What are Franchise Disclosure Requirements?
A franchise is a business model where an individual or entity (the franchisee) is granted the right to operate a business using the branding, products, and operational methods of an established company (the franchisor). In return for varying degrees of done-for-you business, the franchisee typically pays a fee and ongoing royalties to the franchisor.
As part of the comprehensive information-sharing and contract-signing process, a Franchise Disclosure Document (FDD) is provided by the franchisor. This essential document includes details about the franchisor, the franchise system, financial disclosures, and the legal obligations of both parties. An FDD is legally required in the United States for all franchisors. However, each state may have its own requirements about what needs to be a franchise disclosure document, and when it needs to be provided in the franchise solicitation process.
When legal disputes arise in a franchise, there is a significant burden on franchisors to ensure that franchisees have fully understood the terms of their agreement. A poorly-written or incomplete FDD can leave the franchisor open to expensive lawsuits, even without direct damages. This is demonstrated in the case of Brian Lofgren v. AirTrona Canada, where the court found that AirTrona Canada failed to provide Lofgren with the required disclosure documents before he invested in the franchise. Because of this, the court allowed Lofgren to rescind the franchise agreement and get his money back, even though he couldn’t prove that the lack of disclosure caused him financial harm. This important Sixth Circuit Court of Appeals decision arguably removes the causation requirement for a material omission claim.
Franchisors can reduce the risk of expensive lawsuits by prioritizing transparency and presenting comprehensive disclosures in clear and unambiguous language. Financial data may not be conveyed outside of the FDD, so franchisors should include as much financial information as possible.
The timing of FDD delivery is also crucial; lawsuits can result if the franchisee is not allowed ample time to interpret the information. The Federal Trade Commission (FTC) mandates that franchisors provide the FDD to prospective franchisees at least 14 days before they sign any contract or pay any fees. Some states, however, make this requirement 10 days. And some states have no requirement at all. Franchisors can also demonstrate good faith by actively facilitating the franchisee’s due diligence process, providing well-organized and readily accessible information well in advance of deadlines.
In the case of Red Fit, LLC v. Red Effect Int’l Franchise, the decisions revolved around the franchisees’ (Red Fit and Cali Red) argument that the franchisor (Red Effect) failed to provide the required FDD in a timely manner. Franchisees have certain rights, such as the right to rescind agreements, if the FDD is not provided within the legally mandated timeframe.
An FDD can be made more user-friendly for the franchisee by gearing it to the state laws where it is being used. While large corporations commonly use a one-size-fits-all model for their disclosure documents, paying attention in advance to unique contract issues in the relevant state can avoid issues and provide business advantages in the long run.
For example, one area of Michigan franchise law that is commonly misunderstood concerns the law that will be applied to the contract in case of disputes. While “forum selection” clauses mandate that litigation or arbitration processes occur in Michigan, they do not prevent the use of “choice-of-law” provisions. As long as the chosen law offers similar protections, it can be used to consider the points in question instead of Michigan Franchise Law. Thus, the protections of Michigan law may not help a franchisee if the franchisor selects a different state’s law to apply.
Helping franchisors and franchisees navigate the world of franchising is just part of our firm’s history in handling some of Michigan’s most complex and high-stakes legal disputes. Your business deserves an attorney with in-depth familiarity with Michigan franchise law and over 30 years’ experience. August Law can help.