Pre-License Fee and Protections Provided by the Franchise Rule

By Joel D. Rosen, Esquire
July 29, 2014

Deciding whether or not to purchase a franchise can be an exciting but stressful time. It can also be complicated with unanticipated pitfalls blocking your path to success. In 1979, in response to these difficulties, the Federal Trade Commission (“FTC”) promulgated the original franchise rule (“Franchise Rule”). The FTC determined that the Franchise Rule was necessary after finding the franchising industry was struggling with misrepresentations and deception on the part of certain franchisors. To combat these concerns, the Franchise Rule mandated disclosures and procedures designed to safeguard the rights of potential franchisees in their pursuit of franchise ownership.

Protections Provided by the Franchise Rule

One such protection under the Franchise Rule is the requirement that a potential franchisee must be given 14 calendar days from the receipt of the franchise disclosure document (previously known as the Uniform Franchise Offering Circular) before being permitted to sign a binding agreement or make any payment to the franchisor in connection with the proposed sale. This document must contain specific information that the FTC has deemed to be essential in the franchise decision-making process. This built-in delay provides the prospective franchisee with guaranteed time to look over the material information contained in the disclosure document so that his/her ultimate decision can be fully informed.

Pre-License Fee to Allow Time for Due Diligence

Sometimes, however, 14 days may not be enough time for a prospective franchisee to conduct adequate due diligence. A franchisee may find that there are still questions to be resolved before he/she feels comfortable signing an agreement or investing money. At the same time, a prospective franchisee may worry that taking additional time will result in a loss of the opportunity if another interested party acts during the due diligence period. Franchisors eager to complete the sale as soon as possible within the constraints of the Franchise Rule have, with increasing frequency, suggested a creative solution to these two concerns. Some franchisors have begun to offer the prospective buyer a “pre-license fee.” This fee is usually some portion of the ultimate license fee, and effectively holds the franchisee’s place at the table while they conduct additional due diligence.

How the Pre-License Fee Favors the Franchisor

While payment of this pre-license fee does not technically violate the Franchise Rule, asking for a nonrefundable deposit in order to have enough time to understand and seek guidance on the franchise disclosure document certainly seems to fly in the face of the intent of the Franchise Rule. The Franchise Rule was intended to ensure that prospective franchisees have the ability to make informed decisions about their significant investment without unnecessary pressure from the franchisor. The 14 days was not meant as the universal time needed to conduct all due diligence, rather it was a minimum standard to build in some protection for prospective franchisees. By requiring money as soon as the 14 day limit imposed by the Franchise Rule expires, a franchisor is forcing a significant commitment from the prospective franchisee. This ensures that at the end of the day the franchisor ends up with cash, whether or not the sale is finalized. This tactic complies with the law as written, but not with its intent.

Franchisee Beware

A franchisor-franchisee relationship is a long-term commitment and a franchisor who is unwilling to give you the time you need to make an informed decision is probably not one you want to begin a relationship with. A good franchisor wants a buyer who has done his/her homework and will provide the time, to a reasonable degree, to do just that.

For more information about franchise law, please contact Joel Rosen at 610-275-0700 or by email at jrosen@highswartz.com.

The information above is general: we recommend that you consult an attorney regarding your specific circumstances. The content of this information is not meant to be considered as legal advice or a substitute for legal representation.