Disclosure Basics Under Federal and State Franchise Laws

Transcription

1 International Franchise Association 46 th Annual Legal Symposium May 5-7, 2013 JW Marriott Hotel, Washington, DC Disclosure Basics Under Federal and State Franchise Laws Lauren Fernandez FOCUS Brands Atlanta, Georgia Timothy O Brien* Virginia State Corporation Commission Richmond, Virginia Felicia N. Soler Kaufmann Gildin Robbins & Oppenheim, LLP New York, New York *The opinions expressed by Mr. O Brien in this paper and during the oral presentation are his own and do not necessarily represent the views of the Virginia State Corporation Commission or NASAA.

2 TABLE OF CONTENTS I. INTRODUCTION... 1 II. DISCLOSURE UNDER FEDERAL LAW... 1 A. Introduction To The FTC Franchise Rule... 1 B. To Whom Must Disclosure Be Effected?... 1 C. What Must Be Delivered?... 2 D. When Must Disclosure Be Effected? E. How Must Disclosure Be Made? F. Duty To Amend The FDD G. FTC Revised Franchise Rule Exemptions H. Penalties For Noncompliance III. DISCLOSURE UNDER STATE LAWS A. History Of The State Registration/Disclosure Laws B. To Whom Must Disclosure Be Effected? C. What Must be delivered? D. When Must Disclosure Be Effected? E. How Must Disclosure Be Made? F. Duty To Amend The FDD G. Typical Disclosure Issues Raised By State Examiners H. Exemptions From State Disclosure Requirements I. State Penalties for Noncompliance IV. CONCLUSION i

3 I. INTRODUCTION It was almost immediately after franchising came of age in the late 1950's and the decade of the 60's that the criminal community including organized crime began perpetrating deceit and fraud on victims who believed they were investing their money to become franchisees of legitimate businesses. Instead, those unsuspecting victims were purchasing phantom, non-existent franchises. To eradicate that fraud and criminality, the first franchise-specific law of any kind was enacted by the state of California in And since that time, fourteen more states and the Federal Trade Commission ( FTC ) have followed suit, each enacting their own franchise-specific law requiring franchisors to prepare and disclose prospective franchisees with a franchise disclosure document ( FDD ). This paper focuses on the disclosure requirements of the federal FTC Franchise Rule and the fifteen states featuring their own franchise-specific disclosure laws. 1 Although fourteen of those fifteen states also require franchisors to file an application or notice with the state before offering or selling franchises in the state, giving them the name registration/disclosure states, that registration process will not be addressed in this paper. II. DISCLOSURE UNDER FEDERAL LAW A. Introduction To The FTC Franchise Rule In 1978, seven years after the state of California enacted the first franchise-specific law, the FTC promulgated what is colloquially referred to as the FTC Franchise Rule, 2 the first, and to this day only, franchise-specific law at the federal level. Governing alongside, and not preempting, state franchise registration/disclosure statutes, the FTC Franchise Rule would apply to franchise sales activity throughout the United States, its territories and possessions. The FTC Franchise Rule remained unchanged for many years following its adoption. Then, in 1995, the FTC initiated a regulatory review of the FTC Franchise Rule, seeking to improve the Rule to respond to the massive economic, societal and technological changes which had transpired since its enactment. Following 12 years of extensive public hearings and workshops, the FTC comprehensively revised the FTC Franchise Rule on January 22, Accompanying the 2007 revisions to the FTC Franchise Rule was the Commission s Statement of Basis and Purpose 4 (referred to hereafter as the SBP ), which serves to amplify and clarify the revised FTC Franchise Rule s requirements and prohibitions. B. To Whom Must Disclosure Be Effected? The 2007 revisions to the FTC Franchise Rule significantly changed the landscape of franchise disclosure protocol which had subsisted since California enacted the first franchise registration/disclosure statute in Since that time, franchisors had been 1

4 required both under the FTC Franchise Rule and under every state franchise law to furnish their disclosure documents directly to the prospective franchisee. However, the 2007 revisions to the FTC Franchise Rule dramatically changed this platform by permitting a franchisor to effect disclosure upon a franchisee s representative in lieu of the prospective franchisee himself/herself/itself. Indeed the FTC Franchise Rule accomplishes this by including in the definition of a prospective franchisee any agent, representative or employee of the prospective franchisee. 5 The SBP explains the rationale behind the change: 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. 6 A few questions have arisen in connection with this expanded approach. For example, if an agent, representative or employee of the prospective franchisee instead of the prospective franchisee itself is disclosed, who may confirm receipt of the FDD? Can it be just the individual who was disclosed and not the prospective franchisee himself/herself/itself? The answer appears to be yes under the above-quoted provisions of the SBP. C. What Must Be Delivered? Under the FTC Franchise Rule, a franchisor must, as under state franchise registration/disclosure laws, prepare and disseminate to prospective franchisees an FDD containing all material information necessary for them to make informed investment decisions. Unlike the state franchise law protocol, however, no registration of the franchisor, or prior review and approval of its FDD by the FTC, is required by the FTC Franchise Rule. The FTC Franchise Rule s disclosure requirements create a disclosure floor which all franchisors have to comply with nationwide and which all franchise regulating states must accept. The FDD consists of required federal and state cover pages and 23 substantive Items, each of which seeks to elicit material information pertaining to a particular subject or a related group of subjects. 7 The first page of the FDD must be the FTC Franchise Rule cover page, which sets forth the franchisor s name, type of business organization, principal business address, telephone number, address, primary homepage address and a sample of the primary business trademark or service mark that franchisees will use in their businesses. A brief description of the franchised business follows. Then appear disclosures regarding the total investment necessary to begin operation of the subject franchise. Standard disclosure language follows next: the requirement that the franchisor furnish its FDD to the prospective franchisee at least 14 calendar days before the franchisee signs any binding agreement with, or makes any payment to, the franchisor or its affiliate; the fact that the terms of the franchise agreement itself, and not the FDD, will govern the franchise relationship; a suggestion that the prospective 2

5 franchisee review the FDD and franchise agreement with an advisor, such as an attorney or an accountant; and, information sources which prospective franchisees can access to obtain more information on franchising. The FTC Franchise Rule permits franchisors to state on their FTC Franchise Rule cover pages any alternative formats which those franchisors make available for their franchisees to review FDDs (paper, e- mail, web access CD-ROM, etc.). Finally, the FTC Franchise Rule cover page must identify the FDD s Issuance Date, which is an arbitrary date selected by the franchisor and is usually the date that the subject FDD is finalized and/or put into use. Following this FTC Franchise Rule cover page is the state cover page required by all franchise registration/disclosure states. (see discussion in Section III.C. of this paper below for a summary of the contents of the state cover page). The FDD then presents the substantive disclosures required by the FTC Franchise Rule and non-preempted state franchise registration/disclosure law provisions in a series of 23 Items. The first four FDD Items relate to the business of the franchising company itself, the principals of that company and the backgrounds of both. Accordingly, in Item 1 of the FDD is information pertaining to the identity and business form of the franchisor (e.g. corporation, partnership, proprietorship or other business organization); the franchisor's principal business address; the name and address of any corporate parent or affiliate (if that affiliate either offers franchises in any line of business or provides products or services to the franchisees of the franchisor); whether the franchisor has any "predecessors" (i.e. other entities from whom the franchisor acquired the majority of its assets); a description of the franchisor's business; and, a description of the franchises offered by the franchisor. Also in Item 1 is a detailed description of the prior business experience of the franchisor, including the length of time it has conducted a business of the type to be franchised; the length of time the franchisor has offered franchises for sale; and, whether the franchisor has offered franchises in other lines of businesses. Finally, franchisors must disclose in Item 1 any laws or regulations specific to the operation of their franchises (as distinct from those applicable to business in general) and a general description of the competition franchisees will encounter. In Item 2, franchisors must set forth the names, positions and titles of their officers, directors, and other principals and executives who have management responsibility, including their principal occupations and employers over the past five years. Item 3 of the FDD sets forth information regarding the pertinent criminal and civil litigation history of both the franchisor; its officers, directors and other principals; and, if applicable, its parents and affiliates (if they guarantee the franchisor s performance, have themselves offered franchises under the franchisor s principal mark or have had government litigation commenced against them). These required litigation disclosures include whether the franchisor or its officers, directors and other principals have pending against them any administrative, criminal or material civil actions alleging a violation of franchise, antitrust, or securities law or alleging fraud, unfair or deceptive practices, or 3

