With each passing year of franchise industry business growth, a number of U.S. states began enacting franchise-specific statutes and regulations before action was taken on the federal level. As a result, franchise systems across the country must abide by a complex set of rules that differ between the federal and state levels as well as from state to state.
The most well-known franchise regulation is the FTC Franchise Rule.
Title 16 C.F.R. Part 436 – Disclosure Requirements and Prohibitions Concerning Franchising is the official name of the rule though for ease of conversation it is widely known as the FTC Franchise Rule. The significance of the rule is focused on Federal Trade Commission requirements that hold franchisors liable to provide prospective franchisees with a Franchise Disclosure Document (FDD) no later than 14 days before “the prospective franchisee signs a binding agreement with, or makes any payment to, the franchisor or an affiliate in connection with the proposed franchise sale.”
The FDD is an expansive document that covers virtually every aspect of any given franchise system. It outlines the history of the business, key corporate officers, initial and ongoing fees, rules and restrictions, all franchisees in the system, unit turnover rates, causes for termination, and numerous other important details. The FDD for each franchise has the same 23 items with a number of exhibits following each item and the contents of each section are customized for individual franchise systems.
In line with franchise regulation development, several states have also gone a step further. In these states, a government department oversees franchisor FDD drafting and submission by authoritatively reviewing and clearing each FDD. In some of these states, the FDD may also be filed through a state government website that allows prospective franchisee access for research purposes prior to its clearance.
Here is a list of states that administer franchise-specific statutes and regulations, including a requirement to register the FDD before the franchise can be sold in the state:
- New York
- North Dakota
- Rhode Island
- South Dakota
Furthermore, some states have laws that govern aspects of the franchisor-franchisee relationship, including:
- New Jersey
- North Dakota
- South Dakota
Laws governing franchisor-franchisee relationships cover numerous issues, including next of kin decisions in case of franchisee death, contract termination, provisions for franchisees to assemble or form an association amongst themselves, and more.
Rules that govern the general franchise industry are only some of the regulations with which franchise systems must comply. Industry-specific regulations must also be adhered to and franchisors and franchisees must abide by trade regulations and applicable business, commercial, and local state laws.
With such an emphasis placed on compliance to various applicable regulations, it’s no wonder that state regulations can cause unexpected headaches for franchise professionals.
In summer 2013, Globex, a company owned by the Baerns family, sued Steak ‘n Shake Enterprises over its maximum pricing policy for its three-item combo meal. Globex is seeking greater flexibility from its franchisor to operate profitably in the Denver market. Among the cited factors of the case is the statewide minimum wage increase in Colorado effective January 1, 2013. Globex claims that the franchisor’s pricing system, based on corporate-owned stores, is not representative of the actual costs affecting their locations in Colorado. The case is still pending resolution.
International Franchise Regulation
Up to this point, the examined franchise regulations have concerned domestic businesses. The complexity of compliance becomes even greater when franchising internationally.
Franchise regulation abroad is not as comprehensive as it is in the United States, yet it is increasing around the world as nations vie for the economic boost that franchising can provide. According to franchise lawyer Mario L. Herman, at least 24 countries now specifically regulate franchising. Furthermore, the following countries have laws for pre-sale disclosures:
- Canada (Alberta only)
- South Korea
As international franchising expands, organizations such as the International Franchise Association (IFA) and the International Trade Administration branch of the U.S. Commerce Department continue to offer a myriad of resources and support to franchisors who seek to operate internationally.
One key aspect of international franchise regulations is the protection of local interests. Here are a few examples compiled by Philip F. Zeidman, senior partner in the Washington D.C. office of DLA Piper:
- Indonesia: Eighty percent of the vendors or sources utilized by franchisors must be from Indonesian sources. Also, franchisors and master franchisees in certain industries may not operate over a certain number of units.
- Malaysia: Business officials require a set number of franchisees and subfranchisees to be native Malay descendants (also called Bumiputeras).
- South Korea: Franchise growth is limited by percentage on a yearly basis, and certain franchisors cannot build within a set distance of existing operations.
The IFA has a page of international franchising laws comprised of chapter reproductions (with permission) from Getting the Deal Through - Franchise 2013 (contributing editor Philip F. Zeidman of ZLA Piper). It is a great resource for any franchisor looking to franchise internationally, or anyone seeking to learn more about franchise regulations outside the United States.
More Franchise Law and Regulation Sources
For more information on franchise law, there are several sources such as the following: