Franchise Disclosure Documents (FDD)
Mission Accomplished?
(Continued)

By: Kevin B. Murphy, Franchise Attorney, MBA - Mr. Franchise

Franchise Registration States

Of course, in the U.S. there are about 14 franchise registration states where we’d have to pay a registration fee and file the document with the appropriate state agency. But that’s just a rubber stamp and no registration state will refuse to register our franchise offering. Because we’re “thinly capitalized” these states may require an escrow condition where we don’t receive the franchise fee until the franchisee opens for business. Or these registration states may just say we can’t accept payment of the franchise fee until the franchisee opens, and require a simple amendment to our franchise agreement to reflect this condition. That’s the trend here in California and the bottom line is we’d get “registered.”

Even franchise examiners (who are usually attorneys) in registration states issue registration renewal orders to franchise companies who have been operating a couple years and whose audited financial statements say (in an brief footnote): "Since its inception, the franchise company has incurred a net loss of $X million. These and other factors indicate substantial doubt the Company will be able to continue as a going concern."  Translation:  the auditors are saying the company's ready to go broke. 

Result:  Not to worry, the franchise examiners issue renewal orders allowing them to sell franchises to unsuspecting buyers. It's not right, in fact it's outrageous, yet it happens.

Franchise Non-Registration States; FTC To The Rescue?

In the balance of the non-registration states (36) we’d be able to sell franchises with impunity and no regulatory oversight. Of course, there’s the Federal Trade Commission's FTC Franchise Rule that applies in all states. But this only requires producing a franchise disclosure document - FDD. There’s no registration process with the FTC and they rarely get involved in franchise complaints. A 1993 government report found the FTC acted on less than 6% of all franchise complaints.

The U.S. General Accounting Office reports that franchise complaints to the FTC from franchise owners increased ten-fold from 1997-1999. This dramatic rise is profound considering complaint data was only available through June 30, 1999. Since 1998, according to the FTC's website, only one franchise enforcement action was taken against a franchise company. There’s just not enough money or resources available to the FTC, a situation that will only grow worse in the current economy.

My point here is registration of a Franchise Disclosure Document with a governmental agency only means the franchise company paid a filing fee and forwarded its document. There is no due diligence undertaken by examiners in a registration state. So the real guardian of the franchise investment must be you – the franchise investor. Because of the complexities of franchise agreement provisions and offering circular disclosures the need for competent, professional advice is critical. Many of the critical disclosures are required only in a table, where the relevant contract sections of "boilerplate that bites" are listed, without going into any "details." If you're not a franchise attorney looking for red flags, it easy to get duped.

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