Franchising Code of Conduct – Changes in the Wind
By Philip Colman and Raynia Theodore, Principals at Mason Sier Turnbull
The Report on the Review of the Franchising Code of Conduct (“the Code”) conducted by Mr Alan Wein was released on 17 May 2013 (“the Wein Report”).
The Wein Report makes 18 recommendations and it will be interesting to see if the Government accepts and implements all of the recommendations. Of course, the devil will be in the detail and we hope that such detail will be clearly drafted, unlike past attempts.
Most, but not all, of the recommendations are sensible in our view. For the time being, participants in the franchise sector need to be wary of these recommendations and may need to start planning in anticipation of them all being accepted via amendments to the Code and other associated legislation.
The recommendations and our comments are as follows:
- If, under clause 20A of the Code a franchisor gives notice of its intention to renew a franchise agreement, it must give its then current disclosure document to the franchisee. A franchisee should not be legally bound to proceed with a renewal following exercise of an option to renew unless it has received the franchisor’s disclosure document.
This is a sensible proposal. A renewing franchisee needs to know, at the time it is committing to a renewal, what is stated in the franchisor’s current disclosure document.
- Exempting foreign or master franchisors from providing an Annexure 1 Disclosure Document where they have granted a master franchise to a local master franchisee instead requiring them to provide a prescribed shorter form of disclosure document only dealing with those matters between the foreign or master franchisor and the local master franchisee that are relevant to the grant of a sub-franchise by the master franchisee to a sub-franchisee.
This is a sensible proposal in that it should ensure that local sub-franchisees are not burdened with irrelevant (and often confidential) information pertaining to the relationship between the local master franchisee and the foreign or master franchisor.
However, in our view, this does not go far enough. A foreign or master franchisor who issues a master franchise to an Australian master franchisee or who directly issues a unit franchise to an Australian unit franchisee will still need to provide that master franchisee or unit franchisee with an Annexure 1 Disclosure Document.
It will only be in circumstances where the unit franchise is granted by the Australian master franchisee that the limitation on disclosure by the foreign or master franchisor will be reduced.
- Requiring a franchisor to disclose:
(a) The rights of the franchisor and franchisee to conduct and benefit from online sales; andComment
(b) Whether the franchisor is permitted to conduct online sales.
Online sales by franchisors have often been seen as an encroachment on a franchisee’s territorial rights. Up front disclosure of the above is to be applauded so as to ensure that franchisees are aware of the potential impact of online sales on their businesses.
- Removal of the Annexure 2 short form disclosure document. Comment The Annexure 2 short form disclosure document was never used in practice and it makes sense that this option for franchisors selling small franchises is removed.
- Requiring franchisors to provide a short summary to prospective franchisees of the key risks and matters they should be aware of in going into franchising.
This is an excellent recommendation, given that it raises the franchisee education bar and will help ensure that prospective franchisees proceed with their eyes wide open, full well understanding such key risks. This requirement will not overcome the problem of the starry eyed prospective franchisee that chooses to block out anything negative about the decision to proceed.
Most reputable franchisors already provide such a risk statement or something akin to a risk statement.
Interestingly, it is recommended that such a risk statement be standalone and be provided to franchisees at their first point of contact with a franchisor. The FCA has prepared a draft risk statement to give effect to this recommendation.
- Granting to franchisors and franchisees the right to terminate the franchise agreement if:
(a) The other party goes into administration; andComment
(b) The administrator does not turn the business around or find a buyer for the business within a reasonable time (60 days suggested).
We do not agree with this recommendation.
The underlying purpose of this recommendation is to give franchisees a right of exit if an administrator of the franchisor is tardy in ensuring the ongoing life of the franchise network. This seems to fly in the face of Part 5.3 of the Corporations Act 2001 (Cth) which allows administrators to continue to conduct the business of a company under administration if it is in the best interests of creditors. The effect of this recommendation, if it is accepted, is that administrators may be forced to make decisions regarding the disposition of the franchise network that may not be in the best interest of creditors.
The FCA does not support this recommendation and considers that it needs adjustment.
Of course, this recommendation, if accepted, will also cover franchisees that go into administration. However, in reality, most franchise agreements will already give a franchisor a right of immediate termination if a franchisee becomes bankrupt, insolvent under administration or an externally-administered body corporate.
- Allowing the proportion of a franchise fee paid by a franchisee to a franchisor which has gone into external administration (voluntary administration, receivership or liquidation) that is referable to the unexpired portion of the term of the franchise agreement, to be proved as an unsecured debt in the external administration.
