[Federal Register Volume 72, Number 61 (Friday, March 30, 2007)]
[Rules and Regulations]
[Pages 15444-15575]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-5829]



[[Page 15443]]

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Part V





Federal Trade Commission





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16 CFR Parts 436 and 437



Disclosure Requirements and Prohibitions Concerning Franchising and 
Business Opportunities; Final Rule

Federal Register / Vol. 72, No. 61 / Friday, March 30, 2007 / Rules 
and Regulations

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FEDERAL TRADE COMMISSION

16 CFR Parts 436 and 437


Disclosure Requirements and Prohibitions Concerning Franchising

Disclosure Requirements and Prohibitions Concerning Business 
Opportunities
AGENCY: Federal Trade Commission.

ACTION: Final rule.

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SUMMARY: The Federal Trade Commission (the ``Commission'' or ``FTC'') 
amends its Trade Regulation Rule entitled ``Disclosure Requirements and 
Prohibitions Concerning Franchising and Business Opportunity Ventures'' 
(``Franchise Rule'' or ``Rule'') to streamline the Rule, minimize 
compliance costs, and to respond to changes in new technologies and 
market conditions in the offer and sale of franchises. Part 436 sets 
forth those amendments to the Franchise Rule pertaining to the offer 
and sale of franchises. Part 437 sets forth a revised form of the 
original Franchise Rule pertaining solely to the offer and sale of 
business opportunities. This document provides background on the 
Franchise Rule and this proceeding; discusses the public comments the 
Commission received; and describes the amendments the Commission is 
making based on the record. This document also contains the text of the 
final amended Rule and the Rule's Statement of Basis and Purpose 
(``SBP''), including a Regulatory Analysis.

EFFECTIVE DATES: The effective date of the final amended Rule is July 
1, 2007. Permission to use the original Franchise Rule, however, will 
continue until July 1, 2008. After that date, franchisors and business 
opportunity sellers must comply with the final amended Rule only.

ADDRESSES: Requests for copies of the final amended Rule and the SBP 
should be sent to: Public Reference Branch, Room 130, Federal Trade 
Commission, 600 Pennsylvania Avenue, NW, Washington, D.C. 20580. The 
complete record of this proceeding is also available at that address. 
Relevant portions of the proceeding, including the final amended Rule 
and SBP, are available at www.ftc.gov.

FOR FURTHER INFORMATION CONTACT: Steven Toporoff, (202) 326-3135, 
Division of Marketing Practices, Room 286, Bureau of Consumer 
Protection, Federal Trade Commission, 600 Pennsylvania Avenue, NW., 
Washington, D.C. 20580.

SUPPLEMENTARY INFORMATION: The final amended Rule retains most of the 
original Rule's pre-sale disclosures.\1\ Part 436 pertains to 
franchising--business arrangements that offer purchasers the right to 
operate under a trademark or other commercial symbol and that typically 
offer a specific format or method of doing business, such as chain 
restaurants and hotels.\2\ Part 436 modifies the original Rule, 
however, by reducing inconsistencies with state franchise disclosure 
laws, by adopting, in large measure, the disclosure requirements and 
format of the Uniform Franchise Offering Circular (``UFOC'') Guidelines 
used by the 15 states with pre-sale franchise disclosure laws.\3\ Part 
436 of the final amended Rule, however, is not identical to the UFOC 
Guidelines. In several instances, part 436 is narrower. For example, 
part 436 does not incorporate the UFOC Guidelines' mandatory cover page 
risk factors, disclosures pertaining to brokers, or detailed 
disclosures pertaining to franchisees' computer equipment requirements. 
Part 436 also permits a phase-in of audited financial statements.
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    \1\ See 16 CFR Part 436. Provisions of the original Rule are 
cited in this document as 16 CFR 436.[ ]. Citations to the final 
amended Rule are cited simply as 436.[ ] or 437.[ ], respectively. 
The text of the final amended Rule is set forth in Section VII.
    \2\ The specific definition of the term ``franchise'' is 
discussed below in connection with section 436.1(h).
    \3\ We were assisted in the effort to reduce inconsistencies 
between the original Rule and UFOC Guidelines by NASAA's submission 
of a document entitled ``Comparison of UFOC and Proposed FTC 
Disclosure Requirements'' (``NASAA Comparison'') (Jan. 8, 2002). A 
copy of this document is on the public record in this proceeding.
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    Further, part 436 of the final amended Rule corrects a problem with 
the UFOC Guidelines identified in the rulemaking record. Specifically, 
the record establishes that the current Item 20 of the UFOC 
Guidelines--a provision requiring the disclosure of franchisee 
statistics--results in inflated turnover rates. Part 436 of the final 
amended Rule corrects this problem, based upon suggestions contained in 
the record.
    In a few instances, part 436 of the final amended Rule is broader 
than the UFOC Guidelines, addressing franchise relationship issues that 
the rulemaking record establishes are a prevalent source of franchisee 
complaints. To that end, part 436 of the final amended Rule provides 
additional information to prospective franchisees with which to assess 
the quality of the franchise relationship before they buy, including: 
(1) franchisor-initiated litigation against franchisees pertaining to 
the franchise relationship; (2) protected territories; (3) the use of 
confidentiality clauses; and (4) trademark-specific franchisee 
associations.
    Finally, part 436 of the final amended Rule updates the original 
Rule and UFOC Guidelines by addressing new marketing techniques and new 
technologies. For example, part 436 permits franchisors to comply with 
pre-sale disclosure obligations electronically. It also updates 
territorial protection disclosures to address sales via the Internet, 
catalogs, and telemarketing.
    Part 437 of the final amended Rule pertains to business opportunity 
ventures. Business opportunities, such as vending machine routes and 
rack display ventures, typically do not involve the right to use a 
trademark or other commercial symbol and the seller must provide 
purchasers with locations for machines or equipment or with clients.\4\ 
Based upon the rulemaking record, the Commission has proposed that 
business opportunities covered by the original Rule should be addressed 
in a separate, narrowly-tailored trade regulation rule. On April 12, 
2006, the Commission published a Notice of Proposed Rulemaking 
(``Business Opportunity NPR'') for a separate Business Opportunity 
Rule.\5\ Pending completion of the proceeding initiated with that 
notice, business opportunities presently covered by the requirements of 
the original Rule will remain covered, as set forth as part 437 of the 
final amended Rule.
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    \4\ The definition of ``business opportunity'' is discussed 
below in connection with section 437.2(a).
    \5\ 71 FR 19054 (Apr. 12, 2006).
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    Part 437 of the final amended Rule differs from the original Rule 
in three respects only. First, references to ``franchisor'' and 
``franchisee'' in the original Rule have been changed to ``business 
opportunity seller'' and ``business opportunity purchaser,'' 
respectively. Second, the original Rule's definition of ``franchise'' 
set out at section 436.(2)(a) has been changed to ``business 
opportunity'' and the first part of the original definition--the 
``franchise'' elements--have been deleted; the definition now focuses 
on the second part of the original definition--the business opportunity 
elements. Third, part 437 sets forth a new exemption for franchises 
that comply with, or are exempt from, part 436. Except for these three 
changes, all disclosures and prohibitions in part 437 are identical to 
those of the original Franchise Rule.

[[Page 15445]]

STATEMENT OF BASIS AND PURPOSE

I. INTRODUCTION

A. Overview of the Original Franchise Rule

    The Commission promulgated the original Franchise Rule on December 
21, 1978.\6\ Based upon the original rulemaking record, the Commission 
found widespread deception in the sale of franchises and business 
opportunities through both material misrepresentations and 
nondisclosures of material facts.\7\ Specifically, the Commission found 
that franchisors and business opportunity sellers often made material 
misrepresentations about: the nature of the seller and its business 
operations, the costs to purchase a franchise or business opportunity 
and other contractual terms and conditions under which the business 
would operate, the success of the seller and its purchasers, and the 
seller's financial viability. The Commission also found other unfair or 
deceptive practices pervasive: franchisors' and business opportunity 
sellers' use of false or unsubstantiated earnings claims to lure 
prospective purchasers into buying a franchise or business opportunity, 
and franchisors' and business opportunity sellers' failure to honor 
promised refund requests. The Commission concluded that all of these 
practices led to serious economic harm to consumers.\8\
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    \6\ 43 FR 59614 (Dec. 21, 1978). Along with the original Rule, 
the Commission published a Statement of Basis and Purpose 
(``original SBP''), 43 FR 59621 (Dec. 21, 1978) and later Final 
Interpretive Guides to the Rule (``Interpretive Guides''), 44 FR 
49966 (Aug. 24, 1979). Since promulgation of the original Rule in 
1978, the Commission staff has also issued more than 100 advisory 
opinions to help assist the public in interpreting various Rule 
provisions.
    \7\ Original SBP, 43 FR at 59625.
    \8\ Id., at 59627-39.
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    To prevent deceptive and unfair practices in the sale of franchises 
and business opportunities and to correct consumers' misimpressions 
about franchise and business opportunity offerings, the Commission 
adopted the original Franchise Rule, which is primarily a pre-sale 
disclosure rule. The original Rule did not purport to regulate the 
substantive terms of the franchise or business opportunity 
relationship. Rather, it required franchisors and business opportunity 
sellers to disclose material information to prospective purchasers on 
the theory that informed investors can determine for themselves whether 
a particular deal is in their best interest.\9\
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    \9\ The Commission used the same approach in other trade 
regulation rules. See, e.g., Funeral Rule, 16 CFR Part 453; Used Car 
Rule, 16 CFR Part 455.
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B. The Rule Amendment Proceeding

    This Rule amendment proceeding began with a regulatory review of 
the Franchise Rule in 1995.\10\ To initiate the Rule Review, the 
Commission published a Federal Register notice seeking public comment 
on whether there was a continuing need for the Rule and, if so, how to 
improve it in light of industry changes since its promulgation in 1978. 
In response to this notice, the Commission received 75 written 
comments.\11\
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    \10\ 60 FR 17656 (Apr. 7, 1995).
    \11\ Written Rule Review comments are cited as: [Commenter] RR 
[comment number]. A list of all commenters during the Rule Review 
and Rule amendment proceeding, and the abbreviations used to 
identify each, is set forth in Attachment A to this document. Many 
of the comments in this proceeding are available online at: 
www.ftc.gov.
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    In addition, the Commission staff held two public workshops, in 
which a total of fifty individuals participated. The workshops were 
transcribed.\12\ The first workshop--held on September 11-13, 1995, in 
Bloomington, Minnesota--focused on the comments on the Rule, in 
particular whether the Commission should retain the Rule and, if so, 
whether the Commission should reduce inconsistencies between federal 
and state pre-sale disclosure law by incorporating in the Rule the UFOC 
Guidelines adopted by each of the 15 states with franchise disclosure 
laws.\13\ Participants also discussed issues arising from business 
opportunity sales. The second workshop--held on March 11, 1996, in 
Washington, D.C.--focused on the Franchise Rule's application to sales 
of franchises to be located outside the United States.
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    \12\ Rule Review transcripts are cited as [Commenter] RR, 
[Sept.95] or [Mar.96] Tr.
    \13\ The UFOC Guidelines disclosure format is similar in many 
respects to the original Rule's disclosure requirements. To reduce 
compliance costs and burdens, the Commission has permitted 
franchisors to comply with the original Rule by using the UFOC 
Guidelines format, provided that they did so completely and 
accurately. See 60 FR 51895 (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 website: www.nasaa.org. It 
should be noted, however, that the UFOC Guidelines address only 
required pre-sale disclosures. Other provisions of state law 
applicable to franchise sales--such as the time for making 
disclosures, disclosure document updating provisions, and 
exemptions--vary according to each state's franchise statute or 
regulations.
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    As a result of the Rule Review, the Commission determined that the 
Franchise Rule continues to serve a useful purpose and that it should 
be retained. The Commission also determined to modify the Rule in order 
to reduce inconsistencies with the UFOC Guidelines, while updating the 
Rule to address new technologies developed since the original Rule was 
promulgated. Accordingly, in February 1997, the Commission published an 
Advance Notice of Proposed Rulemaking (``ANPR'').\14\ The ANPR 
solicited comment on several proposed Rule modifications which would, 
among other things, create a separate trade regulation for business 
opportunity sales, revise the Rule's disclosure requirements to mirror 
those of the UFOC Guidelines, limit the Rule's application to sales of 
franchises located in the United States, and permit electronic 
disclosure. In response to the ANPR, the Commission received 166 
written comments.\15\ The staff also held six public workshops on the 
issues raised in the comments, as set forth below.\16\
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    \14\ 62 FR at 9115 (Feb. 28, 1997).
    \15\ Written ANPR comments are cited as: [Commenter] ANPR 
[comment number].
    \16\ In general, the first day of each public workshop 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. ANPR workshop transcripts are cited as: 
[Commenter] ANPR [date] Tr.

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             Topic(s)                    Location            Dates
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Trade Show Promoters                Washington, D.C.   July 28-29, 1997
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Business Opportunities              Chicago, IL        August 21-22,
                                                        1997
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UFOC, Internet, International, Co-  New York, NY       September 18-19,
 branding, Alternatives to                              1997
 Traditional Law Enforcement
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Business Opportunities              Dallas, TX         October 20-21,
                                                        1997
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[[Page 15446]]

 
UFOC, Internet, International, Co-  Seattle, WA        November 6-7,
 branding, Alternatives to                              1997
 Traditional Law Enforcement
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Business Opportunities              Washington, D.C.   November 20-21,
                                                        1997
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A total of sixty-five individuals participated in the various ANPR 
public workshops, including franchisees, franchisors, business 
opportunity sellers and their representatives, state franchise and 
business opportunity regulators, and computer consultants.
    After the ANPR workshops, the Commission published a Notice of 
Proposed Rulemaking (``Franchise NPR'') in October 1999.\17\ Focusing 
on franchise sales only, the Franchise NPR included the text of a 
proposed revised Franchise Rule and a detailed discussion of each 
proposed Rule revision. Among other things, the Franchise NPR 
addressed: (1) the application of the Franchise Rule to franchise sales 
outside the United States; (2) the scope of certain existing disclosure 
requirements, such as those regarding litigation and franchisee 
statistics; (3) new disclosure requirements, such as those for 
franchisee associations; and (4) new instructions permitting disclosure 
via the Internet. It also proposed creating exemptions from the 
Franchise Rule for sophisticated prospective franchisees.
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    \17\ 64 FR 57294 (Oct. 22, 1999).
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    The Franchise NPR also specified the process the Commission would 
follow in amending the Franchise Rule, as it pertains to franchise 
sales. Pursuant to the Commission's Rules of Practice, 16 CFR 1.20, the 
Commission determined to use a modified version of the rulemaking 
process set forth in section 1.13 of those Rules.\18\ Specifically, the 
Commission announced that it would publish an NPR, with a 60-day 
comment period, followed by a 40-day rebuttal period. In addition, 
pursuant to Section 18(c) of the FTC Act, the Commission announced that 
it would hold hearings with cross-examination and rebuttal submissions 
only if an interested party requested a hearing. The Commission also 
stated that, if requested to do so, it would contemplate holding one or 
more informal public workshops in lieu of hearings. Finally, pursuant 
to 16 CFR 1.13(f), the Commission announced that staff would issue a 
Report on the Franchise Rule (``Staff Report''), which would be subject 
to additional public comment.\19\
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    \18\ 16 CFR 1.13.
    \19\ Franchise NPR, 64 FR at 57324.
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    In response to the Franchise NPR, the Commission received 40 
comments.\20\ Overwhelmingly, the comments supported the proposed 
revisions, albeit with fine-tuning.\21\ No commenters requested a 
hearing, although, as noted, the Franchise NPR allowed for them.\22\ 
The staff also determined that the record was fully developed for 
franchise issues, requiring no additional public workshops to explore 
further Rule amendment issues.
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    \20\ Franchise NPR comments are cited as: [Commenter] NPR 
[comment number].
    \21\ Many commenters enthusiastically supported the Commission's 
overall approach to revising the Rule. E.g., IL AG, NPR 3, at 10; 
PMR&W, NPR 4, at 1; Holmes, NPR 8, at 1; H&H, NPR 9, at 2; Baer, NPR 
11, at 1; NFC, NPR 12, at 2; Lewis, NPR 15, at 1; IFA, NPR 22, at 3; 
AFC, NPR 30, at 3; J&G, NPR 32, at 1; Tricon, NPR 34, at 1; 
Marriott, NPR 35, at 2.
    \22\ Accordingly, no Presiding Officer was established in this 
proceeding. See Rules of Practice, 16 CFR 1.13(c).
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    Pursuant to the Rule amendment process announced in the Franchise 
NPR, the Commission's Bureau of Consumer Protection issued a Staff 
Report on the Franchise Rule in August 2004.\23\ The Staff Report 
explained in detail the history of the Rule amendment proceeding. It 
also summarized the issues raised during the various notice and comment 
periods, in particular those that arose in response to the Franchise 
NPR. For each Franchise NPR issue, the Staff Report discussed: (1) 
similarities and differences between the proposed revised Rule approach 
and both the original Rule and the UFOC Guidelines approaches; (2) 
pertinent comments; and (3) the staff recommendations on franchise 
issues for inclusion in a final amended Rule.
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    \23\ See Bureau of Consumer Protection, Staff Report to the 
Federal Trade Commission and Proposed Revised Trade Regulation Rule 
(16 CFR Part 436) (Aug. 2004) (``Staff Report''). The Staff Report 
is available at: www.ftc.gov/os/2004/08/0408franchiserulerpt.pdf. In 
September, 2004, the Commission published a notice in the Federal 
Register announcing the availability of, and seeking comment on, the 
Staff Report. See 69 FR 53661 (Sept. 2, 2004). The announcement is 
also available at: www.ftc.gov/os/2004/08/040825franchiserulefrn.pdf.
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    Forty-five commenters responded to the Staff Report.\24\ For the 
most part, the commenters supported the proposed Rule revisions 
pertaining to franchising.\25\ Several, however, voiced concern about 
the scope of one or more Rule provisions, or offered various 
suggestions to fine-tune the Rule to avoid ambiguities.\26\ In other 
instances, several commenters raised issues for further discussion in 
anticipated Compliance Guides, or offered interpretations of Rule 
provisions for inclusion in the Compliance Guides.\27\ In several 
instances, franchisee representatives reiterated views previously 
expressed during the various comment periods to the effect that the 
proposed revised Rule is deficient because it does not mandate 
disclosure of financial performance data\28\ or does not adopt various 
substantive franchise relationship provisions.\29\ As explained in 
greater detail below, the Commission has considered each of these 
comments in determining the form and content of the final amended Rule.
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    \24\ Staff Report comments are cited as ``[Commenter], at ------ 
.'' These comments simply refer to the commenter and not to a 
specific comment number. After the Franchise NPR, the Commission's 
Secretary's Office discontinued the practice of assigning a specific 
comment number to each comment.
    \25\E.g., Bundy, at 1; Cendant, at 1 (representing Ramada, Days 
Inn, Howard Johnson, Travelodge, Knights Inn, Super 8 Motel, Wingate 
Inn, AmeriHost, Century 21, Coldwell Banker, ERA, Sotherby's Intl 
Realty, Avis, and Budget); IFA, at 1; IL AG, at 1; J&G, at 1; 
Kaufmann, at 2 (representing Kaufmann, Feiner, Yamin, Gildin & 
Robbins; YUM! Brands [Pizza Hut, KFC, Taco Bell, Long John Silvers, 
and A&W]; 7-Eleven, Inc.; and Arby's [Arby's and T.J. Cinnamons 
Classic Bakery]); Marriott, at 2; NASAA, at 2; Piper Rudnick, at 1; 
Spandorf, at 1; Starwood, at 1 (representing Four Points Hotels, 
Sheraton Hotels,Westin Hotels, and Luxury Collection Hotels); Wiggin 
and Dana, at 1.
    \26\ Fourteen comments focused solely on a single issue. For 
example, eight comments addressed only the original Rule's exclusion 
for cooperatives (Affiliated Foods; CHS; Graber; IDC; NCBA; NCFC; 
NGA; Riezman Burger). Additional one-issue comments were received 
on: the disclosure of franchisee associations (AAFD); the single 
trademark exclusion (Pillsbury Winthrop); the sophisticated investor 
exemptions (NADA); the Petroleum Marketing Practices Act (Chevron); 
the disclosure of parent information (PREA); and integration clauses 
(Lagarias). Two comments were beyond the scope of the Staff Report: 
Marks (urging Commission to adopt franchise arbitration standards); 
Koutsoulis (opposing the proposed merger of two franchisors).
    \27\ Compliance Guides, which the Commission anticipates staff 
will issue on part 436, would update existing Interpretive Guides 
issued in 1979. See generally Interpretive Guides, 44 FR 49966. 
Compliance Guides on part 437 will be issued by staff once any 
rulemaking on business opportunity ventures is concluded.
    \28\E.g., Selden, at 2; Haff, at 1-3; Blumenthal, at 1; Karp, at 
2; Steinberg, at 1.
    \29\E.g., Blumenthal, at 1; Karp, at 3; Steinberg, at 1-2.

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[[Page 15447]]

C. Continuing Need for the Rule

    Based upon the original rulemaking record and the Commission's law 
enforcement experience extending nearly 30 years,\30\ the Commission 
concludes that a pre-sale disclosure rule continues to serve a useful 
purpose. Overwhelmingly, the comments submitted during the Rule 
amendment proceeding supported the continued need for the Franchise 
Rule.\31\ For example, some commenters emphasized that pre-sale 
disclosure is still necessary to prevent fraud.\32\ Others observed 
that pre-sale disclosure is a cost-effective way to provide material 
information to prospective purchasers about the costs, benefits, and 
potential legal and financial risks associated with entering into a 
franchise relationship. These commenters also stressed that the Rule 
assists prospective franchisees in conducting a due diligence 
investigation of the franchise offering by providing information that 
is not readily available, such as the franchisor's litigation history 
and franchisee termination rates.\33\ Other commenters noted that pre-
sale disclosure helps franchisees understand the franchise relationship 
they are entering better than they could absent such disclosure, 
thereby reducing potential conflicts in franchise systems and post-sale 
litigation costs.\34\ Indeed, some commenters expressed the view 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.\35\ 
One commenter noted that retaining a uniform pre-sale disclosure rule 
enables prospective franchisees to comparison shop for the best 
franchise offering.\36\
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    \30\ As of the date of this Notice, the Commission has filed 
more than 210 suits against more than 650 defendants (both 
franchises and business opportunities) for Franchise Rule violations 
since the Rule was promulgated in 1978. See also Business 
Opportunity NPR, 71 FR 19054 (Apr. 12, 2006) (discussing the 
Commission law enforcement history in combating business opportunity 
covered by the Franchise Rule).
    \31\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. See 
also Staff Report, at notes 15-16. But see, generally, Winslow 
(opposing the Rule).
    \32\E.g., Kaufmann, ANPR 33, at 3 (``Both the Rule and . . . 
state franchise laws have gone a long way toward eradicating massive 
franchise frauds and, by doing so, have restored franchising's 
reputation for integrity and thus cleared the marketplace for the 
offerings of legitimate franchisors.'').
    \33\ E.g., Marks, ANPR, 19 Sept. 97 Tr., at 8-9, 29; Wieczorek, 
RR, Sept.95 Tr., at 62-63. But see Winslow, at 21.
    \34\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.
    \35\ E.g., WA Securities, ANPR 117; Shay, RR, Sept.95 Tr., at 
104.
    \36\ Kaufmann, ANPR 33, at 3.
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    On the other hand, many franchisees and their advocates criticized 
the Rule for not going far enough. They urged the Commission to address 
in this rulemaking a variety of post-sale franchise contract or 
``relationship'' issues, including prohibiting or limiting the use of 
post-contract covenants not to compete,\37\ encroachment of 
franchisees' market territory,\38\ and restrictions on the sources of 
products or services.\39\ Indeed, some franchisees asserted that if the 
Rule cannot address post-sale relationship issues, then the Commission 
should abolish the Rule.\40\
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    \37\E.g., Brown, ANPR 4, at 3; AFA, ANPR 62, at 3; Slimak, ANPR 
130; Leap, ANPR 147; Vidulich, ANPR, 22 Aug. 97 Tr., at 21.
    \38\ E.g., Brown, ANPR 4, at 2; Donafin, ANPR 14; AFA, ANPR 62, 
at 1; Buckley, ANPR 97; Zarco & Pardo, ANPR 134, at 2.
    \39\ E.g., Brown, ANPR 4, at 2; Weaver, ANPR 17; Colenda, ANPR 
71; Haines, ANPR 100; Chiodo, ANPR, 21 Nov. 97 Tr., at 293-94.
    \40\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.'').
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    To address post-sale relationship issues by adopting rule 
provisions that prohibit or limit the use of certain contract terms 
would require record evidence demonstrating specific unfair acts or 
practices. The FTC Act defines an unfair act or practice as one that 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.''\41\ The Act 
also requires that, to justify an industry-wide rule, such practice be 
prevalent.\42\ This proceeding did not yield adequate evidence to 
support a finding of prevalent acts or practices that meet each of the 
three prerequisites for unfairness as articulated in Section 45(n) of 
the FTC Act.
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    \41\ 15 U.S.C. 45(n).
    \42\ 15 U.S.C. 57a.
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    With regard to the first prerequisite, substantial injury, the 
record shows that some franchisees in several franchise systems have 
suffered post-sale harm in the course of operating their franchises, 
and in some instances this injury may be ascribable to acts or 
practices of a franchisor.\43\ The record, however, leaves open the 
related questions of whether such franchisor acts or practices are 
prevalent and whether the injury resulting from acts or practices is 
substantial, when viewed from the standpoint of the franchising 
industry as a whole, not from just a particular franchise system.
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    \43\ There are many factors that influence the success or 
failure of a franchisee, including downturns in the economy, 
shifting consumer preferences, or even franchisees' own conduct. 
Accordingly, franchisor conduct post-sale may be only one factor 
that leads to injury to franchisees. The record is inconclusive, 
with respect to the franchising overall, as to whether franchisor 
acts or practices are a direct and primary cause of poor performance 
or failure by franchisees. In this regard, it is noteworthy that in 
its 2001 audit of the Commission's Franchise Rule Program, the 
General Accounting Office (``GAO'') concluded that there are ``no 
readily available, statistically reliable data on the overall extent 
and nature of [franchise relationship] problems.'' United States 
General Accounting Office, GAO Report to Congressional Requesters, 
Federal Trade Commission Enforcement of the Franchise Rule, GAO-01-
776, at 29 (July 31, 2001). See also Staff Report, at 10-11.
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    With regard to avoidability of injury, the unfairness analysis 
falls short. A franchise purchase is entirely voluntary. The Franchise 
Rule ensures that each prospective franchisee receives disclosures--
expanded in key respects by the current amendments--that explain the 
terms and conditions under which the franchise will operate. 
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. Prospective franchisees are also free to discuss the nature 
of the franchise system with existing and former franchisees, as well 
as trademark-specific franchisee associations, and the amended Rule 
facilitates such discussion by providing prospects with contact 
information. Under these circumstances, the Commission cannot 
categorically 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 its franchise agreement.\44\
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    \44\See FTC v. J.K. Publ'ns, Inc., 99 F. Supp. 2d 1176, 1201 
(C.D. Cal. 2000) (``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.''').
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    The third element requires an analysis of whether injury to 
franchisees deriving from specific franchisor acts or practices 
outweighs countervailing benefits to the public at large or to 
competition. In our law enforcement experience investigating 
relationship issues in individual franchise systems, it has been the 
case that the franchisor actions allegedly causing harm to individual 
franchisees also frequently generate countervailing benefits to the 
system as a whole or to consumer welfare overall that may or may not be

[[Page 15448]]

outweighed by the alleged harm to franchisees. Commenters advocating 
that the Rule include unfairness remedies have asserted injury, but 
have failed to bring forth evidence that such injury outweighs 
potential countervailing benefits that arise from the alleged acts or 
practices. Therefore, the Commission declines to impose industry-wide 
provisions mandating substantive terms of private franchise contracts 
that would impact on the entire franchise industry, not just those 
franchise systems that are the subject of commenters' complaints.\45\ 
Notwithstanding this determination, the Commission, in pursuit of its 
law enforcement mission can consider whether individual franchisors' 
conduct constitutes an unfair act or practice on a case-by-case basis.
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    \45\ The Commission notes that it has voiced concern that 
government-mandated contractual terms may result in affirmative harm 
to consumer welfare. Contractual terms that are driven by market 
forces and forged by private parties acting in their own self-
interest are the ones most likely to result in products being 
brought to market quickly and efficiently. The Commission therefore 
has authorized its staff to file a number of advocacy comments 
recommending against proposed state bills that would have unduly 
limited manufacturers in managing their distribution systems, such 
as by requiring exclusive territories, prohibiting or seriously 
burdening wholesaler terminations, or limiting the ability to 
reorganize a distribution system in response to changing competitive 
conditions. See, e.g., Letter from Maureen Ohlhausen, Dir., Office 
of Policy Planning, et al., to the Hon. Wesley Chesbro, Cal. State 
Senate (Aug. 24, 2005) (comment on proposed beer franchise act); 
Letter from C. Steven Baker, Dir., Chicago Regional Office, to the 
Hon. Dan Cronin, Ill. State Senate (Mar. 31, 1999) (comment on 
proposed legislation on wine and spirits distribution); cf. 
Testimony of Jerry Ellig, Deputy Dir., Office of Policy Planning, 
before joint committee hearings of the Haw. state legislature 
(recommending against gasoline price control legislation, in part on 
grounds that repeal of anti-encroachment statute would be a more 
effective means of reducing prices (Jan. 28, 2003)).
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    Nonetheless, the Commission concludes that the record is sufficient 
to show that misunderstandings about the state of the franchise 
relationship are prevalent, and some more disclosure is warranted to 
ensure that prospective franchisees are not deceived about the quality 
of the franchise relationship before they commit to buying a franchise. 
Franchisee concerns about relationship issues persuade us that better 
disclosure is necessary to ensure that prospective franchisees are 
fully informed about the relationships that they will be entering. To 
that end, part 436 of the final amended Rule expands the Rule's pre-
sale disclosures in a few instances to address franchise relationship 
issues, as detailed throughout this document.

D. Overview of the Final Amended Rule

    The final amended Rule maintains the benefits of the original Rule, 
preventing deceptive and unfair practices identified in the original 
rulemaking through pre-sale disclosure of material information 
necessary to make an informed purchasing decision and prohibition of 
specified misrepresentations. At the same time, part 436 of the final 
amended Rule reduces unnecessary compliance costs. First, part 436 
covers only the sale of franchises to be located in the United States 
and its territories. Second, based upon the record, the Commission also 
has created several new exemptions for sophisticated franchise 
purchasers, including exemptions for large investments and large 
franchisees with sufficient net worth and prior experience.
    Part 436 of the final amended Rule also reduces inconsistencies 
between federal and state pre-sale disclosure requirements. Since the 
original Rule was promulgated, NASAA, which represents the 15 states 
with pre-sale franchise disclosure laws, has developed a standard 
disclosure document, the UFOC. The Commission, as a matter of policy, 
has in the past permitted franchisors to comply with the Franchise Rule 
by furnishing prospective franchisees with a UFOC, even in the 35 
states without franchise disclosure laws.\46\ The Commission found that 
the UFOC Guidelines, taken as a whole, offer consumers the same or 
greater consumer protection as that provided by the original Rule. As a 
result, the UFOC Guidelines already are used by the vast majority of 
franchisors to comply with the Rule,\47\ and, in fact, the UFOC 
Guidelines have become the national franchise industry standard.\48\ 
Further, 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.\49\ Therefore, the UFOC Guidelines, like the Franchise Rule, 
reflect a balance of interests among all affected parties.
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    \46\ Authorization to use the UFOC Guidelines to comply with the 
original Rule's disclosure requirements was first granted by the 
Commission in the Interpretive Guides, 44 FR at 49970-71, on the 
grounds that the UFOC Guidelines, taken in their entirety, provide 
equal or greater consumer protection as the original Rule. The 
Commission ratified this position following subsequent amendments to 
the UFOC requirements by the NASAA, most recently in 1993, 58 FR 
69224 (Dec. 30, 1993).
    Beginning on July 1, 2008, however, franchisors may use part 436 
of the final amended Rule only. Permission to use the UFOC 
Guidelines will be withdrawn on that date because those Guidelines 
will no longer afford prospective franchisees equal or greater 
protection as part 436. This would not preclude consideration of any 
new or revised UFOC Guidelines promulgated by the states in the 
future.
    \47\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.
    \48\ E.g., IFA, NPR 22, at 4-5; Stadfeld, NPR 23, at 2; Karp, 
ANPR, 19 Sept. 97 Tr., at 90.
    \49\ NASAA, ANPR 120, at 2. See also WA Securities, ANPR 117, at 
1.
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    Overwhelmingly, franchisors, franchisees, and franchise regulators 
urged the Commission throughout the Rule amendment proceeding to adopt 
the UFOC Guidelines disclosure format. These commenters include a broad 
range of interests, such as NASAA, the International Franchise 
Association (``IFA''), the American Bar Association's Antitrust 
Section, the American Franchisee Association, the State Bar of 
California Business Law Section, and major franchisors, such as 
Cendant, Marriott, YUM! Brands, 7-Eleven, Arby's, and Starwood Hotels 
and Resorts.\50\
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    \50\ E.g., PMR&W, NPR 4, at 1; H&H, NPR 9, at 2; 7-Eleven, NPR 
10, at 2; Lewis, NPR 15, at 5; NASAA, NPR 17, at 2-4; Bundy, NPR 18, 
at 6; Gurnick, NPR 21, at 2; IFA, NPR 22, at 4-5; Stadfeld, NPR 23, 
at 2; J&G, NPR 32, at 2; Marriott, NPR 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, ANPR 117, at 1; 
Selden, ANPR 133, at 1; Zarco & Pardo, ANPR 134; at 1; Cendant, ANPR 
140, at 2.
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    Accordingly, part 436 of the final amended Rule closely tracks the 
UFOC Guidelines. Nevertheless, part 436 is not identical to the UFOC 
Guidelines. In a few instances, part 436 omits or streamlines a UFOC 
Guidelines disclosure requirement that the Commission believes is 
unnecessary or is overly burdensome--for example, mandatory cover page 
risk factors, broker disclosures, and detailed computer equipment 
disclosures. As explained in greater detail below, part 436 of the 
final amended Rule also avoids problems with Item 20 of the UFOC 
Guidelines (the disclosure of statistical information on franchisees in 
the system) that were revealed during the proceeding and that were 
examined in detail by a number of commenters, including NASAA.
    Part 436 of the final amended Rule also retains a few provisions 
from the original Rule that are not in the UFOC Guidelines, because the 
Commission believes they are necessary to prevent deception. For 
example, part 436 of the final amended Rule retains the original Rule's 
requirement that, in some instances, franchisors disclose information 
about a parent. Similarly, part 436 retains the original Rule's phase-
in of audited financial statements,

[[Page 15449]]

thereby preserving flexibility not present in the UFOC Guidelines.
    At the same time, part 436 of the final amended Rule adds to the 
UFOC Guidelines a few narrowly tailored disclosures based upon the 
Commission's law enforcement experience and the rulemaking record, 
mostly to prevent deception involving the nature of the franchise 
relationship.\51\ For example, as explained in greater detail below, 
part 436 of the final amended Rule expands the UFOC Guidelines' Item 3 
litigation disclosure requirements to include the disclosure of 
franchisor-initiated litigation. In addition, part 436 of the final 
amended Rule goes beyond the UFOC Guidelines' Item 20 franchisee 
statistics disclosures to require disclosure of information about the 
franchisor's use of confidentiality clauses and the existence of 
trademark-specific franchisee associations. In addition, in a few 
instances, part 436 of the final amended Rule requires franchisors to 
make prescribed statements to clarify issues that the record 
established are often misinterpreted by prospective franchisees, 
particularly in the area of protected territories and financial 
performance representations.
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    \51\ A decision to retain any portion of the original Rule may 
be based upon evidence gathered during the original rulemaking and 
the Commission's subsequent enforcement experience, as well as 
evidence adduced during the current rulemaking. Indeed, to the 
extent that nothing supplements evidence from the initial 
rulemaking, there is a presumption that the existing rule should be 
retained. See Motor Vehicle Mfrs. Ass'n v. State Farm Mut. Auto. 
Ins. Co., 463 U.S. 29, 42 (1983).
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    Further, part 436 of the final amended Rule updates the original 
Rule and UFOC Guidelines by addressing changes in the marketplace and 
new technologies. For example, as explained below, part 436 of the 
final amended Rule permits franchisors to furnish disclosures 
electronically and enables franchisees to use electronic signatures. 
Part 436 of the final amended Rule also updates the original Rule and 
UFOC Guidelines to address the impact of the Internet on a franchisor's 
business operations. Specifically, part 436 requires more disclosure 
about the affect of the Internet on sales restrictions imposed on 
franchisees and any right of franchisors to compete online. It also 
addresses financial performance representations made on the Internet.
    Finally, part 436 of the final amended Rule contains a few 
provisions and prohibitions that are necessary to make the Rule 
effective, to facilitate compliance, and to prevent deception. For 
example, part 436 of the final amended Rule prohibits a franchisor from 
unilaterally altering the material terms and conditions of its 
franchise agreements, unless the franchise seller informs the 
prospective franchisee about the changes within a reasonable time 
before execution. Part 436 of the final amended Rule also prohibits the 
use of shills, who are persons paid or otherwise given consideration to 
provide a false favorable report about the franchisor's performance 
history.

E. Continued Application of Commission and NASAA Precedent

    As noted throughout, most of the provisions of the original Rule 
have been retained in the final amended Rule. Accordingly, the original 
SBP remains valid, except to the extent of any conflict with the final 
amended Rule. In the event of any conflict, this document supersedes 
the original SBP. In the same vein, all former informal staff 
advisories remain a source of Rule interpretation, except where this 
SBP contradicts a staff advisory. To the extent that any member of the 
public is concerned that a previous advisory may no longer be 
applicable in light of the final amended Rule, we invite that person or 
entity to seek further clarification from the Commission or the 
staff.\52\
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    \52\ The Commission's Rules of Practice prescribe procedures to 
follow in seeking such advice. 16 CFR 1.3.
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    Further, the Commission anticipates issuance of new Compliance 
Guides on part 436 that will replace the original Interpretive 
Guides.\53\ Because much of part 436 of the final amended Rule is based 
upon the UFOC Guidelines, the Commission anticipates that Compliance 
Guides will likely incorporate, in large measure, the UFOC Guidelines' 
existing sample answers and NASAA's previously issued commentaries on 
the UFOC Guidelines, to the extent such sample answers and commentaries 
do not deviate from the final amended Rule.\54\ The Commission intends 
that the staff coordinate the issuance of Compliance Guides, and future 
interpretations of part 436 of the final amended Rule, with NASAA's 
Franchise and Business Opportunity Project Group in order to minimize 
differences between FTC and state Rule interpretations.
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    \53\ Throughout the Rule amendment proceeding, commenters have 
requested that the Commission explain or interpret various 
provisions in Compliance Guides. The Commission anticipates that 
staff will respond affirmatively to those requests. Compliance 
Guides on part 437 (the business opportunity section) will be issued 
after the conclusion of the business opportunity rulemaking 
proceeding.
    \54\ The Commission also recognizes that over the course of the 
years, franchisors have developed specific language approved by the 
states for compliance with the UFOC Guidelines. The Commission 
anticipates that part 436 of the final amended Rule will be 
interpreted, where consistent with the public interest, in a manner 
that conforms with historic industry practices.
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II. THE LEGAL STANDARD FOR AMENDING THE RULE

A. Section 18 Rulemaking

    Section 18(d)(2)(B) of the FTC Act states that ``[a] substantive 
amendment to, or repeal of, a rule promulgated under subsection 
(a)(1)(B) shall be prescribed, and subject to judicial review, in the 
same manner as a rule prescribed under such subsection.''\55\ Thus, the 
standard for amendment or repeal of a Section 18 rule is identical to 
that for promulgating a trade regulation rule pursuant to Section 18.
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    \55\ 15 U.S.C. 57a(d)(2)(B). The Commission's rulemaking 
standards applicable to the promulgation and amendment of a Section 
18 rule require a preponderance of reliable evidence. See Statement 
of Basis and Purpose, Funeral Rule, 59 FR 1592 (Jan. 11, 1994); 
Credit Practices Rule, 49 FR 7740 (Mar. 1, 1984).
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    Additionally, an SBP must address four factors: (1) the prevalence 
of the acts or practices addressed by the rule; (2) the manner and 
context in which the acts or practices are unfair or deceptive; (3) the 
economic effect of the rule, taking into account the effect on small 
businesses and consumers; and (4) the effect of the rule on state and 
local laws.\56\ These four factors are discussed in detail throughout 
this document. In the next section, we summarize our findings regarding 
each of these factors.\57\
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    \56\ Rules of Practice, 16 CFR 1.14(a)(1)(i)-(iv). In addition, 
the SBP must specify how the public may obtain a copy of the Rule's 
final regulatory analysis. 16 CFR 1.14(a)(v). The current notice 
does not set forth a separate regulatory analysis. Instead, it 
incorporates the Commission's regulatory analysis throughout the SBP 
portion of the notice. This notice, including the SBP, is being 
published in the Federal Register and posted on the FTC's website 
at: www.ftc.gov.
    \57\ Support in the record for each factor is set forth in the 
substantive discussion of each provision of the final amended Rule.
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1. The effect of the rule on state and local laws
    The Commission begins with the effect of the final amended Rule on 
state and local laws, because that factor is unusually prominent in 
this proceeding. As noted above, 15 states have pre-sale franchise 
disclosure laws in the form of the UFOC Guidelines. The rulemaking 
record shows that, as a practical matter, the UFOC Guidelines are, in 
fact, the national disclosure standard for the franchise industry. 
Therefore, by design, the overwhelming effect of the final amended Rule 
on state franchise law will be to mesh more closely with it and

[[Page 15450]]

enhance its effectiveness by promoting consistency and extending its 
reach to nationwide scope.\58\ Moreover, the overwhelming majority of 
commenters throughout the Rule amendment proceeding, including NASAA 
and other state law advocates, urged the Commission to update the 
original Rule by adopting the UFOC Guidelines to bring greater 
uniformity to the field of franchise pre-sale disclosure.\59\ 
Accordingly, in considering the factors outlined above, the Commission 
has given great weight to state franchise laws and their impact on the 
market, as well as the desire of all parties in the field to reduce 
inconsistencies between federal and state franchise disclosure laws.
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    \58\ As noted above, part 437 (the business opportunity section) 
of the final amended Rule is identical in all respects to the 
original Rule, except for its scope of coverage. Accordingly, the 
amendments to the original Rule set forth in part 437 will have no 
effect on state or local business opportunity laws.
    \59\ The Commission intends to continue working with NASAA and 
individual states after the final amended Rule goes into effect in 
order to harmonize federal and state franchise disclosure laws. The 
Commission recognizes that the states have a wealth of experience in 
interpreting the UFOC Guidelines that form the basis of the final 
amended Rule. Accordingly, the Commission anticipates that the staff 
will coordinate with NASAA and the states in issuing future 
Compliance Guides and informal staff advisory opinions, in keeping 
with our goal of federal and state harmonization.
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    The Commission has also carefully weighed the benefits of any 
suggestion to revise the Rule that would compound inconsistencies 
between the Rule and the UFOC Guidelines. Only in very few instances, 
an existing weakness in the UFOC Guidelines compels deviation from 
those Guidelines. The chief example is the revision to the Item 20 
franchise statistics disclosures. Part 436 of the final amended Rule 
adopts a proposal submitted by NASAA to eliminate revealed problems 
with UFOC Item 20 in a streamlined fashion that provides prospective 
franchisees with material information about the franchise system, while 
reducing unnecessary compliance burdens.
    The Commission also has adopted several suggestions offered by 
state regulators, mostly through NASAA, for streamlining the Rule. For 
example, in part 436 the Commission has revised the financial 
performance claim disclosures to eliminate the original Rule's 
requirements that: (1) existing franchise performance data be prepared 
according to generally accepted accounting principles; (2) financial 
performance data be presented to a prospective franchisee in a separate 
financial performance document; and (3) cost information alone trigger 
the Rule's financial performance disclosure and substantiation 
requirements.
2. Deceptive practices
    The original Rule remedied through pre-sale disclosure five types 
of harmful material misrepresentations or omissions that were found to 
be widespread --specifically, misrepresentations about: (1) the 
opportunity being offered for sale (2) costs; (3) contractual terms; 
(4) success of the seller and prior purchasers; and (5) the seller's 
financial viability. Each part 436 disclosure amendment to the original 
Rule addresses one of these five types of misrepresentations or 
omissions of material information.\60\
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    \60\ As noted above, part 437 (the business opportunity section) 
of the final amended Rule is identical in all respects to the 
original Rule, except for its scope of coverage. Accordingly, there 
are no amendments in part 437 that must be addressed here.
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a. Misrepresentations about the franchisor and the franchise system
    In the original rulemaking, the Commission found that franchisors 
and business opportunity sellers routinely misrepresented the nature of 
the business. For example, franchisors misrepresented how long they had 
been in business or the extent of their directors' and officers' prior 
business experience. Such misrepresentations mislead consumers acting 
reasonably under the circumstances into believing that the franchise 
offered for sale is a safe or low risk investment.
    To prevent such deception, the original Rule required franchisors 
and business opportunity sellers to disclose background information on 
the franchisor or business opportunity seller and the business, 
including: the name and address of the franchisor or business 
opportunity seller and any parent company; the name under which the 
franchise or business opportunity seller does or intends to conduct 
business; its trademarks; the prior business experience of the 
franchisor or business opportunity seller and its directors and 
officers; and the business experience of the franchisor or business 
opportunity seller --e.g., experience selling franchises under the same 
or different trademarks, as well as the franchisor or business 
opportunity seller's other lines of business.
    Part 436 of the final amended Rule continues to address 
misrepresentations about the nature of the franchisor and the franchise 
system by requiring the same disclosures as did the original Rule. In a 
few instances, part 436 expands on these disclosures to remedy aspects 
of this type of misrepresentation that have been revealed by our 
enforcement experience or the record developed here. Specifically, part 
436 of the final amended Rule requires franchisors to disclose 
information about the franchisor's predecessors. Similarly, based upon 
the Commission's law enforcement experience in over 50 franchise cases, 
part 436 also remedies misrepresentations about those controlling the 
franchise system by requiring not only disclosures about directors and 
officers, but also about other individuals who have management 
responsibility relating to the sale or operation of the franchises 
being offered for sale.
b. Misrepresentations about costs
    In promulgating the original Rule, the Commission recognized the 
harm to franchisees and business opportunity purchasers resulting from 
misleading cost representations. Representing that costs of buying and 
operating a franchise, for example, are less than they actually are is 
likely to mislead prospective franchisees, acting reasonably under the 
circumstances, into believing that the franchise is more financially 
attractive than is actually the case. Obviously, cost representations 
are highly material. Thus, the original Rule required franchisors and 
business opportunity sellers to disclose fully not only the initial 
fee, but continuing costs throughout the relationship. For example, 
franchisors must disclose required purchases or leases for, among other 
things, inventory, signs, supplies, and equipment. In addition, the 
Commission was concerned about undisclosed indirect payments to the 
franchisor or business opportunity seller, and therefore required 
franchisors and business opportunity sellers to disclose the basis for 
calculating payments to the franchisor or business opportunity seller 
from suppliers that franchisees or business opportunity purchasers are 
required to use. Similarly, franchisors and business opportunity 
sellers must disclose any interest or payments made to celebrity 
endorsers.
    Part 436 of the final amended Rule retains these required cost 
disclosures. It also adopts a few additional cost disclosures that the 
states found necessary to address related misrepresentations or 
omissions, or misrepresentations revealed by our law enforcement 
experience or the record developed here. These include, for example, a 
description of laws or regulations specific to the industry in which 
the franchise operates. Obviously, a franchisee's operating costs

[[Page 15451]]

may increase if he or she must incur hidden costs in the form of 
compliance with various industry-specific regulations governing the 
particular field. Part 436 of the final amended Rule also adopts the 
UFOC Guidelines' required disclosure of fees that the franchisee is 
expected to pay within the first three months of operation (or other 
reasonable time for the industry), as well as more details about 
payments, such as to whom a payment is to be made and whether a payment 
is refundable. At the same time, part 436 of the final amended Rule 
updates cost disclosures by requiring, for example, additional 
information about any required computer systems, based upon the UFOC 
Guidelines. Each of these UFOC provisions is designed to prevent 
misrepresentation of the costs required to commence operation of a 
franchised outlet.
c. Misrepresentations about contractual terms
    Another area of deception identified in the original rulemaking 
record concerns the underlying franchise or business opportunity 
contract. For example, the Commission found that franchisors may 
misrepresent the extent of promised assistance, or fail to disclose 
restrictions and other obligations imposed on the franchisee. 
Accordingly, the original Rule specified a number of disclosures 
pertaining to the legal obligations of both parties under their 
agreement. Specifically, the original Rule required franchisors, for 
example, to disclose information about contractual requirements to use 
designated suppliers, financing arrangements, product sales 
restrictions and protected territories, site selection, and training 
programs. In addition, franchisors had to disclose basic terms of the 
contract, such as the duration, renewal and termination rights, 
assignment rights, and covenants not to compete.
    Part 436 of the final amended Rule retains these disclosure 
requirements. Adopting the UFOC Guidelines approach, however, the 
contract disclosures are required to be presented in easy-to-read 
tables, with references to the franchise agreement, rather than in the 
form of more detailed descriptions. In addition, part 436 updates the 
disclosures by, for example, requiring franchisors to explain how they 
use the term ``renewal'' in their system.
d. Misrepresentations about success
    False or misleading representations about the success of franchise 
systems and business opportunities were perhaps the most prevalent 
misrepresentations identified in the original rulemaking record. These 
included misrepresentations about: the number of franchisees or 
business opportunity purchasers, the expected growth of the system, 
and, most important, the financial performance of existing purchasers.
    To remedy misleading success claims, the original Rule required 
franchisors and business opportunity sellers to disclose statistics 
about the system, including the number of purchasers in the system, the 
number of purchasers who left the system in the previous year, and why 
they left (i.e., termination, cancellation, non-renewal, 
reacquisition). The original Rule also required franchisors and 
business opportunity sellers to furnish the names and contact 
information for at least 10 current purchasers. This information 
enabled prospective purchasers to verify the seller's claims of 
success, and it gave prospective purchasers additional sources from 
which to obtain financial performance data.
    The original Rule also remedied misleading success claims by 
requiring franchisors and business opportunity sellers to disclose 
lawsuits filed by purchasers against them pertaining to their 
relationship and counterclaims filed by a franchisor or business 
opportunity seller in response to a suit filed by a purchaser. The 
existence of such lawsuits is material because this information would 
likely influence a prospective purchaser's decision about what can be a 
sizeable investment in a franchise or business opportunity. The nature 
of the relations between the seller and the purchaser, as reflected in 
litigation, is of central importance.
    In the original rulemaking, the Commission also sought to ensure 
the accuracy and reliability of any financial performance claims made 
by a franchisor or business opportunity seller. Accordingly, the 
Commission prohibited the making of earnings claims unless the 
franchisor or business opportunity seller possessed a reasonable basis 
for the claim, along with written substantiation, at the time the claim 
was made. In addition, the seller had to set forth the claim in a 
separate earnings claims statement containing the bases and assumptions 
underlying the claim. Franchisors and business opportunity sellers were 
also required to warn prospective purchasers that there is no assurance 
that they will achieve the same level of earnings.
    Part 436 of the final amended Rule retains each of these 
disclosures, and it expands on them by requiring franchisors to 
provide, consistent with the UFOC Guidelines, the names of up to 100 
franchised outlets, as well as contact information for former 
franchisees. Part 436 of the final amended Rule also provides 
additional sources of information about the franchise system, including 
the disclosure of trademark-specific franchisee associations. These 
provisions prevent misrepresentations by giving prospective franchisees 
additional sources of information with which to assess franchisor 
claims. With respect to financial performance representations, it 
follows the more streamlined approach of the UFOC Guidelines. 
Specifically, part 436 of the final amended Rule eliminates the need 
for a separate earnings claims document. Instead, the required 
information is incorporated into the text of the disclosure document 
itself (Item 19).
    Finally, as discussed throughout this document, franchisees have 
brought to the Commission's attention what they believe to be abusive 
practices in franchising. These practices include encroachment of 
territories, imposition of source of supply restrictions, modification 
of original franchise agreements as a precondition for renewal, and the 
use of disclaimers to limit liability for misrepresentations, among 
others. As detailed in Section I.C. above, the Commission declines to 
attempt to promulgate a franchise relationship law and, further, 
concludes that the record does not support the promulgation of such a 
law. Nonetheless, the record is sufficient to support requiring 
additional disclosures that will help inform prospective franchisees 
about the quality of the franchise relationship. These include: 
expanded litigation disclosures to include franchisor-initiated 
litigation against franchisees; a warning of the consequences to a 
franchisee when a franchisor offers no exclusive territory; a statement 
of what the term ``renewal'' means in the franchise system; and a 
disclosure of the use, if any, of confidentiality clauses. Taken 
together, each of these amended disclosures in part 436 will enable 
prospective franchisees to better assess the quality of the franchise 
relationship, and their likely success as franchisees.
e. Misrepresentations about financial viability
    In the original rulemaking record, the Commission found that 
franchisors and business opportunity sellers often misrepresented or 
failed to disclose material information about their financial 
viability. As a result, prospective purchasers invested thousands of 
dollars in systems having

[[Page 15452]]

a poor financial history, or even facing bankruptcy. Obviously, a 
franchisee's investment, for example, is at risk if the franchisor is 
not able to perform its contractual obligations as promised. To remedy 
these practices, the original Rule required franchisors and business 
opportunity sellers to disclose bankruptcy information, as well as to 
provide audited financial information. The final amended Rule continues 
to require these disclosures.
3. The economic effect of the rule
    At every stage of the Rule amendment proceeding, the Commission 
solicited comment on the economic impact of the Rule, as well as the 
costs and benefits of each proposed Rule amendment. In finalizing the 
final amended Rule, the Commission has carefully weighed these costs 
and benefits, reducing compliance costs wherever possible. Thus, for 
example, part 436 reduces compliance costs by limiting the Rule's scope 
of coverage to the sale of franchises to be located in the United 
States and its territories.\61\
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    \61\ In so doing, the Commission specifically rejected the 
suggestion that franchisors should 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 
would not likely outweigh the extraordinary costs and burdens 
involved.
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    In the same vein, part 436 of the final amended Rule reduces 
compliance burdens where the record establishes that the abuses the 
Rule is intended to address are not likely to be present. Thus, part 
436 of the final amended Rule retains the exemptions in the original 
Rule as the ones for fractional franchises and leased departments. Part 
436 of the final amended Rule also incorporates the Commission's long-
standing policies exempting from Rule coverage franchises covered by 
the Petroleum Marketing Practices Act, as well as instances where the 
only required payments made by the franchisee are for inventory at bona 
fide wholesale prices. Further, part 436 of the final amended Rule adds 
new exemptions for large investments of at least $1 million (excluding 
unimproved land and any amounts financed by the franchisor), 
investments by large franchisees with five years of business experience 
and $5 million net worth, and for franchise sales to company insiders 
who are already familiar with the company's operations.
    The Commission also has limited the required disclosures of part 
436 in order to minimize compliance burdens. For example, the 
Commission has declined to adopt two UFOC Guidelines provisions on the 
grounds that such provisions are unnecessarily burdensome, without 
corresponding benefits to prospective franchisees. These provisions are 
mandatory risk factors (choice of law and venue) on the disclosure 
document cover page and the disclosure of franchise broker information 
in Items 2, 3, and 4 of the UFOC Guidelines.
    Further, for each disclosure item, the Commission considered less 
costly disclosure alternatives. For example, part 436 of the final 
amended Rule requires the disclosure of franchisor-initiated 
litigation. In response to concerns raised by franchisor 
representatives, Item 3 of part 436 makes clear that this disclosure is 
limited to a one-year snap-shot in time and franchisors need only 
update the disclosure on an annual basis. Franchisors also can reduce 
costs by grouping similar franchisor-initiated suits under a single 
descriptive heading, in lieu of detailed summaries for each suit.
    Similarly, the Commission has adopted in part 436 a narrow 
requirement to disclose independent trademark-specific franchisee 
associations. Franchisors must make this disclosure only if the 
franchisee association asks to be included in the franchisor's 
disclosure document, and the association's request must be updated on 
an annual basis.
    Part 436 of the final amended Rule also reduces the franchisors' 
burdens associated with making financial performance claims. Among 
other things, the original Rule specified that: (1) all financial 
performance claims must be geographically relevant to the franchise 
being offered for sale; and (2) all historical earnings data from 
existing franchisees must be presented using generally accepted 
accounting principles. Moreover, the original Rule required franchisors 
to disseminate financial performance information in a separate 
document. Part 436 of the final amended Rule eliminates these 
requirements.
    Part 436 of the final amended Rule also promotes efficiency and 
reduces compliance costs by enabling franchisors to use their own 
judgment in deciding how to disseminate disclosure documents. For 
example, part 436 permits franchisors to furnish disclosures 
electronically through a variety of media, including CD-ROM, Internet 
website, and email. Individual sections of the disclosure document also 
allow more flexibility than the original Rule, again to promote 
efficiency and reduced compliance costs. For example, Item 5 permits 
franchisors to disclose either fixed fees or ranges of fees. Similarly, 
Item 11 permits franchisors to summarize computer system requirements, 
in lieu of more extensive disclosures.
    In amending the Rule, the Commission has been guided by a 
preference for an approach that prohibits identified harmful practices 
and eschews burdensome affirmative compliance obligations that may only 
be warranted for some few unscrupulous actors. Thus, part 436 of the 
final amended Rule drops the original Rule's across-the-board 
obligation to furnish disclosures early in the sales process--at the 
first personal meeting between the prospective purchaser and the 
franchise seller. Instead, part 436 of the final amended Rule allows 
greater flexibility, requiring that franchisors furnish disclosures 
early in the sales process only if the prospective franchisee requests 
them at that point. Similarly, part 436 of the final amended Rule 
eliminates burdensome waiting periods in some instances. Thus, in lieu 
of the original Rule's mandate that all franchisors furnish copies of 
their completed franchise agreements at least five business days before 
execution, part 436 targets potential fraud directly by prohibiting a 
franchisor from failing to disclose unilateral changes to a franchise 
agreement seven days prior to its execution. As a final example, part 
436 of the final amended Rule prohibits a franchisor from failing to 
furnish a copy of its most recent disclosure document and any quarterly 
updates to a prospective franchisee, upon reasonable request, before 
the prospect signs the franchise agreement. This prohibition is in lieu 
of suggestions that the Commission impose onerous disclosure updating 
obligations on an ongoing basis.
    Finally, in numerous instances the Commission has rejected 
suggestions to impose certain additional requirements upon franchisors, 
and has opted instead to address the underlying issues that prompted 
those suggestions through redoubled consumer education efforts. For 
example, several commenters in the rulemaking record urged the 
Commission to expand the disclosure document to provide prospective 
franchisees with more general information about the nature of 
franchising. Others suggested more disclosure on post-termination 
obligations to third-party vendors, obligations to purchase from 
specific suppliers, and sources of financing, among others. While there 
is merit in their suggestions, the Commission has concluded that the 
appropriate vehicle

[[Page 15453]]

to disseminate such information is through consumer education 
materials, not through the Rule itself. To that end, the cover page of 
the disclosure document set forth in part 436 of the final amended Rule 
references the Commissions' Consumer Guide to Buying a Franchise, where 
such background information is furnished. This approach enables 
prospective franchisees to obtain desirable information without 
imposing new compliance burdens on franchisors.
4. Statement of prevalence
    The Commission promulgated the original Rule based upon its finding 
of prevalent deception in the offer and sale of franchises and business 
opportunity ventures, leading to significant consumer injury. That 
finding retains its validity and the final amended Rule retains almost 
all of the original Rule's disclosure requirements for both franchises 
and business opportunity sellers. In the franchise context, 
modifications of those requirements have been driven by four 
considerations: the goal of harmonizing the Rule with the UFOC 
Guidelines; the need to update the original Rule to address new 
technologies; to reduce unnecessary compliance burdens; and, based on 
the record developed here, to remedy prevalent nondisclosure on issues 
relating to the franchise relationship.\62\
---------------------------------------------------------------------------

    \62\ The Commission is also considering amendments to the 
original Rule as they pertain to business opportunity sales. See 
Business Opportunity NPR, 71 FR 19054 (Apr. 12, 2006).
---------------------------------------------------------------------------

    This last category of modifications constitutes the most 
significant additions to the original Rule. Throughout the Rule 
amendment proceeding, franchisees have complained repeatedly about 
various practices in franchising that they believe are abusive. These 
practices include encroachment of territories, source of supply 
restrictions, modification of franchise agreements upon renewal, and 
the use of confidentiality clauses to prevent franchisees from speaking 
with prospects. To address these issues, franchisees urged the 
Commission to promulgate a substantive franchise relationship law. As 
detailed above in Section I.C., the applicable legal standard that 
could theoretically support promulgation of such a law has not been 
met. Nonetheless, the Commission is persuaded by evidence in the record 
that nondisclosure of material information about franchise 
relationships is prevalent and the record supports additional 
disclosures that will help obviate deception of prospective 
franchisees.
    To that end, part 436 of the final amended Rule adopts a few new 
disclosures that provide prospective franchisees with material 
information about the quality of the franchise relationship or with 
sources of information about such relationships. For example:
    <bullet> In section 436.5(c), the Item 3 requirements to disclose 
information about franchisor litigation have been amended to encompass 
franchisor-initiated litigation, such as suits to collect royalty 
payments, in order to ensure prospective franchisees have material 
information about the nature of the franchisor's relationship with its 
franchisees;\63\
---------------------------------------------------------------------------

    \63\ Multiple franchisor-initiated suits could indicate 
franchisees' inability to comply with royalty payment obligations, 
or possibly a royalty boycott by franchisees. Suits to enforce 
system standards, on the other hand, could show active involvement 
by the franchisor in maintaining standards for the benefit of all 
franchisees within its system. In either case, this is information 
material to prospective franchisees attempting to determine the 
nature of the franchisor's relationship with its franchisees.
---------------------------------------------------------------------------

    <bullet> In section 436.5(l), the Item 12 requirements to disclose 
information about territories contain a new warning to prospective 
franchisees about the consequences of not having an exclusive 
territory-- that, as a result of having no exclusive territory, the 
franchisee ``may face competition from other franchisees, from outlets 
that we own, or from other channels of distribution or competitive 
brands that we control;''
    <bullet> In section 436.5(q), the Item 17 requirements to disclose 
information about renewal of the franchise mandate that a franchisor 
describe what the term ``renewal'' means for its system, and state what 
has been absent from disclosure to date--that franchisees will be 
required to sign a different agreement when renewing, as opposed to 
extending the term of their original agreement.

These new disclosure requirements are tailored to address the prevalent 
franchisor nondisclosure of material information that prospective 
franchisees need to avoid forming the kind of misconceptions about 
these three key aspects of the franchise relationship that have 
prompted the franchisee complaints noted in this record.

III. SECTION-BY-SECTION ANALYSIS OF PART 436

A. Section 436.1: Definitions

    In many instances, the part 436 definitions of the final amended 
Rule are substantively similar to those contained in either the 
original Rule or UFOC Guidelines. These include the terms: 
``affiliate,'' ``fiscal year,'' ``fractional franchise,'' 
``franchise,'' ``franchisee,'' ``franchisor,'' ``leased department,'' 
``person,'' ``prospective franchisee,'' and ``sale of a franchise.'' 
Part 436 of the final amended Rule, however, adds several new 
definitions to the original Rule, including the terms: ``action,'' 
``confidentiality clause,'' ``disclose, state, describe, and list,'' 
``financial performance representation,'' ``franchise seller,'' 
``parent,'' ``plain English,'' ``predecessor,'' ``principal business 
address,'' ``required payment,'' ``signature,'' ``trademark,'' and 
``written.'' At the same time, part 436 of the final amended Rule 
eliminates four of the original Rule's terms, and their definitions, 
that are no longer necessary: ``business day,''\64\ ``time for making 
of disclosures,''\65\ ``personal meeting,''\66\ and ``cooperative 
association.''\67\
---------------------------------------------------------------------------

    \64\See 16 CFR 436.2(f).
    \65\ See 16 CFR 436.2(g).
    \66\See 16 CFR 436.2(o). The original Rule required franchisors 
to provide disclosure documents at the earlier of the first 
``personal meeting'' or ``the time for making disclosures,'' which 
generally meant 10 business days before the prospective franchisee 
paid any fee or signed any contract in connection with the franchise 
sale. The final amended Rule streamlines this requirement by 
eliminating those timing provisions in favor of a clear, bright-line 
14 calendar-day provision. Accordingly, the terms ``time for making 
disclosures,'' ``personal meeting,'' and ``business day'' are 
obsolete.
    \67\ See 16 CFR 436.2(l). Cooperative associations are one of 
four non-franchise relationships that the Commission has excluded 
from the final amended Rule. Unlike Rule exemptions (which are 
substantive limitations on the Rule's scope), the original Rule 
exclusions are explanatory, helping the public better distinguish 
between franchise and non-franchise relationships. Accordingly, the 
Commission anticipates that staff will address non-franchise 
relationships--including the four exclusions--in the Compliance 
Guides instead of in the text of the amended Rule.
---------------------------------------------------------------------------

    Section 436.1 of the final amended Rule is very similar to the 
corresponding section of the proposed Rule published in the Franchise 
NPR, but makes the following revisions: (1) substitutes a definition of 
``confidentiality clause''; for the definition of ``gag clause;'' (2) 
omits proposed definitions of ``Internet,'' ``officer,'' and 
``material;'' and (3) makes non-substantive revisions to improve 
readability, organization, and precision throughout, as well as some 
substantive revisions in response to the comments. The following 
sections discuss each definition of part 436 of the final amended Rule.
1. Section 436.1(a): Action
    Consistent with the original Rule,\68\ section 436.5(c) of the 
final amended

[[Page 15454]]

Rule requires a franchisor to disclose certain legal actions involving 
the franchisor and its directors and officers. The original Rule did 
not define the term ``action.'' Section 436.1(a) in the final amended 
Rule is nearly identical to the definition proposed in the Franchise 
NPR, and closely tracks the UFOC Guidelines' definition of the term 
``action.''\69\ That definition is: ``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.''\70\ The definition differs from the UFOC Guidelines 
definition only in that it refers to a ``judicial action or 
proceeding,'' in lieu of just a ``judicial proceeding.'' This 
modification addresses one commenter's observation that some states may 
retain the distinction between an ``action'' at law and a 
``proceeding'' in equity.\71\ Clearly, both types of legal matters must 
be disclosed.
---------------------------------------------------------------------------

    \68\See 16 CFR 436.1(a)(4).
    \69\ This definition is also consistent with the Commission's 
interpretation of the term ``action,'' as discussed in the 
Interpretive Guides to the Franchise Rule. Interpretive Guides, 44 
FR at 49973.
    \70\See UFOC Guidelines, Item 3 Definitions, ii.
    \71\ NFC, NPR 12, at 25.
---------------------------------------------------------------------------

    The Commission has declined to adopt an additional suggestion that 
``complaints'' referred to in the definition of ``action'' be limited 
to ``served complaints.''\72\ Such a narrowing of the definition of 
``action'' would be inconsistent with the UFOC Guidelines. Moreover, it 
would effectively enable a franchisor to avoid disclosing potentially 
material litigation, even though it had notice of an action, merely 
because it was not served with the papers yet or had successfully 
avoided service of process. In the Commission's law enforcement 
experience, it is not uncommon for defendants to know that a Commission 
action was filed prior to service either by learning of the suit from 
co-defendants or as a result of an asset freeze.\73\
---------------------------------------------------------------------------

    \72\ Lewis, NPR 15, at 7.
    \73\ E.g., FTC v. Joseph Hayes, No. 4:96CV02162SNL (E.D. Mo. 
1996).
---------------------------------------------------------------------------

    In the same vein, IL AG suggested that the term ``action'' should 
refer to both `` filed'' and ``served'' complaints.\74\ A reference to 
``filed complaints'' is unnecessary, however, and would be inconsistent 
with the UFOC Guidelines: the definition of action already refers to 
``complaints . . . in a judicial action or proceeding'' and 
``complaints . . . in . . . an arbitration,'' meaning that a complaint 
has already been filed. Accordingly, the Commission declines to adopt 
these additional revisions to the definition of ``action.''
---------------------------------------------------------------------------

    \74\ IL AG, at 2.
---------------------------------------------------------------------------

2. Section 436.1(b): Affiliate
    Many of the part 436 disclosures pertain to both the franchisor and 
its affiliates.\75\ The original Rule defined the term ``affiliated 
person'' to mean a person:
---------------------------------------------------------------------------

    \75\E.g., Sections 436.5(a) (Item 1); 436.5(c) (Item 3); 
436.5(d) (Item 4); 436.5(h) (Item 8).

     (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.\76\
---------------------------------------------------------------------------

    \76\ 16 CFR 436.2(i).

    Section 436.1(b), like the corresponding definition in the proposed 
Rule, harmonizes federal and state law, closely following the UFOC 
Guidelines by defining ``affiliate'' to mean: ``an entity controlled 
by, controlling, or under common control with, another entity.''\77\ 
This is slightly broader than the UFOC Guidelines' definition, however. 
The UFOC Guidelines' definition uses the narrower term ``franchisor'' 
in place of ``another entity.'' This slight departure from the UFOC 
Guidelines is necessary for the ``large franchisee'' exemption, section 
436.8(a)(5)(ii), as discussed below in the section covering that 
exemption.\78\
---------------------------------------------------------------------------

    \77\See NASAA Commentary on the Uniform Franchise Offering 
Circular Guidelines (1999), Bus. Franchise Guide (CCH), ] 5790, at 
8466 (``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. The record contains no indication that the UFOC 
Guidelines' narrower definition is deficient or would impede the 
Commission's ability to target affiliates in law enforcement 
actions, where warranted.
    \78\See Triarc, NPR 6, at 2. The Staff Report recommended that 
the term ``affiliate'' mean ``controlled by, controlling, or under 
common control with, the franchisor or a franchisee.'' See Staff 
Report, at 21 (emphasis added). While this version was intended to 
capture franchisee affiliates, for purposes of the ``large 
franchisee'' exemption, it also had the unintended consequence of 
broadening affiliate disclosures generally. For example, section 
436.5(d) (Item 4) requires a franchisor to disclose a prior 
bankruptcy of an affiliate. Defining ``affiliate'' expressly to 
include ``franchisee'' would arguably require a franchisor to list 
in its Item 4 bankruptcy disclosures the bankruptcy history of its 
franchisees' affiliates. The final amended Rule does not follow this 
problematic recommendation.
---------------------------------------------------------------------------

3. Section 436.1(c): Confidentiality clause
    Part 436 of the final amended Rule requires franchisors for the 
first time to disclose the use of confidentiality clauses that prohibit 
or restrict existing or former franchisees from discussing their 
experience with prospective franchisees.\79\ Accordingly, section 
436.1(c) of the final amended Rule adds to the original Rule 
definitions the term ``confidentiality clause,''\80\ defined as 
follows:
---------------------------------------------------------------------------

    \79\ Section 436.5(t)(7).
    \80\ Originally, the Commission proposed using the term ``gag 
clause'' to refer to such provisions. Franchise NPR, 64 FR at 57332. 
Several commenters, however, opposed the term ``gag clause'' 
because, in their view, it is pejorative. They prefer a neutral 
term, such as ``confidentiality agreement,'' ``confidentiality 
clause,'' ``nondisclosure clause,'' or ``privacy clause.'' E.g., 
NFC, NPR 12, at 26; BI, NPR 28, at 10. Accordingly, the Commission 
has adopted the term ``confidentiality clause.''

     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 clauses that 
---------------------------------------------------------------------------
protect a franchisor's trademarks or other proprietary information.

    As explained below, the confidentiality clause disclosure 
requirement is intended to prevent deception in the offer and sale of 
franchises by assisting prospective franchisees in verifying a 
franchisor's claims. Specifically, this disclosure requirement is tied 
to the requirement to disclose contact information for existing 
franchised outlets.\81\ Knowing that a franchisor uses a 
confidentiality clause enables prospective franchisees to understand 
that a former or current franchisee may be prohibited from speaking 
about his or her experience and will make efforts to contact other 
former or current franchisees not subject to such a clause. This being 
the disclosure's purpose, the operant definition is limited to 
confidentiality clauses impinging on communications between current or 
former franchisees and prospective franchisees only.\82\ It would not 
cover clauses that prohibit communications between current or

[[Page 15455]]

former franchisees and, for example, the media.
---------------------------------------------------------------------------

    \81\See section 436.5(t)(5). See also UFOC Guidelines Item 20 B.
    \82\ At the same time, the confidentiality clause disclosure 
requirement is not designed to cover specific settlement terms if 
the franchisee is otherwise free to discuss his or her experience 
within the franchise system, including the existence of a litigated 
action with the franchisor.
---------------------------------------------------------------------------

    After carefully considering the comments, the Commission has 
rejected suggestions to limit the definition of confidentiality clause 
to cover only broad clauses that prohibit all communications by current 
or former franchisees\83\ or only circumstances where all or at least 
20% of franchisees are under speech restrictions.\84\ These suggestions 
are narrower than necessary and would defeat the very purpose of the 
confidentiality clause disclosure. Moreover, as stated throughout this 
document, the Commission favors bright-line standards that enable 
franchisors, prospective franchisees, and law enforcers to know when a 
Rule provision applies without resort to fact-finding. In this 
instance, the parties should know whether the confidentiality clause is 
applicable without having to first determine the exact number of 
franchisees under speech restrictions at any given period.
---------------------------------------------------------------------------

    \83\ PMR&W, NPR 4, at 15.
    \84\ NFC, NPR 12, at 33.
---------------------------------------------------------------------------

    Finally, the definition expressly excludes confidentiality 
agreements designed to protect proprietary information. Many 
commenters--both franchisor and franchisee representatives alike--
agreed that proprietary information should be exempted from the 
definition because a franchisor has a reasonable and legitimate concern 
about protecting its trademark and business secrets.\85\ One commenter 
suggested that the Commission make clear that the existence of a 
confidentiality agreement cannot be considered ``proprietary 
information.''\86\ Otherwise, according to this commenter, a franchisor 
could attempt to circumvent the confidentiality agreement disclosure by 
having a prospective franchisee sign an agreement stating that the 
existence of a confidentiality agreement is itself ``proprietary.'' The 
Commission, however, intends that the term ``proprietary information'' 
be limited to trade secrets and intellectual property, the type of 
information that, if disclosed, would put a franchisor at a competitive 
disadvantage.
---------------------------------------------------------------------------

    \85\E.g., Baer, ANPR 25, at 3; AFA, ANPR 62, at 3; Zarco & 
Pardo, ANPR 134, at 4.
    \86\ Bundy, NPR 18, at 3.
---------------------------------------------------------------------------

4. Section 436.1(d): Disclose, state, describe, and list
    Section 436.1(d) sets forth the definition of the terms 
``disclose,'' ``state,'' ``describe,'' and ``list,'' which are used 
throughout part 436. This is another definition not contained in the 
original Rule. The proposed definition published in the Franchise NPR 
was taken from the UFOC Guidelines, stating that these terms mean ``to 
present all material facts accurately, clearly, concisely, and legibly 
in plain English.''\87\
---------------------------------------------------------------------------

    \87\See UFOC Guidelines, General Instruction 150. The phrase 
``plain English'' is defined separately in section 436.1(o), 
consistent with the UFOC Guidelines.
---------------------------------------------------------------------------

    The Commission is persuaded that franchisors should have 
flexibility in presenting their disclosures, provided that the 
disclosures are clear and legible. The Staff Report recommended that 
franchisors should be required to make disclosures in at least 12 point 
upper and lower case type.\88\ This recommendation generated two 
comments, however, asserting that the Commission should not mandate 12 
point type. The commenters noted that 12 point type may result in some 
of the Rule's charts being split into two sections. They suggested that 
smaller fonts, especially in charts, can be very readable and result in 
reduced compliance costs.\89\ The Commission agrees. Accordingly, part 
436 of the final amended Rule does not mandate any specific font size: 
franchisors may choose any font size, provided that their disclosures 
are clear and likely to be noticed, read, and understood by a 
reasonable prospective franchisee.
---------------------------------------------------------------------------

    \88\ This presentation requirement would be consistent with the 
Commission's approach in the original Rule. See 16 CFR 436.1(b)(4).
    \89\ Gust Rosenfeld, at 2-3; Wiggin & Dana, at 6-7.
---------------------------------------------------------------------------

    Two additional Staff Report commenters sought refinements to 
section 436.1(d), as proposed therein. One commenter opined that the 
definition could be interpreted to mean that a franchisor must disclose 
``every material fact regarding the offered franchise, rather than 
disclosing all material facts pertaining specifically to the 
disclosures required pursuant to the Rule.''\90\ The Commission 
believes that this reading of the definition is strained and expressly 
notes that it does not intend such a reading. Throughout the final 
amended Rule, the topic on which the franchisor is required to 
``present all material facts accurately, clearly, concisely, and 
legibly in plain English'' is clear. Moreover, nothing in the record 
suggests that a virtually identical definition in the UFOC Guidelines 
has generated the problems anticipated by this commenter. This being 
the case, the Commission is disinclined to deviate from the UFOC 
Guidelines on this issue. Therefore, the Commission adopts the 
definition as quoted above.
---------------------------------------------------------------------------

    \90\ J&G, at 2.
---------------------------------------------------------------------------

    Another commenter urged that the definition specify that the 
meaning of ``disclose,'' ``state,'' ``describe,'' and ``list'' 
incorporates the concept that the language must be ldquo;understandable 
by a person unfamiliar with the franchise business.''\91\ The 
Commission believes that the final amended Rule's definition of ``plain 
English'' in section 436.1(o) gives more direction to franchisors in 
preparing their disclosures than the more general phrase 
``understandable by a person unfamiliar with the franchise business.'' 
Therefore, we decline to adopt this suggestion.
---------------------------------------------------------------------------

    \91\ IL AG, at 2.
---------------------------------------------------------------------------

    Finally, we note that three commenters urged the Commission to 
define separately the term ``material.''\92\ In particular, they 
asserted that it is unclear whether materiality should be determined 
from the franchisor's or the prospective franchisee's viewpoint. For 
example, isolated instances of franchisee-initiated lawsuits might not 
be material to a franchisor (i.e., not affecting the franchisor's 
financial status), but could be highly material to a prospective 
franchisee seeking information on the quality of the franchise 
relationship.\93\
---------------------------------------------------------------------------

    \92\ Bundy, at 3; Cendant, at 3; IL AG, at 3. The Staff Report 
recommended deletion of this definition based on use of the term in 
the Rule text in at least two distinguishable ways, creating 
unnecessary confusion. Staff Report, at 68-9.
    \93\ See Cendant, at 3.
---------------------------------------------------------------------------

    The original Rule defined ``material, material fact, and material 
change.''\94\ The Commission, however, believes that such definitions 
are not necessary. An understanding of materiality under the final 
amended Rule can best be gained by looking to long-established 
Commission jurisprudence. ``Materiality'' is a cornerstone concept of 
that jurisprudence. To be clear on this important point, the 
Commission, when interpreting Section 5, regards a representation, 
omission, or practice to be deceptive if: (1) it is likely to mislead 
consumers acting reasonably under the circumstances; and (2) it is 
material; that is, likely to affect consumers' conduct or decisions 
with respect to the product at issue.\95\ Accordingly, it is amply 
clear that ``materiality'' is determined by the reasonable consumer 
standard, or in franchise matters, by the reasonable prospective 
franchisee standard. Moreover, since violations of the Franchise Rule 
constitute violations of Section 5, we believe that the Section

[[Page 15456]]

5 deception jurisprudence provides adequate guidance on what the term 
``material'' means in the Franchise Rule context.
---------------------------------------------------------------------------

    \94\ 16 CFR 436.2(n).
    \95\See generally Federal Trade Commission Policy Statement on 
Deception, appended to Cliffdale Assocs., 103 FTC 110 (1984).
---------------------------------------------------------------------------

5. Section 436.1(e): Financial performance representation
    This section of part 436 defines the term ``financial performance 
representation'' to mean:

     any representation, including 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. The term includes a chart, table, or 
mathematical calculation that shows possible results based on a 
combination of variables.\96\
---------------------------------------------------------------------------

    \96\ The part 436 definition is nearly identical to the 
definition as proposed in the Franchise NPR, with slightly modified 
language in some places to improve clarity and precision. No 
commenter raised any concerns about the basic ``financial 
performance representation'' definition. Nevertheless, IL AG posed a 
number of questions about how the definition would be applied in 
various situations, such as representations based upon earnings of a 
franchisor's affiliates or representations based upon industry data. 
IL AG, at 2. Questions such as these are best addressed in the 
Compliance Guides or in staff advisory opinions, where they can be 
analyzed in the context of specific facts.

    This definition comes into play in one of the most important 
sections of the final amended Rule, section 436.5(s), corresponding to 
Item 19 of the UFOC Guidelines. Like Item 19, it governs the making of 
financial performance representations.\97\ The definition incorporates 
the original Rule's approach, in that it specifies that a financial 
performance representation may be in an ``oral, written, or visual'' 
format.\98\ To ensure that part 436 covers implied financial 
performance representations, the definition also refers to financial 
performance representations that are made both ``expressly or by 
implication.''\99\ It also retains the original Rule's reference to 
financial performance representations made in the general media.\100\ 
At the same time, section 436.1(e) adopts several aspects of the UFOC 
Guidelines definition, including references to ``actual'' and 
``potential'' performance (to capture both historical financial 
performance and projections),\101\ as well as the use of charts, 
tables, and mathematical calculations.\102\
---------------------------------------------------------------------------

    \97\ The final amended Rule uses the broad term ``financial 
performance representation,'' rather than the original Rule's more 
limited term ``earnings claim.'' This modification recognizes that 
some industries, such as hotels, use variables other than earnings 
to measure performance, such as room occupancy rates. See Franchise 
NPR, 64 FR at 57297.
    \98\ The original Rule described 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 CFR 436.1(b) 
and (c).
    \99\ To address implied claims, the original Rule used the term 
``suggests.'' The proposed definition of ``financial performance 
representation'' published in the Franchise NPR similarly used that 
term. One franchisee representative observed that the word 
``suggests'' in this context is flawed: it would not reach the 
furnishing of fragments of financial data from which a prospect may 
readily estimate or calculate earnings. Bundy, NPR 18, at 1. The 
Commission agrees that a franchisor can 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. In 
addition, 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.''). See 
Interpretive Guides, 44 FR at 49982. Both types of implied claims 
constitute financial performance representations that are, and 
should be, covered by the final amended Rule. To clarify this 
policy, the final amended Rule uses the phrase ``states, expressly 
or by implication.'' This phrase is widely used, for example, in 
connection with representations challenged under Section 5. E.g., 
FTC v. Prophet 3H, Inc., 06 CV 1692 (N.D. Ga. 2006); FTC v. 
Morrone's Water Ice, Inc., No. 02-3720 (E.D. Pa. 2002).
    \100\See 16 CFR 436.1(e).
    \101\ This streamlines the original Rule, which addressed 
historical performance representations and projections in two 
distinct Rule provisions, 16 CFR 436.1(b) (projections) and 436.1(c) 
(historical information).
    \102\ The staff of the Commission has adopted the same position 
in several informal advisory opinions. E.g., Handy Hardware Centers, 
Bus. Franchise Guide (CCH) ] 6426 (1980) (The Rule's ``earnings 
claim requirements are applicable to `any oral, written, or visual 
representation.'''); Diet Center, Inc., Bus. Franchise Guide (CCH) ] 
6437 (1983) (table with arithmetic calculations uniformly 
demonstrating net profits constitutes a financial performance 
representation).
---------------------------------------------------------------------------

    Two aspects of the definition of the term ``financial performance 
representation'' generated significant comment: whether the Commission 
should treat information about costs and expenses as financial 
performance representations;\103\ and whether the Commission should 
interpret the definition's express inclusion of any ``representation in 
the general media'' to include all financial information available on a 
franchisor's website or through a franchisor's speeches and press 
releases.\104\ Each of these interpretive issues is discussed in the 
sections immediately below.
---------------------------------------------------------------------------

    \103\ See Interpretive Guides, 44 FR 49982.
    \104\ See Interpretive Guides, 44 FR at 49984-85.
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a. Treatment of cost and expense information
    In the Franchise NPR, the Commission made it clear that the section 
436.1(e) definition of ``financial performance representation'' is not 
intended to reach disclosures of expense information, and specifically 
sought comment on this issue.\105\ Most commenters who responded on 
this issue felt that disclosures of expense information should not fall 
within the definition.\106\ Some, however, sought additional 
clarification. For example, the IL AG urged the Commission to modify 
the definition of ``financial performance representation'' to expressly 
exclude expense disclosures mandated in Items 5-7 of the final amended 
Rule (initial fees, ongoing costs, and initial investment), 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.''\107\ Others went 
further, arguing that the dissemination of any expense information 
should not trigger the Item 19 disclosure requirements.\108\
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    \105\ Neither the original Rule nor the final amended Rule 
includes mention of expenses in the definition of ``financial 
performance representation,'' but the Commission indicated its 
intended interpretation in the Franchise NPR's discussion of the 
definition of the term. Specifically, it stated that ``[w]hile the 
Commission does not consider the disclosure of such expense 
information alone to constitute the making of a financial 
performance claim, others arguably may interpret some expense 
information as implying a financial performance representation, such 
as a break-even point. To avoid any confusion, the proposed 
definition of `financial performance representation' . . . 
specifically omits expense information.'' Franchise NPR, 64 FR at 
57329. This interpretation is a departure from the Commission's 
former policy, as articulated in the Interpretive Guides. The Guides 
expressed the view 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. Interpretive Guides, 44 FR at 49982. It 
also departs from UFOC Guidelines Item 19, which expressly lists 
costs among the items of information that constitute an earnings 
claims. See also UFOC Guidelines, Item 19, Instructions i. 
Nevertheless, in light of the comments and the Commission's long law 
enforcement history, the Commission, reiterating its Franchise NPR 
statement quoted immediately above, states its intent that expense 
information not be included in the part 436 definition of 
``financial performance representation.'' As discussed above, the 
states agree. See NASAA, NPR 17, at 2.
    \106\E.g., IL AG, NPR 3, at 3; Baer, NPR 11, at 7; NFC, NPR 12, 
at 13; NASAA, NPR 17, at 2; BI, NPR 28, at 10. But see Bundy, NPR 
18, at 2 (arguing that expense disclosures inevitably will lead 
prospective franchisees to extrapolate earnings without the 
protection of an Item 19 disclosure).
    \107\ IL AG, NPR 3, at 8-9. See also Baer, NPR 11, at 7.
    \108\ NFC, NPR 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. Id. The Commission concludes, however, that 
part 436 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 sales 
are contemplated. If 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 disclosure. For example, an Item 19 disclosure 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.

