Franchisors To Face Tougher Scrutiny As ACCC Uses New Powers Under Franchising Code

By Louise Wolf, Senior Associate, MST Lawyers and Esther Gutnick, Senior Associate, MST Lawyers

As foreshadowed in their Compliance and Enforcement Policy for 2017, the ACCC has been paying close attention to the franchising industry. The amendments to the Franchising Code of Conduct (Code) which came into effect on 1 January 2015 gave the ACCC new powers to impose infringement notices and to seek civil penalties in the Federal Court for breaches of the Code. In recent months the ACCC has been actively exercising these powers. 

We have documented three cases that provide strong examples of the pitfalls facing franchisors.

Case 1: Domino’s becomes the first company to pay infringement notices for breaches of Code

On 4 May 2017, Domino’s Pizza Enterprises Ltd (Domino’s) became the first company to pay penalties under the revised Code following the issue of infringement notices by the ACCC.  The ACCC has the power to issue infringement notices where it has reasonable grounds to believe that a person has contravened certain requirements of the Code.  Currently, the infringement notice penalty amount for a body corporate is fixed at $9000 and $1800 for individuals and other entities per breach.  It is important to note that payment of a penalty specified in an infringement notice is not of itself an admission of a contravention of the Code.

Exercising these new powers, the ACCC issued Domino’s with two infringement notices. The ACCC issued the notices believing that Domino’s had failed to abide by the Code’s requirement to provide franchisees with both the annual marketing fund financial statement and the auditor’s report in respect of the Domino’s marketing fund for the financial year ended 30 June 2016 within the timeframes prescribed by the Code.

The ACCC has since announced that Domino’s has paid the penalties totalling $18,000.

Michael Schaper, ACCC Deputy Chair, commented that ‘marketing fund contributions are often a significant expense and franchisors need to provide timely and accurate disclosure of the fund’s activities’.  He then reaffirmed that one of the ACCC’s enforcement priorities is to ensure that small businesses receive the protection of industry codes.

Case 2: Federal Court proceedings against Ultra Tune, seeking first civil penalties under Code

On 19 May 2017, the ACCC commenced proceedings in the Federal Court against Ultra Tune Australia Pty Ltd (Ultra Tune) for alleged breaches of the Code and the Australian Consumer Law (ACL) exercising, for the first time, their powers to seek civil penalties under the revised Code.   

The Code prescribes civil penalties of up to 300 penalty units for certain breaches of the Code.  The fine equates to an amount of $54,000, given the current Commonwealth rate. 

Ultra Tune is Australia’s second largest motor repairer with over 200 franchises in Victoria, Australian Capital Territory, New South Wales, Queensland and Western Australia. 

The ACCC claims that in 2015, Ultra Tune did not act in “good faith” in its dealings with a prospective franchisee and failed to: 

• provide the required documents to the prospective franchisee before accepting a non-refundable payment
• prepare, audit and provide marketing fund statements to franchisees
• update its disclosure document, or provide copies of it, within the time periods set in the Code.

The ACCC has also claimed that Ultra Tune made false or misleading representations to the prospective franchisee in breach of the ACL.

Mr Schaper said, ‘A significant feature of the Franchising Code is that it provides that franchisors must act in good faith in dealings with prospective franchisees. In addition, the Australian Consumer Law prohibits false or misleading representations.’

Concerning the alleged breaches of the Code, Mr Schaper said, ‘Franchisees need accurate and timely information to help them make informed business decisions.  For this reason, the Franchising Code requires franchisors to provide disclosure documents before accepting non-refundable payments from prospective franchisees, and to provide annual financial statements detailing receipts and expenses for any marketing fund to which franchisees are required to contribute.’

Commenting further, he said, ‘Franchising contributes significantly to the retail economy, and all franchisors must comply with the Code and be transparent in dealings with franchisees. Ensuring that small businesses receive the protections of industry codes is a current ACCC compliance and enforcement priority.’

The ACCC is seeking a refund of the prospective franchisee’s payment, declarations, injunctions, pecuniary penalties, compliance and adverse publicity orders. 

The first case management meeting is due to take place on 16 June 2017. We will be following the case and others like it as they arise and provide regular updates. 

Case 3: Car wash franchisor is the ACCC’s most recent target

On 31 May 2017, the ACCC issued its latest press release concerning a franchisor, alleging that Geowash Pty Ltd, which is currently operating under a Deed of Company Arrangement (Geowash) made false or misleading representations on its website that:

• prospective franchisees could make revenues of $70,216 and estimated profits of $30,439 in an average 28-day period when Geowash did not have reasonable grounds for making such representations; and
• Geowash had a commercial relationship or affiliation with each of Nissan, Kia, Renault, Audi, Emirates, Shell, Hertz, Holden, Ikea, and Thrifty, when it did not.

Further, the ACCC has alleged that Geowash used franchisee funds for purposes that were not permitted by the franchise agreement, including paying commissions to its director and national franchise manager.  The ACCC states it considers that ‘Geowash did not act in good faith in its dealings with franchisees’. 

