The franchising industry is projected to post annualised growth of 2.8 per cent over the next five years according to a recent report by IBIS World1 – one of the leading industry researchers operating in that market. The market "down under" is so rosy, according to The Sydney Morning Herald,2 that it is necessary to ask the question of whether Australia might be too franchised. The newspaper notes the runaway success of franchising in Australia with over 80,000 franchised outlets turning over A$130 billion in sales (about US$100 million) and employing nearly half a million people. Even the more conservative report on the franchising sector published by Griffith University's Asia-Pacific Centre for Franchising Excellence3 noted there was an increase of 8.2 per cent of franchising units in Australia in the two years between 2012 and 2014 and both franchisors and franchisees were reporting increases in revenues and profits.4
These attractive growth prospects have led an increasing number of franchisors to now consider the Australian market for entry.
However, there are some traps that many brands can unwittingly fall into. Below we outline some of the key legal and commercial issues that impact franchising in Australia and provide our top tips for franchisors who are thinking of taking their franchised system there.
1. "Accidentally" franchising and the substantial legal consequences
Many brands are keen to generate the maximum revenue from a trade mark by licensing its use. Some brands choose to simply license their trade mark under a trade mark licence. Others decide to license an entire business format and so franchise a system where the trade mark is just one of the key elements being licensed to a licensee.
Both trade mark licensors and franchisors should be aware that Australia has strict and tough laws which highly regulate businesses that enter into various arrangements for the distribution or licensing of goods or services under a trade mark.
The Competition and Consumer (Industry Codes—Franchising) Regulation 2014 (which is referred to by its more benign-sounding name, the "Franchising Code of Conduct") is of primary importance in Australia. The Franchising Code of Conduct (the "Code") is a mandatory law and it sets out a number of criteria which must be present in order for an agreement to be deemed to be a "franchise agreement" – regardless of what the agreement is actually called on its face. So, many trade mark licences, distribution agreements, services agreements, collaboration agreements and other types of commercial arrangements may in fact be franchise agreements if they, as a matter of substance, fall within the definition of a franchise agreement under the Code.
In summary, there are five criteria for an agreement to be a franchise agreement. These are:
- Agreement: You must have an actual agreement but the trap is that it can be only oral or "implied" – so it need not be a written agreement.
- Rights to carry on a business: The agreement involves a licensor or franchisor granting a person or company (the licensee or franchisee) a right to carry on a business which offers, supplies or distributes goods or services in Australia.
- System or marketing plan: The agreement involves a system or marketing plan which is substantially determined, controlled or suggested by the licensor/franchisor or its associates.
- Trade mark or advertising: The agreement is substantially or materially associated with a trade mark or advertising which is owned, used, licensed or specified by the licensor/franchisor or its associates.
- Payments to be made: Under the agreement, the licensee/franchisee is obliged to pay fees to the licensor/franchisor or its associates. Payments for wholesale goods and services, repayments of loans and rental payments are excluded.
Motor vehicle dealerships: Irrespective of whether any the above five criteria apply, any agreement for a motor vehicle dealership (that is, for a business of buying, selling, exchanging or leasing motor vehicles other than as a credit provider) will be a franchise agreement under the Code.
It is often a very technical assessment as to whether a distribution agreement or a simple trade mark licence is in fact – either accidentally or deliberately – a franchise agreement and many companies entering the Australian market get caught out by this and so breach the Code. Dentons has advised a number of clients who had thought that their agreement was a simple trade mark licence for Australia when in fact it was a franchise agreement. Sometimes the assessment comes down to close analysis of exactly what marketing plans are being imposed on the licensee. There has been case law in Australia which has provided some guidance on the matter,5 but the assessment is almost always technical and one on which legal guidance should be sought.
Whether your agreement is a franchise agreement or not is crucial – as there are severe penalties under the Code for entering into a franchise agreement with another party without having complied with the Code (for example, without having provided the prospective franchisee or licensee with a disclosure document before the contract was entered into or without having included in the agreement certain mandatory provisions). The penalties for breaches of the Code range from financial penalties and infringement notices of up to A$54,000 (about US$40,000) or A$9,000 (about US$6,000) per breach. Additionally, the agreement itself can be unenforceable or set aside, compensation and damages may be payable or other remedies may be available for the licensee/franchisee. So it is important to get it right.
Although Australia does not have any legal barriers to commencing discussions with a potential franchisee (such as those that apply in some jurisdictions in the United States, which require a disclosure document to be provided to a prospective franchisee before a first meeting is held), franchisors and licensors seeking to enter the Australian market should take care as the Code applies to oral (unwritten) agreements and "implied" agreements. So negotiations with prospective licensees or franchisees need to be well managed to minimise the risk of a later challenge by a franchisee or licensee that an unwritten agreement had been entered into with them in breach of the Code.
2. Australian franchising laws protect big business and a variety of commercial structures too
Another issue to keep in mind for those seeking to enter the Australian market is that the Code applies to all sizes of business and a large array of commercial structures. The Code will protect a franchisee irrespective of the size of the franchisee – and many powerful franchisees seek to shelter under its protection.
Also, the franchise laws apply to most commercial franchise structures such as area developer agreements, master franchise agreements and unit franchise agreements.
It is not uncommon in international franchising for a franchisee with a large portfolio of brands under licence to be of greater financial substance than the individual franchisor. Even if the situation is more like a "Goliath Franchisee" versus a "David Franchisor", the Code will apply to and will favour the franchisee. In this sense, unlike the United States, Australia does not have a "sophisticated investor" exemption from the Code.
