Legal Insights

Key changes to the Franchising Code of Conduct

Greg Hipwell,
Jessica Reid,
Shaun Temby,
Mira Martin
, Christopher Marsh, Elizabeth Lilley & Fiona Wallwork

• 11 June 2021 • 15 min read

Long awaited changes to the Franchising Code of Conduct (Code) have finally come into effect via Amending Legislation introduced by the Commonwealth Government.

The changes enacted are perhaps the most extensive that have been made to the Code since it was introduced in 1998, and follow an intense period of ongoing investigations into, and consultation with, the franchising sector. While some changes are more significant than others, it is important that franchisors take the time to digest and carefully understand all of the new changes to the Code.

In this article, we outline our pick of the key changes to the Code that franchisors need to be aware of, together with our preliminary thoughts on those changes (though please note that the below is not a definitive list of all changes). We have also included a link to the Explanatory Statement which helps to further explain the changes to the Code.

Changes that impact the terms of franchise agreements
Overview	What is the change?	Our thoughts on the change
The rights of franchisors to immediately terminate franchise agreements in special circumstances have been removed and replaced with a more complex regime. This change applies to franchise agreements entered into, extended or renewed after 1 July 2021.	The new Code removes the ability for a franchisor to terminate a franchise agreement with immediate effect in special circumstances (such as if a franchisee engages in fraud, voluntarily abandons the business or operates the business in a way that endangers public safety etc.) even if permitted by the franchise agreement. Instead, if the ‘special circumstances’ apply, the franchisor is now obliged to give the franchisee 7 days’ written notice of any proposed termination. If the franchisee disputes the proposed termination, then: the franchisor must not terminate the franchise agreement for 28 days after the termination notice is given (which we are calling a Termination Halt); and the franchisee may refer the dispute to a mediator or conciliator, or refer it to the Australian Small Business and Family Enterprise Ombudsman (Ombudsman) to appoint a mediator or conciliator. During the Termination Halt, the franchisor can exercise a right under the franchise agreement (provided one exists) to direct a franchisee to cease operating the business due to the ‘special circumstances’. The Code changes are unclear on whether a franchisor can still take other actions during the Termination Halt period, such as stepping in to manage the business, but given closure would put a franchisee in breach of its lease (where applicable), this contractual right is practical and needed.	This change significantly limits a franchisor’s ability to urgently terminate a franchise agreement in high risk circumstances. Given these changes will come into effect on 1 July 2021, franchisors need to update their franchise agreements now to reflect the Code changes and ensure that they have adequate contractual rights to direct franchisees to cease operating their businesses in ‘special circumstances.’
Franchisees can propose (but not require) early termination of their franchise agreements. This change applies to franchise agreements entered into, extended or renewed after 1 July 2021.	A franchisee may now give a franchisor a written proposal setting out the terms on which it wishes to terminate a franchise agreement. If the franchisor receives such a proposal, it must provide a ‘substantive written response’ to the franchisee within 28 days. Where a franchisor elects not to agree to the proposed termination, it must provide reasons for doing so.	This provision is clearly aimed at protecting franchisees, but in practice, it does little to affect the rights of either party. That said, franchisors will need to carefully consider the content of any response to franchisees (particularly in the context of the obligation to act in good faith).
With one exception, franchisors can no longer require franchisees to pay for their legal costs relating to a franchise agreement. This change applies to franchise agreements entered into, extended or renewed after 1 July 2021.	A franchise agreement can no longer contain provisions that require a franchisee to pay for or reimburse a franchisor for their legal costs relating to the agreement or any related agreement. The only exception allows a franchisor to charge a fixed amount payable by the franchisee before the franchise business starts, which must be stated as being for the franchisor’s upfront legal costs relating to the agreement (and not for any of the franchisor’s future legal costs).	This amendment will require many franchisors to change their current practices. However, it does not prohibit franchisors charging those fees for franchise agreements in place before 1 July 2021. We query whether the change will simply lead to a restructuring of franchisor fee arrangements. Consideration will need to be given to the rights of franchisors to charge legal fees for the preparation of new franchise agreements upon renewals and transfers in circumstances where the business has already started.

