ACCC v Ultra Tune: Three lessons for franchisors

In a recent Federal Court decision, ACCC v Ultra Tune Australia Pty Ltd [2019] FCA 12 (ACCC v Ultra Tune), Ultra Tune Australia Pty Ltd (Ultra Tune) was ordered to pay a pecuniary penalty of over $2.6 million for breaching the Franchising Code of Conduct 2014 (Cth) (Code) and sections 18 and 29(1) the Australian Consumer Law (ACL). 

This judgment has a significant relevance for the franchising industry for two main reasons:

1. It is the first case to interpret the phrase ‘sufficient detail’ in clause 15(1)(b) of the Code, explaining the level of information franchisors need to include in financial statements provided to franchisees.
2. The Australian Competition and Consumer Commission (ACCC) prevailed with its claim that the franchisor had failed to act in good faith – potentially signalling the likelihood that the ACCC will seek to rely on this provision in future actions under the Code.

As the scrutiny on franchisors continues to increase, significant monetary penalties and reputational damage may arise for a franchisor’s non-compliance with its obligations under the Code.

Background

Ultra Tune is a franchisor with a national network of over 200 franchises across New South Wales, Victoria, Queensland and Western Australia, providing motor vehicle engine repair and maintenance services.

In 2015, Ultra Tune was approached by a prospective franchisee, Mr Ahmed. Mr Ahmed met with Ultra Tune’s NSW State Manager on multiple occasions, ultimately culminating in Mr Ahmed agreeing to begin the process to purchase the Ultra Tune franchise in Parramatta. Mr Ahmed also paid Ultra Tune what he understood to be a refundable deposit before being provided with the documentation Ultra Tune was required by the Code to provide to him.

During their meetings and other various correspondence, Ultra Tune (via senior employees) made critical oral and written representations to Mr Ahmed about rent, profits and the age of the Parramatta franchise. Upon receiving further information through formal documentation, Mr Ahmed realised that the representations made by Ultra Tune were inaccurate and decided he would not proceed with the purchase of the franchise.

Mr Ahmed subsequently requested the return of his deposit, minus costs for the training course he had already attended. Ultra Tune asserted that the money had already been spent and would not be refunded. Upon receipt of a complaint from Mr Ahmed, the ACCC launched an extensive investigation into Ultra Tune’s general compliance with the Code and treatment of prospective franchisees. The ACCC’s investigation found multiple suspected breaches of the Code and the ACL which it pursued in the Federal Court.

Sufficient Detail and Meaningful Information

Among the breaches of the Code, Justice Bromwich held that Ultra Tune, in submitting no more than bare financial statements for its five marketing funds, was in breach of its reporting obligations. These were in essence accounting profit and loss statements. Clause 15(1)(b) of the Code requires statements to include ‘sufficient detail of the fund’s receipts and expenses so as to give meaningful information about sources of income and items of expenditure, particularly with respect to advertising and marketing expenditure’ (emphasis added).

His Honour held that a mere ‘bookkeeping exercise’ would not suffice and the obligations must be read and understood in the context of clause 31(3), namely that the Code ‘seeks to promote transparency and accountability in the way that marketing fees are used by a franchisor’.[1] The financial statements must equip the franchisee, and not just their accountant, with knowledge of ‘what the income and expenses of the fund are for the purpose of making some meaningful assessment of whether that use is appropriate’.[2]

Further general observations made by Justice Bromwich about the level of detail required for compliance include:

• descriptions of expenditure should not be in bare and general terms (Ultra Tune’s use of the description ‘Promotion & Advertising – Television’ was held to be insufficient);
• different items or categories of expenditure may require different levels of detail;
• generally, more significant expenses will be more important to franchisees and require more detail;
• greater detail is required for expenditure on advertising and marketing, as these are specifically emphasised in clause 15(1)(ii);
• information is meaningful if it enables franchisees to understand how, when and on what money from the fund was spent;
• content and form of statements must make sense to an ordinary reader (a franchisee), rather than just an accounting professional; and
• the availability of other sources of information (such as company bulletins and publically available marketing campaigns) is irrelevant as the Code requires that sufficient detail be included in the financial statement itself.

Good Faith 

Prior to this case, the obligation to act in good faith in clause 6 of the Code was untested. Justice Bromwich drew from judicial commentary in other contexts.

He described acting in good faith as exercising power in a reasonable manner, where the quality of the conduct is not ‘capricious, dishonest, unconscionable, arbitrary or the product of a motive which was antithetical to the object of the contractual power’.[3] Further in the franchising context, his Honour added that the focus of the obligation in the Code ‘should ordinarily be on a franchisor’s use of powers and opportunities available by reason of the franchise relationship’.[4]

The ACCC asserted that prohibited conduct is that which ‘harms the franchisee where such conduct is not necessary for the protection of the franchisor’s interests’.[5] The ACCC contended that the following conduct displayed by Ultra Tune and its senior employees breached the obligation to act in good faith:

• failure to honestly disclose information;
• misrepresentations;
• pressure on prospective franchisee for payment before providing any of the required documents;
• treating payments as non-refundable without making this clear;
• immediate expenditure for signage and equipment without any apparent need for urgency; and
• failing to repay money.

Aspects of the conduct that breached the obligation to act in good faith also amounted to contraventions of sections 18 (misleading or deceptive conduct) and 29(1) (misrepresentations) of the ACL.

Implications

The ACCC is demonstrating an increasing propensity to take enforcement action in relation to non-compliance with the Code. Ultra Tune received a pecuniary penalty comprised of:

• $1.1 million for the disclosure obligation contraventions of the Code; and
• $1.504 million for the breaches relating to its conduct towards Mr Ahmed.

The pecuniary penalty relating to conduct towards Mr Ahmed included the maximum penalty of $54,000 for breaching the obligation in the Code to act in good faith. In addition to the pecuniary penalty, Ultra Tune were ordered to pay the ACCC’s costs and refund all money paid by Mr Ahmed.

The conduct of the franchisor and its senior employees were particularly egregious in this case, with Justice Bromwich finding that evidence had been fabricated in some instances to support Ultra Tune’s assertions.

Three lessons for franchisors

The case provides critical lessons for franchisors, including in relation to some basic compliance steps. Franchisors must ensure that:

1. They are in a position to comply with all obligations of the Code in a timely manner (e.g. disclosure documents are updated within 4 months of the end of the franchisor’s financial year). Justice Bromwich found that failing to provide the financial statements on time significantly impacted franchisees’ ability to understand fundamental aspects of the franchise.
2. Financial statements for marketing or other cooperative funds are more than bare accounting statements. The statements must provide a franchisee with sufficient detail and meaningful information to allow the franchisee to assess whether the expenditure is appropriate.
3. They implement an extensive compliance training program and promote a corporate culture conducive to compliance. This is particularly important for senior employees who are likely to engage with prospective and existing franchisees.