Updating Disclosure Documents - more than an annual event
When the Franchising Code of Conduct (“the Code”) came into operation in 1998 and it was clear that a franchisor had to create a disclosure document and update it annually, it was thought that once the annual disclosure document was created, multiple copies could be printed and put on the shelf to be handed out to prospective franchisees when required, with the only variant being disclosure under item 11.2 relating to whether the site or territory to be franchised had been subject to a previous franchise.
How things have changed since 1998!
Firstly, in 2001 clause 6A was inserted. After an amendment in 2010, it now reads: “The purposes of a disclosure document are: (a) to give to a prospective franchisee, or a franchisee proposing to enter into, renew, extend or extend the scope of a franchise agreement, information from the franchisor to help the franchisee to make a reasonably informed decision about the franchise; and (b) to give a franchisee current information from the franchisor that is material to the running of the franchised business.”
Secondly, in 2010 the Code was amended to require franchisors to attach to their disclosure document the franchise agreement in the form in which it is to be executed by the franchisee. This amendment:
• outlawed the previous practice of franchisors attaching their standard pro forma franchise agreement (with no schedule items completed); and
• essentially meant that if the terms of the franchise agreement were amended by negotiation after the disclosure document was given to the prospective franchisee, another disclosure document attaching the amended franchise agreement had to be given at least 14 days before that franchise agreement was signed.
Now, a recent decision of the Federal Court of Australia highlights the need for franchisors to consider whether the entire contents of their disclosure document are up to date and not misleading or deceptive, the disclosure document is issued to a franchisee or prospective
Spar Licensing Case
On 15 October 2012, Justice Griffiths of the Federal Court delivered judgment in SPAR Licensing Pty Ltd & Anor v MIS Qld Pty Ltd & Ors  FCA 116. Although this case also involved issues pertaining to anti-competitive exclusionary provisions, the focus of this article is limited to those aspects of the case which dealt with the Code and misleading and deceptive conduct issues.
This case arose out of a desire by a franchisee (“MIS”) to exit a franchise agreement with a franchisor (“SPAR”) before the end of the term to join a rival of SPAR, Metcash/IGA (“IGA”). SPAR sought to hold MIS to the franchise agreement on the basis that its terms did not give MIS a right to terminate the franchise agreement.
MIS resisted the claim on a number of grounds. It firstly argued that there was an implied term that it could terminate the franchise agreement or that some right existed at common law. The Court rejected these arguments.
MIS also resisted the claim on two further bases:
1. SPAR’s disclosure document was deficient; and
2. It was induced to enter into the franchise agreement by misleading and deceptive conduct of SPAR, and that these breaches of the Code and the Australian Consumer Law were of such significance and character that the Court should either set aside the franchise agreement or vary it so as to give MIS a right of termination.
Facts relevant to disclosure document
In this case:
• 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);
• 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 between 21 July 2010 and 1 February 2011; and
• The financial position of SPAR had significantly deteriorated after 31 August 2009.
Ruling on disclosure document issue
Justice Griffiths held that SPAR had breached its Code obligation to give MIS a current disclosure document. He said: “ …In my view, no assumption should be made that a single disclosure document created within the stipulated four month period after a financial year end (and where there is an existing franchisee) necessarily satisfies the obligation to provide a current disclosure document to a prospective franchisee.
In particular, I do not accept the implication of SPAR’s argument that a disclosure document created within the stipulated four month period where a franchise agreement already exists, is also necessarily “a current disclosure document” in the circumstances of a case such as the present. In my view, this question must turn on the particular circumstances of any case, as well as on the need to give effect to the stated purposes underlying the disclosure document regime. In this case there was a delay of more than six months between provision of the disclosure document and execution of the Franchise Agreement. The relevant financial statements were finalised in about the middle of that period. They were available to the franchisor for about four months prior to the Franchise Agreement being executed by the
parties, but those financial statements were not disclosed to MIS, nor was MIS provided with any solvency statement signed by at least one of the franchisor’s directors in respect of the financial year ended 30 June 2010, nor any supporting independent auditor’s report.
