F.T.C. Public Comment 98

The FTC should consider adopting an exemption for test agreements, expanding upon its existing fractional franchise exemption, clarifying its definition of ""control and assistance,"" and adopting a large and/or sophisticated franchisee exemption, so that more offers of co-branded franchises may be exempt or excluded from the FTC Rule.

FTC.jpg

U.S. Federal Trade Commission
July 25, 1997

Public Comment
Mark A. Kirsch, attorney

Request for public comment on possible revisions to The Franchise Rule.

Comment #98

LAW OFFICES

RUDNICK, WOLFE, EPSTIEN, & ZEIDMAN

A PARTNERSHIP INCLUDING PROFESSIONAL CORPORATIONS
1201 NEW YORK AVENUE, N.W.
PENTHOUSE
WASHINGTON, D.C. 20005-3919
(202) 712-7200
FAX (202) 712-7222

July 25, 1997

The Honorable Donald S. Clark
Secretary
Federal Trade Commission
Sixth Street & Pennsylvania Ave., N.W.
Room 159
Washington, D.C. 20580

Re: 16 C.F.R. Part 436
Co-Branded Franchises

Dear Secretary:

This comment is submitted in response to the Federal Trade Commission's ("FTC") request for comments contained in its Advance Notice of Proposed Rulemaking ("ANPR") that appeared in the February 28, 1997 issue of the Federal Register (Fed. Reg. Vol. 62, No. 40, pp. 9115-9127). The ANPR is the most recent request for comments which the FTC has solicited with respect to its trade regulation rule entitled "Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures," 16 CFR Part 436 ("FTC Rule").

On May 13, 1997, this firm filed comments in response to the ANPR and stated that additional comments regarding co-branded franchises will be submitted separately. The following is our response to the FTC's inquiries regarding the offer of co-branded franchises and whether the FTC should mandate additional or different disclosures for co-branded franchises.

We will not repeat here a summary of our experience and expertise in franchise matters; that information is set forth in our May 13, 1997 comments, as well as in our submissions as panelists at previous FTC workshops regarding the FTC Rule. With respect to the subject of co-branding, however, we have been involved in numerous co-branding transactions and related matters during the past several years, including counseling franchisors and others regarding the structuring of co-branded operations; preparing and negotiating co-brand and multiple-brand license and franchise agreements; preparing and amending disclosure documents to reflect existing and proposed co-branded operations; drafting and negotiating master agreements between two systems for multiple-unit development of co-branded operations; and preparing documentation for international co-branded operations. The co-branding transactions on which we have worked and/or provided advice and assistance range from single-unit dual-brand agreements, to multiple-brand licensing arrangements between systems with several hundred to several thousand potential outlets. In addition to our co-branding work, we have counseled many companies regarding, and prepared numerous agreements and offering circulars pertaining to, the franchising and establishment of non-traditional outlets. In our experience, non-traditional outlets reflect many of the characteristics, and raise many of the same legal and business concerns, as co-branded franchises. Further, our firm's attorneys are frequent authors and lecturers on the subject of co-branding and franchising. Enclosed is a list of articles, programs and speeches on co-branding and/or non-traditional distribution that were authored, co-authored, and/or presented by members of our firm.

I. SUMMARY RESPONSE

A. Co-branding involves diverse business arrangements. The ANPR refers to "co-branded" franchises as an arrangement in which "two or more franchisors combine forces to offer a franchisee the opportunity to operate two or more franchises in one outlet." This definition presumes (as indicated in the ice cream and doughnut example in the ANPR) a joint offer of a combination franchise to a prospective franchisee. In our experience, co-branding is more diverse and varied than the definition and example set forth in the ANPR. For example, it includes, as well, the offer to two (or more) separate franchisees of the opportunity to operate two (or more) franchises at one location. Further, co-branding may involve master license agreements among franchisors of different systems, and/or may include limited duration "test" agreements. For this reason, this comment will not be limited to the single form of co-branding arrangement described in the ANPR; instead, it also will address several other forms of co-branding arrangements, and the impact of the FTC Rule on all of those relationships. We also will discuss certain co-branding arrangements that may not be subject to the FTC Rule.

