Recent high-profile cases involving misleading information from franchisors to franchisees serve as a stark reminder for both parties involved in the franchise agreement. Franchisors must be incredibly cautious in their communication during pre-contractual negotiations to avoid misleading potential franchisees. Franchisees, on the other hand, should pay close attention to any promises made by the franchisor before signing the agreement. Failing to do so could mean discovering later that they were misled. This article will delve into a recent case, Girchow Enterprises Pty Ltd v Ultimate Franchising Group Pty Ltd (Final Hearing) [2023] FCA 420 (UFC Gym case), to illustrate how misleading conduct can unfold in franchising. Additionally, it will discuss the consequences for both franchisors and franchisees.
What Is Misleading and Deceptive Conduct?
The Australian Consumer Law (ACL) states that “a person must not, in trade or commerce, engage in conduct that is misleading or deceptive or is likely to mislead or deceive”.
Claims for misleading and deceptive conduct commonly arise in the context of commercial negotiations made before the parties have entered into the relevant contract (for example, a franchise agreement). To establish misleading or deceptive conduct, the following must be present:
- commercial activity between the parties;
- conduct that was, in the circumstances, misleading and deceptive;
- reliance on that conduct; and
- loss suffered as a result of the conduct.
If one tells a franchisee they will make a certain amount of profit in their first year, this is considered a representation about a future matter. Such a representation is misleading and deceptive unless the person making the claim has reasonable grounds to do so.
The UFC Gym Case
Background
In the UFC Gym case, three separate franchisees brought a case against the franchisor. They alleged that prior to entering into their respective franchise agreements, the franchisor made multiple misleading representations to them. These representations were both oral and written, and included:
- representations about how much the initial start-up costs required to set up the business would be (the actual costs incurred were far greater);
- that the franchisor had preferential agreements with suppliers;
- cash flow forecasts provided to franchisees representing their projected revenue for the first 12 months; and
- statements that the franchisor had a proven business model in Australia and that other UFC gym franchisees were profitable.
The Trial
At the trial, the judge had to determine whether the representations were made, whether they induced the franchisees to enter into their respective franchise agreements and whether the representations were false and/or there was no reasonable basis for making them.
At the trial, the judge was required to determine three primary matters:
- Were the representations made?
- Did the representations induce the franchisees to enter into their franchise agreements?
- Were the representations false, or was there no reasonable basis for making them?
The facts presented to the court stated that:
- the representations were made verbally and in writing;
- the representations did induce the franchisees to enter into the franchise agreement; and
- there was no reasonable basis to make the representations.
It was found that:
- the franchisor had demonstrated no evidence as to how the range of projected start-up costs was calculated;
- rather than having a preferential deal with suppliers, the franchisees were paying significantly marked-up prices for their equipment;
- there was no reasonable basis for the franchisor to rely on the figures used in their cash flow forecasts; and
- the representations made that UFC Gyms was a proven business and that Australian franchisees were profitable were misleading and deceptive. This is because multiple UFC Gyms franchisees were not profitable at the time of the representations.
What Does This Mean for Franchisors?
If you are a franchisor, exercise caution when making claims to potential franchisees without solid evidence to back them up. Overly ambitious projections about their potential profits or downplaying setup costs can induce them to sign the agreement.
If these statements turn out to be misleading, you may be held liable for any losses suffered by the franchisee. The UFC Gym case exemplifies this. The court ordered the franchisor to pay a combined $5 million to the franchisees.
Be aware that clauses in your franchise agreements attempting to waive pre-contractual representations might be unenforceable. Ultimately, this case emphasises the importance of avoiding any unreasonable or unsupportable representations when dealing with potential franchisees.
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Key Takeaways
As a franchisor, you naturally want to convince new recruits of your franchise’s potential. While you may showcase success stories and share optimistic predictions, be cautious not to mislead or deceive potential franchisees. Conduct that is misleading or deceptive could include:
- providing estimated start-up costs or fees the franchisee will have to incur that are lower than they actually end up paying;
- overestimating the potential profit they may be able to make by providing unrealistic forecasts and projections; or
- stating that you have preferential deals with suppliers.
If you require assistance in avoiding misleading and deceptive conduct, our experienced franchising lawyers can help as part of our LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. Call us today on 1300 544 755 or visit our membership page.
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