Savvy entrepreneurs know to review the Franchise Disclosure Document (FDD) before investing in a franchise. This document generally includes 23 numbered items, which include the franchisor’s background, any previous bankruptcies, and any restrictions about territory or supplier use.
One item that warrants especially thorough review is Item 19. This, the Financial Performance Representations, include claims about sales, income, or profits. It specifically states that “no other spoken or written financial performance claim” made by the franchisor is reliable if it is not a part of this item.
The wording of this provision is one example of how the playing field between the franchisor and the franchisee remains unequal in the United States. Those who buy into a franchise are often the victims of a franchisor’s poor practices — practices the franchisor designs to help their own bottom line, often at the expenses of the franchisee.
How can franchisees protect their interests?
Any entrepreneur who has started franchise negotiations knows executives and other representatives of the franchise make financial representations during meetings. So how can someone looking to invest in a franchise know which statements are reliable?
If it is included in Item 19, it is very likely reliable. There are two exceptions: when the franchisor provides actual records or adds information to Item 19 during the negotiation process.
Unfortunately, Item 19 is not the only one that can cause problems for franchisees after the agreement is signed. Other important provisions include the merger and integration clauses, often buried at the end of the contract. These provisions can provide further ammunition for the franchisor to use to remove themselves from accountability for any financial claims made during negotiations.
Can the franchisee trust the franchisor?
As our firm noted in a recent interview, cases where the franchisee sues the franchisor for providing false or misleading financial information during initial negotiations can go both ways. In some instances, the judge will side with the franchisee. In others, with the franchisor. The courts often look at whether it was reasonable for the franchisee to rely on the statements made by the franchisor or their representative when making their determination. Because of this uncertainty, it is especially important for entrepreneurs to carefully review the franchise agreement to help protect themselves from a franchisor’s attempt to remove themselves from accountability when it comes to financial representations.
