Overview

The 2013 Review of the Franchising Code of Conduct (Review) has been recently released. The Review contains 18 recommendations for amendments to the Franchising Code of Conduct. The next step is for the Government to review the recommendations.

Review of Franchising Code of Conduct

Earlier this year, the Minister for Small Business published a discussion paper seeking submissions from the franchising sector in relation to a number of issues, including whether past amendments to the Franchising Code of Conduct (Code) had improved practices within the industry.

The areas covered by the discussion paper included:

  1. good faith in franchising;
  2. enforcement under the Code;
  3. disclosure under the Code;
  4. end of term arrangements; and
  5. dispute resolution in franchising.

Following review of submissions from the franchising industry, 18 recommendations have been made for amendments to the Code as part of the 2013 Review of the Franchising Code of Conduct (Review). We discuss the main recommendations below.

If the recommendations are adopted, the key points are:

  1. Good faith – the Code would include an express obligation on both franchisor and franchisee to act in good faith, with no definition of what ‘good faith’ means.
  2. Enforcement – civil pecuniary penalties would be available for breach of the Code under the Competition and Consumer Act 2010, of up to a maximum of $50,000. The ACCC will be permitted to use its ‘random audit’ powers to audit franchisors for compliance with the Code, in addition to its existing rights.

DISCLOSURE:

  1. New franchising risk statement - franchisors would need to develop a new 2 page statement of generic risks associated with operating a franchise, and give it to prospective franchisees at first point of contact.
  2. Short form disclosure docs – these would be phased out.
  3. Foreign master franchisors – there would be a new obligation on these to give a short form disclosure doc to the Australian master franchisor, which will then in turn need to be disclosed as part of normal disclosure documents provided to franchisee.
  4. Online – there would be a new disclosure item around what rights each of the franchisor / franchisee has to sell, or profit from sales online.
  5. Non disclosure of ex-franchisee details – as part of the disclosure document, franchisor would need to include ex-franchisee contact details. Franchisors would only be able to exclude the contact details if the ex-franchisee has requested that they be excluded. This is in contrast with the current practice of franchisors requiring ex-franchisees agree that their contract details be excluded.

FINANCIAL ISSUES

  1. Franchise fee apportionment – there would be a notional franchise fee apportionment across the franchise term, such that franchisees can seek to recover for unexpired term as a debt in franchisor insolvency.
  2. CapEx – the Code would include a new prohibition on franchisors requiring franchisees to make unreasonable significant unforeseen capital expenditure.
  3. Marketing funds – this area is in for more regulation. There would be a requirement to account separately for marketing / advertising spends, and more regulation about what the fund can be spent on. Contributions would be notionally held on trust for franchisees. Company-owned stores are to contribute on the same basis as franchisees.

ENDING OR TRANSFERRING FRANCHISE

  1. End of term – the obligation on franchisor to disclose intent, will have to be before a franchisee must exercise renewal rights. Otherwise, the franchisee’s notice will not be binding.
  2. Insolvency risk – franchisors and franchisees would have a right to terminate, if an administrator is appointed to the other party and there is no improvement in the business, or buyer found for the business, within 60 days .
  3. Deemed consent by franchisor to franchisee transfer – the time period would run from the later of the date of request and the date on which all information given. Franchisees have to take reasonable steps to provide information.
  4. Restraints of trade post termination unenforceable – franchisors would not be able to enforce restraints of trade post expiry where the franchisee was not in breach and wished to renew the franchise agreement, and where the agreement did not provide for compensation if the franchise was not renewed.
  5. Disputes – Franchisors would not be able to require franchisees to pay legal costs unless the court so orders. Also, franchisors would have to litigate in the jurisdiction in which the franchisee carries on business.

Good faith

Previous reviews of the Code have looked at whether to include an express obligation of good faith for on participants in franchising, and recommended against doing so. This is in keeping with the ongoing government debate over the past five years as to whether to include good faith obligations in legislation and if so, how to do so.

The majority of legislative reviews have concluded that it is not practical to include an obligation to act in good faith without defining what ‘good faith’ means. Because it is difficult to do so, just as it was found to be difficult to define ‘unconscionable conduct’ in the context of the Trade Practices Act (now Competition and Consumer Act), previous reviews have not recommended such an obligation.

