September 2006

RECENT DEVELOPMENTS IN THE LAW RELATING TO FRANCHISING

IN THIS ISSUE - A SYNOPSIS

Directors, Managers and Employees will be Personally Liable for Involvement in Breaches of the Trade Practices Act 1974 (Cth) ("TPA")

In the case of ACCC v Global Prepaid Communications Pty Ltd [1], the Federal Court imposed personal liability on a sales manager and an employee of a corporate-franchisor for breaches of ss.52 and 53 TPA.

In another recent case of O'Conner v Roadrunner Mobile Video Pty Ltd & Ors [2], the corporate franchisor Roadrunner Mobile Video, and one of its directors, were held be liable for the losses and outgoings associated with a franchisee's failed business venture, resulting from a contravention of s.51AD TPA [3]. The franchisor did not provide the franchisee a disclosure document as required by the Franchising Code of Conduct ("Franchising Code"). The franchisee was awarded a refund of its franchise subscription payment and also business outgoings even though the franchisee contributed to the failure of the franchised business.

Waiver of Privileged Information

The concept of privilege in relation to legal advice is a complex issue. It serves to protect communications and advice involving solicitors. Legal advice is generally considered confidential and subject to legal professional privilege. Therefore an opposing party cannot gain access to it in preparation for trial.

However, in Australian Agricultural Company Limited v AMP Life Limited, [3] the court affirmed the common law position that when a party's claim or defence is materially dependent upon legal advice, and the existence of that advice is relied upon, then privilege is waived in respect of that legal advice.

This principle may benefit franchisors defending claims by franchisees. Section 11(2)(a)(i) Franchising Code requires a franchisor to obtain a signed statement from a prospective franchisee that independent (legal) advice has been sought in relation to the proposed franchise venture. The franchisor does not have any automatic right of access to the details of that advice.

If, however, a franchisee asserts reliance [5] on the advice sought pursuant to s.11(2)(a)(i) Franchising Code in relation to such a claim, the principles of waiver will apply to allow the franchisor to gain access to the legal advice. This may be of particular advantage to a franchisor if the legal advice cautioned the franchisee about entering into the arrangement because of misrepresentations and the franchisee disregarded the advice given.

DETAILED REPORT

Directors, Managers and Employees will be Personally Liable for Involvement in Breaches of the Trade Practices Act 1974 (Cth) ("TPA")

ACCC v Global Prepaid Communications Pty Ltd ("Global Case") [6]

In the Global Case the ACCC took action against corporate-franchisors, a manager and an employee for engaging in misleading and deceptive conduct in contravention of multiple sections of the TPA.

The court held that a sales manager and an employee of the corporate-franchisor had a close working relationship and that they both engaged in making and authorising the making of, baseless representations that they could not possibly believe to be true.

Representatives of the franchising company that marketed telecommunication vending-machine products made misrepresentations as to:

(a)ongoing support and training;

(b)expected profits;

(c)availability of product;

(d)profitability of product;

(e)quality of product; and

(f)suitable locations for carrying on business, etc

The franchisors also failed to comply with the Franchising Code of Conduct ( "Franchising Code"). Specifically, disclosure documents and copies of the Franchising Code were not provided to franchisees and confirmation of independent professional advice sought by the franchisees was not obtained. Furthermore, the court found that the aforementioned misrepresentations and misleading or deceptive practices were deeply entrenched in the franchisors' marketing plan, which was used by employees and managers of companies.

Section 75B TPA relates to accessorial liability of individuals involved in a contravention of Part V TPA. An accessory to a contravention of Part V TPA is defined in s.75B TPA as a person who:

(1) (a) has aided, abetted counselled or procured the contravention;

(b) has induced, whether by threats or promises or otherwise, the contravention;

(c) has been in any way, directly or indirectly, knowingly concerned in, or party to, the contravention; or

(d) has conspired with others to effect the contravention.

Section 80 TPA provides that the Court may take action where a person has engaged in conduct that contravenes Part IVA, Part VTPA or where they have been knowingly concerned in, or party to the contravention [7].

The case illustrates that employees of corporate-franchisors cannot seek the protection of their employment to defend personal claims for breaches of the TPA. The Court rejected the employee's argument that he was merely following instructions and that he lacked the requisite knowledge pursuant to s.75B or s.6 TPA to be personally liable. The Court found that that he had adequate personal knowledge to make misleading and deceptive representations and therefore was personally liable as an accessory to the breaches of the TPA committed by the corporate-franchisor.

O'Conner v Roadrunner Mobile Video Pty Ltd & Ors ("O'Connor's case")

In O'Connor's case, the Court held that Roadrunner Mobile Video's had failed to comply with the Franchising Code, as required under s.51AD TPA. Roadrunner Mobile Video did not provide relevant disclosure documents to the franchisee, nor did it obtain written confirmation that advice had been sought by the franchisee in respect of the arrangement [8]. The Court also found the director of Roadrunner Mobile Video personally liable pursuant to s.75B TPA.

The judgement expressly indicates that a director need not be aware of the legal consequences of his or her actions to be liable for them. It was sufficient that the director in this case knowingly participated in the actions that amounted to the breach. Mr Doherty undertook to deal with the prospective franchisee on behalf of, and as a director of, the corporate franchisor. It is not relevant whether he knew that the franchisor's practices constituted a breach of the TPA; in order to satisfy the knowledge requirement for accessory liability, it was sufficient that the director knew that the franchisor was engaging in those practices.

