheless, we agree that the definition of initial investment could be broadened without

sacrificing necessary investor protection. First, the investment threshold should apply to both

single-unit and multiple-unit transactions. We believe that was the Commission’s intention

when drafting the NPR. The total level of the prospective franchisee’s investment, not the

number of units purchased, is the primary factor underlying the proposed exemption. As noted

above, purchasers of multiple units are likely to be current owners or otherwise sophisticated

buyers.

Further, we agree that the Commission should clarify how the exemption will apply to

conversions and transfers of franchised units. We recommend that once an individual qualifies

as a sophisticated investor, he or she remains “sophisticated” if converting its unit to a franchise

system. Indeed, a strong argument can be made that a conversion franchisee is even more

sophisticated than a new franchisee, having worked in the business for a period of time. 

Similarly, we see no reason why a prospective franchisee cannot qualify as a sophisticated

investor if purchasing his or her outlet through a transfer. The fact that a transferee will assume

an existing contract or may renegotiate an existing contract with the franchisor should have no
 

780 Accordingly, the large investment exemption would be available not only for conversion

franchises, but where an existing franchisee switches brands (such as a Hilton becoming a

Marriott) or where a non-franchised, independent business (such as an unaffiliated real estate

agent) becomes affiliated with a real estate franchise system, such as ReMax.

 

781 This proposal is similar to the concept in SEC Regulation D where an entity can qualify

as an accredited investor if all the equity owners are accredited investors. See Karp, Comment

24, at 8.

 

782 64 Fed. Reg. at 57,321.

 

783 Id.

 

784 Marriott, Comment 35, at 6. See also J&G, Comment 32, at 4;

243

bearing on his level of sophistication as an investor, as long as he or she can satisfy the threshold. 

In short, we recommend looking at the total investment made in acquiring the franchise, not just

the investment made when the franchisee signs the franchise agreement, in determination the

application of the large investment exemption.780 

At the same time, we recommend that the Commission narrow the term “investment” in

one respect. Specifically, we are troubled by the issue of investors pooling their resources to

satisfy the threshold. Clearly there is a significant difference between a single individual

purchasing a franchise for $1 million, versus a group of 10, for instance, each contributing

$100,000. Obviously, the larger the group of investors, the smaller each individual investor’s

financial risk may be. In such a circumstance, there is no reasonable assurance that each investor

will be sophisticated. We would propose, therefore, that the exemption apply only if at least one

individual in the investor-group qualifies as “sophisticated” by investing at the threshold level.781 

iii. Offers of franchisor financing

As noted above, the NPR proposed excluding from the proposed $1.5 million threshold

any sums financed by the franchisor or an affiliate.782 The Commission explained that this

exclusion would add a measure of protection to the prospective franchisee because traditional

lenders are more likely than the franchisor to require a due diligence investigation of the

offering.783

J&G and Marriott opposed the exclusion of franchisor-extended credit from the proposed

threshold. For example, Marriott asserted that it does not believe that there are inherent risks that

would justify excluding financing from the franchisor. Indeed, it feared that the proposal might

have the unintended effect of harming franchisees by discouraging franchisors from offering

financing to prospects in order to qualify for the exemption.784 At the same time, Eric Karp

disputed the view expressed in the NPR that lenders may act as an effective check, requiring a
 

785 See 62 Fed. Reg. at 57,321 and n.255.

 

786 64 Fed. Reg. at 57,321.

244

prospect to have sufficient equity capital before granting a loan.785 He contended that there is “no

support in the record as to what amount of equity a bank might require on a franchise investment

of $1.5 Million.” Karp, Comment 24, at 7.

The staff recommends that the Commission continue to exclude franchisor-extended

credit from the large investment threshold. We are convinced that this exclusion will ensure

better protection against fraud. Otherwise, a franchisor could be tempted to increase the cost of

the initial investment to qualify for the large investment exemption, only to turn around and offer

to finance the deal himself, all without proper pre-sale disclosures. In that regard, we agree with

Mr. Karp who observed that the assumption that a prospective franchisee will have a sufficient

level of equity tends to disappear “where a franchisee obtains financing from the franchisor or its

affiliates or from a selling franchisee; in such instances, far less equity may be required.” Karp,

Comment 24, at 7. 

Further, it is reasonable to assume that a lender, in order to minimize its own financial

risk, will ensure that a prospective franchisee will conduct a due diligence investigation of the

franchise offering. Indeed, by involving a lender, the prospective franchisee effectively ensures

that there is an independent, sophisticated entity inserted into the sales process. This additional

safeguard would be lost if sources of financing for purposes of the exemption included the

franchisor and its affiliates. 

iv. Acknowledgment

In the NPR, the Commission proposed that prospective franchisees sign an

acknowledgment if they are not receiving disclosures because their investment satisfies the large

investment exemption. This would reduce the opportunity for fraud by enabling the prospect to

verify that the investment meets or exceeds the exemption threshold.786

Several commenters either did not understand the purpose of the acknowledgment or

believed that it would serve no useful purpose. For example, BI stated: “We do not understand

the purpose or the importance of the acknowledgment by the prospective franchisee of the

application of the exemption. The acknowledgment does not protect the prospective franchisee,

except, perhaps to put the prospect on notice that it may be entitled to receive a disclosure

document.” BI, Comment 28, at 13. 

Seth Stadfeld told us that the acknowledgment could be abused. “[F]ranchisors could

further a fraud by playing up to and flattering the prospective franchisee into thinking that he is

so sophisticated that he doesn’t need the disclosures that the little people need.” Stadfeld,

Comment 23, at 8. On the other hand, Howard Bundy advised that the acknowledgment should
 

787 64 Fed. Reg. at 57,321. No state has a comparable disclosure exemption. Several states

– including California, Indiana, Maryland, New York, North Dakota, Rhode Island, South

Dakota, and Washington – have an exemption from registration for “experienced franchisors.” 

To qualify for the exemption, a franchisor must typically have a net worth of at least $5 million

and have had 25 franchise locations in operation during the previous five years. See generally

Duvall & Mandel, ANPR 114, at 3-4. 

 

788 See Kaufmann, ANPR, 18Sept97 Tr, at 190. 

245

be expanded. He would revise the Rule to read: “The franchisee’s estimated investment,

excluding any affiliate financing, totals at least $1.5 million and the prospective franchisee signs

an acknowledgment stating the basis for the exemption from the Rule and providing the CFR

citation to the Rule and verifying the grounds for the exemption . . . .” Bundy, Comment 18, at

14.

We recommend that the Commission retain, but revise, the acknowledgment requirement

proposed in the NPR. As previously noted, the acknowledgment will ensure that a prospective

franchisee receives notice that the transaction is exempt from the Rule. This would tend to

prevent fraud by enabling the prospective franchisee to verify the applicability of the exemption. 

Further, we believe that abuse of the acknowledgment requirement is unlikely. The

acknowledgment is not a waiver: either the prospective franchise sale is covered by the Rule or

it is exempt. Thus, any flattering statements made by a franchisor have no bearing on the

franchisor’s core obligation to furnish disclosures.

 

At the same time, we agree with Mr. Bundy that the acknowledgment should reference

the Franchise Rule itself. This would enable a prospective franchisee to review the Rule,

understand the exemption, and, ultimately, verify the exemption’s application. Finally, the

acknowledgment needs to be modified to reflect our proposed revised exemption threshold – $1

million excluding real estate costs. Accordingly, we recommend that the Commission adopt the

following acknowledgment: “The franchise sale is for more than $1 million, excluding real

estate costs, and thus is exempted from the Commission’s Franchise Rule disclosure

requirements, pursuant to 16 C.F.R. § 436.8(a)(5)(i).” 

d. Proposed section 436.8(a)(5)(ii):

Large franchisee exemption

In the NPR, the Commission further proposed exempting from the Rule franchise sales

to large entities; namely, those who have been in business for at least five years and have a net

worth of at least $5 million.787 For example, a fast food franchisor may sell a number of

franchised outlets to a hotel chain. Such transactions often are heavily negotiated by

sophisticated counsel who have significant experience in the franchise industry. Even if a large

entity does not have prior experience specifically in franchising, it is reasonable to assume that it

can nevertheless protect its own interests when negotiating a franchise purchase.788
 

789 Advisory 97-7, Bus. Franchise Guide (CCH) ¶ 6,487 (1997).

 

790 See Kirsch, ANPR, 18Sept97 Tr, at 198-99. But see Kezios, id. at 191-92 (opposing

exemption for large institutions, suggesting that they need franchise advice and counsel as well). 

 

791 E.g., IL AG, Comment 3, at 2; PMR&W, Comment 4, at 3; Wendy’s, Comment 5, at 3;

Triarc, Comment 6, at 1; H&H, Comment 9, at 5; Baer, Comment 11, at 16; NFC, Comment 12,

at 22; BI, Comment 28, at 14; Tricon, Comment 34, at 7; Marriott, Comment 35, at 7.

 

792 As a practical matter, the large franchisee exemption would also apply to individuals who

purchase franchises. Any sophisticated investor who has been in business for at least five years

and has generated an individual net worth of over $5 million would likely form a corporation or

other entity in which to conduct business. Indeed, any individual with the requisite experience

and net worth who attempted to conduct business without insulating him or herself from

246

The staff believes that an exemption for large franchisees is a logical extension of the

Rule’s current exemptions. The closest analogous exemption is the fractional franchise

exemption. That exemption, however, is very narrowly tailored, focusing only on persons who

wish to expand their existing product lines, have two years of related experience, and face a

minimal financial risk. 

The following illustrates the need to supplement the fractional franchise exemption with

the proposed large investor exemption. In 1997, the staff was asked for an advisory opinion on

whether a travel services company would be covered by the Rule if it sold outlets to hospitals. 

The only possible exemption in the Rule that could apply is the fractional franchise exemption. 

The staff advised that the hospital could not qualify as a fractional franchisee under the Rule,

however, because it did not have the requisite two years of experience in providing travel-related

services.789 Hospitals and other large institutions such as airports and universities are hardly the

type of “consumers” that the Commission needs to protect.790 

i. Entities covered by the exemption

In the NPR, the Commission proposed that the large franchisee exemption be limited to

corporations. Many commenters supported the proposed exemption, but criticized its narrow

application.791 Specifically, several commenters urged the Commission to consider exempting

other large entities, such as partnerships, finding no rationale for restricting the exemption only

to corporations. We agree. 

We recommend, therefore, that the Commission broaden the proposed exemption to

include other business entities, such as partnerships. Specifically, we recommend that the

Commission revise the proposed exemption to use the word “entity,” while making clear in the

Compliance Guides that the exemption covers corporations, partnerships, and similar business

arrangements.792
potential liabilities may in fact rebut our presumption that such an individual is a sophisticated

investor and, therefore, should receive appropriate disclosures.

 

793 Similarly, J&G maintained that any “entity or group of entities with a $5 million or more

net worth should, by definition, be deemed to have the requisite sophistication to satisfy the

exclusion or exemption.” J&G, Comment 32, at 4. 

247

ii. Net worth and prior experience 

As proposed in the NPR, the large franchisee exemption would require both a threshold

net worth ($5 million), as well as prior experience (five years). Several franchisor advocates told

us that the proposed exemption’s net worth and prior experience prerequisites are overly

restrictive. Some commenters would focus on net worth as the appropriate measure of

sophistication, while others would focus on prior experience.

The NFC, for example, asserted that net worth alone is sufficient to determine

sophistication: “Even if a large corporation does not have prior experience in franchising

specifically, it is reasonable to assume that it can protect its own interests when negotiating for

the purchase of a franchise.” NFC, Comment 12, at 21-22.793 The NFC has offered the following

proposed revised language: 

. . . the franchisee is an organized business entity (including, without limitation, a

corporation; limited partnership; limited liability company; general partnership; or

a functional equivalent) that has a net worth of at least $5 million dollars or is an

affiliate (as defined in § 436.1[(b]) of such an officially recognized business

entity.

NFR, Comment 12, at 23.

H&H, however, contended that a $5 million net worth threshold is too high, limiting the

exemption to a small number of publicly-traded companies. “Many successful private companies

do not seek to accumulate equity, but instead to maximize cash flow to their owners. Thus, such

a high net worth requirement would prevent the exemption of many sophisticated investors.”

H&H, Comment 9, at 5. The firm would set the net worth requirement at $1 million. Id. On the

other hand, Howard Bundy asserted that the $5 million net worth requirement is too low,

sweeping in many very small companies. “That is a small enough net worth to not be indicative

of the level of sophistication that would indicate no need for mandatory disclosures.” Bundy,

Comment 18, at 14. 

In lieu of net worth, Triarc argued in favor of prior experience as the determining factor. 

It noted that it is possible that a franchisee with 10 years of experience and 50 units may wish to

finance its operation with debt rather than equity. Under the circumstances, this presumably

sophisticated franchisee would fail the net worth test:
 

794 See also, e.g., NFC, Comment 12, at 22; J&G, Comment 32, at 4; H&H, Comment 9, at

5. Triarc, for example, noted that one Arby’s franchisee owns 700 units and is one of the largest

privately owned restaurant operators in the world. It asked “why should we have to give

disclosure to that franchisee merely because he sets up a new corporate entity to own his next

Arby’s store?” Triarc, Comment 6, at 1-2.

 

795 NFC, Comment 12, at 22; J&G, Comment 32, at 4; H&H, Comment 9, at 5.

 

796 To that end, we also recommend modifying the definition of “affiliate” to cover both

franchisee and franchisor affiliates, as noted in our discussion of the proposed definitions above.

248

What if a large corporate franchisee with $20.0 million of net worth declares a

$16.0 million dividend to its shareholders or otherwise does a recapitalization

which takes its net worth below the threshold? Over the years, some gigantic

companies that are financially healthy have had huge negative net worths and

negative earnings. . . . We would suggest that net worth is often an indicator of

how a company chooses to finance itself rather than of sophistication. 

Triarc, Comment 6, at 2. 

Finally, a few commenters told us that the proposed exemption prerequisites ($5 million

net worth and five years of experience) would essentially disqualify new corporations. They

asserted that there are legitimate tax and liability reasons why an experienced franchisee may

wish to establish a separate corporation for a particular franchise transactions. For example,

according to Marriott, it is not unusual in the lodging and restaurant industries to form “special

purpose entities (SPEs) . . . to insulate either a parent company or the individual investors from

liability.” Marriott, Comment 35, at 7. If so, then it might be impossible for such new

corporations to satisfy the proposed exemption’s criteria.794 These commenters urged the

Commission to consider the consolidated net worth and experience of franchisee affiliates.795

After considering the arguments supporting and opposing the net worth and priorexperience prerequisites, we conclude that the Commission should retain both prerequisites, with

one modification. We believe that net worth and prior-experience are necessary elements to

ensure that the Rule continues to protect businesses with limited experience, limited assets, and,

by inference, limited prior success. For example, a small sandwich shop franchisee is not

necessarily sophisticated enough to purchase a hotel merely because the franchisee has operated

one or more units for five years. Similarly, several wealthy individuals who form a partnership

without any prior business experience are not necessarily sophisticated merely because of their

net worth. Nonetheless, we agree with the commenters who have observed that the net worth

and prior experience prerequisites may not make sense when applied to franchisee spin-off

subsidiaries or affiliates that are formed primarily for tax or limited-liability purposes. 

Accordingly, we recommend that the Commission permit the aggregation of commonly-owned

franchisee assets in determining the availability of the large entity exemption:796
 

797 64 Fed. Reg. at 57,322. The proposed exemption is modeled after nearly identical

language in California’s statute. Washington and Rhode Island have similar exemptions. See

Duvall & Mandel, ANPR 114, at 21 (suggesting a narrower approach).

 

798 See also AFC, Comment 30, at 3.

 

799 Stadfeld, Comment 23, at 9.

 

800 Bundy, Comment 18, at 14.

249

The franchisee (and its parent and any affiliates) is an entity that has been in

business for at least five years and has a net worth of at least $5 million.

e. Proposed section 436.8(a)(6):

Officers, owners, and managers exemption

The NPR further proposed exempting from the Rule franchise sales to franchisees who

are (or recently have been) officers or owners of the franchisor.797 There does not appear to be

any need for disclosure in such circumstances because we can reasonably assume that the

prospective franchisee already is familiar with every aspect of the franchise system and the

associated risks. Indeed, in some instances, a company may wish to offer units to its owners or

officers only. If not exempt from the Rule, these companies would have to go through the

burden and expense of creating a disclosure document for isolated sales to company insiders. To

ensure that individuals qualifying for the exemption have recent and sufficient experience with

the franchisor, however, the proposed exemption is limited to individuals who have been

associated with the franchisor within 60 days of the sale and who have been involved for at least

two years with the franchise system.

The NPR proposal generated four comments. The NFC and AFC endorsed the proposed

exemption, although the NFC encouraged the Commission to broaden it to include “trustees,

general partners and any individual who has or had management responsibility for the offer and

sale of the franchisor’s franchises or the administration of the franchised network.” NFC,

Comment 12, at 23.798 This would make the exemption parallel to Item 2. Seth Stadfeld,

however, questioned the need for the exemption if the franchisor is already providing disclosures

to others.

799 Howard Bundy urged the Commission to limit the exemption to bona fide officers,

fearing that a franchisor could attempt to skirt disclosure obligations by putting a prospective

franchisee on the board of directors, for example, for a few days or weeks before the sale and

removing him or her shortly thereafter.800 

Based upon the record, the staff recommends that the Commission broaden the proposed

exemption. Specifically, we agree with the NFC’s suggestion that the exemption should cover

not just owners and officers of a franchise system, but others with direct management experience. 

It is reasonable to assume that managers and others with at least two years of direct experience in
 

801 64 Fed. Reg. at 57,321-22. The proposal to adjust thresholds for inflation is modeled

after the Appliance Labeling Rule, 16 C.F.R. Part 305, which sets forth ranges of estimated

annual energy costs and consumption for various appliances. Because energy cost and appliance

efficiencies fluctuate, the Commission adjusts the label requirements periodically by publishing

in the Federal Register new costs and ranges, which then become part of that rule’s labeling

requirements. Specifically, section 305.9(b) of the Appliance Labeling Rule provides: “Table 1,

above, will be revised on the basis of future information provided by the Secretary of the

Department of Energy, but not more often than annually.” This approach is also consistent with

the Commission’s procedures for adjusting thresholds or other information in Commission

enforced statutes. For example, the Commission publishes in the Federal Register annual

adjustments for determining illegal interlocking directorates in connection with Section 19(a)(5)

of the Clayton Act. In addition, under the Debt Collection Improvement Act of 1996, the

Commission adjusted civil penalty amounts from $10,000 to $11,000 to account for inflation. 

Those amounts must be adjusted at least once every four years. See 61 Fed. Reg. 54,549 (Oct.

21, 1996).

250

the franchise system should be well-informed about the operation of that particular system. 

Where a non-franchised company wishes to sell a limited number of outlets to experienced

company personnel only, it would be overly burdensome to force the company to create a

disclosure document when the only beneficiaries of the disclosures are already knowledgeable

individuals. We also note that the proposed exemption is franchise-specific. We do not mean to

suggest that a manager of one company is deemed sophisticated for all franchise sales. Rather,

the exemption would apply only to a manager or other officer seeking to purchase a franchise of

that very company. So revised, the exemption could apply when:

One or more purchasers of at least a 50 percent ownership interest in the

franchise: (1) within 60 days of the sale, has been, for at least two years, an

officer, director, general partner, individual with management responsibility for

the offer and sale of the franchisor’s franchisees or the administrator of the

franchised network; or (2) within 60 days of the sale, has been, for at least two

years, an owner of at least a 25 percent interest in the franchisor.

We also recognize Mr. Bundy’s concern that franchisors may abuse the exemption in an

effort to skirt the Rule. Nonetheless, we believe that this concern has been addressed in the

proposed exemption’s prerequisites. In order to qualify for the exemption, the prospective

franchisee must have served one of the enumerated positions for at least two years. Moreover,

their relationship with the franchisor must be current: within 60 days of the sale. These

prerequisites are likely to ensure that the prospect is in fact a bona fide officer or owner.

4. Proposed section 436.8(b): Inflation adjustment

In the NPR, the Commission proposed publishing revised thresholds for the sophisticated

investment exemptions once every four years to adjust for inflation.801 A four-year adjustment
 

802 Baer, Comment 11, at 16.

 

803 NFC, Comment 12, at 22.

 

804 See, e.g., H&H, Comment 9, at 4; Baer, Comment 11, at 15-16.

 

805 64 Fed. Reg. at 57,319. See n.58 above.

 

806 43 Fed Reg. at 59,708.

251

would be sufficient to ensure that the thresholds keep up with inflation, while relieving the

Commission of the expense and burden of more frequent adjustments.

The NPR’s inflation adjustment proposal garnered three comments. PMR&W agreed

with the need for a threshold adjustment outside of the normal rulemaking process. John Baer

supported the proposal as published in the NPR.802 The NFC offered a slightly different

approach. It suggested that the Commission tie the thresholds amount automatically to reflect

increases in the Consumer Price Index, while placing the burden on the franchisor to prove that it

qualified for the exemption at the time in question.803

We are persuaded that the Commission needs a simplified mechanism to adjust the

sophisticated investor exemption thresholds for inflation quickly without the burdensome

rulemaking amendment procedures. We believe the Rule should contain bright-line thresholds

that are clear to both franchisor and franchisee alike. Thus, any adjustments to Rule thresholds

should be imposed only after proper notice to the public, where the effective date of the

adjustment and the adjustment amount are clear. We believe the most effective way to provide

such notice is through periodic Federal Register announcements of adjustments based upon the

Consumer Price Index. Finally, although not addressed in the NPR, we believe the period

inflation adjustment should also pertain to the minimum payment exemption, currently set at

$500.804

5. Exclusions

Finally, as noted above, the NPR proposed streamlining the Rule by eliminating the four

current Rule exclusions for non-franchise relationships.805 In the SBP, the Commission

explained that these four relationships are not franchises, but might be perceived as falling within

the definition of a franchise.806 To avoid any confusion, the Commission expressly excluded

these four relationships from Rule coverage. In the NPR, the Commission expressed the view

that clarifying exclusions are no longer necessary. Nonetheless, to ensure that no one

misinterprets the proposed elimination of the exclusions as signaling a substantive change in

Commission policy, the Commission made clear that it continues to believe that these four
 

807 As in other areas of Rule interpretation, the staff can address future questions concerning

the definition of the term “franchise” on a case-by-case basis through informal advisory opinions.

 

808 J&G, Comment 32, Attachment, at 9. 

 

809 Baer, Comment 11, at 15. See also IL AG, Comment 3, at 3; PMR&W, Comment 4, at 3;

H&H, Comment 9, at 3; Gurnick, Comment 21, at 7.

 

810 TruServ, Comment 33, at 2.

 

811 64 Fed. Reg. at 57,322. See also 16 C.F.R. § 436.1(f). “Without this provision, the

Commission believes that the disclosures required by the rule could be contradicted in oral sales

presentations and rendered of little value without violating the rule.” SBP, 43 Fed. Reg. at

59,695. 

 

812 64 Fed. Reg. at 57,346. See also 16 C.F.R. § 436.1(h). In the SBP, the Commission

observed that numerous consumers complained about the difficulty they experienced when they

attempted to obtain refunds from their franchisors. “It is clear from the record that all franchisors

252

relationships are not covered by the Rule, and that their elimination is simply part of the

Commission’s general streamlining effort.807

Several commenters opposed the elimination of the four Rule exclusions. J&G stated

that businesses that have relied on these exclusions, and that lawyers advising clients and courts

asked to interpret the proposed Rule might find the exclusions useful.808 Similarly, John Baer

asserted that dropping the exclusions is likely to be misinterpreted and cause confusion over the

extent of Rule coverage.809 For example, TruServ, a hardware retailer cooperative, believes that

there should be a clear distinction between cooperatives and franchises and urged the

Commission to retain the exclusion for cooperatives.810

For the reasons stated in the NPR, the staff recommends that the Commission remove the

current Rule’s four exclusions, as proposed. Nonetheless, we recognize that the exclusions may

still serve a useful purpose, explaining to practitioners the distinctions between business

arrangements that may appear to be franchises. However, we are convinced that the proper place

for such an explanation is in the Compliance Guides that will accompany the revised Rule.

X. PROPOSED SECTION 436.9: ADDITIONAL PROHIBITIONS

A. Background

We next turn to the prohibitions section of the proposed revised Rule. As noted in the

NPR, the Commission proposed retaining the current Rule prohibitions against the making of

statements that contradict the franchisor’s disclosures,811 failing to make promised refunds,812 and
do not adequately adhere to the refund policies they themselves agree to in their contracts.” 43

Fed. Reg. at 59,696-97. See also Staff Review at 29 (some franchisees continue to experience

problems with obtaining refunds).

 

813 64 Fed. Reg. at 57,332. See also 16 C.F.R. §§ 436.1(b)(2) and (c)(2); UFOC Item 19. In

the SBP, the Commission rejected the idea that franchisors should always leave a copy of their

financial performance substantiation with the prospective franchisee. At the same time, it found

that “the benefit to be derived from permitting those prospective franchisees who so wish to

review the franchisor’s substantiation far outweigh speculative harms that could arise from such

disclosure.” 43 Fed. Reg. at 59,691.

 

814 64 Fed. Reg. at 57,323-24.

 

815 Id. at 57,323.

 

816 Id. at 57,322-23.

 

817 The only comments submitted on the proposed financial performance claim prohibition

concerned whether general media should include the Internet. We have already addressed this

issue at length in our discussion of the definition of “financial performance representation” in the

definitions section above. For the reasons stated in that section, we recommend that the

Commission limit electronic financial performance claims to those aimed specifically at

prospective franchisees. 

 

818 At the same time, we recommend that any performance claim also state the dates when

the reported level of financial performance was achieved, consistent with the current Rule. See

16 C.F.R. 436.1(e).

253

failing to make available written substantiation for financial performance representations.813 Few

comments were submitted on these proposed prohibitions, and we recommend that the

Commission retain them in the final revised Rule, with one modification. With respect to

financial performance representations, it may be unreasonable to expect non-franchisor sellers to

possess documentation for the franchisor’s representations. Accordingly, we recommend that the

Commission make clear in the Compliance Guides that a franchise seller can satisfy his or her

obligation to furnish financial performance substantiation by promptly referring any request for

such information to the franchisor. 

The NPR also proposed adding three new prohibitions concerning: (1) the use of

“shills;”814 (2) the use of contract integration clauses;815 and (3) the making of financial

performance representations outside of a disclosure document.816 Other than the comments

already addressed in the definitions section, no comments were submitted on the proposed

financial performance prohibition.817 Accordingly, we recommend that the Commission adopt it

in the final revised Rule.818 In the following section, we discuss the shill, integration clause, and

refund issues.
 

819 The proposed anti-shill prohibition is also broad enough to cover the use of “institutional

shills,” companies that purport to act like a Better Business Bureau that provide consumers with

independent reports on its members. See FTC v. United States Bus. Bureau, Bus. Franchise

Guide (CCH) ¶ 10,865 (S.D. Fla. 1995).

 

820 Scam artists may use shill references in order to bolster their financial performance and

success claims. E.g., Car Checkers of Am., Bus. Franchise Guide (CCH) ¶ 10,163, at 24,04. See

also FTC v. Hart Mktg. Enter., No. 98-222-CIV-T-23 E (M.D. Fla. 1998); FTC v. Unitel Sys.,

Inc., No. 3-97CV1878-D (N.D. Tex. 1997); FTC v. Southeast Necessities Co., Inc., Bus.

Franchise Guide (CCH) ¶ 10,526 (S.D. Fla. 1994).

 

821 The NCL reported that complaints about fake references are among the most common

franchisee and business opportunity complaints it receives. NCL, ANPR 35, at 2. See also Staff

Program Review at 39 (showing that false or deceptive representations pertaining to testimonials

and references is the second most common Section 5 allegation (28 counts) in Commission

business opportunity and franchise cases).

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B. The Record and Recommendations

1. Proposed section 436.9(b): Shills

The NPR proposed prohibiting franchise sellers from using phony references or

“shills.”819 Specifically, franchise sellers would be barred from misrepresenting that any person

has actually purchased or operated one of the franchisor’s franchises and that any person can give

an independent and reliable report about the experience of any current or former franchisee. The

Commission’s law enforcement experience820 shows that shills are often the glue that holds a

scam together by allaying consumers’ concerns about the investment risks.821 

The proposed anti-shill provision generated only one comment. J&G expressed concern

that actors or public figures used in a franchisor’s advertising campaigns “will need to exercise

caution when making endorsements of franchises so as not to run afoul of prohibitions against

misrepresenting that they are able to provide ‘an independent and reliable report about the

franchise or the experiences of any current or former franchisees.’” J&G, Comment 32,

Appendix, at 9. 

There is no evidence in the record on the extent to which franchisors use actors or public

figures to sell franchises, as opposed to selling products and services to the end-user. Based

upon our experience, we believe such practices are rare. More important, our primary concern is

with deception: we see little difference between a franchisor paying unknown individuals to

deceive prospective franchisees, on the one hand, and paying actors or celebrities to deceive

prospective franchisees, on the other. In each case, a franchisor should not be able to pay
 

822 We further note that this view is consistent with the Commission’s Guides Concerning

The Use of Endorsements and Testimonials In Advertising, 16 C.F.R. § 255. These guides

require that any representation in an ad that purports to represent the view of a consumer must, in

fact, reflect the consumer’s actual views or experience: 

Endorsements must always reflect the honest opinions, findings, beliefs, or

experience of the endorser. Furthermore, they may not contain any

representations which would deceive, or could not be substantiated if made

directly by the advertiser.

Id. at § 255.2(a). Therefore, any actor or public figures who might run afoul of this provision in

the Franchise Rule already risks being found in violation of the FTC Act. 

 

823 Id.

255

individuals to lie about their purported experience in order to lure unsuspecting consumers to buy

a franchise.822 We conclude that the NPR’s proposed anti-shill prohibition is entirely proper.

2. Proposed Section 436.9(i): Disclaimers and contract negotiations

In the NPR, the Commission proposed prohibiting franchise sellers from disclaiming or

requiring “a prospective franchisee to waive reliance on any representation made in the

disclosure document or in its exhibits or amendments.” 64 Fed. Reg. at 57,323. At the same

time, the Commission expressed concern that prohibiting franchise sellers from disclaiming or

waiving the contents of a disclosure document could have the unintended consequence of chilling

the negotiation of franchise agreement terms and conditions. Arguably, a franchisor could not

negotiate franchise terms – such as the cost and expiration date – if a prospective franchisee may

not waive the original terms set forth in the disclosure document. To avoid such a result, the

Commission proposed that a prospective franchisee could agree to different terms if the

franchisor identifies the changes, the prospective franchisee initials the changes, and the

prospective franchisee has five days to review the revised contract before signing it or paying a

fee.823

a. Integration clauses and waivers

During the ANPR proceeding, several franchisees and their representatives asserted that

franchisors routinely seek to disclaim liability for their pre-sale disclosures through the use of

contract integration clauses. Through these clauses, franchisees effectively waive any rights they

may have to rely on pre-sale disclosures made to them during the sales process. For example,

Peter Lagarias, a franchisee advocate, told us:

In virtually every lawsuit I have filed for franchisees alleging fraud, franchise

disclosure, or unfair or deceptive practices (under California law since the FTC
 

824 See also, e.g., Manuszak, ANPR 13; Bell, ANPR 30; Sibent, ANPR 41 (and 19 identical

ANPR comments); AFA, ANPR 62, at 3; Bundy, ANPR 119, at 2; Zarco & Pardo, ANPR 134, at

3.

 

825 64 Fed. Reg. at 57,323 and 57,346.

 

826 IL AG, Comment 3, at 6; IL AG Rebuttal, Comment 38, at 3.

256

rule does not provide a private right of action), counsel for the franchisor

defendants have defended the action on lack of justified reliance. Franchisors and

their counsel have systemically written the agreements to strip franchisees of all

fraud claims and rights the minute the agreement is signed by sophisticated

integration, no representation, and no reliance clauses. . . . The Commission

should provide that reliance on the disclosure document and other representations

made in the sale of a franchise is per se justified.

Lagarias, ANPR 125, at 4.824 Another franchisee representative, Andrew Selden, added that

integration clauses are “not well understood and their impact is not appreciated at all until long

after the franchise purchasing commitment is made.” Selden, ANPR 133, Appendix B, at 2.

In response to the ANPR comments, the Commission proposed in the NPR that the Rule

prohibit franchise sellers from disclaiming liability for statements made in a disclosure

document, as well as from requiring a prospective franchisee to waive reliance on any disclosure

document representations.825 This generated significant comment, both supporting and opposing

the proposal.

Several franchisee advocates and state regulators supported the proposed prohibition on

integration clauses. The IL AG, for example, asserted that this proposal would be a valuable

addition to the Rule, noting that franchisees signing a franchise agreement may have no idea that

they are waiving reliance on the disclosure document.826 Similarly, the AFA stated:

The integrity of a franchisor’s disclosure document is critical to prospective

franchisees. The prevalent use of integration clauses to disclaim liability for

required disclosures undermines the very purpose of the Rule, which is to prevent

fraud and misrepresentation in the pre-sale process by ensuring prospective

franchisees have complete and truthful information from which to make sound

investment decisions.

AFA, Comment 14, at 6. NASAA was in full agreement: “Based on the law enforcement

experience of franchise registration states, the vast majority of franchise agreements contain

some type of waiver or integration provision purporting to insulate franchisors from liability for
 

827 See also Karp, Comment 24, at 22-23; NFA, Comment 27, at 2; Morrill, Comment 31, at

1-2.

 

828 Bundy, Comment 18, at 14. See also IL AG, Comment 3, at 6.

 

829 In the alternative, Mr. Stadfeld suggested that the cover sheet contain an explicit warning

that anything stated by the franchisor that is not in the contract should not be relied upon in any

way. Stadfeld, Comment 23, at 10.

