99-27425. Franchise Rule

[Federal Register Volume 64, Number 204 (Friday, October 22, 1999)]
[Proposed Rules]
[Pages 57294-57350]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-27425]

[[Page 57293]]

_______________________________________________________________________

Part IV

Federal Trade Commission

_______________________________________________________________________

16 CFR Part 436

Franchise Rule; Proposed Rule

Federal Register / Vol. 64, No. 204 / Friday, October 22, 1999 /
Proposed Rules

[[Page 57294]]

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FEDERAL TRADE COMMISSION

16 CFR Part 436

Franchise Rule

AGENCY: Federal Trade Commission.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The Federal Trade Commission (the ``Commission'' or ``FTC'')
is commencing a rulemaking to amend its Trade Regulation Rule entitled
``Disclosure Requirements and Prohibitions Concerning Franchising and
Business Opportunity Ventures'' (the ``Franchise Rule'' or ``the
Rule''), based upon the comments received in response to its Advance
Notice of Proposed Rulemaking (``ANPR'') and other information
discussed in this notice. The Franchise Rule requires the pre-sale
disclosure of material information to prospective franchisees about the
franchisor, the franchised business, and the terms and conditions that
govern the franchise relationship.

DATES: Comments must be submitted on or before December 21, 1999.
Rebuttal comments may be submitted on or before January 31, 2000.

ADDRESSES: Written comments should be identified as ``16 CFR Part 436--
Franchise Rule Comment'' and sent to Secretary, Federal Trade
Commission, Room 159, 600 Pennsylvania Avenue, NW., Washington, DC
20580. To encourage prompt and efficient review and dissemination of
the comments to the public, all written comments should also be
submitted, if possible, in electronic form, on either a 5\1/4\ or a
3\1/2\ inch computer disk, with a label on the disk stating the name of
the commenter and the name and version of the word processing program
used to create the document. Programs based on DOS are preferred. Files
from other operating systems should be submitted in ASCII text format
to be accepted. The Commission will also accept comments submitted to
the following E-mail address: ``[email protected]''. In addition,
commenters may leave a short comment on a telephone hotline number
designated for this purpose only: (202) 325-3573.

FOR FURTHER INFORMATION CONTACT: Steven Toporoff, (202) 326-3135, or
Myra Howard (202) 326-2047, Division of Marketing Practices, Room 238,
Bureau of Consumer Protection, Federal Trade Commission, 600
Pennsylvania Avenue, NW., Washington, DC 20580.

SUPPLEMENTARY INFORMATION:
The Commission invites interested parties to submit data, views,
and arguments on the proposed changes to the Rule and to address
specifically the questions set forth in Section H of this notice. The
comment period will remain open for 60 days. All comments will be
available on the public record and, to the extent practicable, placed
on the Commission's Internet web site: <>http://www.ftc.gov>. After the
close of the comment period, the record will remain open for another 40
days for rebuttal comments. If necessary, the Commission will also hold
hearings with cross-examination and post-hearing rebuttal submissions,
as specified in section 18(c) of the Federal Trade Commission Act, 15
U.S.C. 57a(c). Parties who request a hearing must file within the 60-
day period a comment in response to this notice and a statement
explaining why they believe a hearing is warranted and how they would
participate in a hearing. Parties interested in a hearing must also
designate specific facts in dispute and submit a summary of their
expected testimony within the comment period. In lieu of a hearing, the
Commission will also consider requests to hold additional informal
public workshop conferences to discuss the issues raised in this notice
and the comments.

Section A. Background

The Commission is publishing this notice pursuant to section 18 of
the Federal Trade Commission (``FTC'') Act, 15 U.S.C. 57a et seq., and
Part 1, Subpart B, of the Commission's Rules of Practice. 16 CFR 1.7,
and 5 U.S.C. 551 et seq. This authority permits the Commission to
promulgate, modify, and repeal trade regulation rules that define with
specificity acts or practices that are unfair or deceptive in or
affecting commerce within the meaning of section 5(a)(1) of the FTC
Act. 15 U.S.C. 45(a)(1).

1. The Franchise Rule

The Commission promulgated the Franchise Rule on December 21,
1978.¹ Based upon the original rulemaking record, the
Commission found a serious informational imbalance between prospective
franchisees and their franchisors, enabling franchisors to defraud
prospective franchisees through both material misrepresentations and
nondisclosures of material facts.² The Commission concluded
that these practices led to serious economic harm to
franchisees.³
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\1\ 43 FR 59614 (December 21, 1978).
\2\ Statement of Basis and Purpose (``SBP''), 43 FR 59621, 59625
(December 21, 1978).
\3\ Id.
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To prevent fraudulent franchise sales practices, the Commission
adopted a pre-sale disclosure rule. The Franchise Rule does not purport
to regulate the substantive terms of the franchise relationship.
Rather, it requires franchisors to disclose material information to
prospective franchisees on the theory that an informed consumer can
determine whether a franchise deal is in his or her best interest. The
Franchise Rule provides prospective franchisees with four basic types
of material disclosures. First, there are disclosures about the nature
of the franchisor and the franchise system. For example, the franchisor
must disclose the business background of the franchisor and its
officers, their litigation history--including suits filed by
franchisees concerning the franchise relationship--and statistics on
the number of franchisees who have left the system. Second, there are
disclosures that enable a prospective franchisee to assess the
franchisor's financial viability and, thus, ability to perform as
promised. These disclosures include the bankruptcy history of the
franchisor and its officers, as well as the franchisor's audited
financial statements. Third, there are disclosures about the material
costs of the franchise, as well as the terms and conditions that govern
the franchise relationship. Finally, there are disclosures that enable
prospective franchisees to conduct their own due diligence
investigation of the franchise offering, including the names and
addresses of current franchisees.

2. Initial Franchise Rule Review and Request for Comments

In April 1995, as part of its continuing review of FTC trade
regulation rules, the Commission published in the Federal Register a
request for comment on the Rule (``Rule Review Notice'') ⁴
to determine the Rule's current effectiveness and impact. The Rule
Review Notice sought comment on the standard regulatory review
questions, such as the costs and benefits of the Rule, what changes in
the Rule would increase the Rule's benefits to consumers, how would
those changes affect compliance costs, and what changes in the
marketplace and new technologies may affect the Rule.⁵
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\4\ 60 FR 17656 (April 7, 1995).
\5\ References to the Rule Review comments are cited as: the
name of the commenter, RR, commenter number (e.g., NASAA, RR,
Comment 43). Commission staff also held two public workshop
conferences on the Rule. References to the two Rule Review public
workshop transcripts are cited as: name of commenter, Sept. 95 Tr or
March 96 Tr, respectively (e.g., D'Imperio, Sept. 95 Tr, and
Ainsley, March 96 Tr).

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3. Advanced Notice of Proposed Rulemaking

Based upon the comments received during the Rule Review, the
Commission tentatively determined to retain the Franchise Rule, but
sought additional comment on possible amendments to the Rule. To that
end, in February 1997, the Commission published an ANPR, ⁶
seeking comment on specific issues, including: (1) Whether the
Commission should separate the disclosure requirements for business
opportunities from those for franchises; (2) whether the Commission
should revise the Rule's pre-sale disclosures based on the Uniform
Franchise Offering Circular (``UFOC'') Guidelines promulgated by the
North American Securities Administrators Association (``NASAA''); (3)
whether the Commission should modify the Rule to clarify that the Rule
does not reach the sale of franchises to be located or operated outside
the United States, its territories, and possessions; and (4) whether
the Commission should permit franchisors to comply with the Franchise
Rule's disclosure obligations by posting disclosure documents on the
Internet? On the assumption that the Commission would revise the Rule
based upon the UFOC Guidelines model, the Commission solicited
additional comment on specific disclosure items, including: (1) Whether
the Commission should modify the litigation disclosures (UFOC Item 3)
to require franchisors to disclose law suits filed by franchisors
against franchisees; (2) whether the Commission should improve the
franchisee statistics disclosures (UFOC Item 20) and if so, how; (3)
whether the Commission should modify the Rule to prohibit franchisors
from using ``gag clauses'' that restrict former or existing franchisees
from speaking with prospective franchisees or other parties; and (4)
whether the Commission should modify the financial performance
disclosure requirements (UFOC Item 19) to require franchisors to
include specific preambles in their disclosure documents to provide
prospective franchisees with more information about financial
performance claims.
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\6\ 62 FR 9115 (February 28, 1997).
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The ANPR elicited 166 written comments.⁷ In addition,
Commission staff held six public workshop conferences on the Rule in
Washington, D.C. (2 workshops); Chicago, Illinois; New York, New York;
Dallas, Texas; and Seattle, Washington. Sixty-seven individuals
⁸ participated in the public workshops, including
franchisees, franchisors, business opportunity sellers, and their
representatives, state franchise and business opportunity regulators,
and computer consultants. The workshop conferences generated
transcripts totaling 1,548 pages.⁹ Based upon the comments
and the evidence discussed herein, the Commission proposes to amend the
Rule in the form set forth infra at Section I.
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\7\ The Commission received comments through three means: (1) In
writing (108 comments); (2) by E-mail (36 comments); and (3) by
telephone (22 comments). Of the 166 comments, 121 were submitted by
franchisees or their representatives; 34 were submitted by
franchisors or their representatives, and the remainder did not
specify any affiliation. A list of commenters and the abbreviations
used to identify each is attached as Attachment A.
\8\ A list of public workshop participants and the abbreviatins
used to identify each is attached as Attachment B.
\9\ References to the public workshop conferences are cited as:
the name of the commenter, date 97 Tr at ____ (e.g., Simon, 18 Sept
97 Tr at 146).
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Section B. The Continuing Need for the Franchise Rule

Based upon the record, the Commission believes that the Franchise
Rule continues to serve a useful purpose. In response to the ANPR,
commenters who address this issue overwhelmingly urge the Commission to
retain the Franchise Rule.¹⁰ These commenters, including
NASAA,¹¹ the International Franchise Association
(``IFA''),¹² National Consumers League
(``NCL''),¹³ and prominent franchisors,¹⁴ note
that pre-sale disclosure is a cost-effective way to provide material
information to prospective franchisees, is necessary to prevent fraud,
and enables franchising to flourish. Commenters also observe that pre-
sale disclosure helps to reduce economic injury to franchisees by
enabling them to understand fully the nature of the franchise
relationship and the financial and legal commitments they will be
undertaking.¹⁵
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\10\ E.g., Baer, Comment 25, at 2; Hogan & Hartson, Comment 28,
at 2; Kaufmann, Comment 33, at 2-3; SBA Advocacy, Comment 36, at 2-
3; Kestenbaum, Comment 40, at 1; IL AG, Comment 77, at 1. At the
same time, several commenters urge the Commission to streamline the
Rule and to create greater uniformity with state franchise
regulations. E.g., Bruce, Comment 3, at 1; Baer, Comment 25, at 2;
Kaufmann, Comment 33, at 3; IL AG, Comment 77, at 5; Cendant,
Comment 140, at 2.
\11\ NASAA, Comment 120, at 1-4.
\12\ IFA, Comment 82, at 1-2.
\13\ NCL, Comment 35, at 2.
\14\ E.g., Cendant, Comment 140, at 1-2. See also Better Homes &
Gardens Real Estate Service, Re/Max Corporation, and The Prudential
Real Estate Affiliates, Inc., (RR Comment 24, at 1); Snap-On, Inc.
(RR Comment 27, at 1); Little Caesars (RR Comment 31, at 1); The
Southland Corporation (7-Eleven) (RR Comment 47, at 1); Medicap
Pharmacies (RR Comment 48, at 1); Forte Hotels (RR Comment 52, at
1).
\15\ E.g., Hogan & Hartson, Comment 28, at 2; SBA Advocacy,
Comment 36, at 2; Zarco & Pardo, Comment 134, at 1. The record
reveals that franchisees may suffer loses of several hunded thousand
dollars. E.g., Slimak, 22 Aug 97 Tr at 26 ($289,000 loss);
Lundquist, 22 Aug 97 Tr at 48 (half a million dollar loss). See also
NCL, Comment 35, at 2.
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While almost all franchisors responding to the ANPR support the
Rule,¹⁶ existing franchisees and their advocates continue to
criticize the Rule because it does not address what they believe to be
the greatest problem in franchising today: abusive franchise
relationships.¹⁷ They believe that the Commission should use
its unfairness authority under section 5 of the FTC Act to prohibit,
for example, post-term covenants not to compete,¹⁸
encroachment of franchisees' markets,¹⁹ and restrictions on
the sources of products or services.²⁰ They also urge the
Commission to ban franchisors from requiring mandatory arbitration,
waiver of jury trials, and choice of venue and choice of law
provisions, which they believe often impede a franchisee from bringing
suit or favor franchisors in litigation.²¹
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\16\ But see Winslow, Comment 84, at 1.
\17\ E.g., Brown, Comment 4, at 2-3; Purvin, Comment 81, at 4.
\18\ E.g., Rachide, Comment 32, at 3; AFA, Comment 62, at 3;
Slimak, Comment 130, at 1; Vidulich, 22 Aug 97 Tr at 21.
\19\ E.g., Brown, Comment 4, at 2; Manuszak, Comment 13, at 1;
AFA, Comment 62, at 1; Buckley, Comment 97, at 3; Zarco & Pardo,
Comment 134, at 2.
\20\ E.g., Colenda, Comment 71, at 1; Slimak, 22 Aug 97 Tr at
26; Chiodo, 21 Nov 97 Tr at 293-94.
\21\ E.g., Brown, Comment 4, at 3; Bell, Comment 30, at 1;
White, Comment 54, at 1; AFA, Comment 62, at 3; Johnson, Comment 67,
at 1.
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Based upon the record and the Commission's law enforcement
experience over the last twenty years, the Commission believes that
pre-sale disclosure is necessary to protect prospective franchisees
from fraudulent and deceptive franchise sales practices. Pre-sale
disclosure provides prospective franchisees with material information
needed to conduct their own due diligence investigation of the
offering, as well as information that prospective franchisees might not
otherwise be able to obtain on their own, such as the franchisor's
litigation history, failure rates in the franchise system, and audited
financial information. Further, complaints from franchisees about
various contractual issues are prevalent and strongly suggest that pre-
sale disclosure is necessary to ensure that prospective franchisees are
better informed about the relationship they will be entering, including
issues such

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as rights to protected territories and product source restrictions.
At the same time, the Commission recognizes that pre-sale
disclosure addresses only some of the issues franchisees may face in
the course of operating their franchises. From the significant number
of complaints filed by existing franchisees, the Commission has no
doubt that some franchisees are dissatisfied with their franchise
purchase, believe a serious imbalance of power exists between
franchisors and franchisees, or otherwise believe that franchise
contracts are oppressive. Nonetheless, the record does not support the
Commission's ability to broaden the Rule to address substantive
franchise relationship issues.
As an initial matter, franchise relationships are matters of
contract law that traditionally have been regulated at the state level.
Indeed, several states, even those without franchise disclosure laws,
have some type of franchise relationship law. In contrast to the
states, the Commission traditionally does not regulate or set the terms
of private contracts in franchising or in any other economic
sector.²²
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\22\ For example, the Commission's Funeral Industry Practices
Rule, 16 CFR 453, requires funeral homes to disclose pre-sale the
costs of its goods and services, but does not regulate the terms and
conditions of private funeral services contracts. Similarly, the
Used Motor Vehicle Trade Regulati0n Rule (``Used Car Rule''), 16 CFR
455, requires used car sellers to disclose pre-sale whether the car
comes with a warranty, but does not purport to regulate the terms
and conditions of private used car sales.
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Further, the Commission believes that a widespread misconception
exists about the scope of its unfairness jurisdiction. ``Unfairness''
is a term of art that has a specific legal meaning that has been
developed by the Commission over time ²³ and adopted by
Congress in 1994. Section 5 states that the Commission does not have
authority to declare an act or practice unfair unless it meets three
specific criteria: (1) The act or practice causes or is likely to cause
substantial injury; (2) that is not outweighed by countervailing
benefits to consumers or to competition; and (3) is not reasonably
avoidable.²⁴ Accordingly, before the Commission could
consider a rulemaking prescribing the substantive terms of private
contracts,²⁵ the Commission would need evidence not only of
substantial harm, but also specific data that would enable the
Commission to weigh the purported harm against any countervailing
benefits to the public at large or to competition. In addition, the
Commission would need evidence showing that franchisees cannot
reasonably avoid the alleged harm.
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\23\ See FTC v. Orkin Exterminating Co., 108 F.T.C. 263 (1986),
aff'd, Orkin Exterminating Co. v. FTC, 849 F.2d 1354 (11th Cir.
1988), cert denied, 488 U.S. 1041 (1989).
\24\ 15 U.S.C. Sec. 45(n) (added by The Federal Trade Commission
Act Amdnements of 1994, Pub. L. No. 103-312). In amendment the FTC
Act, Congress also made clear that the Commission may not declare an
act or practice unfair based upon public policy concerns alone. Id.
\25\ In Orkin, the seminal case in which the Commission
exercised its unfairness jurisdiction in the context of a commercial
contract, the Commission neither dictated nor revised the
substantive terms of the Orkin contract, but required Orkin to abide
by the contractual terms and conditions that Orkin itself freely
chose and offered to the public. 849 F.2d at 1363.
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While the Commission finds that franchisees and their advocates
suggest economic harm to individual franchisees may result from some
franchise practices, they have not shown to date that such harm is
substantial and not outweighed by countervailing benefits. Further, in
at least some instances, prospective franchisees could also avoid harm
by comparison shopping for a franchise system that offers more
favorable terms and conditions and by considering alternatives to
franchising as a means of business ownership. Thus, the Commission
continues to believe that pre-sale disclosure is the best available
vehicle, within its statutory authority, to address franchise
relationship issues and, as discussed below, proposes to enhance the
Rule's disclosures to enable prospective franchisees to investigate the
franchise relationship fully before they commit to buying a franchise.
This is totally consistent with the Commission's long-held view that
free and informed consumer choice is the best regulator of the market.

Section C. Discussion of Proposed Revisions to the Franchise Rule

1. The Proposed Rule Focuses on the Sale of Franchises

The proposed Rule focuses exclusively on the sale of franchises.
The Commission agrees with the overwhelming view of the commenters who
address this issue that franchises and business opportunities are
distinct business arrangements that require separate disclosure
approaches.²⁶ For example, many of the Rule's pre-sale
disclosures, in particular those pertaining to the parties' detailed
relationship, do not apply to the sale of most business opportunities,
which typically involve fairly simple contracts or purchase agreements.
The Rule's detailed disclosure obligations may also create barriers to
entry for legitimate business opportunity sellers.²⁷
Accordingly, the Commission intends to conduct a separate rulemaking
proceeding for business opportunity sales.
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\26\ E.g., Brown, Comment 4; Baer, Comment 25, at 5; Hogan &
Hartson, Comment 28; IFA, Comment 82, at 2; NASAA, Comment 120, at
4; Selden, Comment 133, at 2. But see NCL, Comment 35.
\27\ See Muncie, Comment 15, at 2.
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2. The Proposed Rule Is Based Upon the UFOC Guidelines

The proposed Rule is based upon the UFOC Guidelines' disclosure
model. Without exception, the commenters who address this issue--
including franchisors and franchisees alike--urge the Commission to
revise the Rule to mirror the UFOC.²⁸ These commenters
emphasize that the UFOC has improved disclosures ²⁹ and is
already used by the vast majority of franchisors.³⁰ Further,
uniformity between federal and state franchise disclosure laws will
help to reduce compliance costs ³¹ and will facilitate
comparison shopping among franchise systems.³² Moreover, as
NASAA notes, the UFOC Guidelines were developed with significant input
from franchisors, franchisees, and other franchise administrators, and
they were subject to public hearings and notice and
comment.³³ Indeed, the UFOC Guidelines have been well-
received by all interests involved in franchising and have become the
national industry standard.³⁴
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\28\ E.g., AFA, Comment 62, at 2; IL AG, Comment 77, at 1; IFA,
Comment 82, at 1; Bundy, Comment 119, at 1; NASAA, Comment 120, at
2; Cendant, Comment 140, at 2.
\29\ E.g., Brown, Comment 4, at 1; Kaufmann, Comment 33, at 3;
AFA, Comment 62, at 2; IL AG, Comment 77, at 1; WA Securities,
Comment 117, at 1; NASAA, Comment 120, at 2-3.
\30\ E.g., Baer, Comment 25, at 2; Hogan & Hartson, Comment 28,
at 5-6; Kaufmann, Comment 33, at 3; Kestenbaum, Comment 40, at 1; WA
Securities, Comment 117, at 1.
\31\ E.g., Brown, Comment 4, at 2; Baer, Comment 25, at 2; AFA,
Comment 62, at 2; WA Securities, Comment 117, at 1; NASAA, Comment
120, at 3. Cendant observes that interpretations of the UFOC often
vary from state to state and asserts that the Commission's
interpretation of the UFOC would bring greater uniformity to the
field. Cendant, Comment 140, at 3.
\32\ Kaufmann, Comment 33, at 3.
\33\ NASAA, Comment 120, at 2.
\34\ E.g., Karp, 19 Sept 97 Tr at 90.
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The proposed Rule, however, differs from the UFOC Guidelines in
several respects. The Commission has reorganized the UFOC disclosures
to conform to the standard Code of Federal Regulations format, has
edited the UFOC disclosures for clarity, and has streamlined the
disclosures where possible. For example, the proposed Rule does not
include many of the UFOC Guidelines' detailed instructions, nor its
sample answers. In a few

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instances, the Commission has made substantive changes, enhancing the
UFOC disclosures by retaining broader provisions in the current Rule or
by adding new disclosures based upon the record and the Commission's
law enforcement experience. Each of these changes is discussed in more
detail below.

3. Title of the Rule

The Commission proposes to change the title of the Rule to
``Disclosure Requirements and Prohibitions Concerning Franchising.''
This proposed change is necessary to eliminate the current title's
reference to business opportunity ventures, which, as discussed above,
will be addressed in a separate rulemaking proceeding.

4. Proposed Section 436.1: Definitions

The proposed Rule begins with a definitions section that sets forth
each definition in alphabetical order. In many instances, the proposed
definitions are substantially similar to those already contained in the
Rule or in the UFOC Guidelines. In some instances, the Commission
proposes to revise a definition for clarity, or to update a definition
to embrace long-standing Commission policies. The Commission also
proposes to add a few new definitions that are needed to clarify new
Rule provisions or instructions (e.g., Internet). At the same time, the
Commission proposes to streamline the Rule by eliminating four
definitions that no longer serve a useful purpose: (1) ``business
day;'' ³⁵ (2) time for making of disclosures; ³⁶
(3) personal meeting; ³⁷ and (4) cooperative
association,³⁸ as discussed below.
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\35\ 16 CFR 436.2(f).
\36\ 16 CFR 436.2(g).
\37\ 16 CFR 436.2(o).
\38\ 16 CFR 436.2(l).
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a. Proposed Section 436.1(a) (``Action'')
Proposed section 436.1(a) adopts the UFOC definition of the term
``action.'' ³⁹ It makes clear that disclosures involving
litigation include not only civil matters brought before a court, but
matters before administrative agencies and arbitrators. This definition
is also consistent with the Commission's current interpretation of the
term ``action.'' ⁴⁰
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\39\ UFOC Item 3, Definitions, ii.
\40\ See Final Interpretive Guides, 44 FR at 49966, 49973
(August 24, 1979).
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b. Proposed Section 436.1(b) (``Affiliate'')
In keeping with the Commission's goal of revising the Rule to
mirror the UFOC Guidelines, proposed section 436.1(b) adopts the UFOC's
definition of the term ``affiliate.'' ⁴¹ This definition is
greatly streamlined from the current Rule definition, which defines
``affiliate'' in three parts as follows:
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\41\ UFOC Item 1, Instructions, v. In several UFOC disclosure
items, the term ``affiliate'' has a more restrictive meaning. In
those instances, the definition of ``affiliate'' is modified,
consistent with the UFOC Guidelines.

The term affiliated person means a person * * * (1) Which
directly or indirectly controls, is controlled by, or is under
common control with, a franchisor; or (2) Which directly or
indirectly owns, controls, or holds with power to vote, 10 percent
or more of the outstanding voting securities of a franchisor; or (3)
Which has, in common with a franchisor, one or more partners,
officers, directors, trustees, branch managers, or other persons
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occupying similar status or performing similar functions.

16 CFR Sec. 436.2(i).
c. Proposed Section 436.1(c) (``Disclose'')
Proposed section 436.1(c) is based upon the UFOC's definition of
the term ``disclose,'' which incorporates a ``plain English''
requirement.⁴² Currently, there is no comparable Rule
definition. The Commission, however, proposes to define the term
``plain English'' in a separate definition, as discussed below.
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\42\ UFOC Instruction 150.
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d. Proposed Section 436.1(d) (``Financial Performance Representation'')
Proposed section 436.1(d) adds an explicit definition of the term
``financial performance representation.'' ⁴³ The current
Rule does not specifically define the term. To the extent that a
definition appears, it is cast as a prohibition: It is a violation of
section 5 to ``make any oral, written, or visual representation to a
prospective franchisee which states a specific level of potential
sales, income, gross, or net profit for the prospective franchisee, or
which states other figures which suggest such a specific level, unless
* * *'' 16 CFR Sec. 436.1(b).
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\43\ The Commission also proposes to use the term ``financial
performance representation,'' instead of the widely used ``earnings
claim.'' Some franchisors do not use ``earnings'' as a measure of
performance. For example, performance in the hotel industry is
typically measured by room occupancy rates.
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The Commission believes that the proposed definition of ``financial
performance representation'' combines the best features of both the
current Rule and UFOC definitions. Like the current Rule, proposed
section 436.1(d) retains the phrase ``or which states other figures
which suggest such a specific level,'' which the Commission believes is
necessary to ensure that franchisors understand fully that the Rule
covers the making of implied financial performance representations.
Following the UFOC approach, the definition also specifies that
financial performance information may include both historical
performance representations and projections and may be in the form of
charts, tables, and mathematical calculations. The Commission also
proposes to update the definition by clarifying that financial
performance representations include those disseminated through the
Internet.
e. Proposed Section 436.1(e) (``Fiscal Year'')
Proposed section 436.1(e) retains the current definition of the
term ``fiscal year'' set out at 16 C.F.R. Sec. 436.2(m)
f. Proposed Section 436.1(f) (``Fractional Franchise'')
Proposed section 436.1(f) slightly modifies the fractional
franchise exemption currently found at 16 C.F.R. Sec. 436.2(h). It
incorporates the Commission's long-standing policy that the parties
must anticipate that the additional sales will not exceed 20 percent of
total sales within the first year of operation.⁴⁴ The
definition also makes explicit what previously has been only implied:
that the parties must have a reasonable basis to assert the
exemption.⁴⁵
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\44\ See Final Interpretive Guides, 44 FR at 49968.
\45\ See Advisory 97-1 Bus. Franchise Guide (CCH) para. 6,481,
at 9,681-82 (1997); Advisory 96-2, Bus. Franchise Guide (CCH) para.
6,477, at 9,675 (1996).
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g. Proposed Section 436.1(g) (``Franchise'')
Proposed section 436.1(g) modifies the definition of the term
``franchise'' in three ways. First, the current definition of the term
``franchise'' was drafted broadly to cover both the sale of franchises
and business opportunities. In light of the Commission's proposal to
address business opportunity sales in a separate trade regulation rule,
the Commission believes the definition of the term ``franchise'' should
now be limited to ensure that it no longer captures ordinary business
opportunity sales. To that end, the Commission proposes to revise the
second definitional elements: significant control or assistance.
Specifically, the Commission proposes to revise the Rule to cover
franchisors that exert or have the authority to exert significant
``continuing control'' over the franchisee's method of operation. While
franchisors typically exert control throughout the franchise agreement
term, business opportunity sellers often do not exert control, or limit
their control to the initial stage of a

[[Page 57298]]

purchaser's business. In a similar vein, the Commission proposes to
revise the Rule to cover only franchisors that offer significant
assistance ``extending beyond the start of the business operation,''
recognizing that in many franchise systems the franchisor's assistance
extends beyond the initial phase of the business. For example, the
franchisor may offer ongoing advertising, training, and business
development plans. In contrast, a business opportunity seller's
assistance is often limited to the initial phase of the purchaser's
business, such as locating vending machines or providing purchasers
with an initial list of accounts.
Second, consistent with its goal of streamlining the Rule wherever
possible, the Commission also proposes to eliminate from the current
definition of ``franchise'' the alternative that the franchisee
``indirectly or directly [is] required to meet the quality standards
prescribed by [the franchisor.]'' 16 CFR Sec. 436.2(a)(1)(i)(a)(2). The
Commission believes that quality standards are simply one form of
control that a franchisor may impose on a franchisee. As long as the
Rule retains the more inclusive ``control'' element, the specific
``quality standards'' element appears to be unnecessary.
Finally, the Commission proposes to modify the definition of the
term ``franchise'' to incorporate three long-standing Commission
policies. The revised definition makes clear that: (1) A relationship
will be deemed a franchise if it meets the three definitional elements
of a franchise, regardless of what it may be called; ⁴⁶ (2)
a business relationship will be deemed a franchise if it is offered or
represented as having the characteristics of a franchise, regardless of
any failure on the franchisor's part to perform as promised;
⁴⁷ and (3) the term ``payment'' includes payments ``by
contract or by practical necessity.'' ⁴⁸
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\46\ See Final Interpretive Guides, 44 FR at 49966.
\47\ SBP, 43 FR at 59699.70.
\48\ See Final Interpretive Guides, 44 FR at 49967.
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h. Proposed Section 436.1(h) (``Franchise Seller'')
Proposed section 436.1(h) introduces a new term--``franchise
seller.'' This definition combines the current terms ``franchisor'' and
``franchise broker'' into a single concept. The Commission believes
that this approach will streamline the Rule considerably. Currently,
whenever the Rule refers to the obligation to furnish disclosure
documents, it must specifically refer to both franchisors and franchise
brokers. Not only is this reference longer than necessary, it is
incomplete because it does not specifically include the franchisor's
employees, sales representatives, and agents who also may sell
franchises and have an obligation to furnish disclosures. Accordingly,
the term ``franchise seller'' refers to all parties having an
obligation to provide disclosure documents. At the same time, the
definition adopts long-standing Commission policy that a franchisee
seeking to sell its own outlet is not covered by the Rule.⁴⁹
---------------------------------------------------------------------------

\49\ See Final Interpretative Guides, 44 FR at 49969.
---------------------------------------------------------------------------

i. Proposed Section 436.1(i) (``Franchisee'')
Proposed section 436.1(i) simplifies the current definition of the
term ``franchisee.'' The current Rule defines the term ``franchisee''
in an awkward and circular fashion: ``any person (1) who participates
in a franchise relationship as a franchisee, as denoted in paragraph
(a) of this section, or (2) to whom an interest in a franchise is
sold.'' 16 CFR Sec. 432.(d). The revised definition deletes unnecessary
references to other Rule sections and focuses on the grant of an
interest in a franchise, which is the core issue triggering a
franchisor's disclosure obligations.
j. Proposed Section 436.1(j) (``Franchisor'')
Similarly, proposed section 436.1(j) streamlines the definition of
the term ``franchisor.'' The proposed definition deletes unnecessary
references to other Rule sections and focuses on the grant of an
interest in a franchise.
k. Proposed Section 436.1(k) (``Gag Clause'')
Proposed section 436.1(k) introduces a new term--``gag clause.''
⁵⁰ As discussed in greater detail below at Section C.8.t.,
the Commission proposes to amend the Rule to require franchisors to
disclose information about gag clauses, namely contractual provisions
that prohibit or restrict existing or former franchisees from
discussing with prospective franchisees their experiences as
franchisees. The proposed definition focuses exclusively on a
franchisee's ability to discuss his or her personal experience as a
franchisee within a franchisor's system. It does not include a
confidentiality agreement between a franchisor and a company officer
who happens to be a franchisee, and it excludes confidentiality
agreements created to protect a franchisor's trade secrets and other
proprietary information.
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\50\ In the ANPR, the Commission used the term ``gag orders.''
During the New York public workshop conference, several panelists
were confused by the use of the word ``order,'' noting that it
implied a court mandate. E.g., Forseth, 18 Sept. 97 Tr at 40;
Zaslav, id., at 55. Accordingly, the Commission will use the term
``gag clause,'' to avoid any implication that the Rule will address
only court imposed speech restrictions.
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l. Proposed Section 436.1(l) (``Internet'')
Proposed Section 436.1(l) is new. It defines the term ``Internet''
broadly to capture all communications between computers and between
computers and television, telephone, facsimile, and similar
communications devices. This definition is necessary because, as
explained in Section C.10. below, the Commission proposes to amend the
Rule to permit franchisors to comply with the Rule electronically,
including the use of the World Wide Web and E-mail.⁵¹
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\51\ The proposed definition is modeled, in part, after the
definition of ``internet'' set forth in the Commission's recently
published Request for Comment on the Interpretation of Rules and
Guides for Electronic Media, 63 FR 24996-97 and n.1 (May 6, 1998)
(``Internet Notice'').
---------------------------------------------------------------------------

m. Proposed Section 436.1(m) (``Leased Department''
Proposed section 436.1(m) (``Leased Department''). Proposed section
436.1(m) greatly streamlines the Rule's leased department exemption.
Leased departments are one of four express Rule exemptions. Currently,
the Rule contains no definition of the term ``leased department.''
Rather, the concept is explained in the exemptions section of the Rule
as follows:

The provisions of this part shall not apply to a franchise * * *
[w]here pursuant to a lease, license, or similar agreement, a person
offers, sells, or distributes goods, commodities, or services on or
about premises occupied by a retailer-grantor primarily for the
retailer-grantor's own merchandising activities, which goods,
commodities, or services are not purchased from the retailer-grantor
or persons whom the lessee is directly or indirectly (a) required to
do business with by the retailer-grantor or (b) advised to do
business with by the retailer-grantor where such person is
affiliated with the retailer-grantor.

16 CFR 436.2(a)(3)(ii). The Commission believes that the proposed
revised definition is shorter, clearer, and easier to understand.
n. Proposed Section 436.1(n) (``Material'')
Proposed section 436.1(n) also streamlines the current definition
of ``material,'' which is currently defined as:

The terms material, material fact, and material change shall
include any fact, circumstance, or set of conditions which has a
substantial likelihood of influencing a

[[Page 57299]]

reasonable franchisee or a reasonable prospective franchisee in the
making of a significant decision relating to a named franchise
business or which has any significant financial impact on a
franchisee or prospective franchisee.

16 CFR Sec. 436.2(n). The proposed definition eliminates the Rule's
current reference to ``significant financial impact.'' The Commission
believes that this reference is redundant in that any circumstance
impacting upon a person's finances would also necessarily influence his
or her decision-making process. Accordingly, the proposed revision is
not a substantive change, but simply part of the Commission's effort to
streamline the Rule where possible.
o. Proposed Section 436.1(o) (``Officer'')
Proposed section 436.1(o) adds a new definition--``officer.''
⁵² Although several Rule disclosures pertain to the
franchisor's officers--such as the disclosures for litigation and
bankruptcies--the Rule currently does not specifically define the term
``officer.'' Rather, in the litigation disclosure, the Commission gives
examples of an officer, including ``the chief executive and chief
operating officer, financial, franchise marketing, training, and
service officers.'' 16 C.F.R Sec. 436.1(a)(2). The proposed definition
makes clear that franchisors must disclose information about all
officers, including de facto officers, with significant managerial
responsibilities for marketing and/or servicing franchises. The
Commission believes that this proposed Rule amendment is necessary to
eliminate any doubt that the Rule is to be read broadly, capturing all
individuals who function as officers, whether or not they are named in
the franchisor's incorporation papers or carry a particular corporate
title.⁵³
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\52\ See NASAA UFOC Guidelines Commentary (June 21, 1994) Bus.
Franchise Guide (CCH) para.5,800, at 8,466 (Item 4 bankruptcy
disclosures).
\53\ See FTC v. P.M.C.S., Inc., No. 96-5426 (E.D. N.Y. 1996)
(franchisor fails to disclose ``silent partner'' with prior
bankruptcy); FTC v. Why USA, Inc., No. 92-1227-PHX-SMM (D. Ariz.
1992) (franchisor fails to disclose officers and their prior
litigation). See also Lay, 22 Aug 97 Tr at 6 (franchisee was not
informed that franchisor's director of franchising (who was not a
corporate officer) had been declared bankrupt).
---------------------------------------------------------------------------

p. Proposed Section 436.1(p) (``Person'')
Proposed section 436.1(p) retains the Rule's current definition of
the term ``person'' set out at 16 CFR Sec. 436.2(b).
q. Proposed Section 436.1(q) (``Plain English'')
Proposed section 436.1(q), a new definition, defines the term
``plain English.'' This definition is necessary because, as discussed
below at Section C.9., the Commission proposes to adopt a requirement
that franchisors write their disclosure documents in plain English,
consistent with the UFOC Guidelines. The proposed definition of ``plain
English'' is modeled after the Securities and Exchange Commission's
(``SEC'') plain English requirement, set forth in the recently
promulgated mutual fund regulations.⁵⁴
---------------------------------------------------------------------------

\54\ Registration Form Used by Open-End Management Investment
Companies, SEC Release No. 33-7512, 17 CFR 274.11A.
---------------------------------------------------------------------------

r. Proposed Section 436.1(r) (``Predecessor'')
Proposed section 436.1(r) introduces a new term--``predecessor.''
Because several of the proposed Rule's disclosures pertain to a
franchisor's predecessors, the Commission has incorporated the UFOC's
definition of that term.⁵⁵ The Commission also proposes to
enhance the UFOC definition to make clear that the term ``predecessor''
includes any person from whom the franchisor has obtained the right to
use the trademark or trade secrets associated with the franchise
system.
---------------------------------------------------------------------------

\55\ See UFOC Item 1.
---------------------------------------------------------------------------

s. Proposed Section 436.1(s) (``Principal Business Address''
Proposed section 436.1(s) introduces a new term--``principal
business address,'' modeled after the UFOC's definition of that
term.⁵⁶ The proposed definition makes clear that a
franchisor must use its principal street address, not a post office box
or private mail drop. The Commission believes the proposed amendment
will reduce fraud in franchise sales by making it easier for
prospective franchisees to find and investigate the franchisor and its
principals.
---------------------------------------------------------------------------

\56\ UFOC, Item 1C, Instructions, i.
---------------------------------------------------------------------------

t. Proposed Section 436.1(t) (``Prospective Franchisee''
Proposed section 436.1(t) follows the current Rule's definition of
the term ``prospective franchisee'' set out at 16 CFR Sec. 436.2(e).
However, where the definition refers to ``franchisor or franchise
broker,'' the Commission has revised the definition to substitute the
new term ``franchise seller,'' as discussed above.
u. Proposed Section 436.1(u) (``Required Payment''
Proposed section 436.1(u) is new. The current Rule does not
specifically define the term ``required payment.'' Proposed section
436.1(u) defines that term in accordance with long-standing Commission
policy that a payment can be required by contract or by practical
necessity.⁵⁷
---------------------------------------------------------------------------

\57\ See Final Interpretive Guides, 44 FR at 49967.
---------------------------------------------------------------------------

v. Proposed Section 436.1(v) (``Sale of a Franchise''
Except for some minor editing, the definition of ``franchise sale''
is the same as that set out at 16 CFR Sec. 436.2(k).
w. Proposed Section 436.1(w) (``Signature'')
Proposed section 436.1(w) introduces a new term--``signature.'' As
discussed in Section C.10. below, the Commission proposes to amend the
Rule to permit franchisors to use electronic media to furnish
disclosure documents under certain conditions, provided prospective
franchisees confirm their identity by signing an acknowledgment of
receipt. Modeled after the Federal Reserve System's Interim Rule
Amending Regulation E, implementing the Electronic Fund Transfer Act
(``EFTA''),⁵⁸ the proposed definition is flexible,
permitting franchisees to confirm their identity by alternative means,
such as the use of digital signatures and passwords.
---------------------------------------------------------------------------

\58\ 63 FR 14528, 14531 (March 25, 1998).
---------------------------------------------------------------------------

x. Proposed Section 436.1(x) (``Trademark'')
Proposed section 436.1(x) adopts the Commission's long-standing
definition of the term ``trademark'' to include service marks, logos,
and other commercial symbols.⁵⁹
---------------------------------------------------------------------------

\59\ See Final Interpretive Guides, 44 FR at 49966.
---------------------------------------------------------------------------

y. Proposed Section 436.1(y) (``Written'')
Proposed section 436.1(y) defines the term ``written'' to include
electronic media, such as computer disk and the Internet. This
definition is necessary because, as discussed below at Section C.10.,
the Commission proposes to amend the Rule to permit franchisors to
furnish disclosures electronically. The proposed definition clarifies
that electronic media fall within the ambit of a ``written''
document.⁶⁰
---------------------------------------------------------------------------

\60\ See Internet Notice, 63 FR at 24996.
---------------------------------------------------------------------------

5. Proposed Section 436.2: Furnishing and Preparing Disclosure
Documents

a. Scope of the Rule
Proposed section 436.2 begins with a new provision that limits the
Rule's scope to the sale of franchises in the United States, its
possessions, or territories. The overwhelming number of ANPR commenters
who address this issue urge the Commission to limit the Rule's
application to domestic franchise

[[Page 57300]]

sales.⁶¹ Only four commenters ⁶² urge the
Commission to enforce the Rule internationally, raising essentially
three arguments: (1) It would be inconsistent for a franchisor to
subject a foreigner to American law and American courts through
contractual choice of venue and choice of law provisions without
simultaneously extending the benefit of American law, namely pre-sale
disclosure; ⁶³ (2) American citizens who purchase a
franchise abroad would not be protected by American law; ⁶⁴
and (3) the Commission has jurisdiction over foreign franchise sales
and should not willingly restrict its own jurisdiction.⁶⁵
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\61\ E.g., SBA Advocacy, Comment 36, at 9; Loeb & Loeb, Comment
63, at 2; IFA, Comment 82, at 3-4; Jeffers, Comment 116, at 7; CA
Bar, Comment 124, at 2-3; Cendant, Comment 140, at 2 and 4-5.
\62\ Brown, Comment 4, at 4-5, and Comments 6, 96, and 103;
Stubbings, Comment 21, at 1; Embassy of Argentina, Comment 132, at
1; Selden, Comment 133, at 2-3.
\63\ Brown, Comments 6, at 2; Embassy of Argentina, Comment 132,
at 1; Selden, Comment 133, at 2.
\64\ Selden, Comment 133, at 2. See also Stubbings, Comment 21,
at 1.
\65\ Brown, Comments 4, at 3; 6, at 2; 103, at 15-16.
---------------------------------------------------------------------------

The Commission believes that the record adequately supports its
tentative finding in the ANPR that mandated pre-sale disclosure in
international franchise sales is unnecessary, may be misleading, and
may impede competition. The Commission developed a pre-sale disclosure
rule in response to problems occurring in the domestic
market.⁶⁶ None of the four ANPR commenters noted above offer
data or other evidence tending to show that fraud or deception by
American companies engaging in international franchises sales is
prevalent.
---------------------------------------------------------------------------

\66\ Hogan & Hartson reviewed the Commission's Rule, as well as
the UFOC Guidelines, and observed that many of the provisions are
limited to disclosures involving the domestic market. For example,
UFOC Item 20 refers to the number of franchise sales ``in this
state.'' Hogan & Hartson, Comment 28, at 3.
---------------------------------------------------------------------------

Further, the record strongly supports the view that franchises are
sold internationally to sophisticated investors who are generally
represented by counsel or who otherwise can protect their own
interests. Moreover, there is no evidence in the record that a
disclosure document addressing the American market would be beneficial
to a prospective foreign investor. Just the opposite appears to be
true. Such a document may be irrelevant and potentially misleading when
given to a foreign investor (or an American investing in a foreign
market) because of vast differences between American and foreign
markets, cultures, and legal systems. Risks to the investor would arise
primarily from economic conditions and cultural values in those
countries, not in the United States. For a disclosure document to be
relevant, a franchisor would have to prepare individual disclosure
documents tailored to each specific foreign market. Such a requirement,
however, would very likely impose extraordinary burdens and costs on
franchisors and would impede competition with companies from countries
without similar disclosure obligations,⁶⁷ despite the lack
of evidence in the record of fraud or deception in foreign franchise
sales.
---------------------------------------------------------------------------

\67\ See Cendant, Comment 140, at 4.
---------------------------------------------------------------------------

