5 legal lessons for franchisors from 2014

The year is almost over, so what have we learned? As lawyers we look at two main sources to tell us about the law, legislation (made by government) and case law (made by judges).  It’s from this second source where the hard lessons are learned by plaintiffs and defendants in trying to convince the court of the merits of their arguments and it’s where the rest of us can learn what to do and what not to do. So if we look back at the major cases in the franchising world in Australia in 2014 what are the lessons for franchisors?

1. 'Current' means ‘now’ (not last year or the year before that)

In the now infamous Spar case we saw a situation where the franchisor issued a disclosure document in July (but dated the previous financial year with the financial reports of the year before that) issued to a franchisee who took more than six months to sign the franchise agreement.  The franchisor didn’t give the franchisee a fresh disclosure or any new financial reports.  Unfortunately the franchisor's finances had taken a downturn and the information in the original disclosure document was hopelessly out of date by the time the franchisee got around to signing.  The franchisee said he would not have signed up if he had the current information and so the franchisor couldn’t enforce the franchise agreement against the unwilling franchisee (who had left to join a competitor).

So important was this case we now have changes to the Franchising Code to make sure franchisors understand that they must give the new financials to a franchisee if they become available before the franchisee signs, even if disclosure has already occurred.  [i]

2. The internet is part of the real world and not an alternate reality

If you grant an exclusive geographic territory to a franchisee and then start selling the same products online to the customers in that territory you are breaching the exclusivity you granted.  It doesn't matter that you are sitting at a computer outside the territory and the sale is made through the virtual world of the internet, the effect is the same as if you set up a shop or a van in the franchisee's territory.  [ii]

3. Be prepared!

Especially if you intend to enter into a massive price war with your major competitor and you might not have the support of all of your troops (aka franchisees). Pizza Hut showed that it takes research, trials, financial modelling as well as firm resolve to launch a bold marketing campaign in the face of opposition from a significant number of its franchisees.  Pizza Hut had enough evidence to show it had reasonable grounds for its decisions and was acting in good faith in the best interests of the franchise system.[iii]

4. A business that doesn't make money is not much of a loss

A drama involving competing video stores in Geraldton was the background of this decision.  Essentially a Civic Video franchisee having been unable to sell its two  struggling stores to any franchisor-approved purchaser sold the businesses to a rival Video Ezy franchisee (in breach of the franchise agreements).  The Video Ezy franchisee closed one of the stores and rebadged the other to Video Ezy.

Civic sued both its former franchisee for the lost future franchise fees and the rival Video Ezy franchisee for inducing the breach of contract.

While they both denied wrongdoing, the Civic franchisee and the Video Ezy franchisee argued that Civic had not suffered any loss anyway because the businesses were failing and would have closed down in any event. They said Civic would not have received any future franchise fees and no arrears would have been paid as the franchisee was insolvent.  In fact, they argued Civic was in a better financial position with the sale to Video Ezy because at least the arrears were paid.

The court agreed that the stores were in no position to continue trading and the franchisee would have closed them down as it had previously threatened.  Ultimately it decided that one of the stores was unsaleable and so there were no future fees likely and only a fairly small amount of fees was lost by Civic from the loss of the other store.

As to the rival Video Ezy franchisee, the court felt he did not induce the breach of the contract but simply took advantage of a commercial opportunity offered to him.[iv]

5. If the franchise is not in Australia, leave the Code out of it!

A franchise agreement entered into in Hong Kong by two companies registered in Hong Kong in respect of a store in Hong Kong referred to obligations under Australia’s Franchising Code of Conduct. This is even though it could not be a franchise agreement under the Code as the franchise was not in Australia. The complications and expense that then arose with each side arguing about which Australian laws apply are surely a lesson for anyone to make sure that when you expand internationally to think hard before trying to export Australian legal concepts overseas.[v]

[i] SPAR Licensing Pty Ltd v MIS Qld Pty Ltd (2014) 314 ALR 35

[ii] Video Ezy International Pty Ltd v Sedema Pty Ltd [2014] NSWSC 143

[iii] A & A (Sydney) Pty Ltd v YUM! Restaurants Australia Pty Ltd [2014] FCA 678

[iv] Civic Video Pty Ltd v Paterson [2014] WASC 321

[v] Manhattan (Asia) Ltd v Dymocks Franchise Systems (China) Ltd [2014] FCA 1143