The Supreme Court of New South Wales has recently held that 7-Eleven was lawfully entitled to terminate a franchisee for fraud in circumstances where the franchisee had been exploiting its workers through an illegal cash-back arrangement. This is a momentous case, as it is the first significant Court decision to confirm that certain types of worker exploitation can constitute fraudulent conduct under the Franchising Code of Conduct which (for most systems) will permit them to immediately terminate the agreements of fraudulent franchisees.

Background

Chahal Group Pty Limited (Chahal) operated a 7-Eleven convenience store at McGraths Hill in New South Wales (Store) under a franchise agreement with 7-Eleven. Mr Chaudry was the sole director of Chalal and was responsible for hiring two employees, namely Mr Ali and Mr Yasa, to work at the Store. The Court heard evidence that Mr Chaudry implemented an arrangement whereby Mr Ali and Mr Yasa:

• were paid the relevant award rates into their bank accounts (as shown on their pay slips)
• were required to withdraw a specified amount of their pay from their account each week to return to Mr Chaudhry
• did so by depositing cash (attached to a paper slip stating their name) into the manual safe drop at the Store.

As a result, Mr Ali was paid only $15 per hour and Mr Yasa was paid only $12 per hour. Mr Yasa gave evidence that Mr Chaudry told him that if he paid him the award rate, the Store would not make any profit. Both men gave evidence that they felt they could not refuse Mr Chaudry’s demands as they wanted and/or needed employment and were fearful of Mr Chaudhry.

Following an investigation, 7-Eleven terminated the franchise agreement on the basis that, in implementing the cash-back arrangement, Chalal had engaged in fraudulent behaviour. Chalal commenced proceedings against 7-Eleven seeking a number of court ordered remedies, including: declarations that the termination notice was invalid, specific performance of the franchise agreement and damages. Chalal’s key argument was that the employees lied about the cash back arrangement out of a desire to have access to compensation under 7-Eleven’s publicly announced compensation package.

Fraudulent behaviour

The Court preferred Mr Ali’s and Mr Yasa’s evidence over that of Mr Chaudry, finding that the franchisee had engaged in fraudulent behaviour and that 7-Eleven had validly terminated the franchise agreement. While not undertaking a detailed analysis of the conduct or the different elements of the legal definition of ‘fraud’, the Court was satisfied that the scheme was fraudulent. The Court's finding was based on Mr Chaudry's actions in:

• deliberately made illegal demands of the employees for the secretive payment of monies to which Mr Chaudry was not lawfully entitled
• was receiving cash back that the Court found he was not going to declare to the ATO.

The Court noted that there was no direct evidence as to whether the practice existed more widely than in respect of these two employees. However, for the purposes of this case, the Court found that the findings made in respect of only the two employees were sufficient to find that 7-Eleven’s termination of the franchise agreement was valid.

Remedies

While the Court was not required to make orders regarding the remedies the franchisee sought, it made a number of comments about the appropriateness of an order for specific performance in circumstances such as those that existed in this case. The Court noted that, if specific performance had been available (which clearly it was not), then such an order would not be appropriate as:

• the franchisor/franchisee relationship self-evidently is based on trust and confidence
• the ongoing fulfilment on both sides of a franchise agreement involves cooperation
• this litigation, the allegations made and the manner in which both sides conducted themselves showed that there was a complete breakdown of whatever trust and confidence the parties may once have had in each other
• any co-operation between the parties could not possibly continue
• accordingly, specific performance was inappropriate as it would join the parties together in a continuing hostile relationship.

Conclusion

The case is significant as it shows that the deliberate, illegal and secretive underpayment of employees can amount to fraudulent conduct, entitling a franchisor to terminate a franchise agreement (where the franchise agreement permits termination on this basis). Importantly, the Court was satisfied that conduct in respect of only two employees was sufficient to make that finding, and that it was unnecessary for 7-Eleven to show that the conduct was more widespread within the franchisee’s business. This decision should give franchisors some comfort that, in circumstances such as these, they are not required to prove widespread fraudulent conduct in order to validly terminate a franchise agreement.