Mr Alan Wein published his report on the Review of the Franchising Code of Conduct as commissioned by the Minister for Small Business, Gary Gray, and the Parliamentary Secretary for Small Business, Bernie Ripoll, on 30 April 2013.

The Minister has stated in a press release on 17 May 2013 that he looks “forward to consulting and engaging with stakeholders, franchisees and franchisors about [the recommendations].”

This update sets out the recommendations made and draws attention to some matters which will need to be considered by the government when determining whether to implement the recommendations made and potential impacts on franchise systems and small business generally.

Recommendations and comment

  1. Disclosure before Renewal

The report recommends that:

  1. a notice under clause 20A of the Code by the franchisor noting an intention to renew the franchise agreement should be accompanied by a disclosure document; and
  2. that a franchisee should not be bound to renew prior to the provision of disclosure by the franchisor.

We consider this a sensible outcome to what has been an issue that franchise systems have differed in their approached to currently.

  1. Short Form Disclosure for foreign or master franchisors

The report recommends that:

  1. the Code be amended to prescribe a short form of disclosure that a foreign or master franchisor must provide to a master franchisee instead of requiring disclosure in accordance with Annexure 1 of the Code.
  2. only franchisees who do not also act as franchisors are provided with the full Annexure 1 disclosure document by their immediate franchisor and all short form disclosure documents are provided to franchisees as an item of disclosure under Annexure 1.

The recommendation also sets out examples of the information thought should be included.

This also appears a practical resolution to an issue that had seen a generation of more paperwork which was not necessarily relevant to the franchisee to which it was being provided.

  1. Online sales disclosure

The report recommends that a franchisor is required to disclose the rights of the franchisor and franchisee to conduct and benefit from online sales, particularly the franchisor to conduct online sales.

This recommendation provides direction to enhance consistency of treatment of an area that has increasingly become an area of concern between the franchisors and franchisees.

  1. Removal Code Annexure 2 (short form disclosure)

The report recommends that the present Annexure 2 be removed from the Code.

If the other recommendations regarding short form disclosure are implemented we do not foresee any issue arising from this recommendation.

  1. Provision short summary

The report recommends that franchisors provide to prospective franchisees a short summary of key risks and matters they should be aware of when going into franchising. Specific matters directed to be included are:

  1. it should be generic;
  2. it should provide more detail than item 1 of Annexure 1 but should not be more than 1-2 pages in length;
  3. it should be a standalone document;
  4. it should be provided to franchisees at their first point of contact with a franchisor.

We have some concerns of what was envisaged by this recommendation which are largely echoed in the discussion contained in the report around this issue.

If what is proposed is a warning statement, similar to the type in Queensland being attached to the front of a sale of land contract, which is a standard form document that is then completed by the franchisor, then we can see how this would be of benefit once such a template is drafted and approved. Presumably this standard template will be either attached as a further annexure to the Code, or with a regulatory delegation to the ACCC, to create and update as required the template form.

If however what is proposed is simply each system putting together its own summary statement, we foresee different styles of documents being created with no consistency across systems leaving potential franchisees investigating systems which they may wish to purchase a franchise from being confused and simply receiving more paperwork which may simply be ignored or passed on to lawyers without the aims of this proposed amendment being achieved.

  1. Rights in external administration

The report recommends that the Code be amended to provide:

  1. franchisees and franchisors with the right to terminate a franchise agreement in the event that an administrator of the other party does not turn the business around, or a new buyer is not found for the franchise system, within a reasonable time after the appointment of an administrator; and
  2. that franchisees be made unsecured creditors of the franchisor by notionally apportioning the initial franchisee fee across the term of the franchise agreement, so that any amount referable to the unexpired portion of the franchise agreement would become a pro rata debt in the event that the franchise agreement ended due to the franchisor’s failure.

We are concerned that the full impact of what is being proposed has not been considered in the context of the Chapter 5 Corporations Act 2001 (Cth) provisions and general insolvency law policy development of successive governments to date.

