How To Leave an Unprofitable Franchise System - Part 2

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My previous post described common disclosure errors that might be used to exit a franchise system. This article describes the process by which disclosure errors can produce this result. The process is by no means automatic, and it requires the involvement of an experienced franchise attorney. In some cases, even obvious and serious disclosure violations do not translate into a pass to leave a franchise system.

But where (a) significant disclosure law violations exist, and (b) applicable state law cooperates, disclosure law violations can be used to exit a system without any continuing obligation not to compete, and sometimes franchisors can also be made to refund fees or reimburse business losses.

There is no private right of action for violation of the FTC Rule under federal law, so the consequences of violation generally depend on applicable state law. If the franchisor and franchisee are located in different states, consequences of disclosure violations can be very different under the laws of their respective states.

The Franchise Agreement almost always specifies that the law of the franchisor's state applies. Frequently that controls which state's law applies.

But sometimes the franchisor is located in a state with a law that permits private actions for disclosure violations, so that the choice of law provision actually gives the franchisee rights it would not have had otherwise. In other cases the franchisee may be located in a state where either (a) state law requires a franchisor to provide a contract amendment invalidating such provisions, or (b) state law provides that contract terms applying a different state's law are not enforceable.

In some cases, the specified state may not have any law addressing FDD disclosure violations, and no lawsuit could therefore be brought for such violations, apart from the possibility of a lawsuit alleging fraud (for example, for issuing misleading financial performance representations).

In other cases, the state may have a law directed at disclosure violations, but the law may include an exemption for certain kinds of franchise sales, for example, where the franchisor is very large (think McDonalds), or the sale of the business involves a very large investment (such as a large hotel investment).

Ohio has a Business Opportunity Law which one commentator has referred to as "the Hidden Franchise Law". The law is complex, and generalizations are hazardous.

But in substance, the law requires a franchise seller to provide the purchaser with an FDD, and gives the purchaser a right to file suit if the FDD or disclosure process violate FTC regulations in significant respects. In such cases, the purchaser can bring a lawsuit and ask the court to "rescind" (or undo) the transaction, and also to award treble damages and attorney fees. In practice, many franchisors quickly offer to settle such claims once they are shown how the FTC regulations were violated.

Attorney Stanley Dub has handled many such cases, and would be pleased to discuss your situation without obligation.

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7 Comments

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    About this Entry

    This page contains a single entry by Stanley Dub published on January 18, 2015 12:24 PM.

    How To Leave an Unprofitable Franchise System - Part 1 was the previous entry in this blog.

    How to Move Beyond Contract Law & Settle Your Franchise Disputes is the next entry in this blog.

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