Legal Insight Issue 21

Franchise Agreements declared void! Will yours stand up?

Justice Murphy of the Federal Court of Australia delivered a recent judgment in the matter of ACCC –v- South East Melbourne Cleaning (in Liquidation) [2015] FCA 25 which found that a franchisor ("Coverall"):

  1. Engaged in conduct that was misleading or likely to mislead in breach of section 18 of the Australian Consumer Law ("ACL");
  2. Made false or misleading representations concerning the profitability, risk and other aspects of the subject business in contravention of section 37(2) of the ACL;
  3. Breached the Franchising Code, thereby contravening the Consumer and Competition Act in connection with profit forecasts which were not based on reasonable grounds and not adequately disclosed; and
  4. Engaged in unconscionable conduct within the meaning of section 21 of the ACL in relation to the supply of rights associated with a franchise system, by failing to pay moneys owed to franchisees and by inappropriately charging sales and marketing fees. 

The two franchise agreements were declared void. Declarations were also made that Coverall's director aided, abetted, counselled or procured and was directly and indirectly knowingly concerned in the contraventions of section 21 of the ACL. 

Coverall's director was disqualified from managing a corporation for 2 years, ordered to pay a $30,000.00 penalty and compensation to the franchisees.

Coverall's disclosure document did not comply with a number of requirements of the Franchising Code, particularly in connection with likely earnings and revenue.  Further, Coverall had not advised a franchisee to seek independent legal, accounting or other business advice, as required under the Franchising Code. 

Murphy J observed that unconscionable conduct need not necessarily involve dishonesty, sharp practice, or conscious wrong doing. The specific conduct, as distinct from the consequences it may have, is an important consideration. 

The main elements of concern to the Court were Coverall's non-compliance with the disclosure requirements, the manifestly unequal relative strengths of the bargaining positions between the parties and failing to pay the franchisees for work they were entitled to be paid. 

His Honour considered that a disqualification order against Coverall's director was appropriate due to the nature and seriousness of his contraventions, which involved serious and deliberate contraventions of the ACL and a disregard for Coverall's and his legal obligations and the significant financial harm caused to the franchisees. 

The take home message is that it is vitally important to comply with the provisions of the Franchising Code of Conduct, particularly the disclosure requirements. Serious care must be taken by franchisors and their directors when making financial representations to franchisees prior to entry into a franchise. The consequences of engaging in misleading or deceptive conduct, breaching the Franchising Code (and hence the ACL) and acting unconscionably are serious, both for franchisors and their directors.

John Vohralik, Consultant Director of Hugh & Associates is a panel mediator under the Franchising Code. Hugh & Associates offers robust legal advice to franchisors, franchisees and their directors in relation to franchise agreements and disputes.