Franchisor Liability in the Face of Misrepresentation

Published on 12/19/2018
Categories: Federal Law, Franchises, Illinois Law

 

When considering franchise opportunities, due diligence is absolutely necessary prior to purchasing any franchise in order to protect yourself and your investment.  What are your options when a franchisor misrepresents the estimated costs to operate a franchise in a disclosure document? Specific contract language for franchise liability will help to protect franchisees from purposeful fraud or misunderstandings.

Mandatory Disclosure

To protect prospective franchises from “substantial losses where franchisors or their representatives have not provided full and complete information,” the Illinois Franchise Disclosure Act[1] imposes liability on franchisors who do not fully disclose pertinent information for the protection of prospective franchisees. The Act seeks to ensure that franchisees make “intelligent decisions” in their purchases and have a better understanding of their legal relationship with franchisors.[2]  Prior to sale, franchisors must register franchises with the Franchise Bureau in the Attorney General’s Office, and a Franchise Disclosure Document (“FDD”) must be provided to the prospective franchisee.[3]

Fraudulent practices made in connection with the offer or sale of any franchise are prohibited.[4] Failure to file an accurate disclosure statement with the Attorney General is also prohibited.[5] All statements therein must be “free from any false of misleading statement of material fact, shall not omit any material fact required to be stated or necessary to make the statements not misleading, and shall be accurate and complete as of the effective date thereof.”[6] To enforce the Act, the Attorney General can terminate or deny the sale of a franchise.[7] Civil penalties and criminal prosecution may also be imposed;[8] and franchisees are entitled to a private right of action, for damages or rescission, against any officer involved in an unlawful sale.[9]

Estimated Costs

As noted above, it is unlawful for franchisors to mispresent information in a disclosure document that would hinder a franchisee from making an informed purchase. Representations of estimated costs presumably qualify as statements that should be protected under the Act.[10] However, whether such misrepresentations are actionable depends on the circumstances surrounding a given case and the specific terms of the franchise agreement.

Section 16 of the Act provides that no material fact shall be omitted from disclosure. But it is well settled in Illinois that financial projections are statements of opinion rather than fact.[11]  Since such statements are merely predictions regarding future occurrences, they are generally not actionable.[12] The Seventh Circuit has found that reliance on projected figures is immaterial where the figures are not representations of pre-existing facts.[13] Rather, representations must reflect some “past income” or historical financial data.[14]

Assuming a franchisor mispresents estimated costs based on some historical data, a franchisee may have a viable claim. In Avon Hardware Co. v. Ace Hardware Corp., for instance, a franchisee was provided a pro forma statement that included projected sales and profits and estimated costs based on the business’s past average performance. The appellate court upheld the decision that projected sales figures were not facts and therefore unactionable; but simultaneously, representations based on historical data were considered factual and actionable.[15] A determination for franchisor liability in this context therefore requires an assessment of the basis for the representations provided to the franchisee. Unless estimated costs are supported by factual findings (such as costs the franchisor has observed over time), they may be considered immaterial or mere predictions.

The terms of the parties’ agreement are additionally significant in determining franchisor liability. If an estimated cost is deemed actionable, courts will review the language contained in the FDD. Courts often find no false or concealed representations were made where franchises explicitly stated that data is inconclusive.[16] The “bespeaks caution” doctrine provides that cautionary language made about projections, estimates, or opinions can render alleged misrepresentations and omissions immaterial.[17] Therefore, disclaimers in the FDD  that information in a pro forma should not be treated as franchisee’s actual results could preclude a franchisee from establishing reasonable reliance on the projections made.[18] Franchisors can therefore evade liability if they have warned of enclosed inconsistencies.

Conclusion

In assessing a franchisor’s liability in this scenario, we must look closely at the terms of the franchisor’s and franchisee’s contractual agreement. A franchisee’s claims will not be actionable if the projected figures are merely predictions, and not prefaced by some historical data or fact. However, even if such claims are considered actionable, cautionary language referencing the disclosures could impede a franchisee’s recovery.

We will continue this discussion in regards to shared territory liability on our next blog.

 

For assistance with purchasing a franchise or other franchise legal issues, please contact Kenneth S. McLaughlin, Jr. at 630-230-8434.

[1] 815 Ill. Comp. Stat. 705/2.

[2] Id.

[3] See id. at § 5; see also Ill. Attorney General, Franchise Information and Publications, http://www.illinoisattorneygeneral.gov/consumers/franchise.html.

[4] 815 Ill. Comp. Stat. 705/6.

[5] Id. at § 14.

[6] Id. at § 16.

[7] Id. at § 22–23.

[8] Id. at § 24–25.

[9] Id. at § 26; Prosecution and civil claims are subject to the statute of limitations provided in the Act.

[10] See West Coast Video Enterprises v. De Leon, No. 90 C 1236, 1991 U.S. Dist. LEXIS 4209, at *2 (N.D. Ill. 1991) (plaintiffs allege that defendants fraudulently induced them to enter into a franchise agreement by misrepresenting estimated franchise costs and expected earnings).

[11] Avon Hardware Co. v. Ace Hardware Corp., 998 N.E.2d 1281, 1288 (Ill. App. 2013).

[12] See Barrington Press, Inc. v. Morey, 752 F.2d 307, 310 (7th Cir. 1985).

[13] Id.; see also Bixby’s Food Systems v. McKay, 193 F. Supp. 2d 1053, 1062 (N.D. Ill. 2002) (“The McKays have not shown that, contrary to the general rule, Miyamoto’s statements about future events, costs, and profitability are actionable misrepresentations under the IFDA, so summary judgment cannot be granted based upon those statements.”).

[14] Avon, 998 N.E.2d at 1288 (citing Mother Earth, Ltd. v. Strawberry Camel, Ltd., 390 N.E.2d 393 (1979)).

[15] Avon, 998 N.E.2d at 1288.

[16]  Id. at 1289.

[17] Id. at 1288.

[18] To state a cause of action for common-law fraud, a plaintiff must plead: (1) a false statement of material fact; (2) knowledge or belief by the defendant that the statement was false; (3) an intention to induce the plaintiff to act; (4) reasonable reliance upon the truth of the statement by the plaintiff; and (5) damage to the plaintiff resulting from this reliance. Id. at 1287.

Written by:  Kenneth S. McLaughlin, Jr., Attorney at Law

NOTE: This publication should not be regarded as legal advice or legal opinion. The content is intended for general informational purposes only. If you have any concerns regarding anything in this publication you may contact your own attorney, CPA, or our law office at 630-230-8434, website www.ma-lawpc.com.

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