Disclosure Document Update Season
By Raynia Theodore, Principal, MST Lawyers
Franchisors, it’s that time of year again!
The Franchising Code of Conduct (the Code) requires franchisors to review and update their Disclosure Documents within four months of the end of each financial year. For franchisors with a financial year ending 30 June this means the update for the financial year ending 30 June 2022 must be completed by 31 October 2022.
Increasing importance of a current Disclosure Document
Non-compliance with the Code by franchisors continues to be on the radar of the Australian Competition and Consumer Commission (ACCC). Given the recent changes to the Code it is expected the ACCC will remain active in the franchising sector and want to test the new provisions and also check franchisor compliance with the new legal obligations.
Under the Code, the ACCC has significant audit and investigative powers and can issue infringement notices currently to $11,100 for a corporation. Further, pecuniary penalties of up to $133,200 per non-compliance can be ordered by the Federal Court for non-compliance with the Code.
Provisions of the Code which attract a penalty for non-compliance include the obligations on franchisors to:
- create a compliant Disclosure Document (clause 8(1));
- update their Disclosure Document within four months after the end of each financial year (clause 8(6));
- give each prospective franchisee a copy of the Code, the new Key Facts Sheet (see below), the Disclosure Document, the Franchise Agreement in the form it is to be executed and other ancillary documents:
- at least 14 days before the prospective franchisee enters into a franchise agreement or makes a non-refundable payment in connection with the proposed franchise agreement (clause 9(1));
- at least 14 days before renewal or extension of the Franchise Agreement (clause 9(2));
- at least 14 days before a franchisor provides its consent to a transfer of a franchise;
- within four months after the end of the last financial year, prepare a statement showing the receipts and expenses of any marketing or other co-operative fund(s) for the last financial year and provide a copy of the statement to each franchisee of the network within 30 days of its preparation (clause 15(2));
- within four months after the end of the financial year to which it relates, have the statement of receipts and expenses of the marketing fund or the co-operative fund audited by a registered company auditor and provide a copy of the auditor’s report to each franchisee of the network within 30 days of receiving it (clause 15(2) and (4));
- notify franchisees, in writing, whether the franchisor intends to extend the franchise agreement or enter into a new franchise agreement at the end of a franchise agreement (clause 18).
On 2 September 2021 the Treasury Laws Amendment (2021 Measures No. 6) 6 Act 2021 (Cth) was passed by the Federal Parliament and has introduced civil penalty provisions to the Code as follows:
- For contraventions by a body corporate, the greater of:
- $10 million;
- if the Court can determine the value of the benefit that the body corporate, and any body corporate related to the body corporate, has obtained directly or indirectly and that is reasonably attributable to the contravention—3 times the value of that benefit; or
- if the Court cannot determine the value of that benefit—10% of the annual turnover of the body corporate during the period of 12 months ending at the end of the month in which the contravention occurred.
- For contraventions by an individual or a person who is not a body corporate, $500,000.
The civil penalties apply to failure to disclose materially relevant facts including updated financial statements and declarations and facts such as a change in majority ownership of the franchisor, certain proceedings and judgments against the franchisor
Updates You Can Make
In light of the above it is more important than ever before for franchisors to comply with the Code and their disclosure obligations. Many of the changes required for the annual update of the Disclosure Document are factual in nature, accordingly, Franchisors can update these sections themselves, including the following:
- details of associates and officers (Item 2) and their business experience (Item 3);
- details of any litigation (Item 4);
- details of the number of existing franchisees and franchised businesses, including their addresses, telephone numbers and the year each franchisee commenced operation (Items 6.1 to 6.3);
- details of the following key events for each of the last three completed financial years (2020, 2021 and 2022) (Item 6.4):
- franchises transferred;
- franchised businesses that ceased operating;
- franchise agreements that either the franchisor or franchisee terminated;
- franchise agreements that were not extended (as defined in the Code);
- franchised businesses that the franchisor bought back;
- franchise agreements that ended when the franchisor acquired the franchised business.
- the name, location and contact details for franchisees involved in any of the above key events, unless the franchisees have specifically asked that their details remain undisclosed (Item 6.5);
- changes to intellectual property (Item 8);
- payments (Item 14), including payments to third parties (Item 14.7) and significant capital expenditure (Item 14.10) where relevant.
