Franchising Focus

February 2012

Contacts

ACCC acts on unfair contract terms

By Jessica Rowe and Eliza Danby

Introduction

The Australian Competition and Consumer Commission (ACCC) has exercised its powers for the first time to take action against a business that it considers has sought to enforce unfair contract terms. Two recent cases – one in Australia and one in the UK - shed light on the types of contract terms that may be likely to attract regulatory attention.

Recap of the “unfair contract terms” law

A national regime prohibiting the enforcement of “unfair contract terms” in standard form contracts was introduced in July 2010. The regime is contained in The Australian Consumer Law (ACL), Schedule 2 to the Competition and Consumer Act 2010 (Cth) and applies to all standard form contracts entered into on or after 1 July 2010.

The aim of the “unfair contract terms” law is to address the imbalance in negotiating power that allows one party to include in a standard form contract a term that is “unfair”. Broadly speaking, a standard form contract is one that is pre-prepared by one party to the agreement and whose terms are not open to negotiation by the other party. A term will be unfair if the term:

  1. would cause significant imbalance in the parties’ rights and obligations under the contract;
  2. is not reasonably necessary to protect the legitimate interests of the party who would be advantaged by the term; and
  3. would cause detriment to a party if it were to be applied or relied upon.

Under the ACL, an unfair term included in a standard form contract will be void. 

Click here for further detail regarding the unfair contract terms law.

First Australian case

The ACCC has taken action under the unfair contracts provisions against NRM Corporation Pty Ltd and NRM Trading Pty Ltd (collectively NRM), which acquired the “AMI” business. The contract in question is a long term consumer contract regarding the provision of medication and services to treat male sexual dysfunction.

Under the contract’s terms, the customer is required to give 30 days’ written notice in order to terminate the contract and, in doing so, becomes liable to pay a number of fees including a fixed administrative fee of 15 per cent of the contract’s price. The ACCC alleges that the fees act as a penalty against a consumer who terminates the contact, causing a significant imbalance in the parties’ contractual rights.

The matter is being heard in the Federal Court in Melbourne, and its outcome will provide guidance to businesses about what a Court considers does and does not constitute an “unfair term” in a standard form contract

UK guidance

Unfair contract terms provisions similar to the Australian provisions exist in the United Kingdom, and were recently used as the basis for action in Office of Fair Trading v Ashbourne Management Services Ltd [2011] EWHC 1237 (Ch). Although Australian courts are not bound by the UK courts’ decision, the case provides insight into how the ACCC and courts might assess the fairness of a contract term.

The alleged unfair terms were contained in a standard form consumer contract used by a company that managed the memberships of gym and health club service providers. Among the terms held to be unfair were those that:

  1. locked consumers into a fixed membership period of one year or more (with termination triggering an obligation to pay all fees payable during the minimum period), as such terms took advantage of a prospective member’s tendency to overestimate how often they would use the gym at the time of taking up a membership. The circumstances in which a customer can terminate or suspend their membership, and any termination fees payable, are relevant to this decision;
  2. imposed a termination fee based on the number of monthly payments left under the contract’s term, with no discount of the fee for accelerated payment; and
  3. permitted the contract to be terminated by the service provider for minor breaches, such as several days’ late payment, by the consumer.

Conclusion

As the ACCC turns its focus towards businesses that seek to enforce unfair contract terms, it is a timely reminder for companies to “sanity check” their standard form consumer contracts. Click here for a checklist of “recommendations for businesses” in relation to the review process. Preventative measures taken now can avoid ACCC attention and action, and the consequences of a term of a standard form contract entered into by large numbers of consumers being unenforceable, and the accompanying adverse publicity.

Auditor’s reports and Guidance Statement GS018

By Allison McLeod

Franchisors are well aware that they are required, under the terms of the Franchising Code of Conduct, to provide certain financial information with their disclosure document. However, the introduction of Guidance Statement GS 018 means that the form of audit report many franchisors have relied on for years to support their financial position may no longer be sufficient.

Under section 20.1 of an Annexure one disclosure document at least one director of the franchisor must provide a statement as to whether, in the director’s opinion, there are reasonable grounds to believe that the franchisor will be able to pay its debts as an when they fall due. This statement must be supported by either:

  1. financial reports of the franchisor for each of the last two completed financial years; or
  2. a copy of an independent audit report provided by a registered company auditor.

To assist company auditors prepare audit reports for the purposes of the Franchising Code of Conduct, the Australian Government Auditing and Assurance Standards Board prepared a guidance statement in November 2002 (Guidance Statement AGST 1040) which included an example audit report. Many auditors and franchisors relied on the example audit report when preparing their audit report and this form of report is commonly found in franchise disclosure documents.

