Be Careful When Relying Upon a Franchisor’s Financial Performance Claims

Prospective franchisees have often been incorrectly told that federal law prohibits a franchisor from disclosing financial performance information to the prospect prior to his or her becoming a member of the franchise system. The revised Federal Trade Commission Franchise Rule now requires that franchisors clearly disclose they are legally permitted to provide financial performance information if they chose to do so. Only about 20% of franchisors made financial performance claims in 2006. Virtually all current disclosure documents and franchise agreements contain warnings that no one is authorized to make financial performance claims on behalf of the franchisor unless those claims have been included in the disclosure document, and also warn you not to rely upon any undisclosed claims if they have been made to you.

The revised Rule also permits a franchisor to give financial results of chosen subsets of its franchise system. Of course, certain additional information must also be disclosed so as to permit the prospect to evaluate the claims which are being made. All financial performance information must now be disclosed within the disclosure document’s Item 19, and not through a separate document as was previously required by the original Rule. Notably, financial performance information no longer needs to be prepared in compliance with generally accepted accounting principals so long as the representations made are “reasonable.” Needless to say, this change represents a much looser standard. The revised Rule also makes clear that providing prospective costs or expenses alone does not constitute the provision of financial performance information.

What does this all mean to you, the prospective franchisee? You should read your franchise disclosure document carefully! While the franchisor may continue to refuse to disclose any financial performance information, the franchisor is now protected from complaint that it has made improper financial performance claims if it chooses to disclose only prospective costs or expenses. In such circumstances the temptation will be great for a prospective franchise to “fill in the blanks” of missing revenue information in an attempt to obtain a more complete picture of the financial performance of units within the system. However, the prospect will be doing so at its own risk.

Compliance with the revised Rule has been mandatory since July 1, 2008. In addition, various state laws may be amended to harmonize them with the revised Rule.