FTC’s New Business Opportunity Rule: Reduced Disclosure But Increased Coverage
Effective March 1, 2012, the FTC’s new business opportunity rule1 became effective. The new business opportunity rule significantly reduces a business opportunity seller’s disclosure obligation to a prospective purchaser, as the previous format (the FTC disclosure statement containing 20 items of required information) has been changed and reduced to a one-page form requiring five items of information that the seller is required to disclose. However, the new business opportunity rule applies to more companies since not only business opportunity sellers currently covered by the interim business opportunity rule will be subject to the new business opportunity rule, but also work-at-home programs, such as jewelry assembly and envelope stuffing, will meet the expanded definition of a business opportunity. While the new business opportunity rule is silent on the subject, this author believes that the new business opportunity rule does not apply to sales made outside of the United States or its territories. For Florida sellers of business opportunities and out-of-state sellers of business opportunities to Florida residents, the new business opportunity rule does not preempt compliance with the Florida Sales of Business Opportunities Act and requires the filing of an FTC business opportunity disclosure document and a Florida business opportunity disclosure document.
Companies Subject to the New Business Opportunity Rule
The definition of a “business opportunity” under the new business opportunity rule involves a commercial arrangement that includes the following three required elements:
1) The seller must solicit a prospective purchaser to enter into a new business (one in which the prospective purchaser is not currently engaged or a new line or type of business).
2) The purchaser must make a “required payment,” that is, all consideration paid by the purchaser to the seller or an affiliate as a condition to obtaining or commencing the operation of the business opportunity. There remains the exception for payments for the purchase of a reasonable amount of inventory at bona fide wholesale prices for resale or lease.
3) The seller must represent that the seller or a designated person (such as a locator or lead generating company) will provide any of three types of assistance: a) providing locations for the purchaser’s use or operation of equipment, displays, vending machines, or similar devices that the purchaser controls; b) providing outlets, accounts, or customers to the purchaser; or c) buying back any of the goods or services that the purchaser makes, including providing payment for such services, such as stuffing envelopes from home or jewelry assembly.
The new business opportunity rule continues to apply to those types of business opportunities covered by the interim business opportunity rule, including vending machines, rack displays (such as greeting cards), pay phones, and Internet kiosks. However, the definition of a business opportunity has been expanded to include work-at-home schemes and has eliminated the definitional element of the “payment of $500 or more on or before the first [six] months of operations” that was a required element of a “business opportunity venture” under the interim business opportunity rule. The new business opportunity rule exempts franchisors covered by the FTC franchise rule as well as multi-level marketing (MLM) arrangements.
FTC Business Opportunity Disclosure Document
The new business opportunity rule requires the business opportunity seller to provide to a prospective purchaser a one-page written disclosure document and certain attachments containing five items of information (FTC business opportunity disclosure document) at least seven calendar days (instead of the previous 10 business days) before a prospective purchaser may sign any documents or pay any money to the seller.2
The FTC business opportunity disclosure document must include the following:
1) Information Regarding Seller — The seller’s identifying information including name, business address, telephone number, the name of the salesperson offering the business opportunity, and the date when the FTC business opportunity disclosure document was furnished to the purchaser.
2) Earnings Claim — Whether the seller makes an earning claim. The seller is not obligated to make an earning claim and can check the “no” box. However, if the seller does make an earnings claim, the seller must check the “yes” box and provide the purchaser with a separate earnings claim statement titled “Earnings Claim Statement Required by Law,” setting forth a) the name of the person making the earnings claim; b) the date of the earnings claim; c) the actual earnings claim; d) the beginning and ending dates during which the represented earnings were achieved; e) the number and percentage of purchasers who achieved the represented level of earnings; f) any characteristics that distinguish purchasers who have achieved the represented level of earnings from those characteristics of the prospective purchasers; and g) other substantiating information.
The seller must have a reasonable basis for the earnings claim at the time the earnings claim is made. The seller can make an earnings claim in the general media, subject to the above requirements. A seller can use industry information only if the seller is able to measure the performance of existing purchasers and document instances in which the existing purchasers’ typical performance equals or exceeds the average performance of other business opportunities available in the industry. The use of a chart, table, or mathematical calculation that demonstrates possible results based on a combination of variables constitutes an earnings claim.
