|December 22, 1999
VIA HAND DELIVERY AND EMAIL: FRANPR@FTC.GOV
Re: 16 CFR Part 436 -- Franchise Rule Comment
Dear Mr. Toporoff:
We are pleased to respond to the Notice of Proposed Rulemaking of the Federal Trade Commission ("Commission" or "FTC") in its rulemaking proceeding to amend its trade regulation rule entitled "Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures" (the "Rule"). We provide our comments on the proposed Rule ("Proposed Rule"), below. We enclose a hard copy of our comments as well as a 3 ½ inch computer disk labeled with the name of the undersigned in WordPerfect (Version 6.1), so marked on the computer disk. We have also submitted our comments via e-mail to the address listed in the Notice of Proposed Rulemaking.
We provide our comments on selected sections
of the Proposed Rule, and selected
1. Section 436.1(g) ("Franchise"). We believe that the definition of "franchise" should be revised to be consistent with the current Interpretive Guides to the Rule so that in order for the control and assistance elements apply only where the control or assistance applies to the franchisee's entire method of operation.
We also note that the payment element of the
"franchise" definition will be met by a
2. Section 436.1 (i) (Definition of
"franchisee"). The Proposed Rule defines franchisee as
"any person who is granted an interest in a franchise."
We believe that this definition may encompass more entities than
intended. For the purpose of clarifying the definition we
suggest that franchisee be defined as "any person who is granted a
franchise." We also suggest clarifying the definition of a
franchisee so that there is no requirement that a disclosure document be
furnished between affiliated companies. Because such transactions
typically involve affiliated companies that are controlled by the same
individuals or entities, the need to provide disclosure is not necessary
for the protection of the affiliated company being granted the
franchise. For example,
3. Section 436.1(j). The phrase "grants an interest in a franchise" is too broad and potentially applies to many situations not contemplated by the Proposed Rule (example: a franchisee who sells ownership interests in his business). We suggest that the commission adopt the language used in several state franchise laws -- "grants a franchise" or "grants or offers to grant a franchise" -- to remove this ambiguity.
4. Section 436.1 (r) (Definition of
"predecessor"). The Proposed Rule requires the
franchisor to disclose specified litigation history involving
predecessors. For the purpose of disclosure under items 3 and 4,
the definition of "predecessors" is overly broad. As
defined, a predecessor includes a person from "whom the franchisor
obtained a license to use the trademark or trade secrets in the
franchise operation." We believe this should be limited to a
substantial number of the franchisors trademarks or trade secrets, not
any trademarks or trade secrets, as franchisors
5. Section 436.1 (t) (Definition of "prospective franchisee"). We are concerned about clearly identifying the person or entity that is required to receive disclosure. The Proposed Rule should provide that it is sufficient for any representative of the franchisee to receive the disclosure document.
6. Sections 436.2 (a) (1) and (2) (14 day disclosure review period/five day contract review period). We agree that the proposed 14-day disclosure period and 5-day contract review period provide much needed clarification by establishing a bright-line test.
7. Section 436.2 (Geographic Scope). We support the
Commission's proposal to explicitly limit the Proposed Rule's
application to the "offer or sale of a franchise to be located in
the United States of America, its territories, or possessions . . .
." As the Commission recognizes, requiring a domestic
franchisor engaged in international franchise sales to provide a
prospective overseas franchisee with a disclosure document addressing
the U.S. market would be unduly burdensome for the franchisor and would
likely be misleading to the prospective franchisee. (See
Supplemental Information, Section C.5.a.) In addition, we believe
enforcement of the Proposed
8. Section 436.2(b) (Furnishing Disclosure Documents). With
regard to a franchisor's mailing of its disclosure document and
completed agreements, we note that the term "first-class mail"
is not defined. We assume this term is intended to refer to the
use of first-class U.S. Mail. We suggest that the Commission
permit the use of private courier services (such as Federal Express),
consider the use of telefax machines, and specify the timing for a
franchisor's use of these delivery methods.
