This article appeared in Issue 3#3 (March/April 2009) of Business Franchise Australia & New Zealand
WHAT ARE THE KEY AREAS OF A LEASE AGREEMENT THAT A FRANCHISEE SHOULD PAY PARTICULAR ATTENTION TO?
The success of a retail franchise is inextricably linked to the success of the lease arrangement.
The Retail Leases Act 1994 (NSW) (the “Act”) and similar legislation in other states governs retail leases for franchises, granting valuable rights to you as a lessee and imposing various obligations on the lessor. These obligations apply before the lease is entered into and during the lease term.
The Act requires your landlord to make a draft lease available for your inspection before you are offered a lease. As negotiations are being entered into, each prospective lessee must be provided with a copy of the retail tenancy guide which explains your rights as a lessee.
The landlord must also provide you with a disclosure statement at least seven days before you enter the lease or occupy the premises. The disclosure statement summarises the lease terms and sets out other relevant information about the premises. Importantly, the disclosure statement will provide an estimate and a break down of the ‘outgoings’ you must pay under the lease. If the landlord fails to give you a disclosure statement within this time, you may be able to terminate the lease at any time within the first six months. Additionally, if you find that the disclosure statement failed to mention important issues or if it was in some way defective, you may be entitled to seek compensation from the landlord.
The lease term, including any option to renew, must be for a minimum of five years unless a solicitor has issued a certificate under s16(3) of the Act. If there is no such certificate, the lease term is automatically increased to five years. The Act also restricts the method of rent review in that the lease may not have terms preventing the rent from decreasing. The lease also cannot prescribe that you pay the higher of two alternate methods of rent review.
In NSW the landlord cannot pass on to a lessee the costs of preparing the lease. There are certain exceptions to this. For example, landlords may pass on the ‘reasonable’ legal costs for amending the lease at the lessee’s request, after the lessee has given a copy of its disclosure statement to the lessor.
As the lease is a legally binding contract which imposes significant obligations upon the lessee, the lessee must examine the document carefully, understand the terms and conditions and consult a lawyer for advice. Entering into a lease agreement that has unfavourable terms may have significant ramifications throughout the term of the lease, affecting the success of the franchise business. For instance, it is critical for all prospective and existing franchisees to ensure that matters such as the term of the lease are adequately dealt with prior to any negotiations being finalised and to ensure that any conditions relating to the lease are adequately dealt with in the contract for sale.
WHAT ACTION SHOULD YOU TAKE?
- confirm that the permitted use of the premises corresponds with your intentions for use of the premises;
- ensure the lease term and an option to renew coincide with the terms of your franchise; for example, it is unwise to enter into a three-year lease if you are entering into a five-year franchise agreement, and in our experience many shopping centre leases do not provide for an option to renew, creating significant problems at the end of the lease term;
- check if the lease is assignable in the future, as you may wish to sell your business before the lease term expires;
- verify the total payments under the lease, and you should carefully consider whether your business will be able to afford those payments, both now and in the future;
- consider the amount of rent payable and understand the timing and calculation of rent increases; you should also ascertain the amounts of any additional payments required such as insurance, maintenance, marketing fees, fit-out costs and outgoings, or shared operating expenses as outlined in the disclosure statement; and
- guarantee that all representations made to you by the landlord have been reflected in the terms of the lease.
THE FINAL CHECK:
After all of the above, it is advisable that before you sign the lease you do a final confirmation with your franchisor to ensure that there is nothing in the lease terms which would contravene your obligations under the franchise agreement.
Contact Justin Ireland at justin.ireland@dcstrategy.com
What are the consequences for a Franchisor that fails to provide complete disclosure in its disclosure document?
Section 6B of the Franchising Code of Conduct (Code) provides that a franchisor must give a current disclosure document to a prospective franchisee or a franchisee proposing to either renew a franchise agreement or extend the scope or term of a franchise agreement. Failure to comply with this provision (and any other provision of the Code) constitutes a breach of the Trade Practices Act 1974 (Cth) (Act). However, what if:
- a franchisor provides a disclosure document to a franchisee or prospective franchisee; and
- the franchisor has put down some information in each section of the disclosure document; and
- the franchisee relies on the information contained in the disclosure document to enter into the franchise agreement with the franchisor; and
- after entering into the franchise agreement with the franchisor, the franchisee discovers that, at the time the franchisor provided the disclosure document to the franchisee, the franchisor failed to make a full disclosure in the disclosure document of the relevant fact or issue that has now come into contention?
