|Via email and Federal Express
December 22, 1999
Re: 16 CFR Part 436 Franchise Rule Comment
Dear Sir or Madam:
This letter contains the comments of The Prudential Real Estate Affiliates, Inc. ("PREA") on the proposed changes to the FTC Franchise Rule. This letter is being delivered by email. A hard copy and an electronic version on a computer disk are following by overnight courier.
Proposed section 436.5(c): Item 3 (Litigation)
a) The Commission proposes to adopt UFOC Item 3, but enhance it by requiring the disclosure of litigation involving the franchisors parent. This will place an unnecessary burden on large established franchisors that are subsidiaries of major corporations without a commensurate benefit to potential franchisees.
PREA is a wholly owned subsidiary of the Prudential Insurance Company of America ("Prudential"). Given the size, scope and diversification of Prudentials operations worldwide, the proposed change would require the disclosure of voluminous amounts of pending and concluded litigation wholly unrelated to franchising or PREAs operations. The disclosure of this information would be both confusing and irrelevant to prospective franchisees.
PREA believes that the proposed change has merit when the franchisor has little business history or assets. In such cases, the prospective franchise is looking to the parent for assurance as to the franchisors continued financial viability and ability to perform. Also, when there is little or no historic information regarding a franchisor, information on the parent may provide important anti-fraud disclosures. Such information, however, is of far less importance when the franchisor has an established track record and substantial assets of its own. Collecting such information would also significantly increase the compliance costs for established franchisors that are subsidiaries of major corporations.
PREA suggests that the Commission adopt an exemption from the proposed requirement if the franchisor has sufficient net worth and experience. Reasonable minimum criteria for exemption could be a net worth on a consolidated basis of not less than $5,000,000 and a requirement that the franchisor has had at least 25 franchisees for the each of the preceding five years.
b) The Commission also proposes to disclose litigation involving predecessors for the first time. PREA does not object to this proposal so long as the information is relevant to the current franchise system. However, the Commission also proposes to enhance the UFOCs definition of "Predecessor" to include any person from whom the franchisor has obtained the right to use the trademark or trade secrets associated with the franchise system [Proposed Section 436.1(r) ("Predecessor")].
PREA sub-licenses its franchisees with Prudentials trademark, which is owned by Prudential and licensed by Prudential to PREA. If the Commissions proposal is adopted as written, it would have the unintended consequence of again requiring PREA to disclose all litigation relating to its parent, Prudential, this time as its "Predecessor" under the definition. This would create the same problems described above. PREA believes that other established franchisors that are subsidiaries of major corporations could have the same problem.
A possible solution would be extending the "established franchisor" exemption we have suggested for litigation involving the parent to include litigation involving a predecessor, if the predecessor and the parent were one and the same entity.
Proposed Section 436.5(u): Item 21 (Financial Statements)
The Commission proposes to require the inclusion of financial statements for a company controlling 80% or more of a franchisor. Again, this will place an unnecessary burden on large established franchisors that are subsidiaries of major corporations without a commensurate benefit to potential franchisees. In addition, the proposal is unclear whether the inclusion of the parents financials requires a parent guarantee.
PREA is a large, long established franchisor with a net worth in excess of $47 million (as of October 31, 1999, unaudited). Adding financial statements for its parent, Prudential, to its disclosure is simply unnecessary and would simply increase the cost of compliance and the complexity of the disclosure without a real increase in the benefit to the franchisee. A guarantee from the parent is also unnecessary given PREAs net worth.
PREA suggests that the Commission adopt an exemption from the proposed requirement if the franchisor itself has sufficient net worth. Reasonable minimum criteria for exemption could be a net worth on a consolidated basis of not less than $5,000,000.
Proposed Section 436.9(e): Sophisticated Investor Exemption.
The Commission also proposes to create a disclosure exemption for large corporate investors. PREA supports this proposal and feels that the five years in business and $5 million net worth requirements are appropriate. PREAs experience, however, suggests that the exemption should be expanded to include the variety of business forms common in heavily negotiated, multi-million dollar transactions today.
For example, PREA is a conversion franchisor of real estate brokerage companies. The largest PREA franchisees are typically long established businesses with net worth figures well in excess of $5million when they purchase the franchise. Often they conduct their business operations through multiple entities and their net worth is calculated on a consolidated basis. It is quite common for a franchise sale to one of these companies to involve a leveraged recapitalization of the companys entire operations. This means that the assets of the existing company (or companies) are transferred to a new company with some equity of the owners being taken out and replaced by debt in the deal. For tax reasons, the new entity is usually some form of limited liability company or limited partnership. Subsidiary entities may be formed for parts of the transaction. The deals involve multi-million dollar values and financing and are always heavily negotiated. Sophisticated counsel and financial advisors represent all parties involved.
PREA believes that the transaction described should fall under the proposed sophisticated investor exemption; that it is not the kind of franchise sale that the Rule was intended to cover. It would not be exempt, however, if the proposal were adopted as written, because the transaction involves successors and multiple entities, some of which may not be corporations.
PREA suggests that the Commission expand the exemption to 1) include individuals and other forms of business entities, such as limited liability companies and partnerships, 2) allow for the $5 million requirement to be met by including consolidated financial figures of a companys parent and affiliates, and 3) permit the experience of predecessor entities to count toward the experience requirement. To do otherwise would result in artificially excluding from the sophisticated investor exemption a large number of transactions that should certainly be covered.
PREA thanks the Commission for consideration of its comments in this matter. Please direct any questions about this letter to the undersigned at the address above.
THE PRUDENTIAL REAL ESTATE AFFILIATES, INC.
Assistant General Counsel,