Mr Doherty was held personally liable, together with Roadrunner Mobile Video, to compensate the franchisee for in excess of $60,000 (including interest) because of failure to comply with the Franchising Code in contravention of s.51AD TPA.

In addition to non-compliance with the Franchising Code, the franchisor in O'Connor's case made misrepresentations as to research studies, backup and support, and upgrade services. However, the Court held that the franchisee had already decided to enter into the franchise arrangement before the misrepresentations were made and that in any event, had the misrepresentations not been made, the franchisee would still have been keen on pursuing the franchise arrangement. Hence the franchisee's claims for misrepresentation and misleading or deceptive conduct under the TPA failed on the basis that they did not cause or induce the franchisee to enter into the franchise arrangement.

Nonetheless, the Court awarded damages wholly on the basis of the franchisor's failure to comply with the Franchising Code in contravention of s.51AD TPA. At paragraphs [83] and [84] of the judgement, Federal Magistrate Phipps states that:

"the information in the disclosure document, independent advice and the passage of time is likely to have modified the O'Connor's initial enthusiasm… if there had not been a contravention of s.51AD of the TPA, they would not have entered into the agreement with Roadrunner Mobile Video." [9]

The outcome of this case reinforces the importance of franchisors adhering to the Franchising Code, as s.51AD TPA can function as a powerful avenue for redress against deceptive or careless franchisors.

Compensation for Losses Incurred v Compensation for 'Lost Profits'

In O'Connor's case, the franchisee applicants claimed damages against the corporate franchisor respondent [10] for losses and outgoings associated with the failed business venture. The claim included an amount for 'lost profit'. The claims for losses and outgoings were generally successful based on the s.51AD TPA breach; however, the claim for 'lost profit' was not awarded.

When assessing an award for the losses and outgoings associated with the franchisee's business, the Court held that the franchisor's failure to comply with Franchising Code caused the franchisee to enter into the arrangement, and that had the Franchising Code been complied with, the franchisee would not have entered into the arrangement. On that basis, an award for all losses and outgoings was made in favour of the franchisee.

However, when assessing an award for ' lost profit' associated with the business venture, the court considered the franchisee's contribution to its own failure, which negatively impacted on any entitlement to an award for 'lost profit'.

Therefore, in the absence of an alternate income stream to rely upon, it appears that putting the O'Connors in the same position that they would have been had they not entered into the agreement results in refunding their franchise subscription costs and awarding an amount for losses and outgoings, but denying any entitlement to any expected profits from the business. After all, if the franchise agreement was not entered into, there would have been no opportunity to make any associated profits.

It is worth noting that if the franchisee applicants had given up paid employment in order to engage in the franchise business, they may have been able to put forward an argument as to entitlement to 'lost income' associated with previous employment. However, evidence suggested that neither of the applicants were employed while, or prior to, carrying on the franchise business.

Waiver of Privileged Information

Division 2.2 of the ACCC's Franchising Code sets out the requirements relating to independent advice that must be sought by the franchisee prior to entering into a franchise arrangement. Section 11(2)(a) of the Franchising Code provides that a signed statement that independent advice has been sought must be provided from a prospective franchisee to the franchisor prior to entering into an arrangement. Section 11(2)(a)(i) provides that the independent advice can be in the form of legal advice.

The key issue relates to legal professional privilege. Legal advice is generally subject to legal professional privilege. As such, a franchisor would ordinarily have no right of access to the particulars of a prospective franchisee's independent legal advice about entering into a franchise arrangement.

Nevertheless, in circumstances where the party relying on privilege acts inconsistently with the maintenance of privilege, the privilege is waived.

In Rio Tinto, Sundberg J stated that: [11]

"… the question whether the respondent has acted in a manner inconsistent with the maintenance of the privilege remains… the inconsistency arises from the combination of the following three facts:

· The respondent has, by his Statement, raised as an issue in the instant proceedings his states of mind;

· The respondent has, by his response to the applicant's request for particulars of his Statement, disclosed that the privileged Scheduled documents had a bearing on those states of mind; and

· The respondent has refused to produce those documents in answer to the first notice to produce."

In Australian Agricultural Company limited v AMP Life Limited ( "Australian Agricultural case") [12], the court emphasised its unwillingness to accept that " any positive defence mounted by AMP which raises its state of mind necessarily constitutes a waiver of privilege". Rather, privilege will be waived under circumstances where a claim or defence is " materially dependent upon legal advice given to that party" [13].

In the Australian Agricultural case, Cowdroy J affirms that it is inconsistent with the maintenance of privilege doctrine for a party to refer to privileged documents in support of a claim or defence on the one hand, and yet at the same time rely on privilege in respect of the information held in those documents. If a party refers to legal advice that materially influences a claim or defence, then it must produce those documents, upon request, to the opposing party in preparation for trial.

A franchisor faced with defending allegations of false representations or misleading or deceptive conduct by a franchisee would be entitled to have access to the legal advice relied upon by the franchisee in support of the franchisee's claim as a party of the discoverable Court process.

Stephens Lawyers & Consultants' franchising lawyers and trade practices lawyers represent leading franchise companies in both litigious and commercial matters.

For further information contact:

Stephens Lawyers & Consultants

Level 3, 530 Lonsdale Street

Melbourne VIC 3000

Phone: (03) 8636 9100

Fax: (03) 8636 9199

Email: stephens@stephens.com.au

Website: www.stephens.com.au

All Correspondence to:

PO Box 13286

Melbourne Law Courts

Melbourne VIC 3000

** Written by Tamir Katz (edited by Katarina Klaric)

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