Wednesday, March 24, 2010

UFOC Disclaimers Did Not Preclude Franchisee Reliance on Nondisclosure

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

The general language of the exculpatory clauses in a coffee shop franchisor’s Uniform Franchise Offering Circular (UFOC) did not preclude several prospective franchisees from reasonably relying on the franchisor’s nondisclosure of the financial losses of its parent company, a Colorado appellate court has decided.

A Colorado trial court’s judgment—dismissing the franchisees’ claim of fraudulent nondisclosure of the historic losses of the franchisor’s parent—was vacated.

Financial Losses of Parent Company

The losses were unlike the financial performance of the franchisor’s company stores, which the franchisor’s UFOC explained was not predictive of franchise results at a different location and under a different management, according to the appellate court. Rather, ongoing parent company losses could foreshadow its insolvency, which could destroy the value of the franchise, regardless of its location or management.

No clause in the UFOC either referred to information about the parent company’s financial condition or negated reasonable inferences that could be drawn from assumptions about this information.

The trial court made no finding that the franchisees had been discouraged from relying on inferences concerning parent company financial information. The only finding was that franchisees had been told that financial information about the parent would not be provided.

Neither of the disclaimers cited by the trial court disclaimed reliance on undisclosed information. Thus, the trial court’s paraphrasing of the disclaimers as “[franchisees] acknowledged that they were not relying on any other information at the time they entered into their Franchise Agreements” was overbroad, the appellate court held.

FTC Franchise Rule

The Federal Trade Commission franchise rule did not preempt Colorado common law, which allegedly required the franchisor to disclose that the parent company had been, or was, unprofitable. The appellate court rejected the franchisor’s contention that, because the parent company was not a guarantor, the franchise rule prohibited the disclosure of financial information about the parent.

The plain language of Section 436.1(a)(20) of the 1979 franchise rule would not preclude a general comment, such as “The franchisor is the wholly owned subsidiary of _________, which has not shown a profit during its _____ years of operation,” according to the court. The section did not preempt common law alleged to require disclosure of the parent financial information.

The franchise rule sought to protect franchisees from unfair or deceptive practices and, as mentioned in the FTC commentary for the 2007 rule, disclosures did not “create a safe harbor for franchisors engaging in otherwise unlawful conduct.”

Preemption of State Law

The FTC addresses preemption in Section 436.10(b), explaining:

“The FTC does not intend to preempt the franchise practices laws of any state or local government, except to the extent of any inconsistency with part 436. A law is not inconsistent with part 436 if it affords prospective franchisees equal or greater protection, such as registration of disclosure documents or more extensive disclosures.”

Because of the reference to “franchise practices laws,” there could be no preemption of common law claims, the court held. In any event, the reference to “inconsistency” limited the court’s inquiry to direct conflict, not express or field preemption.

There was no inconsistency between the prohibition against disclosing a parent’s financial statements absent a guarantee and merely informing prospective franchisees that the franchisor’s parent has been, or is, unprofitable.

The decision—Colorado Coffee Bean LLC v. Peaberry Coffee Inc.—will appear at CCH Business Franchise Guide ¶14,325.

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