For most franchisors, the period between 1 July and 31 October each year is the time to review and update their franchise system’s disclosure document in accordance with the Franchising Code of Conduct. However, this year, franchisors should also be revisiting the drafting of their franchise agreements in light of the "unfair contract terms" regime that will come into force later this year. Under this incoming law, any term found to be unfair will be void and unenforceable.

The new law

As noted in earlier updates (such as here and here), 12 November this year will see the extension of the Australian Consumer Law’s unfair contract terms regime to capture business-to-business transactions where either party is a “small business” who is a party to a “standard form” contract. New franchise agreements entered into, agreements renewed, or overholding that commences, on or after 12 November 2016 will likely be exposed if either party is a small business. Terms of ongoing contracts varied from that time will also become subject to the regime.

To determine whether any terms of a franchise agreement may be vulnerable to challenge, franchisors will need to consider whether:

  • the franchise agreement amounts to a standard form contract;
  • either party to the agreement is a small business; and
  • the term in issue meets the three criteria for being unfair.

Standard form contract

Most franchise agreements will likely be regarded as “standard form”, particularly as the onus will be on the franchisor to prove otherwise. While providing an effective opportunity for a prospective franchisee to negotiate may be a means by which the agreement will be found not to be standard form, the reality is that a franchise system expects uniformity and the majority of most agreements will not be up for negotiation.

Small business

A "small business contract" is a contract:

  • for the supply of goods or services, or the sale or grant of an interest in land;
  • where at the time it was entered into, at least one party employs fewer than 20 people (including full time, part time and casual employees who work on a regular or systematic basis); and
  • where the "upfront price" payable under the contract does not exceed:
    • $300,000; or
    • $1,000,000 if the contract has a duration of more than 12 months.

Many franchisors themselves will fall under the employee headcount criterion. If not, there will need to be consideration of whether or not the franchisee meets the headcount criterion. That question is assessed against the specific franchisee, not any related entities. Therefore, in the case of a multi-unit franchisee that holds each franchise in a separate entity, the staff headcount cannot be aggregated. Each franchisee entity is assessed on its own merits.

As to the question of upfront price, the threshold will be assessed against amounts ascertainable at the time of entering the contract. Therefore, exact amounts such as an initial franchise fee and known minimum royalties will be included in that threshold calculation. However, amounts that cannot be ascertained, such as royalties calculated against sales, would not be included in determining the threshold as such amounts cannot be ascertained at the time of entering the contract.

Unfair

Terms that define the main subject matter or set out the upfront price of a contract, or a term that is required by law, cannot be declared unfair. Any other term will be at risk of being declared void for being unfair.

A term is unfair if it satisfies all three elements of the following test:

  • It would cause a significant imbalance between the rights and obligations of the parties.
  • It is not reasonably necessary to protect the legitimate interests of the business imposing the term.
  • It would cause detriment to a party if it were relied on.

Regard will also be had as to a term’s transparency and the term's context in the contract as a whole. However, a term will be presumed not to be reasonably necessary to protect a franchisor’s legitimate interests, placing the onus on the franchisor to prove otherwise.

Mere compliance with the Franchising Code of Conduct will not necessarily of itself be sufficient for a term to be regarded as fair. While we anticipate that Code compliance, such as compulsory pre-contractual disclosure, will be relevant to the question of whether a term will cause a significant imbalance in parties’ rights and obligations, this has not yet been tested by the courts.

Next steps

Franchisors will need to consider revising provisions in their franchise agreements such as unilateral termination clauses, compulsory acquisition clauses (particularly if for less than market value), provisions imposing liquidated damages that do not reflect actual losses, and clauses allowing the franchisor to unilaterally change the franchisee's obligations. In light of this, the typical absolute right of the franchisor to vary the operations manual may need to be tempered so as to ensure that the franchisor cannot be said to have a substantial imbalance of rights and obligations.

Given that a franchise agreement’s strength is generally only tested at a time when there is a dispute, the risk that a historically typical clause could be found to be unfair, and in turn void and unenforceable, could be significant for a franchise system and the franchisor’s administration of that system. The Australian Competition and Consumer Commission has also indicated that the franchise sector will be an industry of focus for it in the context of unfair contract terms. A timely review is therefore a prudent step for franchisors to take, so that any necessary changes can be put in place well ahead of time.