However in October 2010 Guidance Statement AGST 1040 was replaced with a new guidance statement - Guidance Statement GS 018. The new guidance statement covers many of the same issues as the former guidance statement. However it also includes a revised example audit report. The new example audit report is considerably different from the example audit report that was contained in Guidance Statement AGST 1040.

Many auditors will already be aware that Guidance Statement AGST 1040 has been replaced by Guidance Statement 018. However, franchisors should bring this to the attention of their auditors to ensure that their auditors are familiar with the new Guidance Statement and are preparing their audit reports in accordance with the most up to date information.

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The Personal Property Security Act and Franchising

By Allison McLeod

For some franchise systems the introduction of the Personal Property Security Act 2009 (Cth) (PPSA) may be significant, with specific action required to protect the franchisor’s interests or ensure franchisee compliance. For others it may ultimately prove less critical, or even irrelevant. However we recommend that all franchise systems carefully consider the possible application of the PPSA, and take a conservative and long term approach to the law.

One of the challenges when a new regulatory regime is introduced is anticipating all of the possible scenarios that could arise. This is because our laws are developed and refined not just through legislation, but by regulation, judicial determination and administrative interpretation. It can be years before there is certainty around the meaning of new laws, but in the meantime businesses need to make decisions and protect their assets.

For this reason we have developed a range of PPSA solutions. This article explores what we have called our patch solution, which is essentially intended to protect franchise systems that have considered their position, determined that the PPSA is unlikely to have much application to their business, but nonetheless want to protect themselves from the consequences of unforeseen situations and unfavourable judicial interpretation or legislative amendment.

Essentially we recommend franchisors review their franchise documentation and processes and take steps to ensure that:

  1. the franchisor is permitted to register a “Security Interest” if the franchisor determines that the franchise agreement or a transaction in connection with or contemplated by it constitutes or contains or may in the future constitute or contain a Security Interest under the PPSA; 
  2. the franchisee is required to acknowledge the entitlement of the franchisor to register any Security Interest the franchisor has, and the value given by the franchisor for the Security Interest;
  3. the franchisor has the right to require the franchisee to take action, provide information, produce documents and sign or obtain any documents or consents or do other necessary things to ensure each Security Interest is registered, enforceable and is effective to give the franchisor the desired protection, priority or enforcement rights;
  4. the franchisor has the right to insist on strict compliance with the requirements of any notice issued under the PPSA at the cost and expense of the franchisee, and the franchisor is indemnified for any cost the franchisor incurs in registering, maintaining, discharging and/or enforcing a Security Interest or doing any other thing the franchisee is required to do in connection with a Security Interest held by the franchisor;
  5. the franchisor has the right to obtain prompt notification of any change to information that the franchisee provides to the franchisor in relation to a Security Interest, including any change that would require a Financing Change Statement to be lodged; and
  6. any non-mandatory obligations imposed on the franchisor under the PPSA are waived.

We will be producing a range of further materials as we complete our reviews of client documentation, including a comprehensive article on how the PPSA is likely to affect franchise systems. Clauses such as guarantee clauses, options to purchase, equipment rental provisions and charging provisions are among the areas that have been identified.

For further information contact any member of our franchising team.

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Recent case a Paradise for Franchisors

By Shaun Temby

A recent decision of the Federal Court, Pampered Paws Connection Pty Ltd (on its own behalf and in a Representative Capacity) v Pets Paradise Franchising (Qld) Pty Ltd, has examined the relationship between the disclosure obligations arising under the Franchising Code of Conduct and the prohibition on misleading and deceptive conduct arising under the Australian Consumer Law (formerly known as the Trade Practices Act). It also examined whether a franchise agreement could be legitimately characterised as a sham that essentially camouflaged unlawful tied supply arrangements.

Reassuringly for franchisors, the Court’s practical and commercial approach supports the view that well worded disclosure documents supported by quality training programs for franchisee applicants will significantly reduce the risk of successful claims for breaches of the Code or misleading and deceptive conduct claims. The tied supply arrangements were similarly validated, with the franchisee’s rather tenuous arguments being rejected.

One cautionary note for franchisors to emerge from the Court’s judgement is that care needs to be taken to ensure that disclosure documents reflect the true operations of the business, and not an overly favourable interpretation of those matters based on a strict “black letter” law analysis of contractual obligations.

