SEI Revises Operating Expense Procedures

 

One of the issues at the top of the agenda for the National Coalition for nearly a year has been the changes SEI made to its policies and procedures regarding Operating Expenses. In a letter to SEI dated June 17, 2014 and in an article published that month in this magazine, we made the point that the new policy was more restrictive than the historical treatment of Operating Expenses, and in many cases was contrary to the specific terms of the Franchise Agreement.

Many franchisees reported inconsistent treatment of operating expenses, and the disallowance of many categories of operating expenses previously approved by SEI. These included outside landscaping; snowplowing; interest on lines of credit used to make contributions to the Open Account to maintain Minimum Net Worth; property taxes on inventory, furniture, fixtures and equipment; travel expenses between stores owned by the same franchisee; group health insurance; group life insurance; and telephone lines for the stores.

We brought these matters to the attention of SEI, seeking a uniform and fair approach to Operating Expenses, which was also consistent with the definition of Operating Expenses found in Exhibit F to the Franchise Agreement at page F-53. We requested that SEI:

• Allow all credits and expenses to the extent expressly permitted in the Franchise Agreement;
• Publish a specific list of Miscellaneous Expenses;
• Redefine allowable expenses, to include all customary benefits provided to employees, including health, dental, disability and life insurance;
• Allow as operating expenses all expenses legally deductible as ordinary and necessary expenses under the Internal Revenue Code; and
• Apply all standards regarding operating expenses in a uniform, nondiscriminatory and fair and reasonable manner.

We also suggested that one of the reasons SEI was restricting expense paid-outs to a greater extent than it had in the past was because reducing allowable expenses would increase the profit of franchised stores as reflected in the Item 19 Financial Performance Representations contained in the SEI Franchise Disclosure Document. No doubt, SEI was also aware that many of the new requirements it has been imposing on franchisees, with respect to Fresh Foods and the GEA Form, as just two examples, were also increasing expenses and reducing profit.

On January 9, 2015, Operations and Accounting issued a written message to all franchisees, which indicated that changes were being made to the processing of expense paid-outs “…based on franchisee feedback.”

The essential changes are as follows:

First, franchisees will no longer be required to send copies of supporting invoices and receipts for expense paid-outs.

Second, SEI will no longer review expense paid-outs, nor will it reclassify expenses to unauthorized draw, as it had been doing in the more recent past.

Third, starting mid-March 2015, the paid-out screen will contain a representation by the franchisee that all reported paid outs are legitimate store related expenses for the reported category.

Fourth, while SEI will no longer review paid-outs on a regular basis, it does reserve the right to perform such a review if there is excessive paid-out activity or other unusual activity related to the reporting of operating expenses.

In many ways, this new policy exceeds the request that we made on behalf of franchisees. It reflects in part, SEI’s determination that its interests have not been served by excessive intrusion into the franchisees’ choices of operating expenses, which, after all, is their money to begin with.

However, there are two points that every franchisee should bear in mind going forward:

1. Franchisees should only report as paid-outs those expenses which are ordinary and necessary business expenditures which would be deductible on their business tax returns or on Schedule C to their personal tax returns, in any event. SEI has reserved the right to review these expenditures after the fact, and the IRS always reserves the right to do so as well.
2. SEI has indicated that it may well start to reduce the amount of financial performance information it provides to prospective franchisees in Item 19 of its Franchise Disclosure Documents. We hope and trust that this will not be because they fear that adding legitimate operating expenses will create a less rosy picture for prospective franchisees. No decision appears to have been made on this point, and we will continue to urge SEI to continue to make its Financial Performance Representations as complete and transparent as possible.

We are pleased that the issue of operating expense paid-outs has been resolved in a manner that is highly favorable to the franchisee community. However, there are many other issues facing franchisees and will continue to advocate on behalf of all FOAs and their constituents in the most energetic and effective manner possible.