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1 © 2008 Venable LLP STARTING AND GROWING A FRANCHISE: THE LEGAL NUTS AND BOLTS OF FRANCHISING Thomas W. France Venable LLP February 9, 2012
2 © 2011 Venable LLP Regulation of Franchise Business Relationships A franchise business relationship is subject to regulation under Federal law and in states that have adopted laws governing franchises Federal law –U.S. Federal Trade Commission – 16 Code of Federal Regulations Part 436 –Disclosure Requirements – Federal Disclosure Documents –Enforcement – Administrative actions/civil and criminal penalties State law –Disclosure and Registration –Franchise Relationship Laws
3 What is a Franchise? The Federal Trade Commission has adopted regulations defining what types of business relationships constitute a franchise. Under these regulations, a commercial business arrangement is a franchise if it satisfies each of the following three elements: (1)the franchisee will obtain the right to operate a business that is identified or associated with the franchisor’s trademark, or to offer, sell or distribute goods, services or commodities that are identified or associated with the franchisor's trademark; (2)the franchisor will exert or has authority to exert a significant degree of control over the franchisee’s method of operation, or will provide significant assistance in the franchisee’s method of operation; and (3)the franchisee is required to make a minimum payment of at least $500 during the first 6 months of operations. States that regulate franchises also have adopted laws defining what constitutes a franchise - these laws generally are similar to Federal law, but may include different formulations – marketing plan/community of interest © 2011 Venable LLP
4 Disclosure Requirements Federal and state law require franchisors to disclose certain information to potential franchisees prior to the sale of a franchise Federal Disclosure Documents – Required Disclosure Topics –franchisor and its affiliates –business experience of officers, directors and managers –litigation and bankruptcy –fees that franchisee must pay –estimate of franchisee’s initial investment –restrictions the franchisor imposes on products and services –franchisee’s obligations during the relationship –financing, if any, available from the franchisor –franchisor’s obligations to provide assistance and information about advertising, computer systems and training © 2011 Venable LLP
5 Disclosure Requirements Disclosure Requirements (cont.) –territorial rights –franchisor’s trademarks and other intellectual property –franchisee’s obligation to participate in the operation of the business –restrictions on what the franchisee may sell –information about renewal, termination, transfer and dispute resolution –any public figures who endorse the franchise –optional financial performance representations –information about outlets and franchisees –franchisor’s financial statements –lists and forms of required contracts A potential franchisee must be given time to review the required disclosures before paying any initial fee or signing the franchise agreement © 2011 Venable LLP
6 Acquiring a Franchise New Development –structure and organization of franchisee corporation/LLC/partnership investors –franchise agreement –real estate purchase/lease agreement –development activities – zoning/construction Acquisition of Existing Business –purchase agreement/diligence –structure and organization of franchisee –franchise – franchisor consent/assignment/new agreement –upgrading/renovation © 2011 Venable LLP
7 What Governs the Franchise Relationship? Federal and state law disclosures State Law – regulation of franchise relationship –jurisdiction/which law governs –terminations – good cause and notice and opportunity to cure –limitations on franchisor’s right to consent to transfers –franchisee right to franchise association –discrimination of similarly situated franchisees –purchases of goods and services from franchisor or approved sources –litigation forum clauses Contract Law – the franchise agreement © 2011 Venable LLP
8 The Franchise Relationship The Franchise Agreement –License – right to use trademark and franchise –Fees franchise fees/royalty advertising/marketing contributions –Term of Franchise –Territorial Protection –Construction/Renovation Requirements new development lease/landlord ongoing obligations –Advertising and Marketing local system –Operations system standards/manual/operating procedures employees –Training/Franchisor Support © 2011 Venable LLP
9 The Franchise Relationship The Franchise Agreement (cont.) –Intellectual Property/Confidentiality –Non-Compete restrictions during term post-termination –Accounting and Reports –Liability indemnification insurance –Restrictions on Transfer transfers of business ownership interests in franchisee – Default and Termination Other Agreements –Guaranty –Lease/Owner Agreement –Development Agreement/Right of First Refusal –Management Agreements © 2011 Venable LLP
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