Nothing sinister, just good franchising

The franchisees in the case advanced what was described as a general “thesis” to the Court that relationship between the franchisor and their franchisees was “sinister”, and that the franchise agreement was “a paper tiger” designed to enable Global, and those controlling it, to manipulate the franchisees’ businesses to the benefit of Global. The Court rejected the thesis, finding that there was “nothing sinister” about the Pets Paradise system, regarding the thesis to be “an overstatement of the nature of franchising”. The Court noted the longstanding success of the franchise and stated that the franchisor’s associated entity’s role as the buying and stock supply arm of the franchisor was designed to secure better, preferably exclusive stock for Pets Paradise and its franchisees. This arrangement had good commercial aims and was an indication that the Pets Paradise system was a sophisticated one.

The Court considered a number of specific allegations of alleged false, misleading or deceptive conduct, rejecting most. It held that a representation as to the capability of the IT system had been made, but it was not false. Evidence from the staff that facilitated the franchisee training programme established that the franchisee applicants were trained in the functions and use of the system, which was considered to be a sophisticated management and reporting system based on the evidence of the trainers in relation to the system’s features. Similarly the court rejected that a reference in the disclosure document to “some” products being exclusive could not reasonably be interpreted as “most” and, as such the franchisees could only succeed if they could show that none or only a very small number of the products were exclusive products. The Court held that the representation was not false as some products were exclusive products and that the franchisees weren’t mislead as to the amount that were exclusive products as they had the opportunity to view the products in the supplier’s warehouse during the training period.

As to the tied supply arrangements, the Court found that the combined effect of the franchise agreement, instruction manuals and the supplier’s supply agreement was such that it was clear that stock did have to be purchased from the related entity of the franchisor even though this was in fact contradicted by the express words in the disclosure document. The court focused on the practical reality of being able to secure stock from other sources given the IT system and other factors. However, the Court held that “it does not routinely follow that the [franchisor’s conduct] is misleading or deceptive” because there was a contractual obligation to purchase goods from Global: finding that it was “really a matter of emphasis”. Importantly, the Court accepted the evidence given by the franchisor’s trainers that the franchisees were informed during the training programme of the processes for purchasing from non-approved suppliers and for having other suppliers approved, but that the related entity was the principal supplier to the system.

Breach of the Code

The Court accepted that the disclosure document failed to state all of the documents that the franchisees had to sign in order to be granted the franchise. However it held that because those agreements and the guarantees were revealed and signed into before or at the same time that the franchisee applicants signed the franchise agreement, the franchisee had the opportunity to decide not to proceed with the franchise before incurring any legal liability to do so or suffering any loss from the representation. It also appears that overall the court felt that the conduct was not misleading in any material way, as the omission of the information from the disclosure document was corrected in time.

The Court dealt briefly with several other alleged breaches to the Franchising Code of Conduct, finding that all of the non-disclosures alleged by the franchisees had been proved. However, in almost every instance, his Honour found the breaches to be “technical breaches” which if disclosed would not have prevented the franchisees from proceeding with the franchise. The Court found that there was no loss suffered as a result of the Code breach.

What does it mean for your business?

Franchisors can take some comfort from the commercial and practical approach adopted by the Court in this case. In rejecting the applicant’s conspiracy “thesis”, his Honour relied on the evidence of the franchisor’s staff and other franchisees as to the systems, processes and business reasons underpinning the success of a well established and otherwise successful franchise. This common sense approach was also evident in the Court’s rejection of fanciful interpretations of the disclosure documents in isolation to other information communicated prior to the franchise agreement being entered into.

This emphasis on the commercial reality of the parties’ positions cuts both ways. Franchisors still need to ensure that their disclosure documents reflect the true reality of their business and their franchise system. Reliance on technical legal distinctions will not be automatically accepted by the Court. In doing so, franchisors need to be certain that disclosure documents and training programmes describe their franchising and supply arrangements accurately, and do not attempt to sugar-coat any obligations that franchisees might have. As this case indicates, the courts will look beyond the disclosure document, to internal documents and common practice, to determine the truth of the matter, and if these do not match the representations made to franchisees, liability could arise.

In addition to having such a programme in place, franchisors should make certain that:

  1. they have clear and reliable pre-contracting systems for the supply of information to franchisee applicants;
  2. those systems are followed precisely and that this adherence to the system is properly documented;
  3. information covered in training programmes is standardised, documented and recorded; and
  4. notes of meetings and exchanges with franchisees are recorded together with any unusual statements made by the franchisee applicant’s during those exchanges. 

The more information that can be provided (and that the franchisor can prove was provided) prior to a formal binding agreement being reached, the less likely it is that a franchisee can argue that they were misled. The evidence of staff members responsible for training as to their usual practices, can provide an effective safeguard against misleading and deceptive conduct claims.

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