Most people purchase a franchise with the hope of starting a profitable business. However, if you purchased a franchise because you relied on statements by the franchisor that the business is profitable when in fact it is not, you may be able to sue to recover the profit you have lost. This article will explain when a statement is a misrepresentation and the kind of losses that may be recoverable if you are successful in a misrepresentation claim.

Before Entering a Franchise

Franchisors generally make promises about profit before a franchisee purchases a franchise. The expected performance of the franchise is commonly a major selling point. The potential buyer (or prospective franchisee) will often ask the franchisor about what they can expect from the business and will often ask about the operational costs and revenue. Therefore, the way the franchisor represents profitability can be very influential on the franchisee’s decision to enter into a franchise. These enquiries and discussions are often verbal.

Do not treat verbal statements as binding because they often are not. Especially if the documentation contains disclaimers regarding representations made, any verbal statements will not have much weight in a claim for misrepresentation.

In addition to verbal representations, the franchisor also has disclosure obligations at law. Usually, the documents which support the verbal representations (the franchise agreement and disclosure document) will be sent out sometime after the initial discussions. As a result, it is possible that the documents do not match up with what was said in person.

Confirm Representations Made by Your Franchisor

The best way of confirming your expectations would be to obtain actual sales and profit figures from actual operating stores. Alternatively, you can contact other franchisees to obtain real information about how they are performing. Understandably, some franchisees will be performing better than others. However, if no franchisees respond to your queries or if many voice complaints, this may be a cause for concern.

Franchisees should undertake appropriate due diligence before entering into a business. Due diligence is the process you should go through before purchasing a business or franchise to assess the business and its risks. You should inquire about the:

  • viability of the franchise model;
  • success of existing franchises; and
  • future direction of the business.

It may also be a good idea to seek independent legal and accounting advice.

Misrepresentation

Misrepresentation is a legal principle in contract law. You may be able to make a claim of misrepresentation and claim compensation to recover your loss if you can establish that:

  • the franchisor lied about something before you signed the contract;
  • the lie was intended to get you to buy the franchise business;
  • what the franchisor lied about was important to you; and
  • you signed the agreement because of the lie.

For example, a franchisor of a cafe tells the franchisee that the cafe generates $2 million per year, when, in fact, it is running at a loss.

The franchisee sees the potential in the cafe and is excited by the fact that it is already turning over $2 million per year. She was considering buying another business, but it was only generating $1.5 million per year. As a result, the franchisee decides to enter into the franchise agreement and signs the documents provided by the franchisor. Three months later, the franchisee finds out that the business is actually operating at a significant loss, and decides to bring a claim for misrepresentation. The franchisee would likely have a successful claim for misrepresentation and be able to claim compensation.

How to Avoid Misrepresentations

There are several things you can do to protect yourself against franchisor’s misrepresentations. You can:

  • insist that all records, figures and statements about revenue or profit are in writing;
  • note down the representations made by the franchisor whenever you have important negotiations or conversations, including the:
    • time,
    • date; and
    • substance of the representation;
  • get as much information in writing from the franchisor as possible; and
  • ask for data, facts and figures about existing franchisees, instead of relying on projections.

Further, you can cross-check this data by contacting existing franchisees. Let them know that you are looking to purchase a franchise and that the franchisor has told you they are making a specific amount of money. They may be willing to clarify whether they are actually making that amount of money.

How to Recover Losses

The Franchising Code of Conduct regulates franchise disputes. The Code emphasises that parties should attempt to negotiate and resolve disputes between themselves before escalating matters to court.

You should follow the Code’s guidelines when trying to recover losses you have suffered as a result of the franchisor’s misrepresentations. There are a few reasons for this. Firstly, you may reach a more cost-effective settlement outside of court and save money on legal proceedings. Secondly, if you wish to continue operating your franchise you will want to preserve your relationship with the franchisor.

If your case is successful, the compensation you would receive is determined by reference to the position you would have been in if the franchisor had not made the representations.

For example, you may receive compensation for the expenses you incurred as a result of entering into the franchise agreement.

When negotiating, you can leverage the strength of your case in order to demand a similar amount of damages as would be awarded if the case was in court.

Returning to the cafe example above, the franchisee would have a strong claim for compensation if they can prove the misrepresentation with certainty. This might involve pointing to the specific dates and times the representations were made, and stating exactly what was said.

How Much Compensation Can I Claim?

In calculating how much compensation you can claim, you will likely need to detail the loss you suffered as a result of entering into the franchise. This may include the:

  • fees involved with starting the business;
  • difference between actual earnings and projected earnings; or
  • other costs associated with purchasing the business.

It is worth noting that you do not need to come to an exact figure. If you want to maintain a positive relationship with the franchisor, think about more creative solutions.

For example, you may request:

  • a smaller amount of compensation;
  • a reduction in royalties or franchise fees for a few years; and
  • an extension of the term of your franchise agreement.

When it comes to negotiating a position, it is worthwhile looking at alternatives to going to court. This is because going to court can be a costly and very time-consuming undertaking. In addition, it could damage your relationship with your franchisor. Conducting thorough due diligence before entering into the franchise agreement will help prevent such issues from arising.

Key Takeaways

If your franchisor has made misrepresentations about the franchise, you may be entitled to compensation for the loss you suffered as a result. There are steps that you can take to avoid this happening, including conducting thorough due diligence and requesting as much information as possible in writing. If you have suffered loss, negotiating and resolving the dispute outside of court may be a cheaper and more effective way to resolve the issue. If you have any questions about your franchisor’s potential misrepresentations, get in touch with LegalVision’s franchise lawyers on 1300 544 755 or fill out the form on this page.

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