B. The FTC Rule and the UFOC Guidelines provide adequate disclosure of co-branded franchises. Our comments will describe several approaches by which franchisors grant co-branded franchises, several alternative formats for providing disclosure of co-branded franchises, and typical changes made to a standard franchise offering circular to reflect co-branded franchises. Our experience indicates that the FTC Rule and the Uniform Franchise Offering Circular ("UFOC") Guidelines, if intelligently and conscientiously followed, provide sufficient disclosure for prospective franchisees of co-branded franchises.

C. The FTC should consider adopting new exemptions, or broadening existing exemptions, from the FTC Rule for experienced co-brand franchisees. Co-branding arrangements are more likely to involve larger and more sophisticated "franchisees," such as franchisors of other systems; large, sophisticated and experienced multiple-unit franchisees; and/or large and experienced owners and operators of retail businesses, rather than "mom and pop" franchises. For this reason, some of the implicit assumptions underlying the FTC Rule, i.e., unsophisticated franchisees, unequal bargaining power, and informational imbalance, may not necessarily be accurate or applicable when analyzing co-brand franchises. Accordingly, we believe that the FTC Rule should reflect the economic realities by exempting offers to large and/or sophisticated franchisees; expanding the scope of, and modifying the fractional franchise exemption; adopting an exemption for limited duration test agreements; and clarifying the FTC's interpretation of the "significant control or assistance" standard under the FTC Rule to provide better guidance with respect to the application of the FTC Rule to co-branded transactions. In so doing, the FTC will remove unnecessary disclosure burdens imposed on large, experienced or sophisticated parties to a co-branding transaction.

II. CO-BRANDING INVOLVES DIVERSE BUSINESS PRACTICES

The process of co-branding is driven by varying business needs and goals, such as: a search for new sites in a saturated market; a desire for strengthened product offerings; a desire to add new and proven product lines without the usual research and development process; a response to consumer demands for the company's products or services; a response to competitive pressures and to compete with a competitor's outlets; prospects for improved rates of return where high volume and/or shared costs can be achieved; and the desire to provide added value to franchisees by offering something "new" to the franchise system. Franchisors and other businesses are responding to these needs, goals, and pressures by developing a multitude of marketing and distribution arrangements to better place their products and services in the hands of consumers. Many of these arrangements may be considered "co-branding" and may involve co-branded franchises.

As a preliminary matter, when discussing co-branding and similar arrangements, we and others involved in co-branding have found it useful to define the parties and prospective parties to a co-branding relationship. Generally speaking, in many co-branding operations, there is a branded product or service (for example, submarine sandwiches) typically associated with a particular franchise chain or network, that will be sold from a branded retail outlet that does not typically sell this branded product (for example, a convenience store or a pizza restaurant). The new product or service (e.g., submarine sandwiches) may be referred to as the "entrant" product, and the company that sells this product, or offers licenses or franchises to others to sell this product, is often referred to as the "entrant system" or the "entrant franchisor." (Other names for "entrant" include "guest" or "tenant.") The retail outlet from which the new product is sold is often referred to as the "host" unit, and the company that owns and/or franchises host units is the "host system" or "host franchisor." We will use these terms throughout the balance of our comments.

As noted above, a co-brand or combination franchise that is offered jointly, as described in the ANPR, is only one method of co-branding and is just one example of a "non-traditional" franchise outlet. Co-branding may entail the offer to an existing franchisee (the host) of one system a franchise to operate a business of different system (the entrant), and the offer of the entrant franchise may originate from either the host franchisor or the entrant franchisor. Further, the entrant franchise may be offered to the host franchisee at a different time than the offer of the host franchise. We believe it is important to identify a variety of co-branded and non-traditional distribution arrangements, even though several of these arrangements are not "franchises" under the FTC Rule. We will not, however, analyze the non-franchise co-branded units in the context of the issues raised in the ANPR, but will focus our comments on the "co-branded franchises."

A. Many Co-Branding Arrangements Are Not Franchises

The diverse nature of co-branding may be seen in the following examples of arrangements in which the branded or trademarked product or service of one company is offered from, at, or adjacent to a previously unrelated business:

1. The addition of one branded product or service that is offered at or from an existing business (e.g., branded coffee identified on the menu of, and sold from, a restaurant; branded ice cream sold at and/or used as an ingredient in a dessert sold at a branded restaurant, with such branded product identified on the menu).

2. The addition of (i) equipment (e.g., frozen yogurt machine) that produces a branded product sold from the premises of an existing business, or (ii) the placement of a display case in the existing business from which branded products are offered for sale — usually in the form of a self-serve operation (e.g., doughnut display case at a convenience store).

