Franchise Disputes
By David Bigmore, David Bigmore Solicitors
Thankfully, as the statistics show, most Franchise relationships are profitable and trouble-free. They operate to the benefit of all parties involved. Sadly, however, sometimes things go wrong. Franchising Disputes between Franchisor and Franchisees often follow a familiar pattern.
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Franchisor disputes with a franchisee
It is comparatively rare to find Franchisors instigating a dispute since, if a Franchisee is in serious breach of the Franchise Agreement (such as non-payment of fees), the Franchisor will often simply invoke its extensive rights to terminate and bring the Franchise Agreement to an end. Similarly, if the Franchisee has made any misrepresentations in relation to his or her application for the Franchise (or indeed made or makes any other misrepresentations) there is almost always a provision in the Franchise Agreement entitling the Franchisor to terminate in such circumstances. The Franchisor can therefore usually deal with such matters on a summary basis and avoid long and costly disputes.
Franchisee disputes with a franchisor
It is not so simple for a Franchisee (or a Group of Franchisees) and that fact is what leads to most Franchise disputes.
1) Termination of the Franchise Agreement by the Franchisee:
First, there are seldom any rights in the Franchise Agreement for the Franchisee to terminate. In stark contrast to the Franchisor’s position, the Franchisee usually only has such rights as are granted to him or her by the common law. That means that in order for a Franchisee to terminate the Franchise Agreement he or she has to be able to show a repudiatory breach. A “repudiatory breach” is one that in essence goes to the root of the contract. That is to say, it must be very serious. Most breaches of Franchisor obligations are likely to entitle the Franchisee to damages only. They are not sufficiently serious to justify the Franchisee terminating the Franchise Agreement. The Franchisee will only be entitled to claim monetary compensation. This type of claim often fizzles out since the only way of a Franchisee being paid compensation (in the likely event that the Franchisor refuses to pay anything) is to go to Court or arbitrate or (possibly) mediate. With legal costs being what they are, this is seldom an economic proposition. Moreover, the danger with claiming that a contract has been repudiated by the other party is that if a Franchisee claims repudiatory breach but the court concludes it was not repudiation, any purported termination by a Franchisee for repudiation when a Franchisee is not entitled to, is itself a repudiatory breach of contract entitling the Franchisor to damages which can be very substantial.
ii) Misrepresentation:
So, what can a Franchisee do? The answer almost invariably, if the facts justify it, is to allege misrepresentation. The next question is what are the characteristics and legal rules applicable to a claim for misrepresentation.
Legal characteristics of a misrepresentation
A misrepresentation is basically a ‘lie’. It must be a lie about an existing fact. Generally speaking, therefore, it may not be about the future or a statement of opinion (unless there are underlying existing facts which are materially untrue). At law, misrepresentations are of three types: innocent, negligent and fraudulent. A reckless misrepresentation is the same category as a fraudulent misrepresentation. A fraudulent misrepresentation cannot be excluded by law. If therefore a Franchisor tells a deliberate lie or makes an untrue statement without caring whether it is true or not, that may well offer a way out of the Franchise Agreement for the Franchisee(s).
The next legal characteristic of a misrepresentation is that it must have induced or been a principal factor in inducing the entry by the Franchisee into the Franchise Agreement. It follows that, legally, at common law, all misrepresentations to qualify as such must be made before the Franchise Agreement is entered into and must be the reason or the main reason why the Franchisee entered into the Franchise Agreement.
The remedies for fraudulent misrepresentation are rescission and damages. Rescission means that the Franchise Agreement ceases to be. It is, in effect, ripped up. The post-termination non-compete clauses in favour of the Franchisor will be ineffective.
Depending upon the construction of the contract and the attitude of the Court and certain other factors, in certain circumstances, a Franchise Agreement can be rescinded for negligent misrepresentation. There are however, usually clauses in the Franchise Agreement which seek to exclude the Franchisee’s rights in respect of negligent or innocent misrepresentations which always need to be considered.
Factual characteristics of misrepresentation in franchising
I will now set out a list of the aspects which a Franchising solicitor looks for in relation to advising a Franchisee (or a Group of Franchisees) as to his, her or their rights to rescind a Franchise Agreement. Much of what follows is simplified and should not be acted upon without experienced professional advice.
a) Timing:
First, is there a right to rescind. One looks at the timing. When did the Franchisee first discover the misrepresentation? Undue delay will affect the right to rescind although not necessarily the available damages.
b) Affirmation:
Has the Franchisee affirmed the Franchise Agreement after discovering the misrepresentation? Has the Franchisee done anything since that discovery which affects his or her rights? Renewing the Franchise Agreement in full knowledge of the misrepresentation is very likely to be a bar for rescission.
c) Other bars to rescission:
There are other technical circumstances where the right to rescind may be lost, but the above two (at a) and b)) are the most common in Franchising.
Types of situations in practice
As to the situations which give rise in appropriate cases to a possible claim for misrepresentation the most common complaint is defective or misleading forecasts or projections. Normally, one would think that these cannot give rise to a claim for misrepresentation because they are about the future (and as noted above a lie to qualify as a misrepresentation needs to be of an existing fact). There are also usually extensive disclaimers that turnover is not guaranteed and the figures are illustrations only.
However, many projections/forecasts in Franchising state that they are “based on our pilot” or “based on our Franchisee’s average results” or something similar.
That is to say, they claim to be based on existing fact (even though they are expressly not warranted or guaranteed as being indicative of a Franchisee’s performance in the future).
If they are based on existing fact (pilot, existing Franchisees etc) then they must be accurate.
If there is a pilot and its results are put forward as reflecting a usual Franchise, was the pilot carried out:
a) in a similar territory to a Franchise territory?
b) from a standing start (i.e. the first twelve month’s trading)?
c) (except perhaps for a company-owned pilot) by someone inexperienced in the business rather than an expert?
d) without any employees (if the Franchisee will not have employees)?
e) on all of the other relevant conditions applying to a new Franchisee.
In other words, is what is offered by way of example on all fours with the proposed Franchise operation?
There are various other commonly recurring themes which may produce misrepresentations in appropriate cases. These include misrepresentations as to a) the number of outlets opened b) (in certain circumstances) the number of outlets about to be opened and c) the “failure” rate.
Conclusion
For Franchisors, the advice is that all of your marketing material (including forecasts) needs to be vetted periodically. As one of the leading cases proves, use of the same material year after year is dangerous. There should also be a standard sales presentation which can be verified (e.g. slides).
For Franchisees, the advice is to conduct careful due diligence. Obtain written verifications from the Franchisor as to the accuracy of all key representations such as pilot results, existing franchisee results and failure rates (including the definition of “failure” – it is better to ask how many former Franchisees there have been).
Summary only
I hope that the above is helpful. It is, however, of necessity, a generalised summary only. It does not cover all relevant aspects. Before taking any action based on the above experienced specialist advice should be sought.
If you have a franchise dispute that you would like some FREE initial legal guidance on click here
Written by David Bigmore - 19.01.17
DB has represented many Franchisors, Franchisees and Groups of Franchisees in relation to their contracts or disputes over the last 31 years including (as to Franchisee groups) KFC Franchisee Association, Co-op Franchisees, Post Office Parcels Franchisees, (a large group of) Rosemary Conley Franchisees, Benjy’s Franchisees and many other groups of Franchisees (including high street household names) whose identity requires continuing confidentiality.
