Dibbs Abbott Stillman on franchisees seeking legal and accounting advice

According to Dibbs Abbott Stillman , the Franchising Code of Conduct stresses the importance of making prospective franchisees seek accounting and legal advice. Clause 11 of the Code prohibits a franchisor from entering into a franchise agreement before he or she has received statements from the franchisee or prospective franchisee, including that the latter has received legal and/or business advice or has decided not to seek it. Subclause 11(1) requires that a franchisor is not to enter into a franchise agreement, an agreement about a franchising agreement, or receive non-refundable money, unless the franchisee has provided a written statement that they have:

· received the disclosure document;

· received a copy of the Code; and

· had a reasonable opportunity to understand that material.

Changes to the Code in 2001 replaced a reference to 'non-refundable money' with a reference to 'a non-refundable payment (whether of money or other valuable consideration)'. The change was intended to ensure that the protection provided under subclause 11(1) extends to any valuable consideration.

What the courts say

This provision of the Code has received direct judicial consideration in only three cases so far.

In Walcan v Superior Coffee & Cakes Pty Ltd [2002] FCA 1211, upheld on appeal at [2003] FCAFC 14, the franchisee company entered into a sub-franchisee agreement with the franchisor, Superior Cakes & Coffee Pty Ltd in 1999 for a BB’s Coffee and Bake franchise. It was alleged that misleading statements had been made as to the financial character of the business and that the sub-franchise was purchased in reliance on those representations. Some financial information had been provided to the prospective sub-franchisee as part of a “Disclosure Document”.

It was held by the Court that:

“the applicants have not established the making of the representations upon which they are said to have relied. An acceptance of their evidence was rendered very difficult when one compares the case pursued at the conclusion of the hearing when it is compared with the allegations originally made. They lacked a foundation in fact. There was no independent evidence to suggest that the critical representation was likely to have been made. The evidence for the applicants was itself inconsistent, unreliable and lacking in necessary explanation.”

In coming to that conclusion, the Court regarded it of some importance that the prospective sub-franchisee did not disclose to their accountant an alleged assurance that sales would be achieved, which was contained in disclosure documents and allegedly communicated by other representations. There was no explanation given by the franchisee as to why this was not done.

In the case of The Cheesecake Shop v A & A Shah Enterprises [2004] NSWSC 625 (16 July 2004) the issue was again considered.

The case concerned a dispute between a franchisor and franchisee concerning the termination of a franchise, restraint clauses in the franchise, the validity of the agreement and a renewal and the lease associated with the franchise.

One issue in the litigation was whether the franchisor had breached the Code provisions regarding disclosure and if so, what resulted from that breach. In particular, the Court was asked to consider whether the franchise agreement became unlawful and unenforceable against the franchisee and whether a breach of the Code prevented the franchisor recovering franchise fees.

At paragraph 7, the Court considered whether the franchisor had produced a document in compliance with clause 11(2) of the Code. It held that “On balance I find that the document was not received by TCS.

Nevertheless, I find that Mr and Mrs Shah did receive advice from an independent solicitor and an independent accountant, the latter also producing a business plan. This would, in my view, suffice to satisfy s11(2)(b) if the statement had been signed and received.”

At paragraph 41, the Court referred to the interaction between relevant sections of the Trade Practices Act and the Code and held as follows:

“Section 51AD does not make contracts made in contravention of the Code illegal. The section, like s51AC, is addressed to conduct. The matter is really determined by a consideration of Pt IV of the Act. Section 52 prohibits certain conduct; s51AD prohibits certain conduct; s51AC prohibits certain conduct; s51AA prohibits certain conduct. For all breaches Part VI remedies are available, including a power to declare a contract void. If it is void as illegal, there is no need for this. The argument must fail. If it had succeeded it is difficult to see how it could assist the franchisee. No other claim for damages is clearly articulated by the cross-claim but in any event no damages are shown to have been suffered as a result of non-compliance with the Code. It is true that franchise fees were paid but on the evidence a profit was made so that no order would be made for return of the franchise fees.”

The Court also held at paragraph 44 that “The franchisee and Mr and Mrs Shah were not in any position of disadvantage when they entered into the franchise agreement. They had proper advice from their solicitor and from their accountant. They purchased the business from Mr Pallot of their own volition.”

In Master Education Services v Ketchell [2006] NSWSC 28 (10 February 2006), the franchisor had sued for recovery of unpaid franchise fees in the Local Court in New South Wales. One aspect of the defence to that action was an allegation that the franchisor had failed to comply with clause 11(1) of the Code. It was alleged that non-compliance with the Code was a contravention of the Trade Practices Act that dis-entitled the franchisor to receive non-refundable money under the franchise agreement, such as franchise fees.

The Magistrate decided that the defence should succeed and the decision was appealed to the New South Wales Supreme Court.

It was held by the Supreme Court that there is judicial authority for the proposition that non-compliance with the provisions of clause 11(1) does not render franchise agreements illegal. (The Cheesecake Shop v A & A Shah Enterprises (2004) NSWSC 625 cited with approval). The Court decided that non-compliance with the Code therefore did not render the receipt of non-refundable payments illegal.

Conclusions

Franchisors should make prospective franchisees seek independent legal and accounting advice for a number of reasons. The Code requires that this be done as a matter of law. Moreover, all relevant decided cases on point stress that a franchisee who has sought such advice will find it harder to allege that they were misled by a franchisor into entering into the franchise agreement in the first place. Lastly, compliance with the Code is also an important (but not always essential) factor in determining whether contractual rights under a franchise agreement may be enforced by a franchisor.

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