Beyond the Binder: Item 4-Bankruptcy
What Is Item 4 of the FDD?
Item 4 of the Franchise Disclosure Document (FDD) covers one thing: bankruptcy. It exists to inform prospective franchisees whether the franchisor, any of its affiliates, predecessors, or key executives have filed for bankruptcy within the last 10 years.
The intent is simple: to help franchise buyers understand if the leadership or corporate entities behind the brand have a history of financial instability.
What Must Be Disclosed in Item 4?
Under the Federal Trade Commission (FTC) Franchise Rule, a franchisor must disclose:
Whether the franchisor, any parent company, or any affiliate disclosed in Item 1 has filed for bankruptcy during the 10-year look-back period.
Whether any officer, general partner, managing member, or other individual disclosed in Item 2 has filed for personal bankruptcy, or been a principal of a business that filed.
Any bankruptcy proceedings that were voluntary or involuntary, including Chapter 7 (liquidation), Chapter 11 (reorganization), or any other form of bankruptcy or receivership.
Why Does This Matter to You?
Because bankruptcy isn’t just a legal status—it’s a window into how a business (or executive) handles money, crisis, and creditors.
Here’s why it matters:
1. Financial Mismanagement
A prior bankruptcy can be a sign of poor planning, bad debt, or an unsustainable business model. If it happened once, could it happen again?
2. Executive Judgment
You’re entering into a long-term financial agreement with the people listed in Item 2. A bankruptcy on their record could reflect risky or short-sighted decision-making.
3. Risk to Franchisee Stability
If the franchisor or its affiliates are financially unstable, your royalty dollars may not be reinvested in support, brand development, or marketing. Worse, you could be left stranded if the franchisor files again.
4. Impact on Lending and Resale
Lenders may consider a franchisor’s bankruptcy history when evaluating financing. A buyer may think twice when reviewing your franchise resale listing if they see the brand’s leadership has gone bankrupt in the past.
Real Due Diligence Tips: How to Investigate Bankruptcy History
Franchisors often disclose Item 4 in the barest legal terms. To get the full picture:
1. Search Public Bankruptcy Records
Use the PACER system (Public Access to Court Electronic Records) to search federal bankruptcy filings. Create a free account and look up:
The franchisor entity (and all entities listed in Item 1)
Key executives listed in Item 2
2. Check State Court Records
Some bankruptcy-related actions, such as assignments for the benefit of creditors (ABCs), may be filed at the state level. Search state court dockets for the same names and entities.
3. Search UCC Filings
Search the Secretary of State websites in the franchisor's home state and states where they operate. UCC filings can reveal debt obligations, liens, or past defaults.
4. Look for Affiliates With Similar Names
Bankruptcies can be buried in similarly named LLCs. If you see "Franchise Group Holdings, LLC" but the disclosure is about "Franchise Group Ventures, LLC," dig deeper. These may be intentionally structured to conceal risk.
5. Ask Directly During Discovery Day
Ask the franchisor directly: "Have any entities you manage or control ever filed for bankruptcy? Are there any past bankruptcies that aren't listed in the FDD?" See how they respond. Don’t be afraid to ask for anything and everything they’ve said at any point in your franchise sales process to be put in writing and signed by all those present.
🔎 Backstory: In my own experience with I Heart Mac & Cheese, I discovered far too late that a key individual listed in Item 2 of the 2017 FDD had a personal bankruptcy discharged within the 10-year look-back period, and it was never disclosed. I didn’t uncover this information (by anonymous tip) until I was years into litigation. Had this bankruptcy been properly disclosed under Item 4, it would have materially changed my investment decision.
Even more troubling, the franchisor also failed to disclose a second executive's 2019 bankruptcy, despite it clearly falling within the required disclosure window.
This is why your due diligence must go beyond the FDD. Find out how the omissions occurred in the full backstory.
Bottom Line:
Item 4 is short, but it’s powerful. One well-placed bankruptcy can reveal a financial foundation built on sand. If you’re considering a franchise investment, don’t skip over this section, and don’t take vague wording at face value.
Franchisees deserve more than boilerplate disclosures. They deserve the truth.
Because once you sign, it’s too late for a reality check.
Stay Tuned: Part 5 – Item 5: Initial Fees is coming soon.