Changes that impact dislcosure requirements
Overview	What is the change?	Our thoughts on the change
Franchisors must now prepare and provide to franchisees a ‘Key Facts Sheet.’ The provisions relating to the Key Facts Sheet apply from 1 July 2021.	The Key Facts Sheet must be provided by franchisors to franchisees, and updated annually, in the same way as a disclosure document. Details of the information that must be included in the Key Facts Sheet have not yet been published by the Australian Competition and Consumer Commission, but the Explanatory Statement suggests that the facts sheet is intended to be a simple summary of the information contained within a franchisor’s dislcosure document.	This is an additional compliance burden on franchisors. While the intention seems to be for the facts sheet to summarise critical information, it may have the unintended consequence of deterring franchisees from taking the time to comprehensively digest the content of a franchisor’s disclosure document. On the other hand, the current cumbersome and unhelpful form of disclosure can make it difficult for franchisees to cut through to the key information necessary for them to make an informed decision without obtaining expensive legal advice. The Key Facts Sheet may prove to be a very effective reform.
There are new requirements relating to information that must be disclosed by franchisors in dislcosure documents. The new dislcosure requirements must be contained in any disclosure documents given to franchisees on or after 1 November 2021.	Annexure 1 of the Code has been amended so that a range of new information must be included in a franchisor’s disclosure document. The following new requirements are of note. Disclosure of information relating to rebates and other financial benefits received by a franchisor from a supplier of goods or services to the franchisee. Amongst other details, franchisors must now disclose the total amount of the rebates received by the franchisor from each supplier in the previous financial year expressed as a single aggregate percentage of the total franchisee group purchases made from each supplier. A summary of information regarding the early termination rights of both a franchisor and a franchisee to terminate the franchise agreement. A summary of a franchisee’s rights relating to any goodwill generated by the franchisee under the franchise agreement. A summary of any restraints of trade included in the franchise agreement. Any earnings information given by the franchisor must now be attached to the dislcosure document.	Franchisors will need to pay particularly attention when updating their dislcosure documents this year to ensure that all new areas of disclosure are sufficiently addressed. Franchisors that receive supplier rebates will need to put some time into collating and calculating information relating to those rebates for disclosure purposes.

Other significant changes
Overview	What is the change?	Our thoughts on the change
There are now limitations on when a franchisor can require a franchisee to undertake significant capital expenditure. This change applies to: franchise agreements entered into, extended or renewed after 1 July 2021; and new vehicle dealership agreements entered into, extended or renewed after 1 June 2020.	All franchisors are now prohibited from requiring franchisees to undertake significant capital expenditure unless one of the following exceptions apply. The expenditure was disclosed in the franchisor’s dislcosure document before the franchisee executed, renewed or extended a franchise agreement. To rely on this exception: the information disclosed in the dislcosure document must include details of: the rationale for the expenditure; the amount, timing and nature of the expenditure the anticipated outcomes and benefits of the expenditure; and the expected risks associated with the expenditure; and before the franchise agreement is signed, the franchisor must discuss the expenditure with the franchisee, including the circumstances under which the franchisee is likely to recoup the expenditure. The majority of franchisees approve the expenditure. The expenditure is required to comply with legislative obligations. The expenditure is approved by the franchisee.	This is a significant change to the Code and expands the operation of provisions that were introduced last year in relation to new vehicle dealership agreements. Franchisors will need to implement a strategy around how they intend to enforce future capital expenditure requirements across their networks. For franchisors that will rely on disclosure, new processes will need to be established to ensure that adequate: information relating to all areas of potential expenditure is included in their disclosure documents; and records are kept to evidence discussions with franchisees regarding expenditure.
Conciliation and arbitration have been introduced as alternatives to mediation in the dispute resolution process under the Code. Parties can access the new dispute resolution processes in the Code for any disputes notified on or after 2 June 2021 (including where the relevant franchise agreement was entered into, extended or renewed before 2 June 2021).	The complaint handling procedure under the Code has been broadened to give the parties the option of attending a mediation or conciliation, and the Ombudsman now has the power to appoint either a conciliator or mediator (at the parties’ request). No guidance is provided as to how a conciliation is to be conducted or how it is intended to offer an alternative to, or be different from, mediation. The changes also introduce the option of the Ombudsman appointing an arbitrator to attempt to resolve the dispute, if both parties agree to this in writing. The arbitration must be conducted in Australia and once the process has commenced the parties must attend the arbitration (with fines applying if they don’t). In relation to arbitration, again, not much detail is provided about how the arbitration is to be conducted and which arbitration rules apply. This seems to suggest that those important issues will need to be resolved between the parties and the arbitrator once the arbitration process has commenced.	Overall we expect both franchisees and franchisors will maintain the status quo and continue to use mediation as their preferred method of resolving franchising disputes. It is possible in smaller party to party disputes (where lawyers are not engaged) that conciliation might assist the parties in reaching agreement given the proactive role of the conciliator. There may also be circumstances where a franchisor would opt for arbitration should it be in the parties’ interests to have a dispute resolved in a confidential arbitration as opposed to a public legal proceeding litigated in court.
The circumstances in which post-agreement restraints have no effect are now wider. This change applies to franchise agreements entered into, extended or renewed after 1 July 2021.	Under the previous regime, where a franchisee had requested to renew or extend the franchise agreement and the franchisor denied the request, the restraints would only be effective in certain circumstances, including (relevantly) where ‘the franchisee was in breach of the agreement or any related agreement’. This requirement has now been tightened in favour of franchisees so as only to apply where ‘the franchisee was in serious breach of the agreement or any related agreement immediately before the expiry of the franchise agreement.’	The amended provision makes it more difficult for franchisors to enforce post-expiry restraints and appears to be directed towards preventing the practice of franchisors relying on old or trivial franchise breaches when refusing renewal and then enforcing restraints. Unhelpfully, the Code is silent on what constitutes the time period ‘immediately before’ and what amounts to a ‘serious’ breach leaving the entire issue to be resolved by the Courts.