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[[Page 15457]]

    Notwithstanding language to the contrary in the original 
Interpretive Guides,\109\ the Commission is persuaded that expense 
information alone is insufficient to enable prospective franchisees to 
gauge their potential earnings with any degree of specificity that 
could rise to the level of a financial performance claim.\110\ The 
Commission explained in the Franchise NPR and now reiterates here that 
mere disclosure of cost information does not, in its view, constitute a 
financial performance representation triggering Item 19 disclosure 
obligations. The Commission intends that the explanation that mere 
expense disclosures alone do not constitute a financial performance 
representation, coupled with the deliberate omission of any mention of 
expense information from section 436.1(e) of the final amended Rule, 
will be enough to address this issue.
---------------------------------------------------------------------------

    \109\ Interpretive Guides, 44 FR at 49982.
    \110\ At any rate, according to NASAA, franchisors do not 
routinely disseminate individualized expense information geared to a 
specific offering that might be used to insinuate an earnings level. 
NASAA, 17 NPR, at 2.
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b. General media claims
    Section 436.1(e) of the final amended Rule retains the original 
Rule's provision governing the making of financial performance 
representations in the general media. Under the original Rule, a 
general media financial performance representation, like all other 
financial performance representations, must have a reasonable basis and 
state the number and percentage of outlets earning the claimed amount, 
among other substantiation and disclosure requirements.\111\ There is 
no comparable provision in the UFOC Guidelines.\112\
---------------------------------------------------------------------------

    \111\ See 16 CFR 436.1(b)(5)(i); 436.1(c)(6)(i); 
436.1(e)(5)(ii). Unlike other financial performance claims, a claim 
made in the general media need not be geographically relevant to the 
market in which franchises are being offered for sale.
    \112\ 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 Sec.  31156 (1997) (franchisor must register advertising 
at least three business days before first publication); Md. Code 
Ann., Bus. Reg. Sec.  14-225 (1998) (franchisor must register 
advertising at least seven business days before publication).
---------------------------------------------------------------------------

    In the Franchise NPR, the Commission proposed that the term 
``financial performance representation'' should broadly include the 
dissemination of financial performance information via the 
Internet.\113\ The majority of commenters who addressed this issue, 
however, questioned whether financial performance information posted 
online should constitute ``financial performance representations,'' 
thus triggering the Rule's disclosure and substantiation 
requirements.\114\ These commenters asserted that the Commission should 
not deem financial performance information posted on a franchisor's 
website to be financial performance representations under the Rule, 
unless the information is located in a section of a website that 
solicits franchise purchasers or otherwise specifically targets 
prospective franchisees.\115\ In their view, financial performance 
information on a franchisor's website--including links to press 
releases, interviews, or articles--is intended to educate the general 
public about the company, rather than to attract prospective 
franchisees.\116\ Indeed, some posted information may consist of copies 
of publicly filed reports, such as 10-Qs and 10-Ks, that are submitted 
to the SEC.\117\ At least one commenter feared that equating online 
financial performance information with financial performance 
representations under the Rule would have a chilling effect, 
unreasonably restricting the kinds of materials a franchisor could have 
on its website: ``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?''\118\
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    \113\ In the proposed Rule, the term ``financial performance 
representation'' expressly included ``a representation disseminated 
in the general media and Internet.'' Franchise NPR, 64 FR at 57297, 
57332. (emphasis supplied.) In accordance with the discussion in 
this section of the SBP, the Commission has deleted this phrase to 
dispel potential readings that financial information posted on the 
Internet is per se a financial performance representation.
    \114\E.g., PMR&W NPR 4, at 16; H&H, NPR 9, at 14; NFC, NPR 12, 
at 23-24.
    \115\E.g., Gust Rosenfeld, at 7; Quizno's, NPR 1, at 3; PRM&W, 
NPR 4, at 16; NFC, NPR 12, at 24; BI, NPR 28, at 9.
    \116\E.g., Quizno's, NPR 1, at 3. See also BI, NPR 28, at 9.
    \117\E.g., Quizno's, NPR 1, at 3; PMR&W, NPR 4, at 16; H&H, NPR 
9, at 14; BI, NPR 28, at 9.
    \118\ Quizno's, NPR 1, at 3.
---------------------------------------------------------------------------

    Two Staff Report commenters broadened this argument beyond the 
online context to encompass franchisors' speeches and news releases. In 
the Interpretive Guides, the Commission described ``general media'' 
broadly to include: ``advertising (radio, television, magazines, 
newspapers, billboards, etc) as well as those contained in speeches or 
press releases.''\119\ David Kaufmann, for example, asserted that the 
inclusion of speeches and news releases harms franchisors by making it 
difficult for them to disseminate financial performance information in 
``speeches, press interviews, and other forums not specifically geared 
to the franchise sales process.''\120\ He urged the Commission to 
permit franchisors and their executives to disseminate financial 
performance information to the public freely, unless copies are 
subsequently used in the franchisor's franchise marketing effort.
---------------------------------------------------------------------------

    \119\ Interpretive Guides, 44 FR at 49984-85. The Commission 
excluded, however, ``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.'' Id. at 49985.
    \120\ Kaufmann, at 6. See also Cendant, at 2.
---------------------------------------------------------------------------

    Based upon the comments, the Commission is persuaded that it is 
unwarranted to sweep broadly into the part 436 definition of 
``financial performance representation'' all financial performance 
information posted online or appearing in press releases or speeches. 
The dissemination of financial information online and in press stories 
and releases is for the benefit of more than prospective franchisees, 
including investors, potential suppliers, and members of the general 
public.\121\ Further, the Commission believes that the commenters' 
concerns are well-founded with respect to publicly filed reports 
required by the SEC. The Commission agrees that such filings are 
already publicly available and, more important, have indicia of 
reliability. Indeed, the dissemination of false financial data by 
publicly traded franchisors is already illegal. Thus, to impose the 
Rule's substantiation and disclosure requirements with respect to SEC 
filing

[[Page 15458]]

would be pointless, unworkable, and unduly burdensome.
---------------------------------------------------------------------------

    \121\ Indeed, the staff previously has advised that the 
dissemination of financial performance information 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).
---------------------------------------------------------------------------

    With respect to the dissemination of other financial performance 
information, the Commission believes that a distinction should be made 
between information disseminated in advertisements directed at 
franchisees--be it in print, radio, television, or Internet--and 
information disseminated to the general public. We are convinced that 
deeming financial performance information disseminated publicly to be 
``financial performance representations'' under the Rule would have a 
chilling effect, discouraging franchisors from furnishing truthful 
information to the public. However, where a franchisor utilizes 
financial performance information disseminated, or intended to be 
disseminated, to the general public in its franchise promotional 
materials (e.g., in a brochure or franchisee section of a website), 
includes in its franchise promotional materials a reference to general 
financial information on its website, or otherwise repeats the general 
financial information to prospective franchisees (such as in a face-to-
face meeting with an audience of prospective franchisees), such 
information will be deemed ``financial performance representations,'' 
triggering part 436's disclosure and substantiation requirements.\122\
---------------------------------------------------------------------------

    \122\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 as its 
own and, in so doing, converts the article into an advertising piece 
designed to solicit prospective franchisees.'').
---------------------------------------------------------------------------

    The Commission anticipates that staff will address the narrowed 
scope of general media financial performance representations in the 
Compliance Guides. This is consistent with the approach historically 
adopted, whereby the Commission explained the scope of general media 
claims in the Interpretive Guides, providing illustrative examples and 
more detailed discussion than is possible in the text of the Rule 
itself. As an initial matter, the Commission anticipates that staff 
will retain in the Compliance Guides the original Interpretive Guides' 
determination that communications about financial performance made to 
the trade press and directly to lenders do not constitute general media 
financial performance representations.\123\ At the same time, the 
Commission anticipates that staff will add SEC filings, speeches, and 
news releases to the list of communications not constituting financial 
performance representations under the final amended Rule. There is one 
important caveat, however. Where the franchisor directs the speeches or 
news releases to prospective franchisees or uses copies of speeches or 
news releases in marketing materials aimed at prospective franchisees, 
then such materials will constitute general media financial performance 
representations under the Rule.
---------------------------------------------------------------------------

    \123\ Interpretive Guides, 44 FR at 49984-85 (```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.'').
---------------------------------------------------------------------------

6. Section 436.1(f): Fiscal year
    Several Rule disclosures are based upon the franchisor's fiscal 
year.\124\ Section 436.1(f) retains the original Rule definition of the 
term ``fiscal year,'' making clear that it ``refers to the franchisor's 
fiscal year.''\125\ This issue generated no comment.
---------------------------------------------------------------------------

    \124\E.g., section 436.5(a) (Item 1); section 436.5(c) (Item 3); 
section 436.5(e) (Item 5); section 436.5(t) (Item 20); section 
436.5(u) (Item 21).
    \125\ 16 CFR 436.2(m).
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7. Section 436.1(g): Fractional franchise
    Section 436.1(g) of the final amended Rule adopts the definition of 
the term ``fractional franchise'' that was proposed in the Franchise 
NPR with only minor language changes to improve clarity. This 
definition comes into play in section 436.8(a)(2) of the final amended 
Rule, which retains the original Rule's exemption for fractional 
franchises.\126\ In most instances, the fractional franchise exemption 
arises where an existing business seeks to expand its product line 
through a franchise meeting two criteria: (1) the franchisee or its 
principals have more than two years of experience in the same line of 
business; and (2) the parties reasonably expect that the franchisee's 
sales from the new line of business will not exceed 20% of its total 
sales.\127\
---------------------------------------------------------------------------

    \126\ The fractional franchise is one of several exemptions 
contained in the original Rule that are retained in the final 
amended Rule. In contrast, the UFOC Guidelines contain no 
exemptions. State exemptions, which vary from state to state, are 
set out in state statutes or regulations. In general, state 
franchise laws do not exempt franchisors from the basic obligation 
to furnish prospects with UFOCs. At most, states may exempt 
franchisors from state registration requirements.
    \127\ In the original SBP, the Commission reasoned, with respect 
to fractional franchisees, 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. Original 
SBP, 43 FR at 59707.
---------------------------------------------------------------------------

    Section 436.1(g) clarifies the scope of the original ``fractional 
franchise'' exemption by adding greater precision and specificity.\128\ 
First, it incorporates the Commission's long-standing policy that the 
parties must ``anticipate that sales arising from the relationship will 
not exceed 20% of the franchisee's total volume in sales during the 
first year of operation.''\129\ Second, it makes explicit what 
previously has been only implied: that the parties must have ``a 
reasonable basis'' to assert the exemption.\130\
---------------------------------------------------------------------------

    \128\ The Commission believes that greater precision in the Rule 
text is warranted in light of numerous requests for advisory 
opinions on the scope of the fractional franchise exemption since 
the original Rule was promulgated. See, e.g., Advisory 93-5, Bus. 
Franchise Guide (CCH),] 6449 (1993); Advisory 94-4, id., at ] 6460 
(1994); Advisory 95-2, id., at ] 6467 (1995); Advisory 96-1, id., at 
] 6476 (1996); Advisory 97-1, id., at ] 6481 (1997).
    \129\See Interpretive Guides, 44 FR at 49968.
    \130\ The proposed definition in the Franchise NPR formulated 
this as ``The parties reasonably anticipate . . .'' The final 
language is more precisely in line with basic concepts of FTC 
jurisprudence.
---------------------------------------------------------------------------

    During the Rule amendment proceeding, a few commenters suggested 
that the Commission broaden the fractional franchise exemption. Two 
commenters urged the Commission to broaden the first prong of the 
fractional franchise exemption --``experience in the same type of 
business''--to exempt franchisees with experience in the same industry 
or selling similar or complementary goods or services.\131\ The 
suggestion that the exemption be broadened to ``experience in the same 
industry'' goes far beyond the underlying rationale that supports the 
fractional franchise exemption--namely, the notion that prior 
experience in the same line of business reduces the likelihood of fraud 
or deception because the fractional franchisee likely will be familiar 
with the products to be offered for sale through the franchise 
relationship.
---------------------------------------------------------------------------

    \131\ Piper Rudnick, at 4 (suggesting experience in the same 
basic industry should suffice); H&H, NPR 9, at 4 (complementary 
experience should suffice).
---------------------------------------------------------------------------

    The Commission does not believe that a franchisee in any particular 
economic sector necessarily has sufficient experience to operate a 
different franchise within the same sector. For example, we would not 
necessarily expect a muffler shop franchisee to automatically 
understand the financial risks of operating a quick-lube service 
station, although both operations are in the automotive repair 
industry. Nor would we expect a franchisee operating a small fast-food 
kiosk in a mall to necessarily appreciate the risks of operating a 
large, sit-down full-service restaurant, although both are in the food 
service industry.
    Nevertheless, the Commission has never required experience in the 
identical type of business. Rather, the sale of similar goods may 
qualify for the exemption. As explained in the current

[[Page 15459]]

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.''\132\ 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.
---------------------------------------------------------------------------

    \132\ Interpretive Guides, 44 FR at 49968.
---------------------------------------------------------------------------

    Our reluctance to expand the fractional franchise exemption also 
holds true with respect to the sale of ``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 may 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.
    While the Commission declines to revise the Rule to broaden the 
types of experience needed to qualify for the fractional franchise 
exemption, we agree that the exemption should be expanded with respect 
to the types of individuals whose experience can qualify for the 
exemption.
    The original definition specified that, in determining whether a 
relationship qualified as a the fractional franchise exemption, a 
franchisor could consider the prior experience of the franchisee ``or 
any of the current directors or executive officers thereof.''\133\ 
Marriott recommended that the prior experience of an officer or 
director of an affiliate or parent of the franchisee should also be 
deemed a sound basis for the ``experience'' prong of the definition. 
Marriott noted that the Staff Report recommended the same approach in 
connection with the prior experience prerequisite of the ``large 
franchisee'' exemption.\134\
---------------------------------------------------------------------------

    \133\ 16 CFR 436.2(h).
    \134\ Marriott, at 4.
---------------------------------------------------------------------------

    We are persuaded by Marriott's arguments that a broad reading of 
the fractional franchise exemption is warranted when determining which 
individuals may qualify as having the requisite prior experience. The 
principal factor in applying the fractional franchise exemption of part 
436 is whether the business seeking to expand can obtain practical 
guidance and direction from someone within the business with prior 
experience. It makes little difference whether the business can call 
upon its own directors or officers for guidance or whether the business 
can call upon those of a subsidiary, as long as those individuals have 
prior experience in the same line of business. As in the large 
franchisee exemption, we recognize that franchisors may establish 
subsidiaries for limited liability or tax purposes. In such instances, 
the operations of the franchisor and its subsidiaries are likely to be 
close, such that the prior experience of one is available to help 
direct the business decisions of the other. We believe the same is no 
less true in the fractional franchise context.
    Finally, one commenter, focusing on the second prong of the 
fractional franchise exemption, 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, even if the 
fractional franchisee has had no prior experience with the products or 
services being added to his or her product line.\135\ In short, this 
commenter would delete the prior experience prong from the fractional 
franchise definition. We reject this suggestion.
---------------------------------------------------------------------------

    \135\ J&G, NPR 32.
---------------------------------------------------------------------------

    The Commission believes that prior experience is a necessary 
component of the fractional franchise exemption. A business owner 
seeking a new opportunity is no different from a novice when it comes 
to entering into a type of business with which he or she is 
unfamiliar.\136\ It is precisely in such circumstances that the 
prospective franchisee needs the material disclosures the Rule affords 
in order to make an informed decision whether to invest in the 
opportunity. What distinguishes a fractional franchisee from novices 
and business owners generally is that the fractional franchisee has 
prior experience with the goods and services being offered for sale, 
and thus is less in need of the Rule's protections. Indeed, the record 
is devoid of any data from which we could conclude that ongoing 
businesses seeking to expand into unfamiliar areas do not continue to 
need the Rule's protections. Accordingly, we believe retaining the 
prior experience prerequisite for the fractional franchise exemption is 
a sound approach.
---------------------------------------------------------------------------

    \136\ The Commission recognizes, however, that in some 
instances, prior experience or the ability to consult those with 
prior experience, can be assumed. That is the basis of the new large 
investment exemption from the final amended Rule, discussed below. 
See section 436.8(a)(5)(i). Where an investment is sufficiently 
large--$1 million excluding the cost of unimproved land and any 
franchisor financing--we believe that the prospective franchisee is 
sophisticated and can obtain the information necessary to assess the 
franchise offering without our mandating that it be provided.
---------------------------------------------------------------------------

8. Section 436.1(h): Franchise
    The original Rule defined ``franchise'' broadly to encompass both 
franchises and business opportunity ventures. A franchisor was covered 
by the original Rule if it represented that the business arrangement it 
offered entailed the following three elements: (1) permission to use 
the franchisor's trademark; (2) significant franchisor control over the 
franchise operation or significant franchisor assistance to the 
franchisee; and (3) a required payment from the franchisee to the 
franchisor.\137\ Similarly, a business opportunity seller was covered 
by the original Rule if the seller represented that the business 
arrangement it offered entailed: (1) supplying the buyer with goods or 
services to market to the public; (2) providing location assistance or 
accounts for vending machines or other equipment; and (3) charging a 
required payment from the opportunity purchaser.\138\
---------------------------------------------------------------------------

    \137\ See 16 CFR 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 Staff Report, at 37-41, available online at: 
www.ftc.gov/os/2004/08/0408franchiserulerpt.pdf.
    \138\ See 16 CFR 436.2(a)(1)(ii) and 436.2(a)(2).
---------------------------------------------------------------------------

    Like the proposed section 436.1(h) published in the Franchise NPR, 
this section of the final amended Rule focuses exclusively on franchise 
sales, eliminating the business opportunity section of the definition. 
The amended definition is also more precise than the original 
definition. Specifically, the amended definition clarifies two issues 
that the Commission's Rule enforcement experience suggests are not well 
understood: (1) that a business relationship will be deemed a franchise 
if it satisfies the three elements of a franchise, regardless of the 
nomenclature used to label or describe it;\139\ and (2) that a business 
relationship will be deemed a franchise if the franchisor represents 
that the relationship being offered has the characteristics of a 
franchise, regardless of any failure on the franchisor's part to 
perform as promised.\140\
---------------------------------------------------------------------------

    \139\ See Interpretive Guides, 44 FR at 49966. See also FTC v. 
Morrone's Water Ice, Inc., No. 02-3720 (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) ] 6427 (1981).
    \140\ This is not a change of policy. The original definition of 
``franchise'' added that ``[a]ny relationship which is represented . 
. . to be a franchise (as defined in the original Rule) is subject 
to the requirements of this part.'' 16 CFR 436.2(a)(5). However, 
this provision was set out in the original ``franchise'' definition 
after exemptions and exclusions, and, therefore, was largely 
overlooked or ignored. The final amended Rule makes the definition 
of ``franchise'' more precise by including this policy in the 
introductory part of the amended definition. See also United States 
v. Protocol, Inc., Bus. Franchise Guide (CCH) [1996-97 Transfer 
Binder], ] 11184 at 29550, 29555 (D. Minn. 1997); FTC v. Wolf, Bus. 
Franchise Guide (CCH), ] 10401 (S.D. Fla. 1994); FTC v. Int'l 
Computer Concepts, No. 1:94cv1678 (N.D. Ohio 1994); FTC v. Sage 
Seminars, Inc., No. C-95-2854-SBA (N.D. Cal. 1995). The staff of the 
Commission has provided the same advice in several informal advisory 
opinions. E.g., Real America Real Estate Corp., Bus. Franchise Guide 
(CCH) ] 6428 (1982) (``the applicability of the rule will not be 
defeated by a franchisor's subsequent failure to live up to any such 
commitment'').

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[[Page 15460]]

    Early in the Rule amendment proceeding, a few commenters offered 
suggestions for modifying the definition of ``franchise.'' For example, 
one commenter urged the Commission to adopt the states' definition of 
the term ``franchise.''\141\ However, there is no single state 
definition of the term ``franchise.''\142\ Nevertheless, the Rule's 
definition is entirely consistent with the principles underlying the 
various state definitions, and the Commission concludes that there is 
no persuasive argument to modify the definition further.
---------------------------------------------------------------------------

    \141\ Baer, NPR 11, at 7.
    \142\See Staff Report, at 37-41.
---------------------------------------------------------------------------

    Another commenter 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, 
irrespective of whether or not the relationship independently meets the 
actual . . . definition of a franchise.''\143\ He stated that such an 
approach would be a mistake, ``raising the form of a description of a 
business relationship to a level which would control over the actual 
substance of the relationship.''\144\
---------------------------------------------------------------------------

    \143\ Holmes, NPR 8, at 1. See also Gurnick, NPR 21A; IL AG, NPR 
3.
    \144\Id., at 2.
---------------------------------------------------------------------------

    There are two distinct issues here: (1) whether the Rule should 
apply to a business relationship that the parties call a ``franchise,'' 
even if the relationship does not satisfy the three definitional 
elements of a franchise; and (2) whether the Rule should apply to a 
business relationship that is represented as satisfying the three 
definitional elements of the term ``franchise,'' even if the 
relationship, in fact, does not satisfy those elements--e.g., because 
of the seller's non-performance. The commenter correctly asserted that 
the Rule should not cover situations where the parties mistakenly use 
the term ``franchise'' to describe their business relationship. A 
business relationship constitutes a franchise only if, as promised or 
represented, it satisfies the three elements of the term ``franchise,'' 
and nothing in the ``franchise'' definition is to the contrary.
    The clarification in the amended definition addresses the second 
issue--whether representing a business relationship as satisfying the 
three definitional elements of the ``franchise'' definition (as opposed 
to merely calling a relationship a franchise) is sufficient to bring a 
business relationship under the Rule. The original Rule took the 
position that it was sufficient, and the Commission believes that 
position remains sound.\145\ A prospect seeking to purchase an 
opportunity that is represented as being a franchise should receive a 
disclosure document in order to make an informed investment decision. 
The prospect should not have to investigate whether or not the seller, 
post-sale, actually delivers a franchise or some other type of 
opportunity. 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 before 
the 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, facts that may only be discovered by the 
purchaser post-sale. In short, the seller should not be able to raise 
as a defense to a post-sale Rule violation that it, in fact, offered a 
non-franchise business arrangement if, at the time of sale, its 
representations about the business satisfied the definition of a 
franchise.\146\
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    \145\ 16 CFR 436.1 (``any relationship which is represented . . 
. to be a franchise''); 436.2(a)(5) (``Any relationship which is 
represented either orally or in writing to be a franchise [as 
defined in the Rule] is subject to the requirements of this 
part.'').
    \146\ With respect to required payments, the Commission will 
also consider any obligation to make a payment imposed by the 
franchisor post-sale, as long as the payment must be made within six 
months after the franchisee commences operation of the business. See 
section 436.8(a)(1) (minimum payment exemption).
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9. Section 436.1(i): Franchisee
    The original Rule defined ``franchisee[r]dquo; as: ``any person (1) 
who participates in a franchise relationship as a franchisee . . . or 
(2) to whom an interest in a franchise is sold.''\147\ The definition 
proposed in the Franchise NPR was ``any person who is granted an 
interest in a franchise.'' Section 436.1(i) of the final amended Rule 
adopts an even more precise version: ``Franchisee means any person who 
is granted a franchise.''\148\ This narrowing of the definition is in 
response to commenters who voiced concern that the phrase ``an interest 
in a franchise'' is too broad, arguably sweeping in shareholders of 
publicly traded companies and other investors.\149\ The amended 
definition's focus on the granting of a franchise (as opposed to an 
interest in a franchise) is also consistent with the states' approach, 
thereby reducing unnecessary inconsistencies.\150\
---------------------------------------------------------------------------

    \147\ 16 CFR 436.2(d).
    \148\ The phrase ``granted a franchise'' is intended to be 
interpreted consistent with ordinary contract law principles. 
Accordingly, a prospective franchisee becomes a ``franchisee'' at 
the point when he or she enters into a valid and enforceable 
contractual relationship. This clarification is necessary to avoid 
circumvention of the Rule, especially the Rule's financial 
performance requirements. In our experience, we are aware of 
instances where a franchisor obtains full payment from a prospective 
franchisee before the prospective franchisee actually enters into a 
franchise agreement. Once payment is made, the franchisor then 
proceeds to furnish the individual with earnings information without 
the accompanying disclosures on the mistaken belief that the 
individual has become a franchisee, to whom earnings information can 
be provided without the benefit of an Item 19 disclosure. An 
individual becomes a ``franchisee,'' however, only after the 
franchise is ``granted,'' meaning both payment of consideration and 
the signing or acceptance of the franchise agreement. Otherwise, any 
franchisor could avoid the Rule's financial performance requirements 
by simply delaying the furnishing of financial performance data 
until after the prospective franchisee either makes a ``payment to 
the franchisor'' or simply agrees to the terms of the franchise 
arrangement.
    \149\E.g., H&H, NPR 9, at 25; BI, NPR 28, at 2. The phrase ``an 
interest in a franchise'' has been deleted elsewhere in the final 
amended Rule text for the same reason.
    \150\E.g., Mich. Comp. Laws. 445.1502(4); Wis. Stat. Ann. 
553.03(5). In response to the Staff Report, one commenter, IL AG, 
suggested that the definition of ``franchisee'' make clear that a 
franchisee who sells franchises is also a subfranchisor. IL AG, at 
3. This is unnecessary. The definition of ``franchisor'' includes a 
subfranchisor, which is defined as any person who functions as a 
franchisor by engaging in both pre-sale activities and post-sale 
performance. Section 436.1(k). By its terms, this would include a 
franchisee that also engages in franchise sales activities, if he or 
she also has post-sale performance obligations.
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10. Section 436.1(j): Franchise seller
    Section 436.1(j) of the final amended Rule defines the term 
``franchise seller.'' This term and its definition are needed in order 
to delineate easily all parties subject to one or more provisions of 
the final amended Rule.\151\ Consistent with

[[Page 15461]]

long-standing Commission policy, the definition also makes explicit 
that an individual franchisee seeking to sell his or her own outlet is 
excluded from Rule coverage:\152\
---------------------------------------------------------------------------

    \151\ The original Rule uses the terms ``franchisor'' and 
``franchise broker'' throughout the Rule, and, in some instances, 
references employees and agents. The term ``franchise seller'' 
streamlines the Rule by referencing all such individuals, where 
appropriate, through the use of a single term. But see Winslow, at 
85 (suggesting that the term ``seller'' in the context of 
franchising is inappropriate).
    \152\ See Interpretative Guides, 44 FR at 49969.

     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.

    The definition incorporates several suggestions submitted during 
the Rule amendment proceeding. First, the definition expressly includes 
``subfranchisors,'' a category of franchise sellers not mentioned in 
the Franchise NPR's proposed definition of ``franchise seller.''\153\ 
The inclusion of subfranchisors in the definition is entirely 
consistent with current Commission policy\154\ and the UFOC 
Guidelines.\155\
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    \153\ See Franchise NPR, 64 FR at 57298.
    \154\ Interpretive Guides, 44 FR at 49969.
    \155\ The UFOC Guidelines provide that ``[i]n offerings by a 
subfranchisor, `franchisor' means both the franchisor and 
subfranchisor.'' UFOC Guidelines, General Instructions 240.
---------------------------------------------------------------------------

    Second, the definition narrows the express exclusion of sales of a 
franchise by an existing franchisee. One commenter noted that this 
exclusion should apply only in those situations where an existing 
franchisee transfers ownership in his or her franchise to a purchaser 
without any continuing obligation to the purchaser. He suggested that 
the Rule make clear that the exclusion does not apply where an existing 
franchisee is engaged in repeated franchise sales.\156\ The Commission 
agrees. If an existing franchisee engages in repeated franchise sales, 
he or she will be covered by the final amended Rule as either the 
franchisor's agent, broker, or subfranchisor. To clarify this point, 
the definition narrows the existing franchisee exemption to those 
existing franchisees ``who are otherwise not engaged in franchise sales 
on behalf of the franchisor.''\157\
---------------------------------------------------------------------------

    \156\ Bundy, NPR 18, at 3.
    \157\See IL AG, at 3.
---------------------------------------------------------------------------

    Finally, the definition addresses one commenter's concern that the 
term ``franchise seller'' should exclude a franchisor's employees who 
are not actively involved in franchise sales.\158\ We agree. To that 
end, the definition makes clear that the franchisor's employees, 
representatives, agents, subfranchisors, and third-party brokers are 
covered only if they ``are involved in franchise sales activities.''
---------------------------------------------------------------------------

    \158\ Tricon, NPR 34, at 3.
---------------------------------------------------------------------------

    The Commission has considered, but declines to adopt, two 
additional suggestions with respect to the ``franchise seller'' 
definition. J&G suggested that the Commission define the term 
``broker'' in the Rule itself and proposed the following, narrow 
definition: 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.\159\ The commenter also proposed that the definition 
specifically exclude certain individuals who arguably might be involved 
in a franchise sale, including franchisees,\160\ trade show promoters, 
website 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.''\161\
---------------------------------------------------------------------------

    \159\ J&G, NPR 32. See also IL AG, at 2; Michael Seid.
    \160\See also Lewis, NPR 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.'').
    \161\ J&G, NPR 32, at 10. But see Baer, NPR 11, at 9 (``If any 
party offers to sell a franchise on behalf of a franchisor, that 
person should be considered a franchise seller.'').
---------------------------------------------------------------------------

    The Commission believes that a separate definition of the term 
``broker'' is unnecessary in part 436. In the original Rule, franchise 
brokers were jointly and severally liable with franchisors to prepare 
and to furnish prospective franchisees with disclosure documents.\162\ 
In contrast, under part 436 of the final amended Rule, brokers are no 
longer obligated to prepare or to furnish disclosure documents, as 
explained later in this document. The preparation and distribution of 
the disclosure document is the sole responsibility of the franchisor. 
Rather, coverage of brokers under the final amended Rule is limited to 
prohibitions.\163\ For example, any franchise seller, including 
brokers, cannot make statements that are inconsistent with those found 
in the franchisor's disclosure document.\164\ Because brokers are no 
longer liable for the preparation and distribution of disclosure 
documents and the term ``broker'' does not appear in the final amended 
Rule outside the definition of ``franchise seller,'' no separate 
definition of the term ldquo;broker'' is warranted.
---------------------------------------------------------------------------

    \162\ Interpretive Guides, 44 FR at 49969.
    \163\ Moreover, the final amended Rule includes a separate 
definition of ``franchisor,'' to whom the affirmative disclosure 
requirements apply.
    \164\ Section 436.9(a).
---------------------------------------------------------------------------

    In a similar vein, 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.\165\ 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.
---------------------------------------------------------------------------

    \165\ Frannet, NPR 2, at 1.
---------------------------------------------------------------------------

    With respect to ``brokers,'' we reject the suggestion that brokers 
are distinguishable from middlemen or finders. When promulgating the 
original 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.''\166\ 
Similarly, in the original SBP, the Commission clarified that a broker 
acts on behalf of a franchisor and receives compensation for arranging 
a franchise sale.\167\ The term ``broker,'' therefore, has not been 
limited to those persons who negotiate contract terms or sign franchise 
agreements and accept payments on behalf of a franchisor.\168\
---------------------------------------------------------------------------

    \166\ 16 CFR 436.2(j).
    \167\ Original SBP, 43 FR at 59717 and nn. 176 and 178. Staff 
advisory opinions 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. These opinions are based upon the original SBP, in which the 
Commission stated 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).
    \168\See generally FTC v. Entrepreneur Media, Inc., Bus. 
Franchise Guide (CCH), ] 10583 (C.D. Cal. 1994); FTC v. Shulman 
Promotions, Inc., Bus. Franchise Guide (CCH), ] 10584 (S.D. Ohio 
1994) (trade show promoters held jointly and severally liable as 
brokers under the original Rule for financial performance claims 
made by franchisor-exhibitors on the trade show floor).

---------------------------------------------------------------------------

[[Page 15462]]

    The Commission declines to follow a different approach in adopting 
the final amended Rule. As noted above, the final amended Rule 
prohibits franchise sellers from engaging in certain conduct that may 
deceive prospective franchisees during the sales process. In order to 
prevent deceptive sales practices, the prohibitions section of the 
final amended Rule is broad, covering all persons engaged in sales 
activity. Accordingly, the Commission intends that the term broker in 
the ``franchise seller'' definition to mean a person who: (1) is under 
contract with the franchisor relating to the sale of franchises; (2) 
receives compensation from the franchisor related to the sale of 
franchises; and (3) arranges franchise sales by assisting prospective 
franchisees in the sales process.\169\
---------------------------------------------------------------------------

    \169\ See Gust Rosenfeld, at 2 (supporting the above-noted 
interpretation of the term ``broker''). This interpretation 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 also would 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.
---------------------------------------------------------------------------

11. Section 436.1(k): Franchisor
    The original Rule defined ``franchisor'' as: ``any person who 
participates in a franchise relationship as a franchisor, as denoted in 
paragraph (a) of this subsection.''\170\ The final amended Rule 
streamlines the original definition: ``any person who grants a 
franchise and participates in the franchise relationship.''\171\ 
Consistent with the UFOC Guidelines, the definition also makes clear 
that, ``[u]nless otherwise stated, it includes subfranchisors.''\172\
---------------------------------------------------------------------------

    \170\ 16 CFR 436.2(c).
    \171\ The Franchise NPR proposed that a franchisor include a 
person who grants an ``interest in a franchise.'' The reference to 
granting ``an interest'' is deleted. As BI observed, granting an 
interest is too broad, arguably including a franchisee who sells an 
ownership interest in her own business. BI, NPR 28, at 2. The 
amended definition is also consistent with the language used in 
several state franchise statutes, namely ``grants a franchise,'' or 
``grants or offers to grant a franchise.'' E.g., Mich. Comp. Laws. 
445.1502(5); Wash. Rev. Code 19.100.010(8).
    \172\See Lewis, NPR 15, at 11 (suggesting that the definition 
address ``subfranchisors,'' noting comparable language in the 
Illinois and California Franchise Acts).
---------------------------------------------------------------------------

    In considering revisions to the ``franchisor'' definition, the 
Commission has rejected three additional suggestions. First, one 
commenter opined that it is unclear whether the phrase ``and 
participates in the franchisor relationship'' is intended to modify 
``any person who grants a franchise,'' or is intended to include 
persons other than those who grant a franchise. She urged the 
Commission to revise the definition narrowly to mean the person who 
signs the agreement granting a franchise.\173\
---------------------------------------------------------------------------

    \173\ Spandorf, at 2.
---------------------------------------------------------------------------

    The commenter's suggested change is unwarranted. The two 
definitional phrases are read conjunctively. To be considered a 
``franchisor,'' a person must satisfy two definition elements: (1) 
granting a franchise; and (2) participating in the franchise 
relationship. Further, the second definitional element--participating 
in the franchise relationship--is necessary to distinguish a franchisor 
(who has post-sale performance obligations), from others involved 
solely in the initial franchise sales process (such as a broker). 
Indeed, this commenter's proposed substitute definition could 
inappropriately sweep within the definition of ``franchisor'' third-
party brokers or other agents who are authorized by the franchisor to 
sign the franchise agreement, but who have no post-sale performance 
obligations. We therefore decline to adopt this suggestion.
    Second, NASAA urged the Commission to expand the definition to 
include shareholders of privately-held corporations.\174\ Although 
NASAA did not elaborate, its suggestion is apparently designed to make 
it easier to hold owners of closely-held corporations liable for 
violations of the final amended Rule. We do not believe, however, that 
a mere showing that an individual is a shareholder in a privately held 
corporation can suffice, without more, as a legal basis for subjecting 
that individual to liability to pay potentially significant civil 
penalties or consumer redress\175\ for Rule violations committed by the 
corporation or those actively in control of it. At any rate, where 
warranted, the Commission's enforcement experience indicates no 
difficulty in proving up the necessary level of participation in the 
violative conduct to justify civil penalties, or the requisite control 
over the corporation and knowledge of its violative activity to justify 
recovery of consumer redress. We therefore decline to adopt NASAA's 
suggestion on this issue.
---------------------------------------------------------------------------

    \174\ NASAA, at 4; NASAA, NPR 17, at 3.
    \175\E.g., FTC v. Morrone's Water Ice, Inc., No. 02-3720 (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).
---------------------------------------------------------------------------

12. Section 436.1(l): Leased department
    The final amended Rule retains the original Rule's exemption for 
leased department arrangements.\176\ 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 what arguably 
could be considered control over the operation, such as operating 
hours. As noted in the original SBP, these types of relationships need 
not be protected by the Rule because the likelihood of deception is not 
great, the retailer-lessee typically being experienced and able to 
assess the value of the location. Moreover, the risk is small because 
the retailer-lessee's financial liability to the retailer-grantor is 
limited to rent.\177\
---------------------------------------------------------------------------

    \176\ See 16 CFR 436.2(a)(3)(ii).
    \177\ Original SBP, 43 FR at 59708. See also Interpretive 
Guides, 44 FR at 49968.
---------------------------------------------------------------------------

    Section 436.1(l) of the final amended Rule defines the term 
``leased department'' as:

     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.\178\
---------------------------------------------------------------------------

    \178\ Originally, the Commission proposed in the Franchise NPR a 
much more streamlined version of the definition, 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.'' Franchise NPR, 64 FR 57332. However, one 
commenter voiced concern that this proposed definition could be 
misinterpreted as broadening the exemption to include even 
arrangements where the retailer-grantor requires the retailer-lessee 
to purchase goods from, for example, a specific third-party 
supplier. J&G, NPR 32, Attachment 6, at 13. This was not the 
Commission's intent, and the revised definition corrects that 
possible misinterpretation.

    No commenter raised any substantive concerns about the leased 
department exemption. One commenter, however, suggested that the 
Commission expand the definition of leased department to

[[Page 15463]]

include ``co-branding'' arrangements.\179\ 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.
---------------------------------------------------------------------------

    \179\ J&G, NPR 32, Attachment at 6, 13. Two other commenters 
suggested that the Commission provide more guidance about co-
branding generally, but not in the leased department context. 
Selden, at 3; Quizno's, ANPR 16, at 2. None of these commenters 
identified specific problems posed by co-branding arrangements--
other than noting that co-branded arrangements can be complex--nor 
did they offer any solutions for the Commission's consideration.
---------------------------------------------------------------------------

    The Commission declines to adopt this suggestion. The issue of Rule 
compliance in co-branded arrangements was raised in the ANPR\180\ and 
discussed in detail at the staff's New York public workshop conference 
on September 18, 1997. The ANPR commenters generally agreed that the 
current Rule and UFOC Guidelines are sufficient to address any 
deception issues that may arise in co-branded franchise arrangements. 
The same view was expressed by the participants at the New York 
workshop.\181\ Indeed, no franchisee or state regulator voiced any 
concerns to the contrary.\182\ Therefore, taken as a whole, the record 
does not support the need to adopt new rule provisions specifically 
addressing co-branding.\183\
---------------------------------------------------------------------------

    \180\ In the ANPR, the Commission noted its uncertainty as to 
whether the purchaser of a co-branded franchise acquires two 
individually-trademarked franchises (and thus should receive 
separate disclosures from each franchisor) or acquires a hybrid 
franchise arrangement that has its 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. ANPR, 62 FR at 9122. 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.
    \181\E.g., Kirsch, ANPR, 18 Sept. 97 Tr., at 176; Wieczorek, 
id., at 177-78; Kestenbaum, id., at 178-79; Simon, id., at 179.
    \182\ For example, 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, 18 Sept. 97 Tr., at 182.
    \183\ To the extent that franchisors may be uncertain how to 
apply the final amended Rule in a specific co-branded arrangement, 
they can always seek further guidance from Commission staff through 
an informal advisory opinion. To date, no such requests have been 
submitted, suggesting limited, if any, confusion over this issue.
---------------------------------------------------------------------------

13. Section 436.1(m): Parent
    Section 436.1(m) of the final amended Rule defines the term 
``parent'' as ``an entity that controls another entity directly, or 
indirectly though one or more subsidiaries.'' Several commenters 
suggested that because several Rule provisions address parent 
disclosures,\184\ the Commission should expressly define that 
term.\185\ Although the Rule proposed in the Franchise NPR did not 
define this term, the Commission believes this point is well-taken. 
Accordingly, part 436 of the final amended Rule expressly defines the 
term ``parent.''\186\
---------------------------------------------------------------------------

    \184\See section 436.5(a) (Item 1); section 436.5(c) (Item 3); 
section 436.5(d) (Item 4).
    \185\E.g., PMR&W, NPR 4, at 9; H&H, NPR 9, at 12.
    \186\ The final amended Rule's definition of ``parent'' is 
consistent with the definition of the term ``parent'' in the 
Interpretive Guides: ``an entity that controls the franchisor 
directly, or indirectly through one or more subsidiaries.'' 
Interpretive Guides, 44 FR at 49972. However, because the term 
parent is also used in the final amended Rule to refer to a 
franchisee's parent--e.g., section 436.8 (Exemptions)--the 
definition of ``parent'' deletes the reference to ``franchisor'' and 
replaces it with the broader term ``another entity.'' This is the 
identical approach taken in defining the term ``affiliate.'' See 
section 436.1(b) above.
---------------------------------------------------------------------------

    One commenter suggested an alternative definition: ``Parent means 
an entity that directly or indirectly has an 80% or greater ownership 
interest in the franchisor.''\187\ The commenter, however, did not 
state the basis for his recommendation. Indeed, in promulgating the 
original Rule, the Commission did not adopt an ownership test, but 
focused on control.\188\ We believe that is the proper approach.\189\ 
It is the control and resulting influence over the direction of the 
franchisor--not mere ownership--that is material to a prospective 
franchisee.
---------------------------------------------------------------------------

    \187\ Lewis, NPR 15, at 9. This suggested definition appears to 
derive 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.
    \188\ Interpretive Guides, 44 FR at 49972.
    \189\ The Staff Report's discussion of the ``parent'' definition 
generated one comment. Gust Rosenfeld suggested that a second 
sentence should be added to the definition to the effect that a 
parent entity is an affiliate, but is separately defined because 
certain requirements apply to a parent, but not to other types of 
affiliates. Gust Rosenfeld, at 2. We agree, but believe issues such 
as this are more appropriately addressed in Compliance Guides.
---------------------------------------------------------------------------

14. Section 436.1(n): Person
    Section 436.1(n) of the final amended Rule retains the original 
Rule's definition of the term ``person''--``any individual, group, 
association, limited or general partnership, corporation, or any other 
entity.''\190\ This is identical to the proposed version of this 
definition in the Franchise NPR. During the Rule amendment proceeding, 
a few commenters offered suggestions to modify the definition. Warren 
Lewis, for example, suggested that the Commission add the following to 
the definition: ``An individual is not an entity.''\191\ Mr. Lewis 
maintained that this change would make it clear throughout the Rule 
that ``person'' means an individual or business entity; while entity 
means only a business entity. As another example, IL AG and J&G 
suggested that the definition of ``person'' reference limited liability 
companies.\192\
---------------------------------------------------------------------------

    \190\See 16 CFR 436.2(b).
    \191\ Lewis, NPR 15, at 10.
    \192\ IL AG, at 3; J&G, NPR 32, Attachment, at 14.
---------------------------------------------------------------------------

    The term ``person'' is defined in many Commission rules, as 
referring to a party, regardless of whether the party is an individual, 
organization, or business entity.\193\ Where necessary, the rule text 
distinguishes between parties by using the 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 in the definition of ``person,'' as 
suggested. The Commission also finds that the term ``entity'' is 
sufficient to cover limited liability companies, as well as other forms 
of business arrangements.
---------------------------------------------------------------------------

    \193\E.g., Telemarketing Sales Rule, 16 CFR 310.2(v).
---------------------------------------------------------------------------

15. Section 436.1(o): Plain English
    Part 436 of the final amended Rule adopts the UFOC Guidelines 
requirement that disclosure documents be prepared in plain 
English.\194\ Section 436.1(o) defines ``plain English'' as:
---------------------------------------------------------------------------

    \194\ Section 436.6(a).

     the organization of information and language usage understandable 
by a person unfamiliar with the franchise business. It incorporates 
short sentences; definite, concrete, everyday language; active voice; 
and tabular presentation of information, where possible. It avoids 
legal jargon, highly technical business terms, and multiple 
negatives.\195\
---------------------------------------------------------------------------

    \195\ This definition is based upon the definition of ``plain 
English'' used in the securities context. See Registration Form Used 
by Open-Ended Management Investment Companies, SEC Release No. 33-
7512, 63 FR 13916, at 13939 (Mar. 23, 1998). See also UFOC General 
Instruction 150.

This definition is one of several features of the final amended Rule 
that are designed to preserve the integrity of

[[Page 15464]]

disclosure documents. Application of these writing standards will 
enhance the legibility and understandability of disclosure documents, 
thereby reducing the likelihood of franchisee deception, confusion, or 
misunderstandings.
16. Section 436.1(p): Predecessor
    Section 436.1(p) adopts the UFOC Guidelines' definition of 
``predecessor'' as: ``a person from whom the franchisor acquired, 
directly or indirectly, the major portion of the franchisor's 
assets.''\196\ This definition comes into play in several substantive 
provisions of the final amended Rule, where the Commission is adopting 
the UFOC Guidelines requirement that franchisors disclose material 
information about their predecessors.\197\ The original Rule did not 
require the disclosure of predecessor information. However, as 
discussed later in this document--in particular in connection with Item 
3 litigation disclosures and Item 4 bankruptcy disclosures--predecessor 
disclosures are necessary to prevent fraudulent franchise sales.\198\ 
Our law enforcement experience demonstrates that, in some instances, 
franchisors reincorporate under a new name as a simple way to avoid 
disclosing damaging information.\199\ The disclosure of predecessor 
information will prevent such efforts to circumvent the final amended 
Rule.
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    \196\ UFOC Guidelines, Item 1 Instructions, iii. See also NASAA 
Commentary, Bus. Franchise Guide (CCH), ] 5790, at 8465 (``The 
definition of predecessor in instruction iii to Item 1 should be 
applied throughout the UFOC.'').
    \197\E.g., section 436.5(a)(2) (Item 1); section 436.5(c) (Item 
3); section 436.5(d) (Item 4).
    \198\ Initially, the Commission proposed in the Franchise NPR a 
broader definition that would include as a predecessor a person 
``from whom the franchisor obtained a license to use the trademark 
or trade secrets in the franchise operation.'' Franchise NPR, 64 FR 
at 57332. This proposal was widely criticized as overbroad, H&H, NPR 
9, at 15; BI, NPR 28, at 2, and would result in burdensome 
disclosures that are immaterial to prospective franchisees, PMR&W, 
NPR 4, at 8; Baer, NPR 11, at 11; NFC, NPR 12, at 3-4; Snap-On, NPR 
16, at 2; Marriott, NPR 35, at 13-14. See also Gust Rosenfeld, at 2. 
Commenters also observed that information about the franchisor's 
trademark is already disclosed in Items 12-13. E.g., Baer, NPR 11, 
at 10; Lewis, NPR 15, at 10. The staff of the Commission agreed. 
Accordingly, the proposal was deleted in the revised proposed Rule 
set forth in the Staff Report.
    \199\E.g., FTC v. Wolf, Bus. Franchise Guide (CCH) ] 10401 (S.D. 
Fla. 1994); FTC v. Inv. Dev., Inc., Bus. Franchise Guide (CCH) ] 
9326 (E.D. La. 1989). See also United States v. Lasseter, No. 3:03-
01177 (M.D. Tenn. 2003).
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17. Section 436.1(q): Principal business address
    The final amended Rule requires the disclosure of the principal 
business address of the franchisor, as well as any parent, 
predecessors, and affiliates.\200\ Section 436.1(q) defines the term 
``principal business address'' to mean: ``the street address of a 
person's home office in the United States. A principal business address 
cannot be a post office box or private mail drop.''\201\ This 
definition was not included in the original Rule. Nevertheless, the 
Commission finds that this definition is necessary to enable a 
prospective franchisee to contact the franchisor easily, as well as to 
facilitate effective law enforcement.
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    \200\ See section 436.5(a).
    \201\ See UFOC Guidelines, Item 1C, Instructions, i.
---------------------------------------------------------------------------

    The proposed version of section 436.1(q) has been slightly revised 
to improve its precision, as suggested in one Staff Report comment. 
Initially, the definition of principal business address referred to the 
franchisor's home office. J&G correctly observed, however, that the 
disclosure of a principal business address applies not only to a 
franchisor, but to others, such as a predecessor, as well.\202\ 
Accordingly, the definition has been revised to refer to the more 
general ``person's home office''--be it the franchisor, parent, 
predecessor, or affiliate.
---------------------------------------------------------------------------

    \202\ J&G, at 2.
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18. Section 436.1(r): Prospective franchisee
    The final amended Rule retains a streamlined version of the 
definition of the term ``prospective franchisee'' set forth in the 
original Rule at 16 CFR 436.2(e). Specifically, section 436.1(r) 
defines the term to mean ``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.''\203\ This is identical to the version of this 
definition proposed in the Franchise NPR.
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    \203\ The final amended Rule definition uses the term 
``franchise seller'' in lieu of ``franchisor, or franchise broker, 
or any representative, agent, or employee thereof.'' See section 
436.1(i).
---------------------------------------------------------------------------

    The amended definition addresses several comments raised during the 
Rule amendment proceeding. First, one commenter voiced concern about 
who may receive a disclosure document, suggesting that the Commission 
permit any representative of the franchisee to receive the 
disclosures.\204\ The Commission agrees that representatives of a 
prospective franchisee should be permitted to accept delivery of the 
disclosure document on the prospective franchisee's behalf. Indeed, in 
some instances a prospective franchisee may be a corporation or other 
entity, not an individual. Thus, delivery in such circumstances can 
only be made upon a representative. Even individuals may wish to have 
their attorney or other agent receive the disclosures on their behalf, 
and the Rule should accommodate that possibility. We believe that the 
reference to agent, representative, or employee in section 436.1(r) is 
sufficient for this purpose. Further detail about who may accept 
disclosures for a prospective franchisee is best addressed in the 
Compliance Guides.\205\
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    \204\ BI, NPR 28, at 3.
    \205\See also Piper Rudnick, at 5 (seeking clarification in the 
Compliance Guides on whether the phrase ``agent, representative, or 
employee'' also includes an individual on behalf of a family member 
(spouse, children, siblings), other general and limited partners, 
shareholders, and/or the individual's corporate employer).
---------------------------------------------------------------------------

    One commenter also questioned the use of the word ``approaches'' in 
the definition. Specifically, the commenter feared that the definition 
would include someone surfing the Internet who ``approaches'' a 
franchisor's website.\206\ We believe this concern is unwarranted. The 
``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 communicate with the 
franchisor about a franchise offering. Merely perusing a franchisor's 
website alone does not turn an ordinary Internet surfer into a 
prospective franchisee. Accordingly, no further revision to the 
``prospective franchisee'' definition is warranted.
---------------------------------------------------------------------------

    \206\ J&G, NPR 32, at 7.
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19. Section 436.1(s): Required payment
    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\ Section 436.1(s) defines the term ``required 
payment'' to mean:
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    \207\See section 436.1(h)(3).

     all consideration that the franchisee must pay to the franchisor 
or an affiliate, either by contract or by practical necessity,\208\ 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.
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    \208\ The ``required payment'' definition incorporates the 
Commission's long-standing policy that a payment can be required by 
contract or by practical necessity. See Interpretive Guides, 44 FR 
at 49967.

The only substantive difference between the provision as proposed in 
the

[[Page 15465]]

Franchise NPR and the final amended Rule provision is the addition of 
the second sentence. There is no corresponding definition in the 
original Rule.
    During the Rule amendment proceeding, several commenters raised 
concerns about the scope of the ``required payment'' definition. 
Specifically, commenters voiced concern whether the definition: (1) 
covers royalty payments; (2) covers payments to obtain or commence the 
franchise relationship; (3) excludes payments for inventory; and (4) 
includes payments to third parties. Each of these issues is discussed 
in greater detail below.
a. Royalty payments
    As noted above, the definition of ``required payment'' uses the 
phrase ``consideration that the franchisee must pay.'' IL AG 
interpreted the word ``consideration'' as excluding royalty payments. 
It urged the Commission to clarify that royalties can constitute a 
required fee. Otherwise, ``it will be too simple, even for traditional 
franchisors, to evade franchise laws.''\209\
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    \209\ IL AG, NPR 3, at 5. See also J&G, NPR 32, Attachment, at 
15 (questioning whether ``consideration'' excludes royalty 
payments).
---------------------------------------------------------------------------

    The Commission has always considered royalty payments to be a form 
of required payment under the Rule and nothing in the definition of 
``required payment'' is to the contrary.\210\ Royalty payments 
constitute a direct form of consideration 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 Rule uses the term 
``consideration'' not to imply that only an upfront franchise fee 
constitutes 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.
---------------------------------------------------------------------------

    \210\See Interpretive Guides, 44 FR at 49967 (``Among the forms 
of required payments are . . . continuing royalties on sales.'').
---------------------------------------------------------------------------

b. Payments to obtain or commence a franchise
    One commenter voiced concern that because the definition of 
``required payment'' covers payments made ``as a condition of obtaining 
or commencing operation of the franchise,'' it would encompass ordinary 
business expenses paid to the franchisor. He urged the Commission to 
narrow the definition by specifying that a required payment must be 
made ``for the right to enter into the franchise relationship.''\211\
---------------------------------------------------------------------------

    \211\ Baer, NPR 11, at 8.
---------------------------------------------------------------------------

    The Commission declines to adopt this suggestion. The phrase 
``right to enter into a franchise relationship'' is too narrow, 
suggesting that the required payment definitional element should be 
limited to payments made solely for the right to enter into the 
business, such as an up-front franchise fee. 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.''\212\ The 
Interpretive Guides further provide as examples of required payments 
equipment rentals and real estate leases.\213\ Thus, expenses incurred 
in the ordinary course of business and paid to a franchisor or its 
affiliate may constitute a required payment. Otherwise, unscrupulous 
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.\214\
---------------------------------------------------------------------------

    \212\ Interpretive Guides, 44 FR at 49967.
    \213\Id.
    \214\See Original SBP, 43 FR at 59703 and note 51 (discussing 
problem of ``indirect or disguised'' franchise fees).
---------------------------------------------------------------------------

c. Payments for inventory
    As a matter of Commission policy, reasonable amounts of inventory 
purchased at bona fide wholesale prices have not been interpreted to 
constitute a ``required payment'' under the original Rule.\215\ 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.''\216\ (As noted 
above, the definition proposed in the Franchise NPR did not exclude 
payments for inventory.) Another commenter agreed with Mr. Gurnick and 
urged further expansion of 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 arguably creating a franchise relationship retroactively.\217\
---------------------------------------------------------------------------

    \215\See Interpretive Guides, 44 FR at 49967. In the Franchise 
NPR, the Commission proposed incorporating the inventory exemption 
into the current minimum payment exemption. See Franchise NPR, 64 FR 
at 57345. The minimum payment exemption applies where the total 
required payment made by the franchisee ``from any time before to 
within six months after commencing operation of the franchisee's 
business, is less than $500.'' 16 CFR 436.2(a)(3)(iii). Accordingly, 
the amount of any ``required payment'' must be known before 
determining the applicability of the minimum payment exemption. 
Because the inventory exemption helps to define what constitutes a 
``required payment,'' we conclude that it should be included 
directly in the definition of ``required payment.'' See Staff 
Report, at 61-62.
    \216\ Gurnick, NPR 21A, at 10.
    \217\ Baer, NPR 11, at 8.
---------------------------------------------------------------------------

    The Commission has concluded that the definition of ``required 
payment'' should incorporate the inventory exemption as these 
commenters suggested. Since the Rule's inception, the Commission's 
policy has been that reasonable purchases of inventory for resale at 
bona fide wholesale prices are not construed to be a ``required 
payment.'' The Interpretive Guides state that 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.''\218\ Therefore, the 
final amended Rule provision incorporates this policy, and extends it 
to encompass inventory purchased for lease as well as resale, there 
being no distinction, as a practical matter, between the two 
categories.
---------------------------------------------------------------------------

    \218\ Interpretive Guides, 44 FR at 49967.
---------------------------------------------------------------------------

d. Payments to third parties
    Howard Bundy urged expansion of 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.\219\
---------------------------------------------------------------------------

    \219\ Bundy, NPR 18, at 4.

To address this concern, Mr. Bundy suggested that the Commission modify 
the definition of ``required payment'' to include, after the word 
affiliate: ``or to a vendor, financing provider or other third party 
that the prospective

[[Page 15466]]

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.''\220\
---------------------------------------------------------------------------

    \220\Id.
---------------------------------------------------------------------------

    Mr. Bundy's suggestion generated one rebuttal comment. David 
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.''\221\ 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.''\222\ 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.\223\
---------------------------------------------------------------------------

    \221\ Gurnick, NPR Rebuttal 36, at 2.
    \222\Id., at 3.
    \223\Id., at 3-4. 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.
---------------------------------------------------------------------------

    It is true that the Commission has never considered ordinary 
business payments to third parties as a ``required payment'' under the 
Rule. Indeed, doing so could sweep very broadly. 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 obtaining or commencing operation of a franchise. 
Rather, a third-party payment constitutes a required payment only if 
the third party collects and remits the payment on behalf of the 
franchisor.\224\
---------------------------------------------------------------------------

    \224\See Interpretive Guides, 44 FR at 49967.
---------------------------------------------------------------------------

    Nonetheless, a franchisor may direct or encourage a prospective 
franchisee to incur some costs in order to advance the franchise sale. 
The prospective franchisee may incur these costs and make these kinds 
of payments without the benefit of pre-sale disclosures. Encouraging a 
prospect to incur expenses to advance the franchise sale could 
conceivably increase the likelihood that he or she will go through with 
the deal without a thorough due-diligence investigation. Therefore, the 
Commission has incorporated into the final amended Rule 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.\225\ This prohibition enables a 
prospective franchisee to ask to see a copy of the franchisor's 
disclosure document before agreeing to travel to company headquarters 
or purchase demographic data, for example. The Commission believes this 
approach will better address concerns about pre-disclosure third-party 
payments than would an unworkable alteration of the definition of the 
term ``required payment.''
---------------------------------------------------------------------------

    \225\See section 436.9(e).
---------------------------------------------------------------------------

20. Section 436.1(t): Sale of a franchise
    The part 436 disclosure obligations are triggered only when there 
is an offer for the sale of a franchise.\226\ Section 436.1(t) defines 
the term ``sale of a franchise'' as follows:
---------------------------------------------------------------------------

    \226\See section 436.2.

     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.

Like the original Rule provision, the final amended provision embodies 
the concept that franchisees extending or renewing an existing 
franchise agreement, where there is no interruption in business 
operations, will not be deemed to be entering into a sale, unless their 
new agreement contains terms and conditions materially different from 
their original agreement.\227\
---------------------------------------------------------------------------

    \227\ 16 CFR 436.2(k). See also Interpretive Guides, 44 FR at 
49969.
---------------------------------------------------------------------------

    The final amended Rule provision differs substantively from the 
provision as proposed in the Franchise NPR\228\ because it incorporates 
the Commission policy, as stated in the Interpretive Guides, that the 
term ``sale of a franchise'' does not encompass the transfer of a 
franchise by an existing franchisee where the prospective purchaser has 
no significant contact with the franchisor.\229\ Under long-standing 
Commission policy, a franchisor or subfranchisor must provide 
disclosures to prospective franchisees, but ``a person who purchases a 
franchise directly from an existing franchisee, without significant 
contact with the franchisor, is not a prospective franchisee.''\230\ 
Where a franchisor is not involved in the private sale of an existing 
franchise, the franchisor makes no representations to the prospective 
new purchaser. If there is any fraud in the private sale, it could be 
only by the current franchisee owner, and pre-sale disclosure by the 
franchisor would not likely prevent it. Accordingly, section 436.1(t) 
of part 436 makes clear that a transfer without significant involvement 
of the franchisor is not the sale of a franchise within the ambit of 
the Rule. Further, the franchisor's mere approval or disapproval of the 
purchaser alone is not considered to be significant involvement.\231\
---------------------------------------------------------------------------

    \228\ Franchise NPR, 64 FR at 57333.
    \229\See H&H, NPR 9, at 11.
    \230\ Interpretive Guides, 44 FR at 49969.
    \231\See Interpretive Guides, 44 FR at 49969-70. In contrast, a 
franchisor who actively participates in a franchise transfer must 
make disclosures to a potential transferee, no less than to a 
prospective franchisee. In such an event, 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.
---------------------------------------------------------------------------

    At the same time, the Commission declines to adopt several 
suggested narrowing modifications to the definition of ``sale of a 
franchise.'' H&H urged the Commission to exclude from the definition of 
``sale of a franchise'' the modification of an existing franchise 
agreement where there is no interruption in the franchisee's business 
operation.\232\ 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.\233\ According to H&H, these modifications typically 
entail no new investment and both sides are familiar with the

[[Page 15467]]

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.''\234\
---------------------------------------------------------------------------

    \232\ H&H, NPR 9, at 9-10.
    \233\ H&H, NPR 9, at 10.
    \234\Id.
---------------------------------------------------------------------------

    The Commission agrees that disclosure is 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. 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, the cost of which is probably not outweighed by any tangible 
benefit to the existing franchisee. In any event, franchise agreement 
modifications, most obviously those without any new payment, would not 
constitute a ``sale.'' The definition of ``sale of a franchise,'' 
therefore, need not be revised to address this concern.
    H&H further contended that disclosure is never warranted for 
renewals, 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.''\235\ After 
considering this suggestion, we are unconvinced that renewals should 
always be excluded from the definition of ``sale of a franchise.''
---------------------------------------------------------------------------

    \235\Id., at 11.
---------------------------------------------------------------------------

    As discussed in greater detail below in connection with section 
436.5(q)--Item 17's renewal disclosure--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.\236\ Franchisees, they have 
asserted, not only lack bargaining power over the renewal agreement, 
but also often must accept new onerous terms because they are 
frequently subject to covenants not to compete that effectively prevent 
them from continuing in the same business independently. 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 reasonably wish to see Item 20 closure rates for 
franchises operating under the new franchise agreement. Accordingly, 
the Commission concludes that where the franchise agreement contains 
terms and conditions materially different from the original agreement, 
the renewing franchisee needs advance disclosures in order to make an 
informed renewal decision.\237\
---------------------------------------------------------------------------

    \236\ See discussion of section 436.5(q) below. See also Staff 
Report, at 153-156; Franchise NPR, 64 FR at 57308-09.
    \237\ 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.
---------------------------------------------------------------------------

21. Section 436.1(u): Signature
    The original Rule contained no definition of ``signature.'' To 
facilitate the use of electronic signatures, however, section 436.1(u) 
of the final amended Rule updates the UFOC Guidelines by adding such a 
definition: ``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.'' No comments were 
submitted on this definition, but the Commission has refined the 
language of the proposed definition to achieve greater precision and 
clarity, expressly including the descriptor ``handwritten,'' 
substituting ``electronic'' for ``digital,`` and adding the phrase ``to 
authenticate his or her identity.''
22. Section 436.1(v): Trademark
    Section 436.1(v) of the final amended Rule defines the term 
``trademark.'' The original Rule did not define this term. Consistent 
with long-standing Commission interpretation of the term and the UFOC 
Guidelines, the final amended Rule definition is broad, including 
``trademarks, service marks, names, logos, and other commercial 
symbols.''\238\ No comments were submitted on this definition, and it 
is identical to the version of the definition published in the 
Franchise NPR.
---------------------------------------------------------------------------

    \238\See Interpretive Guides, 44 FR at 49966-967. See also UFOC 
Guidelines, Item 13 Instructions, i.
---------------------------------------------------------------------------

23. Section 436.1(w): Written or in writing
    The final amended Rule updates the original Rule and UFOC 
Guidelines to permit the use of electronic disclosures.\239\ To that 
end, section 436.1(w) of the final amended Rule defines the term 
``written or in writing'' to include not only printed documents, but:
---------------------------------------------------------------------------

    \239\See section 436.6 of the final amended Rule.

     any document or information . . . 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.\240\
---------------------------------------------------------------------------

    \240\See also section 436.8(a)(7), which retains the original 
Rule's exemption for oral statements at 16 CFR 436.2(a)(3)(iv).

No comments were submitted on the Franchise NPR's proposed definition, 
and only minor non-substantive changes in language were made to improve 
clarity.

B. Section 436.2: Obligation To Furnish Documents

    Section 436.2 of the final amended Rule retains the original Rule's 
requirement that franchisors provide prospective franchisees with 
advance written disclosures.\241\ It also retains, in streamlined form, 
elements of the original Rule's requirement that a franchisor ``furnish 
the prospective franchisee with a copy of the franchisor's franchise 
agreement . . . prior to the date the agreements are to be 
executed.''\242\ The final amended Rule provision follows the basic 
concepts of the corresponding provision of the proposed Rule published 
in the Franchise NPR, but, as explained below, it reflects important 
refinements suggested by the comments, and its language has been 
reorganized to improve clarity.
---------------------------------------------------------------------------

    \241\ 16 CFR 436.1(a).
    \242\ 16 CFR 436.1(g).
---------------------------------------------------------------------------

    Section 436.2 of part 436 covers four issues relating to the basic 
obligation to provide a disclosure document. First, it describes the 
geographical scope within which the disclosure obligation applies. 
Second, it establishes the time frame for fulfilling that obligation. 
Third, it limits the obligation of the franchisor to furnish to the 
prospective franchisee an advance copy of the completed franchise 
agreement--apart from the disclosure document--to only those 
circumstances when the franchisor makes material unilateral changes to 
the agreement while the offer is still under consideration. Fourth, and 
finally, the provision sets forth the specific actions

[[Page 15468]]

that constitute the furnishing of disclosures. Each of these aspects of 
section 436.2 generated comments. The following sections discuss those 
issues and the various views of the commenters.
1. Geographical scope of the Rule's application
    Section 436.2 of the final amended Rule makes clear that the part 
436 disclosure requirements and prohibitions are limited to ``the offer 
or sale of a franchise to be located in the United States of America or 
its territories.''\243\ This provision of part 436 is substantively 
identical to the corresponding provision in the proposed Rule. The 
original Rule did not address whether pre-sale disclosure is required 
for sales of franchises to be located outside the United States and its 
territories, and this issue has remained an unsettled area of franchise 
law. This issue was raised early in the proceeding and, based upon the 
record developed, the Commission concludes that application of part 436 
to franchises to be located outside the United States and its 
territories is unwarranted at this time.\244\
---------------------------------------------------------------------------

    \243\ Limitation of the geographic scope of part 436 of the 
final amended Rule is not intended to limit the FTC's jurisdiction, 
as set forth in section 5(a) of the FTC Act, 15 U.S.C. 45(a), and 
section 3 of the U.S. SAFE WEB Act of 2006, Pub. L. No. 109-455, 120 
Stat. 3372.
    \244\ The Staff Report recommended limitation of the Rule's 
scope to sales of franchises to be located in the United States. 
Staff Report, at 72-5.
---------------------------------------------------------------------------

    The record reveals overwhelming support among various franchise 
interests for limiting the reach of the part 436 to sales of domestic 
franchises.\245\ Among other things, the commenters noted that foreign 
franchise purchasers are large sophisticated investors represented by 
counsel and do not need the Rule's protections. Some commenters made 
the point that the Commission developed the Franchise Rule in response 
to problems occurring in the domestic market.\246\ Indeed, a disclosure 
document addressing the American market may be irrelevant and 
potentially misleading when applied to a purchase of a franchise to be 
located outside the United States, due to the vast differences between 
American and foreign markets, cultures, and legal systems.\247\ 
Further, many risks to the prospective franchisee arise 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, but it is likely that any possible 
benefits of such a requirement would not outweigh the extraordinary 
costs and burdens involved.\248\
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    \245\E.g., MSA, at 3-4; PMR&W, NPR 4, at 1; 7-Eleven, NPR 10, at 
1; IFA, NPR 22, at 5; AFC, NPR 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. Five commenters, however, urged the Commission to 
enforce the Rule with respect to foreign franchises, raising 
essentially three points. First, many American foreign franchise 
sales contracts require disputes 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. 
Brown, ANPR 6; Argentine Embassy, ANPR 132; Selden, ANPR 133, at 2-
3. Second, limiting the Rule's applicability to sales of domestic 
franchises would mean that American citizens who purchase a 
franchise to be located abroad from an American franchisor would not 
be protected by American law. Stadfeld, ANPR 23, at 3; Selden, ANPR 
133, at 2-3. See also Stubbings, ANPR 21. Third, the Commission has 
jurisdiction over sales of foreign franchises and should not 
willingly restrict its own jurisdiction. Brown, ANPR 4. None of the 
commenters, however, have shown that limiting the reach of part 436 
to franchises to be located in the United States or its territories, 
as a matter of policy, compromises the Commission's jurisdiction 
over foreign sales under the FTC Act. The Commission retains its 
jurisdiction over such sales, and may exercise its discretion to 
bring an action in appropriate cases.
    \246\ As H&H observed, a close reading of the text of both the 
original Rule and UFOC Guidelines indicates an intent to require 
disclosures involving only domestic franchises. For example, UFOC 
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.
    \247\E.g., Miolla, 11 Mar.96 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 an 
American disclosure document).
    \248\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.''). See also Winslow, at 140.
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    At the same time, the Commission has rejected suggestions to limit 
the scope of the Rule further to exclude sales of franchises to be 
located in American territories.\249\ The FTC Act gives the Commission 
authority to promulgate trade regulation rules involving unfair or 
deceptive acts or practices\250\ ``in or affecting commerce.''\251\ The 
FTC Act includes multiple references to territories in its definition 
of commerce,\252\ including commerce ``in any territory of the United 
States.''\253\ The record does not suggest any convincing rationale for 
contraction of the exercise of that authority as expressed through part 
436 of the final amended Rule. Residents of American territories rely 
on American law for protection, and the Franchise Rule is part of that 
protection.
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    \249\ For example, Marriott asserted that the same policy 
concerns about applying the Rule to franchises located abroad are 
also relevant to Puerto Rico. Marriott apparently treats Puerto Rico 
as a foreign country. It contended that furnishing prospective 
franchisees in this context with a copy of the franchisor's 
disclosure document may be irrelevant or misleading. Marriott, NPR 
35, at 4-5. See also J&G, NPR 32, at 3.
    \250\See section 18(a)(1) of the FTC Act (``The Commission may 
prescribe . . . rules which define with specificity acts or 
practices which are unfair or deceptive acts or practices in or 
affecting commerce (within the meaning of section 45(a)(1) of this 
title).''
    \251\ 15 U.S.C. 45(a).
    \252\ 15 U.S.C. 44 (```Commerce''' means commerce . . . in any 
Territory of the United States . . ., 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.'').
    \253\ 15 U.S.C. 44.
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2. Section 436.2(a): Time frame for making disclosures
    Part 436 of the final amended Rule substantially revises the 
original Rule's timing for making franchise disclosures. Under the 
original Rule, franchisors and brokers had to furnish prospective 
franchisees with disclosure documents at the earlier of two time 
periods: (1) the first personal (face-to-face) meeting; or (2) ``the 
time for making disclosures,'' which was defined as 10 business days 
before the execution of the franchise agreement or payment of any fees 
in connection with the franchise sale.\254\ The final amended Rule 
streamlines the timing provision in two respects. First, part 436 
eliminates the first personal meeting disclosure trigger. Second, part 
436 replaces the original 10-business day trigger with a 14 calendar-
day disclosure trigger. Both of these revisions were included in the 
Rule proposed in the Franchise NPR, but have been slightly revised for 
clarification and better organization. Each is discussed in greater 
detail below.
---------------------------------------------------------------------------

    \254\See 16 CFR 436.1(a), 436.2(g), and 436.2(o).
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a. Elimination of the first personal meeting trigger
    The Franchise NPR's proposal to eliminate the first personal 
meeting disclosure trigger prompted overwhelming support from 
franchisors and their representatives, as well as NASAA.\255\ These 
commenters asserted

[[Page 15469]]

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.\256\
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    \255\See, e.g., PMR&W, NPR 4, at 1; Holmes, NPR 8, at 3; NFC, 
NPR 12, at 13; NASAA, NPR 17, at 3; Marriott, NPR 35, at 9. The 
Commission also raised this issue in the ANPR, prompting favorable 
franchisor comment. See Duvall, ANPR 19, at 3; Baer, ANPR 25, at 6; 
Tifford, ANPR, 18 Sept. 97 Tr., at 158-59; Staff Report, at 76-8.
    \256\E.g., IFA, NPR 22, at 9; Stadfeld, NPR 23, at 4. Kennedy 
Brooks, for example, 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, 18 Sept. 97 
Tr., at 160. See also NCL, ANPR 35, at 4-5; SBA Advocacy, ANPR 36, 
at 9; IL AG, ANPR 77, at 3-4.
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    Some franchisees and their advocates, however, maintained that the 
first personal meeting trigger continues to serve a useful purpose. For 
example, one franchisee representative asserted that there is no basis 
to believe that personal meetings will completely become a thing of the 
past, and warned that eliminating the current first personal meeting 
disclosure trigger would enable franchisors to induce a high level of 
commitment on the part of prospects through protracted discussions 
without providing the disclosure document, with the result that ``the 
14 day cooling off period will then start when the franchisee has 
already decided to make the investment.''\257\
---------------------------------------------------------------------------

    \257\ Karp, NPR 24, at 5-6. See also Bundy, NPR 18, at 5-6; 
Turner, NPR 13, at 1.
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    The Commission believes that a first personal meeting trigger alone 
does little to ensure that a prospective franchisee will receive 
disclosures early in the sales process.\258\ 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 email long before any personal 
meeting occurs. Therefore, after carefully considering the comments, 
the Commission is persuaded that the first personal meeting trigger has 
become largely obsolete and should be deleted.
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    \258\ In the 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.``
    Interpretive Guides, 44 FR at 49970.
---------------------------------------------------------------------------

    Nonetheless, the Commission shares commenters' concern about a 
franchisor influencing a prospective franchisee's decision before the 
prospect receives the franchisor's disclosures.\259\ To address this 
concern, the Staff Report recommended adoption of a new provision to 
prohibit 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.\260\ The Commission has 
determined to follow this recommendation. Accordingly, 436.9(e) of the 
final amended Rule specifies that it is an unfair or deceptive practice 
to ``[f]ail to furnish a copy of the franchisor's disclosure document 
to a prospective franchisee earlier in the sales process than required 
under Sec.  436.2 of this part, upon reasonable request.'' This 
prohibition does not mean that a franchisor must tender a disclosure 
document to any person who may desire a copy. Rather, it applies where 
the parties have already conducted specific discussions or negotiations 
or otherwise taken steps to begin the sales process. This promotes the 
goal of early disclosure in the sales process without reliance on the 
obsolete personal meeting trigger. It also is likely to impose only a 
de minimis burden, if any, on franchisors, who presumably have a 
disclosure document already prepared when discussing a sale with a 
prospective franchisee.
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    \259\ Karp, at 6. See also Original SBP, 43 FR at 59639 
(``[O]nce a prospect has been `hooked,' it is difficult, if not 
impossible, to `extricate himself.''').
    \260\ Staff Report, at 77-8.
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b. Fourteen calendar-days
    Section 436.2(a) of the final amended Rule requires franchisors to 
furnish disclosures ``at least 14 calendar-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.'' The Franchise NPR proposed this modification of the original 
Rule's ``10 business day'' disclosure trigger. Commenters who addressed 
this issue unanimously agreed that a 14 calendar-day disclosure trigger 
is clearer than the original Rule's ``10 business day'' trigger.\261\ 
One commenter, 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.''\262\ 
The Commission intends that 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 on the 15\th\ day after delivery. 
This ensures that prospective franchisees have at least a full 14 days 
in which to review the disclosures.\263\
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    \261\E.g., Gust Rosenfeld, at 3; Baer, NPR 11, at 10; NFC, NPR 
12, at 13; AFC, NPR 30, at 2; Marriott, NPR 35, at 9. See also 
Winslow, at 76.
    \262\ Holmes, NPR 8, at 3. See also Baer, NPR 11, at 10.
    \263\ This approach is consistent with current industry 
practice. See, e.g., www.msaworldwide.com/index.cfm/franchise/calendar (2006). But see J&G, at 2 (noting that this approach is 
inconsistent with the approach used in the Federal Rules of Civil 
Procedure).
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    Section 436.2(a) of the final amended Rule also tightens the 
language used in the proposed version of this provision to describe the 
events that trigger the 14-day disclosure requirement.\264\ The 
original Rule required a franchisor to provide its disclosure document:
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    \264\ The Commission also has decided to clarify the provision 
further by specifying that the described time period is measured in 
``calendar-days'' rather than the possibly ambiguous ``days.''

     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.\265\
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    \265\ 16 CFR 436.2(g). See also Interpretive Guides, 44 FR at 
49970.

    In the proposed Rule, section 436.2(a) would have altered this 
formulation by eliminating the franchisor's knowledge as a triggering 
factor, and rephrasing the remaining factors. Specifically, the 
proposed provision would have conditioned the disclosure obligation on 
either ``the prospective franchisee sign[ing] a binding agreement or 
pay[ing] any fee in connection with the proposed franchise sale.''
    Several commenters, focusing on the use of the terms ``binding 
agreement'' and ``pays any fee,'' criticized the perceived overbreadth 
of this proposed provision. For example, H&H and

[[Page 15470]]

Tricon urged inclusion of the phrase ``with the franchisor or an 
affiliate of the franchisor,'' arguing 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.''\266\
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    \266\ H&H, NPR 9, at 21. See also Tricon, NPR 34, at 3-4. In a 
related but distinct vein, Piper Rudnick urged the Commission to 
clarify in the Compliance Guides that the 14-day deadline for 
disclosure is not triggered by a confidentiality agreement. The firm 
maintained that prospective franchisees often sign confidentiality 
agreements in the course of negotiations with franchisors. Piper 
Rudnick, at 5. While the signing of a confidentiality agreement is 
``in connection with the proposed franchise sale,'' it does not bind 
the prospective franchisee to purchase the franchise or to undertake 
other obligations, such as the signing of a lease. The firm urged 
clarification that the term ``binding agreement'' in the 14-day rule 
is limited to franchise agreements or other agreements that commit 
the prospective franchisee to purchase a franchise. Id. The 
Commission agrees. A confidentiality agreement--often signed by 
prospective franchisees before being granted access to the 
franchisor's operations manual and other proprietary information--
may be a necessary initial step in the sales process, but is not the 
type of agreement that triggers disclosure obligations. This 
assumes, however, that the confidentiality agreement contains no 
other agreements that, in the absence of the confidentiality 
agreement, would trigger disclosure, such as a lease agreement.
---------------------------------------------------------------------------

    On the other hand, Howard Bundy urged broadening the Rule so that a 
franchisor would be required to provide the disclosure document 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.\267\ Mr. Bundy's 
concern was that prospective franchisees may risk losing significant 
sums of money to pursue a franchise before they receive any disclosures 
about the franchise offer.
---------------------------------------------------------------------------

    \267\ Bundy, NPR 18, at 5.
---------------------------------------------------------------------------

    The Commission believes that the concern that prompts Mr. Bundy's 
suggestion is adequately addressed by section 436.9(e) --the new 
prohibition barring franchisors from failing to furnish disclosures 
earlier in the sales process upon reasonable request. A prospect can 
always ask the franchisor for a disclosure document before undertaking 
such obligations as signing a binding agreement, paying any fee in 
connection with the proposed franchise sale, or incurring travel or 
other costs. Thus, a broad disclosure trigger such as Mr. Bundy 
advocates is not necessary.
    Furthermore, the Commission agrees with the commenters who 
suggested that this provision should be more carefully tailored so as 
not to be overly inclusive or imprecise. Accordingly, the final 
provision specifies that disclosure must be made at least 14 calendar-
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.'' Addition of the 
underscored language adds clarity and precision, and puts appropriate 
limits on the provision's reach.
3. Section 436.2(b): Modified contract review period
    Part 436 of the final amended Rule significantly narrows the 
circumstances under which a franchisor must furnish a prospective 
franchisee with a copy of the completed franchise agreement in advance 
of the date of execution. The original Rule required that franchisors 
and brokers furnish prospective franchisees with a copy of the 
completed franchise and related agreements at least five business days 
before the date of execution.\268\ The proposed Rule published in the 
Franchise NPR retained this requirement.\269\ During the Rule amendment 
proceeding, several franchisors and their supporters, as well as NASAA, 
urged the Commission to eliminate the contract review period.\270\ 
PMR&W, for example, asserted that the delay resulting from the 
mandatory disclosure period often harms prospective franchisees:
---------------------------------------------------------------------------

    \268\See 16 CFR 436.1(g).
    \269\ The proposed rule provision used the term ``days'' instead 
of the original Rule's ``business days.''
    \270\ The UFOC Guidelines contain no comparable provision 
requiring advanced disclosure of the completed franchise agreement.

     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 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.\271\
---------------------------------------------------------------------------

    \271\ PMR&W, NPR 4, at 4. See also IFA, NPR 22, at 9; J&G, NPR 
32, at 6; Marriott, NPR 35, at 9; GPM, NPR Rebuttal 40, at 2.

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.\272\
---------------------------------------------------------------------------

    \272\ Marriott, NPR 35, at 9-10. See also Marriott, at 4.

    The Staff Report recommended that the contract review period be 
restricted to instances where the franchisor unilaterally modifies its 
standard franchise agreement. It also recommended substituting ``seven 
calendar-days'' for the Franchise NPR provision's ``five days,'' to be 
consistent with the revision of the former 10-day disclosure trigger to 
14 calendar-days.\273\ After careful consideration of the record, the 
staff recommendation, and the rationale for that recommendation, the 
Commission has decided to modify the text of this Rule requirement in 
the manner recommended in the Staff Report. Section 436.2(b) of the 
final amended Rule specifies that it is a Rule violation for any 
franchisor:
---------------------------------------------------------------------------

    \273\ Staff Report, at 80-2. As a practical matter, five 
business days typically amounts to seven calendar-days.

     to alter unilaterally and materially the terms and conditions of 
the basic franchise agreement or any related agreements attached to the 
disclosure document without furnishing the prospective franchisee with 
a copy of each revised agreement at least seven calendar-days before 
the prospective franchisee signs the revised agreement. Changes to an 
agreement that arise out of negotiations initiated by the prospective 
---------------------------------------------------------------------------
franchisee do not trigger this seven calendar-day period.

    The Commission intended the original Rule's five business day 
review requirement to advance two goals: (1) to ensure that prospective 
franchisees would have time to review and understand the franchise and 
any related agreement before undertaking significant financial and 
legal obligations; and (2) to prevent fraud by discouraging a 
franchisor from unilaterally substituting pages or

[[Page 15471]]

otherwise altering agreements presented to the prospective franchisee 
for signing.
    The first concern--providing time to study the franchise and 
related agreements--is already served by the Rule's basic disclosure 
requirement.\274\ Attached to each disclosure document is a copy of the 
franchisor's basic agreement and any related agreements. At the very 
least, these documents enable prospects to review the basic terms and 
conditions governing the franchise system. Based upon the Commission's 
experience in enforcing and administering the Rule, 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, redisclosure by the 
franchisor is hardly warranted. Thus, section 436.2(b) expressly states 
that ``[c]hanges to an agreement that arise out of negotiations 
initiated by the prospective franchisee do not trigger this seven 
calendar-day period.''
---------------------------------------------------------------------------

    \274\See Gust Rosenfeld, at 3. Gust Rosenfeld noted, however, 
that while the original Rule referred to franchise and related 
agreements, the Staff Report's proposed Rule focused narrowly on 
franchise agreements. Id. See also J&G, at 3. The final amended Rule 
appropriately broadens the contract review provision to refer to 
franchise and related agreements.
---------------------------------------------------------------------------

    Further, the Commission does 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 
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, as a practical matter, can 
seek additional review time, if desired.
    Nonetheless, the possibility of fraud remains a concern. To prevent 
a franchisor from substituting at the last minute provisions that 
differ materially from those in the agreements previously attached to 
the disclosure document, the final amended Rule includes two 
safeguards. First, section 436.2(b) retains a mandatory contract review 
period of seven full days\275\ in situations where the franchisor has 
materially altered the terms and conditions of the standard agreements 
attached to the disclosure document.\276\ The Commission intends that 
this not include situations where the only differences between the 
standard agreements and the completed agreements are ``fill-in-the-
blank'' provisions, such as the date, name, and address of the 
franchisee.\277\ Nor does it include instances where deviations from 
the standard agreement are initiated at the prospective franchisee's 
request.
---------------------------------------------------------------------------

    \275\ As previously noted, part 436 of the final amended Rule 
provision substitutes ``seven calendar-days'' for the Franchise NPR 
provision's ``five days'' to be consistent with the revision of the 
former 10 business-day disclosure trigger to 14 calendar-days.
    \276\See Gust Rosenfeld, at 3; IL AG, NPR 3, at 5; Stadfeld, NPR 
23, at 4.
    \277\ J&G questioned whether ``fill-in-the-blank'' provisions 
include ``things such as the specific radius or geographic area 
comprising a protected territory, or the actual number of stores to 
be opened pursuant to an area development agreement, . . . or the 
specific interest rate payable by the franchisee.'' J&G at 3. The 
Commission will interpret ``fill-in-the-blank'' provisions narrowly 
to include non-contractual items, such as the parties' names, 
addresses, and dates. To the extent that substantive contractual 
details--such as geographic area of a protected territory and 
interest rates--are not disclosed in the basic disclosure document 
or its attachments, then the completed document must be disclosed 
seven calendar days before signing.
---------------------------------------------------------------------------

    Second, the final amended Rule targets potential fraud directly by 
adopting a new prohibition, section 436.9(g), which prohibits a 
franchisor from unilaterally substituting provisions or pages in a 
franchise agreement resulting in a material change unless the 
franchisor first alerts the prospective franchisee about the change 
seven days before execution of the franchise agreement. This approach 
remedies deceptive unilateral modification of franchise agreements in a 
material way without imposing additional disclosure burdens.
    In response to the Staff Report, a few commenters asked for 
additional clarification of the meaning of the term ``negotiations 
initiated by the prospective franchisee.'' For example, Gust Rosenfeld 
urged the Commission to make clear in the Compliance Guides that 
negotiated changes will be considered initiated by the prospective 
franchisee even where some of the changes favor the franchisor.\278\ In 
the same vein, Marriott urged the Commission to change the Staff 
Report's proposed language ``Changes to a franchise agreement that 
result solely from negotiations initiated by the prospective franchisee 
. . . .'' to ``Changes to a franchise agreement that arise out of 
negotiations initiated by the prospective franchisee. . .''\279\ 
Marriott contended that the original language--``result solely from 
negotiations initiated by the prospective franchisee''--could be read 
narrowly to exclude instances where both parties receive benefits 
during the negotiation.
---------------------------------------------------------------------------

    \278\ Gust Rosenfeld, at 3.
    \279\ Marriott, at 4-5. See also Spandorf, at 2.
---------------------------------------------------------------------------

    The Commission recognizes that a negotiated franchise or related 
agreement may result in some changes favoring the franchisor. Whether 
or not a particular change benefits a particular party, however, is 
irrelevant. What is determinative is whether the prospective franchisee 
has knowledge of the change before signing the agreement. As long as 
the prospective franchisee opens the door to changing documents that 
previously have been presented for signing, any discussions about 
changes and any agreed upon changes are clearly made with the 
prospective franchisee's knowledge. Under these circumstances, 
redisclosure would be unwarranted. To make this point clear, the final 
amended Rule adopts an edited form of Marriott's suggested language 
noted above: ``Changes to an agreement that arise out of negotiations 
initiated by the prospective franchisee do not trigger this seven 
calendar-day period.''
4. Section 436.2(c): Actions that constitute the furnishing of 
disclosures
    Section 436.2(c) of the final amended Rule specifies what actions 
constitute furnishing required documents. Although the original Rule 
did not include such a provision, such specificity is needed now, given 
the wide array of disclosure formats and delivery mechanisms available 
in today's marketplace. Accordingly, a franchisor will be considered to 
have furnished a disclosure document 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 United States mail at least three calendar 
days before the required date.\280\
---------------------------------------------------------------------------

    \280\ One commenter urged the Commission to require franchisors 
to prove that an electronic disclosure document was actually 
delivered. Bundy, at 4. He fears that a franchisor could furnish a 
disclosure document using slow bandwidth or other procedures, making 
it difficult for a franchisee to actually read the disclosure 
document. In the same vein, another commenter also urged the 
Commission to spell out what specific documents or types of evidence 
would qualify as valid evidence of the mailing date. BI, NPR 28, at 
4-5. As an initial matter, franchisors always have the burden of 
proof to show that they have complied with the Rule's obligation to 
furnish disclosures. We also believe that 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. 
Nonetheless, to prevent any potential abuse in this area, the final 
amended Rule sets forth several safeguards. Among other things, a 
franchisor must notify the prospective franchisee in advance of any 
prerequisites for obtaining a disclosure document. Section 436.6(g). 
That would include any unusual bandwidth requirements. In addition, 
the franchisor must ensure that its disclosures not only can be 
downloaded, but preserved for future use. Section 436.6(b). Finally, 
the final amended Rule retains a receipt requirement, which will 
effectively prove delivery. Section 436.5(w).


