Franchising, as a business model, has proven to be enormously successful across the globe and particularly in Australia where, according to a recent Griffith University study, we have witnessed net growth in franchise systems of 15 per cent since 2010. Some might argue that one of the factors for the continuing success of franchising in Australia is the enactment of specific and compulsory legislation that governs the relationship between franchisors and franchisees and that work in conjunction with laws that apply to all Australian businesses in general.

Australia is one of only a handful of countries which has enacted such laws. The key pieces of legislation that relate to franchising in Australia are:

• the Franchising Code of Conduct (the Code);

• laws relating to fair trading and business operations, primarily the Competition and Consumer Act 2010 (Cth) (the CCA), the Australian Consumer Law (ACL); the Australian Securities and Investment Commission Act 2001 and the Corporations Act 2001; and

• Common Law.

THE FRANCHISING CODE OF CONDUCT

Since the Code was first introduced as a mandatory industry code in 1998 with the purpose of  “regulating the conduct of participants in franchising towards other participants in franchising,” it has undergone several revisions and amendments.

In 2013, a further extensive review was undertaken by Mr Alan Wein with a number of recommendations made to “improve upon what is already a robust model” by mandating best practice and simplifying regulation to ensure less red tape and to provide clarity in compliance requirements.

Of the 18 recommendations made in the Wein Report, the Government has accepted, or accepted in principle, the vast majority of the recommendations. With the recent change in Government, it is yet to be determined when such recommendations will be implemented. Notwithstanding, below is a summary of the most significant outcomes of the Government’s responses to the Wein Report:

Good Faith

The concept of “good faith” in franchising has been for some time the cause of much conjecture among the franchising community with many concerned that its introduction will give rise to uncertainty about its meaning and scope. While the meaning of “good faith” remains somewhat abstract and elusive, the basic principle behind the concept is that stakeholders will act honestly and sincerely in their dealings with each other and that they will not engage in improper or unfair tactics.

Following the Wein Report, the Government has now accepted the recommendation that the Code is to be amended to include an express obligation that franchisors and franchisees (and their respective “agents”) act in “good faith” as defined in existing Common Law. This Common Law duty will not apply to all aspects of the franchise agreement, or performance of the Code, and the Government has indicated that it will need to consider further the application of the duty.

While it remains to be seen how such obligation will play out in practice and what impact it will have on franchising as an sector, it is clear that stakeholders will need to be educated on what it means to “act in good faith” and how such obligation will apply to “agents”. Doubtless this will mean, at the very least, that stakeholders will need to carefully consider the accuracy of the information given to other parties and to ensure that all material information is fully disclosed.

Disclosure

The Government has accepted that the current disclosure requirements create unnecessary “red tape” in certain multi-level systems. Foreign franchisors will now be required to provide short form Disclosure Documents only and will not be required to update their Disclosure Documents on an annual basis.

This amendment to the Code will likely result in lower compliance costs for foreign franchisors and will perhaps motivate more foreign franchisors to establish networks in Australia.

Online sales

Over the past 5 years, technological advancements have played a significant role in today’s society and the way we do business. More importantly, the worldwide web has become a further sales channel that is clearly here to stay. To date the Code has not sufficiently dealt with the changes in technology in respect to online sales. As a consequence, the Wein Report recommended to the Government and the Government accepted the recommendation, that franchisors will need to provide additional disclosure in respect to their intention to conduct online sales and the respective rights of the franchisor and franchisee.

The implementation of this recommendation reflects the changes in today’s economic environment and will provide greater clarity as to whom will benefit from the online sales.

Marketing funds

The Government accepts that a new approach is warranted for the regulation of marketing funds to ensure greater transparency and that funds collected by franchisors are used for legitimate marketing purposes.

A relatively minor amendment has also been made to the auditing requirements of the marketing fund. The current position is that if 75 per cent of franchisees agree that no audit is required then such agreement remains in place for a three year period. The effect of the amendment is such that franchisors will now need to conduct a vote each year.

Risk statements

Recent research from Griffith University shows that many franchisees make the decision to enter into a franchise agreement regardless of the information provided to them. The Government supports Mr Wein’s recommendation that a risk statement should be provided to prospective franchisees as early on as possible “before they are psychologically and emotionally committed to entering into a franchising relationship.”

