The Federal Trade Commission (“FTC”) has amended its rule entitled, “Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunities” (“Franchise Rule”).[1]  Unless otherwise exempt, the FTC Franchise Rule requires that franchisors provide certain information about the franchise using a Franchise Disclosure Document (“FDD”) to potential franchisees.  Although the amended Franchise Rule applies to both foreign and domestic franchisors, this article explores the significant impact that the amended Franchise Rule is likely to have on international franchising.  Compliance with the amended Franchise Rule becomes mandatory on July 1, 2008.[2]

 

1)    Revisions in the Amended Franchise Rule of Importance to Franchisors with International Operations

 

            The amended Franchise Rule’s provisions concerning geographical scope, parent disclosures and financial statements impact international franchising.

 

a)    Territorial Limitation in the Amended Franchise Rule Clarifies the Reach of the FTC Franchise Rule

 

The amended Franchise Rule provides welcome clarity concerning the international scope of the FTC’s Franchise Rule.  In its Statement of Basis and Purpose, the FTC concedes that the geographical scope of the Franchise Rule’s application was an “unsettled area of franchise law.”[3]  Under the amended Franchise Rule, the franchisor’s obligation to furnish the required disclosures is limited to “the offer or sale of a franchise to be located in the United States of America or its territories.”[4]  Commentators have expressed the view that the amended Franchise Rule will “ease international franchising.”[5]  Franchise sales outside the United States will not be subject to the amended Franchise Rule.  By ending the debate, the amended Franchise Rule allows both foreign and domestic franchisors to plan for future international franchising activities.

 

The FTC Franchise Rule does not preempt state laws that are more protective of prospective franchisees.  Therefore, under the federal system in the United States, state laws governing franchise disclosure and registration[6] and regulating business opportunities[7] will continue to apply.  Thus, franchisors planning to sell franchises, outside of the United States must consider whether state franchise and/or business opportunity laws require disclosure because of either the franchisor’s home jurisdiction or the potential franchisee’s domicile.  Some state franchise disclosure and registration and business opportunity laws are written in such broad terms that those laws may apply even if the franchise will be located outside of the United States.  Franchisors should consult with U.S. franchise counsel to navigate the patchwork of state laws concerning franchise disclosure and registration and business opportunities.

 

b)    Expanded Disclosures Concerning Parent Entities Require Examination of the Business Relationship between Parent and Subsidiary

           

The amended Franchise Rule expressly defines the term “parent” as an entity that controls another, directly or indirectly, through one or more subsidiaries.[8]  The FTC emphasizes that control determines whether an entity is a parent, not mere ownership.  Foreign franchisors are frequently organized with a foreign parent and U.S. subsidiary entity.[9]  Therefore, changes to parent disclosures have significant implications for foreign franchisors.

 

In connection with its definition of “parent,” the amended Franchise Rule expands parent disclosure obligations.  The franchisor must now disclose the name and principal business address of any parent entities.[10]  The franchisor must also disclose pending and concluded litigation involving a parent “who induces franchise sales by promising to back the franchisor financially or otherwise guarantees the franchisor’s performance.”[11]  Franchisors will need to disclose current injunctive or restrictive orders only in the case of a parent entity “who guarantees the franchisor’s performance.”[12]  The franchisor must disclose the bankruptcy history of any parent.[13]  The franchisor must also include financial statements “for any parent that commits to perform post-sale obligations for the franchisor or guarantees the franchisor’s obligations.”[14]  If the parent guarantees the franchisor’s obligations, the guaranty must also be included.[15]  These amendments may prompt foreign franchisors to restructure their franchise businesses to avoid the required parent entity information.

 

c)     Increased Flexibility Concerning the Preparation of Financial Statements May Reduce the Expense of Compliance for Foreign Franchisors

 

The amended Franchise Rule allows franchisors to include financial statements prepared in a manner permitted by the Securities and Exchange Commission (“SEC”).[16]  The SEC recently issued a final rule indicating that it will accept filings from foreign private issuers prepared in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board without reconciliation to generally accepted accounting principles as used in the United States (“U.S. GAAP”).[17]  The SEC’s new rule should be very helpful to foreign franchisors.  However, the reaction of state franchise examiners and prospective franchisees to non-U.S. GAAP financial statements remains an open question.

