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Franchising Regulation Overview

Mar 08, 2012 02:01 PM EST | By Staff Reporter

There is no doubt about it. Putting your money in a franchise is an active investment as contrasted with a securities investment which is passive. Franchisees often place their life savings, time, and energy into the franchise and, as a result, the loss of a franchise investment may be even more catastrophic than the loss of a securities investment.

Franchising as a means of distributing products and services was not aggressively pursued until the 1950's and 60's. The booming popularity and growth of franchising, the profits which inured to franchisors, and oft-repeated stories of franchisees who "struck it rich" through franchising were accompanied by the abuse of that system by a few fly-by-night, unethical and, often, criminal operators. Futuristic Foods, Holiday Magic, Koscot Enterprises, and other such scams were horror stories of tens of millions of dollars of peoples' life savings invested in what they thought were businesses which would provide income, but which instead turned out to be schemes to defraud.

Until the 1970's, the only "franchise law" which existed was that body of law affecting business in general, particularly the antitrust laws and the Lanham Trademark Act. Attempts to prevent, combat, and rectify franchise sales abuse, which became rampant by the early 1970's, date back to the passage in 1971 of the California Franchise Registration and Disclosure Act. Since then, fourteen other states have enacted laws adopting the franchise registration and offering disclosure requirements pioneered by California--Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Oregon, Rhode Island, South Dakota, Virginia, Washington, and Wisconsin (Chapter 553, Wisconsin Statutes, enacted in 1972 - more on that later).

In 1974, the Wisconsin Legislature passed the " Fair Dealership Law " (Chapter 135 of the Wisconsin Statutes), the purpose and policy of which, as affirmed by court cases, was to promote fair business relations between dealers and grantors and to protect dealers against unfair treatment by grantors who are in inherently superior economic positions with superior bargaining power. By definition, the Dealership Law applies to most franchise agreements and may contain provisions which supersede those contracted to between franchisor and franchisee.

In 1975, the Midwest Securities Commissioner's Association (Wisconsin was a member of that Association) adopted Disclosure Guidelines to facilitate the process of complying with the various state franchise laws. The Guidelines contain twenty-three items, each of which sets forth disclosure requirements, instructions, and, in most of the items, sample disclosures as an aid to comply with the requirements. They were intended as a guide to providing full and complete information so that prospective franchisees could make an informed investment decision. That Association was dissolved in 1979 and its Guidelines were assumed by the North American Securities Administrators Association (NASAA) (Wisconsin is an active member of NASAA).

Original 1979 FTC Rule and 2007 Revised FTC Rule

The first federal regulation of franchise offers and sales commenced in October of 1979 when, following ten years of proposals, comment, and study, the Federal Trade Commission's (FTC) Franchise Rule (Disclosure Requirements and Prohibitions concerning Franchising and Business Opportunity Ventures) went into effect. Under that Rule, franchisors were required to make full pre-sale disclosure nationwide in an offering circular, the format for which was set forth in the FTC Compliance guide. That 1979 FTC Rule was not preemptive over state legislation.
There were differences between the original 1979 FTC Rule and the state franchise registration/disclosure statutes. Although both the FTC and the franchise registration states require adequate disclosure, the FTC Rule did not require any filing of the disclosure document. The original state franchise laws required that an offering circular proposed for use must not only be prepared according to NASAA Guidelines, as amended in 1986, 1988, and 1993, but also had to be first submitted to, scrutinized, and permitted or disallowed by the respective state. In states that did not have franchise registration and offering circular disclosure requirements, a franchisor was permitted to use the FTC Rule which, arguably, permits less disclosure than required by the NASAA Guidelines. Possibly the most important difference was that because federal courts have held that the FTC Rule may not be enforced by private lawsuits, franchisees alleging violation of the FTC Rule often brought suit under the state laws. Those state franchise laws provide for broad investigative and enforcement powers.

On January 23, 2007, the FTC adopted a final, amended Franchise Rule ("Amended FTC Franchise Rule"). 16 C.F.R. Part 436. Under it, as of July 1, 2008, all franchisors must prepare and distribute disclosure documents that, at a minimum, comply with the Amended FTC Franchise Rule's disclosure format [labeled the "Uniform Franchise Disclosure Document" ("UFDD")]. Consequently, the UFOC, as promulgated by NASAA, that had been used since 1993 by most franchisors as the disclosure document in connection with the offer and sale of franchises, cannot be used in Wisconsin or any other state jurisdiction after July 1, 2008.
However, under the Amended FTC Franchise Rule, states may impose additional disclosure requirements under state law consistent with the Amended FTC Franchise Rule.
Using that ability to impose additional, not-inconsistent, state requirements, NASAA developed (during 2007 and 2008) and adopted in June 2008 for use by NASAA franchise jurisdictions, the disclosure requirements of the Amended FTC Franchise Rule, with minimal additional requirements, as the successor to the UFOC Guidelines. A link to the NASAA-adopted Amended FTC Franchise Rule and Disclosure Guidelines is contained as an information summary menu item in the Division's Franchise-related Website page entitled "Information Booth." The revised NASAA Franchise Registration and Disclosure Guidelines thus replace as of July 1, 2008, the former NASAA UFOC Guidelines.

Therefore, as of July 1, 2008, Wisconsin will only accept registration filings containing Franchise Disclosure Documents prepared under the Amended FTC Franchise Rule, or under the revised NASAA Registration and Disclosure Guidelines in accordance with its related Instructions. Also, a franchisor registered in Wisconsin as of July 1, 2008 must use one or the other of such disclosure documents to offer and sell their franchises in Wisconsin -- which may require a post-effective filing with the Division of the required disclosure document (unless the franchisor previously has filed such).

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