Aug 17, 2022 - Blog, Franchise Articles by |

If you are interested in buying a franchise and the franchisor considers you to be a qualified candidate, it will provide you with two key documents—the Franchise Disclosure Document (FDD) and the franchise agreement. Both of these documents are extremely important, and, as a prospective franchisee, it is imperative that you carefully review both documents with the help of an attorney.

Why do you need to review both? The FDD and franchise agreement are important for different reasons, and they both provide unique insights into the franchise opportunity. Here is an overview of the key aspects of each document:

Why Is the FDD Important for Prospective Franchisees?

As its name suggests, the FDD is a disclosure document. As such, it is intended to provide information that prospective franchisees need in order to make an informed buying decision. Some of the key reasons to carefully review the FDD when evaluating a franchise opportunity include:

1. The FDD Is Standardized to Help Prospective Franchisees

All franchisors must prepare their FDDs in accordance with the Federal Trade Commission’s (FTC) Franchise Rule. The Franchise Rule establishes the 23 mandatory “Items” of the FDD, and it lists required disclosures for each item.

This is intended to help franchisees efficiently evaluate their franchise opportunities. Once you familiarize yourself with the structure of the FDD (which you can do by reviewing the mandatory Table of Contents), you can pretty easily get yourself pointed in the right direction. Additionally, since all FDDs are standardized, prospective franchisees can easily compare the fundamental aspects of competing franchise opportunities.

2. Certain Disclosures and Omissions Can Raise Immediate Red Flags

The fact that all FDDs are standardized also means that certain disclosures and omissions can immediately raise red flags. For example, franchisors must disclose their litigation and bankruptcy history in Items 2 and 3. If a franchisor has recently filed for bankruptcy or has a track record of litigating with its franchisees, this could be a bad sign.

If a franchisor omits a mandatory disclosure, this should be cause for concern as well. These omissions can be more difficult to spot for the untrained eye, but a lawyer who regularly reviews FDDs will be able to quickly recognize any inadequate disclosures.

3. The FDD Contains Information Not Included in the Franchise Agreement

Along with the franchisor’s bankruptcy and litigation history, the FDD contains various other pieces of information that don’t belong in the franchise agreement. From the franchisor’s financial performance representations in Item 19 (if any) to the franchisor’s system summary in Item 20, the FDD will be prospective franchisees’ only source of certain key information.

4. FDDs Are Subject to Approval and Registration in Some States

Several states have adopted franchise disclosure laws that require franchisors to register their FDDs. In some of these states, such as California, Illinois and Maryland, regulators review franchisors’ FDDs to confirm that they contain all required disclosures. While registration doesn’t guarantee that an FDD is complete, state franchise disclosure laws provide prospective franchisees with an additional layer of protection.

5. The FDD Provides a “Cooling Off” Period

Under the FTC’s Franchise Rule, all FDDs must include a Receipt page that discloses the mandatory 14-day “cooling off” period. This prevents franchisors from requiring franchisees to sign before they have had a chance to hire a lawyer to review the FDD.

Why is the Franchise Agreement Important for Prospective Franchisees?

Now, what about the franchise agreement? Some of the key aspects of a franchise agreement include:

1. The Franchise Agreement Governs the Franchise Relationship

While the primary purpose of the FDD is to provide prospective franchisees with information, the franchise agreement is a legally-binding contract. The franchise agreement governs the franchise relationship, and once you sign, you are bound for the initial term.

2. The Franchise Agreement Contains Information Not Included in the FDD

Just as the FDD contains information not included in the franchise agreement, the franchise agreement contains information not included in the FDD. Carefully reviewing the franchise agreement in full is the only way to fully understand the terms of your franchise opportunity.

3. The Franchise Agreement is Subject to Negotiation

While franchisees can’t—and don’t really have a reason to—negotiate franchisors’ FDD disclosures, franchisees can and should negotiate the terms of their franchise agreements. Franchise agreements are almost always heavily one-sided, and it is up to franchisees to ensure that they secure adequate protections.

4. The Franchise Agreement Specifies When Your Franchisor Can Terminate Your Franchise

As a franchisee, one of the most important things you need to know is when your franchisor can terminate your franchise. The franchise agreement’s Termination section should address this in detail—including any rights you may have to “cure” defaults before they trigger termination. The franchise agreement’s Termination section will outline the franchisor’s post-term restrictive covenants as well.

5. If You Have a Dispute with Your Franchisor, Your Franchise Agreement Will Control

Finally, if you have a dispute with your franchisor, the terms of your franchise agreement will control. This is true not only with regard to the substance of the dispute but also with regard to governing law, venue and means of resolution (i.e., mandatory mediation or arbitration).

So, Which One is More Important?

So, we return to our original question: Which one is more important? The simple answer is, “Neither.” As we said, the FDD and franchise agreement are important for different reasons. While there is some overlap, both documents contain different information, and prospective franchisees must carefully review both in order to make a fully-informed buying decision.

Discuss Your Franchise Opportunity with Attorney Jeffrey M. Goldstein

Attorney Jeffrey M. Goldstein represents prospective franchisees nationwide, and he has exclusively practiced franchise law for more than 30 years. If you are thinking about buying a franchise, Mr. Goldstein can make sure you know everything you need to know about the franchisor’s FDD and franchise agreement. To inquire about our fixed-fee franchise business review programs, call us at 202-293-3947 or request a free initial consultation online today.

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