Item 20 of the Franchise Disclosure Document: Outlets and Franchisee Information

Item 20 of the Franchise Disclosure Document (FDD) requires a franchisor to disclose statistical information on the number of franchised and company-owned outlets for the preceding three-year period, as well as other certain information concerning the franchise system. Some disclosures under Item 20 must be provided in a prescribed tabular format, and others may be provided simply with text. Our team could discuss what information a franchisor must disclose, provide the format for such disclosures, and recommend the best practices for drafting, under Item 20 of the FDD.

Requirements for Item 20 of the FDD

The disclosure requirements for Item 20 are codified under 16 C.F.R. §436.5(t). Under Item 20, a franchisor is required to disclose statistical information on the franchise system in five tables, each of which requires an FTC-prescribed format, as well as additional disclosures following these tables.

Some of the tables under Item 20 are intended to reflect changes in ownership status in the franchise system. For some franchisors, there may be several changes in the status of a particular outlet during the course of the franchisor’s fiscal year. For example, a franchisee may cease operation of the franchise unit, and a franchisor may terminate the franchise agreement as a result. In instances like this—where there are multiple changes in status for a particular franchised outlet during the course of the franchisor’s fiscal year—the FTC Rule provides that only the last event for that specific outlet in that fiscal year must be disclosed. Therefore, in the example above, the franchisor would only report the change in status as a termination. However, if they so choose, franchisors are permitted to use footnotes to the tables in Item 20 to explain multiple changes in status at a particular franchised outlet. These footnotes are not required, but only encouraged by the FTC Rule, except in the case of disclosing multiple franchise owners.

Table 1 of Item 20

Table 1 of Item 20 provides prospective franchisees with a systemwide summary of the net change in both franchised and company-owned outlets in the last three fiscal years. As the column headers indicate, a franchisor must disclose the total number of franchised and company-owned outlets operating at the start and end of each fiscal year. For purposes of Table 1, “outlets” refers to all outlets that are substantially similar to that offered for sale to the prospective franchisee.

With the exception of the italicized text, the components and format of the table below are required by the FTC Rule. Even if there are no company-owned outlets, or if there are not yet franchised outlets in the franchise system, a franchisor must nonetheless include these categories under the “Outlet Type” column and fill in their values as 0. In the “Net Change” column, a franchisor needs only subtract the value in column 3 from the value in column 4 and indicate whether the change is positive or negative.

Item 20 Table No. 1

Systemwide Outlet Summary

Table 2

Under Table 2 of Item 20, a franchisor must disclose the total number of outlet transfers, for each state in which there is at least one franchised outlet, in each of the last three fiscal years. Transfers are reported in separately from changes in ownership under Item 20 because they occur for a variety of reasons unrelated to the franchisee’s operation of the franchise.

With the exception of the italicized text, the components and format of the table below are required by the FTC Rule. For the “Number of Transfers” column, the FTC Rule defines a “transfer” as “the acquisition of a controlling interest in a franchised outlet, during its term, by a person other than the franchisor or an affiliate.” The private sale of an outlet by the existing franchisee-owner to a new franchisee-owner, as well as the sale of a controlling interest in the ownership of a franchise, constitute transfers within the meaning of Table 2.

Item 20 Table No. 2

Transfers of Outlets from Franchisees to New Owners (other than the Franchisor)

Table 3

Under Table 3 of Item 20, a franchisor must disclose the changes in the status of franchisee-owned outlets located in each state for each of the franchisor’s last three fiscal years. Again, in the “State” column, a franchisor must disclose every state in which there is at least one franchised outlet. In the “Outlets at Start of Year” column, a franchisor must state the total number of franchised outlets in each state at the start of each fiscal year. In the “Outlets Opened” column, a franchisor must state the total number of franchised outlets opened in each state during each fiscal year, which includes both new and existing company-owned outlets that a franchisee purchased from the franchisor. Note that the number of existing outlets that are sold to a franchisee under Table 3 must also be reported in Table 4.

In the “Terminations” column, a franchisor must state the total number of franchised outlets that were terminated in each state during each fiscal year. For purposes of Table 3, the FTC Rule defines “termination” as the franchisor’s termination of a franchise agreement prior to the end of its term and without providing any money or other consideration to the franchisee, such as the forgiveness or assumption of debt. A common example of a termination within the meaning of Table 3 is when a franchisor terminates a franchise agreement because of the franchisee’s failure to abide by system standards. Because the franchise agreement is terminated as a result, and the franchisee leaves the franchise system without receiving any payment, this constitutes a “termination” for purposes of Table 3.

In the “Non-Renewals” column, a franchisor must state the total number of non-renewals in each state during each fiscal year. For purposes of Table 3, a “non-renewal” occurs when the franchise agreement for a franchised outlet is not renewed at the end of its term. If the term of the franchise agreement is ten years, and at the conclusion of the tenth year, the franchisor and franchisee do not renew the franchise agreement, this is considered a non-renewal.