[[Page 15472]]


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    The basic concepts of the final amended Rule provision track those 
in the corresponding provision proposed in the Franchise NPR, but the 
language has been revised, reorganized, and in some cases, expanded, to 
achieve greater clarity and specificity.\281\
---------------------------------------------------------------------------

    \281\ For example, where the Franchise NPR version said ``has 
been delivered,'' the final Rule provision says ``was hand-
delivered, faxed, emailed, or otherwise delivered,'' to remove any 
doubt that the alternative modes of delivery are acceptable. 
Similarly, where the Franchise NPR version said ``if a copy has been 
sent . . . by first class mail,'' the final amended provision states 
``a paper or tangible electronic copy (for example, computer disk or 
CD-ROM) was sent . . . by first-class United States mail'' to make 
it clear that a disclosure document in an electronic format is 
considered equivalent to paper.
---------------------------------------------------------------------------

C. Sections 436.3-436.5: The Disclosure Document

    Sections 436.3-436.5 of part 436 set forth the substantive 
disclosures and attachments that franchisors must include in their 
disclosure documents, beginning with the cover page.
1. Section 436.3: Cover page
    The cover page informs prospective franchisees that the disclosure 
document they are receiving contains important information about the 
franchise offer. The proposed Rule published in the Franchise NPR 
incorporated each item of information required in the original Rule's 
counterpart,\282\ with a few exceptions discussed below.\283\ The final 
amended Rule provision follows the cover page proposed in the Franchise 
NPR, with minor editing for clarity.
---------------------------------------------------------------------------

    \282\ 16 CFR 436.1(a)(21).
    \283\ Franchise NPR, 64 FR at 57302.
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    The proposed cover page set forth in the Franchise NPR generated 
little comment. The few comments received generally suggested various 
improvements to the text of the cover page, many of which have been 
incorporated into the final amended Rule.\284\ The substantive 
revisions to the cover page requirement fall into four broad 
categories. First, final amended Rule section 436.3(e)(4) requires that 
the cover page reference sources of additional background information 
that prospective franchisees can use in conducting their due diligence 
investigations, such as the FTC's website and its Consumer Guide to 
Buying a Franchise.\285\ This will enable prospective franchisees to 
find additional background information on franchising, including 
information on how to use a disclosure document.
---------------------------------------------------------------------------

    \284\ In addition, some non-substantive refinements have been 
made to improve the clarity, consistency, and organization of the 
Rule's text. For example, the text now specifies that the various 
required elements of the cover page are to be presented ``in the 
order and form as follows.'' Similarly, section 436.3(a) now 
specifically instructs franchisors that the title is to appear ``in 
capital letters and bold type,'' not merely giving franchisors a 
model that depicts the words ``FRANCHISE DISCLOSURE DOCUMENT'' in 
capitals in the Rule's text, as proposed in the Franchise NPR. In 
addition, the cover page disclosure informing the prospective 
franchisee that he or she must be given 14 days to review the 
document has been conformed to the convention, adopted elsewhere in 
the Rule text, to state time frames in calendar days. See section 
436.2(a) (setting forth the 14 calendar-day time frame within which 
a franchisor must provide disclosure documents). Thus, the required 
cover page disclosure now states that a franchisor must furnish its 
disclosures at least 14 calendar-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. See J&G, at 4 (noting a wording inconsistency in the 
Staff Report's recommended Rule text between the cover page 
disclosure and the substantive timing requirement). Similarly, the 
Commission has adopted the staff recommendation to adapt the UFOC 
Guidelines cover page disclosure requirement on the total investment 
necessary to begin operations (as explained more fully in the text), 
but has modified the staff's recommended version by changing the 
phrase ``including [the total amount in Item 5] that must be paid to 
the franchisor'' to ``This includes [the total amount in Item 5 
(Sec.  436.5(e))] that must be paid to the franchisor or 
affiliate.'' See NASAA; WA Securities (noting a wording 
inconsistency in the Staff Report's recommended Rule text between 
the cover page disclosure of total investment necessary to begin 
operation and Item 5 initial fee disclosure requirements in proposed 
section 436.5(e)).
    \285\See Heron, ANPR 80. A copy of the Consumer Guide to Buying 
a Franchise is currently available at the Commission website: 
www.ftc.gov.
---------------------------------------------------------------------------

    Second, final amended Rule section 436.3(b) updates the cover page 
to embrace electronic disclosure. It requires franchisors to include on 
the cover page their email and primary home page addresses, so that 
prospective franchisees can communicate with the franchisor 
electronically. In the same vein, section 436.3(f) permits franchisors 
to state on the cover page how prospective franchisees may receive a 
copy of the disclosure document in an alternative medium.\286\
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    \286\ In drafting this provision, we have recognized the NFC's 
concern that franchisors have flexibility in directing prospects to 
particular individuals who can assist the prospects in receiving an 
alternatively formatted disclosure document. NFC, NPR 12, at 27. To 
provide as much flexibility as possible, the provision permits 
franchisors to designate either a specific individual or office as a 
contact.
---------------------------------------------------------------------------

    Third, final amended Rule section 436.3, like the proposed version 
published in the Franchise NPR, eliminates information from the 
original Rule's cover page that might be misinterpreted as implying 
greater Commission oversight of franchising than is the case. Several 
franchisees contended that phrases in the original 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.\287\
---------------------------------------------------------------------------

    \287\ Kezios, ANPR, 18 Sept. 97 Tr., at 10. See also Karp, ANPR, 
19 Sept. 97 Tr., at 89-90.
---------------------------------------------------------------------------

    Fourth, to promote greater uniformity with state disclosure laws, 
final amended Rule section 436.3 has been revised to track more closely 
the UFOC Guidelines' cover page elements.\288\ For example, section 
436.3 includes 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 states may be able to provide sources of information about 
franchising.
---------------------------------------------------------------------------

    \288\See generally UFOC Guidelines, Cover Page, Instructions. As 
explained below, however, the Commission has not adopted the UFOC 
Guidelines' cover page risk factors.
---------------------------------------------------------------------------

    With respect to cover page disclosure of the total purchase price, 
final amended section 436.3(e)(1) revises slightly the comparable UFOC 
Guidelines requirement,\289\ based on the record developed here. 
Specifically, BI asserted that the total purchase price disclosure on 
the UFOC Guidelines cover page can be misleading. 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 argued 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.''\290\
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    \289\ UFOC Guidelines, Cover Page, 5 (requiring franchisors to 
state the total amounts in Item 5 (initial fees and payments to the 
franchisor) and Item 7 (initial investment).
    \290\ BI, NPR 28, at 5.
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    The Commission's view, however, is that the purpose of the cover 
page's

[[Page 15473]]

price 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 commencing business 
operations. In fact, limiting the disclosure to the initial franchise 
fee alone could be misleading because that could understate the 
totality of fees that must be paid to the franchisor in order to start 
the business. The cover page price 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.\291\ Nevertheless, the Commission 
recognizes 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. Therefore, to maximize consistency between federal and state law, 
section 436.3 incorporates a modified version of the UFOC cover page 
references 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 (Sec.  436.5(g))]. This includes [the total 
amount in Item 5 (Sec.  436.5(e))] that must be paid to the franchisor 
or affiliate.''
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    \291\ BI's concern would be valid if the cover page required the 
disclosure of only Item 5 (initial fees), but not Item 7 (estimated 
initial investment). For example, in such a scenario, a franchisor 
who leased premises to a franchisee would include the lease payment 
in the Item 5 initial fees, whereas a franchisor who required a 
franchisee to lease premises from a third party would not include 
such payment in Item 5. Arguably, this would distort 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.
---------------------------------------------------------------------------

    In addition, section 436.3 diverges from the UFOC Guidelines in 
that it does not call for the two cover page risk factor disclosures 
required by the UFOC Guidelines regarding choice of venue and choice of 
law.\292\ These two risk factors essentially repeat what franchisors 
already must disclose in Item 17 of the disclosure document.\293\ 
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.\294\ Nonetheless, 
section 436.3(g) of the final amended Rule expressly permits 
franchisors to ``include additional disclosures on the cover page . . . 
to comply with state pre-sale disclosure laws.'' This provision 
effectively permits franchisors to include state mandated risk factors 
on the cover page, without adopting risk factor requirements into the 
final amended Rule.\295\
---------------------------------------------------------------------------

    \292\ See UFOC Guidelines, Cover Page, Instructions, iv.
    \293\ See Cendant, ANPR 140, at 3 (suggesting that risk factors 
belong in the Item 17 disclosures on franchise relationship issues).
    \294\ Other commenters suggested additional 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. 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. Dady & Garner, ANPR 127, at 3. We conclude that 
each of these issues, for the most part, already is addressed in the 
substantive rule disclosure items, or is better handled in 
Commission consumer education materials.
    \295\See NASAA, at 3-4; WA Securities, at 2 (Commission should 
permit state risk factors). See also Tifford, ANPR, 18 Sept. 97 Tr., 
at 15-16 (suggesting that the Commission accommodate risks factors 
developed by the individual states). One commenter, GPM, opposed 
permitting states to add additional risk factors on the cover page. 
The firm suggested that a state should be permitted to require 
additional information only in a state-specific addendum. GPM, NPR 
Rebuttal 40, at 4. We reject this suggestion. As discussed below, 
the final amended Rule does not preempt state laws that afford 
greater or equal protection to prospective franchisees. Indeed, 
states enjoy great latitude in fashioning franchise disclosure laws, 
including how and when state-specific information is to be included 
in disclosure documents. Therefore, franchisors must be permitted to 
add to an FTC disclosure document in order to comply with non-
preempted state law.
---------------------------------------------------------------------------

    The Commission has decided not to make further revisions in the 
cover page requirements that would call for additional education 
messages, notwithstanding several comments urging us to do so. For 
example, 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.''\296\
---------------------------------------------------------------------------

    \296\ AFA, NPR 14, at 4.
---------------------------------------------------------------------------

    The Commission agrees in principle with the AFA's broad point that 
prospective franchisees should be fully informed about the nature of 
franchising. However, the appropriate vehicle for educating prospects 
is through educational materials, not the final amended Rule itself. 
Indeed, the cover page advances this goal because it will reference the 
Commission's Consumer Guide to Buying a Franchise, which contains the 
advice the AFA wants communicated.
2. Section 436.4: Table of contents
    The final amended Rule section 436.4 retains the original Rule's 
requirement for a table of contents, but, like the version of this 
provision proposed in the Franchise NPR, conforms to the UFOC 
Guidelines in the wording and the ordering of required disclosure items 
listed.\297\ This provision generated minimal comment.
---------------------------------------------------------------------------

    \297\ In the original Rule, the table of contents was set forth 
in a footnote at the back of the Rule. See 16 CFR Part 436, note 3.
---------------------------------------------------------------------------

    The final amended provision revises the proposed Rule provision's 
use of the UFOC Guidelines headings in only a few instances to reflect 
more accurately the Rule requirements, as follows: (1) Item 1 is 
changed from ``The Franchisor, its Predecessors, and Affiliates'' to 
``The Franchisor and any Parents, Predecessors, and Affiliates;''\298\ 
(2) Item 5 is changed from ``Initial Franchise Fees'' to ``Initial 
Fees;''\299\ (3) Item 7 is changed from ``Initial Investment'' to 
``Estimated Initial Investment;'' (3) Item 11 is changed from 
``Franchisor's Obligations'' to ``Franchisor's Assistance, Advertising, 
Computer Systems, and Training;'' (4) Item 19 is changed from 
``Earnings Claims'' to ``Financial Performance Representations;'' (5) 
Item 20 is changed from ``List of Outlets'' to ``Outlets and Franchisee 
Information;'' and (6) Item 23 is changed from ``Receipt'' to 
``Receipts.''
---------------------------------------------------------------------------

    \298\ This recognizes the final amended Rule's retention of 
parent disclosures from the original Rule. See discussion of section 
436.5(a)(1) below.
    \299\ Responding to a comment urging that the title of Item 5 be 
changed from ``Initial Franchise Fee'' (as proposed in the Franchise 
NPR) to ``Initial Fees'' so that it would more accurately describe 
the actual subject matter of the Item, the Staff Report recommended 
that the title of Item 5 be ``Initial Fees Paid to the Franchisor.'' 
Staff Report, at 121. However, Howard Bundy's Staff Report comment 
correctly noted that the recommended reference to ``franchisor'' is 
inaccurate because the disclosure applies to fees paid to affiliates 
as well. Accordingly, the final amended Rule deletes the phrase 
``paid to the franchisor'' in favor of simply ``initial fees.''
---------------------------------------------------------------------------

3. Section 436.5(a) (Item 1): The franchisor and any parents, 
predecessors, and affiliates
    Section 436.5(a) of part 436 sets forth the first of the final 
amended Rule's substantive disclosure requirements. As

[[Page 15474]]

proposed in the Franchise NPR,\300\ it retains the original Rule's 
requirement that franchisors disclose background information on the 
franchisor and any parents and affiliates.\301\ It also expands the 
original Rule in three respects to maximize consistency with the UFOC 
Guidelines.\302\ First, franchisors must now disclose information about 
their predecessors for the 10-year period immediately before the close 
of the franchisor's most recent fiscal year.\303\ This will prevent 
unscrupulous franchisors from hiding prior misconduct and avoiding 
disclosure obligations simply by assuming a new corporate 
identity.\304\ Second, franchisors must disclose any regulations 
specific to the industry in which the franchise business operates, such 
as any necessary licenses or permits,\305\ that may affect the 
franchisee's operating costs and ability to conduct business.\306\ 
Third, franchisors must describe the general competition prospective 
franchisees are likely to face.\307\ This disclosure better ensures 
that the prospective franchisee can understand the likely economic 
risks in purchasing a franchise.\308\
---------------------------------------------------------------------------

    \300\ Franchise NPR, 64 FR at 57302-03.
    \301\ See 16 CFR 436.1(a)(1), (3), and (6). The Commission 
historically has emphasized the materiality of franchisor background 
information. In the original 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.''
    Original SBP, 43 FR at 59642.
    \302\ The final amended Rule also corrects an apparent oversight 
in the UFOC Guidelines. Item 1 requires franchisors to disclose the 
address of the franchisor's agent, but does not specifically require 
the franchisor to identify the agent. IL AG, at 4. Section 
436.5(a)(4) of the final amended Rule now requires franchisors to 
both identify the agent and state the agent's principal business 
address.
    \303\See UFOC Guidelines, Item 1.
    \304\See FTC v. Morrone's Water Ice, Inc., No. 02-3720 (E.D. Pa. 
2002) (company allegedly reincorporated as a ``licensor'' following 
an adverse arbitration decision); FTC v. Inv. Dev., Inc., Bus. 
Franchise Guide (CCH), ] 9326 (E.D. La. 1989) (company allegedly 
reincorporated after filing of Commission law enforcement action). 
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).
    \305\See UFOC Guidelines, Item 1E Instructions, vi.
    \306\E.g., FTC v. Car Checkers of Am., Inc., No. 93-623 (mlp) 
(D.N.J. 1993) (failure to disclose state restrictions on the sale of 
service contracts); United States v. Lifecall Sys., Inc., No. 90-
3666 (D.N.J. 1990) (failure to disclose state registration 
requirements). Cf. Funeral Rule, 16 CFR 453.3 (it is a 
misrepresentation to mischaracterize state or local funeral industry 
laws).
    \307\ UFOC Guidelines, Item 1E Instructions, v. Cf. SEC 
Regulations-K (Standard Instructions for Filing Forms Under 
Securities Act of 1933, Securities Act of 1934, and Energy Policy 
and Conservation Act of 1975), 17 CFR 229.101(c)(1)(x) (requiring 
registrants to list, where material, ``the identity of the 
particular market in which the registrant competes, an estimate of 
the number of competitors, and the registrant's competitive 
position, if known or reasonably available to the registrant.''). 
This disclosure is intended to aid prospective franchisees in their 
decision whether to enter a proposed relationship. It is neither 
intended nor interpreted to be a complete antitrust analysis. 
Indeed, such a goal would be impractical in light of the number and 
variety of relevant local antitrust markets that might be involved.
    \308\ Franchisors need only state the types of businesses that 
sell competing goods or services. They need not identify specific 
businesses. See UFOC Guidelines, Item 1, Sample Answer 1 (``Your 
competitors include department store service departments, service 
stations, and other national chains of muffler shops.''). This 
provision is designed to prevent deception by ensuring that 
prospective franchisees understand whether the business they are 
entering is unique. While the potential benefit of this provision is 
limited, the compliance burden is small. Throughout the original 
SBP, the Commission emphasized that potential economic risks to 
prospective franchisees are material. E.g., Original SBP, 43 FR at 
59650-651 (bankruptcy); at 59662 (sales restrictions); at 59668 
(post-term covenants not to compete). A competition disclosure is 
also warranted in light of several franchisee comments 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).
---------------------------------------------------------------------------

    The final amended rule provision tracks the proposed Rule published 
in the Franchise NPR, but is more narrowly tailored in its treatment of 
required disclosures about affiliates. Slight non-substantive 
modifications in the provision's language and organization have also 
been made to improve clarity and precision. Two aspects of section 
436.5(a) that prompted comment are discussed in the following sections: 
the required parent disclosures, and the required predecessor 
disclosures. Finally, various suggestions advanced by commenters but 
not adopted in the final amended Rule are discussed in the final part 
of this section.\309\
---------------------------------------------------------------------------

    \309\ The Commission declines to adopt one additional 
recommendation in the Staff Report. Specifically, staff recommended 
that, in addition to the disclosure of the general competition a 
franchisor may face, the Rule should also require franchisors to 
disclose ``any competition from any entity in which an officer of 
the franchisor owns an interest.'' Staff Report, at 98. The purpose 
of this recommendation was to require franchisors to disclose any 
potential conflicts of interest by their officers. See Bundy, NPR 
18, at 6. But see Piper Rudnick, at 5 (contending that such a 
provision would be overbroad, sweeping in even minority ownership of 
mutual funds); J&G, at 4 (suggesting that such a provision would be 
overbroad, and should be limited to only ``material interests'' in a 
competitor). However, the Commission believes that ordinary 
corporate fiduciary and conflicts of interest law principles are 
sufficient to resolve any potential harm when officers of a 
franchisor own interests in competitors. See generally American Law 
Institute, Principles of Corporate Governance: Analysis and 
Recommendations (2005).
---------------------------------------------------------------------------

a. Parent disclosures
    The retention of the original Rule's parent disclosure requirement 
was not controversial for the vast majority of commenters, including 
NASAA.\310\ A few comments, however, raised two concerns about it. 
First, a few franchisor representatives asserted that a separate parent 
disclosure is unnecessary because a parent, in most instances, would 
already be covered by the Rule's broad definition of 
``affiliate''\311\-- ``an entity controlled by, controlling, or under 
common control with another entity.''\312\ Other commenters questioned 
the relevance of a parent's information, asserting that a parent is a 
legally distinct entity and that disclosing a parent may mislead 
prospective franchisees into believing that the parent exercises 
greater oversight or gives financial backing to the franchisor than 
actually exists. These commenters add that a parent disclosure simply 
clutters an already lengthy disclosure document.\313\
---------------------------------------------------------------------------

    \310\See 16 CFR 436.1(a)(1)(i). The Commission stated in the 
original SBP that parent information is material and that it would 
require the disclosure of information about a parent, even though it 
recognized that the UFOC Guidelines contained no comparable 
disclosure requirement. Original SBP, 43 FR at 59639.
    \311\ Gust Rosenfeld, at 2; PMR&W, NPR 4, at 9; H&H, NPR 9, at 
15-16; J&G, NPR 32, at 9.
    \312\ Section 436.1(b).
    \313\E.g., IFA, at 3; Prudential Financial, at 1; Spandorf, at 
3.
---------------------------------------------------------------------------

    On the other hand, the materiality of parent information was 
demonstrated by Dr. Spencer Vidulich, a Pearle Vision franchisee. He 
related that his franchisor was bought by Cole National Corporation, 
which operates company-owned optical departments in Sears stores. In 
this instance, the disclosure of parent information would have alerted 
prospective Pearle Vision franchisees that their franchisor is owned by 
a company that operates competing outlets.\314\
---------------------------------------------------------------------------

    \314\ Vidulich, ANPR, 22 Aug. 97 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.
---------------------------------------------------------------------------

    Also, contrary to some commenters' assertions, part 436 will not 
reach all parents when, for example, section 436.5(a) reaches only 
those affiliates that ``offer franchises in any line of business or 
provide products or services to the franchisees of the franchisor.'' As 
Dr. Vidulich suggested, it is possible that a parent does not sell 
franchises at all--falling outside the scope of the section's coverage 
of ``affiliates''--but nonetheless could operate competing company-
owned outlets. A requirement

[[Page 15475]]

that a franchisor identify any parent, therefore, is necessary to 
ensure that any parent not falling within Item 1's limited use of 
affiliate will be disclosed.
    Moreover, the Item 1 parent disclosure is significantly limited: 
franchisors must simply identify a parent.\315\ In contrast with the 
Item 1 disclosures for affiliates and predecessors,\316\ a franchisor 
need not disclose, for example, the parent's business background, 
length of time selling franchises or engaging in other lines of 
business.\317\ The Commission concludes that this limited disclosure 
will, at most, impose a minor burden for most franchise systems that is 
outweighed by the potential benefit to prospective franchisees.
---------------------------------------------------------------------------

    \315\ Section 436.5(a)(1).
    \316\ Section 436.5(a)(7).
    \317\ Despite the narrow Item 1 parent disclosure in section 
436.5(a)(1), one commenter asserted that the parent disclosure could 
be a significant burden on some franchisors with elaborate corporate 
structures. Spandorf, at 3. She contended that the final amended 
Rule would require a franchisor to disclose ``all non-affiliate 
parents, including all intermediate parents, not just the ultimate 
parent.'' Id. Accordingly, she urged the Commission to limit the 
parent disclosure to those parents with ultimate control ``and any 
intermediate parent that guarantees the franchisor's obligations to 
franchisees.'' Id. The Commission rejects these suggestions. Item 1 
requires franchisors to disclose the identity of parents to ensure 
that a prospective franchisee understands who may control or 
influence the franchisor's operations. As noted above in the example 
of Pearle Vision, it is highly material to a prospective Pearle 
Vision franchisee that Pearle Vision is owned and controlled by a 
competing system--Cole Vision. That information would escape 
disclosure, however, if Cole Vision did not guarantee Pearle 
Vision's performance or if Cole Vision were, in turn, a subsidiary 
of a larger corporate parent.
---------------------------------------------------------------------------

b. Predecessor disclosures
    Part 436 of the final amended Rule adopts the UFOC Guidelines' 
requirement that franchisors disclose background information about any 
predecessors for 10 years.\318\ During the rulemaking process, no 
commenters objected to the basic principle that predecessor information 
should be disclosed.\319\ A few commenters, however, questioned the 
scope of the disclosure. One commenter asserted that the 10-year 
reporting period is too long, noting that Item 2 establishes only a 
five-year disclosure period for business experience of company officers 
and managers.\320\ Another commenter urged the Commission to narrow the 
focus of Item 1 to require the disclosure of information about only any 
immediate predecessor.\321\ The Commission is not convinced, however, 
that the burden of supplying 10 years of predecessor information--as 
the majority of franchisors already do to comply with the UFOC 
Guidelines--is so great as to justify deviating from the UFOC 
Guidelines on this issue.
---------------------------------------------------------------------------

    \318\ One commenter suggested that the Commission address in the 
Compliance Guides an inconsistency between the Item 1 disclosure set 
forth in the Staff Report and the UFOC Guidelines' Item 1 
disclosure. Whereas the UFOC Guidelines clearly limit the 
predecessor disclosures--the predecessor's name and address and 
prior experience--to a 10-year reporting period, the Staff Report's 
proposed revised Rule could have been read as limiting the 
application of the time period to only the predecessor's name and 
address. Piper Rudnick, at 5. The Commission agrees that the 10-year 
reporting should also limit the reporting of a predecessor's 
experience, and the final amended Rule is revised accordingly by 
adding a cross-reference that limits the applicability of the 
experience disclosures in section 436.5(a)(7) to only those 
predecessors covered by section 436.5(a)(2). The commenter also 
suggested that the prior experience of affiliates should similarly 
be limited to 10 years. Id. This suggestion goes too far and would 
introduce an unnecessary inconsistency between the final amended 
Rule and the UFOC Guidelines, which does not so limit affiliate 
disclosures.
    \319\ As noted above, this provision prevents franchisors from 
hiding prior misconduct and avoiding disclosure obligations simply 
by assuming a new corporate identity. See FTC v. Morrone's Water 
Ice, Inc., No. 02-3720 (E.D. Pa. 2002) (company allegedly 
reincorporated as a ``licensor'' following an adverse arbitration 
decision); FTC v. Inv. Dev., Inc., Bus. Franchise Guide (CCH), ] 
9326 (E.D. La. 1989) (company allegedly reincorporated after filing 
of Commission law enforcement action).
    \320\ H&H, NPR 9, at 16.
    \321\ GPM, NPR Rebuttal 40, at 4.
---------------------------------------------------------------------------

c. Suggestions for additional disclosure requirements that the 
Commission has not adopted
    IL AG urged the Commission to expand the scope of Item 1 in several 
respects. First, IL AG would expand the types of business organizations 
that must be disclosed under section 436.5(a)(5) to include ``members 
with a controlling interest in the franchisor.'' In its view, this is 
necessary to cover limited liability companies.\322\ The Commission 
declines to adopt this suggestion because the examples of different 
types of entities included there is intended to be illustrative, not 
exhaustive, and additional examples of business organizations are 
unnecessary.
---------------------------------------------------------------------------

    \322\ IL AG, at 4.
---------------------------------------------------------------------------

    In addition, IL AG suggested that Item 1 be expanded to include the 
date when the franchisor was organized.\323\ The Commission also 
declines to adopt this suggestion. The franchisor already must disclose 
how long it has been in business and has offered franchises. We believe 
that time period, not the date of organization, is most relevant to a 
prospective franchisee. Moreover, neither the original Rule nor the 
UFOC Guidelines requires this information, and the Commission is 
reluctant to introduce an inconsistency with the Guidelines on this 
point.
---------------------------------------------------------------------------

    \323\ IL AG, at 4.
---------------------------------------------------------------------------

    Finally, IL AG suggested that a description of the competition 
should include competitors of the franchisor's affiliates.\324\ We note 
that the UFOC Guidelines require only a ``general description of the 
competition.'' Depending upon the franchise system, competition of 
affiliates could be sizeable, especially with respect to large, 
publicly traded franchisors. We are not inclined to diverge from the 
UFOC Guidelines in the absence of evidence showing a problem on this 
point.
---------------------------------------------------------------------------

    \324\ IL AG, at 4.
---------------------------------------------------------------------------

4. Section 436.5(b) (Item 2): Business experience
    Consistent with the original Rule and UFOC Guidelines, section 
436.5(b) of the final amended Rule requires the disclosure of the 
business experience of the franchisor's directors, trustees, general 
partnerships, and certain executives.\325\ It differs from the UFOC 
Guidelines's Item 2, however, in two respects. First, it does not 
require a franchisor to disclose brokers.\326\ Second, it expands the 
original Rule and UFOC Guidelines to prevent fraud by requiring the 
disclosure of prior experience of not only directors and executives, 
but other individuals who do not necessarily possess a title, but 
nonetheless will exercise management responsibility relating to the 
sale or operation of franchises being offered for sale. Additionally, 
this final amended Rule provision is narrower than its counterpart as 
proposed in the Franchise NPR, in that it deletes the proposed 
requirement to disclose prior experience of the officers or executives

[[Page 15476]]

of any parent of the franchisor. Each of these issues is discussed in 
detail below.
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    \325\See 16 CFR 436.1(a)(2). In the original 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.'' 
Original SBP, 43 FR at 59642. 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) ] 11335 (N.D. Ill. 1998) (claims regarding medical billing 
expertise and contacts with medical community are material); FTC v. 
Richard L. Levinger, No. 94-0925-PHX RCB (D. Ariz. 1994) (earnings 
claims tied to purported expertise in the restaurant industry are 
material); FTC v. Car Checkers of Am., Inc., No. 93-623 (mlp) 
(D.N.J. 1993) (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).
    \326\See UFOC Guidelines, Item 2 and Instructions, v.
---------------------------------------------------------------------------

a. Brokers
    The original Rule did not require disclosure of brokers. The 
proposed Rule, however, tracking the UFOC Guidelines, required that 
franchisors ``list all brokers.''\327\ As noted above, based upon the 
comments, the final amended Rule does not include the UFOC Guidelines' 
provision that franchisors identify its brokers in Item 2.\328\ During 
the Rule amendment proceeding, a few commenters asserted that such 
disclosure is unnecessary.\329\ For example, Frannet, a franchise 
broker, voiced concern that the proposed inclusion of brokers in Item 2 
would require franchisors to disclose immaterial information about 
``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,'' resulting in a ``voluminous'' UFOC, 
with ``no value to the prospective franchisee.''\330\
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    \327\ Franchise NPR, 64 FR at 57334.
    \328\ Franchisors, of course, would still be required to include 
broker information, if mandated by state law.
    \329\ E.g., Gust Rosenfeld, at 4; J&G, NPR 32, at 10.
    \330\ Frannet, NPR 2, at 2. In this regard, it is noteworthy 
that, had the broker disclosure requirement been retained in the 
final amended Rule, broker information also would have been required 
in Items 3 and 4 disclosures. See Staff Report, at note 320.
---------------------------------------------------------------------------

    On the other hand, Michael Seid, a franchise industry consultant, 
strongly objected to the deletion of broker information from Item 2 
because prospective franchisees often rely on statements made by 
brokers in deciding whether to purchase a franchise. In his view, 
prospective franchisees perceive brokers as being independent, third-
party experts. He opined that listing them in a disclosure document 
would dispel that notion, making it clear that brokers are authorized 
agents of the franchisor.\331\
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    \331\ Seid, at 5-7. See also IL AG, at 4.
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    Some prospective franchisees may rely on a broker's statements in 
the course of purchasing a franchise, and some brokers may make false 
claims--such as false financial performance representations. 
Nonetheless, the Commission is not convinced that broker disclosures 
are warranted in a franchise disclosure document.
    Item 2 appropriately requires franchisors to disclose the 
background of those individuals who control the franchisor and those 
who actually manage franchisees. That information is material because 
prospective franchisees need to know the identity and business 
experience of the individuals in command of the franchisor in order to 
assess whether these individuals are likely to be able to perform as 
promised under the franchise agreement. Unlike franchisors, brokers do 
not create or implement franchisor policy, nor do they oversee 
performance of post-sale obligations to the franchisee. Accordingly, 
prospective franchisees are less likely to give decisive weight to an 
individual broker's expertise or background in assessing the merits of 
purchasing a franchise.
    Moreover, even if a broker were to make false claims, the 
prospective franchisee has the benefit of the franchisor's disclosure 
document to assess those claims before purchasing a franchise. For 
example, a franchisor statement in Item 19 that it does not authorize 
the making of financial performance claims should raise doubts about a 
broker's veracity if the broker were to make his or her own performance 
claims. Similarly, a franchisor's statement in Item 3 that it has been 
sued by franchisees would dispel any claim by a broker that the 
franchisor has not been previously sued. The counteractive effect of 
the disclosure document gives the Commission reason to doubt that the 
inclusion of broker information among the required Item 2 disclosures 
would yield more than a scant benefit to prospective franchisees. 
Further, the disclosure of brokers would also be cumbersome, especially 
for large franchise systems that may employ hundreds of brokers 
nationally. Thus, the Commission concludes that this benefit would not 
likely outweigh the corresponding compliance costs and burdens.
    Finally, the deletion of brokers from Item 2 as had been proposed 
in the Franchise NPR obviously does not curtail brokers' liability for 
false claims. Franchise brokers, like virtually all other individuals 
conducing interstate commerce, remain liable under Section 5 of the FTC 
Act for their own misrepresentations. In short, while the Commission 
favors adopting UFOC Guidelines approach to the fullest extent 
possible, we believe this is one area where an exception is warranted.
b. Individuals with management responsibility
    Section 436.5(b) of part 436 requires a franchisor to disclose not 
only the background of the franchisor's directors and executives, but 
also ``individuals who will have management responsibility relating to 
the sale or operation of franchises offered by this document.''\332\ 
Individuals listed in Item 2 must also disclosure their litigation 
(Item 3) and bankruptcy (Item 4) histories as well. This provision 
ensures that franchisors cannot conceal a manager's lack of experience, 
prior litigation, or bankruptcy history by simply avoiding giving the 
manager a formal title.\333\ Although the language has been revised to 
achieve greater clarity and specificity, this aspect of this provision 
is conceptually very similar to the rule as proposed in the Franchise 
NPR.\334\ The breadth of this provision is intended to leave no doubt 
that franchisors must disclose all individuals who in fact exercise 
management responsibility over the sale or operation of franchises 
being offered for sale, regardless of any formal title.\335\
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    \332\ One commenter voiced concern that Item 2 could be 
misinterpreted to include owners with a controlling interest and 
asked the Commission to clarify this point in the Compliance Guides. 
Gust Rosenfeld, at 3-4. We note that neither the original Rule nor 
the final amended Rule focuses on ownership. Rather, the determining 
factor is control over the franchise operations. Accordingly, an 
owner/investor in a franchise system would not ordinarily have to be 
disclosed in Item 2, unless that owner/investor also manages or 
otherwise exercises control over the franchise operation.
    \333\See FTC v. P.M.C.S., Inc., No. 96-5426 (E.D.N.Y. 1996) 
(franchisor failed to disclose control figure with prior 
bankruptcy); FTC v. The Building Inspector of Am., Inc., No. 93-
10838Y (D. Mass. 1993) (alleging that the franchisor failed to 
disclose the franchisor's current executive officers and their 
business experience, litigation history concerning fraud or 
misrepresentation, and bankruptcy history); FTC v. Why USA, Inc., 
No. 92-1227-PHX-SMM (D. Ariz. 1992) (alleging that franchisor failed 
to disclose officers and their prior litigation). During the Chicago 
public workshop, a former franchisee related that his franchisor did 
not disclose that the franchisor's director of franchising (who was 
not a titled corporate officer) had been discharged in bankruptcy. 
The franchisee 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, 22 Aug. 97 Tr., at 6. See also NASAA, NPR 17, at 3 (``The 
law enforcement experience of some members of the [NASAA] Franchise 
Project Group reflects that franchisors and sellers of business 
opportunities have attempted to avoid litigation disclosures
    . . . by purposefully not giving the title `officer' to 
individuals who, in fact, exercise significant management 
responsibility over a business.''). Cf. FTC v. Netfran Dev. Corp., 
No. 05-CV-22223 (S.D. Fla. 2005) (failure to disclose that executive 
was subject to a Commission order involving fraud or deceptive 
practices); FTC v. Int'l Bartending Inst., No. 94-1104-A (E.D. Va. 
1994) (franchisor failed to disclose that chairman was subject to a 
Commission order involving fraud or deceptive practices).
    \334\ The Franchise NPR's version of Item 2 also referenced 
subfranchisors. As one commenter noted, however, a reference to 
subfranchisors is unnecessary because the term ``franchisor,'' as 
set forth in the Rule's definitions (and the UFOC Guidelines' 
definition), already includes the term ``subfranchisor.'' Gust 
Rosenfeld, at 4. Therefore, that reference has been deleted.
    \335\See Staff Report, at 101-02. In the Franchise NPR, the 
Commission proposed achieving this goal by including within the 
definition of ``officer,'' any ``de facto officer,'' ``namely any 
individual with significant management responsibility for the 
marketing and/or servicing of franchisees whose title does not 
reflect the nature of the position.'' Franchise NPR, 64 FR at 57332. 
Some commenters agreed with the Commission that it is necessary to 
capture individuals who, without an appropriate title, in fact 
function as officers or directors. E.g., NASAA, NPR 17, at 3. Others 
asserted that the term ``de facto officer'' is ``nebulous,'' 
creating more problems than it would solve. E.g., Snap-on, NPR 16, 
at 2; Gurnick, NPR 21, at 3-4; J&G, NPR 32, at 8; Marriott, NPR 35, 
at 12. Another voiced concern about application to large 
corporations, where there may be many directors or managers, each of 
whom would now have to be disclosed. Tricon, NPR 34, at 3. Based 
upon the Franchise NPR comments, the Commission has determined to 
delete the term and description of ``de facto officer'' from the 
final amended Rule. At the same time, Item 2 requires a franchisor 
to identify all individuals who have management responsibility over 
the franchises, regardless of any formal title. This is true even if 
the individual happens to be an officer of a parent or an affiliate.

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[[Page 15477]]

c. Parents
    Part 436 as proposed in the Franchise NPR required franchisors to 
disclose the prior experience of a parent's officers or 
executives.\336\ This proposal, however, was criticized on the grounds 
that such a broad disclosure about directors and officers of a parent 
would clutter Item 2 with information ``of marginal relevance and 
importance to prospective franchisees.''\337\ In response to 
commenters' persuasive arguments, the Commission has determined to omit 
the requirement from section 436.5(b).
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    \336\ Franchise NPR, 64 FR at 57334.
    \337\ Lewis, NPR 15, at 12. See also Gust Rosenfeld, at 4. BI, 
NPR 28, at 5. But see Bundy, NPR 18, at 6-7 (Item 2 should cover not 
only officers and executives of parents, but affiliates as well).
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    The Commission has come to the view that the disclosure of prior 
experience of individuals associated with a parent of a franchisor is 
generally unnecessary. While in many instances a parent's officers may 
exercise general management responsibilities that may affect the 
franchisor, they are not necessarily involved in managing the 
franchisor or its franchises. Because of their lack of direct control 
over the franchisor, background information on them is unlikely to be 
material to a prospective franchisee. Accordingly, the minimal benefit 
that might accrue to prospective franchisees from a disclosure of the 
prior experience of individuals associated with the franchisor's parent 
would not likely outweigh the compliance costs and burdens.
5. Section 436.5(c) (Item 3): Litigation
    Section 436.5(c) of the final amended Rule retains the original 
Rule's requirements to disclose certain pending and prior litigation, 
as well as current injunctive or restrictive orders. Like the original 
Rule, the final amended Rule requires disclosure, in some instances, of 
litigation involving the franchisor's parent.\338\ Consistent with the 
UFOC Guidelines, however, part 436 expands on the original Rule by 
requiring franchisors to disclose actions involving not only the 
franchisor, its directors and officers, and affiliates, but 
predecessors as well.\339\ In addition, section 436.5(c)(1)(i)(B), in 
accord with the UFOC Guidelines, now requires the disclosure of routine 
litigation that may impact the franchisor's financial condition or 
ability to operate the business.\340\ At the same time, as also 
proposed in the Franchise NPR, the Commission has determined that 
section 436.5(c)(1)(B)(ii) of the final amended Rule should expand on 
both the original Rule and UFOC Guidelines by requiring franchisors to 
disclose material franchisor-initiated litigation against franchisees 
involving the franchise relationship.
---------------------------------------------------------------------------

    \338\See 16 CFR 436.1(a)(4). In the original 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.'' Original SBP, 43 FR at 59649. See, e.g., United States 
v. We The People Forms and Serv. Centers USA, Inc., No. CV 04 10075 
GHK FMOx (C.D. Cal. 2004) (full disclosure would have revealed 
lawsuits and injunctions involving the franchisor's bankruptcy 
petition preparation services); FTC v. WhiteHead, Ltd., Bus. 
Franchise Guide (CCH) ] 10062 (D. Conn. 1992) (full disclosure would 
have revealed a $10 million judgment in a fraud action brought by 
former franchisees); FTC v. Joseph Hayes, No. 4:96CV02162SNL (E.D. 
Mo. 1996) (full disclosure would have revealed prior state fines and 
injunctions); FTC v. Inv. Dev., Inc., Bus. Franchise Guide (CCH) ] 
9326 (full disclosure would have revealed insurance fraud 
convictions). See also Marks, ANPR, 19 Sept. 97 Tr., at 8 (``I 
always counsel clients . . . to look at the litigation section among 
one of the first sections.'').
    \339\ See UFOC Guidelines, Item 3. See AFA, at 2.
    \340\ See UFOC Guidelines, Item 3 A. See also AFA, at 2. 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 
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., Original SBP, 43 FR at 
59649.
---------------------------------------------------------------------------

    The comments on Item 3 focused on five broad topics: (1) whether 
and to what extent disclosures about a franchisor's parent should be 
required; (2) to what extent disclosures about a franchisor's 
affiliates should be required; (3) whether disclosure about out-of-
court settlements favorable to the franchisor or settlements that by 
their terms are confidential should be required; (4) whether the Rule 
as proposed in the Franchise NPR needed clarification to avoid implying 
that dismissed actions should be disclosed in cases when no liability 
is imposed upon or accepted by the franchisor; and (5) whether and to 
what extent disclosure of franchisor-initiated litigation would be 
required. Each of these topics is discussed in the sections that 
follow.
a. Parent disclosures
    The original Rule required the disclosure of litigation relating to 
a franchisor's parent.\341\ Part 436 as proposed in the Franchise NPR 
retained this broad approach. The Commission, however, has decided that 
the final amended Rule should narrow considerably the scope of the 
franchisor's obligation to disclose litigation relating to a parent. As 
recommended in the Staff Report, the final amended Rule requires the 
disclosure of litigation relating to a franchisor's parent only in the 
case of a ``parent . . . who guarantees the franchisor's 
performance.''\342\
---------------------------------------------------------------------------

    \341\ As noted previously, this is one area where the original 
Rule was broader than the UFOC Guidelines, which require no 
disclosure of parent information, unless the parent is an affiliate.
    \342\ Staff Report, at 104.
---------------------------------------------------------------------------

    The narrowed scope of the parent litigation disclosure responds to 
persuasive comments challenging the value of broad parent litigation 
disclosures to prospective purchasers and complaining of the burden to 
franchisors. Typical of these comments are those submitted by PMR&W, 
arguing that the parent litigation disclosure is confusing at best and 
offers little if any benefit to prospective franchisees, and noting 
that a publicly-traded parent may face countless 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.''\343\
---------------------------------------------------------------------------

    \343\ PMR&W, NPR 4, at 9. See also IFA, at 3; PREA, at 1-2; 
Spandorf, at 4; Triarc, NPR 6, at 2; NFC, NPR 12, at 28; PREA, NPR 
20, at 1.
---------------------------------------------------------------------------

    Based upon review of the record, including the Staff Report, the 
Commission is persuaded that litigation involving a parent (which may 
be voluminous in the case of a publicly-traded parent) may have little 
bearing on the operation of the franchise system itself. Yet, the 
Commission does not believe that complete elimination of the parent 
litigation disclosure is justified. Rather, the Commission has 
determined to narrowly tailor the parent litigation disclosure to those 
circumstances where the parent guarantees the franchisor's performance, 
as recommended in the

[[Page 15478]]

Staff Report.\344\ Where a parent, for whatever reason, induces 
franchise sales by promising to back the franchisor financially or 
otherwise guarantees the franchisor's performance, the parent's prior 
litigation history becomes material to the prospective franchisee and 
must be disclosed.\345\ As noted throughout this document, background 
information on all parties having post-sale performance obligations is 
material to a prospective franchisee. There is no meaningful 
distinction between parents who make performance guarantees and 
franchisors with various contractual performance obligations.
---------------------------------------------------------------------------

    \344\ See Staff Report, at 104. The Staff Report recommendation 
that the parent litigation disclosure be narrowed to instances where 
the parent guarantees the franchisor's performance prompted few 
comments. PREA and Spandorf opined 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, and advocated an exemption from the 
Item 3 parent litigation disclosure if the franchisor has sufficient 
net worth and experience. They 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. PREA, at 1-2; 
Spandorf, at 4-7. See also PREA, NPR 20, at 1. The Commission finds 
this suggestion unworkable. As noted throughout this document, the 
Commission favors bright-line provisions that enable franchisors to 
determine easily where the Rule applies to a franchise sale. 
Moreover, the Commission is disinclined to adopt exemptions from 
specific required disclosures--as opposed to exemptions from the 
Rule itself. On balance, the Commission believes that the narrowly-
tailored parent litigation disclosure included in the final amended 
Rule strikes the appropriate balance, reducing compliance costs and 
burdens without depriving prospective franchisees of material 
information necessary to make an informed investment decision.
    \345\ But see PREA, at 1-2; Spandorf, 4-7 (asserting that prior 
litigation of a parent who guarantees performance may be irrelevant, 
and urging the Commission to adopt a net worth standard). As an 
alternative, PREA and Spandorf suggested that the Commission adopt 
an approach similar to that of the SEC for the disclosure of legal 
proceedings to securities investors: a guarantor need only disclose 
material legal proceedings other than ordinary routine litigation. 
PREA, at 2. We noted, however, that Item 3 is already limited to 
material suits, or individual suits which, in the aggregate, are 
material. This is sufficient to limit Item 3's reach with respect to 
guarantors.
---------------------------------------------------------------------------

b. Affiliates
    As noted, the original Rule did not require the disclosure of 
litigation involving a franchisor's affiliate. The proposed rule 
published in the Franchise NPR incorporated the UFOC Guidelines' 
requirement that franchisors disclose litigation involving an 
``affiliate who offers franchises under the franchisor's principal 
trademark.'' Section 436.5(c) of the final amended Rule retains this 
concept, but modestly broadens the requirement, consistent with the 
Staff Report and Staff Report comments, to encompass: (1) litigation 
involving not only affiliates who offer franchises under the 
franchisor's principal trademark, but also any affiliate who 
``guarantees the franchisor's performance;'' and (2) with respect to 
the requirement to disclose government injunctions or restrictive 
orders, actions involving an affiliate ``who has offered or sold 
franchises in any line of business within the last 10 years.''\346\
---------------------------------------------------------------------------

    \346\ Item 3 of the proposed Rule published in the Franchise NPR 
required disclosure of government enforcement actions only for an 
affiliate ``who offers franchises under the franchisor's principal 
trademark.'' The final amended Rule requires such disclosure for 
``an affiliate who has offered or sold franchises in any line of 
business within the last 10 years.'' Section 436.5(c)(2) (emphasis 
added).
---------------------------------------------------------------------------

    The affiliate litigation disclosure provision generated limited 
comment.\347\ One commenter urged the Commission to broaden Item 3's 
scope to include litigation involving all affiliates, not just those 
under the franchisor's principal trademark. The UFOC Guidelines' narrow 
reach extends only to instances where affiliates offer franchises under 
the franchisor's principal trademark. Arguably, this restrictive 
approach could allow a franchise system to hide derogatory facts about 
its litigation history by acquiring and operating a competing franchise 
system that uses a different mark. In such an instance, the newly-
acquired franchisor would have no obligation to disclose its past 
litigation, falling outside the definition of both ``predecessor'' and 
``affiliate.'' On the other hand, the record contains no suggestion 
that such instances are common. Thus, the Commission does not believe 
it warranted to require franchisors to disclose all affiliate 
litigation to address that hypothetical concern. Such a measure would 
be broader than necessary to address concerns documented in the record, 
would be burdensome, especially for large companies with multiple 
brands, and would not likely yield commensurate benefits to prospective 
franchisees.
---------------------------------------------------------------------------

    \347\ Piper Rudnick urged the Commission to clarify in the 
Compliance Guides that disclosures involving affiliates and 
predecessors--in Items 1, 3 and 4 --should be limited to the time 
period when the affiliates or predecessors were ``associated'' or 
``affiliated with the franchisor.'' Piper Rudnick, at 5-6. The 
Commission disagrees. As an initial matter, depending upon the 
facts, a predecessor entity and successor franchisor may not exist 
contemporaneously and thus may never be ``associated'' or 
``affiliated'' with each other. As for affiliates, Piper Rudnick's 
suggestion could seriously undermine the very purpose for the 
disclosure itself. The affiliate disclosures in Items 1, 3, and 4 
ensure that a prospective franchisee understands fully the 
background of the franchisor's affiliates. Significant litigation or 
a prior bankruptcy, for example, may signal that the affiliate lacks 
business acumen and, therefore, poses a potential risk, especially 
if franchisees of the system are contractually required to conduct 
business with the affiliate. For that reason, the history of the 
affiliate as a business entity, not its history of association with 
the franchisor, is material to a prospective franchisee and should 
be disclosed.
---------------------------------------------------------------------------

    Nevertheless, as noted above, the Commission has determined to 
expand the requirement to disclose affiliate litigation in two respects 
in order to provide prospects with material information. First, for 
currently effective government injunctive or restrictive orders 
delineated in section 436.5(c)(2), the final amended Rule adopts the 
Staff Report recommendation to broaden Item 3 affiliate coverage to 
include any affiliate who has offered or sold franchises in any line of 
business within the last 10 years.\348\ In the Commission's view, a 
government injunction or comparable order\349\ (with or without a civil 
penalty or other redress), may be an indicator of fraud or other 
unlawful conduct.\350\ Accordingly, a franchisor with a history of 
fraud or Rule violations should not be able to avoid disclosure of 
government actions against it merely by establishing a new corporation 
or switching trademarks. We believe this approach will result in the 
disclosure of material litigation history, without unduly burdening 
large, multi-brand franchise networks.
---------------------------------------------------------------------------

    \348\ Staff Report, at 104-5.
    \349\ The Item 3 disclosure of currently effective injunctive or 
restrictive orders and decrees is also broader than the other Item 3 
disclosures in that it covers Canadian orders and decrees. This is 
consistent with the UFOC Guidelines. See UFOC Guidelines, Item 3, C.
    \350\ 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. Supp. 1581 (N.D. Ga. 1988) (no private right of 
action exists to enforce the Franchise Rule).
---------------------------------------------------------------------------

    Second, section 436.5(c)(1) of the final amended Rule requires 
franchisors to disclose litigation involving not only affiliates that 
offer franchises under the franchisor's principal trademark, but also 
any affiliate that guarantees performance. This responds to NASAA's 
comment, urging the Commission to make clear that the term 
``affiliate'' in Item 3 includes those guaranteeing performance, 
similar to the parent disclosure noted above.\351\ As NASAA noted, 
there is no practical distinction between a parent and an affiliate who 
guarantees performance. In both instances, the prospective franchisee 
may rely on the guarantee in considering whether to purchase the 
franchise. Therefore, the litigation history of both parents and 
affiliates

[[Page 15479]]

who guarantee performance is material and should be disclosed.
---------------------------------------------------------------------------

    \351\ NASAA, at 5.
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c. Settlements
    With respect to settled actions, the original Rule required 
disclosure of any civil action a person subject to the provision ``has 
settled out of court'' in the previous seven fiscal years. It did not 
distinguish between confidential and nonconfidential settlements.\352\ 
Consistent with the UFOC Guidelines, the Franchise NPR proposed that 
franchisors disclose the terms of any settled actions, expressly 
including confidential settlements.\353\ Several commenters voiced 
concern about the requirement to disclose settlements--including 
confidential settlements.
---------------------------------------------------------------------------

    \352\ 16 CFR at 436.1(a)(4)(ii).
    \353\ Footnote 4 in the proposed Rule stated, in relevant part: 
``If a settlement agreement must be disclosed in this Item, all 
material settlement terms must be disclosed, whether or not the 
agreement is confidential.'' Franchise NPR, 64 FR at 57334. See also 
NASAA Commentary, Item 3.
---------------------------------------------------------------------------

    Settlements Favorable to the Franchisor. PMR&W and Warren Lewis 
observed that Item 3 in the Rule as proposed in the Franchise NPR did 
not allow franchisors to omit settled litigation where the settlement 
is favorable to the franchisor or neutral.\354\ Both commenters cited 
to the UFOC Guidelines,\355\ 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.''\356\ The point these commenters 
were making is that the UFOC Guidelines, by implication, would deem 
favorable or neutral settlements to a franchisor not material and would 
not call for their disclosure. The Commission believes this 
interpretation is correct, and intends that result in adopting the 
final version of this provision. Item 3, therefore, permits franchisors 
to omit settled litigation where a settlement is favorable to the 
franchisor or otherwise neutral.\357\
---------------------------------------------------------------------------

    \354\ Footnote 2 in the proposed rule stated: ``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.'' Franchise NPR, 64 FR at 57334. As 
explained in the text above, this footnote has been deleted from the 
final amended Rule.
    \355\ UFOC Guidelines, Item 3 Definitions, iv.
    \356\ PMR&W, NPR 4, at 10; Lewis, NPR 15, at 13. According to 
Mr. Lewis, without such a limitation, the Rule would penalize 
franchisors and subfranchisors who achieve favorable settlements, 
thereby discouraging settlement of litigation. See also Snap On, NPR 
16, at 3.
    \357\ Section 436.5(c)(1)(iii)(B) of the final amended Rule 
specifies that ``held liable'' as used in Item 3 means that ``as a 
result of claims or counterclaims, the person 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.
---------------------------------------------------------------------------

    Confidential Settlements. With respect to the disclosure of 
confidential settlements, David Gurnick commented that the disclosure 
of any settlement terms that the parties agreed to keep confidential is 
bad policy because confidential settlements benefit both parties and 
the ``opportunity for confidentiality is often an important dynamic to 
resolve a dispute.''\358\ He urged that the Rule 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.''\359\
---------------------------------------------------------------------------

    \358\ Gurnick, NPR 21, at 4. See also J&G, NPR 32, at 10-11; 
Marriott, NPR 35, at 15.
    \359\ Gurnick, NPR 21, at 5. But see Stadfeld, NPR 23, at 12 
(urging the Commission to keep the UFOC requirement of disclosing 
specific payments in settlements regardless of confidentiality 
agreements).
---------------------------------------------------------------------------

    Similarly, John Baer 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.''\360\ 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.\361\
---------------------------------------------------------------------------

    \360\ Baer, NPR 11, at 11.
    \361\ 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.'' Baer, NPR, 11, at 11.
---------------------------------------------------------------------------

    In keeping with the goal of reducing inconsistencies with the UFOC 
Guidelines, the Commission is disinclined, based on this record, to 
deviate from the UFOC Guidelines with respect to the scope of the 
confidential settlements disclosure. This issue was debated when NASAA 
revised the UFOC Guidelines in 1993, with input from many interested 
parties. Moreover, franchisors using the UFOC Guidelines format have 
been living under this policy on the state level for more than 10 
years, apparently without much hardship.
    Further, NASAA has recognized that the disclosure requirements 
concerning confidential settlements might raise breach of contract 
issues. Accordingly, 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. Item 3 of the final amended Rule incorporates a similar 
concept. The Commission recognizes that some small or regional 
franchisors who use the Franchise Rule format exclusively have not had 
the opportunity to phase-in confidential settlement disclosures. Based 
on this consideration, the Commission has added a footnote 2 to section 
436.5(c)(3)(ii) of the final amended rule that specifies that ``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.'' Thus, franchisors 
historically using only the Franchise Rule format need not disclose 
confidential settlements entered into prior to the effective date of 
the final amended Rule, and only franchisors who have used the UFOC 
Guidelines format in the past must continue to disclose confidential 
settlements, as is the current practice.
    John Baer raised a related point that the Commission finds 
persuasive. He asserted that it would be 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.''\362\ It would be 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, footnote 2 to 
section 436.5(c) of the final amended Rule provides that ``franchisors 
need not disclose the terms of confidential settlements entered into 
before commencing franchise sales.''
---------------------------------------------------------------------------

    \362\ Baer, NPR 11, at 11.
---------------------------------------------------------------------------

d. Dismissed actions
    As noted above, Item 3 requires a franchisor to disclose certain 
prior actions in which it has been ``held liable.'' Under this 
standard, a dismissal without any imposition or acceptance of liability 
on the franchisor's part, would not have to be disclosed.\363\
---------------------------------------------------------------------------

    \363\ See Franchise NPR, 64 FR at 57334, note 2.
---------------------------------------------------------------------------

    In response to the Staff Report, two commenters observed that this

[[Page 15480]]

limitation on prior actions is undercut by the inclusion in the 
proposed Franchise NPR version of Item 3 of a broad provision requiring 
franchisors and others to disclose if they have ``been a defendant in a 
material action.'' They observed that while dismissals without 
liability need not be disclosed under the ``held liable'' requirement 
of Item 3, they would have to be disclosed under the second more 
general ``defendant in a material action'' requirement. They urged the 
Commission to delete the ``defendant in a material action'' element of 
Item 3, to limit prior litigation disclosures to only those actions in 
which the defendant incurred liability.\364\ In response to these 
comments, the Staff Report concluded that the drafting of the Franchise 
NPR's version of Item 3 resulted in overbreadth, and therefore 
recommended that Item 3 be narrowed accordingly.\365\
---------------------------------------------------------------------------

    \364\ Piper Rudnick, at 1; Duvall, at 1.
    \365\ Additionally, H&H opined that Item 3 of the proposed Rule 
published in the Franchise 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. H&H suggested that 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. H&H, NPR 9, at 17-18. See also NFC, NPR 12, 
at 28. H&H also suggested that the word ``material'' be substituted 
for ``significant.'' H&H, NPR 9, at 18. The final amended Rule 
incorporates these suggestions.
---------------------------------------------------------------------------

    The Commission has carefully considered this point. As noted above, 
the UFOC Guidelines clearly permit franchisors to limit the disclosure 
of prior actions to matters in which they were ``held liable.'' This 
approach is also consistent with the original Rule, which limited prior 
litigation to matters in which the franchisor ``has been held liable . 
. . resulting in a final judgment or has settled out of court.''\366\ 
Moreover, the language ``been a defendant in a material action'' is 
arguably redundant: if a defendant was not held liable in a prior 
action, then the underlying suit was not material. For these reasons, 
the phrase ``been a defendant in a material action'' included in the 
proposed Rule published in the Franchise NPR has been deleted from the 
final amended Rule.\367\
---------------------------------------------------------------------------

    \366\ 16 CFR 436.1(a)(4)(ii).
    \367\ IL AG asserted that franchisors should be permitted to 
disclose settled litigation in its favor or which is neutral. It 
explains that a state franchise examiner would question why a case 
previously listed as pending in one version of a disclosure document 
would then disappear upon settlement or dismissal from later 
versions without explanation. IL AG, at 5. We do not find this 
rationale sufficient to justify retaining a redundancy in the final 
amended Rule. As noted throughout this document, however, states 
have the power to include additional disclosures, if they so choose, 
provided it is possible simultaneously to comply with both the state 
rule and a corresponding final amended Rule provision.
---------------------------------------------------------------------------

e. Franchisor-initiated litigation
    One of the most important ways part 436 of the final amended Rule 
differs from both the original Rule and the UFOC Guidelines is that 
part 436 includes a requirement that franchisors disclose franchisor-
initiated litigation.\368\ Specifically, section 436.5(c)(1)(ii) 
requires a franchisor to disclose litigation in which it:
---------------------------------------------------------------------------

    \368\ Section 436.5(c)(1)(ii) requires disclosure of litigation 
to which a covered person ``was a party,'' and therefore reaches 
more than just actions where the franchisor or other covered person 
was a plaintiff. As a practical matter, however, because other 
elements of Item 3 cover various actions where the franchisor or 
other covered person was or is the defendant, the significance of 
this new part 436 section is that it reaches actions initiated by 
the franchisor or other covered person.

     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 suits involving suppliers or other third parties, 
or indemnification for tort liability.\369\
---------------------------------------------------------------------------

    \369\ See Cendant, ANPR 140, at 3 (noting that in vicarious 
liability cases--where a customer sues the franchisor for alleged 
wrongdoing by the individual franchisee--the franchisor often must 
sue the franchisee to protect its interests and to obtain 
indemnification. Such suits, therefore, are essentially between the 
customer and the franchisee and are not indicative of franchise 
system performance.).

    This final amended Rule provision is substantially the same as its 
counterpart proposed in the Franchise NPR.\370\ Throughout the Rule 
amendment proceeding, franchisees and their representatives,\371\ as 
well as the Small Business Administration,\372\ urged the Commission to 
adopt such a requirement, asserting that franchisor-initiated 
litigation is material because it is a clear indicator of: (1) the 
quality of the franchisor-franchisee relationship; and (2) the extent 
to which the franchisor may be litigious. Others added that the 
original Rule and the UFOC Guidelines compelled franchisors to disclose 
franchisor-initiated litigation only if a franchisee subsequently filed 
a counterclaim. Yet, as these commenters noted, franchisees often do 
not have the financial resources to initiate a suit or to pursue a 
counterclaim.\373\ Therefore, according to their argument, disclosure 
of franchise relationship litigation should not depend upon which party 
happens to have the resources to file a suit. Typical of these comments 
is the one submitted by NFA, an association of Burger King franchisees, 
stating that the disclosure of such information:
---------------------------------------------------------------------------

    \370\ The only difference is that the time frame of the 
requirement has been tightened, now covering only actions ``within 
the past fiscal year,'' instead of ``pending actions.'' This topic 
is addressed in greater detail near the end of the Item 3 
discussion.
    \371\See AFA, at 2; Gee, at 2; Bundy, at 5; Karp, at 2; AFA, 
ANPR 62, at 2; Lagarias, ANPR 125, at 3; Selden, ANPR 133, 
Attachment at 2; Karp, ANPR, 19 Sept. 97 Tr., at 98.
    \372\ SBA, ANPR 36, at 5-6. See also IL AG, ANPR 77, at 2.
    \373\ 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, 7 Nov. 97 
Tr., at 267.

     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.\374\
---------------------------------------------------------------------------

    \374\ NFA, NPR 27, at 2. See also AFA, NPR 14, at 4; NASAA, NPR 
17, at 4; Bundy, NPR 18, at 7; Stadfeld, NPR 23, at 11; Karp, NPR 
24, at 19.

    A few commenters also maintained that compliance costs arising from 
such a disclosure are not great. For example, Seth Stadfeld observed 
that ``once the initial changes are made [to the disclosure document], 
all that must be done is to update the disclosed litigation annually or 
sooner if material changes take place.''\375\ The AFA was more blunt in 
its assessment:
---------------------------------------------------------------------------

    \375\ Stadfeld, NPR 23, at 11. See also Karp, NPR 24, at 20 
(disclosure costs pale in comparison with litigation costs).

     The Commission has a choice. It can save franchisors a few pennies 
on a slightly larger offering circular

[[Page 15481]]

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.\376\
---------------------------------------------------------------------------

    \376\ AFA, NPR 14, at 4.

    In contrast, franchisors generally opposed the disclosure of 
franchisor-initiated litigation. Among other things, they asserted that 
franchisor-initiated litigation is immaterial\377\ and would 
unnecessarily ``bulk up'' disclosure documents, thereby increasing 
compliance costs.\378\ Others opined that the disclosure was 
unnecessary because, in their view, a franchisee aggrieved by a 
franchisor-initiated suit will surely file a counterclaim, which 
clearly must be disclosed under the original Rule.\379\ Other 
franchisors asserted that the disclosure document already informs 
prospective franchisees about the state of the relationship.\380\ Still 
others asserted that Item 3 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.\381\ Indeed, some franchisors argued that the 
disclosure could be misleading, wrongly implying that the franchisor 
has engaged in illegal or other misconduct.\382\ In the same vein, 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.\383\
---------------------------------------------------------------------------

    \377\ H&H, NPR 9, at 17 (little value in requiring franchisors 
to disclose garden variety litigation involving franchisees, such as 
debt collection actions). See also Cendant, at 3; Quizno's, NPR 1, 
at 1; Gurnick, NPR 21, at 5; Kaufmann, ANPR 33, at 4.
    \378\ E.g., Baer, ANPR 25, at 3; Kaufmann, ANPR 33, at 4; 
Jeffers, ANPR 116, at 1-2; Forseth, ANPR, 18 Sept. 97 Tr., at 20. In 
addition, several franchisors voiced concern about the interplay 
between the 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 also 
would 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. Quizno's, NPR 1, at 1. 
See also Lewis, NPR 15, at 13 (franchisor would have to amend their 
disclosure documents); J&G, NPR 32, at 10 (would prevent sales in 
states that require sales to stop until amendments are filed and 
approved).
    \379\ E.g., Quizno's NPR 1, at 1; PMR&W, NPR 4, at 9; Holmes, 
NPR 8, at 4; Quizno's, ANPR 16, at 1; Kaufmann, ANPR 33, at 4; IFA, 
ANPR 82, at 1-2; Cendant, ANPR 140, at 3. But see Lagarias, ANPR 
125, at 3.
    \380\ 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. J&G, NPR 32, at 10. See also GPM, NPR Rebuttal 40, at 4-
5.
    \381\ E.g., Kestenbaum, ANPR 40, at 1; Tifford, ANPR 78, at 3. 
PMR&W asserted that Item 3 has a 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, NPR 4, at 10. See also Winslow, at 77; H&H, NPR 9, at 17; 
J&G, NPR 32, at 10; Marriott, NPR 35, at 14. 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).
    \382\ Snap-On, NPR 16, at 2. See also, e.g., Gurnick, NPR 21, at 
5; NaturaLawn, NPR 26, at 1; J&G, NPR 32, at 10; GPM, NPR Rebuttal 
40, at 4-5; Kaufmann, ANPR 33, at 4; Tifford, ANPR 78, at 3; 
Cendant, ANPR 140, at 3.
    \383\ PMR&W, NPR 4, at 9. See also Snap-On, NPR 16, at 2; J&G, 
NPR 32, at 10; Marriott, NPR 35, at 14.
---------------------------------------------------------------------------

    Based upon the record developed in this proceeding, the Commission 
is convinced that franchisor-initiated litigation is material 
information that prospective franchisees need in order to assess a 
critical aspect of the franchise relationship--the nature of disputes 
and the level of litigation within a franchise system.\384\ We 
recognize that the UFOC Guidelines' Item 3, in limiting required 
disclosures to instances where a franchisee has filed a counterclaim, 
may have focused more narrowly on suits where arguably there was a 
greater probability of wrongdoing on a franchisor's part. We now 
believe that this should be broadened to include additional information 
about the state of the franchise relationship. For example, we agree 
with the commenters who made the point 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.
---------------------------------------------------------------------------

    \384\ For example, a pattern of franchisor-initiated lawsuits, 
such as royalty collection suits, may indicate franchisees' 
unwillingness or inability to pay. Such information would be 
material to a prospective franchisee because it may be an indicator 
of risk in purchasing a franchise and in the quality of the 
relationship with the franchisor.
---------------------------------------------------------------------------

    Nevertheless, the Commission declines to broaden further the 
franchisor-initiated litigation disclosure of part 436, as some have 
suggested, to include litigation involving another franchise system 
owned by the franchisor, as well as litigation involving affiliates and 
third-party suppliers.\385\ The core concern underlying the franchisor-
initiated litigation requirement is the status of the relationship 
between the franchisor and its franchisees in the offered system.\386\ 
Accordingly, the Commission has weighed the modest potential benefit of 
a broader litigation disclosure against the compliance costs and 
burdens, and decided not to require disclosures about litigation 
initiated by the franchisor's affiliates, third-party suppliers, or 
other systems.
---------------------------------------------------------------------------

    \385\ See Bundy, NPR 18, at 7; Stadfeld, NPR 23, at 13. Eric 
Karp urged the Commission to broaden the disclosure further 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, NPR 24, at 20. The Commission 
has rejected this suggestion because it goes beyond the goal of 
providing material information to prospective franchisees about the 
quality of the franchisor-franchisee relationship.
    \386\ Piper Rudnick also urged the Commission to clarify in the 
Compliance Guides the definition of the term ``franchisor 
relationship.'' In particular, the firm would limit ``franchise 
relationship'' to a matter arising from the franchise contract. 
Piper Rudnick, at 6. We believe a definition is unnecessary. Since 
the promulgation of the original Rule, franchisors have had to 
disclose franchisee-initiated litigation and counterclaims involving 
the franchise relationship. Accordingly, such disclosures are not 
new. Moreover, we disagree that the franchise relationship is as 
narrow as Piper Rudnick suggests. Surely, a dispute that arises from 
a lease agreement or promissory note, for example, falls within the 
purview of a relationship issue that should be disclosed.
---------------------------------------------------------------------------

    At the same time, the Commission also has considered various 
alternatives that franchisors assert would reduce franchisors' 
compliance burdens. The alternative that garnered the most support was 
to tie the disclosure to a threshold level of suits.\387\ For example, 
John Baer suggested a 5% threshold, under which a franchisor would not

[[Page 15482]]

have to disclose litigation it initiated unless it has filed suit 
against at least 5% of the franchisees in its system.\388\ Others 
suggested a higher percentage, such as 10%,\389\ 15%,\390\ or 20%,\391\ 
while the IL AG suggested a lower percentage, such as 2%.\392\
---------------------------------------------------------------------------

    \387\ Other suggested alternatives failed to garner significant 
support, including the following. PMR&W suggested 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. PMR&W, 
NPR 4, at 10. Wendy's suggested that the disclosure should be 
limited to ``specifically enumerated types of claims which are 
significant to the entire franchised system,'' as well as a 
significant dollar amount. Wendy's, NPR 5, at 2. Wendy's, however, 
failed to identify a list of appropriate types of suits or an 
appropriate dollar figure. David Holmes would limit the 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, NPR 8, at 4-5. We disagree because a 
counterclaim may shed light on issues in the franchise relationship 
to the same extent as the franchisee's complaint.
    \388\ Baer, NPR 11, at 11. See also Lewis, NPR 15, at 12; BI, 
NPR 28, at 11; Tricon, NPR 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, NPR 17, at 4. Not everyone 
agreed, however, on the proposal to establish a threshold. 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, 
NPR 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, NPR 18, at 7. 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, NPR 23, at 13.
    \389\ NFC, NPR 12, at 28.
    \390\ Holmes, NPR 8, at 4.
    \391\ AFC, NPR 30, at 3.
    \392\ IL AG, NPR 3, at 6 (also recommending no threshold for 
smaller systems, such as those with fewer than 25 franchisees).
---------------------------------------------------------------------------

    The Commission is reluctant to tie the franchisor-initiated 
litigation disclosure of part 436 to a threshold. We believe it is 
impossible, given the limited record on this issue, to fashion a ``one 
size fits all'' approach for every franchise system in all industries. 
Moreover, any threshold would focus on the quantity of suits, 
suggesting that the sole purpose of the provision is to reveal 
litigiousness. When it comes to the state of the relationship, however, 
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 system or show the franchisor's 
willingness to enforce system standards.\393\ With full disclosure, 
prospects can review the number and types of franchisors' suits for 
themselves and draw their own conclusions about whether those suits are 
significant.
---------------------------------------------------------------------------

    \393\ One commenter asserted that the Commission should require 
litigation disclosures only when there have been three consecutive 
fiscal years of lawsuits, regardless of the number of such suits. 
NaturaLawn, NPR 26, at 1. The purpose of the disclosure, however, is 
not limited to litigiousness. As discussed above, any number of 
suits initiated by the franchisor against its franchisees is 
material because it sheds light on the quality of the franchise 
relationship.
---------------------------------------------------------------------------

    Turning more generally to Item 3 of the final amended Rule, it 
includes several refinements to the proposed rule that were offered 
during the proceeding, and that were recommended in the Staff Report. 
These refinements preserve the utility of the disclosure, while 
reducing compliance costs.\394\ First, in order to minimize compliance 
burdens, the franchisor-initiated litigation disclosure requirement is 
limited to suits filed in the previous one-year period.\395\ We believe 
this ``snap-shot'' in time is sufficient to reveal the franchisor's 
practice of initiating litigation, as well as to reveal the types of 
franchise relationship problems that typically arise in the franchise 
system.\396\
---------------------------------------------------------------------------

    \394\ In addition to the refinements noted below, the Commission 
considered, but rejected, several others that find no additional 
support in the rulemaking record and which would be unnecessarily 
inconsistent with the UFOC Guidelines. For example, Duvall urged 
limiting the disclosure of pending actions to franchise disputes 
only, eliminating the reference to actions for fraud, unfair and 
deceptive trade practices, and the like. Duvall, at 1. IL AG urged 
expansion of the scope of the affiliate disclosure to cover all 
affiliates in any line of business. IL AG, at 5. Pu advocated a 
requirement to disclose the name, address, and telephone number of 
the lawyer for the franchisee in any litigation. Pu, at 1.
    \395\ Initially, the Commission proposed that the disclosure of 
franchisor-initiated litigation be limited to pending litigation. 
Franchise NPR, 64 FR at 57303-04. Several commenters opposed that 
approach. For example, Howard Bundy 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, NPR 18, at 7. See also Stadfeld, 
NPR 23, at 13. We agree that focusing on pending litigation is 
insufficient to achieve the goal of shedding light on the quality of 
the franchise relationship. However, we believe that a one-year time 
period is sufficient for that purpose, giving a prospective 
franchisee a snap-shot in time of the franchise system. But see 
Karp, at 2 (contending that suits filed in one year are not 
necessarily representative of the problems that arise in the system 
or the propensity of the franchisor to sue its franchisees).
    \396\ One commenter suggested that the Commission permit a 
franchisor to explain in Item 3 that this disclosure is limited to 
only certain types of actions and only updated annually. Gust 
Rosenfeld, at 4. To the extent that a franchisor finds that its 
compliance with any particular disclosure item may result in 
inaccurate or misleading information being furnished to a 
prospective franchisee, the franchisor may add footnotes to ensure 
accuracy or to avoid misleading statements. This applies to any 
misleading Item 3 litigation disclosure as well.
---------------------------------------------------------------------------

    Second, Item 3 permits franchisors to report franchisor-initiated 
litigation annually, not quarterly. That is, a franchisor would 
disclose all material litigation to which it was a party in the last 
fiscal year. This is intended to make it clear that quarterly updating 
requirements do not demand disclosure of franchisor-initiated actions 
filed in the 12 months prior to the date of the updated document. This 
approach improves on the proposed Rule's ``pending litigation'' 
approach.\397\ It also would have the additional benefit of reducing 
more frequent quarterly updating, which may be burdensome and perhaps 
impracticable in franchise registration states with more frequent 
updating requirements.\398\
---------------------------------------------------------------------------

    \397\ This disclosure approach also would be more representative 
of franchisor-initiated litigation than ``pending litigation,'' 
which would omit suits that may have been settled during the year, 
or which took less than a year to resolve.
    \398\ States typically require immediate updating upon a 
material change.
---------------------------------------------------------------------------

    Third, Item 3 incorporates a ``materiality'' standard.\399\ This is 
consistent with both the original Rule and UFOC Guidelines.\400\ 
Indeed, immaterial information, by definition, is unlikely to influence 
a prospective franchisee's investment decision, while imposing 
unwarranted costs and unnecessarily lengthening disclosure documents.
---------------------------------------------------------------------------

    \399\ The Commission declines to adopt suggested expansion of 
section 436.5(c)(1)(ii) to encompass all suits, regardless of their 
materiality. Stadfeld, NPR 23, at 13.
    \400\ See 16 CFR 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.'').
---------------------------------------------------------------------------

    As noted above in the discussion of section 436.1(d), materiality 
is determined from the viewpoint of the reasonable prospective 
franchisee. Accordingly, any franchisor-initiated litigation that goes 
to the quality of the franchise relationship being offered for sale is 
likely to be material. Indeed, the Commission intends the disclosure of 
franchisor-initiated litigation to be interpreted broadly to cover most 
suits. Nonetheless, we believe a requirement that franchisors disclose 
literally all franchisor-initiated suits goes too far. There may be 
instances where a franchisor-initiated suit might have no bearing on 
the specific franchise relationship being offered for sale. For 
example, franchisors may offer for sale ``non-traditional'' outlets 
operating a unique franchise agreement--such as the operation of an 
outlet on a military base. Franchisor-initiated litigation involving 
unique franchise agreements may be immaterial to the sale of 
``traditional'' outlets operating under the franchisor's standard 
franchise agreement. A blanket provision requiring disclosure of suits 
involving unique agreements might be overbroad and might unnecessarily 
increase the size of the Item 3 disclosure to the disadvantage of both 
prospective franchisees who must read it, as well as the franchisors 
who must prepare the disclosure. A ``materiality'' standard, therefore, 
will ensure that only suits shedding light on the type of relationship 
being offered for sale must be disclosed.

[[Page 15483]]

    Fourth, as recommended in the Staff Report, Item 3 permits a 
franchisor to provide basic, summary information on its initiated 
litigation, without the need for long discussions on each and every 
case.\401\ In addition, 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.
---------------------------------------------------------------------------

    \401\ See Staff Report, at 117-18. The Staff Report proposal 
permitting franchisors to limit the description of each disclosed 
suit generated no comment.
---------------------------------------------------------------------------

    Fifth, and finally, the final amended Rule clarifies the 
relationship between the disclosure of franchisor-initiated litigation 
and the disclosure of counterclaims. Staff Report comments by Wiggin & 
Dana noted that the rule proposed in the Franchise NPR did not 
explicitly address the filing of a franchisee counterclaim after a 
franchisor initiates a suit.\402\ The firm questioned whether a 
franchisor-initiated case followed by a counterclaim would be treated 
as a franchisor-initiated case only--receiving the more narrow 
disclosure treatment--or whether the counterclaim would be considered 
like all other counterclaims--receiving the more extensive disclosure 
treatment.\403\
---------------------------------------------------------------------------

    \402\ Under the original Rule, a counterclaim must be disclosed 
for 10 years and the franchisor must provide more detailed 
information about the nature and status of the action. 16 CFR 
436.1(a)(4)(ii) (actions ``brought by a present or former franchisee 
or franchisees and which involves or involved the franchise 
relationship'').
    \403\ Wiggin & Dana, at 1-2.
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    The Commission intends the franchisor-initiated litigation 
provision of the final amended Rule to expand upon the approach taken 
by the original Rule, not constrict it. Accordingly, franchisors must 
disclose any counterclaims in the same manner as they would have done 
under the original Rule, providing complete case summaries. Only in 
those instances where a franchisor initiates a suit--absent the filing 
of any subsequent counterclaim filed by the franchisee--does the 
franchisor-initiated litigation disclosure requirement apply.
    The final amended Rule makes this point clear as follows. First, 
section 436.5(c)(3) provides instructions for all litigation that must 
be disclosed in Item 3. It requires, for each suit, the disclosure of 
the case title, number or citation, initial filing date, names of the 
parties, the forum, and the relationship of the opposing party to the 
franchisor. Following these basic disclosures are more specific 
disclosures (e.g., summaries of legal and factual claims, relief 
sought, conclusions of law) that pertain to all suits, except for 
franchisor-initiated litigation, which is covered in a separate section 
(section 436.5(c)(4)). Any counterclaim filed by a franchisee in a suit 
would be covered by the section 436.5(c)(3) disclosure requirements.
    The next section--section 436.5(c)(4)--sets forth the instructions 
for ``any other franchisor-initiated suit identified'' in Item 3.\404\ 
The use of the phrase ``any other franchisor-initiated suit'' is 
intended to limit the provision to suits in which no franchisee 
counterclaim has been filed. This section makes clear that, in lieu of 
the more comprehensive disclosure instructions of section 436.5(c)(3), 
a franchisor may disclose franchisor-initiated litigation ``by listing 
individual suits under one common heading.'' Accordingly, Item 3 
affords the franchisor flexibility, permitting the disclosure of 
franchisor-initiated litigation either through the comprehensive 
disclosures of section 436.5(c)(3) or the more abbreviated disclosures 
of section 436.5(c)(4).
---------------------------------------------------------------------------

    \404\ See Wiggin & Dana, at 2.
---------------------------------------------------------------------------

6. Section 436.5(d) (Item 4): Bankruptcy
    Section 436.5(d) of the final amended Rule retains the original 
Rule's disclosure of prior bankruptcies, including any parent's 
bankruptcy.\405\ Consistent with the UFOC Guidelines, it extends the 
original Rule by requiring 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 original Rule's seven years 
limitation.\406\
---------------------------------------------------------------------------

    \405\ See 16 CFR 436.1(a)(5). In the original 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.'' Original SBP, 43 FR at 59650-51.
    \406\ See UFOC Guidelines, Item 4.
---------------------------------------------------------------------------

    Item 4 of the final amended Rule also incorporates several 
refinements based upon the record developed in this proceeding. The 
Rule as proposed in the Franchise NPR, at Item 4, would have required 
the disclosure of an affiliate's prior bankruptcy only if the affiliate 
currently offers franchises under the franchisor's trademark.\407\ One 
commenter suggested that the bankruptcy disclosure should apply to all 
affiliates, consistent with the UFOC Guidelines.\408\ We agree. 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.\409\ In order to reduce inconsistencies between part 436 and the 
UFOC Guidelines, we have revised the disclosure of an affiliate's 
bankruptcy accordingly.\410\
---------------------------------------------------------------------------

    \407\ Franchise NPR, 64 FR at 57304.
    \408\ Bundy, NPR 18, at 7. See NASAA Comparison, at 6.
    \409\ 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. 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, litigation. The disclosure of such affiliate 
information 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 pre-sale disclosure and costs. On the other 
hand, where any affiliate has a current or prior bankruptcy, that 
fact is highly material because the affiliate's parent may wish to 
divert funds away from the franchisor to the affiliate, thereby 
depriving the franchisor of advertisements, training, or other 
services. Under the circumstances, a broader definition of affiliate 
in the Item 4 bankruptcy disclosure is warranted.
    \410\ Consistent with Item 2, the final amended Rule at Item 4 
also extends the UFOC Guidelines by requiring the bankruptcy 
disclosures not only for officers or general partners, but for any 
``other individual who will have management responsibility relating 
to the sale or operation of franchises offered by this document.'' 
This is necessary to prevent franchisors from hiding prior 
bankruptcies of individuals who in fact will manage the franchises, 
but who do not have a formal title.
---------------------------------------------------------------------------

    In its response to the Staff Report, J&G also contended that the 
introductory paragraph of both the proposed Rule in the Franchise NPR 
and the Staff Report are unclear.\411\ As recommended in the Staff 
Report, for example, this paragraph would require a franchisor to 
disclose ``whether the franchisor, any parent, predecessor, affiliate, 
officer, general partner . . . filed for bankruptcy.''\412\ J&G 
contended that it is unclear whether this language requires a 
franchisor to disclose the bankruptcy history of officers or affiliates 
of a predecessor, as well as officers of a parent or affiliate. To 
eliminate confusion on this point, the final amended Rule reads as 
follows:

[[Page 15484]]

``Disclose whether the franchisor; any parent; predecessor; affiliate; 
officer, or general partner of the franchisor, or any other individual 
who will have management responsibility relating to the sale or 
operation of franchises offered by this document . . .''
---------------------------------------------------------------------------

    \411\ J&G, at 4. IL AG advocated that the Commission deviate 
from the UFOC Guidelines by including in the list of persons needing 
to disclose bankruptcy information ``members,'' to make it clear 
that limited liability companies are included. IL AG, at 5. This is 
also unnecessary because nothing in part 436 would prevent a limited 
liability company from qualifying as a parent, predecessor, or 
affiliate, as those terms are used in part 436.
    \412\See Staff Report, proposed section 436.5(d)(1).
---------------------------------------------------------------------------

    The Commission has rejected, however, other suggestions to modify 
Item 4. Several commenters questioned the need to require predecessor 
and parent bankruptcy disclosures. They asserted that the additional 
disclosure burden is not outweighed by any benefit to prospective 
franchisees.\413\ Consistent with our discussions in connection with 
Items 1-3, we 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 that the 
franchisor in which it is considering investing might be sold, possibly 
to a competitor or to a company lacking prior franchise experience.
---------------------------------------------------------------------------

    \413\ J&G, NPR 32, at 11; Marriott, NPR 35, at 15; GPM, NPR 
Rebuttal 40, at 5.
---------------------------------------------------------------------------

    Further, David Gurnick suggested that the time period for reporting 
a bankruptcy should be reduced from 10 to five years.\414\ J&G also 
observed that a 10-year obligation would compel the disclosure of a 
bankruptcy that was actually filed significantly earlier:
---------------------------------------------------------------------------

    \414\ Gurnick, NPR 21, at 6.

     [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!\415\
---------------------------------------------------------------------------

    \415\ J&G, NPR 32, at 11.

    Although the 10-year reporting period may, in rare instances, 
result in the disclosure of a bankruptcy filed more than 10 years 
earlier, the Commission has determined that the 10-year reporting 
period is reasonable in order to give prospective franchisees a 
complete picture of the franchisor's bankruptcy history. We are not 
inclined to deviate from the UFOC Guidelines on this point.
    Finally, NaturaLawn urged the Commission to exclude from Item 4 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.\416\ The Commission believes that 
the disclosure of personal bankruptcy information is necessary to 
prevent deception or fraud. In many instances, prospective franchisees 
entrust considerable initial fees and ongoing funds to franchise 
managers for training and advertising, among other forms of post-sales 
assistance. Accordingly, prospective franchisees may rely to their 
detriment on claims made by such managers. The disclosure of a 
franchisor manager's bankruptcy, therefore, would shed light on that 
manager's ability to safeguard and use those funds properly. Under the 
circumstances, we see no compelling reason to omit a personal 
bankruptcy, especially since such an approach would also deviate from 
the UFOC Guidelines.
---------------------------------------------------------------------------

    \416\ NaturaLawn, NPR 26, at 1.
---------------------------------------------------------------------------

7. Section 436.5(e) (Item 5): Initial fees
    Section 436.5(e) of the final amended Rule requires the disclosure 
of initial fees.\417\ This disclosure is substantively similar to the 
comparable disclosure provision found in the original Rule at 16 CFR 
436.1(a)(7). The final amended Rule, like the proposed Rule published 
in the Franchise NPR, follows the UFOC Guidelines in explicitly 
permitting franchisors to provide a range of fees, whereas the original 
Rule implicitly contemplated a fixed fee.
---------------------------------------------------------------------------

    \417\ In the original SBP, the Commission recognized that the 
disclosure of complete and accurate information about initial 
franchise fees 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.'' Original SBP, 43 FR at 59653.
---------------------------------------------------------------------------

    Item 5 of the final amended Rule is substantially similar to Item 5 
in the proposed Rule published in the Franchise NPR, but it 
incorporates several technical revisions that the commenters suggested. 
One commenter recommended that the title of Item 5 should refer to 
``Initial Fees'' instead of the proposed title, ``Initial Franchise 
Fee,'' recognizing that a prospective franchise may pay more than just 
one fee in order to acquire a franchise.\418\ Consistent with that 
revision, references to ``fee'' in Item 5 have been revised as follows: 
(1) ``these fees are refundable,'' in place of ``this fee is 
refundable;'' and (2) ``Initial fees mean,'' in place of ``initial fee 
means.''\419\
---------------------------------------------------------------------------

    \418\ Lewis, NPR 15, at 14. CA Bar, however, asserted that the 
term ``initial fee,'' as opposed to ``initial franchise fee'' may 
have negative consequences for franchisors selling company-owned 
stores. CA Bar explained that ``initial fees'' or ranges of 
``initial fees'' paid to a franchisor for a company-owned store may 
be proprietary information, especially if fees charged are not 
uniform. CA Bar, at 9. We disagree. Under the current UFOC Item 5, 
all franchisors must disclose the ``initial franchise fee,'' which 
is defined to include ``all fees and payments for services or goods 
received from the franchisor before the franchisee's business 
opens.'' UFOC, Item 5. Accordingly, the Item 5 disclosure is not 
limited to payments marked ``franchise fee.'' We decline to 
introduce a distinction between ``initial fees'' and ``initial 
franchise fees,'' as CA Bar suggested, which would be inconsistent 
with the UFOC Guidelines.
    \419\ Lewis, NPR 15, at 14. But see Gust Rosenfeld, at 8 
(suggesting the broader ``initial payments'' than ``fees,'' which 
may be misconstrued narrowly to refer only to any upfront franchise 
fee).
---------------------------------------------------------------------------

    Second, another commenter correctly noted that the Franchise NPR 
version of Item 5 did not expressly define ``initial fees'' to include 
commitments to make payments to the franchisor. Rather, Item 5 as 
proposed in the Franchise NPR would have defined an initial fee only in 
terms of cash actually paid at the time of the sale.\420\ The 
commenter's point is well-taken. The ``initial fees'' disclosure 
requirements of Item 5 relate to the required payment element in the 
definition of the term ``franchise.''\421\ Under that definition, a 
``required payment'' is not limited to cash, but expressly includes 
commitments to make payments to the franchisor at a later date. 
Otherwise, 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 of the final amended 
Rule expressly includes not just fees that are actually paid, but 
commitments to pay as well.\422\
---------------------------------------------------------------------------

    \420\ Bundy, NPR 18, at 7. (``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.''').
    \421\ Section 436.1(h).
    \422\ The Commission has also clarified the language of Item 5 
in two respects. First, the final amended Rule makes clear that the 
term ``initial fees'' includes payments or commitments to pay an 
affiliate of the franchisor. See NASAA, at 3. This is consistent 
with the NASAA Commentary on the UFOC Guidelines. See also NASAA 
Comparison, at 7. Second, the final amended Rule adds, at the end of 
Item 5, the following sentence: ``Disclose installment payment terms 
in this subsection or in paragraph 436.5(j) of this section.''
---------------------------------------------------------------------------

    Commenters also offered various proposals for modifying Item 5 that 
we believe are unwarranted. While Item 5 requires disclosure of ``the 
range or formula used to calculate the initial fees paid in the fiscal 
year before the issuance date,'' Howard Bundy urged that it require the 
disclosure of any contractual formulas for determining the current 
initial fee. Mr. Bundy opined that it is ``important to have disclosure 
of any contractual formulas that will

[[Page 15485]]

result in this prospect paying a different initial fee than the 
historic information would suggest.''\423\
---------------------------------------------------------------------------

    \423\ Bundy, NPR 18, at 7.
---------------------------------------------------------------------------

    The Commission's view, however, is that as long as the prospect is 
aware of the amount to be paid before the sale, the method the 
franchisor used to derive that amount is not necessarily material. The 
Commission notes that Item 5 ensures that a prospective franchisee 
knows whether fees are uniform and, where they are not, enables the 
prospect to bargain for a lower rate. Item 5 supplies the prospect with 
some historical information that can aid in gauging the parameters of 
the franchisor's willingness to negotiate fees. We believe that this is 
more useful by far than including in the disclosure document current 
contractual formulas. Thus, there is no reason to diverge from the UFOC 
Guidelines on this issue.
    Three other commenters voiced concern about Item 5 as it relates to 
the negotiation of fees. The NFC asserted that Item 5 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, in its view, restricts prospective franchisees' ability 
to initiate fee negotiations.\424\ The Commission's intention is to 
promote the parties' ability to negotiate terms and conditions, 
including fees and other costs. Full and accurate prior disclosure 
furthers that goal. Accordingly, nothing in Item 5 or any other 
provision of part 436 of the final amended Rule prevents the parties 
from negotiating fees.
---------------------------------------------------------------------------

    \424\ NFC, NPR 12, at 10-11.
---------------------------------------------------------------------------

    David Gurnick 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.\425\ Similarly, BI urged that franchisors be permitted to 
disclose that they may lower the initial fees.\426\
---------------------------------------------------------------------------

    \425\ Gurnick, NPR 21, at 6.
    \426\ BI, NPR 28, at 6.
---------------------------------------------------------------------------

    As noted above, however, Item 5 ensures that prospects know when 
fees may vary. This is sufficient to prompt them, if they wish, to 
negotiate for a fee level that suits them. A more extensive or detailed 
disclosure on this issue would only introduce needless nonconformity 
with the UFOC Guidelines without producing any appreciably increased 
benefit to prospective franchisees.
    BI also urged that when the initial fee is negotiated rather than 
established by applying a formula or fixed calculation, the range of 
such negotiated initial fees in the prior fiscal year need not be 
disclosed.\427\ The Commission's view, however, is that providing a 
range of fees, regardless of how or why these ranges came about, is 
useful to prospective franchisees in the negotiation process. Such 
disclosure compels neither party to reach agreement on unacceptable 
terms: franchisors and prospective franchisees remain free to negotiate 
in and outside of any disclosed range. Accordingly, we see no reason to 
deviate from the UFOC Item 5 approach in this regard.\428\
---------------------------------------------------------------------------

    \427\Id.
    \428\ The Commission has decided not to adopt various suggested 
revisions to Item 5 offered by the IL AG. For example, IL AG 
suggested that the Rule require franchisors to disclose specific 
information about the amount of fees that are refundable. IL AG, at 
5. The Commission believes that Item 5 adequately covers this by 
requiring a franchisor to state ``any conditions under which these 
fees are refundable.'' Clearly, this language is flexible enough to 
permit a franchisor to state in its Item 5 disclosure whether it 
offers a full or partial refund.
---------------------------------------------------------------------------

8. Section 436.5(f) (Item 6): Other fees
    Section 436.5(f) of the final amended Rule requires franchisors to 
disclose recurring or occasional fees associated with operating a 
franchise (e.g., royalties, advertising fees, and transfer fees). This 
requirement 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 in 
business and ultimately be successful. This provision covers payments 
made directly to the franchisor or an affiliate, or collected by the 
franchisor or affiliate for the benefit of a third party. This 
disclosure is substantially similar to the comparable original Rule 
disclosure found at 16 CFR 436.1(a)(8).\429\ Following the UFOC 
Guidelines, the Rule, as proposed in the Franchise NPR, expanded the 
scope of this original Rule provision by requiring a disclosure about 
the existence of advertising and purchasing cooperatives from which 
franchisees may be required to purchase goods or services. The proposed 
Rule also required disclosure about 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 by the cooperative. 
This is material information about restrictions on prospective 
franchisees' independence in operating the offered franchise, as well 
as the total costs of doing so.
---------------------------------------------------------------------------

    \429\ In the original 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.'' Original SBP, 43 FR at 59654-55.
---------------------------------------------------------------------------

    The Commission has determined to adopt proposed Item 6 from the 
Franchise NPR, with some fine tuning. Accordingly, Item 6 of the final 
amended Rule incorporates a suggestion from both Warren Lewis and NASAA 
that the proposed title of Item 6 taken from the UFOC Guidelines 
(``Recurring or Occasional Fees'') be replaced with ``Other Fees,'' the 
term actually used throughout the disclosure.\430\ The Commission 
believes this change improves the clarity of the Rule's text and Item 
6.
---------------------------------------------------------------------------

    \430\ Lewis, NPR 15, at 14; NASAA, NPR 17, at 4.
---------------------------------------------------------------------------

    In addition, to conform more closely to the UFOC Guidelines, Item 6 
of the final amended Rule requires that franchisors state explicitly 
what fees are non-refundable (rather than just stating the conditions 
when a fee is refundable).\431\ Again, to conform more closely with the 
UFOC Guidelines, Item 6 requires franchisors to disclose whether 
continuing fees currently being charged are uniformly imposed on all 
franchisees.\432\
---------------------------------------------------------------------------

    \431\ As previously noted, NASAA has urged the Commission 
throughout the Rule amendment proceeding to reduce inconsistencies 
with the UFOC Guidelines to the fullest extent possible. To that 
end, it has submitted into the record a comparison between the 
original Rule and UFOC Guidelines. See NASAA Comparison, at 8; UFOC 
Guidelines, Item 6, Instructions vi. As noted throughout this 
Statement, a primary objective in revising this Rule is to align it 
more closely with the UFOC Guidelines.
    \432\ See NASAA Comparison, at 8.
---------------------------------------------------------------------------

    The Staff Report recommended expansion of Item 6 to require 
franchisors to disclose required payments made to third parties.\433\ 
The Commission has decided not to adopt that recommendation. Early in 
the Rule amendment proceeding, NASAA urged this expansion of Item 
6.\434\ Another commenter supported this suggestion, noting 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.''\435\
---------------------------------------------------------------------------

    \433\ Staff Report, at 126.
    \434\ NASAA, NPR 17, at 4.
    \435\ Bundy, NPR 8, at 8. 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 consumer education issue, not a pre-sale disclosure 
one, that is best handled by Commission and industry educational 
efforts.
---------------------------------------------------------------------------

    Eight Staff Report comments, however, opposed the proposed 
expansion of Item 6 to require the

[[Page 15486]]

disclosure of payments made to third parties. Gust Rosenfeld's comment 
is typical, noting that a franchisor may require franchisees to lease 
premises, obtain necessary licenses, and operate in compliance with 
applicable laws. ``All of the payments to do these things are 
technically `required,' but they are generally applicable to all 
businesses, and the franchisor does not control when they are made, to 
whom they are made, or what the amount is.''\436\ Similarly, Piper 
Rudnick and IFA asserted that a required listing of all possible third-
party suppliers of goods or services would expose a franchisor to 
liability if it forgot to include one or more.\437\
---------------------------------------------------------------------------

    \436\ Gust Rosenfeld, at 4-5. See also Wiggin & Dana, at 2 
(questioning whether the proposed disclosure of payments to third 
parties in Item 6 would cover employee wages, uniform dry cleaning, 
or accountant fees to prepare taxes). Several commenters recommended 
that Item 6 be limited to ongoing payment made to the franchisor or 
its affiliates. Piper Rudnick, at 2; Spandorf, at 7.
    \437\ Piper Rudnick, at 2; IFA, at 3. See also J&G, at 5 
(asserting that the provision would cover not only garden variety 
fees, but an ``infinite plethora of potential and unpredictable (or 
unknowable as a practical matter) payments and fees that may vary by 
locality, such as license and permit fees, or may arise due to 
unpredictable events.''); Duvall, at 1-2 (a franchisor cannot know 
all the required payments made to hundreds of vendors and accounts).
---------------------------------------------------------------------------

    The Commission agrees that the disclosure of third-party fees in 
Item 6 would be overbroad, resulting in the mandatory disclosure of 
information that might not be readily obtainable by the franchisor and 
unnecessarily increasing franchisor's compliance burden without any 
commensurate benefit to prospective franchisees. Moreover, estimates of 
initial payments to third parties are already covered by Items 7 and 8, 
as discussed below. Specifically, Item 7 requires franchisors to 
disclose estimates of pre-sale expenses paid during the initial 
period--typically the first three months--and also requires franchisors 
to ``[l]ist 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.\438\ Franchisors 
must also include an ``additional funds'' category to capture ``any 
other required expenses the franchisee will incur before operations 
begin and during the initial phase of operations.''\439\ Item 8 already 
requires franchisors to disclose franchisee obligations to make 
purchases from required or approved suppliers. These include 
obligations to purchase items such as supplies, equipment, inventory, 
computer hardware and software, and real estate. The Commission is 
persuaded that the Item 7 and Item 8 part 436 disclosures are more than 
sufficient to advise prospective franchisees of the likely purchase 
obligations incurred in operating a franchise.
---------------------------------------------------------------------------

    \438\ Section 436.5(g)(1)(ii).
    \439\ Section 436.5(g)(1)(iii).
---------------------------------------------------------------------------

9. Section 436.5(g) (Item 7): Estimated initial investment
    Section 436.5(g) of the final amended Rule requires franchisors to 
set out in an easy-to-read table all the expenses necessary to commence 
business (e.g., rent, equipment, and inventory)--not just the initial 
fees covered by Item 5 and other fees covered by Item 6. It also 
requires franchisors to disclose any refund conditions. Comparable cost 
disclosures are found in the original Rule at 16 CFR 436.1(a)(7).\440\ 
Consistent with the UFOC Guidelines,\441\ Item 7 also extends the 
original Rule by requiring a franchisor to disclose not only payments 
that the franchisee must make to the franchisor or its affiliates, but 
also estimated payments the franchisee must make to third parties in 
some instances. For example, franchisors must estimate payments for 
utility deposits and business licenses. It also requires franchisors to 
include an ``additional funds'' category\442\ that captures other 
expenses franchisees will incur during the ``initial period'' of 
operations.\443\
---------------------------------------------------------------------------

    \440\ ``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.'' Original SBP, 
43 FR at 59652. The ``[f]ailure to disclose material information as 
to the true cost of the franchise'' is an unfair and deceptive trade 
practice in violation of Section 5. Id., at 59653.
    \441\ UFOC Guidelines, Item 7.
    \442\ PMR&W asserted that the additional funds category is too 
broad. Citing the NASAA Commentary, the firm noted that owners' 
salary, for example, should be excluded. PMR&W, NPR 4, at 10-11. We 
agree, but believe this issue is best addressed by staff in the 
Compliance Guides, which will explain the term ``additional funds'' 
in greater detail.
    \443\ The term ``initial period'' means at least three months or 
some other reasonable period for the industry. A franchisor seeking 
to apply an initial phase other than three months has the burden of 
showing the reasonableness of the phase selected.
---------------------------------------------------------------------------

    Item 7 generated little comment. In response to the Staff Report, 
Howard Bundy asserted that Item 7 is insufficient, failing to reveal a 
franchisee's total initial investment because it does not include 
various payments to third parties beyond the first 90 days. 
Specifically, it misses real estate costs and equipment financing and 
leasing. Mr. Bundy urged the Commission to adopt the following:

     Disclose the total amount (in a range, if appropriate) of all 
obligations to third parties during the entire initial term of the 
franchise that will be necessary to operate the franchised business 
(including real estate leases and equipment leases) that the franchisee 
may be required to personally guaranty.\444\
---------------------------------------------------------------------------

    \444\ Bundy, at 5.

