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New franchising disclosure document guidance – your document may not measure up

Franchising in Australia is a sector under scrutiny.

The sector has been digesting the content of the Fairness in Franchising report and the inter-agency Franchising Taskforce has been established.

In the meantime, the Australian Competition and Consumer Commission (ACCC) has released both a new model franchising disclosure document and a report on Disclosure Practices in Food Franchises (ACCC Disclosure Report). Franchisors may be surprised to learn that their disclosure document may fall materially short of the standards expected by the ACCC.

In this article we:

  • provide an update on the status of the Taskforce’s enquiries
  • outline the key findings of the ACCC Disclosure Report and new model disclosure document, and key action items for franchisors.

The Fairness in Franchising Report – where are we now?

In March 2019 we published a Quick Reference Guide regarding the long-awaited Fairness in Franchising report prepared by the Parliamentary Joint Committee on Corporations and Financial Services. The Report proposed far-reaching changes to the Franchising Code of Conduct (Code).

Many of the recommendations set out in the Fairness in Franchising report were to refer the matter to a ‘to be established’ Franchising Taskforce for further consideration. The role of the Franchising Taskforce was proposed to be to examine the feasibility and implementation of the recommendations. The Taskforce has now been established and is comprised of officers from the Department of Employment, Skills, Small and Family Business, the Department of the Treasury and the Department of the Prime Minister and Cabinet.

The Taskforce has released an Issues Paper that is intended to generate feedback and is framed around the Committee’s recommendations. The deadline for responses to the Issues Paper, which will not be published, is 5pm (AEST) on Friday, 20 September 2019. The Taskforce will use the consultation process to inform the development of the Regulation Impact Statement (essentially final options and recommendations) and advice to the Government on its response to the Report.

Disclosure documents – the new high watermark of best practice

The ACCC has reported on the key findings of 12 targeted compliance checks, conducted this year, on franchise systems in the food services sector. Its report is titled Disclosure Practices in Food Franchising.

The ACCC, in its media release earlier this year, put the food services sector on notice that it would be focusing on businesses in that sector. The ACCC receives around 400 complaints and reports about franchising each year, but in the back half of 2018 the most common reports were about café, restaurant and take away food franchised businesses. Hence the ACCC’s focus on this sector.

It is fair to conclude that the ACCC was not impressed by the results of its compliance checks. It found, “… concerning disclosure practices by franchisors that limited a potential purchaser’s ability conduct due diligence”[1], as well as conduct that may warrant enforcement action.

In parallel, the ACCC has updated its model franchising disclosure, and the new template dated 26 August 2019 is publicly available (New Disclosure Template). The New Disclosure Template is annotated, and provides guidance as to what the ACCC considers reflects best practice and compliance with the Code. The New Disclosure Template picks up, and focuses on, many of the issues identified in the ACCC Disclosure Report.

The key issues covered by the ACCC Disclosure Report and guidance provided in the New Disclosure Template are as follows:

1. Franchisors make it too difficult for potential franchisees to contact former franchisees as part of their due diligence

The ACCC Disclosure Report found that 8 out of 12 franchisors subject to compliance checks made it difficult to contact former franchisees.

Section 6.5 of the disclosure document requires franchisors to provide the ‘name, location and contact details’ of each franchisee that has exited the network in the last three financial years.

The ACCC’s view is that email addresses and mobile numbers are the preferred contact details to provide. It considers that providing only contact details of the previous franchisee’s business location is unlikely to satisfy the Code’s requirements, given that they will no longer be contactable there.

2. Disclosure of supply chain details

The ACCC Disclosure Report concluded that 7 out of 12 franchisors subject to compliance checks did not adequately disclose what essential goods were subject to supply restrictions.

Various provisions in sections 10 and 11 of the disclosure document require franchisors to disclose details regarding the supply of goods or services to franchisees, in particular the existence of supply restrictions.

