December 21, 1999
These comments are submitted in response to the Commission's invitation to interested parties to submit data, views and arguments on the proposed changes to the Franchise Rule as set forth in the notice of proposed rulemaking published on October 22, 1999 ("Notice"). 64 Fed. Reg. 57293. While this firm represents a number of franchisor clients, these comments reflect the views of the authors and not this law firm or any client. The authors' experience in franchise matters range from over 20 years to more than 30 years, each.
These comments respond to many of the numbered Questions on Specific Proposed Changes. However, several important matters that are not covered by those specific Questions are addressed first in our Response to General Questions.
This section of our comments raises alternative proposals that the Commission should consider. The Commission has done a remarkably good job overall of addressing many of the deficiencies in the current UFOC Guidelines and proposing in many cases appropriate revisions. However, the Commission has failed to simplify the disclosure process (indeed, the disclosure process would be made more burdensome for franchisors by requiring additional detailed disclosures) and has not adequately addressed the need for uniformity. Both of these failures would have a negative cost impact on franchisors.
On the issue of uniformity, Section C.14.c of the Notice simply says that proposed Section 436.11(c) retains the preemption provision currently found at note 2 at the end of the Rule. Essentially, this approach would leave the states free to impose additional requirements that allegedly provide equal or greater protection to franchisees, such as registration of disclosure documents or more extensive disclosure. The Commission says this approach is consistent with other Commission trade regulation rules and cites four examples. The four trade regulation rules cited by the Commission as a rationale as to why it should take this approach are inapposite; none of the states have significantly different disclosure burdens in those four substantive areas as is the case in the franchise area. We urge the Commission to make the Franchise Rule preemptive in such a manner that it would allow the states to enforce only their own identical disclosure provisions.
Franchisors should be permitted and, indeed, encouraged to use one Offering Circular in all states without state modifications. There is a need for uniformity of disclosure and it is difficult to see how any state can reasonably contend that the needs of that state justify a different disclosure burden. Many, but not all, of the registration states require that the Offering Circular be amended, either in the text or by means of an addendum, to reflect various state law principles, such as the use of choice of law or venue clauses, the use of liquidated damages clauses, etc. Most of these required changes reflect public policy pronouncements in the state's franchise or other laws and would control even in the absence of a specific disclosure statement in an addendum to the Offering Circular. Attached are sample state addendum requirements. Even a cursory review demonstrates that there is virtually nothing in those additional disclosures that would justify modifying the Commission's disclosure requirements.
The Commission would also allow the states to require additional disclosures on the cover page or on a separate cover page. (See proposed §436.3(h).) It is difficult to understand the need to add additional risk factors on the cover page, but if this is going to be permitted, the Commission should require that all the state specific information be included in a separate state addendum page at the back of the Offering Circular. This should also include the state's effective date which is usually different than the FTC issuance date. See NASAA Commentary Dated April 18, 1999 on the Uniform Franchise Offering Circular Guidelines (Bus. Franchise Guide (CCH) ¶5790, "Cover Page - Effective Date").
While the specific state addendum are a costly nuisance for franchisors and provide no meaningful information for franchisees about the business they are about to buy, there are more serious preemption needs. We will provide several examples where there are unwarranted differences between the proposed FTC Rule and the various state laws or UFOC Guidelines.
1. Proposed Section 436.8(a) of the revised Franchise Rule would require that the Offering Circular be updated annually within 90 days of the franchisor's fiscal year end. A number of the registration states provide that the registered Offering Circular expires at other times. For example:
In other states, the renewal application is to be filed a certain number of days before the current registration expires, but the prior registration is still effective for 1 to 30 days afterwards. For example:
Many franchisors try to get on a fiscal year cycle by having their current state registrations expire 120 days after their fiscal year end. As a result, it is possible to have a situation where the Offering Circular would have to be updated for FTC Franchise Rule purposes 90 days after the fiscal year end, but the prior Offering Circular registered in many of the states can still be used in those states for up to 30 additional days. For franchisors who do not have their registration renewals on a fiscal year end cycle, they would have to update their registered offering circulars in accordance with the state's material change amendment procedures to include their year end financials.
