FRANCHISEE 101: Rocky Road to FDD Disclosure

Lewitt Hackman

An ice cream parlor franchisor in Ohio, Handel Enterprises, Inc., must defend claims that it violated the California Franchise Investment Law (CFIL) for failing to disclose its amended franchise disclosure document (FDD) to a franchisee, who signed a franchise agreement that was part of an outdated FDD, and paid the franchisor an initial franchise fee at that time.

In a meeting in October 2015, Handel’s provided the potential franchisee with its FDD that was registered in California with an effective date of April 13, 2015. In December 2015, the franchisee paid Handel’s a $5,000 deposit toward the initial franchise fee. On January 21, 2016, the parties entered into a franchise agreement granting a franchise for Encinitas, California. Ten days earlier, Handel’s applied to the California Department of Business Oversight (DBO) to amend the same FDD that was previously disclosed to the franchisee in October 2015. That same October 2015 FDD was disclosed to the franchisee again on January 21st. The franchisee alleged that Handel’s amended FDD was approved on January 19, 2016 – the same day that the franchisee wired Handel’s the balance of the franchise fee for the Encinitas location – and two days before signing the franchise agreement. The amended FDD was not shown to the franchisee prior to signing the agreement.

The franchisee alleged that the franchisor broke the law by continuing to offer and sell franchises while its application for amendment was pending, and failed to comply with an exemption for pending applications. The CFIL says a franchisor must promptly notify the DBO by applying to amend the registration of any material changes in the disclosure.

Handel’s argued that changes in the amended FDD were not material because the DBO accepted Handel’s amendment. The trial court rejected this argument, finding that the CFIL puts the duty on the franchisor, not the DBO, to determine if new information is material. Because Handel’s received a deposit in December 2015, and applied for an amendment on January 11, 2016, it was required to comply with the exemption if it wanted the offer to continue while the amendment application was pending.

The court also found that the franchisee plausibly pled a violation of the CFIL by Handel’s failure to provide a copy of the amended FDD and failing to delay signing of the franchise agreement or payment of consideration 14 days after receipt of an effective FDD. Handel’s disclosure obligations, the court found, were not satisfied by disclosure of the FDD in October 2015 because Handel’s applied for amendment on January 11, 2016, acknowledging there were material changes.

A franchisor that amends its FDD while offers are pending, should make sure the DBO’s registration is effective as to the particular agreement to be signed. Failure to stay in regular contact with the DBO while an amendment is pending could result in serious consequences to franchisors if a franchisee signs an outdated franchise agreement.

For details, click: Handel’s Enterprises, Inc. v. Schulenburg, No. 4:18CV508, 2018 WL 3077756 (N.D. Ohio June 22, 2018)

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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