The ACCC’s view is that simply explaining the structure set out in the franchise agreement for the acquisition of goods and services by a franchisee is not sufficient. That is, stating that there may be categories of goods and services that:

  • must be acquired from a specific supplier nominated by the franchisor
  • must be acquired from one of a panel of suppliers approved by the franchisor
  • may be acquired from the franchisee’s choice of supplier

is not sufficient. The ACCC’s view is as follows:[2]

  • in order to ensure compliance, information that is likely to be considered to be important and significantly relevant to a franchisee about the specified matter should be disclosed. This would include names of suppliers and specific types of goods and services that franchisees must obtain from a nominated or approved supplier
  • if there is a current preferred supplier but the agreement allows the franchisor to unilaterally change the supplier, then this should be stated.

The ACCC has also noted that it is not sufficient to simply refer to the operations manual, and that whilst many franchise agreements allow franchisees to source goods and services from outside of the supply chain with consent, it is not clear how often this happens in practice.

3. Disclosure of rebate details

The ACCC drew links between the fact that most franchisors subject to a compliance check had supply restrictions, did not share the benefits of rebates from suppliers with franchisees and could set maximum retail prices.

There is nothing, in and of itself, problematic with franchisors doing any of the things noted above, provided that they are disclosed as required under the Code. In the ACCC Disclosure Report, the ACCC did not assert that any of the franchisors surveyed had incorrectly disclosed whether or not they shared supplier rebates with their network, and noted that franchisors were not required to disclose whether or not they sought to cap prices within their franchised network (where permissible under the Competition and Consumer Act 2010 (Cth)).

Rebates from suppliers is a key revenue stream for many franchisors. However, the ACCC is keen for franchisees to understand how aspects of a supply chain might hang together, and provided the following example:

  • a franchisee must obtain coffee beans from a specific supplier (even though it could obtain beans cheaper elsewhere)
  • the franchisor obtains a rebate each time a franchisee acquires coffee beans from the supplier, but doesn’t share this benefit with franchisees
  • the franchisor enacts a marketing campaign which limits the maximum retail price of coffees to $3, this may impact the profitability of the franchisee for the duration of the promotion.

The ACCC referred to the laws prohibiting unfair contract terms in this context, and seemed to flag that it may look to apply these laws in relation to such terms.

There is obviously a range of legitimate reasons, beneficial for franchisees and customers, why such provisions are necessary, including quality control and brand protection. The above example provided by the ACCC does not reference the fundamental purposes such provisions serve. However, it is relevant to continually assess a franchise agreements compliance with unfair contract term laws (if applicable) and the ACCC’s comments are a reminder to do so.

4. Disclosure of key unavoidable costs

The ACCC Disclosure Report found that a third of franchisors checked were not sufficiently disclosing key unavoidable costs such as wages, rent or inventory.

Section 14 of the disclosure document requires franchisors to disclose various details about the costs associated with operating a franchised business, including start-up costs, reoccurring costs and amounts payable to third parties.

It is clear that completion of this section is difficult for many franchisors, because disclosure documents are a ‘one size fits all’ document, whereas the costs required to be disclosed are not. The costs may vary significantly depending on the nature of the specific business in question. Moreover, the franchisor may not itself operate any unit businesses, and may find it very difficult to accurately estimate costs that may be payable to third parties (such as rent and wages). However, these difficulties do not absolve franchisors of their responsibility and the requirement to do so. The Code does provide some flexibility, as if the amount cannot be easily worked out, the upper and lower limits can be instead disclosed.

Some of the issues identified by the ACCC were that franchisors were not disclosing amounts, but instead were simply referring to categories, such as ‘rent’ or ‘wages’. The ACCC also noted that representations in disclosure documents as to future costs, if incorrect, may render a franchisor liable to actions for misleading and deceptive conduct under The Australian Consumer Law.

Key takeaways for franchisors

In light of the concerns identified by the ACCC, and its updated guidance, all franchisors should review their disclosure documents and, if necessary, improve their disclosure practices. As most franchisors are currently in the process of conducting their annual updates, this is a prime time to do so. A summary of our suggested action items is as follows:

  • Review the contact details provided for past franchisees

Ideally mobile numbers and email addresses should be provided. It may be that processes for the collection of information from franchisees needs to be updated to obtain this information on an ongoing basis.

