Franchise Disclosure Documents – Additional Prohibitions


Additional Prohibitions

In addition to the prohibitions concerning the making of financial performance representations, discussed above, the amended Rule prohibits seven specific acts or practices. Each of the seven is discussed immediately below.

Prohibition Against Contradictory Information

The amended Rule prohibits a franchise seller from making any statement that contradicts the information disclosed in the franchisor’s disclosure document. This prohibition is necessary to prevent deception and to preserve the integrity of the disclosure document.

Prohibited contradictory statements include those made orally, visually, or in writing. For example, a franchise broker would be in violation of the amended Rule if it stated that the franchisor has never been sued by a franchisee, when, in fact, the franchisor has been sued and has disclosed that information in Item 3. Of course, franchise sellers are always free to disseminate additional truthful non-contradictory information to a prospective franchisee, especially if required to do so by state law or at the written request of state franchise examiners.

Prohibition Against Use of “Shill” Testimonials

The amended Rule prohibits the use of fictitious references or “shills.” Specifically, it prohibits franchise sellers from misrepresenting that any person has purchased or operated one of the franchisor’s franchises, when that is not the case, or that any person can give an independent and reliable report about the experience of any current or former franchisee, when that is not the case. The prohibition against the use of shills is also broad enough to cover the use of “institutional shills,” companies that purport to provide consumers with “independent” reports on franchisors that are their members. Sometimes the names of these institutional shills invoke, imitate, or allude to the Better Business Bureau – a legitimate organization that actually does perform the services that these unscrupulous operations only pretend to perform. Because information provided by shills is inherently false and unreliable, it is likely to mislead prospective purchasers.

Prohibition Against Failing to Make Requested Early Disclosures

Any prospective franchisee in the process of purchasing a franchise can request a copy of the franchisor’s disclosure document at any time in advance of the point – 14 calendar days before the franchise agreement is executed or a payment is made to the franchisor or an affiliate – when the franchisor is required to furnish the prospect with a copy of its disclosure document. Franchisors must honor such requests.

The prohibition on failing to furnish disclosure documents earlier than 14 days in advance of execution of a binding agreement or the making of a payment, if requested, pertains to “prospective franchisees” only. A franchise seller has no obligation to furnish disclosures to competitors, the media, academicians, or researchers. Further, the prohibition applies only to prospective franchisees already in the sales process. This means that a franchise seller would be obliged to furnish a disclosure document to any prospective franchisees requesting it who have submitted a franchise application and who have been notified that they qualify to purchase a franchise. A franchisor need not furnish a copy of its disclosure document to individuals casually seeking general information on the franchisor or to those who have not submitted necessary information to demonstrate that they qualify to purchase a franchise.

A franchise seller other than the franchisor can satisfy its obligation to provide updated disclosures by promptly forwarding a prospective franchisee’s request for such updates to the franchisor, provided that the franchisor has promised to fulfill any such request promptly.

Prohibition Against Failing To Furnish Updated Disclosures

The amended Rule prohibits franchise sellers from failing to furnish, upon reasonable request, any updated disclosures prepared under the Rule’s general updating requirements to a prospective franchisee who has previously received a basic disclosure document.19 This prohibition recognizes that the information contained in a disclosure document may become outdated by the time a prospect relying on it is ready to sign a franchise agreement. For example, a franchisor may have filed for bankruptcy after having furnished its disclosure document to a prospective franchisee. Thus, this prohibition prevents deception through omission of material information, ensuring that prospective franchisees can, if they wish, obtain any updated disclosures prepared by the franchisor, while imposing no new automatic disclosure obligations on the franchise seller.

Prohibition Against Failing To Note Unilateral Modifications

As previously discussed, the amended Rule prohibits franchise sellers from presenting a franchise agreement for signing that has terms and conditions materially different from those in the copy of the agreement attached to the disclosure document in Item 22, unless the franchise seller has informed the prospective franchisee of the differences at least seven calendar days before execution of the franchise agreement. Unilateral modifications of material contract terms by the franchise seller without notice to the prospective franchisee are likely to mislead a prospect who has been relying on the standard agreement attached to the disclosure document or on a previous draft as setting forth the parties’ agreement.

Prohibition of Disclaimers and Waivers

The amended Rule prohibits franchise sellers from disclaiming or requiring “a prospective franchisee to waive reliance on any representation made in the disclosure document or in its exhibits or amendments.” This includes the use of integration clauses that purport to disclaim liability for statements authorized by franchisors in their disclosure documents. This prohibition is intended to prevent fraud by ensuring the accuracy of information contained in disclosure documents. It is not intended to ban all uses of integration clauses.

