LEGAL GUIDE
Written by attorney Kenneth F. Darrow | Jul 1, 2010

Overview of What Constitutes a Franchise

Franchising is regulated on both the federal and state level. The Federal Trade Commission Rule, “Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures" (the “FTC Rule"), requires franchisors to meet various pre-sale disclosure requirements, but contains no filing or registration requirements. State statutes that regulate franchising fall into two general classes: (1) state laws mandating pre-sale filing or registration of franchise offerings and/or disclosure, and (2) state statutes regulating the relationship between franchisors and franchisees. State “relationship" statutes deal with issues such as termination, non-renewal, discrimination and similar matters.

The FTC Rule regulates business relationships known as “package and product franchises" and involves the following three characteristics:

(1) The franchisee sells goods or services which are identified by the franchisor’s trademark, service mark, tradename, advertising or other commercial symbol;

(2) the franchisor exercises or has the authority to exercise significant control over the franchisee’s method of operation, or gives the franchisee significant assistance; and

(3) the franchisee is required to make or commit to make a payment to the franchisor or a person affiliated with the franchisor as a condition of obtaining or commencing the business; of $500 or more during the first six months of operation.

The name given to the business arrangement is irrelevant in determining whether it is covered by the FTC Rule. A business arrangement described as a “franchise" will not be covered unless it meets the three definitional elements in the FTC Rule.

The FTC Rule covers relationships that are represented either orally or in writing as having the characteristics specified in the FTC Rule’s definition of “franchise," regardless of whether the representations are, in fact, true or can be fulfilled. So, if a seller of a business arrangement represents that it licenses its trademark, promises to provide significant assistance in the buyer’s business operations, and charges a minimum payment of at least $500, the arrangement will be covered by the FTC Rule even if, for example, the seller, in fact, has no trademark or has no means to provide any assistance to buyers.

Additional resources provided by the author

American Bar Association Forum on Franchising The lawyers' organization devoted to franchising. www.abanet.org/forums/franchising International Franchise Association The trade association serving the franchise industry. www.franchise.org Small Business Administration The U. S. government agency that makes loans to start-up businesses, including franchises. www.sba.gov Federal Trade Commission The U.S. government agency that regulates franchising. http://www.ftc.gov/ North American Securities Administrators Association The organization of state administrators for states that regulate franchising. www.NASAA.org

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