The Franchising Code of Conduct: the new disclosure requirements and ensuring your Franchise Agreement complies with the Code

1.         The Franchising Code of Conduct

The Franchising Code of Conduct (the Code) was first introduced in 1993.  It was initially administered by a company limited by guarantee, the Franchise Code Council.  This Council was widely viewed as ineffective, as a result there was a parliamentary review of the franchising sector and on 1st July 1998 the Code was prescribed under the Trade Practices Act and was given the force of law. It is the only mandatory code under the Trade Practices Act.

The Code is now administered by the Australian Competition and Consumer Commission (ACCC) with the Minister for Small Business and Tourism having ministerial responsibility under the Code.

The Government established the Office of the Mediation Adviser (OMA) in 1998 to assist with the mediation of disputes between franchisees and franchisors.

The Code is designed to protect franchisees by ensuring that franchisees are given information that is material to the running of the franchise business and provides access to a fast and relatively inexpensive way to resolve any disputes.  This is achieved by requiring franchisors to disclose specific facts to franchisees and to follow set procedures in their dealings with franchisees and imposing certain conditions in the franchise agreements. It also provides mechanisms for resolving disputes.

The Code has been through several parliamentary reviews in 2001 and again in 2007.

2.         Maintenance of a disclosure document

Under the Code, the franchisor must create and maintain a disclosure document in the form and layout prescribed by the Code. If the franchised business has an expected annual turnover any time during the term of the agreement of $50,000 or more, the disclosure document must be in accordance with Annexure 1 to the Code.  If turnover is less than $50,000 per annum, the disclosure document must be in accordance with either Annexure 1 or Annexure 2. It is understood that there are very few disclosure documents issued under Annexure 2.

The franchisor is required to attach a copy of the proposed franchise agreement and a copy of the Code to the disclosure document.

The disclosure document must be given to a prospective franchisee or an existing franchisee proposing to renew or extend the scope or term of a franchise agreement.

Sub franchisors

Where a sub franchisor proposes to grant a sub franchise to a prospective sub franchisee, both the franchisor and the sub franchisor must give separate disclosure documents in relation to the master franchise and sub franchise respectively to the prospective sub franchisee.  Alternatively, a joint disclosure document by a franchisor and the sub franchisor may be given.  The sub franchisor is required to comply with the disclosure provisions of Part 2 of the Code. 

3.         Provision of Disclosure Document

Clause 6 of the Code requires a franchisor to provide a disclosure document to:

(a)        Prospective franchisees at least 14 days before they enter a franchise agreement, agree to do so or make a non-refundable payment to franchisor;

(b)        An existing franchisee proposing to renew or extend their agreement;

(c)        An existing franchisee upon written request (within 14 days).

The content of a disclosure document must be monitored to ensure that it does not contain misleading or deceptive information.

Clause 11 of the Code provides that the franchisor must not enter into, renew or extend a franchise agreement unless the franchisor has received:

• a written statement that the proposed franchisee/franchisee has received, read and had a reasonable opportunity to understand the disclosure document and the Code.
• a signed statement that the prospective franchisee has been given advice about the proposed agreement by any of an independent lawyer, accountant or business advisor or where a statement has not been provided by any of the 3 independent advisors a statement that the proposed franchisee has been told to get such advice but has decided not to seek it.

Lease

If the franchisee leases premises from the franchisor or an associate in connection with the business, the franchisor must provide a copy of the lease document one month after the lease is signed by the parties (clause 14 of the Code).

4.         Changes to Disclosure following March 2008 Amendments

Following concerns whether the disclosure provisions under the Code were working effectively, in 2006 the Government called for a review of Part 2 of the Code.  Mr Graham Matthews of KPMG was appointed to review its existing operation and identify areas where amendment was necessary.  The Matthews Committee consulted with a range of stakeholders including the ACCC, the OMA, representative organizations and individual franchisees and franchisors.  Regard was also had to regimes overseas namely the United States, Canada , Europe and Asia.

