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Editor's note: Robert Purvin, Chairman of the American Association of Franchisees and Dealers, defines franchise registration and its limitations to franchise investors.
Who Requires Franchise Registration
The Federal Trade Commission (FTC) and some fifteen states in America require franchisors to provide franchise buyers with a pre-sale franchise disclosure document. The stated purpose of pre-sale disclosure is to provide prospective investors with material information necessary to determine the viability of an offered franchise opportunity. Unfortunately, too often franchise disclosure documents are effectively used to insulate franchisors from oral disclosures that may have been made, or from the failure of a prospective franchisee to perform full due diligence of a deficient opportunity.
In thirteen of these states, the sale of a franchise is similar to the sale of a security. It is unlawful to ‘offer’ or ‘sell’ a franchise in a registration state without first registering the company and franchise disclosure documents, unless covered by an exemption from registration. Franchises sold in registration states often must meet minimal standards in order to offer franchises, or must provide assurance that the franchisor will provide any promised services under the franchise offering and agreement. Buyers of franchised businesses in these states have the right to bring private lawsuits for violation of the state registration and disclosure requirements. Additionally, the Federal Trade Commission (FTC) has adopted a rule requiring all franchisors to provide a Franchise Disclosure Document to all prospective franchisees who are offered or sold a franchise for their business. However, there is no private right of action under the FTC Rule, and private investors have no effective remedy for false disclosures or other violations of the FTC Rule.
The FTC does not review any of the information contained in Franchise Disclosure Documents. Registration states generally review the document to be sure disclosures meeting each state’s technical requirements, but no effort is made by the states to verify the accuracy of franchisor disclosure documents. Each franchise investor is left to ascertain for himself if the information is accurate.
All franchises sold in the US must comply with the Federal Trade Commission's franchise disclosure rules and are subject to common law fraud claims as well as Little FTC Rule (state) violations and claims (unfair business practice claims).
35 Non-Registration States Do Not Require Registration
If a franchisor is a local business in a non-registration state—say only doing business in Texas or Arizona—they naturally wouldn’t register, because there would be no intent to do business or sell franchises in a registration state. Therefore, motive is an important consideration in determining whether the practice is suspect or not.
A Red Flag for an Unregistered Franchisor
If a company avoids registration states in order to legal fees, it does so at enormous peril because there has been no state regulator blessing the completeness of disclosure. In fact, state registration provides a level of protections for franchisors who can fairly claim that their disclosure documents met the requirements of the states where registered.
Writer's note: When I was practicing, I would insist that my clients register somewhere so the offering had passed the scrutiny of a regulatory body.
From the consumer’s perspective, an unregistered franchise is simply a red flag of a company that may be trying to avoid the cost of legal compliance, never an indicator of an upstanding corporate citizen. That said, there is nothing illegal about the practice of selling unregistered franchises in non-registration states. The illegality arises if there is a sale of an unregistered franchise in a registration state, or when there is a misleading disclosure document. Since there are only 13 states that now require pre-sale registration, it is relatively easy to avoid the cost and effort of registering to sell franchises if a franchisor is willing to stay out of these states.
A Further Caution
Writer's note: Prospective investors should be forewarned and aware that compliance with federal and state franchise laws is not a validation or endorsement of a franchise opportunity. Indeed, this author believes that such legal compliance provides greater protection for franchisors (by insulating them from claims of misrepresentation and by giving the appearance of state and federal validation and endorsement) than it does to franchisees and prospective franchisees. Other than the right of disclosure (and, in a few states, some protections regarding termination and the right of franchisees to organize and join an owner’s association), there are no substantive rights conferred on franchisees by virtue of these statutes. The terms of the franchise relationship are governed by the franchise agreement, and with few exceptions neither federal or state laws protect investor interests with regard to franchise investment.