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Before purchasing a franchise business, the potential buyer (or ‘prospective franchisee’) will usually ask a number of questions about the nature of the business, the work involved, and what they can expect. These questions may relate to possible profits or the level of training and support that the franchisee can expect to receive. The franchisor’s answers to these questions are important. They help the buyer decide whether to continue with the purchase and officially become a franchisee. They can also, unfortunately, set the scene for disagreements. This article looks into the type of comments that can land franchisors in hot water and facing a claim of ‘franchisor misrepresentation’.

Understanding Franchisor Misrepresentation

Misrepresentation is a principle in contract law. The rules around misrepresentation are not defined in any legislation. Instead, courts have developed the rules over the years.

At a very basic level, there may be a claim of misrepresentation against a franchisor if:

  • the franchisor lied about something;
  • the lie was told before the franchisee signed the contract (the franchise agreement);
  • the franchisor lied so that they could get the franchisee to buy the franchised business; and
  • what the franchisor lied about was important to the franchisee and the franchisee signed the franchise agreement because of the lie.

Let us look at each of these points in turn.

The Franchisor Lied About Something

If a franchisee is trying to sue a franchisor for misrepresentation, they need to show that what the franchisor said was, in fact, false. For example, a franchisor said that the person who operated the fast-food franchise previously was making $1 million in profit in the second year of operating. After buying the franchise, the franchisee finds out that the store was actually making a loss in the second year. This would be a false representation.

The Franchisor Lied Before the Franchisee Signed the Franchise Agreement

A franchisee can only claim misrepresentation about conversations that happen before the parties sign the legal documents. This is what lawyers refer to as the ‘pre-contractual’ stage.

The Franchisor Lied to Get the Franchisee to Buy the Business

To have misrepresented the franchisee, the franchisor must have lied to get the franchisee to sign on the dotted line. The critical point here is that the franchisor wanted the franchisee to buy the business. They made a promise or a comment to convince the franchisee that it was a good opportunity.

However, the franchisee does not necessarily need to show that the franchisor was trying to ‘deceive’ or ‘defraud’ them. Rather, the franchisee needs to show that the franchisor was trying to get them to sign onto the franchise network.

The Lie Was Important to the Franchisee

The franchisor’s lie must have influenced the franchisee’s decision to buy the business. It is not enough to show that the franchisor lied and that they lied to close the deal. You have to go one step further. You do this by showing the franchisee would not have signed the contract if the franchisor had not made the (false) promise.

If the lie was about something that was not at all important to the franchisee’s final decision to buy, a claim of misrepresentation might be unsuccessful. On the other hand, say the franchisor promised the franchisee that they would only have to commit 20 hours per week to the franchise. This was important to the franchisee as they had other businesses. If the franchisee had to work 50 hours each week on the franchise, the franchisee might be able to bring a claim of misrepresentation.

Most Common Claims

We usually see allegations of misrepresentation in relation to money. A franchisor may have provided an estimate of likely profits or a prediction as to the level of growth the franchisee could expect over the years.

Both parties to the contract should be very careful about statements containing financial information. In particular, if you are receiving or providing projections, the Franchising Code of Conduct says that the forecast or projections must contain certain details, such as the assumptions upon which they are based. For this reason, a qualified account should prepare and review all information about the earnings of a franchise business.

Key Takeaways

If you are a franchisor, be careful about the promises you make franchisees to get them over the line. It can be easy to get excited and exaggerate the opportunity offered by your franchise network. What might seem like a white lie at the start can turn into a serious legal claim.

If you are a franchisee, obtain legal, accounting and business advice on the franchise opportunity. Experts in these areas can objectively identify the risks and advantages of the franchise.

If you need assistance, whether you’re making, or defending, a possible misrepresentation claim, contact LegalVision’s franchise lawyers today on 1300 544 755 or fill out the form on this page.

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