The perils and pitfalls of issuing your own franchise documents
Some franchisors slip into the habit of issuing their own franchise documents internally and do not use a lawyer to issue a range of legally binding agreements. They may have initially engaged a law firm to develop the franchise documents but then they prepare, issue and arrange for signing themselves as they continue to grant franchises, sign leases, issue licenses to occupy and the like.
Why some franchisors issue their own agreements
This practice is more prevalent where the franchise fee and entry point is low – for example home-based or mobile franchises often under $100K. It appears some franchisors are concerned that the additional cost of engaging an external law firm for this ‘administrative’ task may be an impediment to recruitment. Although the franchisor can and generally does pass this cost on to the franchisee, they may still consider the added cost could jeopardise the deal. Is this a good idea? The obvious answer coming from a law firm is ‘no’ – but not for the selfinterested ‘give us work’ reasons you may assume.
Twenty percent of documents not executed correctly
When our firm conducted an internal survey we discovered that approximately 20 per cent of all documents left to clients to execute themselves (without guidance or supervision from a lawyer) were not executed correctly – even when ‘sign here’ stickers were provided in the documents! In client’s archive records were documents that we either needed to send back to be re-executed or we had to obtain an authorisation to complete. In most instances ‘part performance’ cured the defect, but this still indicates the difficulties in properly executing legal documents.
Most frequent errors were:
• Leaving commencement dates or dates of agreement incomplete;
• Not having two directors sign when the company had more than one director;
• Not having guarantor sections witnessed, or having the guarantor sign in the ‘witness’ section;
• Having the guarantor not sign the guarantee section on the assumption that signing as a director means that person has signed the document; • Missing signatures on a page (such as a guarantor annexure or a certificate of independent legal advice);
• Not initialling annexures or appendices; and
• Documents signed by counterpart not matching (ie. an earlier version being signed by one party).
What’s the risk?
If these errors occurred in a lease, most of them would be picked up (in registration states) by the registration authority when registration is attempted, and the documents would then be returned for re-execution (as many lessors and lessees have found out).
However if there is no external review of legal documents and the documents are executed internally without any supervision from an external or in-house lawyer, the chances of these kinds of errors being left undetected and corrected are very high, especially where no registration is required (such as with franchise agreements and licenses to occupy).
On a number of occasions we have had franchisors who have prepared and issued their own documents come to us to enforce a franchise agreement or sub-lease or license to occupy. They then find that the guarantor has not signed the relevant section, or the franchisee has not signed the certificate of independent legal advice, or has not signed the disclosure document receipt page, or signed and dated the disclosure document at the same time as the franchise agreement.
All these errors compromise (sometimes fatally) the ability to recover monies and/or enforce the agreement in a Court. We had a particular instance where a ‘basic’ business sale agreement was drafted internally essentially for the purchase of some stock and an unregistered business name. The vendor then came to us saying their accountant noticed the business sale agreement did not state that the business was being sold as a ‘going concern’. The accountant advised they must now issue GST invoices for the transfer of stock – 18 months after the sale – and lodge a revised statement to the ATO. This would have resulted not only in payment of tax they had not factored into the cost but in serious penalties for late lodgment of tax, had we not negotiated a mutual acknowledgement from both parties Timothy Mak confirming that the business was sold on a going concern basis.
Given the complexity involved in extracting parties from the mess of misunderstanding and confusion that can arise from such situations, it is simply common sense to leave the preparation and scrutiny of all legal documents to those who have a professional responsibility to ensure this is done correctly. And if they do not, have a legal liability attached to their failure to perform. As a law firm, we are required to have professional indemnity insurance and ensure – as a matter of professional service – that legal documents are legally enforceable and correctly executed.
For this reason alone, engaging a law firm is commercially prudent (whether or not it is our law firm that is engaged!). This applies even where the initial franchise fee is relatively small nd the franchises turn over frequently – because these are the cases where mistakes and oversights tend to occur most often. The relatively small cost (to the franchisee) of engaging lawyers to prepare legal documents is an investment in ensuring the documents are enforceable when you come to breaching or otherwise enforcing the agreement.
Other serious risks associated with issuing your own legal documents
In addition to this, two other factors make a compelling argument for the external preparation of franchise agreements. Frequent changes occur to the law which can impact on the franchise sector so franchise agreements can quickly go ‘stale’. Minor errors can easily creep in (such as old references to the Trade Practices Act when it has changed to the Competition and Consumer Act). These are trivial compared to the very significant issues that can arise from not having this important legal document as up to date as possible.
Much more serious examples in recent years include the introduction of the Personal Property Security Act and the impact this has had on the procedures relating to charges and other encumbrances franchisors may elect to secure under the franchise agreement. We still see some franchise documents currently being issued by franchisors referring to outdated concepts such as fixed and floating charges or retention of title clauses for supply of goods to franchisee - and have no mention of the new regime.
Often franchisors will seek professional advice when they hear that the Franchising Code of Conduct has been amended or updated – but they do not realise that other legislation (such as updates to the Privacy Act, or the Personal Property Securities Act, or the legislation relating to registration and cancellation of business names) can also have a significant effect on the franchise business and must be reflected in updates to the franchise agreements and other legal documentation.
For example, what appeared to be a relatively minor administrative change to the electronic system of registering and transferring business names with ASIC several years ago became a serious headache for franchisors who previously used hardcopy consent forms from franchisees to cancel or transfer business names. These forms are now useless. Some franchise agreements issued by franchisors still do not adequately deal with the new electronic system of registering and terminating business names.
So protect yourself and your business and lawyer up
Law firms have a professional responsibility to ensure legal documents issued by the firm are up to date and reflect the current laws relating to all aspects of your franchise agreements. After all, that is what they are in business to do. Finally, with the introduction in the new Franchising Code (January 2015) of infringement notices and penalties (up to $58,000 for pecuniary penalties), there is a real risk that relatively minor errors in franchise agreements and disclosure documents will draw the displeasure of the ACCC – a potentially costly event.
Ensuring your agreements are compliant with arange of legal acts and codes that pertain to theFrequentchan ges occ urto the law which can impact on the franchise sector so franchise agreements can quickly go ‘stale’. ”franchise sector is imperative to the successful growth of your business. And making certain their issuance and execution renders them effectiveand enforceable protects the enterprise value youare building, now and at some future exit point. A failure to do so may be uncovered in the due diligence a potential investor will conduct and can reduce the salability and value of your network.
Using a lawyer with franchise experience to manage your legal requirements is a simple, costeffective risk mitigation policy that will serve you now and in the future as it is certainly cheaper than either remedial work or litigation.
For franchise systems issuing their own franchise agreements, we have to ask a couple of simple questions:
• Are you really aware of the risks of what you are doing?
• Is it worth the hassle as the cost is borne by your franchisees and you both warrant good documents you can enforce?
• Is it worth the penalties, both legal and commercial if you get it wrong?
As Red Adair the renowned oil well firefighter famously said: “If you think it’s expensive to hire a professional to do the job, wait until you hire an amateur”.
Timothy Mak, Managing Partner of the legal team at DC Strategy brings diverse experience in franchise law from commerce and international finance to Global Counsel for several large international franchise networks to intellectual property.
For 30 years DC Strategy has been the region’s only end-to-end franchise consulting, legal, recruitment, brokerage, brand, marketing and technology firm. Franchise programs developed by their highly experienced specialist teams have built over $1.7 billion in enterprise value for their clients in the last decade alone.DCS have specialist franchise lawyers, franchise consultants and trademark lawyers looking after all your commercial, franchise legal and IP and franchisee recruitment and brokerage needs.