    The Commission declines to adopt this proposal. By its terms, Item 
7 of the UFOC Guidelines is designed to furnish prospective franchisees 
with material information about the likely expenses faced in the start-
up phase of the franchise. Armed with such information, a prospective 
franchisee will know whether or not he or she has the financial ability 
to get the franchised outlet operational. Item 7 is not intended to 
capture all expenses made over the life of the franchise, which may 
vary depending upon such factors as the franchisee's choice of 
suppliers and the terms he or she negotiates with them. For example, 
Item 7 recognizes that a franchisor may not know the exact amount of 
real property expenses. Rather than requiring an exact figure, Item 7 
permits franchisors to give an estimate or a low-high range. If neither 
can be determined, Item 7 permits franchisors to simply describe 
property requirements, such as property size and type, and location. 
Moreover, prospective franchisees may be able to get more detailed 
estimates of long-term expenses by speaking directly with existing 
franchisees in their location, or with trademark-specific franchisee 
associations. For these reasons, the Commission is not inclined to 
deviate from the UFOC Guidelines Item 7 on this issue.
    Item 7 of the final amended Rule is substantially similar to its 
counterpart in the Franchise NPR, but has been modified in a number of 
ways to adhere more closely to the UFOC Guidelines. For example, the 
Franchise NPR proposed that the Item 7 table be titled: ``YOUR 
ESTIMATED INITIAL INVESTMENT FOR THE FIRST [REASONABLE INITIAL PHASE] 
MONTHS.''\445\ As one commenter noted, however, the language proposed 
in the Franchise NPR is unnecessarily inconsistent with title of Item 7 
table of the UFOC Guidelines, which is titled ``YOUR ESTIMATED INITIAL 
INVESTMENT.''\446\ Moreover, the ``initial phase'' referenced in UFOC 
Guidelines Item 7 pertains only to the

[[Page 15487]]

``additional funds'' category, not to the entire table.\447\
---------------------------------------------------------------------------

    \445\ Franchise NPR, 64 FR at 57335.
    \446\See PMR&W, NPR 4, at 10-11.
    \447\Id.
---------------------------------------------------------------------------

    In addition, Item 7 as proposed in the Franchise NPR would have 
required franchisors to disclose ``additional funds'' required before 
operations begin and during the initial phase of the franchise.''\448\ 
The Commission noted in the Franchise NPR that this language was 
intended to require a working capital disclosure that could assist 
prospective franchisees in understanding their break-even point. 
Several commenters opposed the Franchise NPR's intention to capture 
working capital and a break-even point; they pointed out that such an 
approach goes beyond what the UFOC Guidelines require and asserted that 
this could be misleading without more detailed earnings information, 
such as in an earnings claim statement.\449\ Indeed, one commenter 
argued persuasively that the Franchise NPR's proposal could create a 
``back-door'' mandatory earnings claim, a position contrary to the 
Commission's view that earnings claims should be voluntary.\450\ The 
Commission finds these arguments persuasive. Accordingly, the final 
amended Rule tracks the language of UFOC Guidelines Item 7 more 
closely, eliminating any implication that the Commission intends for 
franchisors to disclose either a working capital or breakeven point.
---------------------------------------------------------------------------

    \448\ Franchise NPR, 64 FR at 57305.
    \449\ Lewis, NPR 15; Snap-On, NPR 16, at 3; Holmes, NPR 8, at 6.
    \450\ Homes, NPR 8, at 6. See Staff Report, at 159-62.
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10. Section 436.5(h) (Item 8): Restrictions on sources of products and 
services
    The original Rule required franchisors to disclose obligatory 
purchases, restrictions on sources of products and services, and the 
amount of any revenue the franchisor may receive from required 
suppliers.\451\ The final amended Rule requires more detailed and 
extensive disclosures on these topics, consistent with the UFOC 
Guidelines. Specifically, section 436.5(h) of the final amended Rule 
requires franchisors to disclose whether it makes the criteria for 
approving suppliers available to franchisees.\452\ 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., permitting renewals or additional outlets). 
Finally, it requires franchisors to disclose the existence of 
purchasing or distribution cooperatives, and whether the franchisor 
negotiates purchase agreements with suppliers on behalf of franchisees. 
These highly material disclosures inform prospective franchisees about 
critical restrictions on how they will have to operate the franchise, 
which comprise a vitally important aspect of the franchise 
relationship.
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    \451\See 16 CFR 436.1(a)(9)-(11). In the original 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.'' Original SBP, 43 FR at 59655. 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 59656-57.
    \452\ In the Franchise NPR, the Commission proposed that 
franchisors disclose the actual criteria for evaluating, approving, 
or disapproving of alternative suppliers. Franchise NPR, 64 FR at 
57336. Two Franchise NPR commenters voiced concern that this 
proposal goes well beyond what the UFOC Guidelines require, forcing 
franchisors to disclose proprietary information. PMR&W, NPR 4, at 1; 
NFC, NPR 12, at 29. See also Staff Report, at 130-31. The Commission 
agrees. Consistent with the UFOC Guidelines Item 8, the final 
amended Rule requires franchisors to disclose only a general 
description of its selection criteria.
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    During the course of the Rule amendment proceeding, franchisee 
advocates raised various concerns about Item 8. For example, several 
franchisees voiced concern about source restrictions that prevent them 
from obtaining supplies at lower market rates.\453\ Commenters 
generally did not allege that franchisors fail to disclose source 
restrictions, but complained about the ``abusive nature'' of such 
restrictions.\454\ Nevertheless, franchisee advocates questioned the 
sufficiency of the Item 8 disclosures. Specifically, Andrew Selden 
urged the Commission to expand the disclosure of supplier restrictions 
to require franchisors to disclose more information about their 
practices and intentions with respect to the provision of competitive 
alternative sources of supply.\455\ Mr. Selden, however, offered no 
specific language for the Commission's consideration. Robert Zarco 
urged the Commission to require franchisors to warn prospective 
franchisees that:
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    \453\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, 7 Nov. 97, at 288-89; 
Slimak, ANPR, 22 Aug. 97 Tr., at 26. See also Kezios, ANPR 64.
    \454\E.g., Brickner, ANPR 128; 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, 21 Nov. 97 Tr., at 308; Hockert-Lotz, id., at 
325-27.
    \455\ Selden, ANPR 133, Appendix B, at 1.

     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.\456\
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    \456\ Zarco & Pardo, ANPR 134, at 2. In the same vein, the AFA 
asserted that it is insufficient to require a franchisor to disclose 
whether a franchisee can purchase products from unaffiliated 
suppliers. It urged the Commission to require franchisors to 
disclose how long it actually takes for the franchisor to approve 
alternative suppliers, by stating the following:
    ``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, NPR 14, at 4. While the Commission understands that some 
franchisees have experienced difficulties in obtaining franchisor 
approval to use alternative supply sources, the record is 
insufficient to justify a sweeping consumer warning that assumes 
delay in the approval process as a matter of course. Rather, advice 
concerning the approval of alternative suppliers can be addressed in 
consumer education materials.

    The Commission agrees that full disclosure of source restrictions 
and purchasing obligations is warranted. To that end, the final amended 
Rule adopts the broader UFOC Guidelines' Item 8 disclosures. Item 8 
strikes the right balance between pre-sale disclosure and compliance 
costs and burdens. It is sufficient to warn prospective franchisees 
about source restrictions, purchase obligations, and approval of 
alternative suppliers, without requiring franchisors to disclose their 
past practices regarding approving alternative suppliers (which may be 
irrelevant to their current practices) or their future intentions 
(which may be proprietary information or misleading if the franchisor 
abandons the intended direction). Moreover, prospective franchisees can 
always ask existing franchisees or trademark-specific franchisee 
associations about a franchisor's history of approving alternative 
suppliers, if this issue is important in their decision-making process.
    With respect to the disclosure of revenues received from suppliers, 
Howard Bundy suggested that franchisors should disclose the dollar 
amount of any revenues received during some stated period, such as 
during the

[[Page 15488]]

last year.\457\ The disclosure of revenues from suppliers serves an 
``anti-conflict of interest'' purpose, putting prospective franchisees 
on notice that the franchisor, by benefitting materially from a 
relationship with a supplier, may be motivated to require franchisees 
obtain goods or services from that supplier. Accordingly, the highly 
material fact is that the franchisor receives revenues from suppliers 
it requires franchisees to use, not the exact dollar amount received. 
By requiring franchisors to disclose the percentage of revenue derived 
from suppliers, Item 8 achieves that purpose, consistent with the UFOC 
Guidelines.
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    \457\ Bundy, NPR 18, at 8. See also Brown, ANPR 4, at 3 (urging 
the Commission to prohibit direct and indirect ``kick-backs'' from 
third-party vendors to the franchisor).
---------------------------------------------------------------------------

    Finally, in response to the Staff Report, a few commenters offered 
various technical refinements to Item 8.\458\ First, Piper Rudnick 
noted that Item 8 of the Staff Report would require disclosures about 
purchases from ``suppliers . . . under the franchisor's 
specifications[, including] obligations to purchase imposed by written 
agreement or by the franchisor's practice.'' The firm interpreted the 
phrase ``imposed by written agreement'' as modifying the word 
``supplier.'' If so, it maintained that a franchisor would have no 
reason to know if a supplier has a written agreement.\459\ We believe 
this is a strained reading of the provision: ``written agreement'' is 
intended to refer to ``franchisor,'' not to a ``supplier.'' 
Nevertheless, in order to avoid any confusion, we have modified Item 8 
in the final amended Rule now to read as follows: ``Include obligations 
to purchase imposed by the franchisor's written agreement or by the 
franchisor's practice.''\460\
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    \458\ The IL AG also urged the Commission to add ``affiliates'' 
to the list of suppliers. IL AG, at 5. This is unnecessary. 
Franchisors already must disclose purchasers from ``the franchisor, 
its designee, or suppliers approved by the franchisor, or under the 
franchisor's specifications.'' Accordingly, ``designee, or suppliers 
approved by the franchisor'' would cover any required purchases from 
affiliates.
    \459\ Piper Rudnick, at 6.
    \460\ Piper Rudnick also recommended that the Compliance Guides 
clarify the phrase ``obligations to purchase imposed by . . . the 
franchisor's practice.'' Piper Rudnick, at 6. As far as we are 
aware, this phrase, taken from the UFOC Guidelines, has not 
previously raised any interpretive issues. At the very least, 
``franchisor's practice'' may include purchases that are recommended 
by the franchisor, or purchases that are prevalent among 
franchisees, even if not required by contract.
---------------------------------------------------------------------------

    Second, NASAA addressed the placement of footnote 5. Item 8, as 
proposed in the Staff Report, would require franchisors to disclose 
``whether the franchisor or its affiliates will or may derive revenue 
or other material consideration from required purchases or leases by 
franchisees,'' and ``if so describe the precise basis by which the 
franchisor or its affiliates will or may derive that consideration by 
stating . . .'' Footnote 5 added: ``Take figures from the franchisor's 
recent annual audited financial statement . . . 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.'' NASAA observed that the footnote incorrectly seems to 
modify ``precise basis,'' when it should modify ``franchisor's total 
revenue.'' It suggested moving the footnote to the end of section 
436.5(h)(6)(i) so that it will modify ``the franchisor's total 
revenue.''\461\ The final amended Rule adopts that suggestion.
---------------------------------------------------------------------------

    \461\ NASAA, at 5. See also WA Securities, at 3.
---------------------------------------------------------------------------

11. Section 436.5(i) (Item 9): Franchisee's Obligations
    Section 436.5(i) of the final amended Rule adopts UFOC Item 9, as 
proposed in the Franchise NPR.\462\ This disclosure gives prospective 
franchisees an easy-to-understand guide to 25 enumerated contractual 
obligations that are common in franchise relationships, with cross 
references to the specific sections of the franchise agreement and 
disclosure document that discuss each obligation in greater detail. 
There is no counterpart in the original Rule.
---------------------------------------------------------------------------

    \462\ Franchise NPR, 64 FR at 57305.
---------------------------------------------------------------------------

    Item 9 generated only a few comments during the Rule amendment 
proceeding. One franchisor representative maintained that the 
disclosure is unnecessary. He urged that a franchisor be permitted to 
opt out of Item 9 if the franchisor provides prospective franchisees 
with a detailed table of contents or index to its franchise 
agreement.\463\ Similarly, another franchisor representative 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.''\464\ 
According to this commenter, references to these ancillary agreements 
are burdensome and of little value to prospective franchisees. On the 
other hand, a franchisee representative asserted that Item 9 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.''\465\ He suggested that franchisors use a remarks column to 
describe briefly the nature of each obligation.
---------------------------------------------------------------------------

    \463\ Duvall, ANPR 19, at 2.
    \464\ J&G, NPR 32, at 11.
    \465\ Stadfeld, NPR 23, at 14.
---------------------------------------------------------------------------

    The Commission believes that Item 9 serves a useful purpose. As 
stated throughout this document, franchisee complaints submitted during 
the Rule amendment proceeding supported better pre-sale disclosure 
about the nature of the franchise relationship.\466\ Item 9 addresses 
that concern by providing 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 facilitates review of 
a franchise offering by enabling a prospective franchisee to find and 
review the contractual provisions detailing their legal obligations, 
better ensuring that prospective franchisees are not mislead about the 
nature of the franchise relationship. Moreover, many franchisors 
already use the UFOC Guidelines and prepare an Item 9 table. Further, 
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, franchisors 
must direct prospects to those provisions as well.\467\
---------------------------------------------------------------------------

    \466\ Item 9 is consistent with other trade regulation rules 
where the Commission has recognized that information about legal 
risks to consumers is material. E.g., Negative Option Rule, 16 CFR 
425.1(a)(ii) (minimum purchase obligations); Door-to-Door Sales 
Rule, 16 CFR 429.1 (obligations regarding cancellations).
    \467\ 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 indicate that the drafters directed 
franchisors to reference all applicable agreements. We see no 
compelling reason to deviate from the UFOC Guidelines on this point.
---------------------------------------------------------------------------

12. Section 436.5(j) (Item 10): Financing
    Consistent with the UFOC Guidelines Item 10, section 436.5(j) of 
the final amended Rule requires a franchisor to disclose all the 
material terms and conditions of any financing agreements, which 
encompass: the rate of interest, plus finance charges, expressed on an 
annual basis; the number of payments; penalties upon default; and any 
consideration received by the franchisor for referring a prospective 
franchisee to a lender. This disclosure is comparable to the original 
Rule provision found at 16 CFR 436.1(a)(12).\468\ The final

[[Page 15489]]

amended Rule's Item 10 closely tracks the version of this provision as 
proposed in the Franchise NPR, revised to improve the clarity and 
overall consistency of the Rule.\469\
---------------------------------------------------------------------------

    \468\ In the original 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 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. 
Original SBP, 43 FR at 59659-60.
    \469\ The disclosures required by Item 10 are modeled on the 
disclosures lenders make under the Federal Reserve's Regulation M 
(Consumer Leasing),12 CFR Part 213, and Regulation Z (Truth in 
Lending), 12 CFR Part 226. Because these regulations cover personal 
property leases and credit transactions that are ``primarily for 
personal, family, or household purposes,'' however, they generally 
do not apply directly with respect to lease and financing 
transactions undertaken in connection with the purchase of a 
franchise. Sales of franchises generally are not undertaken to 
advance personal, family, or household purposes. The version of Item 
10 proposed in the NPR, following Item 10 in the UFOC Guidelines, 
expressly referenced the Consumer Credit Protection Act's Truth in 
Lending (``TILA'') provisions, 15 U.S.C. 1605-1606. While not 
intending to depart unnecessarily from the UFOC Guidelines, the 
Commission believes that this reference is potentially confusing, 
because the TILA likely does not apply to transactions within the 
scope of the amended Rule. Nevertheless, franchisors can look to 
TILA and to the Consumer Leasing Act for guidance in crafting their 
disclosures under Item 10. The Commission anticipates that staff 
Compliance Guides will illuminate this topic further.
---------------------------------------------------------------------------

    Section 436.5(j), like UFOC Guidelines Item 10, extends the 
original Rule disclosures by requiring franchisors to disclose any 
interest on the financing in terms of the rate of interest, plus 
finance charges, expressed on an annual basis, consistent with such 
disclosures required in consumer credit transactions.\470\ It also 
requires more disclosure than the original Rule 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.\471\
---------------------------------------------------------------------------

    \470\ It is worth noting that interest rates or finance charges 
may fluctuate between the time when the prospective purchaser 
receives the disclosure document and the time when he or she 
actually executes the financing agreement. Section 436.5(j)(1)(iv) 
requires disclosure of what the rate of interest, plus finance 
charges, expressed on an annual basis, was on a specified recent 
date. In situations where the rate may change during the life of the 
loan, disclosure of this fact would be required under the catch-all 
requirement of section 436.5(j)(x), which calls for disclosure of 
``other material financing terms.'' Of course, Item 22--section 
436.5(v)--requires that any financing agreement be attached to the 
disclosure document, and the Item 10 disclosures merely summarize 
key terms.
    \471\ The introduction to UFOC Item 10 makes clear that 
franchisors are permitted to provide this information in summary 
table format, and Appendix A to the final amended Rule offers a 
sample table.
---------------------------------------------------------------------------

