Disclosing financial performance representations in franchise disclosure documents during the COVID-19 pandemic
Many franchisors, as required by the Federal Trade Commission (FTC) Franchise Rule and applicable state franchise laws, updated their Franchise Disclosure Document (FDD) in the spring of 2020. Those FDDs included information from the franchisor’s previous fiscal year, which, in most cases, ended on Dec. 31, 2019. Many franchisors included financial performance representations (FPRs) in Item 19 of their FDD based on revenue data for franchisee and/or company-owned units from fiscal year 2019, which predated the COVID-19 pandemic.
In response to inquiries from state franchise administrators reviewing FDDs seeking guidance on whether franchisors can make historical FPRs in 2020 because of the impact of shutdown orders that resulted from the COVID-19 pandemic, in June 2020, the Franchise and Business Opportunities Project Group of the North American Securities Administrators Association (NASAA) issued guidance regarding franchisors using historical FPRs in 2020. The NASAA represents state and provincial securities regulators in the United States, Canada and Mexico.
The guidance includes factors franchisors should consider when determining current and future use of historical FPRs, while cautioning that franchisors cannot avoid obligations to update FDDs by including disclaimer language suggesting franchisees should not rely on disclosures that do not reflect the impact of COVID-19.
Under federal and state franchise disclosure laws, a franchisor is permitted to make a historical FPR if the franchisor has a reasonable basis and written substantiation for the representation and the franchisor discloses the material bases for the representation. Under the FTC Franchise Rule, franchisors that have already provided FDDs to prospective franchisees may have to provide updated information, including revised FPRs, to those prospective franchisees to reflect material changes in the information provided.
Under some circumstances, an FPR that discloses historically accurate data may contain an omission of a material fact, or an untrue statement of material fact, if material changes have occurred to that FPR by the time it is provided to a prospective franchisee. Whether a franchisor can make and continue to use a historical FPR in 2020 (and beyond) without amending that disclosure depends on a number of factors, including:
- Whether the franchise business has been significantly impacted by the COVID-19 pandemic
- The type of data the franchisor includes in the FPR
- The reasonable inferences a prospective franchisee can draw from the FPR
- When the franchisor estimates a prospective franchisee can expect to open for business after entering into a franchise agreement
- Whether and how the franchisor adapts the franchise business to account for current market conditions resulting from the COVID-19 pandemic
- Whether and how the franchisor adapts the franchise business to account for future market conditions resulting from the COVID-19 pandemic
Not all franchise businesses have been negatively impacted in a significant way by the COVID-19 pandemic. In fact, some franchise businesses have experienced an increase in revenues with no material modification to the operations of the franchise system. Other franchise systems have experienced reductions in revenues or increased costs because of the pandemic, but those changes may not be material. Franchise systems that have been significantly impacted by the COVID-19 pandemic should consider whether they can continue to make a historical FPR in 2020 that does not include updated disclosure reflecting the impact of the COVID-19 pandemic on the franchise business.
Once a franchisor concludes that it will make changes to its franchise system or business model that will materially impact a historical FPR, the franchisor no longer may include a historical FPR that is not updated to reflect those changes and their impact on the FPR.