Nothing stays the same for long, particularly in the world of business and more so post Covid 2019 which accelerated so much change in such a short period of time. Standing still in business means you are going backwards in respect to your customer’s and your competitors.
One of the interesting developments from Covid was the move to innovation and increased interest and activity in the franchise sector. What business has not had to reevaluate their business model, operations and strategy moving forward over the past 2 years?
There have been changes in digital marketing, on line sales, social media and technology and the use of artificial intelligence. At the same time employee’s attitudes and expectations have dramatically changed as has pressure on everyone with rising inflation, wage growth pressures and increasing operational costs for business.
Many people who were made redundant or tired of being an employee wanting more flexibility in their work see franchising as a way of transitioning out of employment to running their own business.
Transition from worker to boss
For anyone looking to establish a business for the first time, it is still the case that starting out as a franchisee is regarded as a safer way to get into business and build experience utilising the training, systems and support of the franchisor.
The Franchise sector underwent considerable scrutiny with Parliamentary enquiries and a revised Franchise Code, placing greater disclosure and compliance obligations on Franchisors. For prospective franchisees the process of finding and then selecting a franchise is exciting on one hand and no doubt downright scary on the other.
The purpose of the Franchise Code is to provide a franchisee with all relevant information they may need to make an informed decision as to whether to take up the franchise. Franchisees see the franchisors “schmick” (yes that is a word) online marketing and can easily get caught up with the hype, but the devil as they say is in the detail.
How can a franchisee make the right decision and really get to understand their rights and obligations before signing on the dotted line? The best way to limit your risk and avoid making the wrong decision is to ensure you have an experienced franchise specialist lawyer on board who can advise you and ensure you have independent financial advice.
Do your due diligence on the franchisor just as they do their due diligence on you!
Get feedback from other franchisees and don’t be rushed into making a decision as once you have taken up a franchise it is not so easy to exit.
How to get the right advice
Franchising is a specialist field and franchises should seek specialist legal advice from a franchise lawyer or contact the Franchise Council of Australia (FCA) who will recommend a franchise lawyer. Irrespective of how attractive and compelling the franchisors marketing and sales pitch may be, the primary decision should not be emotional, it should be financial. That is, will you be able to take a reasonable wage, pay your expenses and interest on loans and get a return on your investment? Franchise lawyers who are members of the Franchise Council of Australia (FCA) are best placed to give you advice to minimise your risk, as we know what’s going on in the franchise sector, the good, the bad, and the downright ugly!
Due to the Franchise Code changes, there are now even more documents for a franchisee to review so seeking specialists advice is even more important and will save you a lot of time and stress! The Franchise Code regulations. On 1 June 2021, the Australian Government made amendments to the Franchising Code following the Government’s response to the Fairness in Franchising Inquiry in 2019. Many of the changes affect agreements entered, renewed, or extended on or after 1 July 2021.
Some changes relate to a dispute notified on or after 2 June 2021, even if the franchise agreement was entered into, extended or renewed before 2 June 2021. Most of the regulations deal with further disclosure obligations for franchisors in the disclosure document and apply to disclosure documents given from 1 November 2021.
Franchisors have to register their systems on the Franchise Register and also update their disclosure documents required by the 30 October in each year. Franchisors also need to upload their key facts sheet on to the ACCC system. The key fact sheet is a summary of the key terms of the arrangement and highlights important information in the disclosure document. Franchisees can now openly access information on franchisors on the Franchise Register and access the franchisors key fact sheet as part of their due diligence before making a decision.
The irony in all this is that franchisees now have more, not less documents to review and absorb before deciding whether to take up a franchise.
Key documents:
Franchisors are required to provide a prospective franchisee on enquiry an information statement which is a standard form under the Code and provides franchise a warning of the risks of franchising.
Franchisors will usually ask the franchisee to sign an NDA or confidentiality agreement before releasing details or any financial or other confidential information about the system to the Franchisee.
Once the franchisee is approved a deposit or document fee is paid to the franchisor (or their lawyers) who will then issue the suite of franchise documents which should include:
- A disclosure document with attachments including trade mark certificates, copy
- lease/licences and financial statements and a copy of the Code;
- The proposed franchise agreement in the form required to be signed by the franchisee;
- Any lease or offer to lease negotiated by the Franchisor or sub-lease or occupancy
- license;
- A receipt for the franchisee to acknowledge they received the suite of documents
- which starts the 14-day disclosure period;
- The legal, accounting and financial advice certificates the franchisee should complete and return with the signed franchise agreement.
The “No Prior Pepresentation” statement
The franchisor may ask the franchisee to sign a no prior representations statement. This is a significant document often overlooked by franchisees and their advisors. The purpose of it is for the franchisee to set out in writing in the document any representations, promises or statements made by the franchisor or their agent in the course of the negotiations on which they (the franchisee) relied to enter into the franchise.
