News Briefs

The proposal would change the exemption in two ways. First it would raise the threshold from the current $750,000 to $1 million. Second, it incorporates the concluding phrase 'exclusive of real estate costs.' The difficulties of interpreting that phrase were cited by several comment submissions.

'We note that the term 'real estate costs' is not defined in the proposals, and we anticipate that this vague phrase will cause uncertainty in the administration of the exemption and confusion among franchisors and their franchisees,' wrote Andrew A. Caffey, a Bethesda, MD-based attorney. Does 'real estate' apply merely to land, or does it apply to building construction, landscaping, and more, Caffey asked. He suggested excluding land acquisition or leasing costs from the calculation of the exemption threshold.

A subcommittee of the Franchise and Distribution Law Committee of the Business Law Section of the Maryland State Bar Association also submitted a comment that the real estate exemption is confusing. The group said the phrase 'exclusive of real estate costs' should be dropped.

The bar committee's comments also touched upon electronic disclosure, identification theft, escrow, and advertising. The committee praised the proposed revision to allow electronic filings of UFOCs, and proposed broadening the types of electronic disclosures that are permitted to include 'memory sticks' and e-mail. In recognition that identity theft is a growing problem, the bar committee pointed out that the salesman disclosure forms that are required to be part of a franchisor's filings expose critical identifying information about salesmen, including Social Security numbers. The committee recommended that filing of salesman disclosure forms be discontinued, or that they can be submitted in redacted form.

Marriott International, which is headquartered in Maryland, also submitted comments that supported electronic disclosure and noted that the real estate reference in the sophisticated franchisee exemption is too vague.

FTC Issues Franchise Opinion Letter on Financial Disclosure

On April 30, the Federal Trade Commission ('FTC') issued an informal staff advisory opinion related to a franchisor's required disclosure of financial statements following a corporate reorganization and change of fiscal year. The FTC's franchise advisory opinions are online at www.ftc.gov/bcp/franchise/netadopin.htm.

The issue most recently addressed by the FTC was raised by a large franchisor (more than 500 franchised outlets) that is wholly owned by a subsidiary of another company ('Immediate Parent'). The franchisor's parent was purchased by the American subsidiary ('U.S. Parent') of a company organized and headquartered outside the United States ('Foreign Parent') in November 2005. The U.S. Parent now owns approximately 60% of the Immediate Parent, and the Foreign Parent owns the remainder. Prior to the acquisition, all parties except the Foreign Parent had fiscal years that ended on Dec. 31, but they requested an opinion about filing financial statements in the years when they transition to adopting the Foreign Parent's fiscal year, which ends March 31.

Section 436.1(a)(20)(1) of the Franchise Rule requires that a franchise disclosure document must contain a balance sheet for the franchisor for the most recent fiscal year, and an income statement and statement of changes in financial position for the franchisor for the most recent 3 fiscal years. The statements must comply with generally accepted auditing standards. Section 436.1(a)(22) of the Franchise Rule requires that after the close of the fiscal year, the franchisor has up to 90 days to prepare a revised disclosure statement, which is the only disclosure document that can be distributed after the 90-day period. Material changes during the course of the year must be noted in revised disclosure statements, though those do not have to be audited. Finally, if the franchisor is a subsidiary, the FTC notes that 'it need not provide audited financial statements of its own, but may include audited financial statement of its parent under limited circumstances,' which are:

• The parent's audited financial statements must be prepared on a combined or consolidated basis according to generally accepted accounting principles.
• The franchisor must include its own unaudited financials.
• The parent must 'absolutely and ir-revocably agree to guarantee to the franchisee all obligations of the franchisor under the franchise agreement and related agreements, and as set forth in the Basic Disclosure Document,' and the guarantee must appear in conjunction with the financial statements.

Given the circumstances, the FTC first advised that the franchisor can use the audited financial statements of either its Immediate Parent or the U.S. Parent, assuming it meets the criteria above. Next, the FTC said that the franchisor can use unaudited financial statements to address financial changes occurring during the course of a franchisor's fiscal year. Specifically, the FTC advised that the franchisor could 'reflect financial changes as a result of the restructuring, [by using] unaudited financials for the period January 1, 2005, through November 17, 2005, and then separate quarterly unaudited financials for the post-acquisition period November 18 until the end of its new fiscal year ' March 31, 2006.'

The last issue to consider is how the franchisor should account for the 15-month reporting period of Jan. 1, 2005, through March 31, 2006. 'We believe the best approach in resolving this issue would be for Franchisor to prepare audited financial statements for the 15-month period January 1, 2005, through March 31, 2006,' wrote the FTC. 'In our view, having audited financials for a 15-month period is better than other possible alternatives.'

To prevent any confusion, the FTC added that the franchisor should 'include a clear caveat' at the beginning of its financial statement that it is using a 15-month financial statement for a limited period, and that year-to-year comparisons must be made carefully.

Finally, the FTC agreed with the decision by several franchise registration states to allow the franchisor extended registration time so that its current registration will remain valid until June 2006, so that the franchisor can reflect its new March 31 fiscal year. The FTC wrote that the extension does not result in noncompliance with the Franchise Rule.

