Franchisors need to exercise a degree of care with the franchise sales process and comply at all times with the disclosure requirements of the Franchising Code of Conduct. Recently, the Federal Court has handed down a landmark decision against franchisor Ultra Tune for failure to comply with “minimum franchisor obligations”.
The decision provides insight into the obligations of franchisors with regard to the standard of detail required in disclosure documents and clarifies the requirement to act in ‘good faith’. Further, the decision highlights the importance for franchisors of meeting the statutory timeframes imposed in relation to disclosure obligations, as well as the strict penalties associated with misleading representations and intentionally covering up breaches of the Franchising Code of Conduct and Australian Consumer Law (ACL).
How does it affect you?
- Good faith: Franchisors must act in good faith, which the court clarified as conduct that is not ‘capricious, dishonest, unconscionable [or] arbitrary’. For franchisors, this prohibits conduct that harms the franchisee where it is not necessary for the protection of the franchisor’s interests. A franchisor must not use its powers and opportunities to the franchisee’s detriment, without an objective legitimate interest.
- Financial statements: For financial statements (especially for marketing funds) to meet franchising code requirements, they must disclose ‘sufficient detail’ so as to give ‘meaningful information’ about income and expenditure, particularly marketing expenditure. The court held that to satisfy this, information must be practical and not merely minimal accounting information. This means that franchisees, as ordinary readers, should understand what the funds’ purposes are so as to assess its appropriateness. This information must be included in the statement itself.
- Corporate culture/compliance: The court was particularly critical of Ultra Tune for conduct that was deemed unremorseful. It was this significant penalties being imposed, particularly if senior employees are involved. To mitigate this, franchisors should establish internal policies and encourage a corporate culture to ensure compliance with obligations. Franchisors should also take steps to remedy any suspected breaches as early as possible.
Breakdown of the decision
The decision concerned Ultra Tune making a number of representations to a prospective franchisee, Mr Ahmed, who paid a refundable deposit. An investigation by the ACCC found multiple breaches, which it pursued in the Federal Court. Ultra Tune denied the representations at trial with manufactured evidence, and downplayed the seriousness of the conduct after later admitting to the breaches.
Bromwich J of the Federal Court agreed with all breaches alleged and imposed a penalty totalling $2,604,000. The two main categories of contravention were a breach of disclosure obligations and illegal treatment of a prospective franchisee.
While the obligation to act in good faith was untested, the court held that Ultra Tune’s conduct breached the Code and amounted to contraventions of the ACL. The misrepresentations were in respect of the franchise price, the rent of premises, the age of the franchised business and the terms applicable to the deposit and its refund.
His Honour clarified the requirement of ‘sufficient detail’ in Clause 15(1)(b) of the Code and held that it was breached in this case as the information was in bare, general terms and did not have any ‘explanatory force’ or permit meaningful insight for the franchisee.
- A franchisor will breach its good faith obligation if its conduct causes detriment to franchisees, without a legitimate interest. This includes failing to disclose information, making misrepresentations, pressuring franchisees to make payments without providing required documents, treating deposits as non-refundable without informing the franchisee and failing to repay the deposit.
- Information for financial statements should make sense for ordinary readers and be useful for franchisee’s to make assessments of the appropriateness of funds, particularly marketing.
- Franchisors should remedy any breaches and implement a corporate culture enforcing good faith conduct. Failure to correct misinformation or an attempt to deceive a regulator will result in maximum penalties.
The decision – and the considerable penalty – is a timely reminder for franchisors to ensure disclosure documents and internal processes meet the high standards required at law. If a breach is suspected or identified, it is important to be open and honest and take steps immediately to rectify the problem.