6 comparable allegations; 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; and whether, in the ten year period immediately prior to the FDD s issuance date, the franchisor or any of its officers, directors or other principals has been convicted of a felony or been held liable in a civil action involving allegations of franchise, antitrust or securities law violations or allegations of fraud, unfair or deceptive practices (or comparable allegations). The FDD must provide the following information for cases that are required to be included in Item 3: the case title; case number or citation; the initial filing date; the names of the parties; the forum; the relationship of the opposing party to the franchisor; a summary of the legal and factual nature of each claim in the action; the relief sought or obtained; if the action is pending, the status of the action; and any conclusions of law or fact. Included in the litigation which must be disclosed in Item 3 is material litigation commenced by the franchisor against its franchisees involving the franchise relationship during the prior fiscal year (excluding actions or proceedings involving suppliers or other third parties, or indemnification for tort liability). The FTC has noted that materiality is to be determined from the viewpoint of a reasonable prospective franchisee and that the requirement to disclose franchisor-initiated litigation is to be interpreted broadly to cover most suits. In an effort to relieve this disclosure burden on franchisors, the FTC Franchise Rule permits the grouping of all such actions or proceedings against franchisees under common headings with only the applicable case names, courts and file numbers listed, as opposed to more extensive case summaries. For example, a franchisor which initiated five royalty collection suits during its preceding fiscal year could satisfy its disclosure obligation by listing the aforementioned information concerning each such suit under the heading Royalty Collection Suits, without the need to provide any additional explanation or elaboration. In Item 4 of the FDD, the franchisor is required to disclose any bankruptcy history of the franchisor, its officers, directors, partners, managers, affiliates and predecessors. Having addresses the franchisor-related disclosures, the FDD then turns its attention to just what monies a franchisee has to spend in order to acquire and commence operation of the franchise in question. These are particularly crucial disclosures for prospective franchisees. In Item 5 of the FDD, a franchisor must disclose its initial fees and any conditions under which those fees are refundable. If initial fees are not uniform, the franchisor must disclose the range or formula used to calculate the initial fees which it received in the fiscal year before the issuance date of the FDD, and the factors that determined this amount. 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, most certainly including any initial franchise fee or equivalent which a franchisee must pay in consideration of the franchisor s execution of the franchise agreement. 4

7 In Item 6 of the FDD, franchisors must disclose in a table all of the additional 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, throughout the term of the franchise relationship. This requires disclosure of fees such as royalties; service fees; advertising fees; training fees; lease payments; and, product purchase charges. With respect to each such fee or payment, the time for payment must be specified; whether the fees are uniformly imposed must be disclosed; the formula used to compute such fee or payment (if applicable) must be set forth; and, the franchisor must state whether any such fee or payment is refundable, in whole or in part, and if so, under what circumstances. Franchisors must also disclose in Item 6 the voting power of any franchisor-owned units on any fees or charges imposed by cooperatives in which such units participate (advertising cooperatives, purchasing cooperatives and so forth). If franchisor-owned units will have controlling voting power over such cooperatives, then the franchisor must disclose the maximum and minimum fees that may be imposed by such entities. If any of the foregoing fees may increase, then the franchisor must disclose the formula that determines the increase or the maximum amount of the increase. The title and column headings of the Item 6 table are proscribed by the FTC Franchise Rule and should be prepared in exact accordance therewith. The types of fees disclosed in the first column of the table, however, should be customized for the particular FDD. The following table is an example of an Item 6 table prepared in accordance with the requirements of the FTC Franchise Rule: ITEM 6 OTHER FEES (1) (2) (3) (4) Type of fee Amount Due Date Remarks Continuing Royalty 5% of Gross We electronically Gross Revenues Revenues debit your bank includes all account on the first revenues from the Thursday of every franchised month, based on Business. your weekly sales reports for the month. Advertising Fee 2% of Gross We electronically Revenues debit your bank account on the first Thursday of every month, based on your weekly sales reports for the month. Payments for When we or affiliate We and our 5

8 Products and Services You Buy from Us or Affiliates require. affiliates may serve as non-exclusive Approved Suppliers. If you choose to buy from us or affiliates, you must pay the prices we or our affiliates set. In Item 7 of the FDD, franchisors have to describe in detail all payments which their franchisees have to expend in order to fulfill their initial investment requirements. In tabular form, the franchisor must disclose information about all "pre-opening" expenditure obligations, including the initial franchise fee itself; the cost of purchasing or leasing the franchised business' premises; construction and other "build out" costs; equipment; inventory; advertising; training; signs; working capital; legal and accounting fees; security deposits; insurance payments; and, utility bills. With regard to each of these categories of expenditures, franchisors must specify when and to whom such payments are going to be made, how such payments are determined, and whether part or all of any such payment is refundable. Also included in the Item 7 table are any additional funds that must be spent for other required expenses the franchisee will incur during the initial period of operations. The FTC Franchise Rule defines a reasonable initial period as at least three months or a reasonable period for the applicable industry. If all or any part of a franchisee's initial investment will or may be financed by the franchisor, then the down payment required, the estimated effective annual interest rate imposed and the estimated loan repayment schedule itself must be specified. Like the Item 6 table, the title and column headings of the Item 7 table are proscribed by the FTC Franchise Rule and should be prepared in exact accordance therewith. The types of expenditures disclosed in the first column of the table, however, should be customized for the particular FDD. The following table is an example of an Item 7 table prepared in accordance with the requirements of the FTC Franchise Rule: ITEM 7 ESTIMATED INITIAL INVESTMENT YOUR ESTIMATED INITIAL INVESTMENT (1) Type of expenditure (2) Amount Initial Franchise Fee $12,000 - $30,000 Real Property See Note 2 (3) Method of payment Lump Sum (4) When due At signing of Franchise Agreement (See Note 1) (5) To whom payment is to be made Us 6

9 Construction/Remodeling/ Leasehold Improvement 0 - $200,000 See Note 3 Inventory (yard signs, riders, etc.) $5,000 - $20,000 Office Equipment & 0 - $70,000 Supplies;Decor, Fixtures See Note 4 & Furnishings Computer Hardware And 0 - $12,500 Software See Note 5 Signs 0 - $20,000 See Note 6 Additional Funds $50,000 - (3 Months) $90,000 See Note 7 Total. $67,000 - $442,500 As contractor or landlord requires Lump sum As seller requires As seller requires As seller requires As expenses occur As contractor or landlord requires When incurred As supplier requires As supplier requires As supplier requires Payroll weekly, other purchases Contractor or landlord Seller Seller Seller Seller Employees, sellers of goods and services Item 8 of the FDD provides information pertaining to the obligation of a franchisee to purchase goods, services or equipment from the franchisor and/or designated third parties. If a franchisee has to purchase or lease goods, services, supplies, equipment or real estate from the franchisor or its designee, the details of those transactions must be set forth in Item 8. If a franchisee has to purchase such goods, services, supplies and/or equipment from third parties, either from suppliers approved by the franchisor or in accordance with specifications issued by the franchisor, then the details of those transactions also must be set forth in Item 8. A franchisor must also disclose if an officer of the franchisor owns a material interest in a supplier with whom franchisees will (or may) deal with. Further, a franchisor must disclose in Item 8 whether it (or any of its affiliates) may or will derive revenue or other consideration from required purchases or leases by its franchisees and, if so, the precise basis by which the franchisor or its affiliates may or will derive such revenue. In such circumstance, the franchisor must disclose its total revenues (derived from its most recent annual audited financial statements); its revenues from all required purchases and leases of products and services; and, the percentage of the franchisor s total revenues derived from such required purchases or leases (with parallel disclosure required if it is the franchisor s affiliate which is receiving revenues based on franchisee purchases of goods or services). In all circumstances, the franchisor must disclose the estimated proportion which the franchisee s required purchases and leases (from designated sources and/or approved suppliers) bear to the entirety of purchases and leases by the franchisee of goods and services required to establish and operate the franchised business. If a purchasing or distribution cooperative exists in the subject franchise network, this fact must be disclosed in Item 8. Critically, if a designated supplier will make payments to the franchisor as a result of franchisee purchases from that supplier, the precise amount of that payment (percentage or flat amount) must be disclosed - - as must any circumstance in which a 7

10 franchisor provides material benefits to a franchisee based on that franchisee s purchase or particular products or services or the use of particular suppliers. Lastly, if the franchisor negotiates purchase agreements with suppliers for the benefit of franchisees, this circumstance must also be conveyed in Item 8. Item 9 of the FDD requires a franchisor to set forth, in a table cross-referencing the applicable provisions of the subject franchise agreement and FDD, all of the principal obligations which a franchisee must assume and discharge under the franchise agreement (and any franchise-related agreements), including: site selection and acquisition; pre-opening purchases and leases; site development; training; time within which the franchised unit must be opened; compliance with the franchisor's standards and policies; restrictions on products or services which may be offered from the franchised unit; warranty and other customer service requirements; territorial development and sales quotas; ongoing product or service purchase requirements; insurance; advertising; covenants not to compete; franchise transfer restrictions; renewal; and, obligations which the franchisee must assume following the expiration or termination of the franchise. Item 10 requires disclosure of any financing arrangements that a franchisor, its agent and/or affiliates offer directly or indirectly to a franchisee. The terms of each financing arrangement must be set forth in the FDD, including, among other pieces of information: the identity of the lender providing the financing and its relationship to the franchisor; 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; the annual percentage rate of interest charged; and whether the debt can be prepaid and the nature of any prepayment penalty. A franchisor offering financing must also annex specimen copies of any and all standard financing documents. The next series of Items in the FDD describes the franchise relationship itself -- who gives and who gets what throughout the term of the franchise. In Item 11, franchisors must disclose in detail all of the obligations which they will fulfill both prior to the opening of the franchised business and thereafter during the operation of that business, including: selecting, leasing or approving the premises of the franchised business; "building out" or otherwise developing the premises; purchasing, leasing or specifying equipment for the franchised business; furnishing sources of supply and/or specifications for goods and services used in the operation of the franchised unit; installing signs and fixtures at the business location; furnishing opening inventory, supplies and related materials; training the franchisee; establishing prices; engaging in advertising activities; establishing and maintaining administrative, bookkeeping, accounting, inventory control or other general operating procedures; and, describing in detail the franchisor's utilization of an operating manual to assist franchisees and their employees in the operation of the franchised business. The franchisor must also describe the requirements for franchised unit computerization. 8

