Franchise contracts and the franchisor/franchisee relationship

Franchise relationship laws

What laws regulate the ongoing relationship between franchisor and franchisee after the franchise contract comes into effect?

Franchising in Australia is, in essence, a contractual relationship supplemented by specific requirements contained in the Franchising Code of Conduct (the Code) including the obligation to act in good faith. In many cases, franchising is subject to the general prohibition on unfair contract terms in standard form small business contracts.

The general prohibitions on misleading or deceptive conduct and unconscionable conduct contained in the Australian Consumer Law (ACL) apply to regulate the ongoing relationship between franchisor and franchisee.

 

Unfair contract terms

Franchise agreements should be reviewed to assess if the prohibition on unfair contract terms applies to the agreement. As a small business is defined as a business with fewer than 20 employees and a typical franchise agreement exhibits many of the characteristics of a standard form contract, the legislation has significant potential application to franchise agreements.

There are some exclusions, such as agreements in which the upfront fee is more than A$300,000 (or A$1 million for a contract with a term of more than a year) and certain special types of contract. Further, where an agreement, including a franchise agreement, is negotiated and there are genuine opportunities for amendment, it may not be considered a standard form contract presented on a ‘take it or leave it’ basis.

If the prohibition applies, a more detailed assessment of the contractual provisions should be conducted. The legislation gives numerous examples of provisions that could potentially be unfair, including a term that:

  • permits one party (but not another party) to avoid or limit performance of the contract;
  • permits one party (but not another party) to terminate the contract;
  • permits one party (but not another party) to vary the terms of the contract;
  • limits one party's liability or right to sue; or
  • permits one party to assign the contract to the detriment of another party without that other party's consent.

 

The legislation provides that a provision in a small business contract is unfair if the contract:

  • would cause a significant imbalance in the parties’ rights and obligations arising under the contract;
  • is not reasonably necessary to protect the legitimate interests of the party that would be advantaged by the term; and
  • would cause detriment (whether financial or otherwise) to a party if it were to be applied or relied upon.

 

For a court to declare that a term is unfair, all three of the above elements must be proven.

The burden of proof is on the party advantaged by the term to prove it is reasonably necessary to protect its legitimate interests. In determining whether a term is unfair, the court may take into account such matters it considers relevant, but must take into account the extent to which the term is transparent and the context of the provision in the contract as a whole.

Generally, few changes are likely to be necessary to template documentation, with the main areas of focus likely to be in relation to provisions dealing with liquidated damages, altering or purporting to exclude legal liability, termination and dispute resolution. If a court declares a provision of a contract to be unfair, that provision is void. However, the contract continues to bind the parties if it can operate without the unfair term. This legislation is currently under review. Possible legislative amendments to introduce penalties for the inclusion of an unfair contract term into a standard form small business contract would be a game-changer for businesses, as it would no longer be possible to take a ‘wait and see’ approach on whether a court determines a clause to be an unfair term.

 

The Franchising Code of Conduct

Clause 6 of the Code obliges each party to a franchise agreement to act in good faith, essentially codifying the common law good faith obligation but also extending it to specific franchising situations, such as any matter arising out of the Code, negotiation of the franchise agreement and disputes.

If, as part of the franchise scheme, the franchise agreement provides that a franchisee must pay money to a marketing or other cooperative fund, the franchisor must prepare an annual financial statement of the fund's receipts and expenses for the last financial year, including the percentage spent on production, advertising, administration and other stated expenses. The franchisor must have the statement audited by a registered company auditor within four months of the end of the financial year to which it relates. The franchisor must give to the franchisee a copy of the statement within 30 days of preparing the statement and a copy of the audit report (if applicable) within 30 days of preparing the report. The requirement for the franchise statement to be audited does not apply for a financial year if 75 per cent of the franchisees in Australia that contribute to the fund agree and such agreement is made within the period prescribed by the Code.

Franchisors have additional disclosure obligations to clarify for franchisees what, if any, arrangements exist in relation to arrangements that apply at the end of the franchise term. In addition, franchisors must give at least six months’ notice of their decision to renew or not to renew a franchise agreement, or enter into a new franchise agreement. Where a franchise agreement is less than six months, the notice period is at least one month.

