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Complex of Federal and State Laws Regulates Franchise Operations As Their Popularity Grows - Part II

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Originally, franchisors had to use documents drafted according to the requirements of the Federal Trade Commission Disclosure Rule.[1] This created a situation that required different versions of the franchise disclosure document to comply with different state disclosure requirements. To allow franchisors to use the same document on a nationwide basis, a Uniform Franchise Offering Circular ("UFOC") was developed and has since been amended by the Midwest Securities Commissioners Association and its successor, the North American Securities Administrators Association ("NASAA"). The Federal Trade Commission issued a franchise disclosure rule in 1978 allowing franchisors the option to use the UFOC in lieu of its document.[2] For this reason, most franchisors now use the UFOC.

Although the states have different disclosure requirements, in some cases a franchisor can use one UFOC nationwide by adopting state-specific language internally in the UFOC and addendums to the disclosure section and the franchise agreement. Nevertheless, some states have contradictory disclosure rules that result in the need for a state-specific UFOC.[3]

The UFOC generally contains a federal cover page, a state-specific cover page (with different language depending on the state)[4], a table of contents (listing the 23 required items[5] that are sections of the UFOC, followed by a list of exhibits in the UFOC), the disclosures for the 23 required items, financial statements (audited financial statements for the past three fiscal years, with unaudited financial statements that are within 90 days of the filing of the UFOC, if necessary),[6] copies of all agreements that the franchisee must execute, and a receipt page for the UFOC.[7]

Additional documents must be filed to register a franchisor to sell in a state. In New York, franchising is regulated by the Investor Protection and Securities Bureau in the office of the state attorney general. The bureau requires a facing page, application page, two copies of the UFOC, supplemental information sheet, verification of the application, salesman disclosure forms, consent to service of process, consent to use the franchisor's financial statements in the UFOC signed by the Certified Public Accountant who prepared them and possibly additional forms depending on specific circumstances.[8]

In certain circumstances, state registration is not necessary. Some states do not require registration if a franchisor has a federally registered trademark or service mark and provides a UFOC to prospective franchisees,[9] or if a franchisor has a certain specified amount of net worth,[10] or an offer is made to a maximum of two persons,[11] or an offer is made to an existing franchisee.[12]

The Federal Trade Commission has defined what constitutes "franchise."[13] In addition, each state that requires registration has its own definition of what is a "franchise"[14] to determine whether it requires registration or regulation.

To offer to sell a franchise in or from New York, a franchisor must first be registered.[15] This applies when an offer to sell a franchise is made in New York, when an offer to buy is accepted in New York, when the franchisee is domiciled in New York, or when the franchised business is or will be operated in New York. An offer to sell is made in New York when the offer either originated from New York or is directed by the offeror to New York and is received at the place where it is directed. An offer to sell is accepted in New York when acceptance is communicated to the offeror from New York.[16] Effectively this means that if a franchisor is located in New York it must register in New York to sell franchises either within or without New York State.

