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The Almost Useless Non Disclosure Agreement

Author Richard Solomon is a conflicts and crisis management lawyer with 50 years of experience in business development, antitrust and franchise law, management counseling and dispute resolution including trials and crisis management.

NDAs, non disclosure agreements, are passed around like candy and cocktails these days. Illustratively, every franchise agreement has a post termination covenant not to compete. Since these are not per se enforceable, there is an overlay of the NDA in the agreement. Theoretically, the departing franchisee that escapes the covenant not to compete still has possession of trade secret or other confidential information of the franchisor that could be the basis of an unfair advantage in subsequently competing against the franchisor. At least that is the theory.

When litigation arises over the covenant not to compete, there is always an injunction against violation of an NDA count. Really competent use of the NDA count should enable a higher likelihood of getting the covenant not to compete enforced. Using these two claims in tandem makes a better case for enforcing the covenant not to compete. Very few franchisors know how to do this, largely because they really have no confidential information or trade secrets, and the NDA is window dressing rather than substance. Everything they do is done by their competitors in a similar fashion. Their "method" is no longer competitively meaningful, if it ever was.

One of the things that makes NDA litigation a charade is that some companies use NDAs to "protect" information that is clearly already in the public domain. Franchisors frequently these days call for an NDA signature before sending out an FDD (a public document) or before allowing a prospect to attend "Discovery Day", an enhanced sales pitch affair that contains absolutely nothing that would ever give anyone any advantage on any level or about any subject whatsoever. That blatant misuse of NDAs makes it extremely hard for them to get any NDA enforcement at all, about anything. Of course, their lawyers lack the guts to tell them this. It isn't PC to tune up a client's misperceptions regarding what the client wants. You are supposed to be there for whatever the client wants. So much for professionalism. Let him find out the hard way one day. By them you can blame it on something else. He may want it anyway, but you should at least make him aware of the realities of enforcement. Of course you probably can't do that if you have never enforced one yourself.

Without the ability to mount a competent defense based upon knowing how these things work in reality, the court or arbitrator is left to enforce the NDA and the covenant not to compete with no significant record having been made by the plaintiff. The defendant must make the franchisor prove the specifics of his case, as opposed to just making the bare allegations and supporting that with a spurious affidavit. The franchisor would have to make a real case if the defendant knew how to approach shifting the burden of proof more effectively.

With no experience in the substance of the matter, the judge usually is amenable to evidence not much more than simply eliciting from the departing franchise an acknowledgement that before becoming a franchise he didn't know how to operate a business in that industry and had no prior experience that could enlighten him and fill in that gap without the training received from the franchisor. That is minimalism in its ultimate form. No one seeking enforcement of covenants not to compete and NDAs should ever be allowed to get away with so thin a record of justification. Why then is unsupported enforcement so frequently obtained?

The fact that someone didn't know something pre contract does not mean that what he was taught was/is either a trade secret or confidential. In any mature franchised business segment, franchisors closely follow what their predecessors and competitors do. Most of their personnel came from competing companies in most instances.

What the franchisee knew before signing the franchise agreement is more significant if it is a conversion franchise transaction, in which instance there should be a record of prior knowledge appended to the NDA to show exclusions for fields of endeavor experience. Conversion franchisees never think to do this, unfortunately. Doing that could make life a lot easier if there is trouble, termination or expiration of the agreement. The question that should be the first on every investor's list is "What is important that is NOT addressed in these documents?"

The disclosure documents follow a prescribed agenda supposedly laid out by people trying to prevent substantial errors and omissions. That, however, is not so. The configuration of the FDD was lobbied heavily be representatives of franchisor groups. There are several areas of informational concern that are deliberately not addressed in the FDD format. They are omitted because the information tends in most instances to be away from closing a sale.

What most attorneys miss about franchise agreements is that there is never a way out. You either fully perform for the whole franchise term or you are automatically at fault for not doing so; in breach of contract; and owe damages/liquidated damages. If the business simply fails, it is due to franchisee error and nothing else could ever be a possible cause. While that isn't true, the franchise contracts of every franchise is written in that manner. You have no exit opportunity if for any reason the business simply does not succeed. Why on earth would anyone ever sign such an agreement? Yet suckers sign them every day, drinking down that Kool Aid and not being given competent advice pre investment. It doesn't explicitly say that you have no way out, but that is how the contract is engineered.

Market and history information is usually dealt with by statements that the company has been in business since and has franchisees. The business of this franchise is competitive. There is a disclosure in Item 20 of the franchisee population history, but few investors or attorneys know how to evaluate that information.

If there are developments in the industry relevant to the franchise that tend to show a less than prosperous future over the life of the franchise, that information is not disclosed. Fraudulent inducement cases based upon non disclosure rather than misrepresentation are few and far between. Since the franchisee represented himself to be a really competent business person when he applied to become a franchisee, court's tend to expect him to have done some good pre investment due diligence. While it is still illegal to defraud the ignorant, stupidity is rarely awarded. Getting someone to "read the documents" is an example of real stupidity.

Even small amounts of good sense would cause a prudent investor to do some market research instead of just taking the franchisor's word about the business environment. Every time someone says the magic words "proven concept" franchise investors start to drool, just like Pavlov's dogs.

Among the most important subtle omissions of all FDDs is the fact that they speak only to about the first 90 days after store opening. They do not address pre store opening expenses and risks, nor do they address risks going forward as the contract is required to be performed for the entire term, usually 10 years. Ask your lawyer whether he has any experience projecting the critical risks throughout the life of the franchise – and beyond for that matter.

One major abuse n franchising that is almost always missed by investors and their lawyers is the combined use of NDA clauses with non disparagement clauses. The latter forbids the franchisee from making any negative statement about the franchisor or any aspect of the franchise relationship. It frequently also recites that everything about the franchise is confidential and that the making of disparaging statements will violate both the non disparagement clause and the NDA.

Now they all tell you to go talk to franchisees as part of your pre investment due diligence. How in the world could talking with franchisees be of any use when they are forbidden to tell you the truth if there are negative aspects or major problems in their franchise relationship?

You can make an argument that since that is a clear abuse, it is probably not enforceable. However no franchisee is interested in getting busted about it even if after spending a bloody fortune in dispute resolution he would prevail on the merits. Winning a lawsuit and losing your business is usually considered to be rather stupid. The FTC and state regulators ought to do something about this practice, but it is very unlikely that either resource will bestir itself to do so.

This is another instance in which the FDD itself fails to inform an investor of serious risks, despite its being there specifically to make such disclosures. The FDD, in my less than humble opinion, is nowhere near an adequate pre investment disclosure document. The NDA abuse issues are a sparkling example of this statement.

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