United States: Federal Trade Commission Initiates Rulemaking Proceeding for Business Opportunity Rule

The Federal Trade Commission will shortly publish in the Federal Register a Notice of Proposed Rulemaking for the FTC’s long-awaited business opportunity rule (Bus Opp Rule). The Bus Opp Rule, if and when promulgated, will replace the business opportunities coverage under the current and proposed amended Franchise Rule.

The proposed Bus Opp Rule will greatly increase the types of transactions and number of sellers that fall within its scope. As a result, many business opportunity sellers and other product distributors who, to date, have avoided coverage under franchise or business opportunity laws will now need to either comply or change their business model. At the same time, the FTC has significantly reduced the amount of required disclosure that sellers must provide to prospective purchasers. This new trade-off between expanded coverage and reduced compliance burdens is likely to set the stage for a spirited rulemaking proceeding.

Public comments will be accepted through June 16, 2006, with an additional rebuttal public comment period extending through July 7, 2006. The FTC, if requested to do so prior to June 16, also will hold hearings with the opportunity for cross-examination and rebuttal submissions, or informal public workshops in lieu of hearings.

1. For franchisors currently covered by the Franchise Rule, the proposed Bus Opp Rule will have no impact. Although franchisors’ franchise offerings also will satisfy the definition of a "business opportunity" under the proposed Bus Opp Rule, the rule explicitly exempts franchisors who (a) satisfy the definitional elements of a "franchise" under the Franchise Rule; (b) utilize a written contract; and (c) require the purchaser to make a payment that meets the Franchise Rule’s minimum $500 payment requirement. This exemption also would apply to several other Franchise Rule exemptions, such as fractional franchises and leased department arrangements.

For franchisors who did not need to comply with the Franchise Rule because they avoided the Franchise Rule’s "required payment" definitional element, such as by deferring franchisee payments for six months or limiting franchisees’ payments to purchases at bona fide wholesale prices of reasonable quantities of inventory for resale, the proposed Bus Opp Rule now will cover these transactions, and these franchisors must, therefore, comply with the Bus Opp Rule.

Business opportunity sellers currently covered by the Franchise Rule now will be covered by the Bus Opp Rule instead of the Franchise Rule. As a result, their disclosure obligations will be significantly eased.
Business opportunity sellers who offer work-at-home businesses or pyramid relationships now will be covered by the Bus Opp Rule.

2. Some product distributors who have relied solely on the bona fide wholesale price exemption to avoid Franchise Rule coverage now will be covered by the Bus Opp Rule. Distributors will need to pay careful attention to this rulemaking proceeding; at a minimum, they should carefully review their current business arrangements with their purchasers and consider their future options.

The three definitional elements are:

1. The seller solicits persons to enter into a new business;
2. The purchaser makes any payment or provides any other direct or indirect consideration through a third party (no $500 minimum payment needed); and
3. The seller either:

(1) Makes an earnings claim; or

(2) Represents that some type of business assistance will be provided to the purchaser. Business assistance means the offer of material advice, information, or support to a prospective purchaser, and specifically includes (a) more detailed versions of the Franchise Rule’s "providing locations/customer accounts" business opportunity definitional element, and "significant assistance" franchise definitional element; (b) purchasing products made, grown, etc. by work-at-home businesses; and (c) paying commissions based on the purchaser’s product sales or recruitment efforts (pyramid schemes).

The FTC has created a unique one-page disclosure document, which is available for download. The FTC’s expressed objective is to focus solely on five categories of information that the FTC believes to be of greatest concern to purchasers. The FTC estimates that it will take each seller five hours and cost $1,250 in legal and clerical costs to initially comply with all obligations under the Bus Opp Rule, and no more than four hours and $1,000 per year thereafter. Most sellers will very likely disagree with the FTC’s cost estimate.

The five categories of information are: (a) earnings claims; (b) criminal and civil actions; (c) cancellation and refund policy; (d) two-year sales, cancellation, and refund history; and (e) a list of purchasers.

For the first three subjects, the seller either checks the "No" box if no disclosure about the subject is needed, or checks the "Yes" box and attaches the required information as an attachment to the one-page disclosure form. The seller also must list the name, address, and telephone number of all purchasers within the past three years, but has the option, similar to the Franchise Rule, of limiting the list to the ten closest to the prospective purchasers’ location. New purchasers must be advised that similar information about them will be included in future disclosure forms.

Disclosure must be made at least seven calendar days before the business opportunity purchaser buys the business or pays any money. Quarterly updates are required for all changes (including the purchaser list); monthly updates are required if fewer than ten purchasers are listed.

Earnings claims disclosures are reasonably similar to the Franchise Rule requirements. One new limitation, however, is that a seller may not provide overall industry earnings information unless the seller can demonstrate that its purchasers’ results are similar to the industry results.

Litigation triggering a "Yes" response is reasonably similar to the Franchise Rule in terms of parties and claims, but disclosure requires only the full caption of the action and the court.

The seller is prohibited from taking 18 actions, among them being:

• Waivers of the seller’s compliance with the law;
• Numerous types of misrepresentations, such as those related to earnings; seller’s ongoing payments to purchasers; costs and other essential features of the business opportunity; seller’s assistance to purchasers; ease of securing locations and accounts; and information about third parties’ relationship with or endorsement of the business opportunity;
• Providing written or oral representations that are inconsistent with the information provided in the disclosure form, or including more than the required information in the form;
• Failing to provide substantiation for any earnings claim;
• Failing to provide refunds or cancellation in the manner set forth in the disclosure form, or misrepresenting these policies;
• Violating any territorial exclusivity rights granted to the purchaser, or misrepresenting the nature of such rights; and
• Using bogus references, or failing to disclose any consideration paid to existing purchasers or special relationships between the seller and any existing purchaser.

1. The Bus Opp Rule will use the same preemption standard as the Franchise Rule--e.g., state laws will be preempted only to the extent that the laws conflict with the Bus Opp Rule and provide less protection to purchasers. However, unlike the Franchise Rule where the UFOC disclosure will suffice for both FTC and state disclosure law purposes, sellers will need two disclosures forms, e.g., the Bus Opp Rule document and the state-required format, because the two laws’ disclosure obligations are so different.
2. Sellers must keep records for three years of (a) all "materially different" versions of their disclosure documents; (b) purchasers’ disclosure document receipts; (c) signed purchaser contracts; (d) cancellation or refund requests; and (e) substantiation of earnings claims.
3. Electronic versions of the disclosure document are acceptable.
4. The disclosure form must include the name of the seller’s salesman and the date the form was provided to the prospective purchaser. The "Receipt" is a duplicate copy of the disclosure form that the prospective purchaser signs and returns to the seller.

This article is intended to provide information on recent legal developments. It should not be construed as legal advice or legal opinion on specific facts. Pursuant to applicable Rules of Professional Conduct, it may constitute advertising.