Australian case finds franchisor liable for franchisee employees

August 21, 2024

Key Points

• Australia's franchise law regime includes provisions in the federal employment law, the Fair Work Act 2009 (Cth) (FW Act) which provide that, in some circumstances, a franchisor may be responsible for contraventions of the FW Act by its franchisees.

• A new Federal Court of Australia case decided in June 2024, Fair Work Ombudsman v 85 Degrees Coffee Australia Pty Ltd [2024] FCA 576 (the 85 Degreescase), ordered the franchisor, 85 Degrees, to pay AUD$1.44 million (around USD$970K) in civil penalties relating to the franchisees of 85 Degrees contravening the FW Act in the franchisee dealings with their own franchisee employees.

• The penalties are the third highest ever secured by the Fair Work Ombudsman (FWO) and the case marks the first time FWO has used the "responsible franchisor entity" provisions to hold a franchisor accountable for its franchisees' actions.

Background

Australia's vicarious liability law which impacts franchisors

• Vicarious liability of the franchisor: Australia's federal law, called the Fair Work Act 2009 (Cth) (the FW Act) imposes liability under section 558B on any "responsible franchisor entities and holding companies" for certain contraventions of the FW Act by its franchisees if:
  • an employer who is a franchisee entity contravenes certain civil remedy provisions of the FW Act; and
  • the contravention by the franchisee entity occurs in the franchisee entity's capacity as a franchisee entity; and
  • the responsible franchisor entity or one of its officers "knew or could reasonably be expected to have known" that the contravention by the franchisee entity or its subsidiary (the contravening franchisee employer) of the same or would occur or a contravention of the "same or a similar character" was "likely to occur".
• Franchisor holding companies also caught: Section 558B also provides that holding companies of the responsible franchisor entity are equally liable in some circumstances.

Defences available to franchisors

• A defence applies however where the responsible franchisor entity or the holding company takes "reasonable steps" to prevent contraventions of that character by the contravening franchisee employer.
• Section 558B provides a non-exhaustive list of matters that a court may take into account in determining whether the responsible franchisor entity or its holding company took "reasonable steps" to prevent the contravention by the contravening franchisee employer of the same or a similar character:

  • the size and resources of the franchise;

  • the extent of influence or control of the franchisor;

  • actions taken to ensure that the contravening franchisee employer had a reasonable knowledge and understanding of the FW Act requirements;

  • arrangements (if any) for assessing the contravening franchisee employer's compliance;

  • arrangements (if any) for receiving and addressing possible complaints about alleged underpayments or other alleged contraventions; and

  • the extent to which arrangements encouraged or required compliance by the contravening franchisee employer.

The 85 Degrees case

• The background to the 85 Degrees case started ten years ago when the FWO began investigations into the business, and found contraventions of applicable employment pay awards and the FW Act.
• 85 Degrees operated a franchise of coffee shops.
• In 2015, the FWO notified 85 Degrees of the contraventions leading 85 Degrees to undertake audits, which uncovered further contraventions.
• FWO undertook subsequent investigations, identifying violations in the period of 1 July 2016 to 26 June 2017 and brought proceedings, resulting in a AUD$475,200 penalty against 85 Degrees in 2022.
• In 2019, the FWO initiated separate proceedings against eight 85 Degrees franchisees. It found multiple violations of the applicable employment pay awards, such as non-compliance with minimum wage requirements, overtime pay and record-keeping obligations.
• The 85 Degrees case was one however where 85 Degrees admitted:

  • liability under the "responsible franchisor" provisions of the FW Act, acknowledging that it had the requisite knowledge of the contraventions by its franchisees; and

  • it could reasonably be expected to have known that the 2019 responsible franchisor contraventions would occur and that contraventions of the same or a similar character were likely to occur; and

  • it actually knew that contraventions of the same or a similar character were likely to occur because of correspondence from the FWO setting out preliminary conclusions to that effect sent and received on that date;

  • that, despite that actual knowledge, acquired roughly a quarter of the way through the contravening period, it did not take reasonable steps to prevent those contraventions from occurring; and

did not dispute the FWO's assertion that the facts demonstrate a systematic failure to ensure compliance within its franchise network.

