IFA Franchise Development Seminars 2016 May 5, 2016

David A. Beyer, Partner Quarles & Brady LLP 101 E. Kennedy Blvd, Suite 3400 Tampa, FL 33602-5195

Bud Culp | General Counsel The Melting Pot Restaurants®, Inc. 7886 Woodland Center Tampa, FL 33614

Sales Compliance Update

I. Disclosure Requirements: Federal and State

Laws Governing Franchises • The FTC Rule

– Pre-sale disclosure – No registration requirement – Applies in all 50 states and U.S. territories

• State Laws – Registration and disclosure laws – Relationship laws – Business opportunity laws

Franchise Registration States California New York Hawaii North Dakota Illinois Rhode Island Indiana South Dakota Maryland Virginia Michigan Washington Minnesota Wisconsin

Who Receives a Disclosure Document?

• Prospective franchisee: – Any person (including agents, employees and

representatives) who approaches or is approached by a franchise seller to discuss the possible establishment of a franchise relationship

Who Must Make Disclosure? • Franchise Seller

– Anyone that offers for sale, sells, or arranges for the sale of a franchise

– This includes the franchisor, its employees, representatives, agents, sub-franchisors, and third party brokers who are involved in franchise sales activities

– This does not include existing franchisees selling their own units

When to Provide a Disclosure Document

FTC Rule 14 calendar days before signing or $

When to Provide a Disclosure Document

• State laws – 10 Business Days:

• Michigan – First Personal Meeting / 10 Business Days

• New York and Rhode Island

Delivery of Franchise Agreements 7-Calendar Day Waiting Period

– If Franchisor makes unilateral and material changes to the Franchise Agreement, it must furnish “execution copies” to the prospect at least 7 calendar days prior to execution.

• Fees, interest rates, protected territory – Delivery requirement is not triggered by:

• Changes to the standard franchise agreement made at the prospect’s request and for its benefit

• Completing “fill in the blank” provisions (e.g., name and address of franchisee)

– 7-calendar day and 14-calendar day periods can run concurrent

Disclosure Document Procedures • The day on which the FDD is delivered is not included for

purposes of calculating the disclosure time period.

• Don’t count the date when the agreements are signed.

• Don’t count holidays or weekends for “business days” (state laws).

• Use a calendar.

FTC Considers Documents Furnished by the Required Date

If the document is:

– Hand-delivered, faxed, e-mailed or otherwise delivered by the date;

– Directions for accessing the document on the Internet are provided by that date; or

– A paper or tangible electronic copy (CD Rom) was sent by first-class U.S. Mail at least 3 calendar days before the required date.

Disclosure Compliance: Electronic Disclosure • FDD may be sent via e-mail or on CD-ROM • Internet access allowed as well • Must be in a form that permits prospect to store,

download, print, or otherwise maintain the document for future reference

Disclosure Compliance: Electronic Disclosure

• Must advise prospect of: – Formats in which FDD is available – Prerequisites for obtaining FDD in a particular format – Conditions necessary for reviewing the FDD in a particular format (Adobe

Acrobat, browsers, etc.)

• Can communicate this form information however you wish: – In person or telephone – E-mail – Franchise applications – Marketing materials

• Must be able to prove you made “format disclosure”

Disclosure Compliance: Electronic Disclosure

Sample Communication for E-Disclosure: We will be sending you the FDD as an attachment to a separate e-mail. Please note that your e-mail account must be able to accept attachments larger than __ MB. If you do not have a high-speed internet connection, it may take a while to download the FDD. You must have Adobe Reader to open the FDD. If you do not already have Adobe Reader installed on your computer, you can download it for free at www.adobe.com.

Receipts

• 2 copies of the Receipt for each FDD • Must identify franchise seller • Must be signed and dated by prospective franchisee • May include instructions for returning • Maintain for 3 years minimum (best practice is to keep

for duration of franchise relationship)

E-Disclosure Receipts • Must obtain “signed” Receipt after the FDD is e-mailed to

prospect. • Franchisor can include a link from Item 23 to a receipt-only web

page, which must be identical to the printed Receipt. • It should provide “fill-in boxes” for prospect to complete. • No other links or materials can be accessible from the web page. • Alternatively, the prospect can open the electronic FDD, print the

last two pages, sign and date the Receipts, and return one copy to the Franchisor.

