Living in the Shadow of National Survival Game

There shall be exempted from the registration provisions of section six hundred eighty-three of this article the offer and sale of a franchise if:

(c) The transaction is pursuant to an offer directed by the franchisor to not more than two persons, other than persons specified in this subdivision, if the franchisor does not grant the franchisee the right to offer franchises to others, a commission or other remuneration is not paid directly or indirectly for soliciting a prospective franchisee in this state, and the franchisor is domiciled in this state or has filed with the department of law its consent to service of process on the form prescribed by the department.

This language has been interpreted to mean that the sale of the first franchise unit is exempt from registration if the unit was only offered to a maximum of two people (See BMW Co., Inc. et al. v Workbench Inc. et al. (No. 86 CIV 4200 1988 WL 45594 (S.D.N.Y. April 29, 1988); CCH Business Franchise Guide ' 9104, at 18,850). This isolated sales exemption is potentially useful for new U.S. franchisors or foreign franchisors that are new to the United States. It permits them to sell one franchise in New York without having to register a disclosure document with the state. However, the exemption would be even more useful if it also exempted franchisors from the New York disclosure requirement. If so, franchisors who qualified for one of the exemptions or exclusions under the FTC Franchise Rule could sell one unit in New York without pre-sale franchise regulation at both the federal and state level. Note that there is no isolated sale exemption under the FTC Franchise Rule. A different exemption or exclusion would be required.

The obvious argument for maintaining New York's disclosure requirement is that the first franchisee should be afforded some protection from a disreputable franchisor. But New York's disclosure requirement is duplicative. As mentioned above, the federal rule also requires disclosure in every state and doesn't have an isolated sales exemption. If the FTC reasonably exempts a franchise sale from its disclosure requirements, then why shouldn't New York follow suit?

On its face, New York's isolated sales exemption only exempts a franchisor from the registration requirement. However, ' 683(8) of the New York Franchise Law provides that:

A franchise which is subject to registration under this article shall not be sold without first providing to the prospective franchisee, a copy of the offering prospectus, together with a copy of all proposed agreements relating to the sale of the franchise '

Registration triggers the need for disclosure. Therefore, it is reasonable to assume that a franchisor that is not subject to registration, by exemption or otherwise, is not required to provide a disclosure document. However, Justice Delaney didn't think so. In National Survival Game he clearly states, “The exemption from filing an offering prospectus does not, however, relieve a franchisor from the disclosure requirements of Article 33 of the General Business Law.” He provides no support for this conclusion and does not discuss ' 683(8) in his decision.

Exemption Language

What evidence is there that isolated sales exemption should apply to both the registration requirement and the disclosure requirement? The answer lies in the language of the other exemptions under the New York Franchise Law.

Section 684(2) exempts from the registration requirement the offer and sale of a franchise if: a) the franchisor has a net worth of $5 million or more, and b) the franchisor files an application for exemption, and c) the franchisor makes 16 prescribed disclosures. This large-franchisor exemption contains the exact same lead-in language as the isolated sales exemption, exempting the franchisor from the registration requirement of Article 33. But applying the same reading to this language makes the disclosure requirement under ' 684(2)(c) redundant. The ' 684(2)(c) disclosure requirement is a subset of the broader offering prospectus disclosure requirement under ' 683. If the franchisor is not exempt from the broader disclosure requirement under ' 683 by virtue of ' 683(8), then why does the exemption contain its own disclosure requirement?

Section 684(5) also provides an exemption from the registration requirement for the sale of a franchise by a franchisee for its own account. One of the conditions to this exemption is that the franchisee must provide the prospective purchaser with the offering prospectus of the franchisor currently registered with the New York Department of Law. This exemption has been interpreted to mean that franchisees are required to provide the disclosure document of their franchisor ' not to create their own. This means that existing franchisees are exempt from both the registration and disclosure requirements in ' 683, even though the exemption itself only references an exemption from the registration requirement.

Other New York Decisions

In my view, Justice Delaney got it wrong by not considering the effect of the first sentence of ' 683(8). Unfortunately, other New York decisions considering the scope of the isolated sales exemption do not contradict his interpretation. In BMW Co., Inc., the court in its opening sentence made a broad statement that ' 684(3)(c) provides an exemption from the New York State Franchise Sales Act, but did not elaborate on the point. Instead, it dealt with whether the exemption can be applied to more than one franchise sale in New York, the court holding that the exemption does not apply to multiple franchise sales where there were no more than two offers per sale. In a more recent case, Burger Bar Five Towns, LLC v. Burger Holdings Corp., 71 A.D.3d 939, 897 N.Y.S.2d 502 (2d Dept. 2010), CCH Business Franchise Law Guide 14,348, at 45,968), the appellate court stated “an exemption to the registration requirement exists for what is commonly referred to as an “isolated sales transaction.” However, this court only considered a violation of the registration requirement and made no comments regarding a corresponding violation of the disclosure requirement, although from the facts it is clear that the defendant franchisor neither registered nor provided a disclosure document.

