Australian Securities Commission v Madison Pacific Property Management Pty Ltd

[1998] FCA 717

FEDERAL COURT OF AUSTRALIA

CORPORATIONS LAW - “prescribed interests” - exemption of franchises from prescribed interests - whether offer of interest including provision of services of a manager for franchised business part of offer of interest in a franchise - whether the offer of provision of services of manager is an offer of a “prescribed interest” - meaning of “common enterprise” within definition of “prescribed interests”.

Property, Stock and Business Agents Act 1941 (NSW)
Trade Practices Act 1974 (Cth) Pt IVB
Trade Practices Amendment (Fair Trading) Act 1988 (Cth)

Corporations Law Pt 7.12; ss 9, 109H, 1064
Companies Code s 215C
Companies Regulations
Corporations Regulations regs 1.02, 7.1.02

D. Magarey, “Prescribed Interests”, Companies and Securities Law Journal 7 (1989), 25

Australian Breeders Co-operative Society Ltd v Jones; Done v Jones; King v Jones; Jones v Mortgage Acceptance Nominees Ltd; Jones v C E Heath Casualty & General Insurance Ltd (1997) 150 ALR 488 - referred to
Australian Softwood Forests Proprietary Limited v Attorney-General for the State of New South Wales; Ex Relatione Corporate Affairs Commission (1981) 148 CLR 121 - applied
A Home Away Pty Ltd v Commissioner of Corporate Affairs (1980) 5 ACLR 299 - referred to
WA Pines Pty Ltd v Hamilton (1980) 5 ACLR 101 - referred to
Waldron v MG Securities Australasia Limited (1975) VR 508 - referred to
Butterworth v Lezemo Pty Ltd (1983) 8 ACLR 737 - distinguished
Khania Nominees Pty Ltd v Hamilton (1986) 10 ACLR 737 - referred to
Hamilton v Shilkin (1986) 11 ACLR 262 - referred to
Hamilton v Campbell (1984) 9 ACLR 24 - referred to
R v Commons (1986) 10 ACLR 873 - referred to

AUSTRALIAN SECURITIES COMMISSION v MADISON PACIFIC PROPERTY MANAGEMENT PTY LTD (ACN 081 776 810) as trustee of the Madison Pacific Property Management Trust and Ors
WAG 3011 of 1998

LEE J
PERTH
23 JUNE 1998

IN THE FEDERAL COURT OF AUSTRALIA
WESTERN AUSTRALIA DISTRICT REGISTRY	WAG 3011 of 1998

BETWEEN:	AUSTRALIAN SECURITIES COMMISSION Applicant
AND:	MADISON PACIFIC PROPERTY MANAGEMENT PTY LTD (ACN 081 776 810) as trustee of the Madison Pacific Property Management Trust First Respondent
AND:	MADISON PACIFIC AUSTRALIA PTY LTD (ACN 081 776 874) as trustee of the Madison Pacific Australia Trust Second Respondent
AND:	MADISON PACIFIC MANAGEMENT PTY LTD (ACN 081 776 758) as trustee of the Madison Pacific Management Trust Third Respondent
AND:	MADISON PACIFIC MARKETING PTY LTD (ACN 081 776 794 ) as trustee of the Madison Pacific Finance Marketing Trust Fourth Respondent
AND:	MADISON PACIFIC FINANCE PTY LTD (ACN 081 776 847 ) as trustee of the Madison Pacific Trust Fifth Respondent

JUDGE:	LEE J
DATE OF ORDER:	23 JUNE 1998
WHERE MADE:	PERTH

MINUTES OF ORDER

THE COURT ORDERS THAT:

The applicant file a minute of proposed orders pursuant to the reasons delivered herein.

Note:  Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

IN THE FEDERAL COURT OF AUSTRALIA
WESTERN AUSTRALIA DISTRICT REGISTRY	WAG 3011 of 1998

BETWEEN:	AUSTRALIAN SECURITIES COMMISSION Applicant
AND:	MADISON PACIFIC PROPERTY MANAGEMENT PTY LTD (ACN 081 776 810) as trustee of the Madison Pacific Property Management Trust First Respondent
AND:	MADISON PACIFIC AUSTRALIA PTY LTD (ACN 081 776 874) as trustee of the Madison Pacific Australia Trust Second Respondent
AND:	MADISON PACIFIC MANAGEMENT PTY LTD (ACN 081 776 758) as trustee of the Madison Pacific Management Trust Third Respondent
AND:	MADISON PACIFIC MARKETING PTY LTD (ACN 081 776 794 ) as trustee of the Madison Pacific Finance Marketing Trust Fourth Respondent
AND:	MADISON PACIFIC FINANCE PTY LTD (ACN 081 776 847 ) as trustee of the Madison Pacific Trust Fifth Respondent

JUDGE:	LEE J
DATE:	23 JUNE 1998
PLACE:	PERTH

REASONS FOR JUDGMENT

The issue for determination in this matter arises out of the intersection of two conflicting principles that apply in the field of commerce. The first principle is that the public is to be properly informed of the details of any investment proposal in which the public is invited to participate and is to be protected from investment schemes in which advancement of the promoter at the expense of the investor is the principal object. The second principle is that entrepreneurial ideas for profit-making activities and participation of the public therein by investment are to be encouraged wherever possible.

