Countdown to 1 January 2015
This article appears in the Nov/Dec 2014 issue of Business Franchise Australia & New Zealand
A new Franchising Code of Conduct has been drafted by the Government (“new Code”) and it is proposed that the new Code will be effective from 1 January 2015.
In his second reading speech, the Honourable Bruce Billson, Minister for Small Business states that the aim of the new Code is to simplify and modernise the way franchising is regulated. He states that the new Code will be more effective and more responsive to the needs of the franchising sector’s unique commercial characteristics and tensions and that the new Code aims to deliver many benefits for franchisees and prospective franchisees.
At the time of writing, the final form of the new Code has not been released. Accordingly, this article is based upon the Exposure Draft of the new Code issued for public and industry consultation in April 2014 and readers should note that the new Code, once passed into law, may be different in some respects from that outlined in this article.
At the time of writing, the new Code had not been tabled before both Houses of Parliament. It cannot become law until the expiration of 15 sitting days after it is tabled before both Houses of Parliament and during that period, it can be vetoed by a successful Disallowance Motion, although that is extremely unlikely to occur.
Penalties for non-compliance with the new Code
The first and most notable change to franchising laws is that monetary penalties will be able to be ordered by the Federal Court for non-compliance with various provisions of the new Code. Such penalties will be up to $51,000 for a single offence. In addition, Infringement Notices can be issued by the Australian Competition and Consumer Commission (“ACCC”) of up to $8,500 for a company and $1,700 for individuals. The Competition and Consumer Amendment (Industry Code Penalties) Bill 2014 (“the Bill”) was finally passed by both Houses of Parliament on 4th September 2014 and amends the Competition and Consumer Act 2010 (Cth) by enabling regulations to be made prescribing monetary penalties and requiring the ACCC to issue infringement notices.
This is excellent news for franchisees because there is now much greater pressure on franchisors to comply strictly with all aspects of the new Code, including by ensuring their disclosure document is accurate, up-to-date and provided to franchisees and prospective franchisees within the time frames specified in the new Code.
The second most notable change is the introduction of an obligation for all parties to a franchise agreement, including persons who are likely to become a party to a franchise agreement, to act in good faith in respect of any matter arising in relation to the franchise agreement or proposed franchise agreement and the new Code. A failure to act honestly, merely acting arbitrarily, or a failure to cooperate to achieve the purposes of a franchise agreement may be considered as indicators of bad faith.
Any clauses in a franchise agreement which attempt to limit or exclude the obligation to act in good faith will have no effect.
Whilst this is of great benefit to franchisees, it is also a double edged sword as the new Code also imposes this duty to act in good faith on franchisees and prospective franchisees in relation to their negotiations and dealings with the franchisor.
The new Code will require franchisors to give an Information Statement prescribed by the new Code to prospective franchisees at an early stage of negotiations. The Information Statement gives information about the risks and rewards of franchising and reminds all prospective franchisees to obtain legal, accounting and business advice, to read all the documents, including the operations manuals, and to know their rights.
This document contains questions and information that may not have otherwise been considered by a franchisee, especially by an inexperienced first time franchisee and business person. However, it is not a complete guide to franchising and should only be used as a first step towards gathering more information about a franchise and the franchise network.
Prospective franchisees should request the Information Statement at the commencement of their discussions with a franchisor if they have not already received the Information Statement from the franchisor.
Simplified information about master franchisors
Where there is a master franchisor, the new Code will remove the need for separate or joint or combined disclosure documents to be given to prospective franchisees. Instead, the sub-franchisor must provide in its disclosure document certain details about the master franchisor and its officers, details of the number of master franchise agreements terminated or not renewed in the last three years and details of the master franchise, including details of the key commercial terms of the master franchise agreement. This change means franchisees are provided with less paperwork, but more meaningful and relevant information about the master franchisor (where relevant).
Specific disclosure about online sales
The new Code will also require disclosure about sales of goods and services online by the franchisor, an associate of the franchisor, the franchisee or other franchisees, including details of how online sales might affect the franchisee’s territory, details of whether goods and services may be made available online via a third party website, details of any agreements that might need to be made with third parties in relation to online sales and details of any profit sharing arrangements.
This is great news for franchisees who might otherwise have been unaware they could be in competition with their franchisor or other franchisees as a result of online trading.
Increase accountability for significant capital expenditure
Under the new Code, franchisors will no longer be permitted to require franchisees to undertake significant capital expenditure during the term of their franchise agreement, unless the expenditure is:
(a) disclosed before the commencement of the franchise agreement;
(b) incurred by all or a majority of franchisees and approved by a majority of franchisees;
(c) incurred by the franchisee to comply with legal obligations (not those imposed by the franchise agreement);
(d) agreed by the franchisee;
(e) regarded by the franchisor as being necessary as capital investment in the franchised business and justified by a statement of the rationale for the investment, the amount required, the anticipated outcomes and benefits and the expected risks.
This benefits franchisees by making franchisors much more accountable when requiring franchisees to undertake capital expenditure.
