The Ultra Tune Penalties – Implications for Franchisors

By Philip Colman, Principal, MST Lawyers

The 18 January 2019 decision of Justice Bromwich in Australian Competition and Consumer Commission v Ultra Tune Australia Pty Ltd [2019] FCA 12 is one of the most significant decisions handed down by Australian Courts since the Franchising Code of Conduct (Franchising Code) commenced in 1998 and has far-reaching implications for franchisors.

In previous articles (21 January 2019 and 30 January 2019), we have provided a broad outline of the decision and that part of the decision concerning the detail required in a franchisor’s marketing fund statement.

This article focuses on how Justice Bromwich assessed penalties for the numerous contraventions of the Franchising Code and Australian Consumer Law (ACL) by Ultra Tune.

This case considered the conduct of Ultra Tune under two main headings:

  1. Contraventions of disclosure obligations (disclosure document and marketing fund statement)
  2. Contraventions concerning the treatment of a prospective franchisee by Ultra Tune

Contraventions of disclosure obligations (disclosure document and marketing fund statement)

Under this heading there were five groups of contraventions, and set out below is how Justice Bromwich determined the respective penalties.

1.  Failure to maintain each of the four separate disclosure documents by updating each within four months of the end of the 2014-15 financial year: Franchising Code, cl 8(6)

This contravention was admitted by Ultra Tune.

The ACCC submitted that because Ultra Tune had 200 franchisees at the time, 200 contraventions had occurred with a potential maximum penalty of $10.8 million but that in the circumstances an appropriate penalty should be $200,000.

Ultra Tune submitted that only one contravention had occurred, with a potential maximum penalty of $54,000

Justice Bromwich decided that:

  • Four contraventions had occurred, primarily because Ultra Tune had separate disclosure documents for each of its four State-based regions (this would give rise to a potential maximum penalty of $216,000);
  • The penalty proposed by the ACCC of $200,000, while severe, was reasonable and appropriate when due regard is had to the number of franchisees at that time; and
  • As the maintenance of disclosure documents is essential to the proper functioning of the Franchising Code, in all the circumstances, a penalty of $200,000 should be imposed.

2.  Failure to prepare each of the five financial statements for the five separate marketing funds within four months of the end of the 2014-15 financial year: Franchising Code, cl 15(1)(a)

This contravention was admitted by Ultra Tune.

The ACCC submitted that 185 contraventions had occurred with a potential maximum penalty of $9.99 million but that in the circumstances an appropriate penalty should be $250,000.

Ultra Tune submitted that only one contravention had occurred, with a potential maximum penalty of $54,000.

Justice Bromwich decided that:

  • Five contraventions had occurred (as there were five separate marketing regions); and
  • Having regard to the interplay with other disclosure obligation contraventions, a penalty of $150,000 should be imposed.

3.  Failure to ensure that each of the five financial statements for the five separate marketing funds included “sufficient detail” for each of two financial years, 2014‑15 and 2015-16: Franchising Code, cl 15(1)(b)

This contravention was denied by Ultra Tune.

The ACCC submitted that 370 contraventions had occurred (185 for each year) with a potential maximum penalty of $19.98 million but that in the circumstances an appropriate penalty should be $350,000.

Ultra Tune submitted that only two contraventions had occurred, with a potential maximum penalty of $108,000.

Justice Bromwich decided that:

  • Ten contraventions had occurred (five each year based on the five separate marketing regions);

The penalty proposed by the ACCC ($350,000) was appropriate particularly given Ultra Tune’s stubborn adherence to its position that no more information was required.

4.  Failure to provide to franchisees one of the five different marketing fund financial statements that related to their region within 30 days after each having been prepared for the 2014-15 financial year and the failure to provide to franchisees an auditor’s report for each of those marketing fund statements: Franchising Code, cl 15(1)(d)

This contravention was admitted by Ultra Tune.

The ACCC submitted that in relation to each of these two categories of contraventions there had been 185 contraventions because there were 185 franchisees who were entitled to receive the marketing fund statement and auditors report by the requisite time.  Thus potential maximum penalties were $9.99 million for each of these contraventions.  Despite this, the ACCC only sought a penalty of $62,500.

Ultra Tune submitted that only one contravention had occurred, with a potential maximum penalty of $54,000.

Justice Bromwich decided that:

  • 185 contraventions because there were 185 franchisees who were entitled to receive the marketing fund statement and auditors report by the requisite time; and
  • The overall penalty that the ACCC sought was inadequate as it failed to reflect the seriousness of the conduct. 

He said:

“The course of conduct approach also fails to have regard to the impact on the 185 individual franchisees who did not receive the information that they were entitled to, when it remained of most use to them.  As a starting point, each dual contravention of not providing the financial statement and not providing the auditor’s report when required warrants a serious starting point sanction of $10,000.  However, when that is multiplied by 185 contraventions, the overall penalty is excessive and disproportionate as it totals $1,850,000.  Adjusted for totality, a penalty of $2,000 per dual contravention produces an overall penalty of $370,000.” 