None of this makes any sense. To address this disparity in the timing of the FTC annual update and the annual state renewals, Section 436.8(a) of the proposed Franchise Rule would have to be revised to provide either that the Offering Circular be updated within 120 days after the fiscal year end, or, alternatively, that franchisors can continue to sell under their current state registrations until they expire under state law. To achieve uniformity and simplify the disclosure burden, modifying the Franchise Rule to require updating within 120 days of the fiscal year end and making the Franchise Rule preemptive in the manner discussed below is the preferred course of action.
2. A similar situation pertains to quarterly updates and material change disclosures. Section 436.8(b) of the proposed Franchise Rule would continue to require that franchisors update their Offering Circulars to reflect any material changes at least each quarter of the fiscal year. Section 436.8(c) would further require franchise sellers to alert prospective franchisees about any material changes since the last quarterly update. The states have different material change requirements. Illinois now requires material change amendments to be filed within 90 days after they occur. Many other states require material changes amendments to be filed promptly (California, Indiana, Maryland, New York), or made before further sales are made (Hawaii), or within 30 days after they occur (Minnesota, South Dakota, Wisconsin), or as soon as reasonably possible (Washington). Several of the states attempt to define the type of material changes that require amendment, but most do not. For franchisors whose renewal is not based on a fiscal year cycle, the issuance of annual financials would require a material change amendment.
There is no reason to have different material change amendment requirements; one standard should apply throughout the country. The Franchise Rule provision is preferable and should be supported by preemption in the manner discussed below.
3. Item 21 of the current UFOC Guidelines and proposed Section 436.5(a) of the proposed Franchise Rule require that if a parent's financials are used, the parent must guarantee the franchisor's obligations to the franchisees under the franchise agreement. At the state level, these guarantees are on state specific guarantee forms that are filed with the states. The proposed Franchise Rule, on the other hand, simply provides that in such situations the existence of the parent's guarantee is to be disclosed. There is no guidance in the proposed Franchise Rule as to the form of guarantee to be used, how it is to be disclosed, and whether it should be provided to the franchisee in some manner. The proposed Franchise Rule should be amended to provide how the guarantee is to be provided, such as by attachment of a copy to the Offering Circular, and to make the requirement preemptive of the state law filing requirements. For example, if the parent's guarantee is attached to the Offering Circular, there is no need to have to file a somewhat different form of guarantee with the various registration states.
4. Many of the states have provisions in their laws which would be in conflict with the proposed Franchise Rule. For example, the New York Franchises Law has a first personal meeting disclosure requirement and requires disclosure of different information in Item 3. There is no reason to have a different disclosure burden under state law, even if it allegedly provides more benefits to franchisees. The Franchise Rule should preempt these types of disparate provisions in the manner discussed below.
The foregoing are some significant examples of the types of disparities that currently exist between the federal and state requirements and would continue to exist if the proposed Franchise Rule is adopted. Other significant examples appear in our comments to the Questions as Specific Proposal Changes posed by the Commission and will not be repeated here. For other examples, however, see our responses to Commission Questions 28, 30, 35 and 36.
The Commission has stated that it seeks to achieve uniformity with the states, but the Commission's failure to have meaningful preemption leaves the situation as murky as before. The problem is exacerbated by the fact that the proposed revision of the Franchise Rule does not include the very helpful explanation of the FTC Rule's intended preemptive effect set forth in the current Interpretive Guides, § I.D.1. Furthermore, there is no indication in the Notice that the Commission intends to issue revised Interpretive Guides. While it may be helpful for the Commission to give clear examples of how it believes preemption will work under the proposed Franchise Rule in revised Interpretive Guides, this still is not a satisfactory answer.
Under the circumstances, we urge the Commission to consider a provision on preemption in proposed Section 436.11(c) similar to that contained in the Federal Hazardous Substances Act(1), as follows:
A provision of this nature would allow the states to enforce the identical disclosure requirements adopted by the FTC, but would not allow the states to deviate from them. The states could still require registration. This will achieve the goal of uniformity of disclosure and reduce the cost burdens on franchisors, yet allow the states to participate in the enforcement process.
