Legal Insights

Franchisors and marketing funds – are you complying with the Code?

Shaun Temby
Fiona Wallwork

• 19 October 2017 • 10 min read

The ACCC has announced that it will be focusing on the marketing obligations of franchisors

The importance of complying with the Franchise Code marketing obligations was reinforced at the recent Franchise Council of Australia National Franchise Convention. The ACCC Deputy Chairman, Dr Michael Schaper, spoke candidly about the commission’s expectations for franchisor compliance with the Franchise Code and, importantly, compliance with the marketing obligations.

We were not surprised to hear that the commission has a particular focus in this area, as this interest has been evident for some time. Earlier this year (in May 2017) the commission issued two infringement notices to Domino’s Pizza with penalties totalling $18,000. The infringements related to Domino’s alleged failure to provide its annual marketing fund financial statement and auditor’s report to its franchisee network within the time limits prescribed by the Code.

However, what is a ‘new’ development, is the commission’s expectation for the range and extent of information concerning marketing income and expenditure that needs to be included in the financial statements and given to the franchise network. The commission expects sufficient detail in the marketing fund financial statement to give meaningful information to the franchisee. According to Dr Schaper, this requires a drill down on all sources of marketing fund income and all expenditure items.

Dr Schaper also indicated that it would not be acceptable for a franchisor to simply disclose percentages or total dollar amounts for the production, advertising and administration expense categories. Rather, percentages or total dollar amounts will need to be supported by notations and explanatory statements that provide a detailed breakdown for each expense item in that expense category. Similarly, with sources of income, sufficient detail should be provided to show monies received from franchisees, franchisor outlets, and any other sources.

It is now the time of year when franchisors are busily updating their disclosure documents and preparing their marketing fund financial statements for the last financial year. Given the ACCC’s recent comments, we recommend that careful consideration be given to the disclosures required in Item 15, and also the preparation and circulation of the annual marketing fund financial statements to the franchise network.

Franchise Code Compliance Checklist

Franchisor marketing obligations

The Competition and Consumer (Industry Codes – Franchising) Regulations 2014 (Cth) (Franchise Code or Code) is the principal legislation that regulates all franchise arrangements in Australia. The Franchise Code is a mandatory industry code. All franchisors must comply with the Code. A franchisor cannot ask a franchisee to waive or agree to the franchisor’s non-compliance with the Code.

The Code includes provisions that regulate franchise system marketing, covering broadly the establishment, maintenance and administration of marketing funds, the collection and use of marketing levies and reporting to the franchise network.

This Compliance Checklist provides a high level summary of the key compliance obligations and requirements for franchisors who collect marketing levies.