3. Operation of a branded product or service business from the premises of an existing business (e.g., operating of a sub/sandwich store from a convenience store; a coffee and pastry cart operated in the lobby of a hotel).

4. Operation of a branded product or service business from a site adjacent to an existing business (e.g., operating a dry-cleaning business or office services business at a gasoline service station; operating a restaurant at or adjacent to a hotel).

5. Operation of more than one branded product or service business on a shared property (e.g.,
the ice cream-and-doughnut example in the ANPR; multiple brand restaurants operated at a highway rest stop; multiple brand and multiple product automotive aftercare businesses operated as a "car care court"; multiple brand food service outlets and gift stores operated from within a hotel).

While the foregoing examples may be viewed by consumers as co-branding, and may, in the franchise context, be considered as "non-traditional" franchised outlets, a closer inspection of the legal and business arrangement reveals that not all co-branded arrangements are "franchises." For example:

1. If the entrant systems sells its branded product (for example, doughnuts, coffee, or frozen yogurt) to a host unit at bona fide wholesale prices for resale, without any requirement to pay any other monies to the entrant system (such as initial fees and royalties), this arrangement will not be a "franchise."

2. If the entrant system sells a branded product to the host, and/or licenses the host to sell a branded product, and the entrant licensor does not impose significant "control" over, or provide significant "assistance" to, the method of operation of the host unit's business, the arrangement may not be a "franchise" (see discussion at § V.B below).

3. If the entrant product or service business operates within the confines of, or adjacent to, the host unit, pursuant to a lease from the host to the entrant, there may not be a "co-branded franchise" (e.g., branded restaurant operated at a hotel; fast food restaurant operated adjacent to a general merchandise store). (This arrangement may involve a grant of a "franchise" from the entrant franchisor to the entrant franchisee (and also from the host franchisor to the host franchisee), but not the grant of a co-branded franchise from one system to the other.)

4. As discussed in § V.A below, the entrant franchise may be a "fractional franchise" under the FTC Rule (and several state laws) and, therefore, may not be the offer of a franchise for which disclosure (and/or registration under some state laws) is required.

In the foregoing situations (and others), the parties and counsel must address in the operative agreements various contract, licensing, trademark control and trade dress, and operational issues. If, however, the arrangement is not a "franchise" under the FTC Rule and state franchise registration/disclosure laws, the franchisor (or licensor) may avoid unnecessary disclosure.

B. Structures For Offering Co-Branded Franchises

While not all co-branded operations are "co-branded franchises," in our experience, entrant franchisors often utilize one of two principal legal structures when granting co-branded franchises — the master franchise or subfranchise agreement, and the direct franchise.

1. Master Franchise

In the master franchise or subfranchise structure, the entrant franchisor grants a master franchise, master license, or subfranchise to the host franchisor, authorizing the host franchisor to:

a. establish and operate entrant system franchises at host-operated units; and

b. grant subfranchises to host franchisees to establish and operate the entrant system businesses at their host units.

This structure is similar to other subfranchise arrangements, except that in co-branding, the entrant subfranchisees already may be franchisees of the existing host franchise system.

2. Direct Franchise

In the direct franchise structure, the entrant franchisor grants direct franchises (a) to the host franchisor (for the operation of entrant system units at host/company-operated units), and/or

(b) to host franchisees, for operation of entrant system franchises at host franchisee units. In several co-branding arrangements in which we have counseled franchisors or drafted and negotiated agreements, particularly in situations in which the entrant franchisor grants direct franchises to many host franchisees, the entrant franchisor has enlisted the assistance of the host franchisor in identifying and soliciting potential host franchisees as candidates for an entrant franchise. In these situations, the host franchisor is likely to be a "franchise broker" for the entrant franchisor, an arrangement which creates a legal obligation and risks under the FTC Rule for both the entrant franchisor and the host franchisor.

As noted above, there are other structures by which entrant system products may be offered at, from, or adjacent to a host unit (e.g., sale of products at bona fide wholesale prices, leasing of space), but these structures may not implicate the FTC Rule or the states' UFOC Guidelines as part of a co-branding arrangement.