11 A franchisor must also set forth extensive disclosures in Item 11 regarding its advertising programs and to what extent the franchisor is obliged to conduct advertising. These disclosures must include specifications regarding media the franchisor may use; whether media coverage is local, regional or national; the source of advertising (for example, an in-house advertising department or an outside advertising agency); whether the franchisor must spend any amount on advertising in the area or territory where the franchised unit is located; the circumstances under which franchisees will be permitted to use their own advertising materials; whether there is an advertising council composed of franchisees that advises the franchisor on advertising policies (and, if so, details regarding how members of the council are selected, whether it has any decisionmaking power and whether the franchisor has the power to form, change or dissolve the advertising council); whether the franchisee must participate in local or regional advertising cooperatives (including detailed disclosures regarding how those cooperatives are composed and administered); whether franchisor-owned outlets must contribute to the advertising fund; who administers the advertising fund; whether the fund is audited or not; whether the financial statements of the advertising fund will be available for review by franchisees; and, how advertising funds were used in the most recently concluded fiscal year. Site selection requirements and approval procedures also have to be addressed in Item 11, as must the typical length of time between the signing of the franchise agreement and the opening of the franchised business. Finally, Item 11 calls for a full and detailed description of the franchisor's training programs and the individuals who are in charge of those programs, including the location, duration and content of such programs; when training will be conducted; the experience of the franchisor's training instructors; any training-related charges which must be borne by franchisees; and, whether additional training programs and/refresher programs will be offered in the future. Item 12 of the FDD provides information relating to the territorial rights (if any) which will be accorded to franchisees under the franchise agreement. If such territorial rights are conferred, then the typical boundaries of a territory must be described in Item 12 (i.e. city, metropolitan area, county, state, radius of specific distance, population, number of registered vehicles or other variant); the rights of the franchisor to itself conduct business within that territory (by means of additional units, the internet, 800 telephone sales, catalogues or otherwise) must be discussed; the restrictions or rights of the franchisor or others to "invade" that territory must be specified; relocation rights must be addressed; and, the degree to which a franchisee will be restricted from soliciting sales or accepting orders from outside of its defined territory must be specified. If the franchisee's territorial rights are conditioned upon it satisfying sales quotas or other measures of market penetration, or if other circumstances or contingencies will permit the franchisor to modify a franchisee's territorial rights, then these must also be described in detail in Item 12. If no territorial rights are conferred upon the franchisee, then a special warning is required by the FTC Franchise Rule: 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. 9

12 In Items 13 and 14 of the FDD, all pertinent information concerning the franchisor's trademarks, service marks, tradenames, commercial symbols, copyrights and patents must be disclosed, including whether they are registered (or pending); whether they are disputed; the extent to which the franchisor will protect its franchisees' rights to use those names, marks, patents and copyrights; whether any infringing uses are actually known to the franchisor which could materially affect a franchisee's use thereof; and, a description of any relevant litigation concerning those names, marks, patents and copyrights. If the franchisor has no federally registered trademark, then the following warning must appear in Item 13: 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. Item 15 addresses the obligation of a franchisee to participate personally in the direct operation of the franchised business. If the franchisee is an individual, then Item 15 will inform that individual whether the franchised business must be under his direct onpremises supervision or whether the franchisee can, alternatively, hire a manager to conduct the on-premises supervision of that business. If the franchisee is a corporation or partnership, then the franchisor is required to identify who must conduct the onpremises management of the franchised business. FDD Item 16 addresses the issue of whether the franchise agreement places any restrictions on franchisees concerning the customers with whom they may deal, or the goods and services which they may offer for sale. Accordingly, you will find in Item 16 a description of any obligation imposed upon franchisees to sell or provide only those goods and services approved by the franchisor; the effect of such restrictions on the franchisees' right to sell or provide other goods or services; a description of any obligation pursuant to which franchisees must sell or provide all (and not just some) of the goods and services authorized by the franchisor; information concerning whether franchisees are restricted as to the customers to whom they may sell their goods and services; and, the extent to which the franchisor has the right to change the types of authorized goods and services which its franchisees may/must sell. Having already introduced the prospective franchisee to the franchisor and its principals; informed it of the payments and investments required to establish a franchised business; and, described in detail the nature of the franchise relationship once that business has been opened, the FDD turns its attention to subjects of critical importance - - the term of the franchise relationship; the ability of a franchisee to renew that relationship; the ability of a franchisor to terminate that relationship; whether franchisees are free to sell their franchises to third parties; applicable covenants not to compete; and, dispute resolution. In Item 17 of its FDD, a franchisor is required to include a table, cross-referencing the applicable provisions of its franchise agreement, which addresses: the length of the initial franchise term; the length of any renewal or extension term; any requirements that a franchisee must fulfill in order to renew or extend its franchise agreement; under what 10

13 circumstances either the franchisor or franchisee may terminate the franchise agreement; what obligations the franchisee must discharge following termination of its franchise agreement; whether the franchisor may sell or assign the franchise agreement; whether sale or assignment of the subject franchise by the franchisee is freely permitted, subject to prerequisites being fulfilled or altogether prohibited (including details regarding any franchisor rights of first refusal or approval concerning any such franchisee sale or transfer); what will transpire upon the death or disability of the franchisee (or, if a business entity, the individuals who manage the franchise on a dayto-day basis); a description of all covenants not to compete which bind the franchisee both during the term of the franchise and following its termination or expiration; whether and under what circumstance the franchise agreement may be modified; the terms and effect of any franchise agreement merger/integration clause (note that the revised FTC Franchise Rule specifically forbids franchisors from disclaiming the contents of their FDDs through any such merger/integration clause); whether franchisor-franchisee disputes are to be resolved by arbitration or mediation; where disputes will be litigated or arbitrated ( forum selection ); and, under what body of law franchisor-franchisee disputes will be decided ( choice of law ). Item 18 of the FDD requires a franchisor to disclose whether or not any "public figure" is associated with the franchise chain and, if so, if that public figure is being compensated. Item 19 addresses the all important subject of financial performance representations. A financial performance representation is any information which a franchisor seeks to impart to prospective franchisees which states, suggests or implies what sales, income or profits a franchisee can derive from the operation of a franchised business. Financial performance representations come in two varieties: a description of the past financial performance of franchised or nonfranchised units and a projection of the future performance of those units. So it is that, with the limited exception of imparting financial performance representations limited solely to the actual operating results of a specific unit being offered for sale, any and all information which a franchisor seeks to give to a prospective franchisee regarding levels or ranges of actual or potential sales, costs, income or profits from franchised or non-franchised units must be set forth in FDD Item 19 (or, if no financial performance representations are being given, that fact must be noted). FDD Item 20 seeks to impart information regarding the historic and prospective growth or contraction of the franchise network, coupled with the current status of that network in terms of the number of operational units. A franchisor must set forth five tables, four of which detail the status of the subject franchise network during each of the franchisor s three most recent fiscal years (how many franchised and company-owned units were open at the beginning of each year/end of each year; how many franchise transfers were effected, on a state by state basis; how many franchised units, again on a stateby-state basis, were terminated, not renewed, reacquired by the franchisor or ceased operations; identical information for company-owned units) and a fifth table featuring the franchisor s estimate of the number of franchises it will grant on a state-by-state basis over its coming fiscal year. 11

14 In addition, franchise specific information is required: the names, unit addresses and unit telephone numbers of all currently operating franchisees must be set forth in Item 20 (usually by means of an exhibit thereto) as must the names, cities, states and current business telephone numbers (or, if unknown, the last known home telephone numbers) of every franchisee who had an outlet terminated, cancelled, not renewed or otherwise ceased doing business during the franchisor s most recently completed fiscal year (or who has not communicated with the franchisor within ten weeks of the issuance date of the FDD). Further, if franchisees signed confidentiality agreements during the franchisor s last three fiscal years which restrict or preclude their ability to communicate their experiences with prospective franchisees, this fact must be disclosed. Finally, a franchisor must disclose in Item 20 information regarding each trademark-specific franchisee organization associated with its franchise network (whether created, sponsored or endorsed by the franchisor or, if organized under state law and timely requesting inclusion in the franchisor s FDD, independent franchisee associations as well). In FDD Item 21, a franchisor must set forth its (and/or, in certain instances, its corporate parent s) audited income statements and balance sheets for the preceding three fiscal years. In FDD Item 22, all franchise and other contracts or agreements between the franchisor and its franchisees -- including not only the franchise agreement itself, but any financing agreements, lease agreements, option agreements, product purchase agreements, area development agreements and the like -- must be set forth in full. Finally, FDD Item 23 is a required receipt form -- that is, a receipt evidencing the fact that a prospective franchisee received a copy of the franchisor's FDD in accordance with law. Given the ability of franchisors to engage in electronic disclosure, this receipt can be downloaded and electronically transmitted back to the franchisor or, more traditionally, printed, signed, and mailed or hand delivered by the prospective franchisee. The franchisor is obliged to identify on each prospective franchisee s Item 23 receipt the name, business address and telephone number of each franchise seller (franchisor-employed salesperson or representative, franchise broker, subfranchisor) involved in offering and selling the franchise to the prospect. D. When Must Disclosure Be Effected? The FTC Franchise Rule requires franchisors to furnish their FDDs to prospective franchisees fourteen calendar days before the prospective franchisee signs a binding agreement with, or makes any payment to, the franchisor or its affiliate. To eliminate confusion as to when the required fourteen day disclosure period has elapsed and the franchise agreement can thus be signed or money accepted, the FTC s SBP specifies that the fourteen days commence the day after delivery of the FDD, such that the signing of any agreement or receipt of payment can take place fifteen days later. 8 Thus, 12

