There was much said about the anticipated effects of the amendments to the Franchising Code of Conduct (Code), which came into force on 1 January 2015. While the most discussed change would arguably be the introduction of an obligation to act in good faith, the changes to disclosure requirements also deserve significant attention as a failure to comply now attracts a possible 300 penalty unit civil penalty.

Earnings information is one part of disclosure. Its importance however was recently highlighted by the case of Manhattan (Asia) Limited v Dymocks Franchise Systems (China) Limited [2014] FCA 1143 (Manhattan v DFS). This case involved a franchise dispute where the franchisee sought damages and rescission of the franchise agreement and largely focused on the Court’s consideration of whether the franchisor company – a company registered only in China – was in fact carrying on a business in Australia. However, part of the Court’s consideration was on ‘earnings information’ provided and this article considers that case discussion and how the introduction of the new Code may change the approach taken.

WHAT HAPPENED?

Manhattan (Asia) Limited (Manhattan) and Dymocks Franchise Systems (China) (DFS China) entered into franchise agreements in 1999 and 2006, whereby Manhattan was to operate a Dymocks bookstore in Hong Kong.

Manhattan was unable to secure an extension of its lease beyond 2009 and subsequently sought to relocate to new premises.

Discussions were held in 2009 between Manhattan and DFS China in respect to the location and selection of the franchise’s new premises. Manhattan subsequently entered into a three year lease for the new premises with a third party in 2009.

Manhattan was provided with another disclosure document in February 2010. The 2006 and 2010 franchise agreements contained clauses providing that there was to be no warranty in respect of the accuracy or reliability of the earnings information. However no earnings information was attached to the 2010 document.

The franchise ceased operating on 31 August 2012. Manhattan commenced proceedings against DFS China with various claims, including breaches of the thenTrade Practices Act 1994 (Cth) and Code.

EARNINGS INFORMATION

At the time, ‘earnings information’ was broadly defined to include information from which historical or future financial details of a franchise can be assessed.

Under both the old and amended Code, earnings information is not required to be provided, but is able to be given in a separate document attached to the disclosure document.

If earnings information is not provided, the franchisor has to include the following statement:

The franchisor does not give earnings information about a [insert type of franchise] franchise. Earnings may vary between franchises. The franchisor cannot estimate earnings for a particular franchise.

Under the old Code, if earnings information was provided, it must have been based on reasonable grounds.

Reasonable grounds for making a representation as to a future matter under theTrade Practices Act 1974 (Cth) and now the Competition and Consumer Act 2010 (Cth) requires there to be a factual foundation for the representation (George v Rockett (1990) 170 CLR 104).

MANHATTAN’S ARGUMENT

Manhattan argued that DFS China made various representations during its 2009 discussions regarding the viability of the new premises which constituted earnings information for the purpose of the Code. The ‘earnings information’ related to:

  • financial information detailed within a number of spreadsheets;
  • reasonable traffic flow; and
  • the viability of the new premises.

In addition, Manhattan claimed that DFS China represented that some of the financial information contained within the spreadsheets were premised on reasonable grounds, and further sought to imply there was a reasonable basis from the conduct of DFS China between 1999 and 2009 in locating, appraising and evaluating potential sites for Dymocks bookstores, through franchise disclosure documents and various email correspondence sent between the parties.

Manhattan claimed that the ‘earnings information’ was not actually based on reasonable grounds and therefore breached the Code.

The difficult issue for the Court to consider was whether the requirement that ‘earnings information’ must be based on reasonable grounds applied to the material alleged to be ‘earnings information’, given that it was not provided with the disclosure document.

Manhattan argued that information in the spreadsheets was ‘earnings information’ as it was made during the term of the 2006 franchise agreement and before Manhattan subsequently entered into the lease in 2009.  

In return, DFS China argued that the requirement only applied to ‘earnings information’ provided in or with a disclosure document and if there is to be a breach of the Code, it can only relate to the failure either to attach ‘earnings information’ or to include a statement of the kind envisaged in the 2010 disclosure document. The Court acknowledged there was considerable force to this argument.

COURT FINDING

The Court noted that there may be a potential gap in the Code if the requirement that ‘earnings information’ be reasonably based does not apply to financial forecasts provided by the franchisor other than under a disclosure document, where the franchisee relies on the forecast to make substantial obligations to third parties which are necessary to enable the conduct of the franchised business.

However, the Court noted that the Code only requires the franchisor to give the prospective franchisee a disclosure document at least 14 days before entry into the franchise agreement or the extension, renewal or renewal of scope of a franchise agreement. This obligation does not extend to when a franchisee enters into collateral arrangements with third parties not associated with the franchisor.

The Court ultimately disagreed with Manhattan’s interpretation of the Code and thus the claim that the  earnings information had no reasonable grounds was unsuccessful.

The ultimate outcome of Manhattan’s claim regarding the representations in the ‘earnings information’ being misleading or deceptive was intertwined with arguments correlating to whether the franchise was ‘carrying on a business’ in Australia and was not made out.

If the franchise had been based in Australia the finding by the Court may have been different.

IMPACT OF NEW FRANCHISING CODE FOR EARNINGS INFORMATION

A few changes have been made in respect of ‘earnings information’ with the start of the amendments to the Code.

The definition of ‘earnings information’ has been expanded to include:

  • historical earnings data for the franchised business or a franchise in the franchise system (and any differences between the franchise in the franchise system and the franchised business);
  • projected earnings for the franchised business and the assumptions on which those projections are based; and
  • any other information from which historical or future earnings information of the franchised business can be assessed.

Prior to the Code being amended, there was support for earnings information to be mandatory. The Franchisees Association of Australia argued that the Code should “be amended to require all franchisors to provide a fully disclosed and costed business model”.[1]

While no doubt ‘earnings information’ is helpful for a potential franchisee to assess the past operation and performance of a franchise business to set a perspective against estimated projected income, it remains an optional provision.

As with all representations made however, the law still prohibits misleading or deceptive representations or representations like to mislead or deceive which could capture earnings information attached to the disclosure document as well as other forms of representations in verbal or written communications.

Therefore, franchisors would be wise to continue to ensure any ‘earnings information’ as the expanded definition now defines, provided is:

  1. compliant with the Code requirements or face up to 300 unit civil penalty; and
  2. is based on reasonable grounds so it is not misleading or deceptive or likely to mislead or deceive.