Gallet Dreyer & Berkey, LLP | Franchise Disclosure Document Gets a New Look
This links to the home page
Media

Franchise Disclosure Document Gets a New Look

July 2019 | By: David T. Azrin, Esq. | GDB 2019 Summer Newsletter
In May 2019, the association of state franchise regulators (known as the North American Securities Administrators Association, or NASAA), issued new rules, effective January 2020, which require franchisors to provide additional written warnings to people considering buying a franchise. 

The new rules require franchisors to include two additional cover pages to the Franchise Disclosure Document given to potential buyers, intended to highlight some of the harsher provisions often contained in franchise agreements which franchisees may overlook.

In a section entitled “What You Need To Know About Franchising Generally,” all franchisors must now disclose concisely that franchise agreements often contain provisions which some might consider unfair, such as the following:
 
  • the franchisee may have to pay royalties even if the business is losing money,
  • the franchise agreement may allow the franchisor to essentially change the terms of the agreement at any time by imposing new operating requirements in the operations manual which may require the franchisee to make additional investments, 
  • the franchisor may require the franchisee to buy certain products or supplies from the franchisor or its designated suppliers at above-market prices,
  • the franchisor might not be obligated to renew the agreement or the franchisor may be allowed to change the terms in the renewal agreement, and
  • the franchise agreement may prohibit the franchisee from staying in the same line of business after the franchise ends. 

These disclosures are required even for franchisors whose agreements do not contain these types of provisions.
In another section, entitled “How to Use this Franchise Disclosure Document,” franchisors must now direct a prospective franchisee to the specific sections of the lengthy disclosure document for answers to some of the most frequently asked questions, such as:
 
  • How much can I earn?
  • How much will I need to invest?
  • Is the franchise system stable, growing, or shrinking? 
  • Does the franchisor have a troubled legal history?, and
  • What is it like to be a franchisee in this system?
 
The new requirements and sample cover pages are available on the NASAA website, at http://www.nasaa.org/industry-resources/corporation-finance/franchise-resources/.

The sale of franchises is already heavily regulated in the United States.  Existing federal and state rules already require franchisors to provide prospective franchise buyers with a lengthy and detailed franchise disclosure document that contains information about, among other things, the franchisor’s background and experience, the franchisor’s litigation history, the required fees, the money the franchisee will need to open the business, the franchisor’s duties to provide assistance including a detailed description of the training program, the restrictions on purchasing products or supplies, a list of every existing franchisee including their contact information, the franchisor’s audited financial statements, and a copy of every agreement the franchisee will be required to sign. The purpose of these regulations is to protect franchisees from what some may consider abusive sales practices. 

The new rules issued by NASAA this year impose additional required upfront disclosures to help ensure that people buying franchises are fully aware of the significant obligations and restrictions which they will be undertaking in becoming a franchisee.