Allegations of employee underpayment within certain franchise networks have commanded significant media attention this year. But there is more to the legal landscape in franchising.

It has been a year of transition and a year of activity with laws extending unfair contracts protections to small businesses to take effect in November 2016 and a number of court cases decided throughout 2016.

This article provides a brief overview of the recent court decisions extracting key insights for franchisors.

Key cases in 2015/2016

Electrodry Carpet Cleaning

The franchisor of an Electrodry Carpet Cleaning business with over 100 franchisees throughout Australia (excluding Sydney) published fake testimonials on internet sites. Electrodry posted and requested that its franchisees post, customer testimonials about the quality of carpet cleaning services, when those customers were not real and the services had not been provided.

The Federal Court ordered the franchisor to pay penalties of $215,000 and made other orders, including injunctions, corrective advertising and the payment of the ACCC’s costs.

Lessons to be learned:

Franchisors should take care in all forms of marketing and ensure that testimonials and reviews that are published are genuine.

Pizza Hut 

The long awaited decision in what has come to be known as the Pizza Hut Class Action was published publicly on 26 February 2016;190 Pizza Hut franchisees sued their franchisor in relation to a decision to reduce pizza prices in 2014.

The basic facts were that the franchisor, Yum Restaurants Australia Pty Ltd (Yum) decided in early 2014 to implement a new model known as the Value Model whereby it would:

• reduce the range of pizzas offered for sale from four to two (reducing the total number of pizzas for sale from 27 to 17) and
• drop prices on the two remaining ranges from $9.95 to $4.95 and from $11.95 to $8.50 respectively.

The Value Model was scheduled to begin on 1 July 2014 and relied on New Zealand data and the results of a trial conducted in the Australian Capital Territory.  The objective of the Value Model was to increase sales by 34.5 percent.

The franchisees made three core allegations, namely:

1. Yum was obliged to set profitable prices;
2. Yum was subject to the following implied duties owed by Yum under the franchise agreement to each franchisee: an implied duty to co-operate with the franchisees to achieve the objects of the franchise agreement and an implied duty to comply with reasonable standards of conduct, taking account of the interests of both parties to the franchise agreement and
3. Yum’s conduct was unconscionable within the meaning of the Competition and Consumer Act 2010 (Cth).

The Court found:

1. Yum was not obliged to fix prices for each product line so each product line was profitable. The object of the franchise agreement was each franchise business, not each pizza;
2. Although Yum owed a duty to co-operate with franchisees, the duty was not breached; and
3. Yum had not engaged in unconscionable conduct.

In effect, the Court found, as a whole, Yum’s decision to implement the Value Model was based on reasonable grounds and made in good faith on the belief that it would increase franchise profitability. Simply because the plan did not maintain profits or realise increased or a maintenance of profits did not make Yum liable for franchisees’ losses.

The evidence showed that, for the most part, Yum had carefully considered the strategy in fixing the maximum prices. No dishonesty, negligence, bad faith or recklessness had been demonstrated nor had any decisions been made capriciously or arbitrarily. .

Lessons to be learned:

Some of the key points to remember, as a result of this decision, are:

1. Typically (and expressly in this case), franchise agreements do not contain any promises that franchisees will make a profit
2. There is a common law duty on parties to commercial contracts to exercise their discretionary powers (i.e. the power the set maximum prices) in good faith, honestly and with reasonable cause. In other words, clauses in franchise agreements that expressly empower one party (typically a franchisor) to make discretionary decisions must be exercised in good faith, honestly and with reasonable cause
3. Decisions that adversely affect franchisees (including, for example decisions that adversely affect sales and profitability), do not necessarily mean a franchisor has not acted in good faith or unconscionably.

Franchisors should carefully think through and research any proposed strategy and ensure there is a reasonable basis for any decision made. 

Franchisors should also keep records of information relied upon, research conducted and any reasoning behind a decision.

What does the balance of 2016 have in store for franchising?

1. Industrial Relations Laws

It is expected that in the franchising sector there will be a continued focus on compliance with industrial relations obligations.

In August 2015, a joint investigation by Four Corners and Fairfax was aired on national television, alleging widespread and systematic wage exploitation of workers being carried out by 7-Eleven franchisees, including underpayments and doctoring of wages. It was alleged that 7-Eleven was aware of the conduct and further, that franchisees could not viably run their stores due to the 7-Eleven franchising model’s inequitable distribution of profits.

In response to the crisis, 7-Eleven established an independent panel to review requests for back pay from current and former workers. Further, it made changes to its franchise business model. 

As franchising heavily relies on the franchisor’s brand, the 7-Eleven matter shows us that the conduct of one franchisee in the network can draw negative media attention and potentially tarnish the reputation of the whole franchise system.

Although ultimately it is the responsibility of the franchisee to comply with their legal obligations, franchisors should consider providing franchisees with resources and establishing processes to encourage compliance.

For example, franchisors could consider running training sessions for franchisees, carrying out certain regulatory audits of the franchise network, establishing advice industrial relations hotlines or a panel of independent advisers which franchisees may wish to engage or enterprise agreements for the franchise network.

Following on from 7-Eleven there are likely to be changes to industrial relations laws. 

The Fair Work Act 2009 (Cth) (FWA) currently provides that a franchisor can be liable and penalised as an accessory for the failure of its franchisees to comply with the FWA if the franchisor has been “knowingly involved in” a contravention by a franchisee.

On 19 May 2016, the Coalition launched its Policy to Protect Vulnerable Workers pledging to introduce a number of reforms to Australia’s workplace relations framework.

The reforms would see a number of amendments to the FWA and additional funding to Australia’s workplace relations watchdog, the Fair Work Ombudsman.

Reforms proposed in the Policy include:

• the introduction of higher penalties for ‘serious contraventions’. This would see employers who deliberately and systematically underpay workers and fail to keep proper records risk fines of up to 10 times the maximum penalties currently provided for in the Act ($10,800 for individuals and $54,000 for bodies corporate).

• the introduction of new offence provisions holding franchisors and parent companies liable for breaches of the Act by their franchisees or subsidiaries in circumstances where they should have been reasonably aware of the breaches and could reasonably have taken action to prevent them from occurring.

For franchisors and parent companies alike, now is the time to implement systems and processes to ensure franchisees and/or subsidiaries are compliant with minimum workplace entitlements to minimise the risk of exposure to bad press and civil penalty should the proposed reforms be introduced.

2. Unfair Contracts Laws

Currently, the Australian Consumer Law contains provisions which protect individual consumers from unfair contract terms in a standard form contracts. The new laws extending these protections to small businesses, which will come into force around November 2016, acknowledge that small businesses, like individual consumers, are vulnerable to unfair terms in standard form contracts and will give courts the ability to declare terms contained in standard form contracts between businesses void, if they are deemed unfair.

These new laws will extend to unfair terms in franchise agreements if the following requirements are met.

• the contract is a standard form;
• the contract is a small business contract; and
• the term in the contract is unfair.

There are tests to be applied to determine whether each of the above elements exists. For example, a contract will be a small business contract if:

• at the time of entering the contract, at least one party to the franchise agreement is a business which employs fewer than 20 people; and
• either the upfront price payable under the contract is less than $300,000 or the contract has a duration of more than 12 months and the upfront price payable under the contract does not exceed $1,000,000.

It is likely that the majority of franchise agreements entered into after the laws take effect will be considered standard form small business contracts. Whether or not the terms of a contract are unfair will depend on the particular circumstances of each contract.

The new unfair contracts regime will see franchisors reviewing their franchise agreements to ensure that vital terms of the franchise agreement are not at risk of being deemed unfair.