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A cautionary tale for franchisors: The risk of financial disclosures and guaranteed franchisee income

02 February 2021

#Corporate & Commercial Law, #Competition & Consumer Law

Published by:

Friedrich Kuepper, Michael Tong, Georgia Bailey

A cautionary tale for franchisors: The risk of financial disclosures and guaranteed franchisee income

A franchise agreement is a serious commitment for both a franchisor and a franchisee. It is common for franchisees, in conducting their due diligence, to request financial information about the business or other franchised businesses in the network.

In these situations, franchisors need to be mindful of the legal implications of sharing any financial information, such as the potential or forecast earnings of their franchised business, with the franchisee. If such information is relied upon by the franchisee and proves to be untrue, inaccurate or misleading and deceptive, the franchisor could be in breach of the Australian Consumer Law (ACL).

To protect themselves, franchisors need to ensure adequate disclaimers are given in materials supplied to franchisees, including any confidentiality agreements. If there is a need to provide financial data in franchise documentation, marketing materials and during initial discussions with prospective franchisees, franchisors need to ensure there is a reasonable basis for so doing. In particular, franchisors should be cautious of making promises about the income of the franchise – which, in certain instances, may be claimed as “guaranteed income”.

Representations in disclosing franchise financial information 

Franchisors expose themselves to significant risks in respect of representations made to the financial viability and performance of the franchised business, especially to future matters. By way of example, such statements may relate to future or projected earnings of the franchised business or are otherwise predictive of the revenue, turnover or cash flow of the franchised business.

These statements may also expose franchisors to a legal claim by a franchisee that the franchisor has made misleading representations or engaged in misleading or deceptive conduct in breach of the ACL. Further, the franchisee may make a complaint to the Australian Competition and Consumer Commission (ACCC) about misleading or deceptive financial representations. Depending on the outcome of an ACCC investigation, the ACCC may take enforcement action against a franchisor, including imposing financial penalties.

In certain circumstances, representations may be determined to constitute a guaranteed minimum income for the franchisee, in which case the franchisor may be liable to compensate the franchisee to the amount of any shortfall of such a guaranteed minimum income.

What is a guaranteed income?

A guaranteed income is in essence a promise made by a franchisor to a franchisee regarding the minimum revenue of the franchised business. In other words, the franchisor guarantees a certain amount of revenue over a predetermined period and, if the guaranteed revenue is not met, the franchisor is liable to make a top-up payment covering the difference. If the franchisee does not earn the guaranteed income and the franchisor does not make the top-up payments, the franchisor may be exposed to significant liability.

Recently, the ACCC instituted proceedings against Megasave Couriers Australia Pty Ltd (Megasave), a franchisor of a courier system, for misleading prospective franchisees with false guarantees of minimum weekly payments and annual income.

Case study: ACCC v Megasave Couriers Australia Pty Ltd

In April 2019, the franchisor Megasave began promoting the sale of the Megasave franchises, a business system responsible for the operation of a parcel courier delivery service. During the sale process, Megasave indicated to potential franchisees that they would receive a guaranteed weekly payment of $2,000 per week and a guaranteed specific annual income of $91,000 per annum. These representations, entitled ‘Franchisee earnings’, were made by Megasave through statements on their website, advertising material and on a document provided to all potential franchisees. The sole director allegedly reinforced those statements through personal text messages and conversations with potential franchisees during the sale process.

From September 2019, Megasave failed to make the promised minimum weekly payments to almost all franchisees. As a result, most franchisees did not receive the guaranteed annual income. In December 2019, Megasave introduced an Operations Manual requiring franchisees to submit a certain number of sale leads every week to enable them to receive the minimum weekly payments. This requirement was not disclosed to franchisees before they purchased the franchise. Following the suspension of all franchisee payments, over 30 franchisees filed complaints with the ACCC. Ultimately, Megasave was found to have engaged in misleading and deceptive conduct and made false or misleading representations in contravention of the ACL.

What steps may a franchisor take?

Franchisors need to be cautious with any communications with franchisees (prospective or otherwise), including in promotional statements, franchise brochures, website information, operations manuals, franchise documents and any other communication across the franchise network. Examples of the kinds of information franchisors need to be particularly careful about include statements about the benefits of the franchises, annual turnover, site suitability, potential earnings and profitability and the risks associated with being a franchisee.

Franchisors need to ensure such information provided to franchisees is accurate, factually based, supportable by evidence and be clear whether it is qualified by any other information not immediately available (i.e. with appropriate disclaimers).

Steps should be taken to ensure any information provided should be clearly recorded in writing to limit ambiguity for dispute later. This may include written confirmation of verbal discussions, for example, by email.  This will also allow the franchisor to include any appropriate disclaimers.

Franchisors should resist the temptation to make promises or guarantees as to performance, including income. However, if promises are made about guaranteed income, franchisors should carefully consider whether the information is accurate and what steps may be required to ensure such income expectations can be met. Unless a franchisor is willing and able to make the required top-up payments, franchisors should refrain from making such promises as a recruitment strategy to entice prospective franchisees into purchasing a franchise.

Franchisors should also encourage potential franchisees to investigate potential earnings themselves, to prepare budgets, test market conditions and seek independent advice (including from accountants or business advisers) so the franchisee may rely upon its own enquiries.

The ACCC is particularly concerned about the potential for a franchisor to target “vulnerable franchisees” from non-English speaking backgrounds. To avoid this issue, franchisors should always urge franchisees to seek independent legal advice to ensure they fully understand the agreement being entered into. Franchisees may also want to consider whether any franchise documentation (and notices) need to be translated into languages other than English.

Authors: Trent Taylor, Friedrich Kuepper, Michael Tong & Georgia Bailey

Disclaimer
The information in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this article is accurate at the date it is received or that it will continue to be accurate in the future.

Published by:

Friedrich Kuepper, Michael Tong, Georgia Bailey

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