New York Franchise Law Blog : Franchise Lawyer & Attorney Charles N. Internicola, Providing National Representation of Franchisees and Franchisors

As franchise counsel I am a strong proponent of “disclosure” – the more of it, the better. Quality disclosures contained in your FDD serve a critical role in mitigating future litigation risk and expense. So, when it comes to FDD disclosure exemptions, we typically proceed with extreme caution. Nevertheless, in the appropriate circumstance, franchisors should consider or at least be aware of potential tools available to them when it comes to potential disclosure exemptions to the Federal Franchise Rule.

One such exemption relates to “Large Franchisees”. The “Large Franchisee Exemption” was incorporated into the federal franchise rule to alleviate and lessen disclosure requirements when dealing with “sophisticated” franchisees. The criteria established by the federal rule are related to “high net-worth” franchisees and certain qualified insiders. The “large franchisee exemption” may be applicable – subject to qualification – to the following individuals / entities / institutions:

• Franchise sales involving ongoing entities such as airports, hospitals and universities with at least $5 million net worth and five years of prior business experience;

• Franchise sales where the initial investment is at least $1 million exclusive of unimproved land and franchisor financing; and

• Franchise sales with “insider” franchise purchases involving owners or officers of the franchise sytem, or managers with at least two years’ management experience in the franchise system.

Before adopting and relying on a disclosure exemption, careful analysis should be given to (a) satisfaction of federal and state law, and (b) a cost-benefit analysis as to the extra burden and cost that disclosure would require.  From a litigation standpoint legal counsel for franchisors must be aware of these disclosure exemptions as potential defenses in litigation involving alleged disclosure violations.

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As franchise counsel I am a strong proponent of “disclosure” – the more of it, the better. Quality disclosures contained in your FDD serve a critical role in mitigating future litigation risk and expense. So, when it comes to FDD disclosure exemptions, we typically proceed with extreme caution. Nevertheless, in the appropriate circumstance, franchisors should consider or at least be aware of potential tools available to them when it comes to available exemptions to the disclosure mandates of the Federal Franchise Rule.

One "grouping" of potential FDD disclosure exemptions relate to transactions involving sophisticated investors, insiders and large franchise investments. These "potential" exemptions, should be evaluated and considered under the following circumstances:

• "Large Franchise Investment". The "Large Franchise Investment" exemption applies to franchise transactions involving a franchisee initial investment  of at least $1 million exclusive of unimproved land and franchisor (including affiliates) financing.  Application of this exemption is dependent upon an analysis of the transaction, satisfaction of the dollar volume criteria and the requirement that the franchisee sign a disclosure acknowledging that the franchise sale was exempt from the Franchise Rule.

• "Large Franchisee Entities". The "Large Franchisee Exemption" applies to franchise sales transactions involving prospective franchisees that are corporate entities, possess a minimum net worth of $5 million and possess no less that 5 years of prior business experience.  By combining both net worth and prior business experience requirements, this exemption is intentionally limited corporate franchisees that possess a predicate level of sophistication.

• "Insiders of the Franchisor". The "Insider Exemption" applies to franchise sales to the owners, directors, and managers of the predecessor entity of the franchisor.  That is, this exemption applies to the officers, owners and managers of a business before it became a franchisor.  These prospective franchisees must possess at least two years experience in the franchisors business and, at the time of becoming a franchisee, have maintained their insider status.These "sophisticated investor" exemptions are an important tool for franchisors to consider and beware of One such exemption relates to “Large Franchisees”.

The foregoing "sophisticated investor" exemptions constitute a critical tool for franchisors to be aware of when planning certain non-traditional franchise sales transactions and when evaluating potential litigation strategy.  Application of the foregoing exemptions requires a fact specific analysis of factors and legal criteria - including applicable rules and regulations associated with each exemption) .  The key, however, is to be aware of this potential "tool". 

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