The Franchise disclosure document (FDD) is designed to give potential franchisees a clear view of the business they may be entering. In this document, franchisors must disclose the rights and responsibilities of a franchisee, the obligations of a franchisor, and other items that give a franchisee a fair understanding of the business.

Item 3 of the FDD requires disclosure of certain legal disputes involving a franchisor or its predecessors, affiliates, parents, or persons disclosed in item 2.  The legal disputes franchisors are required to disclose include formal lawsuits, arbitrations, and settlement agreements.

The legal disputes subject to disclosure under item 3 are often best identified by considering whose legal disputes must be disclosed, and what types of legal disputes must be disclosed. Franchising a business is difficult and FDDs are complex pieces of writing, but by working with a dedicated franchise attorney, a business owner may be able to fully understand what litigation must be listed in item 3 of the franchise disclosure document in North Carolina.

Parties That Must Disclose Litigation

Legal disputes involving the franchisor or their predecessor must always be disclosed to franchisees. In cases where there is a legal dispute involving a franchisor’s parent or affiliate, the legal action only must be disclosed if the entity promises to financially back the franchisor or otherwise guarantees the performance of a contractual obligation.

If a franchisor’s affiliate sells franchises under the franchisor’s principle trademark or has offered or sold franchises in any line of business within the last ten years, then legal disputes involving that affiliate must be disclosed.  A legal dispute involving a person listed in item 2 must be disclosed only if the person is named as formal party to the dispute.

What Types of Litigation Must be Disclosed?

There are four categories of legal disputes that must be disclosed by the franchisor and its predecessors:

  1. Pending criminal, administrative, or civil actions involving violations of securities, franchise, or trade practices. Also, any ongoing allegations of fraud, deception, or unfair trade practices must be declared.
  2. Prior criminal, administrative, or civil actions involving allegations of fraud, deception, or unfair trade practices.
  3. Civil actions involving the franchise relationship.
  4. Currently effective injunctive or restrictive orders (court orders) brought by a government agency.

For purposes of item 3, the franchisor and its predecessors are collectively referred to as the Franchisor. Any involvement in a pending civil action that is not routine or incidental to the franchisor’s business must be fully disclosed as it may influence the decision making of a prospective franchisee.

Regarding past involvement in criminal or civil litigation, franchisors must disclose any felony charges that resulted in a plea or conviction, and any civil action in which a franchisor is held liable for violation of a franchise, antitrust, or securities law, or involving allegations of fraud, unfair or deceptive practices, or comparable allegations. If a civil action in this category results in a settlement agreement, then all material terms of that agreement must be disclosed.  The material terms of a confidential settlement agreement must be also be disclosed, unless it was entered into before the franchisor began the process of selling their franchise. Additionally, a new franchisor or any franchisor that has historically used only the original Franchise Rule format set out at 16 C.F.R. Part 436 does not need to disclose confidential settlements entered prior to the effective date of the amended Rule.

Franchisors must also disclose any franchisor-initiated actions or civil actions filed during the current fiscal year that involve contractual disputes between the franchisor and the franchisee. The Franchisor does not need to disclose legal disputes between the Franchisor and third parties such as a vendor or legal disputes brought by the franchisor against a franchisee for indemnification of tort liability.  Further, a franchisor does not need to disclose a franchisor-franchisee legal dispute based upon a franchise agreement for a non-traditional outlet if that specific agreement and any suit to enforce it are not likely to influence the sale of traditional franchises under the franchisor’s standard franchise agreement.

Court Order Disclosure for Franchisors

Franchisors must disclose whether they or their business are currently subject to a court order resulting from a pending or prior action leveled by a governmental agency, such as the FTC, SEC, or state Attorney General.  The action may be brought under a federal, state, Canadian franchise, securities, antitrust, trade, or other relevant regulation.  Franchisors have no obligation to disclose any court order that has expired or has been vacated or rescinded by the court or issuing agency.  The Franchisor does not need to disclose court orders that they have complied with.

However, a court order dictating a Franchisor to act or to refrain from acting is not considered to be complied with until the order expires by its own terms.  Unfortunately, most FTC injunctive orders do not contain an expiration date and will likely need to be disclosed perpetually.

Let a Local Attorney Help You Disclose Necessary Litigation

Franchisors should disclose full case citations and summaries of legal disputes that are required to be disclosed under item 3 of a franchise disclosure document. Failure to disclose all relevant legal information could result in further legal penalties. Many franchisors are unclear about what litigation must be listed in item 3 of the franchise disclosure document in North Carolina. A dedicated and experienced attorney may be able to help you disclose all relevant information to ensure legal compliance. Call today to get started.

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