15 prospective franchisees have a full fourteen calendar days to review the FDD. To be cautious, many practitioners counsel a 16 day advance disclosure protocol. There is no general requirement under the FTC Franchise Rule that a franchisor furnish any franchise or franchise-related agreement in a form ready for execution (that is, with all names, addresses and individualized data set forth) to a prospective franchisee at any time prior to the franchisee s execution thereof. Instead, only if the franchisor has unilaterally and materially altered the terms of any standard franchise or other agreement attached to its FDD must that franchisor furnish an execution ready copy of that agreement to its prospective franchisee seven calendar days prior to the franchisee s execution thereof. Negotiated changes to a franchisor s standard form of franchise agreement will not trigger this limited franchise agreement disclosure requirement, nor will instances where the only changes made by the franchisor to the standard contract consists of fill in the blank provisions such as the date, name and address of the franchisee. 9 The FTC Franchise Rule features other disclosure obligations and triggers which must be complied with. First, the FTC Franchise Rule requires franchisors to furnish copies of their FDDs to prospective franchisees upon reasonable request earlier in the sales process than is otherwise required by the Rule. Second, the FTC Franchise Rule also requires that disclosure be effected to existing franchisees who are renewing their franchises if the franchisee must make a required payment for the right to enter into a new franchise agreement and/or if the renewal agreement contains terms and conditions that differ materially from the expiring agreement. 10 Lastly, the FTC Franchise Rule features another disclosure trigger under which franchisors are obligated to redisclose with their most recent FDDs, upon reasonable request, any prospective franchisees who are in the sales pipeline. Regarding this requirement, the SBP states: (The Rule) recognizes that the information contained in a FDD may become out-of-date by the time a prospect who relies on such information is ready to sign a franchise agreement. It prevents deception by enabling such prospective franchisees, if they wish, to get any updated disclosures prepared by the franchisor. 11 Critically, a franchisor is under no disclosure obligation whatsoever with regard to the sale or other assignment of a franchise by an existing franchisee where the franchisor has no significant involvement with the transferee. 12 E. How Must Disclosure Be Made? Under the FTC Franchise Rule, franchisors may furnish FDDs to prospective franchisees in any fashion they elect, including hand delivery; ; granting access over the internet; fax; or, by mailing to the prospective franchisee the FDD in either paper or tangible electronic form (such as on a computer disk or CD-ROM) by first class U.S. mail at least three days before the required disclosure date. One of the most revolutionary aspects of the 2007 revisions to the FTC Franchise Rule, which captures not only recent technological innovations but seeks to anticipate and 13

16 capture as well developments which surely will follow, is its authorization for franchisors to engage in pure electronic disclosure, subject to certain limitations. First, before effectuating disclosure, franchisors are required to advise prospective franchisees of the formats in which the FDD is available so that those prospects may request delivery by a method they can easily use. 13 And second, although franchisors are permitted to utilize navigational tools (such as scroll bars, internal links and search features) in the FDD, franchisors are prohibited from using any electronic enhancements - - such as audio, video, other multimedia, pop-up screens and external links - - which a franchisor could otherwise utilize to call attention to favorable portions of its FDD and/or distract prospective franchisees from less than favorable disclosures. Notwithstanding the obvious benefits of pure electronic disclosure for franchisors (e.g. reduction in costs, efficiency, and reliable records), the process would be impossible if, as in the past, a franchisor had to obtain a manually signed FDD Item 23 receipt from each prospective franchisee. Accordingly, the FTC Franchise Rule now expressly permits a franchisee to sign the receipt either manually or by using security codes, passwords, electronic signatures, or similar devices to authenticate his or her identity. The FTC Franchise Rule also authorizes franchisors to include instructions in their Item 23 receipts regarding how the receipts should be returned to the franchisor (for example, by mail to a specified street address, internet transmission, , or fax to a specified fax line number). Thus, the FTC Franchise Rule permits Item 23 receipts to be executed electronically, but clearly puts franchisors in the position of always having in place a protocol designed to capture proof of such electronic receipts not only for Rule compliance but also in defense of any litigation claim that disclosure was not properly effected. F. Duty To Amend The FDD The FTC Franchise Rule requires that all information in a franchisor s FDD be current as of the close of the franchisor s most recent fiscal year. 14 The Rule affords franchisors 120 days following the close of their fiscal years in which to prepare their updated FDDs. 15 In addition to the requirement to update the FDD annually, the FTC Franchise Rule also imposes a quarterly update requirement. Specifically, franchisors must, within a reasonable time after the close of each quarter following their most recent fiscal year, prepare an attachment to their FDDs to reflect any material changes in the franchisor or relating to the franchise business of the franchisor. The attachment(s) must be delivered to prospective franchisees along with the core FDD. 16 Although the FTC Franchise Rule fails to define what constitutes a material change, changes in management personnel, mergers and acquisitions involving the franchisor, significant litigation or arbitration developments, significant changes in the franchisor s financial situation, and any other change that would influence a prospective franchisee s investment decision are likely material changes necessitating a quarterly update. 14

17 An exception to the general FTC Franchise Rule quarterly update protocol pertains to any financial performance representations set forth in a franchisor s FDD. If any such financial performance representation is contained in a franchisor s FDD, then the FTC Franchise Rule requires franchisors to notify their prospective franchisees of any material changes to such representations through the date - - and by the date - - that disclosure is required under the FTC Franchise Rule. 17 In stark contrast to state franchise law requirements, such material changes to financial performance information may be furnished to prospective franchisees outside of the FDD if the franchisor so chooses (through separate writings or other communications). 18 G. FTC Revised Franchise Rule Exemptions Although the FTC Franchise Rule affords exemptions from its disclosure requirements, those exemptions are confined to the 35 states featuring no franchise registration/disclosure laws of their own; are not preemptive on the franchise regulating states; and, unless an identical exemption is available thereunder, do not apply in the 15 states having such laws on their books. The FTC Franchise Rule exemptions are as follows: (1) Minimum Payment Exemption. 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) Fractional Franchise Exemption. The franchise relationship is a fractional franchise. The FTC Franchise Rule defines a fractional franchise as a franchise relationship that satisfies the following criteria when the relationship is created: (1) 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) 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. 19 (3) The Leased Department Exemption. The franchise relationship is a leased department. The FTC Franchise Rule defines a 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 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. 20 The common example of a leased department is a specially designated section such as a make up or jewelry counter at a shopping mall. The space for these types of businesses is typically leased by the mall to a third party retailer and the 15

18 mall will typically exercise controls over the retail operation (i.e., approval rights for all signage, marketing and products). (4) Large Investment Exemption. 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 acknowledgement verifying the grounds for the exemption. The required $1 million investment (excluding unimproved land costs and financing from the franchisor or its affiliate) (the large investment exemption ) is typically calculated by reviewing the prospective franchisee s initial investment as would be set forth in Item 7 of an FDD prepared in accordance with the FTC Franchise Rule. 21 The required $1 million investment necessary for a franchisor to take advantage of the exemption need not be limited to a single unit. 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. 22 It is important to note that the application of the $1 million investment exemption is more difficult when the franchisee entity is comprised of multiple investors. In that case, the exemption will apply only if at least one individual in a franchisee investor group qualifies as sophisticated by investing at the threshold level. 23 (5) Sophisticated Franchisee Exemption. The franchisee entities (including any parent or affiliates) have been in business for at least five years and have a net worth of at least $5 million. A large franchisee need not have five years of business experience in franchising or in the industry that the franchisee will enter as a result of the franchise. Instead, five years of business experience in any business will suffice. 24 The types of prospective franchisee entities eligible for this exemption include corporations, partnerships, other business entities and individuals. (6) Insider Transactions. 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. 25 (7) Oral Agreements. There is no written document that describes any material term or aspect of the relationship or arrangement. (8) The PMPA Exemption. The franchise relationship is covered by the Petroleum Marketing Practices Act, 15 U.S.C

19 H. Penalties For Noncompliance The FTC Franchise Rule directly holds liable a franchisor for any failure to prepare an FDD in accordance with the requirements of the Rule. However, the FTC Franchise Rule only indirectly denominates those other than the franchisor who may be held liable for a franchisor s disclosure violations. An officer or director of a franchisor may be held liable under the FTC Franchise Rule for redress relating to a franchisor s disclosure violations if that officer or director directed the franchisor s employees to prepare false or misrepresented disclosures or failed to stop the company from using an FDD that one or more states had previously rejected as insufficient. Against the franchisor and/or its officers and directors, the FTC is empowered to seek fines of up to $11,000 per violation in addition to other measures of financial relief such as restitution, rescission and damages. In addition, the FTC has the ability to seek temporary restraining orders and preliminary injunctions against an allegedly errant franchisor which would prohibit it from engaging in any further franchise sales activity whatsoever nationwide. Finally, while under the FTC Franchise Rule the FTC may not itself institute criminal proceedings for Rule violations, the FTC may refer to the United States Department of Justice for criminal prosecution any instances of criminal wrongdoing uncovered in the course of an FTC investigation. Notwithstanding the FTC s ability to seek redress for disclosure violations under the FTC Franchise Rule, there exists no private right of action for franchisees injured by Rule violations. However, aggrieved franchisees may commence legal proceedings complaining of FTC Franchise Rule violations under certain states Little FTC Acts - - statutes which, in essence, provide that any violation of the FTC Franchise Rule is deemed to also constitute a violation of the subject Little FTC Act. And since these Little FTC Acts almost universally confer upon individuals the right to commence legal proceedings for any violation of those laws, citizens in those states featuring Little FTC Acts can commence court proceedings against their franchisors complaining of violations of the FTC Franchise Rule. Technically speaking, they are doing so not under the FTC Franchise Rule itself but under their state s Little FTC Act. So it is that citizens of certain states - - those featuring Little FTC Acts - - can commence legal proceedings complaining of violations of the FTC Franchise Rule while citizens of other states may not. 17

