The High Cost of Failing to Maintain State Approvals When Franchising
The Offer and Sale of Franchises
The Basics: The Franchise Disclosure Document
Preparing, maintaining, and disclosing a franchise disclosure document (FDD) is the only legal way to offer and sale franchises in the United States.
Each FDD is broken into 23 Items and contains disclosures tailored to the brand and its leadership. The form requirements are established under the Federal Franchise Rule.
Because franchises are regulated on the federal level, the FDD is required in all states.
The Importance of the FDD
For franchisees, the FDD is the blueprint for business decisions. This document allows them to intelligently evaluate the risks and benefits of a franchise opportunity, and make informed investment decisions.
For franchisors, the FDD is a protective shield for the franchise brand. This document not only defines the legal obligations and liabilities of both franchisor and franchisee, but it also provides a clear framework for operational procedures across all franchises.
State Approval in Franchising
The Franchise Rule establishes minimum criteria for offering and selling franchises. States can also establish their own laws, rules and regulations to supplement federal law.
State approval refers to the process of registering and obtaining approval from individual state authorities to offer or sell franchises within that state. These laws vary by state.
Franchisors must:
- Decide where they want to offer and sale franchises
- Determine how state laws will impact the sales process
- Obtain state level authorization when required
Consequences of Offering Franchises in a Regulating State Without Approval
While the Federal Trade Commission (FTC) sets baseline requirements for franchising, there is no private cause of action established under the franchise rule. Franchisors may have to deal with complaints or federal enforcement, but states are typically more active in enforcing their own laws.
These state laws often impose stricter registration and disclosure obligations than the federal rules. They often provide for a structure for criminal, quasi-criminal and civil causes of action.
Failure to comply with them can result in:
- State-Level Financial Penalties. States have the authority to impose fines and penalties on franchisors who fail to comply with state-specific franchise laws which could lead to significant costs that may strain the franchised business’ financial health.
- State-Imposed Legal Actions. Failure to comply with state-specific franchise laws can lead to legal actions from state regulators, including civil lawsuits or enforcement actions that could shut down the franchisor’s operations in a particular state.
- Revocation or Suspension of Registration. A franchise brand’s registration may be revoked or suspended and the franchisor prevented from offering or seeing franchises within a particular state upon determination that it failed to comply with state-specific franchise laws.
- Damaged Reputation and Franchisee Trust. A violation of state-specific franchise laws severely damages a franchise brand’s reputation and leads to a loss of trust among franchisees. This may prompt existing franchisees to exit the system or discourage potential franchisees from entering.
- Limitations on Future Franchise Sales. Repeated non-compliance with state-specific franchise laws may result in the denial of a future franchise registrations or may result in the prohibition on franchise sales within the state, pending resolution of all outstanding violations.
. - Increased Scrutiny. Franchisors who are found to be non-compliant with state-specific franchise laws may face increased scrutiny from other state regulators, leading to more frequent audits, investigations, and potential legal challenges.
State-level franchise laws can carry significant consequences for franchisors who fail to comply with registration and disclosure requirements. Compliance with both federal and state regulations is crucial to avoid legal costs and ensure that a franchise brand can expand and operate legally within a particular jurisdiction.
Example: The Consequences of Violating Virginia Franchise Laws
The Virginia Retail Franchising Act (Act) governs the offer and sale of franchises in Virginia. The goal of the Virginia Retail Franchising Act is to provide presale disclosure and other protections for prospective franchisees.
All franchises offered or sold in Virginia must either be registered or exempt from registration. (§ 13.1-560)
The State Corporation Commission (SCC) is responsible for establishing rules, reviewing and approving applications, and initiating enforcement actions.
Investigation Process
Pursuant to 13.1-567 of the Act, the SCC has the authority to conduct an investigation and demand production of certain documents. Section 13.1-567 provides:
The Commission may make such investigations within or outside of this Commonwealth as it deems necessary to determine whether any person has violated the provisions of this chapter or any order or injunction of the Commission, and any franchisor found guilty of such a violation may be required to pay the actual costs of the investigation including the time of the investigator. The Commission shall have power to issue subpoenas and subpoenas duces tecum to require the attendance of any person and the production of any papers for the purposes of such investigation. No person shall be excused from testifying on the ground that his testimony would tend to incriminate him, but if, after asserting his claim to the privilege, he is required to testify, he shall not be prosecuted or penalized on account of any transactions concerning which he does testify.
Information or documents obtained or prepared by any member, subordinate or employee of the Commission in the course of any examination or investigation conducted pursuant to the provisions of this chapter shall be deemed confidential and shall not be disclosed to the public; provided, however, that nothing contained herein shall be interpreted to prohibit or limit (i) the publication of the findings, decisions, orders, judgments or opinions of the Commission; (ii) the use of any such information or documents in proceedings by or before the Commission or a hearing examiner appointed by the Commission; (iii) the disclosure of any such information or documents to any quasi-governmental entity substantially associated with the retail franchising business approved by rule of the Commission; or, (iv) the disclosure of any such information or documents to any governmental entity approved by rule of the Commission, or to any attorney for the Commonwealth, or to the Attorney General of Virginia.
The consequences of violating the Act can include:
Injunctions
The SCC has the authority to issue a temporary or permanent injunction.
An injunction is a order that requires a party to do or stop doing a specific act to prevent harm or preserve the status quo. It is a form of equitable relief, often used when monetary damages are insufficient.
Violation an injunction is a criminal offense, punishable by fine and imprisonment.
Void Franchise Agreements
Certain violations of the Act make a franchise agreement voidable.
“Voidable” means a contract or legal agreement is valid and enforceable unless and until one party chooses to void it.
If a franchisor violates certain provisions of the Act, a franchisee can simply provide notice that the franchise agreement is void.
Lawsuits + Attorney Fees
Franchisees can have contract and tort claims in any state, but franchise states often create causes of action for violation of their state franchise laws. These laws can provide an easier way for franchisees to file suit and recover.
In Virginia, any franchisee who has declared the franchise void under § 13.1-565 or who has suffered damages by reason of any violation of § 13.1-564 may bring an action against its franchisor to recover the damages sustained by reason thereof.
If successful, the franchisee shall also be entitled to the costs of the action, including reasonable attorney’s fees.
State Imposed fines
The SCC has the authority to impose a civil file of up to $25,000 – per violation.
The Commission may also request the franchisor to rescind any franchise and to make restitution to the franchisee.
Imprisonment for Violations And False Statements
The Act makes violations criminal – meaning, you may go to jail or prison. Certain violations are punishable by up to 10 years in prison. Others are punishable by a minimum of 30 days in jail and up to 1 year in jail.
🚨 Bottom Line: Franchising without proper registration or in violation of state or federal law isn't just risky—it’s illegal.
Whether you’re eager to grow or simply unaware of the rules, skipping compliance can expose you to fines, lawsuits, rescission demands, and long-term brand damage. If you’re unsure whether your franchise offering is compliant, don’t guess.
Consult a franchise attorney and take the time to do it right—because one misstep now can cost you everything later.
