Legal Insights

Before and after the proposed changes to the Franchising Code of Conduct

By Greg Hipwell, Jessica Reid, Elizabeth LilleyElise Pascoe

• 03 March 2021 • 25 min read
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On 10 November 2020, the Commonwealth Government released for public comment, the draft regulations it proposes will amend the Franchising Code of Conduct (Code).

The Government engaged in a consultation process which closed 4 December 2020 – and the regulations have a proposed start date of 1 July 2021 (transitional arrangements will also apply). However, while there may be some changes following the consultation process, given the draft regulations look to be in a comprehensive and considered form, we think it is unlikely the actual amendments will vary fundamentally from the draft.

For the most part, the changes echo the commitments the Government made in August 2020 as a response to the Fairness in Franchising report – you can read our article about that Fairness in Franchising report here. The changes essentially seek to better protect franchisees and to improve the level of information available to them. Disappointingly, there are a number of lame duck provisions that complicate the drafting of the Code but add nothing to the rights of either franchisors or franchisees and are little more than a platitude aimed at pacifying those advocating greater rights for franchisees. An example of such clause is the provision for optional arbitration with no mention of the rules that are to apply to the conduct of the arbitration. Essentially, franchisors can just refuse to arbitrate and not include arbitration clauses in their franchise agreements. Also, the right of a franchisee to request early termination of a franchise agreement can simply be rejected by a franchisor if it provides reasons.

We will provide a further update when the final form of the regulations are passed by Parliament, but in the meantime, we have set out a comparison between how the Code currently deals with certain issues against what is proposed to be changed under the current draft regulations.

The disclosure regime generally

Proposed changesThe Code's current positionThe proposed change explained

Requirement to provide to a franchisee a “Key Fact Sheet” highlighting information from the Disclosure Document, before the Franchise Agreement is entered into

Clause 11 requires that franchisors provide a prescribed form ‘Information Statement’ as soon as practicable after a prospective franchisee applies or expresses an interest in a franchise.

Clause 9 currently provides a list of documents required to be provided to the franchisee (or prospective franchisee) at least 14 days prior to entry into a franchise agreement or payment of any non-refundable amount – it includes a copy of the Franchise Agreement, the Code, and the Disclosure Document and, if relevant, a copy of leasing material.

Inserted into clause 9 will be a new requirement to also provide a ‘Key Fact Sheet’ highlighting what is intended to be the most critical information in the Disclosure Document.

There are currently three contenders for the fact sheet – which stakeholders could vote on as part of the consultation process.

The number of questions posed in the Key Fact Sheet are numerous. It is not apparent to us that providing an additional document (which is largely a summary of another document, being the disclosure document) improves the nature and quality of the information that is being given to franchisees. Further, this may actually act as a deterrent for franchisees to invest the time to read the disclosure document in full, instead just relying on the Key Fact Sheet.

Disclosure Document to be provided in written and electronic format

The Code is currently silent on this matter.

The documents required to be given 14 days prior to entry into a franchise agreement will need to be provided in printed form, or electronic form, or both, upon request by the franchisee. However, if the franchisor has already provided these documents at the time of a request for them to be provided in a different medium, the franchisor does not need to comply with this request. This is to make it easier for a franchisee to conduct due diligence.

Information Statement has been updated

An Information Statement (in a prescribed form) has to be provided when a franchisee first applies for or expresses an interest in a franchise.

Clause 11(3) has been modified slightly to clarify that the Information Statement must be provided before the franchisor provides a copy of the disclosure document and related disclosure materials. While it was always the intention that the Information Statement was to be provided at an earlier stage than the disclosure statement, some franchisors had developed a practice of providing the Information Statement at the same time as the disclosure document (we assume for administrative ease). It is now clear that this is not permitted under the Code.

There have been some minor updates made to the draft Information Statement – these are mainly comprised of increased warnings, and some references to certain resources being ‘refreshed’.

Nevertheless, Franchisors will need to download this new document to provide to prospective franchisees after 1 July 2021. The updates to the Information Statement includes the provision of warnings and information about:

  • Restraint of trade clauses;
  • Employment laws;
  • ‘Entire Agreement’ clauses;
  • “No agent’ clauses; and
  • ‘Churning’ and ‘burning’ practices.