It is important to recognize that the pre-emption which results from this approach relates solely to the form and contents of the disclosure. It will not affect substantive state law. Indeed, the disclosure requirements could be revised to note that some states have adopted franchise laws which mandate (or preclude) certain types of contract provisions; the disclosure statement should call attention to this fact and should include a statements indicating such state law requirements will supercede the contract language referenced in the disclosure and will be identified to the prospective franchisee by means of a separate writing. In this manner, the FTC Rule can continue to promote disclosure and the provision of information to the prospective franchisee, without enabling states to interpose cost-increasing technical variations in the disclosure process which serve to confuse rather than inform.
In this section of our comments, we respond to those specific questions posed by the Commission for which we believe we can provide useful input. The numbers below correspond to the Commission's numbered questions.
1. Definition of "Financial Performance Representation" (proposed §436.1(d)). Because franchisors should be encouraged to provide all relevant expense information to franchisees in other portions of the Offering Circular, this provision should be revised to state explicitly that compliance with the Rule's expense disclosures obligations does not trigger the proposed Rule's Item 19 financial performance disclosure or substantiation requirements.
2. Definition of "Franchise" (proposed §436.1(g)). The Commission has stated that it only wants to regulate those businesses traditionally considered to be franchises. By modifying its definition of "franchise", however, there is a risk that non-traditional businesses could find themselves covered by the proposed Franchise Rule.
It has never been clear why the Commission in 1978 chose a definition of "franchise" that was at that time and still is different from that commonly used by the states. The Commission should reconsider its definition and adopt a definition used by most of the states. The California definition is the most commonly accepted. There is no rational reason for a different definition in the Franchise Rule.
We support the Commission's view that traditional distribution relationships are not intended to be included in the scope of the "franchise" definition. In order to achieve that goal - and in recognition of the fact that modern product distribution has (and is likely to have) many different features than were seen in the 1970's and 1980's - the Rule needs to be far more explicit.
First, the franchise fee requirement needs to be part of the definition. Second, calling it anything that is required to be paid is not explicit enough. Presumably, the Commission means something that is required to be paid for the right to enter into the franchise relationship. The fact that the required payment must be for the right to enter into a business is crucial to implementing the Commission's stated objective of not sweeping traditional distribution arrangements into the purview of the Rule. As the Court of Appeals stated in Wright-Moore Corp. v. Ricoh Corp., 908 F.2d 128, 136 (7th Cir. 1990), there is a distinction between a fee paid for the right to do business and "fees paid during the course of business." The franchise fee is a required payment which is in the nature of an otherwise unrecoverable investment in intangibles; a wealth transfer which would be unrecoverable or worthless in the event of termination (see Wright-Moore Corp. v. Ricoh Corp., 794 F. Supp. 844, 856-59 (N. D. Ind. 1991); aff'd., 980 F.2d 432 (7th Cir. 1992). See also, Digital Equipment Corp. v. Uniq Digital Technologies, Ltd., 73 F.3d 756, 760 (7th Cir. 1996). Implementing this concept, court after court has emphasized that ordinary business expenses, even when they involve purchases from the putative franchisor, are not to be treated as franchise fees turning ordinary distribution relationships into "franchises." See, e.g., Freudenberg Bldg. Systems, Inc. v. Architectural Floor Systems, Inc., 1995-96 Bus. Franchise Guide (CCH) ¶ 10,791 (D. Mass. 1995); Agee Agricultural Equipment Sales v. Trail King Indus., Bus. Franchise Guide (CCH) ¶ 8,721 (D.S.D. 1986).
The demands of modern business may lead to purchases of items from a manufacturer which are ordinary business expenses even though an aggressive litigant might wish to argue that they are required. For example, a manufacturer may strongly encourage use of a computerized order entry system in which software (or even compatible hardware) is most efficiently obtained through the manufacturer; a manufacturer may prefer point of sale systems which communicate data on a real-time basis back to the factory to make production decisions more effectively; or more complex products may require trained sales staffs. None of these, however, should convert a distribution relationship into a franchise. Similarly, customers who may have previously purchased products (or purchased related items used with products) may now seek to lease them on an "as-needed" basis in order to minimize capital costs. The distributor purchasing inventory for "re-sale" was not a franchisee (see proposed Section 436.9(a)); however, if the "exemption" for required purchases is limited to items being resold, that same distributor (who now purchases items from the manufacturer and makes them available for lease) could become a franchisee (or at least could advance such an argument.) The proposed Franchise Rule should be revised to prevent such arguments.
