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Why consult with a South Carolina Franchise lawyer?
Many people desire to be their own boss, but without feeling the need to reinvent the wheel. By purchasing a franchise, buyers have the potential for selling goods and services that can have instant name recognition and goodwill and can obtain training and ongoing support from a franchisor to help them succeed.
When buying a franchise, different considerations should be given to the purchase depending on whether the franchise being purchased is newly licensed from the franchisor or an on-going franchise purchased from another franchisee. While the purchase of a new franchise is mostly a matter of doing due diligence to find the right franchise at the right price for the right location (involving primarily the negotiation of the franchise agreement and lease agreement), purchasing an on-going franchise has all the potential traps and complexities that are a part of buying any business and revenue stream. More specifically:
For new franchises:
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- The newer and less established the franchisor is, the greater the likelihood that a franchisee can negotiate better terms in the Franchise Agreement
- UFOC contains 23 Items for disclosure as a part of what is a federally required due diligence/disclosure process which a franchisee should carefully consider and not necessarily take everything at face value
- Potential franchisee is highly encouraged to investigate franchisor by communicating with other franchisees, current or not
- Franchisee will be concerned to ensure that it negotiates terms it will be able to abide by, such as:
- reasonable minimum sales targets and notice and cure periods
- renewal of the agreement with material terms remaining the same as the initial Franchise Agreement
- proper indemnification and hold-harmless provisions, and
- express covenants of good faith and fair dealing
- among other issues and concerns.
For on-going franchises, in addition to issues applicable to stock or asset purchases generally, franchisee should also be mindful to:
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- make sure that the term of any property lease is long enough to ensure franchisee can recover its investment, if much of the goodwill of the franchise is associated with the location and that the terms and conditions of the Lease are acceptable
- make sure that Seller is subject to a covenant not to compete with appropriate time and geographic limits
- make sure that the length of the Franchise Term, including renewal periods, is sufficiently long to allow to profit from your investment
- carefully read transferability restrictions on reselling the franchise or devising ownership interests in the franchise through wills or trusts
- the additional need for approval of the transfer and subjection to certain other rights to the Franchisor with regard to trademarks, quality control, training, and other matters
- payment of a franchise transfer fee (often by the transferring party)
- the need for approval of the assignment of the lease and other contracts with third-parties, and
- limitations of the time left in the franchise fee agreement or lease agreement in which to recover and profit from its investment of time and money.
- Franchisee’s obligations under any Asset Purchase Agreement should be contingent on franchisee securing necessary licensing and governmental approvals, as well as successful completion of its due diligence including receive of a South Carolina Tax Compliance Certificate regarding the seller and county or South Carolina Secretary of State lien search, as applicable.
Brief Guide to South Carolina and Federal Law Relating to the Purchase, Operation, and Sale of a Franchise
This guide provides an overview of the laws governing the purchase, operation, and sale of a franchise in South Carolina, as well as the relevant federal regulations. It covers the key aspects of franchise law, including the Federal Trade Commission (FTC) Franchise Rule, South Carolina’s state-specific requirements, franchise registration, disclosures, the relationship between franchisors and franchisees, and the legal implications surrounding the sale and transfer of franchises.
1. Federal Law Governing Franchises
The Federal Trade Commission (FTC) Franchise Rule
The primary federal law governing the sale and operation of franchises in the United States is the FTC Franchise Rule, which is codified in 16 C.F.R. Part 436. The FTC Franchise Rule requires franchisors to provide prospective franchisees with a detailed Franchise Disclosure Document (FDD) before any franchise agreement is signed or money is exchanged.
Key Provisions of the FTC Franchise Rule
Franchise Disclosure Document (FDD): A franchisor must provide an FDD at least 14 days before the franchise agreement is signed. The FDD contains 23 specific items, including information on the franchisor’s business, financial statements, and the terms and conditions of the franchise.
Item 1 – The Franchisor and Its Predecessors: This section provides background on the franchisor’s business, including its history and corporate structure.
Item 19 – Financial Performance Representations: If the franchisor makes any claims regarding the financial performance of its franchise units, they must include substantiation for those claims.
Regulatory Requirements: The FTC requires that all franchise offerings be registered under state law, unless the state has enacted its own exemption from registration.
Prohibited Practices
Misrepresentation: It is illegal for franchisors to make false or misleading statements to prospective franchisees.
Failure to Disclose: If a franchisor fails to provide the FDD or provides incomplete information, it may face penalties or lawsuits.
Franchise Registration and Exemption
While the FTC mandates disclosure, it does not require franchises to be registered with federal authorities. However, the Franchise Investment Law (FILA) in certain states like California and Illinois does require franchisors to register their FDD with state regulators. If a state does not require registration, franchisors may still be obligated to comply with the FTC Franchise Rule.
2. South Carolina Franchise Law
South Carolina does not have a state-specific franchise registration law like California or Illinois. However, South Carolina has provisions that pertain to franchising under its South Carolina Business Opportunity Sales Act. This is important for franchisors operating in the state, as they must comply with both federal and state regulations.
