So you have decided to become a franchisor. Congratulations! This is a very exciting time indeed. A successful franchise agreement is a classic win-win scenario in which both franchisee and franchisor can prosper.
However, experience shows us that not all franchise agreements result in success. In fact, the relationship between franchisor and franchisee can often become strained during the course of the agreement and is liable to break down for any number of reasons.
Using an obvious example, let us consider the situation where a franchised business does not generate revenue anywhere near what was initially expected by the franchisee. Who, if anyone, is to blame? If it turns out that the franchisor did not provide accurate information to the franchisee, what recourse does the franchisee have against the franchisor?
In this article, we provide a brief overview of the relevant law in Australia for the consideration of prospective franchisees.
The Legislative Framework in Australia
The Franchising Code of Conduct (Franchising Code) is a mandatory industry code that applies to most franchise agreements within Australia. It came into effect on 1 January 2015.
The Franchising Code is designed to regulate the conduct of parties to a franchise agreement towards each other. It brought about significant changes to the pre-existing law, largely for the benefit of franchisees.
Some of the main changes the Franchising Code brought about include:
1. A general obligation for parties to a franchise agreement to act in good faith;
2. Increased disclosure obligations on franchisors, including a new information statement that franchisors must give to any prospective franchisee;
3. A requirement for franchisors to provide greater transparency to franchisees as to how money provided by franchisees for marketing and advertising is used;
4. A prescribed dispute resolution mechanism;
5. Financial penalties and infringement notices for serious breaches; and
6. A prohibition on franchisors imposing significant capital expenditure (except in limited circumstances).
Obligation to act in good faith
The obligation to act in good faith under the Franchising Code applies to not only the term of the franchise agreement, but also to any negotiation discussions leading up to the agreement, and any disputes arising after termination.
If a dispute is unable to be resolved and ends up in Court, consideration shall be given as to whether each party acted honestly and cooperatively to achieve the agreement. The Court may also take other considerations into account in making its determination.
The obligation to act in good faith cannot be excluded by operation of the franchise agreement or any documents relating to the franchise agreement. Put simply, neither party may contract out their obligation to act in good faith towards the other party.
Disclosure requirements under the Franchising Code
The disclosure requirements under the Franchising Code require franchisors to provide prospective franchisees with an information statement as soon as practicable after receiving an expression of interest. The information statement is in a prescribed form contained in Schedule 1 - Annexure 2 of the Franchising Code.
In addition, the disclosure document contained in Schedule 1 - Annexure 1 of the Franchising Code requires franchisors to provide additional information to prospective franchisees over and above what was previously required. For example, the new disclosure document must disclose details of any master franchise and the end of term rights of the franchisee, including any option to renew exercisable by the franchisee.
Does the Franchising Code apply to your franchise agreement?
In order for Franchising Code to apply to a franchise agreement, it must meet the following conditions:
the franchisor has granted the franchisee the right to carry on the business of offering, supplying or distributing goods or services in Australia under a system or marketing plan substantially determined, controlled or suggested by the franchisor (or an associate of the franchisor);
the operation of the business is substantially or materially associated with a trademark, advertising or commercial symbol that is owned, used, licensed or specified by the franchisor (or their associate); and
the franchisee is required to pay, or has agreed to pay, a fee to the franchisor (or its associate) before starting or continuing the business, which may be:
an initial capital investment fee;
a payment for goods or services;
a fee based on a percentage of gross or net income; or
a training fee or training school fee.
It is important to note that even if the above requirements are met, the Franchising Code may still not apply. Specifically, the Franchising Code will not apply if:
the agreement was entered into before 1 October 1998 (unless that agreement has been transferred, renewed or extended on or after that date);
another mandatory industry code applies to the agreement; or
the agreement is for goods or services that are substantially the same as those supplied by the franchisee for at least two years immediately prior to entering the franchise agreement, and are likely to provide no more than 20 per cent of the franchisee’s gross turnover for goods or services in the first year of the franchise.
The Franchising Code has operated to stifle various types of predatory business practices of franchisors and has been a welcome addition for franchisees.
However, the protections afforded by the Franchising Code are not absolute, and prospective franchisees should still exercise caution and undertake their own due diligence before entering into a franchise agreement.
If you would like more specific advice in relation to your current or prospective franchise agreement, we recommend you contact Edwards Mac Scovell.