Franchising Year in Review – Lessons from 2021

by Raynia Theodore, Principal and Belinda Ozgun, Lawyer

The franchising sector had another action-packed year in 2021, with significant changes to the Franchising Code of Conduct (‘Code’) coming into effect, requiring Franchisors to review and update their Franchise Agreements and Disclosure Documents to comply with the new Code. Several proceedings instituted by the Australian Competition and Consumer Commission (‘ACCC’) also continued and the question of when an agreement constitutes a ‘Franchise Agreement’ to which the Code applies was again considered and decided in the Federal Court of Australia.

This article summarises some of the key events that occurred and impacted the franchising sector in 2021 and the lessons that can be learned from them.

Amendments to the Franchising Code of Conduct

Significant changes to the Code came into effect from 1 July 2021, requiring Franchisors to take a close look at their processes and procedures, as well as their franchise documents, to ensure ongoing compliance with the Code. The changes intended to address inadequacies in the Code also amplifying the disclosure obligations of Franchisors, increasing penalties, widening dispute resolution options and modifying the termination rights of both Franchisees and Franchisors, amongst other things. The 2021 Code amendments covered almost all stages of the franchising process and necessitated significant changes to franchise documents.

Some of the more significant changes to the Code include the following:

• Disclosure Obligations – The Key Facts Sheet was introduced, summarising the key details of the Disclosure Document in a more concise and easy-to-read format for Franchisees. The Code requires that it be provided to Franchisees and prospective Franchisees alongside the Franchisor’s Disclosure Document. Additional disclosure obligations were imposed on Franchisors in respect of supplier rebates and capital expenditure as well as additional requirements to provide lease documents to Franchisees, where applicable.
• Cooling Off – The cooling off period for Franchisees was extended from seven days to 14 days after entering into the Franchise Agreement and cooling off periods have been introduced for transfers. A further cooling off period can also now be triggered by the provision of further leasing documents if the leasing terms are not substantially identical to those disclosed to a Franchisee at the outset.
• Legal Costs – Clause 19A now prohibits Franchisors from entering into Franchise Agreements that have the effect of requiring a Franchisee to pay all or part of the Franchisor’s legal costs in relation to preparing, negotiating or executing the Franchise Agreement or documents relating to it. However, this new clause does not prevent the Franchisor from requiring a Franchisee to make a payment of a specified amount before the Franchisee starts the business, so long as the amount is specified in the Franchise Agreement and stated to be for the Franchisor’s costs of legal services relating to preparing, negotiating or executing the Franchise Agreement, and not for any amount for the Franchisor’s costs of legal services that will or may be provided after the Franchise Agreement is entered into.
• Termination – The Code no longer allows for Franchisors to terminate a Franchise Agreement immediately in ‘special circumstances’, such as Franchisee insolvency, fraud or abandonment of the franchise. Instead, Franchisors are now required by clause 29 of the Code to provide seven days’ notice of the proposed termination if any of the grounds in clause 29(1) of the Code apply. The introduction of this notice period was cause for concern initially given the nature of some of the special circumstances, such as endangering public health or safety. The concern was that a Franchisee could continue conduct which endangers public health or safety for a period of 7 days or longer if the dispute resolution process is invoked.  However, the amendments to the Code make it clear that the Franchisor may require an offending Franchisee not to operate its franchise provide such right is contained in the Franchise Agreement. In addition by virtue of changes to the Code, Franchisees are now also permitted to propose termination of their Franchise Agreement at any time, A Franchisee proposing termination must set out the reasons for the proposed termination in writing and the Franchisor must provide a substantive written response to the proposal within 28 days.
• Dispute Resolution – The amendments to the Code introduced conciliation and arbitration as alternatives to mediation in the dispute resolution process provided for under the Code. These amendments broaden Franchisors’ and Franchisees’ options.

The Code continues to be updated and amended from time to time. Further minor amendments came into effect from 21 December 2021 and a new compilation of the Code, Compilation No. 6 published on 28 January 2022. It is therefore vital that Franchisors keep up to date with updates to the Code to ensure they are handing out the most current copy to Franchisees. A summary of the most recent amendments to the Code can be found here.

Megasave and Gary Bourne

The ACCC commenced proceedings in the Federal Court of Australia against Megasave Couriers Pty Ltd (‘Megasave’) and its sole Director, Gary Bourne in July 2020 alleging that it had been conducting misleading and deceptive conduct, whilst also making false and misleading representations about it services and business activities. The ACCC alleged that Megasave was making representations to prospective franchisees in relation to guaranteed minimum weekly payments and annual income, despite these payments not being made to existing franchisees. Megasave was also marketing its franchises at different prices over time, ranging between $12,000 and $30,000, despite most franchises being sold for approximately $27,500 each.

During the proceeding, Megasave admitted that there was no reasonable basis for making the representations and by consent, the Federal Court made an order disqualifying Gary Bourne from managing corporations for a period of five years.

A hearing to determine the penalties and compensation for the affected franchisees was subsequently held on 29 April 2021, with the Federal Court ordering Megasave to pay $1.9 million in penalties. In addition, Gary Bourne was ordered to pay a penalty of $120,000.

The Megasave judgement and penalties sends a strong message to Franchisors and their directors, reminding them of their broader obligations under the Australian Consumer Law (‘ACL’) and the penalties that they may potentially face for breaching the ACL.

Franchisors should be careful when making statements and publishing material about financial support that may be available or income likely to be earned by potential franchisees. Further if a guarantee of income is given, Franchisors must honour such obligation.  Franchisors should seek comprehensive legal advice in relation to statements to be made and materials provided to prospective franchisees. Appropriate qualifications and disclaimers may need to be drafted and given to prospective franchisees.

