Evolution of Franchise Fraud

A History Lesson

In the good old days, if you bought a franchise and discovered that you had been induced to make the investment by fraudulent misrepresentation, you went to a lawyer who told you that you had a legal remedy under common law fraud – a material misrepresentation of a presently existing fact was made; you relied upon the misrepresentation(s) in making your investment decision; because of that you made an investment in the franchise and were injured in a manner linked to the nature of the misrepresentation in some reasonable way; and you incurred damages as the proximate result of that injury. If the franchise agreement had an entireties / integration / merger clause, the franchisor asserted that as a defense to the fraud claim, but the court denied the defense because under common law that clause does not trump fraud.

Then franchise investment laws began appearing, and the effect was to make franchise sales by misrepresentation easier to confront. Disclosure was required to beformal, and the principals of the franchisor were madepersonally liable for the company’s false statements. There was also recovery of attorney fees if the franchisee won. These laws facilitated recovery by misled franchisees.

Then, about 25-30 years ago, a lawyer (me) decided that the franchise documents should include specific signed documentation at the closing of a franchise sale that confirmed no representations had been made during the sales process that constituted earnings claims otherthan as contained in Item 19 of the UFOC, and the identification of the maker of the representations if such were claimed, as well as the nature of the claimed representations. That enabled defective sales disclosures either to be corrected or redisclosure to occur or the decision to be made not to make the sale. Trouble was avoidable.

About 10 years ago, the acknowledgement of no aberrant disclosure was moved into the body of the franchise contract and a “no reliance” clause was added. As of now, franchise contracts include merger clauses, acknowledgement clauses and no reliance clauses. Where does this leave the franchise investor? The poor devil now has to do competent due diligence and better understand what these clauses say. If someone said something in the sales process/some sales brochure said things in the sales process that the contract says was not said to you, and you are not smart enough to stop and say that such things were indeed said to you, you can expect courts to deny your fraud claims. The reason for this is the advent of professional level due diligence assistance that is more comprehensive than some lawyer telling you some (but not all) of what the contract says and means, and saying to you that if the things they are telling you are true, it might be a good deal. That just doesn’t cut it anymore. That is essentially worthless. That is not competent due diligence. But it is “cost friendly”/cheap.

Cost friendly and value unfriendly is the road to disaster.

So if you decide to risk upwards of a million dollars in real assets and assumed/contracted for liability, in contracts, leases and loans, but you don’t spend the money for real due diligence, – figure on $ 1,500 for one deal to $ 5,000 for all deals in which you might be interested over a period of several months of providing you with due diligence assistance, be sure to buy a large jar of Vaseline too. You’re gonna need it.