Required Disclosures: Financing
By Mario Herman, Esq.
An increasing number of franchisors are offering some form of
financing to prospective franchisees. There is a requirement that this
information be disclosed in the Franchise Disclosure Document. This article
explains the disclosure requirements for financing.
Pursuant to the Federal Franchise Rule, a franchisor is required to disclose
to each prospective franchisee the terms of each financing arrangement,
including leases and installment contracts, the franchisor, its agent, or
affiliates offer directly or indirectly to the franchisee. The
franchisor may summarize the terms of each financing arrangement in tabular
form, using footnotes to provide additional information. This disclosure is
to be made in Item 10 of the Franchise Disclosure Document (FDD).
For each financing arrangement, the franchisor is required to state: (i)
What the financing covers (for example, the initial franchise fee, site
acquisition, construction or remodeling, initial or replacement equipment or
fixtures, opening or ongoing inventory or supplies, or other continuing
expenses); (ii) The identity of each lender providing financing and his/her
relationship to the franchisor (for example, affiliate); (iii) The amount of
financing offered, or, if the amount depends on an actual cost that may
vary, the percentage of the cost that will be financed; (iv) The rate of
interest, plus finance; charges, expressed on an annual basis. If the
rate of interest plus finance charges expressed on an annual basis may
differ depending on when the financing is issued, the franchisor must state
what that rate was on a specified recent date; (v) The number of payments or
the period of repayment; (vi) The nature of any security interest required
by the lender; (vii) Whether a person other than the franchisee must
personally guarantee the debt.
(viii) Whether the debt can be prepaid and the nature of any prepayment
penalty; (ix) The franchisee’s potential liabilities upon default, including
any: (A) Accelerated obligation to pay the entire amount due; (B)
Obligations to pay court costs and attorney’s fees incurred in collecting
the debt; (C) Termination of the franchise; and (D) Liabilities from cross
defaults such as those resulting directly from non-payment, or indirectly
from the loss of business property.
(x) Other material financing terms.
The franchisor must also disclose whether the loan agreement requires
franchisees to waive defenses or other legal rights (for example, confession
of judgment), or bars franchisees from asserting a defense against the
lender, the lender’s assignee or the franchisor. And, if so, the franchisor
is required to describe the relevant provisions.
The franchisor must also disclose whether the franchisor’s practice or
intent is to sell, assign, or discount to a third party all or part of the
financing arrangement. And, if so, the franchisor must state: (i) The
assignment terms, including whether the franchisor will remain primarily
obligated to provide the financed goods or services; and(ii) That the
franchisee may lose all its defenses against the lender as a result of the
sale or assignment.
Additionally, the franchisor must disclose whether the franchisor or an
affiliate receives any consideration for placing financing with the lender.
And, if such payments exist: (i) Disclose the amount or the method of
determining the payment; and (ii) Identify the source of the payment and the
relationship of the source to the franchisor or its affiliates.
While, in the experience of this commentator, few franchisors offer
financing, if your prospective franchisor does offer financing these are
important terms for a prospective franchisee to understand. An experienced
franchise law attorney can assist you in reviewing and understanding these
Mr. Herman, licensed in Washington, D.C., represents franchisees
domestically and internationally in negotiation, mediation, arbitration, and
litigation with their franchisors.