As I discussed in a former blog, the crucial document in any franchise operation is the uniform franchise disclosure document, or FDD. The first thing to determine in inspecting the FDDs is whether the franchisor has properly registered its offering circular when and where required and whether either state officials or franchisees have instituted disciplinary or legal action against the franchisor. If the latter is the case, the inspection of FDDs will sometimes turn up only a cursory reference to the same, making it necessary to track down and inspect other records – for example, court filings and regulatory records – to obtain a full description of any problems or deficiencies.

As is often the case in any due diligence effort, the lawyer must exercise judgment in assessing any problems uncovered in the record. What was the nature of the complaint? How did the franchisor respond? In the case of either regulatory action or litigation, was the underlying problem serious? Minor? Intentional? The result of clerical error? Was it an isolated incident or part of a pattern of behavior?

The lawyer should also inspect a certain number of franchise agreements actually signed and in use by the franchisor and its franchisees in each state in which the franchisor operates, to ensure that their terms match up with those in the standard agreement contained in the FDD. The caution here is that some franchisors enter into special agreements with specific franchisees – for example by offering them territorial or expansion rights not offered to others – and it is important to identify such arrangements before the closing of the purchase because the buyer of a franchise company generally takes on all of the obligations of the franchisor.

Put another way, the goal in inspecting a certain number of franchise agreements actually in use is to determine whether the contractual relationships between the franchisor and its franchisees are consistent throughout the system and, if not, to dig up enough information for the buyer of the franchise company to assess what impact any differences could have on its value. Indeed, since two important keys to the value of a franchise company are the uniformity and predictability inherent in consistent business practices of both franchisor and its franchisees, any deviations from the norm may have a substantial impact.


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