A franchisor mailing its documents to a prospective franchisee under this provision will, presumably, want to retain some evidence of the date of mailing to assist in the event of a dispute. We believe it would be helpful if the Commission would specify any specific documents or types of evidence which would qualify as valid evidence of the mailing date. Is a dated facsimile machine print-out indicating successful transmission to the franchisee acceptable? Again, we believe the use of private courier services should be permitted and, accordingly, that any receipt or certificate of mailing produced by the use of such a courier should constitute valid evidence of the date of mailing. Further, we assume a simple cover letter is acceptable, and the franchisor need not obtain an official certificate of mailing from the U.S. Post Office. Also, if the prospective franchisee receives the mailed documents in one day, must the parties still apply the remaining two days of the three-day period?
Under section 436.7(b) of the Proposed Rule, a franchisor may transmit its disclosure document and completed agreements to a prospective franchisee electronically, provided the franchisor "simultaneously" furnishes the prospective franchisee with hard copies of the cover page, table of contents and Receipt pages of its disclosure document. We request that the Commission clarify the intended interaction between sections 436.2(b) and 436.7(b). For example, if a franchisor e-mails its documents to a prospective franchisee and mails the required cover page, table of contents and Receipt pages on the same day:
1) has the franchisor furnished the hard copy pages "simultaneously," as required by section 436.7(b)?
2) must the franchisor apply an additional three days to the required 14-day and five-day time periods, given that part of the required disclosure was forwarded to the prospective franchisee via first-class mail?
Lastly, we suggest modifying the language of section 436.2(b) to read as follows: "or if a copy has been sent to the address specified by the prospective franchisee by first-class mail at least three days prior to the required date." We believe substituting the word "required" for the word "specified" would clarify this section, given that "required date" is used in two other places in the section and it is unclear as to what date the phrase "specified date" refers.
9. Section 436.3 (Reference to the FTC Home Page). We agree with the FTC's decision to require the reference to its web page.
10. Section 436.3(e) (Cover Page). This section currently requires that all "initial franchise fees" in Item 5 be summed and included on the cover page. We believe that this practice can be misleading, as it impedes an "apples to apples" comparison for prospective franchisees. We recommend that there be required disclosure on the Cover Page only as to initial franchise fees for the right to enter into the franchise agreement or alternatively, (a) such fees and (b) all Item 5 fees.
Our understanding is that the principal
purpose of this requirement is to put the
11. Section 436.5(b) (Item 2). The Proposed Rule requires
disclosure concerning "directors, trustees, general partners,
officers, and subfranchisors of the franchisor or any parent . . .
." (See Proposed Rule, section 436.5(b).) We note that
"subfranchisors" is not a defined term. We also suggest
that the Commission consider limiting the required disclosure to
directors, trustees, etc. of the franchisor only, not of any parent
entity. If the franchisor is truly distinct from its parent, the
directors, officers, etc. of the parent will have minimal involvement
with the franchise and, accordingly, should not be listed in the
disclosure document. In addition, their inclusion in the document
blurs the line separating the franchisor and parent, arguably exposing
We note that no disclosure is required
regarding the directors, trustees, general partners, or officers of any
franchise brokers. The UFOC Guidelines specifically require
disclosure of this information (See UFOC Guidelines, Instruction
2.v.) Because section 436.5(b) of the Proposed Rule does not do
so, a franchisor is not required in Item 3 or Item 4 of its disclosure
document (sections 436.5(c)(1)) and 436.5 (d)(1) of the Proposed Rule,
respectively) to provide any information regarding the litigation and
bankruptcy history of these individuals. We believe such
information would clearly be beneficial to prospective franchisees, and
12. Section 436.5 (d) (Bankruptcy). Please see our comment to 436.1 (r) above.
13. Section 436.5(e). The Commission's Notice of Proposed Rulemaking appears to indicate that where initial franchise fees are negotiated to a level lower than those disclosed in Item 5, no subsequent disclosure of the negotiated fees are required. Although implied, we do not believe this is clear in the text of the Proposed Rule and suggest that this section be revised to clearly state that where variation in the initial franchise fees are the result of negotiation with the franchisee and are not the result of formula or calculation, a franchisor need not disclose the range of such negotiated initial franchise fees in the prior fiscal year.
