January 2008
THE FRANCHISING CODE OF CONDUCT:
NEW DIRECTIONS IN 2008
From 1 March 2008, much-discussed amendments to the Franchising Code of Conduct (the Code) will take effect. Changes to the Code have been based on recommendations contained in Graeme Matthews' report to the Federal Government in October 2006, and have been subject to close scrutiny and feedback from many sectors in the franchising industry.
Prudent franchisors will review their agreements and processes, including disclosure, recruitment and franchise renewal, to ensure compliance with the amendments before the amended Code is implemented.
Foreign Franchisors
Currently foreign franchisors who grant just one franchise in Australia are exempt from the Code. This position will change, so foreign franchisors will need to check that their agreements and disclosure documents comply.
Audits requested by Franchisees
The amended Code will allow audits at the option of the franchisees. Specifically 75% or more franchisees of a franchise may agree to request a marketing fund audit, so long as the request is made in a specified timeframe (either within five months of the end of the financial year, or within two years of any previous agreement to audit).
Conduct of Franchisors
The amended Code specifically prohibits agreements releasing a franchisor from liability to its franchisee. This prohibition applies retrospectively to agreements entered into after 1 October 1998.
If a prohibited provision is contained in an existing franchise agreement, then such provision will have no effect. Franchisors should ensure that their franchise agreements comply by removing any provision waiving the franchisor's verbal or written representations.
Retrospectivity of this provision has been heavily debated and criticised by franchisors as placing an unnecessary burden on their business. Franchisors may already be aware that they contravene the Trade Practices Act 1974 (Cth) (" TPA") if they engage in misleading and deceptive conduct towards franchisees, including oral or written representations during the recruitment or renewal process. Franchisors should already be monitoring their written and verbal representations when recruiting prospective franchisees or renewing franchise agreements. Ensure that representations - including phone calls, e-mails and facsimiles - are appropriately worded, and well documented.
Prudent franchisors will seek legal advice and check standard documents, letters, forms, procedures, and representations made to franchisees, at all phases of recruitment or renewal of franchises.
The amended Code permits prospective franchisees to form an association, and to make contact with present and past franchises. If existing franchise agreements contain provisions forbidding such association, they must be reviewed and corrected prior to 1 March 2008.
Disclosure
A number of elements of disclosure have been tightened in favour of franchisees by the amendments to the Code.
When a franchisee receives the Disclosure Document they must also receive the franchise agreement in the form in which it is to be executed, together with a copy of the amended Code.
In addition, 14 days prior to signing the franchise agreement, the franchisor must provide to the franchisee copies of all associated agreements and contracts (when and where available), including:
- leases
- sub-leases for premises
- chattel leases
- hire purchase agreements
- guarantees
- mortgage security deposits
- confidentiality agreements
- agreements not to carry out business in the area for a time after the franchise agreement is terminated
- intellectual property licences
Franchisors are advised to review standard disclosure processes before finalising, renewing or extending a franchise agreement. If a franchisor's documents do not strictly comply with the Code, then they jeopardise their right to rely on the franchise agreement for recovery of royalties or other money owed by the franchisee.
The recent decision of the New South Wales Court of Appeal (" NSWCA") - Ketchell v Master of Education Services ("Ketchell") - will inhibit a franchisor's argument that a breach of the Franchising Code of Conduct should be irrelevant to the enforceability of a franchise agreement.
In Ketchell, the franchisor entered into a franchise agreement with the franchisee without receiving from the franchisee a written statement that the franchisee had received, read and had reasonable opportunity to understand the Disclosure Document and the Code, in accordance with Regulation 11 of the Code. The NSWCA decision held that nothing in the TPA expressly or implicitly negated application of the ordinary rule that a contract made illegally was not enforceable. The NSWCA ruled that the franchise agreement was unenforceable and therefore money owed to the franchisor under the franchise agreement was not recoverable. The decision will certainly make it more difficult for franchisors to claim that a breach of the Code is not grounds to invalidate the franchise agreement.
Several new provisions of the amended Code mean that a franchisor must maintain up-to-date contact details of current and past franchisees; and also that their collection of this data conforms with applicable state and federal privacy laws.
If a franchisor or associates of the franchisor receives rebates or financial benefits from a business, then the name of the business will need to be disclosed to the franchisee (currently not a requirement).
Franchisors must also provide the franchisee with the name, location and contact details of past franchisees consenting to such disclosure.
Materially relevant facts (including changes in majority ownership, certain proceedings, judgments, and changes in ownership of intellectual property) must be disclosed to franchisees within 14 days of a franchisor becoming aware of them.
Franchisors must disclose to franchisees any undertakings made to the ACCC under s87B of the Trade Practices Act, within 14 days of giving the undertaking. The amended Code requires such information to be included in the franchise agreement. The Disclosure Document must contain information about the business experience of an executive officer, and franchisees must be provided with information about the directors of a franchise including undertakings under s87B of the Trade Practices Act, civil proceedings and judgments involving the franchise director. Exceptions to this provision for disclosure apply, such as where civil proceedings are brought against the franchise director by a minority of franchisees (10% or 10, whichever is the lower).
Presently a Disclosure Document needs to be provided to a franchisee where they propose to renew or extend a franchise agreement. The amended Code broadens to cover extensions to the scope of the agreement, eg expansion of territory or site operations. Franchisors should review whether such extensions trigger the need for a new agreement and Disclosure Document.
Prospective franchisees are further entitled to information about the history of the territory or site to be franchised, when receiving the Disclosure Document, instead of at a time and place detailed in the Disclosure Document.
Finally, a franchisee may request financial reports of a consolidated entity to which the franchisor belongs, however this only applies if the consolidated entity is required to provide financial reports under the Corporations Act 2001 (Cth).
Clarifications to the Code
The amended Code clarifies the provision that if the franchisee is likely to have an annual turnover at any time during the term of the franchise agreement of $50,000 or more, then the franchisor must provide a Disclosure Document to the franchisee.
In its present form, the Code is inconsistent regarding the cost incurred by a prospective franchisee if terminating a franchise agreement within the cooling-off period. The amended Code specifies that a franchisor may deduct reasonable expenses from the amount paid for the franchise, if the franchisor's expenses or method of calculation have been set out in the agreement.
Summary
The amended Franchising Code of Conduct means that franchisors have a far greater responsibility in terms of disclosure, and more complex requirements for franchise agreements to comply with the Code. Prudent franchisors will undertake an extensive review of their documentation and processes prior to the implementation of the amended Code on 1 March 2008.
Stephens Lawyers & Consultants have a high level of expertise in advising the franchise industry. Stephens Lawyers & Consultants' franchising lawyers and trade practices lawyers represent leading franchise companies in both litigious and commercial matters.
For further information contact:
Stephens Lawyers & Consultants Level 3, 530 Lonsdale Street Melbourne VIC 3000 Phone: (03) 8636 9100 Fax: (03) 8636 9199 Email: stephens@stephens.com.au Website: www.stephens.com.au All Correspondence to: PO Box 13286 Melbourne Law Courts Melbourne VIC 8010To register for newsletter updates and to send your comments and feedback, please email stephens@stephens.com.au
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© Stephens Lawyers & Consultants, December 2007