    Three commenters voiced concerns about Item 10. First, H&H 
suggested that leases referred to in Item 10 should be called 
```finance leases,' a well-established term in commercial law.''\472\ 
The Commission declines to adopt this suggestion. While ``finance 
leases'' may be a term of art used in commercial law, we do not believe 
that the UFOC Guidelines Item 10--upon which section 436.5(j) is 
based--is ambiguous or otherwise unclear. Deviating from the UFOC 
Guidelines on this point, therefore, is unwarranted.
---------------------------------------------------------------------------

    \472\ H&H, NPR 9, at 18.
---------------------------------------------------------------------------

    Second, David Gurnick suggested that the Rule expressly permit 
negotiation of financial terms, and require disclosure indicating 
``that there are other sources of financing, such as banks, which the 
franchisee should consider.''\473\ The Commission, of course, intends 
that franchisees be free to negotiate financing terms. The Commission 
does not believe that the text of the final amended Rule at Item 10 can 
be read to imply that negotiation of financial terms is not permitted, 
or that Item 10 contemplates any restriction of a franchisee's choice 
of lender. Therefore, we believe it unnecessary to deviate from the 
UFOC Guidelines on this point.\474\
---------------------------------------------------------------------------

    \473\ Gurnick, NPR 21, at 6-7.
    \474\ The Commission will ensure that the Compliance Guides 
reiterate the point made here: nothing in Item 10 restricts the 
parties' ability to negotiate over financing terms.
---------------------------------------------------------------------------

    Finally, in response to the Staff Report, IL AG raised a technical 
issue about the sample Item 10 Financing Table, noting that ``Equip. 
Lease'' and ``Equip. Purchase'' have separate lines, while ``Land/
Constr.'' has a single line. The form of the Item 10 Financing Table in 
the final amended Rule, however, is taken directly from the UFOC 
Guidelines, and the record does not reflect that this format has caused 
difficulty for franchisors or confusion on the part of prospective 
franchisees. We therefore decline to deviate from the UFOC Guidelines 
on this point.
13. Section 436.5(k) (Item 11): Franchisor's assistance, advertising, 
computer systems, and training
    Section 436.5(k) retains the original Rule's disclosure of 
franchisor's assistance obligations, including pre-opening assistance 
(e.g., site selection), as well as ongoing assistance (e.g., 
training).\475\ Item 11 of the final amended Rule expands the original 
Rule, however, based upon the UFOC Guidelines' more detailed assistance 
disclosure requirements, including disclosures relating to advertising 
assistance and computer system requirements.\476\
---------------------------------------------------------------------------

    \475\See 16 CFR 436.1(a)(17) and (18). The offer of business 
assistance is one of the hallmarks of a franchise system. In the 
original 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.'' Original SBP, 43 FR at 59676-77.
    \476\See UFOC Guidelines, Item 11.
---------------------------------------------------------------------------

    Section 436.5(k) requires franchisors to begin their Item 11 
disclosure with the statement, in bold type, that ``[e]xcept as listed 
below, [the franchisor] is not required to provide you with any 
assistance.'' This alert counters any express misrepresentations to the 
contrary and corrects any misconception on the prospective franchisee's 
part that a minimum degree of assistance is inherent in any franchise 
offer.\477\ Item 11 also requires franchisors to explain in detail the 
franchisor's site selection criteria and the franchisor's training 
program. As noted above, this provision also requires franchisors to 
disclose the extent of any advertising assistance and the operation of 
local, regional, and national advertising councils or co-ops. These 
disclosures address a common franchisee complaint, namely, that 
franchisees do not get the quality or quantity of advertising they pay 
for.\478\
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    \477\ Our law enforcement experience demonstrates that 
misrepresentation 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 ABC (RNBx) (C.D. Cal. 
2000); FTC v. Indep. Travel Agencies of Am., Inc., No. 95-6137-CIV 
Gonzalez (S.D. Fla. 1995); FTC v. Sage Seminars, Inc., No. C-95-
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, one 
franchisee-commenter reported 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, 22Aug. 97 Tr., at 45. See also Dady & 
Garner, ANPR 127, at 4; Mousey, ANPR, 29 July 97 Tr., at 4-7.
    \478\See, e.g., FTC v. Car Checkers of Am., Inc., No. 93-623 
(mlp) (D.N.J. 1993) (misrepresenting that advertising expenses would 
be minimal or low); United States v. Fed. Energy Sys., Inc., Bus. 
Franchise Guide (CCH) ] 8180 (C.D. Cal. 1984) (misrepresenting 
extent of company advertising assistance); United States v. Ferrara 
Foods, Inc., Bus. Franchise Guide (CCH) ] 7926 (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); Weaver, ANPR 17 (no 
discretion on 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.'').

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[[Page 15490]]

    Section 436.5(k) also addresses major technological changes in 
franchising since the original Rule was promulgated in 1978. Based upon 
UFOC Item 11, this provision requires material disclosure about the 
required use of computers and electronic cash registers.\479\ For 
example, it requires franchisors to disclose whether they will have 
independent access to information and data stored on electronic cash 
register systems or software programs that the franchisee is required 
to use or buy.\480\
---------------------------------------------------------------------------

    \479\ In response to the ANPR, a few commenters voiced concerns 
about obligations to purchase computers or related equipment. E.g., 
Fetzer, ANPR, 19 Sept. 97 Tr., at 42 (needed to purchase a computer 
converter, an additional $7,000 expense); Rafizadeh, ANPR, 7 Nov. 97 
Tr., at 292 (GNC unilaterally forcing franchisees to pay a new $80 
monthly maintenance fee on computer equipment purchased from GNC).
    \480\See 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).
---------------------------------------------------------------------------

    Item 11, as proposed in the Franchise NPR, would have adopted the 
UFOC Guidelines requirement that franchisors identify each 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.\481\ The computer system disclosure was the only Item 
11 issue that generated significant comment during the Rule amendment 
proceeding. Several comments asserted that the UFOC Guidelines Item 11 
computer system disclosures are burdensome, not helpful to prospective 
franchisees, and are unnecessary because the costs associated with 
purchasing computers and related equipment are already disclosed in 
Items 5, 7, and 8.\482\ Marriott, for example, explained that its Item 
11 computer usage disclosure ``results in four to five pages of 
disclosure in each of Marriott's offering circulars yet provides little 
or no benefit to franchisees.''\483\ In addition, one franchisor 
representative 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.''\484\
---------------------------------------------------------------------------

    \481\ Franchise NPR, 64 FR at 57338.
    \482\ Baer, NPR 11, at 13; J&G, NPR 32, at 11.
    \483\ Marriott, NPR 35, at 15-16.
    \484\ Kestenbaum, ANPR 40, at 2. In response to the Franchise 
NPR--which proposed adopting the UFOC Item 11's detailed computer 
systems disclosures--H&H suggested that a franchisor should be 
required to disclose the specifications of any mandatory computer 
system to the extent known or available, observing 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. H&H, NPR 9, at 23. Cf. 
Bundy, NPR 18, at 9 (suggesting that a start-up franchisor disclose 
some guidelines it will follow in selecting a computer system). We 
agree. Accordingly, the Commission intends that, for start-up 
franchisors, the computer system disclosures of Item 11 should be 
read to allow flexibility: a start-up franchisor may indicate that 
computer requirements are yet unknown, or otherwise state its policy 
concerning computer usage, as is warranted. As Mr. Bundy noted, the 
lack of selected computer systems by the franchisor itself reveals 
material information: that the franchisor is not yet computerized, 
which may ``plac[e] the franchisee at a disadvantage in many, if not 
most industries.'' Bundy, NPR 18, at 9.
---------------------------------------------------------------------------

    The Commission believes that Item 11's computer systems 
disclosures, which track the UFOC Guidelines' disclosures, serve a 
useful purpose. There is no question that the costs a franchisee must 
incur to purchase or lease computer and related equipment or software, 
as well as any continuing maintenance or upgrade obligations and their 
associated costs, comprise information that is material to the 
prospective franchisee's purchasing decision. Information about whether 
the franchisor will have access to information stored on the 
franchisee's computers or electronic cash registers also is material, 
because such access very likely would be a key component of the 
relationship between the franchisor and franchisee. As noted throughout 
this document, the Commission is convinced that additional disclosures 
are warranted where they will likely prevent deception about the nature 
of the franchise relationship a prospective franchisee is deciding to 
enter.
    Nonetheless, the computer usage disclosures as set forth in the 
UFOC Guidelines appear to go beyond what is material in some instances 
and likely would 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 Franchise NPR commenters 
who observed 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 would not likely outweigh any 
tangible benefits to prospective franchisees.\485\ We are persuaded 
that it is sufficient 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. 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.
---------------------------------------------------------------------------

    \485\See Staff Report, at 137-38. It is noteworthy that NASAA 
has not opposed this substantive revision to Item 11 of the UFOC 
Guidelines.
---------------------------------------------------------------------------

    On the other hand, one franchisee advocate, Howard Bundy, firmly 
defended the materiality and usefulness of detailed itemized 
disclosures about required computer systems. Specifically, Mr. Bundy 
voiced concern about franchisors that require franchisees to use 
proprietary technology that the franchisor has developed or plans to 
develop. Mr. Bundy asserted that this may negatively impact upon 
franchisees' ability to fix flaws in software, for example. He 
contended that prospective franchisees should have the right to know 
whether they can use ``off-the-shelf'' products, and whether software 
can interface with common systems such as Microsoft Office or Outlook. 
Similarly, they should know whether accounting software complies with 
IRS standards or if they will get periodic updates.\486\
---------------------------------------------------------------------------

    \486\ Bundy, at 6-7.
---------------------------------------------------------------------------

    Mr. Bundy's concern about the potential limitations of franchisor-
developed software has merit. However, we believe the final amended 
Rule already addresses this issue. As noted above, section 436.5(k) 
requires franchisors to ``describe the systems (which includes hardware 
and software components) generally in non-technical language, including 
the types of data to be generated or stored in these systems.'' Thus, 
the ``general description'' requirement is broad enough to cover 
proprietary systems that can be obtained only from the franchisor. 
Moreover, section 436.5(k) will require the franchisor to disclose any 
obligation to provide ongoing maintenance, repair, upgrades, or 
updates. Taken together, these provisions are sufficient to capture 
instances where franchisors require the use of their own software.
    Finally, we note that in response to the Staff Report, Gust 
Rosenfeld raised a technical point about the Item 11 disclosure of the 
franchisor's operating manual. The firm noted that, under the UFOC 
Guidelines, franchisors must include the Table of Contents of the 
operating manual in the disclosure

[[Page 15491]]

document, unless ``the prospective franchisee views the manual before 
purchase of the franchise.''\487\ The firm asserted that the Staff 
Report erred in recommending that the alternative to providing the 
Table of Contents be revised to permit a franchisor to ``offer a 
prospective franchisee the opportunity to review the manual before 
buying the franchise.''
---------------------------------------------------------------------------

    \487\ Gust Rosenfeld, at 5 (citing UFOC Guidelines, Item 11, at 
B. vii.).
---------------------------------------------------------------------------

    The Commission believes the Staff Report is correct. As a practical 
matter, we question how it could be proven that a prospective 
franchisee actually reviewed a manual. Even if a franchisor had a 
prospective franchisee initial each page of a manual, there is no 
assurance that the prospect actually ``reviewed'' the manual. For that 
reason, at most we can require a franchisor to afford a prospective 
franchisee the opportunity to review the manual. At the same time, we 
stress that the ``opportunity to review'' a manual must be a reasonable 
one. A franchisor would not satisfy its disclosure obligation if, for 
example, it offered to show the manual to a prospect only if the 
prospect agreed to fly across country to the franchisor's corporate 
headquarters. In that regard, the opportunity to review a manual means 
that the franchisor must show the manual to the prospect (for example 
in person or online) and permit the prospect sufficient time to review 
it.
14. Section 436.5(l) (Item 12): Territory
    Section 436.5(l) of the final amended Rule retains the original 
Rule's disclosures concerning exclusive territories and sales 
restrictions.\488\ Like the proposed Rule published in the Franchise 
NPR, the final amended Rule is closely modeled on the UFOC Guidelines. 
It therefore expands the original Rule's disclosure requirements 
regarding territories in several respects. These new disclosure 
requirements cover: (1) the conditions, if any, under which a 
franchisor will approve the relocation of the franchisee's business and 
the franchisee's establishment of additional outlets; (2) any present 
plans on the part of the franchisor to operate a competing franchise 
system offering similar goods or services; and (3) in instances when a 
franchisor does not offer an exclusive territory, a prescribed warning 
about the consequences of purchasing a non-exclusive territory. In 
response to some comments, the Commission also has decided to make 
additional modifications to the text of Item 12 in order to update both 
the original Rule and the UFOC Guidelines to address new technologies 
and market developments, such as the Internet and alternative channels 
for distributing a franchisor's goods.\489\
---------------------------------------------------------------------------

    \488\See 16 CFR 436.1(a)(13). In the original SBP, the 
Commission recognized that sales restrictions and limited 
territories affect a franchisee's ability to conduct business and 
are, therefore, material. Original SBP, 43 FR at 59662. See, e.g., 
FTC v. Am. Legal Distrib., Inc., Bus. Franchise Guide (CCH) [1987-
1989 Transfer Binder] ] 9090 (N.D. Ga. 1988); United States v. C.D. 
Control Tech. Inc., Bus. Franchise Guide (CCH), ] 9851 (E.D.N.Y. 
1985); United States 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) ] 9365 
(E.D. La. 1989). Cf. FTC v. Vendors Fin. Serv., Inc., No. 98-N-1832 
(D. Colo. 1998); FTC v. Int'l Computer Concepts, Inc., No. 
1:94cv1678 (N.D. Ohio 1994); FTC v. O'Rourke, Bus. Franchise Guide 
(CCH) ] 10243; FTC v. Am. Safe Mktg., Inc., Bus. Franchise Guide 
(CCH) ] 9350 (N.D. Ga. 1989).
    \489\ Specifically, Item 12 of the final amended Rule extends 
the original Rule by providing a prospective franchisee 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 direct marketing. In the same vein, it 
addresses any restrictions on a franchisee's ability to conduct 
business outside of his or her territory through traditional sales 
and alternative channels of distribution. The Staff Report 
recommended this modification to the proposed Rule. Staff Report, at 
144-45. See PRM&W, NPR 4, at 11 (supporting need to update the 
original Rule to address new technologies and marketing practices).
---------------------------------------------------------------------------

    The Item 12 territory disclosures generated several comments. 
First, franchisees and their advocates urged the Commission to address 
``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, by purchasing and 
operating a competing franchise system, or by selling the same goods or 
services through alternative channels of distribution. Second, other 
commenters questioned the scope of Item 12, urging the Commission to 
require franchisors to disclose more information about their past 
expansion practices, as well as future expansion plans. Third, some 
commenters questioned the terminology 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 warning that might be 
appropriate where a franchisor sells franchises without an exclusive 
territory. Each of these issues is discussed below.
a. Encroachment
    Throughout the Rule amendment proceeding, franchisees and their 
advocates urged the Commission to address ``encroachment.''\490\ The 
commenters contended that encroachment may have a devastating effect 
upon an individual franchisee who does not have a contractually 
protected exclusive territory,\491\ and some urged the Commission to 
ban encroachment as ``an abusive and unfair'' trade practice under 
Section 5 of the FTC Act.\492\
---------------------------------------------------------------------------

    \490\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.
    \491\ 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.
    \492\E.g., AFA, ANPR 62, at 1 (putting up a new outlet to 
compete with an existing franchisee is an unfair trade practice); 
Bell, ANPR 30 (FTC needs to prohibit franchisors from devaluing 
assets through encroachment); Rachide, ANPR 32 (encroachment among 
practices that FTC should prohibit); Marks, ANPR 107 (FTC should 
consider prohibiting franchisor encroachment, unless franchisee 
compensated).
---------------------------------------------------------------------------

    The Commission's view is that the granting of a protected territory 
is fundamentally a private contractual matter for the parties to 
determine for themselves.\493\ While the record establishes 
franchisees' concerns about encroachment, it falls far short of 
supporting a conclusion that not granting a protected territory in a 
franchise agreement constitutes an unfair practice within the meaning 
of the FTC Act. Nor does the record support a conclusion that a 
franchisor's expansion where there are existing franchisees is an 
unfair practice.
---------------------------------------------------------------------------

    \493\ 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).
---------------------------------------------------------------------------

    Section 5(n) of the FTC Act provides that an ``unfair'' practice is 
one that ``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.'' 
While the record suggests that some franchisees in several franchise 
systems may have been harmed by franchisor encroachment, the record 
leaves open the question whether encroachment is prevalent and whether 
the injury resulting from encroachment is substantial, when viewed from 
the standpoint of the franchising industry as

[[Page 15492]]

a whole,\494\ not just from a few franchise systems.\495\ Second, 
assuming a regulatory regime of full and truthful pre-sale disclosure 
on the issue of territories, prospective franchisees can avoid 
potential harm from encroachment by shopping for a franchise 
opportunity that offers an exclusive territory. Finally, the record 
does not support a finding that harm to franchisees resulting from 
encroachment necessarily outweighs potential benefits (expansion of 
markets and increased consumer choice) to consumers or to competition. 
For these reasons, the Commission has determined that the criteria for 
an industry-wide prohibition on encroachment has not been met. Thus, 
the Commission declines to mandate specific contractual terms regarding 
territories.
---------------------------------------------------------------------------

    \494\ As discussed above in the overview of the final rule above 
(section I.D. of this document), the Commission has voiced concern 
that government-mandated contractual terms may result in affirmative 
harm to consumer welfare. Accordingly, the Commission has authorized 
staff to file a number of advocacy comments recommending against 
proposed state bills that would have unduly limited manufacturers in 
managing their distribution systems, such as by requiring exclusive 
territories.
    \495\See Staff Program Review, at 59.
---------------------------------------------------------------------------

b. Scope of the Item 12 disclosures
    A few commenters urged the Commission to require franchisors to 
disclose more information about their past practices with regard to 
expansion into franchisees' areas or their future plans to do so.\496\ 
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 franchisor-
sponsored competitive activities that have the prospect of impacting 
the franchisee's business.''\497\
---------------------------------------------------------------------------

    \496\ One commenter in the Rule amendment proceeding advocated 
broadening the scope of the Rule to require more expanded 
disclosures covering competition by affiliates, the franchisor's 
officers, and franchise sellers. Bundy, NPR 18, at 9. In the absence 
of persuasive record evidence that competition by franchisor 
officers or sellers is a prevalent problem, however, the Commission 
has determined not to deviate from the UFOC Guidelines on this 
issue.
    \497\ Selden, ANPR 133, Appendix B. 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.'').
---------------------------------------------------------------------------

    Franchisors addressing current development plans uniformly opposed 
any disclosure. 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.''\498\ 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.''\499\
---------------------------------------------------------------------------

    \498\ H&H, NPR 9, at 23.
    \499\Id. See also Wendy's, NPR 5, at 2; Baer, NPR 11, at 13 ; 
Lewis, NPR 15, at 15; BI, NPR 28, at 11; J&G, NPR 32, at 12; GPM, 
NPR Rebuttal 40, at 6.
---------------------------------------------------------------------------

    Based on review of the record as a whole, the Commission has 
determined that requiring disclosure of past and planned future 
expansion is unwarranted. With respect to past expansion, 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. It is also 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.
    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.''\500\ Moreover, the Commission is inclined to the view 
that a franchisor's development plan is proprietary information that a 
franchisor should not be required to make public.\501\ 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. For these reasons, we have determined 
not to deviate from the UFOC Guidelines on this point.
---------------------------------------------------------------------------

    \500\ UFOC Item 12C (emphasis added).
    \501\E.g., Wendy's, NPR 5, at 2.
---------------------------------------------------------------------------

c. Terminology
    The final amended Rule fine-tunes the terminology and organization 
of Item 12. As proposed in the Franchise NPR, Item 12 would have 
required 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.''\502\ Several 
commenters raised concerns about the use of these terms.
---------------------------------------------------------------------------

    \502\ Franchise NPR, 64 FR at 57339.
---------------------------------------------------------------------------

    First, BI opposed the use of the term ``exclusive territory'' in 
the Franchise NPR, urging the Commission to use the term ``protected 
territory'' instead. It asserted that the term ``protected territory'' 
is more descriptive of a franchisee's typical contractual rights 
regarding its territory, if any.\503\ Similarly, the firm opposed the 
use of the term franchisee's ``market area.'' It maintained that the 
term ``market area'' is undefined and imprecise. BI advocated use of 
the term ``location.''\504\
---------------------------------------------------------------------------

    \503\ BI, NPR 28, at 6 (``[E]xclusive . . . is ambiguous and 
often misleading.'').
    \504\Id.
---------------------------------------------------------------------------

    The NFC agreed, asserting that the term ``market area'' is a 
``charged word.''\505\ 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 the term ``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 the subject 
franchise agreement.''\506\ 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 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, if any, they can expect to 
receive.''\507\
---------------------------------------------------------------------------

    \505\ NFC, NPR 12, at 19.
    \506\ NFC, NPR 12, at 19. See also J&G, NPR 32, at 12.
    \507\Id. See also J&G, NPR 32, at 12.

---------------------------------------------------------------------------

[[Page 15493]]

    The Commission agrees that terms such as ``market area'' and 
``defined area'' are potentially misleading. Such terms 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. 
Accordingly, we believe the term ``exclusive territory''--as used in 
the UFOC Guidelines\508\--is more precise. While the term ``exclusive 
territory'' is, perhaps, not as ``descriptive'' as the terms 
``protected area,'' or ``limited protected territory,'' its use is 
clarified for prospective franchisees through the disclosures set forth 
in paragraphs (5) and (6) of section 436.5(l). Accordingly, in the 
absence of a stronger showing that alternatives to ``exclusive 
territory'' are more accurate, the Commission has determined to revise 
Item 12 to adhere more closely to the UFOC Guidelines on this point, as 
recommended in the Staff Report.\509\ Thus, the final amended Rule 
substitutes the words ``location'' or ``exclusive territory'' for 
``market area,'' ``area,'' and ``defined'' area, as appropriate.
---------------------------------------------------------------------------

    \508\ 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.
    \509\ In response to the Staff Report, no commenters raised any 
concerns about the recommended choice of terminology used in Item 
12.
---------------------------------------------------------------------------

d. Warning
    Item 12 of the final amended Rule fine-tunes and expands slightly 
the standard warning proposed in the Franchise NPR that is required in 
those instances when franchisors do not offer exclusive territories: 
``You will not receive an exclusive territory. You may face competition 
from other franchisees, from outlets that we own, or from other 
channels of distribution or competitive brands that we control.''\510\
---------------------------------------------------------------------------

    \510\ This language, with minor editing, was suggested by PMR&W, 
which observed that the proposed version of the warning focused only 
on sales from outlets. PMR&W argued convincingly that such a warning 
could be misleading because it fails to take into consideration 
competition from other sources, such as the Internet, direct mail, 
and mail order. PMR&W, NPR 4, at 11. See also J&G, NPR 32, at 12; IL 
AG, NPR Rebuttal 38, at 3.
---------------------------------------------------------------------------

    Given the potential financial risks associated with a non-exclusive 
territory, the Commission believes that franchisors who do not offer an 
exclusive territory should warn prospective franchisees about such 
possible risks.\511\ The Commission generally disfavors the use of 
warnings that merely repeat what is already expressly stated in the 
franchise agreement, but believes that a specific warning regarding 
exclusive territories is warranted in light of the volume and 
persuasiveness of franchisee complaints regarding territory 
issues.\512\ As noted previously, the Commission is convinced that 
additional disclosures are warranted where they will likely prevent 
deception about the nature of the franchise relationship.
---------------------------------------------------------------------------

    \511\ 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 company-owned 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.'').
    \512\ E.g., Brown, ANPR 4, at 2; Parker, ANPR 10; Manusak, ANPR 
13, at 1; Donaphin, ANPR 14; Weaver, ANPR 17; Rachide, ANPR 32, at 
3; AFA, ANPR 62, at 1; L. Gaither, ANPR 68; Orzano, ANPR 73, at 1; 
Buckely, ANPR 97, at 3; Marks, ANPR 107, at 2; Zarco & Pardo, ANPR 
134, at 2; Vidulich, 22 Aug. 97 Tr., at 17; Christiano, 19 Sept. 97 
Tr., at 50; Bundy, 6 Nov. 97 Tr., at 135; Cordell, 6 Nov. 97 Tr., at 
136; Kezios, 6 Nov. 97 Tr., at 142. See also FTC v. Fax Corp. of 
Am., Inc., No. 90-983 (D. N.J. 1990); FTC v. Nat'l Bus. Consultants, 
Inc., No. 89-1740 (E.D. La.1989); FTC v. Am. Legal Distrib., Inc., 
No. 1:89-CV-462-RLV (N.D. Ga. 1989).
---------------------------------------------------------------------------

15. Section 436.5(m) (Item 13): Trademarks
    The original Rule required a franchisor to list the trademark 
identifying the goods or service to be sold by the prospective 
franchisee.\513\ Consistent with the UFOC Guidelines, section 436.5(m) 
of the final amended Rule requires franchisors to disclose whether the 
trademark is registered with the United States Patent & Trademark 
Office; 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.
---------------------------------------------------------------------------

    \513\See 16 CFR 436.1(a)(1)(iii).
---------------------------------------------------------------------------

    These expanded disclosures are 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 one may wish to purchase a franchise--as opposed to starting one's 
own business--is the right to use the franchisor's mark, which 
presumably creates an instant market for the franchisees' goods or 
services.\514\ 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 the franchisee's ability to continue operating the business.
---------------------------------------------------------------------------

    \514\ In the original SBP, for example, the Commission noted 
that a key feature of franchising is the right to use the 
franchisor's trademark. Original SBP, 43 FR at 59623.
---------------------------------------------------------------------------

    Item 13 generated little comment. Howard Bundy suggested that 
franchisors should disclose not only pending trademark litigation, but 
all such litigation in the last 10 years.\515\ The Commission declines 
to adopt this suggestion. The fact that the franchisor may have been 
involved in a trademark dispute a decade ago is not inherently 
material.\516\ What influences a decision to purchase a franchise 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. Accordingly, we decline to deviate from the 
UFOC Guidelines by requiring more extensive disclosures on this point.
---------------------------------------------------------------------------

    \515\ Bundy, NPR 18, at 9.
    \516\ 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.
---------------------------------------------------------------------------

    The Commission has determined to adopt staff's recommendation to 
adhere more closely to the UFOC Guidelines on Item 13 than did the 
proposed Rule on two points. First, the Franchise NPR proposed that 
franchisors disclose how any infringement, opposition, or cancellation 
proceeding ``affects the franchised business.''\517\ This is 
unnecessarily inconsistent with the wording of the UFOC Guidelines, 
which state: ``affects the ownership, use, or licensing'' of the 
trademark.\518\
---------------------------------------------------------------------------

    \517\ Franchise NPR, 64 FR at 57339.
    \518\See NASAA Comparison, at 17.
---------------------------------------------------------------------------

    Second, the Franchise 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.''\519\ 
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:
---------------------------------------------------------------------------

    \519\ Franchise NPR, 64 FR at 57339.

     the franchisor may include an

[[Page 15494]]

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.\520\
---------------------------------------------------------------------------

    \520\ UFOC Guidelines, Item 13B Instructions, v.

---------------------------------------------------------------------------
The Commission adopts the UFOC Guidelines language in both instances.

    In addition, the final amended Rule improves on the clarity and 
precision of the proposed Rule's standard disclosure required when the 
franchisor's trademark is not registered on the Principal Register of 
the United States Patent and Trademark Office. The proposed disclosure 
reads as follows: ``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.'''\521\
---------------------------------------------------------------------------

    \521\ Franchise NPR, 64 FR at 57339.
---------------------------------------------------------------------------

    The final amended Rule's disclosure is:

     We do not have a federal registration for our principal trademark. 
Therefore, our trademark does not have as many legal benefits and 
rights as a federally registered trademark. If our right to use the 
trademark is challenged, you may have to change to an alternative 
trademark, which may increase your expenses.\522\
---------------------------------------------------------------------------

    \522\ Arguing that many prospective franchisees would not 
understand the standard disclosure prescribed in the Franchise NPR's 
proposed Rule--particularly the phrase ``presumptive legal 
rights''--the Staff Report recommended that the Commission simplify 
it. The simplified version recommended by staff, however, was 
criticized by two commenters on the ground that it was not entirely 
accurate from a legal standpoint. Gust Rosenfeld, at 6; Piper 
Rudnick, at 2. The version adopted here corrects the problems 
pointed out by these commenters.
---------------------------------------------------------------------------

16. Section 436.5(n) (Item 14): Patents, copyrights, and proprietary 
information
    Section 436.5(n) of the final amended Rule adopts the UFOC 
Guidelines' requirement for disclosure of information about the 
franchisor's intellectual property. There is no comparable provision in 
the original Rule. Item 14 elicited no comment during the amendment 
proceeding.
    Item 14 requires 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 property.\523\ If counsel permits, 
Item 14 allows a franchisor to include a counsel's opinion or a summary 
of the opinion about legal actions, if the full opinion is 
attached.\524\
---------------------------------------------------------------------------

    \523\ 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. 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.
    \524\See NASAA Comparison, at 20.
---------------------------------------------------------------------------

    The final amended Rule differs from the Franchise NPR proposal, 
however, in several non-substantive respects to add precision and 
improve organization of the provision. Specifically, Item 14 of the 
final amended Rule separates those disclosures pertaining to patents 
from those pertaining to patent applications. At the same time, it also 
groups closely related disclosures--those for patents, patent 
applications, and copyrights--under a single common direction. For 
example, section 436.5(n)(1) of the Franchise NPR stated: ``For each 
patent or copyright: (i) Describe the patent or copyright and its 
relationship to the franchisee; (ii) State the duration of the patent 
of copyright.'' Section 436.5(n)(1) of the final amended Rule 
simplifies this language by eliminating the use of multiple directions. 
Instead, it says: ``(1) Disclose whether the franchisor owns rights in, 
or licenses to, patents or copyrights that are material to the 
franchise. Also, disclose whether the franchisor has any pending patent 
applications that are material to the franchise. If so, state . . .'' 
followed by the specific disclosure requirement for patents, patent 
applications, and copyrights.
    Similarly, section 436.5(n)(1), as proposed in the Franchise NPR, 
referred to the ``issue date.'' The final amended Rule instead uses the 
correct language: ``issuance date.'' In the same vein, Item 14 of the 
final amended Rule corrects imprecise language that would have required 
the disclose of material determinations pending in ``the U.S. Patent 
and Trademark Office or the U.S. Court of Appeals for the Federal 
Circuit.'' In fact, patent and copyright determinations can be made in 
courts other than the U.S. Court of Appeals for the Federal Circuit, as 
noted in other sections of Item 14 (``Describe any current material 
determination of the United States Patent and Trademark Office, the 
United States Copyright office, or a court regarding the patent or 
copyright.''). The language now reads more broadly ``pending in the 
United States Patent and Trademark Office or any court.''
    Finally, Item 14, as proposed in the Franchise NPR, would have 
required franchisors to disclose the ``length of time of any 
infringement.'' However, it is possible that a franchisor may not know 
how long a third party has been infringing its rights. Accordingly, 
Item 14 of the final amended Rule adds the qualifying phrase ``to the 
extent known.''
17. Section 436.5(o) (Item 15): Obligation to participate in the actual 
operation of the franchise business
    Section 436.5(o) of the final amended Rule retains the original 
Rule requirement that franchisors disclose whether franchisees are 
required to participate personally in the direct operation of the 
franchise.\525\ Like the corresponding provision in the Franchise NPR's 
proposed rule, this section of the final amended Rule closely tracks 
the UFOC Guidelines' Item 15. It therefore expands the original Rule on 
this point 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.
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    \525\ See 16 CFR 436.1(a)(14). In the original 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. Original SBP, 43 FR at 
59663.
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    Item 15 generated little comment. In response to the Staff Report, 
NASAA and Washington Securities noted an inconsistency between the 
proposed final amended Rule and the UFOC Guidelines on the disclosure 
of whom a franchisee may hire as an on-premises supervisor and that 
person's training. Whereas the UFOC Guidelines provide that these 
disclosures pertain to all franchisees, the Franchise NPR suggested 
that these disclosures should be limited to franchisees who are 
individuals, but not to business entities.\526\ We agree with the 
commenters that the Franchise NPR's proposed limitation was based upon 
an erroneous reading of the UFOC

[[Page 15495]]

Guidelines, and the final amended Rule makes the appropriate 
correction.
---------------------------------------------------------------------------

    \526\ NASAA, at 5; WA Securities, at 3-4.
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    NASAA also urged the Commission to consider expanding Item 15 to 
include the disclosure of ``operating hours and the method used by 
franchisors to notify franchisees of changes in required operating 
hours.''\527\ The Commission, however, declines to adopt this 
suggestion. While this information might be useful for prospective 
franchisees, it does not rise to the level of materiality such that 
non-disclosure of it may put prospective franchisees in jeopardy of 
being deceived. Moreover, no other commenter raised this point, and in 
the absence of a record dictating that we deviate from the UFOC 
Guidelines, the Commission is reluctant to do so.
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    \527\ NASAA, NPR 17, at 4.
---------------------------------------------------------------------------

    Finally, NASAA and Washington Securities recommended that the 
Commission require franchisors to disclose in Item 15 all agreements 
regarding the franchise that apply to the owners of the franchise.\528\ 
While this suggestion is rooted in the NASAA Commentary on the UFOC 
Guidelines, nothing in Item 15 of the UFOC Guidelines says that 
franchisors must present copies of the actual agreements to prospective 
franchisees. The Commission believes such a requirement would be 
duplicative and burdensome. Franchisors already must include in Item 22 
copies of ``all agreements proposed for use or in use . . . regarding 
the offering of a franchise, including the franchise agreement, leases, 
options, and purchase agreements.'' Presumably, contracts with 
franchise owners would already be disclosed in Item 22. Thus, this 
suggested modification is unnecessary.
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    \528\ NASAA, at 5; WA Securities, at 3-4.
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18. Section 436.5(p) (Item 16): Sales restrictions
    Section 436.5(p) of part 436 retains the original Rule's 
disclosures on sales restrictions. Like other disclosure requirements 
addressing how a franchisee may conduct business, this provision 
requires franchisors to disclose any restrictions limiting the goods or 
services that the franchisee may offer for sale or the customers to 
whom a franchisee may sell goods or services.\529\ Consistent with UFOC 
Guidelines, Item 16 also extends the original Rule disclosures by 
requiring a franchisor to disclose whether the franchisor has the right 
to change the types of goods or 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. No comments were submitted on the Item 16 sales 
restrictions disclosures, and the adopted version is almost identical 
to the version proposed in the Franchise NPR.\530\
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    \529\See 16 CFR 436.1(a)(13). In the original 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. Original SBP, 43 FR at 59661. The 
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 CFR 
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 CFR 425.1(a)(1)(ii) (requiring 
disclosure of post-sale minimum purchase requirements); Disclosure 
of Warranty Terms and Conditions, 16 CFR 701.3(a)(8) (requiring 
material disclosures of limitations and exclusions on warranty 
coverage).
    \530\ The final amended Item 16 is reorganized for greater 
precision and uses more precise language. For example, the final 
amended Item 16 eliminates a redundancy in the Franchise NPR 
regarding the disclosure of any restrictions on customers, which 
appeared in both the introduction to the Item (disclose . . . any 
franchisor-imposed restrictions . . . that limit the franchisee's 
customers) and in the main text (disclose . . . any restrictions on 
the franchisee's customers). The final amended Item 16 also uses 
more precise language, substituting ``disclose [any restrictions] . 
. . that limit access to customers,'' rather than the Franchise 
NPR's inaccurate language ``any restrictions on the franchisee's 
customers.''
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19. Section 436.5(q) (Item 17): Renewal, termination, transfer, and 
dispute resolution
    Section 436.5(q) adopts 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. The final amended Rule provision is almost identical 
to the proposed rule in the Franchise NPR, with only a slight 
modification, described below, with respect to the treatment of the 
term ``renewal.''
    The approach taken in the final amended Rule greatly streamlines 
the original Rule, which required franchisors to detail the rights and 
obligations already spelled out in the franchise agreement.\531\ Item 
17, therefore, reduces compliance burdens, while providing prospective 
franchisees with a detailed road map to the franchise contract, where 
they can read the various provisions in greater detail. At the same 
time, Item 17 expands on the original Rule by requiring disclosures 
pertaining to dispute resolution, including any arbitration or 
mediation requirements, as well as forum-selection and choice of law 
provision disclosures. For each enumerated contract term, the 
franchisor must cross reference the applicable franchise agreement 
provisions and briefly summarize the governing terms.\532\
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    \531\See 16 CFR 436.1(a)(15) (requiring franchisors to describe 
14 categories of terms and conditions).
    \532\ In the original 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.'' Original SBP, 43 FR at 59664. Given the length and 
complexity of the typical franchise agreement, prospective 
franchisees may overlook, or do not fully appreciate, such terms and 
conditions. Id.
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    Most of the comments submitted on Item 17 concerned the use of the 
term ``renewal.'' Franchisee advocates asserted that the term 
``renewal'' is misleading.\533\ 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, that in practice, franchisees who wish to 
continue operating their franchises at the end of the franchise term 
must often sign new contracts that impose materially different terms 
and conditions, such as higher royalty payments or the elimination of 
an exclusive territory. They asserted that renewing 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.\534\ Worse, when a

[[Page 15496]]

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.
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    \533\ 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 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.
    \534\E.g., AFA, NPR 14, at 5; Bundy, NPR 18, at 4; Karp, NPR 24, 
at 20-21; Morrell, NPR 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, 19 Sept. 97 Tr., at 83; Chiodo, ANPR, 21 Nov. 97 
Tr., at 303-04.
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    Several franchisor representatives supported the view that the term 
``renewal'' may be inappropriate. The NFC, for example, stated 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.''\535\ 
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. J&G asserted that the term is potentially 
misleading,\536\ and Tricon urged the Commission to avoid its use 
entirely.\537\
---------------------------------------------------------------------------

    \535\ NFC, NPR 12, at 30.
    \536\ J&G, NPR 32, at 13.
    \537\ Tricon, NPR 34, at 6-7.
---------------------------------------------------------------------------

    On the other hand, several commenters 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.''\538\ Seth Stadfeld, a 
franchisee advocate, agreed, explaining that the term ``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 statutes and should not readily be 
changed.\539\
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    \538\ Baer, NPR 11, at 13. See also IL AG, NPR 3, at 7.
    \539\ Stadfeld, NPR 23, at 15-16. See also NaturaLawn, NPR 26, 
at 2.
---------------------------------------------------------------------------

    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.''\540\
---------------------------------------------------------------------------

    \540\ IL AG, NPR 3, at 7. Similarly, the AFA urged the 
Commission to adopt 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, NPR 14, at 5. See also Bundy, at 7; Bundy, NPR 18, at 5 
(urging the Commission to require franchisors to disclose the 
consequences of renewal).
---------------------------------------------------------------------------

    While the record reveals that there may be confusion over the use 
of the term ``renewal,'' it does not show that use of the term is 
inherently deceptive. The Commission concludes that the term 
``renewal'' is a franchising term of art, meaning that upon the 
expiration of a contract, the franchisees may have the right to enter 
into a new contract, where materially different terms and conditions 
may apply. Moreover, 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, the Commission is disinclined 
to mandate use of a different term or prohibit use of ``renewal.'' At 
any rate, 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. Therefore, the Commission has 
determined not to introduce nonconformity between federal and state 
approaches on the use of this term.
    Nonetheless, the record is persuasive that many prospective 
franchisees may not appreciate the legal import of the term 
``renewal.'' Indeed, franchisees often are surprised to discover that 
``renewal'' means the continuation of their franchise relationship 
under potentially vastly different terms. To prevent potential 
deception with respect to use of the term ``renewal,'' Item 17 of the 
final amended Rule requires franchisors to explain their renewal policy 
in the summary field for provision Item 17(c) (requirements for 
franchisee to renew or extend).\541\ We do not suggest any particular 
form of explanation, however, because that will depend upon the 
individual policies of each franchisor.\542\ If applicable, the 
franchisor must also state that franchisees ``may be asked to sign a 
contract with materially different terms and conditions than their 
original contract.''\543\ 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 instance, given the continued concern raised by franchisee 
advocates and others about renewals.\544\
---------------------------------------------------------------------------

    \541\ In response to the Staff Report, Spandorf opined that Item 
17 as recommended by staff was still confusing, asserting that it 
could mean that a franchisor would have to make the statement about 
renewal even if the franchisor does not offer renewals. Spandorf, at 
7. We do not believe this is a serious concern. Item 17 clearly 
states that franchisors need only address those issues listed in 
Item 17 if applicable. ``If a particular item is not applicable, 
state `Not Applicable.'''
    \542\ One example of a renewal explanation may be: ``If you seek 
to renew your franchise agreement upon expiration, know that royalty 
payments and the size of your exclusive territory may change'' or 
``Upon expiration, you will renegotiate the terms and conditions of 
your contract. Be aware that these terms and conditions may be 
different from those in your original agreement.''
    \543\ Section 436.5(q)(3).
    \544\ In response to the Staff Report, Howard Bundy urged the 
Commission to adopt a negative disclosure whenever a franchisor does 
not offer renewal on the same exact terms as the original agreement: 
``We do not give you the right to renew or extend your franchise on 
the same terms as your current franchise agreement. You should 
consult your franchise attorney about the consequences of this.'' 
Bundy, at 7. We believe the Item 17 requirement that franchisors 
explain what they mean by ``renewal'' is sufficient to address this 
concern.
---------------------------------------------------------------------------

20. Section 436.5(r) (Item 18): Public figures
    Consistent with the UFOC Guidelines, Item 18 requires 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. This section is 
substantively similar to the comparable disclosure provision of the 
original Rule found at 16 CFR 436.1(a)(19).\545\ The final amended Rule 
adopts Item 18 as proposed, with only minor language changes for the 
sake of clarity and improved organization.\546\
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    \545\ In the original 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. 
Original SBP, 43 FR at 59677-78.
    \546\ For example, Item 18 of the Franchise NPR used the 
language: ``Disclose . . . any compensation paid or promised to the 
public figure.'' The final amended Rule substitutes the word 
``given'' for ``paid,'' recognizing that a public figure may be 
``given'' tangible benefits, such as a car, not just a cash payment. 
Accordingly, the term ``given'' is more precise and broader. The 
final amended Rule also improves the organization of Item 18. As 
proposed in the Franchise NPR, Item 18 included the definition of 
``public figure'' upfront, where it interrupted the flow of the 
basic disclosure requirements. Accordingly, Item 18 of the final 
amended Rule is easier to read.
---------------------------------------------------------------------------

    Item 18 generated few comments during the Rule amendment 
proceeding.

[[Page 15497]]

Two commenters questioned the utility of the disclosure. H&H noted that 
this Item is seldom, if ever, applicable and urged the Commission to 
delete it.\547\
---------------------------------------------------------------------------

    \547\ H&H, NPR 9, at 18. 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, NPR 18, at 10. Of the franchisees 
who participated in the Rule amendment 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, 29 July 97 Tr., at 1-32.
---------------------------------------------------------------------------

    The Commission has determined that the information required under 
Item 18 remains material in those instances, relatively uncommon though 
they may be, when a public figure creates his or her own franchise 
system or when a franchisor uses a public figure pitchman. A public 
figure's ownership or management of a franchise system could create the 
impression of greater oversight or influence in the operation of the 
system, making the franchise offering appear to be a less risky 
investment. Similarly, a public figure pitchman's endorsement of a 
franchise system may create the impression that the franchise system is 
sound or a low risk. How much weight a prospect may give a public 
figure endorser's pitch may vary with the level of compensation 
received from the franchisor. If, for example, a pitchman is paid a 
nominal sum, then a prospective franchisee may be inclined to give the 
pitch more weight because the pitchman has little to gain financially 
and thus little motive to fabricate his or her pitch. Accordingly, the 
public figure disclosures concerning level of involvement and 
compensation are material and their potential benefits to prospective 
franchisees would outweigh their costs. To that limited degree, these 
disclosures still serve a useful purpose. In those more typical 
instances when no public figure is involved, Item 18 entails no 
additional compliance burden. On balance, therefore, the Commission is 
disinclined to deviate from the UFOC Guidelines on this point.
21. Section 436.5(s) (Item 19): Financial performance representations
    Section 436.5(s) of part 436, a key anti-fraud provision, addresses 
the making of financial performance representations.\548\ Consistent 
with the original Rule and the UFOC Guidelines, the final amended Rule 
permits, but does not require, franchisors to make such representations 
under limited circumstances. When a franchisor elects to make a 
financial performance claim, the franchisor must, among other things, 
have a reasonable basis for the representation\549\ and disclose the 
basis and assumptions underlying the representation.\550\ Franchisors 
also must include an admonition that a prospective franchisee's actual 
earnings may differ.\551\
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    \548\ In the original 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.''' Original SBP, 43 FR 
at 59684.
    \549\See 16 CFR 436.(1)(b)(2); 436.(1)(c)(2); 436.1(e)(2); UFOC 
Guidelines, Item 19A.
    \550\See 16 CFR 436.1(b)(3); 436.1(c)(3); 436.1(e)(5)(i); UFOC 
Guidelines, Item 19B.
    \551\See 16 CFR 436.1(b)(4); 436.1(c)(5); 436.1(e)(5)(iii); UFOC 
Guidelines, Item 19B Instructions, (c).
---------------------------------------------------------------------------

    Bringing the original Rule's provisions on financial performance 
representations into closer alignment with the UFOC Guidelines entailed 
several deletions or departures from the original Rule. Specifically, 
the final amended Rule differs from the original Rule in that:
    <bullet> It eliminates the requirement that franchisors who decide 
to make financial performance claims provide prospective franchisees 
with a separate financial performance claim document.\552\ Instead, 
consistent with the UFOC Guidelines, it requires any performance claim 
to appear in Item 19 of the disclosure document itself;
---------------------------------------------------------------------------

    \552\See 16 CFR 436.1(d).
---------------------------------------------------------------------------

    <bullet> It eliminates the requirement that all financial 
performance claims be geographically relevant to the franchise offered 
for sale;\553\
---------------------------------------------------------------------------

    \553\See 16 CFR 436.1(b)(1); 436.1(c)(1).
---------------------------------------------------------------------------

    <bullet> It eliminates the requirement that any historical 
financial performance claims must be based upon generally accepted 
accounting principles (``GAAP'');\554\
---------------------------------------------------------------------------

    \554\See 16 CFR 436.1(c)(4); 436.1(e)(2).
---------------------------------------------------------------------------

    <bullet> It permits franchisors, under specific circumstances, to 
disclose, apart from the disclosure document, the actual operating 
results of a specific unit being offered for sale;\555\ and
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    \555\See UFOC Guidelines, Item 19 Instructions i.
---------------------------------------------------------------------------

    <bullet> It permits franchisors to furnish supplemental performance 
information directed at a particular location or circumstance.\556\
---------------------------------------------------------------------------

    \556\See UFOC Guidelines, Item 19 Instructions ii.

For the reasons explained below, the final amended Rule provision, 
however, diverges from Item 19 of the UFOC Guidelines by permitting 
greater disclosure of financial information about subsets of 
franchisor-owned or franchised outlets, provided the franchisor 
discloses specified information about the subset at issue. With certain 
additional refinements described in the following paragraphs of this 
section, including the preamble requirements, Item 19 of the final 
amended Rule closely tracks Item 19 as proposed in the Franchise 
NPR.\557\
---------------------------------------------------------------------------

    \557\ The greatest difference between Item 19 as proposed in the 
Franchise NPR and Item 19 in the final amended Rule is the 
elimination of the GAAP requirement, discussed in greater detail, 
infra.
---------------------------------------------------------------------------

    Nearly all comments on the Item 19 disclosure requirements focused 
on four issues: (1) whether financial performance disclosures should be 
mandatory or voluntary; (2) whether the Rule should permit disclosure 
of financial performance information about geographical or other 
subsets of franchisor-owned or franchised outlets; (3) whether the Rule 
should retain the requirement that historical financial performance 
data be prepared according to GAAP; and (4) whether the Rule should 
require prescribed preambles. Each of these issues is discussed in the 
sections immediately below.\558\
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    \558\ Piper Rudnick's comment on the Staff Report raised an 
issue on a separate topic that the Commission has decided to 
address. The firm noted that there is a problem with section 
436.5(s)(3)(ii)(A) as proposed in the Franchise NPR (and as 
recommended in the Staff Report). Specifically, that provision 
required that the material bases for a financial performance 
representation include a statement of ``the degree of competition in 
the market area.'' Piper Rudnick observed that there may be no 
single ``market.'' If national performance claims are made, it would 
be extremely difficult to describe the ``market.'' As a result, 
franchisors are likely to adopt ``some meaningless boilerplate'' to 
comply. Accordingly, the firm recommended dropping the entire quoted 
phrase. Piper Rudnick, at 3. The Commission has carefully considered 
this point, and has determined that competition is a factor that may 
impact upon a prospective franchisee's ability to achieve 
represented financial performance. A reference to competition 
generally, therefore, is warranted. Nevertheless, the phrase 
``market area'' may be so problematic as to render the particular 
disclosure element meaningless, as the firm predicts. Therefore 
section 436.5(s)(3)(ii)(A) of Item 19 as adopted refers simply to 
``degree of competition,'' without reference to a ``market area.''
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a. Voluntary disclosure of financial performance information
    The Franchise NPR proposed that the making of financial performance 
representations remain voluntary, as was the case under the original 
Rule\559\ and UFOC Guidelines.\560\ Many

[[Page 15498]]

franchisees and their representatives, however, urged the Commission to 
mandate the disclosure of financial performance information.\561\ In 
support of this recommendation, these commenters advanced a number of 
arguments: (1) that financial performance information is the most 
material information prospective franchisees need to make an informed 
investment decision;\562\ (2) that franchisors already have performance 
information and it is a deceptive omission for them to fail to disclose 
this information; (3) that franchisors are in the best position to 
collect and disseminate performance information; (4) that a mandated 
financial performance disclosure would reduce the level of false and 
unsubstantiated oral and written financial performance claims; and (5) 
that more disclosure regarding performance would benefit the 
marketplace and competition.\563\
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    \559\ Franchise NPR, 64 FR 57309-10.
    \560\ UFOC Guidelines, Item 19.
    \561\E.g., AFA, at 2; Bundy, at 7-8; Karp, at 3; Selden, at 2; 
Haff, at 2; Blumenthal, at 1.
    \562\ Karp, ANPR, 19 Sept. 97 Tr., at 100-03. 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.
    \563\See Staff Report, at 159-60; ANPR, 62 FR at 9118. 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, 22 Aug. 97 
Tr., at 46-47.
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    In contrast, franchisors and their advocates uniformly opposed 
mandatory financial performance disclosures, based on the following 
arguments: (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 reasonable performance 
disclosure; (3) financial performance data collected from existing 
franchisees is not necessarily complete and accurate; (4) a mandatory 
performance disclosure would be misinterpreted as a guarantee of future 
performance, thus increasing litigation; and (5) mandating financial 
performance disclosures would have a negative impact upon the 
franchisor-franchisee relationship, subjecting franchisees to more 
extensive accounting oversight and audits.\564\
---------------------------------------------------------------------------

    \564\See Staff Report, at 161-62. E.g., Gust Rosenfeld, at 6; 
Duvall, ANPR 19, at 2; Kaufmann, ANPR 33, at 7; Tifford, ANPR 78, at 
5; Jeffers, ANPR 116, at 5. See also 7-Eleven, NPR 10, at 3 
(suggesting that a typical franchisor would be hard-pressed to 
generate financial performance information without ``very extensive 
and significant effort.''). 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. 
See also AFA, ANPR 62, at 4; IL AG, ANPR 77, at 2; IFA, ANPR 82, at 
3. 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. Cendant, 
ANPR 140, at 2.
---------------------------------------------------------------------------

    Based upon its assessment of the record as a whole, the Commission 
concludes that financial performance representations should remain 
voluntary. In reaching this conclusion, we recognize that false or 
misleading financial performance claims are the most common allegation 
in Commission franchise law enforcement actions.\565\ However, there is 
no assurance that mandating performance claims will in fact reduce the 
level of false claims. Given that many different industries are 
affected by part 436, what makes a financial performance disclosure 
reasonable, complete, and accurate is quite varied. Thus, the 
Commission will not mandate a particular set of financial performance 
disclosures. However, if a franchisor chooses to make such disclosures, 
they, of course, must be reasonable, non-misleading, and accurate.
---------------------------------------------------------------------------

    \565\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 
ABD (RNBx) (C.D. Cal. 2000); FTC v. Tower Cleaning Sys., Inc., 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., Inc., 
No. 95-6137-CIV-Gonzalez (S.D. Fla. 1995); FTC v. Mortgage Serv. 
Assoc., Inc., No. 395-CV-1362 (AVC) (D. Conn. 1995); FTC v. Robbins 
Research Int'l, Inc., No. 95-CV-627-H(AJB) (S.D. Cal. 1995); FTC v. 
Sage Seminars, Inc., No. C-95-2854-SBA (N.D. Cal. 1995). See 
generally Vidulich, 22 Aug. 97 Tr., at 18-19; Marks, 19 Sept. 97 
Tr., at 2-3; Fetzer, 19 Sept. 97 Tr., at 40-41.
---------------------------------------------------------------------------

    Mandating financial performance disclosures would also impose 
substantial new accounting, data collection, and review costs on all 
franchise systems. At the same time, it potentially could expose 
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.
    Further, the record reveals that approximately 20% or more of 
franchisors choose to make financial performance disclosures.\566\ 
Accordingly, prospective franchisees 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 might compel an 
increasing number of franchisors to disclose earnings information 
voluntarily, without a federal government mandate. More important, a 
disclosure document is not the only potential source of financial 
performance information. Prospective franchisees can obtain financial 
performance information from a variety of third-party sources. For 
example, typical expenses, such as labor and rent, may be available 
from industry trade associations and industry trade press. Prospective 
franchisees may be able to discuss earnings and other financial 
performance issues directly with current and former franchisees, as 
well as with trademark-specific franchisee associations. For these 
reasons, we conclude that financial performance representations should 
remain voluntary, consistent with the original Rule and UFOC 
Guidelines.
---------------------------------------------------------------------------

    \566\See, e.g., Bortner, ANPR 37, at 3; NASAA, ANPR 43, at 3.
---------------------------------------------------------------------------

b. Geographic relevance and subgroups
    As noted above, Item 19 of the final amended Rule eliminates the 
original Rule's geographic relevance requirement for financial 
performance representations.\567\ This brings the Rule's financial 
performance disclosure requirements into closer alignment with Item 19 
of the UFOC Guidelines,\568\ as proposed in the Franchise NPR.\569\
---------------------------------------------------------------------------

    \567\See 16 CFR 436.1(b)(1); 436.1(c)(1). The original Rule's 
geographic relevance prerequisite was designed to ensure that a 
financial performance representation was reasonable in light of the 
opportunity being offered for sale. In short, geographic relevance 
``helps to ensure that the representation reflects what the 
franchisee is likely to achieve.'' Original SBP, 43 FR at 59691.
    \568\ 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. In contrast, the original Rule barred such a 
performance claim because such claim is not geographically relevant 
to the prospective franchisee's territory--Florida.
    \569\ Franchise NPR, 64 FR at 57310.
---------------------------------------------------------------------------

    At the same time, the final amended Rule deviates from the 
Franchise NPR by omitting the UFOC Guidelines' requirement that 
franchisors disclose the number and percentage of all

[[Page 15499]]

existing outlets known to have attained a represented performance 
level.\570\ Rather, for the reasons explained below, Item 19 of the 
amended Rule is consistent with the original Rule in requiring 
franchisors to disclose the number and percentage of existing outlets 
known to have attained the represented performance level in the area 
that formed the basis for the representation.\571\
---------------------------------------------------------------------------

    \570\ Item 19B ii of the UFOC Guidelines instructions requires 
``a concise summary of the basis for the claim including a statement 
of whether the claim is based upon actual experience of franchised 
units and, if so, the percentage of franchised outlets in operation 
for the period covered by the earnings claims that have actually 
attained or surpassed the stated results.'' The original Rule did 
not include any counterpart requirement. The original Rule contained 
the same broad number and percentage requirements only for financial 
performance claims made in the general media. 16 CFR 
436.1(e)(5)(ii).
    \571\ 16 CFR 436.1(b)(5)(i); 16 CFR 436.1(c)(6)(i).
---------------------------------------------------------------------------

    The UFOC Guidelines require a franchisor to 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 nine out of 10 franchised stores in a 
particular location (such as Seattle) average $100,000 net profit a 
year. Yet, the UFOC Guidelines prevent the franchisor from disclosing 
truthful information about the universe the franchisor had 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. 
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 records. More important, a franchisor 
may decline to disclose performance information if, in order to do so, 
it must first incur the expense of conducting a system-wide franchisee 
performance analysis.
    To correct this problem, Item 19 of the revised Rule permits 
franchisors to disclose truthful financial performance information 
about a subgroup of existing franchisees under limited conditions.\572\ 
Specifically, the financial information furnished to prospective 
franchisees must have a reasonable basis and the franchisor must 
disclose: (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, and likely 
competition).\573\
---------------------------------------------------------------------------

    \572\ This approach to financial performance substantiation, as 
proposed in the Franchise NPR and recommended in the Staff Report, 
prompted few comments from any of the participants in this 
proceeding.
    \573\See Gust Rosenfeld, at 6 (supporting option of marking 
financial performance representations based upon sub-group data).
---------------------------------------------------------------------------

    Few commenters addressed the revision of Item 19. Among those that 
commented on Item 19, a few specifically supported the elimination of 
the separate geographic relevance prerequisite.\574\ On the other hand, 
IL AG voiced concern that eliminating the geographic relevance 
requirement would not prevent franchisors from ldquo;cherry picking'' 
their best performing franchise locations and then allowing prospects 
to assume that their performance results will be similar.\575\
---------------------------------------------------------------------------

    \574\ ``[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, NPR 28, at 11. See also Baer, NPR 11, at 13.
    \575\ IL AG, NPR 3, at 7.
---------------------------------------------------------------------------

    At the same time, other commenters supported allowing financial 
performance claims based on franchisee subgroups with the specified 
substantiation requirements. John Baer, for example, maintained that 
the 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.''\576\ 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.''\577\
---------------------------------------------------------------------------

    \576\ Baer, NPR 11, at 14.
    \577\ Marriott, NPR 35, at 11. But see PMR&W, NPR 4 (suggesting 
that these provisions may deter the dissemination of financial 
performance information).
---------------------------------------------------------------------------

    Based upon the record, the Commission has concluded that 
eliminating the geographic relevance requirement, coupled with 
permitting broader disclosure of financial performance of subgroups, 
will remove obstacles that discourage franchisors from making financial 
performance data available to prospective franchisees. At the same 
time, Item 19 prevents franchisors from ``cherry picking'' their best 
locations as a basis for financial performance representations. 
Specifically, Item 19's substantiation requirements 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 require franchisors to 
disclose the material differences between the subgroup-units tested and 
the units being offered for sale, so that prospects can avoid drawing 
unreasonable inferences from the representations.
c. GAAP
    As noted, Item 19 of the final amended Rule eliminates the original 
Rule requirement that historical financial performance data must be 
prepared according to GAAP.\578\ The Franchise NPR proposed retention 
of this requirement.\579\ 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 the 
accounting rules would discourage the making of financial performance 
representations:
---------------------------------------------------------------------------

    \578\ See 16 CFR 436.1(c)(4) and 436.1(e)(2). The Commission 
adopted the original GAAP requirement to address concerns about the 
validity of franchisee financial statements used by franchisors to 
make historical financial performance representations. 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.'' Original SBP, 43 FR at 59691. 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.
    \579\ Franchise NPR, 64 FR at 57341, note 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.''

     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

[[Page 15500]]

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.\580\
---------------------------------------------------------------------------

    \580\ NASAA, NPR 17, at 5. See also Bundy, at 7; Gust Rosenfeld, 
at 6; PMR&W, NPR 4, at 12; H&H, NPR 9, at 13; NFC, NPR 12, at 31; 
Lewis, NPR 15, at 15; Snap-On, NPR 16, at 3; J&G, NPR 32, at 7; 
Marriott, NPR 35, at 12; IL AG, Rebuttal NPR 38, at 5. Based on the 
comments, particularly those submitted by NASAA, the Staff Report 
recommended elimination of the GAAP requirement. Staff Report, at 
166-67.
---------------------------------------------------------------------------

    Based upon an assessment of the record, the Commission has 
determined 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 not 
the only approach to ensure the accuracy of historic performance data. 
Franchisors making historical performance representations should have 
the flexibility to formulate such representations, provided that such 
representations are truthful and 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 
historic performance representations, without any pattern of deception 
identified by the states. Finally, eliminating the GAAP requirement is 
likely to reduce compliance burdens, while bringing greater uniformity 
to federal and state disclosure law.
d. Preambles
    As noted above, Item 19 of the final amended Rule differs from the 
original Rule and the UFOC Guidelines by requiring franchisors to 
include prescribed preambles in their Item 19 disclosures. The preamble 
requirements are incorporated in Item 19 as proposed in the Franchise 
NPR.\581\ The preamble requirements 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.\582\ Second, our law enforcement 
experience tells us that prospective franchisees may rely on 
unsubstantiated financial performance representations.\583\
---------------------------------------------------------------------------

    \581\ Franchise NPR, 64 FR 57311 and 57341. Slight wording 
changes have been made to improve overall clarity and consistency, 
and the sentence ``If you are purchasing an existing outlet, 
however, we may provide you with the actual records of that 
outlet,'' to conform with the Rule's substantive liberalization on 
this point.
    \582\E.g., Bundy, at 7; 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.
    \583\E.g., FTC v. Minuteman Press, Int'l, No. 93-CV-2494 (DRH) 
(E.D.N.Y. 1998). See also Franchise NPR, 64 FR at 57311; ANPR, 62 FR 
at 9118.
---------------------------------------------------------------------------

    To prevent deception arising from these two practices, Item 19 
requires franchisors to include in their Item 19 disclosures a 
prescribed preamble stating that the Rule permits the making of 
financial performance representations, if the representations are set 
forth in the franchisor's disclosure document.\584\ This statement 
counters any suggestion that the Franchise Rule prohibits franchisors 
from disclosing financial performance information. Armed with such 
material information, prospective franchisees could question why a 
franchisor does not provide financial performance data, if they wish, 
or shop for a system that discloses financial performance information. 
In addition, this preamble will discourage prospects from relying on 
unauthorized financial performance claims made outside of the 
disclosure document.
---------------------------------------------------------------------------

    \584\ The first preamble reads:
    ``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 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 possible performance at a particular location or 
under particular circumstances.''
---------------------------------------------------------------------------

    For those franchisors who elect not to disclose financial 
performance information, Item 19 requires 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.\585\
---------------------------------------------------------------------------

    \585\ The second preamble reads:
    ``We do 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.''
---------------------------------------------------------------------------

    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.''\586\
---------------------------------------------------------------------------

    \586\ AFA, NPR 14, at 3. Several commenters confirmed that such 
misrepresentations are prevalent and urged the Commission to clarify 
the Rule to combat them. For example, the CA BLS stated:
    ``Franchisees have reported to certain members of the California 
Franchise Legislative Committee that franchisor salespersons 
informed them during the pre-sale discussions in the offer and sale 
of a franchise that the FTC Rule prohibited 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.
---------------------------------------------------------------------------

    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.''\587\
---------------------------------------------------------------------------

    \587\ 7-Eleven, NPR 10, at 3. See also IFA, NPR 22, at 11; 
Stadfeld, NPR 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, NPR 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).

---------------------------------------------------------------------------

[[Page 15501]]

    At the same time, the Commission has rejected various suggestions 
to require more strongly worded preambles. For example, Eric Karp would 
amplify the second preamble to warn prospects that, although the 
franchisor collects financial information, it does not disclose any, 
and he suggested including the phrase, ``Consider why we are unwilling 
to do so.''\588\ In effect, these commenters would turn the absence of 
a financial performance claim into a risk factor. The Commission 
rejects this approach. It does not necessarily follow that the absence 
of a financial performance disclosure necessarily signals a riskier 
investment. It could well be that a company bent on defrauding 
prospective franchisees would manipulate its numbers to create a 
stronger success image, while a successful but punctilious system might 
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 turnover rates, as 
well as the names and addresses of current and former franchisees, who 
can be contacted for information.
---------------------------------------------------------------------------

    \588\ Karp, at 3. In the same vein, Howard Bundy would 
strengthen the second preamble 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, NPR 18, at 10.
---------------------------------------------------------------------------

22. Section 436.5(t) (Item 20): Outlets and franchisee information
    Section 436.5(t) of the final amended Rule retains the original 
Rule's requirement that franchisors disclose the number of franchised 
and franchisor-owned outlets; the names, business addresses, and 
business telephone numbers of current franchised outlets, and 
statistical information on franchise turn-over rates, in particular the 
number of franchises voluntarily and involuntarily terminated, not 
renewed, and reacquired by the franchisor.\589\ To align the final 
amended Rule more closely to the UFOC guidelines, it also extends the 
original Rule by requiring franchisors to disclose the names, business 
addresses, and business telephone numbers of at least 100 current 
franchised outlets (as opposed to the original Rule requirement of at 
least 10 franchised outlets).\590\ It also requires the disclosure of 
some contact information for former franchisees\591\ who have left the 
franchise system in the last fiscal year. Finally, it also makes the 
disclosure more user-friendly than it was in the original Rule by 
requiring the statistical information to be presented in a tabular 
format.
---------------------------------------------------------------------------

    \589\See 16 CFR 436.1(a)(16). In the original 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 goes to 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.'' Original SBP, 43 FR at 
59670. See also ANPR,
    62 FR at 9118. In addition, the disclosure of contact 
information for current franchisees prevents fraud by arming 
prospects with a valuable alternative source of information with 
which to verify franchisor's representations. Id.
    \590\ UFOC Guidelines, Item 20B.
    \591\ Current and former franchisees often have widely different 
experiences. For that reason, in Blenheim Expositions, Inc., 120 FTC 
1078 (1995), the Commission challenged as a violation of Section 5, 
franchisee success claims based upon a Gallup Poll study of current 
franchisees only.
---------------------------------------------------------------------------

    Item 20 of the final amended Rule differs from the UFOC Guidelines 
model in several respects. First, it corrects a double-counting problem 
brought to the Commission's attention during the Rule Review. Second, 
it requires more limited disclosure of personal contact information of 
former franchisees.\592\ Third, when a franchisor resells a specific 
outlet it has reacquired, it mandates that the franchisor disclose the 
outlet's prior franchisee-owners during the franchisor's last five 
fiscal years. Fourth, it addresses franchisors' use of 
``confidentiality clauses,'' which effectively restrict franchisees 
from discussing their experiences with prospective franchisees. 
Finally, it requires the disclosure of trademark-specific franchisee 
associations.\593\ We address each of these issues below.
---------------------------------------------------------------------------

    \592\ The UFOC Guidelines require the disclosure of names, last 
known home address, and telephone number of each franchisee who left 
the system within the last fiscal year. UFOC Guidelines, Item 20E. 
The purpose of the disclosure is to reduce fraud by enabling 
prospective franchisees to learn about the nature of the franchise 
system and, most important, the nature of the franchise relationship 
from those who recently exited the system, voluntarily or 
involuntarily. To reduce inconsistencies between with the UFOC 
Guidelines, the Franchise NPR followed the same approach. Franchise 
NPR, 64 FR at 57343. As explained below, however, Item 20, as 
proposed in the Franchise NPR, would require the disclosure of 
personal information, raising privacy concerns. For that reason, the 
Commission has adopted a more limited approach in the final amended 
Rule.
    \593\ The provision does 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.
---------------------------------------------------------------------------

a. Double-counting
    As proposed in the Franchise NPR, the final amended rule avoids a 
problem with the UFOC Guidelines' version of Item 20.\594\ Like the 
UFOC Guidelines, the final amended Rule Item 20 requires 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 proceeding, no commenters opposed this requirement 
in principle, but commenters almost unanimously voiced concern that 
UFOC Item 20 is seriously flawed and needs to be fixed.\595\ 
Specifically, UFOC Item 20 often results in franchisors ``double-
counting'' changes in franchised outlet ownership, resulting in 
inflated turnover rates.
---------------------------------------------------------------------------

    \594\ The problems with the UFOC Guidelines' Item 20 first 
surfaced during the Rule review that preceded initiation of the rule 
amendment proceeding. Simon, RR Tr., at 223-24; Maxey, RR Tr., at 
224-25. To develop a record on this issue, the ANPR solicited 
comment on whether UFOC Guidelines Item 20 accurately reflects 
franchisees' performance history and, if it does not, how the 
Commission could modify the Item 20 disclosures to reflect 
performance history more accurately. ANPR, 62 FR at 9116. In 
response to the ANPR, several commenters confirmed that Item 20 
results in ``double-counting'' of franchise turnover rates. 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, 19 Sept. 97 Tr., at 91. Accordingly, in the Franchise NPR, the 
Commission attempted to address the identified problems with the 
UFOC version. Franchise NPR, 64 FR at 57342-44. However, commenters 
criticized proposed Item 20 of the Franchise NPR as inadequate to 
solve the problem. E.g., IL AG, NPR 3, at 7; PMR&W, NPR 4, at 13-14; 
H&H, NPR 9, at 19; Snap-On, NPR 16, at 4; NASAA, NPR 17, at 5; Karp, 
NPR 24, at 11; Frandata, NPR 29, at 10. At that time, NASAA, in 
consultation with an Industry Advisory Committee, developed a 
comprehensive revamping of Item 20, which it submitted in its 
Franchise NPR comments. NASAA, NPR 17, at 5-10. Several additional 
commenters either submitted the same proposal or endorsed the NASAA 
proposal. PMR&W, NPR 4, at 14-66 and Exhibit A; NPC, NPR 12, at 31-
32; Frandata, NPR 29, at 11. The Staff Report recommended adoption 
of NASAA's suggested revamping of Item 20. Staff Report, at 180. No 
Staff Report comments offered further criticism of the staff's 
recommendation for revising Item 20.
    \595\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, 19 Sept. 97 Tr., at 91; Simon, RR, Sept.95 
Tr., at 223-24.
---------------------------------------------------------------------------

    The Commission believes that the UFOC Guidelines' ``double-
counting'' problem is attributable to at least two factors. First, UFOC 
Item 20 requires franchisors to report changes in

[[Page 15502]]

franchised outlet ownership according to five enumerated categories: 
(1) transferred; (2) canceled or terminated; (3) not renewed; (4) 
reacquired by the franchisor; or (5) reasonably known to have ``ceased 
to do business.'' The terms describing these categories, however, are 
undefined. The absence of precise definitions blurs the line between 
categories, resulting in a double-counting of outlet closures.\596\ For 
example, a single transaction can quite correctly be characterized as 
either a transfer or a reacquisition. They are often two sides of the 
same coin: a franchisor's assumption of control of a franchised outlet 
that has gone out of business reasonably could be captured either as a 
transfer by the franchisee, or as a reacquisition by the franchisor.
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    \596\See UFOC Item 20D. See also Wieczorek, ANPR, 18 Sept. 97 
Tr., at 31.
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    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.\597\ 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. In such a case, 
UFOC Item 20 arguably calls for the franchisor to report a termination 
followed by a reacquisition as two separate events. Similarly, a 
franchisee may abandon an outlet, and, in response, the franchisor may 
send the franchisee a termination letter, reacquire the outlet, and 
then transfer it to a new franchisee. Although the outlet has changed 
franchisee-ownership only once, the franchisor conceivably would report 
this event four times as a ceased to do business, termination, 
reacquisition, and transfer.\598\
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    \597\ For a detailed discussion of this issue, see Franchise 
NPR, 64 FR at 57312; Staff Report, at 173-77.
    \598\ While the UFOC Item 20 instructions provide that the 
franchisor can add footnotes to clarify the numbers, the use of 
multiple explanatory footnotes removes the benefit of presenting 
information in a readily accessible tabular format. In addition, 
prospective franchisees may not read or fully appreciate the import 
of the footnotes. See Zarco & Pardo, ANPR 134, at 6-7 (``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.'').
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    The final amended Rule remedies the imprecision that characterized 
the delineated reporting categories. Item 20 of the final amended Rule 
sets forth precise definitions to avoid overlapping categories. 
Specifically, ``termination'' means ``the franchisor's termination of a 
franchise agreement prior to the end of its term and without paying 
consideration to the franchisee (whether by payment or forgiveness or 
assumption of debt).'' ``Non-renewal'' occurs ``when the franchise 
agreement for a franchised outlet is not renewed at the end of its 
term.'' ``Reacquisition'' means ``the franchisor's acquisition of an 
outlet for consideration (whether by payment or forgiveness or 
assumption of debt) of a franchised outlet during its term.'' 
``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.''\599\
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    \599\ Staff Report, at 48-53. The definitions of the terms 
``transfer'' and ``reacquisition'' are the same as those proposed in 
the Franchise NPR, with minor reorganization for clarity. The 
definitions of the terms ``termination'' and ``non-renewal,'' 
however, have been revised for greater precision. Specifically, the 
Franchise NPR defined the terms ``termination'' and ``non-renewal'' 
as occurring when the franchisor sends out an ``unconditional notice 
of intent'' to exercise its rights to terminate or not to renew, 
respectively. Franchise NPR, 64 FR at 57343. One commenter noted, 
however, that these proposed definitions are inaccurate, noting that 
``intent to exercise'' rights does not ``necessarily result in the 
completion of the event.'' PMR&W, NPR 4, at 13. The Commission 
agrees. In addition, the final amended Rule deletes the proposed 
definition for ``cancellation''--which would have been similar to 
the definition for ``termination''--because the ``cancellation'' 
reporting category has been deleted from Item 20 because it is 
duplicative of other reporting categories (termination, non-renewal, 
or ceased operations). No commenters raised any concerns in response 
to the Staff Report's revised definitions of the terms 
``termination'' and ``non-renewal.''
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    Beyond better defined reporting categories, commenters offered 
various suggestions to improve Item 20.\600\ The approach suggested by 
NASAA garnered the most support. NASAA asserted that UFOC Item 20 needs 
to be revised in its entirety and, as noted above, submitted for the 
Commission's consideration an alternative that was produced with the 
assistance of an Industry Advisory Committee.\601\ Several other 
commenters submitted the same proposal or endorsed the NASAA 
proposal.\602\ The Staff Report recommended that the NASAA suggestion 
be incorporated into the final amended Rule. After careful 
consideration, the Commission has determined to adopt NASAA's proposal. 
It is the best way to solve the Item 20 double-counting problem. It 
will be easily understood by those in the industry, and it will provide 
prospective franchisees with the information they need without imposing 
undue compliance burdens on franchisors.
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    \600\ Three commenters suggested that the Commission address 
double-counting by adding additional reporting 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 re-franchised; (3) transfers by 
franchisee directly to new franchisee; and (4) transfers by 
franchisee directly to new franchisee more than once. 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 franchisor-owned, as well as distinguish between 
units not renewed by franchisor and units not renewed by 
franchisee). 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 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.'' AFA, ANPR 62, at 3. Another 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. He advised that 
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, he suggested that 
reacquisitions should be moved to the second Item 20 table 
concerning franchisor-owned outlets. Wieczorek, ANPR 122, at 3-4. 
Mr. Wieczorek attached sample tables for the Commission's 
consideration. Id.
    \601\ NASAA, NPR 17, at 5-10.
    \602\See, e.g., Gust Rosenfeld, at 6; PMR&W, NPR 4, at 14-66 and 
Exhibit A; NFC, NPR 12, at 31-32; Frandata, NPR 29, at 11.
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    Accordingly, Item 20 of the final amended Rule contains five 
tables. Table No. 1 indicates the status of a franchisor's system. It 
shows 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.\603\
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    \603\ The instructions to Table No. 1--section 436.5(t)(1)--
defines ``outlet'' to include ``outlets of a type substantially 
similar to that offered to the prospective franchisee.'' Piper 
Rudnick urged the Commission to clarify the phrase ``substantially 
similar'' further in the Compliance Guides. Specifically, the firm 
recommended that ``substantially similar'' should be limited to 
where the outlet does ``business under the same trademark and 
system.'' Piper Rudnick, at 6. We disagree. Section 436.5(t)(1)'s 
``substantially similar'' outlet disclosure serves an important 
anti-fraud purpose, ensuring that a franchise system does not simply 
sell outlets under a new name in order to hide a poor growth record 
or high turnover history. For that reason, the focus of the 
disclosure is properly on the similarities between the goods or 
services sold at the outlets, not the name under which the outlets 
conduct business.
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    Table No. 2 shows transfers, treating them separately from 
terminations and non-renewals. This is appropriate because, as NASAA 
observed, transfers do not affect the total number of outlets in a 
franchise system, and the mere fact that an outlet has been transferred 
tells nothing about the reason for the transfer: ``While some transfers 
are

[[Page 15503]]

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.''\604\ 
Nonetheless, the total number of transfers within a system is material 
because it goes to the stability within the franchise system over time. 
Table No. 2 indicates the number of franchise transfers in each state 
over the last three fiscal years.
---------------------------------------------------------------------------

    \604\ NASAA, NPR 17, at 8.
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    Table No. 3 tracks the turnover rate of franchised outlets.\605\ 
Franchisors must report, by state and for each of the last three fiscal 
years, the outlets at the start of the year, new outlets opened, 
terminations, non-renewals, reacquisitions by the franchisor, outlets 
that ceased to do business,\606\ and outlets at the end of the year.
---------------------------------------------------------------------------

    \605\ To reduce double-counting, Item 20 specifies that multiple 
events are to be reported using a ``last-in-time'' approach. See 
PMR&W, NPR 4, at 13-14. See also NASAA, NPR 17, at 5-10; Frandata, 
NPR 29, at 11. During the Rule amendment proceeding, other 
commenters offered other options, such as a ``first-in-time'' 
approach, or establishing an order of priority among events. We are 
persuaded that a last-in-time approach is appropriate, for the 
reasons noted in the PMR&W comment: ``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.'' PMR&W, NPR 4, at 13-14.
    \606\ The instructions accompanying Table No. 3 include the 
statement that the franchisor must, in column 8 of the table, 
``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, non-renewal, or reacquisition by the 
franchisor.''
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    Table No. 4 tracks the turnover at company-owned outlets. 
Franchisors must disclose, for each of the last three fiscal years, the 
number of 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.
    Finally, Table No. 5 retains the current UFOC 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.
    During the Rule amendment proceeding, Eric Karp submitted a 
variation of the NASAA proposal for the Commission's consideration that 
would greatly expand the NASAA proposal. For example, according to the 
Karp proposal, Table No. 2 would require franchisors to 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. His Table No. 3 would divide new outlets into two categories: new 
outlets that are newly developed and new outlets that were purchased 
from a franchisor. Mr. Karp also 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. Finally, 
Mr. Karp would revise the new growth projection chart, requiring 
franchisors to disclose for each of the last three fiscal years: 
previously projected franchised new outlets; actual number of 
franchised new outlets; franchise agreements signed but outlets not in 
operation; and projected franchised new outlets for next fiscal 
year.\607\
---------------------------------------------------------------------------

    \607\ Karp, at 4; Karp, NPR 24, at 14-19.
---------------------------------------------------------------------------

    The Commission is not persuaded to expand Item 20 as Mr. Karp 
suggested. The additional proposed disclosures would greatly increase 
the size of the already extensive Item 20 disclosure, potentially 
overwhelming prospective franchisees while increasing franchisor 
compliance costs. Further, to streamline the Rule and reduce 
inconsistencies with the UFOC Guidelines, we are disinclined to add new 
Item 20 charts that merely restate information that can already be 
gleaned from the existing charts. For example, the amended Item 20 
disclosures enables prospective franchisees to calculate turnover rates 
for themselves from the data contained in Tables 1 and 3 by comparing 
outlets at the beginning of a fiscal year with the number of outlets 
closed during the year.
b. Identification of former franchisees
    Section 436.5(t)(5) of the final amended Rule adopts the Franchise 
NPR proposal that franchisors disclose contact information for 
franchisees who have exited the franchise system in the most recently 
completed fiscal year, consistent with the UFOC Guidelines.\608\ This 
disclosure, like the parallel disclosure of contact information for 
current franchisees, prevents fraud by giving prospective franchisees 
additional sources of material information about the franchisor, the 
nature of the franchise system and the franchisor-franchisee 
relationship. As explained below, the final amended Rule provision 
differs from the UFOC Guidelines and the Franchise NPR proposal, 
however, to address privacy concerns regarding the disclosure of 
personal contact information.\609\
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    \608\ UFOC Guidelines Item 20 E. In contrast, the comparable 
provision of the original Rule required the disclosure of only the 
number of franchisees who left the system within the last fiscal 
year. 16 CFR 436.1(a)(16).
    \609\ No commenter--including current and former franchisees--
raised any privacy concerns during the course of the Rule amendment 
proceeding. Accordingly, this was not addressed in the Staff Report.
---------------------------------------------------------------------------

    The Franchise NPR, incorporating UFOC Guidelines Item 20, would 
have required franchisors to disclose the name and last known home 
address and telephone number of every franchisee that exited the system 
within the last fiscal year.\610\ While the Commission believes that 
such information serves a valuable anti-fraud purpose--enabling 
prospective franchisees to obtain material information from those with 
hands-on experience with the franchise system--it can be achieved in a 
more limited fashion that also protects former franchisees' privacy--
notwithstanding that this type of information may be available in the 
public domain from such sources as telephone directories. To that end, 
the final amended Rule provision requires franchisors to disclose only 
the name, city and state, and current business telephone number, or, if 
unknown, the last known home telephone number of former franchisees. 
Further, to give prospective franchisees notice that their contact 
information may be disclosed even after they leave the franchise 
system, franchisors must state the following language in immediate 
conjunction with the list of former franchisees: ``If you buy this 
franchise, your contact information may be disclosed in the future to 
other buyers when you leave the franchise system.''\611\ To allow for 
greater flexibility, footnote 10 to the final amended Rule provides 
that franchisors may substitute alternative contact

[[Page 15504]]

information at the request of the former franchisee, such as a home 
address, post office address, or a personal or business email address.
---------------------------------------------------------------------------

    \610\ In contrast, the disclosure of current franchisees' 
contact information is limited to their business address and 
business telephone number.
    \611\ This approach is similar to the proposed disclosure of 
current business opportunity buyers' contact information in recently 
published Business Opportunity Rule Notice of Proposed Rulemaking, 
71 FR 19054, 19071 (Apr. 12, 2006).
---------------------------------------------------------------------------

c. Identification of former franchisee-owners of a specific outlet 
being resold
    Section 436.5(t)(6) of the final amended Rule extends the original 
Rule and UFOC Guidelines Item 20 by addressing turnover at a specific 
outlet. When a franchisor resells an outlet under its control that was 
previously owned by a franchisee,\612\ Item 20 requires the franchisor 
to disclose contact information for each previous owner of that outlet, 
the time period when the previous owner controlled the outlet; the 
reason for each previous ownership change; and the time period(s) when 
the franchisor retained control of the outlet. As explained below, this 
provision is designed to prevent fraud in the resale of a specific 
franchised outlet, by giving prospective purchasers of that outlet 
sources of information with hands-on experience operating the 
outlet.\613\
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    \612\ This modifies slightly the version of Item 20 set forth in 
the Staff Report, which stated: ``If a franchisor is selling an 
existing franchised outlet, disclose the following additional 
information . . .'' Staff Report, at 181 and proposed revised Rule, 
64 FR at 57342-44. Two commenters correctly noted that this language 
is ambiguous because ordinarily a franchisor does not sell an 
existing franchised outlet. Rather, a franchisor may sell an outlet 
in its control that was previously owned by a franchisee. Wiggin & 
Dana, at 3; J&G, at 6. We agree. This provision applies only where 
the franchisor has reacquired or otherwise gained control of an 
outlet. It would not apply where an existing franchisee merely asks 
for the franchisor's assistance in transferring an outlet to a new 
owner.
    \613\ As discussed in the previous section in connection with 
the disclosure of contact information for former franchisees, the 
disclosure of contact information for former franchisees of a 
specific outlet differs from the Franchise NPR proposal to address 
privacy issues. To protect the privacy of former franchisee-owners 
of a specific outlet, the amended Item 20 requires the disclosure of 
only the name, city and state, business telephone number, or, if 
unknown, last known home telephone number of the former franchisee-
owners.
---------------------------------------------------------------------------

    During the Rule amendment proceeding, the IL AG asserted that a 
number of successive sales of a franchised outlet 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 outlet 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.''\614\
---------------------------------------------------------------------------

    \614\ IL AG, NPR 3, at 7. See also Singler, at 1. This provision 
also complements Item 19 provision that permits a franchisor to 
provide supplemental financial performance information about a 
specific unit being offered for sale. In order to prevent 
misrepresentation, a prospective franchisee should be able to speak 
with former owners of a specific unit being offered for sale when a 
franchisor provides financial performance information about that 
specific unit.
---------------------------------------------------------------------------

    The Commission agrees, but is convinced that a five-year reporting 
period is warranted in order to allow sufficient time to identify a 
trend.\615\ As noted throughout this document, the Commission believes 
that more disclosure is warranted to give prospective franchisees 
information about the quality of the relationship between the 
franchisor and franchisee. Information about franchise operations at a 
specific unit advances that goal. Surely, significant turnover at a 
particular location might indicate a lack of promised support for the 
location, or worse, as the IL AG explained, a possible franchisor 
strategy to have the franchisee fail in order to resell the unit. We 
believe any compliance costs to the franchisor, therefore, are 
outweighed by the countervailing benefits to prospective franchisees.
---------------------------------------------------------------------------

    \615\ We note that the Staff Report urged the Commission to 
adopt a three-year reporting period, while the text of the proposed 
revised Rule attached to the Staff Report stated a five-year 
reporting period. Compare Staff Report, at 181 with proposed revised 
Rule, at 56. Some commenters urged the Commission to adopt a three 
year reporting period, Wiggin & Dana, at 3, while others said that 
even a five-year period is insufficient to ``discern the most 
egregious trends''). Singler, at 2. We are convinced that a three-
year reporting period is too short to expose a trend of specific 
unit sales. For example, a single unit could be resold three times: 
once immediately before a three-year reporting period, a second time 
during a three-year period, and a third time immediately after the 
three-year period. In such a scenario, a three-year reporting period 
would capture only one resale. We believe a five-year reporting 
period strikes the right balance between ensuring material 
disclosure and reducing compliance burdens.
---------------------------------------------------------------------------

    In response to the Staff Report, two commenters raised questions 
about the application of this provision. Specifically, they observed 
that a franchisor might not have a particular unit in mind when it 
begins negotiations with a prospective franchisee. They speculated as 
to whether this provision would be triggered if a franchisor were to 
direct a prospect to a particular unit after the franchisor has 
furnished the prospect with a disclosure document. In particular, they 
noted that it would be an open question under state law as to whether a 
franchisor would have to redisclose including unit-specific 
disclosures, and whether redisclosure would trigger an additional 14 
days before signing the agreement.\616\
---------------------------------------------------------------------------

    \616\ Wiggin & Dana, at 4; J&G, at 6.
---------------------------------------------------------------------------

    The commenters urged that a franchisor be permitted to furnish the 
unit-specific disclosures outside the disclosure document, just as a 
franchisor may make supplemental financial performance claims outside 
of the disclosure document without triggering a redisclosure 
obligation.\617\ The Commission believes these comments are well-taken. 
The purpose of this provision is to provide prospective franchisees 
with material information about a specific unit being considered for 
purchase. The need for furnishing this information must be balanced 
against the legitimate concerns of franchisors about compliance costs. 
On balance, the Commission is persuaded that a franchisor who 
recommends a specific unit after having made proper disclosure should 
have the option of providing the unit-specific information in a 
supplement to the disclosure document, if it so chooses. Accordingly, 
Item 20 provides: ``This information may be attached as an addendum to 
a disclosure document, or, if disclosure has already been made, then in 
a supplement to the previously furnished disclosure document.''\618\
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    \617\ Wiggin & Dana, at 4.
    \618\ Indeed, this approach is consistent with UFOC Guidelines 
Item 19, which permits franchisors who have made an Item 19 
financial performance disclosure to provide prospective franchisees 
with supplemental data ``directed to a particular location or 
circumstance, apart from the [disclosure document.]'' UFOC 
Guidelines, Item 19A, Instructions (ii).
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d. Confidentiality clauses
    Section 436.5(t)(7) addresses franchisors' uses of confidentiality 
clauses, as proposed in the Franchise NPR.\619\ This is a new provision 
that is not in the original Rule or UFOC Guidelines. If, during the 
last three fiscal years, franchisees signed a confidentiality clause in 
a franchise agreement, settlement, or in any other contract with the 
franchisor, the franchisor must insert in their Item 20 disclosure the 
following prescribed statement: ``In some instances, current and former 
franchisees sign provisions restricting their ability to speak openly 
about their experience with [name of franchise system]. You may wish to

[[Page 15505]]

speak with current and former franchisees, but be aware that not all 
such franchisees will be able to communicate with you.'' In addition, a 
franchisor may, at its option, also disclose the number and percentage 
of current and former franchisees who signed confidentiality 
agreements, as well as the circumstances under which such clauses were 
signed.
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    \619\ Franchise NPR, 64 FR at 57312-14. As set forth in the 
definitions section, the term ``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 clauses that protect 
franchisor's trademarks or other proprietary information.'' Section 
436.1(c).
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    This provision was prompted by numerous comments from franchisees 
and their advocates urging the Commission to address the use of 
confidentiality clauses in franchising. Indeed, one quarter of the ANPR 
commenters (42 out of 166 commenters) and several speakers at public 
workshop conferences addressed the confidentiality clause issue, the 
majority opposing their use.\620\ The most poignant example was a 
franchisee of an undisclosed franchise system who related 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.\621\ These commenters 
complained that the use of confidentiality clauses is widespread,\622\ 
and several commenters urged the Commission to ban the use of 
confidentiality clauses as a deceptive or unfair trade practice.\623\
---------------------------------------------------------------------------

    \620\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, 19 Sept. 97 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.
    \621\ The franchisee 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, 22 Aug. 97 Tr., at 42-43. See also Maloney, 
ANPR 38, at 2 (``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?'').
    \622\ For example, Susan Kezios of the AFA stated that ``the use 
of gag orders is almost 100 percent in some franchise systems.'' 
Kezios, ANPR, 6 Nov. 97 Tr., at 241. See also NASAA, at 6 (noting 
``continued prevalence of confidentiality clauses in franchising''); 
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, 19 Sept. 97 Tr., at 92-93. 
Several franchisor representatives, on the other hand, insisted that 
confidentiality clauses are rare. E.g., Tifford, ANPR 78, at 3; 
Duvall, ANPR, 6 Nov. 97 Tr., at 240.
    It is apparent that franchisee and franchisor commenters 
addressed two different types confidentiality clauses: pre-sale and 
post-sale confidentiality clauses. The record indicates that 
franchisors do not routinely require franchisees to sign 
confidentiality agreements at the time of sale. See Wieczorek, ANPR, 
18 Sept. 97 Tr., at 50. Indeed, no franchisees who commented on 
confidentiality clauses reported that they were required to sign a 
confidentiality provision in their initial franchise agreement. 
Nonetheless, it is clear that franchisors often require franchisees 
to sign post-sale confidentiality provisions in dispute settlements 
or as a condition to termination. See, e.g., Slimak, NPR 130; 
Maloney, ANPR 38, at 2; D'Alessandro, ANPR, 22 Aug. 97 Tr., at 40; 
AFA, ANPR 62, at 3; Doe, ANPR, 7 Nov. 97 Tr., at 276; Rafizadeh, 
id., at 299-300; Lundquist, ANPR, 22 Aug. 97 Tr., at 42-43; 
Lagarias, ANPR 125, at 3. 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, 18 Sept. 97 
Tr., at 40. See also Marks, ANPR, 19 Sept. 97 Tr., at 8-9.
    \623\See IL AG, NPR 3, at 3 (``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.''). See also IL 
AG, NPR Rebuttal 38, at 3; 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.
---------------------------------------------------------------------------

    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 of a franchise offer. 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.\624\ Attempts to 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.\625\ 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.\626\ In addition, one 
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.\627\
---------------------------------------------------------------------------

    \624\ For example, the AFA 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, 
NPR 14, at 3. See also, NCL, ANPR 35, at 3; Baer, ANPR 25, at 3; 
Karp, ANPR, 19 Sept. 97 Tr., at 95-96.
    \625\ For example, Roger Haines, a Scorecard Plus franchisee, 
related:
    ``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, 18 Sept. 97 Tr., 
at 50 (``[T]he whole concept of a gag order is really destructive 
and . . . needs to be addressed.'').
    \626\See NASAA, ANPR 120, at 4.
    \627\ Selden, ANPR 133, Appendix B.
---------------------------------------------------------------------------

    On the other hand, several franchisors and their representatives 
opposed banning the use of confidentiality clauses. For example, David 
Kaufmann asserted 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.\628\ Others added 
that franchisors must have the ability to protect their trade secrets 
from disclosure.\629\
---------------------------------------------------------------------------

    \628\ E.g., Kaufmann, ANPR 33, at 5-6. See also, e.g., Quizno's, 
NPR 1, at 2; H&H, NPR 9, at 20; Baer, NPR 11, at 14; NaturaLawn, NPR 
26, at 2; Marriott, NPR 35, at 16; Snap-On, NPR 16, at 4 (urging the 
Commission either not to adopt the proposed disclosure or to revise 
it in a manner to accommodate franchisors' interests in fostering 
early and amicable settlements). J&G added that a confidentiality 
clause disclosure is unnecessary because the Rule already sheds 
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, 
NPR 32, at 14.
    \629\E.g., Baer, ANPR 25, at 3. Franchisee advocates also 
recognized franchisor's legitimate need for trademark protection. 
E.g., Singler, at 2; AFA, ANPR 62, at 3; Dady & Garner, ANPR 127, at 
2; Zarco & Pardo, ANPR 134, at 4. For that reason, the definition of 
``confidentiality clause'' specifically excludes confidentiality 
agreements to protect trademarks and other proprietary information.
---------------------------------------------------------------------------

    The Commission believes that the record does not support an 
outright ban

[[Page 15506]]

on confidentiality clauses. Clearly there are instances 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.\630\ Under the circumstances, we cannot conclude that harm 
to franchisees from confidentiality clauses necessarily outweighs the 
potential benefits to franchisees, as well as franchisors. 
Nevertheless, based upon the record, the Commission is persuaded to 
adopt a balanced provision requiring franchisors to disclose their use 
of confidentiality clauses over the last three years. The Commission is 
convinced that franchisees often sign post-sale agreements containing 
confidentiality clauses in connection with dispute settlements and 
terminations. This practice may impede prospective franchisees' ability 
to conduct due diligence investigations of franchise offerings, 
undercutting the primary goal of pre-sale disclosure.\631\
---------------------------------------------------------------------------

    \630\ Marriott, NPR 35, at 16. But see Karp, at 8 (``It 
incorrectly implies that the franchisee that signed the 
confidentiality provision had a choice whether to do so or not.'').
    \631\See AFA, at 3; Karp, at 8. See also FTC v. Orion Prods., 
Bus. Franchise Guide (CCH) ] 10970 (N.D. Cal. 1997) and United 
States v. Tutor Time Child Care Sys., Inc., No. 96-2603 (N.D. Cal. 
1996). While in these two cases the Commission did not challenge the 
defendants' use of confidentiality clauses as either a Rule or 
Section 5 violation in its complaints, it did obtain fencing-in 
provisions in settlements that prohibited the defendants from 
enforcing or entering into confidentiality provisions for a limited 
time.
---------------------------------------------------------------------------

    The Commission believes that the final amended Rule's 
confidentiality clause disclosure requirement strikes the appropriate 
balance between informing prospective franchisees that franchisees in 
the system may not be able to share information with them, and 
minimizing compliance burdens. Of the various proposals offered by the 
commenters, a general disclosure notifying prospects about the 
franchisor's use of a confidentiality provision garnered the most 
support. For example, 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.''\632\
---------------------------------------------------------------------------

    \632\ Bundy, ANPR, 6 Nov. 97 Tr., at 249. See also AFA, at 3; 
Gee, at 2; Pu, at 1-2; Selden, ANPR 133, Appendix B; Zarco & Pardo, 
ANPR 134, at 4; Jeffers, ANPR, 6 Nov. 97 Tr., at 251-52; Wieczorek, 
ANPR, 6 Nov. 97 Tr., at 260. But see Singler, at 2 (permitting 
disclosure, but accepting that individuals may be contractually 
forbidden to discuss the franchisor makes little sense).
---------------------------------------------------------------------------

    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.\633\ Moreover, we are 
unpersuaded that this approach 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.
---------------------------------------------------------------------------

    \633\ Several commenters generally supported this provision. See 
NFA, NPR 27, at 1. See also AFA, NPR 14, at 3; Bundy, NPR 18, at 3; 
Stadfeld, NPR 23, at 5; Karp, NPR 24, at 21-22. But see NASAA, at 6; 
WA Securities, at 4-5; Singler, at 2 (asserting that franchisor 
should be required to disclose number and percentage information 
concerning their use of confidentiality agreements).
---------------------------------------------------------------------------

    Further, the confidentiality disclosure does not reach 
confidentiality clauses addressing specific contract negotiation terms 
and conditions.\634\ We recognize that there may be instances where 
both franchisors and franchisees 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 confidentiality clause disclosure 
would be unwarranted, therefore, where the parties agree to a limited 
restriction that still enables franchisees to discuss their overall 
experience in the franchise system.\635\
---------------------------------------------------------------------------

    \634\See Tricon, NPR 34, at 3 (urging the Commission to exclude 
settlement details--such as the price paid to reacquire a franchised 
outlet--from the disclosure if the franchisee is otherwise free to 
discuss his or her personal experience as a franchisee). See also 
Quizno's, NPR 1, at 2; Marriott, NPR 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.
    \635\ The extent to which franchisors must disclose confidential 
settlement terms and conditions is spelled out in Item 3.
---------------------------------------------------------------------------

    In reaching our conclusion to adopt the confidentiality clause 
disclosure, we have carefully weighed suggestions to expand or to 
narrow the disclosure requirement. For example, we reject the 
suggestion that franchisors identify specific individual franchisees 
listed in Item 20 who are subject to a confidentiality clause.\636\ We 
are persuaded that this suggestion goes beyond what is reasonably 
necessary to address the use of confidentiality clauses. No doubt a 
prospective franchisee's due diligence investigation of the franchise 
offering would be more efficient if the prospect could eliminate from 
its contact list those franchisees under a confidentiality agreement. 
However, we believe this approach would impose an unnecessary burden on 
those franchise systems that list all of their franchisees in Item 20 
on a national basis. Presumably, franchisors would have to update 
records continually on each individual franchisee. Moreover, a 
requirement that franchisors note which specific franchisees are 
subject to a confidentiality clause may have the unintended consequence 
of actually encouraging large 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.
---------------------------------------------------------------------------

    \636\ Commenters maintained that 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. 
See AFA, NPR 14, at 3; Stadfeld, NPR 23, at 6; Cordell, ANPR, 6 Nov. 
97 Tr., at 247-48; Kezios, id., at 256. But see GPM, NPR Rebuttal 
40, at 7 (opposing release of names); Wieczorek, ANPR, 6 Nov. 97 
Tr., at 258-59 (this approach would be unnecessarily burdensome: 
franchisors would have to update their disclosures more frequently, 
especially in franchise registration states).
---------------------------------------------------------------------------

    We also reject suggestions to limit the disclosure to only those 
circumstances where franchisees have signed broad provisions 
restricting all speech\637\ or where a threshold level of franchisees 
have signed confidentiality clauses.\638\ If the purpose of the 
confidentiality clause disclosure were primarily to shed light on the 
extent of problems in the franchise relationship, then we might agree. 
As noted above, however, the disclosure 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

[[Page 15507]]

franchisees listed in the disclosure document might actually be skewed. 
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.
---------------------------------------------------------------------------

    \637\ 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 franchisee communication about the franchise system.'' 
PMR&W, NPR 4, at 15. Rather, the firm urged the Commission to limit 
the disclosure's application to only broad ``non-communication on 
any subject'' prohibitions. Id.
    \638\ 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, 
NPR 12, at 33. See Bundy, ANPR, 6 Nov. 97 Tr., at 249 and Jeffers, 
id., at 251-52 (arguing in favor of a threshold).
---------------------------------------------------------------------------

e. Franchisee associations
    One important difference between the original Rule and UFOC 
Guidelines, on the one hand, and the final amended Rule, on the other, 
is the new requirement that franchisors disclose trademark-specific 
franchisee associations.\639\ The obligation to disclose such 
associations differs depending upon whether the association is 
sponsored or endorsed by the franchisor or is an independent 
association. Section 436.5(t)(8) provides that identifying 
information--name, address, telephone number, email address and Web 
address, to the extent known--must be included for each association 
``created, sponsored, or endorsed by the franchisor.'' For independent 
associations, the same identifying information must disclosed only if 
the independent association:
---------------------------------------------------------------------------

    \639\ The growth of trademark-specific system franchisee 
associations is a recent development in franchising. These 
associations are comprised of franchisees who operate a franchisor's 
particular brand. In some instances, these associations are 
franchisor sponsored or endorsed councils, where franchisee-
participants are either selected by the franchisor or are elected by 
franchisees themselves. In other instances, the associations are 
independent of the franchisor. The emergence of independent 
franchisee associations is not always well-received by the 
franchisor. See Winslow, at 141 (``I believe franchisors ought to be 
allowed to put in the contract that if any franchisees get together 
and form a franchise association to use as a collective bargaining 
power against the franchisor, other than an association approved by 
the franchisor, then the franchisor should have the right to 
terminate the franchise contract with all franchisees in that region 
immediately and shut down further operations under the brand name in 
that area indefinitely.''). Some commenters reported 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 (``[The FTC should prohibit [t]he use 
of retaliation against franchisees involved in franchisee 
organizations that work to educate or rally the franchise group.''). 
See also Karp, at 4; Karp, NPR 24, Appendix A (listing cases 
addressing franchisee organizations). 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).

     is incorporated or otherwise organized under state law and asks 
the franchisor to be included in the franchisor's disclosure document 
during the next fiscal year. Such organizations must renew their 
request on an annual basis by submitting a request no later than 60 
days after the close the franchisor's fiscal year.\640\
---------------------------------------------------------------------------

    \640\ As discussed below, section 436.5(t)(8) also makes clear 
that the franchisor has no obligation to verify the association's 
continued existence at the end of each fiscal year. Franchisors may 
also include the following statement in conjunction with the 
disclosure of independent franchisee associations: ``The following 
independent franchisee associations have asked to be included in 
this disclosure document.''

    During the Rule amendment proceeding, several franchisees and their 
representatives urged the Commission to adopt a trademark-specific 
franchisee association disclosure requirement. For example, one 
---------------------------------------------------------------------------
franchisee representative 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.\641\
---------------------------------------------------------------------------

    \641\ Selden, ANPR 133, Appendix B. 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 businesses to share information with the 
prospective franchisee.'' Cordell, ANPR, 6 Nov. 97 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. See also, NFA, NPR 27, at 2; Stadfeld, 
NPR 23, at 14; Karp, NPR 24, at 9; Bundy, ANPR, 6 Nov. 97 Tr., at 
173; Manuszak, ANPR 13; Zarco & Pardo, ANPR 134, at 3.

    Some franchisors did not oppose a disclosure of franchisee 
associations, especially franchisor-sponsored franchisee advisory 
councils. However, they voiced concern about any mandate to disclose 
all independent franchisee associations. In their view, independent 
associations are often small, informal groups of individual franchisees 
that may come and go at any time, and are often formed on the local or 
regional level without the knowledge or involvement of the 
franchisor.\642\ In short, they fear liability for failing to disclose 
a franchisee association that they did not know exists.
---------------------------------------------------------------------------

    \642\See Baer, NPR 11, at 14; Shay, ANPR, 18 Sept. 97 Tr., at 
71; Wieczorek, ANPR, 6 Nov. 97 Tr., at 169-70; Duvall, id., at 171. 
J&G asserted that independent franchisee associations should qualify 
for inclusion only if they are representative of system franchisees 
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 dues-paying 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, NPR 32, at 13. See also PMR&W, NPR 4, at 15; Marriott, NPR 
35, at 16.
---------------------------------------------------------------------------

    Based upon the record developed in this proceeding, the Commission 
is convinced that a trademark-specific association disclosure is 
warranted under certain circumstances. The disclosure of trademark-
specific franchisee associations--both those sponsored or endorsed by 
the franchisor and independent franchisee associations--will greatly 
assist prospective franchisees in their due diligence investigation of 
the franchise offering, thereby preventing misrepresentations in the 
offer and sale of franchises. We recognize that Item 20 already 
requires franchisors to disclose the names of, and some contact 
information for, franchisees in their systems. This disclosure 
requirement, however, is limited to not 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.\643\ Moreover, a 
franchisor

[[Page 15508]]

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 in Item 20 is to require that 
franchisors disclose the existence of certain franchisee associations, 
providing prospective franchisees with an alternative view of the 
franchise system.
---------------------------------------------------------------------------

    \643\ While 100 franchisees may know about franchisor-sponsored 
associations, they would not necessarily know about independent 
associations, such as those in particular locations, or about 
associations for specific-use franchisee groups (e.g., those 
operating kiosks in malls). Further, there is also evidence in the 
record that franchisors do not readily inform prospects about the 
existence of independent associations. For example, 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. Chiodo, ANPR, 21 Nov. 97 
Tr., at 294-95.
---------------------------------------------------------------------------

    The record also suggests that individual franchisees often are 
reluctant to share information with prospective franchisees. 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.''\644\ In 
his view, franchisees who speak 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.\645\ The trademark-specific franchisee association 
disclosure, therefore, is an important alternative source of 
information about the franchise system.\646\
---------------------------------------------------------------------------

    \644\ Bundy, ANPR, 6 Nov. 97 Tr., at 236-37. See also, e.g., 
Hayden, RR 42; Spencer, RR, Sept.95 Tr., at 74.
    \645\ Bundy, ANPR, 6 Nov. 97 Tr., at 237.
    \646\ Chiodo, ANPR, 21 Nov. 97 Tr., at 294-95. See also 
Galloway, id., at 317-18; Manuszak, ANPR 13.
---------------------------------------------------------------------------

    Finally, a franchisee association disclosure is particularly 
important given that the final amended Rule 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 to learn about franchisee 
performance. A franchisee association disclosure may greatly assist 
prospective franchisees in their effort to obtain and review 
franchisees' financial performance by providing an independent source 
of information.
    At the same time, the disclosure of franchisee associations is very 
narrowly tailored to address franchisors' concerns about the disclosure 
of independent franchisee associations. Specifically, Item 20 of the 
final amended Rule provides that a franchisor must list in its 
disclosure document independent trademark-specific associations only to 
the extent such associations make their existence known to the 
franchisor on an annual basis. This will reduce franchisors' burdens by 
requiring franchisors to disclose only those independent associations 
actually known to them. It requires no special research or 
recordkeeping or updating requirements on a franchisor's part. 
Accordingly, the compliance burden imposed by disclosing independent 
franchisee associations is minimal.
    The final Rule amendment differs from the Franchise NPR, however, 
to add more precision. Specifically, Item 20 of the final amended Rule: 
(1) broadens the types of associations that qualify for inclusion as a 
trademark-specific franchisee association; (2) requires franchisee 
associations to request inclusion in the franchisor's disclosure 
document within 60 days of the end of the franchisor's fiscal year end; 
and (3) permits franchisors to add qualifying language alerting 
prospective franchisees that the associations listed in its disclosure 
document are independent associations. Each of these modifications is 
discussed in the section immediately below.
    Item 20 of the final amended Rule requires franchisors to disclose 
only those independent franchisee associations that are incorporated or 
otherwise organized under state law. This differs slightly from the 
Franchise NPR and Staff Report, which recommended that only 
incorporated franchisee associations qualify for inclusion in a 
disclosure document.\647\ The Commission is persuaded that informal, 
unorganized groups of franchisees are more akin to individual 
franchisees, than an association. In such instances, additional 
disclosure is unwarranted because a prospective franchisee can already 
speak with individual franchisees, whose contact information is also 
provided in Item 20. At the same time, the Commission agrees with Staff 
Report commenters that Item 20 should be read broadly to enable any 
