Franchise Disclosure Questionnaires Face New Challenges

On Behalf of | Nov 1, 2022 | Firm News, Franchisor Law

Franchisors routinely use questionnaires to verify whether prospective franchisees have timely received a franchise disclosure document (“FDD”), understand the details and risks of purchasing the franchise, and whether the franchisee has received information that differs from the FDD (for example, unauthorized financial performance representations or promises of success). These questionnaires enable franchisors to discover any issues that have arisen in the sales process, take corrective action, and make informed decisions regarding whether to go ahead with finalizing a franchise transaction. Many franchise agreements likewise contain similar acknowledgments.

On September 18, 2022, the North American Securities Administrators Association (“NASAA”)[1] adopted a Statement of Policy Regarding the Use of Franchise Questionnaires and Acknowledgments (“Statement of Policy”) that will become effective on January 1, 2023. You can review the Statement of Policy at this link. In its Statement of Policy, NASAA makes clear that it views the use of questionnaires and acknowledgments as wrongly placing the franchisor’s burden of monitoring compliance with the franchise sales process on prospective franchisees. Under this policy, franchisors that use questionnaires and/or acknowledgments (whether in written, verbal, or electronic format) must: (1) refer to these items in Item 22 of the FDD and attach the items as exhibits to the FDD; (2) include a special affirmative disclaimer regarding these items in the FDD, franchise agreement, and/or state specific addenda; and (3) not require prospective franchisee to make certain prohibited statements, including statements:

  • That would cause the prospective franchisee to believe they have waived or surrendered any rights;
  • That would shift the franchisor’s disclosure duties to the prospective franchisee;
  • That the prospective franchisee has read or understands the FDD and/or its exhibits (including franchise agreements);
  • That the prospective franchisee understands the risks associated with the purchase of the franchise;
  • That the prospective franchisee is qualified to own and operate the franchise;
  • That the prospective franchisee has relied solely on the FDD and not relied on other information or representations or statements from other persons or sources;
  • That the prospective franchisee has had the opportunity or has actually consulted with professional advisors or other franchisees;
  • That the prospective franchisee agrees that no unauthorized, inaccurate, or misleading statements were made or that the franchisor is relying on the statement for the purpose of ensuring compliance;
  • That duplicates the statements already made in the FDD and/or its exhibits;
  • That neither the franchisor or franchise seller made any representation (including a financial performance representation) outside of or different from the FDD and its exhibits; and
  • That the success or failure of the franchise is dependent solely or primarily on the franchisee or that the franchisor bears no liability for the franchisee’s success or failure

Although NASAA’s policies do not amend state or federal franchise registration and disclosure laws, state franchise regulators generally adhere to NASAA guidance when reviewing franchise registration applications. California has adopted a similar policy into law as discussed below, and we anticipate that additional states may follow suit.

Notably, the Statement of Policy indicates that it is not “intended to prohibit a Franchisor from conducting factfinding or asking Prospective franchisees questions about the sales process, but Franchisors may not require a Prospective franchisee to document and sign statements that act as waivers in violations of state law.”[2] Franchisors should begin the process of reviewing their questionnaires and acknowledgments, considering their usefulness for their brands, and making appropriate revisions and adjustments. Please contact us so that we can assist you in implementing necessary changes to your documents and discuss potential alternatives.

Recent Amendments to California Franchise Laws

On September 29, 2022, California Governor Gavin Newsom signed Assembly Bill (“AB”) 676 into law. AB 676 amends both the California Franchise Relations Act and the California Franchise Investment Law. These changes will apply to franchise agreements that are entered into, amended, or renewed on or after January 1, 2023[3] and to franchises with indefinite duration that are terminable by either party without cause. You can review redlined changes to the relevant amended California Code at this link.

Prohibited Disclaimers. California law now prohibits and deems unenforceable any language in a franchise agreement that requires a franchisee to waive any provision of the California Franchise Relations Act and any language in a franchise agreement, FDD, acknowledgment, questionnaire, or other writing, disclaiming or denying any of the following:

  • Representations made by the franchisor or its personnel or agents to a prospective franchisee;
  • Reliance by a franchisee on any representations made by the franchisor or its personnel or agents;
  • Reliance by a franchisee on the FDD and any exhibits thereto; and
  • Violations of any provision of the California Franchise Investment Law.

Prohibited Actions by Franchisors. Franchisors are now legally prohibited from:

  • Offsetting amounts owed by a franchisee upon the termination or nonrenewal of a franchise, unless the franchisee agrees to the amount, or the franchisor has obtained a final adjudication of the amount;
  • Refusing to grant a franchise to a prospective franchisee or provide financial assistance to a franchisee based solely on the sex, race, color, religion, ancestry, national origin, disability, medical condition, genetic information, marital status, sexual orientation, citizenship, primary language, or immigration status either of the franchisee/prospective franchisee or of the population that composes the neighborhood or geographic area where the franchise is or would be located; and
  • Making modifications to franchise agreements or requiring a general release in exchange for any assistance related to a state or federal emergency.

New Transfer Requirements. The California Franchise Investment Law now includes the following mandatory transfer requirements:

  • The franchisor must make any form or document it requires a prospective franchisee to submit with a transfer application “reasonably available” or otherwise provide that form or document by email, courier, or certified mail to a prospective franchisee within fifteen calendar days of receiving a written request;
  • The franchisor must make its standards for approval of a transfer application “reasonably available” or otherwise communicate the standards to a prospective franchisee within fifteen calendar days of receiving a written request;
  • A franchisor must notify a prospective transferee of its approval or rejection of a transfer application in writing by email, courier, or certified mail within sixty days of receiving a transfer application; and
  • If a franchisor rejects a transfer application, it must notify the prospective transferee in writing and include the reasons for the rejection. The reasonableness of any rejection will be a “question of fact requiring consideration of all relevant circumstances.”

Clarification of Certain Provisions. AB 676 also revised the California law in terms of the following:

  • The California Franchise Investment Law now applies to the sale of a franchise whenever the franchised business will be located in California, regardless of where the franchisee is domiciled.
  • The state may deny or revoke franchise registration for any listed violation, including if a franchise agreement contains any provision contrary to law or if the franchisor’s method of business includes activities that are illegal where performed.

In response to these prohibitions, franchisors should review their FDDs, agreements, franchise sales materials, questionnaires, and transfer procedures for compliance with California law. Please contact us to evaluate your documents and plan for the implementation of the amended laws and policies.

[1]           NASAA is an organization of state administrators that issues guidance for securities agencies in order to protect consumer investors, including franchisees.

[2]           See Statement of Policy, Footnote 15.

[3]           This excludes amendments that are requested by the franchisee and that are substantially for the franchisee’s benefit, for example, an extension of the current term, a reduction in royalties, etc.