Disclosure Document and forecasting in franchising: the risks of incomplete or unrealistic information

Before signing a franchise agreement, the candidate must be able to assess the strength of the network, the characteristics of the market, the amount of investment and the economic prospects of their future point of sale.

The pre-contractual information document, more commonly known as the DIP, plays a crucial role in this regard. It must provide the prospective franchisee with accurate information enabling them to make an informed decision.

The franchisor is not legally obligated to guarantee the profitability of the business or even to provide projected revenue figures. However, when providing a business plan, projected profit and loss statement, or revenue targets, the data presented must be reliable, consistent, and verifiable.

An incomplete pre-contractual information document (DIP) combined with a clearly unrealistic business plan can invalidate the franchisee's consent and expose the franchisor to liability. In the most serious cases, the franchise agreement can be annulled for error or fraud.

What is a Disclosure Document (DIP) in franchising?

The pre-contractual information document is a file that the franchisor must provide to the candidate before the signing of the franchise contract when the conditions provided for in Article L. 330-3 of the Commercial Code are met.

This obligation applies to the person who makes available to another:

• a trade name;
• a brand;
• a sign;
• or another sign of customer loyalty,

while requiring a commitment of exclusivity or near-exclusivity for the exercise of the activity.

The Disclosure Document (DIP) does not constitute the franchise agreement. It is issued prior to its signing and must allow the candidate to evaluate the network, the project and the commitments that will be required of them.

ArticleL. 330-3 of the Commercial Code requires that the information provided be truthful and allow the other party to make an informed commitment.

When must the pre-contractual information document (DIP) be given to the prospective franchisee?

The pre-contractual information document (DIP) and the draft contract must be submitted at least twenty days in advance:

• the signing of the franchise agreement;
• or the payment of any sum required before the conclusion of the contract.

This twenty-day period should constitute a genuine reflection period. The candidate must be able to read the documents, request explanations, meet with franchisees in the network, conduct their own research, and have the project analyzed by their advisors.

It is therefore not enough to backdate an acknowledgement of receipt or to have a formal acknowledgment signed. The franchisor must be able to establish:

• the actual delivery date;
• the identity of the recipient;
• the exact content of the document transmitted;
• the version of the draft contract attached to the DIP.

Electronic submission is possible, provided that there is a process in place to prove the date of transmission, the identity of the candidate and the integrity of the document.

What should the pre-contractual information document contain?

The content of the DIP is specified by articleR. 330-1 of the Commercial Code.

The document must include information relating to the following elements.

The franchisor's identity and experience

The candidate must be able to precisely identify their future contracting party and know their professional experience.

The public information document must include, in particular:

• the company's identity;
• its legal form;
• its share capital;
• the address of its headquarters;
• its registration number;
• the identity of its leaders;
• its main activities;
• his experience in the relevant sector.

The brand and its distinctive features

The franchisor must provide information enabling verification of the rights it holds over the proposed trademark or brand.

The candidate must, in particular, be able to appreciate:

• the identity of the trademark holder;
• the existence of its recording;
• the duration of the rights granted;
• where applicable, the nature of the license authorizing the franchisor to operate it.

The franchisor's accounts and economic situation

The DIP must contain the financial information required by the regulations, in order to allow the candidate to assess the situation of the company that runs the network.

However, this data alone does not provide information on the profitability of the future point of sale.

The history and current state of the franchise network

The candidate must be able to understand how the network was formed and how it evolves.

The DIP must, in particular, allow him to identify:

• companies belonging to the network;
• their method of operation;
• establishments located in the planned activity zone;
• franchisees who left the network under the conditions stipulated by the regulations;
• any significant changes in the composition of the network.

A purely commercial presentation, limited to the total number of locations and recent openings, is not sufficient if it conceals significant departures, closures or difficulties whose communication is legally required or decisive for the candidate.

The general and local state of the market

The DIP must present the general state of the market for the products or services concerned, as well as its development prospects.

It must also include a presentation of the local market situation.

