Tips to Help Franchisors Prepare for the 2012 Renewal Season

1.   Stay On Top of Your Financial Statements.  Talk to your certified public accountant well before the end of the fiscal year to determine whether additional capitalization is needed to avoid imposition of financial assurances (escrow, bond, or fee deferral) or to see if other adjustments can be made to enhance your financial statements and profitability.  If you wait until after the end of your fiscal year, it will be too late to address these issues.

It is also a good idea to remind your accountant as to the Franchise Disclosure Document ("FDD") requirements for financial statements.  Each year we get last-minute financial statements that are not in compliance with the FDD guidelines.  This results in unnecessary delays.  The types of problems we see include financial statements that are not prepared according to US GAAP and financial statements that are not in comparative format.  We would be happy to provide your accountant with the FDD guidelines for the audited financial statements.

You may also want to ensure your accountant understands the urgency of completing the audit as quickly as possible following year end.  Filing during the last week in March because your audited financial statements were not available sooner can delay the registration process by weeks and, in some states, by months.  Examiners review Franchise Disclosure Documents in the order received.  With hundreds of applications being filed during that last week in March, yours could end up at the bottom of the stack.  Registration delays can cost you franchise sales!

2.   Be Mindful of Discovery Days/Closing Sales.  Be aware of any pending franchise sales, discovery days, or other franchise sales activities leading up to your FDD renewals.  To the extent possible, plan to sign any pending franchise agreements before filing your renewal applications.  In most of the registration states, you must "go dark" until the renewal is approved.  Since some state examiners take weeks and, in some instances, months to complete their review, you may not be able to sell any franchises in those states during this period.  You must coordinate your franchise sales activities accordingly.

3.   Compile in Advance.  You can begin to compile information needed to update your FDD before the end of the fiscal year.  Gathering information for Items 2, 3, 4, 7, 8, 11, 19 and 20, as well as for your Franchise Seller Disclosure Forms, can take a great deal of time – so please start early.  Keep in mind that if you use brokers as part of your sales process, a Franchise Seller Disclosure Form must be included with your state application.  Request a copy of your brokers' Franchise Seller Disclosure Forms from your broker networks.

4.   Update as You Go.  As changes to your franchise system occur, make a note of all transfers and terminations of franchises and area developer rights.  You should keep a running list of current contact information for franchisees who have signed agreements but have not opened, as well as those that have left the system due to terminations, non-renewals, transfers, and other reasons.  Keep in mind that some states consider a 10% reduction in units to be a material change requiring an amendment.

5.   Know Your Commitments.  Review your obligations described in Item 11, the franchise agreement, and, if applicable, other agreements between you and your franchisees.  Consider whether any revisions or changes to your system are in order and, if so, incorporate them into the renewal process.  This avoids the need for an amendment filing which would be required if you wait and make those changes after the renewal applications are filed.

Carefully review your franchise agreement and other agreements, including noncompete agreements, area development agreements, equipment leases and confidentiality agreements.  Have issues arisen in your system that are not adequately addressed in the current documents?  Do you accurately address any territory rights granted to franchisees and any rights you reserve?  Do you account for product supply rebates and advertising funds in your system?  Are national account opportunities addressed adequately?  Are your noncompete provisions adequate in light of recent judicial decisions?

6.   Consider Financial Performance Representations.  If you do not currently include an Item 19 Financial Performance Representation (FPR), should you?  If you choose to make an FPR, review the process and finished product very carefully.  Simply including financial information about franchised or company-owned units in your FDD is not enough to comply with requirements of state and federal franchise laws.  Your FPR must meet all regulatory requirements, i.e., it must be reasonable and not misleading.

Prepare any FPR with the understanding it may be challenged.  That means documenting assumptions included in the FPR and reasons why you consider the FPR to be reasonable.

7.   Stick to Your Target Dates.  In the renewal letter your attorneys will include target deadlines to keep the process moving smoothly and in a timely fashion.  Our experience is that clients who meet these deadlines generally get their applications filed much earlier than clients who do not.  When you get your renewal letter, let your attorney know if the timelines work for you.  If they do not, work with your attorneys to revise them.

8.   Pay Attention to Legal Matters.  Is your company in good standing in the states where you need to be?  Do any pending litigation disclosures need to be updated to reflect pleadings?  It is prudent to keep a list of all pleadings filed and received during the prior fiscal year in a separate file and present copies of the filings with your renewal materials.

