Questions & Answers - Issue 1#4

By HWL Lawyers

This article appeared in Issue 1#4 (May/June 2007)of Business Franchise Australia & New Zealand

Prospective franchisees should be careful when entering into franchise agreements. Such arrangements usually involve a significant commitment on both the franchisee and his or her family. There are often significant upfront fees and set up costs, and the arrangements are usually for a long period (commonly 5 years with a 5 year option although many are longer).

While operating a franchised business within a reputable franchise system is widely regarded as a safer option than setting up your own independent business, prospective franchisees must be careful to fully understand the concept, cost and the agreement terms. The deal should be properly explained to the franchisee by the franchisor and the terms of the franchise agreement should reflect the deal.

It is very important that prospective franchisees do their homework. Not only should they carefully review the terms of the franchise agreement they should also spend time reviewing and considering the information in the disclosure document.

They should check, inter alia, that:

  • they understand who the franchisor company is and who is behind that company;
  • the franchisor is empowered to licence the franchise rights to the prospective franchisee;
  • there are no court proceedings against the franchisor which may affect their decision to purchase the franchise;
  • there are not an unusual amount of exits from the franchise system by franchisees - through sales or terminations;
  • they understand the upfront and ongoing costs of establishing and operating the franchise; and
  • the franchisor is solvent.

Prospective franchisees should take the time to speak to other franchisees within the system. Franchisors are required to list who the current franchisees are together with their business telephone numbers. It is noted that this requirement may be expanded in recently proposed changes to the Franchising Code of Conduct in that franchisor may in the future be required to also list former franchisees of the system. It will be particularly important to contact these franchisees to understand why they left the system.

Finally you should get expert advice. Prospective franchisees should get expert advice from specialist legal, accounting and business advisers.

Q: The franchise agreement I received from the franchisor includes a power of attorney clause, whereby the franchisor is allowed to act on my behalf (as franchisee). Is this type of provision common? What action can the franchisor take on my behalf using the power of attorney?

Power of attorney clauses are frequently included in franchise agreements for the purposes of allowing the franchisor to act on behalf of the franchisee in relation to the franchised business.

The action permissible by a franchisor exercising a power of attorney may vary quite considerably. For example, the action may be limited to enforcing post termination obligations of the franchisee or may be much wider in that the franchisor can do all things and sign all documents to enforce all the terms of the franchise agreement or to operate the franchised business.

Powers of attorney are common clauses in such agreements. In order to be acted upon they will need to be first registered.

These scope of the power of attorney must be carefully considered as if it goes beyond what is reasonably necessary to protect the franchisors and hampers the independent operation of the franchised business then the conclusion and enforcement of such clauses may be unconscionable.

Whilst common, it is still important to review and consider power of attorney clauses due to their potential ramifications. In particular, the following two issues must be given attention: -

The scope of the clause

  • A broad power of attorney clause may leave the franchisee’s control of the franchise business severally limited and restricted.
  • Such clauses may be necessary to ensure that the franchisee undertakes all required action to protect the intellectual property or business of the franchisor, particularly upon termination.
  • Some power of attorney clause seeks to go further than this and to appoint the franchisor to do all things to ensure compliance with any of the obligations under the franchise agreement.
  • These may not be reasonably necessary and may give too much power to the franchisor.

Availability of the powers

The circumstances when the powers detailed under a power of attorney clause are available to a franchisor is also central to the clause’s operation. It is important that the agreement clearly state and identify the conditions necessary for the franchisor to exercise any of the powers detailed in a power of attorney clause. Often trigger events, based upon a breach or the expiration of the franchise agreement, are used as a point of reference.

Answered by: Elisabeth Ritchie, Sydney Office

Q: Prior to executing the franchise agreement, the Franchisor supplied me with documents regarding the sales/profitability of my retail store. In particular the documentation included figures relating to the stores ability to achieve financial targets and the financial performance of the franchise. Although the financial information given to me was very useful and part of the reason why I entered the franchise agreement, the franchise agreement has provisions excluding franchisor liability for any such representations?

Franchise agreements and disclosure documents frequently incorporate acknowledgments, exclusion clauses and disclaimers. All of these types of provisions have the purpose of protecting the franchisor from a later claim that it mislead and/or deceived the franchisee so as to enter into the franchise agreement. An example of such a provision is an acknowledgement in the franchise agreement that were no representations by the franchisor to induce the franchisee entering into the franchise agreement.

The Franchising Code of Conduct does not currently expressly prohibit disclaimer and exclusion clauses. The Government’s recommended changes toThe Code have, however, stated that further consideration will be given to amending the Code to prohibit the inclusion of general waivers of written representations in franchise agreements.

Notwithstanding efforts behind exclusion clauses and disclaimers, franchisors are still required to comply with the Trade Practices Act 1974 (the “Act”) which prohibits misleading and deceptive conduct. In ascertaining whether the franchisor engaged in conduct that was misleading or deceptive, the Court considers the conduct as a whole and whether the representation in question, including the disclaimer, is misleading or deceptive. The Court has further refined this test so that the perspective of a ‘reasonable person’ is adopted for the claimant, in this case it would be the franchisee who is alleging the breach of the Act.

