FTC Considering Changes to Franchise Rule

03 December 2020 Legal News: Distribution & Franchise Publication
Author(s): Peter Loh Nathan D. Imfeld Brantley Smith

For the first time in over a decade, the Federal Trade Commission is considering changes to its Franchise Rule. The Rule represents an effort by the Commission to prevent unfair and deceptive practices by franchisors against prospective franchisees. The Rule requires franchisors to disclose certain information to a franchisee before the parties enter into a franchise agreement. These disclosures take the form of a Franchise Disclosure Document (FDD), which includes 23 categories of information intended to assist prospective franchisees in weighing the risks and benefits of investing in a particular franchise, including things like the litigation and bankruptcy history of the franchisor, initial investment obligations, contact information for current and former franchisees, and a franchisee’s contractual obligations in the establishment and operation of the franchise.

On November 10, 2020, the Commission hosted a workshop to discuss the commentary it received. The topics of discussion included:

Financial Performance Representations

The current version of the FDD permits — but does not require — franchisors to provide estimates of the financial performance of the franchise, called financial performance representations (FPRs). Although many franchisors already make FPRs in some form, the Commission is now deciding whether to amend the Franchise Rule to make them mandatory.

An FPR mandate would be groundbreaking. The Commission’s workshop panel regarded FPRs as the most important information received for the majority of prospective franchisees. However, the panel also noted that not every franchise system can easily provide such information without significant cost. Some cannot provide the information at all—such as foreign franchise systems looking to break into the American market and emerging franchise systems. Accordingly, an extensive and flexible exemptions provision will need to accompany any requirement to provide FPRs.

Accuracy is another problem that the panel discussed. Not every franchise system tracks the financials of its franchisees. The franchisor, therefore, would have to rely on its franchisees to provide accurate financial information and invest money into auditing any such information.

The Commission considered these concerns in 2007 and ultimately decided not to mandate FPRs. It is unclear at this stage which direction the Commission will take this time around.

The Form and Length of the FDD

The Commission also asked panelists to discuss whether the Rule should modify the form and layout of the FDD. The concern is that FDDs have grown so large and unwieldy that prospective franchisees do not read them. The Commission is considering several ways to fix this issue, including:

  • Requiring franchisors to provide executive summaries along with their FDDs;
  • Eliminating certain items of information from the FDD; and
  • Reorganizing the format of the FDD so the most important or relevant issues appear first

The problems with these options, though, are predictable. There is no consensus on what categories of information should be removed from the FDD, nor on what information should be included in a summary. Indeed, not all information is equally important in different franchise systems, so a uniform approach is problematic. Finally, given the possibility that providing a summary might lead prospective franchisees to ignore the rest of the FDD, there is a real chance that modifications to the FDD could do more harm than good.

Disclaimers, Waivers of Reliance, and Questionnaires in the FDD

The Commission is also considering whether to make changes to disclaimers, waivers of reliance, and questionnaires. Currently, the Franchise Rule prohibits the use of disclaimers and waivers of reliance in FDDs. Panelists, however, discussed that franchisors continue to use disclaimers and waivers—or language that serves the same function—despite the Rule’s prohibition, which federal courts and arbitrators occasionally enforce. These provisions appear in places like Item 19—which includes the FPRs discussed above—and in questionnaires.

However, there is a debate about whether the language found in places like Item 19 and questionnaires are disclaimers or merely useful information for a prospective franchisee. One of the problems is that the Franchise Rule does not have a clear definition of what constitutes a “disclaimer” or “waiver or reliance.” The Commission may provide further clarity on this issue to prevent prohibited disclaimers and waivers from slipping into the FDDs disguised under different forms.

The Commission is taking additional comments from the public related to the issues discussed at the workshop until December 17, 2020. After which, the Commission will determine if it will make any amendments to the Franchise Rule.

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