29 November 2013
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Law and Bills Digest
A franchise is an arrangement in which a ‘brand’ owner—the franchisor—allows a franchisee to trade under that brand and typically either allows, or requires, the franchisee to use the franchisor’s business and marketing systems.
The Competition and Consumer Act 2010 (CCA) and the Franchising Code of Conduct (the Code), which is made under the CCA, apply to franchises.
A common characteristic of franchises is that there is an imbalance of power between franchisors and franchisees. Amongst other reasons, this stems from franchisors generally being better resourced and having a deeper understanding of the business than franchisees, as well as having the upper hand in contract negotiations.
Between 2006 and 2008 there were five inquiries at the Commonwealth and state levels into franchising, which sought to address allegations of misuse of power by franchisors. The most significant of these reviews was carried out by the Parliamentary Joint Committee on Corporations and Financial Services, the report of which, entitled Opportunity not opportunism: improving conduct in Australian franchising, called for significant legislative amendments.
Amendments were made to the Code in 2007 and 2010, following which the former Labor Government stated that it did not intend to conduct any further reviews before 2013. On 4 January 2013, the Government appointed Alan Wein to review the Code with particular focus on:
- the efficacy of the amendments that had been made to the Code in 2007 and 2010 and
- other matters such as good faith in franchising, the rights of franchisees at the end of the term of their franchise agreements, including recognition for any contribution they have made to the building of the franchise and the operation of the provisions of the CCA as they relate to enforcement of the Code.
This research paper considers the rationale for many of the recommendations of the Wein review and examines whether the former Government’s mooted legislative amendments would effectively address an imbalance in the franchise relationship or be likely to tip the balance in favour of one party to the franchise agreement.
What is franchising?
Types of franchising
An unbalanced relationship
Reviews of franchising
Matthews review (2006)
South Australia (2007)
Western Australia (2007)
Federal Government: Opportunity not opportunism report (2008)
Expert panel (2010)
Wein review (2013)
Recurring key issues
Importance of disclosure
Current disclosure requirements
Disclosure of rights to compete with franchisee online
Wein review recommendation
Disclosure of unforeseen capital expenditure
Effectiveness of earlier amendments
Wein report recommendation
Disclosure about marketing funds
Limitations of the Code
Effectiveness of earlier amendments
Wein review recommendation—use of marketing funds
Wein review recommendation—accounting for marketing funds
Disclosure of risk before entering into an agreement
Wein review recommendation
Key issue—franchisor failure
Nature of the problem
Effectiveness of earlier amendments
Key issue—good faith in franchising
The duty of good faith
Effectiveness of earlier amendments
Wein review recommendation
Key issue—transfer, renewal and end of term arrangements
Franchisors impeding transfer of franchise by franchisees
Effectiveness of earlier amendments
Wein review recommendation
Renewal and end of term arrangements
Effectiveness of earlier amendments
Franchisee rights to payment for goodwill
Wein review recommendation
Comment—applying the common law
Key issue—dispute resolution
Dispute resolution behaviours
Effectiveness of earlier amendments
State based small business commissioners
Wein review recommendation
Key issues—attribution of legal costs to franchisees
Effectiveness of earlier amendments
Wein review recommendation
Comment—costs of dispute resolution
Current regulatory framework—Commonwealth
Effectiveness of earlier amendments
ACCC compliance and enforcement policy
Wein recommendation—civil pecuniary penalties
Comment—pros and cons of civil pecuniary penalties
Comment—lack of consistency across jurisdictions
Wein review recommendation—infringement notices and audit powers
Wein review recommendation—court orders
Comment—departure from other industry codes
Acknowledgements: thanks to my colleagues Robert Dolamore and Jonathan Chowns for their constructive criticism and comments on an earlier draft of this paper and to Catherine Lorimer for her skilful editing.
The object of the Competition and Consumer Act 2010 (CCA) is to promote competition and fair trading and to provide for consumer protection. The CCA includes a number of provisions that concern the franchising sector. The Franchising Code of Conduct (the Code) was made under Part IVB of the CCA, which provides a framework for industry codes generally. The Code aims to address one feature of franchise arrangements that is said to cause problems; that the franchisor usually has access to better information about the business and its prospects than the franchisee. The Code aims to strike a balance between mandating best practice in relation to disclosure and not unduly constraining the operation of the market.
Generally speaking, regulation must give stakeholders certainty and confidence. Government’s role is to provide protection for vulnerable groups and people and to regulate against conduct and behaviour which is improper, unacceptable and unlawful. The franchising industry is based on commercial arrangements in which both franchisors and franchisees bear some risk. The challenge for government in seeking to regulate conduct in the franchising industry, either through the CCA or the Code, is to strike a balance which protects potentially vulnerable franchisees without attempting to eliminate all risk for them.
This research paper considers the rationale for many of the recommendations of the Wein review and examines whether the former Government’s mooted legislative amendments would effectively address an imbalance in the franchise relationship or be likely to tip the balance in favour of one party to the franchise agreement.
Franchising is a business relationship in which the franchisor (the owner of the business providing the product or service) assigns to independent people (the franchisees) the right to market and distribute the franchisor’s goods or service, and to use the business name for a fixed period of time. The International Franchise Association defines franchising as a “continuing relationship in which the franchisor provides a licensed privilege to do business, plus assistance in organising training, merchandising and management in return for a consideration from the franchisee”.
The term ‘franchising’ is used to describe a number of business models including:
- manufacturer-retailer: where the retailer as franchisee sells the franchisor’s product directly to the public
- manufacturer-wholesaler: where the franchisee under license manufactures and distributes the franchisor’s product
- wholesaler-retailer: where the retailer as franchisee purchases products for retail sale from a franchisor wholesaler and
- retailer-retailer: where the franchisor markets a service, or a product, under a common name and standardised system, through a network of franchisees. This is the classic business format franchise which is the most popular of franchising types.
The business format franchise operates through the use of a format, or a comprehensive system for the conduct of the business, including such elements as business planning, management system, location, appearance and image and quality of goods. Standardisation, consistency and uniformity across all aspects are hallmarks of the business format franchise.
According to the 2012 Franchising Survey undertaken by the Asia-Pacific Centre for Franchising Excellence:
- there are approximately 1,180 business format franchisors in Australia in 2012, compared with 1,025 in 2010 and 1,100 in 2008
- the decline in the franchise sector that occurred during the Global Financial Crisis (GFC) and subsequent economic downturn in Australia between 2008 and 2010 has shifted into recovery mode with a return to net growth in the sector
- there are an estimated 73,000 units operating in business format franchises, reflecting an increase of four per cent during the recovery phase
- the net growth in franchising has occurred predominantly in non-retail industries and
- more than 400,000 people are employed directly in franchising.
The franchising relationship is commonly not evenly balanced. The franchisor generally has greater power because it is better resourced, owns or controls the intellectual property (including trade marks) relating to the franchise business, prepares the franchise agreement which may be offered to a potential franchisee on a ‘take it or leave it’ basis, has broad and detailed knowledge of the business and its prospects and may control the supply of materials and other inputs to the franchisee.
Despite the popularity of franchising in Australia, there has been significant and often very public complaints made about the operation of the franchising sector. First and foremost those complaints have been about the extent and completeness of disclosure. In addition, there have been accusations of improper conduct by franchisors such as churning, and restrictions on assignment. Other grievances have dealt with the issue of dispute resolution and the willingness of attendees to fully participate in the process. Finally, there have been myriad criticisms about the lack of enforceability of the Code.
It is this on-going level of complaints within an apparently popular business model that has given rise to a number of high level reviews.
Graeme Matthews led a review of the operation of the disclosure provisions of the Code in 2006 (the Matthews review). The aim of that review was to identify ways that the Code could be improved. The report by the Matthews Committee (the Matthews report), containing 27 separate recommendations, was delivered to the then Minister for Small Business and Tourism in October 2006.
The Howard Government responded to the report in February 2007, agreeing to 15 of the recommendations and agreeing in principle with six others.
In response to the Matthews review recommendations, the Code was amended with effect from 1 March 2008 (2007 amendments). The object of the amendments was to increase the transparency, quality and timeliness of disclosure to existing and prospective franchisees. Announcing the changes, the Minister stated that:
Prospective franchisees will have greater access to better information before signing on the dotted line. This will assist people to make the right decisions before investing large sums of their money in a business.
A summary of the changes is set out in Appendix 1 of this research paper.
On 24 October 2007 the Economic and Finance Committee of the South Australian Parliament announced an inquiry (the SA inquiry) into the efficacy of the laws regulating the franchise relationship, with particular emphasis on the disclosure of information to potential franchisees and dispute resolution processes.
The Final Report into Franchises by the Economic and Finance Committee (the SA report) was tabled in the South Australian Parliament on 6 May 2008. The key issues to emerge from the SA report were:
- whether the disclosure provisions in the Code are sufficient to counteract ‘churning’ and
- whether there is a duty for a franchisor to contract ‘in good faith’.
On 2 November 2007 the Small Business Minister for Western Australia, Margaret Quirk, announced an inquiry (the WA inquiry) into the operation of franchise businesses in that state.
The report of the Inquiry into the Operation of Franchise Businesses in Western Australia (the WA report) was published in April 2008. The key issues which arose from the WA report were:
- whether a franchisor could, or should, be compelled to enter into a new franchise agreement when the existing agreement ends and
- whether a franchisee should be entitled to compensation for the ‘good will’ that has been created for the franchisor at the end of the agreement period.
The most significant of the inquiries to be held at the Commonwealth level was carried out by the Parliamentary Joint Committee on Corporations and Financial Services (Corporations and Financial Services Committee). The report, entitled Opportunity not opportunism: improving conduct in Australian franchising, made 11 recommendations. Many of those recommendations addressed the common themes which had emerged in the earlier Commonwealth and state inquiries and which were repeated in evidence to the Corporations and Financial Services Committee, being:
- whether the disclosure provisions in the Code were sufficient
- whether a franchisor should be compelled to enter into a new agreement with a franchisee when the existing agreement ends
- whether there should be an obligation to contract in good faith
- whether a franchisor should pay ‘goodwill’ to a franchisee at the end of the franchise agreement in the absence of an option to enter into a new agreement
- whether the mediation arrangements set out in the Code were adequate and
- whether the enforcement provisions of the CCA were sufficient to deal with a breach of the Code.
A summary of the Committee’s recommendations is set out in Appendix 2 of this research paper.
The former Labor Government responded to the report of the Corporations and Financial Services Committee by appointing an expert panel to inquire into and report on the need to introduce measures into the Code to prevent specific behaviours that are inappropriate in a franchising arrangement. In particular the panel was to consider:
- imposition of unforeseen capital expenditure
- unilateral contract variation by the franchisor
- attribution of legal costs
- confidentiality agreements and
- franchisor-initiated changes to franchise agreements when a franchisee is trying to sell the business.
The expert panel report, entitled Strengthening statutory unconscionable conduct and the Franchising Code of Conduct (expert panel report) was submitted to the Government in February 2010. The Labor Government responded by further amending the Code (2010 amendments). A summary of the changes is set out in Appendix 3 of this research paper. Senator Sherry, the former Minister for Small Business, addressing the Franchise Council of Australia on 11 October 2011, stated:
Our amendments to the Franchising Code of Conduct came into force in July last year, giving the sector greater protection, transparency and certainty.
We stand firmly behind a national approach to franchising and we do not intend to review the Code of Conduct before 2013. This will allow sufficient time for the 2010 amendments to provide an informed evaluation.
