A Franchisor Liability Case Study: ASIC v Darranda Pty Ltd

Compliance is an important and ever-changing component of running a business. As a franchisor, it can be tempting to look at the rules that are relevant to your business, prepare systems that comply with those rules, and then set and forget and rely on your franchisees to maintain their own compliance. However, this is a dangerous approach.

An example of the dire consequences for franchisors and franchisees of failing to comply with legal requirements can be found in the recent Federal Court case of Australian Securities and Investments Commission v Darranda Pty Ltd (Liability) [2024] FCA 1015. In this article, we will explain the decision reached in this case and explore the lessons that franchisors and franchisees can learn from it.

ASIC v Darranda Pty Ltd  - The Facts

 Rent4Keeps (Aust) Pty Ltd was the owner and master franchisor of a franchise system offering long-term rental agreements for household goods like whitegoods, televisions, furniture and personal electronic devices. Its roles in the franchise system included brand development, marketing, administration, assessing customer enquiries and connecting them with franchisees.

Darranda Pty Ltd was the largest franchisee of the business, responsible for sourcing goods from retailers on request by customers, delivering those items to the customer and entering into standard-form contracts generated by the franchisor's customer relationship management (CRM) software.

Their target customer base was primarily lower-income households who could not afford to purchase goods outright or access mainstream credit.

Legal Issues

Legal classification of contracts

The contracts offered by Rent4Keeps were structured on the premise that the customer would nominate a third-party giftee, generally a relative or friend, when they entered into the contract but that the Rent4Keeps franchisee would maintain a discretion to choose whether or not to gift the rented item to that giftee at the conclusion of the contract.

This structure was intended to distinguish the contracts as consumer leases, rather than credit contracts. Consumer leases do not give the renter any right or obligation to assume ownership of the rented item at the conclusion of the agreement, whereas credit contracts do. Credit contracts attract stricter regulations under the National Consumer Credit Protection Act 2009 (Cth) ('the Credit Act'), including, among other things, responsible lending requirements and a requirement to hold an Australian Credit Licence, which comes with conditions of its own. Rent4Keeps was seeking to avoid those requirements.

However, the contracts and the context surrounding them were not sufficiently clear to customers to properly establish this distinction. The gift model was often presented to customers as a guaranteed feature of the agreement, suggesting that when the customer nominated a giftee, provided that the customer fulfilled their end of the contract, Rent4Keeps was contractually obligated to gift the item to that person.

Further, the Court found that there was rarely, if ever, any practical action taken by Rent4Keeps to actually gift the item to the nominated giftee at the conclusion of the contract. Automatic reminders programed by the franchisor to notify customers as they were nearing the end of their contracts made no mention of gifting the rented item and the process generally followed by the franchisee did not practically enable them to exercise a discretion to gift at the conclusion of the agreement.

The Court found that the franchisee generally expected the nominated giftee to be a family member or close friend of the customer and that the customer would keep physical possession of the item. To their customers and employees without a detailed understanding of the legal distinction between possession and ownership at law, this would certainly appear as if the customer obtained ownership at the conclusion of the agreement.

For these reasons, the Court held that despite the contractual wording indicating that the agreement did not give the customer a right or obligation to assume ownership of the goods at the end of the agreement's term, the actual practices of Rent4Keeps created an expectation that the customer (or at least their nominee) would own the goods at the end of the term. That led them to the conclusion that the agreements entered into by Rent4Keeps were actually credit contracts, and therefore the franchisor and franchisee were beholden to, and had failed to meet, the requirements under the Credit Act.

Breach of general conduct obligations

The Court found that the franchisor and franchisee each breached the general conduct obligations of the Credit Act by failing to do all things necessary to ensure their credit activities were engaged in efficiently, honestly and fairly. Examples of this included the franchisor failing to update their contractual terms to comply with the Credit Act despite receiving legal advice to do so, implementing misleading scripts used by the franchisee to give the impression that the customer would own the item at the end of the agreement and failing to take action to ensure that correct processes were being followed.

