Retail Food Group (ASX: RFG) is under fire from the Australian Competition and Consumer Commission (ACCC) for allegedly making misleading statements to the market and engaging in unconscionable conduct over a period of four years.
The ACCC also says RFG misused its franchisee's marketing funds to pay for several non-marketing expenses.
RFG's shares tanked 23 percent during early trade on the news before the company went into a trading halt.
The ACCC's case against the hospitality franchisor behind brands including Michel's Patisserie, Donut King and Gloria Jean's Coffee says RFG sold or licenced 42 of its loss-making corporate stores to incoming franchisees between 2015 and 2019.
The corporate watchdog will argue in the Federal Court that during this sale process, RFG withheld critical profit and loss information from the incoming franchisees and falsely represented that the loss-making stores were viable or profitable.
In documents issued to the incoming franchisees, RFG claimed that it couldn't estimate earnings for a particular store.
The ACCC instead alleges that RFG knew the earnings of each loss-making store and was aware they had been loss-making in the current or previous financial year.
"The prospective franchisees simply had no way of knowing the true financial performance of the stores, and we allege that Retail Food Group took advantage of this when selling or licensing the stores," says ACCC Chair Rod Sims.
The ACCC's case also involves allegations that RFG misused marketing funds, to which its franchisees had contributed, to pay for non-marketing expenses in breach of the Franchising Code.
This allegedly included personnel costs for executives and employees who were not in marketing roles.
In the case of the Michel's Patisserie marketing fund, it is alleged that $22 million was siphoned by RFG into implementing a new business model and covering losses from some corporate stores.
"The Franchising Code makes it clear that marketing funds can only be used to cover legitimate marketing and advertising expenses, administration costs, expenses disclosed to franchisees or those agreed to by a majority of franchisees," says Sims.
"We allege that Retail Food group acted in breach of the Code, and in some cases unconscionably, by making improper undisclosed payments from the marketing funds for its own benefit, to the detriment of franchisees."
The ACCC is seeking the full gamut of declarations, injunctions, pecuniary penalties, disclosure and adverse publicity orders, a compliance program order, redress orders and costs from RFG.
RFG: "Even if the allegations did happen, let's put them in the past"
In a response issued to the market, RFG says the issues that are at the crux of the ACCC's case are "relatively narrow in scope and focus".
RFG also says the allegations are "historical" and occurred under senior executives that are no longer with the comapny.
It implied the ACCC is grasping at straws, given that the watchdog has not taken action on other existing allegations that it says are broader and more serious.
"The ACCC has not pursued several of the broad and serious allegations that were raised during the course of its extensive investigation of the company over almost three years," says RFG.
"Even if the allegations did happen, let's put them in the past, where they belong."
"Our franchisees continue to suffer from this drawn-out saga. By punishing RFG, you are punishing them. Remember we are dealing with small business people, many of whom have mortgaged their houses to operate their franchises."
The franchisor says under the leadership of Executive Director Peter George, who was appointed in late 2018, the company is focused on improving franchisees' current turnover and operations.
Over the past two years, RFG says it has divested non-core underperforming units, has increased compliance processes and monitored franchisees' performance and levels of risk.