If the franchisee does not complete it or does not set out any representations in it, then the franchisee cannot later rely on any representations or statements made unless they were specifically set out in the statement. It can be a vital document that can be relied on by a franchisor or franchisee down the track if a dispute arises as a franchisee will often allege, they were verbally promised something by the franchisor before they entered into the agreement.
But if those verbal promises or representations are not in writing or set out in the statement (or in the franchise agreement itself ) the franchise will not be able to rely on it. So, franchises should ensure that any promises or representations that are made which are not set out in the franchise agreement (even in the special conditions) are clearly set out in the representations statement.
Seeking legal advice
Although the Franchise Code changes did not make it compulsory for franchisees to seek legal, accounting and financial advice before entering into a franchise many franchisors are now insisting that their franchisees seek independent advice to protect themselves.
Franchisees lawyer’s role
Seeking legal advice from a franchise law specialist is not only good insurance to help you make the right decision, but your franchise lawyer will focus on the important commercial issues and highlight areas of particular concern where there may be room for negotiation, rather than recommending wholesale changes to an agreement which are unlikely to be accepted and which may aggravate the relationship from the very beginning.
We often see letters from non franchise lawyers acting for a franchisees asking for a myriad of unnecessary “rats and mice” changes or even asking for fees and charges to be varied which we then have to reject and this can aggravate the relationship between the parties before it starts. Some basic rules for franchisees
Rule one: Whether you seek proper legal advice from a franchise law specialist or not you should still read and become familiar with the documents. The franchise agreement is your contract, so you need to understand your rights and obligations. It will also assist you to identify any issues of concern which you can then raise with your lawyer.
Rule two: Do not rely on advice from your suburban conveyancing lawyer, next-door neighbour, your mate at the pub or the sales person at Bunnings! That’s not advice.
Rule three: Realise that going into a franchise carries risk like any business decision and once you are in a franchise getting out of it is not so easy. Franchise agreements are typically 50 to 100 or more pages and can be difficult going without a glass of red wine in hand!
There are many tricks and traps in the agreement which your franchise lawyer will point out, as well as any unusual or unreasonable commercial aspects in the agreement.
Rule four: Franchisors will often say their agreements are not negotiable – that is not always the case and in fact we will often negotiate reasonable concessions for a franchisee that can be included in the special conditions. This is more so where the franchisor is also new and keen to bring franchisees into the system.
Things to reasonably negotiate might be a royalty free period while building the business, reduced establishment fees, your minimum performance criteria, options to renew , the restraint of trade provisions, and seeking franchisor contribution to the setup costs.
Any concessions offered or negotiated with the Franchisor should be set out in the agreement or in other written form, signed by both parties and dated prior to or on the date the franchise agreement is signed.
Disclosure Document
Under the new Code franchisors are required to provide greater disclosure than previously and provide the franchisee a disclosure document with the key fact sheet at least 14 days before they either enter into an agreement or make a non-refundable payment.
The 14-day disclosure period will only start once the franchisor has made the full and proper disclosure required and the key fact sheet is lodged by the franchisor on line with the ACCC.
The key changes to the Disclosure Document are:
Lease information
The franchisor must provide full details of the lease and occupancy rights with a copy of any lease documents for example – offer to lease – agreement to lease – lease – sublease – occupancy license and lease disclosure statement issued by the landlord.
If the franchisor does not provide full and accurate information about the lease rights in the disclosure, the 14-day disclosure period does not start until they provide that information.
If the final lease details are different to the information in the disclosure document previously given, the 14 cooling off period only starts when that information is given, so the franchisor risks a franchisee being able to walk away.
This means the days of signing up a franchisee without a site or while in negotiations for a site are fraught with risk. Franchisors must also disclose if they have any interest in the lease or freehold and disclose any rent incentives offered. Rebates and financial benefits The percentage of rebates the franchisor receives (financial benefit) from each supplier over the last financial year as a percentage of all purchases by franchisees in the group (this excludes supplies by the franchisor or associate of a franchisor) now must be provided.
There is no need to disclose this information if the agreement allows the franchisee to buy from non-approved suppliers or the rebate is paid to a cooperative fund controlled by the franchisor. Rebates do not include payment by a franchise to the franchisor, master franchisor or associate for a wholesale supply and a lease incentive is not a rebate, but franchisors still need to disclose the lease incentives to franchisees.
Earnings information
Franchisors must if they give earnings information give it in the disclosure (not before or after signing the agreement) and include a statement that the information is correct to the best of their knowledge or state that the information may not be accurate.
A breach may attract a civil penalty of $66,000 and failing to provide the information means the 14-day disclosure period would commence only when the information is given and attached in the disclosure.