Landlord disclosures

The Code is currently silent on this matter.

Clause 13 now clarifies that where a lessor of a premises to the franchisor or its associate provides ‘written information’ relating to a lease to a franchisor or its associate (e.g. some form of disclosure statement), the franchisor must give a copy of this written information to the franchisee before entering into a franchise agreement. This was often standard practice by franchisors, but something which they will need to build into their disclosure processes if not.

New matters to be included in Disclosure Document

Proposed changeThe Code's current positionThe proposed change explained

Supplier rebate arrangements

Pursuant to item 10.1(c) the Disclosure Document currently needs to outline details about whether the franchisor (or its associate) has an interest in a supplier from which a franchisee will be required to acquire goods or services.

Currently, item 10.1(j) requires the franchisor to disclose whether they will receive a rebate or other financial benefit from the supply to franchisees. And if so, franchisors will need to disclose the name of the business, and whether that rebate/benefit will be shared with franchisees (directly or indirectly).

In addition to the information required under item 10.1(c), the Disclosure Document needs to include information about whether the Franchisor will get a benefit (whether pecuniary or not) from supplying goods or services to the franchisee (from item 10.1(i) onwards). And if so:

  • the nature of that benefit;
  • who the supplier is;
  • the way the benefit is calculated; and
  • whether the benefit will be shared with franchisees – and if so, the amount kept by the franchisor, the amount given to the franchisees, and the way those amounts are calculated.

There is currently a lack of clarity about the last dot point. For example, it is not clear the exact level of detail required, how a franchisor is to approach it if rebates are fluid, and whether rebates must be disclosed on a SKU basis (but it seems this is required). Franchisors will need to review all arrangements with suppliers when completing this section of the Disclosure Document. For example, are there any marketing benefits franchisors/networks get from using certain suppliers.

Whether the Franchise Agreement includes an arbitration clause

Disclosure document was silent on arbitration provisions in franchise agreement.

New item 17A of the Disclosure Document requires a franchisor to state whether or not the Franchise Agreement provides for arbitration of disputes in a manner consistent with the Code’s new voluntary binding arbitration procedure (see comments on this below).

Information about early exit

Disclosure document was silent on franchisee’s right to end franchise agreement early.

A new item 17B of the Disclosure Document, requires a franchisor to set out what rights the franchisor and a franchisee has to terminate the franchise agreement before it expires and the circumstances in which those rights can be exercised.

There have been related changes to the rights under the Code regarding early exits (see our commentary below in the ‘Early exit’ section) which is intended to be addressed in this section of a franchisor’s disclosure document (along with other rights a franchisee or franchisor may have to bring a franchise agreement to an end before its term).

Information about goodwill rights at end of franchise

Disclosure document currently silent on rights to goodwill at end of franchise.

The Code currently only deals with goodwill payments in the context of whether or not restraints are enforceable, but there is no obligation to set out this information in a Disclosure Document.

A new item 18.1(fa) of the Disclosure Document requires a franchisor to explicitly set out a franchisee’s rights (if any) relating to any goodwill generated by the franchisee at the end of a Franchise Agreement (regardless of whether the business is being sold).

The fact that franchisees are generally not entitled to goodwill payments (or other compensation) at the end of a franchise can come as a surprise to franchisees who have not conducted appropriate due diligence prior to entering into a franchise agreement. Hopefully the inclusion of this item in the disclosure document (as well as a reference to it in the Information Statement) will assist in rectifying some of this confusion.

Earnings information

Item 20 sets out the information which must be given by a franchisor in its disclosure document depending on whether or not franchisor’s provide franchisees with ‘earnings information’.

Modifications have been made to Item 20 of the Disclosure Document so that:

  • if earnings information is given, franchisor’s need to provide a statement that to the best of their knowledge, the earnings information is accurate; and
  • it is clear that ‘earnings information’ can include information given by a franchisor before a disclosure document is provided (e.g. as part of any application/due diligence process with a franchisee).

