Business Structuring and Operations: Where “Keep Calm And Carry On” is not effective

By Alicia Hill, Principal, MST Lawyers

When you purchase a car, it is accepted that there is more to owning it than just driving it continuously until you no longer wish to do so. Similarly, with establishing or purchasing a franchise business, you cannot expect to just operate a franchise until you no longer wish to do so. Franchises are like any other business; with an extra dollop of regulation added in the form of the Franchise Code of Conduct, mandated through the Competition and Consumer Act (Cth).

So just like any other business, franchises, in order to survive need to adjust to changing legislative and market conditions through innovation, new product development, merger or acquisition, operational variations, marketing and structural reform.  This means that consideration needs to be given to the implications of changes introduced to the franchise to ensure the legality of its business operations or face sanction, penalty or the collapse of the legal structure that enables the franchise to operate.

Some recent cases provide examples of why franchises need to carefully consider the legalities of operational changes which will impact their business and adjust accordingly as the World War Two adage ‘Keep Calm and Carry On’ simply does not apply to modern franchise businesses.

Change in approach to dispute resolution

In Authenticateit Pty Ltd v Enikom Pty Ltd [2016] VCAT 2134, Authenticateit commenced proceedings in the Victorian Civil and Administrative Tribunal (VCAT) claiming payment of $13,741.12 for monies owed to it for the provision of computer services.

The contract for service contained a dispute resolution clause requiring the parties to first attempt to resolve the dispute amongst themselves prior to any court proceeding being commenced.

The court was informed that the reasons for the immediate submission to VCAT rather than utilisation of the dispute resolution clause was because:

• The amount of the claim was relatively small and was a straightforward dispute;
• Both parties and the principal officers and witnesses were based in Melbourne;
• Unlike the dispute resolution clause which required an arbitration in Singapore and would result in significant expense , VCAT provided a convenient location without the need for involvement or cost of legal counsel;
• If the dispute had been brought in a court of Victoria it was of a type in which VCAT was a more appropriate forum.

VCAT refused to hear the claim granting a stay on the dispute filed subject to the parties completing the dispute resolution clause requirements in their contract.

If Authenticateit wished to change its approach and carve out disputes of minor monetary value from its existing dispute resolution clause then the obvious answer is to amend the existing clause and ensure that future contracts are updated with the new preferred operational approach.

Change in products offered by the business

In Australian Securities and Investments Commission (ASIC) v Fast Access Finance Pty Ltd (No.2) [2017] FCA 243, the business had developed a new trading model in response to changes in the law on the introduction of the National Consumer Credit Protection Act which prohibited lending at interest rates in excess of 48%.

The model involved the purported sale of diamonds by a franchisee to the customer at one price and sale of those diamonds by the customer to another company associated with the franchisor at half the purchase price so that the customer received half of the amount of the incurred debt. The amount received by the customer was the amount that the franchisee had agreed to provide (being half the purchase price), having regard to the customer’s needs and capacity to repay. However, the customer was required to repay the full amount.

ASIC argued and the court found that the transaction was a provision of credit with an interest rate in excess of 48%. The amounts advanced varied between $500 and $2,000.

The Court found that:

• The diamond model as implemented was specifically designed to circumvent the new law prohibiting excessive interest and requiring the providers of such loans to hold Australian Credit Licences;
• The franchisor had in-house legal and accounting expertise and it was difficult for the court to trust that the Franchisor truly believed it had developed a lawful scheme;
• The ridiculousness of the scheme must also have been evident to the franchisees, although they may have simply assumed that the franchisor was reputable and understood the relevant law;
• The franchisor was exploiting its franchisees but the franchisees were quite happy to exploit their customers;
• the franchisor and the franchisees had all contravened the law, with the franchisor being considered more culpable but with the franchisees also liable for breaches. In addition to compensation orders to repay amounts to affected customers, the two franchisees received penalties of $80,000 and $250,000 respectively and the franchisor a $400,000 penalty.

If Fast Access Finance had wanted to ensure a viable business model adaptive to the changes in law it needed to ensure that it had obtained correct advice and structured the changes to its product offering to ensure compliance.

Change in approach to protecting interests

With the introduction of the Personal Properties Securities Act 2009 (Cth)(PPSA), the nature of the way businesses protected their interests in personal property was dramatically altered. Continued reliance on prior existing contractual and security documentation became problematic due to the manner in which the PPSA operated to affect the rights between various parties.

Additional amendments to the PPSA legislation in 2015 further impacted on businesses’ ability to secure for themselves interests they held in the personal property of another.

Items that became critical operationally to protect business interests included:

• The timing of registration of the interests;
• Ensuring the correct description of the interests registered;
• Whether other legislation protected the interests overriding the PPSA;
• Clear actions when exercising rights compliant with PPSA.

Some franchise systems (franchisors and franchisees) have made informed business decisions based on advice as to what and when they will register interests. Others have discovered after claims from liquidators that what they thought had been secured and recoverable by them in the event of an insolvency was lost having vested pursuant to operation of section 267 of the PPSA.

General Electric International Inc (GE)., in the case of Power Rental Op Co Australia LLC v Forge Group Power Pty Ltd (in liq) (receivers and managers appointed) [2017] NSWCA 8 saw it lose its interest in two gas turbine generators valued at US$28,662,706 having relied on its contractual arrangements rather than registering a financing statement of the PPSA.

On the appointment of liquidators to Forge, the unregistered interests vested in the liquidators by operation of law. The act of registering its interests would instead have preserved GE’s interest in the gas turbines and its failure to register resulted in the loss of these valuable assets.

Like all business operations in today’s market environment, change and adapting to change is critical. Regrettably, the idea of riding out change on existing templates and operational approaches is not always possible and it is necessary to reconsider the operational framework and adjust as needed. Then, if events permit, the ability to Keep Calm and Carry On will be available for a period until the need to reassess, redesign or adjust is again required. Ensuring legally effective change occurs in order to mitigate risk to the business is a critical component.

MST Lawyers are available to advise and assist in keeping all businesses, including franchises, operating effectively. For more information, please contact our Franchising Team by email or call  Alicia Hill on 03 8540 0292, if you would like to discuss these concerns in further detail.