In addition, while we expect that payments
made to the franchisor's affiliates are
14. Section 436.5(l) (Item 12). We suggest that the Commission consider using the term "protected territory" -- as opposed to "exclusive territory" -- throughout section 436.5(l). We believe "protected territory" is simply more descriptive of a franchisee's typical contractual rights regarding its territory, if any. Moreover, we believe the term "exclusive" has different meanings depending on the context and, as such, is ambiguous and often misleading.
Also, we note that the term "market
area" is not defined. We believe this term is
Further, if a franchisor does not grant an exclusive territory and includes in its disclosure document the statement to that effect (required under section 436.5(l)(2)(ii)), why must the franchisor make the additional disclosures required under section 436.5(l)(1)(iv)? The requirements of section 436.5(l)(1)(iv) seem unnecessary in light of the required statement.
We believe the second sentence in section 436.5(l)(1)(ix) should read as follows: "State further any compensation that the franchisor must pay for soliciting or accepting orders inside the franchisee's defined territory; and . . . ."
Also, we note that the phrase "similar goods and services" in section 436.5(l)(3) is not defined, as is the corresponding phrase "similar products and services" in the UFOC Guidelines Instruction 12.C.i. We believe this phrase should be defined, both for clarity and to avoid confusion.
We believe the words "trade names"
can be eliminated from the language in section
15. Section 436.5 (t) (6) (Disclosure of "Gag
Clauses"). Please see our response to the
16. Section 436.5(t)(7) (Item 20). Under section
436.5(t)(7)(i) of the Proposed Rule, a
17. Section 436.5 (w) (3) (Receipt page record keeping requirement). The Proposed Rule requires the franchisor to retain a copy of the signed receipt for a period of at least three years. This provision provides useful clarification regarding the minimum time period the Commission expects franchisors to maintain such records. We note that the three-year minimum time frame appears to create a presumption that the Commission would not expect franchisors to produce receipt pages after such minimum time period has lapsed.
18. Section 436.6(c). This section of the Proposed
Rule indicates that a franchisor may not include any "materials or
information other than that required by [the] Rule . . ."
While the purpose of this section appears to be to limit extraneous
materials and simplify the disclosure given to prospective franchisees,
it may be overly restrictive. As currently drafted the Proposed
Rule repeatedly directs a franchisor to disclose certain categories of
information. For each such category the information disclosed must
be the "material" information relevant to that category. The
Proposed Rule, through application of Section 436.6(c), appears to
prohibit disclosure of
19. Section 436.7(e). The prohibition regarding
multimedia tools, video, animation, or pop-up screens appears to be
overly broad. Although the Proposed Rule should make clear that
any features contained in the electronic copy of the offering circular
should not obscure the required disclosures, we believe that the
Commission should anticipate that there are categories of features which
may add to the offering circular in a way that assists a prospective
franchisee in reading the document. We recognize that the
Commission does not want to permit sales materials to be incorporated
into the offering circular, but we note that under the Proposed Rule
there would be nothing to prohibit the franchisor from providing a
separate electronic document to a prospect containing such
materials. And, in theory, such an electronic document could be
20. Section 436.8(d). Unlike the UFOC Guidelines, the Proposed Rule does not contain a requirement in Item 21 to provide financial statements which are current to within 90 days of the date of the offering circular. However, Section 436.8(d) refers to unaudited financial statements for quarterly revisions. Does this requirement indicate that unaudited financial statements are always material?
21. Section 436.8 (c) (Material Change disclosure). The
Proposed Rule requires the franchisor to notify the prospective
franchisee of any additional material change in the franchisor, the
franchise business or the franchise agreement that has occurred since
the last quarterly disclosure document revision. We agree that a
formal amendment to the disclosure document in this circumstance would
not be cost effective; however, the Commission should clarify the manner
in which such additional material changes should be disclosed. For
example, an oral communication regarding a material change may become
the basis for a dispute. As a policy
22. Section 436.9(g). We recognize that oral arrangements were exempted from the original Rule. Exempting purely oral arrangements from the application of the Rule appears to be in conflict with the purpose of the Rule. It is possible to imagine that unscrupulous companies could utilize this exemption in order to take advantage of investors.
