Ultra Tune fined $2.6m for breaches of Franchising Code of Conduct, Australian Consumer Law

HWL Ebsworth Partner Sean O’Donnell and Special Counsel Mark Hamwood discuss the recent $2.6 million fine against national franchisor Ultra Tune, after action by the ACCC in the Federal Court. The authors state: “The Ultra Tune decision is a stark reminder that strict compliance with the Code – particularly in relation to disclosure documents and marketing fund reporting, as well as the general requirement to act in good faith – remains of paramount importance for all franchisors.” 

In an important decision for all Australian franchisors, national franchisor Ultra Tune has been ordered by the Federal Court to pay fines totalling $2,604,000. The fines (known as pecuniary penalties) sought by the ACCC and awarded by the Court were for various breaches of the Franchising Code of Conduct (Code) and Australian Consumer Law.

In addition to the significant fine, the Court ordered that Ultra Tune at its own expense establish, maintain, administer and comply with a compliance program to ensure compliance by the company its employees and agents with the ACL[1] and Code[2]. The Court also made a redress order[3] to compel Ultra Tune to reimburse a deposit which it had wrongfully kept from a prospective franchisee.

The Ultra Tune decision[4] comes at a time when franchisors have been under sustained public scrutiny since the 2018 Senate committee inquiry into ‘The operation and effectiveness of the Franchising Code of Conduct’. The Committee’s report is due for release on 14 February 2019. Many public submissions by franchisees complained about poor Code compliance by franchisors and conduct which they alleged lacked good faith.

The Ultra Tune decision is a stark reminder that strict compliance with the Code, particularly in relation to disclosure documents and marketing fund reporting, as well as the general requirement to act in good faith, remain of paramount importance for all franchisors. Compliance is not new to the sector but missing Code compliance dates, or being slack with compliance, can carry significant financial and reputational consequences. In an ominous and salient warning to franchisors and the sector generally, Deputy Chair of the ACCC Mick Keogh, released a public statement following the Ultra Tune decision, saying “This outcome should be a strong reminder for franchisors to meet their disclosure obligations or face serious consequences“.

Whilst the Ultra Tune case will be the source of many franchise lawyer articles and provides some much needed guidance to the franchise sector, in some respects it also creates more questions than it answers. Similarly, it is unlikely that many franchisors would be exposed to such a large overall fine as the facts of the case are somewhat unusual (possibly even unique), which helps explain the extraordinary size of the cumulative total of the fines.

Key Learnings for franchisors

• • Compliance is not negotiable. There is absolutely no excuse for slackness or poor compliance, especially for larger franchisors;
  • Timeframes set out in the Code for updating and providing documents to franchisees is strict. Being late, even by a few days is not acceptable and the Code does not include a framework to seek an extension of time from the ACCC;
  • Marketing fund financial statements need to include significantly greater detail. A simple profit and loss statement, or balance sheet, statement will often not suffice. The larger the marketing expense the more detail is required in the financial statements. Franchisors need to work with their franchise lawyers and accountants/auditors to ensure financial statements meet the Code requirement to give “meaningful” information about the receipts and expenses of the fund;
  • Marketing fund statements must be able to be read and understood in isolation. Communication with franchisees, such as through in-house newsletters, is not a substitute for the need for financial statements to contain ‘sufficient detail’ and ‘meaningful information’;
  • Fines can be imposed for each and every breach. Where the obligation relates to each franchisee, such as the requirement to provide a marketing fund financial statement and audit report, failing to have, or provide, those documents constitutes a separate breach in relation to each and every franchisee. Massive fines are likely for larger systems if they get compliance wrong across their system;
  • There is added compliance risk if a franchisor choses to maintain multiple disclosure documents, or run multiple (or separate) marketing funds;
  • Good faith requires a franchisor to consider the franchisee’s interests; however, it does not require a franchisor to favour the franchisee’s interests over its own;
  • Misleading or false representations in a franchise context can also trigger breaches of the ACL, with substantial fines being imposed by the Court. In this case $1M for a single breach. Note: ACL fines are now significantly higher than the maximum $1.1M available in the Ultra Tune case; and
  • If the ACCC are investigating a complaint and compliance breaches are known to exist, a franchisor would be wise to be proactive (such as by bringing these to the attention of the ACCC) rather than reactive. Although the particular conduct Ultra Tune was found to have engaged in, (of presenting misleading documents) is unusual and possibly extreme, seeking to avoid detection of breaches is often only a small step from seeking to conceal them. Similarly, franchisors may well consider ‘self-reporting’ serious compliance breaches, rather than risk a franchisee complaint, or ACCC investigation. The ACCC should also be encouraged to have a clear an express policy to encourage franchisors to self report where breaches are not flagrant, particularly for marketing fund obligations where financial statements may be inadequate. Ultra Tune is unlikely to be the only franchisor who has not complied with the Code requirements for timely and “meaningful” statements.