Other States

Fortunately for franchise practitioners, the situation is much clearer in the other states that have an isolated sales exemption. The Indiana Franchise Disclosure Law clearly states that ' 9, which sets out both the registration and disclosure requirements, does not apply to the offer or sale of a franchise if the franchisor sells no more than one franchise in a 24-month period (Ind. Code, ' 2-2.5-3). Under the Minnesota Franchise Law, it is fairly clear that the isolated sales exemption applies only to registration because the language of other Minnesota exemptions explicitly exempts the franchisor from both registration and disclosure (Minn. Stat. ' 80C.03(e)). Under the Washington Franchise Investment Protection Act, it is clear that the franchisor is only exempt from registration, because providing disclosure is one of the specific conditions to the isolated sales exemption.

Although much clearer than in New York, the language and overall approach in these other states is not consistent and does not lead one to conclude that the New York Franchise Law's isolated sales exemption should necessarily be interpreted to exclude exemption from disclosure. Like Indiana, the New York legislature, based on an integrated reading of the statute, appears to have authorized exemption from both registration and disclosure.

Conclusion

It is time for the finding in National Survival Game to be reconsidered. The only reading of the New York Franchise Law that provides consistency among its various exemptions is that ' 683(8) exempts franchisors from disclosure if they are exempt from registration, including under the isolated sales exemption.

George J. Eydt is a partner at Hodgson Russ LLP in Toronto. He can be contacted at 416-595-2671 or [email protected].

On Nov. 14, 1988, the Honorable Gerald E. Delaney of the N.Y. Supreme Court, Westchester County, released a decision that limited the utility of the New York Franchise Law's isolated sales exemption. His decision in The National Survival Game of New York, Inc. v. NSG of LI Corp. (200 N.Y.L.J. No. 93, p. 27; CCH Business Franchise Guide ' 9294, at 19,622) remains the law in New York. But did Justice Delaney get it right?

Franchise sales in the United States are regulated by both federal and state law. The federal FTC Franchise Rule requires franchisors to provide prospective franchisees with a copy of a disclosure document before taking any money or signing any agreement. Fifteen states also regulate the sale of franchises, and some of these states have both a registration requirement and their own disclosure document requirement. New York is one of these states. But the franchise statute in New York, as well as Indiana, Minnesota, and Washington, provides an exception for isolated franchise sales.

Section 684(3) of the New York Franchise Law reads as follows:

There shall be exempted from the registration provisions of section six hundred eighty-three of this article the offer and sale of a franchise if:

(c) The transaction is pursuant to an offer directed by the franchisor to not more than two persons, other than persons specified in this subdivision, if the franchisor does not grant the franchisee the right to offer franchises to others, a commission or other remuneration is not paid directly or indirectly for soliciting a prospective franchisee in this state, and the franchisor is domiciled in this state or has filed with the department of law its consent to service of process on the form prescribed by the department.

This language has been interpreted to mean that the sale of the first franchise unit is exempt from registration if the unit was only offered to a maximum of two people (See BMW Co., Inc. et al. v Workbench Inc. et al. (No. 86 CIV 4200 1988 WL 45594 (S.D.N.Y. April 29, 1988); CCH Business Franchise Guide ' 9104, at 18,850). This isolated sales exemption is potentially useful for new U.S. franchisors or foreign franchisors that are new to the United States. It permits them to sell one franchise in New York without having to register a disclosure document with the state. However, the exemption would be even more useful if it also exempted franchisors from the New York disclosure requirement. If so, franchisors who qualified for one of the exemptions or exclusions under the FTC Franchise Rule could sell one unit in New York without pre-sale franchise regulation at both the federal and state level. Note that there is no isolated sale exemption under the FTC Franchise Rule. A different exemption or exclusion would be required.

The obvious argument for maintaining New York's disclosure requirement is that the first franchisee should be afforded some protection from a disreputable franchisor. But New York's disclosure requirement is duplicative. As mentioned above, the federal rule also requires disclosure in every state and doesn't have an isolated sales exemption. If the FTC reasonably exempts a franchise sale from its disclosure requirements, then why shouldn't New York follow suit?