Capital Expenditure
Franchisors can only require a franchisee to undertake capital expenditure if a majority of franchisees agree where it affects the majority, or the express consent of the individual franchisee is given.
Term and restraint
Franchisors need to disclose if the franchisee has any right to goodwill at the end of term and if the agreement has a restraint or non-compete clause. The Code has been amended to provide that a franchisor can only rely on a “serious breach” of a breach of a restraint of trade clause (serious breach is not defined and the breach would have to be before the agreement term ends.
This sounds the death knock for restraint of trade provisions for Franchisors to a large extent and they will be left with their right to protect their IP, know-how and confidential information however you will still see most franchise agreements contain a non compete clause.
Termination Rights
The grounds for a Franchisor to terminate for “special circumstances” now require the Franchisor to give a franchisee 7-day prior notice of termination even for special circumstances which then allows the franchisee to raise a dispute.
The franchisor cannot terminate the franchisee if the franchisee raises a dispute, and the parties must try and resolve the matter in that period or refer the matter to the ASBFEO for mediation or arbitration.
In the meantime, the Franchisor can require the franchisee not to operate the business in the 28-day period. All franchise agreements will need to be amended to comply with these new provisions however, these provisions do not apply to pre-1 July 2021 agreements until they are renewed or extended.
Cooling off rights and 14-day disclosure period
The previous 7-day cooling off period was extended to 14 days and the 14 day disclosure period gets reactivated from when the franchisee receives the final lease documentation. The 14-day disclosure commences only if all documents and information are included in the disclosure at the time it is given, this includes earnings information and lease details. If lease information is given later or differs the franchisee has another 14 days disclosure period. Neither the franchisor nor franchisee can reduce the 14-day disclosure period, as this is a mandatory period set by the Code.
Early termination rights for franchisees
Franchisees have a right at any time during the term to write to the franchisor and seek an early termination (with reasons) of the agreement. The franchisor must then respond in writing in 28 days stating whether they agree or not.
If the franchisee does not agree (which is most likely the case) the franchisor must set out reasons in its response within that 28-day period, why it does not agree to an early termination.
There is no guidance as to what “acceptable reasons” for a franchisor are to refuse early termination so we will have to wait until this is tested however the parties can of course seek to take any dispute to mediation or arbitration via the ASBFEO.
Legal costs
It is now illegal for franchisors to charge franchisees any undetermined and future legal service costs other than an upfront fixed fee set out in the agreement. The upfront “fixed amount of dollars” (fixed fee) can only be for preparing, negotiating, and executing the agreement and is usually charged as an upfront document fee payable by the franchisee once approved for the suite of franchise documents to be issued.
Selling a franchise business
As franchisees now benefit from a 14-day cooling off period (even after settlement of the business has occurred) a franchisee, when selling a franchise, should be aware that the new franchisee will have a right to exit, so settlement should not take place until that period has elapsed. This should be made a term in any sale contract.
Key facts sheet
Franchisors must now give franchisees a key fact sheet to with the disclosure document and update it every year as with the disclosure document. The key fact sheet is then lodged with the ACCC online.
Marketing funds
The Code uses the word marketing, instead of advertising to clarify the Code applies to more than just advertising. It clarifies that marketing fund obligations apply to the fund administrator who could be the franchisor, master franchisor or a third party authorised to administer the fund for the franchisor or master franchisor. Civil penalties apply for breaching the rules for payments to and from the marketing fund.
The operations manual
Most franchise agreements include provisions requiring franchisees to comply with the franchisor’s operations manual. Franchisees should ask to see the operations manual before entering into the franchise agreement. As it is a confidential document the franchisor may not agree to provide a copy of it until the franchisee signs the agreement. If that is the case, franchisees should ask to review the operations manual within the cooling off period.
The Franchise Agreement
This is your contract setting out your rights and obligations, generally weighed in favour of the franchisor with consequences for a failure to comply which may give rights to serve a breach notice and even termination. It is often assumed by franchisees that the franchisor’s obligations are positive obligations, however most agreements will state the franchise “may “not that they “must” do certain things. Therefore, it is difficult to allege a franchisor has breached the agreement where they do not have a positive obligation.
Franchisees do have protections under the Franchise Code, the Australian Consumer Laws, unfair contract provisions and can instigate the dispute resolution process and seek mediation or arbitration via the ASBFEO where a dispute cannot be resolved directly with the franchisor.
Fees payable to the Franchisor Franchise Fees
The trend is that franchisors are tending to reduce the up-front franchise fee to make their franchise more attractive and affordable. Franchisors will often charge a training fee but again many are rolling this fee into the up-front franchise fee. There are also a number of other fees that must be set out in the disclosure document that cover things such as technology and IT fees and also renewal and transfer fees.
