The Australian distributor of UFC gym franchises has been dealt a blow by a court ruling that voids the sale of three locations and requires it to pay a $6,000,000 damages award.
Ultimate Franchising Group Pty Ltd signed up operators for locations at Balcatta in Perth and Blacktown and Castle Hill in Sydney following a marketing campaign in early 2016.
The first cab off the rank – Balcatta – came to fruition after a lengthy period of negotiation starting with a PowerPoint presentation at Perth’s Hyatt Regency Hotel in January 2016.
Maz Hagemrad – UFG’s founder and one of its directors – represented in his presentation that the start-up cost was likely to be in the range of $500,000 to $800,000, depending on the floor area of the gym, inclusive of the $60,000 franchise fee.
That included – he said – fit out and all equipment which of themselves were costed at between $250,000 and $350,000.
Similar representations were separately made to the prospective franchisees for the other two locations albeit in different sums reflecting each locations circumstances.
It turned out however the establishment costs representation was in each case, incorrect because each franchisee would be required to pay in addition for equipment and fixtures.
In the case of Castle Hill, Hagemrad also convinced the franchisee that membership would likely grow by between 71 and 150 new members each month to 1272 members within 10 months of opening. A similar statement – that they would likely have 1550 members after 12 months – was made to the prospective Blacktown franchisee.
Assurances were given to the Castle Hill operator that the existing UFC gyms already open were profitable when in fact both the Balcatta franchise and Blacktown franchises were anything but.
Hagemrad also convinced his prospects that they would benefit from numerous “preferential arrangements” he had and was continuing to negotiate with suppliers.
The franchisees – who had no other connection with each other – sued in the same action in the Federal Court for rescission of their agreements and for losses incurred during their conduct of the ill-fated operations.
UFG contended when the matter came before Justice Tom Thawley in Sydney that it should be exculpated for the franchisees misunderstanding that fit out and equipment costs were included in the total set up figure.
Notwithstanding the inclusion of those figures as a separate line item in the franchisor’s projection template, the judge ruled that Hagemrad had stated “the equipment is already accounted for in the initial cost estimate”.
“On no occasion were they expressly told that the amount of $500,000 to $800,000 which had been discussed did not include the Life Fitness equipment,” he observedin concluding the establishment costs representations were misleading and deceptive.
His intimation of “preferential agreements” was also found to be in the same category.
The only arrangement in place was one with fitness equipment supplier – Life Fitness – who offered a 10% discount to UFG so it could on-sell the equipment to the franchisees at full price.
“This was more in the nature of profiteering from franchisees than securing preferential agreements for them with suppliers,” Justice Thawley noted.
Everything supplied to franchisees was in fact substantially marked up in price. For example, a dumbbell set cleared by customs on entry “for home consumption” had a delivered cost of $9,500 but was on sold at $27,250, a nearly 300% mark-up.
Hagemrad and his wife even had an interest in another company – not disclosed to franchisees – that disguised the substantial mark-ups he was passing on. And his brother operated another company that conducted the gym fit outs and had an unsubstantiated charge of $106k that the Balcatta franchisee claimed was a kickback to Hagemrad.
Suffice it to say such arrangements could not be regarded as “preferential” to franchisees.
Notwithstanding they had stated in the documentation they were not relying on any franchisor representations, the court was satisfied they did rely on all the representations that were conveyed.
UFG did not take any submissions pursuant to ACL s4(2) that there were reasonable grounds for making the representations that they did in relation to future matters. Even if they had, the court would have in any event concluded that there were no reasonable grounds for the representations made.
The court appointed a referee to determine the losses of each franchisee by valuing them at the date of entry into the relevant franchise and determining their trading losses.
His Honour declared – after a seven-day trial – each of the three franchise agreements void by reason of the franchisor’s misleading and deceptive conduct.
In the case of Balcatta, damages were awarded in accordance with the referee’s calculations for start-up costs of $1,399,184; net operating losses of $423,045; borrowing costs of: $ 97,067, less the value of plant and equipment at liquidation sale ($174,480) resulting in total damages of $1,744,816.
For Blacktown the total damages came to $1,906,783 and for Castle Hill, $2,352,066 using the same methodology.
The case also contains some cautionary observations about the presentation of affidavit evidence from multiple parties with the same cause of action and relating to similar factual circumstances.