Item 6 of the Franchise Disclosure Document: Other Fees

Item 6 is another item in the Franchise Disclosure Document (FDD) that provides prospective franchisees with the types and amount of fees associated with the operation of the franchise that are payable to the franchisor. It is distinct from Item 5, which covers pre-opening fees in that Item 6 describes recurring fees. Our knowledgeable attorneys could discuss what information a franchisor should disclose under Item 6, how a franchisor should disclose such information, and the best practices for artfully drafting such disclosures under Item 6 of the FDD.

Requirements of Item 6

The disclosures required under Item 6 are codified at 16 C.F.R. 436.5(f). Item 6 has a particular format for disclosing “other fees”. The formatting requirements require a franchisor to provide each type of fee, the amount of that fee, the due date for that fee, and any additional remarks concerning this fee, when applicable. This information should be organized under the following four-column tabular format:

      Item 6

OTHER FEES

Franchisors should be aware that, to follow the requirements of Item 6, the title “OTHER FEES” must be in bold type and all capital letters.

Under Item 6 of the FDD, a franchisor must disclose those fees, other than the initial fees provided for in Item 5, that a franchisee will or may have to pay to the franchisor or its affiliates throughout the franchise relationship. Some of these fees are recurring, such as fees for royalties and advertising. Others are occasional fees, such as transfer fees, renewal fees, or fees payable pursuant to the franchise agreement in the event of a breach or obligation of indemnity.

In addition to fees paid directly to and for the benefit of the franchisor, this document must also disclose those fees collected by the franchisor or its affiliates for the benefit of a third party, such as a lease deposit for a sublease or licensing fees for third-party software. However, a franchisor need not disclose fees to be paid directly by a franchisee to third parties, such as fees for telephone and Internet service, as those are typically disclosed in Items 7 or 8.

After a franchisor has provided the types of fees a franchisee will or may pay upon opening its franchise unit, the franchisor must provide the amount payable for that type of fee. A short statement of the dollar amount typically suffices. However, if the total amount of the fee is not a fixed flat amount, but rather, requires a formula to compute, a franchisor must also disclose that formula.

For example, stating the amount as “a percentage of gross sales” is an acceptable formula, provided the franchisor defines what it means by “gross sales.” If there is a possibility that a type of fee may increase over time, a franchisor must also disclose the maximum amount of the increase or the formula used to determine the increase.

Information in the Remarks Column

In the “remarks” column, a franchisor must provide any other information that is necessary to clarify the nature of the fee. Such information includes, if applicable:

• Whether the fee is payable only to the franchisor;
• Whether the fee is imposed and collected by the franchisor;
• Whether the fee is non-refundable or the circumstances when the fee is refundable;
• Whether the fee is uniformly imposed; and
• The voting power of franchisor-owned franchise units on any fees imposed by cooperatives and, if that voting power is controlling, the maximum and minimum amounts that can be imposed.

Sometimes the amount of information each of these requirements reveal is too long and crammed for aesthetic appeal under the required tabular format. Therefore, a franchisor may elect to disclose the necessary information in footnotes.

What are the Best Practices for Drafting Item 6 of the FDD

Just like with Item 5, before disclosing those fees applicable to Item 6, a franchisor should review their business practices to ensure that Item 6 covers all of the possible fees a franchisee may be required to pay directly to the franchisor or its affiliates, or for the benefit of a third party, during the course of the franchise relationship. This can be accomplished by reviewing previously filed FDDs, internal accounting records, prior franchise agreements, smaller fees, such as website maintenance fees, or fees that only become due upon certain triggers, such as additional training fees and attorneys’ fees. Comparing the fees set forth in the franchise agreement attached to the FDD with those disclosed in Item 6 is a prudent way to ensure that no fees are missing or outdated. Including fees in Item 6 of the franchise disclosure document that are no longer imposed by the franchisor serves no purpose other than to diminish the willingness of a prospective franchisee to enter into a franchise agreement.

Start-up franchisors commonly run into this difficulty in drafting their Item 6 disclosures: at the time of drafting, they have no idea what they may charge for certain occasional fees, such as those for additional training or reimbursements, and the exact amount is not specified in the franchise agreement. In these circumstances, stating the amount vaguely as the “then-current-fee” is insufficient and will likely require revision. Franchisors in these situations should draw on their experience with other clients or similar industries to determine a realistic estimate of the fee amount, or a range of the fee amount, and disclose it.

Despite rigid formatting requirements for Item 6, a franchisor is still capable presenting the disclosures in an artful way. This is where footnotes come into play. If more extensive information on a particular type of fee is necessary to give a prospective franchisee a complete picture of the nature of the fee, it is best practice to include such information in a footnote. This is also helpful for remarks that are relevant to multiple fees, such as those relating to whether the fee is payable to the franchisor, whether the fee is refundable, and whether the fee is imposed uniformly. For example:

      Item 6

OTHER FEES

Footnotes may also be used to explain the rationale behind the variation in the amount of the fee for any fee that is not uniform.

As a final check, a franchisor should compare the disclosures in Item 6 with those in Item 5 to determine if there is unnecessary overlap or are disclosed under the wrong item. Doing so could save the franchisor the time and expense of revising such disclosures upon the likely request of the examiner. As always, consulting with a franchise attorney is the best practice to ensure that all the substantive information is correctly disclosed, and that the formatting requirements are complied with, in Item 6 of the franchise disclosure document.