There has been some recent speculation amongst franchise lawyers about the potential impact of the recent Federal Court appeal decision in the case of Spar Licensing Pty Ltd v MIS Qld Pty Ltd (1 May 2014) on the practice of giving disclosure documents to prospective franchisees. The decision raises some doubts about when to update the disclosure document.

The Franchising Code says that a franchisor has to give a “current” disclosure document to a franchisee (clause 6B).It has been standard practice for franchisors to update their disclosure documents once a year (normally at the end of October when hopefully they have their updated financials or audit report for the previous financial year).  Until the issue of the new disclosure document franchisors usually hand over the existing form of disclosure document to any prospective franchisees.

This practice has always been overlaid with the requirement that the disclosure document should not be misleading or deceptive and that franchisors should provide updated information in relation to any change in specified materially relevant facts under clause 18 of the Code (such as a change of ownership of the franchisor or its intellectual property).

In this case the franchisor of Spar supermarkets issued a disclosure document to its renewing franchisee in July 2010. The disclosure document provided was the one for the previous financial year but would still be regarded as “current” in accordance with the practice of most franchisors as outlined above.

Unfortunately the franchisee did not sign the franchise agreement until February 2011 and Spar did not provide a fresh disclosure document in between. 

In the 6 month period after the issue of the disclosure document but before signing the agreement, the franchisee had discussions with Spar about amending the franchise agreement to allow it to terminate early and switch to a competing brand (IGA).  No change was agreed to be made to the franchise agreement but the Spar representative told the franchisee that early termination was permitted by Spar on payment of a termination fee.  

As it happened, when the franchisee came to terminate and switch to IGA, Spar had changed its position on early terminations and wanted to enforce the terms of the franchise agreement.

It is not always misleading to change your mind (or policy)

The appeal judges of the Federal Court decided that Spar was not guilty of misleading or deceptive conduct in making the statement about allowing early termination on payment of a fee, because when those statements were made that was Spar’s termination policy and the employee who made them therefore had reasonable grounds for saying it. 

It is possible however that the franchisee could have shown a case of “promissory estoppel” if it had proved that Spar had made the statement knowing the franchisee was relying on it to make its decision (unfortunately for the franchisee this evidence was not provided by them in court).

Disclosure Document not current but for different reasons

The judges all agreed that Spar breached the Code as it did not give the franchisee a “current” disclosure document and because this was a material breach the franchise agreement was set aside from the date of the judgement.  Unfortunately for the franchise community the judges in this decision did not agree on the reasons why the disclosure document was not “current” or even on exactly what are a franchisor’s disclosure obligations.

Reason 1- needs to be current when the franchisee signs not just when given

Justice Buchanan (with whom Justice Foster agreed) stated that the disclosure document needed to be “current” at the time the franchise agreement was made (February 2011) or 14 days beforehand and since it was not current at that time, this made it ineffective and a breach of the Code. 

This seems to be based on the fact that the financial position of Spar had declined over the preceding year and the financials for the year ending July 2010 if given would have disclosed this to the franchisee. Justice Buchanan also said that while the Code in clause 6B required the franchisor to give a current disclosure document when a party became a “prospective franchisee’ this does not excuse a failure to give  a disclosure document 14 days prior to signing the franchise agreement (which is required under clause 10 of the Code). 

Effectively Justice Buchanan treated the Code as providing two separate disclosure obligations.  It should be noted that clause 10 in fact provides a minimum disclosure time stating that the disclosure document should be given “at least” 14 days beforehand but it does not specify a maximum time from when disclosure can be given.   This was the point made by Justice Farrell.  Unlike Justice Buchanan he said there was no requirement in the Code to provide a fresh disclosure other than through the update requirements in clause 18.

Reason 2- needs to be current from the start of the new financial year

Justice Farrell did however agree that the disclosure document was not “current” although he considered that it was not current when it was given in July 2010 rather than only at the time the franchise agreement was signed. 

The reasoning for this is that the Code requires that the disclosure document provide a solvency statement by a director of the franchisor as at the end of the last financial year.  Since the solvency statement here was dated at the end of the 2008/2009 financial year rather than the 2009/20010 financial year (which had just passed) it was not current.

Issues to consider for 1 July

This case raises further issues and problems with the drafting of the Code which hopefully will be looked at by the Federal Government in finalising its redraft for next year.

However until then franchisors have to tread with particular care in the process of issuing disclosure documents and signing up franchisees during the July to October period. 

In view of the fact that another financial year is about to end there are some points to remember in issuing documents from 1 July:

  • Use every effort to update your disclosure document as quickly as possible for the new financial year rather than relying on last year’s one to the end of October. 
  • Even though the financial reports or audit report may not yet be available consider having an interim updated version of the disclosure document with other updated information and an updated director’s solvency statement.

The new financials should be provided as soon as possible to the franchisees, no later than the end of October.  Be aware that the Code does not provide a solution for this situation and disclosure of any information after the agreement is already signed is not proper disclosure.  To be safer you may consider providing both the prior year’s disclosure document and the new one.

It should be remembered that two of the three judges did not say that the disclosure document was not “current” when it was provided in July so it is presumably fine to continue to provide the previous year’s financial details until October provided they are not misleading as to the company’s current financial position.  

While Farrell J stated the director’s solvency statement needs to be as at the last financial year (a technically accurate interpretation of the Code), without the finalised company accounts or audit report a director may not always feel comfortable making this statement.  

Tell your accountants of the importance of providing the accounts or finalising their audit report as soon as possible after the end of the financial year and no later than October.

If there has been a delay between the provision of the disclosure document and the signing of the franchise agreement by the franchisee then consider whether the disclosure document is still current and needs updating or fresh disclosure.  

The Spar judgement leaves open certain issues for franchisors such as how long a disclosure document can be relied upon as “current”.  It is possible for example that the significant addition or reduction in the number of franchisees may be a cause to update the disclosure document although arguably this was always the case as a disclosure document or any other document provided to the franchisee must not mislead or deceive.