Patrick McGrath

BA,LLB(Hons) MComLaw(Hons)
Patrick McGrath

Phone +64 9 300 1257
Mobile +64 21 619 540
patrick@mcgrathlaw.co.nz

Vulcan Building Chambers
Level 4 Vulcan Buildings
Cnr Vulcan Lane and
Queen St

PO Box 3320
Auckland 1140
New Zealand

Franchisees Win Damages

Three former King Pie franchisees have been awarded damages of over $700,000.  The case reaffirms the protection the law affords franchisees.

In a recent case in the High Court, the principal director and shareholder of the King Pie franchise company has been ordered to pay over $700,000 to three former franchisees. The case serves as a reminder of the significant personal liability for the individuals behind a franchise even when the actual franchisor is a company. The liability arose out of pre?contractual discussions.

In each of the 3 cases, the former proprietors of the businesses alleged that Mr Dirk Verbeek of King Pie New Zealand Limited was guilty of misleading and deceptive conduct under the Fair Trading Act 1986.

The case proceeded against Mr Verbeek personally, King Pie New Zealand Limited having been put into liquidation previously. In each case, the franchisees sought repayment of the sums they lost in establishing their businesses, trading losses and lost profits.

The Sales Pitch
Reg Phillips of Whangaparaoa happened to be passing the King Pie franchise at Lower Queen Street, Auckland, in April 1997. He was looking for a business opportunity, and he phoned the franchisor and arranged to meet with Mr Verbeek the next day. Mr Verbeek's sales pitch included a discussion about the success of King Pie in South Africa, where King Pie originated. Mr Verbeek outlined King Pie's plans for expansion throughout New Zealand and elsewhere, and gave Mr Phillips a brochure which made claims about turnovers and profits said to be achievable, based on the performance of existing outlets.

At subsequent meetings in May 1997, Mr Verbeek provided financial projections which were specific to a site which was being looked at in the Pacific Plaza Shopping Centre at Whangaparaoa. These financial projections were based on 'assumptions' of sales of 600-1,400 pies per day. Mr Phillips asked Mr Verbeek to provide him with a conservative estimate of how many pies he could sell from the site under consideration. Mr Verbeek said Mr Phillips could realistically turn over 600-800 pies per day.

Mr Phillips signed a franchise agreement which contained the usual disclaimer by the franchisor of warranties or representations including any 'estimates' furnished during negotiations as to turnover and profitability.

Mr Phillips' King Pie shop opened at Whangaparaoa on 31 July 1997. Opening day was very successful. However, sales tumbled within the next few days and, as early as the 18th day of trading, sales fell below the critical level of 600 pies per day. From then until the time Mr Phillips closed his King Pie franchise in April 1998, sales of only around 200 pies per day were achieved.

In the High Court, Justice McGechan found that Mr Verbeek's statement to the effect that Mr Phillips could realistically sell 600 to 800 pies at the specific site being looked at in Whangaparaoa was misrepresentation. His Honour stated:

'I am driven to a conclusion that, put on the spot at Whangaparaoa, Mr Verbeek simply guessed. It was an honest guess, in the sense it was the best he could do. However, there really was no reliable basis on which he could make such a precise forecast. Especially against the background of a request for conservatism and references to realism, his figures should have been pitched as mere guesses, not to be relied on. No such qualification was made. I am satisfied, given Mr Verbeek's apparent expertise, that there was an implied representation that a reasonable factual basis existed for that opinion; that factual basis did not exist; and I find misrepresentation accordingly.'

The High Court found that, in addition to the positive misrepresentations which had been made, Mr Verbeek was also guilty of withholding information. In referring to the success of King Pie South Africa without referring to the difficulties of the operation in Australia, and in referring to a site at Kelston favourably without referring to the South African company's serious doubts about the Kelston site, Mr Verbeek left Mr Phillips with half-truths which were likely to mislead.

Damages
Having decided that Mr Verbeek was guilty of misleading and deceptive conduct, Justice McGechan considered the level of damages which should be awarded in favour of Mr Phillips. His Honour found that damages should be awarded at the 'tort' measure, being damages designed to put the plaintiff back in the position he or she was in prior to the misleading conduct occurring. In Mr Phillips' case, this meant compensating him for the difference between the cost to him of establishing the business, minus the value of the business assets when the business closed, plus trading losses over the trading period, plus interest and legal costs.

