Franchising 2015: A Year in Review
This article appears in the Jan/Feb 2016 issue of Business Franchise Australia & New Zealand
2015 was a big year in franchising. It was a year of transition and a year of activity. The new Franchising Code of Conduct (“the Code”) took effect from 1 January 2015, however, most franchisors were not required to update their Disclosure Documents to reflect the format set out in the new Code until 31 October 2015.
Just as the franchising industry wraps up the transition to the new Code, the landscape is poised for further change, with laws extending unfair contracts protections to small businesses being passed on 20 October 2015 and expected to take effect from November 2016.
In addition to a number of court cases which have been decided throughout 2015, allegations of employee underpayment within certain franchise networks garnered significant media attention. These types of cases emphasise that the regulatory framework governing franchising extends beyond the Code.
This article provides a brief overview of the developments in franchising regulation that have taken place throughout 2015 and draws on a number of recent disputes and court decisions, extracting key insights for franchisees.
THE NEW FRANCHISING CODE OF CONDUCT
The new Code took effect from 1 January 2015, offering greater protections to franchisees, and rendering certain clauses in franchise agreements unenforceable, for example:
• franchise agreements must not contain a clause requiring mediation or legal proceedings to be conducted outside the State or Territory in which the franchised business is located;
• franchise agreements must not contain a clause requiring a franchisee to pay the franchisor’s cost in relation to settling a dispute;
• restraint of trade clauses are now unenforceable by the franchisor in certain (albeit limited) circumstances.
Of major significance was the introduction of civil penalties and/or infringement notices for breaches of the Code, allowing the Australian Competition and Consumer Commission (“ACCC”) to either issue infringement notices to corporations of up to 50 penalty units (currently $9,000) or seek court ordered penalties for corporations of up to 300 penalty units (currently $54,000).
THE NEW UNFAIR CONTRACTS REGIME
Currently, the Australian Consumer Law contains provisions which protect individual consumers from unfair contract terms in a standard form contract. The new laws extending these protections to small businesses which will come into force around November 2016 acknowledge that small businesses, like individual consumers, are vulnerable to unfair terms in standard form contracts and will give courts the ability to declare terms contained in standard form contracts between businesses void, if they are deemed unfair.
When in force, these laws will extend to unfair terms in franchise agreements if the following requirements are met:
• the contract is a standard form;
• the contract is a small business contract; and
• the term in the contract is unfair.
There are tests to be applied to determine whether each of the above elements exists.
For example, a contract will be a small business contract if:
• at the time of entering the contract, at least one party to the franchise agreement is a business which employs fewer than 20 people; and
• either the contract is for a term of 12 months or less and the upfront price payable under the contract is less than $300,000 or the contract has a duration of more than 12 months and the upfront price payable under the contract does not exceed $1,000,000.
It is likely that the majority of franchise agreements (entered into after the laws take effect) will be considered standard form small business contracts. Whether or not the terms of a contract are unfair will depend on the particular circumstances of each contract.
FRANCHISING IN THE MEDIA
In July 2015, franchise network Grill’d attracted negative media attention after a former employee claimed she was sacked after questioning her rate of pay. The particular Grill’d franchisee operated under a registered workplace agreement approved under the ‘Workchoices’ era. In the event that a franchisee has a registered workplace agreement in place, the agreement’s conditions of employment prevail over the terms of a modern award, provided that employees are paid the modern award’s most current base rates of pay.
The Grill’d employee had initiated an application to the Fair Work Commission to terminate the Grill’d franchisee’s registered workplace agreement. The franchisee’s decision to dismiss the employee in such close proximity to her Fair Work Commission application raised questions regarding whether her dismissal was in breach of the general protections laws found in the Fair Work Act 2009.
Lessons to be learned
Even where a franchisee has in place a registered workplace agreement, the franchisee must ensure that actual wages paid to staff do not fall below base rates of pay provided for under relevant modern awards (as increased in line with FWC wage increases implemented on 1 July of each
year). Further, although a franchisee may not be in breach of its legal requirements, negative media attention and reputation damage may still ensue. Franchisees should seek independent advice and make a point of knowing their industrial relations obligations. Franchisees should not rely on the franchisor for this.
In August 2015, a joint investigation by Four Corners and Fairfax was aired on national television, alleging widespread and systematic wage exploitation of workers being carried out by 7-Eleven franchisees, including underpayments and doctoring of wages. It was alleged that 7-Eleven
was aware of the conduct and further, that franchisees could not viably run their stores due to the 7-Eleven franchising model’s inequitable distribution of profits.
In response to the crisis, 7-Eleven established an independent panel to review requests for back pay from current and former workers. Further, it announced that it would review and make changes to its current franchise business model. In September 2015, the Senate Committee held a special public hearing to examine the exploitation of workers at 7-Eleven, as part of an inquiry into Australia’s temporary work visa program. The scandal has seen founder and Chairman Russ Withers and chief executive Warren Wilmot resign, whilst class action looms.
