Annual FDD Updates
For most franchisors the start of the calendar year is the time to start thinking about annual updates to the franchise disclosure document (“FDD”).
The annual FDD update is a time to:
- Make all required updates; and
- Make any substantive changes to the system and contracts between the franchisor and franchisee.
Federal law requires the disclosure document to updated within at least 120 days of the fiscal year end. Please note, updates required by changes during the year are beyond the scope of this blog.
Top 5 Required Annual FDD Updates
The disclosure document contains a series of important disclosures for business and legal compliance. Many of these must be updated on an annual basis.
Earnings Claims
Validation is king when it comes to selling franchises. Franchisors prove they have validated the underlying business system by making an earnings claim in Item 19 of the disclosure document. There are a number of different ways to present an earnings claim.
Franchisors need to update Item 19 each year with up-to-date information and ensure they have proper written substantiation of their earnings claims. The truth and accuracy of the information, along with the manner of presentation is vitally important.
Most franchisor and franchisee lawsuits arise from Item 19 claims.
Opened and Closed Franchised Locations
Franchisors track information on the number of open and closed locations within five tables contained in Item 20 of the FDD. They also disclose the contact information for existing franchisees and those that recently left the system. Each table and their attachments must be current as of the past recent year end.
Company Locations
Franchisors track company owned and franchisee owned locations separately. Company owned locations often include locations owned by affiliates, leadership, and the franchisor. Understanding what counts as a company location and disclosing appropriately is important.
You should discuss all location types with your franchise attorney as disclosure obligations typically extend beyond those under the official trademark. For example, if an owners operate a similar business under a different name, they may need to be disclosed in Item 1 and Item 20.
Franchised Locations
Each year franchisors update information about their existing franchisees. The tables track new outlets, transfers, changes to existing outlets, and projections for future outlets.
Its important that franchisors track any separations or exits from the system to ensure they are tracked properly. One mistake some franchisors make is that they do not document when each outlet opens for business.
Item 20 tracks new outlets by open date, so you must ensure good record keeping throughout the year.
Litigation
Many disputes involving the franchisor, its affiliates, or leadership have to be disclosed in Item 3 of the FDD. This list must be updated annual and as time lapses, some disclosures may fall off the FDD. Disclosure obligations often play a part in how franchisors resolve disputes.
Fees and Discounts
Franchisors list their current franchise fee in Item 5, along with any discounts. When discounts are offered, franchisors are to disclose the range of fees collected in the prior year. It is also important to ensure the figures in Item 5 and Item 6 are current. If you want to increase fees, updating Item 6 is essential.
If you have a national marketing fund, you will also need to make certain disclosures about the use of these funds later in the disclosure document.
Estimated Investment
The cost of operating a business can vary greatly from year to year. Its important to obtain reporting from new franchisees to track how much franchisors are spending to open a new location.
This estimate goes in Item 7 and should be updated annually. Although it is just an estimate, misrepresentations can lead to lawsuits and disputes. This is particularly true if the franchisor opens locations or is aware of the costs incurred by franchisees being higher than the estimates and fails to update the Item 7 figures.
Other Potential FDD Updates
There are other items to update for each year, and the update process presents the best time for franchisors to institute new changes.
Franchisors typically avoid changes during the year because they do not want to “go dark” in franchise registration states.
Since these registrations must be renewed annually regardless of updates to the system, the annual renewal is the perfect time to make changes in the system, processes, fees, and contract terms.
The law and technology are constantly evolving. Also, franchisors learn from their mistakes (and the mistakes of others) and institute corrections in their disclosures and contracts. The annual renewal is the perfect time to make improvements.
Meet the Author
Derek A. Colvin
Derek is a graduate of Penn State Law and Old Dominion University. He started his legal career in 2009 as a prosecuting attorney before entering private practice.
Derek currently serves business clients as a partner at Waldrop & Colvin, the law department for your business. His practice focuses on SMB client legal services and franchise law.
Derek is laser-focused on delivering efficient and effective solutions for business legal needs. As a seasoned litigator and experienced business attorney set on thinking critically and communicating effectively, Derek is well-suited to advise and protect your business.
Derek often serves as outside general counsel providing transactional support for business owners. He represents SMB independent owners, as well as franchisors, and franchisees as a franchise attorney.
Primary Practice Areas: Franchising | Franchise Law (Franchisor Legal Support & Franchisee Legal Support), SMB Mergers & Acquisitions, Entity Formation and Governance, Lease Negotiations, Trademark Registration, Dispute Resolution and Civil Litigation & Outside General Counsel Support
