By Blair A. Rebane and Eric C. Little, Borden Ladner Gervais LLP

The COVID-19 pandemic has had a significant impact on businesses in almost every sector.  For franchisors, managing the effects of the pandemic on franchise systems – which in many cases have been pervasive, complex and multifaceted – has been challenging.  On top of this, the effects of the pandemic and the steps that franchisors and governmental authorities have taken to address them raise disclosure implications which franchisors must consider carefully to ensure they are providing compliant disclosure to prospective or renewing franchisees.

For the majority of franchise systems, the effects of the pandemic have been mostly negative.  Decreased revenues, mandatory or voluntary closures, changes to supplier and customer relationships and standard operating procedures have all taken a toll on franchise systems and made doing business more difficult.  That said, there are some franchise systems that have experienced positive results in connection with the pandemic, due to increased demand for the products or services they offer.  In either case, franchisors must consider whether the effects of the pandemic on their system have impacted any of the information contained in their current form of franchise disclosure document (“FDD”) or raise any new “material facts” that must be disclosed to prospective or renewing franchisees.

This article discusses some of the key items that franchisors should consider to ensure that their FDDs and disclosure practices address the effects of the pandemic on their franchise systems.

Reviewing and Updating Current Form of FDD

In many cases, the pandemic is likely to have implications for the accuracy and completeness of the prescribed information contained in a franchisor’s current form of FDD.  Accordingly, franchisors should carefully review their current form of FDD to determine whether any of the information it contains has been rendered incorrect, out-of-date or potentially misleading as a result of the effects the pandemic has had on their system.  Franchisors should also consider whether any additional information needs to be added to their current form of FDD in order to completely and accurately disclose such effects.  Below are examples of some of the key areas of the FDD that may need to be updated:

• Any information given regarding earnings and operating costs – If the FDD provides any information regarding earnings or operating costs, that information must be carefully reviewed to ensure that it is complete, accurate and up-to-date.  Franchisors should take extra care in explaining the impacts the pandemic has had on the information provided – whether positive or negative – and how that information differs from the franchisor’s pre-pandemic experience.  Franchisors should also review the bases and assumptions underlying the information provided and ensure that they are accurately disclosed in accordance with the requirements of applicable franchise legislation.
• Details of current locations and closures – The FDD should provide details of any mandatory or voluntary closures that were implemented in response to the pandemic.  Franchisors should also ensure that the information provided regarding current franchisees and locations, and franchisees who have left the system, is up-to-date and reflects any changes in the network arising from or in connection with the pandemic.
• Any changes to fees and payments collected by the franchisor – If franchisors have temporarily reduced, waived or deferred the collection of any fees or other payments from franchisees in response to the pandemic, details of those arrangements should be provided in the FDD.
• Any changes to costs of establishing the franchise – For some franchise systems, the pandemic has had an impact on the costs that a franchisee is likely to incur in establishing the franchise.  For example, some businesses have had to change their typical store layout or design requirements in order to accommodate social distancing requirements and implement protective barriers.  Many businesses have also had to purchase personal protective equipment for their employees, which previously would not have been a required expense, and have incurred higher costs for hand sanitizer and cleaning products than they would have in the past.  Franchisors should consider carefully how the pandemic and the steps they have taken to address it within their franchise system might have impacted the costs that a franchisee is likely to incur in establishing and operating their franchised business, and ensure that all such costs are accurately reflected in the FDD.
• Any changes to required products, services and suppliers – The pandemic has created disruptions in many supply chains, as some suppliers have folded, others have been unable to meet the demand for their products or services, and shipping and delivery arrangements have been challenged and forced to adapt.  The FDD should address any changes to the products and services that a franchisee is required or permitted to use in connection with operating their franchised business, as well as any changes to the suppliers they are required or permitted to obtain those products or services from.
• Any changes to training or assistance offered by the franchisor and how it is provided – If the pandemic has caused any material changes in the training or assistance offered by the franchisor and how it is provided to franchisees, those changes should be disclosed in the FDD.  For example, if any new training is offered or required to be completed in connection with the pandemic or the measures the franchise system has adopted to address it, if any in-person training has been changed to virtual or online training, or if the locations or costs for any training have changed, franchisors should consider whether those changes need to be reflected in the FDD in order for the information provided to be complete, accurate and up-to-date.
• Changes to the terms of any financing offered by the franchisor – If the franchisor has modified the terms on which it offers any financing to prospective franchisees, or changed whether it offers financing at all, the details of these changes should be disclosed in the FDD.

