Managing the franchise disclosure process

Identifying the Prospective Franchisees

This is not always as straightforward as it sounds. It may not be unusual for the franchisees to be made up of several related individuals, such as spouse, extended family members or business partners. Information must be obtained about their IDs, corporate interest and positions – which is often outdated or not documented properly, agreements among them, etc.

Defining the Location, Territory and Trading Area

The location, territory and trading areas (all of which are technically different) need to be identified and defined:

• Location refers to the physical location;
• Territory often refers to any protected area granted by the franchisor, and
• Trading area often refers to the areas in which the franchisee can provide deliveries.

The latter two need to be defined properly using metrics that are objectively verifiable. For example, boundaries on a zoomed-out map that do not clearly show the municipal street boundaries of the area will likely be deemed ambiguous and unenforceable.

Depending on whether or not the location of the outlet is known at the outset, the territory and trading areas may change once a location is identified. All that needs to be accounted for in the FDD and contractual in the franchise agreement, including on whom the real obligation to locate a site lies.

Construction or Renovation Costs

Depending on whether or not a location will be finalized early on in the process, the FDD needs to disclose the costs of construction, renovation or conversion of the premises in a much more definitive manner than the broad cost estimates typically found in standard FDDs, which are almost meaningless (a range of $300,000 to $500,000 does not tell much to the prospective franchisee).

History of the Location

Some due diligence investigation about the location and its history is typically in order. A careful review of mainstream online resources can reveal potentially useful information about the previous history of the location, which can be deemed to constitute material fact. For example, is there a history of business failures at this location? If other restaurants have operated at the location but have eventually closed down, a prospective franchisee is entitled to know this information as a warning about the potential risks of the location.

Lease History

Depending on the site-selection obligations in the franchise agreement, once a lease is put in place, key information about the lease along with a copy of the lease document need to be disclosed to the prospective franchisee. Some lease structures involve obligations of the prospective franchisee to the landlord, as an indemnifier, even if the franchisee will be subleasing the space from the franchisor or its affiliate.

For Resales – Historical Sales Revenues

Recent court decisions have confirmed the obligation of the franchisor to disclose a store’s recent sales revenues on a resale, regardless of whether the prospective franchisee did or could have obtained this information directly from the seller.

Conversions – Particulars of the Assets Purchase and Lease History

Where the location involves a conversion of an operation outside the franchise system that closed down (typically an independent location or a former franchisee of another franchise system), the FDD needs to disclose the terms of the purchase of assets from the seller and any other related terms.

Sometimes the franchisor will be buying those assets, while other times the franchisee may be allowed to purchase the assets directly as a condition of entering into a franchise agreement. Regardless, the terms and all material fact relating to the assets acquisition must be disclosed in the FDD.

The lease history in a conversion sometimes goes back years and may involve several former operations and parties. Depending on any renewals or amendments, all such lease-related agreements must be located (or obtained), reviewed with relevant highlights disclosed in the FDD. Some locations may have had many assignments, renewals, or amendments, all of which must be obtained and reviewed.

Depending on the remaining term in the lease, it may be necessary to negotiate a renewal to the lease at the same time.

Materials Given to the Prospective Franchisee Before the FDD

Sometimes a franchisor gives out important information to a prospective franchisee outside of the FDD process, such as information about the location or area, or even financial information. That may require a more legally complex analysis to address any potential statutory non-compliances and to determine what information, documents or agreements need to be drafted into the FDD.

Delivering FDDs and SMCs, Obtaining Receipts, Corporate Documents, and Executing Documents

Once all this information is formulated and drafted, there needs to be an effective process for the assembly and delivery of FDDs, digitally obtaining receipts from prospective franchisees, where necessary preparing Statements of Material Change (SMCs) for new information that becomes available before the signing of franchise agreements (such as lease agreements, financials, etc.), obtaining corporate documents from prospective franchisees, and ultimately executing all franchise and related documents. There should be an efficient process to manage all these steps, hopefully digitally, for multiple locations at a time.

Summary

The successful management of the FDD process is an essential component of supporting a rapidly growing franchise system, while minimizing legal risks. It usually involves a series of steps designed to identify all material fact information, documents or agreements that need to be incorporated into the FDD and related disclosure steps, from the start of the disclosure process to the final execution of franchise and related agreements.

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The information contained in this article is provided for informational purposes only and does not constitute legal advice. Readers should not act on this information without seeking professional legal advice from a lawyer experienced in this area. The content in this article may not reflect the most current legal developments, and the application of law can vary in different provinces and territories. As such, the information in this article is not guaranteed to be complete, correct, or up to date. The author and the publisher of this article disclaim all liability for any actions taken or not taken based on any or all of the contents of this site.

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