Franchisors Beware! First Court Opinion Interprets the "Large Franchisee Exemption"

Large franchisee exemption

In an Order issued December 19, 2018, by Judge Louis A. Bledsoe, III, Chief Business Court Judge, the North Carolina Business Court has become perhaps the first court in the nation to interpret the Federal Trade Commission’s “Large Franchisee Exemption” (“LFE”). See Window World of Baton Rouge, LLC v. Window World, Inc., No. 15 CVS 1, 2018 WL 6722590, at *1 (N.C. Superior Court, Dec. 19, 2018).

Under the Federal Trade Commission’s “Franchise Disclosure Rule,” at least 14 calendar days prior to signing a binding agreement, a franchisor must provide a prospective franchisee with a Franchise Disclosure Document (“FDD”) that discloses 22 defined items of business information, which is intended to provide the franchisee with material information to assist in making the final decision to purchase the franchise.

The LFE, however, excuses franchisors from having to make such disclosures if the franchisee has been in business at least 5 years and meets certain criteria, including a net worth threshold.

The Court held that if an individual creates a business entity as a franchisee, then the net worth of the individual cannot be considered in determining whether or not the Large Franchisee Exemption applies. Instead, a franchisor may only look to the net worth of the business entity in determining whether or not the Large Franchisee Exemption applies. In other words, a franchisor must look only to the net worth of the business entity that will be the franchisee and cannot consider the circumstances of an otherwise large-net-worth individual, who may have extensive business experience, even though he/she owns and/or controls the business entity franchisee. 

In effect, this ruling gives franchisees the ability to claim they were entitled to receive an FDD from a franchisor if the franchisee business entity was in existence for less than 5 years and/or had assets less than US$5,715,500.00. Failure to provide an FDD could result in claims being brought by a disgruntled or former franchisee.

To our knowledge (and apparently the knowledge of the Court), there are no judicial or administrative decisions interpreting the Large Franchisee Exemption anywhere in the U.S. While this is a North Carolina state court opinion (and, therefore, applies only in North Carolina and is not precedential with respect to U.S. federal causes of action), it is illustrative and could be consulted by other courts throughout the United States. As the first opinion on the subject, it may hold somewhat greater weight.

A franchisor debating whether it needs to provide a Franchise Disclosure Document or whether it qualifies for the Large Franchisee Exemption should be aware of this decision and make careful, specific inquiries concerning a potential franchisee that is a corporation, partnership, or limited liability company, and should not rely on the wealth of the individuals that own or control the business entity.

Please contact Art DeBaugh if you have questions.

About the Author

Arthur J. DeBaugh

Art DeBaugh focuses his practice on trademarks, marketing/advertising/promotions issues, copyrights, and business and corporate matters. 
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