STARTING AND GROWING A FRANCHISE:
THE LEGAL NUTS AND BOLTS OF FRANCHISING
Thomas W. France
Venable LLP
February 9, 2012
© 2008 Venable LLP
1
Regulation of Franchise Business Relationships

A franchise business relationship is subject to regulation under Federal
law and in states that have adopted laws governing franchises

Federal law
– U.S. Federal Trade Commission – 16 Code of Federal Regulations
Part 436
– Disclosure Requirements – Federal Disclosure Documents
– Enforcement – Administrative actions/civil and criminal penalties

State law
– Disclosure and Registration
– Franchise Relationship Laws
© 2011 Venable LLP
2
What is a Franchise?


The Federal Trade Commission has adopted regulations defining what types
of business relationships constitute a franchise. Under these regulations, a
commercial business arrangement is a franchise if it satisfies each of the
following three elements:
(1)
the franchisee will obtain the right to operate a business that is identified or
associated with the franchisor’s trademark, or to offer, sell or distribute goods,
services or commodities that are identified or associated with the franchisor's
trademark;
(2)
the franchisor will exert or has authority to exert a significant degree of control over
the franchisee’s method of operation, or will provide significant assistance in the
franchisee’s method of operation; and
(3)
the franchisee is required to make a minimum payment of at least $500 during the
first 6 months of operations.
States that regulate franchises also have adopted laws defining what
constitutes a franchise - these laws generally are similar to Federal law, but
may include different formulations – marketing plan/community of interest
© 2011 Venable LLP
3
Disclosure Requirements

Federal and state law require franchisors to disclose certain
information to potential franchisees prior to the sale of a franchise

Federal Disclosure Documents – Required Disclosure Topics
–
–
–
–
–
–
–
–
–
franchisor and its affiliates
business experience of officers, directors and managers
litigation and bankruptcy
fees that franchisee must pay
estimate of franchisee’s initial investment
restrictions the franchisor imposes on products and services
franchisee’s obligations during the relationship
financing, if any, available from the franchisor
franchisor’s obligations to provide assistance and information about
advertising, computer systems and training
© 2011 Venable LLP
4
Disclosure Requirements

Disclosure Requirements (cont.)
–
–
–
–
–
–
–
–
–
–

territorial rights
franchisor’s trademarks and other intellectual property
franchisee’s obligation to participate in the operation of the business
restrictions on what the franchisee may sell
information about renewal, termination, transfer and dispute resolution
any public figures who endorse the franchise
optional financial performance representations
information about outlets and franchisees
franchisor’s financial statements
lists and forms of required contracts
A potential franchisee must be given time to review the required
disclosures before paying any initial fee or signing the franchise
agreement
© 2011 Venable LLP
5
Acquiring a Franchise

New Development
– structure and organization of franchisee
• corporation/LLC/partnership
• investors
– franchise agreement
– real estate purchase/lease agreement
– development activities – zoning/construction

Acquisition of Existing Business
–
–
–
–
purchase agreement/diligence
structure and organization of franchisee
franchise – franchisor consent/assignment/new agreement
upgrading/renovation
© 2011 Venable LLP
6
What Governs the Franchise Relationship?

Federal and state law disclosures

State Law – regulation of franchise relationship
–
–
–
–
–
–
jurisdiction/which law governs
terminations – good cause and notice and opportunity to cure
limitations on franchisor’s right to consent to transfers
franchisee right to franchise association
discrimination of similarly situated franchisees
purchases of goods and services from franchisor or approved
sources
– litigation forum clauses

Contract Law – the franchise agreement
© 2011 Venable LLP
7
The Franchise Relationship

The Franchise Agreement
–
–
–
–
–
–
–
–
License – right to use trademark and franchise
Fees
• franchise fees/royalty
• advertising/marketing contributions
Term of Franchise
Territorial Protection
Construction/Renovation Requirements
• new development
• lease/landlord
• ongoing obligations
Advertising and Marketing
• local
• system
Operations
• system standards/manual/operating procedures
• employees
Training/Franchisor Support
© 2011 Venable LLP
8
The Franchise Relationship

The Franchise Agreement (cont.)
–
–
–
–
–
–

Intellectual Property/Confidentiality
Non-Compete
• restrictions during term
• post-termination
Accounting and Reports
Liability
• indemnification
• insurance
Restrictions on Transfer
• transfers of business
• ownership interests in franchisee
Default and Termination
Other Agreements
–
–
–
–
Guaranty
Lease/Owner Agreement
Development Agreement/Right of First Refusal
Management Agreements
© 2011 Venable LLP
9