It will soon be that time of year when we will be working with our franchisor clients to prepare the required year-end updates to their Franchise Disclosure Document and file state registration renewal applications.
If you are a franchisor with a December 31 year end, hopefully you have already contacted your auditor about starting the audit process and are gathering information to prepare for the FDD update process that must be completed within the next couple of months.
As was the case in 2020, the registration renewal season this year will likely look different than in years prior to 2020. Many state regulators continue to work remotely (as are we) and, in most states, online filing options are either highly encouraged or required.
Based on comments from state regulators during the annual American Bar Association Forum on Franchising annual franchise law seminar in October 2020 (this year held virtually) and other forums, we anticipate some greater scrutiny by state regulators in reviewing Franchise Disclosure Documents relating to the ongoing pandemic and how it has impacted the franchise systems that are submitting registration applications.
Due to the COVID-19 pandemic, the state franchise examiners are likely going to be looking at the following issues in reviewing updated FDDs submitted with the franchise registration renewal applications:
- Operational changes (i.e., different methods of providing products and services, new safety measures, paring down of products and services offered) that have been implemented into the franchise system due to the COVID-19 pandemic and whether all related disclosures or revisions to existing disclosures have been made.
- Whether there have been negative changes in the franchisor’s financial condition that may give rise to the imposition of financial assurance requirements.
- Whether a material number of franchise units have closed in the last year.
- Whether special sales incentives are being offered and if so, whether all required disclosures have been made.
State franchise examiners will also be giving consideration to the timing of material changes that occurred, especially negative material changes, and may raise questions about whether the franchisor should have filed an amendment during the registration year to reflect these changes i.e., a material number of unit closings, negative change in financial condition). A determination by a state franchise examiner that a franchisor should have amended the state registration earlier in the year may give rise to fines and/or required offers of rescission to franchises sold during that period.
We expect the state franchise examiners to especially give greater scrutiny to the financial performance representations presented in Item 19 of the Franchise Disclosure Document. The examiner will be asking questions about whether the franchisor has a reasonable basis to include the data presented based on the impact that the COVID-19 pandemic has had on the franchise businesses in 2020 and may continue to have on the franchise businesses in the coming year. Without reasonable basis, a franchisor is not permitted to include financial performance representations in Item 19.
Depending on the franchise system and the impact that the COVID-19 pandemic has had on it, possible options for Item 19 may include:
- including a financial performance representation that shows lower performance in 2020 but includes facts (not disclaimers) about how the COVID-19 pandemic impacted the business;
- not including a financial performance representation in 2021, either because financial performance worsened in 2020 or because the data from 2020 was inflated from typical experience due to the COVID-19 pandemic,
- including data for both 2019 and 2020.
As franchisors prepare for the annual FDD update and state renewal process, they should not view the updating requirements under franchise law as merely an administrative process of updating state registrations, but view it as a time to confirm that all FDD disclosures are accurate and complete and that all material changes since the last filing are reflected in the updated FDD. This is also an opportune time to implement franchise program changes that require new or amended disclosures in the Franchise Disclosure Document.
Contact the attorneys at Huck Bouma for assistance in updating your franchise legal documents or renewing your state franchise registrations in 2021.