Franchisor’s liability for forecasts

Forecasts are, by nature, attempts to predict the future. In the course of a franchisor-franchisee relationship, and especially so in the period before a franchise agreement is signed, a franchisor will provide forecasts to a prospective franchisee to demonstrate the future value of the franchise. In fact, before a franchise agreement can be signed, the Franchising Code of Conduct (Code) requires that a number of forecasts are given to a prospective franchisee in a disclosure document, in order to help the prospective franchisee to make a reasonably informed decision.

The Code requires that the disclosure document contain information about:

  • establishment costs, including costs of real property, equipment, fixtures, construction, fit-out, inventory, security deposits, business licenses, insurance, working capital, and any other payments required by the franchisee to begin operations;
  • recurring or one-off payments to the franchisor or an associate of the franchisor;
  • contributions to marketing or cooperative funds; and
  • how the franchisor will determine whether to extend the term of the franchise agreement; and
  • the solvency of the franchisor.

A disclosure document may also contain information about historical earnings, and projected future earnings. Whether included in a disclosure document or not, projections of future earnings are possibly the single most important forecast for a prospective franchisee.

There have been many cases where a franchisee has successfully sued a franchisor because the actual franchise earnings did not come close to unrealistic projected earnings supplied by the franchisor, and the franchised business failed as a result. The ACCC has also taken court action against franchisors in similar situations.[1]

The law in relation to forecasts

Franchisors must ensure that the making of a forecast does not amount to misleading or deceptive conduct, in contravention of section 18 of the Australian Consumer Law (ACL). Where a person makes a forecast, and the person does not have reasonable grounds for making it, the forecast is taken to be misleading and will contravene s 18.[2]

The person who made the forecast is also taken not to have had reasonable grounds for making it unless they adduce evidence to the contrary.[3] While this does not reverse the onus of proof and require a franchisor to prove that they had reasonable grounds, it does require a franchisor to at least produce some evidence that they did have reasonable grounds.

Where a franchisor is found to have engaged in misleading or deceptive conduct, there is also a risk that individuals working for the franchisor could be personally liable if they were “involved” in the contravention.[4]

What are “reasonable grounds”?

The mere fact that circumstances do not follow forecast projections does not mean that making that forecast was misleading or deceptive conduct. Simply because a forecast later turns out to be inaccurate does not mean that it was not made reasonably and honestly. A court will not judge a projection with the benefit of hindsight,[5] but will instead look at whether the person making the forecast had reasonable grounds for making it, at the time it was made, and with the information available and relied upon by them at the time.

For example, in Global Sportsman Pty Ltd v Mirror Newspapers Ltd,[6] the court stated:

that a prediction proves inaccurate does not of itself establish that the maker of the prediction did not believe that it would eventuate or that the belief lacked any, or any adequate, foundation.

Factors suggesting “reasonable grounds”

Whether there are “reasonable grounds” for having made a representation will depend on the level of care taken by the person that made it.[7]  For example, where a prediction is made by a professional, the recipient is likely to expect that the opinion is held based on rational grounds and the person’s requisite expertise. According to the Court in Awad v Twin Creek Properties Pty Ltd,[8] the “broader and more expansive the representation, the wider the responsibility for proof’.[9]

Disregard for accuracy of information

The courts have found misleading representations in respect of future matters where a person knowingly or recklessly makes a false forecast with disregard for its accuracy or where they possess conflicting information.[10] For example, in McPhillips v Ampol Petroleum (Vic) Pty Ltd [11] the owner of a franchise stated that they were going to sell the premises from which that franchise was operating. Therefore, a later statement that the franchise could be renewed by the franchisee was in fact incorrect, and was made without reasonable grounds.

Expert or professional forecasts

If the maker of a statement holds particular expertise or particular skill then they will generally be held to the level of accountability within that professional industry.[12] Professionals who are engaged to make forecasts generally do so with the benefit of a professional association (for example, the respective Australian Accounting Standard). Therefore some forecasts can be somewhat conservative. Notwithstanding their nature the basis of preparation and the assumptions on which they are made should clearly be communicated.