This obligation does not necessarily mean that the franchisor must conduct a full local study on behalf of the candidate. Case law generally distinguishes between:

• the presentation of the local market, which falls under the franchisor's obligation;
• the detailed market study of the project, which normally falls under the due diligence of the prospective franchisee.

The presentation provided must nevertheless be truthful, up-to-date, and sufficiently relevant. A few national or regional data points without a clear connection to the area of ​​operation may prove insufficient.

The essential conditions of the future contract

The candidate must be informed in particular of:

• the duration of the contract;
• of its renewal conditions;
• termination conditions;
• terms of transfer;
• from the field of exclusives;
• investments specific to the brand or retailer;
• entry fees and royalties;
• of the main obligations to which it will be subject.

To complement this analysis, our article Franchise Restaurant: 9 Mistakes to Avoid Before Starting Out lists the essential checks before signing.

Does an incomplete pre-contractual information document automatically render the contract void?

No. An irregularity in the pre-contractual information document does not automatically lead to the cancellation of the franchise agreement.

The franchisee must establish that the missing, inaccurate or misleading information affected their consent.

In particular, he must demonstrate:

• that the information concerned a determining element of his commitment;
• that he would not have entered into the contract, or would have entered into it under different conditions, if he had been properly informed;
• that his error was sufficiently clear;
• or that the franchisor deliberately concealed crucial information.

The judge therefore examines in concrete terms the content of the DIP, the importance of the omitted information, the candidate's experience, his own due diligence and the circumstances in which the contract was signed.

A simple formal imperfection or missing secondary information is not necessarily sufficient.

On the other hand, the absence of important information on the state of the network, local competition, necessary investments or economic difficulties encountered by comparable units can contribute to characterizing a vitiation of consent.

Is the franchisor required to provide a financial forecast?

No text requires the franchisor to establish the candidate's business plan or projected profit and loss statement.

The franchisee is an independent entrepreneur. It is generally their responsibility to develop their own financial forecast, taking into account:

• of the chosen location;
• of the catchment area;
• rent and charges;
• the cost of the work;
• staffing needs;
• prices charged;
• of the margin rate;
• fees due to the network;
• of its financing;
• of its working capital requirements;
• of the seasonality of the activity;
• from local competition.

Ideally, the candidate should have their forecast prepared or verified by a chartered accountant who is familiar with the sector of activity and has all the necessary data.

The franchisor can nevertheless provide economic data from the network's experience: average turnover, average basket size, foot traffic, payroll ratio, gross margin or average time to break even.

He can also submit a forecast template or participate in the development of the business plan. When he does so, the data provided must be accurate and based on sound information.

What obligations are imposed on a franchisor who submits a financial forecast?

When a franchisor decides to provide a projected revenue or operating statement, it cannot communicate arbitrary or excessively optimistic figures.

The assumptions must be:

• sincere;
• reasonable;
• consistent with the project's characteristics;
• adapted to the installation area;
• established using sufficiently recent data;
• comparable to the results of units with similar characteristics;
• accompanied by explanations of their calculation method.

The franchisor must be able to justify the main assumptions made.

It is particularly important to document:

• the points of sale used as references;
• their seniority;
• their surface;
• their location;
• their method of operation;
• the level of investment;
• the differences between a pilot branch and a franchised unit;
• the charges taken into account;
• the effects of the ramp-up of activity;
• the identified risks.

A forecast is obviously never a guarantee of results. A discrepancy between the figures announced and the results achieved is therefore not, in itself, sufficient to establish fault.

On the other hand, a massive and lasting discrepancy may reveal that the initial assumptions were unrealistic, especially when no mismanagement by the franchisee or exceptional external event can explain it.

Does the phrase "non-contractual document" protect the franchisor?

Forecasts frequently include a statement that:

• the data is purely indicative;
• the document is not contractual;
• No revenue figures are guaranteed;
• the candidate must establish their own projections;
• The result depends on his personal management.

These precautions are useful, but they do not allow for the communication of false or manifestly unrealistic information.

The classification as a "non-contractual document" does not eliminate the obligation of good faith or the requirement of sincerity in pre-contractual information.

