The current Franchising Code came into effect on 1 January 2015. The first case involving a penalty for breaching the current Code was decided on 10 November 2017. The case is known as ACCC v Morild Pty Ltd  FCA 1308.
This case is a useful guide to the penalties that may be imposed for breaching the Code, and the issues that the Courts will consider when deciding what the penalty should be.
The case involved the “Pastacup” franchise system, which operates a chain of pasta restaurants in Western Australia and New South Wales. Morild Pty Ltd is the current franchisor. Stuart Bernstein co-founded the Pastacup franchise in 2008 and remains involved in the promotion and management of the franchise.
Mr Bernstein was previously a director of two other companies (SSP Holdings and Pastacup Australia) which acted as franchisors for the Pastacup franchise. Those companies both ended up insolvent.
A Disclosure Statement provided to potential franchisors in 2014 did not disclose that Mr Bernstein had been a director of those other companies, or that those companies had become insolvent while acting as franchisors for Pastacup. The Disclosure Statement was amended in 2016 to state that the two previous franchisors were associates of Morild Pty Ltd and that they were externally administered companies, but the updated Statement failed to disclose Mr Bernstein’s role in those companies, and failed to disclose that the companies had become insolvent while acting as franchisors for the franchise.
The first franchisor, SSP Holdings, entered into a creditor’s voluntary winding up in December 2013 after a general meeting resolved that it could not meet its debts as and when they fell due. SSP Holdings was reported as owing $1,667,238 to its unsecured creditors when it went into liquidation.
Pastacup Australia took over as franchisor but it was wound up in insolvency after an application made by the Deputy Commissioner of Taxation in July 2014. The administrator’s initial report estimated that Pastacup Australia owed $2,006,176 to its unsecured creditors. This estimate was later revised to $2,430,441.
The administrator’s report stated that Pastacup Australia had failed due to a lack of financial management, the failure of several franchised stores, poor record keeping, poor cash flow and trading losses and insufficient capital to provide for the initial set up costs.
The Court found that the failure by Morild and Mr Bernstein to disclose such matters meant that prospective franchisees lost, at least, the opportunity to make a fully informed decision as to whether to commit significant time, money and resources to a Pastacup franchise. The Court also noted that if the franchisor became insolvent, franchisees would lose the right to use the Pastacup intellectual property, which would cause them loss.
Morild and Mr Bernstein admitted that they had breached the Code.
The Court ordered that Morild and Mr Bernstein must include relevant information regarding the previously franchisors and Mr Bernstein’s involvement in those companies in future disclosure statements. This requirement will continue until December 2023 for information about SSP Holdings, and until October 2024 for information about Pastacup Australia.
As this was the first decision about penalties under the current Franchising Code, the Court set out the various arguments about penalties and it’s reasoning in detail, in the hope that this would avoid the need for parties to “reinvent the wheel” in any future cases.
The relevant considerations included:
- The whole course of conduct
- The nature and extent of:
- the act or omission
- any loss or damage caused and
- impact on the market and innocent third parties
- Circumstances in which the act or omission took place
- Any previous contraventions or similar conduct
- Involvement of senior management and whether the conduct was deliberate
- Whether the conduct comprised isolated conduct or occurred over a period of time
- Corporate culture
- Size and financial position of the respondents,
- The deterrent effect of the penalty
- Whether the respondent company has improved or modified its compliance systems since the contraventions
- Whether the respondents have cooperated with the ACCC
The Court also ordered Morild to pay a fine of $100,000 and Mr Bernstein to pay a fine of $50,000, and ordered them to pay costs of $12,000 to the ACCC.
Every case is different so it will always be difficult to to predict the amount the likely penalty. If you are concerned that there may have been a breach of the Code’s requirements, it would be best to seek legal advice immediately.