The benefits of owning and operating a retail franchise are numerous, including fulfilling the dream of being an entrepreneur, marketing a well-established brand, receiving extensive support from the franchisor, and increasing income for a better quality of life. Understanding and adhering to franchise compliance regulations and laws is a crucial aspect of becoming a franchisee. Franchisors are also obligated to comply with these regulations. Franchise compliance also protects both the franchisee and franchisor from potential disputes over the franchise agreement, brand consistency, and other legal responsibilities.

Federal Franchise Regulations

Franchise compliance starts at the federal level at the Federal Trade Commission (FTC). Its primary role is ensuring that a franchisor promptly shares essential documents and other information with a potential franchisee.

• The Franchise Rule (FTC Rule) – This set of regulations outlines the disclosures franchisors must provide to franchisees regarding the specifics of the franchise agreement. These may include the franchisor’s history, business, and franchise experience, as well as the structure of the franchise program. The FTC Rule also requires franchisors to provide information about their financial stability, all costs associated with purchasing and operating a franchise, and the terms and conditions of the franchise agreement applicable to both the franchisor and the franchisee.
• Franchise Disclosure Document (FDD). This document discloses the details of a franchise opportunity. In addition to the items noted above, the FDD can include data and other information that verifies the performance of franchisees in the system, particularly their financial health. With the FDD, potential franchisees are better informed before purchasing a franchise, allowing them to compare multiple franchise systems and protect themselves from misleading or fraudulent sales practices.
• Financial Performance Representations (FPRs) under the FTC regulations governing franchise compliance are documents in which a franchisor states the potential sales, income, and profits a franchisee can expect. The FPR will also reveal operating expenses, Key Performance Indicators (KPIs), and other financial details. This information ensures transparency on the part of a franchisor.

State-Specific Franchise Laws

While the FTC Rule is relatively straightforward, navigating state-specific franchise laws can be more difficult and confusing. For example, a state’s legal definition of a franchise may be different from the FTC’s and can vary from state to state.

• State franchise regulations – States adjudicate franchise laws differently based on factors like franchise location, franchisor residency, and where both parties exchanged and accepted the franchise offer.
• Test for franchise existence – Most states define a franchise by evaluating the franchisee’s marketing program, while others assess a shared marketing interest between franchisor and franchisee.
• “Little FTC Acts” – Some states automatically enforce their franchise laws when a franchisor violates the FTC Rule, allowing franchisees to sue under the Little FTC Act.
• State compliance checklist – State agencies frequently revise registration requirements based on industry shifts or legislation, so franchisees create tailored compliance checklists and consult attorneys.

Franchise Agreements

Because a franchise agreement is a legal contract, it will cover every detail of the franchisor’s and franchisee’s rights and responsibilities, including franchise compliance. As with most legal documents, the franchise agreement was likely created by one or more attorneys, who will likely have written a document that is many pages long and contains numerous legal terms. Again, no one should sign a franchise agreement without advice from an attorney familiar with franchises and the applicable laws.

• Key components of a franchise agreement—The FDD is the most important component on the long list of key components. Others of equal importance include the franchisee’s territory rights and financial obligations, as well as a detailed explanation of the trademarks and brands the franchisee may use.
• More key components of a franchise agreement – An agreement will also include advertising and marketing requirements, training and support from the franchisor, termination clauses, renewal terms, and the limits to the franchisor’s control of how the franchisee operates the business.
• Legal implications—Unsurprisingly, a franchise agreement is a legal document that determines whether the franchisor or franchisee has violated any of its components. Some of the legal hazards include breach of contract, intellectual property infringement, and violations of laws, such as franchise compliance, termination disputes, and misrepresentation.

Continuing Franchise Relationship Laws

The strength of the relationship between the franchisor and the franchisee is often a significant factor in whether the franchisee will be successful. Minimizing disagreements, arguments, and accusations is the responsibility of both parties and is governed by the laws governing franchise relationships. The franchisor’s perspective is the entire franchise system, while the franchisee’s perspective is local, and the two may not align precisely. A franchise agreement typically includes clauses related to the elements of the relationship and the procedures for resolving disputes.

• Termination, renewal, and transfer – Franchisors must show “good cause” to terminate agreements with their franchisees. A material breach of the contract is the basis for “good cause.” Franchisees in many states have the right to renew their franchise agreements unless a contract breach has occurred. Franchisors can also apply the “good cause” principle to stop franchisees from transferring their agreement. Otherwise, franchisees have the right to transfer.
• Dispute resolution – Given the large number of franchise agreements, conflicts are inevitable between a franchisor and a franchisee. Franchise relationship laws also include how to resolve these disputes. Mediation is often the mechanism both parties use. A neutral third party serves as a communicator and negotiator to guide both parties to a solution. Arbitration is another method; however, the franchisor and the franchisee agree that the neutral third party can impose a decision to reach a resolution.

