The disclosure document and franchise agreement
Franchising and the Law
For many years Australia has been one of the most regulated countries in the world when it comes to franchising. In 1998 the Australian Government introduced mandatory requirements to regulate the franchising industry in the form of the Franchising Code of Conduct (Code).
The Code was originally enacted as a federal regulation under the Trade Practices Act 1974, and since 1 January 2011 it is enacted under the Competition and Consumer Act 2010, which superseded the Trade Practices Act 1974.
The Code has seen numerous amendments over the last two decades in an attempt to make the franchisor-franchisee relationship fairer towards franchisees and to restore the balance of power. Further, the new Unfair Contract Terms regime (UCT regime) was introduced under the Australian Consumer Law (ACL) legislation effective 12 November 2016 providing additional protection to franchisees.
The Code dictates main aspects of the franchisor-franchisee relationship.
The Code prescribes what documentation the franchisors must provide to its potential and current franchisees, which include provision of:
- a copy of the disclosure document signed by a director of the franchisor;
- a copy of the franchise agreement in the form in which it is to be executed; and
- a copy of the Code, at least 14 days before:
- the potential franchisee enters into a franchise agreement (or an agreement to enter into a franchise agreement); or
- the prospective franchisee makes a non-refundable payment (whether of money or of other valuable consideration) to the franchisor or an associate of the franchisor in connection with the proposed franchise agreement; or
- renewal or extension of the current franchise agreement between the franchisee and the franchisor.
The purpose of the above requirement of the Code and the prohibition for the potential franchisee to sign the franchise agreement within the 14 days mentioned above, is to allow them time to obtain advice from an accountant, a lawyer and a business adviser without any pressure to sign on the dotted line straight away.
The franchisor must also provide an information statement, as contained in Annexure 2 of the Code, as soon as practicable after the prospective franchisee formally applies or expresses an interest in acquiring a franchised business together with a copy of the lease, licence or sub-lease, if applicable.
The information statement must be produced as a two page document provided separately to the disclosure document.
Good faith provision
Since 2015 amendments, the Code contains an obligation for both parties to the franchise agreement to act in good faith. The penalty for breaching this clause of the Code is hefty, which is the Code’s attempt to ensure that the parties do not take this obligation lightly.
Cooling off period
The Code provides a seven-day cooling off period for all new franchisees, enabling them to terminate the franchise agreement within seven days of signing it or paying any fee to the franchisor. The cooling off provision does not apply on renewal or extension of the franchise agreement already in place or transfers of existing franchises. If the franchisee terminates the franchise agreement pursuant to the cooling off provision, the franchisor must, within 14 days, refund all payments made by the franchisee under the franchise agreement except for any reasonable costs incurred by the franchisor. It is highly recommended that the franchisee finds out prior to signing the franchise agreement the exact amount kept by the franchisor as ‘the reasonable costs’ in the event that the franchisee decides to cool off.
Many franchisors list this amount in the franchise agreement and disclosure document, where it is often referred to as the ‘retention amount’.
The disclosure document is a prescribed form document contained in Annexure 1 of the Code. All franchisors in the country are required to prepare it and provide it to all of its potential (and current) franchisees. The purpose of the disclosure document is to provide information to potential franchisees to help them make an informed decision about the franchise system and whether to proceed with the purchase. The disclosure document must be updated annually within four months of the end of the franchisor’s financial year. For most franchisors the financial year ends on 30 June of each year. However, for some corporations the end of financial year is 31 December.
The disclosure document must keep the numbering and all the questions listed in Annexure 1 of the Code and provide information about:
- the franchisor’s entity, registered and principal place of business addresses;
- the franchisor’s and its directors’ business experience;
- any current and recent litigation affecting the franchise, the franchisor or the franchisor’s directors;
- numbers of, and details of, current and past franchisees broken down by each State or Territory and reasons for past franchisees exiting the system;
- whether franchisor competes with franchisees online;
- whether there are any master franchisees involved in the system;
- all intellectual property owned by the franchisor or its associate and how such intellectual property can be used by the franchisees;
- general requirements for franchisees in relation to purchase of goods and services and operating a territory;
- the marketing fund operated by the franchisor and details of contributions to the marketing fund by other franchisees and the franchisor;
- extensive list of payments at the commencement of the franchise and on-going, including payments to the franchisor and to third parties;
- whether the franchisor provides any financing options to franchisees;
- list of variations to the franchise agreement that can occur without the franchisee’s consent, for example amendments to the franchisor’s manual with which all franchisees have to comply;
- what arrangements apply at the end of the term of the franchise agreement;
- earnings, if provided by the franchisor;
- financial reports for the last two financial years or an audit report of the financials of the franchisor stating that the franchisor is solvent and can pay their debts; and
- any updates which are material since the preparation of the disclosure document.
