This article first appeared in the March 2008 issue of LJN’s Franchising and Business Law Alert and is republished on this website with the permission of ALM Properties, Inc. (www.ljnonline.com)   Its contents are not to be redistributed by viewers or used for commercial purposes.

Dale Cantone Addresses Implementation of the revised Franchise Rule and
Maryland’s Challenges as a Leader in Regulating Franchise Sales
By David L. Cahn

On January 29, 2008, Dale E. Cantone, Deputy Securities Commissioner of the State of Maryland and Chair of the Franchise and Business Opportunity Committee/Project Group of the North American Securities Administrators Association, Inc. (“NASAA”) since 1996, provided his unique perspective on developments in the regulation of franchise sales to the Franchise & Distribution Law Committee of the Maryland State Bar Association.  The meeting, which was attended by approximately twenty attorneys from Maryland , Washington , D.C. and northern Virginia , was held at the Office of the Attorney General in Baltimore , Maryland .   In addition to Mr. Cantone, Peggy Shanks, a senior franchise examiner in the Maryland Division of Securities, also provided her suggestions on how attorneys can obtain quicker approval of franchise registration application.   Both presenters provided their personal opinions and neither spoke on behalf of Maryland ’s Attorney General, Douglas F. Gansler, or NASAA.

Among his remarks, Mr. Cantone noted that, during December 2007, Steven Toporoff, who was the staff attorney within the Federal Trade Commission’s Division of Marketing Practices who spearheaded the revision of the FTC’s Franchise Rule over more than a decade, has been reassigned and is no longer involved in the regulation of franchise sales. As a result new FTC staff attorneys will be in charge of finalizing Compliance Guides related to the revised FTC Franchise Rule, and providing FTC Informal Staff Opinions and answers to Frequently Asked Questions (“FAQs”).

According to Mr. Cantone, the FTC has signaled that it expects to issue its long awaited Compliance Guides during March 2008.  The Compliance Guides provide additional instructions concerning preparation of a Franchise Disclosure Document (“FDD”) under the revised Franchise Rule and other implementation matters. Mr. Cantone stated, however, that the Compliance Guide may be “less than comprehensive” in that they may not address every outstanding question about the new disclosure requirements.  Mr. Cantone implied  that, given Mr. Toporoff’s departure, it is likely that NASAA, the agency that issued the Uniform Franchise Offering Circular (“UFOC”) Guidelines on which the FDD is based, will assume even greater responsibility over how the revised Franchise Rule is interpreted.

During 2007 NASAA issued Interim Instructions concerning the Uniform Franchise Registration Application, in which it recommended that registration states accept the FDD disclosure requirements with inclusion of a new “state cover page,” and additional language on the receipt pages, and state addenda, as previously required under applicable state franchise laws.  The approach recommended by the Interim Instructions has been accepted by all registration states for use in 2008.

NASAA is currently working on a permanent replacement to the UFOC Guidelines, which will govern the requirements for disclosure documents to be used in registration states.  While Mr. Cantone anticipates that the NASAA 2008 disclosure requirements will closely track the revised FTC Rule requirements, he did state that there are some other state regulators who want some of the information deleted under the revised FTC Rule added back into the revised UFOC – specifically identification of all franchise brokers.   Mr. Cantone stated that he does not intend to recommend that NASAA require any such substantive additions at this time.

Following its issuance of the 2008 franchise registration and disclosure requirements to replace the UFOC Guidelines, NASAA also hopes to issue a new “commentary” with answers to open questions about the new requirements, to the extent those open questions are not answered by the FTC.  In addition, NASAA is updating the registration filing forms and instructions.  One change in the works is a proposal to require all franchisors to file one paper version of the application and a copy on a compact disc.

Finally, the NAASA Franchise Project Group has a model exemption project in progress. The goal of this project is to propose, at the state level, a series of uniform exemptions from the registration requirement for those franchise offerings that pose a lower risk of fraud or deception.

