An Introduction to Franchising in the United States

1. An Introduction to Franchising in the United States Andrew Loewinger aloewinger@nixonpeabody.com

2. Franchising in the U.S. 2

3. Non-U.S. Franchisors in the United States • Cartridge World • Ikea • The Body Shop • Senor Frog’s /Carlos’n Charlie’s • FamilyMart Co. Ltd • Pollo Campero • Tim Hortons • Benetton 3

4. Franchise Regulation: Working Towards a More Perfect Union Federal Regulation: • Federal Trade Commission (FTC) Amended Franchise Rule (2007) State Regulation: • Franchise Sales Laws • Franchise Relationship Laws • Business Opportunity Laws 4

5. Federal Regulation • In 2007, the FTC amended its Franchise Rule • The original Franchise Rule (1979): -- Disclosure requirements designed to enable prospective franchisees to make informed decisions about whether to enter into a franchise agreement • Was not consistent with requirements imposed by various states • Imposed additional burdens on franchisors • The Amended Rule doesnot govern the Franchisor – Franchisee relationship. 5

6. The Franchise Relationship Defined FTC Franchise Rule: The Franchisor: • Promises to provide a trademark or other commercial symbol; • Promises to exercise significant control or provide significant assistance in the operation of the business; and • Requires a minimum payment of at least $500 during the first 6 months of operation. * Definitions under state law vary 6

7. Franchisors must provide a “prospective franchisee” with a Franchise Disclosure Document (formerly known as a UFOC), which contains information about the Franchisor and the franchised business. Disclosure Under the Amended Rule OLD RULE: • First personal meeting OR • 10 business days prior to • payment of any monies • execution of the Agreement NEW RULE: • 14 calendar days prior to: • payment of any monies • execution of the Agreement OR • Earlier in the process upon a reasonable request from aprospective franchisee 7

8. Presentation to a Prospective Franchisee • Disclosure no longer mandatory at first-personal meeting • Franchisors can conduct initial information gathering and sales meetings without having to provide an FDD • “Prospective franchisee”  • Completed initial application • Qualified & approved by franchisor • Attendance at “discovery day” • Reduces compliance costs • Allows Non-U.S. Franchisors to test the market * Some states have different disclosure “timing” rules 8

9. What Must Be Disclosed in the FDD?25 REQUIRED ITEMS Background on the Franchisor, Management Personnel, and the Franchised Business (Items 1-4) Fees: Initial Investment, Fees Paid to the Franchisor (Items 5-7) Assistance by Franchisor, Sources of Products & Services, Training, Advertising Requirements, Territorial Restrictions (Items 9-12) Intellectual Property: Trademarks and Patents (Items 13-14) • Franchisee’s Obligations, Summary of the Franchise Agreement, Public Figures, Franchisee Tables (Items 15-18, 20) • Financial Performance Representations (Item 19) • Financial Statements (Item 21) • Contracts (Item 22) • Receipt Page (Item 23) 9

10. Item 19: Financial Performance Representations • Previously known as “Earnings Claims” • Strictly optional – not mandatory • If a Franchisor does not make Financial Performance Representations in Item 19, it is strictly prohibited from making any such representation anywhere else • Franchisor must have “reasonable basis” and written substantiation for the representations • Potential source of liability 10

11. Item 21: Financial Statements • Mandatory requirement: 3 years of audited financial statements prepared according to GAAP • Phase-in of audited financials for start-up franchise systems * • Disclosure of parent financial information required in limited circumstances * Certain states may not allow phase-in of audited financials 11

12. Updating the FDD • Under the Amended Rule, the FDD must be updated • Annually (within 120 days after the close of Franchisor’s fiscal year); and • Quarterly, to reflect material changes • State laws differ, but most require updates on an annual basis and “promptly” after any material changes 12

13. State Regulation:Franchise Sales Laws • Many state laws govern disclosure requirements and the franchisor-franchisee relationship • Franchise relationship laws typically prohibit: • Termination without “good cause” • Requiring that arbitration or litigation be conducted outside the state • Discriminating between franchisees or restricting free association among franchisees • Encroaching on a franchisee’s territory • Unfair restrictions on a franchisee’s right to transfer its franchise 13

14. Registration States California New York Hawaii North Dakota Illinois Rhode Island Indiana South Dakota Maryland Virginia Michigan Washington Minnesota Wisconsin 14

15. A State’s Franchise Law May Apply If: • The offer to sell originates in the state • The offer to sell is directed to the state • The offer to buy is accepted in the state • The prospective franchisee is a resident of the state; or • The franchised business will be located in the state 15

16. Exemptions Under State Law Exemptions include: • Net Worth and Experience • Franchisee Sale • Existing Franchisee • Isolated Transaction • Fractional Franchise • By Order of the Administrator Even if a Franchisor qualifies for an exemption, it must still provide disclosure to prospective franchisees. 16

17. CONCLUSION • Fewer barriers to entry in the U.S. Market • Franchisors may conduct exploratory meetings without triggering the FTC disclosure requirements • FTC Rule applies to the offer or sale of a franchise to be located in the U.S. 17