The most significant changes to the Franchising Code of Conduct (Code) since its introduction in 1998 will come in to effect on 1 January 2015 following the commencement of the Competition and Consumer (Industry Codes – Franchising) Regulation 2014.
The Government asserts that the objective of the Code is to strengthen its effectiveness and responsiveness and to reduce the red-tape for franchisors and franchisees.
We set out below a summary of the key changes introduced by the Code and what franchisors and franchisees need to do in order to comply with the Code by 1 January 2015.
FINANCIAL PENALTIES FOR BREACHES OF CODE
The Australian Competition and Consumer Commission (ACCC) will have additional powers as follows:
- Civil penalties – franchisors and franchisees may be liable for civil penalties of up to $51,000 if they breach certain sections of the Code. See this table for a list of the obligations in the Code which may result in the imposition of a civil penalty (or an infringement notice – see below) if breached.
- Infringement notices – in September 2014 the Government implemented the Competition and Consumer Amendment (Industry Code Penalties) Act 2014 which amends the Competition and Consumer Act 2010 to permit the ACCC to issue infringement notices for breaches of the civil penalty provisions in the Code. The amount the ACCC will be able to impose by way of such infringement notices is initially $8,500 (for a body corporate). If a person pays the amount set out in an infringement notice, proceedings cannot be brought against them in relation to the alleged contravention of the Code. If, however, a person does not pay the amount set out in the infringement notice, they take the risk that the ACCC may seek to have the matter heard in court which could expose them to higher civil penalty amounts.
STATUTORY OBLIGATION OF GOOD FAITH
The Code introduces an express obligation on parties to a franchise agreement to act in good faith in their dealings with one another under or in relation to the franchise agreement or the Code (which includes the negotiation of a prospective franchise agreement).
The meaning of “good faith” is not specifically articulated in the Code. Instead it is defined in the Code as having the meaning set out in the “unwritten law” (being the common law developed by courts in relation to good faith).
In determining whether a party has acted in good faith, the Code provides that a court may have regard to whether the party has acted honestly and not arbitrarily, and whether they have cooperated to achieve the purposes of the franchise agreement.
The Code expressly recognises that a party will not be in breach of the obligation to act in good faith merely by acting in its own legitimate commercial interests.
It is not possible for the parties to contract out of the obligation to act in good faith and a party may be liable for a civil penalty if it breaches this obligation. Franchise participants are subject to this good faith obligation on and from 1 January 2015.
The Explanatory Statement to the Code explains that the good faith obligation is “intended to provide a flexible mechanism for addressing opportunistic and unfair conduct in franchising that may fall below the threshold of more serious misconduct provisions within the Australian Consumer Law or the [Competition and Consumer Act]”.
RIGHTS OF FRANCHISEES BOLSTERED
The Code is good news for franchisees as it bolsters their rights in a number of areas:
- Restraints on former franchisees not enforceable in certain circumstances – a restraint of trade clause in a franchise agreement (e.g. an obligation on the franchisee to not conduct a similar business following termination of the agreement for a certain duration and in a certain territorial location) will not be enforceable if:
- the franchisee had sought to renew the agreement (regardless of whether or not it had a contractual right to renew) on substantially the same terms as those contained in the franchisor’s then current franchise agreement (or agreement that would apply to prospective franchisees);
- the franchisee was not in breach of the agreement (assessed at the time of expiration) and had not infringed the franchisor’s IP or any confidentiality agreement with the franchisor;
- the franchisor does not renew the agreement; and
- either: (1) the franchisee claimed compensation for goodwill because the agreement was not extended but the compensation given was merely a nominal amount and did not genuinely compensate the franchisee for goodwill; OR (2) the agreement did not allow the franchisee to claim compensation for goodwill in the event that it was not extended.
Since it is common for franchise agreements to prohibit the franchisee from claiming compensation for goodwill at the end of the term, if this approach is maintained in franchise agreements which are entered into (or existing agreements varied or transferred) after 1 January 2015, the restraints in those agreements are likely to be unenforceable. See our comments below on what franchisors should consider doing before 1 January 2015 to ensure its restraints are enforceable after 1 January 2015.
- Limitations on requiring capital expenditure – subject to several broad exceptions (such as where it is agreed by the franchisee, disclosed in the disclosure document or agreed by a majority of the franchisees), a franchisor must not require a franchisee to undertake significant capital expenditure during the term of a franchise agreement. Franchisors will not be able to require significant capital expenditure by franchisees (e.g. renovations to premises) without careful planning.
- Marketing contribution by franchisors – if a franchisor operates one or more units of a franchised business, the franchisor must pay marketing fees on behalf of each unit on the same basis as the other franchisees.
- Disputes – a franchisor cannot include a clause in the franchise agreement which attributes the franchisor’s cost of dispute resolution to the franchisee or a clause which requires a franchisee to commence any proceedings or conduct dispute resolution outside the State or Territory where the franchisee’s franchised business is located (unless otherwise agreed at the time of the dispute).
