Item 4 of the Franchise Disclosure Document (FDD) requires a franchisor to disclose the bankruptcy history of the franchisor and its predecessors, parents, affiliates, and individuals disclosed in Item 2 for ten years prior to the date of the FDD. Our experienced attorney could discuss the required disclosures under Item 4, as well as the best practices for drafting this section.
The required disclosures under Item 4 of the FDD are codified at 16 C.F.R. § 436.5(d). A franchisor is required to disclose the bankruptcy history of the following individuals and entities:
Item 4 differs from Item 3 in relation to the disclosures of parents and affiliates. In Item 3, the litigation history of parents and affiliates that is required is generally limited to those parents or affiliates who financially back or guarantee the performance of the franchisor. However, in Item 4, whether the parent or affiliate financially backs or guarantees the performance of the franchisor is irrelevant.
Therefore, any bankruptcy in which an affiliate or a parent was involved during the 10-year reporting period immediately before the issuance date of the disclosure document must be disclosed. Additionally, like in Item 1, a franchisor must disclose the bankruptcy history of all parents of the franchisor; not just a parent that the franchisor reports to or the highest parent in the chain of ownership, but all intermediate parents, as well.
There are a number of actions that comprise the “bankruptcy history” that a franchisor is required to disclose under Item 4. For instance, if an individual or entity above has filed as a debtor (or had filed against it) a petition under the United States Bankruptcy Code, this must ne disclosed in Item 4 of the FDD.
Additionally, if an individual or entity above has obtained a discharge of its debts under the United States Bankruptcy Code, this information must be provided as well. Lastly, a franchise must disclose bankruptcy history if an individual or entity above has been a principal officer of a company or a general partner in a partnership that either:
Once a franchisor has determined that either it, or a parent, predecessor, affiliate, or Item 2 individual has been involved in one of these “bankruptcy history” actions within the last ten years, it must provide the following information for each bankruptcy:
As with Item 3, if a franchisor has no bankruptcy information to report, the franchisor should provide in Item 4 “No bankruptcy is required to be disclosed in this Item.”
Item 4 gives prospective franchisees insight into the financial stability of the franchisor and its associated individuals and entities. While full transparency and candor is best practice in drafting the FDD, just as in Item 3, a franchisor retains discretion to artfully craft the descriptions of the bankruptcy history it discloses.
Therefore, to minimize the negative connotations associated with such bankruptcy, a franchisor can provide a description of the context under which the bankruptcy was filed. Additionally, for bankruptcies filed by unrelated companies where an executive of the franchisor previously worked, the disclosure should identify the executive’s role with the other company and explain the executive’s role in the financial management of the company and the bankruptcy filing.
Doing so can alleviate the effect of the disclosure on the franchisee, and may assuage any concerns that the franchisee has about the financial status of the franchisor or its associated individuals and entities. Careful, artfully worded explanations of the context surrounding such bankruptcies can ultimately make a prospective franchisee more inclined to enter into a franchise agreement with the franchisor. As always, the best practice a franchisor can employ is to consult with its franchise attorney regarding the required disclosures under Item 4 of the FDD.