The Court considered whether damages for lost profits could be awarded under the Fair Trading Act and found that, due to a recent Court of Appeal decision, they could not. In the Court of Appeal decision referred to, the judges divided 3-2 on this question. The decision has been met with criticism from those who say that the Court should retain a wide discretion under the Fair Trading Act to award damages according to the particular case (the Court of Appeal can and on occasion does reverse its own decisions so the future may show a different position on this issue). The effect of this decision on a litigant's case can be significant. Damages awarded for lost profits aim to put the plaintiff in the position he or she would have been in had the misrepresentations complained of been true. In the case of misrepresentations as to profitability, this means not only compensating the plaintiff for amounts lost in setting up the business and trading losses, but also giving the plaintiff the profits falsely promised.

Same Pattern
The other plaintiffs in the case were the proprietors of two other failed King Pie franchises, one at Christchurch and one at Hunters Plaza, Papatoetoe.

Alan Sherris, who with his partner Christine Carman eventually purchased a King Pie franchise at Christchurch, first met Mr Verbeek in August 1996. The pre-contract negotiations and discussions were similar to those in the case of Mr Phillips.

Throughout the first half of 97, Mr Sherris and Ms Carman considered suitable sites at Christchurch. They were looking for a site in a large mall, as they had knowledge of Mr Verbeek's own King Pie franchise at Manukau Shopping Centre, and one at West City (both large malls) which appeared to be successful. However, Mr Verbeek persuaded Mr Sherris and Ms Carman that it was not necessary to locate a King Pie shop in a large mall, the key issue being foot traffic past the shop door as opposed to the total number of mall shoppers. He advised them to locate in the Big Fresh on Moorhouse shopping centre, a small mall in Christchurch. Mr Verbeek claimed the site would do better than his at Manukau, and saw analogies between the site at Kelston and the proposed site at Christchurch.

Mr Sherris and Ms Carman experienced the same trading pattern as Mr Phillips. Their opening day in August 1997 was very successful, but sales soon nose-dived and overall trading was abysmal. They closed in April 1998.

The Court found that Mr Verbeek's statements that it was not necessary to locate a shop in a large mall, and that the Christchurch site would do better than Manukau, were misleading. It was not reasonably open to Mr Verbeek to translate experience derived from the vastly larger overall foot traffic in the Manukau mall to the much smaller mall situation in Christchurch. Mr Verbeek had no experience up to that point in relation to small mall situations. He had no experience at all of King Pie market conditions in Christchurch.

The Court also found that Mr Verbeek failed to disclose to Mr Sherris and Ms Carman the situation in Australia, and King Pie South Africa's serious doubts about the Kelston site.

In awarding damages, the Court adopted the same measure of damages as in Mr Phillips' case, and awarded the former Christchurch proprietors damages covering the difference between establishment costs and the value of the business assets following closure, trading losses, interest and legal costs.

Mr P K Ting purchased a King Pie franchise at Hunters Plaza, Papatoetoe. Mr Ting's case was similar to those of the Whangaparaoa and Christchurch franchisees, except that Mr Ting purchased his franchise well after them. Mr Verbeek made statements to Mr Ting about turnover and profits which were unrealistic and without any reasonable basis. He failed to disclose the situation in Australia and the serious doubts of the South African King Pie company about Kelston. He also failed to disclose the difficulties that the Kelston shop was in by October 1997 when Mr Ting purchased, and failed to disclose the difficulties of the Whangaparaoa and Christchurch franchisees. By the time Mr Ting purchased, even King Pie franchises which had previously been doing reasonably well had suffered a downturn in their businesses. This was not disclosed either.

In Mr Ting's case, the High Court found that Mr Verbeek was guilty of misleading and deceptive conduct under the Fair Trading Act. The Court went further and found he was guilty of deceit as well.

The Need for Care
The case demonstrates again the need for care in pre-contractual negotiations. Predictions about future sales should not be made orally or in writing unless there is a reasonable basis for them which can be demonstrated. There was no disclosure document, as required by the Franchise Association of New Zealand for its members. King Pie did not use signed acknowledgements covering oral representations and estimates. Nor was there a signed list of representations which were intended to be relied on.

Had the documentation been better the misleading and deceit may not have occurred, or may have been neutralised, as the minds of the franchisees and the franchisor would have been focused on the degree of reliance which the parties intended was to be placed on oral statements and estimates. The franchisor would have given much more careful thought about what should be disclosed or represented before making the statements which were made, to the advantage of all those involved.

For franchisees, the judgment reaffirms the protection the law affords against misleading and deceptive conduct. The case is also a strong reminder of the fact that operating through a limited liability company cannot shield an individual from personal liability under the Fair Trading Act, and in the tort of deceit.

Patrick McGrath, Auckland, counsel for the plaintiffs
First published in Franchise New Zealand, 1999