The Franchise Rule defines acts or practices that are unfair or deceptive in the franchise industry in the United States. The Franchise Rule is published by the Federal Trade Commission. The Franchise Rule seeks to facilitate informed decisions and to prevent deception in the sale of franchises by requiring franchisors to provide prospective franchisees with material information prior to the sale. It does not, however, regulate the substance of the terms that control the relationship between franchisors and franchisees.
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In the United States, the Federal Trade Commission has oversight of franchising, rather than the US Securities and Exchange Commission. The FTC administrates oversight via the FTC Franchise Rule.[1] The FTC announced an update to the franchise Rule on January 23, 2007, becoming effective July 1, 2007.[2]
The most recent version of the FTC Franchise Rule was in 2007, is printed in FR 2007a, pp. 15544–15575.
After July 2008, all franchisors in the United States are to use the Franchise Disclosure Document with potential franchisees.
The Federal Trade Commission promulgated the Franchise Rule in the late 1970s. The FTC enforces the Federal Trade Commission Act ("FTC Act"), which prohibits unfair methods of competition and unfair or deceptive acts or practices in or affecting commerce.
The FTC Act also empowers the Commission to prescribe rules that define with specificity acts or practices that are unfair or deceptive. One such rule is the Commission's Franchise Rule.[3]
The Commission focuses much of its Franchise Rule enforcement and consumer educational resources on combating business opportunity fraud.
The Franchise Rule requires franchisors to make material disclosures in five categories:
In addition, franchisors must have a reasonable basis and substantiation for any earnings claims made to prospective franchisees, as well as disclose the basis and assumptions underlying any such earnings claims.
The Franchise Rule generally covers two different types of business arrangements: franchises and business opportunity ventures.
Franchise agreements typically involve retail outlets that bear the franchisor's trademark and follow the franchisor's business operations model, such as fast-food restaurants, hotels, and automotive repair shops. These are commonly known as "business-format" franchises.
Franchise business opportunities rip offs often do not entail a trademark or detailed business plan. The franchise business opportunity typically promises to provide the buyer with equipment that is used to sell products or services to the public, such as vending machines, rack displays, pay phones, or medical billing software, and frequently promises to find the buyer a market for the products or services. Many business opportunities are outright scams that disappear shortly after taking consumers' money. Compliance with The Franchise Rule by business opportunity sellers is low.[3]
In addition to the FTC, fifteen states require pre-sale disclosure in franchise sales in the form of a Uniform Franchise Offering Circular ("UFOC"). Because a UFOC is accepted by both the states and the FTC, the UFOC Guidelines have effectively become the national franchise disclosure standard.
The Franchise Rule has the force and effect of law, and it may be enforced through civil penalty actions in federal courts.(10) The FTC Act authorizes courts to impose civil penalties of not more than $11,000 per compliance violation.
The Franchise Rule requires franchisors to provide all potential franchisees with a disclosure document containing 23 specific items of information about the offered franchise, its officers, and other franchisees.
Required Franchise Disclosure Document topics include: the franchise’s litigation history, past and current franchisees and their contact information, any exclusive territory that comes with the franchise, assistance the franchisor provides franchisees, and the cost of purchasing and starting up a franchise. If a franchisor makes representations about the financial performance of the franchise, this topic also must be covered, as well as the material basis backing up those representations." [4][5]
Franchise termination is covered in the franchise agreement between the franchisor and franchisee. In the 2007 Franchise Rule, comments from former franchisees were listed concerning confidentiality agreements and Franchise fraud.