Lessons for franchisees from recent high profile court cases

Raynia Theodore, Principal, Mason Sier Turnbull

The 2012 calendar was a big year in franchising with a few high profile court cases decided. This article draws on a number of these cases to examine how and why franchise relationships run off the rails, how the disputes can be avoided and what lessons can be learned by both franchisors and franchisees.

SPAR Licensing Pty Ltd & Anor v MIS Qld Pty Ltd & Ors [2012] FCA 116 (“Spar Licensing Case”)

On 15 October 2012, the Federal Court handed down judgment in the SPAR Licensing Case.

This case involved a grocery franchise operated by a franchisee (“MIS”) under a franchise agreement granted by the franchisor (“SPAR”). MIS sought to exit the franchise before the end of the term to join a competitor of SPAR - Metcash/IGA (“IGA”).

The legal arguments: SPAR wanted to hold MIS to the franchise agreement on the basis that the franchise agreement did not give MIS a right to terminate early.

MIS resisted SPAR’s claim and argued as follows:

  1. There was an implied term that it could terminate the franchise agreement or that some right existed at common law.
  2. SPAR’s Disclosure Document was deficient; and
  3. It was induced to enter into the franchise agreement by misleading and deceptive conduct on the part of SPAR, specifically representations or statements by SPAR to the effect that if MIS became a SPAR franchisee and then later wanted to convert to IGA, it could terminate the franchise agreement with SPAR upon payment of certain fees. It was alleged that these representations were misleading and deceptive because SPAR later sought to hold MIS to the franchise agreement and prevent it from converting to IGA.

The key facts:

  • MIS received SPAR’s disclosure document on 21 July 2010 which contained:
  • A statement of solvency as at 31 August 2009 (Item 20.1); and
  • An auditor’s statement in support of the statement of solvency (Item 20.3) relating to the financial year ended 30 June 2009;
  • MIS did not enter into the franchise agreement until 1 February 2011, more than six months after the disclosure document was provided;
  • No updated disclosure document was given by SPAR between 21 July 2010 and 1 February 2011 despite the fact that the financial statements for the year ending 30 June 2010 became available during this period; and
  • The financial position of SPAR deteriorated significantly after 31 August 2009.

Court Ruling

In relation to the three arguments raised by MIS the Federal Court decided as follows:

  1. That there was no term in the franchise agreement that allowed MIS to terminate the franchise agreement and no such right could be implied;
  2. That SPAR had breached its obligation under the Franchising Code of Conduct to give MIS a “current disclosure document”;
  3. That the representations about the ability of MIS to convert to IGA were in fact made and such representations were misleading and deceptive (as evidenced by SPAR seeking to hold MIS to the franchise agreement and preventing it from converting to IGA) and were relied upon by MIS in signing the franchise agreement.

In light of the above the Federal Court ordered that the franchise agreement be amended to give the franchisee the right to terminate the franchise agreement.

SPAR has lodged an appeal in respect of this decision which will be heard by the Full Federal Court in late February 2013 with a decision expected later in the year.

Lessons to be learned

Whilst the franchisee succeeded in this case the case highlights the need for franchisees to conduct due diligence prior to entering into a franchise agreement and ensure that the franchise agreement accurately reflects what the parties have agreed. If the early termination right had been included in the franchise agreement the legal proceedings would have been avoided.

This case also highlights the need for franchisees to request the most up to date information from their franchisor, especially where the courtship phase is a long one.

Trans-It Freight Pty Ltd v Billy Baxter’s (Franchise) Pty Ltd [2012] VCA 71 (“Billy Baxter’s Case”)

This case involved a coffee franchise operated in Glenelg South Australia by a franchisee pursuant to a franchise agreement with the franchisor Billy Baxter’s (Franchise) Pty Ltd. The legal arguments: The franchisee in this case terminated the franchise agreement with the franchisor after the business made losses and was unable to pay its franchise fees under the franchise agreement. The franchisor sued the franchisee for the unpaid franchise fees, approximately $250,000 worth.

The franchisee argued that it was misled and deceived by representations made by a representative of the franchisor prior to entering into the franchise agreement for the site in Glenelg which was a new greenfield site.

Specifically, the franchisee argued that it was told to anticipate a turnover for the franchised business of $1.3M or at least a turnover that would support the payment of operating costs and result in a profit being made.

The store did not reach the represented turnover and the franchisee alleged that it was unable to pay the franchisor the fees due under the franchise agreement and the franchisee terminated the franchise agreement.

The franchisor accepted the franchisee’s termination as a repudiation of the franchise agreement and sued the franchisee for damages.

