Informal Staff Advisory Opinion 98-2

This staff advisory opinion is issued in response to your recent request for advice concerning the Franchise Rule's updating requirements. 16 C.F.R. § 436.1(a)(22).

I. INTRODUCTION

In your letter, you state that your undisclosed franchisor-client uses the Uniform Franchise Offering Circular ("UFOC") format. The franchisor regularly updates its disclosures by the end of each fiscal quarter, at which time it distributes only the revised UFOC. The franchisor gave a prospective franchisee the most recent quarterly revision at the "time for making of disclosures" under the Commission's Franchise Rule, that is at least 10 business days before the prospect signs any agreement or pays any fee in connection with the franchise sale. However, between the end of the most recently required quarterly revision and the "time for making of disclosures" a law suit occurred that would otherwise be reported in the next quarterly revision of the UFOC. You now ask whether the franchisor must disclose that law suit to the franchisee before closing the franchise sale.

II. THE FRANCHISE RULE'S UPDATING REQUIREMENTS

Your request for an advisory opinion raises the issue whether a franchisor has any obligation to disclose new litigation -- and by analogy any other material changes -- to a prospective franchisee after the franchisor timely provided the prospective franchisee with a disclosure document that complied with the Rule's quarterly updating requirements.

The Rule sets forth three updating requirements. First, the information contained in a basic disclosure document must be current as of the close of the franchisor's most recent fiscal year. After the close of each fiscal year, the franchisor must prepare a revised disclosure document within 90 days. 16 C.F.R. § 436.1(a)(22).

Second, a franchisor must also update its disclosures to reflect any material changes. Any such update must be prepared within a reasonable time after the close of each fiscal year quarter. A franchisor, however, need not prepare an entirely new disclosure document each time such a material change occurs. Rather, a franchisor may place any new disclosures in an attachment to the basic disclosure document. Id.

Third, the Rule contains specific updating requirements if a franchisor makes earnings representations. In addition to the above noted updating requirements, a franchisor must notify prospective franchisees of any material changes in the information contained in its attached earnings claim document prior to entering into the franchise relationship. 16 C.F.R. § 436.1(d). See Final Interpretive Guides, 44 Fed. Reg. 49966, 49970 (August 24, 1979). For franchisors using the UFOC format, Item 19 is the functional equivalent of an earnings claim document.

III. ADDITIONAL DISCLOSURE IS DEPENDENT UPON WHETHER THE FRANCHISOR MAKES AN EARNINGS REPRESENTATION

Whether a franchisor must immediately provide a prospective franchisee with the most up-to-date information about a material change is dependent upon whether it makes an earnings representation. In your letter, you do not state whether the franchisor includes earnings representations in its disclosure document. If the franchisor does not make any earnings representations, then it need not provide a prospect with an addendum setting forth any litigation that may have occurred since the last quarterly update.

On the other hand, if the franchisor makes an earnings representation, then it must update the information found in its earnings claims document (or UFOC Item 19) before the sale is consummated. Without more detailed information about the suit, however, we cannot determine whether it would materially affect the franchisor's earnings representation. For example, if the suit alleges that the franchisor made fraudulent earnings representations, we can reasonably assume that the existence of the suit would be highly material to a prospective franchisee who is trying to examine and verify the franchisor's claims.

IV. DISCLOSURE MAY BE REQUIRED UNDER STATE LAW

Although the Rule does not require a franchisor to update its disclosures immediately every time a material change occurs (except where earnings claims are made), nothing in the Rule prohibits a franchisor from doing so. Indeed, such disclosure is clearly within the spirit, if not the exact letter, of the law.

We note further that disclosure may be required under state common law principles of fraud or misrepresentation. It is possible that the suit might be highly material to prospective franchisees, such as a class action brought by a significant number of the franchisees in a system. Such a law suit might affect the franchisor's ability to fulfill its obligations and ultimately the prospective franchisee's decision to buy a franchise. While the Rule may not compel a franchisor to disclose such a suit until its next fiscal quarter, the franchisor may have an obligation to disclose such litigation under state common law principles.

Please be advised that our opinion is based on all the information furnished in your request. This opinion applies only to your client and to the extent that actual company practices conform to the material submitted for review. Please be advised further that the views expressed in this letter are those of the FTC staff. They have not been reviewed, approved, or adopted by the Commission, and they are not binding upon the Commission. However, they do reflect the opinions of the staff members charged with enforcement of the Franchise Rule.

Date: January 7, 1998
Franchise Rule Staff