Five commonly asked legal questions by franchisees

This article appears in the July/August 2013 issue of Business Franchise Australia & New Zealand

In what circumstances may a franchisee terminate the franchise relationship?

Generally speaking, a franchisee may terminate the franchise relationship in four circumstances.

(a) Within seven days after signing the franchise agreement or making a payment under the franchise agreement. This is called a ‘cooling off period’ and is the right given to franchisees by the Franchising Code of Conduct (“the Code”). However, it should be noted that the right of cool off does not apply to any renewals, extensions, extensions of scope or transfers of existing franchise agreements.

(b) If the franchisor consents to early termination. There may be circumstances where the franchisor will agree to let the franchisee out of the franchise agreement early with no or minimal penalty imposed on the franchisee. These circumstances are rare.

(c) In accordance with any other rights under the particular franchise agreement if the franchisor is in breach. If the franchisor has breached an essential or fundamental term of the franchise agreement and has not remedied the breach within a certain timeframe after receiving a written notice from the franchisee outlining the breach and how it can be rectified, the franchisee may be entitled to terminate the franchise agreement.

(d) At common law if:

(i) the franchisor has repudiated the franchise agreement by indicating that it no longer wishes to be bound by its terms;

(ii) the franchisor breaches an essential term of the franchise agreement; or

(iii)the franchisee was induced to enter into the franchise agreement by a false representation or statement and, since becoming aware of the falsity of the representation or statement, has decided to terminate the franchise agreement.

Franchisees should only terminate franchise agreements based on their rights at common law upon receiving legal advice, because if the termination is held to be wrongful, the consequences for the franchisee can be drastic. Such consequences may include requirement to pay all fees otherwise due and payable to the franchisor for the remainder of the term of the franchise agreement, the legal costs of the franchisor and compensation awarded by a judge.

It should be noted that the current laws governing franchising do not provide any rights to the franchisees to end the franchise agreement early or cease paying any fees due under the franchise agreement if the franchisor becomes bankrupt or insolvent.

Further, apart from the cooling off right provided to franchisees by the Code, it is rare to see an early termination clause in the franchise agreement that allows the franchisee to terminate the franchise agreement on notice and without cause. Usually, early termination is tied to a requirement for the franchisee to pay an exit fee or other money to the franchisor.

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

The Code provides that the franchisor may not unreasonably withhold its consent to a transfer. ‘Transfer’ is defined in the Code as an arrangement, in which the franchise is granted, transferred or sold. The Code then gives some examples of the circumstances in which it would be reasonable for the franchisor to withhold consent to a transfer.

These circumstances include where:

(a) the proposed purchaser is unlikely to be able to meet the financial obligations that the proposed purchaser would have under the franchise agreement; or

(b) the proposed purchaser does not meet a reasonable requirement of the franchise agreement for the transfer of the business; or

(d) the proposed transfer will have a significantly adverse effect on the franchise system; or

(e) the proposed purchaser does not agree, in writing, to comply with the obligations of the franchisee under the franchise agreement; or

(f) the franchisee has not paid or made reasonable provision to pay an amount owing to the franchisor, including outstanding fees such as royalties and marketing fee as well as a transfer fees; or

(g) the franchisee has breached the franchise agreement and has not remedied that breach.

Additional conditions may be imposed by the franchise agreement for obtaining the franchisor’s consent to a transfer. A common condition is the requirement that the franchisee pay a transfer fee, usually a percentage of the sale price payable by the purchaser.

Transfers of an ownership interest (e.g. shares) and/or change of control in a franchisee are often deemed by the franchise agreement to be an assignment or a transfer by the franchisee and will trigger the transfer provisions.

May a franchisor refuse to renew the franchise agreement with a franchisee?

There is no obligation on the franchisor to renew the franchise agreement unless a contractual right of renewal is granted to the franchisee by the franchise agreement. However, even with a contractual right, the franchisor may refuse to renew the franchise agreement in certain circumstances. Such circumstances usually include, amongst others:

(a) the franchisee not advising the franchisor, in writing, during a specified period of time (usually between nine to seven months before expiry of the term of the franchise agreement) of its intention to renew; or

(b) the franchisee being in breach of the terms of the franchise agreement at the time of renewal or during the term of the franchise agreement; or

(d) the franchisee refusing to sign the required franchise documentation for the renewal to take place within the time specified by the franchisor;

(e) the franchisee not upgrading the premises from which the franchised business is conducted to suit the franchisor’s current image; or

(f) the franchisee failing to pay moneys owed to the franchisor, in particular, the renewal fee payable under the franchise agreement.