  • Review the responses regarding the supply chain in the disclosure document

An analysis should occur whereby a franchisor considers:

  • what goods and services are subject to an approved or mandated supply chain?
  • within each category, what goods and services are material and relevant to a franchisee?
  • to what extent does the disclosure document currently provide details of these goods, services and suppliers, and therefore what changes may be appropriate?

The ACCC also seems to be noting that if franchisees are contractually permitted to go outside of the preferred or mandated supply chain, but in practice rarely do so, that this may be relevant to a prospective franchisee.

Franchisors will need to consider whether their disclosure documents need to be updated if the goods, services or supplier identities change mid-year.

  • Ensure your franchise agreement complies with unfair contract terms laws

All franchisors who have agreements subject to the unfair contract term laws should have undertaken this exercise already. Further background can be found in our article produced when the laws were introduced in 2016.

However, this should not be a ‘set and forget’ process, and franchisors need to continually be alive to whether or not what is ‘reasonably necessary’ and therefore what terms may be ‘unfair’ has changed over time. This needs to be assessed in the context of the document as a whole.

  • Review costs disclosure sections and make sure disclosures are comprehensive and accurate

Franchisors should develop a strategy around cost disclosures, which should include the use of notes to explain the assumptions upon which cost disclosures are based (if applicable) and details as to how estimates have been calculated. Costs sections should be reviewed annually to ensure they are still relevant. If a proposed franchised business has unique characteristics that render the cost estimates or disclosures unreliable, then franchisors should be providing additional disclosure with the disclosure document that includes specific cost information for that site.

If you would like to discuss disclosure requirements further, please get in touch with a member of our Consumer Markets & Franchising team.

[1] See Page 1 of the ACCC’s Disclosure Practices in Food Franchising report dated August 2019.

[2] See section 10, page 18 of the model disclosure document.

AUTHORS
Jessica Reid | Partner
T
 +61 3 9258 3539
Jessica.Reid@maddocks.com.au
Georgia DeCastella | Graduate Lawyer
+61 3 9258 3326
Georgia.DeCastella@maddocks.com.au

 

Franchising in Australia is a sector under scrutiny.

The sector has been digesting the content of the Fairness in Franchising report and the inter-agency Franchising Taskforce has been established.

In the meantime, the Australian Competition and Consumer Commission (ACCC) has released both a new model franchising disclosure document and a report on Disclosure Practices in Food Franchises (ACCC Disclosure Report). Franchisors may be surprised to learn that their disclosure document may fall materially short of the standards expected by the ACCC.

In this article we:

  • provide an update on the status of the Taskforce’s enquiries
  • outline the key findings of the ACCC Disclosure Report and new model disclosure document, and key action items for franchisors.

The Fairness in Franchising Report – where are we now?

In March 2019 we published a Quick Reference Guide regarding the long-awaited Fairness in Franchising report prepared by the Parliamentary Joint Committee on Corporations and Financial Services. The Report proposed far-reaching changes to the Franchising Code of Conduct (Code).

Many of the recommendations set out in the Fairness in Franchising report were to refer the matter to a ‘to be established’ Franchising Taskforce for further consideration. The role of the Franchising Taskforce was proposed to be to examine the feasibility and implementation of the recommendations. The Taskforce has now been established and is comprised of officers from the Department of Employment, Skills, Small and Family Business, the Department of the Treasury and the Department of the Prime Minister and Cabinet.

The Taskforce has released an Issues Paper that is intended to generate feedback and is framed around the Committee’s recommendations. The deadline for responses to the Issues Paper, which will not be published, is 5pm (AEST) on Friday, 20 September 2019. The Taskforce will use the consultation process to inform the development of the Regulation Impact Statement (essentially final options and recommendations) and advice to the Government on its response to the Report.

Disclosure documents – the new high watermark of best practice

The ACCC has reported on the key findings of 12 targeted compliance checks, conducted this year, on franchise systems in the food services sector. Its report is titled Disclosure Practices in Food Franchising.

