INFORMAL STAFF ADVISORY OPINION 99-7
This staff advisory opinion is issued in response to two requests for clarification of Advisory 99-6, which addressed when business consultants are obligated to furnish prospective franchisees with disclosure documents. Advisory 99-6 has generated more than usual interest. For example, a recent Wall Street Journal article asserted incorrectly that, through Advisory
99-6, Commission staff "has lowered the threshold" by requiring disclosure earlier than before. In Advisory 99-6, staff addressed a particular set of facts, and we analyzed those facts in light of clear statements by the Commission about who qualifies as a "broker" and what constitutes a "first personal meeting" under the Rule. We find nothing new or particularly remarkable in that opinion. Nonetheless, given the apparent interest sparked by Advisory 99-6, further discussion of the applicable standards may be useful.(1)
The first request for clarification was submitted by Franchise Network ("Frannet"), a franchise consulting firm. In its request, Frannet states that it has contracts with approximately 75 franchise systems, each of which has agreed to pay Frannet a fee if a prospective franchisee referred by Frannet ultimately buys a franchise.(2) Frannet asserts, however, that its primary focus is educating consumers by presenting them with a process by which they can evaluate whether any business offering meets their goals and represents an acceptable risk. It contends that, in fact, many clients may take its process and decide not to purchase any franchise at all,(3) or may elect to purchase a franchise from a company that Frannet does not represent.
According to its letter, Frannet's process starts with a meeting during which the client completes a Frannet-generated questionnaire. The questionnaire is designed to reveal "what the client is looking for in a business, personal objectives, business goals, skill levels, and financial resources." Armed with this information, a Frannet Associate can then present various franchise options, which, based on the Associate's expertise, "best fit the client," including those that are within the client's price range. The Associate may introduce as many as six or seven franchise systems at the meeting.
If the client expresses an interest in one or more franchise systems, the Associate will present the client with a copy of a brochure (and, if available, a video) for each such system. In addition, the client is given various research materials on investigating franchises and undertaking a comprehensive due diligence review. At a later time, the Associate contacts the client to determine if he or she has any questions or if the client wishes to speak with any of the franchisors discussed at the meeting. If the answer is "yes," the Associate arranges for the client to speak with a representative of the franchisor. The Associate usually contacts the franchisor and asks that a representative, in turn, contact the client.(4)
Finally, Frannet stresses that it plays no part in the franchisor's approval process. The ultimate decision whether or not to accept the client ultimately as a franchisee is solely within the franchisor's discretion. Frannet represents that it does not assist the prospect in filling out the franchisor's application, does not accept any money on behalf of the franchisor, does not negotiate the terms of the franchise agreement, nor does it discuss earnings or the earnings potential of any franchise system.
B. Tom Miller & Associates
The second request for clarification was submitted by Tom Miller & Associates. In its request, the firm states that its clients work with thousands of licensed business brokers, whose primary concern is to sell businesses, not franchises. Indeed, in its letter, Tom Miller states that business brokers seldom, if ever, meet with prospects to talk about franchising. Rather, prospects typically are interested in non-franchised businesses that the broker has listed and advertised for sale. At a meeting, a broker determines if any of the listed businesses are suitable for the prospect. To do this, the broker typically obtains information from the prospect "that is similar to the information franchisors obtain when they pre-qualify a prospective franchisee."
If a prospect does not qualify for any of the listed businesses, the broker may consider whether the prospect qualifies for the purchase of a franchise. If the prospect is interested, the broker may provide the prospect with information about one or more franchise systems on file. Tom Miller states that the average prospect will meet the minimum qualifications of up to four franchisors. If the prospect would like to know more about any of these franchises, the brokers can furnish three-ring binders containing profiles on each franchise they have on file. The profile gives a history of the franchise and a brief overview of the day to day activities of the franchise. Tom Miller asserts that no earnings claims are contained in the profiles and that its brokers do not make any such claims. If the prospect is interested in a franchise system, the broker passes on the prospect's name to the franchisor. Any further discussions about the franchise are between the franchisor and the prospect.
Frannet and Tom Miller now seek further advice with respect to Advisory 99-6. Specifically, they ask whether, under the facts presented, meetings between their Associates or brokers and consumers constitute "first personal meetings" that trigger the Rule's disclosure obligations. For the following reasons, it is clear that both Frannet Associates and Tom Miller brokers qualify as "brokers" for purposes of the Rule. We further conclude that Frannet's Associates appear to engage in "first personal meetings," while the Tom Miller brokers do not.
