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01 Jan 24

Franchise Fraud & the False Claims Act: Protecting Small Business Owners

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Last Updated on: 1st January 2024, 07:06 pm

Franchise Fraud & the False Claims Act: Protecting Small Business Owners

Opening a franchise can seem like a great way to start a small business. Franchises offer the chance to capitalize on a proven business model with an established brand name, training, and support. But some franchisors use deception and fraud to take advantage of eager entrepreneurs. This article will explore common franchise fraud tactics, legal protections like the False Claims Act, and resources for franchisees who feel they have been scammed.

What is Franchise Fraud?

Franchise fraud refers to intentional deception by a franchisor to get people to invest in their business opportunity. Some common fraudulent tactics include:

  • Fake earnings claims – Promising unrealistic profits or making up fake franchisee testimonials. This convinces investors without revealing the true risks or costs.
  • Hidden fees – Not properly disclosing expenses like royalties, marketing fees, or required purchases that cut into profits.
  • Exaggerated claims – Overstating the success, size, experience, or uniqueness of the franchise system.
  • Inadequate training/support – Claiming comprehensive training and assistance that ends up being lacking.
  • Disregarding failures – Not revealing underperforming or failed locations.

While not all franchise disputes amount to fraud, intentional deception for financial gain is against the law.

Legal Protections Against Franchise Fraud

The Federal Trade Commission (FTC) and state governments have regulations requiring franchisors to provide detailed disclosures to potential franchisees in a Franchise Disclosure Document (FDD). This helps protect investors by requiring information on costs, risks, company litigation history, prior bankruptcies, and more.However, some franchisors still manage to hide key details or lure franchisees in with verbal misrepresentations that contradict their FDD. This is where legal protections like the False Claims Act can help.

The False Claims Act for Franchisees

The False Claims Act (FCA) is a federal law that imposes penalties on companies that defraud the government. But it also allows private citizens to file lawsuits on the government’s behalf in exchange for a portion of the recovered funds. These are known as “qui tam” lawsuits.Over the past decade, franchisees have increasingly used the False Claims Act’s qui tam provisions to sue franchisors that misled them into investing. Since the SBA guarantees loans for franchise locations, deceiving a franchisee to obtain an SBA-backed loan counts as defrauding the government under the FCA.Franchisees can potentially recover 3 times their losses plus fines for the franchisor. For example, in 2019, the owners of a failed Curves fitness franchise used the False Claims Act to win a $3 million settlement after alleging financial misrepresentations by Curves corporate.

Proving Franchise Fraud for an FCA Claim

The False Claims Act imposes major penalties for defrauding the government. So franchisees need sufficient evidence to prove their franchisor knowingly or recklessly misled them.Potential evidence supporting an FCA claim could include:

  • Fake financials – Documents that misrepresent costs, profits, or franchisee success rates.
  • Contradictory information – Verbal claims that contradict the Franchise Disclosure Document.
  • Hidden litigation – Omitting relevant lawsuits from the required litigation disclosures.
  • Covered-up failures – Not revealing underperforming or closed locations.

Additional evidence like secret recordings of conversations with franchisor reps or emails discussing earnings claims can further support allegations of fraud.Without concrete proof, arguing the franchisor “should have known” probably won’t be enough to satisfy the False Claims Act’s strict standards. But franchisees who can demonstrate intentional deception or reckless disregard for the truth may have a strong case, especially if the misconduct was systemic across the franchise system.

Finding Legal Help for Franchise Fraud

The False Claims Act allows franchisees to sue without a lawyer by filing pro se. However, franchisors will almost certainly have experienced legal teams ready to fight back hard. So working with an attorney knowledgeable in franchise litigation is extremely helpful.When researching franchise lawyers, be sure to ask about their specific experience with:

  • Franchise disputes & litigation
  • Fraud allegations & evidence gathering
  • Qui tam lawsuits & False Claims Act cases

Don’t just take their word for it – ask for case references and check their background. For larger franchise systems, finding lawyers who have gone up against that specific company can also be beneficial.Nonprofit organizations like the American Association of Franchisees & Dealers and the International Franchise Association may also have useful resources and lawyer referrals. Online legal marketplaces like Avvo make it easier to compare multiple lawyers at once.

Recovering Financially After Franchise Fraud

Besides just winning a lawsuit, taking legal action under the False Claims Act or state laws can help franchisees recover their losses. Possible financial recovery options include:

Settlements – Many franchise disputes end in a settlement, which may at least partially refund the franchisee’s investment. Structured settlements spread out payments over time.

Treble damages – Under the False Claims Act, successful qui tam plaintiffs can collect triple their losses from the franchisor.

Loan forgiveness – Providing evidence of fraud may convince lenders to forgive outstanding debts related to the franchise.

Tax deductions – Legal fees and losses from investment fraud may be tax deductible.Rebuilding financially after franchise fraud takes time. But by understanding their options under the False Claims Act and state laws, defrauded franchisees can seek justice – and restitution.

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