A recent decision of the Federal Court, Pampered Paws Connection Pty Ltd (on its own behalf and in a Representative Capacity) v Pets Paradise Franchising (Qld) Pty Ltd, has examined the relationship between the disclosure obligations arising under the Franchising Code of Conduct and the prohibition on misleading and deceptive conduct arising under the Australian Consumer Law (formerly known as the Trade Practices Act). It also examined whether a franchise agreement could be legitimately characterised as a sham that essentially camouflaged unlawful tied supply arrangements.

Reassuringly for franchisors, the Court’s practical and commercial approach supports the view that well worded disclosure documents supported by quality training programs for franchisee applicants will significantly reduce the risk of successful claims for breaches of the Code or misleading and deceptive conduct claims. The tied supply arrangements were similarly validated, with the franchisee’s rather tenuous arguments being rejected.

One cautionary note for franchisors to emerge from the Court’s judgement is that care needs to be taken to ensure that disclosure documents reflect the true operations of the business, and not an overly favourable interpretation of those matters based on a strict “black letter” law analysis of contractual obligations.

Nothing sinister, just good franchising

The franchisees in the case advanced what was described as a general “thesis” to the Court that relationship between the franchisor and their franchisees was “sinister”, and that the franchise agreement was “a paper tiger” designed to enable Global, and those controlling it, to manipulate the franchisees’ businesses to the benefit of Global. The Court rejected the thesis, finding that there was “nothing sinister” about the Pets Paradise system, regarding the thesis to be “an overstatement of the nature of franchising”. The Court noted the longstanding success of the franchise and stated that the franchisor’s associated entity’s role as the buying and stock supply arm of the franchisor was designed to secure better, preferably exclusive stock for Pets Paradise and its franchisees. This arrangement had good commercial aims and was an indication that the Pets Paradise system was a sophisticated one.

The Court considered a number of specific allegations of alleged false, misleading or deceptive conduct, rejecting most. It held that a representation as to the capability of the IT system had been made, but it was not false. Evidence from the staff that facilitated the franchisee training programme established that the franchisee applicants were trained in the functions and use of the system, which was considered to be a sophisticated management and reporting system based on the evidence of the trainers in relation to the system’s features. Similarly the court rejected that a reference in the disclosure document to “some” products being exclusive could not reasonably be interpreted as “most” and, as such the franchisees could only succeed if they could show that none or only a very small number of the products were exclusive products. The Court held that the representation was not false as some products were exclusive products and that the franchisees weren’t mislead as to the amount that were exclusive products as they had the opportunity to view the products in the supplier’s warehouse during the training period.

As to the tied supply arrangements, the Court found that the combined effect of the franchise agreement, instruction manuals and the supplier’s supply agreement was such that it was clear that stock did have to be purchased from the related entity of the franchisor even though this was in fact contradicted by the express words in the disclosure document. The court focused on the practical reality of being able to secure stock from other sources given the IT system and other factors. However, the Court held that “it does not routinely follow that the [franchisor’s conduct] is misleading or deceptive” because there was a contractual obligation to purchase goods from Global: finding that it was “really a matter of emphasis”. Importantly, the Court accepted the evidence given by the franchisor’s trainers that the franchisees were informed during the training programme of the processes for purchasing from non-approved suppliers and for having other suppliers approved, but that the related entity was the principal supplier to the system.

Breach of the Code

The Court accepted that the disclosure document failed to state all of the documents that the franchisees had to sign in order to be granted the franchise. However it held that because those agreements and the guarantees were revealed and signed into before or at the same time that the franchisee applicants signed the franchise agreement, the franchisee had the opportunity to decide not to proceed with the franchise before incurring any legal liability to do so or suffering any loss from the representation. It also appears that overall the court felt that the conduct was not misleading in any material way, as the omission of the information from the disclosure document was corrected in time.

The Court dealt briefly with several other alleged breaches to the Franchising Code of Conduct, finding that all of the non-disclosures alleged by the franchisees had been proved. However, in almost every instance, his Honour found the breaches to be “technical breaches” which if disclosed would not have prevented the franchisees from proceeding with the franchise. The Court found that there was no loss suffered as a result of the Code breach.

What does it mean for your business?

Franchisors can take some comfort from the commercial and practical approach adopted by the Court in this case. In rejecting the applicant’s conspiracy “thesis”, his Honour relied on the evidence of the franchisor’s staff and other franchisees as to the systems, processes and business reasons underpinning the success of a well established and otherwise successful franchise. This common sense approach was also evident in the Court’s rejection of fanciful interpretations of the disclosure documents in isolation to other information communicated prior to the franchise agreement being entered into.

This emphasis on the commercial reality of the parties’ positions cuts both ways. Franchisors still need to ensure that their disclosure documents reflect the true reality of their business and their franchise system. Reliance on technical legal distinctions will not be automatically accepted by the Court. In doing so, franchisors need to be certain that disclosure documents and training programmes describe their franchising and supply arrangements accurately, and do not attempt to sugar-coat any obligations that franchisees might have. As this case indicates, the courts will look beyond the disclosure document, to internal documents and common practice, to determine the truth of the matter, and if these do not match the representations made to franchisees, liability could arise.

In addition to having such a programme in place, franchisors should make certain that:

  1. they have clear and reliable pre-contracting systems for the supply of information to franchisee applicants;
  2. those systems are followed precisely and that this adherence to the system is properly documented;
  3. information covered in training programmes is standardised, documented and recorded; and
  4. notes of meetings and exchanges with franchisees are recorded together with any unusual statements made by the franchisee applicant’s during those exchanges.

The more information that can be provided (and that the franchisor can prove was provided) prior to a formal binding agreement being reached, the less likely it is that a franchisee can argue that they were misled. The evidence of staff members responsible for training as to their usual practices, can provide an effective safeguard against misleading and deceptive conduct claims.