3) Legal Actions — Whether the seller, its affiliates (including a parent or subsidiary), or key personnel (including in a prior business) have been involved in any civil or criminal “legal action” against the seller or its representatives (any sales manager, individual who occupies a position or performs a function similar to an officer, director, or sales manager of the seller) within the past 10 years that “involve fraud, misrepresentation, securities law violations, or deceptive or unfair practices including violation of any FTC rule.” This includes matters in arbitration or governmental actions. If there is any such legal action, the seller must include a separate page setting forth the full caption of each action and may choose to include a brief (not to exceed 100 words) description of the action. Bankruptcy filings do not have to be disclosed.
4) Cancellations or Refunds — The seller’s cancellation or refund policies, if any. The new business opportunity rule does not give a purchaser a post-sale right to rescind. If the seller does not have a cancellation or refund policy, it will mark the “no” box. If the seller has a cancellation or refund policy, it will mark the “yes” box and attach a separate page describing the material terms of the seller’s cancellation or refund policy. This includes the period of time the purchaser has to cancel a purchase or request a refund, the specific steps necessary to cancel a purchase or request a refund, any fees or penalties incurred for cancellation, and where unused inventory must be returned to and by what method.
5) List of Purchasers — A list of the 10 purchasers of the business opportunity closest to the prospective purchaser’s home, or in the alternative, a list of all purchasers during the last three years. The list must include only the prior purchasers’ name, states (not addresses), and telephone numbers.
The seller does not file the FTC business opportunity disclosure document with the FTC, and the FTC does not approve it. The seller has the burden of proving compliance with the new business opportunity rule. As discussed further below, the new business opportunity rule does not preempt (eliminate) state business opportunity laws. A seller cannot include disclosures required by state law in the FTC business opportunity disclosure document. If a seller is subject to both the new business opportunity rule and a state’s business opportunity law, it must prepare and provide the purchaser with both disclosure documents. The seller is required to attach a duplicate copy of the FTC business opportunity disclosure document and any attachments, which is to be signed and dated by the purchaser. The seller can send the FTC business opportunity disclosure document to the purchaser electronically, and the purchaser’s electronic or digital signature is allowed. A new requirement provides that if the seller conducts sales of its business opportunities in languages other than in English, the FTC business opportunity disclosure document must be in the same language.
Updating the FTC Business Opportunity Disclosure Document
The FTC business opportunity disclosure document must be updated quarterly (January 1, April 1, July 1, and October 1). If the seller has fewer than 10 purchasers, the seller must update the list of purchasers monthly until the seller has at least 10 purchasers. If there has been a material change in an earnings claim given to a prospective purchaser before he or she purchases the business opportunity, the seller must disclose the material change to the prospective purchaser before finalizing the purchase.
Prohibitions
The seller is subject to the following prohibitions:
1) Disclaiming or requiring a prospective purchaser to waive reliance on any statement made in any document including the FTC business opportunity disclosure document or attachment that is required or permitted to be disclosed by the new business opportunity rule;
2) Making any representation, whether orally, visually, or in writing, that is inconsistent with or contradicts any statement in the FTC business opportunity disclosure document, earnings claim statement, or other attachment;
3) Including any extraneous materials in the business opportunity disclosure document;
4) Making a false earnings claim;
5) Stating that any law or regulation prohibits the seller from making an earnings claim or disclosing the list of purchasers;
6) Failing to provide written substantiation of the earnings claim upon the purchaser’s or the FTC’s request;
7) Misrepresenting how or when commissions, bonuses, incentives, premiums, or other payments from the seller to the purchaser will be calculated or distributed;
8) Misrepresenting costs, performance, efficacy, or material characteristics of the business opportunity;
9) Misrepresenting the seller’s post-sale assistance to the purchaser;
10) Misrepresenting locations, outlets, accounts, or customers;
11) Misrepresenting the seller’s cancellation or refund policy;
12) Failing to provide a refund or cancellation when a refund or cancellation right is given and requested by the purchaser;
13) Misrepresenting the business opportunity as an employment opportunity;
14) Misrepresenting the exclusivity of territories;
15) Assigning a purported exclusive territory to another purchaser;
16) Misrepresenting third-party endorsements or other affiliation;
17) Misrepresenting references, including using shills or signers; and
18) Failing to disclose any consideration paid to a reference or prior purchaser or the personal relationship with a reference or a prior purchaser.
Record Retention
The seller and its principals must retain the following five types of records for at least three years: 1) each materially different FTC business opportunity disclosure document and attachments; 2) each purchaser’s disclosure receipt; 3) each signed written contract with the purchaser; 4) each oral or written cancellation or refund request received from a purchaser; and 5) all substantiation upon which the seller relies from the time the earnings claim is made.
