Government Releases Exposure Draft of “New” Franchising Code
By Philip Colman and Raynia Theodore, Principals, MST Lawyers
In a surprising move, the Government, on 2 April 2014, issued an Exposure Draft of a proposed new Franchising Code of Conduct, that is due to commence on 1 January 2015.
Although many of the existing provisions remain, the clause numbering has changed. In our view, the drafting of some of the new provisions will create greater ambiguity and uncertainty than before.
Regrettably the Exposure Draft does not appear to be consistent with Minister Bruce Billson’s accompanying paper entitled “The Future of Franchising“, nor does it seem to take up the extensive industry input over the past 6 months. Further, rather than achieving the intent to cut red tape and reduce compliance costs, our view is that the opposite may be achieved.
We hope that further consultation over the balance of this month will see an end product that achieves the Government’s stated intent and does not contain the multitude of drafting flaws and ambiguities that exist in the Exposure Draft.
Problems with Application of Code and Commencement Date
The Exposure Draft provides that the Code will apply to franchise agreements entered into or renewed on or after 1 January 2015.
That means there will be two Codes operating, with the existing Code governing franchise agreements entered into before 1 January 2015.
We are not sure if the Government really intended this.
Further, a start date of 1 January 2015 creates problems for franchisors. By 31 October 2014 all franchisors will need to update their Disclosure Documents, which must be in accordance with the current Code. Then, by 1 January 2015, they will need to create a new Disclosure Document that complies with the new Code.
Again, we are not sure if the Government really intended this.
It would make far more sense if the new Code covered all franchise relationships in existence from a specified date. That specified date should be one that avoids the need for franchisors to create 2 Disclosure Documents as outlined above.
Below is a commentary as to some of the changes contemplated in the Exposure Draft.
We support legislation requiring participants in the franchising sector to act in good faith towards each other. The body of case law that has developed enables us to advise our client what good or bad faith entails, yet the Exposure Draft seems to create new and untested notions of good faith, which will only create uncertainty for participants in the sector.
Sensibly, the Franchise Council of Australia (“FCA”) recommended that good faith, as it is defined by case law, become an implied term in all franchise agreements. Instead, the Government has determined that a statutory duty should exist and that a person in breach be liable to a civil penalty of 300 penalty units (currently $51,000).
In one sense we have no qualms with this – our issue is more with the effective creation of a new type of good faith, one that requires parties “to act honestly and not arbitrarily [and] to cooperate to achieve the purposes of the franchise agreement”. This is somewhat different to the common law test. Acting honestly is critical in all forms of life, but sometimes people are innocently dishonest, often because their recollections are not clear. For this reason we would hope that the Government would require some sort of wilful dishonesty before an allegation of bad faith could be sustained.
Post termination restraints
The Exposure Draft contains a provision that post termination restraint provisions will not be enforceable if a franchisee unsuccessfully seeks a new franchise agreement at the end of the term in circumstances where the franchisee was not entitled to more than nominal compensation for the refusal to grant the new term. To qualify for this benefit, the franchisee must have been compliant at the time the new agreement was sought and not have infringed relevant intellectual property during the term of the franchise agreement.
This is a huge interference on the freedom to contract, but it seems that the Government will not be moved on this point.
The Exposure Draft provides that franchisors are required to disclose to franchisees details of any incentive or financial benefit that the franchisor or an associate of the franchisor is entitled to receive under or in relation to a lease of premises.
In circumstances where franchisors pass on these incentives to franchisees, this will not create an issue, but in circumstances where franchisors keep the lease incentive, the requirement to disclose may create animosity from the franchisee. Such disclosure must take place within 1 month after the lease is signed.
The Exposure Draft contains a provision requiring franchisors to maintain a separate bank account for marketing fees and advertising expenses. This is an example of where the Exposure Draft runs contrary to the Government’s stated intention to reduce red tape and compliance costs.
The Exposure Draft has introduced a requirement for franchisors to give prospective franchisees a copy of an ‘Information Statement’ (annexed to the Code) as soon as practicable after it becomes apparent to the franchisor that a franchise agreement will be entered into by the prospective franchisee.
This is a good idea. Our disputes lawyers see so many franchisees who have entered into franchise agreements totally oblivious to the risks of running a franchised business. Of course, there is little that can be done if people do not read the warnings given to them before they enter into a franchise agreement
Significant Capital Expenditure
The Exposure Draft prohibits franchisors from imposing significant capital expenditure without first demonstrating a business case for capital investment in the franchised business.
The Information Statement warns franchisees that expenses not contemplated at the beginning of the term of the franchise agreement, such as those required as a result of a natural disaster, may arise.
In one good move, consistent with our submission to the 2013 review of the Code, the Exposure Draft has alleviated the need for master franchisors to provide any form of disclosure to sub-franchisees. That responsibility will rest on the sub-franchisor (or master franchisee).
Perhaps one of the most significant changes to the Code is the introduction of penalties to be enforced by the Australian Competition and Consumer Commission (“the ACCC”). The Competition and Consumer Act 2010 (Cth) will be amended to give the ACCC the power to impose civil pecuniary penalties for breaches of the Code, as well as to issue infringement notices of up to $8,500. The draft Code sets out the various civil penalties that are to apply for failure to comply with the different provisions of the Code.
For example, failure by a franchisor to provide a franchisee with a copy of the Code, disclosure document and franchise agreement at least 14 days before the franchisee enters into the franchise agreement will attract a civil penalty of 300 penalty units (currently equivalent to $51,000).
Whilst introducing a penalty regime will give the Code some teeth and create a deterrent, there seems to be no distinction in the quantum of the maximum penalties between Code breaches that would be serious and those that would be merely trivial.
What should you do?
Whilst stakeholders are invited to comment on the draft Code, the Government has stated that comments are only sought on the technical aspects of implementing the law, and not on the policy underpinning these reforms.
Given the proposed lead time and the likelihood of further changes we recommend to our franchisor clients that they refrain from making any changes to their franchise agreements or disclosure documents at this stage.
For further information regarding the Exposure Draft of the proposed new Franchising Code of Conduct, contact our experienced Franchising team on Ph: +61 3 8540 0200 or email the authors of this article, Philip Colman and Raynia Theodore.