FTC Proposes New Business Opportunity Rule

On April 12, 2006, the Federal Trade Commission ('FTC') published in the Federal Register (Business Opportunity Rule 71 Fed. Reg. 19054 (proposed April 12, 2006) (to be codified at 16 CFR Part 437)) a Notice of Proposed Rulemaking for the FTC's long-awaited business opportunity rule ('Bus Opp Rule'). The Bus Opp Rule will cover business opportunity sellers who now are covered by the FTC's franchise trade regulation rule ('Franchise Rule'), as well as sellers of certain business opportunities who are not now covered by the Franchise Rule. The FTC has long believed that the same regulation was not the best way to regulate both business opportunity sellers and franchisors. More specifically, the FTC has concluded that each group's special characteristics (such as history of consumer protection problems, sophistication of its target purchasers, required investment commitment, and complexity of business system) required a different regulatory approach. The Bus Opp Rule is designed to create a regulatory scheme to focus on the special characteristics of business opportunities. Until the Bus Opp Rule is promulgated, business opportunity sellers must continue to comply with the current and, if and when adopted, amended Franchise Rule.

A review of the FTC enforcement history and consumer complaints reveals that business opportunities have been a significantly greater problem for consumers than franchises. In addition, several types of business opportunities are not covered by the existing business opportunity definition contained in the Franchise Rule. To cite some statistics, the FTC has initiated 1) 40 Franchise Rule cases against business opportunities covered by the Franchise Rule since 1990; and 2) 15 'sweeps' of business opportunity sellers (including businesses covered and not covered by the Franchise Rule) in conjunction with other federal and state law enforcement agencies. Moreover, with respect to certain types of businesses not currently covered by the Franchise Rule but which the FTC would cover in its proposed Bus Opp Rule, the FTC has 1) brought 60 enforcement actions against 'work-at-home' businesses (such as envelope stuffing and craft assembly programs) since 1990, has received 37,333 consumer complaints against work-at-home businesses from January 1997 through December 2005, and estimates that consumers have lost more than $15 million in purchasing fraudulent work-at-home businesses; and 2) brought 20 enforcement actions against 'pyramid' schemes since 1990 and received 17,858 consumer complaints during the period January 1997 through December 2005 in which consumers have alleged to have sustained more than $46 million in losses.

The definition of a business opportunity in the Bus Opp Rule is significantly broader than the current definition set forth in the Franchise Rule. The expanded coverage is designed primarily to encompass work-at-home and pyramid businesses. The proposed definition has the following three definitional elements:

a) The seller solicits persons to enter into a new business;

b) The purchaser makes any payment or provides any other direct or indirect consideration through a third party (no $500 minimum payment needed); and

c) The seller either: 1) makes an earnings claim; or 2) represents that some type of business assistance will be provided to the purchaser. Business assistance means the offer of material advice, information, or support to a prospective purchaser, and specifically includes: (a) more detailed versions of the Franchise Rule's 'providing locations/customer accounts' business opportunity definitional element, and 'significant assistance' franchise definitional element; (b) purchasing products made, grown, etc. by work-at-home businesses; or (c) paying commissions based on the purchaser's product sales or recruitment efforts (pyramid schemes).

The proposed Bus Opp Rule explicitly exempts franchisors who: 1) satisfy the definitional elements of a 'franchise' under the Franchise Rule; 2) utilize a written contract; and 3) require the purchaser to make a payment that meets the Franchise Rule's minimum $500 payment requirement. Thus, the Bus Opp Rule will have no impact on franchisors who comply with the Franchise Rule. This exemption also would cover several other Franchise Rule exemptions, such as fractional franchises and leased department arrangements and, according to FTC staff, those franchisors who defer required payments for 6 months. It also will exempt franchisors that the FTC has exempted from Franchise Rule compliance after conducting a formal exemption proceeding under '18(g) of the FTC Act.

Franchisors that did not need to comply with the Franchise Rule because they avoided the Franchise Rule's 'required payment' definitional element by limiting franchisees' payments to purchases at bona fide wholesale prices of reasonable quantities of inventory for resale will be covered by the Bus Opp Rule, as will those franchisors who collected a payment of less than $500.

Business opportunity sellers that currently are covered by the Franchise Rule will be covered by the Bus Opp Rule.

