What went wrong in 2017 and what are the lessons for the franchise sector?

Inside Franchise Business: what are the legal lessons from 2017 for the franchising sector?It’s been another eventful year for the franchising sector, with the introduction of new laws to protect vulnerable workers, the Australian Competition and Consumer Commission issuing the first infringement notices under the Franchising Code of Conduct (Code) and the first proceedings under the Code issued.

This article provides a summary of some of the new laws impacting franchising and some of the court cases decided in 2017 as well as the lessons to be learned from them.

The Fair Work Amendment (Protecting Vulnerable Workers) Act 2017

In 2017 the Fair Work Amendment (Protecting Vulnerable Workers) Act 2017 (the Act) came into effect amending the Fair Work Act 2009(FW Act).

The key impact of the Act on the franchising sector is the introduction of a new civil penalty liability for a “responsible franchisor”. The Act defines “responsible franchisor” as a franchisor that has a significant degree of influence or control over the franchisees’ affairs.

A responsible franchisor will breach the Act if one of its franchisees contravenes a civil remedy provision in the FW Act (for example a franchisee contravenes the National Employment Standards, or a modern award, or an enterprise agreement, or a workplace determination or a national minimum wage order) and the franchisor or an officer of the franchisor knew or could reasonably be expected to have known that the contravention by the franchisee would occur or that a contravention by the franchisee of the same or a similar character was likely to occur.

In light of these new laws franchisors can no longer bury their heads in the sand in relation to the activities of their franchisees and should be more proactive in implementing measures to monitor franchisee compliance with workplace laws, including undertaking regular workplace audits of franchisees and taking immediate action against franchisees where a complaint is made by an employee or where non-compliance is identified in an audit.

While the new laws benefit employees they will no doubt lead to increased costs for the franchise sector as result of franchisors having to better monitor franchisee compliance with workplace laws and franchisees ultimately having to pay the increased costs.

Competition and Consumer Amendment (Competition Policy Review) Act 2017

In October 2017, Parliament passed the Competition and Consumer Amendment (Competition Policy Review) Bill (Cth) 2017, introducing many significant changes to the Competition and Consumer Act 2010 (Cth)).

The new laws came into effect on 6 November 2017 and impact franchising in the following respects:

  • third line forcing will only breach the Competition and Consumer Act 2010 (Cth) if the restriction is likely to substantially lessen competition.  Accordingly, franchisors can require franchisees to obtain goods and services from third parties without the need to lodge a notification with the ACCC, provided this is not likely to substantially lessen competition in the relevant market.
  • A person is prohibited from engaging in resale price maintenance (RPM), which involves the supply of goods on the condition that the goods are not to be sold below a price specified by the supplier. It is acceptable, however, to set a maximum price or to recommend a price.
  • businesses can now notify the ACCC of RPM conduct – the supply of goods on the condition that the goods not be sold below a price specified by the supplier.  RPM conduct that has been notified to the ACCC and is not overturned will be immune from prosecution.  Accordingly, a franchisor who supplies products to franchisees can require franchisees not to sell the products below a certain price provide it has notified the ACCC.

Domino’s Pizza

In 2017 Domino’s Pizza Enterprises Ltd became the first company to pay penalties for non-compliance with the Code, specifically for failure to provide the marketing fund’s annual financial statement and an audit report on time for 2016. The ACCC issued two infringement notices totalling $18,000 to Domino’s.

This incident sent a strong message to the franchising sector that franchisors must comply with their obligations under the Code and the ACCC is willing to exercise its powers to issue infringement notices against franchisors.

Ultratune and Geowash cases

On 19 May 2017, the ACCC took Ultra Tune Australia Pty Ltd (Ultra Tune) to the Federal Court for alleged breaches of the Code and the Australian Consumer Law (ACL) exercising, for the first time, its powers to seek civil penalties under the Code.

The ACCC claims that in 2015, Ultra Tune made false or misleading representations to the prospective franchisee; did not act in “good faith” in its dealings with a prospective franchisee and failed to:

  • provide the required documents to the prospective franchisee before accepting a non-refundable payment
  • prepare, audit and provide marketing fund statements to franchisees
  • update its disclosure document, or provide copies of it, within the time periods set in the Code.

The ACCC is seeking a refund of the prospective franchisee’s payment, declarations, injunctions, pecuniary penalties, compliance and adverse publicity orders.

Hot on the heels of the Ultra Tune case, on 31 May 2017, the ACCC applied to the Federal Court to start proceedings against Geowash Pty Ltd (operating under a Deed of Company Arrangement) (Geowash) alleging it made false or misleading representations on its website about the revenues and estimated profits of franchisees and about affiliations with motor vehicle dealers and other companies.

The ACCC has alleged that Geowash used franchisee funds for purposes that were not permitted by the franchise agreement, including paying commissions to its director and national franchise manager.

If permitted to proceed, the ACCC has indicated it will be seeking penalties, compensation for affected franchisees and to have the director and national franchise manager disqualified from managing corporations for five years.

It is clear from the Domino’s, Ultra Tune and Geowash cases that the ACCC is actively enforcing the provisions of the Code and pursuing franchisors, it believes, have not complied with the Code.

It is critical that all franchisors review their systems to ensure Code compliance, in particular,compliance with deadlines set out in the Code, including:

  • preparation of an annual financial statement of the marketing fund’s receipts and expenses within four months of the end of each financial year and providing a copy to all franchisees within 30 days of its preparation; and
  • the auditing of the financial statements of the marketing fund within four months of the end of each financial year by an independent company auditor and providing a copy of the auditor’s report to franchisees within 30 days of its preparation;
  • updating the franchisor’s disclosure document annually within four months after the end of each financial year.

Pastacup case

On 10 November 2017, the Federal Court handed down its decision in the case of ACCC v Morild Pty Ltd.

The Code requires franchisors to provide a disclosure document to prospective franchisees which must contain, among other things, the relevant business experience of the franchisor’s officers.

The franchisor Morild Pty Ltd (Morild) did not disclose, in its disclosure document, that one of its directors Mr. Bernstein had been a director of two previous franchisors of the Pastacup franchise system that had both became insolvent.

The Court held that this was relevant business experience and should have been disclosed to prospective franchisees in Morild’s disclosure document. In failing to do so, Morild had breached the Code (specifically it failed to create a compliant disclosure document and provided a non-compliant disclosure document). Bernstein was also found to be knowingly concerned in the breaches.

The Court granted injunctions against Morild and Bernstein specifically requiring them to include details of the winding up of the previous franchisors in future disclosure documents for a period of 10 years after the date of the relevant winding up of the previous franchisors.

The Court also ordered Morild and Bernstein to pay penalties of $100,000 and $50,000 respectively for their breaches as well as to pay the ACCC’s court costs.

The Pastacup case highlights the importance of compliance with the disclosure obligations under the Code.  Franchisors must examine their current franchise documentation and existing practices to ensure that are not at risk of breaching the Code.  Notably, franchisors must set out in the disclosure document, among other required information, the relevant business experience of officers, bearing in mind that the term officer is broadly defined.

Looking forward to 2018

As 2017 comes to a close, the franchising sector will also be watching with interest to see:

  1. the outcome of the cases instigated in 2017 against Ultra Tune and Geowash;
  2. how the introduction of the new vulnerable workers laws will impact franchisors;
  3. how the unfair contract terms laws, which came into effect in November 2016, manifest in their application to franchise agreements and related documents; and
  4. the effect of the changes to the Competition and Consumer Act 2010 (Cth).