03 Oct 2019

Ultra Tune: Full Federal Court confirms need for franchisors to fine-tune compliance with disclosure obligations

By Adrian Kuti, Simon Ellis and Shirley-Anne Hu

Amidst increasing scrutiny of franchisor behaviour under the Franchising Code, the Full Federal Court affirms Ultra Tune was not transparent in its disclosure of expenses and provides guidance on how to avoid the pitfalls.

As the ACCC continues its close scrutiny of franchisor conduct, and further legislative reform is contemplated following the release of a Parliamentary Joint Committee report into "Fairness in Franchising" earlier this year, the Full Federal Court's confirmation of the findings against Ultra Tune that it had failed to comply with its disclosure obligations generally, and specifically in its dealings in relation to a prospective franchisee, and the imposition of a $2 million fine in respect of that conduct, means that now more than ever franchisors must be alert to their disclosure requirements and duty to act in good faith in all of their dealings with franchisees.

In January 2019, Justice Bromwich imposed penalties totalling $2.6 million on Ultra Tune for the following contraventions of the Franchising Code of Conduct:

  • failing to update its disclosure documents by the required deadline;
  • failing to prepare financial statements for its marketing funds by the required deadline;
  • failing to provide audited marketing fund financial statements to franchisees by the required deadline;
  • failing to provide a disclosure document on request by a franchisee; and
  • failing to include "sufficient detail" in its marketing fund statements to franchisees.

In its appeal to the Full Federal Court, Ultra Tune contested that in providing financial statements to franchisees, it complied with the requirement under the Franchising Code to provide statements of sufficient detail of expenses paid to a marketing or other cooperative fund.

Although the Full Federal Court slightly reduced the total penalties ordered against Ultra Tune down to $2.014 million (on the basis that, while a result of "egregious inadvertence" to its obligations, Ultra Tune's failure to comply with its obligations was not "deliberate"), it dismissed Ultra Tune's appeal as to the sufficiency of the detail provided in its marketing fund statements on the basis that the entry "Promotion & Advertising – Television" did not provide "sufficient detail" as to "give meaningful information" about the item. This was because the financial statements contained only the item itself and no actual information about the item, such as a breakdown of expenditure by reference to pay TV or free to air or the channels on which the television advertising had appeared.

Full Court guidance on a franchisor's disclosure obligations

The Ultra Tune decision marks the first decision by the Full Federal Court as to what constitutes the ‘sufficient detail’ requirement in the Franchising Code.

It is clear from the decision that there is an unambiguous and unavoidable onus on franchisors to act fairly in their relationship with franchisees at all times and to fully disclose all relevant information to existing and prospective franchisees to assist them to fully understand the franchised business of which they are a part or are considering joining, in this case by providing information about how marketing funds are to be or have been used in sufficient detail as to be meaningful to the recipient franchisees.

Specifically, the Full Federal Court observed:

  • The purpose of the Franchising Code is to ensure franchisees are given sufficient detail so they can tell if the actual expenditure for the year has been for the kinds of expenses prospectively identified in the disclosure document;
  • In preparing their marketing fund statements, “a franchisor would be well advised to err on the side of candour”; and
  • It is not sufficient for a franchisor to just list items of expenditure in its marketing fund statements. The words "sufficient detail… so as to give meaningful information" must be given work to do. That is, where meaningful information can be provided, it should be disclosed.

Given this particular item accounted for over 75% of total expenditure, the Full Federal Court had no doubt that Ultra Tune had failed to comply with the requirements of the Franchising Code in this regard.

The "cleaning up" of the Franchising industry continues

The Full Federal Court's judgment is another step in the ongoing scrutiny of the relationship between franchisors and franchisees and the push for greater transparency between the parties. As we have previously reported [link to here], the obligation of the franchisor to act in good faith in entering into agreements with franchisees has recently been the subject of increased investigation and enforcement action by the ACCC and the focus of widespread criticism in the media more broadly.

The franchising sector was a significant focus for the ACCC during 2018 and 2019 and is likely to continue to be a key enforcement priority in 2020, particularly in light of the Parliamentary Joint Committee on Corporations and Financial Services (PJC) report into "Fairness in Franchising", released in March this year which recommended significant changes including:

  • improvements in disclosure and transparency with respect to the use and reporting of marketing funds and when franchises are sold or transferred;
  • introducing new dispute resolution processes including a process for binding commercial arbitration;
  • introducing civil penalties for franchisors' non-compliance; and
  • giving the ACCC more responsibilities and greater enforcement powers.

The PJC has stated that its recommendations are "designed to lift standards and conduct across the industry and to rebuild confidence in franchising in Australia". It is clear from this that Parliament is of the view that the franchising industry in Australia is broken.

What can we expect in 2020?

The focus on franchisor behaviour is unlikely to abate. It is likely that the ACCC will take the PJC's recommendations as a mandate to continue its enforcement of the Franchising Code, with a particular focus on levelling the negotiating power and information shared between the parties to ensure fairness. We expect that the ACCC will push for greater penalties in its enforcement actions in order to achieve general and specific deterrence (as was the case in the Ultra Tune proceedings and other recent ACCC actions in the Federal Court), particularly in respect of large franchises and where the action is deliberate or wilfully negligent.

Franchisors, and especially large franchisors, need to ensure that:

  • the level of information which they routinely provide to franchisees meets the "sufficient detail" requirement under the Franchising Code; and
  • they are acting fairly in their interactions with franchisees (and potential franchisees), not only in providing sufficient (and not false) information, but also in their good faith dealings with franchisees more broadly.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.