United States: Disclosure Issues Arising Out of the Amended FTC Rule

Last Updated: November 25 2010
Article by Charles S. Modell and Joe Fittante

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 distribution.
  • 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 claims.
  • 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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