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Misrepresentations – Franchise Disputes

Misrepresentations – Franchise Disputes

Misrepresentations- Franchise Disputes

Overview

When a franchise relationship breaks down, it is not unusual for disputes to arise between the franchisor and franchisee over who is responsible for the failure of the business.  Often the franchisee will say that the franchisor over-egged the prospects of the business leading them to claim misrepresentation.

To claim misrepresentation, a franchisee must demonstrate that they relied, in whole or part, on an untrue statement of fact made by or on behalf of the franchisor.  Franchisors must always beware that there comes a point at which the “sales patter” becomes more than mere sales puff, and indeed, the franchisee may be able to rely on those statements to exit the franchise agreement completely, perhaps claiming back all money invested into the franchise business.

There are three types of misrepresentation that form the subject of franchise disputes:

  1. Fraudulent – where a statement of fact, either (a) known to be untrue, or (b) which is untrue and the franchisor was reckless, in the sense of being careless as to whether it was true or not;
  2. Negligent – Where a misrepresentation has been made carelessly or without reasonable grounds to believe that the statement is true;
  3. Innocent – Where the franchisor can show that they had reasonable grounds to believe the statement was true.

In franchising situations, the battleground for misrepresentation claims tends to be around profit projections or related financial information.  This is not always the case, and indeed, some franchises end up in litigation concerning the very franchise system itself, which might not law lawful.

If the right to treat the franchise agreement as being over is exercised as a result of a misrepresentation, the contract becomes rescinded, which means, it is treated as never having been entered into in the first place.  This is a dramatic outcome, and franchisors often take steps in their franchise agreements to prevent these types of argument arising.  This is most often done by including entire agreement” and “non-reliance” clauses.

Entire Agreement Clauses

An entire agreement clause in a franchise agreement asserts that the contract constitutes the whole agreement between the parties and seeks to prevent the parties from relying on any preceding agreements, negotiations or discussions that have not been set out in the agreement.  These clauses are used by franchisors to prevent franchise disputes from arising.

Important to note is the fact that such clauses are usually entirely valid and enforceable (see Intrepreneur Pub Co -v- East Crown Ltd [2002] 2 Lloyds Rep 611).  However, poorly drafted clauses may not protect a franchisor.

A good example of this is the case of Papa Johns (Gb) Ltd v Elsada Doyley [2011] EWHC 2621 QB.  In this case, the franchisee alleged that the franchisor had represented to her levels of turnover in the information pack provided based on turnover by existing franchisees and that this was attainable to her.  She claimed that she had relied upon these representations when she had decided to enter the agreement and that the franchisor had owed her a duty of care which it had breached by negligently providing false figures in relation to achievable turnover. The franchisor sought to rely on the terms of the franchise agreement, which included an entire agreement clause purporting to exclude any alleged pre-contractual statements from the terms of the Agreement. The Judge found at trial that the projections provided were in excess of the median average figures of the other franchisees in the network and that the wording in the information pack was a contractual promise and not a pre-contractual statement, meaning the entire agreement clause was not effective here.

An entire agreement clause will not itself prevent a claim for misrepresentation unless it says that it will.  A non-reliance clause is often included as a limb to an entire agreement clause and ensures that each party to the agreement acknowledges that into entering the agreement, they have not relied on any representation or undertaking save as terms expressly incorporated in the agreement itself.

Non-reliance clauses

Non-reliance clauses take effect by way of their ability to operate as an evidential estoppel, which aims to prevent a party from alleging that the facts presented to him were untrue.  However, in order to rely on this clause, a franchisor must show that the requirements in Lowe v Lombank Ltd [1960] 1 WLR 196, are met:

  1. The non-reliance clause must be clear and unambiguous;
  2. The franchisee must have meant it to be acted upon by the franchisor; and
  3. The franchisor had reasonable grounds for believing that it was true and was induced by (i.e. relies upon) such an assertion in agreeing to enter into the franchise agreement.

The Court examined the effectiveness of clauses seeking to exclude liability in Peart Stevenson Associates Limited v Brian Holland [2008] EWHC 1868 (QB).  In this case, the franchisor commenced proceedings seeking damages for repudiatory breach of the franchise agreement.  The franchisee counterclaimed for damages on the basis that the franchisee entered into the agreement in reliance on the fraudulent or negligent misrepresentations of the franchisor.  The franchisor sought to rely upon the non-reliance clause in its its franchise agreement.

The Court upheld the counterclaim, finding that the franchisor had made a number of fraudulent misrepresentations upon which the franchisee had relied upon.  The Court found that the non-reliance clause was unenforceable and noted two reasons for this:

  1. Section 11 of the Unfair Contract Terms Act 1977  prevents a clause which seeks to limit or exclude a person’s liability for misrepresentation only where it is reasonable to do so.  The Court took into account the difference in bargaining powers between the parties, with the franchisee having very little experience in this field and concluded that the clause in this case was unreasonable; and
  1. The three requirements of Lowe v Lombank Ltd. The Court found the fact that the franchisee had signed he franchise agreement containing the non-reliance clause, was not sufficient evidence to show that he meant it to be acted on by the franchisor.  Nor was the Court satisfied that the franchisor believed the statement of non-reliance to be true.

The Court found that the franchisor knew that the franchisee had relied upon the misrepresentations made to him at various pre-contractual meetings.

This case served as a reminder to franchisors that a non-reliance clause is an exclusion clause and, therefore, must fulfil the requirement of reasonableness as set out in legislation.  Given the likelihood that the bargaining powers between the franchisor and franchisee are going to be substantially different, with the franchisee likely to be at a disadvantage, it is likely that clauses seeking to exclude liability for misrepresentation are likely to fail the test of reasonableness.

In order for franchisors to avoid this kind of situation arising, they should be vigilant in their recruitment of franchisees and particularly conscious of the fact that all materials and any “sales pitch” includes representations that are correct and accurate to the best of the franchisor’s knowledge.  Likewise, a franchisee may find that the franchise agreement, whilst seeming to exclude any and all liability, does not actually work as the franchisor might have intended.

 

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