Offer and sale of franchises

Legal definition

What is the legal definition of a franchise?

The application of the Franchising Code of Conduct (the Code) is largely determined by the definition of a franchise agreement, which is broadly described as an agreement that takes the form, in whole or in part, of a written, oral or implied agreement. The Code defines a franchise agreement in clause 5(1), including in its definition any form of franchise, master franchise, licence or distribution agreement. The essence of the definition is as follows:

 

[An agreement] in which a person (the franchisor) grants to another person (the franchisee) the right to carry on the business of offering, supplying or distributing goods or services in Australia under a system or marketing plan substantially determined, controlled or suggested by the franchisor or an associate of the franchisor.

 

The definition has two requirements:

  • that ‘the operation of the business will be substantially or materially associated with a trade mark, advertising or commercial symbol owned, used or licensed by the franchisor or an associate of the franchisor; or specified by the franchisor or an associate of the franchisor’; and
  • that ‘before starting the business or continuing the business the franchisee must pay or agree to pay to the franchisor or an associate of the franchisor an amount, including for example an initial capital investment fee, a payment for goods and services or a fee based on a percentage of gross or net turnover whether or not called a royalty or franchise service fee, or a training fee or training school fee’.

 

The only exemption to the application of the Code is a fractional franchise exemption where sales under the franchise are no more than 20 per cent of the franchisee’s gross turnover. All motor vehicle dealerships (being a business of buying, selling, exchanging or leasing any form of motor vehicle, however structured) are deemed to be franchise agreements. There are additional provisions in the Code, mainly in relation to end of term arrangements and capital expenditure, that only apply to automotive franchise agreements. Oil industry franchise agreements are subject to different, but similar, legislation known as the Oil Code of Conduct.

Following the introduction of amendments to the Code in April 2022, franchisors are now required to register with the Franchise Disclosure Registry. This must be done by November 2022, when the registry will become live for all franchisors' profiles and documents to be publicly searchable.

There is no state regulation of franchising in Australia other than the legislation in South Australia that relates to the resolution of disputes in franchise agreements connected to South Australia. Franchisors are also able to conduct meetings and generally undertake preliminary marketing and prospecting in Australia, but may not enter into a binding agreement or take any non-refundable amount from a prospective franchisee or master franchisee without complying with the Code.

Laws and agencies

What laws and government agencies regulate the offer and sale of franchises?

The Code and the prohibitions on misleading or deceptive conduct contained in the Australian Consumer Law (ACL) regulate the offer and sale of franchises.

Principal requirements

What are the principal requirements governing the offer and sale of franchises under the relevant laws?

The Code includes comprehensive disclosure and franchise relationship provisions. It is supplemented by prohibitions on misleading or deceptive conduct, unconscionable conduct and unfair contract terms in standard form small business contracts contained in the ACL. Amendments to the Code that took effect on 1 July 2021 also extend the 14-day cooling-off period to franchisee-to-franchisee sales.

Franchisor eligibility

Must franchisors satisfy any eligibility requirements in order to offer franchises? Are there any related practical issues or guidelines that franchisors should consider before offering franchises?

There are no eligibility requirements for franchisors before they can offer franchises.

From November 2022, most franchisors will be required to register and provide certain information about their franchise to the Franchise Disclosure Register. This includes the name, Australian business number, registered address, and contact details of the franchisor. Certain other information may be prescribed for inclusion in the franchisor's registration. This information will need to be updated annually. Franchisors may also elect to upload their franchise agreement, disclosure document and key facts sheet. These documents must not include personal information. 

The comprehensive Code pre-contractual disclosure process and the prohibition on engaging in misleading or deceptive conduct contained in the ACL place some natural barriers to entry in a competitive market, particularly where franchisees follow the Code’s process and obtain legal and business advice prior to signing the franchise agreement.