Franchisors, Franchisees Gain Some Relief As California Supreme Court Upholds Retroactivity of Prop 64

On July 24, the California Supreme Court issued two decisions that affirmed that the reforms in the state's broad Unfair Competition Law are retroactive to before the passage of the bill in November 2004.

The reforms, known as Proposition 64, were issued to stem a flood of litigation in California that alleged violations of the state's unfair practices law, especially deceptive advertising. 'Previously [prior to Proposition 64], any person could sue seeking remedies under 17200, whether or not they were injured by the allegedly unlawful conduct,' said Jeff Fillerup, attorney with Luce, Forward, Hamilton & Scripps LLP, in San Francisco. 'This lack of a standing requirement created a class of professional 17200 plaintiffs ' both individuals and corporations.'

Often, franchisors and franchisees would be targeted by private citizens for alleged unfair practices, and occasionally a franchisee would use 17200 to sue a franchisor (see FBLA, November 2004 and March 2005).

Some intermediate appellate courts found Prop 64 to be retroactive, but others disagreed, thus leading to the July 24 California Supreme Court decisions in Californians for Disability Rights v. Mervyn's, LLC, ___Cal.4th___ and Branick v. Downey Savings and Loan Association, ____Cal.4th____.

While a victory for businesses facing nuisance lawsuits, Fillerup noted that the decision in Branick leaves many old cases still in trial courts, where the facts of a plaintiff's standing must still be decided. In Branick, the court addressed whether a plaintiff, whose standing was revoked by Prop 64, could amend its complaint to substitute a new plaintiff who does enjoy standing, and if so, whether such an amendment relates back for purposes of the statute of limitations to the date on which the original complaint was filed. 'The supreme court held that Prop 64 did not bar such an amendment by a plaintiff whose standing was revoked, and that the existing rules relating to amendment of complaints and the relation-back doctrine would apply,' said Fillerup. 'The court declined to rule on whether the plaintiff in Branick had the right to amend the complaint because there was an insufficient record. Instead the matter was remanded for the trial court to rule on a motion for leave to amend the complaint. Thus, it appears that the status of the thousands of 17200 cases pending in November 2004 will be handled on a case-by-case basis going forward.'

Maryland's Proposed Franchise Law Revisions Attract Comments

The Maryland Securities Division received several comments related to its April 14 proposal to amend the state's franchise regulations. The proposal would alter the requirements relating to surety bonds, the exemption from franchise registration, and the periods covered by required sales reports.

The issue that drew the most attention from those who commented was a proposed modification to the exemption for sophisticated franchisees. The proposed section reads: 'The registration provisions of the Maryland Franchise Law do not apply to any offer or sale of a franchise for which the franchisor requires an initial investment by the franchisee of more than $1,000,000, exclusive of real estate costs.'

The proposal would change the exemption in two ways. First it would raise the threshold from the current $750,000 to $1 million. Second, it incorporates the concluding phrase 'exclusive of real estate costs.' The difficulties of interpreting that phrase were cited by several comment submissions.

'We note that the term 'real estate costs' is not defined in the proposals, and we anticipate that this vague phrase will cause uncertainty in the administration of the exemption and confusion among franchisors and their franchisees,' wrote Andrew A. Caffey, a Bethesda, MD-based attorney. Does 'real estate' apply merely to land, or does it apply to building construction, landscaping, and more, Caffey asked. He suggested excluding land acquisition or leasing costs from the calculation of the exemption threshold.

A subcommittee of the Franchise and Distribution Law Committee of the Business Law Section of the Maryland State Bar Association also submitted a comment that the real estate exemption is confusing. The group said the phrase 'exclusive of real estate costs' should be dropped.

The bar committee's comments also touched upon electronic disclosure, identification theft, escrow, and advertising. The committee praised the proposed revision to allow electronic filings of UFOCs, and proposed broadening the types of electronic disclosures that are permitted to include 'memory sticks' and e-mail. In recognition that identity theft is a growing problem, the bar committee pointed out that the salesman disclosure forms that are required to be part of a franchisor's filings expose critical identifying information about salesmen, including Social Security numbers. The committee recommended that filing of salesman disclosure forms be discontinued, or that they can be submitted in redacted form.

Marriott International, which is headquartered in Maryland, also submitted comments that supported electronic disclosure and noted that the real estate reference in the sophisticated franchisee exemption is too vague.

FTC Issues Franchise Opinion Letter on Financial Disclosure

On April 30, the Federal Trade Commission ('FTC') issued an informal staff advisory opinion related to a franchisor's required disclosure of financial statements following a corporate reorganization and change of fiscal year. The FTC's franchise advisory opinions are online at www.ftc.gov/bcp/franchise/netadopin.htm.

