ARE LITIGATION DISCLOSURES IN UNIFORM
FRANCHISE OFFERING CIRCULARS MISLEADING?
- Do Litigation Disclosures In Uniform Franchise Offering Circulars Accurately Report the Results of Litigation?
A franchise case settles in the midst of trial. As part of a confidential settlement agreement, the franchisor buys out the franchise rights of the franchisee at a significant premium in excess of fair value. In exchange, the franchisee agrees to concede liability in the case. In other words, the franchisor buys the right to publicly declare "victory." Victory is extremely important to franchisors since the biggest concern expressed by franchisors in the disposition of any litigation case with franchisees is the risk of an adverse precedent leading to the stereotypic "opening of the floodgates" of litigation against the franchisor.
Such a settlement structure allows the franchisee to realize a significant premium over the fair value for his or her franchise rights and also allows the franchisor to declare victory in communications throughout the franchise system. Presumably, such communications will serve to discourage other franchisees from fighting a similar "losing" battle against the franchisor.
A clear "win-win" result for both sides. Indeed, confidential settlement agreements are often structured in this manner in franchise litigation. However, does this negotiated settlement result in misleading information being published by the franchisor in the Uniform Franchise Offering Circular ("UFOC") about the disposition of such litigation?
The Franchisee Rule (16 C.F.R. §436.1(a)) broadly requires a franchisor to provide prospective franchisees with several cateogires of "information, accurately, clearly, and concisely stated, " including "[a] statement disclosing" any litigation "which was brought by a present or former franchisee or franchisees and which involves or involved the franchise relationship..." 16 C.F.R. §436.1(a)(4)(ii) [emphasis added]. The rule allows franchisors great latitude in describing their litigation experience in the UFOC. Franchisors can be expected to put their best "spin" on their litigation experience with franchisees.
Importantly, the franchisor in the hypothetical settlement discussed above will disclose its "victory" over the franchisee in its UFOC. Are readers of UFOC’s, primarily prospective ee, misled by these manipulated results? Franchisors will argue that there is nothing manipulated or misleading about it. The accurate disposition of the case, reached through negotiation and settlement, is properly reported in the UFOC. The settling franchisee should care not since he achieved the result he was seeking and is no longer in the franchisee system.
A prospective franchisee should pay particular attention to the litigation section of the UFOC, since litigation is the last place a prospective franchisee wants to end up. However, readers of UFOC litigation disclosures must understand that the information contained in the UFOC regarding the disposition of litigation may be technically accurate, but may often not tell the whole story.
