[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]]

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Part IV





Federal Trade Commission





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16 CFR Part 436



Franchise Rule; Proposed Rule

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

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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
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    \49\ See Final Interpretative Guides, 44 FR at 49969.
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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'').
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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).
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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
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    \54\ Registration Form Used by Open-End Management Investment 
Companies, SEC Release No. 33-7512, 17 CFR 274.11A.
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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.
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    \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
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    \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.
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    \58\ 63 FR 14528, 14531 (March 25, 1998).
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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
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    \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
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    \60\ See Internet Notice, 63 FR at 24996.
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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.
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    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.
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    \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.
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    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.
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    \67\ See Cendant, Comment 140, at 4.
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    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
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    \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.
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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.
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    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\
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    \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.
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    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).
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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.
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    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).
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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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
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    \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.
---------------------------------------------------------------------------

    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
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    \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.
---------------------------------------------------------------------------

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

    \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.
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    \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.
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    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.
---------------------------------------------------------------------------

    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).
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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
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    \222\ See, e.g., UFOC Cover Page Instructions; UFOC Item 1C 
Instructions.
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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
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    \223\ See Final Interpretive Guides, 44 FR at 49969.
    \224\ See UFOC Guidelines, General Instructions 230 and 240.
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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
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    \225\ 62 FR at 9122.
    \226\ Su, Comment 24; PR One, Comment 105.
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    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
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    \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.
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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.
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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\
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    \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.
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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.
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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:
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    \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.
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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
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    \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.
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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.
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    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
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    \263\ See also Winslow, Comment 92, 1-2.
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    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.
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    \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
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    \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
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    \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.
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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.
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    \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.
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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
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    \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.
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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
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    \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.
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    \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
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    \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:
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    \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.
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    (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:
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    \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.
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    (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:
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    \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