Franchise Law: Key Legal Considerations Before You Buy or Sell a Franchise

Buying a franchise is one of the most consequential business decisions you can make. Franchising offers the appeal of a proven business model, recognized brand, and operational support — but the legal relationship between franchisor and franchisee is one of the most one-sided in American commerce. And if you are thinking about franchising your own business, you are taking on significant legal obligations as a franchisor. Whether you are on the buying or selling side of a franchise transaction, understanding franchise law before you sign anything is essential.

What Is a Franchise?

Under federal law and most state franchise statutes, a franchise exists when three elements are present: (1) the franchisee is granted the right to operate a business using the franchisor’s trademark or trade name; (2) the franchisor exerts significant control over the franchisee’s method of operation or provides significant assistance; and (3) the franchisee pays a required fee to the franchisor, directly or indirectly. This definition is intentionally broad. Many business arrangements that the parties do not call a “franchise” — including certain dealerships, license arrangements, and distribution agreements — may qualify as franchises under the law, triggering disclosure obligations and statutory protections.

The FTC Franchise Rule: Federal Disclosure Requirements

The Federal Trade Commission’s Franchise Rule (16 C.F.R. Part 436) requires franchisors to provide prospective franchisees with a Franchise Disclosure Document (FDD) at least 14 calendar days before the franchisee signs any agreement or pays any money. The FDD is a comprehensive pre-sale disclosure document that must follow a prescribed format and cover 23 specific items.

What the FDD Must Disclose

The 23 required FDD items include:

• Item 1: The franchisor’s business background and experience
• Item 2: Business experience of the franchisor’s key executives
• Item 3: Litigation history — any pending or prior lawsuits involving the franchisor or its executives
• Item 4: Bankruptcy history of the franchisor and its principals
• Item 5: Initial fees payable to the franchisor
• Item 6: Other fees — royalties, advertising fees, technology fees, etc.
• Item 7: Estimated initial investment (a chart showing the total cost to open and operate the franchise)
• Item 8: Restrictions on sources of products and services
• Item 9: Franchisee’s obligations under the franchise agreement
• Item 10: Financing arrangements offered by the franchisor
• Item 11: Franchisor’s assistance, advertising, computer systems, and training
• Item 12: Territory — the scope of any exclusive or protected territory granted
• Item 13: Trademarks
• Item 14: Patents, copyrights, and proprietary information
• Item 15: Obligation to participate in the actual operation of the franchise
• Item 16: Restrictions on what the franchisee may sell
• Item 17: Renewal, termination, transfer, and dispute resolution provisions
• Item 18: Public figures associated with the franchise
• Item 19: Financial performance representations (optional, but many franchisors include them)
• Item 20: List of existing and former franchisees — including contact information
• Item 21: Financial statements of the franchisor (three years audited)
• Item 22: Contracts to be signed by the franchisee
• Item 23: Receipt page acknowledging the prospective franchisee received the FDD

The FDD is legally required to be written in plain English. It must be updated annually and whenever there is a material change. The FTC Franchise Rule is a disclosure-only regulation — it does not give franchisees substantive rights or regulate the content of the franchise agreement itself.

State Franchise Laws: Significantly Broader Protections

In addition to the FTC Franchise Rule, approximately 14 states have their own franchise disclosure and registration laws that impose additional requirements. These states — including California, Illinois, Maryland, Minnesota, New York, Virginia, and Washington — require franchisors to register their FDD with a state regulatory agency before offering franchises in the state, and may require approval of the FDD. Registration states give their regulators authority to reject FDDs with unfair or misleading terms and to require amendments before the FDD can be used.

Some states go further with franchise relationship laws that govern the ongoing relationship between franchisor and franchisee, including restrictions on termination, non-renewal, and transfer. States like California, Wisconsin, Iowa, and New Jersey provide franchisees with substantive protections against arbitrary termination and non-renewal — regardless of what the franchise agreement says. These relationship laws can dramatically limit a franchisor’s ability to terminate underperforming franchisees or refuse to renew franchise agreements.

The Franchise Agreement: What Prospective Franchisees Need to Know

The franchise agreement is the definitive legal contract between the franchisor and franchisee. Most franchise agreements are drafted exclusively by franchisors and heavily favor the franchisor. While franchisors will tell prospective franchisees that the agreement is ‘standard’ and non-negotiable, many terms — particularly territory, renewal conditions, and transfer rights — may be negotiable, especially for experienced multi-unit operators.

Initial Term and Renewal

Franchise agreements typically run for 5 to 20 years, with renewal options. Read renewal provisions carefully — many franchisors require franchisees to sign the then-current form of franchise agreement upon renewal, which may contain materially different terms than the original agreement (including higher royalties, updated technology requirements, and revised operational standards). Some agreements give franchisors broad discretion to deny renewal.

Territory

Carefully review whether the franchise agreement grants exclusive territory — and what that exclusivity actually covers. Many franchisors grant protected territory for physical locations but reserve the right to sell through alternative channels (e-commerce, ghost kitchens, third-party delivery platforms) within your territory. Understand exactly what protection you have before you invest in a location.

