What is misleading conduct in franchising?
Many disputes and court cases in franchising involve allegations of misleading or deceptive conduct on the part of a franchisor during the recruitment process.
The cases often arise as a result of a franchisor making a statement to a prospective franchisee about the likely projected income of a franchise, usually as a result of questions from a prospective franchisee such as "how much will it cost me" and "how much will I make?"
These questions are not unreasonable questions from a prospective franchisee and answers from the franchisor such as "I can't tell you anything" or "You will need to do your own due diligence" may cause a prospective franchisee to walk away. Therefore, it is often tempting for a franchisor to make statements about the projected income or profit of a franchise.
Some franchisors give historical information (actual past sales results) thinking that this is safer.
But even information that is historical and factually accurate can be misleading or deceptive. For example, a prospective franchisee of a greenfield (new) site in a strip location in Hobart who is provided with the actual sales results for a franchise at large shopping centre in Melbourne, without any explanation of the differences between the two sites, may be misled.
Misleading or deceptive representations may also be made by an existing franchisee to a buyer of their business.
To have a valid claim a franchisee must prove that:
- the conduct that occurred and was misleading and/or deceptive;
- was relied upon by the affected party; and
- caused loss.
However, if a representation or statement is about a future matter (such as an income projection), the Australian Consumer Law deems this to be misleading and/or deceptive, unless the franchisor who made the representation or statement can prove that it was based upon reasonable grounds.
It is critical that prospective franchisees keep copies of all information and documents provided by a franchisor, such as a projected profit and loss statement or projected cash flow, or by a vendor franchisee, such as turnover information.If information is shared verbally the franchisee should make a written note of the information provided.
Franchisees are often asked by a franchisor to sign a Prior Representations Deed at the same time as the franchise agreement. It is important that any representations made by the franchisor are recorded in this Deed.
If representations are not recorded, in writing, the parties may, in the future find, themselves before a court with a "he said, she said" dilemma.
The Franchising Code of Conduct(the Code) also imposes obligations on a franchisor who wants to provide an income projection to a prospective franchisee. Item 20.4 of the franchisor’s disclosure document requires disclosure of:
- the facts or assumptions on which the projection or forecast is based
- the extent of enquiries and research undertaken by the franchisor and any other compiler of the projection or forecast
- the period for which the projection or forecast relates
- an explanation of the choice of the period covered by the projection or forecast
- whether the projection or forecast includes depreciation, salary for the franchisee and the cost of servicing loans
- assumptions about interest and tax.
This Item should be examined carefully by the franchisee and the franchisee’s financial advisers.
When a franchisor ends up in court
A misleading and deceptive conduct case involved Coverall Cleaning Concepts, a franchisor operating a commercial cleaning franchise in Victoria. The Australian Competition and Consumer Commission initiated proceedings in 2014, claiming that Coverall engaged in misleading conduct and breached the Code in relation to two of its franchisees.
The Federal Court found that Coverall had made misleading representations to two franchisees about earnings they would achieve, based on their investment in the franchised businesses, and that Coverall had also failed to pay the franchisees for work they had completed, in breach of the franchise agreements.
The judgement was that Coverall engaged in misleading conduct and breached the Code by providing earnings information that was not based on reasonable grounds. The Court also found that Coverall’s failure to pay the franchisees for work they had completed amounted to unconscionable conduct.
As a result Coverall was ordered to pay the franchisees compensation of approximately $22,000 as well as their franchise fees and payment for work completed. Both franchise agreements were declared void.
A further judgment in the case handed down on 23 March 2015, dealt with the pecuniary penalties sought by the ACCC against Coverall. The Federal Court imposed pecuniary penalties of $250,000 for each of the franchisees affected by Coverall’s contraventions.
The cost of such poor conduct was significant for the franchisor, and although the franchisees were financially recompensed they too paid a high price.
Despite the existence of laws to protect prospective franchisees from misleading or deceptive conduct it is important that franchisees seek appropriate advice. Franchisees should never rely on representations regarding the projected incomeand profitability of a franchise. Franchisees should undertake their own due diligence and investigations.