Franchising is a highly regulated industry that operates under a complex set of federal laws.
Because franchising is regulated by complex laws and regulations that sometimes overlap at the federal and state levels, franchisors often have questions about whether their company is legally compliant. How do you know if your business is considered a franchise? What are the rules for offering and selling a franchise? What can happen if you violate those rules?
In this article, we’ll explore the federal franchise laws that regulate franchise systems in the United States – including what they are, who enforces them, and what you need to know to operate your franchise the right way.
Legal Definition of a Franchise Under Federal Law
As the overarching federal law that governs franchise transactions in all fifty states, the federal Franchise Rule defines a franchise as a continuing commercial relationship or agreement in which the seller of a franchise promises or represents, orally or in writing, that:
The franchisee is granted the right to operate a business or to sell or distribute goods or services using the franchisor’s trademark;
The franchisor maintains the right to exert a significant amount of authority and control over the franchisee’s methods of business operation or assist in the franchisee’s methods of business operations;
The franchisee must remit or promise to remit a required payment to the franchisor or its affiliate as a condition of opening a franchise.
Who Enforces Federal Franchise Laws?
At the federal level, the Federal Trade Commission (FTC) is the government agency tasked with promoting consumer protection and upholding and enforcing the federal Franchise Rule in the United States.
What Federal Franchise Laws Govern
The federal Franchise Rule and the franchise-related enforcement activities of the FTC are primarily focused on activities related to the offering and selling of franchises, including the regulation of franchisor disclosures.
Federal Franchise Disclosure Requirements
The central requirements of the federal Franchise Rule relate to the franchisor’s disclosure of a Franchise Disclosure Document (FDD) to a prospective franchisee prior to the offering or sale of a franchise. The purpose of this requirement is to ensure that prospective franchisees are provided with the information necessary to weigh the potential benefits and risks of investing in a franchise before making a purchase.
The FDD contains 23 important legal disclosure items that include, but are not limited to, information about the franchise opportunity being offered, fees charged by the franchisor, the legal relationship between the franchisor and franchisee, trademarks, financial performance representations and more.
The federal Franchise Rule also imposes specific disclosure periods during which the franchisor must provide a prospective franchisee with specific information about the franchise opportunity being offered. These mandatory disclosure intervals include the 14-day FDD disclosure and waiting period, during which time the franchisor must provide the franchisee with a complete, current FDD prior to the offer or sale of a franchise, and a seven-day disclosure period during which the franchisor must provide the prospective franchisee with complete agreements before the franchisee signs any agreements or remits any fees to the franchisor related to the offer or sale of a franchise.
Federal Franchise Registration Requirements
The federal Franchise Rule does not require that a franchisor register or file its FDD with any specific federal agency, including the FTC. Instead, federal franchise laws require franchisors to monitor their compliance internally while adhering to all federal requirements related to the preparation, maintenance, issuance and disclosure of the FDD.
Despite the lack of registration requirements at the federal level, franchisors should keep in mind that many states have established supplemental registration requirements and other state-specific franchise laws. Always consult with an experienced franchise attorney to determine the legal requirements for the specific locations in which your franchise operates.
Penalties for Violating Federal Franchise Laws
The FTC takes violations of federal franchise laws seriously. Actions filed by the FTC against franchisors in violation of the federal Franchise Rule can result in a variety of penalties including rescission, monetary damages, hefty civil fines, and even personal liability of the franchisor owners depending on the infringement.
Beyond federal franchise laws, franchises are sometimes governed by additional state-specific franchise laws regulated at the local state level. These supplemental laws vary by state, particularly within the Franchise Registration States, the Filing States, and states with franchise disclosure laws and/or franchise relationship laws.
Because the penalties for violating federal and state franchise laws can be severe, franchisors should always consult an experienced franchise attorney to make sure the legal foundation of their franchise system is solid and compliant with laws and regulations at the local state and federal levels.