Isolated Sales Exemption
Companies that are interested in developing a franchise program or offer franchises for sale in or from New York must comply with the New York Franchise Sales Act and the Amended Federal Trade Commission Rule (the “Rule”). The New York Franchise Sales Act requires registration of a franchise disclosure document (“FDD”) prior to the offer of a franchise for sale. Both the New York Franchise Sales Act and the Rule require the disclosure of that FDD to a prospective franchisee prior to the closing of the sale of that franchise.
In limited circumstances under the New York Franchise Sales Act, a franchisor may be exempt from having to register its FDD prior to completing a franchise sale. It is generally understood that disclosure of the FDD to a prospective franchisee is still required under the New York Franchise Sales Act, even when the franchisor is exempt from registration. Although one interpretation of the New York Franchise Sales Act argues that disclosure is not required when the franchisor is exempt from registration, no case has decided that point. Even if the New York Franchise Sales Act exempted a franchisor from having to disclose the FDD to a franchisee, disclosure may nonetheless be required under the Rule. When selling a franchise based on an exemption, the would-be franchisor must carefully analyze both the New York Franchise Sales Act and the Rule.
Of the exemptions available under the New York Franchise Sales Act, the most misunderstood exemption is the Isolated Sales Exemption. The Isolated Sales Exemption permits a franchisor to make a single sale of a franchise in or from New York if certain criteria are met. First, the franchisor cannot make an offer to sell a franchise to more than two people. This requirement would prevent the franchisor from making general solicitations. Instead, the franchisor must carefully target no more than two prospective franchisees. Second, the franchisor may not grant to the franchisee the right to sell franchises to others, which, if permitted, would circumvent this restriction. Third, no commission or payment may be directly or indirectly made to anyone for soliciting a prospective franchisee. This would prohibit the franchisor from using a broker or sale agent in connection with the franchise sale. Fourth, the franchisor must be located in New York or if not, file a consent to service of process with the New York Department of Law. This requirement is a hyper-technical aspect of the New York Franchise Sales Act, but easy enough to satisfy.
It is important to note that nothing in the New York Franchise Sales Act prohibits a franchisor from selling franchises in New York after it has closed a sale based on the Isolated Sales Exemption. The franchisor could sell franchises, but it would need to register its FDD first. Also, the franchisor should be prepared to demonstrate to the New York Attorney General why the first sale was an isolated sale that qualified for exemption from registration.
If a franchisor closes a sale without complying with the New York Franchise Sales Act under the impression that the sale qualifies for the Isolated Sales Exemption and a court determines that the requirements for the exemption were not satisfied, the franchisor may be required to rescind the franchise agreement, pay damages to the franchisee and pay civil penalties.
Any company that seeks to sell a franchise based on the application of the Isolated Sales Exemption would be wise to first consult with a knowledgeable franchise attorney.