Consistent with the statement by Senator Sherry, on 4 January 2013 the former Labor Government appointed Alan Wein to review the Code. In particular, his task was:
- to review the efficacy of the 2007 and 2010 amendments to the Code and
- to inquire into:
– good faith in franchising
– the rights of franchisees at the end of the term of their franchise agreements, including recognition for any contribution they have made to the building of the franchise and
– the operation of the provisions of the CCA as they relate to enforcement of the Code.
During the course of the review 73 submissions were received.
The Wein report, released on 17 May 2013, made 18 recommendations and a number of sub-recommendations. The Labor Government formally responded to the Wein review in July 2013, accepting 11 of the recommendations. In addition, the Government accepted two recommendations in part and eight in principle. A further two recommendations were noted.
As already stated, inquiries into franchising have been dominated by recurring issues. These are:
- the sufficiency of disclosure
- conduct of the parties in all aspects of the franchise agreement, including prior to entering the agreement
- franchisor insolvency
- enforcement of the Code and the need for financial penalties when it is breached.
The Wein review was no different. The remainder of this paper will consider the rationale for many of the recommendations of the Wein review, the latest in a long line of efforts to address issues which continue to trouble franchisees.
The former Labor Government responded to the Wein review with a range of mooted legislative amendments. Despite reports that the proposed franchising reforms have bi-partisan support, the new Abbott Government has not signalled its intentions at the date of publication.
It is the problem of information asymmetry between franchisors and franchisees that is the basis of the concerns about disclosure.
The importance of accurate and up to date disclosure cannot be overstated. Its purpose is to give to a prospective franchisee, or an existing franchisee who is proposing to enter into, renew or extend the scope of a franchise agreement, information from the franchisor that will allow the person to make a reasonably informed decision about the franchise. In addition, it concedes the fact that there are often difficulties for franchisees attempting to carry out due diligence before entering into a franchising agreement as would occur with, say, the purchase of an existing business. As Jenny Buchan of the Australian School of Business explains:
If the franchise is owned by a public company, there will be very little information that is specific to the wholly owned franchisor subsidiary in the published annual returns of the public company.
While it is not difficult to conduct a search of a proprietary company, franchisors often operate different aspects of their businesses through more than one legal entity. The more entities there are, the more expensive and difficult it becomes to conduct a robust due diligence. If any of those entities, including the franchisor, is a trust, it is not possible to objectively verify the identity of the beneficiaries from the public records …
The franchisee, faced with the high cost or the impossibility of conducting a thorough due diligence for itself, will decide to trust the franchisor’s information more or less on face value, or walk away.
The Code is designed to ensure that franchisees are given information that is material to the running of the franchised business, and provide access to a fast and relatively inexpensive way to resolve any disputes. Broadly, it achieves this by requiring franchisors to disclose specific facts to franchisees and to follow set procedures in their dealings with franchisees.
Franchisors are required to create and maintain a disclosure document. The disclosure document must be consistent with the format set out in either Annexure 1 or Annexure 2 of the Code. It must contain information about a range of matters including, but not limited to:
- current and past proceedings (including litigation and arbitration) against the franchisor and directors of the franchisor
- the franchise site or territory
- the supply of goods or services to and from a franchisee
- marketing or cooperative funds to which the franchisee may be required to contribute
- payments that will have to be made by the franchisee in relation to the franchise
- arrangements that apply at the end of the franchise agreement and
- financial details of the franchisor.
The appropriate disclosure document and a copy of the Code must be provided to prospective franchisees and to franchisees proposing to renew or extend an existing franchise agreement at least 14 days before the prospective franchisee enters into, renews or extends the relevant franchise agreement or makes a non‑refundable payment to the franchisor or an associate of the franchisor in connection with the proposed franchise agreement.
The previous reviews of the Code, which are outlined above, recommended various changes to the disclosure provisions. This led to the passage of the 2007 amendments and the 2010 amendments. In accordance with its terms of reference, the Wein review considered whether those amendments to the disclosure provisions had been effective and whether further amendments were needed.
The current disclosure provisions require disclosure of information about a franchisee’s right to operate in an exclusive or non-exclusive territory and whether the franchisor or other franchisees may operate a business that is substantially the same as the franchised business in the franchisee’s territory.
It is unclear, however, whether the franchisor is required to disclose its ability to compete with a franchisee online which would give it access to all physical territories. The Lottery Agents’ Association of Victoria expressed its concern that their franchisor’s move into online markets has had an adverse effect on them in their position as franchisees.
That view was endorsed by the Australian Competition and Consumer Commission (ACCC) in a submission to the review. The ACCC reported receiving 17 complaints from franchisees who were concerned that their franchisor was competing against them through its website.
The Wein review accepted there was a problem in relation to the potential for a franchisor or other franchisees to compete online with a franchisee, concluding that ‘the disclosure of online trading is important to ensure that the provisions of the Code keep pace with changes in technology and purchasing behaviours’. It recommended that the Code be amended to ensure that a franchisor is required to disclose the rights of the franchisor and franchisee to conduct and benefit from online sales, including any ability of the franchisor to conduct online sales.
The Labor Government accepted this proposal with an additional requirement that the franchisor disclose its intention to conduct online sales and not just its ability to do so.
This amendment will be a positive step for franchisors. It does not prevent a franchisor from conducting online sales in competition with the franchisee—provided that the proposed competition is disclosed. This will allow a prospective franchisee to make an informed decision about whether to become a part of that particular franchise.
Franchisees may be required, at times, to undertake capital expenditure to remain competitive and respond to market demands, franchise improvements (such as an increase in the range of products on offer) and regulatory changes. This may be by way of updated branding, shop fit-out or even site relocation. Problems arise when the capital outlay is not outlined to the franchisee prior to entering into the agreement or where the term of the franchise is too short for the franchisee to recoup his or her investment.
In response to these concerns, the 2010 amendments to the Code included a requirement that a franchisor disclose whether the franchisee, through the franchise agreement, the operations manual (or equivalent), or any other means, could be obliged to undertake unforeseen significant capital expenditure that was not disclosed before the franchisee entered into the franchise agreement.
According to one submitter to the Wein review:
Providing details of “unforseen expenses” is in itself a complete nonsense. If the expenses are unforseen, how can a franchisor fill in this section of the Disclosure with any degree of accuracy?
What has occurred practically is that some documents now contain a horrifically long list of possible expenses, the majority of which are highly unlikely to ever occur.
The Queensland Law Society also questioned the efficacy of the amendment stating that ‘the clause needs to be more specific about what is required to be disclosed and more specific about the amounts of the possible capital expenditure that will be undertaken’.
The Wein report considered that a requirement that a franchisee incur significant capital expenditure must not be ‘unreasonable’. That is, ‘there should be a business case for the imposition of the expenditure’. To that end, it recommended that the Code be amended to prohibit franchisors from imposing unreasonable significant unforeseen capital expenditure. The Wein review recommended that the terms ‘unreasonable’ and ‘significant’ should be defined. In essence, a franchisor requiring franchisees to incur significant capital expenditure, the nature and extent of which was not set out in the relevant disclosure document, would have to be able to demonstrate a business case for capital investment in the franchised business.
This recommendation was accepted in principle by the former Labor Government—due to the difficulty in defining the relevant terms. Acknowledging that item 13A of the disclosure document has not been as effective in practice as was intended, the former Labor Government stated that it would remove the requirement to disclose unforeseen capital expenditure in item 13A and include some common examples in the generic risk statement.
From the franchisee perspective, this response fails to address the underlying concern that they may be required, during the life of the franchise agreement, to make significant capital expenditure that they did not foresee and was not disclosed in a meaningful way. This is the harm that item 13A was intended to address.
From the franchisor perspective, the decision to remove item 13A supports the franchisor position that there can be valid reasons for unforeseen capital expenditure.
The introduction of unforeseen refurbishments or other costs may introduce significant financial difficulties for franchisees, particularly if costs are introduced close to the end of the franchise term. However, in the case of rebranding, a franchisor needs to consider all of its franchisees as well as the image of the franchise as a whole. As such, the franchisor may need to ensure refurbishments were introduced into all of its franchised outlets within a defined timeframe … individual franchise agreements are likely to have different start and finish dates, therefore some franchisees could face unforeseen refurbishment costs at the end of their term, others could face these costs at the beginning of the term and others could face the costs in the middle of the term. It is also important to consider that while shop re-fits or the introduction of new policies may require substantial capital outlays from franchisees, a refurbished shop may attract additional customers, which could be beneficial to both individual franchisees and the franchise as a whole.
According to the expert panel there was insufficient evidence about the prevalence of inappropriate conduct in this area. That being the case, ‘a general prohibition of the behaviour may constrain franchisors from making valid commercial decisions, and may not be a proportional response to a potentially confined problem’.
The Wein review seems to have tried to find a middle ground. It did not recommend a prohibition of the behaviour. Instead the Wein review advocated for a reasonableness test in relation to undisclosed capital outlays. What remains though, are questions about who decides what is reasonable and what is not. Presumably these are matters for the courts. In that case, the recommendation delivers neither an easy, or inexpensive, solution to the problem nor certainty for either party to a franchise agreement.
Most franchise agreements require that the franchisee contribute either a fixed amount or a percentage of their turnover to a marketing fund. Most franchise agreements also state that the fund will be used at the discretion of the franchisor and the franchisor does not need to spend a certain amount, or for that matter any amount, of the money contributed in the franchisee’s area.
As early as 2006, the Matthews review noted concerns from franchisees about the operation and management of marketing and other co-operative funds. The concerns related to the lack of transparency in the management and application of such funds and the fate of the franchisees’ contributions in the event of franchisor failure.
In its submission to the Wein review, the ACCC stated that it had received 49 complaints in the last five years about how franchisors are spending marketing funds. The problems with marketing funds have been described as follows:
Some franchisors spend the money in areas which the franchisees do not believe is strictly marketing. For example: a franchise system which uses the money for the registration and maintenance of existing or new trade marks.
… Others want to spend the money attending franchise expos because they believe that is marketing of the system. Some others want to spend the money on conferences.
Those uses of funds are not what would be thought of by any reasonable franchisee as being what was contemplated by the franchisee when they were originally told they were expected to contribute to a fund.
Clause 17 of the Code provides that franchisors are required to provide relevant audited financial statements within five months of the end of the financial year to franchisees who make payments into marketing or other co-operative funds. However, a franchisor does not have to provide a statement if 75 per cent of the franchisor’s franchisees who contribute to the fund, have voted to agree that the franchisor does not have to do so. That agreement remains in force for three years at the end of which time, the franchisees must vote again.
A number of problems arise in relation to marketing funds due to deficiencies in the Code.
First, there is no requirement in clause 17 to particularise the expenditure of monies in the fund. In that case, it is impossible for franchisees to determine what advertising activities were undertaken and where they were undertaken during the relevant financial year. This makes it extremely difficult for a franchisee to determine whether the monies were spent appropriately. If a franchisee disagrees with the way that the monies were expended, he or she may have no recourse but to accept the franchisor’s explanation, depending on the drafting of the franchise agreement.
Second, there is no requirement in clause 17 that monies which are paid to a marketing fund by franchisees be kept by the franchisor in a separate fund. Rather, they may be mixed with other royalty and fee payments in a general fund operated by the franchisor. This makes the auditing of the marketing fund more complex and expensive.
Third, the Code does not require that monies levied on franchisees for marketing and advertising are actually spent.
Fourth, whilst subclause 17(4) of the Code provides that monies paid into a marketing fund must be used to pay for the reasonable costs of administering and auditing the fund, the Code does not limit that amount or provide a method for its calculation.