20 III. DISCLOSURE UNDER STATE LAWS A. History Of The State Registration/Disclosure Laws The essence of state franchise registration/disclosure statutes is simple. Under these laws, no franchise may legally be offered or sold, no contract signed and no money paid unless the prospective franchisee first receives a comprehensive FDD designed to enable that prospect to make an informed investment decision. The fifteen states featuring their own franchise disclosure laws are California 26, Hawaii 27, Illinois 28, Indiana 29, Maryland 30, Michigan 31, Minnesota 32, New York 33, North Dakota 34, Oregon 35, Rhode Island 36, South Dakota 37, Virginia 38, Washington 39 and Wisconsin 40. Of those fifteen states, all but Oregon are so called registration/disclosure states because they also require a pre-sale filing with the state. In California, Hawaii, Illinois, Maryland, Minnesota, New York, North Dakota, Rhode Island, Virginia and Washington, a franchisor must first register itself and its FDD, a daunting task for the uninitiated, before any franchise advertising appears, any franchise offers are made or any franchise sale is effected. In Indiana, South Dakota and Wisconsin, only a notice filing and dissemination of the FDD is required; that document is not reviewed prior to use. Michigan requires only the filing of a Notice of Franchise Offering. And, as stated above, under Oregon law, only disclosure is mandated, without any prior registration, filing or review requirement. With a few notable exceptions, the FTC Franchise Rule does not preempt state franchise registration/disclosure statutes. Instead, the FTC Franchise Rule governs side-by-side with state franchise registration/disclosure laws. The first exception is that the FTC Franchise Rule will preempt a state franchise registration/disclosure statute to the extent the state law does not afford prospective franchisees with equal or greater protection (such as registration of FDDs; more extensive or additional disclosures; or, regulation of the franchisor-franchisee relationship) than the Rule provides. The second exception is with respect to the required contents of a franchisor s FDD the FTC Franchise Rule s disclosure requirements create a disclosure floor which all franchisors have to comply with nationwide and which all franchise regulating states must accept. B. To Whom Must Disclosure Be Effected? One must pay close attention to the jurisdictional scope of each state s franchise law. By their terms, each state registration/disclosure statute governs all franchise sales activity that takes place in this state. But what do the words in this state mean? The answer to that question varies from jurisdiction to jurisdiction, and generally hinges upon where the offer to sell emanated from; where the acceptance of that offer was communicated from; where the prospective franchisee resides; and, where the franchised business will be located. Generally speaking, if any of these four factors is implicated within a franchise-regulating state during the franchise sales process, it is vital to investigate if that state s franchise law may govern the transaction. 18

21 In addition, beware of significant state franchise law jurisdictional twists. For example, New York takes the position that the words in this state are meant to cover any franchise sales activity that actually takes place in New York, that emanates from New York or that is directed to New Yorkers. Therefore, a New York franchisor which only seeks to sell franchises in California must nevertheless register in both New York and California to satisfy both states laws. California has a different approach. Under California s franchise law, 41 if a California franchisor is selling a franchise to a non- California resident and all of the franchised units will be located outside of California, then that franchisor does not have to register in California (but, of course, would still be required to register elsewhere as mandated by other state laws). So to reverse our example, a California franchisor seeking to sell franchises in New York exclusively need only register in New York. Each state franchise registration/disclosure law requires that a franchisor s FDD, registered as necessary, be furnished to each prospective franchisee. Accordingly, it becomes vital to determine just who the prospective franchisee is. Naturally, if the franchisee is an individual who will operate the subject franchise as a sole proprietor, then disclosure to the individual will suffice. However, if the prospective franchisee is a general partnership, then certain court decisions suggest that all partners (not just some and not just the majority partner) must receive the franchisor s FDD. In the case of a limited partnership, disclosure to the general partner will almost always suffice. Finally, disclosure to a prospective entity franchisee (such as a corporation, LLC or some other type of formal legal entity) must be made to an officer authorized and possessing the capacity to receive disclosure on behalf of the entity. C. What Must be delivered? While many key states have recently amended their franchise registration/disclosure laws to mirror the disclosure requirements newly imposed by the revised FTC Franchise Rule, including California; Illinois; Maryland; Rhode Island; and, South Dakota, a number of states featuring franchise registration/disclosure laws - - notably New York - - have not yet amended them to incorporate the FTC Franchise Rule s preemptive, and thus required, disclosure edicts. They do so by having either formally or informally adopted the 2008 Franchise Registration and Disclosure Guidelines 42 as promulgated on June 6, 2008 by the North American Securities Administrators Association, Inc. (colloquially referred to as NASAA ). The NASAA Guidelines, as they are known, govern the preparation and contents of FDDs submitted for registration to the states and, as they must, incorporate the entirety of the preemptive disclosure requirements of the FTC Franchise Rule along with nonpreempted state franchise law additional disclosure mandates. The FDD ordained by the FTC Franchise Rule and the NASAA Guidelines is designed to incorporate all of the common disclosures required by federal and state franchise disclosure laws. The FTC Franchise Rule accomplishes this by permitting franchisors to set forth in their FDDs not just that information required by the Rule but also any 19

22 disclosures required by the franchise regulating states which go beyond the Rule s disclosure floor. Among those disclosures mandated by the NASAA Guidelines, and thus required by all franchise registration/disclosure states, is a state cover page, which follows the FTC Franchise Rule cover page. This state cover page advises prospective franchisees that registration of a franchise does not infer government recommendation of the franchise or verification of the information contained in the subject FDD. It then warns prospective franchisees that many franchise agreements do not allow them to renew same following expiration on the same terms and conditions but, instead, that the franchisee may have to sign an entirely new agreement with different terms and conditions. Then follow the two mandatory risk factors which, if applicable, must be set forth - - one if the franchise agreement requires the franchisee to resolve disputes with the franchisor outside the franchisee s state and another warning franchisees that the subject franchise agreement s governing law provision may not provide the same protections and benefits as the franchisee s home state law. Thereafter appear such other individualized risk factors which the various franchise registration/disclosure states may mandate following review of the FDD. State franchise administrators have wide latitude to insist upon the disclosure of such risk factors and routinely do so if the franchisor is perceived to be undercapitalized; has little experience operating the type of business to be franchised; has experienced significant shrinkage of its franchise network or a dramatic decline in financial condition; and, any other element of the franchise agreement or proposed franchise relationship which a state franchise administrator may deem to pose a risk requiring warning to prospective franchisees. If a franchisor utilizes one or more franchise brokers or referral sources to assist it in selling its franchises, disclosure of this fact must appear on the state cover page with the required caveat: A franchise broker or referral source represents us, not you. We pay this person a fee for selling our franchise or referring you to us. You should be sure to do your own investigation of the franchise. Finally, the franchisor must include the Issuance Date at the bottom of the state cover page. If the franchisor is registering its FDD in multiple states, it must include the State Effective Date Page, which contains effective dates of the franchisor s registrations in all franchise registration states where the franchisor is registered, immediately following the state cover page. The Issuance Date and State Effective Dates are not identical and prompt some confusion. Some of this confusion arises from the fact that the term Issuance Date is nowhere defined in the NASAA Guidelines - - the only time the term appears in said Guidelines is in the sample state cover page accompanying the Guidelines. Likely, the NASAA Guidelines merely borrowed the concept of Issuance Date from the FTC Franchise Rule, which, as noted above, requires that an FDD s Issuance Date be specified on the FTC Franchise Rule cover page. Naturally, the date selected by the franchisor for its FTC Franchise Rule cover page Issuance Date must be the same date for same specified in the state cover page. 20

23 Beyond such disclosures as are universally required by both federal and state law, each franchise regulating state except Oregon and South Dakota features unique or varied disclosure requirements which must be satisfied when franchise sales activity transpires in those states. These one off disclosures are not set forth in the core FDD itself, but rather in addenda to that core FDD (one addendum for each applicable franchise registration/disclosure state). Franchisors utilizing a single FDD to effect franchise sales nationwide aggregate these addenda behind the core FDD. As well, certain states require not only an addendum to the FDD but also an addendum to that state s version of the subject franchise agreement (so that state-specific statutory rights are not just disclosed but incorporated in the franchise agreement itself by means of this addendum). There is no easy way to learn all of the specific state addenda required for a nationwide registration effort. Few state policies on FDD and franchise agreement addenda are memorialized. A close study of each state s franchise registration/disclosure statute, along with the state s franchise relationship law (if it has one), is the first step in ascertaining just what should be set forth in that state s FDD and franchise agreement addenda. Many states require modification of the venue and governing law provisions of franchise agreements. Sometimes a franchise registration/disclosure law makes this explicit, but the requirement can also be a matter of departmental policy that purportedly flows from statutory provisions that prohibit requiring a franchisee to waive any rights that the statute grants. For example, North Dakota has adopted the requirement that North Dakota law, rather than the law of any other state, govern in its entirety each franchise agreement entered into with a North Dakota franchisee. For even the most experienced FDD drafter, state addenda are moving targets. State franchise administrators are constantly developing new requirements in their effort to ensure compliance with their franchise laws while also revising their addenda requirements to reflect new developments (such as judicial decisions holding that the Federal Arbitration Act 43 preempts state franchise law venue requirements as to where franchisor-franchisee disputes must be arbitrated). D. When Must Disclosure Be Effected? State franchise law disclosure timing requirements are in a state of transition following the 2007 revisions to the federal FTC Franchise Rule, which imposed the obligation that franchisors furnish their FDDs to prospective franchisees fourteen calendar days before the prospective signs a binding agreement with, or makes any payment to, the franchisor or its affiliate. 44 However guidance both for franchisors and the franchise regulating states come from the NASAA Guidelines, which indirectly adopt the FTC Franchise Rule s fourteen calendar day disclosure trigger by specifying same in the Guidelines Item 23 Receipt page, while also referencing those states that still require 21

