For an overwhelming majority of franchise transactions in the State of California, a franchisor must first issue and register its FDD with the California Department of Financial Protection and Innovation. However, in California there are certain limited exemptions permitting franchisors to engage in certain franchise transactions without first requiring FDD registration. These California franchise registration exemptions include transactions that involve out-of-state franchise sales, sales to experienced franchisees, fractional franchises, and sophisticated franchisees. If an exemption applies may still need to issue and disclose an FDD but California FDD registration may not be required. Below we discuss these California exemptions.
Warning: The decision and determination as to whether or not a registration exemption applies can only be determined by an experienced franchise lawyer after reviewing the particular facts related to your franchise system, your prospective franchisee and your potential franchise sale, and, after a full review and evaluation of California's franchise laws. This article does not address all of the required facts, circumstances and laws that must be evaluated prior to making any decision about a franchise registration exemption. You cannot base any decision as to whether or not an exemption may or may not apply based on this article.
California Corporations Code Section 31110 is the starting point for understanding California's franchise registration requirement:
"...it shall be unlawful for any person to offer or sell any franchise in this state unless the offer of the franchise has been registered under this part or exempted under Chapter 1 (commencing with Section 31100) of this part."
Unless a specific exemption applies, i.e., an exemption that specifically negates the registration mandate of Section 31110, as a franchisor, you must register your franchise with the state before "offering or selling any franchise" in the State of California.
Potential California FDD registration exemptions include:
- Out of State Franchise Sales
If the franchise sale is to a franchisee that is not a resident of the State of California and relates to a franchised business that will be developed and operated outside the State of California, then California FDD registration is not required even if, as franchisor, you are operating your franchise company from California.
Specifically, California Corporations Code Section 31105 states that "Any offer, sale or other transfer of a franchise, or any interest in a franchise, to a resident of another state or any territory or foreign country, shall be exempted from the provisions of Chapter 2 (commencing with Section 31110) of this part, if all locations from which sales, leases or other transactions between the franchised business and its customers are made, or goods or services are distributed, are physically located outside this state."
- Experienced Franchisees
If the franchise transaction involves individual unit franchise sales to experienced franchisees that satisfy certain experience requirements and criteria, California FDD registration may not be required. If the exemption applies, before a franchisor relies on this registration exemption the franchisor must first file a Registration Exemption Notice with the Department of Financial Protection and Innovation. California Corporations Code Section 31106 creates this exemption, stating:
"There shall be exempted from the provisions of Chapter 2 (commencing with Section 31110) of this part, any offer, sale, or other transfer of a franchise or any interest in a franchise, provided that the offer, sale or transfer meets the requirements in subdivisions (a) and (b):
(a) Any of the following conditions apply:
(1) One or more of the owners of the prospective franchisee owning at least a 50 percent interest in the prospective franchisee meet both of the following:
(A) The owner or owners have had, within the seven years before the date of the sale or other transaction, at least 24 months' experience being responsible for the financial and operational aspects of a business offering products or services substantially similar to those offered by the franchised business.
(B) The owner or owners are not controlled by the franchisor.
(2) One or more of the owners of the prospective franchisee owning at least a 50 percent interest in the prospective franchisee meet both of the following
(A)The owner or owners are, or have been within 60 days prior to the sale or other transaction, an officer, director, managing agent, or an owner of at least a 25 percent interest in the franchisor for at least 24 months.
(B) The owner or owners are not controlled by the franchisor.
(3)The offer, sale, or other transfer is of an additional franchise to an existing franchisee of the franchisor, or to an entity, one or more of the officers, directors, managing agents or owners of at least a 25 percent interest of which is an existing franchisee of the franchisor; provided that, in either case, for 24 months or more the franchisee, or the qualifying person, has been engaged in a business offering products or services substantially similar to those to be offered by the franchise being sold, or otherwise transferred.
(b) The franchisor files with the commissioner a notice of exemption and pays the fee prescribed in subdivision (f) of Section 31500 no later than 15 calendar days after the sale of a franchise in this state pursuant to this section"To invoke the experienced franchisee registration exemption, you must complete and file a Section 31106 Franchise Registration Exemption Notice which must be filed with the California Department of Business Oversight and requires payment of a $450 filing fee.
- Fractional Franchise Exemption
California Corporations Code Section 31108 provides a registration exemption for "fractional franchises". This fractional franchise exemption relates to the sale of a franchise to a franchisee where the franchisee already owns and operates an existing business and where, depending on the facts, the franchise business will be an "add on" to the franchisee's existing business and where the franchised business will constitute only a small percentage of the franchisee's overall gross sales. Section 31108 states:"There shall be exempted from the provisions of Chapter 2 (commencing with Section 31110), any offer or sale of a franchise if the franchise involves the adding of a new product or service line to the existing business of a prospective franchisee, provided all of the following requirements are met:
(a)For at least the last 24 months prior to the date of sale of the franchise, the prospective franchisee, or if the prospective franchisee is not a natural person, an existing officer, director, or managing agent of the prospective franchisee who has held that position with the prospective franchisee for at least the last 24 months, has been engaged in a business offering products or services substantially similar or related to those to be offered by the franchised business.
(b)The new product or service is substantially similar or related to the product or service being offered by the prospective franchisee's existing business.
(c)The franchised business is to be operated from the same business location as the prospective franchisee's existing business.
(d)The parties anticipated, in good faith, at the time the agreement establishing the franchise relationship was reached, that sales resulting from the franchised business will not represent more than 20 percent of the total sales in dollar volume of the franchisee on an annual basis.
(e)The prospective franchisee is not controlled by the franchisor.
(f)The franchisor files with the commissioner a notice of exemption and pays the fee prescribed in subdivision (f) of Section 31500 prior to an offer or sale of such a franchise in this state during any calendar year in which one or more of those franchises are sold."To invoke the fractional franchise registration exemption, you must complete and file a Section 31108 Franchise Registration Exemption Notice which must be filed with the California Department of Business Oversight and requires payment of a $450 filing fee.
- Sophisticated Franchisee Exemption
California Corporations Code Section 31109 contains a registration exemption for sophisticated franchisees that meet certain net worth, income and financial experience requirements. The requirements and conditions for the application of this exemption are extensive and are extremely fact sensitive. To invoke the sophisticated franchisee exemption, you must complete and file a Section 31109 Franchise Registration Exemption Notice which must be filed with the California Department of Business Oversight and requires payment of a $450 filing fee.
Due to the regulatory climate in the State of California, our recommendation is to obtain FDD registration. If timely registration is not possible, registration exemptions may provide a stop-gap solution allowing you to close a deal. Before relying on any registration exemptions, carefully review the facts with your franchise lawyer. To learn more about how we can assist with your FDD registrations and exemptions, contact us at (800) 976-4904 or fill out our contact form.