Why franchise disclosure documents are your best friends
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Friday 9th December, 2022

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Why franchise disclosure documents are your best friends

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Why franchise disclosure documents are your best friends

Emma Lusty explains why you need to fully understand your disclosure documents

As the old adage goes, failing to plan is planning to fail. Franchisors who are contemplating a program of international expansion will have taken advice and consulted with experts regarding the structure that their expansion should take and about how to fund their expansion plans, for example.

One matter that is often overlooked during this initial planning stage is the requirement for franchise-specific registration and/or disclosure documents which often need to be in place – if they are necessary – before a franchisor can sell a franchise and, in any event, before a franchise agreement is signed.

This oversight is common for franchisors who are based in the United Kingdom because we do not have any registration or disclosure requirements for franchising in the U.K., so these matters are not necessarily on a U.K. franchisor’s radar.

Once you have established into which countries you wish to expand, you will need to take advice from local advisors regarding the local franchise laws and, in particular, the local registration and disclosure requirements. Local franchise associations will usually have a wealth of easily accessible information along with a database of affiliated lawyers and other advisors with specialist franchise knowledge.

Franchise Disclosure Documents: a matter of law

As the concept of franchising has grown, many countries, in addition to the United States, have implemented franchise laws. There are now over 30 jurisdictions outside of the U.S. with specific disclosure requirements which require franchisors to deliver a disclosure document to prospective franchisees before the franchise is sold. As such, it is likely that, wherever you expand outside of the U.K., you will need to consider what are the registration and disclosure requirements in those jurisdictions.

For franchisors looking to expand into countries with disclosure requirements, the additional work associated with selling franchises may seem disproportionate. This is compounded by the fact that, internationally, disclosure requirements vary greatly so a “one size fits all” approach cannot be adopted. However, with the right advice and guidance, local to each jurisdiction, the disclosure process does not have to be, although it often is, a complicated, expensive or time consuming exercise and there are many benefits to having disclosure requirements.

Franchising is an efficient and effective way to expand your business both in the domestic market and internationally, however, the concept does sometimes attract bad press. There are many horror stories about businesses which fraudulently and deceitfully make their victims believe that they are investing their money to become a franchisee of a legitimate business, but, instead, those victims are purchasing phantom, non-existent franchises.

The theory is that a registration and disclosure regime will discourage franchisors from being involved in such fraudulent and criminal activity which not only benefits franchisees but also the wider franchise community and the reputation of the concept of franchising as a whole. The reality, particularly in smaller jurisdictions, is that bad news travels fast and so, if there is a badly behaved franchisor trying to sell franchises, prospective franchisees are likely to be able to find out about it.

What a Franchise Disclosure Document should contain

Franchise disclosure documents generally contain information concerning the franchisor and its financial status and history. There will often be a breakdown of the minimum investment requirements and initial and continuing fees payable by franchisees and details of any previous or on-going litigation with which the franchisor is involved. A discerning prospective franchisee will be able to obtain much of this information by conducting its own research and asking the right people the right questions prior to buying a franchise, but a lot of the data that must be provided by franchisors will not be freely available so the disclosure document is useful in ensuring that franchisees are aware of both the good bits and the bad bits about its franchisor’s history so that they can make an informed decision about whether or not to invest in a particular franchise.

As long as franchisees actually read the disclosure document that is provided, the requirement for franchisors to make disclosures does seek to ensure that franchisees conduct at least some due diligence into the franchise that they are acquiring, rather than naively assuming that they are investing in a solid business concept and proven system. This should mean that there is less franchise litigation arising as a result of franchisees becoming disillusioned when their franchise does not perform as expected or when they find out that something is not as they thought it would be.

The downside to strict disclosure and registration requirements is that they can be seen to be a barrier to using franchising as a method of international expansion and even as a barrier to expansion into certain countries at all. An example of this is the “2+1” rule in China which requires franchisors to operate at least two company-owned operations for at least a year prior to selling franchises in China. Fortunately the “within China” part of this rule has been removed! Many countries require franchisors to have been trading for a number of years so new start-ups cannot franchise in those countries.

The perceived benefit of these rules to franchisees is that they can see that a franchisor has a successful trading history before they part with their hard earned cash and, not only that, but franchisors can show that their system and brand works and is a worthwhile investment which will form the foundation of successful businesses for both franchisee and franchisor. The requirements do not always evidence that the system works in a franchise model which is a key factor for a prospective franchisee to consider.

In the U.K., as I mentioned previously, we have no registration or disclosure requirements or even any specific franchise laws and franchising continues to go from strength to strength. The British Franchise Association holds its members to very high standards of ethical franchising which ensures that badly behaved franchisors will find it increasingly difficult to dupe prospective franchisees, regardless of whether or not franchisors are required to make specific disclosures to prospective franchisees before signing franchise agreements. So perhaps a tough franchise disclosure regime is not the be all and end all after all.

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