Does failure to provide mandated disclosure documents vitiate a subsequent franchise agreement?

Yes. Under Minnesota law, a franchisee is entitled to rescind the franchise agreement if he or she chooses to do so.

Federal Law Regulating the Sale of Franchises

There are both federal and state laws that regulate the sale of franchises. On the federal level, the Federal Trade Commission (“FTC”) Franchise Rule (“FTC Rule”) was promulgated in 1979 and recently amended in 2007. (See footnote 1.) The FTC Rule requires franchisors to provide a minimum level of pre-sale disclosure to prospective franchisees. (See footnote 2.) The rule requires franchisors to provide prospective franchisees with sufficient information about the franchisor and the franchised business being offered for sale. (See footnote 3.) Specifically, it is an unfair or deceptive act or practice for any franchisor to fail to furnish a prospective franchisee with a copy of the franchisor’s current disclosure document at least fourteen (14) calendar days before the prospective franchisor signs a binding agreement, or makes any payment to, the franchisor. (See footnote 4.) Here, the federal regulation is narrower than the law in Minnesota where disclosure must be completed before even an offer is made. (See footnote 5.)

To establish that an act or practice is deceptive under section 5 of the FTC Act, the FTC must establish that:

      1. there was a representation;
      2. the representation was likely to mislead consumers acting reasonably under the circumstances, and
      3. the representation was material. (See footnote 6.)

A representation is material if it is of a kind usually relied upon by a reasonably prudent person. (See footnote 7.) Additionally, a presumption of actual reliance arises once the Commission has proved that the defendant made material misrepresentations, that they were widely disseminated, and that consumers purchased the defendant’s product. (See footnote 8.) Express claims, or deliberately made implied claims, used to induce the purchase of a particular product or service are presumed to be material. (See footnote 9.)

The FTC has the power to impose the following penalties for violations of the FTC Rule:

      1. civil penalties of up to $10,000 per day for each violation of the FTC Rule or an FTC cease and desist order;
      2. FTC may compel rescission or reformation of contracts; or
      3. may issue a cease and desist order requiring a party to refrain from engaging in any unfair method of competition or deceptive act or practice in or affecting commerce. (See footnote 10.)

Private citizens cannot sue franchisors for violations of the FTC Rule. (See footnote 11.) Only the FTC can take action to enforce the rule. (See footnote 12). Nevertheless, private citizens may have available causes of action and remedies under relevant state law.

Minnesota Law Regulating the Sale of Franchises

The Minnesota Department of Commerce regulates the registration of franchises. Before a franchise can be offered or sold, it must be registered in accordance with the Minnesota Franchise Act, (See footnote 13) and the rules of the Commerce Department. (See footnote 14.) Minnesota law provides eight exemptions from the registration requirement. These exemptions include:

      1. an offer or sale of a franchise owned by that franchisee, if not affected by a franchisor;
      2. a transaction by an executor, administrator, sheriff, receiver, guardian, conservator, or trustee in bankruptcy;
      3. a sale or offer to a bank, financial organization, or life insurance company;
      4. registered securities;
      5. a single offer or sale of a franchise if not advertised to the general public;
      6. the sale of a fractional franchise, one in which the franchisee has been in that type of business represented by the franchise for more than two years and at least 80 percent of the franchisee’s sales are derived from other sources;
      7. transactions exempted by the commissioner;
      8. an offer or sale of a franchise to a nonresident if the franchise is not to be operated in Minnesota. (See footnote 15.)

As part of the registration process, a franchisor is required to prepare a public offering statement (public disclosure) in accordance with section 80C.04. According to Minnesota Statutes section 80C.02: “No person may offer or sell any franchise in this state unless there is an effective registration (including a public offering statement) on file in accordance with the provisions of sections 80C.01 to 80C.22. For the purposes of sections 80C.01 to 80C.22, an offer to sell or to purchase is made in this state when the offer originates from this state or is directed by the offeror to this state and received by the offeree in this state. (See footnote 16.)