Finally, by limiting the application of the Rule to domestic
franchise sales, the Commission is not restricting its own
jurisdiction. Assuming that the Commission has jurisdiction over
foreign franchise sales,⁶⁸ it will continue to do so even if
the Rule is amended as proposed in the ANPR. Accordingly, in
appropriate circumstances, the Commission may address unfair or
deceptive franchise sales abroad, consistent with its authority under
section 5.⁶⁹
---------------------------------------------------------------------------

\68\ See Branch v. FTC, 141 F.2d 31 (7th Cir. 1944). But see
Nieman v. Dryclean U.S.A. Franchise Company, Inc., ______ F.3d
______ (11th Cir. June 21, 1999).
\69\ Even some commenters favoring the ANPR proposal that the
Commission limit the Rule's scope acknowledge that the Commission
will retain its authority under section 5 to target American
companies that may fraudulently sell franchises abroad. E.g., Hogan
& Hartson, Comment 28, at 4.
---------------------------------------------------------------------------

b. Proposed Section 436.2(a): Obligation To Furnish Documents
Proposed section 436.2(a) sets forth the Rule's two principal
disclosure obligations: It is a violation of section 5 of the FTC Act
for any franchise seller to fail to furnish prospective franchisees
with a copy of the franchisor's disclosure document and the completed
franchise agreement within the specific time frames discussed below.
Consistent with current Commission policy, this section also provides
that the obligation to furnish documents can be satisfied either by the
franchisor itself or by another franchise seller.\70\ At the same time,
it makes clear that all franchise sellers--including the franchisor's
sales representatives and third-party franchise sellers--can be held
individually liable for their failure to furnish prospective
franchisees with the required disclosure documents.
---------------------------------------------------------------------------

\70\ See 16 CFR 436.2(g).
---------------------------------------------------------------------------

c. Proposed section 436.2(a)(1): 14-Day Disclosure Review Period
Proposed section 436.2(a)(1) requires franchisors to furnish
prospective franchisees with disclosure documents 14 days before the
franchisee signs a binding agreement or pays any fee in connection with
the franchise sale. This provision modifies the current Rule provision
that requires franchisors to furnish disclosure document at the earlier
of the first personal (face-to-face) meeting \71\ or at least 10
business days before the franchisee signs a binding agreement or pays a
fee.\72\
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\72\ 16 CFR 436.1(a); 436.2(o).
\72\ 16 CFR 436.1(a); 436.2(f)-(g).
---------------------------------------------------------------------------

In the ANPR, the Commission questioned whether the Rule's current
requirement that franchisors provide prospective franchisees with a
disclosure document at the first personal meeting continues to serve a
useful purpose. Recognizing that the term ``personal meeting'' may be
obsolete in light of the growing use of the telephone, facsimile
machines, and the Internet as vehicles of commerce, the Commission
asked whether the Commission should replace the term ``personal
meeting'' with the term ``first substantive discussion.'' \73\
---------------------------------------------------------------------------

\73\ 62 FR at 9122.
---------------------------------------------------------------------------

Several commenters agree that the term ``personal meeting'' has
become irrelevant in an era where even large investments are made by
telephone or via the Internet.\74\ Many franchisors and their
representatives, however, oppose changing the term ``personal meeting''
to ``substantive discussion.'' They believe that the term ``substantive
discussion'' is ambiguous,\75\ and would not reach Internet sales,
where presumably no actual discussion takes place.\76\ Others fear that
franchisors, who may receive countless telephone calls in a day, may
have to stop talking with callers, lest they trigger the Rule's
disclosure obligations.\77\ Several commenters urge the Commission to

[[Page 57301]]

eliminate the personal meeting trigger altogether and, as an
alternative, require franchisors to furnish disclosures a minimum
number of days prior to the franchise sale.\78\
---------------------------------------------------------------------------

\74\ For example, Kennedy Brook observes that franchise sales
can occur entirely electronically ``where the contact is made over
the Web, where E-mail is exchanged, where telephone [calls] are
exchanged, where documents are sent out by Federal Express, and
where, in fact, there never is a face-to-face meeting.'' Brooks, 18
Sept 97 Tr at 160. See also NCL, Comment 35, at 4-5; SBA Advocacy,
Comment 36, at 9; Kestenbaum, Comment 40, at 2; IL AG, Comment 77,
at 3-4; Winslow, Comment 85, at 1.
\75\ E.g., Duvall, Comment 19, at 3; Baer, Comment 25, at 6;
Loeb & Loeb, Comment 63, at 2; Tifford, Comment 78, at 7-8; IFA,
Comment 82, at 4.
\76\ Hogan & Hartson, Comment 28, at 9. Kenneth Costello also
observes that in the SBP and Final Interpretive Guides the
Commission drew a distinction between sales via mail or telephone
and face-to-face meetings because the latter could be prone to high
pressure sales. He notes that Internet sales require an affirmative
action on the part of the prospective franchisee to investigate a
franchisor via modem, ``a connection that is even more readily
broken than a telephone call.'' Loeb & Loeb, Comment 63, at 2.
\77\ Baer, Comment 25, at 6.
\78\ Duvall, Comment 19, at 3; Baer, Comment 25, at 6; Tifford,
18 Sept. 97 Tr at 158-59.
---------------------------------------------------------------------------

The Commission agrees that the personal meeting disclosure trigger
has become obsolete in the communications age where prospective sellers
now communicate with buyers through a wide array of communications
media, including facsimile machine, E-mail, and the Internet.
Accordingly, proposed section 436.2(a)(1) streamlines the Rule by
eliminating the first personal meeting trigger. As long as the
prospective franchisee has a minimum number of days in which to review
the franchisor's disclosures, that should suffice to combat deceptive
franchise sales. A pre-sale review period can also function as a
``cooling-off'' period, enabling prospective franchisees to resist high
pressure sales techniques. The Commission also proposes to streamline
the Rule further by creating a bright line 14-day review period in lieu
of the Rule's current ``10 business days'' provision. The term ``10
business days'' may be unnecessarily confusing because franchisors must
remember to include all federal holidays, some of which are not
observed in every state. In addition, in most instances, 10 business
days as a practical matter amounts to 14 days.
d. Proposed Section 436.2(a)(2): Five-Day Contract Review Period
Proposed section 436.2(a)(2) streamlines the Rule further by
requiring franchisors to afford prospective franchisees at least five
days to review the completed franchise agreement. This would modify the
current Rule provision found at 16 CFR 436.1(g) that requires
franchisors to furnish prospective franchisees with a copy of the
completed agreement ``at least 5 business days prior to the date the
agreements are to be executed.'' The Commission recognizes that five
business days usually means seven days. However, the Commission
believes that a seven-day contract review requirement might be
burdensome for both franchisors and franchisees who often want to sign
a franchise agreement quickly in order to cement their deal.\79\ The
Commission believes that a five-day review period strikes the right
balance between affording prospective franchisees time to review the
completed contract and accommodating the parties' desire to move the
deal forward.
---------------------------------------------------------------------------

\79\ E.g., Wieczorek, 6 Nov 97 Tr at 25-26.
---------------------------------------------------------------------------

e. Proposed Section 436.2(b): Furnishing Disclosures
Proposed section 436.2(b) provides some additional guidance on what
constitutes ``furnishing'' disclosures. It makes clear that franchisors
can comply with the Rule's timing provisions by delivering a paper
copy, or transmitting an electronic copy of documents, before the
required date. It also clarifies that franchisors who wish to mail
documents should do so by first class mail and by adding an additional
three days in order to ensure that the prospective franchisee receives
the documents in the time frame required by the Rule. Otherwise, it is
possible that a prospective franchisee may receive a copy of the
completed franchise agreement, for example, only a day or two before he
or she is scheduled to sign the agreement. The Commission believes that
this clarification is essential if the Commission, as proposed above,
shortens the timing provision for reviewing completed contacts from
``five business days'' to a bright line ``five days.''
f. Proposed Section 436.2(c): Form of the Disclosures
Proposed section 436.2(c) provides that it is a violation of
section 5 of the FTC Act for a franchisor to fail to include the
information and follow the instructions set forth in sections 436.3-
436.8 of the Rule. It also clarifies the standard of liability for Rule
violations. Currently, franchise brokers are jointly liable with the
franchisor for the content of a disclosure document. Proposed section
436.2(c) makes clear that franchise sellers other than the franchisor
will be liable for the content of a disclosure document only if they
knew or should have known of the violation. This is consistent with the
standard of individual liability for section 5 violations, as
articulated by numerous courts since the Rule was promulgated in the
1970's.\80\
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\80\ See FTC v. Amy Travel Serv., 875 F.2d 564, 573 (7th Cir.
1989); FTC v. Minuteman Press, Bus. Franchise Guide (CCH) para.
11,516 at 31,253 (E.D.N.Y. 1998); United States v. The Building
Inspector of America, 894 F. Supp. 507, 518-20 (D. Mass. 1995); FTC
v. Jordan Ashley, Bus. Franchise Guide (CCH) para.70,570 at 72,096
(S.D. Fla. 1994); FTC v. Kitco of Nevada, 612 F. Supp. 1282, 1292
(D. Minn. 1985); Under this standard, the Commission has brought
numerous actions naming not only owners and corporate officers, but
others who are instrumental in the fraud. E.g., FTC v. FutureNet,
Inc. No. 98-1113 GHK (AIJx) (C.D. Cal. 1998); FTC v. Internet Bus.
Broad., Inc., No. WMN-98-495 (D.Md. 1998); United States v. Toys
Unlimited Int'l, Inc., No. 97-08592 Highsmith (S.D. Fla. 1997); FTC
v. Audiotex Connections Inc., No. CV-97-726 (DRH) (VVP) (E.D.N.Y.
1997).
---------------------------------------------------------------------------

6. Proposed Section 436.3: The Cover Page

Proposed section 436.3 requires all franchisors to begin their
disclosures with an FTC cover page that informs prospective franchisees
that they are receiving important information about the franchise
offering. The Commission proposes to modify the current cover page
requirement, however, to address several suggestions raised in response
to the ANPR. For example, a few franchisees and their supporters urge
the Commission to require more background information on franchising,
its risks, and applicable laws.\81\ They also contend that phrases in
the current cover page such as ``information * * * required by the
Federal Trade Commission'' and ``to protect you'' are misleading
because they imply greater federal oversight of franchise offerings
than actually exists.\82\ Several franchisors also urge the Commission
to coordinate with the states to produce a single, uniform cover
page,\83\ and a few question the value of risk factors and whether the
Commission could, as a practical matter, require the disclosure of risk
factors on a national basis.\84\
---------------------------------------------------------------------------

\81\ Heron, Comment 80, at 1. See also G. Gaither, Comment 69,
at 1; Dady & Garner, Comment 127, at 3.
\82\ See Murphy, Comment 2 at 2; Maloney, Comment 38, at 1;
Heron, Comment 80, at 1; Kezios, 18 Sept 97 Tr at 10; Karp, 19 Sept
97 Tr at 89-90.
\83\ E.g., Simon, 18 Sept 97 Tr. at 9; Kestenbaum, id. at 9-10;
Cantone, id. at 10.
\84\ Cendant, Comment 140, at 3; Forseth, 18 Sept 97 Tr at 11-
12; Simon, id., at 12-13, Kestenbaum, id., at 12.
---------------------------------------------------------------------------

The Commission agrees with those commenters who urge the Commission
to promote greater uniformity with state disclosure laws. Accordingly,
proposed section 436.3 includes the UFOC requirements that the cover
page include, for example, the franchisor's name, logo, brief
description of the franchised business, total purchase price, and a
notice that comparative information is available. The Commission,
however, is not inclined to adopt the UFOC's requirement that
franchisors disclose specific risk factors on the cover page. First,
the Commission notes that the two current UFOC mandated risk factors
(choice of venue and law) merely repeat what is already required to be
disclosed in the disclosure document itself.\85\ Moreover, including
these two risk factors in the FTC cover page might incorrectly signal
prospective franchisees that these are the most important risk factors
for

[[Page 57302]]

consumers to consider. Second, as a practical matter, the Commission
cannot formulate a list of specific risk factors that would be relevant
to all franchise systems on a national basis, nor does the Commission
have the ability to require risk disclosures on an individual franchise
system basis. Nonetheless, the Commission recognizes that state
franchise examiners may require franchisors to include various risk
factors on the cover page and that such disclosures may serve a useful
purpose. In an effort to harmonize federal and state disclosure laws,
proposed section 436.3 makes clear that franchisors are permitted to
include risk factors on the cover page, if they are required to do so
under state law.\86\
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\85\ For example, the choice of venue and choice of law
disclosures repeat what is already disclosed in the text of Item 17.
\86\ See Tifford, 18 Sept 97 Tr at 15-16.
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Proposed section 436.3(b) also updates the current cover page
provision to reflect the growing use of the Internet by franchisors.
Accordingly, it requires franchisors to include their E-mail address
and Internet home page, if applicable, on the cover page. This
information should enable a prospective franchisee to communicate more
readily with the franchisor. Proposed section 436.3(g)(2) also requires
franchisors to include additional statements on the cover page if they
wish to comply with the Rule electronically, such as the Internet.
These requirements are explained more fully below at Section B.10.
Based upon the comments received, the Commission also proposes to
include references to additional resources to enable prospective
franchisees to conduct a due diligence investigation of the franchise
offering. To that end, proposed section 436.3(g)(3) includes a
reference to the Commission's home page \87\ where consumers can find
resources on franchising, and a reference to the Commission's Guide to
Buying a Franchise.\88\ In addition, proposed section 436.3(g)(4) adds
new language to the cover page pointing out the difference between a
disclosure document and a franchise agreement and stresses the need for
prospective franchisees to understand their contract.\89\
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\87\ See Heron, Comment 80, at 4.
\88\ See Cordell, 6 Nov 97 Tr at 156.
\89\ One commenter notes that only a minority of prospective
franchisees use competent counsel before making an investment
decision. He suggests that the Commission essentially require
franchisees to seek professional guidance before making an
investment decision. Murphy, Comment 2, at 1. The Commission
believes such a regulation would be overly intrusive. Nonetheless,
in keeping with Mr. Murphy's suggestion, the Commission proposes
strengthening the cover page's consumer education message by
replacing the current Rule language (``If possible, show * * *''),
with the stronger ``Show your contract and this disclosure document
to an advisor, like a lawyer or an accountant.''
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Finally, proposed section 436.3 eliminates arguably misleading
information from the current cover page, namely, the phrases
``information * * * required by the Federal Trade Commission'' and ``to
protect you.'' To the extent that some prospective franchisees may
misinterpret the phrase ``to protect you'' as implying a greater role
on the Commission's part, the disadvantages of including such language
would appear to outweigh any minimal benefit. Nonetheless, proposed
section 436.3 retains the statement that the Commission has not checked
the disclosures for accuracy. The Commission believes this statement is
essential to warn prospective franchisees not to rely on the
franchisor's disclosures at face value.

7. Proposed section 436.4: Table of Contents

Proposed section 436.4 sets forth a table of contents, which tracks
the order of the required disclosures. For the most part, the proposed
table of contents follows the text set forth in the UFOC Guidelines.
The titles of four disclosure items, however, have been changed. The
Commission believes that these changes better capture the essence of
the respective disclosure provisions. First, Item 7 has been changed
from ``Initial Investment'' to ``Estimated Initial Investment.''
Second, Item 11 has been changed from ``Franchisor's Obligations'' to
``Franchisor's Assistance, Advertising, Computer Systems, and
Training.'' Third, Item 19 has been changed from ``Earnings Claims'' to
the more inclusive term ``Financial Performance Representations.''
Finally, Item 20 has been changed from ``List of Outlets'' to ``Outlets
and Franchisee Information.''

8. Proposed Section 436.5: The Required Disclosure Items

Proposed section 436.5 sets forth the required disclosure items.
For the most part, these proposed disclosures are substantially similar
to the disclosure requirements specified in the UFOC Guidelines. The
Commission, however, believes it is important to retain a few current
Rule disclosure provisions that are broader than the comparable UFOC
provisions and to enhance the UFOC disclosures in a few instances based
upon the record and the Commission's law enforcement experience.
a. Proposed Section 436.5(a): Item 1 (The Franchisor, Its Parent,
Predecessors, and Affiliates)
Proposed section 436.5(a) is modeled after UFOC Item 1.\90\ It
requires the disclosure of background information on the franchisor, as
well as its parent, predecessors, and affiliates. Proposed section
436.5(a) improves the comparable Rule disclosures currently found at 16
CFR 436.1(a)(1), (a)(3), and (a)(6) in three material respects. First,
franchisors must disclose information about their predecessors. This
provision is necessary to prevent franchisors from avoiding disclosure
obligations by simply assuming a new corporate name.\91\ Second,
franchisors must disclose any regulations specific to the industry in
which the franchise business operates, such as necessary licenses or
permits, that may affect the franchisees' ability to conduct business
as well as costs.\92\ An explanatory footnote accompanies the Rule's
text to help franchisors distinguish between general and industry-
specific regulations. Third, franchisors must describe the general
competition prospective franchisees are likely to face, which better
ensures that prospective franchisees will understand the likely
economic risks in purchasing a franchise. The Commission believes that
a disclosure about likely competition is warranted in light of numerous
franchisee complaints concerning competition issues.\93\
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\90\ In response to the ANPR, no commenters raised any concerns
about UFOC Item 1, upon which proposed section 436.5(a) is based.
\91\ E.g., FTC v. Wolf, Bus. Franchise Guide (CCH) para. 10,401
(S.D. Fla. 1994); FTC v. Inv. Dev., Inc., Bus. Franchise Guide (CCH)
para. 9,326 (E.D. La 1989).
\92\ E.g., FTC v. Car Checkers of America, Inc., Bus. Franchise
Guide (CCH) para. 10,163 (D.N.J. 1993); U.S. v. Lifecall Sys.,Inc.,
Bus. Franchise Guide (CCH) para. 9,677 (D.N.J. 1990).
\93\ E.g., Packer, Comment 10, at 1; Manuszk, Comment 13, at 1;
Gray, Comment 22, at 1; Lopez, Comment 123, at 1.
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At the same time, proposed section 436.5(a) retains one feature of
the current Rule, namely the disclosure of information about any parent
of the franchisor. The Commission believes that information about a
franchisor's parent may be highly material to a prospective franchisee.
For example, a parent corporation may directly compete with the
franchisees by offering franchises under a different trademark or by
operating or acquiring a competing franchise system.\94\ For this
reason, the Commission decided to require the disclosure of information
about a parent when it promulgated the Rule originally, even though it
recognized

[[Page 57303]]

that the UFOC Guidelines had no comparable disclosure requirement.\95\
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\94\ See Vidulich, 22 Aug 97 Tr at 16-17.
\95\ SBP, 43 FR at 59639.
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b. Proposed Section 436.5(b): Item 2 (Business Experience)
Proposed section 436.5(b), another anti-fraud provision, requires a
franchisor to disclose the business experience of the company's
officers. The Commission has long recognized that the business
experience of the franchisor and its officers is material because it
provides the ``prospective franchisee with an important indication of
the franchisor's competence and financial soundness.'' ⁹⁶
Proposed section 436.5(b) is substantially similar to UFOC Item
2.⁹⁷ However, the Commission proposes to add a provision
requiring franchisors to disclose the business experience of any
director, trustee, general partner, officer, and subfranchisor of any
parent who will have management responsibility relating to the offered
franchises. The Commission believes that information about all persons
having management responsibility is material to prospective
franchisees, regardless of whether the officer is associated with the
franchisor or the franchisor's parent.⁹⁸
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\96\ SBP, 43 FR at 59640. See, e.g., FTC v. Car Checkers, Bus.
Franchise Guide (CCH) para. 10,163 at 24,043; FTC versus Nat'l
Consulting Group, Inc., Bus. Franchise Guide (CCH) para. 11,335
(N.D. Ill 1998); FTC v. Levinger, No. 94-0925-PHX RCB (D. Ariz.
1994). Cf. FTC v. Goddard Rarities, Inc., No. CV93-4602-JMI (C.D.
Cal. 1993).
\97\ In response to the ANPR, no commenter raised any concerns
about UFOC Item 2, upon which proposed section 436.5(b) is based.
\98\ Cf. 16 CFR 436.1(a)(3).
---------------------------------------------------------------------------

c. Proposed Section 436.5(c): Item 3 (Litigation)
Proposed section 436.5(c) is modeled after UFOC Item
3.⁹⁹ It is one of the most important anti-fraud disclosures,
requiring franchisors to disclose certain material litigation involving
the franchisor, its parent, predecessors, and officers.¹⁰⁰
Proposed section 436.5(c) improves the comparable Rule disclosures
currently found at 16 CFR Sec. 436.1(a)(4) in several material
respects. First, it would require franchisors to disclose litigation
involving predecessors for the first time. Second, it would require a
franchisor to disclose civil actions, other than ordinary routine
litigation, that may impact upon the franchisor's financial condition
or ability to operate the business.¹⁰¹ Following the UFOC
approach, proposed section 436.5(c) also includes three instructional
footnotes, the most important of which advises franchisors on how to
disclose settlement agreements that may have confidentiality clauses
(footnote 4).¹⁰² The other footnotes clarify when
franchisors must disclose dismissed civil actions (footnote 2) and the
inclusion of summary opinions of counsel (footnote 3).
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\99\ Only one commenter, Gary Duvall, criticizes the current
UFOC Item 3 disclosure, upon which proposed section 436.5(c) is
based. Among other things, Mr. Duvall suggests that franchisors
should also be able to disclose cases that are resolved in their
favor, noting that it might be difficult to distinguish between a
dismissal without any liability from a settlement where both parties
received some benefit. Duvall, Comment 19, at 1-2. In addition, he
opposes the disclosure of confidential settlements, asserting that
it ``discourages settlement of disputes, and thereby encourages
prolonging of litigation and arbitration.'' Duvall, Comment 83, at
1. The Commission, however, finds that a franchisor can always err
on the side of caution and disclose a suit if it is not sure whether
or not it is covered by Item 3. In addition, nothing in the Rule
would prohibit a franchisor from making any consistent, truthful
information known to prospective franchisees outside of the
disclosure document. The Commission further believes that
confidential settlements provide prospective franchisees with
material information needed to assess the franchise offering. Mr.
Duvall has submitted no statistics or data to support his bald
assertion that the required disclosure of confidential settlements
causes harm. Accordingly, the Commission has no basis to conclude
that the benefits of such disclosure are outweighed by any costs.
\100\ See, e.g., FTC v. Inc. Dev., Inc., No. 89-0642 (E.D. La.
1989); FTC v. Hayes, No. 4:96CV06126SNL (E.D. Mo. 1996). See also
Marks, 19 Sept 97 Tr at 8.
\101\ This disclosure is entirely consistent with long-standing
Commission policy that a franchisor's continued financial viability
and ability to perform as promised is material to a potential
investor. See, e.g., SBP, 43 FR at 59650-51, and 59682.
\102\ When NASAA revised the UFOC in 1993, it explained that all
settlements must be disclosed, regardless of any confidentiality
clause they may contain. Recognizing that franchisors may have
contractual restrictions on disclosing the existence of confidential
settlements, NASAA made the disclosure requirement prospective--only
confidential settlements entered into after April 15, 1993, (the
date NASAA approved the revised UFOC Guidelines) must be disclosed.
Proposed footnote 4 makes clear that the Commission will follow the
NASAA approach.
---------------------------------------------------------------------------

At the same time, the Commission proposes to enhance UFOC Item 3 by
retaining the current Rule provision requiring the disclosure of
litigation involving the franchisor's parent. In addition, the
Commission would require franchisors to disclose pending franchisor-
initiated law suits against franchisees on issues involving the
franchise relationship. Currently, the Rule (and UFOC Guidelines)
require franchisors to disclose only suits that franchisees have filed
against the franchisor. A franchisor must disclose suits it has
initiated only if the franchisee were to file a subsequent
counterclaim.\103\
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\103\ See 16 CFR 436.1(a)(4)(ii)(B); UFOC, Item 3, A.
---------------------------------------------------------------------------

Based upon the record, the Commission finds that broader litigation
disclosures are warranted to alert prospective franchisees to potential
problems in the franchise relationship. In the ANPR, the Commission
solicited comment on whether it should amend the Rule's litigation
disclosures to require franchisors to disclose franchisor-initiated
litigation in all instances.¹⁰⁴ Several commenters favor the
ANPR proposal, asserting that franchisor-initiated litigation is
material to prospective franchisees because it sheds light on problems
in the franchise relationship, as well as the extent to which the
franchisor is inclined to use litigation to resolve
disputes.¹⁰⁵ Others oppose the ANPR proposal, maintaining
that franchisor-initiated litigation is immaterial to prospective
franchisees.¹⁰⁶ To the extent a franchisee is aggrieved by a
franchisor-initiated suit, the franchisee, in their view, will surely
file a counterclaim, which all agree must be disclosed under current
law.¹⁰⁷ They also contend that litigation should be limited
to suits that imply wrongdoing on the franchisor's part: franchisor-
initiated suits simply demonstrate that the franchisor is enforcing its
rights under the franchise agreement.¹⁰⁸ They fear that
disclosing such litigation would have a negative connotation to
prospective franchisees, implying some wrongdoing on the franchisor's
part.¹⁰⁹ They also contend that an expanded Item 3 would
``bulk up'' disclosure documents, thereby increasing compliance
costs.¹¹⁰ One franchisor representative suggests that if the
Commission were to require such a disclosure that it consider setting
forth a threshold: a franchisor would not have to make the disclosure
unless it has sued at least a certain percentage (i.e., 5%) of the
franchisees in its system.¹¹¹
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\104\ 62 FR at 9120-21.
\105\ SBA, Comment 36, at 4-5; AFA, Comment 62, at 2; IL AG,
Comment 77, at 2; Lagarias, Comment 125, at 3; Selden, Comment 133,
Appendix B, at 2; Karp, 19 Sept 97 Tr at 98.
\106\ E.g., Kaufmann, Comment 33, at 4.
\107\ E.g., Quizno's, Comment 16, at 1; Kaufmann, Comment 33, at
4; IFA, Comment 82, at 1-2; Cendant, Comment 140, at 3.
\108\ E.g., Kestenbaum, Comment 40, at 1; Tifford, Comment 78,
at 3.
\109\ E.g, Kaufmann, Comment 33, at 4; Tifford, Comment 78, at
3; Cendant, Comment 140, at 3. On the other hand, Carl Jeffers, a
franchise consultant, suggests that the disclosure of franchisor-
initiated suits could be viewed as a ``positive attribute,'' showing
that the franchisor is willing to enforce its standards and
trademark, and is willing to eliminate aggressively continuing
violations of its franchise agreement. Jeffers, Comment 116, at 1-2.
\110\ E.g., Baer, Comment 25, at 3; Kaufmann, Comment 33, at 4.
See also Forseth, 18 Sept 97 Tr at 20.
\111\ Baer, Comment 25, at 3.
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After carefully considering the ANPR comments, the Commission
proposes to amend the UFOC Item 3 litigation

[[Page 57304]]

disclosures by requiring franchisors to disclose material information
about pending franchisor-initiated litigation involving the franchise
relationship. There is no doubt that a franchisor must disclose a
franchisor-initiated lawsuit if a franchisee files a counterclaim. In
many instances, however, franchisees do not have the financial
resources to hire an attorney to initiate a suit or to pursue a
counterclaim.¹¹² Therefore, the disclosure of litigation
involving the franchise relationship should not depend upon which party
happens to have the resources and the ability to file a law suit.
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\112\ Peter Lagarias observes that ``[f]ranchisors are often
able to wield the threat of litigation, especially by threatening to
seek attorneys fees, to deter franchisees from suing or maintaining
lawsuits against them. Thus, while loss of a single lawsuit is
seldom significant to franchisors, loss of a lawsuit against their
franchisor is often fatal for franchisees.'' Lagarias, Comment 125,
at 3. See also Merret, Comment 126, at 1; Brandt, Comment 137, at 1;
Doe, 7 Nov 97 Tr at 267.
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More important, the Commission is persuaded that franchisor-
initiated suits may reveal material information to a prospective
franchisee. For example, a franchisor may routinely file suit to
collect royalties from franchisees. Such suits may show that
franchisees are unwilling to pay royalties, or are having difficulty
making their royalty payments. The royalty payments may be too high in
light of franchisees' actual earnings, or the franchisees may be
unsuccessful and cannot afford to pay the royalty fee. A pattern of
such suits is highly material to a prospective franchisee because it is
another source of information from which prospective franchisees can
assess the quality of the relationship with the franchisor and
likelihood of their own success. Moreover, as noted above, the
overwhelming number of commenters who responded to the ANPR are current
franchisees voicing various complaints about their relationship with
the franchisor. These franchisees continue to argue for more
substantive regulation of the franchise relationship. While the record
does not support such a drastic expansion of the Franchise Rule by the
Commission, it does support greater disclosure of suits initiated by
franchisors against franchisees pertaining to the franchise
relationship. Such disclosure no doubt would shed greater light on
problems within a franchise system.
At the same time, the Commission shares the commenters' concerns
that requiring additional disclosures may increase the costs and
burdens of preparing a disclosure document. Therefore, the Commission
proposes to limit the disclosure of franchisor-initiated litigation as
follows. First, the proposed disclosure is limited to ``material''
franchisor-initiated law suits. ¹¹³ Arguably, an isolated
suit against an individual franchisee might not be deemed material
given the number of franchisees in the system. Second, the proposed
disclosure is limited to suits involving the franchise relationship.
Franchisors need not disclose suits they initiated against suppliers,
advertisers, or other third parties. ¹¹⁴ Third, the proposed
disclosure is limited to pending lawsuits: there is no requirement that
franchisor-initiated suits be disclosed for a full 10 years, as
franchisors must do for suits alleging, for example, fraud. The
Commission believes that restricting the disclosure to pending lawsuits
is a good compromise that would likely be sufficient to show a pattern
of suits on the franchisor's part without ``bulking up'' the disclosure
document and imposing undue compliance costs.
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\113\ See Quinzo's, Comment 16, at 1.
\114\ Cendant notes that in vicarious liability cases (where a
customer sues the franchisor for alleged wrongdoings by the
individual franchisee), the franchisor often must sue the franchisee
to protect its interests and to obtain indemnification. Cendant
believes that such suits are really between the customer and the
franchisor and are not indicative of franchise system performance.
Cendant, Comment 140, at 3. The Commission agrees. Accordingly, the
proposed Item 3 disclosure would require franchisors to disclose
only those suits they initiate against franchisees involving the
franchise relationship. Most often, this would include suits for
failure to pay royalties or to comply with operations standards. It
would not extend to all suits filed by the franchisor against the
franchisee, such as suits for indemnification for actions outside
the franchise contract.
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Finally, the Commission wishes to explore further the suggestion
that a franchisor should be required to disclose franchisor-initiated
litigation only if the franchisor has sued at least a certain
percentage of franchisees in its system. At this time, however, the
record is insufficient for the Commission to determine the merits of
this suggestion. Accordingly, the Commission seeks comment on whether a
franchisor-initiated litigation disclosure should be tied to a
threshold and, if so, what threshold would be sufficient.
d. Proposed Section 436.5(d): Item 4 (Bankruptcy)
Proposed section 436.5(d) is substantially similar to UFOC Item 4.
¹¹⁵ It requires franchisors to disclose information about
any prior bankruptcies. Proposed section 436.5(d) enhances the
comparable Rule disclosures found at 16 C.F.R. Sec. 436.1(a)(5) in two
respects: (1) Franchisors would disclose bankruptcy information about
their predecessors and affiliates; and (2) franchisors would make the
disclosures for 10 years, instead of the current seven years. Proposed
section 436.5(d) also clarifies that franchisors must disclose foreign
proceedings comparable to bankruptcy. Proposed section 436.5(d) differs
from the UFOC Guidelines, however, by retaining the Rule's current
requirement that franchisors include information about a parent's prior
bankruptcy. ¹¹⁶
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\115\ In response to the ANPR, no commenter raised any concerns
about UFOC Item 4, upon which proposed section 436.5(d) is based.
\116\ See 16 CFR 436.1(a)(5).
---------------------------------------------------------------------------

e. Proposed Section 436.5(e): Item 5 (Initial Franchise Fee)
Proposed section 436.5(e) begins a series of three disclosures
concerning the total costs involved in purchasing and operating a
franchise. ¹¹⁷ Modeled after UFOC Item 5, it requires
franchisors to disclose information about the initial franchise fee,
including whether such fees are refundable. ¹¹⁸ Proposed
section 436.5(e) enhances the comparable Rule disclosures found at 16
CFR 436.1(a)(7) by enabling franchisors to provide a range of fees,
instead of a fixed fee. Arguably, a franchisor who offers a franchise
at a price that is not reflected in its disclosure document might
violate the Rule because the seller has not provided the prospect with
complete and accurate pre-sale disclosure of the price terms. In
effect, proposed section 436.5(e) clarifies that franchisors can
negotiate with a prospective franchisee over the initial franchise fee,
without potentially violating the Rule.
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\117\ Pre-sale disclose of cost information is prevalent in
Commission trade regulation rules. E.g., Trade Regulation Rule
Pursuant to the Telephone Disclosure and Dispute Act of 1992 (``900
Number Rule''), 16 CFR 308 at 308.3(b); Telemarketing Sales Rule, 16
CFR 310 at Sec. 310.3; Funeral Industry Practices Rule, 16 CFR 453
at 453.2.
\118\ In response to the ANPR, no commenter raised any concerns
about UFOC Item 5, upon which proposed section 436.5(e) based.
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f. Proposed Section 436.5(f): Item 6 (Recurring or Occasional Fees)
Proposed section 436.5(f), the second cost disclosure, is
substantially similar to UFOC Item 6.\119\ It requires franchisors to
disclose recurring fees associated with operating a franchise (e.g.,
royalties, advertising fees, and transfer fees). This disclosure
recognizes that a prospective franchisee's investment is not limited to
the initial franchise fee alone. Rather, a franchisee

[[Page 57305]]

may incur considerable costs in the operation of the business that will
significantly impact upon his or her ability to continue operations and
ultimately be successful.\120\
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\119\ In response to the ANPR, no commenter raised any concerns
about UFOC Item 6, upon which proposed section 436.5(f) is based.
\120\ The failure to disclose all material ongoing costs
involved in using a product or service is a violation of section 5.
See, e.g., FTC v. Minuteman Press Int'l, No. C-93-2496-DRH (E.D.N.Y.
1993); FTC v. SureCheK Sys. No. 1-97-CV-2015 (JTC) (N.D. Ga. 1997);
In the Matter of Jenny Craig, 1998 FTC Lexis 13 (February 27, 1998);
FTC v. Design Travel, No. C-97-0833 MHP (N.D. Cal. 1993); In the
Matter of General Motors, 102 F.T.C. 1741 (1983). Proposed section
436.5(f) is also consistent with many Commission trade regulation
rules that require sellers to disclose post-sale costs and
conditions that will impact upon the consumer's ultimate cost in
using the product or service. E.g., Appliance Labeling Rule, 16 CFR
305 at 305.11; 900 Number Rule, 16 CFR 308 at 308.3; Telemarketing
Sales Rule, 16 CFR 310 at 310.3.
---------------------------------------------------------------------------

Consistent with the UFOC Guidelines approach, proposed section
436.5(f) enhances the comparable Rule disclosure provisions found at 16
CFR 436.1(a)(8) by adding a disclosure about advertising and purchasing
cooperatives from which franchisees are required to purchase goods or
services. The franchisor must also disclose the voting power of any
company-owned outlets in the cooperative and, if company store voting
power is controlling, the range of required fees charged by the
cooperative must be disclosed. These additional disclosures better
enable prospective franchisees to understand their total costs of
conducting business.
g. Proposed Section 436.5(g): Item 7 (Estimated Initial Investment)
Proposed section 436.5(g), the third cost disclosure, requires
franchisors to disclose additional expenses necessary to commence
business (e.g., rent, equipment, inventory) in an easy-to-read tabular
format. It is based upon UFOC Item 7, which addresses fees paid to
third parties.\121\ Proposed section 436.5(g) enhances the comparable
Rule disclosures found at 16 CFR 436.1(a)(7) by requiring franchisors
to disclose ``additional funds'' required before operations begin and
``during the initial phase of the franchise.'' This information is
essentially the same as a working capital disclosure. The UFOC defines
the term ``initial phase'' to mean at least three months or a
reasonable period for the industry. Franchisors must also identify the
factors, basis, and experience they have considered in determining the
level of additional funds. These disclosures assist prospective
franchisees to understand not only the costs of entering into the
business, but their likely operational costs until they can break even.
These enhanced disclosures are entirely consistent with the Rule's
general policy of requiring full cost and expense disclosures.
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\121\ In response to the ANPR, no commenter raised any concerns
about UFOC Item 7, upon which proposed section 436.5(g) is based.
---------------------------------------------------------------------------

h. Proposed Section 436.5(h): Item 8 (Restrictions on Sources of
Products and Services)
Proposed section 436.5(h) is one of several Rule provisions that
require franchisors to state with specificity the legal obligations and
restrictions imposed on the franchisee. Modeled after UFOC Item 8, it
requires the franchisor to disclose obligatory purchases, restrictions
on sources of products and services, the conditions under which the
franchisor will approve alternative supplies or products, and the
amount of any rebates the franchisor may receive from required
suppliers. Proposed section 436.5(h) enhances the current Rule
disclosures found at 16 CFR 436.1(a)(9)-(11) by requiring greater
disclosure about the circumstances under which the franchisor will
authorize substitute goods \122\ and whether, by contract or practice,
the franchisor provides material benefits to franchisees who use
designated or approved suppliers, such as permitting renewals or
providing additional outlets. It also requires the disclosure of
purchasing or distribution cooperatives and whether the franchisor
negotiates purchase arrangements with suppliers for the benefit of
franchisees. These additional disclosures enable prospective
franchisees to assess better their likely costs and benefits, as well
as their independence from the franchisor.
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\122\ In response to the ANPR, a few franchisees reported that
their franchisors failed to approve alternative suppliers or made it
difficult for franchisees to find alternative sources of supplies.
E.g., Chiodo, 21 Nov 97 Tr at 308-09; Hockert-Lotz, id at 325-327.
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In response to the ANPR, several commenters voice concern about
source restrictions that prevent franchisees from obtaining comparable
supplies at cheaper rates.\123\ For example, one franchisee states that
franchisors ``put you in an uncompetitive situation with other people
in the same business because you are paying higher than fair market
value for the price of the goods that you receive from them.'' \124\
These commenters generally do not allege that their franchisors failed
to disclose source restrictions, but complain about the abusive nature
of such restrictions. Other commenters, however, question the
sufficiency of UFOC Item 8, urging the Commission to expand Item 8 to
require franchisors to disclose more information about their practices
and intentions with respect to the provision of competitive alternative
sources of supply,\125\ or to require franchisors to include a specific
risk factor about sourcing restrictions in their Item 8
disclosure.\126\
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\123\ E.g., Manuszak, Comment 13, at 1; Weaver, Comment 17, at
1; Mueller, Comment 29, at 2; Gagliati, Comment 72, at 1; Buckley,
Comment 97, at 1; Rafizadeh, 7 Nov 97 Tr at 288-89; Slimak, 22 Aug
97 Tr at 26. See also Kezios, Comment 64, at 2-3.
\124\ Brickner, Comment 128. Brickner adds that he also must
purchase specific equipment from only one manufacturer and the
franchisor is the only supplier. Id. See also Buckley, Comment 97 at
3; Myklebust, Comment 101; Chiodo, 21 Nov 97 Tr at 293-94.
\125\ Selden, Comment 133, Appendix B, at 1.
\126\ Zarco, Comment 134, at 2. Harold Brown, a franchisee
advocate, also urges the Commission to prohibit direct and indirect
``kick-backs'' from third-party vendors to the franchisor. Brown,
Comment 4 at 3. The Commission, however, believes that proposed
section 436.5(h)(5), requiring the disclosure of revenue to the
franchisor from franchisee purchases, is sufficient to address this
issue.
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The Commission believes that the ANPR comments clearly support the
proposition that full disclosure about source restrictions and
purchasing obligations is warranted. Nonetheless, the Commission
believes that proposed section 436.5(h) strikes the right balance
between pre-sale disclosure and compliance costs and burdens, and is
sufficient to warn prospective franchisees about source restrictions,
purchase obligations, and approval of alternative suppliers.
i. Proposed Section 436.5(i): Item 9 (Franchisee's Obligations)
Except for some minor editing, proposed section 436.5(i) is
identical to UFOC Item 9.\127\ There is no counterpart in the current
Rule. Proposed section 436.5(i) requires franchisors to provide an
easy-to-understand table that cross references the sections of the
franchise agreement and disclosure document that explain the
franchisee's legal obligations in greater detail.\128\ The Commission
finds that this proposed disclosure serves an important consumer
protection function, giving prospective

[[Page 57306]]

franchisees an easy-to-understand roadmap to their franchise agreement
and disclosure document, without imposing great compliance costs or
burdens on franchisors. In addition, the significant number of comments
detailing franchise relationship problems would tend to support the
need to provide prospective franchisees with more guidance in
understanding and reviewing a franchise agreement.
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\127\ Only one commenter, Gary Duvall, raises any concern about
UFOC Item 9, upon which proposed section 436.5(i) is based. Mr.
Duvall suggests that the Commission permit a franchisor to opt out
of Item 9 if the franchisor provides prospective franchisees with a
detailed table of contents or index to their franchise agreement.
Duvall, comment 19, at 2. In an effort to harmonize federal and
state disclosure laws, however, the Commission is inclined to adopt
UFOC Item 9 in its entirety.
\128\ Proposed section 436.5(i) is consistent with other trade
regulation rules where the Commission has recognized that
information about legal risks to consumers is material. E.g., 900
Number Rule, 16 CFR 308 at 308.7 (obligations concerning billing
disputes); Negative Option Rule, 16 CFR 425 at 425.1(a)(1)(ii)
(minimum purchase obligations); Door-to-Door Sales Rule, 16 CFR 429
at 429.1(e) (obligations regarding cancellations); Warranty
Disclosures, 16 CFR 701 at 701.3(a)(5) (obligations to obtain
performance).
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j. Proposed Section 436.5(j): Item 10 (Financing)
Proposed section 436.5(j) requires the franchisor to disclose all
the material terms and conditions of any financing agreements,
including the annual percentage rate, the number of payments, penalties
upon default, and any consideration received by the franchisor for
referring a prospective franchisee to a lender. For the most part,
these disclosures are comparable to the disclosures lenders must make
under the Federal Reserve's Regulation M (Consumer Leasing), 12 CFR
213, and Regulation Z (Truth in Lending), 12 CFR 226. Based upon UFOC
Item 10,\129\ proposed section 436.5(j) enhances the current Rule
disclosures found at 16 CFR 436.1(a)(12) by requiring franchisors to
disclose any interest on the financing in terms of an Annual Percentage
Rate, consistent with other consumer credit transactions. It also
requires more disclosure about what the financing covers, waiver of
defenses, and the franchisor's practice or intent to sell or assign the
obligation to a third party. Proposed section 436.5(j) also makes clear
that the franchisor may provide this information in summary table
format, and Appendix A to the proposed Rule offers a sample table.
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\129\ As with most of the other disclosures, no commenters
raised any objections to UFOC Item 10, upon which proposed section
436.5(j) is based.
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k. Proposed Section 436.5(k): Item 11 (Franchisor's Assistance,
Advertising, Computer Systems, and Training)
Proposed section 436.5(k) requires franchisors to disclose their
obligations to franchisees with respect to pre-opening and ongoing
assistance (such as site selection, training, and advertising) in
tabular form, with cross references to the corresponding provisions of
the franchise contract.\130\ It expands the comparable Rule provisions
found at 16 CFR 436.1(a)(17)-(18) by requiring franchisors to explain
in greater detail their site selection criteria and the nature of their
training program. It also requires additional disclosures concerning
the extent of advertising assistance and the operation of local,
regional, and national advertising co-ops. Proposed section 436.5(k)
also addresses major technological changes in franchising since the
Rule was promulgated in the late 1970s. Specifically, it requires
greater disclosure about the required use of computers and electronic
cash registers.\131\ The Commission believes that these disclosures are
necessary to address frequent franchisee complaints about promised
assistance and related obligations. Each of these expanded disclosures
sheds greater light on the level of services and assistance promised to
prospective franchisees, as well as related franchisee obligations, and
therefore are material. The pre-sale disclosure of this information to
prospective franchisees is also likely to reduce misunderstandings and
conflict during the franchise relationship.
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\130\ Misrepresentations about promised support and assistance
are among the most common allegations in franchise cases and
continue to be a source of numerous franchisee complaints. E.G., FTC
v. Nat'l Consulting Group, Inc., No. 98 C 0144 (N.D. III 1998); FTC
v. Hayes, No. 4:96CV061126 SNL (E.D. Mo. 1996); FTC v. Int'l
Computer Concepts, Inc., No. 1:94CV1678 (N.D. Ohio 1994); United
States v. Megatrend Telecomm., Inc., No. 3:93 CV 22220 AVC (D.Ct.
1993); FTC v. Intellipay, Inc., Bus. Franchise Guide (CCH) para.
10,061 (S.C. Tx. 1992); FTC v. Blanc, Bus. Franchise Guide (CCH)
para. 10,032 (N.D. Ga 1992). See also Lundquist 22 Aug 97 Tr at 45;
Gray, comment 22, at 1; Dady & Garner, Comment 127, at 4; Mousley,
29 July 97 Tr at 4-7.
\131\ In response to the ANPR, a few commenters voiced concerns
about maintenance obligations regarding computer systems and related
equipment. E.g. Fetzer, 19 Sept 97 Tr at 42; Rafizadeh, 7 Nov 97 Tr
at 292. See also NCA-7 Eleven Franchisees, Comment 113, at 2.
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Two commenters, however, question the sufficiency of UFOC Item 11,
upon which proposed section 436.5(k) is based. One franchisee advocate
contends that the UFOC Item 11's short-hand references to the franchise
contract ``offend[s] the basic purpose of the disclosure statement,
namely, to provide the prospective franchisee with a reliably complete
description of what is being purchased.'' \132\ He urges the Commission
to require a franchisor to provide prospects with a more in-depth
analysis of each of the franchisor's obligations. A franchisor
representative raises a concern about the disclosures concerning
computer systems. UFOC Item 11, and by extension proposed section
436.5(k), require franchisors to disclose information about the nature
of their computer systems and any assistance available to franchisees
concerning such systems. This commenter does not disagree with the need
for the disclosure, but notes that many start-up franchisors are ``not
certain which computer system or software they expect to have the
franchisees use. Provision should be made for these new franchisors.''
\133\
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\132\ Brown, comment 4, at 5.
\133\ Kestenbaum, Comment 40, at 2.
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In light of the overwhelming number of comments urging the
Commission to adopt the UFOC format, the Commission finds no compelling
justification to expand Item 11, as suggested above. Requiring
franchisors to repeat in the disclosure document what they already
disclose in their contract would appear to impose costs on franchisors
without any clear benefit to prospective franchisees. Multiple
disclosure might greatly increase the size of a disclosure document,
making it more daunting to read. The Commission, however, is concerned
that the UFOC Item 11 disclosures concerning computer systems may not
provide adequate guidance to start-up franchisors. Specifically, a
start-up franchisor may require franchisees to use computer systems in
the future, but may not have the specific computer requirements
available at the time of the franchise sale. Based upon the record, the
Commission cannot assess the extent to which proposed section 436.5(k)
may impose undue costs or burdens on, or otherwise disadvantage, start-
up franchise systems. Accordingly, the Commission solicits additional
comment on this issue.
l. Proposed Section 436.5(l): Item 12 (Territory)
Proposed section 436.5(l) addresses exclusive territories, as well
as competition from franchisors selling similar goods or services under
the same or a different trade name. The Commission believes this
provision is one of the most important disclosure items, preventing
fraud and misleading statements concerning protected territories and
competition. Indeed, the Commission has brought a number of law
enforcement actions against false or misleading exclusive territory
representations.¹³⁴ Proposed section 436.5(l) enhances the
current Rule's disclosures found at 16 CFR 436.1(a)(3)-(13) in several
respects, including requiring franchisors to disclose the conditions,
if any, under which they will approve the relocation of the
franchisee's business and the franchisee's establishment of additional