9.   Take an Inventory of Your Interests.  Review whether any of your officers own an interest in any supplier, and whether any of your officers or directors have been involved in litigation or administrative proceedings, or have filed for bankruptcy in the prior year.  You will need to review this with respect to both new and existing officers and directors.

10.   Confirm Proper Trademark Maintenance.  What is the status of your company's intellectual property?  Talk to your trademark attorney to verify your trademarks are registered properly and maintained.  Trademark registration is not a one-time procedure.  Once a registration is obtained, certain maintenance documents need to be filed with the United States Patent and Trademark Office at various intervals to maintain the registration.

11.   Be Aware of and Comply With State Tax Initiatives.  Now is the time to assess your state tax reporting and tax liability positions, especially given increased efforts by certain states to impose income tax payment and reporting obligations on out-of-state franchisors. Franchisors may be required, for example, to take affirmative steps to comply with franchise-specific initiatives in states such as California, Iowa, New York, and Washington, and maybe others as time goes on.

California continues its efforts to get franchisors to register and pay tax in the state or otherwise face withholding on royalty payments from in-state franchisees. New York has taken a different approach, requiring franchisors to verify a number of facts specific to their New York franchisees, e.g., amount of royalties paid to the franchisor, franchisee's gross sales, etc. This information could potentially be used to claim franchisors have sufficient "nexus" with New York for tax purposes.

Other states are taking a more direct approach and are pursuing taxes directly from out-of-state franchisors based solely on the receipt of royalties from franchisees in the state. In Washington, for example, the state imposes tax on out-of-state franchisors based on a number of factors, one of which is income from sources within the state. In Iowa, the state's supreme court determined that the receipt of royalties from an in-state franchisee amounted to taxable "nexus" for the out-of-state franchisor, a decision that the U.S. Supreme Court recently declined to review.

12.   Disclose Franchisee Financing.  Some franchisors have responded to the current economic climate by offering financing (or financial assistance, such as guarantees or finance referral programs) to franchisees.  Remember that all financing arrangements – direct and indirect – that are offered by a franchisor, its agents, or affiliates must be disclosed in Item 10.

13.   Review Website for Outdated Information.  Examiners will (and have) reviewed websites, including any virtual brochure posted to your website, to check for disclaimers, false advertisements, noncompliant financial representations and inconsistencies with the information contained in the FDD.  Be mindful of the impact information on your website can have on your system from a regulatory standpoint as well as from a franchise sales perspective.  Examiners may issue a comment letter if the information on your website is inconsistent with the disclosures in your FDD.

14.   Disclaim Disclaimers.  The Amended FTC Rule prohibits use of certain disclaimers.  Any integration clause should be revised accordingly.  You can, however, continue to use closing checklists or questionnaires without use of "disclaimers" prohibited by the rule and/or state laws.

15.   Special Information for U.S. Franchisors with International Franchisees.  Two points to keep in mind:

• Provide U.S. Certificates of Residency to Your Foreign Franchisees.  Under applicable U.S. tax treaty rules, foreign franchisees who are paying royalties to U.S. franchisors must receive a U.S. Residency Certification from the U.S. franchisor in order to benefit from lower, treaty-based withholding taxes imposed on the royalty payments to their U.S. franchisor. U.S. franchisors should file IRS Form 8802 at least 45 days before the certification is needed (such as when a foreign royalty payment is to be made to them), and in any case not earlier than December 1 prior to the year to which the certification is to apply. For cost and time efficiencies, requesting U.S. franchisors should be sure to check certification requests on the form for as many countries as the franchisor will or may receive eligible payments from foreign franchisees during the year in question (2012). When the certification is received (Form 6166), the U.S. franchisor should provide a copy to each foreign franchisee whose payment is eligible for beneficial withholding tax treatment under a U.S. tax treaty.
•  Update International Franchise Registrations.  Some countries require an annual update or amendment to your franchise registration based on information that may have changed in the prior year.  Even if you are not actively offering franchises in a country, you may need to update or amend your registration.  Check with your attorney to see if an update or amendment is necessary.

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Tips to Help Franchisors Prepare for the 2012 Renewal Season is published by the law firm of Faegre & Benson LLP.  Further details are necessary for a complete understanding of the subjects covered by this summary.  For this reason, the specific advice of legal counsel is recommended before acting on any matter discussed within.