Excerpted and updated in September 2003
from a presentation by Carmen D. Caruso to the
Association of Trial Lawyers of America (ATLA) in a
“Litigation at Sunrise” program during their annual
meeting in Chicago, July, 2000.
Earnings Claims
Prospective franchisees want to know how much money they are likely to earn. They are very likely to rely upon the franchisor's earnings claims regarding how much money the other franchisees in the system have earned in recent years.
False earnings claims are a typical subject of FTC actions against
franchisors. The FTC has reported that from 1989-1992, 100% of the FTC's franchise enforcement cases were based on allegations that the franchisor had provided fraudulent or misleading earnings claims. But the FTC does not require franchisors to disclose earnings. The FTC Rule provides that if the franchisor elects to provide earnings claims, it must have a "reasonable" basis for the claims and that they must be substantiated. Acting defensively, most franchisors do not provide earnings claims to prospective franchisees.
Often, however, the UFOC states that the franchisor does not publish earnings claims. Yet despite that statement, a franchise salesperson tells the franchisee (usually verbally) how much the franchisee can expect to earn based on the experience of other franchisees. In other words, an oral earnings claim is made that contradicts the statement in the
UFOC. Typically, the evidence might be that the oral earnings claim was accompanied by a statement that "the law won't let me put this in writing, but just between you and me ..." There is plenty of authority rejecting fraud claims by the franchisee in these circumstances.
However, there is hope for the franchisee. In Federal Trade Commission v. Minuteman Press et al (Oct. 02, 1998), the federal district court held that a printing franchisor and its wholly-owned sign shop affiliate violated the "FTC Act" by making unsubstantiated and false earnings claims to prospective franchisees. The franchisor argued unsuccessfully that the FTC had failed to establish reasonable reliance on the oral earnings claim by any franchisees. The franchisor contended the oral earnings claim had to be viewed with a "disclaimer in the applicable
UFOC's, coupled with the franchisee's acknowledgment in the franchise agreement that no such representations had been made by the
franchisor." The court in Minuteman Press held that the disclaimer of earnings claims was not controlling in FTC enforcement proceedings as opposed to private actions, because actual reliance is not an element of the FTC's claim. The court held that in an action by the FTC under the federal FTC Act:
"While a conflict between UFOC disclaimers and an oral representation may be germane to the issue of reliance, it is the "common-sense net impression," ... which controls. Here, a reasonable consumer could legitimately conclude that he or she was being furnished important specific earnings information,
subrosa, to assist in the decision-making process notwithstanding the general disclaimers in the
UFOC.... (citations omitted)"
Based on Minuteman, franchisees may now argue under state law Little FTC Acts that oral earnings claims are actionable if they were likely to influence the decision-making process despite the general disclaimer of earnings claims in the
UFOC. This author has made this claim successfully in arbitration proceedings [and in pending litigation as of 9/03].
Moreover, "earnings claims" may be actionable where they are false, or where they cannot be substantiated; or where they are not authorized due to lack of proper disclosure.
Success Rates
Another key disclosure issue is a franchisor's claim that X percent (usually a high percentage) of its stores have been successful, i.e., have remained in continuous operation from opening day to the present. But what if, undisclosed to the franchisee, the same store has been sold a number of times – and in each sale, the old franchisee sold the store back to the
franchisor, which resold it to a new franchisee? Would that additional information be material to the prospective franchisee? Would failure to disclose that information amount to fraud? The FTC Rule does not require franchisors to disclose resales or turnovers from one franchisee to the next. Nonetheless, the claim may be made that this practice of "franchise flipping" is highly deceptive and misleading under state law Little FTC Acts and the common law.
