Stricter disclosure requirements will be written into the Franchising Code of Conduct later this year in an effort to help prospective franchisees make more informed decisions before entering into
franchise agreements.
The changes follow the Federal Government's acceptance of 10 of the 15 recommendations made by the Matthews Committee which recently completed reviewing the operation of the code's disclosure provisions.
Although franchisors may wish to hire
franchise lawyers to begin modifying their disclosure documents and business practices to accommodate the proposed changes, there is no urgency to do so. The Matthews Committee recommended that sufficient time be allocated for franchisors to update their disclosure documents to enable them to meet the recommendations contained within the report. Changing franchising documentation is better left until the precise wording of the changes to the code and the unconscionable conduct provisions of the Trade Practices Act are available for scrutiny. Enabling legislation is expected to be introduced into parliament on 8 May 2007 and come into force several months later. This will give the franchising sector time to familiarise itself with the new requirements and give franchisors time to amend their disclosure documents and methods of doing business.
Under the proposed changes, some franchisors that were previously exempt from the code, will now need to comply with it.
The Franchise Council of Australia (FCA) has welcomed the Matthew Committee's findings. The Federal Minister for Small Business and Tourism, Fran Bailey, who called for the review because of "growing industry concerns on the disclosure of information" has said that the "reforms are about empowering people to make the right business decisions" but warned that "no risk can be completely eliminated".
1. Rebates
Perhaps the most contentious recommendation which the Government has accepted is that disclosure documents must disclose the amounts of (or the method of calculating) any rebates or other financial benefits that franchisors (or their associates) receive from the supply of goods or services to franchisees.
Some franchisors may be reluctant to provide this information, especially where they and their associated entities currently receive a second income stream from rebates in addition to the fees and royalties that their franchisees pay (but the reality is that they will have no choice). Although franchisees will welcome the transparency that this requirement will create, franchisors may find it intrusive and complex to administer.
2. Ex-franchisees Subject to complying with privacy laws and obtaining the consent of ex-franchisees, the Government has agreed in principle to a recommendation which allows franchisors to disclose to prospective franchisees, if requested to do so, the names, location and contact details of former franchisees who have left the franchise system. This includes those franchisees that have been terminated or have transferred their franchises.
Under existing provisions, franchisors typically had their lawyers update this core information once a year. The proposed change may require much more regular updates to coincide with each transfer, termination or surrender of a franchise agreement. This proposal is further evidence of the Government's wish to ensure that prospective franchisees can access information that will enhance their ability to make informed decisions. However, the Government has acknowledged that this provision may require further consultation with the industry.
3. Foreign franchise systems Australia is the only country which does not require all foreign franchise systems to adhere to a code of conduct. The current exemption applies to foreign corporations which only grant one franchise in Australia and was included so that such systems could deal with major Australian corporations under a master franchise agreement. Under the new provisions, such systems will be bound by the code.
4. Audits At present, the auditing of marketing and other co-operative funds is not mandatory and can be dispensed with if 75 per cent of contributing franchisees agree. The agreement of franchisees was sometimes sought as part of the franchise agreement. Under the proposed amendments, such 'opting out' will no longer be permitted. This requirement will keep franchisors honest when assessing and paying "marketing" expenses. The cost of having statements audited may put an unwanted and unnecessary financial strain on many small franchise systems whose marketing fund is relatively small or newly established.
Other key changes 1. At the same time that they provide their disclosure document, franchisors will be required to give prospective franchisees a copy of the franchise agreement and all associated agreements and contracts in the form in which they are intended to be executed.
Currently, some franchisors provide only summaries within the disclosure document, or alternatively, attach a pro forma franchise agreement that might have been current as at the date of the disclosure document (which could be up to 364 days ago) but in no way reflects the form of franchise agreement then being offered to prospective franchisees. This is contrary to the spirit of the code which seeks to give prospective franchisees enough time to seek professional advice before making an informed decision.
