Within Australia franchises are a popular structure by which to operate a business. However, disputes revolving around franchise agreements are becoming increasingly common with research indicating that more than half of Australian franchises have been involved in a formal dispute.1

While there are formal avenues to resolve franchise disputes, like mediation and court action, a preventative approach to franchising conflicts is recommended as it can avoid the cost and expense associated with formal avenues and is more likely to maintain the business relationship between the franchisee and franchisor.

In this edition, we look at the identified common causes of franchise disputes and, in more detail, a few particular issues associated with franchises. Finally, we outline some practical preventative steps that can be incorporated into a franchise system to attempt to mitigate the likelihood of disputes.

Common causes of franchise disputes

Disputes between a franchisee and franchisor can arise due to a multitude of reasons. The more common causes include:2

  • poor selection of the franchisees;
  • misrepresentation;
  • communication barriers and/or breakdowns;
  • establishment of a business that is not viable;
  • profitability of the franchise;
  • stress; and
  • dishonesty.

Particular issues for franchises

Communication/Disclosure

Clause 6 of Franchising Code of Conduct requires franchisors to provide potential franchisees with a disclosure document outlining key information about the franchise.

This disclosure requirement is of particular importance to franchises as it can avoid some of the common causes of disputes – like communication barriers or breakdowns, misrepresentation and dishonesty.

Clause 6A of the Franchising Code of Conduct outlines that the purpose of the disclosure document is to allow prospective franchisees to make an informed decision about whether to enter or extend the franchise agreement.

When inadequate or wrongly misrepresented information has been provided by the franchisor, the franchisee is denied the opportunity to make a reasonably informed business decision.

In Dorrian and Anor v Rushlyn Pty Ltd and Anor [2013] FMCA 101 a dispute arose due to a failure by the franchisor to disclose the number of franchisees who had ceased to operate in the last three years. The Court agreed this information should have been disclosed.

In SPAR Licensing Pty Ltd v MIS QLD Pty Ltd [2012] FCA 1116 a dispute arose due to a six month delay between Spar Licensing Pty Ltd (SPAR) giving MIS Qld Pty Ltd (MIS) the disclosure document and the franchise agreement being entered into. During that period SPAR’s financial position deteriorated significantly. Thus the financial reports in the disclosure document MIS relied on when entering the agreement were outdated. The Court found that SPAR had an obligation to provide MIS with an up-to-date disclosure document that reflected ‘current and reliable financial information’.

Viability and profitability of the business

A key consideration for franchisees when deciding whether or not to enter the franchise agreement is the viability of the business. Inaccurate representations or false promises as to viability can result in franchise disputes.

In the case of Brotherson v Hursle Pty Ltd [2013] QDC 257, Mr and Mrs Brotherson were interested in joining a coffee van franchise run by Hursle Pty Ltd (Hursle) in the area of Lismore. Hursle made representations such as:

  • the franchisor would build the business to 100 cups per day before handover;
  • the Brotherson’s would sell 150 cups per day; and
  • the feasibility study revealed excellent prospects for Lismore.

Once the Brotherson’s entered into the agreement and started running the business it became apparent that many of the representations were false and they instituted proceedings against Hursle.

The Court ordered the Brotherson’s receive compensation to the amount of $202,732.58 for loss suffered as the Brotherson’s had relied on the representations when deciding to enter the franchise agreement.

Closely linked to the viability of the business is its profitability and franchisors should take care with what representations they make.

In Trans-It Freighters Pty Ltd v Billy Baxters (Franchising) Pty Ltd [2012] VSCA 71 the franchisor made a number of representations regarding the profitability of the franchise, including that the anticipated turnover for the first year of business was $1.3 million. The Court found the franchisor had no foundation for such a representation. The franchisor was ordered to pay the franchisees damages.

These cases demonstrate the importance of franchisors and franchisees entering an agreement based on accurate facts and transparency of communication. The cases also demonstrate how misrepresentations at the start of the relationship can lead to disputes later.

Dishonesty/Fraud

Fraud is another main issue for franchises. Dishonest behaviour by one party to another can lead to a dispute.

In Hoy Mobile Pty Ltd v Allphones Retail Pty Ltd (No 2) [2008] FCA 810 both the franchisor and franchisee were guilty of fraud.

Allphones Retail Pty Ltd (Allphones) electronically manipulated statements passed on to Hoy Mobile Pty Ltd (Hoy Mobile) in order to reduce the commissions and bonus payments available. The Court recognized this to be ‘calculated dishonesty’.

In turn, Hoy Mobile unlocked phones and sold them at a higher price without telling Allphones. The Court also viewed this behaviour to be ‘downright dishonest’.

The Court ordered Allphones pay the money it owed Hoy Mobile, less the money Hoy Mobile owed Allphones. As with any other relationship, honesty and fair treatment is the best approach in a franchise business.

Steps to prevent disputes

As outlined in the Australian Competition and Consumer Commission’s Franchising Code Compliance Manual, it is important that the parties to a franchise agreement maintain as strong a working relationship as possible because they are both working towards the same goal of financial viability.

While conflicts between a franchisor and franchisee are likely to arise; preventative measures can reduce the chances of a significant dispute.

Firstly, both parties should ensure that they comply with the Franchising Code of Conduct and fully disclose all matters that can affect the franchise. In doing so, both parties are minimising the prospect of miscommunication and misunderstanding that could potentially arise. Consequently, both the franchisee and franchisor should ensure to keep well-documented and up to date records of matters – including disclosure documents.

Franchisors may benefit from ensuring that:

  • They are carefully selecting the right franchisees for their business, ensuring that any potential franchisees suit the style and culture of the franchise3. This may include having a list of characteristics a potential franchisee should possess and a questionnaire to help assess potential franchisees. This would allow franchisors to only choose franchisees who are the right fit for their particular franchise.
  • Their  sales  staff  are  informed  and  trained  in  complying  with  franchising  laws  so  as  to  prevent  any misrepresentations being made.

Franchisees should also take it upon themselves to check the facts provided by the franchisor are accurate before entering an agreement.

In some instances it may be beneficial for franchisors to establish a policy / system that provides for regular visits and inspections as well as making themselves both available and approachable to discuss any of the franchisee’s concerns or questions. This can help foster a relationship that allows for the development, or maintenance, of mutual trust and confidence.

Finally, developing a clear and concise internal dispute resolution process that can deal with smaller matters before they escalate will provide both parties with the opportunity to resolve matters in a more timely manner and refocus on what is more important – the financial viability of the franchise.