Penalties for Failure to Comply
A person’s failure to comply with the new business opportunity rule will constitute a violation of §5 of the FTC act, thereby entitling the FTC to bring an action. Although there is no private right of action for violation of the new business opportunity rule, a failure to comply with the new business opportunity rule may also violate a state’s unfair and deceptive practices law and give rise to a private right of action by the purchaser. This may entitle the purchaser to various remedies, which may include rescission of the transaction and a suit for damages, including court costs and attorneys’ fees.
State Business Opportunity Laws
The new business opportunity rule does not preempt (replace) state business opportunity laws, except to the extent of any conflict with the new business opportunity rule. This article contains only a brief summary of state business opportunity laws, except for the Florida Sales of Business Opportunities Act,3 discussed further below.
Currently, 25 states regulate business opportunities or seller-assisted marketing plans (the business opportunity states).4 Since these state business opportunity laws afford equal or greater protection and require more extensive disclosure than required by the new business opportunity rule, the seller must also comply with these states’ business opportunity laws. A state’s business opportunity law may apply if 1) the seller is located in a business opportunity state; 2) the seller advertises in, or offers a business opportunity in, a business opportunity state; 3) the purchaser is a resident of the business opportunity state; or 4) the purchaser intends to operate the business opportunity in a business opportunity state. Unlike the new FTC business opportunity rule, the business opportunity states have a minimum dollar investment threshold ranging from $200 to $500 that may enable sellers to avoid their application if the required payment amount is below the threshold.
In addition, the definition of a business opportunity under state law may be more extensive than the definition of a business opportunity under the new business opportunity rule. There are several different types of business opportunities covered by state business opportunities laws, including: 1) sellers of vending machines, racks, display cases, and currency-operated amusement machines that provide locations or location assistance; 2) sellers that buy back the items that the purchaser produces, grows, fabricates, or assembles; 3) sellers that guarantee in writing that the purchaser will derive income; 4) sellers that provide the purchaser with a sales or marketing program; and 5) sellers that represent to the purchaser the existence of a market for the goods or services.
These laws generally require, among other things, the preparation of a disclosure document that must be given to a prospective purchaser for presale review between 48 hours and 10 business days before the purchaser can sign any contact with the seller or give the seller any money. Most of these states also require the registration and approval of the business opportunity offering by a state regulatory body.
The business opportunity rule does not require the seller to disclose its financial condition (or to have a minimum net worth requirement). The business opportunity states may require such disclosure. Some business opportunity states require all business opportunity sellers to post a security bond. Some business opportunity states prohibit the seller from taking the entire purchase price before delivering the items to the purchaser. California, Michigan, and South Carolina require that the seller appoint a person or company located in that state, other than a governmental official, to act as a registered agent to receive service of process. Certain business opportunity states require either salespersons to register or the seller to provide a list of salespersons. A number of business opportunity states require that all advertising materials directed toward prospective purchasers, including advertisements intended to appear in publications located in that state, be filed with the state as part of the registration process. Certain business opportunity states require sellers to provide a post-sale right to cancel. Most business opportunity states require the seller’s contract to provide that the items purchased as part of the business opportunity be delivered within a specified time ( e.g., 45 days). Otherwise, the purchaser has a right to cancel the contract.
As a result, sellers of business opportunities operating in the business opportunity states will need two types of disclosure statements: 1) the FTC business opportunity disclosure document and 2) a state-specific disclosure document. Sellers operating in multiple states may need even more forms of state-specific disclosure documents.
Florida Sales of Business Opportunities Act
Under the Florida Sale of Business Opportunities Act,5 a “business opportunity” is defined as the sale or lease of any products, equipment, supplies, or services to enable a purchaser to start a business for an initial price or fee that exceeds $500, and the seller promises that it (or anyone affiliated with or referred by it) will do any one of the following: provide locations, or assist you in finding locations, for the use of vending machines, racks, display cases, or other similar devices, or currency operated amusement machines or devices, on premises that neither the seller or the purchaser owns or leases; buy any of the things the purchaser makes, produces, fabricates, grows, breeds, or modifies using supplies, services, or goods sold to the purchaser; guarantee in writing that the purchaser will earn income exceeding the price or rent paid by the purchaser; refund all or part of the price or rent paid; repurchase any of the products, equipment, supplies, or goods supplied by seller, if the purchaser is unsatisfied; or provide a sales or marketing program enabling the purchaser to earn income.
