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What Item 3 Can Reveal about a Franchisor

 

Item 3 of the Franchise Disclosure Document, or FDD, requires franchisors to reveal whether or not the franchise, any of its affiliates or any of the people listed in Item 2 of the FDD are involved in any pending, current and/or prior lawsuits involving certain types of litigation that affect the franchise relationship, including any material civil actions initiated by the franchisor against franchisees. Material civil actions, for purposes of the new Franchise Rule, are defined as a civil action that is likely to influence a prospective franchisee’s decision to invest in the franchise.  When reviewing the FDD, if there are any lawsuits listed in Item 3, it is important to look into the suits to determine the circumstances and the “who, what, when, where, and why” of the case, so to speak.  You should be cautious of any litigation involving the franchisor as a defendant because it could be a signal of larger issues with the franchisor’s system or operations.

If there are not any lawsuits listed in Item 3, this is a good thing but that does not necessarily mean the franchisor has never been involved in any lawsuits because the franchisor only has to disclose its involvement in certain types of legal actions within the last ten years from the issuance date of the FDD.  Also, the franchisor only has to disclose material franchisor-initiated lawsuits against franchisees that have been filed over the course of the last fiscal year.  Therefore, even if there are no suits listed in Item 3, you should ask the franchisor whether it has been involved in any litigation over the course of the franchise and whether the franchisor has ever initiated a lawsuit against any of its franchisees and the reasons why.  Item 3 provides valuable information for prospective franchisees, gives insight into the legal foundation and strategies of a franchisor, and should be considered when deciding whether or not to invest in a franchise.

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