Item 1 | Franchise Disclosure Documents

Franchisor Disclosures

Item 1: The Franchisor And Any Parents, Predecessors, And Affiliates

Item 1 of the amended Rule requires franchisors to disclose background information on the franchisor and any parents, predecessors, and affiliates. Unlike the UFOC Guidelines instructions for Item 1, the amended Rule does not expressly require a franchisor to refer to itself as “we,” or to use initials, or a one or two-word shorthand form. Nor does the amended Rule require the franchisor to refer to the franchisee as “you.” However, this approach is consistent with the amended Rule’s general requirement that disclosure must be in plain English. Accordingly, franchisors may use such abbreviated references throughout the disclosure document.

Franchisor Disclosures

Like the UFOC Guidelines, Item 1 of the amended Rule calls for identification of the franchisor. The term “franchisor” means any person who both grants a franchise and participates in the franchise relationship post-sale. This includes any subfranchisor that acts as a franchisor, engaging in pre-sale activities and having post-sale performance obligations. Item 1 also requires disclosure of the type of business organization used by the franchisor – whether a corporation, partnership, or any other business organization, such as a limited liability company.

Agent for Service of Process Disclosure

Item 1 also calls for identification of the franchisor’s agent for service of process. Item 1 of the UFOC Guidelines required franchisors to disclose only the address of the franchisor’s agent, but did not specifically require the franchisor to identify the agent. Item 1 of the amended Rule clarifies this point, specifically requiring franchisors both to identify the agent and to state the agent’s principal business address.

Parent Disclosures

Item 1 of the amended Rule differs from the UFOC Guidelines by requiring franchisors to identify any parent companies. Under the amended Rule, a “parent” means “an entity that controls another entity directly, or indirectly though one or more subsidiaries.” The term includes all parents in the chain of ownership, not just the immediate parent-owner of the franchisor, and not just the “ultimate” or “highest” parent in a chain of ownership. Note that Item 1 only requires that franchisors identify parents and provide their principal business addresses. Item 1 does not call for the kind of detailed information about parents that it requires 10 The same time frame should also be used for predecessor disclosures in Item 3 (litigation) and Item 4 (bankruptcy).

Predecessor Disclosures

The amended Rule requires the disclosure of any predecessor during the prior ten-year period immediately preceding the close of the franchisor’s most recent fiscal year.10 The amended Rule defines a predecessor as a person from whom the franchisor acquired, directly or indirectly, the major portion of the franchisor’s assets.

A change in ownership of a franchisor alone does not necessarily mean that the franchisor under the former ownership will be considered the “predecessor” of the franchisor under the new ownership. The former ownership must be disclosed as a predecessor only if the new ownership has acquired the majority of the franchisor’s assets from the former ownership, calculated as of the date of the acquisition of those assets. For example, if on July 1, 2006, Glenmont Mufflers purchased 60% of its assets from Belmont Mufflers, and 40% from various suppliers, then Glenmont Mufflers must list Belmont Mufflers as a predecessor.

Further, implicit in the definition of “predecessor” is the requirement that the franchisor purchased operating assets from the predecessor entity and that the predecessor itself operated or franchised the same or a similar business. In short, the mere purchase by a franchisor of another entity’s assets by itself does not make the selling entity a predecessor. For example, if Belmont buys the assets of a real estate office – such as a building, fixtures, desks, files, and computers – neither the real estate office nor its owners would be a predecessor.

Principal Business Address Disclosure

Item 1 calls for the disclosure of the principal business address of the franchisor, parent, predecessor, and affiliates. The definition of the term “principal business address” is similar to the definition of that term in the UFOC Guidelines. It refers to the physical address of the home office in the United States. The term excludes post office boxes, private mail drops, such as UPS Store private boxes, and email addresses.

Applicable Government Regulations Disclosure

Item 1 calls for the disclosure of any laws that apply to the franchised business specifically. Laws that pertain to all businesses generally – such as child labor laws, local signage restrictions, no-fault liability insurance requirements, business licensing laws, and tax regulations – need not be disclosed, even if those laws have a substantial or disproportionate impact on the business being offered for sale. Only laws that pertain solely and directly to the industry in which the franchised business is a part must be disclosed in Item 1. Examples include the following:

  • A real estate brokerage franchisor would disclose that franchisees are covered by broker licensing laws.
  • An optical products franchisor would disclose that franchisees are covered by applicable optometrist/optician staffing regulations and licensing requirements.
  • A lawn care franchisor would disclose that certain laws regulating pesticide application to residential lawns will require that franchisees post notices on treated lawns.

A legal document preparation service would disclose that the preparation of bankruptcy petitions by non-lawyers is regulated by the U.S. Bankruptcy Code. In any case where industry-specific laws are disclosed, statutory citation and identification are unnecessary. The disclosure should simply state that a specific type of regulation exists and that prospective franchisees should investigate the matter further.

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