The Matthews review noted that, at that time, franchisors had an option to seek approval from 75 per cent of their franchisees to avoid the requirement to have marketing funds audited. The Matthews review recommended that the option be removed. The 2007 amendments did not put this recommendation into effect. (That is, subclause 17(2) was not deleted). However, under the 2007 amendment the decision to choose whether annual audits are to be undertaken is to be renewed every three years.
According to the Wein review those ‘amendments to the Code do not appear to have gone far enough to prevent disputation and potential, or perceived, misuse of marketing and advertising funds’. Consequently, the Wein review recommended that a number of amendments be made to the Code in relation to the administration of marketing funds.
First, the marketing and advertising fund should only be used for expenses which are clearly disclosed to franchisees by way of the disclosure document, and which are legitimate marketing and advertising expenses.
The former Labor Government accepted this recommendation.
Whilst this will be a welcome statement of principle for franchisees, there is no detail about what will be considered a ‘legitimate’ expense. Depending on how broadly that term is defined, it may be that some franchisees will remain frustrated by the manner in which marketing funds are expended. At the same time, some franchisors may consider that it is not appropriate for the Government to interfere in what are essentially commercial decisions for the benefit of the franchise as a whole.
Second, it was recommended that a franchisor should separately account for marketing and advertising costs. This is a direct response to a call by submitters to the Wein review that ‘it would be prudent for the marketing or other cooperative fund [to] be explicitly required to be held in trust for franchisees instead of being incorporated into the franchisor’s general revenue’.
In addition, the Wein review recommended that contributions to marketing funds from individual franchisees should be held on trust for franchisees generally, with the franchisor to have wide discretion as to how to expend the funds, subject to an annual independent audit.
The former Labor Government was silent about whether it would require marketing and advertising costs to be placed into a separate account, stating only that it would take steps to make the administration of those funds more transparent.
However it stated that it would ‘not amend the Code to require that marketing and advertising funds are to be treated as trust funds or held in a trust account’.
The requirement that marketing funds should be placed in a trust account is not a new idea. As early as 2006, submitters to the Matthews review suggested that this should occur. However the Matthews review rejected the suggestion. The Labor Government then concurred with that position. It rejected the Wein review recommendation on the grounds that imposing such a requirement could result in unintended tax consequences and ‘may increase the compliance costs and risks in a way that is disproportionate to the benefit that a trust fund arrangement would confer on franchisees’.
From a franchisee perspective, if marketing or other co-operative funds were to be treated as trust funds or held in a trust account the franchisee ‘can then have a chance of recouping the money if an administrator is appointed to the franchisor. This would provide better ultimate protection than an audit and may cost the franchisor less’. If the recommendation were accepted, a fiduciary relationship would be established between the franchisor and franchisee in relation to those monies. In that case, the franchisor would have a duty not to retain the benefit of the funds in the marketing account for him or herself. This would go some way to appeasing those franchisees who consider that the franchisor has not spent marketing funds appropriately—in particular where the relevant funds were not spent at all.
From the franchisor perspective requiring these funds to be placed in a trust account may be considered to create an unwelcome increase in the cost of administering the franchise business.
The power imbalance between a franchisor and its franchisees is apparent in the operation of clause 17 of the Code. The Wein review recommendation, if accepted in total, would have imposed onerous duties on franchisors with respect to marketing and advertising funds. However, the recommendation as accepted by the Government does not appear to fully address the gaps in clause 17 of the Code which impact significantly on franchisees as outlined above.
In its original form, the Code required that a statement be set out on the first page of the disclosure document which indicated, amongst other things, that entering into a franchise agreement is ‘a serious undertaking’ and that the franchise agreement would be legally binding once it was signed.
The adequacy of the statement was questioned in 2006 by the Matthews review, which noted that some of the problems which had been revealed during the review ‘may have been avoided if the prospective franchisee had a clearer understanding of the significant risks that were involved in becoming a franchisee’.
The matter was raised again in submissions to the Corporations and Financial Services Committee, which recommended that the Code be amended to require that disclosure documents have a ‘clear statement by franchisors of the liabilities and consequences applying to franchisees in the event of franchisee failure’. The 2010 amendments included such a statement. The risk statement in its current form is set out in Appendix 4.
The expert panel took the matter a little further, recommending that a short, simple, ‘plain English’ document be provided to prospective franchisees earlier in the process of entering a franchise agreement ‘to ensure the message is conveyed prior to the franchisee becoming emotionally invested in the particular franchise opportunity’. The document, as proposed by the expert panel, ‘would emphasise to prospective franchisees the key costs, benefits and risks of the franchise system, while leaving more complete disclosure to the formal disclosure documents already required’.
The Wein review considered that ‘the arguments in favour of a short summary of key risks and matters a prospective franchisee should be aware of when going into franchising are persuasive’. The Wein review recommended that the Code be amended to require that a short generic statement, setting out the key risks and other matters of which a prospective franchisee should be aware, and be provided at the first point of contact with the franchisee.
The former Labor Government accepted the recommendation and stated its intention to develop the final form of the document in consultation with key stakeholders. The provision of the risk statement will be required only in respect of the first grant of a franchise, including to an incoming party as part of a transfer or novation. This means that franchisees that are renewing, extending, or extending the scope of, their franchise agreement will not need to be provided with the risk statement. Clearly, as that group of franchisees already has a relationship with the franchisor, the need for a low level, simple risk statement is less pressing.
According to the ACCC:
There is anecdotal evidence (and complaint data) suggesting that many franchisees do not read, or at least do not understand, the disclosure document they receive before they enter into a franchise agreement. This is usually attributed to the length and complexity of most disclosure documents.
The provision of the sort of risk statement which has been mooted does not address the concern that a potential franchisee may not make a rigorous assessment of the contents of the disclosure document. At its worst, the potential franchisee may interpret the risk statement as an assurance that the franchise business is low risk.
In addition, despite its recommendation, the Wein review acknowledged the lack of clarity around what the proposed risk statement would contain and the extent to which it would depart from the requirements of the existing item 1 of Annexure 1 to the Code. The ACCC suggests that such a document could set out those elements of a franchising arrangement that appear to be most misunderstood by franchisees such as rights to renewal, what happens if the agreement is not renewed, the franchisor’s right to terminate the agreement for breach by the franchisee, and what happens if the franchisor fails—even though that information is already contained in the disclosure document.
Depending on many variables, such as the strength of the franchisor’s brand, the size of the franchisee’s investment, the amount of money the franchisee has borrowed, the particular franchise model adhered to, the amount of time remaining on the franchise and the location of franchisees’ businesses, the impact of the franchisor’s failure on its franchisees ranges from slight to catastrophic.
Clause 23 of the Code provides that a franchisor may terminate a franchisee under specified circumstances. However, the Code does not contain an equivalent right for a franchisee to exit the contract in the event of franchisor failure.
The operation of the Code must be considered in the context of the Corporations Act 2001. When a business fails, the Corporations Act operates to allow for the orderly winding up and deregistration of the insolvent company. Generally the liquidator is concerned with exercising control of as much property as is available that can then be realised for the benefit of creditors. However, in some cases liquidators do not wish to retain property because it is too onerous, worth little or is unsaleable. In those circumstances, liquidators will wish to get rid of the property in order to avoid the responsibilities and costs in relation to it and to avoid prolonging of the administration. A liquidator may do this by an action of disclaimer under section 568 of the Corporations Act.
Once a liquidator has been appointed for a franchisor, the individual agreements between the franchisor and its franchisees become either an asset or a liability in the franchisor’s insolvency. As the franchisor’s insolvency does not automatically bring the franchise agreements to an end, it is for the liquidator to decide whether to exercise his or her right to disclaim onerous assets—including, but not limited to, a lease of the premises a franchisee trades from, an agreement with a supplier or the franchise agreement itself.
The Corporations and Financial Services Committee sets out the problem of franchisor failure as follows:
… though section 18(2)(g) of the Code requires the franchisor to give written notice to a franchisee or prospective franchisee when the franchisor becomes an externally administered body corporate, the appointment of an administrator for a franchise system does not of itself terminate or constitute repudiation of the agreement. When companies fail, secured creditors are given priority over remaining assets, followed by unsecured creditors, shareholders and then other parties. When a franchisor fails, a franchisee may be terminated with little prospect of compensation or ability to continue trading, yet may still be required to pay franchise fees, including royalty payments, to the liquidator until the franchisor is wound up—despite no longer receiving support or services from the franchisor.
The problem is compounded by the lack of contractual remedies available to the franchisees of an insolvent franchisor. Franchisees cannot sue an insolvent franchisor in contract for the following reasons:
- the franchisor has not breached the franchise agreement by becoming insolvent as the agreement is invariably silent on the issue
- the contractual remedy of an award of damages is useless in circumstances where the franchisor has no assets
- the powers given to administrators and liquidators under the Corporations Act trump contract law rights and
- no one except a liquidator can initiate proceedings against a party in administration without the consent of the court—a step which would be prohibitively expensive for a franchisee.
The Corporations and Financial Services Committee recommended that ‘the Government explore avenues to better balance the rights and liabilities of involved parties in the event of franchisor failure’. As already stated, a warning about the risk to the franchisee of franchisor failure was included in the generic risk statement until the 2010 amendments came into effect (see Appendix 4).
In accordance with its terms of reference, the Wein review canvassed opinions about whether the amendment had been effective. Jenny Buchan of the University of New South Wales submitted that:
This notice is insufficient to warn franchisees about the specific risk they as a franchisee potentially face if their franchisor fails. Every franchise network is structured differently so there are numerous possible scenarios when one party becomes insolvent. It is within the franchisor’s power to set out the basic likely consequences … The current wording does not go far enough to set out in black and white what the consequences of insolvency may be.
The Wein review noted that ‘in general, submissions to the review felt that the government’s 2010 amendment to the Code did little to address the problem of franchisor failure’. However, it also acknowledged that it had received ‘no submissions from franchisees (or former franchisees) who stated they had participated in a franchisor’s business which subsequently went into insolvency’. That being the case, it is unclear how many franchisees have been affected by franchisor failure.
Nevertheless, the Wein review recommended, in recognition that the problem of franchisor failure is a ‘serious and ongoing one’, further amendment of the Code to ‘provide franchisees with more certainty regarding the procedure and timing of the options they will be faced with if the franchisor fails’. The proposed amendment has two parts:
- provide franchisees and franchisors with a right to terminate the franchise agreement in the event that any administrator of the other party does not turn the business around, or a new buyer is not found for the franchise system, within a reasonable time (recommendation 6a) and
- ensure the franchisees can be made unsecured creditors of the franchisor by notionally apportioning the franchise fee across the term of the franchise agreement, so that any amount referrable to the unexpired portion of the franchise agreement would become a debt in the event the franchise agreement ended due to the franchisor’s failure (recommendation 6b).
Both parts of the recommendation were accepted in principle by the former Government, which stated that it would undertake further consultation with the industry and with relevant experts on the implications of the recommendation.
There are different types of ‘administration’—insolvency, receiver management, voluntary administration, or personal bankruptcy; the nature of the administration of the franchisor will have a bearing on how recommendation 6a would operate. The Wein review acknowledged that appointed insolvency officials may have different powers and obligations. This is one of the reasons that the Government needs to consult further on the recommendation.
From a franchisee perspective, allowing the franchisee to terminate the franchise agreement relieves him, or her, of the ongoing obligation to pay fees for services and products which the franchisor may no longer be delivering and to make ongoing royalty payments.
However, it is not a ‘cure all’ measure for franchisees. It will not release the franchisee from third party obligations. For example, a franchisee may still have to meet lease payments for premises and equipment which were used in the franchise business. In that case, the termination of the franchise agreement may well be an act that crystallises the franchisee’s own business debts, thereby sending him, or her, inadvertently into bankruptcy or insolvency.
