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Item 10 of the Franchise Disclosure Document (FDD) requires a franchisor to disclose whether the franchisor, its agent, or affiliates offers financing arrangements to franchisees and, if so, the material terms and conditions of these arrangements. For franchisors that do not offer financing to franchisees, Item 10 is simple. It merely requires that a non-financing franchisor provide a negative disclosure. Item 10 is different from other Items of the FDD in that it implicitly recommends, but does not prescribe, the format that the disclosures must take.

Still, providing information relating to financing arrangements in a tabular format presents the franchise information to prospective franchisees neatly and concisely. Therefore, our team recommend franchisors present Item 10 information in a table. Additionally, our knowledgeable attorneys could describe what information a franchisor must disclose in Item 10 as well as the most effective way to organize it. During a consultation with one of our team members we could also recommend some of the best practices for artful drafting, under Item 10 of the FDD.

Requirements for the Financing Item of the FDD

The Federal Trade Commission (FTC) regulates disclosure requirements and prohibitions concerning franchising under the Amended Franchise Rule, 16 C.F.R. §436.5 (the “FTC Rule”). The particular disclosure requirements for Item 10 are found under § 436.5(j). Under Item 10, franchisors are first required to disclose the existence and terms of each financing arrangement that the franchisor, its agent, or affiliates offer directly or indirectly to the franchisee. The term “financing arrangement” under Item 10 includes leases and installment contracts. Direct financing arrangements offered by the franchisor, its agent, or affiliates are simple enough to spot. Where some confusion arises is determining what makes an offer for financing “indirect.” The FTC Rule attempts to clarify this confusion by providing the following as examples of financing arrangements indirectly offered to the franchisee:

  • A written arrangement between a franchisor or its affiliate and a lender, for the lender to offer financing to a franchisee;
  • An arrangement in which a franchisor or its affiliate receives a benefit from a lender in exchange for financing a franchise purchase; and
  • A franchisor’s guarantee of a note, lease, or other obligation of the franchisee.

Franchisors Who Do Not Offer Financing

If the franchisor, its agents, and its affiliates do not directly or indirectly offer financing arrangements to franchisees, then the franchisor need only provide a negative disclosure stating that the franchisor does not offer any financing. While the FTC Rule does not require that specific language be used in the negative disclosure, below are a few good examples:

  • “We do not offer any direct or indirect financing.”
  • “We do not offer direct or indirect financing, and we do not guarantee your notes, leases or other obligations.”
  • “We do not offer direct or indirect financing of your initial franchise fee. We do not receive any direct or indirect payments for financing you might obtain. We will not guarantee any financing you might obtain.”

So long as this negative disclosure is made, there is nothing left for a non-financing franchisor to disclose in Item 10.

Franchisors Who Do Offer Financing Arrangements

For those franchisors who offer, or whose agents or affiliates offer, financing arrangements directly or indirectly to franchisees, the next requirement in Item 10 of the FDD is to disclose the material terms and conditions of those financing arrangements. The FTC Rule does not require a particular format for these disclosures but does permit franchisors to summarize the terms of each financing arrangement in tabular form. It also permits franchisors to utilize footnotes as a means to provide additional information, as necessary.

Based on the amount of information that Item 10 calls for franchisors to disclose, as well as the possibility that a franchisor will have to disclose multiple different financing arrangements, it is highly recommended that a franchisor disclose the terms of the relevant financing arrangements in the tabular format recommended by the FTC. Each row in this table represents a separate financing arrangement.

