This fall we posted about the North American Securities Administrators’ (NASAA) adoption of a Statement of Policy Regarding the Use of Franchise Questionnaires and Acknowledgments (the “SOP”). Technically, NASAA’s SOP guidance was adopted on September 18th and is already in effect, but enforcement will begin on January 1, 2023. The SOP may be short, but unanswered questions and open issues abound. In this, the first in a series of posts on the topic, we focus on what the new SOP means for state franchise FDD updates and renewals.
The SOP addresses the common use by franchise systems of (1) “Questionnaires” in which franchisors require prospective franchisees to answer a series of questions about what did or did not occur during the franchise sales process; and (2) “Acknowledgements” which NASAA considers a type of disclaimer masquerading as a benign confirmation provision within or at the end of the franchise agreement.
As we previously blogged, the SOP will now prohibit specific types of disclaimers, but as the new year fast approaches, franchise lawyers are left to ponder the means of compliance. The first step is to put the SOP in context. The practical Q&A below may help:
- Don’t the franchise state examiners understand that Questionnaires and Acknowledgements help identify potential wrongful conduct by sales agents and brokers before the transaction is completed? Yes, but NASAA has taken the position that franchisors must police its own personnel, not shift that responsibility to franchisees.
- Must all Questionnaires and Acknowledgments be included in the FDD? Yes. If the sales process includes verbal interviews, recordings or similar videos or statements, then a transcript must be included.
- Will all registration states require compliance with the SOP? States that regulate franchise offerings have broad discretion to interpret the disclosure requirements in the interest of fairness to prospective franchisees. That discretion, however, often adopts and implements the guidance provided by the NASAA Franchise Project group. It is thus likely that at least those states with anti-waiver provisions and anti-fraud statutes will implement the SOP in 2023. Setting aside California (discussed below) a franchise system is not required to revise its FDD to comply with the SOP until it is told to do so. However, a franchise system is risking comment letters and a delay in renewal if it does not proactively comply with the SOP for all registration states.
- What if my franchise system wants to retain its Questionnaire and Acknowledgements in non-registration states? The Amended FTC Franchise Rule includes a limited ban on disclaimers in the FDD or its exhibits, but the FTC has not issued any statements or positions with respect to the use of Questionnaires and Acknowledgments. There is certainly an administrative burden to maintaining two or more separate FDDs, and state examiners often scrutinize a system that uses multiple FDDs. A franchise system should conduct a risk analysis to determine if the necessity and usefulness of its questionnaire or acknowledgment outweighs the risks and delay multiple FDDs may engender. For example:
- Does the franchise system use outside brokers or sales agents?
- Does the franchisor have a sophisticated vetting and compliance program in place to weed out as many potential issues that may arise in the sales process?
- What alternative best practices can the franchise system implement to accomplish the same purpose of the questionnaire and acknowledgement?
- Does the franchise system have a history of litigation where enforcement of these statements or responses was impactful to a case?
- What is the volume of sales in non-registration states in which the franchisor could continue to use questionnaires and acknowledgements?
- What should a franchise system do to comply with the SOP during renewal season? First, include the newly required legend. All state examiners will be looking for that legend. Second, remove all expressly prohibited statements identified in the SOP. Third, analyze any remaining statements to determine if they could reasonably be considered “subjective, unreasonable or simply repeat disclosures requirements to be stated in the FDD.” Consider whether the questionnaire or acknowledgment any longer serves any utility once the edits are completed. Finally, review the entirety of the FDD for statements that a state examiner could consider a disclaimer. Practitioners may have seen an uptick in recent years of regulators requesting the removal of language imbedded within the FDD (especially in Item 7 and Item 19) perceived as an inappropriate disclaimer, even if the franchisor believes the disclosure to relay beneficial information to a potential franchisee. Confused yet? Stay tuned. One of our follow-up blog posts will take a deeper dive into differentiating between a prohibited disclaimer and permissible explanation and practice tips to minimize state comment letters.
- Does California’s Assembly Bill 676 require action by franchisors? AB 676 clarifies California’s anti-waiver provision in the California Franchise Investment Law to specifically state that asking a franchisee to disclaim or deny reliance on representations made by the franchisor or its agents is contrary to California public policy, void and unenforceable. Any provision in the franchise agreement or FDD to the contrary will not be enforced by a court. The California Department of Financial Protection and Innovation recently released a “What’s New in 2023 for Franchisors” update on its website providing guidance for franchise filers.
- Wait! Does that mean I need to file a post-effective amendment in California before my franchise registration lapses? No. Our understanding from Theresa Leets and Dale Cantone who both led the Regulatory Developments Workshop at the ABA Forum on Franchising Annual Meeting in San Diego last month, California and other states will take a pragmatic approach, rather than inviting hundreds of post-effective amendments being filed next month. States simply do not have the resources to handle such a volume of filings. Although the SOP commands a material change, California does not anticipate initiating taking immediate enforcement actions.
- What is the effect of the SOP on franchise fraud litigation? Disclaimers were previously effectively used by franchisors to disclaim justifiable reliance by franchisees, almost as an irrebuttable presumption. If use of the disclaimers is criticized as not being consistent with public policy, the evidentiary effect could be muted or eliminated. Nevertheless, the disclaimers which were legally and validly used prior to this SOP may have some evidentiary import and probably will have some limited weight in certain states. As franchisors, the best-case argument for franchisors is that the tribunal should not ignore the factual assertions of the franchisee at the time the agreement was signed but should hear any arguments by the franchisee as to why their answers to the questionnaire was inaccurate. Even in states that do not prohibit the practice, the use of Questionnaires and Acknowledgments after the SOP comes into effect will be suspect and a franchisor should be careful of how it uses them during dispute resolution.
*This post was updated on January 10th to include California’s DFPI updated information on AB 676.