AJPark

Many retailers look to franchise their businesses.  And why not?  Having established one successful business, the lure of replicating that success is enticing.  But franchising a business needs to be handled openly and honestly.

Franchising can go wrong

The recent conviction and sentencing of Stewart John Brown and Robert Llewelyn Parr for misleading possible franchisees about the potential profits of their franchise business is a lesson to all.

From 2005, the Commerce Commission received complaints from people who bought, or were planning to buy, Wizard Vapour or Clean Co franchises.  The Commission’s investigations suggested that the franchisors may have breached both the Fair Trading Act and the Crimes Act. The Commission referred the matter to the New Zealand Police and continued to assist the police with its investigation.

Those investigations found that Mr Brown and Mr Parr, the owners of the Wizard Vapour and Clean Co franchises, had mispresented both the profitability and business history of those franchise businesses to prospective franchisees.  Mr Parr had pretended to be a successful franchisee, and provided false information about the profitability of the business.  In other cases, potential franchisees were falsely told they would be the first distributor in a particular area. 

Unfortunately, two franchises were purchased based on false information. 
The police subsequently laid charges under the Crimes Act against both men for obtaining by false pretences and obtaining by deception. Both men pleaded guilty to those charges.  As a result, Mr Brown was sentenced to nine months home detention and ordered to pay reparation of $24,000 at a rate of $300 per week.  Mr Parr was sentenced to four months community detention and 150 hours community work.  As you can see, the penalties can be severe. 

Even if the police had not become involved in the case, the penalties Mr Brown and Mr Parr could have faced under the Fair Trading Act would have been substantial. It seems likely that the Commerce Commission would have pursued Mr Brown’s and Mr Parr’s companies and both men personally as directors of those companies.

Under the Fair Trading Act, companies can be fined up to $200,000 for every offence, and individuals can be fined up to $60,000 for every offence. Criminal convictions against companies and directors can also be awarded under the Fair Trading Act.

What lessons can be learned?

A successful relationship between a franchisor and franchisee is established when negotiations are in good faith, and all statements and representations are accurate.

However, the statements and representations made by a franchisor to a franchisee during franchise negotiations are a common cause of dispute.  Disputes usually arise from statements made about the profitability, or potential profitability, of a franchise. 

During negotiations, the franchisor will want to present the most attractive package to the franchisee, and the potential franchisee is often relying on that information to decide whether to take on the franchise.

If a franchisor has made representations that are wrong or untrue and the franchisee relies on those representations, then the franchisee may be able to claim for misrepresentation and recover damages for any losses suffered. It is important to note that failing to mention information about the business is also seen as making a representation that is wrong or untrue.

So, a franchisor needs to be careful about statements it makes (or decides not to make) to franchisees.  Any representations made should be backed up with factual data. If assumptions are made, they must be reasonable, based on factual data, and presented as assumptions, and not as facts.

While it may be tempting, a franchisor should avoid making promises about the likely success of a franchise, particularly when discussing financial turnover and profit projections. 

What can a potential franchisee do?

Franchisees need to be wary of the temptation of franchisors to oversell—especially when it will make its decisions based largely on the information provided by the franchisor. Franchisees should take notes of what is said and agreed in all discussions in case they need to show they relied on those statements later. The representations on which a franchisee based its decision to purchase the franchise can be included in the franchise agreement.

Franchisees should also make their own enquiries about the franchise. They should verify claims before making any financial commitment.  The franchisor can play a role in encouraging a franchisee to do this, and could suggest that a franchisee talks to other franchisees.

A franchisor can also improve its position legally by insisting that a potential franchisee gets independent legal and accounting advice before agreeing to purchase a franchise.  As a franchisor, you can get a certificate from the franchisee’s professional advisors to confirm the franchisee has sought advice and has not relied on any representations made by the franchisor.

The Franchise Association of NZ

Finally, potential franchisees should check that a franchisor is a member of the Franchise Association of New Zealand. Members of the Association have agreed to be bound by the Association’s Code of Conduct. Among other things, the Code:

• stipulates information the franchisor will provide to potential franchisees;
• requires that a member’s franchise agreement contains a cooling off period for a new franchisee to reflect on their decision to buy a franchise and retract it if need be;
• provides a dispute resolution process.

While not all franchisors will be members of the Association, a potential franchisee should at least ask the franchisor whether it is, and if not, why not.

A franchise could work for you
While a franchise model can provide a solid platform to run a business, it does not guarantee that you will be successful.  Franchisors should stress the reality of success and failure to franchisees, and ensure that they understand that success will depend on how the franchisee runs the business. 

As a franchisee you need to recognise that all businesses involve some element of risk. Make sure you know the potential risks by making appropriate checks before you say ‘yes’. 

Franchishing is not a quick road to riches, but it can be a successful and profitable way to future growth and prosperity.  Whether you are a franchisor or franchisee, having an understanding at the outset of the importance of any representations and statements made during negotiations, can help smooth the path ahead.

An edited version of this article was published in NZ Retail, March 2010.

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  Corinne Blumsky

  Partner