In Brotherson v Hursle Pty Ltd[13], the franchisor of a coffee van business told prospective franchisees that they were “guaranteed” to sell at least 100 cups a day, could easily sell 150 cups a day, and that a “feasibility study” of the franchise territory showed it could support three coffee vans.[14] The Court held that on the franchisor’s own evidence, the “feasibility study” was “manifestly fatuously superficial,” and consisted of the franchisor performing an Internet search to determine the number of businesses in the territory, then dividing that number by 350 on the assumption that 350 businesses were capable of supporting one coffee van. The Court was highly critical of this approach, saying that:

“…what was represented in the documents as to the content of a feasibility study which would be carried out was misleading and deceptive because the defendant did not have any reasonable basis for saying that there would be a feasibility study which gathered the information said to be gathered, or analysed it in a meaningful way. In those circumstances, in my opinion the making of these representations was clearly misleading and deceptive conduct.

 This I think is a matter of some significance, because the feasibility study is presented in the documents as a sophisticated exercise which is capable of identifying in advance whether an area is going to be successful for a business of this nature. The exercise described by the defendant would be completely inadequate for that purpose.”[15]

Reliance on third party expertise

In many cases, forecasts in relation to the profitability of a business may be prepared by accountants and business advisors who may specialise in preparing such documents. Provided that professionals had been retained, and the franchisor has no reason to doubt the competency of the expert then it may be adequate to rely on their forecast.[16] When relaying information from a third party it is important to consider the relationship with that party, the reliability of the person making the statement, and any methods used to test their veracity. Furthermore, information of a third party must always be relayed to a recipient accurately and fairly.[17]

Representations as to future conduct

A representation made by a franchisor that in future it will, or will not act in a particular way will not be rendered misleading or deceptive merely by the fact that the franchisor acts in a different way. It is sufficient that, at the time of making the representation, the franchisor genuinely intends to act (or not act) in that way, and has the capacity to do so.[18] However we suggest that where a franchisor decides to depart from previous representations about its conduct, it should ensure that there are good reasons for doing so. A Court could infer from an arbitrary, capricious or unexplained change of mind that the original representation was not made on reasonable grounds, or that the franchisor never intended to act in the way it represented.

Additional requirements of the Code

Where a franchisor includes information about projected or future earnings in a disclosure document, the disclosure document must include the following details:

  • the facts and assumptions on which the projection or forecast is based;
  • the extent of enquiries and research undertaken by the franchisor and any other compiler of the projection or forecast;
  • the period to which the projection or forecast relates;
  • an explanation of the choice of the period covered by the projection or forecast;
  • whether the projection or forecast includes depreciation, salaries and the cost of servicing loans; and
  • assumptions about interest and tax.[19]

Where a franchisor makes a statement or claim in the disclosure document, and relies on a document to support the statement or claim, the franchisor must keep a copy of that document for at least six years.[20]

General guidance for making forecasts

When making forecasts as a Franchisee, some general guidelines include:

  • Be conservative when estimating earnings and expenses. It is better to err on the low side for earnings, and the high side for expenses. A franchisee is unlikely to sue you if the franchised business is more profitable than projected.
  • Wherever possible, use hard evidence and not assumptions, estimates, anecdotes or hearsay as the basis for forecasts. If you could have obtained hard evidence without difficulty, but did not, this may not give you a reasonable basis for your forecast. For example:
    • if a franchisee will incur certain costs for renting a serviced office, obtain written quotes from providers of serviced offices and keep those quotes in a safe place;
    • if costs vary from city to city, obtain quotes in multiple cities and provide the forecast as a range of costs; and
    • if a franchisee will have to purchase equipment, obtain quotes for suitable equipment.
  • Retain copies of all evidence and other documents for at least six (6) years.
  • Act conservatively. Where you have conflicting information on a particular issue, consider taking a conservative approach by using the “worst case” information, or disclosing both sets of information. If, without reasonable grounds, you use the “best case” information and do not disclose the existence of the “worst case” information, you run the risk of misleading the franchisee.
  • Ensure that assumptions are realistic, documented and fully disclosed. Even if documented and fully disclosed, forecasts based entirely on assumptions may not be reasonable.
  • Do not make representations as to what you will or will not do in future, unless at the time the representations are made you truly and honestly intend to act in the way you represent, and are able to do so.
  • Do not give forecasts verbally. Restricting forecasts to written form will limit the scope for disputes about what was, or was not said. If you must give forecasts verbally, consider making an audio-recording of the discussion.
  • Do not give verbal expansions or commentary on, or qualifications of your forecasts. For example, it may defeat the point of a conservative, well-documented written earnings forecast if a prospective franchisee is verbally told “that’s just a worst-case scenario, most of our Franchisees make four times more than that” – especially if most of your Franchisees don’t make four times more than that.
  • Critically review your forecasts and particularly your disclosure document.  Have one of your staff (or one of ours) act as “devil’s advocate” and go over your disclosure document with a fine-toothed comb, as if they were an investigator from the ACCC, and challenging you to justify any potentially problematic claims.
  • Remember that the ACCC has powers under the ACL to issue “substantiation notices”.  Substantiation notices which require the production within 21 days of information or documents to substantiate a claim or representation made by the recipient. If you have fully-documented your forecasts during their preparation, it will greatly simplify responding to a substantiation notice.
  • Write your Disclosure Document as if you had to defend it in Court – because one day you might. In particular, if one of your Franchisees fails financially because their earnings were significantly lower than forecast, or their costs were significantly higher than forecast, there is a very good chance that your forecasts will come under scrutiny.