Lessons to be learned
Before entering into a franchise agreement, franchisees should seek financial and/or business advice in order to prepare a business plan incorporating cash flow projections, which are sensitivity tested for a range of scenarios. Franchise specific information can be found in the franchisor’s disclosure document such as the rate of royalty payments and franchise fees, however franchisees should conduct their own due diligence as to the projected revenue and other expenses of the business.
Further, franchisees should consider whether the franchisor is actively carrying out audits of the franchise network and policing franchisee conduct to ensure that franchisees are operating in accordance with the manuals, keeping appropriate records and adhering to key regulatory requirements. As franchising heavily relies on the franchisor’s brand, the actions of even one or two franchisees can damage the franchise brand and the franchise network as a whole.
KEY CASES IN 2015
Coverall Cleaning Concepts
The ACCC had initiated legal proceedings against franchisor Coverall earlier in 2014, claiming that Coverall engaged in misleading conduct and breached the Code in relation to two of its franchisees. In January 2015, the Federal Court delivered its judgement, finding that Coverall had made representations to the franchisees that they would achieve specified earnings based on their investment in the franchised businesses. Coverall had also failed to pay the franchisees for work they had completed, in breach of the franchise agreements. The Court held that Coverall engaged in misleading conduct and breached the Code by providing earnings information that was not based on reasonable grounds. It further held that Coverall’s failure to pay the franchisees for work they had completed amounted to unconscionable conduct.
The Court ordered Coverall to pay the franchisees compensation totalling approximately $22,000 as well as their franchise fees and payment for work completed. In a further judgement, handed down on 23 March 2015, the Federal Court ordered Coverall to pay a financial penalty of $500,000.
Lessons to be learned
In handing down the financial penalties totalling $500,000 to Coverall, the Court noted that the “structurally unequal relationship between franchisees and franchisors” meant that a large financial penalty was justified, in order to deter other franchisors from exploiting franchisee vulnerability by acting unconscionably or providing misleading information as to profitability and risk.
The Coverall case demonstrates the court’s willingness to issue large penalties in order to deter franchisor misconduct.
In the case of Marmax Investments Pty Ltd v RPR Maintenance Pty Ltd, the franchisor, Spanline Weatherstrong Building Systems Pty Ltd (“Spanline”) and the franchisee, RPR Maintenance Pty Ltd (“RPR”) were parties to a franchise agreement which granted RPR an exclusive territory. Marmax
Investments Pty Ltd (“Marmax”), also a franchisee of Spanline, operated in the territory adjacent to RPR’s territory. RPR commenced legal proceedings against Spanline and Marmax in June 2012, claiming that Marmax had encroached on its territory by servicing customers residing within RPR’s territory, and that Spanline had breached the franchise agreement by not taking appropriate action to prevent Marmax from operating in RPR’s territory.
RPR was initially successful at trial against both Spanline and Marmax. The trial judge held that Spanline breached RPR’s franchise agreement by not ensuring that RPR’s franchise was exclusive and by failing to take reasonable and available steps to ensure that Marmax did not service customers in RPR’s territory.
However, on appeal in 2015, the Full Federal Court found that although Spanline was prohibited from operating the franchised business or granting further franchised businesses within RPR’s exclusive territory, in the absence of direct requirements in the franchise agreement, Spanline was not obliged to take any positive action preventing other franchisees from encroaching RPR’s exclusive territory.
Lessons to be learned
This case highlights that prospective franchisees should review the territory provisions in the franchise agreement carefully to determine whether the rights are exclusive or not, and if they are exclusive, to determine whether the franchisor has an express obligation to take action against those who infringe upon the franchisee’s exclusive territory. Though a franchisee may have contractual rights to an exclusive territory, this case, which was initiated by the franchisee in 2012, demonstrates that enforcing those rights can be costly and time consuming.
WHAT DOES 2016 HAVE IN STORE FOR FRANCHISING?
As the transition period to comply with the new Code has come to an end for many franchisors, the ACCC have confirmed that they will be conducting more franchisor checks across states and territories. With civil penalties and infringement notices now available in their enforcement toolkit, the ACCC may be looking to exercise these powers in the event that franchisors are found to be in breach of the Code.
It is expected that in the franchising sector there will be a continued focus on compliance with industrial relations obligations. Even if franchisors are not actively driving industrial relations compliance, franchisees should undertake regular reviews to ensure they are complying with applicable laws.
Finally, the new unfair contracts regime may see franchisors review their franchise agreements to ensure that vital terms of the franchise agreement are not at risk of being deemed unfair. Existing franchisees may find franchisors refrain from enforcing certain provisions and make amendments to franchise agreements when the time comes to renew.
MST Lawyers has over 25 years’ experience in franchising, representing clients throughout Australia and internationally in a variety of industries. MST Lawyers can assist you in reviewing your franchise agreement documentation in anticipation of these changes to unfair contract terms legislation.
Written by Raynia Theodore and Marian Ngo in the Corporate Advisory and Franchising Team at MST Lawyers.
Please contact the Franchising Team for assistance or further information.