In deciding to make a purchase of a franchise, any potential franchisee wants to understand the potential sales volume and return on investment the franchise can expect to earn. Franchisors selling franchises also know providing historical financial performance measures can be an important factor in a franchisee’s final purchasing decision. Franchisees wanting to rely on these statistics probably want to include them in the final franchise agreement. Franchisors looking to avoid any potential liability related to these statistics must be careful to keep them out of the final franchise agreement. What about a franchisor that made oral financial performance representations prior to a final franchise agreement?
The Georgia Supreme Court recently said, in Legacy Academy, Inc. v. Mamilove, that a franchisor can discharge liability associated with pre-contractual oral financial representations through a franchise agreement’s final merger clause. In Mamilove, two franchise owners sued a daycare franchisor, Legacy Academy, for rescission of a franchise agreement ten years after signing it. Mamilove’s owners alleged fraud, negligent misrepresentation, and violation of Georgia’s Racketeer Influence and Corrupt Organizations Act. The court dismissed all Mamilove’s allegations and emphasized that Mamilove’s owners never even read the final franchise agreement. Had the owners taken the time to read the franchise agreement, the court reasoned the owners would have seen the merger clause nullifying all pre-contractual negotiations.
Suits like these can arise when a franchise does not live up to its owners’ economic expectations. In Mamilove, the daycare center lost $212,300 in its first year, with net earnings peaking at $103,692 in 2004, and net earnings dropping to $28,299 in 2009. Legacy Academy representatives, in turn, made oral statements to Mamilove’s owners to the effect that they could expect to make between $260,000 and $460,000 of net income for the franchise’s first two years of operation.
Bottom Line: While the Georgia Supreme Court in this instance concluded that the franchisor’s pre-contract, oral financial performance representations were nullified due to the merger clause in the final agreement, that won’t always be the case. As our own Liz Sigety noted in her excellent series on financial performance representations here on this blog, franchisors need to be careful to follow the law in the states in which they operate.
Special thanks to our summer associate David Magagna who provided great assistance in writing this post.