This staff advisory opinion is issued in response to your request for advice on whether the Franchise Rule prohibits a franchisor from amending its disclosure document and franchise agreement after accepting consideration from a prospective franchisee.
In your letter, you state that your client, a prospective franchisee, received a copy of a franchisor's offering circular and proposed franchise agreement in January 1998.(1) During that month, the franchisor and prospective franchisee also had various discussions about the proposed franchise purchase. On one occasion, the franchisor mentioned that it might want a right to "buy back" the franchise prior to the expiration of the franchise term in the event the franchisor went public or sold some of its assets. However, on this one occasion, the parties did not discuss the precise events that would trigger a buy back, nor the purchase price for a buy back. Moreover, nothing about buy back rights was mentioned in the franchisor's offering circular provided to the prospective franchisee.
You state further that negotiations regarding the terms of the franchise agreement began in February 1998. The terms of the franchise agreement were heavily negotiated and revised from February 1998 until early May 1998, with the involvement of legal counsel on both sides. You state that at no time during these negotiations was the buy back provision mentioned by the franchisor or its attorney. In early May 1998, the parties verbally agreed on the precise terms and conditions of the franchise agreement, and the franchisor's attorney sent a final, unsigned draft of the franchise agreement to the franchisee with instructions to sign it, pay the initial franchise fee of $5,000, and return the agreement. The franchisee then signed the agreement and sent two checks to the franchisor, one for the initial franchise fee and one as a down payment on the purchase of certain goods.
At the end of May 1998, after the franchisor received the fees and the franchise agreement signed by the franchisee, the franchisor announced that it would not execute the franchise agreement until it provided the franchisee with a new offering circular and a revised franchise agreement allowing the franchisor to buy back the franchise and terminate the franchise agreement prior to the otherwise set expiration date of the franchise agreement.
You now ask whether the Franchise Rule prohibits a franchisor from amending its disclosures and franchise agreement after the prospective franchisee has paid consideration to the franchisor? Specifically, you ask in the event a prospective franchisee has paid consideration to the franchisor:
Is the Franchisor still permitted at this time to amend the Franchise Offering Circular to bring itself in compliance with the FTC's Franchise Disclosure Rule? Or has the "time for making disclosures" elapsed such that Franchisor's insertion of "buy back" provision into the franchise agreement at this time would give [rise] to a violation of the FTC Rule (even though Franchisor has not executed the franchise agreement)? Can the Franchisor avoid a violation of the FTC Rule by simply avoiding signature of the franchise agreement and walking away from the transaction?
II. THE OBLIGATION TO PROVIDE DISCLOSURES
We begin our analysis by noting that the Franchise Rule requires franchisors to provide prospective franchisees with a disclosure document at the earlier of the first personal meeting or the "time for making of disclosures." 16 C.F.R. Section 436.1(a). The term "time for making of disclosures" is defined in Section 436.2(g) to mean:
ten (10) business days prior to the earlier of (1) the execution by a prospective franchisee of any franchise agreement or any other agreement imposing a binding legal obligation on such prospective franchisee . . . or (2) the payment by a prospective franchisee . . . of any consideration in connection with the sale or proposed sale of a franchise.
The Franchise Rule also contemplates that the franchisor and prospective franchisee may negotiate the terms and conditions of the franchise agreement. Indeed, there may be a lapse of several months between the parties' personal meeting and the actual execution of the franchise agreement. Recognizing that the terms and conditions of the franchise agreement may differ from those set forth in the disclosure document, the Rule requires franchisors to provide the prospective franchisee with a copy of the franchisor's completed franchise agreement, and any related agreements, at least 5 business days prior to the date the agreements are to be executed. Id. at 436.1(g). Accordingly, prospective franchisees should review both the disclosure document and the franchise agreement in order to understand the precise terms and conditions that will govern the franchise relationship.
III. WHETHER A FRANCHISOR CAN WITHDRAW AN OFFER OF A FRANCHISE IS A MATTER OF STATE CONTRACT LAW
From your letter, it appears that you believe that a franchisor should be bound by the terms of its franchise offering once the prospective franchisee has signed the franchise agreement and/or tendered payment. We do not necessarily agree.
It is true that the Franchise Rule implicitly requires that a franchisor's disclosure document and contract accurately reflect the terms and conditions of a bona fide offer. While it might be possible to imagine scenarios in which the Rule or section 5 would be violated if a franchisor were to make sham offers consistently by negotiating contractual terms with prospective franchisees that differ materially from those in the disclosure, we have yet to see such a case. Presumably, franchisors have a vested interest in maintaining the uniformity of their franchise systems, a goal ordinarily achieved in part by the use of standard-form franchise agreements. Nothing in the Rule, however, seeks to supplant the common law of contracts, which is a matter of applicable state law. As discussed below, there is an important distinction between the Rule's timing provisions and whether a franchisor has entered into a binding contract under state law.
Based upon the facts presented, the franchisor must have provided your client with a complete and accurate disclosure document at least 10 business days before your client tendered a check to pay for the franchise. In addition, the franchisor must have provided a completed copy of its contract 5 business days before your client tendered payment as well. As long as the disclosure document accurately reflects the terms and conditions of the contract, both of which were furnished to your client, it appears that the franchisor has complied with the Franchise Rule's timing provisions.
Nonetheless, the franchisor's compliance with the Rule's timing provisions does not necessarily mean that it entered into a binding contract with your client. The Franchise Rule imposes no obligation on either party to execute a franchise agreement, nor does it dictate when a binding contract has been established. Nothing in the Rule would prevent a prospective franchisee from declining a franchise offer even after receiving a disclosure document and participating in multiple negotiations. Similarly, a franchisor is not bound to execute a franchise agreement merely because the franchisor provided a prospective franchisee with a disclosure document.
Rather, whether the parties have created a binding franchise agreement is strictly a question of whether there has been an offer and acceptance under state law. Assuming arguendo that state law provides that the prospective franchisee accepted the franchisor's offer to purchase a franchise by signing the franchise agreement and tendering payment, then the franchisor could not unilaterally seek to amend that contract. That would constitute a breach of contract, even if the franchisor furnished the franchisee with a revised disclosure document and agreement setting forth the new proposed term. On the other hand, if there is no acceptance under applicable state law until the franchisor signs the agreement, then the franchisor would appear to be free to withdraw its original offer and propose a revised one, or none at all.(2) The Franchise Rule, however, would require the franchisor to provide a copy of the revised contact to the prospective franchisee at least five days in advance of its execution. Depending upon the changes made, the Rule might also require delivery of a revised disclosure document at least ten business days in advance of the contract's execution.
Please be advised that our opinion is based on all the information furnished in your request. This opinion applies only to your client and to the extent that actual company practices conform to the material submitted for review. Please be advised further that the views expressed in this letter are those of the FTC staff. They have not been reviewed, approved, or adopted by the Commission, and they are not binding upon the Commission. However, they do reflect the opinions of the staff members charged with enforcement of the Franchise Rule.
Date: December 29, 1998
Franchise Rule Staff
1. The franchisor is in the retail clothing and apparel business.
2. Whether the franchisor should be estopped from withdrawing its original offer is similarly a matter of state contract law.