Because Geowash is operating under a Deed of Company Arrangement, the ACCC is required to seek leave of the Federal Court to commence the action.  If permitted to proceed, the ACCC has indicated it will be seeking penalties, compensation for affected franchisees and to have the director and national franchise manager disqualified from managing corporations for five years.

Time for all franchisors to learn from the mistakes of others

It is clear that the ACCC is actively enforcing the provisions of the Code and pursuing franchisors,  it believes, have not complied.

It is critical that all franchisors review their system to ensure Code compliance.  In particular,  diligence is required to meet the specific obligations and deadlines  set out in the Code, including:

• preparation of an annual financial statement disclosing the marketing fund’s receipts and expenses within four months of the end of each financial year. Furthermore, a copy must be provided to all franchisees within 30 days of its preparation; and

• the auditing of the financial statements of the marketing fund within four months of the end of each financial year by an independent company auditor unless 75% of contributing franchisees vote against the audit within three months of the end of each financial year. In the absence of such a vote each year, a copy of the auditor’s report must be provided to franchisees within 30 days of its preparation;

• ensuring the return of refundable monies to franchisees;

• updating the franchisor’s disclosure document annually within four months after the end of each financial year and ensuring that it contains either:
  • the franchisor’s financial reports for the last two completed financial years; or
  • an audit report prepared by a registered company auditor within four months of the end of the financial year to which it relates; and
  • if the franchisor has been in existence for less than two years, a statutory declaration and associated further audit of solvency also prepared by a registered company auditor.

Assuming that a franchisor’s financial year ends on 30 June, the annual update of the Disclosure Document must be completed between 1 July and 31 October.  However, disclosure is not just a once a year event.  There are ongoing obligations to disclose materially relevant facts to franchisees over and above the obligation to update the Disclosure Document annually.

For example, complete financial statements are required to include audit reports or solvency statements /declarations made by directors. Such documents must be provided to each prospective franchisee either with the Disclosure Document or separately but before the franchisee enters into the Franchise Agreement.  This obligation exists even if the last date for updating the Disclosure Document has not yet expired.  Failure to do so exposes the franchisor to the possibility of civil penalties of up to $54,000.

In addition, to avoid the risk of civil penalties, franchisors must also ensure they disclose to all franchisees the following occurrences within a reasonable time (not more than 14 days):

• proceedings against the franchisor, a franchisor’s associate or one of their directors in Australia alleging:
  • a breach of the franchise agreement;
  • a contravention of the trade practices law or the Corporations Act; or
  • unconscionable conduct, misconduct or an offence of dishonesty;
• a judgement against the franchisor or associate of the franchisor under:
  • Part 3 of the Independent Contractors Act 2006; or
  • a State or Territory law regulating workplace relations or independent contractors;
• civil proceedings in Australia against the franchisor or its associate or one of their directors by at least 10 percent or 10 franchisees (whichever is lower);
• any judgement against the franchisor or its associate in Australia not discharged within 28 days, for $100,000 for small proprietary companies or $1 million for other companies;
• any judgement entered against a franchisor or its associate against any matter required to be disclosed in Item 4 of the Disclosure Document;
• the franchisor or an associate becomes an externally-administered body corporate;
• a change in the intellectual property, or ownership or control of the intellectual property, that is material to the franchise system;
• the existence and content of:
  • undertakings given by the franchisor or an associate under s.87B of the Competition and Consumer Act 2010; and
  • any order made by the Federal Court of Australia under that section about such an undertaking.

It is also important to note that the annual update requirement and the obligation to disclose materially relevant facts are the minimum standard for ongoing disclosure.  Liability for misleading and deceptive conduct can arise from not telling a person something they should be told.

The overarching purpose of the Disclosure Document is to provide information necessary for a prospective franchisee to make an informed decision.  Accordingly, even if disclosure of certain information is not technically required, there may be a duty to disclose such information to ensure that a prospective franchisee is not misled.  For example, if a large number of franchises were terminated, prospective franchisees should be informed, despite the fact an update of the franchisor’s disclosure document may not be due.  Failure to do so could result in a decision being made to enter into a franchise agreement on the basis of misleading information.

In relation to representations as to all future matters, such as potential profits, in addition to common law principle that such representations must be based upon reasonable grounds, care must be taken in completing the items in the Disclosure Document which relate to the provision of earnings information to franchisees. 

Breaches of the obligation to act in good faith are now being alleged by the ACCC against two franchisors.  The treatment of the Federal Court of this new obligation under the Code will be instructive for franchisors in the future.

MST Lawyers has an experienced team of franchising lawyers who can assist you with any questions about franchisors’ obligations under the Code, including disclosure requirements, obligations regarding refundable money, misleading or deceptive representations and good faith.  For more information, please contact our Franchising Team by email or call +61 3 8540 0200.