 

830 See also Marriott, Comment 35, at 8; GPM Rebuttal, Comment 40, at 10-11.

 

831 Baer, Comment 11, at 16-17.

 

832 J&G, Comment 32, at 4-5. See also Marriott, Comment 35, at 7-8.

257

oral or other representations that conflict with the required disclosure document or franchise

agreement.” NASAA, Comment 17, at 12.827

A few commenters support, but would expand, the proposal. Howard Bundy, for

example, would prohibit franchisors from disclaiming liability for statements also made in their

written marketing material.828 Seth Stadfeld would ban integration clauses in franchise

agreements altogether. He asserted that such clauses are “the single greatest tool used by

franchisors to evade responsibility for misrepresentations and omissions of material facts that

take place in a franchise marketing program.” Stadfeld, Comment 23, at 9-10.829 

Franchisors, on the other hand, either opposed the proposed disclaimer prohibition or

would limit the prohibition’s scope. Several franchisors strongly asserted that integration clauses

are necessary for two purposes. As J&G explained, franchisors have to be able to rely on the

final franchise agreement as the manifestation of the intent of the parties. In addition, franchisors

must be able to disclaim liability for unauthorized statements made by rogue salesman, such as

unauthorized earnings claims. The firm advised that the proposal fails to explain how

franchisors may lawfully protect themselves without using “the merger and integration clause

[the Commission] proposes to ban.” J&G, Comment 32, at 4-5.830

Franchisors also suggested that the proposed anti-disclaimer provision is unnecessary. 

According to John Baer, for example, the Commission could always take action if a franchisor’s

disclosure document contains false information.831 In the same vein, J&G asserted that the basis

for the proposal is that integration clauses may deny a franchisee a remedy when franchisees

litigate against franchisors. The firm noted, however, that only the FTC is authorized to bring a

claim for violation of the Franchise Rule; the Commission’s ability to address false

representations in a disclosure document will survive any integration clause between the

franchisor and franchisee.832 
 

833 We also note that a franchisor’s advertisements are subject to Commission substantiation

and anti-deception requirements, as are all other advertisements under Section 5.

258

PMR&W asserted that the NPR proposal would effectively ban the use of integration

clauses. The firm, however, suggested that the Commission could limit the proposed prohibition

by applying it only “if an integration clause or other contract provision specifically disclaims

representations made in the disclosure document. Alternatively, or perhaps additionally, require

a representation by the franchisor at the end of Item 17 that the information contained in the

disclosure document is unaffected by any integration clause.” PMR&W, Comment 4, at 17.

It is clear that franchisors use integration clauses and waivers in many different contexts,

not just for pre-sale disclosure. The impact of these clauses and waivers in the franchise

industry, however, is unclear. Nevertheless, based upon the record, the staff recommends that

the Commission prohibit the use of integration clauses and waivers in limited circumstances, as

follows. 

i. Third-party statements 

As an initial matter, we note that the NPR did not purport to ban integration clauses or

waivers as a deceptive or unfair practice, and we propose no such step now. Indeed, it is the

Commission’s view that integration clauses and waivers serve valid purposes, including ensuring

that a prospective franchisee relies solely on information authorized by the franchisor or within

the franchisor’s control in making an investment decision. For example, a franchisor reasonably

may seek to disclaim responsibility for unauthorized claims made by rogue salespersons,

statements made by former or existing franchisees, or even unattributed statements found in the

trade press. Therefore, at the very least, integration clauses and waivers are necessary to protect a

franchisor from statements or representations made by third parties.

ii. Statements outside the disclosure document

Further, we do not suggest that the proposed anti-disclaimer prohibition reach statements

in a franchisor’s advertising materials.833 While there is some merit in the argument that

franchisors should not disclaim or waive any authorized statement outside of the disclosure

document, our concern is the reliability and integrity of the franchisor’s required disclosures. A

broader anti-integration and anti-waiver policy is unnecessary to address this concern.

iii. Disclosures other than contractual terms

At the same time, we continue to believe that franchise sellers should not be able to use

integration clauses or waivers to insulate themselves from false or deceptive statements made in

their disclosure documents. This is particularly true of those sections of the disclosure document

pertaining to matters other than the terms of the franchise agreement, such as the franchisor’s

prior business experience, litigation history, financial performance representations, and financial
 

834 See 16 C.F.R. § 436.1(f). 

 

835 The Commission has also recognized that waivers of rights afforded by Commission

trade regulation rules are disfavored. For example, section 455.3(b) of the Used Car Rule, 16

C.F.R. § 455.3(b), requires used car sellers to incorporate the Buyers Guide into their sales

contracts. This ensures that used car sellers cannot technically comply with the Rule by affixing

the Buyers Guide to a car window, and then turn around and require consumers to waive the very

rights granted them under the Rule. Similar anti-waiver provisions can be found in the Credit

Practices Rule, 16 C.F.R. § 444.2 (barring certain waivers in credit transactions), Cooling-Off

Period Rule, 16 C.F.R § 429.1(d) (barring inclusion in any door-to-door contract of any

confession of judgment or “any waiver of any rights to which the buyer is entitled under this

section”), and Ophthalmic Practices Rule, 16 C.F.R. § 456.2(d) (barring efforts to have a patient

waive or disclaim the liability or responsibility of the ophthalmologist or optometrist for the

accuracy of the eye examination). 

 

836 As noted above in section V, prospective franchisees often rely on the disclosures in

making their investment decision, especially when such disclosures appear to have the backing of

the Federal Trade Commission. Cf. FTC v. Minuteman Press, No. 93-CV-2496 (DRH)

(E.D.N.Y. Memorandum and Order Oct. 2, 1998) (court holds that a reasonable consumer could

“legitimately conclude that he or she was being furnished important specific earnings information

. . . notwithstanding . . . general disclaimers in the UFOC”). 

 

837 See J&G, Comment 32, at 5.

259

statements. The Commission has long recognized that the integrity of a franchisor’s disclosures

is critical to prospective franchisees. For that reason, disclosures must be complete, accurate,

legible, and current. Further, the Rule also prohibits franchisors from making statements that

contradict those in their disclosure documents.834 The use of integration clauses or waivers835 to

disclaim statements in the disclosure document that the franchisor makes or authorizes would

undermine the Rule’s very purpose by signaling to prospective franchisees that they cannot trust

or rely upon the disclosure document.

836

Nevertheless, we recognize that an integration clause or waiver would permit a franchisor

to narrow its disclosures in unique circumstances. For example, an ice cream store franchisor

may make an Item 19 financial performance representation pertaining to units based in Florida. 

If the franchisor sells units in southern states, the Florida-based representation would be

reasonable. However, if the franchisor were to sell a unit in Alaska, the franchisor might wish to

use a contract integration clause to ensure that the financial performance representation is

inapplicable to the particular sale in Alaska.837

In such instances, however, franchisors may be able to protect themselves from liability

without reliance on integration clauses or waivers. For example, the ice cream store franchisor

noted above, at the very least, could provide the prospective Alaskan franchisee with a disclosure
 

838 E.g., Cummings v. HPG Int’l, Inc., 244 F.3d 16, 21 (1st Cir. 2001) (A party cannot induce

a contract by fraudulent misrepresentations and then use contractual devices to escape liability);

Betz Labs. v. Hines, 647 F.2d 402 (3d Cir. 1989) (Integration clause is part of the contract and if

fraud taints the relationship between the parties, the integration clause itself is struck down); Tibo

260

document that deletes the Item 19 representation. Moreover, the statement of bases and

assumptions attached to the disclosure document could make clear that the financial performance

representation pertains to Florida or other southern states only. We also note that nothing in the

proposed anti-integration clause prohibition would prevent a franchisor from having a

prospective franchisee sign an acknowledgment that the Florida-based performance

representation does not apply to states such as Alaska. We solicit comment on whether these

approaches would protect the franchisor’s interests without compromising the integrity of the

disclosure document itself. 

 iv. Contract terms

A more difficult question arises concerning the use of integration clauses or waivers in

connection with disclosures pertaining to the franchise agreement itself. Prospective franchisees

receive disclosures that summarize contractual terms – such as payments, rights to exclusive

territories, and training – as well as a copy of the franchise agreement. It is not unreasonable to

assume that, at times, there may be discrepancies or inadvertent conflicts between the two

documents. Under the circumstances, franchisors reasonably may assert that the contract itself

should be controlling.

Further, if integration or waivers were not permitted, franchisors might simply

incorporate language from the contract, which may be in “legalese,” into the disclosure document

in order to avoid discrepancies. This may have the unintended consequence of making the

franchisor’s disclosure document less clear.

Accordingly, we must balance these concerns with the prospective franchisees’

reasonable expectation that the franchisor’s discussion of contractual terms in the disclosure

document can be relied upon and trusted. As an initial matter, we recognize that the

Commission’s ability to bring suit against false or deceptive disclosures, regardless of any

contract integration clause or waiver, may encourage complete and accurate disclosure. 

Nevertheless, we believe that franchisees should not have to rely on Commission action post-sale

to resolve conflicting contractual terms. Rather, we believe that a limited proposed integration

clause prohibition will encourage franchisors to review their disclosures for accuracy prior to use,

thereby avoiding post-sale conflicts and litigation. However, we seek comment on whether we

have properly balanced these competing interests.

Further, courts have limited the circumstances where integration clauses matter most – 

pre-sale fraud. Where there is fraud in the inducement, courts are likely to void the contract,

regardless of any integration clause or waiver.838 For example, in Alphagraphics Franchising,
Software, Inc. v. Gordon Food Serv., Inc., 51 U.C.C. Rep. Serv. 2d, 2003 U.S. Dist. LEXIS

12020 (W.D. Mich. 2003) (An explicit integration clause bars parol evidence with the exception

of fraud or other grounds sufficient to set aside a contract); Jones Distrib. Co. v. White Consol.

Indus., 943 F. Supp. 1445, 1470-71 (N.D. Iowa 1996) (Fine-print, boiler-plate integration

provision is not legally enforceable when there has been fraud that has induced the making of the

contract); Ron Greenspan Volkswagen v. Ford Motor Land Dev. Corp., 38 Cal. Rptr. 2d 783, 790

(Ct. App. 1995) (Merger clause will not insulate a seller from liability for misrepresentations,

even if the clause specifically disclaims such misrepresentations); Nobles v. Citizens Mortgage

Corp., 479 So.2d 822 (Fla. Dist. Ct. App. 1985) (Under Florida law, a merger or integration

clause will not bar evidence of fraud in the inducement). 

261

Inc., v. Whaler Graphics, Inc., 840 F. Supp. 708 (D. Ariz. 1993), the court held that there was

fraud in the inducement regarding an arbitration forum selection clause, despite the presence of

an integration clause in the franchise contract. “It is well-settled that a party cannot free himself

from fraud by incorporating [an integration clause] in a contract.” (Citations omitted).

Accordingly, integration clauses or waivers are not likely to protect franchisors from private suits

based upon fraudulent statements made in a disclosure document, even without Commission

intervention.

In addition, we believe that franchisors most likely will not import “legalese” into the

disclosure document. We note that Item 9 (Franchisee’s Obligations) and Item 17 (Renewal,

Termination, Transfer, and Dispute Resolution), for example, only require a franchisor to

reference, not summarize, the contract. Accordingly, the opportunity for discrepancies is

reduced. Other contract provision disclosures require more detail than the contract itself (e.g.,

the Item 11 discussion of training; the Item 12 discussion of territories, and the Item 16

discussion of sales restrictions). We believe that franchisors can write these disclosures to avoid

discrepancies with the contract. Nevertheless, we seek comment on whether plain English

requirements have been subverted by the importation into the disclosure document of legalistic

contractual provisions that are difficult to understand.

b. Contract negotiations

At the same time, we recognize that prospective franchisees may seek to negotiate terms

different from those set forth in the standard contract attached to their disclosure documents. For

example, the prospective franchisee may seek a longer term, reduced fees, or modified exclusive

territory. Arguably, an integration clause would facilitate negotiations by releasing the parties

from restraints imposed by the contractual terms previously disclosed in the disclosure document.

As an initial matter, the staff believes that franchise sellers and prospective franchisees

should be free to negotiate the terms of the franchise agreement, as in all other commercial

transactions, without fear of violating the Rule. The Commission has no interest in preventing

the parties from seeking the best deal possible, as long as the prospective franchisee understands

in advance of the sale how the terms and conditions differ from the standard ones set forth in the
 

839 Two franchisor representatives specifically urged the Commission to clarify the Rule to

ensure that the parties are free to negotiate contract terms. See Baer, ANPR 25, at 4-5; Duvall &

Mandel, ANPR 114, at 22. They feared that if the franchisor negotiates with a prospective

franchisee for different terms than what appears in the disclosure document, (e.g., a different

initial franchise fee or royalty payment), the franchisor will effectively violate the Rule because

the franchisor will not have furnished the prospective franchisee with a disclosure document

spelling out the specific agreed-upon terms and conditions in advance of the sale.

 

840 64 Fed. Reg. at 57,323.

 

841 IL AG, Comment 3, at 6. See also J&G, Comment 32, Attachment, at 10.

 

842 See section V.C. above.

262

disclosure document, and has the opportunity to review the actual franchise agreement prior to

the sale.839

The use of an integration or waiver clause, however, is unnecessary to permit contract

negotiations. As noted above, the NPR addressed this issue by proposing that a prospective

franchisee could negotiate contract terms different from those in the standard contract attached to

the disclosure document if: (1) the franchisor identifies the changes; (2) the prospective

franchisee initials the changes; and (3) the prospective franchisee has five days to review the

revised contract before signing it or paying a fee.840 Having been fully informed about changes in

the franchise agreement before signing, a franchisee would have no grounds to sue post-sale. 

Nevertheless, commenters voiced concerns about the proposed contract negotiation provision.

The IL AG, for example, observed that the proposed review period for negotiated

contracts would begin five days before the prospective franchisee signs the franchise agreement

or pays any fee. This would conflict with the proposed general five-day provision, requiring the

parties to wait five days before signing the franchise agreement only, but not before paying a

fee.841 Warren Lewis suggested revised language as follows: “if: (1) the franchise seller

identifies the changed terms and conditions; (2) the prospective franchisee has 5 days before

signing the contract or paying any fee to review the revised contract; and (3) the prospective

franchisee initials the changed terms and conditions before or when signing the revised contract.” 

Lewis, Comment 15, at 21. Mr. Lewis also urged the Commission to allow flexibility during the

five-day review period, especially if the changes to the contract are requested by the prospective

franchisee. 

Upon further reflection, we believe that the NPR’s approach toward contract negotiations

is unnecessary. Many of the concerns about how to permit contract negotiations in lieu of

integration clauses or waivers are already addressed in our discussion of the contract review

period above.842 Specifically, in that section we recommend no contract review period where

changes are made at the request of the prospective franchisee. Indeed, as noted above, where the
 

843 64 Fed. Reg. at 57,322.

 

844 One commenter, Dady & Garner, suggested that franchisees should always receive a

refund (minus actual costs) if they never actually open or operate an outlet. Dady & Garner,

ANPR 127, at 4. We believe the substantive terms and conditions of refunds are a matter of

contract between the parties, provided the terms and conditions of any refund policy are spelled

out in the disclosure document or franchise agreement.

263

prospective franchisee is fully informed about the contractual terms that will govern the

relationship before signing the contract, no harm can result and there is no basis for a suit. 

Where changes to the contract are initiated by the franchisor, however, we recommend a

limited contract review period. At the same time, we also propose a new prohibition, barring

franchisors from failing to alert the prospective franchisee to changes between the standard

agreement attached to the disclosure document and the agreement to be executed by the parties. 

We believe these proposals are sufficient to prevent fraud in the negotiation process and preserve

the integrity of the franchisor’s disclosures. Indeed, in those situations, the prospective

franchisee will be able to review the revised contract prior to sale and compare it to the

disclosure document. 

To avoid any confusion on this issue, we recommend that the Commission make clear in

the Rule that the proposed integration clause prohibition does not pertain to contract

renegotiations. Accordingly, we recommend that the Commission add the following language to

the proposed anti-disclaimer prohibition: “Provided, however, that this provision is not intended

to prevent a prospective franchisee from voluntarily waiving specific contract terms and

conditions set forth in his or her disclosure document during the course of franchise sale

negotiations.”

3. Proposed section 436.9 (j): Refunds

In the NPR, the Commission also proposed retaining the current prohibition against

failing to make refunds.843 As set forth at 16 C.F.R. § 436.1(h), the current Rule prohibits

franchisors and brokers from failing “to return any funds or deposits in accordance with any

conditions disclosed pursuant to paragraph (a)(7) of this section.” No comments were submitted

on this proposal. Nonetheless, we believe that this prohibition should be fine-tuned in one

respect. The current refund prohibition is limited to instances where the franchisor or broker

makes an express refund promise in the disclosure document itself. It is possible, however, that a

franchise seller may not make any specific promise in the disclosure document itself, but may do

so either in the franchise agreement, or in a separate contract or letter of understanding. The

harm resulting from the failure to honor a promised refund is the same, regardless of where that

promise is written. We propose, therefore, that the Commission make clear that the failure to

honor any written refund promise will constitute a Rule violation.844
 

845 We also recommend that the Compliance Guides make clear that other franchise sellers

can satisfy their obligation to furnish disclosure documents earlier in the sales process by

promptly forwarding a prospective franchisee’s request to the franchisor, provided that the

franchisor has promised to fulfill any such requests promptly.

264

4. Summary of additional prohibition recommendations

Finally, as noted throughout this Report, we have proposed a few narrowly tailored

additional prohibitions as alternatives to more detailed disclosures. Although we have addressed

the rationale for those new prohibitions in detail above, we will summarize them briefly in this

section.

a. Proposed section 436.9(e): Prohibition on failing to furnish 

disclosures to a prospective franchisee early in the sale 

process, upon reasonable request

As noted above, we propose that the Commission eliminate the current first personal

(face-to-face) meeting disclosure trigger. Nonetheless, we recognize the potential value of early

disclosure to a prospective franchisee. To that end, we recommend a new prohibition barring

franchisors from failing to furnish a copy of the franchisor’s disclosure document to a

prospective franchisee, upon reasonable request, earlier in the sales process than is otherwise

required by the Rule.845 

b. Proposed section 436.9(f): Prohibition on failing to furnish

existing disclosures to a prospective purchaser of an existing

outlet, upon reasonable request

As discussed above, the proposed Rule would retain the Commission’s current policy that

franchisors furnish disclosures to prospective transferees only if the franchisor is actively

involved in the sales process. At the same time, we recognize the potential benefits of pre-sale

disclosure to all prospective purchasers. Rather than compelling franchisors to furnish such

disclosures, however, we propose a new prohibition barring franchisors from failing to furnish

existing disclosures to a prospective purchaser of an existing outlet, upon reasonable request.

c. Proposed section 436.9(g): Prohibition on failing to furnish 

updated disclosures to a prospective franchisee, upon

reasonable request

In our discussion of the proposed updating instructions, we voice concern that a

prospective franchisee may rely on stale disclosures by the time he or she is ready to execute the

franchise agreement. We stop short, however, of recommending that franchisors be compelled to

update their disclosures continuously during the sales process. Rather, any prospective

franchisee who is in the sales cycle should have the right to obtain a copy of the franchisor’s
 

846 As with the early disclosure prohibition discussed above, we further recommend that the

Compliance Guides make clear that other franchise sellers can satisfy their obligation by

promptly forwarding a prospective franchisee’s request to the franchisor, provided that the

franchisor has promised to fulfill any such requests promptly.

 

847 64 Fed. Reg. at 57,324.

 

848 “If any provision of this regulation is stayed or held invalid, the remainder will stay in

force.” See 16 C.F.R. § 436.3.

265

most recent disclosure document before they agree to execute the franchise agreement. To that

end, we recommend that the Commission prohibit franchisors from failing to furnish a copy of

the franchisor’s most recent disclosure document and any quarterly updates to a prospective

franchisee, upon reasonable request, before the prospective franchisees signs a franchise

agreement.846 

d. Proposed section 436.9(h): Prohibition on failing to note

contract revisions

In section V.B of this Report, we express concern that a franchisor could commit fraud at

the time of executing a franchisee agreement by substituting contract provisions, without notice

to the prospective franchisee, that differ materially from those in the original, standard contract

attached to the disclosure document. To prevent such abuse, we recommend that the

Commission prohibit franchisors from substituting provisions or pages in the agreement without

first bringing such changes to the prospective franchisee’s attention in a reasonable time before

he or she signs the agreement. 

XI. PROPOSED SECTIONS 436.10 and 436.11: OTHER LAWS, RULES, ORDERS,

AND SEVERABILITY

A. Background

The last sections of the NPR addressed three additional issues:847 (1) the revised Rule’s

effect on other Commission laws and rules, and on outstanding Commission orders; 

(2) preemption of state franchise laws that may be inconsistent with the Rule; and (3)

“severability.”848 No comments were submitted on the proposal that the Commission modify

outstanding orders that may conflict with the final revised Rule or on the proposed standard

severability provision. Accordingly, we recommend that the Commission adopt these proposals,

as set forth in the NPR. Comments, however, were submitted on the effect of the Rule on other

Commission laws and on preemption. We discuss these two issues below.
 

849 43 Fed. Reg. at 59,719.

 

850 64 Fed. Reg. at 57,324.

 

851 Bundy, Comment 18, at 15.

 

852 NFC, Comment 12, at 24.

266

B. The Record and Recommendations

1. Proposed section 436.10(a):

Legality of practices

The current Rule makes clear that the Commission expresses “no opinion as to the

legality of any practice mentioned [in a disclosure document].” 16 C.F.R. § 436.3. A disclosure

provision should not be construed as condoning or approving of any matter disclosed, or as “an

indication of the Commission’s intention not to enforce any applicable statute.” Id. In the SBP,

the Commission shed additional light on this issue, explaining that some of the Rule’s provisions

may require franchisors to disclose practices that may raise legal issues, such as antitrust

issues.849 By requiring disclosure, the Commission was not giving approval to practices that

might violate other Commission laws.

In the NPR, the Commission again made clear that it reserves the right to pursue

violations of antitrust or other laws even if a franchisor effectively discloses the violation when

complying with the Rule’s disclosure requirements. In short, pre-sale disclosure does not create

a safe harbor for franchisors engaging in otherwise unlawful conduct.850 

This proposal generated two comments. Howard Bundy focused on the first part, that

“the Commission does not approve or otherwise express any opinion on the legality of any matter

a franchisor may be required to disclose by this Rule.” He would make it a separate prohibition

for a franchisor to represent to any person that the Commission has reviewed or approved the

form or content of any disclosure document.851 

The NFC focused on the last sentence, that the “Commission also intends to enforce all

applicable statutes and trade regulation rules.” In essence, the NFC contended that, under more

recent case law, disclosure in some instances may shield a practice that otherwise might be a law

violation. According to the NFC, a franchisor’s disclosure of certain product or sourcing

restrictions, for example, may relieve the franchisor from antitrust “tying” liabilities.852

The staff recommends that the Commission retain the proposal on the revised Rule’s

legal effect, as set forth in the NPR. We agree with Mr. Bundy that no franchisor should

represent that the Commission has reviewed or approved any disclosures. Our proposed revised

Rule, however, would mandate that a franchisor state expressly on their disclosure document
 

853 For example, under the current Rule, no disclosure of state or local licensing provisions is

required. Nonetheless, in U.S. v. Lifecall Sys. Inc., No. 90-3666 (D.N.J. 1990), the Commission

alleged that the defendants violated Section 5 by misrepresenting that purchasers of their

emergency alert system franchises would not have to register with state or local authorities. See

also Car Checkers of Am., Bus. Franchise Guide (CCH) ¶ 10,163 (alleging that defendants

violated Section 5 by failing to disclose state insurance licensing requirements); Blanc, Bus.

Franchise Guide (CCH) ¶ 10,032 (alleging that defendants violated Section 5 by misrepresenting

availability of medical insurance). Cf. FTC v. Carribean Clear, Inc., Bus. Franchise Guide

(CCH) ¶ 10,029 (D.S.C. 1992) (permanent injunction included prohibition against future

misrepresentations of the effectiveness and safety of defendants’ swimming pool water purifier). 

Similarly, a practice may violate the Rule and Section 5 simultaneously. For example, in

numerous Franchise Rule cases the Commission alleges that the defendants violated Section 5 by

using shills (phony references), even though that conduct also violates the Rule’s mandate to

disclose completely and accurately information about existing and former franchisees. See 16

C.F.R. § 436.1(a)(16).

267

cover page that the Commission has not reviewed or approved of the disclosures. This should be

sufficient to correct any misrepresentation to the contrary. Moreover, such a false statement

would already be actionable as a violation of Section 5 of the FTC Act. Under the

circumstances, we believe no additional prohibition is needed.

We also find the NFC’s concerns to be misplaced. The “legal effect” proposal restates

the general policy that disclosure alone does not shield a franchisor from otherwise illegal

conduct. To that end, it reserves the Commission’s right to enforce other Commission laws that

may affect a franchisor’s conduct. When enforcing the laws it administers, the Commission, of

course, will analyze the facts and the current state of the law to determine whether there is in fact

a law violation in the first instance. The proposal does nothing more than state that the

Commission will continue to enforce the laws it administers, where there is a legal basis to do so. 

If a disclosure makes conduct legal, as the NFC asserts, then the Commission obviously would

have no reason to believe the franchisor has committed a law violation.

The staff further recommends that the Commission adopt the proposal clarifying that

compliance with the Rule’s specific disclosure obligations will not shield a franchisor from other

violations of Section 5. In short, a franchisor may violate Section 5 by omitting material

information even if the franchisor complies fully with the Rule’s specific disclosure

requirements.853 The staff believes that this Rule clarification merely restates current

Commission law, and is critical in an age of quickly advancing technologies and changes in

corporate structures. For example, we cannot now predict what disclosures will be material in

the future, in particular franchisors’ and franchisees’ rights and obligations concerning issues

such as Internet home-pages, electronic advertising, and electronic commerce. Nor can we

predict large corporate bankruptcies, and even criminal suits against company officials, which

have become more common. Therefore, a franchisor’s disclosure obligations under Section 5
 

854 In its comment, H&H seemed to interpret the proposal as requiring franchisors to include

other, unspecified, material information in their disclosure documents. H&H asserted that this

would be unfair, giving the franchise community no indication what may or may not be deemed

material. H&H, Comment 9, at 8. Proposed section 436.10(a) merely reaffirms the current state

of the law that franchise sellers may have other obligations under Section 5 of the FTC Act

beyond those stated in the Franchise Rule. In that regard, franchise sellers are no different from

other businesses subject to Commission trade regulation rules. For example, Section 5 would

prohibit a used car salesman from misrepresenting a rebate program or from misrepresenting

whether a used car had previous damage, even though the salesman may otherwise comply with

the Used Car Rule’s warranty disclosures.

 

855 64 Fed. Reg. at 57,324. See also 16 C.F.R. Part 436, note 2. Elevating the preemption

discussion from a footnote to a Rule section is consistent with other Commission trade

regulations rules. See, e.g., Appliance Labeling Rule, 16 C.F.R. Part § 305.17; Cooling-Off

Rule, 16 C.F.R. § 429.2; Mail Order Rule, 16 C.F.R. § 435.3(b)(2); R-Value Rule, 16 C.F.R.

§ 460.23. 

268

must remain flexible to ensure that franchisors continue to provide prospective franchisees with

material information as new technologies and marketing practices emerge, and corporations

restructure. This does not mean that a franchisor must include other material information in its

disclosure document. Indeed, the prohibition against including additional materials, other than

non-preempted state law requirements, would bar a franchisor from expanding its disclosures to

include even additional material information.854 Rather, a franchisor might be compelled under

Section 5 to disclose information to a prospective franchisee separately from the disclosure

document.

2. Proposed section 436.10(c):

Preemption

In the NPR, the Commission proposed retaining the preemption provision currently found

at footnote 2, with minor editing:855

The FTC does not intend to preempt the franchise practice laws of any State or

local government, except to the extent of any inconsistency with this Rule. A law

is not inconsistent with this Rule if it affords prospective franchisees equal or

greater protection, such as registration of disclosure documents or more extensive

disclosures.

In response to the NPR, The IL AG urged the Commission to include the following

statement in the Rule regarding preemption: “Compliance with a state franchise regulation that is

substantially the same as an FTC requirement shall also satisfy that corresponding FTC

regulation.” IL AG, Comment 3, at 9. We believe such language is unnecessary in light of the
 

856 But see IL AG Rebuttal, Comment 38, at 1-2 (“federalism has served the public well”). 

 

857 PMR&W, Comment 4, at 7-8.

 

858 See also Baer, Comment 11, at 2; GPM Rebuttal, Comment 40, at 8. A few commenters

told us that additional guidance is needed in understanding the interrelationship between the Rule

and the UFOC Guidelines. For example, PMR&W urged the Commission to clarify conflicting

updating requirements and how broader UFOC provisions might apply in non-registration states. 

E.g., PMR&W, Comment 4, at 7. We acknowledge this concern. Currently, the Commission

addresses such issues in the Interpretive Guides. We believe this is the best approach for

addressing explanations of Commission policy. Accordingly, we recommend that the

Commission address the interrelationship between federal and state disclosure issues in the

Compliance Guides that will accompany the revised Rule. 

269

Rule’s preemption provision that basically says the same thing. Moreover, it could confuse the

issue by adding a new, undefined, standard – “substantially the same.”

Several franchisors urged the Commission to preempt the field of pre-sale disclosure in

order to ensure that there is one, national, disclosure standard.856 PMR&W, for example, voiced

concern that some of the “forward-thinking” aspects of the NPR – such as the phase-in of audited

financial statements and revised cover page – could be rendered ineffective by contrary state

policies. The firm did not challenge states’ right to comment on a franchisor’s failure to comply

with a required disclosure standard during the registration and review process. However, the

underlying disclosure standard should be uniform.857 Similarly, Snap-On maintained that:

the myriad of state regulations that apply to franchise disclosure add a great deal

of extra effort to the Offering Circular process and serve no real purpose beyond

what has already been served by compliance with the Federal Trade Commission

Rule on Franchising. As such, complete preemption of state law in this area,

which would make the franchise regulations truly uniform, is sought.

Snap-On, Comment 16, at 1.858

We reject the call to expand the preemptive effect of the Rule. As a preliminary matter, it

is clear that the proposed revised Rule, if adopted, would create a new disclosure floor with

which all franchisors must comply. It is our hope that NASAA and the states would adopt the

revised Rule, further reducing inconsistencies between federal and state law. However, the

Commission lacks the legal basis to preempt the field of pre-sale disclosure law.

The preemptive effect of any federal law is fundamentally a question of Congressional

intent. Unless Congress has expressly provided for preemption by occupying the field, then

preemption can exist only where there is a conflict between federal and state law that creates an

“obstacle to the accomplishment and execution of the full purposes and objectives of
 

859 Gade v. Nat’l Sold Wastes Mgmt. Ass’n, 505 U.S. 88, 98-99 (1992); Fla. Lime & Avocado

Growers, Inc., v. Paul, 373 U.S. 132, 141 (1963); Hines v. Davidowitz, 312 U.S. 52, 67 (1941). 

These standards apply to federal regulations, as well as federal statutes. E.g., Fid. Fed. Sav. &

Loan Ass’n v. de la Cuesta, 458 U.S. 141, 153 (1982).

 

860 Rice v. Santa Fe Elevator Corp., 331 U.S. 218, 230 (1947).

 

861 Cipollone v. Liggett Group, Inc., 505 U.S. 504, 516 (1992).

 

862 E.g., Am. Fin. Servs. Ass’n v. FTC, 767 F.2d 957, 989 (1985). See also Paul R. Verkuil,

Preemption of State Law by the Federal Trade Commission, 1976 Duke Law Journal 225.

 

863 E.g., Am. Fin. Servs., 767 F.2d 957 (Credit Practices Rule); Harry and Bryant Co. v.

FTC, 726 F.2d 993 (4th Cir. 1984) (Funeral Rule); Am. Optometric Assoc. v. FTC, 626 F.2d 896

(D.C. Cir. 1980) (Opthalmic Practices Rule). 

 

864 Fla. Lime & Avocado Growers, 373 U.S. at 141.

 

865 E.g., Mail or Telephone Order Merchandise Rule, 16 C.F.R. § 435.3; R-Value Rule, 

16 C.F.R. § 460.23.

 

866 E.g., Funeral Rule, 16 C.F.R. § 453.9; Credit Practices Rule, 16 C.F.R. § 444.5; and Used

Car Rule, 16 C.F.R. § 455.6.

270

Congress.”859 Indeed, the Supreme Court has been reluctant to find preemption of state laws,

holding that there is a presumption against preemption,860 unless that is the “clear and manifest

purpose of Congress.”861

The Federal Trade Commission Act does not include any clause directly preempting state

law. Furthermore, the legislative history of the Act and of the 1975 amendments to the Act

establishing the Commission’s rulemaking authority indicate that Congress did not intend the Act

to occupy the field of consumer protection regulation.862 Any preemptive effect of the Franchise

Rule, therefore, is limited to instances where state law conflicts with the FTC requirements, such

that a “repugnancy” is created between the state laws and the Commission regulations.863

Preemption would occur where there is an “actual conflict between the two schemes of

regulation [such] that both cannot stand in the same area.”864 Accordingly, the Commission

generally has declared the preemptive effect of Commission rules to be limited to the extent of an

inconsistency only865 and in some instances (such as with the UFOC Guidelines) has provided a

mechanism by which a state or local government may petition the Commission to permit

enforcement of any part of a state or local law that would provide for greater consumer

protections than an FTC rule’s requirements.866 Therefore, absent federal legislation evidencing

a clear intent from Congress to occupy the field of pre-sale franchise disclosure, the revised

Franchise Rule would not affect state laws providing greater consumer protection. 
 

867 Although the Executive Order is not binding on independent agencies, such as the Federal

Trade Commission, it nonetheless sets forth principles that the Commission might consider in

determining the preemptive effect of its regulations.

271

We further note that preemption of state franchise disclosure laws would be inconsistent

with the current policy on federalism, as announced in Executive Order 13132 on August 4,

1999.867 Among other things, the Executive Order provides that federal agencies should carefully

assess the necessity of limiting the policymaking discretion of the states and such actions should

be taken “only where there is constitutional and statutory authority for the action and the national

activity is appropriate in light of the presence of a problem of national significance.” It also

encourages agencies, in appropriate circumstances, to defer to the states to establish standards. 

As noted above, there is no statutory basis for preempting the states in the franchise pre-sale

disclosure arena, nor do we find any compelling reason to limit the states’ discretion in this field. 