The far-reaching effects on franchisees arising from franchisor failure are described as follows:
Although franchisees may be creditors, that status does not fully recognise the extent of their investment in the franchise, or their losses when the franchisor fails. In fact, if a liquidator is appointed to a franchisor, the franchisee may experience outcomes it had not contemplated by way of the liquidation crystallising not only the claims of the franchisee but also the liabilities the franchisor required the franchisee to take on to third parties.
From a franchisor’s perspective, the effect of recommendation 6a may be interpreted as an attempt to thwart the efforts of the administrator or liquidator to sell the franchise business as a going concern. In addition, the Wein review conceded that the ability of franchisors to attract and retain capital and credit could be affected by changes which significantly altered the right of the parties on the insolvency of a franchisor, such as an immediate right for the franchisee to terminate. Hence the recommendation that the franchisee’s right to terminate should only arise ‘within a reasonable time’ such as 60 days.
A liquidator is responsible for collecting the assets of the failed franchisor and distributing them to the creditors. Debts are paid in the order stipulated in the Corporations Act. If the funds are insufficient to meet all the debts in full, they are paid proportionately. In addition, a liquidator may hold a creditors’ meeting (or meetings) to advise the creditors of the likelihood of a return, the progress of the winding up and to allow the creditors’ wishes to be taken into account.
Under recommendation 6b, a franchisee of a failed franchisor becomes an unsecured creditor in any winding up. This will give franchisees the right to attend a creditors’ meeting. However the notional debt created by recommendation 6b is not a priority debt. As unsecured creditors, franchisees’ rights to distribution of monies come after the franchisor’s employees and secured creditors in terms of priority. That being the case, many franchisees may see any amendment in response to this recommendation as not delivering any concrete benefit to them.
The question arises whether insolvency and bankruptcy law in Australia ‘simply do not provide viable solutions for franchisees and failed franchisors’. The Wein review cautioned against tipping the balance of the franchise relationship in the event of insolvency stating:
While the result for franchisors and franchisees in the context of insolvency will almost always be a negative one, that does not necessarily mean there is a problem with the insolvency regime. Rather, it is a consequence of insolvency itself.
No policy rationale has been put forward which would justify making franchisees a special case in the insolvency regime at this time. However, the commercial implications of the Personal Property Securities Act 2009 on the franchise sector are yet to be assessed . It has been reported that:
Franchisors are amending their agreements, in light of the new legislation, to provide the franchisor with the power to register their security interests against the franchisee and to prohibit the franchisee from giving security interests to third parties without the franchisor’s consent. In addition [Personal Property Securities Act] … provides specific ‘notice’ requirements when franchisors want to take back possession of goods on termination.
Greater franchisee education would appear to be warranted. This would include ‘not just the insolvency of the franchisor but also entities that may be relevant to the network such as the owner of [the intellectual property in the brand], any leasing company and any companies that supply goods or services to the network that may be related to the franchisor or to its owners’.
Calls for a requirement that there be a duty of good faith in franchising have typically accompanied allegations of opportunistic conduct by franchisors who are perceived to be taking advantage of the imbalance of bargaining power between franchisors and franchisees.
The Wein review noted that there had been repeated calls over time for the introduction into the Code of an express duty to act in good faith. In particular, the Corporations and Financial Services Committee expressed its concern at the continuing absence of an explicit overarching standard of conduct for parties entering into a franchising agreement. The Corporations and Financial Services Committee accepted that there is an inherent and necessary imbalance of power in franchise agreements in favour of the franchisor. Unfortunately, abuse of the power could lead to a range of opportunistic conduct including ‘encroachment, kickbacks, churning, non‑renewal, transfer, termination at will and unreasonable unilateral variations to the agreement’. As a result, the Corporations and Financial Services Committee gave lengthy consideration to the question of whether a duty to act in good faith should be inserted into the Code—and decided that it should.
In broad terms the duty of good faith connotes compliance with honest standards of conduct which are reasonable, having regard to the interests of the parties.
There is disagreement about whether Australian law has unequivocally accepted a duty of good faith in the performance and enforcement of contracts generally.
In relation to franchises, there is legal authority for the view that a duty of good faith can be implied. The NSW Supreme Court said in a 2007 case that the duty requires the franchisor to act:
- reasonably and honestly
- without simply relying on information provided by third parties or ‘wilfully shutting (one’s) eyes’ or refraining from making inquiries, but exercising the degree of ‘caution and diligence to be expected of an honest person of ordinary prudence’
- without some ulterior motive
- with recognition and regard to the legitimate interests of both parties in the enjoyment of the fruits of the contract, and
- to avoid action rendering the plaintiff’s interests under the agreement ‘nugatory, worthless, or … seriously undermined’
However, the High Court has not reached a binding conclusion on the issue.
In Australia, some courts have accepted, to some degree, the implication of obligations of good faith in contractual dealings. For instance, it has been suggested that good faith embraces three notions: an obligation on the parties to cooperate in achieving their contractual objects, compliance with honest standards of conduct and compliance with standards of conduct which are reasonable having regard to the interests of the parties. However, uniform acceptance and understanding of concepts, content and implications of good faith obligations has not emerged in the Australian jurisdictions.
Just as some Australian courts have tried to define what conduct satisfies the duty of good faith, others have expressed views about the limits of the duty. The NSW Court of Appeal had this to say:
… it was appropriate to imply into the Agreement an obligation that the parties would act in good faith towards each other. That is consistent with the approach adopted in a number of decisions of this court … However, these decisions have emphasised that the obligation does not require a party to act in the interests of the other party or subordinate its own legitimate interests to those of the other party, although it does require it to have due regard to the rights and interests of the other party. 
Despite the recommendations of the Corporations and Financial Services Committee, the Government did not insert a duty of good faith into the Code in the terms that had been suggested. The Regulatory Impact Statement for the 2010 amendments explains the arguments for and against the imposition of the duty as follows:
On one hand, proponents of the need for a reference to good faith within the Franchising Code argue that it could serve as an aspirational goal for franchise sector participants, would recognise the interdependent nature of the franchising relationship and would recognise a principle which is being tested in the Courts. In contrast … there is wide disagreement in both the Courts and academia as to the suitability and applicability of the good faith principle in commercial arrangements. Furthermore … there is a lack of a universally accepted specific definition of good faith and there is wide disagreement on the implications of inserting a reference to good faith within the Franchising Code.
As a compromise, clause 23A was inserted into the Code by the 2010 amendments to provide that nothing in the Code limits any obligation imposed by the common law, applicable in a state or territory, on the parties to a franchising agreement to act in good faith. According to the relevant explanatory statement ‘the insertion of the new clause 23A within the Code preserves and recognises any developments in the case law on the concept of good faith’.
According to the Wein review, the key concerns with clause 23A are that:
- it does not necessarily prevent arguments that there is no duty to act in good faith
- it can be contracted out of by the parties
- it is not a duty under the Code and is therefore not enforceable by the ACCC and
- because it is not defined, the nature of any obligation to act in good faith presents a ‘lawyers picnic’ as parties have to get legal advice about what it means.
The Wein report notes that, when the inclusion of a duty of good faith was first mooted:
The government was concerned that uncertainty would be increased by an express statement of the requirement in the Code, since neither franchisors nor franchisees would be certain of the occurrence of a breach. Further, in any given situation the franchisor’s perspective on the scope of the concept may differ from that of the franchisee.
Those comments remain valid. One submitter stated:
Good faith is a term with capacity to mislead franchisees who would believe that it means what it says: good faith. It is impossible for franchisors and franchisees to approach all issues in good faith as their relationship is replete with conflicts of interest. … It is optimistic to think it would be possible to monitor whether good faith has been adhered to in a franchise. … I would delete Clause 23A that was inserted in 2010 as I believe it has the potential to delude the parties into a sense of unachievable entitlement.
Unsurprisingly, most of the submissions to the Wein review commented on the issue, displaying the same polarity of views as were expressed to previous inquiries. However, according to the Wein review, ‘more submissions supported an obligation to act in good faith than did not support such an obligation’. That being the case the Wein review recommended that the Code be amended to include an express obligation to act in good faith. The recommended application of the duty of good faith is extremely broad. It is to:
- extend to the negotiation of a franchise agreement, the performance of a franchise agreement, the performance of obligations under the Code, and the resolution of any disputes between the parties
- apply to both the franchisor and the franchisee or prospective franchisee and the agents of these parties and
- not be able to be limited or excluded by any provision of the franchise agreement.
The former Labor Government’s response to the recommendation was lukewarm. Whilst it stated that it accepted the recommendation, it also noted its concerns about:
- the application of the duty—that is, whether it should apply to all aspects of the franchise agreement, including negotiations of the agreement—and whether the unwritten law of good faith should be extended to the performance of all obligations of the Code
- the nature of the duty and
- the extension of the duty to agents which ‘may result in the Code regulating parties who it was not intended to regulate’.
Recommendation 9b is that the unwritten law relating to good faith should be incorporated into the Code in a manner similar to that which was used to incorporate the unwritten law related to unconscionable conduct into the Australian Consumer Law. The Wein review suggests that the following conduct may be interpreted as conduct which is not in good faith:
- the franchisor imposing unsafe practices for workers or customers
- forcing franchisees to promote the franchisor’s products in a way that diminishes the sale of other products sold by the franchisee
- general mismanagement and waste of marketing funds
- threatening the franchisee with breach, non-renewal, or competition from a new operator if certain conditions are not met
- forcing inventory upon the franchisee and requiring it to sell products with unsustainable margins
- forcing the franchisee to buy overpriced goods from the franchisor
- cost shifting to the franchisee or not maintaining the franchisee’s margin and
- franchisees using social media to post negative comments about their franchisor or their dispute with their franchisor.
The danger in inserting an express obligation to act in good faith as recommended is that aggrieved franchisees may interpret the obligation differently from the courts. This is even more so, in the context of proposed amendments to the Code to impose pecuniary penalties for a breach of the Code. Recommendation 9f specifically responds to the possibility that franchisees might interpret the duty more broadly than intended.
Importantly, recommendation 9c provides that the duty will apply to both the franchisor and the franchisee. As one submitter stated:
Regrettably, I have seen many instances of franchisees behaving poorly in the lead up to mediations, including the posting of denigrating comments on internet blogs and social media and discussing the subject matter of their dispute with mainstream media …
Clearly such action would be considered bad faith and the mandating of obligations for parties to act in good faith would give the franchisor access to remedies for code breaches in these circumstances.
Whilst the inclusion of such a list may be instructive, it is always for the court to determine the question based on the precise circumstances of each individual case. Importantly, it may:
… add to the sentiment of over regulation in the franchising industry, particularly from the perspective of overseas investors. It may also lead [to] would-be franchisors deciding to pursue a different business model, which would have the effect of decreasing participation in the sector.
There are foreseeable difficulties in interpreting the obligation to act in good faith in the context of a relational contract such as a franchise agreement. However, the inclusion of such a duty would allow the courts to consider, on a case by case basis, the nature of the obligation and the types of conduct that breach it. This would allow fine tuning of the relevant provision in the future as the jurisprudence around good faith in franchising emerges.
When a franchisee decides to sell his or her franchise business, the franchisor may have a number of options open to it, depending on the nature of the franchise agreement:
- the franchisor may have an option to buy the business for itself. In that case the franchisor may decide to operate a company owned franchise business at the relevant site
- the franchisor may allow the franchisee to sell the franchise business based on the franchise agreement which is in force or
- the franchisor may opt to allow the franchisee to sell the franchise business based on a new franchise agreement.
