The Item 19 Earnings Claim That Wasn't Representative
A franchisor includes an Item 19 Financial Performance Representation in its FDD stating that 'average annual gross sales for franchised units in California were $1.2 million in 2024.' The figure is based on the top 10 performing units out of 50 total units. The FDD does not disclose that the figure is based on a subset or that it excludes lower-performing units. A prospective franchisee, relying on the claim, invests $200,000 and opens a unit. After one year, the franchisee's gross sales are $600,000. The franchisee complains to the DFPI, alleging the earnings claim was misleading. The franchisor argues that the claim was literally true because it stated 'average' and the top 10 units did average $1.2 million. The franchisor also points out that the FDD included a disclaimer that actual results may vary.
1. Was the Item 19 earnings claim misleading under California law? Analyze the requirements for earnings claims and the use of a subset.
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Under California Corporations Code section 31101 and the DFPI's guidelines, an Item 19 earnings claim must be truthful, not misleading, and have a reasonable basis. The claim that 'average annual gross sales for franchised units in California were $1.2 million' is misleading because it is based only on the top 10 of 50 units. By using only the highest-performing units, the franchisor creates a false impression of typical performance. The FDD must disclose the basis of the claim, including the number of units included and excluded, and the time period. The failure to disclose that the figure is based on a subset of top performers is a material omission. The disclaimer that results may vary does not cure the misleading nature of the claim. The franchisor's argument that the statement is literally true is unavailing because the overall impression is misleading. The DFPI may find a violation of section 31200 and require corrective action.
2. What should the franchisor have done to make the earnings claim compliant?
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The franchisor should have based the earnings claim on all California units, or if using a subset, clearly disclose the criteria for inclusion and the number of units excluded. The FDD should state that the figure represents the average of all 50 units, or if not, provide the average of all units and the range. It should also disclose the median and the number of units that attained or exceeded the stated figure. The franchisor must have a reasonable basis for the claim and retain substantiation. The claim should be presented in a manner that does not mislead, and the disclaimer should be clear and conspicuous. The franchisor should also ensure that the Item 19 is updated annually and that any material changes are disclosed.