The regulations amending the Franchising Code of Conduct which came into effect on 1st March 2008 directly increased disclosure obligations for franchisors in disclosure documents and indirectly lengthened the period in practical requirements of disclosure.

The Regulations require franchisors to give a current disclosure document to franchisees proposing to extend the scope or term of the franchise agreement.  Previously a franchisor need only provide a disclosure document to prospective franchisees and franchisees proposing to renew or extend their franchise agreements. 

The Regulations now require a copy of the franchise agreement in the form in which it is to be executed be included in the documents given.

Typically a franchisor will have the franchisor’s pro forma franchise agreement available for intending franchisees.  This document will form the basis of negotiations for the franchise agreement which is ultimately agreed between the parties and once this document is settled, it must then be provided to the intending franchisee in final and executable form before the 14 day disclosure period begins to run.

Various technical amendments to the prescribed content of the disclosure documents have been made, which are summarised below:

• Front page – Warning: The warning that must be included on the front page of disclosure documents now makes it clear that franchisors can retain an amount equal to its “reasonable” expenses where a franchisee “cools off” if the expenses or their method of calculation have been set out in the agreement.
• Item 2 -   Franchisor details

The name, position, qualifications and business experience of each “officer” of the franchisor must be listed (whether or not they have management responsibilities for the business).  “Officer” is defined in the Corporations Act to include directors, secretaries and persons who participate in making significant decisions in relation to the business or who have the capacity to significantly affect the business’ financial standing.

• Item 3 – Business experience:

A summary of the relevant business experience in the last 10 years of each person mentioned in item 2.6 must be provided. This is more onerous as it covers each officer of the franchisor rather than just specified officers as previously required.

• Item 4 – Litigation: Disclosure of proceedings against the franchisor and the franchisor’s directors and the content of any order or undertaking must now be disclosed.

This requirement is extensive.  Commercial litigation often contains either an allegation of breach of the Trade Practices Act or the Corporations Act.  It is probably prudent   that an index search of the Courts in the relevant jurisdictions under the name of a franchisor and all its directors be conducted.

• Item 5 - Payments to agents

The payment of a "spotter's fee" to a franchisee or other incentives for introducing prospective franchisees should be noted as should payments to any 3rd parties. However only the name of the payee need be provided (and not the amount).

• Item 6 -   Existing franchises

Under item 6.5 disclosure is now required of the name, location and contact details of past franchisees that have been terminated, transferred the franchise or otherwise exited the system, during the past three years. The requirement is linked to the requirement in item 6.4 if the information is available. The franchisor does not have to provide the details if the prior franchisee has requested that the details not be provided. Franchisors must now keep records of departing franchisees.

The policy intent is that prospective franchisees should be able to speak to franchisees that have left the system, not just those still within it. A franchisor is taken to comply with item 6.4 if the name, location and contact details are provided.  It is arguable that if the franchisor complies with item 6.4, item 6.5 is satisfied.

• Item 7 – Intellectual property:          No new amendment
• Item 8 - Franchise site or territory :  No new amendment
• Item 9 – Supply of goods or services to a franchisee: The names of any parties that provide a rebate or financial benefit to the franchisor (or an associate of the franchisor) in connection with the supply of goods or services to franchisees must be disclosed. 

It is not necessary to disclose the amounts or method of calculation of such rebates or other benefits.

This had been a contentious recommendation by the Matthews Committee and the government moderated the initial proposal to require disclosure of the amounts or method of calculation following industry representations.

• Item 10 -   Supply of goods or services by a franchisee:  No new amendment
• Item 11-   Sites or territories

Details of whether the territory or site of the franchise has been subject to a franchised business operated by a previous franchise granted by the franchisor must be provided in a separate document and with the disclosure document.

• Item 12-   Marketing fund

This is related to the new provisions in clause 17 of the Code which require the fund to be audited within 4 months after the end of the financial year and a statement sent to the franchisee. The franchisor must keep details of who contribute, to the fund, how much must be contributed, who controls the fund, whether the fund is audited, the kind of expenses which it may be used, etc.

