Refresh on Franchisor Basics: When to Update your FDD?
The maintenance of a "current and updated" FDD represents one of the primary regulatory requirements imposed on a franchisor. Failure to maintain a current FDD and/or renewed state registration will result in either lost franchise sales (since franchises cannot be sold) or litigation exposure (in the event that sales are made during a period of non-compliance). Although the timing of the FDD updating process is well understood (and not often disputed) it is nevertheless important for franchisors and their management team to recognize the significance of maintaing a "current FDD" and the timing of when an FDD must be updated.
Starting with the premises that the information and disclosures contained in a franchisor's FDD must be current, under the federal franchise rule, Franchisors are required to update their FDD under the following three circumstances:
- Annually (Mandatory). Franchisors must update their FDD no less frequently than annually. Annual revisions and updates to an FDD must occur within one hundred and twenty (120) days from the close of the franchisor's fiscal year;
- Quarterly (If Material Change Occurs). If events or circumstances materially change information or disclosures contained in the FDD then the FDD must be revised. The revisions will be attached to the current FDD and must be reported "within a reasonable time" from the close of the franchisors most recent fiscal quarter;
- Immediately (When dealing with Item 19). When providing a prospective franchisee with a disclosure document a franchisor must also immediately notify the prospective franchisee of any and all material changes that the franchisor knows or should have known about respecting any Item 19 financial performance representations contained in the FDD.
Knowing when to update your FDD is not a complex process, however it does require organization and the implementation of safeguards to ensure that your financial performance representations (if any) are continuously monitored and that your management team discusses and evaluates the status of your FDD disclosures on a regular basis.
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Inherent to every franchise system is the license of intellectual property rights that, for good reason, has been (and should remain) focused on the trademarks and trade dress associated with the franchise system. While trademarks, logos, and trade dress are critically important intellectual property ("IP") assets, an additional (and possibly overlooked) IP asset may exist in the form of "design patents" issued by the United States Patent and Trademark Office. Design patents relate to the "novelty" and "ornamental appearance" of a product and may add a supplemental layer of IP protection for franchisors. When evaluating your IP portfolio and whether or not you are maximizing the legal protection of your IP assets, consider the following:
Many times, "start-up" franchisors (and, too often, some established franchisors) overlook the necessity of maintaining a thorough operations manual that is both "current and relevant" to the particular franchise system. That is, many times operations manuals are viewed as an "afterthought" or a"generic" obligation to be sourced out to third party vendors.
For the start-up and established franchisor alike, as your franchise system evolves continuous consideration must be given to your franchise agreement and "the legal rights that you reserve for your franchise system". That is, basic to every franchise agreement are the "reservation clauses" identifying and establishing alternative channels of distribution and legal rights that are not granted, conveyed or licensed to your franchisees. These reserved rights typically address alternative channels of distribution and markets that are expressly reserved to the franchisor. Examples include internet sales, mail order sales, captive market accounts and licensed products sold through alternative sales channels.
Has the United States economy changed? Are we in a "new economy"?
There are many reasons why, for many, the purchase of a franchise makes sense. However, buying a franchise may not be right for you. I was, again, reminded of this "obvious and basic fact" during a conference call today with a client considering a substantial investment in a multi-unit franchise. The investment was sizable and, quite frankly, there was plenty of opportunity in the deal. After a substantial legal review (where everything looked good and substantial negotiating points were achieved) he decided that "becoming a franchisee was not right for him" - so he walked away from the deal.
In a comment to a recent post -
From a franchisors perspective litigation is a critical "cost factor" that must be contained and mitigated. When consulting with franchisors (both start-up and established) one issue that provides good reason for concern is the ability of "franchisee associations" to sue you directly. Traditionally, the issue of "standing" - that is the right to sue another individual or company - requires that, in commercial transactions, the parties possess a direct relationship and "privity" with one another. When dealing with certain associations (including franchisee associations) the courts have expanded the concept of "privity" and have afforded certain associations the right to sue even where a direct relationship may not exist. That is, although you may have no dealings or contractual relationship with a "franchisee association", the "association may nevertheless possess the legal right to sue your company. Considering the significance of this issue and to better address the question of - why? - that franchisors rightfully ask, the following is a brief review and summary of some of the case law involving a franchisee association's right to sue (My comment follows at the end):