The ACCC, in its media release earlier this year, put the food services sector on notice that it would be focusing on businesses in that sector. The ACCC receives around 400 complaints and reports about franchising each year, but in the back half of 2018 the most common reports were about café, restaurant and take away food franchised businesses. Hence the ACCC’s focus on this sector.

It is fair to conclude that the ACCC was not impressed by the results of its compliance checks. It found, “… concerning disclosure practices by franchisors that limited a potential purchaser’s ability conduct due diligence”[1], as well as conduct that may warrant enforcement action.

In parallel, the ACCC has updated its model franchising disclosure, and the new template dated 26 August 2019 is publicly available (New Disclosure Template). The New Disclosure Template is annotated, and provides guidance as to what the ACCC considers reflects best practice and compliance with the Code. The New Disclosure Template picks up, and focuses on, many of the issues identified in the ACCC Disclosure Report.

The key issues covered by the ACCC Disclosure Report and guidance provided in the New Disclosure Template are as follows:

1. Franchisors make it too difficult for potential franchisees to contact former franchisees as part of their due diligence

The ACCC Disclosure Report found that 8 out of 12 franchisors subject to compliance checks made it difficult to contact former franchisees.

Section 6.5 of the disclosure document requires franchisors to provide the ‘name, location and contact details’ of each franchisee that has exited the network in the last three financial years.

The ACCC’s view is that email addresses and mobile numbers are the preferred contact details to provide. It considers that providing only contact details of the previous franchisee’s business location is unlikely to satisfy the Code’s requirements, given that they will no longer be contactable there.

2. Disclosure of supply chain details

The ACCC Disclosure Report concluded that 7 out of 12 franchisors subject to compliance checks did not adequately disclose what essential goods were subject to supply restrictions.

Various provisions in sections 10 and 11 of the disclosure document require franchisors to disclose details regarding the supply of goods or services to franchisees, in particular the existence of supply restrictions.

The ACCC’s view is that simply explaining the structure set out in the franchise agreement for the acquisition of goods and services by a franchisee is not sufficient. That is, stating that there may be categories of goods and services that:

  • must be acquired from a specific supplier nominated by the franchisor
  • must be acquired from one of a panel of suppliers approved by the franchisor
  • may be acquired from the franchisee’s choice of supplier

is not sufficient. The ACCC’s view is as follows:[2]

  • in order to ensure compliance, information that is likely to be considered to be important and significantly relevant to a franchisee about the specified matter should be disclosed. This would include names of suppliers and specific types of goods and services that franchisees must obtain from a nominated or approved supplier
  • if there is a current preferred supplier but the agreement allows the franchisor to unilaterally change the supplier, then this should be stated.

The ACCC has also noted that it is not sufficient to simply refer to the operations manual, and that whilst many franchise agreements allow franchisees to source goods and services from outside of the supply chain with consent, it is not clear how often this happens in practice.

3. Disclosure of rebate details

The ACCC drew links between the fact that most franchisors subject to a compliance check had supply restrictions, did not share the benefits of rebates from suppliers with franchisees and could set maximum retail prices.

There is nothing, in and of itself, problematic with franchisors doing any of the things noted above, provided that they are disclosed as required under the Code. In the ACCC Disclosure Report, the ACCC did not assert that any of the franchisors surveyed had incorrectly disclosed whether or not they shared supplier rebates with their network, and noted that franchisors were not required to disclose whether or not they sought to cap prices within their franchised network (where permissible under the Competition and Consumer Act 2010 (Cth)).

Rebates from suppliers is a key revenue stream for many franchisors. However, the ACCC is keen for franchisees to understand how aspects of a supply chain might hang together, and provided the following example:

  • a franchisee must obtain coffee beans from a specific supplier (even though it could obtain beans cheaper elsewhere)
  • the franchisor obtains a rebate each time a franchisee acquires coffee beans from the supplier, but doesn’t share this benefit with franchisees
  • the franchisor enacts a marketing campaign which limits the maximum retail price of coffees to $3, this may impact the profitability of the franchisee for the duration of the promotion.

The ACCC referred to the laws prohibiting unfair contract terms in this context, and seemed to flag that it may look to apply these laws in relation to such terms.