The disclosure document is to be updated annually within four months of the end of the financial year. However, a franchisor is required to disclose to a franchisee within a reasonable time, but not more than 14 days after the franchisor becomes aware of certain materially relevant facts, including:

  • any change in majority ownership or control of the franchisor;
  • any proceedings by a public agency such as the Australian Competition and Consumer Commission;
  • a judgment or arbitration award in criminal or civil proceedings in Australia against the franchisor alleging:
    • breach of a franchise agreement;
    • contravention of trade practices law or the Competition and Consumer Act (CCA);
    • unconscionable conduct;
    • misconduct; or
    • an offence of dishonesty;
  • a judgment against the franchisor under certain workplace relations and industrial relations laws; and
  • civil proceedings in Australia against the franchisor or an associate of the franchisor by 10 per cent or 10 (whichever is the lower) of the franchisor’s franchisees in Australia.

 

The Code provides that a franchisor cannot unreasonably withhold consent to a franchisee’s request to assign a franchise agreement and curtails somewhat a franchisor’s ability to terminate a franchise agreement. Immediate termination is only available in very limited circumstances, with most cases requiring a franchisee to be given written notice of default and an opportunity (of not more than 30 days) to cure the default. The Code also requires disclosure of whether the franchisor will amend the franchise agreement prior to, or on transfer of, a franchise agreement.

The Code contains a mediation process that, if activated by a party, is mandatory. Mediation is a process involving the resolution of disputes by consensus. The mediation process has been extremely successful in resolving disputes, with a success rate in excess of 80 per cent.

 

Motor vehicle dealerships

All motor vehicle dealerships are deemed franchise agreements and are therefore subject to the general provisions of the Code. There are additional provisions in the Code, mainly in relation to end of term arrangements and capital expenditure, that only apply to automotive franchise agreements. The changes made to the Code in 2020 were largely disclosure-oriented, but further changes in effect as of 2 June 2021 also deal with the duration of a franchise agreement as well as return on investment, goodwill and compensation in the event of an early withdrawal from the Australian market, rationalisation of a network or changes to distribution model in Australia. Amendments to the good faith obligation now provide that a court must consider whether the terms of the franchise agreement are fair and reasonable.

Network rationalisation and changes to the distribution model are particularly relevant issues for many automotive brands in Australia as distribution options for new products, such as electric and autonomous vehicles, must be considered. Great care must be taken before entering any agreement after 1 July 2021, particularly as further changes have been flagged for late 2021 that are likely to contain additional restrictions on automotive franchisors.

Operational compliance

What mechanisms are commonly incorporated in agreements to ensure operational consistency and adherence to brand standards?

Franchise agreements typically contain extensive inspection and audit powers to enable a franchisor to ensure operational consistency and adherence to brand standards.

Amendment of operational terms

May the franchisor unilaterally change operational terms and standards during the franchise relationship?

Yes, subject to having the contractual power to do so in the franchise agreement, and the obligations to act in good faith and to avoid unconscionable conduct. The Code also contains a requirement to set out in the disclosure document the circumstances in which the franchisor has unilaterally varied a franchise agreement in the past three financial years and the circumstances in which the franchise agreement may be unilaterally varied.

Policy affecting franchise relations

Do other government or trade association policies affect the franchise relationship?

No.

Termination by franchisor

In what circumstances may a franchisor terminate a franchise relationship? What are the specific legal restrictions on a franchisor’s ability to terminate a franchise relationship?

Provided the franchisor has the contractual right to terminate in the franchise agreement, a franchisor may terminate a franchise agreement:

  • for breach, provided the franchisor has given the franchisee reasonable written notice and an opportunity to remedy the breach;
  • on reasonable notice where there is no breach provided the franchisor gives the reasons for termination; and
  • without notice or reasons, in special circumstances limited to:
    •  the loss of any licence the franchisee needs to carry on the business;
    • insolvency;
    • company deregistration;
    • abandonment of the franchised business or the franchise relationship;
    • conviction of a serious offence;
    • business operations endangering public health or safety; and
    • fraud.

