Overview of U.S. Franchise Legal Requirements
Franchising is a business model in which an individual or group (the franchisor) grants the right to use its trademark or trade name, as well as its business systems and procedures, to another individual or group (the franchisee) in exchange for fees and royalties. The franchisee operates a business using the franchisor’s products, services, and systems, while also adhering to the franchisor’s rules and regulations.
Franchising has become a significant component of the U.S. economy, with approximately 733,000 franchise establishments generating $674 billion in economic output and employing 7.6 million people in 2020, according to the International Franchise Association (IFA). However, franchising is also highly regulated, with a complex legal framework that governs the relationship between franchisors and franchisees.
Federal and state laws regulate franchising in the U.S. The primary federal law is the Federal Trade Commission’s (FTC) Franchise Rule, which requires franchisors to provide potential franchisees with a Franchise Disclosure Document (FDD) containing detailed information about the franchisor’s business and the terms of the franchise agreement. The FDD must be provided at least 14 days before the franchise agreement is signed, giving potential franchisees ample time to review and consider the terms of the agreement.
The FDD must contain a variety of information, including the franchisor’s business experience, litigation history, fees and costs, trademarks, restrictions on sources of products and services, termination and renewal rights, and financial performance representations (if any). The financial performance representations must be based on actual data, be accompanied by certain disclosures, and have a reasonable basis for the representations made.
The FTC Franchise Rule also regulates the advertising and promotion of franchises, prohibiting false or misleading statements and requiring substantiation for any claims made. The franchisor must disclose any material facts that would affect a potential franchisee’s decision to invest in the franchise.
In addition to the FTC Franchise Rule, many states have their own franchise laws, which often impose additional requirements on franchisors. For example, some states require franchisors to register their FDDs with the state before offering franchises to residents of that state. Other states have laws that govern the relationship between franchisors and franchisees, such as laws requiring good faith and fair dealing or prohibiting certain types of franchise fees.
One of the most significant state franchise laws is California’s Franchise Relations Act (CFRA), which provides additional protections to franchisees. The CFRA requires franchisors to provide written notice to franchisees before terminating or not renewing a franchise agreement, and to provide a specific reason for the termination or non-renewal. The CFRA also prohibits franchisors from taking certain actions against franchisees, such as retaliating against a franchisee for filing a complaint or imposing unreasonable restrictions on the transfer of the franchise.
Additional U.S. State Registration Requirements:
Another important state franchise law is the New York Franchise Act, which requires franchisors to provide franchisees with a disclosure document that is substantially similar to the FTC’s FDD. The New York Franchise Act also imposes additional requirements on franchisors, such as prohibiting the use of certain provisions in franchise agreements, requiring franchisors to act in good faith and deal fairly with franchisees, and providing franchisees with the right to associate with each other.
Franchise law also includes contract law, as franchise agreements are binding contracts between franchisors and franchisees. Franchise agreements typically cover topics such as the term of the franchise, fees and royalties, advertising and promotion, training and support, territory, and termination and renewal rights.
For more information on how to franchise your business and how to manage the process of starting a franchise business, contact us.