Where the franchisor requires a sale to proceed based on a new agreement, delays in updating the franchise agreement may defer the sale process. In addition, the changes to the franchise agreement may make the franchise less attractive to a prospective purchaser by, for example, reducing the term of the agreement, the extent of the franchisee territory or other changes that reduce the expected return on investment for the incoming franchisee. These concerns were raised in a submission to the Wein review by the LPO Group, which argued that:
Australia Post is also taking advantage of the assignment process to make amendments to individual License Agreements. Consent to assignment is withheld until the purchasers agree to changes to the existing Licence, in breach of the original Agreement. Vendors are informed by Australia Post that they have no say in this process as the Agreement is between the purchaser and Australia Post and does not extend to the vendor. This effectively means an existing Licensee has no right to sell the business they own and operate, and the means to realise the return on the capital investment has been greatly diminished, if not extinguished.
Nevertheless, the expert panel acknowledged that:
…there may be legitimate commercial and regulatory reasons for the franchisor to amend the franchise agreement; these amendments may take effect in some agreements toward the end of the term while in others toward the beginning. It is therefore not appropriate to prohibit this behaviour. [emphasis added]
In order to balance the rights of franchisors to amend the franchise agreement against those of franchisees at the time of sale of a franchise, the 2010 amendments contained the following changes to the Code:
- a definition of the term novation was inserted into clause 3 of the Code
- item 17A of the disclosure document requires franchisors to disclose the circumstances in which the franchisor has unilaterally varied a franchise agreement in the last three financial years and the circumstances in which unilateral variations to their agreement may take place in the future and
- item 17D of the disclosure document requires disclosure about whether the franchisor will amend the franchise agreement on or before the transfer or novation of a franchise agreement.
The Queensland Law Society argued that the definition of novation which had been inserted into the Code does not ‘reflect normal practice’ and ‘should be clarified’. Other submitters agreed that ‘the terminology in the Code does not reflect the way in which franchisors typically require franchise business sales to occur’.
There is a difference between a franchisee seeking a purchaser for his or her business and a franchisor seeking a potential franchisee whose values and work ethic are consistent with the franchisor’s and who will bring financial resources to the franchise business. Where the sale of an existing franchisee business involves the execution of a new agreement, the purchaser is entitled to all the rights afforded to a prospective franchisee. As the initial negotiations occur between the existing and potential franchisees rather than between the franchisor and the potential franchisee the time taken by a franchisor to consent to a sale may be exacerbated by a lack of information about a potential purchaser.
According to the Wein review, novation ‘is a highly technical area of the law … but in the short time it has been in place it has raised nascent concerns about how the provisions actually operate when placed up against what is happening in the marketplace’. As it was clear that ‘some confusion could result from the present wording’, the Wein review made recommendations to clarify the time limits within which the franchisor must consent to a transfer of a franchise agreement.
The Wein review recommended that subclause 20(4) of the Code be amended to read:
- The franchisor is taken to have given consent to the transfer or novation if the franchisor does not, within 42 days after the request was made, or all information reasonably required by the franchisor under the franchise agreement has been provided, whichever is the latter, give to the franchisee written notice:
(i) that consent is withheld; and
(ii) setting out why consent is withheld.
b. The franchisee should take all reasonable steps to provide all information required under the franchise agreement to enable the franchisor to be able to properly evaluate the request. [Amendments underlined]
The recommendation was accepted in principle, with the former Labor Government noting that ‘some franchisees have expressed concern that the proposed wording may allow a franchisor to frustrate or delay the transfer or novation by repeatedly requesting additional information from the franchisee’.
The Corporations and Financial Services Committee considered the following matters related to end of agreement arrangements:
- whether there should be an automatic right of renewal at the end of the first term of a franchise agreement or whether non-renewal by a franchisor should only be permitted where ‘good cause’ can be shown
- the circumstances in which a franchisor should be able to terminate an agreement, including potential abuses of current termination provisions within the Code (churning)
- whether a payment for the franchisee’s contributed value to the business (goodwill) should be mandated if the agreement is terminated or not renewed for any reason.
The Corporations and Financial Services Committee recommended that the Code be amended to require franchisors to disclose to franchisees, before a franchising agreement is entered into, what process will apply in determining end of term arrangements. It did not support an automatic right of renewal or the requirement for good cause to be shown for not renewing a franchise agreement acknowledging that ‘it is not the role of the law to force unwilling parties to enter into any commercial arrangement, including franchise agreements’. The expert panel did not express a contrary view.
In addition, the Corporations and Financial Services Committee stated:
While the committee recognises the commercial arguments underlying the application of restraint of trade clauses during the time in which a franchisee and franchisor have a working relationship, it is the view of the committee that it may not be appropriate in all circumstances for such restraints to apply once the franchise agreement has ended. The committee notes the severe restrictions that such restraints might impose on the ability of former franchisees to generate income as independent businesspeople.
Whilst the Corporations and Financial Services Committee considered restraint of trade issues, it did not make any specific recommendation about them. The expert panel did not consider restraint of trade issues as part of its review.
The 2010 amendments inserted clause 20A into the Code to require a franchisor to notify the franchisee, at least six months before the end of the term of the franchise agreement, whether the franchisor would renew the franchise agreement and if so, whether the franchisee would be required to enter into a new franchise agreement. Item 17C of the disclosure statement sets out in full the matters to be disclosed.
The Regulatory Impact Statement for the 2010 amendments states:
… there is a common belief among franchisees, even when their agreements are for a fixed term, that they would be entitled to renew their agreement when it expires.
However, franchising by definition involves a franchisor granting a franchisee a right to carry on the business under a franchise business model offered and controlled by the franchisor for a specified period of time. The franchisee pays the franchisor a fee in exchange for the use of the franchisor’s brand and systems. There is neither an automatic right of renewal of franchise agreements nor a right to compensation (via an exit payment) for franchisees if a franchisor decides not to renew a franchise agreement.
According to the Wein review, ‘there are disparate views on whether the 2010 amendments have been effective’. On the one hand, many submitters acknowledged that franchisees are better informed about end of term arrangements due to the inclusion in the Code of clause 20A and the terms of item 17C of the disclosure document.
On the other hand, some submitters contend that the amendments do not remedy the harm which is perceived to be caused by the franchisor because there is nothing in the Code ‘that prevents a franchisor not renewing an agreement, and simply taking over the thriving business that the franchisee has established through his own hard work and investment’. According to Competitive Foods Australia, ‘the amendments have not been effective because they do not recognise property rights for the franchisee. Instead they make franchising look like retail leasing, which it is not’.
Those who argue in favour of such rights consider that they crystallise at the end of the franchise agreement and should be recognised by mandating a payment for the value that the franchisee has contributed to the business—goodwill— if the agreement is terminated or not renewed for any reason. This point of view has been aired during the course of each of the reviews of franchising laws and practice since 2008 but has failed to gain traction. The Federal Court of Australia has found that there is no entitlement to payment for goodwill.
The Wein review recommended an amendment to the Code to offer limited protection to franchisees when the franchisor declines to renew a franchise agreement. It recommended that, if certain conditions are satisfied, restraint of trade clauses in the franchise agreement, which prevent the franchisee from carrying on a similar business in competition with the franchisor, are not enforceable by the franchisor against the franchisee. Those conditions are that:
- the franchisee wishes to have the franchise agreement renewed on substantially the same terms
- the franchisee is not in breach of the agreement
- the agreement does not contain provisions allowing a franchisee to make a claim for compensation in the event that the franchise is not renewed and
- the franchisee abides by all confidentiality clauses in the agreement and does not infringe the intellectual property of the franchisor.
The former Labor Government accepted this recommendation, stating that:
the Government will also ensure that restraint of trade clauses are unenforceable not only in cases of non-renewal … but also where the franchisor has not extended a franchise agreement, and where the franchisor has terminated the franchise agreement ‘without cause’ and the other conditions set out in the recommendation are met.
The position is that a right to payment for goodwill upon expiry or termination of the franchise term exists only if it is set out in the franchise agreement. In the absence of such a term, no such right exists. The Wein review recommendation, however, recognises the unfairness of a franchisee being restrained from competing with the franchise in circumstances where the franchisor’s actions have brought about the end of the franchise arrangements and without compensation for the goodwill generated by the former franchisee. In a sense, the right to compete can be seen to some extent as compensation for the absence of compensation for goodwill.
However, set against the existing law on restraint of trade, the value of the Wein recommendation is open to question. Subject to some exceptions, a restraint of trade contract is void as a matter of public policy. For instance, a restraint of trade may be justified if it is reasonable as between the parties and it is not contrary to the public interest. In essence, the recommendation is merely an application of the common law position. That being the case, from a franchisee perspective, the recommendation delivers very little, given that a restraint of trade clause may not be enforceable anyway.
The recommendation is also open to the criticism that it may be easy for a franchisor to avoid and that a franchisor may engage in ‘mischievous’ conduct by manufacturing the circumstances required to enable it to avoid being bound by a restraint of trade clause. According to the former Labor Government, those concerns would be addressed by the decision to introduce a good faith requirement.
Submitters to the Corporations and Financial Services Committee reported a reluctance on the part of some franchisees to engage in mediation due to ‘fear of retribution; potentially high costs; a sense that franchisors are unlikely to engage in meaningful negotiation; and the possibility the franchisors will draw out the process in order to pressure the franchisee into giving in to franchisor demands’.
In making the 2010 amendments, the Government recognised that there was:
… limited data on what types of behaviour, by one party to a franchise dispute are typically viewed as indicators of a genuine attempt by that party in resolving their dispute. Similarly, there is limited data on the numbers of franchise sector participants that may be subject to unconstructive or unscrupulous conduct during dispute resolution.
That being the case, the 2010 amendments to the Code inserted a non-exhaustive list of behaviours (at subclause 29(8) of the Code) that parties to a franchising dispute could exhibit to indicate that they are engaging in dispute resolution in a constructive manner.
The Wein review received submissions which indicated on the one hand that there remained an unwillingness and refusal on the part of some franchisors and franchisees to attend mediation and resolve disputes. In particular, concerns were expressed that the amendment requiring parties to ‘approach the resolution of the dispute in a reconciliatory manner’ was too vague a concept. On the other hand, submitters such as the Office of the Franchising Mediation Adviser considered that the ‘processes are operating effectively’. According to Spencer and Young:
… compelling “genuine, reconciliatory participation” in mediation is a contradiction in terms; for mediation to be genuinely successful (and successful in the long term) participation must be genuine and consensual. But no law can enforce a state of mind.
Importantly, some states have established small business commissioners to offer low cost alternative dispute resolution services—including for franchising disputes. According to the Office of the Franchising Mediation Adviser (OFMA), ‘the different Small Business Commissioners around Australia play a useful role in advising and assisting with problems at an early stage and in this respect are complementary to our role’.
However, in cases where a franchising dispute is mediated using services other than those of the OFMA, the parties do not have to comply with the behaviours which were inserted by the 2010 amendments to the Code. One submitter provided the example of a franchisee who had ‘embarked on an aggressive social media and media campaign pending mediation, which has in turn incited death threats against the directors of a franchisor’.
Another submitter provided anecdotal evidence of a dispute that was referred to a state Small Business Commissioner by a franchisee. In that case, the franchisor’s solicitors advised the Small Business Commissioner that they wanted the dispute resolution to be conducted in accordance with Part 4 of the Code or the method set out in their franchise agreement, but this was refused. In light of that experience, it has been suggested that:
the ACCC and the small business commissioners need to have a protocol on how franchise disputes are to be resolved or it means the whole Part 4 process of the Code is useless if the dispute is referred to a state small business commissioner.
The Law Council of Australia concurred with that suggestion.
