For both franchisors and prospective franchisees alike, issues concerning “earnings claims”, or the lack thereof, merit serious consideration and evaluation:
The decision making process starts with an initial determination as to whether or not the franchisor will include an earnings claims in its their FDD (Item 19). The typical advantage to including an earning claim representation is to assist with franchise sales and, in certain circumstances, to limit future litigation exposure. If a franchisor elects to include an earnings claim then the next level of inquiry resorts to assembling, documenting and properly structuring the information contained in Item 19. If the franchisor elects to “not” include an earnings claim (a decision made by many franchisors) then the franchisor’s primary task will require the establishment and enforcement of a compliance program designed to prevent the inadvertent (or intentional) disclosure of “earnings” related information to prospective franchisees.
The evaluation of a franchisor’s Item 19 earnings claims – or the lack thereof – represents a critical due diligence task for prospective franchisees. If Item 19 disclosures are included, franchisees must evaluate the earnings information disclosed and whether or not such “claims” provide insight into the potential “profitability” of a franchise unit. If earnings claims are “not” included then franchisees must be certain that they do not rely on any oral “earnings” statements or representations made the franchisors sales staff – that is franchisors are not permitted to make earnings claims or representations unless they are contained in writing in FDD Item 19.
Some basic – but critical – information to be aware of when considering “earnings claims”:
- Not Required by Law. Earnings claims are “not” required by law. However, if a franchisor, in connection with the offer or sale of a franchise, wishes to disclose an earnings claim or any earnings based information, such information must be disclosed in Item 19 of the franchisor’s FDD.
- Not Prohibited by Law. In many franchise sales settings franchisees are advised (typically by a franchisors sales agent) that “by law” the franchisor “is not permitted to make an “earnings claim” . The intended implication of such statement, sometimes, is for the prospective franchisee to assume that “the earnings are great and that the franchisor would be glad to disclose them but cant because of the franchise laws”. Prospective franchisees need to know that this is not the case and that a franchisor’s decision as to whether or not to include an Item 19 earnings claim is an optional decision. For many legitimate reasons many franchisors elect to “not “include earnings claims representations, however, this decision is optional.
- Must have a Reasonable Basis. When drafting and preparing an earnings claim, franchisor’s and their legal counsel must ensure that the franchisor possesses a “reasonable basis” for the earnings claim. Faced with this ambiguous legal standard, franchisors must ensure that the earnings claim is based on representative and current information that is documented in writing. Factors that should be included in this disclosure include the basis for the earnings claim, whether or not the claim is based on actual franchisee data and variations within the data pool.
When it comes to “earnings claims” that are many more factors to consider. When drafting Item 19 disclosures, sometimes, the process is more art than science. However when approached properly and diligently, earnings claims will serve as an important information and legal tool benefitting both franchisors and franchisees.