Reading the FDD: The Argument Against Simplification

By: Rochelle Spandorf | 5,338 Reads | 9 Shares

Featured in: Franchise Update Magazine: Issue 2, 2021

%3Cp%3E%3Cem%3EIn+this+first+of+a+special+2-part+series%2C+a+veteran+franchise+attorney+looks+at+franchisee+complaints+that+FDDs+are+too+complicated+to+be+understandable.+Part+2%2C+in+the+next+issue+of+this+newsletter%2C+offers+10+tips+on+how+to+read+an+FDD+critically.%3C%2Fem%3E%3C%2Fp%3E%0D%0A%3Cp%3ENo+smart+franchisor+wants+to+sign+up+a+new+franchisee+who+has+not+read+the+franchise+disclosure+document+%28FDD%29.+The+FDD+%28franchising%26rsquo%3Bs+equivalent+to+a+public+company%26rsquo%3Bs+Form+10-K%29+is+a+government-mandated+pre-sale+disclosure+document+that+franchisors+must+deliver+to+a+prospective+franchisee+at+least+14+days+before+the+franchisee+signs+any+binding+agreement+or+pays+any+money+to+the+franchisor%2C+even+a+refundable+deposit.%3C%2Fp%3E%0D%0A%3Cp%3EThe+FDD+must+contain+the+franchisor%26rsquo%3Bs+answers+to+23+distinct+categories+%28Items%29+of+questions+about+the+franchisor%2C+the+franchisor%26rsquo%3Bs+management%2C+and+the+franchise+program%2C+as+well+as+the+franchisor%26rsquo%3Bs+audited+financial+statements+and+a+complete+copy+of+all+contracts+that+a+franchisee+must+sign.%3C%2Fp%3E%0D%0A%3Cp%3EAnswering+questions+with+brevity+is+not+necessarily+the+best+practice+for+franchisors.+Most+franchisors+write+their+FDDs+defensively+to+protect+themselves+against+future+claims+by+franchisees+over+business+losses+that+they+allege+are+due+to+FDD+misstatements+or+omissions.%3C%2Fp%3E%0D%0A%3Cp%3EA+prospect+who+is+told+by+a+franchisor+or+business+broker+that+FDD+delivery+is+a+mere+formality+because+everything+they+need+to+know+about+the+franchise+program+can+be+found+on+the+franchisor%26rsquo%3Bs+website+or+learned+during+a+discovery+day+visit+%26ndash%3B+should+reject+that+franchise+program+and+find+a+reputable+one.+There+are+a+few+thousand+active+franchise+concepts+in+the+U.S.+across+all+industry+sectors%2C+including+some+run+by+Fortune+500+companies.+Smart+franchisors+want+franchise+buyers+to+understand+the+deal+they+are+getting+into+before+signing+a+long-term+contract+allowing+use+of+the+franchisor%26rsquo%3Bs+most+valuable+asset%2C+the+franchise+brand.%3C%2Fp%3E%0D%0A%3Ch2%3EThe+franchisee%26rsquo%3Bs+lament%3C%2Fh2%3E%0D%0A%3Cp%3EA+September+2019+%3Cem%3ENew+York+Law+Journal%3C%2Fem%3E+article+written+by+a+highly+regarded+franchisee+attorney+and+friend+of+mine+describes+franchising+from+the+perspective+of+representing+franchisee+owners+who+have+failed+in+business.+These+are+franchisees+who+seek+legal+help+to+extricate+themselves+from+an+unsuccessful+franchise+investment+after+a+few+years+of+operation%3B+they+are+losing+money+and%2C+notwithstanding+their+contractual+commitment+to+operate+for+a+longer+period%2C+continuing+in+business+makes+no+financial+sense.%3C%2Fp%3E%0D%0A%3Cp%3EThe+classic+franchise+agreement%2C+the+article+critiques%2C+lacks+an+%26ldquo%3Bout+clause%26rdquo%3B+allowing+a+franchisee+to+terminate+the+arrangement+absent+proof+of+the+franchisor%26rsquo%3Bs+material+breach%2C+an+observation+that+is+unremarkable+if+only+because+it+is+entirely+consistent+with+basic+contract+law.+It+also+claims+that+franchise+agreements+give+the+franchisor+too+much+control+over+basic+aspects+of+the+franchisee%26rsquo%3Bs+business%2C+allowing+the+franchisor+to+dictate+uniform+standards+for+trade+dress%2C+operating+protocols%2C+authorized+goods+and+services%2C+hours+of+operation%2C+and+suppliers.