The Wein review recommended that the Code should be amended to provide that subclause 29(8) applies to participation in any alternative dispute resolution process whether under OFMA, state small business commissioners, privately retained, court appointed or otherwise.
The former Labor Government accepted the recommendation—and in particular acknowledged that ‘there is some ambiguity where the parties do not purport to be mediating under the Code, or do not turn their mind to the issue prior to attending mediation’.
That being the case, the former Government agreed to amend the Code to make it clear that franchisors and franchisees should abide by the behaviours set out in subclause 29(8) in any mediation, whether under the Code or not.
Section 51AEA of the Competition and Consumer Act provides that it is the Parliament’s intention that a law of a State or Territory should be able to operate concurrently with Part IVB unless the law is directly inconsistent with that Part.
Whilst the recommendation is consistent with those terms, the reasons for the drift of franchisees to the Small Business Commissioners away from the OFMA do not appear to have been identified and addressed.
The decision to implement the Code as a mandatory code in 1998 was influenced by a desire to address the major problems in the sector, including the high cost of actions under the then Trade Practices Act 1974 (since renamed as the CCA) and the difficulties experienced by franchisees in obtaining redress from an infringing franchisor.
Nevertheless, franchisees can still face significant expenses because, as the expert review observed, under some franchise agreements, franchisees may be required to pay the franchisor’s legal costs incurred in dispute resolution generally or in relation to specific kinds of dispute resolution, like mediation.
In relation to the costs of mediation, the expert panel noted that the Code (at that time) provided that parties were equally liable for the costs of mediation unless they agree otherwise and that the parties were to pay for their own costs of attending mediation. That said, the expert panel conceded that there might not be meaningful agreement about the payment of the costs of mediation due to the imbalance of bargaining power between a franchisor and franchisee.
In relation to legal costs, other than for mediation in accordance with the Code, the expert panel noted that a wide variety of commercial agreements contain clauses attributing the costs of dispute resolution to one or other of the parties to the agreement. The expert panel acknowledged that there may be legitimate business reasons to include such a clause, which might be reflected for example in a lower franchise fee under the agreement.
That being the case, the expert panel did not believe that ‘steps should be taken to prohibit or restrict such provisions in franchising, without fully understanding the possible implications for the wider business community’.
Responding to the comments of the expert panel, the 2010 amendments inserted item 13B into the disclosure document, requiring the franchisor to disclose whether he or she would attribute their legal costs incurred in dispute resolution to the franchisee. Clause 31 of the Code provided (prior to the 2010 amendments) that the parties were equally liable for the ‘costs of mediation’ unless they agreed otherwise. Subclause 31(4) was inserted into the Code by the 2010 amendments to put beyond doubt what specific costs the term ‘costs of mediation’ covered—that is, the cost of the mediator, room hire and of any additional input (including expert reports) that were agreed by both parties as being necessary to the conduct of the mediation.
Few submitters to the Wein review commented on the effectiveness or otherwise of the amendments about the attribution of legal costs. However, one submitter was critical of item 13B of the disclosure document as it merely requires disclosure of whether or not the franchisor will attribute the costs of ‘dispute resolution’ to the franchisee. It was asserted that item 13B does nothing to address the harm to a franchisee who may be required by a franchisor to pay all the costs of dispute resolution (other than mediation), including litigation.
Another submitter complained of franchise agreements which require the franchisee to litigate any proceedings in the home state of the franchisor—thereby increasing the costs to be borne by an aggrieved franchisee—and advocated an amendment which would:
… give franchisees the right to litigate and bring alternative dispute resolution proceedings in their home State, and that the laws of their home State govern the franchise … [on the grounds that] … if a franchisor chooses to do business in a particular State, they should abide by that State’s laws and submit to the jurisdiction of its courts.
The Wein review recommended that the Code be amended to ensure that franchisors cannot:
- attribute the legal costs of dispute resolution to a franchisee unless ordered by a court (recommendation 14a) or
- require a franchisee to litigate outside the jurisdiction in which the franchisee’s business primarily operates (recommendation 14b).
The former Labor Government accepted recommendation 14a in principle, stating that it would amend the Code to prevent a franchisor attributing the costs of dispute resolution to a franchisee in the franchise agreement.
In relation to recommendation 14b, the government response was to act to preserve the parties’ ability to negotiate a suitable forum for their disputes. It pledged to include mechanisms in the Code to ‘ensure that an appropriate court, such as the court in the jurisdiction in which the franchisee conducts its business, will deal with the dispute’.
The implementation of recommendation 14a may remove one of the barriers to effective dispute resolution for franchisees.
According to the Wein review the rationale for recommendation 14b was that it is ‘a more direct means of reducing the cost to franchisees of raising a dispute with their franchisor’. However, for those franchisors which have franchisees in a number of states, there is a danger that outcomes of disputes will vary—particularly in relation to questions of good faith—depending on the jurisprudence in each state.
Section 51AD of the CCA provides that ‘a corporation must not, in trade or commerce, contravene an applicable industry code’. If a franchisor fails, for example, to provide disclosure documents as required by the Code, it will be in breach of the Code and, correspondingly, in breach of the CCA. Following several contradictory decisions, the High Court has made it clear that a failure to comply with the Code does not necessarily render a franchise agreement void for illegality and therefore unenforceable. This means that where the franchisor has not complied with the Code, the onus is on the franchisee to seek one of the remedies set out in the CCA. The question for many franchisees is what, exactly, is the penalty to be applied to a franchisor whose conduct is a breach of the Code.
A breach of the Code is a breach of section 51AD (in Part IVB) of the CCA. The remedies available for a breach of the Code include injunctions, damages and other remedial orders, including third party redress. The ACCC, which enforces compliance with the Code, can also issue a public warning notice for likely breaches of the Code.
While the contravention of certain provisions of the CCA attracts civil pecuniary penalties, pecuniary penalties are not currently available for breaches of the Code. Similarly, where the ACCC has reasonable grounds to believe that a person has contravened certain provisions of the CCA, the ACCC can issue an infringement notice stating the penalty which is payable under the notice. However the ACCC is not, currently, empowered to issue infringement notices for likely breach of the Code.
The Corporations and Financial Services Committee recommended that the ACCC be given the power to investigate suspected breaches of industry codes—without having to rely on specific complaints from industry participants. The Government agreed with this recommendation and the ACCC was subsequently given audit powers. In addition, the Corporations and Financial Services Committee acknowledged that the ‘lack of pecuniary penalties for breaches of the Code means there is insufficient deterrence for conduct that contravenes the Code’ and recommended legislative amendments to include pecuniary penalties for Code breaches. The Government rejected that recommendation indicating that it would ‘keep this matter under review and allow time for the extensive improvements which will be made to the Franchising Code to take effect’.
Amendments in the Trade Practices Amendment (Australian Consumer Law) Act (No. 2) 2010 implemented a strengthened enforcement and redress regime for industry codes of conduct. In particular:
- the ACCC was empowered to issue public warning notices for repeated or serious breaches of prescribed industry codes
- a Court could issue an order that it considered appropriate to grant redress to a non-party who had suffered loss or damage due to a breach of a prescribed industry code and
- the ACCC was given a random audit power to allow it to inspect documents or records required to be kept pursuant to a prescribed industry code.
The ACCC reports that it has issued audit notices on 16 franchise systems across Australia in the six months to 30 June 2013. However, the submission by the ACCC to the Wein review highlights the limitations of the audit power. Even though the ‘ACCC can obtain a franchisor’s disclosure document, it cannot compel the franchisor to provide documents or other information that supports the information set out in the disclosure document’.
Section 155 of the CCA enables the ACCC to obtain information from a person to whom a notice is directed relating to a matter that constitutes, or may constitute, a contravention of the CCA. However, the power to issue a notice is predicated on the Chairperson or Deputy Chairperson having reason to believe that the person to whom the notice is directed is capable of providing information about a possible contravention of the CCA. It cannot, therefore, be utilised to assist the ACCC in its audit function in respect of franchises.
The ACCC does not pursue all the complaints it receives and is unlikely to become involved in resolving individual consumer or small business disputes. According to its compliance and enforcement policy, the ACCC’s role is to focus on those circumstances that harm the competitive process or result in widespread consumer detriment.
The effect of this policy, according to one submitter to the Wein review, is that sanctions are only applied ‘at the suit of individual franchisees, and then typically, after substantial losses (to those franchisees) and at great cost and through all the uncertainties of litigation’.
In making its recommendations for amendments to the CCA, the Wein review endorsed the views of the Australian Small Business Commissioner which advocated a ‘facilitative approach’ to Code compliance, focussing on education rather than punishment of non-compliance. It recommended that the CCA be amended to allow civil pecuniary penalties to a maximum of $50,000 to be available as a remedy for a breach of the Code.
The Government accepted recommendation 15a in principle. The matter of the amount of the relevant penalty requires further consideration. Pecuniary penalties must be consistent with the other penalties in the CCA to ensure that they are reasonable and proportionate to the harm caused by the relevant conduct.
The Law Council of Australia (LCA) summarised the various arguments in favour of imposing civil pecuniary penalties for a breach of the Code as follows:
- penalties would operate as an effective deterrent to breaching the Code
- due to the cost of justice, franchisees do not possess the resources to pursue franchisors—that is, the sector is characterised by an imbalance of power and therefore the state should intervene
- it is inconsistent that penalties do not exist for a breach of the Code given that penalties exist for other breach of the CCA, including the Australian Consumer Law and
- the introduction of penalties would increase the confidence of investors and parties to a franchise agreement.
The LCA opined that these points ‘do not outweigh the public cost and regulatory risk associated with the introduction of civil penalties’. Having set out the reasons for imposition of pecuniary penalties, the LCA rebutted each of them and suggested that there are other, more efficient ways of addressing franchisee concerns, such as having the ACCC conduct a larger number of audits or the establishment of a Franchising Ombudsman. In particular, the LCA proposed that more empirical research could be undertaken ‘into the nature of the complaints against franchisors by franchisees so as to determine whether introducing civil penalties would significantly change the existence of those complaints’.
Other submitters to the Wein review rejected the proposition outright. For instance, the Australian National Retailers Association said that the imposition of pecuniary penalties ‘would not be consistent with how other industry codes are enforced and their purpose, which is to enforce minimum standards rather than act as another form of regulation’. Minter Ellison Lawyers referred to the comments of the High Court in Ketchell’s case that ‘the purpose of the Code is to regulate the conduct of persons in the franchising industry in order to improve business practices, to provide some protection to franchisees proposing to enter into franchise agreements and to decrease litigation’. They said that ‘conferring additional powers on the ACCC to issue penalties for Code breaches is, in the circumstances unnecessary and arguably inappropriate’.
Given the push by some states—particularly South Australia—to impose their own laws and penalties for perceived improper franchising conduct, it seems that the imposition of civil pecuniary penalties for breach of the Code is now inevitable. Despite the recommendation and its acceptance by the Government there has been some scepticism about its usefulness:
The reality is that the ACCC rarely brings civil proceedings against franchisees or franchisors that have breached the Code alone and that with the higher standard of proof required in a proceeding seeking civil pecuniary penalties, it is unlikely that the ACCC would issue such proceedings, given its other enforcement powers.
The Wein review also recommended that the ACCC be allowed to:
- issue an infringement notice for a breach of the Code (recommendation 15b) and
- use its random audit powers to assess a franchisor’s compliance with all aspects of the Code, not just to require the production of documents created under the Code (recommendation 15c).
The former Labor Government accepted recommendation 15b on the grounds that infringement notices will act as a deterrent to breaches of the Code and this, together with a pecuniary penalty regime, is necessary to promote effective compliance with the Code.
