No-no to Inflated Franchise Income Claims

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No-no to Inflated Franchise Income Claims

Franchisors need to be careful that they do not mislead potential franchisees with the hope that they will receive a minimum ‘guaranteed’ income. The Australian Competition & Consumer Commission (“ACCC”) is closely monitoring such representations after receiving many complaints. The bulk of the complaints relate to franchisors in the cleaning and home services industry.

Franchisors misrepresenting the potential income of a franchise can be subject to litigation and court imposed penalties of up to $1.1 million per contravention.

Recently, in SPAR Licensing Pty Ltd v MIS QLD Pty Ltd (No 2), the Federal Court emphasised the importance of disclosing current financial documents prior to entering into a franchise agreement.

SPAR Licensing Pty Ltd v MIS QLD Pty Ltd (No 2)

Facts

SPAR Licensing Pty Ltd (“Franchisor”) and MIS Qld Pty Ltd (“Franchisee”) entered into negotiations in 2010 in relation to the grant of the franchise. In July 2010, the Franchisee was given the draft franchise agreement and disclosure document. However, it wasn’t until 1 February 2011 that the franchise agreement was executed.

The disclosure document included a Statement of Solvency which expressly related to the position as at 30 June 2009, and an independent auditor’s statement which claimed there were “reasonable grounds to believe that SPAR Licensing Pty Limited will be able to pay its debts as and when they fall due”. The disclosure document did not contain any financial reports in respect of either SPAR Licensing or the consolidated SPAR Group.

Reasoning

The Franchising Code requires a franchisor to give a current disclosure document to a prospective franchisee at least 14 days before entering into a franchise agreement. The contents of a long form disclosure document are set out in Annexure 1 to the Franchising Code, and relevantly in this case, include disclosure of certain financial details of the franchise in the form of financial reports for the last two financial years or an independent auditor’s report.

In this case, the relevant financial statements were finalised on 10 September 2010, which was after the provision of the disclosure document but before the execution of the franchise agreement. However, these financial statements were not disclosed to the Franchisee, nor was the Franchisee provided with a solvency statement in respect of the financial year ended 30 June 2010, nor any supporting independent auditor’s report.

During the six month delay between when the Franchisee received the disclosure document and when the franchise agreement was ultimately executed, the financial position of the SPAR Group seriously deteriorated as was reflected in the 2010 financial statements and report finalised on 10 September 2010. The financial report stated that there was “significant uncertainty whether the group will be able to continue as a going concern”.

The Court held that the Franchisor’s failure to provide the Franchisee with current financial information prior to entry into the franchise agreement deprived the Franchisee the ability to make an informed decision about whether or not to enter into the franchise. The Franchisor should have disclosed the 2010 financial statements and report to the Franchisee. Therefore, the Franchisor had contravened the Franchising Code.

Relief

Despite the seriousness of the Franchisor’s contravention, the Court did not consider it was appropriate to set aside the franchise agreement. Rather, it considered that, it was appropriate to vary the terms of both the franchise agreement to enable the Franchisee to terminate those agreements on payment of the requisite termination and associated fees.

It was also held that the Franchisee did not establish any basis on which they should receive an additional award of damages in respect of the breach as their loss was offset by a growth in sales.

The case outlines the importance of providing current financial documents prior to entering into a franchise agreement. Prior to entering into a franchise agreement, franchisors will need to review disclosure documents to ensure there is no material change in circumstances which renders prior disclosure misleading or out of date.

Pie Face

More recently, reports have emerged that three franchisees from the fast food chain Pie Face are threatening to sue their franchisor for millions of dollars, claiming they were misled with regard to both cost and profits when they first bought into the business and have lost heavily from their investment. Other Pie Face franchisees that have faced similar issues may also join the case, meanwhile others await the outcome from a complaint to the ACCC.

Accusing franchisors of misrepresenting the potential costs and profits is not uncommon. The ACCC regularly receives complaints of this nature from disgruntled franchisees.

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