%3C%2Fp%3E%0D%0A%3Cp%3EHowever%2C+the+fact+a+franchisor+dictates+these+things+is+explainable+by+well-settled+trademark+law%3A+a+franchisor+%26ndash%3B+as+brand+owner+%26ndash%3B+must+establish+rules+for+all+franchisees+to+follow+to+ensure+that+the+licensed+brand+stands+for+the+same+thing+in+the+minds+of+consumers+who+engage+in+transactions+across+branded+outlets+owned+by+different+franchisees.%3C%2Fp%3E%0D%0A%3Cp%3EOmitted+from+the+article+is+any+mention+of+whether+the+franchisees+who+seek+to+escape+from+a+franchise+deal+gone+bad+%26ndash%3B+a+painful+outcome+that+no+one+may+trivialize+%26ndash%3B+bothered+to+read+the+FDD+or+franchise+contracts+before+signing+them.+Nor+does+the+article+mention+if+the+franchisees+engaged+legal+counsel+to+help+them+evaluate+the+franchise+opportunity+or+conducted+due+diligence+to+validate+the+franchise+program+%28e.g.%2C+interviewing+existing+franchisees%29+before+leaping+in.%3C%2Fp%3E%0D%0A%3Cp%3EFranchise+agreements+are%2C+by+necessity%2C+%3Cem%3Eincomplete+contracts%3C%2Fem%3E%3A+they+require+mutual+performance+over+a+relatively+long+term%2C+on+average+10+years.+As+a+result%2C+they+expressly+vest+franchisors+with+discretion+to+adjust+the+franchise+program+to+keep+the+brand+relevant+as+consumer+preferences%2C+technology%2C+and+competition+inevitably+change+over+the+contract%26rsquo%3Bs+long+term.+This+is+not+to+say+that+all+franchisors+use+their+contract+power+benevolently+or+fairly%3B+some+do+not.+But%2C+the+fact+that+the+franchise+contract+gives+the+franchisor+control+in+the+first+place+to+dictate+operating+requirements+and+lacks+an+%26ldquo%3Bout+clause%26rdquo%3B+for+franchisees+are+risks+that+can+readily+be+identified+before+buying+a+franchise+by+carefully+reading+the+FDD%2C+engaging+counsel+to+read+it%2C+and+interviewing+existing+and+former+franchisees+whose+contact+information+is+in+the+FDD.%3C%2Fp%3E%0D%0A%3Cp%3EThe+Federal+Trade+Commission+%28FTC%29%2C+which+has+administered+a+federal+franchise+sales+law+%28the+Franchise+Rule%29+since+1979%2C+requires+franchisors+to+disclose+on+the+very+first+page+of+the+FDD+in+no-nonsense+terms+three+basic+warnings%3A+%3Cem%3E1%29+%26ldquo%3BBuying+a+franchise+is+a+complex+investment%26rdquo%3B%3B+2%29+%26ldquo%3BRead+all+of+your+contract+carefully%26rdquo%3B%3B+and+3%29+%26ldquo%3BShow+your+contract+and+this+disclosure+document+to+an+advisor%2C+like+a+lawyer+or+an+accountant.%26rdquo%3B%3C%2Fem%3E%3C%2Fp%3E%0D%0A%3Cp%3EYet%2C+despite+these+clear+admonitions%2C+research+shows+that+most+franchisees+buying+their+first+franchise+neither+read+the+FDD+nor+consult+with+a+qualified+franchise+attorney+before+signing+a+franchise+agreement.+Instead%2C+researchers+say+that+most+franchisees+base+their+buying+decision+on+%26ldquo%3Brelatively+shallow%26rdquo%3B+less+informative+sources%2C+such+as+statements+in+franchise+advertisements%2C+newspaper+articles%2C+or+franchise+prices.%3C%2Fp%3E%0D%0A%3Cp%3EIt+is+textbook+law+that+a+party+cannot+evade+the+consequences+of+a+contract+that+the+party+signed+without+reading.+While+people+are+free+to+sign+legal+documents+without+reading+them%2C+the+documents+are+still+binding.+This+truism+applies+to+all+contracts%2C+not+just+franchise+contracts.+The+principle+is+rooted+in+the+%3Cem%3E%26ldquo%3Bsanctity+of+contracts%26rdquo%3B%3C%2Fem%3E%2C+a+doctrine+that+recognizes+that+contract-making+benefits+the+general+public+and+depends+on+parties+being+able+to+rely+on+their+contracts+being+enforced+as+written.