The South Carolina Business Opportunity Sales Act (BOA)
South Carolina’s Business Opportunity Sales Act, codified at S.C. Code Ann. § 39-57-10 et seq., regulates the sale of franchises and business opportunities in the state. The BOA protects franchisees from fraudulent practices and requires certain disclosures before a franchise agreement is executed.
Key Provisions of the Business Opportunity Sales Act
Disclosure Requirement: Similar to the FTC Franchise Rule, South Carolina requires that franchisors provide a Franchise Disclosure Document to prospective franchisees at least 10 days before any agreement is signed or payment is made.
Franchise Relationship Laws: South Carolina also enforces laws related to the franchise relationship, which govern issues like franchise termination, renewal, and transfer.
State-Specific Franchise Exemptions: The BOA also includes certain exemptions where a franchisor may not need to file the FDD with the state or meet certain disclosure requirements, such as when the franchisee is an experienced investor or has a net worth above a certain threshold.
Termination, Non-Renewal, and Transfer of Franchise Agreements
Under South Carolina law, the termination or non-renewal of a franchise agreement is governed by the South Carolina Franchising Act, codified at S.C. Code Ann. § 39-57-140. This Act prohibits the franchisor from terminating or refusing to renew a franchise agreement without good cause.
Good Cause for Termination or Non-Renewal: Franchisors must prove that termination or non-renewal is based on specific actions, such as franchisee default, failure to comply with the franchise agreement, or breach of contract.
Transfer of Franchise Ownership: Franchise agreements often include provisions that require the franchisor’s approval before a franchisee can transfer or sell their franchise. South Carolina law requires that such transfer provisions must be reasonable and not arbitrarily withheld.
South Carolina Case Law
Case law in South Carolina has helped define the contours of franchise law in the state, especially around the issue of franchisee protection against unfair practices.
In Meadows v. Franchising Enterprises, Inc., 405 S.C. 204 (2014), the South Carolina Supreme Court clarified that a franchisor could be held liable for damages when it wrongfully terminated a franchise agreement without just cause.
3. Franchise Sale and Transfer: Key Considerations
The sale or transfer of a franchise is a complex process that involves various legal considerations, including:
Franchise Sale and Transfer Requirements
Franchise Agreement Terms: Most franchise agreements contain provisions about the sale or transfer of a franchise. These provisions typically include a requirement that the franchisor must approve the buyer and ensure that the buyer meets the necessary qualifications.
Due Diligence: Prospective buyers must conduct due diligence before purchasing a franchise. This includes reviewing the FDD, analyzing the franchisor’s business model, and ensuring that they understand the legal obligations in the franchise agreement.
Right of First Refusal
Many franchisors include a right of first refusal (ROFR) provision in the franchise agreement, which gives the franchisor the option to purchase the franchise before the franchisee sells it to a third party.
South Carolina Case Law on ROFR: In South Carolina Franchisee Assoc. v. Subway, Inc., the court upheld the enforceability of a ROFR provision in a franchise agreement, emphasizing that such terms are standard in franchise law and provide the franchisor with the right to control the sale of a franchise to a third party.
Tax Considerations
When buying or selling a franchise, both parties must consider the tax implications of the transaction.
4. Dispute Resolution and Franchise Litigation
Dispute Resolution Clauses
Franchise agreements typically contain dispute resolution clauses requiring that disputes between the franchisor and franchisee be resolved through arbitration or mediation, rather than through litigation. South Carolina courts generally enforce these clauses, unless they conflict with public policy or state law.
South Carolina Franchise Litigation: In Sam’s Club, Inc. v. Holman, the South Carolina Court of Appeals affirmed the enforceability of an arbitration clause in a franchise agreement, holding that the arbitration process is a valid and enforceable alternative to litigation under South Carolina law.
Franchisee Rights Under South Carolina Law
Franchisees in South Carolina have the right to challenge franchise terminations, non-renewals, and other actions they believe are unlawful. Franchisees can file claims under the South Carolina Unfair Trade Practices Act (SCUTPA), codified at S.C. Code Ann. § 39-5-20, which prohibits unfair or deceptive practices in trade and commerce.
5. Conclusion
Franchise law in South Carolina and the United States is governed by a combination of federal regulations, including the FTC Franchise Rule, and state laws that provide additional protections for franchisees. Key considerations include proper franchise disclosure, franchisee protections regarding terminations and non-renewals, and specific legal requirements related to franchise sale and transfer. Both franchisors and franchisees must ensure compliance with these laws to avoid disputes and potential litigation.
It is advisable for both parties to consult with legal professionals familiar with federal and South Carolina franchise laws to ensure that all requirements are met when purchasing, operating, or selling a franchise.
Key References
FTC Franchise Rule: 16 C.F.R. Part 436.
South Carolina Business Opportunity Sales Act: S.C. Code Ann. § 39-57-10 et seq.
South Carolina Franchising Act: S.C. Code Ann. § 39-57-140.
South Carolina Unfair Trade Practices Act (SCUTPA): S.C. Code Ann. § 39-5-20.
Case Law:
Meadows v. Franchising Enterprises, Inc., 405 S.C. 204 (2014).
South Carolina Franchisee Assoc. v. Subway, Inc..
Sam’s Club, Inc. v. Holman.