 

2)    Additional  Revisions of Note to the International Franchising Community

 

            Some of the major disclosure revisions also have the potential to reduce the compliance costs associated with cross-border franchising and to lower some of the perceived barriers to the franchise market in the United States.  These major revisions include:  a) elimination of the first personal meeting trigger for franchisors to provide the required disclosures; b) modification of the mandatory contract review period; c) inclusion of alternative methods for the delivery of the required disclosures; and d) additional exemptions from the amended Franchise Rule.

 

a)    Omission of First Personal Meeting Trigger Facilitates Compliance in a Global Economy

 

            The FDD must be furnished to prospective franchisees in advance.  The prior franchise rule required that the FDD be furnished by the first personal meeting between the franchisor and the franchisee.  The amended Franchise Rule eliminated the first personal meeting as the trigger date to provide the FDD.  However, the required disclosures must be provided at least 14 calendar 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 sale,”[18] and a prospective franchisee may request a copy of the disclosure document even earlier in the sales process.[19] The amended Franchise Rule’s elimination of the first personal meeting trigger reflects changes in how international transactions are conducted through new technologies, including, without limitation, the Internet and email.  This change reduces the compliance burden on franchisors conducting international franchising operations because the timing of the first personal meeting is no longer a concern.

 

b)    Changes to the Mandatory Contract Review Period Improve the Odds of Concluding International Transactions in a Timely Manner

 

            The amended Franchise Rule changes the circumstances under which the franchisor must give the franchisee a specified amount of time to review a copy of the complete franchise agreement.  Instead of mandating a five business day contract review period, the amended Franchise Rule increases this period to seven calendar days.  Further, the mandated contract review period is only required where the franchisor makes unilateral changes to the franchise agreement or a related document.[20]  Therefore, franchisee-initiated or mutually agreed upon changes will not trigger a mandatory contract review period.  This modification to the contract review period should benefit foreign franchisors because potential franchisees will no longer be able to unnecessarily prolong the closing of international transactions.

 

c)     Permitted Use of Electronic Means to Furnish the Required Disclosures Reduces Compliance Costs and Speeds Up Delivery

 

            The amended Franchise Rule expressly permits electronic delivery and defines the accepted methods for delivery of the required disclosures.[21]  Under the amended Franchise Rule, the FDD may be hand-delivered (in a paper or CD ROM format), faxed, emailed or otherwise delivered, by example, furnishing directions for accessing the document on the Internet by the required date.[22]  Information concerning the availability of alternative formats of the FDD and how to request alternative formats should be provided to each prospective franchisee.[23]  The amended Franchise Rule allows franchisors to select the format and delivery mechanism for the furnishing of the required disclosures.  This flexibility will benefit franchisors conducting business throughout the world.  The ability to deliver disclosures by email or through the Internet allows foreign franchisors to meet their delivery obligations from international locations at a lower cost.

 

d)    New Exemptions from the Amended Franchise Rule May Eliminate the Need to Compile Costly Disclosures

 

            The amended Franchise Rule includes three new exemptions.  The amended Franchise Rule will not apply to franchise sales to:  (i) franchisees making an initial investment of more than $1,000,000 (excluding unimproved land and franchisor financing);[24] (ii) franchisees with five years of prior business experience and at least a $5,000,000 net worth[25] (the exemptions set forth in (i) and (ii) are collectively referred to as the “sophisticated investor exemptions”);[26] or (iii) the owners, directors and managers of the  franchisor entity (“insider exemption”).[27]  The new exemptions may allow foreign franchisors to more easily enter the United States.  However, franchisors interested in only making exempt sales should carefully monitor whether any state franchise disclosure and registration laws and/or business opportunity laws which limit or prevent such exempt sales are applicable.  Although some of the states with franchise disclosure and registration laws have exemptions, the state-level exemptions do not mirror the federal-level exemptions.

 

            The foregoing sections of the amended Franchise Rule appear to be a move to facilitate international franchising by accommodating new technologies, reducing certain costs associated with disclosure, and removing barriers to franchising in the United States.  Only time will tell if this is the case.