When buying a franchised business, franchisees should understand that there is no automatic renewal right provided to them by the Code and any renewal will be subject to the conditions of the franchisor’s franchise agreement.

In what circumstances may a franchisor terminate the franchise relationship?

Generally speaking, a franchisor may terminate a franchise relationship in the following circumstances:

(a) the franchisee breaches the franchise agreement and does not remedy that breach within a reasonable time (which does not have to exceed 30 days) after being given notice by the franchisor to remedy the breach. The notice issued by the franchisor must outline to the franchisee what must be done to remedy the breach and the timeframe within which the breach must be remedied (this time frame will be what the franchisor considers to be a reasonable time for remedy); or

(b) the franchisee no longer holds a licence that a franchisee must hold to carry on the franchised business; or

(d) the franchisee is convicted of a serious offence, which is defined in the Code; or (e) the franchisee voluntarily abandons the franchised business or the franchise relationship; or

(f) the franchisee operates the franchised business in a way that endangers public health and safety; or

(g) the franchisee is fraudulent in connection with the operation of the franchised business; or

(h) the franchisee agrees to termination of the franchise agreement.

Pursuant to the Code, the franchisor may terminate the franchise agreement immediately and without any prior notice in the circumstances set out in paragraphs (b) to (h) above.

Franchisees should note that some franchise agreements contain provisions by which the franchisee agrees on circumstances that would entitle the franchisor to terminate the franchise agreement immediately. Franchisees should review the proposed franchise agreement carefully prior to signing it and obtain proper legal advice in relation to the circumstances that will entitle the franchisor to terminate the franchise agreement.

What actions are available to franchisees if a franchisor engages in misleading or deceptive practices in connection with the offer and sale of franchises?

If the franchisor engages in misleading or deceptive practices, the franchisee may seek remedies under Schedule 2 of the Competition and Consumer Act 2010 (Cth) (“CCA”), known as the Australian Consumer Law (“ACL”) and generally under the CCA itself. These remedies are found under the prohibition on misleading and deceptive conduct provisions of the ACL and also at common law on ground of misrepresentation. The remedies available under the ACL and CCA include, but are not limited to:

(a) the franchise agreement being declared void and the franchisor having to refund all funds paid by the franchisee;

(b) damages;

(d) in certain circumstances, declarations of certain matters by the franchisor.

If a breach of the CCA is involved, franchisees may also seek the intervention of the ACCC.

The ACCC may seek the following:

(a) a redress order (other than for damages) in favour of the franchisee(s);

(b) non-punitive orders, e.g. community service, establishment of a compliance program, establishment of a training program and engaging in corrective advertising, etc.;

(d) an order disqualifying a person (director or directors of the franchisor) from managing a corporation.

Franchisees should note that the ACCC is selective in which matters it pursues based on public interest and also based on the evidence available in relation to the allegations of the franchisor’s misdemeanours.

On the other hand, at common law a right to terminate the franchise agreement may exist where a party has entered into a franchise agreement as a result of an inducement by a franchisor making a false representation.

If the franchisor is found to have misrepresented information to the franchisee by the court, depending on the circumstances of the case, the court may award the franchisee damages.

Franchisees should bear in mind that proving misleading and deceptive conduct and misrepresentation is not an easy task and requires solid evidence against the franchisor. Therefore, franchisees should keep accurate file notes of all conversations with the franchisor and confirm all things, in writing, to be able to produce such records in the future, if required.

Located in Melbourne’s industrial heartland, Mason Sier Turnbull has strong commercial law skills and prides itself on providing clients with great service and sensible solutions.

Jane Garber is a Senior Associate at Mason Sier Turnbull.

Contact Jane on:

Phone: 03 8540 0271
Email: jane.garber@mst.com.au
Web: www.mst.com.au