Franchising in the U.S. is regulated at the Federal level by the Federal Trade Commission (“FTC”) and according to various state laws by state agencies (MD, VA, CA, IL and NY) that require franchisors to provide prospective franchisees with information that describes the franchisor-franchisee relationship.
The core legal documents include: (i) the Franchise Disclosure Document, commonly referred to as the “FDD”, and (ii) the Franchise Agreement (the “FA”), which is included in the FDD. The purpose of the FDD is to provide prospective franchisees with information about the franchisor, the franchise system and the agreements (including the FA) they will need to sign so that they can make an informed decision. The FTC regulates the contents of the FDD, however it does not approve the FDD.
The FDD provides a detailed disclosure about the franchisor, any affiliated companies, the management team, the estimated cost of starting and running the franchise, the fees that will be paid to the franchisor along with a copy of the FA that will be signed at closing and a list of all current and former franchisees along with their contact information. The franchisor must also provide audited financial statements in the FDD. It is presented in a uniform and pre-determined format to allow for, among other things, comparisons to other FDDs.
By law, a franchisor cannot sell a franchise until the franchisor has presented the prospective franchisee with the FDD. In fact, 14 states require franchisors to register their FDDs with the state or to notify them that they will offer franchises before they begin to conduct any franchising activity in the state.
Receipt of the FDD is governed by the “14-day rule.” This is a cooling-off period in which franchisors must give prospective franchisees 14 days to think about their decision before they are allowed to sign the FA and become a franchisee. The FA is more specific than the FDD about the terms of the relationship between the franchisor and franchisee. The FA is the legal, written document signed by the franchisee and the franchisor that governs the relationship and specifies the terms of the franchise purchase and the franchise relationship.