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How to Protect your Franchise from Misrepresentation Claims

02/08/2012

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United Kingdom

How to Protect your Franchise Business from Misrepresentation Claims

This article first appeared in Franchise World, 1 Aug 12

The word "misrepresentation" sends a chill through even the most experienced and ethical franchisor.  Particularly in these harsh economic times, when franchisees struggle or fail, the person who is going to get the blame will be their franchisor.  As soon as the franchisee realises that running his own business is not quite as easy as he expected, the accusations start to fly – "you told me I'd make £xx profit", "you told me my costs would only be £xx a month", "you told me the support from head office is the best in the industry but I haven't seen my franchise manager for months".  Sound familiar?

All franchise companies have a "sales pitch" when they promote their franchise offering but when does that sales pitch tip over the line of being a misrepresentation giving the franchisee a claim against the franchisor?

During pre-sale discussions, many things are said by the franchisor to encourage the franchisee to buy a franchise.  If an untrue statement of fact is made by a franchisor to a franchisee which induces the franchisee to enter into a franchise agreement and the franchisee suffers loss as a result, the franchisee may have a claim against the franchisor for misrepresentation. 

In England and Wales (the jurisdiction about which this article is written) a representation will be:

  • Fraudulent where it has been made knowingly, or without belief in its truth, or recklessly as to its truth.  Fraudulent misrepresentation is the hardest to prove as the franchisee has to prove an absence of honest belief.
  • Negligent where it is made carelessly or without reasonable grounds for believing its truth.  If the franchisee can prove that the statement was false, the franchisor has to prove that he reasonably believed the statement to be true.  The burden of proof is therefore reversed making negligent misrepresentation easier to prove.
  • Innocent where the franchisor can show that he had reasonable grounds to believe the statement was true.   

The remedies available to the franchisee will depend on the type of misrepresentation: if the misrepresentation was made fraudulently or negligently the franchisee will be entitled to: (i) have the agreement rescinded (i.e. set aside); (2) the parties put back into the position they were in before the agreement; and (3) damages to put the franchisee into the position he would have been in had he not signed it.  If the misrepresentation was innocent, the franchisee will be entitled to rescission or damages but not both.  The claim may therefore be substantial.

So how can a franchisor minimise the risk of being faced with a misrepresentation claim? 

  • Voluntary pre-contractual disclosure

Although there is no legal requirement for pre-contractual disclosure in the UK, there are considerable advantages in using a carefully drafted voluntary disclosure document which can be referred to in the event of any dispute about the pre-contractual information given to the franchisee.

  • A well drafted franchise agreement

Courts in the UK are reluctant to imply terms into detailed commercial agreements and will also take a common sense approach to the interpretation of such agreements.  The standard agreement should be drafted by experienced franchise lawyers and reviewed regularly to ensure it keeps up to date with developments in the law and the franchisor's business.  Consider including:

(a) An "entire agreement" clause stating that the agreement is the entire agreement between the parties and supersedes any prior agreement or negotiations and excluding all pre-contractual statements or representations. 

(b) An exclusion of liability for misrepresentation. 

(c) "non-reliance" clause which states that the franchisee has not relied on any pre-contractual statements. 

Any clause which attempts to exclude or limit the liability of one of the parties has to be “reasonable” otherwise it could be unenforceable under the Unfair Contract Terms Act 1977 and therefore all clauses falling into the above categories need to be carefully drafted.  Liability for fraudulent misrepresentation cannot be excluded.

  • Control of sales personnel

A written script and questions and answers sheet can be useful evidence to show what your sales personnel would have said to a prospect.  Keep these documents up to date and ensure that you have documents to back up the facts and figures.

  • Encourage prospects to speak to existing franchisees

This ensures that prospects get the true picture and the franchisor can show that it has nothing to hide.  However, beware of limiting the list to "cherry picked" top performing franchisees, the franchisor should allow access to all franchisees to avoid criticism.

  • Regularly update brochures and sales materials to ensure all information is accurate and up to date

Market conditions are difficult at the moment, but how many franchisors are still selling their franchises based on projections drawn up in the good times?  Regularly audit recruitment material to ensure that it is up to date and keep the raw information used in compiling financial information, as this is invaluable if a claim rears its head in future.  Also consider adding a "health warning" to figures that are quoted.

  • Keep records of what is said to prospects

Consider investing in a CRM system to track progress with prospects and ask sales staff to input notes of what is discussed in sales meetings.  As sales staff meet many prospects, it is very helpful to have a contemporaneous note of discussions to support what was said if a misrepresentation claim is made. 

Misrepresentation claims can be expensive and time consuming to defend and the outcome can be uncertain as it is often one person's word against another.  In addition, such claims can be very damaging to a franchisor from a PR perspective, even if the franchisor is ultimately successful.  Prevention is better than cure so a regular critical audit of your recruitment procedures and documentation can save a great deal of time and money in the future. 

Victoria Hobbs and Graeme Payne, Partners, in our Franchise Law Group at Field Fisher Waterhouse LLP

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