organized independent franchisee association to seek inclusion in the 
franchisor's disclosure document.\648\ Accordingly, any organized 
independent association--whether it is incorporated, a partnership, 
limited liability company, or trust, among other forms of association--
qualifies for inclusion under Item 20.
---------------------------------------------------------------------------

    \647\ Franchise NPR, 64 FR at 57344; Staff Report, at 58. The 
original approach was taken in response to commenters' concerns that 
requiring the disclosure of independent associations would be too 
broad, requiring the disclosure of even informal groups of 
franchisees, as noted above. However, several comments contended 
that the incorporation requirement was too restrictive, asserting 
that the Commission should permit the inclusion of all franchisee 
association that make their existence known to the franchisor. 
Bundy, at 9; Gust Rosenfeld, at 6-7; Singler, at 2-3; Stadfield, NPR 
23.
    \648\ In response to the Staff Report, AAFD, in particular, 
noted that it is organized as a trust and its member franchisee 
associations form as chapters of that trust. It asserted that such 
association members, although not incorporated, are organized and 
should qualify for inclusion in a disclosure document. AAFD. See 
also IL AG, at 8.
---------------------------------------------------------------------------

    Item 20 of the final amended Rule makes explicit that an 
independent franchisee association's request for inclusion in a 
disclosure document must be renewed annually by submitting a request 
for inclusion no later than 60 days after the close of the franchisor's 
fiscal year. This is more precise than the Franchise NPR, which 
contains no specific time frame during which independent associations 
should submit their request to the franchisor.\649\
---------------------------------------------------------------------------

    \649\ The Staff Report recommended that the Commission add 
precision to the Rule by requiring franchisee associations to submit 
their requests 90 days after the close of the franchisor's fiscal 
year. Staff Report, at 197. The staff's thinking was that a 90-day 
period would afford franchisors sufficient time to include any 
franchisee association information well before the expiration of the 
120-day annual update period. Id. This view, however, was based on 
the assumption that a significant number of franchisors need 120 
days to complete their annual updates. One commenter, however, 
argued that 60 days would be sufficient, noting that many 
franchisors complete their annual updates earlier than 120 days. 
Wiggin & Dana, at 4. In determining the appropriate time period for 
inclusion requests, it is appropriate not to interfere with 
franchisor's ordinary business practices. In particular, requiring 
franchisors ready to disseminate their updated disclosure documents 
to wait 90 days on the mere chance that a franchisee association may 
ask for inclusion in their document is unwarranted. Independent 
franchisee associations seeking inclusion should make their requests 
known to the franchisor as soon as possible. Surely, a franchisee 
association can submit its request before the close of the 
franchisor's fiscal year or soon thereafter. We are convinced that a 
60-day period is a more balanced approach, enabling franchisee 
associations to request inclusion, while minimizing franchisor's 
compliance burden.
---------------------------------------------------------------------------

    Third, Item 20 of the final amended Rule permits franchisors to 
include a limited disclaimer, if they wish. Specifically, Item 20 
provides that a franchisor can add to the independent franchisee 
association disclosure the following statement: ``The following 
independent franchisee associations have asked to be included in this 
disclosure document.''\650\ We believe

[[Page 15509]]

this statement makes clear that the franchisor is not necessarily 
endorsing or supporting the associations listed. This statement, 
coupled with the requirement that only an organized independent 
association must be disclosed and only upon the association's request, 
strikes the right balance between pre-sale disclosure and compliance 
burdens.
---------------------------------------------------------------------------

    \650\ This revises the disclaimer recommended in the Staff 
Report, which added the following additional sentence: ``We do not 
endorse these associations and their members may not represent all 
franchisees in the [name of franchisor] franchise system.'' Several 
commenters criticized this additional statement on the grounds that 
no association is going to represent 100% of all franchisees in a 
system. AFA, at 3-4. The commenters also noted that the proposed 
additional sentence is unnecessarily negative in tone. It should 
suffice that a franchisor simply notes that the independent 
associations have asked to be included, without implying that the 
independent association is a renegade group. AFA, at 3-4; 
Blumenthal, at 1-2; Bundy, at 9; Karp, at 5. While we are persuaded 
that an introductory statement may be warranted before listing 
independent associations--to distinguish them from franchisor 
endorsed or sponsored associations--the statement should be neutral 
and not imply any opinion on the merits of the independent 
associations. This is the same approach taken with respect to 
franchisor-endorsed or sponsored associations, where no such 
disclaimer is required. Accordingly, Item 20 of the final amended 
Rule deletes the last sentence from the Staff Report's version of 
the trademark-specific franchisee association voluntary disclaimer.
---------------------------------------------------------------------------

    At the same time, the Commission has rejected the suggestion 
offered by some commenters that independent franchisee associations 
seeking inclusion in the franchisor's disclosure document should be 
representative of a significant number of franchisees in the franchise 
system.\651\ These commenters urged the Commission to apply a threshold 
qualification test whereby a franchisor would not have to disclose an 
independent franchisee association unless the association represented a 
portion of system franchisees, such as 25% of system franchisees.\652\
---------------------------------------------------------------------------

    \651\See PMR&W, NPR 4, at 15; BI, NPR 28, at 13.
    \652\ Stadfeld, NPR 23, at 14-15. See also H&H, NPR 9, at 20-21 
(if the organization represents 30% of franchisees); NFC, NPR 12, at 
33 (if the organization represents 20% of the franchisees); BI, NPR 
28 (unspecified threshold). But see IL AG, NPR Rebuttal 38, at 4 
(``Setting a minimum percentage of franchisees to be a qualified 
association is virtually unworkable.'').
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    The Commission recognizes that Item 20 may result in the disclosure 
of independent franchisee 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 independent 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 association 
should be forced to establish that they represent a specific percentage 
of franchisees in a system. Rather, prospective franchisees can 
determine for themselves whether to contact independent franchisee 
associations and what weight to give any information such associations 
provide.
23. Section 436.5(u) (Item 21): Financial statements
    Section 436.5(u) of the final amended Rule retains the original 
Rule's basic requirement that franchisors disclose three years of 
audited financial statements prepared according to generally accepted 
accounting principals (``GAAP'').\653\ To maximize consistency with the 
UFOC Guidelines, it expands the original Rule by incorporating the UFOC 
Guidelines' requirement that financial disclosures be in a tabular 
format that compares at least two fiscal years. This provides 
prospective franchisees with information with which to assess financial 
trends, rather than just an isolated snap-shot of the franchisor's 
finances.
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    \653\ 16 CFR 436.1(a)(20). In the original 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.'' Original SBP, 43 FR at 59679. For that reason, the 
Commission concluded that the disclosure of basic financial 
information by all franchisors ``is essential.''
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    The final amended Rule provision differs from UFOC Guidelines Item 
2, however, in three respects. First, while it requires the use of 
GAAP, it also recognizes that what currently is ``GAAP'' may change by 
federal government oversight of the accounting profession. Accordingly, 
it provides that franchisors must use GAAP, as revised by any future 
government mandated accounting principles. It also allows flexibility 
by permitting accounting standards recognized by the Securities and 
Exchange Commission. Second, consistent with other provisions of the 
final amended Rule, it requires the disclosure of a parent's financial 
information in limited circumstances. Specifically, a franchisor must 
include a parent's financial statements if the parent has post-sale 
performance obligations or guarantees the franchisor's performance. 
Third, Item 23 retains the Commission's long-standing policy of 
permitting franchisors to phase-in audited financial statements over 
three years.\654\
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    \654\ ``Without the auditing requirement, the financial 
statements remain nothing more than the franchisor's own 
representation of its financial condition.'' Original SBP, 43 FR at 
59679-680. Nonetheless, the costs associated with preparing audited 
financial statements might create a barrier to entry by start-up 
franchisors. In the original SBP, the Commission made it clear that, 
as a matter of policy, franchisors can use unaudited financials 
during a phase-in period. Id., at 59681.
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    Four aspects of section 436.5(u) that prompted comment are 
discussed in the following section: (1) the required use of GAAP in 
preparing financial statements; (2) the scope of a parent's obligation 
to disclose financial information; (3) the obligation of subfranchisors 
to disclose financial information; and (4) the phase-in of audited 
financial statements. We discuss each of these issues below.
a. The requirement to prepare financial statements according to GAAP
    Section 436.5(u)(1) of the final amended Rule requires franchisors 
to prepare financial statements according to ``United States generally 
accepted accounting principles, as revised by any future government 
mandated accounting principles, or as permitted by the Securities and 
Exchange Commission.'' This differs from the Franchise NPR, which 
proposed that franchisors use United States GAAP only in preparing 
their financial statements, consistent with the original Rule and UFOC 
Guidelines.\655\
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    \655\ Franchise NPR, 64 FR at 57344. See 16 CFR 436.1(a)(20); 
UFOC Item 21. See also Advisory 02-4, Bus. Franchise Guide (CCH), ] 
6515 (Nov. 18, 2002).
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    During the Rule amendment proceeding, a few commenters opposed the 
Franchise NPR's proposed requirement that foreign franchisors prepare 
financial statements according to United States GAAP only. These 
commenters asserted that this requirement would impose expenses and 
burdens on foreign corporations entering the American market. H&H's 
comment was typical: ``For companies located in many foreign countries, 
. . . a requirement to convert to US accounting standards would be 
enormously expensive.''\656\ H&H urged the Commission to permit foreign 
franchisors to prepare financial statements that ``conform to U.S. GAAP 
or otherwise to generally accepted accounting principles established in 
the country of the company's domicile.''\657\ IL AG, however, argued 
that foreign companies should follow United States GAAP or be permitted 
to reconcile their financial statements to United States

[[Page 15510]]

GAAP through footnotes and explanations.\658\
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    \656\ H&H, NPR 9, at 13. See also NFC, NPR 12, at 33.
    \657\ H&H, NPR 9, at 13. 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, NPR 15, at 17. Mr. Lewis, 
however, provided no criteria or examples that would help us 
determine what GAAP are or are not ``comparable.''
    \658\ IL AG, NPR Rebuttal 38, at 5.
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    As noted in our discussion of section 436.2 concerning the scope of 
the Rule, the sale of franchises outside the United States was not an 
important issue when the Commission promulgated the Franchise Rule in 
1978. The Commission recognizes, however, that application of only 
United States GAAP in today's global economy may impede competition 
from foreign franchisors. Accordingly, 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.
    In determining whether to maintain the original Rule's stance on 
the use of GAAP in Item 21 financial statements, the Commission focuses 
strongly on the primary purpose of a disclosure document, which is to 
provide prospective franchisees with material information in a clear 
and conspicuous manner. Consistent with that principle, the Commission 
believes that franchisors must present financial data in a format that 
is meaningful to American prospective franchisees, as well as to their 
advisors. To that end, the suggestion offered by IL AG--that foreign 
franchisors use United States GAAP or reconcile their financial 
statements to United States GAAP--adds needed flexibility, while 
reducing costs and burdens on foreign franchisors. As noted in the 
Staff Report, this is the very position adopted by the SEC for the 
registration of securities by foreign companies.\659\
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    \659\ Staff Report, at 201.
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    The SEC permits foreign companies registering securities to prepare 
financial statements using accounting procedures other than United 
States GAAP under limited circumstances. The first prerequisite is that 
such statements be prepared ``according to a comprehensive body of 
accounting principles.''\660\ 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 United States GAAP. The company must also reconcile its statements 
with United States 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 United States GAAP 
and applicable SEC regulations.\661\
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    \660\ We noted that NASAA, in response to the Staff Report, 
suggested that the Rule simply mandate United States GAAP, or a 
reconciliation to United States GAAP, without referencing the SEC. 
NASAA, at 7. See also WA Securities, at 5. The Commission concludes 
that referencing the SEC is appropriate. Given the absence of any 
indication in the record that foreign accounting principles are 
inherently deceptive, flexibility in preparing financial statements 
is warranted. As long as the SEC would permit foreign accounting 
standards or foreign financial statements, we see no policy reason 
to differ. This is particularly true of financial statements 
prepared according to Canadian GAAP, which receives more lenient 
treatment under SEC law. See Spandorf, at 8 (recommending an 
accommodation to permit the use of Canadian GAAP).
    \661\ 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 United States GAAP, it must audit the 
financials according to United States generally accepted auditing 
standards (United States GAAS) and the auditor must comply with the 
United States standards for auditor independence. See Id., General 
Instruction E(c).
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    The Staff Report recommended that the final amended Rule permit 
foreign financial statements that satisfy the SEC criteria. The 
Commission has determined that that recommendation is sound. As a 
starting point, application of the SEC accounting standards ensures 
against deception by requiring foreign franchisors to establish that 
their financials are prepared ``according to a comprehensive body of 
accounting principles.'' Further, it adds flexibility and minimizes 
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. The Commission has 
determined to adopt this flexible approach, given the absence of any 
showing or suggestion in the record that reconciled foreign financial 
statements are inherently deceptive or misleading.\662\ At the same 
time, we recognize the possibility exists that American accounting 
principles may evolve over time. Under the circumstances, Item 21 
updates the original Rule by adding language designed to ensure that 
financial statements are prepared according to United States GAAP, ``as 
revised by any future government mandated accounting principles, or as 
permitted by the Securities and Exchange Commission.''\663\
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    \662\ Of course, the Commission retains its Section 5 authority 
to challenge any deceptive foreign statements.
    \663\ This modifies the version of Item 21 in the Staff Report, 
which would permit 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.'' One 
comment questioned whether the third part--revised by any future 
government mandated accounting principles--was a third option 
distinct from the other two. Piper Rudnick, at 3-4. The language 
``or as revised by any future government mandated accounting 
principles'' recognizes that what is currently considered United 
States GAAP may be modified in the future by government mandate, 
especially by regulations or rulings of the Federal Accounting 
Standards Board. Accordingly, it is not intended to comprise a 
separate option, but should be read to modify ``United States 
generally accepted accounting principles.'' The final amended Rule 
adopts this revised language.
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b. Parent financial information
    Section 436.5(u)(iv) of the final amended Rule requires a 
franchisor to disclose a parent's financial statements in two 
circumstances: (1) when the parent commits to perform post-sale 
obligations for the franchisor; or (2) when the parent guarantees 
obligations of the franchisor. This narrows the Franchise NPR proposal, 
which would have required disclosure of parent financial information in 
all instances.\664\ As with other Rule provisions, several commenters 
questioned the routine inclusion of parent information in a disclosure 
document. 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 
statements are not relevant and are rarely requested.\665\ 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.''\666\
---------------------------------------------------------------------------

    \664\ Franchise NPR, 64 FR at 57315. We also note that the Staff 
Report recommended that franchisors disclose financial statements of 
any parent ``or other entity'' with post-sale performance 
obligations or which guarantees the franchisor's performance. The 
inclusion of the phrase ``other entity'' prompted three comments 
voicing concern that it would sweep in suppliers that provide goods 
or services to franchisees. Piper Rudnick, at 3; Spandorf, at 8-9; 
Starwood, at 3. The Commission agrees that a reference to ``other 
entity'' would be an unwarranted expansion of Item 21. According, 
the reference to ``other entity'' has been deleted from the final 
amended Rule.
    \665\ PMR&W, NPR 4, at 16. See also Lewis, NPR 15, at 18; Snap-
On, NPR 16, at 4; PREA, NPR 20, at 2; Marriott, NPR 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, NPR 32, at 13.
    \666\ Lewis, NPR 15, at 18. See also Baer, NPR 11, at 5; IL AG, 
NPR Rebuttal 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, 
NPR 18, at 11 (emphasis in original).

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[[Page 15511]]

    The Commission believes these points are well-taken and are 
consistent with our view expressed in other sections of this document 
that a franchisor need not disclose parent information in all 
instances. Therefore, proposed Item 21 has been modified to limit a 
parent's financial information to those circumstances when the parent 
either: (1) commits to perform post-sale obligations for the 
franchisor; or (2) guarantees obligations of the franchisor. To the 
extent that a prospective franchisee is asked to rely on a parent to 
perform post-sale contractual obligations,\667\ or relies on a parent's 
guarantee, the financial stability of the parent becomes a material 
fact that should be disclosed.\668\
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    \667\ Two commenters voiced concern about the ``post-sale 
performance obligation'' language set forth in the Staff Report. 
Specifically, they contended that sections 436.5(u)(1)(ii) and 
436.5(u)(1)(iv) of the Staff Report are inconsistent. In their view, 
section 436.5(u)(1)(iv) requires a franchisor to furnish financial 
statements if the franchisor has post-sale performance obligations. 
They then noted that is it highly unlike that a franchisor would 
ever enter into a franchise relationship without some post-sale 
obligations to the franchisee. The commenters concluded therefore 
that section 436.5(u)(1)(iv) requires franchisor financials in all 
instances. This interpretation is in direct conflict with section 
436.5(u)(1)(ii), however, that expressly permits a franchisor to use 
the financials of an affiliate-guarantor. Piper Rudnick, at 3-4; 
Spandorf, at 8-9. The commenters misread section 436.5(u)(1)(iv) of 
the Staff Report. Under that section of the Staff Report, a 
franchisor must provide financial statements ``for the franchisor, 
subfranchisor, and any parent . . . that commits to perform post-
sale obligations for the franchisor or guarantees the franchisor's 
obligations.'' The reference to ``post-sale obligations'' refers to 
``parent,'' not to the ``franchisor.'' If the commenter's reading of 
section 436.5(u)(1)(iv) were correct, then the section would have 
the following absurd meaning: ``a franchisor must provide financial 
statements for the franchisor . . . that commits to perform post-
sale obligations for the franchisor.'' To avoid any confusion on 
this point, section 436.5(u)(1)(iv) of the final amended Rule has 
been revised to read: ``Include separate financial statements for 
the franchisor and subfranchisor, as well as for any parent that 
commits to perform post-sale obligations for the franchisor or 
guarantees the franchisor's obligations.''
    \668\ Where a parent guarantees performance, Item 21 also 
requires a franchisor to attach a copy of the guarantee to the 
disclosure document. Although the UFOC Guidelines are not clear on 
this point, we believe that Item 21, Instruction v. contemplates 
this requirement. Moreover, it is sound policy. Before a prospective 
franchisee is asked to invest in a franchise, he or she should be 
able to assess the extent of any performance or financial 
guarantees.
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c. Subfranchisor financial information
    Section 436.5(u)(iv) of the final amended Rule also requires the 
disclosure of financial information of any subfranchisor. During the 
Rule amendment proceeding, a few commenters 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.\669\ The 
commenters, however, interpreted the term ``subfranchisor'' more 
broadly than it is used in the final amended Rule. As noted in our 
discussion of the term ``franchisor'' above, the term ``subfranchisor'' 
is limited in the Rule 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 may be called 
``subfranchisors,'' but who act like brokers, having no post-sale 
commitments to franchisees.\670\ Where a person--be it subfranchisor or 
parent --commits to perform under the franchise agreement, its 
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.
---------------------------------------------------------------------------

    \669\ Bundy, at 9; H&H, NPR 9, at 21; Lewis, NPR 15, at 17.
    \670\ This approach parallels the UFOC Guidelines, which require 
subfranchisor financial statements only when the subfranchisor is 
the applicant for franchise registration.
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d. Phase-in of audited financial statements
    Section 436.5(u)(2) of the final amended Rule retains the original 
Rule provision permitting start-up franchise systems to phase-in 
audited financial statements within three years.\671\ However, the 
final amended Rule streamlines the phase-in. Under the original Rule's 
phase-in, a franchisor could furnish a balance sheet for ``the first 
full fiscal year following the date on which the franchisor must first 
comply with [the Rule.]''\672\ This can be problematic because 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, 2006, using a calendar 
fiscal year). At the conclusion of that fiscal year (December 31, 
2006), the franchisor would have sold franchises for ten months. Yet, 
under the original Rule's phase-in, the franchisor's first fiscal year 
would not end until December 31, 2007, because the phase-in uses the 
language ``first full fiscal year'' after starting to sell 
franchises.\673\
---------------------------------------------------------------------------

    \671\ There is no comparable provision in the UFOC Guidelines. 
The extent to which any state may permit a phase-in of audited 
financial statements is a matter of individual state law. For 
example, California and Illinois permit a phase-in of audited 
financial statements under limited conditions set forth in their 
franchise regulations. On the other hand, Virginia and Minnesota, 
for example, always require audited financial statements.
    \672\ 16 CFR 436.1(a)(20)(ii).
    \673\Id.
---------------------------------------------------------------------------

    To clarify the timing of the phase-in, section 436.5(u)(2) of the 
final amended Rule replaces 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.\674\ 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.\675\
---------------------------------------------------------------------------

    \674\See Franchise NPR, 64 FR at 57315.
    \675\ No comments were submitted on this modification of the 
original Rule's phase-in of audited financial statements.
---------------------------------------------------------------------------

    The phase-in of audited financial statements generated little 
comment during the Rule amendment proceeding. Franchisors, the AFA, and 
IL AG supported the phase-in.\676\ One franchisee advocate, however, 
noted, 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 years, for all practical 
purposes, even more investors will risk losing everything.''\677\ On 
the other hand, John Baer not only supported the phase-in, as drafted 
in the Franchise NPR, but urged the Commission to make it 
preemptive.\678\
---------------------------------------------------------------------------

    \676\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.
    \677\ Bundy, NPR 18, at 11. 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, NPR 18, at 11.
    \678\ ``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, NPR 11, at 15.
---------------------------------------------------------------------------

    NASAA supported the phase-in generally, but raised two concerns. 
First, NASAA observed that the phase-in section of the Rule does not 
specifically reference GAAP, possibly leading franchisors to conclude 
that unaudited financial statements need not be prepared according to 
GAAP. It urged

[[Page 15512]]

the Commission to apply GAAP to all financial statements, audited or 
unaudited.\679\ We agree. There are two prerequisites for financial 
statements: (1) the data underlying the statement must be prepared 
according to GAAP (or according to SEC standards), and (2) the 
financials must be audited according to United States generally 
accepted audited standards (``GAAS'').\680\ The phase-in of audited 
financials addresses only the second prerequisite--audits. Where a 
franchisor takes advantage of the phase-in, it nonetheless must satisfy 
the first prerequisite, preparing its financial data according to GAAP 
(or SEC standards).
---------------------------------------------------------------------------

    \679\ NASAA, at 7. See also WA Securities, at 6; CA Dept of 
Corps., at 2.
    \680\ 16 CFR 436.1(a)(20)(i) (``such statements are required to 
have been examined in accordance with generally accepted auditing 
standards by an independent certified or licensed public 
accountant). See also IL AG, at 9.
---------------------------------------------------------------------------

    Nevertheless, we believe that the final amended Rule already is 
clear on this point. As noted above, the introduction to Item 21 starts 
with the first prerequisite--that financial statements must be prepared 
according to ``United States generally accepted accounting principles, 
as revised by any future government mandated accounting principles, or 
as permitted by the Securities and Exchange Commission.'' Item 21 then 
discusses the second prerequisite--audits: with the exception of the 
phase-in of audited financials, ``financial statements must be audited 
. . . using generally accepted United States auditing standards.'' 
Thus, the Rule makes clear that the phase-in modifies the GAAS 
prerequisite only; the accounting prerequisite still continues to apply 
to all financial statements prepared under Item 21.\681\
---------------------------------------------------------------------------

    \681\ NASAA also noted that the Staff Report referred 
incorrectly to ``United States auditing principles,'' when the 
proper accounting term is ``United States auditing standards'' or 
``GAAS.'' NASAA, at 7-8. See also WA Securities, at 6. Item 21 of 
the amended Rule makes that correction.
---------------------------------------------------------------------------

    NASAA also questioned the reference to ``start-ups'' in the phase-
in provision. It voiced concern 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.''\682\ 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.\683\
---------------------------------------------------------------------------

    \682\ NASAA, NPR 17, at 11.
    \683\Id.
---------------------------------------------------------------------------

    The Commission believes NASAA's point is well-taken, and, therefore 
we wish to clarify that for Item 21 purposes, the term ``start-up'' is 
to be read narrowly, meaning 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.\684\ 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.
---------------------------------------------------------------------------

    \684\See Interpretive Guides, 44 FR at 49981 (``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.'').
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24. Section 436.5(v) (Item 22): Contracts
    Consistent with the UFOC Guidelines, section 436.5(v) requires 
franchisors to attach to the disclosure document a copy of all relevant 
agreements, such as the franchise agreement, leases, options, or 
purchase agreements.\685\ This is substantively similar to the original 
Rule requirement that franchisors provide prospective franchisees with 
copies of relevant documents at least five business days prior to the 
date of execution.\686\ The final amended Rule's Item 22 is identical 
to the Item 22 proposed in the Franchise NPR.
---------------------------------------------------------------------------

    \685\ UFOC Guidelines, Item 22.
    \686\ See 16 CFR 436.1(g). The attached documents 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 original 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.'' Original SBP, 43 
FR at 59696.
---------------------------------------------------------------------------

    Only one comment was submitted on Item 22. In response to the 
Franchise NPR, 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 should 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.\687\ While it is possible that a franchisor may misread Item 22 
to include future settlement negotiations, 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 
decline to revise Item 22, as this commenter suggested.
---------------------------------------------------------------------------

    \687\ Gurnick, NPR 21, at 7.
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25. Section 436.5(w) (Item 23): Receipts
    Section 436.5(w) of the final amended Rule reduces inconsistencies 
with the UFOC Guidelines by adopting the UFOC Guidelines Item 23 
requirement that franchisors include an acknowledgment of receipt in 
the disclosure document.\688\ The original Rule has no counterpart. 
Like the cover page, the receipt serves an important educational 
purpose,\689\ informing prospects that they have 14 calendar-days to 
review the disclosures, that they should receive certain attachments, 
and that they can report possible law violations.\690\
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    \688\ Item 23 of the final amended Rule differs from the 
Franchise NPR in one respect. It deletes the Franchise NPR proposal 
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. 
Franchise NPR, 64 FR at 57344. The Commission proposed this 
requirement in the Franchise NPR to ensure that the prospective 
franchisee in fact received the disclosures before the franchisor 
finalized the franchise sale. This proposal prompted comments both 
for and against the proposal. Compare PMR&W, NPR 4, at 5 with Baer, 
NPR 11, at 15. The Staff Report recommended that this provision be 
deleted. Staff Report, at 207-08. For the reasons stated in the 
Staff Report, we agree. Franchisors always have the burden of proof 
to establish compliance with the Rule's disclosure and timing 
provisions. In addition, the amended Rule's general recordkeeping 
requirements at section 436.6--requiring franchisors to retain a 
copy of each signed receipt for at least three years--are sufficient 
to prove compliance. Finally, given the elimination of the automatic 
contract review waiting period from the final amended Rule, the 
addition of another waiting period would add an unnecessary 
compliance burden.
    \689\ Other Commission trade regulation rules contain similar 
messages. E.g., Energy Guides, 16 CFR Part 305, App. L. (``Compare 
the energy use . . . with others before you buy.''); Cooling-Off 
Rule, 16 CFR 429.1 (Notice of right to cancel); Used Car Rule, 16 
CFR 455.2 ( ``Below is a list of some major defects that may occur 
in used motor vehicles.'').
    \690\See IL AG, NPR 3, at 9 (``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.''). See also Baer, NPR 11, at 15.
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    At the same time, Item 23 is flexible, affording franchisors and 
franchisees greater latitude in demonstrating receipt than the 
comparable UFOC Guidelines provision. Whereas UFOC Item 23 requires 
franchisors to acknowledge receipt with a handwritten signature, Item 
23 updates the Rule by allowing the parties to use electronic 
acknowledgments of receipt. As discussed in the definitions section 
above, the term ``signature'' includes not only written signatures, but 
electronic

[[Page 15513]]

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.\691\
---------------------------------------------------------------------------

    \691\ Item 23 also provides that franchisors may include 
specific instructions on how prospects should submit the receipt, 
such as via facsimile or email. This enables the parties to 
determine for themselves the most efficient and cost-effective way 
for the prospective franchisee to transmit the acknowledgment.
---------------------------------------------------------------------------

    Item 23 of the final amended Rule also incorporates several 
suggestions offered by commenters. For example, Warren Lewis advised 
that the title of Item 23 should be ``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.\692\ He 
also urged the Commission to replace ``franchisee's signature'' used in 
the Franchise NPR version of Item 23 with ``prospective franchisee's 
signature,'' noting that some prospective franchisees object to signing 
receipts as ``franchisees,'' since this designation is inaccurate until 
they have actually signed the franchise agreement.\693\ NASAA also 
suggested that the Commission clarify that the acknowledgment page must 
be placed as the last two pages of the disclosure document. It observed 
that ``[t]he States that review franchise offerings have noted many 
instances where this page was buried in the middle of the disclosure 
document.''\694\ We believe these suggestions are sound, and Item 23 of 
the final amended Rule reflects these changes.
---------------------------------------------------------------------------

    \692\ Lewis, NPR 15, at 18.
    \693\ Lewis, NPR 15, at 18.
    \694\ NASAA, NPR 17, at 11.
---------------------------------------------------------------------------

    Another commenter addressed the second paragraph of the Item 23 
receipt. As proposed in the Franchise NPR, this paragraph stated, in 
relevant part: ``If [name of the 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].'' H&H urged the Commission to substitute 
``binding agreement'' with ``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.\695\ 
As noted in our discussion of the disclosure trigger above, we agree 
with this approach and have revised Item 23 of the final amended Rule 
accordingly.\696\
---------------------------------------------------------------------------

    \695\ H&H, NPR 9, at 21.
    \696\ At the same time, the final amended Rule prohibits a 
franchisor from failing to furnish disclosures earlier in the sale 
process, upon reasonable request. See section 436.9(e).
---------------------------------------------------------------------------

    At the same time, we reject several suggestions offered in response 
to the Staff Report to modify Item 23. Four commenters noted that Item 
23, as recommended in the Staff Report, requires franchisors to state 
the name, principal business address, and telephone number of each 
``franchise seller'' in the receipt.\697\ These commenters maintained 
that this disclosure requirement is a carry-over from the UFOC Item 2 
requirement, now eliminated in the final amended Rule, that franchisors 
disclose brokers. They urged the Commission to delete the reference to 
``sellers'' in Item 23 as well, asserting that this requirement would 
result in franchisors having to disclose potentially hundreds of 
names.\698\
---------------------------------------------------------------------------

    \697\ The version of Item 23 proposed in the Franchise NPR 
referenced ``any subfranchisor or broker.'' Staff recommended 
instead ``franchise seller,'' and the Commission has adopted this 
approach.
    \698\ Wiggin & Dana, at 4; Piper Rudnick, at 4; J&G, at 7; 
Duvall, at 2.
---------------------------------------------------------------------------

    As a preliminary matter, we note that UFOC Item 2 requires not only 
the naming of brokers, but a statement about their prior experience. 
Also, once an individual is named in Item 2, the franchisor must also 
disclose their litigation history in UFOC Item 3 and their bankruptcy 
history in UFOC Item 4. As discussed previously, we believe such 
extensive disclosures are unnecessary with respect to brokers. 
Nonetheless, we believe that a prospective franchisee should have 
contact information for any seller with whom he or she is dealing.\699\ 
Accordingly, the disclosure of ``sellers'' in the Item 23 receipt is to 
be read narrowly, referring to the specific individual(s) dealing with 
the prospective franchisee. This approach is also helpful for law 
enforcement purposes, identifying who may be responsible for furnishing 
the disclosures. Accordingly, we believe there are sufficient grounds 
for retaining the seller disclosure in Item 23.
---------------------------------------------------------------------------

    \699\ This does not mean that a franchisor must create 
individualized disclosure documents for each franchise sale. 
Clearly, a franchisor could create a receipt with a fill-in-the-
blank for the seller's information. The company or its agent could 
fill in the blank with the appropriate information prior to 
furnishing the disclosure document.
---------------------------------------------------------------------------

D. Section 436.6: General Instructions

    Section 436.6 of part 436 sets forth the basic instructions for 
preparing a disclosure document. In the Franchise NPR, the Commission 
proposed two new sections that would set forth the basic instructions 
for preparing a disclosure document. The first section--Franchise NPR 
section 436.6--set forth general instructions applicable to all 
disclosure documents.\700\ Specifically, the Franchise NPR proposed 
retaining the original Rule's three basic instructions: (1) that 
disclosures be prepared clearly, legibly, and concisely in a single 
document; (2) that franchisors respond positively or negatively to each 
disclosure item; and (3) that franchisors do not add any materials to a 
disclosure document, except for information required or permitted by 
non-preempted state law. The proposed instructions also contained the 
Commission's current policy that subfranchisors should provide 
disclosures about the franchisor, and, to the extent applicable, about 
themselves. Consistent with the UFOC Guidelines, disclosure documents 
would also have to be written in plain English.\701\ None of these 
basic instructions generated any significant comment in response to the 
Franchise NPR or Staff Report.
---------------------------------------------------------------------------

    \700\ Franchise NPR, 64 FR at 57345.
    \701\ The Staff Report proposed the same general instructions. 
Staff Report, at 208-09.
---------------------------------------------------------------------------

    In a second section--Franchise NPR section 436.7--the Franchise NPR 
proposed specific instructions pertaining to electronic 
disclosures.\702\ In order to prevent fraud and circumvention of the 
Rule's pre-sale disclosure requirements, the Franchise NPR proposed, 
among other things, that: (1) prospective franchisees consent to 
receiving electronic disclosures; 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. In addition, it called for all disclosures 
to be in a form that would permit each prospective franchisee to 
download, print, or otherwise maintain the document for future 
reference. Multimedia features--such as audio, video, ``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 Franchise NPR proposed permitting 
franchisors to include navigational tools, such as internal links, 
scroll bars, and search features. Finally, the Franchise NPR proposed 
that franchisors furnishing disclosure documents electronically retain 
a

[[Page 15514]]

specimen copy of their disclosures for a period of three years.
---------------------------------------------------------------------------

    \702\ Franchise NPR, 64 FR at 57345.
---------------------------------------------------------------------------

    On June 30, 2000, Congress enacted the Electronic Signatures in 
Global and National Commerce Act (``E-SIGN'').\703\ E-SIGN eliminates 
barriers to ecommerce by, among other things, giving legal effect to 
electronic transactions, including pre-sale disclosure, and permitting 
electronic signatures. Further, E-SIGN 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, defining ``consumer'' to mean an ``individual who 
obtains, through a transaction, products or services which are used 
primarily for personal, family, or household purposes.''\704\ Thus, by 
its terms, E-SIGN may have prohibited restrictions such as those 
proposed in the Franchise NPR for electronic franchise disclosure.
---------------------------------------------------------------------------

    \703\ 15 U.S.C. 7001.
    \704\ 15 U.S.C. 7006(1).
---------------------------------------------------------------------------

    In light of E-SIGN, the Commission has reconsidered the Franchise 
NPR proposals. As explained below, the final amended Rule eliminates 
the Franchise NPR's proposed electronic disclosure instructions--
Franchise NPR section 436.7. In lieu of specific electronic disclosure 
instructions, the final amended Rule contains a broad general 
instructions section that covers the furnishing of all disclosure 
documents, paper and electronic alike. We discuss each general 
instruction immediately below.
1. Section 436.6(a): Requirement to follow the Rule's disclosure and 
updating provisions
    Section 436.6(a) of the final amended Rule provides that it is an 
``unfair or deceptive act or practice in violation of Section 5 of the 
FTC Act for any franchisor to fail to include the information and 
follow the instructions for preparing disclosure documents set out in 
Subpart C (basic disclosure requirements) and Subpart D (updating 
requirements) of the Rule. The Commission will enforce this provision 
according to the standards of liability applicable in actions under 
Sections 5, 13(b), and 19 of the FTC Act.''\705\
---------------------------------------------------------------------------

    \705\ 15 U.S.C 45(a); 53(b); 57b.
---------------------------------------------------------------------------

    The original Rule specified that franchisors and franchise brokers 
are jointly and severally liable for furnishing disclosure documents. 
However, it did not specifically address who would be liable for a 
disclosure document's content. During the Rule amendment proceeding, 
the Commission sought to clarify liability for preparing disclosures, 
proposing in the Franchise NPR that franchise sellers would be liable 
for the contents of a disclosure document if they knew or should have 
known of the violation.\706\
---------------------------------------------------------------------------

    \706\ Franchise NPR, 64 FR at 57301, 57333. A showing of 
knowledge is necessary when seeking to hold an individual liable for 
redress for a corporation's law violations in Section 5 matters, as 
discussed further below.
---------------------------------------------------------------------------

    A few commenters voiced concern about the proposed standard. John 
Baer, for example, stated that the Franchise NPR proposal imposed 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.\707\
---------------------------------------------------------------------------

    \707\ Baer, NPR 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.''\708\ 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:
---------------------------------------------------------------------------

    \708\Id.

     (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 knew the 
significance of doing so nor be in a position to stop the 
practice.\709\
---------------------------------------------------------------------------

    \709\ Tricon, NPR 34, at 6. See also Baer, NPR 11, at 10.

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.''\710\
---------------------------------------------------------------------------

    \710\ NASAA, NPR 17, at 3.
---------------------------------------------------------------------------

    Based upon the comments, the staff recommended a revised liability 
standard in the Staff Report. The staff noted that all Commission trade 
regulation rules implement Section 5 of the FTC Act and, therefore, the 
final amended Rule should incorporate the standard of liability 
developed in Section 5 cases. Under Section 5 law, individuals can be 
enjoined in connection with a corporation's law violations if they 
participated directly in them or had the authority to control 
them.\711\ Applying this standard to the Franchise Rule, the Staff 
recommended 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.
---------------------------------------------------------------------------

    \711\E.g., FTC v. Amy Travel Servs., Inc., 875 F.2d 564, 573 
(7\th\ Cir.), cert denied, 439 U.S. 954 (1989); FTC v. Atlantex 
Assocs., 1987-2 Trade Cas. (CCH), ] 67788 at 59255 (S.D. Fla. 1978), 
aff'd, 872 F.2d 966 (11\th\ 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., FTC v. J.K. Publ'ns, Inc., 99 F. Supp. 2d 1176, 
1203 and note 67 (C.D. Cal. 2000).
---------------------------------------------------------------------------

    Several commenters voiced concern about the Staff Report's proposed 
``direct participation or control'' liability standard. In particular, 
the commenters asserted that the ``authority to control'' language is 
too broad. For example, David Kaufmann noted that all senior officers 
of a corporate franchisor technically could be deemed to have the 
authority to control the contents of a disclosure document and, 
therefore, could be deemed liable, even if they were unaware of the 
particular violation, or had no responsibility for it.\712\ Mr. 
Kaufmann opined, however, that it is appropriate to hold an individual 
liable for directly participating in a content violation.\713\
---------------------------------------------------------------------------

    \712\ Mr. Kaufmann observed that the New York Franchise Act 
imposes liability upon any officer, director, or management employee 
who materially aids in the act or transaction constituting the 
violation of the Act. Lack of knowledge after due diligence is a 
defense. Kaufmann, at 7-8.
    \713\See also Cendant, at 2-3 (suggesting that the following 
liability standard: ``Any other franchise seller will be liable for 
the violations . . . if he or she directly participated in 
preparation of the disclosure document.'').
---------------------------------------------------------------------------

    J&G criticized the Staff Report's proposed liability standard as 
imposing strict liability for all sellers even where their ``control'' 
is limited, attenuated, or indirect. According to J&G, under the 
standard recommended in the Staff Report, liability could be found for 
employees, advisors, consultants, attorneys, and accountants of a 
franchisor who ``participate'' in the preparation of a disclosure 
document or in the sales process in some manner. Outside consultants, 
advisors, and attorneys could be held liable even if

[[Page 15515]]

they had no knowledge of the facts underlying the violation.\714\
---------------------------------------------------------------------------

    \714\ J&G, at 3-4.
---------------------------------------------------------------------------

    On the other hand, Howard Bundy argued that those in a corporate 
structure who have ``authority to control'' content should be liable 
for conduct of the corporation. ``This is consistent with what Congress 
and the SEC have mandated in the post-Enron world with regard to 
officers of a public corporation.''\715\ Mr. Bundy stated that a broad 
standard is important to force responsibility for accuracy and 
completeness to the highest levels in the franchisor's organization.
---------------------------------------------------------------------------

    \715\ Bundy, at 2.
---------------------------------------------------------------------------

    Because violations of part 436 constitute violations of Section 5, 
the Commission is persuaded that liability for the content of a 
disclosure document must be based upon liability standards applicable 
in FTC enforcement actions under Sections 5, 13(b), and 19. In that 
regard, there is a distinction between the standard of liability for 
injunctive relief and that for redress. In general, case law 
establishes that an individual may be enjoined for corporate misconduct 
if he or she participated directly in the wrongful practice or had the 
authority to control the corporate defendant.\716\ In the franchise 
context, an officer or director of a franchisor may be enjoined against 
violating the Rule if the officer or director, for example, has 
authority to control or directly prepared, or directed others to 
prepare, false or otherwise inaccurate disclosure documents.\717\
---------------------------------------------------------------------------

    \716\FTC v. Publ'g Clearing House, Inc., 104 F.3d 1168, 1170 
(9\th\ Cir. 1997). See also FTC v. J.K. Publ'ns, Inc., 99 F. Supp. 
2d at 1203; FTC v. Am. Standard Credit Sys., Inc., 874 F. Supp. 
1080, 1087 (C.D. Cal. 1994). Authority to control the company can be 
evidenced by active involvement in business affairs and the making 
of corporate policy, including assuming the duties of a corporate 
officer. FTC v. Amy Travel Serv., Inc., 875 F.2d at 573. Similarly, 
an individual's status as a corporate officer and authority to sign 
documents on behalf of the corporate defendant can be sufficient to 
demonstrate the requisite control. FTC v. Publ'g Clearing House, 
Inc., 104 F.3d at 1170.
    \717\See FTC v. Five-Star Auto Club, Inc., 97 F. Supp. 2d 501 
(S.D.N.Y. 2000) (individual defendant participated directly in the 
deceptive acts or practices by, among other things, drafting and/or 
approving marketing materials); FTC v. Atlantex Assocs.,1987-2 Trade 
Cas. (CCH), ] 67788 (individual defendant liable because he had the 
authority to control the company's actions, including the authority 
to control representations made by salespeople).
---------------------------------------------------------------------------

    In order to hold an individual liable to pay consumer redress, 
however, the Commission must show more than just authority to control 
the corporation. It must show the individual possessed some level of 
knowledge or awareness of the misrepresentations.\718\ The Commission 
may establish the requisite knowledge by showing that the individual 
had ``actual knowledge of material misrepresentations, or an awareness 
of a high probability of fraud along with an intentional avoidance of 
the truth.''\719\ For example, an officer or director of a franchisor 
would be liable for redress if he or she directed the franchisor's 
employees to prepare false or misrepresented disclosures, or failed to 
stop the company from using a faulty disclosure document that one or 
more states had previously rejected as insufficient.\720\ Similarly, a 
franchisor's sales manager could be held individually liable for 
redress where the sales manager has authority to control those 
preparing disclosure documents, and has knowledge that the disclosures 
are false, or otherwise inaccurate.\721\
---------------------------------------------------------------------------

    \718\FTC v. Amy Travel Serv., Inc., 875 F.2d at 574. See also 
FTC v. J.K. Publ'ns, Inc., 99 F. Supp. 2d 1176 at 1204; FTC v. 
Atlantex Assocs., 1987-2 Trade Cas. ] 67788; FTC v. Kitco of Nevada, 
Inc., 612 F. Supp. at 1282. For the Commission to obtain civil 
penalties against a defendant, the standard of knowledge is even 
higher: ``actual knowledge or knowledge fairly implied on the basis 
of objective circumstances that [the] act or practice is unfair or 
deceptive and is prohibited by such rule.'' 15 U.S.C. 45(m)(1)(A).
    \719\FTC v. Publ'g Clearing House,104 F.3d at 1171; FTC v. Am. 
Standard Credit Sys., Inc., 874 F. Supp. at 1089; FTC v. Minuteman 
Press, Int'l, 53 F. Supp. 2d 248, 259-260 (E.D.N.Y. 1998); FTC v. 
Int'l Diamond Corp., 1983-2 Trade Cas., ] 65725 at 69707 (N.D. Cal. 
1983). It is axiomatic that the Commission need not show intent to 
defraud, or bad faith. See, e.g., FTC v. World Travel Vacation 
Brokers, Inc., 861 F.2d 1020, 1029 (7\th\ Cir. 1988) (citing 
Beneficial Corp. v. FTC, 542 F.2d 611, 617 (3\rd\ Cir. 1976), cert 
denied, 430 U.S. 983 (1977)); Removatron Int'l Corp. v. FTC, 884 
F.2d 1489, 1495 (1\st\ Cir. 1989) (citing Chrysler Corp. v. FTC, 561 
F.2d 357, 363 (D.C. Cir. 1977)); Regina Corp. v. FTC, 322 F.2d 765, 
768 (3\rd\ Cir. 1963); FTC v. Patriot Alcohol Testers, Inc., 798 F. 
Supp. 851, 855 (D. Mass. 1992).
    \720\See, e.g., FTC v. Five-Star Auto Club, 97 F. Supp. 2d at 
501 (failure to reform program in light of extensive state law 
enforcement cease and desist orders shows reckless indifference to 
the truth, or an awareness of high probability of fraud coupled with 
an intentional avoidance of the truth); FTC v. Safety Plus, Inc., 
No. 91-352 (E.D. Ky. 1992) (taking affirmative steps to remedy 
deceptive practices shows knowledge of the deceptive practices).
    \721\See FTC. v. H.N. Singer, Inc., 668 F.2d 1107 (9\th\ Cir. 
1982) (sales manager liable for restitution because of his authority 
to control and knowledge of the deceptive acts and practices of his 
salespeople).
---------------------------------------------------------------------------

2. Section 436.6(b): Formatting requirements
    As proposed in the Franchise NPR, section 436.6(b) of the final 
amended Rule specifies that all disclosures must be prepared ``clearly, 
legibly, and concisely in a single document.''\722\ At the same time, 
it includes the UFOC Guidelines requirement that disclosures must be 
prepared using plain English. It also updates the UFOC Guidelines to 
address electronic disclosure: section 436.6(b) provides that 
disclosures must be in a form that ``permits each prospective 
franchisee to store, download, print, or otherwise maintain the 
document for future reference.'' This prevents deception, ensuring that 
prospective franchisees can review the disclosure document at will, as 
well as show a copy of the disclosure document to their advisors, if 
they wish to do so.\723\ Thus, for example, a franchisor would violate 
section 436.6(b) 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. 
No comments addressed this issue. Accordingly, the final amended Rule 
adopts this provision as proposed in the Franchise NPR.
---------------------------------------------------------------------------

    \722\ Franchise NPR, 64 FR at 57345. See 16 CFR 436.1(a) and 
436.1(a)(21). The ``single document'' requirement prevents 
``piecemeal and confusing disclosures by the franchisor.'' Original 
SBP, 43 FR at 59682.
    \723\See Bundy, ANPR, 6 Nov. 97 Tr., at 129 (disclosures need to 
be either downloaded onto disk or provided in paper form).
---------------------------------------------------------------------------

3. Section 436.6(c): Affirmative responses
    Consistent with the original Rule and Franchise NPR, section 
436.6(c) of the final amended Rule specifies that franchisors must 
respond affirmatively or negatively to each disclosure item.\724\ 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. For example, a franchisor without any 
litigation would state something to the effect: ``The franchisor has no 
litigation required to be disclosed by Item 3.'' In addition, each 
disclosure item must contain the appropriate heading.\725\ No comments 
addressed this issue. Accordingly, the final amended Rule adopts this 
provision as proposed in the Franchise NPR.
---------------------------------------------------------------------------

    \724\ Franchise NPR, 64 FR at 57345. See 16 CFR 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.'' 
Original SBP, 43 FR at 59684.
    \725\See 16 CFR 436.1(a)(24).
---------------------------------------------------------------------------

4. Section 436.6(d): Additional materials
    The final amended Rule retains the original Rule's policy 
prohibiting franchisors from including additional materials in their 
disclosures, except for information ``required or permitted by this 
Rule or by state law not pre-empted

[[Page 15516]]

by this Rule.''\726\ This prohibition is necessary to ensure that 
franchisors do not include information that is non-material, confusing, 
or distracting from the core disclosures.\727\ As proposed in the 
Franchise NPR, the final amended Rule also updates the original Rule by 
prohibiting the use of new technological developments, such as audio, 
video, and ``pop-up'' screens, and external links,\728\ which could be 
used to call attention to favorable portions of a disclosure document 
or to distract prospective franchisees from damaging disclosures.\729\ 
The Commission recognizes, however, that navigational features may 
benefit prospective franchisees by making it easier to read an 
electronic disclosure document.\730\ To that end, the final amended 
Rule, consistent with the Franchise NPR, specifically permits the use 
of ``scroll bars, internal links, and search features.''
---------------------------------------------------------------------------

    \726\ Franchise NPR, 64 FR at 57345. See 16 CFR 436.1(a)(21). 
The Franchise NPR referred to ``any materials or information other 
than that required by this Rule or by state law not preempted by 
this Rule.'' One commenter 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 permitted by this Rule . . .'' Lewis, NPR 15, at 19. We agree, 
and the final amended Rule reflects this change.
    \727\See Original SBP, 43 FR at 59682. Accordingly, franchisors 
may include information expressly required or expressly permitted by 
state law or information requested by a state franchise examiner. 
This provision is not intended to permit franchisors to include any 
information (such as testimonials or general promotional materials) 
in a disclosure document on the ground that it is not specifically 
prohibited by state law.
    \728\ The prohibition on external links, like the requirement 
that a disclosure be a single document, effectively prevents 
franchisors from furnishing disclosures through a series of linked, 
but separate, documents. This ensures that electronic disclosures, 
in particular, can be downloaded and printed in their entirety. See 
Bundy, NPR 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. This would 
violate the very concept of full disclosure underlying the Rule.
    \729\ BI commented that a prohibition on the use of multimedia 
features ``appears to be overly broad.'' BI, NPR 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.
    \730\ 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, NPR 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 navigational 
features it believes are warranted.
---------------------------------------------------------------------------

    The prohibition against adding to a disclosure document generated a 
number of comments during the Rule amendment proceeding. Several 
commenters voiced concern that the prohibition against adding to a 
disclosure document ``is an unfair trap for franchisors and 
subfranchisors.'' For example, Warren Lewis asserted:

     [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.\731\
---------------------------------------------------------------------------

    \731\ Lewis, NPR 15, at 19. See also Holmes, NPR 8, at 9; 
Stadfeld, NPR 23, at 15; BI, NPR 28, at 8.

    The Commission believes that its long-standing policy limiting 
disclosures to only authorized or permitted materials is sound. As 
discussed above, this limitation is necessary to ensure that a 
franchisor does not bulk-up a disclosure document with unnecessary 
information or features that will discourage a prospective franchisee 
from reading the document or distract a prospective franchisee's 
attention from negative disclosures. For example, it is entirely proper 
to prohibit a franchisor from including general advertising, 
testimonials, or-- in the case of electronic media-- multimedia tools, 
in its disclosure documents. On the other hand, the Commission 
recognizes that unique features of electronic media, such as scroll 
bars, internal links, and search features that may aid prospective 
franchisees in reviewing their disclosures. Such features serve a 
useful purpose in an electronic environment, and the final amended Rule 
specifically permits their use.\732\
---------------------------------------------------------------------------

    \732\ Section 436.6(d), however, makes clear that navigational 
tools must be 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) is prohibited.
---------------------------------------------------------------------------

    In reaching this conclusion, we agree with the commenters' concern 
that it may be desirable to include additional material information in 
a disclosure document to ensure that required disclosures are accurate. 
The prohibition on adding to a disclosure document should be read 
narrowly to prohibit the inclusion of materials that are not 
specifically required or permitted by the Rule.\733\ Where the Rule 
requires a franchisor to make a disclosure, however, the franchisor 
always may add brief footnotes or other clarifications to ensure that 
the disclosure is complete and not misleading.
---------------------------------------------------------------------------

    \733\ We note that nothing in the Rule prohibits a franchisor 
from furnishing prospective franchisees with non-deceptive and non-
contradictory information outside of its disclosure document. See 16 
CFR 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.'').
---------------------------------------------------------------------------

    Finally, in response to the Staff Report, David Kaufmann asserted 
that the prohibition against adding to a disclosure document set forth 
at section 436.6(d) creates an inconsistency with state anti-fraud laws 
that require a disclosure document to contain all material 
information.\734\
---------------------------------------------------------------------------

    \734\ Kaufmann, Attachment 1, at 10-11. In the same vein, Howard 
Bundy recommended that the Commission create a separate, 
miscellaneous section of a disclosure document, where a franchisor 
can add other material disclosures necessary to make the disclosure 
document non-deceptive. Bundy, at 2-3.
---------------------------------------------------------------------------

    Section 436.6(d) is not intended to preempt state law. As 
previously discussed, a franchisor can always include information in a 
disclosure document that is required by state law. Typically, such 
state disclosures will arise in two circumstances. First, state law may 
require specific disclosures that go beyond those required by the 
Franchise Rule, or may contain a broad anti-fraud provision requiring 
franchisors to include in their disclosure document all material 
information. Second, a state franchise examiner may require, as a 
matter of discretion, on a case-by-case basis, a particular disclosure 
in order to prevent deception by a franchisor. In either instance, the 
final amended Rule accommodates state interests by permitting the 
franchisor to add state

[[Page 15517]]

information to its basic disclosure document.
5. Section 436.6(e): Multi-state documents
    As proposed in the Franchise NPR, section 436.6(e) of the final 
amended Rule permits franchisors to ``prepare multi-state disclosure 
documents by including non-preempted, state-specific information in the 
text of the document or in Exhibits attached to the disclosure 
document.''\735\ This instruction will decrease compliance costs 
significantly, by enabling franchisors to use one, united disclosure 
document for both federal and state purposes. No comments were 
submitted on this issue. Accordingly, the final amended Rule adopts 
this provision, as proposed in the Franchise NPR.
---------------------------------------------------------------------------

    \735\ Franchise NPR, 64 FR at 57345.
---------------------------------------------------------------------------

6. Section 436.6(f): Subfranchisor disclosures
    Consistent with the original Rule, section 436.6(f) makes clear 
that subfranchisors must disclose the required information about the 
franchisor, and, to the extent applicable, the same information 
concerning the subfranchisor.\736\
---------------------------------------------------------------------------

    \736\See Interpretive Guides, 44 FR at 49969. 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 subfranchisor 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.
---------------------------------------------------------------------------

    The Franchise NPR proposed that subfranchisors ``should'' disclose 
the required information. Howard Bundy suggested that the subfranchisor 
instructions be revised to replace ``should disclose'' with ``shall 
disclose.''\737\ 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. We agree, and section 
436.6(f) of the final amended Rule is revised accordingly.
---------------------------------------------------------------------------

    \737\ Bundy, NPR 18, at 11.
---------------------------------------------------------------------------

    At the same time, H&H voiced concern about subfranchisors' 
disclosure obligations, correctly observing 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.''\738\ As discussed above in connection with the 
definition of ``franchisor,'' 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.\739\ Accordingly, we believe that the subfranchisor 
instructions set forth at section 436.6(f) are clear and no additional 
revision is necessary.
---------------------------------------------------------------------------

    \738\ H&H, NPR 9, at 6.
    \739\ In our view, a new definition to address subfranchising is 
unnecessary because the term ``franchisor'' adequately addresses the 
issue. The Commission anticipates that staff will also explain 
subfranchising more fully in the Compliance Guides, with 
hypothetical examples.
---------------------------------------------------------------------------

7. Section 436.6(g): Disclosure of any prerequisites to receiving or 
reviewing disclosure documents
    Section 436.6(g) requires that, before a franchisor furnishes a 
disclosure document, it must ``advise the prospective franchisee of the 
formats in which the disclosure document is 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.''\740\
---------------------------------------------------------------------------

    \740\ This instruction is an alternative to the originally 
proposed prior-consent mandate for electronic disclosures. Several 
commenters opposed a prior consent requirement. See NFC, NPR 12, at 
15; Frandata, NPR 29, at 5; AFC, NPR 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, NPR 12, at 15. See also 
McDonalds, NPR 7, at 2. We agree. Section 436.6 permits a wide 
variety of disclosure formats, provided that the prospective 
franchisee is made aware of any prerequisites to using them.
---------------------------------------------------------------------------

    This provision was not previously noted in the Franchise NPR.\741\ 
It is intended to prevent deception, by ensuring that prospective 
franchisees, prior to disclosure, know whether or not they will receive 
a disclosure document in a form they can easily review.\742\ For 
example, a franchisor would disclose if it furnishes disclosures via 
CD-ROM only. In addition, the franchisor must disclose if there are any 
special conditions to reviewing a disclosure document. The franchisor 
would disclose, for example, 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). No comments were 
submitted on this proposed Rule amendment. Accordingly, the Commission 
adopts this provision in the final amended Rule.\743\
---------------------------------------------------------------------------

    \741\ As noted above, the Franchise NPR proposed a new section--
section 436.7--that set forth comprehensive electronic disclosure 
instructions. Among other things, that proposed section would have 
permitted prospective franchisees to furnish disclosures 
electronically only with the prospective franchisee's ``express 
consent.'' Proposed section 436.7(a). While an ``express consent'' 
requirement is now prohibited by E-SIGN, the underlying concepts--
that a prospective franchisee should know the formats in which 
disclosure documents will be provided, and any prerequisites to 
obtaining one--nonetheless continue to apply, regardless of the 
media (i.e., paper document or electronic document) selected by the 
franchisor to comply with the final amended Rule.
    \742\ This is consistent with section 436.3(f) of the final 
amended Rule, allowing franchisors to state in the cover page 
whether alternative disclosure formats are available and how 
prospective franchisees may obtain one.
    \743\ One commenter, however, observed that this section does 
not specify how or when the franchisor should communicate this 
information to the prospect. Kaufmann, at 3. He suggested that the 
Commission advise in the Compliance Guides that franchisors may 
communicate this information in any fashion and at any time prior to 
furnishing the disclosure document it chooses-- in person, 
telephonically, in writing, in email, in its marketing materials, or 
applications. Id. But see Bundy, at 10 (asserting that the provision 
does not provide sufficient guidance, recommending that the 
Commission specify which formats are preferred). We agree that the 
final amended Rule should be as flexible as possible. Section 
436.6(g) is not intended to be a new trigger or timing for 
disclosures provision. As long as the franchisor has communicated 
this information before the 14 calendar-days for disclosure starts 
running, the franchisor has complied with this provision. 
Flexibility is also called for, provided that the franchisor can 
demonstrate that it has communicated the required information. For 
many systems, the easiest way to impart this information will be in 
the franchisor's initial application form, or in the first written 
contact after acceptance of the application when the issue of 
furnishing the disclosure document first arises.
---------------------------------------------------------------------------

8. Section 436.6(h): Disclosure document recordkeeping
    Section 436.6(h) of the final amended Rule requires franchisors to 
``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.'' This provision modifies slightly the language used in the 
Franchise NPR--which limited the recordkeeping instruction to 
electronic disclosure documents.\744\ Section 436.6(h) now applies to 
all disclosure documents, regardless of the medium

[[Page 15518]]

used.\745\ 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.\746\
---------------------------------------------------------------------------

    \744\ Franchise NPR, 64 FR at 57345.
    \745\ Many states require franchisors to keep records on 
franchise sales transactions. 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.
    \746\ 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.
---------------------------------------------------------------------------

    During the Rule amendment proceeding, a few commenters urged the 
Commission to adopt a longer recordkeeping requirement.\747\ 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 
Rule instructions ensuring that prospective franchisees can retain 
copies of their disclosures for future reference. In short, franchisees 
should safeguard their disclosure documents post-sale, and the Rule 
instructions, as noted above, accommodate that interest.
---------------------------------------------------------------------------

    \747\ Bundy, NPR 18, at 13; Stadfeld, NPR 23, at 5.
---------------------------------------------------------------------------

9. Section 436.6(i): Receipt recordkeeping
    Finally, section 436.6(i) of the final amended Rule requires 
franchisors to ``retain a copy of the signed receipt for at least three 
years.''\748\ This section was proposed in the Franchise NPR in 
connection with the Item 23 receipt requirement. However, because this 
recordkeeping requirement is not a disclosure, but is more akin to an 
instruction, it has been moved to the final amended Rule's general 
instructions section.
---------------------------------------------------------------------------

    \748\See BI, NPR 28, at 7-8 (This ``provides useful 
clarification regarding the minimum time period the Commission 
expects franchisors to maintain such records.'').
---------------------------------------------------------------------------

    Section 436.6(i)'s three-year record retention period is consistent 
with the statute of limitations for trade regulation rule enforcement 
actions brought under Section 19 of the FTC Act.\749\ Further, many 
franchise registration states already require franchisors to maintain 
complete records involving each franchise sales transaction.\750\ 
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.\751\
---------------------------------------------------------------------------

    \749\ Several Commission trade regulation rules also require a 
three-year recordkeeping requirement. See, e.g., Wool Labeling Rule, 
16 CFR 300.31(c); Fur Labeling Rule, 16 CFR 301.41(b); Textile 
Labeling Rule, 16 CFR 303.39(c); Alternative Fuel Labeling Rule, 16 
CFR 309.23; R-Value Rule, 16 CFR 460.9.
    \750\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.
    \751\ No comments were submitted on this proposed Rule section.
---------------------------------------------------------------------------

E. Section 436.7: Updating Requirements

    Section 436.7 of the final amended Rule specifies three updating 
requirements to ensure that franchisors' disclosures are timely. In 
most respects, the updating requirements are identical to those set 
forth in the original Rule and Franchise NPR, and have generated few 
comments.
    First, section 436.7(a) of the final amended Rule retains the 
current requirement that franchisors prepare annual updates after the 
close of their fiscal year,\752\ but it has expanded the number of days 
in which franchisors are permitted to prepare updates from 90 to 120 
days.
---------------------------------------------------------------------------

    \752\See 16 CFR 436.1(a)(22).
---------------------------------------------------------------------------

    Second, sections 436.7(b) and (c) retain the requirement that 
franchisors update their disclosures within a reasonable time after the 
close of each quarter to reflect any material changes.\753\
---------------------------------------------------------------------------

    \753\See 16 CFR 436.1(a)(22).
---------------------------------------------------------------------------

    Third, section 436.7(d) continues the original Rule's policy that 
franchise sellers, when furnishing their disclosures, must notify 
prospective franchisees of any material changes that the seller knows 
or should have known in any Item 19 financial performance 
representations.\754\ We discuss each of these provisions immediately 
below.
---------------------------------------------------------------------------

    \754\See 16 CFR Sec. Sec.  436.1(d)(2) and (e)(6). Section 
436.7(e) also retains the Commission's current policy that audited 
information in a disclosure document need not be re-audited 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. See 16 CFR 
436.1(22).
---------------------------------------------------------------------------

1. Section 436.7(a): Annual updates
    As noted above, section 436.7(a) expands the time period proposed 
in the Franchise NPR for making annual updates from 90 to 120 days 
after the close of the franchisor's fiscal year.\755\ In response to 
the Franchise NPR, several commenters urged the Commission to adopt a 
120-day requirement. For example, PMR&W stated 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.\756\ For these 
reasons, the Commission is persuaded that the updating requirement 
should be expanded from the original Rule's 90 days to 120 days. This 
revision has the potential of reducing franchisors' compliance burdens, 
while potentially reducing inconsistencies with state updating 
policies.\757\
---------------------------------------------------------------------------

    \755\ Franchise NPR, 64 FR at 57345 (retaining the original 
Rule's 90-day annual update requirement).
    \756\ PMR&W, NPR 4, at 5. See also Baer, NPR 11, at 4; Lewis, 
NPR 15, at 19-20; IFA, NPR 22, at 11; J&G, NPR 32, Attachment, at 3.
    \757\ In response to the Staff Report, however, Gust Rosenfeld 
suggested that ``120 days'' should be expressed as ``four months.'' 
The firm noted that during leap years, 120 days would fall on April 
29, or if the franchisor's fiscal year end is June 30\th\, 120 days 
would fall on October 28. Gust Rosenfeld, at 7. While we recognize 
there may be rare instances where 120 days does not fall at the end 
of a month, we are reluctant to change the language of section 
436.7(a) to be inconsistent with state law.
---------------------------------------------------------------------------

2. Sections 436.7(b)-(c): Quarterly updates
    Sections 436.7(b) and (c) of the final amended Rule retain the 
original Rule and Franchise NPR requirement that franchisors update 
their disclosures at least quarterly to reflect any material 
changes.\758\ This requirement generated no significant comment during 
the Rule amendment proceeding.\759\ We believe it

[[Page 15519]]

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.
---------------------------------------------------------------------------

    \758\ Franchise NPR, 64 FR at 57345. See also 16 CFR 
436.1(a)(22).
    \759\ PMR&W, for example, noted that the original Rule's 
quarterly update requirement is a bright-line rule that ``is clear 
and intelligible to franchisors and their counsel.'' PMR&W, NPR 4, 
at 6. Similarly, the NFC states that a quarterly update requirement 
is consistent with long-standing Commission policy. NFC, NPR 12, at 
16. One commenter, responding to the comparable provision in the 
Staff Report, noted that the Franchise NPR would have required a 
franchisor to update information quarterly ``relating to the 
franchise business of the franchisor.'' J&G, at 7. The firm asserted 
that this language could require the disclosure of more information 
than is required by the actual disclosure Items. It suggested that 
the Commission adopt the alternative language: any material change 
to ``the disclosures included, or required to be included, in the 
disclosure document.'' We agree, and section 436.7(b) of the final 
amended Rule reflects that change.
---------------------------------------------------------------------------

    Section 436.7(c) modifies the quarterly update provision proposed 
in the Franchise NPR, however, to accommodate the extension of the 
annual update from 90 to 120 days, as previously discussed. The 
obligation to update disclosures quarterly necessarily precedes the 
conclusion of the 120-day annual update period. Accordingly, additional 
clarification of the interrelationship between the annual and quarterly 
update requirements is warranted. To that end, section 436.7(c) 
provides that a franchisor's annual update (120 days after the close of 
the fiscal year) ``shall include the franchisor's first quarterly 
update, either by incorporating the quarterly update information into 
the disclosure document itself, or through an addendum.'' The following 
tables illustrate the point, by comparing procedures under the original 
Rule with those under section 436.7(c).

                              Hypothetical Using Procedures Under the Original Rule
December 31, 2005...........................  Fiscal year ends.
January-March, 2006.........................  First quarter of new fiscal year.
April 1, 2006...............................  Franchisor must use annual updated disclosure document.
Reasonable time after April 1, 2006.........  Franchisor amends annual update with a quarterly update, if
                                               warranted.
Reasonable time after July 1, 2006..........  Franchisor amends annual update (and any previous quarterly
                                               update) with a quarterly update, if warranted.
Reasonable time after October 1, 2006.......   Franchisor amends annual update (and any previous quarterly
                                               update(s)) with a quarterly update, if warranted.
Reasonable time after January 1, 2007.......  Franchisor amends 2006 annual update (and any previous quarterly
                                               updates(s)) with a quarterly update, if warranted.
----------------------------------------------------------------------------------------------------------------


                                Hypothetical Using Final amended Rule Procedures
December 31, 2005...........................  Fiscal year ends.
January-March, 2006.........................  First quarter of new fiscal year.
May 1, 2006.................................  Franchisor must use annual updated disclosure document containing
                                               any first quarter update either integrated in the body of the
                                               disclosure document itself or in an addendum.
Reasonable time after July 1, 2006..........  Franchisor amends annual update with a quarterly update, if
                                               warranted.
Reasonable time after October 1, 2006.......  Franchisor amends annual update (and any previous quarterly
                                               update(s)) with a quarterly update, if warranted.
Reasonable time after January 1, 2007.......  Franchisor amends annual update (and any previous quarterly
                                               updates(s)) with a quarterly update, if warranted.
----------------------------------------------------------------------------------------------------------------

3. Section 436.7(d): Material changes to financial performance 
information
    Section 436.7(d) retains the original Rule requirement that a 
franchisor notify prospective franchisees of any material changes to 
previously furnished financial performance information.\760\ The 
Franchise NPR proposed a broader updating requirement that would have 
compelled franchisors to notify prospects of any material changes 
before delivery of the disclosure document.\761\ This proposal 
generated several comments, both supporting and opposing the expanded 
updating proposal.
---------------------------------------------------------------------------

    \760\ 16 CFR 436.1(d)(2) and 436.1(e)(6).
    \761\ NPR, 64 at 57319.
---------------------------------------------------------------------------

    IL AG and Howard Bundy favored the broader updating 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.''\762\
---------------------------------------------------------------------------

    \762\ IL AG, NPR 3, at 4. See also Bundy, NPR 18, at 13; BI, NPR 
28, at 8-9. On the other hand, the NFC praised the Commission's 
flexibility in permitting notification by any means. NFC, NPR 12, at 
16.
---------------------------------------------------------------------------

    On the other hand, several franchisors opposed the updating 
requirement for various reasons. Marriott, for example, asserted the 
proposal would be 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 time' ongoing 
disclosure.''\763\ Marriott would eliminate the proposed expanded 
update provision in its entirety.\764\
---------------------------------------------------------------------------

    \763\ Marriott, NPR 35, at 3-4. 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 in 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, NPR 35, at 4.
    \764\ Marriott, NPR 35, at 4. See also PMR&W, NPR 4, at 6.
---------------------------------------------------------------------------

    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.

[[Page 15520]]

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?\765\
---------------------------------------------------------------------------

    \765\ PMR&W, NPR 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.\766\
---------------------------------------------------------------------------

    \766\ NFC, NPR 12, at 16.

    It is clear from the comments that there are two competing 
concerns. 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. 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.
    Based upon the record, the Commission is persuaded that, on 
balance, a continuing update requirement is unwarranted. 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 original Rule's quarterly update 
requirement is sufficient to ensure timely disclosures, while 
minimizing compliance costs.
    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 
facilitate that goal, the Commission has adopted 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.\767\ We believe this prohibition is unlikely to 
increase franchisor's compliance costs and burdens. Franchisors most 
likely will have updated disclosures documents prepared in the ordinary 
course of their business. 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.
---------------------------------------------------------------------------

    \767\See section 436.9(f). This provision also address the 
commenters' concerns about permitting franchisors to furnish updates 
orally.
---------------------------------------------------------------------------

    At the same time, we are persuaded that the final amended Rule 
should retain the original Rule's continuing update requirement for 
financial performance information.\768\ The original Rule required 
franchisors to notify prospective franchisees of any material changes 
in a financial performance representation before the prospective 
franchisee pays a fee or signs the franchise agreement.\769\ 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 financial data in making their 
investment decision.\770\
---------------------------------------------------------------------------

    \768\ But see IL AG, at 10 (suggesting that the Rule state that 
franchisors may have other disclosure obligations under Section 5 of 
the FTC Act); Bundy, at 3 (suggesting a continuous updating 
requirement for ``materially adverse events.''). The quarterly 
update provision specifies when a franchisor must prepare revised 
disclosures to ensure that they are timely. It does not address 
whether a franchisor may have other obligations to notify 
prospective franchisees of material changes under state common law 
fraud or misrepresentation principles.
    \769\See 16 CFR 436.1(d)(2) and 436.1(e)(6). Like the original 
Rule, the final amended Rule requires the franchisor to ``notify'' 
the prospective franchisee of any material change in financial 
performance information. It does not require a franchisor to update 
its disclosures more often than quarterly, nor does it require a 
franchisor to re-disclose to a prospective franchisee. Rather, 
``notification'' means that the franchisor must inform the 
prospective franchisee, which can be accomplished outside of the 
disclosure document. How a franchisor ``notifies'' a prospective 
franchisee is within the sound discretion of the franchisor. 
Notification can be made in writing, or by telephone call, email, or 
other electronic transmission, provided that the franchisor can 
prove that it has informed the prospective franchisee about the 
material change to the performance data.
    \770\But see J&G, at 11 (asserting that financial performance 
information should be updated only quarterly).
---------------------------------------------------------------------------

F. Section 436.8: Exemptions

    Section 436.8 of part 436 sets forth exemptions from the final 
amended Rule. In the original Rule, the exemptions were set out in the 
middle of the Rule's definitions, where they modified the term 
``franchise.''\771\ To make the exemptions easier to find, the 
Commission has decided to move them to a separate ``exemptions'' 
section in the final amended Rule.\772\
---------------------------------------------------------------------------

    \771\ 16 CFR 436.2(a)(3).
    \772\ This approach is consistent with other Commission rules, 
including the Telemarketing Sales Rule, 16 CFR 310.6; the Care 
Labeling Rule, 16 CFR 423.8, and the Cooling-Off Period Rule, 16 CFR 
429.3. 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 final amended Rule 
may nonetheless have to prepare and disseminate UFOCs for state law 
purposes.
---------------------------------------------------------------------------

    Section 436.8 retains the original Rule exemptions for: (1) 
franchise sales under $500;\773\ (2) fractional franchises;\774\ (3) 
leased departments;\775\ and (4) oral contracts.\776\ Section 436.8 
also adds two new exemptions, one for franchise sales involving 
petroleum marketers, and one for three categories of ``sophisticated 
investors.'' Finally, the final amended Rule deletes the original 
Rule's four exclusions found at 16 CFR 436.2(a)(4)(i)-(iv) for non-
franchise relationships involving: (1) employer-employees and general 
partnerships; (2) cooperative organizations; (3) testing or 
certification services; and (4) single trademark licenses.\777\
---------------------------------------------------------------------------

    \773\See 16 CFR 436.2(a)(3)(iii).
    \774\See 16 CFR 436.2(a)(3)(i).
    \775\See 16 CFR 436.2(a)(3)(ii).
    \776\See 16 CFR 436.2(a)(3)(iv).
    \777\ As discussed below, although the Commission is deleting 
the exclusions from the final amended Rule text, it is retaining the 
exclusions as a matter of policy and incorporating them by reference 
in this Document.
---------------------------------------------------------------------------

    The final amended Rule section 436.8 is substantially similar in 
both form and content to its counterpart proposed in the Franchise 
NPR.\778\ The principal difference is a lowering of the dollar 
threshold for the sophisticated investor ``large investment'' exemption 
from $1.5 million to $1 million. This and the other substantive 
differences between the proposed and final amended Rules are explained 
below.
---------------------------------------------------------------------------

    \778\ Franchise NPR, 64 FR at 57345. The final amended Rule 
provision, however, has been renumbered as section 436.8. In the 
Franchise NPR, it was numbered section 436.9.
---------------------------------------------------------------------------

1. Section 436.8(a)(1): Minimum payment exemption
    Section 436.8(a)(1) retains the original Rule's $500 required 
minimum payment exemption found at 16 CFR 436.2(a)(3)(iii). 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.''\779\ As explained below, the 
Commission believes the exemption and its $500

[[Page 15521]]

threshold continue to serve a useful purpose.
---------------------------------------------------------------------------

    \779\ Original SBP, 43 FR at 59704.
---------------------------------------------------------------------------

    During this Rule amendment proceeding, no commenter recommended 
eliminating or reducing the $500 minimum payment threshold. Several 
commenters, however, urged the Commission to raise the $500 minimum 
threshold, with some commenters suggesting a $1,000 threshold,\780\ 
while others suggested a $2,500,\781\ or a $5,000 threshold.\782\ These 
commenters maintained that an upward adjustment is warranted to reflect 
the increase in costs since the Rule was promulgated in 1978. In 
addition, two commenters also urged the Commission to increase the 
thresholds periodically, perhaps every four years, to reflect the rate 
of inflation.\783\
---------------------------------------------------------------------------

    \780\ Typical of these comments was H&H, which urged the 
Commission to raise the threshold to $1,000 in order to recognize 
the fact that costs in general have increased substantially since 
the Rule was initially promulgated. H&H, NPR 9, at 4. See also 
Gurnick, NPR 21A, at 8; GPM, NPR Rebuttal 40, at 9.
    \781\ Baer, NPR 11, at 15-16. In the alternative, Mr. Baer 
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. 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.
    \782\ J&G, NPR 32, at 14.
    \783\See H&H, NPR 9, at 4; Baer, NPR 11, at 15-16.
---------------------------------------------------------------------------

    In contrast, the IL AG urged the Commission to retain the $500 
threshold in order to protect small investors.\784\ In a similar vein, 
a franchisee representative 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.''\785\
---------------------------------------------------------------------------

    \784\ IL AG, NPR Rebuttal 38, at 2 (``To exempt franchises 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.'').
    \785\ Bundy, NPR 18, at 14.
---------------------------------------------------------------------------

    The Commission has determined to retain the original Rule's $500 
minimum payment exemption. The original Rule included a threshold 
dollar amount to exclude transactions where the prospective franchisee 
was at risk to lose an amount of money too small to justify imposition 
of the expense and burden of preparing a disclosure document upon 
sellers. This is particularly true with less complex business 
opportunities, which, even today, may cost under $500. However, with 
the extraction of business opportunity regulation to a new rule 
separate from the Franchise Rule, it can be argued that any investment 
in a franchise, as a practical matter, will be a significant investment 
risk. This may suggest that the exemption may no longer serve a useful 
purpose.
    We note that the Staff Report described research exploring the 
relevance of the $500 threshold to the amounts actually charged for 
initial franchise fees in the current market. The staff examined over 
1,000 franchise profiles listed in Bond's Franchise Guide (13\th\ ed. 
2001).\786\ All but 41 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 that an 
initial fee was ``not applicable,'' or that they charged an initial 
franchisee fee of $1,000 or less.\787\ Thus, even a $5,000 threshold 
would not reduce significantly the number of franchisors that must 
comply with the Rule's disclosure obligations.
---------------------------------------------------------------------------

    \786\ 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.
    \787\ The Staff Report noted 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.
---------------------------------------------------------------------------

    Given the significant investment required to purchase nearly any 
franchise, a plausible argument could be made for eliminating the 
threshold altogether. However, the minimum payment exemption continues 
to serve a very narrow, but important, purpose: To the extent that a 
less complex 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. Thus, the 
final amended Rule retains the minimum payment exemption.\788\
---------------------------------------------------------------------------

    \788\ Howard Bundy opined that the $500 minimum payment 
exemption should reference payments by contract or by practical 
necessity. Bundy, NPR 18, at 4. The $500 minimum payment exemption, 
however, already references the term ``required payment,'' which in 
turn is defined to include both payments by contract and by 
practical necessity. Accordingly, no further refinement of the Rule 
is necessary on this point.
---------------------------------------------------------------------------

2. 436.8(a)(4): Petroleum marketers and resellers exemption
    Section 436.8(a)(4) of the final amended Rule expressly exempts 
petroleum marketers and resellers covered by the Petroleum Marketing 
Practices Act (``PMPA'').\789\ Although this exemption was not part of 
the original Rule, in 1980 the Commission granted a petition for an 
exemption from the Rule filed by several oil companies and oil jobbers, 
pursuant to Section 18(g) of the FTC Act.\790\
---------------------------------------------------------------------------

    \789\ 15 U.S.C. 2801.
    \790\ 45 FR 51765 (Aug. 5, 1980).
---------------------------------------------------------------------------

    In considering the petition, the Commission noted that the most 
frequently cited complaint about the petroleum franchise industry 
concerned termination and renewal practices. The Commission also noted 
that, after the close of the original franchise rulemaking record, 
Congress had 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 granting the petition, 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].''\791\ The final amended Rule incorporates the 1980 exemption 
as an express Rule exemption.
---------------------------------------------------------------------------

    \791\ 45 FR at 51766. 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.''
    45 FR at 51766. Since 1980, the Commission has received only 
isolated complaints regarding abuses in the relationship between 
petroleum company franchisors and their franchisees, and has no 
reason to believe that a pattern of abuse is likely to develop in 
the near future.
---------------------------------------------------------------------------

    Two commenters voiced concern about this exemption. J&G maintained 
that the exemption 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.\792\ In the same vein, Chevron noted that the PMPA 
covers agreements not only for gasoline sales, but for other refiner-
branded services or products at a gasoline station. For example, a 
Chevron gasoline station may also have a Chevron branded (or no brand) 
car wash, repair

[[Page 15522]]

center, or mart. According to Chevron, all of these services or 
products are sold as part of a unified deal when the prospective 
franchisee purchases the franchised gasoline outlet. Therefore, the 
Commission should also exempt the sale of such tangential services or 
goods sold along with a gasoline station under a unified 
agreement.\793\
---------------------------------------------------------------------------

    \792\ J&G, NPR 32, Attachment at 6.
    \793\See Pillsbury Winthrop (on behalf of Chevron U.S.A. Inc.).
---------------------------------------------------------------------------

    In response to these comments, the Commission intends that it be 
clear that the PMPA exemption should be read broadly to cover other 
branded services and products (such as a car wash or mart) sold to the 
prospective franchisee under the same franchise agreement as the 
gasoline station. The Commission believes that, as a practical matter, 
it may be impossible to divide a single franchise agreement for 
gasoline and other services into its component parts for disclosure 
purposes, and such an approach is inconsistent with the PMPA. 
Nevertheless, separate or subsequent sales of a franchise to a gasoline 
station owner, such as a 7-Eleven or Subway outlet, fall outside of the 
exemption. 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 prospective 
franchisee.
3. Sections 436.8(a)(5) and (a)(6): Sophisticated investor exemptions
    Sections 436.8(a)(5) and (a)(6) add three new exemptions to the 
final amended Rule, collectively referred to as the ``sophisticated 
investor exemptions.'' As noted, the sophisticated investor exemptions 
as adopted are substantially similar to their counterparts as proposed 
in the Franchise NPR.\794\
---------------------------------------------------------------------------

    \794\ Franchise NPR, 64 FR at 57345.
---------------------------------------------------------------------------

    Franchisors enthusiastically supported the creation of 
sophisticated investor exemptions.\795\ They maintained that 
franchising today often involves heavily-negotiated, multi-million 
dollar deals between franchisors and highly sophisticated individuals 
and corporate franchisees with highly competent counsel. In the course 
of such deals, prospective franchisees often demand and receive 
material information from the franchisor that equals or exceeds the 
disclosures required by the Rule. These commenters asserted that such 
business arrangements are not the kinds of franchise sales that the 
Commission originally intended to cover.
---------------------------------------------------------------------------

    \795\E.g., Gust Rosenfeld, at 7; J&G, at 7; Marriott, at 2-4; 
Starwood, at 2-3; 7-Eleven, NPR 10, at 2; NFC, NPR 12, at 17; IFA, 
NPR 22, at 7; AFC, NPR 30, at 2-3; Marriott, NPR 35, at 6. See also 
Kaufmann, ANPR, 18 Sept. 97 Tr., at 165; Wieczorek, id., at 187-88; 
Tifford, id., at 194 (noting that the Rule imposes unnecessary costs 
on sophisticated franchisees and adds unwarranted delay in the high-
paced negotiation process, where parties often are anxious to cement 
their deals quickly to beat out the competition).
---------------------------------------------------------------------------

    On the other hand, several franchisees and their advocates opposed 
the exemptions, or expressed reservations about them.\796\ Some feared 
that while prospective franchisees may appear to be sophisticated--
either 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.\797\
---------------------------------------------------------------------------

    \796\See, e.g., Bundy, NPR 18, at 14; Stadfeld, NPR 23, at 7-8; 
Karp, NPR 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.'').
    \797\See Selden, at 1; Gee, at 2; Karp, at 6-7; Pu, at 2; Zarco 
& Pardo, ANPR 134, at 4-5; Kezios, ANPR, 6 Nov. 97 Tr., at 47-48; 
Bundy, id., at 48-49; Stadfeld, NPR 23, at 8; Karp, NPR 24, at 6-8; 
NFA, NPR 27, at 3. See also NADA (urging the Commission to consider 
exemptions on a case-by-case basis only).
---------------------------------------------------------------------------

    Section 436.8(a)(5)(i)--the ``large franchise investment'' 
exemption--exempts franchise sales where the initial investment is at 
least $1 million, exclusive of unimproved land and franchisor 
financing. Section 436.8(a)(5)(ii)--the ``large franchisee'' 
exemption--exempts franchise sale to ongoing entities--such as 
airports, hospitals, and universities--with at least $5 million net 
worth and five years of prior business experience. Section 
436.8(a)(6)--the ``insiders'' exemption--exempts franchise sales to the 
owners, directors, and managers of an entity before it becomes a 
franchisor.\798\ Each of these exemptions is discussed in the section 
below.
---------------------------------------------------------------------------

    \798\ Two commenters noted that the inclusion of the three 
sophisticated investor exemptions in the final amended Rule could be 
misleading because a franchisor may still have obligations to make 
disclosures under state law. Bundy, at 3; IL AG, at 10. Howard 
Bundy, for example, urged the Commission to include a warning in the 
final amended Rule itself that exemption from the Franchise Rule 
does not necessarily mean exemption from state disclosure law. While 
this observation is true, the Commission believes the appropriate 
place to delineate the relationship between the final amended Rule 
and state law is in anticipated Compliance Guides and other business 
and consumer education materials.
---------------------------------------------------------------------------

a. Section 436.8(a)(5)(i): Large investment exemption
    Section 436.8(a)(5)(i) exempts from the Rule franchise sales where 
the prospective franchisee makes an initial investment totaling at 
least $1 million, excluding the cost of unimproved land.\799\ To ensure 
that the large investment exemption is not overly broad and does not 
create a loophole, section 436.8(a)(5)(i) sets forth additional 
safeguards beyond the $1 million threshold to preserve protection for 
the average investor.\800\ First, section 436.8(a)(5)(i) makes clear 
that funds obtained from the franchisor (or an affiliate) cannot be 
counted toward the $1 million initial investment threshold. Second, 
section 436.8(a)(5)(i) requires the prospective franchisee to sign an 
acknowledgment that the franchise sale is exempt from the Franchise 
Rule because the prospective franchisee will be making an initial 
investment of at least $1 million.
---------------------------------------------------------------------------

    \799\ At least 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.
    \800\ These safeguards were included in the proposed version of 
this provision. Franchise NPR, 64 FR at 57321 and 57345.
---------------------------------------------------------------------------

i. Need for the large initial investment exemption
    As noted above, franchisors urged the Commission to adopt a large 
initial investment exemption,\801\ while franchisees either opposed it 
or offered suggestions to limit it.\802\ Specifically, several 
franchisee commenters asserted that wealth or ability to make a large 
franchise investment does not necessarily equate with business 
sophistication. They urged the Commission to focus instead on the 
investor and his or her business background, rather than ability to pay 
alone.\803\
---------------------------------------------------------------------------

    \801\E.g., PMRW, NPR 4, at 3; Wendy's, NPR 5, at 2; McDonalds, 
NPR 7, at 2; H&H, NPR 9, at 4; Baer, NPR 11, at 16; NFC, NPR 12, at 
20. Marriott, for example, stated that not only are sophisticated 
franchisees able to protect their own interests, but the self-
interest of others involved in the project, such as bankers, is 
sufficient to protect those interests as well. Marriott, NPR 35, at 
6. See, e.g., Baer, NPR 11, at 16; Gurnick, NPR 21, at 3; J&G, NPR 
32, at 3.
    \802\ Stadfeld, NPR 23, at 8; Karp, NPR 24, at 6.
    \803\ Karp, at 7; Karp, NPR 24, at 6-7. See also Stadfeld, NPR 
23, at 7-8 (``Being wealthy should not be a basis for being 
screwed.'').
---------------------------------------------------------------------------

    For example, Eric Karp criticized the notion of a large investment 
exemption because it 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

[[Page 15523]]

income the prospective franchisee has from which one can estimate his 
or her financial sophistication and tolerance of risk.\804\
---------------------------------------------------------------------------

    \804\ Karp, NPR 24, at 7. See also Selden, at 2 (``The idea that 
disclosure becomes unnecessary when the investment exceeds an 
arbitrary threshold, because scale is a proxy for sophistication or 
bargaining power, is an oxymoron.''); Gee, at 3 (``The FTC should 
focus on the capabilities of the investor as opposed to the size of 
the investment.''). Mr. Selden also asserted that franchisors are 
not always forthcoming with information, suggesting that had the 
Commission solicited the views of franchisees of large hotel 
systems, for example, we would have a different impression. Id. We 
note, however, that not a single hotel franchisee or large 
restaurant franchisee submitted any comment in response to the large 
investment exemption discussed in the ANPR, NPR, and Staff Report. 
Accordingly, we are unconvinced that Mr. Selden's concerns raise a 
serious issue.

In lieu of the ``investment'' model offered by the Commission, Mr. Karp 
urged the Commission to consider SEC Regulation D,\805\ which 
``properly focuses on the qualifications of the investor, not the size 
of the investment.'' In his view, the large franchise exemption 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.''\806\
---------------------------------------------------------------------------

    \805\See 17 CFR 230.501(5), (6), and (8). See also Wendy's, NPR 
5, at 2.
    \806\ Karp, NPR 24, at 8.
---------------------------------------------------------------------------

    Mr. Karp also discounted the potential benefit of the 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 the threshold level. 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.\807\
---------------------------------------------------------------------------

    \807\ Karp, NPR 24, at 6. See also Bundy, ANPR, 6 Nov. 97 Tr., 
at 21-22; Jeffers, id., at 23-24; Stadfeld, NPR 23, at 8.
---------------------------------------------------------------------------

    After reviewing the comments, we are persuaded that a large 
investment exemption is warranted. Since the Rule's inception, the 
Commission has considered a prospective franchisee's level of 
investment as one measure 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.\808\
---------------------------------------------------------------------------

    \808\ 45 FR 51763-64 (Aug. 5, 1980).

Accordingly, it is clear that investment level is one indicium of 
sophistication.
    More important, we are convinced 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 specific business experience of each 
individual prospective franchisee would be 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 business background. Similarly, absent such verification, 
law enforcers would not be able to discern whether any specific 
franchise relationship was covered by the Rule. This approach could 
create a regulatory nightmare for both franchisors and franchise law 
enforcers.
    We are also convinced that the large investment exemption offers 
tangible benefits to franchisors. Clearly, there are franchise systems, 
such as lodging, where the typical franchise investment is likely to 
exceed the large investment exemption's monetary threshold. 
Accordingly, the large investment exemption will provide regulatory 
relief at least in those instances. We recognize that the large 
franchise investment exemption, however, will provide only limited 
relief for franchisors that sell franchises both above and below the 
threshold. In such instances, the franchisor must prepare disclosure 
documents in order to sell at levels below the threshold. Accordingly, 
the costs of providing disclosures to all franchisees, including those 
above the threshold, may not be large, but neither is the potential 
benefit to the purchaser. 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 demand and obtain pre-sale material 
information regardless of external prompting or compulsion, then the 
case for federal intervention is not compelling.
    Further, the Rule's costs and burdens are unwarranted in situations 
where the likelihood of abuse is low. This concept is incorporated into 
the statutory provision of the FTC Act that gives franchisors the right 
to petition the Commission for a trade regulation rule exemption, 
including an exemption limited to a specific set of facts.\809\ Thus, a 
franchisor, if it wished, could petition the Commission for an 
exemption only for sales above a certain dollar figure (although to 
date none has done so). The large investment exemption need not be 
``all or nothing'' to benefit franchisors. The very fact that 
franchisors uniformly supported the large investment exemption tends to 
confirm that it will provide them with some desired regulatory relief. 
On balance, we believe that a narrowly crafted large investment 
exemption offers the potential for reducing franchisors' regulatory 
burdens and preserving Commission resources by reducing the number of 
exemption petitions, without sacrificing protections for the average 
investors the Franchise Rule was originally promulgated to protect.
---------------------------------------------------------------------------

    \809\ Section 18(g) of the FTC Act. 15 U.S.C. 57a(g). One 
commenter observed that while franchisors can file individual 
petitions for exemptions from the Rule under Section18(g) of the FTC 
Act, the process is costly and the delay involved often renders this 
approach an unviable option. Duvall & Mandel, ANPR 114, at 16. 
Section 18(g) of the FTC Act provides a mechanism for parties to 
petition for relief from Commission trade regulation rules where 
potential abuse is unlikely. Section 18(g) exemption petitions are 
placed on the public record for comment. The entire process of 
reviewing and granting such a petition may take several months to 
more than one year, depending on any comments received.
---------------------------------------------------------------------------

ii. The $1 million investment threshold
    Section 436.8(a)(5)(i) provides that franchise sales involving an 
investment of $1 million --excluding the cost of unimproved land and 
franchisor financing--qualify for the large investment exemption. We 
are convinced that a $1 million threshold strikes the right balance 
between providing relief for sophisticated investors and protecting 
consumers.
    The large investment exemption proposed in the Franchise NPR 
incorporated a higher $1.5 million threshold, based upon the Commission 
staff's analysis of the costs to purchase more than 1,350 franchises 
listed in various trade publications, including Enterprise Magazine's 
The Franchise

[[Page 15524]]

Handbook; (``Franchise Handbook''); Entrepreneur Magazine's Franchise 
500, and the International Franchise Organization's Franchise 
Opportunities Guide.\810\
---------------------------------------------------------------------------

    \810\ For a detailed discussion of staff's analysis, see Staff 
Report, at 238.
---------------------------------------------------------------------------

    Very few single-unit franchises cost more than $1.5 million: the 
maximum estimated cost of establishing a franchise exceeded $1.5 
million in only about 3% of the listed systems. Thus, 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 in the cited 
sources involve a maximum investment totaling less than $500,000. Thus, 
in order to qualify for the $1.5 million exemption, an investment in 
the vast majority of systems would involve the purchase of either a 
single large franchise--such as a hotel or the most expensive 
restaurant location--or multiple units.\811\ Of the 12 restaurant 
systems listed in the Franchise Handbook with maximum investments of 
$1.5 million or above, all listed a minimum investment below $1.5 
million to establish a location. Three listed less than $1 million as 
the minimum investment, and seven estimated the minimum investment to 
be between $1 million and $1.2 million, or the purchase of three or 
more units.\812\
---------------------------------------------------------------------------

    \811\ In light of the management demands on operating multiple 
units, it is reasonable to believe that purchasers of multiple units 
may be persons with significant prior business experience.
    \812\ We also assume that in many instances this universe of 
sophisticated investors will include existing franchisees with 
significant ``hands-on'' experience with the franchisor. In its 
Franchise NPR comment, NFC describes at length the changing nature 
of franchising in the United States. Specifically, NFC notes that:
    ``While franchising's roots may be traced to the grant of 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 
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 
franchises and (ii) existing franchisees whose experience, 
profitability, and mastery of the franchisor's system strongly 
suggest future success.''
    NFC, NPR 12, at 17. Accordingly, at least some franchisees 
purchasing multiple units are existing franchisees with prior 
``hands-on'' experience with the franchisor.
---------------------------------------------------------------------------

    During this proceeding no consensus emerged on the appropriate 
investment threshold for the large investment exemption. Several 
commenters supported the Franchise NPR's proposed $1.5 million 
threshold.\813\ Other commenters urged the Commission to increase the 
threshold. For example, NASAA recommended a $3 million threshold. In 
its view, a $1.5 million threshold may place too many transactions 
outside the Rule's protections, because, according to NASAA, even 
unsophisticated investors may have access to $1.5 million to invest in 
a franchise.\814\ On the other hand, several commenters suggested that 
the threshold should be lower. For example, McDonald's suggested that 
the threshold should be set at $1 million.\815\ The IFA proposed a 
variation on this theme. It supported a $1 million threshold, excluding 
land.''\816\ It observed that a 1997 update to the Profile of 
Franchising identified 52 franchise companies offering franchises with 
an initial investment exceeding $1 million, excluding land. This 
equates to 4.4% or less of all franchise systems.\817\ Thus, at a $1 
million threshold for the exemption, more than 95% of all franchise 
systems would remain within the ambit of the Rule.\818\ Some commenters 
recommended an even lower threshold. PMR&W, for example, recommended 
$500,000.\819\
---------------------------------------------------------------------------

    \813\E.g., Baer, NPR 11, at 16; Gurnick, NPR 21, at 3; Marriott, 
NPR 35, at 6.
    \814\ NASAA, NPR 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, NPR 23, at 8. See also NFA, NPR 27, at 3.
    \815\ ``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, 
NPR 7, at 2. See also 7-Eleven, NPR 10, at 3; NFC, NPR 12, at 20; 
BI, NPR 28, at 13. Wendy's suggested that the threshold be lowered, 
but did not offer any specific amount. Wendy's, NPR 5, at 2.
    \816\ As discussed below, IFA initially stated that ``real 
estate'' should be excluded in calculating the large investment 
threshold. IFA, NPR 22, at 7. In its Staff Report comment, however, 
the IFA clarified that by ``real estate,'' it mean raw, unimproved 
land. See IFA, at 3.
    \817\ IFA, NPR 22, at 7.
    \818\ The Staff Report recommended a $1 million threshold for 
the exemption, excluding land and franchisor financing, as discussed 
below. Staff Report, at 240.
    \819\ PMR&W opined that the $1.5 million threshold would benefit 
only:
    ``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, NPR 4, at 3. See also Cendant, ANPR 140, at 4 (suggesting 
a $750,000 threshold); H&H, NPR 9, at 4 (advocating a lowered 
threshold, but not specifying an amount); Duvall & Mandel, ANPR 114, 
at 21 (suggesting 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). The Commission rejects this approach 
as unworkable, because it would require franchisors to make 
subjective judgments about each purchaser's business acumen.
---------------------------------------------------------------------------

    The Commission gives particular 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.\820\ The Commission believes that 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. Thus, the Commission has 
adopted a $1 million threshold for the exemption.
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    \820\ The Commission has a history of considering and granting 
petitions for exemption to the Franchise Rule under section 18(g) of 
the FTC Act. In numerous exemption petition proceedings, the 
Commission has considered the size of investment as an indicium of 
sophistication. E.g., Paccar, Inc., 68 FR 67442 (Dec. 2, 2003); 
Rolls-Royce Corp., 68 FR 67443 (Dec. 2, 2003); Austin Rover Cars of 
North America, 52 FR 6612 (Mar. 4, 1987); Volkswagen of America, 
Inc., 49 FR 13677 (Apr. 6, 1984); Automobile Importers of America, 
Inc., 45 FR 51783 (Aug. 5, 1980). Based upon this experience in 
analyzing various franchise systems, the Commission believes that a 
large investment typically entails a sophisticated purchaser: ``As a 
practical matter, investments of this size and scope typically 
involve knowledgeable investors, the use of independent business and 
legal advisors, and an extended period of negotiation that generates 
the exchange of information necessary to ensure that investment 
decisions are the product of an informed assessment of the potential 
risks and benefits.'' Mercedes-Benz of North America, Inc., 57 FR 
1745 (Jan. 15, 1992) (granting petition for exemption).
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    Exclusion of unimproved land. The $1 million threshold for the 
large investment exemption excludes payments for unimproved land. The 
Commission believes that the inclusion of unimproved land in the 
exemption would have two negative consequences. First, inclusion of 
unimproved land would tend to inflate the initial cost of a franchise 
investment and place too many transactions outside the ambit of the 
Rule's protections. As the IFA noted, approximately 52 franchise 
systems, or less than 5% of the universe of franchise systems, would 
qualify for an exemption with a threshold investment of $1 million, 
excluding unimproved land.
    Second, the Commission has a strong preference for a bright-line 
standard that can be readily applied across franchise systems. It seems 
unworkable to require a franchisor to calculate on an offer-by-

[[Page 15525]]

offer basis the cost of land, which could vary widely depending on 
local market conditions. A single, clear threshold is vastly superior, 
in our view. Accordingly, for these reasons, we believe that $1 
million, excluding unimproved land, strikes the appropriate balance.
    Finally, we note that the Staff Report, adopting language offered 
by the IFA in response to the Franchise NPR, proposed to exclude ``real 
estate.'' In response to the Staff Report, three commenters urged the 
Commission to clarify the meaning of the term ``real estate'' either in 
the Rule or in Compliance Guides. The IFA, for example, noted that the 
term ``real estate'' may encompass ``raw land, buildings, leasehold 
improvements, fixtures, and the like.''\821\ The IFA asserted that the 
value of the exemption would be diminished if all such items were 
excluded from consideration in determining whether an initial 
investment totals $1 million. It suggested that the term ``real 
estate'' be defined to exclude only the franchisee's investment in 
unimproved land.\822\ Similarly, Starwood urged that only ``land'' 
should be excluded, but ``all real estate improvements and fixtures 
should be counted in the sum invested.''\823\ Piper Rudnick offered yet 
a different version: ``any real property acquired to establish and 
operate the franchised business.''\824\
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    \821\ IFA, at 3.
    \822\ IFA, NPR 22, at 7.
    \823\ Starwood, at 2. See also Marriott, at 2 (an ``investment'' 
should include buildings).
    \824\ Piper Rudnick, at 6-7.
---------------------------------------------------------------------------

    After considering the comments, the Commission has concluded that 
the phrase ``unimproved land'' is more appropriate than ``real 
estate.'' As IFA noted, the exclusion of fixtures, equipment, and other 
improvements to property from the $1 million threshold would leave the 
exemption so narrow, that it would be useless in all but the most 
expensive franchise offerings, defeating the very purpose of the 
exemption. Excluding ``real estate''--which is significantly broader 
than the more limited term ``unimproved land''--would also impact 
disproportionately real estate-intensive companies--such as hotels and 
restaurants. The justification for a large investment exemption is that 
individuals investing $1 million or more are sufficiently sophisticated 
that they do not need the Rule's protections. This rationale applies 
equally whether the prospective franchisee invests $1 million to 
purchase a building or the prospective franchisee buys equipment or 
other assets. Accordingly, excluding unimproved land from the large 
investment exemption's $1 million threshold strikes the appropriate 
balance between providing franchisors with a clear threshold, while 
ensuring regulatory relief for large investments.
    Exclusion of franchisor financing. Section 436.8(5)(i) does not 
count monies that are obtained through franchisor (or affiliate) 
financing toward the large initial investment exemption's $1 million 
threshold. The exclusion of franchisor financing adds a measure of 
protection to the prospective franchisee because traditional lenders 
are very likely to require a due diligence investigation of the 
offering, whereas the franchisor or its affiliate likely would not.
    A few commenters opposed the exclusion of franchisor-financing when 
calculating a prospective franchisee's initial investment. 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 this exclusion might have the unintended effect 
of harming franchisees by discouraging franchisors from offering 
financing to prospects in order to qualify for the exemption.\825\
---------------------------------------------------------------------------

    \825\ Marriott, NPR 35, at 6. See also J&G, NPR 32, at 4. At the 
same time, Eric Karp disputed the view expressed in the Franchise 
NPR that lenders may act as an effective check, requiring a prospect 
to have sufficient equity capital before granting a loan. 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, NPR 24, at 7.
---------------------------------------------------------------------------

    After careful assessment of the comments, the Commission has 
concluded that financing obtained from the franchisor or an affiliate 
should not be counted toward the large investment exemption threshold. 
Otherwise, a franchisor could be tempted to increase the cost of the 
initial investment to qualify for the large investment exemption, while 
simultaneously offering to finance the deal itself, all without proper 
pre-sale disclosures. In that regard, the Commission agrees with Eric 
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.''\826\
---------------------------------------------------------------------------

    \826\ Karp, NPR 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.
iii. Acknowledgment
    To take advantage of the large investment exemption, section 
436.8(5)(i) requires the franchisor to obtain the prospective 
franchisee's signed acknowledgment that the investment satisfies the $1 
million threshold. This will reduce the opportunity for fraud by 
enabling the prospect to verify that the investment meets or exceeds 
the exemption threshold. Therefore, it will reduce the probability that 
the franchisor will misrepresent the initial cost of the franchise to 
qualify for the exemption, as well as provide a paper trail in the 
event an enforcement action becomes necessary.
    Several commenters failed to 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.''\827\
---------------------------------------------------------------------------

    \827\ BI, NPR 28, at 13.
---------------------------------------------------------------------------

    Seth Stadfeld asserted that the acknowledgment requirement 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.''\828\ On the other hand, Howard Bundy advised that the 
acknowledgment should 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 . . .''\829\
---------------------------------------------------------------------------

    \828\ Stadfeld, NPR 23, at 8.
    \829\ Bundy, NPR 18, at 14.
---------------------------------------------------------------------------

    The Commission is convinced that the acknowledgment requirement 
serves a useful purpose. As previously noted, the acknowledgment will 
ensure that a

[[Page 15526]]

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. A prospective franchisee's signing of the acknowledgment does 
not give rise to the exemption. A franchisor must furnish disclosures 
unless the specific criteria for the exemption is satisfied. Thus, 
whether a prospective franchisee is flattered into signing an 
acknowledgment is irrelevant. 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. Accordingly, the acknowledgment requirement of the final 
amended Rule has been revised to incorporate these revisions.
iv. Meaning of ``initial investment''
    During the Rule amendment proceeding, several commenters voiced 
concerns about how to define ``investment'' for purposes of the large 
investment exemption. 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?''\830\ The 
NFC voiced similar concerns and urged the Commission to clarify that 
the term ``investment'' means the franchisee's estimated investment, as 
set out in Item 7 of the disclosure document.\831\
---------------------------------------------------------------------------

    \830\ J&G, NPR 32, Attachment, at 6.
    \831\ NFC, NPR 12, at 20. See also CA Bar, at 7; Marriott, at 2; 
Marriott, NPR 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.'')). 
Others raised alternative calculation approaches. For example, 
Wendy's observed that the focus on the franchisee's investment 
should ``exclude 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, NPR 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. J&G, NPR 32, at 4.
---------------------------------------------------------------------------

    The Commission's intent is that, for purposes of the large 
investment exemption, the level of a prospective franchisee's 
investment should be limited to the ``initial investment,'' as set 
forth in Item 7. For that reason, the phrase ``estimated investment'' 
has been replaced in the Rule's text with the phrase ``initial 
investment.'' Focusing on Item 7 when applying the exemption brings 
needed certainty to all parties, while ensuring that the exemption is 
narrowly focused to protect prospective franchisees making smaller 
investments. It is not farfetched to assume that a large universe of 
franchisees investing $100,000 or less today might actually pay more 
than $1 million (excluding unimproved land) to the franchisor during 
the course of a lengthy franchise agreement, especially when royalty 
and advertising fees, as well as ongoing product purchases, are 
considered. For that reason, a broad large investment exemption would 
effectively eviscerate the Rule's protection.\832\
---------------------------------------------------------------------------

    \832\ CA Bar, at 7 (including expenses over the life of the 
franchise term ``would likely render the $1 million threshold 
meaningless . . . because the accumulated expenditures over a 10 or 
20 year period could easily exceed $1 million dollars.'').
---------------------------------------------------------------------------

    The term ``initial investment,'' however, need not be limited to a 
single unit. The Commission notes with approval the comments of H&H and 
the NFC, urging revision of the Rule to clarify 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.''\833\
---------------------------------------------------------------------------

    \833\ NFC, NPR 12, at 21. See also H&H, NPR 9, at 4.
---------------------------------------------------------------------------

    The Commission has carefully considered the Staff Report 
recommendation to place limits on the large investment exemption to 
protect investors who pool their resources to purchase a franchise at 
or above the threshold level.\834\ The Commission shares the staff's 
concern. 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 risk. In 
such a circumstance, the level of each individual investment provides 
no indicium of sophistication. Accordingly, the Commission has added 
footnote 11 to the Rule to provide that the large franchise exemption 
applies only if at least one individual in an investor-group qualifies 
as ``sophisticated'' by investing at the threshold level.
---------------------------------------------------------------------------

    \834\ Staff Report, at 243.
---------------------------------------------------------------------------

    Several commenters assessed this issue differently. IL AG suggested 
that each member of an investment group should be required to satisfy 
the $1 million investment threshold in order to be deemed 
``sophisticated.\835\ In contrast, Marriott asserted that franchisees 
in large transactions typically form joint ventures or obtain financing 
from outside equity investors. Marriott maintained that there is little 
benefit in requiring a franchisee to break down the relative financial 
responsibilities of each equity investor in order to determine the 
application of the large investment exemption.\836\ Marriott also noted 
that the list of investors may change over the course of contract 
negotiations, making it difficult to determine at the time of sale 
whether any single investor qualifies for the exemption.
---------------------------------------------------------------------------

    \835\ IL AG, at 11.
    \836\ Marriott, at 3. See also Starwood, at 2.
---------------------------------------------------------------------------

    The Commission has concluded, however, that the limitation in 
footnote 11 is necessary to ensure that the large investment exemption 
strikes the right balance between providing relief for franchisors 
where the likelihood of abuse is reduced, and ensuring continued 
protection for those prospective franchisees who, although wealthy, may 
lack business experience. As explained above, the large investment 
exemption is premised on the Commission's assumption that ability to 
pay indicates sophistication. That assumption fails when no one 
investor standing alone is investing at the requisite threshold level. 
In short, sophistication does not arise merely by aggregating otherwise 
unsophisticated investors.
v. Conversion franchises and transfers
    During this proceeding, several commenters questioned whether the 
large investment exemption would cover business arrangements such as 
conversion franchises and transfers. In a conversion franchise, a 
business owner has already invested in his or her existing business and 
