Business Law Notes
Spring 2010 Edition
Franchise Disclosure Document – Item by Item Analysis
(Part three of a series)
The Franchise Disclosure Document (FDD) is required by federal law to be given to most prospective franchisees. A careful review of the FDD is an essential step in your review of any franchise opportunity.
Following up on our previous two articles on the subject, this article lists more things to look for in the FDD:
ITEM 8 – Restrictions on Sources of Products and Services. Franchisors, in order to maintain uniformity of appearance and quality within the franchise system, will exercise substantial control over products, advertising, equipment, sources of supplies, decor, and virtually every other aspect of a franchisee’s business. This is normal and an important part of the franchise system. However, increasingly, restrictions on sources of products and services have become a major area of abuse. In all likelihood, somewhere in Item 8 of your FDD you will see a sentence or two indicating that the franchisor reserves the right to receive payments from suppliers as a result of dealings with you and other franchisees. In other words the franchisor is expressly reserving the right to receive “kickbacks” from the suppliers they choose. This creates an obvious conflict of interest and all too many franchisors are tempted to turn their legitimate right to oversee quality control and uniformity into a “profit center” at the expense of their franchisees. In extreme cases, a franchisee may find that its customers can purchase products at retail at the same price or cheaper than the franchisee is paying for the products at wholesale from the designated supplier.
ITEM 9 – Franchisee’s Obligations. These items should be thoroughly studied and the corresponding provisions of the franchise agreement should be read carefully. Generally speaking, you must assume that the franchisor will rigorously insist on your performance of each of these requirements. Also, you can expect the court system to rigorously uphold the franchisor’s right to enforce these provisions. In your due diligence investigation, you should ask current and former franchisees about each of these items and how the franchisor has dealt with them in the past.
ITEM 10 – Financing. Some franchisors offer startup financing. Claims of misrepresentation about financing were identified early on as a problem by the Federal Trade Commission. Typically, if you default under the financing offered by the franchisor, this will also be a default under the franchise agreement and vice versa. For this reason, a missed payment on your financing could result in the loss of your franchise. A loss of your franchise agreement would constitute a default under the financing, requiring the loan to be repaid in full. Great caution should be exercised in accepting financing from the franchisor. If you are not receiving financing from the franchisor but were referred to a lender by the franchisor, check Item 10 to see if the franchisor receives a referral fee.
Also, note that franchise brokers will sometimes encourage prospective franchisees to use their 401 (k) or IRA or other retirement savings to finance of the purchase of a franchise. Generally speaking, we believe that any new business opportunity is far too speculative and risky to jeopardize your retirement savings.
ITEM 11 – Franchisor’s Assistance, Advertising, Computer Systems, and Training. The Federal Trade Commission franchise rule requires that each franchisor include in Item 11 the following statement in bold type:
“Except as listed below, we are not required to provide you with any assistance.”
That about says it all. What you see is what you get. What you see is ALL you get.
One of the most frequent complaints from franchisees, especially concerning small or startup franchise systems, is that the franchisor is not giving them any support. Unfortunately, the typical franchise agreement does not require the franchisor to give you ongoing support or much of anything. If the franchise agreement does not require the franchisor to give ongoing support and spell that support out in some detail, a court or arbitrator will not require the franchisor to give ongoing support. Also, courts and arbitrators will not enforce the oral promises made to you by brokers and salesmen.
If you do decide to proceed with the franchise opportunity, we recommend that you take full advantage of all assistance that the franchisor offers. After all this is what you are paying for. You should take advantage of site location assistance, initial training, ongoing training, advertising assistance, telephone support, etc.
George G. Hearn, Member-Manager of our firm, was one of the presenters at the March 4, 2010 Administrative Law Seminar sponsored by the Administrative Law Section of the N.C. Bar Association Foundation. Hearn joined four other attorneys presenting a panel discussion about occupational licensing boards . There are over 50 such boards in North Carolina, including those regulating the practice of medicine, law, architecture, nursing, real estate brokerage and certified public accounting. Hearn and our firm have been privileged since December, 1989 to represent the North Carolina Veterinary Medical Board, which licenses veterinarians and registers veterinary technicians and regulates the practice of veterinary medicine .. Each attorney on the panel prepared written materials for the seminar participants explaining the role and function of their respective client board.
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