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Tuesday
Nov292011

Franchise Law – 23 Items of the Franchise Disclosure Document (Part 2 of 2)

Business Litigation Attorney EncinoFranchise & Business Litigation Attorney

 

by David Gurnick
818.907.3285

This is the second of a two part blog on the Franchise Disclosure Document, or FDD.  Anyone who offers or sells a franchise in the United States must prepare an FDD and present it to their prospective franchisees.

A prospective franchisee must receive the FDD at least fourteen (14) days before any agreement is signed, or before the franchisor receives any consideration relating to the sale of the franchise.

The FDD contains information about the franchisor, its history, management personnel, litigation, terms and obligations of the franchise and other key aspects about the franchise that an investor should know.

The first 12 points of the FDD are explained in: Franchise Law – 23 Items of the Franchise Disclosure Document (Part 1 of 2). Items 13-23 are discussed below.

13. Trademarks.

One of the defining elements of every franchise is the existence of a trademark that the franchisor permits the franchisee to use, and that the franchisee uses to identify the business.

In this disclosure the franchisor identifies its principal trademarks, provides details as to their registration status in the United States Patent and Trademark Office and the trademark office of any state, and discloses if there have been any infringements of the trademark.

14. Patents, Copyrights and Proprietary Information

In addition to trademarks, most franchise systems also claim to own trade secrets. In a few systems, the franchisor claims to own valuable copyrights or patents that are licensed to the franchisee. Information on trade secrets, copyrights and patents is disclosed in this disclosure item.

15. Obligation To Participate In The Operation of the Franchise Business.

Often, an individual or couple buys and actively operates their franchise. It is common to see the owner behind the counter of a Subway sandwich shop, or local gas station, or in the management office of a franchised hotel. Franchisors prefer this and sometimes require that the franchisee actively participate in operation of the business.

Some franchisees acquire multiple units. When that occurs, the franchisee cannot possibly be in all locations at once. Sometimes investors buy franchises, planning to hire others to run them.  This item discloses the extent that the franchisor requires the franchisee to actively participate in operating the business or will allow the franchisee to be absent or passive with the franchise operated by others.

16. Restrictions On What The Franchisee May Sell.

All McDonalds sell hamburgers, fries and shakes. Imagine if some locations also sold tacos, burritos and enchiladas, and other locations sold spaghetti, ravioli and macaroni, and still others sold chop suey and won ton soup. Soon the public would be confused about the system’s products.

To maintain uniformity between locations, franchisors set limits on the products and services that their franchisees may sell. This disclosure item summarizes those limits.

17. Renewal, Termination, Transfer and Dispute Resolution.

At its core, a franchise is a license that permits a franchisee to do business using the system and identity and know-how of the franchisor. Because franchises involve a sizeable investment, some important considerations in buying a franchise, are the duration of the license, circumstances in which the license could be terminated early, whether it can be renewed and any restrictions on the franchisee’s ability to transfer the franchise to someone else.

This disclosure item is a table that identifies and summarizes key provisions of the franchise agreement on these and related subjects.

18. Public Figures.

In the 1970s franchisors often enlisted famous people to endorse their business and lend their names and reputation to the process of offering and selling franchises. Typically, these famous people were getting paid, but that was not disclosed to naive franchisee investors. Therefore, the FDD is required to disclose whether any famous people are involved in offering and selling franchises, and summarize their compensation for doing so.

19. Earnings Claims.

A question that many potential franchisees ask is “how much money will I earn?” By presenting selective data, or even manipulating numbers, the answer to this question could potentially be overly positive, or even misleading.

The FDD permits a franchisor to present information on the past financial results and even future projections. But they must be accurate, have a reasonable basis, and be accompanied by certain disclaimers specified in the disclosure rules. Any such earnings claims are contained in this item of the FDD.

20. List of Outlets.

The franchisor is required to attach a list of locations, with names and contact information for the owner of each franchise.  A list of ex-franchisees who recently left the system must also be attached.  This information assists a prospective franchisee who may wish to contact and interview some existing and former franchisees to hear and evaluate their satisfaction with the franchise system.

22. Financial Statements

A franchisor is required to provide its audited financial statements for the past three years. This is useful for the prospective franchisee to evaluate the franchisor’s financial performance and financial condition.

22. Contracts.

A copy of each contract to be entered into, must be attached as an exhibit to the FDD. This provides the potential franchisee an opportunity to review the actual contracts before they are entered into.

23. Receipt.

The last item of the FDD is a receipt. Two copies of the receipt are attached to the FDD. One copy is to be signed by the recipient of the FDD and returned to the franchisor. The recipient may keep the other copy.

The franchisor is required to present the FDD to the prospective franchisee at least 14 days before any agreement is entered into and any consideration is paid. The receipt, when signed and dated to acknowledge receipt of the FDD, provides the franchisor a record confirming that this requirement was satisfied.

Franchise Law in the United States

The FDD is a useful tool for prospective franchisees in evaluating a franchise being offered. Even though the categories of information are uniform, each company’s FDD differs from each other company, and a particular company’s FDD will differ from year-to-year.

This article has summarized the contents of the FDD’s 23 disclosure items, but the discussion is only a summary. The detailed regulatory instructions for preparing the FDD include various additional subjects and requirements within the above categories.

David Gurnick is a franchise law attorney and author of two books, Distribution Law of the United States and Franchise Depositions, both available through Juris Publishing, Inc.  Mr. Gurnick is certified as a specialist in Franchising and Distribution Law by the State Bar of California, Board of Legal Specialization. You may reach him at Lewitt Hackman: 818.990.2120 or dgurnick@lewitthackman.com.

 

 

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