How franchisors can avoid misrepresentation

Many disputes and court proceedings in franchising involve allegations of misrepresentation or misleading or deceptive conduct on the part of a franchisor during the recruitment phase.

The allegations usually are that the franchisor mispresented potential earnings and profitability of a franchise.

Most prospective franchisees wanting to buy a franchise want answers to two main questions:

  • “how much will it cost me?”
  • “how much will I make?”

These questions are not unreasonable questions and sometimes answers from the franchisor such as “I can’t tell you” or “Seek advice and do your own due diligence”, will cause a prospective franchisee to lose interest and look to another franchise network.

Therefore, it is tempting for a franchisor to make some form of statement to a prospective franchisee about the likely projected income of a franchise.

However, before making any statements franchisors should ask themselves the following questions:

  • what can they say?
  • how should they say it?
  • what are the risks?
  • is it worth it?

In answering these questions it is important that franchisors understand the various laws that apply to conduct which is fraudulent, misleading or deceptive.

Franchisors, avoid deceptive conduct during franchise recruitment

The Australian Consumer Law (ACL), in Schedule 2 to the Competition and Consumer Act 2010 (Cth) (CCA), prohibits conduct by corporations in trade or commerce which is misleading or deceptive or is likely to mislead or deceive.

A violation of the ACL can expose a franchisor to pecuniary penalties, but also and more importantly, civil liability to pay compensation to the party affected by the misleading and deceptive conduct.

If a breach of the CCA is involved, franchisees may also seek the intervention of the Australian Competition and Consumer Commission (ACCC).

Under the common law, a right to terminate the franchise agreement may exist where the party has entered into the franchise agreement induced by a false representation.

Given these laws franchisors must be careful not to mislead and/or deceive prospective franchisees during the recruitment process.

To have a valid claim for misleading or deceptive conduct the franchisee must prove that:

  • the conduct that occurred and was misleading and/or deceptive;
  • was relied upon by the affected party; and
  • caused loss

However, if the conduct is a representation or statement about a future matter (such as an income projection), the ACL deems this to be misleading and/or deceptive, unless the franchisor can prove that the representation or statement was based upon reasonable grounds.

With misrepresentation at common law it is a defence if the person making the statement can show that he or she believed on reasonable grounds that it was true, or that someone else made the statement and he or she had no reason to know that it was made, or was not true.

Therefore, the franchisor who wants to provide an income projection to a prospective franchisee must make sure that every figure in the projection is based upon reasonable grounds.

Similarly if a projected profit and loss statement or projected cash flow is given, there must be reasonable grounds to support the projected sales and every item of projected expenditure.

Franchisors, don’t second guess turnover

Franchisors should not guess at or pluck figures out of the air.  If an income projection is given and is based upon the performance of other franchises, there must be proper comparators.  Demographics, the type of location and shopping centre and levels of competition are a few of the sorts of factors that need to be considered.

There must be a serious economic analysis behind each projection.

It is also critical that the franchisor keep detailed records and supporting documents to evidence how it arrived at the projected figures.  This documentation might be needed in Court one day or it may be required to answer an ACCC query or audit.

If a franchisor can prove the existence of reasonable grounds for the income projection, it will escape liability, even if the projected income did not eventuate.

The franchisor who wants to provide an income projection to a prospective franchisee, must also comply with the Franchising Code of Conduct by ensuring that Item 20.4 of its disclosure document is completed.  This item requires disclosure of:

  • the facts or assumptions on which the projection or forecast is based
  • the extent of enquiries and research undertaken by the franchisor and any other compiler of the projection or forecast
  • the period for which the projection or forecast relates
  • an explanation of the choice of the period covered by the projection or forecast
  • whether the projection or forecast includes depreciation, salary for the franchisee and the cost of servicing loans
  • assumptions about interest and tax.

It is always prudent for a franchisor to heavily qualify any projections.

The reality is that the franchisor does not know how the franchisee might perform, whether they may be affected by personal issues, whether new competition might come into the area, whether there might be a downturn in the economy or whether the brand or the products sold might be the subject of serious reputational damage (recent examples being Caltex, Retail Food Group and Volkswagen).

These types of disclaimers or qualifications do not provide automatic protection for franchisors but there have been cases where a well-drafted disclaimer has caused a Court to conclude that a prospective franchisee could not have relied upon the information in question.

Franchisors should also avoid giving verbal income projections. Franchisors who do may be faced with the “he said, she said” dilemma and a Court may simply not accept the franchisor’s account of conversations.

It is better to record everything in writing and to make sure the disclaimer and qualifications form part of the same document. Then there can be no doubt as to the content and terms of the income projection.

There isn’t any doubt that there is risk associated with giving an income projection. Although a franchisor might think it has reasonable grounds upon which to base the income projection, the franchisee, or more importantly, a Court, may not agree.

Is there any value in providing an income projection?

Some franchisors merely give historical information (actual past sales results) thinking that this is acceptable.

But even this can be dangerous.

Even though the information provided might be factually accurate (i.e. there is no misrepresentation), it should be noted that the law focuses on conduct and if the conduct is misleading and/or deceptive there will be legal exposure.

For example, providing to a prospective franchisee of a greenfield (new) site in a strip location in Hobart the actual sales results for a site in a large shopping centre in Melbourne, without any explanation of the differences between the two sites, might be misleading or deceptive. That is why item 20.2(b) of a disclosure document requires franchisors to explain differences between the sites.

So, is it worth it? This is really a commercial decision that must be made by weighing up the benefits (achieving the sale of the franchise) against the cost of doing the research to establish reasonable grounds and the cost of getting it wrong.

If franchises can be sold without the need to give income projections, then there is no point providing them. But if franchises can’t be sold without giving such projections, franchisors really have little choice and in this case sufficient time and money should be invested in doing thorough investigation and analysis to establish reasonable grounds. Appropriate qualifications or disclaimers should also be provided with the information.

In addition, it would be wise that franchisors take out insurance against such claims.  Franchisors should factor these costs into their business planning and pricing.