On 1 January 2015, the existing Franchising Code of Conduct set out in the Trade Practices (Industry Codes — Franchising) Regulations 1998 (Old Code) will be replaced by the new code set out in the Competition and Consumer (Industry Codes – Franchising) Regulation 2014 (New Code). If you are a franchising participant, you are probably wondering what you should be doing in preparation for January.
In this paper:
- we answer some questions you might have about how the New Code applies to you; and
- provide further detail about some of the main changes introduced by the New Code which we flagged when we covered the exposure drafts in our April paper.
I am an existing franchisor / franchisee under the Old Code. Will the New Code apply to me?
Yes. The New Code will apply to your conduct after 1 January 2015 if you are party to a franchise agreement entered into on or after 1 October 1998.
For example, from 1 January 2015:
- you will be under a statutory obligation to act in good faith in your dealings with the other party to your franchise agreement (more on the good faith obligation below); and
- if you are an existing franchisor, you will be subject to a continuing obligation to disclose certain materially relevant matters to your franchisees if your disclosure document does not mention them (more on that below, too).
Help! I am an existing franchisor under the Old Code. Don’t tell me I have to update my disclosure document by 1 January 2015?!
No, you are in luck. The New Code gives existing franchisors a grace period for updating disclosure documents to ensure that they are compliant with the New Code.
As an existing franchisor, you will have until 31 October 2015 to update your disclosure document. After that, you must update your disclosure document within 4 months after the end of each financial year (and bearing in mind that your financial year might not be the standard Australian 1 July – 30 June financial year).
Example: you are an existing US franchisor under the Old Code and your financial year is 1 January – 31 December. You must update your disclosure document to comply with the New Code by 31 October 2015: you will be obliged to give a New Code-compliant disclosure document to any new or renewing franchisee from 31 October 2015. After that, you will have to update your disclosure document by 1 May each year (being 4 months after the end of your financial year). (Bear in mind, however, that you will be subject to the New Code’s other obligations throughout the whole 1 January 2015 – 1 May 2016 period, such as the good faith obligation and ongoing disclosure obligations discussed below).
How does the New Code differ from the Old Code?
The New Code differs in a number of ways, not all of which we can discuss in this paper. Here are some of the most important.
Good faith obligation
Unlike the Old Code, the New Code imposes a statutory obligation on parties to a franchise agreement to act in good faith towards one another. This obligation also extends to parties proposing to enter into a franchise agreement. A franchise agreement cannot exclude or modify the good faith obligation.
Rather than trying to define ‘good faith’, the New Code uses the common law concept of ‘good faith’ which courts have developed over the years. However, the New Code makes it clear that whether a party acted honestly and not arbitrarily, and whether a party cooperated to achieve the purposes of the franchise agreement, are relevant considerations.
Some restraint of trade clauses may not be effective
Franchisors often want to limit franchisees’ ability to compete with the franchised business after the franchise agreement ends. Under the New Code, however, a restraint of trade clause will not be enforceable after the expiry of a franchise agreement if all of the following apply:
- the franchisee wanted to extend the franchise agreement on substantially the same terms;
- the franchisee was not in breach of the franchise agreement, had not infringed the franchisor’s intellectual property nor breached any confidentiality agreement with the franchisor;
- the franchisor does not extend the franchise agreement; and
- the franchisee claims compensation for goodwill because the agreement was not extended, but either the compensation given to the franchisee was nominal and did not provide genuine compensation for the goodwill, or the agreement did not allow the franchisee to claim compensation for goodwill at all.
The New Code only affects restraint of trade clauses preventing the franchisee from competing with the franchisor’s business.1 Other kinds of restraint clauses, like those preventing franchisees from soliciting a franchisor’s employees or using the franchisor’s intellectual property, are not affected.
Certain other terms in franchise agreements are prohibited
The New Code prohibits a franchise agreement from requiring:
- a release of the franchisor from all liability towards the franchisee (this prohibition also existed under the Old Code);
- a party to bring an action or engage in dispute resolution outside Australia or outside a State or Territory in which the franchised business is based; and
- a franchisee to pay the franchisor’s costs of settling a dispute under the agreement.
Disclosure document differences
Under the New Code, master franchisors are no longer required to provide a disclosure document to subfranchisees. This removes the unnecessary duplication involved in both master franchisors and subfranchisors (commonly referred to as ‘master franchisees’) preparing disclosure documents for subfranchisees, and eases the disclosure burden on master franchisors to some extent.
The ‘short form’ disclosure document that was a feature of the Old Code will also be removed in favour of one standard disclosure document template. The New Code, however, will allow franchisors to shorten and improve the readability of their disclosure documents by placing a list of inapplicable items in an attachment to, rather than in the main body of, the disclosure document.
In addition to providing a disclosure document to prospective franchisees at least 14 days before entering into a franchise agreement (as required by the Old Code), under the New Code franchisors will be required to give a copy of a generic ‘information statement’ to franchisees ‘as soon as practicable after the prospective franchisee formally applies or expresses an interest in acquiring a franchised business’. In practice, this will usually mean that the information statement must be given to the prospective franchisee earlier than the disclosure document. The form of this statement is set out in Annexure 2 of the New Code.
Ongoing disclosure of materially relevant matters
The New Code increases the disclosure burden on franchisors by requiring them to disclose certain material matters if they arise and have not been mentioned in a disclosure document. For example, a franchisor must tell a franchisee within 14 days of becoming aware of any of the following matters:
- a change in majority ownership or control of the franchisor, certain associates of the franchisor or the franchise system;
- proceedings against the franchisor or an associate of the franchisor for breach of a franchise agreement, trade practices law or the Corporations Act (among others), and certain judgments entered against the franchisor or its associates;
- the franchisor or an associate of the franchisor going into administration; or
- a change in the intellectual property, or ownership or control of the intellectual property, that is material to the franchise system.
These ongoing disclosure obligations have been introduced to remove the ambiguity which the Old Code created by only requiring franchisors to give franchisees a ‘current’ disclosure document.2 The New Code makes it clear that not only must franchisors update their disclosure documents annually, they must also disclose particular matters to franchisees if they arise before the disclosure document is due to be updated.
Civil penalties and infringement notices
The New Code, together with amendments to the Competition and Consumer Act 2010,3 provides that franchisors may be subject to civil penalties of up to $51,000 for breaching certain New Code provisions – including breaching the good faith obligation and failing to comply with the ongoing disclosure requirements discussed above.
Additionally, the Australian Competition and Consumer Commission (ACCC) will be empowered to issue ‘infringement notices’ to parties in breach of the New Code, which could result in fines of up to $8,500 per breach.
What should I do now?
Franchising participants need to be aware of their obligations under the New Code in preparation for 1 January 2015.
Reviewing and modifying existing disclosure documents can be complex and time-consuming, so franchisors in particular would do well to start thinking about reviewing their franchise systems to ensure they are New Code-compliant, even if they do not plan on updating their disclosure documents until the 31 October 2015 deadline.
As always, we are more than happy to assist franchising participants as they move into this new era of franchising regulation.