SUMMARY OF FINANCING OFFERED

Item FinancedSource of FinancingDown PaymentAmount FinancedTerm (Yrs)Interest RateMonthly PaymentPrepay PenaltySecurity RequiredLiability Upon DefaultLoss of Legal Right on Default
Initial Fee
Land/Constr
Leased Space
Equip. Lease
Equip.
Purchase
Opening
Inventory
Other
Financing

Item Financed

This column is meant to briefly describe what the particular financing arrangement covers. The content under this column is not mandatory for Item 10 but is provided solely as an example based on common financing arrangements offered by a franchisor, its agents, or its affiliates. In addition to those provided, other examples of an “Item Financed” may include:

  • Site Acquisition,
  • Construction,
  • Remodeling,
  • Initial or Replacement Equipment,
  • Initial or Replacement Fixtures,
  • Ongoing Inventory
  • Initial or Ongoing Supplies, and
  • Other Continuing Expenses).

Regardless of what the “Item Financed” is, franchisors must attach sample copies of the financing documents as an exhibit under Item 22, and must cite the section and name of the document containing the financing terms and conditions.

Source of Financing and Down Payment

Under these columns, the franchisor should disclose the identity of each lender providing financing and their relationship to the franchisor (i.e., affiliate or agent) as well as the amount of down payment required for the financing arrangement. The down payment column is most commonly used in conjunction with the estimated initial investment disclosures in Item 7. Under 26 C.F.R. § 436.5(g)(2)(7)(ii), franchisors may refer franchisees to this table for additional details concerning the franchisor’s financing part of the initial investment.

Amount Financed and Term

Under these columns, the franchisor must disclose the amount of financing offered. If, however, the amount of financing depends on an actual, variable cost, the franchisor may state the amount financed as the percentage of the cost that will be financed. Then, the franchisor should state the length of the term set forth in the financing arrangement.

Interest Rate

Under this column, the franchisor must provide the rate of interest under the financing arrangement, plus finance charges, expressed on an annual basis. However, because interest rates or finance charges may fluctuate between the time the prospective franchisee receives the FDD and the time when he or she actually executes the financing agreement, the franchisor is permitted to state the interest rate in an alternative way. Thus, if the interest rates or finance charges may differ depending on when the financing is issued, the franchisor must also state what the amount was on a specified recent date.

Additionally, a franchisor may include a footnote stating that the interest rate may vary or state a formula by which the rate may change until the financing agreement is signed. Where the rate may change during the life of the loan, disclosure of that fact is required under the Item 10 “catch-all” requirement, which calls for disclosure of “other material financing terms.”

Monthly Payment and Security Required

The column is titled “Monthly Payment” as an example. Ultimately, under this column, the franchisor must state either the number of payments or the period of repayment, as set forth in the financing arrangement. If applicable, the franchisor also must state the nature of any security interest required by the lender.

Personal Guarantee and Prepay Penalty

Under these columns, the franchisor must state whether a person other than the franchisee must personally guarantee the debt. Additionally, the franchisor must state whether the franchisee’s debt can be prepaid and the existence and nature of any prepayment penalty.

Liability Upon Default

Under this column, the franchisor must state the franchisee’s potential liabilities upon default, as set forth in the financing arrangement. The following potential liabilities upon default are specifically required to be disclosed under Item 10 of the FDD if found in the financing arrangement:

  • Accelerated obligation to pay the entire amount due;
  • Obligations to pay court costs and attorney’s fees incurred in collecting the debt;
  • Termination of the franchise; and
  • Liabilities from cross defaults such as those resulting directly from non-payment, or indirectly from the loss of business property.

Other Material Financing Terms

There is not a specific column for this disclosure requirement in the table above. This disclosure requirement serves as a catchall, and the franchisor may utilize footnotes to the table in order to disclose any other material financing terms set forth in the particular financing arrangement.

In addition to the information disclosed in the Item 10 table, for any financing that is arranged through a third-party lender, the franchisor must disclose whether the loan agreement requires franchisees to waive any legal rights, such as the right to a jury trial. The franchisor must also disclose whether the loan agreement bars franchisees from asserting a defense against the lender, the lender’s assignee, or the franchisor. If the answer to either of these questions is “yes,” the franchisor must describe the relevant provisions in the financing agreement setting forth those terms.