+Courts+advance+this+public+policy+by+limiting+their+role+to+enforcing+contracts+and+rarely+creating%2C+dissolving%2C+or+changing+contracts.%3C%2Fp%3E%0D%0A%3Cp%3EIf+a+majority+of+franchisees+sign+franchise+agreements+without+reading+them%2C+it+is+fair+to+say+that%2C+despite+their+efforts%2C+franchise+regulators+and+franchisee+advocates+have+done+a+poor+job+in+educating+franchisees+about+the+blunt+consequences+of+blindly+signing+franchise+contracts.+When+unsuccessful+franchisees+seek+legal+help+for+rescue+from+a+deal+gone+bad%2C+they+learn+the+sobering+lesson+that+the+law+strictly+limits+the+circumstances+in+which+a+court+will+unwind+a+contract.+If+only+these+franchisees+had+sought+the+advice+of+experienced+franchise+counsel+before+buying+the+franchise.%3C%2Fp%3E%0D%0A%3Ch2%3EThe+FDD+readability+problem%3C%2Fh2%3E%0D%0A%3Cp%3EThe+FTC+recently+invited+the+public+to+comment+on+several+proposed+adjustments+to+the+41-year-old+Franchise+Rule.+One+proposal+advanced+by+franchisee+advocates+would+upend+the+longstanding+pre-sale+disclosure+process.+Proponents+maintain+that+the+FDD+has+grown+so+complicated+and+voluminous+that+it+is+%3Cem%3E%26ldquo%3Bintimidating%26rdquo%3B%3C%2Fem%3E+to+the+average+prospective+franchisee%2C+so+much+so+that+the+FTC+should+no+longer+expect+franchisees+to+read+the+FDD+before+buying+a+franchise.+They+urge+the+FTC+to+fix+the+%26ldquo%3Breadability%26rdquo%3B+problem+by+requiring+franchisors+to+prepare+and+deliver+a+summary+FDD+containing+just+specific+highlights%2C+something+short+and+straightforward+enough+that+franchisees+will+read.+Proponents+of+changing+the+pre-sale+disclosure+process+also+assert+that+prospective+franchisees+cannot+afford+and+%3Cem%3Eshould+not+be+expected%3C%2Fem%3E+to+hire+an+attorney+to+digest+the+%26ldquo%3Bbig%26rdquo%3B+FDD+for+them.%3C%2Fp%3E%0D%0A%3Cp%3EFranchising+%3Cem%3Eis%3C%2Fem%3E+a+complex+investment.+It+is+the+wrong+business+opportunity+for+someone+unwilling+to+invest+the+time+and+resources+to+read+the+contracts+or+have+them+explained+before+signing+them.+I+say+this+having+written+and+reviewed+hundreds+of+FDDs+during+my+40-year+career+as+a+franchise+attorney+representing+mostly+startup+franchisors+%26ndash%3B+but+also+having+helped+scores+of+prospective+franchisees+analyze+the+FDD+and+contracts+to+ensure+that+they+appreciate+what+is+expected+of+them%2C+what+they+can+expect+from+the+franchisor%2C+and+to+identify+atypical+contract+provisions+and+red+flags+that+could+spell+trouble+ahead.%3C%2Fp%3E%0D%0A%3Cp%3EWhile+I+appreciate+that+parsing+through+long+contracts+written+in+legalese+%28the+universal+language+of+all+contracts%29+is+challenging+for+non-lawyers%2C+it+is+difficult+to+understand+why+franchise+buyers+are+apparently+unwilling+to+invest+in+legal+counsel.+If+franchise+buyers+find+the+%26ldquo%3Bbig%26rdquo%3B+FDD+and+its+many+exhibits+so+confounding%2C+why+would+they+invest+what+often+is+their+life+savings+in+a+binding+agreement+without+hiring+legal+counsel+to+advise+them+about+what+they+are+getting+into%3F%3C%2Fp%3E%0D%0A%3Cp%3EFurthermore%2C+it+is+difficult+to+accept+the+affordability+excuse+for+not+hiring+legal+counsel.+Compared+to+the+amount+of+money+that+franchisees+will+invest+to+buy+and+start+up+a+franchise+business%2C+the+cost+to+hire+an+experienced+franchise+attorney+to+wade+through+the+FDD+and+contracts+is+nominal.