now seeks to associate with a particular franchisor's brand by entering 
into a franchise agreement with that franchisor. 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 converted to the franchise system.''\837\
---------------------------------------------------------------------------

    \837\ H&H, NPR 9, at 4. 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, NPR 12, at 
20. See also Starwood, at 2; PREA, NPR 20, at 3; Marriott, NPR 35, 
at 6.
---------------------------------------------------------------------------

    In a similar vein, the NFC questioned whether a transfer of a 
franchise directly from a franchisee to a new purchaser

[[Page 15527]]

can qualify for the exemption. It urged the Commission to include 
transfers in the definition of ``investment,'' where the purchasing 
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.''\838\
---------------------------------------------------------------------------

    \838\ NFC, NPR 12, at 21.
---------------------------------------------------------------------------

    The Commission's view is that the definition of ``initial 
investment'' is broad enough to include conversion franchises and 
transfers without sacrificing necessary protection for franchise 
purchasers. Specifically, when considering a conversion franchisee's 
``initial investment'' in a franchise, it is reasonable to consider the 
conversion franchisee's previous investment in the unit. 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, the sale of an existing franchise would 
qualify for the large investment exemption in a transfer. The fact that 
a transferee will assume an existing contract or may renegotiate an 
existing contract with the franchisor should have no bearing on his or 
her level of sophistication as an investor, as long as he or she 
satisfies the monetary threshold.
b. Section 436.8(a)(5)(ii): Large franchisee exemption
    Section 436.8(a)(5)(ii) exempts from the final amended Rule 
franchise sales to large entities; namely, those who have been in any 
business for at least five years and have a net worth of at least $5 
million.\839\ The Commission is persuaded that large entities 
negotiating franchise deals--such as airports, hospitals, and 
universities--can obtain the benefits of the amended Rule without 
federal government intervention.
---------------------------------------------------------------------------

    \839\ 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.
---------------------------------------------------------------------------

i. Need for the large franchisee exemption
    In the Franchise NPR, the Commission proposed exempting franchise 
sales to large ``corporate'' franchisees.\840\ 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 in franchising, or in the 
franchised business in particular, it is reasonable to assume that it 
can nevertheless protect its own interests when negotiating a franchise 
deal.
---------------------------------------------------------------------------

    \840\ Franchise NPR, 64 FR at 57321. See Kaufmann, ANPR, 18 
Sept. 97 Tr., at 190. But see Kezios, 18 Sept. 97 Tr., at 191-92 
(opposing exemption for large institutions, suggesting that they 
need franchise advice and counsel as well).
---------------------------------------------------------------------------

    Indeed, the Commission stated in the Franchise NPR that a large 
franchisee exemption is a logical extension of the original Rule's 
fractional franchise exemption. To qualify as a fractional franchisee, 
among other things, a prospect must have two years of experience in the 
same line of business. Thus, the fractional franchise exemption is very 
narrowly tailored, focusing only on persons who wish to expand their 
existing product lines. While the fractional franchise exemption is 
appropriate for individuals and small businesses seeking to expand, it 
may be unnecessarily narrow for larger, more sophisticated corporations 
seeking to become franchisees.\841\
---------------------------------------------------------------------------

    \841\ For example, in 1997, FTC 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 staff advised that the 
hospital could not qualify as a fractional franchisee because it did 
not have the requisite two years of experience in providing travel-
related services. Advisory 97-7, Bus. Franchise Guide (CCH) ] 6487 
(1997). Hospitals and other large institutions such as airports and 
universities, however, are hardly unsophisticated prospective 
franchisees.
---------------------------------------------------------------------------

    The Staff Report proposed a large franchisee exemption identical to 
that in the Franchise NPR. Five franchisor representatives continued to 
support the proposed exemption,\842\ while three franchisees opposed it 
for the same reasons previously voiced in response to the Franchise 
NPR.\843\
---------------------------------------------------------------------------

    \842\ Gust Rosenfeld, at 7; J&G, at 7; Marriott, at 2; Piper 
Rudnick, at 6-7; Starwood, at 3.
    \843\ Selden, at 1 (large franchisee exemption thresholds are 
too low); Gee, at 2; Pu, at 2 (Commission should focus on 
capabilities of franchisee, not size of investment). Two franchisee 
associations--the AAFD and the AFA--did not comment on this issue.
---------------------------------------------------------------------------

ii. Covered entities
    The large franchisee exemption is intended to cover franchisees 
that are ``entities.'' In the Franchise NPR, the Commission proposed 
that the large franchisee exemption be limited to corporations. Many 
commenters supported the proposed exemption, but criticized its narrow 
application.\844\ 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. The Commission agrees, and has expanded the provision in 
the final amended Rule to encompass corporations, partnerships, and 
similar arrangements.\845\
---------------------------------------------------------------------------

    \844\E.g., IL AG, NPR 3, at 2; PMR&W, NPR 4, at 3; Wendy's, NPR 
5, at 3; Triarc, NPR 6, at 1; H&H, NPR 9, at 5; Baer, NPR 11, at 16; 
NFC, NPR 12, at 22; BI, NPR 28, at 14; Tricon, NPR 34, at 7; 
Marriott, NPR 35, at 7.
    \845\ Nothing prevents an ``entity'' under this provision from 
being an individual, but most individuals who have been in business 
for at least five years and have generated an individual net worth 
of at least $5 million are likely to have created a corporation or 
other formal organization through which to conduct business.
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iii. Net worth
    To qualify for the large franchisee exemption, section 
436.8(a)(5)(ii) specifies that the prospective franchisee-entity must 
have a net worth of $5 million.\846\ During the Rule amendment 
proceeding, several commenters opined that the exemption's net worth 
prerequisite is overly restrictive.\847\ H&H, for example, 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.''\848\ The firm urged a net worth requirement of $1 
million.\849\ 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

[[Page 15528]]

small enough net worth to not be indicative of the level of 
sophistication that would indicate no need for mandatory 
disclosures.''\850\ The Commission believes that the $5 million net 
worth requirement strikes the right balance, granting relief to 
sophisticated entities, while protecting those entities for whom the 
purchase of a franchise would be a significant financial risk.
---------------------------------------------------------------------------

    \846\ Net worth of an entity can readily be determined from the 
entity's balance sheet or other financial information, typically 
submitted as part the application process.
    \847\ At the same time, several franchisee representatives 
criticized the large franchisee exemption as inappropriate. For 
example, Andrew Selden asserted that the large franchisee exemption 
will ``sweep in thousands of small business entrepreneurs who own 
three or four units or independent businesses, or perhaps unrelated 
family wealth. Personal net worth has no correlation whatsoever with 
the need for information to make an informed business investment 
decision in respect to an unfamiliar franchise.'' Selden, at 1. As 
noted above, however, the sophisticated investor exemptions are 
premised not on the notion that sophisticated investors do not need 
pre-sale disclosure, but that they are able to obtain such 
information, or greater information, without federal government 
intervention. This is particularly true of large franchisees, such 
as hospitals, airports, and universities, among others.
    \848\ H&H, NPR 9, at 5.
    \849\Id.
    \850\ Bundy, NPR 18, at 14.
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iv. Prior experience
    In addition to requiring $5 million net worth, section 
436.8(a)(5)(ii) requires large franchisees to have five years of prior 
business experience in any line of business, as proposed in the 
Franchise NPR. A few commenters opined that the prior experience 
prerequisite is unnecessary, and urged the Commission to focus only on 
the large franchisee's net worth. The NFC, for example, asserted that: 
``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.''\851\
---------------------------------------------------------------------------

    \851\ NFC, NPR 12, at 21-22. 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, NPR 32, 
at 4.
---------------------------------------------------------------------------

    On the other hand, Triarc urged the Commission to focus on prior 
experience in lieu of net worth. 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:

     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.\852\
---------------------------------------------------------------------------

    \852\ Triarc, NPR 6, at 2.

    After considering these arguments, the Commission concludes that 
both the $5 million net worth and five years experience prerequisites 
are necessary 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 sandwich shops 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. Both prerequisites are necessary to ensure 
that the large franchisee exemption does not create a loophole, putting 
small and unsophisticated entities at an unacceptable financial risk.
v. Affiliates and parents
    Finally, section 436.8(a)(5)(ii) refines the proposed exemption 
published in the Franchise NPR, which used the term ``corporation'' and 
made no mention of parents or affiliates. As revised, a franchisor may 
consider the prior experience and net worth of the franchisee's 
affiliates and parents when determining whether the franchisee 
qualifies as a ``large franchisee.''
    A few commenters noted that the prior experience and net worth 
prerequisites 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 transaction. 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.''\853\ If so, then 
such a new corporation would not meet the exemption's net worth and 
prior experience prerequisites.\854\ These commenters urged the 
Commission to permit the franchisor to consider the consolidated net 
worth and experience of franchisee affiliates and parents.\855\ The 
Commission is persuaded 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, section 436.8(5)(ii) makes 
clear that a franchisor may aggregate commonly-owned franchisee assets 
in determining the availability of the large entity exemption:\856\
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    \853\ Marriott, NPR 35, at 7.
    \854\See also, e.g., NFC, NPR 12, at 22; J&G, NPR 32, at 4; H&H, 
NPR 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, NPR 6, at 
1-2.
    \855\ Starwood, at 3; NFC, NPR 12, at 22; J&G, NPR 32, at 4; 
H&H, NPR 9, at 5.
    \856\ In the same vein, the definition of ``affiliate'' covers 
both franchisee and franchisor affiliates, as noted in our 
discussion of the definitions, above.

     The franchisee (or 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.\857\
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    \857\ This modifies slightly an earlier version of the large 
franchisee exemption which would have required the purchaser and its 
parent or affiliates to satisfy the net worth and prior experience 
prerequisites. See Marriott, at 3-4; J&G, at 7.
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c. Section 436.8(a)(6): Officers, owners, and managers exemption
    Section 436.8(a)(6) of the final amended Rule adds a new exemption 
for officers, owners,\858\ and managers of a business before it becomes 
a franchisor.\859\ In such circumstances, it reasonably can be assumed 
that the prospective franchisee already is familiar with every aspect 
of the business system and the associated risks. Thus, disclosure would 
serve little purpose. Indeed, in some instances, a company may wish to 
offer units only to its owners, officers, and managers. 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 business, however, section 
436.8(a)(6) is limited to individuals who have been associated with the 
company within 60 days of the sale and who have been involved for at 
least two years with the company.
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    \858\ CA Bar would limit this exemption to those with an equity 
ownership in the company. In its view, those with a non-equity 
interest, such as a lender, typically do not participate in the 
business, in contrast to an equity owner, and therefore should be 
excluded from the exemption. CA Bar, at 8. While CA Bar's 
observation is correct, the Rule need not be revised to address this 
issue. A lender or other non-equity interest owner will be excluded 
from the exemption because he or she will not satisfy the 
exemption's prior experience prerequisite.
    \859\ The ``insider'' 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).
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    Section 436.(8)(a)(6) refines the proposed Rule's ``insiders'' 
exemption which would have limited the exemption to owners and 
officers. During the Rule amendment proceeding, several commenters 
urged the Commission to broaden the exemption to include ``trustees, 
general partners and any individual who has or had management 
responsibility for the offer

[[Page 15529]]

and sale of the franchisor's franchises or the administration of the 
franchised network.''\860\ In short, these comments urged that the 
exemption parallel the list of company insiders disclosed in Item 2. 
Seth Stadfeld, however, questioned the need for the exemption if the 
company is already providing disclosures to others.\861\ 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.\862\
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    \860\ NFC, NPR 12, at 23. See also AFC, NPR 30, at 3.
    \861\ Stadfeld, NPR 23, at 9.
    \862\ Bundy, NPR 18, at 14.
---------------------------------------------------------------------------

    Based upon the record, the Commission has adopted the NFC's 
suggestion that the exemption should cover not just owners and officers 
of a franchise system, but others with direct management 
experience.\863\ It is reasonable to assume that managers and others 
with at least two years of direct experience in the business should be 
well-informed about its operations.\864\ 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. The Commission notes 
that the exemption is company-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.
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    \863\ For that reason, we decline to include ``trustees.'' 
Nothing in the designation ``trustee'' ensures that the individual 
will have an adequate level of experience within the system to 
justify an exemption from receiving pre-sale disclosures. On the 
other hand, if a trustee functions as an officer or manages the 
franchise systems, he or she will qualify for the exemption as 
either an officer or manager.
    \864\ CA Bar observed that section 436.8(a)(6) refers to 
``purchasers'' It questioned whether the insider exemption is 
limited to individual insiders only, or to entities formed by 
individual-insiders. It correctly observed that insiders who are 
likely to purchase a franchise are likely to do so by forming a 
partnership, corporation, or other entity through which to conduct 
business. We believe the term ``purchaser'' is broad enough to 
include an individual who intends to operate as an entity.
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    Howard Bundy's concern that franchisors may abuse the exemption in 
an effort to skirt the Rule is adequately addressed. Specifically, in 
order to qualify for the exemption, the prospective franchisee must 
have served in one of the enumerated positions for at least two years. 
Moreover, their relationship with the company 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.
d. Section 436.8(b): Inflation adjustment
    Section 436.8(b) of the final amended Rule provides that the 
Commission shall adjust the size of the monetary thresholds for the 
exemptions listed in section 436.8 every fourth year based upon the 
Consumer Price Index.\865\ This would affect the minimum payment 
exemption,\866\ as well as the three sophisticated investor exemptions. 
As explained below, this approach differs from the proposed inflation 
adjustment published in the Franchise NPR in two respects: (1) it sets 
a specific time period when the adjustments must occur (every fourth 
year); and (2) adds specificity by tying the adjustment to the Consumer 
Price Index.
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    \865\ This approach is also consistent with the Commission's 
procedures for adjusting thresholds or other information in 
Commission enforced statutes. Under the Debt Collection Improvement 
Act of 1996, the Commission adjusted civil penalty amounts from 
$10,000 to $11,000 per violation to account for inflation. Those 
amounts must be adjusted at least once every four years. See 61 FR 
54549 (Oct. 21, 1996). Similarly, the Appliance Labeling Rule, 16 
CFR Part 305, 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. The Commission also publishes in the Federal Register 
adjustments for determining illegal interlocking directorates in 
connection with Section 19(a)(5) of the Clayton Act.
    \866\See, e.g., H&H, NPR 9, at 4; Baer, NPR 11, at 15-16.
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    In the Franchise NPR, the Commission proposed revising the amended 
Rule's monetary thresholds once every four years to adjust for 
inflation.\867\ The Commission believed that a four-year adjustment is 
necessary to ensure that the thresholds reasonably keep up with 
inflation.
---------------------------------------------------------------------------

    \867\ Franchise NPR, 64 FR at 57321-22.
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    The Franchise NPR proposal garnered three comments. PMR&W and John 
Bear agreed with the need for a threshold adjustment and supported the 
Franchise NPR proposal. The NFC supported the inflation adjustment, but 
offered a slightly different approach. It suggested that the Commission 
tie the threshold amounts 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.\868\
---------------------------------------------------------------------------

    \868\ NFC, NPR 12, at 22.
---------------------------------------------------------------------------

    The Commission is persuaded that the final amended Rule should 
contain bright-line thresholds that are clear to both franchisor and 
franchisee alike. Thus, any adjustment to the Rule thresholds should be 
imposed only after an announcement to the public, where the effective 
date of the adjustment and the adjustment amount is clear. The most 
effective way to provide such notice is through Federal Register 
announcements and that the adjustments should be based upon a clear 
standard--the Consumer Price Index.\869\ Accordingly, the Commission 
intends to publish every fourth year adjustments to the amended final 
Rule's monetary thresholds based upon the Consumer Price Index. 
Finally, to add greater specificity, the final amended Rule makes clear 
that the term ``Consumer Price Index'' means ``the Consumer Price Index 
for all urban consumers published by the Department of Labor.''\870\
---------------------------------------------------------------------------

    \869\ The Staff Report made the same recommendation. Staff 
Report, at 250-51. No comments were submitted on this 
recommendation.
    \870\ See Federal Maritime Commission, Civil Monetary Penalty 
Inflation Adjustment, 46 CFR 506.2(c) (```Consumer Price Index' 
means the Consumer Price Index for all urban consumers published by 
the Department of Labor.'').
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4. Exclusions
    Finally, the final amended Rule removes the four exclusions for 
non-franchise relationships found in the original Rule: (1) employer-
employee and general partners; (2) cooperative associations; (3) 
certification and testing services; and (4) single trademark 
licenses.\871\ In the original SBP, the Commission stressed that these 
four relationships are not franchises, but might be perceived as 
falling within the definition of a franchise.\872\ To avoid any 
confusion, the Commission expressly excluded these four relationships 
from Rule coverage.
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    \871\ See 16 CFR 436.2(a)(4).
    \872\ 43 FR at 59708.
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    During the Rule amendment proceeding, several commenters opposed 
the removal of the exclusion for cooperatives for various reasons.\873\ 
According to these commenters, the exclusion helps to distinguish 
between franchises and cooperatives, a distinction that may not be 
apparent to new cooperative members.\874\ Second, removing the 
cooperative exclusion from the Rule could lead to costly

[[Page 15530]]

litigation over Rule coverage issues.\875\ Third, retaining an express 
exclusion in the Rule itself is needed to ensure that the Commission 
does not change its view and seek to enforce the Rule against 
cooperatives in the future.\876\ Fourth, the value of retaining the 
exclusion outweighs any benefit from streamlining the Rule.\877\
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    \873\E.g, Spandorf, at 12.; Duvall, at 2-3; AMF; CHS; IDS.
    \874\E.g., CHS, at 1-2; IDS, at 2; NCBA, at 2. See also J&G, NPR 
32, Attachment, at 9; TruServ, NPR 33, at 2; Baer, NPR 11, at 5; IL 
AG, NPR 3, at 3; PMR&W, NPR 4, at 3; H&H, NPR 9, at 3; Gurnick, NPR 
21, at 7.
    \875\E.g., NCBA, at 4; NCFC, at 2.
    \876\E.g., AMF; CHS; NCBA, at 5.
    \877\E.g., Spandorf, at 12; CHS; Reizman Burger, at 3-4.
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    The Commission appreciates the concern raised by these commenters. 
Nonetheless, we see no compelling reason to keep the exclusions in the 
Rule itself. As a preliminary matter, removing the exclusions from the 
Rule should not be equated with expanding the scope of part 436 to 
cover entities currently dealt with in these exclusions: the Commission 
continues to hold that these business relationships do not meet the 
criteria for such coverage. They simply do not satisfy the definitional 
elements of the term ``franchise.'' Removal of the exclusions from the 
Rule is part of the Commission's effort to streamline the Rule.
    Nevertheless, the Commission included the exclusions in the 
original Rule to clarify the limits of the term ``franchise,'' and for 
that reason the concepts embodied in the exclusions continue to serve a 
valuable consumer education function.\878\ However, as with other 
sections of this document, we are disinclined to include general 
consumer education materials in the text of the final amended Rule 
itself, absent compelling evidence that such messages are warranted to 
address specific problems identified in the record. While the 
commenters asserted that confusion exists over the definition of the 
term ``franchise,'' not a single individual cooperative member voiced 
any confusion over the scope of the ``franchise'' definition, nor any 
concern about the distinction between franchises and cooperatives, 
during the entire Rule amendment proceeding. Under the circumstances, 
the proper forum to discuss limits to the definition of the term 
``franchise'' is in this document and in future Compliance Guides. To 
that end, the Commission reaffirms the four exclusions and specifically 
adopts the discussion of the exclusions set forth in the original SBP 
at 43 FR 59708-10.
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    \878\ We also note that there are many other business 
relationships that share some similarities with franchises, such as 
distributorships, multilevel marketing programs, and some work-at-
home schemes. Yet, these arrangements were not expressly excluded 
from the Rule. Rather, the definition of the term ``franchise'' is 
sufficient to set out the parameters of the Rule's scope. To the 
extent that these relationships may be confused with franchises, the 
Commission has provided needed clarification in the Final 
Interpretative Guides. The same approach is warranted for 
cooperatives. Nonetheless, based upon the comments, the Commission 
specifically reaffirms the four exemptions in this Statement and 
anticipates that future Compliance Guides will do the same. As in 
other areas of Rule interpretation, the staff of the Commission can 
also address future questions concerning the definition of the term 
``franchise'' on a case-by-case basis through informal advisory 
opinions.
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G. Section 436.9: Additional Prohibitions

    The final amended Rule prohibits nine acts or practices that 
violate Section 5 of the FTC Act. The original Rule contained four of 
them, namely, prohibitions against: (1) making statements that 
contradict the franchisor's disclosures;\879\ (2) making financial 
performance representations without a reasonable basis and without 
written substantiation for the representation at the time the 
representation is made;\880\ (3) failing to make available written 
substantiation for any financial performance representations;\881\ and 
(4) failing to make promised refunds.\882\
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    \879\See 16 CFR 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.'' Original SBP, 43 FR at 59695.
    \880\See 16 CFR 436.1(b)(2) and (c)(2); UFOC Item 19. Original 
SBP, 43 FR at 59684-690 (The earnings representation standards are 
``intended to prevent or minimize potential misrepresentations or 
distortions in the representations made by franchisors, while at the 
same time permitting franchisors to use informative representations 
as part of their marketing scheme.'').
    \881\See 16 CFR 436.1(b)(2) and (c)(2); UFOC Item 19. In the 
original SBP, the Commission rejected the idea that franchisors 
should always provide a copy of their substantiation of financial 
performance claims to 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 outweighs speculative harms that could arise from 
such disclosure.'' Original SBP, 43 FR at 59691.
    \882\See 16 CFR 436.1(h). In the original 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 do 
not adequately adhere to the refund policies they themselves agree 
to in their contracts.'' Original SBP, 43 FR at 59696-97. See also 
Staff Review, at 29 (some franchisees continue to experience 
problems with obtaining refunds).
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    Second, the final amended Rule adds two new prohibitions concerning 
the furnishing of disclosures. Specifically, section 436.9(e) prohibits 
franchise sellers from failing to furnish a copy of the basic 
disclosure documents to prospective franchisees early in the sales 
process, upon reasonable request. Section 436.9(f) prohibits franchise 
sellers from failing to furnish a prospect in the sales process who has 
already received the basic disclosure document with a copy of any 
updated disclosure document or quarterly update to an existing 
disclosure document, upon reasonable request, before the prospective 
franchisee signs a franchise agreement.\883\
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    \883\ We decline to adopt a third prohibition recommended in the 
Staff Report that would have prohibited franchisors from failing to 
furnish a prospective transferee of an existing franchised outlet 
with a copy of an existing disclosure document of the franchisor, 
upon request. As recommended in the Staff Report, this prohibition 
would not have required a franchisor to prepare a current disclosure 
document solely for the benefit of a transferee. Rather, a 
franchisor would have been permitted to give a prospective 
franchisee a copy of its most recent disclosure document. For 
example, a franchisor who stopped selling franchises and no longer 
possessed a current disclosure document could have complied with 
this prohibition by giving a prospective transferee a copy of its 
most recent disclosure document, even if that document were at the 
time out-of-date. See Staff Report, at 264. In response to the Staff 
Report, five commenters opined that this proposed prohibition would 
have resulted in franchisors being forced to disclose information 
that could have been misleading to the prospective transferee, 
subjecting the franchisor to potential liability. CA Bar, at 10; 
Kaufmann, at 6; Seid, at 7; Spandorf, at 10-11; Wiggin and Dana, at 
5. We agree. An ``existing'' disclosure document would have no 
relevance to a transfer unless the document were current. Moreover, 
a current disclosure document may not accurately portray the 
business arrangement entailed in the transfer, because it would 
explain the terms and conditions of the franchisor's current 
franchise agreement, while a transferee assumes the terms and 
conditions of an ongoing franchise agreement. Moreover, to the 
extent that a potential transferee wishes to see a copy of the 
franchisor's disclosure document, he or she can obtain a copy from a 
commercial service, from a franchise registration state, and more 
frequently online (such as through California's Cal-Easi website). 
But see Bundy, at 10.
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    Third, the final amended Rule adds two anti-fraud prohibitions 
designed to preserve the integrity of the disclosure document and 
franchise agreement. Section 436.9(g) prohibits franchise sellers from 
materially altering the terms and conditions of any franchise agreement 
presented to a prospective franchisee for signing, unless the seller 
informs the prospective franchisee of the changes seven days before 
execution of the agreement. Section 436.9(h) prohibits franchise 
sellers from disclaiming or requiring a franchisee to waive reliance on 
any representation made in a disclosure document or its exhibits or 
attachments.
    Finally, section 436.9, based upon our law enforcement history and 
the obviously deceptive nature of the practice, adds a new anti-shill 
prohibition designed to prevent the use of paid testimonials or shill 
references. Specifically, section 436.9(b) prohibits franchise sellers 
from misrepresenting that any person has purchased a similar franchise 
or operated a similar franchise

[[Page 15531]]

from the franchisor, or that any person can provide an independent and 
reliable report about the franchise or the experiences of any current 
or former franchisees. Each of these prohibitions is discussed in the 
following sections.
1. Section 436.9(a): Inconsistent statements
    Section 436.9(a) of the final amended Rule retains the original 
Rule prohibition against making statements that contradict the 
information required to be disclosed in the disclosure document. Such 
prohibited contradictory statements include those made orally, 
visually, or in writing. Because the information in the disclosure 
document must be complete and accurate, any statements contradicting 
that information would be false or likely to mislead prospective 
franchisees. Moreover, such statements would likely influence the 
purchasing decision of a prospect giving reasonable interpretation to 
such statements.
    This is particularly true of financial performance representations. 
Our law enforcement experience\884\ and the record\885\ show that 
franchisors often state in their disclosure document that they do not 
furnish financial performance claims, yet give prospective franchisees 
false or misleading financial performance data outside of the 
disclosure document. Thus, the purpose of this prohibition is to 
prevent deception and to preserve the integrity of the information 
disseminated to prospective franchisees by ensuring that all required 
information will be disclosed in the form of the disclosure 
document.\886\
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    \884\E.g., FTC v. Netfran Dev. Corp., No. 05-CV-22223 (S.D. Fla. 
2005); FTC v. Morrone's Water Ice, Inc., No. 02-3720 (E.D. Pa. 
2002).
    \885\ For example, Peter Lagarias stated: ``In my experience, 
the providing of earnings claims in contravention of . . . [Item 19] 
often occurs both orally and in writing. The most common written 
method of earnings claims is by newspaper or magazine articles about 
the franchise system which contain the earnings claims. These news 
articles are reproduced and provided to prospective franchisees in 
contravention of the Rule.'' Lagarias, RR 13, at 2. See also Brown, 
ANPR 4, at 4 (``There have therefore been endless variations of 
supposedly `indirect' franchisor representations of profitability, 
[ranging] from the proverbial notation on a napkin or envelope, to 
prearranged referrals to `typical'' franchisees, to use of `company 
store' figures with plain implications of comparability, and to the 
required preparation of a `business plan' by the prospective 
franchisee and its `review' and `oral adjustment' by franchisor or 
personnel.''); Bundy, ANPR 119, at 1 (``I have never met a 
franchisee who had been in operation more than a few weeks who did 
not receive earnings claims before investing in a franchise. It 
simply does not happen. They either have received them from the 
franchisor or its agent directly (often in writing or on floppy 
disk) or from third parties to whom they have been directed.''); IL 
AG, RR 25, at 2 (``The most common situation and opportunity for 
abuse is the franchisor sales representative who makes oral 
representations as to earnings potential when talking with 
prospects.''); WA Securities, RR 37, at 3 (``Our fraud 
investigations reveal that a substantial number of franchisors or 
their sales representatives are making written or oral earnings 
claims to prospective franchisees even when the disclosure document 
states that no earnings claims are made.''); AAFD, RR 39, at 6 
(``Probably less than 2% of franchisors make formal earnings 
disclosures, [while] the vast majority of franchisees claim they 
have received oral (and often informal written) earnings claims and 
projections.'').
    \886\ Of course, franchisors are always free to disseminate 
additional truthful information to a prospective franchisee. See 16 
CFR 436.1(a)(21) (franchisors are not precluded 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 document).
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2. Section 436.9(b): Shills
    Section 436.9(b) of the final amended Rule prohibits the use of 
fictitious references or ``shills.''\887\ Specifically, it prohibits 
franchise sellers from misrepresenting that any person has actually 
purchased or operated one of the franchisor's franchises or that any 
person can give an independent and reliable report about the experience 
of any current or former franchisee. Because information provided by 
shills is inherently false, it is likely to mislead prospective 
purchasers. Yet, a reasonable prospective purchaser would have no 
reason to doubt the shill's statements. Also, because shills are 
represented as having experience with the franchisor or otherwise able 
to give an independent and reliable report about the franchisor, their 
statements are likely to influence the prospect's purchasing decision. 
Indeed, the Commission's law enforcement experience\888\ shows that 
shills are often the glue that holds a scam together by allaying 
consumers' concerns about the investment risks.\889\
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    \887\ The 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) ] 10865 (S.D. Fla. 1995).
    \888\ Scam franchisors frequently use shill references in order 
to bolster their financial performance and success claims. E.g., FTC 
v. Car Checkers of Am., Inc., No. 93-623 (mlp) (D.N.J. 1993); FTC v. 
Am. Legal Distrib., Inc., No. 1:88-CV-519-MHS (N.D. Ga. 1988). Harm 
resulting from the use of shills is also demonstrated by numerous 
Commission business opportunity law enforcement actions.  E.g., FTC 
v. Am. Entertainment Distrib., Inc., No. 04-22431 CIV-Huck (S.D. 
Fla. 2004); FTC v. Hart Mktg. Enter., No. 98-222-CIV-T-23 E (M.D. 
Fla. 1998); FTC v. Unitel Sys., Inc., No. 3-97CV18780-D (N.D. Tex. 
1997).
    \889\ 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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    The 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.'''\890\
---------------------------------------------------------------------------

    \890\ J&G, NPR 32, Appendix, at 9.
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    The Commission finds the rulemaking record lacks any evidence that 
would shed light 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 law enforcement experience, we 
believe such practices are rare. More important, our primary concern is 
with preventing deception: we see little difference between a 
franchisor paying (or otherwise inducing) unknown individuals to 
deceive prospective franchisees, on the one hand, and paying (or 
otherwise inducing) actors or celebrities to deceive prospective 
franchisees, on the other. In each case, a franchisor should not be 
able to pay (or otherwise induce) individuals to lie about their 
purported experience in order to lure unsuspecting consumers to buy a 
franchise.\891\ We are persuaded, therefore, that the anti-shill 
prohibition is entirely proper.
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    \891\ This view is consistent with the Commission's Guides 
Concerning The Use of Endorsements and Testimonials In Advertising, 
16 CFR 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.'' 16 CFR at 
255.2(a). Therefore, any actor or public figure who might run afoul 
of this provision in the Franchise Rule already risks violating the 
FTC Act.
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3. Section 436.9(c): Financial performance representations
    Section 436.9(c) of the final amended Rule retains the original 
Rule's prohibition on the making of financial performance 
representations, unless the franchisor has a reasonable basis and 
written substantiation for the representation at the time the 
representation is made. As discussed above in connection with Item 19, 
false and unsubstantiated financial performance claims have been 
prevalent in fraudulent sales, are highly material, and are inherently 
likely to mislead

[[Page 15532]]

prospective franchisees acting reasonably under the circumstances.\892\ 
Indeed, our law enforcement experience demonstrates that prospects rely 
on financial performance claims in making their investment 
decision.\893\ Thus, this prohibition is necessary to prevent 
deception.
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    \892\E.g., original SBP, 43 FR at 59684-85 (``The use of 
deceptive and inaccurate profit and loss statements by franchisors 
has resulted in a legion of `horror stories.''). See also Staff 
Review, at 25 (earnings claims most frequently reported franchise 
problem).
    \893\E.g., FTC v. Netfran Dev. Corp., No. 05-CV-22223 (S.D. Fla. 
2005); United States v. Robert Lasseter, No. 3:03-1177 (M.D. Tenn. 
2003); FTC v. Morrone's Water Ice, Inc., No. 02-3720 (E.D. Pa. 
2002); FTC v. Car Wash Guys Int'l., Inc., No. 00-8197 ABC (RNBx) 
(C.D. Cal.); FTC v. Tower Cleaning Sys., Inc., No. 96 58 44 (E.D. 
Pa. 1996); United States v. Tutor Time Child Care Sys., Inc., No. 
96-2603 (N.D. Cal. 1996); FTC v. Mortgage Serv. Assocs., Inc., No. 
395-CV-1362 (AVC) (D. Conn. 1995); FTC v. Sage Seminars, Inc., C-95-
2854-SBA (N.D. Cal. 1995).
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    Section 436.9(c) of the amended Final Rule revises the original 
Rule, however, by permitting the franchisor to make financial 
representations in Item 19 of the disclosure document. This achieves 
greater uniformity with the UFOC Guidelines, by eliminating the 
original Rule's requirement that a franchisor making financial 
performance claims furnish prospects with a separate earnings 
disclosure document.
4. Section 436.9(d): Availability of financial performance 
substantiation
    Section 436.9(d) of the final amended Rule also retains the 
original Rule's prohibition against failing to make available to 
prospective franchisees and to the Commission, upon reasonable request, 
written substantiation for any financial performance representation 
made in Item 19.\894\ This prohibition is tied to the previous 
prohibition against the making of unreasonable and unsubstantiated 
financial performance representations. The prohibition against failing 
to make available written substantiation ensures that prospective 
franchisees and the Commission can review and verify the data 
underlying any performance representation, while relieving franchisors 
of the burden of having to present what could be voluminous data in the 
disclosure document itself. Knowing that their financial performance 
claims are subject to Commission review--coupled with the Commission's 
authority to bring Rule enforcement actions for false or 
unsubstantiated claims--helps discourage the making of unsubstantiated 
claims, thus ultimately preventing fraud.
---------------------------------------------------------------------------

    \894\ 16 CFR 436.1(b)(2); 436.1(c)(2).
---------------------------------------------------------------------------

5. Section 436.9(e): Earlier disclosure upon request
    Section 436.9(e) of the final amended Rule prohibits a franchise 
seller from failing to furnish a copy of the franchisor's disclosure 
document to a prospective franchisee earlier than required, upon 
request.\895\ Accordingly, any prospective franchisee in the sales 
process can obtain a copy of the franchisor's disclosure document 
before the standard 14-day time for making disclosures set out in 
section 436.2 (14 calendar-days before the signing of a franchise 
agreement or payment of any fee in connection with the franchise sale). 
Because prospects may incur a variety of costs in determining whether 
to consider a particular franchise offering, a franchisor's withholding 
of its disclosure document can result in economic injury. For example, 
as discussed above in connection with the timing of making disclosures, 
early disclosure may prevent injury by enabling prospects to review the 
franchisor's disclosure document before agreeing to pay money to 
advance the sale, such as incurring travel expenses to visit company 
headquarters.
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    \895\ The prohibition on failing to give out disclosures earlier 
in the sales process pertains to ``prospective franchisees'' only. A 
franchisor has no obligation to furnish disclosures to competitors, 
the media, academicians, or researchers. It applies to prospective 
franchisees already in the sales process. Accordingly, a franchisor 
need not furnish a copy of its disclosures to individuals seeking 
general information on the franchisor or who do not qualify to 
purchase a franchise. We would expect a franchisor to furnish 
disclosures, upon request, to any prospective franchisees who have 
submitted a franchise application and who have been notified that 
they qualify to purchase a franchise. See IFA, at 3. See also 
Winslow, at 91.
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    Further, the Commission is convinced that this prohibition is also 
necessary in light of our decision to eliminate the original Rule's 
mandatory face-to-face disclosure trigger. As discussed in connection 
with section 436.2 above, the Commission is persuaded that the face-to-
face meeting trigger is unnecessary given the explosion of alternative 
media since the original Rule was promulgated in the 1970s. 
Nonetheless, the Commission recognizes that several commenters voiced 
concern that, absent early disclosure, a franchise seller could 
influence a prospective franchisee's investment decision well before 
the prospect could verify the franchisor's claims through the 
disclosure document, or before the prospect expends funds reviewing the 
offering.\896\ To address these concerns, we are persuaded that it is 
proper to require franchise sellers to furnish disclosures earlier than 
the standard 14 calendar-days disclosure trigger, upon the franchisee's 
reasonable request.\897\ The Commission believes this prohibition 
strikes the right balance between relieving franchisors of the burden 
to furnish disclosures at the first face-to-face meeting in all 
instances, and the prospective franchisee's desire to review 
disclosures early in the sales process before investing significant 
time, effort, and money in considering the franchise offering.\898\
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    \896\ Turner, NPR 13, at 1; Karp, NPR 24, at 5-6; Bundy, NPR 18, 
at 5-6. See also original SBP, 43 FR at 59639 (``[O]nce a prospect 
has been `hooked,' it is difficult, if not impossible, to `extricate 
himself.''').
    \897\ IFA urged the Commission to define the term ``reasonable 
request.'' IFA, at 3. We note that the similar term ``reasonable 
demand'' has long been part of the original Rule in connection with 
the provision of written substantiation for financial performance 
representations. 16 CFR 436.1(b)(2) and 1(c)(2) (``such material is 
made available to any prospective franchisee and to the Commission 
or its staff upon reasonable demand.''). Similarly, the UFOC 
Guidelines provide that a franchisor making financial performance 
claims must include a statement in its Item 19 disclosure that 
``substantiation of the data used in preparing the earnings claim 
will be made available to the prospective franchisee on reasonable 
request.'' UFOC, Item 19d. There is no indication in the record that 
the use of the terms ``reasonable request'' or ``reasonable demand'' 
has been confusing or otherwise unclear. We believe determinations 
about ``reasonableness'' can be made only on a case-by-case basis. 
At a minimum, we will consider whether a request is ``reasonable'' 
based upon the timing and manner in which the request has been made. 
For example, it may be unreasonable for a prospective franchisee to 
request a copy of the disclosure document on the morning of the day 
a franchisor's representative flies to the prospect's city for a 
meeting. Similarly, it may not be reasonable for a prospective 
franchisee to make the request by leaving a message with the doorman 
at the franchisor's headquarters, or at the hotel where a 
franchisor's representative is staying.
    \898\ It is noteworthy that state franchise laws, at the very 
least, require franchisors to file current disclosure documents 
before franchisors may offer franchises for sale. Franchisors 
typically have disclosure documents available at the time they make 
franchise offerings. Accordingly, this new prohibition imposes no 
requirement that did not already exist under the original Rule's 
first face-to-face meeting disclosure requirement and under state 
franchise filing laws. But see Duvall, at 2 (this prohibition 
negates any benefit gained from eliminating the ``first personal 
meeting requirement'').
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6. Section 436.9(f): Furnishing updated disclosures
    Section 436.9(f) prohibits a franchisor from failing to furnish a 
prospective franchisee who has received a basic disclosure document 
with updated disclosures, upon the prospect's reasonable request. 
Specifically, it prohibits the franchisor from failing to furnish ``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.''

[[Page 15533]]

    Section 436.9(f) recognizes that the information contained in a 
disclosure document may become out-of-date by the time a prospect who 
relies on such information is ready to sign a franchise agreement.\899\ 
It prevents deception by enabling such prospective franchisees, if they 
wish, to get any updated disclosures prepared by the franchisor. At the 
same time, section 436.9(f) imposes no continuous updating requirement 
on franchisors.\900\ Rather, it strikes the appropriate balance, 
preventing deception by enabling a prospective franchisee to gain 
access to the most current updated disclosures prepared by the 
franchisor, while imposing no new affirmative disclosure obligations on 
the franchisor.\901\
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    \899\ For example, a franchisor may have filed for bankruptcy 
after having furnished disclosures to a prospective franchisee. A 
bankruptcy filing, as discussed above, is clearly material because 
it calls into question the franchisor's continued financial 
viability and, thus, ability to perform its obligations under the 
franchise agreement.
    \900\ This is consistent with the original Rule, which required 
franchisors to update their disclosures to ensure accuracy of its 
current disclosure document used with new prospects, but did not 
require re-disclosure to prospective franchisees who have already 
received a basic disclosure document. 16 CFR 436.1(a)(22) (setting 
forth two update requirements: (1) the annual update after the close 
of the franchisor's fiscal year; and (2) quarterly updates if there 
is a material change).
    \901\ Franchise sellers other than the franchisor can satisfy 
their obligation to provide updated disclosures by promptly 
forwarding a prospective franchisee's request to the franchisor, 
provided that the franchisor has promised to fulfill any such 
requests promptly.
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7. Section 436.9(g): Unilateral modifications
    As previously discussed, the final amended Rule eliminates the 
original Rule's requirement that franchisors in every case afford a 
prospective franchisee five business days to review the completed 
franchise agreement. The Commission concluded that the review period is 
unnecessary, provided that the franchise seller does not make any 
unilateral modifications to the basic form of the franchise agreement 
previously furnished to the prospective franchisee at the time of 
furnishing its disclosure document. Unilateral modifications of 
material contract terms by the franchise seller without notice to the 
prospective franchisee are likely to mislead a prospect who has been 
relying on a previous draft as setting forth the parties' agreement.
    Indeed, a franchise seller could commit fraud at the time of 
executing a franchise agreement by substituting material 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 deception, we adopt a new 
prohibition barring franchise sellers from substituting provisions or 
pages in the agreement without first bringing such changes to the 
prospective franchisee's attention at least seven days before execution 
of the agreement.
8. Section 436.9(h): Disclaimers and waivers
    Section 436.9(h) prohibits 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.'' This prohibition is intended to prevent fraud by 
preserving the completeness and accuracy of information contained in 
disclosure documents.
    The Franchise NPR proposal to prohibit the use of disclaimers and 
waivers prompted comment on three issues: (1) the need for the 
prohibition; (2) the scope of the prohibition; and (3) the effect of 
the prohibition on parties' ability to negotiate contract terms. The 
following section discusses each of these issues in detail.
a. Section 436.9(h) is necessary to prevent fraud by preserving the 
truthfulness of information contained in a disclosure document
    During the Rule amendment proceeding, several franchisees and their 
representatives observed that franchisors routinely seek to disclaim 
liability for statements made in their disclosure documents through the 
use of contract integration clauses in their franchise agreements. By 
signing a franchise agreement containing such a clause, franchisees 
effectively waive any rights they may have to rely on information 
contained in the disclosure document.\902\ The use of such clauses, 
therefore, may lead to deception by enabling franchisors to make 
incomplete, inaccurate, or even false statements in their disclosure 
documents, while prospects effectively waive reliance on any such 
statements by signing the franchise agreement.
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    \902\ For example, Peter Lagarias, a franchisee advocate, 
asserted:
    ``In virtually every lawsuit I have filed for franchisees 
alleging fraud, franchise disclosure, or unfair or deceptive 
practices (under California law since the FTC 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. 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; Selden, ANPR 133, 
Appendix B, at 2; Zarco & Pardo, ANPR 134, at 3.
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    To remedy this problem, several franchisee advocates and state 
regulators urged the Commission to prohibit the use of contract 
integration clauses as a means of disclaiming statements made in a 
disclosure document.\903\ The IL AG, for example, asserted that such a 
prohibition 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.\904\ Similarly, the 
AFA stated:
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    \903\E.g., AFA, at 4; Bundy, 11-12; Haff, at 3; Karp, at 7; 
Lagarias, at 1-3.
    \904\ IL AG, NPR 3, at 6; IL AG, NPR Rebuttal 38, at 3.

     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.\905\
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    \905\ AFA, NPR 14, at 6.
---------------------------------------------------------------------------

    A few commenters urged the Commission to expand on the prohibition 
that was proposed in the Franchise NPR. Howard Bundy, for example, 
urged prohibiting franchisors from disclaiming liability for any 
authorized statements, including those made in their written marketing 
material.\906\ Seth Stadfeld advocated a ban on 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.''\907\
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    \906\ Bundy, NPR 18, at 14. See also Haff, at 3; Singler, at 3; 
IL AG, NPR 3, at 6.
    \907\ Stadfeld, NPR 23, at 9-10. 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. Id., at 10.
---------------------------------------------------------------------------

    Franchisors, on the other hand, either opposed the prohibition on 
disclaimers or urged limitation on the prohibition's scope. Several 
franchisors strongly asserted that integration clauses are necessary 
for two purposes. First, as J&G

[[Page 15534]]

explained, franchisors have to be able to rely on the final franchise 
agreement as the manifestation of the intent of the parties. Second, 
franchisors must be able to disclaim liability for unauthorized 
statements made by a rogue salesman, such as unauthorized earnings 
claims.\908\
---------------------------------------------------------------------------

    \908\ J&G, NPR 32, at 4-5. See also Marriott, NPR 35, at 8; GPM, 
NPR Rebuttal 40, at 10-11.
---------------------------------------------------------------------------

    PMR&W asserted that the prohibition would effectively ban the use 
of integration clauses. The firm, however, suggested that the 
Commission could limit the 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.''\909\
---------------------------------------------------------------------------

    \909\ PMR&W, NPR 4, at 17.
---------------------------------------------------------------------------

    CA Bar observed that the disclaimer prohibition is likely to 
increase the use of legalese in disclosure documents. It opined that, 
if the prohibition is adopted, franchisors are likely to import 
legalese from their franchise agreements to the disclosure document in 
order to avoid any conflicting language. On the other hand, ``[i]f the 
franchisor is able to include (and rely upon) an integration clause, it 
decreases that potential for problems arising from unintentional 
inconsistency.''\910\
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    \910\ CA Bar, at 10.
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    Finally, a few franchisors suggested that the disclaimer 
prohibition is unnecessary. According to John Baer, for example, the 
Commission could always take action if a franchisor's disclosure 
document contains false information.\911\ In the same vein, J&G 
asserted that the basis for the prohibition 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.\912\
---------------------------------------------------------------------------

    \911\ Baer, NPR 11, at 16-17.
    \912\ J&G, NPR 32, at 4-5. See also Marriott, NPR 35, at 7-8.
---------------------------------------------------------------------------

    After carefully reviewing the record, the Commission is persuaded 
that a limited disclaimer prohibition, rather than a total ban, is 
warranted. As an initial matter, the Commission is convinced 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 former 
or existing franchisees, or unattributed statements found in the trade 
press. Therefore, at the very least, integration clauses and waivers 
protect a franchisor from unauthorized statements or representations 
made by non-agent, third parties.\913\
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    \913\ The Staff Report stated that integration clauses may be 
warranted to enable franchisors to disclaim liability for statements 
made by a ``rogue salesman.'' Staff Report, at 258. This statement 
generated significant comment by franchisee representatives 
asserting that franchisors should always be liable for statements 
made by their sales force. E.g., AFA, at 4 (``The franchisor must 
accept responsibility for the person who it authorized and directed 
to sell franchises to prospective franchisees.''); Bundy, at 12 
(``No one can reasonably argue that the franchisor should be able to 
disclaim statements made by its employees or agents within the scope 
of their agency.''); Gee, at 2 (``Sales staff puff, exaggerate, and 
outright misrepresent the terms of the agreement. . . . Appropriate 
protection . . . for such abuses is essential.''); Haff, at 3 
(``That salesperson is often the franchisee's only connection to the 
franchisor.''); Lagaria, at 2 (``A franchisor should remain liable 
for misconduct in the sales process, particularly by its own 
employees and agents.''); Pu, at 2 (``The FTC should not permit 
franchisors to disclaim responsibility for the statements of rogue 
salespeople.''). While we agree that franchisors in most instances 
are responsible for statements made by their sales force, there may 
be exceptions that can be only be determined based upon the 
particular facts on a case-by-case basis, in light of agency law and 
Section 5 of the FTC Act.
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    At the same time, we are persuaded that franchise sellers should 
not be able to use integration clauses or waivers to insulate 
themselves from false or deceptive statements made in a franchisor's 
disclosure document. This is particularly true of those sections of the 
disclosure document pertaining to matters other than the terms of the 
franchise agreement that cannot be negotiated, such as the franchisor's 
prior business experience, litigation history, financial performance 
representations, and financial statements. The Commission has long 
recognized that the integrity of a franchisor's disclosures is critical 
to prospective franchisees who rely on such information in making their 
investment decision. For that reason, disclosure documents must be 
complete, accurate, legible, and current. Further, as discussed above, 
the original\914\ and final amended Rules also prohibit franchisors 
from making statements that contradict those in their disclosure 
documents. The use of integration clauses or waivers\915\ to disclaim 
statements in the disclosure document that the franchisor authorizes 
would undermine the Rule's very purpose by signaling to prospective 
franchisees that they cannot trust or rely upon the disclosure 
document.\916\
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    \914\See 16 CFR 436.1(f).
    \915\ Waivers of rights afforded by Commission trade regulation 
rules are disfavored. For example, section 455.3(b) of the Used Car 
Rule, 16 CFR 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 CFR 444.2 (barring certain waivers in credit transactions), 
Cooling-Off Period Rule, 16 CFR 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 CFR 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).
    \916\ 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, Int'l, No. 93-CV-2494 (DRH) (E.D.N.Y. 1998) 
(holding that a reasonable consumer could ``legitimately conclude 
that he or she was being furnished important specific earnings 
information . . . notwithstanding . . . general disclaimers in the 
UFOC'').
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    It is true that the Commission can bring law enforcement actions 
against false or deceptive disclosures, regardless of any contract 
integration clause or waiver. This encourages complete and accurate 
disclosure. Nevertheless, we believe that franchisees should not have 
to rely on Commission action post-sale to resolve conflict between a 
disclosure document and franchise agreement. Rather, we believe that 
section 436.9(h) will prevent pre-sale deception by encouraging 
franchisors to review their disclosures for accuracy prior to use, 
thereby avoiding post-sale conflicts and litigation.
    Further, courts have limited the circumstances where integration 
clauses have the most potential for harm. Where there is fraud in the 
inducement, courts are likely to void the contract, regardless of any 
integration clause or waiver.\917\

[[Page 15535]]

Finally, 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.\918\
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    \917\E.g., Cummings v. HPG Int'l, Inc., 244 F.3d 16, 21 (1\st\ 
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 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).
    \918\ For example, in Alphagraphics Franchising, 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.'' Id., at 711 (citations omitted).
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    The Commission recognizes that an integration clause or waiver may 
be one way for a franchisor to narrow its disclosures efficiently 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.\919\
---------------------------------------------------------------------------

    \919\See J&G, NPR 32, at 5.
---------------------------------------------------------------------------

    Nevertheless, franchisors could protect themselves from liability 
without resort to 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 document that 
deletes the Item 19 representation. In the alternative, 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. Nothing in section 436.9(h) would 
prevent a franchisor from having a prospective franchisee sign a clear 
and conspicuous acknowledgment that the Florida-based performance 
representation does not apply to states such as Alaska.
    Finally, we recognize the possibility that some franchisors may be 
tempted to import into their disclosure documents legalese from their 
franchise agreements, in an effort to avoid having conflicting 
provisions. Such a possibility, however, is addressed by the Rule's 
requirement that disclosure documents be prepared in plain 
English.\920\ On balance, however, we are persuaded that the benefit of 
promoting the reliability and integrity of substantive disclosures 
outweighs any possible loss of clarity in how the disclosures are 
presented.
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    \920\ Section 436.6(b).
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b. Scope of section 436.9(h)
    As noted above, section 436.9(h) is designed to address a specific 
problem brought to our attention during the Rule amendment proceeding: 
franchisors' use of integration clauses to disclaim authorized 
statements made in disclosure documents or in their exhibits or 
attachments. By prohibiting this practice, the disclaimer prohibition 
preserves the integrity of the material information disclosed in a 
franchisor's disclosure document, thus preventing deception. By its 
terms, section 436.9(h) does not reach statements made in a 
franchisor's advertising materials.
    A few commenters urged the Commission to adopt a broader 
prohibition that would prevent franchisors from disclaiming any 
authorized statement--whether in a disclosure document or promotional 
materials.\921\ However, the Commission is persuaded that a broader 
prohibition would go beyond what is necessary to address the underlying 
issue identified in the record--the need to prevent deceptive 
disclosure documents. Further, franchise advertisements, like other 
industry advertisements, are already subject to Commission 
substantiation and anti-deception requirements under Section 5 of the 
FTC Act. Moreover, any franchisor who makes statements in promotional 
literature that are inconsistent with the disclosure document and 
franchise agreement would violate the section 436.9(a) ban on the 
making of contradictory statements.\922\ Accordingly, a broader 
disclaimer prohibition is unwarranted to achieve the goal of preserving 
the integrity of franchisors' disclosures.
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    \921\ Haff, at 3; Singler, at 3. Mr. Haff, for example, asserted 
that it is unconscionable for the FTC to permit a franchisor to 
disclaim its own materials through a franchise agreement integration 
clause. Haff, at 3.
    \922\ For example, a franchisor would be liable for a Rule 
violation if its promotional literature made financial performance 
claims, while its Item 19 said that no such claims are authorized, 
or its promotional literature stated that exclusive territories are 
available, while its disclosure document offered no such benefit.
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c. Effect of section 436.9(h) on parties' ability to negotiate 
contracts
    Section 436.9(h) states that the disclaimer prohibition ``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 sales 
negotiations.'' This proviso is necessary because, in its absence, a 
franchisor might conclude that it is prohibited from agreeing to any 
terms or conditions not spelled out in the standard agreement attached 
as an exhibit to its disclosure document.\923\ Clearly, franchise 
sellers and prospective franchisees should be free to negotiate the 
terms of the franchise agreement, as in all other commercial 
transactions. 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 disclosure 
document and has the opportunity to review the actual franchise 
agreement prior to the sale.
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    \923\ 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.
---------------------------------------------------------------------------

    In response to the Staff Report, Howard Bundy voiced concern that 
the section 436.9(h) contract negotiation proviso is too broad and 
could subsume the Rule.\924\ He feared that a franchisor could initiate 
negotiations and permit a person to become a franchisee only if he or 
she agrees to waive essential terms. Mr. Bundy urged the Commission to 
limit the proviso ``to negotiations initiated by the prospective 
franchisee and that result in changes that are no less favorable to the 
franchisee than the standard terms.''\925\
---------------------------------------------------------------------------

    \924\ Bundy, at 11.
    \925\Id., at 12.
---------------------------------------------------------------------------

    The Commission recognizes that an integration clause may facilitate 
negotiations by releasing the parties from restraints imposed by the 
contractual terms previously disclosed in the disclosure document. The 
use of an integration or waiver clause, however, is unnecessary to 
permit contract negotiations. As previously discussed, the final 
amended Rule addresses how franchisors and prospective franchisees may 
negotiate contracts without violating the Rule. Specifically, section 
436.2(b) provides that no mandatory contract review period is necessary 
where changes are made at the request of the prospective franchisee. 
This recognizes that where the prospective franchisee is fully informed 
about the contractual terms

[[Page 15536]]

that will govern the relationship before signing the contract, no harm 
can result. Where changes to the contract are initiated by the 
franchisor, however, section 436.9(g) prohibits the franchisor from 
failing to point out the changes, and section 436.2(b) provides for a 
limited contract review period. These Rule provisions are sufficient to 
prevent fraud in the negotiation process, while preserving the 
integrity of the franchisor's disclosures.
9. Section 436.9 (i): Refunds
    Section 436.9(i) prohibits franchisors from failing to make refunds 
as promised in their disclosure document or in a franchise or other 
agreement. The failure to honor refund promises is an unfair practice 
in violation of Section 5.\926\ It often results in substantial injury 
to franchisees that they cannot reasonably avoid.\927\ Moreover, the 
record is devoid of any evidence suggesting that this harm is 
outweighed by any countervailing benefits.
---------------------------------------------------------------------------

    \926\See FTC v. Hillary's Servs., Inc., No. 94-CV-2312 (E.D. Pa. 
1994); FTC v. Richard L. Levinger, No. 94-0925-PHXRCB (D. Ariz. 
1994); FTC v. McKleans, Inc., Bus. Franchise Guide (CCH) ] 9853 (D. 
Conn. 1989) (franchisors violated the Franchise Rule by, among other 
things, failing to provide promised refunds). See also FTC v. 
William A. Skaife, Bus. Franchise Guide (CCH) [1989-1990 Transfer 
Binder] ] 9555 (C.D. Cal. 1990); FTC v. Nat'l Bus. Consultants, 
Inc., Bus. Franchise Guide (CCH) ] 9385 (E.D. La. 1989); FTC v. Am. 
Legal Distrib., Inc., No. 1:88-CV-519-MHS (N.D. Ga. 1988); United 
States v. Tuff-Tire Am., Inc., Bus. Franchise Guide (CCH) [1985-1986 
Transfer Binder] ] 8353 (M.D. Fla. 1985); United States v. Fed. 
Energy Sys., Inc., Bus. Franchise Guide (CCH) [1983-85 Transfer 
Binder] ] 8180 (C.D. Cal. 1984) (franchisors misrepresented refund 
policy in violation of Section 5); FTC v. Nat'l Audit Defense 
Network, Inc., No. CV-S-02-0131 LRH-PAL (D. Nev. 2002); FTC v. 
Travel Bahamas Tours, Inc., No. 97-6181-CIV-Ferguson (S.D. Fla. 
1997) (companies misrepresented refund policy in violation of 
Section 5 of the FTC Act). Cf. Philips Elecs. N. Am. Corp., FTC No. 
022-3095 (2002); Tim R. Wofford, FTC No. 012 3191 (2002) (the 
failure to honor rebate offers as promised violates Section 5 of the 
FTC Act).
    \927\See original SBP, 43 FR at 59696 (``Numerous consumers 
complained about the difficulty they experienced when they attempted 
to obtain refunds from their franchisors.'').
---------------------------------------------------------------------------

    Section 436.9(i) retains, but slightly revises, the original Rule's 
prohibition against failing to make promised refunds. As set forth at 
16 CFR 436.1(h), the original Rule prohibited 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.'' 
This provision was 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. 
Accordingly, section 436.9(i) makes clear that the failure to honor any 
written refund promise will constitute a Rule violation.\928\
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    \928\ One commenter, Dady & Garner, suggested that franchisees 
should always receive a refund (excluding 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. No other comments were submitted in 
connection with the Franchise NPR's proposed retention of the refund 
prohibition.
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H. Sections 436.10 and 436.11: Other Laws and Rules, and Severability
    The last sections of the final amended Rule address three 
additional issues: (1) the final amended Rule's effect on other 
Commission laws and rules; (2) preemption of state franchise laws that 
may be inconsistent with the Rule; and (3) ``severability.'' Each of 
these issues is addressed below.
1. Section 436.10(a): Relationship to other laws and rules
    The first part of section 436.10(a) provides that the Commission 
does not approve or express any opinion on the legality of any matter a 
franchisor may be required to disclose by the Rule. At the same time, 
it makes clear that the Commission intends to enforce all applicable 
statutes and rules.\929\ This is slightly broader than the same 
provision in the proposed Rule, which was limited to ``trade regulation 
rules.''\930\
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    \929\ This is slightly broader than the same provision in the 
original Rule set forth at 16 CFR 436.3, which is limited to 
enforcement of statutes: ``A provision for disclosure should not be 
construed as . . . an indication of the Commission's intention not 
to enforce any applicable statute.'' The revised language of final 
amended Rule is also clearer, eliminating the use of double 
negatives.
    \930\ Franchise NPR, 64 FR at 57346.
---------------------------------------------------------------------------

    This provision clarifies the relationship between Franchise Rule 
disclosure and other statutes and rules enforced by the Commission. As 
stated in the original SBP, some of the Rule's provisions may require 
franchisors to disclose practices that may raise legal issues, such as 
antitrust issues.\931\ By requiring disclosure, the Commission does not 
approve of practices that might violate other Commission laws. In 
short, pre-sale disclosure does not create a safe harbor for 
franchisors engaging in otherwise unlawful conduct.\932\
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    \931\ Original SBP, 43 FR at 59719.
    \932\ Howard Bundy urged the Commission to add a separate 
prohibition against a franchisor representing to any person that the 
Commission has reviewed or approved the form or content of any 
disclosure document. Bundy, NPR 18, at 15. While we agree with Mr. 
Bundy, in principle, we are not persuaded that a new prohibition is 
warranted. The final amended Rule already mandates that franchisors 
state expressly on their disclosure document 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, any misrepresentation about Commission approval 
of a disclosure document is already actionable as a violation of 
Section 5 of the FTC Act.
---------------------------------------------------------------------------

    During the Rule amendment proceeding, the NFC focused on the 
sentence that the ``Commission also intends to enforce all applicable 
statutes and trade regulation rules.'' 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.\933\
---------------------------------------------------------------------------

    \933\ NFC, NPR 12, at 24.
---------------------------------------------------------------------------

    The NFC's concerns are misplaced. Section 436.10 restates the 
general policy that disclosure alone does not shield a franchisor from 
otherwise illegal conduct. Section 436.10(a) does nothing more than 
state that the Commission will continue to enforce the laws it 
administers in accordance with its legal authority. If a disclosure 
makes conduct legal, as the NFC asserted, then the Commission obviously 
would have no reason to believe the franchisor has committed a law 
violation.
    The second part of section 436.10(a) provides that ``franchisors 
may have additional obligations to impart material information to 
prospective franchisees outside of the disclosure document under 
Section 5 of the Federal Trade Commission Act.''\934\ During the Rule

[[Page 15537]]

amendment proceeding, a few franchisors voiced concern that this 
provision does not give any guidance to franchisors about what specific 
information needs to be disclosed. For example, Piper Rudnick stated 
that ``no matter how thorough or detailed the franchise offering 
circular may be, this sentence places all franchisors at risk of 
violating the Revised Rule by not also making whatever disclosure may 
be required by this open-ended and ambiguous disclosure 
obligation.''\935\
---------------------------------------------------------------------------

    \934\ For example, under the original Rule, no disclosure of 
state or local licensing provisions was required. Nonetheless, in 
United States 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 FTC v. Car Checkers of Am., Inc., No. 93-623 
(mlp) (D.N.J. 1993) (alleging that defendants violated Section 5 by 
failing to disclose state insurance licensing requirements); FTC v. 
Claude Blanc, Bus. Franchise Guide (CCH) ] 10032 (alleging that 
defendants violated Section 5 by misrepresenting availability of 
medical insurance). Cf. FTC v. Carribean Clear, Inc., Bus. Franchise 
Guide (CCH) ] 10029 (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 has alleged 
that the defendants violated Section 5 by using shills (fictitious 
references), even though that conduct also violated the Rule's 
mandate to disclose completely and accurately information about 
existing franchisees. See 16 CFR 436.1(a)(16).
    \935\ Piper Rudnick, at 4. See also Kaufmann, Attachment 1, at 
9-10; H&H, NPR 9, at 8.
---------------------------------------------------------------------------

    No franchisor need worry that it may violate the Rule for failing 
to include material information not specifically required or permitted 
by the Rule or state law. As for every other person over which the 
Commission has jurisdiction, franchisors must not engage in unfair or 
deceptive acts or practices. For example, Section 5 would prohibit a 
used car seller from misrepresenting a rebate program or from 
misrepresenting whether a used car had previous damage, even though the 
seller may otherwise comply with the Used Car Rule's warranty 
disclosures.
2. Section 436.10(b): Preemption
    Section 436.10(b) retains the original Rule's preemption statement 
found at footnote 2:\936\
---------------------------------------------------------------------------

    \936\ 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 CFR Part 305.17; 
Cooling-Off Rule, 16 CFR 429.2; Mail Order Rule, 16 CFR 435.3(b)(2); 
R-Value Rule, 16 CFR 460.23.

     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.

16 CFR Part 436, note 2.\937\
---------------------------------------------------------------------------

    \937\ As noted previously, starting on July 1, 2007, franchisors 
have the option of complying with either part 436 of the final 
amended Rule, the UFOC Guidelines, or the original Franchise Rule. 
Beginning on July 1, 2008, however, franchisors may use part 436 of 
the final amended Rule only. Permission to use the UFOC Guidelines 
will be withdrawn on that date because those Guidelines will no 
longer afford prospective franchisees equal or greater protection as 
part 436. This would not preclude consideration of any new or 
revised UFOC Guidelines promulgated by the states in the future.
---------------------------------------------------------------------------

    During the Rule amendment proceeding, several franchisors urged the 
Commission to preempt the field of pre-sale disclosure to ensure a 
single, national, disclosure standard.\938\ The preemptive effect of 
the final amended Rule, however, is not a subject of Commission 
discretion. Rather, the preemptive effect of any federal law is 
fundamentally a question of Congressional intent.\939\
---------------------------------------------------------------------------

    \938\E.g., IFA, at 4; Kaufmann, at 9-10; Spandorf, at 10; PMR&W, 
NPR 4, at 7-8; Baer, NPR 11, at 2; Snap-On, NPR 16, at 2; GPM, NPR 
Rebuttal 40, at 8. But see IL AG, NPR Rebuttal 38, at 1-2 
(``federalism has served the public well'').
    \939\English v. Gen. Elec. Co., 496 U.S. 72, 78 (1990); 
Schneidewind v. ANR Pipeline Co., 485 U.S. 293, 299 (1988).
---------------------------------------------------------------------------

    First, Congress can define explicitly the extent to which federal 
law preempts state law.\940\ If Congress has explicitly addressed the 
issue of preemption in a statute, then the statutory language governs 
and no further analysis is required.\941\ Even in the absence of 
explicit statutory language, state law is preempted where it regulates 
conduct in a field that Congress intended the federal government to 
occupy exclusively. Congressional intent to occupy a field may be 
inferred from a ``scheme of federal regulation . . . so pervasive as to 
make reasonable the inference that Congress left no room for the States 
to supplement it,'' or where an act of Congress ``touch[es] a field in 
which the federal interest is so dominant that the federal system will 
be assumed to preclude enforcement of state laws on the same 
subject.''\942\ In addition, Congress may choose to grant sufficiently 
broad regulatory authority to a federal agency as to permit the agency 
itself, by regulation, to provide expressly for the preemption of state 
law.\943\
---------------------------------------------------------------------------

    \940\Shaw v. Delta Air Lines, Inc., 463 U.S. 85, 95-98 (1983).
    \941\Cipollone v. Liggett Group, 505 U.S. 504, 517 (1992).
    \942\English, 496 U.S. at 79; Rice v. Santa Fe Elevator Corp., 
331 U.S. 218, 230 (1947). Where the field in question has been 
traditionally occupied by the states, congressional intent to 
supersede state laws much be ``clear and manifest.'' Jones v. Rath 
Packing Co., 430 U.S. 519, 525 (1977) (quoting Rice, 331 U.S. at 
230).
    \943\City of New York v. FCC, 486 U.S. 57, 62-68 (1988) 
(upholding FCC regulations preemping state and local standards for 
the quality of cable television signals).
---------------------------------------------------------------------------

    Finally, state law is preempted to the extent that it actually 
conflicts with federal law. Thus, federal law will preempt state law 
where it is impossible for a private party to comply with both state 
and federal requirements.\944\ In addition, preemption occurs where 
state law ``stands as an obstacle to the accomplishment and execution 
of the full purposes and objectives of Congress.''\945\
---------------------------------------------------------------------------

    \944\English, 496 U.S. at 79; Fla. Lime & Avocado Growers, Inc., 
v. Paul, 373 U.S. 132, 141 (1963).
    \945\English, 496 U.S. at 79; Gade v. Nat'l Solid Wastes Mgmt. 
Ass'n, 505 U.S. 88, 98-99 (1992); 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).
---------------------------------------------------------------------------

    The Federal Trade Commission Act does not include any clause 
directly preempting state law or authorizing the Commission to do so. 
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.\946\ Any preemptive effect of 
the Franchise Rule, therefore, is limited to instances where it is 
impossible for a private party to comply with both state and the 
Commission regulations, or where application of state regulations would 
frustrate the purposes of the Franchise Rule.\947\ In this regard, the 
Commission generally has declared the preemptive effect of Commission 
rules to be limited to the extent of an inconsistency only.\948\ 
Accordingly, the amended Franchise Rule would not affect state laws 
providing greater consumer protection.\949\
---------------------------------------------------------------------------

    \946\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 L.J. 225.
    \947\ Preemption would occur where there is an ``actual conflict 
between the two schemes of regulation [such] that both cannot stand 
in the same area.'' Fla. Lime & Avocado Growers, 373 U.S. at 141. 
See also, Am. Fin. Servs., 767 F.2d 957 (Credit Practices Rule); 
Harry and Bryant Co. v. FTC, 726 F.2d 993 (4\th\ Cir. 1984) (Funeral 
Rule); Am. Optometric Assoc. v. FTC, 626 F.2d 896 (D.C. Cir. 1980) 
(Opthalmic Practices Rule).
    \948\E.g., Mail or Telephone Order Merchandise Rule, 16 CFR 
435.3; R-Value Rule, 16 CFR 460.23.
    \949\ When promulgating the original Rule, the Commission 
authorized franchisors to use the UFOC Guidelines to comply with the 
original Rule's disclosure requirements on the grounds that the UFOC 
Guidelines, taken in their entirety, provide equal or greater 
consumer protection as the original Rule. See Interpretive Guides, 
44 FR at 49970-71. The Commission ratified this position following 
subsequent amendments to the UFOC requirements by the NASAA, most 
recently in 1993, 58 FR 69224 (Dec. 30, 1993). Examples of state and 
local laws not preempted by the original or amended Rule include 
registration of franchisors and franchise salespersons, escrow or 
bonding requirements, substantive regulation of the franchisor-
franchisee relationship (e.g., termination practices, contract 
provisions, and financing arrangements), and disclosure laws 
requiring more extensive disclosures than those provided by the 
amended Rule.
---------------------------------------------------------------------------

    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.\950\

[[Page 15538]]

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 in large measure, which the commenters 
agreed is superior to the current Franchise Rule, the states have taken 
a leadership role in this field. 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.
---------------------------------------------------------------------------

    \950\ 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.
---------------------------------------------------------------------------

3. Section 436.11: Severability
    Finally, as proposed in the Franchise NPR,\951\ section 436.11 
contains a standard severability provision, stating that if any 
provision of this regulation is stayed or held invalid, the remainder 
will stay in force.\952\ This provision is comparable to the 
severability provisions in other Commission trade regulation 
rules.\953\ This provision generated no comments in response to both 
the Franchise NPR and Staff Report. Accordingly, the amended Rule 
adopts the severability provision proposed in the Franchise NPR.
---------------------------------------------------------------------------

    \951\ Franchise NPR, 64 FR at 57324.
    \952\See 16 CFR 436.3.
    \953\E.g., Pay-Per-Call Rule, 16 CFR 308.8; Used Car Rule, 16 
CFR 455.7
---------------------------------------------------------------------------

IV. SECTION-BY-SECTION ANALYSIS OF PART 437

    As noted above, part 437 of the final amended Rule continues to 
cover the offer and sale of business opportunities, such as vending 
machine and rack display promotions.\954\ Except for the three changes 
discussed immediately below, part 437 is identical to the original 
Rule, imposing no new substantive disclosure requirements or 
prohibitions.
---------------------------------------------------------------------------

    \954\See Interpretive Guides, at 49968. See generally Business 
Opportunity NPR, 71 FR at 19054-57.
---------------------------------------------------------------------------

A. New definition for ``business opportunity''

    Section 437.2(a) of the final amended Rule defines the term 
``business opportunity'' consistent with the original Rule's business 
opportunity definitional elements. In so doing, it eliminates 
references to franchising, which are now addressed in part 437 of the 
final amended Rule. First, the term ``franchise'' in the original Rule 
definitions has been eliminated and substituted with the term 
``business opportunity.'' Second, the franchise definitional elements 
of the original Rule's ``franchise'' definition have been eliminated. 
Accordingly, the definitional elements of the term ``business 
opportunity'' are now identical to those set forth in the original 
Rule:
    (a) The term business opportunity means any continuing commercial 
relationship created by any arrangement or arrangements whereby:
    (1) A person (hereinafter ``business opportunity purchaser'') 
offers, sells, or distributes to any person other than a ``business 
opportunity seller'' (as hereinafter defined), goods, commodities, or 
services which are:
    (i)(A) Supplied by another person (hereinafter ``business 
opportunity seller''); or
    (B) Supplied by a third person (e.g., a supplier) with whom the 
business opportunity purchaser is directly or indirectly required to do 
business by another person (hereinafter ``business opportunity 
seller''); or
    (C) Supplied by a third person (e.g., a supplier) with whom the 
business opportunity purchaser is directly or indirectly advised to do 
business by another person (hereinafter ``business opportunity 
seller'') where such third person is affiliated with the business 
opportunity seller; and
    (ii) The business opportunity seller:
    (A) Secures for the business opportunity purchaser retail outlets 
or accounts for said goods, commodities, or services; or
    (B) Secures for the business opportunity purchaser locations or 
sites for vending machines, rack displays, or any other product sales 
displays used by the business opportunity purchaser in the offering, 
sale, or distribution of said goods, commodities, or services; or
    (C) Provides to the business opportunity purchaser the services of 
a person able to secure the retail outlets, accounts, sites, or 
locations referred to in paragraphs (a)(ii)(A) and (B) of this section; 
and
    (2) The business opportunity purchaser is required as a condition 
of obtaining or commencing the business opportunity operation to make a 
payment or a commitment to pay to the business opportunity seller, or 
to a person affiliated with the business opportunity seller.

B. Eliminating other references to franchising

    Part 437 of the final amended Rule further eliminates all other 
references to franchising, by substituting for the terms 
``franchisor,'' ``franchisee,'' and ``franchise'' used throughout part 
437 the terms ``business opportunity seller,'' ``business opportunity 
purchaser,'' and ``business opportunity.'' This ensures that part 437 
will cover only the offer and sale of business opportunities. For 
example, section 437.2(a)(3) retains, but modifies, the original Rule's 
exemption for fractional relationships to cover business opportunities 
only: the term ``fractional franchise'' is replaced by the term 
``fractional business opportunity.''

C. Franchise exemption

    Section 437.2(a)(3)(v) adds a new exemption to part 437 of the 
final amended Rule for those business arrangements that comply with the 
Franchise Rule, or are exempt from compliance with the Franchise Rule, 
as set forth in part 436. Accordingly, it is designed to eliminate 
potential overlap and duplicative compliance burdens between the 
franchise rule and the business opportunity rule, parts 436 and 437, 
respectively. Specifically, section 437.2(a)(3)(v) exempts from 
coverage of part 437 all business arrangements that comply with part 
436, or that satisfy one or more exemptions to part 436. For example, 
businesses exempt from part 436 coverage pursuant to the fractional 
franchise exemption would not be subjected to coverage under part 437. 
This is an appropriate result because the same rationale underlying 
exemption of these types of businesses from part 436 would also dictate 
that they not be covered by part 437-- i.e., in the case of a 
fractional franchise, the franchisor is not likely to deceive the 
prospective franchisee or to subject the prospective franchisee to 
significant investment risk. Therefore, imposing the requirements of 
either part 436 or part 437 would not be justified.

V. REGULATORY ANALYSIS AND REGULATORY FLEXIBILITY ACT REQUIREMENTS

    Under section 22 of the FTC Act,\955\ the Commission must issue a 
regulatory analysis for a proceeding to amend a rule only when it: (1) 
estimates that the

[[Page 15539]]

amendment will have an annual effect on the national economy of 
$100,000,000 or more; (2) estimates that the amendment will cause a 
substantial change in the cost or price of certain categories of goods 
or services; or (3) otherwise determines that the amendment will have a 
significant effect upon covered entities or upon consumers.
---------------------------------------------------------------------------

    \955\ 15 U.S.C. 57b.
---------------------------------------------------------------------------

    In general, the commenters supported the proposed franchise 
amendments because they reduce inconsistencies with state franchise 
disclosure laws, reduce compliance burdens on franchisors that are not 
likely to engage in abusive practices that the Rule was intended to 
prevent, and update the original Rule to address new technologies. Only 
one commenter addressed the economic impact of part 436, voicing 
concern generally that the original and amended Franchise Rule impose 
unnecessary costs.\956\ No commenter, however, indicated that the 
amendments would have an annual impact of more than $100,000,000, cause 
substantial change in the cost of goods or services, or otherwise have 
a significant effect upon covered entities or consumers.\957\
---------------------------------------------------------------------------

    \956\See generally Winslow. However, this commenter did not 
quantify the additional cost burdens arising as a result of the Rule 
amendments--as opposed to those imposed by the original Rule or by 
state law--nor provide any data or statistics supporting his view, 
that would permit us to assess the economic impact of the Rule 
amendments.
    \957\ As previously noted, part 437 of the final amended rule 
(the business opportunity section) is substantively identical to the 
business opportunity coverage of the original Rule. Part 437 imposes 
no additional disclosures, recordkeeping requirements, or 
prohibitions on business opportunity sellers. Accordingly, the part 
437 amendments impose no economic costs or compliance burdens on 
business opportunities covered by the original Franchise Rule.
---------------------------------------------------------------------------

    At the same time, some commenters questioned whether particular 
rule amendments pertaining to franchising might be unnecessary, or 
offered alternatives. Section III of this document analyzes these 
comments in detail. After careful consideration of the comments, and 
the record as a whole, the Commission has determined that there are no 
facts in the record, or other reasons to believe, that the part 436 
amendments will have significant effects on the national economy, on 
the cost of goods or services, or on covered parties or consumers. In 
any event, to the extent, if any, these final rule amendments will have 
such effects, the Commission has previously explained above the need 
for, and the objectives of, the final amendments; the regulatory 
alternatives that the Commission has considered; the projected benefits 
and adverse economic or other effects, if any, of the amendments; the 
reasons that the final amendments will attain their intended objectives 
in a manner consistent with applicable law; the reasons for the 
particular amendments that the agency has adopted; and the significant 
issues raised by public comments, including the Commission's assessment 
of and response to those comments on those issues.
    The Regulatory Flexibility Act (``RFA''),\958\ requires that the 
agency conduct an analysis of the anticipated economic impact of 
proposed rule amendments on small businesses. The purpose of a 
regulatory flexibility analysis is to ensure that the agency considers 
the impact on small entities and examines regulatory alternatives that 
could achieve the regulatory purpose while minimizing burdens on small 
entities. Section 605 of the RFA provides that such an analysis is not 
required if the agency head certifies that the regulatory action will 
not have a significant economic impact on a substantial number of small 
entities.\959\
---------------------------------------------------------------------------

    \958\ 5 U.S.C. 601- 612.
    \959\ 5 U.S.C. 605.
---------------------------------------------------------------------------

    The Commission believes that none of the amendments to the original 
Franchise Rule is likely to have a significant impact on small 
businesses. Most small businesses covered by the original Franchise 
Rule are likely to be business opportunity sellers, such as vending 
machine and rack display route sellers. These small businesses will 
continue to be covered by the same substantive provisions of the 
original Rule, through part 437. On the other hand, the numerous 
amendments to the original Franchise Rule that pertain to franchising--
set out in part 436--will not apply to the offer or sale of business 
opportunities. In short, none of the amendments to the original 
Franchise Rule are likely to affect a substantial number of small 
businesses. Accordingly, the Commission has no reason to believe that 
the amendments will have a significant impact upon such entities.
    Moreover, the Commission is adopting amendments that in large 
measure reduce inconsistencies with state law. In many instances, small 
businesses that sell franchises, especially those conducting business 
on a national basis, already comply with state disclosure laws in the 
form of the UFOC Guidelines. Accordingly, many of the amendments will 
impose no new compliance costs on either small or large businesses. 
Further, in some instances, the Commission has specifically narrowed a 
UFOC provision to reduce compliance costs, which will benefit small 
business franchisors in particular. For example, in considering the 
disclosure of computer systems, the Commission declined to adopt the 
states' sweeping disclosure of computer system requirements, in favor 
of a more limited disclosure. In addition, the Commission will permit 
electronic compliance with the Franchise Rule, which holds the promise 
of reducing costs for all franchisors, including small business 
franchisors.
    In a few instances, the part 436 amendments will impose new 
disclosure requirements on all franchisors. These amendments are 
designed to provide prospective franchisees with more information about 
the quality of the franchise relationship. In these instances, the 
Commission has taken great care to keep compliance costs to a minimum. 
For example, with respect to the new franchisor-initiated litigation 
disclosure, franchisors need only report such litigation for a period 
of one year. This contrasts with the original Rule's seven-year 
reporting period (and the UFOC Guidelines 10-year reporting period) for 
prior litigation against the franchisor. Similarly, a franchisor may 
disclose franchisor-initiated litigation by grouping any suits under a 
single heading, as opposed to the original Rule and UFOC Guidelines 
approach for other litigation, which requires full case summaries.
    Similarly, the Commission has narrowed the new disclosure of 
independent trademark-specific franchisee associations. Franchisors 
need not make this disclosure unless the association specifically asks 
to be included in the franchisor's disclosure document. Further, such 
requests must be renewed by the association on an annual basis. In 
addition, franchisors need not update this disclosure on a quarterly 
basis. The Commission believes that these, and other efforts to narrow 
amendments to the Rule discussed throughout this document, will result 
in the easing of compliance burdens for all franchisors, especially 
small business franchisors.
    Accordingly, the Commission concludes that the amendments to the 
original Franchise Rule will not have a significant or disproportionate 
impact on the costs of small business, whether they sell franchises or 
business opportunities. Based on available information, therefore, the 
Commission certifies that the Franchise Rule amendments published in 
this document will not have significant economic impact on a 
substantial number of small businesses.

[[Page 15540]]

    Nonetheless, to ensure that no such impact, if any, has been 
overlooked, the Commission has conducted the following final regulatory 
flexibility analysis, as summarized below.

A. Need For And Objective Of The Rule

    As previously discussed, the Commission is issuing these rule 
amendments to achieve four goals: (1) to reduce inconsistencies with 
state franchise disclosure laws; (2) to respond to changes in the 
marketing of franchises and new technological developments, in 
particular electronic communications; (3) to reduce compliance costs 
where the record and the Commission's law enforcement experience shows 
that the abuses the Rule was intended to address are not likely to 
occur; and (4) to address the need for franchisors to disclose material 
information about the quality of the franchise relationship, the 
absence of which the record shows is a prevalent problem.

B. Significant Issues Raised By Public Comment, Summary Of The Agency's 
Comment, Summary Of The Agency's Assessment Of These Issues, And 
Changes, If Any, Made In Response To Such Comments

    The Commission has reviewed the comments received during the Rule 
amendment proceeding and has made changes to the original Rule, as 
appropriate. Section III of this document contains a detailed 
discussion of the comments and the Commission's responses. Among other 
things, the Commission, based upon the record, has narrowed the scope 
of part 436--the franchise section--by eliminating coverage of business 
opportunities, many of which are small businesses. In addition, part 
436 will apply only to the sale of franchises to be located in the 
United States.
    Further, part 436 of the final amended Rule reduces many 
inconsistencies with state franchise laws that use the UFOC Guidelines 
format. Accordingly, many of the rule amendments will impose no new 
compliance costs on small businesses, especially those that conduct, or 
plan to conduct, business on a national basis. Further, in some 
instances, the Commission has specifically narrowed a UFOC provision to 
reduce compliance costs, which will benefit small businesses in 
particular. For example, based upon the comments, the Commission 
declined to adopt the states' sweeping disclosure of computer system 
requirements, in favor of a more limited disclosure. Most important, 
part 436 of the final amended Rule permits franchisors to furnish 
disclosure documents electronically, which holds the promise of 
reducing costs for all franchisors, including small business 
franchisors.
    Where part 436 of the final amended Rule imposes new disclosure 
requirements, the Commission has carefully considered approaches that 
will reduce compliance burdens, especially on small businesses. For 
example, with respect to the new franchisor-initiated litigation 
disclosure, franchisors need only report such litigation for a period 
of one year. This contrasts with the original Rule's seven-year 
reporting period (and the UFOC Guidelines 10-year reporting period) for 
prior litigation against the franchisor. Similarly, a franchisor may 
disclose franchisor-initiated litigation by grouping any suits under a 
single heading, as opposed to the original Rule and UFOC Guidelines 
approach for other litigation, which requires full case summaries. 
Similarly, the Commission has narrowed the new disclosure of 
independent trademark-specific franchisee associations. Franchisors 
need not make this disclosure unless the association specifically asks 
to be included in the franchisor's disclosure document. Further, such 
requests must be renewed by the association on an annual basis. In 
addition, franchisors need not update this disclosure on a quarterly 
basis. The Commission believes that these, and other efforts to narrow 
amendments to the original Franchise Rule discussed throughout this 
document, will result in the easing of compliance burdens for all 
franchisors, especially small business franchisors.

C. Description And Estimate Of Number Of Small Entities Subject To The 
Final Rule Or Explanation Why No Estimate Is Available

    The Commission cannot readily estimate the number of small entities 
subject to the final amended Rule. Franchising is a method of 
distribution, not an industry, nor an economic sector. Accordingly, 
businesses in a wide array of industries engage in the distribution of 
products or services through franchising, and the number of franchisors 
in any one economic sector is constantly changing.
    Moreover, the SBA's standards for determining size--based on either 
number of employees or annual receipts--are inapplicable to 
franchising.\960\ For example, the most relevant SBA standards 
pertaining to franchising are arguably those for the retail sales 
industry. The most common ``small business'' threshold (measured in 
receipts) for the retail trade industry is $6 million.\961\ However, 
these standards apply to franchisees engaging in retail sales 
activities, not to the franchisors that sell the underlying franchised 
units.\962\
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    \960\ The SBA size thresholds set forth what constitutes a small 
entity in a particular line of business, regardless of whether the 
entity is a franchisor, licensee, contractor, parent corporation, 
affiliate, agent, or other entity. For the same reason, it is 
difficult to estimate the number of small entities that will be 
subject to the business opportunity requirements set forth at part 
437.
    \961\ See generally 13 CFR Part 121. According to the SBA 
standards, the $6 million receipts threshold applies to retailers as 
diverse as automotive parts and tire stores; floor coverings and 
window treatment stores; camera and photography stores; hardware and 
garden suppliers; many food stores; health care product stores; many 
clothing stores; sporting good stores; florists; and pet supply 
stores. The $6 million threshold also is applicable to hotels; 
restaurants; automotive repair centers; car washes; and laundry 
services. While the $6 million threshold is typical of a wide cross-
section of small businesses, some of which may be franchises, it 
sheds no light on the number of franchisors that are small 
businesses.
    \962\ Industry data are also difficult to come by. In the 
1990's, the International Franchise Association produced a series of 
reports called The Profile of Franchising that sought to quantify 
and describe franchise systems in the United States. While these 
reports shed light on numerous aspects of franchising--such as the 
number of franchise systems in various economic sectors, how long 
companies were in business before beginning to franchise, and how 
many franchisees are in the system--the reports did not purport to 
examine the number of staff employed by the franchisors nor 
franchisors' annual receipts, factors used in a regulatory 
flexibility analysis. More recently, in 2004, the International 
Franchise Association produced a study called Economic Impact of 
Franchised Businesses. This study examined the economic impact that 
franchised units have in the marketplace, for example, the number of 
individuals employed by franchised units. This study, like the 
Profiles of Franchising, is not useful in determining the number of 
franchisors that are small businesses and subject to the final 
amended Rule.
---------------------------------------------------------------------------

    Nonetheless, in the Franchise NPR the Commission estimated that 
there are 2,500 business format and product franchisors and 2,500 
business opportunities covered by the original Rule.\963\ The 
Commission estimated that as many as 70% of those 5,000 franchisors are 
small entities, including some start-up franchise systems and most 
business opportunities.\964\ The Franchise NPR specifically asked for 
comment on these estimates. No comments were submitted. Accordingly, 
our best estimate is that 3,500 franchisors covered by the original 
Rule were small businesses, 2,500 of which were business opportunities.
---------------------------------------------------------------------------

    \963\ Franchise NPR, 64 FR at 57325. See also 70 FR 51817, 
51818-20 (Aug. 31, 2005).
    \964\ Franchise NPR, 64 FR at 57325.
---------------------------------------------------------------------------

    Once business opportunity ventures are no longer covered by part 
436 of the final amended Rule, the number of

[[Page 15541]]

``small businesses'' subject to the Rule amendments will be greatly 
reduced. Of the remaining 2,500 franchisors covered by part 436 of the 
final amended Rule, many are mature, well-established franchise 
systems, including many publicly traded companies. In the absence of 
additional information on the size of franchisors, we will estimate for 
purposes of this analysis that 1,000 franchisors (3,500 covered by the 
original Rule minus the exclusion of 2,500 business opportunities) will 
qualify as small businesses subject to the part 436 amendments. At the 
same time, each of the 2,500 business opportunities covered by the 
original Rule--most likely small entities--will remain covered by the 
identical disclosure requirements, as set forth in part 437.

D. Description Of The Projected Reporting, Recordkeeping, And Other 
Compliance Requirements Of The Rule, Including An Estimate Of The 
Classes Of Small Entities That Will Be Subject To The Rule And The Type 
Of Professional Skills That Will Be Necessary To Comply

    As discussed in the Paperwork Reduction Act analysis of this notice 
(Section VI), the amendments will impose compliance requirements (e.g., 
disclosure) and minor recordkeeping requirements on franchisors. This 
may affect some small business franchisors. No additional recordkeeping 
or disclosure requirements are imposed on business opportunities that 
remain covered under part 437. The incremental cost of the part 436 
amendments on franchisors is difficult to estimate. As suggested by the 
lack of comment on the subject, the Commission expects that the added 
costs of the amendments will be small. Finally, compliance with the 
amended Rule will require, in many instances, the professional 
assistance of an attorney to prepare disclosure documents.\965\ 
However, franchisors (and business opportunity sellers) typically need 
such professional assistance in order to comply with state franchise 
and business opportunity disclosure laws, in particular the preparation 
of required financial statements. Accordingly, no new or additional 
professional skills are required as a result of amendments to the 
original Rule.
---------------------------------------------------------------------------

    \965\ In preparing disclosure documents for franchisor clients, 
attorneys may also arrange for the assistance of accountants, 
especially to prepare audited financial statements.
---------------------------------------------------------------------------

E. Steps The Agency Has Taken To Minimize Any Significant Economic 
Impact On Small Entities, Consistent With The Stated Objectives Of The 
Applicable Statutes, Including The Factual, Policy, And Legal Reasons 
For Selecting The Alternative(s) Finally Adopted, And Why Each Of The 
Significant Alternatives, If Any, Was Rejected

    As discussed throughout this document, the Commission has 
considered all alternatives that would reduce compliance costs on all 
franchisors, including small business franchisors, while achieving the 
intended objectives of the Rule. For example, part 436 of the final 
amended Rule narrows the scope of the original Rule by eliminating 
coverage of business opportunities, many of which are small businesses. 
Part 436 of the final amended Rule, while reducing compliance with 
state pre-sale disclosure laws, minimizes compliance costs where 
possible. For example, part 436 of the final amended Rule narrows the 
disclosure of computer system requirements. Where a part 436 rule 
amendment expands the original Rule, it does so in a fashion designed 
to minimize compliance burdens. This is most evident regarding the new 
disclosures pertaining to franchisor-initiated litigation and 
independent, trademark-specific franchisee associations, as discussed 
above. Further, in many instances part 436 of the final amended Rule 
permits franchisors the flexibility to comply with Rule provisions in a 
manner that makes the most sense for their particular business. For 
example, franchisors can determine the best medium in which to furnish 
their disclosures, as well as to receive receipts from prospective 
franchisees.
    Moreover, part 436 of the final amended Rule permits disclosure and 
recordkeeping electronically. This offers the promise of greatly 
reducing compliance costs, especially for small businesses. All 
franchisors, including small businesses, may furnish disclosures using 
the approach that is most economical for their business, whether that 
means furnishing a paper document, an electronic disclosure document 
made available to prospective franchisees through a password-protected 
website, or through email or CD-ROM.
    At the same time, the Commission has rejected numerous suggestions 
to revise the original Rule that would result in significantly 
increased costs for all franchisors, in particular small business 
franchisors. For example, several commenters urged the Commission to 
mandate the disclosure of financial performance data. Other commenters 
urged the Commission to expand greatly the reporting of franchise 
turnover rates. Further, commenters suggested that the Commission 
incorporate into the disclosure document various risk factors or 
consumer education notices to prospective franchisees. As discussed 
above in Section III, the Commission finds that the benefits of these 
suggested amendments would not outweigh the compliance costs.
    Finally, the Commission has determined to give franchisors ample 
time to come into compliance with the final amended Rule. To that end, 
franchisors can start using the final amended Rule on July 1, 2007, if 
they so choose. At the very latest, all franchisors must come into 
compliance with the final amended Rule by July 1, 2008. This approach 
will benefit large and more seasoned franchisors that wish to take 
advantage of the improvements incorporated in part 436 of the final 
amended Rule. At the same time, it permits small business franchisors, 
in particular, ample opportunity to consider the best and most cost-
effective means to comply with part 436 of the final amended Rule.

VI. PAPERWORK REDUCTION ACT

    In accordance with the Paperwork Reduction Act, as amended, 44 
U.S.C. 3501-3520, the Office of Management and Budget (``OMB'') has 
approved the information collection requirements contained in the 
amended Rule through October 31, 2008, and has assigned OMB control 
number 3084-0107.
    No comments were received in response to the Franchise NPR 
addressing the Commission's paperwork burden estimates. Nonetheless, 
the Commission staff revised its approach to calculating the burden 
when seeking to extend the clearance for the Rule in 2002.\966\ 
Specifically, taking into account that new entries are more likely to 
require additional time to prepare disclosures than their more seasoned 
counterparts, the Commission staff distinguished between existing 
entities covered by the Rule and the likely number of new entries when 
calculating compliance burdens.\967\ This burden analysis approach was 
retained when Commission staff sought an extension of the clearance for 
the Rule in 2005.\968\ As with the Franchise NPR, no paperwork

[[Page 15542]]

related comments were received in response to the Commission's 2002 and 
2005 Notices.\969\
---------------------------------------------------------------------------

    \966\See 67 FR 21243 (Apr. 30, 2002); 67 FR 45734 (July 10, 
2002) (``2002 Notices'').
    \967\ 67 FR at 21245; 67 FR at 45736.
    \968\See 70 FR 28937, 28940 (May 19, 2005); 70 FR 51817, 51819 
(Aug. 31, 2005) (``2005 Notices'').
    \969\ One Staff Report commenter voiced concern that the 
Franchise Rule imposed unnecessary burdens. See generally Winslow. 
Mr. Winslow's concerns are addressed below.
---------------------------------------------------------------------------

    As set forth in the 2005 Notices, based on a review of trade 
publications and information from state regulatory authorities, staff 
believes that, on average, from year to year, there are approximately 
5,000 American franchise systems, consisting of about 2,500 business 
format franchises and 2,500 business opportunity sellers, with perhaps 
about 10% of that total (500) reflecting an equal amount of new and 
departing business entrants.\970\
---------------------------------------------------------------------------

    \970\ Unless otherwise noted, ``franchisors'' as used in this 
document solely pertains to business format franchisors.
---------------------------------------------------------------------------

A. Part 436

    Staff has calculated burdens based on the above estimates. Some 
franchisors, however, for various reasons, are not covered by the Rule 
in certain situations (e.g., when a franchisee buys bona fide inventory 
but pays no franchisor fees). Moreover, 15 states have franchise 
disclosure laws similar to the Rule. These states use a disclosure 
document format known as the Uniform Franchise Offering Circular 
(``UFOC''). In order to ease compliance burdens on the franchisor, the 
Commission has authorized use of the UFOC in lieu of its own disclosure 
format to satisfy the Rule's disclosure requirements. Staff estimates 
that about 95 percent of all franchisors use the UFOC format. As noted 
throughout this document, revised part 436 tracks the UFOC Guidelines 
in large measure. Accordingly, the burden hours stated below reflects 
staff's estimate of the incremental burden that part 436 may impose 
beyond information requirements imposed by states and/or followed by 
franchisors who use the UFOC.
Estimated annual hours burden for part 436: 19,500 hours.
    As set forth in the 2005 Notices, staff estimates that, during the 
first year of clearance, the 250 or so new franchisors will require 32 
hours to prepare their disclosure document (two more hours than under 
the original Rule) and the remaining 2,250 established franchisors will 
require six hours to update their existing disclosure document (three 
more hours than under the original Rule). After the first year, 
however, the time required for established franchisors should be the 
same as under the original Rule, as the new disclosure format becomes 
familiar. Accordingly, during the remaining two years of the clearance, 
staff estimates it will take three hours for established franchisors to 
update their existing disclosure document (same as the original Rule). 
Thus, the average annual hours burden for established franchisors 
during the three-year clearance period will be approximately 4 hours 
((6 hours during first year of clearance + 3 hours during second year 
of clearance + 3 hours during third year of clearance) / 3 years).
    As set forth in the 2005 Notices, under the original Rule, covered 
franchisors may need to maintain additional documentation for the sale 
of franchises in non-registration states, which could take up to an 
additional hour of recordkeeping per year. This yields a cumulative 
total of 2,500 hours per year for covered franchisors (1 hour x 2,500 
franchisors).
    Part 436 of the amended Rule would also increase franchisors' 
recordkeeping obligations. Specifically, a franchisor would be required 
to retain copies of receipts for disclosure documents, as well as 
materially different versions of its disclosure documents. Such 
recordkeeping requirements, however, are consistent with, or less 
burdensome, than those imposed by the states.
    Thus, staff estimates the average hours burden for new and 
established franchisors during the three-year clearance period will be 
19,500 ((32 hours of annual disclosure burden x 250 new franchisors) + 
(4 hours of average annual disclosure burden x 2,250 established 
franchisors) + (1 hour of annual recordkeeping burden x 2,500 
franchisors)).
Estimated annual labor cost burden for part 436: $4,282,500.
    One commenter, Lance Winslow, stated in response to the Staff 
Report that the average total cost to prepare a franchise disclosure 
document is $25,000-35,000.\971\ The Commission agrees that many 
franchisors typically spend $25,000-35,000 on disclosure documents. 
Much of these costs, however, are not imposed by part 436, but by state 
law. For example, a large portion of the costs that franchisors 
typically pay for disclosures is the result of audited financial 
requirements and state registration requirements, costs that would 
continue to exist whether or not the Commission adopted the amended 
Rule. As stated above, staff's burden estimates reflect the incremental 
burden that part 436 may impose beyond the information requirements 
imposed by states.
---------------------------------------------------------------------------

    \971\ Winslow, at 23-35.
---------------------------------------------------------------------------

    As set forth in the 2005 Notices, staff estimates that an attorney 
will prepare the disclosure document at $250 per hour. Accordingly, 
staff estimates that 250 new franchisors will annually each incur 
$8,000 in labor costs (32 hours x $250 per hour) and, during the first 
year of the clearance, established franchisors will each incur $1,500 
in labor costs (6 hours x $250). During the remaining two years of 
clearance, staff estimates established franchisors will annually each 
incur $750 in labor costs (3 hours x $250 per hour). Thus, the average 
annual labor cost estimate for established franchisors during the 
three-year clearance period will be approximately $1,000 (($1,500 in 
labor costs during first year of clearance + $750 in labor costs during 
second year of clearance + $750 in labor costs during third year of 
clearance) / 3 years).
    Further, staff anticipates that recordkeeping under part 436 will 
be performed by clerical staff at approximately $13 per hour. Thus, at 
2,500 hours of recordkeeping burden per year for all covered 
franchisors will amount to a total annual cost of $32,500 (2,500 hours 
x $13 per hour).
    Thus, the total estimated labor costs under part 436 is $4,282,500 
(($8,000 attorney costs x 250 new franchisors) + ($1,000 attorney costs 
x 2,250 established franchisors) + ($13 clerical costs x 2,500 
franchisors)).
Estimated non-labor costs for part 436: $8,000,000.
    In response to the Staff Report, Mr. Winslow stated that the costs 
of printing documents for his franchise system exceed $24,000 without 
postage.\972\ Mr. Winslow further indicated that the number of 
disclosure documents sent out each year will increase under the amended 
Rule.\973\ Finally, Mr. Winslow stated that franchisors will incur 
significant costs if they send disclosure documents electronically, 
including bandwidth fees and fees associated with hiring a contractor 
to create a searchable website.\974\
---------------------------------------------------------------------------

    \972\ Winslow at 28.
    \973\ Winslow at 31, 93.
    \974\ Winslow at 28.
---------------------------------------------------------------------------

    As an initial matter, in developing cost estimates, Commission 
staff consulted with practitioners who prepare disclosure documents for 
a cross-section of franchise systems. Accordingly, the Commission 
believes that its cost estimates are representative of the costs 
incurred by franchise systems generally. In addition, Mr. Winslow fails 
to provide a basis for his

[[Page 15543]]

assertion that the demand for disclosure documents will increase as a 
result of the amended Rule. Finally, many franchisors establish and 
maintain websites for ordinary business purposes, including advertising 
their goods or services and to facilitate communication with the 
public. Accordingly, any costs franchisors would incur specifically as 
a result of electronic disclosure under part 436 appear to be low.
    As set forth in the 2005 Notices, staff estimates that the non-
labor burden incurred by franchisors under part 436 will differ based 
on the length of the disclosure document and the number of disclosure 
documents produced. Staff estimates that 2,000 franchisors (80% of 
total franchisors covered by the Rule) will print 100 disclosure 
documents at $35 each. Thus, staff estimates that 80% of covered 
franchisors will each incur $3,500 in printing and mailing costs ($35 
for printing and mailing x 100 disclosure documents). Staff estimates 
that the remaining 20% of franchisors (500) will send 50% of the 100 
documents electronically, with a cost of $5 per electronic disclosure. 
Thus, staff estimates that 20% of covered franchisors will each incur 
$2,000 in distribution costs (($250 for electronic disclosure [$5 for 
electronic disclosure x 50 disclosure documents] + $1,750 for printing 
and mailing [$35 for printing and mailing x 50 disclosure documents])).
    Thus, the cumulative annual hours burden for part 436 of the 
amended Rule is approximately 19,500 hours ((32 hours of annual 
disclosure burden x 250 new franchisors) + (4 hours of average annual 
disclosure burden x 2,250 established franchisors) + (1 hour of annual 
recordkeeping burden x 2,500 total business format franchisors)). The 
cumulative annual labor costs for part 436 of the amended Rule is 
approximately $4,282,500 (($8,000 attorney costs x 250 new franchisors) 
+ ($1,000 attorney costs x 2,250 established franchisors) + ($13 
clerical costs x 2,500 total business format franchisors)). Finally, 
the cumulative annual non-labor costs for part 436 of the amended Rule 
is approximately $8,000,000 (($3,500 printing and mailing costs x 2,000 
franchisors) + (($250 electronic distribution costs + $1,750 printing 
and mailing costs) x 500 franchisors)).

B. Part 437

    As noted throughout this document, business opportunities covered 
by the original Franchise Rule will remain covered, without any 
substantive change, under part 437 of the amended Rule. Part 437 of the 
amended Rule imposes no additional disclosures, recordkeeping, or 
prohibitions.\975\
---------------------------------------------------------------------------

    \975\ In April 2006, the Commission published the Business 
Opportunity NPR, 71 FR 19054 (Apr. 12, 2006). Among other things, 
the proposed Business Opportunity Rule would amend part 437 
substantially, reducing the number of disclosures pertaining to 
business opportunities. At the same time, the proposed Business 
Opportunity Rule would expand part 437 to include a broader array of 
business opportunities than covered by the original Franchise Rule. 
In response to the business opportunity NPR, the Commission received 
over 17,000 comments, many opposing the inclusion of multilevel 
marketing companies under the proposed rule. Several comments 
specifically questioned the paperwork burdens that might be imposed 
by the part 437 amendments. E.g., DSA, Business Opportunity NPR. 
Commission staff is currently analyzing the comments. For now, 
however, only those businesses opportunities covered by the original 
Franchise Rule--such as vending machine and rack display 
opportunities--remain covered under part 437.
---------------------------------------------------------------------------

Estimated annual hours burden for part 437: 16,750 hours.
    The burden estimates for compliance with part 437 will vary 
depending on the business opportunity sellers' prior experience with 
the Franchise Rule. As set forth in the 2005 Notices, staff estimates 
that 250 or so new business opportunity sellers will enter the market 
each year, requiring approximately 30 hours each to develop a Rule-
compliant disclosure document. Thus, staff estimates that the 
cumulative annual disclosure burden for new business opportunity 
sellers will be approximately 7,500 hours (250 new business opportunity 
sellers x 30 hours). Staff further estimates that the remaining 2250 
established business opportunity sellers will require no more than 
approximately 3 hours each to update the disclosure document. 
Accordingly, staff estimates that the cumulative annual disclosure 
burden for established business opportunity sellers will be 
approximately 6,750 hours (2250 established business opportunity 
sellers x 3 hours).
    Business opportunity sellers may need to maintain additional 
documentation for the sale of business opportunities in some states, 
which could take up to an additional hour of recordkeeping per year. 
Accordingly, staff estimates that business opportunity sellers will 
cumulatively incur approximately 2,500 hours of record keeping burden 
each year (2,500 business opportunity sellers x 1 hour).
    Thus, the total burden for business opportunity sellers is 
approximately 16,750 hours ((7,500 hours of disclosure burden for new 
business opportunity sellers + 6,750 hours of disclosure burden for 
established business opportunity sellers + 2,500 of recordkeeping 
burden for all business opportunity sellers)).
Estimated annual labor cost burden for part 437: $3,595,000.
    Labor costs are determined by applying applicable wage rates to 
associated burden hours. Staff presumes an attorney will prepare or 
update the disclosure document at $250 per hour. Accordingly, staff 
estimates that business opportunity sellers incur approximately 
$3,562,500 in labor costs due to compliance with the Rule's disclosure 
requirements ((250 new business opportunity sellers x $250 per hour x 
30 hours per business opportunity) + (2,250 established business 
opportunity sellers x $250 per hour x 3 hours per business 
opportunity)).
    Staff anticipates that recordkeeping would be performed by clerical 
staff at approximately $13 per hour. At 2,500 hours per year for all 
affected business opportunities, this would amount to a total cost of 
$32,500 (2,500 hours for recordkeeping x $13 per hour). Thus, the 
combined labor costs for recordkeeping and disclosure for business 
opportunity sellers is approximately $3,595,000 ($3,562,500 for 
disclosures + $32,500 for recordkeeping).
Estimated non-labor cost for part 437: $3,887,500.
    Business opportunity sellers must also incur costs to print and 
distribute the disclosure document. These costs vary based upon the 
length of the disclosures and the number of copies produced to meet the 
expected demand. Staff estimates that 2,500 business opportunity 
sellers print and mail 100 documents per year at a cost of $15 per 
document, for a total cost of $3,750,000 (2,500 business opportunity 
sellers x 100 documents per year x $15 per document).
    Business opportunity sellers must also complete and disseminate an 
FTC-required cover sheet that identifies the business opportunity 
seller, the date the document is issued, a table of contents, and a 
notice that tracks the language specifically provided in part 437 of 
the Rule. Although some of the language in the cover sheet is supplied 
by the government for the purpose of disclosure to the public, and is 
thus excluded from the definition of ``collection of information'' 
under the PRA, see 5 CFR 1320.3(c)(2), there are residual costs to 
print and mail these cover sheets, including within them the 
presentation of related information beyond the supplied text. Staff 
estimates that 2,500 business opportunity sellers

[[Page 15544]]

complete and disseminate 100 cover sheets per year at a cost of 
approximately $0.55 per cover sheet, or a total cost of approximately 
$137,500 (2,500 business opportunity sellers x 100 cover sheets per 
year x $0.55 per cover sheet).
    Accordingly, the cumulative non-labor cost incurred by business 
opportunity sellers each year due to compliance with part 437 will be 
approximately $3,887,500 ($3,750,000 for printing and mailing documents 
+ $137,500 for completing and mailing cover sheets).
    Thus, the cumulative annual hours burden for part 437 of the 
amended Rule is approximately 16,750 hours ((30 hours of average annual 
disclosure burden x 250 new business opportunity sellers) + (3 hours of 
annual disclosure burden x 2,250 established business opportunity 
sellers) + (1 hour of annual recordkeeping burden x 2,500 total 
business opportunity sellers)). The cumulative annual labor costs for 
part 437 of the amended Rule is approximately $3,595,000 (($7,500 
attorney costs x 250 new business opportunity sellers) + ($750 attorney 
costs x 2,250 established business opportunity sellers) + ($13 clerical 
costs x 2,500 total business opportunity sellers)). Finally, the 
cumulative annual non-labor costs for part 437 of the amended Rule is 
approximately $3,887,500 (($1,500 printing and mailing costs x 2,500 
business opportunity sellers) + ($55 cover sheet costs x 2500 business 
opportunity sellers)).

List of Subjects in 16 CFR Part 436 and 437

    Advertising, Business and industry, Franchising, Trade practices.

VII. FINAL RULE LANGUAGE

0
For the reasons set out in this document, the Commission revises 16 CFR 
Part 436 as follows:

PART 436--DISCLOSURE REQUIREMENTS AND PROHIBITIONS CONCERNING 
FRANCHISING

Subpart A--Definitions
Sec.
436.1 Definitions.
Subpart B--Franchisor's Obligations
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.
Subpart G--Other Provisions
436.10 Other laws and rules.
436.11 Severability.

Appendix A to Part 436--Sample Item 10 Table--Summary of Financing 
Offered
Appendix B to Part 436--Sample Item 20(1) Table--Systemwide Outlet 
Summary
Appendix C to Part 436--Sample Item 20(2) Table --Transfers of 
Franchised Outlets
Appendix D to Part 436--Sample Item 20(3) Table--Status of Franchise 
Outlets
Appendix E to Part 436--Sample Item 20(4) Table--Status of Company-
Owned Outlets
Appendix F to Part 436--Sample Item 20(5) Table--Projected New 
Franchised Outlets


    Authority: 15 U.S.C. 41-58.

Subpart A--Definitions


Sec.  436.1  Definitions.

    Unless stated otherwise, the following definitions apply throughout 
part 436:
    (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, another entity.
    (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 clauses that protect franchisor's trademarks or 
other proprietary information.
    (d) Disclose, state, describe, and list each mean to present all 
material facts accurately, clearly, concisely, and legibly in plain 
English.
    (e) Financial performance representation means any representation, 
including 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. The 
term includes a chart, table, or mathematical calculation that shows 
possible results based on a combination of variables.
    (f) Fiscal year refers to the franchisor's fiscal year.
    (g) Fractional franchise means a franchise relationship that 
satisfies the following criteria when the relationship is created:
    (1) The franchisee, any of the franchisee's current directors or 
officers, or any current directors or officers of a parent or 
affiliate, 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% 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 promises or represents, 
orally or in writing, that:
    (1) The franchisee will obtain 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 will exert or has authority to exert a 
significant degree of control over the franchisee's method of 
operation, or provide 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) Franchisee means any person who is granted a franchise.
    (j) 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.
    (k) Franchisor means any person who grants a franchise and 
participates in the franchise relationship. Unless otherwise stated, it 
includes subfranchisors. For purposes of this definition, a 
``subfranchisor'' means a person who functions as a franchisor by 
engaging in both pre-sale activities and post-sale performance.
    (l) Leased department means an arrangement whereby a retailer 
licenses or otherwise permits a seller to conduct

[[Page 15545]]

business from the retailer's location where the seller purchases no 
goods, services, or commodities directly or indirectly from the 
retailer, a person the retailer requires the seller to do business 
with, or a retailer-affiliate if the retailer advises the seller to do 
business with the affiliate.
    (m) Parent means an entity that controls another entity 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 short sentences; definite, concrete, everyday 
