The Franchise Memorandum

The United States District Court in Colorado recently denied dismissal of a franchisee’s fraud claim in connection with the franchisor’s failure to provide an updated Franchise Disclosure Document when the franchisee was granted additional territory. In McKinnis v. Fitness Together Franchise Corp., 2010 U.S. Dist. Lexis 133976 (D. Colo. Dec. 6, 2010), the plaintiff—a Fitness Together master franchisee—claimed that the franchisor committed fraud by selling the plaintiff an additional master franchise territory and requiring that the sale be accomplished by amending an existing master franchise agreement between the parties, rather than by executing a new master franchise agreement. The franchisor did not provide FDD disclosure to the plaintiff prior to the sale of the new territory—apparently because it did not have an up-to-date document prepared. The franchisor argued that the fraud claim was barred by a provision of the agreement requiring that all claims be brought within one year of accrual. The court rejected this argument, noting that a fraud claim (if successful) enables the franchisee to rescind the agreement, thereby negating the one-year limitations period. This case is an important reminder to franchisors to provide updated FDD disclosures to existing franchisees that are adding a new territory, rather than attempting to bootstrap onto a prior agreement.

Also noteworthy was the court’s rejection and dismissal of the plaintiff’s claims for breach of contract and breach of the covenant of good faith and fair dealing, both of which arose out the franchisor’s repurchase of a territory from a different master franchisee. The plaintiff claimed that it had a right of first refusal to purchase the subject territory; however, the court found that the plain language of the master franchise agreement applied the plaintiff’s purchase option only to sales by the franchisor—not sales from a different franchisee to the franchisor.