Scope of the Prohibition

The prohibition against disclaimers and waivers is designed to address a specific problem: franchisors’ use of waivers or integration clauses or similar contract provisions to disclaim authorized statements made in their disclosure documents or in exhibits or attachments to their disclosure documents. By prohibiting this practice, the disclaimer and waiver prohibition preserves the integrity of the material information disclosed in a franchisor’s disclosure document, thus preventing deception.

By its terms, the prohibition is limited to waivers or disclaimers pertaining to statements made in the disclosure document and its exhibits or attachments. The prohibition does not reach statements made in a franchisor’s advertising or other promotional materials. Note, however, that such statements, like statements made in any other industry advertisements or promotional materials, are already subject to the prohibition in Section 5 of the FTC Act against material misrepresentations. Nor can franchise sellers omit material information necessary to prevent prospective purchasers from being deceived. Moreover, any statement, advertisement, or promotional message that contradicts information contained in the disclosure document violates the amended Rule’s prohibition against the making of contradictory statements. For example, it would violate the Rule for a franchisor to use promotional literature containing financial performance claims, while its Item 19 disclosure states that no such claims are authorized. Similarly, if its promotional literature states that exclusive territories are available, when its disclosure document offers no such benefit, the franchisor would be in violation of the amended Rule.

Parties’ Ability to Negotiate Contracts Terms

The amended Rule states that the disclaimer prohibition “is not intended to prevent a prospective franchisee from voluntarily waiving specific contract terms and conditions set forth in his or her disclosure document during the course of franchise sales negotiations.” Without this proviso, a franchisor might reasonably conclude that it is prohibited from agreeing to any terms or conditions not specifically set forth in the standard agreement attached as an exhibit to its disclosure document. A franchisor need not use an integration or waiver clause, however, to preserve the parties’ ability to negotiate contract terms.

As previously discussed, franchise sellers and prospective franchisees may negotiate contract terms without violating this prohibition of the amended Rule. Specifically, the amended Rule provides that no mandatory contract review period is necessary where changes are made at the request of the prospective franchisee. This recognizes that where the prospective franchisee is fully informed about the contractual terms that will govern the relationship before signing the contract, no harm can result. Where changes to the contract are initiated by the franchisor, however, the amended Rule prohibits the franchisor from failing to point out the changes and provides for a limited seven calendar day contract review period. Accordingly, the parties can freely modify the standard agreement attached to a disclosure document without the need of a waiver or integration clause.

Alternatives to Disclaimers and Waivers

Finally, nothing in the amended Rule would prevent a franchise seller from seeking alternative ways to narrow its disclosures to avoid making misleading statements. For example, an ice cream store franchisor may make an Item 19 financial performance representation pertaining to units based in Florida. If the franchisor sells units in southern states, the Florida based representation may be reasonable. However, if the franchisor were to sell a unit in Alaska, the franchisor might be well advised to provide the prospective Alaskan franchisee with a disclosure document that deletes the Item 19 representation. In the alternative, the statement of bases and assumptions attached to the disclosure document could make clear that the financial performance representation pertains to Florida or other southern states only. The prohibition against disclaimers and waivers also would not prevent a franchisor from having a prospective franchisee sign a clear and conspicuous acknowledgment that the Florida-based performance representation does not apply to states such as Alaska.

Sample Integration Provision

This Agreement and all exhibits to this Agreement constitute the entire agreement between the parties and supersede any and all prior negotiations, understandings, representations, and agreements. Nothing in this or in any related agreement, however, is intended to disclaim the representations we made in the franchise disclosure document that we furnished to you. You acknowledge that you are entering into this Agreement as a result of your own independent investigation of our franchised business and not as a result of any representations about us made by our shareholders, officers, directors, employees, agents, representatives, independent contractors, or franchisees that are contrary to the terms set forth in this Agreement, or in any disclosure document, prospectus, or other similar document required or permitted to be given to you pursuant to applicable law.

Prohibition Against Failing to Make Promised Refunds

The amended Rule prohibits franchise sellers from failing to make refunds as promised in the disclosure document or in a franchise or other agreement. This slightly revises the original Rule’s prohibition against failing to make promised refunds. The original Rule prohibited franchisors and brokers from failing “to return any funds or deposits in accordance with any conditions disclosed pursuant to paragraph (a)(7) of this section.” That prohibition was limited to instances where the franchisor or broker made an express refund promise in the disclosure document itself. It is possible, however, that a franchise seller may not make any specific promise in the disclosure document, but may do so either in the franchise agreement, or in a separate contract or letter of understanding. The harm resulting from the failure to honor a promised refund is the same, regardless of where the promise is written. Accordingly, the amended Rule makes clear that the failure to honor any written refund promise will constitute an independent Rule violation.

This article is part of a series of articles on starting a franchise in Minnesota.
CREDIT: The content of this post has been copied or adopted from the Federal Trade Commission’s Franchise Rule Compliance Guide.

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