Instructions for Updating Disclosures
Franchisors must ensure that their disclosure documents are accurate and up to date. To that end, the amended Rule imposes three basic updating requirements: (1) annual updates; (2) quarterly updates; and (3) notification of changes in financial performance information.
Annual Updating Requirement
After the close of each fiscal year, a franchisor must update its disclosure document to ensure that the document is current. These annual updates, including updated audited financial information, must be prepared within 120 days of the close of the fiscal year. After the 120-day period, the franchisor may use only the updated disclosure document and no other.
Quarterly Updating Requirement
Within a reasonable time after the close of each quarter of the fiscal year, a franchisor must prepare and include in Item 22 an attachment to its disclosure document to reflect any material changes to the information the document contains. Material changes include such events as the recent filing of a bankruptcy petition or the filing against the franchisor of a legal action that may have a negative effect on its financial condition.
Note, however, that several of the disclosure requirements in the amended Rule require only annual updating. For example, the franchisor-initiated litigation disclosures in Item 3 need be updated only once a year. Similarly, the statistical information about franchised outlets (such as changes in ownership over the course of a fiscal year) required by Item 20 need be revised only on an annual basis, as is the case for the disclosure of trademark-specific franchisee associations.
In addition, any financial information required to be audited need not be re-audited for a quarterly update. If there is a material change affecting previously audited financial information, a franchisor may furnish unaudited information in the quarterly update, provided that the franchisor states in the update, in immediate conjunction with the financial information, the fact that the updated financial information has not been audited.
Franchisors are always free to update their disclosure documents more frequently than the Rule requires. For example, if a franchisor furnishes its disclosure document on a website, it could update the disclosures frequently – e.g., monthly – to ensure accuracy. This is not required, but it is permitted if a franchisor wishes to do so. In addition, franchisors may update more frequently if state law requires it. For example, some state laws require immediate updating when a material change occurs.
Each prospective franchisee should receive, at a minimum, the current basic disclosure document and any prior quarterly updates available when the disclosure is made. For example, a prospective franchisee who receives disclosures in August 2008 should receive not only the franchisor’s annually updated 2008 disclosure document, but also any quarterly updates for the quarters ending March 31, 2008, and June 30, 2008.
Relationship Between Annual and Quarterly Updates
Because franchisors have 120 days to prepare their annual updates, it is possible that the annual update requirement and the quarterly update requirement may overlap. For example, a franchisor whose fiscal year coincides with the calendar year may wish to sell franchises after the close of its first quarter at the end of March 2008, but before the 120 days have elapsed that are allowed for completion of its annual update by May 1, 2008. In such circumstances, the franchisor should prepare and furnish a quarterly update to its 2007 disclosure document until such time as preparation of the 2008 annual update is completed. The annual 2008 update must include the first quarterly update, either by incorporating information from the quarterly update into the text, or by attaching the quarterly update as an addendum to the 2008 annual update.
Prospective Franchisee’s Right to Obtain
Updated Disclosures and Any Quarterly Updates
Once a franchisor furnishes its disclosure document to a prospective franchisee, the amended Rule does not obligate the franchisor to make an affirmative offer to provide the most recent annual or quarterly updates of the document to the prospective franchise on an ongoing basis while he or she is still considering the purchase of a franchise. For example, if a franchisor furnishes a disclosure document to a prospective franchisee on December 5, 2008, the franchisor has no obligation to make an affirmative offer to that same prospective franchisee of an updated disclosure document or any quarterly updates prepared in 2009. However, under the amended Rule, prospective franchisees have the right, upon reasonable request before signing the franchise agreement, to obtain the most recent annual update of a franchisor’s disclosure document and any quarterly updates, and it is a violation of the amended Rule for a franchisor to fail to comply with such a request.
When Is a Request “Reasonable”?
Suppose that a prospective franchisee has arranged to sign a franchise agreement in August 2009. That prospect has the right to ask for and receive a copy of the franchisor’s 2009 annual update, as well as any quarterly updates prepared for the quarters ending on March 31, 2009, and June 30, 2009. The prospective franchisee’s request must be “reasonable.” For example, if the franchisor stopped offering franchises at the end of 2008 – after providing the prospective franchisee with its most recent disclosure documents and quarterly updates – it would not be reasonable for the prospective franchisee to ask for a 2009 annual update because the franchisor would no longer be preparing disclosure documents in the ordinary course of its business.
How Long After Updates Before Signing the Franchise Agreement?
Finally, the amended Rule provides that a prospective franchisee can ask for any updates “before the prospective franchisee signs a franchise agreement.” This is to ensure that the prospect has the most current information before signing the franchise agreement. Nevertheless, this does not mean that the franchisor must furnish the requested updates 14 calendar days before the parties sign the agreement. Any reasonable time before execution of the agreement will suffice. It also does not mean that a prospective franchisee may ask for updates repeatedly throughout the sales negotiation process. Rather, the amended Rule contemplates that franchisors need provide the updates only once – a reasonable time before execution of the agreement. It may make good business sense and foster good relations, however, to honor a prospective franchisee’s request for more frequent updates, and nothing in the amended Rule would prohibit that.
Material Changes Relating to Financial Performance Representations
The amended Rule requires that, at the time of furnishing a disclosure document, any franchise seller (including any broker) must notify a prospective franchisee if the seller knows of any material changes relating to a financial performance representation. This obligation arises even if a disclosure document is furnished at a time that falls between quarterly updates. For example, a franchisor may prepare an annual update to its disclosure document that contains an Item 19 financial performance representation. A franchise broker may then furnish that disclosure document to a prospective franchisee on June 1, 2008. If the broker knows of a material change in information underlying the Item 19 representation – such as new survey results that cast doubt on the accuracy of the Item 19 financial performance representation – the broker must notify the prospective franchisee of that fact when furnishing the disclosure document. The term “notify” does not mean furnishing an updated disclosure document all over again. A seller may inform the prospective franchisee of the material change underlying the Item 19 in any reasonable manner, such as by letter, telephone call, or email. Of course, the franchise seller has the burden of proving that such notification was made.
This article is part of a series of articles on starting a franchise in Minnesota.
CREDIT: The content of this post has been copied or adopted from the Federal Trade Commission’s Franchise Rule Compliance Guide.