The new look of franchising revealed

In brief

Just over six months after the release of the Exposure Draft for the new Franchising Code of Conduct, the new-look Code has been finalised and enacted. Partners Tim Golder and Andrew Wiseman and Lawyer Julia Kovarsky report on the practical implications for franchisors.

Application of the New Code

Apart from several provisions which are expressly excluded or have transitional arrangements, the New Code will apply from 1 January 2015 to all conduct (acts or omissions) of franchisors and franchisees who entered a franchising agreement on or after 1 October 1998.¹ However, parties will be allowed to discharge any outstanding obligations which arose under the Old Code. For franchise agreements entered into between 1 March 2008 and 1 January 2015, provisions relating to jurisdiction for settling disputes, costs of settling disputes and the effect of restraint of trade clauses will not apply. Agreements entered into prior to 1 March 2008 are also permitted to include a waiver by the franchisee of any verbal or written representations made by the franchisor.² A key factor to keep in mind is that these exceptions cease to operate if the franchise agreement is varied in any way (materially or immaterially) or transferred on or after 1 January 2015.³ For example, an extension of the term of a franchise agreement made on or after 1 January 2015 will mean the New Code applies in full to that agreement.⁴

Changes which were expected

Our Focus article (Focus: It's crunch time! Changes to the Franchising Code are nigh!) gave an overview of the proposed changes as indicated in the Exposure Draft of the New Code, released by the Federal Government in April 2014. These anticipated reforms have now mostly been carried through to the New Code.

As foreshadowed, the New Code contains a raft of civil pecuniary penalty provisions, so that breaches will attract penalties of up to $51,000. ⁵ Infringement notices of up to $8500 can be also issued by the ACCC as an alternative to the civil penalty.⁶ Of particular note is the fact that most provisions relating to disclosure will now incur civil pecuniary penalties if breached, meaning careful compliance with disclosure obligations by franchisors will be required.

The express obligation to act in good faith forms part of the New Code.⁷ Parties to a franchise agreement are required to act in accordance with the obligation of good faith in respect of any matters arising under or in relation to the franchise agreement and the New Code. Unlike the Exposure Draft, the New Code does not expressly define 'acting in good faith', leaving it to the unwritten law. However, 'whether the party acted honestly and not arbitrarily', and 'whether the party cooperated to achieve the purposes of the agreement' remain factors a court may take into account. The Explanatory Statement makes clear that the obligation is intended to 'provide a flexible mechanism for addressing opportunistic and unfair conduct in franchising' which does not have to meet the high threshold of misleading or deceptive conduct, or unconscionable conduct.⁸

The disclosure obligations imposed on franchisors by the New Code are as expected. Disclosure documents, which only need to be updated from 31 October 2015,⁹ will follow a new format. Simplifying the process of creating a disclosure document, only items relevant to the particular franchise have to be included in the body of the document and there is no need to cross-reference sections of the agreement.¹⁰ Master franchisors have been relieved of the need to provide disclosure documents to sub-franchisees.¹¹ However, new categories of disclosure, particularly whether online sales by the franchisor or franchisee will be permitted, have been included.¹² Franchisors must provide a generic information statement. This is in standard form and explains the risks and rewards of franchising.¹³ An information statement does not need to be provided to every person inquiring about the franchised business, but the obligation is triggered once a formal application or expression of interest is received.¹⁴

Marketing funds and capital expenditure

Contributions to marketing and advertising funds must now be kept in a separate bank account by the franchisor (although not a trust account, as contemplated in the Exposure Draft).¹⁵ When franchisees are required to pay money into a marketing or cooperative fund, the franchisor still has the obligation to prepare detailed annual financial statements relating to the fund within four months after the end of the financial year unless 75 per cent of the franchisees vote otherwise.¹⁶ Franchisors are required to contribute to the marketing or advertising fund on the same basis as any other franchisee if they themselves operate a franchised business.¹⁷ Restrictions are also in place which limit the ability of franchisors to require significant capital expenditure by franchisees during the term of the franchise agreement.¹⁸

