Are you a franchisor or a part of a franchise sales team? Do you want to learn more about franchise sale compliance and ensure that your sales practices comply with franchise laws and are consistent with best practices? Then this guide is for you.
In this guide you’ll learn the fundamentals of franchise sales compliance including the franchise laws, regulations, and best practices that your team should have in place for every franchise sale. While this guide is not a replacement for the advice and consultation that you should be undertaking with your legal counsel, it should serve as a great reference guide for those discussions and consultations. Always be sure to verify the information in this guide with your franchise lawyer and please check back periodically as we will be updating this guide. Remember, below we are outlining the basis and not everything that is involved in the franchise sales and compliance process.
Franchise sales compliance is the process and practice of selling franchises in compliance with federal and state franchise laws, rules and regulations. The centerpiece of all franchise sales compliance practices involve the proper issuance, registration, and disclosure of a Franchise Disclosure Document (FDD). Good franchise sales compliance practices help franchisors reduce litigation risk from franchisees and build a stable foundation for franchise system growth.
The basics of franchise sales compliance, include:
Below we discuss the franchise sales compliance basics in more detail.
For assistance with improving and implementing the right franchise sales compliance process for your franchise system contact our team at (800) 976-4904 or by email. We offer franchise sales training and legal support for franchisors.
Franchise sales compliance begins with the issuance of an FDD.
Your FDD is issued when it’s prepared in compliance with the federal and state franchise laws and when, as a franchisor, you elect to use or make the FDD available in the offer or sale of a franchise. Your FDD issuance date is the date that you and your franchise legal counsel designate and determine the FDD to be current and in compliance with the franchise laws. The issuance date of your FDD must be stated at the bottom of the FDD cover-page and within your FDD receipt page. At the federal level you are not required to register or file your FDD with any federal agency or regulator.
The information contained in your FDD must be accurate and current, without material omissions or representations, and must contain the 23 Disclosure Items required under the Federal Franchise Rule. A properly issued FDD must also contain state specific modifications and amendments depending on the states that you are offering or selling franchises in.
TIP: Once issued your FDD must remain current and without material omissions or misrepresentations. At a minim your FDD must be updated no less frequently than annually, within 120 days of the end of your fiscal year which means April 30th if you operate on a calendar fiscal year. In the “FDD Updates and Renewals” section below we provide more detail about updating your FDD and your state specific registrations and filings.
Although you are not required to register or file your FDD at the federal level, in the 13 states known as the franchise registration states you must first register your FDD with the designated state regulator before offering or selling a franchise in the state. Additionally, in the 10 states known as the franchise filing states you must first complete the filing or a state specific notice before offering or selling a franchise in the state. Franchise registration states require FDD registration no less frequently than annually and franchise filing states, depending on the state, require either a one-time filing or annual filing. Whether or not you are required to register or file with a particular state also depends on whether or not the trademarks of your franchise system are registered with the United States Patent and Trademark Office.
Visit our Interactive Franchise Registration Map to check the registration and filing states of each state and state specific franchise laws.
If a state does not qualify as a franchise registration or filing state, then following issuance of your FDD you may offer and sell franchises within that state. If a state qualifies as a franchise registration or filing state then following the issuance of your FDD you must complete the applicable state registration or filing before offering or selling a franchise in that state.
TIP: When determining where you may need to register or file your FDD, evaluate (a) the state of residence of the franchisee, (b) the state where the franchised business will be established or operated, and (c) the state within which you are conducting your franchise sales activities. Your will need to register or file, as applicable, in each of these states if they are franchise registration or filing states. Learn more about the Steps to Registering (and Filing) your FDD.
Once your FDD is issued and, as applicable, registered or filed at the state level, the next step is to disclose your FDD to prospective franchisees. FDD Disclosure occurs when you deliver your complete and properly issued FDD to a prospective franchisee and the prospective franchisee signs and dates the FDD Receipt Page. The FDD Receipt page should be contained in Item 23 of your FDD and your FDD should contain two duplicate copies of the FDD receipt page at the very end of your FDD. You may electronically disclose your FDD and have a prospective franchisee electronically sign your FDD receipt.
Disclosure of Franchise Sellers on Receipt Page – Depending on the internal team members involved in the potential franchise sale and whether or not a franchise broker was involved in the franchise sale, you may be required to update your FDD receipt page to indicate the “franchise sellers” involved in the sale. For example, if a franchise broker is involved in the sale you should add the franchise brokers name as a franchise seller on the receipt page. The receipt page should include blank spaces to allow you to do this. Learn more about how to disclose franchise sellers and brokers on your FDD receipt page.