We will seek to explain in this article the relevant case facts and extract the important comments from the Court to explain the key learnings.

Broad issue – code compliance

The ACCC bought proceedings against Ultra Tune for allegedly breaching its Code updating and disclosure obligations and for unconscionable conduct and bad faith towards a prospective franchisee. The Code breaches related to:

• • Failing to update annually its disclosure document;
  • Failing to prepare financial statements for the marketing fund within the requisite time;
  • Failing to ensure that the financial statement for the marketing fund provided ‘sufficient detail’ so as to give ‘meaningful information’ to franchisees;
  • Failing to give to franchisees the marketing fund financial statement and auditor’s report within 30 days of them being prepared; and
  • Failing to provide a disclosure document to an existing franchisee within the requisite time following a written request by the franchisee.

Relevantly, Ultra Tune admitted all the alleged Code breaches, save that it disputed that its marketing fund statements for 2 financial years lacked the required level of detail. Ultra Tune maintained its financial statements provided sufficient and meaningful information.

Relevant Facts and legal issues – Code compliance

Whilst the facts of the case relevant to compliance are lengthy and unique to the Ultra Tune system, the relevant facts were:

• • Ultra Tune divided its business into 5 geographical areas (NSW, VIC, QLD, NSW-Metro & NSW -Country). It maintained 5 separate marketing funds and also chose to have 4 disclosure documents (one for each state);
  • Total franchisee numbers ranged from 135 in 2012, to 200 in 2016;
  • The alleged Code breaches related to both the ‘old’ Code and current Code;
  • Ultra Tune admitted it failed to prepare, or provide, financial statements for the marketing funds within the requisite time in numerous financial years prior to the current Code (commencing on 1 January 2015). No pecuniary penalties existed under the ‘old’ Code for a contravention of the Code but the Court considered such breaches were relevant to the seriousness of any breaches of the current Code and in any overall assessment or calculation of fines to be imposed;
  • Ultra Tune admitted it failed to prepare its 5 marketing fund statements within 4 months of the end of the 2014-2015 financial year (instead, completing them on 24 December 2015);
  • Ultra Tune admitted it failed to update its 4 disclosure documents within 4 months of the end of the 2015-2016 financial year (instead, completing the update on 26 February 2016);
  • Ultra Tune admitted it failed to provide an existing franchisee with a disclosure document within 14 days of request (instead, providing the disclosure document 3 months after request);
  • It was accepted that Ultra Tune had prepared marketing fund statements for the 2014-2015 and 2015-2016 financial years, had those statements audited and provided them (and the audit reports) to franchisees. However the adequacy of the financial statements was challenged by the ACCC, who claimed they lacked ‘sufficient detail’;
  • The financial statements were in the form of a profit and loss statement for each region, with a limited number of line items for ‘income’ and ‘expenses’; and
  • The ACCC argued that the admitted and contested breaches of the Code (except the admitted breach for failing to give out a disclosure document within time) were all separate breaches and referable to the actual number of franchisees at the relevant time. That is, potentially $54,000[5] for each breach (noting 4 disclosure documents and 5 marketing funds), multiplied by the number of franchisees affected; potentially tens of millions of dollars. Ultra Tune argued that the fines should not be cumulative; that there were single breaches for each failure to give a document, not separate breaches referrable to each franchisee.

