Buying a Franchise: The Legal Perspective

You have always wanted to own your own business and you have decided now is the time to take that leap.  However, you want the advantages that can come with operating a franchised business where the “secret sauce,” be it actual recipes, a brand name, operating system, are already established and have the potential to get your business off to a faster start, in addition to covering the gaps in your knowledge base. Many franchise purchases start this way, with the next step being attendance at “Discovery Day” where you have discussions with the prospective franchisor’s personnel and learn about the franchise.

Many prospective franchisees think that after arranging for financing, the only thing left to do is to sign the franchise agreement and begin the process of opening the new business.  However, one big step has been missed – considering all of the legal aspects involved in starting a new business and a new franchise relationship.  Legal considerations are especially important because this is the beginning of a relationship with a contract term between 5 and 20 years.

By this point you should have received the Franchise Disclosure Document (“FDD”) from the prospective franchisor.  The prospective franchisor is required by the Federal Trade Commission’s Amended Franchise Rule to provide the FDD to prospective franchisees except in certain limited circumstance.  The FDD has 23 sections (called “Items”) that provide information on the prospective franchisor, the franchise system, and the prospective franchise relationship.  These Items include, among other things, information on the franchisor and its business (Item 1); litigation the franchisor has been involved in (Item 3); estimates of the fees and costs involved (Items 5, 6, 7); rights, restrictions, and obligations of the franchisor and franchisee (Items 8, 9, 11, 12, 15, 16); a financial performance representation, if the franchisor chooses to make one (Item 19); information on the franchise and company owned outlets (Item 20); and any contracts, including the franchise agreement (Item 22).

While understanding all of this information before you sign the franchise agreement is important, many prospective franchisees either briefly review selected portions or do not review anything besides that franchise agreement.  This can create significant problems in the future for the prospective franchisee because they do not have a complete or accurate understanding of the information contained in the FDD and franchise agreement, and do not understand their or the franchisor’s duties and obligations.  Often prospective franchisees, even if they review them do not understand these obligations because the description of the obligation in the FDD is not specific enough and the franchise agreement is in legalese.  Further, the franchise agreement is typically written in a manner that is very favorable to the franchisor and a person not experienced in franchise law will not see all of the potential pitfalls.

Care also needs to be taken when reviewing the financial performance representation in Item 19, which is one of the few Items prospective franchisees do review, as it is the only financial information a franchisor can provide to a prospective franchisee.  Prospective franchisees, however, need to be careful when reviewing this information because it is highly technical and they need to be sure they understand all of the limitations on the information provided.

In addition to reviewing this information, there are also other aspects of the Amended Franchise Rule and, potentially applicable state franchise statutes, that have a significant impact on the relationship that the prospective franchisee will be in for many years.

As should be plainly evident, engaging an experienced franchise attorney before signing the franchise agreement is a relatively modest investment that will pay significant dividends in the long run for the prospective franchisee through a better understanding of their rights and obligations and, potentially, avoid the costly mistake of entering into a franchise agreement that is not a good deal.

If you are considering purchasing a franchise, contact one of our experienced franchise and distribution law attorneys to discuss a review of your FDD and franchise agreement and the ways that we can assist with your new business.