Franchising – Ultra Tune and the Franchise Code

By a decision of the Federal Court on 18 January 2019 by Justice Bromwich, national franchisor Ultra Tune was ordered to pay fines totaling $2,604,000. The fines (known as pecuniary penalties) sought by the ACCC and awarded by the Court were for various breaches of the Franchising Code of Conduct (Code) and Australian Consumer Law.

The Court found that Ultra Tune had failed to act in good faith in breach of the Franchising Code, and had made false or misleading representations in breach of the ACL, in its dealings with a prospective franchisee. Ultra Tune made false or misleading representations to the prospective franchisee about the price of the franchise, the ongoing rent of the premises, and the age of the franchise. The prospective franchisee was also told that a $33,000 deposit was refundable when it was not.

Ultra Tune also breached the Code by failing to prepare marketing fund statements within the required timeframes, failing to provide these statements and audit reports to franchisees, and failing to include sufficient detail in the statements.

“The cover up that Ultra Tune attempted reflects a significantly heightened need for deterrence, in relation to conduct that was already a most serious and fundamental breach of the Franchising Code in taking the deposit in the first place, reflecting as it does Ultra Tune’s attitude in relation to its contravening conduct,” Justice Bromwich said.

“There must be no tolerance for manufacturing evidence to deceive a regulator, and even less when the deception is maintained in this Court.”

“Franchisors often have the stronger bargaining position in their dealings with franchisees, which is why compliance with the Franchising Code and the Australian Consumer Law is so important,” said ACCC Deputy Chair Mick Keogh.

“This outcome should be a strong reminder for franchisors to meet their disclosure obligations or face serious consequences.”

Justice Bromwich also awarded the ACCC indemnity costs.

These are the first proceedings that the ACCC has brought against a franchisor alleging a breach of the Franchising Code obligation to act in “good faith” in business dealings with franchisees.

This decision comes at a time when franchisors have been under sustained public scrutiny since the 2018 Senate committee inquiry into ‘The operation and effectiveness of the Franchising Code of Conduct’. The Committee’s report was due for release on 14 February 2019. Many public submissions by franchisees complained about poor Code compliance by franchisors and conduct which they alleged lacked good faith.

The Ultra Tune decision is a reminder that strict compliance with the Code, particularly in relation to disclosure documents and marketing fund reporting, as well as the general requirement to act in good faith, remain of paramount importance for all franchisors. Compliance is not new to the sector but missing Code compliance dates, or being slack with compliance, can carry significant financial and reputational consequences.

Key issues for franchisors

Compliance is not negotiable. There is absolutely no excuse for slackness or poor compliance, especially for larger franchisors;

Timeframes set out in the Code for updating and providing documents to franchisees is strict. Being late, even by a few days is not acceptable and the Code does not include a framework to seek an extension of time from the ACCC;

Marketing fund financial statements need to include significantly greater detail. A simple profit and loss statement, or balance sheet, statement will often not suffice. The larger the marketing expense the more detail is required in the financial statements. Franchisors need to work with their franchise lawyers and accountants/auditors to ensure financial statements meet the Code requirement to give “meaningful” information about the receipts and expenses of the fund;

Marketing fund statements must be able to be read and understood in isolation. Communication with franchisees, such as through in-house newsletters, is not a substitute for the need for financial statements to contain ‘sufficient detail’ and ‘meaningful information’;

Fines can be imposed for each and every breach. Where the obligation relates to each franchisee, such as the requirement to provide a marketing fund financial statement and audit report, failing to have, or provide, those documents constitutes a separate breach in relation to each and every franchisee. Massive fines are likely for larger systems if they get compliance wrong across their system;

There is added compliance risk if a franchisor chooses to maintain multiple disclosure documents, or run multiple (or separate) marketing funds;

Good faith requires a franchisor to consider the franchisee’s interests; however, it does not require a franchisor to favour the franchisee’s interests over its own;

Misleading or false representations in a franchise context can also trigger breaches of the ACL, with substantial fines being imposed by the Court. In this case $1M for a single breach. Note: ACL fines are now significantly higher than the maximum $1.1M available in the Ultra Tune case; and

Assessment of fines for Code breaches

Although Ultra Tune admitted most of its Code compliance breaches, there was significant disagreement about the fines that should apply and the quantum of those fines. The ACCC’s primary position was that each breach was a separate breach and referable to the number of franchisees at the relevant time. Given there were 185 and 200 franchisees at the end of each relevant financial year and the maximum fine was $54,000 for each financial year, the potential aggregate of fines could easily have exceeded $10M.

 

Reprinted poiniton partners