We recently reported on the proceedings brought by the Australian Competition and Consumer Commission (ACCC) against Retail Food Group (RFG), alleging misuse of franchise marketing funds and failure to comply with disclosure obligations.
The RFG proceedings are the latest in legal and regulatory activity focussed on franchisors misusing marketing funds. Such activity includes the Parliamentary Joint Committee’s Fairness in Franchising inquiry, the ACCC’s successful penalty proceedings against Ultra Tune, and the claims recently brought against Hog’s Breath Café by several of its franchisees.
RFG’s defence to the ACCC’s allegations
Critical allegations against RFG from the ACCC include:
- misappropriated money from its marketing fund in several ways, including spending $22 million to cover the cost of implementing its infamous switch from fresh cakes to frozen, as well as company store losses
- used its marketing fund for expenses that could not properly be characterised as marketing expenses (such as wages of RFG executives and employees that did not work in those areas) and for costs other than the administration or audit of the fund
- failed to disclose the above conduct to its franchisees and adopted such a ‘high level of generality’ in its annual marketing fund statements, such that RFG did not give franchisees meaningful information about expenditure from the fund (as required by the Franchising Code of Conduct).
Misappropriation of marketing funds
RFG admitted applying approximately $100,000 of the alleged $22 million to operational and marketing expenditure associated with promotional strategies and campaigns and for implementing the ‘fresh to frozen’ business model. Interestingly, RFG asserts that it incurred $18 million in costs, which was written off, without accessing franchisee marketing funds or contributions to pay those expenses.
It is unclear if the $18 million is part of the $22 million that forms part of the ACCC’s case, or is additional. If the latter, then it seems RFG’s argument is that it was reasonable to spend marketing funds on those losses, because RFG also contributed to them from its own funds. If that is the primary argument, RFG’s may not be successful in defending the claim. The key for RFG will be proving the cost of the ‘fresh to frozen’ trial fell within the definitions for marketing in the franchise agreements and disclosure documents and that it fully accounted for those costs in their annual marketing fund statements.
Staff wages and expenses
RFG admits using marketing funds to pay a percentage of executives’ and employees’ wages. However, RFG states it calculated the ratios by referring to the time and resources expended by those executives and employees in ‘marketing’ activities as defined in the franchise agreement and its disclosure document. RFG further argues determining the size of the allocations during an annual budgeting process, reviewed periodically throughout the year based on the ‘marketing’ functions completed by particular departments.
We will be intrigued to see how the evidence and discovery sheds light on this alleged budgeting and review process, in particular whether there was any rigour behind these processes (for example, timesheets, accounting system and other documents). If RFG’s alleged budgeting and review processes were too informal or lacked rigour, then it may have difficulties defending the ACCC’s claims. Without the necessary evidence to prove that the amounts deducted were accurate and permitted by the franchise agreement and disclosure document, this defence may also be difficult for RFG to make out.
RFG denies its disclosure was inadequate but does not provide further detail or explanation to support that denial. Accordingly, RFG is forcing the ACCC to prove that part of its claim. The bare denial points to the lack of any available positive defence for RFG and so it appears that RFG will merely be arguing that its disclosure was adequate. Given the level of disclosure by larger franchisors has historically been low – at least until last year’s surprising Ultra Tune decision – this aspect of the claim may pose a serious risk for RFG.
RFG’s defence to ACCC’s claims at this stage is fairly bare and lacking in substantial detail, particularly concerning the approximately $22 million of allegedly misappropriated funds and the allegation that RFG’s disclosure with respect to the marketing fund was inadequate. The next steps, including further and better particulars and evidence, will shed additional light on these issues. The proceedings will now progress slowly towards a trial, likely sometime in 2022.
The seriousness of the ACCC’s allegations and the obvious expense involved in defending them, viewed against the current climate of inquiry (by the ACCC, the Government and franchisees) into franchisors’ use of marketing funds, means marketing fund and disclosure compliance is more critical than ever. Franchisors should keep their obligations under the Code and their franchise agreements front of mind to avoid penalties and the expense and resources involved in legal proceedings.