[[Page 57307]]

outlets. Franchisors must also disclose any present plans to operate a
competing franchise system offering similar goods or services or to
sell through alternative channels of distribution.
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\134\ E.g., FTC v. Int'l Computer Concepts, Inc., No. 1:94CV1678
(N.D. Ohio 1994); FTC v. O'Rourke, No. 93-6511 (S.D. Fla. 1993); FTC
v. Nat'l Bus. Consultants, Inc., Bus. Franchise Guide (CCH) para.
9,365 (E.D. La. 1989); FTC v. American Safe Mktg., Inc., Bus.
Franchise Guide (CCH) para. 9,350 (N.D. Ga. 1989); FTC v. American
Legal Distrib., Inc., Bus. Franchise Guide (CCH) para. 9,090 (N.D.
Ga. 1988); United States v. C.D. Control Tech., Inc., Bus. Franchise
Guide (CCH) para. 9,851 (E.D.N.Y. 1985).
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Unlike most disclosure items--which generated little comment in
response to the ANPR--UFOC Item 12 generated a significant number of
comments. In particular, franchisees and their advocates complain about
``encroachment,'' where a franchisor essentially competes with its
franchisees by establishing company-owned or new franchised-outlets in
the same market, or sells the same goods as the franchisee through
alternative channels of distribution.¹³⁵ These commenters
contend that encroachment has a devastating effect upon an individual
franchisee who does not have a contractual right to an exclusive
territory,¹³⁶ and they urge the Commission to ban
encroachment as an abusive and unfair practice. Other commenters urge
the Commission at the very least to expand the disclosures about
territories to include more information about the franchisor's past
practices and specific expansion plans.¹³⁷ Finally, several
franchisees suggest that the Commission should strengthen the UFOC's
``encroachment'' risk factor. For example, one commenter suggests that
franchisors should be required to state: ``The company reserves the
right to increase the number of franchised or company-owned units in an
area. In the past, we have been known to put another outlet in close
proximity to an existing unit. This action generally has a negative
impact on the gross and/or net sales of the pre-existing unit.''
¹³⁸
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\135\ E.g., Brown, Comment 4, at 2; Manuszak, Comment 13, at 1;
AFA, Comment 62, at 1; Orzano, Comment 73, at 1; Buckley, Comment
97, at 3; Marks, Comment 107, at 2; Zarco & Pardo, Comment 134, at
2.
\136\ E.g., Parker, Comment 10, at 1; L. Gaither, Comment 68, at
1; Vidulich, 22 Aug 97 Tr at 17; Christiano, 19 Sept 97 Tr. at 50;
Bundy, 6 Nov 97 Tr at 135.
\137\ For example, Andrew Selden suggests that ``Item 12 should
be elaborated to require full disclosure of past practice, current
intention or future possibility of franchisor-sponsored competitive
activities that have the prospect of impacting the franchisee's
business.'' Seldon, Comment 133, Appendix B, at 1. See also, Dady &
Garner, Comment 127, at 4.
\138\ Zarco & Pardo, Comment 134, at 2. See also G. Gaither,
Comment 69, at 1; Orzano, Comment 73, at 1; Dady & Garner, Comment
127, at 3; Cordell, 6 Nov 97 Tr at 136; Kezios, 6 Nov 97 Tr at 142.
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The Commission believes that proposed section 436.5(l) strikes the
appropriate balance, ensuring that prospective franchisees will receive
material information about the extent to which they will receive a
protected territory and/or are likely to face competition from the
franchisor. Disclosure about a franchisor's past practices and future
policies, however, appears to be unwarranted. A franchisor's past
policies and practices regarding territories and means of distribution
are arguably irrelevant because they do not necessarily shed any light
on the franchisor's practices that will govern a particular franchise
relationship.¹³⁹ In the same vein, a franchisor's expansion
policies in one location may be irrelevant to a prospective franchisee
who intends to operate his or her outlet in another. Moreover,
prospective franchisees may be able to discover past practices on their
own by speaking with current and former franchisees.
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\139\ The Commission believes that the issue of encroachment is
essentially a contractual matter. Absent an express grant of a
protected territory, a franchisor is generally free to establish as
many outlets (company-owned or franchised) in any particular market
as it wishes. A few state courts (or federal courts applying state
law), however, have held that encroachment violates state implied
covenants of good faith and fair dealing. See, e.g., In re Vylene
Enter., Inc., 90 F.3d. 1472 (9th Cir. 1996).
---------------------------------------------------------------------------

The Commission also believes it is unreasonable to require
franchisors to disclose hypothetical possibilities about future
expansion. Indeed, by not granting an exclusive territory, the
franchisor has effectively reserved to itself the unrestricted right to
expand the number of outlets or to sell its products or services via
alternative channels of distribution. For that reason, proposed section
436.5(l) provides that franchisors not offering exclusive territories
must state: ``You will not receive an exclusive territory. [Franchisor]
may establish other franchised or company owned outlets that may
compete with your location.'' Although the Commission generally
disfavors the use of risk factors that merely repeat what is expressly
or impliedly stated in the franchise agreement, the Commission agrees
that the disclosure of this specific risk factor is warranted in light
of the considerable number of franchisee complaints regarding
encroachment. Armed with such information, prospective franchisees can
shop for a competing franchise system that does offer protected
territories, if they so choose.
m. Proposed Section 436.5(m): Item 13 (Trademarks)
Proposed section 436.5(m) is intended to be identical to UFOC Item
13. It requires franchisors to disclose information about the principal
trademarks that will be licensed to the franchisee for use in operating
the outlet.¹⁴⁰ This is an anti-fraud provision, ensuring
that franchisors do not misrepresent the value of the trademark
underlying the franchise system.
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\140\ In response to the ANPR, no commenter raised any concerns
about UFOC Item 13, upon which proposed section 436.5(m) is based.
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The current Rule provision addressing trademarks, section
436.1(a)(iii), merely requires the franchisor to identify its
trademarks. Following UFOC Item 13, proposed section 436.5(m) enhances
the current Rule requirements by requiring more detailed disclosures,
including whether the trademark is registered with the U.S. Patent &
Trademark Office,¹⁴¹ and the existence of any pending
litigation, settlements, agreements, or superior rights that may limit
the franchisee's use of the trademark. Proposed section 436.5(m) also
explains the franchisor's contractual obligations to protect the
franchisee's right to use the mark against claims of infringement or
unfair competition. These additional disclosures are entirely
consistent with the Commission's long-standing policy of requiring the
disclosure of material information about the costs and benefits of
entering into the franchise relationship.
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\141\ If the mark is not registered, the franchisor must provide
the following warning: ``By not having a Principal Register federal
registration for (name or description of symbol), (Name of
Franchisor) does not have certain presumptive legal rights granted
by a registration.''
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n. Proposed Section 436.5(n): Item 14 (Patents, Copyrights, Proprietary
Information)
Proposed section 436.5(n) is intended to be identical to UFOC Item
14.¹⁴² It is another anti-fraud provision, ensuring that
franchisors do not misrepresent the nature of their intellectual
property, such as secret recipes or manufacturing processes, the
existence of which often makes the purchase of a franchise an
attractive option, especially to consumers without prior business
experience. Like trademark limitations, restrictions on the use of the
franchisor's intellectual property are material because they not only
can seriously diminish the value of the franchise, but could undermine
the franchisee's ability to operate the business. No comparable
provision is found in the current Rule. In keeping with the goal of
reducing inconsistencies between federal and state disclosure law, the
Commission

[[Page 57308]]

believes that adopting UFOC Item 14 is warranted.¹⁴³
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\142\ In response to the ANPR, no commenter raised any concerns
about UFOC Item 14, upon which proposed section 436.5(n) is based.
\143\ Proposed section 436.5(n) is substantially similar to
other required disclosures. It complements Item 13, which requires
the disclosure of information about the franchisor's trademark, and
it parallels Item 3, which requires the disclosure of certain
litigation.
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o. Proposed Section 436.5(o): Item 15 (Obligation To Participate in the
Actual Operation of the Franchise Business)
Proposed section 436.5(o) is intended to be identical to UFOC Item
15.¹⁴⁴ It requires franchisors to disclose whether
franchisees must participate personally in the direct operation of the
franchise.¹⁴⁵ Proposed section 436.5(o) enhances the current
Rule disclosures found at 16 CFR 436.1(a)(14), however, in several
respects. It requires franchisors to disclose not only obligations
under the franchise agreement, but obligations to participate directly
arising from other agreements or as a matter of practice. Franchisors
must also state if direct participation is recommended. Proposed
section 436.5(o) also requires franchisors to disclose any limitations
on whom the franchisee can hire as a supervisor and any restrictions
that the franchisee must place on its manager. If the franchise is a
business entity, the franchisor must also disclose the amount of equity
interest that the supervisor must have in the franchise. Armed with
such disclosures, prospective franchisees will have a much better
understanding of the personal commitment required to operate the
franchise.
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\144\ In response to the ANPR, no commenter raised any concerns
about UFOC Item 15, upon which proposed section 436.5(o) is based.
\145\ This requirement is consistent with the Commission's long-
standing view that prospective franchisees should be able to assess
their legal obligations under the franchise agreement, as well as
the degree of independence they will be able to exercise in
operating their business. SBP, 43 FR at 59662-63. Personal
participation requirements might also result in economic injury to
franchisees who, under their franchise agreement, are restricted
from engaging in other businesses or who have signed covenants not
to compete in the same business. Id.
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p. Proposed Section 436.5(p): Item 16 (Sales Restrictions)
Proposed section 436.5(p) is intended to be identical to UFOC Item
16.¹⁴⁶ Like other Rule provisions governing a franchisee's
method of operation, it requires a franchisor to disclose any
restrictions limiting customers to whom the franchisee is permitted to
sell, or the goods or services that the franchisee may offer for
sale.¹⁴⁷ Proposed section 436.5(p) enhances the current Rule
disclosures found at 16 CFR 436.1(a)(13) by also requiring the
franchisor to disclose whether the franchisor has the right to change
the types of authorized goods and services and whether there are limits
on the franchisor's right to make such changes. These disclosures will
better enable a prospective franchisee to understand the scope of the
franchisor's contractual rights regarding product sales.
---------------------------------------------------------------------------

\146\ In response to the ANPR, no commenters raised any concerns
about UFOC Item 16, upon which proposed section 436.5(p) is based.
\147\ Sales restrictions can cause serious economic injury to
franchisees by limiting the scope of the franchisee's market and
ultimately the franchisee's profitability. SBP, 43 FR at 59661.
Comparable disclosures about the terms, conditions, and restrictions
on the use of goods and services are found in many Commission rules.
E.g., Telemarketing Sales Rule, 16 CFR 310 at 310.3; Negative Option
Rule, 16 CFR 425 at 425.1(a)(1)(ii); Disclosure of Warranty Terms
and Conditions, 16 CFR 701 at 701.3(a)(8).
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q. Proposed Section 436.5(q): Item 17 (Renewal, Termination, Transfer,
and Dispute Resolution)
Proposed section 436.5(q) is intended to be identical to UFOC Item
17. It requires franchisors to summarize in tabular form 23 enumerated
terms and conditions of a typical franchise relationship, such as the
duration of the franchise agreement, rights and obligations upon
termination, post-term covenants not to compete, and assignment and
transfer rights.¹⁴⁸
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\148\ The Commission has recognized that the terms and
conditions governing the franchise relationship ``may well be the
most important provisions in a franchise agreement, since they limit
what the franchisee may do with his capital asset.'' Given the
length and complexity of the typical franchise agreement, such terms
and conditions are often overlooked or not fully appreciated. The
Commission has also recognized that there is often an informational
imbalance between franchisors and franchisees about the
relationship. ``This information imbalance makes the clear and
concise disclosure [about franchise relationship issues] essential,
if a prospective franchisee is to make an informed business
judgment.'' SBP, 43 FR at 59664.
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Proposed section 436.5(q) enhances the current Rule disclosures
found at 16 CFR 436.1(a)(15) by requiring disclosures about arbitration
or mediation of disputes, as well as forum-selection and choice of law
provisions. At the same time, it greatly streamlines the Rule's
disclosures. The Rule currently requires franchisors to detail the
rights and obligations already spelled out in the franchise agreement.
Proposed section 436.5(q), in contrast, requires franchisors to cross
reference the applicable contractual provisions in an easy-to-read
table with only a brief summary of each provision. This streamlined
approach reduces compliance burdens, while providing prospective
franchisees with a detailed road map to the contract, where they can
read the various provisions in greater detail.
In response to the ANPR, a few commenters offer specific
suggestions about UFOC Item 17, upon which proposed section 436.5(q) is
based. One commenter questions whether the Item 17 disclosure is
necessary in the first instance, suggesting that a franchisor be
permitted to opt out of Item 17, if it provides a detailed table of
contents or index to its franchise agreement.¹⁴⁹ In
addition, several franchisees and their representatives state that the
term ``renewal'' in Item 17 is misleading. They maintain that the word
``renew'' implies that the franchisee is able to continue to operate
the franchise under substantially similar terms and conditions as under
the original franchise agreement. They assert, however, that in reality
franchisees who wish to continue operating the franchise upon
expiration must often sign radically new contracts that impose
substantially different terms and conditions, such as higher royalty
payments or the elimination of an exclusive territory. Further, they
assert that, in many instances, franchisees have no choice but to sign
even the most abusive, one-sided contracts because the franchisee has a
substantial economic investment in the franchise and simply cannot walk
away from it without incurring a significant economic
loss.¹⁵⁰ Franchisees also note that if they do walk away
from the franchise, they are often bound by covenants not to compete
that restrict their ability to operate a similar business for a number
of years.¹⁵¹
---------------------------------------------------------------------------

\149\ Duvall, Comment 19, at 2.
\150\ E.g., Bores, Comment 9, at 1; Rachide, Comment 32, at 1;
Chabot, Comment 37, at 1; Rich, Comment 65, at 1; Orzano, Comment
73, at 1; Geiderman, Comment 131, at 1; Vidulich, 22 Aug 97 Tr at
19-20; D'Alessandro, 22 Aug 97 Tr at 41; Chiodo, 21 Nov 97 Tr at
303-04.
\151\ For example, the AFA states:
``Renewal'' is a misnomer. ``Re-license,'' ``rewrite'' or even
``re-franchise'' is a more accurate description of what actually
happens at the end of the initial contract term. Most franchisees
find that when it is time to ``renew,'' they are not ``renewing''
their existing franchise agreement, but are entering into a wholly
new franchise agreement, often with materially different financial
and operational terms. They are presented these ``renewal''
contracts on a ``take it or leave it'' basis and are under enormous
coercion pressures to sign--especially if the old agreement contains
a post-termination covenant not to compete. This is truly ``holding
a gun to the head'' of the ``renewing'' franchisee.
AFA, Comment 62, at 2.
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As noted previously, the overwhelming number of ANPR comments were
submitted by franchisees who voice various franchise relationship
concerns.¹⁵² The stream of franchisee complaints about
relationship issues demonstrates that there is a continuing need for
complete

[[Page 57309]]

and clear disclosure about the basic contractual terms and conditions
that will govern the franchise relationship. In an effort to harmonize
federal and state disclosure laws, the Commission is inclined to adopt
UFOC Item 17 as set forth in the UFOC Guidelines. Nonetheless, the
Commission wishes to explore further whether the use of the term
``renewal'' is misleading. On the one hand, ``renewal'' appears to be a
term of art that is well understood in franchising to mean that the
parties enter into a new contract. Indeed, UFOC Item 17 specifically
distinguishes between renewals and extensions. Although not defined in
the Rule, the term ``extension'' implies that a franchisee can continue
to operate under the same terms and conditions for an additional
period. In contrast, it would appear that a ``renewal'' means that the
franchisee may continue in operation, but under modified conditions.
Given the number of comments on this issue, however, the Commission
wishes to explore further whether the term ``renewal'' is misleading
and possible alternatives that would be more useful.
---------------------------------------------------------------------------

\152\ See supra at Section B.
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r. Proposed Section 436.5(r): Item 18 (Public Figures)
Proposed section 436.5(r) is intended to be identical to UFOC Item
18.¹⁵³ It requires franchisors to disclose the involvement
of a public figure in the franchise system, including any management
responsibilities, the total investment made in the franchise system,
and any compensation received. A comparable disclosure provision is
currently found at 16 CFR 436.1(a)(19). This information helps
prospective franchisees understand the extent of any financial and
managerial commitments from the public figure, as well as any
obligations to the public figure. Prospective franchisees can then
decide for themselves whether an association with a public figure is
valuable to them.¹⁵⁴
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\153\ In response to the ANPR, no commenter raised any concerns
about UFOC Item 18, upon which proposed section 436.5(r) is based.
\154\ See SBP, 43 FR at 59677-78.
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s. Proposed Section 436.5(s): Item 19 (Financial Performance
Representations)
Background. Proposed section 436.5(s), perhaps the most important
anti-fraud provision, addresses financial performance representations.
In the original rulemaking record developed in the 1970s, the
Commission found ``that franchises have been marketed through * * *
unsubstantiated claims regarding potential sales, income, [and] gross
or net profit of franchises.'' ¹⁵⁵ The Commission's law
enforcement experience shows that the making of false or
unsubstantiated earnings representations continues to be prevalent.
Indeed, the making of false or unsubstantiated earnings representations
is the most frequent count alleged in Commission Franchise Rule cases.
Of the more than 150 Rule cases filed to date, all but three allege
false or unsubstantiated earnings claims.¹⁵⁶
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\155\ Final Interpretive Guides, 43 FR at 59628.
\156\ E.g., FTC v. GreenHorse Communications, Inc., No. 98-CV-
245-M (D.N.H. 1998); FTC v. Nat'l Consulting Group, Inc., No. 98-C
0144 (N.D. Ill. 1988); FTC v. Hart Mktg. Enter., Ltd., No. 98-22-
CIV-T-23E (M.D. Fla. 1988); FTC v. Shelton, No. CV-N-97-00712-ECR
(RAM)(D. Nev. 1997); FTC v. Hayes, No. 4:96CV06126 SNL (E.D. Mo.
1997); FTC v. Tower Cleaning Sys., Inc., No. 96 58 44 (M.D. Pa.
1996).
---------------------------------------------------------------------------

Although financial performance representations are highly material
to prospective franchisees, the Commission stated in the ANPR that it
was inclined not to mandate earnings disclosures.¹⁵⁷ After
reviewing the Rule Review comments, the Commission acknowledged that
financial performance information is material to prospective
franchisees, but rejected mandating such disclosures in favor of a free
market approach. The Commission noted that approximately 20 percent of
franchisors choose to make earnings disclosures and that prospects, in
theory, can find franchise systems that voluntarily disclose earnings
information. Moreover, the Commission observed that prospective
franchisees can obtain earnings information from a variety of sources.
``For example, typical expenses, such as labor and rent, may be
available from industry trade associations and industry trade press.''
62 FR 9118. Prospective franchisees are also free to discuss earnings
and other performance issues with former and current franchisees.
Perhaps most important, the Commission noted that the record does not
provide a sufficient basis for the Commission to formulate an earnings
disclosure that would both be useful to and not mislead prospective
franchisees. The Commission also noted that mandating earnings
disclosures might impose burdens and costs on existing franchisees (who
would have to release their earnings information to their franchisor)
without any record support showing that such increased burdens and
costs are outweighed by benefits to prospective franchisees.
¹⁵⁸
---------------------------------------------------------------------------

\157\ 62 FR at 9118.
\158\ Id.
---------------------------------------------------------------------------

While rejecting mandated financial performance disclosures, the
ANPR explored whether the Commission should nonetheless revise the
Rule's performance disclosure requirements in two respects. First, the
Commission observed that some franchisors actually misrepresent that
the Commission or the Franchise Rule prohibits franchisors from making
performance information available.¹⁵⁹ Second, the Commission
questioned whether prospective franchisees should be cautioned not to
rely on unsubstantiated earnings representations.¹⁶⁰
Accordingly, the Commission solicited comment on whether the Rule
should be modified to require all franchisors to provide specified
preambles to their Item 19 disclosure that would explain financial
performance representations in greater detail.¹⁶¹ The
prescribed preamble would make it clear that franchisors can make
earnings disclosures if they have a reasonable basis to do so. At the
same time, it would discourage prospects from relying on unauthorized
earnings information.¹⁶²
---------------------------------------------------------------------------

\159\ Id.
\160\ Id.
\161\ The ANPR proposed that all franchisors state the following
in their Item 19 disclosure:
The FTC's Franchise Rule permits a franchisor to provide you
with information about the actual or potential sales, income, or
profits of its outlets, provided that there is a reasonable basis
for such information and the franchisor offers to provide you with
written substantiation. You should not rely on any information on
sales, income, or profits provided by a franchisor or its
salespersons if written substantiation is not offered.
Franchisors who do not make earnings disclosures would add the
following additional statement:
This franchisor does not make any representations about sales,
income, or profits. We also do not authorize our salespersons to
make any such representations either orally or in writing.
Id. at 9121-22.
\162\ Id. at 9119.
---------------------------------------------------------------------------

In general, no new arguments were raised in response to the ANPR
either supporting or opposing mandatory earnings disclosures.
Franchisees and their allies continue to argue that earnings
information is material, that mandating earnings disclosures will curb
deceptive or false earnings claims already being made, and that it is a
material omission for franchisors to fail to disclose earnings
information they possess.¹⁶³ They also contend that
prospects need historical earnings information in order to conduct a
due diligence investigation of the franchise offering.¹⁶⁴ On
the other hand,

[[Page 57310]]

franchisors and their allies continue to oppose mandatory earnings
disclosures, maintaining that earnings information obtained from
franchisees is often unavailable or unreliable, that mandating the
disclosure of earnings information will increase litigation, and that
prospects can often obtain earnings information directly from current
and former franchisees.¹⁶⁵ In addition, a few commenters
urge the Commission to coordinate its policy with NASAA to promote
uniformity between federal and state disclosure laws.¹⁶⁶ One
franchisor suggests that the FTC prohibit states from mandating
earnings disclosures by preempting the field.¹⁶⁷
---------------------------------------------------------------------------

\163\ E.g., Brown, Comment 4, at 4; SBA Advocacy, Comment 36, at
8; AFA, Comment 62 at 4; Purvin, Comment 79, at 2; Lagarias, Comment
125, at 1-2; Dady & Garner, Comment 127, at 1-2; and Selden, Comment
133, at 2 and Appendix C; Lundquist, 22 Aug 97 Tr at 46-47.
\164\ E.g., Karp, 19 Sept 97 Tr at 100-01. Quoting several
business texts, Mr. Karp asserts that historical earnings
information is critical to any evaluation of a business. for
example, he cites Internal Revenue Service Ruling 59-60, Item D,
which provides that: ``detailed profit and loss statements should be
obtained and considered for a representative period immediately
prior to the required date of appraisal, preferably five or more
years.'' Mr. Karp believes that the failure of franchisors to
disclose historical earnings information deprives prospects of
material information that is essential in evaluating the franchise
offering.
\165\ See, e.g., Duvall, Comment 19, at 2; Hogan & Hartson,
Comment 28, at 7; Kaufmann, Comment 33, at 7; Tifford, Comment 78,
at 5; IFA, Comment 82, at 3; Jeffers, Comment 116, at 5.
\166\ Tifford, Comment 78, at 6; AFA, Comment 62, at 4; IL AG,
Comment 77, at 2; IFA, Comment 82, at 3.
\167\ Cendant, Comment 140, at 2.
---------------------------------------------------------------------------

At the same time, several commenters support the ANPR proposed
preambles as an alternative to mandating earnings disclosures, noting
that this approach would rely on market pressures, not government
mandates, to encourage franchisors to disclose earnings information
voluntarily. For example, one commenter states:

We believe that these required disclosures not only would
correct misrepresentations by franchisors that the Rule prevents
them from making earnings claims, but also would bring more market
pressure to bear on franchisors to make reliable earnings claims.
Such market pressures may result in a substantial increase in the
amount of financial information disclosed to franchisees without the
costs and other burdens attendant to a government mandate.

Hogan & Hartson, Comment 28, at 8.¹⁶⁸
---------------------------------------------------------------------------

\168\ See also Duvall, Comment 19, at 2; Kaufmann, Comment 33,
at 7; Jeffers, Comment 116, at 5; Zarco & Pardo, Comment 134, at 6;
CA BLS, Comment 124, at 2.
---------------------------------------------------------------------------

A few commenters, however, offer specific suggestions to improve
the proposed preambles. For example, some commenters voice concern that
phrases such as ``do not rely on'' unauthorized earnings information
may be misinterpreted as a disclaimer of liability where salespeople
routinely make false or unauthorized earnings claims.¹⁶⁹
Another commenter voices concern that the first preamble proposed in
the ANPR could be misinterpreted as enabling franchisors to provide
earnings information outside of the disclosure document, as long as the
franchisor followed the Rule's requirements.¹⁷⁰ Several
commenters also offer substitute language. For example, one commenter
notes that some industries--such as the hotel industry--do not use
sales, income, or profits as measures of performance.¹⁷¹ He
suggests that the preamble include the more inclusive term ``financial
performance'' to capture those industries. Another commenter recommends
that the term ``outlets'' be revised to make it clear that a financial
performance claim can be based on either company-owned or franchised
outlets.¹⁷² A few commenters also suggest that the
Commission add a provision stating that prospective franchisees should
report any unauthorized financial performance claims to the franchisor
and/or to the Federal Trade Commission and to state
authorities.¹⁷³ Finally, NASAA suggests that the Commission
require franchisors who choose not to make earnings disclosures to make
the following statement:

\169\ SBA Advocacy, Comment 36, at 8; CA BLS, Comment 124, at 2;
Lagarias, Comment 125, at 4-5.
\170\ Kaufmann, Comment 33, at 15.
\171\ Wieczorek, 6 Nov 97 Tr at 183-84.
\172\ IL Ag, Comment 77, at 2. See also AFA, Comment 62, at 6.
\173\ WA Securities, Comment 117, at 3; NASAA, Comment 120, at
8; Zarco & Pardo, Comment 134, at 6; Kezios, 18 Sept 97 Tr at 91;
Tifford, 18 Set 97 Tr at 91-92.
---------------------------------------------------------------------------

This information is very important to any prospective
franchisee, and our failure to provide it makes it more difficult
for you to make an informed decision about purchasing a franchise,
as well as increases your financial risks in purchasing a franchise
from us. Unless you obtain this type of information on your own,
your risks may be substantial.

NASAA, Comment 120 at 8.¹⁷⁴
---------------------------------------------------------------------------

\174\ See also Cordell, 6 Nov 97 Tr at 199-200.

Revised Financial Performance Disclosures. Based upon the record,
the Commission continues to believe that financial performance
disclosures should remain voluntary and that ordinary market forces are
sufficient to provide an incentive for franchise systems to make
performance information available to prospective
franchisees.¹⁷⁵ At the same time, the Commission proposes to
amend the Rule by adopting the greatly streamlined UFOC Item 19
approach toward financial performance representations. First, following
the UFOC Guidelines, proposed section 436.5(s) would permit franchisors
to make financial performance claims in the text of their disclosure
documents, without the need to create separate ``earnings claim''
documents. Second, proposed section 436.5(s) would permit franchisors
to disclose truthful information about the financial performance of all
or a subgroup of franchisor-owned or franchised outlets, provided the
franchisor also describes the characteristics of the included outlets
that may differ materially from those of the outlet that is offered for
sale. In contrast, the current Rule permits such disclosures only if
the data is directly relevant to the prospective franchisee's
geographic market territory.¹⁷⁶
---------------------------------------------------------------------------

\175\ See Hogan & Hartson, Comment 28, at 7; Kaufmann, Comment
33, at 7; Tifford, Comment 78, at 5; IFA, Comment 82, at 3.
\176\ See 16 CFR 436.1(b)(1); 436.1(c)(1).
---------------------------------------------------------------------------

Third, proposed section 436.5(s) incorporates two UFOC Item 19
provisions that greatly facilitate franchisors' ability to provide
prospects with performance information. A franchisor who provides a
prospective franchisee with the actual operating results of a specific
unit being offered for sale need not comply with the general Item 19
disclosure requirements provided that the franchisor gives the
information only to the potential purchaser of that unit and provides
the potential purchaser with the name and last known address of each
owner of the unit during the prior three years. In addition, a
franchisor who make Item 19 financial performance representations can
provide prospective franchisees with supplemental performance
representations directed at a particular location or circumstance,
apart from the disclosure document, provided that the franchisor
furnishes such supplemental performance representations in writing,
explains how it differs from the Item 19 disclosure, follows the Item
19 format, and leaves the information with the prospective franchisee.
Both of these enhancements, which have no parallel in the current Rule,
make it easier for franchisors to provide prospects with material
performance information narrowly tailored to the particular outlets in
question.
At the same time, proposed section 436.5(s)'s financial performance
disclosure provision differs from the UFOC approach in one significant
way. UFOC Item 19--as well as the current Rule--requires franchisors
who make financial performance disclosures to state the number and
percentage of the franchised outlets that have actually attained or
surpassed the stated performance claim. The Commission

[[Page 57311]]

believes that this disclosure may be misleading and may actually
discourage franchisors from making financial performance information
available to prospective franchisees. For example, a franchisor may
have statistics showing that 9 out of 10 franchised stores in a
particular location (such as Seattle) average $100,000 net profit a
year. Yet, the current UFOC and Rule requirements would prevent the
franchisor from disclosing truthful information about the universe the
franchisor has measured--the 10 franchised outlets in Seattle. Rather,
the franchisor would be forced instead to state 9 out of the entire
number of all franchises nationwide (e.g., 9 out of 1,000) have earned
the $100,000 claimed.
This approach arguably would prevent a franchisor who does not have
complete financial performance information on each and every franchise
in its system from making truthful performance representations about a
subset of franchisees, such as franchisees operating in a particular
geographic area or operating a particular kind of unit (e.g., kiosks in
shopping malls). Moreover, in the example noted above, a disclosure
that 9 out of 1,000 franchisees have earned the represented amount
($100,000) is misleading because it implies that 991 franchisees have
not earned the claimed amount when, in fact, the franchisor may not
have sampled or otherwise measured the remaining group of 991.
Accordingly, the Commission proposes to amend the Rule to permit a
franchisor to disclose historical financial performance information in
its Item 19 disclosures if there is a reasonable basis for such
information and the franchisor: (1) Discloses the nature of the
universe of outlets measured; (2) the dates during which the reported
level of financial performance was achieved; (3) the number of outlets
in the universe measured during the relevant period; (4) the number of
outlets from the universe measured whose performance were utilized in
arriving at the representation; (5) of the number of outlets whose data
was utilized, the number and percentage that actually attained or
surpassed the stated results; and (6) characteristics of the included
outlets that may differ materially from those being offered to the
prospective franchisee.¹⁷⁷
---------------------------------------------------------------------------

\177\ For example, a franchisor may state a historical
performance representation as follows:
Franchised outlets in Seattle earned $100,000 in 1998.
The Franchisor has sampled all of its franchised outlets in
Seattle during the period 1998. The sample included 10 outlets. Nine
of the 10 outlets responded. Of the nine responding franchised
outlets, all attained or surpassed net profits of $100,000. We note,
however, that each of the franchised outlets in Seattle has been in
business for over 10 years and is located in an urban center.
---------------------------------------------------------------------------

Based upon the record, the Commission also proposes to adopt the
ANPR proposal that franchisors include prescribed preambles in Item 19
to clarify the law regarding financial performance claims. Among other
things, the first preamble corrects the common misrepresentation that
the Commission or the Rule actually prohibits the making of financial
performance disclosures.¹⁷⁸ In light of the Commission's
extensive law enforcement history combating false and unsubstantiated
performance claims, the Commission also believes that the first
preamble is necessary to encourage prospective franchisees to consider
financial performance representations made in an Item 19 disclosure
only. In addition, the Commission believes that the second preamble,
which is used only if the franchisor does not disclose performance
information, is warranted to alert prospective franchisees that any
subsequent performance claims are unauthorized and, impliedly, should
not be relied upon.
---------------------------------------------------------------------------

\178\ Several commenters state that such misrepresentations are
prevalent and urge the Commission to clarify the Rule to address
this problem. For example, Peter Lagarias states: ``I am personally
aware of franchisors (and sometimes even their lawyers) stating that
earnings claims are forbidden by the Commission's Rule. The
Commission should clarify in the Rule that the franchisor could
elect to make earnings claims but has elected not to make earnings
claims.'' Lagarias, Comment 125, at 4. See also Hogan & Hartson,
Comment 28, at 8; SBA Advocacy, Comment 36, at 8; AFA, Comment 62,
at 5; Purvin, Comment 79, at 2; Jeffers, Comment 116, at 5; CA Bar,
Comment 124, at 1.
---------------------------------------------------------------------------

The proposed revised preambles incorporate many of the suggestions
offered in response to the ANPR. For example, some commenters voice
concern that phrases in the original preamble such as ``do not rely
on'' unauthorized performance information may be misinterpreted as a
disclaimer of liability in those instances where salespeople routinely
make false or unauthorized performance claims.¹⁷⁹
Accordingly, the revised preamble deletes the reference to ``do not
rely'' in favor of a broader statement alerting prospective franchisees
that a franchisor can provide financial performance data ``only if the
information is included in the disclosure document.'' The proposed
revised first preamble also clarifies the law regarding financial
performance disclosures by noting two exceptions to the general rule
that performance claims must appear in Item 19: (1) Actual records of
an existing outlet for sale; and (2) supplemental performance
information about a particular location. The Commission also agrees
with the commenters who suggest that the second preamble include a
provision encouraging prospective franchisees to report any
unauthorized earnings claims to the franchisor, the Federal Trade
Commission, and state authorities.¹⁸⁰
---------------------------------------------------------------------------

\179\ SBA Advocacy, Comment 36, at 8; CA Bar, Comment 124, at 2;
Lagarias, Comment 125, at 4-5.
\180\ WA Securities, Comment 117, at 3; NASAA, Comment 120, at
8; Zarco & Pardo, Comment 134, at 6; Kezios, 18 Sept 97 Tr at 91;
Tifford, 18 Sept 97 Tr at 91-92.
---------------------------------------------------------------------------

t. Proposed Section 436.5(t): Item 20 (Outlets and Franchisee
Information)
Proposed section 436.5(t) is another anti-fraud disclosure
provision. Based upon UFOC Item 20, it requires franchisors to disclose
in tabular form statistical information on the number of franchises and
franchisor-owned outlets, including the number of franchises that have
failed or otherwise ceased operations. It also requires franchisors to
provide prospective franchisees with the names and addresses of current
and former franchises, with which they can verify the franchisors'
representations and learn more about the franchise
relationship.¹⁸¹ For these reasons, the Commission agrees
that Item 20 is among the most material disclosure items.¹⁸²
---------------------------------------------------------------------------

\181\ SBP, 43 FR at 59670-73.
\182\ See Karp, 19 Sept 97 Tr at 95; Slimak, 22 Aug 97 Tr at 33.
---------------------------------------------------------------------------

Proposed section 436.5(t) enhances the less comprehensive
disclosures found at 16 CFR 436.1(a)(16) by requiring franchisors to
disclose the names and addresses of former as well as current
franchisees. It also increases the number of franchisees about whom
information is disclosed from 10 to either all or at least 100. This
information prevents fraud by arming prospective franchisees with a
source of information with which they can conduct their own due
diligence investigation of the franchise offering. At the same time,
proposed section 436.5(t) corrects a ``double counting'' problem in
UFOC Item 20 that was identified during the Rule Review proceeding. As
explained below, proposed section 436.5(t) also improves UFOC Item 20
by addressing the use of gag clauses and trademark-specific franchisee
associations.
``Double Counting'' Issue. During the Rule Review, commenters
voiced concern that UFOC Item 20 is flawed

[[Page 57312]]

and needs to be fixed.¹⁸³ Specifically, commenters observed
that franchisors may report a change in franchise ownership in multiple
categories, which may inflate the overall number of franchise closings.
Accordingly, in the ANPR, the Commission acknowledged this concern and
solicited comment on how UFOC Item 20 could be improved.¹⁸⁴
---------------------------------------------------------------------------

\183\ E.g., Simon, RR Tr. at 223-24; Perry, RR Tr. at 263.
\184\ 62 FR at 9121.
---------------------------------------------------------------------------

In response to the ANPR, several commenters confirm the ``double
counting'' problem.¹⁸⁵ However, only a few commenters offer
concrete solutions, as noted below, and no consensus has emerged on how
to correct the problem. Specifically, three commenters suggest that the
Commission solve the double counting problem by adding additional
categories to the Item 20 disclosure.¹⁸⁶ Another commenter
believes that most double reporting problems are attributable to the
inclusion of transfers and reacquisitions in the UFOC Item 20 table
that summarizes franchised outlets. He suggests that transfers should
be reported in a separate column located on the side of the franchisee
statistics table and that reacquisitions be moved to the second UFOC
Item 20 table concerning company-owned outlets.¹⁸⁷ At the
same time, this commenter suggests that franchisors report multiple
ownership changes only once, according to which event was ``first-in
time.'' ¹⁸⁸ Other commenters suggest that the Commission
require franchisors to report multiple events according to a
predetermined order of priority.¹⁸⁹ Specifically, the
Commission could require franchisors to report multiple ownership
changes only once, but eliminate ``picking and choosing'' of categories
by assigning a specific order of priority such as termination, non-
renewal, reacquisition, and transfer. For example, a franchisor might
report an ownership change as a termination, regardless of what other
events may have occurred before (abandonment of the property) or after
(reacquisition or transfer).
---------------------------------------------------------------------------

\185\ E.g. Hogan & Hartson, Comment 28, at 6; AFA, Comment 62,
at 3; IL AG, Comment 77, at 2; Tifford, Comment 78, at 4; IFA,
Comment 82, at 2; Cendant, Comment 140, at 3; Karp, 19 Sept 97 Tr at
91.
\186\ For example, Robert Zarco recommends that the Commission
create 12 categories to capture various combinations of ownership
changes. Transfers, for instance, would be divided into four
distinct categories: (1) Transfers by the franchisee to the
franchisor; (2) transfers by the franchisee to the franchisor, but
ultimately re-franchised; (3) transfers by the franchisee directly
to a new franchisee; and (4) transfers by the franchisee directly to
a new franchisee more than once. Zarco & Pardo, Comment 134, at 6-7.
See also AFA, Comment 62, at 3; Karp, Comment 136, at 2-6.
\187\ Wieczorek, Comment 122, at 2.
\188\ Id.
\189\ Simon, 18 Sept 97 Tr at 23-24; Tifford, id. at 25-26. See
also Bundy, 6 Nov 97 Tr at 229.
---------------------------------------------------------------------------

The Commission believes that proposed section 436.5(t) fixes the
double counting problem within the framework of the UFOC Guidelines.
Franchisors would start the disclosure by noting the states where they
have outlets (column 1) and the number of outlets opened at the
beginning of the fiscal year (column 2). Franchisors then note the
number of franchises with the same ownership at the end of the year
(column 3). Next, franchisors report on franchisees who have left the
system during the course of the term of the franchise agreement because
of one of three events--termination, reacquisition, and transfer
(columns 4-6). Franchisors then report outlets that were not renewed at
the end of the franchise term (column 7). To ensure that all outlets
are accounted for, there is a miscellaneous category ``outlets that
ceased operation or closed for other reasons'' (column 8). This
category would capture information about events such as an abandonment
of an outlet. To aid prospective franchisees in understanding the net
effect of changes in ownership, franchisors also report the total
number of outlets discontinued during the fiscal year (column 9).
Finally, to account for franchisees that have joined the system during
the fiscal year, franchisors report the total number of outlets in
operation at the end of the year (column 10).
The Commission believes that proposed section 436.5(t) solves the
double counting problem in a streamlined and efficient manner without
increasing compliance burdens. First, proposed Item 20 addresses the
core source of double counting--imprecise reporting categories. To that
end, it defines with specificity the terms ``termination,''
``reacquisition,'' ``transfer,'' and ``nonrenewal,'' creating mutually
exclusive categories. A ``termination'' occurs when a franchisor sends
a franchisee an unconditional notice that it will terminate the
franchise agreement before the end of the agreement term. A
``reacquisition'' is limited to instances where the franchisee sells
his or her outlet back to the franchisor. A ``transfer,'' in turn, is
limited to instances where a franchisee sells his or her outlets
directly to a new franchise owner. Finally, a nonrenewal occurs when a
franchisor sends a franchisee an unconditional notice that it will not
renew the franchise agreement at the end of the agreement term. These
proposed definitions eliminate a major source of double count:
overlapping categories.¹⁹⁰ At the same time, the proposed
definitions have the additional benefit of informing a prospective
franchisee about the extent to which franchisees recoup some of their
investment when they leave the system.¹⁹¹
---------------------------------------------------------------------------

\190\ Several commenters urged the Commission to define the
terms ``transfers'' and ``reacquisitions'' more precisely. IL AG,
Comment 77, at 2; Tifford, Comment 78, at 4; Wieczorek, Comment 122,
at 1-2.
\191\ See Kaufmann, 18 Sept 97 Tr at 27; Karp, 19 Sept 97 Tr at
92.
---------------------------------------------------------------------------

Second, proposed section 436.5(t)(1)(xi) reduces double counting by
adopting a ``first-in-time'' approach: when an ownership change
involves two or more events, the franchisor reports only the event that
occurs first.¹⁹² For example, a franchisor may formally
notify a franchisee that the franchise will be terminated on a specific
date and the franchisee then transfers the outlet to a new owner. Under
the ``first-in-time'' instruction, the termination would be considered
the first event.
---------------------------------------------------------------------------