Jump Swim

In December 2020, the ACCC initiated proceedings against Jump Loops Pty Ltd (in liquidation) (‘Jump Swim’) and its Director, Ian Michael Campbell with the leave of the Court, following the discontinuation of a previous proceeding in 2019. In May 2021, the Federal Court declared, by consent, that the Franchisor falsely represented to 174 Franchisees that they would have an operational swim school within 12 months of signing a Franchise Agreement with Jump Swim. Further, it declared, that the Franchisor accepted payments from 127 Franchisees, despite knowing that there was no reasonable basis for believing that it would be able to provide the Franchisee with an operational swim school within the represented time frame. As a result, the Court ordered Jump Swim to pay penalties of $23 million for making false or misleading representations and wrongly accepting payments from franchisees. In addition, the Court also ordered the founder and former Managing Director, Ian Michael Campbell, to pay $400,000 in penalties and $500,000 in compensation to affected franchisees.

The ACCC acknowledged that many of the affected franchisees would not likely be compensated for their loss given the Franchisor’s liquidation, however the enormous penalties most certainly sent a strong message to Franchisors and their directors.

This case again highlights that Franchisors should be careful when making statements to potential franchisees.

Geowash

An appeal was filed in February 2020 by the Director and National Franchising Manager of Geowash Pty Ltd (‘Geowash’) in relation to the penalties totalling $4.2 million imposed on them by the Federal Court in January 2020. On 22 June 2021, the Full Federal Court rejected the arguments and dismissed the appeal against the decision of the Federal Court that the individuals were knowingly concerned in relation to breaches of the Code and the ACL by Geowash.

The Full Federal Court unanimously found the primary judge’s ‘characterisation of the system or pattern of conduct as unconscionable was founded upon deliberate deceptiveness and dishonesty’ and that Geowash’s ‘so called “business model’ was a largely consistent approach to extract money from a group of people by falsely representing to them that moneys would be used in a particular way, when it was not intended to do so.’ 

In addition to the financial penalties imposed for breaching the Code and the ACL, Geowash’s director and manager were each restrained for four and five years from being involved in a similar business to Geowash, or a franchise and disqualified from directorship for four and five years each. They were also personally ordered to provide an additional $500,000 to compensate franchisees who suffered financial losses as a result of their dishonest conduct.

The key message from the Geowash case is that Franchisors who engage in unconscionable conduct face high penalties and executives who are found to have aided and abetted can also be ordered to compensate franchisees and may be restrained from being involved in franchise operations and disqualified from directorships.

Freedom Foods

Freedom Foods brought proceedings in the Federal Court of Australia seeking a declaration that Blue Diamond Growers had breached sections 18 and 21 of the ACL and challenging the validity of the arbitration clause in the agreement between the parties.

In the case of Freedom Foods Pty Ltd v Blue Diamond Growers, the Federal Court considered when an agreement could be classified as a Franchise Agreement for the purposes of compliance with the Code. Freedom Foods Pty Ltd (‘Freedom Foods’) argued that the agreement was a Franchise Agreement for the purposes of the Code, therefore, invalidating Blue Diamond Growers’ arbitration clause in the agreement. However, the Federal Court found that the agreement was not in fact a Franchise Agreement within the meaning of clause 5(1)(b) of the Code. Following the judgement, Freedom Foods made an application to appeal the Court’s decision.

The Full Federal Court found that the appeal should be refused in relation to clause 5(1). The Court held the Federals Court’s decision was correct. Clause 5(1)(b) of the Code states that ‘a franchise agreement is an agreement in which a person (the franchisor) grants to another person (the franchisee) the right to carry on the business of offering, supplying or distributing goods or services in Australia under a system or marketing plan substantially determined, controlled or suggested by the franchisor or an associate of the franchisor’.

The primary judge concluded that the agreement was an agreement under which Blue Diamond Growers granted Freedom Foods the right to carry on the business of offering, suppling or distributing goods in Australia, however there was no requirement for Freedom Foods to operate under a marketing plan, despite mention of a marketing plan in the clause. The primary judge found that there was not enough to establish that the promotional plan in place was ‘substantially determined, controlled or suggested’ by Blue Diamond Growers and the Full Court, on appeal, agreed.

The decision brings an end to the back-and-forth litigation between the two businesses in Australia, setting the stage for further court battles in the United States. More importantly, the case provides further clarity and insight into the factors which determine when an agreement is in fact a franchise agreement for the purposes of the Code.

The key takeaway from this case is that the question of whether an agreement is a franchise agreement is not a simple question to answer. Legal advice should be sought from lawyers expert in franchising law.

Looking Forward to 2022

Following the 2021 amendments to the Code, the Federal Government has remained focused on improving franchisee information and awareness. In September 2021 the Government released draft amendments to the Code setting out further changes to it, to come into effect in 2022. These amendments reflect the 2021-22 budget announcement of $4.3 million for the development of a new Franchise Disclosure Register (‘Register’), due to commence on 31 March 2022. The Register will be a public database of franchisors’ Disclosure Documents and other relevant information which is currently only provided by franchisors to prospective franchisees or existing franchisees on request. Its intended purpose is to assist prospective franchisees in making informed decisions and conducting their own due diligence before entering into a franchise agreement, by allowing them to search the public Register for documents and relevant information relating to numerous franchise systems.

Click here for further details in relation to the Register.

2022 is sure to be another eventful year for the franchising sector.

If you have any queries about the above cases or require advice or assistance with franchising, please feel free to contact the MST Franchising team by email franchise@mst.com.au or by telephone +613 8540 0200.