MISLEADING CONDUCT
Prospective franchisees need to understand the laws that apply to conduct that is fraudulent, misleading or deceptive.
Legal pointers that can help you avoid deceptive conduct.
Many disputes and court proceedings in franchising involve allegations of misrepresentation or misleading or deceptive conduct on the part of a franchisor – specifically, allegations the franchisor misrepresented potential earnings and profitability of a franchise business.
To avoid being misled it is important for prospective franchisees to understand the various laws that apply to conduct that is fraudulent, misleading or deceptive.
Under Australian Consumer Law (ACL), the Competition and Consumer Act 2010 (CCA) prohibits conduct by corporations in trade or commerce that is misleading or deceptive, or is likely to mislead or deceive. A violation of the
ACL can expose a franchisor to pecuniary penalties, but also – and more importantly – civil liability to pay compensation to a franchisee affected by the misleading and deceptive conduct.
Franchisees may also seek the intervention of the Australian Competition and Consumer Commission (ACCC) if the misleading or deceptive conduct provisions of the CCA have been breached.
Under common law, a right to terminate the franchise agreement may exist where the party has entered into the franchise agreement induced by a false representation. To have a valid claim for misleading or deceptive conduct, a franchisee must prove that: the conduct was misleading and/or deceptive; was relied upon by the affected party; and
caused loss.
However, if the conduct is a representation or statement about a future matter (such as an income projection), the ACL deems this to be misleading and/or deceptive, unless the franchisor can prove that the representation or statement was based upon reasonable grounds.
BELIEVED TRUE
With misrepresentation at common law, it is a defence if the person making the statement can show that he or she believed on reasonable grounds that it was true, or that someone else made the statement without reason to know it was not true.
The above laws also apply to vendor franchisees who may sell their franchised business to a new franchisee and provide misleading information about the potential earnings and profitability of a franchise business.
It is critical 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 documents provided by a vendor franchisee, such as turnover information. If information is shared verbally, the franchisee should make a written note of the information. Financial and legal advice should be sought in relation to the information provided, and in particular as to whether changes should be made to the franchise agreement or sale-of-business agreement to reflect any representations made.
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 at any stage, the parties could well find themselves before a court some day with a “he said, she said” argument.
QUERY METHODOLOGY
If an income projection has been given, a prospective franchisee should query the methodology of the projection and request copies of records and supporting documents.
Australia’s Franchising Code of Conduct imposes obligations on franchisors who want to provide an income projection to a prospective franchisee. The franchisor’s disclosure document requires disclosure of:
• the facts or assumptions on which the
projection or forecast is based
• the extent of inquiries 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.
Some franchisors do not give projections but rather historical information (past sales figures), but even this information can be misleading. Even though the information provided might be factually accurate, if it is provided to a franchisee buying a “greenfield” franchise (a franchise in a new location) the franchisee may be led to believe their franchise will perform at the same level.
ORDERED TO PAY
A misleading and deceptive conduct case involved Coverall Cleaning Concepts, a commercial cleaning franchise in Victoria. The ACCC 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 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 judgment was that Coverall engaged in misleading conduct and breached the code by providing earnings information that was not based on reasonable grounds. Coverall was ordered to pay the franchisees compensation of about $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 in 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.
Although the franchisees in this case were financially recompensed, they paid a high price in that they lost time and money from the business venture and also became involved in a legal dispute.
Accordingly, it is important franchisees seek appropriate advice. They should never rely on representations regarding the projected income and profitability of a franchise, but undertake their own due diligence and investigations and not hesitate to question a franchisor or vendor franchisee about information provided.
Although the franchisees in this case were financially recompensed, they paid a high price in that they lost time and money from the business venture and also
became involved in a legal dispute.