• The Court also noted that the major point of distinction between this case and the earlier proceedings involving 85 Degrees, apart from prior direct liability of 85 Degrees as an employer, and later extended liability as a responsible franchisor for its franchisee contraventions, is that the overall underpayments by the franchisees of 85 Degrees in these later proceedings were much less and those subsequent underpayments had all been rectified by the franchisees.

The extent of franchisor influence or control over franchisees - and why the defence was not available

• The Court in the 85 Degrees case did comment on the nature of the franchise arrangements and whether the operation of the franchises was tightly controlled by 85 Degrees.
• It noted that, under the contractual arrangements with franchisees, 85 Degrees had the ready means of ascertaining what was happening and taking reasonable steps to prevent the contraventions from occurring and so, if that had been done, it would have made available a defence to that effect provided by section 558B(7) of the FW Act.
• The Court noted specifically that the failure of 85 Degrees to do so meant that defence was not able to be relied upon - noting that the "responsible franchisor" must have "a significant degree of influence or control over the franchisee entity's affairs" (under section 558A(2)(b) of the FW Act) - meaning that section 558B will more easily apply to such arrangements.
• In the 85 Degrees case, 85 Degrees merely issued two letters to its franchisees after the FWO investigation commenced - reminding them to comply with their workplace obligations - but without setting out the nature of those obligations or how they may comply. The Court commented that the features of the franchise arrangements which cemented the finding that 85 Degrees was a responsible franchisor, were features found in most franchise systems, being:

  • System: 85 Degrees required operation of franchises in accordance with the 85 Degrees "System", being a method of promoting and selling 85 Degrees products in their stores; and

  • Operations Manual: to ensure compliance with the System, 85 Degrees created, and required compliance with, a detailed operations manual, specifying, among other things, minimum performance standards for franchisees and procedures for how stores were to be managed; and

  • Training: 85 Degrees required and provided training to franchisees' store managers and other staff; and

  • Product control: franchisees were required to sell products they purchased from 85 Degrees, which it manufactured at its central kitchen, at prices specified by 85 Degrees; and

  • Equipment control: franchisees were required to use equipment, and point of sale and security systems, as stipulated by 85 Degrees; and

  • Audit: 85 Degrees had a right to inspect and audit the franchisees' records, and a right to conduct "mystery customer" checks on franchisee locations.

  • Lease control: The Court also noted that, in addition to its control under the contractual arrangements, 85 Degrees leased store locations to three of its franchisees - and so 85 Degrees had an "unusual level of familiarity with the detail of the operations of its franchisees" as it had previously directly operated the 85 Degrees retail business, including two of the store locations later transferred to franchisees. Specifically, the Court commented that the 85 Degrees "System" used by franchisees was based on the way in which 85 Degrees had directly operated its stores prior to the transfer to the franchise model.

• The Court noted that, the nature of these franchise arrangements together with the prior history of contraventions, was why 85 Degrees could not have established the defence in section 558B(3) of the FW Act and that it was "always likely" that it would be liable for contraventions by its franchisees that were able to be proven by the FWO, including in particular whether 85 Degrees had the states of mind set out about its knowledge or likely knowledge as required in section 558B(1)(d) of the FW Act.

The result - penalties of AUD$1.44 million

• In July 2022, 85 Degrees effectively ceased business in Australia after its ultimate holding company, Gourmet Master Co Ltd, decided to wind up the 85 Degrees' business progressively by either waiting for franchise agreements to expire or by terminating them.
• The Court thought that, in these circumstances, specific deterrence was not a major consideration in ascertaining the appropriate penalty - especially as the franchisor stayed registered in Australia to face and meet the consequences of the contraventions - which the Court considered was conduct that deserved credit, ameliorating substantially the need for specific deterrence.
• The Court noted that the risk of future contraventions by 85 Degrees was slight to non-existent, however the risk of future contraventions by similar participants in the same industry was high, as is the risk in franchise arrangements in many other industries sharing similar characteristics, especially in relation to a vulnerable workforce.
• The Court considered that this was demonstrated by:

  • the repeated contravening conduct by 85 Degrees itself and later in failing to take reasonable steps to prevent its franchisees doing more of the same; and

  • the exposé of systemic non-compliance by franchisees, particularly in the food retail industry and particularly affecting vulnerable workers - which was the background to the package of reforms that introduced franchisor liability in the amending legislation;¹ and