Of course, the specific items that may need to be updated will vary from one franchise system to another, based on the experience of that system and its own response to the pandemic.  Franchisors will need to think critically about their own FDD, and where updates may be needed to any of the information it contains.

Disclosure of New “Material Facts”

In addition to any updates to the prescribed information contained in a franchisor’s current form of FDD, franchisors should also consider whether there are any new “material facts” that need to be disclosed to prospective or renewing franchisees as a result of the effects of the pandemic on the franchise system.  “Material facts” include any information about the franchisor or the franchise system that would reasonably be expected to have a significant effect on the value or price of the franchise to be granted or the decision to acquire the franchise.  Below are some examples of information that might constitute a material fact in the context of the pandemic:

• the overall impact the pandemic has had on revenues or operating costs within the franchise system;
• any changes to standard operating procedures, methods for provision or delivery of products or services or hours of operation within the franchise system;
• temporary modifications or waivers of certain obligations under the franchise agreement or any other agreement relating to the franchise;
• any known disruptions in the supply chain for required products or services, or any material changes in the pricing terms for such products or services, arising from or in connection with the pandemic;
• any changes to build-out timelines or anticipated delays in relation to the construction, opening and operation of the franchised business;
• any industry-specific measures imposed by governmental authorities in response to the pandemic that are relevant to the establishment and operation of the franchised business; and
• any site specific material facts relating to a particular franchise being offered.

If any developments have occurred in connection with the pandemic that could potentially rise to the level of a material fact, franchisors should ensure that those developments are disclosed in the FDD.

Disclosure of “Material Changes”

For any prospective franchisees who have been given an FDD but have not yet signed a franchise agreement, franchisors should consider carefully whether any “material changes” have occurred since the FDD was provided, in connection with the pandemic or the steps that the franchisor or relevant governmental authorities have taken in response to it.  A “material change” is a change in the business, capital or control of the franchisor, or a change in the franchise system, that would reasonably be expected to have a significant adverse effect on the value or price of the franchise to be granted or on the decision to acquire the franchise.  If a material change has occurred, the franchisor must provide the franchisee with a statement of material change as soon as practicable after the change has occurred and before the prospective franchisee signs the franchise agreement or makes any payment to the franchisor in relation to the franchise.  Since the pandemic, the various responses to it, and its effects on franchise systems are all unfolding on an ongoing basis, and can change rapidly, franchisors must exercise extra diligence to stay abreast of these matters and ensure that any developments that could constitute a material change are disclosed to prospective franchisees in accordance with applicable franchise legislation.

Key Takeaways

The pandemic and its ongoing effects on franchise systems present significant disclosure challenges for franchisors.  In order to stay on top of these challenges, the best practice is for franchisors to review their standard form of FDD often and ensure that it is updated promptly to reflect any developments associated with the pandemic that affect the accuracy of its contents or that potentially constitute new material facts regarding the franchise being offered.  As the pandemic continues to unfold, franchisors should take extra care to ensure that every FDD that is provided to a prospective or renewing franchisee is entirely up-to-date, complete and accurate, and that any material changes that arise after an FDD is given to a prospective or renewing franchisee are properly disclosed to the franchisee before they sign the franchise agreement or make any payment to the franchisor.  While it seems that little is certain when it comes to the pandemic, its evolution and its effects, one thing that is clear is that COVID-19 and the business environment it has created will be with us for many months to come.  Accordingly, franchisors should ensure that their FDDs and disclosure practices are properly updated and aligned to ensure compliance with their statutory disclosure obligations.

ABOUT THE AUTHORS

Blair A. Rebane is a partner at Borden Ladner Gervais LLP (“BLG”) and the National Leader of the firm’s Franchise and Distribution Group.  Eric C. Little is a partner in the Corporate Commercial Group at BLG, who practices corporate commercial law with an emphasis on franchising, licensing and distribution.