Therefore to answer the example question, it would be necessary to obtain further details. Amongst other information, the following would need to be provided:

  • Did the financial documentation supplied by the franchisor to the franchisee have relevant disclaimers and acknowledgements regarding the franchisee’s reliance upon the financial figures supplied, the franchisee’s intention to take independent advice and the sample nature of the material?
  • Did the franchisee obtain independent legal, business and financial advice?
  • Was the franchisee sufficiently mature to understand the documents and the exclusion clauses?
  • Did the franchisee conduct vigorous investigations?

If the answer to all of the above questions is ‘yes’ and there are no other factual complications, then it is likely that a Court will find that a reasonable person in the position of the franchisee would not have been mislead or deceived. Consequently, the franchisor would be deemed not to have engaged in misleading or deceptive conduct under the Act.

The franchisee must be aware and advised of such acknowledgments since the franchisor (or a representative of the franchisor) may have given the franchisee information contravening these acknowledgements. If a representation was made to the franchisee in contradiction to the acknowledgements or disclaimers and the franchisee is relying upon such a statement then it is important that the parties resolve the inconsistent positions prior to entering into the franchise agreement.

Answered by: Aram Stepanian, Sydney Office

Q: I am considering purchasing a franchise business from an existing franchisee. How do I acquire the rights to carry on the franchise business?

There are generally two ways in which franchise rights can be transferred/issued where a franchise business is being purchased from an existing franchisee, being by way of assignment of the existing franchisee’s franchise agreement, or a fresh franchise agreement being granted by the franchisor to the purchasing franchisee.

Assignment - The vendor franchisee may assign its rights and interests under the Franchise Agreement to the purchasing franchisee. A Deed of Assignment is entered into by both the vendor and purchaser and the franchisor will need to confirm its consent to the assignment.

In the event of assignment the vendor franchisee should ensure that it is not responsible for the franchise business or the actions of the purchasing Franchisee after completion of the sale of the Business. Similarly, the purchasing franchisee should ensure that it does not inherit liability for any actions of the vendor franchisee that pre-date the assignment.

New Franchise Agreement – The purchasing franchisee enters into the then current form of Franchise Agreement directly with the franchisor. The vendor franchisee’s Franchise Agreement is terminated and the franchisor may require the vendor franchisee to enter into a Deed of Surrender and/or a Deed of Release (the two documents may be combined). The Deed of Surrender confirms the early termination of the Franchise Agreement and the Deed of Release releases either or both of the vendor franchisee and franchisor from any obligations and claims they may have against each other.

Commonly, a transfer of the existing franchisee’s franchise agreement will not require the purchasing franchisee to pay an initial fee in respect of the grant of the franchise, although the term of the Agreement will be for the remaining balance of the term of the existing franchisee’s franchise agreement.

Where a new franchise agreement is granted, the term may (not must) be a longer term than that remaining on the vendor franchisee’s agreement. In such event it is however usual than an initial fee in respect of the grant of the franchise is usually payable by the purchasing franchisee.

Answered by: Eric Louca, Sydney Office

Q: “Can a franchisor force a franchisee to sell its products or services at certain prices?”

It is vitally important for franchisors and franchisees to maintain ‘consistency’ between franchises. For many this includes retail prices. However, there is a general prohibition on fixing prices under the Trade Practices Act (TPA), that extends to the franchise relationship where the franchisor competes with some or all of its franchisees through a franchise operated business. The TPA also strictly prohibits franchisors from forcing franchisees to sell below a certain price.

Section 45A of the TPA specifically prohibits competitors from creating arrangements that attempt to control prices, and Section 48 of the TPA prohibits the specifying of a minimum price, or the price, below which the product or service must not be resold. Any breach of sections 45A or 48 are strictly prohibited.

The common view that franchisees in the same group are not considered to be competitors, is a misconception, as in reality they often are.

Provided there is appropriate care taken and the franchisees know that they set their own prices and that in no case do they have to comply with any statement by the franchisor as to minimum prices, franchisors are able to:

  • recommend prices for the products or services; and
  • specify maximum prices for the products or services.

Any recommendation of price or specifying of a maximum price must be clear that it does not attempt to fix the price of the good or service. Also, franchisors that supply to franchisees must be careful when specifying a maximum price, detailing any situation where the maximum price will not apply (e.g. the maximum price is less than the direct cost price). In some situations franchisors that have only supplied raw materials to franchisees may not be prohibited from specifying the price of the finished product, as the prohibition applies only to resale of the supplied goods and may not apply where the original goods have been transformed.

The Australian Competition and Consumer Commission (ACCC) takes any indication of price fixing and resale price maintenance very seriously, and in the last ACCC eJournal, 4 out of 9 new ACCC matters were price fixing or resale price maintenance. Therefore franchisors and franchisees should always be mindful of the laws surrounding pricing specific to their business and prepare a list of matters that they can and cannot do.

Answered by: Peter van Rompaey, Melbourne Office