Rather, by adopting the UFOC Guidelines, which the commenters agree is superior to the current

Franchise Rule, the states have taken a leadership role in this field. For that reason, we

recommend, and many of the commenters support, using the UFOC Guidelines model when

revising the Rule. Under the circumstances, we must reject any suggestion that the Commission

expand the Franchise Rule’s preemptive effect. There simply is no legal or policy basis for such

an expansion.

XII. CONCLUSION

The rule amendment record demonstrates the need to update the Franchise Rule to

address new technologies and to provide prospective franchisees with more disclosure about the

nature of the franchise relationship, while minimizing discrepancies between federal and state

law. This report analyzes the entire record and sets forth the staff’s recommendations as to the

form of the final revised Rule. We recognize that reasonable people may differ with our

recommendations. We, therefore, welcome comment on this report and the proposed final

revised Rule provisions during the next 60 days, as provided by the Commission’s Rules of

Practice, 16 C.F.R. § 1.13(h).
1

ATTACHMENT A

TABLE OF COMMENTERS

Notice of Proposed Rulemaking

Comment 1. Patrick E. Meyers, The Quizno’s Corporation (“Quizno’s)

Comment 2. Steven A. Rosen, Frannet (“Frannet”)

Comment 3. Robert Tingler, Franchise Bureau Chief, Illinois Attorney General (“IL AG”)

Comment 4. Dennis E. Wieczorek, Piper Marbury Rudnick & Wolfe (“PMR&W”)

Comment 5. Jack Schuessler, Wendy’s Intl, Inc. (“Wendy’s”)

Comment 6. Curtis S. Gimson, Triarc Restaurant Group (“Triarc”)

Comment 7. Eugene Stachowiak, McDonald’s (“McDonalds”)

Comment 8. David E. Holmes (“Holmes”)

Comment 9. Erik B. Wulff, John F. Dienelt, Hogan & Hartson (“H&H”)

Comment 10. Ronnie R. Volkening, 7-Eleven, Inc. (“7-Eleven”)

Comment 11. John R.F. Baer, Robert T. Joseph, Alan H. Silberman, Sonnenschein Nath & 

Rosenthal (“Baer”)

Comment 12. Morton A. Aronson, Neil A. Simon, David J. Kaufmann, National Franchise 

 Council (“NFC”)

Comment 13. Alaska Turner (“Turner”)

Comment 14. Susan P. Kezios, American Franchisee Association (“AFA”)

Comment 15. Warren L. Lewis, Lewis & Kolton (“Lewis”)

Comment 16. John W. Regnery, Snap-On Inc. (“Snap-On”)

Comment 17. Dale E. Cantone, Stephen W. Maxey, Joseph J. Punturo, NASAA Franchise and 

 Business Opportunity Project Group (“NASAA”)

Comment 18. Howard E. Bundy, Bundy & Morrill, Inc. (“Bundy”)

Comment 19. Laurie Taylor (“Taylor”)

Comment 20. Jonathan Hubbell, Prudential Real Estate Affiliates (“PREA”)

Comment 21. David Gurnick, Arter & Hadden (“Gurnick”)

Comment 22. Don J. DeBolt, Matthew R. Shay, International Franchise Association (“IFA”)

Comment 23. L. Seth Stadfeld, Weston, Patrick, Willard & Redding (“Stadfeld”)

Comment 24. Eric H. Karp, Witmer, Karp, Warner & Thuotte (“Karp”)

Comment 25. Janet L. McDavid, American Bar Association, Section of Antitrust Law 

 (“ABA AT”)

Comment 26. Randall Loeb, NaturaLawn of America (“NaturaLawn”)

Comment 27. Tony Rolland, National Franchisee Association (“NFA”)

Comment 28. Andrew P. Loewinger, Buchannan Ingersoll (“BI”)

Comment 29. Jeffrey E. Kolton, Frandata (“Frandata”)

Comment 30. AFC Enterprises (“AFC”)

Comment 31. Howard Morrill, Bundy & Morrill, Inc. (“Morrill”)

Comment 32. Carl E. Zwisler, Jenkens & Gilchrist (“J&G”)

Comment 33. Diane T. Nauer, TruServ Corporation (“TruServ”)
2

Comment 34. Brian H. Cole, Tricon (“Tricon”)

Comment 35. Steven Goldman, Mark Forseth, Marriott Corp. (“Marriott”)

Rebuttal Comment 36. Gurnick (see supra Comment 21).

Rebuttal Comment 37. Kezios (see supra Comment 14).

Rebuttal Comment 38. IL AG (see supra Comment 3)

Rebuttal Comment 39. Bundy (see supra Comment 18)

Rebuttal Comment 40. John W. Fitzgerald, Gray, Plant, Mooty, Mooty & Bennett (“GPM”)

Advance Notice of Proposed Rulemaking

Commenters

ANPR Comment 1. Kevin Brendan Murphy, Mr. Franchise (“Murphy”) 

ANPR Comment 2. Murphy (see supra, Comment 1).

ANPR Comment 3. Mike Bruce, The Michael Bruce Fund (“Bruce”)

ANPR Comment 4. Harold Brown, Brown & Stadfeld (“Brown”)

ANPR Comment 5. Frances L. Diaz (“Diaz”)

ANPR Comment 6. Brown (see supra, Comment 4).

ANPR Comment 7. Diaz (see supra, Comment 5).

ANPR Comment 8. Marian Kunihisa (“Kunihisa”)

ANPR Comment 9. Kevin Bores, Domino’s Pizza Franchisee (“Bores”)

ANPR Comment 10. Terrence L. Packer, Supercuts Franchisee (“Packer”)

ANPR Comment 11. John Delasandro (“Delasandro”)

ANPR Comment 12. William Cory (“Cory”)

ANPR Comment 13. Joseph Manuszak, Domino’s Franchisee (“Manuszak”)

ANPR Comment 14. Daryl Donafin, Taco Bell Franchisee (“Donafin”)

ANPR Comment 15. David Muncie, National Claims Service, Inc. (“Muncie”)

ANPR Comment 16. Patrick E. Meyers, The Quizno’s Corp. (“Quizno’s”)

ANPR Comment 17. David Weaver, Domino’s Pizza Franchisee (“Weaver”)

ANPR Comment 18. Karen M. Paquet, Domino’s Pizza Franchisee (“Paquet”)

ANPR Comment 19. Gary R. Duvall Graham & Dunn (“Duvall”)

ANPR Comment 20. Andrew J. Sherman, Greenberg & Tauris (“Sherman”),

ANPR Comment 21. S. Beavis Stubbings (“Stubbings”)

ANPR Comment 22. Jim & Evalena Gray, Pearle Vision Franchisee (“J&E Gray”)

ANPR Comment 23. Ernest Higginbotham (“Higginbotham”)

ANPR Comment 24. Henry C. Su & Bryon Fox (“Su”)

ANPR Comment 25. John R. F. Baer, Keck, Mahin & Cate (“Baer”),

ANPR Comment 26. Clay Small & Lowell Dixon, Nat’l Franchise Mediation Program Steering 

Committee (“NFMP”)

ANPR Comment 27. Richard T. Catalano (“Catalano”)

ANPR Comment 28. Neil Simon & Erik Wulff, Hogan & Hartson (“H&H”)

ANPR Comment 29. Glenn A. Mueller, Domino’s Pizza Franchisee (“Mueller”)

ANPR Comment 30. Doug Bell et al. Supercuts Franchisees (“Supercut Franchisees”)
3

ANPR Comment 31. Michael L. Bennett, Longaberger Co. (“Longaberger”)

ANPR Comment 32. John Rachide, Domino’s Pizza Franchisee (“Rachide”)

ANPR Comment 33. David J. Kaufmann, Kaufmann, Feiner, Yamin, Gildin & 

Robbins (“Kaufmann”)

ANPR Comment 34. Joseph N. Mariano, Direct Selling Association (“DSA”)

ANPR Comment 35. Linda F. Golodner & Susan Grant, National Consumers League (“NCL”)

ANPR Comment 36. Jere W. Glover & Jennifer A. Smith, U.S. Small Business Administration 

 Office of Chief Counsel for Advocacy (“SBA Advocacy”)

ANPR Comment 37. Robert Chabot, Domino’s Pizza Franchisee (“Chabot”)

ANPR Comment 38. Teresa Maloney, National Coalition of 7-Eleven Franchisees (“Maloney”)

ANPR Comment 39. BLANK

ANPR Comment 40. Harold L. Kestenbaum (“Kestenbaum”)

ANPR Comment 41. Samuel L. Sibent, KFC Franchisee (“Sibent”)

ANPR Comment 42. Oren C. Crothers, KFC Franchisee (“Crothers”)

ANPR Comment 43. Matthew Jankowski, KFC Franchisee (“Jankowski”)

ANPR Comment 44. Rodney A. DeBoer, KFC Franchisee (“DeBoer”)

ANPR Comment 45. Liesje Bertoldi, KFC Franchisee (“L. Bertoldi)”

ANPR Comment 46. Steve Bertoldi, KFC Franchisee (“S. Bertoldi”)

ANPR Comment 47. Charles Buckner, KFC Franchisee (“Buckner”)

ANPR Comment 48. Walter J. Knezevich, KFC Franchisee (“Knezevich”)

ANPR Comment 49. Jeffrey W. Gray, KFC Franchisee (“J. Gray”)

ANPR Comment 50. Fred Jackson, KFC Franchisee (“Jackson”)

ANPR Comment 51. Ronald L. Rufener, KFC Franchisee (“Rufener”

ANPR Comment 52. Tim Morris, KFC Franchisee (“Morris)”

ANPR Comment 53. Scarlett Norris Adams, KFC Franchisee (“Adams”)

ANPR Comment 54. Calvin G. White, KFC Franchisee (“White”)

ANPR Comment 55. Nick Iuliano, KFC Franchisee (“N. Iuliano”)

ANPR Comment 56. Dolores Iuliano, KFC Franchisee (“D. Iuliano”)

ANPR Comment 57. Ralph A Harman, KFC Franchisee (“R. Harman”)

ANPR Comment 58. Saundra S. Harman, KFC Franchisee (“S. Harman”

ANPR Comment 59. Richard Braden, KFC Franchisee (“Barden”)

ANPR Comment 60. K.F. C. of Pollys, KFC Franchisee (“Pollys”)

ANPR Comment 61. Joan Fiore, McDonalds Franchisee (“Fiore”)

ANPR Comment 62. Susan P. Kezios, American Franchisee Association (“AFA”)

ANPR Comment 63. Kenneth R. Costello, Loeb & Loeb (“Costello”)

ANPR Comment 64. AFA (ANPR see supra, Comment 62)

ANPR Comment 65. Susan Rich, KFC Franchisee (“Rich”)

ANPR Comment 66. Fiore (see supra Comment 61)

ANPR Comment 67. Mike Johnson, Subway Franchisee (“Johnson”)

ANPR Comment 68. Laurie Gaither, GNC Franchisee (“L. Gaither”)

ANPR Comment 69. Greg Gaither, GNC Franchisee (“G. Gaither”)

ANPR Comment 70. Greg Suslovic, Subway Franchisee (“Suslovic”)

ANPR Comment 71. Richard Colenda, GNC Franchisee (“Colenda”)
4

ANPR Comment 72. Bob Gagliati, GNC Franchisee (“Gagliati”)

ANPR Comment 73. Pat Orzano, 7-Eleven Franchisee (“Orzano”)

ANPR Comment 74. Linda Gaither, GNC Franchisee (“Li Gaither”)

ANPR Comment 75. Kevin 100 (“Kevin 100")

ANPR Comment 76. Robert James, Florida Department of Agriculture & Consumer Services 

(“James”)

ANPR Comment 77. Robert A. Tingler, Office of the Attorney General, State of Illinois

(“IL AG”)

ANPR Comment 78. John M. Tifford, Rudnick, Wolfe, Epstien & Zeidman (“Tifford”)

ANPR Comment 79. Robert L. Purvin, Jr. (“Purvin”)

ANPR Comment 80. Teresa Heron, My Favorite Muffin Franchisee (“Heron”)

ANPR Comment 81. Purvin (see supra Comment 79)

ANPR Comment 82. Matthew R. Shay, International Franchise Association (“IFA”)

ANPR Comment 83. Duvall (see supra Comment 19)

ANPR Comment 84. Lance Winslow, Car Wash Guys (“Winslow”)

ANPR Comment 85. Winslow (see supra Comment 84)

ANPR Comment 86. Rick Gue, The Pampered Chef, (“Pampered Chef”)

ANPR Comment 87. John M. Tifford, Coverall North America (“Coverall”)

ANPR Comment 88. John M. Tifford, Merchandise Mart Properties (“Merchanise Mart”)

ANPR Comment 89. Dirk C. Bloemendaal, Amway Corproation (“Amway”)

ANPR Comment 90. Winslow (see supra Comment 84)

ANPR Comment 91. Winslow (see supra Comment 84)

ANPR Comment 92. Winslow (see supra Comment 84)

ANPR Comment 93. Winslow (see supra Comment 84)

ANPR Comment 94. Andrew A. Caffey (“Caffey”)

ANPR Comment 95. Entrepreneur Media, Inc. (“Entrepreneur”)

ANPR Comment 96. Brown (see supra Comment 4)

ANPR Comment 97. Raymond & Robert Buckley, Scorecard Plus Franchisees (“Buckley”)

ANPR Comment 98. Mark A. Kirsch, Rudnick, Wolfe, Epstien & Zeidman (“Kirsch”)

ANPR Comment 99. Dale E. Cantone, Maryland Division of Securities, Office of the Attorney 

 General (“Md Securities”)

ANPR Comment 100. Roger C. Haines, Scorecard Plus Franchisee (“Haines”)

ANPR Comment 101. David E. Myklebust, Scorecard Plus Franchisee (“Myklebust”)

ANPR Comment 102. Robert Larson (“Larson”)

ANPR Comment 103. Brown (see supra Comment 4)

ANPR Comment 104. Mark B. Forseth, CII Enterprises (“CII”)

ANPR Comment 105. Bertrand T. Unger, PR One (“Pr One”)

ANPR Comment 106. Dennis E. Wieczorek, Rudnick & Wolfe (“Wieczorek”)

ANPR Comment 107. Gerald A. Marks, Marks & Krantz (“Marks”)

ANPR Comment 108. Brown (see supra Comment 4)

ANPR Comment 109. Everett W. Knell (“Knell”)

ANPR Comment 110. Anne Crews, Mary Kay, Inc. (“Mary Kay”)

ANPR Comment 111. Carl Letts, Domino’s Pizza Franchisee (“Letts”)
5

ANPR Comment 112. Kat Tidd (“Tidd”)

ANPR Comment 113. Ted Poggi, National Coalition of Associations of 7-Eleven Franchisees

 (“NCA 7-Eleven Franchisees)

ANPR Comment 114. Gary R. Duvall & Nadine C. Mandel (“Duvall & Mandel”)

ANPR Comment 115. Sherry Christopher, Christopher Consulting, Inc. (“Christopher”)

ANPR Comment 116. Carl C. Jeffers, Intel Marketing Systems, Inc. (“Jeffers”)

ANPR Comment 117. Deborah Bortner, State of Washington, Department of Financial 

 Institutions, Securities Divisions (“WA Securities”)

ANPR Comment 118. Carmen D. Caruso, Noonan & Caruso (“Caruso”)

ANPR Comment 119. Howard Bundy, Bundy & Morrill, Inc.(“Bundy”)

ANPR Comment 120. Franchise & Business Opportunity Committee, North American 

 Securities Administrations Association (“NASAA”)

ANPR Comment 121. Tifford (see supra Comment 78)

ANPR Comment 122. Wieczorek (see supra Comment 106)

ANPR Comment 123. John & Debbie Lopez, Baskin & Robbins Franchisee (“Lopez”)

ANPR Comment 124. Susan R. Essex & Ted Storey, California Bar, Business Law 

 Section (“CA BLS”) 

ANPR Comment 125. Peter C. Lagarias, The Legal Solutions Group (“Lagarias”)

ANPR Comment 126. James G. Merret, Jr. (“Merret”)

ANPR Comment 127. W. Michael Garner, Dady & Garner (“Garner”)

ANPR Comment 128. Jeff Brickner (“Brickner”

ANPR Comment 129. Bernard A. Brynda, Baskin & Robbins Franchisee (“Brynda”)

ANPR Comment 130. Caron B. Slimak, Jacadi USA Franchisee (“Slimak”)

ANPR Comment 131. Dr. Ralph Geiderman, Pearl Vision Franchisee (“Geiderman”)

ANPR Comment 132. Felipe Frydmann, Minister of Economic & Trade Affairs, Embassy of the 

 Argentine Republic (“Argentine Embassy”)

ANPR Comment 133. Andrew C. Selden, Briggs & Morgan (“Selden”)

ANPR Comment 134. Robert Zarco, Zarco & Pardo (“Zarco & Pardo”)

ANPR Comment 135. Jason H. Griffing, Baskin & Robbins Franchisee (“Griffing”)

ANPR Comment 136. Erik H. Karp, Witmer, Karp, Warner & Thuotte (“Karp”)

ANPR Comment 137. William D. Brandt, Ferder, Brandt, Casebeer, Copper, Hoyt & 

 French (“Brandt”)

ANPR Comment 138. Robert S. Keating, Baskin & Robbins Franchisee (“Keating”)

ANPR Comment 139. A. Patel, Baskin & Robbins Franchisee (“A. Patel”)

ANPR Comment 140. Joel R. Buckberg, Cendant Corporation (“Cendant”)

ANPR Comment 141. Duvall (see supra Comment 19)

ANPR Comment 142. NCL (see supra Comment 35)

ANPR Comment 143. AFA (see supra Comment 62)

ANPR Comment 144. Catalano (see supra Comment 27)

ANPR Comment 145. DSA (see supra Comment 34)

ANPR Comment 146. Keating (see supra Comment 139)

ANPR Comment 147. Kathie & David Leap, Baskin & Robbins Franchisee (“Leap”)

ANPR Comment 148. Ted D. Kuhn, Baskin & Robbins Franchisee (“Kuhn”)
6

ANPR Comment 149. Mike S. Lee, Baskin & Robbins Franchisee (“Lee”)

ANPR Comment 150. R. Deilal, Baskin & Robbins Franchisee (“Deilal”)

ANPR Comment 151. Frank J. Demotto, Baskin & Robbins Franchisee (“Demotto”)

ANPR Comment 152. Thomas Hung, Baskin & Robbins Franchisee (“Hung”)

ANPR Comment 153. Jean Jones, Baskin & Robbins Franchisee (“Jones”)

ANPR Comment 154. Hang, Baskin & Robbins Franchisee (“Hang”)

ANPR Comment 155. Dilip Patel, Baskin & Robbins Franchisee (“D. Patel”)

ANPR Comment 156. Terry L. Glase, Baskin & Robbins Franchisee (“Glase”)

ANPR Comment 157. R.E. Williamson, Baskin & Robbins Franchisee (“Williamson”)

ANPR Comment 158. R. M Valum, Baskin & Robbins Franchisee (“Valum”)

ANPR Comment 159. Rajendra Patel, Baskin & Robbins Franchisee (“R. Patel”)

ANPR Comment 160. Jerry & Debbie Robinett, Baskin & Robbins Franchisee (“Robinett)

ANPR Comment 161. Ronald J. Rudolf, Baskin & Robbins Franchisee (“Rudolf”)

ANPR Comment 162. Kamlesh Patel, Baskin & Robbins Franchisee (“K. Patel”)

ANPR Comment 163. Nicholas & Marilyn Apostal, Baskin & Robbins Franchisee (“Apostal”)

ANPR Comment 164. Patrick Sitin, Baskin & Robbins Franchisee (“Sitin”)

ANPR Comment 165. Paul & Lisa SeLander, Baskin & Robbins Franchisee (“SeLander”)

ANPR Comment 166. S. Bhilnym, Baskin & Robbins Franchisee (“Bhilnym”)

ANPR Comment 167. Mike & Kathy Denino, Baskin & Robbins Franchisee (“Denino”)

Workshop Participants

Michael Bennett, Longaberger Company (“Bennett”)

Kennedy Brooks (“Brooks”)

John Brown, Amway Corporation (“J. Brown”)

Howard Bundy, Bundy & Morrill (“Bundy”)

Delia Burke, Jenkins & Gilchrist (“Burke”)

Andrew Caffey, Esq. (“Caffey”)

Dale Catone, Office of the Maryland Attorney General (“Cantone”)

Emilio Casillas, Washington State Securities Division (“Casillas”)

Richard Catalano, Esq. (“Catalano”)

Sherry Christopher, Esq. (“Christopher”)

Michael W. Chiodo, Domino’s Franchisee (“Chiodo”)

Martin Cordell, Washington State Securities Division (“Cordell”)

Joseph Cristiano, Carvel Franchisee (“Cristiano”)

John D’Alessandro, Quaker State Lube Distributor (“D’Alessandro”)

Mark Deutsch, former franchisee (“Deutsch”)

Steve Doe, Franchisee (“Doe”)

Gary Duvall, Graham & Dunn (“Duvall”)

Eric Ellman, Direct Selling Association (“Ellman”)

Debbie Fetzer, Snap-On Franchisee (“Fetzer”)

David Finigan, Illinois Securities Department (“Finigan”)

Mark B. Forseth, Jenkens & Gilchrist (“Forseth”)
7

Richard W. Galloway, Domino’s Pizza Franchisee (“Galloway”)

Elizabeth Garceau, Pro Design (“E. Garceau”)

Michael Garceau, Pro Design (“M. Garceau”)

Roger Gerdes, Microsoft Corp. (“Gerdes”)

Rick Geu, The Pampered Chef (“Geu”)

Judy Gitterman, Jenkens & Gilchrist (“Gitterman”)

Susan Grant, National Consumers League (“Grant”)

Bruce Hoar, Hanes Franchisee (“B. Hoar”)

Thomas Hoar, Hanes Franchisee (“T. Hoar”)

Nelson Hockert-Lotz, Domino’s Pizza Franchisee (“Hockert-Lotz”)

Tee Houston-Aldridge, World Inspection Network (“Houston-Aldridge”)

Robert James, Florida Dept. of Agriculture & Consumer Services (“James”)

Carl Jeffers, Intel Marketing Systems (“Jeffers”)

Erik Karp, Witmer, Karp, Warner & Thuotte (“Karp”)

David Kaufmann, Kaufmann, Feiner, Yamin, Gildin & Robbins (“Kaufmann”)

Harold Kestenbaum, Hollenbrug, Bleven, Solomon, Ross (“Kestenbaum”)

Susan Kezios, American Franchisee Association (“Kezios”)

Mark Kirsch, Rudnick Wolfe, Epstien & Zeidman (“Kirsch”)

Charles Lay, Brite Site Franchisee (“Lay”)

Mike Ludlum, Entreprenuer Media (“Ludlum”)

Marge Lundquist, Franchisee (“Lundquist”)

Gerald Marks, Marks & Krantz (“Marks”)

Philip McKee, National Consumers League (“McKee”)

Dianne Mousley, Mike Schmidt’s Phil. Hoagies Franchisee (“Mousley”) 

Joseph Punturo, Office of the New York Attorney General (“Punturo”)

Mehran Rafizadeh, GNC Franchisee (“Rafizadeh”)

David R. Raymond, Esq. (“Raymond”)

Iris Sandow, Blimpie Franchisee (“Sandow”) 

Philip Sanson, Illinois Securities Department (“Sanson”)

Matthew Shay, International Franchise Association (“IFA”)

David Silverman, Sportworld Int’l (“Silverman”)

Neil Simon, Hogan & Hartson (“Simon”)

Caron Slimak (“Slimak”), Jacadi USA Franchisee

J. H. Snow, Jenkens & Gilcrist (“Snow”)

Adam Sokol, Illinois Attorney General’s Office (“Sokol”)

Kat Tidd, Esq. (“Tidd”)

John Tifford, Rudnick Wolfe, Epstien & Zeidman, (“Tifford”)

Robert Tingler, Franchise Bureau Chief. Illinois Attorney General’s Office (“Tingler”)

Bertrand Unger, PR One (“Unger”)

Dr. Spencer Vidulich, Pearle Vision Franchisee (“Vidulich”)

Dick Way, PR One (“Way”)

Dennis Wieczorek, Rudnick & Wolfe (“Wieczorek”)
8

Erik Wulff, Hogan & Hartson (“Wulff”)

Barry Zaslav, Coverall North America (“Zaslav”)

Rule Review (“RR”)

RR Comment 1. Robert E. Mulloy, Jr. (“Mulloy”)

RR Comment 2. Stanley M. Dub, Dworken & Bernstein (“Dub”)

RR Comment 3. Marvin J. Migdol, Nationwide Franchise Marketing Services (“Migdol”

RR Comment 4. SCPromotions, Inc. (“SCPromotions”)

RR Comment 5. R. Dana Pennell (“Pennell”)

RR Comment 6. Robin Day Glenn (“Glenn”)

RR Comment 7. Jack McBirney, McGrow Consulting (“McBirney”)

RR Comment 8. SRA International (“SRA International”)

RR Comment 9. Harld Brown, Brown & Stadfeld (“Brown”)

RR Comment 10. Ronald N. Rosenwasser (“Rosenwasser”)

RR Comment 11. Louis F. Sokol (“Sokol”)

RR Comment 12. J. Howard Beales III, Professor, George Washington University (“Beales”)

RR Comment 13. Peter Lagarias (“Lagarias”)

RR Comment 14. Harold L. Kestenbaum (“Kestenbaum”)

RR Comment 15. Walter D. Wilson, Better Business Bureau of Central Georgia, Inc. (“Wilson”)

RR Comment 16. Connie B. D’Imperio, Color Your Carpet, Inc. (“D’Imperio”)

RR Comment 17. Q.M. Marketing, Inc (“Q.M. Marketing”)

RR Comment 18. David Gurnick, Kindel & Anderson (“Gurnick”)

RR Comment 19. U-Save Auto Rental (“U-Save Auto Rental”)

RR Comment 20. The Longaberger Co. (“Longaberger”)

RR Comment 21. Direct Selling Association (“DSA”)

RR Comment 22. American Bar Association, Section on Antitrust Law (“ABA AT”)

RR Comment 23. Dennis E. Wieczorek, Rudnick & Wolfe (“Wieczorek”)

RR Comment 24. Real Estate National Nework (“RENN”)

RR Comment 25. Attorney General Jim Ryan (“General Ryan”), State of Illinois

RR Comment 26. Alan S. Nopar (“Nopar”)

RR Comment 27. Snap-On, Inc. (“Snap-On”)

RR Comment 28. Steven Rabenberg, Explore St. Louis (“Rabenberg”)

RR Comment 29. Douglas M. Brooks, Martland & Brooks (“Brooks”)

RR Comment 30. Rober N. McDonald (“Commissioner McDonald”), Securities Commissioner, 

 State of Maryland

RR Comment 31. Little Ceasars (“Little Ceasars”)

RR Comment 32. International Franchise Association (“IFA”)

RR Comment 33. Brownstein, Zeidman & Lore (“Brownstein Zeidman”)

RR Comment 34. Jere W. Glover (“Glover”), Counsel for Advocacy, U.S. Small Business 

 Administration (“SBA Advocacy”)

RR Comment 35. Jan Meyers, Chair, House Committee on Small Business

 (“Representative Myers”)
9

RR Comment 36. Neil A. Simon, Hogan and Hartson (“Simon”)

RR Comment 37. Deborah Bortner (“Bortner”), Washington State Department of Financial 

 Institutions, Securities Division

RR Comment 38. American Franchisee Association (“AFA”)

RR Comment 39. American Association of Franchisees & Dealers (“AAFD”)

RR Comment 40. Warrren Lewis, Lewis & Trattner (“Lewis”)

RR Comment 41. Century 21 Real Estate Corp. (“Century 21")

RR Comment 42. John Hayden (“Hayden”)

RR Comment 43. North American Securities Administrators Association (“NASAA”)

RR Comment 44. Robert L. Perrry (“Perry”)

RR Comment 45. The State Bar of California, Business Law Section (“CA BLS”)

RR Comment 46. Mike Gaston, Barkely & Evergreen (“Gaston”)

RR Comment 47. The Southland Corp. (“Southland”)

RR Comment 48. Medicap Pharmacies, Inc. (“Medicap”)

RR Comment 49. Rochelle B. Spandorf (“Spandorf”), ABA Forum on Franchising, Andrew C. 

 Selden (“Selden”), David J. Kaufman (“Kaufmann”)

RR Comment 50. Joyce G. Mazero, Locke Pernell Rain Harrell (“Mazero”)

RR Comment 51. Mark B. Forseth, Locke Pernell Rain Harrell (“Forseth”)

RR Comment 52. Forte Hotels (“Forte Hotels”)

RR Comment 53. R.A. Politte (“Politte”)

RR Comment 54. Politte (see supra, Comment 53).

RR Comment 55. Brown (see supra, Comment 9).

RR Comment 56. Wieczorek (see supra, Comment 23).

RR Comment 57. Scott Shane, Georgia Institute of Technology (“Shane”)

RR Comment 58. Friday’s (“Friday’s”)

RR Comment 59. Carl E. Zwisler, Keck, Mahin & Cate (“Zwisler”)

RR Comment 60. Wieczorek (see supra, Comment 23)

RR Comment 61. Enrique A. Gonzalez, Gonzalez Cavillo Y Forastierei (“Gonzalez”)

RR Comment 62. Pepsico Restaurants (“Pepsico”)

RR Comment 63. IFA (see supra, Comment 32)

RR Comment 64. Atlantic Richfield Co (“ARCO”)

RR Comment 65. David Clanton (“Clanton”)

RR Comment 66. Leonard Swartz, Arthur Andersen & Co. (“Swartz”)

RR Comment 67. John R.F. Baer, Keck, Mahin & Cate (“Baer”)

RR Comment 68. Lynn Scott (“Scott”) 

RR Comment 69. Eversheds (“Eversheds”)

RR Comment 70. Brownstein Zeidman (see supra, Comment 33)

RR Comment 71. Penny Ward, Baker & McKenzie (“Ward”)

RR Comment 72. Matthias Stein (“Stein”)

RR Comment 73. Byron Fox, Hunton & Williams (“Fox”)

RR Comment 74. Papa Johns Pizza (“Papa Johns”)

RR Comment 75. Harold L. Kestenbaum (See supra, Comment 14)
10

Rule Review September 1995 Public Workshop Conference

Panelists

Harold Brown, Brown & Stadfeld (“Brown”)

Sam Damico, Q.M. Marketing, Inc. (“Damico”)

Connie B. D’Imperio, Color Your Carpet, Inc. (“D’Imperio)

Eric Ellman (“Ellman”), Direct Selling Assocation (“DSA”)

Mark B. Forseth, Locke Purnell Rain Harrell (“Forseth”)

Mike Gason, Barkely & Evergreen (“Gaston”)

Susan Kezios, American Franchisee Association (“AFA”) (“Kezios”)

William Kimball, Iowa Coalition for Responsible Franchising (“Kimball”)

Warren Lewis, Lewis & Trattner (“Lewis”)

Steven Maxey (“Maxey”), North American Securities Administrators Association 

(“NASAA”)

Joyce G. Mazero, Locke Purnell Rain Harrell (“Mazero”)

Barry Pineles (“Pineles”), U.S. Small Business Administration (“SBA Advocacy”)

Robert Purvin, American Association of Franchisees & Dealers (“AAFD”) (“Purvin”)

Steven Rabenberg, Explore St. Louis (“Rabenberg”)

Matthew R. Shay (“Shay”), International Franchise Association (“IFA”)

Neil A. Simon, Hogan & Hartson (“Simon”)

Robin Spencer (“Spencer”), representing American Franchisee Association

Leonard Swartz, Arthur Anderson & Co. (“Swartz”)

John Tifford, Brownstein Zeidman & Lore 

Ronnie Volkening (“Volkening”), The Southland Corp. (“Southland”)

Dennis E. Wieczorek, Rudnick & Wolfe (“Wieczorek”)

William J. Wimmer (, Iowa Coalition for Responsible Franchising “Wimmer”)

Public Participants

Peter Denzen (“Denzen”)

Bob Hessler, Wendy’s (“Hessler”)

Chris Huke, SC Promotions (“Huke”)

Michael Jorgensen (“Jorgensen”)

Robert L. Perry (“Perry”)

Brian Schnell, Gray, Plant Mooty (“Schnell”)

March 1996 Public Workshop Conference

Panelists

Kay M. Ainsley, Ziebart Intl, Corp. (“Ainsley”)

John R.F. Baer, Keck, Mahin & Cate (“Baer”)
11

Michael Brennan, Rudnick & Wolfe (“Brennan”)

Joel R. Buckberg, HFA, Inc. (“Buckberg”)

David A. Clanton, Baker & McKenzie (“Clanton”)

Kenneth R. Costello, Loeb & Loeb (“Costello”)

Edward J. Fay, Kwik Kopy Corp. (“Fay”)

Mark B. Forseth, Locke Purnell Rain Harrell (“Forseth”)

Byron E. Fox, Hunton & Willaims (“Fox”)

Bruce Harsh, International Trade Specialist, U.S. Department of Commerce (“Harsh”)

Arnold Janofsky, Precision Tune (“Janofsky”)

Susan P. Kezios (“Kezios”), American Franchisee Association (“AFA”)

Alex S. Konigsberg, QC (, Lapoint Rosenstein “Konigsberg”)

Andrew P. Loewinger, Abraham Pressman & Bauer (“Loewinger”)

H. Bret Lowell, Brownstein Zeidman (“Lowell”)

John Melle, Office of U.S. Trade Representative (“Melle”)

Raymond L. Miolla, Burger King Corp. (“Miolla”)

Alex Papadakis, Hurt Sinisi Papadakis (“Papadakis”)

Matthew R. Shay (“Shay”), International Franchise Association (“IFA”)

Neil A. Simon, Hogan & Hartson (“Simon”)

Leonard Swartz, Arthur Anderson & Co. (“Swartz”)

Greg L. Walther, Outback Steakhouse Intl (“Walther”)

Dennis E. Wieczorek, Rudnick & Wolfe (“Wieczorek”)

Erik B. Wulff, Hogan & Hartson (“Wulff”)

Philip F. Zeidman (“Zeidman”)

Carl Zwisler, Keck, Mahin & Cate (“Zwisler”)

Public Participants

Jeff Brams, Sign-A-Rama and Shipping Connections (“Brams”)

Pamela Mills, Baker & McKenzie (“Mills”)
1

ATTACHMENT B

PROPOSED FINAL REVISED RULE

PART 436 – DISCLOSURE REQUIREMENTS AND PROHIBITIONS CONCERNING

FRANCHISING

Subpart A – Definitions

Sec.

