Last June we blogged about a lawsuit that ended favorably for a franchisor. In Braatz, LLC v. Red Mango FC, LLC, the trial court determined that a franchisor did not violate Wisconsin’s “14-day Rule”, which requires franchisors to provide an “offering circular” (aka FDD) to prospects 14 days before selling a franchise. 3:14-CV-4516-G (N.D. Tex. Apr. 27, 2015).
The franchisees appealed to the 5th Circuit, and that court recently decided again in favor of the franchisors, but under a different rationale. See Braatz, LLC v. Red Mango FC, LLC, No. 15-10498 (5th Cir. Mar. 30, 2016).
In Braatz, potential franchisees inquired about purchasing a Red Mango franchise, and they received a business plan and financial projections. The next day, they received Red Mango’s offering circular; however, it did not contain the business plan or financial projections.
The prospects decided to purchase the franchise, and in late December 2011 (over a month after receiving the offering circular) they returned a signed franchise agreement and check to Red Mango. The franchise agreement included a questionnaire, in which the franchisees were asked whether Red Mango had given them financial information that was not in the offering circular. The franchisees answered “yes” based on the business plan and financial projections.
Sometime between January 6 and 16, 2011, Red Mango mailed a blank copy of the same questionnaire to the franchisees. Red Mango told the franchisees that they must change their answer or they could not open a franchise. They changed their answer and returned the questionnaire sometime before January 16. Importantly, this portion of the transaction took place in less than 14 days.
In 2014, the franchisees’ franchise closed and they declared bankruptcy. Shortly thereafter, the plaintiffs filed a suit against Red Mango, alleging that Red Mango’s failure to provide them with 14 days to consider the revised questionnaire was a violation of the Wisconsin Franchise Investment Law (“WFIL”). The plaintiffs sought to rescind the franchise agreement.
Because the trial court determined that the violation was not material to the franchisee’s decision to purchase the franchise–as required by WFIL–it held in favor of Red Mango. The appellate court also exonerated Red Mango, but under a different rationale. It noted that the 14-Day Rule requires franchisors to provide the “offering circular” to prospects 14 days in advance of selling a franchise. The court clarified what “offering circular” means under the WFIL:
The phrase ‘offering circular’ specifically refers to disclosure documents filed with the state when a franchisor registers. . . . The rule does not, for example, entitle a franchisee to 14 days to consider ‘any new information’ about the franchise agreement.
The court held that Red Mango complied with the 14-Day Rule when it provided the offering circular to the franchisees at least 14 days prior to selling the franchise. The 14-Day Rule did not (as the franchisee’s argued) require Red Mango to give them another 14 days to consider the change to the questionnaire.
In Braatz, the claims against Red Mango were defeated twice in two courts and under two different legal rationales. But a strong legal defense comes at a cost to a franchisor’s bottom line. Of course, it’s not possible to avoid a lawsuit every time. But strict compliance with federal and state disclosure laws and robust sales team training and communication provides the best defense against a lawsuit being filed in the first place.