Franchising Code of Conduct

• we have seen some information bulletins that some law firms have put out to their clients, and
• one client has specifically told us that it has received certain advice as to the disclosure obligations of a USA franchisor to its Australian master franchisee and to the franchisees in Australia.

Disclosure by foreign franchisors

The first issue relates to disclosure requirements for overseas franchisors.

The Franchising Code of Conduct (Code) enacted under the Trade Practices Act 1974 (Act) previously excluded overseas franchisors who granted one master franchise for the whole of Australia. This exemption has been omitted from the Code as from 1 March 2008. This means that the Code purports to apply to overseas franchisors.

We think the Code now requires overseas based franchisors to give a disclosure document:

• to a prospective master franchisee in Australia. That disclosure document must comply with the Code.
• to individual franchisees in Australia to whom that USA based franchisor grants a franchise directly. That disclosure document must comply with the Code.

We think the Code also requires the foreign franchisor and master franchisee to give to potential sub-franchisees either:

(i) a joint disclosure document. That disclosure document has to contain the various obligations of the foreign franchisor to the Australian master franchisee and the obligations that the Australian master franchisee has to individual franchisees; or
(ii) a separate disclosure document for potential sub-franchisees. In other words, the unit franchisee receives two disclosure documents under this option, one from the foreign franchisor and one from the Australian master franchisee.

We think it is clear foreign franchisors must do one or the other.

One serious issue for foreign franchisors in giving a joint disclosure document is that we think this brings with it joint liability. The foreign franchisor would be jointly liable for any errors not only in detailing the obligations that the foreign franchisor has with the master franchisee, but also for any errors in that part of the disclosure document which the Australian master franchisee prepares.

We think paragraph 6B of the Code has the result that even if the Act has no territorial application to foreign franchisors in terms of enforcement, an Australian master franchisee will not be able to grant franchise agreements to individual franchisees unless it has a joint disclosure document or two separate disclosure documents to give to sub-franchisees.

Foreign franchisors who do nothing will be effectively preventing their Australian master franchisees from granting any franchise agreements as of 1 March 2008.

Australian master franchisees should be contacting their overseas franchisor to ensure their system is compliant.

Consolidated accounts

Another issue is that franchisors (both foreign and Australian) franchise directly with unit franchisees in Australia through a wholly owned subsidiary. Some lawyers are saying that if a franchisor is a ‘consolidated entity’ under our Corporations Act 2001, then the accounts of the consolidated entity must be disclosed. We disagree. There are circumstances where they need not be disclosed. The requirement for disclosure of financial information is contained in paragraph 20 of the disclosure document.

Paragraph 20.1 says the disclosure document must contain a statement signed by a director effectively saying that there are reasonable grounds to believe the company can pay its debts as and when they fall due.

Paragraph 20.2 says that the franchisor must also disclose its financial accounts for the last two years and, if the franchisor is part of a consolidated entity, then the consolidated entity must disclose its last two years’ financial accounts.

However, paragraph 20.3 says that paragraph 20.2 does not apply in some circumstances. In other words, if those circumstances do exist, then there is no need to disclose the accounts of the consolidated entity. Those circumstances are if the franchisor has an independent audit carried out and that independent audit is provided with the statement under paragraph 20.1 of a director stating that the company can pay its debts as and when they fall due.

A consolidated entity only has to provide its financial accounts if the franchisor does not annex to the disclosure document an audit certificate relating only to the franchisor.

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.