Background
Billy Baxters is a coffee shop franchise system.
The case of Trans-It Freight Pty Ltd v Billy Baxters (Franchise) Pty Ltd [2012] VCA 71 involves the Billy Baxters' franchisor and its former Glenelg franchisee. The franchisee had terminated their franchise agreement after the business made losses and it was unable to pay the franchise fees. The franchisor sued the franchisee, seeking recovery of unpaid royalties and advertising fees under the franchise agreement.
In the first instance, the Supreme Court of Victoria found against the franchisee who had admitted that $250,000 worth of fees were unpaid. However, the franchisee had also issued a counter-claim, seeking compensation for its losses suggesting that the franchisor's representative had made misleading and deceptive statements before the franchisee signed up to the lease and franchise agreement.
The question to the Court was whether the statements of projected turnover and reasonableness of rent made by the franchisor's representative were misleading and deceptive under the Trade Practices Act 1974. The franchisee stated that the franchisor's representative had told it the anticipated turnover for the business was $1.3 million and that this would allow the franchisee to pay the rent and return a profit.
In finding against the franchisee, the Court found that the franchisor's representative had in fact provided a spread sheet template to the franchisees which allowed the franchisee to play around with figures for the business and determine viability themselves. The franchisee (who was an experienced franchisee itself) was also advised to enter its own information into the spread sheet and seek independent advice. The franchisee ignored this advice.
The Court found that the $1.3 million turnover claim was false. However, it was made on reasonable grounds so there had not been a breach by the franchisor.
The Appeal
On Appeal, a critical consideration for the Court was the set rent for the premises of $160,000 per annum which had been agreed between the franchisor and the landlord. The Court of Appeal found that the franchisor's representative would have told the franchisees that the ideal maximum rental was 15% of the turnover for the business.
The Court also found that the figure of $1.3 million was provided without reasonable grounds and that the turnover figure's only connection to the rent figure was that the business would need to make that amount of turnover as a minimum to make the rent affordable. The Court held that franchisor's representative had no foundation on which to base the representation that the franchisee could expect the turnover of the business would be $1.3 million and there was no evidence of any analysis that could back up that projection.
In a unanimous decision, the Court of Appeal agreed that the franchisor's representative's comments were not made on reasonable grounds and the decision of the Supreme Court was overturned with the franchisor ordered to pay the franchisees damages of $1.22 million.
Lessons for Franchisors
- Franchisors should make sure that they closely monitor and oversee the actions of their representatives in dealing with prospective franchisees. It is important that representatives are educated on the kinds of statements that should not be made to prospective franchisees and to be clear at all times that franchisees should conduct their own due diligence and draw their own conclusion from their research. Any statements made about turnover and profitability when franchisees are considering the business are likely to become an issue if the business subsequently fails.
- Franchisors should also review their documents and procedures surrounding site selection.
- Prospective franchisees should also be required to seek independent legal and financial advice before proceeding to enter into a franchise agreement.
- Prospective franchisees should also be encouraged to undertake their own demographic, analysis and feasibility studies for the site they are considering.
- Careful attention should also be paid to the information provided in the disclosure document. However, the greatest risk lies in the statements made by representatives of a franchisor in their attempt to make the business seem more attractive to prospective franchisees. Discussions around figures and potential or expected income for a particular site need to be approached very carefully to ensure franchisees are not entering into franchise agreements on any false or misleading information.
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