Legal rights knowledge lacking in franchising

ADELAIDE: Despite the rapid growth of franchising across Australia, a disturbingly high number of franchisees are either unaware of, or do not properly understand, their fundamental legal rights and responsibilities, a major law firm has warned.

“As more franchises are established and competition intensifies, franchisors are becoming increasingly vigilant about protecting their investment,” says Thomas Playford partner and franchise law expert, David Gaszner.

“Legal provisions protecting the confidentiality of the franchise system and specific restraint of trade clauses that prevent former franchisees from unfairly competing with their franchisor are an increasingly contentious issue.”

Restraint of trade clauses prohibit franchisees that part company with their franchisor from establishing a competitive business and poaching customers. Confidentiality clauses prevent franchisees from taking for themselves the intellectual property of the franchisor.

Gaszner says disagreements over restraint of trade clauses and the allied confidentiality provisions are becoming increasingly significant in disputes between franchisors and franchisees in which Thomson Playford has acted.

According to the Franchising Australia 2004 report there were approximately 850 business format franchise systems in Australia in 2004, up from 700 in 2002.

One-third of franchisors reported that franchisees had departed their franchise system but had continued to operate independently, and approximately one-quarter of franchisors had or intended to take legal action against these former franchisees.

“Former franchisees often forget that the very clause that prevents them from setting up in competition with the franchisor and using its intellectual property had, in fact, enabled them to build their own successful franchised business in the first place,” Gaszner says. “One of the main problems is that some people go into franchising without fully understanding what is involved.”

He emphasises that before taking up a franchise, franchisees should ensure they fully understand the obligations and responsibilities they will be agreeing to.

“A franchise agreement should be reviewed against a thorough understanding of the commercial relationship that it creates and the business environment in which the parties will later operate,” he says. “Unfortunately, such agreements are too often reviewed in the abstract and as something of a formality, divorced from a realistic assessment of life inside a franchised system.

“If those advising prospective franchisees began with a blunt review of how a franchised system operates and then put their advice in that context, I believe many of the disputes that are emerging might be avoided.”

Gaszner says the need for correct documentation and education has never been so important to both parties.

“It is fundamental to successful franchising that the participants adhere to the franchised system,” he maintains. “A strong restraint of trade clause remains one of the most effective tools by which a franchisor can protect their system and especially their other franchisees.

“A poorly drafted restraint of trade clause may be unenforceable. This may impact on both the uptake of new franchises and severely erode the value of existing franchises, as current franchisees see the resale value of their businesses diminish due to the increased competition in the market.

“There is no blanket restraint of trade clause to cover all industries. Instead, they must be tailored to meet each individual case.”

The Franchise Council of Australia is a not for profit membership organisation that is the peak body representing the franchising sector in Australia.