29 Oct 2012
Was that a misrepresentation? Issues to be aware of in franchise documentation and related communications.
Earl Gray and Sonya Hill examine a recent High Court case (Barrie v Nature Discoveries Ltd  NZHC 2209) that considered alleged breaches of the Fair Trading Act 1986 in the context of a franchise relationship. Specifically, the case considered whether information contained in a franchise disclosure document constituted a misrepresentation and whether the franchisee relied on it. The case suggests an amendment to the wording of paragraph 10(b) of the Franchise Association of New Zealand model disclosure document. It also considered the interesting question of whether a fiduciary relationship exists between a franchisor and franchisee.
In 2005, Nature Discoveries advertised the availability of franchises in a franchise trade magazine.
Nature Discoveries stores are themed around the natural and scientific world, with interactive involvement between customers and merchandise. The standard fit-out of the stores includes a rock wall, a waterfall, a cave and various interactive goods and exhibits that customers can handle or engage with.
The concept appealed to Mr Barrie who, either personally or via entities associated with him, purchased four Nature Discoveries stores, all within a six month period. The four stores were (in order of purchase): Queensgate, Porirua, Glenfield and Northlands. Each store was run pursuant to a franchise agreement.
Exchange of information
After seeing the advertisement for the Nature Discoveries franchise opportunity, Mr Barrie contacted Mark Chan, a real estate agent who was listed as the contact person.
Mr Chan (on behalf of Nature Discoveries) sent Mr Barrie various documents including a copy of the advertisement, a business information profile and a franchise disclosure document which set out a number of financial projections. The disclosure document followed the Franchise Association model (a copy of which is available on the Franchise Association of New Zealand (FANZ) website).Mr Barrie and Mr Garlick, the CEO of the Nature Discoveries group, then engaged in a series of emails by which Mr Garlick provided financial information about the stores in response to queries raised by Mr Barrie.
Was there a misrepresentation?
Mr Barrie alleged that six misrepresentations were made in breach of the Fair Trading Act 1986. Of these, Simon France J found that the facts supported only one alleged misrepresentation. However, this representation was unintended and not relied upon by Mr Barrie. Mr Barrie's case therefore failed.
Mr Barrie alleged that a misrepresentation was made in the franchise disclosure document stating that Nature Discoveries stores had previously achieved turnovers of $800,000 and $950,000 under the heading "Financial Projections".
This information was provided in the form of a table in the disclosure document and was preceded by the words:
"Note: 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."
This wording follows that set out in the FANZ model disclosure document (paragraph 10(b), second option) and is commonly used by Members of FANZ or entities voluntarily choosing to comply with FANZ disclosure document requirements.
Mr Barrie read this as saying that a Nature Discoveries store located in a high socio-economic, medium density population area had previously achieved sales of $800,000 and that a Nature Discoveries store located in a high socio-economic, high density population had achieved sales of $950,000. No stores had achieved such sales. The question was whether it was reasonable for Mr Barrie to read the table in the way he did.
The Judge interpreted the wording used as meaning that the sales figures are hypothetical but the gross profit margins and expenses are based on actual experiences.
The Judge went on to say that Mr Barrie's reading of the extract was not unreasonable. Most people would read it as saying the figures had been experienced by the franchisor in other stores. Therefore, the disclosure document contained an unintended misrepresentation that unnamed Nature Discoveries stores had previously achieved turnovers of $800,000 and $950,000.
The Judge suggested the following amendments to ensure that "the wording more accurately stated its intention":
"Note: These figures indicate the Gross profit margins and revenue expenses at stated projected turnover levels which have been experienced by the Franchisor in its own operations at projected turnover levels. There is no guarantee that you will achieve the same results, nor is it intended that you should rely on them as a guarantee."
Following on from this, the judge considered whether Mr Barrie had relied on this unintended misrepresentation in making his decision to purchase the franchise. Ultimately the Judge held that while Mr Barrie had given some consideration to the financial information provided, there had been no reliance on it by him in making the decision to purchase. Other information he garnered, his own calculations, and his business approach, drove Mr Barrie's decision. Therefore an essential element of misrepresentation was missing.
Second to sixth allegations
The remaining allegations of misrepresentation were made in relation to both the disclosure document and the surrounding communications between Mr Barrie and Mr Garlick. The Court noted that there needs to be a proper factual basis for estimates or projections, but on the facts held, none of these allegations supported a finding of misrepresentation. In the case of opinions from Mr Garlick, the Judge held the opinions were honestly held, the basis for the opinion was clearly articulated, and the opinions were reasonable based on the information available to Mr Garlick. Moreover, someone is entitled to expect a reader to bring a degree of reality to information about expenses and, as Mr Barrie did as an experienced businessman, undertake their own analysis. The opinions or projections could not be regarded as commitments by Nature Discoveries. The case also contains some interesting discussion about what may constitute misrepresentation.
Was there a breach of fiduciary duty?
Mr Barrie claimed that fiduciary duties existed over and above the obligations arising from the franchise agreement, because the relationship of franchisor and franchisee is inherently fiduciary in nature.
The Judge rejected this claim, holding that the franchisor/franchisee relationship is not one which engenders expectations of trust, loyalty and confidence, and an expectation that the franchisor will not act out of self-interest. Although particular elements of franchise arrangements may attract fiduciary obligations, this would be a fact specific inquiry and it goes too far to suggest that the whole relationship is inherently fiduciary.
The Judge also held that the contractual arrangement itself prevented the relationship from being fiduciary. The Franchise Agreement stated: "Nothing in this agreement makes the Franchisee an agent, partner, joint venture, subcontractor, ... or employee of the Franchisor."
Simon France J considered whether there were any particular aspects of the relationship that could give rise to fiduciary obligations. Only one is worth mentioning. Nature Discoveries established a website through which some products could be ordered and purchased online. The Judge noted that this raised interesting issues as to whether the establishment of the website breached the exclusivity provisions of the franchise agreements. However, the case was not pleaded in that way, and no case for breach was made out on this point, even if there was a duty.
Mr Barrie did not succeed on any of his causes of action.
Although an unintended misrepresentation was found to exist in the wording of the disclosure document, Mr Barrie did not rely on this wording in making his decision to purchase the franchise.
Franchisors should re-visit the wording of their disclosure documents to ensure that, where information relating to profit and sales figures is provided, the explanatory paragraph for this information is not unintentionally misleading. If in doubt, we suggest using the wording provided by the Judge in this case and set out above.