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The Ultimate Franchising Group Pty Ltd (UFG), the Australian master franchisor for USA-based UFC (Ultimate Fighting Championship) Gyms, has been ordered to pay $5 million to three franchisees after a ruling in the Federal Court of Australia.

In a judgement earlier this month - Girchow Enterprises Pty Ltd v Ultimate Franchising Group Pty Ltd (Final Hearing) [2023] FCA 420 - Federal Court Justice Thomas Thawley ruled that UFG had provided inaccurate establishment costs and income projections to franchisees, finding that UFG had misled the franchisees about businesses which were "near valueless" and unlikely to operate profitably.

Justice Thawley ruled that each of the franchise agreements - in Balcatta, Western Australia and at Blacktown and Castle Hill in NSW - be declared void and ordered UFG to pay compensation of $1.7 million, $1.9 million and $1.4 million to the respective business owners.

The franchisees had alleged that UFG made misleading and deceptive representations to induce them into entering into UFC Franchise Agreements, and that their establishment costs exceeded the upper limit of $800,000 that was represented.

Judge Thawley found that UFG and its Directors Maz Hagemrad and Samer Husseini had indicated that it had a proven business model in Australia with UFC gyms operating profitably and that locations reached breakeven with 600 to 700 members.

He noted “the applicants (then) expended money on setting up businesses which did not and were unlikely ever to generate a profit.”

Judge Thawley stated “the businesses had no value as a going concern - this was not a case of businesses turning a profit.

“The applicants incurred expenditure on setting up near valueless businesses.”

In his judgement, Judge Thawley held that no income representations were made to the Balcatta franchisee, as UFG merely provided a ‘template’ excel spreadsheet which the franchisee could populate with different membership numbers and weekly fees.

UFG had communicated that the spreadsheet could be used as a ‘working hypothesis and not as something could be guaranteed or necessarily even likely’. Even if the representations were made out, his Honour viewed that the franchisee used their financial expertise to undertake their calculations and did not rely on UFG’s representations or the spreadsheet.

Conversely, the Blacktown franchisee had no experience in owning a gym.

Here the Court found UFG’s conduct to be misleading despite the franchisee having obtained advice from an accountant and business adviser.

UFG had revised the franchisee’s cashflow document which doubled the estimated gross income based on a significantly higher growth in memberships and no cancellations despite having no reasonable grounds for making such assertions.

The representations were separated into two categories - ‘income representations’ and ‘establishment cost representations’.

Some of the representations included:

Income representations

• That the gross annual income and gross profit for each franchise could be calculated based on the ‘cash flow template’ excel spreadsheet provided by UFG. The spreadsheet contained formulas for operating expenses based on the number of memberships and cancellations, and could forecast the gross income.
• That the gross annual income would be $1,248,830, with the gym growing by 100 - 150 new members per month.

Establishment representations

• That the range of establishment cost for the building, construction and fit out of the franchise were accurate
• That the range of establishment cost for the lease or purchase of equipment of the franchise were accurate.

Establishment cost representations
The Court found that UFG’s representations that the upper limit of the establishment costs would be $800,000 were misleading. At no point throughout UFG’s discussions with franchisees did it advise that the upper limit would be exceeded.

At the time when the Wetherill Park franchise was close to opening, UFG informed the Balcatta franchisee that updated establishment costs would be ‘per our original estimations’.

This was incorrect, as equipment in the gym was treated as an ongoing expense for the Wetherill Park franchise rather than an establishment cost as conveyed in the Disclosure Document.

The gym equipment alone was approximately $360,000 so there was no reasonable basis to convey that equipment costs could be as inexpensive as the lower limit of $300,000.

The franchise agreements and related personal guarantees were set aside, and UFG was ordered to pay damages to the franchisees.

Key takeaways
MST Lawyers suggest that there are substantial risks in providing projections about the financial earnings, growth or sales potential of a franchise because there are severe consequences if the projections are inaccurate.

It is important for franchisors to understand the differences between establishment costs and ongoing operational costs and to disclose these expenses in the correct section of their disclosure document to avoid misleading franchisees.

Background
Pursuant to a Master Territory Agreement, UFG is the Australian franchisor of the Ultimate Fighting Championship (UFC) Gyms franchise of the USA.

In 2016 UFG began setting up the franchise and recruiting prospective franchisees. At the time of the discussions there was only one franchisee - Wetherill Park - which had not commenced trading.

UFC Gym Penrith ceased operations as of Friday 23rd March with the owners blaming "three years of COVID disruption and the compounding challenges of economic uncertainty". 

Click here to view case details. 

Click here to view an opinion from MST Lawyers on The Importance of Accurately Disclosing Payments Payable by Franchisees (Disclosure Document Item 14).

Image credit UFC Gym.

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