Most franchisors completed and filed their Franchise Disclosure Documents in the last 10 weeks, and the last thing they will be thinking about is stopping sales to amend that document so soon after renewal. However, under both state and federal law, there is an obligation to amend as material changes occur in the information disclosed in the FDD, and recent events, including COVID-19 and civil unrest, may have created events in your system that require amendment at this time, or could soon require an amendment.
It is not unusual that information contained in the FDD changes during the year. For example, a new lawsuit may be brought against you, or an officer position may change. In some cases, these will not be considered material changes that require an amendment (though the issue is fact specific). However, there are some states that give examples of changes that they, by law, deem material, and that you may not have considered. For example, in Minnesota, and in a handful of other states, the closing of 10% of all franchises, or 10% of all franchises located in that state, is considered a material event that requires an amendment. For a franchisor with 10 or fewer franchises in one of these states, the permanent closing of just one location, whether caused by events outside the franchisor’s control, or otherwise, requires an amendment be made to the FDD. The same is true of the commencement of any new products or services—such as carryout or delivery—if the change requires an additional investment in excess of 20% of the current average investment made by all franchisees. Likewise, the discontinuation of any products or services that represented 20% of the average gross sales of existing franchisees on an annual basis is deemed to be material in Minnesota.
If your system has had any of these changes or has suffered any other material changes in the FDD since filing of your renewal application, you may be required to amend that document at this time, notwithstanding the short time the document has been in use. Under federal law, with one exception to be addressed below, you have until the end of the calendar quarter (so the end of June for a calendar-based franchisor) to make these changes, but under state law the requirement varies from “within 30 days” to “as soon as practicable,” to “immediately” after any material change has occurred.
The exception to the quarterly updating requirements under federal law is for changes in Item 19, which require an amendment be prepared immediately. Some states have questioned whether a significant downturn in sales from 2019 results, which have occurred in many systems as a result of COVID-19, should require an updated disclosure in Item 19. Certainly, if the downturn is expected to be a permanent or long-term downturn, it should be considered material. In the case of a system whose new franchisees may not be open until 2021, a temporary downturn may not be deemed material. This is a fact-specific question that should be examined on a case by case basis. One could also take a risk-adverse position and amend to include results through the first 5 or 6 months of the year, just to avoid any second guessing should the unusual issues facing us all today continue longer than otherwise expected.
The issue of whether material information in an FDD has changed is one that we have always recommended our clients consider at least quarterly. However, in these times where economic and health conditions seem to change weekly, the issue should be at the forefront of every franchisor’s mind—at least for the foreseeable future.