It has been over 3 years since the latest in a long line of Australian federal government inquiries into franchising commenced. This week the government released changes to the Franchising Code, many of which commence as early as 1 July and which will complicate the process of signing franchisees in Australia during the transition period.
Many of the changes to the Code were foreshadowed in the 2019 Parliamentary Joint Committee on Corporations and Financial Services Fairness in Franchising Report and in the government's response to the report and exposure draft released last year. However, the obligations on franchisors have been further tightened in a number of respects, most particularly for franchise agreements involving the sale of new passenger or light goods motor vehicles.
Many of these changes are unique to Australia, taking Australian franchising regulation further away from international norms and creating additional difficulties for franchisors wishing to expand their businesses to Australia.
- Franchisors will need to review their franchise agreements for necessary changes before they issue any franchise agreement which will be signed on or after 1 July 2021.
- Although disclosure documents need not be changed before 1 November 2021, changes to the disclosure process and to the information statement, and the introduction of an additional "key facts sheet", occur from 1 July and this will complicate the transition process.
- Additional disclosure about possible future capital expenditure and rebates will be of concern to many franchisors and will require significant care and attention.
Summary of key changes
Capital expenditure: Franchisors will be prohibited from requiring franchisees to undertake significant capital expenditure during the term of the franchise agreement unless this has been disclosed in the disclosure document, is required by law or is agreed by the franchisee, consistent with changes made last year for the motor vehicle sector. It will no longer be possible for franchisors to justify expenditure as a necessary capital investment in the franchised business. Further, significant details of the expenditure must be provided in the disclosure document, including the rationale for and the amount, timing and nature of the expenditure, and the franchisor and franchisee must separately discuss the expenditure before entering into, renewing or extending the term or scope of the franchise agreement. It is likely to be very difficult for franchisors to predict the types of expenditure that may need to be incurred and provide the level of detail required, especially in long-term franchise agreements. Some franchisors may wish to consider offering shorter terms to enable capital expenditure to be more accurately predicted.
Disclosure process: Franchisors will be required to provide a "key facts sheet" to the franchisee in addition to a disclosure document prior to entering into, renewing or extending the term or scope of the franchise agreement. The key facts sheet must be in the form published on the Australian Competition and Consumer Commission (ACCC) website and must only include information relating to the franchise that is in the disclosure document or is otherwise required to be provided under the Code. The key facts sheet must be updated in the same way as the disclosure document - within 4 months of the end of each financial year. The form of the key facts sheet is not yet available, but any franchisee signing a franchise agreement on or after 1 July 2021 must have received the key facts sheet at least 14 clear days prior. While the Explanatory Statement states that the key facts sheet will not create new substantive disclosure obligations for the franchisor, it will undoubtedly increase the administrative burden for franchisors by requiring an additional document to be maintained and updated.
A new section has also been included to require the franchisor to provide a disclosure document and key facts statement to a prospective transferee of an existing franchise agreement at least 14 days before the franchisor gives consent to the transfer. A penalty will apply for breach of this requirement. The effect of this perplexing change is that the franchisor will not be able to give their consent to the transfer until 14 days after giving the transferee the required documents. This may cause issues around the timing of transfers and franchisors will need to review and update their transfer approval processes.
Additionally, the form of information statement a franchisor must provide to a prospective franchisee has changed effective 1 July 2021.
The franchisee may now request documents in printed form, electronic form or both, before they are provided.
Cooling off: The cooling off period will be extended from 7 to 14 days after the franchisee enters into or makes a non-refundable payment under the franchise agreement. If the franchisee is to lease premises from the franchisor, the franchisee will have a 14 day cooling off period after receiving a document setting out the terms of the proposed lease. If the terms of the final lease are not substantially identical to the proposed terms, there will be a further 14 day cooling off period from the franchisor's receipt of the final lease. There will also be a cooling off period where the franchise is transferred, whether or not the franchisee is required to enter into a new franchise agreement and for 14 days after the earlier of when the new franchisee takes possession or "becomes the franchisee". This change will add further complexities to the transfer process and it is unclear what benefit it will provide to franchisees.
Termination: A new right will be introduced for franchisees to propose early termination of the franchise agreement and how this should be effected. This is intended to give franchisees who wish to leave the network (whether due to financial hardship or other reasons) an exit mechanism. The franchisor must respond to the franchisee's proposal within 28 days - with reasons if they refuse the request - and must act in good faith in early termination negotiations. If the franchisor refuses to agree to termination, the franchisee may implement the dispute resolution procedures and require the franchisor to enter mediation to resolve the matter.