Franchisors will need to carefully consider what historical or other financial information it gives to its franchisees (or facilitates the exchange of between franchisees) to make sure that it is not warranting the accuracy of information prepared/provided by franchisees to prospective franchisees (e.g. as part of a sale process). Where information is exchanged between franchisees, franchisors should ensure that appropriate disclaimers are put in place. It is particularly problematic to require a franchisor to warrant the accuracy of projections or forecasts. While such information should be based on reasonable assumptions it will deter franchisors from providing any forward looking information.

Significant Capital Expenditure

Proposed changeThe Code's current positionThe proposed change explained

Removal of right for franchisor to require a franchisee to undertake Significant Capital Expenditure (‘Cap Ex’) that it ‘considers necessary’ in the course of an arrangement

Under the Code currently, a franchisor can only require Cap Ex to be expended by a franchisee if: (i) disclosed in its disclosure document prior to entry into the franchise agreement; (ii) approved by a majority of franchisees; (iii) required to comply with legislative obligations; (iv) agreed by franchisees; or (v) that the franchisor considered as necessary capital investment, which must be accompanied by a statement justifying this and addressing specific criteria set out in the Code.

Option (v) for franchisors to require Cap Ex that they deem “necessary” in the course of a franchise arrangement will no longer be available. This will mean that the franchisor will need the franchisee to agree to Cap Ex – or they will need to set it out very clearly in the Disclosure Document and the agreement before it is entered into or renewed.

When completing Disclosure Documents, franchisors will need to consider future plans for the network to ensure they incorporate any potential capital investments that will be required by franchisees as part of these (see comments below on the type of information about Cap Ex that needs to be included). This will need to be balanced against the commercial risk of disclosing this information and potentially putting competitors on notice of upcoming changes to the network.

Earlier this year, this same change was made to the Code, but in relation to new vehicle dealership agreements only. It is now proposed that it applies to all franchise arrangements. You can read our article on the changes made to franchises in the new car retail market in February, here.

As much information as practicable about Cap Ex requirements to be provided in the Disclosure Document

Currently, franchisors need to disclose certain information in respect of Cap Ex in the Disclosure Document such as:

  • whether the franchisor will consider Cap Ex undertaken in determining the arrangements to apply at the end of the agreement; and
  • whether the franchisor requires a payment in respect of Cap Ex to be made before the agreement is entered into.

A new clause 30A will compel franchisors that require Cap Ex to disclose as much information as practicable about that required expenditure in the disclosure document.

The types of information proposed to be given include in respect of the expenditure include: the amount, timing and nature of the Cap Ex, the risks involved, the outcomes and benefits, and the rationale of the Cap Ex.

This criteria is similar to the criteria a franchisor must currently satisfy in their written statement justifying they deem Cap Ex necessary (which will no longer be available under the Code).

Requirement to discuss Cap Ex with franchisee

This is not a current requirement.

New clause 30A(3) provides that a franchisor and franchisee must discuss any Cap Ex required in the Disclosure Document with the franchisee. The discussion needs to include circumstances under which the franchisee is likely to recoup the expenditure – having regard to their geographical area and operations. This communication will need to be carefully managed by franchisors to ensure that they do not make misleading claims to franchisees on their likely returns on investment.

Dispute resolution

Proposed changeThe Code's current positionThe proposed change explained

Availability of more dispute resolution processes other than mediation, including voluntary binding arbitration

The Code provides for mediation processes as the only pre-court dispute resolution procedure.

Mediation still remains the starting point for dispute resolution in the draft proposed Code. However, now parties can engage in a number of dispute resolution processes with the help and guidance of the Ombudsman, including conciliation, arbitration and multi-party dispute resolution (ADR Process/es), which are set out in more detail below.

There will be penalties involved for failing to attend the ADR Process.

Availability of voluntary binding arbitration

The Code provides for mediation processes as the only pre-court dispute resolution procedure.

There is a comprehensive voluntary, binding arbitration procedure being introduced which involves some participation from the Ombudsman.

The Code’s arbitration procedure is engaged if both parties agree to resolve a dispute by arbitration under a new agreement, or if the Franchise Agreement provides that disputes are resolved under Subdivision C of the Code.