Less Disclosure, More Prohibitions, and Similar Pre-emption Standard

The FTC also has concluded that prospective business opportunity purchasers do not need as much pre-sale disclosure information as prospective franchise purchasers. Business opportunity businesses tend to be less complex and require smaller investments, utilize simpler contracts, and rely less on the seller's ongoing assistance than franchised businesses. Moreover, business opportunities typically have fewer financial and management resources available to shoulder the compliance burdens imposed by the Franchise Rule's pre-sale disclosure document. For this reason, the proposed Bus Opp Rule sharply reduces the amount of required pre-sale disclosures.

The FTC has created a unique one-page disclosure document that limits required disclosures to five categories of information that the FTC believes to be of greatest importance to purchasers. The five categories of information are: 1) earnings claims; 2) criminal and civil actions; 3) cancellation and refund policies; 4) a 2-year sales, cancellation, and refund history; and 5) a list of purchasers. For the first three categories, the seller either checks the 'No' box if no disclosure about the category is needed, or checks the 'Yes' box and, in addition, attaches the required information to the one-page disclosure form. The seller also must list the name, address, and telephone number of all purchasers within the past 3 years, but has the option, similar to the Franchise Rule, of limiting the list to the 10 purchasers closest to the prospective purchasers' location. New purchasers must be advised that similar information about them will be included in future disclosure forms.

Disclosure must be made at least 7 calendar days before the business opportunity purchaser buys the business or pays, directly, indirectly, or through a third party, any money to the seller. Quarterly updates are required for all changes (including the purchaser list); monthly updates are required if fewer than 10 purchasers are listed.

Earnings claims disclosures are reasonably similar to the Franchise Rule requirements. The seller may not provide overall industry earnings information unless the seller can demonstrate that its purchasers' results are similar to the industry results.

Litigation triggering a 'Yes' response is reasonably similar to the Franchise Rule in terms of parties and types of claims requiring disclosure, but the required disclosure is limited to the full caption of the action and the identity of the court.

Electronic versions of the disclosure document are acceptable.

The disclosure form must include the name of the seller's salesman and the date the form was provided to the prospective purchaser. The 'Receipt' is a duplicate copy of the disclosure form that the prospective purchaser signs and returns to the seller.

In addition to the required disclosures, the proposed rule lists 18 prohibited actions, among them being:

• securing waivers of the seller's com-pliance with the law;
• numerous types of misrepresentations, such as those related to earnings, seller's ongoing payments to purchasers, costs and other essential features of the business opportunity, seller's assistance to purchasers, ease of securing locations and accounts, and information about third parties' relationship with or endorsement of the business opportunity;
• providing written or oral representations that are inconsistent with the information provided in the disclosure form, or including more than the required information in the form;
• failing to provide substantiation for any earnings claim;
• not following the cancellation or refund policy described in the disclosure form, or misrepresenting these policies;
• violating any territorial exclusivity rights granted to the purchaser, or misrepresenting the nature of such rights; and
• using bogus references, or failing to disclose any consideration paid to existing purchasers or special relationships between the seller and any existing purchaser.

Finally, the Bus Opp Rule will use the same pre-emption standard as the Franchise Rule; eg, state laws will be pre-empted only to the extent that the laws conflict with the Bus Opp Rule and provide less protection to purchasers. However, unlike the Franchise Rule, in which the UFOC disclosure will suffice for both FTC and state disclosure law purposes, sellers will need two disclosure forms, eg, the Bus Opp Rule document, and the state-required format, because the two laws' disclosure obligations are so different.

Sellers must keep records for 3 years of: 1) all 'materially different' versions of their disclosure documents; 2) purchasers' disclosure document receipts; 3) signed purchaser contracts; 4) cancellation or refund requests; and 5) substantiation of earnings claims.

One group that should pay special attention to the rulemaking proceeding is the 'non-pyramid' product distributors who have relied solely on the bona fide wholesale price exemption to avoid Franchise Rule coverage. They will now be covered by the Bus Opp Rule and should pay careful attention to this rulemaking proceeding; at a minimum, they should carefully review their current business arrangements with their purchasers and consider their future options.

The FTC proposes to greatly expand the scope of its business opportunity coverage to include many business opportunity sellers and other product distributors who, to date, have avoided coverage under franchise or business opportunity laws. At the same time, the FTC proposes to significantly reduce the amount of required disclosure that sellers must provide to prospective purchasers. Given these factors, the proposed Bus Opp Rule appears to reflect an interesting trade-off between coverage and compliance.

John M. Tifford is a partner in DLA Piper Rudnick Gray Cary US LLP in Washington, DC. He was the program adviser for franchising at the Federal Trade Commission in 1978 when the Franchise Rule was promulgated and administered the Franchise Rule program until he joined DLA Piper in 1988. He can be contacted by phone at 703-773-4244 or by e-mail at [email protected].