Liability of the franchisor

The franchisor in this case was held liable because they were "involved in" the above contraventions. The Credit Act states that a person (which can be a company) is involved in a contravention if, and only if, they have been "in any way, by act or omission, directly or indirectly, knowingly concerned in or party to" that contravention.

 For a party to be "knowingly concerned" in something requires more than just their knowledge. They must have engaged in some sort of conduct, either by doing something or failing to do something, that involves them in or connects them with the contravention.

The party must have actual knowledge of the central facts that make up the contravention. This precedent was set in the pivotal High Court case of Yorke v Lucas (1985) 158 CLR 661, conducted by Haarsma Lawyers's own Stephen Haarsma. Using the facts in that case as an example, for a party to be involved in a contravention of a statute prohibiting misleading conduct, that party must have had actual knowledge that the representations they were making were misleading.

Rent4Keeps (Aust) had drafted the template that all of the franchisee's contracts were based off, operated the customer resource management (CRM) system, issued manuals to franchisees guiding their conduct and had an obligation to monitor compliance processes.

The Court accepted that the "governing minds" of the franchisor (its director and its CEO) did not have actual knowledge of all of the contractual terms in the contracts, but this was not enough to save it from liability. The Court found that they did have actual knowledge of the effect of the ownership provisions and the gifting mechanism and had received legal and regulatory warnings about their consequences.

Penalties

The penalties for these contraventions were steep. The franchisor, Rent4Keeps (Aust), was fined $4 million, and the franchisee, Darranda Pty Ltd, was fined $3.4M for overcharging consumers on essential household goods and failing to comply with their regulatory obligations as credit licensees.

Lessons for Franchisors

Compliance is an issue for franchisors, not just franchisees

Franchisors can inherit the legal risk and liability associated with non-compliance with regulations, even when their franchise agreements allocate that responsibility to their franchisees. This is especially likely in circumstances where the franchisor designs, controls or endorses the systems used by the franchisees. Any franchisor who exports legal documentation for franchisee use, like the rent agreements in this case, must make sure that they are compliant with any relevant regulations, and should consider seeking legal advice to confirm this.

Contract wording cannot override practice

Courts will consider how agreements operate in practice. If the systems put in place by franchisors lead to non-compliant outcomes, they can be held liable, even if the terms of the contract say something different.

Compliance is not set-and-forget, and must be monitored

Franchisors cannot simply create systems that are compliant and rely on their franchisees to follow them. They must oversee the conduct of their franchisees, create standardised training specific to their business and employ mechanisms to audit and enforce franchisee compliance with their systems.

Brand identity must match legal reality

In this case, Rent4Keeps, by its name and other aspects of its marketing, represented to potential customers that they would "keep", or own, the items they rented at the end of their agreements. While a franchise's name and branding are not enough on their own to override the actual terms of a contract, these representations were found to create legal expectations. Franchisors must ensure that the brand identity they are fostering is consistent with the legal reality of their services.

Ignorance is not a defence

The contraventions by the franchisee and franchisor were not as a result of malice, ill-will or an intention to exploit customers. They were at least partially the result of a lack of competence in operating within a highly regulated industry. However, this did not shield them from liability. It is important for franchisors and franchisees alike to stay informed about the regulations in their industry, and to keep their conduct compliant. Failure to do so can result in significant penalties.

Takeaways

• Australian Securities and Investments Commission v Darranda Pty Ltd (Liability) [2024] FCA 1015 sets an important precedent that explains some of the circumstances where franchisors can be held liable for the actions of their franchisees.
• There is a distinction between consumer leases, which do not give the renter a right or obligation to own an item at the end of an agreement, and credit contracts, which do.
• Franchisors can be held liable for contraventions made by a franchisee when they are "involved in" those contraventions.
• Franchisors can be found to be involved in contraventions when their have engaged in conduct relating to it and have actual knowledge of the facts of the contravention.
• Compliance must be considered constantly, and positive action must be taken by franchisors to ensure that their franchisees comply with relevant regulations.