Update on Financial Performance Representations (FDD Item 19)

In January each year, Franchise Times features their annual “20 to Watch” in franchising for the year. In addition to listing our long time client, Anytime Fitness, at the top of the list, this year’s list includes the North American Securities Administrators Association’s pending Commentary on financial performance representations as one of the top 20 things or people to watch in franchising in 2016. In our last newsletter, we reported that the Commentary had been issued for public comment. NASAA received extensive comments, and the task force that issued the Commentary has been scheduling at least two conference calls a month to work their way through the comments. What does this mean for franchisors?

One thing that is clear, which Franchise Times recognized in highlighting the Commentary and its importance to franchising, is that NASAA does intend to issue the Commentary, and all franchise disclosure documents will have to comply with the Commentary. However, it is just as clear, as we predicted in our last newsletter, that the Commentary will not be effective for filings in 2016. Rather, the Commentary will undergo further changes, will be reissued for public comment, and will apply, at the earliest, to filings in 2017.

While the Commentary will not have the force of law in 2016, franchisors that ignore it this year do so at their own peril. A California regulator has already said that she will use the Commentary as a guide when reviewing disclosure documents filed in the upcoming renewal season. Moreover, since the Commentary does not purport to change the law, but rather to interpret what constitutes a “reasonable basis,” a requirement for existing financial performance representations, it will not be surprising to see franchisee lawyers start citing the Commentary as a guideline for judges. Reliance on the Commentary for this purpose would be inappropriate, as the Introduction to the Commentary will clearly state that the Commentary does not apply until after the effective date, and then only to franchise disclosure documents issued or amended after the effective date. However, that does not mean that a clever franchisee lawyer will not try to convince a judge to look at the Commentary when determining the reasonableness of an existing financial performance representation. For that reason, franchisors that are renewing their disclosure documents in March and April need to be familiar with the Commentary, and best practices would suggest they conform their existing Item 19 disclosures to the proposed Commentary in their next disclosure document update. For companies with a well-drafted Item 19, that should not require extensive changes.

If you are an attorney reading this summary, and you plan to attend the International Franchise Association’s Legal Symposium in May, you will have the opportunity to attend a workshop that addresses the current status of the Commentary, including changes made by the task force in response to public comments. I will be one of the moderators on the workshop, along with Ron Gardner from the franchisee-firm of Dady & Gardner, and Dale Cantone from the Maryland Attorney General’s office. All three of us are members of the task force that issued the original Commentary, and is reviewing the comments. We will therefore be able to provide, at the workshop, up to the minute information on pending changes to the Commentary. In the meantime, you should use the published draft as a general guideline for any financial performance representation you prepare.