\192\ See Wieczorek, Comment 122, at 2; 6 Nov 97 Tr at 225-26.
---------------------------------------------------------------------------

While the Commission proposes a chronological approach (``first-in-
time'') to reporting ownership changes, it nonetheless wishes to
explore further the suggestion that the Commission require franchisors
to report ownership changes according to a precise order of priority.
The record, however, is devoid of any information from which the
Commission could prioritize changes in ownership. Accordingly, the
Commission seeks comment on whether the proposed first-in-time
approach, coupled with precise category definitions, is sufficient to
address the double counting issue, or whether the Commission should
establish a specific order of priority. If an order of priority is
preferred, then the Commission solicits specific suggestions for
creating such a priority list.
Gag Clause Issue. In the ANPR, the Commission explored the use of
gag clauses, contractual provisions that prohibit or restrict former or
existing franchisees from discussing their experiences within the
franchise system.¹⁹³ Recognizing that gag clauses may harm
prospective franchisees by limiting their ability to conduct a due
diligence investigation of the franchise offering,¹⁹⁴ the
Commission asked for

[[Page 57313]]

comment on the extent to which franchisors use gag clauses to inhibit
franchisee speech, whether the Commission should modify the Rule to
prohibit franchisors from using gag clause provisions, and alternatives
that would ensure that prospective franchisees can freely obtain
information from former and existing franchisees about their experience
with the franchise system.
---------------------------------------------------------------------------

\193\ 62 FR at 9121.
\194\ See FTC v. Orion Prod., Bus. Franchise Guide (CCH) para.
10,970 (N.D. Cal. 1997), and FTC v. Tutor Time Child Care Sys., Bus.
Franchise Guide (CCH) para. 10,971 (N.D. Cal. 1997). Cf. FTC v.
Comprehensive Accounting Corp., Bus. Franchise Guide (CCH) para.
8911 (N.D. Ill. 1987 (Defendants prohibited from ``wrongfully
discouraging'' franchisees from giving unfavorable references to
potential investors.'').
---------------------------------------------------------------------------

In response, a quarter of the commenters (42 out of 166 commenters)
address the gag clause issue, the majority opposing their
use.¹⁹⁵ In addition, several participants at the Commission
staff's six public workshop conferences on the ANPR identified gag
clauses as a problem. The most poignant example was a franchisee of an
undisclosed franchise system who attended the Chicago public workshop
conference. She told Commission staff that she had to speak quickly
because she was on her way to sign a final agreement terminating her
relationship with her franchisor. The termination agreement she was to
sign included a gag clause.¹⁹⁶
---------------------------------------------------------------------------

\195\ E.g., Manuszak, Comment 13, at 1; Sibent, Comment 41, at 1
(and 19 identical comments); AFA, Comment 62 at 3; IL AG, Comment
77, at 2; Buckley, Comment 97, at 1; Marks, Comment 107, at 2; WA
Securities, Comment 117, at 2; NASAA, Comment 120, at 4; Dady &
Garner, Comment 127, at 2. Opponents of gag clauses include several
franchisor representatives. E.g., Kestenbaum, Comment 40, at 2.
Cendant opposes the use of gag clauses outside of litigation, except
to protect trade secrets or other proprietary information. Cendant,
Comment 140, at 3.
\196\ Lundquist, 22 Aug 97 Tr at 42-43. See also Maloney,
Comment 38, at 2.
---------------------------------------------------------------------------

Commenters opposing the use of gag clauses, including state
regulators and some franchisors, assert that such clauses inhibit
prospective franchisees from learning the truth about the franchise
system as they attempt to conduct their due diligence investigation of
the franchise offering.¹⁹⁷ Attempts to restrict franchisee
speech through gag clauses may deceive prospects by effectively
eliminating one source of information, namely those who may have a
dispute with the franchisor or are otherwise disgruntled.¹⁹⁸
Indeed, a franchisor, if it wished to do so, could use gag clauses to
ensure that prospects speak with only those franchisees who are
successful or otherwise inclined to give a positive
report.¹⁹⁹ In addition, one commenter contends that the harm
flowing from gag clauses goes beyond individual franchise sales, noting
that gag clauses intimidate franchisees against testifying before
legislative committees and public agencies, such as the
Commission.²⁰⁰
---------------------------------------------------------------------------

\197\ NCL, for example, states: ``Because the experience of
others who have purchased a franchise or business opportunity is the
best indicator of potential earnings and other factors for
prospective buyers, `gag orders' that prohibit people from sharing
their experience with others should be prohibited.'' NCL, Comment
35, at 3. See also Baer, Comment 25, at 3; Karp, 19 Sept 97 Tr at
95-96.
\198\ From example, Roger Haines, a Scorecard Plus franchisee,
states:
I had spoken to some of the franchisees that had left the
system. I now feel certain that they painted a picture that was not
close to being the truth based on the gag order that [the
franchisor] imposed. Had I gotten the truth from these people, my
decision certainly would have been different. Every franchisee
leaving the system has had a gag order placed on them, making it
impossible for current and future franchisees to get the facts.
Haines, Comment 100, at 2.
\199\ See NASAA, Comment 120, at 4.
\200\ Selden, Comment 133, Appendix B, at 2.
---------------------------------------------------------------------------

On the other hand, several franchisors or their representatives
oppose banning the use of gag clauses. For example, one commenter
contends that gag clauses prevent disgruntled franchisees from
inflaming others and enable franchisors to end relationships with
problem franchisees without spending considerable resources. He asserts
that banning gag clauses would impede informal settlements between
franchisors and franchisees.²⁰¹ Other commenters note that
franchisors must have the ability to protect their trade secrets from
disclosure.²⁰²
---------------------------------------------------------------------------

\201\ Kaufmann, Comment 33, at 5-6; See also Tifford, Comment
78, at 3; IFA, Comment 82, at 2; Duvall, 6 Nov 97 Tr at 247;
Gitterman, 6 Nov 97 Tr at 250-51.
\202\ Baer, Comment 25, at 3. Even franchisee advocates
recognize franchisor's legitimate need for trademark protection.
E.g., AFA, Comment 62, at 3; Zarco & Pardo, Comment 134, at 4.
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Other commenters offer a variety of suggestions on how the
Commission might address the use of gag clauses short of an outright
ban. For example, a few commenters suggest that franchisors should note
in their Item 20 which specific franchisees are subject to a gag clause
provision. Such a requirement would accomplish two goals
simultaneously. It would alert prospective franchisees that the
franchisor may require its franchisees to sign gag clauses, and it
would save prospects the time and trouble of trying to contact
franchisees who, in fact, are not free to speak.²⁰³ In
response, however, one commenter contends that such an approach would
be unnecessarily burdensome, observing that franchisors would have to
update their disclosures more frequently, especially in franchise
registration states.²⁰⁴
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\203\ See Cordell, 6 Nov 97 Tr at 247-48; Kezios, id. at 256.
See also NASAA, Comment 120, at 4.
\204\ Wieczorek, 6 Nov 97 Tr at 258-59.
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As an alternative, several comments suggest that franchisors
disclose the number and percentage of current and former franchisees
subject to gag clauses. Indeed, of the various proposals suggested in
response to the ANPR and during the public workshop conferences, a
general disclosure about the use of gag clauses garnered the most
support.²⁰⁵ Finally, one commenter adds that franchisors
should disclose the use of gag clauses over a period of three years in
order to highlight a pattern or trend in their usage. He observes:
``the fact that 1 out of 100 of 1996's former franchisees had a gag
order does not really fairly present the picture if you have 80 out of
100 in 1995.'' Bundy, 6 Nov 97 Tr at 257. Rather, franchisors should
present information that would reveal a trend.
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\205\ Zarco & Pardo, Comment 134, at 4. Similarly Howard Bundy
adds that ``[i]n a perfect world I would have a list of those that
are subject to [gag clauses], so I didn't have to make all those
extra 75 calls. But I could live with or without that. It's more
important to disclose the fact that they do exists.'' Bundy, 6 Nov
97 Tr at 249. See also Selden, Comment 133, Appendix B, at 2;
Jeffers, 6 Nov 97 Tr at 251-52. See also Wieczorek, 6 Nov 97 Tr at
260.
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Based upon the record, the Commission proposes to modify UFOC Item
20 to require franchisors to disclose information about their use of
gag clauses, which bar franchisees from speaking with others about
their personal experiences as franchisees.²⁰⁶ The Commission
finds that such clauses are widespread in termination agreements and
dispute settlements.²⁰⁷ Neither the current Rule or UFOC
Guidelines addresses this issue.
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\206\ The term ``gag clause'' is defined in proposed section
436.3(k) as: ``any contractual provision entered into by a
franchisor and a current or former franchisee that prohibits or
restricts the franchisee from discussing his or her personal
experience as a franchisee within the franchisor's system. It does
not include confidentiality agreements that protect the franchisor's
trademarks or proprietary information.
\207\ For example, one franchisee signed an agreement upon
termination that contained the following clause:
The Slimak parties shall not make any derogatory or disparaging
action or make any false, derogatory, or disparaging comment,
publicly or privately, concerning the Jacadi parities, or any of the
directors, officers, shareholders, affiliates, employees, agents,
consultants, successors, or assigns or Jacadi products * * *. If
questioned by any third party as to the circumstances surrounding
the termination of the franchise agreement. The Slimak Parties shall
state only that the parties mutually agreed to terminate their
commercial relationship.
Slimak, Comment 130, at 1. See also Doe, 7 Nov 97 Tr at 276.
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Proposed section 436.5(t)(6) provides that a franchisor must
disclose the existence of gag clauses if, within the last three fiscal
years, franchisees have signed gag clause provisions in any agreement,
settlement, or other contract. In addition, the franchisor must state

[[Page 57314]]

the consequences to the prospective franchisee, namely that current and
former franchisees may not be able to speak freely about their
experiences. To add flexibility, the Commission proposes further that
the franchisor be permitted to disclose the number and percentage of
its current and former franchisees in each of the last three years that
are subject to a gag clause. This optional disclosure would enable a
franchisor to disclose how widespread the use of gag clauses is in its
system. For example, a franchisor might wish to disclose such data to
demonstrate that its franchisees sign gag clauses in isolated instances
only, or that the trend is away from using such clauses. At the same
time, proposed section 436.5(t)(6) would also permit a franchisor to
explain its use of gag clauses. The Commission believes that a bald
risk factor or disclosure about the number and percentage of
franchisees under a gag clause arguably may be misleading and
prejudicial to a franchisor.²⁰⁸ For example, a franchisor
conceivably may enter into an agreement containing a gag clause only at
the request of the franchisee during the course of negotiations. The
Commission believes that a franchisor should be able to clarify any
disclosures about gag clauses with additional, truthful information
that puts the use of gag clauses into a proper context.
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\208\ Two commenters suggest that the Commission require a
disclosure about gag clauses only if the number of franchisees
subject to such clauses surpasses some threshold. They imply that
isolated instances of gag clause usage may be misleading to
prospective franchisees or prejudicial to the franchisor. See Bundy,
6 Nov 97 Tr at 249; Jeffers, id. at 251-52. The Commission believes
that the flexibility offered by proposed section 436.5(t)(6), in
particular the franchisor's ability to explain when it uses gag
clauses, appears sufficient to address this concern.
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Franchisee Association Issue. In response to the ANPR, a number of
franchisees and their advocates urge the Commission to revise UFOC Item
20 to require the disclosure of trademark-specific franchisee
associations. In some instances, these organizations are recognized
councils approved by the franchisor, where franchisee-participants are
selected by the franchisor or are elected by the system's franchisees.
In other instances, the organizations are independent of the
franchisor.²⁰⁹ One commenter explains the need for such a
disclosure as follows:
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\209\ Not all independent franchisee associations are well-
received by the franshisor. Indeed, some commenters have told us
that in some instances franchisors have filed suit to stop the
formation of an independent group or have retaliated against
individuals who have participated in such groups. E.g., Donafin,
Comment 14, at 1. See also Mueller, Comment 29, at 1-2; Bell,
Comment 30, at 1; Rachide, Comment 32, at 3.

The UFOC Guidelines currently require disclosure of the
existence of purchasing cooperatives known to the franchisor, but
this is not adequate disclosure of a fact of growing importance to
franchisees, which is the existence, or non-existence, of an
autonomous franchisee association representing franchisees in that
particular franchise organization. When an organization represents a
substantial plurality of franchisees in the system, perhaps over
30%, and its existence is known to the franchisor, that fact should
be disclosed, possibly by an additional category in the list of
existing franchisees required in item 20, as an additional and
---------------------------------------------------------------------------
critical source of information about the franchise opportunity.

Selden, Comment 133, Appendix B. at 1.²¹⁰
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\210\ Similarly, Martin Cordell, a franchise examiner for the
State of Washington, observes that disclosing trade associations
could ``be a much more ready source of information as opposed to
individual franchisees who have to take time out of the businesses
to share information with the prospective franchisee.'' Cordell, 6
Nov 97 Tr at 168-69. Similarly, Susan Kezios of the AFA told us that
associations, ``have a collective memory of what has been going on
historically in the franchise system that one or another individual
franchisees may or may not have.'' Id. at 176. See also Manuszak,
Comment 13, at 1; Zarco & Pardo, Comment 134, at 3; Kezios, 6 Nov 97
Tr. at 168; Wieczorek, 6 Nov 97 Tr at 170; Bundy, id. at 173.
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Franchisors generally do not oppose a disclosure for trademark
franchisee associations, especially franchisor-sponsored franchisee
advisory councils and recognized independent franchisee associations.
However, they voice concern about any mandate to disclose independent
franchisee associations. They assert that such organizations are often
small, informal groups that come and go, or organizations formed on the
local or regional level without the knowledge of the franchisor.
²¹¹ In short, they fear liability for failing to disclose
the existence of groups that they do not know exist.
---------------------------------------------------------------------------

\211\ Shay, 18 Sept 97 Tr at 71; Wieczorek, 6 Nov 97 Tr at 169-
70; Duvall, id. at 171.
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Based upon the record, the Commission agrees that franchisors
should disclose the existence of trademark-specific franchisee
associations. ²¹² The Commission has long recognized that
the names and addresses of current franchisees is material information,
enabling prospective franchisees to conduct their own due diligence
investigation of the franchise system. Providing prospective
franchisees with information about an organized group of franchisees is
a logical extension, giving franchisees yet an additional source of
material information from which they can learn about the system,
especially franchisees' financial performance history. This disclosure
is particularly important if individual former and existing franchisees
of a system are subject to gag clauses or are otherwise reluctant to
talk with prospective franchisees. ²¹³
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\212\ The Commission is not suggesting that franchisors
disclose the existence of broad-based associations that represent
franchisee interests generally, such as the American Franchisee
Association or the American Association of Franchisees & Dealers.
\213\ The record indicates that franchisees may be reluctant to
share information about their system with prospective franchisees
either because they do not have the time, or because they fear
retaliation from their franchisor. For example, Howard Bundy told us
that he often instructs his franchisee clients to state only their
``name, rank, and serial number and refer [the prospect] back to the
franchisor for everything else.'' Mr. Bundy explains that
franchisees who make statements in connection with a franchise sale
might be deemed franchise brokers under state law and could be
liable for any claims or damages resulting from the sale. He also
fears that franchisees who volunteer information might be subject to
a defamation suit by the franchisor. Bundy, 6 Nov 97 Tr at 236-37.
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The Commission believes proposed section 436.5(t)(7) strikes the
right balance between providing disclosure to prospective franchisees
and eliminating franchisors' potential liability for failing to
disclose the existence of franchisee organizations that are unknown to
them. It would require franchisors to disclose organizations whose
existence is known to them either because the franchisor sponsors the
organization or formally recognizes the organization. In addition, it
would require the franchisor to disclose incorporated, independent
franchisee associations, but only to the extent that such organizations
make their existence known to the franchisor on an annual basis. This
would eliminate franchisors' concerns about having to disclose every
small, informal group of franchisees by limiting the disclosure to
incorporated organizations, which are more likely than unincorporated
organizations to have an ``institutional history,'' as well as the time
and inclination to speak with prospective franchisees. It would also
shift the burden to the franchisee association to ask specifically to
be included in the franchisor's disclosure document. The Commission
believes that this approach would relieve franchisors of the burden of,
and potential liability associated with, having to identify such
organizations. To further reduce compliance costs and burdens, proposed
section 436.5(t)(7) makes clear that a franchisor must list the
franchisee organization in its disclosure document to be used in the
next fiscal year only. This relieves franchisors of the burden of
having to verify the continued existence of the organization in the
future. In short, a franchisee organization would have the

[[Page 57315]]

burden to renew its request for inclusion in the disclosure document on
an annual basis.
u. Proposed section 436.5(u): Item 21 (Financial Statements)
Based upon UFOC Item 21, proposed section 436.5(u) requires the
disclosure of audited financial information based upon generally
accepted accounting principles. It improves the comparable Rule
disclosures currently found at 16 CFR 436.1(a)(20) by requiring
franchisors to present financial disclosures in columns that compare at
least two fiscal years. This will enable prospective franchisees to
analyze better the franchisor's fiscal status by seeing at a glance a
broad snap-shot of the company's historical earnings performance.
At the same time, the Commission proposes to modify the Rule to
clarify the Commission's three-year phase-in of audited financial
statements.²¹⁴ In the ANPR, the Commission solicited comment
on whether the Commission should retain the phase-in.²¹⁵
Without exception, the commenters who address this ANPR issue continue
to support a three-year phase-in,²¹⁶ and no commenter offers
any refinements or alternatives to the Commission's current phase-in
approach.
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\214\ 16 CFR 436.1(a)(20(ii).
\215\ 62 FR at 9121.
\216\ E.g., Duvall, Comment 19, at 1; Baer, Comment 25, at 4;
Kaufmann, Comment 33, at 6; Kestenbaum, Comment 40, at 2; AFA,
Comment 62, at 3; IL AG, Comment 77, at 3; Tifford, Comment 78, at
4; IFA, Comment 82, at 1; Jeffers, Comment 116, at 2.
---------------------------------------------------------------------------

The proposed phase-in clarifies and streamlines the Commission's
current phase-in provision in several ways. As with the current phase-
in, franchisors will be allowed two fiscal years before they are
required to provide full audited financial statements. The proposed
phase-in, however, eliminates the arguably confusing current
distinction between a franchisor's first ``partial'' or ``full'' fiscal
year by collapsing ``partial'' and ``full'' fiscal years into one
category. Under this proposal, all franchisors will be required to
include audited financial statements in their disclosure documents by
their third year, whether or not their first fiscal year was a partial
or full year. The proposed phase-in also clarifies the Rule by setting
forth the phase-in schedule in a clear and easy-to-understand table.
This should enable franchisors to understand quickly the Rule's phase-
in requirements. The Commission believes that the proposed phase-in of
audited financial statements not only reduces compliance costs for
start-up franchise systems, but effectively removes a potentially
significant barrier to entry.
v. Proposed Section 436.5(v): Item 22 (Contracts)
Proposed section 436.5(v) incorporates UFOC Item 22.²¹⁷
It is also substantially similar to the current Rule instruction found
at 16 CFR Sec. 436.1(g). It prevents fraud by requiring franchisors to
attach copies of all agreements pertaining to the franchise sale, such
as the franchise agreement and any leases, options, or purchase
agreements. This enables prospective franchisees to compare what the
franchisor represents in its disclosures about the franchisor's and
franchisee's legal obligations with the actual agreements that will
govern the franchise relationship.²¹⁸
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\217\ In response to the ANPR, no commenter raised any concerns
about UFOC Item 22, upon which proposed section 436.5(v) is based.
\218\ In the SBP, the Commission recognized that this
requirement ``will therefore have a remedial effect in that it will
encourage accurate discussion of the required information in the
disclosure statement.'' 43 FR at 59696.
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w. Proposed Section 436.5(w): Item 23 (Receipt)
Proposed section 436.5(w) incorporates the UFOC Guidelines' Item 23
receipt requirement.²¹⁹ There is currently no comparable
Rule requirement. The Commission believes that proposed section
436.5(w) will serve an important anti-fraud purpose. The Commission's
law enforcement experience indicates that franchisees in many instances
claim that they never received a copy of the franchisor's disclosure
document. A requirement that franchisees acknowledge receipt of the
disclosure document will better ensure that franchisees actually
receive the disclosures with all required attachments. The receipt also
serves an important consumer education function, informing prospects
that they have 14 days to review the disclosures, that franchisees
should receive certain attachments, and that franchisees can report
possible law violations. Further, as explained below, a receipt is
necessary to prove delivery in the event that a franchisor chooses to
make disclosures via the Internet.²²⁰
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\219\ In response to the ANPR, no commenter voiced any concerns
about UFOC Item 23, upon which proposed section 436.5(w) is based.
\220\ See infra Section C.10.b.
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At the same time, the Commission believes that the UFOC Item 23
receipt should be modified to afford franchisees greater flexibility in
acknowledging receipt of a disclosure document. To that end, proposed
section 436.5(w) would allow prospective franchisees to acknowledge
receipt through a ``signature.'' As explained supra at Section C.4.w.,
the Commission proposes to define the term ``signature'' to include not
only written signatures, but digital signatures, passwords, security
codes, and other devices that will enable a prospective franchisee to
easily acknowledge receipt, confirm their identity, and submit the
information to the franchisor. Proposed section 436.5(w) also provides
that franchisors may include specific instructions on how to submit the
receipt, such as via facsimile. This would enable the parties to
determine for themselves the most efficient way for the prospective
franchisee to acknowledge receipt.
Proposed section 436.5(w) also adds two new provisions. First,
section 436.5(w)(2) provides that franchisors shall obtain a signed
copy of the receipt at least five days before the prospective
franchisee signs the franchise agreement or pays any fee in connection
with the franchise sale. In effect, franchisors must have the signed
receipt at the time they furnish prospective franchisees with the
completed franchise agreement. The Commission believes this provision
is necessary to ensure that the prospective franchisee receives the
disclosures in a timely fashion. It also prevents fraud by effectively
prohibiting franchisors from requiring franchisees to backdate the
disclosure document receipt after the sale has been completed. Finally,
section 436.5(w)(3) adds a minor recordkeeping provision, requiring
franchisors to retain a copy of the signed receipt for a period of at
least three years. This provision is necessary in order for franchisors
to prove compliance with the rule's disclosure and timing provisions.
The Commission believes that this requirement should not impose any
significant costs or burdens on franchisors, who generally would retain
a copy of the receipt as a standard business practice, especially to
comply with the laws of many franchise registration states that require
franchisors to keep records of each franchise sale.

9. Proposed Section 436.6: Instructions for Preparing Disclosure
Documents

The next section of the proposed Rule sets forth the basic
instructions for preparing a disclosure document. For the most part,
the existing Rule instructions are unchanged.
a. Proposed Section 436.6(a): Plain English
Proposed section 436.6(a) adopts the UFOC's requirement that
disclosure documents be written in plain English.

[[Page 57316]]

The plain English requirement is also consistent with the efforts of
the federal government's National Performance Review to make all
federal rules and regulations easier to understand.²²¹ The
definition of the term ``plain English'' is discussed supra at Section
C.4.q.
---------------------------------------------------------------------------

\221\ See . Indeed, several agencies already
have incorporated plain English requirements in their rules and
guides. See, e.g., www.sec.gov/consumer/
plaine.htm (SEC plain English guides);
www.irs.ustreas.gov/basic/tax-regs/
reglist.htm (Internal Revenue Service plain
English guides).
---------------------------------------------------------------------------

b. Proposed Section 436.6(b): Responses
Proposed section 436.6(b) directs franchisors to respond to each
required disclosure item, either positively or negatively. Except for
minor editing, proposed instruction 436.6(b) is identical to the
current Rule provision found at 16 CFR Sec. 436.1(a)(24).
c. Proposed Section 436.6(c): No Additional Materials
The first part of proposed section 436.6(c) specifies that
franchisors may not include additional information in the disclosure
document except for information required by non-preempted state law.
This part is identical to the current Rule provision found at 16 CFR
436.1(a)(21). The remainder of the instruction makes clear that
franchisors preparing multi-state disclosures may include state-
specific information in an attachment to their basic disclosure
document. This instruction reduces compliance burdens and costs because
franchisors need not generate disclosure documents tailored for each
state. This approach is consistent with several instructions found
throughout the UFOC Guidelines.²²²
---------------------------------------------------------------------------

\222\ See, e.g., UFOC Cover Page Instructions; UFOC Item 1C
Instructions.
---------------------------------------------------------------------------

d. Proposed Section 436.6(d): Subfranchisors
Proposed section 436.6(d) addresses disclosure obligations
pertaining to subfranchisors. Specifically, it requires subfranchisors
to disclose the required information about the franchisor and, to the
extent applicable, the same information about the subfranchisor. This
is consistent with current Commission policy,²²³ as well as
the UFOC Guidelines.²²⁴
---------------------------------------------------------------------------

\223\ See Final Interpretive Guides, 44 FR at 49969.
\224\ See UFOC Guidelines, General Instructions 230 and 240.
---------------------------------------------------------------------------

10. Proposed Section 436.7: Instructions for Electronic Disclosure
Documents

Proposed section 436.7 sets forth instructions to enable
franchisors to comply with the Franchise Rule electronically. In the
ANPR, the Commission solicited comment on how franchisors might comply
with the Franchise Rule via the Internet.²²⁵ In response,
two commenters offer substantially similar proposals, recommending that
the Commission permit compliance via the Internet in at least the
following scenario: (1) The franchisor has a web site that provides
general information about its franchise system; (2) individuals
interested in being considered for a franchise can fill out and
transmit an online application; (3) applicants deemed by the franchisor
to be serious prospects would be given a password to gain access to a
section of the web site containing disclosure documents; and (4) the
applicant reviews the appropriate disclosure document
online.²²⁶
---------------------------------------------------------------------------

\225\ 62 FR at 9122.
\226\ Su, Comment 24; PR One, Comment 105.
---------------------------------------------------------------------------

The Commission does not wish to impede franchisors' ability to
maximize the use of new technologies in their efforts to comply with
the Rule. The Commission, therefore, proposes that franchisors be free
to use electronic media to furnish their disclosures to the fullest
extent possible.²²⁷ As the Commission recognized in its
Internet Notice, electronic transmission of disclosures may be
``easier, more efficient, and less costly to industry members.''
²²⁸ Electronic disclosure would also greatly reduce perhaps
the chief costs imposed by the Rule: printing and distribution costs.
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\227\ To that end, the proposed Rule adds three new definitions.
See supra at Section C.4. First, the term ``written'' has been
revised to include all media that are capable of being printed and
read. Second, the Commission has added the ``Internet,'' which is
defined to include all communications between computers and between
computers and other communications devices. Finally, the term
``signature,'' includes electronic signatures, passwords, and other
devices as a substitute for the traditional handprinted signature.
\228\ 63 FR at 25001.
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As explained below, the Commission proposes no new sweeping
requirements in this area. Rather, proposed section 436.7, for the most
part, elaborates upon concepts that are already part of the Rule, in
particular how to ``furnish'' disclosures electronically and how to
prepare ``clear,'' ``concise,'' and ``legible'' disclosures in an
electronic environment. Nonetheless, in order to prevent fraud and
circumvention of the Rule's pre-sale disclosure requirements, the
proposed Rule contains two new, modest requirements: (1) That
franchisors using electronic media provide prospective franchisees with
a paper summary document containing an expanded cover page, table of
contents, and acknowledgment of receipt, and (2) that franchisors
retain a specimen hard copy of each materially different version of
their disclosures.
a. Proposed Section 436.7(a): Consent
Proposed section 436.7(a) makes clear that a franchisor can furnish
disclosures electronically only if it obtains the prospective
franchisee's informed consent.²²⁹ It also provides that
prospective franchisees retain the right to revoke acceptance of an
electronic disclosure document for any reason and obtain a paper copy
up until the time of the franchise sale.
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\229\ For example, the Commission expects a franchisor to
disclose in advance the medium used to furnish its disclosures (such
as computer disk, CD-ROM, E-mail, or Internet) and any specific
applications necessary to view the disclosures (such as Windows 95,
or DOS, or a particular Internet browser).
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The Commission believes that the obligation to furnish disclosures
would be a hollow one if franchisors could force prospective
franchisees to receive disclosures in an electronic format that they
cannot actually receive or read.²³⁰ The Commission is also
concerned that fraudulent operators will gravitate toward electronic
media as a new way to avoid pre-sale disclosure. For example, a scam
artist could decide to furnish its disclosures only in some obscure
format that is essentially unaccessible to most prospective
franchisees. In keeping with the Rule's very purpose--to prevent
fraud--the Commission believes that candidates for a franchise who are
trying to conduct their own due diligence investigation should be able
to review a hard copy disclosure document if that medium is more
convenient to them. Disclosure documents are often very lengthy and
prospective franchisees may have difficulty reading the document on
screen or downloading the document onto a disk. Some prospective
franchisees simply may not wish to pay the cost to print the disclosure
document from their computer screen. Until such time as electronic
media are more widely used, and consumers are more comfortable with
such media, the traditional paper copy should remain available as an
option.
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\230\ This proposal is similar to the position adopted by the
SEC with respect to federal securities regulations. See Use of
Electronic Media For Delivery Purposes, SEC Release No. 33-7233, 60
FR 53458 (October 13, 1995) (``SEC Release''), formally adopted in
SEC Release No. 33-7289, 61 FR 24652 (May 15, 1996), which advises
the securities industry how it may use electronic media to deliver
information (i.e., prospectuses and proxy materials) required under
various federal securities statutes. A copy of the SEC release is
found at http://www/sec.gov/rules/proposed/33-
7233.txt.
---------------------------------------------------------------------------

In the same vein, the Commission believes that franchisees should
have

[[Page 57317]]

the ability to revoke acceptance of an electronic disclosure document
in favor of a paper copy up until the time of the sale.²³¹
Requiring franchisors to provide prospective franchisees with a paper
copy should not impose any significant burdens or costs. If a
prospective franchisee finds that he or she cannot easily read a
disclosure document electronically, it would be relatively easy, and
cost little, for the franchisor to print a copy of its electronic
version and mail it to the prospect.²³² This proposal is
consistent with the Commission's Internet Notice, where the Commission
---------------------------------------------------------------------------
recognized that:

\231\ See SEC Release, 60 FR at 53460-61. Similarly, the Federal
Reserve agrees in principle that consumers should be able to get a
paper copy of electronic transfer disclosures, stating that it
``expects that financial institutions will accommodate a consumer's
request for a paper copy, or that they will redeliver disclosures
electronically, to the extent that it is feasible to do so.'' See
Interim Rule on Electronic Fund Transfers (``EFT Rule''),
implementing the Electronic Fund Transfer Act, 15 U.S.C. 1693 et
seq. (1978), 63 FR 14528, 14530 (March 25, 1998). See also Selden,
Comment 133, at 3; Zarco & Pardo, Comment 134, at 5.
\232\ See Wieczorek, 6 Nov 97 Tr at 61; Duvall, id., at 62-63.
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The requirement that certain information should be provided to
another person implies that such information actually be received by
that person. Therefore, although it may be advantageous to use new
technology to comply with affirmative [disclosure] requirements,
industry members should be mindful of certain issues. For example,
the requirement to give, mail, deliver, or furnish information would
not be met if the intended recipient does not have the technological
capabilities of receiving or viewing the information. In certain
circumstances, industry members may need to obtain the recipient's
consent to deliver information by a certain electronic method,
inform the recipient of any particular medium applications needed to
view the information, or deliver the information on paper.

63 FR at 25001.
Finally, to ensure that prospective franchisees are notified about
their right to receive a paper copy, proposed section 436.3(g) requires
any franchisor seeking to furnish disclosures electronically to add the
following provision to their cover page:

You may have elected to receive an electronic version of your
disclosure document. If so, you may wish to print or download the
disclosure document for future reference. You have the right to
receive a paper copy of the disclosure document up until the time of
the sale. To obtain a paper copy, contact [name] at [address] and
[telephone number].

Thus, prospective franchisees who wish to revoke acceptance of an
electronic disclosure document for any reason will know whom to contact
to receive a paper copy.
b. Proposed Section 436.7(b): Notice and Receipt
Proposed section 436.7(b) requires a franchisor who furnishes
disclosures electronically to provide prospects with a paper summary
document containing the following three items from its disclosure
document: (1) The cover page, (2) the table of contents, and (3) the
Item 23 receipt. Franchisors already prepare these three items as part
of their disclosure document and should be able to produce the summary
document at a relatively low cost. The Commission believes the proposed
summary document requirement serves two anti-fraud purposes: (1)
Advance notice of the importance of the information being disclosed;
and (2) proof of receipt.
Based upon the Commission's law enforcement experience, it appears
that many prospective franchisees are unaware of the Franchise Rule or
that they should receive pre-sale disclosures. The Rule currently
addresses this problem by requiring a cover page that conspicuously
states, among other things, the name of the franchisor, that the
document contains important information, and certain cautionary
messages. In addition, the table of contents provides a summary of the
types of disclosures contained in the document. The Commission believes
that a prospective franchisee is more likely to read the disclosures if
he or she knows that it contains information such as the franchisor's
litigation history (Item 3), financial performance information (Item
19) and statistics on franchisees in the system (Item 20).
The proposed paper summary document would serve the same consumer
education function, alerting the prospective franchisee to the
importance of the electronic disclosures. Unlike a paper disclosure
document--which clearly announces its contents on the cover page--an
electronic disclosure document does not impart any information unless
and until the prospective franchisee actually assesses it by opening a
file or otherwise calling it up on a computer screen. The Commission is
concerned that this might provide scam artists with a new fertile
ground to commit fraud. For example, a franchise seller may seek to
furnish disclosures under the Rule by simply handing a prospect an
unmarked computer disk, without any further explanation. In such an
instance, the prospect may fail to read the disclosures contained on
the disk, or, worse, might discard the disk, because nothing draws his
or her attention to the importance of the information contained on the
disk. Similarly, a franchisor, in theory, might seek to comply with the
Rule by verbally telling a prospective franchisee to visit the
franchisor's web site to view the franchisor's disclosure document, or
by scrolling through a copy of its disclosure document online during a
presentation in a hotel room.²³³
---------------------------------------------------------------------------

\233\ The Federal Reserve has also expressed concern about
disclosures posted on the Internet without prior notice: ``Simply
posting information on an Internet site without some appropriate
notice and instructions about how the consumer may obtain the
required information would not satisfy the [disclosure]
requirement.'' 63 FR at 14529. Similarly, the SEC has stated that
stock issuers and others providing electronic delivery of
information should have ``reason to believe that any electronic
means so selected will result in the satisfaction of the delivery
requirements.'' SEC Release, 60 FR at 53461-62.
---------------------------------------------------------------------------

To combat such potential fraud, proposed section 436.7(b) requires
franchisors offering electronic versions of their disclosure documents
to provide prospective franchisee with a paper summary document. Armed
with the paper summary, the prospective franchisee would realize that:
(1) They should receive disclosures; (2) the franchisor's Internet
addresses (i.e., E-mail and web site); (3) they have at least 14 days
to review the disclosures; and (4) information on how to get a paper
copy. For additional protection, section 436.7(b)(2) requires that the
franchisor's receipt be incorporated into the summary document. This
would prevent a franchisor from having a prospect sign only the
receipt, without the benefit of reviewing the important consumer
educational messages contained in the cover page, as well as in the
table of contents.
In addition to serving a consumer education function, the summary
document is necessary to prove delivery and receipt of the disclosures.
Unlike paper disclosure documents, there is no certainty that
prospective franchisees will actually receive disclosures that are sent
via E-mail or made available over the Internet. As the Commission
recognized in its Internet Notice:

Because there may be technological difficulties that could
impede the electronic delivery of information, it may be necessary
for industry members to confirm that the recipient in fact received
the information. Most facsimile machines routinely confirm when the
facsimile has been successfully transmitted. Senders, for example,
might require recipients to confirm receipt by return e-mail or
verify in some manner the recipients' access to information posted
on the Web site.

63 FR at 25001.
The proposed Rule would provide prospective franchisees with
several options for acknowledging receipt of the disclosure document.
Prospective franchisees of course could sign the

[[Page 57318]]

receipt in either the paper summary document or Item 23 of the
disclosure document. Proposed section 436.7(b)(1)(iii) would also
enable prospective franchisees to ``sign'' the receipt in the
disclosure document electronically. As discussed above, the term
``signature'' is defined broadly to include not only the traditional
written signature, but digital signatures and other identity
verification devices, such as passwords or security
codes.²³⁴ This differs from the UFOC Guidelines, which
permits a written signature only.
---------------------------------------------------------------------------

\234\ See 63 FR at 14531.
---------------------------------------------------------------------------

While the Commission believes that franchisors and prospective
franchisees should be able to take advantage of new technologies, it
nonetheless rejects the suggestion that a franchisor be permitted to
demonstrate receipt through ``electronic verification,'' such as
embedding a code in a disclosure document that would send a signal to
the franchisor once an electronic disclosure documents has been
opened.²³⁵ The Commission believes that prospective
franchisees should take some affirmative step to acknowledge receipt
and confirm their identify. The acknowledgment of receipt serves not
only as proof of delivery, but, as discussed above, a consumer
education vehicle. For example, the acknowledgment form reminds the
prospect that he or she is to receive supplemental documents along with
the basic disclosure document, such as contracts or lease agreements.
It also informs the prospect to report any inaccuracies in the
disclosure document to the Commission and state authorities. These
potential benefits to prospective franchisees might be lost if the
franchisor could prove delivery solely through electronic verification.
Requiring a prospect to sign the acknowledgment would better ensure
that the prospect has actually read the acknowledgment page.
---------------------------------------------------------------------------

\235\ For a description of electronic verification, see Gerdes,
6 Nov 97 Tr at 79-82; Jeffers, id. at 86-87.
---------------------------------------------------------------------------

c. Proposed Section 436.7(c): Preservation of Disclosures
Proposed section 436.7(c) requires franchisors to ensure that an
electronic version of a disclosure document must be capable of being
printed, downloaded, or otherwise preserved as one single document. The
Commission believes that the concept of ``furnishing'' disclosures
implies that prospective franchisees will receive a document that can
be preserved for future reference.²³⁶ This requirement is
particularly important with respect to disclosures disseminated via the
Web (which are often transitory), especially if the franchisor does not
maintain an online archive of its disclosure documents.
---------------------------------------------------------------------------

\236\ The Federal Reserve has come to a similar conclusion. See
63 FR at 14530. See also Bundy, 6 Nov 97 Tr at 129.
---------------------------------------------------------------------------

d. Proposed Section 436.7(d): Single Document
Proposed section 436.7(d) makes clear that electronic disclosures,
like hard copies, must be capable of being reviewed as a single, self-
contained document. This proposal is analogous to the Internet Notice's
discussion of unavoidability, where the Commission stated:

to ensure effectiveness, disclosures ordinarily should be
unavoidable by consumers acting reasonably. On the Internet or other
electronic media, this means that consumers viewing an advertisement
should necessarily be exposed to the disclosure in the course of a
communication without having to take affirmative action, such as
scrolling down a page, clicking on a link to other pages, activating
a ``pop up,'' or entering a search term to view the disclosure.

63 FR at 25003.
The Commission recognizes that a franchisor, in theory, could
divide its disclosures into separate documents that are hyperlinked
together or accessed through a pop-up screen or other device. However,
the Commission believes that prospective franchisees reviewing
electronic disclosures should not have to surf the franchisor's web
site or take affirmative action to access the required disclosures. In
addition, if a prospective franchisee sought to download or print the
disclosure document for future reference, disclosures contained in a
separate, but linked text, would most likely be excluded. In short, any
impediment to the prospect's ability to review all portions of a
disclosure document online or to preserve the text as a single document
would render the document an ineffective communication.
e. Proposed Section 436.7(e): Features
Proposed section 436.7(e) addresses the use of special features
available in electronic media. Many special features exist in an
electronic environment, such as audio, video, graphics, pop-up screens,
and scrolling messages. Proposed section 436.7(e) limits the use of
special features to those that will assist a prospective franchisee to
navigate through a disclosure document, such as internal hyperlinks,
scroll bars, and search functions. Such features are the functional
equivalent of leafing through a hard-copy document. In other respects,
however, an electronic disclosure document must be unadorned. The
Commission is concerned that, if permitted, franchisors could use
graphics, animation, audio, video, and other features to call attention
to favorable portions of their disclosure document or to distract
prospects from damaging disclosures--such as litigation (Item 3) and
franchisee failure rates (Item 20).\237\
---------------------------------------------------------------------------

\237\ This recommendation is consistent with the current Rule's
prohibition on adding any material to the disclosure document beyond
what is specifically required by the Rule. 16 CFR 436.1(f).
---------------------------------------------------------------------------

f. Proposed section 436.7(f): Accessibility
Proposed section 436.7(f) requires that electronic disclosures
remain accessible at least until the time of the sale. The concept of
``furnishing'' disclosures implies that prospective franchisees will
receive a document that can be reviewed at will. The Commission is
concerned that a scam artist, for example, may embed a code or a virus
in a computer disk that will effectively destroys its contents.
Similarly, as noted above, disclosure documents posted on the Internet
are often transient: A disclosure document used one day may be updated
the next. It is also possible that a franchisor, for some reason, may
simply decide to suspend disseminating its disclosures online, leaving
prospective franchisees who have agreed to accept disclosures via the
Web without any ability to access the disclosures.
At the same time, the Commission recognizes that any obligation on
the franchisor's part to ensure that electronic documents remain
accessible should be limited. For example, a document posted on the
Internet may become inaccessible not because of any action taken by the
franchisor, but because of the consumer's computer problems or because
of system failures. Accordingly, proposed section 436.7(f) makes clear
that technical failures beyond the franchisor's reasonable control
(such as system crashes) will not render a document inaccessible.
Further, the Commission recognizes that franchisors are under
obligations to update their disclosure documents periodically. A
requirement that disclosures remain accessible indefinitely arguably
may result in franchisors having to post multiple versions of its
disclosures on the Internet to ensure that each prospective franchisee
has continued access to his or her particular version. The Commission
doubts that the costs and burdens of such a requirement would be
outweighed by any benefits. Accordingly, proposed section 436.7(f)

[[Page 57319]]

also makes clear that updating disclosure documents on the Internet
will not render a previously posted disclosure document inaccessible.
As long as a prospective franchisee has access to the franchisor's
current disclosure document, that should suffice.
g. Proposed Section 436.7(g): Record Retention
Proposed section 436.7(g) requires franchisors who furnish
electronic disclosures under the Rule to comply with a modest
recordkeeping requirement. Specifically, franchisors must maintain a
specimen copy of each materially different version of their disclosures
for three years. The Commission believes that a limited record
retention requirement is necessary for effective law enforcement. For
example, one commenter observes that ``only about 24 to 25 percent of
[franchise systems] are likely to be here five years from now.'' \238\
Franchisors merge, go into bankruptcy, sell their assets, and
maintenance of old records becomes very difficult, ``particularly if
they are available only in electronic form.'' He further observes that
``[e]lectronic form of documents is evolving at such a rapid clip that
something that is available in Microsoft Word 97 today may not be
readable in Microsoft Word 99 tomorrow.'' \239\ In short, he advocates
a recordkeeping requirement in order to enable a franchisee to be able
to show (and ultimately prove) what form of document he or she relied
upon.
---------------------------------------------------------------------------

\238\ Bundy, 6 Nov 97 Tr. at 58.
\239\ Id.
---------------------------------------------------------------------------

The Commission agrees. While the Rule currently does not require a
franchisor to keep copies of its disclosure documents, it does require
a franchisor to make copies of its disclosures (and financial
performance claims substantiation) available to the Commission upon
request. Franchisors also routinely keep copies of their disclosure
documents, without federal oversight, for their own business records
\240\ and to comply with state record retention requirements. It is not
unreasonable to expect franchisors to retain copies of their
disclosures in order to mount a defense to a Commission, state, or
private action. Moreover, any minimal recordkeeping costs associated
with electronic disclosures would be substantially outweighed by the
vast savings in reduced, or eliminated, printing and distribution costs
associated with disseminating paper disclosure documents.
---------------------------------------------------------------------------

\240\ See Houston-Aldridge, 6 Nov 97 Tr at 130-31.
---------------------------------------------------------------------------

11. Proposed Section 436.8: Instructions for Updating Disclosure
Documents

The last of the instructions sections--proposed section 436.8--
concerns disclosure updating requirements. With one exception, as
discussed below, the updating requirements are identical to the
instructions already contained in the current Rule.
a. Proposed Section 436.8(a): Annual Updates
Proposed section 436.8(a) sets forth the basic updating requirement
that franchisors must revise their disclosures 90 days after the close
of the fiscal year. This instruction is identical to the current Rule
updating requirement set forth at 16 CFR 436.1(a)(22).
b. Proposed Section 436.8(b) Quarterly Updates. Proposed section
436.8(b) provides that franchisors must update their disclosure
documents to reflect any material changes on at least a quarterly
basis. This instruction is also identical to the current Rule updating
requirement set forth at 16 CFR 436.1(a)(22).
c. Proposed Section 436.8(c): Material Change Disclosures
Proposed section 436.8(c), a new provision, would enhance the
current Rule's updating provisions to require franchise sellers to
notify prospective franchisees about any material changes that may have
occurred since the prospective franchisees received their disclosure
documents. For example, it is possible that a franchisor may file for
bankruptcy, lose a class action suit that might affect its ability to
continue in business, or undergo some other material change since the
last quarterly update. Currently, franchisors must notify prospective
franchisees only about material changes underlying a financial
performance representation.\241\ To prevent fraud, proposed section
436.8(c) makes clear that it is an omission of material information in
violation of section 5 of the FTC Act for a franchisor to fail to alert
prospective franchisees about material changes when it knows that
prospective franchisees are relying on the incomplete information
contained in a disclosure document. Franchise sellers, therefore, must
alert prospective franchisees about any material changes since the last
quarterly update when they furnish the disclosure document. Franchise
sellers must also alert prospective franchisees to any additional
material changes when they deliver a copy of the completed franchise
agreement at least five days before the franchise agreement is
executed. This proposed revision of the Rule's updating requirements
does not require franchisors actually to amend their disclosure
documents, which might impose unwarranted costs. Rather, a franchisor
must simply notify the prospective franchisee about any such material
changes. An oral statement or faxed letter, for example, would be
sufficient.
---------------------------------------------------------------------------

\241\ See 16 CFR 436.1(e)(6).
---------------------------------------------------------------------------

d. Proposed Section 436.8(d): Updated Audited Information
Proposed section 436.8(d) retains the Commission's current policy
that audited information in a disclosure document need not be re-
audited on a quarterly basis. Rather, a franchisor can update its
audited disclosures by including unaudited information, provided the
franchisor discloses that the information is unaudited. This
instruction is identical to the current Rule updating requirement set
forth at 16 CFR 436.1(a)(22).

