As a prospective franchisee, receiving a copy of the franchisor’s Franchise Disclosure Document (FDD) can seem overwhelming. You have been sold on the franchise opportunity and told you are a strong candidate for franchise ownership, and all of a sudden you find yourself sifting through hundreds of pages of information and being asked to sign something that says you have read and understood everything the franchisor has put in front of you.
A typical FDD is actually a series of documents. There is the “core” FDD, which consists of 23 “Items” mandated by the Federal Trade Commission (FTC), and then there the exhibits that follow. One of these exhibits is a copy of the franchisor’s standard franchise agreement. The franchise agreement itself can be excruciatingly complicated, and even a single provision buried deep within its pages can spell the beginning of the end for your newly-acquired franchise.
Key Components of the FDD and Franchise Agreement
While the franchise agreement will ultimately govern your franchised business, you cannot afford to overlook the core of the FDD. Both documents are important, and both should inform your decision as to whether to become a franchisee:
FDD: Key Disclosure Items
The FDD is a disclosure document; it is not a binding agreement. While you will be asked to sign the receipt in Item 23, signing the receipt does not commit you to anything contained in the FDD. In most franchise systems, some of the most useful information can be found in the following Items of the FDD:
- Items 3 and 4 – These Items should disclose any material litigation in which the franchisor is involved as well as any recent bankruptcy filings.
- Items 5 through 7 – These Items should outline the primary fees and expenses associated with the franchise opportunity. Note that Item 7 provides “estimates,” and may not necessarily reflect your actual initial investment.
- Items 8, 11 and 16 – These Items should cover any purchasing restrictions, training programs, site approval requirements and other limitations on your operations as a franchisee.
- Item 12 – Item 12 should explain how your territory will be defined and whether your territory is exclusive or protected.
- Items 19 and 21 – If the franchisor provides any financial performance representations, these will be disclosed in Item 19. The franchisor must provide its financial statements in Item 21.
- Item 20 – In Item 20, you will find five tables with information about current, former and anticipated future franchisees.
Franchise Agreement: Key Contract Provisions
Your franchise agreement will be organized into “sections,” each of which may have numerus subsections. Some of these sections may overlap (and potentially even be inconsistent with one another), and you will need to watch for these types of issues when attempting to discern your substantive rights and obligations as a franchisee. Some of the sections that are likely to have the greatest impact on your franchise include:
- Term and Renewal
- Royalty and Advertising Fees
- Franchisee’s Obligations
- Territory Rights and Restrictions
- Renewal and Transfer Rights
- Default and Termination
- Liquidated Damages
- Dispute Resolution (including mandatory mediation or arbitration)
While the FDD should summarize much of the information contained in the franchise agreement, prospective franchisees cannot solely rely on the FDD when seeking to understand the terms of their contracts. A thorough franchise business review should assess the material provisions of both documents in order to allow for informed decision-making, and should not be biased toward confirming a pre-established interest in the franchise opportunity.
Contact the Goldstein Law Firm
If you are considering a franchise opportunity, it is important to have the FDD and franchise agreement reviewed by an experienced attorney. We offer three tiers of flat-fee franchise business review services that are focused on identifying the potential risks associated with buying your chosen franchise. For more information and a free initial consultation, please call (202) 293-3947 or contact us online today.