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Proposed ‘Plain English’ disclosure requirements for franchisors

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On 3 March 2010 the Minister for Small Business Dr Craig Emerson released the much anticipated report by a panel of trade practices experts commissioned to look into the franchising sector.

The panel was asked to consider the following:

  • Whether the unconscionable conduct provisions in the Trade Practices Act 1974 (Cth) (“the Act'”) should be amended to include a list of examples of conduct that would constitute unconscionable conduct or whether a statement of principles concerning unconscionable conduct should be introduced into the Act.
  • Whether the Franchising Code of Conduct (“the Code”) should be amended to include a list of examples of specific behaviours inappropriate in franchising arrangements, with particular reference to five matters, being:
    • unilateral contract variation;
    • unforeseen capital expenditure;
    • franchisor initiated changes to franchise agreements when a franchisee is trying to sell its business;
    • attribution of legal costs; and
    • confidentiality agreements.

In relation to unconscionable conduct, the panel found that a list of examples would not improve the understanding or implementation of unconscionable conduct provisions in the Act. However, the development of interpretative principles would assist:

  • the courts in interpreting the provisions,
  • regulators in enforcing the provisions; and
  • the franchising sector in understanding the provisions.

Whilst principles can already be distilled from decided cases, the panel recommended that regulators pursue additional test cases in diverse industries to further develop principles and the law in this area.

In relation to amendments to the Code, the panel recommended against the five behaviours detailed above becoming legislated examples of unconscionable conduct.

In summary the panel found as follows:

  • There are legitimate commercial reasons for unilateral contract variations in franchising (e.g. changes to operations manuals). The panel recommended improved disclosure of the circumstances in which unilateral variations can be made and disclosure of the circumstances in which such unilateral variations have been made by the franchisor in the preceding three financial years.
  • There is no need for a prohibition on unforeseen capital expenditure. Again the panel favoured disclosure of whether a significant capital expenditure would be a factor to be considered in deciding whether or not to renew the franchise and disclosure of instances where it has been used as a factor in the past.
  • There may be legitimate commercial reasons for a franchisor to amend its franchise agreements where the franchisee is seeking to sell its business. Rather than a prohibition on changes to the franchise agreement in such circumstances the panel recommended upfront disclosure of the prospect of changes to the franchise agreement where the franchisee is seeking to sell its franchise.
  • Clauses attributing legal costs were common in many agreements and should not be prohibited; however, the panel favoured improved disclosure of the circumstances in which the franchisee will be liable for such costs.
  • Confidentiality agreements should not be prohibited; however, prospective franchisees should be better educated as to what information can be discussed with or disclosed to existing and former franchisees (e.g. outcomes of mediation, settlement agreements reached by the parties, trade secrets).

From the above summary, the main theme is the need for additional or improved disclosure to prospective franchisees. One of the concerns of the panel was that “franchisees remain unaware of the nature of the franchise relationship and the potential key costs, benefits and risks of the franchise business model in general.”

To address this issue the panel has recommended the development of a short simple “Plain English” document to be provided to prospective franchisees before they are “psychologically, financially and legally committed to entering into a franchise agreement”.

The purpose of this “Plain English” document would be to facilitate a better understanding of the franchise agreement and the nature of the franchise relationship prior to the prospective franchisee committing to an agreement.

The document would be provided in addition to the Disclosure Document and would not be intended to relieve the prospective franchisee of the need to carry out its own due diligence. It would simply be a “ready reference” as to the nature of the franchise relationship.

Plain English guides exist in retail leasing with most retail legislation mandating the precise form of the guide to be issued to prospective tenants. However, these guides are produced by the industry regulators and not landlords. What is proposed by the panel is that franchisors develop their own document.

The precise details of what franchisors will be required to include in this document are not yet known, however, the report provides some guidance as to what will need to be included. The key details of the franchise relationship would need to be summarised, including the main costs, benefits and risks. There is also suggestion that a statement that ‘franchising is a business and that like any business the franchise (or franchisor) could fail during the franchise term’ may be incorporated in this document, to emphasise that a franchise is not a risk-free venture. The further disclosure of unforeseen capital expenditure and unilateral contract variations may also be contained within this document.

As the report stands, the panel does not believe it is necessary that the “Plain English” document be prescribed or mandated by legislation unless evidence emerges that franchisees remain unaware of their obligations and key risks. The panel suggests that the “industry” develop the “Plain English” document. This could mean that each franchisor develops its own document that is appropriate to its own circumstances, which may lead to inconsistency in the information that is disseminated to prospective franchisees and may make it difficult for prospective franchisees considering different franchise systems to make an accurate comparison of the systems.

Other recommendations made by the panel include:

  • More research by the government and the regulators into the five specified franchising behaviours and the nature and incidence of problems associated with these behaviours.
  • More research in relation to the interests of small business especially in respect of the effectiveness of the Act and the Code in protecting small business interests.
  • Consideration by all the governments in Australia as to whether there is a need for consistent and improved dispute resolution mechanisms for small business disputes.

If you would like further information or have any other franchising queries, please contact one our Franchise lawyers.

Authors: Raynia Theodore & Richard Lim