+Once+the+franchisee+signs+on+the+dotted+line%2C+they+will+face+far+greater+expenses+opening+and+operating+the+franchise+business+%26ndash%3B+just+to+break+even+%26ndash%3B+than+the+up-front+investment+in+good+legal+representation.+Hiring+an+experienced+franchise+counsel+before+buying+a+franchise+is+the+ounce+of+prevention+hailed+by+Benjamin+Franklin.%3C%2Fp%3E%0D%0A%3Ch2%3EDebunking+the+readability+problem%3C%2Fh2%3E%0D%0A%3Cp%3EThere+are+numerous+articles+written+by+franchise+consultants+offering+different+perspectives+for+how+a+franchise+buyer+should+critically+read+the+FDD+or+find+the+right+franchise.+Some+of+these+articles+are+extraordinarily+basic%2C+written+so+simplistically+that+they+leave+the+impression+that+selecting+a+franchise+and+digesting+the+legal+documents+are+tasks+that+are+easy+to+do.+Add+to+this+the+fundamental+attraction+of+franchising+%26ndash%3B+being+one%26rsquo%3Bs+own+boss+in+control+of+one%26rsquo%3Bs+own+destiny%26nbsp%3B+%26ndash%3B+and+the+sheer+number+of+franchised+businesses+represented+in+the+U.S.+economy%2C+and+it+may+seem+to+a+first-time+franchise+buyer+that+anyone+can+find+financial+success+by+investing+in+a+franchise.+Buying+a+franchise+is+a+complex+investment%2C+and+performing+appropriate+due+diligence+and+engaging+legal+counsel+before+signing+a+franchise+contract+will+%3Cem%3Enot%3C%2Fem%3E+eliminate+the+risk+embedded+in+every+business+investment%2C+franchise+or+not.%3C%2Fp%3E%0D%0A%3Cp%3EIt+is+important+to+debunk+the+notion+that+FDDs+today+are+so+complicated+that+franchisees+may+rightfully+not+read+them.+Anyone+who+buys+a+franchise+will+have+to+sign+other+contracts+to+get+their+franchised+business+open+%26ndash%3B+leases%2C+bank+loans%2C+supplier+agreements%2C+and+more+%26ndash%3B+for+which+the+law+does+not+provide+a+plain+language%2C+pre-signing+disclosure+like+the+FDD.%3C%2Fp%3E%0D%0A%3Cp%3EWhile+the+FDD%26rsquo%3Bs+plain-English+disclosures+cannot+change+the+relational+dynamics+or+level+the+playing+field+between+franchise+parties+as+a+whole%2C+the+FDD+does+a+good+job+of+comprehensively+explaining+the+parties%26rsquo%3B+mutual+rights+and+duties+in+what+may+fairly+be+described+as+a+lopsided+power+arrangement.+Franchisees+lose+sight+of+the+forest+for+the+trees+by+blaming+the+FDD%26rsquo%3Bs+girth+as+a+reason+for+signing+franchise+contracts+without+reading+them.+Proper+due+diligence+of+a+complex+investment+is+%3Cem%3Enot%3C%2Fem%3E+something+that+can+or+should+be+abbreviated%2C+condensed%2C+or+hastened.%3C%2Fp%3E%0D%0A%3Cp%3E%3Cem%3EPart+2%2C+%26ldquo%3BTen+Tips+for+Reading+an+FDD%2C%26rdquo%3B+will+appear+in+the+next+issue.%3C%2Fem%3E%3C%2Fp%3E%0D%0A%3Cp%3E%3Cem%3E%3Cstrong%3ERochelle+Spandorf%3C%2Fstrong%3E+is+a+partner+with+Davis+Wright+Tremaine+and+chairs+the+firm%26rsquo%3Bs+franchise+practice.+She+is+a+nationally+recognized+business+franchise+and+distribution+attorney+representing+franchisors%2C+manufacturers%2C+licensors%2C+suppliers%2C+franchisees%2C+and+distributors+in+their+domestic+and+international+expansion+and+strategic+development.+She+has+the+distinction+of+being+the+first+woman+to+chair+the+ABA+Forum+on+Franchising%2C+the+nation%26rsquo%3Bs+preeminent+association+of+franchise+attorneys%2C+and+is+recognized+by+her+peers+as+a+Global+Elite+Thought+Leader+in+franchise+law.+Contact+her+at+%3Ca+href%3D%22mailto%3Arochellespandorf%40dwt.com%22+target%3D%22_blank%22+rel%3D%22noopener%22%3Erochellespandorf%40dwt.com%3C%2Fa%3E+or+213-633-6898.%3C%2Fem%3E%3C%2Fp%3E

Published: June 27th, 2021