In late January, Justice Murphy handed down a scathing judgement against South East Melbourne Cleaning (in Liquidation), formerly known as Coverall Cleaning Concepts South East Melbourne, finding that Coverall engaged in unconscionable and misleading conduct, and that it had contravened the Franchising Code in relation to two of its franchisees, and also that Coverall’s sole owner and director was involved in the conduct and liable to compensate the franchisees.

Background

n the period January 2013 to September 2014, Coverall Cleaning Concepts South East Melbourne (Coverall) operated a commercial cleaning franchise business. Coverall negotiated cleaning contracts with commercial businesses and its franchisees provided the relevant cleaning services, with Coverall deducting fees of 14 percent of the gross billings for the cleaning work from the amounts payable to the franchisees. Coverall promised franchisees a guaranteed minimum monthly amount of gross billings for a nominated up-front acquisition price.

One of the franchisees, Mr Eliaser, purchased a franchise plan for $28,150, made up of cash and a loan from Coverall. From October 2103 until April 2014, Mr Eliaser provided cleaning services to Coverall’s customers, for which Coverall was paid in full, yet he only was paid a fraction of what he was entitled, and was not provided with the guaranteed billings. Coverall also charged Mr Eliaser a sales and marketing fee.

A second franchisee, Mr Patel, paid $24,000 for his franchise plan, paid partly by cash and by a loan from Coverall. Like Mr Eliaser, he provided cleaning services for which Coverall was paid by its customers but only received a part payment from Coverall. He was not paid the guaranteed billings. When Mr Patel sought to be released from his agreement, Coverall agreed to do so only if Mr Patel paid it money and released it from its obligations to pay Mr Patel for the cleaning services. Mr Patel did not accept those conditions. Later, Coverall engaged a debt collection agency to collect loan instalment payments from Mr Patel.

Unconscionable Conduct

The Court found that Coverall had engaged in unconscionable conduct in relation to Mr Eliaser by:

  • failing to pay monies owed to him when it had been paid by its customers, and knowing that in order to undertake the relevant cleaning services, Mr Eliaser travelled a long distance and incurred costs in so doing
  • charging him a ‘sales and marketing fee’ when he received no payment for the work he had undertaken in the three months prior, and when the franchise agreement only allowed this fee to be charged if Coverall had provided Mr Eliaser with a gross volume of billings of $4,000 per month, which it had not.

That conduct was in the context of:

  • Coverall being an experienced franchisor ‡
  • Mr Eliaser being young, with no business experience and no previous experience of a franchise
  • Coverall having the sole right to collect monies from its customers
  • Coverall knowing that Mr Eliaser had not obtained legal, business or accounting advice ‡
  • Coverall knowing that Mr Eliaser had an incentive to continue providing the cleaning services because of the loan from Coverall
  • Coverall having failed to comply with certain requirements of the Franchising Code (relating to the provision of earnings information not based on reasonable grounds, and entering into the franchise agreement without first obtaining a signed statement from Mr Eliaser about seeking legal, business and accounting advice)
  • Coverall making misrepresentations in contravention of the ACL by representing to Mr Eliaser that he would obtain income of at least $4,000 a month, when it did have reasonable grounds for making that representation.

I​n relation to Mr Patel, similar findings of unconscionable conduct were made but in respect of Mr Patel, that conduct included:

  • telling Mr Patel that Coverall would demand repayment of the loan if he terminated the franchise, when Coverall was not entitled to that payment
  • offering to release Mr Patel from his franchise agreement on terms that he pay $6,500 and release Coverall when Coverall had failed to provide him the benefit of the franchise agreement
  • engaging agents to demand payment of the loan when Coverall had failed to provide Mr Eliaser with the benefit of the franchise
  • seeking from Mr Patel, if he refused cleaning jobs, a release in respect of all obligations, liabilities and claims when that release was not required by the franchise agreement.

In so finding, Justice Murphy applied the decision in ACCC v Lux Distributors by evaluating the conduct “by reference to a normative standard of conscience which may develop and change over time and which must be understood and applied in the context in which the circumstances arise”.

Other breaches

The Court also found Coverall in breach of the CCA by being in breach of obligations under the Franchising Code. It also found that Coverall had engaged in misleading or deceptive conduct in relation to representations it made about the income the franchisees would obtain if they purchased the franchise.

Justice Murphy also found that the owner and sole director of Coverall had been involved in Coverall’s contravention. He provided an undertaking to the Court that he would not, for two years, be directly or indirectly involved in the management and/or marketing of a franchise business. He was disqualified from managing corporations for a period of two years, ordered to pay a penalty of $30,000 and pay a contribution of $5,000 toward the ACCC’s legal costs. Importantly for the franchisees, he was ordered to pay them compensation for the loss and damage they had suffered.

Implications

The decision serves as a reminder for franchisors to ensure they:

  • comply with all the obligations of the Franchising Code
  • do not make inaccurate statements or promises to potential franchisees
  • take care not to take advantage of an unequal bargaining position with franchisees.