In general, selling and offering a franchise is regulated by state and federal franchise laws. Registering a franchise impacts the sale and offer of a franchise, so it is important to know when registration is required. In Rhode Island, franchisors are required to register before offering and selling franchises. Having to register before offering and selling a franchise can be frustrating for a franchisor because registration can take a long time and be expensive. As a result, franchisors are often stuck waiting for a registration to finalize, when they can be offering and selling their franchise.
Luckily, Rhode Island has several exemptions from registration. These exemptions can be based on the different types of transactions or can be based on the characteristics of franchisors and potential franchisees. If one of these exemptions apply, then franchisors can avoid the registration process and sell their franchise a lot sooner.
The seasoned franchisor exemption is available to franchisors if they meet certain net worth and experience standards. For example, McDonald’s does not have to register in most states because it meets the net worth and experience standards. The net worth standard in Rhode Island is $10 million or the parent company has a net worth of $10 million and guarantees all the franchisor’s obligations. 19 R.I. Gen. Laws Ann. § 19-28.1-6(1). The experience standard requires franchisors to have at least 25 franchisees in 25 separate locations that conduct substantially the same business during the 5 years immediately before the sale. 19 R.I. Gen. Laws Ann. § 19-28.1-6(1).
The large franchisee exemption is available to franchisors when potential franchisees have strong bargaining positions. Potential franchisees must have a net worth of $1 million or individual/joint net worth with a spouse of $200,000 in each of the 2 years before the purchase. 19 R.I. Gen. Laws Ann. § 19-28.1-6(4). Also, potential franchisees must have sufficient knowledge and experience in financial and business matters and be “capable of evaluating the merits and risks of the franchise.” 19 R.I. Gen. Laws Ann. § 19-28.1-6(4).
The fractional franchise exemption is available to franchisors when a franchise is only a small percentage of the potential franchisee’s business. A “fractional franchise” is meant to allow an existing business to add new, but similar products or services. Potential franchisees must have at least 2 years of experience in the established business in which the potential franchisee will become a component. 230-50-10-1 R.I. Code R. § 1.5. Additionally, the franchise must be operated from the same location as the potential franchisee’s existing business. 230-50-10-1 R.I. Code R. § 1.5. The products or services offered must be substantially similar to the existing products or services offered by the franchise. 230-50-10-1 R.I. Code R. § 1.5. Franchisors and potential franchisees must anticipate that sales from the franchise will not be more than 20% of the total sales of the potential franchisee in the first year. 230-50-10-1 R.I. Code R. § 1.5. Lastly, franchisors must not control potential franchisees. 230-50-10-1 R.I. Code R. § 1.5.
The insider exemption is available to franchisors if potential franchisees are already associated with franchisors. The idea is that “insiders” are knowledgeable about the franchise business, so Rhode Island is less concerned about sophistication or experience issues. “Insiders” are generally partners, executive officers, directors, or managers. Potential franchisees must have been an officer, director, partner, or affiliate of the franchisor for at least 2 years and the offer or sale must be made for the potential franchisee’s own benefit. 19 R.I. Gen. Laws Ann. § 19-28.1-6(3).
The sale to existing franchisee exemption is available to franchisors when an additional franchise is sold to a current franchisee. The sale of an additional franchise must be “substantially the same” as the franchise that the potential franchisee has operated for at least 2 years. 19 R.I. Gen. Laws Ann. § 19-28.1-6(5).
The renewal of an existing franchise agreement exemption is available to franchisors that already have agreements with potential franchisees. Rhode Island only requires that there be no interruption in the operation of the business and no material change in the relationship. 19 R.I. Gen. Laws Ann. § 19-28.1-6(6).
The sale by existing franchisee exemption is available to franchisors when the franchisor is not involved in the sale. In other words, the sale cannot be affected by or through the franchisor, but the franchisor may reserve a right to approve or disapprove the current franchisee’s choice of the new franchisee. 19 R.I. Gen. Laws Ann. § 19-28.1-6(2).
The leased departments exemption is available to franchisors when a business is operated on the franchisor’s premises and is incidental to the franchisor’s business. In Rhode Island, a sale or offer is exempt if the sale of goods or services at a retail outlet are located within or adjacent to a retail establishment, but the potential franchisee is not required to purchase goods or services from the retail establishment. 19 R.I. Gen. Laws Ann. § 19-28.1-6(9).
The sales by executors, trustees, etc. exemption is available to franchisors when a transaction is made by judicial officers. For example, transactions by an executor, administrator, sheriff, marshal, receiver, trustee in bankruptcy, guardian, or conservator are exempt. 19 R.I. Gen. Laws Ann. § 19-28.1-6(7).
The out of state franchise exemption is available to franchisors when a state allows them to sell outside the state to non-residents. There are four requirements in Rhode Island. First, the potential franchisee must not be a resident of Rhode Island. Second, the franchise business cannot be operated wholly or partly in the state. Third, the offer or sale cannot violate federal law or the law where the franchise business is operated. Fourth, the potential franchisee cannot be present in the state during the offer or sale. 19 R.I. Gen. Laws Ann. § 19-28.1-7.
An exemption by order depends on a couple of things. The director may exempt a transaction that is not necessary or appropriate in the public interest or for the protection of potential franchisees. 19 R.I. Gen. Laws Ann. § 19-28.1-6(10).
Aside from these exemptions, certain transactions are definitionally excluded. If a transaction is excluded, then registration is not required. In Rhode Island, nominal fees are excluded.
The nominal franchise fee exclusion is available to franchisors when annual franchise fees are only nominal. For example, in Rhode Island, the franchise fee cannot be more than $500. 19 R.I. Gen. Laws Ann. § 19-28.1-3(7).
Again, if an exemption applies, franchisors can skip the registration process. Keep in mind that these exemptions are specific to Rhode Island and can be very different than federal exemptions. Additionally, there are some Rhode Island exemptions that may impact disclosures, but not registration, and vice versa. Thus, it is important to consider how federal and state exemptions interact with each other when registering, selling, and offering a franchise.