OVERVIEW OF THE FRANCHISE DISCLOSURE DOCUMENT (FDD)

Franchisors in the process of drafting their first ever franchise agreements and disclosure documents must comply with the format described in the FTC Franchise Rule as amended.

The FTC format requires that franchisor to provide information pursuant to detailed guidelines organized in twenty-three parts. Briefly that information appears in the items or sections listed below which make up an FDD:

Item 1. The Franchisor, Its Predecessors and Affiliates
Item 2. Business Experience
Item 3. Litigation
Item 4. Bankruptcy
Item 5. Initial Franchise Fee
Item 6. Other Fees
Item 7. Initial Investment
Item 8. Restrictions on Sources of Products and Services
Item 9. Franchisee's Obligations
Item 10. Financing
Item 11. Franchisor's Obligations
Item 12. Territory
Item 13. Trademarks
Item 14. Patents, Copyrights, and Proprietary Information
Item 15. Obligation to Participate in the Actual Operation of the Franchise
Item 16. Restrictions on What the Franchise May Sell
Item 17. Renewal, Termination, Transfer and Dispute Resolution
Item 18. Public Figures
Item 19. Earnings Claims
Item 20. List of Outlets
Item 21. Financial Statements
Item 22. Contracts
Item 23. Receipt

As you can see, the FDD contains an enormous amount of information about the franchisor's offering. Some would argue that the regulations originally conceived to protect prospective franchisees by requiring full disclosure have actually placed a very strong tool in the hand of the franchisor. When a franchisee and franchisor end up in a dispute the very detailed disclosures made by the franchisor in the FDD often provide an excellent defense against the franchisee's claims that he was misled. The franchisor can go to court against its disgruntled franchisee with a signed receipt showing that the franchisee received a more comprehensive disclosure than a small business buyer might typically be able to access in even a comprehensive due diligence inquiry. The bias of many franchisors -- and of course of their lawyers -- is for over disclosure. Prudent franchisors include all of the "bad news" that might conceivably be required by the regulations and guidelines. Out of an excess of caution, franchisors tend to state their disclosures in a very conservative fashion. Sales representatives then have to answer difficult questions posed by prospective franchisees, but the result tends to be a fair and open exchange of information.

Franchisors are well advised to think of the FDD not as a sales tool but as a risk management tool. When a franchisor takes the approach that it only wants to do business with prospective franchisees who are fully informed, the credibility gained through openness becomes an excellent selling point.

Prospective franchisees are well advised to study the FDD very carefully. Catalog the disclosures that are confusing, that seem troubling or that describe contract terms that are onerous. Discuss these issues with current and former franchisees in the system. They can be found in Item 20 of the FDD. Discuss these issues with counsel experienced in franchise matters. The FDD is not a complete guide to due diligence for a prospective franchisee, but it is an enormously useful tool in that process. Sometimes the size of the document itself is daunting, but it is a mistake to allow this wealth of information to go uninvestigated.

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