- marketing or other co-operative fund expenditure for the 2021 financial year (Item 15.1(g));
- details of any unilateral variations made to existing franchise agreements in the last three financial years (Item 17); and
- details of whether, in the last three financial years, you have considered any significant capital expenditure undertaken by franchisees in deciding what arrangements will apply at the end of a franchise agreement (Item 18.2).
MST Lawyers’ Role in Your Update
MST Lawyers can assist in the annual update of your Disclosure Document.
We will conduct trademark searches and company searches of the franchisor and its related entities to ensure all trademark information and information about the franchisor and its associates and officers in the Disclosure Document is correct.
Further, there are a number of sections of the Disclosure Document involve legal rather than factual updates. Given that franchise networks evolve and change over time, we recommend you review the Disclosure Document. If your policies and practices have changed we recommend that you have us amend your Disclosure Document and check your Franchise Agreement to determine whether any changes are required to the Franchise Agreement. The key areas of the Franchise Agreement to consider are:
- Items 9 and 13 (franchise sites or territories);
- Item 10 (supply of goods and services to franchisees) including details of rebates and/or financial benefits received from suppliers of goods and services to franchisees Item;
- Item 11 (franchisee’s supply of goods or services);
- Item 12 (supply of goods or services – online sales);
- Item 14.10 (significant capital expenditure);
- Item 16 (financing);
- Item 18 (arrangements to apply at the end of the franchise agreement).
- Item 20 (disclosure of any earnings information provided to franchisees). If earnings information is provided it must be included in the Disclosure Document or an attachment to it. If you provide earnings information or intend to do Item 20 will need to be amended. It is critical to have a lawyer assist you with the completion of this section and draft appropriate qualifications and disclaimers. This is an area that can expose franchisors to claims (by franchisees) of misleading or deceptive conduct and misrepresentation and it is important that it be accurate and correct.
Key Facts Sheet
The 2021 Code changes also introduced a new document, the Key Facts Sheet, which must be provided to prospective franchisees along with the other franchise documents required by the Code. The Key Facts Sheet highlights key information that is already disclosed in the Disclosure Document and must also be updated annually in line with the Disclosure Document, that is within 4 months of the end of each financial year.
The requirement to provide a Key Facts Sheet is also a civil penalty provision such that non-compliance may attract a penalty. So, it is equally important that the Key Facts Sheet is maintained in line with the Disclosure Document.
The timing requirements that apply to the Disclosure Document apply to the provision of the Key Facts Sheet to prospective franchisees and franchisees.
Franchisors need to include in their Disclosure Document a solvency statement signed by at least one franchisor director and the franchisor’s financial reports for the last two financial years, or an independent audit report prepared by a registered company auditor in respect to the 2022 financial year. The audit report must be completed within 4 months of the end of the franchisor’s financial year.
As stated above, if the franchisor operates a marketing fund or other co-operative fund, a statement that shows each fund’s receipts and expenses for the 2022 financial year must be prepared before 31 October. Such statement must be provided to each franchisee within 30 days of its preparation. Further, the Franchisor must have the statement audited before 31 October, unless 75% of the Australian franchisees who contribute to the fund vote to agree that an audit is not required. Please note that the vote must occur by 30 September 2022 and by virtue of the Code, the vote is required to be conducted annually. The audit report must also be provided to franchisees within 30 days of receipt.
More Than an Annual Update
Franchisors should treat the formal requirement in the Code that their Disclosure Document be updated annually within four months of the end of their financial year as an absolute minimum requirement.
Before a Disclosure Document is handed out to a prospective franchisee, franchisors should review the Disclosure Document to ensure that it is still up to date and does not give a franchisee a false impression about the franchisor or the system. For example, a Disclosure Document created on 31 October 2022 might say that there have been no franchise terminations in the past three financial years, but in the period after 31 October 2022 and before the next update is required to be completed on 31 October 2022 a large number of franchisees may have been terminated. Although it might be factually correct that there were no franchise terminations in the past three financial years, the failure to disclose a high percentage of franchisees exiting the network after 31 October 2022 would give a prospective franchisee the wrong impression and be potentially misleading and deceptive, exposing the franchisor to claims by the franchisee. It is, therefore, critical that franchisors regularly check the contents of their Disclosure Document.
The COVID-19 pandemic continues to impact many franchise networks and may necessitate additional disclosure. Supply chain issues and costs may impact the information contained in the Disclosure Document, in particular, Item 14 (costs). Franchisors should consider whether additional information should be disclosed in their Disclosure Documents.