There has been increasing discussion regarding franchisor obligations towards marketing funds. Recently, a group of Hog’s Breath Cafe franchisees has brought a class action against the franchisor regarding an alleged failure to comply with their marketing fund. If you are a franchisor who chooses to operate a marketing fund, you should refer to the Franchising Code of Conduct (‘the Code’) which outlines the obligations that apply to all franchisors. In the recent Ultra Tune case, the courts provided further guidance on interpreting these obligations, particularly concerning the level of detail required in marketing fund reports.
This article will outline the allegations against Hog’s Breath Cafe and some key takeaways you should keep in mind as a franchisor.
This factsheet sets out the three key financial disclosure obligations every franchisor needs to comply with.
What Are the Claims?
In this case regarding the operation of marketing funds, the group of franchisees have alleged the franchisor (amongst other claims) has:
- failed to implement any advertising, public relations and promotional campaign for the benefit of the franchisees of the franchise system;
- failed to pay or require its associates to pay advertising fees into the advertising fund for company-owned stores;
- used advertising fund monies for items that were not legitimate marketing or advertising expenses, including using the funds to pay their employees wages who were not undertaking marketing roles and to promote competing brands; and
- failed to prepare or provide annual financial statements and audit reports setting out the funds expenses for the prior financial year, including a failure to provide meaningful information.
The franchisees have also brought other claims arising from the:
- franchisor’s alleged failure to disclose rebates received for the supply of goods to the franchisees;
- the charging of incorrect fees;
- claims that the franchisor engaged in unconscionable conduct; and
- the franchisor’s breach of their duty to act in good faith.
What Legal Tests Will Be Applied to the Claims?
According to the claims brought by the franchisees, the franchisor is potentially in breach of multiple provisions of the Code. In civil claims, the franchisees must satisfy the Court on the ‘balance of probabilities’ that the claims are true before the franchisor can be deemed liable.
To succeed in their claim, the franchisees must prove that the franchisor has breached each relevant provision in the Code. In addition, the franchisor’s conduct may also amount to a breach of their obligations at common law, such as the duty to act in good faith.
Substantiating some of these claims may be significantly more difficult than others. In particular, this may be the case where the claims deal with areas of the Code that are open to interpretation and reliant on common law. Additionally, recent common law provides precedent on some factors the Court may consider. For instance, to determine whether the franchisor provides ‘meaningful information’, the Court may consider whether the:
- franchisor prepares financial statements in a manner that franchisees are in a position to identify what the income and expenses of the fund are to make some meaningful assessment of whether that use is appropriate; and
- use of a marketing fund can and should easily be the subject of meaningful disclosure to franchisees so that they can adequately assess how they spend the required amount of contribution money.
The Court’s decision on whether Hogs Breath has breached its marketing fund obligations will likely form an important precedent. Furthermore, it will assist our understanding of the law concerning marketing funds per the Code.
Continue reading this article below the formCurrent Status of Proceedings
Currently, the proceedings are in the pre-hearing stage. So, the hearing will not proceed until the group of franchisees make payment of security for costs in the quantum according to the Court orders. Effectively, this means the proceedings are stalled but not yet finalised.
Potential Ramifications for the Franchisor
If the franchisees can prove the claims, the franchisor may incur damages of up to $133,200 for each breach of the Code. In this case, the penalties could be exponential where the group of franchisees are claiming multiple breaches of various sections of the Code.
Some other potential ramifications that the Hog’s Breath franchisor might face include:
- an order to pay franchisees concerning damages if the franchisees can prove the franchisor’s conduct caused them loss or damages;
- disclosure of the proceedings in the Disclosure Document (noting that this is one of the materially relevant disclosure items that needs to be disclosed to Franchisees by way of an update to the Disclosure Document); and
- negative publicity, particularly where the mainstream media reports court judgments against franchisors (consider 7-Eleven!).
Key Takeaways
We continue to see cases brought against franchisors by franchisees and the Australian Competition and Consumer Commission (‘ACCC’) alleging that franchisors have not complied with their marketing fund obligations. However, it may be helpful to consider that many franchisors operating a marketing fund are unaware of all the obligations they must comply with. As such, they can expose themselves to significant penalties.
If you operate a marketing fund, you should engage a lawyer to review your marketing fund and ensure you are complying with all of your obligations. In light of recent case law, we advise franchisors to use caution and ensure complete honesty in any disclosure to franchisees, including information concerning the marketing fund.
If you need assistance understanding your franchisor obligations or reviewing your marketing fund, our experienced franchise lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. Call us today on 1800 534 315 or visit our membership page.
Frequently Asked Questions
The balance of probabilities is a standard the Court uses in civil claims. That is to say, the Court must be satisfied that an alleged claim is true. It is helpful to think of the balance of probabilities as a more than 50% likelihood.
If you are a franchisor who chooses to operate a marketing fund, you can refer to the Franchising Code of Conduct (‘the Code’) which outlines the obligations that apply to all franchisors.
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