What is material? What is immaterial? See if your beliefs match the regulations.

The FTC franchise disclosure law and state laws require that the franchise disclosure document be amended for any “material change.” The term “material change” can be an enigma. We dug up state regulations that may surprise you. Take the quiz below and see if you can identify which changes are considered material.

Q.1

1. In order to pay for the new features being offered by the system’s proprietary software, the franchisor is increasing the software user fees that it charges franchisees by $5 per month. Is this a material change?

No. The franchise disclosure document must only be amended when there is increase in royalty or initial franchise fees.
Yes. The franchise disclosure document needs to be amended for any change in initial or continuing fees.

Q.2

The franchisor announced at its annual convention that it will decrease the initial grand marketing contributions it charges to all existing franchisees. “So, if you are considering buying a second franchise territory, now is the time!” Is this a material change?

No. The franchise disclosure document must be amended for any change in fees. A change in fees is defined as an increase in fees.
Yes. The franchise disclosure document must be amended for any change in fees. That expressly includes an increase or decrease in fees.

Q.3

3.Good news! The franchise is growing. To better support the growing system, the franchisor has announced the hiring of a new vice president of operations. Is this addition of new staff a material change?

No. The franchise disclosure document only needs to state the management as of end of the previous fiscal year.
Yes. An amendment to the FDD is required upon any change in management.

Q.4

4.John Doe has acquired majority shares in the franchise system from his father. John is not making any changes to the franchisor’s sales or management team and does not plan to control or manage the operations of the franchise. His father has long ago stepped away from controlling or managing the franchise. John plans to have the same hands off approach. Is John’s acquisition of the franchise a material change?

No. Simply a change in ownership interest of the franchisor is not a material change.
Yes. Any change in ownership interest in the franchisor is a material change.

Q.5

5.A franchisee has filed a complaint in Illinois against the franchisor based on the franchisor’s failure to renew the franchise agreement for good cause. Is this a material change?

No. A material change does not occur until a judgment against the franchisor is assessed or the franchisor is found liable to the franchisee.
Yes. The filing of a complaint alleging violations of franchise law is a material change. Failure to renew for good cause is a violation of the Illinois franchise laws.

Q.6

6.Franchisor, in response to significant quality issues, is changing the designated supplier for one of the franchise’s retail products. Is this a material change?

No. Simply changing a designated supplier without a change to franchisee purchase requirements is not a material change.
Yes. Any significant change in the franchisee required purchases is a material change; this includes the modification to or a designation of a supplier that franchisees must make purchases from.

Q.7

It is July, just past midyear. Due to an economic down turn and the closing of one of its largest franchise locations, the franchisor’s revenues are down by almost 30% percent. Is this a material change?

No. The franchisor is only required to include audit financials for the last 3 fiscal years.
Yes. A significant change in the franchisor’s financials is considered a material change-the franchise disclosure document must be updated with unaudited financial statements.

Q.8

8.The franchisor has been bought out by a private equity group. Franchisees are jumping ship. More than 2% of the franchisees, just in the last 3 months have ceased to operate. The private equity group has made offers to purchase another 5% of the franchise locations and 4% of the franchises have decided not to renew their franchises. Is the loss of franchise locations a material change?

No. The franchisor is only required to update Item 20 tables listing the number of franchisee at the end of each fiscal year.
Yes. Based on state laws, the loss of a set percentage of franchisees is a material change requiring the updating of the disclosure document.

Q.9

For tax reasons, the franchisor’s accountant has suggested the franchisor change from a corporation to a limited liability company. The Franchisor will continue to do business as “Dog’s Best Friend.” The franchisor’s company name will go from DBF franchise, Inc. to DBF Franchise, LLC. That is the only change. Is the change from DBF franchise, Inc. to DBF Franchise, LLC a material change?

No. This is not a significant change to the business structure or name of the franchisor.
Yes. Any change to the franchisor’s name is a material change.

Q.10

10.A material change occurred, the director of franchise sales recognized the need to modify the franchise disclosure document and submit an amended registration in the state of Maryland; however, not wanting to lose the deal, he proceed to sell a franchise to a resident of Maryland without amending the disclosure document or filing an amended registration. The director of franchise sales may be:

guilty of a felony
subject to a fine not exceeding $10,000
imprisonment not exceeding 5 years
all of the above