Franchisee and supplier selection

Are there any legal restrictions or requirements relating to the manner in which a franchisor recruits franchisees or selects its or its franchisees’ suppliers? What practical considerations are relevant when selecting franchisees and suppliers?

There are no legal restrictions or requirements in relation to the manner in which a franchisor recruits franchisees or selects its own or its franchisees’ suppliers. Supply arrangements must be disclosed in the disclosure document, with amendments to the Code in effect as of 1 July 2021 significantly expanding disclosure obligations in relation to rebates and financial benefits. The general prohibition on unconscionable conduct contained in the ACL can apply if the mandated supply chain arrangements are unnecessarily onerous or place the franchisee at a substantial competitive disadvantage.

Pre-contractual disclosure – procedures and formalities

What procedures and formalities for pre-contractual disclosure are required or advised in your jurisdiction? How often must the disclosures be updated?

There are two pre-contractual disclosure obligations under the Code in Australia. Franchisors must provide an information statement (essentially a brochure on the advantages and disadvantages of franchising) in the prescribed form to a prospective franchisee at the earliest opportunity after the prospect formally expresses interest in a franchise (which must not be later than seven days). The intent of this disclosure obligation is to highlight the potential risks of franchising and emphasise the importance of due diligence to prospective franchisees well before they decide to enter into the franchise agreement. The information statement must be in the form prescribed, which is available on the Australian Competition and Consumer Commission's (ACCC's) website. 

In addition, franchisors are required to produce a disclosure document that strictly complies in form and content with the terms of Annexure 1 (full form) of the Code. The disclosure document is required to be ‘in the form and the order and under the numbering' and ‘under the titles’ set out in the annexures to the Code. Although some of the information contained in existing disclosure materials assists in the preparation of the Australian document, foreign systems must instruct local counsel to undertake a comprehensive redraft to meet the format requirements of the Code. Supplementing the general disclosure obligation is a Code requirement to provide a key facts sheet in the prescribed form. The key facts sheet is, in essence, a summary of important facts contained in the disclosure document. The prescribed information statement and the form of the key facts sheet are now accessible on the ACCC’s website.

Certain modifications to the franchise agreement must be made concerning releases of liability, franchisee freedom of association, cooling-off periods, assignment and termination. A franchisor is prohibited from passing on to franchisees a franchisor’s legal costs, subject to very limited exceptions. There are also provisions limiting termination, providing cooling-off protections and dealing with dispute resolution, including mechanisms for group franchise dispute resolution. 

A general review of documentation for Competition and Consumer Act compliance is also highly desirable, as the terms and language of a franchise agreement are relevant in assessing conduct such as unconscionable conduct. Plain-English drafting is highly desirable.

A franchisor must, under the Code, give a disclosure document and a key facts sheet to a prospective franchisee or a franchisee proposing to renew or extend a franchise. A franchisor must give a copy of the Code and a disclosure document to a prospective franchisee at least 14 days before the prospective franchisee:

  • enters into a franchise agreement;
  • makes an agreement to enter into a franchise agreement; or
  • pays non-refundable money to the franchisor or an associate of the franchisor in connection with the proposed franchise agreement.

 

The franchisor must also provide at this time a copy of the franchise agreement ‘in the form in which it is to be executed’, which means that the document must contain all commercial terms and be essentially ready to be signed. Failure to comply with this requirement can invalidate disclosure and is a pitfall for foreign franchisors that are used to providing more of a template franchise agreement with the disclosure material.

A foreign franchisor entering into a master franchise agreement with a master franchisee that has the right to grant unit franchises and sub-franchises in Australia must also provide to the master franchisee a disclosure document relating to the terms of the master franchise agreement. As of 1 January 2015, a franchisor is required to give a disclosure document to a master franchisee, but the franchisor is not required to give a disclosure document to a sub-franchisee of the master franchisee. These disclosure requirements can create potential liability for foreign franchisors, so it is important that legal advice from an experienced franchise attorney is obtained regarding the form of these documents before entering into the Australian market.

