Change is inevitable in a franchise system, and disclosure then becomes a concern. Disclosure may be a business issue for the existing franchisees, but it becomes a legal issue in the offer and sale of franchises. The question is whether the information would be considered by a hypothetical purchaser of a franchise as significant. Case law is sparse, but certain registration states, such as New York, provide examples of material change requiring disclosure.
Examples of material business changes that must be disclosed are closures or buybacks of five percent or more of the franchises in one year, change of control, management, corporate name, state of incorporation, and commencement of any new product, service, or model line increasing the investment or risk of the franchisee, and discontinuing or modifying the marketing plan of system where the total sales affected could be 20% or more of the franchisor’s business. Material financial changes or defaults will also require disclosure.
Often the timing of the disclosure is problematic because some states require immediate disclosure. In the case of a merger discussion, no disclosure is required until definitive or binding contracts are signed. A non-binding letter of intent does not normally trigger a disclosure obligation. Some material changes must be disclosed immediately and some not for 45 days.
Best practices suggest ceasing new sales until counsel has had an opportunity to review the material change and the steps for disclosure are agreed upon. Even in regulated states, protocols are in place to allow sales during the change process and allow disclosure and sale with subsequent disclosures to occur when necessary.