• Item 13 - Payments : No new amendment
• Item 14- Financing :  No new amendment
• Item 15 to 17 – Summary of obligations: The obligations of the franchisee and franchisor under the franchise agreement, and the key terms of the franchise agreement no longer need to be summarised in the disclosure document, but these obligations/terms must be cross referenced to the relevant terms in the franchise agreement.
• Item 18 – Related agreements: The current requirement to disclose any related agreements that the franchisee (or a party related to the franchisee) is required to enter into under the franchise agreement has been maintained.

However, all relevant documents must be provided to the franchisee 14 days before the date that the franchisee signs the franchise agreement, or when they otherwise become available.

This includes leases, licences of intellectual property, etc

• Item 19 -   Earnings information: No new amendment
• Item 20 – Financial details: The financial reporting requirements under Item 20 have been extended to include any consolidated entity to which the franchisor belongs if:

Foreign franchisors

The exemption for foreign franchisors has been removed (see clause 5(3)), and the Code will now apply to franchisors that:

Associates

The definition of “associates” of the franchisor has been extended to include a party who supplies real property to a franchisee (e.g. as landlord).

5.         Mandatory Conditions of Franchise Agreement – Code of Conduct

Cooling off period ( clause 13 of the Code):

A franchisee can terminate an agreement within seven days after the earlier of entering into the agreement or making a payment under the agreement.

Copy of lease (clause 14 of the Code)

If a franchisee leases premises from the franchisor or an associate of the franchisor, a franchisor must give to the franchisee either a copy of the agreement to lease or a copy of the lease.

Association of franchisees or prospective franchisees (clause 15 of the Code)

A franchisor must not induce franchisees or prospective franchisees form forming an association or associating with other franchisees or prospective franchisees

Prohibition of release from liability (clause 16 of the Code)

Section 16 of the Code now prohibits Franchise Agreements entered into after 1 October 1998 containing or requiring franchisees to sign a general release from liability and it has been extended to a waiver of any verbal or written representation made by the franchisor.

Marketing and other cooperative funds (clause 17 of the Code)

Franchisors are now allowed for 4 months to prepare the annual financial statements of the marketing fund instead of previously three and the report is no longer required to breakdown the amount spent on production, advertising or administration etc.

A copy of the statement must be provided to franchisees within 30 days of its preparation unless 75% of the franchisees agree that the franchisor does not have to do so.   If consent has been given, it lasts for two years.

It seems that both voluntary and compulsory marketing funds are caught by the provisions.

The Concept of Continuing Disclosure ( clause 18 of the Code)

Franchisors are required to continually disclose "materially relevant facts" to franchisees including:

1. A judgment or an award against a director of the franchisor in addition to the franchisor;
2. Civil proceedings against a director of the franchisor by at least 10 or 10% of franchisees (in addition to proceedings against the franchisor); and 
3. Any undertaking provided by the franchisor to the ACCC in relation to a breach of the Trade Practices Act.

In addition, disclosure of materially relevant facts must occur within 14 days of the relevant fact occurring (previously 60 days)

Mandatory Terms to Transfer, Assignment and Termination

The franchisor cannot unreasonably withhold its consent to the transfer or assignment of the franchise. It is reasonable to refuse in the following circumstances:

1. the proposed transferee is unlikely to be able to meet the financial obligations that the proposed transferee would have under the franchise agreement; or
2. the proposed transferee does not meet a reasonable requirement of the franchise agreement for the transfer of a franchise; or
3. the proposed transferee has not met the selection criteria of the franchisor; or
4. the agreement to the transfer will have a significantly adverse effect on the franchise system; or
5. the proposed transferee does not agree in writing to comply with the obligations of the franchisee under the franchise agreement; or
6. the franchisee has not paid or made reasonable provision to pay an amount owing to the franchisor; or
7. the franchisee has breached the franchise agreement and has not remedied the breach.

The franchisor is taken to have given consent to the transfer if the franchisor does not, within 42 days after the request was made, give to the franchisee written notice:

1. that consent is withheld; and
2. setting out why consent is withheld.