Further references

Template Information Statement

Franchise Council of Australia

Legislation

The Franchising Code of Conduct

Competition and Consumer (Industry Codes—Franchising) Regulation 2014

Related articles

What is a Franchise Agreement?

Changes to the Franchising Code of Conduct

Franchisees’ end of term arrangements – valuation of goodwill versus risk of competition

When is your licensee really a franchisee?

Marketing funds for franchises

Renewing or extending a Franchise – what’s the difference?

Further information

If you need assistance or advice on any franchising matters, telephone us for an obligation free and confidential discussion.

 

Malcolm Burrows B.Bus.,MBA.,LL.B.,LL.M.,MQLS.

Malcolm-BurrowsLegal Practice Director

Telephone: (07) 3221 0013

Mobile: 0419 726 535

e: mburrows@dundaslawyers.com.au

 

 

Disclaimer

This article contains general commentary only. You should not rely on the commentary as legal advice. Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.

 

[1] See, e.g. ACCC v South East Melbourne Cleaning Pty Ltd [2015] FCA 25.

[2] Australian Consumer Law, s 4(1).

[3] Australian Consumer Law, s 4(2).

[4] See, e.g. Australian Consumer Law, s 236: “… the claimant may recover the amount of the loss or damage by action against [the contravener], or against any person involved in the contravention.”

[5] Auswest Timbers Pty Ltd v Secretary to the Department of Sustainability & Environment [2010] VSC 389 at paras [47], [48].

[6] Global Sportsman Pty Ltd v Mirror Newspapers Ltd (1984) 2 FCR 82.

[7] Awad v Twin Creek Properties Pty Ltd [2012] NSWCA 200.

[8] [2012] NSWCA 200.

[9] Awad v Twin Creek Properties Pty Ltd [2012] NSWCA 200.

[10] Thompson v Mastertouch TV Service Pty Ltd (No 3) (1978) 38 FLR 397.

[11] [1990] FCA 46.

[12] Citrus Qld Pty Ltd v Sunstate Orchards Pty Ltd (No 7) [2008] FCA 1364 [455] (Collier J); Caffey v Leatt-Hayter [No.3] [2013] WASC 348.

[13] [2013] QDC 257.

[14] Brotherson v Hursle Pty Ltd [2013] QDC 257.

[15] Brotherson v Hursle Pty Ltd [2013] QDC 257 at [44]-[45].

[16] Lake Koala Pty Ltd v Walker [1991] 2 Qd R 49.

[17] ACN 070 037 599 Pty Ltd & McEwen v Larvick Pty Ltd [2008] QCA 416[112]-[113].

[18] Body Bronze International Pty Ltd v Fehcorp Pty Ltd [2011] VSCA 196. Note that this finding relates only to misleading and deceptive conduct, and in some cases an estoppel may apply.

[19] Franchising Code of Conduct, cl 20.4.

[20] Franchising Code of Conduct, cl 19(2) and (3).

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