In this edition:
ACCC crackdown on inflated franchise income claims
Harvey Norman franchisees in the ACCC's firing line
Franchisees blaming the Carbon Tax for increasing product prices
No-no to inflated franchise income claims
Franchisors need to be careful that they do not mislead potential franchisees with the hope that they will receive a minimum 'guaranteed' income. The Australian Competition & Consumer Commission ("ACCC") is closely monitoring such representations after receiving many complaints. The bulk of the complaints relate to franchisors in the cleaning and home services industry.
Franchisors misrepresenting the potential income of a franchise can be subject to litigation and court imposed penalties of up to $1.1 million per contravention.
Recently, in SPAR Licensing Pty Ltd v MIS QLD Pty Ltd (No 2), the Federal Court emphasised the importance of disclosing current financial documents prior to entering into a franchise agreement.
SPAR Licensing Pty Ltd v MIS QLD Pty Ltd (No 2)
SPAR Licensing Pty Ltd ("Franchisor") and MIS Qld Pty Ltd ("Franchisee") entered into negotiations in 2010 in relation to the grant of the franchise. In July 2010, the Franchisee was given the draft franchise agreement and disclosure document. However, it wasn’t until 1 February 2011 that the franchise agreement was executed.
The disclosure document included a Statement of Solvency which expressly related to the position as at 30 June 2009, and an independent auditor's statement which claimed there were "reasonable grounds to believe that SPAR Licensing Pty Limited will be able to pay its debts as and when they fall due". The disclosure document did not contain any financial reports in respect of either SPAR Licensing or the consolidated SPAR Group.
The Franchising Code requires a franchisor to give a current disclosure document to a prospective franchisee at least 14 days before entering into a franchise agreement. The contents of a long form disclosure document are set out in Annexure 1 to the Franchising Code, and relevantly in this case, include disclosure of certain financial details of the franchise in the form of financial reports for the last two financial years or an independent auditor's report.
In this case, the relevant financial statements were finalised on 10 September 2010, which was after the provision of the disclosure document but before the execution of the franchise agreement. However, these financial statements were not disclosed to the Franchisee, nor was the Franchisee provided with a solvency statement in respect of the financial year ended 30 June 2010, nor any supporting independent auditor's report.
During the six month delay between when the Franchisee received the disclosure document and when the franchise agreement was ultimately executed, the financial position of the SPAR Group seriously deteriorated as was reflected in the 2010 financial statements and report finalised on 10 September 2010. The financial report stated that there was "significant uncertainty whether the group will be able to continue as a going concern".
The Court held that the Franchisor's failure to provide the Franchisee with current financial information prior to entry into the franchise agreement deprived the Franchisee the ability to make an informed decision about whether or not to enter into the franchise. The Franchisor should have disclosed the 2010 financial statements and report to the Franchisee. Therefore, the Franchisor had contravened the Franchising Code.
Despite the seriousness of the Franchisor's contravention, the Court did not consider it was appropriate to set aside the franchise agreement. Rather, it considered that, it was appropriate to vary the terms of both the franchise agreement to enable the Franchisee to terminate those agreements on payment of the requisite termination and associated fees.
It was also held that the Franchisee did not establish any basis on which they should receive an additional award of damages in respect of the breach as their loss was offset by a growth in sales.
The case outlines the importance of providing current financial documents prior to entering into a franchise agreement. Prior to entering into a franchise agreement, franchisors will need to review disclosure documents to ensure there is no material change in circumstances which renders prior disclosure misleading or out of date.
More recently, reports have emerged that three franchisees from the fast food chain Pie Face are threatening to sue their franchisor for millions of dollars, claiming they were misled with regard to both cost and profits when they first bought into the business and have lost heavily from their investment. Other Pie Face franchisees that have faced similar issues may also join the case, meanwhile others await the outcome from a complaint to the ACCC.
Accusing franchisors of misrepresenting the potential costs and profits is not uncommon. The ACCC regularly receives complaints of this nature from disgruntled franchisees.
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11 Harvey Norman franchisees in the ACCC's firing line
The ACCC has identified consumer guarantees as a matter of particular concern, having received more than 16,000 complaints in the last year.
As a result of the ACCC's crusade, 11 Harvey Norman franchisees are in the ACCC's firing line for allegedly misleading consumers by saying they did not have to give a refund or exchange for goods with a major fault. This contravenes Australian Consumer Law.
