With hefty fines coming into effect later this year for unfair contract terms in standard form contracts, franchisors are being warned to review the terms of their franchise agreements.
The Competition and Consumer Act was amended in November 2022 to introduce penalties for unfair contract terms in standard form contracts. There is a 12-month grace period for businesses to get their agreements in order. The changes will apply to standard form contracts entered into or renewed after the grace period.
In what will be the first-ever penalties for a breach of the unfair contract terms regime, companies could be ordered to pay in excess of $50 million per breach. The changes to the law are intended to protect consumers and small businesses against an imbalance in bargaining power, in particular ‘take it or leave it’ style clauses in contracts.
Even though there are usually legitimate reasons for a franchisor to retain a certain amount of control, it is worth taking the time to consider the fine print in the franchise agreement.
The test for unfairness for a contract term under the Australian Consumer Law is:
- it would cause a significant imbalance in the parties’ rights and obligations arising under the contract; and
- it is not reasonably necessary to protect the legitimate interests of the party who would be advantaged by the term; and
- it would cause detriment (whether financial or otherwise) to a party if it were to be applied or relied on.
Franchisors are not immune from these changes. It is likely that a franchise agreement will be considered a standard form contract because of the limited ability for a franchisee to negotiate the terms of the contract.
Unfair contract terms in a franchising agreement may include:
- Clauses which allow a franchisor to unilaterally vary the agreement.
- One-sided termination clauses for no cause.
- Broad indemnity clauses in favour of the franchisor.
- Broad limitation of liability clauses in favour of the franchisor.
- Penalty charges for breach or termination of the franchise agreement by a franchisee that don’t accurately reflect the franchisor’s loss.
- Restraint of trade clauses that go beyond protecting the legitimate business interests of the franchisor.
Hypothetical case study 1
Robert has a hairdressing franchise. The franchise agreement allows the franchisor to increase the royalty payable by the franchisee at any time during the term at the franchisor’s absolute discretion. Robert is not allowed to terminate the franchise agreement even if he does not agree to the increase.
The franchise agreement also states if Robert leaves the business at any time before the end of the negotiated term he must pay a termination fee of $500,000.
! These contract clauses would likely be considered unfair. This is because the first allows a unilateral variation to the franchise agreement and the second may be problematic if the termination fee is not a genuine pre-estimate of the franchisor’s loss.
Hypothetical case study 2
Anita has a dog grooming franchise. Her franchise agreement states the franchisor can terminate the franchise agreement at any time for no reason however Anita does not have the same right to terminate.
The franchise agreement also includes a restraint of trade clause which prevents Anita from operating a dog grooming franchise anywhere in Australia for 10 years after the term of the franchise agreement ends.
! These contract clauses would likely be considered unfair. This is because the first allows only the franchisor (but not the franchisee) to terminate for no reason and the second is a restraint clause that is likely to be broader than reasonably necessary to protect the franchisor’s interests.
It is vital that franchisors act swiftly to ensure their franchise agreements are in order before the grace period ends.
In reviewing certain clauses franchisors should consider the following:
- What purpose does this clause serve?
- Does this clause create a power imbalance? If so, can it be changed?
- Would the franchisee be concerned about this clause?
- Is the clause reasonably necessary to protect the franchisor’s legitimate interests?
Franchise agreements are typically weighted in favour of the franchisor and allow certain flexibility for changes to be made, particularly by way of changes to the operations manual. This is often necessary so that the franchisor can retain control of their brand, reputation and business model and for the franchise system to remain dynamic and adaptable. In many cases, there may be legitimate reasons for certain clauses to be retained in a franchise agreement but there may be room for a more balanced approach to be taken.
Of course, there is also an obligation under the Franchising Code of Conduct for both parties to act in good faith in their dealings with one another.
Franchisors should seek professional legal advice about how the unfair contract terms regime may impact their business and what changes can be made now.