436.1 Definitions.

Subpart B – Obligations of Franchisors and Other Franchise Sellers

436.2 Obligation to furnish documents.

Subpart C – Contents of a Disclosure Document

436.3 Cover page.

436.4 Table of contents.

436.5 Disclosure items.

Subpart D – Instructions 

436.6 Instructions for preparing disclosure documents.

436.7 Instructions for updating disclosures.

Subpart E – Exemptions

436.8 Exemptions

Subpart F – Prohibitions

436.9 Additional prohibitions.
2

Subpart G – Other Provisions

436.10 Other laws, rules, orders.

436.11 Severability.

Appendix A to § 436.5(j): Sample Item 10 Table – Summary of Financing Offered

Appendix B to § 436.5(t): Sample Item 20(1) Table – System-Wide Outlet Summary

Appendix C to § 436.5(t): Sample Item 20(2) Table – Transfers of Franchised Outlets

Appendix D to § 436.5(t): Sample Item 20(3) Table – Status of Franchise Outlets

Appendix E to § 436.5(t): Sample Item 20(4) Table – Status of Company-owned Outlets

Appendix F to § 436.5(t): Sample Item 20(5) Table – Franchised Outlet Turnover Rates

Appendix G to § 436.5(t): Sample Item 20(6) Table – Projected New Franchised Outlets

Authority: 15 U.S.C. 41-58.
3

Subpart A – Definitions

§ 436.1 Definitions.

Unless stated otherwise, the following definitions apply throughout this Rule:

(a) Action includes complaints, cross claims, counterclaims, and third-party

complaints in a judicial action or proceeding, and their equivalents in an administrative action or

arbitration. 

(b) Affiliate means an entity controlled by, controlling, or under common control

with, the franchisor or a franchisee.

(c) Confidentiality clause means any contract, order, or settlement provision that

directly or indirectly restricts a current or former franchisee from discussing his or her personal

experience as a franchisee in the franchisor’s system with any prospective franchisee. It does not

include confidentiality clauses that protect franchisor’s trademarks or other proprietary

information. 

(d) Disclose, state, describe, and list mean to present all material facts accurately,

clearly, concisely, and legibly in plain English.

(e) Financial performance representation means any oral, written, or visual

representation to a prospective franchisee, including a representation in the general media that

states, expressly or by implication, a specific level or range of actual or potential sales, income,

gross profits, or net profits. A chart, table, or mathematical calculation that shows possible

results based on a combination of variables is a financial performance representation. 

(f) Fiscal year refers to the franchisor’s fiscal year.
4

(g) Fractional franchise means a franchise relationship that satisfies the following

criteria when the relationship is created:

(1) The franchisee or any of the franchisee’s current directors or officers has more

than two years of experience in the same type of business; and 

(2) The parties have a reasonable basis to anticipate that the sales arising from the

relationship will not exceed 20 percent of the franchisee’s total dollar volume in sales during the

first year of operation.

(h) Franchise means any continuing commercial relationship or arrangement,

whatever it may be called, in which the terms of the offer or contract specify, or the franchise

seller represents, orally or in writing, that:

(1) The franchisee obtains the right to operate a business that is identified or

associated with the franchisor’s trademark, or to offer, sell, or distribute goods, services, or

commodities that are identified or associated with the franchisor’s trademark;

(2) The franchisor exerts or has authority to exert a significant degree of control over

the franchisee’s method of operation, or provides significant assistance in the franchisee’s

method of operation; and

(3) As a condition of obtaining or commencing operation of the franchise, the

franchisee makes a required payment or commits to make a required payment to the franchisor or

its affiliate.

(i) Franchise seller means a person that offers for sale, sells, or arranges for the sale

of a franchise. It includes the franchisor and the franchisor’s employees, representatives, agents,

subfranchisors, and third-party brokers who are involved in franchise sales activities. It does not
5

include existing franchisees who sell only their own outlet and who are otherwise not engaged in

franchise sales on behalf of the franchisor.

(j) Franchisee means any person who is granted a franchise.

(k) Franchisor means any person who grants a franchise and participates in the

franchise relationship. Unless otherwise stated, it includes subfranchisors.

(l) Lease department means an arrangement whereby a retailer licenses or otherwise

permits a seller to conduct business from the retailer’s location where the seller purchases no

goods, services, or commodities directly or indirectly from: (1) the retailer; (2) a person the

retailer requires the seller to do business with; or (3) a retailer-affiliate if the retailer advises the

seller to do business with the affiliate.

(m) Parent means an entity that controls the franchisor directly, or indirectly through

one or more subsidiaries.

(n) Person means any individual, group, association, limited or general partnership,

corporation, or any other entity.

(o) Plain English means the organization of information and language usage

understandable by a person unfamiliar with the franchise business. It incorporates the following

six principles of clear writing: short sentences; definite, concrete, everyday language; active

voice; tabular presentation of information; no legal jargon or highly technical business terms; and

no multiple negatives.

(p) Predecessor means a person from whom the franchisor acquired, directly or

indirectly, the major portion of the franchisor’s assets.

(q) Principal business address means the street address of the franchisor’s home
6

office in the United States. A principal business address cannot be a post office box or private

mail drop.

(r) Prospective franchisee means any person (including any agent, representative, or

employee) who approaches or is approached by a franchise seller to discuss the possible

establishment of a franchise relationship.

(s) Required payment means all consideration that the franchisee must pay to the

franchisor or an affiliate, either by contract or by practical necessity, as a condition of obtaining

or commencing operation of the franchise. A required payment does not include payments for

the purchase of reasonable amounts of inventory at bona fide wholesale prices for resale or lease.

(t) Sale of a franchise includes an agreement whereby a person obtains a franchise

from a franchise seller for value by purchase, license, or otherwise. It does not include extending

or renewing an existing franchise agreement where there has been no interruption in the

franchisee’s operation of the business, unless the new agreement contains terms and conditions

that differ materially from the original agreement. It also does not include the transfer of a

franchise by an existing franchisee where the franchisor has had no significant involvement with

the prospective transferee. A franchisor’s approval or disapproval of a transfer alone is not

deemed to be significant involvement.

(u) Signature means a person’s affirmative step to authenticate his or her identity. It

includes a person’s handwritten signature, as well as a person’s use of security codes, passwords,

electronic signatures, and similar devices to authenticate his or her identity.

(v) Trademark includes trademarks, service marks, names, logos, and other

commercial symbols.
7

(w) Written or in writing means any document or information in printed form or in

any form capable of being preserved in tangible form and read. It includes: type-set, word

processed, or handwritten document; information on computer disk or CD-ROM; information

sent via email; or information posted on the Internet. It does not include mere oral statements.

Subpart B – Obligations of Franchisors and Other Franchise Sellers

§ 436.2 Obligation to furnish documents.

In connection with the offer or sale of a franchise to be located in the United States of

America, its territories, or possessions, unless the transaction is exempted under Subpart E of this

Rule, it is an unfair or deceptive act or practice in violation of Section 5 of the Federal Trade

Commission Act:

 (a) For any franchisor to fail to furnish a prospective franchisee with a copy of the

franchisor’s current disclosure document, as described in Subparts C and D, at least 14 days

before the prospective franchisee signs a binding agreement with, or makes any payment to, the

franchisor or an affiliate in connection with the proposed franchise sale.

(b) For any franchisor to alter unilaterally and materially the terms and conditions of

the basic franchise agreement attached to the disclosure document without furnishing the

prospective franchisee with a copy of the revised franchise agreement, and any related

agreements, at least seven days before the prospective franchisee signs the revised franchise

agreement. Changes to a franchise agreement that result solely from negotiations initiated by the

prospective franchisee do not trigger this seven-day period. 

(c) For purposes of paragraphs 436.2(a) and (b) of this section, the franchisor has

furnished the documents by the required date if: (1) a copy of the document was hand-delivered,
8

faxed, emailed, or otherwise delivered to the prospective franchisee by the required date; 

(2) directions for accessing the document on the Internet were provided to the prospective

franchisee by the required date; or (3) a paper or tangible electronic copy (for example, computer

disk or CD-ROM) was sent to the address specified by the prospective franchisee by first-class

U.S. mail at least three days before the required date.

(d) For any franchisor to fail to include the information and follow the instructions in

Subparts C and D when preparing the disclosure document to be furnished to a prospective

franchisee. Any other franchise seller will be liable for the violation of these Subparts if they

either directly participated in them or had the authority to control them. 

Subpart C – The Contents of a Disclosure Document

§ 436.3 Cover page.

Begin the disclosure document with a cover page, stating the following in the order and

form shown below:

(a) The title “FRANCHISE DISCLOSURE DOCUMENT” in capital letters and bold

type;

(b) The franchisor’s name, type of business organization, principal business address,

telephone number, and, if applicable, email address and primary home page address;

(c) A sample of the primary business trademark that the franchisee will use in its

business;

(d) A brief description of the franchised business;

(e) The following statements:

(1) The total investment necessary to begin operation of a [franchise system name]
9

franchise is [the total amount of Item 7], including [the total amount in Item 5] that must be paid

to the franchisor. 

(2) This disclosure document summarizes certain provisions of your franchise

agreement and other information in plain English. Read this disclosure document

and all agreements carefully. You must receive this disclosure document at least

14 days before you sign a binding agreement or make any payment in connection

with the franchise sale.

(3) Buying a franchise is a complex investment. The information in this disclosure

document can help you make up your mind. Information comparing franchisors is

available. Call your state agency or your public library for sources of information. 

More information on franchising, such as “A Consumer’s Guide to Buying a

Franchise,” is available from the FTC. You can contact the FTC at 1-877-FTCHELP or by writing to the FTC at 600 Pennsylvania Avenue, NW, Washington,

DC 20580. You can also visit the FTC’s home page at www.ftc.gov for

additional information. In addition, there may be laws on franchising in your 

state. Ask your state agencies about them. [The following sentence in bold type]

Note, however, that no governmental agency has verified the information

contained in this document. 

(4) You should also know that the terms of your contract will govern your franchise

relationship. Don’t rely on the disclosure document alone to understand your

contract. Read all of your contract carefully. Show your contract and this

disclosure document to an advisor, like a lawyer or an accountant.

(5) The issuance date.

(f) A franchisor may include the following statement between the statements set out

at paragraphs 436.3(e)(2) and (3) of this section: “You may wish to receive your disclosure

document in another format that is more convenient for you. To discuss the availability of

disclosures in different formats, contact [name or office] at [address] and [telephone number].”

(g) Franchisors may include additional disclosures on the cover page, on a separate

cover page, or addendum to comply with state pre-sale disclosure laws.

§ 436.4 Table of contents.

Include the following table of contents. State the page where each disclosure Item begins.
10

List all exhibits by letter, following the example shown below.

Table of Contents

1. The Franchisor and any Parent, Predecessors, and Affiliates

2. Business Experience

3. Litigation

4. Bankruptcy

5. Initial Fees Paid to the Franchisor

6. Other Fees

7. Estimated Initial Investment

8. Restrictions on Sources of Products and Services

9. Franchisee’s Obligations

10. Financing

11. Franchisor’s Assistance, Advertising, Computer Systems, and Training

12. Territory

13. Trademarks

14. Patents, Copyrights, and Proprietary Information

15. Obligation to Participate in the Actual Operation of the Franchise Business

16. Restrictions on What the Franchisee May Sell

17. Renewal, Termination, Transfer, and Dispute Resolution

18. Public Figures

19. Financial Performance Representations

20. Outlets and Franchisee Information

21. Financial Statements

22. Contracts

23. Receipts

Exhibits

A. Franchise Agreement
11

§ 436.5 Disclosure items.

(a) Item 1: The Franchisor, and any Parent, Predecessors, and Affiliates.

Disclose:

(1) The name and principal business address of the franchisor; any parent; and any

affiliate that offer franchises in any line of business or provide products or services to the

franchisees of the franchisor.

(2) The name and principal business address of any predecessors during the 10-year

period immediately before the close of the franchisor’s most recent fiscal year.

(3) The name that the franchisor uses and any names it intends to use to conduct

business.

(4) The principal business address of the franchisor’s agent for service of process.

(5) The type of business organization used by the franchisor (for example, 

corporation, partnership) and the state in which it was organized.

(6) The following information about the franchisor’s business and the franchises

offered:

(i) Whether the franchisor operates businesses of the type being franchised;

(ii) The franchisor’s other business activities;

(iii) The business the franchisee will conduct;

(iv) The general market for the product or service the franchisee will offer. In

describing the general market, consider factors such as whether the market is developed or

developing, whether the goods will be sold primarily to a certain group, and whether sales are

seasonal;
12

(v) In general terms, any laws or regulations specific to the industry in which the

franchise business operates; and

(vi) A general description of the competition, including competition from any entity in

which an officer of the franchisor owns an interest.

(7) The prior business experience of the franchisor; any predecessors; and any

affiliates that offer franchises in any line of business or provide products or services to the

franchisees of the franchisor, including:

(i) The length of time each has conducted the type of business the franchisee will

operate;

(ii) The length of time each has offered franchises providing the type of business the

franchisee will operate; and 

(iii) Whether each has offered franchises in other lines of business. If so, include:

(A) A description of each other line of business;

(B) The number of franchises sold in each other line of business; and

(C) The length of time offering franchises in each other line of business.

(b) Item 2: Business Experience.

Disclose by name and position the franchisor’s directors, trustees, general partners,

principal officers, and any other individuals who occupy a similar status or perform similar

functions. In addition, disclose any other executives and subfranchisors who will have

management responsibility relating to the sale or operation of franchises offered by this
13

document. For each person listed in this section, state his or her principal positions and

employers during the past five years, including each position’s starting date, ending date, and

location.

(c) Item 3: Litigation.

(1) Disclose whether the franchisor; a parent who guarantees the franchisor’s

performance; a predecessor; an affiliate who offers franchises under the franchisor’s principal

trademark; and any person identified in paragraph 436.5(b) of this section:

(i) Has pending against that person:

(A) An administrative, criminal, or material civil action alleging a violation of a

franchise, antitrust, or securities law, or alleging fraud, unfair or deceptive practices, or

comparable allegations; 

(B) Civil actions, other than ordinary routine litigation incidental to the business,

which are material in the context of the number of franchisees and the size, nature, or financial

condition of the franchise system or its business operations.

(ii) Was a party to any material civil action involving the franchise relationship in the

last fiscal year. For purposes of this section, “franchise relationship” means contractual

obligations between the franchisor and franchisee directly relating to the operation of the

franchised business (such as royalty payment and training obligations). It does not include

actions involving third parties, such as suppliers or indemnification for tort liability.

(iii) Has in the 10-year period immediately before the disclosure document’s issuance

date:

(A) Been convicted of or pleaded nolo contendere to a felony charge; 
 

1 Franchisors may include a summary opinion of counsel concerning any action if counsel

consent to use the summary opinion and the full opinion is attached to the disclosure document.

14

(B) Been held liable in a civil action, or been a defendant in a material action,

involving an alleged violation of a franchise, antitrust, or securities law, or involving allegations

of fraud, unfair or deceptive practices, or comparable allegations. “Held liable” means that, as a

result of claims or counterclaims, the franchisor must pay money or other consideration, must

reduce an indebtedness by the amount of an award, cannot enforce its rights, or must take action

adverse to its interests.

(2) Disclose whether the franchisor; a parent who guarantees the franchisor’s

performance; a predecessor; an affiliate who has offered or sold franchises in any line of business

within the last 10 years; or any other person identified in paragraph 436.5(b) of this section is

subject to a currently effective injunctive or restrictive order or decree resulting from a pending

or concluded action brought by a public agency and relating to the franchise or to a Federal,

State, or Canadian franchise, securities, antitrust, trade regulation, or trade practice law.

(3) For each action identified in this subsection, state the title, case number or

citation, the initial filing date, the names of the parties, the forum, and the relationship of the

opposing party to the franchisor (for example, competitor, supplier, lessor, franchisee, former

franchisee, or class of franchisees). Summarize the legal and factual nature of each claim in the

action, the relief sought or obtained, and any conclusions of law or fact.1 Provided, however, for

franchisor-initiated litigation, franchisors may list individual suits under one common heading,

which will serve as the summary (for example, royalty collection suits). In addition, state:
 

2

If a settlement agreement must be disclosed in this Item, all material settlement terms

must be disclosed, whether or not the agreement is confidential. However, franchisors need not

disclose the terms of confidential settlements entered into before commencing franchise sales.

Further, any franchisor who has historically used only the Franchise Rule format, or who is new

to franchising, need not disclose confidential settlements entered prior to the effective date of this

Rule.

15

(i) For pending actions, the status of the action.

(ii) For prior actions, the date when the judgment was entered and any damages or

settlement terms.2

(iii) For injunctive or restrictive orders, the nature, terms, and conditions of the order

or decree.

(iv) For convictions or pleas, the crime or violation, the date of conviction, and the

sentence or penalty imposed.

(d) Item 4: Bankruptcy.

(1) Disclose whether the franchisor, any parent, predecessor, affiliate, officer, general

partner, or any other individual who occupies a similar status or performs similar functions has,

during the 10-year period immediately before the date of this disclosure document:

(i) Filed as debtor (or had filed against it) a petition under the U.S. Bankruptcy Code

(“Bankruptcy Code”).

(ii) Obtained a discharge of its debts under the Bankruptcy Code.

(iii) Been a principal officer of a company or a general partner in a partnership that

either filed as a debtor (or had filed against it) a petition under the Bankruptcy Code, or that
16

obtained a discharge of its debts under the Bankruptcy Code while, or within one year after, the

officer or general partner held the position in the company.

(2) For each bankruptcy, state:

(i) The current name, address, and principal place of business of the debtor;

(ii) Whether the debtor is the franchisor. If not, state the relationship of the debtor to

the franchisor (for example, affiliate, officer); and

(iii) The date of the original filing and the material facts, including the bankruptcy

court, and the case name and number. If applicable, state the debtor’s discharge date, including

discharges under Chapter 7 and confirmation of any plans of reorganization under Chapters 11

and 13 of the Bankruptcy Code.

(3) Disclose cases, actions, and other proceedings under the laws of foreign nations

relating to bankruptcy.

(e) Item 5: Initial Fees Paid to Franchisor.

Disclose the initial fees and any conditions under which these fees are refundable. If the

initial fees are not uniform, disclose the range or formula used to calculate the initial fees paid in

the fiscal year before the issuance date and the factors that determined the amount. For this

section, “initial fees” means all fees and payments, or commitments to pay, for services or goods

received from the franchisor or any affiliate before the franchisee’s business opens, whether

payable in lump sum or installments. Disclose installment payment terms in this subsection or in

paragraph 436.5(j) of this section.
 

3

If fees may increase, disclose the formula that determines the increase or the maximum

amount of the increase. For example, a percentage of gross sales is acceptable if the franchisor

defines the term “gross sales.”

17

(f) Item 6: Other Fees.

Disclose, in the tabular form shown below, all other fees that the franchisee must pay to

the franchisor or its affiliates, that the franchisor or its affiliates impose or collect in whole or in

part for a third party, or that the franchisee is required to pay directly to a third party. Include any

formula used to compute the fees.3

Item 6 Table:

(1)

Type of fee

(2)

Amount

(3)

Due Date

(4)

Remarks

(1) In column (1), list the type of fee (for example, royalties, and fees for lease

negotiations, construction, remodeling, additional training or assistance, advertising, advertising

cooperatives, purchasing cooperatives, audits, accounting, inventory, transfers, and renewals).

(2) In column (2), state the amount of the fee. If the payment is made directly to a

third party, then state either the amount of the fee or, if unknown, the following sentence: “The

amount of the fee is unknown and may vary depending upon factors, such as the third-party

supplier selected.”

(3) In column (3), state the due date for each fee.

(4) In column (4), include remarks, definitions, or caveats that elaborate on the

information in the table. If remarks are long, franchisors may use footnotes instead of the
18

remarks column. If applicable, include the following information in the remarks column or in a

footnote:

(i) Whether the fees are payable only to the franchisor;

(ii) Whether the fees are imposed and collected by the franchisor;

(iii) Whether the fees are non-refundable or describe the circumstances when the fees

are refundable;

(iv) Whether the fees are uniformly imposed; and 

(v) The voting power of franchisor-owned outlets on any fees imposed by

cooperatives. If franchisor-owned outlets have controlling voting power, disclose the maximum

and minimum fees that may be imposed.

(g) Item 7: Estimated Initial Investment.

Disclose, in the tabular form shown below, the franchisee’s estimated initial investment. 

State the title “Your Estimated Initial Investment” in bold type. Franchisors may include

additional expenditure tables to show expenditure variations caused by differences such as in site

location and premises size.
19

Item 7 Table:

YOUR ESTIMATED INITIAL INVESTMENT

(1)

Type of

expenditure

(2)

Amount

(3)

Method of

payment

(4)

When due

(5)

To whom

payment is to be

made

Total.

(1) In column (1):

(i) List each type of expense, beginning with pre-opening expenses. Include the

following expenses, if applicable. Use footnotes to comment on expenditures.

(A) The initial franchise fee;

(B) Training expenses;

(C) Real property, whether purchased or leased;

(D) Equipment, fixtures, other fixed assets, construction, remodeling, leasehold

improvements, and decorating costs, whether purchased or leased;

(E) Inventory to begin operating; and

(F) Security deposits, utility deposits, business licenses, and other prepaid expenses.

(ii) List separately and by name any other specific required payments (for example, 

additional training, travel, or advertising expenses) that the franchisee must make to begin

operations.

(iii) Include a category titled “Additional funds – [initial period]” for any other

required expenses the franchisee will incur before operations begin and during the initial period

of operations. State the initial period. A reasonable initial period is at least three months or a
20

reasonable period for the industry. Describe in general terms the factors, basis, and experience

that the franchisor considered or relied upon in formulating the amount required for additional

funds.

(2) In column (2), state the amount of the payment. If the amount is unknown, use a

low-high range based on the franchisor’s current experience. If real property costs cannot be

estimated in a low-high range, describe the approximate size of the property and building and 

the probable location of the building (for example, strip shopping center, mall, downtown, rural,

or highway).

(3) In column (3), state the method of payment.

(4) In column (4), state the due date.

(5) In column (5), state to whom payment will be made.

(6) Total the initial investment, incorporating ranges of fees, if used.

(7) In a footnote, state:

(i) Whether each payment is non-refundable, or describe the circumstances when

each payment is refundable.

(ii) If the franchisor or an affiliate finances part of the initial investment, the amount

that it will finance, the required down payment, the annual interest rate, rate factors, and the

estimated loan repayments. Franchisors may refer to paragraph 436.5(j) of this section for

additional details.

(h) Item 8: Restrictions on Sources of Products and Services.

Disclose the franchisee’s obligations to purchase or lease goods, services, supplies,

fixtures, equipment, inventory, computer hardware and software, real estate, or comparable items
 

4 Franchisors may include the reason for the requirement. Franchisors need not disclose in

this Item the purchase or lease of goods or services provided as part of the franchise without a

separate charge (such as initial training, if the cost is included in the franchise fee). Describe

such fees in Item 5 of this section. Do not disclose fees already described in paragraph 436.5(f)

of this section.

21

related to establishing or operating the franchised business either from the franchisor, its

designee, or suppliers approved by the franchisor, or under the franchisor’s specifications.

Include obligations to purchase imposed by written agreement or by the franchisor’s practice.4

For each applicable obligation, state:

(1) The good or service required to be purchase or leased.

(2) Whether the franchisor or its affiliates are approved suppliers or the only

approved suppliers of that good or service. 

(3) Any supplier in which an officer of the franchisor owns an interest.

(4) How the franchisor grants and revokes approval of alternative suppliers,

including:

(i) Whether the franchisor’s criteria for approving suppliers are available to

franchisees; 

(ii) Whether the franchisor permits franchisees to contract with alternative suppliers

who meet the franchisor’s criteria;

(iii) Any fees and procedures to secure approval to purchase from alternative

suppliers;

(iv) The time period in which the franchisee will be notified of approval or

disapproval; and 

(v) How approvals are revoked.
 

5 Take figures from the franchisor’s most recent annual audited financial statement

required in paragraph 436.5(u) of this section. If audited statements are not yet required, or if the

entity deriving the income is an affiliate, disclose the sources of information used in computing

revenues.

22

(5) Whether the franchisor issues specifications and standards to franchisees,

subfranchisees, or approved suppliers. If so, describe how the franchisor issues and modifies

specifications.

(6) Whether the franchisor or its affiliates will or may derive revenue or other

material consideration from required purchases or leases by franchisees. If so, describe the

precise basis by which the franchisor or its affiliates will or may derive that consideration by

stating:5

(i) The franchisor’s total revenue;

(ii) The franchisor’s revenues from all required purchases and leases of products and

services;

(iii) The percentage of the franchisor’s total revenues that are from required purchase

or leases; and

(iv) If the franchisor’s affiliates also sell or lease products or services to franchisees,

the affiliates’ revenues from those sales or leases.

(7) The estimated proportion of these required purchases and leases by the franchisee

to all purchases and leases by the franchisee of goods and services in establishing and operating

the franchised businesses.

(8) If a designated supplier will make payments to the franchisor from franchisee

purchases, disclose the basis for the payment (for example, specify a percentage or a flat
23

amount). For purposes of this disclosure, a “payment” includes the sale of similar goods or

services to the franchisor at a lower price than to franchisees.

(9) The existence of purchasing or distribution cooperatives.

(10) Whether the franchisor negotiates purchase arrangements with suppliers,

including price terms, for the benefit of franchisees.

(11) Whether the franchisor provides material benefits (for example, renewal or

granting additional franchises) to a franchisee based on a franchisee’s purchase of particular

products or services or use of particular suppliers.

(i) Item 9: Franchisee’s Obligations.

Disclose, in the tabular form shown below, a list of the franchisee’s principal obligations. 

Cross-reference each listed obligation with any applicable section of the franchise or other

agreement and with the relevant disclosure document provision. If a particular obligation is not

applicable, state “Not Applicable.” Include additional obligations, as warranted.

Item 9 Table:

[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
 

6

Indirect offers of financing include a written arrangement between a franchisor or its

affiliate and a lender, for the lender to offer financing to a franchisee; an arrangement in which a

franchisor or its affiliate receives a benefit from a lender in exchange for financing a franchise

purchase; and a franchisor’s guarantee of a note, lease, or other obligation of the franchisee.

24

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 terms of each financing arrangement, including leases and

installment contracts, that the franchisor, its agent, or affiliates offer directly or indirectly to the

franchisee.6 The franchisor may summarize the terms of each financing arrangement in tabular
 

7

Include sample copies of the financing documents as an exhibit to paragraph 436.5(v) of

this section. Cite the section and name of the document containing the financing terms and

conditions.

25

form, using footnotes to provide additional information. For a sample Item 10 table, see

Appendix A of this Rule. For each financing arrangement, state:

(i) What the financing covers (for example, the initial franchise fee, site acquisition,

construction or remodeling, initial or replacement equipment or fixtures, opening or ongoing

inventory or supplies, or other continuing expenses).7

(ii) The identity of each lender providing financing and their relationship to the

franchisor (for example, affiliate).

(iii) The amount of financing offered or, if the amount depends on an actual cost that

may vary, the percentage of the cost that will be financed.

(iv) The annual percentage rate of interest (“APR”) charged, computed as provided by

Sections 106-107 of the Consumer Protection Credit Act, 15 U.S.C. 1605-1606. If the APR may

differ depending on when the financing is issued, state the APR on a specified recent date.

(v) The number of payments or the period of repayment.

(vi) The nature of any security interest required by the lender.

(vii) Whether a person other than the franchisee must personally guarantee the debt.

(viii) Whether the debt can be prepaid and the nature of any prepayment penalty.

(ix) The franchisee’s potential liabilities upon default, including any:

(A) Accelerated obligation to pay the entire amount due;

(B) Obligations to pay court costs and attorney’s fees incurred in collecting the debt;

(C) Termination of the franchise; and 
26

(D) Liabilities from cross defaults such as those resulting directly from non-payment,

or indirectly from the loss of business property.

(x) Other material financing terms.

(2) Disclose whether the loan agreement requires franchisees to waive defenses or

other legal rights (for example, confession of judgment), or bars franchisees from asserting a

defense against the lender, the lender’s assignee or the franchisor. If so, describe the relevant

provisions.

(3) Disclose whether the franchisor’s practice or intent is to sell, assign, or discount to

a third party all or part of the financing arrangement. If so, state:

(i) The assignment terms, including whether the franchisor will remain primarily

obligated to provide the financed goods or services; and

(ii) That the franchisee may lose all its defenses against the lender as a result of the

sale or assignment.

(4) Disclose whether the franchisor or an affiliate receives any payments for placing

financing with the lender. If such payments exist:

(i) Disclose the amount or the method of determining the payment; and

(ii) Identify the source of the payment and the relationship of the source to the

franchisor or its affiliates.

(k) Item 11: Franchisor’s Assistance, Advertising, Computer Systems, and

Training.

Disclose the franchisor’s principal assistance and related obligations as described below. 

For each obligation, cite the section number of the franchise agreement imposing the obligation. 
27

Begin by stating: “Except as listed below, [the franchisor] is not required to provide you with

any assistance.” 

(1) Disclose the franchisor’s pre-opening obligations to the franchisee, including any

assistance in:

(i) Locating a site and negotiating the purchase or lease of the site. If provided, state:

(A) Whether the franchisor generally owns the premises and leases it to the franchisee;

(B) Whether the franchisor selects the site or approves an area in which the franchisee

selects a site. If so, state further whether and how the franchisor must approve a franchiseeselected site;

(C) The factors that the franchisor considers in selecting or approving sites (for

example, general location and neighborhood, traffic patterns, parking, size, physical

characteristics of existing buildings, and lease terms); and

(D) The time limit for the franchisor to locate or approve or disapprove the site and 

the consequences if the franchisor and franchisee cannot agree on a site.

(ii) Conforming the premises to local ordinances and building codes and obtaining

any required permits.

(iii) Constructing, remodeling, or decorating the premises.

(iv) Hiring and training employees.

(v) Providing for necessary equipment, signs, fixtures, opening inventory, and

supplies. If provided, state:

(A) Whether the franchisor provides these items directly or only provides the names of

approved suppliers;
28

(B) Whether the franchisor provides written specifications for these items; and

(C) Whether the franchisor delivers or installs these items.

(2) Disclose the typical length of time between the earlier of the signing of the

franchise agreement or the first payment of consideration for the franchise and the opening of the

franchisee’s business. Describe the factors that may affect the time period, such as ability to

obtain a lease, financing or building permits, zoning and local ordinances, weather conditions,

shortages, or delayed installation of equipment, fixtures, and signs.

(3) Disclose the franchisor’s obligations to the franchisee during the operation of the

franchise, including any assistance in:

(i) Developing products or services the franchisee will offer to its customers;

(ii) Hiring and training employees;

(iii) Improving and developing the franchised business;

(iv) Establishing prices;

(v) Establishing and using administrative, bookkeeping, accounting, and inventory

control procedures; and

(vi) Resolving operating problems encountered by the franchisee.

(4) Describe the advertising program for the franchise system, including the

following:

(i) The franchisor’s obligation to conduct advertising, including:

(A) The media the franchisor may use; 

(B) Whether media coverage is local, regional, or national;
29

(C) The source of the advertising (for example, an in-house advertising department or

a national or regional advertising agency); and

(D) Whether the franchisor must spend any amount on advertising in the area or

territory where the franchisee is located.

(ii) The circumstances when the franchisor will permit franchisees to use their own

advertising material.

(iii) Whether there is an advertising council composed of franchisees that advises the

franchisor on advertising policies. If so, disclose:

(A) How members of the council are selected;

(B) Whether the council serves in an advisory capacity only or has operational or

decision-making power; and 

(C) Whether the franchisor has the power to form, change, or dissolve the advertising

council.

(iv) Whether the franchisee must participate in a local or regional advertising

cooperative. If so, state:

(A) How the area or membership of the cooperative is defined;

(B) How much the franchisee must contribute to the fund and whether other

franchisees must contribute a different amount or at a different rate;

(C) Whether the franchisor-owned outlets must contribute to the fund and, if so,

whether those contributions are on the same basis as those for franchisees;

(D) Who is responsible for administering the cooperative (for example, franchisor,

franchisees, or advertising agency);
30

(E) Whether cooperatives must operate from written governing documents and

whether the documents are available for the franchisee to review;

(F) Whether cooperatives must prepare annual or periodic financial statements and

whether the statements are available for review by the franchisee; and

(G) Whether the franchisor has the power to require cooperatives to be formed,

changed, dissolved, or merged.

(v) Whether the franchisee must participate in any other advertising fund. If so, state:

(A) Who contributes to the fund;

(B) How much the franchisee must contribute to the fund and whether other

franchisees must contribute a different amount or at a different rate;

(C) Whether the franchisor-owned outlets must contribute to the fund and, if so,

whether it is on the same basis as franchisees;

(D) Who administers the fund; 

(E) Whether the fund is audited and when it is audited;

(F) Whether financial statements of the fund are available for review by the

franchisee; and

(G) Use of the fund in the most recently concluded fiscal year, the percentages spent

on production, media placement, administrative expenses, and a description of any other use. 

(vi) If not all advertising funds are spent in the fiscal year in which they accrue, how

the franchisor uses the remaining amount, including whether franchisees receive a periodic

accounting of how advertising fees are spent.
31

(vii) The percentage of advertising funds, if any, that the franchisor uses principally to

solicit new franchise sales.

(5) Disclose whether the franchisor requires the franchisee to buy or use electronic

cash registers or computer systems. If so, describe the systems generally in non-technical

language, including the types of data to be generated or stored in these systems, and state the

following:

(i) The cost of purchasing or leasing the systems; 

(ii) Any obligation of the franchisor, any affiliate, or third party to provide ongoing

maintenance, repairs, upgrades, or updates;

(iii) Any obligations of the franchisee to upgrade or update any system during the term

of the franchise, and, if so, any contractual limitations on the frequency and cost of the

obligation;

(iv) The annual cost of any optional or required maintenance, updating, upgrading, or

support contracts; and 

(v) Whether the franchisor will have independent access to the information that will

be generated or stored in any electronic cash register or computer system. If so, describe the

information that the franchisor may access and whether there are any contractual limitations on

the franchisor’s right to access the information.

