The Federal Government has just released the final version of the new Franchising Code of Conduct, which will replace the old Franchising Code with effect from 1 January 2015. Legislation to amend the Competition and Consumer Act to give effect to new penalties for certain breaches – court awarded fines of up to $51,000 and ACCC powers to issue infringement notices of $8,500 per breach – will take effect 1 January 2015.
This is the most significant change to franchising regulation since the enactment of the Code in 1998, and represents the final part of the comprehensive review of franchising regulation that commenced in early 2013. Although the new Code is fundamentally the same as the old Code there are some new requirements, and changes to existing requirements. Accordingly, franchise systems will still need to review their franchise agreements and disclosure documents, and make adjustments to their disclosure processes.
Features of the new Franchising Code of Conduct
The key features of the new Code are:-
- Alterations to the prior disclosure process so that franchisors must issue a new document – an Information Statement in the form set out in the new Annexure 2 of the Code – when a franchisee formally applies or expresses interest in a particular franchise, such as by completing an application form or paying a deposit;
- Substantial changes to the form of the disclosure document, including the deletion of certain requirements such as the time consuming requirement to cross-reference agreement clauses in the disclosure document. So franchisors will need to cease using their old format disclosure document, and create a new format document that complies with the new Code;
- Substantial changes to the disclosure obligations in a master franchise situation, including removal of the requirement to provide a unit franchisee with a disclosure document from a head franchisor, or a joint disclosure document from head franchisor and master franchisee. Now only the master franchisee must provide disclosure, but the master franchisee must give more detail about the master franchise arrangement in its disclosure document;
- Reduced disclosure document updating obligations for franchisors that entered into 1 or fewer franchise agreements during a year and do not intend to enter into another franchise agreement in the following year;
- New disclosure obligations in relation to issues such as on-line sales, end of term arrangements and master franchise arrangements;
- New requirements in relation to the operation of marketing funds, including a requirement to establish a separate bank account into which all contributions are to be made. In addition franchisors must contribute to the fund in respect of any corporate stores or outlets they operate, on the same basis as franchisees;
- Strengthened requirements in relation to franchisee capital expenditure during the term of the franchise;
- Altered arrangements in relation to end of term – if a franchisee requests an extension of term and is not in breach or otherwise ineligible, but is not granted an extension or paid compensation by the franchisor, then the franchisor is unable to enforce any post-termination restraint of trade clause; and
- Codification of the common law duty of good faith, such that franchisors and franchisees must act in good faith in relation to any matter arising under or relating to the franchise agreement and the Code.
The new Code also provides enhanced capacity for franchisors and franchisees to transact and comply with the Code electronically.
Application of the new Code
The new Code will apply to all franchise agreements executed after 1 October 1998, not just those executed on or after 1 January 2015. However there will be grandfathering of some clauses and transitional arrangements will exist.
Some Code obligations will not apply to agreements executed prior to 1 January 2015, and the new good faith obligation will only apply to conduct on or after 1 January 2015 in relation to franchise agreements entered into from 1 October 1998. Importantly the Code will apply once any franchise agreement executed before 1 October 1998 is extended or transferred, and any grandfathering clause will cease to apply if such a franchise agreement is varied, as well as if it is transferred or extended. The table below summarises the application of the new Code.
Click here to view table.
Will franchise agreements need to change?
The only Code changes that impact directly on the content of franchise agreements concern restraint of trade clauses, capital expenditure clauses and dispute resolution. However with the impending introduction in late 2015 of a prohibition on “unfair contract terms” in “standard form” business contracts (which has the potential to catch franchise agreements) it would be prudent to consider any necessary changes to franchise agreements in this broader context. Similarly we recommend franchise systems that have a master franchise arrangement consider including provisions that allow them to charge for the cost of producing any disclosure document specifically requested by a franchisee in circumstances where the franchisor has taken advantage of the exemption from updating. (We recommend such a clause includes an option for limited compliance at no cost to the franchisee, such as providing a copy of the most recent financial statements.)
The new Code will contain a requirement to act in good faith in relation to any matter arising under or in relation to the agreement and the Code, and will supplement recent cases that have given a broader meaning to the existing prohibition on unconscionable conduct. Accordingly it would be prudent to consider whether franchise agreements contain any provisions that are very unfair or go beyond what is reasonably necessary to protect the legitimate interests of the franchisor. The good faith requirement may also see franchisors give some consideration to including a statement of purposes in the franchise agreement, as the new duty requires parties “to cooperate to achieve the purposes of the agreement.”
Franchisors will need to consider how they intend to address post-termination non-compete clauses. Most franchise systems will not find the new Code a problem, as they will happily grant an extension of term to an existing franchisee that seeks a further term and is otherwise compliant. Those that wish to preserve their right to decline to do so will need to consider whether to build in a compensation arrangement, or use other mechanisms (such as holding the head lease) to protect themselves from unfair competition.
Should I act now, or wait?
Our recommendation is to conduct an immediate review and determine a document updating strategy that lists the tasks to be undertaken, and the timing.
The key issues to determine are:-
- Whether, and when, to amend or update your franchise agreement?
- Is there merit in having a new provision allowing franchisors to charge for providing an updated disclosure document on request when they are not otherwise obliged to update it?
- Whether, and when, to update your disclosure document?
- What needs to happen with the operation of the marketing fund in addition to setting up a separate bank account?
- How will the new Information Statement be disseminated, and how will records be kept?
- Are there any necessary changes to document retention and general record keeping in view of the Code changes?
- Is there merit in moving to a fully electronic disclosure, document production and knowledge management system?
- Are there any necessary improvements to risk management and compliance, including compliance training, in view of the new penalty regime?
- Are there any existing franchisee matters or disputes where action should be taken for any reason prior to January 1, 2015?
If you need to update your franchise agreement you will need to also update your disclosure document. Similarly the new Code provides that franchisors can elect to comply early if they wish.
For most clients it will make sense to conduct a broader review commencing early 2015, with a view to updating the disclosure document on completion of the review. Although some are spruiking the importance of an immediate update we are not convinced that is necessary for most systems.
The complicating factor has been the recent Federal Court decision in SPAR Licensing Pty Ltd v MIS Qld Pty Ltd. This case is now authority for the proposition that the disclosure document to be provided to a franchisee must be current at least in terms of financial reports and the solvency statement (and possibly more broadly) not just at the time disclosure is given, but at the time the franchise agreement is signed. Clause 17 of the new Code attempts to provide additional clarity for franchisors by noting that if a new solvency statement and financial reports are available they must be provided under the continuous disclosure obligation as soon as practicable, but before the franchisee enters into the franchise agreement.
Other issues to consider
A lot has been happening in franchising in recent times in addition to the review of the Code, and the introduction of new Code penalties. In the context of a review we recommend consideration of the following:-
- The implications for franchise and other documentation (including customer documentation) of the proposed new unfair contract terms provisions;
- The new Federal privacy regime – we see privacy as an important strategic issue for franchise systems in the next 10 years;
- Opportunities to increase tied supply and franchisee price controls presented by the ACCC notification and authorisation processes;
- Opportunities for substantial costs savings and compliance enhancement presented by electronic document production, Code compliance and knowledge management.