Why your Franchise may come with a Money Back Guaranty

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The Franchise Disclosure Document [FDD], is given to each prospective franchisee.  It contains countless required disclosures.  The disclosures includeseverything from who are the persons with franchise management and sale responsibilities, what fees are changed, what are the revenues and profits of the franchisor, and what if any, representations the franchisor makes regarding franchisee earnings.

What if something is missing?  What if something is inaccurate in the Franchise Disclosure Document?

The general answer, if there is a material inaccuracy in the Franchise Disclosure document, is rescission.  If the FDD contains misinformation, the common remedy is the franchisee is entitled to rescission.

Rescission is like a money back guaranty.  Rescission operates to undo the transaction- to put everything back the way it was if before the franchise agreement was signed.  That means the franchisee is entitled to be reimbursed the initial franchisee fee and a lot more.  If the franchisee bought inventory, paid travel expenses for the initial training, purchased equipment, and put a deposit on utilities, the franchisee may be entitled to compensation for all these things.  How much could this cost?  How much money may the franchise be entitled?  Look at the initial investment cost listed in item 7 of the FDD.  Yes, it is all those things and anything else the franchisee paid.

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Does every inaccuracy, every omission in the FDD warrant rescission?  No, of course not.  It is up to a court, a trier of fact, and perhaps state enforcement agencies.  Cases go both ways.  In a case by the Georgia court of appeals, the answer was no.  The case is Legacy Academy, Inc., et al. v. Doles-Smith Enterprises, Inc., et al.  The facts of the case revealed an accuracy in the Franchisor’s cash flow statement in the FDD.  And, that the FDD contained an inaccuracy in the Franchisor’s litigation history.  The case arose when the franchisee notified the franchisor it was unilaterally terminating the franchise agreement.  And, the franchise discontinued paying royalties, de-branded and continued business operations.  The franchisee was upset, because it was not turning a profit.  The franchisor sued for failure to pay royalties. The franchisee counter-sued saying it was entitled rescission of the franchise agreement.

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The lower courts agreed and awarded the franchisee 350,000 dollars in negligent misrepresentations and 40,000 dollars in negligence.  But, the Appellate court reversed saying that the errors and omissions in the franchisor’s cash flow statement and the litigation history did not cause the franchisee to lose money.  The errors in the FDD did not depreciate or lessen the value of the franchise; therefore, the franchisee was not entitled to damages for negligent misrepresentations.  The damages that the franchisee suffered where consequential and not connected the franchisor’s errors in the FDD.  This left the franchisee with damages solely for negligent, which were offset by royalty payments that the franchisee failed to pay and were due.  It was almost a wash.  The franchisee nor the franchisor got a large payout.

Interesting didee of a case.  It shows that when it comes to errors in the FDD, the court can go either way.  The risk of the errors in the FDD can cost 40,000 dollars or 400,000  dollars or nothing.  It is all in how the court decides and there is no predictability.

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