Valuing a claim for misrepresentation in a franchising dispute

Misrepresentation is a common claim that franchisees bring against their franchisor when they feel that they have been mis sold a franchised business. In this article, we discuss what is a misrepresentation and how to calculate what remedies may be awarded if a franchisee successfully claims that their franchisor has misrepresented the franchise to them.

What is misrepresentation?

A misrepresentation is an untrue statement of fact or law made by one person/ company or agent on their behalf to another which induces them to enter into a contract which causes them loss.

There are three types of misrepresentation:

1. Fraudulent misrepresentation – where a false representation has been made knowingly, or without belief in its truth, or recklessly as to its truth.
2. Negligent misrepresentation – where a statement is made by one contracting party to another carelessly or without reasonable grounds for believing its truth.
3. Innocent misrepresentation – where a misrepresentation is made entirely without fault (i.e. where the maker can show that it had reasonable grounds to believe its statements was true).

Remedies for misrepresentation

The remedies for misrepresentation are rescission of the contract and/or damages. However, it varies depending on the type of misrepresentation.

• Fraudulent misrepresentation – Damages and rescission
• Negligent misrepresentation – Damages and rescission (unless the court awards damages in lieu of rescission)
• Innocent misrepresentation – Rescission (unless the Court awards damages in lieu of rescission).

Rescission

When a contract is rescinded, it is cancelled and the parties are returned to the position that they were in before they entered into the contract.

Consequently, the franchise agreement will be set aside. The franchisee will cease operating the franchised business and will no longer be liable to pay the franchisor any money owed under it or have to honour any post termination restrictions contained in the franchise agreement.

Damages

If the representation induced a franchisee to enter into a contract, the aim of a damages award will be to put the franchisee in a position it would have been in had it not entered into the contract. Essentially, a Court will compare the franchisee’s position before the contract was signed with their position as a result of their reliance on the misrepresentation and signing the contract.

A franchisee seeking damages must prove that its loss resulted from the franchisor’s misrepresentation (e.g. entering into the relevant contract caused the franchisee to suffer loss).  Further, for negligent and innocent misrepresentation any loss must be reasonably foreseeable. However, for fraudulent misrepresentation, a franchisor will be held liable for all direct consequences of their wrongs even if they are unforeseeable.

A franchisee must take reasonable steps to avoid any further loss. If they do not, they may be unable to recover this loss against their franchisor.

Consequently, a franchisee who was induced to enter into a franchise agreement, may be entitled to recover the initial fee paid to the franchisor, training and ‘royalty’ fees, any loan obtained to operate the franchised business etc. Further, if the franchise business has been operating at a loss, then the franchisee may be able to recover these losses against the franchisor.

However, if the franchised business was operating at a profit, the franchisee will have to account for such profit or any other benefit that it has received as a result of the franchised business.

What if the franchisee is my limited company and I have given a personal guarantee under the franchise agreement?

Where the franchisee is a limited company, many franchisors will require the individual behind the company to give a personal guarantee. This means that the individual will be personally liable to the franchisor for any debts owed by the limited company.

If the franchise is operated by a limited company, then the Court will look at the company’s losses and not the individual’s losses. A Court would look at factors such as initial fee paid, any loans taken by the company and loss of future earnings by the company. But if the individual guarantor of the franchisee company gave up work to run the franchise, then his/her loss of earnings can also be claimed.

How long do I have to bring a claim for misrepresentation?

For innocent and negligent misrepresentation, the general rule is that an individual or company has 6 years from when the cause of action accrued (i.e. the date damage is caused) to bring a claim. However, an individual or company may also be able to bring a claim for misrepresentation 3 years from the date when it knew or ought to have known about the misrepresentation.

For fraudulent misrepresentation, the limitation period does not begin to run until the party has discovered the fraud, or could with reasonable diligence have discovered it.

Case example: Sharn Panesar Limited (1) Sharn Panesar (2) –v- Pistachios in the Park Limited (1) Aysin Djemil (2)

Mr Panesar, a chef and catering manager by trade, operated a successful café in a manor house gardens. He approached Pistachios in the Park Limited to consider franchising his operation. Mr Panesar spoke with Mr Djemil, the managing director of Pistachios in the Park Limited, at a grand opening for another franchised café. A location for a café became available at Frimley Park. Mr Panesar was provided with a business plan that contained projected earnings.

In the middle part of 2011, the projections contained in a prospectus were revised downwards, but the projections in the business plan were not updated. Neither the revised projections or prospectus were provided to Mr Panesar.

Mr Panesar was not successful operating the franchise and in November 2014, Pistachios in the Park terminated the franchise agreement.

Mr Panesar, after seeking legal advice, issued a claim against Pistachios in the Park and Mr Djemil on the basis that he was only provided with one piece of financial information, the business plan, that the information in the business plan was wrong; that it was known to be wrong, and that it was never corrected in that respect.

There was no dispute that the projections contained in the business plan were inaccurate and that the defendants knew this. The Court held that at the time the business plan was handed over the defendants knew that the information in the business plan was wrong; they had updated the prospectus, but they had not updated the information in the business plan. In short, the defendants’ actions amounted to fraudulent misrepresentation.

The Court ordered that Sharn Panesar Limited and Mr Panesar were entitled to recover the initial fee paid for the franchise business and damages for loss of earnings until the end of the 5-year franchise term, despite the franchise being terminated by the defendants in November 2014. Pistachios in the Park and Mr Djemil were ordered to pay Sharn Panesar Limited and Mr Panesar damages in excess of £200,000.

Pistachios in the Park and Mr Djemil sought to appeal the trial Judge’s decision on 3 grounds:

1. Error in finding of causation – the Appellants asserted that the trial Judge erred to hold that Mr Panesar would not have entered into the Franchise Agreement if the business plan provided to him had contained accurate figures. This ground was dismissed on the basis that the representation was not the principal reason for Mr Panesar entering into the Franchise Agreement, but it was a significant factor.
2. Error in reference to inaccurate figures – the Appellants asserted that the trial Judge erred in basing his decision on an unpleaded allegation – that not only were the business plan figures not updated, but the original figures themselves may not have been accurate. This ground was dismissed on the basis that the trial Judge found that Mr Panesar did not receive the prospectus with its updated figures and the case was not decided by reference to the figures in the prospectus.
3. Error in rejecting valid termination agreement – the Appellants asserted that the trial Judge was wrong to consider that the Franchise Agreement had not been validly terminated and therefore the cut off point for damages should have been November 2014. This ground was rejected on the basis that the trial Judge did not find that the Franchise Agreement had not been validly terminated, but that there was insufficient evidence to suggest that it was a valid termination. It was for the Appellants to provide a valid termination and not for the Respondents to show that the termination was not valid.

Consequently, the appeal failed.

This case is an example of where directors can be personally liable for damages in the event of fraudulent misrepresentation.

If you think you may have a claim for misrepresentation, or are defending a claim for misrepresentation and want some advice, please do not hesitate to contact Catherine Morris or Russell Ford.