Franchise Law For Beginners (Part I)

Try to recall when you first started searching for franchise opportunities. Chances are, beyond getting excited about some of concepts (and saying “hey, I could do this”), you were surprised to see that a rather large number of lawyers in the U.S. tout their experience in “franchise litigation” on their shingles.

Or think back to the day you dreamed of franchising your business across the country and learned from a franchise lawyer that although we have a national franchise law (the FTC Franchise Rule), the process of selling a franchisein realityrequires compliance with different franchise laws across different states.

Yes, it's true that franchise law and franchise litigation is an established field in which lawyers help franchisors navigate a costly regulatory maze, or represent franchisors or franchisees who sue each other for money damages or equitable relief, such as an injunction to shut down someone’s business and prevent them from earning the only living they know for a designated period of time.

Both franchisors and franchisees have ample reason to question whether the legal system exists to serve franchising, or if it’s the other way around.

The Current State of Franchise Law

After 28 years of franchise litigation experience, I have reached three conclusions.

1. The current franchise laws (or lack of franchise laws) contain too many traps for the unwary.
2. We could do a lot better if we tried.
3. The problem is the never-ending, franchisors versus franchisees struggle for power.

So here is an insight that should be obvious: franchising is not a zero sum game. Franchisors and franchisees have a common goal in their mutual prosperity. Thus, having a body of “Franchise Law” that creates confusion and promotes conflict is extremely counter-productive for all.

What is the Purpose of Franchise Law?

Let’s start at the beginning. At the most fundamental level, “Franchise Law” purports to protect franchisees from two ancient legal doctrines: freedom of contract and caveat emptor ("let the buyer beware"). This is no easy task. In the abstract, most folks might agree that any two business persons ought to be able to agree on whatever they want, as long as their agreement does not result in harm to anyone else.

So, for example, if a franchisee and her franchisor were to agree upfront that the franchisor could commit fraud in the franchise sales process, our libertarian friends might say “that’s fine,” absent proof that the franchisee had not lost her mind before signing the contract. To them, nothing that was actually agreed to could ever be deemed unfair.

Surely, you say, this could never happen. No court would ever rule that a franchisor is permitted to insert language into the franchise agreement saying “WE HAVE THE RIGHT TO DEFRAUD YOU” and thus let a deliberate fraud go unpunished.

The "No Reliance" Clause

But substitute the following: "YOU ACKNOWLEDGE THAT, IN BUYING OUR FRANCHISE, YOU ARE NOT RELYING ON ANYTHING WE MIGHT HAVE TOLD YOU."

This is called a “no reliance” clause and it could be a game-changer. Now the franchisor may very well state in its written disclosure documents that "WE DO NOT MAKE ANY REPRESENTATIONS AS TO WHAT YOU MIGHT EARN” but then tell you in person at discovery day that all of its established units gross over one million dollars a year and you will be getting one of the best possible locations. With that reassurance, which contradicts what they said in writing (and not just any writing, but the very writings that the law requires), you sign the franchise agreement and write a check. Later on, when your unit sales never approach a million and you cannot pay your bank loans, you sue for fraud.

Do you have any doubt that your franchisor will cite the “no reliance” clause in the franchise agreement and argue that as a “matter of law” it cannot be found guilty of fraud? Are you surprised to learn some courts have agreed with franchisors in cases similar to this hypothetical scenario? These types of clauses can be defeated but it is not easy.

Life is full of surprises, but learning the hard way that you supposedly agreed in writing that your franchisor has the legal right to defraud you should not be one of them.

Stick around and we will explore Franchise Law with the view of running the bad franchisors out of town, enabling franchisees to protect themselves, and getting franchisors and franchisees into win-win relationships. And just maybe getting some more of the good franchisors to join us in this effort.

Carmen D. Caruso is a trial lawyer who concentrates in franchise & dealership litigation among other business disputes. He has represented the world’s largest franchisor and now serves as a trial counsel for the independent association of a prominent national brand. He has handled many system-wide disputes affecting dozens, hundreds and thousands of franchises in addition to handling terminations or fraud claims that were just as important to the affected owners. Carmen also enjoys counseling franchisors that seek to achieve win-win franchising relationships. You may contact Carmen at the Carmen D. Caruso Law Firm