Currently Disclosure Documents contain a risk statement on the front page. The amendment will mean that the following additional statements are to be incorporated into a stand alone document and provided separately to the Disclosure Document.

• The need to consider whether the franchise system is a good fit;

• The importance of obtaining professional advice from an expert in franchising;

• The need to research the franchise system, including talking to current and former franchisees, and to carefully study the Disclosure Document;

• The potential for the franchisee to incur unforeseen capital expenditure;

• The risks of franchising generally and any risks specific to the franchise system;

• What prospective franchisees should consider before entering into a Franchise Agreement.

The risk statement will be required for new franchisees only and not for those franchisees who are renewing, extending, or extending the scope of their Franchise Agreement.

Right to terminate in case of administration

Mr Wein recommended that the Code should be amended to provide that either party to a Franchise Agreement may terminate the agreement in the event that the other party is placed into administration and that the administrator fails to turn the business around, or a suitable buyer is not found, within a reasonable time.

While the Government accepts in principle Mr Wein’s recommendation, it acknowledges that the implementation of such recommendation raises complex issues and may impact the access to credit for both franchisors and franchisees and impede the opportunity to sell the business as a going concern.

The Code currently contains provisions which allow the franchisor to terminate the Franchise Agreement in the event the franchisee becomes bankrupt, insolvent under administration or an externally-administered body. Some may argue that the implementation of the above recommendation simply provides the franchisee with reciprocal rights.

Further, it was recommended that the Code be amended to ensure that franchisees can be made unsecured creditors of the franchisor by apportioning the franchise fee paid under the Franchise Agreement across the term of the Franchise Agreement. The effect of this would mean that any amount apportioned for the remainder of the term would become a debt owed to the franchisee if the agreement ended due to the franchisor’s failure.

The Government supports the policy intent of the above recommendation but acknowledged it will require further consultation with industry experts while considering the impact on insolvency, taxation, contract and franchising law.

Enforcement

The Government accepted the recommendation that the Code be amended to provide the ACCC with powers to seek court-ordered civil pecuniary penalties for breaches of the Code. The Wein Report recommended that the maximum penalty of $50,000 should be available as a remedy. The Government is undertaking further consultation as to the appropriate maximum penalty while considering having prescribed penalties for specific breaches of the Code, with the more serious breaches attracting higher penalties.

For franchisors, the above amendment means that they will need to ensure that they have strong compliance policies in place and that their employees are educated in respect to such policies.

Restraint of trade

The Government supports the recommendation that the Code is to be amended to state that if certain conditions are satisfied, any restraint of trade clauses in the Franchise Agreement will not be enforceable by the franchisor against the franchisee. This approach is an attempt to balance the rights of the parties at the end of the Franchise Agreement but will only apply to specific circumstances and will not limit the operation of the unwritten law dealing with restraint of trade.

Clearly, franchisors will need to carefully consider the provisions within their Franchise Agreements which prohibit their franchisees from carrying on a similar business in competition with the franchisor at the end of the franchise term.

For franchisors, the implementation of the above amendments to the Code will mean that they will need to carefully review and undertake a significant update of their Franchise Agreements and Disclosure Documents. For franchisees, the changes by and large place an obligation on the franchisor to provide greater transparency in their dealings with the franchisee while also emphasising the requirement that franchisees provide accurate information to the franchisor.

The effect of the above amendments is intended to provide stakeholders with certainty and confidence in the franchising sector, to protect those that need protection but also allow parties the freedom to negotiate generally acceptable commercial agreements.

TOP FIVE THINGS TO CONSIDER IN FRANCHISING

Franchisor
1. Is your Disclosure Document and Franchise Agreement compliant with the Code?

2. Is your brand properly protected?

3. Do you have the appropriate corporate structure?

4. What is your recruitment strategy?

5. Do you have the right advisors and support team around you?

Franchisee
1. Have you conducted proper due diligence on the franchise system and the franchisor?
2. Does the term of the Franchise Agreement match the lease agreement (if applicable)?

3. What are the restraint clauses and how will they impact you?

4. Do you have the right business skills?

5. Will the franchise system suit your lifestyle?

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