23. Section 436.10(d). This Section prohibits
certain financial performance statements (if no financial performance
representations are contained in the disclosure document) made by agree
that financial performance
Finally, such information is also often available in a company's financial statements; this issue remains unaddressed by the proposed changes to 436.10(d). We believe that comments made by franchisor representatives should only be subject to the restrictions on financial performance representations if they are part of the franchise sales process. Therefore, we believe that the purpose of the Proposed Rule would be more clearly served by applying this prohibition to only those communications made or directed to prospective franchisees.
24. Section 436.10(d)(2). This section requires in all advertising a "conspicuous admonition that a new franchisee's individual financial results may differ," but does not indicate whether specific language must be used. We therefore assume that a franchisor may choose the text of such an admonition.
RESPONSES TO COMMISSION'S SPECIFIC QUESTIONS ON PROPOSED CHANGES:
Question 2. We believe that the omission of the references to expenses in the definition of a financial performance representation is a positive development. The inclusion of expenses in the definition of financial performance representations is unnecessary. We recognize that some franchisors may attempt to characterize disclosure of cost or expense information as information that "suggests a specific level or range of potential or actual sales, income, gross profits, or net profits." To the extent any such disclosure has such an effect, it would be subject to the Proposed Rule's requirement with regard to financial performance representations.
Question 5. As noted below, we believe the use of such "gag clauses" is warranted in a number of cases (e.g., settlement agreements). In response to question 5 raised by the Commission in section H.2 of the Supplemental Information, however, we believe the term "gag clause" implies the use of "strong arm" tactics by a franchisor and, accordingly, is prejudicial. We suggest that the Commission consider using either "nondisclosure clause" or "privacy clause", which we believe are both free of prejudicial overtones.
Question 9. The Proposed Rule would hold franchisor's employees or sales representatives liable for violation of Sections 436.3-436.8 only if they "knew or should have known of the violation." The "knew or should have known" standard may be inappropriate, if the Commission applies such a standard to all franchisors regardless of their size or experience in the franchise industry. How does the Commission contemplate applying this standard to the variety of companies, their structure and circumstances surrounding violations of the Proposed Rule?
Question 13. The Proposed Rule requires a franchisor to
disclose franchisor-initiated lawsuits against the franchisee in Item
3. We believe that, although the disclosure is limited to pending
litigation, the type of actions requiring disclosure needs
clarification. We find troublesome the standard for disclosure of
pending actions -- "directly relating to the operation of the
franchised business" -- as it is vague and could be overly
broad. We recommend disclosure of pending actions should be
subject to a different test related to the franchise agreement (e.g.,
pending actions (1) substantially related to the franchise agreement or
(2) directly arising out of the
We believe it is advisable to limit the scope of disclosure by providing that a franchisor would not have to make the disclosure unless it had pending litigation against a certain threshold percentage of its franchisees. We believe that a 5% threshold of franchisees would be appropriate.
Question 14. We believe that the disclosure requirements relating to electronic cash registers and computers are not unduly burdensome for franchisors, including start-up franchisors. Start-up franchisors often have not developed concrete plans or requirements for electronic equipment. In such instances, franchisors simply provide disclosure as to current and possible future requirements.
Question 16. We assume the term "development
plans" used in this question refers to a franchisor's plans to open
additional company-owned units. If that is correct, we do not
believe a franchisor should be required to disclose this information in
Item 12, because it would not provide a prospective franchisee with any
information not already provided in the disclosure document. For
example, in Item 20, a franchisor (pursuant to section 436.5(t)(3)) must
already provide estimates of the number of company-owned units it plans
to open in each state in the one-year period after the close of its
most-recent fiscal year. In addition, in Item 12, a franchisor
(pursuant to section 436.5(l)(3)) must disclose its "present plans
to operate or franchise a business under a different trademark" if
that business sells goods or services similar to those
Question 18. We believe that the omission of the geographic relevancy requirement represents the removal of a substantial impediment to franchisors who might wish to provide financial performance data to prospective franchisees, because it will lower the obstacles to, and costs of, compiling the data necessary to produce a meaningful representation. We believe it is unlikely to have any material effect on the quality of such representations, as geographic relevancy is often quite attenuated.
