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Disclosure Document Update Season

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By Raynia Theodore, Principal, MST Lawyers

Franchisors, its that time of year again for you to review and update your Disclosure Document for the financial year ending 30 June 2020.

The Franchising Code of Conduct (the Code) requires franchisors to update their Disclosure Documents within four months of the end of their financial year.  For most franchisors, this will mean their Disclosure Documents must be updated by 31 October 2020.  Whilst the Australian Securities & Investments Commission (ASIC) has temporarily changed its regulatory work and priorities and the lodgement time frames for financial reports to allow it and regulated entities to focus on the impact of COVID-19, there is no relief or extensions of time for franchisors to comply with their Code obligations.

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).  This year alone we have seen the Bob Jane Corporation Pty Ltd give  the ACCC a court-enforceable undertaking to comply with its obligations under the Code in relation to the renewal and extension of franchise agreements.  On 3 July 2020, the ACCC also initiated proceedings against franchisor Megasave Couriers Australia Pty Ltd (Megasave) in the Federal Court of Australia alleging that Megasave conducted misleading and deceptive conduct in contravention of section 18 of the Australian Consumer Law (ACL), while also making false and misleading representations regarding its services pursuant to section 29(1)(g) of the ACL, and misleading representations about their business activities pursuant to section 37(2) of the ACL.

Under the Code, the ACCC has significant audit and investigative powers and can issue infringement notices which have recently increased to $11,100 for a corporation. Further, as from 1 July 2020 pecuniary penalties of up to $66,600 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 of 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 Disclosure Document and the Franchise Agreement in the form it is to be executed 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));
  • give an existing franchisee a copy of the Code, the Disclosure Document and the Franchise Agreement in the form it is to be executed at least 14 days before renewal or extension of the Franchise Agreement (clause 9(2));
  • 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(1));
  • 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 its preparation (clause 15(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).

Updates You Can Make

Because many of the changes required for the annual update will be factual, you can prepare much of the Disclosure Document update yourself, including updating 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 (2018, 2019 and 2020) (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 your intellectual property (Item 8);
  • payments (Item 14), including payments to third parties (Item 14.7).
  • marketing or other co-operative fund expenditure for the 2020 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).

You can make all these changes yourself. However, we do recommend that you ask us to check your changes against the Code requirements.

MST Lawyers’ Role in Your Update

MST Lawyers can assist you in the annual update of your Disclosure Document.

The following sections of the Disclosure Document involve legal rather than factual updates. Given that franchise networks evolve and change over time, we recommend you review these sections and advise whether they accurately reflect what occurs in your network:

  • Items 9 and 13 (franchise sites or territories);
  • Item 10 (supply of goods and services to franchisees);
  • Item 11 (franchisee’s supply of goods or services);
  • Item 12 (supply of goods or services – online sales);
  • Item 16 (financing);
  • Item 18 (arrangements to apply at the end of the franchise agreement).

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.

Importantly, if you provide earnings information or intend to do so, you need to update Item 20.  It is critical to have a lawyer assist you with the completion of this section, as it is an area that can expose franchisors to claims (by franchisees) of misleading or deceptive conduct and misrepresentation.

We will conduct trademark searches and company searches of the franchisor and its related entities to ensure all trademark information and information about the associates and officers of the franchisor in the Disclosure Document is correct.

Final Reminders

You need to include in your 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 2020 financial year.  The audit report must be completed within 4 months of the end of the franchisor’s financial year.

As stated above, if you operate a marketing fund or other co-operative fund you must also prepare a statement that shows each fund’s receipts and expenses for the 2020 financial year before 31 October. You must provide the statement to each of your franchisees within 30 days of its preparation. Further, you must have the statement audited before 31 October, unless 75% of your Australian franchisees who contribute to the fund vote to agree that an audit is not required. Please note that the vote must be held by 30 September 2020 and by virtue of the Code, the vote is required to be conducted annually. If your franchisees vote that the fund does not require an audit, there is no need to obtain an audit report this financial year.

More Than an Annual Update

Franchisors should treat the formal requirement in the Code that franchisors update their Disclosure Document 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, you should review it 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 2019 might say that there have been no franchise terminations in the past three financial years, but in the period after 31 October 2019 and before the next update is required to be completed on 31 October 2020 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 2019 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 may also impact this year’s annual update of the Disclosure Document.  The pandemic has caused many franchised businesses to reduce hours, close for periods of time and affected revenues of both franchisees and franchisors.  This may impact the information contained in the Disclosure Document, in particular, Items 6.4 (key events), Item 20 (earnings information) and Item 21 (the franchisor’s financial position and solvency).  Franchisors should include additional information in their Disclosure Document this year that addresses the impact of COVID-19 on their franchise network.

With the ACCC continuing to be so active in the sector it is vital that your Disclosure Document and internal processes comply with the Code. In particular, franchisors need to make sure that the annual update of the Disclosure Document is completed on time. It is equally important that information provided in the Disclosure Document is accurate and not misleading in any way.

If you have any queries about the above, please feel free to contact Raynia Theodore in our Franchising team by email franchise@mst.com.au or by telephone +61 3 8540 0200.