 

Termination by franchisee

In what circumstances may a franchisee terminate a franchise relationship?

A franchisee has a statutory right to terminate the franchise agreement under cooling-off provisions that have been significantly amended with effect as of 1 July 2021. The essence of the cooling-off arrangement is that a franchisee is entitled to terminate the franchise agreement within 14 days of entering into the agreement or making any payment under the agreement. However, the new provisions potentially link the cooling-off period to the provision of lease details or documentation and also now apply to franchisee-to-franchisee sales.

From 1 July 2021, the franchisee may provide a written proposal to terminate at any time. Although this does not give the franchisee a specific right to terminate, it does create a framework that requires careful navigation by the franchisor. The franchisor must provide a substantive written response to any proposal within 28 days, including the franchisor’s reasons if the franchisor refuses to terminate on the grounds proposed. Both the franchisor and franchisee must act in good faith and a refusal to terminate on the grounds proposed may give rise to a dispute to which the alternative dispute resolution process applies.

Renewal

How are renewals of franchise agreements usually effected? Do formal or substantive requirements apply?

Franchise agreements are often drafted with a defined initial term and a further term at the franchisee’s discretion. The franchisee is typically required to elect to renew in writing and the franchisor can only refuse to renew if the franchisee is in breach or fails to satisfy reasonable renewal preconditions.

Refusal to renew

May a franchisor refuse to renew the franchise agreement with a franchisee? If yes, in what circumstances may a franchisor refuse to renew?

Upon the expiry of the franchise agreement, a franchisee has no legal right to an extension. However, a franchisor must disclose what will happen at the end of the agreement’s term in the disclosure document and must advise the franchisee of its intention in relation to any extension (typically at least six months’ notice is required) prior to the end of the term. If the franchisor refuses to extend the agreement of a compliant franchisee that wishes to extend and no genuine goodwill compensation is paid to the franchisee, any non-compete provision in the franchise agreement that might otherwise restrict the franchisee at the end of the term has no effect.

Transfer restrictions

May a franchisor restrict a franchisee’s ability to transfer its franchise or restrict transfers of ownership interests in a franchisee entity?

Yes.

Fees

Are there laws or regulations affecting the nature, amount or payment of fees?

No.

Usury

Are there restrictions on the amount of interest that can be charged on overdue payments?

There are no specific usury laws relating to interest payments. However, interest charged for overdue payments should reflect a genuine estimate of the loss that the non-defaulting party will incur as a result of the default and is often linked to specific state-based legislation that prescribes penalty interest rates or bank indicator lending rates plus several percentage points. Agreed provisions for the late payment of fees should also be drafted to ensure they are not rendered unenforceable as penalties. A franchisee may challenge a late fee provision on the basis that it is an unfair term under the ACL or that the charging of an exorbitant fee is unconscionable conduct.

Foreign exchange controls

Are there laws or regulations restricting a franchisee’s ability to make payments to a foreign franchisor in the franchisor’s domestic currency?

There are no laws that specifically restrict a franchisee’s ability to make payments to a foreign franchisor in the franchisor’s domestic currency.

If the franchisee is a financial services or gambling activity provider, or is otherwise classified as a ‘reporting entity’ under the Anti-Money Laundering and Counter-terrorism Financing Act 2006 (Cth), then they are required under the Act to report certain cross-border transactions to the Australian Transaction Reports and Analysis Centre.

Confidentiality covenant enforceability

Are confidentiality covenants in franchise agreements enforceable?

Yes.

Good-faith obligation

Is there a general legal obligation on parties to deal with each other in good faith during the term of the franchise agreement? If so, how does it affect franchise relationships?