(6) Disclose the table of contents of the franchisor’s operating manual provided to

franchisees as of the franchisor’s last fiscal year-end or a more recent date. State the number of

pages devoted to each subject and the total number of pages in the manual as of this date. This
32

disclosure may be omitted if the franchisor offers the prospective franchisee the opportunity to

view the manual before buying the franchise.

(7) Disclose the franchisor’s training program as of the franchisor’s last fiscal yearend or a more recent date.

(i) Describe the training program in the tabular form shown below:

Item 11 Table

Training Program

Subject Hours of Classroom

Training

Hours of On-TheJob TrainingLocation

(A) In column (1), state the subjects taught.

(B) In column (2), state the hours of classroom training for each subject.

(C) In column (3), state the hours of on-the-job training for each subject.

(D) In column (4), state the location of the training for each subject. 

(ii) State further:

(A) How often training classes are held and the nature of the location or facility where

training is held (for example, company, home, office, franchisor-owned store);

(B) The nature of instructional materials and the instructor’s experience, including the

instructor’s length of experience in the field and with the franchisor. State only experience

relevant to the subject taught and the franchisor’s operations;

(C) Any charges franchisees must pay for training and who must pay travel and living

expenses of the training program enrollees;
33

(D) Who may and who must attend training. State whether the franchisee or other

persons must complete the program to the franchisor’s satisfaction. If successful completion is

required, state how long after signing the agreement or before opening the business the training

must be completed. If training is not mandatory, state the percentage of new franchisees that

enrolled in the training program during the preceding 12 months; and

(E) Whether additional training programs or refresher courses are required. 

(l) Item 12: Territory.

Disclose:

(1) Whether the franchise is for a specific location or a location to be approved by the

franchisor;

(2) Any minimum territory granted to the franchisee (for example, a specific radius, a

distance sufficient to encompass a specified population, or another specific designation);

(3) The conditions under which the franchisor will approve the relocation of the

franchised business or the franchisee’s establishment of additional franchised outlets;

(4) Franchisee options, rights of first refusal, or similar rights to acquire additional

franchises; and

(5) Whether the franchisor grants an exclusive territory. 

(i) If the franchisor does not grant an exclusive territory, state: “You will not receive

an exclusive territory. You may face competition from other franchisees or

franchisor-owned outlets, or from other channels of distribution or competitive

brands that we control.”

(ii) If the franchisor grants an exclusive territory, disclose:
34

(A) Whether continuation of territorial exclusivity depends on achieving a certain

sales volume, market penetration, or other contingency, and the circumstances when the

franchisee’s territory may be altered. Describe any sales or other conditions. State the

franchisor’s rights if the franchisee fails to meet the requirements; and 

(B) Any other circumstances that permit the franchisor to modify the franchisee’s

territorial rights (for example, a population increase in the territory giving the franchisor the right

to grant an additional franchise in the area), and the effect of such modifications on the

franchisee’s rights.

(6) For all territories (exclusive and non-exclusive):

(i) Any restrictions on the franchisor from soliciting or accepting orders from

consumers inside the franchisee’s territory, including:

(A) Whether the franchisor or an affiliate has used or reserves the right to use other

channels of distribution, such as through the Internet, catalog sales, telemarketing, or other direct

marketing sales, to make sales within the franchisee’s territory using the franchisor’s principal

trademarks;

(B) Whether the franchisor or an affiliate has used or reserves the right to use other

channels of distribution, such as through the Internet, catalog sales, telemarketing, or other direct

marketing, to make sales within the franchisee’s territory of products or services under 

trademarks different from the ones the franchisee will use under the franchise agreement; and

(C) Any compensation that the franchisor must pay for soliciting or accepting orders

from inside the franchisee’s territory.
35

(ii) Any restrictions on the franchisee from soliciting or accepting orders from

consumers outside of his or her territory, including whether the franchisee has the right to use

other channels of distribution, such as through the Internet, catalog sales, telemarketing, or other

direct marketing, to make sales outside of his or her territory.

(iii) If the franchisor or an affiliate operates, franchises, or has plans to operate or

franchise a business under a different trademark and that business sells or will sell goods or

services similar to those the franchisee will offer, describe:

(A) The similar goods and services;

(B) The different trademark;

(C) Whether outlets will be franchisor owned or operated;

(D) Whether the franchisor or its franchisees who use the different trademark will

solicit or accept orders within the franchisee’s territory;

(E) The timetable for the plan;

(F) How the franchisor will resolve conflicts between the franchisor and franchisees

and between the franchisees of each system regarding territory, customers, and franchisor

support; and 

(G) The principal business address of the franchisor’s similar operating business. If it

is the same as the franchisor’s principal business address stated in paragraph 436.5(a) of this

section, disclose whether the franchisor maintains (or plans to maintain) physically separate

offices and training facilities for the similar competing business.
36

(m) Item 13: Trademarks.

(1) Disclose each principal trademark to be licensed to the franchisee. For this Item,

“principal trademark” means the primary trademarks, service marks, names, logos, and

commercial symbols the franchisee will use to identify the franchised business. It may not

include every trademark the franchisor owns.

(2) Disclose whether each principal trademark is registered with the United States

Patent and Trademark Office. If so, state: 

(i) The date and identification number of each trademark registration; 

(ii) Whether the franchisor has filed all required affidavits;

(iii) Whether any registration has been renewed; and

(iv) Whether the principal trademarks are registered on the Principal or Supplemental

Register of the U.S. Patent and Trademark Office.

(3) If the principal trademark is not registered with the United States Patent and

Trademark Office, state whether the franchisor has filed any trademark application, including any 

“intent to use” application or an application based on actual use. If so, state the date and

identification number of the application.

(4) If the trademark is not registered on the Principal Register of the U.S. Patent and

Trademark Office, state: “Our trademark is unregistered. Therefore, our right to use the

trademark may be challenged. If so, franchisees may have to change to an alternative trademark,

which may increase your operating costs.”

(5) Disclose any currently effective material determinations of the U.S. Patent and

Trademark Office, the Trademark Trial and Appeal Board, or any state trademark administrator 
 

8 The franchisor may include an attorney’s opinion relative to the merits of litigation or of

an action if the attorney issuing the opinion consents to its use. The text of the disclosure may

include a summary of the opinion if the full opinion is attached and the attorney issuing the

opinion consents to the use of the summary.

37

or court; and any pending infringement, opposition, or cancellation proceeding. Include

infringement, opposition, or cancellation proceedings in which the franchisor unsuccessfully

sought to prevent registration of a trademark in order to protect a trademark licensed by the

franchisor. Describe how the determination affects the ownership, use, or licensing of the

trademark.

(6) Disclose any pending material federal or state court litigation regarding the

franchisor’s use or ownership rights in a trademark. For each pending action, disclose:8

(i) The forum and case number;

(ii) The nature of claims made opposing the franchisor’s use of the trademark or by

the franchisor opposing another person’s use of the trademark; and

(iii) Any effective court or administrative agency ruling in the matter.

(7) Disclose any currently effective agreements that significantly limit the

franchisor’s rights to use or license the use of trademarks listed in this Rule in a manner material

to the franchise. For each agreement, disclose:

(i) The manner and extent of the limitation or grant;

(ii) The extent to which the agreement may affect the franchisee;

(iii) The agreement’s duration;

(iv) The parties to the agreement;

(v) The circumstances when the agreement may be canceled or modified; and
38

(vi) All other material terms.

(8) Disclose:

(i) Whether the franchisor must protect the franchisee’s right to use the principal

trademarks listed in this Item, and must protect the franchisee against claims of infringement or

unfair competition arising out of the franchisee’s use of the trademarks;

(ii) The franchisee’s obligation to notify the franchisor of the use of, or claims of

rights to, a trademark identical to or confusingly similar to a trademark licensed to the franchisee;

(iii) Whether the franchise agreement requires the franchisor to take affirmative action

when notified of these uses or claims. Identify who has the right to control administrative

proceedings or litigation;

(iv) Whether the franchise agreement requires the franchisor to participate in the

franchisee’s defense and/or indemnify the franchisee for expenses or damages if the franchisee is

a party to an administrative or judicial proceeding involving a trademark licensed by the

franchisor to the franchisee, or if the proceeding is resolved unfavorably to the franchisee; and

(v) The franchisee’s rights under the franchise agreement if the franchisor requires the

franchisee to modify or discontinue using a trademark. 

(9) Disclose whether the franchisor knows of either superior prior rights or infringing

uses that could materially affect the franchisee’s use of the principal trademarks in the state

where the franchised business will be located. For each use of a principal trademark that the

franchisor believes is an infringement that could materially affect the franchisee’s use of a

trademark, disclose:
39

(i) The nature of the infringement;

(ii) The locations where the infringement is occurring;

(iii) The length of time of the infringement (to the extent known); and 

(iv) Any action taken or anticipated by the franchisor.

(n) Item 14: Patents, Copyrights, and Proprietary Information.

(1) Disclose whether the franchisor owns rights in patents or copyrights that are

material to the franchise, including:

(i) A description of the patent or copyright and its relationship to the franchise; and

(ii) The duration of the patent or copyright.

(iii) For copyrights, state:

(A) The registration number and date of each copyright; and

(B) Whether the franchisor can and intends to renew the copyright.

(iv) For patents, state:

(A) The patent number, issue date, and title for each patent, and the serial number,

filing date, and title of each patent application; and

(B) The type of patent or patent application (for example, mechanical, process, or

design). 

(2) Describe any current material determination of the U.S. Patent and Trademark

Office, the U.S. Copyright Office, or a court regarding the patent or copyright. Include the forum

and case number. Describe how the determination affects the franchised business.
 

9

If counsel consents, the franchisor may include a counsel’s opinion or a summary of the

opinion if the full opinion is attached.

40

(3) State the forum, case number, claims asserted, issues involved, and effective

determinations for any material proceeding pending in the U.S. Patent and Trademark Office or

any court.9

(4) If an agreement limits the use of the patent, patent application, or copyright, state

the parties to and duration of the agreement, the extent to which the agreement may affect the

franchisee, and other material terms of the agreement.

(5) Disclose the franchisor’s obligation to protect the patent, patent application, or

copyright and to defend the franchisee against claims arising from the franchisee’s use of the

patented or copyrighted items, including:

(i) Whether the franchisee must notify the franchisor of any infringement claims or

whether the franchisee’s notification is discretionary;

(ii) Whether the franchise agreement requires the franchisor to take affirmative action

when notified of infringement; 

(iii) Who has the right to control litigation;

(iv) Whether the franchisor must participate in the defense of a franchisee or

indemnify the franchisee for expenses or damages in a proceeding involving a patent, patent

application, or copyright licensed to the franchisee;

(v) Any requirement that the franchisee modify or discontinue using the subject

matter covered by the patent or copyright; and
41

(vi) The franchisee’s rights under the franchise agreement if the franchisor requires the

franchisee to modify or discontinue using the subject matter covered by the patent or copyright. 

(6) If the franchisor knows of any patent or copyright infringement that could

materially affect the franchisee, disclose:

(i) The nature of the infringement;

(ii) The locations where the infringement is occurring;

(iii) The length of time of the infringement (to the extent known); and 

(iv) Any action taken or anticipated by the franchisor.

(7) If the franchisor claims proprietary rights in other confidential information or

trade secrets, describe in general terms the proprietary information communicated to the

franchisee and the terms for use by the franchisee. The franchisor need only describe the general

nature of the proprietary information, such as whether a formula or recipe is considered to be a

trade secret. 

(o) Item 15: Obligation to Participate in the Actual Operation of the Franchise

Business.

(1) Disclose the franchisee’s obligation to participate personally in the direct

operation of the franchise business and whether the franchisor recommends participation. 

Include obligations arising from any written agreement or from the franchisor’s practice.

(2) If personal “on-premises” supervision is not required, disclose the following:

(i) If the franchisee is an individual, state:

(A) Whether the franchisor recommends on-premises supervision by the franchisee; 

(B) Limits on who the franchisee can hire as an on-premises supervisor; and 
42

(C) Whether an on-premises supervisor must successfully complete the franchisor’s

training program.

(ii) If the franchisee is a business entity, state the amount of equity interest that the

on-premises supervisor must have in the franchise.

(3) Disclose any restrictions that the franchisee must place on its manager (for

example, maintain trade secrets, covenants not to compete).

(p) Item 16: Restrictions on What the Franchisee May Sell. 

Disclose any franchisor-imposed restrictions or conditions on the goods or services that

the franchisee may sell or that limit access to customers, including:

(1) Any obligation on the franchisee to sell only goods and services approved by

the franchisor;

(2) Any obligation on the franchisee to sell all goods and services authorized by

the franchisor; and

(3) Whether the franchisor has the right to change the types of authorized goods and

services and whether there are limits on the franchisor’s right to make changes.

(q) Item 17: Renewal, Termination, Transfer, and Dispute Resolution.

Disclose, in the tabular form shown below, a table that cross-references each enumerated

franchise relationship item with the applicable provision in the franchise or related agreement. 

(1) Describe briefly each contractual provision. If a particular item is not applicable,

state “Not Applicable.”
43

(2) If the agreement is silent about one of the listed provisions, but the franchisor

unilaterally offers to provide certain benefits or protections to franchisees as a matter of policy,

use a footnote to describe the policy and state whether the policy is subject to change. 

(3) In the summary column for provision (c), state what the term “renewal” means for

your franchise system, including, if applicable, a statement that franchisees may be asked to sign

a contract with different terms and conditions than their original contract. 

Item 17 Table

[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.

Provision Section in franchise or other

agreement

Summary

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
44

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. 

Disclose:

(1) Any compensation or other benefit given or promised to a public figure arising

from either the use of the public figure in the franchise name or symbol, or the public figure’s

endorsement or recommendation of the franchise to prospective franchisees.

(2) The extent to which the public figure is involved in the management or control of 

the franchisor. Describe the public figure’s position and duties in the franchisor’s business

structure.
45

(3) The public figure’s total investment in the franchisor, including the amount the

public figurer contributed in services performed or to be performed. State the type of investment

(for example, common stock, promissory note).

(4) For purposes of this subsection, a public figure means a person whose name or

physical appearance is generally known to the public in the geographic area where the franchise

will be located. 

(s) Item 19: Financial Performance Representations.

(1) Begin by stating the following:

The FTC’s Franchise Rule permits a franchisor to disclose information about the actual or

potential financial performance of its franchised and/or franchisor-owned outlets, if there

is a reasonable basis for the information, and the information is included in the disclosure

document. Financial performance information that differs from that included in Item 19

may be given only if: (1) a franchisor provides the actual records of an existing outlet

you are considering buying; or (2) a franchisor supplements the information provided in

this Item 19, for example, by providing information about performance at a particular

location or under particular circumstances.

(2) If a franchisor does not provide any financial performance representation in Item

19, also state:

This franchisor does not make any representations about a franchisee’s future financial

performance or the past financial performance of company-owned or franchised outlets.

We also do not authorize our employees or representatives to make any such

representations either orally or in writing. If you are purchasing an existing outlet,

however, we may provide you with the actual records of that outlet. If you receive any

other financial performance information or projections of your future income, you should

report it to the franchisor’s management by contacting [name and address], the Federal

Trade Commission, and the appropriate state regulatory agencies.

(3) If the franchisor makes any financial performance representations to prospective

franchisees, the franchisor must have a reasonable basis and written substantiation for the
46

representations at the time the representations are made and must state the representations in the

Item 19 disclosure. The franchisor must also disclose the following:

(i) Whether the representation is an historic financial performance representation

about the franchise system’s existing outlets, or a subset of those outlets, or is a forecast of the

prospective franchisee’s future financial performance.

(ii) If the representation relates to past performance of the franchise system’s existing

outlets, disclose the material bases for the representation, including: 

(A) Whether the representation relates to the performance of all of the franchise

system’s existing outlets or only to a subset of outlets that share a particular set of characteristics

(for example, geographic location, type of location (such as free standing vs. shopping center),

degree of competition in the market area, length of time the outlets have operated, services or

goods sold, services supplied by the franchisor, and whether the outlets are franchised or

franchisor-owned or operated); 

(B) The dates when the reported level of financial performance was achieved;

(C) The total number of outlets that existed in the relevant period and, if different, the

number of outlets that had the described characteristics; 

(D) The number of outlets with the described characteristics whose actual financial

performance data were used in arriving at the representation;

(E) Of those outlets whose data were used in arriving at the representation, the

number and percent that actually attained or surpassed the stated results; and 
47

(F) Characteristics of the included outlets, such as those characteristics noted in

§ (s)(3)(ii)(A) of this section, that may differ materially from those of the outlet that may be

offered to a prospective franchisee.

(iii) If the representation is a forecast of future financial performance, state the

material bases and assumptions on which the projection is based. The material assumptions

underlying a forecast include significant factors upon which a franchisee’s future results are

expected to depend. These factors include, for example, economic or market conditions that are

basic to a franchisee’s operation, and encompass matters affecting, among other things, a

franchisee’s sales, the cost of goods or services sold, and operating expenses.

(iv) Include a conspicuous admonition that a new franchisee’s individual financial

results may differ from the result stated in the financial performance representation; and

(v) State that written substantiation for the financial performance representation will

be made available to the prospective franchisee upon reasonable request. 

(4) If a franchisor wishes to disclose only the actual operating results for a specific

outlet being offered for sale, it need not comply with this section, provided the information is

given only to potential purchasers of that outlet.

(5) If a franchisor furnishes financial performance information according to this

section, the franchisor may deliver to a prospective franchisee a supplemental financial

performance representation about a particular location or variation, apart from the disclosure

document. The supplemental representation must:
48

(i) Be in writing; 

(ii) Explain the departure from the financial performance representation in the

disclosure document; 

(iii) Be prepared in accordance with the requirements of paragraph (s)(3)(i)-(iv) of this

section; and 

(iv) Be furnished to the prospective franchisee.

(t) Item 20: Outlets and Franchisee Information.

(1) Disclose, in the tabular form shown below, the total number of franchised and

company-owned outlets for each of the franchisor’s last three fiscal years. For purposes of this

subsection, “outlet” includes outlets of a type substantially similar to that offered to the

prospective franchisee. A sample Item 20(1) Table is attached as Appendix B to this Rule.
49

Table No. 1

Systemwide Outlet Summary

For years [ ] to [ ]

Column 1

Outlet Type

Column 2

Year

Column 3

Outlets at the

Start of the Year

Column 4

Outlets at the

End of the Year

Column 5

Net Change

Franchised 2002

2003

2004

CompanyOwned2002

2003

2004

Total Outlets 2002

2003

2004

(i) In column (1), include three outlet categories titled “franchised,” “companyowned, and “total outlets.”

(ii) In column (2), state the last three fiscal years.

(iii) In column (3), state the total number of each type of outlet operating at the

beginning of each fiscal year.

(iv) In column (4), state the total number of each type of outlet operating at the end of

each fiscal year.

(v) In column (5), state the net change, and indicate whether the change is positive or

negative, for each type of outlet during each fiscal year.
50

(2) Disclose, in the form of the tables listed below, the number of franchised and

company-owned outlets and changes in the number and ownership of outlets for each state during

each of the last three fiscal years. Except as noted below, each change in ownership shall be

reported only once in the following tables. If multiple events occurred in the process of

transferring ownership of an outlet, report the event that occurred last in time. Where a single

outlet changed ownership two or more times during the same fiscal year, report the event that

happened last and use footnotes to explain the preceding events.

(i) Disclose, in the tabular form shown below, the total number of franchised outlets

transferred in each state during each of the franchisor’s last three fiscal years. For purposes of

this subsection, “transfer” means the acquisition of a controlling interest in a franchised outlet,

during its term, by a person other than the franchisor or an affiliate. A sample Item 20(2) Table

is attached as Appendix C to this Rule.
51

Table No. 2

Transfers of Franchised Outlets

For years [ ] to [ ]

Column 1

State

Column 2

Year

Column 3

Number of Transfers

2002

2003

2004

2002

2003

2004

Total 2002

2003

2004

(A) In column (1), list each state with one or more franchised outlets. 

(B) In column (2), state the last three fiscal years.

(C) In column (3), state the total number of completed transfers in each state during

each fiscal year.

(ii) Disclose, in the tabular form shown below, the status of franchisee-owned outlets

in each state for each of the franchisor’s last three fiscal years. A sample Item 20(3) Table is

attached as Appendix D to this Rule.
52

Table No. 3

Status of Franchised Outlets

For years [ ] to [ ]

Col.1

State

Col.2

Year

Col. 3

Outlets at

Start of

Year

Col. 4

 Outlets

Opened

Col. 5

Terminations

Col. 6

NonRenewals

Col. 7

Reacquired

by

Franchisor

Col. 8

Ceased

OperationsOther 

Reasons

Col. 9

Outlets 

at End of

 the Year

2002

2003

2004

2002

2003

2004

Totals

(A) In column (1), list each state with one or more franchised outlets. 

(B) In column (2), state the last three fiscal years.

(C) In column (3), state the total number of franchised outlets in each state at the start

of each fiscal year.

(D) In column (4), state the total number of franchised outlets opened in each state

during each fiscal year. Include both new outlets and existing company-owned outlets that a

franchisee purchased from the franchisor. (Also report the number of existing company-owned

outlets that are sold to a franchisee in Column 7 of Table 4).

(E) In column (5), state the total number of franchised outlets that were terminated in

each state during each fiscal year. For purposes of this subsection, “termination” means the

franchisor’s termination of a franchise agreement prior to the end of its term and without
53

providing any consideration to the franchisee (whether by payment or forgiveness or assumption

of debt).

(F) In column (6), state the total number of non-renewals in each state during each

fiscal year. For purposes of this subsection, “non-renewal” occurs when the franchise agreement

for a franchised outlet is not renewed at the end of its term. 

(G) In column (7), state the total number of franchised outlets reacquired by the

franchisor in each state during each fiscal year. For purposes of this subsection, a “reacquisition”

means the franchisor’s acquisition for consideration (whether by payment or forgiveness or

assumption of debt) of a franchised outlet during its term. (Also report franchised outlets

reacquired by the franchisor in column 5 of Table 4).

(H) In column (8), state the total number of outlets in each state not operating as one

of the franchisor’s outlets at the end of each fiscal year for reasons other than termination, nonrenewal, or reacquisition by the franchisor.

(I) In column (9), state the total number of franchised outlets in each state at the end

of the fiscal year.

(iii) Disclose, in the tabular form shown below, the status of company-owned outlets

in each state for each of the franchisor’s last three fiscal years. A sample Item 20(4) Table is

attached as Appendix E to this Rule.
54

Table No. 4

Status of Company-Owned Outlets

For years [ ] to [ ]

Col. 1

State

Col. 2

Year

Col. 3

Outlets at

Start of

the Year

Col. 4

 Outlets

Opened

Col. 5

Outlets

Reacquired

From

Franchisee

Col. 6

Outlets

Closed

Col. 7 

Outlets

Sold to

Franchisee

Col. 8

Outlets at

End of the

Year

2002

2003

2004

2002

2003

2004

Totals 2002

2003

2004

(A) In column (1), list each state with one or more company-owned outlets. 

(B) In column (2), state the last three fiscal years.

(C) In column (3), state the total number of company-owned outlets in each state at

the start of the fiscal year.

(D) In column (4), state the total number of company-owned outlets opened in each

state during each fiscal year. 

(E) In column (5), state the total number of franchised outlets reacquired from

franchisees in each state during each fiscal year.
55

(F) In column (6), state the total number of company-owned outlets closed in each

state during each fiscal year. Include both actual closures and instances when an outlet ceases to

operate under the franchisor’s trademark.

(G) In column (7), state the total number of company-owned outlets sold to

franchisees in each state during each fiscal year.

(H) In column (8), state the total number of company-owned outlets operating in each

state at the end of each fiscal year.

(3) Disclose, in the tabular form shown below, projected new franchised outlets. A

sample Item 20(5) Table is attached as Appendix F to this Rule.
56

Table No. 5

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

Column 1

State

Column 2

Franchise

Agreements Signed

But Outlet Not

Opened

Column 3

Projected New

Franchised Outlet In

The Next Fiscal Year

Column 4

Projected New CompanyOwned Outlet In the

Current Fiscal Year

Total

(i) In column (1), list each state where one or more franchised or company-owned

outlets are located or are projected to be located. 

(ii) In column (2), state the total number franchise agreements that had been signed

for new outlets to be located in each state as of the end of the previous fiscal year where the

outlet had not yet opened.

(iii) In column (3), state the total number of new franchised stores in each state

projected to be opened during the next fiscal year.

(iv) In column (4), state the total number of new company-owned outlets in each state

that are projected to be opened during the current fiscal year.

(4) If a franchisor is selling an existing franchised outlet, disclose the following

additional information for that outlet for the last five fiscal years. This information may be

attached as an addendum to this disclosure document.

(i) The name and last known address and telephone number of each previous owner

of the outlet;
57

(ii) The time period when each previous owner controlled the outlet;

(iii) The reason for each previous change in ownership (for example, termination, nonrenewal, voluntary transfer, ceased operations); and

(iv) The time period(s) when the franchisor retained control of the outlet (for example,

after termination, non-renewal, or reacquisition).

(5) Disclose the names of all current franchisees and the address and telephone

number of each of their outlets. Alternatively, disclose this information for all franchised outlets

in the state, but if these franchised outlets total fewer than 100, disclose this information for

franchised outlets from contiguous states and then the next closest states until at least 100

franchised outlets are listed.

(6) Disclose the name and last known home address and telephone number of every

franchisee who had an outlet terminated, canceled, not renewed, or otherwise voluntarily or

involuntarily ceased to do business under the franchise agreement during the most recently

completed fiscal year or who has not communicated with the franchisor within 10 weeks of the

disclosure document issuance date.

(7) Disclose whether franchisees signed confidentiality clauses in a franchise

agreement, settlement, or in any other contract, during the last three fiscal years. If so, state the

following: “In some instances, current and former franchisees sign provisions restricting their

ability to speak openly about their experience with [name of franchise system]. While we

encourage you to speak with current and former franchisees, be aware that not all such

franchisees will be able to communicate with you.” Franchisors may also disclose the number

and percentage of current and former franchisees who during each of the last three fiscal years
58

signed agreements that include confidentiality clauses and may disclose the circumstances under

which such clauses were signed.

(8) Disclose, to the extent known, the name, address, telephone number, email

address, and Web address of each trademark-specific franchisee organization associated with the

franchise system being offered, if such organization:

(i) Has been created, sponsored, or endorsed by the franchisor; or

(ii) Is incorporated and asks the franchisor to be included in the franchisor’s

disclosure document during the next fiscal year. Such organizations must renew their request for

inclusion in the disclosure document annually and within 90 days after the close of the

franchisor’s fiscal year. The franchisor has no obligation to verify the organization’s continued

existence at the end of each fiscal year. Franchisors may also include the following statement: 

“The following independent franchisee associations have asked to be included in this disclosure

document. We do not endorse these organizations and their members may not represent all

franchisees in the [name of franchisor] franchise system.” 

(u) Item 21: Financial Statements.

(1) Include the following financial statements prepared according to United States

generally accepted accounting principles, or as permitted by the Securities and Exchange

Commission, or as revised by any future government mandated accounting principles. Except as

provided in § (u)(2) of this section, these financial statements must be audited by an independent

certified public accountant using generally accepted United States auditing principles. Present

the required financial statements in a tabular form that compares at least two fiscal years. 
59

(i) The franchisor’s balance sheet for the previous two fiscal year-ends before the

disclosure document issuance date. In addition, include statements of operations, stockholders

equity, and cash flows for each of the franchisor’s previous three fiscal years.

(ii) Instead of the disclosure required by § (u)(1)(i) of this section, the franchisor may

include financial statements of any of its affiliates if the affiliate’s financial statements satisfy

§ (u)(1)(i) of this section and the affiliate absolutely and unconditionally guarantees to assume

the duties and obligations of the franchisor under the franchise agreement. The affiliate’s

guarantee must cover all of the franchisor’s obligations to the franchisee, but need not extend to

third parties. If this alternative is used, attach a copy of the guarantee to the disclosure document.

(iii) When a franchisor owns a direct or beneficial controlling financial interest in

another corporation, its financial statements should reflect the financial condition of the

franchisor and its subsidiaries.

(iv) Include separate financial statements for the franchisor, subfranchisor, and any

parent or other entity that commits to perform post sale obligations for the franchisor or

guarantees the franchisor’s obligation. Attach a copy of any guarantee to the disclosure

document.

(2) A start-up franchise system that does not yet have audited financial statements, 

may phase-in the use of audited financial statements by providing, at a minimum, the following

statements in the times indicated below:
60

(i) The franchisor’s first partial or full fiscal

year selling franchises. 

An unaudited opening balance sheet.

(ii) The franchisor’s 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’s 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 § (u)(1)(i) of this

section.

(iv) Start-up franchisors may phase-in the use of audited financial statements,

provided the franchisor:

(A) Prepares audited financial statements as soon as practicable; 

(B) Prepares unaudited statements in a format that conforms as closely as possible to

audited statements; and 

(C) Includes one or more years of unaudited financial statements or clearly and

conspicuously discloses in this section that the franchisor has not been in business for three years

or more, and cannot include all financial statements required in § (u)(1)(i) of this section.

(v) Item 22: Contracts. 

Attach a copy of all proposed agreements regarding the franchise offering, including the

franchise agreement and any lease, options, and purchase agreements.

(w) Item 23: Receipts.

Include two copies of the following detachable acknowledgment of receipt in the form set

out below as the last pages of the disclosure document:
61

(1) State the following:

Receipt

This disclosure document summarizes certain provisions of the franchise agreement and

other information in plain language. Read this disclosure document and all agreements

carefully.

If [name of franchisor] offers you a franchise, it must provide this disclosure

document to you 14 days before you sign a binding agreement or make a payment with

the franchisor or an affiliate in connection with the proposed franchise sale.

If [name of franchisor] does not deliver this disclosure document on time or if it contains

a false or misleading statement, or a material omission, a violation of federal law and

state law may have occurred and should be reported to the Federal Trade Commission,

Washington, D.C. 20580 and [state agency].

(2) Disclose the name, principal business address, and telephone number of each

franchise seller offering the franchise.

(3) State the issuance date.

(4) If not disclosed in paragraph 436.5(a) of this section, state the name and address

of the franchisor’s registered agent authorized to receive service of process.

(5) State the following:

I received a disclosure document dated _____ that included the following

Exhibits:

(6) List the title(s) of all attached Exhibits.

(7) Provide space for the prospective franchisee’s signature and date.

(8) Franchisors may include any specific instructions for returning the receipt (for

example, street address, email address, facsimile telephone number).
62

Subpart D – Instructions

§ 436.6 Instructions for Preparing Disclosure Documents 

(a) Disclose the information required in Subpart C clearly, legibly, and concisely in a

single document using plain English. The disclosures must be in a form that permits each

prospective franchisee to store, download, print, or otherwise maintain the document for future

reference.

(b) Respond fully to each disclosure Item. If a disclosure Item is not applicable,

respond negatively, including a reference to the type of information required to be disclosed by

the Item. Precede each disclosure Item with the appropriate heading.

(c) Do not include any materials or information other than those required or permitted

by this Rule or by state law not preempted by this Rule. For the sole purpose of enhancing the

prospective franchisee’s ability to maneuver through an electronic version of a disclosure

document, the franchisor may include scroll bars, internal links, and search features. All other

features (e.g, multimedia tools such as audio, video, animation, or pop-up screens) are

prohibited. 

(d) Franchisors may prepare multi-state disclosure documents by including nonpreempted, state-specific information in the text of the disclosure document or in Exhibits

attached to the disclosure document.

(e) Subfranchisors shall disclose the required information about the franchisor, and,

to the extent applicable, the same information concerning the subfranchisor.

(f) Before furnishing a disclosure document, the franchisor shall advise the

prospective franchisee of the formats in which the disclosure document is made available, any
63

prerequisites for obtaining the disclosure document in a particular format, and any conditions

necessary for reviewing the disclosure document in a particular format.

(g) Franchisors shall retain, and make available to the Commission upon request, a

sample copy of each materially different version of their disclosure documents for three years

after the close of the fiscal year when it was last used.

(h) For each completed franchise sale, franchisors shall retain a copy of the signed

receipt for at least three years.

§ 436.7 Instructions For Updating Disclosures

(a) All information in the disclosure document shall be current as of the close of the

franchisor’s most recent fiscal year. After the close of the fiscal year, the franchisor shall, within

120 days, prepare a revised disclosure document, after which a franchise seller may distribute

only the revised document and no other disclosure document. 

(b) The franchisor shall, within a reasonable time after the close of each quarter of the

fiscal year, prepare revisions to be attached to the disclosure document to reflect any material

change in the franchisor or relating to the franchise business of the franchisor. Each prospective

franchisee shall receive the disclosure document and the quarterly revisions for the most recent

period available at the time of disclosure. 

(c) If applicable, the annual update shall include the franchisor’s first quarterly

update, either by incorporating the quarterly update information into the disclosure document

itself, or through an addendum. 

(d) When furnishing a disclosure document, the franchise seller shall notify the

prospective franchisee of any material changes that the seller knows or should have known 
64

occurred in the information contained in any financial performance representation made in Item

19.

(e) Information that must be audited pursuant to § 436.5(u) of this Rule need not be

audited for quarterly revisions; provided, however, that the franchisor states in immediate

conjunction with the information that such information was not audited.

Subpart E – Exemptions

§ 436.8 Exemptions. 

(a) The provisions of this Rule shall not apply if the franchisor can establish any of

the following:

(1) The total of the required payments, or commitments to make a required payment, 

to the franchisor or an affiliate that are made any time from before to within six months after

commencing operation of the franchisee’s business is less than $500.

(2) The franchise relationship is a fractional franchise.

(3) The franchise relationship is a leased department.

(4) The franchise relationship is covered by the Petroleum Marketing Practices Act, 

15 U.S.C. 2801. 

(5)(i) The franchisee’s estimated investment, excluding any financing received from the

franchisor or an affiliate and excluding real estate costs, totals at least $1 million and the

prospective franchisee signs an acknowledgment verifying the grounds for the exemption. The

acknowledgment shall state: “The franchise sale is for more than $1 million, excluding real

estate costs, and thus is exempted from the Commission’s Franchise Rule disclosure

requirements, pursuant to 16 C.F.R. § 436.8(a)(5)(i)”; or
65

(ii) The franchisee (and its parent or any affiliates) is an entity that has been in

business for at least five years and has a net worth of at least $5 million. 

