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Franchising is an incredibly diverse and regulated industry, with laws in place throughout the United States to protect both franchisees and franchisors. The federal Franchise Rule is the primary regulation framework, but certain states have their own unique franchise specific laws and general business opportunity laws as well. These laws vary greatly from state to state, with different duties, obligations and restrictions placed on franchisors depending on where they are offering franchise opportunities. State laws supplement the federal Franchise Rule. As such, it is imperative for franchisors to have a comprehensive understanding of state franchise laws in order to operate successfully and responsibly across the country. Understanding these laws can also benefit prospective and current franchisees who reside in a franchise registration states.
Once the Franchise Disclosure Document (“FDD”) has been issued, a franchisor can begin offering franchises in about half of the United States (An overview of federal franchise law and the FDD) . Its imperative that franchisors understand the franchise laws of their home state and the franchise laws of any state where they wish to do business. Regulating states fall into five categories:
Registration states impose the most stringent obligations on franchisors and typically provide prospects and existing franchisees with the most rights. The term registration states is typically used to describe states that require a franchisor to submit an application and a copy of their disclosure document before doing business. Franchisors must apply and await approval before offering any franchise in these states. Many of these states will review the FDD and will provide comments which must be addressed before they will grant approval to offer franchises. All registration states impose fees for registration and require permission on an annual basis. Failure to comply with these state laws can result in criminal and civil liability.
Annual filing states do not actually collect and review the disclosure document. Instead, they require franchisors to submit an annual notice or request for exemption. These states may have specific franchise protections, but largely the purpose of a filing state is to have the franchisor register before doing business.
One time filing states simply require the franchisor to submit a one time notice or exemption filing. These states typically do not impose franchise specific laws nor dedicate specific resources to investigating franchises.
Historically, people have been tricked into investing funds based off of false or misleading information in various business opportunities. Business opportunity states have enacted specific disclosure requirements to help protect investors in their state. However, because the franchise disclosure document is a thorough document intended to educate buyers, the FDD usually satisfies state business opportunity laws as long as the franchisor has a federally registered trademark. If the franchisor has not yet obtained a federally registered trademark and no other exemption applies, they must also register in business opportunity states before offering or selling any franchise.
The term non-registration state is used to refer to states that have not passed any franchise specific laws. In these states, franchisors can offer franchises by disclosing the FDD, without any additional state obligation imposed or permission required. Non-registration states do not have specific disclosure requirements and do not establish any special causes of action for either state regulators or franchisees. From a compliance standpoint, it is easiest for franchisors to do business in these states.
Under the Supremacy Clause of the United States Constitution, federal law overrides any state and local laws that may conflict with them. Federal law applies to residents of all states and state laws supplement, or add to, the requirements of the federal Franchise Rule. One unique aspect of franchising is that there are no federal franchise examiners and there is no federal requirement for registration. Instead, franchise oversight and enforcement largely occurs at the state level. Regulators often work together and often follow guidance issued by the North American Securities Administrators Association (the “NASAA”). In general terms, registration states impose more duties, obligations, and limitations on franchisors than other states.
The Franchise Legal Hub has categorized each state, which is current as of July 1, 2024. Of course, this list is no substitute for legal advice. Understanding the law and complying with the law is often nuanced and full of pitfalls. This is merely an overview. We strongly encourage franchisors to work closely with a qualified attorney when franchising.
*Connecticut is a one time filing state once the franchisor has a federally registered trademark.
Franchise laws impact various aspects of a franchisors business. Compliance requires an appreciate of legal requirement and the legal consequences of failing to comply. State regulators often have the authority to initiate investigations, impose fines, and prevent a franchisor from doing business in their state. Certain state laws can also impose criminal sanctions on the franchisor and any bad actors.
The key to doing business in any regulating state is to obtain permission before offering or selling any franchise. The process typically involves submission of the required information and payment of the required filing fee. States will formally respond by acknowledging registration or filing. In most registration states, state law mandates a state specific disclosures be included as a supplement to the FDD disclosed and the franchise agreement signed. The approval process can take anywhere from a few days to a few months depending on the state.
Most regulating states require annual updates to either the filing or registration. Registration states typically also require a post-effective amendment filing on any material change. At minimum, steps must occur on an annual basis to maintain approval in registration and annual filing states. Annual updates occur when the FDD is updated. The Franchise Rule requires every FDD to be updated within 120 days of the franchisor’s fiscal year.
The federal franchise rule makes it an unlawful and deceptive trade practice to commit various acts in connection with the offer or sale of a franchise; however, the franchise rule does not itself create a private cause of action. Private causes of action arise typically arise from contract or from state laws. In most states, franchisees can bring suit in tort for fraud or in contract for breach of the franchise agreement (if applicable). However, state laws often go beyond and provide franchisees with a private right of action specific to franchise disclosure law. Some states also provide for a limited right of recession. These private causes of action supplement a franchisees right to recourse and vary by state. State laws must be taken account in offering franchises and in dispute resolution.
All businesses are subject to general advertising laws. Generally speaking, advertisements must be truthful, not misleading, and backed by facts or evidence when appropriate. Franchisors must also contend with franchise specific advertising laws. On the federal level, this primarily means never making an earnings claim that is not included in Item 19 of the disclosure document and providing a clear franchise disclaimer. On the state level, certain advertisements must be registered prior to use, must contain state specific disclaimers, or must comply with any state exclusions. For example, certain states prohibit any earnings claim in an advertisement. Other states require all advertisements to be filed 3-7 days prior to their first use. Understanding federal and state advertising requirements is essential when advertising, whether it be online, by email, or direct solicitation.