In the “Reacquired by Franchisor” column, a franchisor must state the total number of franchised outlets reacquired by the franchisor in each state during each fiscal year. For purposes Table 3, a “reacquisition” means the return of a franchise outlet during its term to the franchisor in exchange for money or some other consideration, such as forgives or assumption of debt. An example of a reacquisition is when a franchisor and franchisee mutually agree to terminate the franchise agreement before its natural expiration, and the franchisor agrees to buy back the outlet with money, or to forgive an overdue royalty payment due from the franchisee. Note that a franchisor must also disclose the number of outlets reacquired by a franchisor in Table 4 of Item 20.

In the “Ceased Operations–Other Reasons” column, a franchisor must state the total number of outlets in each state not operating as one of the franchisor’s outlets at the end of each fiscal year for any reason other than termination, non-renewal, or reacquisition. This includes abandonment of the franchised outlet by a franchisee, as well as franchisees that are in an “inactive status.” Finally, in the “Outlets at End of the Year” column, a franchisor must state the total number of franchised outlets in each state at the end of the fiscal year. The example Table 3 below also contains an example of when a footnote can be used to show multiple changes in ownership for a particular franchised outlet. With the exception of the italicized text, the components and format of the table below are required by the FTC Rule.

Item 20 Table No. 3

Status of Franchised Outlets

Table 4

Under Table 4 of Item 20, a franchisor must disclose the status of company-owned outlets located in each state for each of the last three fiscal years. The headers in Table 4 indicate what a franchisor should disclose under that particular column. In fact, Table 4 is notably similar to Table 3, with the exception that Table 4 asks for the total number of company-owned outlets closed; meaning, actual closures and when a franchised outlet ceases to operate under the franchisor’s trademark. Table 4 is different than Table 3 in that it does not require the franchisor to allocate status changes in different columns based on the actions of franchisees. With the exception of the italicized text, the components and format of the table below are required by the FTC Rule.

Item 20 Table No. 4

Status of Company-Owned Outlets

Table 5

Under Table 5, a franchisor must disclose its projections for new outlet openings in each state, as well as the number of franchise agreements that have been signed but have not yet resulted in the opening of a franchised outlet. Any franchise agreement that the franchisor has entered into with a franchisee, but which has yet to open at the end of the fiscal year must be reported in the “Franchise Agreements Signed But Outlet Not Opened” column. In the last two columns, a franchisor must disclose the projected number of new franchised and company-owned outlets for the next fiscal year. The FTC Rule does not require any specific formula for franchisors to make such projections, and only require that such projections have a reasonable basis, such as a historical market trends or the franchisor’s own track record. With the exception of the italicized text, the components and format of the table below are required by the FTC Rule.

Item 20 Table No. 5

Projected Openings as of [Last Day of Last Fiscal Year]

Franchisee Information in Item 20 of the FDD

In addition to the tables required, a franchisor must also disclose contact information for its current franchisees. This information must include the franchisee’s name, and the address and telephone number of their outlets. If a franchisor has fewer than 100 current franchisees, it must provide disclose each franchisee’s contact information. If a franchisor has 100 or more current franchisees, a franchisor may take one of two paths. First, the franchisor may provide only the franchisee contact information for franchisees in the state where they are offering to sell franchises, as long as there are at least 100 franchises in the state. Alternatively, if there are not at least 100 franchises in the state where the franchisor is offering to sell franchises, the franchisor must provide contact information for all franchisees in contiguous states, and then the next closest states in proximity, until there is contact information for at least 100 franchised outlets.

If a franchise is operated from the franchisee’s home, franchisors may substitute a post office box or current email address for the home address of the franchisee. Additionally, franchisors should list only the telephone number of the franchisee’s business, if there is a separate line for the business, and not the franchisee’s personal phone number. If there is not a separate telephone number for the franchisee’s business, a franchisor may disclose a valid email address as a substitute.

Next, a franchisor must disclose contact information for two types of former franchisees. First, a franchisor must disclose former franchisees who had an outlet terminated, canceled, not renewed, or otherwise voluntarily or involuntarily ceased to do business under the franchise agreement during the most recently completed fiscal year. Additionally, they must disclose former franchisees who have not communicated with the franchisor within 10 weeks of the disclosure document issuance date. Franchisors may substitute alternative contact information at the request of the former franchisee, such as a home address, post office address, or a personal or business email address. If a franchisor has former franchisees that fall within one of the two categories stated above, it must disclose the name, city, state, and current business telephone number.

If the current business telephone number of a franchisee falling under this disclosure is unknown, a franchisor may state the last known telephone number of the franchisee. Additionally, to ensure that prospective franchisees are aware that their contact information will be disclosed once they leave the franchise system, the franchisor must provide the following statement, “If you buy this franchise, your contact information may be disclosed to other buyers when you leave the franchise system.”

Previous Owner Information

Under Item 20 of the franchise disclosure document, if a franchisor is selling a previously owned franchised outlet that is now under the franchisor’s control, it must disclose the following additional information on that outlet for the last five fiscal years.

• The name, city and state, current business telephone number, or if unknown, last known home telephone number of each previous owner of the outlet;
• The time period when each previous owner controlled the outlet;
• The reason for each previous change in ownership; and
• The time period(s) when the franchisor retained control of the outlet.