Changes specific to ‘new vehicle dealership agreements’

Overview

What is the change?

Our thoughts on the change

Courts must consider whether the terms of a new vehicle dealership agreement are ‘fair and reasonable’ in determining whether the parties have acted in good faith.

This change applies to new vehicle dealership agreements entered into, extended or renewed after 1 July 2021.

There is currently no legal guidance as to when the terms of an agreement will be ‘fair and reasonable.’

The Explanatory Statement offers little explanation in relation to this change, only noting that the purpose of the change is to enshrine the principle that manufacturers should act in good faith in negotiating and offering the substantive terms of an agreement, including terms relating to the duration of the agreement and the proposed calculation of compensation for dealers in the event of early termination.

This is a concerning amendment to the Code and we will need to wait and see how the words ‘fair and reasonable’ are interpreted by a Court before being able to provide meaningful guidance in relation to the scope of this change.

In the meantime, manufacturers should draw on:
- existing and understood legal concepts relating to ‘unfair contract terms,’ ‘unfair / unjust conduct’ and ‘reasonableness’; and
- the new requirements set out in Part 5 of the Code,
to guide how they approach the terms of their new vehicle dealership agreements.

Mandatory principles relating to new vehicle dealership agreements have been introduced.

This change applies to new vehicle dealership agreements entered into, extended or renewed after 1 July 2021.

There are two key principles introduced in Part 5 of the Code that are relevant to new vehicle dealership agreements.

New vehicle dealership agreements must contain provisions addressing compensation payable to dealers in specific circumstances.
- The first circumstance is if a dealer’s agreement is terminated before it expires as a result of a manufacturer withdrawing from the Australian market, rationalising its network or changing its distribution model. In these circumstances the agreement must:
  - specify how compensation will be determined, including for lost profit, unamortised capital expenditure, loss of opportunity in selling established goodwill and the costs of winding up the dealer’s business; and
  - contain provision for the franchisor to buy back or compensate the franchisee for new road vehicles, spare parts and special tools.
- The second circumstance is where a dealer’s agreement is not renewed or a new agreement is not entered into, in which case the agreement must contain provision for the franchisor to buy back or compensate the franchisee for new road vehicles, spare parts and special tools.
Manufacturers are prohibited from entering into new vehicle dealership agreements unless the tenure of the agreements is long enough to give dealers a reasonable opportunity to make a return on any investment required by the manufacturer as part the agreement.

Although initially the compensatory provisions appear concerning, they generally reflect:

the existing legal position of dealers to claim damages in the event that their agreements are terminated early by a manufacturer; and
common practice across the industry in relation to the buy back or compensation for new vehicles, parts and special tools when a dealer agreement comes to an end.

The principle regarding tenure is more impactful in that it will now require manufacturers to potentially provide significant tenure to dealers under their agreements (e.g. 5 plus years), and have some basis upon which to show that the tenure is an appropriate period of time that gives the dealer a reasonable opportunity to make a return on its financial investment.