Over the last couple of years, the Franchising Code of Conduct has increased the disclosure obligations on franchisors. However, franchisors have always had to make sure that, in simple terms, they deliver what they promise to franchisees.

Under the Australian Consumer Law, franchisors can be liable where they engage in misleading or deceptive conduct – which can include promising an amount of start-up costs without a reasonable basis.

The Federal Court recently found that this is what took place within the ‘UFC Gym’ system in Australia.

That system was being operated under a master franchise which began in 2015. Essentially, the franchisor was found to have made misleading or deceptive statements to three different franchisees.

While the evidence was contested and the circumstances were different, the franchisor was found to have at least misled the franchisees about how much it would cost to get each franchise up and running. There was also a misrepresentation about the existence of ‘preferential suppliers’ to keep costs low for franchisees, which in reality would only be to the benefit of the franchisor.

The Court ultimately found that, because of the misleading or deceptive statements, the franchise agreements are void and the franchisees are entitled to be compensated in the total sum of more than $5 million. It is now being reported that the entities behind the franchisor have been placed into voluntary administration, which suggests it is unable to pay the compensation that the Court has awarded to the franchisees.

There are a number of lessons that arise from this case:

• In the disclosure document, franchisors must give a detailed range of establishment costs. In the UFC Gym case, the franchisor gave the franchisee two disclosure documents because the franchisee paused negotiations for several months.
  
  The range of establishment costs was much higher in the second than it was in the first and the second also included a disclaimer that the costs could vary. However, due to some confusion it was not clear that the franchisees actually reviewed the second disclosure document (and the Court found they did not read it).
  
  The updated disclosure document was held to be not enough to overcome the specific representations that the franchisor had made. This finding emphasises how important it is for franchisors to adhere to the following:
  • Be as accurate as possible when giving the range of establishment costs. These figures are likely to be one of the most important factors that franchisees will consider when entering into a franchise.
    
    If there is no reference point for what these costs will be (for example, if the system is new), then the franchisor should obtain estimates and quotes in order to justify the figures they put forward.
     
  • Be consistent when talking to prospective franchisees about costs. There should not be any representations made that undermine the figures stated in the disclosure document; and
     
  • Provide timely updates. The Franchising Code generally requires this anyway, but franchisors are best served making sure franchisees have a clear picture of what their commitments are.
    
    That is especially the case if material costs have changed in the period up to when the franchisee signs the franchise agreement.
• While the franchisees may have been largely successful in Court, they are now facing the real possibility of a ‘pyrrhic’ victory. Franchisees must be comfortable that the franchisor is solvent and capable of meeting its financial obligations.
  
  It’s not clear that the franchisees could have done anything differently in this case, but at a minimum, franchisees should review the financial information that franchisors have to provide.
   
• Franchisees must take in all the material they are given by the franchisor. If they have questions or want clarity on anything, that should happen before the agreement is signed.
  
  It is certainly better to leave a bad deal on the table than raise a dispute after the commitment has been made.

We should also add that it has been reported that at least one of the parties to the case has filed an appeal.  Whatever the outcome of the appeal, both sides of the franchise bargain should apply the lessons from this case to their own practices.

Please don’t hesitate to contact our Franchising and Retail Team if you have any questions about your franchise.