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Franchising ’14: A Year in Review

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By Marianne Marchesi, Associate, MST Lawyers

2014 was a big year for franchising, with the new Franchising Code of Conduct (“the Code”) dominating most of the discussion. Litigation between franchisees and franchisors was rife and the Australian Competition and Consumer Commission (“the ACCC”) was more active than ever, with a number of investigations making their way to the Federal Court.

The New Code

The Exposure Draft of the new Code was released in April 2014. At the time, the Federal Government invited comments from industry stakeholders on the new Code, requesting that these be limited to the implementation of the new Code and not its technical aspects. The main concern raised by stakeholders was the issue of transitioning to the new Code. The concern was that the new Code would apply to franchise agreements entered into or renewed on or after 1 January 2015, meaning there would, in effect, be two Codes operating.

This was addressed when the new Code was released on 30 October 2014, as it provides that it applies to franchise agreements entered into on or after 1 October 1998. Further, the new Code provides for a transitional period, pursuant to which franchisors with an existing disclosure document may update the disclosure document by 31 October 2015 instead of 1 January 2015.

The key aspects of the new Code include:

  • introduction of an obligation of parties to a franchise agreement to act in good faith
  • reduced disclosure for master franchisors
  • prohibition on franchisors from requiring franchisees to incur significant capital expenditure
  • requirement for franchisors to maintain a separate bank account for the marketing fund
  • requirement for franchisors to provide prospective franchisees with an ‘Information Statement’
  • the introduction of penalties for breaches of the Code

For an in-depth summary of the new Code, see our article here.

Key Cases

There were a number of disputes between parties to franchise agreements in 2014, most centring around misleading and deceptive conduct and breaches of the Code.

SPAR Licensing

In the Full Federal Court decision of SPAR Licensing Pty Ltd v MIS QLD Pty Ltd [2014]FCAFC 50, the Court found that SPAR (the franchisor) had breached the Code by not providing a current disclosure document.

In that case, SPAR provided its disclosure document to the franchisee in July 2010, with its financial statements for the 2008/2009 financial year. Approximately six months later in February 2011, the franchisee entered into the franchise agreement. Unbeknownst to the franchisee, SPAR’s financial position had significantly deteriorated during this time.

The Court held that SPAR had not provided a current disclosure document and therefore committed a material breach of the Code. Justice Buchanan and Justice Foster decided this on the basis that the disclosure document was not current at the time the franchise agreement was entered into. Justice Farrell, whilst coming to the same conclusion, held that as the financial statements were provided in relation to the 2008/2009 financial year and the disclosure document was provided in the first month of the 2010/2011 financial year, the disclosure document was not compliant with the Code. As a result, the Court set aside the franchise agreement.

Spanline

In the Federal Court case of RPR Maintenance Pty Ltd v Marmax Investments Pty Ltd [2014]FCA 409, restraint of trade clauses in a franchise agreement were considered.

Spanline (the franchisor) and RPR (the franchisee) were parties to a franchise agreement which granted RPR an exclusive territory. RPR claimed that another franchisee in the system, Marmax, had encroached on its territory by servicing customers in that territory, and that Spanline had breached the franchise agreement by not taking appropriate action to prevent the encroachment.

In this case, even though the customer chose to use Marmax for the job in question, the judge held that Spanline breached RPR’s franchise agreement by not ensuring that RPR’s franchise was exclusive and by failing to take reasonable and available steps to ensure that Marmax did not service customers in RPR’s territory.

Frontline

In Julstar Pty Ltd v Hart Trading Pty Ltd [2014]FCAFC 151, Julstar purchased an existing Frontline franchised business from an existing franchisee, Hart Trading. Hart Trading made a number of representations to Julstar, including in relation to earnings of the franchised business and the number of potential clients, and the general success of Frontline franchises. Frontline (the franchisor) also made representations to Julstar, including that its franchisees had a “100% success rate”.

When the franchised business was not as successful as Julstar anticipated, it took action against the former franchisee and the franchisor, alleging misleading and deceptive conduct.

The Full Federal Court upheld the decision of the Federal Court that Hart Trading and Frontline had not engaged in misleading and deceptive conduct. In coming to its decision, the Court considered that the director of Julstar was employed in the former franchisee’s business prior to purchasing the business, and so would have had some knowledge of the level of business activity and profit.

This case was also a good example of the need to keep proper records of all documents received and representations made. In this case, poor record keeping resulted in difficulties for both parties, in particular Julstar, in establishing their case.

