2. Significant Control or Assistance:  The franchisor exercises significant control over, or offers significant assistance in, the franchisee's method of operation.

3. Required Payment: The franchisee is required to make any payment to the franchisor or an affiliate, or a commitment to make a payment, as a condition of obtaining the franchise or commencing operations. (NOTE: There is an exemption from coverage for required payments of less than $500 within six months of the commencement of the franchise).

NOTE: These requirements vary from state to state.   For example, Illinois does not apply the six month test for determining the $500 exemption.   Other states, such as Connecticut, do not require the payment of any fees to create a franchise if the first two stated elements are present.

This Article discusses the Federal Trade Commission (FTC) Rule entitled "Disclosure Requirements and Prohibitions Concerning Franchising And Business Opportunity Ventures" (the "FTC Rule").   As stated by the FTC, "the Rule is designed to enable potential franchisees to protect themselves before investing by providing them with information essential to an assessment of the potential risks and benefits, to meaningful comparisons with other investments, and to further investigation of the franchise opportunity."   The FTC Rule prohibits fraud in the initial sale of a franchise (as opposed to resales by a franchisee, or renewals or extensions by a franchisor), where the franchise affects interstate commerce.  

In summary, the FTC Rule states the following:

▪ Requires the delivery of disclosure statements, requires that registered franchise brokers make franchise sales, and prohibit untrue statements in any required report.

▪ Prohibits fraudulent practices, which are very broadly defined, concerning the offer or sale of a franchise -, i.e., with respect to "disclosure fraud" only.  Franchisors typically comply with the FTC Rule by issuing a Uniform Franchise Offering Circular (UFOC).

In summary, franchisors disclose in a UFOC:

. The corporate identity of the franchisor, its predecessors and affiliates, the business experience of the franchisors officers and directors, and whether any of these persons or corporations have been a debtor in bankruptcy within ten years.

▪ Any litigation within ten years by franchisees against the franchisor, or other litigation where claims of fraud or franchise law violations were alleged against the franchisor.

▪ All fees of any kind, payable to the franchisor including royalties, marketing or advertising fees, transfer fees, audit fees, service charges, late fees, costs or attorneys' fees, indemnification obligations, rent, customer reimbursement obligations.

▪ The total initial investment required or expected of the franchisee and the terms of any company-sponsored financing.

▪ Any restrictions on sources of products and services, as well as on the products or services that the franchisee could sell.

▪ The franchisee's obligations during the franchise relationship, including an obligation to participate in the business personally.

▪ The franchisor's obligations during the franchise relationship.

▪ Any territorial restrictions on the franchisee's sales or the franchisor's expansion.

▪ The franchisor's trademarks, patents, copyrights and proprietary information.

▪ Renewal, termination, transfer and dispute resolution procedures in the franchise agreement.

▪ Whether public figures are used to promote the franchise.

▪ A list of all franchise outlets - including information as to transfers, cancellations, terminations, non-renewals, reacquisition by the franchisor, and departures from the system.

▪ The franchisor's most recent audited financial statements.  Contracts that the franchisee would be required to execute, including, e.g., a franchise reservation agreement, standard form of franchise agreement, lease or sublease where applicable, promissory note, confidentiality agreement.

[As of 2000, when this Article was written, the FTC was] considering amendments to its rule.   Among the proposals [then] under consideration are:

▪ Whether franchisors should be required to disclose earnings information,

▪ Whether to require disclosure of lawsuits filed by the franchisor against franchisees, and

▪ Whether to prohibit franchisors from imposing "gag orders" which prohibit current franchisees from sharing their experiences with prospective franchisees.

NOTE:   Neither the Federal Trade Commission Act nor the FTC Rule provide a private cause of action to enforce the provisions of the Rule.   However, a private right of action may be asserted under state laws known as "Little FTC Acts."

Excerpted and updated in September 2003 from a presentation by Carmen D. Caruso to the Association of Trial Lawyers of America (ATLA) in a"Litigation at Sunrise" program during their annual meeting in Chicago, July, 2000.

Source: cdcaruso.com