At present the ACCC may issue an infringement notice under clauses 134–134A of Schedule 2 to the CCA where it has reasonable grounds to believe that a person has contravened certain consumer protection laws. Once an infringement notice penalty is paid, the ACCC may not commence court proceedings in relation to the alleged contravention. In addition payment is noted on the ACCC’s infringement register which is published on its website. That being the case, the information about the payment will be able to be ascertained by any prospective (or existing) franchisee even though infringement notices do not need to be recorded in the disclosure document. However, there is no guarantee that a prospective franchisee will include a review of the ACCC’s infringement register as part of his or her due diligence.
The Government accepted recommendation 15c that the ACCC should be able to investigate a party’s compliance with all aspects of the Code.
The Wein review also made the following recommendations in relation to the orders that a court may make under the CCA:
- that a breach of the Code should be a matter about which a court may make an order under section 86E to disqualify a person from managing corporations (recommendation 15d) and
- that the court can make franchising specific orders under section 87, including orders requiring a franchisor to give a royalty free period or to pay a sum of money into a marketing or cooperative fund applicable to that franchise system (recommendation 15e).
The former Labor Government did not agree that disqualification from being a company director is necessarily appropriate as it is a serious penalty more appropriately directed towards conduct which is found to be unconscionable or where false and misleading statements have been made. However, it was noted that there may be scope for a compromise by way of a partial disqualification power which would allow a person to be banned from being a franchisor, or participating in the franchising sector, either indefinitely or for a limited period of time. The former Labor Government indicated that it would further consider this possibility.
It also noted the terms of recommendation 15e but considered that the court already has the power to make orders that are tailored to the circumstances of the case under the enforcement provisions of the CCA. Those orders are not industry specific but rather aimed at remedying the harm caused by the conduct in question. That being the case the former Labor Government did not intend to amend section 87 of the CCA.
It is significant that recommendation 15a which has been accepted in principle, and recommendations 15b and 15c which have been accepted in full are not intended to apply to other existing industry codes ‘nor is it intended that they set any precedent for any future industry codes’. The result is likely to be an increasingly complex legislative framework which treats a breach of the Franchising Code of Conduct differently and arguably more harshly than a breach of other industry codes.
The Wein review recommended that the Code should not be subject to further review until five years after any amendments arising out the review take effect. Whilst the Government accepted the recommendation in principle, it stopped short of setting a time limit on the next review stating only that it was committed to ensuring that the franchising industry would benefit from having time for the amendments that flow from the review to take effect before they are assessed.
The franchise industry has been the subject of a number of inquiries at the state and Commonwealth level since 2006. This has led to amendments to the Code in order to ameliorate the hardship which has been reported by many franchisees. In addition, there have been, since 2006, significant steps to update the CCA including the codification of the prohibition against unconscionable conduct.
The Wein review canvassed many of the same issues that were the subject of those earlier inquiries. It assessed the relevant amendments and found some of them to be ineffective or only partially effective. The recommendations in the Wein review ‘mop up’ existing gaps—generally with a view to tipping the balance of the franchise relationship in favour of franchisees.
An important aspect of the Wein review is the identification of the need for further education for prospective franchisees to ensure that they have a complete understanding of the nature of the franchise agreement and the legal commitment which they will make if it is entered into. However, even improved education is no substitute for better franchisee selection. The particular nature of the franchisor-franchisee relationship means selecting the right franchisee from the outset is in the best long-term commercial interests of both the franchisor and franchisee. The franchisor’s resources that are required to ‘support unsuitable franchisees can outweigh the advantages to be gained by franchising, and may even contribute to the failure of the franchisor’.
That being the case, without targeted and appropriate selection of franchisees by franchisors, the repeating themes of complaints about franchising will continue. As the Industrial Relations Commission put it:
Overall, the applicants’ evidence seems to me to establish that they were approaching this business with the degree of gullibility so often found in unsuccessful franchise operators. They were taking a view of their prospects which was if not irrational, certainly over-brimming with confidence.
The challenge for the new Abbott Government will be to consider the Wein review recommendations afresh and to apply an even handed response which does not unduly tip the balance of the franchise relationship too far in favour of franchisees—to the detriment of franchising generally.
Summary of 2007 amendments to the Code
|Franchisees will be provided with a copy of the franchise agreement in the form it is intended to be executed with the disclosure document. No longer will it be an option to provide only a summary of the franchise agreement.
|Copies of documents relating to the franchise agreement, where available, will be provided at least 14 days before the franchise agreement is signed. Where the documents are not available at that time, the documents are to be provided to the franchisee or prospective franchisee when they become available.
|Details of section 87B undertakings under the TPA by franchisors will have to be disclosed to franchisees within 14 days, rather than the 60 days previously required. These undertakings are voluntary and legally enforceable undertakings that a party may give to the ACCC to, for example, settle or avoid proceedings alleging that the party has breached the TPA.
|Franchisors will be required to disclose from whom they receive rebates and financial benefits.
|Details of the expenses of marketing and other cooperative funds will need to be provided by franchisors to franchisees, and the provision allowing franchisees (if 75 per cent of them agree) to choose that annual audits not be undertaken will be continued. However that this decision will have to be renewed every three years.
|The last known particulars of name(s) and contact details of each ex-franchisee will be disclosed, unless the ex-franchisee requests that it be withheld. Franchisors will not be required to update this contact information nor keep it for more than three years.
|The business experience of all ‘officers’ of the franchisor (as defined by the Corporations Act 2001) will need to be disclosed.
|Financial reports will have to be supplied within four months, rather than three months, in line with the Corporations Act 2001.
|Prospective franchisees to whom Annexure 2 applies will be able to request any of the additional information in Annexure 1 (the ‘long form’).
Disclosure of materially relevant facts to franchisees will have to be provided within 14 days rather than 60 days which is considered to be an unreasonably long period of time.
|Foreign franchisors will no longer be exempt from the Code. It is considered that all franchise systems operating in Australia should be subject to the same rules and protection through the Code and its disclosure requirements should be afforded to those dealing with foreign franchisors.
Materially relevant facts concerning franchisor directors will need to be disclosed to prospective and existing franchisees and the scope of disclosure will extend from just serious offences (defined as an offence under any Australian law for which there is a jail term of more than five years for a first conviction) to also include contravention of any provision of the Corporations Act 2001.
|Franchisors will be forbidden from inhibiting prospective franchisees from communicating with each other or existing franchisees. This is in addition to the prohibition on franchisors inhibiting franchisees from communicating with each other for lawful purposes.
|General waivers (that is, broad disclaimers), regarding prior written or verbal representations, will not be permitted in franchise agreements.
|Where the franchisor is part of a consolidated entity required to produce audited financial reports under the Corporations Act 2001 for that consolidated entity, those reports will need to be provided to franchisees on request. In the case of foreign franchisors, the use of their local accounting standards and auditors will be accepted.
|The details and history of the territory or site to be franchised will need to be provided together with the disclosure document.
|The definition of ‘associate’ of a franchisor will include a person who supplies real property to a franchisee. This will mean that it will be clear that franchisors will have to disclose information about rental and other property expenses.
|A copy of the Code will have to be provided with the disclosure document.
|A current disclosure document will need to be provided when either the scope or term of a franchise agreement is proposed to be extended.
|A disclosure document in accordance with Annexure 1 will be required if the annual turnover of the franchised business is expected to be $50,000 or more at any time during the term of the agreement.
|Franchisors will be able to charge a prospective franchisee for reasonable expenses incurred if an agreement is terminated by the prospective franchisee within the ‘cooling off’ period. Reasonable expenses will be permitted to be deducted from the amount returned if the expenses or their method of calculation have been set up in the agreement.
|Conditions within the franchise agreement will have to be noted, that deal with obligations for a franchisee regarding site and premises selection and acquisition as well as maintenance and appearance of site and premises, vehicles and equipment.
Source: Explanatory Statement, Trade Practices (Industry Codes—Franchising) Amendment Regulations 2007 (No. 1), accessed 24 October 2013.
Summary of the recommendations of the Corporations and Financial Services Committee
|Recommendation 1: that the Franchising Code of Conduct be amended to require that disclosure documents include a clear statement by franchisors of the liabilities and consequences applying to franchisees in the event of franchisor failure.
|Recommendation 2: the government investigate the benefits of developing a simple online registration system for Australian franchisors, requiring them on an annual basis to lodge a statement confirming the nature and extent of their franchising network and providing a guarantee that they are meeting their obligations under the Franchising Code of Conduct and the Trade Practices Act 1974.
|Recommendation 3: the government review the efficacy of the 1 March 2008 amendments to the disclosure provisions of the Franchising Code of Conduct within two years of them taking effect.
|Recommendation 4: the government explore avenues to better balance the rights and liabilities of franchisees and franchisors in the event of franchisor failure.
|Recommendation 5: the Franchising Code of Conduct be amended to require franchisors to disclose to franchisees, before a franchising agreement is entered into, what process will apply in determining end of term arrangements. That process should give due regard to the potential transferability of equity in the value of the business as a going concern.
|Recommendation 6: the name of the Office of the Mediation Adviser be changed to the Officer of the Franchising Mediation Adviser and that the Franchising Code of Conduct be amended to reflect this change.
|Recommendation 7: the government require the Australian Bureau of Statistics to develop mechanisms for collecting and publishing relevant statistics on the franchising sector.
|Recommendation 8: the following new clause be inserted into the Franchising Code of Conduct: 6 Standard of Conduct
Franchisors, franchisees and prospective franchisees shall act in good faith in relation to all aspects of the agreement.
|Recommendation 9: the Trade Practices Act 1974 be amended to include pecuniary penalties for breaches of the Franchising Code of Conduct.
|Recommendation 10: consideration be given to amending the Trade Practices Act 1974 to provide for pecuniary penalties in relation to breaches of section 51AC, section 52, and the other mandatory industry codes under section 51AD.
|Recommendation 11: the ACCC be given the power to investigate when it receives credible information indicating that a party to a franchising agreement, or agreements, may be engaging in conduct contrary to their obligations under the Franchising Code of Conduct.
Summary of 2010 amendments to the Code
Amendments to the Franchising Code:
- clause 20A: requires franchisors to inform franchisees, at least six months prior to the end of the franchise agreement, of their decision either to renew or not renew a franchise agreement
- clause 23A: provides that nothing in the Code limits any obligation imposed by the common law, applicable in a state or territory, on the parties to a franchising agreement to act in good faith
- subclause 29(8): incorporates a non-exhaustive list of behaviours that provide guidance to franchisees and franchisors of the conduct expected of them when engaging in dispute resolution under the Franchising Code.
Amendments to the disclosure document:
- franchisors to provide a statement that franchising is a business and, like any business, the franchise (or franchisor) could fail during the franchise term and this could have consequences for the franchisee
- franchisors to disclose whether the franchisor will require the franchisee, through the franchise agreement, the operations manual (or equivalent), or any other means, to undertake significant capital expenditure that was not foreseen and, therefore, not disclosed by the franchisor before the franchisee entered into the franchise agreement
- franchisors to disclose the circumstances in which the franchisor has unilaterally varied a franchise agreement in the last three financial years and the circumstances in which unilateral variations to the agreement may take place in the future
- franchisors to state whether the franchisor will attribute costs their costs, including legal costs, incurred in dispute resolution to the franchisee
- franchisors to disclose whether a confidentiality obligation will be imposed on the franchisee and the type of matters that would be covered by the obligation
- franchisors to disclose whether the franchisor will amend the franchise agreement on or before transfer or novation of a franchise agreement and
- franchisors to disclose the details of the process that will apply in determining arrangements to apply at the end of the agreement.
