Guidance Issued on COVID-19’s Impact on Financial Performance Representations (FDD Item 19)

Item 19 of a Franchise Disclosure Document (FDD) gives franchisors the opportunity to provide information as to how much money a prospective franchisee could earn with a franchised business by disclosing certain historical financial performance representations. Franchisors are not required to disclose this information, but without it, franchisors are prohibited from making any written or verbal statement about the sales, potential earnings or other financial information of its franchisees. At a minimum, an Item 19 financial performance representation includes the gross sales for both company-owned and franchise outlets. More complex disclosures may include other financial information such as net profits.

There is no doubt that many franchise systems have been affected by the outbreak of COVID-19 and the resulting shelter-in-place orders (with some states and municipalities still enforcing restrictions). Many franchise systems have been forced to alter their business models and system standards; others have decreased operating hours or closed some outlets altogether. These changes will likely continue and may even become permanent. With these changes, a question that has lingered among many franchise systems is how to address the impact of COVID-19 in an Item 19 disclosure of historical (pre-COVID) financial data, specifically for franchisors’ 2020 FDD, which likely discloses only financial information through the end of 2019.

The North American Securities Administrators Association (NASAA) recently issued guidance on this issue: https://www.nasaa.org/wp-content/uploads/2020/06/FPRs-in-the-time-of-COVID-19.pdf?utm_source=NASAA.org+Updates+%28RSS%29&utm_campaign=2c407f5642-RSS_EMAIL_CAMPAIGN&utm_medium=email&utm_term=0_0835d82b94-2c407f5642-148167001

This guidance includes several factors that franchisors should consider to determine whether they can continue to rely on the disclosed historical financial representations or whether they need to amend their disclosure. The guidance notes that certain anti-fraud provisions prohibit franchisors from making material misrepresentations or omissions and franchisors have an affirmative obligation to update their FDDs with any material changes, including their financial performance representations. The guidance also cautions that franchisors cannot avoid the obligation to include a disclaimer that prospective franchisees should not rely on disclosures that do not address the impact of COVID-19. Finally, the guidance forewarns that franchisors should expect to respond to questions from state examiners (in those states that require registration) regarding how their historical financial representations comply with state and federal requirements.

Certain registration states are also starting to release their own state-specific guidance. The state of Washington, for example, has released similar guidance: https://dfi.wa.gov/sites/default/files/notice-nasaa-fpr-guidance.pdf

Contact Christina Fugate or any member of the Franchise Group if you have questions.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.