Legal Advice - How Do The Code Changes Affect You?

By John Sier, Principal, Mason Sier Turnbull

In response to recent parliamentary inquiries, amendments to the Franchising Code of Conduct (Code) were enacted and now apply to all franchise agreements entered into on or after 1 July 2010. Since the announcement, most of the discussion has focussed on how the amendments affect franchisors and their disclosure obligations.

This article will focus on the implications of the Code changes for franchisees and prospective franchisees. As someone considering entering into a franchise agreement or as an existing franchisee, the changes to the Code mean that you are entitled to answers to following questions.

Is the franchisor able to change my franchise agreement unilaterally?

The franchisor cannot change the actual wording of your franchise agreement without your agreement. However, concern about other ways in which franchisors are able to change the terms of the agreement without your consent has led to one of the recent changes to the Code.

The Code now requires franchisors to disclose the circumstances in which they may be able to make unilateral changes in the future. For example, most franchise agreements require franchisees to comply with an operations manual and state that the operations manual may be changed by the franchisor. By amending the operations manual, the franchisor may be able to change any part of the system including the intellectual property, the branding, the authorised products and services, minimum performance requirements and marketing requirements.

Other examples include:

  • If you exercise your option for a new term, a requirement may be for you to enter into a franchise agreement for the further term that may have different terms, even different financial terms.
  • On sale of your business, the purchaser may be required to enter into a franchise agreement with different terms, including different, more onerous financial terms, thereby potentially devaluing your business.

The Code now requires franchisors to keep records from 1 July 2010 of all such unilateral changes made to the franchise agreement (and manuals) and such changes will need to be disclosed in all disclosure documents issued after 1 July 2011. From 1 July 2013, franchisors will be required to disclose the prior three years of unilateral changes.

This may prove to be an onerous task for some large franchisors. However, it may provide valuable information for franchisees by giving an insight into the types of changes that have been made in the past and give clear disclosure about the types of changes which franchisors have the ability to make in the future. 

What are the costs I might incur when operating the franchise?

The Code now requires franchisors to disclose all recurring or isolated payments that are within the knowledge or control of the franchisor or are reasonably foreseeable by the franchisor, that may be payable by the franchisee to a person other than the franchisor. In short, this includes all costs and expenses that may be payable by a franchisee in operating their business.

This is a potentially onerous task for franchisors, because all such estimates or ranges of estimates must be based on reasonable grounds, or else they could be misleading.

However, such information may provide a valuable starting point to guide franchisees or prospective franchisees when constructing their budgets and business plans, particularly ones who have never operated their own businesses before. However, prospective franchisees should treat such estimates as a starting point only, and not rely on such figures as being an exhaustive list of the types of expenses, nor an accurate representation of the extent of such expenses. It is vital that all prospective franchisees investigate and make their own assessment (with the help of their advisers) as to their likely expenses of operating the business. 

Is there any significant capital expenditure that I could incur during the term that I might not know about when I sign a franchise agreement?

The franchisor is now required to disclose that a franchisee may be required, pursuant to the terms of the franchise agreement or operations manual, to undertake unforeseen significant capital expenditure that was not disclosed by the franchisor before the franchisee entered into the franchise agreement. Depending on the type of franchise, there are numerous types of significant capital expenditure that might be unforeseen by the franchisee at the time the franchise agreement is signed. For example, refurbishment of a premises required by either the franchisor or the landlord on renewal or before sale; the fitting out of a new premises after a relocation required by a landlord; a new fitout and new signage after a change to the brand, image or ‘get up’ required by the franchisor; equipment repairs or replacement including computer hardware, software and point of sale systems and vehicles. The Code does not require franchisors to give estimates of the expenses, only to disclose the reasons or triggers that may cause capital expenditure to be incurred. All franchisees need to be mindful of these areas of potential capital expenditure and attempt to plan and budget for them as best they can.

Does the marketing fund need to be audited?

The Code provides that the annual financial statement of a marketing fund must be audited unless 75 per cent of the franchisees who contribute to the fund vote to agree that it need not be audited. The changes to the Code have now clarified that such an agreement will apply for three years. After the expiry of the three years, the requirement to have the marketing fund audited will apply again, unless there is a further vote of the franchisees to agree otherwise. A prospective franchisee may wish to find out whether there is any agreement in place that the annual financial statement of the marketing fund need not be audited and when such agreement is due to lapse. Even if there is agreement not to have the financial statement audited, franchisors are still required to prepare annual financial statements for marketing funds and to provide such statements to all franchisees within 30 days of preparation.

Does the Code require parties to act in good faith?

The Code, in itself, does not require parties to act in good faith. However, an amendment to the Code made it clear that the Code does not limit any of the obligations on parties to a franchise agreement that are already imposed under the common law, to act honestly and fairly with each other.

What standards of behaviour are acceptable during mediation? Who pays for the costs of mediation? If there is a dispute, can the franchisor make me pay their costs?

The amendments to the Code require parties to approach the resolution of a dispute in a reconciliatory manner by, for example, attending and participating in meetings, at the beginning of the mediation process, being clear about what they seek to achieve, observing confidentiality obligations during and after the mediation and not taking action or refusing to take action during the dispute by refusing to provide or providing inferior goods, services, or support which has the effect of damaging the reputation of the franchise system. In relation to costs, unless the parties agree otherwise (including in the franchise agreement) the ‘costs of the mediation’ will be shared equally by the parties to the mediation. ‘Costs of the mediation’ are defined as the cost of the mediator, the cost of room hire and the cost of any additional input (including expert reports) agreed by both parties to be necessary to the conduct of the mediation.

The Code now requires that the disclosure document state whether the franchisor will attribute the franchisor’s costs, including legal costs, incurred in dispute resolution, to the franchisee. Typically, franchise agreements require franchisees to pay for the franchisor’s costs incurred in connection with a franchisee’s breach or termination of the franchise agreement. Such requirements should be specified in the disclosure document. In the case of litigation, a court may determine whether one party’s legal costs are to be paid by the other.

What happens at the end of the term of my franchise agreement?

The Code now requires franchisors to disclose their processes at the end of term of the franchise agreement. For example, whether there will be an option for renewal and what conditions will apply, whether there will be a right to sell the business at the end of the term, whether the franchisor has a right to purchase the business and the basis upon which it will be valued, whether the franchisee will be entitled to any exit payment and whether any significant capital expenditure will be taken into account in determining the end of term arrangements.

In further changes to the Code, at least six months prior to the end of the term of the franchise agreement (or one month before if the term is less than six months), franchisors are now required to provide written notice to franchisees stating whether they intend to renew the franchise agreement for a further term or not. Such a notice may be conditional upon the franchisee validly exercising its option to renew and otherwise complying with the terms of the franchise agreement. The requirement to give this notice applies independent of any requirement for franchisees to exercise their option for renewal. The wording of the amendments to the Code suggest that the requirement to give the notice only applies to franchise agreements entered into after 1 July 2010, but it is recommended that franchisors aspiring to best practice should comply in relation to all franchise agreements irrespective of their commencement date. In summary, the benefit to franchisees resulting from the changes to the Code is increased disclosure. This should clarify some of the fundamental matters that have been the source of some conflict and confusion in the past. However, despite the increased disclosure, legal and accounting advice should always be sought from advisers who are experienced in franchising, prior to entering into a franchise agreement..

The author John Sier, thanks Louise

Wolf, Associate of Mason Sier Turnbull

for her contribution to this article.

Daniel Marks, Principal

Mason Sier Turnbull Lawyers

1300 MST LAW

www.mst.com.au.