Anyone who has a passing interest in franchising will know that the Franchise Sector is under scrutiny. This article focuses on three issues where the Disclosure Obligations of Franchisor’s have been under the spotlight.
Fairness in Franchising – Marketing Fund Review
The recent parliamentary inquiry in to franchising “Fairness In Franchising” disclosed 31% of all submissions received raised issues with marketing funds in franchising. The concerns raised were primarily in relation to:
- franchisor misuse of funds and lack of accountability;
- reporting requirements not providing meaningful information to franchisees;
- a lack of franchisor and auditor understanding of what is required to meet the reporting requirements;
- the provision of marketing fund statements to franchisees with insufficient detail to provide meaningful information;
- marketing fund statements not being audited within four months of the end of the franchisor’s financial year.
In this context, the ACCC has been reviewing and where relevant taking action against Franchisors.
The ACCC Investigates the Food Franchising Sector
The ACCC has recently undertaken a series of compliance checks from a sample of food franchisors. They found found that the majority of the franchisors audited neglected in providing adequate information to prospective franchisees. The ACCC were concerned to find that:
- Most franchisors made it too difficult to contact former franchisees;
- Most franchisors did not adequately disclose what essential goods were subject to supply restrictions;
- Some franchisors did not sufficiently disclose key unavoidable ongoing costs, such as wages, rent or inventory; and
- 40 per cent of prospective franchisees did not get any independent advice before buying a franchise.
The Ultratune Case – Recent Appeal Sets Penalties for Breach of the Code
In January 2019, the Franchisor Ultratune was found guilty of, among other things, breaching the Franchising Code of Conduct. The breach related to the failure to prepare marketing fund statements within the time frame required under the Code.
Under the Code, a Franchisor who operates a marketing fund (being a fund created from the payment of marketing levies by franchisees) must provide by 31 October each year an Income and Expense Statement for the Fund. That Fund must also be audited unless three quarters of the Franchisee network provides their consent to have the fund remain unaudited.
The legal framework for the case was based on Part IVB of the Competition and Consumer Act (CCA) which allows for the creation of Industry Codes. Relevantly, the Franchise Sector is subject to a code of conduct, the most recent version being updated in 2015. The CCA enables the ACCC to issue civil penalties for breaches of an Industry Code (Section 76 (1) CCA).
The original case bought by the ACCC, found that Ultratune had breached the franchising code by failing to prepare marketing fund statements within the required time frames, provide these statements and audit reports to franchisees, and provide sufficient detail in the statements (being contraventions of Section 8 (6), 15 (1) (a), 15 (1) (b) and 16 (1) of the Code.
Ultratune admitted to various breaches of the Code and disputed others. The trial judge found various breaches of the Code and imposed a substantial penalty of $1,100,000.
Ultratune appealed against aspects of the finding of breach and the severity of the penalty imposed. The appeal in part was based on whether a contravention of Section 15 (1) of the Code can be breached multiple time and those invoke multiple penalty or whether a multiplicity of breaches is still a single contravention.
The Appeal Court accepted that there was an error in the original trial on this issue and was prepared to reduce the overall penalty to $510,000 for those distinct penalties.
The Utlratune Case is authority for how penalty units should be assessed on specific breaches of the Code.
Take Out Points
Compliance with the Code is mandatory and essential. Whilst the parliamentary enquiry has identified failures with disclosure, the imposition of penalties under the CCA makes continued non compliance a risky strategy for any franchisor. As a result, it is essential that all franchisor’s review their Disclosure Documents and ensure that all Code requirements (and obligations) are satisfied. Failing to do so, could result in substantial penalty for the franchisor.
In light of the ACCC’s report and the Ultratune Case, we recommend that Franchisor’s pay extra attention in relation to the following matters when undertaking the Annual Disclosure review:
- Ensure that Marketing Levies are received in held in separate Bank Accounts. Prepare the Annual Income Statement and ensure that the Statement is audited. Or that ¾ of franchisees confirm in writing that they do not want an audit;
- Review the contact details of former franchisees in your disclosure document and provide both a mobile phone and personal email address of all former franchisees. If the former franchisee has requested to opt out, ensure that you have a copy of the opt out request signed by that franchisee.
- Ensure that the disclosure document provides sufficient details of supply restrictions to franchisees, including what type of goods and services are subject to the restrictions. Do not rely on references to the operations manual or a definition of approved products without actually listing details of the type of goods and services in the disclosure document.
- Review the overheads of running a franchise and ensure that the payments are realistic.
- Encourage prospective franchisees to obtain independent professional advice.
Written by Heath Adams