The new year brought a strong warning for franchisors who make false or misleading representations to prospective franchisees. In January 2019,  the Federal Court handed down their decision in an Australian Competition and Consumer Commission (ACCC) action against franchisor Ultra Tune, finding that Ultra Tune had breached the:

The decision included a hefty $2.6 million penalty. In this article, we will outline what:

  • the decision means for franchisors;
  • it tells us about the good faith requirement; and
  • franchisors should be doing to ensure that they are acting in line with the court’s decision.

Why Should Franchisors Care About This Decision?

For franchisors, the penalty imposed on Ultra Tune is a strong indicator that the courts sympathise with the damaging impact of franchisors misleading prospective franchisees in pre-contractual dealings. The decision also provides insight into when a franchisor will have violated the good faith requirement of the Code.

The Decision

The ACCC’s legal action against Ultra Tune arose as a result of the franchisor’s practices in dealing with a prospective franchisee, including:

  • the failure to comply with mandatory disclosure requirements;
  • the making of false and misleading representations about the Ultra Tune franchise system; and
  • a failure to act in good faith. This means acting honestly, reasonably and fairly. 

In its decision, the court found that Ultra Tune failed on each of these counts in its dealings with a prospective franchisee, Mr Ahmed, concerning the proposed purchase of an Ultra Tune franchise in Parramatta.

In particular, the court found that Ultra Tune had made false and misleading representations to Mr Ahmed about:

  • the length of time the Parramatta franchise had been operating;
  • the total purchase price of that franchise; and
  • whether a $33,000 ‘deposit’ was refundable.

The court ordered Ultra Tune to repay the $33,000 deposit to Mr Ahmed. In addition to this, Ultra Tune were required to pay a $2.6 million fine to the ACCC. 

What Does This Tell Us About the Good Faith Requirement?

This decision gives franchisors a fresh understanding of what they need to do to uphold their good faith obligation. Additionally, the decision significantly builds on previous court decisions on the issue.

It is likely that the following will be considered a failure to act in good faith:

  1. failing to disclose information about the franchise honestly;
  2. making misrepresentations about the franchise;
  3. putting pressure on a prospective franchisee to pay a deposit before providing disclosure documentation;
  4. treating a deposit as non-refundable without the prospective franchisee knowing;
  5. spending deposited money immediately on expenses such as equipment, fit out or signage, without any real urgency;
  6. failing to repay the deposit where a prospective franchisee did not know that the deposit was non-refundable.

Furthermore, the decision demonstrates that what is prohibited by the good faith requirement is conduct that harms the franchisee (or prospective franchisee), where the conduct is not necessary for the protection of the franchisor’s interests.

Checklist for Franchisors

In light of this court decision, franchisors should carefully review their franchisee engagement practices. In particular, franchisors should ensure they:

  1. follow the timeframes imposed by the Code concerning pre-contractual disclosure. A copy of the Code, a disclosure document and the franchise agreement should be provided at least 14 days before the franchisee enters into a franchise agreement or makes a non-refundable payment;
  2. keep the information in their disclosure document and other materials accurate. This especially applies to purchase and establishment costs;
  3. only make representations to prospective franchisees that can be supported by fact. For example, historical records of the franchise;
  4. clearly state whether a deposit is to be refundable or non-refundable;
  5. allow franchisees the opportunity to make inquiries and undertake due diligence before pushing them to sign documents or make a deposit; and
  6. not spend deposited money until the franchise agreement has been executed (and, ideally, the cooling off period has elapsed).

Key Takeaways

While Ultra Tune was ordered to repay the $33,000 deposit to Mr Ahmed, the $2.6 million penalty was payable to the ACCC. This $2.6 million does not represent the ‘loss’ suffered by Mr Ahmed. Rather, it is a penalty for breaching the Code and the ACL. Accordingly, franchisors should be wary that they not only face repaying actual losses arising from violating the Code, but also hefty penalties.

Furthermore, with the upcoming Parliamentary Committee’s Inquiry on the operation and effectiveness of the Franchising Code of Conduct, compliance is more important than ever for franchisors. If you have any questions, contact LegalVision’s franchise lawyers on 1300 544 755 or fill out the form on this page.

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