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HG Alert: Franchisee unsuccessful in suing franchisor for failed business - 4 Nov 2010

A recent decision of Justice Buchanan of the Federal Court has highlighted the risks franchisees take when suing franchisors for losses arising from failed business enterprises. The case also serves to outline the inherent risks involved in starting a franchise with limited knowledge or experience in a specific industry, in spite of the statutory measures designed to protect franchisees when doing so.

Relevant conclusions

This case should serve as a timely reminder to franchisees that:

  • entry into a franchise is, like any small business, a risk for the franchisee and it needs to protect itself from the possibility of genuine misrepresentations and unconscionable conduct on the part of the franchisor;
  • a prospective franchisee cannot simply rely on the statutory framework as the ultimate protection against an unscrupulous franchisor; and
  • they must ensure that they take care in their negotiations with franchisors, obtain independent financial and legal advice on their business plan and that any representations upon which they have relied to enter into the franchise are adequately recorded in their franchise agreement.

Equally, a franchisor needs to protect itself from the inevitability that some franchisees will fail and will seek to pass the blame for that failure onto the franchisor. To protect itself, the franchisor should:

  • seek to enhance its protection by relying upon statements in letters to the franchisee of the kind the Bank used in this case; and
  • rely upon the actions of the franchisee in preparing a business plan and obtaining independent advice on the viability of their business.

Background

The recent case of Astram Financial Services Pty Ltd v Bank of Queensland Ltd has indicated that the relevant facts of a franchise, when read as a whole, are most likely to determine its outcome, not the legislation relied upon by the franchisee.

In this case, a former franchisee of the Bank of Queensland, known as Astram Financial Services Pty Ltd, and the director of the franchisee, Leicester Ramsey, sought relief for alleged breaches of sections 52 and section 51AC of the Trade Practices Act.

Allegations of misleading and deceptive conduct

Mr Ramsey alleged that representatives of the Bank had made a number of misrepresentations to him (and to his former business partner) relating to:

  • the expected turnover for the prospective franchise;
  • the ability to achieve the expected turnover;
  • the belief that the expected turnover would be sufficient for the prospective franchise to break even;
  • the amount of working capital that would be required by the prospective franchise; and
  • corporate and local area marketing to be undertaken.

Mr Ramsey alleged each of these misrepresentations was made during introductory meetings between various representatives of the Bank and Mr Ramsey (and in some cases, Mr Ramsey and his former business partner). Mr Ramsey also alleged that the misrepresentations were made with respect to future matters and that the Bank had no reasonable grounds for making these representations within the meaning of section 51A of the Trade Practices Act.

Mr Ramsey alleged that he (and Astram) relied on each of these misrepresentations for the purposes of entering into a franchise agreement with the Bank and to enter into other ancillary documents relating to the franchise.

Mr Ramsey later incorporated Astram as the vehicle to operate his franchise and opened a franchise of the Bank at Campbelltown in New South Wales in August 2005. Astram's business subsequently failed in August 2006.

Misleading and deceptive conduct: conduct of the franchisor as a whole

Astram's and Mr Ramsey's case sought to have the Court focus on the alleged misrepresentations made at introductory meetings and attempted to give those alleged misrepresentations prominence over all other commercially significant events which transpired.

In his judgment, Justice Buchanan rejected this approach on the basis that it was "seriously flawed", "uncommercial" and "contrary to principle". His Honour held that "It [was] well established, for the purpose of the operation of section 52 of the Trade Practices Act, that the conduct of a party must be assessed as a whole."

In particular, His Honour referred to letters provided to Mr Ramsey and/or Astram in which the Bank disclaimed liability for predictions about matters like costs, revenue and future profitability of the franchise. Relevantly, the Bank disclaimed liability in these letters by repeatedly stating that it could not give "assurances", "make predictions" or "make representations" regarding each of these matters.

His Honour also referred to statements in those letters where the Bank encouraged the prospective franchisee to obtain independent financial and legal advice and to prepare their own business plan so that they could satisfy themselves as to the financial viability of the business.

Justice Buchanan held that because Mr Ramsey had then prepared his own business plan, obtained independent financial and legal advice on that plan and had the benefit of reading each of the letters prior to entry into the franchise agreement, he (or through him, Astram) was not misled by the Bank.

Alternative claim for unconscionable conduct

In addition to rejecting the claim for relief for misleading and deceptive conduct against the Bank, Justice Buchanan also rejected Mr Ramsey's and Astram's alternative claim for relief for unconscionable conduct. His Honour determined that Mr Ramsey and Astram had failed to establish that the Bank's conduct involved a "high level of moral obloquy" or was "highly unethical".

His Honour held that there was no basis for him to conclude that the Bank was responsible for the business decisions made by Mr Ramsey and that, while the Bank was astute enough to protect its own interests in the transaction, the fact that "things proved to be more difficult than [Mr Ramsey] assumed does not suggest that there was any unconscionable conduct on the part of the Bank".

As demonstrated by this decision, inherent tension between the rights and interests of franchisors and franchisees mean there will nearly always be two sides to every story in a franchise dispute, and while the statutory protection in place for franchisees will provide some assistance, it will not overcome facts which, as a whole, do not support the claims made.

As at the date of publication of this article, the Federal Court website records that Astram and Mr Ramsey are appealing this decision.

For more information, please contact HopgoodGanim's Litigation and Dispute Resolution team.