Garner, Ginsburg & Johnsen, P.A. Law Offices

What is Franchisor Fraud? When Are Misleading Statements Actually Fraudulent?

Let’s take a look at some advertising language that franchisors use to entice potential franchise buyers.  After all, these advertisements are often the sole reason a prospective franchisee reaches out to a franchisor in the first place.

• “Own your own business by owning a franchise.”
• “We want to share our successful franchise opportunity with a very select few who want to achieve more for themselves and their families.”
• “This will reap you great rewards! Get the income you have always wanted and live the lifestyle you deserve. Create wealth and business equity to retire on your own terms!”
• “I have the desire to own my own business!”
• “Aspire to something better, succeed, and control your career.”
• “Start growing your own business in a rapidly expanding market.”
• “Unparalleled support.”
• “Franchise support every step of the way.”

Prospective franchisees often take these advertisements literally, only to find out that such statements are not binding on the franchisor and are not necessarily unlawful misrepresentations even if they turn out to be false.  Upon learning this, franchisees often respond as follows: “But no court would say it’s OK to lie to a prospective franchisee, and the franchisor was unfair in representing the business this way.”  First, while such advertisements are often unfair in the sense that they oversell the system, they are often not unlawful.  Second, courts frequently allow overstatements in advertising on the grounds that such representations constitute “mere puffery.”

In order for a statement to be truly fraudulent in the legal sense, generally speaking, it must be a statement of present or past material fact that is false.  (One exception to this rule is that in some cases, a statement about future performance can be fraudulent where it does not accurately reflect past or present circumstances.)  The distinction between false statements of fact and puffery, however, is not always clear.  Puffing is defined as “the expression of an exaggerated opinion—as opposed to a factual misrepresentation—with the intent to sell a good or service.”  Black’s Law Dictionary 1269 (8th ed. 2004).

Let’s take a look at the above advertisements viewed in this context.

• Whether or not franchisees own their own business is a matter of opinion or at least a matter of interpretation. On one hand, a franchisee does not actually own his or her own business because the franchise agreement can be terminated or expire, in which case, the franchisee may not have any right to the equity he or she built in the business.  On the other hand, because franchisees can build equity in a franchise and sell the business as a franchise, there is an argument to be made that franchisees do own their franchise businesses.
• A franchisor that advertises the “great rewards” a prospective franchisee will obtain is closer to the line separating fraud and puffery, depending on the circumstances. While we would argue that if most franchisees are not profitable or earning a decent living at the time the statement is made, it should constitute fraud, franchisors will argue that this statement is no different from saying that the franchise offers an excellent opportunity, which would likely be “mere puffery.”  Compare In re Shopko Securities Litigation, 2002 WL 32003318 (E.D. Wis. 2002) (holding that statements and predictions of success are mere puffery) with Gross v. GFI Group, Inc., 162 F. Supp. 3d 263 (S.D. N.Y. 2016) (holding that a statement that a merger was a “singular and unique opportunity to optimize value” was not mere puffery).
• Franchisors advertising “support every step of the way” are likely not making fraudulent statements even if the franchisor does not actually provide such support in practice. How can they do that?  First, it is not a statement of something that is verifiable by reference to past or present facts – it is more like a promise to do something in the future.  The problem here, however, is that when a prospective franchisee signs a franchise agreement, the only terms that bind the franchisor are in the written agreement, and the franchisee, by signing the agreement, disclaims any statements or representations not included in the franchise disclosure document or franchise agreement.

The distinction between fraudulent statements and puffery is not the only difficulty in bringing fraud claims against franchisors.  Regardless, franchisees that are induced to purchase a franchise by means of misleading advertisements may be able to successfully assert a claim for fraud.  In the case of an advertisement, for example, touting the likelihood of significant returns could be fraudulent if the franchisee can show that most franchisees in the system were failing or not profitable at the time the representation was made.

Franchisees asserting fraud claims have an uphill battle for the reasons set forth above (as well as other reasons not discussed here), but with strong franchise counsel, it is not always an insurmountable hill. Whether you’re franchise owner or a franchisee, you do have rights and you do have options. When you need a franchise lawyer on your side, contact Garner, Ginsburg & Johnsen!