12. Proposed Section 436.9: Exemptions

The Commission proposes to retain all of the existing Rule
exemptions and to add several additional exemptions. At the same time,
the Commission proposes to eliminate the exclusions currently found at
16 CFR 436.2(a)(4)(i)-(iv).\242\ In the SBP, the Commission recognized
that these four relationships are not franchises, but might be
perceived as falling within the definition of a franchise.\243\ To
avoid any confusion, the Commission expressly excluded these four
relationships from Rule coverage. The Commission believes that these
exclusions no longer serve a useful purpose. While there may have been
some confusion about the extent of Rule coverage at the time the
Commission promulgated the Franchise Rule nearly twenty years ago, the
Commission does not believe that such confusion exists today. Since the
Rule went into effect in the 1970s, the franchise community has become
very familiar with the Rule's requirements, including the definition of
the term franchise. In eliminating the four exemptions, however, the
Commission is not signaling a substantive change in Commission policy.
Rather, the elimination of the

[[Page 57320]]

exclusions is simply part of the Commission's general effort to
streamline the Rule.
---------------------------------------------------------------------------

\242\ The Rule currently excludes four non-franchise
relationships: (1) Employer-employee and general partnership
relationships; (2) relationships created by membership in a
cooperative association; (3) relationships in a testing or
certification service; and (4) ``single'' license relationships.
\243\ SBP, 43 FR at 59708.
---------------------------------------------------------------------------

a. Proposed Section 436.9(a): Minimum Payment Exemption
Proposed section 436.9(a) is substantially similar to the
Commission's current $500 minimum investment exemption found at 16 CFR
436.2(a)(3)(iii). This exemption ensures that the Rule ``focuses upon
those franchisees who have made a personally significant monetary
investment and who cannot extricate themselves from the unsatisfactory
relationship without suffering a financial setback.'' \244\ Proposed
section 436.9(a) also enhances the current minimum payment exemption by
incorporating the Commission's long-standing policy exemption for
inventory purchases into an express Rule exemption. In the Final
Interpretive Guides, the Commission stated that, as a matter of policy,
it would exempt from the Rule's ``required payment'' definitional
element reasonable amounts of inventory purchased at bona fide
wholesale prices for resale.\245\ In adopting this policy, the
Commission recognized that it is often difficult to distinguish between
inventory purchases that are required by contract or by practical
necessity and those that are merely discretionary. The Commission
noted, however, that franchisors could disguise up-front franchisee
fees by inflating the level of inventory franchisees must purchase and/
or inflating the purchase price. To reduce this fear, the Commission
limited the policy exemption to reasonable amounts of inventory (as
determined by standard industry practices) and purchases at bona fide
wholesale prices.\246\ The proposed exemption, therefore, does not
change Commission policy, but makes it clear that traditionally non-
franchised businesses can sell inventory without the fear of triggering
the Rule's minimum payment requirement.
---------------------------------------------------------------------------

\244\ SBP, 43 FR at 59704.
\245\ Final Interpretive Guides, 44 FR at 49967.
\246\ Id.
---------------------------------------------------------------------------

b. Proposed Section 436.9(b): Fractional Franchise Exemption
Proposed section 436.9(b) retains the fractional franchise
exemption currently found at 16 CFR 436.2(a)(3)(i). However, the
definition of the term ``fractional franchise'' has been modified
slightly, as discussed above at Section C.4.f.
c. Proposed Section 436.9(c): Leased Department Exemption
Proposed section 436.9(c) retains the leased department exemption
currently found at 16 CFR 436.2(a)(3)(ii). However, the Commission has
streamlined the exemption by creating a clearer and shorter definition
of the term ``leased department,'' as discussed above at Section C.4.m.
d. Proposed Section 436.9(d): Petroleum Marketers and Resellers
Exemption
Proposed section 436.9(d) adds a new exemption for petroleum
marketers and resellers covered by the Petroleum Marketing Practices
Act (``PMPA''). 15 U.S.C. 2801. In 1980, the Commission granted a
petition for an exemption from the Rule filed by several oil companies
and oil jobbers, pursuant to section 18(g) of the FTC Act.\247\
Specifically, the Commission stated that the Rule ``shall not apply to
the advertising, sale or other promotion of a `franchise,' as the term
`franchise' is defined by the [PMPA].'' \248\ In considering the
petition, the Commission noted that the most frequently cited complaint
voiced in the record about the petroleum franchise industry concerned
termination and renewal practices. After the close of the Commission's
franchise rulemaking record, Congress passed the PMPA, which
specifically addressed that complaint, requiring, among other things,
pre-sale disclosure of franchisees' termination and renewal rights.
Accordingly, the Commission concluded that the Franchise Rule was
largely duplicative of the PMPA and related federal regulations.
---------------------------------------------------------------------------

\247\ See 45 FR 51765 (August 5, 1980).
\248\ Id. at 51766.
---------------------------------------------------------------------------

Since 1980, Commission staff has received only isolated complaints
regarding abuses in the relationship between petroleum franchisors and
their franchisees, and the Commission has no reason to believe that a
pattern of abuse is likely to develop in the near future. Moreover,
even if such abuses did occur, the Commission has already committed
itself to handling the matter through an industry-specific
rulemaking.\249\ For these reasons, the Commission proposes to
incorporate the 1980 policy exemption into the Rule as an express Rule
exemption.
---------------------------------------------------------------------------

\249\ At the time the Commission granted the petition, it
recognized that circumstances may change in the industry which would
warrant a fresh review:
[I]f circumstances change in the future and evidence of renewed
misrepresentations in the ale of petroleum franchises reappears on a
significant scale, a new rulemaking proceeding may be undertaken
that is tailored to the specific needs of the industry. In the
interim, if isolated abuses occur, they will be subject to the
adjudicative procedures and remedies provided by section 5 of the
FTC Act.
---------------------------------------------------------------------------

e. Proposed Section 436.9(e): Sophisticated Investor Exemptions
Proposed section 436.9(e) sets forth two new exemptions, which
collectively can be referred to as ``sophisticated investor''
exemptions: (1) the large investment exemption; and (2) the large
corporate franchisee exemption. In response to the ANPR, several
commenters urge the Commission to adopt a sophisticated investor
exemption to the Rule.\250\ These commenters note that franchising
today may involve heavily-negotiated, multi-million dollar deals
between franchisors and highly sophisticated individual and corporate
franchisees who are represented by counsel. In the course of such
deals, the franchisees often demand and receive information from the
franchisor that equals or exceeds the disclosures required by the Rule.
They contend that these are not the kinds of franchise sales that the
Rule was intended to cover. Commenters further assert that the Rule's
mandatory waiting requirements (currently 10 business days to review
disclosures and five business days to review completed contracts)
impose unnecessary costs and add unwarranted delay in the high-paced
negotiation process, where parties often are anxious to cement their
deals quickly to beat out the competition.\251\ At the same time, some
commenters voice concern about the breath of any such exemption. They
fear that investors may appear to be sophisticated only because of a
certain net worth or prior business experience, but may have limited
knowledge of the risks inherent in operating the specific franchise
being offered. In short, they contend that the Commission should
protect the wealthy, but inexperienced.\252\
---------------------------------------------------------------------------

\250\ See Tifford, Comment 78, at 2; Duvall & Mandel, Comment
114, at 2-3; Cendant, Comment 140, at 2; Kaufmann, 18 Sept 97 Tr at
190; Wieczorek, id. at 192; Forseth, id. at 194-95. See also Caruso,
Comment 118, at 1. Some commenters did not advance a sophisticated
investor exemption, but did not oppose it. See Bundy, 6 Nov 97 Tr at
19-20.
\251\ See Kaufmann, 18 Sept 97 Tr at 165, 170-71; Wieczorek, id.
at 187-88 and 6 Nov 97 Tr at 26. One Commenter notes that while
franchisors can file individual petitions for exemptions to the Rule
under section 18(g), the process is costly and the delay involved
often renders this approach an unviable option. Duvll & Mandel,
Comment 114, at 16.
\252\ See Zarco & Pardo, Comment 134, at 4-5; Kezios, 6 Nov 97
Tr at 47-48; Bundy, id, at 48-49.
---------------------------------------------------------------------------

Based upon the record, the Commission agrees that appropriate
exemptions for sophisticated investors are warranted. The Commission
has long recognized that the Rule's

[[Page 57321]]

protections may be unnecessary where the likelihood of abuse does not
exist. Proposed section 436.9(e)(1) would exempt franchise sales where
the investment totals at least $1.5 million. The Commission believes
that one measure of ``sophistication'' is the size of the investment.
In granting petitions for exemption from the Franchise Rule under
section 18(g) of the FTC Act, the Commission has noted several factors
that, when present, suggest that application of the Rule may be
unwarranted, including the size of the investment. For example, in
granting the Petition submitted by the Automobile Importers of America,
Inc.,\253\ the Commission observed:
---------------------------------------------------------------------------

\253\ 45 FR 51763 (August 5, 1980).

Prospective motor vehicle dealers make extraordinarily large
investments. As a practical matter, investments of this size and
scope involve relatively knowledgeable investors or the use of
independent business advisors, and an extended period of
negotiation. The record is consistent with the conclusion that the
transactions negotiated by such knowledgeable investors over time
and with the aid of business advisors produce the pre-sale
information disclosure necessary to ensure that investment decisions
are the product of an informed assessment of the potential risks and
---------------------------------------------------------------------------
benefits of the proposed investment.

Id. at 51,764.
The Commission believes that a $1.5 million threshold is sufficient
to exempt sophisticated investors, yet protect ordinary consumers who
seek to purchase a franchise. Consumers who have $1.5 million available
to invest in a franchise are likely to be experienced business
persons.²⁵⁴ Further, an investment of $1.5 million most
likely would involve the purchase of a single large investment--such as
a hotel or the most expensive restaurant location--or the purchase of
multiple, less costly units. Purchasers of multiple units are more
likely to be persons with significant business experience in light of
the management demands such as hiring staff and ensuring efficient
operation of the outlets. In addition, purchasers of multiple units are
likely to include existing franchisees with significant prior
experience with the franchisor. These experienced investors are not
likely to purchase a franchise on impulse, are more likely to negotiate
over the terms of any contract, and are more resistant to high pressure
sales representations.
---------------------------------------------------------------------------

\254\ See Wieczorek, 6 Nov 97 Tr at 43.
---------------------------------------------------------------------------

Proposed section 436.9(e)(1) has additional safeguards beyond the
$1.5 million threshold to ensure that average consumers will be
protected. First, the proposed exemption makes clear that funds
obtained from the franchisor (or an affiliate) cannot be counted toward
the $1.5 million threshold. Most purchasers of a franchise, or group of
franchises, that require a $1.5 million level of investment will have
to turn to banks or other sources of financing. Lenders most likely
will ensure that the investor has conducted a due diligence
investigation of the offering before approving any loan.²⁵⁵
This assurance, however, is absent if the source of any funds is the
franchisor or an affiliate. Indeed, a prospective franchisee who is
inclined to purchase without a thorough examination of the proposed
franchise deal may also be lulled into making a large investment when
offered attractive financing by the franchisor.
---------------------------------------------------------------------------

\255\ Lenders are also likely to require the prospective
investor to have sufficient equity capital in order to qualify for a
loan. Indeed, with an investment of $1.5 million, a lending
institution may require equity of several hundred-thousand dollars
before considering a loan. This lending-industry requirement further
ensures that, as a practical matter, the proposed exemption would be
limited to sophisticated investors only.
---------------------------------------------------------------------------

Second, the proposed large investment exemption requires the
prospective franchisee to sign an acknowledgment that the franchise
sale is exempt from the Franchise Rule because the prospective
franchisee will be investing more than $1.5 million. This requirement
will reduce the probability that the franchisor may misrepresent the
cost of the franchise. It will also provide a paper trail in the event
an enforcement action becomes necessary.
While the Commission believes that the proposed large investment
exemption is proper, it nonetheless solicits additional comment on this
issue. Specifically, the Commission seeks comment on whether the
proposed $1.5 million threshold is too high or low and, if so, what
would be an alternative threshold, including any specific facts or data
that would support such an alternative.
Proposed section 436.9(e)(2) would exempt from the Rule the sale of
franchises to large corporations, namely those that have been in
business for at least five years that have a net worth of at least $ 5
million.²⁵⁶ There appears to be little risk for abuse where
a franchisor sells a single or multiple franchises to a large corporate
franchisee. Such transactions often are heavily negotiated by
sophisticated counsel who have significant experience in the franchise
industry. Even if a large corporation does not have prior experience in
franchising specifically, it is reasonable to assume that it can
protect its own interests when negotiating for the purchase of a
franchise.²⁵⁷ Nonetheless, the Commission solicits
additional comment on the proposed large corporation exemption.
Specifically, the Commission seeks comment on whether the proposed 5
years and $5 million thresholds are sufficient and solicits any
alternatives.
---------------------------------------------------------------------------

\256\ No state has a comparable exemption. Several states--
including California, Indiana, Maryland, New York, North Dakota,
Rhode Island, South Dakota, and Washington--have an exemption from
registration for ``experienced franchisors,'' focusing on the
franchisor, rather than on the prospective investor. To qualify for
the exemption, a franchisor must typically have a net worth of at
least $5 million and have had 25 franchise locations in operation
during the previous five years. See generally Duvall & Mandel,
Comment 114, at 3-4.
\257\ See Kaufmann, 18 Sept 97, Tr at 190. The proposed large
corporate-franchisee exemption is also a logical extension of the
rule's fractional franchise exemption. The fractional franchisee
exemption focuses narrowly on purchasers who wish to expand their
product lines, have experience in the field, and face a minimal
financial risk. For example, a small grocery store owner probably
would be a fractional franchisee if he or she became a snack food
distributor. Under the current rule, however, a hospital purchasing
the same snack food distributorship probably would not be deemed a
fractional franchisee because of a lack of prior experience in food
sales. This is an illogical result, given the hospital's greater
financial resources and bargaining power. Hospitals and other large
institutions such as airports and universities are hardly the type
of ``consumers'' that the Commission needs to protect. See Kirsch,
18 Sept 97 Tr at 198-99. But see Kezios, id. at 191-92.
---------------------------------------------------------------------------

Finally, proposed section 436.9(e) states that the Commission may
publish revised thresholds for the sophisticated investor exemption
once every four years to adjust for inflation. While the Commission
believes that the proposed thresholds are sufficient today, it is quite
possible that in a few years these thresholds will be too low because
of inflation. Accordingly, the Commission proposes to publish revised
thresholds in the Federal Register once every four years.²⁵⁸
A four-year adjustment period appears to strike the right balance

[[Page 57322]]

between ensuring that the thresholds keep up with inflation and
relieving the Commission of the expense and burden of more frequent
adjustments. Nonetheless, the Commission solicits comment on whether a
periodic inflation adjustment is warranted, the costs and benefits of a
four-year adjustment period, as well as any alternatives.
---------------------------------------------------------------------------

\258\ This inflation adjustment proposal is modeled after the
Appliance Labeling Rule, 16 CFR 305, which sets forth ranges of
estimated annual energy costs and consumption for various
appliances. Because energy cost and appliance efficiencies
fluctuate, the Commission adjusts the label requirements
periodically by publishing in the Federal Register new costs and
ranges, which then become part of the rule's labeling requirements.
To that end, section 305.9(b) of the Appliance Labeling Rule
provides: ``Table 1, above, will be revised on the basis of future
information provided by the Secretary of the Department of Energy,
but not more often than annually.'' The proposal is also consistent
with the Commission's procedures for adjusting thresholds or other
information in Commission-enforced statutes. For example, the
Commission publishes in the Federal Register annual adjustments for
determining illegal interlocking directorates in connection with
section 19(a)(5) of the Clayton Act, as well as adjustments to civil
penalties at least once every four years under the Debt Collection
Improvement Act of 1966. See 61 FR 54549 (October 21, 1996).
---------------------------------------------------------------------------

f. Proposed Section 436.9(f): Officers and Owners Exemption
Proposed section 436.9(f) would exempt sales to franchisees who are
(or recently have been) officers or owners of the
franchisor.²⁵⁹ There does not appear to be any need for
disclosure in such circumstances because we can reasonably assume that
the prospective franchisee already is familiar with every aspect of the
franchise system and the associated risks. Further, in some instances,
a company may wish to offer units to its owners or directors only. If
not exempt, these companies would have to go through the burden and
expense of creating a disclosure document for isolated sales to company
insiders. To ensure that individuals qualifying for the exemption have
recent and sufficient experience with the franchisor, the proposed
exemption is limited to individuals who have been associated with the
franchisor within 60 days of the sale and who have been within the
franchise system for at least two years.
---------------------------------------------------------------------------

\259\ The proposed exemption is modeled after nearly identical
language in California's franchise statute. Washington and Rhode
Island have similar exemptions. See Duvall & Mandel, Comment 114, at
21.
---------------------------------------------------------------------------

g. Proposed Section 436.9(g): Oral Contracts
The final exemption, proposed section 436.9(g), retains the current
exemption for oral contracts found at 16 CFR 436.2(a)(3)(iv). In the
SBP, the Commission recognized that problems of proof make it difficult
to regulate purely oral agreements. In addition, the record indicated
that oral arrangements are usually informal and require only nominal
investments. ²⁶⁰
---------------------------------------------------------------------------

\260\ SBP, 43 FR at 59708.
---------------------------------------------------------------------------

13. Proposed Section 436.10: Additional Prohibitions

The next section of the Proposed Rule--proposed section 436.10--
sets forth additional prohibitions. Proposed section 436.10 differs
from the current Rule prohibitions in several respects. First, it
updates the Rule's provisions regarding financial performance
representations made in the general media to include representations on
the Internet and other advertising vehicles. Second, it prohibits
franchisors from including integration clauses in their contracts that
would effectively absolve them from liability for statements made in
their disclosure documents. Finally, it makes clear that the use of
paid references (shills) is an unfair and deceptive act or practice in
violation of section 5 of the FTC Act.
a. Proposed Section 436.10(a): No Contradictory Statements
Proposed section 436.10(a) prohibits franchisors from making any
statements that are contradictory to those set forth in their
disclosure documents. Except for minor editing, this is identical to
the current Rule prohibition set out at 16 CFR 436.1(f).
b. Proposed Section 436.10(b): Refunds
Proposed section 436.10(b) prohibits franchisors from failing to
honor their refund guarantees. This is similar to the comparable Rule
provision found at 16 CFR Sec. 436.1(h). However, the Commission
proposes to modify the prohibition slightly. The current section
436.1(h) prohibits franchisors from failing ``to return any funds or
deposits in accordance with any conditions disclosed pursuant to
paragraph (a)(7) of this section.'' Thus, the provision is limited to
instances where the franchisor makes an express refund promise in the
disclosure document itself. The Commission's law enforcement experience
indicates, however, that in some instances franchisors do not make any
specific promise in the disclosure document, but do so either in the
franchise agreement or in a separate contract or letter of
understanding. Proposed section 436.10(b) makes clear that the failure
to honor any written refund promise in connection with a franchise sale
will constitute a Rule violation. ²⁶¹
---------------------------------------------------------------------------

\261\ One commenter, Dady & Garner, suggests that franchisees
should always receive a refund (minus actual costs) if they never
actually open or operate an outlet. Dady & Garner, Comment 127, at
4. The Commission believes that the substantive terms and conditions
of refunds are a matter of contract between the parties. As long as
the terms and conditions of any refund policy are spelled out in the
disclosure document or franchise agreement, that appears to be
sufficient.
---------------------------------------------------------------------------

c. Proposed Section 436.10(c): Written Substantiation
Proposed section 436.10(c) prohibits franchisors from failing to
make available to prospective franchisees and to the Commission upon
reasonable request written substantiation for any financial performance
representations made in an Item 19 disclosure. Except for minor
editing, this provision is identical to the current Rule provision
found at 16 CFR 436.1(b) and 436.(1)(c).
d. Proposed Section 436.10(d): Financial Performance Statements
Proposed section 436.10(d) addresses the dissemination of financial
performance representations outside of a disclosure document, including
the general media, Internet advertising, and unsolicited commercial E-
Mail. In the ANPR, the Commission questioned the continuing need for
the general media claims provision currently set out at 16 CFR
436.1(e). ²⁶² In response, no commenter raised any concerns
about the Rule's existing approach toward general media financial
performance claims. On the other hand, a few commenters note the
proliferation of financial performance claims in the general media. For
example, the AFA states:

\262\ 62 FR at 9122.
---------------------------------------------------------------------------

You have to look no further than last Thursday's edition of the
Wall Street Journal to see examples of misleading advertisements
with regard to earnings potential. For example, one franchisor
consistently advertises by saying ``60% to 80% gross profit
margins.'' An advertisement for a master franchisee states ``a
proven method of making a fortune.'' * * * Consumers see the
advertisement first, the franchise agreement second and then the
franchisor's salesperson says something like ``we are prohibited by
law from making any earnings claims.'' But the damage has already
been done--the consumer has seen the ad.

AFA, Comment 62, at 6. ²⁶³
---------------------------------------------------------------------------

\263\ See also Winslow, Comment 92, 1-2.
---------------------------------------------------------------------------

Based upon the record, the Commission believes that disclosure
requirements for financial performance representations made in the
general media continue to serve a useful purpose. The Commission's law
enforcement experience also demonstrates that such claims are prevalent
and continue to attract a number of consumers.²⁶⁴ Indeed,
the communications age has ushered in new advertising media such as the
Internet and unsolicited commercial E-mail. For example, many companies
have home pages that contain express financial performance
representations and thousands of consumers receive ``spam'' E-mail
messages encouraging them to invest in various
opportunities.²⁶⁵

[[Page 57323]]

Accordingly, guidance concerning financial performance representations
in traditional and new advertising media is clearly warranted.
---------------------------------------------------------------------------

\264\ For example, the Commission's 1995 Project Telesweep, in
which the FTC and state law and local enforcement authorities filed
nearly 100 law enforcement actions, was based upon the finding that
many franchise and business opportunity sellers seek to attract
consumers through advertisements, in particular advertisements with
outrageous earnings representations.
\265\ Indeed, the Commission has testified before the Senate
Commerce, Science and Transportation Committee that ``the
proliferation of deceptive, unsolicited commercial E-mail * * *
could undermine consumer confidence and slow the growth of Internet
commerce,'' noting that the FTC has collected over 100,000 pieces of
unsolicited commercial E-mail and receives up to 1,500 new pieces
daily. See FTC News, Growth of Deceptive ``Spam'' Could Undermine
Consumer Confidence in Internet (June 17, 1998).
---------------------------------------------------------------------------

Proposed section 436.10(d) prohibits any franchise seller from
making a financial performance representation outside of a disclosure
document unless the seller: (1) has a reasonable basis for the claim;
(2) has written substantiation for the claim at the time it is made;
(3) includes the representation in Item 19 of its disclosure document;
(4) includes the number and percentage of the measured outlets that
support the claim from its Item 19 disclosure; and (5) includes a
conspicuous admonition that a new franchisee's individual financial
results may differ from those stated in the representation. In short, a
franchisor may make a financial performance claim in advertising
materials only if the claim is consistent with, and includes the
limited required information taken from, its Item 19 disclosures made
to prospective franchisees.
The Commission finds that the proposed section 436.10(d) approach
to financial performance claims greatly streamlines the current Rule
provision and should make it easier for franchisors to disseminate
truthful financial performance information. For example, under the
current Rule approach, franchisors making general media performance
representations are required to give a prospective franchisee a
separate earnings claim document that sets forth the claim in detail
and, depending upon the nature of the claim, specific cautionary
language. Proposed section 436.10(d) would eliminate these
requirements. The Commission believes that the Item 19 disclosure
requirements, in the format described above, are sufficient to provide
meaningful performance information to prospective franchisees without
the need for a separate disclosure document.
e. Proposed Section 436.10(e): Disclaimers
Proposed section 436.10(e), a new prohibition, addresses the issue
of contract integration clauses. It would prohibit franchisors from
disclaiming liability for, or causing franchisees to waive reliance on,
statements made in their disclosure documents. In response to the ANPR,
a number of franchisees and their representatives commented that
franchisors routinely seek to disclaim liability for their pre-sale
disclosures through the use of contract integration clauses. These
clauses effectively force franchisees to waive any rights they have to
rely on pre-sale disclosures made to them during the sales process. For
example, one commenter states:

In virtually every lawsuit I have filed for franchisees alleging
fraud, franchise disclosure, or unfair or deceptive practices (under
California law since the FTC rule does not provide a private right
of action), counsel for the franchisor defendants have defended the
action on lack of justified reliance. Franchisors and their counsel
have systemically written the agreements to strip franchisees of all
fraud claims and rights the minute the agreement is signed by
sophisticated integration, no representation and no reliance clauses
* * *. The Commission should provide that reliance on the disclosure
document and other representations made in the sale of a franchise
is per se justified. ²⁶⁶
---------------------------------------------------------------------------

\266\ See also Manuszak, Comment 13, at 1; Bell, Comment 30, at
1; Sibent, Comment 41, at 1 (and 19 identical comments); AFA,
Comment 62, at 3; Bundy, Comment 119, at 2; Selden, Comment 133,
Appendix B, at 2; Zarco & Pardo, Comment 134, at 3.

Lagarias, Comment 125, at 4.
Another commenter adds that integration clauses are not well
understood and their impact is not appreciated at all until long after
the franchise purchasing commitment is made. ²⁶⁷
---------------------------------------------------------------------------

\267\ Selden, Comment 133, Appendix B, at 2.
---------------------------------------------------------------------------

Based upon the record, the Commission does not recommend banning
the use of integration clauses as a deceptive or unfair act or
practice. Integration clauses can serve a useful purpose, ensuring that
prospective franchisees rely only on information authorized by the
franchisor or within the franchisor's control. For example, a
franchisor reasonably may seek to disclaim liability for unauthorized
claims made by rogue salespersons, statements made by former or current
franchisees, or even unattributed statements found in the trade press.
The Commission, however, believes it is a violation of section 5
for franchisors to use integration clauses essentially to shield
themselves from liability for false or deceptive statements made in
their disclosure documents. The Commission has long recognized that the
integrity of a franchisor's disclosure document is critical to
prospective franchisees. For that reason, disclosures must be complete,
accurate, legible, and current. The Rule also prohibits franchisors
from making any statements that contradict those in a disclosure
document. The use of integration clauses to disclaim liability for
required disclosures undermines the very purpose of the Rule, which is
to prevent fraud and abuse by ensuring that prospective franchisees
have complete, truthful, material information with which to make a
sound investment decision. ²⁶⁸ Accordingly, proposed section
436.10(e) will better ensure that prospective franchisees will receive
complete and truthful pre-sale disclosures.
---------------------------------------------------------------------------

\268\ Integration clauses effectively requre franchisees to
waive reliance on statements made in the disclosure document. The
Commission has long disfavored the waiver of rights afforded by
Commission trade regulation rules. See Used Care Rule, 16 CFR 455 at
Sec. 455.3(b), Credit Practices Rule, 16 CFR 444 at Sec. 444.2;
Cooling-Off Period Rule, 16 CFR 429 at Sec. 429.1(d); and Ophthalmic
Practices Rule, 16 CFR 456 at Sec. 456.2(d).
---------------------------------------------------------------------------

At the same time, the Commission recognizes that a prohibition on
disclaimers or waivers may have the unintended effect of chilling the
parties' willingness to negotiate freely franchise contract terms. A
franchisor may interpret an anti-disclaimer prohibition to mean that it
is bound by the terms and conditions set forth in a disclosure document
only and that any modification will constitute a Rule violation. To
rectify this potential misinterpretation, proposed section 436.10(e)
specifically provides that a prospective franchisee can agree to terms
and conditions that differ from those specified in a disclosure
document if: (1) the franchise seller identifies the changes; (2) the
prospective franchisee initials the changes in the franchise agreement;
and (3) the prospective franchisee has five days to review the
completed revised contract before the sale is consummated, consistent
with proposed section 436.2(a)(2) described above.
f. Proposed Section 436.10(f): Shills
Proposed section 436.10(f) adds a prohibition against franchisors' use
of phony references or ``shills.'' Proposed section 436.10(f) would
make it a Rule violation for a franchisor to misrepresent that any
person has actually purchased or operated one of the franchisor's
franchises. It also would make it a Rule violation for a franchisor to
misrepresent that any person can give an independent and reliable
report about the experience of any current or former franchisee. The
Commission's law enforcement experience demonstrates that, in many
instances, scam artists use shill references in order to bolster their
earnings and success claims. ²⁶⁹ Indeed, shills are often
the

[[Page 57324]]

glue that holds the scam together by allaying consumers' concerns about
the investment. ²⁷⁰
---------------------------------------------------------------------------

\269\ E.g., FTC v. Hart Mktg. Enter., Inc., No. 98-222-CIV-T-23
(M.D. Fla. 1988); FTC v. Stillwater Vending, Ltd., No. 97-386-JD
(D.N.H. 1997); FTC v. Unitel Sys., Inc., No. 3-97CV1878-D (N.D. Tex.
1997); FTC v. Southeast Necessities Co., Inc., No. 6848-CIV-Hurley
(S.D. Fla. 1994); Car Checkers of America, Bus. Franchise Guide
(CCH) para. 10,163, at 24,042. Indeed, in two actions, the
Commission named a shill in its complaint, charging each with
violating section 5 of the FTC Act. See FTC v. Vendors Fin. Serv.,
Inc., No. 98-N-1832 (D. Colo. 1998); FTC v. Urso, Bus. Franchise
Guide (CCH) para. 11,410 (S.D. Fla. 1997). Cf. O'Rourke, Bus.
Franchise Guide (CCH) para. 10,243 (evidence of shills admitted at
contested Preliminary Injunction hearing).
\270\ NCL reports that complaints about fake references are
among the most common franchisee and business opportunity complaints
its receives. NCL, Comment 35, at 2.
---------------------------------------------------------------------------

14. Proposed Section 436.11: Other Laws, Rules, and Orders

Proposed section 436.11 addresses the effect the revised Rule may
have on other Commission laws and outstanding Commission orders. It
also discusses preemption of state franchise laws that may be
inconsistent with this Rule.
a. Proposed Section 436.11(a): Effect on Other Commission Laws
Proposed section 436.11(a) makes clear that the Commission does not
express any opinion about the legality of any practices that might be
disclosed in a franchisor's disclosure document. The current Rule
contains a comparable provision at note 1 at the end of the Rule. In
the SBP, the Commission recognized that some of the Rule's provisions
may require franchisors to disclose practices that may raise antitrust
issues. ²⁷¹ The provision makes clear that the Commission
reserves the right to pursue violations of antitrust laws even if a
franchisor discloses the violation in complying with the Rule's
disclosure requirements. In short, disclosure does not create a safe
harbor for franchisors engaging in otherwise unlawful conduct. At the
same time, proposed section 436.11(a) clarifies that compliance with
the Rule's specific disclosure requirements will not shield a
franchisor from the broader anti-deception provision of section 5 of
the FTC Act. ²⁷² The Commission finds that this
clarification is critical especially in an age of quickly developing
technologies. The Commission cannot now predict what information about
the franchise relationship will be material in the future, in
particular franchisors' and franchisees' rights and obligations
concerning issues such as the use of Internet home-pages, electronic
advertising, and electronic commerce. Franchisors' disclosure
obligations under section 5 must remain somewhat flexible to ensure
that franchisors continue to provide prospective franchisees with all
material information as new technologies and marketing practices
emerge.
---------------------------------------------------------------------------

\271\ SBP, 43 FR at 59719.
\272\ See, e.g., FTC v. Hart Mktg. Enter. Ltd., Inc., No. 98-
222-CIV-T-23 E (M.D. Fla. 1998); FTC v. Inetintl.com, No. 98-2140
(C.D. Cal. 1998); FTC v. Maher, No. WMN-98-495 (D.Md. 1998); FTC v.
Nat'l Consulting Group, Inc., No. 98 C 0144 (N.D. Ill. 1998).
---------------------------------------------------------------------------

b. Proposed Section 436.11(b): Effect on Prior Commission Orders
Since the Rule went into effect in the 1970s, the Commission has
brought over 150 franchise and business opportunity cases. The
Commission recognizes that it is possible that the revised Rule may
impose disclosure or other obligations that are inconsistent with the
terms of existing Commission orders. To reduce any potential conflicts
between existing orders and provisions of the revised Rule, proposed
section 436.11(b) would permit firms under order to petition the
Commission for relief consistent with the provisions of the revised
Rule.
c. Proposed Section 436.11(c): Preemption
Proposed section 436.11(c) retains the preemption provision
currently found at note 2 at the end of the Rule. ²⁷³ It
provides that the Commission does not intend to preempt state or local
franchise practices laws, except to the extent of any inconsistency
with the Rule. It provides further that a law is not inconsistent if it
affords prospective franchisees equal or greater protection, such as
registration of disclosure documents or more extensive disclosures.
---------------------------------------------------------------------------

\273\ See 16 CFR 436, note 2. This approach is consistent with
other Commission trade regulation rules. See, e.g., Appliance
Labeling Rule, 16 CFR 305 at Sec. 305.17; Cooling-Off Rule, 16 CFR
429 at Sec. 429.2; Mail Order Rule, 16 C.F.R. 435 at
Sec. 435.3(b)(2); R-Value Rule, 16 CFR 460 at Sec. 460.23.
---------------------------------------------------------------------------

d. Proposed Section 436.12: Severability
Proposed section 436.12 retains the severability provision
currently found at 16 CFR 436.3. This provision makes clear that, if
any part of the rule is held invalid by a court, the remainder will
still be in effect. ²⁷⁴
---------------------------------------------------------------------------

\274\ This provision is comparable to the severability
provisions in other Commission trade regulation rules. See, e.g.,
900-Number Rule, 16 CFR 308.8; Telemarketing Sales Rule, 16 CFR
310.8.
---------------------------------------------------------------------------

Section D--Rulemaking Procedures

Pursuant to 16 CFR 1.20, the Commission has determined to use the
following rulemaking procedures. These procedures are a modified
version of the rulemaking procedures specified in section 1.13 of the
Commission's Rules of Practice.
First, the Commission intends to publish a single Notice of
Proposed Rulemaking. The comment period will be open for 60 days,
followed by a 40-day rebuttal period. Second, pursuant to section 18(c)
of the Federal Trade Commission Act, ²⁷⁵ the Commission will
hold hearings with cross-examination and rebuttal submissions only if
an interested party requests a hearing by the close of the comment
period. Parties interested in a hearing must also submit within the
comment period the following: (1) a comment on the NPR; (2) questions
of fact in dispute; and (3) a summary of the expected testimony.
Parties wishing to cross-examine witnesses must also file a request by
the close of the comment period. If requested to do so, the Commission
may also consider holding one or more informal public workshop
conferences in lieu of hearings. After the close of the comment period,
the Commission will publish a notice in the Federal Register stating
whether hearings (or a public workshop conference in lieu of hearings)
will be held and, if so, the time and place of the hearings and
instructions for those wishing to present testimony or engage in cross-
examination of witnesses.
---------------------------------------------------------------------------

\275\ 15 U.S.C. 57a(c).
---------------------------------------------------------------------------

Finally, after the conclusion of the rebuttal period, and any
hearings or additional public workshop conferences, Commission staff
will issue a Report on the Franchise Rule (``Staff Report''). The
Commission will announce in the Federal Register the availability of
the Staff Report and will accept comment on the Staff Report for a
period of 60 days.

Section E--Communications to Commissioners and Commissioner
Advisors by Outside Parties

Pursuant to Commission Rule 1.18(c)(1), the Commission has
determined that communications with respect to the merits of this
proceeding from any outside party to any Commissioner or Commissioner
advisor shall be subject to the following treatment. Written
communications and summaries or transcripts of oral communications
shall be placed on the rulemaking record if the communication is
received before the end of the comment period on the staff report. They
shall be placed on the public record if the communication is received
later. Unless the outside party making an oral communication is a
member of Congress, such communications are permitted only if advance
notice is

[[Page 57325]]

published in the Weekly Calendar and Notice of ``Sunshine'' Meetings.
²⁷⁶
---------------------------------------------------------------------------

\276\ See 15 U.S.C. 57a(i)(2)(A); 45 FR 50814 (1980); 45 FR
78626 (1980).
---------------------------------------------------------------------------

Section F--Regulatory Analysis and Regulatory Flexibility Act
Requirements

Section 22 of the FTC Act, 15 U.S.C. 57b, requires the Commission
to issue a preliminary regulatory analysis for a rule amendment
proceeding if it: (1) estimates that the amendment will have an annual
effect on the national economy of $100,000,000 or more; (2) estimates
that the amendment will cause a substantial change in the cost or price
of certain categories of goods or services; or (3) otherwise determines
that the amendment will have a significant effect upon covered entities
or upon consumers. Based upon the record, the Commission has
preliminarily determined that the proposed amendments to the Rule will
not have such an effect on the national economy, on the cost or prices
of franchised goods or services, or on covered businesses or consumers.
To ensure that the Commission has considered all relevant facts,
however, it requests additional comment on this issue.
The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601 et seq.,
requires an agency to conduct an analysis of the anticipated economic
impact of proposed rule amendments on small businesses. ²⁷⁷
The purpose of a regulatory flexibility analysis is to ensure that the
agency considers the impact on small entities and examines regulatory
alternatives that could achieve the regulatory goals while minimizing
burdens on small entities. The RFA does not apply if the agency head
certifies that the regulatory action will not have a significant
economic impact on a substantial number of small entities. As discussed
below, the Commission believes that the proposed Rule amendments will
not have a significant economic impact upon small businesses subject to
the Rule. Accordingly, the Commission certifies that the RFA does not
apply to the proposed Franchise Rule amendments.
---------------------------------------------------------------------------

\277\ The RFA addresses the impact of rules on ``small
entities,'' defined at ``small business,'' ``small governmental
entities,'' and ``small [not-for-profit] organizations.'' 5 U.S.C.
601. The Franchise Rule applies only to the first type of entity.
---------------------------------------------------------------------------

The proposed Rule amendments affect pre-sale disclosure for the
sale of franchises, and thus are likely to have an impact on all
franchisors, some of which are small entities. Determining the precise
number of small entities affected by these proposed amendments,
however, is difficult due to the wide range of industries involved in
franchising. The Commission estimates that there are approximately
5,000 franchisors selling franchises in the United States, including
2,500 business format and product franchisors and 2,500 business
opportunity sellers. Most business opportunities and some established
and start-up franchise systems would likely be considered small
businesses according to the applicable SBA size standards. As a result,
the Commission estimates that as many as 70% of franchisors, as defined
by the Rule, are small entities.
Nonetheless, the proposed amendments do not appear to have a
significant economic impact upon such entities. For the most part, the
Commission's proposed amendments, as detailed throughout this notice,
streamline and reorganize the Rule's disclosures based upon the UFOC
Guidelines model. The Rule's revised disclosure requirements,
therefore, would be more closely aligned with the UFOC format, which is
considered by many to be the national franchise disclosure standard.
²⁷⁸ Other proposals seek to clarify and refine the Rule, for
instance, by providing new or revised definitions. Accordingly, we
would expect the vast majority of franchisors to incur only minor costs
in adapting to the proposed revised Rule. ²⁷⁹
---------------------------------------------------------------------------

\278\ See supra at Section C.2.
\279\ The franchisors who do not currently use the UFOC format
would, of course, have greater compliance costs associated with
adapting to a new format. However, the number of small entities
within this subset does not appear to be substantial.
---------------------------------------------------------------------------

Further, in a few instances, the proposed amendments will reduce
franchisors' compliance costs. For example:

(1) Proposed Section 436.2

This provision limits the scope of the Rule to franchise sales in
the United States, potentially relieving franchisors of substantial
costs associated with preparing disclosure documents for international
sales. Because franchisors selling internationally are generally large
franchisors, we do not expect this proposal to have a significant
effect on small entities.

(2) Proposed Section 436.9(e)

This provision sets forth new exemptions for sophisticated
investors. These proposals similarly will reduce costs to those
franchisors that are not likely to engage in fraudulent franchise
sales. Since the proposed exemptions, by their terms, apply only to
large investments, or investments made by very large companies, we
would expect little if any impact on small entities.

(3) Proposed Section 436.7

This provision expressly permits franchisors to utilize the
Internet and other electronic media to furnish disclosure documents.
Allowing this distribution method could greatly reduce franchisors'
compliance costs over the long run, especially costs associated with
printing and distributing disclosure documents. As a result of this
proposal, we expect franchisors' compliance costs will decrease over
time, but do not expect the immediate impact to be substantial for most
franchisors, in particular smaller franchise systems.
A few proposed Rule amendments, however, may increase franchisors'
compliance costs. Nonetheless, the Commission expects these costs to be
de minimis and to decline after the franchisors' initial fiscal year of
complying with the proposed amended Rule. These proposals require
franchisors to disclose additional material information that will shed
light on the state of the franchise relationship or increase
prospective franchisees' ability to conduct their own due diligence
investigation of franchise offerings. While these proposals could
potentially impact both large and small franchisors, we would expect
any impact to be greatest with larger franchise systems. For example,

(1) Proposed Section 436.3.

This would require franchisors to include in the disclosure
document's cover page references to several franchise resources, such
as the Commission's Internet web site and its ``Consumer Guide to
Purchasing a Franchise.'' These references assist prospective
franchisees by notifying them of valuable information that is available
on franchising. The provision applies to all franchisors, but at
minimal cost.

(2) Proposed Section 436.5(c)

This provision would require franchisors to disclose pending
litigation brought by franchisors against their franchisees involving
the franchise relationship. Providing this additional information gives
prospective franchisees further insight into the relationship between
the franchisor and current and former franchisees. While this proposed
change would apply to all franchisors, the impact is likely to be
greatest on large systems, which by definition, have a significant
number of franchisees, and therefore, a greater

[[Page 57326]]

likelihood of pending litigation against franchisees.

(3) Proposed Section 436.5(t)(6)

This would require franchisors to make a prescribed statement about
the use of ``gag clauses,'' if applicable. This proposed section also
includes two additional optional disclosures, whereby franchisors are
permitted to disclose the number and percentage of franchisees who have
signed gag clauses, and the circumstances under which the gag clauses
were signed. The economic impact of including the prescribed statement
alone is negligible. Any additional costs will arise from franchisors'
voluntarily complying with the Rule's optional provisions. Further, we
can expect that larger systems are more likely than small entities to
have a significant number of franchisees who have signed gag clause
provisions.

