Tips to Help Franchisors Prepare for the 2011 Renewal Season

As you prepare for the upcoming renewal season, we recognize that increased efficiency is likely a top priority for your franchise system. The Faegre & Benson franchise team has identified 15 tips to help you to save time and money in preparing for a successful 2011 renewal season.

1.   Stay On Top of Your Financial Statements. Talk to your certified public accountant well before the end of the fiscal year to determine whether additional capitalization is needed to avoid imposition of financial assurances (escrow, bond, or fee deferral) or to see if other adjustments can be made to enhance your financial statements and profitability. If you wait until after the end of the fiscal year, it will be too late to address these issues.

You may also want to ensure your accountant understands the urgency of completing the audit as quickly as possible following year end. Filing the last week in March because your audited financial statements weren't available sooner can delay the registration process by weeks and, in some states, by months. Examiners review Franchise Disclosure Documents in the order received. With hundreds of applications being filed during that last week, yours could end up at the bottom of the stack. Registration delays can cost you franchise sales!

2.   Be Mindful of Discovery Days/Closing Sales. Be aware of any pending franchise sales, discovery days, or other franchise sales activities. To the extent possible, plan to sign any pending franchise agreements before filing your renewal applications. In some states, you must "go dark" until the renewal is approved. Since some state examiners take weeks and, in some instances, months to complete their review, you may not be able to sell any franchises in those states during this period. You must coordinate your franchise sales activities accordingly.

3.   Compile in Advance. You can begin to compile information needed to update your franchise disclosure document before the end of the fiscal year. Gathering information for Items 2, 3, 4, 7, 8, 11, 19 and 20, as well as for the Franchise Seller Information sheet, can take a great deal of time – so please start early.

4.   Update as you Go. As changes to your franchise system occur, make a note of all transfer and terminations of franchises and area developer rights. You should keep a running list of contact information for franchisees who have signed agreements but have not opened, as well as those that have left the system due to terminations, non-renewals, transfers, and other reasons.

5.   Know your Commitments. Review your obligations described in Item 11, the Franchise Agreement, and, if applicable, other agreements between you and your franchisees. Consider whether any revisions or changes to your system are in order and, if so, incorporate them into the renewal process. This avoids the need for another amendment filing.

Carefully review your franchise agreement and other agreements you, including noncompete agreements, area development agreements, equipment leases and confidentiality agreements. Have issues arisen in your system that are not adequately addressed in the current documents? Do you accurately address any territory rights granted to franchisees and any rights you reserve? Do you account for product supply rebates and advertising funds in your system? Are national account opportunities addressed adequately? Are your noncompete provisions adequate in light of recent judicial decisions?

6.   Consider Financial Representations. If you do not currently include an Item 19 Financial Performance Representation (FPR), should you? If you choose to make an FPR, review the process and finished product very carefully. Simply including financial information about franchised or company-owned units in your Franchise Disclosure Document is not enough to comply with requirements of state and federal franchise laws. Your FPR must meet all regulatory requirements, i.e, it must be reasonable and not misleading.

Prepare any FPR with the understanding it may be challenged. That means documenting assumptions included in the FPR and reasons why you consider the FPR to be reasonable.

7.   Stick to Your Target Dates. In the renewal letter we will send to you in December, we include target deadlines to keep the process moving smoothly and in a timely fashion. Our experience is that clients who meet these deadlines generally get their applications filed much earlier than clients who do not. When you get your renewal letter, let us know if the timelines work for you. If they do not, work with your attorneys to revise them.

8.   Pay Attention to Legal Matters. Is your company in good standing in the states where you need to be? Do you need to disclose new franchisor or franchisee-initiated litigation? It is prudent to keep a list of all pleadings filed and received during the prior fiscal year in a separate file and present copies of the filings with your renewal materials.

9.   Take an Inventory of Your Interests. Review whether any of your officers own an interest in any supplier, have been involved in litigation or administrative proceedings, or have filed for bankruptcy in the prior year. You will need to review this with respect to both new and existing officers.

10. Confirm Proper Trademark Maintenance. What is the status of your company's intellectual property? Talk to your trademark attorney to verify your trademarks are registered properly and maintained. Trademark registration is not a one-time procedure. Once a registration is obtained, certain maintenance documents need to be filed with the United States Patent and Trademark Office at various intervals to maintain the registration.

11. Ensure Compliance With State Tax Initiatives. Now is the time to assess your state tax reporting and tax liability positions, especially given increased efforts by certain states to impose income tax payment and reporting obligations on out-of-state franchisors. Franchisors may be required, for example, to take affirmative steps to comply with recent initiatives in California, Iowa, New York, and Washington.

California is continuing its efforts to get franchisors to register and pay tax in the state or otherwise face withholding on royalty payments from in-state franchisees. New York has taken a different approach, enacting legislation that requires franchisors to verify a number of facts specific to their New York franchisees, e.g., amount of royalties paid to the franchisor, franchisee's gross sales, etc. This information could potentially be used to claim franchisors have sufficient "nexus" with New York for tax purposes.

Other states are taking a more direct approach and are pursuing taxes directly from out-of-state franchisors based solely on the receipt of royalties from franchisees in the state. In Washington, for example, a new statute would impose state tax on out-of-state franchisors based on a number of factors, one of which is income from sources within the state. In Iowa, the state's supreme court has already heard arguments on whether the receipt of royalties from an in-state franchisee amounted to taxable "nexus" for the out-of-state franchisor; a decision in that case, one that will be watched closely by many states and taxpayers, is pending.

12. Disclose Franchisee Financing. Some franchisors have responded to the current economic climate by offering financing (or financial assistance, such as guarantees or finance referral programs) to franchisees. Remember that all financing arrangements – direct and indirect – that are offered by a franchisor, its agents, or affiliates must be disclosed in Item 10.

13. Review Website for Outdated Information. Examiners will (and have) audited websites to check for disclaimers, false advertisements, and noncompliant financial representations. Be mindful of the impact information on your Website can have on your system from a regulatory standpoint as well as from a franchise sales perspective.

14. Disclaim Disclaimers. The Amended FTC Rule prohibits use of certain disclaimers. Any integration clause should be revised accordingly. You can, however, continue to use closing checklists or questionnaires without use of "disclaimers" prohibited by the rule and/or state laws.

15. International Franchisors Obtain US Certificates of Residency. Under applicable US tax treaty rules, foreign franchisees must receive a US Residency Certification from the US franchisor to whom they pay royalties and other payments eligible for reduction in local withholding taxes. Franchisors should file IRS Form 8802 at least 45 days before the certification is needed (such as when a foreign royalty payment is to be made), and in any case not earlier than December 1 prior to the year to which the certification is to apply. For cost and time efficiencies, be sure to check certification requests on the form for as many countries as the franchisor will or may receive payments during the year in question (2011). When the certification is received (Form 6166), provide a copy to each foreign franchisee whose payments are eligible for beneficial treatment under a US tax treaty.

Tips to Help Franchisors Prepare for the 2011 Renewal Season is published by the law firm of Faegre & Benson LLP. Further details are necessary for a complete understanding of the subjects covered by this summary. For this reason, the specific advice of legal counsel is recommended before acting on any matter discussed within.