We have assumed that the reference to administrator solely refers to voluntary administrator and not to other forms of external administrators also referenced in the Corporations Act, such as Receivers, Receivers and Managers, Liquidators, Provisional Liquidators and Controllers. However this assumption may be incorrect which would, we envisage, raise serious concerns for secured creditors amongst others.

As we understand it in practice where a franchisee has an administrator appointed most franchisors have in their franchise agreements a provision which will permit them to terminate the franchise agreement.

By providing franchisees with the same rights to terminate where a voluntary administrator is appointed, such an amendment will potentially:

  1. override the moratorium effect presently in place under the auspices of Chapter 5 of the Corporation Act, particularly where ‘reasonable time’ for a turn around does not match the current legislative requirements available;
  2. reduce the voluntary administrator’s ability to turn around the business, or reach an outcome which benefits all creditors, in effect permitting a franchisee to prefer its interests ahead of other creditors to the potential detriment of the majority (in amount and value of a financially troubled business);
  3. result in franchisees being given rights ahead of landlords, the ATO, employees, and other creditors or parties who would be bound by the Corporations Act process, with questionable benefit in placing one category or party ahead of others.

Further by mandating the initial franchise fee be a pro rata debt in an administration, when in the normal circumstances it would not be treated as such as the fee is acquired to buy the franchise which is granted (thus not being a debt due and payable), this will:

  1. negatively effect all other creditors of a failed franchise system but increasing the number of creditors and amount owed to creditors (thereby reducing any potential return to all creditors if a dividend less than 100 cents in the dollar is declared);
  2. likely increase the costs of an administration due to the notification and meeting requirements for companies under administration; and
  3. alter the general law understanding of what constitutes a ‘debt’ for the purposes of external administration.

The report notes that a general consultation on these recommendations has not been undertaken and we would hope that prior to amendments being made such consultation is undertaken to consider whether there is in fact need for the recommended amendments.

  1. Prohibition on unreasonable significant unforeseen capital expenditure

The report recommends that:

  1. the Code be amended to prohibit franchisors from imposing unreasonable significant unforeseen capital expenditure.
  2. ‘Unreasonable’ and ‘significant’ should be defined, with a view to a franchisor being able to demonstrate a business case for capital investment in the franchised business.

As with any recommendation for a definition of terms such as ‘unreasonable’ there will be difficulty in coming up with a definition that is capable of catching all situations that may arise. Historically this has resulted in those terms being left to common law / the courts to provide commentary and definition on a case by case basis to determine the meaning and application of such words.

This recommendation also requires franchisors to justify their position as to why such expenditure is needed. We foresee test cases needing to be run to verify when a business case has been made out to justify the expenditure if this recommendation is implemented.

  1. Marketing fund accounting

The Code be amended with respect to the administration of marketing funds based on principles including:

  1. a franchisor should separately account for marketing and advertising costs;
  2. contributions to the marketing fund from individual franchisees should be held in trust with the franchisor having a wide discretion as to how to expend;
  3. company owned units must contribute on the same basis as franchisees;
  4. the fund can only be used for expenses which are clearly disclosed to franchisees in the disclosure document which are legitimate marketing and advertising expenses;
  5. a once yearly audit be conducted on funds over a threshold value with no capacity for franchisees to vote against such audit;
  6. the results of the audit should be available to franchisees yearly.

We foresee this placing an additional administrative burden of franchise systems and resulting in anomalies of treatment between systems, as by invoking a trust regime, compliance with the respective State trust legislation in which the franchisor operates will need to be complied in addition to normal accounting compliance.

  1. Express good faith obligation

The report recommends that the Code be amended to include an express obligation to act in good faith. Such an obligation should:

  1. extend to the negotiation of a franchise agreement, the performance of a franchise agreement, the performance of obligations under the Code, and the resolution of any disputes between the parties whether or not there is a valid franchise agreement at the time of the dispute;
  2. not be defined, instead the unwritten law relating to good faith should be incorporated in a manner similar to unconscionable conduct prohibition set out in section 20 of the Australian Consumer Law;
  3. apply to both the franchisor and franchisee or prospective franchisee and the agents of these parties;
  4. not be able to be limited or excluded by any provision of the contract between the parties (such provisions should be declared void);
  5. be clearly stated as not preventing a party from acting in its legitimate commercial interests; and
  6. expressly exclude an argument that a franchisor has not acted in good faith because there is no term in a franchise agreement specifying a right of renewal.