If the Commission decides to retain its unique definition of "franchise", other portions of the definition need addressing also. Proposed Section 436.1(g)(2)(ii) should be amended to clarify that the provision of significant assistance in the franchisee's method of operation must be "continuing" (just as the control must be "continuing" in Section 436.1(g)(2)(i)). In addition, either Section 436.1(g)(3) or 436.1(u) should be revised to reflect the fact that the required consideration must have been contemplated by the parties and required at the time the contract was entered into.
With such revisions, the proposed definition of franchise would include franchises traditionally covered by the Rule and will not inadvertently eliminate businesses that should be considered to be franchises. However, the elimination of the exclusions which appear in the current Rule (16 C.F.R. § 436.2(a)(4)) could lead to the inclusion of businesses not traditionally covered by the Franchise Rule. See our comment to Question 33.
3. Definition of "Franchise Seller" (proposed §436.1(h)). There is no reason to have a separate definition of "franchise broker" or separate disclosure obligations for such persons. If any party offers to sell a franchise on behalf of a franchisor, that person should be considered a franchise seller. On the other hand, the definition is too broad if it is intended to apply to the new standard of liability in proposed §436.2(c). See our comments to Question 9.
4. Definition of "Gag Clause" (proposed §436.1(k)). We see no reason for the disclosure of so-called "gag clauses" and therefore recommend that this definition be deleted. If the Commission would prefer simply to ban the use of such clauses in future contracts or settlement agreements, that is a different issue and should be directly addressed. See our comments to Question 26.
5. Definition of "Internet" (proposed §436.1(l)). It seems strange to define "Internet" as including communications between a computer and telephones and facsimiles. A preferred definition might be "computer communications".
6. Definition of "Officer" (proposed §436.1(o)). The proposed definition of "officer" is adequate, but it makes more sense simply to use the term "management personnel" to cover the persons listed in the officer definition.
1 New Standard of Liability (proposed §436.2(c)). Proposed Section 436.2(c) imposes an impossible standard of liability. As anyone who has drafted an Offering Circular can testify, there is no certainty as to the nature of the information that has to be included in the various disclosure sections of the Offering Circular and reasonable persons often differ in good faith as to what has to be disclosed. Disclosure in many respects is a very subjective, rather than objective, matter. We suggest that the proposed standard be revised to make it a violation for a franchisor to fail to use "commercially reasonable good faith efforts" to disclose the required information. We also believe that imposing this duty on all "franchise sellers", as defined in proposed §436.1(k), is unfair because someone at the franchisor has the responsibility of deciding what is required to be disclosed and other employees with a difference of opinion as to what should be disclosed should not be held liable for a failure to disclose something a responsible official decided not to disclose.
2. 14 Day Disclosure Provision (proposed §436.2(a)(1)). The requirement that the disclosure document be provided 14 days before signing a binding agreement or paying a "fee" (i.e., should it be "consideration"?) is a desirable change (as was dropping the first personal meeting requirement). It eliminates the uncertainty of what is a business day. The Commission may want to clarify whether the day the document is given and/or the day the document is received should be included in the 14 day calculation.
3. 5 Day Contract Provision (proposed §436.2(a)(2)). The proposed change requiring that a copy of the completed contract be provided to the prospective franchisee 5 days before the franchisee signs the contract is desirable because it still provides adequate time protection for the franchisee. Again, the Commission may want to clarify whether the day the document is given and/or the day the document should be received is included in the five-day calculation. It would also be helpful to clarify that the 5 day period can run concurrently with the 14 day period, which the Commission appears to do in an oblique manner in proposed Section 436.10(e).
