The parol evidence rule generally bars the admission of extrinsic evidence of prior or contemporaneous oral agreements, or prior written agreements, to explain or vary the meaning of a contract where parties have reduced their agreement to an unambiguous integrated writing.

In Cottman Transmission Systems, LLC v. Kershner, 536 F.Supp.2d 543 (E.D.Pa.,2008) it was recently held that the parol evidence rule prevents the franchisees in that case from relying upon the franchisor's UFOC to establish their claims of fraud in the inducement and negligent misrepresentation.

The Kershner franchisees assert that the franchisor made inaccurate Earnings Claims in its UFOC, thereby distorting the facts upon which the franchisees had based their investment decisions.

The court held that the merger and integration clauses contained in the agreements preclude the franchisees from claiming reliance upon representations in the UFOC.  The court accordingly granted the franchisor's motion to dismiss the claims of fraud in the inducement and negligent misrepresentation.

In our view, not only is the Kershner ruling incorrect, it is directly contrary to the fundamental purpose of the FTC Franchise Rule.

As an initial matter, it should be noted that Cottman Transmission Systems is by no means the only franchisor that has included merger and integration clauses in its franchise agreements.  The North American Securities Administrators Association (NASAA) has observed that, "[b]ased on the law enforcement experience of franchise registration states, the vast majority of franchise agreements contain some type of waiver or integration provision purporting to insulate franchisors from liability for oral or other representations that conflict with the required disclosure document or franchise agreement."

The practice is as rampant as it is wrong.

The Federal Trade Commission's Franchise Rule prohibits franchise sellers from disclaiming liability for statements made in a disclosure document.  The Rule provides that it is an unfair or deceptive act or practice for any franchise seller to disclaim or require a prospective franchisee to waive reliance on any representation made in the disclosure document or in its exhibits or amendments.  16 CFR § 436.9(h).  Section 436.9(h) is intended to prevent fraud by preserving the completeness and accuracy of information contained in disclosure documents.  72 Fed.Reg. 15444, at 15533.

Analysis of the Basis and Purpose for the new Rule (which became optional as of July 1, 2007 and will become mandatory as of July 1, 2008) leaves no doubt that the Kershner ruling cannot stand.  Although the disclosures in Kershner took place prior to the effective date of the new Rule, the new Rule in many respects merely clarified the existing Rule.  In conjunction with its issuance of the new Rule, the FTC Staff explained that while franchisors may use integration and waiver clauses to serve certain purposes, such clauses cannot be used to insulate franchisors from false or deceptive statements made in disclosure documents.  The FTC Staff specifically noted in this regard that "[t]his is particularly true of those sections of the disclosure document pertaining to matters other than the terms of the franchise agreement that cannot be negotiated, such as the franchisor's prior business experience, litigation history, financial performance representations, and financial statements."  72 Fed.Reg. at 15534.  (Emphasis added).

Adopting a comment submitted by the American Franchisee Association, the FTC Staff concluded as follows:

The Commission has long recognized that the integrity of a franchisor's disclosure document is critical to prospective franchisees who rely on such information in making their investment decision . . . The use of integration clauses or waivers to disclaim statements in the disclosure document that the franchisor authorizes would undermine the Rule's very purpose by signaling to prospective franchisees that they cannot trust or rely upon the disclosure document.

72 Fed.Reg. at 15534.

The Kershner franchisees clearly should be allowed to introduce inaccurate Earnings Claims in the UFOC to establish their claims.  What we find to be particularly distressing about the court's ruling is that UFOCs truly are not "parol evidence". To the contrary, disclosure documents are specifically intended to be relied upon by franchisees in their investment decisions; their contents in essence are incorporated into the franchise agreement.

The franchisees are attempting to appeal the order on an interlocutory basis. Stay tuned.