Your Non-disclosure Agreement Might Not Be Enforceable if You Did the Franchise Wrong

If you had decided to franchise your business, you may have proprietary formulas, sales contact lists, recipes, and other information that you need to keep confidential. We know that you as the franchisor are under a lot of pressure to get the prospective franchisee operating as soon as possible. Sometimes the prospective franchisee may pressure you into starting their training and operations even before you had a chance to prepare and give them the franchise agreement. That is an extremely risky thing to do. If you do not follow the franchising requirements as set out by the Federal Trade Commission (“FTC”), any and all agreements you made with the franchisee, including your non-disclosure agreement, might end up unenforceable and your confidential information may be vulnerable.

What Is a Non-disclosure Agreement?

A non-disclosure agreement (also referred to as an “NDA” or “confidentiality agreement”) is a contract between one or more parties in which the parties agree to not disclose confidential information that they have shared with each other while conducting business. There are various things which may be protected, such as preparation methods and recipes for food and drinks, secret formulas, unique software, client lists and contact information, non-public accounting figures, or any specific information or item that would set your business apart from a competitor.

What Does the FTC Require of a New Franchise?

A “franchise” is any relationship in which (1) the franchisor licenses a trademarked brand to the franchisee; (2) the franchisor exercises “significant control” over the franchised business; and (3) the franchisor receives a payment of at least $500 during the first six months of operation. This is incredibly broad and encompasses many relationships whether the parties know it or not. Per the FTC’s “Franchise Rule”, before a franchise agreement is legally binding, a franchisor must give the franchisee a Franchise Disclosure Document (“FDD”), which must contain certain financial disclosures along with many other disclosure “items”. The purpose of this is to provide prospective franchisees with enough information to make an informed decision on whether to proceed with the agreement. A franchisee has 14 calendar days from the receipt of the disclosure document to decide whether to continue with the agreement before it becomes legally binding. Prior to and during those 14 days, the franchisor may not initiate any fees, nor sign any agreement with the franchisee. Thus, when the franchisor collects fees from franchisee or has the franchisee sign any agreement related to the franchise (including an NDA) before the 14 day disclosure period ends, the franchisor is in violation of the Franchise Rule and sometimes even state franchise regulations.

What to Do if the Franchise Agreement Has Gone Wrong

If you have found yourself in violation of the federal rule or any existing state regulations, your non-disclosure agreement may be jeopardized. Since non-disclosure agreements, depending on how they were drafted, are often a part of the whole franchise agreement, courts will seldom treat NDAs as a separate contract. If it was a covenant to the agreement, the NDA will usually be treated as such, and thus be rendered void together with the franchise agreement. If it was a separate agreement, it may not survive unless the agreement contains information that would be considered a trade secret.

But there still may be hope for the franchisor. Trade secrets are a big part of the business world, which often go together with non-disclosure agreements. A trade secret is a secret held by a person or entity that either has a potential value to others that may be commercially realized by them, or it has a value to its holder that may be commercially realized and would be less valuable if disclosed. Unlike other intellectual property, trade secrets must be enforced by the party which owns them, so your only option may be to file a misappropriation claim against the Franchisee if they use that confidential information after the franchise agreement has fallen through. However, courts decide whether to grant protection against disclosure of the trade secret on a case-by-case basis.

The Bottom Line

Do NOT train or otherwise give confidential information to franchisees unless and until the franchise agreement is provided to the franchisee in compliance with the Franchise Rule.

Whether you have accidentally violated the Franchise Rule or ran into other issues during your franchising and believe your non-disclosure agreement may be in trouble, Peacock Law P.C. can help you! Justin Muehlmeyer can be reached at 505-589-3318 or JRM@PeacockLaw.com