Part 7.12 of the Corporations Law reflects the first principle as did like provisions of the Companies Codes and Companies Acts which preceded it. Part 7.12 seeks to prevent canvassing of the public for potential investors if the approach to the public is not made by prospectus in the same manner as subscriptions of capital are sought from the public by a corporation for the purpose of carrying out the objects of the corporation. Provisions such as Pt 7.12 arose from the need to protect the public from the promotion of “blue sky” investment schemes that held out the prospect of returns to investors in proposals commonly ill-defined and sometimes fraudulent. (Australian Breeders Co-operative Society Ltd v Jones; Done v Jones; King v Jones; Jones v Mortgage Acceptance Nominees Ltd; Jones v C E Heath Casualty & General Insurance Ltd (1997) 150 ALR 488, 530.)

Recognition of the second principle is embodied in the exemption from the restrictions of Pt 7.12 given to invitations to subscribe or purchase any right to participate, or any interest, as franchisee in a franchise. The exemption was first introduced by the exercise of discretionary powers of the National Companies and Securities Commission (“the NCSC”) under s 215C of the Companies Code. By Policy Statement No 118 issued on 22 January 1986 the NCSC set out conditions to be fulfilled before the discretion to exempt a franchise would be exercised. The conditions included a requirement that a franchisor give adequate disclosure of a franchise proposal.

On 1 September 1987 provisions removing franchise schemes from the definition of prescribed interests in the Companies Code were added to the CompaniesRegulations. A definition of franchise substantially in the same terms as the definition now in force under the Corporations Law, although not identical, was inserted in the Companies Regulations in 1988. No disclosure requirements were promulgated in respect of the promotion of schemes offering interests in franchises to the public.

Since 1 February 1993 a voluntary self-regulatory Franchising Code of Practise was introduced which provides for adequate disclosure of franchise schemes to be given by the promoters thereof who feel inclined to follow the Code. By the Trade Practices Amendment (Fair Trading) Act  1988 (Cth) a new Pt IVB has been inserted in the Trades Practices Act 1974 (Cth) to come into effect on a date after 30 June 1998 under which certain “industry codes” will bind participants in an “industry”. It is intended that such a code will apply to offers to the public of interests in franchises. Failure to comply with disclosure provisions of such a code would be an infringement of the Trade Practices Act.

I turn now to the relevant provisions of Pt 7.12 of the Corporations Law. Under s 1064 no person, other than a public corporation, shall make available, offer for subscription or purchase, or issue an invitation to subscribe for or buy, any prescribed interest.

“Prescribed Interest” is defined in s 9 as meaning:

“(a)     a participation interest; or

(b)a right, whether enforceable or not, whether actual, prospective or contingent and whether or not evidenced by a formal document, to participate in a time-sharing scheme;

but does not include:

(c)a right or interest, or a right or interest included in a class or kind of rights or interests, declared by the regulations to be an exempt right or interest, or a class or kind of exempt rights or interest, for the purposes of Chapter 7...”

“Participation Interest” as defined in s 9:

“...means any right to participate, or any interest:

(a)in any profits, assets or realisation of any financial or business undertaking or scheme whether in Australia or elsewhere;

(b)in any common enterprise, whether in Australia or elsewhere, in relation to which the holder of the right or interest is led to expect profits, rent or interest from the efforts of the promoter of the enterprise or a third party; or

(c)in any investment contract;

whether or not the right or interest is enforceable, whether the right or interest is actual, prospective or contingent, whether or not the right or interest is evidenced by a formal document and whether or not the right or interest relates to a physical asset...”

Regulation 7.1.02 of the Corporations Regulations provides:

“For the purposes of the definition of ‘prescribed interest’ in section 9 of the Corporations Law, any right to participate, or any interest, as franchisee in a franchise is an exempt right or interest for the purposes of Chapter 7 of that Law.”

