An Overview of the New FTC Rule

This article outlines the key elements of the New Rule. The New Rule changes the coverage of the existing FTC Rule, including the following:

1. It applies only to franchises for locations in the United States, or its territories.
2. It no longer covers 'business opportunities.'
3. It retains exemptions for franchise fees under $500, 'fractional franchises,' 'leased departments,' and 'oral franchises,' and codifies exemptions for franchises governed by the Petroleum Marketing Practices Act.
4. It deletes exclusions for general partnerships, employer-employee relationships, cooperatives, certification and testing services, and single-trademark licenses (commenting that the exclusions are unnecessary because they were not included in the first place).
5. It adds several new exemptions for: a) franchises requiring an investment exceeding $1 million, excluding unimproved land and amounts financed by the franchisor or its affiliate; b) franchises sold to a franchisee that is five or more years old with a net worth exceeding $5 million; or c) 'insider' transactions in which at least 50% of the owners of the franchisee were 25%-owners or managers of the franchisor.

The New Rule will change the timing of franchisor presale disclosures. An extensive discussion of this area can be found on page 5 of this issue of FBLA, but the highlights are:

1. The franchisor no longer must deliver the Uniform Franchise Offering Circular ('UFOC') at the 'first personal meeting' (first face-to-face meeting) with the prospective franchisee.
2. Franchisors must deliver the UFOC 14 calendar days (rather than 10 business days) before the franchisee signs any franchise or other binding agreement with, or pays any consideration to, the franchisor or any affiliate, or earlier upon a prospect's reasonable request.
3. Franchisors must deliver execution-ready copies of the UFOC and all other related agreements seven calendar days (rather than five business days) before they are executed. This waiting period applies only if the franchisor unilaterally (i.e., not in response to franchisee-initiated negotiations) makes material changes to the terms of the basic franchise agreement attached to the UFOC.

The New Rule changes the updating requirements as follows:

1. Annual updates must be made within 120 (rather than 90) days after the franchisor's fiscal year end.
2. The New Rule retains quarterly UFOC updates for material changes, but now requires notice to the franchisee (but not an amended UFOC) of any material changes to any financial performance representations (i.e., Item 19 earnings claims) about which the franchisor knows or should have known.
3. The New Rule prohibits waivers of any representation in the UFOC, but expressly permits negotiated changes.
4. The New Rule will allow the UFOC and contracts to be delivered either by paper or electronically via the Internet, e-mail, computer disks, or compact discs, and eliminates the requirement for traditional handwritten signatures. The franchisee must be able to store, download, print, or otherwise maintain the documents for future reference. The electronic UFOC may include scrollbars, internal links, and search features, but no other technological developments such as audio, video, 'pop-up' screens, or external links.

See the full story in the March issue of LJN's Franchising Business & Law Alert.

Kenneth R. Costello is a partner in the Los Angeles office of Bryan Cave LLP, a full-service international law firm. He can be contacted at 310-576-2100 or kenneth.costello@bryancave.com.

On Jan. 22, 2007, after more than a decade of study, the FTC released its long-anticipated new Federal Trade Commission Rule on Franchising (the 'New Rule'). The New Rule comes into effect on a voluntary basis on July 1, 2007, with compliance becoming mandatory on July 1, 2008. Additional compliance guides are expected by July 1, 2007. Franchisors will have to make significant changes to their existing disclosure documents and follow new rules for how and when they are delivered to prospective franchisees.