A franchisee’s healthy skepticism can quickly lose its vigor after attending a well executed discovery day. That’s because a discovery day is typically focused on closing the deal. Although discovery day is nominally all about providing specific and valuable information to suitably qualified prospective franchisees, it really can be almost entirely about selling the franchise concept. And along with a sales focus comes a heavy dose of very positive statements and assurances, most of which you won’t find in the franchise agreement.
In fact, the franchise agreement will specifically disclaim these assurances in what’s called an “integration” or “merger” clause. This clause essentially says that if the franchisor’s promises are not set forth within “four corners” of your franchise agreement, you cannot rely on them and the franchisor will not be bound by them.
A typical merger clause is usually under the heading “Entire Agreement” and generally says something like:
This Agreement and any other agreement executed by the parties concurrently with the parties’ execution of this Agreement represent the entire fully integrated agreement between the parties and supersede all other negotiations, agreements, representations and covenants, oral or written. Notwithstanding the foregoing, nothing in this Agreement shall disclaim or require Franchisee to waive reliance on any representation that [Franchisor] made in the Franchise Disclosure Document (including its exhibits and amendments) that [Franchisor] delivered to Franchisee in connection with this franchise offering. Except for the changes permitted to be made unilaterally by [Franchisor] hereunder, no amendment, change or variance from this Agreement shall be binding on either party unless mutually agreed to in writing by the parties and executed by their authorized officers or agents.
(The italicized language is required by the Franchise Rule, a Federal Trade Commission regulation that governs franchises).
There’s a pretty good reason for merger clauses: certainty. A contract is meant to capture the final intent of the parties. Most deals go through any number of negotiations before the parties execute a final contract. And reasonable parties expect the final contract to be just that: final. Parties to a contract are expected to live with the deal they struck, good or bad, and not litigate issues that presumably were settled during arm’s length negotiations and reduced to writing in their final agreement. In fact, merger clauses are sometimes called “Big Boy” clauses as in, “we’re big boys and can look after ourselves.”
Of course, franchise agreements are a little different from most arm’s length commercial agreements. Specifically, a prospective franchisee generally cannot count on the normal give-and-take of most business negotiations. In most cases, particularly with well established franchisors and especially if you are buying a single unit, there is simply little or no negotiation and there’s really only one “big boy” involved. And it’s not you.
So, prospective franchisees need to be especially wary of any promises, assurances or representations made by the franchisor development team during discovery day. You may hear a lot of things that go a long way toward confirming your investment decision but you also need to confirm that any promises, whether spoken or contained in a PowerPoint presentation, are actually part of your deal and are reflected in your franchise agreement. If any of these promises are not set forth in the final franchise agreement, the franchisor effectively never made them.
Franchise agreements generally are governed by State law. And the case law in many States provides exceptions for a merger clause’s general disavowal of promises made but not “merged” or “integrated” into the final contract. These exceptions, though, are more often than not an elusive – and expensive – remedy.
For example, franchisees can bring a lawsuit against the franchisor claiming fraud or fraudulent inducement if they think that the franchisor broke a promise not reflected in the franchise agreement. In addition, if the franchisor sues the franchisee, the franchisee may assert a defense that he or she was fraudulently induced to sign the franchise agreement by promises or representations not made in the final agreement.
But don’t count on winning. Under the laws of many States, the existence of a merger clause is the beginning and end of the analysis: if a franchise agreement contains a merger clause, the case ends in favor of the party seeking to exclude evidence of any promises or representations not made in the agreement. For other States, a merger clause only has teeth to the extent that the promise or representation alleged was specifically disclaimed in the franchise agreement. Some State courts will consider the relative sophistication of the parties and refuse to enforce a merger clause where a party did not understand what it meant. Finally, some States will allow a fraudulent inducement claim to proceed irrespective of the existence of a merger clause and regardless of the sophistication of the parties. Of course, that means only that a franchisee may make the claim. Whether the franchisee ultimately will prevail on that claim is another matter entirely.
Bottom line: if your franchisor makes a promise or representation on which you relied or that is a significant consideration in your investment decision, either (1) make sure that your franchise lawyer gets it into the final franchise agreement or (2) make sure that the merits of the deal remain compelling for you even without that promise or representation.
Mike Sheehan is a franchise consultant and attorney. He is the president of Focus Ventures (www.focusonfranchise.com) and formerly served as a securities attorney and as general counsel for a Fortune 100 financial services company. His Franchise Focus Blog (www.franchisefocus.blogspot.com) focuses on helpful information, tips and current news for prospective franchisees.
This article should not be construed as legal advice or a legal opinion on any specific facts or circumstances. The contents are intended for general information purposes only and you are urged to consult your own franchise attorney concerning your own situation and any specific legal questions you may have.