Keeping disclosure current

Disclosure documents existing as at 1 January 2015 do not have to be updated until 31 October 2015, for those franchisors whose financial years end on 30 June. However, all future disclosure documents will need to be updated within four months after the end of each financial year.¹⁹ Helpfully for non-Australian franchisors, local franchisors or master franchisees, or those tied to overseas financial years, the definition of 'financial year' is no longer limited to the 1 July to 30 June year. A financial year is any 12-month cycle on which the franchisor operates.²⁰ Another useful amendment is that less active franchisors do not need to update their disclosure documents if new franchising activity is minimal, unless an update is requested by the franchisee.²¹ Where financial details of the franchisor become available before the franchise agreement is entered into, but were not available at the time the disclosure document was prepared, the franchisor does not have to amend the disclosure document but has to provide the financial details to prospective franchisees as soon as practicable before entering the agreement.²² Copies of leases, as well as details of any incentive that the franchisor or an associate can receive as a result of the lease, will need to be provided to franchisees within one month of entering the lease or agreement to lease.²³ Any other agreements which the franchisee will be required to execute will also need to be provided to them at least 14 days before they are entered into, or when they become available.²⁴

Record keeping obligations to enable audits

As well as the disclosure requirements, record keeping obligations are imposed on franchisors by the New Code. A written record of any document that is required to be given to a franchisee or prospective franchisee must be kept by the franchisor.²⁵ The records must be kept for at least six years, but documents provided electronically can be kept in electronic form or hard copy.²⁶ These record keeping obligations are designed to enable the ACCC to conduct its auditing and enforcement functions.²⁷

Dispute resolution

Amendments of note in the New Code relate to dispute resolution. Although agreements entered into before 1 January 2015 are exempt, new or extended agreements cannot contain a clause that requires proceedings or mediation to resolve a dispute to be brought in a state or territory outside of where the franchised business is based, or outside Australia.²⁸ The costs to a franchisor of settling a dispute cannot be required to be paid by a franchisee.²⁹ Part 4 of the New Code sets out two alternative complaint handling procedures. All franchise agreements must contain the minimum internal complaint handling procedure set out in the Code.³⁰ This requires written notification of the nature of the dispute and preferred outcome, following which the parties should try to agree about how to resolve the dispute within three weeks. If this attempt is unsuccessful, the dispute can be referred to a mediator for mediation, which the parties must attend. When a dispute arises, the parties can choose whether to proceed under the internal dispute resolution mechanism set out in the agreement, or under the New Code.³¹ The New Code sets out a complaint handling procedure consisting of notification and mediation, and prescribes how mediation may be terminated and the costs shared.

Restraint of trade

The New Code also imposes restrictions on the effectiveness of restraint of trade clauses in agreements entered into on or after 1 January 2015. This is not to say that restraint of trade clauses will not be permitted in franchising agreements, but that their effect is limited in certain circumstances. The New Code provides that a restraint of trade clause seeking to prevent a former franchisee from competing with the franchisor will have no effect if:

• the franchisee gave written notice to the franchisor seeking to extend the franchise agreement;
• the franchisee was not in breach of the franchise agreement;
• the franchisee did not infringe the franchisor's intellectual property rights or confidentiality regime;
• the franchisor does not extend the agreement; and
• either the agreement did not allow the franchisee to claim compensation for goodwill or the compensation given by the franchisor was merely nominal.³²

All of the above conditions must be met before the restraint of trade clause will be of no effect. The Explanatory Statement clarifies that this is not intended to affect the operation of restraint clauses which prevent a former franchisee approaching staff of the franchisor or using the franchisor's intellectual property.³³ Only those restraints seeking to limit competition from former franchisees will be caught by the provision.

Next steps

Considering the hefty civil pecuniary penalties that can be imposed for breaches of the New Code, franchisors should review and amend their systems, agreements and disclosure documents as necessary, in preparation for 1 January 2015 and 31 October 2015. While significant amendments to agreements will not be required, some changes may be needed. In particular, amendments will likely be required to provide for the mandated internal complaint handling procedures. There are no transitional arrangements or exceptions that apply to that part of the New Code. However, the New Code will apply with full force to franchise agreements amended after 1 January 2015, without the benefit of any carve outs. The limited relief from operation of the New Code may therefore be somewhat illusory.