Franchisors providing forecast financial information need to be careful!

franchisor providing financial informaiton

The Federal Circuit Court recently found that representations made by a franchisor were misleading and deceptive, or were likely to mislead and deceive the franchisee. The franchisor was ordered to pay the franchisee $788,980[1].

The allegations made in the proceedings are allegations that are frequently raised in franchising disputes.

The franchisor provided cash flow projections, a break-even analysis, gross profit calculations and a summary of set up costs (“the financial documents”) for a proposed franchised business in the Forest Hill Chase Shopping Centre.

The franchisee claimed that representatives of the franchisor made the following oral representations:

  1. That the forecast sales were conservative and based on the average sales from other outlets;
  2. The franchisor did not guarantee the revenue for the proposed franchised business;
  3. The expenses in the cash flow projection were based on the franchisor’s experience in operating stores;
  4. The costs were based on actual costs of operating other franchised stores; and
  5. The estimated set up costs would be $294,938.

In addition to the financial documents, the franchisor published a statement on its website that franchised stores achieved high yields. Not surprisingly, the actual set up costs were $363,752, significantly higher than estimated. The actual sales figures were substantially lower than the forecast sales. To make matters worse, a similar business opened in the shopping centre, causing a further reduction in revenue.

After the franchisee ceased trading and closed the doors to the store, the franchisor continued trading the business as a company store. However, the company store achieved approximately 46% of the projected sales before also closing the doors.

The franchisor argued that the franchisee did not rely on the representations made. This was based on an email exchange in which the franchisee said it would probably proceed with the franchise before the representations were made; and also the fact that a director of the franchisee performed his own calculations. The Court found that the franchisee relied on some of the representations made.

The Court found that there was no evidence presented by the franchisor that there were reasonable grounds for making any of the representations. There were a number of breaches of the Franchising Code of Conduct. However, the Court found that those breaches did not result in the franchisee suffering any loss.

The franchisor cross claimed that the franchisee misrepresented to them that the directors of the franchisor would work full time in the franchised business. On the facts, one of the directors held full time employment elsewhere, and did not work in the franchised business full time. The franchisor argued that had it known this at the outset, it would not have entered into the franchise agreement. This was dismissed by the Court.

The judgement is a reminder that if a franchisor is going to provide financial information, or a model of prospective earnings, or make statements as to the desirability of a particular site, then the franchisor needs to have reasonable grounds for making those representations. It is not sufficient to include a disclaimer or warning to the franchisee to conduct its own investigation. If financial information is provided, ensure that it is accurate. My preference is that forecast financial information is not provided at all.