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BUYING A FRANCHISE–DUTY TO DISCLOSE HIGH FAILURE RATES?

Bundy Law Firm PLLC June 15, 2012

Franchise site BlueMauMau just released a list of the 25 worst franchise investments-without even asking the question of whether such extraordinarily bad results give rise to a duty to disclose high failure rates to those who are buying a franchise.

The bluemaumau list is derived from limited data from the Small Business Administration. It is limited to only franchise companies with more than 50 franchisees with SBA loans. It does not include franchisees who obtained private financing from banks, credit unions, family or friends. It does not include franchisees who liquidated or put at risk their retirement funds and lost everything. I assume the true franchise failure rate of some of the listed franchise systems (not to mention the many companies without 50 or more franchisees with SBA loans) are materially higher.

The question that the franchise community needs to address, in light of such high failure rates is whether, if a franchise system is experience such high failure rates, do they have a duty to disclose that to their prospective franchisees? Is there not an implied representation in offering a franchise opportunity that the existing outlets are at least breaking even after some reasonable start-up time? If the system continues to promote its franchises as “successful”, “profitable”, “tested”, etc., should it not be required to disclose that 75% of it’s franchisees failed? Remember, the franchises were only “granted” to a few chosen “qualified” candidates after a rigorous “selection process”.

If I sold you a car without an engine without letting you look under the hood, while representing that it was “well tested”, “highly successful” and that other owners had won many races, you could sue for fraud when you learned the truth. There is a duty of full disclosure, having represented that it is a working car.

The same applies were I to sell you a business (as distinguished from a franchise). If I know that an event is about to happen that will cause the business to fail, I have a duty to tell you that before you buy.

Unfortunately, franchisors can comply with the Federal Trade Commission Franchise Rule without giving you the full truth. It is time that the FTC and the courts clearly hold franchisors responsible for providing full and complete disclosure of such facts that may not be easily discoverable by a prospective franchisee.

If you are thinking about investing in a franchise, you should contact an experienced franchisee lawyer and insist upon full disclosure to franchisees before buying a franchise.