There are a number of answers to this scenario depending on the particulars of the situation.
1. Failure by the franchisor to disclose a materially relevant fact.
If the franchisor has failed to disclose a materially relevant fact, such as the change in majority ownership or control of the franchisor, the franchisor will have breached the Code and therefore be in breach of the Act.
2. Failure by the franchisor to disclose a fact that is not a materially relevant fact and the franchisor has no knowledge of the omission.
Despite the franchisor not knowing that it has omitted certain information from its disclosure document, it may still have engaged in misleading or deceptive conduct, which is prohibited under the Act. This is because the courts have determined that instances of misleading or deceptive conduct occur when a representation is found to have conveyed a meaning that is false. This means that a franchisor may be in breach of the Act despite making representations to one of its franchisees in its disclosure document that it believed to be honest, innocent and without any intention to mislead or deceive at the time it was made.
3. Failure by the franchisor to disclose a fact that is not a materially relevant fact and the franchisor has actual knowledge of the omission.
Where there is evidence that the franchisor had the intention to deceive the franchisee or of the franchisor’s recklessness, the courts will more easily decide that the franchisor has breached the Act than if the franchisor had no intention to mislead or deceive the franchisee.
A franchisee that successfully proves that its franchisor has breached the Code or the Act will be able to seek the remedies available under the Act.
Since its commencement in July 1998, the Code has sought to regulate the conduct of franchise participants and ensure that franchisees are provided with sufficient information to make an informed decision about the franchise. Recent changes introduced in March 2008 increased, among other things, the disclosure obligations on franchisors. Further increases in the obligations on franchisors have been proposed including the inclusion in the Code of a clause relating to good faith. In light of this proposed change and the changes that have already been made, prudent franchisors will take every caution to ensure the accuracy of the information provided in their disclosure documents.
Contact Nicolas Jeha at nicolas.jeha@dcstrategy.com
What does it mean to have a duty of good faith and is a franchisor obliged to act in good faith with respect to its franchisees?
The duty of good faith is a core concept in contract law. It is a duty implied in contracts that parties must use their best endeavours to give effect to the terms of their contract and must not do anything which is deemed to be contrary to the agreement.
There has been plenty of discussion in the franchise sector as to whether the Franchising Code of Conduct needs to incorporate an express duty of good faith on the parties to a franchise agreement. A recent South Australian government inquiry, together with a number of recent disputes between franchisors and franchisees, a number of which have involved alleged misrepresentations about earning forecasts, have highlighted the need to clarify the law surrounding good faith.
An example of this is a case which the ACCC commenced in July 2008 where the ACCC in the Federal Court in Brisbane initiated an action against Seal-A-Fridge Pty Ltd and its director. In Seal-A-Fridge, the franchisor increased the fees associated with their national telephone number without discussion or agreement with its franchisees. This was contrary to the franchise agreement. Furthermore, the franchisor disconnected non-complying franchisees from the telephone number in the event they did not pay the increased fees. Finally, the franchisor was also found to have failed to comply with disclosure requirements under the Code and found to have unreasonably withheld consent for transfers of franchise agreements in contravention of the Code. There was also a question as to whether this constituted a breach of the Trade Practices Act in relation to misleading and deceptive conduct.
The findings made were at their core an upholding of the concept of good faith. If a franchisor misleads a franchisee, acts against the “spirit” of a franchise agreement or otherwise engages in practices which deprives a franchisee of its rights or commercial viability, the duty of good faith becomes relevant. It has been shown time and time again that courts are willing to find in favour of franchisees if it is deemed that a franchisor has not acted in good faith.
Bearing this in mind, those against the express provision for a duty of good faith in the Code are of the opinion that the articulation of such a duty will only create more uncertainty as to its operation. They maintain that the good faith argument is still available at common law which can prevent franchisors from working actively against the interests of their franchise network.
The bottom line is that although not expressly provided for in the Code, there does exist an implied duty between franchisee and franchisor which precludes either party from engaging in practices that affect each other on a commercial or legal basis.
Contact Gaurav de Fontgalland at gaurav.defontgalland@dcstrategy.com