Video Ezy

The case of Video Ezy International Pty Ltd v Sedema Pty Ltd [2014]NSWSC 143 is very relevant to the new provision in the Code with respect to online sales.

Video Ezy and Sedema were parties to a franchise agreement in which Sedema was granted an exclusive territory. In 2011, Video Ezy sued Sedema for unpaid franchise fees. As is often the case, the franchisee counter-claimed, arguing that Video Ezy had breached the franchise agreement by conducting online sales of movies and DVDs in its exclusive territory.

Video Ezy argued that the exclusivity only applied to the physical shop and not to online sales. The Supreme Court rejected this argument. It found that Video Ezy had breached the franchise agreement and also acted unconscionably and in bad faith by competing with its own franchisee in the franchisee’s exclusive territory.

ACCC Investigations

The ACCC announced in late 2013 that it would be auditing franchisors in the fast food and fitness industries to test their compliance with the Code.  In 2014, it audited six fast food franchisors and six fitness franchisors who were largely found to be compliant.

The ACCC stated that the main concerns raised during this process included:

  • failure to disclose information about existing and former franchisees, such as their contact details
  • other omissions in the disclosure document
  • failure to audit the marketing fund statement or to have the audited statement prepared within four months after the end of the financial year.

A number of other franchisors were also investigated by the ACCC, many of which made their way to the Federal Court.

Coverall Cleaning Concepts

Coverall made projections to franchisees about the volume of work and earnings which turned out to be false. The ACCC initiated proceedings in 2014 claiming that Coverall engaged in unconscionable conduct and made false or misleading representations. It is currently seeking penalties, declarations and compensation for the two affected franchisees.

SensaSlim

SensaSlim supplied an oral spray that claimed to cause weight loss and was part of a “large worldwide clinical trial”. SensaSlim did not disclose the involvement of Peter Foster in the franchise system in its disclosure document (who had previously been banned from being involved in a weight loss or cosmetic health business).

The ACCC claimed that this was misleading and deceptive, and that disclosure of Mr Foster’s involvement would have been important to potential franchisees.

In April 2014, the Federal Court agreed. It also held that SensaSlim engaged in misleading or deceptive conduct by making false representations about the “large worldwide clinical trial”.

Taxsmart

The ACCC investigated Taxsmart for claiming that its graduate program would enable accounting graduates to meet the legal requirements for registration as a tax agent.

In May 2014, the Federal Court found that Taxsmart had engaged in misleading and deceptive conduct and ordered that it repay approximately $260,000 in franchise fees to five former franchisees.

Electrodry

The ACCC is seeking declarations, penalties, injunctions and corrective notices against Electrodry Carpet Cleaning for posting fake online testimonials.

The ACCC is claiming that the testimonials were written and posted by people associated with Electrodry, and not genuine customers.

Harvey Norman

The ACCC took action against nine Harvey Norman franchisees for making false and misleading representations to consumers about their consumer guarantee rights under the Australian Consumer Law. Some of the representations made included that the franchisee had no obligation to provide:

  • remedies for damaged goods unless notified within a short specified period, such as 14 days;
  • an exchange or refund for faulty goods supplied; and
  • a remedy independently of the relevant product manufacturer.

The matter proceeded to the Federal Court and nine judgments were made with penalties totalling $234,000 imposed on the franchisees. In addition to penalties, the Court also made orders including declarations and injunctions for the franchisees to display in-store corrective notices and implement a consumer law compliance program.

Key Lessons

The general theme of much of the activity in the franchising industry has centred around misleading and deceptive conduct, false representations and breaches of the Code.

Tips for avoiding conflict and investigations by the ACCC include:

  • Have a proper understanding of the Code and speak to a franchising lawyer if you have any questions or concerns
  • Keep proper records of all communications with franchisees, including copies of any documents provided to franchisees
  • Provide or ensure that your franchisees obtain adequate training on the Code, consumer laws and any other laws affecting your industry
  • Encourage (or insist) that franchisees obtain legal advice prior to entering into the franchise agreement
  • If any representations are made to a franchisee, ensure these are based on reasonable grounds and set out the assumptions on which they are based
  • Resolve conflicts early and ensure your franchise agreement has a proper complaint handling procedure

For further information about the new Franchising Code of Conduct or if you have another other franchising enquiries, please contact our Franchise Law team by email franchise@mst.com.au or by telephone +61 8540 0200.