4. "Predecessor" Information (proposed §436.5). It is useful to require disclosure of the franchisor's predecessors, as long as everyone understands what a "predecessor" is. However, the Commission has modified the definition of "predecessor" (proposed §436.1(r)) to include trademark licensors. This is unnecessary because the trademark license and the trademark owner will be disclosed in Item 13. In addition, while the Commission wants franchisors to disclose parent information, a parent should not be considered a predecessor simply because it set up the subsidiary. The definition of "predecessor" should be revised to indicate that it does not include the parent that organized the franchisor or the licensor that licenses a mark. Although it is useful to have disclosure about the parent, detailed disclosure about the predecessor is not necessary and only serves to confuse the prospective franchisee because the predecessor has no responsibility for the franchisor's activities.
5. Material Civil Litigation Disclosure (proposed §436.5(c)(ii)). Proposed Section 436.5(c)(ii) calls for too much information and would be extremely burdensome for franchisors. We are opposed to the additional litigation disclosures. If the FTC persists in this requirement, however, we believe a 5% threshold would be appropriate; i.e., a franchisor would not have to make the disclosure that it had material civil actions involving the franchise relationship unless more than 5% of its franchisees were involved in these actions.
The Commission should also bring same balance to the disclosure of confidential settlement agreements. See notes 102 and 284 in the Notice. While perhaps it is understandable that a franchisor would have to disclose some information about confidential settlement agreements it entered while a franchisor because it has to be held to be knowledgeable of this and prior similar disclosures obligation, it is manifestly unfair to require disclosure of such confidential settlement agreements if they were entered into by a company at a time when it was not yet engaged in franchise activities. The proposed Franchise Rule should be revised to provide that it is not necessary to require disclosure of the terms of confidential settlement agreements if they were entered into before the company engaged in franchise sales. In such situations, the company could not be held to know that it could not protect the confidentiality of a settlement agreement since it was not bound at that time by this or prior similar disclosure obligations.
A further problem is disclosing the exact dollar amount or terms of a confidential settlement. This often can expose the franchisor to the choice of not being able to register its franchise in a particular state or making a disclosure and possibly breaching the terms of the confidential settlement agreement. A reasonable compromise is included in the current Interpretive Guides, which allow disclosure only of an approximate dollar amount, such as "the low four figures." See Final Interpretive Guides §II(4).
Alternatively, the Rule could establish ranges which could be referenced, similar to the categories used in disclosure documents for government officials. In addition, where a case has been settled by purchase or re-purchase of a franchised business and the amount does not exceed the fair market value of the business, a franchisor should be permitted to state that "The settlement included a purchase of the franchise (or such other property as was purchased) for an amount which, in our judgment, does not exceed its fair market value."
There are, in addition, litigation disclosure obligations which are technically required by the Rule as a result of corporate organizational structure, notwithstanding their lack of obvious relevance to franchising or the franchisor's franchise operations. It has become commonplace to include parent corporations, officers and directors as defendants, and to include claims for fraud, violations of RICO statutes and violation of unfair act or practice statutes, all for possible in terrorem effect. Where a franchisor (or an individual subject to disclosure requirements) is engaged in various other unrelated business activities (as often occurs when the franchisor is a conglomerate or where individuals wear multiple "hats"), there can be a litigation disclosure obligation simply because the parent entity or the individual is named in a list of defendants. The proposed Rule should provide that where such claims involve franchising activities (in any business) or where the claims involve specific allegations that an individual active in the business in which the franchise is being offered has engaged in fraud, etc., disclosure is required. However, in situations where detailed case-by-case disclosure is now technically required, but the litigation does not involve the franchising activities of the defendant or specific allegations bearing on conduct of an individual actively involved in operation of the franchised business which is the subject of the disclosure document, it should be sufficient for the franchisor to cover those cases with a statement along the following lines: "In the ordinary course of business operations involving activities unrelated to the franchised business, our company (or its affiliates) and various individuals connected with us (including those listed in Item 2, above), are named, from time-to-time, in complaints which may include allegations of various types not involving franchising activities. Such litigation is not listed in this disclosure statement; however, further information regarding such cases may be obtained by asking us, in writing."
6. Electronic Cash Registers and Computer Systems Disclosure (proposed §436.5(k)). The disclosure of specific details about electronic cash registers and computer systems in the Offering Circular is not very helpful, especially since technology is changing so fast and those specifications often are in a state of flux. If the Commission believes this type of detailed information is useful, the proposed Franchise Rule should be revised to provide simply that the franchisor disclose in writing to the prospective franchisee prior to the signing of the contract the electronic cash registers, computer equipment and software that will be required to be used in the franchisee's business.
