Items of the Federal Disclosure Document

The items listed in the Federal Disclosure Document contain necessary information about the franchisor that enables the prospective franchisee to make an informed decision about whether to invest in the franchise system in the U.S. Respectively, franchisors wishing to franchise in the U.S. need to draft their own Federal Disclosure Document.

The first item requires the franchisor to provide the basic information of the franchisor, including information about parent companies, predecessors, and affiliates.¹ Item number one provides the basic structure of the franchise, for example, the principal business address, official names that the franchisor uses, and any predecessors dating back ten years.

The second item is the franchisors business experience;² it is an essential item since it lists up to five years of prior business experience of any person that has actual management responsibility, as opposed to title only, employed by the franchisor. However, if the experience is directly relevant to the franchises that are being sold, information beyond five years is acceptable, but not mandatory.³ In addition, the investor should keep in mind that franchisors are not required to list the business experience of their brokers.⁴ The second item also requires persons to list any prior association with another franchise, which enables the investor to examine if the franchisor has operated other franchise systems that have failed.

Item three requires the franchisor to list prior and ongoing litigation, including arbitration proceedings, and is one of the most valuable items in the Federal Disclosure Document. Any persons, parent, or affiliates listed in items one or two must list in item three if they have a pending litigation in an administrative, criminal or civil matter; the same applies if they have in the past ten year period prior to the Federal Disclosure Document’s issuance date been convicted of a felony or been held liable in a civil action for unfair or deceptive practices (including civil actions with franchises).⁵ An essential additional requirement is that the franchisor must disclose litigation that they initiated during the last fiscal year regarding the franchise relationship.⁶ During the Franchise Rule amending proceedings, the franchisees representatives, as well as the Small Business Administration, stated the importance of including the franchisor initiated litigation because it was a clear indication of “(1) the quality of the franchisor-franchisee relationship; and (2) the extent to which the franchisor may be litigious.”⁷ This is also corroborated by the FTC Franchise Rule Compliance Guide, which states that litigation within a franchise system may be an indicator of the problems in the franchise relationship.⁸

Item four is bankruptcy, which requires all the persons and entities listed in items two to list any bankruptcies that they have filed.⁹ Furthermore, unlike in items two and three, item four does not limit the affiliates or parent to only those who guarantee performance or back the franchisor financially; all affiliates and parent need to disclose bankruptcies from the last ten years.¹⁰ Investors should be wary of franchise systems with multiple listing under item four.

Together, items one through four give a comprehensive background about the franchisor. The investor will be able to view the history of the most influential persons and companies associated with the franchise. Most importantly, the investor will be able to view any problems that exist or have existed.

If you have any questions regarding any of these items as a prospective franchisee or as a franchisor wishing to draft a Federal Disclosure Document, contact franchise attorney Mario Herman for further assistance.