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Important Update – Franchising Code of Conduct Penalties substantially increased to include “Mega Civil Penalties”

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By Philip Colman, Principal, MST Lawyers

On 9 September 2021 we published a bulletin concerning the then foreshadowed increase in penalties for contraventions of the Franchising Code of Conduct (Code).

On 18 March 2022 the regulations giving effect to the increase in penalties were registered and these will take effect on 15 April 2022 and relate to contraventions occurring on or after this date.

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

As is evident below, the Code now has some very serious teeth such that franchisors who are ambivalent about compliance should now expect severe financial penalties.

The amendments:

  • Double most maximum civil penalties to 600 penalty units (currently $133,200) and create these penalties for Code contraventions where no penalty existed in the past; and
  • Significantly imposed “mega civil penalties” (as I describe it) for certain contraventions of the Code.

A mega civil penalty is:

  • 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.

  • For contraventions by an individual or a person who is not a body corporate, $500,000.

I set out below the circumstances in which a corporation or an individual may be liable for a mega civil penalty.

Code clause Contravention
17(1) A failure by a franchisor to give a franchisee a statement or declaration of the type referred to in item 21 of Annexure 1 prior to the signing of a franchise agreement in circumstances the statement or declaration is not reflected in the disclosure document (this relates to the director’s statement or, if required statutory declaration, of solvency or insolvency).
17(2) A failure by a franchisor to disclose to franchisees materially relevant facts within a reasonable time (not more than 14 days) of the franchisor becoming aware of them – broadly speaking, this includes

·         Changes in majority ownership or control of the franchisor or the franchise system

·         Certain proceedings and judgments

·         Proceedings against a franchisor by 10 or 10% of franchisees in the network

·         Certain unsatisfied judgments against the franchisor

·         The franchisor going into external administration

·         Changes in ownership or control of intellectual property material to the franchise system

·         Undertakings given under s.87B of the Competition and Consumer Act and orders of the Federal Court relating to such an undertaking.

 

33 A franchisor engaging in conduct that would restrict or impair a franchisee or prospective franchisees freedom to form an association or to associate with other franchisees or prospective franchisees for a lawful purpose.
46A(1) A franchisor entering into a new vehicle dealership agreement that does not provide for compensation for early termination and specify how the compensation will be determined.
46A(2) A franchisor entering into a new vehicle dealership agreement that does not provide for the franchisor to buy back or compensate the franchisee for new road vehicles, spare parts and specific tools if a franchise agreement is not renewed or it is terminated in certain circumstances.
46A(3) A franchisor entering into a new vehicle dealership agreement that purports to exclude a franchisee’s right to compensation.
46B A franchisor entering into a new vehicle dealership agreement that does not provide the franchisee a reasonable opportunity to make a return on the franchisee’s investment during the term.

I set out below the circumstances in which a corporation or an individual may be liable for a civil penalty of 600 penalty units (currently $133,200).  Those clauses described in italics are new civil penalty provisions.

