• Whether a franchisor had a duty to disclose non-required material information.
• Whether the prospective franchisees could reasonably rely on the absence of any disclosure to assume that no bad information existed.
• Whether exculpatory clauses in the disclosure document (disclaimer clauses in Item 19), the integration clause in the franchise agreement and the acknowledgements in the franchise agreement precluded the prospective franchisees from relying on the nondisclosure.
The franchisees brought claims of fraudulent nondisclosure, negligent misrepresentation, alter ego and violation of the Colorado Consumer Protection Act. The franchisees also brought the additional claim of aiding and abetting fraudulent nondisclosure against the law firm that prepared the franchisor’s disclosure document (then a UFOC).
The franchisees alleged that the franchisor failed to disclose:
• that most of its company owned and operated stores were operating at a loss; and
• that its parent company had been operating at a loss for several years.
The franchisees did not allege that they had been provided with false information. They alleged that there was material information, other than what they were told, and other than what was required to be disclosed in the UFOC, that the franchisor should have disclosed to them. The franchisor did disclose the gross sales of all if its company owned stores in Item 19, but not any additional information on cost of goods sold or operating expenses of its stores.
The franchisor claimed it did not have a duty to disclose either the profitability of the company owned stores or the profitability of its parent company, either under the FTC Franchise Rule or otherwise. The franchisor also felt that is was not liable under the franchisees’ claims because its parent company’s operating losses were the result of its rapid growth, some of its company owned stores were profitable, and its retail sales had increased in the years immediately before it implemented its franchising program, all of which rendered the nondisclosure immaterial.
Company Owned Stores
With regard to the failure to disclose the profitability of the company owned stores, the Court found that even though the franchisor actively concealed material financial facts, the franchisees could not rely on the lack of disclosure to bring a claim against the franchisor. The Court based its logic on two reasons. First, the Court found that the exculpatory clauses (disclaimers) in Item 19 and the integration clauses, acknowledgements and disclaimers in the franchise agreement and related documents that the franchisees signed were adequate to preclude the franchisees from inferring that the company owned stores were profitable. Second, the Court found that there was adequate publicly available information from which the franchisees could determine the profitability of a store.Item 19 of the UFOC contained disclosures that are commonly found when a franchisor includes an earnings claim (now called a financial performance representation). The Court found that these disclaimers were adequate to preclude a claim of reliance and that the franchisees could therefore not rely on the absence of additional information to infer that any additional information would not be material. Also, in signing the franchise agreement, the franchisees agreed to several acknowledgements, disclaimers, statements of non-reliance and integration provisions. Simultaneously with the signing of the franchise agreement, the franchisees also signed a Closing Acknowledgement that contained acknowledgements and disclaimers similar to those in the franchise agreement.
In addition to the Item 19 disclaimers, several of the franchisees testified that they had used the Item 19 gross sales and “publicly available store expense information” to prepare a “break even revenue point” of the company owned stores. The franchisees then used this information to prepare pro forma analyses to determine profitability at different levels of revenue to determine the revenues that they needed to achieve in order to obtain certain returns on their investments. The Court then found that because there was adequate publicly available information from which a determination of the profitability of the company owned stores could be made, the franchisees could not have relied justifiability on the franchisor’s failure to provide this information.
The franchisor therefore won this round.
Parent Company Profitability
On the claims for failure to disclose the profitability of the parent company, the Court reached a different conclusion. The Court found that the exculpatory clauses were not adequate to preclude a franchisee’s reasonable reliance on the nondisclosure of information on the parent company’s operating history. The exculpatory clauses addressed a franchisee’s non-reliance on any affirmative representations that might be made outside of the UFOC and franchise agreement, but did not address a failure to disclose material information. The Court pointed out that none of the exculpatory clauses addressed non-reliance on undisclosed but material information. Since the exculpatory clauses were not specific enough to cover the failure to disclose material information about the parent company’s profitability, the Court found that the franchisees’ reasonable reliance claim on the nondisclosure was sufficient to move forward.
The franchisees won this round. At least temporarily.
Complying With the FTC Franchise Rule Was Not Dispositive
The Court did not spend a lot of time in reaching the conclusion that fully complying with the FTC Franchise Rule requirements would not insulate the franchisor from liability for claims of nondisclosure of material information. In reaching this conclusion, the Court cited the FTC Franchise Rule statement that the requirements did not “preclude franchisors . . . from giving other nondeceptive information orally, visually, or in separate literature so long as such information is not contradictory to the information in the disclosure document.” The Court further cited the Federal Regulations which provide that the disclosures do not “create a safe harbor for franchisors engaging in otherwise unlawful conduct.”
Conclusion
The old saying “If you can’t say something nice, don’t saying nothing at all,” may satisfy the golden rule, but may not be the best policy to avoid legal liability. . . or does the double negative save you?
