Managing Your FDD's Item 19 in the Time of Covid-19

Managing Your FDD's Item 19 in the Time of Covid-19

By: Lynne Hanson and Niki Vinod Schwab | 6,177 Reads | 13 Shares
Featured in: Franchise Update Magazine: Issue 3, 2020

Managing Your FDD's Item 19 in the Time of Covid-19

%3Cp%3EIn+June+2020%2C+the+North+American+Securities+Administrators+Association+%28NASAA%29+promulgated+new+commentary+regarding+the+inclusion+of+historical+financial+performance+representations+%28FPRs%29+in+Item+19+of+Franchise+Disclosure+Documents+%28FDDs%29%2C+given+the+impacts+of+the+Covid-19+pandemic+on+retail+businesses.+Because+of+state+and+municipal+government+orders%2C+many+businesses+were+required+to+shut+their+doors+to+customers+for+the+better+part+of+March+through+June.+As+a+result%2C+revenue+for+these+businesses+declined+significantly+during+the+second+quarter+of+2020.%3C%2Fp%3E%0D%0A%3Cp%3EAs+required+by+the+Federal+Trade+Commission+%28FTC%29+Franchise+Rule+and+applicable+state+franchise+laws%2C+many+franchisors+updated+their+FDDs+in+the+spring+of+this+year.+Those+FDDs+included+information+from+the+franchisor%26rsquo%3Bs+previous+fiscal+year%2C+which%2C+in+most+cases%2C+ended+on+December+31%2C+2019.+Many+franchisors+included+an+FPR+in+Item+19+of+their+FDD+based+on+revenue+data+for+franchisee+and%2For+company-owned+outlets+from+fiscal+year+2019%2C+which+predated+the+Covid-19+pandemic.%3C%2Fp%3E%0D%0A%3Cp%3EIn+response+to+inquiries+from+state+franchise+regulators+seeking+guidance+on+whether+franchisors+can+make+historical+financial+performance+representations+in+2020+because+of+the+impacts+of+the+shutdown+orders+that+resulted+from+the+Covid-19+pandemic%2C+NASAA+has+provided+the+following+guidance.%26nbsp%3B%3C%2Fp%3E%0D%0A%3Ch2%3E%3Cstrong%3EFranchisors+are+obligated+to+update+all+material+disclosures%2C+including+historical+financial+performance+representations%2C+to+disclose+material+changes%3C%2Fstrong%3E%3C%2Fh2%3E%0D%0A%3Cp%3EUnder+federal+and+state+laws%2C+franchisors+have+long+had+an+affirmative+obligation+to+amend+the+FDD+midyear+to+reflect+material+changes%2C+including+material+changes+in+FPRs.+Although+in+most+FDDs+the+historical+FPR+data+from+2019+accurately+reflects+the+revenue+achieved+in+the+previous+fiscal+year%2C+NASAA+is+requiring+franchisors+to+update+that+data+for+the+first+half+of+2020+to+include+additional+financial+performance+information+in+Item+19%2C+or+to+delete+their+Item+19+disclosures+altogether.%3C%2Fp%3E%0D%0A%3Ch2%3E%3Cstrong%3EFailure+to+update+Item+19+may+be+considered+deceptive%2C+misleading%2C+or+fraudulent%3C%2Fstrong%3E%3C%2Fh2%3E%0D%0A%3Cp%3EState+and+federal+franchise+laws+make+it+illegal+for+franchisors+to+make+untrue+statements+of+a+material+fact+or+to+omit+material+facts+that+make+a+statement+not+misleading.+The+materiality+of+a+fact+is+viewed+from+the+perspective+of+a+reasonable+prospective+franchisee.+NASAA+is+now+conflating+the+obligation+to+update+for+material+changes+and+the+anti-fraud+obligation+with+the+Item+19+regulations+on+disclosing+historical+FPRs%2C+to+suggest+that+a+failure+to+amend+an+historical+FPR+could+be+misleading.%3C%2Fp%3E%0D%0A%3Ch2%3E%3Cstrong%3ECertain+factors+should+be+weighed+to+determine+if+historical+financial+performance+representations+should+be+updated.