John W. Fitzgerald
January 31, 2000
MAIL TO FRANPR@ftc.gov
FEDERAL TRADE COMMISSION
Re: 16 C.F.R. Part 436—Franchise Rule Rebuttal Comments
Ladies and Gentlemen:
I write on behalf of the Franchise and Product Distribution Practice Group of Gray, Plant, Mooty, Mooty & Bennett, P.A., a law firm based in Minneapolis, Minnesota. Members of our Franchise Group are actively involved in both the ABA Forum on Franchising and the International Franchise Association. At Gray Plant Mooty, our Franchise Group represents more than 50 franchisors located throughout the United States and Canada. These clients range from start-up franchisors to very seasoned franchise organizations that have developed successful worldwide franchise operations. Our Franchise Group is committed to educating and enabling each of our clients to comply with applicable state, federal and international franchise laws, including the FTC Rule (the “Rule”). Consequently, we are keenly interested in the recently proposed modifications to the Rule, as published in the Federal Trade Commission’s (the “Commission”) Notice of Proposed Rulemaking (“NPR”). Having reviewed the numerous comments submitted to the Commission in response to the NPR, we offer several rebuttal comments for your consideration as you prepare a final draft of the Rule.
Proposed Section 436.1—Definitions
Although we certainly agree that the Rule should apply to every offer or sale of a franchise as defined under the Rule, we do not endorse the broad view “that anyone who is involved in the offer or sale of a franchise is responsible to comply with the Rule.”  Many individuals have such a remote or indirect relationship to actual franchise sales transactions that they should not be included within the scope of the Rule.  Specifically, we are of the opinion that lead referral sources should not be included within the proposed Rule and recommend that the definition of “franchise seller” in proposed § 436.1(h) be altered to read as follows:
Franchise seller means a person that offers for sale, sells, or arranges for the sale of an interest in a franchise. It includes the franchisor and its employees, representatives, agents and third-party brokers.It does not include franchisees who sell only their own outlets or any person whose sole activity in connection with the sale of a franchise is to introduce the prospective franchisee to the franchisor, even if such person receives a commission when the sale occurs.
(Underlining indicates the proposed change.) This change would eliminate the burdensome requirement otherwise imposed upon franchisors who utilize lead referral sources to manage and disclose detailed information on a host of individuals who have relatively little connection to the sale process and whose five-year employment histories, for example, are of no interest to prospective franchise buyers. Third-party brokers who do more than introduce the prospective franchisee to the franchisor, however, are still expressly included in the definition of franchise seller.
Proposed Section 436.2—Furnishing and Preparing Disclosure Documents
With respect to section 436.2, our rebuttal comments are as follows:
Section 436.3—The Cover Page
While we agree with the Commission’s rejection of the UFOC’s risk factor disclosure requirement, we are nonetheless concerned that the new Rule still allows states to impose such a requirement.  While franchisors generally must prepare and attach state-related addenda to offering circulars used within states that have promulgated express franchise laws, the Commission’s proposed § 436.3 results in something more burdensome. Franchisors remain exposed to the obligation to prepare distinct cover pages for each state that may impose such a requirement. Such requirements by individual states will derail the positive, efficient trend toward use of a single, multi-state UFOC by franchisors. Instead, the Commission should require states to conform to the Commission’s cover page format in an effort to simplify compliance by franchisors. Should a state feel that a particular additional disclosure is necessary, such concern could be satisfied in a state-specific addendum. This is true for the body of the offering circular as well. In short, the Rule should require each state to precisely adopt the terms of the FTC-modified UFOC disclosure document and cover page, while allowing states to provide for the attachment of clearly enumerated addenda to the end of the disclosure document. While respecting individual state autonomy, this preemptive step will enhance the ease, and therefore the likelihood, of compliance for franchisors.
