What is a franchisee acquiring: business system or business potential?
by
Norton Rose
Business format franchising is the standard franchise model today. The term itself eloquently expresses the concept and explains the reasons for its pre-eminence - the franchisor provides an entire business format and management system in addition to brand and rights to produce or supply the system’s product or service.
The key issue of what a franchisee actually acquires under a franchise agreement was recently considered by the Federal Court in Bannerhey Pty Ltd v 1800 000 000 Pty Ltd [2008] FCA 53. The franchisor "owned" the telephone number 1800 000 000 and the domain names 1800000000.com and 1800000000.com.au and granted exclusive rights to master licensees for these numbers / names in New South Wales and Queensland. The master licence opportunity was advertised in laudatory terms:
This is a rare opportunity to play a key role in expanding what is destined to become one of Australia’s most successful franchise systems. Initial investment requirements of circa $400,000 are expected to generate unmatched returns and business growth.
The main complaint of those who acquired master licence rights was the alleged lack or absence of a business system or model which could be applied in promoting sales of sub-licences. The action was based on misleading conduct – that the state master licensees had been misled by representations made in conversations and meetings and otherwise. The Franchising Code of Conduct was, apparently, complied with and there was no allegation of breach of contract.
The main complaint of those who acquired master licence rights was the alleged lack or absence of a business system or model which could be applied in promoting sales of sub-licences. The action was based on misleading conduct – that the state master licensees had been misled by representations made in conversations and meetings and otherwise. The Franchising Code of Conduct was, apparently, complied with and there was no allegation of breach of contract.
Edmunds J found "the whole concept of a business system model to be elusive":
At one level it was nothing more than the ideas and concepts that the Jacobsons had in mind as to how the telephone number 1800 000 000 might be best promoted and marketed to maximise returns. At this first level, the system or model not only existed, but its structure and content were largely conveyed … prior to the signing of the Master Licence Agreement. At another level, it was the manifestation of those ideas and concepts in a material form which could be utilised as promotional and marketing tools – to assist State licensees, in their selling enterprises. At this level, they did not exist at the time of the signing of the Master Licence Agreement although they did by early 2002. The elusive nature or character of the system or model stemmed from the impression drawn from evidence that a system was represented to exist, but was not forthcoming, at a higher level, although this higher level was never articulated.
The judge concluded that: …
the applicants in both proceedings entered into their respective Master Licence Agreement not in reliance on misleading and deceptive conduct on the part of the respondents, but in reliance on their attraction to the telephone number and their respective perceptions, based on their successful experiences in franchise operations, of its potential to make money.
There is no doubt that their attraction and interest in this regard was fostered and promoted, indeed flamed, by the enthusiasm of the respondents for the number and the underling concepts and ideas the respondents had in mind for its exploitation, in particular the unit sub-licensing system. But it was only when the applicants in both proceedings realised that that potentiality was as ‘dead as a doornail’ that they formed the view they had been misled and deceived. Prior to that time they were ready, willing and able to sell ‘the product’ into the market in respect of which their monopoly existed, and attempted to do so.
I have no doubt that the respondent … through his enthusiasm for ‘the product’ and his belief in what he perceived to be its inevitable success made boasts in relation to its potentiality which went beyond the truth. But I also believe that the applicants in both proceedings recognised these boasts for what they were and did not rely on them for that reason or because they knew them to be false. But I am not prepared to find that the initial false claim, known to be such by the applicants in both proceedings at the time they entered into their respective Master Licence Agreements, in some way infects or otherwise stains the findings I have otherwise made on the balance of the pleadings in the fact of the evidence.
The case is a compelling reminder that damages for misleading conduct require more than proof that misleading representations were made. It must also be proved that the franchise agreement was entered into in reliance on such representations. The applicants' failure to so prove was fatal to their recovering damages in this case.
Deacons is Australia's leading franchise law firm, with offices in Melbourne, Sydney, Perth, Brisbane, Canberra and in 11 locations in Asia. We have assisted over 200 franchise companies, from large international corporations to start up franchisors. We do not handle franchisee matters. 18.06.2008
FCA Member
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