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FTC Franchise Rule – Disclosures Required Prior to Investment

The Federal Commission (FTC) mandates that the prospective franchisee must first acknowledge the receipt of the Universal Franchise Offering Circular (UFOC) 14 days before the Franchise Agreement can be signed or any money paid to the franchisor. What is the connection between the FTC and franchising?

The FTC was created in 1914 – an era that witnessed the rise of monopolistic business trusts that stifled competition. The FTC is charged with the mission to prevent unfair business practices that thwart competition in commerce. Over the course of the 20th century, the US government enacted more laws giving the FTC stronger authority in pursuing and enforcing “unfair an deceptive acts or practices.” It is the only federal agency that has jurisdiction over both consumer and competitive business interests in various sectors of the economy. Basically, the FTC acts as a watchdog to stop actions that interfere with consumers’ right to make an informed decision regarding business opportunities.

Since franchisors compete against each other to recruit franchisees, the FTC regulates how franchisors present themselves and their business proposition to prospective investor franchisees. The franchise investment process therefore must conform to the FTC’s Franchise Rule, which governs what franchisors must disclose to prospective franchisees before any contractual agreement is signed. This rule theoretically eliminates unfair or deceptive practices during the franchisee recruitment process.

The UFOC and 14-day rule are direct results of the FTC Franchise Rule, which as a trade regulation rule,  has the full force and effect of federal law. Federal and state courts have ruled that the Franchiser Rule can only be enforced by the FTC, who has the authority to seek injunctions, civil penalties, and compensation for consumers when businesses engage in deceptive practices.

The Franchise Rule basically imposes six different requirements regarding "advertising, offering, licensing, contracting, sale or other promotion" of a franchise:

1. Basic Disclosures: the Franchisor must give investors a basic disclosure document (the UFOC) 14 days before any contracts can be signed.

2. Earnings Claims: if the franchisor offers earnings claims, there must be a reasonable basis for doing so, and the proof that validates the claim must be supplied to prospective franchisee.

3. Advertised Claims:  applies to advertisements that make earnings claims, and mandates that such ads include the actual percentage of existing franchisees who have realized those earnings.

4. Franchise Agreements: the Franchisor must supply its standard Franchise Agreement along with any other contracts when it delivers the basic disclosure documents.

5. Refunds: Franchisors must refund deposits and initial payments according to the conditions regarding refunds detailed in the disclosure document.

6. Contradictory Claims:  this prohibits franchisors from making claims in any promotional materials or by word of mouth that contradict the information in the disclosure document.

Failure to comply with any of the six requirements makes the franchisor liable for Franchise Rule violations. Beyond these six basic requirements, the Franchise Rule also stipulates specific disclosures about the business relationship between the francshisor and franchisee, investment and fee requirements, trademark usage, and more.

The UFOC is the disclosure document intended to meet compliance with the FTC’s Franchise Rule. The FTC does have its own disclosure form, but most franchisors rely on guidelines established by the North American Securities Administrators Association (NASAA) for detailing the 23 items found in the UFOC.

A prospective franchisee should look at the UFOC as a combination Bible, dictionary, and encyclopedia that defines the franchise business, operations, finance, marketing, support – all the responsibilities and expectations of both the franchisor and franchisee. The NASAA requires that a UFOC be written in “plain English” and, though this seems helpful and logical, any prospective franchisee should seek legal advice from, and a thorough review of the UFOC document, by an lawyer experienced in franchise contract law.

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