Franchisees: Get Everything In Writing
Franchisees involved in franchise agreement reviews or FDD reviews must get everything in writing; if not, courts judging franchise disputes that arise during the course of the franchise relationship will probably not help.
In cases where a franchisee or dealer is able to show that statements a salesman made are fraudulent, salespeople accused of fraud regularly invoke various legal rules and contract clauses to shield themselves from liability. Franchisors often use these rules and contract clauses to defend themselves when franchisees claim the franchisor misrepresented the terms of a deal.
First, many businesses, including franchisors, put terms in their written agreements that are called “merger” clauses or “integration” clauses. Basically, these clauses state that the franchisee forgives the salesman for any fraudulent statements the seller may have made to the customer during the sales process. Such clauses also state that the customer agrees never to argue or claim that the seller made misleading statements. Further, a merger or integration clause states that the written agreement is the complete statement of all the agreed-upon terms. The merger or integration clause therefore keeps out of the legally binding agreement any statements or promises made in conversation (unless those statements or promises are finally written into the agreement’s text). This means that in the face of merger and integration clauses in a franchise agreement, a franchisee cannot rely on any promise or statement made by the franchisor or its sales staff if that promise has not been clearly written in the franchise agreement.
Like other businesses, franchise companies regularly rely upon merger clauses and integration clauses included in franchise agreements to protect themselves from potential fraud claims. An example of a merger clause in a franchise agreement is:
“Neither [the Franchisor] nor any other person on [the Franchisor’s] behalf has made any oral or written representation to Licensee not fully set forth herein on which Licensee has relied in entering into this Agreement, and Licensee releases any claims against [the Franchisor] or its agents based upon any oral or written representation not set forth herein.”
An example of an integration clause in a franchise agreement is:
“This Agreement, together with all instruments, exhibits, attachments and schedules hereto, constitutes the entire agreement (superseding all prior representations, agreements, and understandings, oral or written) of the parties hereto with respect to the facility.”
In addition to relying on merger and integration clauses to shield themselves from fraud claims, businesses defending themselves against fraud claims in court regularly attempt to hide behind what is known as the “parol evidence rule.” Unlike merger and integration clauses, which are terms explicitly included by the seller in the written agreement, the parol evidence rule is a rule of contract law that is applied by courts. The parol evidence rule basically says that the final written agreement is the only agreement a court will enforce, not any prior negotiations nor any oral promises made by salesmen. Moreover, earlier tentative agreements, negotiations and promises cannot be introduced at trial by a franchisee to prove fraud. When a court strictly applies the parol evidence rule it prohibits a customer from testifying at trial about the false statements made to him by the seller.
Although there are legitimate reasons for recognizing merger clauses and the parol evidence rule (for example, to prevent fraud at trial, as well as to make contracts dependable for business), in the opinion of this author, such reasons should never “trump” the goal of punishing those guilty of fraud. Some courts, agreeing with this position, have created a fraud exception to the applicability of merger clauses and the parol evidence rule. Under this exception, neither a merger clause nor the parol evidence rule will be applied to keep out evidence used to show misrepresentation or fraud in forming a contract.
Other courts, however, are more eager to uphold a business’s right to rely on a written agreement, regardless of whether the business made fraudulent statements to get the customer to sign the agreement. These courts refuse to recognize the fraud exception, and therefore prohibit the introduction of evidence of fraud at trial. In the following case involving a franchisee, the court unfortunately refused to recognize the fraud exception and applied the parol evidence rule and the franchise agreement’s merger clause to dismiss the franchisee’s fraud claims.
In Meehan v. United Consumers Club, the Meehans, a father and son team, entered into a franchise agreement with United Consumers Club in 1995. The Meehans alleged that when they were negotiating the agreement, United Consumers Club made several promises in conversation about the earnings the Meehans could expect from the franchise, the rate of success, the pricing of their product, and the support they would get from the franchisor. However, none of these promises were actually put in the written franchise agreement the Meehans finally signed with United Consumers, nor were the promises in United Consumers’ Unified Franchise Offering Circular (UFOC). But United did make sure that the franchise agreement contained an express disclaimer (i.e., a merger clause) requiring the franchisee to agree that he did not receive or rely on any warranty about the revenue, profit or success of the franchise that was not in the written agreement. Moreover, the disclaimer required the franchisee to agree that he did not rely on any promises by any agents of the company (e.g., sales people).
The Meehans’ franchise was not as profitable as they thought United Consumer had led them to expect, nor did they receive the support they thought United had promised them in negotiations. As a result, they sued United Consumers Club for fraud. However, the trial court would not consider the franchisees’ evidence of United Consumers’ promises made during negotiations. The court merely considered the merger clause of the franchise agreement, which excluded any oral statements or promises from the legally binding franchise agreement. As a result, the trial court dismissed the Meehans’ case. On appeal, the appeals court agreed with the trial court, holding that “it is simply unreasonable to continue to rely on representations after stating in writing that you are not so relying . . . . Based on the franchise agreement and the offering circular, we find Meehan could not justifiably rely on representations regarding earnings or success rates.” The merger clause prevented the Meehans’ from proving any fraud.
When considering a franchisee’s ability to establish fraud claims, it is important to distinguish between “fraud in the inducement” and “fraud in the execution.” Fraud in the inducement refers to false statements of fact used to convince a customer to purchase the salesperson’s product. In contrast, fraud in the execution arises where a person deceptively puts false statements in a written agreement. Fraud in the execution occurs, for instance, where a salesman falsely tells a customer that a previously agreed-upon term has been included in the final written agreement, when it has not.
In cases of fraud in the execution in particular, businesses often assert an additional legal defense — that the defrauded customer has a “duty to read” the agreement before signing it. Like the merger clause and parol evidence rules discussed above, the “duty to read” can keep a defrauded customer from asserting fraud claims in court (as was the case for the Meehans). Again, this author believes that any business justification for imposing a duty to read on customers before signing an agreement is severely outweighed by the goal of prohibiting fraud, and that those courts that impose this duty to bar a fraud claim are incorrect.
As the above discussion makes clear, regardless of how skilled a negotiator you may be, you should never execute a written agreement of any significance without having an experienced litigator review the final written document. And remember, based on the many inconsistent rulings by courts on the fraud issue, you should never rely on any promises or representations made to you by a salesman that have not been specifically put in the written agreement. To protect yourself from the beginning, you should retain a franchisee lawyer who represents only franchisees, not franchisors and suppliers, to represent you before you sign a dealer or franchise agreement.