COVID-related restrictions have resulted in many businesses adapting their operations. While most businesses can freely make changes, franchises have to consider how these may affect their Franchise Disclosure Document. Under federal law and most state franchise laws, the FDD must be updated annually. In addition to annual updates, franchisors must amend their FDD if there is a material change to the information in the FDD. In some cases, actions taken by franchisors to address the pandemic may be a material change for these purposes.
Definition of a Material Change
What constitutes a material change varies by state and under federal law, but generally, it is a fact, circumstance, or condition that would have a substantial likelihood of influencing the franchisee’s conduct or decisions. Materiality is determined from the point of view of the franchisee.
The most frequent types of “material changes” that require FDD updates or amendments involve:
- management personnel changes;
- mergers and acquisitions involving the franchisor;
- new litigation or arbitration or significant developments in existing cases;
- changes to the franchise agreement, fees, or franchise program;
- changes in existing franchisees (including unilateral terminations by franchisees); and
- adverse changes in the franchisor’s financial status.
Material Changes Resulting from COVID-19
Many of the 23 items in the FDD have the potential to have been affected by COVID-19. Some examples include:
- Fees and royalties. Franchises may have been severely impacted by COVID-19 financially such that the franchisor may consider reducing fees or royalties to attract new franchisees and support existing ones. This can include modifications to the initial franchise fee as well as any occasional and recurring fees.
- Initial investment. As a result of COVID-19, some businesses may need new inventory and equipment, such as air filtration systems, sanitizing equipment and supplies, plexiglass dividers, etc., which could increase the initial investment amount.
- Mandated suppliers. The franchisor may want franchisees to use its contractors and suppliers for certain products and services needed because of COVID-19 concerns. These must be included in the FDD.
- Training programs. Franchisors may need to provide training and manuals to franchisees on any modifications in how the business operates, such as cleaning procedures, customer interactions, etc.
- Franchisor losses. COVID-19 may have significantly hurt the franchisor’s finances. Substantial quarterly losses or other adverse changes in the franchisor’s financial condition must be reported.
This is not intended to be a complete list but does indicate the wide range of actions that may impact the FDD. If you are a franchisor and may have made material changes in the last few months, contact Lusthaus Law to discuss your situation.