CounterPoint: Earnings Claims Should Not Be Mandatory

Writer's Note: In countering Harry Rifkin's opinion piece titled

Why the FTC Got it Right – An Argument against Mandatory Earnings Claims

By David L. Cahn, Franchise & Business Law Group, Baltimore, Maryland

 The new Federal Trade Commission franchisor disclosure rules include several important revisions to the old Uniform Franchise Offering Circular guidelines. One important change that was not made, however, was to make earnings claims (now “Financial Performance Representations” or “FPRs”) mandatory. While the FTC recognized that there was a potential for abuse with its non-mandatory structure, it properly took steps to minimize this potential, rather than taking the unnecessary step of mandating FPRs.

While we encourage out franchisor clients to provide financial performance information whenever feasible and appropriate, it just does not make sense for all franchisors to provide FPRs. For example, in a sales-type franchise in which success is widely variable and largely dependent on the traits of the franchisee, providing financial performance information that is of value to prospective franchisees is extremely difficult. Likewise, early-stage franchisors simply may not have enough franchisees with significant track records susceptible to meaningful interpretation to develop either a historical or projective FPR. Some companies with innovative business ideas start franchising very early in their existence, and there has never been a legal requirement that a brand or business system be “tried and true” before granting franchises.

Additionally, exactly what information should and could be required in a mandatory FPR? It is difficult to envision a definition of the type of data would have to be provided to allow a franchisor to satisfy a mandatory FPR requirement. This issue becomes more complex when revisions and renewal requirements are considered. It seems that a mandatory FPR requirement for all franchisors would have to either be so formulaic and contingent on franchisor-specific information as to make regulation a nightmare, or else be so open-ended and generalized as to defeat the purpose of having a mandatory disclosure! Moreover, mandatory disclosures may be drafted in such a way as to mislead franchisees, and franchise regulators are not in the practice of checking the accuracy of information provided in an FDD. Also, adding a mandatory FPR requirement would inevitably lead to additional registration delays and battles with the already-overburdened franchise regulators.

The FTC’s new Item 19 disclosure language will make it more difficult for franchise salespeople to claim that they “are prohibited by law” from providing an FPR, and the revised regulations made it easier for franchisors to provide an FPR in the form of data sub-sets. For the foreseeable future the need to provide an FPR when offering franchises should determined by market forces, not regulation.

The best remedy for combating unlawful earnings claims is more aggressive enforcement and pursuit of claims by the FTC and the state regulators. In addition, judges should think carefully about whether, in cases where a franchisee claims to have received an unlawful FPR it is in keeping with the intent of the franchise disclosure laws to grant summary judgment to a franchisor based simply on the use of an Item 19 “negative disclosure.” Requiring that such claims be decided on the facts at trial or arbitration will force franchisors to either provide an FPR in the Disclosure Document or to take a substantial action (such as videotaping an interview with each signing franchisee) to destroy the credibility of franchisees who later claim to have received an unlawful FPR.

In summary, given the inherent difficulty in structuring a mandatory FPR rule, the recent revisions to the FPR regulations by the FTC, and the other steps that can be taken to reduce the incidents of unlawful earnings claims, now is not the time to make the provision of an FPR mandatory for all franchisors.