This time, perhaps influenced by several proposals to legislate on a State by State basis a good faith obligation, the Review has recommended that an express obligation to act in good faith be included in the Code, in relation to all aspects of franchising – negotiation, performance, and resolution of disputes  - but without including a definition of ‘good faith’. The Review does not identify evidence drawn upon to reach this different conclusion (for instance, examples of franchisors or franchisees engaging in non-‘good faith’ conduct) nor does the Review give examples of what non-‘good faith’ conduct would look like. In fact, the case studies put to the ACCC did not result in the ACCC identifying such conduct.

The Review only goes so far as to include a list of examples of ‘selected problematic behaviour’, including:

  1. The franchisor imposing unsafe practices for workers or customers;
  2. Unfairly competing with franchisees in online environments;
  3. General mismanagement and waste of marketing funds;
  4. Extreme pressure to meet sales targets with repercussions for not meeting them; and
  5. Forcing the franchisee to buy overpriced goods from the franchisor.

While these examples are provided under the heading of ‘good faith’, and are suggestive of behaviour which may amount to not acting in good faith, the Review itself concedes that not all of these behaviours would breach an obligation to act in good faith. Further, the Review admits that many of these behaviours already fall within the scope of existing (and adequate) prohibitions on misleading, deceptive or unconscionable conduct.

The Review also does not factor in that the Code already mandates conduct going beyond any good faith requirement under the common law. For instance, obligations on franchisors to disclose information, or to give notices of intended conduct, go beyond what ‘good faith’ would require at common law. It may have been in fact more appropriate to instead prohibit intentional conduct the object of which is to injure the other party in the franchise relationship.

It is very possible that under the proposed Code amendment, franchisees and franchisors will be in a position where they are entitled to exercise a right under a franchise agreement, but uncertain as to whether to do so would breach their obligation to act in ‘good faith’ – unless they consult lawyers. As discussed below, it is proposed that breach of the Code result in civil pecuniary penalties.

Enforcement under the Code

A number of previous reviews have looked at whether specific civil penalties should be introduced for breach of the Code and concluded that the Trade Practices Act (now the Competition and Consumer Act 2010 (CCA)) sufficiently provided remedies.

This Review recommends amending the CCA to provide specific remedies in relation to breach or potential breach of the Code, including:

  1. civil penalties to a maximum of $50,000 for breach of the Code;
  2. allowing the ACCC to issue infringement notices for breach of the Code, and granting them the power to audit at random to assess compliance with the Code (expanding the ACCC’s existing powers);
  3. amending the list of contraventions that may give rise to a person being disqualified from managing corporations to include breaches of the Code; and
  4. that a court may now make franchising specific orders under the CCA, including (for instance) requiring a franchisor to pay money into its marketing fund, or give a royalty-free period to a franchisee.

It seems unlikely that the ACCC will ever pursue single franchisees for breaches of the Code. These are more likely to be powers only ever exercised against franchisors.

Disclosure

Further generic risk statement

Despite the past amendments to the Code to address concerns that franchisees were entering franchises without sufficient information about inherent business risks, or indeed business education, the concern still exists.

To address this, rather than mandate education for all new prospective franchisees, the Review recommends that franchisors be required to:

  1. create a short generic risk statement about entering into a franchise (of no more than 2 pages); and
  2. provide it to prospective franchisees at the first time the person contacts the franchisor.

It is difficult to see how a further risk statement (in addition to that already required to be contained in the franchisor’s disclosure document) will address issues arising from persons entering into franchise arrangements without sufficient preparation or understanding of business issues. Rather, this will be a further compliance cost for franchisors, and a further point for franchisees to raise in disputes – that the franchisor did not properly comply with the Code by failing to give the statement, or by giving a risk statement that (quite feasibly in under two pages) did not cover all of the risks.

Master franchisor disclosure documents

The Code had in the past included an exemption in relation to foreign franchisor grants of master franchises into Australia, which was removed in 2008. Because of that, foreign franchisors are required to comply with the requirement to provide a full disclosure document to their Australian master franchisees, even if the Australian master franchisee was a sophisticated and informed entity.

The Review recommends that instead, foreign or master franchisors be required to provide:

  1. a short form disclosure document to master franchisees; and
  2. the full disclosure document to franchisees not acting as master franchisees.