(4) Proposed Section 436.5(t)(7)

This provision would require franchisors to disclose the names and
addresses of trademark-specific franchisee associations that request to
be included in the franchisors' disclosure document. This information
would further assist prospective franchisees in investigating the
franchise system, with virtually no change in the cost of preparing a
disclosure document. The number of trademark-specific franchisee
associations in any single franchise system is likely to be limited,
especially in small franchise systems. Further, those associations that
wish to be included in the disclosure document must provide the
franchisor with all of the relevant information. Thus, including this
information in a disclosure document should have very little impact on
franchisors' document preparation costs.
For the reasons outlined above, the Commission believes that the
proposed Rule amendments, taken as a whole, will likely have a
negligible economic impact on franchisors' compliance costs,
particularly for small franchisors. Presumably, compliance costs will
vary with the size of the franchise system, with smaller franchisors
incurring lower costs. The Commission estimates that franchisors will
be required to spend between 1 and 5 hours to comply initially with the
proposed revised disclosure requirements. At an average hourly billing
rate of $250, the estimated cost to each system will be between $250
and $1,250. These amounts are not significant, especially in the
context of franchisors' total yearly income and expenses. Further, any
initial compliance costs will presumably decrease after the franchisor
has revised its disclosures into the new format, and may well be offset
by the Rule amendments' streamlined disclosure provisions.
Therefore, based on the available information, the Commission
certifies that amending the Franchise Rule will not have a significant
economic impact on a substantial number of small businesses. To ensure
that no significant economic impact is being overlooked, however, the
Commission requests comments on this issue. The Commission also seeks
comments on possible alternatives to the proposed amendments to
accomplish the stated objectives. After reviewing any comments
received, the Commission will determine whether a final regulatory
flexibility analysis is appropriate.

Section G--Paperwork Reduction Act

In this notice, the Commission proposes to alter some information
collections contained in the Franchise Rule. As required by the
Paperwork Reduction Act of 1995 (``PRA''), 44 U.S.C. 3507(d), the
Commission has submitted a copy of the information collections to the
Office of Management and Budget (``OMB'') for its review. The current
public disclosure and recordkeeping burden for collections of
information contained in the Rule is 36,200 hours, approved under OMB
Control No. 3084-0107, expiration date March 31, 1999. In that
clearance submission, we estimated there were 3,613 franchisors. For
the following calculations, we estimate that there are currently 5,000
franchise systems, consisting of 2,500 business format and product
franchisors and 2,500 business opportunity sellers. The 1999 estimate
of the cost to comply with the collections of information contained in
the Rule, which includes both business format and product franchisors
and business opportunities, is $19,925,000, and the total burden hours
associated with these collections is currently projected to be
33,500.\280\ As discussed below, we expect that the proposed Franchise
Rule amendments will result in a large information collection savings,
resulting primarily from eliminating business opportunities from Rule
coverage.
---------------------------------------------------------------------------

\280\ See 64 FR 1206 (January 8, 1999), announcing a request for
a three year extension of the Franchise Rule's current information
collection requirements. In that notice, the burden hour estimate
was reduced from 36,200 to 33,500.
---------------------------------------------------------------------------

The proposed amendments are designed to improve the Rule's
organization and language, while also adding and changing some of the
disclosure items. The proposals will impact franchisors differently,
and, depending on the particular franchisor, may eliminate completely,
reduce, or slightly increase, franchisors' compliance costs and
burdens. Some of the more significant proposed amendments address the
scope of the Franchise Rule, such as the proposal that separates the
disclosure requirements for franchises from those of business
opportunities. Other proposals offer new disclosure alternatives or
requirements, and may impact franchisors' information collection. These
include, for example, giving franchisors the option to use the Internet
to furnish disclosure documents, and requiring franchisors to disclose
information about known trademark-specific franchisee associations.
Still other proposed amendments simply clarify certain existing
disclosure requirements and should also provide an overall benefit to
affected respondents without increasing costs. These clarifications,
however, are not changes to the regulation and accordingly, they do not
affect the collections of information contained in the regulation.
Where proposals do change an information collection requirement, we
discuss them below. Following is a summary of the more important
proposed amendments to the Rule:

(1) Eliminating the Rule's Coverage of Business Opportunities

The proposed Rule will no longer apply to business opportunity
sellers, who will be covered by a separate Rule. Thus, compliance costs
for business opportunity sellers will drop to zero. In the past, we
have estimated that approximately five hours are needed for business
opportunities to comply with the information collection requirements
contained in the Rule, and 15 hours are needed by franchisors.
Eliminating business opportunities from the Rule would therefore result
in a total savings of 12,500 labor hours (2,500 business opportunity
sellers x 5 hours) and $3.125 million (12,500 hours x $250 per
hour), as well as a savings of $3.75 million in printing costs (2,500
business opportunity sellers x $1,500 printing costs per company).

(2) Adopting Three Sophisticated Investor Exemptions

Proposed section 436.9(e) will exempt certain franchise offerings
from the Rule's disclosure obligations. This proposal acknowledges that
in very large transactions, and in transactions that involve certain
owners and managers of the franchise system, the

[[Page 57327]]

individuals involved have the experience and resources necessary to
obtain important information about the franchise system independently.
For those companies that qualify, these exemptions could eliminate all
disclosure burdens. Assuming that 5 percent of franchise systems, or
125 firms, will be exempted, this will result in a reduction of 1,875
hours and $468,750 (1,875 x $250).

(3) Revising the Rule's Disclosure Requirements Based Upon the UFOC
Guidelines Model

Revising the Rule based on the UFOC Guidelines model will benefit
affected entities by bringing greater uniformity to franchise
disclosure documents. In practice, the UFOC is the national standard.
Because the proposed revised Rule format is patterned after the UFOC
format, we estimate that franchisors' time and costs needed to comply
with the Franchise Rule will be reduced by 1 hour, for a net savings of
2,375 hours and $593,750 (1 hour x $250 per 2,375 companies).

(4) Improving the Rule's Organization and Language

Deleting provisions that no longer serve a useful purpose and
streamlining the Rule by adopting, for instance, a clear, bright line
disclosure trigger, will make the Rule easier to understand and thus,
foster easier compliance. Although the net savings under this proposal
attributable to better organization and language are difficult to
quantify, we believe that franchisors may save an average of 1 hour in
compliance time at $250 per hour, for a net savings of 2,375 hours and
$593,750

(5) Permitting Compliance Through the Internet and Other Electronic
Media

Proposed section 436.7 could potentially reduce franchisors'
compliance costs significantly, especially the costs and hours
associated with printing and distributing disclosure documents, which
at 6 hours per year, is the bulk of the current hourly burden estimate.
Distributing documents electronically would eliminate the 6 hours per
year for those franchisors no longer printing and mailing any of their
disclosure documents. We approximate that 20 percent of franchisors, or
475 franchisors, will initially make use of this proposal, and each
will distribute 50 of their 100 documents electronically, saving three
hours per year. This will result in a reduction of 1,425 hours. This
provision, however, will also require franchisors to adapt and
distribute their electronic and summary documents. We estimate that
those 475 franchisors will spend 1 hour to adapt and distribute their
electronic and summary documents for an additional burden of 475 hours.
Accordingly, franchisors' use of the electronic disclosure option will
result in a net reduction of 950 hours.
Further, we have previously estimated that printing and mailing one
disclosure document averages approximately $25.00 ($35 for franchisors
and $15 for business opportunity sellers) and that 5,000 franchisors
and business opportunity sellers print and distribute 100 copies
annually, for a total cost of $12.5 million. We believe that the
proposed amendment permitting electronic disclosure would reduce the
distribution cost per electronic disclosure document to $5.00, for a
total net savings of $712,500 (475 franchisors furnishing 50 electronic
disclosure documents each at a saving of $30 per electronic disclosure
document). We anticipate that time and costs will further decline in
the future as more franchisors make greater use of electronic media.

(6) Disclosing Additional Resources and Information for Franchisees

Proposed section 436.3 requires the disclosure document's cover
page to reference the Commission's Internet web site, where consumers
can find resources on franchising and related topics. This information
will provide significant benefit to consumers, as will requiring the
cover page to note the availability of the Commission's Consumer Guide
To Purchasing a Franchise. Another proposed amendment, proposed section
436.5(a), would require franchisors to disclose information about their
predecessors, industry-specific regulations, and the general
competition prospective franchisees are likely to face. Finally,
proposed 436.5(t)(7) would require a franchisor to disclose the names
and addresses of trademark-specific franchisee associations that ask to
be listed in the franchisor's disclosure document. These associations
can often provide prospects with additional information on the
franchise system.
The proposed cover sheet changes would not constitute ``collections
of information'' as that term is defined in the PRA, because the text
is being provided by the Government and the PRA exempts any
``information that is originally supplied by the Federal government to
the recipient for the purpose of disclosure to the public.'' 5 C.F.R.
Sec. 1320.3(c)(2). Requiring disclosure of predecessor information,
regulations and competition, while not exempt, would only impose a de
minimis burden, since presumably, franchisors would already possess
this information. Likewise, disclosing information about trademark-
specific franchisee associations would also impose only a de minimis
burden on the affected entities, since franchisors would only be
responsible for disclosing information about those associations that
request to be included in the disclosure document. We estimate that
only one hour per year per franchisor would be needed to comply with
these disclosure requirements for a total increase of 2,375 hours and a
cost of $593,750.

(7) Disclosing Additional Information About the Franchise Relationship

Proposed section 436.5(c), which requires franchisors to disclose
pending lawsuits brought against franchisees, would give potential
franchisees information about the types of problems in the franchise
system, and the extent to which a franchisor uses litigation to resolve
disputes. The Rule currently requires the disclosure of litigation
brought by franchisees against franchisors and this has not proven to
be overly burdensome. Disclosing additional lawsuits would also
generally be de minimis, since this information is well-known by the
franchisor, is usually already compiled during the ordinary course of
business, and can easily be updated at the beginning and end of a
lawsuit. Accordingly, we have assigned 1 hour to this task for a total
of 2,375 hours and a cost of $593,750.

(8) Requiring Disclosure About Gag Clauses

Proposed section 436.5(t)(6) includes a new provision that requires
franchisors to disclose their use of gag clauses. The proposed
amendment requires that, if applicable, franchisors make a prescribed
statement that informs prospective franchisees that sometimes, current
or former franchisees sign provisions restricting their ability to
discuss their franchise experience. The proposal also offers
franchisors two additional options: (1) a franchisor may disclose the
number and percentage of current and former franchisees who have signed
agreements with gag clauses within the last three years; and (2) a
franchisor may explain the circumstances surrounding the gag clauses.
However, because this proposal's only actual requirement is to include
specific text provided by the Commission, it is exempt from the PRA.
Therefore, no additional burden hours are associated with this
proposal.

[[Page 57328]]

(9) Requiring Prescribed Statements About Financial Performance
Representations

Proposed sections 436.5(s)(1) and (2) require franchisors to
include in their disclosure documents two prescribed statements that
clarify the law regarding financial performance representations. The
first statement is mandatory for all franchisors, and makes clear that
financial performance representations are allowed under certain
circumstances. This statement combats a common misrepresentation--that
the FTC's Franchise Rule does not permit franchisors to make earnings
representations. If franchisors do not provide financial
representations, they must also include a second prescribed statement
that includes an acknowledgment that they do not provide any type of
financial performance representations, either oral or written. The
proposed Rule provides the specific text that franchisors must use for
both statements, and is therefore exempt from the PRA. Accordingly, no
burden hours are associated with this proposed amendment.

(10) Recordkeeping Requirements

The proposed amended Rule would set forth two recordkeeping
requirements. As an initial matter, proposed section 436.5(w) adds a
requirement that franchisors include in their disclosure document a
receipt that prospective franchisees must sign and return at least five
days before a franchise agreement is signed or the franchisee pays any
franchise fee. The proposal also requires franchisors to keep signed
receipts for each completed franchise sale for at least three years.
This proposed item contains the required language and format for the
receipt, and the franchisor must only fill-in its franchise-specific
information. Franchisors are also required to include a receipt under
the current UFOC Guidelines. Thus, there is very little burden
associated with producing the receipt.
Further, proposed section 436.5(w) would require franchisors to
retain a copy of the signed receipts for at least three years. In
addition, proposed section 436.7(g) would require franchisors who elect
to furnish disclosures electronically to retain a specimen copy of each
materially different version of their disclosure document for a period
of three years. These recordkeeping provisions should impose a de
minimis additional burden on franchisors. Many franchisors already
retain sales receipt in order to comply with state regulations. In
addition, we can assume that a large number of franchisors would retain
receipts as well as copies of their disclosures in the ordinary course
of business. Thus, the few franchisors who do not already retain these
records in the ordinary course of business will experience an increased
paperwork burden. We therefore estimate that franchisors, on average,
will require 30 minutes per year to maintain these records for a total
increase of 1,188 hours and $297,000.

Total cost to comply with the Franchise Rule = $12,165,750
($19,925,000-$7,759,250)
Revised total annual burden hours = 19,363 (33,500-14,137)

Organizations and individuals desiring to submit comments on the
information collection requirements should direct comments to the
Office of Information and Regulatory Affairs, OMB, Room 10235, New
Executive Office Building, Washington, DC 20503; Attention: Desk
Officer for the Federal Trade Commission.
The FTC considers comments by the public on these collections of
information in:
Evaluating whether the proposed collection of information
is necessary for the proper performance of the functions of the agency,
including whether the information will have a practical use;
Evaluating the accuracy of the agency's estimate of the
burden of the collection of information, including the validity of the
methodology and assumptions used;
Enhancing the quality, usefulness, and clarity of the
information to be collected; and
Minimizing the burden of collection of information on
those who are to respond, including through the use of appropriate
automated electronic, mechanical, or other technological collection
techniques or other forms of information technology; e.g., permitting
electronic submission of responses.
OMB is required to make a decision concerning the
collection of information contained in these proposed regulations
between 30 and 60 days after publication of this document in the
Federal Register. Therefore, a comment to OMB is best assured of having
its full effect if OMB receives the comment within 30 days of
publication. This does not affect the deadline for the public to
comment to the agency on the proposed regulations.

Section H--Request for Comments

The Commission invites members of the public to comment on any
issues or concerns they believe are relevant or appropriate to the
Commission's consideration of the proposed Franchise Rule amendments.
The Commission requests that factual data upon which the comments are
based be submitted with the comments. In addition to the issues raised
above, the Commission solicits public comment on the specific questions
identified below. These questions are designed to assist the public and
should not be construed as a limitation on the issues on which public
comment may be submitted.

1. General Questions

Please provide comment, including relevant data, statistics,
consumer complaint information, or any other evidence, on each
different proposed change to the Rule. Regarding each proposed revision
commented on, please include answers to the following questions:
(a) What is the impact (including any benefits and costs), if any,
on:
1. Prospective franchisees;
2. Existing franchisees; and
3. Franchisors (including small franchisors and start-up
franchisors)?
(b) What alternative proposals should the Commission consider? How
would these proposed alternatives affect the costs and benefits of the
proposed Rule?

2. Questions on Specific Proposed Changes

In response to each of the following questions, please provide: (1)
detailed comment, including data, statistics, consumer complaint
information, and other evidence, regarding the issues addressed in the
question; (2) comment as to whether the proposed changes do or do not
provide an adequate solution to the problems they were intended to
address; and (3) suggestions for additional changes that might better
maximize consumer protections or minimize the burden on franchisors.
Definitions
1. The proposed definition of ``financial performance
representation''--section 436.1(d)--includes any representation that
``states or suggests'' a value or range of potential or actual
financial performance. This definition seeks to make clear that implied
earnings representations are considered financial performance
representations. Does this definition clarify what the Commission
considers to be financial performance representations? If not, what
alternative definition should the Commission consider?
2. Based upon the UFOC model, the proposed Rule requires
franchisors to

[[Page 57329]]

disclose various expenses, including the initial franchise fee
(proposed 436.5(e)), recurring or occasional fees (proposed 436.5(f)),
and estimated initial investment (proposed 436.5(g)). While the
Commission does not consider the disclosure of such expense information
alone to constitute the making of a financial performance claim, others
arguably may interpret some expense information as implying a financial
performance representation, such as a break-even point. To avoid any
confusion, the proposed definition of ``financial performance
representation''--section 436.l(d)--specifically omits expense
information. Is the omission of expense information from the proposed
definition sufficient to make clear that compliance with the Rule's
expense disclosure obligations does not trigger the Rule's Item 19
financial performance substantiation requirements? At the same time,
could the proposed definition inadvertently be interpreted as
permitting franchisors to disclose additional, non-required expense
data without complying with the Rule's Item 19 requirements? If so,
could franchisors make ``back-door'' earnings representations in the
guise of additional expense information? What alternative definition
should the Commission consider?
3. The proposed definition of the term ``franchise''--section
436.1(g)--is designed to include franchises that traditionally have
been covered by the Rule, while eliminating ordinary business
opportunities that will be covered by a separate business opportunity
rule. Does the proposed revised definition capture the appropriate
universe of franchises? Does the definition inadvertently eliminate
businesses that should be considered franchises?
4. The proposed definition of ``franchise seller''--section
436.1(h)--combines into a single concept the current terms
``franchisor'' and ``franchise broker.'' This alleviates the necessity
for using both terms when discussing obligations to furnish documents.
It also seeks to clarify who is considered to be a franchise seller.
Does the proposed definition include the appropriate persons? Are there
other persons that should be included in the definition?
5. Proposed section 436.1(k) provides a definition of the term
``gag clause,'' which refers to contractual provisions that prohibit or
restrict franchisees' ability to discuss their own personal experiences
within the franchise system. Does this proposed definition clearly
identify the types of provisions that are considered gag clauses? Does
the use of the term ``gag clause'' accurately describe these types of
contractual provisions? Is there another term that would be preferable?
6. Proposed section 436.1(l) provides a broad definition of the
term ``Internet,'' which refers to all computer-to-computer
communications, including the World Wide Web, and communications
between computers and television, telephone, facsimile, and similar
communications devices. Given the rapidly evolving computer
environment, does this definition allow enough room--or too much room--
for new types of computer communication? Is the definition consistent
with other agencies' definitions of Internet?
7. The proposed definition of officer--section 436.1(o)--includes
``a de facto officer,'' an individual with significant management
responsibility whose title does not adequately reflect the nature of
the position. This revised definition, based upon the UFOC Guidelines,
clarifies that the actual functions a person performs within a company,
whether or not the person possesses a title, will be considered when
determining if the individual is subject to the disclosure provisions
in proposed sections 436.3-436.5. Is the proposed definition sufficient
to enable franchisors to determine who is deemed to be an officer for
purposes of the Rule? What alternative definition might be appropriate?
8. The proposed definition of ``signature''--section 436.1(w)--
refers to a person's affirmative steps to authenticate his or her
identity. This includes both written and electronic signatures. In
light of the growing use of electronic communications, is the expansion
of the Rule to include electronic signatures desirable? Are there
sufficient safeguards in place to discourage unlawful uses of
electronic signatures?
Liability
9. The proposed Rule sets forth a new standard of liability.
Proposed section 436.2(c) would hold franchisors liable for any failure
to comply with the disclosure requirements and instructions set forth
in sections 436.3-436.8. In contrast, proposed section 436.2(c) would
hold other sellers (such as the franchisor's employees and sales
representatives) liable for violations of sections 436.3-436.8 only if
they ``knew or should have known of the violation.'' What are the costs
and benefits of holding other franchise sellers liable for Rule
violations? If other franchise sellers are to be held liable, is a
``knew or should have known'' standard appropriate? What alternative
standards of liability should the Commission consider?
Timing Provisions
10. Proposed section 436.2(a)(1) would require franchisors to
provide disclosure documents at least 14 days before a prospective
franchisee either signs a binding agreement or pays a fee in connection
with the franchise sale. This proposal would eliminate the current ``10
business day'' period in favor of a bright line ``14 days.'' Is this
modification desirable? What alternatives should the Commission
consider?
11. Proposed section 436.2(a)(2) would require the franchisor to
provide a copy of its completed contract at least five days before the
prospective franchisee signs the contract. This proposal would
eliminate the current ``five business day'' period in favor of a bright
line ``five days.'' Does this proposal afford prospective franchisees
sufficient time to conduct a due diligence review of a franchise
offering? If five days does not provide a sufficient review period,
what would be an appropriate review period?
Disclosures
12. Proposed section 436.5 retains the current Rule requirement
that franchisors disclose information concerning their predecessors.
What are the costs and benefits of this disclosure requirement? In
particular, is information about predecessors useful to prospective
franchisees in deciding whether to purchase a franchise from the
current franchisor? Further, the proposed Rule would require
franchisors to disclose information about predecessors during the past
10 years. Is this information readily available to franchisors? Should
the disclosure be limited to information about the franchisor's
immediate predecessor?
13. Proposed section 436.5(c)(ii) would require franchisors to
disclose all pending material civil actions involving the franchise
relationship. Would these additional disclosures provide prospective
franchisees with useful information? Would it be advisable to limit the
scope of the disclosure, by providing, for example, that a franchisor
would not have to make the disclosure unless it had sued a certain
threshold percentage of its franchisees? If so, would a 5% threshold be
appropriate? What other alternatives should the Commission consider?
14. Proposed section 436.5(k) requires franchisors to disclose
information about whether they require their franchisees to purchase or
use electronic

[[Page 57330]]

cash registers and computer systems. Franchisors must also disclose
detailed information about any required systems. Does this proposal
sufficiently specify what information is required to be disclosed? Does
this proposal unduly burden franchisors, in particular start-up
franchisors, who may not possess specific computer requirements at the
time the disclosure document is prepared? What alternatives should the
Commission consider?
15. Proposed section 436.5(1)(2)(ii) would require franchisors that
do not offer exclusive territories to make the statement: ``You will
not receive an exclusive territory. [Franchisor] may establish other
franchised or franchisor-owned outlets that may compete with your
location.'' Does this statement sufficiently alert prospective
franchisees about potential competition from within the franchise
system? What alternative statement would be appropriate?
16. Proposed section 436.5(1) requires franchisors to disclose
whether they offer protected territories. Should proposed section
436.5(l) also require franchisors to disclose their current development
plans? Is such information proprietary? What costs and benefits would
be involved in disclosing current development plans?
17. Proposed section 436.5(q), among other things, requires
franchisors to disclose information about ``renewals.'' Is the term
``renewal'' misleading? Does it imply that prospective franchisees will
be able to extend their contracts for an additional period under the
same terms and conditions as their current contract? Is there a
distinction between an ``extension'' and a ``renewal'' of a contract?
If the term ``renewal'' is misleading, what alternatives would be more
accurate?
18. Proposed section 436.5(s), consistent with the UFOC Guidelines,
would eliminate the requirement that financial performance
representations must be geographically relevant to the franchise being
offered. Would this proposal have an impact on the number of
franchisors making financial performance representations or on the
quality of such representations?
19. Proposed sections 436.5(s)(3)(i)-(ii) detail the information
franchisors must provide if they elect to make historical performance
representations. Do these required disclosures provide prospective
franchisees with sufficient information to assess the representation?
How can these disclosures be improved?
20. Proposed sections 436.5(s)(3)(ii)(A) and (F) require
franchisors that make financial performance representations to: (1)
describe the characteristics of the outlets underlying the
representation; and (2) describe how those characteristics may differ
materially from those of the outlet that may be offered to a
prospective franchisee. Do these sections provide franchisors with
sufficient guidance about what characteristics they must disclose? How
can these sections be improved? Are these characteristics sufficient to
enable prospective franchisees to assess the relevance of the financial
performance representation to the franchise offering being considered?
If not, what additional disclosures are desirable to provide
prospective franchisees with the necessary information?
21. Proposed section 436.5(s)(3)(iv) retains the current
requirement that franchisors making financial performance
representations to prospective franchisees must include a conspicuous
admonition that a new franchisee's individual financial results may
differ from the results stated in the financial performance
representation. Should this admonitions be required for all financial
performance representations? If not, when is it unnecessary?
22. Commenters have noted that Item 20 may cause franchisors to
``double count'' franchise closures. How often and under what
circumstances does this occur? Does the proposed section 436.5(t)
approach solve the double counting problem? Do the instructions and
sample tables provide sufficient guidance on how to present the
required information?
23. If multiple events occur in the process of a change in the
ownership or closure of a unit, proposed section 436.5(t)(1) directs
franchisors to report that change under the heading for the event that
occurred first (a ``first-in-time'' approach). For example, if a
franchisor formally notifies a franchisee that the franchise agreement
for a particular unit will be terminated, and the franchisee
subsequently sells his rights back to the franchisor or to a third-
party, the franchisor would record this series of events as a
``termination,'' since that event occurred first. In many instances,
this approach would capture terminations by the franchisor rather than
any subsequent transfers or reacquisitions. Does this approach capture
the right information? Is there any evidence that suggests that
information about terminations by a franchisor is more meaningful to
prospective franchisees than subsequent transfers or reacquisitions?
24. Instead of a first-in-time approach, should the Commission
consider prioritizing the various events that may occur, so that
franchisors would report unit closures and ownership changes that
involve multiple events according to the highest assigned applicable
category (an ``order-of-priority'' approach)?
A. Should the Commission adopt the order of priority set forth in
columns (4) through (8) of the proposed Item 20 table? Like the first-
in-time approach, this approach would tend to stress terminations and
cancellations over reacquisitions and transfers. Under this approach, a
franchisor would report events according to the following order: (1)
termination or cancellation by the franchisor; (2) reacquisition by the
franchisor for consideration (whether by payment or forgiveness or
assumption of debt); (3) transfer by the franchisee to a new owner; (4)
post-term non-renewals; and (5) events other than termination/
cancellation, reacquisition, transfer, or post-term non-renewal.
B. Should the order of priority focus on reacquisitions and
transfers over terminations and cancellations? Under this approach, a
franchisor would report events according to the following order: (1)
reacquisitions by the franchisor for consideration (whether by payment
or forgiveness or assumption of debt); (2) transfer by the franchisee
to a new owner; (3) termination or cancellation by the franchisor; (4)
post-term non-renewal; and (5) events other than reacquisition,
transfer, termination/cancellation, or post-term non-renewal.
C. Are either of these approaches preferable to the first-in-time
approach? Should the Commission consider other orders of priority? How
might the application of a specific order of priority lead to different
results than the first-in-time approach? What kinds of information
would a specific order-of-priority approach tend to provide that is not
available from the first-in-time approach? What evidence is there that
prospective franchisees would find this additional information valuable
to them?
25. Consistent with the UFOC guidelines, proposed section
436.5(t)(4) requires that franchisors disclose the names, addresses,
and telephone numbers of either all of their franchisees or at least
100 of their franchisees. The current Rule requires that franchisors
disclose the names, addresses, and telephone numbers of only 10
franchisees. What are the costs and benefits of disclosing the names,
addresses, and telephone numbers of additional franchisees?
26. Proposed Item 20--section 436.5(t)(6)--also includes a new
provision that requires disclosure of information about the use of gag
clauses.

[[Page 57331]]

Would this proposal provide prospective franchisees with useful
information? Will this proposal affect the ability of franchisors and
franchisees to reach future settlements? Is the three-year reporting
period appropriate? If not, should it be longer or shorter?
27. Proposed Item 20--section 436.5(t)(7)--also would require
franchisors to disclose information about trademark-specific franchisee
associations. Would this provision provide prospective franchisees with
useful information? Does the proposal strike the correct balance
between costs imposed on franchisors and the benefits to prospective
franchisees?
28. Proposed section 436(u)(2) sets forth the phase-in of audited
financial statements for new franchisors. Do the instructions and table
provide sufficient guidance on how to phase-in audited financial
statements? Should the Commission consider alternative phase-in
approaches?
29. Proposed section 436.5(w)(2) would require franchisors to prove
that prospective franchisees actually received a disclosure document.
Does this proposal serve a useful purpose? Do franchisors already
retain similar records in the ordinary course of business? What
alternative methods should the Commission consider?
30. The proposed Rule disclosures are based upon the UFOC
Guidelines. As explained in this notice, however, there are several
instances where the Commission intends the proposed Rule to differ from
the UFOC Guidelines. Aside from those instances already noted, are
there other instances where a proposed Rule provision appears to be
inconsistent with the comparable UFOC provision in a material way?
Electronic Disclosures
31. Proposed section 436.7(b) would permit franchisors to furnish
disclosure documents electronically, and sets forth the conditions
under which franchisors may do so. What approaches are other federal
and state agencies taking regarding electronic disclosure? Is the
Commission's proposal consistent with other federal and state agencies'
approaches? Are there other approaches the Commission should consider?
32. Proposed section 436.7(b) would require franchisors who furnish
disclosures electronically to provide prospective franchisees with a
written summary document. One purpose of the summary document is to
help ensure that prospective franchisees understand the importance of
receiving a disclosure document and their rights if they cannot read an
electronic version. Will this provision achieve that goal? Will the
summary document add significantly to the costs associated in providing
electronic disclosure documents?
Exemptions
33. Proposed section 436.9 provides that certain franchise
relationships are exempt from the Rule's disclosure requirements. Does
this provision adequately inform franchisors that they nonetheless are
subject to the applicable Rule prohibitions set forth at 436.10 (i.e.,
failure to return refunds)?
34. Assuming business opportunities will be addressed in a separate
rule, does proposed section 436.9(a), which retains the current $500
threshold for franchise sales, continue to serve a useful purpose? What
threshold would ensure that the Franchise Rule continues to apply to
transactions involving a ``personally significant monetary
investment?''
35. Proposed section 436.9(e)(1) would create a disclosure
exemption for large investments. Is the proposed $1.5 million threshold
appropriate? What alternative threshold would be preferable? Are the
other protections included in this proposed exemption sufficient to
limit it to only sophisticated investors? Specifically, is it
appropriate to exclude funds received from the franchisor or affiliate
towards the $1.5 million? Does the required franchisee acknowledgment
add any additional protection to prospective franchisees?
36. Proposed section 436.9(e)(2) also creates a disclosure
exemption for large corporate investors. Do the proposed five years in
business and $5 million net worth requirements accurately characterize
the type of corporate investors that should be excluded from Rule
coverage? Should the limits be raised or lowered? What other
alternatives should the Commission consider in determining the proper
class of exempted corporate-investors?
37. Does proposed section 436.9(e) adequately address the impact of
inflation on the proposed sophisticated investor thresholds? Are there
more effective ways of adjusting for inflation? Does the inherent
uncertainty in an inflation adjustment present problems to franchisors
or prospective franchisees? If the Commission publishes its inflation-
adjusted thresholds several months before their effective dates, would
that provide sufficient notice to franchisors or prospective
franchisees?
Miscellaneous
38. Proposed section 436.10(e) would prohibit franchisors from
disclaiming (or requiring a franchisee from waiving reliance on) any
statement made in a disclosure document. Would this proposal serve a
useful purpose? What are the potential costs and benefits associated
with the proposal? What alternatives should the Commission consider to
ensure that prospective franchisees can rely on the accuracy of
statements made in a disclosure document?
39. Proposed section 436.11(b) states that franchisors can petition
the Commission to amend any outstanding FTC order that applies to any
franchisor that may be inconsistent with any provision of the revised
Rule. Is this express reference to the opportunity for order
modification by the Commission needed?
40. Should the Commission revise the Franchise Rule to add a
requirement that franchisors state in their disclosure documents the
name, business address, and telephone number of the primary individuals
who were responsible for preparing the disclosure document? This
proposal would be similar to franchisors including information about
the accounting firm that prepared their audited financial statements.
Would such a requirement improve the quality of advice that prospective
franchisors are given by their advisors? Could this requirement help
reduce fraud in the sale of franchises, by giving advisors an incentive
to be more cautious about advising clients who may be ill-prepared
financially or otherwise to enter into franchising or to support a
franchise system?

Section I--Proposed Rule

List of Subjects in 16 CFR Part 436

Advertising, Business and industry, Franchising, Trade practices.

Accordingly, it is proposed that part 436 of title 16 of the Code
of Federal Regulations, be revised to read as follows:

PART 436--DISCLOSURE REQUIREMENTS AND PROHIBITIONS CONCERNING
FRANCHISING

Subpart A--Definitions

Sec.
436.1 Definitions.

Subpart B--Obligations of Franchisors and Other Franchise Sellers

436.2 The obligation to furnish documents.

Subpart C--The Contents of a Disclosure Document

436.3 Cover page.
436.4 Table of contents.
436.5 Disclosure items.

[[Page 57332]]

Subpart D--Instructions

436.6 Instructions for preparing disclosure documents.
436.7 Instructions for electronic disclosure documents.
436.8 Instructions for updating disclosures.

Subpart E--Other Provisions

436.9 Exemptions.
436.10 Additional prohibitions.
436.11 Other laws, rules, orders.
436.12 Severability.

Appendix A: Sample Item 10 Table--Summary of Financing Offered

Appendix B: Sample Item 20(1) Table--Franchised Outlet Summary for
Fiscal Years 1995-1997

Appendix C: Sample Item 20(2) Table--Franchisor--Owned Outlets Summary
for 1995-1997

Appendix D: Sample Item 20(3) Table--Projected Openings as of December
31, 1997

Authority: 15 U.S.C. 41-58.

Definitions

Sec. 436.1 Definitions.

Unless stated otherwise, the following definitions shall apply
throughout this rule:
(a) Action includes complaints, cross claims, counterclaims, and
third-party complaints in a judicial proceeding, and their equivalents
in an administrative action or arbitration proceeding.
(b) Affiliate means an entity controlled by, controlling, or under
common control with the franchisor.
(c) Disclose means to state all material facts accurately, clearly,
concisely, and legibly in plain English.
(d) Financial performance representation means any oral, written,
or visual representation to a prospective franchisee, including a
representation disseminated in the general media and Internet, that
states or suggests a specific level or range of potential or actual
sales, income, gross profits, or net profits. A chart, table, or
mathematical calculation that demonstrates possible results based upon
a combination of variables is a financial performance representation.
(e) Fiscal year refers to the franchisor's fiscal year.
(f) Fractional franchise means a franchise relationship, which when
the relationship is created:
(1) The franchisee or any of the franchisee's current directors or
officers has more than two years of experience in the same type of
business; and
(2) The parties reasonably anticipate that the sales arising from
the relationship will not exceed more than 20 percent of the
franchisee's total dollar volume in sales during the first year of
operation.
(g) Franchise means any continuing commercial relationship or
arrangement, whatever it may be called, in which the terms of the offer
or contract specify, or the franchise seller represents, orally or in
writing, that:
(1) The franchisee obtains the right to operate a business or
offer, sell, or distribute goods, commodities, or services that are
identified or associated with the franchisor's trademark;
(2) The franchisor:
(i) Exerts or has authority to exert a significant degree of
continuing control over the franchisee's method of operation, including
but not limited to, the franchisee's business organization, promotional
activities, management, or marketing plan; or
(ii) Provides significant assistance in the franchisee's method of
operation (e.g., the franchisee's business organization, promotional
activities, management, or marketing plan), extending beyond the start
of the business operation. Promotional assistance alone, however, will
not constitute ``significant'' assistance in the absence of other forms
of assistance; and
(3) As a condition of obtaining or commencing operation of the
business, the franchisee is required by contract or by practical
necessity to make a payment, or a commitment to pay, to the franchisor
or a person affiliated with the franchisor.
(h) Franchise seller means a person that offers for sale, sells, or
arranges for the sale of an interest in a franchise. It includes the
franchisor and its employees, representatives, agents, and third-party
brokers. It does not include franchisees who sell only their own
outlets.
(i) Franchisee means any person who is granted an interest in a
franchise.
(j) Franchisor means any person who grants an interest in a
franchise and participates in the franchise relationship.
(k) Gag clause means any contractual provision entered into by a
franchisor and a current or former franchisee that prohibits or
restricts that franchisee from discussing his or her personal
experience as a franchisee within the franchisor's system. It does not
include confidentiality agreements that protect franchisors' trademarks
or other proprietary information.
(l) Internet means all communications between computers and between
computers and television, telephone, facsimile, and similar
communications devices. It includes the World Wide Web, proprietary
online services, E-mail, newsgroups, and electronic bulletin boards.
(m) Leased department means an arrangement whereby a retailer
licenses or otherwise permits an independent seller to conduct business
from the retailer's premises.
(n) Material, material fact, and material change includes any fact,
circumstance, or set of conditions that has a substantial likelihood of
influencing a reasonable franchisee or prospective franchisee in making
a significant decision.
(o) Officer means any individual with significant management
responsibility for the marketing and/or servicing of franchises, such
as the chief executive and chief operating officers, and the financial,
franchise marketing, training, and service officers. It also includes a
de facto officer, namely an individual with significant management
responsibility for the marketing and/or servicing of franchises whose
title does not reflect the nature of the position.
(p) Person means any individual, group, association, limited or
general partnership, corporation, or any other business entity.
(q) Plain English means the organization of information and
language usage understandable by a person unfamiliar with the franchise
business. It incorporates the following six principles of clear
writing: Short sentences; definite, concrete, everyday language; active
voice; tabular presentation of information; no legal jargon or highly
technical business terms; and no multiple negatives.
(r) Predecessor means a person from whom the franchisor acquired,
directly or indirectly, the major portion of the franchisor's assets or
from whom the franchisor obtained a license to use the trademark or
trade secrets in the franchise operation.
(s) Principal business address means the address of the
franchisor's home office in the United States. A principal business
address cannot be a post office box or private mail drop.
(t) Prospective franchisee means any person (including any agent,
representative, or employee) who approaches or is approached by a
franchise seller to discuss the possible establishment of a franchise
relationship.
(u) Required payment means all consideration that the franchisee
must pay to the franchisor or its affiliate, either by contract or by
practical necessity, as a condition of obtaining or commencing
operation of the franchise.
(v) Sale of a franchise includes an agreement whereby a person
obtains a franchise or interest in a franchise for value by purchase,
license, or otherwise. It does not include extending or

[[Page 57333]]

renewing an existing franchise agreement where there is no interruption
in the franchisee's operation of the business, unless the new agreement
contains terms and conditions that differ materially from the original
agreement.
(w) Signature means a person's affirmative steps to authenticate
his or her identity. It includes a person's written signature, as well
as a person's use of security codes, passwords, digital signatures, and
similar devices.
(x) Trademark includes trademarks, service marks, names, logos, and
other commercial symbols.
(y) Written means any information in printed form or in any form
capable of being preserved in tangible form and read. It includes:
type-set, word processed, or handwritten documents; documents on
computer disk or CD-Rom; documents sent via E-mail; or documents posted
on the Internet. It does not include mere oral statements.

Obligations of Franchisors and Other Franchise Sellers

Sec. 436.2 The obligation to furnish documents.

In connection with the offer or sale of a franchise to be located
in the United States of America, its territories, or possessions,
unless the transaction is exempted under the provisions of section
436.9, it is an unfair or deceptive act or practice in violation of
section 5 of the Federal Trade Commission Act:
(a) For any franchise seller to fail to furnish a prospective
franchisee with the following documents within the following time
frames. The obligations set forth in this subsection are satisfied if
either the franchisor or other franchise seller furnishes the required
documents to the prospective franchisee:
(1) A current disclosure document. A copy of the franchisor's
current disclosure document, as described in sections 436.3-436.8, at
least 14 days before the prospective franchisee signs a binding
agreement or pays any fee in connection with the proposed franchise
sale; and
(2) Completed franchise agreement. A copy of the completed
franchise agreement, and any related agreements, at least five days
before the prospective franchisee signs the franchise agreement.
(b) For purposes of this section, a franchise seller will be
considered to have furnished the documents by the required date if a
copy of the document--either a paper copy or, with the consent of the
prospective franchisee, an electronic copy--has been delivered to the
prospective franchisee by that date, or if a copy has been sent to the
address specified by the prospective franchisee by first-class mail at
least three days prior to the specified date. Documents shall also be
considered to have been furnished by the required date if a copy has
been sent by electronic mail or if directions for accessing the
document on the Internet have been provided to the prospective
franchise by that date.
(c) For any franchisor to fail to include the information and
follow the instructions required by sections 436.3-436.8 in preparing
the disclosure document to be furnished to prospective franchisees. Any
other franchise seller shall be liable for violations of these sections
if they knew or should have known of the violation.

The Contents of a Disclosure Document

Sec. 436.3 Cover page.

Begin the disclosure document with a cover page that consists of
the following:
(a) The title ``FRANCHISE DISCLOSURE DOCUMENT'' in boldface type.
(b) The franchisor's name, type of business organization, principal
business address, telephone number, and, if applicable, E-mail address
and primary Internet home page address.
(c) A sample of the primary business trademark under which the
franchisee will conduct its business.
(d) A brief description of the franchised business.
(e) The total amounts in Item 5 (Initial Franchisee Fee) and Item 7
(Estimated Initial Investment) of the disclosure document.
(f) The issuance date.
(g) The following statements in the order and form shown below:
(1) This disclosure document summarizes certain provisions of the
franchise agreement and other information in plain English. Read this
disclosure document and all agreements carefully. You must receive this
disclosure document at least 14 days before you sign a binding
agreement or pay any fee. You must also receive completed copies of all
contracts at least five days before you sign them.
(2) If the franchisor furnishes an electronic version of its
disclosure document, also insert the following:
You may have elected to receive an electronic version of your
disclosure document. If so, you may wish to print or download the
disclosure document for future reference. You have the right to receive
a paper copy of the disclosure document up until the time of sale. To
obtain a paper copy, contact [name] at [address] and [telephone
number].
(3) Buying a franchise is a complicated investment. The information
contained in this disclosure document can help you make up your mind.
Note, however, that the Federal Trade Commission (FTC) has not checked
the information and does not know if it is correct. Information
comparing franchisors is available. Call your State agency or your
public library for sources of information. Additional information on
franchising, such as ``A Consumer's Guide to Buying a Franchise,'' is
available from the FTC. You can contact the FTC in Washington, D.C., or
visit the FTC's home page at www.ftc.gov> for further information. In
addition, there may be laws on franchising in your State. Ask your
State agencies about them.
(4) You should also know that the terms and conditions of your
contract will govern your franchise relationship. While the disclosure
document includes some information about your contract, don't rely on
it alone to understand your contract. Read all of your contract
carefully. Show your contract and this disclosure document to an
advisor, like a lawyer or an accountant.
(5) Federal Trade Commission, Washington, DC 20580.
(h) Franchisors may include additional disclosures on the cover
page, or on a separate cover page, to comply with any applicable State
pre-sale disclosure laws.

Sec. 436.4 Table of contents.

Include the following table of contents. State the page where each
disclosure Item begins. List all exhibits by letter, following the
example shown below.

Table of Contents

1. The Franchisor, its Parent, Predecessors, and Affiliates
2. Business Experience
3. Litigation
4. Bankruptcy
5. Initial Franchise Fee
6. Other Fees
7. Estimated Initial Investment
8. Restrictions on Sources of Products and Services
9. Franchisee's Obligations
10. Financing
11. Franchisor's Assistance, Advertising, Computer Systems, and
Training
12. Territory
13. Trademarks
14. Patents, Copyrights, and Proprietary Information
15. Obligation to Participate in the Actual Operation of the
Franchise Business
16. Restrictions on What the Franchisee May Sell

[[Page 57334]]

17. Renewal, Termination, Transfer, and Dispute Resolution
18. Public Figures
19. Financial Performance Representations
20. Outlets and Franchisee Information
21. Financial Statements
22. Contracts
23. Receipt

Exhibits

A. Franchise Agreement

Sec. 436.5 Disclosure items.