Note that a franchisor can attach this information as an addendum to the FDD or, if disclosure has already been made, in a supplement to the previously furnished FDD. Also, this disclosure is an exception to Item 20’s general rule that a franchisor need only disclose the most recent status change for a franchised outlet. If there are multiple franchised units with previous franchisee-ownership that are being sold, the franchisor must provide the information for each previously owned franchised outlet.

Confidentiality Agreements

Under Item 20, a franchisor must disclose whether its current or former franchisees signed confidentiality agreements during the last three fiscal years. For purposes of this disclosure, a confidentiality agreement is “any contract, order, or settlement provision that directly or indirectly restricts a current or former franchisee from discussing his or her personal experience as a franchisee in the franchisor’s system with any prospective franchisee.” Therefore, if the confidentiality agreement does not restrict the current or former franchisee from discussing his or her personal experience as a franchisee—and say, restricts them from discussing their personal experience as a manager in the franchise system—then such an agreement need not be disclosed under Item 20. Similarly, a confidentiality agreement restricting a franchisee from discussing specific terms of a settlement with a franchisor, but does not restrict the franchisee from discussing having a dispute with the franchisor, would not need to be disclosed under Item 20.

If its franchisees have signed confidentiality agreements, the franchisor must provide the following statement, “In some instances, current and former franchisees sign provisions restricting their ability to speak openly about their experience with [name of franchise system]. You may wish to speak with current and former franchisees, but be aware that not all such franchisees will be able to communicate with you.”

Although not required, a franchisor may also disclose the number and percentage of current and former franchisees who, during each of the last three fiscal years, signed agreements that include confidentiality clauses and may disclose the circumstances under which such clauses were signed.

Franchisee Associations

The last disclosure requirement under Item 20 of the FDD relates to franchisee associations. For this disclosure requirement, a franchisor must disclose, to the extent known, the contact information for trademark-specific franchisee organization associated with the organization if the association has either (1) been created, sponsored, or endorsed by the franchisor; or (2) is incorporated or otherwise organized under state law and asks the franchisor to be included in the franchisor’s disclosure document during the next fiscal year. For each of these two categories, the franchisor should disclose the name, address, telephone number, email address, and Web address (to the extent known) of each trademark-specific franchisee organization associated with the franchise system being offered.

If the trademark-specific organization falls within category (1), the franchisor must also state the relationship between the organization and the franchisor; namely, whether it was created, sponsored, or endorsed by the franchisor. Under category (2), a franchisor “sponsors” an association if it contributes to it financially, or provides tangible benefits such as office space, equipment, or personnel. A franchisor is considered to “endorse” an association if the franchisor takes affirmative steps to promote awareness of the association, its membership, or growth. However, if a franchisor merely recognizes the existence of the association, such as by meeting with one or more of its members or referencing the existence the association in an email, this is does not mean the franchisor endorses or sponsors the organization.

If a trademark-specific organization falls within category (2), note that such organizations must renew their request with the franchisor on an annual basis by submitting a request no later than sixty days after the close of the franchisor’s fiscal year. Additionally, the franchisor has no obligation to verify the organization’s continued existence at the end of each fiscal year, and if a franchisor elects to do so, it may include the following statement: “The following independent franchisee organizations have asked to be included in this disclosure document.”

Item 20 Nuances

For former franchisee information, the FTC provides that a franchisor may disclose contact information for former franchisees in an exhibit or an attachment to its FDD; provided, that two conditions are met. The first being that the franchisor discloses in Item 20 the number of former franchisees listed in the exhibit or attachment. The second being the franchisor includes the required cautionary notice both in Item 20 and in the exhibit or attachment. 

Additional NASAA Requirements for Item 20

The Guidelines from the North American Securities Administrators Association for Item 20 state that franchisors should use separate charts for statistics reflecting a subfranchisor’s region and for statistics reflecting national data for the franchise being offered. Additionally, the commentary to the Guidelines states that franchisors need not include separate charts or lists of outlets for area developers or area representatives. Lastly, the commentary to the Guidelines states that a franchisor, when listing current and former franchisees, should do so by state, with the applicable states listed in alphabetical order, then within each state by city, with the applicable cities also in alphabetical order.

Item 20 Drafting Tips and Best Practices

Item 20 is one of the denser sections in the FDD. Although the prescribed tabular formats inherently limit the degree of a  franchisor’s artful drafting, such drafting can still be accomplished through the use of footnotes; particularly, where multiple changes in ownership can be more adequately explained. It is best practice for a franchisor to use footnotes following each table to explain the activity in the best possible light for the franchise system and to shape the franchisee’s perception of the data presented in Item 20. Additionally, it is highly recommended that a franchisor use separate charts where necessary under Item 20, as it fosters precision and clarity, which is consistent with the FTC Rule’s goal of full and accurate disclosure. It is a wise decision to contact a seasoned franchise attorney to ensure that the necessary information required under Item 20 of the franchise disclosure document is provided completely, accurately, and in the best possible light for the franchisor.