Master franchisees would also be required to provide the foreign / master franchisor short form disclosure documents to sub-franchisees, including:

  1. contact details for the foreign / master franchisor;
  2. material obligations delegated to the master franchisee;
  3. intellectual property arrangements; and
  4. the potential impact on the sub-franchisee if the master franchise ends.

While well intentioned, the now unavoidable consequence is that:

  1. foreign / master franchisors who appoint master franchisees in Australia will need to maintain two forms of disclosure documents; and
  2. while savvy franchisees will benefit from access to further information about the foreign / master franchise arrangements, less savvy franchisees will now receive even more bulky documentation with which to grapple.

Other disclosure issues

If the Review’s recommendations are addressed by legislation, franchisors will need to review and update franchise agreements and disclosure documents for the following:

  1. Due to the changing business environment, more goods and services are now sold through online channels. This has led to misunderstandings and disputes between franchisor and franchisee as to whether franchisors or franchisees should be permitted to maintain an online presence, or sell through websites or social media. The Review recommends that as part of the Disclosure Document, franchisors be required to detail what rights the franchisor and franchisee have to sell or benefit from online sales, in connection with the franchise system.
  2. As part of the new ‘end of term’ amendments to the Code, the franchisor will be required to give a notice to the franchisee about whether it intends to renew the franchise agreement. The Review recommends that a franchisee’s exercise of a renewal option be made non-binding if the franchisor requires the franchisee to exercise that right before the franchisor gives its ‘end of term’ notice.
  3. Because the Review did not receive any evidence that any franchise system in Australia is using the short form disclosure document permitted by the Code, the Review recommends it be removed.  Any franchisor using the short form disclosure document will now need to update and expand its disclosure to comply with Annexure 1 of the Code.
  4. As part of a Disclosure Document, franchisors are required to make the name and contact details of ex-franchisees available, unless the franchisee has requested in writing the details not be disclosed. It is not uncommon for franchisors not to include these details in Disclosure Documents. The Review recommends that franchisors only be permitted to not include those details where it is the franchisee who has initiated the request for non-disclosure. This is odds with other recent government reform around privacy, where businesses are required to ensure that consent is obtained to disclose personal information. Here, a franchisor would need to be able to prove that a franchisee has refused consent in order to be able to not disclose that personal information.
  5. The Review recommends clarifying the Code to provide that the franchisor’s obligation to provide the franchisee with a copy of the franchise agreement at least 14 days before entry into the franchise arrangement is not intended to be re-triggered if there are changes to the agreement that are:
    1. requested by the franchisee (ie in negotiation); or
    2. minor.
    3. The Review recommends amending the ongoing franchisor disclosure obligations to require that a franchisor disclose a change in ownership or control of the franchise system. This would cover a situation where the franchisor sells the franchisor’s business, but not its shares.

Financial issues

General financial issues

  1. It is not uncommon for franchise agreements to only give franchisors termination rights in relation to a franchisee insolvency, and not the reverse.

    The Review recommends that the Code provide both franchisor and franchisee with a termination right, should an administrator be appointed to the other party, and the business is not ‘turned around’, or a buyer found, within 60 days.

    It is difficult to comment on this without knowing what the drafting around  ‘turned around’ will look like.

    Franchisors will need to update franchise agreements around termination rights, and ensure that any existing rights to terminate for franchise insolvency deal with the appointment of administrators in a way that is consistent with the changes to the Code, if amended as proposed.

  2. The Review also recommends that any ‘franchise fee’ be treated as apportioned across the term of the agreement, such that if the agreement is terminated early for franchisor failure, the pro rata amount of the franchise fee for the unexpired term be refundable, and a debt due to the franchisee.

    Again, it is difficult to comment on how useful this will be, given the number of creditors a franchisor may potentially have, and particularly secured creditors. Franchisees will need to seek advice as to whether the right to be repaid constitutes a registrable security interest under the Personal Property Securities Act 2009 (Cth).

  3. The Review acknowledges the issue franchisors have faced with being required to disclose ‘unforeseen capital expenditure’ which franchisees may be required to make, and recommends amending the Code to clarify what should be disclosed.

    In addition, the Review recommends amending the Code to prohibit franchisors requiring ‘unreasonable significant unforeseen capital expenditure’ by franchisees, with ‘unreasonable’ and ‘significant’ to be defined. The aim is to require franchisors to demonstrate a business case to the franchisee for capital investment in the business.

