Several attorneys specializing in franchise litigation
collaborated at the ABA Forum to present a workshop entitled
"Litigating Disclosure Claims," which highlighted
the most frequently litigated disclosure-related issues brought by
franchisees. This workshop examined the new provisions in the
Amended FTC Rule that are likely be the subject of litigation.
Franchisors should be aware of these issues, many of which are
summarized below, in order to take steps to address and avoid this
type of litigation in the future.
Competition. Item 12 of the Amended FTC Rule
now requires franchisors to identify their rights related to
alternative channels of distribution, such as the Internet,
telemarketing, and other methods of direct sales. As franchisors
are increasingly using the Internet and e-commerce as a means to
market their products, franchisees face increased direct
competition from this type of marketing, and litigation may arise
as a result. It is important for franchisors to identify and
disclose restrictions on the franchisees in their use of
alternative channels of distribution, and franchisors should also
disclose their own rights related to use of alternative channels of
Renewal. The Amended FTC Rule now requires
franchisors not only to describe any renewal opportunities
available to the franchisee in Item 17, but also to specifically
define the term "renewal" and what it means in
relation to the franchise system. For example, many franchisors
allow franchisees to renew their agreements on the
"then-current" form franchise agreement. If this
is the case, the franchisor must affirmatively state in Item 17
that franchisees may renew, but the new contract may contain
materially different terms and conditions than their original
contract. Failure of the franchisor to disclose this information
could result in litigation from franchisees seeking to renew under
the terms of their original agreement.
Financial Performance Representations. Another
disclosure issue that is often litigated are the financial
performance representations (formerly known as "earnings
claims") set forth in Item 19. Many times claims are
brought that the performance representation stated in Item 19 is
either fraudulent or a negligent misrepresentation if the claim is
inaccurate, or if the franchisor does not have a basis for the
representations made. Additionally, litigation may arise if agents
of the franchisor make financial performance representations
outside of that disclosed in the disclosure document. The Amended
Rule includes in the definition of a "financial
performance representation" representations related to
non-monetary measures of performance, implied representations, and
references to actual or potential performance. The Amended Rule
does however, specifically allow financial performance
representations to be made in the media, if they are directed to
the general public and not specifically to prospective franchisees,
and the franchisor complies with requirements related to media
Parent companies. Item 1 of the Amended FTC
Rule now requires franchisors to identify any controlling parent
company. The term "parent" is defined as
"an entity that controls another entity directly or
indirectly through one or more subsidiaries." This
disclosure allows franchisees to determine whether the franchisor
is owned by a company that operates outlets that the franchisee
will be competing with, and failure to disclose any controlling
parent company could result in a franchisee claim.
Other. Of course, many commonly litigated
claims prior to the adoption of the Amended Rule continue to be an
issue, including claims related to the accuracy of the franchisees
estimated initial investment in Item 7 and disclosure of the
franchisee's obligations to purchase goods from designated
suppliers. Item 8 now also requires franchisors to disclose the
interest of its officers in any suppliers. Other litigation issues
arising out of the Amended FTC Rule relate to the expansion of the
definition of a "Franchise Seller" and the
prohibition on merger and integration clauses.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C.
This summer the SEC and the Wall Street Journal have reported several noteworthy items concerning the SEC’s whistleblower program, one of the most controversial components of the Dodd-Frank Act of 2010.