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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 disclosures.

Mr. Herman, licensed in Washington, D.C., represents franchisees domestically and internationally in negotiation, mediation, arbitration, and litigation with their franchisors.

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