Oil refiner and petrol giant Caltex Australia is heading for a legal battle with its franchisees after ramping up an investigation and audit into hundreds of stores amid allegations of rampant worker exploitation.

Heightening tensions among its network of 650 franchise sites come weeks after Caltex was outbid by arch-rival BP for the purchase of 527 Woolworths-owned fuel and convenience store sites.

The sale is subject to regulatory approval but if it proceeds it will strip Caltex of an exclusive supplier arrangement to supply up to 3.5 billion litres of petrol and diesel to Woolworths.

Caltex has made some headway with a few smaller acquisitions but it means the pressure is on to find new revenue streams and bolster its share price, which, in the past year has underperformed the S&P/ASX200 by a whopping 30 per cent.

Having to deal with a wage fraud scandal that has the potential to damage its brand if it isn’t handled properly is something the company can ill afford.

It is understood that Caltex wrote to at least 150 franchisees two days before Christmas warning them they were being investigated and that “Caltex is taking allegations of breaches of workplace obligations within the Caltex franchise network very seriously”. (It said the entire network will be subject to a similar audit over the next 18 months).

The letter said franchisees had until January 25 to supply specific documents to Ernst & Young. It said “you should treat any requests for information and assistance as though they are requests being made by Caltex”.

Caltex is the latest franchise network to become embroiled in allegations of wage fraud and a flawed business model.

Reviewing the model

In November the Fair Work Ombudsman, which enforces minimum pay rates across Australia, conducted a series of raids on Caltex service stations across the country.

Some workers, mostly students from Pakistan and India on student visas, are being paid as little as $12 an hour, which is less than half the award rate.

Since the scandal broke Caltex has tried to go on the front foot by instigating a holistic review of its franchise model and governance processes. It has made a significant number of key management changes and hired a string of consultants, accountants and lawyers.

The letter sent to franchisees and obtained by The Financial Review is understood to have sent chills downs the spines of franchisees, particularly the sentence warning them they could be terminated.

“Caltex reserves its right in respect of any default identified during the investigation and audit … to take immediate steps to terminate the franchise agreement [both in accordance with the Franchise Code and Oil Code] or to conduct follow-up investigations and audits,” the letter says.

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.

This allows Caltex to punt the franchisee immediately without compensation.

Future of franchisees

In one case a franchisee from South Australia was terminated and lost seven stores, which he says were valued at $5 million. Another in NSW was terminated, losing four stores, with $1.5 million of his money blowing up.

It has created a lot of uncertainty, particularly when the newly appointed general manager of retail operations outlined in a newsletter that any franchise agreements due to expire will most likely be held over rather than renewed.

It said it expected more Calstores (corporate stores) “in the event that serious breaches lead to the termination of any agreements, or screening checks lead us to not proceed with proposed agreements, or there are new sites brought in to Caltex Australia for example”.

Importantly, it said any new franchise arrangements would only be offered on a short-term basis, heightening speculation that Caltex is preparing to ditch the franchise model and make a land grab for the stores. “All of these measures will give Caltex time to confirm the sustainability of our business model and to ensure we have the right business model and arrangements for both parties before we enter long term arrangements,” the letter said.

More than 100 franchisees are so concerned they are believed to have sought legal advice from three different law firms in the past few weeks. Some are considering joining a class action, while others want to challenge the legality of the audit and investigation.

The AFR can reveal that the Ernst and Young audit requires franchisees to hand over details of employees, residency status, nature of the visa held, all employee files including super records, all rosters from July 1, 2015 to June 2016, employee timesheets and console user records, a summary of how the payment of payroll takes place, ATO integrated client accounts, PAYG payment summary lodged with the ATO for June 2014, 2015 and 2016 and Business Activity Statements for all quarters from June 2015 to June 2016.

Caltex chief executive Julian Segal said in a statement the company was investigating every allegation received, cooperating with the Fair Work Ombudsman and other authorities and “implementing a forensic audit program to detect and sanction wrong-doing, including the termination of franchise agreements where that is reasonable and appropriate”.

‘I wanted to be able to sleep at night’

In the past year Caltex audited eight franchisees and terminated five of them for misconduct. It is a high strike rate. It increased that to 50 in November and is now stretching it out across the entire network.

A number of former and current franchisees, including Kevin Crossey who operated a number of sites in NSW between 1998 and 2014, have come forward alleging the Caltex franchise model is flawed, forcing underpayment of wages.

Crossey said he repeatedly told head office there was a problem with wage fraud but he was ignored.

Crossey sold out in 2014 because it was getting increasingly difficult to make a living. “It got to a point where we couldn’t be compliant and so I decided I wanted to be able to sleep at night so we sold out.”

The franchisee who bought one of Crossey’s stores is understood to have struggled and applied for financial assistance.

On January 11 a large group of franchisees gathered in Sydney to discuss the audit and payroll compliance issues. It is understood that some franchisees openly admitted to paying $14 an hour for wages. They blamed it on a franchise model that left them with little option but to cut corners.

Caltex has demonstrated it has a zero tolerance of wage fraud but unlike 7-Eleven, which has set up a compensation scheme and has so far paid $70 million to underpaid workers, Caltex is playing hardball, blaming it on the franchisees.

The best Caltex can do is offer counselling to workers, a hotline to report misconduct and a guarantee they will be paid properly in the future.

It is seizing stores and striking fear into the hearts of the franchise network.

Some may applaud such a hardline approach and argue it is a powerful weapon against worker exploitation.

It certainly is but in the US there have been examples were franchisors have been accused of deliberately churning franchisees to make money.

It has prompted speculation that Caltex’s end game is to use the audit to repossess most of the sites, turn them into corporate stores, then rack up the goodwill, which on the secondary market is valued at hundreds of millions of dollars.

Time will tell, but after a series of scandals in the $170 billion franchise industry and allegations of unsustainable business models the clock is ticking for some tough government action to get to the bottom of the mess.

Extracted from Australian Financial Review.