Franchise Documentation

FRANCHISE DOCUMENTATION – Phase 2

Two types of franchise documentation are required: legal and operational. This how to franchise a business article by an MBA franchise attorney who doesn’t just talk the talk, but has actually walked the walk, continues below with a more detailed examination of both types of franchise documents, showing drafting strategies and pitfalls to avoid. Because the franchise operations manual is also a legal document, it requires a particular review and focus. Various documents are filed with the so-called franchise registration states; in addition there are 24 states with business opportunity laws that can apply to franchise companies.

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THE FRANCHISE DOCUMENTATION PHASE

Copyright 1982-2012, Kevin B. Murphy, B.S., M.B.A., J.D. – all rights reserved

If your company made doing a good job at the planning stage its number one priority, franchise documentation goals will be apparent. Proprietary assets (like recipes, formulas, methods, branding, operating techniques and customer information) need to be identified and protected. A catchy and appropriate name, logo and tag lines are registered as trademarks or service marks.

Franchise Operations Manual
A franchise operations manual and franchise training program are developed, often from scratch, to impart business day-to-day operating skills to franchise owners as well as ensure uniformity of products and services. The franchise operations manual and training program curriculum must be drafted or edited with a particular focus. Certain topics, chapters and policies used in manuals for company-owned locations, for example, are entirely inappropriate in a franchise environment, creating significant franchise liability issues.

Also, because the franchise operations manual is incorporated by reference in the franchise agreement, the manual becomes a living, modifiable extension of the contract between the parties. As such, it requires a particular level of review and legal focus. Depending on content, various sections of the operations manual may need to be disclosed throughout the FDD Franchise Disclosure Document. Boilerplate and template operations manuals fail to take these details into account. Their use invariably sets up the franchise company for future liability issues – a “smoking gun” for which there is no defense. For a detailed discussion of franchise operations manuals, including how your company can and should write its own manual in three easy steps, read the information at our Franchise Operations Manual page of this website. The support aspect of the franchise relationship needs to be carefully considered, structured and incorporated into the documents.

Franchise Disclosure Document
Finally, and only after all of the above are underway, a FDD Franchise Disclosure Document, similar to a securities (stock offering) prospectus, is prepared by a competent franchise attorney. Doing it correctly and with a balanced, fair perspective can save going to the courtroom later. Using a boilerplate or online FDD template will almost certainly guarantee a visit to the courtroom down the road. Since these visits cost hundreds of thousands of dollars and up, they are not cheap and far outweigh the cost of doing it right to begin with.

Franchise companies in their FDD must provide detailed information, presented in twenty-three items or chapters. Within these items are hundreds to potentially thousands of discrete disclosures required, all depending on the specifics of the franchise company, its franchise program and documents used.

Like a template operations manual, a template FDD can never address these case-by-case factors. Using one is a serious mistake that only sets up the company for expensive, future franchise litigation. The Table of Contents for the current FDD lists all twenty-three items which are:

Item 1. The Franchisor and any Parents, Predecessors and Affiliates

Item 2. Business Experience

Item 3. Litigation

Item 4. Bankruptcy

Item 5. Initial Fees

Item 6. Other Fees

Item 7. Estimated Initial Investment

Item 8. Restrictions on Sources of Products and Services

Item 9. Franchisee’s Obligations

Item 10. Financing

Item 11. Franchisor’s Assistance, Advertising, Computer Systems and Training

Item 12. Territory

Item 13. Trademarks

Item 14. Patents, Copyrights, and Proprietary Information

Item 15. Obligation to Participate in the Actual Operation of the Franchise

Item 16. Restrictions on What the Franchise May Sell

Item 17. Renewal, Termination, Transfer and Dispute Resolution

Item 18. Public Figures

Item 19. Financial Performance Representations

Item 20. Outlets and Franchisee Information

Item 21. Financial Statements

Item 22. Contracts

Item 23. Receipts

Franchise Registration and Business Opportunity Compliance
The entire document, sometimes running into hundreds of pages, along with its exhibits (franchise contract, audited financials, etc.) is then registered with various regulatory agencies to comply with applicable federal and state franchise laws. A registration-review process is required before any franchises can be advertised or sold in those franchise registration states having a registration requirement, such as a California franchise registration under the California Franchise Investment Law. Other franchise registration states like Illinois, New York, etc. have similar registration requirements. In addition to the franchise registration states, other states have business opportunity laws. In these states, the definition of a “biz opp” is so broad it can and often does apply to a franchise. Knowing these states’ definitions and appropriate, available exemptions, is absolutely necessary.

AVOIDING LEGAL PITFALLS IN THE FRANCHISE DOCUMENTATION PHASE

From the snapshot above, it should be obvious the Franchise Disclosure Document (FDD) contains an enormous amount of information, all of which must be presented in a manner that is true, complete and not misleading. The detailed disclosures made by the franchise company in this document often spell the difference between success and failure in future claims someone was misled or franchise disclosure requirements were not satisfied. This obviously cannot be accomplished in do-it-yourself franchise kits or FDD templates. Franchise companies must think of their Franchise Disclosure Document (FDD) not as a sales tool but more of a franchise risk management tool. As discussed below, another key component is adopting and implementing a carefully crafted Franchise Disclosure Compliance Program sm to manage disclosure documents and control the dissemination of information.

As an example of documentation difficulties, consider the plight of franchise companies that get sued by disgruntled franchise owners, looking to break away from their franchise agreements and the franchise network. A favorite technique is to carefully examine the Franchise Disclosure Document, looking for things that were either not disclosed in the detail required, or were disclosed inconsistently. For example, Franchise Disclosure Document says x whereas franchise agreement says y or the franchise operations manual says z about the same topic. Or franchise agreement or operations manual says x and this is not disclosed as required in the FDD.

All of a sudden, violations of franchise disclosure and registration laws arise, giving unhappy, disgruntled franchise owners a springboard to break away from the franchise network and recover damages. A studied examination of these cases invariably shows the same cause: the legal documents were not drafted by a recognized franchise attorney or franchise expert. Instead, a general practice attorney or firm undertook a learning experience paid for by the client. Or, a franchise consulting group engaged in the unauthorized practice of law by drafting franchise disclosure documents, using boilerplate samples, searching and replacing most (but not all) occurrences of hamburgers to tax returns. Or the company used a do-it-yourself franchise kit or FDD template.

Having one firm author, edit and review all documents (legal and ops) is not only cost-effective – it also avoids inconsistencies that can plague the franchise company as legal pitfalls in the form of future franchise litigation.

FDD Franchise Disclosure Document update: FTC Franchise Rule amendment
On January 23, 2007 the Federal Trade Commission, following a twelve year review, announced a sweeping amendment to its Franchise Rule. These changes, with a phase in period starting July 1, 2007, and a required effective date of July 1, 2008 require all franchise companies to make substantial changes to their franchise offering circulars (now called Franchise Disclosure Documents under the FTC Franchise Rule Amendment). The previous option to elect between the FTC format and the UFOC format no longer applies – all franchise companies must follow the FTC format and produce what is known as a Franchise Disclosure Document FDD with the 23 items or chapters detailed above.

This how to franchise a business series continues with Franchise Training