Termination

The Code prescribes the circumstances and manner in which franchisors can terminate agreements and limits their ability to do so.  Termination that fails to comply with the Code will not be effective and may amount to unconscionable conduct under The Trade Practices Act.

Termination in the event of a franchisee breach

If a franchisee breaches a material provision of the franchise agreement, the franchisor must:

1. give reasonable notice (which need not be greater than 30 days) of its intention to terminate; and
2. provide clear and unequivocal notice to the franchisee of what needs to be done to remedy the breach, and the timeframe for doing so.

If the franchisee remedies the breach during the prescribed period, franchisor cannot proceed to termination.

Termination in the absence of a franchise breach

Where the franchisor has the right under a franchise agreement to terminate the agreement where there has been no breach by the franchisee, if the franchisor wishes to exercise that right, it must provide the franchisee with reasonable written notice of its intention including the reasons for it.

Termination under special circumstances

The franchisor does not have to comply with the termination procedures outlined in the Code, and may terminate without notice, when the franchisee:

1. fails to hold a required licensed to carry on the business;
2. is insolvent or is under administration;
3. voluntarily abandons the franchise;
4. is convicted of a serious offence;
5. operates the business so as to endanger the health or safety of the public;
6. is fraudulent; or
7. agrees to the  termination.

Resolving Disputes

Part 4 of the Code deals with dispute resolution. A franchise agreement entered into after 1 October 1998 must contain a complaint handling procedure that complies with clause 29 and 30. This includes the right to appoint a mediator to mediate any dispute.

The ACCC advises that the Office of Mediation Advisor figures reveal that approximately 70% of disputes which are mediated end up settling.[1]

6.         Consequences for failing to comply with the Code Illegal Contracts – General Law

The recent case of Ketchell v Master Education Services Pty Ltd [2007] NSWCA 161 the New South Wales Court of Appeal held that although the franchisor had substantively complied with its obligations under the Code, its failure to receive a Code Certificate prior to entering into a franchise agreement rendered that agreement illegal and unenforceable.  As clause 11 of the Code states that a franchisor “must not” enter into a franchise agreement or accept a non refundable payment before receiving a Code Certificate, the Court had no discretion to decide whether or not the agreement was enforceable. It was unenforceable. The case was appealed to the High Court which decided on 27 August 2008 that a beach of the Code does NOT result in the franchise agreement being void for illegality

In Hoy Mobile Pty Ltd v Allphones Retail Pty Ltd No. 2 [2008] FCA 810 the Federal Court refused to follow the New South Wales Court of Appeal in Ketchell and said the intention of the Code was to protect the position of franchisees not to denude them of the capacity to enforce rights against the franchisor by reason of a failure on the part of the franchisor.  The High Court in Ketchell has now vindicated this decision.

Breach of the Trade Practices Act – statutory

Although the prescriptive words “must not” are not used elsewhere in the Code, the Franchising Code of Conduct is a mandatory code under the Trade Practices Act.  Therefore, any breach of the Code allows the Court to impose any sanction specified in Part VI of the Act as it sees fit.

S. 51AD Trade Practices Act provides that a corporation must not contravene an applicable  industry code.

Injunctions

1. Requiring a person to do an act or thing: s. 80(5); or
2. Restraining a person from engaging in specified conduct: s. 80(4).

Orders

1. To disclose information or publish corrective advertising: s. 80A;
2. To compensate people who have suffered loss or damage (or are likely to) as a result of a contravention: s. 87;
3. Under s87, orders:
   • refusing to enforce a contract or declaring all or part of a contract or arrangement void;
   • varying any contract or arrangement in any manner and from any date;
   • that money be refunded or property returned;
   • the payment of compensatory damages;
   • the repair or the provision of parts for goods supplied;
   • the supply of specified services; and
   • varying or terminating the operation of an instrument creating or transferring an interest in land.

Compensation

            For loss or damage caused a breach of the Code: s. 82 TPA

Various other heads of relief and remedies under the general law; e.g. unconscionable conduct, estoppel, undue influence, breach of duty of good faith.

Contact: David Beale - dbeale@rbhm.com.au