Franchisor 101: Can’t Break the Broker

Lewitt Hackman

A Minnesota federal court ruled in favor of a franchise broker on summary judgment. The court dismissed misrepresentation claims brought by a military veteran who alleged unlawful inducement to invest in a failed kickboxing business. The court held that only one of the many claimed pre-sale statements was a material statement of fact. The other statements were mere puffery or predictions of future events. The one actionable statement – that none of the franchisor’s outlets had closed – could not have reasonably been relied on in deciding to buy the franchise.

The broker, FranChoice, sold a franchise for the (ILKB) franchise system. Of many statements the franchisee claimed were false, the trial court focused on the following as alleged statements of past or present fact: (i) ILKB franchises were suitable for absentee ownership, (ii) other ILKB franchisees made $10,000 to $20,000 in monthly profits, (iii) no ILKB franchises were struggling, (iv) ILKB locations broke-even before their grand openings, and (v) ILKB handled all marketing. The court observed that the franchisee offered no evidence that any of these representations were false when made.

Regarding alleged misrepresentations that (i) start-up costs would be no more than $275,000, (ii) the franchisee should expect to make $10,000 to $20,000 in monthly profits, and (iii) only 200 members were needed for the kickboxing center to break-even, the court held such statements were merely predictions of future events. The franchisee failed to show they were not reflective of past or present circumstances when made.

The only actionable misrepresentation was FranChoice’s statement that no ILKB outlets ever closed. This statement was found to be untrue. But the court was persuaded by evidence that FranChoice emphasized to the franchisee to conduct his own investigation. FranChoice pointed to the FDD, which listed 12 franchises that closed, and contact information for the former owners. The court noted the franchisee was a West Point graduate with an MBA and determined he could not have justifiably relied on an erroneous statement that was directly contradicted by the FDD.

The franchisee asserted false statements on FranChoice’s website. These included representations that (i) FranChoice takes rigorous pre-screening measures to present only strong, stable, high quality opportunities, (ii) FranChoice consultants are “experts” who “truly understand” their franchise companies, and (iii) FranChoice provides all the information potential franchisees need to “find the opportunity that fits their goals.” The franchisee challenged FranChoice’s assertions that it vets litigation, failures, and owner satisfaction of the franchises it sells. But these were outside the scope of the alleged false statements in the pleadings. And even if the court were to consider such statements, the court viewed the website representations as puffery. As an evidentiary matter, the court found FranChoice did review ILKB’s FDD, directed the prospective franchisee to review it and provided sample questions to ask.

Franchise brokers can be instrumental in helping start-up franchise systems take flight and existing ones stay present in the franchise marketplace. Brokers can also mire a franchisor in bad publicity and litigation if not carefully selected or if the brokers do not operate with care. Franchisors that outsource franchise sales should consider a potential broker’s experience, reputation and wherewithal to defend and protect themselves and the franchisor they represent, should rescission or misrepresentation claims arise out of the pre-sale experience.

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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Lewitt Hackman

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