Franchisors have always had to operate under a regulated environment, but scrutiny has increased. We are still seeing continued cases in the media of franchisees alleging they were misled and induced to enter into franchise arrangements due to representations as to expected turnover, or cost of goods and in some cases expected profit.
What you need to know about representations
Representations can be verbal, in writing, on websites, in emails or in promotional materials issued every day to the market and prospective franchisees.
Misrepresentations
A misrepresentation is an untrue or misleading statement made by one party during negotiations that induces the other party to enter into and sign the contract.
Misrepresentation refers only to a statement or action made before a franchisee signs the franchise agreement.
A misrepresentation can also be by an omission of some material fact or failing to disclose the true state of affairs. For example, the site proposed was previously unsuccessful. It could be that material information had it been disclosed to a franchisee prior to signing may have impacted on their decision to proceed.
Franchisors, their managers, staff and agents are in the business of expansion and recruiting prospective franchisees and often do so with enthusiasm for the brand. However, franchisors need to be ever more careful in the current environment.
Penalties increased
Penalties under the Australian Consumer Laws (ACL) have significantly increased. Now companies are liable for whichever is greater:
- $10,000.00;
- Or three times the value of the benefit obtained from the contravention or offence (if it can be calculated).
If the benefit cannot be calculated the penalty is 10 per cent of the company’s annual turnover in the prior 12 months.
The penalties for individuals including managers and directors involved in the contravention have increased from $220,000 to $500,000 per breach and cover false or misleading representations, unfair sales practices and unconscionable conduct.
The Australian Competition and Consumer Commission has indicated it is pursuing companies for unfair contract terms.
So, the message to all companies and management staff is to think before you make a promise and send that email or make that statement about expected weekly revenues If in any doubt seek legal advice before you publish or send that email as it could be costly.
Ask these questions:
- Can I deliver on that promise?
- Can I substantiate the information I have just provided the franchisee?
As lawyers we often see that the truth lies in the middle, but words matter and can be held against you.
Prior representation deeds
Often the franchisor will ask the franchisee to document the promises or representations made to them by the franchisor or its employee or agent prior to entering into the franchise agreement. The purpose of a Prior Representations Deed is for the franchisee to set out in writing any representations that they consider were made to them before entering into the franchise agreement and upon which they relied.
The franchisor may then decide not to go ahead with the franchisee to avoid a potential future claim against them for misleading and deceptive conduct. Or alternatively the franchisor can then address any misunderstanding or assumptions that the franchisee has made in relation to the matters set out.
It can be helpful to address any misunderstandings or miscommunication before the franchisee commits.
All franchisors should issue the deed as a separate document to franchisees with their suite of franchise documents.
Franchisees and their advisors need to carefully consider the deed and detail the statements that they relied on, for example “a promise to deliver the franchisor’s goods from their warehouse daily”.
It is a document that is often forgotten but can have significant impact in the event of a dispute.
It’s important to remember a franchisor is not necessarily protected in the event of a dispute even if the franchisee signed the deed stating “no representations were made “as the franchisee can still assert that there were misrepresentation’s made in marketing information, emails or in meetings.
Real life court case
Guirguis Pty Ltd & Ors v Michel’s Patisserie System Pty Ltd & Ors [2016] QDC 117 is an example where it did protect the franchisor against a claim by the unhappy franchisees.
Before entering the franchise agreement, the franchisees signed a Deed of Prior Representations and filled out a questionnaire detailing any verbal or written statements or representations made by the franchisor which influenced their decision to sign up to the franchise.
The franchisees did not list any representations made by the franchisor regarding delivery of products. However, they did list representations that were made about lease terms and ongoing support.
The franchisor also sent a further letter to the franchisees after the deed was signed asking if any further representations were made that they wished to disclose, and none followed.
Despite this, the franchisees insisted in court they relied on representations by the franchisor that there would be regular deliveries of snap frozen products, which had induced them to sign up to the business.
The Court found the franchisee had two opportunities to have set those representations out in the Deed and a later date and failed to do so.
The Court found in favour of the franchisor and held the franchisees’ purported termination of the franchise agreement (they abandoned the business) was unlawful as it did not comply with the terms of the franchise agreement and the franchisor was awarded $650,000 (rounded off) in damages.
To succeed in a claim alleging misrepresentation, the party alleging it must show that:
- the alleged misrepresentation was made;
- the franchisee relied on the misrepresentation; and
- suffered loss and damage as a result.
Negligent misstatement and breach of contract
The franchisees in this case also brought a claim based on negligent misstatement or breach of contract, both of which failed.
The franchise agreement stated the franchisee could not claim for any loss as a consequence of the non-supply of products.
The franchisee did not challenge whether these clauses were prohibited by the Franchising Code of Conduct.
What can, and should a franchisor do?
Here are some basic rules to bear in mind by franchisors:
- Don’t promise what you cannot deliver.
- Provide training in the Australian Consumer Laws to your managers and staff including support staff so they understand the limits of what can and should be said.
- Don’t withhold information that you would consider relevant if you were a franchisee even if you consider it may be perceived negatively by a franchisee.
- Ensure that you can support with credible data, any financial information you have provided and that it is tailored to the particular site. The information for a greenfield site for example will be different to an existing going concern.
- Ensure your disclosure document is updated annually, and correctly reflects the franchisors then current model and fees particularly the set up and ongoing costs that may have changed over time.
- Ensure the franchisees and guarantors sign a Deed of Prior Representations statement before they sign the franchise agreement and follow them up with a prompt at a later date and prior to signing the franchise agreement particularly if some time has elapsed since the first meetings, provision of the franchise documentation and signing of the deed.
- Don’t let the franchisee go into a site or a lease that you wouldn’t want to take on as a franchisor or company owned store.
Encourage franchisees to do their research and insist they seek independent financial and legal advice from franchise specialists prior to entry into the franchise agreement.
It is all about transparency and disclosure which is one of the key issues raised in the recommendations from the fairness in franchising report particularly in relation to financial disclosure by franchisors.
So, in short don’t promise a rose garden if all you can deliver is a handful of blue thistles.
