Misleading conduct in the context of a franchise agreement

Franchisors are obliged to provide prospective franchisees with certain information before entering into an agreement. The new Franchising Code of Conduct (the Code), which will take effect on 1 January 2015, makes some changes to the disclosure requirements (including in relation to online sales), but the information covered remains largely the same, dealing with issues such as litigation affecting the franchisor, details of existing franchisees, intellectual property and earnings and financial data.

Some of the potential pitfalls for franchisors providing this sort of information were illustrated in a recent decision of the Full Federal Court.[1] In that case, a franchisee (and its owner, Ms Stariha) alleged that the franchisor and a person associated with another franchisee (Mrs Hart) had engaged in misleading and deceptive conduct in the context of their disclosure of financial and other information before the parties entered the agreement, and that this misleading conduct had induced the franchisee to proceed, ultimately to its detriment.

The case was somewhat unusual in that Ms Stariha had been employed by Mrs Hart’s company (which was another franchisee) to run the Gold Coast office of the business for about a year before purchasing the franchise for that office, and Ms Stariha also used the financial information provided by the Mrs Hart to prepare her own, detailed spreadsheets about the future financial performance of Gold Coast business before entering the franchise. Initially the Gold Coast franchise performed well, but in the aftermath of the financial crisis its business declined and eventually it ceased to trade, at which point Ms Stariha and her company commenced court proceedings claiming that:

  • Mrs Hart had told her that the spreadsheet that Ms Stariha had prepared was accurate, that the Gold Coast business had EBIT of $80,000 in the previous year and would achieve the same figure in the first year of Ms Stariha operating the franchise, and that the franchise would be profitable into the future; and
  • Mr Davis, the managing director of the franchisor, had told her that the price of $240,000 for the franchise was “fair” and that the franchise businesses had a “100% success rate”, and had failed to disclose that a former franchisee was currently in legal proceedings against the franchisor.

The court (both at trial and on appeal) found in favour of the franchisor, holding that there was insufficient evidence that any of the alleged misleading conduct had occurred. Also relevant to the court’s conclusion was the fact that for at least seven months after purchasing the franchise Ms Stariha had not complained about any of the matters that she later cited as misleading conduct.

Although the franchisor succeeded in this case, the decision serves as a useful warning about the risks associated with:

  • providing forecasts of a franchise’s revenue, profit or performance;
  • commenting on forecasts prepared by the prospective franchisee; and
  • more generally, misrepresenting or failing to disclose any pertinent information.

To minimise these risks, franchisors should where possible ensure that:

  • all disclosures of information are documented and recorded;
  • disclosure is limited to the information specified in the Code;
  • no opinions or predictions are made to a prospective franchisee; and
  • no endorsement or approval is given in respect of any forecasts or other information prepared by the prospective franchisee.

For more information about these issues, please contact Geoffrey Shiff or David Jackson.

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