Mr. Cantone also addressed developments within Maryland ’s Division of Securities.  He remarked that the number of registration applications has continued to mushroom, from about 1100 filings in 2003 to over 1600 in 2006.  This number continued to increase in 2007 and examiners are expecting even more this spring.  More than fifty percent (50%) of the filings are submitted in March, April and May, shortly after franchisors receive their annual audited financial statements.  Unfortunately, the Division of Securities has the same number of examiners and amount of resources that it had in 2003.

Mr. Cantone also acknowledged that the Maryland Franchise Registration and Disclosure Law will need to be amended to allow complete harmonization between Maryland law and the 14 day delivery requirements under the revised FTC Rule, and that it would be appropriate at this time to consider revisions to Maryland ’s regulations concerning franchising.   Mr. Cantone agreed to work cooperatively with the MSBA’s Franchise Law Committee on such legislative and regulatory changes, and encouraged the cooperation of the International Franchise Association’s legal and legislative committee with regard to such changes.

In a question and answer session, Mr. Cantone responded to a question about the scope of the FTC’s new disclosure requirement in Item 20 regarding “confidentiality agreements,” or “gag clauses.”  Mr. Cantone stated that, in his personal opinion, the disclosure required in item 20 about confidentiality agreements is fairly narrow and would not be triggered if a franchisee agrees not to discuss the terms of a settlement, so long as the franchisee is free to discuss his or her personal experiences as a franchisee.

Peggy Shanks, a senior franchise examiner at the Maryland Division of Securities, provided advice regarding what attorneys can do to facilitate the registration process. She highlighted several changes to the FTC Rule that can easily be overlooked and can lead to delayed registration approval. One such change is the disclosure now required in Item 12 concerning whether the franchisee is prohibited from doing business outside of its Territory. 

Item 11 now requires that the franchisor provide a negative disclosure if it does not provide an advertising program. Also in Item 11, the FTC rule requires that the franchisor disclose whether the training program must be completed to the franchisor’s satisfaction and any consequences if the franchisee does not adequately complete training. Ms. Shanks noted that if a consequence for failure to complete training is the termination of the franchise agreement, the franchisor must also include whether initial fees will be refunded in connection with Item 5. Similarly, if the franchisor and franchisee cannot agree on a site, the franchisor should disclose whether the franchisor will refund the initial fees as a result of such consequences.

Ms. Shanks emphasized that, when preparing Item 20, franchisors need to make sure to disclose whether confidentiality clauses have been signed in the past three years, and, if so, to respond fully to this new requirement, not just to the first part.

When drafting multi-state offerings, Ms. Shanks emphasized the importance of including a state-specific addendum not only for the Franchise Agreement but also for all other agreements which may be in the Franchise Disclosure Document, including Development Agreements. Also, on the receipt page of a multi-state offering, in addition to listing the FTC’s requirement of delivering the FDD at least 14 complete days before signing of the franchise agreement or accepting any fee payment, the states should be listed that have additional triggers for when the disclosure document must be provided to a prospective franchisee, including those remaining states with the 10 business day rule and the three remaining states (Maryland, New York, and Rhode Island) that require the disclosure document to be provided to the franchisee the earlier of the first personal meeting or 10 business days before receiving a fee payment or a signed agreement.

According to Ms. Shanks, when submitting a response to a deficiency letter you only need to provide the redline pages and the clean changed pages. Submission of a complete clean version is only necessary when the pagination has changed as a result of the required revisions.  Ms. Shanks would prefer that redline versions be submitted without format changes and with the deleted text displayed at the bottom of the page as opposed to in balloon in the margins. Organizing the document in this manner will make it easier for franchise examiners to review the document and provide a quicker response.

Most fundamentally, Ms. Shanks concluded by saying that the best way an applicant can have his or her filing reviewed expeditiously is to follow all of the directions and include all of the disclosures required by the guidelines.