In the United States, regulations governing franchising differ across the states. In broad terms, these differences can be divided into two categories: those that affect registration and disclosure, and those that affect relationships between franchisors and franchisees.
Registration and disclosure rules govern the types of information that franchisors must provide to government regulators and franchisees, as well as permitted sales and advertising practices.
In 14 “registration” states, franchisors must obtain approval from regulators before they can sell franchises. In many of these states, the franchisors also need to provide regular reports to the authorities about the status of their franchise systems.
In nine states, franchisors must submit any advertisements they use to attract franchisees for regulatory approval. Most of these states also limit what the ads can say, generally barring franchisors from claiming that the investment in the franchise is “safe,” or that government regulators have “approved” the franchise.
In some registration states, franchisors also are required to post bonds if their balance sheets are weak. In others, franchisors are required to put any fees paid by franchisees into escrow until they have provided the services that the fees are designed to pay for.
Because regulators in registration states evaluate the franchisors’ disclosure documents and, in many cases, impose other requirements on franchisors, unscrupulous and fly-by-nigh franchisors are more likely to be found out in registration states. Therefore, the willingness of a franchisor to operate in a registration state provides a (limited) signal of franchise system quality.
Nineteen states have laws that govern relationships between franchisors and franchisees. In all of these states, except one, franchisors may not terminate franchisees without “good cause” (such as the franchisee’s insolvency, abandonment of operations, or failure to comply with the terms of the franchise agreement). In 12 of these states franchisees must be permitted to “cure” problems before franchisors are allowed to terminate them.
Several of the “relationship” states impose other rules to protect franchisees. In ten states, when a franchise relationship ends, franchisors are required to repurchase the equipment, inventory, and other assets that franchisees were required to obtain as a condition of participation in the system. In ten states, the franchisor must show “good cause” to block transfer of the franchise to another party.
Some relationship states have laws protecting the franchisee against encroachment – the opening of new outlets within a certain distance of existing ones. Others have rules ensuring free association, or the participation of franchisees in trade associations. Still others have laws governing purchases that franchisors require franchisees to make from designated suppliers, and requirements that franchisors operate in good faith.
Relationship laws protect franchisees by making harder for franchisors to terminate or not renew agreements with them. However, they also make it more difficult for franchisors to control franchisee free riding. The threat of termination, which ensures that franchisees uphold system quality and contribute to collective advertising, is not as effective in relationship states.
Registration and relationship laws make franchising different in different states. Before prospective franchisees buy a franchise, they should be aware of their state’s laws and how they affect franchising in that state.