Franchisors are required to update their disclosure document annually within four months of the end of their financial year. They are also required to provide a copy of their current disclosure document to an existing franchisee within 14 days of written request. However, there are some exemptions from updating for franchisors that have granted no more than one franchise agreement in the year and do not intend to grant a franchise in the following year.

The Code contains somewhat unusual provisions in relation to legal and business advice, and to cooling-off periods:

  • A franchisor must not, by virtue of the Code, enter into, renew or extend a franchise agreement unless the franchisor has received from the franchisee or prospective franchisee a written statement that the franchisee or prospective franchisee has received, read and had a reasonable opportunity to understand the disclosure document and the Code.
  • Before a franchise agreement is made, the franchisor must have received from the prospective franchisee signed statements that the prospective franchisee has been given advice about the proposed franchise business from at least one independent legal adviser, business adviser or accountant, or has been told that this advice should be sought but has decided not to seek it.
  • A franchisee may terminate a franchise agreement without cause within 14 days after entering into the agreement or paying any money under the agreement, whichever comes first. If the franchisee terminates such an agreement, the franchisor must, within 14 days, repay all money paid by the franchisee to the franchisor under the agreement less reasonable expenses, provided that those expenses have been disclosed in the disclosure document provided to the franchisee.

 

Pre-sale disclosure to sub-franchisees

In the case of a sub-franchising structure, who must make pre-sale disclosures to sub-franchisees? If the sub-franchisor must provide disclosure, what must be disclosed concerning the franchisor and the contractual or other relationship between the franchisor and the sub-franchisor?

Disclosure to sub-franchisees is typically undertaken by the sub-franchisor, as it is the ‘franchisor’ for the purposes of a franchise agreement in the Code. Joint disclosure may be required if the franchisor is also a party to the franchise agreement, so this should be avoided if possible.

Item 7 in the disclosure document to be provided by the sub-franchisor to the sub-franchisee includes specific disclosure obligations concerning the franchisor in relation to business details, senior employees and franchise agreement termination. It also includes key provisions of the franchise agreement between the franchisor and the sub-franchisor, such as the agreement’s term, territory, renewal, extension, scope, transfer, termination and consequences of termination.

Item 8 in the disclosure document requires information to be provided in relation to ownership of intellectual property and details of any agreement that significantly affects the sub-franchisor’s right to use or give others the right to use the intellectual property. This is likely to require some disclosure in relation to the agreement between the franchisor and the sub-franchisor.

Due diligence

What due diligence should both the franchisor and the franchisee undertake before entering a franchise relationship?

The Code provides a strong framework for franchisee due diligence, combining preliminary disclosure through the information statement with the more common formal pre-contractual disclosure process. The information statement broadly explains franchising, the franchise relationship and the risks of franchising, and outlines how to undertake due diligence, obtain advice, read documents, understand the franchisee’s rights and obtain further information. The disclosure document contains extensive information, and is provided as part of a process that allows 14 days between provision and signing to facilitate obtaining legal and business advice. Not only is obtaining advice strongly encouraged, but franchisees must certify as part of the pre-contractual process that they have obtained advice or have been told to obtain advice but have elected not to do so. A list of franchisees’ and former franchisees’ contact details is provided as part of the disclosure document, which is an excellent reference point. Franchisees should speak to several existing and former franchisees, read documentation carefully, and obtain legal and business advice.

Franchisors should conduct their own due diligence of prospective franchisees, particularly in relation to financial resources, business acumen and customer service skills.

Failure to disclose – enforcement and remedies

What actions may franchisees or any relevant government agencies take in response to a franchisor’s failure to make required disclosures? What legal remedies are available? What penalties may apply?

