Penalties if Disclosure Documents don’t comply

Introduction

A recent Federal Court case where a franchisor and its former director were given very large fines for not complying with the Franchising Code and in particular for providing a Disclosure Document that did not contain everything required (even though there was no evidence of any loss or damage on the part of franchisees), highlights the importance of considering carefully the contents of a Franchising Code Disclosure Document and ensuring that it complies fully with the Franchising Code in every respect.

Disclosure Document requirements under the Franchising Code of Conduct

The latest Franchising Code of Conduct (Sch 1 to the Competition and Consumer (Industry Codes – Franchising) Regulation 2014 (Cth) (the Code) came into effect on 1 January 2015. The Code now includes financial penalties for serious breaches.

In this case the following provisions were important (although you should always consider all the requirements in the Franchising Code as failure to comply with other Franchising Code requirements may be equally problematic).

Clause 8(1) of the Code provides:

A franchisor must create a document (a disclosure document) relating to a franchise that complies with subclauses (3), (4) and (5).

Civil penalty: 300 penalty units

Clause 8(3) of the Code provides that the information in a disclosure document must be set out in the form and order of Annexure 1 to the Code (which sets out a pro-forma disclosure document for franchisee or prospective franchisee).

Item 3.1 of Annexure 1 to the Code (the pro-forma disclosure document) requires the franchisor to provide a summary of the relevant business experience of each associate of the franchisor, including length of experience in (a) working in the franchise system; and (b) working for the franchisor.

In addition, clause 9(1) of the Code requires that a franchisor must give (amongst other things) a copy of an updated disclosure document to a prospective franchisee at least 14 days before the prospective franchisee (amongst other things) enters into a franchise agreement. The civil penalty for breaching clause 9(1) of the Code is 300 penalty units.

Action Taken by ACCC for Franchising Code breaches

In September 2016 the Australian Competition and Consumer Commission (ACCC) took its first action seeking penalties under the Code, against the franchisor of the Pastacup franchise system Morild Pty Ltd. The ACCC took the view that Morild Pty Ltd had breached the Code by providing to prospective franchisees (prior to December 2016) a disclosure document which in the view of the ACCC had failed to comply with the Code. In particular the ACCC took the view that certain information should have been included in Item 3.1 of the disclosure document of Morild Pty Ltd.

Australian Competition and Consumer Commission v Morild Pty Ltd [2017] FCA 1308 (10 November 2017)

Background

Pastacup Australia Pty Ltd (ACN 127 162 289) (the original franchisor of the Pastacup system) (“the First Pastacup Franchisor Company”) was incorporated on 21 August 2007. Mr Stuart Bernstein was a director of the First Pastacup Franchisor Company and a co-founder of the franchise system.

Pastacup International Pty Ltd (“the Pastacup IP Company”) is and was the owner of the intellectual property used in the Pastacup franchise system. Mr Stuart Bernstein was until 22 June 2016 also a director of the Pastacup IP Company.

The Pastacup IP Company licensed the First Pastacup Franchisor Company to use the Pastacup intellectual property.

On 12 April 2011

    1. the First Pastacup Franchisor Company changed its name to SPP Holdings Pty Ltd; and
    2. a new company called Pastacup Australia Pty Ltd (ACN 150 392 340) (“the Second Pastacup Franchisor”) was registered. Mr Stuart Bernstein was a director of the new Pastacup Australia company.

At some time before 6 December 2013, the Second Pastacup Franchisor began acting as the franchisor for the Pastacup franchise system in the place of SPP Holdings Pty Ltd.

The current franchisees of the First Pastacup Franchisor Company were transferred to the Second Pastacup Franchisor Company and the Pastacup IP Company granted to the Second Pastacup Franchisor a licence to use the Pastacup intellectual property.

On 6 December 2013, the First Pastacup Franchisor Company went into liquidation and as a result, the Pastacup IP Company had the right to (and presumably did) terminate the licence to use the intellectual property.

On 6 July 2014 the Deputy Commissioner of Taxation applied to the Federal Court of Australia to have the wound up.

On 19 September 2014 Morild Pty Ltd became the franchisor of Pastacup and the franchisees of the Second Pastacup Franchisor were transferred to Morild Pty Ltd. Mr Stuart Bernstein was a director of Morild Pty Ltd.

The Pastacup IP Company granted to Morild Pty Ltd the right to use the Pastacup intellectual property.

On 21 October 2014 the Federal Court of Australia ordered that the Second Pastacup Franchisor Company be wound (be placed in liquidation).

Again the Pastacup IP Company had the right to terminate the licence to use the intellectual property if the Second Franchisor Company became insolvent (and presumably did so).

Document to comply with the requirements of the Code, in particular, the failure of the November 2014 Disclosure Document to comply with Annexure 1 to the Code (that is the pro-forma disclosure document).

As a consequent of the Section 155 Notice, in or about January 2016, Morild Pty Ltd prepared a new Pastacup disclosure document (dated 8 January 2016) (the January 2016 Disclosure Document).

The summary of the business experience for the last 10 years of Stuart Bernstein as a director of Morild Pty Ltd (set out in the January 2016 Disclosure Document):

    1. stated that Stuart Bernstein was the founder of the Pastacup concept;
    2. stated that: “[Mr Bernstein] has been working in the franchise system since its inception in 2008 and for the Franchisor since its incorporation in 2014” and “[t]he Franchisor was incorporated and acquired the Pastacup franchise system in 2014“;
    3. identified a list of “associates” of Morild Pty Ltd which “have been externally-administered body corporates in the last 10 years”, including SSP Holdings Pty Ltd and Pastacup Australia Pty Ltd; and
    4. stated that an administrator was appointed to SPP Holdings Pty Ltd and Pastacup Australia Pty Ltd.