This will fly in the face of provisions in franchise agreements that provide that the franchise fee is fully earned upon the grant of the franchise. It assumes that a franchise fee is earned as the term of the franchise progresses.
The reality is that it is very rare for the unsecured creditors of a company that has gone into external administration to receive any dividend out of the external administration.
We, therefore, wonder whether this recommendation has any serious merit.
The FCA does not support this recommendation.
- Prohibiting franchisors from imposing upon franchisees “unreasonable significant unforeseen capital expenditure”.
The Wein Report suggests that the terms “unreasonable” and “significant” will need to be defined with a view to a franchisor being able to demonstrate a business case for the capital investment in the franchised business.
From a franchisee’s perspective, such a prohibition makes a lot of sense. It is important that franchisees are made aware of significant capital expenditure they may need to undertake during the term of the franchise agreement.
We expect that franchisors will now be more diligent in being up front with franchisees as to the types of capital expenditure they may need to incur during the term of a franchise agreement. Things that, in the past, might have been seen as unforeseeable will now be considered by franchisors as foreseeable – expenditures such as equipment upgrades and replacement and store refurbishments.
The FCA has queried the necessity of this recommendation noting that it is critical that franchisors remain able to continuously improve the franchise system and introduce new technology.
- The marketing fund provisions be amended to provide:
(a) That a franchisor should account separately for marketing and advertising costs.Comment
This will not entail a separate bank account, but just a separate ledger.
(b) Franchisee contributions should be held on trust for franchisees generally, but with the franchisor having a wide discretion as to how to expend the funds provided such expenditure is on items referred to in the disclosure document and which are legitimate marketing and advertising expenses.
The holding of contributions on trust for franchisees generally will mean that if the franchisor goes into liquidation, any money in the marketing fund will not be available for the winding up. There will need to be some clarity as to the entitlement of current and former contributing franchisees at this point in time.
The provisions should also make it clear that, notwithstanding the holding of contributions on trust for franchisees generally, an exiting franchisee will have no right to any proportion of the marketing fund – otherwise there will be mayhem every time this occurs by way of franchise business sale or termination.
The FCA has questioned the introduction of the formalised trust concept, noting it may have undesirable taxation and other consequences. We agree with the FCA’s view.
(c) Company owned units contribute to the marketing fund on the same basis as franchised units.
This is a very fair approach and a good recommendation.
(d) That there by no ability for franchisees to vote against the audit of marketing funds over a certain threshold value.
We do not believe this is a good idea. If franchisees democratically vote against the need to audit a marketing fund, there seems to be no valid reason why a franchisor should be compelled to conduct an audit just because the fund meets the threshold value.
(e) The results of any audit and other detailed information about marketing fund expenditure be made available to franchisees annually.
Such a provision already exists in clause 17(1) of the Code and hence any further amendment is unnecessary.
- The Code requires that:
(a) There be an obligation to act in good faith in relation to all matters pertaining to the franchise relationship, including pre-agreement negotiations, performance of the agreement, performance of Code obligations and all disputes (whether or not there is a valid franchise agreement at the time of the dispute);Comment
(b) The obligation to act in good faith apply to franchisors, franchisees, prospective franchisees and their agents;
(c) The concept of good faith is to be determined not by any Code definition but by case law;
(d) Parties are not able to contract out or limit such good faith obligations;
(e) Obligations of good faith should not prohibit a party from acting in its legitimate commercial interests; and
(f) A failure to include a right of renewal in a franchise agreement will not constitute bad faith.
We support this recommendation. Stay tuned for a further article which will deal with what might constitute a breach of such a good faith obligation.
- The Code be amended to effectively require franchisors to disclose whether an exiting franchisee who has agreed that its contact details not be included in the Disclosure Document, initiated that this occur.
Presently, if a franchisee in relation to which certain key events have occurred (such as termination or transfer) has agreed that his, her or its details not be disclosed in the franchisor’s Disclosure Document, the franchisor is not obliged to make disclosure of the franchisee’s contact details.
The proposed amendment would only allow non-disclosure to occur where the request for non-disclosure has been initiated by the affected franchisee.
This will cut out the practice of franchisors demanding that franchisees agree to non-disclosure of their details as part of an agreement regarding transfer or termination or as part of a dispute settlement agreement.
Given that the underlying purpose of disclosure is to enable franchisees to make an informed assessment of the franchise offering, we believe that this proposed change is a very good idea.
However, we note most reputable franchisors allow franchisees to elect whether or not they would like their personal contact details disclosed in future disclosure documents.