(a) Item 1: The Franchisor, Its Parents, Predecessors, and
Affiliates.
(1) Disclose the name of the franchisor. Also disclose the names of
any parent and affiliates of the franchisor and the relationship with
the franchisor. For purposes of this paragraph (a) the term
``affiliate'' means an entity controlled by, controlling, or under
common control with the franchisor, that offers franchises in any line
of business or is providing products or services to the franchisees of
the franchisor.
(2) Disclose the name of any predecessors during the 10-year period
immediately before the close of the franchisor's most recent fiscal
year.
(3) Disclose the name under which the franchisor does or intends to
do business.
(4) Disclose the principal business address of the franchisor, its
parent, predecessors, and affiliates, and the franchisor's agent for
service of process.
(5) Disclose the type of business organization used by the
franchisor (e.g., corporation, partnership), and the State in which it
was organized.
(6) Disclose the following information about the nature of the
franchisor's business and the franchises to be offered:
(i) Whether the franchisor operates businesses of the type being
franchised;
(ii) The franchisor's other business activities;
(iii) The business to be conducted by the franchisee;
(iv) The general market for the product or service to be offered by
the franchisee. In describing the general market, consider factors such
as whether the market is developed or developing, whether the goods
will be sold primarily to a certain group, and whether sales are
seasonal;
(v) In general terms, any laws or regulations specific to the
industry in which the franchise business operates; ¹ and
---------------------------------------------------------------------------

\1\ Only laws pertaining specifically to the industry sector of
the franchised business, and not businesses generally, must be
disclosed in this Item. For example, a real estate brokerage
franchisor should disclose the existence of broker licensing laws;
an optical products franchisor should disclose the existence of
applicable optometrist/optician staffing regulations and licensing
requirements; a lawn care franchisor should disclose that certain
environmental laws regulating pesticide application to residential
lawns will require that franchisees post notices on treated lawns.
It is not necessary to include laws or regulations that apply to
businesses generally, such as general business licensing laws, tax
regulations, or labor laws.
---------------------------------------------------------------------------

(vi) A general description of the competition.
(7) Disclose the prior business experience of the franchisor, its
parent, predecessors, and affiliates, including:
(i) The length of time each has conducted the type of business to
be operated by the franchisee;
(ii) The length of time each has offered franchises providing the
type of business to be operated by the franchisee; and
(iii) Whether each has offered franchises in other lines of
business, including:
(A) A description of each other line of business;
(B) The number of franchises sold in each other line of business;
and
(C) The length of time offering each other line of business.
(b) Item 2: Business Experience. Disclose the position and name of
the directors, trustees, general partners, officers, and subfranchisors
of the franchisor or any parent who will have management responsibility
relating to the offered franchises. List all franchise brokers. For
each person listed, state the principal positions and employers during
the past five years, including each position's beginning date, ending
date, and location.
(c) Item 3: Litigation.
(1) Disclose whether the franchisor, its parent, predecessor, a
person identified in paragraph (b) of this section, or an affiliate who
offers franchises under the franchisor's principal trademark:
(i) Has pending against that person:
(A) An administrative, criminal, or material civil action alleging
a violation of a franchise, antitrust, or securities law, or alleging
fraud, unfair or deceptive practices, or comparable allegations; or
(B) Civil actions, other than ordinary routine litigation
incidental to the business, which are significant in the context of the
number of franchisees and the size, nature, or financial condition of
the franchise system or its business operations.
(ii) Is a party to any pending material civil action involving the
franchise relationship. For purposes of this paragraph, ``franchise
relationship'' means contractual obligations between the franchisor and
franchisee directly relating to the operation of the franchised
business (e.g., royalty payment and training obligations). It does not
include suits involving third-parties such as suppliers or
indemnification for tort liability.
(iii) Has during the 10-year period immediately before the
disclosure document's issuance date:
(A) Been convicted of a felony or pleaded nolo contendere to a
felony charge;
(B) Been held liable in a civil action by final judgment. ``Held
liable'' means that, as a result of claims or counterclaims, the
franchisor must pay money or other consideration, must reduce an
indebtedness by the amount of an award, cannot enforce its rights, or
must take action adverse to its interests; or
(C) Been a defendant in a material action involving an alleged
violation of a franchise, antitrust, or securities law, or involving
allegations of fraud, unfair or deceptive practices, or comparable
allegations.²
---------------------------------------------------------------------------

\2\ Franchisors are not required to disclose actions that were
dismissed by final judgment without liability or entry of an adverse
order. However, franchisors must disclose dismissal of a material
action in connection with a settlement.
---------------------------------------------------------------------------

(iv) Is subject to a currently effective injunctive or restrictive
order or decree resulting from a pending or concluded action brought by
a public agency and relating to the franchise or to a Federal, State,
or Canadian franchise, securities, antitrust, trade regulation, or
trade practice law.
(2) For each action identified in paragraph (c)(1) of this section,
state the title, case number or citation, the initial filing date, the
names of the parties, and the forum. State the relationship of the
opposing party to the franchisor (e.g., competitor, supplier, lessor,
franchisee, former franchisee, or class of franchisees). Summarize the
legal and factual nature of each claim in the action, the relief sought
or obtained, and any conclusions of law or fact.³ In
addition:
---------------------------------------------------------------------------

\3\ Franchisors may include a summary opinion of counsel
concerning any action if a consent to use the summary opinion is
included as part of the disclosure document.
---------------------------------------------------------------------------

(i) For pending actions, state the status of the action;
(ii) For prior actions, state the date when the judgment was
entered and any damages and/or settlement terms; ⁴
---------------------------------------------------------------------------

\4\ If a settlement agreement must be disclosed in this Item,
all material settlement terms must be disclosed, whether or not the
agreement is confidential. Because of difficulties in retrieving
information and/or obtaining releases from older confidentiality
agreements, franchisors are not required to disclose the settlement
terms of settlements entered before April 15, 1993, consistent with
the policy adopted by the North American Securities Administrators
Association's Uniform Franchise Offering Circular Guidelines.

---------------------------------------------------------------------------

[[Page 57335]]

(iii) For injunctive or restrictive orders, state the nature,
terms, and conditions of the order or decree; and
(iv) For convictions or pleas, state the crime or violation, the
date of conviction, and the sentence or penalty imposed.
(d) Item 4: Bankruptcy.
(1) Disclose whether the franchisor, its parent, predecessor, a
person identified in paragraph (b) of this section or an affiliate who
offers franchises under the franchisor's principal trademark has,
during the 10-year period immediately before the date of this
disclosure document:
(i) Filed as debtor (or had filed against it) a petition under the
U.S. Bankruptcy Code (``Bankruptcy Code'');
(ii) Obtained a discharge of its debts under the Bankruptcy Code;
or
(iii) Been a principal officer of a company or a general partner in
a partnership that either filed as a debtor (or had filed against it) a
petition under the Bankruptcy Code or that obtained a discharge of its
debts under the Bankruptcy Code while or within one year after the
officer or general partner held the position in the company.
(2) For each bankruptcy:
(i) State the name, address, and principal business of the debtor;
(ii) If the debtor is not the franchisor, state the relationship of
the debtor to the franchisor (e.g., affiliate, officer); and
(iii) State the date of the original filing. Identify the
bankruptcy court, and the case name and number. If applicable, state
the debtor's discharge date, including discharges under Chapter 7 and
confirmation of any plans of reorganization under Chapters 11 and 13 of
the Bankruptcy Code.
(3) Disclose cases, actions, and other proceedings under the laws
of foreign nations relating to bankruptcy, as if they took place under
the Bankruptcy Code.
(e) Item 5: Initial Franchise Fee. Disclose the initial franchise
fee and the conditions under which this fee is refundable. If the
initial fee is not uniform, disclose the range or the formula used to
calculate the initial fees paid in the fiscal year before the issuance
date and the factors that determined the amount. For purposes of this
Item, ``initial fee'' means all fees and payments for services or goods
received from the franchisor before the franchisee's business opens,
whether payable in lump sum or installments.
(f) Item 6: Recurring or Occasional Fees. Disclose, in the tabular
form shown below, any recurring or occasional fees that the franchisee
must pay to the franchisor or its affiliates, or that the franchisor or
its affiliates impose or collect in whole or in part on behalf of a
third party. Include any formula used to compute the fees.⁵
---------------------------------------------------------------------------

\5\ If fees may increase, disclose the formula that determines
the increase or the maximum amount of the increase. For example, a
percentage of gross sales is acceptable if the franchisor defines
the term ``gross sales.''

----------------------------------------------------------------------------------------------------------------
(1) Type of fee (2) Amount (3) Due date (4) Remarks
----------------------------------------------------------------------------------------------------------------

----------------------------------------------------------------------------------------------------------------

(1) In column (1), disclose the type of fee (e.g., royalties, and
fees for lease negotiations, construction, remodeling, additional
training or assistance, advertising, advertising cooperatives,
purchasing cooperatives, audits, accounting, inventory, transfers, and
renewals).
(2) In column (2), disclose the amount of each fee.
(3) In column (3), disclose the applicable due date for recurring
fees.
(4) In column (4), include any relevant remarks, definitions, or
caveats that elaborate on the information in the table. If remarks are
lengthy, franchisors may use footnotes instead of the remarks column.
If applicable, include the following information in the remarks column
or in a footnote:
(i) If the fees are payable only to the franchisor;
(ii) If the fees are imposed and collected by the franchisor;
(iii) The terms and conditions under which any fee is refundable;
and
(iv) The voting power of franchisor-owned outlets on any fees
imposed by cooperatives. If franchisor-owned outlets have controlling
voting power, disclose the maximum and minimum fees that may be
imposed.
(g) Item 7: Estimated Initial Investment. Disclose, in the tabular
form shown below, the franchisee's estimated initial investment. Title
the table ``Your Estimated Initial Investment For The First [reasonable
initial phase] Months.'' A reasonable initial phase is at least three
months or a reasonable period for the industry. Franchisors may include
additional expenditure tables to show expenditure variations caused by
differences such as in site location and premises size.

Your Estimated Initial Investment for the First [reasonable initial phase] Months
----------------------------------------------------------------------------------------------------------------
(3) Method of
(1) Type of expenditure (2) Amount payment (4) When due (5) To whom paid
----------------------------------------------------------------------------------------------------------------

-------------------------------------------------------------------------------
Total...........................
----------------------------------------------------------------------------------------------------------------

(1) In column (1), disclose each type of expense, beginning with
pre-opening expenses. Include the following expenses, if applicable.
Use footnotes to comment on expenditures.
(i) The initial franchise fee.
(ii) Training expenses.
(iii) Real property, whether purchased or leased.
(iv) Equipment, fixtures, other fixed assets, construction,
remodeling, leasehold improvements, and decorating costs, whether
purchased or leased.
(v) Inventory required to begin operation.
(vi) Security deposits, utility deposits, business licenses, and
other prepaid expenses.
(vii) List separately and by name any other specific payment (e.g.,
additional training, travel, or advertising expenses).
(viii) Include an additional expense category named ``other
payments'' for any other miscellaneous expenses that the franchisee
will incur before operations begin and during the initial phase.
(2) In column (2), state the amount of the payment. If the specific
amount is not ascertainable, use a low-high range based on the
franchisor's current experience. If real property costs cannot be
estimated in a low-high range, disclose the approximate size of the
property and building, and describe the probable location of the
building (e.g., strip shopping center, mall, downtown, rural, or
highway).
(3) In column (3), disclose the method of payment.
(4) In column (4), disclose the applicable due date.
(5) In column (5), disclose to whom payment will be made.
(6) Total the initial investment, incorporating ranges of fees, if
used.
(7) Disclose in a footnote:
(i) The conditions under which each payment is refundable; and
(ii) If the franchisor or an affiliate finances part of the initial
investment, the amount that it will finance, the required down payment,
the annual percentage rate of interest, rate factors, and the estimated
loan repayments. Franchisors may refer the reader to Item 10 for
additional details.

[[Page 57336]]

(h) Item 8: Restrictions on Sources of Products and Services.
Disclose franchisees' obligations to purchase or lease goods, services,
fixtures, equipment, real estate, or comparable items related to
establishing or operating the franchised business either from the
franchisor, its designee, or suppliers approved by the franchisor, or
under the franchisor's specifications. Include obligations to purchase
imposed by written agreement or by the franchisor's
practice.⁶ For each applicable obligation:
---------------------------------------------------------------------------

\6\ Franchisors may include the reason for the requirement.
Franchisors are not required to disclose in this Item the purchase
or lease of goods or services provided as part of the franchise
without a separate charge (e.g., initial training, the cost for
which is included in the franchise fee); such fees should be
described in paragraph (e) of this section. Franchisors should not
disclose fees already described in paragraph (e) of this section.
---------------------------------------------------------------------------

(1) Disclose the item required to be purchased or leased.
(2) Disclose whether the franchisor or its affiliates are either
approved suppliers or the only approved suppliers of that item.
(3) Disclose how the franchisor grants and revokes approval of
alternative suppliers. State:
(i) The criteria for evaluating, approving, or disapproving of
alternative suppliers;
(ii) Whether the franchisor permits franchisees to contract with
alternative suppliers who meet the franchisor's criteria;
(iii) Any fees and procedures to secure approval;
(iv) How approvals are revoked; and
(v) The time period within which the franchisee will receive
notification of approval or disapproval.
(4) Disclose whether the franchisor issues specifications and
standards to franchisees, subfranchisees, or approved suppliers.
Describe how the franchisor issues and modifies specifications.
(5) Disclose whether the franchisor or its affiliates will or may
derive revenue or other material consideration as a result of required
purchases or leases by franchisees.⁷ Describe the precise
basis by which the franchisor or its affiliates will or may derive such
consideration by disclosing:
---------------------------------------------------------------------------

\7\ Figures should be taken from the franchisor's most recent
annual audited financial statement required in paragraph (u) of this
section. If audited statements are not yet required, or if the
entity deriving the income is an affiliate, disclose the sources of
information used in computing revenues.
---------------------------------------------------------------------------

(i) The franchisor's total revenue;
(ii) The franchisor's revenues from all required purchases and
leases of products and services;
(iii) The percentage of the franchisor's total revenues represented
by the franchisor's revenues from required purchases or leases; and
(iv) If the franchisor's affiliates also sell or lease products or
services to franchisees, disclose affiliate revenues from those sales
or leases.
(6) Disclose the estimated proportion of these required purchases
and leases to all purchases and leases by the franchisee in
establishing and operating the franchised business.
(7) If a designated supplier will make payments to the franchisor
as a result of purchases by franchisees, disclose the basis for the
payment (e.g., specify a percentage or a flat amount). For purposes of
this paragraph, a ``payment'' includes the sale of similar goods or
services to the franchisor at a lower price than that available to
franchisees.
(8) Disclose the existence of purchasing or distribution
cooperatives.
(9) Disclose whether the franchisor negotiates purchase
arrangements with suppliers, including price terms, for the benefit of
franchisees.
(10) Disclose whether the franchisor provides material benefits
(e.g., renewal or granting additional franchises) to a franchisee based
on a franchisee's purchase of particular products or services or use of
particular suppliers.
(i) Item 9: Franchisee's Obligations. Disclose, in the tabular form
shown below, a list of the franchisees' principal obligations. Cross-
reference each listed obligation with any applicable franchise
agreement and disclosure document section(s). Respond to each listed
obligation. If a particular obligation is not applicable, state ``Not
Applicable.'' Include additional obligations, as is warranted.
This table lists your principal obligations under the franchise and
other agreements. It will help you find more detailed information about
your obligations in these agreements and in other items of this
disclosure document.

----------------------------------------------------------------------------------------------------------------
Obligation Section in agreement Disclosure document item
----------------------------------------------------------------------------------------------------------------
a. Site selection and ................................... ..........................................
acquisition/lease
b. Pre-opening purchases/leases ................................... ..........................................
c. Site development and other ................................... ..........................................
pre-opening requirements
d. Initial and ongoing training ................................... ..........................................
e. Opening ................................... ..........................................
f. Fees ................................... ..........................................
g. Compliance with standards ................................... ..........................................
and policies/operating manual
h. Trademarks and proprietary ................................... ..........................................
information
i. Restrictions on products/ ................................... ..........................................
services offered
j. Warranty and customer ................................... ..........................................
service requirements
k. Territorial development and ................................... ..........................................
sales quotas
l. Ongoing product/service ................................... ..........................................
purchases
m. Maintenance, appearance, and ................................... ..........................................
remodeling requirements
n. Insurance ................................... ..........................................
o. Advertising ................................... ..........................................
p. Indemnification ................................... ..........................................
q. Owner's participation/ ................................... ..........................................
management/staffing
r. Records and reports ................................... ..........................................
s. Inspections and audits ................................... ..........................................
t. Transfer ................................... ..........................................
u. Renewal ................................... ..........................................
v. Post-termination obligations ................................... ..........................................
w. Non-competition covenants ................................... ..........................................
x. Dispute resolution ................................... ..........................................
y. Other (describe)
----------------------------------------------------------------------------------------------------------------

[[Page 57337]]

(j) Item 10: Financing.
(1) Disclose the terms and conditions of each financing
arrangement,⁸ including leases and installment contracts,
that the franchisor, its agent, or affiliates offers directly or
indirectly to the franchisee.⁹ The franchisor may summarize
the terms of each financing arrangement in tabular form, using
footnotes to provide additional information. For a sample Item 10
table, see Appendix A to this part. For each financing arrangement,
disclose:
---------------------------------------------------------------------------

\8\ Payments due within 90 days on open account financing are
not required to be disclosed under this section.
\9\ Indirect offers of financing include a written arrangement
between a franchisor or its affiliate and a lender, for the lender
to offer financing to a franchisee; an arangement in which a
franchisor or its affiliate receives a benefit from a lender in
exchange for financing a franchise purchase; and a franchisor's
guarantee of a note, lease, or other obligation of the franchisee.
---------------------------------------------------------------------------

(i) A description of what the financing covers (e.g., the initial
franchise fee, site acquisition, construction or remodeling, initial or
replacement equipment or fixtures, opening or ongoing inventory or
supplies, or other continuing expenses); ¹⁰
---------------------------------------------------------------------------

\10\ Include specimen copies of the financing documents as an
exhibit to paragraph (v) of this section. Cite the section and name
of the document containing the financing terms and conditions.
---------------------------------------------------------------------------

(ii) The identity of the lender(s) providing the financing and any
relationship to the franchisor (e.g., affiliate);
(iii) The amount of financing offered or, if the amount depends on
an actual cost that may vary, the percentage of the cost that will be
financed;
(iv) The annual percentage rate of interest (``APR'') charged,
computed as provided by Sections 106-107 of the Consumer Protection
Credit Act, 15 U.S.C. 1605-1606. If the APR may differ depending on
when the financing is issued, disclose the APR on a specified recent
date;
(v) The number of payments or the period of repayment;
(vi) The nature of any security interest required by the lender;
(vii) Whether a person other than the franchisee must personally
guarantee the debt;
(viii) Whether the debt can be prepaid and the nature of any
prepayment penalty;
(ix) The franchisee's potential liabilities upon default, including
any:
(A) Accelerated obligation to pay the entire amount due;
(B) Obligations to pay court costs and attorney's fees incurred in
collecting the debt;
(C) Termination of the franchise; or
(D) Liabilities from cross defaults such as those resulting
directly from non-payment, or indirectly from the loss of business
property; and
(x) Other material financing terms.
(2) Disclose whether any provisions of the loan agreement require
franchisees to waive defenses or other legal rights (e.g., confession
of judgment), or bar the franchisee from asserting a defense against
the lender, the lender's assignee or the franchisor. If so, describe
the relevant provisions.
(3) Disclose whether the franchisor's practice or intent is to
sell, assign, or discount to a third party all or part of the financing
arrangement. If so, disclose:
(i) The assignment terms, including whether the franchisor will
remain primarily obligated to provide the financed goods or services;
and
(ii) That the franchisee may lose all its defenses against the
lender as a result of the sale or assignment.
(4) Disclose whether the franchisor or an affiliate receives any
payments for the placement of financing with the lender. If such
payments exist:
(i) Disclose the amount or the method of determining the payment;
and
(ii) Identify the source of the payment and the relationship of the
source to the franchisor or its affiliates.
(k) Item 11: Franchisor's Assistance, Advertising, Computer
Systems, and Training. Disclose the franchisor's principal assistance
and related obligations as described below. For each obligation, cite
the section number of the franchise agreement imposing the obligation.
Begin by stating: ``Except as listed below, [the franchisor] is not
required to provide any assistance to you.''
(1) Disclose the franchisor's pre-opening obligations to the
franchisee including any assistance in:
(i) Locating a site and negotiating the purchase or lease of the
site. Disclose:
(A) Whether the franchisor generally owns the premises and leases
it to the franchisee;
(B) Whether the franchisor selects the site or approves an area
within which the franchisee selects a site. Disclose further how and
whether the franchisor must approve a franchisee-selected site;
(C) The factors that the franchisor considers in selecting or
approving sites (e.g., general location and neighborhood, traffic
patterns, parking, size, physical characteristics of existing
buildings, and lease terms);
(D) The time limit for the franchisor to locate or to approve or
disapprove the site. Disclose further the consequences if the
franchisor and franchisee cannot agree on a site.
(ii) Conforming the premises to local ordinances and building codes
and obtaining any required permits;
(iii) Constructing, remodeling, or decorating the premises;
(iv) Hiring and training employees; and
(v) Providing for necessary equipment, signs, fixtures, opening
inventory, and supplies. In addition, disclose further:
(A) Whether the franchisor provides these items directly or merely
provides the names of approved suppliers;
(B) Whether the franchisor provides written specifications for
these items; and
(C) Whether the franchisor delivers or installs these items;
(2) Disclose the typical length of time between the signing of the
franchise agreement or the first payment of consideration for the
franchise and the opening of the franchisee's business. Describe the
factors that may affect the time period such as ability to obtain a
lease, financing or building permits, zoning and local ordinances,
weather conditions, shortages, or delayed installation of equipment,
fixtures, and signs.
(3) Disclose the franchisor's obligations to the franchisee during
the operation of the franchise, including any assistance in:
(i) Developing products or services to be offered by the franchisee
to its customers;
(ii) Hiring and training employees;
(iii) Improving and developing the franchised business;
(iv) Establishing prices;
(v) Establishing and using administrative, bookkeeping, accounting,
and inventory control procedures; and
(vi) Resolving operating problems encountered by the franchisee.
(4) Describe the advertising program for the franchise system.
Disclose the following:
(i) The franchisor's obligation to conduct advertising, including:
(A) The media the franchisor may use;
(B) Whether media coverage is local, regional, or national;
(C) The source of the advertising (e.g., an in-house advertising
department or a national or regional advertising agency); and
(D) Whether the franchisor must spend any amount on advertising in
the area or territory where the franchisee is located.
(ii) Disclose the conditions under which the franchisor permits
franchisees to use their own advertising material.
(iii) Disclose whether there is an advertising council composed of
franchisees that advises the franchisor on advertising policies. If so,
disclose:

[[Page 57338]]

(A) How members of the council are selected;
(B) Whether the council serves in an advisory capacity only or has
operational or decision-making power; and
(C) Whether the franchisor has the power to form, change, or
dissolve the advertising council.
(iv) Disclose whether the franchisee must participate in a local or
regional advertising cooperative. If so, disclose:
(A) How the area or membership of the cooperative is defined;
(B) How much the franchisee must contribute to the fund and whether
other franchisees are required to contribute at a different rate;
(C) Whether the franchisor-owned outlets must contribute to the
fund and, if so, whether it is on the same basis as franchisees;
(D) Who is responsible for administration of the cooperative (e.g.,
franchisor, franchisees, or advertising agency);
(E) Whether cooperatives must operate from written governing
documents and whether the documents are available for review by the
franchisee;
(F) Whether cooperatives must prepare annual or periodic financial
statements and whether the statements are available for review by the
franchisee; and
(G) Whether the franchisor has the power to require cooperatives to
be formed, changed, dissolved, or merged.
(v) Disclose whether the franchisee must participate in any other
advertising fund. If so, disclose:
(A) Who contributes to the fund;
(B) How much the franchisee must contribute to the fund and whether
other franchisees are required to contribute at a different rate;
(C) Whether the franchisor-owned outlets must contribute to the
fund and, if so, whether it is on the same basis as franchisees;
(D) Who administers the fund;
(E) Whether the fund is audited and when it is audited;
(F) Whether financial statements of the fund are available for
review by the franchisee; and
(G) Use of the fund in the most recently concluded fiscal year, the
percentages spent on production, media placement, administrative
expenses, and a description of any other use.
(vi) If all advertising funds are not spent in the fiscal year in
which they accrue, explain how the franchisor uses the remaining
amount. Indicate whether franchisees will receive a periodic accounting
of how advertising fees are spent.
(vii) Disclose the percentage of advertising funds, if any, that
the franchisor uses principally to solicit new franchise sales.
(5) Disclose whether the franchisor requires the franchisee to buy
or use electronic cash registers or computer systems. If so, describe
the systems generally in non-technical language.
(i) Identify each hardware component and software program by brand,
type, and principal functions.
(A) If the hardware component or software program is the
proprietary property of the franchisor, an affiliate, or a third party,
state whether the franchisor, an affiliate, or a third party has the
contractual right or obligation to provide ongoing maintenance,
repairs, upgrades, or updates. Disclose the current annual cost of any
optional or required maintenance and support contracts, upgrades, and
updates;
(B) If the hardware component or software program is the
proprietary property of a third party, and no compatible equivalent
component or program has been approved by the franchisor for use with
the system to perform the same functions, identify the third party by
name, business address, and telephone number, and state the length of
time the component or program has been in continuous use by the
franchisor and its franchisees;
(C) If the hardware component or software program is not
proprietary, identify compatible equivalent components or programs that
perform the same functions and indicate whether they have been approved
by the franchisor.
(ii) State whether the franchisee has any contractual obligation to
upgrade or update any hardware component or software program during the
term of the franchise and, if so, whether there are any contractual
limitations on the frequency and cost of the obligation.
(iii) For each electronic cash register system or software program,
describe how it will be used in the franchisee's business, and the
types of business information or data that will be collected and
generated. State further whether the franchisor will have independent
access to the information and data and, if so, whether there are any
contractual limitations on the franchisor's right to access the
information and data.
(6) Disclose the table of contents of the franchisor's operating
manual(s) provided to franchisees as of the franchisor's last fiscal
year-end or a more recent date. State further the number of pages
devoted to each subject and the total number of pages in the manual as
of this date. Alternatively, this disclosure may be omitted if the
prospective franchisee views the manual before purchase of the
franchise.
(7) Disclose the franchisor's training program as of the
franchisor's last fiscal year-end or a more recent date.
(i) Describe the nature of the training program summarized in
tabular form, as follows:

Training Program
----------------------------------------------------------------------------------------------------------------
Hours of classroom Hours of on-the-job
Subject training training Location
----------------------------------------------------------------------------------------------------------------

(A) In column (1), state the subjects taught.
(B) In column (2), state the hours of classroom training for each
subject.
(C) In column (3), state the hours of on-the-job training for each
subject.
(D) In column (4), state the location of the training for each
subject.
(ii) Disclose how often training classes are held and the nature of
the location or facility where training is held (e.g., company, home,
office, franchisor-owned store).
(iii) Describe the nature of instructional materials and the
instructor's experience. State the length of experience of the
instructor in the field and, specifically, with the franchisor. State
only the experience that is relevant to the subject taught and the
franchisor's operations;
(iv) Disclose any charges franchisees must pay for training and who
must pay travel and living expenses of the enrollees in the training
program;
(v) Disclose who may and who is required to attend the training.
State whether the franchisee or other persons must complete the program
to the franchisor's satisfaction. If successful completion is required,
state how long after the signing of the agreement or before the opening
of the business the training must be completed. If training is not
mandatory, state the percentage of new franchisees that enrolled in the

[[Page 57339]]

training program during the preceding 12 months; and
(vi) Whether any additional training programs and/or refresher
courses are required.
(l) Item 12: Territory.
(1) Disclose the following information concerning the franchisee's
market area (with or without an exclusive territory):
(i) If applicable, the minimum area granted to the franchisee
(e.g., a specific radius, a distance sufficient to encompass a
specified population, or another specific designation);
(ii) Whether the franchise is granted for a specific location or a
location to be approved by the franchisor;
(iii) Any conditions under which the franchisor will approve the
relocation of the franchised business or the franchisee's establishment
of additional franchised outlets;
(iv) Whether the franchisor has established or may establish
another franchisee who may also use the franchisor's trademark within
the defined area;
(v) Whether the franchisor has established or may establish
franchisor-owned outlets or other channels of distribution using the
franchisor's trademark within the defined area;
(vi) Whether the franchisor or its affiliate has established or may
establish other franchises or franchisor-owned outlets or another
channel of distribution selling or leasing similar products or services
under a different trademark within the defined area;
(vii) Restrictions on the franchisor regarding operating
franchisor-owned stores or on granting franchised outlets for a similar
or competitive business within the defined area; (viii) Restrictions on
franchisees from soliciting or accepting orders outside of their
defined territories;
(ix) Restrictions on the franchisor from soliciting or accepting
orders inside the franchisee's defined territory. State further any
compensation that the franchisor must pay for soliciting or accepting
orders inside the franchisee's defined territories; and
(x) Franchisee options, rights of first refusal, or similar rights
to acquire additional franchises within the territory or contiguous
territories.
(2) Describe any exclusive territory granted the franchisee.
(i) If the franchisor grants an exclusive territory, disclose:
(A) Whether continuation of the franchisee's territorial
exclusivity depends on achievement of a certain sales volume, market
penetration, or other contingency, and under what circumstances the
franchisee's territory may be altered. Specify any sales or other
conditions. State the franchisor's rights if the franchisee fails to
meet the requirements; and
(B) Any other circumstances that permit the franchisor to modify
the franchisee's territorial rights (e.g., a population increase in the
territory giving the franchisor the right to grant an additional
franchise within the area), and the effect of such modifications on the
franchisee's rights;
(ii) If the franchisor does not grant exclusive territories, state:
``You will not receive an exclusive territory. [Franchisor] may
establish other franchised or franchisor-owned outlets that may compete
with your location.''
(3) If the franchisor or an affiliate operates, franchises, or has
present plans to operate or franchise a business under a different
trademark and that business sells goods or services similar to those to
be offered by the franchisee, describe:
(i) The similar goods and services;
(ii) The trade names and trademarks;
(iii) Whether outlets will be franchisor owned or operated:
(iv) Whether the franchisor or its franchisees who use the
different trademark will solicit or accept orders within the
franchisee's territory;
(v) A timetable for the plan;
(vi) How the franchisor will resolve conflicts between the
franchisor and the franchisees and between the franchisees of each
system regarding territory, customers or franchisor support; and
(vii) The principal business address of the franchisor's similar
operating business. If it is the same as the franchisor's principal
business address disclosed in paragraph (a) of this section, disclose
whether the franchisor maintains (or plans to maintain) physically
separate offices and training facilities for the similar competing
business.
(m) Item 13: Trademarks.
(1) Disclose each principal trademark to be licensed to the
franchisee. For purposes of this Item, ``principal trademark'' means
the primary trademarks, service marks, names, logos, and commercial
symbols to be used by the franchisee to identify the franchised
business. It does not include every trademark owned by the franchisor.
(2) For each principal trademark, disclose whether the trademark is
registered with the United States Patent and Trademark Office.
(i) For each registration, state:
(A) The date and identification number of each trademark
registration or registration application;
(B) Whether the franchisor has filed all required affidavits;
(C) Whether any registration has been renewed; and
(D) Whether the principal trademarks are registered on the
Principal or Supplemental Register of the U.S. Patent and Trademark
Office, and if not, whether an ``intent to use'' application or an
application based on actual use has been filed with the U.S. Patent and
Trademark Office.
(ii) If the trademark is not registered on the Principal Register
of the U.S. Patent and Trademark Office, state: ``By not having a
Principal Register federal registration for [name or description of
symbol], [name of franchisor] does not have certain presumptive legal
rights granted by a registration.''
(3) Disclose any currently effective material determinations of the
U.S. Patent and Trademark Office, the Trademark Trial and Appeal Board,
or the trademark administrator of any State or court; and any pending
infringement, opposition, or cancellation proceeding. Include
infringement, opposition, or cancellation proceedings in which the
franchisor unsuccessfully sought to prevent registration of a trademark
in order to protect a trademark licensed by the franchisor. Describe
how the determination affects the franchised business.
(4) Disclose any pending material federal or State litigation
regarding the franchisor's use or ownership rights in a trademark. For
each pending action, disclose: \11\
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\11\ Franchisors may include a summary opinion of counsel
concerning any action if a consent to use the summary opinion is
included as part of the disclosure document.
---------------------------------------------------------------------------

(i) The forum and case number;
(ii) The nature of claims made opposing the franchisor's use or by
the franchisor opposing another person's use; and
(iii) Any effective court or administrative agency ruling
concerning the matter.
(5) Disclose agreements currently in effect that significantly
limit the rights of the franchisor to use or license the use of
trademarks listed in this Item in a manner material to the franchise.
For each agreement, disclose:
(i) The manner and extent of the limitation or grant;
(ii) The extent to which the franchisee may be affected by the
agreement;
(iii) The agreement's duration;
(iv) The parties to the agreement;
(v) The circumstances under which the agreement may be canceled or
modified; and
(vi) All other material terms.
(6) Disclose whether the franchisor must protect the franchisee's
right to use the principal trademarks listed in this Item, and must
protect the franchisee

[[Page 57340]]

against claims of infringement or unfair competition arising out of the
franchisee's use of the trademarks. Disclose further:
(i) The franchisee's obligation to notify the franchisor of the use
of, or claims of rights to, a trademark identical to or confusingly
similar to a trademark licensed to the franchisee;
(ii) Whether the franchise agreement requires the franchisor to
take affirmative action when notified of these uses or claims. Identify
who has the right to control administrative proceedings or litigation;
(iii) Whether the franchise agreement requires the franchisor to
participate in the franchisee's defense and/or indemnify the franchisee
for expenses or damages if the franchisee is a party to an
administrative or judicial proceeding involving a trademark licensed by
the franchisor to the franchisee, or if the proceeding is resolved
unfavorably to the franchisee; and
(iv) The franchisee's rights under the franchise agreement if the
franchisor requires the franchisee to modify or discontinue the use of
a trademark.
(7) Disclose whether the franchisor actually knows of either
superior prior rights or infringing uses that could materially affect
the franchisee's use of the principal trademarks in the State in which
the franchised business is to be located. For each use of a principal
trademark that the franchisor believes constitutes an infringement that
could materially affect the franchisee's use of a trademark, disclose:
(i) The nature of the infringement;
(ii) The location(s) where the infringement is occurring;
(iii) The length of time of the infringement (to the extent known);
and
(iv) Action taken by the franchisor.
(n) Item 14: Patents, Copyrights, and Proprietary Information.
(1) Disclose whether the franchisor owns rights in patents or
copyrights that are material to the franchise. For each patent or
copyright:
(i) Describe the patent or copyright and its relationship to the
franchise;
(ii) State the duration of the patent or copyright;
(iii) For copyrights, state:
(A) The registration number and date of each copyright; and.
(B) Whether the franchisor can and intends to renew the copyright.
(iv) For patents, state:
(A) The patent number, issue date, and title for each patent, and
the serial number, filing date, and title of each patent application;
and
(B) Describe the type of patent or patent application (e.g.,
mechanical, process, or design).
(2) Describe any current material determination of the U.S. Patent
and Trademark Office, the U.S. Copyright Office, or a court regarding
the patent or copyright. Include the forum and case number. Describe
how the determination affects the franchised business.
(3) State the forum, case number, claims asserted, issues involved,
and effective determinations for any material proceeding pending in the
U.S. Patent and Trademark Office or the U.S. Court of Appeals for the
Federal Circuit.\12\
---------------------------------------------------------------------------

\12\ Franchisors may include a summary opinion of counsel
concerning any action if a consent to use the summary opinion is
included as part of the disclosure document.
---------------------------------------------------------------------------

(4) If an agreement limits the use of the patent, patent
application, or copyright, state the parties to and duration of the
agreement, the extent to which the franchisee may be affected by the
agreement, and other material terms of the agreement.
(5) Disclose the franchisor's obligation to protect the patent,
patent application, or copyright and to defend the franchisee against
claims arising from the franchisee's use of the patented or copyrighted
items. Disclose further:
(i) Whether the franchisee must notify the franchisor of claims or
infringements or if the action is discretionary;
(ii) Whether the franchise agreement requires the franchisor to
take affirmative action when notified of infringement. Disclose who has
the right to control litigation;
(iii) Whether the franchisor must participate in the defense of a
franchisee or indemnify the franchisee for expenses or damages in a
proceeding involving a patent, patent application, or copyright
licensed to the franchisee;
(iv) Requirements that the franchisee modify or discontinue use of
the subject matter covered by the patent or copyright; and
(v) The franchisee's rights under the franchise agreement if the
franchisor requires the franchisee to modify or discontinue use of the
subject matter covered by the patent or copyright.
(6) If the franchisor actually knows of an infringement that could
materially affect the franchisee, disclose:
(i) The nature of the infringement;
(ii) The location(s) where the infringement is occurring;
(iii) The length of time of the infringement; and
(iv) Action taken or anticipated by the franchisor.
(7) If the franchisor claims proprietary rights in other
confidential information or trade secrets, describe in general terms
the proprietary information communicated to the franchisee and the
terms and conditions for use by the franchisee. The franchisor need
only describe the general nature of the proprietary information, such
as whether a formula or recipe is considered to be a trade secret.
(o) Item 15: Obligation to Participate in the Actual Operation of
the Franchise Business.
(1) Disclose the franchisee's obligation to participate personally
in the direct operation of the franchise business and whether the
franchisor recommends participation. Include obligations arising from
any written agreement or from the franchisor's practice.
(2) If personal ``on-premises'' supervision is not required,
disclose the following:
(i) If the franchisee is an individual, state:
(A) Whether the franchisor recommends on-premises supervision by
the franchisee;
(B) Limitations on whom the franchisee can hire as an on-premises
supervisor, and
(C) Whether an on-premises supervisor must successfully complete
the franchisor's training program.
(ii) If the franchisee is a business entity, state the amount of
equity interest that the on-premises supervisor must have in the
franchise.
(3) Disclose any restrictions that the franchisee must place on its
manager (e.g., maintain trade secrets, covenants not to compete).
(p) Item 16: Restrictions on What the Franchisee May Sell. Disclose
any franchisor-imposed restrictions or conditions on the goods or
services that the franchisee may sell or that limit the franchisee's
customers. Disclose further:
(1) Any obligation on the franchisee to sell only goods and
services approved by the franchisor;
(2) Any obligation on the franchisee to sell all goods and services
authorized by the franchisor;
(3) Whether the franchisor has the right to change the types of
authorized goods and services and whether there are limits on the
franchisor's right to make changes; and
(4) Any restrictions on the franchisee's customers.
(q) Item 17: Renewal, Termination, Transfer, and Dispute
Resolution. Disclose, in the tabular form shown below, a table that
cross-references each enumerated franchise relationship item with the
applicable provision in the franchise or related agreement. Summarize
briefly each contractual provision. If a particular item is not
applicable, state ``Not Applicable.'' If

[[Page 57341]]

the agreement is silent concerning one of the listed provisions, but
the franchisor unilaterally offers to provide certain benefits or
protections to franchisees as a matter of policy, use a footnote to
describe this policy and state whether the policy is subject to change.
This table lists certain important provisions of the franchise and
related agreements. You should read these provisions in the agreements
attached to this disclosure document.

------------------------------------------------------------------------
Section in
Provision franchise or other Summary
agreement
------------------------------------------------------------------------
a. Length of the franchise term
b. Renewal or extension of the
term.
c. Requirements for franchisee
to renew or extend.
d. Termination by franchisee...
e. Termination by franchisor
without cause.
f. Termination by franchisor
with cause.
g. ``Cause'' defined--curable
defaults.
h. ``Cause'' defined--
noncurable defaults.
i. Franchisee's obligations on
termination/non-renewal.
j. Assignment of contract by
franchisor.
k. ``Transfer'' by franchisee--
defined.
l. Franchisor approval of
transfer by franchisee.
m. Conditions for franchisor
approval of transfer.
n. Franchisor's right of first
refusal to acquire
franchisee's business.
o. Franchisor's option to
purchase franchisee's business.
p. Death or disability of
franchisee.
q. Non-competition covenants
during the term of the
franchise.
r. Non-competition covenants
after the franchise is
terminated or expires.
s. Modification of the
agreement.
t. Integration/merger clause...
u. Dispute resolution by
arbitration or mediation.
v. Choice of forum.............
w. Choice of law...............
------------------------------------------------------------------------

(r) Item 18: Public Figures. Disclose the following information
about any public figures involved in the franchise. A public figure
means a person whose name or physical appearance is generally known to
the public in the geographic area where the franchise will be located.
(1) Any compensation paid or promised to a public figure arising
from either the use of the public figure in the franchise name or
symbol; or the endorsement or recommendation of the franchise to
prospective franchisees.
(2) The extent to which the public figure is involved in the actual
management or control of the franchisor. Describe the public figure's
position and duties in the franchisor's business structure.
(3) The total investment of the public figure in the franchisor.
Describe the extent of the amount contributed in services performed or
to be performed. State the type of investment (e.g., common stock,
promissory note).
(s) Item 19: Financial Performance Representations.
(1) All franchisors begin by stating:
The FTC's Franchise Rule permits a franchisor to provide
information about the actual or potential financial performance of its
franchised and/or franchisor-owned outlets, if there is a reasonable
basis for the information, and if the information is included in the
disclosure document. Financial performance information that differs
from that included in Item 19 may be given only where: a franchisor
provides the actual records of an existing outlet you are considering
buying; or a franchisor provides financial performance information in
paragraph (s) of this section and supplements that information by
providing, for example, information about possible performance at a
particular location.
(2) If a franchisor does not provide any financial performance
representations, also state:
This franchisor does not make any representations about a
franchisee's financial performance. We also do not authorize our
employees or representatives to make any such representations either
orally or in writing. If you receive any financial performance
information or projections of your future income, you should report it
to the franchisor's management by contacting [name and address of
person to be notified], the Federal Trade Commission, and the
appropriate State regulatory agencies.
(3) If the franchisor makes any financial performance
representations to prospective franchisees, the franchisor must have a
reasonable basis and written substantiation for the representations at
the time they are made, and must state the representations in its Item
19 disclosure. The franchisor must also disclose the following:
(i) Whether the representation is an historical financial
performance representation about the franchise system's existing
outlets,¹³ or a subset of those outlets, or is a forecast of
the prospective franchisee's future financial performance.¹⁴
---------------------------------------------------------------------------

\13\ If a financial performance representation is a
representation concerning historical financial performance or if
historical financial performance data are used as the basis for a
forecast of future earnings, the historical data must be prepared
according to U.S. generally accepted accounting principles.
\14\ A statement or prediction of future performance that is
prepared as a forecast in accordance with the statement on standards
for accountants' services on prospective financial information (or
its successor) issued by the American Institute of Certified Public
Accountants, Inc., is presumed to have a reasonable basis.
---------------------------------------------------------------------------

(ii) If the representation relates to the past performance of the
franchise system's existing outlets, disclose the material bases for
the representation, including:
(A) Whether the representation relates to the performance of all of
the franchise system's existing outlets or only to a subset of outlets
that share a particular set of characteristics (e.g., geographic
location, type of location (such as free

[[Page 57342]]

standing vs. shopping center), degree of competition in the market
area, length of time the outlets have been in operation, services or
goods sold, services supplied by the franchisor, and whether the units
are franchised or franchisor-owned or operated);
(B) The dates during which the reported level of financial
performance was achieved;
(C) The total number of outlets that existed in the relevant period
and, if different, the number of outlets that had the described
characteristics;
(D) The number of outlets with the described characteristics whose
actual financial performance data were utilized in arriving at the
representation;
(E) Of those outlets whose data were utilized in arriving at the
representation, the number and percent that actually attained or
surpassed the stated results; ¹⁵ and
---------------------------------------------------------------------------

\15\ An historical financial performance representation will
have a reasonable basis if it is representative of the usual
experience of the system's outlets or a subset of those outlets that
share specified characteristics. A representation would not have a
reasonable basis if, for example, only a small minority of the
stated set of franchisees earn such an amount, if profits were due
to non-recurring conditions, of if the franchisees used inconsistent
systems for reporting financial performance information.
---------------------------------------------------------------------------

(F) Characteristics of the included outlets, such as those noted in
paragraph (s)(3)(i) of this section, that may differ materially from
those of the outlet that may be offered to a prospective franchisee.
(iii) If the representation is a forecast of future financial
performance, state the material bases and assumptions on which the
projection is based. The material assumptions underlying a forecast
include significant factors upon which a franchisee's future results
are expected to depend. These factors include, for example, economic or
market conditions that are basic to a franchisee's operation, and
encompass matters affecting, among other things, a franchisee's sales,
the cost of goods or services sold, and operating expenses;
(iv) Include a conspicuous admonition that a new franchisee's
individual financial results may differ from the result stated in the
financial performance representation; and
(v) State that written substantiation for the financial performance
representation will be made available to the prospective franchisee
upon reasonable request.¹⁶
---------------------------------------------------------------------------

\16\ Franchisors must possess written substantiation for any
financial performance representations and must make this
substantiation available to prospective franchisees and the
Commission upon reasonable request. The franchisor may impose
reasonable time and place limitations, and may restrict copying of
documents. However, restrictions that as a practical matter
frustrate a franchisee's ability to review the franchisor's
financial performance information will be deemed to violate the
Rule. See Section 436.10(c) (prohibition on failing to make
information available). In order to protect franchisees from
unwarranted disclosure of sensitive financial information, the
franchisor may delete information that might identify the
franchisee. This limitation, however, does not apply to disclosures
made to the Commission.
---------------------------------------------------------------------------

(4) If a franchisor wishes to disclose only the actual operating
results for a specific outlet being offered for sale, it is not
required to comply with this section, provided the information is given
only to potential purchasers of that outlet and is accompanied by the
name and last known address of each owner of the outlet during the
prior three years.
(5) If financial performance representations are provided in
paragraph (s) of this section, the franchisor may deliver to a
prospective franchisee a supplemental financial performance
representation about a particular location or variation, apart from the
disclosure document. The supplemental representation must:
(i) be in writing;
(ii) explain the departure from the financial performance
representation in the disclosure document;
(iii) be prepared in accordance with the requirement set forth
above in paragraphs (s)(3)(i)-(iii) of this section; and
(iv) be left with the prospective franchisee.
(t) Item 20: Outlets and Franchisee Information.
(1) Disclose, in the tabular form shown below, the status of
franchised outlets by State for each of the franchisor's last three
fiscal years. For purposes of this paragraph, ``outlets'' includes
outlets of a type substantially similar to that offered to the
prospective franchisee. A sample Item 20(1) Table is attached as
Appendix B to this part.