24 delivery earlier than fourteen calendar days in advance of a transaction or receipt of money. But despite the fact that the NASAA Guidelines were meant to be adopted by the various states featuring franchise registration/disclosure statutes, not all of those states have revised their franchise regulations to mirror the fourteen calendar day disclosure trigger featured in the FTC Franchise Rule and referenced in the NASAA Guidelines. Indeed, Michigan, New York and Rhode Island feature disparate disclosure triggers in their franchise statutes, which must be amended if those states desire to come into line with the revised FTC Franchise Rule and NASAA Guidelines. Thus, until Michigan, New York and Rhode Island adopt the FTC Franchise Rule s FDD dissemination trigger, franchisors seeking to satisfy their disclosure obligations will confront a dichotomy of timing requirements when dealing with franchise sales regulated by those states franchise laws. This dichotomy is particularly important for franchisors to understand since the state disclosure trigger may require disclosure earlier than the fourteen calendar days required by the FTC Franchise Rule. For example, under New York 45 and Rhode Island 46 law, a franchisor must provide a copy of its FDD to the prospective franchisee at the earlier of (a) the first personal meeting between the franchisor and franchisee and (b) ten business days before the prospective signs a binding agreement with, or makes any payment to, the franchisor or its affiliate. The New York Franchise Act defines first personal meeting to mean the first face to face meeting between a franchisor or franchisor's agent or any representative or employee thereof and a prospective franchisee which is held for the purpose of discussing the sale or possible sale of a franchise. 47 The Rhode Island Franchise Investment Act affords the disclosure trigger substantially the same meaning. 48 The disclosure trigger under Michigan law is simply that disclosure must be effected ten business days before the prospective signs a binding agreement with, or makes any payment to, the franchisor or its affiliate (the same as the New York and Rhode Island disclosure trigger except without the first personal meeting prong). E. How Must Disclosure Be Made? As discussed above, the FTC Franchise Rule explicitly authorizes franchisors to furnish FDDs to prospective franchisees in any fashion they elect - - including the authority conferred on franchisors to fulfill their disclosure obligations through electronic communications (posting their FDDs on the internet; delivering their FDDs by ; and/or, otherwise electronically disseminating such documents). As for the franchise regulating states, in September 2003 NASAA issued a Statement of Policy setting forth a proposed regulation which, if adopted by the franchise regulating states, would enable franchisors to deliver FDDs in a pure electronic fashion. In the years following NASAA s proclamation, only two franchise regulating states adopted NASAA s Statement of Policy through the passage of legislation or the promulgation of regulations. More recently, NASAA proclaimed its support for electronic disclosure in the NASAA Guidelines which provide in pertinent part: Unless a Franchise 22

25 Filing State has adopted its own requirements regarding electronic disclosure, franchisors may deliver a Franchise Disclosure Document electronically by complying with the NASAA Statement on Policy Regarding Electronic Delivery of Franchise Disclosure Documents, adopted September 14, It is anticipated that, given the revised FTC Franchise Rule s authorization for pure electronic disclosure and NASAA s Statement of Policy and Guidelines, the franchise regulating states, coordinating through the NASAA Franchise Project Group, will all soon authorize pure electronic disclosure. As of March 1, 2013, California, Indiana, South Dakota and Virginia enacted laws or regulations expressly authorizing electronic delivery of FDDs. Reports suggest that virtually all of the remaining states featuring franchise registration/disclosure statutes are already countenancing pure electronic disclosure by franchisors notwithstanding the fact that they have not yet gotten around to amending their statutes or regulations (as applicable). Indeed, many such states have let it be known that they will undertake no enforcement activity whatsoever against a franchisor which engages in electronic disclosure notwithstanding the fact that such activity is nominally violative of those state s laws/regulations. In a similar fashion, the franchise regulating states have deliberately turned a blind eye to many franchisors which over the past number of years have effected disclosure by means of CD-ROM s. F. Duty To Amend The FDD Like the FTC Franchise Rule, franchisors are also required under state franchise registration/disclosure laws to update and amend their FDDs annually (at the time of franchise registration renewal). Much confusion may arise, however, from the fact that many state franchise registration/disclosure statutes also require franchisors to update and amend their FDDs within a specified period of time (either 90 or 120 days) following the close of the franchisor s most recent fiscal year (a time which may vary significantly from the franchisor s renewal date). For example, a new franchisor that secures its initial franchise registration on October 1st in a registration/disclosure state that grants registrations for a period of one year will have to renew that registration on or before the following October 1st by, among other things, updating and amending its FDD. However, if that franchisor is on a December 31st fiscal year, it will also have to amend its FDD within either 90 or 120 days following the close of its most recently completed fiscal year, leading to a double update scenario. Although the FTC Franchise Rule and state franchise registration/disclosure statutes both require a franchisor s FDD to be amended annually, it is critical to note that, with respect to the obligation to amend the FDD mid-year, the FTC Franchise Rule conflicts with virtually every state franchise registration/disclosure statute. As discussed above, the only mid-year update required by the FTC Franchise Rule is a quarterly update requirement. 49 On the other hand, each and every state franchise registration/disclosure law requires that franchisors immediately amend (and re-register 23

26 as necessary) their FDDs - - and cease selling franchises while they do so - - each and every time a material change to the facts set forth therein transpires. Accordingly, unless a franchisor is offering and selling franchises exclusively in the socalled FTC states (that is, the 35 states which feature no franchise registration/disclosure laws of their own), that franchisor had best not rely on the FTC s more liberal updating requirements lest it find itself in violation of every state franchise registration/disclosure statute applicable to its activities. To the contrary, that franchisor is required by such state franchise registration/disclosure statutes immediately to update its FDD upon the occurrence of any material change to the facts set forth therein to avoid accruing significant liabilities under those laws. Although state registration/disclosure laws, like the FTC Franchise Rule, fail to define what constitutes a material change, the termination, closing or failure to renew a significant percentage of the network s franchises, changes in management personnel, a change in the franchisor s corporate structure (such as converting from a corporation to a limited partnership), a change in the franchisor s address, significant litigation or arbitration developments and significant changes in the franchisor s financial situation are likely material changes necessitating FDD amendment and re-registration. The promulgation of a franchisor s latest annual audited financial statements is universally deemed to constitute a material change. Upon the occurrence of any need to amend its FDD - - whether in connection with the annual franchise registration renewal process or upon the occurrence of a material change to the facts set forth in the FDD - - the franchisor s pre-amended FDD is deemed legally stale and may not be utilized to offer and sell franchises until it is amended as required by law. In those states where FDDs are statutorily subjected to review and/or registration requirements, franchise sales activity must cease until the franchisor s amended FDD is registered as required by law (unless an exemption from registration is available). The result is a blackout period, consisting of the time period between the date the franchisor becomes aware of material changes to the information contained in its now-outdated FDD and the date on which registration of its amended FDD is obtained, during which no franchise sales activity can take place in the subject franchise registration/disclosure state. Following this blackout period, franchisees who are in the pipeline and received what are now outdated FDDs must be re-disclosed with the newly registered, amended FDDs. G. Typical Disclosure Issues Raised By State Examiners As stated above, this paper does not address the specifics of the registration process of a franchisor s FDD in the state registration/disclosure states. However, it is important to note that, as part of the registration process, state examiners in California, Hawaii, Illinois, Maryland, Minnesota, New York, North Dakota, Rhode Island, Virginia and Washington will review the FDD and, to the extent deficiencies are identified (i.e. areas in which the subject FDD does not comply with the disclosure requirements of the 24

27 NASAA Guidelines or the individual state registration/disclosure law), issue a comment letter detailing the modifications that must be made before registration is approved. Although comment letters can vary widely depending on what state issues the comment letter and what FDD is reviewed, there are certain comments that arise time and time again: General Disclosure Comments Item 1 Item 2 1. A franchisor is asking for a comment letter if its FDD features disclosure deficiencies that an examiner has previously identified and communicated to the franchisor. 2. Do not remove a fee deferral or other financial assurance (references to same which are generally included in the requesting state s addenda to the FDD and franchise and other applicable agreements) arbitrarily without a clear reason for doing so (and without telling the examiner that it has been removed). 3. Although required, franchisors often fail to affirmatively address whether or not it or its affiliates have ever operated a business of the type being franchised. 4. Item 2 requires the inclusion of the employment history of specific individuals during the last five years. Although employment should be included if it commenced more than five years ago but ended within the last five years, employment should not be included if it commenced and ended more than five years ago. For example, assuming the FDD containing the following sample Item 2 bio is issued in March 2013, the first, second, and third sentences should remain (the third sentence because although Mr. Jones employment with DEF Inc. began more than five years before the FDD s Issuance Date, it ended within the last five years) but the fourth sentence should be deleted (since Mr. Jones employment with GHI LLC began and ended more than five years before the FDD s Issuance Date): Mr. Jones has been employed by the franchisor as President since November From February 2009 to October 2011, Mr. Jones was the CEO of ABC Corp. in Detroit, Michigan. From September 2003 to January 2009, Mr. Jones was the Vice President of Sales for DEF Inc. in Las Vegas, Nevada. Mr. Jones served as a Sales Executive for GHI LLC in Los Angeles, California from January 2003 to August