  • a report tendered by the FWO (and unchallenged by 85 Degrees) which highlighted the scale of non-compliance by franchises in the food retail sector and the ongoing need for general deterrence.²

• The Court, in assessing the size of the penalty, also took into consideration 85 Degrees' history and pattern of contraventions (first contravening as an employer, entering into an enforceable undertaking to desist, contravening further as an employer, and then with a change to a franchise model, failing to prevent its franchisees replicating substantially the same conduct) and the fact that 85 Degrees did not ultimately find a way of achieving compliance by its franchisees, but "rather gave up and has not really tried to do so at all".
• The fact that 85 Degrees had actual knowledge of the contraventions throughout three-quarters of the contravening period was noted by the Court as requiring a strong deterrent response, despite the cooperation of 85 Degrees with the FWO in admitting to the contraventions.
• The Court ordered payment of AUD$1.44 million in penalties (around USD$970K) - the third highest ever secured by the FWO and the FWO's first successful use of section 558B of the FW Act provisions which extend liability for contraventions by franchisees to their responsible franchisor.

Implications and actions that franchisors need to take

The case is a warning for franchisors who should specifically take the following actions.

• Consider the degree of control over franchisee operations - and how that control may be exercised to ensure that franchisees comply with legal obligations to their personnel under the FW Act.
• Be aware that merely informing franchisees of their obligations is unlikely to be sufficient of itself to evidence "reasonable steps" have been taken to prevent the contraventions by franchisee employers.
• Update and implement training and guidance to franchisees on their FW Act obligations and keep records of this activity.
• Put in place systems for monitoring franchisee FW Act compliance including reporting procedures, audits and supporting policies and processes).
• Act on FW Act breaches that are identified and ensure that they are addressed.

Franchisors and franchisees should be aware also that pecuniary penalties for staff underpayments or breaches of other workplace protections (such as record-keeping) have increased significantly, and will increase significantly again in 2025.

In February 2024, applicable penalties were raised fivefold (to AUD$93,900 as of June 2024) and, for serious contraventions (from AUD$187,800 to AUD$939,000).

In addition, effective 1 January 2025, a court will be able to impose a penalty of the greater of these amounts or three times the value of the underpayment.

The recent federal budget has allocated the FWO additional funding of AUD$28 million over the next four years to pursue underpayments by large corporate employers specifically.

The franchise sector can expect to be targeted by the FWO as a result.

We recommend that franchisors also review and update their franchisee compliance arrangements to ensure they have the necessary mechanisms to ensure franchisee compliance and detect franchisee non-compliance and to minimise the risk of being held liable for franchisee contraventions of the FW Act.

Dentons can assist franchisors, their holding companies and franchisees to comply with workplace laws.

Please contact, Robyn Chatwood, Partner and Franchising Practice Group Lead, Paul O'Halloran, Partner and Edmund Burke, Partner in the Employment and Safety team or your usual franchising or employment contact in Dentons for further information.

1. Explanatory Memorandum, Fair Work Amendment (Protecting Vulnerable Workers) Bill 2017 (Cth) at [37] citing Senate Education and Employment References Committee, Parliament of Australia, A National Disgrace: The Exploitation of Temporary Work Visa Holder (Report, March 2016). The Bill's Explanatory Memorandum makes specific mention of systemic underpayments by franchisees, largely affecting international student workers, as an impetus for its reforms: Explanatory Memorandum at (i), citing A National Disgrace; FWO, Report of the Fair Work Ombudsman's Inquiry into 7-Eleven (April 2016).
2. FWO, Emerging franchises compliance activity (Report, December 2019). FWO Report). The Court mentioned that from 2011 to 2015, the FWO investigated seven emerging franchisor businesses in the fast food, restaurant and café sector, including 76 franchisee businesses. Those investigations found that 78% of businesses were non-compliant with employment obligations and stated that, "Reflecting to an extent the case at hand, the most common forms of contraventions related to issuing of pay slips (24% of franchisee businesses), payment of penalty rates (20%) and payment of minimum hourly rates (16%). It is in this context that the FWO identified, as of 2019, compliance in franchise networks as a strategic priority in 2019. In those circumstances, the Fair Work Act's regulatory objectives can be supported significantly by deterrent penalties, thereby further advancing the objective of deterrence with which the Court is required to be primarily concerned following Pattinson."