    Perhaps guidance will be gained from the drafting implementation. At present, the issues caused by the early amendment around disclosure have not been addressed, and the proposed prohibition is so uncertain – and commercially focused – as to be an overreach.

Marketing funds

Marketing funds are in for a major overhaul. The discussion paper called for submissions about whether franchisees considered there to be sufficient transparency around disclosure of payments to the marketing fund. The Review calls for amendment in a number of key respects:

  1. Franchisee contributions will be required to be held on trust for franchisees generally, with franchisors to have ‘wide’ discretion about how the funds should be expended. Franchisees will need to seek advice again about how best to protect this interest;
  2. Franchisors will need to account separately for marketing and advertising costs, and the fund will only be permitted to be used for expenses as disclosed in the Disclosure Document. This is aimed at preventing franchisors from using the marketing fund to pay for attending conferences, paying for trade mark registrations etc;
  3. Company owned stores will be required to contribute to the fund in the same way as franchisees. It will be interesting to see to what extent the drafting on this takes into account marketing spend by franchisors generally; and
  4. A compulsory independent audit will be required each year for funds over a threshold amount, with no ‘opt out’ franchisee vote permitted. The result of the audit, and other detailed information about the spend of the fund will be required to be disclosed to franchisees on an annual basis.

Dealings with franchise agreements

Ending or transferring franchise agreements

  1. To protect franchisees from franchisor inaction, the Code currently provides that a franchisor’s consent is deemed to have been given to a proposed transfer or novation of a franchise agreement, if the franchisor does not give written notice refusing consent with reasons within 42 days.

    To address issues arising in practice, the Review recommends expanding this provision to allow for situations where a franchisee has not given information about the proposed transferee or novatee, and where the period would now run from the later of the day of the request and the day on which the franchisee has provided all information reasonably required by the franchisor.

  2. The Review recommends expressly providing in the Code that post expiry restraint of trade obligations are not enforceable against the franchisee where the agreement has not been renewed by the franchisor. This is despite the franchisee not being in breach and, further, where the franchisee is not entitled to claim compensation if the agreement is not renewed.
  3. If a franchisor wants to assign its franchise system to a purchaser, including novation of franchise agreements, the Code is not exactly clear on what the franchisor must do to comply with the Code. This appears to have been raised in a number of submissions, and is commented upon in the Review. However, the Review did not recommend any amendments to more expressly regulate whether franchisee consent to novation is or is not required for compliance with the Code.
  4. The Review has proposed that the Code be further amended to define ‘extend, or extend the scope of, a franchise agreement’ to give better clarity as to whether a unilateral contract variation by the franchisor, or a holding over permitted by the franchisor, is intended to be included.
  5. The Review recommends clarifying section 23 of the Code, which provides that a franchisor is not required to comply with the termination provisions set out in clauses 21 and 22 of the Code in special circumstances, to provide that clause 23 does not give a franchisor a right to terminate in those special circumstances.

    Franchisors will need to review their agreements to confirm that they have a contractual right to terminate in those special circumstances.

Dispute resolution

  1. While the drafting will be important, it appears that this is intended to expand the avenues which a franchisee or a franchisor may use to try to resolve disputes to other forms of resolution, including under the SA Small Business Commissioners Act 2011.
  2. The Review also seeks to protect franchisees further in relation to disputes, by recommending the Code be amended to provide:
    1. Franchisors cannot require franchisees to pay their legal costs of a dispute, unless ordered by a court. While this protects franchisees with legitimate issues, it also exposes franchisors to more claims from disgruntled franchisees; and
    2. Franchisors cannot require franchisees to litigate outside the jurisdiction in which the franchisee’s business primarily operates. This effectively seeks to override any choice of jurisdiction clause a franchisor may include in a franchise agreement. It also imposes burdens on franchisors operating in more than one state.
  • Next steps

The Review included some recommendations for technical or clarifying drafting changes to the Code. However, the bulk of the above issues await drafting proposals. The Minister’s website notes that the government is now to consider the Review’s recommendations.

If the recommendations are adopted, once drafting is released to implement the recommended changes to the Code, franchisors will need to review their franchising practices, including franchise agreements, disclosure documents, and any pre-entry documents given to prospective franchisees. The changes are not, as the Review acknowledges, minor.