When the fiscal year ends, it is time for franchisors to start the annual process of updating their Franchise Disclosure Document (FDD). Under the Federal Trade Commission (FTC) Rule, franchisors are obligated to update their FDD within 120 days from the end of the franchisor’s fiscal year. (Although their fiscal year is often the same as the calendar year, it need not be.) In addition, some states also require franchisors to renew and update their registration or filing at least annually, although those deadlines may vary from the FTC deadline. While this work can be time-consuming and complex, it can also be the impetus for franchisors to review their business and make modifications. In 2021, the update process has added importance since many businesses may have made or will make changes because of COVID.
Types of Updates Required
There are many items in the FDD that are likely to require updating. Common examples include:
- Item 2 – Company Leadership History. The directors and principal officers of the franchisor may have changed in the prior year which would require that this Item be updated.
- Item 3 – Lawsuits. Certain lawsuits involving the franchisor, its parents, predecessors, affiliates, or leadership team filed in the prior year will have to be included.
- Item 8 – Mandated Suppliers. Franchisors must disclose the prior year’s revenues earned by the franchisor and its affiliates from the sale of products or services to franchisees.
- Item 19 – Historical/Projected Financial Performance. If the franchisor opted to make these representations in the FDD, they need to be updated.
- Item 20 – Number of Units. The charts showing the number of franchised and company owned units for the prior 3 fiscal years must be updated, including the number of outlets opened, terminated, not renewed, reacquired by franchisor, or ceased operations for other reasons; updated contact information for current franchisees and those whose outlet was terminated, cancelled, non-renewed or otherwise ceased operations under the franchise agreement in the prior year; and updated financial statements.
Reviewing Your Franchise Program
Conducting a yearly review of your franchise system is always a good idea, but the requirement of annual updates makes it a necessity. It is important to evaluate what was most/least successful in your business, market changes and future trends. This year, franchisors also have to analyze the impact of COVID. Some franchise systems were hit hard in 2020 and will continue to have issues in 2021. These may need to be reflected in updates to their FDD. For example, changes in suppliers, required equipment, delivery services, contactless payment, menu items, etc. may affect various items in the FDD and require updating.
Franchisors that have already made or experienced changes may need to act quickly to update their FDD or risk liability. In addition to annual updates, franchisors are required to amend their FDD if there is a material change to the information in the FDD. Generally, under federal law, the franchisor must update the FDD with any material changes within a reasonable time following the end of each calendar quarter. However, states may have a different period. Some examples of possible material changes include modifications to franchise fees, initial investment amount, and mandated suppliers. In addition, franchisors must report adverse changes in the franchisor’s financial condition. If franchisors may have experienced a material event, they should speak to an attorney about amending their FDD.
For those contemplating future changes, it is important to consult an attorney to discuss how they will affect the FDD.
If sales are in the pipeline during the annual update period or when a material event has occurred, an attorney is a necessity to advise franchisors regarding providing appropriate documents to prospective franchisees and complying with the applicable waiting period before closing the sale.
Consequences of Failing to Update and Renew Your Franchise
Failure to update the FDD has serious consequences. Franchisors must provide prospective franchisees with a copy of a current FDD or face significant liability. Further, if state renewals are not filed as required, the franchisor must halt all franchise sales and cannot offer to sell franchises in that state until the filings are made. If the state registration expires, some states also require franchisors to refile as though they were a first-time applicant – which may mean paying a higher fee or filing a reinstatement application or equivalent.
There are a wide range of actions that may impact FDD updates as well as strict deadlines that apply. Lusthaus Law has a long history of guiding franchisors through this process. Contact us for help with your franchise.