Dibbs Abbott Stillman: why franchisors must give disclosure document

According to Dibbs Abbott Stillman , franchisees of Queensland based Roadrunner Mobile Video ("Roadrunner") whose mobile home video hire franchise failed have been awarded $40,126 in damages (refunding the franchise fee, cost of equipment and services purchased by the franchisees to operate it) plus $20,000 in interest by the Federal Magistrate's Court of Australia from the system's franchisor for:

· not giving the franchisees a disclosure document, in breach of s.51AD of the Trade Practices Act 1974 (Cth) (the "Act"); and

· inducing the franchisees to enter the franchise on the basis of misleading an deceptive statements, where provision of a disclosure document would have affected their decision to enter the franchise, in breach of s.52 of the Act.

Roadrunner's managing director was also held jointly liable for his involvement in the contravention of the Act, under s.75B of the Act.

Failure to give disclosure document

Roadrunner admitted that it had not given the franchisees a disclosure document as required by the Franchising Code of Conduct (the "Code") and had therefore breached s.51AD of the Act.

Misleading and deceptive conduct

The franchisee's franchise was the first to be granted in Victoria, although a master franchisee operated in the State. The franchisees that Roadrunner had made misleading and deceptive statements about the franchise. The alleged statements, made in an advertisement for the franchise, an "Investment Guide" to prospective franchisees and in a conversation at a subsequent meeting between the parties, were that:

"Individual territories have been carefully determined by university research taking into consideration relevant demographics": In fact, this research was not a university research project, but rather a report done on the Queensland area for a previous business of Roadrunner's managing director in 1989, by university graduates. The statement was therefore misleading.

The master franchisee had purchased and was operating the master franchise in Victoria, and that the master franchisee was responsible for the promotion of the franchise system in Victoria:

Ultimately this was correct because a master franchisee had been appointed under a master franchise agreement, which provided that it was to provide promotion in the franchisee's territory (it did not imply that the master franchisee had any particular level of experience).

Franchisees of Roadrunner were making $750-$1,200 working from 25 to 35 hours a week: Roadrunner produced evidence of franchisees who were earning these amounts after expenses. As the franchisees did not produce any evidence to the contrary, it was ruled not to be misleading.

Experienced canvassers of Roadrunner would canvass customers by door-knocking on behalf of the franchisees, and 100 customers were guaranteed from that canvassing: As the area in which the franchise operated had 30,000 potential customers, there were reasonable grounds for making the statement and so it was not misleading.

Roadrunner would provide the franchises with high level of back up and ongoing support: The investment guide referred to "backup and support" being provided through regular meetings, informative newsletters and extensive advertising. In fact, there could not be regular meetings as the franchisor was based in Queensland, therefore immediate support would have to come from the master franchisee (who was less experienced); there was no evidence given about newsletters; there was no advertising done or any intention to advertise. There could be no reasonable expectation when these statements were made that they could be correct, therefore they were misleading.

Roadrunner would upgrade videos on a weekly basis at no cost to the franchisees for the first 2 months: A list of items promised to be supplied as a part of the initial franchise package included 300 videos which would be upgraded "on a weekly basis for an initial two months at no cost to you". The franchisees received only 191 videos, which they said were old or not functional. Roadrunner argued that what it had intended by its statements was that 191 videos would be provided to begin with, and then the balance at no cost over 2 months. The Court held that a reasonable expectation arising from the statements made by Roadrunner was that it would supply 300 videos initially and upgrade them weekly for 2 months. Therefore the representation was misleading.

To claim damages for a breach of s52 of the Act, the franchisees would have to show that the false and misleading representations made to them had caused them to enter the franchise.

The Court had taken from the evidence that the franchisees had decided to proceed on the basis of the documents sent to them by Roadrunner (so only the representations in the written material were relevant to the cause of their decision to sign up). The Court felt that when the franchisees made their decision to proceed, the absence of those representations (the territories not being backed up by university research, a statement that ongoing support would come from an inexperience master franchisee and the true method of how videos would be supplied) would not have changed their minds about taking up the franchise.

However, Roadrunner had:

· not provided a disclosure document at least 14 days before the franchisees entered the franchise agreement, or at all

· not sought a written statement from the franchisees that it they had a reasonable opportunity to read the disclosure document

· not obtained a written statement from the prospective franchisees that they had sought independent legal, business or accounting advice, or had chosen not to seek it despite the recommendation of Roadrunner

The Code states that the purpose of a disclosure document is given a prospective franchisee information from the franchisor to enable them to make a reasonably informed decision. The Court said, had this information been provided in a disclosure document, the franchisees would have realised that a significant number of other franchisees did not renew their franchises in the past; they would have sought independent advice and probably be been told to make their own investigations and talk to other franchisees; they would have had more time, at least 14 days, to rationally consider their decision. The Court held that the combination of these factors would have dissuaded the franchisees from entering the franchise agreement. That is, the breach of s.51AD (failure to give a disclosure document) led to the breach of s52. Because a director of Roadrunner "knew all the facts which constituted the misrepresentation" he was held to be knowingly involved in the contravention of the Act and therefore jointly liable for damages.

Roadrunner claimed that the franchisees had operated their business poorly. Although his Honour agreed that the franchisees had not followed the Roadrunner system effectively, this had only contributed to their losses, it was not the cause of them. Damages were adjusted accordingly.

Lessons for franchisors

· Give prospective franchisees disclosure documents and allow them at least 14 days to consider them: In this case the franchisees would not have been able to make out their claim of misleading and deceptive conduct, except for the fact the Code entitled them to further basic information which would probably have affected their decision to enter the franchise.

· Urge your franchisees to get independent legal advice: If the franchisees here had sought independent advice, as the Court notes, they would have been told to assess the franchise independently of the franchisor's statements, and would have alerted Roadrunner to the fact that it should provide a disclosure document. It is better to sort out any legal problems with a prospective franchisee than it is to fight it out with an ex-franchisee later.

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