Proposed Section 436.5—The Required Disclosure Items
Although we support the Commission’s decision to adopt the UFOC disclosure model, we offer the following rebuttal comments regarding the Commission’s version of the UFOC Guidelines:
Proposed Section 436.6—Instructions for Preparing Disclosure Documents
In the Commission’s NPR at pages 60-61, the Commission indicates that because the instructions clearly allow franchisors to attach state-specific information to their particular offering circular, compliance costs and burdens will be reduced “because franchisors need not generate disclosure documents tailored for each state.” While we wholly endorse the end that the Commission is striving to achieve, we simply note that under the proposed Rule, states might choose – by statute – to mandate alterations in disclosure requirements within the body of the document itself. As long as such state-mandated modifications are more protective than the proposed Rule, the Commission would apparently allow state enforcement of such provisions. Although this possibility may occur only in isolated circumstances (i.e., only one or two jurisdictions), the possibility nevertheless exists, leaving franchisors potentially exposed to otherwise unnecessary compliance burdens. We believe this problem can be easily solved. We recommend that the Commission expressly state, within the Rule, that the federal UFOC format will control and that any state-imposed modifications must be in the form of clearly defined and clearly itemized requests for attachments and/or addenda. 
Proposed Section 436.7—Instructions for Electronic Disclosure Documents
Consistent with many comments directed to the Commission, we applaud the Commission’s acceptance of electronic disclosure methods. However, unlike some who have commented, we do not believe that it is necessary for a franchisor “to furnish the prospect with a summary-type document which contains the cover sheet, table of contents, receipt and described summary,”  as required by proposed § 436.7(b). This requirement poses an unjustified increase in the compliance burden already resting upon franchisors and effectively eliminates some of the efficiency of electronic disclosure.  As a practical matter, under the proposed Rule, if a prospect wants a hard copy of the entire circular, the franchisee can request such a copy and the franchisor must provide it. Although we recognize the Commission’s concern with balancing bargaining power in a franchise relationship, we oppose a disclosure model which assumes that franchisees are incapable of choosing – and then being held accountable for – a particular disclosure format. In response to the suggestion that a prospective franchisee will not appreciate the importance of an electronically distributed document, we believe this concern overlooks a fundamental and momentous shift in the nation’s mode of commerce. Furthermore, the Commission can effectively address this concern by publishing its own notices or warnings at its web site, to which the franchisee will now be directed pursuant to the proposed cover page modifications. 
Proposed Section 436.8—Material Changes
We have no rebuttal comment with respect to this section.
We disagree with the suggestion that proposed § 436.9(a) “should be modified to provide that the $500 threshold includes both amounts the franchisee actually pays, but also any amounts that the franchisee, during the last six months, agrees to pay in the future – either by contract or practical necessity.”  The proposed modification would eliminate the bright-line character of the Rule without offering justifiable gains. Where a franchisee pays less than $500 to the franchisor over a six-month span, or greater, it is safe to assume that the relationship is not of the type which the Rule is designed to regulate. In fact, the Commission should consider raising the amount specified to $1000 or higher.
We strongly favor the Commission’s inclusion of the sophisticated investor exemptions to the Rule and we believe that proposed § 436.9(e) is “reasonably tailored to its stated objectives” and not “antithetical to the purposes of the Rule.”  The sophisticated investor exemptions, including the large investor exemption, recognize the fact that the spirit of the Rule is to provide full disclosure sufficient to place the prospective franchisee on an even playing field with the franchisor. Where the playing field is already level, which is undoubtedly the case in the vast majority of transactions involving more than $1.5 Million, no such need exists. This is particularly true in light of the proposed large investment exemption’s exclusion from the threshold amount of any amounts received from the franchisor or an affiliate.  Even where a franchisor is already required to produce a disclosure document because less than 100 percent of its franchisees qualify under the sophisticated investor exemptions, compliance burdens are nevertheless eased by reducing the number of individuals to whom disclosure must be made and subsequently tracked.  In discussing various new exemptions created under the proposed Rule, one commenter asks, “if the document already exists why should the [prospect] not receive it?”  This question, while certainly reasonable, ignores the fact that the Rule’s disclosure requirements are accompanied by waiting periods  —time periods which may unnecessarily delay the consummation of business transactions between informed and experienced parties. And, in response to the concern that prospective franchisees planning to invest more than $1.5 Million may not prevail “in their efforts at due diligence. . . without the aid of mandatory disclosure requirements,” we note that such prospects are free to leave unattractive or uncertain business ventures at the table.
