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Financial Performance Representations: The Effect of COVID-19 and other Issues relating to Compliance with Item 19 of the Franchise Disclosure Document

In October of 2020, the attorneys at Carter & Tani attended the virtual American Bar Association Forum on Franchising’s annual franchise law seminar.  Among the wide range of topics presented was a workshop on financial performance representations (FPRs).

There were two state regulators on the panel on FPRs – one from Maryland and the other from California.  They discussed the impact of COVID-19 on financial performance representations that franchisors disclose in Item 19 of their FDDs. We learned that during the COVID-19 pandemic, state examiners are requesting franchisors to explain why their 2019 FPR still has a reasonable basis, and are requiring in some cases that franchisors provide comparable data showing 2020 results. If the 2020 results show material changes from the 2019 FPRs, franchisors are being required to disclose the 2020 results in their FDDs in comparison format, or to remove the 2019 FPRs altogether. We can expect greater scrutiny of FPRs as we file franchise registration renewals for our clients in 2021.  The following options for presenting a financial performance representation in the 2021 FDD were discussed:

(1) including an FPR that shows lower performance in 2020 but including facts (not disclaimers) about how the pandemic impacted the business;

(2) not including an FPR if 2020 data was inflated due to the pandemic); or

(3) including data for both 2019 and 2020.

We are also facing challenges from state regulators regarding language we include in Item 19, to explain or provide context for the figures in the FPRs.  State regulators have requested that we delete some explanations or factors on which the FPRs are based, claiming them to be “indirect disclaimers.”  Disclaimers are not permitted in Item 19, because their presence may have the effect of negating the validity of the figures and/or admonishing the prospective franchisees that they should not rely on the figures.  We have successfully responded to such requests in a number of instances, and have been permitted to leave the explanations or factors in Item 19 where we were able to show the state regulators that the explanations were important information for the prospective franchisees to consider in assessing what their performance might be if they decide to purchase a franchise.  Such explanations  could give some added protection to the franchisor if a claim were to be brought against them regarding the accuracy of the FPRs.

In addition to issues that have come up due to the pandemic, the regulators cautioned against certain types of financial performance representations that have been submitted to them which may be problematic:

  • FPRs based on survey responses where the response rate may not be high enough to be representative of the entire franchise system.
  • FPRs based on mature outlets only (i.e., only units in operation for at least 24 months or more) which could mislead prospective franchisees into thinking they can achieve these results from the outset.
  • FPRs based on the number of franchisees and not the number of outlets owned by those franchisees which could result in the numbers shown as being achieved being misleading.
  • FPRs based on territories of different sizes or different populations making it more difficult to for a prospective franchisee to determine what they possibility could achieve.
  • FPRs broken down into subsets which could be picked to present only the most positive results.

Care must be taken whenever a franchisor is developing a financial performance representation to be included in its Franchise Disclosure Document.  If you use or are considering using FPRs in your FDD, contact Carter & Tani Attorneys at Law to speak with a franchise attorney today about whether your FPRs comply with these franchise law developments.