Franchise Law Basics

A franchise gives franchisors the opportunity to leverage their business format plan using management by franchisers who have a vested effort in the success of the business, and gives business owners (franchisees) the stability of a tested business model along with the freedom to manage day-to-day operations. Keeping up with the legal requirements and business considerations of a franchise can be both intimating and confusing, so if you are considering purchasing a franchise, you need to research the details thoroughly beforehand. You should only work with a reputable franchisor that meets all of the legal requirements for opening a franchise in your area, and be sure that you’re ready for the responsibility of managing a business. To help you get started, following are franchise law basics. For more detailed information and personalized advice, you need to consult a franchise law attorney.

Franchise Law Basics

What Is a Franchise?

A franchise is a relationship between the franchisor of a trademarked chain who licenses its business format plan, and an individual or group franchisee who operates the actual business. This relationship could include licensing of service marks, trade names, or any other symbols that are associated with that particular franchise and a structure for business operations (marketing plan). The business owner (the franchisee) sells the company’s (the franchisor) goods or services. These goods and services are required to meet quality standards or to be presented or prepared in a specified way.
The franchise relationship should benefit both parties, because (1) the franchisor can leverage its business format and operational expertise and (2) the franchisee will get to use well-known brand names, goods, services, and franchisor’s business operation plan and expertise for their business. It is important for the franchisee to realize it is only licensing the right to operate using the franchisor’s business plan, so there may be restrictions on ability to transfer the business, or on operating independently in competition with the franchise system after the franchise agreement ends or is terminated.

Laws Regulating Franchises

Both federal and state franchising laws exist (not all states have franchise laws, and they vary significantly). At the federal level, franchising is regulated by the United States Federal Trade Commission (FTC). At the state level, state laws are typically enforced by the attorney general or securities division, though this will vary from state to state. If your franchise will be located in another state, you may need to consult other state laws about franchising. In Missouri, the Missouri Franchise Act governs franchise regulations, but is fairly limited and doesn’t require registration of the disclosure document with Missouri. Federal and State law generally provides that if several elements are present the relationship is considered a franchise:

1. the franchisee shell goods or services meeting the franchisor’s quality standards or which are identified by the franchisor’s mark
2. the franchisor exercises significant control or gives significant assistance in the method of operations
3. the franchisee is required to pay $500 or more to the franchisor or an affiliate within 6 months of opening

or

1. the franchisee sells goods or services supplied by the franchisor or an affiliate
2. the franchisor assists in securing accounts, or locations or sites for vending machines or rack displays, or provides the services of person able to do either
3. the franchisee is required to pay $500 or more to the franchisor or an affiliate within 6 months of opening

Generally, federal laws require disclosure, and some state laws require disclosure, registration and advertising. Some states also regulate the commercial relationship between the parties. For example, pre-sale disclosure is required, and some specific sales practices are prohibited. A franchise is also required to register with those states that require registration, and it must comply with related advertising laws to sell franchises in that state. There is no federal registration.

Consequences of Violating Franchise Laws

Violation of franchise laws can be financially devastating. The FTC or state agencies can impose fines, require rescission of prior franchisee sales, or prohibit future franchise sales. Usually the franchisor receives the brunt of the penalties. Also, Franchisees can sue franchisors for failure to comply with applicable laws.

– – – – –

If you are interested in being a franchisee or a franchisor, contact Carnahan, Evans, Cantwell & Brown. We can help you explore the legal implications of becoming a franchisor or purchasing a franchise, and ensure that you comply with all applicable federal and state regulations. Call us at 417-447-4400 for more information.