As a final related point, we believe there is some risk that exempted franchisors would not be aware that they are subject to the Rule prohibitions set forth in proposed section 436.10. The Commission may want to consider making an express reference to section 436.10 within the introductory sentence of 436.9.
Proposed Section 436.10—Additional Prohibitions
We strongly oppose any suggestion that integration clauses should be banned under the Rule.  Integration clauses have become an important part of this nation’s common law fabric, and for good reason. These contractual provisions provide a clear indication to a court or any other third party that the contracting parties have reached a meeting of the minds regarding their respective obligations in a contractual relationship, and that these commitments have been intentionally merged into a single document.
Prior to executing a franchise agreement, a prospect will likely speak with franchisor representatives, past and present franchisees of the system (and perhaps outside the system), business professionals, and financial and legal advisors. Furthermore, the prospect will review various documents in addition to the franchise agreement, including the UFOC. In light of the vast amount of information provided to the prospective franchisee during the negotiation process, it is critical that the parties obtain a clear measure of certainty and predictability as to which terms and conditions will actually govern the eventual franchise relationship. A carefully and succinctly drafted integration clause can provide this sense of certainty to all of the parties involved – including the franchisee.
Unfortunately, proposed § 436.10(e) will likely foreclose, as a practical matter, the use of integration clauses by franchisors.  For, if it chooses to do so under the proposed Rule, the Commission could construe any generally worded integration clause as a disclaimer – in violation of § 5 of the FTC Act – of representations made in an offering circular. Consequently, notwithstanding the Commission’s acknowledgment of the “useful purpose” served by integration clauses and the Commission’s related desire not to impose an outright ban on such clauses,  franchisors will be chilled, by the language of the proposed Rule, from using these legitimate contractual provisions.
We have no further rebuttal comments with respect to the Commission’s proposed changes to the Rule.
If we can provide any further clarification to the above-outlined recommendations, please feel free to contact us at your convenience. Thank you for your attention and consideration of these important matters.
Very truly yours,
John W. Fitzgerald
 Howard E. Bundy, Comment 18, at 3 (Dec. 21, 1999) (emphasis added).
 See generally, Frannet, Comment 2 (December 17, 1999).
 L. Seth Stadfeld, Comment 23, at 2 (Dec. 21, 1999).
 See Matthew R. Shay, International Franchise Association, Comment 82, at 3 (May 16, 1997).
 Eric H. Karp, Comment 24, at 4 (Dec. 21, 1999).
 See NPR, at 20.
 See Karp, Comment 24, at 4 (suggesting that certain franchisees will make up their mind to invest in a franchise prior to the commencement of the 14-day review period, thus rendering the period useless).
 Howard E. Bundy, Comment 18, at 7 (Dec. 21, 1999).
 Stadfeld, Comment 23, at 3.
 We raise this point here because we feel it is a significant issue that was, to our knowledge, generally overlooked during the most recent comment period.
 Bundy, Comment 18, at 8 (emphasis added).
 Susan P. Kezios, Comment 14, at 4 (Dec. 22, 1999).
 To see evidence of the unjustified negative inferences which would be drawn from the disclosure of franchisor-initiated litigation, the Commission need look no further than the National Franchisee Association’s comment letter, in which Mr. Rolland asserts that proposed §436.5(c) will assist prospective franchisees “by serving as an indicator of how franchisors resolve their disputes, and whether or not such franchisors are quick to resort to litigation in order to resolve disputes.” Comment 27, at 1. The bare disclosure of such data would say nothing as to how quickly a franchisor resorts to litigation, yet many franchisees will assume the worst.
