Financial statements
Discovery days/closing sales
Compile in advance
Updating
Commitments
Financial performance representations
Sticking to target dates
Pay attention to legal matters
Inventory
Trademark maintenance
State tax initiatives
Disclose franchisee financing
Review website
Disclaim disclaimers
Information for US franchisors with international franchisees
In preparation for the upcoming renewal season, increased efficiency is likely to be a top priority for any franchise system. This update contains tips to help franchisors save time and money in preparing for a successful 2012 renewal season.
Financial statements
Talk to a certified public accountant before the end of the fiscal year to establish whether additional capitalisation is needed to avoid the imposition of financial assurances (escrow, bond or fee deferral) or to determine if other adjustments can be made to enhance financial statements and profitability. Waiting until after the end of the fiscal year will be too late to address these issues.
It is recommended to remind an accountant of the franchise disclosure document requirements for financial statements. Last minute financial statements that do not comply with franchise disclosure document guidelines result in unnecessary delays. Typical problems include financial statements that are not prepared according to US generally accepted accounting principles and that are not in comparative format.
Ensure that the accountant understands the urgency of completing the audit as quickly as possible following year end. Filing during the last week in March because audited financial statements were not available sooner can delay the registration process by weeks – in some states, by months. Examiners review franchise disclosure documents in the order received. With hundreds of applications being filed during that last week of March, delayed submissions could end up at the bottom of the pile. Registration delays can cost in terms of franchise sales.
Discovery days/closing sales
Be aware of any pending franchise sales, discovery days or other franchise sales activities leading up to franchise disclosure document renewals. To the extent possible, plan to sign any pending franchise agreements before filing renewal applications. In most registration states, it is necessary to 'go dark' until the renewal is approved. Since some state examiners take weeks (in some instances, months) to complete their review, it may not be possible to sell any franchises in those states during this period. Therefore, it is important to coordinate franchise sales activities accordingly.
Compile in advance
Information needed to update franchise disclosure documents can be compiled before the end of the fiscal year. Gathering information for Items 2, 3, 4, 7, 8, 11, 19 and 20 and for franchise seller disclosure forms can take a great deal of time, so it is best to start early. If brokers are used as part of the sales process, a franchise seller disclosure form must be included with the state application. A copy of the brokers' franchise seller disclosure forms can be requested from broker networks.
Updating
Make a note of all transfers and terminations of franchises and area developer rights as changes to the franchise system occur. It is recommended to keep a running list of current contact information for franchisees which have signed agreements but have not opened, as well as those that have left the system due to terminations, non-renewals, transfers and other reasons. Some states consider a 10% reduction in units to be a material change requiring an amendment.
Commitments
Franchisors are recommended to be aware of and review any obligations described in Item 11 of the franchise disclosure documents, the franchise agreement and, if applicable, other agreements with franchisees. Consider whether any revisions or changes to systems are in order and, if so, incorporate them into the renewal process. This avoids the need for an amendment filing which would be required if changes are made after the renewal applications are filed.
Carefully review franchise agreement and other agreements, including non-compete agreements, area development agreements, equipment leases and confidentiality agreements. Consider whether issues have arisen in the system which are not adequately addressed in the current documents. Were any territory rights granted to franchisees and any reserved rights accurately addressed? Have product supply rebates and advertising funds in the system been accounted for? Are national account opportunities addressed adequately? Are any non-compete provisions adequate in light of recent judicial decisions?
Financial performance representations
Franchisors which do not currently include an Item 19 financial performance representation are recommended to consider whether they should. If a franchisor chooses to make a financial performance representation, the process and finished product should be reviewed carefully. Simply including financial information about franchised or company-owned units in a franchise disclosure document is not adequate to comply with requirements of state and federal franchise laws. A financial performance representation must meet all regulatory requirements (ie, it must be reasonable and not misleading).
Prepare a financial performance representation with the understanding that it may be challenged. This means documenting assumptions included in the financial performance representation and reasons why the financial performance representation is considered to be reasonable.
Sticking to target dates
In a renewal letter, an attorney will include target deadlines to keep the process moving smoothly and in a timely fashion. Clients which meet these deadlines generally get their applications filed much earlier than clients which do not. Once a renewal letter has been received, it is advisable to let the attorney know if the timelines are plausible. If not, then they should be revised in collaboration with the attorney.