In addition to the common law duty of good faith, there is now a statutory obligation for each party to a franchise agreement to act towards another party in good faith in relation to any matter arising under, or in relation to, the franchise agreement or the Code. Pecuniary penalties apply to any breach of this duty. Although the duty itself remains a common law duty, the Code explicitly applies good faith to franchise agreements and extends the application of the duty to the Code itself, as well as to the negotiation of franchise agreements and disputes. For automotive franchisors, the Code now requires a court to consider, in the context of assessing good faith, whether the terms of a franchise agreement are fair and reasonable.

Franchisees as consumers

Does any law treat franchisees as consumers for the purposes of consumer protection or other legislation?

As the franchise relationship is comprehensively covered by the Code and the ACL, there is little relevance to franchisees being treated generally as consumers. Where goods or services are supplied to franchisees for consumption, as opposed to resale, the provisions of the ACL and the CCA concerning fitness for purpose and product liability can apply.

Language of the agreement

Must disclosure documents and franchise agreements be in the language of your country?

There is no explicit requirement that the franchise agreement be in English, but the authors are not aware of a case where a franchise agreement has been made in a language other than English in Australia.

Restrictions on franchisees

What types of restrictions are commonly placed on the franchisees in franchise contracts?

Franchise agreements commonly contain extensive restrictions on franchisees, including in relation to:

  • territorial operations;
  • product sourcing;
  • exclusivity of product offerings;
  • product ranging and services;
  • merchandising and display;
  • maximum (but not minimum) pricing;
  • internet selling; and
  • sales and marketing.

 

Employee solicitation clauses are not common and governing law clauses typically choose Australian law given that conduct (which is extensively regulated) is regulated by Australian law. Foreign choice of law and jurisdiction clauses are permissible, subject to a requirement that dispute resolution must first involve mediation in Australia under the prescribed process set out in the Code.

Courts and dispute resolution

Describe the court system. What types of dispute resolution procedures are available relevant to franchising?

When franchisors, domestic or foreign, commence a dispute with a franchisee, they are required to follow the dispute resolution procedures outlined in the franchise agreement, which must provide for mediation.

Mediation is highly effective at resolving franchise disputes, but if it is unsuccessful, franchisors often initiate proceedings in the federal courts (including the Federal Circuit Court and the Federal Court), which have jurisdiction to hear matters relating to a breach of federal law (of which the Code is an example).

Franchisors can instead bring their dispute through the state or territory courts under the common law. The appropriate court may depend on the value of claims, as lower courts (including the Federal Circuit Court and the lower state and territory courts) only hear matters up to certain values. Appeals can be made from the Federal Circuit Court, and Federal Court decisions can be appealed to the Full Court of the Federal Court. Likewise, appeals from the lower state courts are heard in the supreme court of each state or territory. Appeals from either the Full Court of the Federal Court or the state’s supreme court can be made to the High Court.

Arbitration – advantages for franchisors

What are the principal advantages and disadvantages of arbitration for foreign franchisors considering doing business in your jurisdiction? Are any other alternative dispute resolution (ADR) procedures particularly favoured or disfavoured in your jurisdiction?

Arbitration is not commonly used in Australia, mainly because the Australian court system is effective and efficient, and mediation has proved to be highly successful in resolving disputes in Australian franchising. In Australia, there are very few arbitrators qualified in franchising and no particular advantages of arbitration over court litigation. Unlike in the United States, damages awards in Australia do not feature treble damages and rarely involve punitive damages. In court proceedings, it is normal for the unsuccessful party to pay the legal costs for both parties.

Most commonly, mediation is used as an alternative dispute resolution mechanism to resolve franchise disputes. Mediation must be included in dispute resolution provisions of franchise agreements and is also available under the Code. Further, federal courts are also able to order parties to undertake mediation prior to trial. Mediation is therefore frequently used and highly effective at resolving franchise disputes.

Amendments to the Code in effect as of 2 June 2021 broaden the alternative dispute resolution options to conciliation and arbitration, including binding voluntary arbitration. However, arbitration remains voluntary and franchise systems are unlikely to choose to adopt these new options.

National treatment

In what respects, if at all, are foreign franchisors treated differently (legally, or as a practical matter) from domestic franchisors?

Foreign franchisors are not treated any differently to domestic franchisors in Australia.