ADDITIONAL ADMININISTRATION FOR FRANCHISORS
As franchisors will be aware, considerable time and resources are spent producing up to date disclosure documentation and complying with a number of procedural requirements set out in the Code. While some burdensome requirements have been removed (such as summarising the franchise agreement obligations in the disclosure document), a number of additional administrative and procedural requirements have been introduced:
- Information Statement – franchisors must provide prospective franchisees with an information sheet (set out in the Code) which outlines the risks and rewards of franchising as soon as practicable after the prospective franchisee applies to become, or expresses interest in becoming, a franchisee – this is in a prescribed form and may simply be reproduced.
- Online activities – further details of the franchisor’s (or any of its associates’) online trading activities need to be set out in the franchise disclosure document, including the impact of such activities on the franchisee territory and any profit sharing arrangements that apply to goods or services made available online that would affect the franchisee.
- Marketing – franchisors must provide further disclosure on the types of expenses marketing funds are being used for and must maintain a separate bank account for receipt of the marketing and advertising fees contributed by franchisees.
- Record keeping – if the Code requires or allows a franchisee to give something to a franchisor in writing (for example, the disclosure document receipt and advice certificates required to be obtained from the franchisee under clause 10 of the Code), the franchisor must retain it (or a copy of it) for a period of at least 6 years. Also, if a franchisor makes a statement or claim in a disclosure document and relies on a document to support that statement or claim, the franchisor must keep that supporting document.
- Extensive details of associates must be disclosed – in addition to outlining each corporate associate of the franchisor (which is already currently required by the Code), the disclosure document will also need to include:
- a description of the relationship with the associate and the relevance of the relationship to the franchise system and franchise;
- details of current proceedings and specific previous proceedings and offences relating to associates (including directors of any corporate associates); and
- the number of businesses similar to the franchised business which are owned or operated in Australia by an associate of the franchisor.
- No renewal statement – if the franchisee does not have the option to renew the franchise agreement or extend the term of the franchise agreement, the disclosure document must include a prescribed statement intended to alert the franchisee to this risk.
Franchisors will need to make a number of changes to their disclosure documents and processes to take account of these new requirements.
WHAT DO FRANCHISORS NEED TO DO?
Franchisors need to address the following (note that some are time critical):
1. From 1 January 2015 franchisors will need to provide the information statement described above to prospective franchisees.
2. Where the franchisor does not currently pay its franchisees any genuine compensation for goodwill at the end of a franchise arrangement and wishes to impose post termination restraints on those franchisees from conducting a similar business post termination, the franchisor should consider negotiating an extension to its current agreement (or enter a new agreement) with those franchisees before 1 January 2015 in order to take advantage of the transitional arrangements in the Code
3. Franchisors need to review their franchise agreements to determine whether they need to make any of the following amendments in respect of new franchise agreements to be entered into on or after 1 January 2015 (or if any existing franchise agreement will be varied (which includes an extension to the term) or transferred on or after that date):
- consider the appropriateness of any post termination restraints imposed on enforceability is a key concern, consider including a provision which permits the franchisor to pay genuine compensation to the franchisee for its goodwill if the franchisor does not agree to renew the franchise agreement;
- ensure the disputes clause complies with the new Code requirements regarding the jurisdiction of any dispute resolution and ensure there is no requirement on the franchisee to pay the franchisor’s costs in the franchise agreement; and
- ensure any provisions which state that the parties are not obliged to act in good faith, or documents incorporated by reference which do so, are amended to remove such statements.
It is important to note that any variation (however small) to an existing franchise agreement (which is made on or after 1 January 2015) will bring the franchise agreement under the Code in its entirety (without any of the transitional carve outs).
A broader review of the franchise agreement may also be warranted given the possibility that the Government will introduce legislation which would impose unfair contract term restrictions on standard form small business contracts (which would likely capture many franchise franchisees and, if their agreements).1 Motor vehicle manufacturers with dealerships in NSW are already subject to restrictions on the imposition of unfair contract terms under their Dealer Agreements2 but any new Commonwealth legislation would likely impact all industries and jurisdictions.
4. By 1 January 2015, the franchisor needs to create a separate bank account for marketing funds and, if applicable, contribute to those funds in the same manner and proportion as if it were a franchisee.
5. By 1 January 2015, the franchisor needs to adjust its processes so that:
- it complies with the new record retention requirements;
- all prospective franchisees are given an information statement in the prescribed form (see Annexure 2 of the Code). This does not apply to renewals or extensions of existing franchise agreements; and
- it carefully plans any capital expenditure requirements it proposes to impose on franchisees post 1 January 2015 and communicate and implement this in a manner which complies with the Code.
6. An existing disclosure document does not need to be updated by 1 January 2015, as there is a transitional procedure which permits the existing disclosure document to be given up to 1 November 2015. However, franchisors:
- should start to gather the necessary information required so that it can start amending the disclosure document so that it complies with the new Code requirements on or before 31 October 2015; and
- should still update its disclosure document within 4 months after the end of the franchisor’s financial year.
Franchisors should however note that once they update the disclosure document after 1 January 2015, then they will need to comply with all new disclosure document requirements in the Code.