What Franchisors Need to Know When Drafting Their Franchise Agreements

A franchise expert offers some experienced advice about the potholes you may run into when creating your franchise agreement.
What Franchisors Need to Know When Drafting Their Franchise Agreements
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The following excerpt is from Rick Grossmann's book Franchise Bible. Buy it now from Amazon | Barnes & Noble | IndieBound

The Federal Trade Commission (FTC) requires that all companies that offer franchises in the United States adhere to the FTC regulations. Here are some items to factor in as you develop your franchise documents so you can be sure you’re complying with all legal regulations:
  • Hire a qualified franchise attorney to write your documents. Franchising is a very intricate specialty, and you do not want to risk this step by doing it yourself or using an attorney that doesn’t have a franchise practice.
  • Set up a system for tracking the distribution of the franchise documents to ensure that the state-appropriate documents are sent to the correct states.
  • Create a tracking system that notes the distribution dates and receipts for all franchise documents.
  • Implement systems to track compliance items within the franchise documents, such as annual financial reports and insurance certificates.
  • Allowing compliance items to go by the wayside can reduce the durability of your contracts. Don’t forget to include them.
  • Map out the registration states, and create a strategy and budget for moving into those states as needed.

Related: 3 Key Questions That Will Help You Decide If Your Business Can Be Franchised

The disclosure document required by the applicable state governments typically must contain, among other things, the following information:

  • Background information regarding the franchisor, predecessors and affiliates
  • The identity and business experience of key personnel
  • Pending franchisor litigation
  • Prior franchisor bankruptcies
  • Details of franchise fees and other fees
  • An outline of the franchisee’s initial investment
  • Franchisor’s assistance and related obligations of both the franchisor and franchisee
  • Territory
  • Trademarks
  • Patents, copyrights, and proprietary information
  • Obligations of the franchisee to participate in the actual operation of the franchised business
  • Restrictions on what the franchisee may sell
  • Renewal, termination, transfer and dispute resolution
  • Arrangements with public figures
  • Financial performance representations
  • Outlets and franchisee information
  • Financial statements of the franchisor

In addition, a copy of the franchise agreement and an explanation of its more pertinent provisions are also required.

Related: The Pros and Cons of Franchising Your Business

In most cases, if you’re in a registration state, you will submit your application with the franchise agreement and disclosure document to a state official, who will then determine whether or not it has met the requirements of the state law and advise you accordingly. These state statutes, like the federal statute, require a complete disclosure of certain enumerated items. The states do not determine whether or not the statements in the disclosure document are true or false, but, in the event that a stated item is not true, the state gives the franchisee an additional legal right for damages.

In some cases, a violation may result in administrative or criminal sanctions or both, in addition to the civil remedies afforded to the franchisee. States that have franchise investment laws have statutes that can be used in seeking damages through the courts or arbitration for both loss of profit and return of monies spent in the event that a franchisor violates these laws. This is in addition to remedies for fraud that are available to any victimized business owner.

In addition, the states with franchise registration laws, and the FTC under its rules on franchising, have given government authorities certain powers to seek criminal remedies against franchisors violating the franchise acts and, in some instances, the power to order the franchisor to pay back franchise fees received in violation of the acts.

If you insist upon creating your own disclosure documents -- which franchise experts do not recommend -- you should familiarize yourself with the laws of the state in which you intend to franchise. At the very least, contact the various state agencies to see whether you are required to comply with their laws if you’re selling to a franchisee residing in that state or if you even want to operate franchises in that state.

Related: Smart Tips for Growing Your Franchise

In all states with franchise registration laws, if the prospective franchisee is a resident of the state and the franchise is to be operated in that state, the franchise laws of that state will apply. Also remember that you can make no claims regarding existing franchisees’ earnings or potential earnings unless you provide an earnings claim document. Those states with franchise registration laws also require an approved earnings claim document.

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