In situations of material and substantive non-disclosure by a franchisor, a franchisee can take legal action via civil proceedings to obtain various common law and equitable remedies, including damages, rescission, injunctions and other orders a court may deem fit. Damages are typically calculated by reference to the actual damage suffered by the franchisee and can be awarded in addition to other remedies such as rescission, amendment or termination of the franchise agreement, or other order a court may see fit.

In addition, the ACCC takes an active enforcement role. The ACCC has the power to investigate and seek penalties for contraventions of the Code. The ACCC’s use of enforcement tools varies on a case-by-case basis depending on the circumstances of the contravention. Where there are reasonable grounds for believing a contravention of a penalty provision has occurred, the ACCC can issue an infringement notice of A$11,100 to a franchisor without the need to apply to any court. The ACCC can also enforce the Code by court proceedings with the power to seek a civil penalty of A$133,200 for each contravention. Additionally, the ACCC can obtain orders against the franchisor that include compensation and damages, disqualification of directors, and injunctions. The ACCC also has the power to accept formal undertakings by which a franchisor can commit to specific remedies for the breach.

Some provisions of the Code contain greater financial penalties. These provisions relate to: 

  • disclosure of materially relevant facts; 
  • restricting the freedom of association of franchisees or prospective franchisees; and
  • certain terms of new vehicle dealership agreements. 

 

For companies, the maximum penalty per contravention will be the greater of: 

  • A$10 million;
  • three times the value of the benefit received; or
  • 10 per cent of annual turnover in the preceding 12 months, if a court cannot determine the benefit obtained from the offence.

 

For individuals, the maximum penalty per contravention will be A$500,000. 

Often action in relation to disclosure breaches is coupled with claims for misleading or deceptive conduct, or unconscionable conduct (or both), which attract higher financial penalties. Recent cases have seen damages awards in excess of A$2 million against franchisors that have breached the Code and the ACL, such as Australian Competition and Consumer Commission v Ultra Tune Australia Pty Ltd [2019] FCA 12, and Australian Competition and Consumer Commission v Geowash Pty Ltd (Subject to a Deed of Company Arrangement) (No 4) [2020] FCA 23.

General legal principles and codes of conduct

In addition to any laws or government agencies that specifically regulate offering and selling franchises, what general principles of law affect the offer and sale of franchises? What industry codes of conduct may affect the offer and sale of franchises?

The offering and selling of a franchise is a commercial dealing subject to the provisions of the ACL contained in Schedule 2 of the Competition and Consumer Act 2010 (Cth). The ACL governs the conduct of both the franchisor and franchisee in such dealings and, among other things, prohibits them from engaging in conduct that is unconscionable, misleading, deceptive, or likely to mislead or deceive.

General common law contract principles also apply to franchise agreements. These principles can affect the validity and enforceability of a franchise agreement depending on the terms of the agreement, surrounding circumstances, and conduct of the parties prior to and after its execution. For example, a franchise agreement may be avoided where misleading or deceptive conduct, duress, unconscionable conduct, or undue influence has taken place.

There are a number of mandatory industry codes in Australia that may apply to the franchise agreement and are enforceable by the ACCC including:

  • the Food and Grocery Code of Conduct;
  • the Horticulture Code of Conduct;
  • the Oil Code of Conduct; and
  • the Unit Pricing Code.

 

Additionally, voluntary industry codes may apply to parties to franchise agreements where they have elected to be bound by them.

Fraudulent sale

What actions may franchisees take if a franchisor engages in fraudulent or deceptive practices in connection with the offer and sale of franchises?

Under the ACL, several remedies are available to a franchisee where a franchisor has engaged in fraudulent or deceptive practices regarding the offer and sale of a franchise. These remedies include the voiding or varying of parts or the entirety of the franchise agreement, monetary damages and orders (or injunctions) compelling certain actions by the franchisor.

Under common law contract principles, a franchisee may obtain an order of rescission whereby the franchise agreement is rendered void and unenforceable. Additionally or alternatively, a franchisee may be awarded monetary damages.