The franchise disclosure document (FDD) annual update season will conclude at the end of this month for many franchisors. For those franchisors whose fiscal years do not coincide with the calendar year, the updating process may be on-going after May 1, 2013 or may not even start until later in the year. In addition, franchisors must in certain cases provide quarterly updates to their FDDs throughout the year. Accordingly, during this time of year, prospective franchisees may receive an FDD that is in the process of being updated and that may not reflect the most current information. This article discusses how prospective franchisees should approach the franchise disclosure process to ensure that they get the most current information if they receive an FDD while an update is pending.
The Requirements for Updating FDDs
The Federal Trade Commission (FTC) requires franchisors to prepare a revised FDD within 120 days after the close of its fiscal year. After that date, the franchisor “may distribute only the revised FDD and no other disclosure document.” According to the FTC, the 120-day deadline “ensures that prospective franchisees receive a disclosure document that is not stale, since many of the required disclosures provide information only for the prior fiscal year.”
The FTC also requires quarterly updates to the FDD to reflect any “material changes” to the disclosures included or required to be included in the FDD. These updates must be made “within a reasonable time after the close of each quarter of the fiscal year.” “Material changes” include events like a recent bankruptcy or a lawsuit that may have a negative effect on the franchisor’s financial condition.
Sometimes the annual and quarterly update requirements may overlap. If a quarterly update is required during the period in which the franchisor is preparing its annual FDD update, the annual update must include the franchisor’s first quarterly update either by incorporating the quarterly update information into the FDD itself or through an addendum to the FDD.
In addition, if a franchisor whose fiscal year is the same as the calendar year wants to sell a franchise after the close of its first quarter on March 31, 2013 but before May 1, 2013 (120 days after the close of the calendar year), the franchisor must prepare and furnish to prospective franchisees any required quarterly updates to the 2012 FDD until the time when the 2013 annual FDD update is ready.
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Moreover, when furnishing an FDD, the franchisor must notify the prospective franchisee of any changes that the franchisor knows or should have known occurred that would materially affect the information contained in any financial performance representations. Item 19 of the FDD permits franchisors to make representations about their actual or forecasted financial performance. In the case of a material change to a financial performance representation, the franchisor notification obligation arises even if the FDD is furnished at a time that falls between quarterly updates. The notification need not be in the form of an updated FDD; the franchisor may inform the prospective franchisee of the Item 19 material change in any reasonable manner such as by letter, telephone call or email.
What to do when the FDD delivered to you is in the process of being updated
There is no “right” time to buy a franchise, but there may be an inconvenient or less than ideal time in terms of receiving fresh disclosure. For example, if you began your quest to become a franchise owner in February, chances are that the FDD the franchisor gave to you has a lot of stale data. The audited financials and information about outlets, lawsuits as well as some of the basic financial terms may be over a year old. But what about the quarterly updates mentioned above? Well, as it turns out, several of the FDD disclosure requirements only mandate annual updating, including information about franchisor-initiated litigation, the statistical information about franchised outlets and trademark-specific franchisee associations. In addition, any financial information required to be audited does not need to be re-audited for a quarterly update, although a franchisor may disclose unaudited information for a quarterly update where there has been a material change affecting previously audited financial information.
Still, there is no reason to delay or accommodate your franchise search based on whether the franchisor is in the process of updating its disclosures. A prospective franchisee is entitled to receive, at a minimum, the current FDD and any prior quarterly updates that are available when the FDD is furnished. Moreover, even where a prospective franchisee received an FDD that may soon be updated and signed a receipt for that FDD, he or she has a right, upon reasonable request before signing the franchise agreement, to get the most recent annual update of a franchisor’s FDD, as well as any quarterly updates. And, it’s a violation of the FTC’s Franchise Rule for a franchisor to fail to comply with that request. The FTC’s only example of what may be an unreasonable update request – the franchisor stopped offering franchises after giving the prospective franchisee the most recent FDD – makes it pretty clear that most update requests will be deemed to be reasonable.
Importantly, there is, of course, nothing that can compel you to sign a franchise agreement, even if you signed a receipt. The receipt is little more than a milestone that marks the beginning of a 14-calendar day “cooling off period” that must run its course before the franchisor may allow you to sign the franchise agreement or pay any money to the franchisor.
Note, though that the franchisor does not need to give you the requested FDD update 14 calendar days before you may sign the franchise agreement; any “reasonable time” before the signing of the franchise agreement will suffice. But again, you are not bound by the franchise agreement until you sign it.
The bottom line is that if you received an FDD while the franchisor was in the process of updating it, you should request all updates before you make any binding commitment to the franchisor. The laws protecting franchisees are largely based on full disclosure and you owe it to yourself to ensure that you receive full and current disclosure. Further, if an updated annual FDD will be issued within a short (days, not weeks or months) period, your best course may be to delay signing the franchise agreement until you receive the updated disclosure. One possible and maybe even likely downside to this tack is that the new FDD and the associated franchise agreement may disclose higher fees or may otherwise provide less favorable terms than the old FDD.
Mike Sheehan is a franchise consultant and franchise attorney. He is the president of Focus Ventures and formerly served as a securities attorney and as general counsel for a Fortune 100 financial services company. His Franchise Focus Blog focuses on helpful information, tips and current news for prospective franchisees.
This article should not be construed as legal advice or a legal opinion on any specific facts or circumstances. The contents are intended for general information purposes only and you are urged to consult your own franchise attorney concerning your own situation and any specific legal questions you may have.
© 2013 Mike Sheehan. All rights reserved.