While the below questions are among the most frequent from our franchisor clients, you may have additional questions about franchising. Contact Einbinder & Dunn to become a client and find answers to your questions and concerns.
Q. What is franchising?
A. Franchising is a method of expanding your business by licensing your trademark and business system to a franchisee who pays you a fee for the right to operate a franchise using your business system and your trademark. The franchisee shall conduct its business operations in accordance with standards and specifications you establish. Along with the right to use the franchisor's trademark and business system, franchisors will typically provide franchisees with pre-opening training, post-opening training and overall support.
Q. What are the advantages of franchising?
A. They are numerous. Because franchisees incur the costs of opening their own unit, franchising will allow you to expand your business without expending significant capital per unit. Keeping your costs low per each unit reduces your risk while increasing the overall return on your investment. Franchising also allows you to grow your business on a much faster level than you would generally be able to do on your own. Additionally, not having to manage each unit on a day-to-day basis will allow you to devote more time to developing your brand and strengthening its presence in the marketplace. Many other advantages exist, including reducing your exposure to risks relating to signing leases, additional financing and vicarious liability for employee acts. If you are interested in franchising a business concept, you should refer to our questionnaire. See: Can Your Business Be Franchised?
Q. What types of franchises can be offered?
A. Generally, franchises fall into two categories. Franchises either operate in the retail sector or in any of the service industries. In each of these categories, a vast array of options exists in the types of franchises offered. For retail franchises, franchisors may offer anything from full retail store franchises to kiosk franchises to store-in-a-store franchises that offer all product lines, one product line or a combination of the product lines. Similarly, for service franchises, franchisees can offer a full assortment of services, one specific service or a combination of services. The types of franchises that may be offered are varied, each as unique as the particular business model developed by the franchisor.
Q. What is a Franchise Disclosure Document (FDD)?
A. Before a franchisor is legally permitted to sell a franchise, the franchisor must comply with certain rules promulgated by the Federal Trade Commission (FTC) and/or statutes enacted by the state the franchisor is selling from or the state the franchisor is selling into. The purpose of these rules and/or statutes is to require the franchisor to provide the potential franchisee with information for the franchisee to use to make an informed decision as to whether or not to purchase the franchise. Previously, franchisors prepared a disclosure document known as the Uniform Franchise Offering Circular (UFOC), which contained all of the material information necessary for the franchisee to make an informed decision. The franchisor was then required to disseminate the UFOC to each potential franchisee. In 2007, the FTC revised its Rule on Franchising. The FTC rule requires that franchisors provide potential franchisees with a Franchise Disclosure Document (FDD) rather than the UFOC. The FDD is similar to the UFOC format but does contain differences. As of July 1, 2008, all franchisors must use the FDD format and are no longer permitted to use the UFOC format.
Q. What kind of information is in an FDD?
A. The FDD consists of 23 separate items of information and is intended to provide the franchisee with all of the material information concerning the franchise system that the franchisee will need to make an informed decision as to whether or not to purchase the franchise. Conceptually, the FDD is similar to a stock prospectus in that the purpose is to provide sufficient accurate information so that the franchisee can make an informed investment decision. Among the 23 items of information contained in the FDD, the franchisor must provide a history of the franchisor and its founders, information relating to the types of products offered under the franchise and the general condition of the marketplace for those types of goods, a description of the initial franchise fees and all fees that are to be paid during the course of the franchise relationship, a description of the kinds of assistance the franchisor will supply to its franchisees, an explanation of the system standards for advertising development and placement, site selection and build out, and computer systems. The FDD will also detail the size and scope of the territory granted to the franchisee and will discuss the rights retained by the franchisor. Additionally, franchisors may choose to disclose information relating to the financial performance of the franchise system or franchisees operating within the system.
Q. Are there legal requirements to selling my franchise?
A. Yes, there are legal requirements that you must follow. Before you may sell a franchise, you must prepare an FDD. Once you have prepared the FDD, you may be able to sell franchises in the majority of the states in the U.S., but you must comply with certain disclosure timing requirements relating to the dissemination of your FDD. In 13 states, franchisors are required to register their FDD before it can be disseminated to potential franchisees and used to sell a franchise in that state: California, Hawaii, Illinois, Indiana, Maryland, Minnesota, New York, North Dakota, Rhode Island, South Dakota, Virginia, Washington and Wisconsin. In addition to these 13 states, several other states require franchisors to file documents with that state or provide that state with notice before selling a franchise there.
