The Amended FTC Rule: How will your franchise system be affected?

By Doug Ferguson and Dan Block

The Federal Trade Commission’s amended Franchise Rule has been enacted with the phase-in period set to expire on July 1, 2008. The amended rule will require revisions to your offering circular – which is now called a Franchise Disclosure Document, or the FDD.

Numerous changes have been made to the disclosure system as a whole. Most importantly, the amended rule changes the disclosure timing, permits electronic disclosures and changes the updating requirements. It also creates new exemptions and clarifies its applicability to international transactions.

Under the amended rule, the Franchise Disclosure Document must be provided to a prospective franchisee at least 14 calendar days before the prospective franchisee signs any franchise or other binding agreement or pays consideration to you or your affiliate. The former requirement that a disclosure document be delivered before the first “face-to-face” meeting has been removed.

Also, if you’ve made material changes to the terms of the basic franchise agreement attached to the Disclosure Document, then execution-ready copies of the franchise agreement, along with all other agreements must be delivered to the prospect at least seven calendar days before being executed. This requirement does not apply to “fill in the blank” provisions like dates, names and addresses that are added to the basic form of the agreements or to changes that are initiated at the prospective franchisee’s request. Remember, you cannot unilaterally substitute provisions in a franchise agreement resulting in a material change unless you first notify the prospective franchisee about the change at least seven days before execution of the agreement.

Updating requirements have also changed. The Disclosure Document must be updated each year within 120 days following your fiscal year end, instead of 90 days under the prior rule – but this extended time period will not apply for your renewal in 2008. The Disclosure Document must also be updated within a reasonable amount of time after the close of each quarter of your fiscal year if there have been any material changes in the prior quarter. A quarterly update also requires inclusion of your most recent financial statements, which can be submitted unaudited.

The amended rule now permits the Franchise Disclosure Document to be delivered to a prospect electronically, which may be by Internet, e-mail, computer disks, compact discs or other forms, though restrictions apply. Electronic signatures are also permitted.

Additionally, the amended rule prohibits “shills.” You cannot misrepresent that any person has actually purchased or operated one of your franchises or that any person can give an independent and reliable report about the experience of any current or former franchisee.

The amended rule provides exemptions from the obligation to provide a disclosure document if the prospect qualifies as a “big boy franchisee” or is a purchaser who has or had a prior managerial affiliation with the franchisor, although restrictions apply. A “big boy franchisee” is a franchisee making an initial investment, excluding real estate costs, of at least $1 million dollars, or a franchisee who has been in business for at least five years and has a net worth of at least $5 million.

The amended rule also clarifies that it does not apply in the case of a transaction involving a US franchisor and a franchisee located in another country who intends to operate its franchised business outside of the United States.

Note that as of the date of this article, some states that have registration and/or disclosure laws have not updated their laws to conform to the amended FTC Rule. Until that occurs, not all of the procedures discussed above apply in all states.

For an item-by-item breakdown of the amended FTC rule, which includes tables and changes made to Item 20, or other information about franchise law compliance or franchising in general, contact Doug Ferguson directly at dferguson@rwolaw.com or Dan Block directly at dblock@rwolaw.com.