Among other things, Subdivision C provides:

  • the parties ask the Ombudsman (whose functions are explained further below) to appoint an arbitrator to resolve the dispute;
  • the Ombudsman will assess whether the complaint is frivolous or vexatious, or has already been arbitrated, and if not, will appoint an arbitrator within 14 days;
  • the arbitrator will have significant powers to determine how and where the arbitration is conducted, and is to notify the Ombudsman of certain matters along the way;
  • the arbitrator can make a decision to resolve the dispute and bind the parties; and
  • each party to a dispute will pay half of the costs of the arbitration – unless the parties agree otherwise.

Availability of multi-franchisee dispute resolution

Clause 52 currently provides that franchisees may request multi-franchisee dispute resolution.

The new clause 40B allows 2 or more franchisees that have corresponding disputes under their franchise agreements with the same franchisor to agree to refer their dispute to a single arbitrator, conciliator or mediator (ADR Practitioner). Franchisors can also refer common disputes to a single ADR Practitioner for resolution.

However, if multiple franchisees request that a matter is resolved under the same ADR Process, the franchisor cannot refuse to take part in multi-party dispute resolution if the ADR Practitioner decides it is appropriate to resolve it all together. The franchisor is required to attend the process to try and resolve the dispute, despite their disagreement. This same obligation does not apply for franchisees.

Dispute Resolution functions to lie with the Australian Small Business and Family Enterprise Ombudsman (‘Ombudsman’)

There is a ‘mediation adviser’ named in the Code – which has a similar supervisory function to the Ombudsman and assists the party/ies to conduct mediation only.

A newly inserted clause 4A provides powers and functions for the Ombudsman to assist franchise disputes – but in more ways than just mediation. Mediation will remain the first.

The Ombudsman oversees disputes and has the power to appoint (or refer the matter to) an ADR Practitioner to facilitate the dispute on request of one or more of the parties (to be used when parties cannot agree on an ADR Practitioner).

The Code provides that the Ombudsman needs to be advised of certain ADR milestones for disputes dealt with under the Code.

There are also confidentiality obligations that will be written into the new Code, requiring parties to keep the ADR Process private. The Code is currently silent on this – meaning it is up to parties to establish confidentiality obligations themselves (or otherwise in accordance with the terms of the franchise agreement).

Termination of franchise agreements

Proposed changeThe Code's current positionThe proposed change explained

Cooling off period

Cooling off period is currently 7 days.

This period is proposed to change to 14 days.

In addition, the clock can start ticking on this period quite late as it can only start on the later of the following:

  • the date the franchisee has received their franchise agreement;
  • (if they’re entering into one) the date they receive the lease for the site;
  • the date they’ve made their first payment under the agreement.

As such, these will all need to have been provided as soon as possible, so that the cooling off period begins and ends – to create certainty of contract and enable enforceability. Even if for instance, that first payment is the last of the above events to occur – and it is made on the day the franchisee opens its doors, they will still have 14 days to cool off. If a franchisee does terminate an agreement, the franchisor would need to return all payments received, but the franchisor may deduct from this amount its reasonable expenses – as long as the expenses or method are set out in the Disclosure Agreement.

It has also been clarified in the Code that cooling off rights will apply to transfers where the incoming franchisee is required to enter into a new franchise agreement (e.g. the incoming franchisee signs up to the franchisor’s ‘current form’ of franchise agreement).

Where a transfer occurs without a new franchise agreement being entered into (e.g. the seller’s franchise agreement is assigned to the buyer franchisee ‘as is’ or the sale is completed by way of a sale of shares and the existing franchise agreement remains ‘on foot’ as is), then, within 14 days after becoming the franchisee, the buyer franchisee may by written notice to the seller franchisee and franchisor:

  • cease to be the franchisee;
  • if the old franchisee can become the franchise for those purposes – cause the old franchisee to do so; and
  • terminate the ‘transfer’ agreement between the buyer and seller franchisees.

This new clause 26A also includes obligations on the parties to refund amounts paid under the franchise agreement and ‘transfer agreement’.

Depending on the terms of the sale between the buyer and seller, this process could become quite complicated as it essentially allows a buyer to ‘unwind’ the sale. It may be that franchisors will need to provide some guidance to franchisees as part of the transfer process around a buyer’s rights under this section of the Code.