II. LEGAL STANDARD
A. The Definition of "Broker"
Section 436.1 of the Franchise Rule states that it is an unfair or deceptive act or practice within the meaning of section 5 of the Federal Trade Commission Act for any franchisor or franchise broker to fail to furnish prospective franchisees with disclosure documents within the time frame set out in the Rule.(5)
The Rule defines the term broker broadly to mean "any person other than a franchisor or a franchisee who sells, offers for sale, or arranges for the sale of a franchise." 16 C.F.R. § 436.2(j). The term "broker" captures not only franchise sales representatives who have the authority to sign franchise agreements and accept payment on behalf of the franchisor, but also any persons who "arrange for the sale of a franchise." This includes independent business consultants and, in some instances, trade show promoters(6) who arrange for franchise sales by putting prospective franchisees in contact with franchisors.
At the very least, anyone who acts on behalf of one or more franchisors to further a franchise sale, and receives a commission or other consideration if a sale is ultimately consummated, will be considered a broker under the Rule. See Statement of Basis and Purpose, 43 Fed. Reg. 59614, 19717 (December 21, 1978) & notes 176 and 178.(7) It is reasonable to assume that a consultant paid by the franchisor has a strong economic incentive to arrange a franchise sale by putting the consumer in direct contact with one or more franchise systems. For example, in Advisory 99-6, we found that a consultant paid by franchisors "arranges" for a franchise sale if he or she discusses the prospect's specific business interests, prescreens prospects through interest questionnaires, recommends specific franchise options, and even assists prospects in completing the franchisor's application form, which includes gathering the prospect's financial information.
B. Brokers' Obligation to Furnish Disclosure Documents
As stated in Advisory 99-6, franchisors and franchise brokers are obligated to furnish disclosures at the earlier of the "time for making of disclosures" or the first "personal meeting." The "time for making of disclosures" means 10 business days before the prospect signs a binding agreement or pays a fee in connection with the franchise sale. 16 C.F.R. § 436.2(g). The term "personal meeting," in turn, is defined as "a face-to-face meeting between a franchisor or franchise broker . . . and a prospective franchisee which is held for the purpose of discussing the sale or possible sale of a franchise." Id. at § 436.2(o).
C. Definition of "First Personal Meeting"
While there is no doubt that a face-to-face meeting between a franchisor's sales representative or third-party agent and a consumer constitutes a personal meeting, the question remains whether the Commission contemplated that such a meeting would constitute a first personal meeting for purposes of triggering the Rule's disclosure requirements. That is a question of fact that can only be determined on a case-by-case basis.
It is clear that the Commission does not consider every chance encounter between a consumer and franchise seller to constitute a first personal meeting under the Rule. Statement of Basis & Purpose, 43 Fed. Reg. at 59714. Indeed, in the Final Interpretive Guides to the Rule the Commission elaborated upon the term first personal meeting, as follows:
Even where a face to face meeting occurs. It is not necessarily a "first" personal meeting. In interpreting this term, the Commission will consider such factors as whether the franchisor clearly indicated at the outset of the discussion that it was not prepared to discuss the possible sale of a franchise at that time, whether the meeting was initiated by the prospective franchisee rather than the franchisor, whether the meeting was limited to a brief and generalized discussion and whether earnings claims are made.
44 Fed. Reg. 49966, 49970 (August 24, 1979).(8)
At the same time, the Commission made clear in the Statement of Basis and Purpose that group discussions of franchising and prescreening of prospects may constitute a first personal meeting:
The Commission cannot accept the "distinction" made by several franchisors that such initial personal meetings as those involving group discussions of franchising led by franchisor salesmen, or review and discussion of franchise "interest questionnaires," are not meetings involving the "possible sale" of a franchise. . . . The term "prospective franchisee," is defined as including any person who approaches, or is approached by, a franchisor or its agent or representative "for the purpose of discussing the establishment, or possible establishment, of a franchise relationship involving such a person." The rule therefore seeks to protect all such persons from the commission of unfair and deceptive trade practices by the franchisor through timely disclosure.
43 Fed. Reg. at 59713, n.138.
Accordingly, we may conclude that a face-to-face meeting constitutes the "first personal meeting" if the following factors, among others, are present: The franchisor's representative or independent agent meets personally with consumers in a setting where there is a likelihood or expectation of discussing the possible purchase of a franchise. During the meeting, the representative or agent: (1) seeks to match the consumer with one or more specific franchise systems based upon criteria furnished by the consumer; (2) discusses the merits of one or more specific franchise systems;(9) and (3) contacts the franchisor on behalf of the consumer or otherwise advises the consumer on how to contact one or more franchise systems. Finally, the representative or agent receives a commission or other compensation if a franchise sale is ultimately consummated through the referral.
