If there was any doubt whether – since last year's successful case against UltraTune – the Australian Competition and Consumer Commission (ACCC) was still focussed on addressing the misuse of franchise marketing funds, proceedings recently commenced by the ACCC against Retail Food Group (RFG) should dispel those doubts. The proceedings should also satisfy some commentators who criticised the ACCC for failing to take action against RFG, particularly after the scathing findings of the Parliamentary Joint Committee in its Fairness in Franchising inquiry, which identified a disconnect between disclosure requirements and industry practice for marketing funds. With the recent franchisee action against Hog’s Breath also considered, we call ‘times up’ on franchisors dragging the chain on strong marketing fund compliance practices.

The ACCC's allegations

Under the Franchising Code of Conduct (Code), franchisors must provide disclosure documents to prospective franchisees. The purpose of a disclosure document is to give a prospective franchisee information to help them make a reasonably informed decision about purchasing a franchise. For marketing funds, this means franchisors must explain who the funds are collected from and provide meaningful information on how they may spend those funds. With some exceptions, the Code also requires franchisors each year to provide franchisees with an audited financial statement as to fund expenditure, that provides franchisees with 'sufficient detail' to assist franchisees in understanding how the franchisor has used their marketing funds and if they used them appropriately.

Amongst other concerns as to RFG's financial disclosure to prospective franchisees, the ACCC is alleging that RFG:

• misappropriated money from its marketing fund in several ways, including $22 million used to cover the cost of implementing the infamous switch from fresh cakes to frozen and losses in company stores
• used its marketing fund for expenses that could not properly be characterised as marketing expenses (such as wages of RFG executives and employees that did not work in those areas) and for costs other than the administration or audit of the fund
• failed to disclose the above conduct to its franchisees and adopted such a ‘high level of generality’ in its annual statements, that they did not give franchisees meaningful information about expenditure from the fund.

Our observations on the allegations

As we observed in our earlier Hog's Breath update, it is not uncommon for franchisors to pay from the marketing fund for the salary and administration costs of marketing and business development personnel. Franchisors can commercially justify these expenses as necessary to retain qualified staff with knowledge of the brand, its services and/or products and its customers. Frequently, keeping marketing work ‘in-house’ can also deliver efficiencies and cost savings, as it can be cheaper than hiring an external agency. However, problems can arise when the franchisor uses the marketing fund to pay for the costs of staff that don't contribute to marketing and business development, where the the costs allocation to the fund is disproportionate to the benefit received, or where the franchisor does not provide complete and transparent disclosure of these practices.

Another concern with marketing funds is that franchisors may be tempted to use the money in them to offset large or unexpected costs or even losses. Franchisors can justify this expenditure if it falls within what it has disclosed to its franchisees and is permitted under the terms of their franchise agreements. Too frequently, however, the precise boundaries of permitted and disclosed expenditure is vague and poorly defined. The risk is that franchisors exploit these ‘grey areas’ to justify spending on matters wholly unrelated to marketing or business development. The problem is compounded when the franchisor then attempts to hide this expenditure with vague and opaque information in annual audit statements.

If the ACCC proves its allegations against RFG, then it would appear that RFG has failed to meet its disclosure obligations under the Code, breached its franchise agreements and acted dishonestly and in bad faith in its management and administration of the fund. Given the trust placed by franchisees in RFG when paying marketing fund contributions and the power and information imbalance that exists in this relationship, in our view, it is not too big a step for the Court to find that this conduct was unconscionable.

What next for franchisors?

Since the publication of the Fairness in Franchising report, the ACCC has provided detailed guidance outlining its expectations concerning proper marketing fund disclosure, management and administration. To ensure compliance with the Code and avoid the heavy penalties for breach, franchisors should be actively reviewing:

• their disclosure documents to ensure that the Code requirements are being met (particularly given the clear signal sent by the Court in the Ultra Tune decision)
• the nature and extent of different types of expenditure from their marketing funds to ensure that they align with their disclosure document and franchise agreement
• their annual financial statements provide meaningful financial and other information concerning the different types of expenditure from the marketing fund.