Franchise agreements are generally drawn by lawyers after months of detailed consultation and workshopping with clients and consultants.
From the detailed business plan the lawyer’s role is to then document the business model.
The lawyer’s role is to reflect the franchise model that has been workshopped into the core contractual documents.
A franchise agreement is a fixed term agreement and generally considered to be drawn heavily in favour of the franchisor. The agreement protects the franchisor’s intellectual property, their system and brand.
Pre-agreement:
Franchisors aim to ensure their agreements are uniform, although there may be special conditions or concessions negotiated in the lead up to signing a franchise agreement by the franchisee or their lawyers.
The time to negotiate special conditions or concessions ideally is within the 14 day disclosure period prior to signing the franchise agreement.
There is greater ability to negotiate concessions where it is a new franchise system rather than an established system as the franchisor may be keen to get franchisees on board.
The franchisor may be willing, for example, to make concessions on the upfront franchise fee, waiving the minimum performance obligations for the start up phase, waiving marketing fund contributions or providing an extended territory in which to operate.
We have on occasion negotiated early exit rights where the franchisee brought into the franchise an existing business which had established goodwill and reputation.
Once the franchise agreement is signed, can you vary it?
Most franchise agreements have a provision that states the franchise agreement can only be varied by written agreement of the parties.
The Franchising Code does not specifically address this issue, other than providing an obligation on both parties to act in good faith. Franchise agreements also often provide that on renewal or extension of a franchise the terms of the new franchise agreement may differ from the original.
Where there is a renewal and/or variation of a franchise agreement entered into before 1 January 2015, the franchisor will need to vary the new franchise agreement to comply with changes to the Code and also update their disclosure document.
Unfair contracts laws and their impact on franchising
In addition to the changes to the Franchising Code, the changes to the unfair contract provisions contained in the Australian Consumer Law will come into effect on 12 November 2016 and restricts unfair terms in relation to standard form small business contracts.
These changes will apply to franchise agreements and ancillary agreements.
This will require franchisors to review and revise provisions in their franchise agreements, which may be rendered void and unenforceable.
The impact however may not be as severe as first thought as the law provides that if a provision is determined unfair, the provision is void and unenforceable but the agreement continues to bind the parties. The Franchisor cannot rely on the unfair term and if it does so it would enable a franchisee to argue that it is unlawful, apart from also being a breach of the good faith obligations under the Code and possibly conduct against good conscience.
The ACCC will enforce the law to agreements entered into, amended, extended or renewed on or after 12 November 2016 and has indicated that it will target the franchise sector (amongst others) due to the imbalance of power in the relationship between franchisors and franchisees.
Who does it cover?
A contract shall be deemed a small business contract if:
- at least one party employs fewer than 20 persons (includes full-time, part-time and casual employees employed on a regular and systematic basis); and
- whether the upfront price of the contract is equal to or less than $300,000.00 AUD (regardless of the term) or as is more likely in franchising the term is for more than 1 year and the upfront price is greater than $1,000,000.00 AUD.
Most franchise agreements are 5 or 10 year terms and the upfront costs can vary greatly.
The “upfront price” includes any “consideration” provided at the time the contract is entered into. This includes franchise fees or upfront payments for supplies, stock or inventory or fit out but it does not include “contingent” payments such as royalties payable.
A small business contract will be presumed to be standard form unless a party can prove otherwise.
The court can use its discretion to determine whether a contract is a standard form contract taking into consideration:
- The bargaining powers of the parties;
- Whether the contract was prepared in advance of discussions between the parties;
- Whether the parties were given an opportunity to negotiate the terms of the contract; and
- Whether the contract takes into account the specific characteristics of the other party, or the particular transaction.
It is likely that most franchise agreements will qualify as standard form contracts but master franchise agreements which are often individually negotiated may fall outside the Act as they are individually negotiated.
What does this mean?
If a franchise agreement falls under the Act, a provision is considered to be an unfair contract term where:
- It will cause a significant imbalance in that party's rights and obligations under the contract;
- It will cause loss, financial or otherwise, to a party if applied or relied on; and
- It is not reasonably necessary to protect the legitimate interests of the party who would be advantaged by them.
In determining whether a provision is “unfair” the Court will also take into account whether the term is clear, legible and in plain English.
Specific issues in franchise agreements:
The provisions that may be considered unfair and which commonly appear in franchise agreements include terms that only enable the franchisor at its sole discretion to:
- Avoid or limit its obligations;
- Vary or terminate the contract
- Renew or not renew the contract
- Vary the price or other “characteristics” of what is supplied without the other party being able to terminate;
- Assign the franchisor’s rights without the franchisee’s consent.
- Unilaterally determine if a breach has occurred.
Terms that limit one party's perceived liability or allow one party to assign the agreement to the detriment of another will be unfair. This may mean that terms allowing franchisors to assign their rights under a franchise agreement without the franchisee consent may be considered unfair.
Terms that limit a party's right to sue the other party or restrict evidence one party can present, are also likely to be considered unfair.
Terms which are not unfair are those that specify the scope of the franchise grant, setting the upfront price payable and terms applicable by law, for example, under the Franchising Code.
There are a number of terms in franchise agreements that allow a franchisor to act unilaterally that will need to be reviewed.
For it to not be a standard form contract a franchisor would have to encourage negotiation, which is adverse to their interests, in having a standard form contract.
Franchisors should begin the process of reviewing their agreements to comply with these new changes as they have until 12 November 2016 to do so.