III. DISCLOSURE OF CO-BRANDED FRANCHISES UNDER THE FTC RULE

Under the FTC Rule, as well as most state franchise registration/disclosure laws, the structures noted in the previous section — master franchise and direct franchise — impose disclosure obligations on the entrant franchisor and, in some cases, the host franchisor as well.

In the master franchise or subfranchise approach, there are two distinct disclosure obligations:

1. The entrant franchisor must provide disclosure to the host franchisor regarding the offer to the host franchisor of the master franchise or subfranchise; and

2. The host franchisor must provide disclosure to the host franchisees regarding the offer of the entrant system franchises.

In the direct franchise approach, the entrant franchisor must provide disclosure to the host franchisor (for a host company-owned unit) and/or to host franchisees; this disclosure will describe the entrant system franchise. Also, in those situations in which the host franchisor is a "franchise broker" for the entrant franchisor (because of activities such as identifying and/or soliciting potential host franchisees as potential co-branded outlets), the entrant franchisor will have to disclose information about the host franchisor as a broker.

A. Varying Forms of UFOCs

Our experience has shown that just as there is diversity among co-branded franchise arrangements, there is no one method by which a co-branding arrangement is disclosed in the UFOC.(1) The proposed structure of the co-branded operation — including whether the offer will be made by the entrant franchisor or the host franchisor, whether the second or third brand added to an existing unit, or whether there is a history of similar co-branded operations — may affect the nature and scope of the disclosure. Among the several alternative disclosure format structures for offering co-branding franchises that franchisors have used are:

1. Inserting co-brand disclosures into the franchisor's standard UFOC. The additional information may include information regarding the co-brand franchise that is distinct or different from the franchisor's regular franchise (e.g., a separate Item 7 chart for the estimated initial investment, or notes in Item 7 explaining the differences from the norm).

2. Creating a separate "co-brand" UFOC that addresses only the offer of the franchise for co-branded locations and co-branded units.

3. Creating a multiple-brand co-brand UFOC that offers franchises for more than one brand to be operated in a co-branded setting. This may occur if the host franchisor and entrant franchisor are the same or related entities, or if the host franchisor has a subfranchise to grant entrant franchises. (This form is most likely to be used in the ice cream-and-doughnut scenario example described in the ANPR.)

4. Modifying the host franchisor's standard UFOC to reflect the host franchisor's conditions for approval of the host units to operate as co-branded units. (An amendment to the host's standard form franchise agreement also may be necessary.) This alterative is often the preferred method in direct franchise arrangements and in some master franchise arrangements. In these situations, the host franchisee will also receive a UFOC from the entrant franchisor (possibly of the form described in 1 or 2 above).

B. Special Disclosures for Co-Branded Franchises

The ANPR requests comments about whether prospective co-branded franchisees need additional or different disclosures than prospective franchisees for non co-branded franchises. We believe that the current disclosure requirements are sufficient. This, of course, assumes that the entrant franchisor, along with counsel, thoroughly review, analyze, and respond to the UFOC Guidelines in conjunction with the proposed co-brand franchise arrangement.

We have prepared many UFOCs that disclose co-branded franchises, and have advised franchisors concerning their obligations to disclose relevant information about the offer of a co-brand franchise. While no two UFOCs or co-branded franchises are exactly the same, certain co-brand elements will be common to most UFOCs. The following list identifies the UFOC Items that are most likely to include disclosures concerning a co-branded operation, and/or include information that distinguishes between the co-branded franchise and the traditional franchises granted by the franchisor.

Item 1 — will identify the entrant system and host system, and the relationship, if any, between the entrant franchisor and host franchisor (for example, a subfranchise relationship, franchise broker, etc.).

Item 2 — will identify the host franchisor as a franchise broker, if applicable. In the subfranchise approach to co-branding, Item 2 will include information regarding personnel from the entrant system and the host system.

Item 5 — the initial fees for co-branded operations may be different than for the non co-branded franchise.

Item 6 — the ongoing fees may vary for co-branded operations, especially with respect to advertising fees and required marketing expenditures.

Item 7 — a separate Item 7 chart, a revised standard chart, or footnotes and explanations to the standard Item 7 chart will be needed if the initial investment differs for a co-brand operation.

Item 8 — there may be situations in which the co-branding arrangement leads to changes in, or restrictions on, potential sources of supply which may need to be disclosed in Item 8.

Item 9 — a new chart or an amended chart for Item 9 will be required if there is a separate entrant system co-brand franchise agreement, and/or a co-brand addendum to the host franchise agreement.