(6) One or more purchasers of at least a 50 percent ownership interest in the

franchise: (1) within 60 days of the sale, has been, for at least two years, an officer, director,

general partner, individual with management responsibility for the offer and sale of the

franchisor’s franchisees or the administrator of the franchised network; or (2) within 60 days of

the sale, has been, for at least two years, an owner of at least a 25 percent interest in the

franchisor.

(7) There is no written document that describes any material term or aspect of the

relationship or arrangement.

(b) For purposes of the exemptions set forth in this subsection, the Commission may

adjust the size of the thresholds every four years based upon the Consumer Price Index.

Subpart F – Prohibitions

§ 436.9 Additional Prohibitions.

It is an unfair or deceptive act or practice in violation of Section 5 of the Federal Trade 

Commission Act for any franchise seller covered by this Rule to:

(a) Make any claim or representation, orally, visually, or in writing, that contradicts

the information required to be disclosed by this Rule.

(b) Misrepresent that any person:

(1) Purchased a franchise from the franchisor or operated a franchise of the type

offered by the franchisor; or
66

(2) Can provide an independent and reliable report about the franchise or the

experiences of any current or former franchisees.

(c) Disseminate any financial performance representations to prospective franchisees,

including any representations made in the general media, unless the franchisor has a reasonable

basis and written substantiation for the representation at the time the representation is made, and

the representation is included in Item 19 of the franchisor’s disclosure document. In conjunction

with any such financial performance representation, the franchise seller shall also:

(1) Disclose the information required by §§ 436.5(s)(3)(ii)(B) and (E) of this Rule if

the representation relates to the past performance of the franchisor’s outlets; and

(2) Include a clear and conspicuous admonition that a new franchisee’s individual

financial results may differ from the result stated in the financial performance representation.

(d) Fail to make available to prospective franchisees, and to the Commission upon

reasonable request, written substantiation for any financial performance representations made in

Item 19.

(e) Fail to furnish a copy of the franchisor’s disclosure document to a prospective

franchisee earlier in the sales process than required under § 436.2 of this Rule, upon reasonable

request.

(f) Fail to furnish existing disclosures to a prospective purchaser of an existing

franchised outlet, upon reasonable request.

(g) Fail to furnish a copy of the franchisor’s most recent disclosure document and any

quarterly updates to a prospective franchisee, upon reasonable request, before the prospective

franchisee signs a franchise agreement.
67

(h) Present for signing a franchise agreement in which the terms and conditions differ

materially from those presented as an attachment to the disclosure document, unless the seller

informed the prospective franchisee of the differences within a reasonable time before execution.

(i) Disclaim or require a prospective franchisee to waive reliance on any

representation made in the disclosure document or in its exhibits or amendments. Provided,

however, that this provision is not intended to prevent a prospective franchisee from voluntarily

waiving specific contract terms and conditions set forth in his or her disclosure document during

the course of franchise sale negotiations.

(j) Fail to return any funds or deposits in accordance with any conditions disclosed in

the franchisor’s disclosure document, franchise agreement, or any related document.

Subpart G – Other Provisions

§ 436.10 OTHER LAWS, RULES, ORDERS.

(a) The Commission does not approve or express any opinion on the legality of any

matter a franchisor may be required to disclose by this Rule. Further, franchisors may have

additional obligations to disclose material information to prospective franchisees under Section 5

of the Federal Trade Commission Act. The Commission intends to enforce all applicable statutes

and trade regulation rules.

(b) If an outstanding FTC or court order applies to a franchisor, but differs from any

provision of this regulation, the franchisor can petition the Commission to amend the order.

(c) The FTC does not intend to preempt the franchise practices laws of any state or

local government, except to the extent of any inconsistency with this Rule. A law is not
68

inconsistent with this Rule if it affords prospective franchisees equal or greater protection, such

as registration of disclosure documents or more extensive disclosures.

§ 436.11 SEVERABILITY.

If any provision of this regulation is stayed or held invalid, the remainder will stay in

force.
69

Appendix A: Sample Item 10 Table – Summary of Financing Offered

Item

Financed 

Source of

Financing

Down

Payment

Amount

Financed

Term

(Yrs)

APR

%

Monthly

Payment

Prepay

Penalty

Security

Required

Liability

Upon

Default

Loss of

Legal

Right on

Default

Initial Fee

Land/

Constr

Equip.

Lease

Equip.

Purchase

Opening

Inventory

Other

Financing
70

Appendix B: Sample Item 20(1) Table – Systemwide Outlet Summary

Systemwide Outlet Summary

For years 2002 to 2004

Column 1

Outlet Type

Column 2

Year

Column 3

Outlets at the

Start of the Year

Column 4

Outlets at the

End of the Year

Column 5

Net Change

Franchised 2002 859 1,062 +203

2003 1,062 1,296 +234

2004 1,296 2,720 +1,424

Company

Owned

2002 125 145 +20

2003 145 76 -69

2004 76 141 +65

Total Outlets 2002 984 1,207 +223

2003 1,207 1,372 +165

2004 1,372 2,861 +1,489
71

Appendix C: Sample Item 20(2) Table – Transfers of Franchised Outlets

Transfers of Franchised Outlets

For years 2002 to 2004

Column 1

State

Column 2

Year

Column 3

Number of Transfers

NC 2002 1

2003 0

2004 2

SC 2002 0

2003 0

2004 2

Total 2002 1

2003 0

2004 4
72

Appendix D: Sample Item 20(3) Table – Status of Franchise Outlets

Status of Franchise Outlets

For years 2002 to 2004

Col. 1

State

Col .2

Year

Col. 3

Outlets

at Start

of Year

Col. 4

Outlets

Opened

Col. 5

Terminations

Col. 6

NonRenewals

Col. 7

Reacquired

by

Franchisor

Col. 8

Ceased

OperationsOther 

Reasons

Col. 9

Outlets 

at End of

 the Year

AL 2002 10 2 1 0 0 1 10

2003 11 5 0 1 0 0 15

2004 15 4 1 0 1 2 15

AZ 2002 20 5 0 0 0 0 25

2003 25 4 1 0 0 2 26

2004 26 4 0 0 0 0 30

Totals 2002 30 7 1 0 0 1 35

2003 36 9 1 1 0 2 41

2004 41 8 1 0 1 2 45
73

Appendix E: Sample Item 20(4) Table – Status of Company-Owned Outlets

Status of Company Owned Outlets

For years 2002 to 2004

Col.1

State

Col.2

Year

Col.3

Outlets at

Start of

the Year

Col.4

 Outlets

Opened

Col.5

Outlets

Reacquired

From

Franchisees

Col.6

Outlets

Closed

Col.7

Outlets 

Sold to

Franchisees

Col.8

Outlets

at End

of the

Year

NY 2002 1 0 1 0 0 2

2003 2 2 0 1 0 3

2004 3 0 0 3 0 0

OR 2002 4 0 1 0 0 5

2003 5 0 0 2 0 3

2004 3 0 0 0 1 2

Totals 2002 5 0 2 0 0 7

2003 7 2 0 3 0 6

2004 6 0 0 3 1 2
74

Appendix F: Sample Item 20(5) Table – Projected New Franchised Outlets

Projected New Franchised Outlets

As of December 31, 2004

Column 1

State

Column 2

Franchise Agreements

Signed But Outlet Not

Opened

Column 3

Projected New

Franchised Outlet in

the Next Fiscal Year

Column 4

Projected

New

CompanyOwned

Outlets in the

Current

Fiscal Year

CO 2 3 1

NM 0 4 2

Total 2 7 3
1

ATTACHMENT C

NOTICE OF PROPOSED RULEMAKING

PART 436 -- DISCLOSURE REQUIREMENTS AND PROHIBITIONS CONCERNING 

FRANCHISING

SUBPART A - DEFINITIONS

Sec.

436.1 Definitions.

SUBPART B - OBLIGATIONS OF FRANCHISORS AND OTHER FRANCHISE

SELLERS

436.2 The Obligation To Furnish Documents.

SUBPART C - THE CONTENTS OF A DISCLOSURE DOCUMENT

436.3 Cover page.

436.4 Table of contents.

436.5 Disclosure items. 

SUBPART D - INSTRUCTIONS

436.6 Instructions for preparing disclosure documents.

436.7 Instructions for electronic disclosure documents.

436.8 Instructions for updating disclosures.

SUBPART E - OTHER PROVISIONS

436.9 Exemptions.

436.10 Additional prohibitions.

436.11 Other laws, rules, orders. 

436.12 Severability.

AUTHORITY: 15 U.S.C. 41-58.
2

SUBPART A - Definitions

§ 436.1 Definitions.

Unless stated otherwise, the following definitions shall apply throughout this rule:

(a) Action includes complaints, cross claims, counterclaims, and third-party complaints

in a judicial proceeding, and their equivalents in an administrative action or arbitration

proceeding.

(b) Affiliate means an entity controlled by, controlling, or under common control with the

franchisor.

(c) Disclose means to state all material facts accurately, clearly, concisely, and legibly in

plain English.

(d) Financial performance representation means any oral, written, or visual

representation to a prospective franchisee, including a representation disseminated in the general

media and Internet, that states or suggests a specific level or range of potential or actual sales,

income, gross profits, or net profits. A chart, table, or mathematical calculation that

demonstrates possible results based upon a combination of variables is a financial performance

representation.

(e) Fiscal year refers to the franchisor’s fiscal year.

(f) Fractional franchise means a franchise relationship, which when the relationship is

created:

(1) The franchisee or any of the franchisee’s current directors or officers has more than

two years of experience in the same type of business; and 

(2) The parties reasonably anticipate that the sales arising from the relationship will not

exceed more than 20 percent of the franchisee’s total dollar volume in sales during the first year

of operation.

(g) Franchise means any continuing commercial relationship or arrangement, whatever it

may be called, in which the terms of the offer or contract specify, or the franchise seller

represents, orally or in writing, that:

(1) The franchisee obtains the right to operate a business or offer, sell, or distribute

goods, commodities, or services that are identified or associated with the franchisor’s trademark;

(2) The franchisor: 

(i) Exerts or has authority to exert a significant degree of continuing control over the

franchisee’s method of operation, including but not limited to, the franchisee’s business

organization, promotional activities, management, or marketing plan; or 

(ii) Provides significant assistance in the franchisee’s method of operation (e.g., the

franchisee’s business organization, promotional activities, management, or marketing plan),

extending beyond the start of the business operation. Promotional assistance alone, however,

will not constitute “significant” assistance in the absence of other forms of assistance; and

(3) As a condition of obtaining or commencing operation of the business, the franchisee

is required by contract or by practical necessity to make a payment, or a commitment to pay, to

the franchisor or a person affiliated with the franchisor.
3

(h) Franchise seller means a person that offers for sale, sells, or arranges for the sale of

an interest in a franchise. It includes the franchisor and its employees, representatives, agents,

and third-party brokers. It does not include franchisees who sell only their own outlets.

(i) Franchisee means any person who is granted an interest in a franchise.

(j) Franchisor means any person who grants an interest in a franchise and participates in

the franchise relationship. 

(k) Gag clause means any contractual provision entered into by a franchisor and a current

or former franchisee that prohibits or restricts that franchisee from discussing his or her personal

experience as a franchisee within the franchisor’s system. It does not include confidentiality

agreements that protect franchisors’ trademarks or other proprietary information.

(l) Internet means all communications between computers and between computers and

television, telephone, facsimile, and similar communications devices. It includes the World

Wide Web, proprietary online services, E-mail, newsgroups, and electronic bulletin boards.

(m) Leased department means an arrangement whereby a retailer licenses or otherwise

permits an independent seller to conduct business from the retailer’s premises.

(n) Material, material fact, and material change includes any fact, circumstance, or set

of conditions that has a substantial likelihood of influencing a reasonable franchisee or

prospective franchisee in making a significant decision.

(o) Officer means any individual with significant management responsibility for the

marketing and/or servicing of franchises, such as the chief executive and chief operating officers,

and the financial, franchise marketing, training, and service officers. It also includes a de facto

officer, namely an individual with significant management responsibility for the marketing

and/or servicing of franchises whose title does not reflect the nature of the position.

(p) Person means any individual, group, association, limited or general partnership,

corporation, or any other business entity.

(q) Plain English means the organization of information and language usage

understandable by a person unfamiliar with the franchise business. It incorporates the following

six principles of clear writing: Short sentences; definite, concrete, everyday language; active

voice; tabular presentation of information; no legal jargon or highly technical business terms; and

no multiple negatives.

(r) Predecessor means a person from whom the franchisor acquired, directly or

indirectly, the major portion of the franchisor’s assets or from whom the franchisor obtained a

license to use the trademark or trade secrets in the franchise operation.

(s) Principal business address means the address of the franchisor’s home office in the

United States. A principal business address cannot be a post office box or private mail drop.

(t) Prospective franchisee means any person (including any agent, representative, or

employee) who approaches or is approached by a franchise seller to discuss the possible

establishment of a franchise relationship. 

(u) Required payment means all consideration that the franchisee must pay to the

franchisor or its affiliate, either by contract or by practical necessity, as a condition of obtaining

or commencing operation of the franchise.

(v) Sale of a franchise includes an agreement whereby a person obtains a franchise or

interest in a franchise for value by purchase, license, or otherwise. It does not include extending

or renewing an existing franchise agreement where there is no interruption in the franchisee’s
4

operation of the business, unless the new agreement contains terms and conditions that differ

materially from the original agreement.

(w) Signature means a person’s affirmative steps to authenticate his or her identity. It

includes a person’s written signature, as well as a person’s use of security codes, passwords, 

digital signatures, and similar devices.

(x) Trademark includes trademarks, service marks, names, logos, and other commercial

symbols.

(y) Written means any information in printed form or in any form capable of being

preserved in tangible form and read. It includes: type-set, word processed, or handwritten

documents; documents on computer disk or CD-Rom; documents sent via E-mail; or documents

posted on the Internet. It does not include mere oral statements.

SUBPART B - Obligations of Franchisors and Other Franchise Sellers

§ 436.2 The obligation to furnish documents.

In connection with the offer or sale of a franchise to be located in the United States of

America, its territories, or possessions, unless the transaction is exempted under the provisions of

section 436.9, it is an unfair or deceptive act or practice in violation of section 5 of the Federal

Trade Commission Act:

(a) For any franchise seller to fail to furnish a prospective franchisee with the following

documents within the following time frames. The obligations set forth in this subsection are

satisfied if either the franchisor or other franchise seller furnishes the required documents to the

prospective franchisee:

(1) A current disclosure document. A copy of the franchisor’s current disclosure

document, as described in sections 436.3 - 436.8, at least 14 days before the prospective

franchisee signs a binding agreement or pays any fee in connection with the proposed franchise

sale; and

(2) Completed franchise agreement. A copy of the completed franchise agreement, and

any related agreements, at least five days before the prospective franchisee signs the franchise

agreement.

(b) For purposes of this section, a franchise seller will be considered to have furnished

the documents by the required date if a copy of the document -- either a paper copy or, with the

consent of the prospective franchisee, an electronic copy -- has been delivered to the prospective

franchisee by that date, or if a copy has been sent to the address specified by the prospective

franchisee by first-class mail at least three days prior to the specified date. Documents shall also

be considered to have been furnished by the required date if a copy has been sent by electronic

mail or if directions for accessing the document on the Internet have been provided to the

prospective franchise by that date. 

(c) For any franchisor to fail to include the information and follow the instructions

required by sections 436.3 - 436.8 in preparing the disclosure document to be furnished to

prospective franchisees. Any other franchise seller shall be liable for violations of these sections

if they knew or should have known of the violation.
5

SUBPART C - The Contents of a Disclosure Document

§ 436.3 Cover page.

Begin the disclosure document with a cover page that consists of the following:

(a) The title “FRANCHISE DISCLOSURE DOCUMENT” in boldface type.

(b) The franchisor’s name, type of business organization, principal business address, 

telephone number, and, if applicable, E-mail address and primary Internet home page address.

(c) A sample of the primary business trademark under which the franchisee will conduct

its business.

(d) A brief description of the franchised business.

(e) The total amounts in Item 5 (Initial Franchisee Fee) and Item 7 (Estimated Initial

Investment) of the disclosure document.

(f) The issuance date.

(g) The following statements in the order and form shown below:

(1) This disclosure document summarizes certain provisions of the franchise

agreement and other information in plain English. Read this disclosure document

and all agreements carefully. You must receive this disclosure document at least

14 days before you sign a binding agreement or pay any fee. You must also

receive completed copies of all contracts at least five days before you sign them.

(2) If the franchisor furnishes an electronic version of its disclosure document, also insert

the following:

You may have elected to receive an electronic version of your disclosure document. If so,

you may wish to print or download the disclosure document for future reference. You

have the right to receive a paper copy of the disclosure document up until the time of sale. 

To obtain a paper copy, contact [name] at [address] and [telephone number].

(3) Buying a franchise is a complicated investment. The information contained in this

disclosure document can help you make up your mind. Note, however, that the Federal

Trade Commission (FTC) has not checked the information and does not know if it is

correct. Information comparing franchisors is available. Call your State agency or your

public library for sources of information. Additional information on franchising, such as

“A Consumer’s Guide to Buying a Franchise,” is available from the FTC. You can

contact the FTC in Washington, D.C., or visit the FTC’s home page at <www.ftc.gov>

for further information. In addition, there may be laws on franchising in your State. Ask

your State agencies about them.

(4) You should also know that the terms and conditions of your contract will govern your

franchise relationship. While the disclosure document includes some information about

your contract, don’t rely on it alone to understand your contract. Read all of your contract

carefully. Show your contract and this disclosure document to an advisor, like a lawyer

or an accountant. 

(5) Federal Trade Commission, Washington, DC 20580

(h) Franchisors may include additional disclosures on the cover page, or on a separate

cover page, to comply with any applicable State pre-sale disclosure laws.
6

§ 436.4 Table of contents.

Include the following table of contents. State the page where each disclosure Item begins. 

List all exhibits by letter, following the example shown below.

TABLE OF CONTENTS

1. The Franchisor, its Parent, Predecessors, and Affiliates

2. Business Experience 

3. Litigation

4. Bankruptcy

5. Initial Franchise Fee

6. Other Fees

7. Estimated Initial Investment

8. Restrictions on Sources of Products and Services

9. Franchisee’s Obligations

10. Financing

11. Franchisor’s Assistance, Advertising, Computer Systems, and Training

12. Territory

13. Trademarks

14. Patents, Copyrights, and Proprietary Information

15. Obligation to Participate in the Actual Operation of the 

Franchise Business

16. Restrictions on What the Franchisee May Sell

17. Renewal, Termination, Transfer, and Dispute Resolution

18. Public Figures

19. Financial Performance Representations

20. Outlets and Franchisee Information

21. Financial Statements

22. Contracts

23. Receipt

EXHIBITS

A. Franchise Agreement

§ 436.5 Disclosure items. 

(a) Item 1: The Franchisor, Its Parents, Predecessors, and Affiliates.

(1) Disclose the name of the franchisor. Also disclose the names of any parent and

affiliates of the franchisor and the relationship with the franchisor. For purposes of this

paragraph (a), the term “affiliate” means an entity controlled by, controlling, or under common

control with the franchisor, that offers franchises in any line of business or is providing products

or services to the franchisees of the franchisor.
 

1

 Only laws pertaining specifically to the industry sector of the franchised business, and not

businesses generally, must be disclosed in this Item. For example, a real estate brokerage

franchisor should disclose the existence of broker licensing laws; an optical products franchisor

should disclose the existence of applicable optometrist/optician staffing regulations and licensing

requirements; a lawn care franchisor should disclose that certain environmental laws regulating

pesticide application to residential lawns will require that franchisees post notices on treated

lawns. It is not necessary to include laws or regulations that apply to businesses generally, such

as general business licensing laws, tax regulations, or labor laws.

7

(2) Disclose the name of any predecessors during the 10-year period immediately before

the close of the franchisor’s most recent fiscal year.

(3) Disclose the name under which the franchisor does or intends to do business.

(4) Disclose the principal business address of the franchisor, its parent, predecessors, and

affiliates, and the franchisor’s agent for service of process.

(5) Disclose the type of business organization used by the franchisor (e.g., corporation,

partnership), and the State in which it was organized.

(6) Disclose the following information about the nature of the franchisor’s business and

the franchises to be offered:

(i) Whether the franchisor operates businesses of the type being franchised;

(ii) The franchisor’s other business activities;

(iii) The business to be conducted by the franchisee;

(iv) The general market for the product or service to be offered by the franchisee. In 

describing the general market, consider factors such as whether the market is developed or

developing, whether the goods will be sold primarily to a certain group, and whether sales are

seasonal;

(v) In general terms, any laws or regulations specific to the industry in which the

franchise business operates;1 and

(vi) A general description of the competition.

(7) Disclose the prior business experience of the franchisor, its parent, predecessors, and

affiliates, including:

(i) The length of time each has conducted the type of business to be operated by the

franchisee;

(ii) The length of time each has offered franchises providing the type of business to be

operated by the franchisee; and 

(iii) Whether each has offered franchises in other lines of business, including:

(A) A description of each other line of business;

(B) The number of franchises sold in each other line of business; and

(C) The length of time offering each other line of business.

(b) Item 2: Business Experience. Disclose the position and name of the directors,

trustees, general partners, officers, and subfranchisors of the franchisor or any parent who will

have management responsibility relating to the offered franchises. List all franchise brokers. For
 

2

 Franchisors are not required to disclose actions that were dismissed by final judgment

without liability or entry of an adverse order. However, franchisors must disclose dismissal of a

material action in connection with a settlement.

8

each person listed, state the principal positions and employers during the past five years,

including each position’s beginning date, ending date, and location.

(c) Item 3: Litigation.

(1) Disclose whether the franchisor, its parent, predecessor, a person identified in

paragraph (b) of this section, or an affiliate who offers franchises under the franchisor’s principal

trademark: 

(i) Has pending against that person:

(A) An administrative, criminal, or material civil action alleging a violation of a

franchise, antitrust, or securities law, or alleging fraud, unfair or deceptive practices, or

comparable allegations; or 

(B) Civil actions, other than ordinary routine litigation incidental to the business, which

are significant in the context of the number of franchisees and the size, nature, or financial

condition of the franchise system or its business operations.

(ii) Is a party to any pending material civil action involving the franchise relationship. 

For purposes of this paragraph, “franchise relationship” means contractual obligations between

the franchisor and franchisee directly relating to the operation of the franchised business (e.g.,

royalty payment and training obligations). It does not include suits involving third-parties such

as suppliers or indemnification for tort liability.

(iii) Has during the 10-year period immediately before the disclosure document’s

issuance date:

(A) Been convicted of a felony or pleaded nolo contendere to a felony charge; 

(B) Been held liable in a civil action by final judgment. “Held liable” means that, as a

result of claims or counterclaims, the franchisor must pay money or other consideration, must

reduce an indebtedness by the amount of an award, cannot enforce its rights, or must take action

adverse to its interests; or 

(C) Been a defendant in a material action involving an alleged violation of a franchise,

antitrust, or securities law, or involving allegations of fraud, unfair or deceptive practices, or

comparable allegations.2

(iv) Is subject to a currently effective injunctive or restrictive order or decree resulting

from a pending or concluded action brought by a public agency and relating to the franchise or to

a Federal, State, or Canadian franchise, securities, antitrust, trade regulation, or trade practice

law.

(2) For each action identified in paragraph (c)(1) of this section, state the title, case

number or citation, the initial filing date, the names of the parties, and the forum. State the

relationship of the opposing party to the franchisor (e.g., competitor, supplier, lessor, franchisee,

former franchisee, or class of franchisees). Summarize the legal and factual nature of each claim
 

3

 Franchisors may include a summary opinion of counsel concerning any action if a consent

to use the summary opinion is included as part of the disclosure document.

 

4

 If a settlement agreement must be disclosed in this Item, all material settlement terms must

be disclosed, whether or not the agreement is confidential. Because of difficulties in retrieving

information and/or obtaining releases from older confidentiality agreements, franchisors are not

required to disclose the settlement terms of settlements entered before April 15, 1993, consistent

with the policy adopted by the North American Securities Administrators 

Association’s Uniform Franchise Offering Circular Guidelines.

9

in the action, the relief sought or obtained, and any conclusions of law or fact.

3

 In addition:

(i) For pending actions, state the status of the action; 

(ii) For prior actions, state the date when the judgment was entered and any damages

and/or settlement terms;4

(iii) For injunctive or restrictive orders, state the nature, terms, and conditions of the

order or decree; and

(iv) For convictions or pleas, state the crime or violation, the date of conviction, and the

sentence or penalty imposed.

(d) Item 4: Bankruptcy.

(1) Disclose whether the franchisor, its parent, predecessor, a person identified in

paragraph (b) of this section, or an affiliate who offers franchises under the franchisor’s principal

trademark has, during the 10-year period immediately before the date of this disclosure

document:

(i) Filed as debtor (or had filed against it) a petition under the U.S. Bankruptcy Code

(“Bankruptcy Code”);

(ii) Obtained a discharge of its debts under the Bankruptcy Code; or 

(iii) Been a principal officer of a company or a general partner in a partnership that either

filed as a debtor (or had filed against it) a petition under the Bankruptcy Code or that obtained a

discharge of its debts under the Bankruptcy Code while or within one year after the officer or

general partner held the position in the company.

(2) For each bankruptcy: 

(i) State the name, address, and principal business of the debtor;

(ii) If the debtor is not the franchisor, state the relationship of the debtor to the franchisor

(e.g., affiliate, officer); and

(iii) State the date of the original filing. Identify the bankruptcy court, and the case name

and number. If applicable, state the debtor’s discharge date, including discharges under Chapter

7 and confirmation of any plans of reorganization under Chapters 11 and 13 of the Bankruptcy

Code.

(3) Disclose cases, actions, and other proceedings under the laws of foreign nations

relating to bankruptcy, as if they took place under the Bankruptcy Code.
 

5

 If fees may increase, disclose the formula that determines the increase or the maximum

amount of the increase. For example, a percentage of gross sales is acceptable if the franchisor

defines the term “gross sales.”

10

(e) Item 5: Initial Franchise Fee. 

Disclose the initial franchise fee and the conditions under which this fee is refundable. If

the initial fee is not uniform, disclose the range or the formula used to calculate the initial fees

paid in the fiscal year before the issuance date and the factors that determined the amount. For

purposes of this Item, “initial fee” means all fees and payments for services or goods received

from the franchisor before the franchisee’s business opens, whether payable in lump sum or

installments.

(f) Item 6: Recurring or Occasional Fees. 

Disclose, in the tabular form shown below, any recurring or occasional fees that the

franchisee must pay to the franchisor or its affiliates, or that the franchisor or its affiliates impose

or collect in whole or in part on behalf of a third party. Include any formula used to compute the

fees.5

(1)

Type of Fee

(2)

Amount

(3)

Due Date

(4)

Remarks

(1) In column (1), disclose the type of fee (e.g., royalties, and fees for lease negotiations,

construction, remodeling, additional training or assistance, advertising, advertising cooperatives,

purchasing cooperatives, audits, accounting, inventory, transfers, and renewals).

(2) In column (2), disclose the amount of each fee.

(3) In column (3), disclose the applicable due date for recurring fees.

(4) In column (4), include any relevant remarks, definitions, or caveats that elaborate on

the information in the table. If remarks are lengthy, franchisors may use footnotes instead of the

remarks column. If applicable, include the following information in the remarks column or in a

footnote:

(i) If the fees are payable only to the franchisor;

(ii) If the fees are imposed and collected by the franchisor;

(iii) The terms and conditions under which any fee is refundable; and 

(iv) The voting power of franchisor-owned outlets on any fees imposed by cooperatives. 

If franchisor-owned outlets have controlling voting power, disclose the maximum and minimum

fees that may be imposed.

(g) Item 7: Estimated Initial Investment. 

Disclose, in the tabular form shown below, the franchisee’s estimated initial investment.

Title the table “Your Estimated Initial Investment For The First [reasonable initial phase]

Months.” A reasonable initial phase is at least three months or a reasonable period for the

industry. Franchisors may include additional expenditure tables to show expenditure variations
11

caused by differences such as in site location and premises size.

YOUR ESTIMATED INITIAL INVESTMENT FOR THE FIRST 

[REASONABLE INITIAL PHASE] MONTHS

(1)

Type of

Expenditure

(2)

Amount

(3)

Method of 

Payment

(4)

When Due

(5)

To Whom Paid

Total

(1) In column (1), disclose each type of expense, beginning with pre-opening expenses. 

Include the following expenses, if applicable. Use footnotes to comment on expenditures.

(i) The initial franchise fee.

(ii) Training expenses. 

(iii) Real property, whether purchased or leased.

(iv) Equipment, fixtures, other fixed assets, construction, remodeling, leasehold

improvements, and decorating costs, whether purchased or leased.

(v) Inventory required to begin operation.

(vi) Security deposits, utility deposits, business licenses, and other prepaid expenses.

(vii) List separately and by name any other specific payment (e.g., additional training,

travel, or advertising expenses).

(viii) Include an additional expense category named “other payments” for any other

miscellaneous expenses that the franchisee will incur before operations begin and during the

initial phase.

(2) In column (2), state the amount of the payment. If the specific amount is not

ascertainable, use a low-high range based on the franchisor’s current experience. If real property

costs cannot be estimated in a low-high range, disclose the approximate size of the property and

building, and describe the probable location of the building (e.g., strip shopping center, mall,

downtown, rural, or highway).

(3) In column (3), disclose the method of payment.

(4) In column (4), disclose the applicable due date.

(5) In column (5), disclose to whom payment will be made.

(6) Total the initial investment, incorporating ranges of fees, if used.

(7) Disclose in a footnote: 

(i) The conditions under which each payment is refundable; and 

(ii) If the franchisor or an affiliate finances part of the initial investment, the amount that

it will finance, the required down payment, the annual percentage rate of interest, rate factors,

and the estimated loan repayments. Franchisors may refer the reader to Item 10 for additional

details.
 

6

 Franchisors may include the reason for the requirement. Franchisors are not required to

disclose in this Item the purchase or lease of goods or services provided as part of the franchise

without a separate charge (e.g., initial training, the cost for which is included in the franchise

fee); such fees should be described in paragraph (e) of this section. Franchisors should not

disclose fees already described in paragraph (f) of this section.

 

7

 Figures should be taken from the franchisor’s most recent annual audited financial

statement required in paragraph (u) of this section. If audited statements are not yet required, or

if the entity deriving the income is an affiliate, disclose the sources of information used in

computing revenues.

12

(h) Item 8: Restrictions on Sources of Products and Services. 

Disclose franchisees’ obligations to purchase or lease goods, services, fixtures,

equipment, real estate, or comparable items related to establishing or operating the franchised

business either from the franchisor, its designee, or suppliers approved by the franchisor, or

under the franchisor’s specifications. Include obligations to purchase imposed by written

agreement or by the franchisor’s practice.6 For each applicable obligation:

(1) Disclose the item required to be purchased or leased.

(2) Disclose whether the franchisor or its affiliates are either approved suppliers or the

only approved suppliers of that item.

(3) Disclose how the franchisor grants and revokes approval of alternative suppliers. 

State:

(i) The criteria for evaluating, approving, or disapproving of alternative suppliers; 

(ii) Whether the franchisor permits franchisees to contract with alternative suppliers who

meet the franchisor’s criteria;

(iii) Any fees and procedures to secure approval;

(iv) How approvals are revoked; and

(v) The time period within which the franchisee will receive notification of approval or

disapproval.

(4) Disclose whether the franchisor issues specifications and standards to franchisees,

subfranchisees, or approved suppliers. Describe how the franchisor issues and modifies

specifications.

(5) Disclose whether the franchisor or its affiliates will or may derive revenue or other

material consideration as a result of required purchases or leases by franchisees.7 Describe the

precise basis by which the franchisor or its affiliates will or may derive such consideration by

disclosing:

(i) The franchisor’s total revenue;

(ii) The franchisor’s revenues from all required purchases and leases of products and

services; 

(iii) The percentage of the franchisor’s total revenues represented by the franchisor’s

revenues from required purchases or leases; and

(iv) If the franchisor’s affiliates also sell or lease products or services to franchisees,

disclose affiliate revenues from those sales or leases.
13

(6) Disclose the estimated proportion of these required purchases and leases to all

purchases and leases by the franchisee in establishing and operating the franchised business.

(7) If a designated supplier will make payments to the franchisor as a result of purchases

by franchisees, disclose the basis for the payment (e.g., specify a percentage or a flat amount). 

For purposes of this paragraph, a “payment” includes the sale of similar goods or services to the

franchisor at a lower price than that available to franchisees.

(8) Disclose the existence of purchasing or distribution cooperatives.

(9) Disclose whether the franchisor negotiates purchase arrangements with suppliers,

including price terms, for the benefit of franchisees.

(10) Disclose whether the franchisor provides material benefits (e.g., renewal or granting

additional franchises) to a franchisee based on a franchisee’s purchase of particular products or

services or use of particular suppliers.

(i) Item 9: Franchisee’s Obligations. 

Disclose, in the tabular form shown below, a list of the franchisees’ principal obligations. 

Cross-reference each listed obligation with any applicable franchise agreement and disclosure

document section(s). Respond to each listed obligation. If a particular obligation is not

applicable, state “Not Applicable.” Include additional obligations, as is warranted.

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

purchases/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
14

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)
 

8

 Payments due within 90 days on open account financing are not required to be disclosed

under this section.

 

9

 Indirect offers of financing include a written arrangement between a franchisor or its

affiliate and a lender, for the lender to offer financing to a franchisee; an arrangement in which a

franchisor or its affiliate receives a benefit from a lender in exchange for financing a franchise

purchase; and a franchisor’s guarantee of a note, lease, or other obligation of the franchisee. 

 

10 Include specimen copies of the financing documents as an exhibit to paragraph (v) of this

section. Cite the section and name of the document containing the financing terms and

conditions. 

15

(j) Item 10: Financing.

