Many franchisors operate their business through a private company or trust allowing them to enter agreements such as supply agreements, terms and conditions and franchise agreements through a separate legal entity. This business structure is typical as it provides for a form of limited liability. Earlier this year, a former director of Kleenmaid, a franchise company was held liable for criminal actions as reported by the Australian Securities and Investment Commission. We explain the facts of this case below as well as key takeaways for franchisors and franchisees.
Kleeinmaid Case Background
Kleenmaid traded in Australia as a white goods appliance distributor. It was structured whereby a group of companies operated under the Kleenmaid brand. Kleenmaid also operated as a franchise system, which means several separate, individual businesses operated retail or service-oriented Kleenmaid franchises. This involved selling the white goods products, but also coordinating warranty repairs and maintenance of the products.
One of the associated companies of the franchisor, EDIS Services Logistics Pty Ltd (EDIS), was responsible for the import, wholesale and retail of Kleenmaid products. A former director of EDIS, Bradley Young, was involved in obtaining funds from Westpac to purchase inventory from a company named Orchard KM Pty Ltd (Orchard KM). This company was also the former trading company of the Kleenmaid group prior to corporate restructuring. The receipt of funds from Westpac was made while Orchard KM was in serious debt and without full disclosure to Westpac that EDIS and Orchard KM traded at arms-length (i.e. they were a part of the same corporate group).
The courts found that this behaviour amounts to criminal insolvent trading on the part of the former director of EDIS, Bradley Young. The jury found Bradley Young to be guilty of:
- Dishonestly gaining loan facilities; and
- Criminal insolvent trading.
This verdict allowed for a sentence of imprisonment.
Directors of a franchise who are involved in the everyday decision making of a company may become personally liable for their actions. A director may also be liable and tried under criminal law for their conduct, which will not only impose fines or penalties – but also incorporate terms of imprisonment. Directors and officeholders of a franchise company should remain fully aware of their corporate responsibilities and understand that their actions may be subject to scrutiny.
From the franchisee perspective, this case provides a clear indication of the importance of due diligence and investigating the role and solvency of corporate associates of the franchisor, not only the franchisor itself. As noted above, Kleenmaid had undertaken a corporate restructure and many franchisees may have entered their franchise agreements with a solvent company, not knowing the full financial status of the Kleenmaid group as a whole. Franchisees should not overlook their due diligence and when considering the purchase of a franchise and should investigate the corporate structure of the franchisor – especially those that may be much larger.
The Franchising Code of Conduct also regulates details of the franchisor company that need to be disclosed. If you are planning to purchase a franchise, analyse the amount of company-owned stores as well as the amount of transfers and/or terminations of the franchise agreement. This will provide you with details as to how the franchise is managed and whether it is growing or facing difficulties in keeping franchisees. Due diligence is always key in setting up a new company just as it is for an individual wishing to purchase franchises, particularly if they are entering into franchise agreements with franchisors who may have complex corporate structures.
Kleenmaid’s collapse saw many franchisees lose their businesses as well as their investments. Many could no longer continue operations and at times, occupy their premises. Kleenmaid’s collapse and the recent verdict on the director of EDIS also showcases the willingness of the courts to pierce the corporate veil, leaving a director personally liable for their actions. If you have any questions about franchise director duties or need assistance in conducting due diligence when purchasing a franchise, get in touch with our franchising team on 1300 544 755.