The reason for the Code being one sided and protecting franchisees irrespective of the power balance between the parties is because of the history of the laws. The Australian franchise legislation has existed since 1998 and it was put in place at a time when there was significant public debate about "big business" from "overseas" bullying small "mum and dad" investors who were at risk of losing their life savings. Although the origin of these laws in Australia reflect a desire on the part of legislators to protect small business, they have the effect of favouring large powerful franchisees – who are often legally well advised. As a result, franchisee and regulatory proceedings under the Code against franchisors is now a prominent litigious area in Australia.6
The regulator, the Australian Competition and Consumer Commission (ACCC), plays an active role in promoting compliance with the Code through its enforcement actions. In 2013, the ACCC reported that it had received over 2,000 complaints related to franchising and the Code alone.7
3. Other regulations protecting small business franchisees
Another potential issue for franchisors entering the Australian market to keep in mind is the presence of other regulations which protect "small business" and so advantage franchisees.
The Australian Consumer Law8 prohibits what is known as "unconscionable conduct" – which is a difficult concept to nail down and which has been a contentious area. In short, certain conduct is unconscionable if harsh or oppressive to another party (either another business or a consumer). Conduct may also be unconscionable where one party knowingly exploits a special disadvantage of another. Such laws will protect small business owners who are franchisees and advice should be sought to make sure that any prospective franchisor does not include in its agreement provisions which would not be enforceable under these consumer protection and small business protection laws.
There are also other laws protecting small business franchisees of which to be mindful. In 2015, the Australian federal government enacted the Treasury Legislation Amendments (Small Business and Unfair Contract Terms) Act 2015 (Cth), which comes into force in late 2016 and which will apply to certain "standard form contracts". Once in force, any standard form contract is entered into, renewed or varied will be caught if the counterparty is a small business who employs fewer than 20 people and who pays an up-front fee of less than A$1 million (about US$750,000) for a contract of over 12 months.
If the franchisee to a franchise agreement has had little or no opportunity to negotiate its terms (that is, it is presented on a "take it or leave it" basis) then it is likely that the new laws will apply to it and the franchise agreement will be considered to be a "standard form contract" and so the new law will apply to it.
The effect of the new law is that it prohibits certain "unfair contract terms". If they are present in the franchise agreement, then the contract can be declared void by a court and the franchisee may have remedies of injunctions, compensation or damages against the franchisor.
4. Providing an initial disclosure document is not the end of it
Most franchisors entering Australia will be alert to the potential need to provide a form of disclosure document to a franchisee before the contract is entered into. However, there are some tricks with the Australian disclosure requirements and legal advice should be sought as the penalties for getting disclosure wrong are severe and the franchisor could risk the franchise agreement being set aside on that basis or worse (having to pay compensation and damages to the franchisee).
Another issue to bear in mind is that the Code requires franchisors to provide a disclosure document to both new and renewing franchisees. And, under the Code, precise details, format and information must be disclosed in accordance with a mandatory pro forma.
Prospective Australian franchisors should also be aware that the disclosure document will need to be updated annually within four months after the end of the Australian financial year (i.e. by the end of October each year as the financial year end is 30 June).
The franchise disclosure documents must be given to potential new franchisees and to existing franchisees proposing to renew their agreements at least 14 days before the franchisee signs its franchise agreement and the disclosure must be accompanied by the franchise agreement in the form in which it is to be signed as well as a copy of the Code.
One of the unique aspects of the Australian franchising laws is that they additionally place a "continuous disclosure" obligation on the franchisor. This means that franchisors must notify their franchisees within 14 days of certain "materially relevant facts", including details of the following:
- Proceedings against the franchisor or a franchisor director by 10 per cent or at least 10 franchisees or investigations, judgments or arbitration awards against the franchisor or franchisor director which are relevant to the franchise system.
- Changes in ownership or control of the franchisor or intellectual property of the franchise business.
- The franchisor becoming externally administered or being required to make court-enforceable undertakings.
Franchisors will need good management systems and procedures to make sure they get disclosure right.
5. You need to think about your expansion strategies
Another trap for many new franchisors entering the Australian market is that they are not aware of some of the compliance and risk issues associated with expansion of their franchise after they have entered into their agreement with their franchisees. The reason it is necessary to think this through is because the franchisor has an additional disclosure obligation in relation to issues such as on-line sales and when they are extending a agreement – either its term, territory, trade marks or its scope in any other way.
This can be a technical area. Bottom line is that franchisors need to be aware that they simply cannot alter the scope of the franchise agreement with the franchisee without thinking through the need to comply with any disclosure obligations or other laws in place that protect franchisees from franchisors exercising rights to unilaterally vary the franchise agreement.
How many franchisors have set up systems which will alert their management to the need to potentially comply with the legal requirements such as disclosure obligations when altering the franchisee's agreement, or the intellectual property or trade marks being licensed, or the agreement's scope or term? Advice should be sought and good franchise management systems, processes and structures need to be put in place with the compliance programme.
In this way, franchisors in Australia can avoid any expensive "rookie" mistakes.
In conclusion, the outlook for franchisors entering into the Australian market is sunny but obtaining good advice as part of due diligence on the Australian market is necessary. Most Australian legal requirements are straightforward and would not negatively effect a franchisor with good practices. Good franchisors prepare for market entry by setting up their legal compliance programmes from the beginning.