There is obviously a range of legitimate reasons, beneficial for franchisees and customers, why such provisions are necessary, including quality control and brand protection. The above example provided by the ACCC does not reference the fundamental purposes such provisions serve. However, it is relevant to continually assess a franchise agreements compliance with unfair contract term laws (if applicable) and the ACCC’s comments are a reminder to do so.

4. Disclosure of key unavoidable costs

The ACCC Disclosure Report found that a third of franchisors checked were not sufficiently disclosing key unavoidable costs such as wages, rent or inventory.

Section 14 of the disclosure document requires franchisors to disclose various details about the costs associated with operating a franchised business, including start-up costs, reoccurring costs and amounts payable to third parties.

It is clear that completion of this section is difficult for many franchisors, because disclosure documents are a ‘one size fits all’ document, whereas the costs required to be disclosed are not. The costs may vary significantly depending on the nature of the specific business in question. Moreover, the franchisor may not itself operate any unit businesses, and may find it very difficult to accurately estimate costs that may be payable to third parties (such as rent and wages). However, these difficulties do not absolve franchisors of their responsibility and the requirement to do so. The Code does provide some flexibility, as if the amount cannot be easily worked out, the upper and lower limits can be instead disclosed.

Some of the issues identified by the ACCC were that franchisors were not disclosing amounts, but instead were simply referring to categories, such as ‘rent’ or ‘wages’. The ACCC also noted that representations in disclosure documents as to future costs, if incorrect, may render a franchisor liable to actions for misleading and deceptive conduct under The Australian Consumer Law.

Key takeaways for franchisors

In light of the concerns identified by the ACCC, and its updated guidance, all franchisors should review their disclosure documents and, if necessary, improve their disclosure practices. As most franchisors are currently in the process of conducting their annual updates, this is a prime time to do so. A summary of our suggested action items is as follows:

  • Review the contact details provided for past franchisees

Ideally mobile numbers and email addresses should be provided. It may be that processes for the collection of information from franchisees needs to be updated to obtain this information on an ongoing basis.

  • Review the responses regarding the supply chain in the disclosure document

An analysis should occur whereby a franchisor considers:

  • what goods and services are subject to an approved or mandated supply chain?
  • within each category, what goods and services are material and relevant to a franchisee?
  • to what extent does the disclosure document currently provide details of these goods, services and suppliers, and therefore what changes may be appropriate?

The ACCC also seems to be noting that if franchisees are contractually permitted to go outside of the preferred or mandated supply chain, but in practice rarely do so, that this may be relevant to a prospective franchisee.

Franchisors will need to consider whether their disclosure documents need to be updated if the goods, services or supplier identities change mid-year.

  • Ensure your franchise agreement complies with unfair contract terms laws

All franchisors who have agreements subject to the unfair contract term laws should have undertaken this exercise already. Further background can be found in our article produced when the laws were introduced in 2016.

However, this should not be a ‘set and forget’ process, and franchisors need to continually be alive to whether or not what is ‘reasonably necessary’ and therefore what terms may be ‘unfair’ has changed over time. This needs to be assessed in the context of the document as a whole.

  • Review costs disclosure sections and make sure disclosures are comprehensive and accurate

Franchisors should develop a strategy around cost disclosures, which should include the use of notes to explain the assumptions upon which cost disclosures are based (if applicable) and details as to how estimates have been calculated. Costs sections should be reviewed annually to ensure they are still relevant. If a proposed franchised business has unique characteristics that render the cost estimates or disclosures unreliable, then franchisors should be providing additional disclosure with the disclosure document that includes specific cost information for that site.

If you would like to discuss disclosure requirements further, please get in touch with a member of our Consumer Markets & Franchising team.

[1] See Page 1 of the ACCC’s Disclosure Practices in Food Franchising report dated August 2019.

[2] See section 10, page 18 of the model disclosure document.

AUTHORS
Jessica Reid | Partner
T
 +61 3 9258 3539
Jessica.Reid@maddocks.com.au
Georgia DeCastella | Graduate Lawyer
+61 3 9258 3326
Georgia.DeCastella@maddocks.com.au