Earnings Disclaims: 'Shh, Don't Quote Me On That'

An earnings claim is an earnings claim is an earnings claim. Or is it? A growing trend among franchisors is to make earnings "disclaims." That is when franchisors furnish earnings claims to prospective franchisees, either inside or outside the four corners of its disclosure document, but attempts to insulate itself from liability for such earnings claims through the use of various disclaimers in the disclosure document and the franchise agreement.

Remarkably, this trend has persisted despite the 2007 revision to the Franchise Rule which makes it an unfair or deceptive practice for a franchisor to disclaim or require a prospective franchisee to waive reliance on any representation made in the disclosure document. 16 C.F.R. §436.9(h).

As franchisors are well aware, earnings claims - now politely termed "financial performance representations" - are particularly persuasive tools because they address the primary question asked by virtually all prospective franchisees: "how much can I earn by investing"? See e.g., "How Much Can I Make?", Robert E. Bond, 4th Ed. (observing that single most important task facing prospective franchisee is to get an accurate and reliable sense of a business's potential sales, expenses and profits). What prospective franchisee wouldn't want to know - prior to investing - how much existing franchisees in the system were earning? It is for this very reason that, as noted by the Federal Trade Commission, "false and unsubstantiated financial performance claims have been prevalent in fraudulent sales, are highly material, and are inherently likely to mislead prospective franchisees acting reasonably under the circumstances."

In two recent decisions addressing pre-2007 disclosures, federal district courts in Wisconsin and Pennsylvania have held that a franchisor's disclaimers do not bar its franchisees from pursuing claims for fraudulent inducement.

Following the lead of the Hon. William C. Griesbach in Westerfield v. Quiznos Franchise Co., LLC, 2008 WL 2512467 (E.D.Wis. Apr.16, 2008), the court in Martrano v. Quiznos Franchise Co., LLC, 2009 WL 1704469 (W.D.Pa.,2009) denied Quiznos' motion to dismiss the plaintiff-franchisees' fraudulent inducement claims on the basis of disclaimers in the franchise documents. The Martrano court noted that, in addition to Westerfield, other courts considering this issue have similarly refused to enforce franchise agreement disclaimer provisions on the ground that a party cannot waive the right to sue for fraud in the inducement by a provision in the contract whose validity is challenged. The Martrano court also found that Quiznos may have had a duty to disabuse the reasonable reader of a predictable misunderstanding based on its disclosures.

The best view is the Martrano and Westerfield courts, which is buttressed by following policy considerations articulated by the FTC in enacting 16 C.F.R. §436.9(h) in 2007:

The Commission has long recognized that the integrity of a franchisor's disclosures is critical to prospective franchisees who rely on such information in making their investment decision. For that reason, disclosure documents must be complete, accurate, legible and current . . . The use of integration clauses or waivers to disclaim statements in the disclosure document that the franchisor authorizes would undermine the Rule's very purpose by signaling to prospective franchisees that they cannot trust or rely upon the disclosure document.

Particularly in light of the 2007 amendments to the Franchise Rule, franchisors' continued use of such unfair and deceptive disclaimers is highly puzzling. As clarified by the revised Franchise Rule, franchisors have a straightforward choice:

• make no earnings claims at all, and include in item 19 of the disclosure document a recitation specifically reciting this fact
• make earnings claims and present them in full in Item 19, without any accompanying disclaimers or waivers

Having dangled an earnings claim carrot, franchisors cannot then pull it back. Regrettably, it appears that some franchisors will only learn this lesson the hard way - through earnings claim litigation.