Operating a marketing fund – Things you need to know

Franchisors who operate a marketing or cooperative fund must comply with the obligations under the Franchising Code of Conduct (Code) which relate to administration, financial reporting and auditing of the financial statements for those funds. These obligations are strict and time is of the essence for compliance purposes. This article will focus on marketing funds as they are more common than cooperative funds.

The Code requires all franchisors to update their Disclosure Document (DD) within 4 months of the end of each financial year. The Code defines a ‘financial year’ to be the 12 month period in respect of which financial statements relating to the franchise are prepared for the franchisor (FY). The majority of franchisors in Australia operate a FY ending on 30 June and  they will need to update their DD before 31 October 2019 which includes specific marketing fund obligations as outlined below.

This article discusses Marketing Fund obligations and DD requirements under the Code, explores recent learnings and suggests proactive steps flowing from the “Ultra Tune” case¹. It also considers some recommendations in the “Fairness in Franchising” Report² (Report) relevant to marketing funds.

Marketing and Disclosure Document update requirements (assuming 30 June FY)

If you operate a marketing fund you will need to:

1. Within 4 months after the end of the last FY, prepare an annual financial statement (AFS) detailing all of the fund’s receipts and expenses for the last FY;
2. Ensure that the AFS includes sufficient detail of the fund’s receipts and expenses so as to give meaningful information about:
   • sources of income; and
   • items of expenditure, particularly with respect to advertising and marketing expenditure.
3. Have the AFS audited by a registered company auditor by no later than 31 October (unless the applicable exemption dealt with below applies); and
4. Give to each of your franchisees who are required to contribute to the fund a copy of the:
   • AFS, within 30 days of preparing the statement; and
   • a copy of the auditor’s report, within 30 days of preparing the report (if the audit report is required).

As both the AFS and the audit of the AFS must be prepared at the latest by 31 October 2019, you must provide the AFS and the audit of the AFS to your franchisees within 30 days of their preparation which means the entire process must be completed by no later than 30 November 2019. Therefore careful diligence must be observed about actual preparation dates to avoid non-compliance. In the Ultra Tune case the Court found that Ultra Tune overlooked the requirement to actually provide each franchisee with the AFS and auditors report on an annual basis.

Exemption to have AFS audited

A franchisor will not have to comply with its obligation to have the AFS of the fund audited if:

1. 75% of its franchisees in Australia, who contribute to the fund, have voted to agree that the franchisor does not have to comply with its obligation to have the AFS audited for that FY; and
2. The above agreement is made within 3 months after the end of the FY, that is by 30 September 2019.

Franchisors must keep proper records of any vote which is taken as this is a record the ACCC may request to validate that a proper vote was taken and that at least 75% voted in favour of not having the AFS audited. The voting process should be transparent.

Additional obligation re marketing funds

For completeness, the Code also provides that for each marketing or other cooperative fund, controlled or administered by or for the franchisor, to which franchisees may be required to contribute, the DD needs to include the following details:

1. The kinds of persons who contribute to the fund (for example, franchisee, franchisor, outside supplier);
2. How much the franchisee must contribute to the fund and whether other franchisees must contribute at a different rate;
3. Who controls or administers the fund;
4. Whether the fund is audited and, if so, by whom and when;
5. How the fund’s financial statements can be inspected by franchisees;
6. The kinds of expense for which the fund may be used;
7. The fund’s expenses for the last financial year, including the percentage spent on production, advertising, administration and other stated expenses;
8. Whether the franchisor or its associates supply goods or services for which the fund pays and, if so, details of the goods or services; and
9. Whether the franchisor must spend part of the fund on marketing, advertising or promoting the franchisee’s business.

The details of the expenses, including a percentage spent on production, advertising, administration and other state expenses is presented differently to the AFS and requires a grouping of expenses under those headings in the item in the DD. Usually that item cannot be completed until the AFS has been prepared.

It is extremely important to ensure that if a franchisor intends to charge the marketing fund for goods or services they provide then the basis of the charge should be clearly set out for transparency. Whilst the reasonable costs of administration and audit of the fund can be paid from the fund, clause 31 of the Code prohibits a franchisor from using the marketing fund to pay for expenses unless they have either been disclosed in the DD, they are legitimate marketing or advertising expenses or the majority of franchisees have agreed to them. In some cases a vote to approve an expense may be required if it has not been disclosed or is not a legitimate marketing or advertising expense.

Compliance tips, including learnings flowing from the “Ultra Tune” case

At the beginning of the year, the Federal Court handed down a decision about an Ultra Tune prospective franchisee. The case had been brought by the ACCC against Ultra Tune. The case amongst other things, sheds some light on the marketing fund obligations under the Code. We have summarised below some compliance tips to assist franchisors and their accountants meet their Code obligations.

