On September 16, 2014, the Franchise and Business Opportunity Project Group of the North American Securities Administrators Association (NASAA) issued a Multi-Unit Commentary to provide guidance in addressing certain disclosure requirements in 3 different types of multi-unit franchising structures. All of the state franchise regulators are members of NASAA so we can expect that the state franchise regulators will follow the guidelines addressed in the commentary in 2015. The effective date of this Commentary is 180 days after the date of adoption, or 120 days after the franchisor’s next fiscal year end for Franchise Disclosure Documents already in existence.
The new Multi-Unit Commentary includes guidelines for disclosure in the Franchise Disclosure Document for 3 types of multi-unit franchising structures: (1) Area Development, (2) Subfranchise Rights, and (3) Area Representation (see descriptions of each below).
The Franchise Disclosure Documents of franchisors offering one or more of these multi-unit franchising structures may already be in compliance since the commentary largely provides clarification or confirmation on how FTC Guidelines should be interpreted when disclosing information on multi-unit arrangements, rather than imposing new requirements. However, now is the time to review with franchise counsel if changes will need to be made to the Franchise Disclosure Document (FDD) to bring it into compliance with this new commentary.
The following summarizes the guidelines issued under the Commentary for each of the multi-unit franchising structures:
Area Development (this arrangement offers to one person or entity the right to own and operate multiple unit franchises):
- The offer of an Area Development Agreement can be done within the same FDD as the offer of the unit franchise.
- In Item 1, a franchisor must state that the Area Developer will be required to sign the “then-current form of franchise agreement” as they open each unit franchise under the Area Development Agreement, and that the franchise agreement may be different than the franchise agreement that is in the FDD they originally received when they sign the Area Development Agreement.
- In Items 11 and 12, the franchisor must disclose that it will determine or approve the location of future units and any territories for those units using its then-current standards for approving sites and designating territories.
- If the termination of the Area Development Agreement is cause for termination of any of the Area Developer’s existing unit Franchise Agreements, or vice versa, this must be disclosed in Item 17.
- Franchisors are not permitted in Item 20 (Table 5) to disclose the number of unit franchises that the Area Developers have agreed to open in the future.
- There are to be no separate tables in Item 20 for Area Developers under the Area Development Agreements. Only their open unit franchises are reported in Item 20.
- There is not to be a separate list of current and former Area Developers in the FDD; however, in the list of unit franchisees included in the FDD, Area Developers must be identified by placing a footnote or symbol next to their names with an accompanying Area Developer notation in the footnote.
- If an Area Developer has signed an Area Development Agreement but has not yet opened a unit franchise, they should still be identified in the list of current franchisees with a notation that they have not yet opened a unit.
- If a franchisor offers Area Development Agreements but does not have any Area Development Agreements in place as of the end of the fiscal year, that information is to be disclosed in Item 20.
- If an Area Developer Agreement is terminated without the Area Developer ever opening a unit franchise, the Area Developer must be included in the list of former franchisees.
Subfranchise Rights (this arrangement grants to a person or entity the right to enter into unit franchise agreements with third parties – subfranchisees – in a designated geographic area; sometimes called Master franchises)
- The offering of subfranchise (Master franchise) rights by a franchisor must be in a separate FDD from the offering of the unit franchise.
- A franchisor must disclose in Item 1 of both their subfranchise and unit FDDs that they offer both unit franchises and subfranchise (Master franchise) rights.
- Item 20 of the FDD for subfranchise (Master franchise) rights should only include information on subfranchises (Master franchises). It is not to include Item 20 information on unit franchises in the franchise system.
- If a franchisor requires its subfranchisors to use the franchisor’s form of unit franchise agreement for the sale of unit franchises in the subfranchisor’s territory, the form of unit franchise agreement must be included in the franchisor’s FDD for subfranchise rights.
- However, if a franchisor requires its subfranchisors to use the franchisor’s form of unit Franchise Disclosure Document for the subfranchisor’s offer of its unit franchises, a copy of that unit FDD is not to be included in the franchisor’s FDD for subfranchise rights.
Area Representatives (this arrangement grants to a person or entity the right to solicit and recruit unit franchisees to enter into a franchise agreement with the franchisor and to provide support services to those unit franchisees on behalf of the franchisor)
- The offering of area representative franchises by a franchisor must be in a separate FDD from the offering of the unit franchise.
- The franchisor’s FDD for unit franchises in the area representative’s territory is not to include information on the financial arrangements between the franchisor and the area representative.
- When the franchisor grants management responsibility relating to the offer and sale of franchises to the area representative, disclosures required by Items 2, 3 and 4 must be included in the franchisor’s unit FDD for the area representative. If the franchisor has area representatives operating in different states, this information can be included either in the body of the FDD or in separate state specific addenda to the FDD. If the franchisor does not grant management responsibility to the area representative, that fact must be disclosed in Item 1 of the franchisor’s unit FDD.
- A franchisor must disclose in Item 1 of both their subfranchise and unit FDDs that they offer both unit franchises and subfranchise rights.
- In Item 8 of the franchisor’s unit FDD, it must disclose if any area representatives are receiving rebates or deriving revenue from purchases by unit franchisees.
- If the area representative will provide training to unit franchisees, information on the area representative as instructor must be included in Item 11 of the franchisor’s unit FDD.
- Item 20 of the FDD for area representative rights should only include information on area representatives. It is not to include Item 20 information on unit franchises in the franchise system.
- Information on existing and former area representatives is not to be included in Item 20 of the franchisor’s FDD for unit franchises.
- Area representatives are to be listed as franchise sellers on the receipt page of the franchisor’s FDD for unit franchises.
Arguably, this commentary would only apply to Franchise Disclosure Documents registered or filed in registration states. However, the commentary states that the Project Group consulted with FTC state before finalizing the commentary, so it would be good practice to follow the commentary in all states.