Franchisor Obligations and Misconduct – Individuals Personally fined

Hefty Fines For The Franchisor Company, The Director and The National Franchising Manager

ACCC v Geowash

In February 2019, the Federal Court determined that Geowash (a carwash and detailing franchisor) had made false or misleading representations and breached its duty to act in good faith when dealing with franchisees. The conduct of Geowash was a breach of Australian Consumer Law, the Franchising Code of Conduct and decidedly unconscionable conduct at common law.

In February 2019, the Federal Court determined that Geowash (a carwash and detailing franchisor) had made false or misleading representations and breached its duty to act in good faith when dealing with franchisees. The conduct of Geowash was a breach of Australian Consumer Law, the Franchising Code of Conduct and decidedly unconscionable conduct at common law.

Geowash’s conduct which was reprimanded by the Court included the following:

  • Making a representation that it would charge franchisees in accordance with the fees disclosed in the Franchise Agreement and Disclosure Document and diverging from this representation;
  • Making false representations on its website as to gross revenues and gross profits franchisees could be expected to make;
  • Making a false representation that Geowash had a commercial relationship or affiliation with several well known brands and companies;
  • Negotiating start up purchase prices with franchisees on an assessment of how much Geowash believed each prospective franchisee was willing to pay;
  • Using funds acquired from franchisees for the purchase of the franchise to first pay sales commissions to the company’s director (Ms Ali) and the national franchising manager (Mr Cameron) and using the remainder to pay general expenses of the organisation, after representing to franchisees that the funds would meet the actual costs of fitting out and establishing each franchise;
  • Generally adopting a business model which was inherently dishonest.

The above conduct fell into several categories of offences under the Australian Consumer Law including:

  • Misleading and deceptive conduct;
  • False or misleading representations of a material aspect of business activity;
  • Misleading representations of sponsorship or affiliation;
  • Engagement in unconscionable conduct; and
  • Failure to comply with their duty to act in good faith under clause 6 of the Franchising Code of Conduct.
The court’s determination of penalties and sanctions took place on 24 January 2020 and can be read in full here. The franchisor was penalised a total amount of $4.2 million, with the sole director of the franchisor company (Ms Ali) personally liable for $1,045,000 and the national franchising manager (Ms Cameron) personally liable to pay $656,000. In addition to the penalties, Ms Ali and Mr Cameron were asked to pay $500,000 each into a redress fund to compensate franchisees who suffered losses as a result of their conduct. This is a large sum of money for individuals, considering penalties are often absorbed by the corporate veil.

Following their successful prosecution of this case, the ACCC Deputy Chair Mick Keogh was quoted in the ACCC press release to give the following message: “Franchisors are often in a position of power compared to their franchisees, and Geowash’s actions, including those of its executives, were very serious breaches of its obligations under the Code and the Australian Consumer Law….These significant penalties should send a clear and strong message to franchisors and franchise executives about the importance of complying with their obligations under the Franchising Code of Conduct and Australian Consumer Law.”

Both Ms Ali and Mr Cameron were also disqualified from managing corporations, Ms Ali for five years and Mr Cameron for four.

The ACCC are closely monitoring compliance with the good faith obligations under the Franchising Code of Conduct. As stated by the ACCC Deputy Chair in the ACCC press release of 11 February 2019 regarding the Geowash case, “This is the second recent court action we’ve taken against a franchisor for a breach of the Franchising Code’s good faith obligations. The ACCC is committed to pursuing franchisors who disregard their obligations under the Code and the consumer law.” The other case the Deputy Chair was talking about involved motor repairer Ultra Tune and is discussed below. Although the franchisor entity was found liable, the directors in that case incurred no personal liability.

How can directors be personally liable?

Under the Corporations Act 2001 (Cth), directors have particular duties which they owe to the Company. These duties include matters such as acting with care and diligence, acting in good faith and for a proper purpose, avoiding conflicts of interest, acting in the best interests of the company, and avoiding insolvent trading, to list a general few. Therefore, action can be brought against a Company director under this legislation for issues that concern the director’s conduct.

Furthermore, directors can be liable under the Australian Consumer Law for any prohibited conduct which they engage in as an individual.

To illustrate, the prohibition against misleading and deceptive conduct under section 18 of the Australian Consumer Law applies to a person, which legally means a company or individual.

In fact, under section 236(1) of the Australian Consumer Law, where any individual or company contravenes a provision of Chapter 2 or 3 of the Australian Consumer Law, the claimant can bring an action against any person who was involved in the contravention.

The ACL defines the term ‘involved’ as follows:
involved: a person is involved, in a contravention of a provision of this Schedule or in conduct that constitutes such a contravention, if the person:
(a) has aided, abetted, counselled or procured the contravention; or
(b) has induced, whether by threats or promises or otherwise, the contravention; or
(c) has been in any way, directly or indirectly, knowingly concerned in, or party to, the contravention; or
(d) has conspired with others to effect the contravention.