 It is completely illogical to suggest that franchisor compliance is not burdensome if compliance does not rival the cost of engaging in complex litigation. See Karp, Comment 24, at 11; see also Stadfeld, Comment 23, at 7 (suggesting that “[t]he modest additional cost burden on the franchisor to include the additional information is well worth the price”).
 In response to one commenter opposing “some arbitrary threshold [trigger]” because a “prospective franchisee should make his or her own determination as to whether the number of lawsuits is at a level that indicates a problematic franchise system,” we believe individuals can draw reasonable and adequate conclusions from the fact that litigation is or is not below a certain level. Karp, Comment 24, at 10. Moreover, simply because a franchisor is not required to disclose franchisor-initiated litigation, does not mean a prospective franchisee would not be able to conduct his or her own investigation if deemed important to that prospect.
 See Bundy, Comment 18, at 9 (favoring affiliate disclosure).
 See Bundy, Comment 18, at 12.
 Kezios, Comment 14, at 2; see also Karp, Comment 24, at 12-13 (claiming that “[t]he absence of financial performance information in the typical UFOC creates a vacuum that allows and even encourages representations as to income and profits”).
 Kezios, Comment 14, at 2.
 See Karp, Comment 24, at 13.
 We respectfully disagree with Mr. Stadfeld’s statement “that the franchisor remains the only source of current, useful and plausibly reliable information in this area.”
 NPR, at 46.
 Karp, Comment 24, at 10.
 Kezios, Comment 14, at 3. See also NPR, at 53 (noting that “a few commenters suggest that franchisors should note. . .which specific franchisees are subject to a gag clause provision”). Although it does not appear, under the text of proposed § 436.5 (t)(6) that the Commission is requiring such franchisee-specific disclosure, there is at least some confusion on the issue. See NFA, Comment 27, at 1 (Dec. 22, 1999) (noting its support of “the proposed rule which would require that franchisors disclose the names of franchisees who are required to sign gag clauses”).
 See, e.g., Karp, Comment 24, at 11-12 (proposing that the definition of “gag clause” should include agreements protecting proprietary information).
 If the Commission believes, in light of comments received, that modification of proposed § 436.5(t)(6) is in order, we would support: (1) the Commission’s adoption of a “gag clause” definition applying exclusively to “broad ‘no communication on any subject’ prohibitions,” PMR&W, Comment 4, at 10 (Dec. 20, 1999); and (2) the Commission’s insertion of a threshold percentage of use; for example, the “gag clause” provision would only be triggered if such clauses were used in more than five percent (or some other appropriate figure) of all franchise relationships.
 As noted in our discussion of proposed § 436.3, we include this comment here as we believe the point was largely overlooked in the most recent comment period.
 See Stadfeld, Comment 23, at 3.
Comment 10, at 2 (Dec. 21, 1999) (supporting the IFA’s
recommendation “to eliminate any paper requirements in the
disclosure process as electronic disclosure technology advances permit”).
 Such notice will be particularly useful for franchisees that have requested electronic disclosure, inasmuch as it is reasonable to assume that these same franchisees will be particularly familiar with the Internet and will have little, if any, trouble finding the Commission’s site.
 Howard E. Bundy, Comment 18, at 18 (Dec. 21, 1999).
 Karp, Comment 24, at 4, 5.
 See proposed § 436.9 (e)(1).
 Karp, Comment 24, at 4 (suggesting the “proposed Exemption would be of little benefit to a franchisor unless 100% of its franchise sales involve a transaction of $1.5 Million or more); see also Stadfeld, Comment 23, at 5.
 Stadfeld, Comment 23, at 6.
 See proposed § 436.2 (a)(1) - (2).
 See Karp, Comment 24, at 12; Stadfeld, Comment 23, at 6.
 See PMR&W, Comment 4, at 12.
 NPR, at 79.