Similarly, a clause by which the candidate acknowledges having carried out their own checks does not necessarily neutralize the consequences of misleading information provided by the franchisor.

A distinction must be made:

• the legitimate absence of any guarantee regarding future results;
• and the faulty communication of data that the franchisor knew, or should have known, was unrealistic.

Does the experience of the prospective franchisee exonerate the franchisor?

The candidate's professional experience is taken into consideration when assessing their consent and the due diligence they could reasonably have undertaken.

A former manager, an industry professional, or a candidate already operating several points of sale normally has a superior analytical capacity to that of a novice entrepreneur.

However, this experience does not exempt the franchisor from providing the truthful information required by law.

An experienced candidate cannot always reconstruct the following on their own:

• the actual results of the other units;
• the number and causes of departures from the network;
• the performance of the pilot establishments;
• the internal difficulties of the concept;
• the assumptions used to construct the forecasts;
• local information held by the franchisor.

Fraudulent concealment or the communication of deliberately misleading data is not necessarily excused by the competence of the franchisee.

Article1139 of the Civil Code specifies that an error resulting from fraud is always excusable.

Can an unrealistic forecast lead to the cancellation of the franchise agreement?

The contract may be cancelled when the information provided has caused a decisive error regarding the normally foreseeable profitability of the activity.

It is not enough for the franchisee to demonstrate that their business has been unprofitable. The underperformance may result from:

• of inappropriate management;
• from a lack of involvement;
• of excessive recruitment;
• of an excessively high rent;
• from a poor location chosen by the franchisee;
• due to a cash flow shortage;
• of an unpredictable market evolution;
• of an exceptional economic event.

To obtain the cancellation, the franchisee must establish that the forecasts were objectively unrealistic from the outset and that they determined his consent.

The judge may, in particular, compare:

• the figures announced;
• the results actually obtained;
• the performance of other comparable units;
• the results from the pilot establishments;
• the assumptions of the business plan;
• local market data;
• the actual level of charges;
• potential management errors.

When the franchisor has voluntarily communicated excessively optimistic figures or concealed essential information, the fraud defined byarticle 1137 of the Civil Code may be established.

Incomplete and unrealistic public policy framework: the ruling of December 1, 2021

In a judgment dated December 1, 2021, No. 18-26.572, the commercial chamber of the Court of Cassation examined the situation of a franchisee of the SoCoo'c network.

The franchisor had provided a six-page Disclosure Document, which was particularly brief. The presentation of the local market was limited to a few departmental consumption figures and did not include any sufficiently precise information on other establishments located in the geographical area.

The franchisor had also submitted a business plan including projected operating accounts for three years.

The results achieved were far from what was expected:

• a gap of more than 78% was noted during the first year;
• average discrepancies close to 49% appeared in the following years;
• no decisive management error was attributed to the franchisee;
• The franchisor did not justify the plausibility of its forecasts by the results of other comparable units.

The Court of Cassation upheld the appeal judges' finding that the erroneous information concerned a substantial element of the franchisee's commitment.

The excessively optimistic nature of the forecast, combined with the shortcomings of the public interest declaration concerning local competition and the state of the network, had caused a decisive error regarding the profitability of the activity.

The fraud charge was upheld despite the franchisee manager's professional experience in the relevant sector.

This decision does not mean that every deviation from a forecast constitutes fraud. It penalizes a combination of factors:

• grossly unrealistic forecasts;
• a considerable and persistent discrepancy with the results;
• a particularly incomplete private international law;
• the lack of economic justification for the assumptions;
• the absence of mismanagement explaining the poor performance;
• the decisive nature of this information for consent.

What sanctions does the franchisor risk?

The consequences depend on the seriousness of the breaches and their impact on the franchisee's consent.

The invalidity of the franchise agreement

If the error or fraud is established, the franchisee can request the cancellation of the contract.

In principle, the nullity of a contract entails reciprocal restitution. However, calculating this restitution can be complex when the contract has been performed for several years and the franchisee has benefited from the brand, know-how, and support of the network.

The awarding of damages

The franchisee can seek compensation for damages directly caused by the erroneous information.