Excluded from the definition of “business opportunities” are the sale of ongoing businesses with some conditions, the not-for-profit sale of sales demonstration equipment, materials, or samples for a price that does not exceed $500; any sales training course offered by the seller that does not exceed $500; the sale or lease of laundry and dry cleaning equipment; certain franchise offerings; and sales or marketing programs accompanied by the licensing of a registered trademark.
If you are a seller of business opportunities and you are located in Florida, an out-of-state seller selling business opportunities to a Florida resident, or the business opportunity will be located in Florida, the Florida Sales of Business Opportunities Act applies. The disclosure document required by Florida for a business opportunity is not regulated by federal law and contains more information than the information disclosed by the FTC new business opportunity rule. The seller must give the Florida business opportunity disclosure document to the prospective purchaser at least three working days before the purchaser can sign any contract with the seller or give the seller any money.
The Florida business opportunity disclosure document must include:6
1) The name of the seller; whether the seller is doing business as an individual, partnership, corporation, or other business entity; the names under which the seller has done business; and the name of any parent or affiliated company that will engage in business transactions with the purchasers or who take responsibility for statements made by the seller.
2) The names, addresses, and titles of the seller’s officers, directors, trustees, general partners, general managers, and principal executives and of any other persons charged with the responsibility for the seller’s business activities relating to the sale of business opportunities.
3) The length of time the seller has a) sold business opportunities; or b) sold business opportunities involving the products, equipment, supplies, or services currently being offered to the purchaser.
4) A full and detailed description of the actual services that the business opportunity seller undertakes to perform for the purchaser.
5) A copy of a current (not older than 13 months) financial statement of the seller, updated to reflect material changes in the seller’s financial condition. This financial statement does not have to be prepared or audited by a certified public accountant.
6) If the seller promises training to the purchaser, a complete description of the training, the length of the training, and the cost or incidental expenses of that training, which cost or expense the purchaser will be required to incur.
7) If the seller promises services to be performed in connection with the placement of the equipment, product, or supplies at a location, the full nature of those services, as well as the nature of the agreements to be made with the owners or managers of the location where the purchaser’s equipment, product, or supplies will be placed.
8) If the business opportunity seller is required to secure a bond, guaranteed letter of credit, or certificate of deposit pursuant to §559.807, either of the following statements is required: a) “As required by Florida law, the seller has secured a bond issued by _______________, a surety company authorized to do business in this state. Before signing a contract to purchase this business opportunity, you should confirm the bond’s status with the surety company.”; or b) “As required by Florida law, the seller has established a guaranteed letter of credit or certificate of deposit (number of account) with (name and address of bank or savings institution). Before signing a contract to purchase this business opportunity, you should confirm with the bank or savings institution the current status of the guaranteed letter of credit or certificate of deposit.”
9) The following statement is required: “If the seller fails to deliver the product, equipment, or supplies necessary to begin substantial operation of the business within 45 days of the delivery date stated in your contract, you may notify the seller in writing and cancel your contract.”
10) If the seller makes any statement concerning sales or earnings or a range of sales or earnings that may be made through this business opportunity, a statement is required disclosing: a) total number of purchasers of business opportunities involving the product, equipment, supplies, or services being offered who have actually achieved sales of or received earnings in the amount or range specified within three years prior to the date of the disclosure statement; b) total number of purchasers of business opportunities involving the product, equipment, supplies, or services offered within three years prior to the date of the disclosure statement.
11) Information regarding a) total number of persons who purchased the business opportunity being offered by the seller within the past three years; b) the names, addresses, and telephone numbers of the 10 persons who previously purchased the business opportunity from the seller and who are geographically closest to the potential purchaser.
12) A statement disclosing who, if any, of the persons listed in subsections one and two:
a) Has at any time during the previous 10 fiscal years, regardless of adjudication, been convicted of, or found guilty of, or pled guilty or nolo contendere to, or has been incarcerated within the last 10 years as a result of having previously been convicted of, or found guilty of, or pled guilty or nolo contendere to, a felony or a crime involving fraud, theft, larceny, violation of any franchise or business opportunity law or unfair or deceptive practices law, embezzlement, fraudulent conversion, misappropriation of property, or restraint of trade.
b) Has at any time during the previous seven fiscal years been held liable in a civil action resulting in a final judgment or has settled out of court any civil action or is a party to any civil action involving allegations of fraud (including violation of any franchise or business opportunity law or unfair or deceptive practices law), embezzlement, fraudulent conversion, misappropriation of property, or restraint of trade or any civil action which was brought by a present or former franchisee or franchisees and which involves or involved the franchise relationship. However, only material individual civil actions need be so listed pursuant to this paragraph, including any group of civil actions which, irrespective of the materiality of any single such action, in the aggregate is material.
