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Understanding Item 3 of the Franchise Disclosure Document: Litigation History

While Item 3 allows prospective franchisees to dig into a brand’s legal past, it’s up to them to take the disclosed information and do their homework to differentiate baseless allegations from possible patterns.

By Cassidy McAloonSenior Writer
10:10AM 07/13/17

When it comes to determining which business ownership opportunity is the right one for you, there are no shortage of factors designed to help you make the best possible choice. But the Franchise Disclosure Document—or FDD—is one of the most valuable tools at your disposal.

Every brand’s FDD contains 23 categories that are designed to break down their franchise concepts. And Item 3, the section highlighting a brand’s litigation history, is not one that prospective candidates want to ignore. By highlighting the current legal battles that a brand is currently facing, aspiring local owners have the opportunity to see any potential problems that could arise with a concept down the road. However, it’s important for potential franchisees to take context into consideration when examining a brand’s legal history.

“The litigation history of a brand can be very telling about a franchise system. But it’s not always a bad thing. That’s why it’s important for prospective franchisees to have a full understanding of the type of litigation that a brand has been engaged in,” said Amy Cheng, founding partner of Cheng Cohen LLC. “Some systems are willing to spend money on litigation to ensure that their franchisees are complying with their system’s standards. Others have been sued by their franchisees. Those are two different scenarios, and it’s important to be able to separate the two from one another to determine what they could mean for the brand down the line.”

For example, it’s possible for franchisors to be facing baseless allegations from their existing or former franchisees. That’s not something that should block a candidate from moving forward with a brand, highlighting why it’s essential for prospective owners to do their research on the surrounding factors of a specific legal case.

“Baseless allegations are made against franchisors all the time. That’s not to say that all allegations are without merit, but it does mean that candidates need to do their due diligence to figure out what’s real versus what’s an anomaly,” said Cohen. “For example, if a franchisor was sued by one of their franchisees for not providing an adequate amount of support, a candidate should talk to other owners in the system to see if there are other franchisees who feel the same way.”

Ardag Tachian, director of franchise recruitment at Hungry Howie’s Pizza, agrees. He notes that it’s critical for candidates to thoroughly review a brand’s Item 3 to see if there are any legal patterns that would possibly be a red flag.

“Item 3 of the FDD is extremely important because it highlights any litigation that may be current with a franchisor. Sometimes litigation is just the cost of doing business and may be unavoidable. But it would behoove a would-be franchisee to look into a brand’s history to see if there is any sort of pattern that they can draw from,” said Tachian.

Ultimately, Item 3 of FDDs are designed to provide an overview of a brand’s litigation history—they don’t serve as a comprehensive list detailing every case that’s ever been made by or against a concept. That’s why when going through the due diligence process, you should use Item 3 as a starting point to dig deeper into a brand’s full legal presence.

“At the end of the day, Item 3 of the FDD provides prospective franchisees with an overview of a brand’s specific litigation history. But it isn’t enough for candidates to limit their knowledge on the topic to what’s disclosed,” said Cohen. “Item 3 is meant to give franchisees a heads up about the type of litigation involved with a specific brand. It’s then up to prospective owners to use that information to do their own homework.”