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ACCC report highlights penalties for franchisors for failing to meet disclosure obligations
The ACCC has recently published its bi-annual “Small business in focus” report (‘the Report’) for the period July to December 2017, which includes insights into the work that the ACCC undertakes to protect franchisees.
The Report includes statistics about the number of reports it receives about “Franchising Code related issues” that reveals that between July to December 2017 it received 29 reports of “inadequate disclosure” under the Franchising Code, 20 reports of “not acting in good faith” and 11 reports of “improper termination of a [franchise] agreement”.
With the most common complaints to the ACCC relating to disclosure obligations, it is unsurprising that the Report reveals that both of the enforcement actions the ACCC took during this period (in the field of franchising law) related to allegations of inadequate disclosure.
We discuss both actions below.
ACCC’s court action against Pastacup franchisor — summary
Apparently in the first case where court ordered penalties have been imposed under the most recent iteration of the Franchising Code of Conduct (‘Code’) (which came into effect on 1 January 2015), the Pastacup franchisor was fined $100,000 and its co-founder and former director fined $50,000 for failing to comply with disclosure obligations.
Background
Under the Code, the franchisor was required to give to potential franchisees a disclosure document that, amongst other things, included: a summary of the relevant business experience for the last 10 years of each officer of the franchisor (item 3.1); and whether an associate of the franchisor had been bankrupt or insolvent in the last ten years (item 4.2).
The case
The disclosure document developed by the franchisor in 2014 included statements about its then director (Mr Bernstein) and that his experience included “setting up and operating successful cafes, Piccolo Mono and CafBondi” in Sydney, and that he “holds a Bachelor of Commerce degree and is responsible for the Pastacup concept and became a director of Pastacup early in 2008”.
The disclosure document did not, however, disclose the insolvency of the two predecessor Pastacup franchisors or that Mr Bernstein had been a director of those companies.
The court held that for this reason the franchisor (and Mr Bernstein personally) had breached the Code.
Further iterations of the disclosure statement that were subsequently developed and given to potential franchisees suffered from similar deficiencies.
Some of the factors the court had to consider in assessing the relief it would award were the loss or damage caused and the impact on innocent third parties.
Interestingly, the court found that “loss” in this sense could mean loss of opportunity to make an informed decision about the franchise, it did not matter that there was no evidence of a franchisee being financially impacted by the defective disclosure document.
The following passage of the judgment is illustrative:
130. Deciding to take a franchise is usually a significant decision for the franchisees. A significant financial commitment was and is required from Pastacup franchisees to setup and operate a Pastacup franchise.
131. Because of the significance of such decisions, the Franchising Code requires that a franchisor create and give to prospective franchisees a disclosure document that, amongst other things, includes a summary of the relevant business experience of the franchisor and each of its officers for the last 10 years. The purpose of the disclosure document is to help franchisees make a reasonably informed decision about the franchise.
132. In my view, Mr Bernstein’s involvement in two predecessor franchisor companies which were wound up by reason of insolvency was “business experience” that would be relevant as it would help franchisees make a reasonably informed decision about the franchise.
133. The respondents failed to disclose this relevant business experience of Mr Bernstein as a director of predecessor Pastacup franchisors in the drafting and provision of the 2014 Disclosure Document to the nine Prospective Franchisees. The Prospective Franchisees subsequently entered into franchisee agreements with Morild without fully appreciating Mr Bernstein’s relevant business experience.
134. Loss or damage can be of a non-pecuniary nature: ACCC v Coles Supermarkets Australia Pty Ltd (2015) 327 ALR 540. In Coles Supermarkets, Allsop CJ observed (at [57]) that the relevant loss or damage was the loss by consumers of an opportunity to make a different purchasing choice had they been provided with accurate information.
135.The Prospective Franchisees in Pastacup lost an opportunity to make a fully informed decision based on all relevant business experience of Mr Bernstein, which would have included accurate information about the two predecessor franchisor companies having been wound up by reason of insolvency.
136.The contraventions were reasonably serious because:
(a) they affected the ability of innocent third parties, specifically the Prospective Franchisees, to make a reasonably informed decision when they expended significant time, money and resources required to set-up and operate a Pastacup franchise;
(b) if Morild, like the two predecessor Pastacup franchisors before it, became insolvent and Pastacup International terminated its licence, then the franchisees could be left without the use of the Pastacup intellectual property and this would cause them loss;
(c) the contravening conduct was repeated; and
(d) given the possibility that the franchisees could be left without Pastacup’s intellectual property if Morild became insolvent, it was important for Morild to inform prospective franchisees of the history of insolvency in the respondents’ predecessor companies and Mr Bernstein’s involvement with these companies.
The court determined it was appropriate to fine the franchisor $100,000 and Mr Bernstein $50,000. It also granted a series of injunctions which set out the wording that the franchisor must use in its disclosure statements for the next 10 years (!)
ACCC issues infringement notice to courier company
The Report also states that the ACCC issued an infringement notice of $9,000 to a courier company for allegedly breaching the Franchising Code by providing an inadequate disclosure document to prospective franchisees. The allegation was that the disclosure document failed to include details of former franchisees that had terminated or transferred their franchises.
The courier company also provided the ACCC with a court enforceable undertaking to address the ACCC’s concerns that it had made false or misleading representations regarding the future earnings of courier franchisees by advertising an “income guarantee” of $1,500 per week for 30 weeks to prospective franchisees.
The ACCC was concerned that prospective franchisees would understand this representation to be the likely income they could therefore expect to earn at the end of the stipulated period.
The courier company has now undertaken to provide actual earnings information to prospective franchisees, and not to describe the financial support provided to franchisees as an “income guarantee” in future marketing of its courier franchises.
Key lessons for franchisors arising from the ACCC’s enforcement actions
The above matters highlight the ACCC’s determination to pursue franchisors, amongst other things, for failure to adequately comply with Code disclosure requirements and also its readiness to issue infringement notices in appropriate circumstances.
The Pastacup decision confirms that the loss of opportunity to make a fully informed purchasing choice (eg a decision about whether to enter into the franchise agreement) due to a deficient disclosure document, is a relevant factor which the court will take into account in determining financial penalties for franchisors.
Franchisors should regularly review their disclosure documents to make sure that they are accurate and up to date. The greater the potential for an omission or misrepresentation to adversely affect a potential franchisee’s ability to make an informed decision about the franchise on offer, the greater the need for scrutiny.