| Licensing, Technology Transfers, |
Introduction
The review of how we prepare franchise documents, contracts and UFOCs, is long
overdue. The documents are so lawyerese loaded that it is even difficult to
prepare franchisor witnesses to give clear and convincing testimony that doesn’t
make the franchisor look like a chiseler. Law firms will forever continue to use
the same legalese because that’s what law firms do. The notion that it is
possible to tailor franchise documents to each particular franchisor’s
circumstances and make what they say fit the facts of the relationship gets
little attention. Obviously it’s easier to use the vague, over lawyered, one
size fits most documents that everyone already has on a disk. But being easier
to use because it requires little or no creative thought is not as helpful as
what clients would prefer if only they knew what that might be.
What is done now is to continue to use the vague, generalized language, and to
supplement that with disclaimers, wishful thinking limiting provisions,
entireties/integration clauses that don’t work to protect anyone if fraud is
claimed, and bogus liquidated damages clauses to give a franchisor the
appearance of having counterclaims if suit is brought by a franchisee –
something to bargain with – something to make any litigation/arbitration more
easily drawn out.
That is a terrible approach, especially when some clear thought could provide
documents that franchisor witnesses could testify about without looking like
they are selecting the most convenient of definitions when reasonable minds can
readily see other definitions that make the contract and UFOC language seem
inherently misleading. Why inflict that on yourself? Why not have documents that
are by their own language the statements you would make on the witness stand to
show a judge, jury or arbitrator that you said exactly what was meant, without
ambiguity, and that any claim of being mislead is inherently a bogus claim. It
involves using more clear and emphatic statements. It sure beats asking a
franchisee candidate, at the moment of closing, to sign a statement that he did
not receive earnings claims information when you know he received it – he
received it from you or someone “sponsored” by you – and you called it something
else so he wouldn’t recognize when asked to sign that exonerating questionnaire
that he had in fact received exactly what you are asking him to acknowledge he
did not receive. There is a better way. That is only one glaring example of how
ridiculous the present situation is becoming. Earnings claims are not the only
issue. I’m just using earnings claims to illustrate the inadequacy of current
practice.
The Remedy
The remedy for this problem is to make changes in the documentation so that they
clearly describe how the system really works. That is not happening now because
the documents are configured to accommodate changes in applicable law and to
optimize franchisor options in all circumstances, without regard to operational
need to fit the facts. But you can provide the same level of protection with
respect to legal issues, and in addition create documents that are wonderful
exhibits in the sense that they say what you want your franchisor witnesses to
be able to say on the witness stand without opening them to effective cross
examination. In effect, your documents become the outlines of direct testimony,
and there is nothing in the documents that can be used as an outline for cross
examination. That’s the target.
There are many areas in the franchise agreement and in the UFOC where this
approach would substantially improve the quality of the franchisor’s position in
any dispute. I will illustrate only one glaring item where the legalese almost
never accounts for the realities. I will also illustrate one way this could be
handled that would eliminate the problem for every franchisor who isn’t simply
trying to deceive. Item 19, Earnings Claims, is the hot button issue, mainly
because the purpose of investment to obtain profit; franchisors want to convey a
very definite impression of positive profitability; and franchisors run like
hell from any suggestion that there be mandatory disclosure of the actual
profitability of the system. The basis of that fear is that mandatory
profitability disclosure would mean that the most profitable chain would sell
and everyone further down the food chain would starve. There is no other basis
for the fear. All the other “reasons” why it should not be done are spurious.
Here is the scenario in reality. The prospective franchisee is sent
marketing/sales brochure material. Statements made in that material do not
compare favorably with the language of the UFOC or with the language of the
franchise agreement. The UFOC package informs the prospect to take it to an
attorney or other financial advisor and have the material explained. The UFOC
and its exhibits are then taken by most of the prospects to an attorney who, at
best, may be a business generalist. The marketing/sales brochure materials may
or may not be included in the packet that the attorney sees. This is usually
done at about the time when the UFOC information package is received. The
attorney informs the prospect that the franchise agreement is very one sided,
and always disadvantageous to the franchisee. The prospect asks the attorney if
s/he thinks it’s a “good deal”. Even the dumbest attorney says “It could be if
what they say is true”.
There is not enough material to do a fraud analysis. The attorney isn’t paid to
do a fraud analysis. The attorney doesn’t know how to do a fraud analysis – s/he
doesn’t even know what else to ask for/look for in order to do a fraud analysis.
Additional numbers that are obvious earnings claim information frequently have
not been provided to the prospect yet, but if they have been, they may or may
not be included in what the attorney has been given to examine. In many
instances, that additional earnings claim information comes from the
franchisor’s sales organization, frequently an outside group that is required to
be disclosed in the UFOC. Amongst the newer franchisors, their position is that
they are not responsible for what the outside franchise sales organization does,
because there is a contract in which the outside sales folks promise to conduct
their activities in compliance with the law and the franchisor claims that they
should be able to rely on that contract clause for their protection against
subsequent fraud claims. That is utter nonsense.