- The deeming of consent by a franchisor to a franchisee transferring a franchise not occur until the latter of 42 days from the written request for consent to transfer or the time at which all information required by the franchisor under the franchise agreement has been provided.
Presently, consent is deemed to be given to a transfer 42 days after the written request for consent by a franchisee, if the franchisor does not respond to the request. This change will effectively impose an obligation on the transferring franchisee to provide to the franchisor all information required by the franchisor under the franchise agreement to enable the franchisor to assess the request for transfer.
This is a good recommendation and is supported by us.
- Post termination restraints or non-competition clauses be unenforceable in circumstances where a franchisor chooses not to renew a franchise agreement (presumably where it has the right to do so) and:
(a) The franchisee had a wish to have the franchise agreement renewed on substantially the same terms;Comment
(b) The franchisee was not in breach of the franchise agreement;
(c) The franchise agreement does not contain provisions allowing for compensation to be paid to the franchisee if the franchise is not renewed;
(d) The franchisee abides by confidentiality obligations;
(e) The franchisee does not infringe the intellectual property of the franchisor.
This seems to be the compromise for the Wein Report not recommending that compensation be paid to franchisees on the expiry of the franchise agreement.
We do not support this recommendation, nor did we support the proposition that compensation be paid to franchisees on the expiry of the franchise agreement. This recommendation flies in the face of the parties’ freedom to contract. Further, adequate legal protections already exist in relation to post termination restraints or non-competition clauses.
The FCA has stated it prefers no change in this area.
- The Code be amended to ensure that the dispute resolution behavioural rules in clause 29(8) apply to any dispute resolution process.
In summary those rules require disputants to act in a reconciliatory manner and not do things that may have the effect of damaging the franchise system. Having recently been involved in mediation conducted outside the Code mediation regime where the franchisee acted in a way that would otherwise have been in breach of the dispute resolution behavioural rules in clause 29(8), we made strong submissions in support of this amendment, which have been accepted.
- Prohibiting franchisors from attributing its dispute resolution costs to the franchisee unless a Court so orders. Comment This is an excellent idea and is consistent with standard practice even in relation to Court ordered mediations.
- Prohibiting franchisees from litigating outside the jurisdiction in which the franchisee’s business primarily operates.
We do not support this recommendation. If adopted it would require a Perth based franchisor who wants to sue a franchisee operating in Victoria, to sue in the Victorian Courts. This will create unfairness for the franchisor. There are already forum and cross-vesting laws in existence that enable Courts to move the venue of litigation elsewhere in appropriate cases and there seems to be no basis upon which franchisees require additional protection.
- The Competition and Consumer Act 2001 (Cth) be amended to allow for:
(a) Penalties of up to $50,000 for Code breaches;
(b) The ACCC to issue infringement notices for Code breaches (similar to “on the spot” fines);
(c) The ACCC to conduct a wider audit of a franchisor’s compliance with the Code than is presently allowed;
(d) Courts to make orders in the event of a Code breach:
(i) Disqualifying a person from managing a corporation;
(ii) Giving a franchisee royalty relief for specified period;
(iii) Requiring franchisors to pay money into the marketing fund.
One of the fundamental problems with the Code since it was introduced in 1998 was that it had little teeth. The introduction of penalties improves this situation, but it will still require the willingness of the ACCC or a funded litigant to bring a person who as breached the Code to Court.
The introduction of infringement notices for breaches of the Code is a good thing. The ACCC will need to act in accordance with law in issuing such notices but it will always be open to recipients to challenge them in Court.
The wider audit powers are also a good thing – this should ensure that franchisors are more compliance conscious.
Finally, the franchise specific remedies in point (d) above are also a good recommendation.
- It is recommended that the Code be amended to make the policy intent of its provisions clearer, remove ambiguities and improve certainty of industry practice.
This is long overdue. We hope that the Government enlists the aid of senior and experienced franchise lawyers in this process.
In conclusion, we are a little disappointed that a number of the recommendations appear to be outside the terms of reference of the review. The submission lodged by us and no doubt many other submitting parties was limited to the terms of reference and therefore, the submissions did not address some of the issues detailed above.
With a Federal election due in September 2013, it is uncertain whether the Government will consider and make decisions on the Wein Report beforehand. Whatever decisions are made by Government it is critical, in our view, that this opportunity be used to substantially tidy up the drafting of the Code so as to give greater certainty for participants in the sector and allow us to provide advice in a more confident manner.
For further information on the Franchising Code of Conduct, please contact Philip Colman, Principal in our Dispute Resolution and Litigation team or Raynia Theodore, Principal in our Franchising team on (03) 8540 0200.