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Before Buying a Franchise, Read the Disclosure Document

In last week's blog, I discussed a number of areas that a prospective franchisee must consider and fully understand before joining any franchise system. In this blog, I would like to focus on the subject of understanding the franchise circular and understanding the representations made by the franchisor to you before you decide to sign up. In brief, a franchise offering circular is a document required by the Federal Trade Commission that covers 23 distinct areas, including but not limited to, requirements for an initial investment, operating practices, advertising, royalties, and territory. The circular will also tell you in no uncertain terms that the franchisor does not give you any guarantees of success when entering the franchise system.

1. All franchisees must understand that the only guarantee that the franchisor will give you is that you will get no guarantees. This simply means that a franchisee is on his own with regard to understanding as many of the terms and provisions of the franchise circular as is necessary. This is the reason why you will need both an attorney and an accountant to review the legal and financial components of the franchise documents in order for you to make the right decision. 

2. To better understand the importance of reviewing the circular in advance, let's look at a fairly recent California state court ruling which illuminates just how important it is for each and every prospective franchisee to read the Uniform Franchise Offering Circular before acquiring a franchise. In Ayu's Global Tire v. Big O Tires, Inc, the relevant facts are as follows: The trial record before The Court of Appeal of the State of California, Second Appellate District revealed that the Plaintiff, Ayu's purchased a Big O Tires franchise in February of 2008. Prior to acquiring the franchise, he received Big O's Uniform Franchise Circular ( UFOC). After operating the store for about 13 months, Ayu's had to close due to financial difficulties. The following year, Ayu's sued Big O, alleging that Ayu's was defrauded in the following areas: That Big O misled Ayus as to how much experience is needed to open such a store, that Big O provided exaggerated earnings, that Big O concealed the fact that many of the franchisees had failed and that Big O failed to conform to its representations made regarding the development of new products and services. The case was decided under Colorado law as the franchise agreement called for the application of Colorado law in the event of a legal dispute.

Under Colorado law, like Massachusetts, Ayu's as an aggrieved party must show that it reasonably relied on Big O's misrepresentation in proving a case for fraud. The Appeals Court found based on the trial record that certain information was available to Ayu's and open to inspection and further investigation at or prior to the time Ayu's purchased the franchise. The Court stated, "If the purchaser does not avail himself of these means and opportunities, he will not be heard to say that he has been deceived by the vendor's representations." The Court also found that Ayu did not consult with other franchisees prior to purchasing the franchise which explicitly went against the franchise circular which directed each franchisee to reach out to others in the system prior to purchase. 

3. The Court also held that with respect to Ayu's claims as to both concealings failed franchises and tire sale prices that, in each case, the franchise circular addressed the issue of those franchises that were either canceled, transferred or terminated.  As to tire prices, had Ayu's read the franchise circular it would have realized that Big O was only required to provide tires to franchisees "to the extent available" and, moreover, that Big O retained the contractual right to set tire prices for the franchisees.

4. As to the store location claim, the circular was clear that any decision as to store location was to be made by Ayus. On that issue, the Court found in favor of Big O.

Clearly, this case is a shining example of a situation where a business did not do its homework. In fact, Ayu did not even hire an experienced attorney to assist in its franchise purchase. As a result, Ayu's lost money and suffered a setback to its reputation. Ultimately, Ayu's was kicked out of the Big O system for ultimately not being able to successfully operate its Big O franchise. Had Ayu's taken the time to review the materials in advance of joining the Big O system it may have decided not to join at all. As I say to all of my clients, there is no room in the equation for ignorance or lack of homework when making important business decisions such as purchasing a franchise. Let the Katz Law Group keep you focused on making the right decision for your potential franchise business by calling us at 508-480-8202

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