We see this recommendation as one which only adds to the confusion of the existing law on good faith (which the Code incorporates in clause 23A), by arguably restating much of which is already addressed by the existing common law and then attempting to assert it is to be applied in situations where case law may have found that good faith does not apply, or only applies in a limited context.

The existing law on good faith has been one of development over time. It is still not clear, with no High Court guidance at this point, and various States and Territories courts apply good faith with varying effect.

Presently arguments about good faith are being presented to courts for adjudication as a not infrequent submission in franchise cases before the courts. There is no present inability to raise this as an argument in any litigation and the courts are developing, much as occurred with unconscionable conduct case law, the understanding of parties as to what is good faith. The need for the implementation of the recommendation in its present form is not clear.

  1. Franchisee initiated non-publication request

The report recommended that the Code be amended to ensure that a written request from a franchisee that its details not be disclosed to prospective franchisees has in fact been initiated by the franchisee, for example by prohibiting a franchisor initiating, procuring, or encouraging such a request from a franchisee.

We are of the view that this recommendation is not required on the basis that the franchisee may at any point, even if asked by a franchisor to provide a non-publication request, simply say no. Amending the Code is not necessary in our view in this regard. If the franchisor wants to negotiate with the franchisee for this request then this provides the franchisee with a bargaining chip in any negotiation, particularly if this is an early exit request from a franchise system.

Additionally apart from the details of the franchisee we do not see how it would affect the other disclosures required to be made of the franchisor relating to numbers of franchises in the system, judgments, etc under the code.

  1. Consent to transfer or novation

The report recommends that clause 20(4) of the Code be amended so that consent of a franchisor to a transfer or assignment is given where all information reasonably required by a franchisor is provided or 42 days after the request, whichever is the later.

The franchisee is also required to take all reasonable steps to provide information required to enable the franchisor to evaluate the request.

We consider this a practical outcome where all relevant information is provided.

  1. Inability to enforce restraints of trade

The report recommends that the Code be amended to state that if all the following conditions are satisfied any restraint of trade clauses in the franchise agreement which prevent the franchisee from carrying on a similar business in competition with the franchisor are not enforceable by the franchisor against the franchisee:

  1. the franchisee wishes the franchise agreement renewed on substantially the same terms;
  2. the franchisee is not in breach of the agreement;
  3. the agreement does not contain provisions allowing a franchisee to make a claim for compensation in the event that the franchise is not renewed;
  4. the franchisee abides by all confidentiality clauses in the agreement and does not infringe the intellectual property of the franchisor; and
  5. the franchisor does not renew the franchise agreement.

We have some concerns over this recommendation given the present acknowledged position in the common law of a willingness to protect the good will of a business and enforce (on the sale of a business) restraint of trade clauses against the selling party. Given that franchise systems containing potentially multiple franchisees would be affected we would hope that further consultation is undertaken on whether this recommendation in reality is required.

  1. Extension of 29(8) to all ADR processes

The report recommends that the Code should be amended to provide that clause 29(8) applies to participation in any ADR process whether under OFMA, State small business commissioners, privately retained, court appointed or otherwise.

We consider this recommendation is sensible but note the general concern over the fragmentation of the legislative governance where Commonwealth and State’s each seek to regulate franchise operation.

  1. Legal costs and choice of jurisdiction restricted

The report recommends that the Code be amended to ensure that franchisors cannot:

  1. attribute the legal costs of dispute resolution to a franchisee unless ordered by a court;
  2. require a franchisee to litigate outside the jurisdiction in which the franchisee’s business primarily operates.

We see no concerns in the first part of this recommendation but query the need for the second part as the parties choice of forum for dispute resolution is a matter of contract between the parties and is capable of identification and negotiation prior to entering into a franchise agreement.

