Item 11 of the Franchise Disclosure Document (FDD) provides an overview of a franchisor’s obligations to a franchisee, as set forth under the franchise agreement. As this is one of the densest Items of the FDD, franchisors most often struggle to disclose information in this section completely and accurately. While some of the required disclosures are categorical, others are required only if the nature of the franchise system makes them applicable. Our dedicated attorneys could This article will discuss the information a franchisor must disclose, the format it must take, and the best practices for drafting such disclosures under Item 11 of the FDD.
The FDD disclosure requirements are codified under the Federal Trade Commission’s Amended Franchise Rule, 16 C.F.R. §436 et seq. (the “FTC Rule”). In particular, the information that must be disclosed under Item 11 is codified at § 436.5(k). Under Item 11, the FTC Rule requires disclosure of a franchisor’s obligations under the relevant franchise agreement to furnish assistance to franchisees and help with advertising, computer systems, training, and operating manuals. Completely and accurately fulfilling the disclosure requirements under Item 11 is best done by categorizing the information into five main parts: assistance, advertising, computer systems, training, and manuals.
Under Item 11, franchisors must first disclose their obligations, as set forth in the franchise agreement, to furnish assistance to franchisees. Obligations to furnish assistance includes a franchisor’s pre-opening obligations, as well as post-opening obligations, along with a disclosure stating the typical length of time it takes to open a franchise. The general rule of thumb when drafting the FDD is that it should contain only those disclosures required by the FTC Rule. Therefore, while some franchisors may furnish pre- or post-opening assistance to franchisees, they are not specifically obligated to provide this under the franchise agreement, and as a result, are not required to be disclosed under Item 11. Moreover, some state examiners may require that disclosures about these types of “optional” assistance be removed from the FDD. Nonetheless, if a franchisor elects to do so, it must set out those obligations separately and clearly identify them as assistance that is not required by the franchise agreement.
Before discussing the substance of the pre- and post-opening obligations that a franchisor must disclose under Item 11, it is important to briefly note the format that the FTC Rule requires. At the top of Item 11, the FTC Rule requires franchisors to provide the following statement in bold type: “Except as listed below, [the franchisor] is not required to provide you with any assistance.” Additionally, for each obligation disclosed, franchisors are required to provide a specific reference to the section in the franchise agreement where that obligation is found.
The FTC Rule requires that franchisors disclose the actions they are obligated to take before the opening of the franchise. Some of these actions include:
Particularly, if the franchise agreement obligates the franchisor to locate and negotiate the purchase or lease of the franchisee’s site, then the FTC Rule requires that the following information also be disclosed:
If the franchise agreement obligates the franchisor to provide for necessary equipment, signs, fixtures, opening inventory, or supplies, then the FTC Rule requires that the following information also be disclosed:
After setting forth any pre-opening obligations found in the franchise agreement, franchisors must then disclose their obligations to provide assistance to a franchisee after the franchise is opened. While the FTC Rule provides several types of post-opening assistance that must be disclosed under Item 11, if they are not relevant to the franchise system, they may be omitted. The FTC Rule requires that franchisors disclose under Item 11 the following, if any, post-opening obligations to furnish assistance to a franchisee:
After listing the pre- and post-opening obligations to furnish assistance to a franchisee, a franchisor must provide an estimated range for the typical length of time it takes to open a franchise. This estimated range must be the time between signing the franchise agreement or receiving the first payment of consideration and opening the franchised business. Franchisors are also required to describe any factors that may impact this time frame, such as the ability to obtain a lease, financing or building permits, zoning and local ordinances, weather conditions, shortages, or delayed installation of equipment, fixtures, and signs.
After disclosing the franchisor’s obligations to furnish assistance to franchisees under the franchise agreement, the FTC Rule requires franchisors to disclose specific information about the franchise system’s advertising program. The disclosures related to the franchise system’s advertising program include describing:
If not all advertising funds are spent in the fiscal year in which they accrue, Item 11 of the FDD should describe how the franchisor uses the remaining amount, including whether franchisees receive a periodic accounting of how advertising fees are spent.
If the franchise agreement obligates the franchisor to conduct advertising, then the franchisor must also disclose the media that is used; whether the coverage will be local, regional, or national; the source of the advertising; and whether the franchisor must spend any amount on advertising in the area. If there is a council composed of franchisees that advises the franchisor on advertising policies, then a franchisor must also disclose how members of the council are selected; whether the council serves in an advisory capacity only or has operational or decision-making power; and whether the franchisor has the power to form, change, or dissolve the advertising council. If the franchisee must participate in a local or regional advertising cooperative, then a franchisor must also disclose the following:
For any other advertising fund a franchisee is required to participate in under the franchisee agreement, a franchisor must disclose:
For disclosures on the use of advertising funds in the last fiscal year, if there is a reasonable basis for claiming so at the time the disclosure is made, a franchisor may characterize internal costs associated with advertising production, such as supplies or computer graphics, as production expenses. Similarly, if an advertising fund pays all or part of the salaries of franchisor personnel who are involved in the advertising of the franchise system’s products or services, those costs can be characterized as a production or administrative expense, provided that the characterization is further explained in Item 11 of the franchise disclosure document.
