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Summary of NASAA Financial Performance Representations Commentary

June 2020

The North American Securities Administrators Association Franchise Project Group (“NASAA”) recently provided guidance for state regulators and franchisors reviewing a franchisor’s historical financial performance representation (“Historical FPR”) in Item 19 of the franchise disclosure document (“FDD”) during a time in which many businesses have been impacted by the COVID-19 global pandemic.


Many franchise companies have been required to cease operations, deal with changes in consumer attitudes/patterns, and consider the possible long-term implications of the shutdown, in some markets. Also, many franchisors updated their FDDs in the spring of 2020, before the COVID-19 shutdown that included a Historical FPR in Item 19. With this background, state franchise administrators asked NASAA two questions:

1.    Can a franchisor make a Historical FPR in 2020 considering the substantial impact that COVID-19 has had on many businesses?

2.    What must franchisors do (if anything) in the future to make sure that the information contained in a Historical FPR meets the requirements of state and federal law?


Although NASAA did not answer these two questions directly, NASAA did provide some insight. NASAA notes that, under some circumstances, a Historical FPR that discloses historically accurate data may contain an omission of a material fact, or an untrue statement of material fact, if material changes have occurred to that Historical FPR by the time it is provided to a prospective franchisee. NASAA states that there are a number of factors that need to be considered when a franchisor is looking to continue to use a Historical FPR in 2020 without amending this disclosure (state franchise law requires franchisors to amend a registration to reflect any material changes in a registered FDD). These factors include:

  • Whether the franchise business has been significantly impacted by the pandemic;
  • The type of data the franchisor includes in the FPR;
  • The reasonable inferences a prospective franchisee can draw from the FPR;
  • When the franchisor estimates a prospective franchisee can expect to open for business after entering into a franchise agreement;
  • Whether and how the franchisor adapts the franchise business to account for current market conditions resulting from the pandemic; and
  • Whether and how the franchisor adapts the franchise business to account for future market conditions resulting from the pandemic.

NASAA alerts franchisors that franchise systems (especially systems that have been significantly impacted by COVID-19) should consider whether the franchisor has a reasonable basis today to make the Historical FPRs contained in their 2020 FDDs considering the impact that the pandemic has had on the business. Franchise systems that have changed business models (such as the development of a take-out format) due to the pandemic must also be aware that if the change materially impacts the Historical FPR, the franchisor must make sure the changes are reflected in the Historical FPR.


Although NASAA declined to provide more specific guidance at this time due to the uncertainty of the pandemic, NASAA cautions franchisors who do make Historical FPRs to be prepared to respond to comments from state examiners asking for explanation. NASAA also warns franchisors that they cannot disclaim the Historical FPR with any of the following disclaimers (all of which are prohibited by the FTC Franchise Rule):  that the Historical FPR is not representative of what prospective franchisees can expect due to COVID-19 consequences; the franchisor cannot predict how the franchise system will be affected by COVID-19; or suggest in some other way that prospective franchisees should not rely on the disclosure due to COVID-19.


Finally, NASAA reminds franchisors that if material changes occur that make one or more representations made in the FDD (including a Historical FPR) inaccurate or misleading, the franchisor has an obligation to amend its FDD, make appropriate filings with the franchise state regulators, and redisclose its franchisee prospects. 

 

This communication is not intended to constitute legal advice. Since the emergency regulations and guidelines are evolving rapidly and each of your circumstances are unique, we encourage you to reach out to us if you have questions about how this or other COVID-19 related government action.

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