Code clause Contravention
6(1) A failure to act in good faith in respect of any matter arising under a franchise agreement or the Code.
6(4) A franchisor entering into a franchise agreement that includes a provision that limits or excludes or purports to limit or exclude the obligation to act in good faith.
6(5) A franchisor entering into a franchise agreement that includes a provision that limits or excludes or purports to limit or exclude the obligation to act in good faith by applying, adopting or incorporating, with or without modification, the words of another document.
8(1) A failure by a franchisor to create a disclosure document.
8(6) A failure by a franchisor to update its disclosure document within 4 months after the end of each financial year.
8(8) A failure by a franchisor (who is otherwise exempted from the obligation to update) to update its disclosure document if it receives a request from a franchisee for a copy of its disclosure document.
9(1) A failure by a franchisor to give certain documents to a prospective franchisee (franchise agreement, disclosure document, key fact sheet, the Code and certain leasing documents if applicable) (Disclosure Material) at least 14 days prior to the franchisee entering into the franchise agreement or making a non-refundable payment.
9(2) A failure by a franchisor to give to a franchisee Disclosure Material at least 14 days prior to any renewal or extension of the term or scope of a franchise agreement at least 14 days before such renewal or extension.
9(2A) A failure by a franchisor to give to a franchisee Disclosure Material and any transfer documents to a prospective transferee at least 14 days prior to the franchisor consenting to the transfer.
9A(2) A failure by a franchisor to update its key facts sheet within 4 months after the end of each financial year.
9A(4) A failure by a franchisor (who is otherwise exempted from the obligation to update) to update its key facts sheet if it receives a request from a franchisee for a copy of its key facts sheet.
11(1) A failure by a franchisor to give the prescribed Information Statement within the as soon as practicable (not later than 7 days) after a prospective franchisee formally applies or expresses an interest in acquiring a franchised business.
13(1) A failure by a franchisor to provide to a franchisee the lease or agreement to lease and details of any financial benefit or incentive the franchisor may receive.
13(2) A failure by a franchisor to provide to a franchisee the above within 1 month after the lease or agreement to lease is signed.
13(2A) In circumstances where the franchisor leases the premises and grants occupancy rights to a franchisee, a failure by the franchisor to give to the franchisee any information relating to the lease that the landlord is required to give to the franchisor (such as a Disclosure Statement).
13(2B) A failure by the franchisor to do the above as soon as practicable and not less than 7 days after a request is made.
13(3) In circumstances where the franchisor leases the premises and grants occupancy rights to a franchisee, a failure by the franchisor to give to the franchisee the franchisor’s lease or agreement to lease and details of any financial benefit or incentive the franchisor may receive and documents relating to the franchisee’s right to occupy the premises.
13(4) A failure by a franchisor to provide to a franchisee the above within 1 month after the franchisee’s occupation commences.
13(4A) In circumstances where the franchisor leases the premises and grants occupancy rights to a franchisee, a failure by the franchisor to give to the franchisee any information relating to the lease that the landlord is required to give to the franchisor (such as a Disclosure Statement).
13(4B) A failure by the franchisor to do the above as soon as practicable and not less than 7 days after a request is made.
14(1) A failure by a franchisor to provide to a franchisee, certain other agreements that a franchisee may be required to sign.
15(2) A failure by a marketing fund administrator to prepare a compliant statement of a marketing fund’s receipts and expenses (and have it audited if required) within 4 months after the end of each financial year.
15(4) A failure by a marketing fund administrator to give to franchisees a compliant statement of a marketing fund’s receipts and expenses (and auditor’s report if an audit is required) within 30 days.
16(1) A failure by a franchisor to provide to a franchisee a copy of its updated disclosure document and key facts sheet within 14 days (or 2 months if the franchisor was otherwise exempted from having to update these documents).
18(2) A failure by a franchisor to provide to a franchisee an end of term notice within the requisite time.
18(3) Where the franchisor intends to renew or extend the franchise agreement, a failure by a franchisor to include in the end of term notice a statement to the effect that the franchisee may seek an updated disclosure document.
19A(1) A franchisor entering into a franchise agreement that has the effect of requiring a franchisee to pay certain of its legal costs.
22 A franchisor entering into a franchise agreement that includes a provision requiring the franchisee to pay the franchisor’s costs in relation to settling a dispute.
25(2) A franchisor unreasonably withholding its consent to the transfer of a franchise agreement.
25(6) A franchisor unreasonably revoking its consent to the transfer of a franchise agreement.
26(3) A failure by a franchisor to repay money to a franchisee who has lawfully cooled off.
26A(4) A failure by a franchisor to repay money to a transferee (purchaser) franchisee who has lawfully cooled off.
26A(6) A failure by a transferor (selling) franchisee to repay money to a transferee (purchaser) franchisee who has lawfully cooled off.
27(2) A failure by a franchisor to give a franchisee a compliant breach notice if it intends to terminate the franchise agreement.
27(4) A franchisor terminating a franchise agreement in circumstances where a franchisee has remedied the breaches specified in a breach notice.
28(3) A failure by a franchisor to give reasonable notice of termination and the reasons for termination where the franchisor has a contractual right to terminate the franchise agreement before it expires without the consent of the franchisee.
29(2) A franchisor terminating a franchise agreement in special circumstances (such as insolvency, loss of licence, abandonment etc) without giving 7 days’ notice of the proposed termination.
30(1) A franchisor requiring a franchisee to undertake significant capital expenditure during the term of the franchise agreement.
31(2) A failure by a fund administrator to maintain a separate bank account for a marketing fund.
31(3) A failure by a franchisor or master franchisor to make like contributions to the marketing fund in respect of units they operate as franchisees are required to make.
31(4) A fund administrator utilising the marketing fund to make payments not authorised by the Code.
32(3) A franchisor engaging in conduct with the intention of influencing a former franchisee to make or not make a request that their details be included in the disclosure document.
41A(3) A failure by a party to a dispute to attend an ADR process.
43B(8) A failure by a party to a dispute to attend arbitration.
47(2) & 47(3) A failure by a franchisor of a new vehicle dealership to provide to a franchisee an end of term notice within the requisite time
47(4) Where the franchisor of a new vehicle dealership intends to renew or extend the franchise agreement, a failure by a franchisor to include in the end of term notice a statement to the effect that the franchisee may seek an updated disclosure document.
47(5) Where the franchisor of a new vehicle dealership intends to neither renew nor extend the franchise agreement, a failure by a franchisor to provide to the franchisee reasons for its intention.

In summary, there are now:

  • 7 clauses, a contravention of which will attract a mega civil penalty; and

 

  • 48 clauses, a contravention of which will attract a civil penalty of 600 penalty units (currently $133,200).

The imposition of mega civil penalties 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 consumer laws and industry codes of conduct, including in agriculture and 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).

In my last article I gave a frightening example, which I repeat here.  Imagine what the outcome might be if mega civil penalties are imposed on 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 for which a mega civil penalty applies.

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

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 from 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 their 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@mst.com.au

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