Integration Clauses and the New AAFD Standard

Typically when a prospective franchisee buys a franchise, they rely upon a number of things: the sales material, what the sales pitch was at discovery day, some stories from hand picked franchisees, and a general sales line.

None of these representations are in the contract, and are explicitly excluded by what attorneys call "integration clauses" or "four corner clauses".

Worse, for the prospect, when they come to sign the franchise agreement they unwittingly state that they are not relying upon any representations.

Some franchisors are even trying to distance themselves from the representations that they made in their FDD, or Franchise Disclosure Document

As, Dale Cantone, Assistant AG, Maryland Securities Division, noted in a recent ABA Franchising Forum thread,

State examiners are seeing quite a number of FDDs with integration clauses that I think may violate the new prohibition against waivers and disclaimer under the Amended FTC Franchise Rule. For example, a typical franchise agreement integration clause may be

"This Agreement states the entire agreement between you and us related to the subject matter of this agreement and fully replaces all prior agreements, representations, and understandings between you and us, whether oral or written, related to the subject matter of this Agreement."

I think this language is a problem under the new FTC Rule because an FDD contains prior representations and understandings that are disclaimed by the integration clause.

Many franchisors have added language to their integration clauses such as "Nothing in the Agreement is intended to disclaim the representations we made in the franchise disclosure document that we furnished to you."

That phrase (or something similar) certainly addresses any concerns about compliance with the new Rule prohibition. But some fanchisors are using the same integration clauses they have always used. Franchisors and their counsel may want to look again at the FTC's prohibition against waivers and disclaimer and consider whether your integration clauses comply with the new FTC Rule.

The legal significance of the integration or waiver clause should not be understated.

In a recent case, from Pennslyvania, Eric Karp wrote:

"The parol evidence rule generally bars the admission of extrinsic evidence of prior or contemporaneous oral agreements, or prior written agreements, to explain or vary the meaning of a contract where parties have reduced their agreement to an unambiguous integrated writing. Cottman Transmission Systems, LLC v. Kershner (pdf), 536 F.Supp.2d 543 (E.D.Pa.,2008) it was recently held that the parol evidence rule prevents the franchisees in that case from relying upon the franchisor's UFOC to establish their claims of fraud in the inducement and negligent misrepresentation.

The Kershner franchisees assert that the franchisor made inaccurate Earnings Claims in its UFOC, thereby distorting the facts upon which the franchisees had based their investment decisions. The court held that the merger and integration clauses contained in the agreements preclude the franchisees from claiming reliance upon representations in the UFOC.The court accordingly granted the franchisor's motion to dismiss the claims of fraud in the inducement and negligent misrepresentation."

In response to this problem and others like it, the AAFD recently passed a new Standard.

Standard 15.5.Representation Disclaimers. Without limiting any obligations that a franchisor might have under applicable law, a franchisor should not disclaim or require a franchisee to waive reliance on any representation made in the franchisor’s disclosure document, including its exhibits or amendments, or in the franchisor’s authorized written or visual franchise marketing materials.

The proposed comment, but not adopted commentary is:

This prohibition is intended to prevent fraud by preserving the completeness and accuracy of information contained in disclosure documents. Franchisors routinely seek to disclaim liability for statements made in their disclosure documents through the use of blanket contract integration clauses in their franchise agreements. By signing a franchise agreement containing such a clause, franchisees arguably waive any rights they may have to rely on information contained in the disclosure document. The use of such clauses, therefore, may lead to deception by enabling franchisors to make incomplete, inaccurate, or even false statements in their disclosure documents, while prospects effectively waive reliance on any such statements by signing the franchise agreement. The integrity of a franchisor’s disclosure document is critical to prospective franchisees. The prevalent use of integration clauses to disclaim liability for required disclosures undermines the very purpose of the disclosure document, which is to prevent fraud and misrepresentation in the pre-sale process by ensuring prospective franchisees have complete and truthful information from which to make sound investment decisions.

The commnentary will be discussed between now and the September, 2008 meeting, where it is anticipated that it will be voted on.