This article was first published in The Franchise Review, March 2017.
Franchise agreements have traditionally favoured franchisors for the simple reason that franchisors draft and issue the documents and have strong bargaining power in their negotiations with franchisees.
Franchisors set the fees, vary the operations manual at their discretion and dictate most of the processes and systems of each franchise business. Exercising this level of control allows franchisors to maintain consistency across their brand and franchise network. However, this can sometimes be to the franchisee’s detriment.
On 12 November 2016, the Treasury Legislation Amendment (Small Business and Unfair Contract Terms) Act (the Act or Unfair Contracts Laws) came into operation. The changes extended the scope of the unfair contract terms regime to include ‘small business contracts’. Consequently, franchisors may need to review and update their franchise agreement and remove any ‘unfair’ terms. Franchisees should also understand their rights under the regime and by extension, their franchise agreement.
Small Businesses and Standard Contracts
The Act will apply to a franchise agreement where:
- either the franchisee or franchisor is a small business with fewer than 20 employees; and
- the initial franchise fee is:
- less than $300,000; or
- if the term of the franchise agreement is over 12 months (which is usually the case), less than $1 million; and
- the franchise agreement is a ‘standard form’ agreement (generally includes contracts that the franchisor offers on a ‘take-it-or-leave-it’ basis).
In circumstances where the franchise agreement is considered a small business and standard form contract, there are a number of consequences for both franchisees and franchisors that span the entire length of the relationship – from pre-contractual negotiations to termination.
If a particular term of a franchise agreement is found to be ‘unfair’ under the new laws, any franchisee, franchisor or guarantors cannot enforce that particular term. This doesn’t mean that the entire franchise agreement will be thrown out – only that this term is void and will be severed from the rest of the agreement.
So, how do you know if a term is (or is likely to be) seen as unfair?
Section 24 of the Australian Consumer Law (ACL) defines an unfair term as one that would:
- cause a significant imbalance between the franchisee’s and franchisor’s obligations; and
- isn’t reasonably necessary to protect the legitimate business interests of the party that is advantaged by the term; and
- cause detriment to either the franchisee or franchisor if the other party relied upon the term.
Even if parties entered into the agreement before 12 November 2016, they wouldn’t necessarily escape the force of the Unfair Contract Laws. The new regime will also apply to agreements that are varied or renewed after this date.
The new laws and the meaning of unfair contract terms are a valuable guiding principle for pre-contractual negotiations between the franchisor and a prospective franchisee. Previously, a franchisor has typically offered the franchise agreement on a ‘take-it-or-leave-it’ basis. In the past, franchisors have preferred to adopt a uniform approach to their legal documents for expediency and consistency in the franchise network. However, a franchisor that refuses to negotiate with its franchisees is likely to be seen as issuing a ‘standard form’ contract.
A franchisor that refuses, point-blank, to negotiate with its franchisees is likely to be seen as issuing a ‘standard form’ contract.
For incoming franchisees and their legal advisors, section 24 of the ACL can be a useful way to assess which clauses of the franchise agreement they should negotiate to amend or delete. Franchisees should ask themselves the following:
- Do any of the clauses significantly favour the franchisors?
- Are these clauses necessary to protect the franchisor’s interests?
- Would these clauses cause detriment to the franchisee?
‘Franchisors should provide franchisees with the opportunity to negotiate their franchise agreement to avoid any ‘unfair’ obligations.’
For franchisors, the ACL also indicates which clauses are likely to be unenforceable, even if they remain in the franchise agreement. By taking the new laws into consideration, franchisors can weigh up the legal risks of enforcing or retaining these kinds of clauses.
Changes to the Franchise System or Agreement
The most obvious recommendation for franchisors is to be open to making minor amendments to the franchise agreement during the negotiation phase if the compromise is not onerous.
Also, franchise agreements typically have a clause allowing the franchisor to unilaterally amend or update the operations manual (which often forms part of the agreement).
Franchisors should understand the risks involved if they leave any clause permitting a unilateral variation to the terms of the franchise relationship without first notifying their franchisees. For example, clauses that affect operational standards or fit-outs or clauses allowing the franchisor to reduce a franchisee’s exclusive territory. These types of unilateral variations may be seen as unfair – especially in circumstances where the power to enforce the amendments weigh in the franchisor’s favour and following through with the amendments would cause financial (or other) detriment to the franchisee.
Where an amendment to the system is necessary to protect the franchisor’s legitimate business interests or improve network standards, there is likely to be more support for the view that the clause giving rise to the right of a unilateral variation was not, in fact, unfair.
Franchisors should then clearly communicate the benefits of any unilateral changes to the network as evidence that the change was not unfair. Franchisors should also consult with franchisees (via their franchise advisory council or through discussion groups at conferences) when making significant changes to operational standards, and consider any reasonable requests for changes.
The Franchising Code of Conduct (the Code) provides the franchisor with various grounds upon which they can immediately terminate a franchise agreement. In some circumstances, unilaterally ending a franchise agreement without cause, and outside of the circumstances outlined in the Code, may also be considered unfair. If a franchisor is unsure whether the contract gives rise to a termination, they should speak first with their legal advisor.
Accordingly, franchisors should take care to limit their rights of unilateral termination to situations where a franchisee has breached the agreement or has otherwise satisfied one of the special circumstances justifying termination under the Code. In situations where the franchisee has not breached any aspect of the franchise agreement, it is particularly important that franchisors seek proper advice regarding termination to ensure that they are meeting their new obligations and those under the Code when taking any action to terminate.
Franchisors should be open to amending their franchise documents where it makes sense to do so. The ‘take it or leave it’ approach may now expose you to the court reviewing your franchise agreement in the event of a dispute.
For franchisees – if the franchisor did not provide you with the opportunity to negotiate your franchise agreement and you are suffering as a result, you should seek legal advice regarding the nature of the obligations imposed on your business and whether those obligations are now considered ‘unfair’.
For the franchise industry – it is unclear how these new laws will apply in the franchise space until the definition of ‘unfair’ is fleshed out through test cases and ACCC investigations. This may take a long time to clarify. In the meantime, franchisors should exercise caution when making significant unilateral changes to their operating systems.