III. APPLICATION OF THE STANDARD
A. Frannet Associates and Tom Miller Brokers are Franchise "Brokers" Under the Rule
There is no question that Frannet Associates and Tom Miller brokers qualify as franchise "brokers" under the Rule. Even if they do not actually negotiate, sign contracts, or accept money on behalf of individual franchise systems, they nonetheless "arrange for the sale of a franchise" by introducing prospective franchisees to specific franchise concepts and by putting prospective franchisees in contact with specific franchisors. Moreover, they are paid by the franchisor if a sale is ultimately consummated. That is all that is required to constitute a "broker" under the Rule.
B. Frannet Associates' Meetings Constitute First Personal Meetings Under the Rule
For the following reasons, we further conclude that initial meetings between Frannet Associates and their clients, as described above, constitute "first personal meetings" under the Rule. There is no doubt that Frannet Associates meet with clients specifically to discuss the possible sale of a franchise. Indeed, Frannet's literature is replete with references to franchising, including a "Checklist for Franchisees," Four Week Franchise Research Plan," and "Franchise Selection Do's and Don'ts." It also appears that the primary, if not sole, source of income for Frannet comes from generating franchise sales. Similarly, consumers who approach a Frannet Associate intend to discuss not only franchising as a method of doing business, but the possible purchase of a franchise. Accordingly, they constitute "prospective franchisees" under the Rule. While an individual client ultimately may have various purchase options -- including purchasing a non-franchised business or seeking an employment opportunity -- there is no question that they come to the meeting prepared to discuss franchise options.
We further observe that Frannet Associates arrange for franchise sales by prescreening prospective franchisees through general questionnaires designed to assist the client in evaluating his or her interests, goals, and resources. As noted in advisory 99-6, the administration of a questionnaire by a broker for the purpose of eliciting information from the consumer with which to recommend specific franchise systems under contract will be sufficient to make the meeting a "first personal meeting."
In reaching our conclusion, we reject the notion that there is a distinction between a general questionnaire designed by the broker and a specific questionnaire prepared by a franchisor. The nature of the questionnaire is not at issue, but how it is used. For example, a broker who administers its own general personality test and then proceeds to discuss with the consumer franchising as a method of conducting business, without referring to any specific franchise system, or who provides the consumer with general reference materials on franchise systems -- such as directories, magazines, or general literature -- would not engage in a first face-to-face meeting for Rule purposes. However, where a broker solicits information from a consumer and takes the next step of suggesting one or more franchise systems that match the consumer's interests or qualifications, we may conclude that the parties are engaging in a "first face-to-face" meeting for the purpose of arranging for the possible sale of a franchise.
C. Tom Miller Brokers' Meetings Do Not Constitute First Personal Meetings Under the Rule
In contrast to the Frannet Associates described above, the Tom Miller brokers do not arrange meetings with their clients with the expectation of discussing franchise sales. Rather, these brokers' focus on the sale of specifically listed non-franchised businesses. Accordingly, consumers who meet with the brokers do not expect to discuss franchising as a method of doing business, nor to discuss specific franchise systems. Discussions of franchising apparently are incidental at most, limited only to those occasions where a sale of a listed business is not a viable option. Thus, a discussion about franchises, under the circumstances, is more closely analogous to a "chance encounter," rather than a prearranged one.
Further, there is a distinction between how the two companies use general interest questionnaires. While there is no doubt that Frannet uses the questionnaires to sell franchises, Tom Miller brokers use the questionnaires to sell non-franchised businesses. The mere possibility that Tom Miller brokers may ultimately use a consumer's responses to a general questionnaire to suggest a franchise purchase alone appears to be insufficient to turn a meeting about listed non-franchised businesses into a "first personal meeting" to sell franchises.(10)
Finally, we note that Tom Miller brokers are much less active in fostering a franchise deal than are the Frannet Associates. Frannet has a very detailed process for educating prospective franchisees about franchising and how to investigate a franchise offering. Its advice is clearly designed to lead a prospect through the steps necessary to complete a franchise sale. Under the circumstances, there is no question that Frannet Associates "arrange" for franchise sales, starting with the face-to-face personal meeting. In contrast, Tom Miller brokers, at most, pass along the names of qualified leads to franchisors. We do not believe that the Commission intended that every meeting between a consumer and a general business broker constitutes a first face-to-face meeting under the Rule merely because the possibility exists that the broker may suggest the purchase of a franchise and pass along the consumer's name as a lead. Rather, the issue is whether the consumer has a reasonable expectation that there will be a discussion of the "possible sale of a franchise."
