The recent decision of Dorrian & Anor v Rushlyn Pty Ltd & Anor 1 highlights the need for franchisors to ensure they have provided Code compliant disclosure documents and meet their obligations under the franchise agreement.

It also provides a reality check for franchisees that not all losses suffered from a failed franchise are recoverable from the Franchisor.

Facts

Mr and Mrs Dorrian, entered into a franchise agreement with Rushlyn Pty Ltd, a company responsible for the operation and sales of the James’ Home Services franchise, to purchase the South Australian State Master Franchise.

Prior to entering the agreement, the Dorrians had received disclosure documents from Rushlyn.

The disclosure documents in question did not record that up to fifteen Regional Master Franchisees in New South Wales and Victoria had ceased to operate between September 2006 and November 2008.

In proceedings before the Federal Magistrates Court the Dorrians alleged, among other things, that:

  1. Rushlyn had contravened the Franchising Code of Conduct (Code) by failing to provide comprehensive disclosure; and that
  2. Rushlyn had breached the franchising agreement by failing to provide training services to them.

Allegation 1: Contravention of the Code

Under the Trade Practices Act 1974 (Cth), a corporation must not contravene an applicable industry code.

The Dorrians alleged that:

  1. the disclosure document provided to them was deficient because it did not draw their attention to the failings of Regional Master Franchises in New South Wales and Victoria;
  2. if the information in question had been included in the disclosure document then Mr Dorrian would have made further enquiries before proceeding with the venture. If, following the enquiries, Mr Dorrian was not given a satisfactory explanation then he may not have gone ahead with entering into the franchise agreement.

Rushlyn argued:

  1. this information was not required to be included in the disclosure documents as Rushlyn had not been a party to those agreements; and
  2. the events requiring disclosure, listed in item 6.4 of annexure 1 to the Code, use the terms “franchised business” and “franchise agreement”. It would be anomalous if “franchised business” where it is referred to in the annexure of the Code had a wider meaning than “franchise agreement”.

Finding

Federal Magistrate Cameron disagreed with Rushlyn’s submissions stating that the term “franchised businesses” is used ‘to refer to the various enterprises operating as franchisees in a particular franchise structure.’

This finding was supported by reference to clause 6A of the Code, which states that the purpose of a disclosure document is, amongst other things, to enable an intending franchisee to make an informed decision about whether to enter a particular franchise.

For these reasons, his Honour concluded that Rushlyn should have included the information regarding the failed Regional Master Franchises in the disclosure documents.

Consequently, the Court found that Rushlyn had contravened section 51AD of the Trade Practices Act 1974 (Cth).

However the Court found that there was insufficient evidence to demonstrate that the Dorrians would have acted differently if the omitted information had been supplied. The Court said that here was no evidence to identify or substantiate the loss and damage they suffered as a result of the non-disclosure. As such, there was an insufficient factual basis to order relief in relation to Rushlyn’s breach of s 51AD.

The Court dismissed this aspect of the Dorrians’ claim.

Allegation 2: Failure to provide training

In a separate argument, the Dorrians argued that they had only been provided with a third of the training required under the franchise agreement.

The Dorrians alleged that:

  1. Rushlyn devoted only sixteen and a half days to training them between October 2009 and July 2010 instead of seventy days as required under the franchise agreement;
  2. from July 2010 onwards, the Dorrians did not receive the requisite five days of training and the provision of training was critical and lack of training was a material cause of the failure of the franchise business; and
  3. the Dorrians’ submitted that the lack of training was a material contributor to the failure of the business and as such, they should be compensated a total of $1,000,000 less contingencies.

Rushlyn argued that:

  1. they offered the requisite training but the Dorrians denied this;
  2. their obligations under the franchise agreement provided that they were entitled to comply “by whatever means it consider[ed] appropriate”
  3. the additional training would not have made a difference to the fate of the applicant’s franchise and the failure of the business could be attributed to Mr Dorrian’s shortcomings.

Finding

The Court noted that this condition that the Franchisor was entitled to comply by whatever means appropriate did not give Rushlyn a license to fail to provide the hours of training it was contracted to provide.

The Court ultimately awarded the Dorrians $658,993.40 to compensate for money they had spent running the business.

The Court did not make an award for the loss of potential profits as there was no evidence that the Dorrians would have made any profit even if they had received the training the Franchisor had contracted to provide as contained in the franchise agreement.

Takeaway points

When preparing a disclosure document, franchisors should be cautious in determining what to omit from the disclosure.

The purpose of the disclosure document is to allow a potential franchisee to make an informed decision when entering into the agreement. Accordingly, Courts are inclined to read obligations relating to disclosure documents in favour of the franchisee.

Franchisors should ensure that any promises they make or obligations they agree to perform under the franchise agreement are fulfilled.

Franchisees should also note that a breach of the Code with respect to disclosure does not automatically entitle the franchisee to damages.