Although the January 2016 Disclosure Document disclosed that the First Franchisor Company and the Second Franchisor Company were externally administered bodies corporate as set out above, it did not:

Morild Pty Ltd prepared a disclosure document in November 2014 as the franchisor of the Pastacup franchise system (the November 2014 Disclosure Document).

The summary of the business experience for the last 10 years of Mr Stuart Bernstein as a director of Morild Pty Ltd (set out in the November 2014 Disclosure Document) included the following:

Mr Bernstein operated as part owner and director of cafes in North Perth for six years “following a 2 year stay in Sydney setting up and operating successful cafes, Piccolo Mono and Cafe Bondi”. Prior to that, he was the owner and operator of various food outlets. He “holds a Bachelor of Commerce degree and is responsible for the Pastacup concept and became a director of Pastacup early in 2008”; and (b) the Pastacup brand was launched in March 2008. The concept of Pastacup was trialled and tested under another name for 3 years prior to the name change to Pastacup

after careful consideration of the type of business the owners wanted to offer the public… Testing of recipes, customer feedback and kitchen operations had shown amazing results prompting management to open a Pastacup franchise pilot store. Using feedback and experience from the North Perth store, the brand was redefined in the development of the logo, the look and feel of the store, the culture and pricing strategies.

The November 2014 Disclosure Document did not disclose the previous two insolvent franchisor companies of the Pastacup franchise system or that Mr Stuart Bernstein was a director of the previous two insolvent franchisor companies of the Pastacup franchise system.

In December 2015 the Australian Competition and Consumer Commission (“ACCC”) issued a Section 155 Notice to Morild Pty Ltd. The Section 155 Notice described the matters being investigated by the ACCC, namely the failure of the November 2014 Disclosure

    1. identify the First Franchisor Company and the Second Franchisor Company as predecessor franchisors of the Pastacup franchise system;
    2. refer to Mr Bernstein’s role as director of those companies; and
    3. state that each of the First Franchisor Company and the Second Franchisor Company were wound up by reason of insolvency.

Morild Pty Ltd created a new disclosure document in December 2016, by which time Mr Bernstein had resigned as a director of Morild Pty Ltd.

Declarations made by the Federal Court

The Federal Court made the following declarations:

1                 Mr Stuart Bernstein (the first respondent) contravened clause 8(1) of the Code and thereby contravened s51ACB of the Competition and Consumer Act 2010 (Cth) (CCA) by failing, between 1 January 2015 and at least 8 January 2016, to create a franchise disclosure document concerning the Pastacup franchise system that disclosed the relevant business experience of Mr Stuart Bernstein, including that he was previously a director of SPP Holdings Pty Ltd and the Second Pastacup Franchisor) who had acted as franchisors of the same franchise system and went into winding up by reason of insolvency.

2                 Between 18 March 2015 and 25 September 2015, the first respondent contravened clause 9(1) of the Code and thereby contravened s 51ACB of the CCA by giving a franchise disclosure document dated 18 November 2014 concerning the Pastacup franchise system to prospective franchisees which document did not disclose that the relevant business experience of the first respondent’s director, Mr Bernstein, included that he was previously a director of two companies who had acted as franchisors of the same franchise system and went into winding up by reason of insolvency.

3                 Mr Bernstein was a person knowingly concerned: (a) within the meaning of s 75B(1)(c) of the CCA in the first respondent’s contraventions of s 51ACB of the CCA referred to in paragraphs 1 and 2 above; (b) within the meaning of s 76(1)(e) of the CCA in the first respondent’s contraventions of cl 8(1) and cl 9(1) of the Franchising Code referred to in paragraphs 1 and 2 above; and (c) within the meaning of s 80(1)(e) of the CCA in the first respondent’s contraventions of s51ACB of the CCA referred to in paragraphs 1 and 2 above.

Penalties

The Federal Court of Australia ordered the following:

1                 that Morild Pty Ltd pay to the Commonwealth of Australia a penalty of $100,000.00 with payment to be made in 24 monthly instalments, with the first payment occurring on the first day of the month following the date that this order is made and each subsequent next payment occurring on the first day of each subsequent month.

2                 that Mr Bernstein pay to the Commonwealth of Australia a penalty of $50,000.00 with payment to be made in 24 monthly instalments, with the first payment occurring on the first day of the month following the date on which Mr Bernstein is discharged from bankruptcy and each subsequent next payment occurring on the first date of each subsequent month.

Interestingly, the Federal Court found that there was no evidence that any of the franchisees that had entered into franchise agreements with Morild Pty Ltd had suffered any loss or damage as a result of being provided with a disclosure document which did not comply with the Code.

The Role of the ACCC

In respect of the penalties set out above, the ACCC Deputy Chair, Dr Michael Schaper commented:

“These are the first court ordered penalties for breaches of the new Franchising Code. These significant penalties should send a strong message to other franchisors that they must meet their disclosure obligations. The Franchising Code requires franchisors to provide prospective franchisees with a disclosure document which contains important information about the franchise and the franchisor. Full and accurate disclosure by the franchisor is essential to enable prospective franchisees to make informed business decisions.”

Lessons arising from Pastacup

The ACCC has once again confirmed that it is a priority to ensure that franchisors comply with the requirements of the Code. The case of ACCC v Morild Pty Ltd illustrates the complexities which can arise and the importance which must be given to preparing and updating disclosure documents.

Franchisors must take care to ensure that they have made full disclosure and that their Disclosure Documents contain all of the information required and all of the information is accurate and not in any way misleading.

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