Misrepresentation in franchising

A recent High Court case has underlined the need for franchisors to be careful about the accuracy of financial information provided to a prospective franchisee and, equally, the need for franchisees to ensure they undertake proper due diligence prior to making their decision to buy a franchise.

The case in question is Barrie v Nature Discoveries Ltd, decided in the Wellington High Court in August 2012. The franchisor was a retail franchise system which promoted a concept of interactive involvement of customers, using the merchandise in the store. The general theme was science and the natural world. Each store was fitted out with a rock wall and waterfall, cave and various interactive exhibits that customers were encouraged to handle and engage with.
Over a period of some six months, a Mr Barrie purchased four Nature Discoveries franchises in various locations around New Zealand.

During the course of negotiations with the franchisor to purchase the first store, Mr Barrie was given various documents by the franchisor including a document headed “financial projections.”

As is fairly typical with such documents , it included a form of disclaimer, using the following words - “These figures indicate the gross profit margins and revenue expenses at stated turnover levels which have been experienced by the franchisor in its own operations. There is no guarantee that you will achieve the same results nor is it intended that you should rely on them as a guarantee.”

The document gave various projections of sales scenarios that might be expected to be achieved. As it transpired, at the time the disclosure documents were produced, including the financial projections document, none of the existing stores had achieved turnovers at the highest levels stated in the projections. However, there were various email communications between the franchisor and Mr Barrie, where the franchisor openly provided reasons supporting the projections. The Court found that this established a pattern of open assistance on the part of the franchisor.

The Court found that there was a misrepresentation on the face of the projection document in that it contained the statement that an unnamed store had previously achieved a certain turnover, whereas that was not correct. The Judge however found that that misrepresentation, whilst it was a matter Mr Barrie gave consideration to, was not in the end something he relied upon in deciding to purchase his first franchise. He found that Mr Barrie was enthused by the project and committed to it on a grand scale, independently of the turnover projection. The crucial element of reliance was therefore missing.

He reiterated the well-established law that projections are, of course, not in and of themselves statements of fact which can be sued upon if they happen to turn out to be incorrect. They are merely statements as to what one person thinks about something that might happen in the future. That said, they do however imply statements of fact, namely, that they are honestly held expressions of opinion and that the maker of them has a reasonable basis for holding them. On that score, His Honour went into some detail in his decision to describe the steps taken by the franchisor to verify its belief that the figures projected were achievable. He found the franchisor held the honest belief the projections were achievable and that there was a reasonable basis for making them.

The net result was that Mr Barrie lost. He failed on two critical elements. First, he did not establish that he in fact relied on the turnover projection in making his decision. Reliance must be proved in every case. It does not matter whether Mr Barrie might have also relied on other factors, but it is essential to prove on balance that he placed some or part reliance on the document in question to make his decision to purchase. Second, the projections were found to have been based on facts then in the possession of the maker (the franchisor).

The sting in the tail for Mr Barrie was that the franchisor then succeeded on its counterclaim for judgment for unpaid accounts for goods supplied. Those counterclaims amounted to well over $400,000.00. As well as that, he will pay costs.

As with the sale and purchase of any business, it can be all too easy, with the benefit of hindsight set against a backdrop of a slacking economy, to point the finger at the nearest target when things go wrong. Human nature being what it is, in the rush and enthusiasm to buy a franchise, the overly enthusiastic will always find it hard to slow down and investigate the negatives, through the channels of proper due diligence. Reading between the lines in the Barrie decision, it appears the Judge was of the view that Mr Barrie certainly progressed with great haste, acquiring four outlets over 6 months, a mammoth pace indeed, even for the most brave-hearted.
The case serves as a recent and useful example of the way in which the Courts analyse and regard these sometimes layered and complex factual situations.