Obligation to Update the disclosure document
Updating Documents and Maintaining Compliance
The FDD contains 23 separate items, which contain a serious of disclosures relating to the franchisor, the costs associated with purchasing, opening, and operating a franchised business, and the legal rights and obligations between the franchisor and franchisee. By its very nature, the disclosures and terms change.
The annual update
At minimum, each disclosure document must be updated on an annual basis. This annual update occurs within 120 days of the fiscal year end. The primary reason for this is based on the requirement for franchisors to produce audited financial reports for their fiscal year end. If the fiscal year end is December 31, then the FDD expires on April 30 of each year (except on leap years when it expires April 29). Franchisors often use the annual update as an opportunity to make any substantive changes to its disclosure document and franchise agreement.
Material Change Updates
Under federal law, franchisors are required to prepare quarterly updates to be attached to the FDD disclosing any material changes. There are also certain requirements relating to Item 19 updates, which are found in Section 436.7 of the Franchise Rule. Franchisors should be cognizant that most states that regulate franchising require updates more frequently than every quarter on the occurrence of a material change. Regardless of the deadlines, if a material change occurs, it is vital to update the document quickly to avoid any misrepresentations and to apprise prospects of the new document.
Define 'Material'
What is a material change? The federal rule does not specifically define the term, but the FTC has provided guidance. Essentially, any variation from the current FDD terms that is likely to impact the conduct or decisions of a current or potential franchisee will be material. Additionally, certain states have defined the term or expressly stated that certain acts are material. This is a case-by-case determination, except in obvious cases. For example, it is material if the CEO is replaced. Likewise, it is material if the franchisor raises its fees. It would also be material if the franchisor filed bankruptcy. However, not all changes to the business or the disclosure document are material.
Effect of making updates on State Franchise Registration
Updates to the FDD may require franchisors to obtain state approval before they can resume offering franchises in those states. This depends on how the state regulates franchises. In registration states, an annual registration is required for the annual update and a post-effective amendment filing is required for a material change update. In non-registration states, the new FDD can be disclosed as soon as it is issued by the franchise attorney.