The FTC Rule requires disclosure of any franchisee obligations to purchase or use point-of-sale (POS) or other computer systems contained in the franchise agreement, as well as information related to their hardware and software components. However, franchisors need not identify each and every piece of hardware and software by brand, type, and principal function; but rather, must only disclose the following:
It is important to note that when disclosing information relating to POS and computer systems, franchisors must do so in non-technical language.
Under Item 11, franchisors are also required, generally, to disclose the table of contents of the franchisor’s operating manual provided to franchisees as of the franchisor’s last fiscal year-end or a more recent date. Franchisors are also required to state the number of pages devoted to each subject and the total number of pages in the manual as of the date of the disclosure is made.
Franchisors may omit this disclosure under Item 11 if they offer a prospective franchisee the opportunity to view the manual before buying the franchise. However, merely asking a prospective franchisee to first sign a confidentiality agreement before permitting access to the operating manual will not permit the franchisor to omit this disclosure requirement.
Finally, the FTC Rule requires franchisors to disclose information pertaining to their training program under Item 11, as of the end of their last fiscal year-end or a more recent date. The FTC Rule further requires that some of the information pertaining to the training program be disclosed in a prescribed four-column tabular format.
The four columns should be titled in accordance with the example below, and should contain the following information: the “Subject” column should state the subjects taught under the training program; the “Hours of Classroom Training”; the “Hours of On-the-Job-Training”; and the “Location”.
|Hours of Classroom Training
|Hours of On-the-Job Training
|New York, NY
|Store Opening Assistance
In addition, the FTC Rule requires that franchisors provide the following information underneath the table.
When disclosing who may and who must attend training, the franchisor must also include whether the franchisee or other persons must complete the program to the franchisor’s satisfaction and if so, how long after signing the franchise agreement or before opening the business the training must be completed. And if training is not mandatory, the franchisor must state the percentage of new franchisees that enrolled in the training program during the preceding twelve months
For most franchisors, Item 11 is one of the longest and densest sections of the FDD. Because of the significant amount of information it entails, it is best practice to organize the information in a clear and concise way, such as organizing the information under subheadings similar, and providing the information under each subheading in chronological order. Doing so presents the franchise system more favorably and makes it easier for prospective franchisees to digest.
While franchisors are required to cross-reference sections of the franchise agreement when disclosing their obligations to furnish assistance, they are highly discouraged from cross-referencing other items of the FDD. For example, cross-referencing Item 2 for the experience of a franchisor’s training instructors is discouraged because Item 11 only calls for the instructor’s length of experience in the field and with the franchisor. Ultimately, it is best to avoid the temptation to cross-reference, and instead provide clear and concise language, speaking directly to the disclosures required under Item 11.
Even if the franchisor’s operations manual is completely online and does not contain the same type of table of contents that is typically found in a hardcopy, the table of contents and page counts must be included in Item 11. Because franchisors are moving toward providing their operating manuals in ways alternative to hard copies, the disclosure obligations have become more difficult to satisfy. For example, because web-based manuals may not have page numbers, some state franchise examiners have required franchisors to count numbers of screens for each subject, or to print the materials and count the printed pages, in order to satisfy this disclosure requirement. If a franchisor intends to include a link to the table of contents under Item 11, it should only be to the table of contents attached to the FDD. In the event the operating manual is incomplete when the FDD is otherwise ready, a franchisor can include the table of contents of the franchisor’s then-current manual and alert the prospect that the manual is in the process of being finalized.
If a franchisor permits prospective franchisees to review the operations manual under the terms of a confidentiality agreement, they may omit disclosures relating to the operating manual under Item 11. However, if the franchisor requires franchisees to sign a confidentiality agreement for this purpose, it must also disclose that requirement and include the form of confidentiality agreement as an exhibit to the FDD.
For start-up franchisors in particular, it can be challenging to accurately detail the specific subjects to be covered in training and to estimate the hours spent on each subject. Therefore, it is best practice for a start-up franchisor to fully consider the training to be provided before handing out the first FDD. Because start-up franchisors also tend to struggle with pinpointing current and ongoing costs related to technology, it is recommended that they provide conservative estimates. In the event a start-up franchisor’s computer system requirements are not yet finalized, it is best practice to indicate that the computer requirements are yet to be determined or otherwise provide the franchise system’s policy concerning computer systems.
For franchisors offering more than one branded or trademarked franchise for sale, they should generally segregate their disclosures for advertising funds for each brand. If that is impractical, franchisors may combine its advertising fund disclosures for all of its brands, as long as the FDD makes clear that the advertising funds are aggregated across brands.
As always, consulting with a seasoned franchise attorney is the best way for a franchisor to ensure that the information required under Item 11of the franchise disclosure document is properly disclosed and painted in a light most favorable to the franchisor.