Questions 22-24. Item 20 has always been difficult to read. The combination of numerous columns, data for three years (or more), and rows for each state in which the system operates makes the chart relating to franchised outlet information both difficult to read and prepare. We believe that many prospective franchisees are overwhelmed by the amount of data in the chart and simply do not attempt to read it. In fact, many franchisors have indicated to us that prospective franchisees do not read the charts in Item 20 because they are too complicated. Generally, we believe the addition of more categories of information (and consequently more columns) will only make the chart more complex and more daunting to prospective franchisees.
As the Commission has recognized, it is sometimes difficult for a franchisor to determine in which column a particular event should be placed or for a prospective franchisee to accurately interpret the disclosure provided. This is true for two reasons. First, the facts of a particular circumstance may be more complicated than anticipated by the UFOC Guidelines or the Proposed Rule, and therefore could be properly characterized as falling under more than one classification. In this case, under the UFOC Guidelines, a franchisor would simply list the same event twice under different categories ("double counting"), but would still identify the total number of franchises operating in the particular state at the end of the appropriate year. Second, the categories of events contained in each column are not sufficiently clear so that a franchisor or a prospective franchisee would immediately understand the meaning of the name of the category (for example, many franchisors refer to the sale of a company-owned unit to a franchisee as a "transfer").
Although "first-in-time" or
"order of priority" approaches each have some appeal, we
We believe that although brevity and clarity
are the goals of this disclosure, they tend to work at cross
purposes. We believe that there are two approaches the Commission
could adopt which would more closely reach these goals. First, in
addition to a simplified chart containing a list of franchised outlets
open at the end of each year, franchisors could be required to state
briefly -- in prose -- the precise circumstance surrounding the event
leading to the closure (or transfer) of a franchised unit. If this
approach were adopted, franchisors and prospective
Question 26. The Proposed Rule requires the disclosure of
the existence of so-called "gag" clauses if franchisees have
signed gag clauses in a "franchise agreement, settlement, or any
other contract." However, we believe that if a franchisor uses
"gag" clauses in certain isolated situations (i.e., settlement
agreements), the disclosure of such gag clauses would not be required
information to the franchisee. We suggest limiting the
franchisor's obligation to disclose the existence of gag clauses in the
franchise agreement and other contracts signed in connection with the
grant of a franchise, excluding settlement agreements. We believe
the disclosure of "gag"
Question 27. Under section 436.5(t)(7)(ii) of the
Proposed Rule, a franchisor must disclose contact information for each
franchisee organization associated with the franchise system, if the
organization is incorporated and requests inclusion in the franchisor's
disclosure document. As it is currently worded, this section would
require a franchisor to provide contact information for every
incorporated franchisee association requesting it, no matter how many
such associations exist and have requested inclusion, and no matter how
few franchisees may actually be members
Question 35. We believe that the reason for providing an
exemption for sales to sophisticated franchisees is that they are likely
to receive counsel from professional advisors prior to entering into a
contract. If this is correct, we believe that the threshold
investment level could be reduced to at least $1 million and still serve
the purpose of the exemption. We do not understand the purpose or
the importance of the acknowledgment by the prospective franchisee of
the application of the exemption. The acknowledgment does not
protect the prospective franchisee,
Question 36. We note that the sophisticated franchisee exemption provided by this section applies only to corporations. We believe that it should be expanded to apply to other business entities (including limited liability companies and partnerships) and individuals. Moreover, the Commission may wish to consider extending the exemption to individuals with a certain amount of experience in a particular industry -- e.g., 5 years experience -- as such individuals have sufficient experience in the relevant business.
* * *
We hope that our comments are helpful to the
Commission in its public comment
Very truly yours,
Enclosure: 3 ½ inch computer disk