The disclosure document and the solvency statement must be signed by one of the directors of the franchisor. It must contain a table of contents indicating the page number on which each item begins. If the disclosure document attaches other documents, the table of contents must list these other documents too.
The franchise agreement is a binding contract between the franchisor and the franchisee outlining the rights and responsibilities of the parties. The Code dictates that the franchise agreement drafted by the franchisor must include:
- a cooling-off period of seven days from the signing of the franchise agreement;
- information about the operation of the marketing fund;
- information about how the franchisee can transfer their franchised business and pre-conditions to transfer; and
- a full list of grounds for termination, including immediate termination and termination after serving of breach notice(s).
In relation to the termination of the franchise agreement, the Code is specific as to in which circumstances the franchisor is able to terminate the franchise agreement immediately and without prior notice to the franchisor.
In all other scenarios the franchisor is required to provide a written notice to the franchisee outlining the breach, the time required to rectify the breach (usually between 7 – 30 days) and consequence(s) of non-compliance, which is, in most cases, termination. If any part of the termination clause contained in the franchise agreement is inconsistent with the Code, the Code will prevail.
Penalties and Australian Competition and Consumer Commission (ACCC)
The 2015 amendments to the Code introduced two significant changes, such as penalties for breaching various sections of the Code and a good faith provision. The ACCC is the regulator given the task to enforce the Code and has done so since the inception of the Code. Franchisees and franchisors risk financial penalties and infringement notices for breaching the provisions of the Code. Further, the ACCC publishes infringement notices within a public register on its website for all breaches of the Australian Consumer Law, including breaches of the Code.
Other Related Legislation
Australian Consumer Law (ACL) The ACL was enacted to commence from 1 January 2011 and it replaced the Trade Practices Act 1974 and other state and territory consumer legislation. It is contained in Schedule 2 to the Competition and Consumer Act 2010 (Cth). The aim of ACL is to protect consumers and ensure fair trading across Australia.
All Australian courts and tribunals, whether state based or federal, can enforce the ACL.
The ACCC is the federal regulator of ACL in relation to conduct engaged in by corporations and also conduct involving the use of postal, telephonic and internet services. There are also state and territory based consumer protection agencies, in relation to the conduct engaged in by persons carrying on a business in, or connected with, the respective state or territory.
Since 12 November 2016 the UCT regime applies to franchise agreements entered on or after that date if the franchise agreement:
1. Is a standard form contract
Standard form contract means it is either for the supply of goods or services or the sale or grant of an interest in land and it is prepared by one party without any room for negotiation of any of its terms.
2. Is a small business contract
A small business contract must be a small business which employs less than 20 people in total (including casuals and permanent employees) and where the contract contains the upfront price payable of no more than $300 000 if the contract is for less than 12 months or no more than $1 million if the contract is for longer than 12 months.
3. Includes a clause within the franchise agreement which is unfair
The term will be considered unfair if it creates a great imbalance of power between the parties, including disproportional rights and obligations as well as when such term is not necessary to protect the legitimate business interests of the party ‘in power’, such as the franchisor.
Individuals can apply to a court to have a term of a standard form contract they entered into declared unfair and therefore void. ACCC and other state and territory regulators can also apply to the court to declare a term unfair.
Although there are no penalties as such for having the unfair term in the contract, consumers, ACCC and state and territory regulators can seek compensation for any loss incurred as a result of an unfair term contained in a standard form contract.
There are some contracts excluded from the operation of the UCT regime, for example company constitutions and shipping contracts. Any contracts entered prior to the commencement of the UCT regime are also excluded unless they are varied post the date UCT regime came into effect.
Other provisions of the Competition and Consumer Act 2010 (Cth)
Apart from the Code being one of the regulations enacted under the Competition and Consumer Act 2010 (Act), the Act broadly covers most business dealings in Australia. The most relevant parts of the Act when it comes to the franchising industry are:
- Part IV – anti-competitive practices, including resale price maintenance, exclusive dealing and anti-competitive agreements;
- Part IVA – unconscionable conduct; and
- Part V – unfair practices, including misleading or deceptive conduct such as misrepresentations, product safety and information, pyramid selling, warranties, and other relevant provisions.
The above-mentioned parts of the Act may be able to assist franchisees who have encountered anticompetitive, unconscionable or unfair / misleading behaviour from the franchisor.
Before signing on the dotted line, all potential franchisees should do thorough due diligence and seek advice of lawyers and accountants with franchising experience.