Important Bulletin – Franchising Code of Conduct Penalties about to be substantially increased to include “Mega Civil Penalties”

By Philip Colman, Principal, MST Lawyers

Last week, the first stage in what I regard as being by far the most significant change in franchising laws in Australia, was completed.

On 2 September 2021 the Treasury Laws Amendment (2021 Measures No. 6) 6 Act 2021 was passed by the Federal Parliament.

Provisions in this Act that are relevant to franchising include an amendment to section 51AE(2) of the Competition and Consumer Act 2010 (Cth) (the Act under which the Franchising Code of Conduct (Code) is made) to allow the Code to be amended to allow for civil penalty provisions imposing the following penalties:

1. For contraventions by a body corporate, the greater of:

                (a)          $10 million;

(b)          if the Court can determine the value of the benefit that the body corporate, and any body corporate related to the body corporate, has obtained directly or indirectly and that is reasonably attributable to the contravention—3 times the value of that benefit; or

(c)           if the Court cannot determine the value of that benefit—10% of the annual turnover of the body corporate during the period of 12 months ending at the end of the month in which the contravention occurred.

2. For contraventions by an individual or a person who is not a body corporate, $500,000.
3. For provisions in the Code that do not impose the above civil penalties, a civil penalty not exceeding 600 penalty units (currently $133,200).

In this article, I will call a civil penalty of the type referred to in items 1 and 2 above a Mega Civil Penalty

The Code has to be formally amended for these new civil penalties to come into play and at the date of publication this has not occurred. But it will in the very near future.

Currently there are 45 sections of the Code that impose maximum civil penalties of 300 penalty units (currently $66,600).

The Government has privately released for comment an Exposure Draft of a regulation that would amend the Code penalties so as to introduce these significantly higher penalties for some contraventions of the Code.  If the Exposure Draft is fully adopted by the Government and the Code is amended, the civil penalty regime in the Code would be in accordance with the table https://www.mst.com.au/documents/Franchising%20Code%20of%20Conduct%20Civil%20PenaltyProvisions.pdf.

As you can see from the table if the Exposure Draft becomes law, Mega Civil Penalties can be imposed for contraventions of many provisions, including:

• Good faith obligations;
• Disclosure obligations;
• Marketing fund obligations;
• Termination obligations;
• Mediation attendance obligations; and
• Some new motor vehicle dealership obligations.

In fact, there is potential for Mega Civil Penalties to apply to 13 types of contraventions, with civil penalties being doubled for the other 32 types of contraventions.

The imposition of penalties of the type referred to in point 1 above could force many franchisors into insolvency resulting in the potential collapse of franchise networks and huge financial losses for both franchisors and franchisees.  No doubt many employees will lose their jobs and there will be collateral damage to landlords and suppliers.

These types of penalties for contravention of franchising laws are unheard of around the world and, even in Australia, they are reserved for the most egregious conduct such as anti-competitive conduct and cartel conduct.

Admittedly, these are maximum penalties, and they can only be imposed if the ACCC brings proceedings in the Federal Court of Australia seeking a civil penalty.  And, of course, the ACCC can instead issue an infringement notice which would result in a civil penalty of $11,100 for a corporation and $2,220 for an individual.  Circumstances where the ACCC is more likely to consider the use of an infringement notice, rather than taking the matter to court, include where:

• the conduct relates to isolated or non-systemic instances of non-compliance;
• there have been lower levels of franchisee harm or detriment; or
• the facts are not in dispute.

But the ACCC is not afraid to go to Court and it has the resources to do so.  Its current Compliance and Enforcement Priorities include:

“Ensuring that small businesses receive the protections of the competition and fair trading laws, including franchising”

and states:

“When deciding whether to pursue a matter, the ACCC will prioritise those which fall within our current priority areas. The ACCC will give particular consideration to those matters which also have the following factors:

• conduct that is of significant public interest or concern
• conduct that results in substantial consumer or small business detriment
• national conduct by large traders, recognising the potential for greater consumer detriment and the likelihood that conduct of large traders can influence other market participants
• conduct involving a significant new or emerging market issue or where our action is likely to have an educative or deterrent effect
• where our action will assist to clarify aspects of the law, especially newer provisions of the Act.

While the ACCC will always prioritise current priority areas, we will also retain capacity to pursue other matters that display the above factors and will continue important residual work in areas previously identified as priority areas.”

