Loosey Goosey Franchisor Registration

Part 1 of 3: Growing Number of Franchisors Seen Skirting State Registration Laws

The growth rate for new franchisors, according to FranData, a firm that researches the franchise industry, is exploding. At the same time, young franchisors seem to be increasingly deciding not to bother with state registration requirements before marketing their franchise offerings. That’s illegal, but even so, many franchisors prefer to develop a queue of ready-to-go buyers in registration-required states before initiating steps to legal compliance. By doing this, they can appreciably shorten the time between registration-related fees paid and franchise down payments received.

State regulators, franchise associations and some lawyers are warning firms against such practices.

Mark Leyes, Director of Communications for California’s Department of Corporations, insists, “Any violation of the law [derived from the franchise rule] is significant and is taken very seriously.”

California is not the only state with such a stance. Other states take similar positions.

Martin Cordell, Chief of Enforcement at the Securities Division in Washington, another state that requires registration, reminds the franchise community why it is important for franchisors to register before they begin marketing franchise opportunities. Cordell says, “The franchise registration process helps to ensure that prospective franchise buyers are provided the material facts regarding a franchise investment opportunity, as franchisors are required to file their franchise disclosure documents as a condition of registration.” He continues, “Good franchise disclosure helps reduce the potential of fraudulent and deceptive marketing practices in the offer of franchises.”

And state officials aren’t the only ones warning against registration shortcuts that skirt the law.

Terry Hill, spokesperson for the International Franchise Association, an association of franchisors and franchisees, strongly discourages such practices. He declares, “While such activities may be happening, the International Franchise Association is not aware of them occurring in registration states and would strongly discourage any franchisor from such action.”

Why is the proper registration of franchisors, a process that involves divulging franchise disclosure documents, stressed so much by the states—even when no sale has been made?

Starting with California in 1973, states became involved in regulating franchising because of the many complaints of fraudulent practices they received from buyers, especially about “fly by night” companies that had no proven product or system. In order to better protect business buyers, some states wrote and passed statutes stipulating that firms would not be allowed to offer franchise opportunities without first being registered in the state and making presale disclosures to investors. The federal government followed in 1979 with the Federal Trade Commission’s Franchise Rule, which requires franchisors to provide a disclosure document to all prospective franchisees.

The Federal Trade Commission has updated their nearly three-decade-old franchise rule. As of July 1, 2008, franchise investors are required to be given franchise disclosure documents 14 days before a franchise purchase.

While officially discouraging noncompliance, some feel that if franchisors adhere to the new 14-day rule, the infraction of franchisors first testing the market for potential buyers is minor.

John Tifford, Managing Partner with Plave Koch PLC in Virginia, emphasizes the practicalities of running a registration office and of franchising. He led the Federal Trade Commission’s Franchise Rule program during its early days from 1978-1988. He states, "While not approving of or condoning franchisors who 'jump the gun' on marketing their franchise opportunities before going through all of the various FTC, state registration and disclosure hoops, the real economic injuries sustained by franchisees from franchisors’ legal violations arise after the sale is made and not during the pre-sale negotiation process." Tifford adds, "If no sale is ever made, or the franchisor ultimately complies with any applicable FTC or state registration or pre-sale disclosure obligations, then in either event, a franchisee’s potential economic injury resulting from a delayed pre-sale disclosure or registration should be limited."

Nick Bibby, a well-known franchise consultant, wonders about the practical effect of registration requirements. According to Bibby, "State registration [for a franchisor] is a 'prudent' practice, where required, as it cooperates with local law. But, from a practical point of view, I would think that most franchisors would rather not 'turn away' a request for information in unregistered states, but instead collect those names until a sufficient inventory of names is collected to justify the cost of registration. This, of course, applies primarily to new and emerging franchisors. State registration and other 'business opportunity' laws are designed to add to a prospective buyer's protection in terms of conducting their 'due diligence,' but in fact, the notion of due diligence is simply that, a notion, as opposed to a practiced reality."

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Related Readings:

• Part 2 of 3: Widespread Registration Problem
• Part 3 of 3: Difficulty of Enforcing Registration
• Unlimited MedSearch Sells Franchises without Registering
• Registration (Franchipedia article from AAFD's Bob Purvin)
• Registration History (Franchipedia article)
• An Interview with Susan Kezios on Skirting Franchise Registration