References
  1. ^ 16 C.F.R. Part 436.
  2. ^ 16 C.F.R. Part 436.
  3. ^ e.g. Indiana has required its agent to receive service of process to be listed in Item 1 of the UFOC and Minnesota has required that this information not be included in Item 1 of the UFOC for any sales of franchises to be made in its state for the same franchisor.
  4. ^ e.g. New York- 13 N.Y.C.R.R. 200.4(i)
  5. ^ e.g. New York- 13 N.Y.C.R.R. 200.4(iii)- Franchisor, Its Predecessors and Affiliates; Business Experience; Litigation; Bankruptcy; Initial Franchise Fee; Other Fees; Initial Investment; Restrictions on Sources of Products and Services; Franchisee's Obligations; Financing; Franchisor's Obligations; Territory; Trademarks; Patents, Copyrights and Proprietary Information; Obligation to Participate In The Actual Operation of the Franchise Business; Restrictions on What the Franchisee May Sell; Renewal, Termination, Transfer and Dispute Resolution; Public Figures; Earnings Claims; List of Outlets; Financial Statements; Contracts and Receipt.
  6. ^ e.g. New York- 13 N.Y.C.R.R. 200.4(iii).
  7. ^ NASAA guidelines adopted on April 25, 1993.
  8. ^ e.g. New York- 13 N.Y.C.R.R. 200.10.
  9. ^ e.g. Connecticut (Business Opportunity Investment Act, Conn. Gen'l Stat., Title 36b, Chap. 672c, 36b-61(6)) provided a copy of the trademark or service mark is filed with the state prior to an offer or sale of the franchise in the state.
  10. ^ e.g. New York- net worth of at least $5,000,000 (General Business Law, Art. 33, 684(2)) and an exemption form is filed with the Attorney General prior to offering a franchise for sale.
  11. ^ e.g. New York (General Business Law, Art. 33, 684(3)(c)) (with additional conditions).
  12. ^ e.g. New York (General Business Law, Art. 33, 684(3)(d)) (with additional conditions).
  13. ^ 16 C.F.R. 436.2 Definitions. As used in this part, the following definitions shall apply:
    (a) The term "franchise" means any continuing commercial relationship created by any arrangement or arrangements whereby:
    (1)(i)(A) a person (hereinafter "franchisee") offers, sells, or distributes to any person other than a "franchisor" (as hereinafter defined), goods, commodities, or services which are:
    (1) Identified by a trademark, service mark, trade name, advertising or other commercial symbol designating another person (hereinafter "franchisor"); or
    (2) Indirectly or directly required or advised to meet the quality standards prescribed by another person (hereinafter "franchisor") where the franchisee operates under a name using the trademark, service mark, trade name, advertising or other commercial symbol designating the franchisor; and
    (B)(1) The franchisor exerts or has authority to exert a significant degree of control over the franchisee's method of operation, including but not limited to, the franchisee's business organization, promotional activities, management, marketing plan or business affairs; or
    (2) The franchisor gives significant assistance to the franchisee in the latter's method of operation, including, but not limited to, the franchisee's business organization, management, marketing plan, promotional activities, or business affairs; Provided, however, That assistance in the franchisee's promotional activities shall not, in the absence of assistance in other areas of the franchisee's method of operation, constitute significant assistance; or
    (ii)(A) A person (hereinafter "franchisee") offers, sells, or distributes to any person other than a "franchisor" (as hereinafter defined), goods, commodities, or services which are:
    (1) Supplied by another person (hereinafter "franchisor"), or
    (2) Supplied by a third person (e.g., a supplier) with whom the franchisee is directly or indirectly required to do business by another person (hereinafter "franchisor"); or
    (3) Supplied by a third person (e.g., a supplier) with whom the franchisee is directly or indirectly advised to do business by another person (hereinafter "franchisor") where such third person is affiliated with the franchisor; and
    (B) The franchisor:
    (1) Secures for the franchisee retail outlets or accounts for said goods, commodities, or services; or
    (2) Secures for the franchisee locations or sites for vending machines, rack displays, or any other product sales display used by the franchisee in the offering, sale, or distribution of said goods, commodities, or services; or
    (3) Provides to the franchisee the services of a person able to secure the retail outlets, accounts, sites or locations referred to in paragraphs (a)(1)(ii)(B) (1) and (2) of this section; and
    (2) The franchisee is required as a condition of obtaining or commencing the franchise operation to make a payment or a commitment to pay to the franchisor, or to a person affiliated with the franchisor.
    (3) Exemptions. (not listed here).
    (4) Exclusions. (not listed here).
  14. ^ e.g. New York (General Business Law, Art. 33, 681.-
    3. "Franchise" means a contract or agreement, either expressed or implied, whether oral or written, between two or more persons by which:
    (a) A franchisee is granted the right to engage in the business of offering, selling, or distributing goods or services under a marketing plan or system prescribed in substantial part by a franchisor, and the franchisee is required to pay, directly or indirectly, a franchise fee, or
    (b) A franchisee is granted the right to engage in the business of offering, selling, or distributing goods or services substantially associated with the franchisor's trademark, service mark, trade name, logotype, advertising, or other commercial symbol designating the franchisor or its affiliate, and the franchisee is required to pay, directly or indirectly, a franchise fee. A franchise under this article shall not include any agreement, contract, or franchise subject to the provisions of article eleven-B of this chapter or section one hundred ninety-nine of this chapter, or any agreement or contract for the sale of motor fuel.
  15. ^ New York (General Business Law, Art. 33, 683.1).
  16. ^ New York (General Business Law, Art. 33, 681.12).



ABOUT THE AUTHOR: MITCHELL J. KASSOFF
Mitchell J. Kassoff Mitchell J. Kassoff, Esq. is a tenured professor of law and taxation at Pace University in New York City, a lecturer for Continuing Legal Education (for attorneys) on the topic "How to Franchise a Business" and for business owners on the topic "How to Franchise Your Business." He is admitted to the Bars of New York and New Jersey, a past chairman of the American Bar Association Committee on the Use of Computer Produced Data and a consultant to the National Conference of State Tax Judges. He received a bachelor's degree in public accounting magma cum laude from the State University of New York at Albany and a J.D. from the University of Virginia School of Law.

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