On April 12, 2006, the Federal Trade Commission ('FTC') published in the Federal Register (Business Opportunity Rule 71 Fed. Reg. 19054 (proposed April 12, 2006) (to be codified at 16 CFR Part 437)) a Notice of Proposed Rulemaking for the FTC's long-awaited business opportunity rule ('Bus Opp Rule'). The Bus Opp Rule will cover business opportunity sellers who now are covered by the FTC's franchise trade regulation rule ('Franchise Rule'), as well as sellers of certain business opportunities who are not now covered by the Franchise Rule. The FTC has long believed that the same regulation was not the best way to regulate both business opportunity sellers and franchisors. More specifically, the FTC has concluded that each group's special characteristics (such as history of consumer protection problems, sophistication of its target purchasers, required investment commitment, and complexity of business system) required a different regulatory approach. The Bus Opp Rule is designed to create a regulatory scheme to focus on the special characteristics of business opportunities. Until the Bus Opp Rule is promulgated, business opportunity sellers must continue to comply with the current and, if and when adopted, amended Franchise Rule.

A review of the FTC enforcement history and consumer complaints reveals that business opportunities have been a significantly greater problem for consumers than franchises. In addition, several types of business opportunities are not covered by the existing business opportunity definition contained in the Franchise Rule. To cite some statistics, the FTC has initiated 1) 40 Franchise Rule cases against business opportunities covered by the Franchise Rule since 1990; and 2) 15 'sweeps' of business opportunity sellers (including businesses covered and not covered by the Franchise Rule) in conjunction with other federal and state law enforcement agencies. Moreover, with respect to certain types of businesses not currently covered by the Franchise Rule but which the FTC would cover in its proposed Bus Opp Rule, the FTC has 1) brought 60 enforcement actions against 'work-at-home' businesses (such as envelope stuffing and craft assembly programs) since 1990, has received 37,333 consumer complaints against work-at-home businesses from January 1997 through December 2005, and estimates that consumers have lost more than $15 million in purchasing fraudulent work-at-home businesses; and 2) brought 20 enforcement actions against 'pyramid' schemes since 1990 and received 17,858 consumer complaints during the period January 1997 through December 2005 in which consumers have alleged to have sustained more than $46 million in losses.

The definition of a business opportunity in the Bus Opp Rule is significantly broader than the current definition set forth in the Franchise Rule. The expanded coverage is designed primarily to encompass work-at-home and pyramid businesses. The proposed definition has the following three definitional elements:

a) The seller solicits persons to enter into a new business;

b) The purchaser makes any payment or provides any other direct or indirect consideration through a third party (no $500 minimum payment needed); and

c) The seller either: 1) makes an earnings claim; or 2) represents that some type of business assistance will be provided to the purchaser. Business assistance means the offer of material advice, information, or support to a prospective purchaser, and specifically includes: (a) more detailed versions of the Franchise Rule's 'providing locations/customer accounts' business opportunity definitional element, and 'significant assistance' franchise definitional element; (b) purchasing products made, grown, etc. by work-at-home businesses; or (c) paying commissions based on the purchaser's product sales or recruitment efforts (pyramid schemes).

The proposed Bus Opp Rule explicitly exempts franchisors who: 1) satisfy the definitional elements of a 'franchise' under the Franchise Rule; 2) utilize a written contract; and 3) require the purchaser to make a payment that meets the Franchise Rule's minimum $500 payment requirement. Thus, the Bus Opp Rule will have no impact on franchisors who comply with the Franchise Rule. This exemption also would cover several other Franchise Rule exemptions, such as fractional franchises and leased department arrangements and, according to FTC staff, those franchisors who defer required payments for 6 months. It also will exempt franchisors that the FTC has exempted from Franchise Rule compliance after conducting a formal exemption proceeding under '18(g) of the FTC Act.

Franchisors that did not need to comply with the Franchise Rule because they avoided the Franchise Rule's 'required payment' definitional element by limiting franchisees' payments to purchases at bona fide wholesale prices of reasonable quantities of inventory for resale will be covered by the Bus Opp Rule, as will those franchisors who collected a payment of less than $500.

Business opportunity sellers that currently are covered by the Franchise Rule will be covered by the Bus Opp Rule.

Less Disclosure, More Prohibitions, and Similar Pre-emption Standard

The FTC also has concluded that prospective business opportunity purchasers do not need as much pre-sale disclosure information as prospective franchise purchasers. Business opportunity businesses tend to be less complex and require smaller investments, utilize simpler contracts, and rely less on the seller's ongoing assistance than franchised businesses. Moreover, business opportunities typically have fewer financial and management resources available to shoulder the compliance burdens imposed by the Franchise Rule's pre-sale disclosure document. For this reason, the proposed Bus Opp Rule sharply reduces the amount of required pre-sale disclosures.

