Walking the Fine Line in Item 19 Explanatory Notes

Walking the Fine Line in Item 19 Explanatory Notes

When drafting an Item 19, you may think your job is done once you compile the data, but the job is far from complete. The next part of the Item 19 process is drafting the background and explanatory notes to accompany Item 19 and explain the data contained therein.

One problem you may face is whether to include certain “disclaimer” language that protects the franchisor (to a certain extent) from franchisees making claims if they do not reach or surpass the figures presented in Item 19. So how can you strike a balance between protecting the franchisor and complying with the FTC Rule on disclaimers in Item 19? The answer lies in the explanatory notes.

The explanatory notes (and background) of Item 19 provide you with a unique opportunity to fully explain where the financial performance representation came from.

At the outset, you should always include:

(i) whether the data represents corporate/affiliate-owned units or franchisee-owned units;

(ii) the number of units that were excluded; and

(iii) the reason such units were excluded.

Further, you should also include any information that would distinguish the units represented in the financial performance representation from a new prospect. For example, if all of your units are located in Southern California but you’re selling a franchise in Minnesota, it’s important to note that the units in Southern California likely have established substantial goodwill associated with the trade name that may not exist in Minnesota.

Lastly, you can also include the following information about the units represented:

(a) size differentiations in the units;

(b) any differences in fees; and

(c) number of years of operation.

The more information you include about the units represented, the more information a franchisee will have when it is evaluating the financial performance representation. So while you cannot “disclaim away” your liability, you can certain try to “explain it away”.