A Primer on Business Opportunities (“Biz Ops”), Part II: disclosure and filing requirements

In the first part of this blog series on business opportunities, I explored the definition of “business opportunity” (or “Biz Op”) to determine what type of enterprises may fall under federal and state law and thereby trigger compliance issues.

After conducting this initial inquiry to determine whether or not a seller’s offering qualifies as a business opportunity, the seller can then determine what is required, both federally and in each state the Biz Op is sold. Of course if a seller is not marketing a Biz Op, there are no special business opportunity requirements with which it must comply (keep in mind, however, that even if a seller is not selling a “business opportunity,” it must still comply with other state and federal laws concerning fraud and unfair or deceptive business practices or the sale of securities) .

If a seller is in fact marketing a Biz Op, it must comply with the following regulations.

Federal law requires the business opportunity seller to provide prospective purchasers with a one page form disclosure document disclosing the seller’s name, address, and phone number; whether the seller had been the subject of a civil or criminal action; whether the seller offers a cancellation or refund policy; whether the seller makes any earnings claims (earnings claims can be express {“you’ll make a million dollars”} or implied {purchasers of this business opportunity drive Ferraris]); and the name and phone number of ten (10) other purchasers closest in distance to the prospective purchaser. If the seller has litigation history or makes earning claims it will have to attach these to the disclosure documents as additional pages.

All things considered, this disclosure document is much simpler and more streamlined than it once was. Prior to March 2012, the business opportunity rules were contained along with the franchise rules under one code section, 16 CFR § 436. This rule required extensive disclosures, as is still the case with regard to franchises.  The Federal Trade Commission (“FTC”), which promulgates business opportunity and franchise regulations, ultimately determined that while franchises involved complex contractual licensing relationships and substantial investment costs, business opportunities often involved simple contracts and significantly lower investments. As such, the extensive disclosure requirements of the franchise rule imposed unnecessary compliance costs on both business opportunity sellers and buyers.

Therefore, the FTC decided to split the franchise rule into two separate code sections, one governing franchises and the other governing Biz Ops. The first business opportunity rule was set out in new code section 16 CFR § 437 as an “interim rule.” The interim rule was identical to the previous franchise rule, requiring the same detailed disclosures. Finally, however, in March 2012, the new and much-simplified business opportunity rule went into effect. As stated, the new rule requires the seller to disclose a one-page form disclosure document to prospective purchasers. This disclosure must be given to each prospective purchaser 7 days before the purchaser gives the seller any consideration or enters into a contract. This must be given to every prospective purchaser in every state, whether or not the state has its own law on point, and cannot be combined with other information that may confuse or obscure the disclosures required by federal law.

In addition to the federal disclosure requirement, many state laws not only require disclosure to the prospective purchaser, but also require registration with the state. Typically this means that the seller sends a copy of the state-specific disclosure and any required attachments (typically a copy of the contract the seller uses with purchasers; financial statements of the seller) along with a required payment (typically a couple hundred dollars) to the state’s regulating department (often the secretary of state, the attorney general, or the securities commission). If a state requires the seller to register the disclosure document with the state, it is critical the seller does so before soliciting sales in that state.

Each year the seller is required to file a renewal and pay the renewal fee. Throughout the course of a year, a seller is required to file an amendment if any material changes in the required information occur.

A number of state laws, however, were created to mirror the former federal business opportunity law, which required much more extensive disclosures. Despite the fact that the federal rule has since changed and become more simplistic, many such states have retained the more extensive disclosure requirements and have not amended their disclosure requirements. As such, these state disclosures may require the seller to disclose additional information such as the name and address of each of the seller’s salespersons, the business and education background of the seller’s principals and officers, as well as their personal litigation and bankruptcy histories; the terms and conditions of the offer and any training provided; statistical figures regarding the amount of business opportunities sold, failed, terminated, refunded, and still operating; audited financial statements; proof that the seller has obtained a bond; certain disclaimers or mandatory refund periods required by state law, or even copies of advertisements used by the seller. The disclosure document often also requires the seller to attach a copy of the proposed contract, which also must include certain content required by state law.

