The frightening geographic reach of New York franchise law

The rationale for this broad reach is to maintain New York’s reputation as an international financial center and to protect the state from becoming a home base for fraud.  But by making a few simple changes, New York can change a frightening franchise law that discourages business into one that  actually attracts business while preserving the state’s reputation as a financial center and maintaining its ability to combat fraud.

Unnecessary Burdens Discourage Business

The NYFA requires a franchisor in a transaction with the slightest connection to New York to prepare a franchise disclosure document and register in New York.  Failure to do so exposes the franchisor to a possible allegation of noncompliance if there is a falling out between the parties.

New York’s overly broad definition of a franchise amplifies the problem.  In addition to its expansive geographic scope, the NYFA applies to a wide range of transactions that no other state would define as a franchise.

The legal costs of analyzing the potential application of the NYFA to a shockingly wide range of business transactions can be significant.  The legal uncertainty over whether the franchise law applies to transactions both within and outside the state discourages companies from locating in New York.

The NYFA also applies to international sales.  Not even the Federal Trade Commission regulates franchise sales abroad.

It makes little sense for a company offering franchises outside the U.S. to prepare a franchise disclosure document for that offering.  International transactions are specific to the destination country.  Countries have different languages, laws, cultures and marketplaces.  The dollar figures disclosed in a U.S. document will don’t work in a foreign context.  The foreign franchisee or master franchisee is likely to be experienced and the transaction is always negotiated.

Why does the NYFA apply beyond the borders of New York State?  David Kaufmann explained in an article in the New York Law Journal of June 26, 2012, that the reason was “to maintain New York’s reputation as the world’s financial marketplace”.  The NYFA protects the state from being “viewed as the home base of fraud” in franchising.

These are laudable goals.  But the same goals can be accomplished in other ways without adverse effects.

The law simply needs to maintain the general antifraud provision in the sale of franchises, the private right of action and the power of the Attorney General’s Office to prosecute offenders.

The additional requirements of registration and disclosure for out-of-state sales are not necessary.  On the contrary, they are an impediment to business.

Finding a Better Approach

Specifically, the goals of maintaining New York’s reputation as the world’s financial marketplace and protecting the state from being viewed as the home base of fraud can be accomplished using any one of the following possible alternative approaches in conjunction with a general antifraud provision, even if the revised law has same geographic scope as the current law:

• Remove the registration requirement altogether.  Oregon takes this approach.
• Require a simple notice filing.  Michigan and Wisconsin take this approach.
• Exempt out-of-state sales.  California takes this approach.
• Exempt just foreign sales.  The NYS Bar Association has endorsed this partial solution in conjunction with a correction in the definition of a franchise and many other changes.

Any of these approaches would:

• simplify and clarify franchise compliance for companies doing business in New York;
• eliminate an unnecessary trap for the unwary; and
• make New York more appealing as a business location.

Any of these approaches would also reduce administrative costs, especially if combined with a change in the definition of a franchise in New York to conform to the definition in all the other states.  Examiners in the New York Attorney General’s Office review franchise disclosure documents in detail and often require changes before the franchise offering is registered.  This full-review registration process costs time and taxpayer money.

A Simple Formula

By making a few changes in the its franchise law, New York can reduce the state’s administrative costs while improving the state’s business climate.  It can do so in a way that preserves its reputation as the world’s financial marketplace and its ability to prosecute locally-based fraud.

The formula is simple.  Continue to empower defrauded franchisees and the Attorney General to bring claims against New York based franchisors that violate the law regardless of the franchisee’s location.  But stop requiring New York based franchisors to prepare disclosure documents and register in New York if none of their franchised businesses will be located in New York.