Best Practices for Franchise Compliance

By following several best practices for franchise compliance, franchisors and franchisees can avoid violating federal and state laws, disputes, and other disagreements, and instead focus on working together to benefit both parties. These best practices ensure franchise compliance by both parties and can strengthen the business and operational structures of franchisors and franchisees.

• Regular audits and updates—To protect themselves and their franchisees, franchisors conduct regular internal audits and updates. This best practice ensures that franchisees comply with all applicable federal and state laws, as well as all terms of the franchise agreement. When franchisees are found to be non-compliant, franchisors should consistently communicate with them and apply non-compliance standards in a fair and equitable manner.
• Proactive risk assessment – Franchisors can make any audits easier and minimize the number of franchisees who may have violated franchise compliance by regularly reviewing their compliance policies and procedures.
• Legal advice and training – Although franchisors operate their business (the franchise system) with the guidance of legal counsel, they should specifically seek advice about franchise compliance. An attorney can assist the franchisor with developing sections in the franchisee training program and updating the operations manual with content related to federal and state laws and regulations.
• Documentation and record keeping—All these other best practices will be in vain unless franchisors document all franchise compliance forms, audits, franchisee communications, and other documents and data. A recording-keeping system to store, retrieve, and protect all documentation is also essential.
• Technological support—Franchisors can also utilize various technologies to streamline compliance management. With an automated system, Certificate of Insurance (COI) renewals can be quickly processed, franchisors can view each franchisee’s compliance status, and system data analysis can identify which franchisees may need additional assistance with franchise compliance.

Conclusion

With almost one million franchise establishments in the US in 2024 and millions more throughout the long history of the retail franchise model, franchise compliance laws, regulations, and policies have been refined. Understanding the concept of franchise compliance and adhering to related laws and regulations are the primary responsibilities of every franchisee. These include the FTC’s Franchise Rule, state-specific laws such as the Little FTC Acts, the Franchise Disclosure Document (FDD), and the Franchise Practices Rule (FPR), which are typically part of any franchise agreement. Franchisees must know and follow franchisors’ compliance policies and procedures and franchise relationship laws regarding terminations, renewals, transfers, and dispute resolution. Franchisors’ responsibility is to provide franchisees with comprehensive training, ensuring they are compliant, and to document and maintain records regarding franchise compliance. For more information about how DTiQ’s Solutions have helped over 37,000 franchises, speak to one of our experts.

Frequently Asked Questions

Q: What is franchise compliance?

A: Franchisors and franchisees and their franchise agreements are subject to various federal and state-specific laws and regulations governing the operation of a franchisee and franchisor-franchisee relationship. At the federal level, these include the FTC Franchise Rule, which outlines the disclosures franchisors must provide to franchisees regarding the specifics of the franchise agreement; the Franchise Disclosure Document, which specifies the franchise opportunity; and Financial Performance Representations, in which franchisors state the potential sales, income, and profits franchisees can expect. State franchise compliance laws vary from state to state, but some have “Little FTC Acts.” These are triggered when the FTC Franchise Rule has been violated.

Q: What is a franchise agreement, and how does it relate to franchise compliance?

A: A franchise agreement is the binding legal document between the franchisor and franchisee, detailing both parties’ rights and responsibilities, including franchise compliance. The FDD is an integral part of the agreement; however, franchisees must thoroughly understand their territory rights, financial obligations, and the terms governing their use of franchisors’ trademarks and brands. Franchisors also use the agreement to determine if franchisees have violated the agreement and franchise compliance laws and regulations.

Q: What are franchise relationship laws?

A: Franchise relationship laws state the specifics of the franchisor-franchisee relationship, including how to deal with disagreements, arguments, and accusations. The statutes and agreement will outline the method for terminating the franchise agreement and describe franchisees’ rights to renew and/or transfer their franchises. Franchisors must declare they have “good cause” to terminate agreements if contractual obligations are breached and to prevent a transfer. When a dispute arises, franchise relationship laws include resolution methods, such as mediation and arbitration. A neutral third party manages the resolution negotiations and can declare a binding arbitration agreement.

Q: What are the best practices for franchise compliance?

A: Applying various best practices to franchisors’ and franchisees’ business operations ensures that both parties understand the laws and regulations governing franchise compliance, so they can avoid violating them. Many best practices are most beneficial when developed and managed by franchisors. Franchisors should conduct regular internal audits of their franchisees to assess franchise compliance. Franchisors can also regularly review compliance policies and procedures and minimize misunderstandings and unintended violations. Seeking good legal advice to protect franchisors and assisting in training for both franchisors and franchisees on franchise compliance greatly benefits both parties. Franchisors can maximize their and their franchisees’ protection under the law by documenting all communications and agreements and maintaining complete records regarding franchise compliance.