When the coverup is worse than the crime - How a franchisor turned a $30,000 debt into a $2.6 million fine

Franchising makes up a significant portion of the Australian economy. There are approximately 80,000 individual franchise outlets in Australia, employing nearly 500,000 people.[1]  Franchises are found in all types of industries – from food to insurance to healthcare to motor vehicles. Due to the unique nature of franchises, franchise agreements have been regulated by the Australian Government since the introduction of the Franchise Code of Conduct in 1998 (Franchise Code). The Franchise Code is reviewed and updated regularly, and the most recent version of the Code was released in 2014.

Out of Tune

In ACCC v Ultra Tune, a potential franchisee paid $30,000 to Ultra Tune as a deposit to take over an Ultra Tune franchise. After the franchisee paid the deposit and realised some of the things he had been told about the franchise were incorrect, he asked for the deposit to be paid back. Bromwich J found that a senior officer of Ultra Tune had fabricated an invoice for $30,000 as justification for not repaying the deposit. The franchisee complained to the ACCC, who subsequently investigated Ultra Tune and found systemic failures by Ultra Tune to comply with the Franchise Code for all 185 of its franchise stores. This resulted in a fine of $1.5 million for the treatment of the franchisee, and $1.1 million for the systemic failure to comply with the disclosure obligations of the Franchise Code.

In relation to the failure by Ultra Tune comply with its disclosure obligations, it was fined on a “per franchise” basis – which meant the potential penalty it faced was $9.9 million (185 x $54,000). As many (if not all) franchisors provide a single, standard disclosure document to all their franchisees, any breach of disclosure is potentially very expensive. 

It looks like disclosure obligations will be getting even more onerous for franchisors in the future.

Systematic exploitation in the franchise industry

On 22 March 2018, the Australian Senate referred an inquiry into the operation and effectiveness of the Franchise Code to a bi-partisan Parliamentary Joint Committee on Corporations and Financial Services. The Committee released its final report on 14 March 2019 (2019 Report).

The 2019 Report found there were serious problems in the Australian franchise industry arising from the imbalance of power between franchisors and franchisees. In particular, it identified “systematic exploitation of some franchisees by a subset of franchisors and a regulatory framework that does not provide adequate protection against such practices”.

The primary method the Franchise Code employs to protect franchisees from opportunistic behaviour by franchisors and the inherent power imbalance that arises in the relationship is the duty of the franchisor to disclose information to the franchisee (or prospective franchisee). This is primarily regulated through the requirement for the franchisor to provide the franchisee with a “Disclosure Document” (Clause 8 of the Franchise Code).  This requires the franchisor to do things such as include certain information in the Disclosure Document (clause 8(3)), and to update the Disclosure Document at the end of each financial year (clause 8(6)).

In the case of ACCC v Ultra Tune, the Court said that although the $1.1 million penalty for failing to disclose was a “severe” penalty, it was reasonable given “the maintenance of disclosure documents is essential to the proper functioning of the Franchising Code”.

The Parliamentary Joint Committee on Corporations and Financial Services was concerned however that despite the significant penalties for failure to properly provide Disclosure Documents by Franchisors as in ACCC v Ultra Tune, there were still “loopholes” in the law that franchisors were continuing to exploit and to profit from at the expense of their franchisees. The 2019 Report therefore made a number of recommendations including that the government update the Franchising Code to:

• Ensure Franchisors provided franchisees with disclosure documents in electronic format, as well has hard copy;
• Detailed earnings including 2 years’ worth of BAS’s, P&L, balance sheets and assessment of labour costs are provided to incoming franchisees. Or, where the franchise is a greenfield franchise, such financial documents from a similar franchise; and
• Greater clarity, consistency and accountability with respect to the use and reporting of marketing funds is imposed.

Where next?

While the 46^th Australia Parliament has yet to be constituted, given the bi-partisan nature of the Committee, and the importance of franchises to small business in Australia, it would be expected that the Government will be undertaking some form of further reform of franchises during this term.

Ultra Tune has filed a notice of intention to appeal against the fine imposed by the Federal Court – but they are no doubt wishing they had just paid the $30,000 in the first place.

For more information, please contact Andrew Robinson or Sam Spackman on 02 9234 1500.

[1] https://www.aph.gov.au/Parliamentary_Business/Committees/Joint/Corporations_and_Financial_Services/Franchising

Update

On 20 September 2019, the Full Court of the Federal Court delivered its judgment in relation to Ultra Tune’s appeal of the decision of Bromwich J at first instance.

The appeal was successful in part because, as the Full Court said:

“While we agree with much of what the primary judge said about the imposition of penalties, the fact that we take a different view about the number of contraventions necessitates appellate review of the penalties imposed.”

The Full Court determined that calculating penalties should not be done on a 'per franchisee' basis because:

“... a penalty on a per franchisee basis would involve a substantial element of double punishment. It is also impossible and to a degree artificial to seek to eliminate such double punishment by ascribing individual amounts to each contravention for each franchisee. It is more appropriate to identify an overall total recognising that it is the proper sum for all the contraventions per franchisee avoiding double punishment.”

On the basis of this new method of calculating penalties, the Full Court found the total penalties imposed should be $2,014,000 (rather than $2,604,000 in the original judgment). Ultra Tune was awarded 60 percent of its costs of the appeal.

For more information, please contact Andrew Robinson or Sam Spackman on 02 9234 1500.