The FTC has created a unique one-page disclosure document that limits required disclosures to five categories of information that the FTC believes to be of greatest importance to purchasers. The five categories of information are: 1) earnings claims; 2) criminal and civil actions; 3) cancellation and refund policies; 4) a 2-year sales, cancellation, and refund history; and 5) a list of purchasers. For the first three categories, the seller either checks the 'No' box if no disclosure about the category is needed, or checks the 'Yes' box and, in addition, attaches the required information to the one-page disclosure form. The seller also must list the name, address, and telephone number of all purchasers within the past 3 years, but has the option, similar to the Franchise Rule, of limiting the list to the 10 purchasers closest to the prospective purchasers' location. New purchasers must be advised that similar information about them will be included in future disclosure forms.

Disclosure must be made at least 7 calendar days before the business opportunity purchaser buys the business or pays, directly, indirectly, or through a third party, any money to the seller. Quarterly updates are required for all changes (including the purchaser list); monthly updates are required if fewer than 10 purchasers are listed.

Earnings claims disclosures are reasonably similar to the Franchise Rule requirements. The seller may not provide overall industry earnings information unless the seller can demonstrate that its purchasers' results are similar to the industry results.

Litigation triggering a 'Yes' response is reasonably similar to the Franchise Rule in terms of parties and types of claims requiring disclosure, but the required disclosure is limited to the full caption of the action and the identity of the court.

Electronic versions of the disclosure document are acceptable.

The disclosure form must include the name of the seller's salesman and the date the form was provided to the prospective purchaser. The 'Receipt' is a duplicate copy of the disclosure form that the prospective purchaser signs and returns to the seller.

In addition to the required disclosures, the proposed rule lists 18 prohibited actions, among them being:

• securing waivers of the seller's com-pliance with the law;
• numerous types of misrepresentations, such as those related to earnings, seller's ongoing payments to purchasers, costs and other essential features of the business opportunity, seller's assistance to purchasers, ease of securing locations and accounts, and information about third parties' relationship with or endorsement of the business opportunity;
• providing written or oral representations that are inconsistent with the information provided in the disclosure form, or including more than the required information in the form;
• failing to provide substantiation for any earnings claim;
• not following the cancellation or refund policy described in the disclosure form, or misrepresenting these policies;
• violating any territorial exclusivity rights granted to the purchaser, or misrepresenting the nature of such rights; and
• using bogus references, or failing to disclose any consideration paid to existing purchasers or special relationships between the seller and any existing purchaser.

Finally, the Bus Opp Rule will use the same pre-emption standard as the Franchise Rule; eg, state laws will be pre-empted only to the extent that the laws conflict with the Bus Opp Rule and provide less protection to purchasers. However, unlike the Franchise Rule, in which the UFOC disclosure will suffice for both FTC and state disclosure law purposes, sellers will need two disclosure forms, eg, the Bus Opp Rule document, and the state-required format, because the two laws' disclosure obligations are so different.

Sellers must keep records for 3 years of: 1) all 'materially different' versions of their disclosure documents; 2) purchasers' disclosure document receipts; 3) signed purchaser contracts; 4) cancellation or refund requests; and 5) substantiation of earnings claims.

One group that should pay special attention to the rulemaking proceeding is the 'non-pyramid' product distributors who have relied solely on the bona fide wholesale price exemption to avoid Franchise Rule coverage. They will now be covered by the Bus Opp Rule and should pay careful attention to this rulemaking proceeding; at a minimum, they should carefully review their current business arrangements with their purchasers and consider their future options.

The FTC proposes to greatly expand the scope of its business opportunity coverage to include many business opportunity sellers and other product distributors who, to date, have avoided coverage under franchise or business opportunity laws. At the same time, the FTC proposes to significantly reduce the amount of required disclosure that sellers must provide to prospective purchasers. Given these factors, the proposed Bus Opp Rule appears to reflect an interesting trade-off between coverage and compliance.

John M. Tifford is a partner in DLA Piper Rudnick Gray Cary US LLP in Washington, DC. He was the program adviser for franchising at the Federal Trade Commission in 1978 when the Franchise Rule was promulgated and administered the Franchise Rule program until he joined DLA Piper in 1988. He can be contacted by phone at 703-773-4244 or by e-mail at [email protected].