5.  Failure to provide a disclosure statement when requested by a franchisee on 16 December 2015 (and required to be provided within 14 days of the request): Franchising Code, cl 16(1).

This contravention was admitted by Ultra Tune.

Only one such contravention was committed, thus a potential maximum penalty of $54,000.  The ACCC sought a penalty of $30,000 which Justice Bromwich considered appropriate noting that:

“The obligation to provide a disclosure statement promptly when requested requires support by such a sanction so as to forcefully encourage compliance by Ultra Tune and by other franchisees.”

Thus, the total penalty imposed for Ultra-Tunes failure to meet disclosure document and marketing fund statement obligations was $1,100,000.

Contraventions concerning the treatment of a prospective franchisee (Mr Ahmed) by Ultra Tune

Under this heading there were six contraventions and set out below is how Justice Bromwich determined the respective penalties.

1.  Failure to act in good faith: Franchising Code, cl 6(1)

Until the point where final written submissions were provided to the Court, Ultra Tune denied this allegation.

The Court held that Ultra Tune failed to act in good faith by:

  • Failing to honestly disclose information about the franchise;
  • Making the false representations to Mr Ahmed as to how long the franchise had been open, the rent payable and the purchase price;
  • Putting pressure on Mr Ahmed to pay $33,000 before providing documentation relevant to the purchase of the franchise;
  • Requiring the payment of $33,000 and subsequently treating it as a non-refundable deposit without making it apparent to Mr Ahmed that the money would be treated as non-refundable;
  • Making a decision to expend the $33,000 immediately towards signage (and other equipment), without any apparent need for urgency;
  • Failing to repay to Mr Ahmed the money (or failing to co-operate with Mr Ahmed to recover the money from the person who received the benefit of the equipment purchased). 

Justice Bromwich accepted the ACCC’s submission that this conduct was serious enough to fall within the worst category so as to justify the maximum penalty of $54,000, noting that “the deterrent message in relation to failing to act in good faith should not be diluted”.

2.  Making false or misleading representations to the effect that the deposit was unconditionally refundable: ACL, s 29(1)(m)

This contravention was denied by Ultra Tune.

Section 29 of the ACL prohibits the making of certain false or misleading representations in trade or commerce.  The maximum penalty for contravention of this section of the ACL is $1.1 million.  After considering the overlap between this contravention and the contravention of the good faith obligation, which was subject to a separate penalty, Justice Bromwich said

Plainly enough, representations about conditions attaching to deposits is a serious and fundamental concern, especially if it may be seen to have been used as device to secure the payment of a deposit in circumstances in which key information that could, and undoubtedly, in this case, would have resulted in the payment not being made in the first place.  I have no difficulty in characterising Ultra Tune’s behaviour in relation to the deposit as being in the worst category, again noting that it does not have to be the worst imaginable.  That is particularly so as the most serious aspects of Ultra Tune’s conduct revolves around the deposit.  The first stage was extracting it from Mr Ahmed.  The second stage was resisting all attempts to repay it, including through making further false representations to justify not doing so.  Such behaviour, arising not just in a franchise context, but in a range of other contexts, needs to be firmly condemned and deterred … I am therefore satisfied that as a starting point, the maximum penalty of $1.1 million is justified when due regard is had to the scale of Ultra Tune’s business and the seniority of Mr Tatsis.  Once again, this is no mere extension of vicariously liability, but direct liability by Ultra Tune via one of its most senior managers.  Such conduct by Ultra Tune and by other franchisors tempted to do the same must be forcefully deterred.  However, I consider that the preceding penalty for the good faith contravention, overlapping as it does with this contravention, and totality considerations flowing from the contraventions that are still to be considered, warrants some degree of adjustment downwards.  In all the circumstances, I propose to impose a pecuniary penalty of $1 million for the s 29(1)(m) contravention.” 

3.  Making false or misleading representations that the franchise had been “open for about six months”: ACL, s 29(1)(b)

This contravention was denied by Ultra Tune.

The falsity arose from the fact that the business had been operating as an Ultra Tune franchise for 18 months with some periods of closure during that period.  The ACCC sought a penalty of $300,000 which Justice Bromwich considered was appropriate.

4.  Failure to give documents to a franchisee or prospective franchisee: Franchising Code, s 9(1)

This contravention was not seriously opposed by Ultra Tune.

This clause of the Code requires the franchisor to give certain documents to a prospective franchisee at least 14 days before a franchise agreement is entered into or a non-refundable payment is made.  The ACCC sought the maximum penalty of $54,000.  Justice Bromwich imposed a penalty of $50,000.

