A franchisor is required to provide franchisees and potential franchisees with a disclosure document which sets out details of the franchise and including financial reports and other materially relevant facts. Failure to provide a franchisee with this disclosure document is a breach of the Franchising Code of Conduct (the Code). The Australian Competition and Consumer Commission regulates the Code and can initiate proceedings against businesses who fail to meet their obligations under the Code.
Pastacup – a Western Australian franchise owned by Franchisor Morlid Pty Ltd (Morlid) – has been brought to the attention of the ACCC for failing to disclose materially relevant information in the disclosure document.
What is the Franchise Disclosure Document?
The franchisor provides a franchisee with the disclosure document before they enter a franchise system or when a franchise agreement is renewed or extended. A franchisor should also issue a disclosure document to franchisees if there are significant changes to the franchise or its structure.
A franchisee must have a good understanding of the franchise system that they are entering into or be aware of any changes to the franchise. The disclosure document plays a key role in advising franchisees of this information. The document includes details about the financial reports or earning potential for franchisees and helps a prospective franchisee determine whether it will be financially viable for them to operate the business. The disclosure document will also list details of the franchisor company’s officers and their relevant business experience.
The disclosure document, if not used for advertising marketing material, is to provide the franchisee with a complete and accurate update on matters relating to the franchise system. ACCC deputy chair, Dr Michael Schaper, explained the importance of the document:
“People who decide to buy into a franchise system often put their savings on the line and, in doing so, should be able to make informed business decisions on the basis of full and accurate disclosure by the franchisor.”
What Was Considered Materially Relevant Facts?
Apart from financial information, the disclosure document also contains other vital information about the franchise’s status. For example, if ownership changes because the franchisor sold the franchise system. The franchisor is required to disclose in writing to the franchisees any details relating to these types of matters within 14 days of becoming aware of the information or event.
The materially relevant fact in question concerning the ACCC’s proceedings against Pastacup relates to the franchisor or one of the franchisor directors having been insolvent within the last ten years. Bernstein was a former director of Morild and also the former director of two previous franchisor companies of Pastacup which both became insolvent. The ACCC claims that under the Code, Morild as the current franchisor company should have disclosed this detail to potential franchisees.
Annexure I of the Code clearly sets out the requirement to disclose this information. The ACCC will need to show that the insolvencies of the two previous companies of which Bernstein was director occurred within ten years of providing the disclosure document and also that Morild was aware of the insolvencies.
Penalties Under the Revised Code
The Code was updated in January 2015 and introduced financial penalties and infringement notices that could be issued where a Franchisor is found to be in serious breach of the Code.
Under the revised Code, the ACCC can finally seek penalties for violations and can ask for up to $54,000 in penalties, as the court decides. The ACCC is hoping that being able to enforce and impose penalties for breaches of the Code will act as a deterrent to other Franchisors.
Although the new Franchising Code of Conduct has been in operation for over a year, this is the first matter where the ACCC has sought penalties for breach. Franchisors should not take their obligations under the Code lightly nor should they underestimate the penalties and action that the ACCC can take if they discover a breach.
While the Code provides strong protection for franchisees and small businesses, they are not immune from these penalties and are equally as liable under the Code. Franchisors and franchisees risk financial penalties and infringement notices if they breach certain provisions.
Whether the omission of insolvency details was an oversight or intentional, the franchisor should have known their obligations and what would be considered a materially relevant fact. It may be that disclosing Bernstein’s history and relationship with the insolvent companies may put off potential franchisees, but the effect of the information is precisely the reason why disclosure is required in the first place.
If you have any questions about your obligations as a franchisor or need assistance reviewing your disclosure document, get in touch with our franchise lawyers on 1300 544 755 or fill out the form on this page.