Franchise Agreements are legally binding documents that govern the business relationship between Franchisors and their Franchisees. As well as Franchise Agreements, Franchisors will often have ancillary documents which Franchisees must also enter into, the most common of these being Licenses to Occupy premises. The importance to Franchisors of ensuring that these documents are appropriately prepared, executed and are enforceable cannot be overstated.
Once a Franchisor has engaged a law firm to prepare their first template set of Franchise Documents, and signed up their first few franchisees, it is not uncommon for Franchisors to issue their own Franchise Documents in house without involving their lawyer.
Primarily the reason for this is to save the Franchisees additional cost in setting up the franchised businesses.
While there is certainly something to be said for cost saving, there are a number of traps which Franchisors can fall into when issuing their own documents if they do not have someone in their organisation with adequate knowledge of the legal issues that may arise.
In this article, we set out some of the common pitfalls experienced by Franchisors when issuing their own franchise documents, and the associated risks:
- DISCLOSURE OF RELEVANT INFORMATION
The Franchising Code of Conduct (Code) requires a Disclosure Document to be given to all franchisees (either prospective or current) at least 14 days before the Franchisee enters into a new Franchise Agreement or pays any non-refundable fees.
The Disclosure Document which is given to each Franchisee must comply with the Code by being in the prescribed format and containing all of the information which the Code requires. Disclosure Documents must be updated by a Franchisor at the conclusion of each financial year by 31 October at the latest.
Disclosure obligations to Franchisees not only include the content of the Disclosure Document itself, but also items such as associated Leases or Licenses to Occupy and benefits or incentives the Franchisor may receive from a Landlord or associated party.
Any facts of “material consequence” such as changes to the Franchisor’s financial position, ownership, certain legal proceedings or judgments and changes to the intellectual property of the franchise must also be disclosed to all franchisees.
Quite a number of these issues have the potential to be overlooked by a Franchisor altogether, or the disclosure time frames may not be complied with in the process of issuing documents to franchisees as Franchisor’s may not consider these to be ‘relevant’ or ‘important information’ for a franchisee to be made aware of in a timely manner.
Failure to give correct Disclosure to a franchisee exposes the Franchisor to financial penalties of up to $54,000. If an issue is systemic within the Franchisor’s Disclosure Document or the Franchisor’s procedure for issuing documents, this has the potential to significantly increase the Franchisor’s financial exposure.
- INCORRECT PARTIES OR IMPROPER EXECUTION
Another major issue for Franchisors is the importance of getting the party details correct in the Franchise Agreement.
For example, if a Franchisee is a Company or a Trust, the full and correct details must be included in the documentation and the Franchisor needs to take appropriate steps to ensure the correct individuals sign the Agreement. Alternatively, if the Franchisee will be more than one individual, such as a husband and wife partnership, then each Franchisee’s name must be included in the documents as a Franchisee if the Agreement is to be enforced against each of them in the future.
Some Franchise Agreements also contain multiple places for execution, such as guarantor sections, legal, accounting and financial advice certificates, and ancillary documents in schedules that must also be signed, for example restraint of trade agreements, confidentiality agreements and the like.
If these are not checked for proper execution at the time they are returned to the Franchisor, the first time a missing signature or some other issue may be identified is after a dispute has arisen. At that stage, it will likely be too late to correct any errors in execution.
If a Franchise Agreement is not executed properly, this has the potential to fatally compromise the Franchisor’s ability to enforce their agreement against the Franchisee.
- FAILURE TO TAKE SECURITY
If a Franchisee is a special purpose Company or a Trust set up specifically to operate a Franchised Business, Franchisor’s may not necessarily realise the importance of obtaining a personal guarantee from the owners or directors, or if they do, they may not check that a personal guarantee has been executed in a manner that will render it enforceable later on.
Another significant issue is the failure to remember to register (or the failure to register properly) a general security interest over the Franchisee on the Personal Property Securities Register where the Franchise Agreement provides for this. In the event of insolvency of the Franchisee, the Franchisor’s security will become worthless if it has not been registered appropriately and entitlement to assets will be lost to liquidators.
- RECORD KEEPING
The Code requires the Disclosure Document to be given to an existing or prospective Franchisee at least 14 days before entering into a new franchise agreement.
To protect itself, Franchisors should always keep a written record of when a Disclosure Document was issued to a Franchisee. Failure to keep a written record exposes the Franchisor to risk of a dispute as to whether the Franchisor did in fact comply with it’s Code obligations.
Section 10 of the Code further prohibits a Franchisor from entering into a franchise agreement (or renewing, transferring or extending an existing agreement) unless the Franchisee has provided a written statement that they have received, read and had a reasonable opportunity to understand the disclosure document and the code.
This statement is typically known as a “section 10 certificate” and is often provided to franchisees either as a separate document or as a schedule to the Franchise Agreement itself. If a Franchisor has not received this back from a franchisee before they sign a Franchise Agreement, this is a breach of the Code.
- FAILING TO UPDATE AGREEMENT TERMS AFTER CHANGES IN THE LAW
From time to time there are also important changes in other laws that can affect how a Franchise Agreement operates, or that can affect a Franchisor’s implementation of their systems and procedures.
It is important to ensure that Franchise Agreements are kept up to date with changes to other laws such as the Privacy Act 1988 (Cth), the Personal Property Securities Act 2009 (Cth), and the Business Names Registration Act 2011 (Cth).
A good example of this is the changes that were made several years ago to introduce a central business names register administered by ASIC. Franchise Agreements that provided for Franchisees to sign business name transfer forms to be held in escrow by the Franchisor needed to be updated to allow for the new electronic procedures. It is still possible to find franchise agreements in the marketplace that have not been updated to reflect those changes made to the law four years ago in 2012.
Law firms have a professional responsibility to ensure that franchise documents issued by them are up to date and in line with all current laws relating to franchising. By engaging a law firm to prepare and issue franchise documents on their behalf, Franchisors can be reassured that any changes in the law that are relevant to their document will be brought to their attention.
There are a significant number of legal elements required to ensure that franchise documents will be properly prepared and enforceable. As such, the process of issuing and signing franchise documents is not a purely administrative task and requires at least some understanding of legal issues to get right. The consequences of failing to get it right can range from fines issued by the ACCC, to unenforceable franchise agreements.
Franchisors should carefully consider these risks when making a decision to start issuing franchise documents in house. Sometimes an upfront outlay in legal fees can save significant loss down the track.