On September 16, 2014, the Franchise and Business Opportunity Project Group of the North American Securities Administrators Association (“NASAA”) adopted a Multi-Unit Commentary (“Commentary”) that affects the disclosure of multi-unit franchise development, including traditional area development, subfranchising and area representative arrangements. This guidance must be adopted by franchisors within 120 after the fiscal year end of a franchisor with an effective Franchise Disclosure Document (“FDD”), or within 180 days for a new franchisor. Compliance with the Commentary may dramatically alter a multi-unit franchisor’s cost of compliance due to the way in which NASAA addresses one type of multi-unit development arrangement: the area representative.
Under the Commentary, an area representative is a party granted the right to solicit third parties to enter into unit franchise agreements, but unlike a subfranchising program, the franchisor and not the area representative is the party to the unit franchise agreement.
The reason the Commentary has the potential to increase a franchisor’s cost of compliance with franchise disclosure and registration laws is because the Commentary now requires that an area representative program be disclosed in an FDD that is separate from a franchisor’s single unit and/or area development programs. This means that franchisors who offer single unit franchises and have area representative programs will have two (2) FDDs with separate registrations to manage in the various registration states. Prior to NASAA’s adoption of the Commentary, members of the Greensfelder Franchise and Distribution Group voiced concern that requiring two (2) FDDs in this situation could lead to confusion because area representatives will typically need to receive both disclosure documents as a result of the typical obligation imposed under area representative programs to require the representative to open at least one model unit under a franchise agreement. The need for multiple disclosures might be further complicated if a franchisor’s area representative FDD has been approved but they are still waiting approval on the single unit FDD. Furthermore, with the growing demand on state franchise regulators, the Commentary’s position on requiring these multiple registrations will only add to the states’ burden.
Under the Commentary, the area representative program will also have an impact on a franchisor’s single-unit franchise offering. For example, the area representative that has management responsibility relating to the sale or operation of franchises will need to be disclosed in Item 2, which will trigger litigation and bankruptcy disclosures relative to that individual, and rebates received by the area representative or its affiliates (to the extent a franchisor is aware of them) must be disclosed in Item 8.
In addition to dealing with area representative disclosures, the Commentary clarified and confirmed aspects of the disclosure obligations of the other common types of multi-unit franchise programs: area development and subfranchising.
Area development typically involves a single developer being granted the right to open a specified number of franchised outlets within a given territory according to a specified schedule. The Commentary affirms the way in which most franchisors have disclosed information related to their area development program in their FDD, including that the area development program can be disclosed in the same FDD as a single-unit franchise program. The Commentary also confirms that there should not be separate tables in Item 20 listing the number of area development arrangements in place. Instead, the list of current and former franchisees should identify outlets opened (or closed) by an area developer by use of footnotes. In short, for most franchise systems, the Commentary does not alter the disclosures they were already making for their area development program.
A subfranchise arrangement involves the franchisor granting rights to another (the subfranchisor) that permit the subfranchisor to enter into unit franchise agreements with third parties (the subfranchisees) in a specified territory. The subfranchisor essentially acts as the franchisor in the territory, and is therefore soliciting subfranchisees and providing training and other support services that the franchisor commits to provide in a unit franchise agreement. The master franchisor and subfranchisor usually share fees paid by the subfranchisees. As with the area development guidance, the Commentary confirms, rather than alters, the typical disclosure procedures that most franchisors already implement in their FDD.
Subfranchising requires separate FDDs. The separate FDDs will, however, have certain disclosures that overlap, such as the disclosure in the subfranchisor’s FDD to subfranchisees of litigation and bankruptcy of both the master franchisor and the subfranchisor, and the disclosure in the subfranchisor’s FDD of the unit outlets of both the subfranchisor and of the system as a whole. One exclusion from these overlapping disclosure obligations, however, is that a master franchisor should not disclose in the FDD for its subfranchising program the Item 20 information about single-unit franchises that are opened or closed. In other words, a master franchisor should not disclose to its prospective subfranchisors the number of unit outlets that are opened or closed.
The above describes some of the Commentary’s new requirements on multi-unit franchise programs. The full text of the adopted Commentary is available at http://www.nasaa.org/wp-content/uploads/2011/08/Franchise-Multi-Unit-Commentary-effective-Adopted-Sept.-16-2014.pdf.
Franchisors should review their multi-unit offerings to determine if their FDD incorporates the new NASAA Multi-Unit Commentary before renewing in the several franchise registration states.