What Are the Key Financial Assurance Mechanisms for Franchises?

Several states have enacted laws to regulate the relationships between franchisors and franchisees. These states are often referred to as “registration states.” Some of these states’ laws seek to protect franchisees who are executing agreements with franchisors that may have limited operations or weak balance sheets. State regulators may require franchisors to meet these “financial assurance” requirements as a condition of registering their franchise. Financial assurance requirements are not uniform across the registration states, with each state taking its own view on whether a franchisor is adequately capitalized. In view of this, franchisors should contact the lawyers at Franchise.Law for guidance on the various financial assurance mechanisms for franchises in the states where their franchisees are located.

From our offices in Charlotte, NC, our lawyers maintain a multi-jurisdictional practice to advise franchisors throughout the United States on laws and regulations, focusing on federal franchise law and multi-state compliance.

What Are the More Common Financial Assurance Mechanisms?

Many states impose key financial assurance mechanisms that protect a franchisee’s initial investment prior to the onset of franchise operations. Those mechanisms might include:

• Requiring the franchisor to purchase a surety bond in an amount equal to or greater than the initial franchise fees
• Holding down payments and certain franchise fees in an escrow account that precludes payment of those fees until certain conditions are met
• Requiring the franchisor to enhance its finances with capital infusions or other investments that provide greater certainty of continuing operations
• Obligating a corporate parent, affiliate, or another third party associated with the franchisor to guarantee its franchise agreement obligations to the franchisee

The attorneys at Franchise.Law could help franchisors determine which mechanisms apply to them in the states where their licensed franchisees operate.

Can a Franchisor Negotiate Less Restrictive Financial Mechanisms?

States embody key financial assurance mechanisms in their franchise laws to prevent out-of-state franchisors from taking advantage of local businesses. States also impose financial stability tests that establish which mechanisms the franchisor must adhere to. The lawyers at Franchise.Law are uniquely qualified to negotiate financial assurance requirements with state regulators. Attorney Jonathan N. Barber, Esq. participated in the legislative process and achieved favorable surety bond terms for franchisors in revisions to the Virginia Retail Franchise Act. Additionally, the attorneys at Franchise.Law are experienced with convincing regulators to reconsider the imposition of financial assurance requirements and with achieving approval of alternative means of financial assurance from regulators.

For example, if a state recommends the purchase of a surety bond, which can be expensive, the franchise’s attorney could use evidence of the franchisor’s strength and financial viability to argue for a deferred-fee option, with initial franchise fees payable a short time after the franchisee commences operations. Franchise attorneys who have experience with all of the registration states, like the attorneys at Franchise.Law, could develop the best negotiation strategy to reduce financial assurance mechanism burdens.

What Are the Penalties for Failure to Comply with Financial Assurance Mechanisms?

If a franchisor is required to meet a financial assurance requirement and fails to do so, they can face significant claims by the affected franchisees and the state regulators. Franchisees can have claims for rescission and restitution against the franchisor. State regulators can impose civil penalties and ban the franchisor from offering and selling franchises in that state. The specific penalties that a franchisor might face for failing to comply with key financial assurance mechanisms vary from state to state.

Additionally, the franchisor will have to disclose any state action in Item 3 of its franchise disclosure document indefinitely, which can have a crippling impact on franchise sales. All of this can be easily avoided by working with a franchise attorney who is experienced with navigating financial assurance requirements.

As with all matters that can affect the validity of a Franchise Disclosure Document, a franchisor can save time and resources by consulting with a knowledgeable franchise attorney at Franchise.Law before state regulators issue stop orders or consider the imposition of fines and other penalties.

Call Franchise.Law To Learn More About Financial Assurance Mechanisms for Franchises

Knowing the key financial assurance mechanisms for franchises is essential for the long-term success of your franchisor operations. With their federal scope and multi-state experience, the attorneys at Franchise.Law could help keep your operations above board and avoid state regulatory problems. Please call our office today to speak with one of our lawyers.