The term “franchise” is defined in reg 1.02 as follows:

“...an agreement or arrangement, whether express or implied, oral or written, between 2 or more persons by which:

(a)a party to the agreement or arrangement (in this definition called ‘the franchisor’) authorises or permits another party (in this definition called ‘the franchisee’), or a person asociated with the franchisee, to exercise the right to engage in the business of offering, selling or distributing goods or services in Australia or in an external Territory, under a marketing plan or system controlled by the franchisor or a person associated with the franchisor; and

(b)the business carried on by the franchisee or the person associated with the franchisee, as the case may be, is capable of being identified by the public as being substantially associated with a mark identifying, commonly connected with or controlled by the franchisor or a person associated with the franchisor; and

(c)the franchisor exerts, or has authority to exert, a significant degree of control over the business; and

(d)it may reasonably be expected that, in carrying on the business, the franchisee or a person associated with the franchisee is, or will be, substantially dependent on goods or services supplied by the franchisor or a person associated with the franchisor;”

In this proceeding the Australian Securities Commission (“the Commission”) contends that the first to fifth respondents, each a proprietary company, engaged in conduct that contravened s 1064 of the Corporations Law and seeks an order restraining the respondents, or any of them, from continuing that conduct.

In their defence the respondents say that the right or interest made available, offered for subscription or purchase, or in respect of which an invitation to subscribe for or buy, has been issued, is a right to participate, or interest, as franchisee in a franchise and is not a prescribed interest for the purpose of s 1064.

The matter has been treated by the parties as one requiring urgent determination. The proceedings were commenced on 4 June 1998 and a defence filed on 8 June 1998. When the application for an interlocutory injunction came on for hearing on 12 June 1998 the parties advised the Court that as far as the parties were concerned the only issue raised by the pleadings was whether the right to participate, or interest, offered by the respondents was a right to participate, or interest, as franchisee in a franchise. They were content to have the trial of that issue conducted forthwith. I had some doubt that all material facts relevant to that issue had been sufficiently exposed to permit that course to be followed but the parties were satisfied that the matter could be determined on the contents of affidavits filed and documents exhibited thereto.

The need for urgent disposal of the matter referred to above was occasioned, as set out in an affidavit filed by the respondents, by the possible enactment of the Managed Investments Bill 1997 which  would repeal the provisions of the Corporations Law dealing with prescribed interests and replace them with provisions relating to “managed investment schemes”, provisions which would include the proposal the subject of this application.

The respondents, therefore, believed they were looking through a closing window of opportunity.

I will now outline the relevant facts.

In the pleadings and in the arguments of counsel the respondents were referred to as a group in respect of their participation in making available or offering a relevant investment proposal and they will be dealt with in the same way in these reasons except where it is necessary to deal separately with the involvement of a particular respondent.

Each respondent has been joined in the proceeding in its capacity as a single trustee of a named trust. All issued shares in each respondent are held by MPI Holdings Pty Ltd.

The respondents have had prepared and printed a set of documents relating to a “Madison Pacific Franchise”. The principal documents are entitled:

(a)       “Information Memorandum”

(b)“Franchise Agreements”

(c)“Your Key Questions Answered”

These documents, together with the second of the documents referred to the following paragraph, are referred to hereafter as the offer documents.

Other documents of relevance are “An Operations Manual” marked as a “draft”; pro-forma documents for sub-promoters or agents to forward to their clients in marketing the investment scheme on behalf of the respondents, and a pro-forma Property Agency and Services Areement.

In the Information Memorandum under the heading “The Offer Explained” and the sub-heading “(a) Exclusive Opportunity” it is stated that applicants for the interest on offer have the opportunity to “carry on a business under an exclusive Franchise”. The nature of the opportunity is described as follows:

“This franchise utilises the Madison Pacific System and the Madison Pacific Image and promotes, provides and markets Madison Pacific Services to owners of specified properties within the Sydney metropolitan area.

It also provides the option of having the business run under professional management by an approved Manager.”

Under the sub-heading “(b) Franchise” the following details are provided:

“A limited number of franchises are now offered which entitle the owner to participate in the commercialisation of the Madison Pacific System. Franchisees will be appointed for a period of twenty years.

A franchise incorporates a ‘territory’ initially consisting of more than 300 addresses within the Sydney metropolitan area, spread over many suburbs to achieve a balance of opportunity for individual franchises. Thus no one franchise territory will comprise a concentration of addresses in a particular building, suburb or area, but rather a broad spread of addresses across the Sydney metropolitan area.

The composition of the addresses listed and comprising a ‘territory’, will be computer generated to ensure that all franchises are treated similarly.

The territories will increase in size over time with the addition of new addresses to the database.

The franchise will entitle the Franchisee to operate a business providing services to property owners. Income is derived by Franchisees providing Madison Pacific property management services to owners of properties within the franchised territory.”

