Topic: Franchises and Franchising
Franchisors often make missteps and mistakes in selling a franchise opportunity. Generally
these arise in two categories: 1) misrepresentations in the disclosure
documents provided to prospective franchisees; and 2) failure to know
and follow the procedural requirements during the sales process.
franchisors must give a prospective franchisee a franchise disclosure document
(FDD) prior to entering into a franchise sale. The FDD has 23 sections and
hundreds of specific issues that must be disclosed to the prospective
franchisee prior to entering into a franchise agreement. Just providing an FDD
is not enough – it must be materially correct and not misleading. The
consequences for inaccurate information can be severe. Some of the areas that are regularly
inaccurately disclosed include the following:
rebates. Supplier rebates not only pertains to actual rebates that the
franchisor may receive from suppliers due to franchisee purchases, but also applies
to any other benefit that the franchisor receives from the supplier due to the
Territorial rights and restrictions. Often the FDD will not accurately define
the territorial rights of the franchisee and will fail to correctly disclose
the franchisor’s reservations. If this is not clear and a dispute arises in the
future, the franchisor may be more vulnerable to a lawsuit by the franchisee.
costs. The franchisor is required to provide the prospective franchisee with an
accurate estimation of the startup costs for opening a franchise. Often this
information is inaccurately reported in order to show a lower cost investment
to help entice franchisees to purchase the franchise. However, this can be very
dangerous for the franchisor. This is one of the easiest ways for a franchisee
to show inaccuracy in the FDD provided by the franchisor.
Rule, there are very specific rules related to providing disclosures, waiting
periods and restrictions on what franchisors can tell a franchise prior to
completing a franchise sale. If your franchise sellers do not follow the rules
for franchise sales, the franchise sale may be illegal and lead to serious
consequences, such as rescission of the franchise agreement by the franchisee. Some
of the common mistakes include:
page. Failing to collect a signed receipt page after sending the disclosure
document to a prospective franchisee. Under the FTC Franchise Rule, the
franchisor must keep a copy of all receipts for 3 years, whether or not the
prospective franchisee purchases the franchise or not. This is the best defense to show that the FDD was provided
and show that the waiting period was met. Too often the franchisor does not
have this document when a problem arises with a franchisee.
period. Not waiting the full 14 day period before collecting money or signing a
binding agreement. Under the rule, the franchisor must send the FDD and give
the prospective franchisee a full 14 days to review the documents.
claims. Providing financial performance representations also known as earnings
claims, either verbal or written, outside the FDD. Under the rule, the franchisor
may provide numbers on historic or projected earnings ONLY within Item 19 of
the FDD. There are certain disclosures and cautions that the franchisor must also
provide with this information. Often sales staff will give out numbers that can
be construed as financial performance representations. Even if these are
accurate numbers, the rule only allows this information to be provided if it is
in the FDD with the required cautions and warnings.
registrations. Some states require that the franchisor register its FDD with
the state prior to selling (or even offering to sell) franchises in the state.
Too often sales staff will offer a franchise or sell a franchise to a person
who is in a registration state or plans to open the franchise in a registration
state, without knowing if the franchisor’s FDD has been registered. This sort
of action can create a rescission action for any contract entered into and it
can also trigger fines and fees from the registration state. If the action is
in blatant violation of the law, it may cause the state to disallow any further
franchise sales in the state by the franchisor.
All of these issues can be avoided by ensuring that you
provide accurate information to the attorney preparing your disclosure documents, regularly update your FDD for any material
changes to the franchise system, and train your
franchise sellers to understand the rules required to sell franchises.
Avoid these common mistakes made by franchisors when selling a franchise. By following these simple tips you can potentially avoid litigation down the road.