5. Making false or misleading representations as to the price of the rent: ACL, s 29(1)(i)

This contravention was denied by Ultra Tune.

It was found that Ultra-Tune gave false information to Mr Ahmed regarding premises rental in that he was told the rental was $45,000 plus GST per annum when it was, in fact, $50,000 plus GST per annum.  The ACCC sought a penalty of $100,000, despite the maximum penalty of $1.1 million.  Justice Bromwich imposed a penalty of $50,000, noting that the contravention was at the lower end of seriousness.

6.  Making false or misleading representations as to the price of the franchise: ACL, s 29(1)(i)

This contravention was denied by Ultra Tune.

It was found that Ultra Tune gave false information to Mr Ahmed regarding the price of the franchise in that he was told it would cost $163,000 but was not told he would have to install new signage at a cost of $12,100.  The ACCC sought a penalty of $100,000, despite the maximum penalty of $1.1 million.  Justice Bromwich imposed a penalty of $50,000 noting that the contravention was at the lower end of seriousness.

Thus, the total penalty imposed for Ultra-Tune’s contravention of the good faith obligation and contraventions of the ACL was $1,504,000.

Hence to total penalty of $2,604,000.

Costs

The ACCC sought indemnity costs (a costs order that is harsher, from Ultra Tune’s perspective, than the normal type of costs order that would be made in favour of a successful party in a case such as this).  It did so largely as a result of the way in which Ultra Tune conducted its defence.  In awarding indemnity costs, Justice Bromwich said:

“The attempt to cover up the deplorable conduct of Ultra Tune towards Mr Ahmed was not abandoned in this Court, but rather was persevered with, and this took up the lion’s share of the evidence, hearing time and submission length and time, as well as preparation by the ACCC.  Ultra Tune made many submissions that were simply unsustainable.   This was not a case that was prudently defended as to all of the alleged contraventions having taken place.  It probably should not have been more than a penalty hearing conducted on an agreed statement of facts.  Only a very small proportion of the costs would have been incurred had Ultra Tune approached this litigation in an appropriate fashion.  The ACCC should not bear the costs of that forensic decision.”

What does this mean for franchisors?

At the time of writing, no appeal from this decision has been lodged.  Short of this decision or parts of it being overturned on appeal, the following implications arise:

  • The penalty regime in the Code and in the ACL has teeth, and the Federal Court will not hesitate to impose severe penalties for contraventions of the Code and the ACL.
  • Franchisors should not just worry about civil liability for contraventions of the Code and the ACL.  Some of the contraventions of the ACL, in this case, might be seen as trivial, but the Court clearly saw otherwise.
  • Franchisor directors, employees and agents need to be vigilantly trained about the need to be open, honest and not misleading when dealing with franchisees and prospective franchisees and to avoid giving lazy guessing type responses to queries.
  • Franchisors faced with like proceedings need to think very seriously about whether to admit the contraventions (despite having an arguable defence) and possibly offering enforceable undertakings to the ACCC, to avoid the consequences of an adverse decision (both in terms of legal and other costs and increased penalties).
  • A franchisor that only creates one disclosure document or one marketing fund statement would only commit one contravention if it failed to update its disclosure document or prepare its marketing fund statement within 4 months of the end of its financial year.
  • Bigger systems might have a penalty nearer the maximum imposed given that a Court can take account of the number of franchisees in the network at the time of the contravention.
  • Franchisors that prepare multiple disclosure documents and/or multiple marketing fund statements (as Ultra Tune did) might wish to consider creating one disclosure document and/or one consolidated marketing fund statement (if this is possible). It must be remembered at all times both documents must comply with the Code and particularly the reasoning in this case as to what comprises sufficient detail in a marketing fund statement.
  • Lack of sufficient detail in a marketing fund statement will result in multiple contraventions based upon the number of franchisees who are entitled to receive that statement. The bigger the franchise network, the more likely the penalty will be larger for these contraventions because the starting point for a Judge to work back from (total maximum penalties) will be much higher.
  • Failing to respond within 14 days to a simple request from a franchisee for a copy of the franchisor’s current disclosure document is not trivial, but serious.  To be able to do so, franchisors must firstly ensure their disclosure document is updated within four months of the end of each financial year and have systems in place to ensure these requests are dealt with expeditiously.

MST Lawyers’ Dispute Resolution & Litigation team is highly experienced in acting for franchisors against which the ACCC or franchisees make allegations of contraventions of the Franchising Code or the ACL. Our experience arises from past cases and a thorough understanding of the ACCC’s Compliance & Enforcement Policy, with Alicia Hill being a member of the ACCC Consultative Committee for Small Business and Franchising. 

If you would like to speak to us about your franchising needs, you can email our Franchise team or call +61 3 8540 0200.