The franchisee issued a counterclaim alleging that they had been induced to enter into the franchise agreement based on the misleading and deceptive conduct of the representative of the franchisor and the franchisee sought compensation for its losses. The franchisor initially succeeded in the Supreme Court of Victoria, however, the franchisee appealed to the Victorian Supreme Court of Appeal where the Court found:

  1. That a representative of the franchisor had indeed made representations as to the potential turnover of the franchised business based on the location of the franchised business;
  2. That there were no reasonable grounds for the franchisor to make representations regarding the potential turnover of the store; and
  3. That the franchisee had relied on the representations in entering into the franchise agreement.

The Court awarded the franchisee damages in the sum of $1.22 million.

Whilst a good decision for the franchisee the decision is a hollow victory in that the franchisor went into liquidation shortly after the decision putting the 21 chain network at risk and the franchisee is not likely to receive the damages awarded by the Court.

Lessons to be learned

A franchisee should:

  • Keep detailed notes of all discussions with the franchisor’s representatives and where possible obtain written confirmation of any representations or promises made.
  • where projections have been given by the franchisor, the franchisee should ask the legal advice franchisor how the franchisor arrived at the projections. Ask what assumptions were made, what enquiries and research was undertaken by the franchisor?
  • even if the franchisor provides an explanation of how the projections were arrived at, franchisees should obtain independent advice from their financial adviser about the projections given and also conduct their own enquiries and investigations as to the location for the franchised business, the demographics and feasibility of the location.

Whilst the franchisees were successful in both the above cases the success was the result of long protracted court proceedings which cost them both time and money. With appropriate advice these cases could have been avoided.

Winnebago Industries, Inc. v Knott Investments Pty Ltd (No 2) [2012} FCA 785, Winnebago Industries, Inc.

A US company had manufactured and sold motor homes in the US since the 1960s. Over time it expanded its operations and sold its motor homes around the world, including in the US, Canada, the UK and continental Europe.

In 1982 Knott Investments Pty Ltd an Australian company which was not related to the US company began to manufacture and sell motor homes bearing the Winnebago name and logos developed by Knott Investments. Winnebago Industries sued Knott Investments and the Federal Court found that Winnebago Industries had acquired a sufficient reputation in the Australian market and that the conduct of Knott Investments in using the name and brand constituted passing off and misleading and deceptive conduct. The court then ordered the cancellation of Knott Investments’ registered trade mark. As a result of this case Knott Investments and its dealers would be forced to re-brand. The implication for franchising is that franchisees should ensure that their franchisors have legitimate rights to use the relevant trademarks and intellectual property of the franchise network before signing any franchise agreement. Information about the ownership of trademarks and intellectual property can be obtained from the franchisor’s Disclosure Document and from trade mark searches.

ACCC Cases

The 2012 year also saw the Retail Food Group who owns Brumby’s Bakeries having to give the ACCC a court enforceable undertaking as a result of comments made by Brumby’s managing director to its franchisees suggesting to franchisees that they blame the carbon tax for retail price increases.

The ACCC has also now instituted proceedings in the Federal Court against eleven Harvey Norman franchisees for misleading and deceptive conduct claiming that the franchisees misled consumers about their rights under the consumer guarantee provisions of the Australian Consumer Law.

The lesson to be learned from these ACCC cases is that franchisees as independent business owners must be aware of their legal obligations under all applicable laws. Franchisees should not blindly follow the franchisor’s directives and assume policies and documents such as warranty and refunds policies are correct. Franchisees should educate themselves as to their obligations under all applicable laws - whether consumer laws, employment laws or tax laws.

It appears there are more cases on the way in 2013 with franchisees of the Pie Face chain having announced they plan to sue the franchisor alleging misleading or deceptive conduct on the part of the franchisor arising from alleged financial projections given by the franchisor. The franchisor has disputed the allegations.

Tips to avoid conflict/disputes:

  • before signing a franchise agreement ask lots of questions of the franchisor and clarify any representations or statements made;
  • keep detailed notes of all discussions with the franchisor;
  • ensure that the franchise agreement includes all the terms that have been agreed upon with the franchisor;
  • get independent legal and accounting advice early;
  • obtain your own independent feasibility study or site report in respect of any premises to be leased and conduct your own due diligence in respect of the franchise network - speak to other franchisees both (existing and former) whose details should be set out in the franchisor’s disclosure document;
  • know your obligations under the laws that apply to your business - don’t just rely on the franchisor;
  • address issues of concern with the franchisor early and use the dispute resolution processes in the franchise agreement and the Franchising Code of Conduct to try and resolve any dispute.

Located in Melbourne’s industry heartland, Mason Sier Turnbull has strong commercial law skills and prides itself on providing clients with great service and sensible solutions.

Raynia Theodore, Principal in Mason Sier Turnbull’s Corporate Advisory & Franchising team.

Contact Raynia on

Phone:03 8540 0242
Email: raynia.theodore@mst.com.au
Web: www.mst.com.au