The Risk of Failing to Consider Disclosure Obligations in Confidential Settlements

01/25/2017 / Henry Pfutzenreuter

Franchisors who enter into settlement agreements requiring that they keep their terms confidential put themselves in jeopardy if they fail to first consider their disclosure obligations. It is well settled that franchisors may not attempt to contract around “Item 3” of the Franchise Disclosure Document (FDD), which requires they disclose whether they were “a party to any material civil action involving the franchise relationship in the last fiscal year.” This disclosure includes “all material settlement terms . . . whether or not the agreement is confidential.” A recent Seventh Circuit decision highlights the issues that can arise when franchisors fail to carve out their disclosure obligations in confidential settlement agreements. 

In Caudill v. Keller Williams Realty, Inc. 828 F.3d 575 (7th Cir. July 6, 2016), the Seventh Circuit affirmed a lower court’s dismissal of a franchisee’s claim that a franchisor breached the confidentiality provision of a settlement agreement by disclosing the settlement’s terms in “Item 3” of the franchisor’s FDD. The franchisee alleged that the franchisor’s disclosure not only caused actual damages in the form of lost profits and reputational harm, but also breached the confidentiality agreement’s liquidated damages provision, which established damages of $10,000 per breach. The franchisee claimed that she was entitled to approximately $20 million in liquidated damages because the franchisor had sent the FDD to approximately 2,000 prospective franchisees and other interested parties. 

The Seventh Circuit, however, affirmed the lower court’s dismissal of the franchisee’s claim on the basis that she had failed to establish her damages. The Seventh Circuit agreed with the lower court that liquidated damages were unavailable because there was no basis to conclude that their amount was “a reasonable estimate at the time of contracting of the likely damages from breach,” a requirement to recover liquidated damages in most jurisdictions. The Seventh Circuit acknowledged that while “[o]ne can . . . imagine” that a conflict could arise between a confidentiality agreement and a franchisor’s disclosure obligations, the franchisee’s damages would need to go beyond mere “speculation.” But the Seventh Circuit also noted that an additional requirement for the franchisee to recover in such circumstances would be that the disclosure is not one that is “required by state or federal law.”

We generally recommend to our clients that confidentiality provisions of settlement agreements with franchisees be one-way provisions, binding only the franchisee. Franchisees usually exit the system when signing a settlement agreement – or already exited the system – and so they have no reason to speak with other franchisees about their settlement. On the other hand, the franchisor needs to live with the franchise system and the consequences of the settlement. Thus, franchisees have no reason to disclose the terms of a settlement, but the franchisor should be able to make any truthful disclosures, voluntarily or as required by law. If unable to negotiate such a provision, settling franchisors should make sure to carve out their disclosure obligations from any confidentiality agreement.