14-Day Disclosure Waiting Period – Once the FDD receipt page is signed you must wait 14 days from the date of signing the FDD receipt page before you may enter into any agreement with the prospective franchisee or accept any funds from the prospective franchisee. When calculating the 14 day waiting period you do not include the initial day that the FDD is disclosed and the receipt is signed and you must wait a full 14 days. Learn more about the 14 day FDD disclosure period and how to count the 14 days. Since the 14 day disclosure period is required under federal law, it applies in all the states, however, at the state level, Michigan, New York, Oregon and Wisconsin also require that the FDD disclosure period be at least 10 business days.
7-Day Contract Disclosure Period – Your FDD should contain your form franchise and franchise related agreements and so when you disclose your FDD to a prospective franchisee he or she will have access to your franchise agreements. If at the time of signing your franchise agreement, you add material terms or provisions to the franchise agreement that go beyond “fill in the blank provisions”, i.e., like defining the franchisee’s protected territory or development schedule, then you must give/disclose the fully completed franchise agreement to the franchisee not less than 7 days before the agreement is signed or money is paid. An examples of “fill in the blank” provisions that do not trigger this 7 day waiting period include adding a date to the agreement and filling in the franchisees name and information. The 7 day waiting period can run at the same time as the 14 day waiting period as long as the fully completed franchise agreement is disclosed to the franchisee.
TIP: You cannot give a prospective franchisee a separate receipt page, i.e., you can’t, separate the receipt from the FDD and email the FDD receipt page to a prospective franchisee and ask them to separately sign it. The FDD receipt page must be a part of the FDD and the 14 day disclosure period only begins to run when the FDD receipt page is signed and dated. Learn more about the FDD Disclosure Periods and how to count the 14-day and 7-day waiting periods.
ADDITIONAL TIP: It’s important to make sure that each individual that will be signing your franchise agreement is properly disclosed with the FDD. If the franchisee will be a corporate entity, you should disclose the franchisees individual shareholders / members if they will be individually signing personal guarantees.
Once your FDD has been properly disclosed to your prospective franchisee and he or she has signed off on the FDD receipt, the next step in the franchise compliance process is preparing the franchise agreement and, as discussed in the section above, properly disclosing the completed franchise agreement to the franchisee. When preparing the franchise agreement, we recommend that your processes include the following steps which should be reviewed and handled by your franchise lawyer:
TIP: Once you receive the FDD receipt page carefully calendar the 14 day disclosure period. Likewise carefully document and calendar the 7 day period.
CAUTION: If your franchise sale involves states that impose financial assurance requirements like California, Hawaii, Illinois, Maryland, Minnesota, North Dakota, Virginia, and Washington, before accepting any funds or initial fees from the franchisee you must first determine whether or not the particular state has imposed a financial assurance requirement on your franchise system. Many times, when dealing with emerging franchisors that may not possess sufficient capital, certain states may condition FDD registration on your agreement to a financial assurance requirement which may require the deferral of your initial franchise fees and other requirements. So be sure to check if a financial assurance requirement has been imposed.
CAUTION: If your franchise sale involves the State of California and you have negotiated and agreed to an addendum modifying the terms of the franchise agreement you may be required to obtain approval from the California Department of Business Oversight or, if the changes are for the benefit of the franchisee, file them with the state. Be sure to discuss this with your attorney.
Good franchise sales compliance requires an updated and current FDD that avoids misrepresentations and omissions. At a minimum, your FDD must be updated and reissued annually, however, there are many circumstances that may require you to make immediate or quarterly updates to your FDD. When you update your FDD, you will also be required to amend your FDD registrations in the franchise registration states. Consider the following FDD update obligations:
TIP: When dealing with your annual FDD updates and franchise registration states, you should submit your FDD renewal application well before the annual deadline as the states will require at least one to two months to process your application. If you file your applications too late, your registration renewals will be delayed and your franchise sales will “go dark” within the state and leave you unable to sell franchises.
The biggest litigation exposure for franchisors come from franchisee claims related to unauthorized financial performance representations and misstatements made in the franchise sales process. It’s critical that your franchise sales team is strictly trained to avoid making any financial performance representations other than referring a franchisee to Item 19 of your FDD. It’s also critical that your sales team avoid making promises or representations that go outside the disclosures of your FDD. Evaluate all franchisee advertisements and franchise sales team communications.
Learn more about Financial Performance Representations, what they are and what you must avoid.
For assistance with improving and implementing the right franchise sales contact our team at (800) 976-4904 or by email. We offer franchise sales training and legal support for franchisors.
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