(1) Disclose the terms and conditions of each financing arrangement,8 including leases

and installment contracts, that the franchisor, its agent, or affiliates offers directly or indirectly to

the franchisee.9 The franchisor may summarize the terms of each financing arrangement in

tabular form, using footnotes to provide additional information. For a sample Item 10 table, see

Appendix A to this part. For each financing arrangement, disclose: 

(i) A description of what the financing covers (e.g., the initial franchise fee, site

acquisition, construction or remodeling, initial or replacement equipment or fixtures, opening or

ongoing inventory or supplies, or other continuing expenses);10

(ii) The identity of the lender(s) providing the financing and any relationship to the

franchisor (e.g., affiliate);

(iii) The amount of financing offered or, if the amount depends on an actual cost that

may vary, the percentage of the cost that will be financed;

(iv) The annual percentage rate of interest (“APR”) charged, computed as provided by

Sections 106-107 of the Consumer Protection Credit Act, 15 U.S.C. 1605-1606. If the APR may

differ depending on when the financing is issued, disclose the APR on a specified recent date;

(v) The number of payments or the period of repayment;

(vi) The nature of any security interest required by the lender;

(vii) Whether a person other than the franchisee must personally guarantee the debt;

(viii) Whether the debt can be prepaid and the nature of any prepayment penalty;

(ix) The franchisee’s potential liabilities upon default, including any:

(A) Accelerated obligation to pay the entire amount due;

(B) Obligations to pay court costs and attorney’s fees incurred in collecting the debt;

(C) Termination of the franchise; or 

(D) Liabilities from cross defaults such as those resulting directly from non-payment, or

indirectly from the loss of business property; and 

(x) Other material financing terms.

(2) Disclose whether any provisions of the loan agreement require franchisees to waive

defenses or other legal rights (e.g., confession of judgment), or bar the franchisee from asserting

a defense against the lender, the lender’s assignee or the franchisor. If so, describe the relevant

provisions.
16

(3) Disclose whether the franchisor’s practice or intent is to sell, assign, or discount to a

third party all or part of the financing arrangement. If so, disclose: 

(i) The assignment terms, including whether the franchisor will remain primarily

obligated to provide the financed goods or services; and

(ii) That the franchisee may lose all its defenses against the lender as a result of the sale

or assignment.

(4) Disclose whether the franchisor or an affiliate receives any payments for the

placement of financing with the lender. If such payments exist:

(i) Disclose the amount or the method of determining the payment; and

(ii) Identify the source of the payment and the relationship of the source to the franchisor

or its affiliates.

(k) Item 11: Franchisor’s Assistance, Advertising, Computer Systems, and Training. 

Disclose the franchisor’s principal assistance and related obligations as described below. 

For each obligation, cite the section number of the franchise agreement imposing the obligation. 

Begin by stating: “Except as listed below, [the franchisor] is not required to provide any

assistance to you.” 

(1) Disclose the franchisor’s pre-opening obligations to the franchisee including any

assistance in:

(i) Locating a site and negotiating the purchase or lease of the site. Disclose:

(A) Whether the franchisor generally owns the premises and leases it to the franchisee;

(B) Whether the franchisor selects the site or approves an area within which the

franchisee selects a site. Disclose further how and whether the franchisor must approve a

franchisee-selected site;

(C) The factors that the franchisor considers in selecting or approving sites (e.g., general

location and neighborhood, traffic patterns, parking, size, physical characteristics of existing

buildings, and lease terms); 

(D) The time limit for the franchisor to locate or to approve or disapprove the site. 

Disclose further the consequences if the franchisor and franchisee cannot agree on a site.

(ii) Conforming the premises to local ordinances and building codes and obtaining any

required permits;

(iii) Constructing, remodeling, or decorating the premises;

(iv) Hiring and training employees; and

(v) Providing for necessary equipment, signs, fixtures, opening inventory, and supplies. 

In addition, disclose further:

(A) Whether the franchisor provides these items directly or merely provides the names of

approved suppliers;

(B) Whether the franchisor provides written specifications for these items; and

(C) Whether the franchisor delivers or installs these items;

(2) Disclose the typical length of time between the signing of the franchise agreement or

the first payment of consideration for the franchise and the opening of the franchisee’s business. 

Describe the factors that may affect the time period such as ability to obtain a lease, financing or

building permits, zoning and local ordinances, weather conditions, shortages, or delayed

installation of equipment, fixtures, and signs.
17

(3) Disclose the franchisor’s obligations to the franchisee during the operation of the

franchise, including any assistance in:

(i) Developing products or services to be offered by the franchisee to its customers;

(ii) Hiring and training employees;

(iii) Improving and developing the franchised business;

(iv) Establishing prices;

(v) Establishing and using administrative, bookkeeping, accounting, and inventory

control procedures; and

(vi) Resolving operating problems encountered by the franchisee.

(4) Describe the advertising program for the franchise system. Disclose the following:

(i) The franchisor’s obligation to conduct advertising, including:

(A) The media the franchisor may use; 

(B) Whether media coverage is local, regional, or national;

(C) The source of the advertising (e.g., an in-house advertising department or a national

or regional advertising agency); and

(D) Whether the franchisor must spend any amount on advertising in the area or territory

where the franchisee is located.

(ii) Disclose the conditions under which the franchisor permits franchisees to use their

own advertising material.

(iii) Disclose whether there is an advertising council composed of franchisees that

advises the franchisor on advertising policies. If so, disclose:

(A) How members of the council are selected;

(B) Whether the council serves in an advisory capacity only or has operational or

decision-making power; and 

(C) Whether the franchisor has the power to form, change, or dissolve the advertising

council.

(iv) Disclose whether the franchisee must participate in a local or regional advertising

cooperative. If so, disclose:

(A) How the area or membership of the cooperative is defined;

(B) How much the franchisee must contribute to the fund and whether other franchisees

are required to contribute at a different rate;

(C) Whether the franchisor-owned outlets must contribute to the fund and, if so, whether

it is on the same basis as franchisees;

(D) Who is responsible for administration of the cooperative (e.g., franchisor, 

franchisees, or advertising agency);

(E) Whether cooperatives must operate from written governing documents and whether

the documents are available for review by the franchisee;

(F) Whether cooperatives must prepare annual or periodic financial statements and

whether the statements are available for review by the franchisee; and

(G) Whether the franchisor has the power to require cooperatives to be formed, changed,

dissolved, or merged.

(v) Disclose whether the franchisee must participate in any other advertising fund. If so,

disclose:

(A) Who contributes to the fund;
18

(B) How much the franchisee must contribute to the fund and whether other franchisees

are required to contribute at a different rate;

(C) Whether the franchisor-owned outlets must contribute to the fund and, if so, whether

it is on the same basis as franchisees;

(D) Who administers the fund; 

(E) Whether the fund is audited and when it is audited;

(F) Whether financial statements of the fund are available for review by the franchisee;

and

(G) Use of the fund in the most recently concluded fiscal year, the percentages spent on

production, media placement, administrative expenses, and a description of any other use.

(vi) If all advertising funds are not spent in the fiscal year in which they accrue, explain

how the franchisor uses the remaining amount. Indicate whether franchisees will receive a

periodic accounting of how advertising fees are spent.

(vii) Disclose the percentage of advertising funds, if any, that the franchisor uses

principally to solicit new franchise sales.

(5) Disclose whether the franchisor requires the franchisee to buy or use electronic cash

registers or computer systems. If so, describe the systems generally in non-technical language.

(i) Identify each hardware component and software program by brand, type, and principal

functions.

(A) If the hardware component or software program is the proprietary property of the

franchisor, an affiliate, or a third party, state whether the franchisor, an affiliate, or a third party

has the contractual right or obligation to provide ongoing maintenance, repairs, upgrades, or

updates. Disclose the current annual cost of any optional or required maintenance and support

contracts, upgrades, and updates;

(B) If the hardware component or software program is the proprietary property of a third

party, and no compatible equivalent component or program has been approved by the franchisor

for use with the system to perform the same functions, identify the third party by name, business

address, and telephone number, and state the length of time the component or program has been

in continuous use by the franchisor and its franchisees;

(C) If the hardware component or software program is not proprietary, identify

compatible equivalent components or programs that perform the same functions and indicate

whether they have been approved by the franchisor.

(ii) State whether the franchisee has any contractual obligation to upgrade or update any

hardware component or software program during the term of the franchise and, if so, whether

there are any contractual limitations on the frequency and cost of the obligation.

(iii) For each electronic cash register system or software program, describe how it will be

used in the franchisee’s business, and the types of business information or data that will be

collected and generated. State further whether the franchisor will have independent access to the

information and data and, if so, whether there are any contractual limitations on the franchisor’s

right to access the information and data.

(6) Disclose the table of contents of the franchisor’s operating manual(s) provided to

franchisees as of the franchisor’s last fiscal year-end or a more recent date. State further the

number of pages devoted to each subject and the total number of pages in the manual as of this

date. Alternatively, this disclosure may be omitted if the prospective franchisee views the
19

manual before purchase of the franchise.

(7) Disclose the franchisor’s training program as of the franchisor’s last fiscal year-end

or a more recent date.

(i) Describe the nature of the training program summarized in tabular form, as follows:

TRAINING PROGRAM

Subject Hours of Classroom

Training

Hours of On-The-Job

Training

Location

Su

(A) In column (1), state the subjects taught.

(B) In column (2), state the hours of classroom training for each subject.

(C) In column (3), state the hours of on-the-job training for each subject.

(D) In column (4), state the location of the training for each subject. 

(ii) Disclose how often training classes are held and the nature of the location or facility

where training is held (e.g., company, home, office, franchisor-owned store).

(iii) Describe the nature of instructional materials and the instructor’s experience. State

the length of experience of the instructor in the field and, specifically, with the franchisor. State

only the experience that is relevant to the subject taught and the franchisor’s operations;

(iv) Disclose any charges franchisees must pay for training and who must pay travel and

living expenses of the enrollees in the training program;

(v) Disclose who may and who is required to attend the training. State whether the

franchisee or other persons must complete the program to the franchisor’s satisfaction. If

successful completion is required, state how long after the signing of the agreement or before the

opening of the business the training must be completed. If training is not mandatory, state the

percentage of new franchisees that enrolled in the training program during the preceding 12

months; and

(vi) Whether any additional training programs and/or refresher courses are required. 

(l) Item 12: Territory.

(1) Disclose the following information concerning the franchisee’s market area (with or

without an exclusive territory):

(i) If applicable, the minimum area granted to the franchisee (e.g., a specific radius, a

distance sufficient to encompass a specified population, or another specific designation);

(ii) Whether the franchise is granted for a specific location or a location to be approved

by the franchisor;

(iii) Any conditions under which the franchisor will approve the relocation of the

franchised business or the franchisee’s establishment of additional franchised outlets;

(iv) Whether the franchisor has established or may establish another franchisee who may

also use the franchisor’s trademark within the defined area;

(v) Whether the franchisor has established or may establish franchisor-owned outlets or

other channels of distribution using the franchisor’s trademark within the defined area; 

(vi) Whether the franchisor or its affiliate has established or may establish other
20

franchises or franchisor-owned outlets or another channel of distribution selling or leasing

similar products or services under a different trademark within the defined area;

(vii) Restrictions on the franchisor regarding operating franchisor-owned stores or on

granting franchised outlets for a similar or competitive business within the defined area;

(viii) Restrictions on franchisees from soliciting or accepting orders outside of their

defined territories;

(ix) Restrictions on the franchisor from soliciting or accepting orders inside the

franchisee’s defined territory. State further any compensation that the franchisor must pay for

soliciting or accepting orders inside the franchisee’s defined territories; and

(x) Franchisee options, rights of first refusal, or similar rights to acquire additional

franchises within the territory or contiguous territories.

(2) Describe any exclusive territory granted the franchisee.

(i) If the franchisor grants an exclusive territory, disclose:

(A) Whether continuation of the franchisee’s territorial exclusivity depends on

achievement of a certain sales volume, market penetration, or other contingency, and under what

circumstances the franchisee’s territory may be altered. Specify any sales or other conditions. 

State the franchisor’s rights if the franchisee fails to meet the requirements; and

(B) Any other circumstances that permit the franchisor to modify the franchisee’s

territorial rights (e.g., a population increase in the territory giving the franchisor the right to grant

an additional franchise within the area), and the effect of such modifications on the franchisee’s

rights;

(ii) If the franchisor does not grant exclusive territories, state: “You will not receive an

exclusive territory. [Franchisor] may establish other franchised or franchisor-owned outlets that

may compete with your location.”

(3) If the franchisor or an affiliate operates, franchises, or has present plans to operate or

franchise a business under a different trademark and that business sells goods or services similar

to those to be offered by the franchisee, describe:

(i) The similar goods and services;

(ii) The trade names and trademarks;

(iii) Whether outlets will be franchisor owned or operated:

(iv) Whether the franchisor or its franchisees who use the different trademark will solicit

or accept orders within the franchisee’s territory;

(v) A timetable for the plan;

(vi) How the franchisor will resolve conflicts between the franchisor and the franchisees

and between the franchisees of each system regarding territory, customers or franchisor support;

and

(vii) The principal business address of the franchisor’s similar operating business. If it is

the same as the franchisor’s principal business address disclosed in Item 1, disclose whether the

franchisor maintains (or plans to maintain) physically separate offices and training facilities for

the similar competing business.

(m) Item 13: Trademarks.

(1) Disclose each principal trademark to be licensed to the franchisee. For purposes of

this Item, “principal trademark” means the primary trademarks, service marks, names, logos, and
 

11 Franchisors may include a summary opinion of counsel concerning any action if a consent

to use the summary opinion is included as part of the disclosure document.

21

commercial symbols to be used by the franchisee to identify the franchised business. It does not

include every trademark owned by the franchisor.

(2) For each principal trademark, disclose whether the trademark is registered with the

United States Patent and Trademark Office. 

(i) For each registration, state:

(A) The date and identification number of each trademark registration or registration

application; 

(B) Whether the franchisor has filed all required affidavits;

(C) Whether any registration has been renewed; and

(D) Whether the principal trademarks are registered on the Principal or Supplemental

Register of the U.S. Patent and Trademark Office, and if not, whether an “intent to use”

application or an application based on actual use has been filed with the U.S. Patent and

Trademark Office.

(ii) If the trademark is not registered on the Principal Register of the U.S. Patent and

Trademark Office, state: “By not having a Principal Register federal registration for [name or

description of symbol], [name of franchisor] does not have certain presumptive legal rights

granted by a registration.”

(3) Disclose any currently effective material determinations of the U.S. Patent and

Trademark Office, the Trademark Trial and Appeal Board, or the trademark administrator of any

State or court; and any pending infringement, opposition, or cancellation proceeding. Include

infringement, opposition, or cancellation proceedings in which the franchisor unsuccessfully

sought to prevent registration of a trademark in order to protect a trademark licensed by the

franchisor. Describe how the determination affects the franchised business.

(4) Disclose any pending material federal or State litigation regarding the franchisor’s

use or ownership rights in a trademark. For each pending action, disclose:11

(i) The forum and case number;

(ii) The nature of claims made opposing the franchisor’s use or by the franchisor

opposing another person’s use; and

(iii) Any effective court or administrative agency ruling concerning the matter.

(5) Disclose agreements currently in effect that significantly limit the rights of the

franchisor to use or license the use of trademarks listed in this Item in a manner material to the

franchise. For each agreement, disclose:

(i) The manner and extent of the limitation or grant;

(ii) The extent to which the franchisee may be affected by the agreement;

(iii) The agreement’s duration;

(iv) The parties to the agreement;

(v) The circumstances under which the agreement may be canceled or modified; and

(vi) All other material terms.

(6) Disclose whether the franchisor must protect the franchisee’s right to use the

principal trademarks listed in this Item, and must protect the franchisee against claims of
22

infringement or unfair competition arising out of the franchisee’s use of the trademarks. 

Disclose further:

(i) The franchisee’s obligation to notify the franchisor of the use of, or claims of rights

to, a trademark identical to or confusingly similar to a trademark licensed to the franchisee;

(ii) Whether the franchise agreement requires the franchisor to take affirmative action

when notified of these uses or claims. Identify who has the right to control administrative

proceedings or litigation;

(iii) Whether the franchise agreement requires the franchisor to participate in the

franchisee’s defense and/or indemnify the franchisee for expenses or damages if the franchisee is

a party to an administrative or judicial proceeding involving a trademark licensed by the

franchisor to the franchisee, or if the proceeding is resolved unfavorably to the franchisee; and

(iv) The franchisee’s rights under the franchise agreement if the franchisor requires the

franchisee to modify or discontinue the use of a trademark. 

(7) Disclose whether the franchisor actually knows of either superior prior rights or

infringing uses that could materially affect the franchisee’s use of the principal trademarks in the

State in which the franchised business is to be located. For each use of a principal trademark that

the franchisor believes constitutes an infringement that could materially affect the franchisee’s

use of a trademark, disclose:

(i) The nature of the infringement;

(ii) The location(s) where the infringement is occurring;

(iii) The length of time of the infringement (to the extent known); and 

(iv) Action taken by the franchisor.

(n) Item 14: Patents, Copyrights, and Proprietary Information.

(1) Disclose whether the franchisor owns rights in patents or copyrights that are material

to the franchise. For each patent or copyright:

(i) Describe the patent or copyright and its relationship to the franchise;

(ii) State the duration of the patent or copyright;

(iii) For copyrights, state:

(A) The registration number and date of each copyright; and.

(B) Whether the franchisor can and intends to renew the copyright.

(iv) For patents, state:

(A) The patent number, issue date, and title for each patent, and the serial number, filing

date, and title of each patent application; and

(B) Describe the type of patent or patent application (e.g., mechanical, process, or

design). 

(2) Describe any current material determination of the U.S. Patent and Trademark Office,

the U.S. Copyright Office, or a court regarding the patent or copyright. Include the forum and

case number. Describe how the determination affects the franchised business.

(3) State the forum, case number, claims asserted, issues involved, and effective

determinations for any material proceeding pending in the U.S. Patent and Trademark Office or
 

12 Franchisors may include a summary opinion of counsel concerning any action if a consent

to use the summary opinion is included as part of the disclosure document.

23

the U.S. Court of Appeals for the Federal Circuit.12

(4) If an agreement limits the use of the patent, patent application, or copyright, state the

parties to and duration of the agreement, the extent to which the franchisee may be affected by

the agreement, and other material terms of the agreement.

(5) Disclose the franchisor’s obligation to protect the patent, patent application, or

copyright and to defend the franchisee against claims arising from the franchisee’s use of the

patented or copyrighted items. Disclose further:

(i) Whether the franchisee must notify the franchisor of claims or infringements or if the

action is discretionary;

(ii) Whether the franchise agreement requires the franchisor to take affirmative action

when notified of infringement. Disclose who has the right to control litigation;

(iii) Whether the franchisor must participate in the defense of a franchisee or indemnify

the franchisee for expenses or damages in a proceeding involving a patent, patent application, or

copyright licensed to the franchisee;

(iv) Requirements that the franchisee modify or discontinue use of the subject matter

covered by the patent or copyright; and

(v) The franchisee’s rights under the franchise agreement if the franchisor requires the

franchisee to modify or discontinue use of the subject matter covered by the patent or copyright. 

(6) If the franchisor actually knows of an infringement that could materially affect the

franchisee, disclose:

(i) The nature of the infringement;

(ii) The location(s) where the infringement is occurring;

(iii) The length of time of the infringement; and 

(iv) Action taken or anticipated by the franchisor.

(7) If the franchisor claims proprietary rights in other confidential information or trade

secrets, describe in general terms the proprietary information communicated to the franchisee and

the terms and conditions for use by the franchisee. The franchisor need only describe the general

nature of the proprietary information, such as whether a formula or recipe is considered to be a

trade secret. 

(o) Item 15: Obligation to Participate in the Actual Operation of the Franchise Business.

(1) Disclose the franchisee’s obligation to participate personally in the direct operation of

the franchise business and whether the franchisor recommends participation. Include obligations

arising from any written agreement or from the franchisor’s practice.

(2) If personal “on-premises” supervision is not required, disclose the following:

(i) If the franchisee is an individual, state:

(A) Whether the franchisor recommends on-premises supervision by the franchisee; 

(B) Limitations on whom the franchisee can hire as an on-premises supervisor, and 

(C) Whether an on-premises supervisor must successfully complete the franchisor’s

training program.
24

(ii) If the franchisee is a business entity, state the amount of equity interest that the onpremises supervisor must have in the franchise.

(3) Disclose any restrictions that the franchisee must place on its manager (e.g., maintain

trade secrets, covenants not to compete).

(p) Item 16: Restrictions on What the Franchisee May Sell. 

Disclose any franchisor-imposed restrictions or conditions on the goods or services that

the franchisee may sell or that limit the franchisee’s customers. Disclose further:

(1) Any obligation on the franchisee to sell only goods and services approved by

the franchisor;

(2) Any obligation on the franchisee to sell all goods and services authorized by

the franchisor; 

(3) Whether the franchisor has the right to change the types of authorized goods and

services and whether there are limits on the franchisor’s right to make changes; and

(4) Any restrictions on the franchisee’s customers.

(q) Item 17: Renewal, Termination, Transfer, and Dispute Resolution. 

Disclose, in the tabular form shown below, a table that cross-references each enumerated

franchise relationship item with the applicable provision in the franchise or related agreement. 

Summarize briefly each contractual provision. If a particular item is not applicable, state “Not

Applicable.” If the agreement is silent concerning one of the listed provisions, but the franchisor

unilaterally offers to provide certain benefits or protections to franchisees as a matter of policy,

use a footnote to describe this policy and state whether the policy is subject to change. 

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.

Provision Section in franchise or other

agreement

Summary

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
25

f. Termination by franchisor

with cause

g. “Cause” defined - curable

defaults

h. “Cause” defined -

noncurable 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
26

u. Dispute resolution by

arbitration or mediation

v. Choice of forum

w. Choice of law

(r) Item 18: Public Figures. 

Disclose the following information about any public figures involved in the franchise. A

public figure means a person whose name or physical appearance is generally known to the

public in the geographic area where the franchise will be located. 

(1) Any compensation paid or promised to a public figure arising from either the use of

the public figure in the franchise name or symbol; or the endorsement or recommendation of the

franchise to prospective franchisees.

(2) The extent to which the public figure is involved in the actual management or control

of the franchisor. Describe the public figure’s position and duties in the franchisor’s business

structure.

(3) The total investment of the public figure in the franchisor. Describe the extent of the

amount contributed in services performed or to be performed. State the type of investment (e.g.,

common stock, promissory note).

(s) Item 19: Financial Performance Representations.

(1) All franchisors begin by stating: 

The FTC’s Franchise Rule permits a franchisor to provide information about the

actual or potential financial performance of its franchised and/or franchisor-owned

outlets, if there is a reasonable basis for the information, and if the information is

included in the disclosure document. Financial performance information that differs

from that included in Item 19 may be given only where: a franchisor provides the

actual records of an existing outlet you are considering buying; or a franchisor

provides financial performance information in paragraph (s) of this section and

supplements that information by providing, for example, information about possible

performance at a particular location.

(2) If a franchisor does not provide any financial performance representations, also state:

This franchisor does not make any representations about a franchisee’s financial

performance. We also do not authorize our employees or representatives to make

any such representations either orally or in writing. If you receive any financial

performance information or projections of your future income, you should report

it to the franchisor’s management by contacting [name and address of person to be

notified], the Federal Trade Commission, and the appropriate State regulatory

agencies.
 

13 If a financial performance representation is a representation concerning historical financial

performance or if historical financial performance data are used as the basis for a forecast of

future earnings, the historical data must be prepared according to U.S. generally accepted

accounting principles.

 

14 A statement or prediction of future performance that is prepared as a forecast in accordance

with the statement on standards for accountants’ services on prospective financial information (or

its successor) issued by the American Institute of Certified Public Accountants, Inc., is presumed

to have a reasonable basis.

 

15 An historical financial performance representation will have a reasonable basis if it is

representative of the usual experience of the system’s outlets or a subset of those outlets that

share specified characteristics. A representation would not have a reasonable basis if, for

example, only a small minority of the stated set of franchisees earn such an amount, if profits

were due to non-recurring conditions, or if the franchisees used inconsistent systems for reporting

financial performance information.

27

(3) If the franchisor makes any financial performance representations to prospective

franchisees, the franchisor must have a reasonable basis and written substantiation for the

representations at the time they are made, and must state the representations in its Item 19

disclosure. The franchisor must also disclose the following:

(i) Whether the representation is an historical financial performance representation about

the franchise system’s existing outlets,13 or a subset of those outlets, or is a forecast of the

prospective franchisee’s future financial performance.14

(ii) If the representation relates to the past performance of the franchise system’s existing

outlets, disclose the material bases for the representation, including: 

(A) Whether the representation relates to the performance of all of the franchise system’s

existing outlets or only to a subset of outlets that share a particular set of characteristics (e.g.,

geographic location, type of location (such as free standing vs. shopping center), degree of

competition in the market area, length of time the outlets have been in operation, services or

goods sold, services supplied by the franchisor, and whether the units are franchised or

franchisor-owned or operated); 

(B) The dates during which the reported level of financial performance was achieved;

(C) The total number of outlets that existed in the relevant period and, if different, the

number of outlets that had the described characteristics; 

(D) The number of outlets with the described characteristics whose actual financial

performance data were utilized in arriving at the representation;

(E) Of those outlets whose data were utilized in arriving at the representation, the

number and percent that actually attained or surpassed the stated results;15 and 

(F) Characteristics of the included outlets, such as those noted in paragraph (s)(3)(i) of

this section, that may differ materially from those of the outlet that may be offered to a

prospective franchisee.

(iii) If the representation is a forecast of future financial performance, state the material
 

16 Franchisors must possess written substantiation for any financial performance

representations and must make this substantiation available to prospective franchisees and the

Commission upon reasonable request. The franchisor may impose reasonable time and place

limitations, and may restrict copying of documents. However, restrictions that as a practical

matter frustrate a franchisee’s ability to review the franchisor’s financial performance

information will be deemed to violate the Rule. See Section 436.10(c) (prohibition on failing to

make information available). In order to protect franchisees from unwarranted disclosure of

sensitive financial information, the franchisor may delete information that might identify the

franchisee. This limitation, however, does not apply to disclosures made to the Commission.

28

bases and assumptions on which the projection is based. The material assumptions underlying a

forecast include significant factors upon which a franchisee’s future results are expected to

depend. These factors include, for example, economic or market conditions that are basic to a

franchisee’s operation, and encompass matters affecting, among other things, a franchisee’s

sales, the cost of goods or services sold, and operating expenses;

(iv) Include a conspicuous admonition that a new franchisee’s individual financial results

may differ from the result stated in the financial performance representation; and

(v) State that written substantiation for the financial performance representation will be

made available to the prospective franchisee upon reasonable request.

16

 

(4) If a franchisor wishes to disclose only the actual operating results for a specific outlet

being offered for sale, it is not required to comply with this section, provided the information is

given only to potential purchasers of that outlet and is accompanied by the name and last known

address of each owner of the outlet during the prior three years.

(5) If financial performance representations are provided in paragraph (s) of this section,

the franchisor may deliver to a prospective franchisee a supplemental financial performance

representation about a particular location or variation, apart from the disclosure document. The

supplemental representation must:

(i) be in writing; 

(ii) explain the departure from the financial performance representation in the disclosure

document; 

(iii) be prepared in accordance with the requirement set forth above in paragraph

(s)(3)(i)-(iii) of this section; and 

(iv) be left with the prospective franchisee.

(t) Item 20: Outlets and Franchisee Information.

(1) Disclose, in the tabular form shown below, the status of franchised outlets by State

for each of the franchisor’s last three fiscal years. For purposes of paragraph, “outlets” includes

outlets of a type substantially similar to that offered to the prospective franchisee. A sample Item

20(1) Table is attached as Appendix B to this part.
29

FRANCHISED OUTLETS SUMMARY FOR YEARS

[YR-3 - YR-1]

(1)

State

and 

Year

(2)

Outlets at

Beginning of 

Fiscal

Year

(3)

Outlets

With

Same

Ownership at

End of

Fiscal

Year

(4)

Outlets

Terminated

by

Franchisor

During the

Fiscal Year

(5)

Outlets

Reacquired

by

Franchisor

During the

Fiscal Year

(6)

Outlets

Transferred by

Franchisee

to New

Owner

During the

Fiscal Year

(7)

Outlets

That

Were Not

Renewed

During

the Fiscal

Year 

(8)

Outlets

That

Ceased

Operation

or Closed

for Other

Reasons

During the

Fiscal Year

(9)

Total

Number of

Outlets

Discontinued During

the Fiscal

Year

(10)

Total

Outlets 

in

Operation

at End of

Fiscal

Year

State

YR-1

YR-2

YR-3

Totals

YR-1

YR-2

YR-3

(i) In column (1), list each State where one or more franchised outlets are located. 

Below each State, list each of the last three fiscal years.

(ii) In column (2), disclose the number of outlets in each State in operation at the

beginning of each fiscal year.

(iii) In column (3), disclose the number of outlets in each State where the controlling

ownership of the outlet did not change during the year.

(iv) In column (4), disclose the number of outlets in each State where the franchisee

operating the outlet at the beginning of the fiscal year did not operate the outlet at the end of the

fiscal year because the franchisor terminated or canceled the franchise agreement without

providing any consideration to the franchisee (whether by payment or forgiveness or assumption

of debt) before the end of the agreement term. For purposes of this Item, a termination or

cancellation occurs when the franchisor sends the franchisee an unconditional notice of intent to

exercise its right to terminate or cancel the franchise agreement.

(v) In column (5), disclose the number of outlets in each State where the franchisee

operating the outlet at the beginning of the fiscal year did not operate the outlet at the end of the

fiscal year because the franchisor reacquired the outlet for consideration (whether by payment or

forgiveness or assumption of debt) from that franchisee before the end of the agreement term.

(vi) In column (6), disclose the number of outlets in each State where the franchisee

operating the outlet at the beginning of the fiscal year did not operate the outlet at the end of the

fiscal year because that franchisee transferred controlling interest in the franchise to one or more

new owners, other than the franchisor or an affiliate, before the end of the agreement term.
30

(vii) In column (7), disclose the number of outlets in each State where the franchisee

operating the outlet at the beginning of the fiscal year did not operate the outlet at the end of the

fiscal year because the franchise agreement was not renewed at the end of its term. For purposes

of this Item, a nonrenewal occurs when the franchisor sends the franchisee an unconditional

notice of intent to exercise its right not to renew the franchise agreement after it expires.

(viii) In column (8), disclose the number of outlets in each State where the franchisee

operating the outlet at the beginning of the fiscal year did not operate the outlet at the end of the

fiscal year for reasons other than termination, reacquisition, transfer, or post-term non-renewal

(include here outlets that are still owned by the franchisee operating the outlet at the beginning of

the fiscal year, but which have ceased to do business under the franchise agreement).

(ix) In column (9), disclose the total number of outlets in the State where a franchisee

operating an outlet at the beginning of the year did not continue to operate the outlet at the end of

the fiscal year. This figure should be the sum of the figures in columns (4) through (8).

(x) In column (10), disclose the number of outlets in each State in operation at the end of

the fiscal year. 

(xi) Report the ownership status of each outlet only once. The sum of columns (3) and

(9) should equal the number of outlets at the beginning of the fiscal year (column 2). If an outlet

is involved in more than one ownership change in a given fiscal year, report only the change in

ownership by the franchisee operating the outlet at the beginning of the year. If the change in

ownership of an outlet could be reported in more than one category, report only the event that

occurred first chronologically.

(2) Disclose, in the tabular form shown below, a table showing the status of franchisorowned outlets by State for each of the franchisor’s last three fiscal years. A sample Item 20(2)

Table is attached as Appendix C to this part.
31

FRANCHISOR-OWNED OUTLETS SUMMARY

FOR [ YR-3 - YR-1]

(1)

State and Year

(2)

Outlets

Operating at the

Beginning of the

Fiscal Year

(3)

Outlets Opened

During the

Fiscal Year

(4)

Outlets Closed

During the

Fiscal Year

(5)

Total Number of

Outlets at the

End of the Fiscal

Year

State

YR-1

YR-2

YR-3

Totals

YR-1

YR-2

YR-3

(i) In column (1), list each State where one or more franchisor-owned outlets are located. 

Below each State, list each of the last three fiscal years.

(ii) In column (2), disclose the number of franchisor-owned outlets in each State

operating at the beginning of each fiscal year.

(iii) In column (3), disclose the number of franchisor-owned outlets opened in each State

during each fiscal year.

(iv) In column (4), disclose the number of franchisor-owned outlets closed in each State

during each fiscal year.

(v) In column (5), disclose the number of franchisor-owned outlets in operation in each

State at the end of each fiscal year.

(3) Disclose, in the tabular form shown below, an estimate for each applicable State that

reflects the number of franchised and franchisor-owned outlets to be opened during the one-year

period after the close of the franchisor’s most recent fiscal year. A sample Item 20(3) Table is

attached as Appendix D to this part.
32

PROJECTED OPENINGS

AS OF [Close of Fiscal Year]

(1)

State

(2)

Franchise

Agreements Signed

But Outlet Not Open

(3)

Projected Franchised

Outlets in the Next

Fiscal Year

(4)

Projected FranchisorOwned Outlets in the

Next Fiscal Year

TOTALS

(i) In column (1), list each State where the franchisor has signed a franchise agreement,

but the outlet is not yet opened, as well as each State where the franchisor expects to open a new

outlet (franchisor-owned or franchised) in the next fiscal year.

(ii) In column (2), disclose the number of franchise agreements signed in each State

where the outlet is not yet opened.

(iii) In column (3), disclose the projected number of new franchised outlets in each State

in the next fiscal year.

(iv) In column (4), disclose the projected number of new franchisor-owned outlets in the

next fiscal year.

(4) Disclose the names of all current franchisees and the address and telephone number

of each of their outlets. In the alternative, the franchisor may disclose all franchised outlets in the

State, but if these franchised outlets total fewer than 100, disclose franchised outlets from

contiguous States and then the next closest State(s) until at least 100 franchised outlets are listed.

(5) Disclose the name and last known home address and telephone number of every

franchisee who has had an outlet terminated, canceled, not renewed, or otherwise voluntarily or

involuntarily ceased to do business under the franchise agreement during the most recently

completed fiscal year or who has not communicated with the franchisor within 10 weeks of the

disclosure document issuance date.