Q. What happens if I sell a franchise without disseminating the FDD or registering it, if required?
A. Numerous fines and penalties may be imposed if you sell a franchise without using an FDD or fail to register your FDD in a registration state or fail to file the proper paperwork in states that require filing before selling in that state. Depending on the situation, you may be subject to liability under both federal laws and state statutes. Additionally, if you sell a franchise in violation of federal laws or state statutes, you will open the door for franchisee initiated lawsuits subjecting yourself to liability to your franchisees for any losses they may incur in the operation of their franchise business.
Q. When litigation does arise, what are the more common areas for dispute that arise during the franchisee-franchisor relationship?
A. Generally, a dispute between a franchisee and a franchisor involves one of eight common issues. The eight issues relate to (1) termination of the franchisee, (2) enforcement of the post-term obligations, (3) issues of vicarious liability, (4) statutory compliance issues, (5) fraudulent practices, (6) intellectual property matters, (7) territorial encroachment and (8) general contract disputes. Many cases involve matters arising after a franchise is terminated. Along with terminating the franchisee's relationship with the franchisor, it is vital to the health of the franchise system that the franchisee complies with its post-term obligations, including any non-competition and non-disclosure agreements. Vicarious liability is a legal term that in this context is used to describe where a claim against a franchisor is based on acts or omissions by the franchisee. Typically, a well-drafted franchise agreement would insulate franchisors from vicarious liability claims. Also common areas for dispute are claims relating to the franchisor's failure to comply with statutory requirements either because of violations of registration, disclosure, relationship laws, or other federal and state regulations.
Q. How can a franchisor avoid litigation and other legal issues?
A. The best way to minimize exposure to litigation or other legal risks is to comply with all applicable statutory requirements, including federal laws and state statutes. Additionally, your FDD and all related agreements should be drafted with a view toward clearly stating the rights of the franchisor and the franchisee so as to avoid any confusion. All documents should be unambiguous and written to provide the franchisor with the maximum amount of protection possible.
Q. What is Einbinder & Dunn's experience in representing franchisors?
A. Einbinder & Dunn has extensive experience representing both start-up and established franchisors in a wide variety of industries, including restaurant services, home maintenance and improvement, real estate, pet care, garbage removal, and home child care services. The firm provides a full range of transactional, litigation and dispute resolution services throughout the U.S. and assists franchisor clients with the development, registration, operation, restructure and expansion of their businesses.
Einbinder & Dunn assists its franchisor clients in all matters relating to franchise law compliance, the preparation and registration of their FDD, developing their in-house compliance department, negotiating and closing the sale of franchises, and the franchisor-franchisee relationship.
Additionally, Einbinder & Dunn counsels franchisors on the development of an optimal corporate structure to maximize asset protection and streamline the generation of revenues; register trademarks for use in connection with the franchise system; all agreements; the best methods to protect and license their trademarks, trade secrets and other intellectual property; and means for minimizing risk exposure. Finally, the firm also assists franchisor clients in real estate matters, including lease and sublease preparation and drafts agreements with third parties with or without relation to the franchise system.
For existing franchisors, Einbinder & Dunn conducts a comprehensive review of existing documents to ensure both compliance with all state and federal regulations as well as insulation from problems arising during the franchisor-franchisee relationship. The firm will also assist existing franchisors in converting their current disclosure documents into the new FDD format (FDD Conversion).
Einbinder & Dunn has successfully brought claims against franchisees to enforce non-competition and non-disclosure agreements and to protect the franchisor's trademarks, services marks, trade dress and other intellectual property. The firm has also successfully defended franchisor clients from actions brought by franchisees relating to alleged breaches of franchise agreements, including encroachment, improper termination, diminution of franchisee territories and post-termination matters, among many other issues.
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For questions or additional information about Einbinder & Dunn's franchise law services, please contact Einbinder & Dunn by clicking here to fill out a contact form or by calling 866-490-4909 or 212-391-9500 to speak with one of the firm's partners.