The break-up: What happens when franchises go wrong

A franchise has often been compared to a marriage. Franchisor and franchisee have a close working relationship built on trust and mutual respect.

But just as some marriages break down in divorce, there are times when franchisees and franchisors get caught up in costly disputes.

All sorts of issues might come up. A franchisee could say the franchisor had given undertakings on how the business would perform when they signed up, and it didn’t.

On the other side, the franchisee might be underperforming for a whole range of reasons. Maybe they have discovered they are not cut out to run a business, maybe they’re getting divorced.

A handful of disputes end up in court but most are resolved outside because franchisees usually can’t afford a lengthy court case and the franchisor needs to keep costs down, with an empty store costing them money.

A slice of the legal pie

The most recent case has seen Pie Face franchisees preparing to sue the company for millions of dollars, with one franchisee alleging that undisclosed costs were a key factor in the underperformance of his stores.

Pie Face, founded in 2003 by former investment banker Wayne Homschek and his wife Betty Fong, sells savoury and sweet gourmet pies along with sausage rolls, sandwiches and drinks.

The franchisees claim they are losing money because the franchisor is opening outlets close to their stores.

Prit Dutta, one of the three Brisbane-based Pie Face franchisees taking legal action, said the marriage didn’t work because Pie Face was not keeping its commitments.

“The problem was they opened too many shops within a three minute walk,’’ Dutta said. “When we purchased the shop, they found the location and they built the shop and they sold it to us with forecast figures of what the shop would do and it’s not matching the forecasts.”

“I paid $450,000 for the store. They have sold bigger shops with more fit outs and more inclusion for $390,000. I keep asking them why did you charge me more?”

He says the franchisor had also left off key expenses like staff entitlements, accounting and IT costs.

As a result of all this, his store was not making the profit figures that had been forecast.

He said he had challenged the franchisor to come in and run the store themselves to see if they could make the profit. When they didn’t, he took legal action.

But Homschek has defended his company, telling SmartCompany “we’re in the business of franchising, and not everyone is going to be a good franchisee”.

“Not all of them are going to make the business what it could be,” he said.

When projections don’t materialise

There have been other cases. Last year, for example, there was the Billy Baxter’s case where a Glenelg franchise suffered losses.

As a result, the franchise owners were unable to pay the fees due under the franchise agreement.

They terminated the franchise agreement and the franchisor accepted their termination as repudiation of the franchise and proceeded to pursue legal action to recoup the outstanding fees.

The franchisees denied the claim. They hit back with a counterclaim that they had been induced to enter into the franchise agreement by the misleading and deceptive conduct.

In the end and in a unanimous decision, a previous decision was reversed by the Victorian Court of Appeal into the franchisee’s favour, with $1.22 million damages awarded.

In the Muffin Break case of 2007, the franchisor granted a franchise to operate a muffin shop at a particular shopping centre and the franchisor’s representative allegedly made various representations, orally, with respect to the anticipated performance of the unit.

The projections did not hold true, and the franchisee sued for misrepresentation. The franchisor was ordered by the courts to pay $316,570.31, plus interest on a loan.

Courting costly litigation

The franchise industry claims that the dispute level is low, far lower than the divorce rate, but the Franchise Relationship Institute puts the average level of disagreement at 18%.

Ilya Furman, the principal solicitor at Franchise Legal, says the industry’s claims are misleading.

“The industry can claim that only a very small percentage of relationships give birth to a serious dispute and the vast majority of those disputes are fairly quickly resolved but the statistics don’t truly reflect the reality,’’ Furman says.

“The reality is most franchisees can’t afford to take it to court, in which case the franchisee doesn’t have much choice.”

“They either do nothing about it and live with it, or within a tight budget mount some sort of case and live with a settlement under very much compromised conditions.”

“And there are some problems franchisees will just live with if overall if it’s commercially viable for them to continue.”

He says the disputes just keep coming in. His firm picks up lots of work. “They have been fairly constant certainly in the last 10 years that I’ve been in the business,’’ he says. “In terms of disputes, we have a constant flow of work.”

Where does it all go wrong?

The most common flash points? “The common areas usually are promises made by franchisors to induce the franchisee into entering the agreement and those promises not being fulfilled. Usually it’s: ‘You told me I would make this much and I made nowhere near that much.’

“Another common complaint is the franchisor not delivering support services. Other disputes relate to franchisees that are more advanced and saying, ‘I’m happy running the business but I don’t need the franchisor’.”

He says there is only way to avoid this from happening – do the proper due diligence before entering an agreement and get good legal advice.

Unfortunately, he says, many aspiring franchisees don’t do that.

“Good legal advice and negotiation before entering into the agreement will get rid of a lot of it and then good legal advice at the early stage of a disagreement can also prevent them developing into big disasters,’’ he says.

“Most franchisees don’t get good legal advice before they enter into agreements and often don’t really understand the financial commitments. They think, ‘It’s a business, I’ll give it a go and if it doesn’t work, I’ll just go and do something else’. But usually it’s very difficult to just go and do something else.”

The reality is that in a five to 10 year agreement, the franchisee would have to pay out the franchisor if they decided to terminate before the agreement expires.

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