In brief: The Federal Court has awarded a substantial penalty of $500,000 against a franchisor that had contravened both the Australian Consumer Law and the Franchising Code of Conduct. Partner Andrew Wiseman (view CV) and Law Graduate Catherine Francis report on the implications of the decision for franchisors.

HOW DOES IT AFFECT YOU?

  • This case demonstrates that the Federal Court is willing to enforce significant civil penalties for breaches of the Franchising Code of Conduct, and to listen to the ACCC in doing so.
  • The new Franchising Code of Conduct replaced the 1998 Franchising Code of Conduct. It applies to all conduct of franchisors and franchisees on or after 1 January 2015.
  • The new Code has direct penalty provisions.
  • The ACCC has a strong appetite to pursue contravening franchisors.

BACKGROUND

Franchising is primarily regulated by the Competition and Consumer Act 2010 (Cth) (CCA) (previously the Trade Practices Act). The Franchising Code of Conduct (the Franchising Code) is a mandatory industry code prescribed by regulation under the CCA. The Australian Competition and Consumer Commission (ACCC) is responsible for taking enforcement action under the Franchising Code in appropriate cases.

FEDERAL COURT DECISION

The ACCC brought an action against South East Melbourne Cleaning Pty Ltd (in liquidation), formerly Coverall Cleaning Concepts South East Melbourne Pty Ltd (Coverall), alleging contraventions of the Australian Consumer Law (ACL) and the Franchising Code. In October 2014, the Federal Court made declarations of contravention against Coverall.1 The court awarded a pecuniary penalty of $500,000 against Coverall on 23 March 2015 for the contraventions.2

The court held that Coverall had contravened provisions of the ACL, including the prohibition on unconscionable conduct,3 and the prohibition on false or misleading representations.4 In particular, Coverall made false or misleading representations concerning the profitability, risk or other material aspect of the business activity that Coverall invited other person to engage or participate in, which contravened Section 37(2) of the ACL.5 The unconscionable conduct concerned failure to pay money owing to one of the franchisees for work done, while continuing to charge a franchising fee.

Several of the contraventions were also breaches of the Franchising Code. Coverall had made presentations to two prospective franchisees about projected earnings information that was not based on reasonable grounds. In addition, Coverall had failed to disclose the matters required to be disclosed by the Franchising Code. Coverall had also entered into a franchise agreement with one of the franchisees without obtaining a signed statement that the franchisee had obtained independent advice, as required under the Franchising Code.

The court noted that, in the circumstances of the case, the franchisees were in a significantly weaker bargaining position than the franchisor. Coverall was an experienced franchisor, while the franchisees were first-time franchisees with no business experience and limited ability to comprehend legal documentation. Coverall was also aware that the franchisees had not obtained independent advice as required under the Franchising Code. These circumstances were relevant to the contraventions of the ACL for unconscionable conduct and the breaches of the Franchising Code.

In the proceedings of 23 March 2015,6 Justice Murphy noted that the ACL provides for pecuniary penalties for contraventions of certain provisions of up to $1.1 million in respect of each contravention.7 In determining the penalty, the court must have regard to all relevant matters. These include the nature of the conduct, the loss or damage suffered, the circumstances of the conduct, and whether the person has previously been found to have engaged in similar conduct.8 The court also noted that one of the key purposes of the civil penalty regime is to deter conduct that contravenes the CCA. The penalty must therefore be sufficiently high to constitute a deterrent both to the contravener and to others who might contravene the Act.9

The court held that the nature and circumstances of Coverall's contraventions should attract a substantial penalty.10 The conduct was serious, in that Coverall had made false and misleading representations to induce two potential franchisees to enter into franchise agreements. Coverall had further engaged in exploitative conduct, and had showed intentional or reckless disregard for their legal obligations. The court also took into account the stronger bargaining power of the franchisor in negotiating the franchises. The conduct also caused significant financial harm to the two franchisees.

The court noted that the Franchising Code seeks to address the unequal relationship between franchisors and franchisees.11 There is therefore a need for the court to deter franchisors from conduct that does not comply with the Franchising Code, including making false or misleading representations as to prospective earnings and associated risks.

COMMENT

The total penalty of $500,000 imposed by the court in the case recognised contraventions of the ACL, several of which were also breaches of the Franchising Code. It should be noted that the old Franchising Code contained in the Trade Practices (Industry Codes – Franchising) Regulations 1998 applied to this case.

Our article Focus: The new look of franchising revealed gave an overview of the new Franchising Code of Conduct contained in theCompetition and Consumer (Industry Codes—Franchising) Regulation 2014 (Cth) (the New Franchising Code). The New Franchising Code applies from 1 January 2015 to all conduct (acts or omissions) of franchisors and franchisees who entered a franchising agreement on or after 1 October 1998.12

The New Franchising Code introduces significant pecuniary penalties for breaches of certain provisions, which the ACCC can enforce. Particular provisions of the New Franchising Code that attract civil pecuniary penalties are:

  • Good faith;
  • All disclosure obligations;
  • Notification of end of term;
  • Termination for breach;
  • Influencing former franchisees to request that its details are not disclosed;
  • Restricting or impairing franchisees from forming an association; and
  • Not attending mediation.

Serious breaches of the New Franchising Code will attract penalties of up to $51,000.13 Infringement notices of up to $8500 for a body corporate can be also issued by the ACCC as an alternative to the civil penalty.14 A penalty or infringement notice can be issued for each breach, so if the same breach occurs in respect of multiple franchisees, the penalty is multiplied.

The CCA allows penalties to be issued against persons, not just corporations.15 It is possible for a person to be found personally liable of a contravention of the New Franchising Code and have to pay a civil pecuniary penalty.

Given the firm hand the Federal Court is willing to use in meting out punishment for contraventions of the ACL, all franchisors should think long and hard about teasing the edges of the myriad of provisions under the new Code that now attract penalties for breach.