c) Is subject to any currently effective state or federal agency or court injunctive or restrictive order, or has been subject to any administrative action in which an order by a governmental agency was rendered, or is a party to a proceeding currently pending in which such order is sought, relating to or affecting business opportunities activities or the business opportunity seller-purchaser relationship or involving fraud (including violation of any franchise or business opportunity law or unfair or deceptive practices law), embezzlement, fraudulent conversion, misappropriation of property, or restraint of trade. Such statement shall set forth the identity and location of the court or agency; the date of conviction, judgment, or decision; the penalty imposed; the damages assessed; the terms of settlement or the terms of the order; and the date, nature, and issuer of each such order or ruling. A business opportunity seller may include a summary opinion of counsel as to any pending litigation, but only if counsel’s consent to the use of such opinion is included in the disclosure statement.
13) A statement disclosing who, if any, of the persons listed in subsections one and two at any time during the previous seven fiscal years has a) filed in bankruptcy; b) been adjudged bankrupt; c) been reorganized due to insolvency; d) been a principal, director, executive officer, or partner of any other person that has so filed or was so adjudged or reorganized during or within one year after the period that such person held such position in relation to such other person. If so, the name and location of the person having so filed or having been so adjudged or reorganized, the date thereof, and any other material facts relating thereto shall be set forth.
14) A copy of the written business opportunity contract that the seller uses as a matter of course and presented to the purchaser for signing. The contract must contain a) the terms of payment; b) a full and detailed description of the acts or services that the seller is to perform for the purchaser; c) the seller’s principal business address; d) the name and address of its agent in the State of Florida who is authorized to accept service of process; and e) the approximate delivery date of products and supplies which the seller is to deliver to the purchaser.7
Conclusion
On and after March 1, 2012, those companies complying with the interim business opportunity rule ceased use of the FTC disclosure statement format and instead began to use the FTC business opportunity disclosure document, and otherwise comply with the new business opportunity rule, for all sales within the United States and its territories. In Florida, there is a problem created with the new FTC business opportunity law.
Historically, many multistate business opportunity sellers that met the definition of a “business opportunity venture” under the old FTC franchise rule filed an FTC disclosure statement with the Florida Department of Agriculture and Consumer Services in lieu of the state-mandated disclosure statement based on the last paragraph of F.S. §559.803:
Should any seller of business opportunities prepare a disclosure statement pursuant to 16 C.F.R. ss. 436.1 et seq., a Trade Regulation Rule of the Federal Trade Commission regarding Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures, the seller may file that disclosure statement in lieu of the document required pursuant to this section. Should the seller be required pursuant to 16 C.F.R. to prepare any other documents to be presented to the prospective purchaser, those documents shall also be filed with the department.
The new FTC business opportunity rule is contained in 16 C.F.R. Part 437. The rule’s disclosure requirements are far less extensive than required by Florida law. I doubt that the new FTC business opportunity disclosure document, which must be filed with the Florida Department of Agriculture and Consumer Services, will be treated as a Florida business opportunity disclosure document because it fails to satisfy Florida’s disclosure requirements; thus, a Florida business opportunity disclosure document must also be prepared and filed.
Companies that market and sell products or services to persons to enable the person to start a business should consult their counsel to see if their business arrangements now meet the three elements of a business opportunity under the new FTC business opportunity rule and/or the five elements of the business opportunity under the Florida Sales of Business Opportunities Act.
1 See FTC Press Release (Nov. 22, 2011); 12 C.F.R Part 437.
2 Appendix A to 12 C.F.R. Part 437 (English version) and Appendix B to 12 C.F.R. Part 437 (Spanish version).
3 Fla. Stat. 559, Part IX.
4 Alaska, California, Connecticut, Florida, Georgia, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maine, Maryland, Michigan, Minnesota, Nebraska, New Hampshire, North Carolina, Ohio, Oklahoma, South Carolina, South Dakota, Texas, Utah, Virginia, and Washington.
5 Fla. Stat. §559.801(a)(1).
6 Fla. Stat. §559.803.
7 Fla. Stat. §559.811.
Keith J. Kanouse is an attorney concentrating in franchising, business opportunity sales, distributorships/dealerships, and licensing law.
This column is submitted on behalf of the Business Law Section, Mindy Mora, chair, and Melanie E. Damian and Peter F. Valori, editors.
A version of this article was published in the February 2012 issue of the ABA’s Business Law Today , and is reprinted with permission.