Marketing fund statements – ‘sufficient detail’ and ‘meaningful information’

This is the first Court decision which has examined the provisions of the current Code relating to marketing funds and the meaning of terms such as ‘sufficient detail’ and ‘meaningful information’. The focus of the Court centred on a line item in the marketing fund statement called ‘Promotion & Advertising – Television’. This expense item was the major marketing expense of the relevant regional fund (over 75%).

The Court made a number of comments about the line item in question, some of which pose more questions than answers. Nevertheless, the Court found that the line item in question was inadequate and that the more significant the item of expenditure, ‘the greater the level of detail that will be required to facilitate an informed assessment by the franchisee concerned‘. Likewise, franchisees should not be taken to have accounting expertise and therefore the information provided must have a ‘qualitative‘ character. The Court noted that such a ‘bare’ line item did not assist a franchisee to know things like; to whom have the fees been paid?, what services were obtained and when? In fact the Court pithily said the line item ‘has the active quality of providing largely meaningless information except as to raw quantum‘.

Whilst the Court made general observations that franchisors should not ‘skimp‘ on information provided in marketing fund statements and should ‘err on the side of candour, rather than secrecy‘, some of the observations and findings do little to assist franchisors going forward. For example, the Court said that a line item for ‘customer support’ was ‘cryptic‘ and ‘may be inadequate‘ but declined to make any actual finding on this line item. Similarly, the Court held that what is ‘meaningful’ will vary from case to case and accepted that some items of expenditure (like accounting fees and bank charges) may require little explanation, other than by the inclusion of such a line item.

The Court also accepted that the adequacy of the financial statement must be considered and assessed as a whole and the terms ‘sufficient detail’ and ‘meaningful information’ were ‘subjective‘. However in a critical finding which may be at odds with the purpose of marketing fund statements, the Court held that a franchisee’s knowledge about marketing fund expenses, such as from newsletters or viewing the actual television advertisements, was irrelevant to assessing whether the financial statement provided sufficient, in particular “meaningful”, information to a franchisee.  Likewise, the mention of ‘television’ in the line item, which must of itself convey some level of detail, appears to have been ignored by the Court. If the terms ‘sufficient detail’ and ‘meaningful information’ are subjective, and the purpose of the Code obligations is to allow franchisees to make an informed assessment of whether funds have been spent on legitimate marketing,  surely some consideration of the franchisee’s actual state of knowledge from all sources is required. And what if a franchisee simply says “I don’t understand” a particular expense. Is that evidence of a breach because that franchisee didn’t find the particular information “meaningful”?

Assessment of fines for Code breaches

Although Ultra Tune admitted most of its Code compliance breaches, there was significant disagreement about the fines that should apply and the quantum of those fines. The ACCC’s primary position was that each breach was a separate breach and referrable to the number of franchisees at the relevant time. Given there were 185 and 200 franchisees at the end of each relevant financial year and the maximum fine was $54,000 for each financial year, the potential aggregate of fines could easily have exceeded $10M.

Fortunately the Court carefully examined the relevant provisions of the Code and ultimately accepted that not all of the breaches were referrable to each franchisee. However, the Court did consider clause 15 of the Code imposed separate (individual) obligations, each capable of involving a breach and attracting its own fine. The Court made the following findings:

Broad issue – illegal conduct in respect of a prospective franchisee

The franchisor’s conduct toward a prospective franchisee was also examined. The franchisee was considering purchasing the existing Parramatta Ultra Tune store. The ACCC alleged that Ultra Tune had:

• • Breached the obligation to act in good faith towards the prospective franchisee;
  • Failed to give a disclosure document to the prospective franchisee before receiving a non refundable deposit;
  • Wrongfully failed to return the deposit paid by the prospective franchisee; and
  • Made a number of false or misleading representations about the Parramatta store, including about the price, the proper rental, the time the store had operated and conditions concerning the refund of the ($33,000) deposit.

