Ten Tips for Franchisors This FDD Renewal Season

Seyfarth Shaw LLP

Federal law requires franchisors to update their franchise disclosure documents (“FDD”) within 120 days after their fiscal year end (“FYE”).  State registrations must also be renewed annually.  Here are ten best practices for franchisors to consider as they gear up to update their FDDs to help ensure that their franchise agreement and FDD are up to date and there is no interruption in franchise sales activities.

1. Develop and follow a FDD process timeline to ensure all activities leading up to the final FDD are completed timely. A sample is attached here.

2. Do a Strategic Review of current franchise agreement, FDD, and operations manual to make sure they reflect changes in the law and address current legal issues and trends. Things to consider as part of a 2023 strategic review include:

  • Recent court decisions and legislation such as the California FAST Act, AB 257 and potential  updates to Item 7; the definition of independent contractor; the enforceability of arbitration agreements; and noncompete and non-solicitation provisions.
  • Changes in federal or state law including, for example, digital advertising / marketing, social media, and privacy, non-competes, etc. Also, some states impose income taxes and reporting obligations on out-of-state franchisors.  Make sure you review the law in the states where you sell franchises.
  • The franchisor’s policies regarding Environmental, Social, and Governance (ESG) and Diversity, Equity, and Inclusion (DEI) and whether those policies reflect best practices.
  • Recent FTC or similar updates such as the North American Securities Administrators Association (NASAA) Statement of Policy re: Franchise Questionnaires & Acknowledgments (effective January 1, 2023).

3. Know Your Deadlines. It is a violation of federal and state franchise sales laws for a franchisor to offer or sell franchises with an out-of-date FDD or expired state registration.  Some state registration periods expire earlier than federal law.  For example, Hawaii requires updating and filing by March 31, and California requires updating and filing within 110 days after the FYE.  It is essential to know and docket all deadlines.

4. Contact Your Outside Auditor Early. Item 21 requires updated audits.  Late audits are the primary reason for missed deadlines. Impress upon the auditor that filing deadlines are fixed by law and a late audit can cost you franchise sales.

5. Compile Annual Updates for FDD. Even if the franchisor is not making any program changes requiring modifications to the franchise agreement, all franchisors must update certain FDD information (and franchise seller disclosure forms).  Because this information must be current, franchisors need to compile annual updates.  Examples of information required  to be updated include:

  • Item 1. Number of outlets operated by franchisors and its subsidiaries.
  • Item 2. Changes in key management (directors, officers, and other executives).
  • Items 3. Litigation - changes in the status of pending matters, new cases in which Item 2 individuals are defendants, and franchisor actions initiated against franchisees during the last fiscal year.
  • Item 5. Initial Fees paid by Franchisee - Franchise Fee range, any changes to Initial Fees, number of franchisees who failed to meet financial obligations, etc.
  • Item 6. Other Fees - Royalties, remodeling costs, advertising, etc., and any changes to fees or any new programs.
  • Item 7. Any changes in projected opening costs based on recent experiences.
  • Item 8. Payments from suppliers during the last fiscal year, any new restrictions on sources of products, updates about officers who own an interest in recommended or mandatory suppliers, amount spent on advertising, revenues from franchisees' required purchases and/or leases and percentage of total revenues and total revenue amount.
  • Item 11. Percentage breakdown on advertising fees used during the last fiscal year.
  • Item 13. Updates about trademarks and known infringers.
  • Item 16. Any new restrictions on what the franchisee may sell?
  • Item 19. Financial Performance Representations (“FPR”) (more detail on FPRs below).
  • Item 20. Franchise statistics and corresponding lists of existing franchise outlets and recent terminations, updates to Franchise Owners Association information, if applicable, etc.
  • Item 22. All proposed agreements regarding the franchise offering, including the franchise agreement and any lease, options, and purchase agreements.  Review all  contracts franchisees are required to sign to assess continuing enforceability. Update provisions based on recent court decisions or changes in the law.

6. Communicate with Franchise Sales and Operations Team. Let your franchise sales and operations teams know about impending deadlines so that all needed information is received timely and any pending franchise sales and sales activities can be coordinated and, if possible, completed ahead of time.  Review new business developments, policies, initiatives and, if necessary, set up a call/meeting with business stakeholders to ensure any items are understood fully and can be properly disclosed.

7. Item 19:  Update or Reconsider. If a franchisor makes an Item 19 FPR, it should be reevaluated based on fiscal year results.  FPRs are a common target for unhappy franchisees, so it is important to make sure the FPR is not only accurate but explains all of the bases and assumptions for the FPR.  If the latest data is not rosy, consider omitting the FPR from the updated FDD, but with notice and explanation to the sales team.  If the franchisor intends to include an FPR, update the numbers and, if any parameters are changed, include an explanation of all assumptions.  If the current FDD does not include a FPR, but the latest numbers are impressive, consider adding a FPR now since doing so will avoid mid-year material change amendment filings and extra filing fees.  Have your franchise attorney review any FPR.

8. Review IP. The annual update is a good time for franchisors to review its IP portfolio to make sure it has filed applications to protect new logos or brand names, filed the necessary applications to maintain existing trademark registrations, and taken steps to protect patents and copyrights valuable to the franchise system.

9. Review Website Content and Advertising. Consistency between the marketing department and website content of what your FDD says is essential.  Review your website to make sure it is entirely consistent with the terms of your franchise offering.  For example, if there is no FPR in the FDD, the website cannot provide any information to prospective franchisees about historical or potential income, sales, earnings, profits or break-even points.  It is essential to make sure all other forms of advertising used to attract franchise prospects is legally compliant and registered in the states where the franchisor distributes or publishes the advertising.

10. Sales Compliance Refresher Training. Before completing FDD updates, franchisors should schedule refresher training for the franchise sales team and others who interact with prospects during the franchise sales process.  Refresher training should include franchise sales compliance rules and company sales policies.  This is particularly important if you decided to add or remove an FPR.  Use the updated FDD to remind the sales team of the rules of the road.

The number, scope, and complexity of the disclosure issues facing franchisors is unique.  Seyfarth’s franchise team understands these challenges and can help all franchisors navigate these issues to facilitate the FDD renewal and disclosure process.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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