How does the Six month prohibition on franchise payments under the US Franchise laws work?

Asked 11 months ago - Los Angeles, CA

My franchise agreement says that there will be no payments to franchisor for a six month period. I am told that was done to exclude the franchise from the US Franchise law. Can the franchisor go back and collect those payment after the 6 month period has expired or are they gone forever?

Attorney answers (7)

  1. Matthew J. Kreutzer

    Pro

    Contributor Level 6

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    Lawyers agree

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    Answered . I agree with Ms. Lanard that the likely reason the franchisor has structured your agreement in this way is to avoid the application of the FTC Franchise Rule, specifically by structuring the agreement so that it does not meet the "required payment" element of the franchise definition. Not requiring a licensee to make a payment over $540 within the first six months of the relationship can be an effective way of avoiding the application of that rule, depending on how the agreement is structured.

    But I also agree with my colleagues that California does not have the same exemption as does the FTC, and a franchisor cannot avoid application of the California Franchise Investment Law by not requiring a payment within the first six months. As a result, your franchisor very well may have violated California franchise law by doing things that way (I am assuming based on your question that you did not receive a Franchise Disclosure Document, and the franchisor was neither registered nor exempt from registration in California).

    My suggestion would be that you consult with a franchise attorney and have that person review your contract. Even if the contract would otherwise bind you to make a payment to the franchisor, you may have a remedy under California law.

  2. Janet Spiro Martin

    Pro

    Contributor Level 13

    1

    Lawyer agrees

    Answered . Dear Los Angeles, all my colleagues have given you accurate advice. I am a California franchise attorney and there is no exclusion from complying with California disclosure and registration laws; there is an exemption from FRANCHISE REGISTRATION in CA based on net worth or franchisor, and number of franchise units, but no exemption from the disclosure laws. One can easily look up whether or not the franchisor is registered in CA (link below) and if not, and they have not filed an exemption notice, you have some rescission rights if you have already signed on. I agree with my colleagues this may not be a good investment for you, even if you have not yet invested any money. Sounds like a Non US company is trying to franchise in California and potentially elsewhere without proper legal counsel. I would not pay anything and get a quick review of your document, in case it truly is NOT a franchise under the CA franchise definition, despite being called a franchise agreement. I would be glad to assist.

    The foregoing is for informational purposes only and may not be relied on as attorney-client advice.
  3. Nancy L. Lanard

    Contributor Level 13

    2

    Lawyers agree

    1

    Answered . The Federal Trade Commission (FTC) that governs franchising in the US nationwide says that a sale of an opportunity that meets 3 requirements constitutes a franchise - license of a trademark, control over the licensee's business and receipt by the licensor/franchisor of $500 or greater in the first 6 months of business for royalties or any other fees. It sounds like the franchisor/licensor is trying to avoid the last requirement. CA also has a state franchise law that must be complied with too. To my knowledge, CA does not have the limitation of 6 months for the payment of a franchise fee to be considered a "franchise fee" under their statute.

    In my opinion, any system that would provide you with a "franchise agreement" but not comply with the franchise laws, is a system that you should walk away from. You should retain counsel to advise you whether you have the right to rescind the agreement, get any monies back and walk away.

    This response does not create an attorney-client relationship and is not intended to provide legal advice for your... more
  4. Bryan Warren Dillon

    Contributor Level 8

    Answered . The manner of payment does not in any way exempt a business from the franchise laws in California or under the Fair Trade Commissions Rules. Any payments under the agreement are going to be determined by the terms of the franchise agreement, and either side, you or the franchisor, are generally bound by those terms. If you have an issue with payments being required under your agreement, you should really contact an experienced franchise attorney. You can find many on here who will do an initial consultation for free. Good Luck!

    Bryan Dillon
    Certified Specialist - Franchise and Distribution Law
    The State Bar of California Board of Legal Specialization.

    Singler & Dillon, LLP
    127 S. Main Street
    Sebastopol, CA 95472
    (707) 823-8719 tel. (707) 823-8737 Fax
    www.singler-law.com

  5. Kenneth F. Darrow

    Contributor Level 9

    1

    Lawyer agrees

    Answered . Under the FTC Rule, one of the requirements that qualifies a business realtionship as a franchise requiring discloure, is the payment of more than $540 to the franchisor within the first 6 months of the franchise relationship. This is known as the minimum payment exemption. If there are no such payments, then the relationship is not a franchise under the FTC Rule, but not under any applicable state laws. This does not mean that the relationship is not a "franchise", rather it means that disclosure under the FTC Rule is not required. and a FDD does not have to be given by the franchisor in those states subject to the FTC Rule. The FTC position is that after 6 months, the franchisee will have had enough experience with the franchise to evaluate it.
    If the Agreement defers the payments to a pont in time more than 6 months after the franchise business has been in operation, the payments can be collected by the franchisor at that time. If the franchisee is not satisfied with the franchise having had "hands-on" experience with it for 6 months, the franchisee can assert any legal claims against the franchisor when the franchisor seeks to collect on the payments deferred for the 6 month period; this is the rationale of the FTC for not requiring disclosure in the case of the minimum payment exemption.
    If the Agreement does not provide for deferral of the payments, then the franchisor would have no basis to collect.
    You should consult with an experienced franchise lawyer to fully understand your rights.

  6. Mary Michelle Clapp

    Contributor Level 8

    Answered . Many franchisors offer a period of time after the business opening where no royalties or advertising fees are due. This is not for the purpose of avoiding franchise laws, but for the purpose of marketing the franchises. It is a benefit to the franchisee, and unless the contract discloses otherwise, these fees are not usually due later - Again, that depends on the language in the disclosure and agreement.

    Several of the registration states (like CA) often impose restrictions on new or undercapitalized franchisors that no fees are due (or must be escrowed) until all initial opening obligations of the franchisor (like training) are fulfilled and the business is open.

    This response is not intended as legal advice or to establish an attorney-client relationship. It is for... more
  7. Brooke Ashton

    Contributor Level 5

    Answered . I agree with my colleagues that deferring the collection of fees for 6 months does not get a franchisor out of the franchise disclosure rules in states that have their own franchise statutes, such as California.

    But to answer your question about whether or not the franchisor can go back and collect the deferred fees, this is a contract question. We would need to look at the language of the contract to determine the answer. However, if the purpose of the deferral is to get out of the franchise regulations, then they should not be able to go back and collect the fees. The purpose of the franchise rule is to stop fraud. The 6 month rule for collecting fees is basically to keep small licensors that only collect a small amount from their license agreements from falling under the definition of a franchise because there is less concern that there is fraud in a situation with very little money involved. If the franchisor is just trying to avoid compliance with the franchise rules by deferring fees for 6 months, but then goes back and collects on those amounts, I would argue that he/she did not really defer the fees or meet the purpose of the 6 month rule.

    BROOKE ASHTON
    ATTORNEY AT LAW
    Telephone: (801) 575-5000
    Facsimile: (801) 575-5006
    www.franchisebusinesslawgroup.com

    THOMPSON OSTLER & OLSEN
    57 West 200 South, Suite 350
    Salt Lake City, UT 84101

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