How Can a Franchise Owner Get Out of An Agreement?
Q: My brother bought a pizza franchise two years ago and it hasn’t worked out. He’s losing money every month, and he can’t even afford to pay himself a salary. He’d love to sell the franchise but nobody will buy it. Now he’s behind in his payments to the franchiser, and they’re threatening to shut him down. He invested about $200,000 in the business, but if he shuts down he’d only be able to get about $25,000 for the equipment. The franchiser has offered to buy him out for $35,000, and will probably run the store until it can be sold to somebody new. Is the franchisor allowed to do that?
A: In short, yes. This sort of thing happens frequently, and not only in franchise businesses, but franchise contracts are typically written to favor the franchiser. Franchisers usually control many basic issues that affect their franchises, such as where to advertise, what products to offer, and what promotions to run. People buy franchises because they expect to benefit from the franchiser’s established business model and name recognition. When a franchised business fails, the business owner may feel cheated even if the franchiser has not violated the franchise contract.
Q: So is there anything my brother can do so he can avoid filing for bankruptcy?
A: There is one possibility worth exploring. When your brother bought the franchise, he should have received a disclosure document, usually called an FDD. Franchisers must give these documents to franchise buyers at least 14 days before they commit to the purchase. The disclosure document must comply with many complicated rules, and franchisers often make mistakes. For example, the rules require franchisers to estimate various costs related to their investment, to list previous lawsuits and bankruptcies related to the franchiser, and to include current financial statements for the franchiser, which typically must be audited. Franchisers are not required to include earnings or sales projections, but if they do include these, they must be able to support the projections.
If the franchiser gave your brother a disclosure document that violated the disclosure rules, he may have the right to file a lawsuit or bring an arbitration action, which could force the franchiser to give him back his money, and maybe even to reimburse him for his past business losses. If your brother decides to file such a claim, he should do so within three years from the time he purchased the franchise. He should consult with a franchise lawyer to determine if this is an option.
This “Law You Can Use” column was provided by the Ohio State Bar Association (OSBA). It was prepared by Stanley M. Dub, a Cleveland-area attorney who focuses on franchise law.