Fees and Royalties

Beyond the initial franchise fee, most franchisees pay ongoing royalties (typically 4–10% of gross sales), advertising and marketing fund contributions (typically 1–4% of gross sales), technology fees, training fees, and other recurring charges. These fees come off the top of revenue regardless of whether the franchisee is profitable. Model your financial projections carefully using real-world fee structures.

Termination and Cure Rights

Franchise agreements generally give the franchisor broad termination rights. Many agreements allow termination without cure — meaning immediately and without an opportunity to fix the problem — for certain enumerated defaults (bankruptcy, criminal conviction, health violations, abandonment). Other defaults may require a notice and cure period of 30 to 60 days. In states with franchise relationship laws, these contractual termination provisions may be limited by statute.

Transfer Restrictions and Right of First Refusal

If you want to sell your franchise, you will almost certainly need franchisor approval. Most agreements give the franchisor a right of first refusal to purchase the franchise at the same price and terms as an offer from a third party. The franchisor can also require the buyer to meet its standards, complete training, and sign the current form of franchise agreement. Transfer fees are typically assessed. These restrictions can significantly complicate the exit process and reduce the value of your franchise investment.

Post-Termination Obligations

After a franchise agreement ends — whether through expiration, termination, or transfer — franchisees are typically subject to non-competition covenants that prevent them from operating a competing business for one to two years within a defined geographic area. The enforceability of these covenants varies by state. California, for example, will not enforce franchise non-competes at all. In other states, courts will enforce them if they are reasonable in scope, duration, and geography.

Due Diligence Before Buying a Franchise

The FDD provides a road map for due diligence. Before signing, prospective franchisees should:

• Review all 23 FDD items thoroughly with a franchise attorney
• Contact existing and former franchisees listed in Item 20 and ask candid questions about franchisee satisfaction, franchisor support, and whether they would do it again
• Review Item 19 financial performance representations critically — and note that not all franchisors provide them
• Hire a CPA experienced in franchising to review your financial projections and the franchisor’s financial statements
• Research any litigation disclosed in Item 3 to understand the nature and outcome of disputes
• Verify the territory provisions and understand exactly what protection you are getting
• Have a franchise attorney negotiate any available improvements to the franchise agreement before signing
• Talk to your commercial banker about financing — SBA loans are commonly used for franchise purchases

Franchising Your Own Business: What Franchisors Must Do

If you are considering franchising your own business, you are taking on the role of franchisor — which comes with substantial legal obligations and costs. Franchising is not a quick or cheap growth strategy.

Creating the FDD

You must prepare a compliant FDD before offering or selling any franchises. Preparing the FDD requires working with a franchise attorney to draft each of the 23 required items, prepare the franchise agreement and all other contracts to be attached as exhibits, and have three years of audited financial statements prepared by a CPA. The cost of preparing an FDD from scratch — including attorney fees and audit costs — typically ranges from $50,000 to $150,000 or more, depending on complexity.

State Registration

If you plan to offer franchises in any of the 14 registration states, you must register your FDD with the state agency before offering franchises in that state. Registration can take weeks to months and may require amendments to your FDD. Some states — notably California — require franchisors to escrow franchisee fees until certain milestones are met if the franchisor does not meet minimum net worth or performance requirements.

Trademark Registration

A franchise is built around a trademark. Before franchising, ensure your brand name and logo are federally registered with the USPTO. You cannot grant franchisees the right to use your trademark if you do not own it or if it is not registered. Unregistered trademarks create significant legal risk for both the franchisor and franchisees.

Ongoing Compliance Obligations

As a franchisor, you must update your FDD at least annually (within 120 days of your fiscal year end), and within 90 days of any material change. You must maintain records of all FDD deliveries. You must comply with relationship law requirements in states where your franchisees operate. And you must manage the franchisee relationship in a way that maintains the value and standards of your brand across all locations.

Red Flags When Evaluating a Franchise Opportunity

• Pressure to sign quickly or before the 14-day waiting period expires
• Reluctance to provide the FDD or allow you time to review it
• No financial performance representations in Item 19 — or projections that seem unrealistically optimistic
• High franchisee turnover or a large number of former franchisees listed in Item 20
• Significant ongoing litigation disclosed in Item 3
• Franchisor without audited financials, recent bankruptcy, or undisclosed principals
• Vague or minimal territory protection
• Extremely short cure periods or broad termination-without-cure provisions
• Royalties and fees that consume an unrealistic percentage of projected revenue

Conclusion

Franchising can be an excellent business model for the right person in the right system — but it is not a guaranteed path to success, and the legal framework is complex and heavily tilted toward franchisors in most systems. Whether you are a prospective franchisee evaluating an opportunity or an entrepreneur considering franchising your own business, retain an experienced franchise attorney before taking any significant step. The legal investment at the front end is a fraction of the cost of getting it wrong after you have signed a 10-year franchise agreement or begun selling franchises without a compliant FDD.