Franchise Disclosure Document – Item by Item Analysis (Part five of a series)

Business Law Notes

Spring 2011 Edition

 

FRANCHISE DISCLOSURE DOCUMENT – ITEM BY ITEM ANALYSIS
(Part five of a series)

By M. Blen Gee, Jr.

The Franchise Disclosure Document (FDD) is required by federal law to be given to all prospective franchisees. A careful review of the FDD is an essential step in your review of any franchise opportunity. Following up on our previous four articles on the subject, this article lists more things to look for in the FDD:

ITEM 15 – Personal Operation of Franchise. Many franchisors require the franchisee to devote substantially all of his or her time to the operation of the franchised business. Others will have much less stringent requirements . Item 15 should be reviewed carefully to be sure that the franchisor’s requirements meet your short-term and long-term personal goals.

ITEM 16 – Restrictions on What Can Be Sold. Typically, the franchisor will have specific products and services that you must provide to customers. Also, the franchisor typically very strictly limits the sale of products and services that are not approved for the franchise system. This can vary dramatically from franchise system to franchise system. The failure to provide required products and services and the sale of unauthorized products and services are frequent areas of dispute and can lead to franchise termination. This is an important area to discuss with existing and past franchisees .

ITEM 17 – Renewal, Termination, Transfer and Dispute Resolution. Item 17 is one of the most important and useful provisions of the FDD. The section contains a summary of many of your most important rights and obligations under the franchise agreement and should be studied carefully. Key provisions to the study include duration of your franchise agreement, rights to renew the franchise, your right to terminate (very important), the franchisor’s right to terminate you, your ability to sell the franchise or pass it to a family member upon your death, the franchisor’s rights to purchase your business, noncompetition obligations, exclusive territory, and the obligation to arbitrate or file suit in another state.

ITEM 18 – Public Figures. Endorsements by public figures of franchise opportunities are much less common than they have been in the past. If any public figure does endorse or recommend the franchise, these endorsements or recommendations should be ignored. There is no substitute for thorough investigation of the franchise opportunity and good business judgment. ITEM 19 – Financial Performance Representations. A franchisor that makes representations as to past performance of the franchise or potential future performance exposes itself to great risk that a franchisee may sue the franchisor because of failure of the franchisee’s business to live up to these representations. Consequently, many franchisors categorically refuse to make any sort of financial performance representations.

The franchisor’s decision not to make financial performance representations or to only make very limited representations leads to several problems for the prospective franchisee. Often, you will find that brokers and even franchisor executives will make oral representations to you about the performance of the franchise system and individual franchisees. In the event of a dispute later, they will all disavow having ever made these statements. More importantly, the franchise agreement will be drafted in a way that prevents you from raising these oral statements in any arbitration or lawsuit. For this reason you can never rely on any oral statements made to you about the financial performance of the franchise system or its franchisees.

The second big problem is that you will frequently find that you cannot get good, reliable financial information about the performance of the franchise system. Individual franchisees are free to provide you with information, but few business people are willing to share details of their finances with strangers.

While this may be frustrating, if you cannot get adequate information about the performance of the franchise system, you should not become a franchisee.

If the franchisor does, however, make financial performance representations (include detailed financial information about the performance of the franchise system) in the Franchise Disclosure Document, this is a good sign and the information should be studied carefully.
 

About our Author:

 

M. Blen Gee, Jr. is an honors graduate of the University of North Carolina School of Law. His areas of concentration include business and corporate law, including sales of businesses; business litigation, including arbitration and mediation; franchise law; automobile dealer law; and insurance company insolvency. Mr. Gee has earned the highest peer-review rating for professional excellence and ethical standards by the national publication Martindale Hubbell.

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