THE NEED FOR CAUTION
in this article:
December 2009 - What are the lessons for potential franchise buyers from the successful prosecution of two men for misrepresentation in selling franchises? We’ve spoken to one of the victims and learned more about how the men lied – including pretending to be a successful franchisee. We also look at the most common type of complaints about franchises made to the Commerce Commission.
In 2005, the Commerce Commission started investigating complaints from 13 people who had bought into two companies called Wizard Vapour Technology Ltd and Clean Co International Ltd. The companies were run by Stewart John Brown of Christchurch and Robert Llewelyn Parr of Horowhenua.
The complainants alleged that the two men had misrepresented the opportunities in a number of ways. The initial investigation found that in addition to possible breaches of the Fair Trading Act (which is the Commission’s concern), there also appeared to be breaches of the Crimes Act and referred the case to the Police. Following an investigation, in October 2009 both men pleaded guilty in the Christchurch District Court to charges of obtaining by false pretences and obtaining by deception. The charges related to six complainants who had lost a total of $379,000. Brown was sentenced to nine months home detention and ordered to pay $24,000 reparation at $300 per week. Parr was sentenced to four months community detention and 150 hours community work.
Wizard Vapour Technology and Clean Co were carpet and water blasting businesses. (Clean Co is not connected with Auckland-based Cleancorp, which has over 100 franchisees – Ed.) Clean Co distributors bought machines and display stands which were placed in high traffic outlets for rental by householders. There was an initial investment but no ongoing fee, although operators were required to buy the necessary chemicals from Brown’s companies. Because of this, one operator we spoke to said, ‘It was never actually a franchise as such – more of a distributorship.’ However, a supply arrangement of this kind is quite a common method of generating ongoing revenue for a franchisor (see article) and the businesses have consistently been referred to as franchises by the Commerce Commission.
One of those who bought a Clean Co business was Rod Wardrop, who paid $62,000 +gst for the North Shore franchise. Mr Wardrop is still operating his business under the Clean Co name, although he no longer has any connection with Brown and Parr. ‘There’s nothing wrong with the business at all,’ he told Franchise New Zealand. ‘The actual machines are very good and haven’t given us any trouble at all. Most of our customers say that we are better than Rug Doctor and we get a lot of repeat business and word of mouth referrals. In fact, of the eight or so businesses that were originally sold, I think most of us are still operating. I just buy the chemical direct from other manufacturers now. The business is fine – it’s the way Stewart Brown was selling them that was the problem.’
So what went wrong? The Commerce Commission and Police investigation found that Mr Brown and Mr Parr had made misrepresentations about both the profitability and business history of Wizard Vapour and Clean Co. In some cases, to persuade prospective franchisees to buy into the business, Mr Parr pretended to be a successful franchisee and gave them false information about the profitability of the business he represented when he had no such business. Franchisees were sometimes told that they were the first distributor in a particular area when this was not the case. The result was that ‘people buying into these two franchise businesses made their decisions based on false information provided to them by Mr Brown and Mr Parr,’ said Adrian Sparrow, the Commerce Commission’s Director of Fair Trading.
At the depositions hearing in 2007, Rod Wardrop had given details of his experience. He had originally answered a newspaper advert and received an information pack that contained projected profitability and promises of ongoing assistance and warranties. From this and from his enquiries, he believed that he could make around $80,000 in sales with a very high profit margin. Clean Co was to place radio and Yellow Pages advertising, none of which happened. Placement of product stands was unsatisfactory and Mr Wardrop had to move them at his own expense. Promised training and support was not provided.
He had asked to speak to an existing franchisee and been given a mobile number for ‘Richard and Irene’ in Invercargill. ‘Richard’ had told him that he had been in the business for three years and was very busy. However, he declined to give a home number to be contacted on. Some time later, after buying the business, when Mr Wardrop had to contact a ‘Bob’ regarding setting up retail outlets for the machines, he was surprised to find that ‘Bob’s’ cellphone number was the same as ‘Richard’s’. This turned out to be Robert Parr. Other complainants had similar stories to tell, and two described how they had been told they were to be the first distributors in an area when this was not the case.
Stewart Brown declined to be interviewed for this article. His counsel, Jonathan Eaton, told the Court that it was a genuine business with nationwide distribution but both men lied to the complainant about how successful it was. Former franchisee Rod Wardrop feels that the two men got off lightly and at the time of going to press has heard nothing about any reparation.
While it is not illegal to sell a franchise that is subsequently unsuccessful because of circumstances beyond the control of the franchisor, or because of the poor performance of the franchisee, it is illegal to sell a franchise based on representations that are misleading or false. As the Commerce Commission’s Adrian Sparrow says, ‘Any business opportunity entails some risk and a franchise failing or not performing as expected does not necessarily mean that the Fair Trading or Crimes Acts have been breached.’
Cases such as Clean Co and Wizard Vapour Technology are mercifully rare, but business buyers do need to be on their guard and take time to check out the facts behind any opportunity. Brown’s lawyer suggested to Rod Wardrop that he had ‘moved with real haste’ in signing the deal within a few days of making his first enquiry, and Mr Wardrop says that with hindsight he probably did not do as much checking as he should have done. Although talking with existing franchisees is always a good move, as this case demonstrated it is possible to be tricked. It’s also a good idea to check on the background of people involved with a company: both Brown and Parr have previously appeared before the Court.
As Adrian Sparrow said, ‘It is important that anyone looking at a franchise opportunity ensures that they seek professional advice and independently verify claims made about franchises before making any financial commitment. Prospective franchisees should not only rely on statements regarding earnings and ongoing support but should also follow up by visiting the seller’s or other franchisees’ offices to check first hand what facilities there are to provide training, ordering support and other back-up.’
One role of the Commerce Commission is to investigate possible breaches of the Fair Trading Act. The Commission reports that it has received approximately 12 complaints about franchises in the year to November 2009; this figure is down from 40 complaints the previous year (although that figure seems to have been unusually high after the publicity given to one high-profile case of alleged systematic fraud). The most common types of complaints concern:
- Misrepresentations in relation to the profitability of the venture;
- Guarantees of volumes of work;
- Misrepresentations about the goods/services that are the subject of the franchise;
- Misrepresentations about the area (territory) covered by the franchise or the extent to which it is an exclusive area; and
- Misrepresentations about the nature of ongoing support for the franchisee.
‘The Commission’s assessment of all 12 complaints was that they did not meet the Commission’s enforcement criteria for further action,’ said Mr Sparrow. ‘The Commission also received other enquiries about franchises that fall outside of the Commission’s legislation: these were either franchisees seeking legal advice, which the Commission does not provide, or complaints which focused on contractual matters, which falls outside of the Commission’s remit.
‘It can be the case in [the franchise sector] that fair trading complaints are often intertwined with contractual issues wherein evidence can be difficult to establish – particularly in the criminal context – with much of the allegations being based on future events and verbal representations.’
Franchisees who feel they have been misled should not, therefore, expect the Commerce Commission to get involved unless there is clear evidence of breaches of the Fair Trading Act. In any case, taking action after buying a dud opportunity is not nearly as effective as carrying out the research necessary to avoid buying one in the first place. Sadly, as the Commerce Commission has said, ‘It would appear that many people entering into franchise agreements are not seeking independent legal advice, even though they have had little or no previous experience in running a business.’
Our thanks to the Commerce Commission and lawyers Peter Woods and Stewart Germann for their assistance in preparing this article
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