With another end of financial year comes the time to update your disclosure documents…but is that enough?

A recent Federal Court decision, SPAR Licensing Pty Ltd v MIS QLD Pty Ltd[1],  provides us with further guidance in relation to franchisors’ compliance requirements with the Franchising Code of Conduct.

The decision also explores pre-franchise agreement representations – a commonly litigated aspect of franchising law.

Background

The appellants (SPAR Licensing Pty Ltd and SPAR Australia Pty Ltd, together referred to as SPAR) are suppliers of dry groceries and related services to independent retail grocery outlets.  MIS Qld Pty Ltd (MIS) and SPAR entered a franchise agreement in February 2011 for a term of 5 years.  The franchise agreement set out terms requiring MIS to operate under SPAR’s banner and source dry groceries exclusively from SPAR.

MIS’ directors and shareholders (the second, third and fourth respondents, together the Director / Guarantors) guaranteed MIS’ obligations under the franchise agreement.

Franchising Code breaches

A key issue on appeal was whether the disclosure document provided to MIS (on 21 July 2010) ought to have been updated and re-disclosed to MIS prior to entering into the franchise agreement in February 2011.

Findings at first instance were made concerning SPAR’s 30 June 2010 financial position that:

  • its losses amounted to $5.8 million in the end 2010 financial year;
  • SPAR’s creditors had capped its finance facility at $6.2million, which ‘presented a problem for the Group in meeting its debts…‘;
  • While directors indicated an ability to pay debts as a going concern, this statement was qualified by multiple other concerns, which were also mirrored by the Group’s independent auditors, of uncertainty around SPAR’s ability to continue as a going concern.

Turning to the ongoing disclosure obligations under the Franchising Code, and in particular clause 6B which sets out the requirement to give a prospective franchisee a current disclosure document (‘current disclosure document’ not being defined in the Code), Justice Buchanan found that SPAR’s disclosure document was not current at the time the franchise agreement was made, some 7 months after disclosure.

Accordingly, the Full Court found that SPAR had contravened s 51AD of the TPA and the franchise agreement was set aside from the date of judgment. The Court did not accept MIS’ argument that the order to set the agreement aside should operate retrospectively because the franchise agreement continued to apply throughout the relevant period.

Interestingly, Justice Farrell highlighted that the Code as currently drafted does not in fact impose obligations to provide a fresh disclosure document.  Her Honour did find, however, that the disclosure document was non-compliant on the basis of the Code clause 6(2)(a)(i).  This requires disclosure in accordance with the Code’s Annexure 1: where the franchised business’ expected annual turnover is to be $50,000 or more, a directors’ solvency statement setting out their opinion as to the franchisor’s ability to pay its debts as and when they fall due is required.  This ought to have been provided in relation to the 2009/10 financial year, and was only provided in relation to the 2008/09 financial year. The Federal Government’s April 2014 reviews, which you can read about in our previous blog post here, consolidate this approach, requiring increased transparency to franchisees (particularly around financial disclosure).

In cautioning against the ‘perils for a franchisee in entering into an arrangement with an insolvent franchisor’, Justice Farrell found that clause 6B requiring a current disclosure document ought to reinforce rather than confine the Appendix 1 requirements of the Code. This is in keeping with the Code’s overall purpose to offer protection to franchisees.

Misleading conduct?

The other key issue on appeal was whether pre-franchise agreement representations made by one of SPAR’s executives concerning the ability to release MIS from the agreement prior to completion of the 5 year term, was misleading or deceptive under s 52 of the Trade Practices Act (now s 18 of the Australian Consumer Law).

Briefly summarised, the Court held that the representations did not constitute misleading and deceptive conduct because they reflected SPAR’s policy practice at the time.

Key messages

The key messages from this judgment (particularly against the backdrop of the Federal Government’s 2014 Franchise Review Updates, heralding significant changes to the Code, particularly in relation to transparency of information to franchisees) are that:

  • Franchisors should carefully schedule their end of financial year directors’ statements prescribed by Annexure 1 of the Code as and when required;
  • The additional good faith obligations soon to be introduced to the Code will reinforce disclosure obligations, and potentially, create additional costs implications by way of Code penalties where contravention occurs; and
  • Franchisors should be aware of the requirement to update disclosure documents more frequently than each financial year where circumstances which impact, or may potentially impact, the franchise arise.  Given the increased transparency which the Code reviews are calling for, franchisors should err on the side of caution and seek advice in relation to their disclosure obligations wherever any changed circumstances apply.