Royalty
Most franchise agreements provide payment of a service fee or royalty typically paid monthly or weekly, either as a percentage of the franchisee’s gross sales or a specific dollar amount. The point here is that the franchisor receives their royalty based on gross sales or turnover not the profit of the franchise – so make sure the business is viable and you can at the very least draw a wage for your efforts from running the franchise business! It is therefore critical franchisees do objective financial analysis and prepare cash flow projections with their accountant.
Tip: If relying on the franchisor’s earnings information, ensure their model makes provision for a salary to the owner /operator before showing a profit.
Working capital
We often find that the working capital requirements are understated by franchisors particularly for a new greenfield site so check with your accountant what would be a reasonable level of working capital to avoid financial stress in the first 6 to 12 months of operation. Also allow a buffer for unexpected costs which may not be included in the Disclosure Document, such as employees, insurances, utility bills and other outgoings and now lockdown events!
Term and renewal
It is likely due to the changes to the Code and franchisees right to seek early termination of the agreement during the term that the days of long-term agreements such as 10 or 20 year terms are over and most agreements tend to offer a 5-year term with options. The capital expenditure must be clearly set out in the disclosure documents so the franchisees can budget for those future costs.
Sites and territories
Mobile franchises (such as those providing gardening or cleaning services) will generally be granted for a specific territory – listed as a number of postcodes or marked on a map attached to the agreement. The territory may be exclusive or non exclusive and this should be understood so you are aware if the franchisor or other franchisees can operate in the territory. Retail franchises (such as cafes or gyms) generally are not allocated a territory just a site from which they operate. Social media and on-line sales need to be carefully reviewed and set out in the disclosure document.
Obligations end of term
Upon expiry or termination of the franchise agreement, the franchisee will usually be required to cease to use the trade marks, deliver up the premises and lease, return all documents relating to the system to the franchisor, all confidential information including customer details, transfer phone numbers, domain names and social media accounts to the franchisor.
The franchisor will often have the right under the agreement to acquire the assets of the business, including a transfer of the lease of the premises (if any) but usually at a nominal written down value and with no regard to any goodwill The Code provides that if the franchisee seeks an extension or renewal of the franchise at the end of the term and the franchisor refuses (provided the franchisee is not in dispute) the franchisor cannot then enforce the non-compete clauses against the franchisee unless the franchisor has offered the franchisee compensation.
The new Code amendments now make it even more difficult for franchisors to enforce a restraint of trade provision.
Goodwill
Most franchise agreements provide that any ‘goodwill’ developed in the franchise business remain the franchisors on the basis that the franchisee has only developed its goodwill by reason of the license given by the franchisor to use its system, brand, and IP and once that ends there is no goodwill that the franchisee can claim. Under the Code disclosure requirements, the franchisor must set out if the franchisee is entitled to retain any goodwill at the end of the term.
Existing Franchisees
The Disclosure Document requires greater disclosure of contact details of franchisees so you should use the 14-day disclosure period to contact existing franchisees and gather feedback about the franchise system from a number of franchisees.
Summary
Do your due diligence on the franchisor just as they do their due diligence on you! Also, remember it is one thing getting into a franchise, but it can be difficult getting out of one. Deciding whether to enter into a franchise agreement is a huge step emotionally and financially so seek specialist legal, accounting and business advice before committing. The best investment is getting the right legal and financial advice before committing to a franchise opportunity so you can make an informed decision.
R
obert is an Accredited Commercial Law Specialist with over 35 years expertise in franchise, license, and distribution law, acting for local and international franchisors and companies, advising franchisees and master franchisees with extensive experience in dispute resolution and mediation. Sanicki Lawyers is a dynamic and progressive law firm based in Melbourne and Brisbane with a talented team of lawyers who advise clients on Intellectual Property, Franchising and a broad range of corporate and commercial matters. Robert regularly publishes articles online and internationally on Franchising, Licensing and Distribution and is a Member of the Franchise Council of Australia (FCA), the International Franchise Lawyers Association (IFLA) and the Global Referral Network a network of specialist lawyers around the world. Robert is highly recognized as a leading Franchise Lawyer in Australia having been named as a Leading Franchise Lawyer in Australia in Who’s Who Legal: Franchise 2021 and nominated again in 2023 and is on the Advisory Board of a number of clients, as well as acting as a resident director for overseas companies.
Accredited Commercial Law and Franchise Specialist
Special Counsel | Sanicki Lawyers Melbourne/Brisbane | 0412 673 757
robert@sanickilawyers.com.au
Member: Franchise Council Australia (FCA), International Franchise Lawyers Association (IFLA), US Commercial Service, AICD and Global Referal Network