Amendments to the Franchising Code of Conduct

• review and amend their disclosure documents and franchise agreements to ensure they comply with the Code after 1 March 2008
• review franchisee recruitment and renewal procedures, and put procedures in place to capture the additional information that will have to be disclosed.

In this brief, we discuss the changes to the Franchising Code of Conduct (Code) and the implications for franchise systems. Cutlers will also be holding a workshop on Wednesday 4 October that will provide you with practical steps to ensure your system is compliant from 1 March 2008.

Definition updates

The amended Code includes a number of amended definitions including:

1 the definition of ‘associate’, which has been expanded to include persons associated with the franchisor who supply ‘real property’ to franchisees, and
2 the definition of ‘serious offence’, which has been amended to include contraventions of the Corporations Act 2001.

The expansion of the definition of ‘serious offence’ to include contraventions of the Corporations Act 2001 is not limited to significant or major offences under the Corporations Act 2001. As a result franchisors will be required to disclose in part 4.2 of the disclosure document where they have been ‘convicted’ of seemingly minor offences such as failure to lodge with ASIC prescribed forms within the period specified under that Act.

Exemptions for foreign franchisors will no longer apply

The previous exemption from the Code for foreign franchisors that granted only one franchise or master franchise in Australia has been removed. The amended Code will apply to foreign franchisors granting or renewing franchises or master franchises in Australia. Foreign franchisors will have to give a disclosure document to their Australian master franchisees.

One consequence of this change is that the Australian master franchisee will be a sub-franchisor under clause 6B(2)(a) of the Code. The Australian master franchisee will have to give to sub franchisees a disclosure document covering the master franchisee / sub franchisee relationship.

The amended Code also includes consequential amendments so that the accounts required to be provided by foreign franchisors under part 20.2 of the disclosure document need to comply with the ‘foreign equivalent’ of the provisions of the Corporations Act 2001 relating to preparation of accounts.

When the scope of a franchise changes

A franchisor must give a disclosure document to an existing franchisee under the amended Code when a franchisee is proposing to renew or extend the scope or term of an existing franchise agreement. The ‘scope’ of a franchise agreement is not defined in the amended Code. This is an area for concern because it may include changes not only to territories, but to the goods sold or services provided in the franchised business and other material changes to the franchise agreement.

The combined effect of clauses 10 and 11 of the amended Code is that if a franchisor wants to extend the scope of a franchise, the franchisor will not only have to give a disclosure document at least 14 days before the extension in term or scope, but it may have to enter into a new agreement and receive the statement under clause 11(1) that the franchisee has received, read and had a reasonable opportunity to understand the disclosure document and the Code.

Under the amended Code franchisors must produce a disclosure document within 4 months from the end of each financial year. This period has been increased from the 3 months under the current Code.

When long form disclosure documents must be given

Under the amended Code the long form disclosure under Annexure 1 must be given if the franchised business has an expected turnover of $50,000 or more per annum ‘at any time during the term of the franchise agreement’.

Franchise agreement to be given with disclosure document

The amended Code requires that a disclosure document must include the franchise agreement ‘in the form in which it is to be executed’ by the new franchisee. This wording is significant as it would appear that the franchise agreement given to a prospective franchisee will need to be in final form, and not a sample document which is currently adequate for complying with the current Code.

This means that under the amended Code if amendments are made to the franchise agreement after the initial disclosure document is given, franchisors must wait a further 14 days from giving the prospective franchisee the final franchise agreement before entering into that franchise agreement (or receiving any non-refundable payments) as the 14 day disclosure period may need to start over.

The words ‘in which it is to be executed’ is inconsistent with the explanatory statement to the amended Code released by the Minister of Small Business and Tourism, which states that ‘the regulations amend the code to require the franchisor to provide the franchise agreement in the form it is intended to be executed’. The Franchise Council of Australia is making urgent submissions to the Minister about this inconsistency, otherwise the amendment will cause a significant impediment to inclusions in their recruitment processes.

Obligation to provide associated documents

Under item 18 of Annexure 1 of the amended Code franchisors must not only disclose the existence of related agreements that the franchisee is required to enter into (such as leases, confidentiality agreements, IP licenses, security documents, restrictive covenants and supply agreements), but also give copies of these documents to the prospective franchisee.

Under the revised Code franchisors must provide these documents at least 14 days before the prospective franchisee signs the franchise agreement, or if the documents are not available at this time – when they become available.

Disclosure of material facts

The obligations of franchisors to disclose materially relevant facts under parts 18(2)(b) and 18(2)(d) have been extended in the amended Code to include proceedings against directors of the franchisor under these parts.