language; active voice; and tabular presentation of information, where 
possible. It avoids legal jargon, highly technical business terms, and 
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 a 
person's home 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.
    (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--Franchisors' Obligations


Sec.  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 or its territories, unless the 
transaction is exempted under Subpart E of this part, 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 of this part, at least 14 calendar-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 or any related 
agreements attached to the disclosure document without furnishing the 
prospective franchisee with a copy of each revised agreement at least 
seven calendar-days before the prospective franchisee signs the revised 
agreement. Changes to an agreement that arise out of negotiations 
initiated by the prospective franchisee do not trigger this seven 
calendar-day period.
    (c) For purposes of paragraphs (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, 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 United States mail at least three calendar 
days before the required date.

Subpart C--Contents of a Disclosure Document


Sec.  436.3  Cover page.

    Begin the disclosure document with a cover page, in the order and 
form as follows:
    (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] franchise is [the total amount of Item 7 (Sec.  
436.5(g))]. This includes [the total amount in Item 5 (Sec.  436.5(e))] 
that must be paid to the franchisor or affiliate.
    (2) This disclosure document summarizes certain provisions of your 
franchise agreement and other information in plain English. Read this 
disclosure document and all accompanying agreements carefully. You must 
receive this disclosure document at least 14 calendar-days before you 
sign a binding agreement with, or make any payment to, the franchisor 
or an affiliate in connection with the proposed franchise sale. [The 
following sentence in bold type] Note, however, that no governmental 
agency has verified the information contained in this document.
    (3) 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.
    (4) Buying a franchise is a complex investment. The information in 
this disclosure document can help you make up your mind. More 
information on franchising, such as ``A Consumer's Guide to Buying a 
Franchise,'' which

[[Page 15546]]

can help you understand how to use this disclosure document, is 
available from the Federal Trade Commission. You can contact the FTC at 
1-877-FTC-HELP or by writing to the FTC at 600 Pennsylvania Avenue, 
NW., Washington, D.C. 20580. You can also visit the FTC's home page at 
www.ftc.gov for additional information. Call your state agency or visit 
your public library for other sources of information on franchising.
    (5) There may also be laws on franchising in your state. Ask your 
state agencies about them.
    (6) [The issuance date].
    (f) A franchisor may include the following statement between the 
statements set out at paragraphs (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.


Sec.  436.4  Table of contents.

    Include the following table of contents. State the page where each 
disclosure Item begins. List all exhibits by letter, as shown in the 
following example.

Table of Contents

1. The Franchisor and any Parents, Predecessors, and Affiliates
2. Business Experience
3. Litigation
4. Bankruptcy
5. Initial Fees
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


Sec.  436.5  Disclosure items.

    (a) Item 1: The Franchisor, and any Parents, Predecessors, and 
Affiliates.
    Disclose:
    (1) The name and principal business address of the franchisor; any 
parents; and any affiliates 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 identity and 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.
    (v) In general terms, any laws or regulations specific to the 
industry in which the franchise business operates.
    (vi) A general description of the competition.
    (7) The prior business experience of the franchisor; any 
predecessors listed in Sec.  436.5(a)(2) of this part; 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.
    (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.
    (C) The length of time each has offered 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 will have management responsibility 
relating to the sale or operation of franchises offered by this 
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 
predecessor; a parent or affiliate who induces franchise sales by 
promising to back the franchisor financially or otherwise guarantees 
the franchisor's performance; an affiliate who offers franchises under 
the franchisor's principal trademark; and any person identified in 
Sec.  436.5(b) of this part:
    (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 suppliers 
or other third parties, 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.
    (B) Been held liable in a civil 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 person must pay money or other consideration, must 
reduce an indebtedness by the amount of an

[[Page 15547]]

award, cannot enforce its rights, or must take action adverse to its 
interests.
    (2) Disclose whether the franchisor; a predecessor; a parent or 
affiliate who guarantees the franchisor's performance; an affiliate who 
has offered or sold franchises in any line of business within the last 
10 years; or any other person identified in Sec.  436.5(b) of this part 
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 paragraphs (c)(1) and (2) of this 
section, 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). Except 
as provided in paragraph (c)(4) of this section, 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\ In addition, state:
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    (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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    (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.
    (4) For any other franchisor-initiated suit identified in paragraph 
(c)(1)(ii) of this section, the franchisor may comply with the 
requirements of paragraphs (c)(3)(i) through (iv) of this section by 
listing individual suits under one common heading that will serve as 
the case summary (for example, ``royalty collection suits'').
    (d) Item 4: Bankruptcy. (1) Disclose whether the franchisor; any 
parent; predecessor; affiliate; officer, or general partner of the 
franchisor, or any other individual who will have management 
responsibility relating to the sale or operation of franchises offered 
by this document, 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 
United States 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 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).
    (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. 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 section or in 
Sec.  436.5(j) of this part.
    (f) Item 6: Other Fees. Disclose, in the following tabular form, 
all other 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 for a third party. State the title ``OTHER FEES'' 
in capital letters using bold type. Include any formula used to compute 
the fees.\3\
---------------------------------------------------------------------------

    \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.''

                              Item 6 Table
                               OTHER FEES
------------------------------------------------------------------------
Column 1  Type of                       Column 3  Due       Column 4
       fee          Column 2  Amount        Date             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.
    (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 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.
    (v) The voting power of franchisor-owned outlets on any fees 
imposed by

[[Page 15548]]

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 
following tabular form, the franchisee's estimated initial investment. 
State the title ``YOUR ESTIMATED INITIAL INVESTMENT'' in capital 
letters using bold type. Franchisors may include additional expenditure 
tables to show expenditure variations caused by differences such as in 
site location and premises size.

                                                  Item 7 Table:
                                        YOUR ESTIMATED INITIAL INVESTMENT
----------------------------------------------------------------------------------------------------------------
                                                                                              Column 4  To whom
  Column 1  Type of       Column 2  Amount     Column 3  Method of     Column 4  When due     payment is to be
     expenditure                                     payment                                        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 include 
remarks, definitions, or caveats that elaborate on the information in 
the Table.
    (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.
    (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 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 Sec.  436.5(j) of this part 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 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 
the franchisor's written agreement or by the franchisor's practice.\4\ 
For each applicable obligation, state:
---------------------------------------------------------------------------

    \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 Sec.  436.5(f) of this 
part.
---------------------------------------------------------------------------

    (1) The good or service required to be purchased 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.
    (v) How approvals are revoked.
    (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:
    (i) The franchisor's total revenue.\5\
---------------------------------------------------------------------------

    \5\ Take figures from the franchisor's most recent annual 
audited financial statement required in Sec.  436.5(u) of this part. 
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.
---------------------------------------------------------------------------

    (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 purchases or leases.
    (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.

[[Page 15549]]

    (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 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 following 
tabular form, a list of the franchisee's principal obligations. State 
the title ``FRANCHISEE'S OBLIGATIONS'' in capital letters using bold 
type. 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:
                        FRANCHISEE'S OBLIGATIONS
     [In bold] This table lists your principal obligations under the
   franchise and other agreements. It will help you find more detailed
   information about your obligations in these agreements and in other
                   items of this disclosure document.
------------------------------------------------------------------------
                                        Section in         Disclosure
            Obligation                  agreement        document item
------------------------------------------------------------------------
a. Site selection and acquisition/  .................  .................
 lease
------------------------------------------------------------------------
b. Pre-opening purchase/leases      .................  .................
------------------------------------------------------------------------
c. Site development and other pre-  .................  .................
 opening requirements
------------------------------------------------------------------------
d. Initial and ongoing training     .................  .................
------------------------------------------------------------------------
e. Opening                          .................  .................
------------------------------------------------------------------------
f. Fees                             .................  .................
------------------------------------------------------------------------
g. Compliance with standards and    .................  .................
 policies/operating manual
------------------------------------------------------------------------
h. Trademarks and proprietary       .................  .................
 information
------------------------------------------------------------------------
i. Restrictions on products/        .................  .................
 services offered
------------------------------------------------------------------------
j. Warranty and customer service    .................  .................
 requirements
------------------------------------------------------------------------
k. Territorial development and      .................  .................
 sales quotas
------------------------------------------------------------------------
l. Ongoing product/service          .................  .................
 purchases
------------------------------------------------------------------------
m. Maintenance, appearance, and     .................  .................
 remodeling requirements
------------------------------------------------------------------------
n. Insurance                        .................  .................
------------------------------------------------------------------------
o. Advertising                      .................  .................
------------------------------------------------------------------------
p. Indemnification                  .................  .................
------------------------------------------------------------------------
q. Owner's participation/           .................  .................
 management/staffing
------------------------------------------------------------------------
r. Records and reports              .................  .................
------------------------------------------------------------------------
s. Inspections and audits           .................  .................
------------------------------------------------------------------------
t. Transfer                         .................  .................
------------------------------------------------------------------------
u. Renewal                          .................  .................
------------------------------------------------------------------------
v. Post-termination obligations     .................  .................
------------------------------------------------------------------------
w. Non-competition covenants        .................  .................
------------------------------------------------------------------------
x. Dispute resolution               .................  .................
------------------------------------------------------------------------
y. Other (describe)                 .................  .................
------------------------------------------------------------------------
------------------------------------------------------------------------


[[Page 15550]]

    (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 form, using footnotes to provide 
additional information. For a sample Item 10 table, see Appendix A of 
this part. For each financing arrangement, state:
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    (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\
---------------------------------------------------------------------------

    \7\ Include sample copies of the financing documents as an 
exhibit to Sec.  436.5(v) of this part. Cite the section and name of 
the document containing the financing terms and conditions.
---------------------------------------------------------------------------

    (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 rate of interest, plus finance charges, expressed on an 
annual basis. If the rate of interest, plus finance charges, expressed 
on an annual basis, may differ depending on when the financing is 
issued, state what that rate was 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
    (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 
consideration 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 of both the franchisor and franchisee as 
follows. For each obligation, cite the section number of the franchise 
agreement imposing the obligation. Begin by stating the following 
sentence in bold type: ``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 such assistance is 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 franchisee-selected 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).
    (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 any such assistance is provided, state:
    (A) Whether the franchisor provides these items directly or only 
provides the names of approved suppliers.
    (B) Whether the franchisor provides written specifications for 
these items.
    (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.
    (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.
    (C) The source of the advertising (for example, an in-house 
advertising department or a national or regional advertising agency).
    (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.

[[Page 15551]]

    (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).
    (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.
    (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.
    (G) How the funds were used in the most recently concluded fiscal 
year, including 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.
    (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.
    (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 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 year-end or a more recent date.
    (i) Describe the training program in the following tabular form. 
Title the table ``TRAINING PROGRAM'' in capital letters and bold type.

                              Item 11 Table
                            TRAINING PROGRAM
------------------------------------------------------------------------
                    Column 2  Hours    Column 3  Hours
Column 1  Subject     of Classroom      of On-The-Job       Column 4
                        Training          Training          Location
------------------------------------------------------------------------
                   .................  ................  ................
------------------------------------------------------------------------

    (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.
    (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.
    (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.

[[Page 15552]]

    (4) Franchisee options, rights of first refusal, or similar rights 
to acquire additional franchises.
    (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, from outlets that we own, or from other 
channels of distribution or competitive brands that we control.''
    (ii) If the franchisor grants an exclusive territory, disclose:
    (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.
    (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 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 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.
    (C) Any compensation that the franchisor must pay for soliciting or 
accepting orders from inside the franchisee's territory.
    (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 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.
    (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 Sec.  436.5(a) of this part, 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 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.
    (iv) Whether the principal trademarks are registered on the 
Principal or Supplemental Register of the United States 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 United States Patent and Trademark Office, state: ``We do not have 
a federal registration for our principal trademark. Therefore, our 
trademark does not have many legal benefits and rights as a federally 
registered trademark. If our right to use the trademark is challenged, 
you may have to change to an alternative trademark, which may increase 
your expenses.''
    (5) Disclose any currently effective material determinations of the 
United States Patent and Trademark Office, the Trademark Trial and 
Appeal Board, or any state trademark administrator 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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    (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.
    (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 section 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.
    (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 section, 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

[[Page 15553]]

affirmative action when notified of these uses or claims.
    (iv) Whether the franchisor or franchisee has the right to control 
any administrative proceedings or litigation involving a trademark 
licensed by the franchisor to the franchisee.
    (v) 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.
    (vi) 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:
    (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).
    (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, or licenses to, patents 
or copyrights that are material to the franchise. Also, disclose 
whether the franchisor has any pending patent applications that are 
material to the franchise. If so, state:
    (i) The nature of the patent, patent application, or copyright and 
its relationship to the franchise.
    (ii) For each patent:
    (A) The duration of the patent.
    (B) The type of patent (for example, mechanical, process, or 
design).
    (C) The patent number, issuance date, and title.
    (iii) For each patent application:
    (A) The type of patent application (for example, mechanical, 
process, or design).
    (B) The serial number, filing date, and title.
    (iv) For each copyright:
    (A) The duration of the copyright.
    (B) The registration number and date.
    (C) Whether the franchisor can and intends to renew the copyright.
    (2) Describe any current material determination of the United 
States Patent and Trademark Office, the United States Copyright Office, 
or a court regarding the patent or copyright. Include the forum and 
matter 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 
United States Patent and Trademark Office or any court.\9\
---------------------------------------------------------------------------

    \9\ If counsel consents, the franchisor may include a counsel's 
opinion or a summary of the opinion if the full opinion is attached.
---------------------------------------------------------------------------

    (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 patented or copyrighted 
items, including:
    (i) Whether the franchisor's obligation is contingent upon the 
franchisee notifying 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 any 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) Whether the franchisor's obligation is contingent upon the 
franchisee modifying or discontinuing the use of the subject matter 
covered by the patent or copyright.
    (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).
    (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 franchisee's 
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, whether the franchisor 
recommends on-premises supervision by the franchisee.
    (ii) Limits on whom the franchisee can hire as an on-premises 
supervisor.
    (iii) Whether an on-premises supervisor must successfully complete 
the franchisor's training program.
    (iv) If the franchisee is a business entity, the amount of equity 
interest, if any, that the on-premises supervisor must have in the 
franchisee's business.
    (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 or services 
approved by
    the franchisor.
    (2) Any obligation on the franchisee to sell all goods or services 
authorized by
    the franchisor.
    (3) Whether the franchisor has the right to change the types of 
authorized goods or 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 following tabular form, a table that 
cross-references each enumerated franchise relationship item with the 
applicable provision in the franchise or related agreement. Title the 
table ``THE FRANCHISE RELATIONSHIP'' in capital letters and bold type.
    (1) Describe briefly each contractual provision. If a particular 
item is not applicable, state ``Not Applicable.''
    (2) If the agreement is silent about one of the listed provisions, 
but the

[[Page 15554]]

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 Item 17(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 
materially different terms and conditions than their original contract.

                                                 Item 17 Table:
                                           THE FRANCHISE RELATIONSHIP
[In bold] This table lists certain important provisions of the franchise and related agreements. You should read
                    these provisions in the agreements attached to this disclosure document.
----------------------------------------------------------------------------------------------------------------
                                                         Section in franchise or
                      Provision                              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                ............................  ............................
----------------------------------------------------------------------------------------------------------------
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.
    (3) The public figure's total investment in the franchisor, 
including the amount the public figure contributed in services 
performed or to be performed. State the type of investment (for 
example, common stock, promissory note).
    (4) For purposes of this section, 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 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

[[Page 15555]]

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 possible 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:

     We do 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, address, and telephone number], the 
Federal Trade Commission, and the appropriate state regulatory 
agencies.

    (3) If the franchisor makes any financial performance 
representation to prospective franchisees, the franchisor must have a 
reasonable basis and written substantiation for the representation at 
the time the representation is made and must state the representation 
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, 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, 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.
    (F) Characteristics of the included outlets, such as those 
characteristics noted in paragraph (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) A clear and conspicuous admonition that a new franchisee's 
individual financial results may differ from the result stated in the 
financial performance representation.
    (v) A statement 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:
    (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.
    (iv) Be furnished to the prospective franchisee.
    (t) Item 20: Outlets and Franchisee Information. (1) Disclose, in 
the following tabular form, the total number of franchised and company-
owned outlets for each of the franchisor's last three fiscal years. For 
purposes of this section, ``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 part.

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

[[Page 15556]]

 
Total Outlets           2004                  .....................  .....................  ....................
                      ------------------------------------------------------------------------------------------
                        2005                  .....................  .....................  ....................
                      ------------------------------------------------------------------------------------------
                        2006                  .....................  .....................  ....................
----------------------------------------------------------------------------------------------------------------

    (i) In column 1, include three outlet categories titled 
``franchised,'' ``company-owned, 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.
    (2) Disclose, in the following tabular form, the number of 
franchised and company-owned outlets and changes in the number and 
ownership of outlets located in each state during each of the last 
three fiscal years. Except as noted, 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. If a single outlet changed ownership two or 
more times during the same fiscal year, use footnotes to describe the 
types of changes involved and the order in which the changes occurred.
    (i) Disclose, in the following tabular form, the total number of 
franchised outlets transferred in each state during each of the 
franchisor's last three fiscal years. For purposes of this section, 
``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 part.

                           Item 20 Table No. 2
   Transfers of Outlets from Franchisees to New Owners (other than the
                               Franchisor)
                          For years [ ] to [ ]
------------------------------------------------------------------------
                                                    Column 3  Number of
    Column 1  State           Column 2  Year             Transfers
------------------------------------------------------------------------
                          2004                    ......................
                        ------------------------------------------------
                          2005                    ......................
                        ------------------------------------------------
                          2006                    ......................
------------------------------------------------------------------------
                          2004                    ......................
                        ------------------------------------------------
                          2005                    ......................
                        ------------------------------------------------
                          2006                    ......................
------------------------------------------------------------------------
Total                     2004                    ......................
                        ------------------------------------------------
                          2005                    ......................
                        ------------------------------------------------
                          2006                    ......................
------------------------------------------------------------------------

    (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 following tabular form, the status of 
franchisee-owned outlets located 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 part.

[[Page 15557]]



                                               Item 20 Table No. 3
                                          Status of Franchised Outlets
                                              For years [ ] to [ ]
----------------------------------------------------------------------------------------------------------------
                       Column 3                                             Column 7       Column 8     Column 9
 Column 1   Column 2  Outlets at   Column 4      Column 5      Column 6    Reacquired       Ceased      Outlets
  State       Year     Start of     Outlets    Terminations      Non-          by        Operations-   at End of
                         Year       Opened                     Renewals    Franchisor   Other Reasons   the Year
----------------------------------------------------------------------------------------------------------------
            2004      ..........  ..........  ..............  ..........  ............  .............  .........
          ------------
            2005      ..........  ..........  ..............  ..........  ............  .............  .........
          ------------
            2006      ..........  ..........  ..............  ..........  ............  .............  .........
----------------------------------------------------------------------------------------------------------------
            2004      ..........  ..........  ..............  ..........  ............  .............  .........
          ------------
            2005      ..........  ..........  ..............  ..........  ............  .............  .........
          ------------
            2006      ..........  ..........  ..............  ..........  ............  .............  .........
----------------------------------------------------------------------------------------------------------------
Totals      2004      ..........  ..........  ..............  ..........  ............  .............  .........
          ------------------------------------------------------------------------------------------------------
            2005      ..........  ..........  ..............  ..........  ............  .............  .........
          ------------------------------------------------------------------------------------------------------
            2006      ..........  ..........  ..............  ..........  ............  .............  .........
----------------------------------------------------------------------------------------------------------------

    (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 section, ``termination'' means the franchisor's termination of a 
franchise agreement prior to the end of its term and without 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 section, ``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 section, 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, non-renewal, 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 following tabular form, the status of 
company-owned outlets located 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 part.

                                               Item 20 Table No. 4
                                         Status of Company-Owned Outlets
                                              For years [ ] to [ ]
----------------------------------------------------------------------------------------------------------------
                            Column 3                      Column 5                                     Column 8
  Column 1     Column 2    Outlets at     Column 4        Outlets        Column 6       Column 7      Outlets at
   State         Year       Start of       Outlets    Reacquired From     Outlets     Outlets Sold    End of the
                              Year         Opened        Franchisee       Closed      to Franchisee      Year
----------------------------------------------------------------------------------------------------------------
              2004        ............  ............  ...............  ............  ..............  ...........
            ----------------------------------------------------------------------------------------------------
              2005        ............  ............  ...............  ............  ..............  ...........
            ----------------------------------------------------------------------------------------------------
              2006        ............  ............  ...............  ............  ..............  ...........
----------------------------------------------------------------------------------------------------------------
              2004        ............  ............  ...............  ............  ..............  ...........
            ----------------------------------------------------------------------------------------------------
              2005        ............  ............  ...............  ............  ..............  ...........
            ----------------------------------------------------------------------------------------------------
              2006        ............  ............  ...............  ............  ..............  ...........
----------------------------------------------------------------------------------------------------------------
Totals        2004        ............  ............  ...............  ............  ..............  ...........
            ----------------------------------------------------------------------------------------------------

[[Page 15558]]

 
              2005        ............  ............  ...............  ............  ..............  ...........
            ----------------------------------------------------------------------------------------------------
              2006        ............  ............  ...............  ............  ..............  ...........
----------------------------------------------------------------------------------------------------------------

    (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.
    (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 following tabular form, projected new 
franchised and company-owned outlets. A sample Item 20(5) Table is 
attached as Appendix F to this part.

                           Item 20 Table No. 5
         Projected Openings As Of [Last Day of Last Fiscal Year]
------------------------------------------------------------------------
                        Column 2          Column 3          Column 4
                       Franchise        Projected New     Projected New
 Column 1  State   Agreements Signed     Franchised       Company-Owned
                     But Outlet Not     Outlet In The     Outlet In the
                         Opened       Next Fiscal Year  Next 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 of 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 outlets 
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 next 
fiscal year.
    (4) 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.
    (5) Disclose the name, city and state, and current business 
telephone number, or if unknown, the last known home 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.\10\ State in 
immediate conjunction with this information: ``If you buy this 
franchise, your contact information may be disclosed to other buyers 
when you leave the franchise system.''
---------------------------------------------------------------------------

    \10\ Franchisors may substitute alternative contact information 
at the request of the former franchisee, such as a home address, 
post office address, or a personal or business email address.
---------------------------------------------------------------------------

    (6) If a franchisor is selling a previously-owned franchised outlet 
now under its control, disclose the following additional information 
for that outlet for the last five fiscal years. This information may be 
attached as an addendum to a disclosure document, or, if disclosure has 
already been made, then in a supplement to the previously furnished 
disclosure document.
    (i) The name, city and state, current business telephone number, or 
if unknown, last known home telephone number of each previous owner of 
the outlet;
    (ii) The time period when each previous owner controlled the 
outlet;
    (iii) The reason for each previous change in ownership (for 
example, termination, non-renewal, 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).
    (7) Disclose whether franchisees signed confidentiality clauses 
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]. You may wish to

[[Page 15559]]

speak with current and former franchisees, but 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 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 (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. If 
so, state the relationship between the organization and the franchisor 
(for example, the organization was created by the franchisor, sponsored 
by the franchisor, or endorsed by the franchisor).
    (ii) Is incorporated or otherwise organized under state law and 
asks the franchisor to be included in the franchisor's disclosure 
document during the next fiscal year. Such organizations must renew 
their request on an annual basis by submitting a request no later than 
60 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 organizations have 
asked to be included in this disclosure document.''
    (u) Item 21: Financial Statements. (1) Include the following 
financial statements prepared according to United States generally 
accepted accounting principles, as revised by any future United States 
government mandated accounting principles, or as permitted by the 
Securities and Exchange Commission. Except as provided in paragraph 
(u)(2) of this section, these financial statements must be audited by 
an independent certified public accountant using generally accepted 
United States auditing standards. Present the required financial 
statements in a tabular form that compares at least two fiscal years.
    (i) The franchisor's balance sheet for the previous two fiscal 
year-ends before the disclosure document issuance date.
    (ii) Statements of operations, stockholders equity, and cash flows 
for each of the franchisor's previous three fiscal years.
    (iii) Instead of the financial disclosures required by paragraphs 
(u)(1)(i) and (ii) of this section, the franchisor may include 
financial statements of any of its affiliates if the affiliate's 
financial statements satisfy paragraphs (u)(1)(i) and (ii) 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.
    (iv) When a franchisor owns a direct or beneficial controlling 
financial interest in a subsidiary, its financial statements should 
reflect the financial condition of the franchisor and its subsidiary.
    (v) Include separate financial statements for the franchisor and 
any subfranchisor, as well as for any parent that commits to perform 
post-sale obligations for the franchisor or guarantees the franchisor's 
obligations. 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 at the 
indicated times:

(i) The franchisor' first partial    An unaudited opening balance sheet.
 or full fiscal year selling
 franchises.
------------------------------------------------------------------------
(ii) The franchisor' second fiscal   Audited balance sheet opinion as of
 year selling franchises.             the end of the first partial or
                                      full fiscal year selling
                                      franchises.
------------------------------------------------------------------------
(iii) The franchisor' third and      All required financial statements
 subsequent fiscal years selling      for the previous fiscal year, plus
 franchises.                          any previously disclosed audited
                                      statements that still must be
                                      disclosed according to paragraphs
                                      (u)(1)(i) and (ii) of this
                                      section.
------------------------------------------------------------------------

    (iv) Start-up franchisors may phase-in the disclosure 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.
    (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 paragraphs (u)(1)(i) and (ii) 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 following form as the last 
pages of the disclosure document:
    (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 calendar-days before you sign a 
binding agreement with, or make a payment to, 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 (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).

[[Page 15560]]

Subpart D--Instructions


Sec.  436.6  Instructions for preparing disclosure documents.

    (a) It is an unfair or deceptive act or practice in violation of 
Section 5 of the FTC Act for any franchisor to fail to include the 
information and follow the instructions for preparing disclosure 
documents set forth in Subpart C (basic disclosure requirements) and 
Subpart D (updating requirements) of part 436. The Commission will 
enforce this provision according to the standards of liability under 
Sections 5, 13(b), and 19 of the FTC Act.
    (b) Disclose all required information 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.
    (c) 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.
    (d) Do not include any materials or information other than those 
required or permitted by part 436 or by state law not preempted by part 
436. 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, pop-up screens, or links to external 
information) are prohibited.
    (e) Franchisors may prepare multi-state disclosure documents by 
including non-preempted, state-specific information in the text of the 
disclosure document or in Exhibits attached to the disclosure document.
    (f) Subfranchisors shall disclose the required information about 
the franchisor, and, to the extent applicable, the same information 
concerning the subfranchisor.
    (g) Before furnishing a disclosure document, the franchisor shall 
advise the prospective franchisee of the formats in which the 
disclosure document is 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.
    (h) 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.
    (i) For each completed franchise sale, franchisors shall retain a 
copy of the signed receipt for at least three years.


Sec.  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 to the 
disclosures included, or required to be included, in the disclosure 
document. 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 occurred in the information 
contained in any financial performance representation made in Item 19 
(section 436.5(s)).
    (e) Information that must be audited pursuant to Sec.  436.5(u) of 
this part 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


Sec.  436.8  Exemptions.

    (a) The provisions of part 436 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 initial investment, excluding any financing 
received from the franchisor or an affiliate and excluding the cost of 
unimproved land, 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 the cost of unimproved land and any 
financing received from the franchisor or an affiliate-- and thus is 
exempted from the Federal Trade Commission's Franchise Rule disclosure 
requirements, pursuant to 16 CFR 436.8(a)(5)(i)'';\11\ or
---------------------------------------------------------------------------

    \11\ The large franchise exemption applies only if at least one 
individual prospective franchisee in an investor-group qualifies for 
the exemption by investing at the threshold level stated in this 
section.
---------------------------------------------------------------------------

    (ii) The franchisee (or 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% ownership interest in 
the franchise: 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 
franchises or the administrator of the franchised network; or within 60 
days of the sale, has been, for at least two years, an owner of at 
least a 25% 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 section, the 
Commission shall adjust the size of the monetary thresholds every 
fourth year based upon the Consumer Price Index. For purposes of this 
section, ``Consumer Price Index'' means the Consumer Price Index for 
all urban consumers published by the Department of Labor.

Subpart F--Prohibitions


Sec.  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 part 436 to:
    (a) Make any claim or representation, orally, visually, or in 
writing, that contradicts the information required to be disclosed by 
this part.
    (b) Misrepresent that any person:
    (1) Purchased a franchise from the franchisor or operated a 
franchise of the type offered by the franchisor.

[[Page 15561]]

    (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 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 
(Sec.  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 Sec. Sec.  
436.5(s)(3)(ii)(B) and (E) of this part if the representation relates 
to the past performance of the franchisor's outlets.
    (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 (Sec.  436.5(s)).
    (e) Fail to furnish a copy of the franchisor's disclosure document 
to a prospective franchisee earlier in the sales process than required 
under Sec.  436.2 of this part, upon reasonable request.
    (f) 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.
    (g) 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 franchise seller informed the 
prospective franchisee of the differences at least seven days before 
execution of the franchise agreement.
    (h) 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.
    (i) 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


Sec.  436.10  Other laws and rules.

    (a) The Commission does not approve or express any opinion on the 
legality of any matter a franchisor may be required to disclose by part 
436. Further, franchisors may have additional obligations to impart 
material information to prospective franchisees outside of the 
disclosure document under Section 5 of the Federal Trade Commission 
Act. The Commission intends to enforce all applicable statutes and 
rules.
    (b) 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 part 436. A law is not inconsistent with part 436 if 
it affords prospective franchisees equal or greater protection, such as 
registration of disclosure documents or more extensive disclosures.


Sec.  436.11  Severability.

    If any provision of this part is stayed or held invalid, the 
remainder will stay in force.

                                  Appendix A to Part 436--Sample Item 10 Table
                                          SUMMARY OF FINANCING OFFERED
----------------------------------------------------------------------------------------------------------------
                                                                                                         Loss of
                                                                                              Liability   Legal
   Item     Source of    Down      Amount     Term    Interest   Monthly   Prepay   Security     Upon     Right
 Financed   Financing   Payment   Financed   (Yrs)      Rate     Payment   Penalty  Required   Default      on
                                                                                                         Default
----------------------------------------------------------------------------------------------------------------
Initial    ..........  ........  .........  .......  .........  ........  ........  ........  .........  .......
 Fee
----------------------------------------------------------------------------------------------------------------
Land/      ..........  ........  .........  .......  .........  ........  ........  ........  .........  .......
 Constr
----------------------------------------------------------------------------------------------------------------
Leased     ..........  ........  .........  .......  .........  ........  ........  ........  .........  .......
 Space
----------------------------------------------------------------------------------------------------------------
Equip.     ..........  ........  .........  .......  .........  ........  ........  ........  .........  .......
 Lease
----------------------------------------------------------------------------------------------------------------
Equip.     ..........  ........  .........  .......  .........  ........  ........  ........  .........  .......
 Purchase
----------------------------------------------------------------------------------------------------------------
Opening    ..........  ........  .........  .......  .........  ........  ........  ........  .........  .......
 Inventor
 y
----------------------------------------------------------------------------------------------------------------
Other      ..........  ........  .........  .......  .........  ........  ........  ........  .........  .......
 Financin
 g
----------------------------------------------------------------------------------------------------------------


                                 Appendix B to Part 436--Sample Item 20(1) Table
                                            Systemwide Outlet Summary
                                             For years 2004 to 2006
----------------------------------------------------------------------------------------------------------------
                                               Column 3  Outlets at   Column 4  Outlets at
Column 1  Outlet Type      Column 2  Year     the Start of the Year   the End of the Year   Column 5  Net Change
----------------------------------------------------------------------------------------------------------------
Franchised             2004                   859                    1,062                  +203
                      ------------------------------------------------------------------------------------------

[[Page 15562]]

 
                       2005                   1,062                  1,296                  +234
                      ------------------------------------------------------------------------------------------
                       2006                   1,296                  2,720                  +1,424
----------------------------------------------------------------------------------------------------------------
Company Owned          2004                   125                    145                    +20
                      ------------------------------------------------------------------------------------------
                       2005                   145                    76                     -69
                      ------------------------------------------------------------------------------------------
                       2006                   76                     141                    +65
----------------------------------------------------------------------------------------------------------------
Total Outlets          2004                   984                    1,207                  +223
                      ------------------------------------------------------------------------------------------
                       2005                   1,207                  1,372                  +165
                      ------------------------------------------------------------------------------------------
                       2006                   1,372                  2,861                  +1,489
----------------------------------------------------------------------------------------------------------------


             Appendix C to Part 436--Sample Item 20(2) Table
  Transfers of Franchised Outlets from Franchisees to New Owners (other
                          than the Franchisor)
                         For years 2004 to 2006
------------------------------------------------------------------------
                                                    Column 3  Number of
    Column 1  State           Column 2  Year             Transfers
------------------------------------------------------------------------
NC                       2004                     1
                        ------------------------------------------------
                         2005                     0
                        ------------------------------------------------
                         2006                     2
------------------------------------------------------------------------
SC                       2004                     0
                        ------------------------------------------------
                         2005                     0
                        ------------------------------------------------
                         2006                     2
------------------------------------------------------------------------
Total                    2004                     1
                        ------------------------------------------------
                         2005                     0
                        ------------------------------------------------
                         2006                     4
------------------------------------------------------------------------


                                 Appendix D to Part 436--Sample Item 20(3) Table
                                           Status of Franchise Outlets
                                             For years 2004 to 2006
----------------------------------------------------------------------------------------------------------------
                       Column 3                                             Column 7       Column 8     Column 9
 Column 1   Column 2  Outlets at   Column 4      Column 5      Column 6    Reacquired       Ceased      Outlets
  State       Year     Start of     Outlets    Terminations      Non-          by        Operations-   at End of
                         Year       Opened                     Renewals    Franchisor   Other Reasons   the Year
----------------------------------------------------------------------------------------------------------------
AL         2004       10          2           1               0           0             1              10
          ------------------------------------------------------------------------------------------------------
           2005       11          5           0               1           0             0              15
          ------------------------------------------------------------------------------------------------------
           2006       15          4           1               0           1             2              15
----------------------------------------------------------------------------------------------------------------
AZ         2004       20          5           0               0           0             0              25
          ------------------------------------------------------------------------------------------------------
           2005       25          4           1               0           0             2              26
          ------------------------------------------------------------------------------------------------------
           2006       26          4           0               0           0             0              30
----------------------------------------------------------------------------------------------------------------
Totals     2004       30          7           1               0           0             1              35
          ------------------------------------------------------------------------------------------------------
           2005       36          9           1               1           0             2              41
          ------------------------------------------------------------------------------------------------------

[[Page 15563]]

 
           2006       41          8           1               0           1             2              45
----------------------------------------------------------------------------------------------------------------


                                 Appendix E to Part 436--Sample Item 20(4) Table
                                         Status of Company-Owned Outlets
                                             For years 2004 to 2006
----------------------------------------------------------------------------------------------------------------
                            Column 3                      Column 5                                     Column 8
  Column 1     Column 2    Outlets at     Column 4        Outlets        Column 6       Column 7      Outlets at
   State         Year       Start of       Outlets    Reacquired From    Outlets    Outlets Sold to   End of the
                              Year         Opened       Franchisees       Closed      Franchisees        Year
----------------------------------------------------------------------------------------------------------------
NY           2004         1             0             1                0            0                2
            ----------------------------------------------------------------------------------------------------
             2005         2             2             0                1            0                3
            ----------------------------------------------------------------------------------------------------
             2006         3             0             0                3            0                0
----------------------------------------------------------------------------------------------------------------
OR           2004         4             0             1                0            0                5
            ----------------------------------------------------------------------------------------------------
             2005         5             0             0                2            0                3
            ----------------------------------------------------------------------------------------------------
             2006         3             0             0                0            1                2
----------------------------------------------------------------------------------------------------------------
Totals       2004         5             0             2                0            0                7
            ----------------------------------------------------------------------------------------------------
             2005         7             2             0                3            0                6
            ----------------------------------------------------------------------------------------------------
             2006         6             0             0                3            1                2
----------------------------------------------------------------------------------------------------------------


             Appendix F to Part 436--Sample Item 20(5) Table
                    Projected New Franchised Outlets
                         As of December 31, 2006
------------------------------------------------------------------------
                                                            Column 4
                        Column 2          Column 3        Projected New
                       Franchise        Projected New     Company-Owned
 Column 1  State   Agreements Signed     Franchised      Outlets in the
                     But Outlet Not    Outlets in the    Current Fiscal
                         Opened       Next Fiscal Year        Year
------------------------------------------------------------------------
CO                 2                  3                 1
------------------------------------------------------------------------
NM                 0                  4                 2
------------------------------------------------------------------------
Total              2                  7                 3
------------------------------------------------------------------------
------------------------------------------------------------------------


0
Add a new part 437 as follows:

PART 437--DISCLOSURE REQUIREMENTS AND PROHIBITIONS CONCERNING 
BUSINESS OPPORTUNITIES

Sec.
437.1 The Rule.
437.2 Definitions.
437.3 Severability.

    Authority:  15 U.S.C. 41-58.


Sec.  437.1  The Rule.

    In connection with the advertising, offering, licensing, 
contracting, sale, or other promotion in or affecting commerce, as 
``commerce'' is defined in the Federal Trade Commission Act, of any 
business opportunity, or any relationship which is represented either 
orally or in writing to be a business opportunity, it is an unfair or 
deceptive act or practice within the meaning of Section 5 of that Act 
for any business opportunity seller or business opportunity broker:
    (a) To fail to furnish any prospective business opportunity 
purchaser with the following information accurately, clearly, and 
concisely stated, in a legible, written document at the earlier of the 
``time for making of disclosures'' or the first ``personal meeting'':
    (1)(i) The official name and address and principal place of 
business of the business opportunity seller, and of the parent firm or 
holding company of the business opportunity seller, if any;
    (ii) The name under which the business opportunity seller is doing 
or intends to do business; and
    (iii) The trademarks, trade names, service marks, advertising or 
other commercial symbols (hereinafter collectively referred to as 
``marks'') which identify the goods, commodities, or services to be 
offered, sold, or distributed by the prospective business opportunity 
purchaser, or under which

[[Page 15564]]

the prospective business opportunity purchaser will be operating.
    (2) The business experience during the past 5 years, stated 
individually, of each of the business opportunity seller's current 
directors and executive officers (including, and hereinafter to 
include, the chief executive and chief operating officer, financial, 
business opportunity marketing, training and service officers). With 
regard to each person listed, those persons' principal occupations and 
employers must be included.
    (3) The business experience of the business opportunity seller and 
the business opportunity seller's parent firm (if any), including the 
length of time each: (i) Has conducted a business of the type to be 
operated by the business opportunity purchaser; (ii) has offered or 
sold a business opportunity for such business; (iii) has conducted a 
business or offered or sold a business opportunity for a business (A) 
operating under a name using any mark set forth under paragraph 
(a)(1)(iii) of this section, or (B) involving the sale, offering, or 
distribution of goods, commodities, or services which are identified by 
any mark set forth under paragraph (a)(1)(iii) of this section; and 
(iv) has offered for sale or sold business opportunities in other lines 
of business, together with a description of such other lines of 
business.
    (4) A statement disclosing who, if any, of the persons listed in 
paragraphs (a) (2) and (3) of this section:
    (i) Has, at any time during the previous seven fiscal years, been 
convicted of a felony or pleaded nolo contendere to a felony charge if 
the felony involved fraud (including violation of any business 
opportunity law, or unfair or deceptive practices law), embezzlement, 
fraudulent conversion, misappropriation of property, or restraint of 
trade;
    (ii) Has, at any time during the previous seven fiscal years, been 
held liable in a civil action resulting in a final judgment or has 
settled out of court any civil action or is a party to any civil action 
(A) involving allegations of fraud (including violation of any business 
opportunity law, or unfair or deceptive practices law), embezzlement, 
fraudulent conversion, misappropriation of property, or restraint of 
trade, or (B) which was brought by a present or former business 
opportunity purchaser or business opportunity purchasers and which 
involves or involved the business opportunity relationship; Provided, 
however, That only material individual civil actions need be so listed 
pursuant to this paragraph (4)(ii) of this section, including any group 
of civil actions which, irrespective of the materiality of any single 
such action, in the aggregate is material;
    (iii) Is subject to any currently effective State or Federal agency 
or court injunctive or restrictive order, or is a party to a proceeding 
currently pending in which such order is sought, relating to or 
affecting business opportunity activities or the business opportunity 
seller-purchaser relationship, or involving fraud (including violation 
of any business opportunity law, or unfair or deceptive practices law), 
embezzlement, fraudulent conversion, misappropriation of property, or 
restraint of trade.
    Such statement shall set forth the identity and location of the 
court or agency; the date of conviction, judgment, or decision; the 
penalty imposed; the damages assessed; the terms of settlement or the 
terms of the order; and the date, nature, and issuer of each such order 
or ruling. A business opportunity seller may include a summary opinion 
of counsel as to any pending litigation, but only if counsel's consent 
to the use of such opinion is included in the disclosure statement.
    (5) A statement disclosing who, if any, of the persons listed in 
paragraphs (a) (2) and (3) of this section at any time during the 
previous 7 fiscal years has:
    (i) Filed in bankruptcy;
    (ii) Been adjudged bankrupt;
    (iii) Been reorganized due to insolvency; or
    (iv) Been a principal, director, executive officer, or partner of 
any other person that has so filed or was so adjudged or reorganized, 
during or within 1 year after the period that such person held such 
position in such other person. If so, the name and location of the 
person having so filed, or having been so adjudged or reorganized, the 
date thereof, and any other material facts relating thereto, shall be 
set forth.
    (6) A factual description of the business opportunity offered to be 
sold by the business opportunity seller.
    (7) A statement of the total funds which must be paid by the 
business opportunity purchaser to the business opportunity seller or to 
a person affiliated with the business opportunity seller, or which the 
business opportunity seller or such affiliated person imposes or 
collects in whole or in part on behalf of a third party, in order to 
obtain or commence the business opportunity operation, such as initial 
business opportunity fees, deposits, down payments, prepaid rent, and 
equipment and inventory purchases. If all or part of these fees or 
deposits are returnable under certain conditions, these conditions 
shall be set forth; and if not returnable, such fact shall be 
disclosed.
    (8) A statement describing any recurring funds required to be paid, 
in connection with carrying on the business opportunity business, by 
the business opportunity purchaser to the business opportunity seller 
or to a person affiliated with the business opportunity seller, or 
which the business opportunity seller or such affiliated person imposes 
or collects in whole or in part on behalf of a third party, including, 
but not limited to, royalty, lease, advertising, training, and sign 
rental fees, and equipment or inventory purchases.
    (9) A statement setting forth the name of each person (including 
the business opportunity seller) the business opportunity purchaser is 
directly or indirectly required or advised to do business with by the 
business opportunity seller, where such persons are affiliated with the 
business opportunity seller.
    (10) A statement describing any real estate, services, supplies, 
products, inventories, signs, fixtures, or equipment relating to the 
establishment or the operation of the business opportunity business 
which the business opportunity purchaser is directly or indirectly 
required by the business opportunity seller to purchase, lease or rent; 
and if such purchases, leases or rentals must be made from specific 
persons (including the business opportunity seller), a list of the 
names and addresses of each such person. Such list may be made in a 
separate document delivered to the prospective business opportunity 
purchaser with the prospectus if the existence of such separate 
document is disclosed in the prospectus.
    (11) A description of the basis for calculating, and, if such 
information is readily available, the actual amount of, any revenue or 
other consideration to be received by the business opportunity seller 
or persons affiliated with the business opportunity seller from 
suppliers to the prospective business opportunity purchaser in 
consideration for goods or services which the business opportunity 
seller requires or advises the business opportunity purchaser to obtain 
from such suppliers.
    (12)(i) A statement of all the material terms and conditions of any 
financing arrangement offered directly or indirectly by the business 
opportunity seller, or any person affiliated with the business 
opportunity seller, to the prospective business opportunity purchaser; 
and

[[Page 15565]]

    (ii) A description of the terms by which any payment is to be 
received by the business opportunity seller from (A) any person 
offering financing to a prospective business opportunity purchaser; and 
(B) any person arranging for financing for a prospective business 
opportunity purchaser.
    (13) A statement describing the material facts of whether, by the 
terms of the business opportunity agreement or other device or 
practice, the business opportunity purchaser is:
    (i) Limited in the goods or services he or she may offer for sale;
    (ii) Limited in the customers to whom he or she may sell such goods 
or services;
    (iii) Limited in the geographic area in which he or she may offer 
for sale or sell goods or services; or
    (iv) Granted territorial protection by the business opportunity 
seller, by which, with respect to a territory or area, (A) the business 
opportunity seller will not establish another, or more than any fixed 
number of, business opportunities or company-owned outlets, either 
operating under, or selling, offering, or distributing goods, 
commodities or services, identified by any mark set forth under 
paragraph (a)(1)(iii) of this section; or (B) the business opportunity 
seller or its parent will not establish other business opportunities or 
company-owned outlets selling or leasing the same or similar products 
or services under a different trade name, trademark, service mark, 
advertising or other commercial symbol.
    (14) A statement of the extent to which the business opportunity 
seller requires the business opportunity purchaser (or, if the business 
opportunity purchaser is a corporation, any person affiliated with the 
business opportunity purchaser) to participate personally in the direct 
operation of the business opportunity.
    (15) A statement disclosing, with respect to the business 
opportunity agreement and any related agreements:
    (i) The term (i.e., duration of arrangement), if any, of such 
agreement, and whether such term is or may be affected by any agreement 
(including leases or subleases) other than the one from which such term 
arises;
    (ii) The conditions under which the business opportunity purchaser 
may renew or extend;
    (iii) The conditions under which the business opportunity seller 
may refuse to renew or extend;
    (iv) The conditions under which the business opportunity purchaser 
may terminate;
    (v) The conditions under which the business opportunity seller may 
terminate;
    (vi) the obligations (including lease or sublease obligations) of 
the business opportunity purchaser after termination of the business 
opportunity by the business opportunity seller, and the obligations of 
the business opportunity purchaser (including lease or sublease 
obligations) after termination of the business opportunity by the 
business opportunity purchaser and after the expiration of the business 
opportunity;
    (vii) The business opportunity purchaser's interest upon 
termination of the business opportunity, or upon refusal to renew or 
extend the business opportunity, whether by the business opportunity 
seller or by the business opportunity purchaser;
    (viii) The conditions under which the business opportunity seller 
may repurchase, whether by right of first refusal or at the option of 
the business opportunity seller (and if the business opportunity seller 
has the option to repurchase the business opportunity, whether there 
will be an independent appraisal of the business opportunity, whether 
the repurchase price will be determined by a predetermined formula and 
whether there will be a recognition of goodwill or other intangibles 
associated therewith in the repurchase price to be given the business 
opportunity purchaser);
    (ix) The conditions under which the business opportunity purchaser 
may sell or assign all or any interest in the ownership of the business 
opportunity, or of the assets of the business opportunity business;
    (x) The conditions under which the business opportunity seller may 
sell or assign, in whole or in part, its interest under such 
agreements;
    (xi) The conditions under which the business opportunity purchaser 
may modify;
    (xii) The conditions under which the business opportunity seller 
may modify;
    (xiii) The rights of the business opportunity purchaser's heirs or 
personal representative upon the death or incapacity of the business 
opportunity purchaser; and
    (xiv) The provisions of any covenant not to compete.
    (16) A statement disclosing, with respect to the business 
opportunity seller and as to the particular named business being 
offered:
    (i) The total number of business opportunity purchasers operating 
at the end of the preceding fiscal year;
    (ii) The total number of company-owned outlets operating at the end 
of the preceding fiscal year;
    (iii) The names, addresses, and telephone numbers of (A) The 10 
business opportunity outlets of the named business opportunity business 
nearest the prospective business opportunity purchaser's intended 
location; or (B) all business opportunity purchasers of the business 
opportunity seller; or (C) all business opportunity purchasers of the 
business opportunity seller in the State in which the prospective 
business opportunity purchaser lives or where the proposed business 
opportunity is to be located, Provided, however, That there are more 
than 10 such business opportunity purchasers. If the number of business 
opportunity purchasers to be disclosed pursuant to paragraph 
(a)(16)(iii)(B) or (C) of this section exceeds 50, such listing may be 
made in a separate document delivered to the prospective business 
opportunity purchaser with the prospectus if the existence of such 
separate document is disclosed in the prospectus;
    (iv) The number of business opportunities voluntarily terminated or 
not renewed by business opportunity purchasers within, or at the 
conclusion of, the term of the business opportunity agreement, during 
the preceding fiscal year;
    (v) The number of business opportunities reacquired by purchase by 
the business opportunity seller during the term of the business 
opportunity agreement, and upon the conclusion of the term of the 
business opportunity agreement, during the preceding fiscal year;
    (vi) The number of business opportunities otherwise reacquired by 
the business opportunity seller during the term of the business 
opportunity agreement, and upon the conclusion of the term of the 
business opportunity agreement, during the preceding fiscal year;
    (vii) The number of business opportunities for which the business 
opportunity seller refused renewal of the business opportunity 
agreement or other agreements relating to the business opportunity 
during the preceding fiscal year; and
    (viii) The number of business opportunities that were canceled or 
terminated by the business opportunity seller during the term of the 
business opportunity agreement, and upon conclusion of the term of the 
business opportunity agreement, during the preceding fiscal year.
    With respect to the disclosures required by paragraphs (a)(16) (v), 
(vi), (vii), and (viii) of this section, the disclosure statement shall 
also include a general categorization of the reasons

[[Page 15566]]

for such reacquisitions, refusals to renew or terminations, and the 
number falling within each such category, including but not limited to 
the following: failure to comply with quality control standards, 
failure to make sufficient sales, and other breaches of contract.
    (17)(i) If site selection or approval thereof by the business 
opportunity seller is involved in the business opportunity 
relationship, a statement disclosing the range of time that has elapsed 
between signing of business opportunity agreements or other agreements 
relating to the business opportunity and site selection, for agreements 
entered into during the preceding fiscal year; and
    (ii) If operating business opportunity outlets are to be provided 
by the business opportunity seller, a statement disclosing the range of 
time that has elapsed between the signing of business opportunity 
agreements or other agreements relating to the business opportunity and 
the commencement of the business opportunity purchaser's business, for 
agreements entered into during the preceding fiscal year.
    With respect to the disclosures required by paragraphs (a)(17) (i) 
and (ii) of this section, a business opportunity seller may at its 
option also provide a distribution chart using meaningful 
classifications with respect to such ranges of time.
    (18) If the business opportunity seller offers an initial training 
program or informs the prospective business opportunity purchaser that 
it intends to provide such person with initial training, a statement 
disclosing:
    (i) The type and nature of such training;
    (ii) The minimum amount, if any, of training that will be provided 
to a business opportunity purchaser; and
    (iii) The cost, if any, to be borne by the business opportunity 
purchaser for the training to be provided, or for obtaining such 
training.
    (19) If the name of a public figure is used in connection with a 
recommendation to purchase a business opportunity, or as a part of the 
name of the business opportunity operation, or if the public figure is 
stated to be involved with the management of the business opportunity 
seller, a statement disclosing:
    (i) The nature and extent of the public figure's involvement and 
obligations to the business opportunity seller, including but not 
limited to the promotional assistance the public figure will provide to 
the business opportunity seller and to the business opportunity 
purchaser;
    (ii) The total investment of the public figure in the business 
opportunity operation; and
    (iii) The amount of any fee or fees the business opportunity 
purchaser will be obligated to pay for such involvement or assistance 
provided by the public figure.
    (20)(i) A balance sheet (statement of financial position) for the 
business opportunity seller for the most recent fiscal year, and an 
income statement (statement of results of operations) and statement of 
changes in financial position for the franchisor for the most recent 
three fiscal years. Such statements are required to have been examined 
in accordance with generally accepted auditing standards by an 
independent certified or licensed public accountant.
    Provided, however, That where a business opportunity seller is a 
subsidiary of another corporation which is permitted under generally 
accepted accounting principles to prepare financial statements on a 
consolidated or combined statement basis, the above information may be 
submitted for the parent if (A) the corresponding unaudited financial 
statements of the business opportunity seller are also provided, and 
(B) the parent absolutely and irrevocably has agreed to guarantee all 
obligations of the subsidiary;
    (ii) Unaudited statements shall be used only to the extent that 
audited statements have not been made, and provided that such 
statements are accompanied by a clear and conspicuous disclosure that 
they are unaudited. Statements shall be prepared on an audited basis as 
soon as practicable, but, at a minimum, financial statements for the 
first full fiscal year following the date on which the business 
opportunity seller must first comply with this part shall contain a 
balance sheet opinion prepared by an independent certified or licensed 
public accountant, and financial statements for the following fiscal 
year shall be fully audited.
    (21) All of the foregoing information in paragraphs (a) (1) through 
(20) of this section shall be contained in a single disclosure 
statement or prospectus, which shall not contain any materials or 
information other than that required by this part or by State law not 
preempted by this part. This does not preclude business opportunity 
sellers or brokers 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 required 
by paragraph (a) of this section. This disclosure statement shall carry 
a cover sheet distinctively and conspicuously showing the name of the 
business opportunity seller, the date of issuance of the disclosure 
statement, and the following notice imprinted thereon in upper and 
lower case bold-face type of not less than 12 point size:

Information for Prospective Business Opportunity Purchasers Required by 
Federal Trade Commission

* * * * *
    To protect you, we've required your business opportunity seller 
to give you this information. We haven't checked it, and don't know 
if it's correct. It should help you make up your mind. Study it 
carefully. While it includes some information about your contract, 
don't rely on it alone to understand your contract. Read all of your 
contract carefully. Buying a business opportunity is a complicated 
investment. Take your time to decide. If possible, show your 
contract and this information to an advisor, like a lawyer or an 
accountant. If you find anything you think may be wrong or anything 
important that's been left out, you should let us know about it. It 
may be against the law.

    There may also be laws on business opportunities in your state. 
Ask your state agencies about them.

    Federal Trade Commission,
    Washington, D.C.

    Provided, That the obligations to furnish such disclosure statement 
shall be deemed to have been met for both the business opportunity 
seller and the business opportunity broker if either such party 
furnishes the prospective business opportunity purchaser with such 
disclosure statement.
    (22) All information contained in the disclosure statement shall be 
current as of the close of the business opportunity seller's most 
recent fiscal year. After the close of each fiscal year, the business 
opportunity seller shall be given a period not exceeding 90 days to 
prepare a revised disclosure statement and, following such 90 days, may 
distribute only the revised prospectus and no other. The business 
opportunity seller shall, within a reasonable time after the close of 
each quarter of the fiscal year, prepare revisions to be attached to 
the disclosure statement to reflect any material change in the business 
opportunity seller or relating to the business opportunity business of 
the business opportunity seller, about which the business opportunity 
seller or broker, or any agent, representative, or employee thereof, 
knows or should know. Each prospective business opportunity purchaser 
shall have in his or her possession at the ``time for making of 
disclosures,'' the disclosure statement and quarterly revision for the 
period most recent to the ``time for making of disclosures'' and 
available at

[[Page 15567]]

that time. Information which is required to be audited pursuant to 
paragraph (a)(20) of this section is not required to be audited for 
quarterly revisions. Provided, however, That the unaudited information 
is accompanied by a statement in immediate conjunction therewith that 
clearly and conspicuously discloses that such information has not been 
audited.
    (23) A table of contents shall be included within the disclosure 
statement.
    (24) The disclosure statement shall include a comment which either 
positively or negatively responds to each disclosure item required to 
be in the disclosure statement, by use of a statement which fully 
incorporates the information required by the item. Each disclosure item 
therein must be preceded by the appropriate heading, as set forth in 
Note 3 of this part.
    (b) To make any oral, written, or visual representation to a 
prospective business opportunity purchaser which states a specific 
level of potential sales, income, gross or net profit for that 
prospective business opportunity purchaser, or which states other facts 
which suggest such a specific level, unless:
    (1) At the time such representation is made, such representation is 
relevant to the geographic market in which the business opportunity is 
to be located;
    (2) At the time such representation is made, a reasonable basis 
exists for such representation and the business opportunity seller has 
in its possession material which constitutes a reasonable basis for 
such representation, and such material is made available to any 
prospective business opportunity purchaser and to the Commission or its 
staff upon reasonable demand.
    Provided, further, That in immediate conjunction with such 
representation, the business opportunity seller shall disclose in a 
clear and conspicuous manner that such material is available to the 
prospective business opportunity purchaser; and Provided, however, That 
no provision within paragraph (b) of this section shall be construed as 
requiring the disclosure to any prospective business opportunity 
purchaser of the identity of any specific business opportunity 
purchaser or of information reasonably likely to lead to the disclosure 
of such person's identity; and Provided, further, That no additional 
representation as to a prospective business opportunity purchaser's 
potential sales, income, or profits may be made later than the ``time 
for making of disclosures'';
    (3) Such representation is set forth in detail along with the 
material bases and assumptions therefor in a single legible written 
document whose text accurately, clearly and concisely discloses such 
information, and none other than that provided for by this part or by 
State law not preempted by this part. Each prospective business 
opportunity purchaser to whom the representation is made shall be 
furnished with such document no later than the ``time for making of 
disclosure''; Provided, however, That if the representation is made at 
or prior to a ``personal meeting'' and such meeting occurs before the 
``time for making of disclosures'', the document shall be furnished to 
the prospective business opportunity purchaser to whom the 
representation is made at that ``personal meeting'';
    (4) The following statement is clearly and conspicuously disclosed 
in the document described by paragraph (b)(3) of this section in 
immediate conjunction with such representation and in not less than 
twelve point upper and lower-case boldface type:

 CAUTION

    These figures are only estimates of what we think you may earn. 
There is no assurance you'll do as well. If you rely upon our 
figures, you must accept the risk of not doing as well.

    (5) The following information is clearly and conspicuously 
disclosed in the document described by paragraph (b)(3) of this section 
in immediate conjunction with such representation:
    (i) The number and percentage of outlets of the named business 
opportunity business which are located in the geographic markets that 
form the basis for any such representation and which are known to the 
business opportunity seller or broker to have earned or made at least 
the same sales, income, or profits during a period of corresponding 
length in the immediate past as those potential sales, income, or 
profits represented; and
    (ii) The beginning and ending dates for the corresponding time 
period referred to by paragraph (b)(5)(i) of this section, Provided, 
however, That any business opportunity seller without prior business 
opportunity experience as to the named business opportunity business so 
indicate such lack of experience in the document described in paragraph 
(b)(3) of this section.
    Except, That representations of the sales, income or profits of 
existing business opportunity outlets need not comply with paragraph 
(b) of this section.
    (c) To make any oral, written, or visual representation to a 
prospective business opportunity purchaser which states a specific 
level of sales, income, gross or net profits of existing outlets 
(whether business opportunity purchaser-owned or company-owned) of the 
named business opportunity business, or which states other facts which 
suggest such a specific level, unless:
    (1) At the time such representation is made, such representation is 
relevant to the geographic market in which the business opportunity is 
to be located;
    (2) At the time such representation is made, a reasonable basis 
exists for such representation and the business opportunity seller has 
in its possession material which constitutes a reasonable basis for 
such representation, and such material is made available to any 
prospective business opportunity purchaser and to the Commission or its 
staff upon reasonable demand, Provided, however, That in immediate 
conjunction with such representation, the business opportunity 
purchaser discloses in a clear and conspicuous manner that such 
material is available to the prospective franchisee; and Provided, 
further, That no provision within paragraph (c) of this section shall 
be construed as requiring the disclosure to any prospective business 
opportunity purchaser of the identity of any specific business 
opportunity purchaser or of information reasonably likely to lead to 
the disclosure of such person's identity; and Provided, further, That 
no additional representation as to the sales, income, or gross or net 
profits of existing outlets (whether business opportunity purchaser-
owned or company-owned) of the named business opportunity business may 
be made later than the ``time for making of disclosures'';
    (3) Such representation is set forth in detail along with the 
material bases and assumptions therefor in a single legible written 
document which accurately, clearly and concisely discloses such 
information, and none other than that provided for by this part or by 
State law not preempted by this part. Each prospective business 
opportunity purchaser to whom the representation is made shall be 
furnished with such document no later than the ``time for making of 
disclosures,'' Provided, however, That if the representation is made at 
or prior to a ``personal meeting'' and such meeting occurs before the 
``time for making of disclosures,'' the document shall be furnished to 
the prospective business opportunity purchaser to whom the 
representation is made at that ``personal meeting'';
    (4) The underlying data on which the representation is based have 
been

[[Page 15568]]

prepared in accordance with generally accepted accounting principles;
    (5) The following statement is clearly and conspicuously disclosed 
in the document described by paragraph (c)(3) of this section in 
immediate conjunction with such representation, and in not less than 
twelve point upper and lower case boldface type:

 CAUTION

    Some outlets have [sold] [earned] this amount. There is no 
assurance you'll do as well. If you rely upon our figures, you must 
accept the risk of not doing as well.

    (6) The following information is clearly and conspicuously 
disclosed in the document described by paragraph (c)(3) of this section 
in immediate conjunction with such representation:
    (i) the number and percentage of outlets of the named business 
opportunity business which are located in the geographic markets that 
form the basis for any such representation and which are known to the 
business opportunity seller or broker to have earned or made at least 
the same sales, income, or profits during a period of corresponding 
length in the immediate past as those potential sales, income, or 
profits represented; and
    (ii) The beginning and ending dates for the corresponding time 
period referred to by paragraph (c)(6)(i) of this section, Provided, 
however, That any business opportunity seller without prior business 
opportunity experience as to the named business opportunity business so 
indicate such lack of experience in the document described in paragraph 
(c)(3) of this section.
    (d) To fail to provide the following information within the 
document(s) required by paragraphs (b)(3) and (c)(3) of this section 
whenever any representation is made to a prospective business 
opportunity purchaser regarding its potential sales, income, or 
profits, or the sales, income, gross or net profits of existing outlets 
(whether business opportunity purchaser-owned or company-owned) of the 
named business opportunity business:
    (1) A cover sheet distinctively and conspicuously showing the name 
of the business opportunity seller, the date of issuance of the 
document and the following notice imprinted thereon in upper and lower 
case boldface type of not less than twelve point size:

Information for Prospective Business Opportunity Purchasers About 
Business Opportunity [Sales] [Income] [Profit] Required by the Federal 
Trade Commission.

    To protect you, we're required the business opportunity seller 
to give you this information. We haven't checked it and don't know 
if it's correct. Study these facts and figures carefully. If 
possible, show them to someone who can advise you, like a lawyer or 
an accountant. Then take your time and think it over.

    If you find anything you think may be wrong or anything 
important that's been left out, let us know about it. It may be 
against the law.

    There may also be laws on business opportunities in your State. 
Ask your State agencies about them.

    Federal Trade Commission,
    Washington, D.C.

    (2) A table of contents.
     Provided, however, That each prospective business opportunity 
purchaser to whom the representation is made shall be notified at the 
``time for making of disclosures'' of any material change (about which 
the business opportunity seller, broker, or any of the agents, 
representations, or employees thereof, knows or should know) in the 
information contained in the document(s) described by paragraphs (b)(3) 
and (c)(3) of this section.
    (e) To make any oral, written, or visual representation for general 
dissemination (not otherwise covered by paragraph (b) or (c) of this 
section) which states a specific level of sales, income, gross or net 
profits, either actual or potential, of existing or prospective outlets 
(whether business opportunity purchaser-owned or company-owned) of the 
named business opportunity business or which states other facts which 
suggest such a specific level, unless:
    (1) At the time such representation is made, a reasonable basis 
exists for such representation and the business opportunity seller has 
in its possession material which constitutes a reasonable basis for 
such representation and which is made available to the Commission or 
its staff upon reasonable demand;
    (2) The underlying data on which each representation of sales, 
income or profit for existing outlets is based have been prepared in 
accordance with generally accepted accounting principles;
    (3) In immediate conjunction with such representation, there shall 
be clearly and conspicuously disclosed the number and percentage of 
outlets of the named business opportunity business which the business 
opportunity seller or broker knows to have earned or made at least the 
same sales, income, or profits during a period of corresponding length 
in the immediate past as those sales, income, or profits represented, 
and the beginning and ending dates for said time period;
    (4) In immediate conjunction with each such representation of 
potential sales, income or profits, the following statement shall be 
clearly and conspicuously disclosed:
    CAUTION
    These figures are only estimates; there is no assurance you'll 
do as well. If you rely upon our figures, you must accept the risk 
of not doing as well.

    Provided, however, That if such representation is not based on 
actual experience of existing outlets of the named business opportunity 
business, that fact also should be disclosed;
    (5) No later than the earlier of the first ``personal meeting'' or 
the ``time for making of disclosures,'' each prospective business 
opportunity purchaser shall be given a single, legible written document 
which accurately, clearly and concisely sets forth the following 
information and materials (and none other than that provided for by 
this part or by State law not preempted by this part):
    (i) The representation, set forth in detail along with the material 
bases and assumptions therefor;
    (ii) the number and percentage of outlets of the named business 
opportunity business which the business opportunity seller or broker 
knows to have earned or made at least the same sales, income or profits 
during a period of corresponding length in the immediate past as those 
sales, income, or profits represented, and the beginning and ending 
dates for said time period;
    (iii) With respect to each such representation of sales, income, or 
profits of existing outlets, the following statement shall be clearly 
and conspicuously disclosed in immediate conjunction therewith, printed 
in not less than 12 point upper and lower case boldface type:

 CAUTION

    Some outlets have [sold] [earned] this amount. There is no 
assurance you'll do as well. If you rely upon our figures, you must 
accept the risk of not doing as well.

    (iv) With respect to each such representation of potential sales, 
income, or profits, the following statement shall be clearly and 
conspicuously disclosed in immediate conjunction therewith, printed in 
not less than 12 point upper and lower case boldface type:

 CAUTION

    These figures are only estimates. There is no assurance you'll 
do as well. If you rely upon our figures, you must accept the risk 
of not doing as well.

    (v) If applicable, a statement clearly and conspicuously disclosing 
that the business opportunity seller lacks prior

[[Page 15569]]

business opportunity experience as to the named business opportunity 
business;
    (vi) If applicable, a statement clearly and conspicuously 
disclosing that the business opportunity seller has not been in 
business long enough to have actual business data;
    (vii) A cover sheet, distinctively and conspicuously showing the 
name of the business opportunity seller, the date of issuance of the 
document, and the following notice printed thereon in not less than 12 
point upper and lower case boldface type:

Information for Prospective Business Opportunity Purchasers About 
Business Opportunity [Sales] [Income] [Profit] Required by the Federal 
Trade Commission

    To protect you, we've required the business opportunity seller 
to give you this information. We haven't checked it and don't know 
if it's correct. Study these facts and figures carefully. If 
possible, show them to someone who can advise you, like a lawyer or 
an accountant. If you find anything you think may be wrong or 
anything important that's been left out, let us know about it. It 
may be against the law. There may also be laws about business 
opportunities in your State. Ask your State agencies about them.

    Federal Trade Commission,
    Washington, D.C.

    (viii) A table of contents;
    (6) Each prospective business opportunity purchaser shall be 
notified at the ``time for making of disclosures'' of any material 
changes that have occurred in the information contained in this 
document.
    (f) To make any claim or representation which is contradictory to 
the information required to be disclosed by this part.
    (g) To fail to furnish the prospective business opportunity 
purchaser with a copy of the business opportunity seller's business 
opportunity agreement and related agreements with the document, and a 
copy of the completed business opportunity and related agreements 
intended to be executed by the parties at least 5 business days prior 
to the date the agreements are to be executed.
    Provided, however, That the obligations defined in paragraphs (b) 
through (g) of this section shall be deemed to have been met for both 
the business opportunity seller and the broker if either such person 
furnishes the prospective business opportunity purchaser with the 
written disclosures required thereby.
    (h) To fail to return any funds or deposits in accordance with any 
conditions disclosed pursuant to paragraph (a)(7) of this section.


Sec.  437.2  Definitions.

    As used in this part, the following definitions shall apply:
    (a) The term business opportunity means any continuing commercial 
relationship created by any arrangement or arrangements whereby:
    (1) A person (hereinafter ``business opportunity purchaser'') 
offers, sells, or distributes to any person other than a ``business 
opportunity seller'' (as hereinafter defined), goods, commodities, or 
services which are:
    (i)(A) Supplied by another person (hereinafter ``business 
opportunity seller''); or
    (B) Supplied by a third person (e.g., a supplier) with whom the 
business opportunity purchaser is directly or indirectly required to do 
business by another person (hereinafter ``business opportunity 
seller''); or
    (C) Supplied by a third person (e.g., a supplier) with whom the 
business opportunity purchaser is directly or indirectly advised to do 
business by another person (hereinafter ``business opportunity 
seller'') where such third person is affiliated with the business 
opportunity seller; and
    (ii) The business opportunity seller:
    (A) Secures for the business opportunity purchaser retail outlets 
or accounts for said goods, commodities, or services; or
    (B) Secures for the business opportunity purchaser locations or 
sites for vending machines, rack displays, or any other product sales 
displays used by the business opportunity purchaser in the offering, 
sale, or distribution of said goods, commodities, or services; or
    (C) Provides to the business opportunity purchaser the services of 
a person able to secure the retail outlets, accounts, sites or 
locations referred to in paragraphs (a)(ii)(A) and (B) of this section; 
and
    (2) The business opportunity purchaser is required as a condition 
of obtaining or commencing the business opportunity operation to make a 
payment or a commitment to pay to the business opportunity seller, or 
to a person affiliated with the business opportunity seller.
    (3) Exemptions. The provisions of this part shall not apply to a 
business opportunity:
    (i) Which is a ``fractional business opportunity''; or
    (ii) 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 retailer-grantor where such person is affiliated with the 
retailer-grantor; or
    (iii) Where the total of the payments referred to in paragraph 
(a)(2) of this section made during a period from any time before to 
within 6 months after commencing operation of the business opportunity 
purchaser's business, is less than $500; or
    (iv) Where there is no writing which evidences any material term or 
aspect of the relationship or arrangement; or
    (v) Which complies with the franchise disclosure requirements set 
forth at part 436 or falls under one or more of the exemptions set 
forth at Sec.  436.8 of part 436.
    (4) Exclusions. The term ``business opportunity'' shall not be 
deemed to include any continuing commercial relationship created solely 
by:
    (i) The relationship between an employer and an employee, or among 
general business partners; or
    (ii) Membership in a bona fide ``cooperative association''; or
    (iii) An agreement for the use of a trademark, service mark, trade 
name, seal, advertising, or other commercial symbol designating a 
person who offers on a general basis, for a fee or otherwise, a bona 
fide service for the evaluation, testing, or certification of goods, 
commodities, or services; or
    (iv) An agreement between a licensor and a single licensee to 
license a trademark, trade name, service mark, advertising or other 
commercial symbol where such license is the only one of its general 
nature and type to be granted by the licensor with respect to that 
trademark, trade name, service mark, advertising, or other commercial 
symbol.
    (4) Any relationship which is represented either orally or in 
writing to be a business opportunity (as defined in paragraph (a) of 
this section) is subject to the requirements of this part.
    (b) The term person means any individual, group, association, 
limited or general partnership, corporation, or any other business 
entity.
    (c) The term business opportunity seller means any person who 
participates in a business opportunity relationship as a business 
opportunity seller, as denoted in paragraph (a) of this section.
    (d) The term business opportunity purchaser means any person (1) 
who participates in a business opportunity relationship as a business 
opportunity purchaser, as denoted in paragraph (a)

[[Page 15570]]

of this section, or (2) to whom an interest in a business opportunity 
is sold.
    (e) The term prospective business opportunity purchaser includes 
any person, including any representative, agent, or employee of that 
person, who approaches or is approached by a business opportunity 
seller or broker, or any representative, agent, or employee thereof, 
for the purpose of discussing the establishment, or possible 
establishment, of a business opportunity relationship involving such a 
person.
    (f) The term business day means any day other than Saturday, 
Sunday, or the following national holidays: New Year's Day, 
Washington's Birthday, Memorial Day, Independence Day, Labor Day, 
Columbus Day, Veterans' Day, Thanksgiving, and Christmas.
    (g) The term time for making of disclosures means ten (10) business 
days prior to the earlier of (1) the execution by a prospective 
business opportunity purchaser of any business opportunity agreement or 
any other agreement imposing a binding legal obligation on such 
prospective business opportunity purchaser, about which the business 
opportunity seller, broker, or any agent, representative, or employee 
thereof, knows or should know, in connection with the sale or proposed 
sale of a business opportunity, or (2) the payment by a prospective 
business opportunity purchaser, about which the business opportunity 
seller, 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 business opportunity.
    (h) The term fractional business opportunity means any 
relationship, as denoted by paragraph (a) of this section, in which the 
person described therein as a business opportunity purchaser, or any of 
the current directors or executive officers thereof, has been in the 
type of business represented by the business opportunity relationship 
for more than 2 years and the parties anticipated, or should have 
anticipated, at the time the agreement establishing the business 
opportunity 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 business opportunity purchaser.
    (i) The term affiliated person means a person (as defined in 
paragraph (b) of this section):
    (1) Which directly or indirectly controls, is controlled by, or is 
under common control with, a business opportunity seller; 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 business opportunity seller; or
    (3) Which has, in common with a business opportunity seller, one or 
more partners, officers, directors, trustees, branch managers, or other 
persons occupying similar status or performing similar functions.
    (j) The term business opportunity broker means any person other 
than a business opportunity seller or a business opportunity purchaser 
who sells, offers for sale, or arranges for the sale of a business 
opportunity.
    (k) The term sale of a business opportunity includes a contract or 
agreement whereby a person obtains a business opportunity or an 
interest in a business opportunity for value by purchase, license, or 
otherwise. This term shall not be deemed to include the renewal or 
extension of an existing business opportunity where there is no 
interruption in the operation of the business opportunity business by 
the business opportunity purchaser, unless the new contracts or 
agreements contain material changes from those in effect between the 
business opportunity seller and business opportunity purchaser prior 
thereto.
    (l) A cooperative association is either (1) an association of 
producers of agricultural products authorized by section 1 of the 
Capper-Volstead Act, 7 U.S.C. 291; or (2) an organization operated on a 
cooperative basis by and for independent retailers which wholesales 
goods or furnishes services primarily to its member-retailers.
    (m) The term fiscal year means the business opportunity seller's 
fiscal year.
    (n) The term material, material fact, and material change shall 
include any fact, circumstance, or set of conditions that has a 
substantial likelihood of influencing a reasonable business opportunity 
purchaser in the making of a significant decision relating to a named 
business opportunity business or that has any significant financial 
impact on a business opportunity purchaser or prospective business 
opportunity purchaser.
    (o) The term personal meeting means a face-to-face meeting between 
a business opportunity seller or broker (or any agent, representative, 
or employee thereof) and a prospective business opportunity purchaser 
which is held for the purposes of discussing the sale or possible sale 
of a business opportunity.


Sec.  437.3  Severability.

    If any provision of this part or its application to any person, 
act, or practice is held invalid, the remainder of the part or the 
application of its provisions to any person, act, or practice shall not 
be affected thereby.

    Note 1: The Commission expresses no opinion as to the legality 
of any practice mentioned in this part. A provision for disclosure 
should not be construed as condonation or approval with respect to 
the matter required to be disclosed, nor as an indication of the 
Commission's intention not to enforce any applicable statute.


    Note 2: By taking action in this area, the Federal Trade 
Commission does not intend to annul, alter, affect, or exempt any 
person subject to the provisions of this part from complying with 
the laws or regulations of any State, municipality, or other local 
government with respect to business opportunity practices, except to 
the extent that those laws or regulations are inconsistent with any 
provision of this part, and then only to the extent of the 
inconsistency. For the purposes of this part, a law or regulation of 
any State, municipality, or other local government is not 
inconsistent with this part if the protection such law or regulation 
affords any prospective business opportunity purchaser is equal to 
or greater than that provided by this part. Examples of provisions 
that provide protection equal to or greater than that provided by 
this part include laws or regulations which require more complete 
record keeping by the business opportunity seller or the disclosure 
of more complete information to the business opportunity purchaser.


    Note 3: [As per Sec.  437.1(a)(24) of this part]:

DISCLOSURE STATEMENT

    Pursuant to 16 CFR 437.1 et seq., a Trade Regulation Rule of the 
Federal Trade Commission regarding Disclosure Requirements and 
Prohibitions Concerning Business Opportunities, the following 
information is set forth on [name of business opportunity seller] 
for your examination:
    1. Identifying information as to the business opportunity 
seller;
    2. Business experience of the business opportunity seller's 
directors and executive officers.
    3. Business experience of the business opportunity seller.
    4. Litigation history.
    5. Bankruptcy history.
    6. Description of business opportunity.
    7. Initial funds required to be paid by a business opportunity 
purchaser.
    8. Recurring funds required to be paid by a business opportunity 
purchaser.
    9. Affiliated persons the business opportunity purchaser is 
required or advised to do business with by the business opportunity 
seller.
    10. Obligations to purchase.
    11. Revenues received by the business opportunity seller in 
consideration of purchases by a business opportunity purchaser.
    12. Financing arrangements.
    13. Restriction on sales.

[[Page 15571]]

    14. Person participation required of the business opportunity 
purchaser in the operation of the business opportunity.
    15. Termination, cancellation, and renewal of the business 
opportunity.
    16. Statistical information concerning the number of business 
opportunity purchasers (and company-owned outlets).
    17. Site selection.
    18. Training programs.
    19. Public figure involvement in the business opportunity.
    20. Financial information concerning the business opportunity 
seller.

    By direction of the Commission.
Donald S. Clark,
Secretary.

    Note: Attachment A is published for information purposes only 
and will not be codified in Title 16 of the Code of Federal 
Regulations.

ATTACHMENT A.

TABLE OF COMMENTERS

Rule Review Commenters

    RR 1. Robert E. Mulloy, Jr. (``Mulloy'')
    RR 2. Stanley M. Dub, Dworken & Bernstein (``Dub'')
    RR 3. Marvin J. Migdol, Nationwide Franchise Marketing Services 
(``Migdol'')
    RR 4. SCPromotions, Inc. (``SCPromotions'')
    RR 5. R. Dana Pennell (``Pennell'')
    RR 6. Robin Day Glenn (``Glenn'')
    RR 7. Jack McBirney, McGrow Consulting (``McBirney'')
    RR 8. SRA International (``SRA International'')
    RR 9. Harold Brown, Brown & Stadfeld (``Brown'')
    RR 10. Ronald N. Rosenwasser (``Rosenwasser'')
    RR 11. Louis F. Sokol (``Sokol'')
    RR 12. J. Howard Beales III, Professor, George Washington 
University (``Beales'')
    RR 13. Peter Lagarias (``Lagarias'')
    RR 14. Harold L. Kestenbaum (``Kestenbaum'')
    RR 15. Walter D. Wilson, Better Business Bureau of Central Georgia, 
Inc. (``Wilson'')
    RR 16. Connie B. D'Imperio, Color Your Carpet, Inc. (``D'Imperio'')
    RR 17. Q.M. Marketing, Inc (``Q.M. Marketing'')
    RR 18. David Gurnick, Kindel & Anderson (``Gurnick'')
    RR 19. U-Save Auto Rental (``U-Save Auto Rental'')
    RR 20. The Longaberger Co. (``Longaberger'')
    RR 21. Direct Selling Association (``DSA'')
    RR 22. American Bar Association, Section on Antitrust Law (``ABA 
AT'')
    RR 23. Dennis E. Wieczorek, Rudnick & Wolfe (``Wieczorek'')
    RR 24. Real Estate National Nework (``RENN'')
    RR 25. Attorney General Jim Ryan (``General Ryan''), State of 
Illinois
    RR 26. Alan S. Nopar (``Nopar'')
    RR 27. Snap-On, Inc. (``Snap-On'')
    RR 28. Steven Rabenberg, Explore St. Louis (``Rabenberg'')
    RR 29. Douglas M. Brooks, Martland & Brooks (``Brooks'')
    RR 30. Robert N. McDonald (``Commissioner McDonald''), Securities 
Commissioner, State of Maryland
    RR 31. Little Ceasars (``Little Ceasars'')
    RR 32. International Franchise Association (``IFA'')
    RR 33. Brownstein, Zeidman & Lore (``Brownstein Zeidman'')
    RR 34. Jere W. Glover (``Glover''), Counsel for Advocacy, U.S. 
Small Business Administration (``SBA Advocacy'')
    RR 35. Jan Meyers, Chair, House Committee on Small Business 
(``Representative Myers'')
    RR 36. Neil A. Simon, Hogan and Hartson (``Simon'')
    RR 37. Deborah Bortner (``Bortner''), Washington State Department 
of Financial Institutions, Securities Division
    RR 38. American Franchisee Association (``AFA'')
    RR 39. American Association of Franchisees & Dealers (``AAFD'')
    RR 40. Warrren Lewis, Lewis & Trattner (``Lewis'')
    RR 41. Century 21 Real Estate Corp. (``Century 21'')
    RR 42. John Hayden (``Hayden'')
    RR 43. North American Securities Administrators Association 
(``NASAA'')
    RR 44. Robert L. Perrry (``Perry'')
    RR 45. The State Bar of California, Business Law Section (``CA 
BLS'')
    RR 46. Mike Gaston, Barkely & Evergreen (``Gaston'')
    RR 47. The Southland Corp. (``Southland'')
    RR 48. Medicap Pharmacies, Inc. (``Medicap'')
    RR 49. Rochelle B. Spandorf (``Spandorf''), ABA Forum on 
Franchising, Andrew C. Selden (``Selden''), David J. Kaufman 
(``Kaufmann'')
    RR 50. Joyce G. Mazero, Locke Pernell Rain Harrell (``Mazero'')
    RR 51. Mark B. Forseth, Locke Pernell Rain Harrell (``Forseth'')
    RR 52. Forte Hotels (``Forte Hotels'')
    RR 53. R.A. Politte (``Politte'')
    RR 54. Politte (see supra, RR 53).
    RR 55. Brown (see supra, RR 9).
    RR 56. Wieczorek (see supra, RR 23).
    RR 57. Scott Shane, Georgia Institute of Technology (``Shane'')
    RR 58. Friday's (``Friday's'')
    RR 59. Carl E. Zwisler, Keck, Mahin & Cate (``Zwisler'')
    RR 60. Wieczorek (see supra, RR 23)
    RR 61. Enrique A. Gonzalez, Gonzalez Cavillo Y Forastierei 
(``Gonzalez'')
    RR 62. Pepsico Restaurants (``Pepsico'')
    RR 63. IFA (see supra, RR 32)
    RR 64. Atlantic Richfield Co (``ARCO'')
    RR 65. David Clanton (``Clanton'')
    RR 66. Leonard Swartz, Arthur Andersen & Co. (``Swartz'')
    RR 67. John R.F. Baer, Keck, Mahin & Cate (``Baer'')
    RR 68. Lynn Scott (``Scott'')
    RR 69. Eversheds ([ldqu]o;Eversheds'')
    RR 70. Brownstein Zeidman (see supra, RR 33)
    RR 71. Penny Ward, Baker & McKenzie (``Ward'')
    RR 72. Matthias Stein (``Stein'')
    RR 73. Byron Fox, Hunton & Williams (``Fox'')
    RR 74. Papa John's Pizza (``Papa Johns'')
    RR 75. Harold L. Kestenbaum (see supra, RR 14)

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

[[Page 15572]]

    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 (Wimmer''), Iowa Coalition for Responsible 
Franchising

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'')
    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 (``Konigsberg''), Lapoint Rosenstein
    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'')

Advance Notice of Proposed Rulemaking Commenters

    ANPR 1. Kevin Brendan Murphy, Mr. Franchise (``Murphy'')
    ANPR 2. Murphy (see supra, ANPR 1).
    ANPR 3. Mike Bruce, The Michael Bruce Fund (``Bruce'')
    ANPR 4. Harold Brown, Brown & Stadfeld (``Brown'')
    ANPR 5. Frances L. Diaz (``Diaz'')
    ANPR 6. Brown (see supra, ANPR 4).
    ANPR 7. Diaz (see supra, ANPR 5).
    ANPR 8. Marian Kunihisa (``Kunihisa'')
    ANPR 9. Kevin Bores, Domino's Pizza Franchisee (``Bores'')
    ANPR 10. Terrence L. Packer, Supercuts Franchisee (``Packer'')
    ANPR 11. John Delasandro (``Delasandro'')
    ANPR 12. William Cory (``Cory'')
    ANPR 13. Joseph Manuszak, Domino's Franchisee (``Manuszak'')
    ANPR 14. Daryl Donafin, Taco Bell Franchisee (``Donafin'')
    ANPR 15. David Muncie, National Claims Service, Inc. (``Muncie'')
    ANPR 16. Patrick E. Meyers, The Quizno's Corp. (``Quizno's'')
    ANPR 17. David Weaver, Domino's Pizza Franchisee (``Weaver'')
    ANPR 18. Karen M. Paquet, Domino's Pizza Franchisee (``Paquet'')
    ANPR 19. Gary R. Duvall Graham & Dunn (``Duvall'')
    ANPR 20. Andrew J. Sherman, Greenberg & Tauris (``Sherman'')
    ANPR 21. S. Beavis Stubbings (``Stubbings'')
    ANPR 22. Jim & Evalena Gray, Pearle Vision Franchisee (``J&E 
Gray'')
    ANPR 23. Ernest Higginbotham (``Higginbotham'')
    ANPR 24. Henry C. Su & Bryon Fox (``Su'')
    ANPR 25. John R. F. Baer, Keck, Mahin & Cate (``Baer'')
    ANPR 26. Clay Small & Lowell Dixon, Nat'l Franchise Mediation 
Program Steering Committee (``NFMP'')
    ANPR 27. Richard T. Catalano (``Catalano'')
    ANPR 28. Neil Simon & Erik Wulff, Hogan & Hartson (``H&H'')
    ANPR 29. Glenn A. Mueller, Domino's Pizza Franchisee (``Mueller'')
    ANPR 30. Doug Bell et al. Supercuts Franchisees (``Supercut 
Franchisees'')
    ANPR 31. Michael L. Bennett, Longaberger Co. (``Longaberger'')
    ANPR 32. John Rachide, Domino's Pizza Franchisee (``Rachide'')
    ANPR 33. David J. Kaufmann, Kaufmann, Feiner, Yamin, Gildin & 
Robbins (``Kaufmann'')
    ANPR 34. Joseph N. Mariano, Direct Selling Association (``DSA'')
    ANPR 35. Linda F. Golodner & Susan Grant, National Consumers League 
(``NCL'')
    ANPR 36. Jere W. Glover & Jennifer A. Smith, U.S. Small Business 
Administration Office of Chief Counsel for Advocacy (``SBA Advocacy'')
    ANPR 37. Robert Chabot, Domino's Pizza Franchisee (``Chabot'')
    ANPR 38. Teresa Maloney, National Coalition of 7-Eleven Franchisees 
(``Maloney'')
    ANPR 39. BLANK
    ANPR 40. Harold L. Kestenbaum (``Kestenbaum'')
    ANPR 41. Samuel L. Sibent, KFC Franchisee (``Sibent'')
    ANPR 42. Oren C. Crothers, KFC Franchisee (``Crothers'')
    ANPR 43. Matthew Jankowski, KFC Franchisee (``Jankowski'')
    ANPR 44. Rodney A. DeBoer, KFC Franchisee (``DeBoer'')
    ANPR 45. Liesje Bertoldi, KFC Franchisee (``L. Bertoldi)''
    ANPR 46. Steve Bertoldi, KFC Franchisee (``S. Bertoldi'')
    ANPR 47. Charles Buckner, KFC Franchisee (``Buckner'')
    ANPR 48. Walter J. Knezevich, KFC Franchisee (``Knezevich'')
    ANPR 49. Jeffrey W. Gray, KFC Franchisee (``J. Gray'')
    ANPR 50. Fred Jackson, KFC Franchisee (``Jackson'')
    ANPR 51. Ronald L. Rufener, KFC Franchisee (``Rufener'')
    ANPR 52. Tim Morris, KFC Franchisee (``Morris)''
    ANPR 53. Scarlett Norris Adams, KFC Franchisee (``Adams'')
    ANPR 54. Calvin G. White, KFC Franchisee (``White'')
    ANPR 55. Nick Iuliano, KFC Franchisee (``N. Iuliano'')
    ANPR 56. Dolores Iuliano, KFC Franchisee (``D. Iuliano'')
    ANPR 57. Ralph A Harman, KFC Franchisee (``R. Harman'')
    ANPR 58. Saundra S. Harman, KFC Franchisee (``S. Harman'')
    ANPR 59. Richard Braden, KFC Franchisee (``Barden'')
    ANPR 60. K.F. C. of Pollys, KFC Franchisee (``Pollys'')

[[Page 15573]]

    ANPR 61. Joan Fiore, McDonalds Franchisee (``Fiore'')
    ANPR 62. Susan P. Kezios, American Franchisee Association (``AFA'')
    ANPR 63. Kenneth R. Costello, Loeb & Loeb (``Costello'')
    ANPR 64. AFA (see supra, ANPR 62)
    ANPR 65. Susan Rich, KFC Franchisee (``Rich'')
    ANPR 66. Fiore (see supra, ANPR 61)
    ANPR 67. Mike Johnson, Subway Franchisee (``Johnson'')
    ANPR 68. Laurie Gaither, GNC Franchisee (``L. Gaither'')
    ANPR 69. Greg Gaither, GNC Franchisee (``G. Gaither'')
    ANPR 70. Greg Suslovic, Subway Franchisee (``Suslovic'')
    ANPR 71. Richard Colenda, GNC Franchisee (``Colenda'')
    ANPR 72. Bob Gagliati, GNC Franchisee (``Gagliati'')
    ANPR 73. Pat Orzano, 7-Eleven Franchisee (``Orzano'')
    ANPR 74. Linda Gaither, GNC Franchisee (``Li Gaither'')
    ANPR 75. Kevin 100 (``Kevin 100'')
    ANPR 76. Robert James, Florida Department of Agriculture & Consumer 
Services (``James'')
    ANPR 77. Robert A. Tingler, Office of the Attorney General, State 
of Illinois (``IL AG'')
    ANPR 78. John M. Tifford, Rudnick, Wolfe, Epstien & Zeidman 
(``Tifford'')
    ANPR 79. Robert L. Purvin, Jr. (``Purvin'')
    ANPR 80. Teresa Heron, My Favorite Muffin Franchisee (``Heron'')
    ANPR 81. Purvin (see supra, ANPR 79)
    ANPR 82. Matthew R. Shay, International Franchise Association 
(``IFA'')
    ANPR 83. Duvall (see supra, ANPR 19)
    ANPR 84. Lance Winslow, Car Wash Guys (``Winslow'')
    ANPR 85. Winslow (see supra, ANPR 84)
    ANPR 86. Rick Gue, The Pampered Chef, (``Pampered Chef'')
    ANPR 87. John M. Tifford, Coverall North America (``Coverall'')
    ANPR 88. John M. Tifford, Merchandise Mart Properties (``Merchanise 
Mart'')
    ANPR 89. Dirk C. Bloemendaal, Amway Corproation (``Amway'')
    ANPR 90. Winslow (see supra, ANPR 84)
    ANPR 91. Winslow (see supra, ANPR 84)
    ANPR 92. Winslow (see supra, ANPR 84)
    ANPR 93. Winslow (see supra, ANPR 84)
    ANPR 94. Andrew A. Caffey (``Caffey'')
    ANPR 95. Entrepreneur Media, Inc. (``Entrepreneur'')
    ANPR 96. Brown (see supra, ANPR 4)
    ANPR 97. Raymond & Robert Buckley, Scorecard Plus Franchisees 
(``Buckley'')
    ANPR 98. Mark A. Kirsch, Rudnick, Wolfe, Epstien & Zeidman 
(``Kirsch'')
    ANPR 99. Dale E. Cantone, Maryland Division of Securities, Office 
of the Attorney General (``Md Securities'')
    ANPR 100. Roger C. Haines, Scorecard Plus Franchisee (``Haines'')
    ANPR 101. David E. Myklebust, Scorecard Plus Franchisee 
(``Myklebust'')
    ANPR 102. Robert Larson (``Larson'')
    ANPR 103. Brown (see supra, ANPR 4)
    ANPR 104. Mark B. Forseth, CII Enterprises (``CII'')
    ANPR 105. Bertrand T. Unger, PR One (``Pr One'')
    ANPR 106. Dennis E. Wieczorek, Rudnick & Wolfe (``Wieczorek'')
    ANPR 107. Gerald A. Marks, Marks & Krantz (``Marks'')
    ANPR 108. Brown (see supra, ANPR 4)
    ANPR 109. Everett W. Knell (``Knell'')
    ANPR 110. Anne Crews, Mary Kay, Inc. (``Mary Kay'')
    ANPR 111. Carl Letts, Domino's Pizza Franchisee (``Letts'')
    ANPR 112. Kat Tidd (``Tidd'')
    ANPR 113. Ted Poggi, National Coalition of Associations of 7-Eleven 
Franchisees (``NCA 7-Eleven Franchisees)
    ANPR 114. Gary R. Duvall & Nadine C. Mandel (``Duvall & Mandel'')
    ANPR 115. Sherry Christopher, Christopher Consulting, Inc. 
(``Christopher'')
    ANPR 116. Carl C. Jeffers, Intel Marketing Systems, Inc. 
(``Jeffers'')
    ANPR 117. Deborah Bortner, State of Washington, Department of 
Financial Institutions, Securities Divisions (``WA Securities'')
    ANPR 118. Carmen D. Caruso, Noonan & Caruso (``Caruso'')
    ANPR 119. Howard Bundy, Bundy & Morrill, Inc.(``Bundy'')
    ANPR 120. Franchise & Business Opportunity Committee, North 
American Securities Administrations Association (``NASAA'')
    ANPR 121. Tifford (see supra, ANPR 78)
    ANPR 122. Wieczorek (see supra, ANPR 106)
    ANPR 123. John & Debbie Lopez, Baskin & Robbins Franchisee 
(``Lopez'')
    ANPR 124. Susan R. Essex & Ted Storey, California Bar, Business Law 
Section (``CA BLS'')
    ANPR 125. Peter C. Lagarias, The Legal Solutions Group 
(``Lagarias'')
    ANPR 126. James G. Merret, Jr. (``Merret'')
    ANPR 127. W. Michael Garner, Dady & Garner (``Garner'')
    ANPR 128. Jeff Brickner (``Brickner'')
    ANPR 129. Bernard A. Brynda, Baskin & Robbins Franchisee 
(``Brynda'')
    ANPR 130. Caron B. Slimak, Jacadi USA Franchisee (``Slimak'')
    ANPR 131. Dr. Ralph Geiderman, Pearl Vision Franchisee 
(``Geiderman'')
    ANPR 132. Felipe Frydmann, Minister of Economic & Trade Affairs, 
Embassy of the Argentine Republic (``Argentine Embassy'')
    ANPR 133. Andrew C. Selden, Briggs & Morgan (``Selden'')
    ANPR 134. Robert Zarco, Zarco & Pardo (``Zarco & Pardo'')
    ANPR 135. Jason H. Griffing, Baskin & Robbins Franchisee 
(``Griffing'')
    ANPR 136. Erik H. Karp, Witmer, Karp, Warner & Thuotte (``Karp'')
    ANPR 137. William D. Brandt, Ferder, Brandt, Casebeer, Copper, Hoyt 
& French (``Brandt'')
    ANPR 138. Robert S. Keating, Baskin & Robbins Franchisee 
(``Keating'')
    ANPR 139. A. Patel, Baskin & Robbins Franchisee (``A. Patel'')
    ANPR 140. Joel R. Buckberg, Cendant Corporation (``Cendant'')
    ANPR 141. Duvall (see supra, ANPR 19)
    ANPR 142. NCL (see supra, ANPR 35)
    ANPR 143. AFA (see supra, ANPR 62)
    ANPR 144. Catalano (see supra, ANPR 27)
    ANPR 145. DSA (see supra, ANPR 34)
    ANPR 146. Keating (see supra, ANPR 139)
    ANPR 147. Kathie & David Leap, Baskin & Robbins Franchisee 
(``Leap'')
    ANPR 148. Ted D. Kuhn, Baskin & Robbins Franchisee (``Kuhn'')
    ANPR 149. Mike S. Lee, Baskin & Robbins Franchisee (``Lee'')
    ANPR 150. R. Deilal, Baskin & Robbins Franchisee (``Deilal'')
    ANPR 151. Frank J. Demotto, Baskin & Robbins Franchisee 
(``Demotto'')
    ANPR 152. Thomas Hung, Baskin & Robbins Franchisee (``Hung'')
    ANPR 153. Jean Jones, Baskin & Robbins Franchisee (``Jones'')
    ANPR 154. Hang, Baskin & Robbins Franchisee (``Hang'')
    ANPR 155. Dilip Patel, Baskin & Robbins Franchisee (``D. Patel'')
    ANPR 156. Terry L. Glase, Baskin & Robbins Franchisee (``Glase'')
    ANPR 157. R.E. Williamson, Baskin & Robbins Franchisee 
(``Williamson'')
    ANPR 158. R. M Valum, Baskin & Robbins Franchisee (``Valum'')
    ANPR 159. Rajendra Patel, Baskin & Robbins Franchisee (``R. 
Patel'')
    ANPR 160. Jerry & Debbie Robinett, Baskin & Robbins Franchisee 
(``Robinett'')
    ANPR 161. Ronald J. Rudolf, Baskin & Robbins Franchisee 
(``Rudolf'')

[[Page 15574]]

    ANPR 162. Kamlesh Patel, Baskin & Robbins Franchisee (``K. Patel'')
    ANPR 163. Nicholas & Marilyn Apostal, Baskin & Robbins Franchisee 
(``Apostal'')
    ANPR 164. Patrick Sitin, Baskin & Robbins Franchisee (``Sitin'')
    ANPR 165. Paul & Lisa SeLander, Baskin & Robbins Franchisee 
(``SeLander'')
    ANPR 166. S. Bhilnym, Baskin & Robbins Franchisee (``Bhilnym'')
    ANPR 167. Mike & Kathy Denino, Baskin & Robbins Franchisee 
(``Denino'')

ANPR 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'')
    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'')
    Erik Wulff, Hogan & Hartson (``Wulff'')
    Barry Zaslav, Coverall North America (``Zaslav'')

Franchise Rule Notice of Proposed Rulemaking Commenters

    NPR 1. Patrick E. Meyers, The Quizno's Corporation (``Quizno's'')
    NPR 2. Steven A. Rosen, Frannet (``Frannet'')
    NPR 3. Robert Tingler, Franchise Bureau Chief, Illinois Attorney 
General (``IL AG'')
    NPR 4. Dennis E. Wieczorek, Piper Marbury Rudnick & Wolfe 
(``PMR&W'')
    NPR 5. Jack Schuessler, Wendy's Intl, Inc. (``Wendy's'')
    NPR 6. Curtis S. Gimson, Triarc Restaurant Group (``Triarc'')
    NPR 7. Eugene Stachowiak, McDonald's (``McDonalds'')
    NPR 8. David E. Holmes (``Holmes'')
    NPR 9. Erik B. Wulff, John F. Dienelt, Hogan & Hartson (``H&H'')
    NPR 10. Ronnie R. Volkening, 7-Eleven, Inc. (``7-Eleven'')
    NPR 11. John R.F. Baer, Robert T. Joseph, Alan H. Silberman, 
Sonnenschein Nath & Rosenthal (``Baer'')
    NPR 12. Morton A. Aronson, Neil A. Simon, David J. Kaufmann, 
National Franchise Council (``NFC'')
    NPR 13. Alaska Turner (``Turner'')
    NPR 14. Susan P. Kezios, American Franchisee Association (``AFA'')
    NPR 15. Warren L. Lewis, Lewis & Kolton (``Lewis'')
    NPR 16. John W. Regnery, Snap-On Inc. (``Snap-On'')
    NPR 17. Dale E. Cantone, Stephen W. Maxey, Joseph J. Punturo, NASAA 
Franchise and Business Opportunity Project Group (``NASAA'')
    NPR 18. Howard E. Bundy, Bundy & Morrill, Inc. (``Bundy'')
    NPR 19. Laurie Taylor (``Taylor'')
    NPR 20. Jonathan Hubbell, Prudential Real Estate Affiliates 
(``PREA'')
    NPR 21. David Gurnick, Arter & Hadden (``Gurnick'')
    NPR 22. Don J. DeBolt, Matthew R. Shay, International Franchise 
Association (``IFA'')
    NPR 23. L. Seth Stadfeld, Weston, Patrick, Willard & Redding 
(``Stadfeld'')
    NPR 24. Eric H. Karp, Witmer, Karp, Warner & Thuotte (``Karp'')
    NPR 25. Janet L. McDavid, American Bar Association, Section of 
Antitrust Law (``ABA AT'')
    NPR 26. Randall Loeb, NaturaLawn of America (``NaturaLawn'')
    NPR 27. Tony Rolland, National Franchisee Association (``NFA'')
    NPR 28. Andrew P. Loewinger, Buchannan Ingersoll (``BI'')
    NPR 29. Jeffrey E. Kolton, Frandata (``Frandata'')
    NPR 30. AFC Enterprises (``AFC'')

[[Page 15575]]

    NPR 31. Howard Morrill, Bundy & Morrill, Inc. (``Morrill'')
    NPR 32. Carl E. Zwisler, Jenkens & Gilchrist (``J&G'')
    NPR 33. Diane T. Nauer, TruServ Corporation (``TruServ'')
    NPR 34. Brian H. Cole, Tricon (``Tricon'')
    NPR 35. Steven Goldman, Mark Forseth, Marriott Corp. (``Marriott'')
    NPR Rebuttal 36. Gurnick (see supra, FR-NPR 21)
    NPR Rebuttal 37. Kezios (see supra, FR-NPR 14)
    NPR Rebuttal 38. IL AG (see supra, FR-NPR 3)
    NPR Rebuttal 39. Bundy (see supra, FR-NPR 18)
    NPR Rebuttal 40. John W. Fitzgerald, Gray, Plant, Mooty, Mooty & 
Bennett (``GPM'')

Staff Report

    Affiliated Foods Midwest (``Affiliated Foods'')
    American Association of Franchisees and Dealers (``AAFD'')
    American Franchisee Association (``AFA'')
    Briggs & Morgan (``Selden'')
    Bundy & Morrill, Inc. (``Bundy'')
    Car Wash Guys (``Winslow'')
    Cendant Corp. (``Cendant'')
    CHS, Inc. (``CHS'')
    Gary Duvall (``Duvall'')
    Frost Brown Todd (``Graber'')
    David Gurnick (``Gurnick'')
    Gust Rosenfeld (``Gust Rosenfeld'')
    Illinois Attorney General (``IL AG'')
    Independent Distributors Cooperative (``IDC'')
    International Franchise Association (``IFA'')
    Jeffrey S. Haff (``Haff'')
    Jenkens & Gilchrist (``J&G'')
    Johnson, Hearn, Vinegar, Gee & Mercer (``Gee'')
    Kaufmann, Feiner, Yamin, Gildin & Robbins (``Kaufmann'')
    A. Koutsoulis (``Koutsoulis'')
    Law Office of Marc N. Blumenthal (``Blumenthal'')
    Law Office of Peter A. Singler (``Singler'')
    Legal Solutions Group (``Lagarias'')
    Marks & Associates (``Marks'')
    Michael H. Seid & Assoc. (``Seid'')
    National Automobile Dealers Assoc. (``NADA'')
    National Cooperative Business Assoc. (``NCBA'')
    National Council of Farmer Cooperatives (``NCFC'')
    National Grocers Assoc. (``NGA'')
    North American Securities Administrators Association (``NASAA'')
    Pillsbury Winthrop (``Chevron'')
    Pillsbury Winthrop (``Pillsbury Winthrop'')
    Piper Rudnick (``Piper Rudnick'')
    Prudential Real Estate Affiliates (``PREA'')
    Richard Pu (``Pu'')
    Riezman Berger (``Riezman Berger'')
    Spandorf, Silberman, Joseph, and Baer (``Spandorf'')
    Starwood (``Starwood'')
    State Bar of California--Franchise Law Committee (``CA Bar'')
    State of California Department of Corporations (``CA Dep't of 
Corps'')
    Paul Steinberg (``Steinberg'')
    Washington State Department of Financial Institutions (``WA 
Securities'')
    Wiggin & Dana (``Wiggin & Dana'')
    Witmer, Karp & Warner (``Karp'')
[FR Doc. E7-5829 Filed 3-29-07; 8:45 am]
BILLING CODE 6750-01-S