November 9, 2012

Franchisor Liability Around Projections

THE CASE

A recent Victorian Court of Appeal decision awarded Ross and Sue Pollard (“Franchisee”) $1.22 million in damages against Bill Baxter’s (Franchising) Pty Ltd (“Franchisor”). The Franchisor operates 21 stores throughout Australia and is now in provisional liquidation.

The Franchisor sued the Franchisee, who terminated the Franchise Agreement after the business sustained losses and was unable to pay the franchise fees of $250,000. The Franchisor accepted the termination as repudiation of the contract and sued for the recovery of unpaid royalties and advertising levies under the agreement.

At trial, the Franchisee defended the Franchisor’s claim and issued a counterclaim alleging that they had been induced to enter into the agreement based on the misleading and deceptive conduct of a representative of the Franchisor.

The decision was made pursuant to theTrade Practices Act 1974 (now the Competition and Consumer Act 2010), and considered whether the projected turnover and rent were misleading and deceptive.  The Franchisee alleged that the representative of the Franchisor indicated to them an anticipated turnover of $1.3 million, which would allow the business to pay the rent of $160,000 per annum and return a profit.

In May 2009, the Supreme Court of Victoria upheld the Franchisor’s claim and dismissed the Franchisee’s counterclaim.  The judgement highlighted that the representative provided a spreadsheet template for the Franchisee, and the Franchisee, being experienced in franchising, ignored the advice to enter their own information into the spreadsheet, and seek independent legal, business and accounting advice.

As a result, the Supreme Court ordered that the Franchisee and guarantors pay the outstanding fees, interest and the Franchisor’s legal costs.

THE APPEAL

The Court of Appeal found that the figure of $1.3 million was projected to the Franchisee without reasonable grounds, and that the only connection between the rent and the projected turnover was that the franchise would need to reach the figure of $1.3 million as the minimum to make the rent affordable.

The Court found that the figure had no logical connection with what the turnover would actually be, and there was no evidence of any analysis that could support the projection made by the representative.

In a unanimous decision, the Court of Appeal agreed that the representations of the representative were not made on reasonable grounds.  The court overturned the Supreme Court’s decision, and ordered the Franchisor to pay the Franchisee damages of $1.22 million.

HOW DOES THIS DECISION AFFECT YOU?

  • It is imperative that thorough due diligence of a franchise system is undertaken by a prospective franchisee.
  • As a result of this case, franchisors may be more cautious about releasing financial information, which could restrict access to important information by potential franchisees.
  • Many contracts include an “entire agreement” clause, prohibiting parties from relying upon anything not recorded in the contract. The Franchising Code of Conduct (under the force of the Competition and Consumer Act) prohibits these clauses in a franchise agreement. As a result, franchisors should always obtain prior representations statement from a potential franchisee. This can assist to clarify any misunderstandings between the parties.
  • Franchisors would be well advised to closely monitor and oversee the actions of their representatives in dealing with prospective franchisees. Statements about turnover and profitability will always be heavily scrutinized if the business subsequently fails.
  • Franchisors should review their documents and procedures and insist that franchisees seek legal and financial advice before entering into a franchise agreement.