I was shocked recently while attending a workshop covering franchisee recruitment (formerly known as "franchise sales") by the participants' responses to the following situation:
Assume that the franchisor says nothing in his Franchise Disclosure Document's Item 19 as to financial performance. Instead, the franchisor suggests that prospective franchisee prepare a business plan that would include a projection of revenues and costs for the proposed franchise.
The prospect follows this request. In reviewing the prospect's submission, the franchisor sees that the projected revenue level is way out of line. It may be far too optimistic, or perhaps too low. As for expenses, they are also far off, and, in addition, perhaps incomplete. Does the franchisor inform the prospect that he is out of the ballpark? In so doing, would he be making an unlawful financial performance representation (FPR)? The participants at this program, I should note, were not rookies. Most of the attendees had several years of experience.
The responses to this question were split. Some said yes and some said no, thus demonstrating how much of a trap the FPR requirements of the FTC's Franchise Disclosure Rule and the corresponding state franchise sales regulation laws can be.
As a matter of background, and without being too technical, FPRs are made when the franchisor directly or indirectly provides a prospective franchisee with information that would enable the franchisee to calculate a specific level of financial performance, or a range of performance levels. It can be numerical information, or information from which numerical information can be implied ("You will earn enough to buy a Cadillac!"). Historically, information about costs was also considered sufficient for the franchisor to be deemed as having made an FPR, but under the revised FTC Disclosure Rule that is no longer the case as long as that information is not expressed as a percentage of sales.
Normally, when thinking about FPRs, one envisions information being disseminated by the franchisor. However, as the hypothetical above demonstrates, the origin of the information can be the franchisee, and it is here that a franchisor can easily fall into the FPR trap, and the temptation to do so is great.
If the franchisor responds at all, he has already become victim of this Venus Flytrap. By commenting in almost any way, the franchisor has made an FPR. If he says, "Okay," he has, arguably, blessed the numbers. Obviously, if he says anything stronger, his problem has been exacerbated. Even a "thank-you," might be problematical. The best counseling advice here is to make sure that when the franchisor receives the business plan, he notifies the prospect in writing that the franchisor has not commented in any way on the projections included in the business plan. As any good trial lawyer will tell you, never volunteer information gratuitously unless there is a method in your madness.
Now for the more difficult situations. First, suppose the projections are too low. In the absence of comment by the franchisor, the prospect may turn his attentions to other franchise opportunities. However, any attempt to save the prospect can be treacherous. Of course, this problem truly arises only when the prospect decides that there can be better deals to look at. In the end, if the prospect buys, he should be making more money than anticipated--rarely a bad result that leads to litigation or adversary relationships.
If the numbers are overly optimistic, however, the franchisor must decide on which poison to choose. If he fails to comment, the franchisee is likely to be disappointed by the results of his operations, which, in turn, is likely to result in a franchisor-franchisee dysfunctional relationship. Perhaps this will lead to a lawsuit, but it very well could result in the franchisee going bust and shutting his unit--never something a franchisor wants to see.
But if the franchisor decides to inform the franchisee that his projections are off, he has now made an FPR. If he decides to sell to the prospect, the franchisee may have a "put" on the franchisor. That is, the franchisee may be able to demand at some point, when it is evident that the franchise is going to fail, either damages or rescission as a result of the franchisor commenting upon the FPR. Not a good solution either.
The only safe course here is for the franchisor not to make an offer to sell to this prospect. However, even here it is possible that if the prospect resided in a registration state, state authorities could claim that the franchisor has violated state law. Although I think the chances of this happening are slim, they are not theoretically impossible.
And so, the Good Samaritan, as is often the case, gets his teeth bashed in by doing the right thing. Will justice ultimately prevail? The Scriptures say that "the meek shall inherit the earth." But in a quote often attributed to Woody Allen, J. Paul Getty aptly qualified that statement by saying, "but not its mineral rights."
Rupert Barkoff is a partner in the Atlanta office of Kilpatrick Stockton LLP, where he chairs his firm's Franchise Practice Team. He is a past chair of the American Bar Association's 2000 member Forum on Franchising, current chair of the Georgia State Bar Association's Franchise Section, and co-editor-in-chief of Fundamentals of Franchising.