In a civil penalty hearing, the ACCC will make submissions as to an appropriate penalty which the Judge may or may not accept.  The things the Court considers[1] include

• the size of the contravening company;
• the deliberateness of the contravention and the period over which it extended;
• whether the contravention arose out of the conduct of senior management of the contravener or at some lower level;
• whether the contravener has a corporate culture conducive to compliance with the Act (or the Australian Competition and Consumer Law) as evidenced by educational programmes and disciplinary or other corrective measures in response to an acknowledged contravention;
• whether the contravener has shown a disposition to co-operate with the authorities responsible for the enforcement of the Act in relation to the contravention;
• whether the contravener has engaged in similar conduct in the past;
• the financial position of the contravener;
• whether the contravening conduct was systematic, deliberate or covert.
• the effect of the contravening conduct on a functioning market together with any other economic effects of the contravening conduct; and
• the degree of market power of the contravener as evidenced by its market share and the ease of entry into the market.

But even a Mega Civil Penalty of a small fraction of the maximum could severely hurt many franchisors in Australia. 

We have seen from the Ultra Tune case[2] how one mistake can lead to hundreds of contraventions.  In that case Ultra Tune was, amongst other things, found to have contravened the obligation to prepare an annual financial statement of its marketing fund as required by cl 15(1)(b) of the Code and to give that statement and any auditor’s report to each franchisee as required by cl 15(1)(d) for the 2015-2016 year.  The Court held there were 200 contraventions because there were 200 franchisees in its network at the relevant time. 

The maximum penalty at the time for 200 contraventions was $10.8 million ($54,000 each). 

Ultra Tune received a civil penalty of $150,000 for these 200 contraventions (about 1.4% of the maximum).

A frightening example

Imagine what the outcome might be if Mega Civil Penalties are introduced for a franchisor with 200 franchisees who, for example, fails to disclose to its franchisees, a change of its majority ownership or control within 14 days of that occurring.  This could be very easily overlooked in the hype of a sale transaction.

This contravenes clause 17(2) of the Code.  A contravention of clause 17(2) will attract a Mega Civil Penalty of a minimum of $10 million if the Exposure Draft of the Code reflects what the Government decides to do. 

Based on the reasoning of the Full Federal Court in Ultra Tune, there would be 200 contraventions.

Thus, the total maximum penalty for 200 contraventions would be $2 billion. 

If the Court imposed 1.4% of the maximum, the civil penalty would be $28 million.

Conclusion

Whatever the outcome, there will certainly be some increased penalties for Code contraventions including Mega Civil Penalties. 

As there are many unclear and untested provisions of the Code, franchisors would be crazy to try an understand its provisions without the benefit of sound legal advice for an experienced franchising lawyer. 

Franchisors will probably be advised to be conservative, play it safe, err on the side of fuller and better compliance.  But getting and acting on legal advice is a factor a Court will take into account and, if that advice was negligently given (which rarely happens) all lawyers have professional indemnity cover.

Franchisors should also look at their own insurance cover including cover for directors and officers to ascertain whether cover exists or can be obtained in respect of civil penalties.

There are lots of things than can be done to minimise risk, but there is nothing better than fully understanding ALL Code obligations and ensuring that all franchisor directors, employees, agents and contractors are also thoroughly trained on Code compliance.  Franchisors need to become compliance-centric and provide ongoing education and training to all of its directors, employees, agents or contractors who may be engaging in conduct regulated by the Code.

At MST Lawyers, we have a very talented team of franchising lawyers who have been at the cutting edge of the Code’s evolution since 1998.  Our goal is to give clear, accurate and correct advice to our clients.  We will make calls and not sit on the fence, because we are confident that the advice we give is accurate and correct.  Our points of contact are:

Raynia Theodore: raynia.theodore@mst.com.au

Esther Gutnick: Esther Gutnick esther.gutnick@mst.com.au

Philip Colman: Philip Colman philip.colman@mst.com.au

Alicia Hill: alicia.hill@mst.com.au

 

[1] Competition and Consumer Commission v Singtel Optus Pty Ltd (No 4) [2011] FCA 761; 282 ALR 246

[2] Ultra Tune Australia Pty Ltd v Australian Competition and Consumer Commission [2019] FCAFC 164