The franchisor must also disclose whether the franchisor intends, or it is customary in the franchisor’s business practice, to sell, assign, or discount to a third party all or part of the financing arrangement. If the franchisor so intends, the franchisor must also state:

  • The assignment terms, including whether the franchisor will remain primarily obligated to provide the financed goods or services; and
  • That the franchisee may lose all its defenses against the lender as a result of the sale or assignment.

Lastly, the franchisor must disclose whether it or an affiliate receives any consideration for placing financing with the lender. If such payments exist, the franchisor must also disclose the amount or the method of determining the payment and identify the source of the payment and the relationship of the source to the franchisor or its affiliates.

Franchise Disclosure Document Item 10 Nuances

Under the FTC Rule, franchisors may disclose installment payment terms either in Item 5 or in Item 10 of the FDD. It is important to note that the franchisor’s disclosure of the material terms and conditions of offered financing arrangements in Item 10 does not prevent the franchisor and franchisee from negotiating different terms and conditions after the disclosure.

However, because such changes in financing terms or conditions are presumptively material to the franchisee’s purchasing decision, if franchisor unilaterally changes the terms or conditions to a particular financing arrangement offered, a prospective franchisee has seven calendar days to review those changes.

Additional NASAA Requirements

In 2008, the North American Securities Administrators Association (NASAA) adopted the disclosure requirements of the FTC Rule, and added some additional requirements to form its Franchise Registration and Disclosure Guidelines. The Guidelines serve as a model for states with a specific franchise registration and disclosure law.

The commentary to the Guidelines provides that, although not specifically excluded by Item 10, payments due from a franchisee to a franchisor within 90 days on an open account financing arrangement do not need to be disclosed under Item 10.

Regarding the requirement that a franchisor attach as an exhibit to Item 22, samples of financing contracts that a franchisee may sign, if there are variations in any collateral contracts, a franchisor need not attach all the varying collateral contracts as exhibits under Item 22 of the FDD. NASAA has explicitly recognized that, in some cases, attaching every variation of a collateral financing contract that a franchisee must sign as part of a franchise purchase may unduly clutter the FDD, and ultimately discourage its review by prospective franchisees. The Guidelines provide that if there are variations in a particular type of collateral contract, such as loan agreements that vary state by state, a franchisor need only attach a sample document of the financing contract as an exhibit to Item 22 of the FDD. To the extent there are any material differences in the contracts, the franchisor should disclose those differences under Item 10 or in state specific addenda.

Tips for Drafting Item 10

It is best practice to disclose the necessary information under Item 10 in a way that is clear and digestible to a prospective franchisee. Item 10 affords franchisors a substantial amount of flexibility how they wish to present the required information.  While franchisors are permitted to disclose the information in another format, clarity in Item 10 is best accomplished by stating the material terms and conditions of the financing arrangements in a tabular format, with footnotes, as necessary, for further explanation. Careful attention must be given to ensure that all required information is disclosed and that, if a table is used for the disclosures, notes are used to explain the information disclosed.

It is worth noting that, while the interest rate disclosures are modeled on the disclosures lenders make under the Federal Reserve’s Truth in Lending and Consumer Leasing regulations for consumer credit, these regulations generally do not apply directly to lease and financing transactions undertaken in connection with the purchase of a franchise. However, it is prudent for franchisors to look into the substance of these for guidance in preparing their Item 10 interest rate disclosures.

Additionally, if a franchisor is on the SBA Registry, some practitioners may include a statement similar to the following in the FDD: “We are listed on the SBA’s Franchise Registry Program.” Although this information can be useful to a prospective franchisee and helpful as a sales tool to the franchisor, it is not a required disclosure. Some state examiners may require the franchisor to remove such a statement because it is not technically required. To avoid the possible ramifications for non-compliance under Item 10 of the franchise disclosure document, and to ensure that the information is presented appropriately and accurately, it is best practice to consult with a seasoned franchise attorney before drafting any Item of the FDD.

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