Item 11 — if the advertising program and/or training programs for the co-branded franchises differ from the non co-brand franchise, revisions will be needed. Also, there may be references to the manuals of both the entrant and the host systems.

Item 12 — territory (and exclusivity) issues are a significant hurdle to clear in any co-brand alliance, and the UFOC of the host and/or the entrant should reflect these aspects of the co-brand arrangement.

Item 13 — if the co-branded entrant franchise is granted by the host franchisor rather than the entrant franchisor, Item 13 will need to be revised. Clearly, if the co-brand franchise involves
the simultaneous offer of two or more trademarked or branded franchises, information
regarding the principal marks of both franchises will need to be disclosed.

Item 17 — if there is a separate co-brand franchise agreement, or co-brand addendum to the franchise agreement, the terms and provisions of those documents should be summarized in Item 17.

Item 19 — if the franchisor presents earnings information concerning non co-brand operations, these disclosures will need to be revised, either to (a) include information for the co-branded operations; or (b) clearly note that the information presented does not reflect co-branded operations.

Item 20 — to the extent that separate disclosures for co-branded franchises would be relevant or useful, separate charts for (i) co-branded operations, (ii) franchisees that operate from a co-branded site (with another brand), and/or (iii) the franchisees that operate co-branded units, could be included in Item 20.

Item 22 — co-brand agreements and/or addenda to standard agreements to reflect co-brand operations will need to be included.

In sum, there is no need to modify the FTC Rule to include new or different disclosures because the current UFOC Guidelines are sufficient to ensure that appropriate information about co-brand operations is presented.

IV. TEST AGREEMENTS AND PILOT PROGRAMS

As noted above, there are many variations in co-branded franchises, and franchise systems are continually exploring new marketing and distribution channels. Entrant systems seeking to expand to new markets, and host systems seeking new product offerings through co-branding, may engage in a pilot program or test program before a full-scale roll-out of the co-branded concept. As the name implies, a test program is often implemented as a means to work out the kinks in a co-brand operation. A test program is designed to:

• Determine whether the economics of the co-branding operation work;

• Determine whether labor, equipment, and other needs are compatible;

• Develop operational techniques for preparing, offering, and selling the dual brands side by side;

• Develop manuals, training programs, and other guidance that will be necessary for the training of unit operators; and

• Enable executives and other employees of the two systems to develop a strong working relationship.

To test the co-brand alliance, particularly in situations in which multiple-unit co-brand development is envisioned, many companies will enter into a test agreement. The test is often granted to the host franchisor for host company-owned units, although sometimes an entrant will test the concept at host franchisee units. The agreement may provide that fees, such as initial fees, royalties, and/or advertising fees, will be waived during the test period. Finally, test agreements usually are for a limited term and for a limited number of sites.

A test agreement can be structured to avoid the application of the franchise disclosure rules, but it is not always possible. When coverage under the FTC Rule cannot be avoided, a franchisor must decide whether the test is worth the expense and burden of creating a disclosure document which is of little value to the host operator, particularly if (a) the host operator has extensive experience in the industry of the entrant system (and the "fractional franchise" exemption discussed below is not available or applicable), or (b) the test is of limited duration, and/or there are agreement provisions that minimize the potential financial exposure to the host operator (i.e., the unwinding of the test would put the host operator in substantially the same position as if it rescinded the test agreement).

For this reason, we urge the FTC to exempt limited duration test agreements in circumstances where the financial and legal risks to the franchisee are minimal. More specifically, we recommend that the offer of a franchise would be exempt if the agreement (a) provided for a term of less than 18 months; (b) did not require an initial payment of more than $1,000 in the first six months (and periodic or ongoing royalty, advertising or other fees do not exceed $1,000 in any six month period), (c) allowed the franchisee to terminate without cause, and (d) contained a refund or equipment/inventory repurchase requirement at the expiration of the test if the parties do not continue the relationship.

V. EXEMPTIONS AND EXCLUSIONS FROM FTC RULE COVERAGE

A large number of co-branding transactions appear to meet the policy rationale for non-coverage under the FTC Rule, but perhaps because co-branding was not a factor in the 1970's when the FTC Rule was drafted and promulgated, the FTC Rule's exemptions and exclusions may not be broad enough to literally apply to co-branding transactions. For this reason, we urge the FTC to consider minor modifications, as noted below, to eliminate any ambiguity about the applicability of the FTC Rule (or of exemptions from the FTC Rule) to co-branding transactions.

