Material Change Amendments in Franchise Registration States

Franchisors are usually focused on updating disclosure documents annually. What can oftentimes be overlooked is the ability to amend the offering during the year or the requirement to do so upon the occurrence of certain events. Determining when a “material” change has occurred can be difficult, and navigating the amendment process lacks uniformity in application and can affect the sales process dramatically.

What constitutes a “material” change?

Generally, a “material” change occurs any time there is a fact, circumstance or set of conditions which would likely influence a reasonable prospective franchisee in the making of the decision to purchase the franchise. The following are examples (and not an exhaustive list) of what the the Federal Trade Commission and various state franchise laws consider material changes:

• filing of a bankruptcy

• negative change in franchisor’s financial statements

• closing, during any 3 month period, of either the greater of 1% or 5 franchised outlets system-wide, or the lesser of 15% or 2 franchised outlets located in the state

• reorganization, change in control or management, or a change in corporate name or state of incorporation

• changes in disclosed litigation or the filing of new litigation

• material negative change in the financial performance representation

A material change can also be an optional change implemented by the franchisor. For example:

• new fee or changes in fees

• new product line or ceasing to offer a particular product line

• changing the financial performance representations

How long after a material change must an amendment be filed?

Under the FTC Franchise Rule, an amended FDD must be prepared within a reasonable time after the close of each fiscal quarter in which a material change occurred. Generally the franchise registration states require amendments to be filed sometime between the occurrence of the material change and 30 days after the end of the quarter.

What happens to the sales process during the pendency of a material change amendment?

One of the hardest aspects of navigating material change amendments is strategizing the timing of filing so as to disrupt the franchise sales process as little as possible. Each franchise registration state which requires the filing of an amendment differs on when such filings are effective. These range from immediately upon filing to waiting for the affirmative approval of the state regulator. Many of these states also have different views on the franchisor’s right to continue to sell prior to the approval of the amendment. However, a franchisor should not be making offers with an FDD that fails to disclose a material fact.

A franchisor must navigate a variety of timing requirements once it determines a material change has occurred. This requires strategy and coordination with the sales force. While suspended activity in certain states for some period of time is likely, with careful planning between the legal team and sales team, the impact on franchise sales can be minimized.