The proper preparation of a franchise disclosure document (“FDD”) can be complex and the rules governing such preparation are often evolving, so it is beneficial for franchisors to engage a franchise lawyer to handle the task. It is imperative that franchisors are aware that their FDDs must be drafted in accordance with the Federal Trade Commission’s (FTC) franchise rule, as amended in 2007, as well as relevant state laws.
The FTC governs what information is required to be disclosed in an FDD and even provides for certain mandatory language to be included for certain types of disclosures. There are 23 disclosure items in an FDD. These disclosure items are intended to be organized and prepared in such a way that will give a prospective buyer a complete overview of what to expect when entering a franchise system with the franchisor. The FTC’s goal is to protect the potential buyer and assure that they will have a comprehensive list of essential information needed to make an informed decision about committing to such an investment. Requiring franchisors to disclose certain information in a uniform way helps to prevent franchisors from taking advantage of a potential buyer by concealing unfavorable information about the franchise system. The FTC disclosure items, include, but are not limited to, litigation history of the franchise system, fees and expenses associated with opening the business, the estimated cost of the initial investment, and the franchisee’s obligations under the franchise agreements. Thoroughly reading through an FDD can take some time, which is likely why the drafters of the FTC require franchisors to provide to a prospective franchisee a FDD within a specified period of time before completing the sale of a franchise to that prospective franchisee. While the FTC requires the FDD to be drafted in plain English so that it is easily understood, a franchise attorney’s review of the FDD would be beneficial to alert a potential buyer of risks that may not be apparent in the document.
Franchisors should also be aware that certain states have implemented their own regulations for franchises and FDD preparation. The following states require franchisors to register their FDDs with the state: California, Hawaii, Illinois, Indiana, Maryland, Minnesota, New York, North Dakota, Rhode Island, South Dakota, Virginia, Washington and Wisconsin. The basic FTC document must be supplemented to be accepted for registration in certain states, typically with a state specific addendum. Registration must typically be renewed on an annual basis. Particular rules governing registration and associated fees will vary from state to state. Other states, such as Florida, require a filing that is something less than full registration of an FDD; for example, franchisors may have to file documents with that state or provide the state with notice before selling a franchise. Often times, filing an FDD will satisfy the filing or notice requirements by that state.
Before selling a franchise, a franchisor should assure that their FDD is in compliance with the FTC franchise rule and be sure that they have complied with all applicable state regulations, including ongoing registration requirements and the filing of annual reports.