What to do when you think your franchisee is committing fraud

If you are a franchisor who suspects your franchisee of committing fraud, you must tread carefully and develop a game plan. Franchisee fraud is not uncommon, and franchisors have specific legal rights when fraud occurs. Surprisingly, I’ve encountered many instances of franchisees committing fraud in my career, and I’ve assisted numerous franchisors in navigating this complex legal issue. This article explores what franchisee fraud entails and outlines the actions franchisors should take when they suspect one of their franchisees is engaging in fraudulent activities.

What is Franchisee Fraud?

Fraud is not defined in the Franchising Code. Accordingly, the common law definition applies. Fraud, according to Australian law, involves intentionally deceiving someone to gain an unfair advantage or cause them harm. This can include actions such as lying, withholding information, or manipulating documents for personal gain. Fraud is a serious offence and can lead to severe penalties, including fines and imprisonment.

In the context of franchising, fraud may occur when a franchisee deliberately underreports sales, forges documents, or claims to have qualifications they do not have. 

What does the Franchising Code say about fraud? 

Clause 29 of the Franchising Code grants franchisors the authority to terminate a franchise agreement with seven days’ notice under certain ‘special circumstances.’ One such circumstance is fraud. Therefore, if your franchisee commits fraud, you possess the legal right to terminate the agreement.

Of course, you should not terminate on the basis of a mere suspicion of fraud. If you do, and it transpires there was no fraud, the franchisee could pursue a claim against you. 

Franchisors should also be mindful that any termination of franchise agreements needs to be recorded in the disclosure document. 

What should I do when I suspect fraudulent activity? 

If you suspect a franchisee is committing fraud, you should: 

1. Investigate Since fraud is a serious allegation, conducting a thorough investigation is crucial as the first step. This typically involves gathering all the relevant documents, and can include making enquiries with third parties. You may wish to engage a third party to undertake this investigation, such as a forensic accountant. 
2. Provide the franchisee with an opportunity to respond In most cases, it is appropriate to provide the franchisee with an opportunity to respond. There may be a plausible explanation, or the franchisee may have made a genuine mistake. Keep a written record of any requests and responses made or provided. 
3. Obtain legal advice Before taking any action, franchisors should obtain legal advice from a franchise lawyer. This will enable you to understand your legal rights, and identify any risks. Your franchise lawyer will also be able to assist in preparing documentation, such as correspondence with the franchisee and internal reports. 
4. Issue a formal termination notice (if applicable) If you choose to terminate the franchise agreement as a consequence of the fraud, a formal notice of termination should be issued. This will need to comply with the requirements of the Franchising Code, as well as any relevant clauses in the franchise agreement. Your franchise lawyer will be able to assist draft this document. If you do not wish to terminate (for example, because you believe the franchise relationship may be salvaged), you should at least ensure that there is a written record of the events, and the franchisee is made aware such conduct will not be tolerated moving forward. 

Can I recover from the franchisee if the fraud caused me harm? 

In most cases, you can seek to recover any financial harm you suffer as a consequence of the fraud. If the franchise agreement was also personally guaranteed, you could also claim losses against the guarantor. 

The fraud will almost always represent a breach of contract (being the franchise agreement). For example, if a franchisee underreported sales and paid less franchise fees as a result, that would be a breach of the clauses requiring them to accurately report sales in the manner required by the franchisor, and pay franchise fees based on the actual sales. 

Accordingly, the ‘harm’ here would likely constitute contractual damages. If you are a franchisor who has been financially harmed by your franchisees fraudulent actions, you should consult a franchise lawyer to determine the best approach to recover damages. 

If you are a franchisor and you require advice on this issue, please reach out for an obligation-free initial discussion. 

Key Takeaways

1. Fraud is one of the special circumstances in the Franchising Code. 
2. Before alleging fraud, franchisors should undertake a thorough investigation and develop a game plan. 
3. If franchisors wish to terminate the franchise agreement as a consequence of the fraud, they should issue a formal notice of termination. 
4. If the fraud caused harm, franchisors can usually seek to recover contractual damages, including against guarantors.