A. Fractional Franchise Exemption

Many co-branded operations involve a host operator that has experience in the operation of a business that is similar to the entrant franchisor's business, and the expected level of sales from the entrant franchise may not be significant. Accordingly, the FTC Rule will not apply to the arrangement if it falls within the scope of the "fractional franchise" exemption.(2)

While the FTC, through its Interpretive Guides, Statement of Basis and Purpose, and several interpretive opinions, has provided some guidance with respect to determining whether a franchisee has been in the "type of business" of the franchisor, in light of the potential variations that may exist within co-branding, as well as the experience of many host franchisors and host unit operators, we believe that further clarification of the fractional franchise exemption may be warranted. For example, if a host franchisee operates a hamburger restaurant, and seeks a co-brand franchise for a pizza or Mexican restaurant, will his prior experience with hamburger restaurants specifically, or food service generally, be sufficient to satisfy the exemption? Or, when adding a sandwich franchise to a convenience store, will the convenience store's food service experience satisfy the exemption? We believe that the "type of business" requirement should be clarified to indicate that these types of arrangements — including those in which the franchisee has experience in competitive industries or competitive segments of the same industry — will satisfy the exemption.

In addition, the calculation of the 20% sales volume figure may be subject to varying interpretations. For example, assume that when a co-branded franchise is offered to a (host) multiple-unit franchisee, the co-branded entrant franchise will not be operated at all of the host's units. Several questions are raised by this scenario: (a) will the sales from the entire host enterprise be aggregated in calculating the denominator of the equation to determine whether the revenue from the entrant business exceeds the 20% limitation? (b) will the sales from only the host units that have entrant franchises be aggregated in calculating the revenue for the denominator of the equation? or (c) will the 20% limitation be calculated on a store-by-store basis?

We believe that the FTC should elaborate on the standards it applies in evaluating franchises under the fractional franchise exemption so that franchisors and franchisees can better assess, particularly in co-branding arrangements, whether the fractional franchise exemption is available or whether the franchisor will be required to provide a co-branding-specific UFOC. In addition, we urge the FTC to increase the revenue threshold under the exemption, as it applies to co-branded franchises, to a level of 30% to 40%.

Finally, the FTC may wish to establish a safe harbor for franchisors. For example, if a franchisor has a reasonable basis from which to believe that a franchise is subject to the fractional franchise exemption, and the prospective franchisee certifies in writing that it satisfies the criteria for the exemption, then the franchisor should not be liable for failing to comply with the FTC Rule if it is later discovered that the prospective franchise did not meet the requirements. A safe harbor will reduce uncertainty of franchisors and will increase the efficiency by which co-branded franchises are offered. We believe that such a rule will not eliminate meaningful disclosure to prospective franchisees.

B. "Control or Assistance"

Another potential avenue from coverage under the FTC Rule may be found in the second definitional element of a franchise — "control or assistance" over the franchisee's "method of operation." The FTC Rule is quite broad in defining "significant control" and "significant assistance," and many entrant franchises, particularly those offered to less sophisticated or experienced host franchisees will satisfy these definitional elements. In these situations, disclosure under the FTC Rule will be required.

It is clear, however, that there exist co-branding arrangements, particularly ones in which the host franchisee is an experienced franchisor or operator of another business, that do not involve an entrant franchisor exerting significant control over, or providing significant assistance to, a host franchisee's entire method of operation. In such cases, the franchisee may not be "dependent" upon the franchisor's "superior" business expertise, and/or the franchisee may not "rely" on the franchisor's advice and assistance. A determination of whether the control or assistance element is satisfied is not, however, so clear, and will depend upon factors such as the entrant franchisor's size and experience, the host franchisee's size and experience, the products and services that will be offered in the co-branded setting, and other elements of the co-brand license or franchise. We urge the FTC to provide additional guidance regarding its interpretation of the "control or assistance" element of the definition of a franchise as it applies to co-branding.

