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Franchisers: Watch Out for Fraud When Using a Franchise Broker
As a lawyer exclusively representing franchisees, the types of claims that I see are numerous and varied. Anything from a franchisor’s failure to approve a transfer, to a threatened termination, to failure to support the franchise in a way the franchisee is expecting (which happens a lot) — the calls I receive keep my job interesting. However, the call that I and my colleagues get most frequently relates to fraud; someone somewhere oversold the franchise opportunity, typically in multiple ways.
Unlike the sale of a typical business, someone who is selling a franchise is really selling the use of a trademark and particularized systems. Finding the location, building the unit, and operating the business are all left up to the franchisee. Because the franchisee bears nearly the entirety of the financial risk, government regulation, at both the state and federal level, focuses primarily on attempting to prevent fraud in the sale of franchises by requiring robust disclosure of the franchise opportunity.
Unsurprisingly, the primary question franchisees want answered is “after I have paid to get into this business, how much money can I make?” To help answer this question, one of the federally required disclosures, known as Item 19, prevents a franchisor from making financial performance representations outside of the disclosure document (the FDD) or that are in any manner inconsistent with what is contained within the FDD. In other words, you can tell someone that the average franchisee makes a certain amount per year, but you need the data that establishes that to be true; you cannot cherry-pick the data to drive up the number, and if you say it in your marketing materials, those numbers need to appear in your FDD as well.
One of the giant loopholes in franchising, however, is that the Item 19 financial performance representations are optional. Franchisors can choose to omit any financial performance representations and disclaim any representations of any sort that someone makes to a prospective franchisee.
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