7. Exclusive Territories Disclosure (proposed §436.5(1)(2)(ii)). Proposed Section 436.5(1)(2)(ii) sets forth an adequate disclosure to alert prospective franchisees about potential competition from within the franchise system.
8. Protected Territories Disclosure (proposed §436.5(1)). It is not appropriate to require franchisors to disclose current development plans unless they have been publicly announced. Such information is proprietary and, indeed, its disclosure could be misleading if it never comes to fruition.
9. "Renewal" Term (proposed §436.5(q)). While the term "renewal" seldom reflects what actually happens when a franchisee enters into a successor contract for a subsequent term, that is an accepted term of art in franchising and should not be changed. Moreover, the various state relationship laws use that term and to revise it for disclosure purposes is likely to cause more confusion than clarity. Alternatively, the Commission could include a new definition of "renewal" to indicate that it includes extensions.
10. Geographic Relevance of Financial Performance Requirements (proposed §436.5 (s)). If the Commission's goal is to encourage more franchisors to make financial performance representations, eliminating the geographically relevant requirement would be helpful.
11. Historical Performance Representations (proposed §436.5(s)(3)(i) - (ii)). The required disclosures of information that franchisors must provide if they elect to make historical performance representations provides prospective franchisees with sufficient information to assess the representation.
12. Outlet Characteristics (proposed §436.5(c)(3)(ii)(A) and (F)). These sections provide franchisors with sufficient guidance about what characteristics of the outlets underlying the representation must be disclosed and how they may differ materially from outlets offered to a prospective franchisee. However, requiring disclosure of the degree of competition in the market area would be difficult, very subjective and costly to prepare, and we recommend that it be deleted.
13. Admonition of Franchisee's Results (proposed §436.5(s)(3)(iv)). An admonition that a new franchisee's individual franchise results may differ from the results stated in the financial performance representation should be included as the final statement in all financial performance representations in all capital letters.
1. Disclosure of Franchisee Names (proposed §436.5(t)(4)). The disclosure of more, rather than fewer, franchisee names is helpful. This is one area where additional information will be helpful to prospective franchisees because it will give them a bigger universe of existing owners to contact when they are considering whether to buy a franchise.
2. "Gag Clauses" Disclosure (proposed §436.5(t)(6)). As noted above, we believe the disclosure of "gag clauses" is unnecessary and recommend that Section 436.5(t)(6) be dropped. If this provision were to be retained, it should be applied prospectively only to franchise or settlement agreements signed after the Franchise Rule is revised. Furthermore, it does not seem appropriate to include this in Item 20; perhaps it belongs in Item 17.
3. Trademark-Specific Franchisee Associations (proposed §436.5(t)(7)). This provision would require disclosure of each trademark-specific franchise organization associated with the franchisor if it was created, supported or recognized by the franchisor or, if it is incorporated, it asks to be included in the Offering Circular. We have no objection to this disclosure as long as it is limited to organizations organized by the franchisor or specifically authorized by the franchisor to use its mark (this would not include independent franchisee associations of a particular franchisor's franchisees). However, we do not understand the second clause which seems to say that even an unrecognized association must be included in the offering circular if it is incorporated and asks to be included. We suggest deleting proposed Section 436.5(t)(7)(ii) because it is redundant at best and confusing. Moreover, we believe this disclosure would be inappropriate in Item 20 and suggest that it be moved elsewhere, such as to Item 11.
4. Phase-in of Audited Financial Statements (proposed §436(u)(2)). The proposed provision regarding the phase-in of audited financial statements is desirable and should be preemptive. The Commission should be aware that several of the states require the use of audited opening balance sheets in order to register a start-up franchisor. We believe that this is another example of why the Franchise Rule should preempt inconsistent state law requirements. One set of financials should be acceptable throughout the country.
5. Proof of Receipt (proposed §436.5 (w)(2)). Requiring franchisors to prove that prospective franchisees actually received a disclosure document is useful for both franchisors and prospective franchisees. For the franchisor, it is a consistent reminder of the need to comply with the 14 day disclosure rule.