Critically, and a significant explanation for the ultimate magnitude of the fine and scathing comments by Justice Bromwich relating to these breaches, the Court found that Ultra Tune had put forward documents and evidence that were misleading and that this was done in an attempt to justify its refusal to refund the deposit  to the franchisee. Specifically, His Honour said this was done to ‘mislead the ACCC, and initially maintained in this proceeding as being true with the evident purpose of misleading this Court‘…’documents were created to justify and to conceal Ultra Tune’s reprehensible conduct towards [the intending franchisee]’.

We don’t intend to dwell on this aspect of the case for the purposes of this article as the facts were unusual, as was the conduct of Ultra Tune. The Court was scathing in its assessment of Ultra Tune’s senior executives, ultimately finding that they intentionally misled the prospective franchisee and displayed little remorse. This included misleading the prospective franchisee about: how long the business operated, the circumstances under which the deposit would be refunded, who owned the business (namely, a franchisee, not Ultra Tune), the proper rental payable and the actual price of the business. It was an extensive list of misinformation.

Good Faith – Clause 6 of the Code

In examining Ultra Tune’s conduct, the Court provided some useful guidance on the obligation to act in good faith, especially in the context of a franchisor being able to act in its own legitimate commercial interests. The Court accepted the ACCC’s position that a franchisor must not use ‘powers and opportunities available to it to the detriment of a franchisee in the absence of any objective legitimate interest in doing so‘, and ‘must co-operate‘ where possible ‘providing that such co-operation is not to the detriment of the franchisor‘.

Cynical resort to the black letter of the contract is against good faith, which requires that regard be had to the franchisee’s interests in the franchise arrangement. The Court ultimately accepted the proposition that the Code prohibits ‘conduct that harms the franchisee where such conduct is not necessary for the protection of the franchisor’s interests‘.

The Court found that Ultra Tune breached the obligation to act in good faith towards the prospective franchisee and awarded the maximum fine of $54,000 for that breach.

The Court also had no hesitation in finding multiple serious breaches of the Australian Consumer Law (ACL) based on the evidence provided by the franchisee. The Court found that Ultra Tune had made a number of false representations in breach of s29 of the ACL, including whether the deposit was refundable, how long the Parramatta store had been opened, the rental cost and the price of the Parramatta franchise.

The conduct of Ultra Tune towards the prospective franchisee, coupled with the fabrication of documents and giving of false evidence to try and justify why the deposit was not refunded, was most heinous and the Court imposed a $1M fine. The Court looked at each aspect of Ultra Tune’s conduct and imposed the following fines:

Retaining Deposits

Having found that the franchisee was told, prior to entering into a franchise agreement, that a refundable deposit was payable, it was hardly surprising that the Court found the franchisee was misled when the franchisor sought to retain the whole deposit after the franchisee withdrew before signing.

However, that finding does not really assist any wider discussion of whether deposits are always refundable, or only sometimes (in which case, when, and when not), or never. The Court was not asked to consider any of those wider issues as the franchisor instead tried to defend its conduct on other grounds. So, for example, the Court was not asked to consider whether the arrangement the franchisee conceded was disclosed to it, namely that part of the deposit would be retained if the franchisee didn’t proceed in order to cover the cost of initial training, was nevertheless unenforceable, or against good faith, or unconscionable.

Any general consideration of the position with pre-contract deposits is still best begun with the High Court’s statement in Masters v Cameron[6] that “the prima facie inference [from a payment of a deposit before a contract is concluded] is that the intention was to provide a sum which should take on the character of a deposit upon the making of a contract, but in the meantime should not become the property of the intending vendor“. Such a payment is therefore repayable to the payer if no contract eventuates.

However, as a matter of contract law, this “prima facie” position can be altered if there is, in fact, some statement about the payment (such as appears to have occurred here) or, even more so, some agreement about its purpose and whether it will be refunded.

