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11 November 2008
Enforceability of Non-reliance Clauses
Should the relationship between a franchisor and franchisee break down, it is not unusual for a failing franchisee to allege that the franchisor mis-sold the franchise by understating the risks of the business. This can trigger an examination by both parties of what exactly was said by the franchisor to the prospective franchisee in pre-contractual discussions, on the basis of which the latter decided to enter into the franchise agreement. The franchisor should be confident that the information given to the prospective franchisee at that stage was entirely accurate. However, in the event of any doubt, a franchisor may well point to any non-reliance clause in the franchise agreement. Non-reliance clauses are commonly used to seek to limit the franchisor’s liability for any representations made to a prospective franchisee except those expressly contained in the contract, and may state that the franchisor makes no representations or guarantees as to the profitability or any other aspect of the franchise business. On July 30 2008 the High Court considered the issue of how far a non-reliance clause protects the franchisor in Peart Stevenson Associates Limited v Brian Holland. (1)
The claimant was a franchisor who had developed a franchise model for the provision of inspection services in relation to gas and electrical appliances. The defendant had taken on the franchise in 2006 but it had failed to live up to expectations of profitability. Disputes arose between the claimant and the defendant in relation to a number of matters, including outstanding franchise fees owed by the defendant. The claimant terminated the franchise agreement, and the defendant subsequently set up a rival business within the franchise territory.
The claimant sued for damages flowing from the defendant’s alleged breaches of the franchise agreement, including alleged breach of post-termination restrictive covenants. One such covenant was a non-compete clause which prohibited the franchisee from being “engaged or interested or concerned in the supply of products and services similar to the services" provided by the franchise, within the franchise territory for a period of one year following termination of the agreement. The defendant counter-claimed for misrepresentation, alleging that, among other things, the claimant had misrepresented the average profit margin of franchisees and the failure rate of franchises.
The court found that the defendant should pay damages for the breaches which resulted in termination of the agreement. The court used the actual and projected figures of the defendant’s franchise, as supplied by the defendant, to calculate the level of the franchise fees that the claimant would have earned had the agreement continued, rejecting the claimant’s calculation based on average figures for other franchisees. On this basis, the claimant was awarded damages of £20,430.71.
The court also found that the defendant had breached the non-compete covenant, but it valued the claimant’s loss as significantly lower than the damages claimed and awarded only nominal damages of £2. This was because the court found no evidence that the breach had caused the franchisor actual damage. The court was clear: if a franchisor cannot, or will not, replace an outgoing franchisee in the territory for reasons other than the franchisee’s breach of the agreement, the franchisor’s loss will be minimal. Mere breach of a restrictive covenant following termination will not automatically give rise to damages.
Moreover, the court upheld the defendant’s counterclaim and found that the claimant had made a number of fraudulent misrepresentations which the defendant had relied upon in entering into the franchise agreement. Damages of £228,940 were awarded to the defendant (based largely on the income he lost by taking the franchise). Damages received by the defendant therefore exceeded those awarded to the claimant by £149,081.99.
Enforceability of Non-reliance Clauses
A key element in the court’s findings was its view of the effect of a non-reliance clause in the franchise agreement on the defendant’s claim that he relied on the misrepresentations when entering into the agreement. The clause stated that the defendant acknowledged that he had not relied upon any oral or written representation made to him by the franchisor or his employees and that he had made his own independent investigations into all matters relevant to the franchise business.
A further paragraph stated:
“ the franchisee hereby acknowledges… that in giving advice to and assisting the franchisee in establishing the business the franchisor bases its advice and recommendations on experience actually obtained in practice and is not making or giving any representations guarantees or warranties with regard to such matters or generally in connection with the sales volume profitability or any other aspect of the business”.
The court considered two approaches to assessing the enforceability of non-reliance clauses. The first approach concerns the fact that the clause seeks to limit or exclude the franchisor’s liability for misrepresentation, and is therefore effective only to the extent that it is reasonable, in accordance with Section 11 of the Unfair Contract Terms Act 1977. The burden is on the party seeking to rely on the non-reliance clause to show that it is reasonable. On this approach, the court held that the non-reliance clause did not meet the requirement of reasonableness.
The second approach concerns whether the clause meets the following requirements identified in the Court of Appeal case of Lowe v Lombank Ltd :(2)
The court found that although the clause was clear and unambiguous, the fact that the defendant had signed the franchise agreement which contained the non-reliance clause was not sufficient evidence that he meant it to be acted on by the claimant. Nor was the court satisfied that the claimant believed the statement of non-reliance to be true. Instead, the court found that the claimant knew that the defendant had relied on the misrepresentations that it had made to him at various pre-contractual meetings.
The court found that it did not need to decide which of the two approaches above was correct, because they both led to the same conclusion: that the non-reliance clause did noprovide any defence to the franchisor in relation to the fraudulent misrepresentations that the court found it had made to the franchisee.
The first key lesson to emerge from this case with regards to damages is that the level of damages for a franchisee’s pre-termination breaches of a franchise agreement is likely to be calculated by reference to actual and projected figures for the franchise in question rather than by reference to average figures for other franchises of the franchisor. The second is that if a franchisor cannot, or will not, replace an outgoing franchisee in the territory for reasons other than the franchisee’s post-termination breach of the agreement, the franchisor may be entitled to only nominal damages for that breach.
Regarding mis-selling the franchise and non-reliance clauses, the key lessons are as follows:
For further information on this topic please contact Richard Little or Vanessa Smith at Eversheds by telephone (+44 20 7919 4500) or by fax (+44 20 7919 4919) or by email (email@example.com or firstname.lastname@example.org).
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