NASAA Issues Final Commentary on Franchisor Financial Performance Representations

On May 8, 2017, the North America Securities Administration (“NASAA”) issued the final version of its commentary on franchisor financial performance representations (the “FPR Commentary”).  The FPR Commentary applies to franchise disclosure documents (“FDDs”) updated after its effective date.[1]

The Federal Trade Commission’s Amended Franchise Rule (the “FTC Rule”), permits a franchisor to make financial performance representations in Item 19 of its FDD only if it has a “reasonable basis” for those representations.  See 16 C.F.R. § 436.5(s)(3).  The FTC Rule, however, does not define what a “reasonable basis” would be.  The FPR Commentary provides guidance on this issue.

Here are some of the key takeaways:

  • Forecasts and Projections.  Forecasts and projections must be based on historical data and cannot be based on mere hypothetical situations or expectations.
  • Averages and medians.  Whenever a franchisor discloses an average of numbers, it must also disclose the median, and vice versa, because the existence of outliers may make the average/median misleading, even if accurate.
  • Subsets.  A franchisor cannot make a financial performance representation based solely on the performance of a subset of the best performing outlets.  If the franchisor discloses such a subset, it must also disclose the corresponding worst performing outlets—even if the FDD includes system-wide financial performance information.
  • Use of data from franchisor-owned business units.  Whether a franchisor has operational franchised outlets or not, a franchisor can make a financial performance representation disclosing gross or net profit based solely on company-owned data. When using this data, however, franchisors must account for material financial and operational differences between company-owned outlets and operational franchised outlets such as royalty fees and differences in costs attributable to economies of scale.

If you a potential franchisee reviewing a FDD or an existing franchisee that believes you may have been induced to make a bad investment through an unreasonable financial performance representation, Ichter Davis is ready and willing to help.

[1] The FPR Commentary’s effective date is around or about November 8, 2017 (180 days after NASAA adopted the FPR Commentary) or 120 days after a franchisor’s next fiscal year end if the franchisor has an effective FDD as of May 8, 2017.

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