The Life of A Franchise Disclosure Document
Franchisors offer and sell franchise opportunities through disclosure of the then-current Franchise Disclosure Document (“FDD”). Each FDD has a limited life cycle and it is important that franchisors understand when their FDD expires. Franchisors must also understand how to handle the expiration of state franchise registration.
When Does My FDD Expire?
Under the federal Franchise Rule, every FDD expires 120 days after the end of the franchisor’s fiscal year end. If you follow a calendar year, this means the FDD expires April 30 of each year (or April 29 during leap years). If you do not follow a calendar year, the expiration date will be based on your actual fiscal year end. When the FDD expires, it cannot be used in any state.
This 120 day rule applies in all states and to all franchisors; however, other occurrences may also require the FDD to be updated. Further, state registration requirements must be taken into account when applicable.
It is vital that franchisors understand each circumstances requiring an updated FDD and properly adhere to state and federal requirements.
Update Required Annually
Every FDD is updated on an annual basis because of the 120 day rule. An annual update is the bear minimum, which all franchisors must adhere to. Annual updates are required because prospects should be provided with current information when making an investment decision. The annual updates often include:
- All material changes the franchisor wants to implement in the FDD and Franchise Agreement.
- Updated Item 2 information (lawsuits and actions filed).
- Updated Item 7 data (the estimated initial investment).
- Updated Item 11 data (training, manual, use of marketing funds, etc.)
- Updated Item 19 data (the financial performance representation).
- Updated Item 20 data (franchised and company outlets).
- The current financial audit report.
Franchisors typically use the annual update as a time to make systemwide changes because implementing material changes during the year can result in a sales blackout period. Meaning, franchises cannot be sold until the change is implement and approved in any registrations states. Maintaining an ongoing relationship with a franchise attorney is essential.
Update Required on Occurrence of Material Change
Franchisors have an ongoing obligation to provide up-to-date information. Therefore, the FDD must be updated upon the occurrence of any material event or change in material circumstance. What is a material change?
A ‘Material Change’ is a fact, circumstance, or condition that is likely to effect a prospective franchisee’s decision to purchase a franchise opportunity. The FTC’s compliance guide lists a few absolutes, like a bankruptcy filing or a lawsuit that may adversely effect the franchisors finances, adverse changes franchisors financial stability, and changes to the financial performance of franchised or company owned outlets. Certain states have passed laws defining the occurrence of certain events as always being material.
Examples of material changes include:
- A lawsuit against the franchisor
- A bankruptcy filing
- A change in the franchisor’s ownership
- A challenge to the franchisors trademark
- Changes in the franchisor’s executive or management team
- Changes to the initial or ongoing fees charged to franchisees
- Changes to the initial investment estimate required to launch a franchised business
- Changes to the franchisor’s financial information
- Changes to the franchisee’s earnings potential
This list is non-exhaustive and will vary by circumstance. A material change determination requires a legal analysis to ensure adherence to federal and state laws.
When Do Material Change Updates Have to be Made to the FDD?
The FTC’s Franchise Rule requires quarterly updates. However, certain Registration States also require a franchisor to update its FDD in response to material change. In many instances, the timeframe to update the FDD and submit amendment filings (as applicable) in the event of a material change at the state level is much shorter than the federal quarterly requirement. In some states, updates are required on occurrence.
expiration in franchise registration states
An indispensable part of franchising is an understanding of how states regulate franchises. While the FTC Franchise Rule applies in all states, each state can also supplement federal requirements. This means that franchisors must have permission to offer franchises and must adhere to certain rules in some states. A description and list of state franchise laws can be found here.
The Registration States require a franchisor to update its FDD and submit a franchise registration each year. If the renewal application is not filed in a timely fashion, a franchisor’s registration will lapse, and all sales activity in the state must cease. This is commonly referred to as “going dark.” If a franchisor goes dark, then it must once again file an initial franchise registration application with the state. Compared to renewal applications, initial franchise registration applications generally cost more money and may take longer to become effective.
Likewise, franchisors must submit a post-effective amendment application upon the occurrence of any material change and should “go dark” until approved. Again, the law varies by state and circumstance.
Disclosing the Updated FDD
Under Federal Law
Compliance with federal and state disclosure laws can be tricky. We provide a general overview of federal franchise laws and disclosure obligations here.
Generally speaking, Franchisors must always disclose their then-current disclosure document. Under the Franchise Rule, the franchisor may not technically be required to furnish the newly issued FDD to previously disclosed prospects, unless the prospective franchisee makes a “reasonable request”. However, best practices is to re-disclose all pending prospective franchisees and wait an additional 14 calendar days (or longer time required by state law) before accepting any fees or a signed franchise agreement.
Prospects should be aware of any material changes and have access to up-to-date disclosures. Also, franchisors typically improve their disclosure documents and contracts as time goes on in response to the occurrence of certain events.
In Franchise Registration States
Seasoned franchisors know that the timeline for franchise registration and renewal can be unpredictable. Mitigating risk and managing compliance can be a challenge. Again, an understanding of state franchise laws is essentially. The most conservative approach is for franchisors is to stop offering and selling franchises while their renewal and amendment applications are pending with the Registration States. Some states have provided specific instructions for franchisors to follow while updates are pending, but there are certain risks and strict adherence is required.
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