6. Other UFOC Modifications. The Commission's revisions to the UFOC Guidelines are generally sound and desirable, but the fact that differences remain demonstrates again the need for uniformity through preemption of the type we advocate.
1. Exemptions (proposed §436.9). While this provision states that exempt franchisors are exempted only from the disclosure obligations in proposed Section 436.2 - .9, it would be useful to state affirmatively that they are subject to Section 436.10.
A more serious concern is that the Commission has chosen to delete several long-standing exclusions on the ground that they are no longer necessary. We believe that the dropping of these exclusions is likely to be misinterpreted and recommend that they be reinstated in the proposed Franchise Rule. This includes the cooperative association, partnership and single-license exclusions. Many companies have relied on the existence of these exclusions and their deletion is likely to create confusion and uncertainty about the scope of coverage. Those excluded entities should not be subject to any provisions of the Franchise Rule, including proposed Section 436.10.
2. $500 Threshold (proposed §436.9(a)). The threshold amount has been $500 for over 20 years. It should be raised to either $2500 and an inflation adjuster added or to 1% of the amount of average retail sales achieved by outlets using the franchised system in the United States in the most recent year for which data is available, whichever is more. If a system has average retail sales of $1 million/year, $10,000 is not a number which should trigger concerns. There is no need for the Commission to regulate de minimus investments with this type of burdensome and costly disclosure obligation.
3. Large Investment Exemption (proposed §436.9(e)(1)). The disclosure exemption for large investments is a prudent revision and the $1.5 million proposed threshold is appropriate. This provision should be preemptive and apply to all sales situations so a state cannot require registration or disclosure if the Franchise Rule calls for an exemption.
4. Large Corporate Investors (proposed §436.9(e)(2)). The disclosure exemption for large corporate investors is also a prudent revision, but it should not be limited to corporations. Any business entity (partnership, limited liability company, trust, etc.) or individual with that type of net worth should also be exempted. This provision also should be preemptive.
5. Inflation Adjusters (proposed §436.9(e)). The proposed sophisticated investor thresholds adequately address the impact of inflation.
6. Prohibition on Disclaiming Statements in a Disclosure Document (proposed §436.10(e)). This proposed provision may make the most serious change suggested by the Commission. Unfortunately, proposed Section 436.10(e) mixes apples and oranges. The first sentence would prohibit a prospective franchisee from waiving reliance on a representation made in the disclosure document or its exhibits or amendments. Under the common law, unless there has been fraud in representations made prior to signing, any prior discussions are merged into the contract if there is an integration clause. That integrated document is the basis of the bargain between the parties. If there has been a representation in the disclosure document that was fraudulent, the FTC (or the states) can take appropriate action and the franchisee has his common law and state specific private remedies. On the other hand, if all the Commission intended to say by this proposed provision was that a disclaimer provision in the franchise agreement is not binding on the Commission or does not prohibit the Commission from taking action against the franchisor for violating the Franchise Rule, that can be stated directly. See Section 436.10(a).
The second sentence seem to be completely contrary to the Commission's current views regarding negotiated changes. The parties should be free to negotiate changes to the contract as long as the prospective franchisee has 5 days to review the changes before signing. (Did the Commission make a mistake in referring to 5 days before signing a contract or "paying any fee"?)
We recommend that the entire proposed Section 436.10(e) be deleted.
1. Preparer's Disclosure. We do not believe the Franchise Rule should be revised to require a statement of which individuals were responsible for preparing the disclosure document. Many people are typically involved in the process and this provides no useful information other than to identify potential witnesses in litigation.
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Thank you for the opportunity to provide comments on the proposed revisions to the Franchise Rule. Simplification of the disclosure process and providing for meaningful preemption to achieve uniformity would not only reduce costs but make the disclosures more meaningful and useful to franchisees. We would be pleased to participate in a workshop on the various issues raised in this letter.
Very truly yours,
By: John R. F. Baer
Robert T. Joseph
Alan H. Silberman
1. See Pub. L. 94-284, §17(a) (5-11-76), 90 Stat. 510; 15 U.S.C.A. §1261 note ("Effect upon Federal and State Law").