The New Year has commenced with a strong warning for franchisors who make false or misleading representations, or act dishonestly to prospective franchisees. In January 2020, the Federal Court handed down their decision in an Australian Competition and Consumer Commission (ACCC) action against franchisor Geowash. Here, the ACCC found that Geowash had breached the:

Geowash had knowingly and systematically: 

  • used false information to entice prospective franchisees;
  • overcharged and misappropriated fees; and 
  • generally did not act in good faith.

The decision included a significant $4.2 million penalty, setting a new record for penalties of this nature and surpassing that against franchisor Ultra Tune this time last year. Importantly, these penalties were not just against the company but against its executives. This means that franchisors cannot always rely on the limited legal responsibility provided by companies if they break the law.

This article will outline what this decision means for franchisors and their executives when speaking to prospective franchisees. Further, it will outline the impact this decision has on the personal legal responsibilities of executives in the franchise industry.

Why Should Franchisors Care About This Decision?

The fine the ACCC imposed against the executives of Geowash means that even if the franchisor company is in liquidation (as it was in this case), legal responsibility could extend to executives. This is if they were responsible for making misleading and deceptive statements.

The decision also highlights how seriously the court views misconduct when it is systematic and intentional, as opposed to one-off or accidental.

The Misconduct

Geowash was a hand car wash and detailing business that was investigated in late 2015 by the ACCC for misconduct in breach of the Code and the ACL.

The main allegations the ACCC identified were that Geowash:

  • made misleading representations regarding the potential revenue and profitability of a Geowash franchise; and
  • falsely published that major brands were clients of Geowash when they were not. 

Furthermore, Geowash executives charged fees to franchisees based on what they thought the franchisee could pay, rather than what they required. They then used the excess to pay themselves sales commissions of up to 20%. The executives used these fees to cover Geowash’s general expenses, rather than go towards fundamental business investment, such as constructing or obtaining facilities. 

These actions were particularly malicious, given that the prospective franchisees were vulnerable due to their inexperience and had significantly less bargaining power than the franchisor.

The Penalties

The Federal Court ordered a number of penalties against the executives of Geowash.

Penalty Description
Financial Penalty $4.2 million in total, comprised of: 

  • $2.5 million against Geowash (in liquidation);
  • $1.045 million against one executive; and 
  • $656,000 against the other.

These amounts do not represent the actual ‘loss’ the franchisees suffered, but are the penalties for breaching the Code and the ACL. 

Restraint From Franchising  The executives were each restrained for four and five years from being involved in a similar business to Geowash, or a franchise.
Disqualification From Directorship The executives are not allowed to be a company director for four and five years each.
Compensation For Franchisees The executives must personally provide an additional $500,000 to compensate franchisees who suffered financial losses as a result of their dishonest conduct.

Here, Geowash’s director and manager were found to have aided and abetted the legal breaches, which made them legally responsible for a personal fine.

This serves as a lesson for directors and managers that the ACCC can ‘pierce’ corporate entities when pursuing such claims. A corporate franchise structure will not offer protection if you have broken the law. 

5 Lessons for Franchisors When Navigating the Law

1. Act Honestly

The ACL protects those in vulnerable positions, such as consumers or franchisees who have little experience running a business.

Therefore, you must keep in mind that your position of power as a franchisor places a higher legal obligation on you to act honestly. If not, you may breach the ACL and face penalties exceeding $200,000 for individuals and $1,000,000 for companies.

2. Act Truthfully

Misleading and deceptive conduct is illegal under the ACL. This includes making false statements about the profitability of your business. Further, falsely stating that your business is affiliated with brands that it is not affiliated with is also illegal under the ACL.

Therefore, you must ensure that:

  • the financial information and business analysis you provide to prospective franchisees is accurate; and
  • you do not make any false or misleading statements about your business.

Geowash got in trouble because it took one month of profitability from a single franchisee, and extended this into an annual estimate without demonstrating a reasonable basis for doing so. Ultimately, this was misleading as this was used to entice franchisees, rather than portray an accurate prediction of profitability. 

If you are going to provide figures and forecasts, make sure you disclose the method on which the calculations have been based.

3. Abide by Your Franchise Documents

Geowash breached its obligation of good faith by charging fees higher than what was agreed upon in their franchise agreements. It is therefore crucial that you:

  • only charge what you reasonably need for any establishment or set-up costs;
  • do not over-charge franchisees;
  • do not collect and hold onto funds too early; and
  • only use such funds for appropriate purposes.

4. Be Mindful of Personal Legal Responsibility for Executives

An individual can be held legally responsible for the actions of a franchisor company if they were knowingly invlolved in any legal breaches. This risk is greater for smaller businesses with fewer employees. Regardless, responsibility for the company remains with its directors and other executives, like managers.

Individuals can be held accountable for dishonest or illegal conduct, even if the company is in the process of being closed down as part of voluntary administration.

While it is not easy to bring legal action against companies in these situations, the court allows the ACCC to do this. Recent actions of the ACCC have shown they are ready, willing and able to prosecute such matters. 

5. Stay Up to Date With the Code

Following the parliamentary inquiry last year, the industry is likely to see further changes increasing the protections for franchisees and obligations on franchisors.

Therefore, it is crucial to stay up to date with any changes to the Code as they may have implications for your business.

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Checklists for Franchisors

As part of your internal review of your procedures, you should consider:

  1. how you determine your fees;
  2. whether you are using these fees properly;
  3. whether you collect the fees at an appropriate time;
  4. if you have a reasonable and up-to-date basis for estimating the profitability or other forecasts of prospective franchisees;
  5. whether you properly and accurately disclose any affiliations or major clients;
  6. whether you are complying with the terms set out in your franchise documents; and
  7. if you and your associates act with complete honesty in all dealings and discussions with franchisees.

Key Takeaways

This hallmark decision demonstrates how crucial it is that, if you run a franchise system, you and your executives comply with the Code and the ACL. Most notably, when dealing with prospective franchisees, you must:

  • act honestly in all discussions regarding profitability;
  • do not make or publicise any false advertising; and
  • collect and use franchise fees appropriately.

If you have any questions about ensuring your franchise is compliant, contact LegalVision’s franchise lawyers on 1300 544 755 or fill out the form on this page.

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