2015 has been a landmark year for the regulation of franchising in Australia, introducing a significantly enhanced Franchising Code with financial penalties for certain breaches.
2016 may pose even greater regulatory challenges following the commencement of a law which passed the Australian Parliament last month. While not specifically directed at franchising, it will affect the content of franchise agreements to a far greater extent than the Franchising Code, and in a manner unique to the franchising world.
This Alert examines this new and concerning law, and reminds franchisors of their recently enhanced Franchising Code obligations.
A new test of "fairness"
The Australian Consumer Law in Australia's Competition and Consumer Act 2010 (Cth) currently includes provisions which void "unfair" terms in contracts for the supply of goods or services to individuals predominantly for their personal use or consumption.
The Treasury Legislation Amendment (Small Business and Unfair Contract Terms) Act 2015, which passed through Parliament last month extends these provisions to "small" business contracts. The new law will apply to a contract entered into or renewed on or after 12 November 2016, and to all variations or extensions which occur after that date. The scope of its coverage is broad, and "small" turns out to be anything but that.
The unfair contract terms law will apply to many franchise systems. Although contracts already subject to "equivalent" laws can be exempted, it seems clear that the Franchising Code is not "equivalent" for this purpose. The Australian Competition and Consumer Commission (ACCC) is the regulator of this new law, as well as of the Franchising Code. It has already announced that the franchising sector will be the priority sector for its compliance activities in relation to this new law.
The new business unfair terms laws will apply to a term of a contract where:
- the term is in a "standard form contract" (in effect, a contract prepared by one party before discussions commenced and with little or no opportunity to negotiate the individual terms); and
- at least one party to the contract is a business that employs fewer than 20 employees at the time the contract is made (excluding casuals unless employed on a 'regular and systematic basis'); and
- the total consideration payable for the supplies under the contract does not exceed AUD 300,000 for contracts with a duration of 12 months or under or AUD 1 million for contracts with a duration of more than 12 months. The "consideration" for these purposes includes all consideration for the supplies to be made or rights to be granted, where the consideration or its method of calculation is disclosed before the contract is made.
An "unfair" term in a franchise agreement will be void. The rest of the franchise agreement will continue if it is capable of operating without the term. A term will be "unfair" if:
- it would cause a significant imbalance in the parties’ rights and obligations arising under the contract; and
- it is not reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by the term; and
- it would cause detriment (whether financial or otherwise) to a party if it were to be applied or relied on.
In determining whether a term of a contract is unfair, a court may take into account such matters as it thinks relevant, but it must take into account the extent to which the term is "transparent" and the contract as a whole. This means that documents such as operations manuals or policies that form part of the contract need to be examined, as will obligations to comply with documents referenced in these. Transparency requires that the term is expressed in reasonably plain language, is legible, is presented clearly and is readily available to any party affected by the term.
- a contract is presumed to be "standard form" and a term is presumed not to be reasonably necessary to protect its legitimate interests, unless the party seeking to rely on the term proves otherwise; and
- terms that define the main subject matter of the contract and the consideration for them are not subject to the fairness test, although the consideration may be if its method of calculation was not clearly disclosed up front; and
- terms that are required or expressly permitted by law, such as by the Franchising Code, are not subject to the test.
The legislation includes a "grey list" of clauses which may be unfair. They are examples only and unfairness needs to be judged in the context of each contract as a whole. While not prohibited, they create a presumption that the term may well be unfair.
Many of the terms on the list are unilateral rights or restrictions, such as the right of a party to terminate, or vary the contract or the supplies under it, without reference to the other. Others relate to a restriction on the rights of a party to enforce an agreement, or the liabilities of a party under an agreement, such as broad indemnities that can make the small business party liable for things outside their control, and liquidated damages provisions that do not reflect actual losses.
What do franchisors need to do?
The first step will be for franchisors is to assess whether and to what extent the unfair terms law might apply to them. This requires determining:
- whether there is likely to be a genuine negotiation of the agreement terms in each case;
- whether any party to an agreement may be a business which employs fewer than 20 people. Counting the number of employees will be problematic for franchised businesses in particular, as the time for counting the number is the time which the contract is entered into, and new businesses are unlikely to have many or any employees at this time;
- whether the total consideration payable under the contract over its life will definitely be over the appropriate AUD 300,000 or AUD 1 million threshold. Unless the agreement contains an obligation to make minimum payments over the threshold amount, merely assuming that they will do so will not take the contract outside of its reach, unless and until the thresholds are actually met. The ACCC's position is that royalty payments variable by reference to sales cannot be included for this purpose. As a result, for any franchise agreement having a term of more than 12 months, only upfront or ongoing fixed or specified minimum payments can be included.
Having decided that the unfair terms law may apply, a franchisor should then review its contract terms to determine whether they may be open to challenge under the new regime.
Although the unfair contract terms laws do not apply to standard form contracts entered into before 12 November 2016, it is important to note that they will apply to any contract renewed after this time. For that reason, no franchisor should enter into an agreement containing a renewal clause unless it permits the franchisor to change the agreement terms at the time of renewal. If there is any risk of the parties "holding over" under an expired agreement, franchise agreements should be changed to contemplate this, to avoid the holding over resulting in a new agreement.
Foreign franchisors need to be particularly wary of changes their local master franchisees will need to be making to their local sub-franchise agreements, as it is important to ensure that these remain enforceable in all respects.
Are you Code compliant?
The ACCC's compliance and enforcement priorities policy for 2015 has franchising in its sights. The policy highlights the ACCC's new powers under the Franchising Code from 1 January 2015 to issue infringement notices for contraventions of the Code and to seek penalties of up to AUD 51,000 from a Court for serious breaches of certain provisions.
This underlines the importance of ensuring that you are familiar with the new Code requirements and that you amend the processes used in the administration of your franchise network to ensure they comply with the new requirements, including:
- maintaining a separate bank account for marketing and advertising fees received from franchisees and using marketing and advertising fees to cover only specified types of expenses;
- paying marketing and advertising fees on the same basis for any units operated by the franchisor;
- provding an "information statement" to prospective franchisees after they formally apply for or express an interest in a franchise;
- retaining documents required to be created under the Code for at least six years after their provision;
- not requiring dispute resolution proceedings to be commenced in any place other than the State or Territory where the franchisee's business is based;
- ensuring that all franchise agreements and disclosure documents have been updated to comply with the Code changes and to include all likely significant capital expenditure that may be required and the likely use of marketing fees; and
- providing updated financial disclosure once available to prospective franchisees, before they sign a franchise agreement.