C. Large and/or Sophisticated Franchisees

As noted in our May 13, 1997 comments, we urged the FTC to create a large and/or sophisticated franchisee exemption. The rationale for such an exemption is amplified in many co-branding arrangements. The size, experience and sophistication of many types of franchisees that purchase franchises in today's economy — from huge multinational corporations that operate co-branded sites, to franchisors that seek co-branding relationships, to multiple unit operators in franchise systems, and even to single unit franchisors with experience in the system — strongly suggest that slavish adherence to disclosure rules is unnecessary for many franchisees and is a burden to franchisors. For example, a large prospective co-branding host ranchisee may have more information regarding the economics of integrating a new business into a co-brand operation than the entrant franchisor that is seeking this sophisticated franchisee as its co-brand partner. We believe that the benefit from creating rules that will permit co-branding to be explored in diverse and creative methods will relieve franchisors of the burden of unnecessary disclosure. Further, new rules will not result in harm to the public interest nor harm to individual prospective franchisees if they do not receive a disclosure document, because these are franchisees with experience and for whom additional disclosure may be of little value.

Finally, many master franchise or subfranchise deals between an entrant franchisor and a host franchisor are heavily negotiated arrangements between two experienced franchisors who do not need a franchise offering circular describing the other's franchise system. Under the FTC Rule, disclosure of the proposed subfranchise will be required. We recommend that the FTC exempt from disclosure these arrangements if the master franchisee/subfranchisor is an experienced franchisor or multiple unit operator.

VI. SUMMARY

While not the direct focus of the ANPR and our comments, it should not be overlooked that many co-branding arrangements between two franchise systems begin with an agreement between the two systems that sets forth the parameters of the proposed co-branding arrangements. This master — or "umbrella" — agreement may contain specific development obligations of the two systems; include mutually agreed-upon forms of co-brand franchise agreements and/or addenda that will be offered to the franchisees; address issues of exclusivity and encroachment; describe operational issues such as shared or joint advertising between the systems, compatibility of point-of-sale and computer systems, and delegation of field inspection responsibilities; and set forth other responsibilities that are necessary for a successful collaborative co-branding alliance. This umbrella agreement (as well as the planning and negotiations of the two systems) lays the foundation for a strong co-branding alliance, and may be as or more important than franchise disclosure issues in contributing to the success or failure of the venture.

Co-branding has evolved as a result of business pressures and consumer demands. Franchisors and franchisees are continually searching for the right formula and right mix in a dynamic business environment, and it is too early to determine where co-branding will be tomorrow. The FTC should make every effort to encourage this process, and should be sensitive to the possibility that the process could be stifled through unnecessary and costly regulation, especially in the absence of clear evidence of fraud, abuse, or consumer injury.

Recognizing where we stand today on the co-branding timeline, we suggest the following:

1. The current UFOC Guidelines provide sufficient disclosure of co-branded franchises, particularly if franchisors carefully consider the application of the UFOC Guidelines to the co-branded franchise, and diligently adhere to the disclosure requirements; additional or different disclosure rules for co-branded franchises are not necessary. If the FTC determines that disclosures applicable only to co-branded franchises are desirable, any new disclosure obligations should permit information regarding diverse co-branding arrangements to be disclosed in appropriate, and possibly varying, ways.

2. The FTC should consider adopting an exemption for test agreements, expanding upon its existing fractional franchise exemption, clarifying its definition of "control and assistance," and adopting a large and/or sophisticated franchisee exemption, so that more offers of co-branded franchises may be exempt or excluded from the FTC Rule.

* * *

We hope that the foregoing comments are helpful to you. We would be pleased to provide additional information, and/or participate in any FTC hearings on the subject, if you so desire.

Very truly yours,

RUDNICK, WOLFE, EPSTIEN & ZEIDMAN

By:

Mark A. Kirsch

Enclosure

1. We will address the disclosure rules under the UFOC Guidelines because they have been accepted by the FTC, and most franchisors follow the UFOC Guidelines in preparing offering circulars.

2. Section 4.36.2(h) defines "fractional franchise" as "any relationship … in which the person described therein as a franchisee, or any of the current directors or executive officers thereof, has been in the type of business represented by the franchise relationship for more than two years and the parties anticipated, or should have anticipated, at the time the agreement establishing the franchise relationship was reached, that the sales arising from the relationship would represent no more than 20% of the sales and dollar volume of the franchisee."

For Review, see FTC “Table of Commenters”
http://www.ftc.gov/bcp/franchise/comments/tabcomm.htm


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Risks: F.T.C. Public Comments, United States, 1997, Co-branding, United States, 19970725 Comment 98

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