Nevertheless, as deposits are required to be refunded in full[7] if a franchisee exercises their right to terminate within the “cooling off” period, it may be readily argued that there should be a high threshold for a franchisor who wishes to argue against repaying any part of a deposit to a prospective franchisee who simply decides not to enter into a franchise agreement. Many franchisors elect to refund deposits in full to avoid disputes and complaints to the ACCC. Ironically, it was such a complaint to the ACCC by the prospective franchisee in question which led to a contested Court hearing and $2,604,000 fine for Ultra Tune. As Justice Bromwich observed ‘Ultra Tune’s decision to retain Mr Ahmed’s deposit has been calamitous for it, opening the door for the ACCC to examine a myriad of deficiencies‘.

Not only will Ultra Tune be compelled to pay the fine and refund the deposit to the franchisee but it will also have to pay interest and legal costs. The Court also ordered that Ultra Tune at its own expense establish, maintain, administer and comply with a compliance program to ensure compliance by the company its employees and agents with the ACL[8] and Code[9]. Ultra Tune will also be required to publish on its website (and in major newspapers) corrective advertisements and provide a copy to each of its franchisees.

This article was written by Sean O’Donnell, Partner and Mark Hamwood, Special Counsel with assistance from Massimo Di Maio, Associate.

Sean O’Donnell is one of Australia’s leading franchise and dispute lawyers. He is recognised by his international and local peers as a ‘Thought Leader’ in franchising, an accolade only applying to 4 other lawyers in Australia. He heads up the firms national retail and franchising practice. Sean has 20 years of experience assisting clients involved in the retail and franchise sectors, particularly assisting with strategic change of a network and resolving complex disputes in a broad range of industries. His practice in franchising covers both non contentious advice work to litigated disputes. This unique combination was validated in the publication of Who’s Who Legal 2017 where his clients commended him on his “incredible market understanding”, “commercial and practical advice” and “his superb litigation abilities”.  Sean is also listed in Best Lawyers for his franchise expertise. Sean was the President of the NSW/ACT Chapter of the FCA and a director of the FCA National board from 2012 to October 2017. He had a significant role in the drafting and implementation of the new Franchising Code in 2015, including submissions to government about redrafting of the Code. Contact Sean at sdonnell@hwle.com.au

Special Counsel Mark Hamwood specialises in resolving disputes involving franchising, property ownership or use and trusts and estates. Mark  assists franchising clients, principally in the retail food, property and business services industries. Mark’s recent experience includes: National retailing client: Assisting a national retailing client resolve disputes over the use of its name and logos in a large regional town; Master franchisee: Assisting a state master franchisee in the retail allied computer products industry resolve a dispute over the continuation of their agreement with the franchisor; Commercial building occupant: Assisting a large commercial building occupant in the building products industry resolve “make good” disputes at the end of its lease; and, National and local franchisors: Assisting national and local franchisors in predominantly retailing related businesses bringing about an orderly termination of relationships with defaulting franchisees and resolving disputes about termination, including with landlords. Contact Mark at mhamwood@hwle.com.au or connect via LinkedIn

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[1] S246(2)(b) of the ACL
[2] S86C(2)(b) of the Competition and Consumer Act 2010
[3] A redress order under S51ADB of the Competition and Consumer Act 2010
[4] ACCC v Ultra Tune Australia Pty Ltd [2019] FCA 12
[5] The maximum civil penalty is now $63,000 but was $54,000 at the time of the relevant breach
[6] Masters v Cameron(1954) 91 CLR 353 at 364
[7] Less any amount for reasonable expenses provided such amount is set out in the franchise agreement
[8] S246(2)(b) of the ACL
[9] S86C(2)(b) of the Competition and Consumer Act 2010

Important Disclaimer: The material contained in this publication is of a general nature only and is based on the law as of the date of publication. It is not, nor is intended to be legal advice. If you wish to take any action based on the content of this publication we recommend that you seek professional advice.