ACCC Chairman Rod Sims said "The Australian Consumer Law provides consumers with rights to certain remedies from retailers and manufacturers when goods fail to comply with the consumer guarantee provisions, including that goods are of acceptable quality and fit for the purpose for which they were sold".
The ACCC alleges that the franchisees misled consumers who purchased faulty mobile phones, laptops, refrigerators and espresso machine about these rights by making representations including that:
the franchisee had no obligation to provide remedies for damaged goods unless notified within a specific period of time such as 24 hours or 14 days;
the franchisee had no obligation to provide remedies for goods still covered by the manufacturers warranty;
the franchisee had no obligation to provide refunds or replacements for particular items such as large appliances or items priced below a certain amount; and
consumer must pay a fee for the repair and return of faulty products.
The ACCC says that a consumer's rights under the Australian Consumer Law "cannot be excluded, restricted or modified" as Australian consumers have the right to ask for repairs, replacement or a refund if goods are faulty, unsafe, look unacceptable or do not do what they are supposed to do.
The alleged actions of the 11 franchisees have caused the ACCC to commence Federal Court proceedings against them.
Each contravention carries a potential infringement notice fine of $6,600 or penalties of up to $1.1 million.
It will be interesting to see the defence the 11 franchisees put on in response to the ACCC's allegations.
The case against the 11 Harvey Norman franchisees is not the first of its kind, with the ACCC having commenced proceedings in the Federal Court against Hewlett-Packard Australia Pty Ltd (a wholly owned subsidiary of Hewlett-Packard Company) ("HP") on 16 October 2012 for alleged contraventions of the Australian Consumer Law by making false or misleading representations to:
consumers in relation to consumers' statutory warranties and consumer guarantee rights; and
retailers that HP was not liable to indemnify them if they provided consumers with a refund or replacement without HP's prior authorisation.
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Franchisees can't blame everything on the Carbon Tax
The rising cost of utilities, other business expenses and the introduction of unpopular taxes is no excuse for businesses to incorrectly point the finger to these expenses as the reason for increasing product prices. In recent times, there have been examples of businesses doing just this and they have had to bear the wrath of the public, media and the consumer watchdog.
Brumby Bakeries decided to increase their prices and sent out an internal newsletter to franchisees advising them to put up their prices and "let the carbon tax take the blame".
In a copy of the June 2012 edition of the newsletter, the former managing director of Brumby Bakeries Deane Priest said:
"We are doing an RRP review at present which is projected to be in line with CPI, but take an opportunity to make some moves in June and July, let the Carbon tax [sic] take the blame, after all your costs will be going up due to it."
The comments in the newsletter instigated an investigation by the ACCC. At the time, the ACCC said it "would be concerned if any franchisor encouraged or induced its franchisees to make misleading price claims about the impact of the carbon price".
As a result of the ACCC's investigation and the public condemnation, Retail Food Group, owner of Brumby Bakeries took a number of prompt actions to redress any impact of the newsletter. This included writing to franchisees and outlining their legal obligations associated with price representations and the effect of the carbon tax and developing training for staff and franchisees regarding their legal obligations.
Retail Food Group cooperated with the ACCC and offered a court enforceable undertaking that neither Retail Food Group nor its subsidiaries, including Brumby Bakeries will engage in similar conduct in the future.
Genesis Fitness Club
GFC Berwick Pty Ltd trading as Genesis Fitness Club ("Genesis") intended to increase its membership fees between 9% to 15% blaming the carbon tax. In April 2012 Genesis sent a letter to 2,122 of its members promoting a 'RATE FREEZE' offer, offering members a range of lengthy contract extensions at current or reduced membership rates so they could avoid having to pay the increased fees.
The ACCC was of the view that Genesis "did not have a reasonable basis" to claim that the carbon tax would increase the cost of gym memberships and were concerned that the false claims "may have encouraged" people to sign up for lengthy contract extensions they otherwise would not have signed.
As part of the resolution of this matter, all affected members were written to by Genesis Fitness Club offering them the opportunity to withdraw from the contract extensions at no cost.
Genesis also had to pay $6,600 as a result of an infringement notice issued by the ACCC.
These cases are a reminder that all businesses must not:
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Contact your local office below if you wish to know more about your franchising obligations.
Sydney (City) +61 2 9391 3000
Sydney (North Ryde) +61 2 9804 5700
Melbourne +61 3 8602 9200
Brisbane +61 7 3303 8448
Adelaide +61 8 8414 3333
Perth +61 8 9488 1300
Hobart +61 3 6231 0131
Darwin +61 8 8924 2600