The printed form of Franchisee Agreement (“the Agreement”) contained in the booklet “Franchise Agreements”provides as follows:

“GRANT OF FRANCHISE

2.1Franchise

In consideration of the Franchisee punctually paying to the Franchisor or Madison Pacific (as the case requires) all sums of money to be paid by the Franchisee under this Agreement and observing and performing all of the Franchisee’s Covenants, the Franchisor grants to the Franchisee an exclusive franchise to conduct one Madison Pacific Outlet providing the Madison Pacific Services to the Specified Properties during the Term using the Madison Pacific System and the Madison Pacific Image, subject to this Agreement.

2.2Exclusive Rights

(a)The Franchisor reserves unto itself the exclusive right to provide the Madison Pacific Services to all properties throughout the State other than the Specified Properties.

(b)Subject to the Franchisee complying with each of the Franchisee’s Covenants, the Franchisor will not during the Term grant any other person a franchise to conduct a Madison Pacific Outlet providing services to the Specified Properties or the right to otherwise provide similar services to owners of the Specified Properties (or do either itself).”

In the Agreement Madison Pacific Services, Madison Pacific System, Madison Pacific Image and Madison Pacific Outlet and Specified Properties are defined as follows:

“‘Madison Pacific Services’ means the services authorised by the Franchisor from time to time for provision in a Madison Pacific Outlet. As at the Commencement Date the Madison Pacific Services comprise the following:

(a)property repairs and maintenance services, which include the coordination of all works and services and control of costs associated with the general upkeep, cleaning, repairs and replacement of items as required;

(b)the compilation and maintenance of the Madison Pacific Brand and Model Identification Register;

(c)recommendations on property presentation to maximise rental potential and market value;

(d)regular property inspections;

(e)preparation of monthly statements and the provision of administrative services; and

(f)monitor, administer, supervise and authorise the disbursement of property outgoings.”

The nature of the service set out in item (b) of this definition is not further described in the Agreement or other documents.

“‘Madison Pacific System’ means any one or more of the business formats, systems, methods, procedures, policies, operations and standards relating to and controls upon the conduct of a business providing the Madison Pacific Services using any part of the Madison Pacific Image under franchise from the Franchisor, as may be specified by the Franchisor from time to time in the Operations Manual or otherwise in writing.”

“‘Madison Pacific Image’ means the Trade Marks, and the name ‘Madison Pacific’ and other related and ancillary trade marks, trade names, copyrights, emblems, designs, logos, labels, signs, symbols and indicia devised and employed by the Franchisor to identify and distinguish Madison Pacific Services and Madison Pacific Outlets exploiting the Madison Pacific System and includes any future additions and modifications.”

“‘Madison Pacific Outlet’ means a business conducted under franchise from the Franchisor providing some or all of the Madison Pacific Services.”

“‘Specified Properties’ means the address of properties located within the State allocated to the Franchisee by the Franchisor upon the execution of this Agreement (and being not less than three hundred (300) sites) and any other property addresses located within the State which may be allocated to the Franchisee by the Franchisor after the date of this Agreement.”

According to the Information Memorandum the first respondent (“Madison Pacific”) has acquired the business of Bligh Realty Pty Ltd “a specialist real estate company” in Sydney. It may be assumed that Madison Pacific is licensed under the Property, Stock and Business Agents Act 1941 (NSW) to carry on business as a real estate agent.

A recital to the Agreement states that Madison Pacific is entitled to market and sell certain services; has developed an image, techniques and materials for the marketing and sale of those services; and has “licensed” the second respondent (“Madison Pacific Australia”) to use the Madison Pacific System and the Madison Pacific Image and to grant to a franchisee of Madison Pacific Australia the right to use the Madison Pacific System and the Madison Pacific Image within New South Wales on the terms and conditions set out in the licence. The recital does not say that Madison PacificAustralia is authorized to use Madison Pacific Services or may authorize another to use those services.

The substance of the right or interest obtained under the Agreement is a right to conduct a business of providing services to property owners, being services authorized by Madison Pacific Australia, and in conducting that business to use the name Madison Pacific and a symbol or logo said to be associated with that name. As described in the Agreement the “authorized” services would not be limited to services required by property owners whose properties are occupied by lessees or tenants, but it is implicit in the Agreement that Madison Pacific Services are so restricted and restricted, in particular, to residential properties. The right to conduct such a business is limited to the “300 sites” in Sydney that constitute the “Specified Properties”. Madison Pacific Australia reserves the right to supply Madison Pacific Services to other properties in New South Wales.

On the face of the material that constitutes the offer documents there may be some doubt as to the nature of the “300 sites” and considerable doubt as to how a “business” offering Madison Pacific Services is to be established by a person to whom an interest as franchisee is offered. How a business conducted under franchise as a Madison Pacific Outlet is to be established in respect of the “300 sites” allocated on execution of the Agreement is not the subject of detailed explanation in the offer documents.

