A franchise is an authorization granted to somebody to sell a company's good or services. Dealerships are a type of franchise involving the distribution of a product or a brand name, such as cars, tools, and gasoline, rather than the distribution of an entire business format, such as fast-food restaurants or home repair stores. Dealers tend to have more control over their operations than do franchisees, so that you might see Smith's Subaru, but you'll never see Smith's McDonald's.
Those interested in starting a new business have been attracted to franchises because they typically offer much of what the new owner may lack - name recognition, management expertise, and financing. They can also be quite expensive, which means that someone interested in a franchise should discuss his or her options with an experienced franchise attorney before taking the plunge.
Franchising is a combination of federal and Illinois law. Franchises that affect interstate commerce are governed by federal laws that are enforced by the Federal Trade Commission. Under FTC rules, a business relationship is a franchise, regardless of what the contract calls it, if there is a continuing commercial relationship between the two parties that falls into one of three categories.
The first category is the business format franchising mentioned above. The second category is product franchising, also mentioned above, and the third category is business opportunity arrangements, the most common example of which is vending machines, where the franchisor provides the machines, the locations, and the product while the franchisee operates and maintains the machines.
FTC Disclosure Document. The FTC rules are primarily concerned with disclosure, so that the franchisee understands the risks before the contract is signed. The FTC has issued a document called the FTC Disclosure Document that, if given to the franchisee, complies with the franchisor's obligations under the FTC rules. The FTC Disclosure Document asks the franchisor to disclose information about itself, information about the franchisee, details of the franchise agreement, and supporting facts for any earnings claims it has made to the franchisee.
The information about itself includes its business history, litigation history, and financial statements. The information about the franchisee includes a description of the business, the amount the franchisee is investing, financing details, and sales restrictions, if any. The details of the franchise agreement include a listing of any required fees, information about exclusive service areas, and terms of the agreement. The fourth requirement, supporting facts, is designed to protect the franchisee. For example, if the franchisor supplied the franchisee with materials used to make up his or her mind about the franchise that claim that all of their franchisees made at least x dollars last year, the franchisor must support the claim with facts.
Although the FTC Disclosure Document satisfies the FTC rules, it may not meet all state franchise disclosure rules. The Illinois Franchise Disclosure Act provides that both the FTC and UFOC disclosure documents satisfy state laws. An experienced attorney should be able to determine if the document meets state requirements should the franchisee be doing business in states other than Illinois.
UFOC. The Midwest Securities Commissioner's Association developed a second disclosure document, called the Uniform Franchise Offering Circular. Its goal was to simplify disclosure statements, and it meets all the requirements of both the FTC rules and state disclosure laws. The UFOC has 21 items, which include all of the key items in the FTC Disclosure Document.
Filing requirements. Illinois has adopted the Uniform Franchise and Business Opportunities Act, which requires that franchisees be given access to information and prohibits misrepresentations by franchisors. Under Illinois law, the franchisor interested in signing a franchise agreement must register the franchise with the state by filing a series of documents with the Illinois Attorney General and paying a $500 filing fee. The state will then either grant or deny the franchise. The franchisor then must file a report annually.
The FTC can fine any franchisor that fails to file federal disclosure documents up to $10,000 per day.
Terminations. The termination of a franchising agreement can give rise to litigation unless it is handled appropriately. Before terminating an agreement, a franchisee or franchisor should consult an attorney experienced in franchise agreements.
If the agreement allows either party to terminate the agreement at any time with proper written notice, terminating parties need only insure that they have met the notice requirement. If, however, the agreement allows either party to terminate only for good cause, terminating parties must insure that they are terminating the agreement for an appropriate reason.
Good cause is often defined in the contract and may include bankruptcy or insolvency of one of the parties, a failure to live up to minimum performance standards defined in the contract, or misrepresentations made by one of the parties.
During the course of a franchising relationship, the franchisor and franchisee often supplement the terms of their agreement, or in some cases alter the terms. These amendments or changes can occur explicitly in conversations or through the course of their business dealings. Where amendments or changes occur, it is always a good idea to reduce them to writing and make them part of the original contract, where possible. At termination, the terminating party may have difficulty establishing good cause if the claim is based on terms that are not part of the original contract.
Arbitration. Arbitration clauses are becoming increasingly common in franchise agreements, and a growing number of disputes are being resolved in arbitration. Prior to signing a franchise agreement, both parties should have a clear understanding of how their disputes will be resolved and where they will be resolved.
Additional Illinois franchise laws. In addition to the general laws on franchises and franchise agreement disclosures, Illinois regulates specific types of franchises that it deems involve the public welfare and interest. For example, the state has special rules governing motor vehicles, cable television, and health facilities.