Franchisor Code Compliance Checklist – Marketing
Regulation	Code requirement	Compliance notes
Establish and maintain separate bank account Regulation 31(1)	A franchisor must maintain a separate bank account for marketing fees and advertising fees contributed by franchisees.	A separate bank account is required. All marketing / advertising fees must be paid into the marketing bank account, or transferred to the marketing fund bank account on receipt. Franchisor outlet marketing fees must be paid into the marketing fund bank account.
Franchisor units to contribute marketing fees Regulation 31(2)	If a franchisor operates one or more units of a franchised business, the franchisor must pay marketing fees and advertising fees on behalf of each unit on the same basis as other franchisees.	Regulation 31(2) refers to units operated by the ‘franchisor’. There is an argument that units operated by another entity in the franchisor corporate group, are not units operated by the franchisor. However, it is generally established franchisor practice that corporate group units which otherwise operate on the same basis as franchised units must also pay marketing fees on the same basis as franchisees.
Using marketing fees to meet expenses Regulation 31(3)	Marketing fees and advertising fees may only be used to: (1) meet expenses disclosed in paragraph 15.1(f) of the disclosure document; or legitimate marketing or advertising expenses; or have been agreed by the majority of the franchisees (2) pay other reasonable costs of administrating and auditing a marketing fund	Any term of the franchise agreement which provides for other expenses to be paid out of the marketing fund would not be enforcement. Paragraph 15.1(f) of the disclosure document must clearly outline the expenses that the marketing fees may be used to meet. Failing to disclose a relevant marketing expense in the disclosure document, will trigger the need for the franchisor to assert that it is a ‘legitimate’ expense (which is open to objection) or otherwise obtain the agreement of the majority of the franchisees (which adds time and cost, and agreement may not be reached).
Prepare annual financial statements Regulation 15(1)(a) and (b)	The franchisor must prepare an annual financial statement detailing all of the fund’s receipts and expenses for each financial year. The statement must be prepared within 4 months of the end of the financial year. Penalty provision: Civil penalty may be applied (up to $63,000 for each breach). Infringement Notice may also be issued (penalty of $10,500)	The statement must include sufficient detail of the fund’s receipts and expenses to give meaningful information about sources of income and items of expenditure (particularly with respect to advertising and marketing expenditure. For a 30 June financial year end, the financial statement must be prepared by 31 October. But note if the statement is to be audited, then the financial statement must be prepared in advance to allow time for the audit report.
Audit of annual financial statement Regulation 15(1)(c) (e)	The annual marketing fund must be audited by registered company auditor within 4 months of the end of the financial year. A franchisor does not have to have the statement audited if 75% of the franchise network vote to agree, and that agreement is made within 3 months of the end of the financial year. Penalty provision: Civil penalty may be applied (up to $63,000 for each breach). Infringement Notice may also be issued (penalty of $10,500)	If a franchisor does not want to have the financial statement audited, it must obtain franchisee agreement. Franchisee must be obtained by a vote of all franchisees who contribute, and 75% (or more) must vote to agree that no audit is required. Franchisee vote and agreement must be obtained within 3 months of the end of the financial year. For a 30 June financial year end, agreement must be obtained by 30 September. For a 30 June financial year end, the audit report must be prepared by 31 October.
Provide copy of statement and report to franchise network Regulation 15(1)(d)	A copy of the marketing fund statement and the audit report must be provided to each existing franchisee within 30 days of preparation. Penalty provision: Civil penalty may be applied (up to $63,000 for each breach). Infringement Notice may also be issued (penalty of $10,500)	Take care providing the financial statement and the audit report at the same time. The financial statement is likely to have been prepared at a date in advance of the audit, and thus the 30 day time limit may be a different date. The ACCC closely monitors franchisor compliance with this Regulation. See for example the recent ACCC action against Dominos – Infringement Notice (and penalty) imposed for providing marketing statement and audit report to franchisees outside of the required time frames.
Disclose information in disclosure document Item 15 of Annexure 1 (Disclosure Document)	A franchisor must disclose certain information in relation to the marketing fund and collection / use of marketing fees in Item 15 of the disclosure document. An accurate and current response must be given to each disclosure item.	Failure to disclose the required information in the form specified would comprise a breach of Regulation 8 of the Code. A breach of Regulation 8 is a penalty provision, and civil penalties may be applied. Misleading or inaccurate information in the disclosure document may give grounds for an action for misleading or deceptive conduct, or for making false or misleading representations in contravention of the ACL. Always check that the information disclosed is consistent with actual practice and relevant contractual terms in the franchise agreement.
Disclose information in disclosure document Item 15(g) of Annexure 1 (Disclosure Document)	The disclosure requirements in 15(g) include an obligation on the franchisor to disclose the fund’s expenses for the last financial year, including % spent on production, advertising, administration and other stated expenses.	A franchisor may attach the marketing fund financial statement to the disclosure document to comply with 15(g). But note the requirement that % of each stated expense must also be provided.
Obligation to act in good faith Regulation 6	Each party (the franchisor and the franchisee) to a franchise agreement must act in good faith towards the other party. The obligation to act in good faith extends to pre-agreement negotiations and disputes and cannot be limited or excluded by the parties. Penalty provision: Civil penalty may be applied (up to $63,000 for each breach). Infringement Notice may also be issued (penalty of $10,500)	The general obligation on the franchisor to act in good faith, would extend to the collection of marketing levies and operation of the marketing fund.
Keeping certain information Regulation 19	A franchisor must keep all documents which support statements / claims in a disclosure document for at least 6 years.	Reg 19 imposes an obligation to retain all records relevant to preparation of the marketing financial statements and each of the marketing disclosures made in Item 15.