On one view of the documents it may be thought that the “300 sites” are tenant-occupied residential properties in respect of which Madison Pacific Services may be offered by a person conducting such a business. For example, in the booklet “Your Key Questions Answered” the following representation is made:

“Stability of cash flow. Income is dervied from regular rental payments sourced from an extensive portfolio of residential properties.”

That stated suggests that an extensive portfolio of tenanted residential properties is to be drawn upon by Madison Pacific Australia to provide the base for the business to be conducted as a Madison Pacific Outlet. However, as 3,000 franchises are said to be on offer, the appropriate assumption would appear to be that “300 sites” will apply to 300 addresses in Sydney that include all forms of property; occupied residences, tenanted residences, business premises, industrial premises, vacant blocks and so on. If that is so as few as 25 per cent of the 300 sites may be tenant-occupied residential properties.

The services described as Madison Pacific Services are those usually provided by a real estate agent instructed by an owner to collect rentals and carry out managerial duties in respect of a residential property occupied under a lease or tenancy agreement. In the absence of any other information it may be assumed that it would be extremely difficult for an operator of a Madison Pacific Outlet to persuade an owner of tenanted residential premises and a real estate agent appointed by the owner to transfer to that person the performance of services which may be assumed to be profitable for the real estate agent or to have the real estate agent reduce its fee and remit fees to the operator from the rentals collected by the agent.

An owner who lets residential premises without employing an agent may consider an offer to provide management services in respect of the premises for payment of a fee but the operator of Madison Pacific Outlet would have to rely on payments from the owner and could not collect the rent from which the fees for services could be deducted.

The booklet “Your Key Questions Answered” states that there is a “projected average return of $8,150 p.a., before loan repayments and income tax, over the twenty year term of the franchise” and that statement appears to be based upon a table in the Information Memorandum headed “Detailed Projected Cash Flow” which sets out “Projections for a typical Madison Pacific Franchise” and represents the total “Net Operating Cash Flow” over twenty years for such a franchise to be approximately $160,000.

The facts or research on which such projections are based are not set out in the offer documents. A letter from Deloitte Corporate Finance Company Pty Limited addressed to Madison Pacific Australia is included in the Information Memorandum and states that the projected cash flows have been reviewed including a review “on a test basis” of “evidence supporting the assumptions underlying the projections to ensure that the projections present a view which is consistent with our understanding of the anticipated future cash flows of the project and the assumptions of the Madison Pacific Directors.” It is to be noted that the letter includes the following as factors bearing upon the returns “owners” may receive:

·   “the ability of (Madison Pacific Australia) to acquire and attract a sufficient number of property managements”.

·   “the ability of (Madison Pacific Australia) to negotiate property management service fees on the terms assumed.”

On the face of the offer documents the task of attracting property managements and negotiating fees falls to the business conducted by the “owner”. Madison Pacific Australia as “franchisor” will not be concerned with those matters for each “franchised business.”

In addition to the representation as to the “stability of cash flow” set out above the booklet “Your Key Questions Answered” also makes the following statement:

“Limited risk. The regular nature of the income stream and the general stability of the rental market ensures an overall low risk.”

The Information Memorandum under the heading “Important Notice” states that:

“Madison Pacific has additionally taken legal advice that a business investor does not require a licence, in accordance with the Property, Stock and Business Agents Act 1941 (NSW), to operate a Madison Pacific Franchise.”

If the above statements as to stability of cash flow and limited risk carry the implication that the income stream of a “business investor” is protected by the payment of rentals to the investor, such an implication would not be correct.

The foregoing examination of the offer documents raises a doubt as to whether a “business investor” could establish a business described in the offer documents unless acting in conjunction with an agent licensed under the Property, Stock and Business Agents Act 1941 (NSW). Therefore, a doubt must arise whether the substance of the offer to grant a franchise to conduct such a business is sufficient to attract the meaning of the term “franchise” as defined in reg 1.02.

It is to be noted that the franchise defined in reg 1.02 in which a right to participate, or interest, as franchisee in a franchise is an exempt right or interest for the purpose of Pt 7.12 is one in which the conduct of a business is an integral part. That is, a bare right or interest a franchisee may obtain in the grant of a franchise in respect of the use of an idea will not be an exempt right or interest. The franchise must relate to the establishment of a business which uses the franchisor’s system of marketing goods or services; the franchisor must have a mark known to the public, the mark to be used in the business of the franchisee; the business carried on by the franchisee must be subject to a significant degree of control by a franchisor; and it may reasonably be expected that the business carried on by the franchisee will be substantially dependent on goods and services supplied by the franchisor.

