Project Group Issues New Guidelines About Selling Franchises During the Pandemic
Franchisors and state regulators have been struggling with the issue of how franchisors can continue to sell franchises in the midst of the coronavirus pandemic in a way that is not misleading, particularly if their franchise disclosure document (FDD) contains historical information from 2019 about franchisee financial performance which predates the pandemic? While it is not mandatory for franchisors to include any historical financial performance information in the FDD, about one-third of franchisors choose to include such information.
This month, a Project Group of the North American Securities Administrators Association (NASAA) tried to help answer this question by issuing guidelines that are likely to be followed by state regulators in the thirteen states which require franchise registration (including New York, California, Illinois, Washington, and others).
In those guidelines, the Project Group emphasized that not all franchise systems have been impacted in the same way by the pandemic. Certain systems have been negatively impacted in a significant way and may have difficulty recovering, while other systems may have actually experienced an increase in revenues with no expected material modification to operations.
As a result, the Project Group stated, it is impossible to issue a blanket rule for all systems that franchisors can never use historical financial performance information that predates the pandemic. Rather, franchisors and regulators must make a case-by-case determination, based on several factors, including whether the system has been negatively impacted, and how the franchisor has adapted to account for market conditions resulting from the pandemic.
If franchisees in the system have experienced a material drop in revenue due to the pandemic, a franchisor might need to update its FDD to include the more recent financial performance information which reflects the effects of the pandemic. In addition, if a franchisor has decided to significantly change its methods of operations or business model because of the pandemic, such as expanding or starting take-out and delivery services, or limiting the number of customers, the franchisor should not continue to use historical information that does not reflect the effects of those changes.
The guidelines encourage franchise regulators to ask franchisors questions to explain how their historical financial performance information is not misleading in light of the pandemic.
The Project Group also cautioned that franchisors cannot avoid the issue by including a disclaimer that the historical financial information might not be representative of what the prospective franchisee can expect due to the pandemic, or that the franchisor cannot predict how the system will be affected by the pandemic. While such statements may be true, the group stated, such statements violate the prohibition against including disclaimers which suggest to a prospective franchisee that it cannot rely on the information in the FDD. Instead, the franchisor must either provide updated information about revenues reflecting the effect of the pandemic, or the franchisor should not include any historical financial performance information.
Franchisors that use historical revenue information that predates the pandemic in their FDDs should carefully consider whether such information might be considered misleading, and must be prepared to answer regulators’ questions about whether the information might be misleading, in light of the pandemic.