Franchisor’s FDD Deception

Financial disclosure documents (FDDs) are supposed to be a way for franchisors to convey pertinent information regarding investment to prospective franchisees, and the law mandates that FDDs be …

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Financial disclosure documents (FDDs) are supposed to be a way for franchisors to convey pertinent information regarding investment to prospective franchisees, and the law mandates that FDDs be written in “plain English.” A quick look at Cold Stone Creamery’s (a franchise ice cream parlor) FDDs shows how franchisors go to great lengths to confuse investors. “Plain English” requires the document be written in short sentences, everyday language, active voice and be tabulated when possible. It’s clear with the sample franchise’s documents that the only attempt the franchise attorneys made at clarity was to preface the FDD items with a statement about them being in “plain English.” For more on this continue reading the following article from Blue MauMau.

Because Cold Stone Creamery received some unflattering press recently, I started to read their franchise disclosure document (FDD) the other day to get some background information but I got knocked stone cold on the very first item of their disclosure.

Item 1 is intended to let you know with whom you’re dealing. Like all other parts of the franchise disclosure document, it’s supposed to be written in "plain English." You may find, though, that it’s sometimes written in "unreadable English," or what I like to call, charitably, "plain Sanskrit." Item 1’s mandate is simple enough: disclose background information on the franchisor and any parents, predecessors and affiliates. This deceptively easy requirement, coupled with the "plain English" requirement, might lead an unsuspecting reader reasonably to expect something akin to "Item 1 of the FDD for Dummies." But what you get instead sometimes reads like a James Joyce novel.

Cold Stone’s Item 1 disclosure is prefaced with the cold comfort that "We have written this Disclosure Document in ‘plain English’ in order to comply with legal requirements." What follows is anything but "plain." You learn in the first substantive paragraph, for example, that your franchisor is Kahala Franchising, L.L.C.

which is an Arizona limited liability company which was formed on December 29, 2008 for the purpose of owning all of the intellectual property assets and franchising business of Kahala Franchise Corp., a wholly owned subsidiary of Kahala Corp. (the "Parent Company" and "Kahala"), and Cold Stone Creamery, Inc., which is an indirect and wholly owned subsidiary of Kahala.

Got that? Simple enough. But what starts with a minor muddle turns into a complete morass through the next eight or so pages. And that mess is only made murkier if you’re steadfast enough to try to clarify it by reading the notes to the financial statements. In Note 1 you’ll learn that Kahala Franchising, L.L.C.

was organized to hold certain intellectual property and to administer, finance, manage, license, franchise and operate such intellectual property in the business of quick service food restaurants operating under the Samurai Sam’s Teriaki Grills, Taco Time, and The Great Steak & Potato Company brand names (collectively, the "Concepts").

Wait a minute, though. What about Cold Stone Creamery? After all, that’s the franchise I thought I was reading about. There’s probably an explanation somewhere in the chaos but it wasn’t in plain sight.

"Plain English" means the "organization of information and language usage understandable by a person unfamiliar with the franchise business." Specifically, the requirement instructs the scribe to use

  • Short sentences
  • Definite, concrete, everyday language
  • Active voice and
  • Tabular presentation of information, where possible.

The FDD drafter is also told to avoid

  • Legal jargon
  • Highly technical business terms and
  • Multiple negatives.

All of this, of course, is easier to require than to do. And many franchisor lawyers only will pay lip service to the requirement by stating that the inscrutable clutter that follows is in "plain English." It certainly isn’t helpful that the Federal Trade Commission, unlike the Securities and Exchange Commission, doesn’t review or comment on disclosure documents. And I’m also not sure whether State franchise authorities spend any review time on the "plain English" rule.

The point of all of this is that you don’t have to read very much of an FDD before you permanently unfriend the franchisor’s lawyers. Admittedly, they have to translate a lot of complex disclosure into simple prose. But some do a better job than others and if the franchisor’s lawyers are on the wrong side of the bell curve, you’re in for a painful slog.

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.

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