The intent of the exemption provision is that the restrictions of Pt 7.12 in respect of the offer of prescribed interests will not apply to offers to participate in the establishment of business undertakings as franchised operations. The restrictions of Pt 7.12 will continue to apply, however, if the offer relates to a right or interest in an idea for a business, the franchisor not having developed an appropriate system for the marketing of goods or services for use in such a business, or not being in a position to supply intellectual property or know-how, systems, goods or services to provide a foundation on which a franchisee may establish the proposed franchise business.

In other words, Pt 7.12 will continue to apply to a proposal that relies on a wider concept of franchise than appears in reg 1.02, and is within the class of proposals that Pt 7.12 is designed to control.

The case submitted by the Commission was that when considered together the offer documents involve a proposal that remains a prescribed interest, not attracting the exemption afforded to a right to participate, or interest, as franchisee in a franchise by reg 7.1.02.

The conjunction of circumstances relied upon by the Commission are that in addition to the offer of a franchise as described in the offer documents, the respondents also offer a loan from “an independent financial institution”; a loan from the fifth respondent (Madison Pacific Finance); the provision of marketing services for one year by the fourth respondent (Madison Pacific Marketing); a “guarantee” by Madison Pacific Finance of the business investor’s indebtedness under the foregoing borrowings; and the services of the third respondent (Madison Pacific Management) as an “approved Manager” under the Agreement (cl 10). The offers of a loan from Madison Pacific Finance and marketing services from Madison Pacific Marketing are available only if the offer of the management services of Madison Pacific Management is accepted by an investor. The whole proposal is said to offer taxation advantages in that a sum of $32,500 payable for the package of services, $31,500 “is expected to be tax deductible”.

Tthe Commission relied, in particular, on the offer of the services of Madison Pacific Management to conduct the “franchised business” under management and the promotion of the scheme to investors resident in this State who may be expected to invest only if such an offer of management was included in the proposal.

The Information Memorandum describes the Manager’s role as follows:

“If appointed, Madison Pacific Management will, on behalf of the Franchisee, manage and direct the day to day operations of the Madison Pacific business and will endeavour to promote, advance and improve the business. Regular financial and operational reports will be provided to Franchisees by Madison Pacific Management to enable them to adequately monitor their Madison Pacific business.

An analysis of the fees charged by the Manager in the first year, relative to the second and later years, highlights the additional works and services that will be performed by the Manager in the first year. The servicing, introduction and development of rapport with new tenants and landlords, together with the establishment of new records and close physical analysis of the franchise territory itself is significantly greater in the first year.”

A printed form of agreement for the appoint of Madison Pacific Management as Manager is contained in the booklet “Franchise Agreements”. The recital to the management agreement states that Madison Pacific Management “is experienced in the management of businesses similar to the Franchised Business and has been approved by Madison Pacific to manage Franchised Businesses”.

Under the management agreement Madison Pacific Management is appointed sole and exclusive Manager of the Franchised Business for a period coterminous with the term of the franchise (20 years). A franchisee may terminate the management agreement within that period if the Manager has committed four or more breaches of the Manager’s duties set out in the management agreement or “ceases to be approved by Madison Pacific to manage Franchised Businesses”. It may be noted that under the management agreement if Madison Pacific Management ceases to be so approved it will be deemed to have assigned the management agreement to Madison Pacific.

Under the management agreement Madison Pacific Management meets the expenses of the business and indemnifies the franchisee against all such costs, charges and expenses. Madison Pacific Management is to receive a fee of $5,530 for the first year and 43 per cent of the“gross profit” of the business each year thereafter. The whole of the balance of the “gross profit” is to be applied by the Manager to loan repayments and franchise fees payable by the franchisee.

The Commission submits that the entire arrangement involving, in particular, the appointment of Madison Pacific Management as Manager is designed to have the Madison Pacific Group conduct a business in which the “business investor” is but a passive investor supplying funds to be used by the Group to promote the business of Madison Pacific with the expectation by the investor of a return from the efforts of Madison Pacific and the Madison Pacific Group. (See: D. Magarey, “Prescribed Interests”, Companies and Securities Law Journal 7 (1989), 25 at 36-37.)

To determine whether the characterization of a prescribed interest applied by the Commission to the offer documents is appropriate it is necessary to determine what form of transaction constitutes a franchise as defined in reg 1.02 to ascertain whether the exemption for a right to participate, or interest, as a franchisee in a franchise extends to the combination of transactions attacked by the Commission.

Under reg 1.02 there are four elements to be satisfied. First there is to be an agreement or arrangement by which a franchisor authorizes or permits a franchisee to exercise the right to engage in the business of, inter alia, selling services under a marketing plan or system controlled by the franchisor. On the facts of this case there may be a question whether the marketing plan or system controlled by Madison Pacific, or Madison Pacific Australia, is sufficient for the purposes of the definition but the Commission was content to assume that it was for the purpose of its argument.

