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

Business Law Notes

Fall 2009 Edition



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

By M. Blen Gee, Jr.

Far and away the most important legal protection for franchisees in this country is the broad pre-contract disclosure requirements of the Federal Trade Commission (FTC) in a document called a Franchise Disclosure Document (FDD). However, the Federal Trade Commission does not examine the FDD: you must do your own due diligence investigation. A careful review of the FDD is essential.

Following up on our previous article on the subject, this article lists more things to look for in the FDD:

ITEM 3 – Litigation. If the franchisor reports any litigation in this section, you must look at this very carefully.

Large franchisors will have lots of litigation. This is normal and Is not necessarily a sign of problems, However, it is critical that you learn more about the nature of these litigations. If you can find out what these litigations were about, it may give you clues to the problems franchisees are having with the franchisor. Some franchisors use litigation to punish franchisees that get out of line. Even when the franchisee wins, the franchisee will have spent tens of thousands of dollars in attorneys fees and will think twice before challenging franchisor policy decisions again. litigation may reveal a pattern of franchisee problems with the franchisor or fundamental flaws in the franchise system.

For smaller and newer franchisors, a lot of litigation is a red flag that caution is required. A new or small, well run franchise system should have very little litigation. Find out as much as you can. You may need an attorney to help you interpret what you find .

Also, remember that the franchisor only updates this information once a year. You should ask whether there are any recently filed litigations that are not listed in the FDD. If you are told there are no recent litigations, document the answer with a follow up letter or email.

Not all franchise related lawsuits have to be reported. If the lawsuit is over and the franchisor was not “held liable,” it does not have to be reported. Past lawsuits that the franchisor won are important to know about as well. Ask questions: find out what the unreported suits were about and why the franchisor was not “held liable.” Franchisees who are no longer in the system may be a good source of information.

ITEM 4 – Bankruptcy. A previous bankruptcy of a franchisor or one of Its key managers Is a warning sign. The financial decline of a franchisor is one of the major sources of problems for franchisees,

Item 5 – Initial Franchise Fee. This is typically nonrefundable. “Nonrefundable” means nonrefundable. Since you are unlikely to get this money back, you should be sure to get your money’s worth by taking advantage of all training, site location and other assistance offered to new franchisees.

Item 6 – Other Fees. This is a spot to look for hidden fees. What is the interest rate on late royalty payments and other obligations owed to the franchisor? If the interest rate is very high, in the event of litigation over the royalty or other amounts, as time drags on a high interest rate may put pressure on you to accept an unfavorable settlement.

Look for one-sided attorney’s fees provisions; the franchisor gets attorneys fees if it wins but you do not.

Run the numbers. Be realistic in your assessment; assume that you will have to pay the highest fee in each situation where the franchisor has discretion. Also be wary of the salesman who says “Oh, they never charged that fee.” The salesman will be long gone when you find you are assessed a fee that the franchisor “never charges.”

Be skeptical of any items that you are required to purchase at “current published prices.” Mandatory purchases at inflated prices is a common franchisor abuse.

Item 7 – Estimated Initial Investment. This section may be helpful, but we recommend that you look at actual local costs (such as lease and up-fit costs, furniture and fixtures and equipment) rather than relying on estimates contained in the FDD. Be especially wary of thing you must purchase from the franchisor, its affiliates, or “approved suppliers.” This is a frequent area of abuse.

>> Read part three of our Franchise Disclosure Document series

In the News

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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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