Thursday, August 18, 2011

Failure to Disclose Earnings of Franchised Store Was Not Fraud, Franchise Law Violation

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

A convenience store franchisor did not commit common law fraud or violate either the Illinois Franchise Disclosure Act (IFDA) or Illinois “little FTC Act” by failing to provide material information on the historical performance of a store to a prospective franchisee that had requested such information in connection with her consideration and purchase of the franchise for the store, according to a federal district court in Chicago.

After terminating the franchisee for failing to meet the franchise’s minimum net worth requirement, the franchisor brought suit seeking a preliminary injunction forcing the franchisee to surrender the store premises and meet her other post-termination obligations.

The franchisee counterclaimed, alleging that the franchisor was required to disclose financial information concerning the particular store she was considering and eventually purchased because the store’s financial performance was supposedly “below average” for the region. The franchisor had refused to provide the franchisee with sales figures for the store, which had been operating for less than one year.

The franchisor was not required by either the FTC Franchise Rule or the North American Securities Administrators Association’s Uniform Franchise Offering Circular (UFOC) Guidelines to disclose earnings information for any of its stores, let alone the store that the franchisee decided to purchase, the court determined.

Earnings Claim

Although the franchisor elected to include an earnings claim in its UFOC, that was a specific disclosure of “the most recently available annual averages of the actual sales, earnings and other financial performance” in each market area in the state, the court noted.

The franchisor specifically disclosed in its UFOC that it was not providing information related to stores that had been opened for less than 12 months, such as the store in question, and informed the franchisee that it would not provide such information, the court noted.

The franchisee argued that she should have been provided with information on the store’s “historical poor performance” in order to correct a misimpression created by the earnings claim. However, a logical fallacy of the franchisee’s argument was that the earnings claim was not offered as indicative of the actual performance of the store, the court reasoned.

Duty to Make Further Representations

While admitting that the information provided by the franchisor might not have been false, the franchisee maintained that the franchisor was under a duty to make further representations in order to prevent the provided information from being misleading. However, the earnings claim made by the franchisor was only “misleading” if the franchisee ignored the express terms of the earnings claim and made projections based upon her own assumptions concerning historical information of other stores, the court decided. The franchisee could not have done so consistent with the disclaimers in her franchise agreement and in the UFOC.

The franchisee contended that the disclaimers in the franchise agreement and UFOC were somehow inoperative because the information, or lack thereof, was material to her investment decision. However, the franchisor was not under an obligation to disclose every piece of information that could have been material to the franchisee’s investment decision, the court held.

Because the franchisor had no duty to disclose the historical financial performance of the store, the franchisee’s common law fraudulent omission claim, as well as her IFDA and “little FTC Act” claims, failed.

The decision in 7-Eleven, Inc. v. Spear appears at CCH Business Franchise Guide ¶14,644.

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