A Special Question and Answer Session with the Franchise Regulators

Webinar Summary –

In this webinar, franchise regulators from the States of Maryland and California discussed how their states are responding and adapting to Covid-19 with regard to franchise regulation, franchise disclosure document filing, financial performance representations, and new accounting rules. The regulators also answered detailed questions relating to adaptations to rules and regulations for submission, filing and accounting procedures for franchises.

Key Bullets –

• Some states are providing relief for franchises regarding filing requirements and extensions; check with each state for changes to any notary requirements and electronic signature rules
• Disclosure documents are being updated due to recent changes, and regulators are concerned about outdated information in FDDs, particularly given recent job losses and revenue changes
• Beware that your Financial Performance Representation does not read like a disclaimer as these are not allowed in FDDs
• ASC 606 implementation has been deferred; franchisors who have not yet completed their audit may defer

Full Bullets –

• Robert Cresanti introduced Theresa Leets and Dale Cantone and welcomed their insights and wealth of knowledge
• Theresa Leets provided a disclaimer about their comments
• Dale Cantone discussed what states are doing
  • Relief to applicants for franchise disclosure documents
  • Check with each state for updates for the registration filing requirements and any extensions that may have been granted
  • Some states have waived notary requirements, and are allowing for electronic signatures
  • Some states are working on a case-by-case basis
  • Registrations are not at a standstill, registrations are still coming through
• Filing Extensions Generally
  • Federal and State franchise laws require franchisors to update disclosure documents
  • A concern with granting filing extensions is that it could allow franchisors to give inaccurate and/or outdated information to prospects
    • Regulators are concerned about outdated information; particularly given recent job losses
• Increase in scams given Covid-19 – investment scams; vaccines and cures; franchising should be a beacon for financial stability
• Franchise sales people view FDD as a sales tool; Lawyers view it as a defense document. It is neither of these things! It is a disclosure document
  • Franchisors will need to be continually updating their FDD given recent changes
  • Covid-19 Disclosures- franchisors should not be coming up with their own risk factors on anything
  • Do not add disclaimers in: Item 1 or Item 19
  • References to Covid-19 seem to convey how uncertain things are, and that the reader should not rely on this document
• Disclaimers are prohibited!
  • No disclaimers preserves integrity of material information disclosed in disclosure document
  • Prevents deception
  • Item 19 admonition: “Some outlets have earned this amount. Your individual results may differ. There is no assurance that you’ll earn this much”
• Concern that franchisors are going further than presenting historical data, and saying that they cannot rely on the data
• Can you disclose anything about Covid-19 in Item 19?
  • Yes, as long as its factual and not a disclaimer
• Making a Financial Performance Representation
  • If a franchisor has included an FPR based on historical data, then if any downturn in revenue becomes material, then the FDD is required to be updated
  • Federal law requires that the seller must notify the prospective franchisee

• New State Cover sheets
  • Only add risk factors if required in the instructions or by a state regulator
  • “State Effective Dates” has moved to the end of the FDD
• ASC 606 Implementation deferred
  • FASB agreed to defer for 1 year the required implementation of ASC 606
  • Franchisors who have not yet completed their audits can wait to implement
• ASC 606 Comment Letters
  • Regulators are seeing Audits that disclose adoption of ASC 606 but use Legacy disclosures
  • If you receive a letter for clarification this might be because it is impossible to tell from the notes the financial statement the method of adoption
• ASC 606 Adoption
  • Notes should tell the reader:
    • Method of adoption
      • Full or modified retrospective
    • A table showing line items within the financial statements that were adjusted
  • 5 steps to recognizing revenue
    • This is where you identify performance obligations under the franchise agreement
  • Disclose how the initial franchise fees are to be allocated
    • Over the term of the franchise agreement
    • Upfront for separate performance obligations
• Changes to DocQNet
  • California’s online portal to find and view FDDs
  • California is changing how to view search results; to view a document you’ll need to submit a Public Records Act request
  • Let the DBO know how this change is affecting you

Questions:

Will states question every FPR based on 2019 data?

• Different states are taking a different view of this. At least one state is liberally questioning whether franchisors have a reasonable basis for an FPR based on 2019 data. Things may not be like they were in 2019. Other states are taking a more cautious approach.
  • As long as FPR complies with NASAA commentary, then that is a good place to start. If the FPR has disclaimers, that will trigger concern from regulators

Calendar Year End audits will not reflect franchisors’ current franchisors financial situation, how to best reflect this?

• File a post-effective amendment

Will states allow for online payment of filing fees?

• Some states already allow for this. Others are not set up for this

Applications dated on the same day or after consent on financials?

• FTC requires that franchisors identify FDD issuance date

Will the FTC extend their updating requirements?

• No current move to do this

Commentary from NASAA?

• No decision yet on this, and not 100% agreement between states and NASAA

May a franchisor choose what standard to apply to their audit, as long as the choice is clear?

• All renewals before April 8, 2020 would be filing with ASC 606. If they wish to restate the audit under Legacy, they may do so.

If there is a material change in the disclosures included in a disclosure document, then that triggers an amendment. It is up to the franchisor what is a “material change”. It’s fact-specific and fluid given the current scenario. If the franchisor has determined that the numbers are materially different, then that would require an amendment.