Franchised Outlets Summary for Years
[YR-3--YR-1]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Outlets
that
Outlets Outlets Outlets Outlets ceased Total
Outlets Outlets terminated reacquired transferred that were operation Total number outlets
at with same by by by not or closed of outlets in
State and year beginning ownership franchisor franchisor franchisee renewed for other discontinued operation
of fiscal at end of during the during the to new during reasons during the at end of
year fiscal fiscal fiscal owner the during fiscal year fiscal
year year year during the fiscal the year
fiscal year year fiscal
year
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
--------------------------------------------------------------------------------------------------------------------------------------------------------
State:
YR-1...................................... ......... ......... .......... .......... ........... ......... ......... ............ .........
YR-2...................................... ......... ......... .......... .......... ........... ......... ......... ............ .........
YR-3...................................... ......... ......... .......... .......... ........... ......... ......... ............ .........
Totals:
YR-1...................................... ......... ......... .......... .......... ........... ......... ......... ............ .........
YR-2...................................... ......... ......... .......... .......... ........... ......... ......... ............ .........
YR-3...................................... ......... ......... .......... .......... ........... ......... ......... ............ .........
--------------------------------------------------------------------------------------------------------------------------------------------------------

(i) In column (1), list each State where one or more franchised
outlets are located. Below each State, list each of the last three
fiscal years.
(ii) In column (2), disclose the number of outlets in each State
in operation at the beginning of each fiscal year.
(iii) In column (3), disclose the number of outlets in each
State where the controlling ownership of the outlet did not change
during the year.
(iv) In column (4), disclose the number of outlets in each State
where the franchisee operating the outlet at the beginning of the

[[Page 57343]]

fiscal year did not operate the outlet at the end of the fiscal year
because the franchisor terminated or canceled the franchise
agreement without providing any consideration to the franchisee
(whether by payment or forgiveness or assumption of debt) before the
end of the agreement term. For purposes of this Item, a termination
or cancellation occurs when the franchisor sends the franchisee an
unconditional notice of intent to exercise its right to terminate or
cancel the franchise agreement.
(v) In column (5), disclose the number of outlets in each State
where the franchisee operating the outlet at the beginning of the
fiscal year did not operate the outlet at the end of the fiscal year
because the franchisor reacquired the outlet for consideration
(whether by payment or forgiveness or assumption of debt) from that
franchisee before the end of the agreement term.
(vi) In column (6), disclose the number of outlets in each State
where the franchisee operating the outlet at the beginning of the
fiscal year did not operate the outlet at the end of the fiscal year
because that franchisee transferred controlling interest in the
franchise to one or more new owners, other than the franchisor or an
affiliate, before the end of the agreement term.
(vii) In column (7), disclose the number of outlets in each
State where the franchisee operating the outlet at the beginning of
the fiscal year did not operate the outlet at the end of the fiscal
year because the franchise agreement was not renewed at the end of
its term. For purposes of this Item, a nonrenewal occurs when the
franchisor sends the franchisee an unconditional notice of intent to
exercise its right not to renew the franchise agreement after it
expires.
(viii) In column (8), disclose the number of outlets in each
State where the franchisee operating the outlet at the beginning of
the fiscal year did not operate the outlet at the end of the fiscal
year for reasons other than termination, reacquisition, transfer, or
post-term non-renewal (include here outlets that are still owned by
the franchisee operating the outlet at the beginning of the fiscal
year, but which have ceased to do business under the franchise
agreement).
(ix) In column (9), disclose the total number of outlets in the
State where a franchisee operating an outlet at the beginning of the
year did not continue to operate the outlet at the end of the fiscal
year. This figure should be the sum of the figures in columns (4)
through (8).
(x) In column (10), disclose the number of outlets in each State
in operation at the end of the fiscal year.
(xi) Report the ownership status of each outlet only once. The
sum of columns (3) and (9) should equal the number of outlets at the
beginning of the fiscal year (column 2). If an outlet is involved in
more than one ownership change in a given fiscal year, report only
the change in ownership by the franchisee operating the outlet at
the beginning of the year. If the change in ownership of an outlet
could be reported in more than one category, report only the event
that occurred first chronologically.
(2) Disclose, in the tabular form shown below, a table showing the
status of franchisor-owned outlets by State for each of the
franchisor's last three fiscal years. A sample Item 20(2) Table is
attached as Appendix C to this part.

Franchisor-Owned Outlets Summary for [YR-3--YR-1]
----------------------------------------------------------------------------------------------------------------
Outlets
operating at Outlets opened Outlets closed Total number
State and year the beginning during the during the of outlets at
of the fiscal fiscal year fiscal year the end of the
year fiscal year
(1) (2) (3) (4) (5)
----------------------------------------------------------------------------------------------------------------
State:
YR-1.......................................... .............. .............. .............. ..............
YR-2.......................................... .............. .............. .............. ..............
YR-3.......................................... .............. .............. .............. ..............
Totals:
YR-1.......................................... .............. .............. .............. ..............
YR-2.......................................... .............. .............. .............. ..............
YR-3.......................................... .............. .............. .............. ..............
----------------------------------------------------------------------------------------------------------------

(i) In column (1), list each State where one or more franchisor-
owned outlets are located. Below each State, list each of the last
three fiscal years.
(ii) In column (2), disclose the number of franchisor-owned
outlets in each State operating at the beginning of each fiscal
year.
(iii) In column (3), disclose the number of franchisor-owned
outlets opened in each State during each fiscal year.
(iv) In column (4), disclose the number of franchisor-owned
outlets closed in each State during each fiscal year.
(v) In column (5), disclose the number of franchisor-owned
outlets in operation in each State at the end of each fiscal year.

(3) Disclose, in the tabular form shown below, an estimate for each
applicable State that reflects the number of franchised and franchisor-
owned outlets to be opened during the one-year period after the close
of the franchisor's most recent fiscal year. A sample Item 20(3) Table
is attached as Appendix D to this part.

Projected Openings As of
[Close of Fiscal Year]
----------------------------------------------------------------------------------------------------------------
Franchise agreements Projected franchised projected franchisor-
State signed but outlet not outlets in the next owned outlets in the
open fiscal year next fiscal year
----------------------------------------------------------------------------------------------------------------
(1) (2).................... (3).................... (4)

Totals......................... ....................... ....................... .......................
......................
..........
----------------------------------------------------------------------------------------------------------------

(i) In column (1), list each State where the franchisor has
signed a franchise agreement, but the outlet is not yet opened, as
well as each State where the franchisor expects to open a new outlet
(franchisor-owned or franchised) in the next fiscal year.
(ii) In column (2), disclose the number of franchise agreements
signed in each State where the outlet is not yet opened.
(iii) In column (3), disclose the projected number of new
franchised outlets in each State in the next fiscal year.
(iv) In column (4), disclose the projected number of new
franchisor-owned outlets in the next fiscal year.

(4) Disclose the names of all current franchisees and the address
and

[[Page 57344]]

telephone number of each of their outlets. In the alternative, the
franchisor may disclose all franchised outlets in the State, but if
these franchised outlets total fewer than 100, disclose franchised
outlets from contiguous States and then the next closest State(s) until
at least 100 franchised outlets are listed.
(5) Disclose the name and last known home address and telephone
number of every franchisee who has had an outlet terminated, canceled,
not renewed, or otherwise voluntarily or involuntarily ceased to do
business under the franchise agreement during the most recently
completed fiscal year or who has not communicated with the franchisor
within 10 weeks of the disclosure document issuance date.
(6) If franchisees have signed gag clauses in a franchise
agreement, settlement, or in any other contract, during the last three
fiscal years:
(i) State: ``In some instances, current and former franchisees sign
provisions restricting their ability to speak openly about their
experience with [name of franchise system]. While we encourage you to
speak with current and former franchisees, be aware that not all such
franchisees will be able to communicate with you.''
(ii) Franchisors may also disclose the number and percentage of
current and former franchisees who during each of the last three fiscal
years have signed agreements that include gag clauses and may disclose
the circumstances under which such clauses were signed.
(7) Disclose the name, address, and telephone number of each
trademark-specific franchisee organization associated with the
franchise system being offered, if such organization:
(i) Has been created, supported, or recognized by the franchisor;
or
(ii) Is incorporated and asks the franchisor to be included in the
franchisor's disclosure document during the next fiscal year. All such
organizations must renew their request for inclusion in disclosure
documents on an annual basis. The franchisor has no obligation to
verify the organization's continued existence during or at the end of
each fiscal year.
(u) Item 21: Financial Statements.
(1) Include the following financial statements prepared according
to generally accepted United States accounting principles. Except as
provided in paragraph (u)(2) of this section, these financial
statements must be audited by an independent certified public
accountant. Present the required financial statements in a tabular form
that compares at least two fiscal years.
(i) Financial statements: The franchisor's balance sheet for the
previous two fiscal year-ends before the disclosure document issuance
date. In addition, include statements of operations, of stockholders
equity, and of cash flows for each of the franchisor's previous three
fiscal years.
(ii) Affiliated company statements: Instead of the disclosure
required by paragraph (u)(1)(i) of this Section, the franchisor may
include financial statements of its affiliated company if the
affiliated company's financial statements satisfy paragraph (u)(1)(i)
of this section and the affiliated company absolutely
andunconditionally guarantees to assume the duties and obligations of
the franchisor under the franchise agreement. The affiliate's guarantee
must cover all of the franchisor's obligations to the franchisee, but
is not required to extend to third parties. If this alternative is
used, disclose the existence of a guarantee.
(iii) Consolidated and separate statements:
(A) When a franchisor owns a direct or beneficial controlling
financial interest in another corporation, its financial statements
should reflect the financial condition of the franchisor and its
subsidiaries.
(B) Include separate financial statements for the franchisor and
any subfranchisor or comparable entity.
(C) Include separate financial statements for a company controlling
80 percent or more of a franchisor.
(2) To the extent that start-up franchise systems do not yet have
audited financial statements, they may phase-in the use of audited
financial statements according to the following schedule:

(i) If this is the franchisor's: The following financial
statements included in the
franchisor's disclosure
document must be audited.
(A) First partial or full fiscal year None.
selling franchises.
(B) Second fiscal year selling Balance sheet opinion as of
franchises. the end of the last fiscal
year.
(C) Third and subsequent fiscal years All required financial
selling franchises. statements for the previous
fiscal year, plus any
previously disclosed
audited statements that
still must be disclosed
according to paragraph
(u)(1)(i) of this section.

(ii) Audited financial statements shall be prepared as soon as
practicable.
(iii) Unaudited statements should be in a format that conforms as
closely as possible to audited statements.
(iv) Disclose clearly and conspicuously in paragraph (u) of this
section the following, if applicable:
(A) The franchisor has not been in business for three years or
more, and cannot include all of the financial statements required in
paragraph (u)(1)(i) of this section; or
(B) The franchisor includes one or more years of unaudited
financial statements.
(v) In the event a start-up franchise system begins offering
franchises before the close of its first full fiscal year of
operations, provide at a minimum the company's unaudited opening
balance sheet.
(v) Item 22: Contracts. Attach a copy of all proposed agreements
regarding the franchise offering, including the franchise agreement and
any lease, options, and purchase agreements.
(w) Item 23: Receipt.
(1) Include the following detachable acknowledgment of receipt in
the form set out below.
(i) State the following:
This disclosure document summarizes certain provisions of the
franchise agreement and other information in plain language. Read this
disclosure document and all agreements carefully.
If [name of franchisor] offers you a franchise, it must provide
this disclosure document to you 14 days before the earlier of:
(1) the signing of a binding agreement; or
(2) any payment to [name of franchisor or affiliate].
You must also receive a franchise agreement containing all material
terms at least 5 days before you sign a franchise agreement.
If [name of franchisor] does not deliver this disclosure document
on time or if it contains a false or misleading statement, or a
material omission, a violation of federal law and State law may have
occurred and should be reported to the Federal Trade Commission,
Washington, D.C. 20580 and [State agency].
(ii) Disclose the name, principal business address, and telephone
number of any subfranchisor or franchise broker offering the franchise.
(iii) State the issuance date.
(iv) If not disclosed in Sec. 436.5(a), state the name and address
of the franchisor's registered agent authorized to receive service of
process.
(v) Provide the following statement:
I have received a disclosure document dated ____ that included the
following Exhibits:'

[[Page 57345]]

(vi) List the title of all attached Exhibits.
(vii) Provide a space for the franchisee's signature and date.
(viii) Franchisors may include any specific instructions for
returning the receipt (e.g., street address, E-mail address, facsimile
telephone number).
(2) Franchisors shall obtain a signed copy of the receipt at least
5 days before the franchise agreement is signed or the prospective
franchisee pays any fee in connection with the franchise sale.
(3) For each completed franchise sale, franchisors shall retain a
copy of the signed receipt for a period of at least 3 years.

Subpart D--Instructions

Sec. 436.6 Instructions for Preparing Disclosure Documents

(a) Disclose the information required in sections 436.3-436.5
clearly, legibly, and concisely stated in a single document, using
plain English.
(b) Respond fully to each disclosure Item. If a particular
disclosure Item is not applicable, respond negatively, including a
reference to the type of information required to be disclosed by the
Item. Precede each disclosure Item with the appropriate heading.
(c) Do not include any materials or information other than that
required by this Rule or by State law not preempted by this Rule.
Franchisors may prepare multi-State disclosure documents by including
State-specific information in the text of the disclosure document or in
Exhibits attached to the disclosure document.
(d) Subfranchisors should disclose the required information about
the franchisor, and, to the extent applicable, the same information
concerning the subfranchisor.

Sec. 436.7 Instructions For Electronic Disclosure Documents.

Franchise sellers can furnish disclosures electronically under the
following conditions:
(a) The prospective franchisee expressly consents to accept the
disclosures in the electronic medium offered by the franchise seller.
Prospective franchisees, however, always retain the right to obtain a
paper disclosure document from the franchise seller up until the time
of the sale.
(b) The franchise seller simultaneously furnishes the prospective
franchisee with a paper summary document containing only the following
three items from the franchisor's disclosure document:
(1) The cover page;
(2) The table of contents; and
(3) Two copies of the franchisor's Item 23 Receipt, with
instructions to acknowledge receipt through a signature.
(c) The electronic version of the franchisor's disclosure document
must be capable of being printed, downloaded onto computer disk, or
otherwise preserved by a prospective franchisee as one single document.
(d) The electronic version of the franchisor's disclosure document
must be a self-contained document that is the functional equivalent of
a paper disclosure document. A prospective franchisee must be able to
read each part of the disclosure document, including attachments,
without having to take any affirmative action other than scrolling
through the document.
(e) For the sole purpose of enhancing the prospective franchisee's
ability to maneuver through the electronic version of the disclosure
document, the franchisor may include scroll bars, internal links, and
search features. All other features (e.g., multimedia tools such as
audio, video, animation, or pop-up screens) are prohibited.
(f) The electronic version of the franchisor's disclosure document
must remain accessible at least until the time of the sale. An
electronic version will still be deemed accessible if technological
failures occur that are beyond the franchisor's reasonable control.
Further, an electronic version on the Internet will be deemed
accessible if it is updated and replaced with a more current version.
(g) Franchisors furnishing disclosure documents electronically must
retain, and make available to the Commission upon request, a specimen
copy of each materially different version of their electronic
disclosure documents for a period of three years.

Sec. 436.8 Instructions For Updating Disclosures

(a) All information contained in the disclosure document shall be
current as of the close of the franchisor's most recent fiscal year.
After the close of the fiscal year, the franchisor shall, within 90
days, prepare a revised disclosure document, after which the franchisor
may distribute only the revised document and no other.
(b) The franchisor shall, within a reasonable time after the close
of each quarter of the fiscal year, prepare revisions to be attached to
the disclosure document to reflect any material change in the
franchisor or relating to the franchise business of the franchisor.
Each prospective franchisee shall receive the disclosure document and
the quarterly revisions for the most recent period available at the
time.
(c) When furnishing a disclosure document, the franchise seller
shall notify the prospective franchisee of any additional material
change in the franchisor, the franchise business, or franchise
agreement that has occurred since the last quarterly disclosure
document revision. Franchise sellers shall also notify the prospective
franchisee of any other known material change in the franchisor, the
franchise business, or franchisee agreement at the time the completed
franchise agreements are delivered to the prospective franchisee
pursuant to section 436.2(a)(2).
(d) Information that is required to be audited pursuant to
Sec. 436.5(u) is not required to be audited for quarterly revisions;
provided, however, that the franchisor states in immediate conjunction
with the information that such information has not been audited.

Subpart E--Other Provisions

Sec. 436.9 Exemptions. The disclosure requirements of sections 436.2--
436.8 shall not apply if the franchisor can establish any of the
following:

(a) The total of the required payments to the franchisor or an
affiliate that are made any time before to within six months after
commencing operation of the franchisee's business is less than $500,
not including payment for the purchase of reasonable amounts of
inventory at bona fide wholesale prices for resale.
(b) The franchise relationship is a fractional franchise.
(c) The franchise relationship is a leased department.
(d) The franchise relationship is covered by the Petroleum
Marketing Practices Act, 15 U.S.C. 2801.
(e)(1) The franchisee's estimated investment, excluding any
financing received from the franchisor or an affiliate, totals at least
$1.5 million and the prospective franchisee signs an acknowledgment
verifying the grounds for the exemption; or
(2) The franchisee is a corporation that has been in business for
at least five years and has a net worth of at least $5 million.
Provided, however, that the Commission may publish revised thresholds
once every four years to adjust for inflation.
(f) One or more purchasers of at least a 50 percent ownership
interest in the franchise are, or have been within 60 days of the sale,
an officer, director, managing agent, or an owner of at least a 25
percent interest in the franchisor, for at least 24 months.

[[Page 57346]]

(g) There is no written document that describes any material term
or aspect of the relationship or arrangement.

Sec. 436.10 Additional Prohibitions.

It is an unfair or deceptive act or practice in violation of
section 5 of the Federal Trade Commission Act for any franchise seller
to:
(a) Make any claim or representation, orally, visually, or in
writing, that contradicts the information required to be disclosed by
this Rule.
(b) Fail to return any funds or deposits in accordance with any
conditions disclosed in the franchisor's disclosure document, franchise
agreement, or related document.
(c) Fail to make available to prospective franchisees, and to the
Commission upon reasonable request, written substantiation for any
financial performance representations made in Sec. 436.5(s).
(d) Disseminate any financial performance representation to
prospective franchisees, including any representations made in the
general media and Internet, unless the franchise seller has a
reasonable basis for the representation, has written substantiation for
the claim at the time the claim is made, and the representation is
included in Sec. 436.5(s) of the franchisor's disclosure document. In
conjunction with any such financial performance representation, the
franchise seller shall also:
(1) Disclose the information required by Sec. 436.5(s)(3)(ii)(E) if
the representation relates to the past performance of the franchisor's
outlets; and
(2) Include a conspicuous admonition that a new franchisee's
individual financial results may differ from the result stated in the
financial performance representation.
(e) Disclaim or require a prospective franchisee to waive reliance
on any representation made in the disclosure document or its exhibits
or amendments. Provided, however, that a prospective franchisee can
agree to contractual terms and conditions that differ from those
specified in a disclosure document if:
(1) the franchise seller identifies the changed terms and
conditions;
(2) the prospective franchisee initials the changes; and
(3) the prospective franchisee has 5 days before signing the
contract or paying any fee to review the revised contract.
(f) Misrepresent that any person:
(1) Has purchased a franchise from the franchisor or operated a
franchise of the type offered by the franchisor; or
(2) Is able to provide an independent and reliable report about the
franchise or the experiences of any current or former franchisees.

Sec. 436.11 Other Laws, Rules, Orders.

(a) The Commission does not approve or otherwise express any
opinion on the legality of any matter a franchisor may be required to
disclose by this Rule. Further, franchisors may have other obligations
to disclose material information to prospective franchisees under
section 5 of the Federal Trade Commission Act. The Commission also
intends to enforce all applicable statutes and trade regulation rules.
(b) If an outstanding FTC order applies to a franchisor but differs
from any provision of this regulation, the franchisor can petition the
Commission to amend the order.
(c) The FTC does not intend to preempt the franchise practices laws
of any State or local government, except to the extent of any
inconsistency with this Rule. A law is not inconsistent with this Rule
if it affords prospective franchisees equal or greater protection, such
as registration of disclosure documents or more extensive disclosures.

Sec. 436.12 Severability.

If any provision of this regulation is stayed or held invalid, the
remainder will stay in force.

Appendix A: Sample Item 10 Table

Summary of Financing Offered
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Loss of legal
Item financed Amount financed Down payment Term (yrs) APR (percent) Monthly payment Prepay penalty Security Liability upon rights on
required default default
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Initial fee
Land/Constr
Leased space
Equip. lease
Equip. purchase
Opening inventory
Other financing
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Appendix B: Sample Item 20(1) Table

Franchised Outlet Summary for Years 1995-1997
--------------------------------------------------------------------------------------------------------------------------------------------------------
Outlets Outlets
Outlets Outlets transferred that ceased
Outlets at Outlets terminated reacquired by Outlets operation Total number Total
beginning with same by by franchisee that were or closed of outlets outlets in
State and year of fiscal ownership franchisor franchisor to new not renewed for other discontinued operation
year at end of during the during the owner during the reasons during the at end of
fiscal year fiscal year fiscal year during the fiscal year during the fiscal year fiscal year
fiscal year fiscal year
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
--------------------------------------------------------------------------------------------------------------------------------------------------------
AL:
1997............................ 2 1 1 0 0 0 0 1 1
1996............................ 2 2 0 0 0 0 0 0 2
1995............................ 1 1 0 0 0 0 0 0 2

[[Page 57347]]

MI:
1997............................ 4 3 1 0 0 0 0 1 4
1996............................ 7 4 0 0 2 1 0 3 4
1995............................ 8 6 0 1 0 0 1 2 7
WY:
1997............................ 3 2 0 0 0 0 1 1 2
1996............................ 1 1 0 0 0 0 0 0 3
1995............................ 0 0 0 0 0 0 0 0 1
---------------------------------------------------------------------------------------------------------------------
Totals:
1997............................ 9 6 2 0 0 0 1 3 7
1996............................ 10 7 0 0 2 1 0 3 9
1995............................ 9 7 0 1 0 0 1 2 10
--------------------------------------------------------------------------------------------------------------------------------------------------------

Appendix C: Sample Item 20(2) Table

Franchisor-Owned Outlets Summary for 1995-1997
----------------------------------------------------------------------------------------------------------------
Outlets
operating at Outlets opened Outlets closed Total number
State and year the beginning during the during the of outlets at
of the fiscal fiscal year fiscal year the end of the
year fiscal year
(1) (2) (3) (4) (5)
----------------------------------------------------------------------------------------------------------------
AL:
1997.......................................... 5 0 0 5
1996.......................................... 3 2 0 5
1995.......................................... 4 2 3 3
MI:
1997.......................................... 4 1 0 5
1996.......................................... 6 0 2 4
1995.......................................... 5 2 1 6
WY:
1997.......................................... 1 0 0 1
1996.......................................... 0 2 1 1
1995.......................................... 0 0 0 0
----------------------------------------------------------------------------------------------------------------
Totals:
1997.................................... 10 1 0 11
1996.................................... 9 4 3 10
1995.................................... 9 4 4 9
----------------------------------------------------------------------------------------------------------------

Appendix D: Sample Item 20(3) Table

Projected Openings as of December 31, 1997
----------------------------------------------------------------------------------------------------------------
Franchise Projected Projected
agreements franchised franchisor-owned
State signed but outlets in the outlets in the
outlet not open next fiscal year next fiscal year
(1) (2) (3) (4)
----------------------------------------------------------------------------------------------------------------
AL........................................................ 1 1 0
MI........................................................ 0 3 2
WY........................................................ 1 0 0
-----------------------------------------------------
Totals.............................................. 2 4 2
----------------------------------------------------------------------------------------------------------------

[[Page 57348]]

By direction of the Commission.
Donald S. Clark,
Secretary.

NPR Attachment A--Table of Commenters

Comment 1. Kevin Brendan Murphy, Esq., Mr. Franchise (``Murphy'')
Comment 2. Murphy (see supra, Comment 1)
Comment 3. Mike Bruce, The Michael Bruce Fund (``Bruce'')
Comment 4. Harold Brown, Esq., Brown & Stadfeld (``Brown'')
Comment 5. Frances L. Diaz, Esq. (``Diaz'')
Comment 6. Brown (see supra, Comment 4)
Comment 7. Diaz (see supra, Comment 5)
Comment 8. Marian Kunihisa (``Kunihisa'')
Comment 9. Kevin Bores, Domino's Pizza Franchisee (``Bores'')
Comment 10. Terrence L. Packer, Supercuts Franchisee (``Packer'')
Comment 11. John Delasandro (``Delasandro'')
Comment 12. William Cory (``Cory'')
Comment 13. Joseph Manuszak, Domino's Pizza Franchisee
(``Manuszak'')
Comment 14. Daryl Donafin, Taco Bell Franchisee (``Donafin'')
Comment 15. David Muncie, National Claims Service, Inc. (``Muncie'')
Comment 16. Patrick E. Meyers, The Quizno's Corporation
(``Quizno's'')
Comment 17. David Weaver, Domino's Pizza Franchisee (``Weaver'')
Comment 18 Karen M. Paquet, Domino's Pizza Franchisee (``Paquet'')
Comment 19. Gary R. Duvall, Esq., Graham & Dunn (``Duvall'')
Comment 20. Andrew J. Sherman, Esq., Greenberg & Traurig
(``Sherman'')
Comment 21. S. Beavis Stubbings, Esq. (``Stubbings'')
Comment 22. Jim & Evalena Gray, Pearle Vision Franchisee (``J&E
Gray'')
Comment 23. Ernest Higginbotham, et al., Strasburger & Price
(``Higginbotham'')
Comment 24. Henry C. Su, Esq., & Byron Fox, Esq. (``Su'')
Comment 25. John R.F. Baer, Esq., Keck, Mahin & Cate (``Baer'')
Comment 26. Clay Small, Esq., & Lowell Dixon, Esq., Nat'l Franchise
Mediation Program Steering Committee (``NFMP'')
Comment 27. Richard T. Catalano, Esq. (``Catalano'')
Comment 28. Neil Simon, Esq., & Erik Wulff, Esq., Hogan & Hartson
(``Hogan & Hartson'')
Comment 29. Glenn A. Mueller, Domino's Pizza Franchisee
(``Mueller'')
Comment 30. Doug Bell, et al., Supercuts Franchisees (``Supercuts
Franchisees'')
Comment 31. Michael L. Bennett, The Longaberger Co.
(``Longaberger'')
Comment 32. John Rachide, Domino's Pizza Franchisee (``Rachide'')
Comment 33. David J. Kaufmann, Esq., Kaufmann, Feiner, Yamin, Gildin
& Robbins (``Kaufmann'')
Comment 34. Joseph N. Mariano, Esq., Direct Selling Association
(``DSA'')
Comment 35. Linda F. Golodner & Susan Grant, National Consumers
League (``NCL'')
Comment 36. Jere W. Glover, Esq., & Jennifer A. Smith, Esq., U.S.
Small Business Administration, Office of Chief Counsel for Advocacy
(``SBA Advocacy'')
Comment 37. Robert Chabot, Domino's Pizza Franchisee (``Chabot'')
Comment 38. Teresa Maloney, National Coalition of Associations of 7-
Eleven Franchisees (``Maloney'')
Comment 39. BLANK
Comment 40. Harold L. Kestenbaum, Esq. (``Kestenbaum'')
Comment 41. Samuel L. Sibent, KFC Franchisee (``Sibent'')
Comment 42. Oren C. Crothers, KFC Franchisee (``Crothers'')
Comment 43. Matthew Jankowski, KFC Franchisee (``Jankowski'')
Comment 44. Rodney A. DeBoer, KFC Franchisee (``DeBoer'')
Comment 45. Liesje Bertoldi, KFC Franchisee (``L. Bertoldi'')
Comment 46. Steve Bertoldi, KFC Franchisee (``S. Bertoldi'')
Comment 47. Charles Buckner, KFC Franchisee (``Buckner'')
Comment 48. Walter J. Knezevich, KFC Franchisee (``Knezevich'')
Comment 49. Jeffrey W. Gray, KFC Franchisee (``J. Gray'')
Comment 50. Fred Jackson, KFC Franchisee (``Jackson'')
Comment 51. Ronald L. Rufener, KFC Franchisee (``Rufener'')
Comment 52. Tim Morris, KFC Franchisee (``Morris'')
Comment 53. Scarlett Norris Adams, KFC Franchisee (``Adams'')
Comment 54. Calvin G. White, KFC Franchisee (``White'')
Comment 55. Nick Iuliano, KFC Franchisee (``N. Iuliano'')
Comment 56. Dolores Iuliano, KFC Franchisee (``D. Iuliano'')
Comment 57. Ralph A. Harman, KFC Franchisee (``R. Harman'')
Comment 58. Saundra S. Harman, KFC Franchisee (``S. Harman'')
Comment 59. Richard Braden, KFC Franchisee (``Braden'')
Comment 60. K.F.C. of Pollys, KFC Franchisee (``Pollys'')
Comment 61. Joan Fiore, McDonald's Franchisee (``Fiore'')
Comment 62. Susan P. Kezios, American Franchisee Association
(``AFA'')
Comment 63. Kenneth R. Costello, Esq., Loeb & Loeb, LLP (``Loeb &
Loeb'')
Comment 64. AFA (see supra Comment 62)
Comment 65. Susan Rich, KFC Franchisee (``Rich'')
Comment 66. Fiore (see supra Comment 61)
Comment 67. Mike Johnson, Subway Franchisee (``Johnson'')
Comment 68. Laurie Gaither, GNC Franchisee (``L. Gaither'')
Comment 69. Greg Gaither, GNC Franchisee (``G. Gaither'')
Comment 70. Greg Suslovic, Subway Franchisee (``Suslovic'')
Comment 71. Richard Colenda, GNC Franchisee (``Colenda'')
Comment 72. Bob Gagliati, GNC Franchisee (``Gagliati'')
Comment 73. Pat Orzano, 7-Eleven Franchisee (``Orzano'')
Comment 74. Linda Gaither, GNC Franchisee (``Li Giather'')
Comment 75. Kevin 100 (``Kevin 100'')
Comment 76. Robert James, Florida Dept. of Agriculture & Consumer
Services (``James'')
Comment 77. Robert A. Tingler, Esq., Office of the Attorney General,
State of Illinois (``IL AG'')
Comment 78. John M. Tifford, Esq., Rudnick, Wolfe, Epstien & Zeidman
(``Tifford'')
Comment 79. Robert L. Purvin, Jr. (``Purvin'')
Comment 80. Teresa Heron (``Heron'')
Comment 81. Purvin (See supra Comment 79)
Comment 82. Matthew R. Shay, Esq., International Franchise
Association (``IFA'')
Comment 83. Duvall (See supra Comment 19)
Comment 84. Lance Winslow, Car Wash Guys (``Winslow'')
Comment 85. Winslow (See supra Comment 84)
Comment 86. Rick Geu, The Pampered Chef, Ltd. (``Pampered Chef'')
Comment 87. John M. Tifford, Esq., Coverall North America, Inc.
(``Coverall'')
Comment 88. John M. Tifford, Esq., Merchandise Mart Properties, Inc.
(``Merchandise Mart'')
Comment 89. Dirk C. Bloemendaal, Esq., Amway Corporation (``Amway'')
Comment 90. Winslow (See supra Comment 84)
Comment 91. Winslow (See supra Comment 84)
Comment 92. Winslow (See supra Comment 84)
Comment 93. Winslow (See supra Comment 84)
Comment 94. Andrew A. Caffey, Esq. (``Caffey'')
Comment 95. Entrepreneur Media, Inc. (``Entrepreneur'')
Comment 96. Brown (See supra Comment 4)
Comment 97. Raymond & Robert Buckley, Scorecard Plus Franchisee
(``Buckley'')
Comment 98. Mark A. Kirsch, Esq., Rudnick, Wolfe, Epstien & Zeidman
(``Kirsch'')
Comment 99. Dale E. Cantone, Esq., Maryland Division of Securities,
Office of the Maryland Attorney General (``MD Securities'')
Comment 100. Roger C. Haines, Scorecard Plus Franchisee (``Haines'')
Comment 101. David E. Myklebust, Scorecard Plus Franchisee
(``Myklebust'')
Comment 102. Robert Larson (``Larson'')
Comment 103. Brown (See supra Comment 4)
Comment 104. Mark B. Forseth, Esq., CII Enterprises (``CII'')
Comment 105. Bertrand T. Ungar, Esq., PR ONE, LLC (``PR ONE'')
Comment 106. Dennis E. Wieczorek, Esq., Rudnick & Wolfe
(``Wieczorek'')
Comment 107. Gerald A. Marks, Esq., Marks & Krantz (``Marks'')
Comment 108. Brown (See supra Comment 4)
Comment 109. Everett W. Knell (``Knell'')
Comment 110. Anne Crews, Mary Kay, Inc. (``Mary Kay'')
Comment 111. Carl Letts, Dominos Pizza Franchisee (``Letts'')
Comment 112. Kat Tidd, Esq. (``Tidd'')

[[Page 57349]]

Comment 113. Ted Poggi, National Coalition of Associations of 7-
Eleven Franchisees (``NCA 7-Eleven Franchisees'')
Comment 114. Gary R. Duvall, Esq., & Nadine C. Mandel, Esq. (Duvall
& Mandel)
Comment 115. Sherry Christopher, Esq., Christopher Consulting, Inc.
(``Christopher'')
Comment 116. Carl C. Jeffers, Intel Marketing Systems, Inc.
(``Jeffers'')
Comment 117. Deborah Bortner, Esq., State of Washington, Department
of Financial Institutions, Securities Division (``WA Securities'')
Comment 118. Carmen D. Caruso, Esq., Noonan & Caruso (``Caruso'')
Comment 119. Howard Bundy, Esq., Bundy & Morrill, Inc. (``Bundy'')
Comment 120. Franchise & Business Opportunity Committee, North
American Securities Administrators Association, Inc. (``NASAA'')
Comment 121. Tifford (See supra Comment 78)
Comment 122. Wieczorek (See supra Comment 106)
Comment 123. John & Debbie Lopez, Baskin Robbins Franchisee
(``Lopez'')
Comment 124. Susan R. Essex, Esq., & Ted S. Storey, Esq., Business
Law Section, The State Bar of California (``CA BLS'')
Comment 125. Peter C. Lagarias, Esq., The Legal Solutions Group
(``Lagarias'')
Comment 126. Jame G. Merret, Jr. (``Merret'')
Comment 127. W. Michael Garner, Esq., Dady & Garner (``Dady &
Garner'')
Comment 128. Jeff Brickner (``Brickner'')
Comment 129. Bernard A. Brynda, Baskin Robbins Franchisee
(``Brynda'')
Comment 130. Caron B. Slimak, Jacadi USA Franchisee (``Slimak'')
Comment 131. Dr. Ralph Geiderman, Pearl Vision Franchisee
(``Geiderman'')
Comment 132. Felipe Frydman, Minister, Economic & Trade Affairs,
Embassy of the Argentine Republic (``Argentine Embassy'')
Comment 133. Andrew C. Selden, Esq., Briggs & Morgan (``Selden'')
Comment 134. Robert Zarco, Esq., et al., Zarco & Pardo (``Zarco &
Pardo'')
Comment 135. Jason H. Griffing, Baskin Robbins Franchisee
(``Griffing'')
Comment 136. Erik H. Karp, Esq., Witmer, Karp, Warner & Thuotte
(``Karp'')
Comment 137. William D. Brandt, Esq., Ferder, Brandt, Casebeer,
Cooper, Hoyt & French (``Brandt'')
Comment 138. Robert S. Keating, Baskin Robbins Franchisee
(``Keating'')
Comment 139. A. Patel, Baskin Robbins Franchisee (``A. Patel'')
Comment 140. Joel R. Buckberg, Cendant Corporation (``Cendant'')
Comment 141. Duvall (See supra, Comment 19)
Comment 142. NCL (See supra, Comment 35)
Comment 143. AFA (See supra, Comment 62)
Comment 144. Catalano (See supra, Comment 27)
Comment 145. DSA (See supra, Comment 34)
Comment 146. Keating, (See supra, Comment 139)
Comment 147. Kathie & David Leap, Baskin Robbins Franchisee
(``Leap'')
Comment 148. Ted D. Kuhn, Baskin Robbins Franchisee (``Kuhn'')
Comment 149. Mike S. Lee, Baskin Robbins Franchisee (``Lee'')
Comment 150. R. Deilal, Baskin Robbins Franchisee (``Deilal'')
Comment 151. Frank J. Demotto, Baskin Robbins Franchisee
(``Demotto'')
Comment 152. Thomas Hung, Baskin Robbins Franchisee (``Hung'')
Comment 153. Jean Jones, Baskin Robbins Franchisee (``Jones'')
Comment 154. Hang, Baskin Robbins Franchisee (``Hang'')
Comment 155. Dilip Patel, Baskin Robbins Franchisee (``D. Patel'')
Comment 156. Terry L. Glase, Baskin Robbins Franchisee (``Glase'')
Comment 157. R.E. Williamson, Baskin Robbins Franchisee
(``Williamson'')
Comment 158. R.M. Valum, Baskin Robbins Franchisee (``Valum'')
Comment 159. Rajendra Patel, Baskin Robbins Franchisee (``R.
Patel'')
Comment 160. Jerry & Debbie Robinett, Baskin Robbins Franchisee
(``Robinett'')
Comment 161. Ronald J. Rudolf, Baskin Robbins Franchisee
(``Rudolf'')
Comment 162. Kamlesh Patel, Baskin Robbins Franchise (``K. Patel'')
Comment 163. Nicholas & Marilyn Apostal, Baskin Robbins Franchisee
(``Apostal'')
Comment 164. Patrick Sitin, Baskin Robbins Franchisee (``Sitin'')
Comment 165. Paul & Lisa SeLander, Baskin Robbins Franchisee
(``SeLander'')
Comment 166. S. Bhilnym, Baskin Robbins Franchisee (``Bhilnym'')
Comment 167. Mike & Kathy Denino, Baskin Robbins Franchisee
(``Denino'')

NPR Attachment B--Workshop Conferences: Panelists

Michael Bennett, Esq., Longaberger Company (``Bennett'')
Kennedy Brooks, Esq. (``Brooks'')
John Brown, Esq., Amway Corporation (``J. Brown'')
Howard Bundy, Esq., Bundy & Morrill (``Bundy'')
Delia Burke, Esq., Jenkins & Gilchrist (``Burke'')
Andrew Caffey, Esq. (``Caffey'')
Dale Cantone, Esq., Office of the Maryland Attorney General
(``Cantone'')
Emilio Casillas, Washington State Securities Division (``Casillas'')
Richard Catalano, Esq. (``Catalano'')
Sherry Christopher, Esq. (``Christopher'')
Martin Cordell, Esq., Washington State Securities Division
(``Cordell'')
John D'Alessandro (``D'Alessandro'')
Gary Duvall, Esq., Graham & Dunn (``Duvall'')
Eric Ellman, Esq., Direct Selling Association (``Ellman'')
David Finnigan, Esq., Illinois Securities Department (``Finnigan'')
Mark B. Forseth, Esq., Jenkens & Gilchrist (``Forseth'')
Elizabeth Garceau, PRO Design (``E. Garceau'')
Michael Garceau, PRO Design (``M. Garceau'')
Roger Gerdes, Microsoft Corporation (``Gerdes'')
Rick Geu, Esq., The Pampered Chef (``Geu'')
Judy Gitterman, Esq., Jenkens & Gilchrist (``Gitterman'')
Susan Grant, National Consumers League (``Grant'')
Tee Houston-Aldridge, World Inspection Network (``Houston-
Aldridge'')
Robert James, Florida Dept. of Agriculture & Consumer Services
(``James'')
Carl Jeffers, Intel Marketing Systems (``Jeffers'')
David Kaufmann, Esq., Kaufmann, Feiner, Yamin, Gildin & Robbins
(``Kaufmann'')
Harold Kestenbaum, Esq., Hollenburg, Bleven, Solomon, Ross
(``Kestenbaum'')
Susan Kezios, America Franchisee Association (``Kezios'')
Mark Kirsch, Esq., Rudnick, Wolfe, Epstien & Zeidman (``Kirsch'')
Mike Ludlum, Entrepreneur Media (``Ludlum'')
Philip McKee, National Consumers League (``McKee'')
Joseph Punturo, Esq., Office of the New York Attorney General
(``Punturo'')
Philip Sanson, Esq., Illinois Securities Department (``Sanson'')
Matthew Shay, Esq., International Franchise Association (``Shay'')
David Silverman, Sportsworld Int'l. (``Silverman'')
Neil Simon, Esq., Hogan & Hartson (``Simon'')
J. H. Snow, Esq., Jenkens & Gilchrist (``Snow'')
Adam Sokol, Esq., Illinois Attorney General's Office (``Sokol'')
Kat Tidd, Esq. (``Tidd'')
John Tifford, Esq., Rudnick, Wolfe, Epstien & Zeidman (``Tifford'')
Bertrand Unger, Esq., PR ONE (``Unger'')
Dick Way, PR ONE (``Way'')
Dennis Wieczorek, Esq., Rudnick & Wolfe (``Wieczorek'')
Erik Wulff, Esq., Hogan & Harston (``Wulff'')
Barry Zaslav, Coverall North America (``Zaslav'')
Michael W. Chiodo, Domino's Franchisee (``Chiodo'')
Joseph Cristiano, Carvel Franchisee (``Cristiano'')
John D'Alessandro, Quaker State Quick Lube Distributor
(``D'Alessandro'')
Mark Deutsch, Former Franchisee (``Deutsch'')
Steve Doe,'' Franchisee (``Doe'')
Debbie Fetzer (``Fetzer'')
Richard W. Galloway, Domino's Pizza Franchisee (``Galloway'')
Bruce Hoar & Thomas Hoar, Hanes Franchisee (``Hoar'')
Nelson Hockert-Lotz, Domino's Franchisee (``Hockert-Lotz'')
Robert L. James, Florida Dept. of Agriculture & Consumers Services
(``James'')
Eric Karp, Esq., Witmer, Karp, Warner & Thuotte (``Karp'')
Susan Kezios, American Franchisee Association (``Kezios'')
Charles Lay, Brite Site Franchisee (``Lay'')
Marge Lundquist, Franchisee (``Lundquist'')
Gerald Marks, Esq., Marks & Krantz (``Marks'')
Dianne Mousley, Mike Schmidt's Phil. Hoagies Franchisee
(``Mousley'')
Mehran Rafizadeh, GNC Franchisee (``Rafizadeh'')

[[Page 57350]]

David W. Raymond, Esq. (``Raymond'')
Iris Sandow, Blimpie Franchisee (``Sandow'')
Caron Slimak, Jacadi Franchisee (``Slimak'')
Robert Tingler, Esq., Franchise Bureau Chief, Illinois Attorney
General's Office (``Tingler'')
Dr. Spencer Vidulich, Pearle Vision Franchisee (``Vidulich'')

[FR Doc. 99-27425 Filed 10-21-99; 8:45 am]
BILLING CODE 6750-01-P

Visit the Official Version

Document Information

Published:: 10/22/1999
Department:: Federal Trade Commission
Entry Type:: Proposed Rule
Action:: Notice of proposed rulemaking.
Document Number:: 99-27425
Dates:: Comments must be submitted on or before December 21, 1999. Rebuttal comments may be submitted on or before January 31, 2000.
Pages:: 57294-57350 (57 pages)
PDF File:: 99-27425.pdf
CFR: (13): 16 CFR 436.5(u); 16 CFR 436.1; 16 CFR 436.2; 16 CFR 436.3; 16 CFR 436.4; More ...