The UFOC also says either that the franchisor doesn’t provide earnings claims
information or that the only earnings claims information that is provided is
that which is stated in Item 19. Not only is that untrue is almost every
instance amongst newer franchisors (and many of the more established franchisors
as well), but what is later provided to the prospective franchisee is not
identified as earnings claim information. The franchisee prospect, no matter
what his business background, is too ignorant to catch on that any information
about sales, break even points, cost percentages of gross sales that should be
met in operating the franchise business, “assistance” provided in order to
facilitate preparation of a business plan in support of a small business loan
application, the simple reassurance that the pro forma in his business plan is
“reasonable” are all forms of earnings claims information. In some instances,
knowing that he has received such information, he signs a pre closing
questionnaire acknowledging that he has not been given earnings information
other than /in contradiction of the information in Item 19 – he does this
because he doesn’t know how to make the connection between the extraneous
information and what is specifically called ’Earnings Claims” in Item 19. To a
fraud examiner that ambiguity would be considered a deliberate advantage taking
of the prospect’s ignorance/stupidity. Though you may disagree with that
statement, you can bet that is what the franchisee’s counsel will argue in
court/arbitration. The door that is left open for that argument to have traction
is caused by Item 19 being poorly drafted.
The customary regimen is to disclaim that profit is guaranteed – advise that
there are risks attendant upon competition, proper management, and all sorts of
other potential negative events. It then goes on to say that the franchisee
recognizes that success/failure will be dependent upon his astuteness in
operating the business. It may also state that no one is authorized to provide
Earnings Claim information other than what is stated in Item 19.
Since that language does not close the door on the scenario being presentable as
a fraudulent scheme/evidence of a fraudulent scheme, the franchisee’s case gains
traction that it should not have. It has traction because Item 19 is still
drafted the way it was drafted fifteen years ago. The Item 19 language is on the
franchisor’s lawyer’s disk and is considered boilerplate. It’s in the written
materials of every drafting course in every CLE seminar. It certainly won’t
protect the charlatan, and it also won’t protect the essentially honest
franchisor who relies on his law firm to cover the territory and doesn’t
recognize that the territory is open to attack. “They must know what they’re
doing” masquerades as management reassurance – it’s very much like whistling
while you walk through a cemetery. That they don’t know what they’re doing is
usually the product of their not knowing what you are doing. They don’t know
that you are giving out earnings claim information and calling it something
else/that your sales organization is giving out earnings claim information that
you think is not attributable to you. In every large organization, it is
axiomatic that the right hand does not know what the left hand is doing. This is
certainly true of franchisors and their traditional law firms’ approach to
preparing contracts and disclosure materials.
Additionally, since you are required to provide substantiation of the “numbers”
you give out, and since you are not providing substantiation even if we didn’t
count the information not specifically included in Item 19, your lawyers have
left you way out on a very thin limb. I have seen what is provided when Item 19
information substantiation has been requested. It is laughable in most instances
and inadequate in the rest. If we do count the earnings claim information that
is given out and that is not specifically stated in Item 19, your exposure on
the substantiation issue is really substantial.
It isn’t that difficult to encompass what you are giving out in its totality
within the language of Item 19, and to prepare reasonable substantiation,
including effective footnoting. Ask your lawyers why you aren’t doing that. Ask
your CFO why there is such poor coordination between the preparers of your UFOC
and your management. Your CFO and your Director of Franchising are where the
rubber meets the road in this context. In most of the situations that cross my
desk, they aren’t working together, and they see each other as being at cross
purposes. What I see suggests that coordination is not happening. What your
lawyers get by way of supervision is not effective from the perspective of
producing a good selling document and a good disclosure package.
If your lawyers are too timid to “help” your management folks get it done well,
you ought to do yourself a favor and get another law firm. And if you simply
cannot substantiate what you are telling your franchisee prospects, what, I ask,
does that tell you?
The industry needs to recognize that without positive earnings claim
information, there is no reason to buy the franchise – that positive earnings
claim information is in fact being provided – that most franchisors are simply
pretending that things are other than they really are in the context of Item 19
information – and that it is just a matter of time until some saber tooth trial
lawyer who knows how to deal with these facts comes knocking at your door. You
can lock that door. Why don’t you do it?
Conclusion
This is only one of many areas of franchise selling and disclosure methods that
need to be reassessed. An aggressive evaluation of your program just might scare
the hell out of you, but it might also save you a fortune. The people who did it
the way it is presently done aren’t going to be able to do that. They won’t come
to you and show you the blemishes that they have been neglecting for years. It’s
better to hear about these shortcomings in private than in a courtroom in the
presence of a jury, or in an arbitration hearing. And if you intend to go
international, these facts fit patterns of liability under almost every other
legal system. Add to that the cultural inclinations to accept the proposition
that Americans are slick, and – especially if you have only been franchising for
about seven or so years – your whole system may not be able to absorb even one
big hit. As you know, once one franchisee stings you hard, the others will close
on you like a pack of wolves.
Copyright 1997 - 2008 || Richard A. Solomon
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 | Licensing, Technology Transfers, |