+These+include+the+following%3A%3C%2Fstrong%3E%3C%2Fh2%3E%0D%0A%3Cul%3E%0D%0A%3Cli%3EWhether+the+franchised+business+has+been+significantly+affected+by+the+Covid-19+pandemic%3C%2Fli%3E%0D%0A%3Cli%3EThe+type+of+data+the+franchisor+includes+in+the+FPR%3C%2Fli%3E%0D%0A%3Cli%3EThe+reasonable+inferences+a+prospective+franchisee+can+draw+from+the+FPR%3C%2Fli%3E%0D%0A%3Cli%3EWhen+the+franchisor+estimates+a+prospective+franchisee+can+expect+to+open+for+business+after+entering+into+a+franchise+agreement%3C%2Fli%3E%0D%0A%3Cli%3EWhether+and+how+the+franchisor+adapts+the+franchised+business+to+account+for+current+market+conditions+resulting+from+the+Covid-19+pandemic%3C%2Fli%3E%0D%0A%3Cli%3EWhether+and+how+the+franchisor+adapts+the+franchised+business+to+account+for+future+market+conditions+resulting+from+the+Covid-19+pandemic%3C%2Fli%3E%0D%0A%3C%2Ful%3E%0D%0A%3Cp%3EIf+outlets+represented+in+an+FPR+have+experienced+material+changes+in+financial+performance%2C+the+franchisor+may+no+longer+make+an+historical+FPR+that+is+not+updated+to+reflect+those+changes.%3C%2Fp%3E%0D%0A%3Ch2%3E%3Cstrong%3ENon-monetary+impacts+may+also+require+updates+to+FPRs%3C%2Fstrong%3E%3C%2Fh2%3E%0D%0A%3Cp%3EAs+a+result+of+the+Covid-19+pandemic%2C+some+franchise+systems+have+changed+or+will+change+how+they+deliver+goods+and+services+to+the+public.+Some+changes+may+be+temporary.+However%2C+franchisors+may+alter+their+business+models+permanently+to+adapt+to+new+consumer+demands+and+attitudes+in+a+post%26ndash%3BCovid-19+world.+Once+a+franchisor+concludes+that+it+will+make+changes+to+its+franchise+system+or+business+model+that+will+materially+affect+an+historical+FPR%2C+the+franchisor+no+longer+may+include+an+historical+FPR+that+is+not+updated+to+reflect+those+changes+and+their+impact+on+the+FPR.%3C%2Fp%3E%0D%0A%3Ch2%3E%3Cstrong%3ENow+what%3F%3C%2Fstrong%3E%3C%2Fh2%3E%0D%0A%3Cp%3EFranchisors+whose+outlets+have+been+affected+by+the+Covid-19+pandemic+and+resulting+shutdowns+are+likely+acutely+aware+of+the+impact+those+closures+have+had+on+the+revenues+of+each+outlet.%3C%2Fp%3E%0D%0A%3Cp%3EFranchisors+should+review+their+Item+19+disclosures+and+compare+those+FPRs+against+their+system%26rsquo%3Bs+financial+realities+in+2020.+If+the+Covid-19+pandemic+has+affected+the+performance+of+the+system%26rsquo%3Bs+outlets+in+such+a+way+that+those+historical+FPRs+may+appear+misleading%2C+changes+to+the+FPR+or+deletion+of+the+entire+FPR+may+be+appropriate.%3C%2Fp%3E%0D%0A%3Cdiv+id%3D%22divfade%22%3E%26nbsp%3B%3C%2Fdiv%3E%0D%0A%3Cp%3E%3Cstrong%3ELynne+M.+Hanson%3C%2Fstrong%3E%2C+Co-Chair+of+the+%3Ca+href%3D%22https%3A%2F%2Fwww.moyewhite.com%2Fservices%2Fpractice-areas%2Ffranchise-and-distribution%22+target%3D%22_blank%22+rel%3D%22noopener%22%3EFranchise+and+Distribution+Group%3C%2Fa%3E+and+a+Partner+at+Moye+White%2C+concentrates+on+franchising+and+distribution+regulatory+law.+She+has+represented+franchisors+in+business%2C+trademark%2C+regulatory%2C+and+transactional+matters+for+more+than+20+years+and+can+be+reached+at+303-292-7927+or+%3Ca+href%3D%22mailto%3Alynne.hanson%40moyewhite.com%22%3Elynne.hanson%40moyewhite.com%3C%2Fa%3E.+%3Cstrong%3ENiki+Vinod+Schwab%3C%2Fstrong%3E%2C+an+attorney+at+Moye+White%2C+advises+clients+on+a+range+of+commercial+issues%2C+including+business+planning+and+formation%2C+contract+negotiations%2C+and+commercial+leasing.+She+can+be+reached+at+303-295-9811+or+%3Ca+href%3D%22mailto%3Aniki.schwab%40moyewhite.com%22%3Eniki.schwab%40moyewhite.com%3C%2Fa%3E.%3C%2Fp%3E
Published: July 22nd, 2020

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