(6) If franchisees have signed gag clauses in a franchise agreement, settlement, or in any

other contract, during the last three fiscal years:

(i) State: “In some instances, current and former franchisees sign provisions restricting

their ability to speak openly about their experience with [name of franchise system]. While we

encourage you to speak with current and former franchisees, be aware that not all such

franchisees will be able to communicate with you.”

(ii) Franchisors may also disclose the number and percentage of current and former

franchisees who during each of the last three fiscal years have signed agreements that include gag

clauses and may disclose the circumstances under which such clauses were signed.

(7) Disclose the name, address, and telephone number of each trademark-specific

franchisee organization associated with the franchise system being offered, if such organization:

(i) Has been created, supported, or recognized by the franchisor; or 

(ii) Is incorporated and asks the franchisor to be included in the franchisor’s disclosure
33

document during the next fiscal year. All such organizations must renew their request for

inclusion in disclosure documents on an annual basis. The franchisor has no obligation to verify

the organization’s continued existence during or at the end of each fiscal year.

(u) Item 21: Financial Statements.

(1) Include the following financial statements prepared according to generally accepted

United States accounting principles. Except as provided in paragraph (u)(2) of this section, these

financial statements must be audited by an independent certified public accountant. Present the

required financial statements in a tabular form that compares at least two fiscal years. 

(i) Financial statements: The franchisor’s balance sheet for the previous two fiscal

year-ends before the disclosure document issuance date. In addition, include statements of

operations, of stockholders equity, and of cash flows for each of the franchisor’s previous three

fiscal years.

(ii) Affiliated company statements: Instead of the disclosure required by paragraph

(u)(1)(i) of this section, the franchisor may include financial statements of its affiliated company

if the affiliated company’s financial statements satisfy paragraph (u)(1)(i) and the affiliated

company absolutely and unconditionally guarantees to assume the duties and obligations of the

franchisor under the franchise agreement. The affiliate’s guarantee must cover all of the

franchisor’s obligations to the franchisee, but is not required to extend to third parties. If this

alternative is used, disclose the existence of a guarantee. 

(iii) Consolidated and separate statements: 

(A) When a franchisor owns a direct or beneficial controlling financial interest in another

corporation, its financial statements should reflect the financial condition of the franchisor and its

subsidiaries.

(B) Include separate financial statements for the franchisor and any subfranchisor or

comparable entity.

(C) Include separate financial statements for a company controlling 80 percent or more

of a franchisor.

(2) To the extent that start-up franchise systems do not yet have audited financial

statements, they may phase-in the use of audited financial statements according to the following

schedule: 
34

(i) If this is the franchisor’s: The following financial statements included in

the franchisor’s disclosure document must be

audited:

(A) First partial or full fiscal year selling

franchises. 

None.

(B) Second fiscal year selling franchises. Balance sheet opinion as of the end of the last

fiscal year.

(C) 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 paragraph (u)(1)(i) of

this section. 

(ii) Audited financial statements shall be prepared as soon as practicable. 

(iii) Unaudited statements should be in a format that conforms as closely as possible to

audited statements. 

(iv) Disclose clearly and conspicuously in paragraph (u) of this section the following, if

applicable: 

(A) The franchisor has not been in business for three years or more, and cannot include

all of the financial statements required in paragraph (u)(1)(i) of this section; or

(B) The franchisor includes one or more years of unaudited financial statements.

(v) In the event a start-up franchise system begins offering franchises before the close of

its first full fiscal year of operations, provide at a minimum the company’s unaudited opening

balance sheet.

(v) Item 22: Contracts. Attach a copy of all proposed agreements regarding the

franchise offering, including the franchise agreement and any lease, options, and purchase

agreements.

(w) Item 23: Receipt.

(1) Include the following detachable acknowledgment of receipt in the form set out

below.

(i) State the following:

This disclosure document summarizes certain provisions of the franchise

agreement and other information in plain language. Read this disclosure

document and all agreements carefully.

If [name of franchisor] offers you a franchise, it must provide this disclosure

document to you 14 days before the earlier of:

(1) the signing of a binding agreement; or

(2) any payment to [name of franchisor or affiliate].
35

You must also receive a franchise agreement containing all material terms at least

five days before you sign a franchise agreement.

If [name of franchisor] does not deliver this disclosure document on time or if it

contains a false or misleading statement, or a material omission, a violation of

federal law and State law may have occurred and should be reported to the Federal

Trade Commission, Washington, D.C. 20580 and [State agency].

(ii) Disclose the name, principal business address, and telephone number of any

subfranchisor or franchise broker offering the franchise.

(iii) State the issuance date.

(iv) If not disclosed in section 436.5(a), state the name and address of the franchisor’s

registered agent authorized to receive service of process.

(v) Provide the following statement:

I have received a disclosure document dated _____ that included the following

Exhibits:”

(vi) List the title of all attached Exhibits.

(vii) Provide a space for the franchisee’s signature and date.

(viii) Franchisors may include any specific instructions for returning the receipt (e.g.,

street address, E-mail address, facsimile telephone number).

(2) Franchisors shall obtain a signed copy of the receipt at least 5 days before the

franchise agreement is signed or the prospective franchisee pays any fee in connection with the

franchise sale.

(3) For each completed franchise sale, franchisors shall retain a copy of the signed receipt

for a period of at least 3 years.

SUBPART D - Instructions

§ 436.6 Instructions for Preparing Disclosure Documents 

(a) Disclose the information required in sections 436.3 - 436.5 clearly, legibly, and

concisely stated in a single document, using plain English.

(b) Respond fully to each disclosure Item. If a particular disclosure Item is not

applicable, respond negatively, including a reference to the type of information required to be

disclosed by the Item. Precede each disclosure Item with the appropriate heading.

(c) Do not include any materials or information other than that required by this Rule or

by State law not preempted by this Rule. Franchisors may prepare multi-State disclosure

documents by including State-specific information in the text of the disclosure document or in

Exhibits attached to the disclosure document.

(d) Subfranchisors should disclose the required information about the franchisor, and, to

the extent applicable, the same information concerning the subfranchisor.
36

§ 436.7 Instructions For Electronic Disclosure Documents. Franchise sellers can

furnish disclosures electronically under the following conditions:

(a) The prospective franchisee expressly consents to accept the disclosures in the

electronic medium offered by the franchise seller. Prospective franchisees, however, always

retain the right to obtain a paper disclosure document from the franchise seller up until the time

of the sale.

(b) The franchise seller simultaneously furnishes the prospective franchisee with a paper

summary document containing only the following three items from the franchisor’s disclosure

document:

(1) The cover page;

(2) The table of contents; and

(3) Two copies of the franchisor’s Item 23 Receipt, with instructions to acknowledge

receipt through a signature.

(c) The electronic version of the franchisor’s disclosure document must be capable of

being printed, downloaded onto computer disk, or otherwise preserved by a prospective

franchisee as one single document. 

(d) The electronic version of the franchisor’s disclosure document must be a selfcontained document that is the functional equivalent of a paper disclosure document. A

prospective franchisee must be able to read each part of the disclosure document, including

attachments, without having to take any affirmative action other than scrolling through the

document.

(e) For the sole purpose of enhancing the prospective franchisee’s ability to maneuver

through the electronic version of the disclosure document, the franchisor may include scroll bars,

internal links, and search features. All other features (e.g., multimedia tools such as audio, video,

animation, or pop-up screens) are prohibited.

(f) The electronic version of the franchisor’s disclosure document must remain accessible

at least until the time of the sale. An electronic version will still be deemed accessible if

technological failures occur that are beyond the franchisor’s reasonable control. Further, an

electronic version on the Internet will be deemed accessible if it is updated and replaced with a

more current version.

(g) Franchisors furnishing disclosure documents electronically must retain, and make

available to the Commission upon request, a specimen copy of each materially different version

of their electronic disclosure documents for a period of three years.
37

§ 436.8 Instructions For Updating Disclosures

(a) All information contained in the disclosure document shall be current as of the close

of the franchisor’s most recent fiscal year. After the close of the fiscal year, the franchisor shall,

within 90 days, prepare a revised disclosure document, after which the franchisor may distribute

only the revised document and no other. 

(b) The franchisor shall, within a reasonable time after the close of each quarter of the

fiscal year, prepare revisions to be attached to the disclosure document to reflect any material

change in the franchisor or relating to the franchise business of the franchisor. Each prospective

franchisee shall receive the disclosure document and the quarterly revisions for the most recent

period available at the time. 

(c) When furnishing a disclosure document, the franchise seller shall notify the

prospective franchisee of any additional material change in the franchisor, the franchise business,

or franchise agreement that has occurred since the last quarterly disclosure document revision. 

Franchise sellers shall also notify the prospective franchisee of any other known material change

in the franchisor, the franchise business, or franchisee agreement at the time the completed

franchise agreements are delivered to the prospective franchisee pursuant to section 436.2(a)(2).

(d) Information that is required to be audited pursuant to section 436.5(u) is not required

to be audited for quarterly revisions; provided, however, that the franchisor states in immediate

conjunction with the information that such information has not been audited.

SUBPART E - OTHER PROVISIONS

§ 436.9 Exemptions. 

The disclosure requirements of sections 436.2 - 436.8 shall not apply if the franchisor can

establish any of the following:

(a) The total of the required payments to the franchisor or an affiliate that are made any

time before to within six months after commencing operation of the franchisee’s business is less

than $500, not including payment for the purchase of reasonable amounts of inventory at bona

fide wholesale prices for resale. 

(b) The franchise relationship is a fractional franchise.

(c) The franchise relationship is a leased department.

(d) The franchise relationship is covered by the Petroleum Marketing Practices Act, 

15 U.S.C. 2801. 

(e)(1) The franchisee’s estimated investment, excluding any financing received from the
38

franchisor or an affiliate, totals at least $1.5 million and the prospective franchisee signs an

acknowledgment verifying the grounds for the exemption; or

(2) the franchisee is a corporation that has been in business for at least five years and has

a net worth of at least $5 million. Provided, however, that the Commission may publish revised

thresholds once every four years to adjust for inflation.

(f) One or more purchasers of at least a 50 percent ownership interest in the franchise are,

or have been within 60 days of the sale, an officer, director, managing agent, or an owner of at

least a 25 percent interest in the franchisor, for at least 24 months.

(g) There is no written document that describes any material term or aspect of the

relationship or arrangement.

§ 436.10 Additional Prohibitions.

It is an unfair or deceptive act or practice in violation of section 5 of the Federal Trade 

Commission Act for any franchise seller to: 

(a) Make any claim or representation, orally, visually, or in writing, that contradicts the

information required to be disclosed by this Rule.

(b) Fail to return any funds or deposits in accordance with any conditions disclosed in the

franchisor’s disclosure document, franchise agreement, or related document.

(c) Fail to make available to prospective franchisees, and to the Commission upon

reasonable request, written substantiation for any financial performance representations made in

section 436.5(s), above.

(d) Disseminate any financial performance representation to prospective franchisees,

including any representations made in the general media and Internet, unless the franchise seller

has a reasonable basis for the representation, has written substantiation for the claim at the time

the claim is made, and the representation is included in section 436.5(s) of the franchisor’s

disclosure document. In conjunction with any such financial performance representation, the

franchise seller shall also:

(1) Disclose the information required by section 436.5(s)(3)(ii)(E) if the representation

relates to the past performance of the franchisor’s outlets; and

(2) Include a conspicuous admonition that a new franchisee’s individual financial results

may differ from the result stated in the financial performance representation.

(e) Disclaim or require a prospective franchisee to waive reliance on any representation

made in the disclosure document or its exhibits or amendments. Provided, however, that a

prospective franchisee can agree to contractual terms and conditions that differ from those

specified in a disclosure document if: 

(1) the franchise seller identifies the changed terms and conditions;
39

(2) the prospective franchisee initials the changes; and

(3) the prospective franchisee has 5 days before signing the contract or paying any fee to

review the revised contract.

(f) Misrepresent that any person:

(1) Has purchased a franchise from the franchisor or operated a franchise of the type

offered by the franchisor; or

(2) Is able to provide an independent and reliable report about the franchise or the

experiences of any current or former franchisees.

§ 436.11 Other laws, rules, orders.

(a) The Commission does not approve or otherwise express any opinion on the legality of

any matter a franchisor may be required to disclose by this Rule. Further, franchisors may have

other obligations to disclose material information to prospective franchisees under section 5 of

the Federal Trade Commission Act. The Commission also intends to enforce all applicable

statutes and trade regulation rules.

(b) If an outstanding FTC order applies to a franchisor but differs from any provision of

this regulation, the franchisor can petition the Commission to amend the order.

(c) The FTC does not intend to preempt the franchise practices laws of any State or local

government, except to the extent of any inconsistency with this Rule. A law is not inconsistent

with this Rule if it affords prospective franchisees equal or greater protection, such as registration

of disclosure documents or more extensive disclosures.

§ 436.12 Severability.

If any provision of this regulation is stayed or held invalid, the remainder will stay in force.
1

ATTACHMENT D

Comparison Chart: NPR and Proposed Revised Rule

NPR Proposal Status Revised Proposal

Section 436.1 Definitions Section 436.1 Definitions

436.1(a:) Action Revised 436.1(a): Action

436.1(b): Affiliate Revised 436.1(b): Affiliate

436.1(c): Disclose Revised and renumbered 436.1(d): Disclose, state,

describe, and list

436.1(d): Financial performance

representation

Revised and renumbered 436.1(e): Financial performance

representation

436.1(e): Fiscal year Same, but renumbered 436.1(f): Fiscal year

436.1(f): Fractional franchise Same, but renumbered 436.1(g): Fractional franchise

436.1(g): Franchise Revised and renumbered 436.1(h): Franchise

436.1(h): Franchise seller Revised and renumbered 436.1(i): Franchise seller

436.1(i): Franchisee Revised and renumbered 436.1(j): Franchisee

436.1(j): Franchisor Revised and renumbered 436.1(k): Franchisor

436.1(k): Gag clause Revised and renumbered 436.1(c): Confidentiality clause

436.1(l): Internet Deleted

436.1(m): Leased department Revised and renumbered 436.1(l): Leased department

436.1(n): Material Deleted

436.1(o): Officer Deleted

New 436.(m): Parent

436.1(p): Person Revised and renumbered 436.1(n): Person

436.1(q): Plain English Same, but renumbered 436.1(o): Plain English

436.1(r): Predecessor Revised and renumbered 436.1(p): Predecessor

436.1(s): Principal business

address

Same, but renumbered 436.1(q): Principal business

address
2

436.1(t): Prospective franchisee Same, but renumbered 436.1(r): Prospective franchisee

436.1(u): Required payment Revised and renumbered 436.1(s): Required payment

436.1(v): Sale of a franchise Revised and renumbered 436.1(t): Sale of a franchise

436.1(w): Signature Revised and renumbered 436.1(u): Signature

436.1(x): Trademark Same, but renumbered 436.1(v): Trademark

436.1(y): Written Revised and renumbered 436.1(w): Written

Section 436.2 The obligation to

furnish documents

436.2 Obligation to furnish

documents

436.2: Domestic application Same 436.2: Domestic application

436.2(a)(1): Fourteen-day trigger Revised and renumbered 436.2(a): Fourteen-day trigger

436.2(a)(2): Five-day trigger Revised and renumbered 436.2(b): Seven-day trigger

436.2(b): Delivery Revised and renumbered 436.2(c): Delivery

436.2(c): Liability Revised and renumbered 436.2(d): Liability

Section 436.3 Cover page Section 436.3 Cover page

436.3(a)-(d): Title, background,

trademark, and description

Same 436.3(a)-(d): Title, background,

trademark, and description

436.3(e): Reference to Items 5 

and 7

Revised and renumbered 436.3(e)(1): Reference to Items 5

and 7.

436.3(f): Issuance date Same, but renumbered 436.3(e)(5): Issuance date

436.3(g)(1): General background

information

Revised and renumbered 436.3(e)(2): General background

information

436.3(g)(2): Electronic

disclosure

Revised and renumbered 436.3(f): Alternative formats

436.3(g)(3): Sources of

information

Revised and renumbered 436.3(e)(3): Sources of

information

436.3(g)(4): Information about

the contract

Same, but renumbered 436.3(e)(4): Information about the

contract

436.3(g)(5): Federal Trade

Commission

Deleted
3

436.3(h): Inclusion of state

disclosures

Revised and renumbered 436.3(g): Inclusion of state

disclosures

Section 436.4 Table of

Contents

Section 436.4 Table of Contents

436.4 at 1: The Franchisor,

Parent, Predecessors, and

Affiliates

Revised 436.4 at 1: The Franchisor and any

Parent, Predecessors, and

Affiliates

436.4 at 2-4: Business

Experience, Litigation,

Bankruptcy

Same 436.4 at 2-4: Business Experience,

Litigation, Bankruptcy

436.4 at 5: Initial Franchisee Fee Revised 436.4 at 5: Initial Fees Paid to the

Franchisor

436.4 at 6-22: Same 436.4 at 6-22:

436.4 at 23: Receipt Revised 436.4 at 23: Receipts

Section 436.5 Disclosure items Section 436.5 Disclosure items.

Section 436.5(a) Item 1: The

Franchisor, its Parents,

Predecessors, and Affiliates

Section 436.5(a) Item 1: The

Franchisor and any Parent,

Predecessors, and Affiliates

436.5(a)(1): Background on

franchisor, parent, and affiliates

Revised 436.5(a)(1): Background on

franchisor and any parent and

affiliates

436.5(a)(2): Background on

predecessors

Revised 436.5(a)(2): Background on

predecessors

436.5(a)(3): Franchisor’s name Same 436.5(a)(3): Franchisor’s name

436.5(a)(4): Principal business

address

Revised 436.5(a)(4): Principal business

address

436.5(a)(5): Type of business

organization

Same 436.5(a)(5): Type of business

organization

436.5(a)(6)(i)-(v): Nature of the

franchisor’s business

Revised 436.5(a)(6)(i)-(v): Nature of the

franchisor’s business

New 436.5(a)(6)(vi): Competition from

entity in which company officer

owns an interest
4

436.5(a)(7): Prior business

experience

Revised 436.5(a)(7): Prior business

experience

436.5(a) Footnote 1: Industry

regulations

Deleted (to be included in

Compliance Guides)

Section 436.5(b) Item 2: 

Business Experience

Revised Section 436.5(b) Item 2: 

Business Experience

Section 436.5(c) Item 3: 

Litigation

Section 436.5(c) Item 3: 

Litigation

436.5(c)(1): Introduction Revised 436.5(c)(1): Introduction

436.5(c)(1)(i): Pending suits Revised 436.5(c)(1)(i): Pending suits

436.5(c)(1)(ii): Franchise

relationship suits

Revised 436.5(c)(1)(ii): Franchise

relationship suits

436.5(c)(1)(iii): Convictions,

prior civil actions

Revised 436.4(c)(1)(iii): Convictions,

prior civil actions

436.5(c)(1)(iv): Injunctive

actions

Revised and renumbered 436.5(c)(2): Injunctive actions

436.5(c)(2): Description of

litigation

Revised and renumbered 436.5(c)(3): Description of

litigation

436.5 Footnote 2: Favorable

settlements, dismissed actions

Deleted (to be included in

Compliance Guides)

436.5 Footnote 3: Summary

opinion

Revised and renumbered 436.5 Footnote 1: Summary

opinion

436.5 Footnote 4: Confidential

settlements

Revised and renumbered 436.5 Footnote 2: Confidential

settlements

Section 436.5(d) Item 4: 

Bankruptcy

Section 436.5(d) Item 4: 

Banktruptcy

436.5(d)(1): Basic instruction Revised 436.5(d)(1): Basic instruction

436.5(d)(1)(i)-(iii): Basic

disclosure

Same 436.5(d)(1)(i)-(iii): Basic

disclosure
5

436.5(d)(2): Description of

matters

Same 436.5(d)(2): Description of

matters

436.5(d)(3): Foreign

bankruptcies

Same 436.5(d)(3): Foreign bankruptcies

Section 436.5(e) Item 5:

Initial Franchise Fee

Revised Section 436.5(e) Item 5:

Initial Fees Paid to the

Franchisor

Section 436.5(f) Item 6:

Recurring or Occasional Fees

Revised Section 436.5(f) Item 6:

Other Fees

436.5(f): Basic instruction Revised 436.5(f): Basic instruction

436.5(f)(1): Type of fee Same 436.5(f)(1): Type of fee

436.5(f)(2): Amount of the fee Revised 436.5(f)(2): Amount of the fee

436.5(f)(3): Due date Same 436.5(f)(3): Due date

436.5(f)(4): Remarks Revised 436.5(f)(4): Remarks

New 436.5(f)(4)(iv): If fees are

uniformly imposed

436.5(f) Footnote 5: Fee

increases

Same, but renumbered 436.5(f) Footnote 3: Fee increases

436.5(g) Item 7: Estimated

Initial Investment

436.5(g) Item 7: Estimated

Initial Investment

436.5(g): Basic instruction Revised 436.5(g): Basic instruction

436.5(g)(1)(i)-(vii): Table

column 1

Same, but renumbered 436.5(g)(1)(i)-(ii): Table column

1

436.5(g)(1)(viii): Table column 1

(other payments)

Revised and renumbered 436.5(g)(1)(iii): Table column 1

(other payments)

436.5(g)(2)-(5): Table columns

2-5

Same 436.5(g)(2)-(5): Table columns 

2-5

436.5(g)(6)-(7): Total and

footnotes

Same 436.5(g)(6)-(7): Total and

footnotes

436.5(h) Item 8: Restrictions

on Sources of Products and

Services

436.5(h) Item 8: Restrictions on

Sources of Products and

Services
6

436.5(h)(1): Basic instructions Revised 436.5(h): Basic instructions

436.5(h)(2): Approved suppliers Revised 436.5(h)(2): Approved suppliers

New 436.5(h)(3): Supplier in which

officer has an interest

436.5(h)(3): Alternative

suppliers

Revised and renumbered 436.5(h)(4): Alternative suppliers

436.5(h)(4)-(10): Other

disclosures

Same, but renumbered 436.5(h)(5)-(11): Other

disclosures

436.5(h) Footnote 6: Reasons for

requirement

Same, but renumbered 436.5(h) Footnote 4: Reasons for

requirement

436.5(h) Footnote 7: Audited

figures

Same, but renumbered 436.5(h) Footnote 5: Audited

figures

436.5(i) Item 9: Franchisee’s

Obligations

Revised 436.5(i) Item 9: Franchisee’s

Obligations

436.5(j) Item 10: Financing Same 436.5(j) Item 10: Financing

436.5(j) Footnote 8: Payments

due within 90 days

Deleted (to be included in

Compliance Guides)

436.5(j) Footnote 9: Indirect

offers

Same, but renumbered 436.5(j) Footnote 6: Indirect

offers

436.5(j) Footnote 10: Copies of

financing documents

Same, but renumbered 436.5(j) Footnote 7: Copies of

financing documents

436.5(k) Item 11: Franchisor’s

Assistance, Advertising,

Computer Systems, and

Training

436.5(k) Item 11: Franchisor’s

Assistance, Advertising,

Computer Systems, and

Training

436.5(k)(1)-(4): Pre-opening and

ongoing assistance, advertising

Same 436.5(k)(1)-(4): Pre-opening and

ongoing assistance, advertising 

436.5(k)(5): Electronic

equipment

Revised 436.5(k)(5): Electronic equipment
7

436.5(k)(6)-(7): Operating

manual, training

Same 436.5(k)(5): Operating manual,

training

Section 436.5(l) Item 12: 

Territory

Section 436.5(l) Item 12: 

Territory

436.5(l)(1)(i): Minimum area Same, but renumbered 436.5(l)(2): Minimum area

436.5(l)(1)(ii): Specific location Same, but renumbered 436.5(l)(1): Specific location 

436.5(l)(1)(iii): Relocation Same, but renumbered 436.5(l)(3): Relocation

436.5(l)(1)(iv): Other franchisees Deleted

436.5(l)(1)(v): Franchisor-owned

outlets and other channels of

distribution

Revised and renumbered 436.5(l)(6)(i)(A): Franchisorother channels of distribution

under principal trademark

436.5(l)(1)(vi): Other channels

of distribution under different

mark

Revised and renumbered 436.5(l)(6)(i)(B): Franchisor -

other channels of distribution

under different mark

436.5(l)(1)(vii): Restrictions on

franchisor outlets within territory

Deleted

436.5(l)(1)(viii): Restrictions on

franchisee outside territory

Revised and renumbered 436.5(l)(6)(ii): Restrictions on

franchisee outside territory

436.5(l)(1)(ix): Restrictions on

franchisor inside territory

Revised and renumbered 436.5(l)(6)(i): Restrictions on

franchisor inside territory

436.5(l)(1)(x): Right of first

refusal

Revised and renumbered 436.5(l)(4): Right of first refusal

436.5(l)(2)(i)(A)-(B): 

Exclusivity

Revised and renumbered 436.5(l)(5): Exclusivity

436.5(l)(2)(ii): No exclusive Revised and renumbered 436.5(l)(5)(i): No exclusive

436.5(l)(3): Present plans Revised and renumbered 436.5(1)(6)(iii): Present plans

Section 436.5(m) Item 13:

Trademark

Section 436.5(l) Item 13: 

Trademark
8

436.5(m)(1): Principal

trademarks

Same 436.5(m)(1): Principal trademarks

436.5(m)(2): Registration Revised 436.5(m)(2): Registrations

436.5(m)(3): Applications

436.5(m)(4): Unregistered

tradermarks

436.5(m)(3)-(6): Determinations,

pending litigation, current

agreements, obligations to defend

Same, but renumbered 436.5(m)(5)-(8): Determinations,

pending litigation, current

agreements, obligations to defend

436.5(m)(7): Superior rights Revised and renumbered 436.5(m)(9): Superior rights

436.5(m) Footnote 12: Summary

opinion

Revised and renumbered 436.5(m) Footnote 8: Summary

opinion

Section 436.5(n) Item 14: 

Patents

Section 436.5(n) Item 14: 

Patents

436.5(n)(1)-(2): Description of

patents and copyrights 

Same 436.5(n)(1)-(2): Description of

patents and copyrights

436.5(n)(3): Court actions Revised 436.5(n)(3): Court actions

436.5(n)(4)-(7): Agreements,

obligations, other proprietary

information

Same 436.5(n)(4)-(7): Agreements,

obligations, other proprietary

information

436.5(n) Footnote 12: Opinion of

counsel

Revised and renumbered 436.5(n) Footnote 9: Opinion of

counsel

Section 436.5(o) Item 15: 

Obligations to participate

Same Section 436.5(o) Item 15: 

Obligations to participate

Section 436.5(p) Item 16: 

Restrictions on what franchise

may sell

Same Section 436.5(p) Item 16: 

Restrictions on what franchise

may sell
9

Section 436.5(q) Item 17: 

Renewal, Termination

Section 436.5(q) Item 17: 

Renewal, Termination

436.5(q): Basic instruction Same, but renumbered 436.5(q): Basic instruction

436.5(q)(1): Summarize each

contract provision

436.5(q)(2): Assistance as matter

of policy

New 436.5(q)(3): Explain term

“renewal”

Section 436.5(r) Item 18: 

Public Figures

Same Section 436.5(r) Item 18: Public

Figures

Section 436.5(s) Item 19: 

Financial performance

representations

Section 436.5(s) Item 19: 

Financial performance

representations

436.5(s)(1): First preamble Revised 436.5(s)(1): First preamble

436.5(s)(2): Second preamble Revised 436.5(s)(2): Second preamble

436.5(s)(3): Basic instructions Same 436.5(s)(3): Basic instructions

436.5(s)(3)(ii): Past performance Same 436.5(s)(3)(ii): Past performance

436.5(s)(3)(iii): Forecasts Same 436.5(s)(3)(iii): Forecasts

436.5(s)(3)(iv)-(v): Admonition

and substantiation

Same 436.5(s)(3)(iv)-(v): Admonition

and substantiation

436.5(s)(4): Actual outlets Same 436.5(s)(4): Actual outlets

436.5(s)(5): Supplemental

information

Same 436.5(s)(5): Supplemental

information

436.5(s) Footnote 13: GAAP Deleted

436.5(s) Footnotes 14-16:

Reasonable basis, written

substantiation

Deleted (to be revised and

placed in Compliance

Guides)

Section 436.5(t) Item 20: 

Outlets and Franchisee

Information

Section 436.5(t) Item 20:

Outlets and Franchisee

Information
10

436.5(t)(1): Franchised Outlets

Summary

Revised 436.5(t)(1): Systemwide Outlet

Summary

New 436.5(t)(2)(i): Transfers of

Franchised Outlets

New 436.5(t)(2)(ii): Franchised outlets

436.5(t)(2): Franchisor-Owned

Outlets Summary

Revised and renumbered 436.5(t)(2)(iii): Company-owned

outlets

436.5(t)(3): Projected openings Revised 436.5(t)(3): Projected new

franchised outlets

New 436.5(t)(4): Sales of exiting units

436.5(t)(4): Names and

addresses of current franchisees

Same, but renumbered 436.5(t)(5): Names and addresses

436.5(t)(5): Names and

addresses of former franchisees

Same, but renumbered 436.5(t)(6): Names and addresses

of former franchisees

436.5(t)(6): Gag clauses Revised and renumbered 436.5(t)(7): Confidentiality

clauses

436.5(t)(7): Trademark-specific

organizations

Revised and renumbered 436.5(t)(8): Trademark-specific

organizations

New 436.5(t)(8)(ii): Disclaimer

Section 436.5(u) Item 21: 

Financial Statements

Section 436.6(u) Item 21: 

Financial Statements

436.5(u)(1): Basic disclosure Revised 436.5(u)(1): Basic disclosure

436.5(u)(1)(i): Financial

statements

Same 436.5(u)(1)(i): Financial

statements

436.5(u)(1)(ii): Affiliated

company statements

Revised 436.5(u)(1)(ii): Affiliated

company statements

436.5(u)(1)(iii): Consolidated

and separate statements

Revised 436.5(u)(1)(iii): Consolidated and

separate statements

436.5(u)(2): Phase-in Same 436.5(u)(2): Phase-in

Section 436.5(v) Item 22: 

Contracts

Same Section 436.5(v) Item 22: 

Contracts
11

Section 436.5(w) Item 23: 

Receipt

Section 436.5(w) Item 23: 

Receipt

436.5(w)(1): Basic instruction Revised and renumbered 436.5(w): Basic instruction

436.5(w)(1)(i): Text Revised and renumbered 436.5(w)(1): Text

436.5(w)(1)(ii): Disclosure of

names

Revised and renumbered 436.5(w)(2): Disclosure of names

436.5(w)(1)(iii)-(viii): Various

statements

Same, but renumbered 436.5(w)(3)-(8): Various

statements

436.5(w)(2): Timing for receipt Deleted

436.5(w)(3): Recordkeeping Same, but renumbered 436.6(h): Receipt recordkeeping

Section 436.6 Instructions Section 436.6 Instructions

436.6(a): Plain English Same 436.6(a): Plain English

New 436.6(a): Capable of preservation

436.6(b): Responses Same 436.6(b): Responses

436.6(c): No additional materials Same 436.6(c): No additional materials

New 436.6(c): Navigational tools

436.6(c): Multi-State disclosures Same, but renumbered 436.6(d): Multi-State disclosures

436.6(d): Subfranchisors Revised and renumbered 436.6(e): Subfranchisors

New 436.6(f): Format and prerequisite

disclosure

New 436.6(g): Disclosure document

recordkeeping

Same, but renumbered 436.6(h): Receipt recordkeeping

Section 436.7 Instructions for

electronic disclosure documents

Deleted

Section 436.8 Instructions For

Updating

Section 436.7 Instructions for

Updating

436.8(a): Annual updates Revised and renumbered 436.7(a): Annual updates

436.8(b): Quarterly updates Same, but renumbered 436.7(b): Quarterly updates
12

New 436.7(c): Relationship between

annual and quarterly updates

436.8(c): Material changes Revised and renumbered 436.7(d): Material changes 

436.8(d): Update of audited

information

Same, but renumbered 436.7(e): Update of audited

information

Section 436.9 Exemptions Section 436.8 Exemptions

436.9(a): $500 Minimum

payment exemption

Revised and renumbered 436.8(a)(1): $500 Minimum

payment exemption

436.9(b): Fractional franchise

exemption

Same, but renumbered 436.8(a)(2): Fractional franchise

exemption

436.9(c): Leased department

exemption

Same, but renumbered 436.8(a)(3): Leased department

exemption

436.9(d): PMPA exemption Same, but renumbered 436.8(a)(4): PMPA exemption

436.9(e)(1): Large initial

investment exemption

Revised and renumbered 436.8(a)(5)(i): Large initial

investment exemption

436.9(e)(2): Large investor

exemption

Revised and renumbered 436.8(a)(5)(ii): Large investor

exemption

436.9(e)(2): Inflation adjustment Revised and renumbered 436.8(b): Inflation adjustment

436.9(f): Owner exemption Revised and renumbered 436.8(a)(6): Owner exemption

436.9(g): Oral agreements Same, but renumbered 436.8(a)(7): Oral agreements

Section 436.10 Additional

Prohibitions

Section 436.9 Additional

Prohibitions

436.10 (a): Contradictory

statements

Same, but renumbered 436.9(a): Contradictory

statements

436.10(b): Refunds Same, but renumbered 436.9(j): Refunds

436.10(c): Written substantiation

for performance claims

Same, but renumbered 436.9(d): Written substantiation

for performance claims

436.10(d): Financial Information Revised and renumbered 436.9(c): Financial Information

436.10(e): Disclaimers Revised and renumbered 436.9(i): Disclaimers

436.10(f): Shills Same, but renumbered 436.9(b): Shills
13

New 436.9(e): Requests for early

disclosure

New 436.9(f): Requests for disclosure

by transferee

New 436.9(g): Requests for updated

disclosures

New 436.9(h): Materially altering 

contract terms without notice

Section 436.11 Other Laws,

Rules, Orders.

Same, but renumbered 436.10 Other Laws, Rules,

Orders

436.11(a): Non-approval Same, but renumbered 436.10(a): Non-approval

436.11(b): Outstanding Orders Same, but renumbered 436.10(b): Outstanding Orders

436.11(c): Preemption Same, but renumbered 436.10(c): Preemption

Section 436.12 Severability Same, but renumbered 436.11 Severability