1. An AFS needs to include significantly greater detail than what most franchisors have produced in the past – for example a simple profit and loss statement, or balance sheet will not suffice. The larger the marketing expense, the greater level of detail will be expected in the AFS and where in doubt, an AFS should ‘err on the side of candour, rather than secrecy‘. In practice we suggest this means that detailed notes or attached documents should form part of the AFS to itemise and explain an expense item, including where money has been spent in multiple geographical regions within a network;
2. An AFS must be able to be read and understood in isolation. Communications with franchisees, such as in-house newsletters, cannot be relied upon at a later time to help explain an expense item within the AFS. Therefore the AFS must have sufficient notes or supporting documentation to validate an expense item;
3. The deadlines stated under the Code are not negotiable. To ensure franchisors meet their 31 October (and 30 November deadlines above), franchisors should start preparing their AFS as soon as possible. They should commence to instruct any external accountants well prior to October to ensure accountants and auditors have sufficient time to prepare proper financial documentation and reports;
4. Significant fines can be imposed for any breach of the Code with respect to marketing funds. For example, failing to provide the AFS within the requisite time will constitute a separate breach for each franchisee where the AFS was not provided. The larger the franchise system the more substantial the potential fine, as was the case for Ultra Tune;
5. Non-compliance risk significantly increases if a franchisor chooses to maintain multiple disclosure documents, or run multiple (or separate) marketing funds, as was the case for Ultra Tune. We would recommend against multiple funds given the heightened compliance risk if that can be avoided;
6. Keeping full and proper records is critical and essential to demonstrate to the ACCC (and possibly a Court) that a franchisor has complied with its ongoing Code obligations and that claimed or incurred expenses which are in fact legitimate ‘marketing or advertising’ expenses; and
7. Where a franchisor is taking money from a marketing fund relating to marketing costs incurred by a related franchisor company or for internal staff costs of marketing people, then a franchisor should be able to demonstrate that such expense is fair and reasonable and the basis of calculation has been disclosed properly.

Recommendations in the Report

The Government is currently considering whether and how to potentially implement various recommendations contained in the Report. Among its 71 recommendations, the Report included recommendations regarding marketing funds and additional disclosure obligations. These will remain “recommendations” until the Government decides whether some or all to the recommendations should be implemented via new legislation. However it is clear from some submissions to the Inquiry and the subsequent recommendations, that transparency of marketing funds is paramount and current practices are not considered adequate.

Relevant to marketing funds, the Report recommends that:

1. “Actual” financial statements for the marketing fund be provided to franchisees within 30 days of the end of each quarter, rather than yearly. The recommendation as currently drafted does not require that audited financial statements be provided quarterly;
2. An AFS must have “sufficient” detail to be specified in the Code and by the Australian Accounting Standards Board (AASB) (R6.9). The Report does not specify what constitutes “sufficient detail” but the Ultra Tune case demonstrates what is not acceptable;
3. The AASB prepare and issue an audit guidance statement and Chart of Accounts for marketing or cooperative funds (R6.11);
4. Clauses 15 and 31 of the Code be amended to provide that both clauses apply where a franchisee is required to make regular payments to the franchisor to cover advertising and marketing activities;
5. Clause 31 of the Code (marketing and advertising fees) is amended to include civil penalties for a breach of this provision of the Code;
6. Master franchisors be required to comply with clauses 15 (copy of financial statements) and 31 (marketing and advertising fees) where a sub franchisee directly or indirectly contributes to a marketing fund controlled by master franchisor (R6.10); and
7. The Government clarifies how “unused funds” should be distributed when a franchisor is wound up (R6.12).

What to do now?

In our experience most franchisors are diligent and reasonably transparent with respect to marketing funds and expenditure from a marketing fund so there should be no cause for panic. However, franchisors must accept that transparency, strict compliance with the Code and proper record keeping is non-negotiable.

Being ‘a few days late’ or ‘forgetting’ your compliance obligations is not a defence. Likewise, over charging a marketing fund for expenses is not acceptable. Franchisee’s expect transparency and accountability for their cooperative marketing dollar spend. Whilst most franchisors are inclusive with marketing budgets and plans the sector has been warned that greater transparency is required. There is no doubt the ACCC will be targeting some franchisors this year to check whether sufficient detail and meaningful information is being provided in an AFS by a franchisor.

Please get in touch with our franchising team if you have any queries in relation to the above article or if you need any assistance to comply with your Code obligations, especially if you operate a marketing fund.

This article was written by Sean O’Donnell, Partner, Derek Sutherland and Massimo Di Maio, Associate.

¹ ACCC v Ultra Tune Australia Pty Ltd [2019] FCA 12
² “Fairness in Franchising” Report released on 14 March 2019 by the Parliamentary Joint Committee on Corporations and Financial Services.