Pay attention to legal matters
A franchisor must consider whether its company is in good standing in the relevant states. Do any pending litigation disclosures need to be updated to reflect pleadings? It is prudent to keep a list of all pleadings filed and received during the prior fiscal year in a separate file and present copies of the filings with renewal materials.
Inventory
A franchisor should review whether any of its officers own an interest in any supplier, whether any officers or directors have been involved in litigation or administrative proceedings or have filed for bankruptcy in the previous year. This will need to be done with respect to both new and existing officers and directors.
Trademark maintenance
A franchisor must consider the status of its company's intellectual property. Talk to a trademark attorney to verify that any trademarks are properly registered and maintained. Trademark registration is not a one-time procedure. Once registration is granted, certain maintenance documents need to be filed with the United States Patent and Trademark Office at various intervals in order to maintain the registration.
State tax initiatives
Assess state tax reporting and tax liability positions, especially given increased efforts by certain states to impose income tax payment and reporting obligations on out-of-state franchisors. Franchisors may be required, for example, to take affirmative steps to comply with franchise-specific initiatives in states such as California, Iowa, New York and Washington – and perhaps others as time goes on.
California continues its efforts to compel franchisors to register and pay tax in the state or otherwise face withholding on royalty payments from in-state franchisees. New York has taken a different approach, requiring franchisors to verify a number of facts specific to their New York franchisees (eg, amount of royalties paid to the franchisor, franchisee's gross sales). This information could potentially be used to claim franchisors have sufficient 'nexus' with New York for tax purposes.
Other states are taking a more direct approach and are pursuing taxes directly out-of-state franchisors based solely on the receipt of royalties from franchisees in the state. In Washington, for example, the state imposes tax on out-of-state franchisors based on a number of factors, one of which is income from sources within the state. In Iowa, the state's supreme court determined that the receipt of royalties from an in-state franchisee amounted to taxable 'nexus' for the out-of-state franchisor, a decision that the US Supreme Court recently declined to review.
Disclose franchisee financing
Some franchisors have responded to the current economic climate by offering financing (or financial assistance, such as guarantees or finance referral programs) to franchisees. All financing arrangements – direct and indirect – that are offered by a franchisor, its agents or affiliates must be disclosed in Item 10 of the franchise disclosure documents.
Review website
Examiners will (and have) reviewed websites, including any virtual brochures, to check for disclaimers, false advertisements, noncompliant financial representations and inconsistencies with the information contained in the franchise disclosure document. Be mindful of the impact information on a website can have on a system from a regulatory standpoint, as well as from a franchise sales perspective. Examiners may issue a comment letter if the information on a website is inconsistent with the disclosures in a franchise disclosure document.
Disclaim disclaimers
The amended Federal Trade Commission rule prohibits use of certain disclaimers. Any integration clause should be revised accordingly. Checklists or questionnaires without disclaimers that are prohibited by the rule and/or state laws can, however, still be used.
Information for US franchisors with international franchisees
Provide US Certificates of Residency to foreign franchisees
Under applicable US tax treaty rules, foreign franchisees which are paying royalties to US franchisors must receive a US Residency Certification from the US franchisor in order to benefit from lower, treaty-based withholding taxes imposed on the royalty payments to their US franchisor. US franchisors should file Internal Revenue Service Form 8802 at least 45 days before the certification is needed (eg, when a foreign royalty payment is to be made to them) and in any case not earlier than December 1 prior to the year to which the certification is to apply. For cost and time efficiencies, requesting US franchisors should check certification requests on the form for as many countries as the franchisor will or may receive eligible payments from foreign franchisees during the year in question (2012). When the certification is received (Form 6166), the US franchisor should provide a copy to each foreign franchisee whose payment is eligible for beneficial withholding tax treatment under a US tax treaty.
Update international franchise registrations
Some countries require an annual update or amendment to franchise registrations based on information that may have changed in the previous year. Registration may need to be updated or amended even if franchises in a country are not actively being offered. Check with an attorney to see if an update or amendment is necessary.
For further information on this topic please contact Jeffrey Brimer at Faegre Baker Daniels LLP's Denver office by telephone (+1 303 607 3500), fax (+1 303 607 3600) or email ([email protected]). Alternatively, please contact Mary Beth Brody at Faegre Baker Daniels LLP's Minneapolis office by telephone (+1 612 766 7000), fax (+1 612 766 1600) or email ([email protected]).