The issue most recently addressed by the FTC was raised by a large franchisor (more than 500 franchised outlets) that is wholly owned by a subsidiary of another company ('Immediate Parent'). The franchisor's parent was purchased by the American subsidiary ('U.S. Parent') of a company organized and headquartered outside the United States ('Foreign Parent') in November 2005. The U.S. Parent now owns approximately 60% of the Immediate Parent, and the Foreign Parent owns the remainder. Prior to the acquisition, all parties except the Foreign Parent had fiscal years that ended on Dec. 31, but they requested an opinion about filing financial statements in the years when they transition to adopting the Foreign Parent's fiscal year, which ends March 31.

Section 436.1(a)(20)(1) of the Franchise Rule requires that a franchise disclosure document must contain a balance sheet for the franchisor for the most recent fiscal year, and an income statement and statement of changes in financial position for the franchisor for the most recent 3 fiscal years. The statements must comply with generally accepted auditing standards. Section 436.1(a)(22) of the Franchise Rule requires that after the close of the fiscal year, the franchisor has up to 90 days to prepare a revised disclosure statement, which is the only disclosure document that can be distributed after the 90-day period. Material changes during the course of the year must be noted in revised disclosure statements, though those do not have to be audited. Finally, if the franchisor is a subsidiary, the FTC notes that 'it need not provide audited financial statements of its own, but may include audited financial statement of its parent under limited circumstances,' which are:

• The parent's audited financial statements must be prepared on a combined or consolidated basis according to generally accepted accounting principles.
• The franchisor must include its own unaudited financials.
• The parent must 'absolutely and ir-revocably agree to guarantee to the franchisee all obligations of the franchisor under the franchise agreement and related agreements, and as set forth in the Basic Disclosure Document,' and the guarantee must appear in conjunction with the financial statements.

Given the circumstances, the FTC first advised that the franchisor can use the audited financial statements of either its Immediate Parent or the U.S. Parent, assuming it meets the criteria above. Next, the FTC said that the franchisor can use unaudited financial statements to address financial changes occurring during the course of a franchisor's fiscal year. Specifically, the FTC advised that the franchisor could 'reflect financial changes as a result of the restructuring, [by using] unaudited financials for the period January 1, 2005, through November 17, 2005, and then separate quarterly unaudited financials for the post-acquisition period November 18 until the end of its new fiscal year ' March 31, 2006.'

The last issue to consider is how the franchisor should account for the 15-month reporting period of Jan. 1, 2005, through March 31, 2006. 'We believe the best approach in resolving this issue would be for Franchisor to prepare audited financial statements for the 15-month period January 1, 2005, through March 31, 2006,' wrote the FTC. 'In our view, having audited financials for a 15-month period is better than other possible alternatives.'

To prevent any confusion, the FTC added that the franchisor should 'include a clear caveat' at the beginning of its financial statement that it is using a 15-month financial statement for a limited period, and that year-to-year comparisons must be made carefully.

Finally, the FTC agreed with the decision by several franchise registration states to allow the franchisor extended registration time so that its current registration will remain valid until June 2006, so that the franchisor can reflect its new March 31 fiscal year. The FTC wrote that the extension does not result in noncompliance with the Franchise Rule.

Franchisors, Franchisees Gain Some Relief As California Supreme Court Upholds Retroactivity of Prop 64

On July 24, the California Supreme Court issued two decisions that affirmed that the reforms in the state's broad Unfair Competition Law are retroactive to before the passage of the bill in November 2004.

The reforms, known as Proposition 64, were issued to stem a flood of litigation in California that alleged violations of the state's unfair practices law, especially deceptive advertising. 'Previously [prior to Proposition 64], any person could sue seeking remedies under 17200, whether or not they were injured by the allegedly unlawful conduct,' said Jeff Fillerup, attorney with Luce, Forward, Hamilton & Scripps LLP, in San Francisco. 'This lack of a standing requirement created a class of professional 17200 plaintiffs ' both individuals and corporations.'

Often, franchisors and franchisees would be targeted by private citizens for alleged unfair practices, and occasionally a franchisee would use 17200 to sue a franchisor (see FBLA, November 2004 and March 2005).

Some intermediate appellate courts found Prop 64 to be retroactive, but others disagreed, thus leading to the July 24 California Supreme Court decisions in Californians for Disability Rights v. Mervyn's, LLC, ___Cal.4th___ and Branick v. Downey Savings and Loan Association, ____Cal.4th____.

While a victory for businesses facing nuisance lawsuits, Fillerup noted that the decision in Branick leaves many old cases still in trial courts, where the facts of a plaintiff's standing must still be decided. In Branick, the court addressed whether a plaintiff, whose standing was revoked by Prop 64, could amend its complaint to substitute a new plaintiff who does enjoy standing, and if so, whether such an amendment relates back for purposes of the statute of limitations to the date on which the original complaint was filed. 'The supreme court held that Prop 64 did not bar such an amendment by a plaintiff whose standing was revoked, and that the existing rules relating to amendment of complaints and the relation-back doctrine would apply,' said Fillerup. 'The court declined to rule on whether the plaintiff in Branick had the right to amend the complaint because there was an insufficient record. Instead the matter was remanded for the trial court to rule on a motion for leave to amend the complaint. Thus, it appears that the status of the thousands of 17200 cases pending in November 2004 will be handled on a case-by-case basis going forward.'