States have varying requirements for the timing of disclosure documents to prospective purchasers. A number of states require that the seller give disclosure documents to prospective purchasers no less than 48 hours prior to the time the purchaser signs a contract or gives any consideration (typically, the whole or a part of the purchase price). Some states, however, require disclosures be made 10 business days prior. It is critical that the seller have a clear guide to follow when marketing to prospective purchasers to ensure it does not run afoul of state-specific disclosure requirements.

Some states also require the seller to secure a bond, against which aggrieved purchasers can recover. Not all sellers must secure a bond, but only those that make certain representations, such as a guaranty that the purchaser will derive income from the business opportunity that exceeds the price paid, or a representation by the seller that it buy back from purchaser any unsold products.

Based on the foregoing it is not difficult to see why a Biz Op seller may seek to negotiate a balance between the representations it makes in courting prospective purchasers and the corresponding compliance required under state law. This nuanced dance is explored in greater detail in Part III of this blog series, which explores business opportunities as a growth strategy.

 

 

 

The importance of timing in the sale of your franchise: when to say “No” to a prospective franchisee

Your franchise is up and running and generating a buzz.  You are getting inquiries from across the US, some of which are clearly qualified buyers itching to get into this new franchise opportunity.

It’s difficult to turn away a prospective buyer, but sometimes that’s exactly what you need to do, at least temporarily.

Say, you get an inquiry from a prospective franchisee in New York. You are aware that New York is one of the states that requires franchise registration–in fact, you have already begun the process of registration with the state. Is now a good time to enter preliminary conversations with the prospective buyer? What if you fully disclose to the buyer the fact that you are still waiting on approval from the State of New York and cannot consummate any deal until such time as you are approved, are you in the clear now?

The answer, as you may have suspected, is no.

The previous summary is based on Reed v. Oakley, 661 N.Y.S. 2d 757 (1996). In Reed, a franchisor began negotiating with a prospective buyer after the franchisor had registered with the state of New York, but before receiving approval. The franchisor informed the buyer it was not able to close the deal until it was approved by New York, and the initial agreement of the parties even specified that the buyer was to receive disclosure documents and have the required time to review them before any deal would close.

When the relationship between buyer and franchisor later soured, the buyer cried foul, claiming that the franchisor violated New York’s Franchise Sales Act by soliciting and negotiating the sale of a franchise prior to receiving approval to sell franchises in the state of New York. The court agreed with the buyer, finding that New York’s Franchise Sales clearly prohibits solicitation or negotiation of a franchise sale prior to registration approval. The fact that franchisor appears to have acted in good faith and did in fact give the buyer all the relevant disclosures plus time to review them prior to closing the deal appeared to have no influence on the court’s decision.

The real rub in this case for the franchisor is the loss it sustained. Typically, the remedy for violation of the New York Franchise Sales Act is the amount of damages the buyer can prove were sustained by the franchisor’s violation of the law. If, however, the franchisor has “willfully” violated New York’s Franchise Sales Act, then the franchisee may rescind the contract, get all his money back, plus 6% interest, plus attorneys fees, and court costs.

Ouch!

Sometimes the word “willfull” is associated with conduct you would think of as knowingly wrong, but in Reed v. Oakley, the court determined that the word “willful” means simply “voluntary and intentional, as opposed to inadvertent.” The franchisor had, in fact, voluntarily and intentionally negotiated with Reed, and in so doing it “willfully” violated New York law, subjecting it to all of the penalties.

In the world of franchise and business opportunity sales, it is almost unavoidable that a few buyers will feel that the business they have bought does not quite meet their expectations. If this happens to you, you want to be sure that you have fully complied with all state disclosure laws.

Compliance can be challenging, given the fact that there are both federal and state requirements, state franchise laws vary from state to state, and franchise requirements can be rather complex. Sometimes franchisors are tempted to do it all themselves, but like an attempted home haircut that winds up back in the barber’s chair, a do-it-yourself approach all too often results in franchisee complaints, state action, wasted money, and worst of all, wasted time. A franchise attorney can help you avoid the disclosure pitfalls, protect your intellectual property, and bolster your contracts and agreements, freeing you up to focus on the job you should be doing, growing your business.

Before you begin soliciting franchisees or advertising in a state, make sure you are informed of the law. Develop a registration roll-out game plan, follow it, and avoid the pitfalls.  A franchise attorney at Briskin, Cross and Sanford can help you do this.