The FTC’s Franchise Rule and various state laws require franchisors to amend their FDD upon the occurrence of a material event or a material change in the information provided in the FDD.  Due to this requirement, franchisors must routinely consider whether their franchise system has undergone any material changes.   As we enter another calendar quarter in 2020 during these unprecedented times, this process is particularly challenging as franchisors must also consider the impact of the COVID-19 pandemic.

In addition to the fact that many businesses in many states are still closed, many franchisors have implemented changes to their unit-level business model to address governmental stay-at-home and social distancing mandates and to meet the evolving market demand brought on by the ongoing COVID-19 pandemic and consumers’ reactions to the virus.  While temporary operational changes that are introduced to abide by the state and local laws may not trigger an obligation to amend the FDD, an amendment might be required where those operational changes become long-term or permanent system changes, or require a significant capital expenditure by unit-owners.  Additionally, the general health of the system may have changed, if the franchisor’s financial condition has suffered, or an unusual number of units have permanently closed for business.

In evaluating the “materiality” of any changes, franchisors should consider whether it is reasonably likely to influence the decision of a prospective franchisee to acquire or renew a franchise.  Some examples of “material changes” that may have arisen out of COVID-19 include:

• a significant change in the franchisor’s financial position;
• a significant change in unit-level economics (e.g., where the businesses are allowed to accommodate only a percentage of its customer capacity);
• departure of individuals disclosed in Item 2;
• changes in key product/supplier arrangements;
• operational changes that require a significant additional capital investment, for example additional safety equipment;
• operational changes that are a significant departure from the existing system process flow (e.g., requiring carryout service for restaurants that previously did not offer carryout service; requiring franchisees to offer online classes, etc.);
• reduced franchisor support or training; or
• termination, closure, failure to renew or repurchase of a significant number of franchise outlets.

Additionally, under the FTC Rule, any financial performance representations made in Item 19 must have a reasonable basis at the time of disclosure, which means it must be considered on an ongoing basis throughout the year. Given the volatility of the current market situation, franchisors must closely monitor their Item 19 data and assess whether it continues to give prospective franchisees a clear and reasonable view of the financial potential of the franchised business.

A failure to amend an FDD as required  FTC Rule and the state laws and regulations can have serious ramifications including rescission, civil and, in some cases, criminal liabilities.  The severity of the consequences warrant a serious look at and discussion regarding the pandemic-related impacts on the franchisor, the unit-level operations, and the system generally and, perhaps more than ever, whether an FDD amendment is necessary or appropriate.