Common Sense on Item 19

Franchise Disclosure Document

Believe it or not, the courts are capable of exercising common sense when it comes to the one element in the Franchise Disclosure Document that, if sloppily written, can make a plaintiff's attorneys salivate - Item 19.

Item 19 is where prospective franchisees think they may find the answer to the question: How much money will I make if I sign up with this franchisor? Prudent franchisors, on the other hand, make sure they don't, but it remains true that Item 19 gives rise to many a tussle between franchisors and unhappy franchisees.

Federal Trade Commission rules do not prohibit franchisors from divulging specific financial information to prospective franchisees in Item 19, including data on potential sales, income, gross profits, and so on. But those franchisors who do so must back up everything they say.

That's an open invitation to disappointed franchisees to look around for a plaintiff's attorney, of course, so franchisors must watch their words when it comes to Item 19. Even so, sooner or later, many franchisors face litigation over Item 19, and if they don't settle, they must hope to find themselves in the company of a judge with common sense.

Exactly that happened in three recent cases involving Item19. In the one, the franchisor's Item 19 disclosed data only on gross sales and, in the notes, stated that the franchisor had no access to the cost information of its franchisees and hence knew nothing of their profits.

The franchisee's argument was that in fact the franchisor knew everything there was to know about franchisees' profits since the franchisor required them to submit regular financial statements.

Not so fast, ruled the court. The franchisor's Item 19specified that the franchisor made no claims as to its franchisees' costs of sales or operating expenses and that the franchisor's employees moreover had no authority to provide any such data. In effect, this put prospective franchisees on notice that it was up to them to dig up any such information through their due-diligence interviews with existing franchisees.

In short, the unhappy franchisee had no case, the court ruled.

The other two cases followed similar lines. In the one, the franchisor offered some data on the earnings of existing franchisees but took care to warn prospective franchisees that they must not rely on the data when putting together their own projections. This made it clear that, as in the first case, prospective franchisees had to do their own due diligence.

The third case involved an individual who wanted to buy an existing franchise outlet, and the question hinged on certain discrepancies between the franchisee's tax returns and pro forma financial statements. The court ruled that any such discrepancies should have alerted the buyer to do some digging, and because he did not, he, too, had no case.

Common sense prevailed in each of these cases, but Item 19litigation remains a threat to any franchisor, making the lesson clear: Get expert legal help when fashioning the language you use under Item 19, not to mention the numbers you divulge, if any.