Source: Explanatory Statement, Trade Practices (Industry Codes—Franchising) Amendment Regulations 2010 (No. 1) accessed 24 October 2013.
Generic risk statement
|This disclosure document contains some of the information you need in order to make an informed decision about whether to enter into a franchise agreement.
Entering into a franchise agreement is a serious undertaking. Franchising is a business and, like any business, the franchise (or franchisor) could fail during the franchise term. This could have consequences for the franchisee.
A franchise agreement is legally binding on you if you sign it.
You are entitled to a waiting period of 14 days before you enter into this agreement.
If this is a new franchise agreement (not a renewal, extension, extension of the scope or transfer of an agreement), you will be entitled to a 7 day ‘cooling off’ period after signing the agreement, during which you may terminate the agreement.
If you decide to terminate the agreement during the cooling off period, the franchisor must, within 14 days, return all payments (whether of money or of other valuable consideration) made by you to the franchisor under the agreement. However, the franchisor may deduct from this amount the franchisor’s reasonable expenses, if the expenses or their method of calculation have been set out in the agreement.
Take your time, read all the documents carefully, talk to other franchisees and assess your own financial resources and capabilities to deal with the requirements of the franchised business.
You should make your own enquiries about the franchise and about the business of the franchise.
You should get independent legal, accounting and business advice before signing the franchise agreement. It is often prudent to prepare a business plan and projections for profit and cash flow. You should also consider educational courses, particularly if you have not operated a business before.
. The laws which support the franchising sector are discussed in detail under the heading ‘Enforcement’ in this Research Paper.
. The ACCC reported that 252 complaints related to disclosure issues, which represents 19 per cent of the total number of overall complaints and inquiries in the period from July 2001 to June 2006. See G Matthews, Review of the Disclosure Provisions of the Franchising Code of Conduct, Office of Small Business, Canberra, October 2006, p. 15, accessed 24 October 2013 and P Switzer, ‘Franchisees to back Rudd’s bully brief against predatory pricing‘, The Australian, 30 April 2008, p. 35, accessed 24 October 2013.
. ‘Churning’ occurs where a franchisor sells a site or territory that is known to be unprofitable. When the franchisee inevitably fails, the franchisor reclaims the site for a nominal price and resells it to another franchisee who will also ultimately fail. See D Lynch, ‘Franchisee goes butter-side down’, Australian Financial Review, 23 April 2008, p. 16, accessed 24 October 2013.
. N Hoy, Submission to the Parliamentary Joint Committee on Corporations and Financial Services, Inquiry into the Franchising Code of Conduct, no. 8, undated, accessed 24 October 2013 and J Clout, ‘Franchisees get short shrift in disputes‘, Australian Financial Review, 18 November 2008, p. 45, accessed 24 October 2013.
. R Borradale, Submission to the Parliamentary Joint Committee on Corporations and Financial Services, Inquiry into the Franchising Code of Conduct, no. 16, undated, accessed 24 October 2013.
. Information about the relevant inquiries in the period up to the end of 2008 are set out in P Pyburne, Current legal issues in franchising, Background note, Parliamentary Library, Canberra, November 2008, accessed 24 October 2013.
. Economic and Finance Committee, Final Report: Franchises, Parliament of South Australia, Adelaide, 6 May 2008, accessed 24 October 2013.
. Details of the terms of reference, submissions to the Committee, transcripts of oral evidence and the final report are available on the Inquiry website, accessed 24 October 2013.
. Commonwealth Government Response to the report of the Parliamentary Joint Committee on Corporations and Financial Services—Opportunity not opportunism: improving conduct in Australian franchising, 16 November 2009, accessed 24 October 2013.
. Forward looking franchise regulation: Commonwealth government response to the review of the Franchising Code of Conduct, July 2013, accessed 24 October 2013. Recommendations 2–5, 10, 12–13, 15(b), 15(c), 16 and 18.
. Ibid., recommendations 8 and 9.
. Ibid., recommendations, 1, 6(a), 6(b), 7, 11, 14, 15(a) and 17.
. Ibid., recommendations 15(d) and 15(e).
. Clause 6A of the Code. Importantly the Code does not contain a definition of the term ‘reasonably informed decision’.
. J Buchan, ‘Challenges that franchisees of insolvent franchisors pose for liquidators’, Insolvency Law Journal, 16(1), 2008, pp. 29–30.
. Clause 6 of the Code.
. Clause 7 of the Code.
. Item 4 of Annexure 1 of the Code.
. Item 8 of Annexure 1 of the Code.
. Items 9 and 10 of Annexure 1 of the Code.
. Item 12 of Annexure 1 of the Code.
. Item 13 of Annexure 1 of the Code.
. Item 17C of Annexure 1 of the Code.
. Item 20 of Annexure 1 of the Code.
. Clause 10 of the Code.
. Item 8, Annexure 1 of the Code.
. ACCC, Submission to the review of the Franchising Code of Conduct, op. cit., p. 8.
. Ibid., recommendation 3.
. In item 13A of the disclosure document, at Annexure 1 of the Code.
. Item 13A of Annexure 1 of the Code.
. Review of the Franchising Code of Conduct, op. cit., p. 52.
. Ibid., recommendation 7, p. 53.
. ACCC, Submission to the review of the Franchising Code of Conduct, op. cit., p. 3.
. Franchise marketing and other cooperative funds, op. cit.
. Paragraphs 17(1)(a) and (b) provide that the franchisor must within 4 months after the end of the last financial year, prepare an annual financial statement detailing all of the fund’s receipts and expenses for the last financial year and have the statement audited by a registered company auditor. Paragraph 17(1)(c) requires the franchisor to give a copy of the statement and auditor’s report to the franchisees within 30 days.
. Ibid., recommendation 8d.
. M Evans, Outline of equity and trusts, Butterworths, Australia, 1988, paragraph 509. The gist of any fiduciary relationship is that equity will not allow the fiduciary to enter into any engagements in which he has, or could have, a personal interest conflicting with that of his principal; nor will it allow him to retain any benefit or gain obtained, or received, by reason of his fiduciary position or through some opportunity or knowledge resulting from it.
. Item 1.1(e) of the disclosure document.
. Ibid., recommendation 5.
. Under clause 3 of the Code, novation in relation to a franchise means the termination of the franchise and entry into a new franchise with a proposed transferee on the same terms as the terminated franchise. Transfer, under clause 3 of the Code, includes an arrangement in which the franchise is granted, transferred or sold.
. M Murray and J Harris, Keay’s insolvency: personal and corporate law and practice, seventh edition, Thomson Reuters, Sydney, 2011, pp. 437–438.
. J Buchan, Franchisees as consumers: benchmarks, perspectives and consequences, Springer, New York, p. 114.
. J Buchan, Submission, op. cit., p. 14, accessed 24 October 2013.
. J Buchan, Submission, op. cit., p. 7, accessed 24 October 2013.
. J Buchan, Franchisees as consumers: benchmarks, perspectives and consequences, op. cit., p. 115.
. E Greenblat, ‘Administrators take rebel booksellers to court’, The Sydney Morning Herald, 8 April 2011, accessed 24 October 2013; C Zappone, ‘Booksellers’ woes worsen as franchisees seek to defect’, The Sydney Morning Herald, 5 April 2011, accessed 24 October 2013; D Sutherland, Submission to the review of the Franchising Code of Conduct, 14 February 2013, p. 7, accessed 24 October 2013.
. Corporations Act 2001, section 556.
. Corporations Act 2001, section 555.
. Corporations Act 2001, section 547.
. D Sutherland, op. cit., p. 6, accessed 24 October 2013.
. Ibid., recommendation 8, p. 115.
. Explanatory statement, Trade Practices (Industry Codes—Franchising) Amendment Regulations 2010 (No. 1), p. 5, accessed 24 October 2013.
. J Buchan, Submission, op. cit., pp. 7–8.
. Ibid., recommendation 9, p. 82.
. Ibid., Recommendation 9a.
. Ibid., Recommendation 9c.
. Ibid., Recommendation 9d.
. That is, clauses 20 and 21 of the Australian Consumer Law prohibit unconscionable conduct. Clause 22 of the Australian Consumer Law lists a range of circumstances to which the Court may have regard in deciding whether impugned conduct is ‘unconscionable’ for the purposes of the CCA.
. This is discussed under the heading of ‘Enforcement’ in this research paper.
. Franchise agreements commonly give franchisors the ability to change the terms of the agreement unilaterally.
. LPO Group, op. cit., accessed 24 October 2013.
. As set out at footnote 93, under clause 3 of the Code, novation in relation to a franchise means the termination of the franchise and entry into a new franchise with a proposed transferee on the same terms as the terminated franchise. Transfer, under clause 3 of the Code, includes an arrangement in which the franchise is granted, transferred or sold.
. Queensland Law Society, op. cit., accessed 24 October 2013.
. D Sutherland, op. cit., p. 20, accessed 24 October 2013.
. Ibid., recommendation 11, p. 86.
. Ibid., recommendation 5, p. 82.
. Economic and Finance Committee, Final Report: Franchises, Parliament of South Australia, Adelaide, 6 May 2008, accessed 24 October 2013; Small Business Development Corporation, Inquiry into the Operation of Franchise Businesses in Western Australia: Report to the Western Australian Minister for Small Business, Perth, April 2008 p. ii, accessed 24 October 2013; Opportunity not opportunism: improving conduct in Australian franchising, op. cit., pp. 61–82.
. An example of an effective restraint clause is in Raine & Horne Pty Ltd v Adacol Pty Ltd  NSWSC 36.
. E Spencer and S Young, op. cit., accessed 24 October 2013.
. Office of the Franchising Mediation Adviser, op. cit., p. 1.
. P Colman (Mason Sier Turnbull Lawyers), op. cit., p. 4.
. D Sutherland, op. cit., pp.32–33, accessed 24 October 2013.
. Competition and Consumer Act 2010, section 80.
. Competition and Consumer Act 2010, section 82.
. Competition and Consumer Act 2010, section 86C.
. Competition and Consumer Act 2010, section 51ADB.
. Competition and Consumer Act 2010, section 51ADA.
. For example, under section 224 of the Australian Consumer Law (which is located in Schedule 2 to the CCA) penalties of $1.1 million for a corporation and $220,000 for a person that is not a body corporate, apply in respect of unconscionable conduct.
. Competition and Consumer Act 2010, sections 134–134A.
. Inserted by Trade Practices Amendment (Australian Consumer Law) Act (No. 2) 2010, accessed 24 October 2013.
. Competition and Consumer Act 2010, section 51ADA.
. Competition and Consumer Act 2010, section 51ADB.
. Competition and Consumer Act 2010, section 51ADD.
. Ibid., recommendation 15a.
. M Terceiro, legal practitioner agrees with this point stating that that if the ACCC had access to civil pecuniary penalties for Franchising Code breaches, its ability and willingness to enforce the Franchising Code would be significantly enhanced. M Terceiro, Submission to the review of the Franchising Code of Conduct, 22 February 2013, p. 4, accessed 24 October 2013.
. Small Business Commissioner Act 2011 (SA) amended the Fair Trading Act 1987 (SA) to establish a Small Business Commissioner empowered to deal with contraventions of industry codes (section 28F) and for the imposition of civil pecuniary penalties of up to $50,000 for a corporation and $10,000 for a natural person who contravenes an industry code (section 86B).
. P Colman (Mason Sier Turnbull Lawyers), op. cit., p. 12.
. The other mandatory industry codes are the Trade Practices (Industry Codes—Oilcode) Regulations 2006, the Trade Practices (Horticulture Code of Conduct) Regulations 2006 and the Trade Practices (Industry Codes — Unit Pricing) Regulations 2009.
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