The current provisions permitting the franchisor to terminate the franchise agreement immediately in special circumstances (such as insolvency of or fraudulent acts or endangering public health or safety by the franchisee) will be amended to require the franchisor to provide 7 days' notice of termination to the franchisee. The franchisee will then be able to raise a dispute in relation to the proposed termination, in which case the franchisor will not be able to terminate until the end of 28 days from giving the termination notice. This will restrict the franchisor from acting swiftly in situations that could have a potentially serious impact on the franchise network. However, the franchisor will be able to require the franchisee to stop operating the franchised business while dispute resolution proceedings are taking place provided the franchisor has a right under the franchise agreement to do so in the particular circumstances. Franchisors should ensure their agreements are amended to clearly include such a right.
Dispute resolution: Changes have been made to allow conciliation and voluntary binding arbitration, in addition to the existing mediation model. Importantly, franchisors can now be required to participate in multi-party mediation or conciliation if the dispute is referred to mediation or conciliation by a group of franchisees with similar disputes with the franchisor. However, the franchisor's agreement will be required for a dispute to be referred to arbitration.
Franchisor's legal costs: Franchisors will be prohibited from requiring in the franchise agreement that the franchisee pay all or part of the franchisor’s legal costs relating to preparing, negotiating or executing the agreement. A penalty applies for breach of this prohibition. However, a franchisor can require the franchisee to pay a fixed amount before the franchisee starts the franchised business so long as it is specified in the franchise agreement and the agreement states the amount is for the franchisor's legal costs of preparing, negotiating or executing the agreement and does not include costs for legal services provided after the agreement is entered into.
Marketing funds: There have been various minor changes to the marketing fund provisions in order to clarify the language, but the requirements are essentially unchanged. However, civil penalties will now apply for breach of the requirements relating to maintaining a separate bank account for marketing fund payments, payments into the fund for franchisor operated units and use of money paid into the fund.
Disclosure Document: There will be additional disclosure obligations that will require changes to franchisors' disclosure documents for any disclosure document provided on or after 1 November 2021. In particular, more extensive details of supplier rebates and other financial benefits will need to be provided - including, the nature of each rebate, name of the business providing it, the amount of rebates received and, if rebates are shared with franchisees, the method for working out how much is shared. The changes extend the disclosure obligation to include rebates received by a master franchisor, when previously the obligation only applied to the franchisor and associates of the franchisor. The changes do however make it clear that the price paid by the franchisee for the supply of goods and services and any lease incentives received by the franchisor, master franchisor or an associate will not be considered a rebate or financial benefit that is required to be disclosed.
The changes do not yet include the government's previously announced doubling of the pecuniary penalties specified in the Code. Nor do they include requirements to register the franchise and make annual filings, although the government is developing a registration mechanism and model. We expect the government to release further information on these changes in the months to come.
More changes for motor vehicle sector
The motor vehicle sector has been the subject of more numerous recent inquiries, and changes specific to franchises of new passenger and light goods vehicles were made to the Code on 1 June 2021:
- extending the 6 months non-renewal notice requirement at the end of term to 12 months;
- requiring the franchisor to discuss, plan and agree end of term arrangements if an agreement is not renewed including for the handling of capital intensive stock;
- restricting the ability to require a franchisee to incur significant capital expenditure to that which is disclosed in some detail in the disclosure document: removing the ability for the franchisor to require it by providing details of the rationale, benefits and risks in term; and
- requiring the franchisor to discuss the expenditure and the circumstances under which the franchisee is likely to recoup the expenditure, before entering into, renewing or extending the agreement.
The changes regarding significant capital expenditure have now been expanded to the franchising sector as a whole, but the 12 months' notice requirement and end of term requirements around stock remain unique to the new motor vehicle sector.
None of the previous government inquiries or consultations referred to the following extremely onerous requirements, which have been added to the Code for the new passenger and light goods vehicles sectors:
- franchise agreements entered into on or after 1 July 2021 must provide for the franchisee to be compensated if the franchise agreement is terminated because the franchisor withdraws from the Australian market, rationalises its network or changes its distribution models in Australia and must specify how the compensation is to be terminated with specific reference to lost profit, unamortised capital expenditure, loss of opportunity in selling goodwill and the costs of winding up the franchised business;
- franchise agreements entered into on or after 1 July 2021 must provide for the franchisor to buy back or compensate the franchisee for new road vehicles, spare parts and special tools if the franchise agreement is not renewed or the franchise agreement is terminated because the franchisor withdraws from the market or rationalises or changes its distribution models;
- a franchisor must not enter into a franchise agreement on or after 1 July 2021 unless it provides the franchisee with a reasonable opportunity to make a return, during the agreement term, on any investment required by the franchisor as part of entering into or under the agreement.