At some time during the life of a franchise system, you may suspect that one of your franchisees is acting dishonestly or fraudulently in the operation of its franchise business and you decide that you want to end the relationship.
It is a difficult situation, because making an allegation against someone that they are acting fraudulently is a very serious accusation. As a consequence there is a high burden of proof required. An allegation of fraud can have significant ramifications for the person concerned as well as their business and the entire network, particularly where the alleged fraud may involve customers, staff or third parties such as landlords, suppliers or government.
It is well accepted that fraud involves a deliberate dishonest intent and purpose. It is important to remember that just because a franchisee may breach the law, it does not necessarily mean that they are acting fraudulently giving rise to an immediate right to terminate.
DO I HAVE A LEGAL RIGHT TO TERMINATE IMMEDIATELY FOR FRAUD?
The right for a franchisor to terminate for fraudulent acts by a franchisee is a contractual right that arises under the terms of the franchise agreement and it is not a statutory right embodied in the Franchising Code of Conduct.
Clause 23 of the Code simply provides that a franchisor does not have to follow the procedure in Clause 21 of the Code (a breach notice procedure) if the franchisee is “fraudulent in connection with the operation of the franchised business”. This appears to limit the fraudulent conduct to matters involved in operating the franchised business, rather than other fraudulent acts perpetrated on third parties unconnected with the business.
The effect of the Code is to allow a franchisor, with evidence of fraud, to act quickly and not have to wait to terminate until after it follows the breach notice procedure in clause 21 by giving the franchisee a breach notice and an opportunity to remedy. It reflects the fact that fraud (and other special circumstance events listed in clause 23 of the Code) may destroy the fabric of trust that exists in a franchise relationship and as a consequence a franchisor may not want to continue in its relationship with a fraudulent franchisee.
If you believe a franchisee has acted fraudulently you need to carefully read your franchise agreement and seek advice whether the conduct in question reaches the relevant contractual threshold to allow you to immediately terminate. Alternatively you may have to follow the breach notice procedure in clause 21 before you can terminate.
If the proper process of termination is not followed by either party, then that conduct may:
- amount to a repudiation of the franchise agreement by the party that is wrongly purporting to terminate, this can allow the innocent party to accept that repudiation and terminate the agreement itself; or
- result in the notice (and therefore the termination) being challenged as being unenforceable or defective and therefore unlawful (including on the basis that it does not follow the correct procedure in the Code).
It is important to remember that the unconscionable conduct provisions in the Australian Consumer Law (ACL) will apply to any termination and that despite having a contractual right to do so, in exercising that right in all the circumstances a franchisor should still not act unconscionably.
WHAT AMOUNTS TO FRAUD?
Fraud involves deliberate intentional deceitful behaviour usually associated with some financial advantage or other benefit being obtained by a person perpetrating the fraud to the detriment of another. Whilst an act of fraud can occur once, when it occurs it is usually more likely to be systemic and occur on more than one occasion even though the conduct may not be exactly the same. This may demonstrate a deliberate premeditated and persistent pattern of behaviour that evidences the dishonest intent.
A franchisor is not obliged under the Code to wait until the franchisee is charged with or convicted of fraud by authorities before acting, however it may also be prudent for a franchisor to consider making an official complaint about the conduct to the police to enable them to investigate that conduct and take action.
CONCLUSION
Proving fraud against a franchisee is notoriously difficult because the onus of proving the fraud rests with the person making the allegation.
You must have at the time you intend to terminate the agreement sufficient evidence to conclusively determine that the conduct is actually fraudulent and not simply a breach of contract; the latter would specifically require the issue of a notice of breach. If it was an express breach then the process in the franchise agreement and clause 21 of the Code would need to be followed before any termination of the agreement occurred for non-remedy.
Seeking to terminate on the basis of fraud is not without risk for franchisors and unless there is sufficient evidence of fraudulent behaviour, a franchisor could face claims of repudiation and unlawful termination where a franchisee’s agreement is terminated improperly.
Ultimately the issue of evidence is extremely important and where there is insufficient evidence to establish fraud then it is extremely risky to terminate solely on that basis. A safer alternative may be to take the time to gather more suitable evidence or issue a dispute notice to the franchisee and seek a mediated outcome .
Laura Young and Derek Sutherland, below
HWL Ebsworth’s Retail & Franchising team comprises a select group of retail leasing, franchising, general commercial and competition specialists in offices throughout Australia (Melbourne, Sydney, Norwest, Canberra, Brisbane and Perth). For further information on the authors of this article or the HWL Ebsworth Retail & Franchising team (including key contacts for each state), please go to http://www.hwle.com.au/expertise/retail-and-franchising.html.