28 Item 3 Item 5 Item 6 Item 7 Item 8 5. Do not use puffery/extraneous information in the Item 2 bios (i.e. Mr. Jones has worked his way to the top of the quick service restaurant industry, starting twenty years ago as a cashier). 6. If a settlement agreement must be disclosed in this Item, all material settlement terms must be disclosed, whether or not the agreement is confidential. 7. Disclose only those initial fees that must be paid to the franchisor or any affiliate. Do not include fees that are payable to third, unaffiliated, parties. 8. The initial fees disclosed in Item 5 should include all of those fees disclosed in the Item 7 table that are payable to the franchisor or an affiliate. 9. The total amount of initial fees that must be paid to the franchisor or any affiliate disclosed in Item 5 should match the total amount of initial fees that must be paid to the franchisor or any affiliate disclosed on the FTC Cover Page. 10. Do not include in the Item 6 table fees/costs that are payable to parties other than the franchisor or one of the franchisor s affiliates. 11. Fees payable under contingencies (per the franchise agreement) must be included in the Item 6 table. 12. The Item 7 table should include all of those fees disclosed in Item The totals from the Item 7 table should match the totals that appear on the FTC Cover Page. 14. The products, goods and/or services that are subject to some manner of sourcing restriction must be clearly identified. 15. Franchisors must disclose whether it or its affiliates will or may derive revenue or other material consideration from required purchases or leases by franchisees. If the disclosure is affirmative for the franchisor, then it must include its total revenue from the most recent fiscal year, the total amount the franchisor received from the franchisee and the percentage of total revenues the franchisee 26

29 purchases represent. If the franchisor s affiliates also sell or lease products or services to franchisees, the affiliates revenues from those sales or leases must also be included. Item If a particular obligation is not applicable, affirmatively state Not Applicable in the table. Item Do not use weak or vague disclosure regarding the experience of a training instructor. Instead, the following must be disclosed with respect to an instructor s experience: 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. 18. Franchisors are required to disclose whether the franchisee is required to participate in a local or regional advertising cooperative. If it is, there are further disclosure requirements (i.e. (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; (e) whether cooperatives must operate from written governing documents and whether the documents are available for the franchisee to review; (f) whether cooperatives must prepare annual or periodic financial statements and whether the statements are available for review by the franchisee; and (g) whether the franchisor has the power to require cooperatives to be formed, changed, dissolved, or merged). Some examiners may take the position that a franchisor who discloses that franchisees are not currently required to participate in an advertising cooperative but they may be so required in the future should also make the rest of the required disclosures. Item If the franchisor does not grant an exclusive territory or if maintaining the exclusive or protected territory (or the franchise) is dependent on the franchisee achieving minimum sales levels, a risk factor should be added to the state cover page. Item In row t of the table, add the required FTC language: Only the terms of the franchise agreement are binding (subject to state law). Any representations or 27

30 Item 19 promises outside of the disclosure document and franchise agreement may not be enforceable. 21. A financial performance representation is defined as 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. 50 Any such representation a franchisor plans on making must be included in the franchisor s FDD Item In Item 19, franchisors are required to disclose 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 (i.e. geographic location, type of location, 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). Furthermore, franchisors must disclose the number of outlets with the described characteristics whose actual financial performance date were used in arriving at the representation. A comment may be received in the event that data from only a small portion of outlets with the described characteristics is included in the representation---an examiner s concern of course being that the franchisor cherry picked those outlets with high levels of performance and excluded those outlets that underperformed. Item The total number of franchised outlets for each of the last three fiscal years reported in Table No. 1 (Systemwide Outlet Summary) must match the total number of franchised outlets for each of the last three fiscal years reported in Table No. 3 (Status of Franchised Outlets). Further, the total number of company-owned outlets for each of the last three fiscal years reported in Table No. 1 must match the total number of company-owned outlets for each of the last three fiscal years reported in Table No. 4 (Status of Company-Owned Outlets). 24. In each of Table No. 1 (Systemwide Outlet Summary), 3 (Status of Franchised Outlets) and 4 (Status of Company-Owned Outlets), the number of outlets in a particular state at the end of one year should equal the number of outlets at the beginning of the following year. 25. In Table No. 3 (Status of Franchised Outlets), Col. 3 (Outlets at Start of Year) plus Col. 4 (Outlets Opened) minus Col. 5 (Terminations) minus Col. 6 (Non- 28

31 Renewals) minus Col. 7 (Reacquired by Franchisor) minus Col. 8 (Ceased Operations- Other Reasons) should equal Col. 9 (Outlets at End of the Year). 26. In Table No. 4 (Status of Company-Owned Outlets), Col. 3 (Outlets at Start of the Year) plus Col. 4 (Outlets Opened) plus Col. 5 (Outlets Reacquired From Franchisee) minus Col. 6 (Outlets Closed) minus Col. 7 (Outlets Sold to Franchisee) should equal Col. 8 (Outlets at End of the Year). 27. If multiple events occurred in the process of transferring ownership of an outlet, report the event that occurred last in time. Then use a footnote to the table to describe the changes involved and the order in which the changes occurred. For example, if a franchised outlet was transferred and then terminated, all within the same fiscal year, nothing should be reported in Table No. 2 and a termination should be reported in Table No. 3. A footnote to Table No. 3 should report that that terminated outlet was transferred earlier in the year. 28. The lists of current and former franchisees (which are very often included as exhibits to the FDD) should be alphabetized first by state, then by city, and then by franchisee name. 29. The list of current franchisees should clearly identify that the list is current as of a certain date. 30. The list of former franchisees should include contact information for transferors reported in Table No. 2 (Transfers of Outlets from Franchisees to New Owners (other than the Franchisor)). 31. Affiliate-owned outlets must also be counted in the tables, generally as companyowned outlets with a footnote explaining that they are affiliate-owned. H. Exemptions From State Disclosure Requirements Important to remember is that the FTC Franchise Rule s disclosure exemptions are confined to the 35 states featuring no franchise registration/disclosure statutes of their own; are not preemptive on the franchise regulating states; and, unless an identical exemption is available thereunder, are unavailable in the fifteen states which have franchise registration/disclosure laws on their books. That being said, states featuring franchise registration/disclosure laws also provide useful exemptions from registration requirements that are available to franchisors in those fifteen states. Franchisors must be sure, however, to carefully review the available exemption to ascertain whether it excuses the franchisor from just registration or also from disclosure. Entire industries or certain types of business arrangements are exempted from registration and/or disclosure requirements either due to public policy or to the existence of other legislation that regulates those industries or types of business arrangements. 29

32 So it is that motor vehicle dealers, petroleum marketers, bank credit plans and farm machinery purveyors are exempted from the coverage of certain state statutes. The most commonly employed exemption under state registration/disclosure laws applies to franchisors whose net worth exceeds a specified amount (or whose net worth exceeds a specified amount and whose parent s net worth exceeds a specified amount and such parent guarantees the performance of the franchisor) and whose experience administering franchise networks of a given size spans a specified number of years. The rationale behind the exemption is that larger, more established franchisors are less likely to perpetrate abuse in the area of franchise sales and are more likely to be held financially accountable. The following table summarizes the net worth/experience exemptions featured by state registration/disclosure laws: State Net Worth/Experience Exemption California (1) Either (a) audited financials of Franchisor ($5 million) or (b) audited financials of Franchisor ($1 million) and audited financials of parent ($5 million) or (c) unaudited financials of Franchisor ($1 million) and audited financials of parent ($5 million) and a guarantee; and (2) fulfillment of experience requirement. Illinois Jumbo Exemption: Either (a) audited financials of Franchisor ($15 million) or (b) unaudited financials of Franchisor ($1 million) and audited financials of parent ($15 million). Large Franchisor Exemption: (1) Either (a) audited financials of Franchisor ($5 million) or (b) unaudited financials of Franchisor ($1 million) and audited financials of parent ($5 million) and a guarantee; and (2) fulfillment of experience requirement. Indiana (1) Either (a) certified financials of Franchisor ($5 million) or (b) certified financials of Franchisor ($1 million) and certified financials of parent ($5 million); and (2) fulfillment of experience requirement. Maryland (1) Audited financials of Franchisor ($10 million) and (2) fulfillment of experience requirement. New York Jumbo Exemption: Either (a) audited financials of Franchisor ($15 million) or (b) audited financials of Franchisor ($3 million) 30

33 State Net Worth/Experience Exemption and audited financials of parent ($15 million). Large Franchisor Exemption: Either (a) audited financials of Franchisor ($5 million) or (b) audited financials of Franchisor ($1 million) and audited financials of parent ($5 million). North Dakota (1) Either (a) audited financials of Franchisor ($10 million) or (b) unaudited financials of Franchisor ($1 million) and audited financials of parent ($10 million); and (2) fulfillment of experience requirement. Rhode Island (1) Either (a) Audited financials of Franchisor ($10 million) or (b) audited financials of parent ($10 million) and (2) Experience requirement. Virginia (1) Either (a) Audited financials of Franchisor ($15 million) or (b) unaudited financials of Franchisor ($1 million) and audited financials of parent ($15 million) and a guarantee and (2) Experience requirement. Washington (1) Either (a) audited financials of Franchisor ($5 million) or (b) audited financials of Franchisor ($1 million) and audited financials of parent ($5 million); and (2) Experience requirement. Also commonly exempted from the registration requirement (and sometimes also the disclosure requirement) of state registration/disclosure laws are isolated franchise sales effectuated by franchisees for their account. An exemption is also often granted where the prospective franchisee is a bank, savings institution, trust company or other institutional buyer or a broker/dealer. Virtually all state franchise registration/disclosure statutes relieve a franchisor from the burden of effecting disclosure to an existing franchisee who is either renewing its franchise or acquiring additional franchises. The caveat behind these state exemptions, however, is that the renewal or additional franchise agreement being entered into by the parties must be the same in all material respects as the franchisee s existing franchise agreement. If not, then full disclosure to the existing franchisee is required by means of an FDD registered as may be necessary. The FTC Franchise Rule, however, contains no analogous exemption, meaning that franchisors enjoying the existing franchisee exemption in such states will need to effect disclosure in any event unless another FTC 31