On its face, New York's isolated sales exemption only exempts a franchisor from the registration requirement. However, ' 683(8) of the New York Franchise Law provides that:

A franchise which is subject to registration under this article shall not be sold without first providing to the prospective franchisee, a copy of the offering prospectus, together with a copy of all proposed agreements relating to the sale of the franchise '

Registration triggers the need for disclosure. Therefore, it is reasonable to assume that a franchisor that is not subject to registration, by exemption or otherwise, is not required to provide a disclosure document. However, Justice Delaney didn't think so. In National Survival Game he clearly states, “The exemption from filing an offering prospectus does not, however, relieve a franchisor from the disclosure requirements of Article 33 of the General Business Law.” He provides no support for this conclusion and does not discuss ' 683(8) in his decision.

Exemption Language

What evidence is there that isolated sales exemption should apply to both the registration requirement and the disclosure requirement? The answer lies in the language of the other exemptions under the New York Franchise Law.

Section 684(2) exempts from the registration requirement the offer and sale of a franchise if: a) the franchisor has a net worth of $5 million or more, and b) the franchisor files an application for exemption, and c) the franchisor makes 16 prescribed disclosures. This large-franchisor exemption contains the exact same lead-in language as the isolated sales exemption, exempting the franchisor from the registration requirement of Article 33. But applying the same reading to this language makes the disclosure requirement under ' 684(2)(c) redundant. The ' 684(2)(c) disclosure requirement is a subset of the broader offering prospectus disclosure requirement under ' 683. If the franchisor is not exempt from the broader disclosure requirement under ' 683 by virtue of ' 683(8), then why does the exemption contain its own disclosure requirement?

Section 684(5) also provides an exemption from the registration requirement for the sale of a franchise by a franchisee for its own account. One of the conditions to this exemption is that the franchisee must provide the prospective purchaser with the offering prospectus of the franchisor currently registered with the New York Department of Law. This exemption has been interpreted to mean that franchisees are required to provide the disclosure document of their franchisor ' not to create their own. This means that existing franchisees are exempt from both the registration and disclosure requirements in ' 683, even though the exemption itself only references an exemption from the registration requirement.

Other New York Decisions

In my view, Justice Delaney got it wrong by not considering the effect of the first sentence of ' 683(8). Unfortunately, other New York decisions considering the scope of the isolated sales exemption do not contradict his interpretation. In BMW Co., Inc., the court in its opening sentence made a broad statement that ' 684(3)(c) provides an exemption from the New York State Franchise Sales Act, but did not elaborate on the point. Instead, it dealt with whether the exemption can be applied to more than one franchise sale in New York, the court holding that the exemption does not apply to multiple franchise sales where there were no more than two offers per sale. In a more recent case, Burger Bar Five Towns, LLC v. Burger Holdings Corp. , 71 A.D.3d 939, 897 N.Y.S.2d 502 (2d Dept. 2010), CCH Business Franchise Law Guide 14,348, at 45,968), the appellate court stated “an exemption to the registration requirement exists for what is commonly referred to as an “isolated sales transaction.” However, this court only considered a violation of the registration requirement and made no comments regarding a corresponding violation of the disclosure requirement, although from the facts it is clear that the defendant franchisor neither registered nor provided a disclosure document.

Other States

Fortunately for franchise practitioners, the situation is much clearer in the other states that have an isolated sales exemption. The Indiana Franchise Disclosure Law clearly states that ' 9, which sets out both the registration and disclosure requirements, does not apply to the offer or sale of a franchise if the franchisor sells no more than one franchise in a 24-month period (Ind. Code, ' 2-2.5-3). Under the Minnesota Franchise Law, it is fairly clear that the isolated sales exemption applies only to registration because the language of other Minnesota exemptions explicitly exempts the franchisor from both registration and disclosure (Minn. Stat. ' 80C.03(e)). Under the Washington Franchise Investment Protection Act, it is clear that the franchisor is only exempt from registration, because providing disclosure is one of the specific conditions to the isolated sales exemption.

Although much clearer than in New York, the language and overall approach in these other states is not consistent and does not lead one to conclude that the New York Franchise Law's isolated sales exemption should necessarily be interpreted to exclude exemption from disclosure. Like Indiana, the New York legislature, based on an integrated reading of the statute, appears to have authorized exemption from both registration and disclosure.

Conclusion

It is time for the finding in National Survival Game to be reconsidered. The only reading of the New York Franchise Law that provides consistency among its various exemptions is that ' 683(8) exempts franchisors from disclosure if they are exempt from registration, including under the isolated sales exemption.

George J. Eydt is a partner at Hodgson Russ LLP in Toronto. He can be contacted at 416-595-2671 or [email protected].