As noted above, the purposes of the disclosure document (as declared in clause 6A) are to help a franchisee (including a prospective franchisee) to make a reasonably informed decision about a franchise and to give the franchisee (including a prospective franchisee) “current information” regarding the franchisor which is material to the running of the franchised business. There is a clear risk that those purposes may not be achieved if a prospective franchisee is provided with a disclosure document which does not contain current and prescribed information concerning such a centrally important matter as the solvency and financial position of the franchisor to enable the prospective franchisee to make an informed decision whether or not to enter into a franchise agreement…
In circumstances where the Franchise Agreement between SPAR Licensing and MIS was not executed until 1 February 2011, I consider that SPAR Licensing was obliged to create and provide MIS with a disclosure document which contained the required financial information pertaining to SPAR Licensing (either independently or, where appropriate, as part of a consolidated group) which was current at the time MIS’s directors were determining whether or not to sign the Franchise Agreement...
If MIS had entered into the Franchise Agreement shortly after being provided with the Disclosure Document around 21 July 2010 (noting of course that some allowance would need to be given to the minimum 14 day period which has to be provided to a prospective franchisee to enable it to absorb the material it receives from the franchisor and to enable it to obtain relevant advice), it may well be that the Disclosure Document would have been compliant.”
Justice Griffiths also held that this breach was serious enough to justify him varying the franchise agreement to permit MIS to terminate the franchise agreement upon payment of certain fees.
Misleading and deceptive conduct claim
The alleged misleading and deceptive conduct comprised representations 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 of SPAR seeking to hold MIS to the franchise agreement and preventing it from converting to IGA.
Ruling on misleading and deceptive conduct claim
Justice Griffiths held that:
• These representations were in fact made;
• They were misleading and deceptive (as evidenced by SPAR seeking to hold MIS to the franchise agreement and preventing it from converting to IGA); and
• MIS relied upon those representations in signing 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.
It could be suggested that this is a unique case, one where there was a long period of time between the provision of the disclosure document and the signing of the franchise agreement, with a deterioration of the franchisor’s financial position in the interim.
But I believe this decision has broader application. It emphasises the point that franchisors cannot give franchisees or prospective franchisees disclosure documents that fly in the face of reality.
For example a disclosure document created on 31 October 2012 might say there have been no franchise terminations in the past 3 completed financial years, but in the period from 31 October 2012 there may have been a high percentage of franchisees exiting the network. Although it might be factually correct that there have been no franchise terminations in the past 3 completed financial years, the failure to disclose the high percentage of franchisees exiting the network after 31 October 2012, would give a prospective franchisee the wrong impression and does not fulfil the stated purpose of a disclosure document as set out in clause 6A of the Code. It is also potentially misleading and deceptive.
Another example arises where, in the period between the annual update and the handing out of a disclosure document to a prospective franchisee, the franchisor’s territory selection policy has significantly changed such that the prospective franchisee might be misled as to the level of territorial protection it might receive.
Many more examples of changes that might have occurred post the annual update but before the handing out of a disclosure document to a prospective franchisee can be envisaged. You only need to look at each item of the disclosure document and realise that if it is not up to date at the time it is handed out to a prospective franchisee, there is a real risk the disclosure document will give the prospective franchisee the wrong impression and not fulfil the stated purpose of a disclosure document as set out in clause 6A of the Code and/or be misleading or deceptive.
Therefore, the formal requirement that franchisors update their disclosure document annually not later than 4 months after the end of the financial year, must be seen as an absolute minimum requirement.
The Code has now been operating for 14 years. It is incumbent on franchisors to know every aspect of disclosure as second nature. Franchisors should be able to recite each item of disclosure without need to refer to the Code and be alert to anything that may occur in their business that might cause the disclosure document to convey the wrong impression. They should amend, or instruct their solicitors to amend, their disclosure document accordingly.
It is important that franchisors seek legal advice in relation to their disclosure document obligations in the light of this decision.
Philip Colman is a Principal at Mason Sier Turnbull, a law firm renowned for its franchising expertise.
Located in Melbourne’s industry heartland, Mason Sier Turnbull has strong commercial law skills and provides clients with sensible solutions.
Contact Philip Colman:
Phone: 03 8540 0240