Those drafting the legislation will need to accommodate the fact that it is not always possible to have the schedule to the franchise agreement completed at the same time that disclosure is made.
2. Franchisors will also be required to provide copies of any other documents that a franchisee must sign as part of the franchise acquisition process at least 14 days prior to the date on which the signature is required.
Most franchisors already adhere to this timetable but the provision needs to be drafted carefully to ensure that although delivery within 14 days will not always be possible, the policy intent of this recommendation is reflected.
3. Franchisors will be required to disclose to franchisees any undertakings they have given under s.87B of the Trade Practices Act within 14 days.
Undertakings under this section typically involve such things as:
- The agreement not to engage in misleading or deceptive conduct
- The updating of disclosure documents
- The implementation of a Trade Practices compliance program or a dispute resolution procedure
- The provision of information to franchisees in the future, such as copies of court orders and specific financial information
4. Disclosure of materially relevant facts under clause 18 of the code will have to be made in 14 days rather than in 60 days.
Clause 18 requires ongoing disclosure to all franchisees of changes in majority ownership or control of a franchisor, changes in the ownership or control of the intellectual property that is material to the franchise system and specified legal proceedings and judgments.
5. The financial disclosure obligations under Item 20 of Annexure 1 will be extended to include financial reports for the relevant consolidated entity.
It is not clear why this recommendation was made or accepted. If the intention was to allow franchisors to provide consolidated accounts instead of special accounts for the franchisor entity it will be a welcome reform. However, such a move may undermine a franchisor's ability to keep sensitive information confidential.
6. When providing the disclosure documents, a franchisor must also provide a separate document containing the details and history of the site being franchised.
The Government noted that this information is "potentially of critical importance to prospective franchisees" and should be provided with the disclosure document. In practice, franchisors will therefore need to consider which territory a potential franchisee is considering when providing that franchisee with the disclosure document.
In addition to these and other changes, the Government has flagged its intention to consult with the Australian Competition and Consumer Commission (ACCC) and the FCA where appropriate. It has also raised the possibility that educational campaigns may be required on some matters. Some of the changes recommended by the Matthews Committee will be addressed by amending section 51 AC of the Trade Practices Act which deals with unconscionable conduct, rather than amending the Franchising Code itself. The changes to section 51AC will deal with matters such as good faith and fair dealing in franchise agreements and the franchisor's right to unilaterally terminate the franchise agreement.
Conclusion Although already welcomed by the FCA, the devil - if there is one - will be in the detail.
One hopes that, before the changes are put in place, there will be an opportunity to fine tune some of the provisions and try to minimise compliance costs.
The reality is that franchisors will no longer be able to print off multiple copies of their disclosure documents once a year and take them off the shelf when issuing them to prospective franchisees.
Prior to the Matthews Committee's review, Australian franchising operated under one of the most onerous disclosure regimes in the world. The new provisions will make that regime more onerous.
Many people will applaud this, arguing that transparency res confidence in the sector. Others may argue that we are now at the point where enough is enough.
The sale of a franchise business is subject to a far stricter regime than that which applies to normal sale of business transactions. It is perhaps fair to ask what special circumstances make that necessary or desirable.
It should also be remembered that disclosure comes at a price that is invariably passed on to the ultimate consumer. Not all franchise systems are big, mature and profitable.
Many operators cannot afford to have their lawyers scrutinize their compliance systems every few months. By the same token, they cannot afford the legal fees and court-imposed penalties of non-compliance.
Whilst the recommendations which the Government has accepted will bolster the protection afforded to franchisees by increasing the franchisors' disclosure obligations, franchisees must still take responsibility for conducting their own due diligence, obtaining appropriate advice, assessing risks and deciding whether to join a particular system.
Minister Bailey made this clear in the Government's response to the Matthews Committee's report when she said, "Decisions relating to the viability and associated risks of any business venture are ultimately the decisions of the businesses themselves".
This article appears courtesy of
Mason Sier Turnbull.
For additional information see the
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running a franchise pages.
28-Aug-2007