Despite the entrenched legal doctrine which states that a corporate veil cannot be pierced, it is clear that certain legislation provides an exemption to this rule, exposing its directors and/or executives to personal liability in certain instances.

Why were the directors held personally liable in the Geowash case?

In this matter, both Ms Ali and Mr Cameron caused Geowash to engage in the prohibited conduct mentioned above and were therefore “knowingly concerned or a party to” the contraventions, whether directly or indirectly, and therefore captured by s236(1) of the Australian Consumer Law.

His Honour Colvin J, alluded to various circumstances which would have cumulatively resulted in the high degree of personal liability from Ms Ali and Mr Cameron. Both individuals benefitted financially and to a considerable degree from the misrepresentations made. Both individuals were aware that they were dealing with people who were not savvy in business, financially vulnerable and very trusting of the information provided to them. The individuals were knowingly involved in the conduct of Geowash, in that the extent and nature of their involvement was such to have caused the contravening conduct. Furthermore, His Honour mentions many times that the further actions taken by the individuals and their general conduct during the hearing of this case showed no “remorse or contrition” for the situation of the franchisees that they misled.

Other cases where directors personally liable
Since the new Franchising Code of Conduct was effected in 2015, the ACCC has been vigilant in monitoring compliance amongst franchised businesses. In 2015, the ACCC brought proceedings against South East Melbourne Cleaning Pty Ltd. Contraventions of the Australian Consumer Law and the Franchising Code of Conduct in this case have similar overtones to the Geowash case.

The conduct involved false and misleading representations being made to potential franchisees about their potential profits and earnings, and further misrepresentations about the business systems used to distribute the money from customers to franchisees. The Company was liable to pay a penalty of $500,000. One of the directors faced a penalty of $30,000, and another director was disqualified from managing a corporation for two years.

In their commentary of this matter at the time, Watkins Tapsell made the following assessment: “it is evident that the Court is quite happy to order penalties against a Director individually, even where there is a company structure in place, if the Director is aware of, or is engaging in conduct that is in breach of the Franchising Code.” In this case, the director who was penalised was found to have used ‘unfair tactics in his dealings’ with franchisees.

Furthermore, in ASICs investigations of white goods company Kleenmaid, a director of the company was found criminally liable for his conduct in the operation of the Kleenmaid franchise in 2016 (R v Armstrong & Ors [2015] QDC 80). The conduct involved insolvent trading and dishonestly obtaining loan facilities. Kleenmaid had failed to disclose to the lender (Westpac) that one of the entities forming part of the corporate group for whom the loan was to benefit was in serious debt. A summary of the case can be found here.

What about the case of Ultra Tune from 2019? Why wasn’t the director personally liable here?

The Geowash case comes after the recent matter of Australian Competition and Consumer Commission v Ultra Tune Australia Pty Ltd [2019] FCA 12 (18 January 2019).

At the time of this matter, the franchisor was Australia’s second largest motor vehicle repair business. Ultra Tune was penalised over $2 million primarily for its failure to act in good faith under section 6 of the Franchising Code of Conduct and for failing to include sufficient details about the franchise in the disclosure document provided to prospective franchisees. Ultra Tune was also found to have made false and misleading representations about a particular franchise site to a prospective franchisee, putting Ultra Tune in breach of the Australian Consumer Law. In comparison to the Geowash case, no executives were found personally liable for the conduct of Ultra Tune.

At [325], the Federal Court found “Given that the worst of the conduct was engaged in by the most senior officer of the company in NSW, it is a case of direct, rather than vicarious liability – the conduct of Mr Tatsis and of Mr Cott was, directly, the conduct of Ultra Tune , not just vicarious liability for the actions of a lesser employee or agent.” Although the Court found that the conduct of senior management was misleading and deceptive, these individuals were taken to be engaging in such conduct in accordance with the standard procedures of Ultra Tune, and there was no evidence of their conduct being out of character from their standard practice. The Court noted at [366] that the penalty imposed on Ultra Tune took into account the state manager’s conduct and “is no mere extension of vicariously liability, but direct liability by Ultra Tune via one of its most senior managers”.

Therefore, where the conduct of individuals managing the Franchisor entity is misleading or in breach of Australian franchising legislation, it is evident that the Court will consider this conduct in light of the standard procedures of the Company.

Conclusion

In light of the above, the Geowash decision shows why franchisors have to be very careful in representing their business operations and expected fees accurately when dealing with franchisees. The ACCC are definitely willing to consider the wrongdoing of individuals as a way of deterring misleading conduct. Franchisors are now under more scrutiny and investigation that ever before.

Key Takeaways

Here are our recommendations on how you can minimise your chances of being personally liable when you are operating a franchise.

  1. Don’t make any representations that you can’t justify to potential and current franchisees.
  2. Be accurate in any statements or written correspondence made to the prospective franchisee.
  3. Make sure figures in your Disclosure Document are accurate as to likely establishment and ongoing costs of the franchise.
  4. Don’t make any false representations on likely revenue or profits.

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