The time for disclosure of materially relevant facts under part 18(1) of the amended Code has also been reduced to 14 days after the franchisor becomes aware of that materially relevant fact, which is significantly less than the 60 days specified in the current Code.

In addition to the requirement for franchisors to disclose to franchisees the existence of any orders or enforceable undertakings given under s87 of the Trade Practices Act, the amended Code requires disclosure of the content of these orders or undertakings.

Disclosure of history of the franchise territory

If a franchise territory or site has been the subject of a previous franchise, under the amended Code franchisors must disclose the history of that territory or site in a separate document and give that document to a prospective franchisee with the disclosure document.

Disclosure of past franchisees

In addition to the current requirement to disclose the number of franchisees that have left or been expelled from the franchise system in the previous 3 financial years, franchisors under the amended Code will now have to give the contact details of these past franchisees unless these past franchisees have requested in writing that their details not be disclosed. Franchisors will need to give careful consideration to how they approach this issue; to avoid any suggestion that they have deliberately withheld the names of past disgruntled franchisees.

Officers

The requirement to disclose name, positions and qualifications in part 2.6 of the disclosure document has been extended in the amended Code to include all ‘officers’ of the franchisor and will no longer be limited to officers having management responsibilities. A summary of each of the business experience of these officers must also be disclosed in part 3.6 of the disclosure document under the amended Code.

Summary of franchise agreement

Completing parts 15, 16 and 17 of disclosure documents under the amended Code will require references to provisions of the franchise agreement to be included. The option under the current Code to include a summary of the provisions in the franchise agreement (rather than references to specific sections) for these parts of the disclosure document has been removed.

This means that where sub franchisors are involved, sub franchisees will have to be given a copy of the master franchise agreement with the disclosure document that deals with the master franchise relationship.

Waivers

The amended Code prohibits the inclusion in a franchise agreement of (or a requirement to sign) a waiver of any verbal or written representations made by the franchisor. From 1 March 2008, franchisors must not require franchisees to sign waivers of any verbal or written representations made by the franchisor.

This is significant as it is common in commercial agreements for a statement to be included that the written agreement supersedes any previous agreement of the parties and that no representations are made by either party other than those expressly stated in the written agreement.

Of further significance is that this provision of the amended Code is expressed to apply from 1 October 1998 rather than from the commencement of the amended Code on 1 March 2008. We understand that the Franchise Council of Australia is making submissions to the Minister about this effective date, however, unless this date is changed franchisors will need to check their existing franchise agreements for the entire period after 1 October 1998 to ensure these agreements do not contain provisions which purport to exclude prior representations of the franchisor.

This amendment to the Code provides further motivation for franchisors to carefully and regularly review their franchisee recruitment processes and ensure that controls are in place to prevent representations being made by or on behalf of the franchisor that could in any way be problematic once the franchise agreement is entered into.

Rebates

One of the most contentious and keenly anticipated issues leading up to the release of the amendments to the Code is how the Government would elect to treat disclosure of rebates received by franchisors.

In addition to existing disclosure requirements relating to rebates, from 1 March 2008 franchisors must disclose whether the franchisor (or an associate) will receive a rebate or financial benefit from the supply of goods or services to franchisees, and the name of the business providing that rebate or financial benefit. The amended Code does not require franchisors to disclose the amount of rebates or the method of their calculation to franchisees.

Financial disclosure for franchisors that are part of consolidated entities

If a franchisor is part of a consolidated entity that has to provide audited financial reports under the Corporations Act 2001, unless the franchisor gives the director’s statement under paragraph 20.1 and the statement is supported by an independent audit under paragraph 20.3, paragraph 20.2 of the amended Code states that a franchisor must give those consolidated accounts to a franchisee on request.

Audit of marketing funds

The Code currently requires franchisors to produce annual financial statements for the accounts of a marketing fund and to provide this statement to franchisees on request. The amended Code includes an absolute obligation to provide annual financial statements to franchisees.

The period after the end of the financial year to prepare the annual financial statement and have it audited has been increased from 3 to 4 months, and the prescriptive requirements for the details to be included in the annual financial statement has been removed.

The ability for 75% of franchisees to agree not to require the franchisor to have the marketing fund’s accounts audited will remain. However, under the amended Code this agreement is not open ended and has to be agreed by relevant franchisees within either 5 months of the end of the financial year for that financial year or within 2 years from the end of the financial for which agreement is reached.

Further information

Thomson Playford Cutlers works with franchisors as a strategic partner to improve overall network performance. We manage compliance issues and address the legal considerations that contribute to franchise network efficiency, profitability and expansion.