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FDD Item 4: Bankruptcy

Within Item 4, the franchisor must disclose whether or not the franchisor, the franchisor’s affiliates, predecessors, and/or individual management team members identified in Item 2 previously filed for bankruptcy.

For franchisors preparing their first Franchise Disclosure Document (FDD), understanding its purpose and knowing the right information to include in each item is critical for maintaining legal compliance.

The role of Item 4 of the FDD is to provide prospective franchisees with important information about a franchisor’s past and present financial stability. Although the guidelines for Item 4 disclosures are relatively straightforward, it’s still important for franchisors to understand whose bankruptcy information is required to be disclosed under federal law.

Below, we’ll explore the individuals whose bankruptcies must be disclosed in Item 4 and identify the information franchisors need to include in their FDD for it to be legally compliant.

Which Bankruptcies Must be Disclosed

16 CFR § 436.5 states that franchisors must disclose any bankruptcy proceeding in which they or certain individuals associated with the franchise either:

  1. Filed a petition as a debtor (or had one filed against it) under the U.S. Bankruptcy Code;

  2. Obtained a discharge of debts under the Bankruptcy Code; or

  3. Were a principal officer of a company or a general partner in a partnership that either filed as a debtor in a petition under the Bankruptcy Code, or had one filed against it, or obtained a discharge of debts during the time they held such a title or position or within a year after holding that title or position.

Whose Bankruptcies Must be Disclosed

Like the other items in the FDD, the federal Franchise Rule establishes specific guidelines regarding the individuals and entities whose information must be disclosed in the FDD under federal law. These individuals include:

Franchisor

Under the federal Franchise Rule, franchisors must disclose their bankruptcy history in Item 4 of the FDD to provide prospective franchisees with adequate information to make an informed decision about any potential financial risks related to doing business with the franchisor.

Predecessors

In addition to providing information about their bankruptcy history, franchisors must disclose the bankruptcy history of their predecessors in Item 4. This information can serve to protect prospective franchisees from fraud in situations where a franchisor has reorganized following bankruptcy in an attempt to circumvent Item 4 disclosures.

Parents and Affiliates

For disclosure purposes in Item 4, affiliates are generally defined more broadly than in Item 3. Unlike the parent and affiliate disclosures in Item 3, bankruptcy disclosures for parents and affiliates in Item 4 are not limited only to those parties that have guaranteed the franchisor’s performance or financially backed the franchisor. Instead, the bankruptcy history of all of the franchisor’s affiliates and parents must be disclosed in Item 4.

Item 2 Individuals

Within Item 4, franchisors must disclose the bankruptcy history of the individuals named in Item 2 of the FDD. This includes directors, trustees, general partners, principal officers and any other individuals that will have management responsibilities relating to either the sale or operation of the franchise, regardless of their formal titles.

Because determinations about individuals with management responsibilities are sometimes made on a case-by-case basis, franchisors should consult an experienced franchise attorney to identify the specific individuals for whom bankruptcy information must be disclosed in Item 4.

Reporting Period

Under the federal Franchise Rule, bankruptcy disclosures in Item 4 are limited to 10 years from the date of disposition immediately preceding the issuance date of the FDD.

Information to Include in Item 4

Per the amended Franchise Rule, the specific information that must be included about each bankruptcy disclosure in Item 4 includes:

  • The debtor’s name, address and principal place of business;

  • Whether the debtor is the franchisor; if not, describe the debtor’s relationship to the franchisor;

  • A summary of the bankruptcy filing including its original filing date, material facts about the case, the name of the court in which the case was filed, the case number and name, and the discharge date of the debt (when applicable), as well as any plans of reorganization.

The details of any bankruptcy-related cases, actions and other proceedings filed under the laws of foreign nations must also be disclosed in Item 4.

It’s important to note that if a franchisor has no bankruptcies to disclose in Item 4, they shouldn’t leave the item blank. Instead, franchisors should specifically state in writing that they have no bankruptcies to disclose as of the FDD issuance date.

Other Considerations

The purpose of Item 4 is to help franchisees assess the financial stability and background of the franchisor before making an investment decision. However, franchisees and franchisors should keep in mind that there are many reasons that a franchisor or its parents, affiliates or management might have declared bankruptcy in the past.

Because of that, it’s always a good idea for franchisors to include a description of the context under which the bankruptcy was filed. This can add clarity for prospective franchisees about the franchisor’s financial situation while minimizing potentially negative impressions associated with prior bankruptcies.

To learn more about how we can help you franchise your business, register your FDD, and scale your franchise, contact us at (800) 976-4904 or fill out our contact form.