  1. Permit civil pecuniary penalties

The report recommends that the Competition and Consumer Act 2010 (Cth) (CCA) be amended to:

  1. allow civil pecuniary penalties to a maximum of $50,000 to be available as a remedy for a breach of the Code;
  2. allow the ACCC to issue an infringement notice for a breach of the Code;
  3. allow the ACCC to use its powers under section 51ADD of the CCA (random audit powers) to assess a franchisors compliance with all aspects of the Code, not just require production of documents created under the Code;
  4. include a breach of the Code in the contraventions for which a court may make an order under section 86E (order disqualifying a person managing a corporation); and
  5. specify that the Court can make franchising specific orders requiring a franchisor to:
  1. give a royalty free period to a franchisee affected by a breach of the Code; and
  2. pay a sum of money specified by the court into any marketing or co-operative fund applicable to the franchise system.

We have no objection to the imposition of civil pecuniary penalties for some breaches of the Code but consider that it would be appropriate to identify which provisions of the Code would be subject to these styles of penalties and what the maximum penalty for a breach of each of the identified clauses is to be.

The grant to the ACCC of broader powers (expanding the audit powers) is of concern due to the potential for such investigations to be wide ranging and expensive, without necessarily resulting in the finding of any contravention. It is hoped that draft legislation and perhaps an enforcement protocol from the ACCC on how they intend to utilize any drafted powers would allay concerns.

We assume that the reference to disqualifying a person would be drafted in the same manner as the Corporations/ASIC Act provisions and would have no objection to this outcome if it is enacted in the same manner.

  1. Motor vehicle minimum term and standard contractual terms analysis review prior to next review of Code

The report recommends that an analysis of the impact of a minimum term and standard contractual terms for motor vehicle agreements should be undertaken prior to a future review of the Code.

This recommendation picks up on some of the practical issues arising in this area.

  1. No further review for 5 years

The report recommends that there should not be another amendment of the Code for a minimum of five years after any amendments to the Code take effect in response to this report.

This appears a practical approach in light of the number of relatively recent reviews and amendments of the Code.

  1. Code be amended – technical or minor changes to drafting of Code provisions

The report recommends:

  1. change in definition of ‘financial year’;
  2. define the term ’extend or extend the scope of a franchise agreement;
  3. define the use of novation if the Code;
  4. insert the word ‘intended’ into clause 10(c) of the Code and a guidance note saying immaterial changes or changes at the request of the franchisee do not trigger a further 14 day disclosure period;
  5. insert the word ‘novation’ into clause 13(2) of the Code;
  6. amend clause 14 of the Code to make reference to obligations of the kind under clause 18.2 of the disclosure document for consistency;
  7. reword clause 15 to remove double negatives;
  8. references to legislation in clause 18(2)(a) to be reviewed and updated if required; and this clause amended to include as an updateable event changes to the majority control of the franchisor;
  9. amend clause 20A so that the notice required to be provided is provided in writing;
  10. insert a guidance note into clause 23 to clarify that it does not provide a franchisor with the right to terminate in the circumstances specified in that clause;
  11. reword clause 29 to remove the double negatives;
  12. Annexure 1 - references to legislation to be reviewed and updated if required, a guidance note to be inserted on what ‘other financial benefit includes’, amend the requirements to disclose unforeseen capital expenditure, clarify whether immaterial variations of the operations manual require disclosure under clause 17A, consider defining the term ‘projection’ and ‘forecast’, Item 20 be amended to make it clear that if a franchisor cannot give the 2 years financial reports then it must complete a solvency declaration and independent audit report as at the date of disclosure; clarify the disclosure required if the franchisor was not solvent at the relevant time and explicitly require the information mentioned in Item 20 to be attached to the disclosure document;
  13. The government consider amending the OilCode so it is consistent with any amendments made to the Franchising Code.

Tidying up these issues, as long as appropriately drafted, can only assist in the implementation, understanding and enforcement of the Code.

Takeaway points

The government has received and is considering the report. Whether substantive steps are taken prior to the September election is unclear. If you have any concerns about these recommendations we recommend raising these with the Minister of Small Business’ office.