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A franchisor’s duty to avoid misleading and deceptive conduct during pre-contract negotiations

business business law franchises franchising code of conduct good faith misleading and deceptive conduct unconscionable conduct Apr 12, 2023

The franchising industry has been a vital part of the Australian economy, contributing significantly to employment and economic growth. According to 2022 figures, the franchising industry in Australia is estimated to be worth around $172 billion, with approximately 1,120 franchisors operating in Australia, with over 90,000 franchise units and about 600,000 people employed in the industry. The franchising industry contributes significantly to the Australian economy, accounting for around 4% of all businesses and approximately 470,000 small and medium-sized enterprises. Franchising is also a significant employer, providing jobs across a range of industries, including retail, food services, and personal services.

However, franchising can also be a complex and high-risk business model, particularly when it comes to compliance with the relevant franchising laws such as the Franchising Code of Conduct. Another issue that the industry needs to consider is the risk of misleading and deceptive conduct, which can have severe consequences for both franchisors and franchisees.

A 2022 court case involving misleading and deceptive conduct has brought this issue to the forefront. In the case of Lanhai Pty Ltd v 7-Eleven Stores Pty Ltd [2022] VSC 132, the Supreme Court of Victoria considered whether a representation made by the franchisor regarding the length of the lease for the business premises was misleading and deceptive conduct.  It also considered whether the franchisor failed to act in good faith towards the franchisee (in breach of clause 6 of the Franchising Code) and engaged in unconscionable conduct (in breach of section 21) when it chose to terminate the Franchise Agreement in April 2021.

The franchisee entered into a franchising agreement in 2015.  The franchisor was the lessee of the premises.  The lease was a 6 year lease, expiring in mid 2021 with a 5 year option to renew.  The franchisor chose not to renew the lease because of the store’s underperformance.  The issue was whether the franchisor had represented to the franchisee that the franchise would last for 10 years (as argued by the franchisee), or whether the franchisor had made it clear that it would be either 10 years, or at the expiration of the initial lease term if the lease was not renewed (as argued by the franchisor).  The argument concerned the effect of a statement contained in the Information Brochure which read:

“The typical term of the 7-Eleven Store Agreement is 10 years, unless limited by an earlier expiry of the property lease. All rights and obligations of 7-Eleven and the franchisee are set out in the Store Agreement.”

Another document given to the franchisee during the pre-contract negotiations listed a number of lease opportunities, with an asterix:

“Options are not guaranteed and lease extensions will be decided on a case by case basis at the sole discretion of 7-Eleven.”

The Court held that the franchisor had engaged in misleading and deceptive conduct (in breach of section 18 of the Australian Consumer Law), as the explanatory note clarifying the true meaning of a “minimum 10 year franchise term” was not sufficient to correct the otherwise erroneous assumption adopted by the franchisee.  In particular, it noted that the explanatory note was not featured prominently in the franchising documentation and was not brought to the franchisee’s attention at all.

The Court was also satisfied that but for the franchisor’s misleading and deceptive conduct the franchisee would not have entered into the franchise agreement, and that as a result of the franchisor’s conduct, the franchisee invested $796,000 in the capital investment and therefore lost the opportunity to pursue a series of ‘cascading’ opportunities.  The franchisor was ordered to pay damages of $595,246.40 (pursuant to section 236 of the Australian Consumer Law) – calculated as approximately $807,000 with a 20% discount for the risk entailed in business ownership.

In relation to the remaining issues, the Court decided that the franchisor did not act in good faith, nor engaged in unconscionable conduct, by not renewing the lease, which was done in pursuit of its “legitimate interests”.

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