Franchise Registration

• In a registration state, a franchisor cannot offer or sell a franchise before it is registered with the state

• Must amend if there is “material change”

Jurisdictional Scope

• Which state laws apply to the transaction? – Where does the prospect live? – What territory will be covered? – Where are discussions/negotiations

held? – Where will the franchisee’s principal

place of business be located?

Jurisdictional Scope

Scenario: Franchisor is approached by a Maryland resident interested in operating a franchise in Virginia. The prospect and franchise seller had meetings in New York.

• FTC Rule: Update annually within 120 days from franchisor’s FYE

• States vary: • 1 Year from Effective Date:

Indiana North Dakota Virginia Maryland Rhode Island Washington Michigan South Dakota Wisconsin

• 120 Days from FYE (110 in California and 90 in Hawaii)

Updating the Disclosure Document

• Amendments as needed for any “material change” in the information

• Substantial likelihood of influencing a reasonable franchisee or a reasonable prospective franchisee in the making of a significant decision

Material Changes － Examples • Change in the franchise fee or a significant

increase in the initial investment • A significant adverse change in financial

condition • The filing of any litigation required to be

disclosed in item 3 • Changes in Financial Performance

Representations

II. Financial Performance Representations

Financial Performance Representation

“Any representation, including any oral, written or visual representation, to a prospective franchisee, including a representation in the general media, that states, expressly or by implication, a specific level or range of actual or potential sales, income, gross profits, or net profits. The term includes a chart, table, or mathematical calculation that shows possible results based on a combination of variables.” F.T.C. Rule §436.1(e)

Which if any of these statements are financial performance representations?

“Earn a $10,000 profit” “Sales volume of $250,000” “Earn up to $25,000 per year income” “Earn enough money to buy a new Porsche” “100% return on investment within the first

year” “Make big money” “This business is a real cash cow” “Opportunity of a lifetime”

Financial Performance Representations Any financial performance representation must be contained in

FDD. No verbal claims even if 100% true. Must have a reasonable basis and written substantiation. Must include a statement in Item 19 to advise prospective

franchisees that written substantiation will be made available upon reasonable request.

Bases and assumptions must be included in Item 19 disclosure.

Negative Disclosure – Item 19 FPR is not mandatory, but must be in the FDD if made. If no FPR is made in FDD, no financial performance

information can be provided to prospective franchisees during the sales process; AND

FDD must include mandatory disclosures that explicitly state that no financial performance information is being provided.

What Financial Information is NOT an FPR?

Cost and expense information is NOT restricted. BUT cost information cannot be presented as a

percentage of sales, profits or another measure that would allow a prospective franchisee to calculate the potential income, sales or profits.

What Financial Information is NOT an FPR?

Actual operating results of a specific outlet offered for sale • The financial performance information should be given only to

potential purchasers of the particular unit being offered for sale. Audited financial statements Financial information not directed toward prospective franchisees:

Statements Made to Lenders and Bankers Press Releases and News Stories Public Company Disclosures (e.g., 10-Q and 10-K) Operating Information Provided to Existing Franchisees

What Financial Information is NOT an FPR?

Audited financial statements Financial information not directed toward prospective franchisees: Statements Made to Lenders and Bankers Press Releases and News Stories Public Company Disclosures (e.g., 10-Q and 10-K) Operating Information Provided to Existing Franchisees But beware - existing franchisees can also be potential

franchisees!

Use of Financial Performance Representations

If a franchisor includes a financial performance representation in Item 19, the franchisor can use the FPR outside of the FDD, as long as the information is consistent with and does not exceed the information presented in the FDD: – Franchisor’s website – Advertising (except MD and MN)/Media Claims – Discussions with prospective franchisees – Supplemental FPRs

What is a General Media Claim?

FPR used in advertising is referred to as a “general media claim.” This includes all forms of advertising ‒ e.g., television, print, radio, billboards and Internet.

FPR restrictions apply to general media claims.

General Media Claims

Franchisor must disclose the following information for “general media claims”:

• The number and percentage of outlets from which supporting data was gathered for the FPR that actually attained or surpassed the represented level of financial performance;

• The time period when the performance levels were achieved; and

• A clear and conspicuous admonition that a new franchisee’s results may differ from the FPR.

Financial Performance Representations: Recent Developments

Median results Separation of Company Units Business Plans Disclosure Questionnaires