Any person who violates the Minnesota Franchise Act is liable to the franchisee or franchisor who is harmed by the violation for actual damages and lost profits, as well as cots, disbursements, and attorneys’ fees. (See footnote 17.) A franchisee is also entitled to rescind the franchise agreement if he/she chooses. (See footnote 18. ) Section 80C.17(1) reads:

A person who violates any provision of sections 80C.01 to 80C.13 and 80C.15 to 80C.22 or any rule or order thereunder shall be liable to the franchisee or subfranchisor who may sue for damages caused thereby, for rescission, or other relief as the court may deem appropriate.

In Chase Manhattan Bank v. Clusiau Sales & Rental, Inc., the court construed section 80C.17(1) to declare the legislature’s intent to afford a franchisee who suffers harm by reason of the franchisor’s violation of the franchise statute the right to have his agreements with the franchisor treated as entirely void and to be restored to the position he occupied prior to his involvement with the franchisor. (See footnote 19). Specifically, the court stated, “[t]he effect of the remedy of rescission is generally to extinguish a rescinded contract so effectively that in contemplation of the law it never had existence.” (See footnote 20.)

In addition, any person who directly or indirectly controls the liable person or who materially aids in the act in violation of the statute is jointly and severally liable. (See footnote 21.) This gives the franchisee the ability to sue not only the franchisor but all of the officers and directors of the franchisor. Liability can be avoided only if the person shows he or she had no actual or reasonable means of attaining knowledge of the violation. (See footnote 22.)

Mississippi Law Regulating the Sale of Franchises

Mississippi does not currently have a franchise law requiring franchisors to provide pre-sale disclosures, known as a “Franchise Disclosure Document,” to potential purchasers. There are currently fifteen (15) states that require such a disclosure. These states include California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Oregon, Rhode Island, South Dakota, Virginia, Washington, and Wisconsin. (See footnote 23.)

[1] 16 C.F.R. § 436.

[2] 16 C.F.R. § 436.2.

[3] Id.

[4] 16 C.F.R. § 436.2(a).

[5] Minn. Stat. § 80C.02 (2012).

[6] See FTC v. Tashman, 318 F.3d 1273, 1277 (11th Cir. 2003) (citing FTC v. Atlantex Assocs., 1987 WL 20384 (S.D. Fla. 1987), aff’d 872 F.2d 966 (11th Cir. 1989).

[7] FTC v. Jordan Ashley, Inc., 1994 WL 200775 (S.D. Fla. 1994) (citing FTC v. Amy Travel Serv. Inc., 875 F.2d 564 (7th Cir.).

[8] FTC v. Figgie Int’l, Inc. 994 F.2d 595, 605 (9th Cir. 1993) cert. denied, 510 U.S. 1110 (1994).

[9] In the Matter of Thompson Med. Co., Inc., 104 F.T.C. 648, 816 (1984).

[10] 15 U.S.C. § 45(m).

[11] 15 U.S.C. § 45(m)(1)(A).

[12] Id.

[13] Minn. Stat. §§ 80C.01-80C.30 (2012).

[14] Minn R. 2860.0100-2860.9930 (2012).

[15] Minn. Stat. § 80C.03 (2012).

[16] Minn. Stat. § 80C.19(2) (2012).

[17] Minn. Stat. § 80C.17 (2012). See Hughes v. Sinclair Mktg., Inc., 375 N.W.2d 875 (Minn. Ct. App. 1985), aff’d in part, 389 N.W.2d 194 (Minn. 1986) (awarding damages for lost future profits).

[18] Minn. Stat. § 80C.17, subdiv. 1 (2012). See Nauman v. J’s Reestaurants Int’l, Inc., 316 N.W.2d 523 (Minn. 1982); Chase Manhattan Bank v. Clusiau Sales & Rental, Inc., 308 N.W.2d 490 (Minn. 1981); Martin investors, Inc. v. Vander Bie, 269 N.W.2d 868 (Minn. 1987).

[19] Clusiau, 308 N.W.2d at 494.

[20] Koch v. Han-Shire Investments, 140 N.W.2d 55 (1966).

[21] Minn. Stat. § 80C.17, subdiv. 2 (2012).

[22] Id.