Second, the business carried on by the franchisee (pursuant to the foregoing authority or permission) is to be capable of being identified by the public as being substantially associated with a mark identifying the franchisor, or a person associated with a franchisor. There is no evidence before the Court on the issue of the capability of the public to connect the mark set out in the schedule to the Agreement as a mark with which Madison Pacific or Madison Pacific Australia is associated. Again, for the purposes of its case, the Commission was prepared to accept that the requirement was satisfied.

Third, the franchisor is to have authority to exert a significant degree of control over the business of the franchisee. Under the Agreement Madison Pacific Australia limits the scope of the business that a franchisee may conduct and during the first year of the term of the franchise may direct the operator of a franchised business to “conduct such promotion of the franchised business” as Madison Pacific Australia requires. No argument was submitted that this requirement was not satisfied.

Fourth, there is to be a reasonable expectation that in carrying on the business a franchisee will substantially depend on goods or services to be supplied by the franchisor, or person associated with the franchisor. It is not clear what facts are relied upon to satisfy this element. The goods or services referred to in the definition will be those the franchisor has contracted to supply or those which, in the context of the franchise agreement or arrangement, it is essential for the existence of a franchised business that they be supplied by a franchisor able and willing to supply them. The inclusion of the latter meaning is necessary, otherwise a franchise could be stultified at the time of the grant by a franchisor’s lack of intention to supply goods or services required by a franchisee from the franchisor to establish a franchised business.

Counsel for the respondents submitted that the services of Madison Pacific Management under a management agreement would come within the fourth requirement of the definition of franchise as services supplied by a person associated with Madison Pacific Australia on which, under the proposed franchise scheme, a franchisee would substantially depend to carry on the franchised business.

I am unable to agree. The appointment of Madison Pacific Management as sole and exclusive Manager of a franchised business for the whole of the term of the franchise would not be an arrangement that would be within the contemplation of the fourth limb of the definition of a franchise as a service on which the franchisee would reasonably expect to be substantially dependent in carrying on that business. Madison Pacific Management carries on business as a manager of businesses franchised by Madison Pacific Australia and according to the terms of the management agreement is an independent contractor responsible for all costs of the managed business, indemnifying the franchisee against such costs. On its face such an arrangement is external to a franchise agreement and not an element capable of defining a franchise. The goods or services to be supplied by a franchisor on which a franchisee may reasonably expect to be substantially dependent are those which go to the essence of the business developed by the franchisor and essential for a franchisee to obtain in carrying on the franchised business if the business is to be conducted successfully in the style of the franchisor’s business. Providing for the conduct of a franchised business for the term of the franchise to be carried out by a manager associated with the franchisor tends to negate the concept of franchise embodied in the definition of that term in reg 1.02. Sole and exclusive management by a person associated with the franchisor is not a service upon which a franchisee may reasonably expect to be substantially dependent in carrying on a franchised business.

It goes without saying that a franchisee may employ a manager to carry on a franchised business, but equally the existence of that right can play no part in the definition of a franchise.

Having found that neither the inclusion in the offer documents of an offer by Madison Pacific Management to conduct a franchised business as manager nor, if regarded separately, the offer by Madison Pacific Management to so act is relevant to the offer of a right to participate, or an interest, as franchisee in a franchise as that term is defined in reg 1.02, it is necessary to consider whether such an offer by Madison Pacific Management in conjunction with the offer of a franchise involves the offer of a prescribed interest.

The submission of the Commission is that if the whole of the arrangement is examined there is included in the offer a proposal that is not the offer of an interest as franchisee and even if the remainder of the offer , if taken on its own, may be the offer of a right to participate in a franchise, the whole of the proposal is not such an offer and, therefore, is not the offer of an exempt right or interest.

The respondents say that all components of the offer are incidental to a franchise which is the substance of the offer. That is, some components may be dealings which are not necessary for satisfying the requirements of a franchise as defined but they are relevant to, and may be expected to be associated with, the grant and conduct of a franchise.

In dealing with this question I will treat both the conduct of the respondents as a group in respect of the package of the offer documents and the separate conduct of Madison Pacific Management in offering to manage the businesses of “business investors” as raising the same issue. The history of judicial examination of Pt 7.12 and its predecessors shows that whilst it is acknowledged that the terms are of wide import and the limits of their operation difficult to discern, it is necessary that they be given effect as drawn given the nature of the mischief the provisions are intended to address. (The Australian Softwood Forests Proprietary Limited v Attorney-General for the State of New South Wales; Ex Relatione Corporate Affairs Commission (1981) 148 CLR 121 per Mason J at 129-130; A Home Away Pty Ltd v Commissioner of Corporate Affairs (1980) 5 ACLR 299 per Young CJ at 301-302; WA Pines Pty Ltd v Hamilton (1980) 5 ACLR 101 per Jones J at 104-105.)

