Pursuant to federal and state law, Franchisors are required to provide prospective franchisees with a franchise disclosure document (FDD) to enable franchisees to make informed decisions about whether to purchase the franchise. This documentation is crucial to protecting franchisees who should seek legal representation to ensure they are well-informed before entering into an agreement.
As previously discussed, the Federal Trade Commission’s (FTC) Franchise Rule requires franchisors to provide an FDD to any prospective franchisee at least 14 days before an agreement is signed or any consideration is paid for the franchise. Various state laws may have different timing requirements and it is imperative that franchisors comply with all applicable laws.
Basics of Item 3
Every FDD contains 23 items of information, which as indicated above, is provided so that franchisees have an opportunity to make an informed decision about the investment. Specific items of the FDD deserve a bit more focus. Today, let’s discuss what is included in FDD Item 3 and why it is so critical for franchisors and franchisees.
In Item 3, franchisors are required to disclose information about current and prior litigation. This includes whether the franchisor or any of its predecessors, certain affiliates and any of the individuals listed in Item 2 of the FDD, have been convicted of certain crimes or have been found liable – or settled lawsuits – relating to the franchise relationship.
Lawsuits Against the Franchisor
Why would a franchisee sue a franchisor? Lawsuits against the franchisor often arise in connection with the franchisor’s failure to comply with franchise sales laws or franchise relationship laws.
Lawsuits against franchisors can include those arising from:
- The franchisor or its sales personnel making material misrepresentations to the franchisee during the sales process.
- The FDD containing Item 19 disclosures for which the franchisor does not have a reasonable basis or written substantiation.
- The franchisor improperly terminating a franchise agreement.
Lawsuits Filed by the Franchisor
Item 3 also includes franchisor-initiated lawsuits against franchisees commenced in the prior year.
Typical lawsuits against franchisees include those arising from:
- The franchisee failing to timely pay royalties.
- The franchise failing to comply with system standards, including, e.g., using non-approved third-party vendors.
- The franchisee failing to comply with non-competition covenants.
Strategizing with a NY Franchise Lawyer
Litigation is not uncommon when it comes to franchising (and most business and commercial ventures). And Item 3 disclosures require context when determining the extent to which a prospective franchisee should be concerned.
It is acceptable to consider: Are the lawsuits material to the operation of the franchise? Are there a significant number of lawsuits that may impact the health of the system?
A qualified NY franchise lawyer can help you decipher if the lawsuits were par for the course or if they indicate negative trends or broader problems in the franchise system.
Franchisors should speak with knowledgeable counsel to ensure their Item 3 is complete; similarly franchisees should speak with counsel to determine how to assess a franchisor’s Item 3 disclosure.
Contact Lusthaus Law
Lusthaus Law’s website is a resource for New York franchisors and franchisees. We have published two downloadable and complimentary e-books and our Insights blog is regularly updated to reflect industry trends and recent achievements in client representation.
Contact us today to learn more about how Lusthaus Law P.C. can help you navigate a clear path for your franchise’s successful future.
