DEAR FRANNY: I was recently reading Pizza Today's Top 100 pizza company list [type in pg. 56]. I always like to check system-wide sales when this particular list is published. One of the franchises listed stated system-wide sales at over $100 million (or about $620,000 per store average). I know that this figure is wildly exaggerated.

My first question is: (1) Are sales figures like this that important to purchasing a franchise? (2) Is it OK for a company to do this, legally? (3) Does anyone ever check these claims?

I know franchisors can't make earnings claims or anything like that but the situation I describe just seems a little fishy to me.

Regards,
SUSPICIOUS SAM

Editor's note: This was an actual inquiry sent to the Blue MauMau community. The editor asked well-known franchisee attorneys David J. Meretta and Eric Karp of Witmer, Karp, Warner & Ryan LLP to respond.

DEAR SUSPICIOUS:

Thanks for your questions.  Addressing them in order:

(1) Information concerning a franchisor’s system-wide sales can be useful to a prospective franchisee, but only in combination with additional information that allows the prospect to understand the basis for the claim, and to determine the significance of the system-wide totals in the context of that particular franchise system.  At a minimum, such additional information will include the number of franchised units and the number of franchisor-owned locations in operation during the preceding year.  With respect to certain franchise systems, however, system-wide average sales could be meaningless to a prospective franchisee.  For example, if the franchisor you observed on the Pizza Today list has a large number of high-performing franchisor-owned locations that average $750,000 in annual sales, the per-store average sales of franchised locations necessarily would be far below the $620,000 system-wide average that you calculated.  Toward this end, the system-wide average can also be skewed by unusually high- or low- performing franchised locations.  For this reason, we would suggest that, rather than average sales, it is the median sales of system-wide franchised locations (which is not skewed by extreme performers) that offers a far more telling glimpse to prospective franchisees of how a new franchised location might perform.

(2) Your second question - whether a franchisor legally may disseminate earnings claim information through third parties - is particularly intriguing.  As a starting point for this analysis, a franchisor’s earnings claim (now politely termed a “financial performance representation” – FPR - under the Revised FTC Rule) – which includes any statement of the franchisor that would inform the recipient about the financial performance of existing franchised units - is per se illegal if it varies from what the franchisor has disclosed in Item 19 of its FDD.  In other words, a franchisor who does make an Item 19 FPR may make an earnings claim outside of the FDD (such as in a third party trade publication), but only if that claim is identical to the franchisor’s Item 19 disclosures.  A franchisor who elects to make no FPR in its Item 19 is prohibited altogether from making an FPR outside of the FDD.

The lists of third-party publishers such as Pizza Today, which include system-wide sales totals as well as the number of units, do in fact allow prospective franchisees to estimate the average (but not the median) financial performance of existing franchised units; you did precisely that with respect to the pizza franchisor you mentioned in your e-mail - notwithstanding your skepticism as to the validity of the resulting figure. The burning question thus becomes: is the information in such lists directly attributable to representations made by the franchisor?

The answer appears to be yes, at least with respect to certain pizza franchisors.  According to Pizza Today, their Top 100 pizza company list is compiled in part from the survey responses of U.S. pizza chain executives, and in part from information published in the 2009 Directory of Chain Restaurant Operators (CRO).  Although we do not know the source of the information contained in the CRO Directory, it is clear that at least some of the information in the Pizza Today Top 100 was furnished directly to Pizza Today by franchisors. In our view, such information that is furnished directly by a franchisor to third party publishers constitutes an FPR, and is illegal with respect to any franchisor that does not present the identical information in Item 19 of its FDD.

In this regard, we note with interest that trade publications are not the only medium outside the FDD through which franchisors make FPRs. For example, some publicly held franchisors elect to include in their SEC 10-Q filings system-wide franchise sales and gross margin information, even though such information is not required by the SEC and does not directly pass through to the franchisor’s bottom line revenue.  We believe that such disclosures likewise are illegal with respect to any franchisor that does not present the same disclosures in Item 19.

 (3) With respect to your final question, we are not aware that Pizza Today or other third party publishers engage in substantiation of the statistics presented in their published lists, but we tend to doubt that they do. We note that neither the FTC nor state regulators police such statistics; the mission of those bodies is to ensure compliance with the format and manner of disclosure, not to audit the accuracy of same.  Pursuant to the FTC Rule, however, franchisors must have a “reasonable basis” for the information presented in an FPR, and must provide written substantiation of such information upon request.

Sincerely,
FRANNY
Answering for Franny, franchisee attorneys David J. Meretta and Eric Karp

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About the authors: Mr. Meretta is an associate at Boston-based law firm Witmer, Karp, Warner & Ryan LLP. He received his undergraduate and law school education from the University of Michigan and is admitted to the state bars of Massachusetts and Michigan. He clerked for the Honorable Lawrence M. Glazer of the 30th Judicial Circuit Court of Michigan, and has represented franchisees and franchisee associations throughout the country.

Karp and Meretta, Esq. / wkwr

Mr. Eric Karp is listed in the International Who's Who of Franchise Lawyers, published by Law Business Research. He serves as counsel to numerous franchisee associations in such chains as McDonald's, Pearle Vision, 7-Eleven, Denny's, Dunkin Donuts, Choice Hotels, TCBY Yogurt, Jackson Hewitt, Resort Maps, Portable On Demand Storage, and Colors on Parade.  Mr. Karp served on the Board of Directors of the American Franchisee Association (AFA) for ten years and since 1996 he has served on the Franchise Project Group of the Franchise and Business Opportunities Committee of the North American Securities Administrators Association. Mr. Karp currently serves as the Editor-In-Chief of The Franchise Lawyer, a publication of the ABA Forum on Franchising.