The 2014 decision of the Federal Court in Australian Competition & Consumer Commission v South East Melbourne Pty Ltd (In Liquidation) warns that franchisors should be particularly careful when encouraging franchisees to sign up to franchise agreements. 

Background facts 

South East Melbourne Cleaning Pty Ltd (formerly Coverall Cleaning Concepts South East Melbourne Pty Ltd) (Coverall) was a franchisor of a professional cleaning services franchise system operating in Victoria. 

Coverall had a series of initial meetings with two potential franchisees, Mr Patel and Mr Eliaser. The Court found that representations made by Coverall during initial negotiations and Coverall’s subsequent behaviour amounted to misleading conduct, unconscionable conduct, and a contravention of the Franchising Code. 

Misleading conduct 

Representatives of Coverall provided Mr Patel and Mr Eliaser with a Franchise Schedule. Based on this Schedule, and representations made by the representatives, Coverall guaranteed the franchisees that if they purchased a franchise for a particular sum, Coverall would provide them with enough work to generate a specified minimum amount of revenue each month. 

Coverall promised that, even if the franchisees were not provided with enough work to generate the guaranteed minimum amount of revenue, Coverall would pay them that minimum amount for the first 24 months of their business. 

The Court found that Coverall did not have reasonable grounds for making the representations, and, as a result, that Coverall had engaged in false and misleading conduct in contravention of the Australian Consumer Law. 

Unconscionable conduct 

The Court also found that Coverall had engaged in unconscionable conduct in contravention of the Australian Consumer Law. 

Coverall engaged in a number of unconscionable acts in relation to Mr Patel, for example:

  • Coverall collected money from Mr Patel’s customers for the cleaning services he provided, but failed to pass these payments on to him. This was in breach of the franchise agreement.
  • Coverall threatened to demand the balance of Mr Patel’s franchise fee if he terminated the franchise, even though Coverall would not have been entitled to that payment.
  • Coverall offered to release Mr Patel from the franchise agreement only if he paid them a fee of $6,500, and if he promised to release it from its obligation to pay the money they owed to him. 

Coverall had also engaged in unconscionable conduct in relation to Mr Eliaser, as it did not pay him for the work he had undertaken for months at a time. Coverall also charged Mr Eliaser a ‘sales and marketing fee’ it was not entitled to demand under the franchise agreement.

In determining whether Coverall’s conduct amounted to unconscionable conduct, the Court took into account the fact that Mr Patel and Mr Eliaser had ‘significantly weaker’ bargaining power than Coverall. Coverall was an experienced franchisor but, by contrast, the men were first-time franchisees who had not obtained independent legal or financial advice. Coverall knew the franchisees had not received this advice.

The Court also observed that both franchisees were misled and misinformed by Coverall in relation to their rights under their franchise agreements.

Contravention of the Franchising Code

The Court also found that Coverall contravened the disclosure requirements of the Franchising Code by providing Mr Patel and Mr Eliaser with a copy of the Franchise Schedule without disclosing information such as:

  • the facts and assumptions on which the projection of future earnings in the Schedule was based;
  • the research on which the projection was based;
  • the period of time to which the projection was related; and
  • whether costs such as salaries and depreciation were included in the projection.

Orders

The Court found that Coverall’s former director was knowingly a party to Coverall’s unconscionable conduct.

The Court ordered that the former director be disqualified from managing a corporation for two years, and to pay a $30,000 penalty for his involvement in the unconscionable conduct. He was also required to pay compensation to both Mr Eliaser and Mr Patel of an amount that represented the loss and damage they had suffered.

Both the former director and another Coverall representative were prohibited from being involved in the management or marketing of a franchise business for a period of two years.

Implications of the decision

This decision highlights the importance of franchisors complying with their obligations under a franchise agreement. Franchisors should also be aware that if they make representations to potential franchisees about the profitability of the franchise, they must have reasonable grounds for making these assertions. Franchisors also need to be careful, if they are in a dispute with a franchisee, not to misrepresent the rights and obligations under the franchise agreement.

Similar breaches of the Franchising Code could result in serious financial penalties for franchisors since the commencement of the new Franchising Code on 1 January 2015.