Accordingly, we conclude that a meeting between Frannet Associates and a client --prospective franchisee -- constitutes a "first personal meeting" under the Franchise Rule. We therefore would expect the Associates to provide prospects with disclosure documents at that time, just as they apparently provide them with other franchisor-supplied literature and, in some instances, video tapes. In contrast, we do not believe that general business brokers -- whose primary business is focused on the sale of non-franchised businesses -- need provide disclosures to consumers at their face-to-face meeting, unless the consumer would have a reasonable expectation of discussing franchising at the onset of the meeting or where earnings representations are made.(11) The mere possibility that the broker may discuss franchise options, does not turn a consumer who attends a meeting to discuss the purchase of a specifically listed non-franchised business into a "prospective franchisee."
Please be advised that our opinion is based on all the information furnished in your respective requests. This opinion applies only to your clients and to the extent that actual company practices conform to the material submitted for review. Please be advised further that the views expressed in this letter are those of the FTC staff. They have not been reviewed, approved, or adopted by the Commission, and they are not binding upon the Commission. However, they do reflect the opinions of the staff members charged with enforcement of the Franchise Rule.
Date: November 12, 1999 Franchise Rule Staff
1. We note that the Commission has proposed to eliminate the first "personal meeting" trigger from the Franchise Rule. See Notice of Proposed Rulemaking, 64 Fed. Reg. 57294, 57300-301 (October 22, 1999). If so, this issue could be moot in many instances. To the extent that any party may disagree with the conclusions expressed in this advisory opinion, the proper vehicle to effect change would be to file a comment in the Commission's ongoing rulemaking proceeding.
2. Consumers learn about Frannet in one of several ways, including: (1) attending a seminar on franchising presented by a Frannet Associate; (2) referral by the Small Business Administration, attorney, accountant, or banker; and (3) national and local advertisements placed by Frannet in the general media or on the Internet.
3. Frannet states that only 1 in 6 prospects who begin the Frannet process ultimately purchase a franchise.
4. Frannet will also provide the client with a list of attorneys and accountants who can assist the client in reviewing the opportunity.
5. Franchise brokers are jointly and severally liable with franchisors if they fail to comply with the Rule's disclosure requirements. In the Final Interpretative Guides to the Rule, the Commission stated:
The rule establishes the same obligation for both the "franchisor" and the "franchise broker." Either the franchisor or the franchise broker may satisfy the requirements set out in § 436.1(a)-(e) and (g) by furnishing the required disclosure documents. The requirements of the rule apply jointly to both the franchisor and the franchise broker; however, compliance by one will constitute compliance by the other.
44 Fed. Reg. at 49969.
6. Indeed, the Commission has entered into consent agreements with several trade show promoters to resolve allegations that they, as brokers, were jointly and severally liable with the franchisor-exhibitors for making earnings claims on trade show floors without providing the required earnings claim disclosures. See FTC v. Shulman Promotions, No. 94-858 (S.D. Ohio 1994); FTC v. Entrepreneur Media, Inc., No. 94-8523 Ex (C.D. Cal. 1994). Pursuant to Commission policy, however, trade show promoters are conditionally exempt from the Rule as brokers, if they furnish show attendees with specific consumer education notices.
7. For example, in the Statement of Basis and Purpose, the Commission cited Congressman Claude Pepper of Florida, who observed that "[a] good many franchises are sold through sales companies who specialize in merchandising several franchises. These companies are paid by commissions . . . . They are the agents of the franchisor . . . ." 43 Fed. Reg. at 59717 n. 178.
8. The Commission also offered the following advice:
The Commission believes that by using common sense precautions, franchisors can defer the first personal meeting until such time as they are prepared to provide the required disclosures.
9. The "merits" of a particular system would include factors that an individual prospective franchisee would deem material in deciding whether to consider the particular franchise system, including: (1) the cost of purchasing the franchise; (2) training and other assistance; (3) the franchisor's selection process; (4) availability of particular locations; and (5) potential earnings.
10. Our opinion would be different, however, if Tom Miller advertised new franchised units (rather than resales by existing franchisees) and consumers responded with an expectation of discussing the possible purchase of a franchise.
11. A meeting at which earnings or performance representations are made always constitutes a "first personal meeting" for Rule purposes.