That approach is consistent with the longstanding principle of statutory interpretation adopted in s 109H of the Corporations Law which requires a construction of a provision of the Corporations Law to be preferred that promotes the purpose and object underlying the law to a construction that would not promote that purpose or object.

The purpose of the provisions in Pt 7.12 is to protect the public from inadequately disclosed and speculative proposals to which the public is invited to subscribe, it being suggested to the investor that the investor can expect a return from the act of investment.

That part of the definition of prescribed interest set out above most likely to be attracted on the facts of this case is that of a participation interest, in particular par (b) of the definition of that expression, dealing with a common enterprise and the expectation of profit therefrom.

As Mason J said in Australian Softwood at p133:

“An enterprise may be described as common if it consists of two or more closely connected operations on the footing that one part is to be carried out by A and the other by B, each deriving a separate profit from what he does, even though there is no pooling or sharing of receipts of profits. It will be enough that the two operations constituting the enterprise contribute to the overall purpose that unites them. There is then an enterprise common to both participants and, accordingly, a common enterprise.”

“Profit” as used in this part of the definition of prescribed interest is a gain or advantage and not the balance of a receipt after outgoings relevant to the gaining of the receipt have been deducted. (Waldron v MG Securities Australasia Limited (1975) VR 508 per Pape J at 528-529.)

The indicia referred to in Australian Softwood are present in this matter where absentee investors are invited to have Madison Pacific Management control and operate the business in which they have invested. The business of Madison Pacific Management is, inter alia, managing the businesses of “business investors”. In the offer documents it is contemplated that investors resident in this State who subscribe funds under the proposal will require a party to conduct the “franchised business” on their behalf and pursuant to the offer documents Madison Pacific Management is made available for that task. For such investors Madison Pacific Management is to establish the “franchised business” and the business will not exist unless and until Madison Pacific Management is able to create it using such experience as it has in the relevant field and the connection it has with Madison Pacific.

The holder of a right or interest obtained under the Agreement who appoints Madison Pacific Management to control and conduct a “franchised business” is led to expect profit from the efforts of Madison Pacific Management and, indeed, for an investor it represents the only way in which a profit could be obtained. The return of a profit in such an investor’s business is wholly dependent on the efforts of Madison Pacific Management carrying on its business as a manager of such businesses in conjunction with conducting the investor’s business.

The common enterprise is to be found in the close connection of the operation of the “franchised business” with the business of Madison Pacific Management and the expectation that the efforts of Madison Pacific Management will provide the gain to be received by either business. The proposal on offer is not that an investor as proprietor of a business, and as employer, engage the services of an employee to manage the employer’s business. The proposal is that Madison Pacific Management as an independent contractor, carrying on business as the manager of businesses franchised by Madison Pacific Australia, approved so to act by Madison Pacific, conduct and control a “franchised business” to provide a return for a “business investor”.

The circumstances of this case are clearly distinguishable from those considered in Butterworth v Lezemo Pty Ltd (1983) 8 ACLR 737 where it was held that a common enterprise between a franchisor and franchisee was not to be found in the general promotion of franchised businesses by advertising undertaken by a franchisor. More analogous to the facts of the instant case were those considered in Khania Nominees  Pty Ltd v Hamilton (1986) 10 ACLR 737; Hamilton v Shilkin (1986) 11 ACLR 262; Hamilton v Campbell (1984) 9 ACLR 24; and R v Commons (1986) 10 ACLR 873. In each of those cases it was held that there was a common enterprise between an investor and a promoter, or person associated with a promoter, of the scheme invested in where the promoter, or person associated with the promoter, had covenanted or was expected to use its efforts to assist the investor to receive a return from the investment.

It is unnecessary to consider other submissions on the application of Pt 7.12 to the facts of this case. There is no issue that the offer documents constitute an offer to the public.

There will be orders as sought in the application consistent with the foregoing reasons. The Commission is to file a minute of proposed orders accordingly.

I certify that this and the preceding twenty pages are a true copy of the Reasons for Judgment herein of the Honourable Justice Lee

Associate:

Dated:             

Counsel for the First Applicant:	J A Chaney
Solicitor for the First Applicant:	Australian Securities Commission
Counsel for the First-Fifth Respondents:	K J Martin QC M L Bennett
Solicitors for the First-Fifth Respondents:	Bennett & Co
Date of Hearing:	11 June 1998
Date of Judgment:	23 June 1998