Increased transparency of marketing funds
The new Code will require franchisors to maintain a separate bank account for marketing and advertising fees contributed by franchisees.
In addition, franchisors will be required to pay marketing and advertising fees for each business operated by the franchisor on the same basis as franchisees.
Marketing or advertising fees will also only be able to be used to meet expenses that are:
(a) disclosed in the franchisor’s disclosure document; or
(b) legitimate marketing or advertising expenses; or
(c) agreed to by a majority of franchisees; or
(d) used to pay the reasonable costs of administering and auditing a marketing fund.
Finally, if franchisees vote not to audit the marketing fund, the vote must be undertaken annually, instead of being effective for three years.
The new level of transparency around the use of marketing funds benefits franchisees and should reduce the level of conflict that can occur between franchisors and franchisees in relation to marketing fund contributions and what they are used for.
Jurisdiction and costs of settling disputes
Under the new Code, clauses requiring actions or proceedings to be brought in any State or Territory other than the one in which the franchised business is located, will be unenforceable.
Whether this provision will apply to franchise agreement entered into before 1 January 2015 remains to be seen.
In addition, franchise agreements must not contain an obligation for the franchisee to pay the costs of the franchisor in relation to settling a dispute under the franchise agreement.
This benefits franchisees by potentially reducing the cost of raising and being in dispute with their franchisor.
Restraints of trade and nonrenewal of franchise agreement
Restraint provisions will be of no effect if:
a. the franchisee had sought to renew the agreement on substantially the same terms; and
b. the franchisee was not in breach of the agreement; and
c. the franchisee had not infringed the intellectual property of the franchisor during the term of the agreement; and
d. the franchisor does not renew the agreement; and
i. the franchisee claimed compensation because the agreement was not renewed, but the compensation given was merely a nominal amount and did not genuinely compensate the franchisee; or
ii. the agreement did not allow the franchisee to claim compensation in the event that it was not renewed.
No inducement against association of franchisees
The new Code will prevent franchisors from restricting or impairing the freedom of franchisees or prospective franchisees to form an association or to associate with others for a lawful purpose by imposing civil penalties.
Disclosure regarding lease and occupancy licence
If a franchisee leases a premises from the franchisor, the new Code will require the franchisor to provide to the franchisee, within one month after the signing of the lease or agreement to lease, a copy of the lease or agreement to lease as well as details of any incentive or financial benefit that the franchisor or an associate of the franchisor is entitled to receive as a result of the lease or agreement to lease.
If a franchisee occupies, under license, premises which are leased by a franchisor or its associate, the franchisor (or its associate) must give to the franchisee both:
(a) a copy of the lease or agreement to lease; and
(b) details of any incentive or financial benefit that the franchisor or an associate of the franchisor is entitled to receive as a result of the lease or the agreement to lease;
or all of the following:
(a) a copy of the documents that give the franchisee the right to occupy the premises;
(b) written details of the conditions of occupation; and
(c) details of any incentive or financial benefit that the franchisor or an associate of the franchisor is entitled to receive as a result of the lease or the agreement to lease.
The copy documents and details must be given within one month after the earlier of that date on which the occupation commences or the licence to occupy is signed by all the parties.
It is of benefit to franchisees to be aware of any financial incentives received by the franchisor from the landlord at an early stage, to give them an opportunity to better negotiate the terms of their franchise with the franchisor.
Entitlement to disclosure document on renewal
Franchisors are already required to provide notice to franchisees, at least 6 months before the end of the term of their franchise agreement, of the franchisor’s decision whether or not to renew the franchise agreement or enter into a new franchise agreement.
The new Code will require that the franchisor’s notice include a statement that the franchisee is entitled to request a copy of the franchisor’s current disclosure document, provided they have not already made such a request in the previous 12 months.
In summary, the changes to the Code will provide greater transparency between franchisors and franchisees. It will assist franchisees with their pre-purchase research and will increase transparency and disclosure in relation to marketing and capital expenditure. Franchisees should not assume the new Code only imposes additional obligations on franchisors as the new Code includes an important obligation on franchisees, as well as franchisors, to act in good faith.
The ability for the ACCC and courts to impose monetary penalties on franchisors and franchisees will give the new Code serious clout and new force which should ensure a better level of compliance by all parties.
However, these benefits do not remove the need for franchisees and prospective franchisees to undertake the task of reading all relevant agreements and conducting their own research. It is also still imperative that franchisees seek advice from lawyers, accountants and business advisors who are experienced in franchising.
Louise Wolf is a Senior Associate in the Corporate Advisory and Franchising Team at MST Lawyers. She is one of several experienced franchising lawyers at MST Lawyers who advise franchisors, franchisees and suppliers to the franchise sector on all aspects of franchising, including providing pre-purchase and ongoing advice to franchisees.
Located in Melbourne’s industry heartland, MST Lawyers has strong commercial law skills and provides clients with sensible solutions.
For more information contact MST Lawyers at:
Phone: 03 8540 0200