Franchise disclosure documents (FDDs) are the prospectus that would-be franchisees use to decide whether they should invest in the business. Item 17 covers renewal, termination, transfer and dispute resolution: all extremely important components of the franchisor-franchisee agreement. Prospective franchisees must be wary of the terms contained in this Item, as it will bind them with regard to how they will settle disputes between the franchisor, how the agreement can be terminated or renewed, and whether rights can be transferred. For more on this continue reading the following article from Blue MauMau.
This is the fifth in a series of articles for prospective franchisees that discuss the components of a franchise disclosure document. Unlike almost all other articles about what you will learn in a franchise disclosure document, however, this series will focus on what you may not learn. This focus is intended to help you both refine and expand your due diligence efforts.
When you’re ready to begin a new adventure in franchising, some of the last things you want to think about are any potential troubles along the way and the last day of your journey. It’s hard enough to focus on the immediate, and maybe overwhelming, tasks at hand with any business startup. But you need to think about the disputes that almost inevitably arise. To be sure, everything is exciting and full of promise when you’re packing your bags but the trip might get bumpy and at least some disagreements with the franchisor are nearly a certainty.
You also really need to put a decent amount of thought and planning into the final phase of your franchise relationship or, at least, about what happens at the end of the initial franchise term.
So, you need to understand what your rights and responsibilities are during and after the journey. For these purposes, Item 17 of the franchise disclosure document (FDD) is really a brief set of directions. The franchise agreement is the roadmap.
What you will learn.
The importance of Item 17 can be easily overlooked. That’s because it is simply a table that refers the reader to the relevant sections in the franchise agreement that pertain to renewal, termination, transfer and dispute resolution. And a lot of Item 17 is little more than a sound bite.
Nevertheless, Item 17 contains some very critical information, even if that information simply leads you to further, required reading. Among the things you will learn are:
- The length of the initial franchise term;
- Whether the initial franchise term may be extended or "renewed" (more about that below) and upon what terms and conditions;
- Whether and under what circumstances you as the franchisee can terminate the franchise (don’t be too surprised to see a "None" or "Not Applicable" here);
- The circumstances under which the franchisor may terminate the franchise with or (almost never) without "cause;"
- The meaning of "cause" and when it’s something you can fix (generally, you can fix or "cure" a late payment but not a felony conviction);
- Your obligations as a franchisee on termination or non-renewal (mainly to learn and abide by a word I bet you’ve never heard of or used: de-identification (scrubbing any connection to the franchise trademark));
- The franchisor’s transfer approval rights and the conditions attached to those rights;
- Whether the franchisor has a right of first refusal or option to acquire your franchised business (in other words, whether you will have any liquidity/marketability issues when you want to sell your business);
- What happens upon death or disability of the franchisee;
- Any covenants not to compete both during the franchise term and after it terminates or expires;
- How the franchise agreement may be modified (generally, only in a written agreement signed by both parties; most franchisors will note here, though, that they have the unilateral right to modify the operations manual, sometimes an indirect way to modify the franchise agreement);
- The terms of the not dazzling but critically important "integration" or "merger" clause (think of it as a reverse Miranda warning: anything the franchise sales team says generally can’t and won’t be held against the franchisor unless it’s also in the franchise agreement); and
- The terms for any dispute resolution (franchisors tend to favor arbitration, a process that for many reasons may not favor the franchisee).
Item 17 goes beyond a simple summary of franchise agreement terms in a couple of places. For example, Item 17(c) requires the franchisor to state what the term "renewal" means for the franchise. This is actually pretty important because in the world of franchising the term "renewal" is an acknowledged (even by the Federal Trade Commission) "term of art." What this means is that the lay person might mistakenly ascribe a common sense meaning to it like: new franchise term with the same or similar terms and conditions. That, of course, would be too easy. So let’s try: new franchise term but with potentially very different terms and conditions. To the untrained eye that may look like a completely new agreement but in franchising it’s not. And, under Item 17(c), the franchisor has to tell you when a seemingly brand new agreement is in fact simply a "renewal" of your perhaps materially different old agreement.
In addition, you may get a footnote that alerts you to certain Item 17 benefits and protections about which the franchise agreement is silent but that the franchisor unilaterally offers as a matter of policy (and whether that policy is subject to change).
What you will not learn.
FDD Item 17 does not tell you a lot of what you need to know about renewals, terminations, transfers and disputes. For any meaningful detail, you need to read the cross-referenced sections of the franchise agreement and review them with a qualified franchise attorney.
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.