When Caltex Australia boss Julian Segal and a group of senior officers were called to a meeting with the workplace regulator in Sydney on February 21 they knew the news wouldn't be pretty.
The Fair Work Ombudsman had been investigating wage fraud allegations for 18 months and Segal had a good idea what was coming.
Caltex has been busy doing its own mandatory audits, so far 293 audits. The results were alarming. The first round of audits showed an 80 per cent non-compliance rate, and the second round, showed 60 per cent.
The FWO's investigation found a 76 per cent failure rate from the 25 stores it had audited, a figure that would do nothing to help the Caltex brand, which has already been battered by a wage fraud scandal exposed by Fairfax Media in late 2016.
Caltex is one of a long line of franchisors found to be presiding over rampant underpayment of workers and a flawed business model that has driven franchisees to cut corners including exploiting workers.
In Caltex's case it had an added twist, with stories emerging of workers threatened with violence and in one case sending hit men to visit their family in Pakistan to guarantee their silence.
Some workers were paid $12 an hour in cash, which is less than half the award rate, some sleeping on mattresses at the back of the store to reduce travel time; some franchisees sponsored workers on a visa or paid for their education so they could stay in this country and work like slaves.
The meeting between Segal and Fair Work Ombudsman Natalie James left little room for doubt that the FWO report would be a shocker.
The regulator's view was that Caltex was presiding over a non-compliant and unsustainable operating model.
It had "significant" concerns about the accuracy of the time and wage records it was provided (including timesheets, rosters and pay slips) and that some franchisees were deliberately manipulating the records. This made it virtually impossible to estimate the dollar size of the wage fraud scandal.
The exit
Whether Caltex decided to go on the front foot and gazump the regulator and the negative report by announcing a plan to exit the franchise business, is hard to know.
What we do know is that on February 27 Caltex told the market it was getting out of the franchising game and stressed that it had nothing to do with underpayment issues.
It didn't mention the February 21 meeting with the FWO or that a report was imminent.
Some see Caltex's announcement as a corporate whitewash, a way to brush the ugly truth under the carpet.
Caltex is adamant its decision to exit the franchise system by 2020 was based on a strategic decision.
It said it had been reviewing its retail operating model – including the franchisee model – since 2016, before the worker exploitation scandal broke.
According to Caltex, at February 23, 2018, of the 292 sites that have been audited, 193 sites have had their franchise agreements terminated and 29 sites are in progress to resolve disputes. The terminations are due to serious breaches or non-compliance or a decision by some franchisees to prematurely end their contracts after refusing to participate in the audit.
In a statement to the Financial Review it said: "In the early stages of our audit program … the rate of non-compliance was approximately 80 per cent. We started our audit program by prioritising sites where we had received calls to our whistleblower line, so absolutely expected the non-compliance rate to be higher to start with.
"By the time we entered tranche two of our program, a much larger group, it was around 60 per cent... Based on declining whistle-blower activity over time, and other observations to date, we expect we will see this non-compliance rate decline further as we complete the final tranche of audits during 2018-19."
In some cases, franchisees refuse to do the audits because they have been underpaying workers; in other cases they believe Caltex will use technicalities to terminate them.
Under the Caltex franchise agreement, if a franchisee is terminated due to a breach of the franchise agreement (which can occur for wage underpayment as well as other reasons) the value of the business is returned to Caltex with the franchisee receiving only the value of any stock or other owned assets.
"You acknowledge and agree that except expressly provided under the agreement or as may be required by law, at the end of the franchise you are not entitled to receive any payment or compensation from Caltex," reads the relevant clause in a franchise agreement.
Some may argue it is a powerful weapon against worker exploitation.
But it is a power not afforded to the regulator and it can be open to abuse. For franchisees, termination can mean financial devastation. They lose their store, receive no compensation and are left with a big bank loan.
There is a power imbalance between franchisees and franchisors that needs to be addressed.
The decision to exit franchising will affect 237 Caltex franchisees and 433 sites. The transition to corporate sites will be complete by 2020 and will cost Caltex up to $120 million.
A letter to franchisees said those franchisees offered a reduced tenure would be offered an amount equal to the greater of two times the initial franchise fee, which is a far cry from the hundreds of thousands of dollars, or in some cases $1 million-plus, franchisees paid for stores on the secondary market, including goodwill.
'Public relations stunt'
In May 2017 Caltex set up a $20 million compensation scheme for underpaid workers.
Some, including Professor Allan Fels, described the scheme as "a public relations stunt".
The Fair Work Ombudsman's report on underpayment makes it clear that "the lack of, and unreliability of, records provided by franchise operators suggests serious and systemic non-compliance".
According to Caltex, at February 26, 2016, it had received 269 claims from workers with 155 approved, valued at $3.9 million.
This is despite 193 stores either being terminated or leaving the system mainly after refusing to participate in an audit. Each store has at least five workers.
Perhaps the surprisingly low level of claims is due to the limitations Caltex has put on the fund, including allowing workers to go back only two years, despite wage fraud going on for years, and giving workers only a limited time to lodge a claim.
Caltex isn't liable to make payments to workers who have been underpaid. But going forward it is. Under the Protecting Vulnerable Workers Act, which is now in place, franchisors are on the hook if they are found to have significant influence on the franchisee network and underpayment has occurred.
The franchise sector has received a lot of bad publicity in recent years. It started with 7-Eleven and its flawed business model, then moved to Domino's, Caltex and Retail Food Group.
In the past couple of weeks, things have heated up considerably when Retail Food Group reported an $88 million loss, flagged the closure of 200 stores and revealed its banks have put it on a tight éleash.
Domino's has also been battered by investors as it battles a wage fraud scandal, a questionable business model and an exposé by colleague Joe Aston that its chief enthusiasm officer Don Meij was selling his stock including in the same trading session as the company was buying its own shares, as well as his multiple margin loans.
None of it is a good look and does little for franchising. But the problems can't be brushed aside as a few bad apples. As one former franchisor said: "If the house is on fire, we need to acknowledge it."