Depending on the circumstances, the following may be invoked:

• lost investments;
• operating losses;
• the debt incurred;
• the costs of creation and installation;
• the loss of value of the fund;
• certain lost opportunities;
• the personal injury of the manager, when it is distinct from that of the company.

Each item must be established in its principle, its amount and its causal link with the alleged fault.

The personal responsibility of the franchisee manager

The manager may sometimes seek compensation for damages specific to him, for example when he has personally invested funds, provided a guarantee or suffered a loss of income.

However, his damages should not be confused with those of the franchisee company. The decrease in the value of his shares or the losses incurred by the company do not automatically constitute compensable personal injury.

What precautions should the franchisor take?

The franchisor can limit the risks by implementing a rigorous procedure for preparing and delivering the pre-contractual information document (DIP).

It is particularly recommended to:

1. regularly update network information;
2. check the departures, cancellations and closures that must be mentioned;
3. prepare a real and recent presentation of the local market;
4. to precisely identify the investments specific to the concept;
5. retain proof of the contents and date of delivery;
6. distinguish historical data from forecasting assumptions;
7. avoid national averages that are not adapted to the local project;
8. explain the method for calculating the forecasts;
9. present several scenarios, including a cautious scenario;
10. retain the elements that justify the assumptions;
11. clearly indicate the factors dependent on the franchisee's management;
12. avoid any promise of guaranteed profitability.

When figures are communicated, they must be able to be explained and defended several years later before an expert or a court.

What checks should the prospective franchisee carry out?

The DIP does not exempt the candidate from conducting their own investigations.

Before signing, it is advisable to:

• contact several active franchisees;
• interview former members of the network;
• check recent departures and closures;
• compare the sales figures of similar units;
• conduct a local market study;
• have the location validated;
• negotiate the commercial lease under suitable conditions;
• to build an independent forecast;
• test several revenue hypotheses;
• incorporate a sufficient working capital requirement;
• check the consistency of the rent with the expected margin;
• analyze the impact of royalties and imposed purchases;
• have the pre-contractual information document and the franchise agreement reviewed by a lawyer;
• Have the business plan reviewed by a chartered accountant.

Particular caution is advised when a project only becomes profitable in the most favorable scenario or assumes very rapid revenue growth.

How should we react when the results are far below expectations?

A discrepancy between forecasts and results should not be analyzed in isolation.

We need to search quickly for:

• if the initial data were adapted to the area;
• if the actual cost of the investments had been presented correctly;
• if the charges had been underestimated;
• if the advertised performance was comparable to that of similar units;
• if the network has experienced unreported departures or closures;
• if the promised assistance was provided;
• if the concept has evolved since the signing;
• management errors may explain part of the discrepancy.

Evidence must be retained: pre-contractual information document, versions of the forecast, emails, sales presentations, exchanges with the bank, financing files, social accounts and data transmitted by the network.

The statute of limitations should also be monitored. The starting point for the action may be subject to debate, particularly when determining when the franchisee discovered, or should have discovered, the unrealistic nature of the information provided.

What are the key takeaways?

The franchisor is not required to guarantee the franchisee's success or to build their financial forecast.

However, he must provide a sincere and complete pre-contractual information document (DIP) that meets legal requirements and is sufficiently precise to allow the candidate to make an informed decision.

If forecasts are provided, they must be based on sound, consistent, and verifiable assumptions. A statement indicating that the document is non-contractual does not permit the presentation of manifestly unrealistic figures.

For their part, candidates remain independent entrepreneurs. They must conduct their own market research, build their business plan, and verify that the project remains viable under conservative assumptions.

When an incomplete pre-contractual information document and an unrealistic forecast have determined the franchisee's consent, the franchisor's liability may be incurred and the contract may, depending on the circumstances, be cancelled for error or fraud.

ARST Avocats assists franchisors and franchisees in drafting and auditing the Disclosure Document, negotiating the franchise agreement, analyzing forecasts and handling disputes related to pre-contractual information and network profitability.

Morgan Jamet,
Partner Attorney – ARST Avocats