Franchisors should also be checking their processes and documentation to ensure that whatever form the transfer takes (in particular whether it involves a new franchise agreement being entered into), they are not left in a situation where there is no franchisee at all following the exercise of any of these cooling off rights.

Early exit

The Code does not currently include early exit rights for franchisees. As such, franchisees need to turn to terms of the franchise agreement itself, or the law of contract, to terminate.

Under new clause 26B, a franchisee will be able to propose termination at any time on written notice to the franchisor.

A franchisor is required to provide a ‘substantive’ response within 28 days. If the franchisor refuses termination (or termination on the terms proposed by the franchisee), their response must include reasons for refusal. If a franchisor refuses a termination proposal, a dispute may be deemed to have arisen.

This new clause 26B is very light on detail and while it doesn’t specifically require that franchisor’s must not unreasonably withhold consent to a proposed termination, we can envisage that this will be the nature of disputes which arise between the parties under this section. Franchisors will also need to take care when responding to these requests for termination as what they do or say as part of this, may have an impact in any future disputes with the franchisees.

Termination by franchisor on particular grounds

The Code currently holds provisions that allow a franchisor to terminate the agreement without notice in special circumstances, if the agreement allows it – including the franchisee becoming bankrupt, insolvent, endangering public health or safety, or acting fraudulently.

There will be a notice period of 7 days stipulated by the Code for these types of terminations, during which a franchisee can dispute the termination.

The Code will provide that ADR Practitioners may make orders to essentially freeze the notice period, by directing a franchisor to delay termination, considering the likely effect the termination will have on the franchise’s reputation and the risk of hardship to the parties. The freeze period is only for so long as the ADR process takes to complete. However, unless both parties agree, neither party can unilaterally bring the ADR Process to an end and the ADR Practitioner cannot bring it to an end until at least 30 days have elapsed since the process begins.

Even if an ADR Practitioner freezes the notice period, a franchisor may still require a franchisee to cease operating all or part of the business which endangers public health/safety.

This change will be problematic for franchisors. They will need to consider what rights they have to manage the business, on a franchisee’s behalf, whilst the notice period is on foot or if a ‘freeze’ of termination is ordered by an ADR Practitioner. This may require franchisors to update their franchise agreements to deal with temporary operation of the franchised business by the franchisor or its nominated representatives.

Other changes

Proposed changeThe Code's current positionThe proposed change explained

Penalty units increase

There are civil penalties imposed for certain breaches under the Code – the maximum penalty being 300 penalty units.

The maximum penalty units for the breaches stipulated under the Code have all doubled to 600 penalty units – meaning a breach could cost $133,200.

Prevention of retrospective variation of the Franchise Agreement

The Code is currently silent on this matter (but it is regulated by unfair contract term laws, which apply to many franchise agreements).

Under clause 31A a franchisor cannot vary a Franchise Agreement with retrospective effect unless:

  • 3 or more franchise agreements allow the franchisor to make the retrospective variation; and
  • a majority of franchisees under those agreements consent to the making of the variation.

Civil pecuniary penalties for breaches around the use and management of marketing and cooperative funds

The Code currently deals with the use and management of such funds at clause 31.

There will be civil penalties available for breach of clause 31.

Clause 31 has also been extended to apply to master franchisors.

These increased penalties will be welcome by regulators who have shown a willingness to enforce provisions of the Code against franchisors who do not comply with their marketing fund obligations, such as in the recent Ultra Tunes decision.

Franchisor’s legal costs relating to franchise agreement

The Code is currently silent on this matter (note there are restrictions relating to payment of costs for mediation).

Under new clause 19A, franchise agreements cannot require franchisees to pay unspecified amounts in connection with the franchisor’s legal costs of preparing, negotiating or executing the franchise agreement or related documents. However, franchise agreements can require legal costs be paid by the franchisee if they are specified in dollars, stated as being the franchisor’s legal costs and do not include legal costs after the franchise agreement is entered into.

This is intended to give franchisee’s certainty over costs and will prevent franchisors ‘recouping’ additional legal fees from franchisees where these legal fees may be in excess of what was originally anticipated.

Looking for more information on the proposed changes to the Franchise Code?

Contact our Consumer Markets & Franchising team

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