34 Franchise Rule disclosure exemption is available to them (though they will not have to register their FDDs in such states unless they must do so to accommodate other franchise sales activity). The issue often arises regarding what disclosure, if any, need be furnished to the transferee of a franchised business - - that is, to an individual or entity acquiring an existing franchise from a franchisee. If the franchise transfer is being effected by means of the existing franchisee merely assigning its existing franchise agreement to the transferee - - with no new franchise agreement being entered into between the transferee and the franchisor, the franchisor playing absolutely no role in marketing or selling the existing franchisee s franchise to the transferee, and the franchisor s role strictly limited to approving or disapproving the transfer based on the transferee s experience and qualifications - - then the franchisor need not effect any disclosure whatsoever to the transferee. On the other hand, if the franchise transfer is being accomplished by means of the franchisor entering into a new franchise agreement with the transferee-franchisee (the most common way in which such transactions are accomplished), or if the franchisor otherwise plays any role in marketing the transferred franchise or lining up the transferee candidate, then the franchisor is obliged by law to effect full disclosure to that prospective transferee in accordance with the mandates of the federal and state franchise registration/disclosure statutes addressed herein. State franchise registration/disclosure laws feature exemptions in addition to those mentioned in this paper, including sophisticated/experienced franchisee exemptions 51 (where the prospective franchisee has at least a specified net worth and/or operating history) and fractional franchise exemptions 52 (where the franchise-related revenues to be derived by the franchisee entity total less than 20% of the entity s overall gross revenues). I. State Penalties for Noncompliance Most state franchise registration/disclosure laws enumerate and define fraudulent and unlawful practices in the broadest of terms. Any intentional making of an untrue statement of a material fact; any intentional omission of a material fact whose absence renders another statement misleading; any scheme or artifice to defraud; any act or practice which would or does operate as a fraud or deceit; any violation of any franchise registration/disclosure statute, or any rules or regulations promulgated thereunder; and, any attempt to compel franchisee waiver of any given statute s provisions are, under most state franchise registration/disclosure statutes, declared fraudulent and unlawful practices. State registration/disclosure statutes confer upon franchise administrators broad powers to investigate franchise sales fraud and illegality. If they do uncover fraud, these administrators can institute civil proceedings seeking (without limitation) restitution; damages; injunctions; fines and penalties; and, court-ordered receiverships. Many state franchise administrators also possess stop order powers - - the ability ex parte to suspend a franchisor s franchise registration, and thus its ability to legally and offer and 32

35 sell franchises, should the administrator believe that fraudulent or illegal activity, is being engaged in by the subject franchisor. Moreover, violation of state franchise registration/disclosure statutes in many states gives rise to criminal liability which accrues per violation. Finally, any franchisee who believes that his/her/its franchise was sold in violation of state franchise registration/disclosure statutes is empowered thereby to commence legal proceedings against the franchisor to recover damages caused by the alleged violation. Indeed, almost all state franchise registration/disclosure laws confer upon franchisees the right to commence legal proceedings complaining of statutory violations against their franchisors - - and their franchisors officers, directors, and managers who engaged in the violative conduct - - seeking one or more of the following remedies: (i) actual damages all payments expended to acquire and implement the franchise and lost past and future profits and earnings; (ii) injunctive relief preventing the franchisor from engaging in specified activities, such as franchise termination, non-renewal or placing additional units in proximity to existing units; (iii) attorneys' fees, court costs and other administrative fees if the franchisee prevails in the lawsuit; (iv) rescission, which requires the franchisor to cancel the franchise agreement, relieve the franchisee from all liability under that agreement and restore the franchisee to the economic position it would have been in had the franchise agreement not been executed; and, (v) punitive damages, over and above the franchisee's "actual" damages, where permitted by statute or under other limited circumstances. IV. CONCLUSION The goal of the FTC Franchise Rule and the state registration/disclosure laws to eradicate fraud and eliminate criminals and organized crime from the franchise arena has largely been achieved. Due to the diligent enforcement of these laws by federal and state regulators, there hasn t been any widescale and massive fraud visited by a criminal or organized crime franchisor in decades. Franchisors the very subjects of these laws who are required to expend countless hours and monies to comply with them recognize their effectiveness and the value to the franchise community of a clean marketplace for franchise sales which these statutes make possible. 33

36 ENDNOTES 1 California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Oregon, Rhode Island, South Dakota, Virginia, Washington, and Wisconsin. 2 Federal Trade Commission Trade Regulation Rule: Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures, 16 C.F.R et seq. (1978) C.F.R. 436, Disclosure Requirements and Prohibitions Concerning Franchising (December 21, 1978 as amended January 22, 2007). 4 Amended FTC Rule Statement of Basis and Purpose, 72 Fed. Reg (March 30, 2007) (hereinafter referred to as SBP ) C.F.R (r). 6 SBP at C.F.R (a) through (w). 8 SBP at C.F.R (b) and SBP at C.F.R (t). 11 SBP at SBP at SBP at C.F.R (a). This section provides: 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. 15 Id C.F.R (b). This section provides: 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.F.R (d). This section provides: 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)). 18 SBP at 15520, n C.F.R (g) C.F.R (l). 21 SBP at Id. 23 Id. 24 SBP at SBP at California Franchise Investment Law, California Corporations Code, Div. 5, Parts 1-6, Section et. seq. 27 Hawaii Franchise Investment Law, Hawaii Rev. Stat., Title 26, Ch. 482E, Section 482-E1 et seq. 28 Illinois Franchise Disclosure Act, Illinois Compiled Statutes, Ch. 815, Section 705/1 et seq. 29 Indiana Code, Title 23, Article 2, Ch. 2.5, Section 1 et seq. 30 Maryland Franchise Registration and Disclosure Law, Ann. Code of Maryland, Business Regulation, Title 14, Section et seq. 31 Michigan Franchise Investment Law, Michigan Compiled Laws, Ch. 445, Section et seq. 32 Minnesota Statutes, Ch. 80C, Section 80C.01 et seq. 33 New York General Business Law, Art. 33, Section 680 et seq. 34 North Dakota Franchise Investment Law, North Dakota Century Code Ann., Title 51, Ch , Section et seq. 34

37 35 Oregon Franchise Transactions Law, Oregon Revised Statutes, Title 50, Ch. 650, Section et seq. 36 Rhode Island Franchise and Distributorship Investment Regulations Act, General Laws of Rhode Island, Title 19, Ch. 28.1, Section et seq. 37 South Dakota Franchises for Brand-Name Goods and Services Law, South Dakota Codified Laws, Title 37, Ch. 37-5B, Section 37-5B-1 et seq. 38 Virginia Retail Franchising Act, Virginia Code, Title 13.1, Ch. 8, Section et seq. 39 Washington Franchise Protection Act, Revised Code of Washington, Title 19, Ch , Section et seq. 40 Wisconsin Franchise Investment Law, Wisconsin Stats., Ch. 553, Section et seq. 41 California Franchise Investment Law, California Corporations Code, Div. 5, Parts 1-6, Section North American Securities Administrators Association, Inc. ( NASAA ) 2008 Franchise Registration and Disclosure Guidelines (Amended and Restated UFOC Guidelines), adopted on June 6, 2008, CCH Bus. Franchise Guide U.S.C. Section 1, et seq C.F.R (a). 45 N.Y. Gen. Bus. Laws R.I. Gen. Bus. Laws New York Franchise Sales Act, Sec. 683 (8). 48 Rhode Island Franchise Investment Act (a)(1) C.F.R (b). 50 FTC Franchise Rule and NASAA s 2008 Franchise Guidelines (Section VII, Definitions, Subsection [e]) 51 Sophisticated/Experienced franchisee exemptions: California Franchise Investment Law, California Corporations Code, Div. 5, Parts 1-6, Section 31106; Maryland Regulations, State Law Department, Division of Securities, Title 02, Subtitle 02, Ch. 8, Section (E); Wisconsin Franchise Investment Law, Wisconsin Stats., Ch. 553, Section Fractional franchise exemptions: Federal Trade Commission Trade Regulation Rule: Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures, 16 CFR 436, Section (a) (3) (i); California Franchise Investment Law, California Corporations Code, Div. 5, Parts 1-6, Section 31108; Illinois Franchise Disclosure Act, Illinois Compiled Statutes, Ch. 815, Section 705/3; Indiana Code, Title 23, Article 2, Ch. 2.5, Section 1 (a); Minnesota Statutes, Ch. 80C, Virginia Retail Franchising Act, Virginia Code, Title 13.1, Ch. 8, Section 80C.03; 301 (a) (2); Wisconsin Franchise Investment Law, Wisconsin Stats., Ch. 553, Section