FRANCHISOR DISCLOSURE – HERE’S WHAT YOU NEED TO KNOW

 

It’s critical for a franchisee to do some due diligence before signing a franchise agreement.

 

 

This includes reviewing the mandatory information a franchisor must provide to a prospective franchisee under the Franchising Code of Conduct, which is the key piece of legislation governing the arrangements between parties to a franchise agreement.

 

As a result of recent changes to disclosure obligations under the Code (2021), even more information must now be provided to a franchisee up-front. 

 

The amount of information a franchisee receives is overwhelming for many.  Here is a guide for what to look out for when navigating your way through the paperwork leading up to the important moment of signing a franchise agreement.

 

Disclosure period

 

The disclosure document is designed to help a franchisee make a reasonably informed decision about the franchise and must be provided  to a franchisee at least 14 days before a franchise agreement is entered into.  The period between receiving that document and signing the franchise agreement is referred to as the disclosure period.

 

That 14 day disclosure period is a good time to seek advice from a lawyer before finally committing by signing the franchise agreement.  

 

What information is disclosed 

 

The disclosure document must be in the form prescribed by the Code and must contain information about various things, including:

 

  • the franchisor (including involvement in any disputes), the franchise system and current franchisees;
  • proposed arrangements for the supply of goods and services to and by the franchisee, including increased disclosure about rebates payable to the franchisor;
  • estimated payments for establishing and operating the business;
  • details about the marketing fund (if applicable).

 

What documents accompany the disclosure document?

 

The disclosure document must be accompanied by a copy of the Code and a copy of the franchise agreement in the completed form in which it is to be executed (not just a template).

Since the 2021 changes, the disclosure document must now also be accompanied by additional documents including:

  • key facts sheet – the key facts sheet is a new short form document which provides a snapshot of some of the key information contained in the disclosure document;

 

  • headlease documents – a copy of the lease of the premises held by the franchisor must be provided if the franchisor proposes to sublease the premises to the franchisee;

  • earnings information if the franchisor has given, or proposes to give, earnings information (such as historical or projected earnings data) then it must be provided to the franchisee with the disclosure document;


  • significant capital expenditure – additional information must be disclosed about any ”significant capital expenditure” that might be incurred by the franchisee.

 

What should a prospective franchisee be concerned about?

 

Aspects of a franchise arrangement that often lead to concerns or disputes include matters related to the marketing fund, significant capital expenditure and termination rights/end of term arrangements, which are described below.

  • Marketing funds

 

A marketing fund may be established by a franchisor to collect funds for marketing or promotional activities for the franchise network.  Franchisees contribute to the fund and a franchisor must also contribute to the fund for each of its company-owned stores on the same basis as a franchisee.  

 

A franchisor must prepare an annual financial statement in relation to the fund, which must be included in the disclosure document (as well as shared with franchisees already in the franchise system).  The financial statement must include sufficient detail of the fund’s receipts and expenses so as to give meaningful information about sources of income and items of expenditure. 

 

The amount of detail required to be included in the financial statement was confirmed in a seminal 2019 case, in which ACCC took action against Ultra Tune for various breaches of the Code. 

 

The case now serves as a useful handbook for franchisors when completing their marketing fund financial statement. Bare financial statements are not sufficient. For example, including one line of “television advertising” would not be enough to inform a franchisee about where the advertising took place and when.

  • Significant capital expenditure

 

The recent changes to the Code require franchisors to disclose additional details about significant capital expenditure that may be incurred by a franchisee during the term of the franchise agreement.

 

“Significant capital expenditure” is not defined but could include, for example, upgrades to facilities or premises or major changes to the brand and image of the franchise.

 

The disclosure document must include details about the amount, timing, nature and rationale for the expenditure, as well as anticipated benefits and risks. 

 

The franchisor must also have a discussion with the franchisee about the expenditure including the circumstances under which the franchisee may recoup the expenditure.

  • Termination rights and end of term arrangements 

 

What happens when the term of the franchise agreement comes to an end?

 

The disclosure document must include details about the term of the franchise agreement and whether there are options to renew or extend the franchise agreement.

 

Generally, at the end of the term of a franchise agreement, the franchisee does not have a right to sell the business, will not have any entitlement to an “exit payment” or a payment for “goodwill” and this must be disclosed in the disclosure document so a franchisee knows what to expect. 

 

The Code now requires the disclosure document to include a summary of the rights of each of the franchisor and the franchisee to terminate the franchise agreement before it expires.  Generally, the franchisee only has a right to terminate during the 14 day cooling-off period.

 

The new amendments in practice

 

A franchisor in breach of its disclosure obligations risks attracting a financial penalty under the Code (up to $133,200 for a breach of a civil penalty provision and potentially up to $10M for breach of the continuous disclosure obligations under section 17 of the Code).  

 

There are also risks of a claim by a franchisee (such as for misrepresentation) and brand damage. 

The recent Code changes have increased transparency on matters such as supplier or leasing rebates or financial benefits, which previously were not required to be disclosed. 

Later this year, a new franchise disclosure register will be established and franchisors will need to upload certain information about their franchise system, which will be publicly available online.  This may assist franchisees to compare different franchise offerings, including ahead of receiving documents from a franchiser.

It can be daunting for a franchisee to navigate through the paperwork, so seeking the advice of an experienced franchise lawyer is recommended. 

 

 

 

About the author

Seva Surmei is a principal in the transactions team at DMAW Lawyers, which is a leading commercial law firm providing services throughout Australia.

Seva specialises in franchising, licensing and distribution.  She acts for major franchisors in the establishment, development and operation of franchise systems including advising on compliance with the Code.

Seva is a committee member and secretary of the Franchise Council of Australia, a committee member of the Women in Franchising group and has recently been named as a leading lawyer in franchise law by Best Lawyers (2021 and 2022 editions) and franchise lawyer of the year Adelaide (Best Lawyers 2022 edition).

 https://dmawlawyers.com.au/team/seva-surmei/

Contact

Ph: 0421 931 777

Email: ssurmei@dmawlawyers.com.auDMAW – https://dmawlawyers.com.au/